Microsoft's $3.04 billion in net profit on $13.37 billion in revenue last quarter met Wall Street's expectations, and the company had full-year revenue of more than $50 billion for the first time in its history.
Beyond the big numbers, however, some analysts were underwhelmed by the financial performance of the company's most important product: the new Windows Vista operating system.
"Vista appears to be disappointing," said Israel Hernandez, analyst with Lehman Brothers, noting that revenue growth for the Windows Client division was below his expectations and at the low end of Microsoft's previous guidance.
"I think it missed most Street expectations. ... One quarter after the biggest product cycle in the company's history, you'd think you'd see a little more upside," Hernandez said.
Sarah Friar, analyst with Goldman Sachs — which does investment-banking business with Microsoft, as does Lehman Brothers — repeated those sentiments in a note to investors after Microsoft reported its fiscal fourth-quarter results Thursday: "Client revenue of $3.8 billion (up 14 percent year-over-year) was slightly shy of our $3.9 billion estimate — somewhat surprising given recent data on PC growth."
Worldwide PC shipments in the three months ended June 30 grew at a faster-than-expected pace of 12.5 percent, according to market researcher IDC.
Microsoft's fourth-quarter profit was up 7.3 percent from the same period a year ago, but the results could have been better. The company took a one-time $749 million charge against its net profit — 8 cents a share — related to hardware problems and an associated warranty extension, announced July 5, on the company's Xbox 360 video-game console.
Earnings per share, accounting for the charge, were 31 cents, up from 28 cents last year. Not including the charge, earnings per share came in at 39 cents, matching the average estimate of analysts polled by Thomson Financial.
After-hours drop
Ahead of the earnings announcement, Microsoft stock gained 59 cents, or 1.9 percent, to close at a 52-week high of $31.51 in regular trading. Investors bid shares back down to $30.90 in the after-hours market.
Microsoft's core businesses performed well in the fourth quarter:
Server and Tools grew revenue 14.5 percent and had $1.05 billion in operating profit. The Microsoft Business Division, which produces its other major product, Office 2007, turned in revenue growth in the quarter of 18.6 percent and operating profit of nearly $3 billion.
The Online Services business, where Microsoft competes most directly with Google, saw advertising revenue in the quarter increase 33 percent to $544 million.
The business still lost $239 million, and Microsoft Chief Financial Officer Chris Liddell said that will continue to be the case.
"Realistically, next year is going to continue to be a year of investment, and that means losses," he said in an interview. "But directionally, getting the revenue momentum ... is obviously good news."
While Vista so far didn't dazzle, analysts saw reasons for optimism in other parts of Microsoft's report. Company management did, too, prompting them to increase guidance for the 2008 fiscal year, which began July 1.
"In '08, we are looking to deliver another year of double-digit revenue, operating income and earnings-per-share growth," Liddell said in a conference call Thursday.
The company said the money-losing Entertainment and Devices Division, responsible for the Xbox 360, could see revenue grow between 10 and 19 percent in fiscal 2008, the first year it is expected to show a profit.
Asked why the division may have such a wide variance, Liddell said it was, in part, a strategic move, given the highly competitive game-console business.
Speculation has swirled around whether Microsoft would lower the price of the Xbox 360.
"We have a pricing strategy for the next 12 to 24 months," Liddell said. "... 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."
In the longer term, businesses look to be preparing for broader adoption of Vista and the other major new products. The company said the renewal rate for multiyear corporate software-licensing agreements was above its historical high of 75 percent.
Companies essentially pay an annual fee to gain upgrade rights to any new software Microsoft produces, covered under a given enterprise agreement.
"It gives [Microsoft] plenty of visibility in terms of the demand for their products," said Sid Parakh, technology analyst at McAdams Wright Ragen in Seattle.
"It also reinforces their confidence in whatever new products are being built."
New products due in the coming year include an update to Windows Server and to the SQL Server business-database software.
The company is also at work on a service pack for Vista, though it has been mum on the precise timing of its release.
Liddell said that while overall business spending on IT appears relatively stable from Microsoft's perspective, the company is winning a "higher share of the wallet from some of our customers."
"We're seeing a really healthy and encouraging trend from just being a desktop-software provider to being much more of an infrastructure provider to enterprises," he said.
He credited Microsoft's internal sales force and its third-party partners — the system builders and business consultants that generate much of the company's sales — for the trend and for the high enterprise-agreement renewal rate.
Their efforts came at a cost. Operating expenses, excluding cost of revenues, increased 13 percent, driven by employment costs and sales support for partners.
Hiring slowdown
Liddell suggested Microsoft's employment growth will slow down in the coming year. The company had 76,539 employees globally as of February; about 46 percent work in the Puget Sound region.
Liddell said employment growth in the fiscal fourth quarter was about 10 percent, down from the "mid-teens" six to 12 months ago.
Bob Toomey, chief equity strategist at EK Riley Investments, said he doesn't expect that to have much impact on a Seattle-area economy that is "starting to simmer down."
"I still think 10 percent is healthy growth and I still see Microsoft as a growth engine for our economy, even though they're slowing their growth rate down a little bit," said Toomey, who owns Microsoft shares.
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