Why the Dip in Office Revenues?

Microsoft's most recent quarterly financial report showed a stumble in the lucrative Office suite's otherwise steady march toward ever-larger revenues. Revenues for the Information Worker unit fell 3 percent compared to the year-ago quarter. On the other hand, profits from the unit shot up 11 percent.

The health of Microsoft's Information Worker unit, which contains the Office suite, is vital to the company. Three business segments -- Information Worker, Client, and Server & Tools -- regularly account for more than three-quarters of the company's revenues and nearly all of the company's profits.

The Information Worker revenue drop was the only notable blemish in a financial quarter that had financial analysts describing Microsoft as hitting on all cylinders. Even for this flawed quarter, the Office numbers are awe-inspiring. In the three months leading up to Dec. 31, 2004, Microsoft's Information Worker unit pulled down $2.777 billion in revenues, with a whopping $2.026 billion of that in profits.

Microsoft management's discussion of the results in its 10Q filing with the Securities & Exchange Commission last week contains one major explanation for the shortfall -- the comparison quarter included the launch of Office 2003, which provided an obvious boost to sales.

"Information Worker revenue decreased in the second quarter primarily due to the favorable impact of the launch of Office 2003 in the comparable period of the prior year," Microsoft states. For the comparable 2003 quarter (Microsoft's second quarter of its fiscal 2004) Microsoft counted $137 million in Office XP revenues it had actually sold in the previous quarter. Those revenues were booked with the understanding that customers would be eligible for a free upgrade to Office 2003 when it shipped in a few months. The decision padded Q2 2004 revenues, making comparisons for Q2 2005 tougher still.

What's remarkable about the quarter, though, is that it's the first time since Microsoft began publicly providing revenue figures for Information Worker (and other business segments) in October 2002 that the Information Worker unit hasn't beaten the revenues for the comparable quarter in the previous year.

Going back a little further, Microsoft managed to keep growing revenues after the previous Office launch -- Office XP in May 2001. A year later, Microsoft's fourth quarter of fiscal 2002, the company reported in its earnings release that "desktop applications revenue also grew on the strength of continuing demand for Office by enterprise customers." Elsewhere in that earnings release, Microsoft attributed the "slight increase" in Office revenues partly to multi-year licensing agreements and OEM licensing. In other words, getting the increase in sales a year after the launch was tough sledding, but the company managed it.

This time, Microsoft reported, "We experienced a decline of 4 percent or $104 million in retail and commercial licensing." Revenues from the customers who grabbed two-year Upgrade Advantage deals to delay Licensing 6.0 are disappearing. Upgrade Advantage revenues declined by $175 million compared to the year-ago quarter.

There were a few bright spots in the most recent quarter: Microsoft managed to translate the weak dollar into a $99 million revenue gain and revenue from OEM pre-installed copies of Office through the system builder channel increased by 5 percent or $18 million.

The huge boost in profits from $1.830 billion to $2.026 billion has several causes, according to the 10Q filing. The biggest is the company-wide decrease in stock-based compensation expenses. Marketing costs for the massive Office 2003 launch also weren't a consideration this quarter.

Analyst Matt Rosoff with Directions on Microsoft in Kirkland, Wash., is receptive to Microsoft's explanation of the Information Worker revenue slowdown. "I think that's just basically because there was a big spike last year with the launch of Office 2003. You also had a little bit of that unearned revenue [Upgrade Advantage] that was being carried forward. They're back to the more normal components of unearned revenue," Rosoff said.

According to Rosoff, Microsoft does face a challenge in encouraging sales of Office between now and the expected 2006 launch of the next version, code-named "Office 12." "Everybody who wants to be on Office 2003 is on Office 2003, and Microsoft hasn't said that much about Office 12," Rosoff said.

Microsoft expresses some hope that the heavy server and services integration of the Office System 2003 will lead to a longer sales cycle by giving enterprises more to evaluate. In addition to several Office suites, the Office System includes Microsoft SharePoint Portal Server, Microsoft LiveMeeting, Microsoft Project and other servers and services.

In the 10Q, Microsoft sets low expectations for Information Worker in its Q3. "We expect continued reduction in Upgrade Advantage earned revenue to be partially offset by sustained momentum in our OEM and multi-year licensing offerings and increased purchasing of Office System 2003 as enterprises complete their product evaluations," the company wrote.

About the Author

Scott Bekker is editor in chief of Redmond Channel Partner magazine.