Microsoft Posts Hearty Earnings Despite Xbox Charge

Microsoft (Nasdaq: MSFT) managed to post a 7.3 percent increase in earnings for its fourth quarter, despite a mammoth US$750 million charge relating to fixes to its Xbox 360 product, as strong enterprise sales helped the company surpass the $50 billion revenue mark for the fiscal year.

The Redmond, Wash.-based company's fourth-quarter revenue was $13.37 billion, a 13 percent increase over the year before, and was boosted by the newly released Windows Vista and Office 2007.

For the full year, revenue was $51.12 billion, an increase of 15 percent.

Fixing Defects

Net income was $3 billion, or 31 cents a share, up from $2.8 billion in last year's fourth quarter. Without the Xbox charge -- which Microsoft took to write off warranty replacements and other costs associated with addressing what it called an "unacceptable" number of defects in the device -- earnings would have been up 26 percent year-over-year.

Surpassing the $50 billion revenue mark for the first time was "testament to the innovation and value that our product groups delivered into the marketplace," said Microsoft Chief Operating Officer Kevin Turner, In 2008, Microsoft will introduce a slew of new products, including a new version of the Windows Server product and a new CRM suite, driving growth, he added.

Despite the mostly upbeat report, Microsoft stock was off in a down market -- a sell-off fueled by rival Google's (Nasdaq: GOOG) earnings miss. By the close of business, Microsoft shares were off about 0.35 percent to $31.16.

View on Vista

The fact that Microsoft could absorb the Xbox write-off hit without pushing its bottom line into the red underscores the company's sheer size and profitability. The Xbox fiasco, however, is a reminder that Microsoft's consumer division remains a poor stepchild to the company's main business of providing software to enterprises and individuals.

Microsoft has designs on making the Xbox part of larger digital home strategy , one where its products serve as an intermediary between the Internet and home entertainment.

Though Microsoft said its results were lifted by Vista and Office 2007, the increase was relatively modest given the strong jump in PC sales reported by two research firms earlier in the week, Goldman Sachs analyst Sarah Friar said in a research note Friday.

Mixed Messages

Microsoft's Client Services group, which produces Windows, saw revenue rise 14 percent to $3.8 billion, while the Business division, which makes Office 2007, posted an 18 percent increase.

"In the enterprise, there is a mixed message on the (Vista) platform," Enderle Group Principal Analyst Rob Enderle told the E-Commerce Times. "Corporations do appear to be renewing their enterprise agreements, but Vista deployments remain very small. This suggests, that they do appear to be planning to deploy and may simply be waiting" for the first update to be released, he noted.

For now, Enderle added, "revenue is meeting expectations, deployments in enterprises are not, but trends look good."

Market Share Gains

Microsoft's online advertising revenue grew 33 percent; online services revenue was up 19 percent. Web advertising growth going forward will be around 20 percent, CFO Chris Liddell said in a research note. That growth may be a sign that Microsoft has found traction in the space where its previous efforts to compete with Google and Yahoo (Nasdaq: YHOO) have been mostly disappointing.

In fact, data released earlier this week showed Microsoft making market share gains in the search space, with comScore saying that new efforts to drive usage of MSN Live Search had paid dividends for Microsoft.

The unit remains a money loser for Microsoft, however, and Liddell said that may be the case again in 2008, as the unit remains an investment focus.

"They are advancing, though slowly, in online search," Enderle said. Microsoft has said it would take five years for it to get to where it wants to be in the space, and Google's position of market dominance doesn't seem to be at risk. "When you compare Google and Microsoft numbers you see Microsoft strengthening and Google weakening but overall Google remains in a very strong leadership position," he added.

Xbox 360 Price Cut Coming?

Next year may see Microsoft's entertainment division, which makes the Xbox, produce its first profit, with the unit posting 10 to 19 percent revenue growth as well, Liddell said.

That range may suggest Microsoft wants to give itself pricing flexibility, fueling speculation that it will cut the price of the Xbox 360 later this year, such as during the holiday season, InStat analyst Brian O'Rourke told the E-Commerce Times.

Sony's (NYSE: SNE) recent decision to cut the price of the PlayStation 3 may lend credence to that theory, he added, though Microsoft is mindful of denting its bottom line in a division that is close to climbing out of the red for the first time.

"Every company struggles with pricing, and Nintendo has only upped the ante with the Wii" -- which has a lower price tag and is outselling both the Xbox and PlayStation 3 -- O'Rourke noted. "It will be what everyone's watching for later this year," he said.

Keeping Quiet

Liddell was coy when asked in the conference call about Xbox pricing, saying only that Microsoft has a strategy in place for the next two years. "At this stage, we're keeping relatively quiet about that because from a competitive point of view we really don't want to signal anything," he added.

Microsoft projected first-quarter revenue will be between $12.4 billion and $12.6 billion with earnings of 38 to 40 cents per share.

The software giant said it returned $31 billion to shareholders during the fiscal year through a combination of dividends and an aggressive stock buyback program.