Microsoft trims profit outlook

Microsoft's commitment to winning a bigger chunk of online services and advertising business was underscored Thursday when the company slightly lowered its profit forecast for the current fiscal year to reflect planned spending increases.

"We do not make these investments lightly as the loss in this division will be a drag on an otherwise exceptionally good performance," Chief Financial Officer Chris Liddell said in a conference call with reporters and analysts as Microsoft closed the books on its 2008 fiscal year.

The company had $60.42 billion in revenue for the year, which ended June 30, up 18 percent from 2007 and the fastest revenue growth rate for the company since 1999. Full-year operating income was $22.49 billion, up 21 percent, and earnings per share hit $1.87, up 32 percent.

For the fourth quarter, revenue was $15.84 billion, but earnings per share of 46 cents fell a penny short of Wall Street expectations. That stemmed in part from sales in businesses that have slimmer profit margins and hiring increases, among other expenses.

The earnings miss, coupled with the lowered guidance for the current fiscal year, pushed Microsoft shares down more than 6 percent in after-hours trading to $25.88. It closed the regular session at $27.52; the company made its earnings report after the market closed.

The stock also gave back some earlier gains as optimistic investors bought up shares ahead of the earnings news, said Alan Davis, analyst at D.A. Davidson in Lake Oswego, Ore.

Microsoft's decision to pump an additional $500 million into its businesses this year, and the market's reaction to it, adds another chapter to a story that has been running for much of this decade.

"They seemed to always be defending themselves on the spending side," Davis said. "It reared its head again today."

Some portion of Microsoft investors would rather see the company use the huge and still-growing revenue stream from its core businesses of Office and Windows to deliver bigger profits.

Analysts peppered Liddell with questions about how long the increased investments will continue and when they might result in a better return from the Online Services Business, which posted a $1.23 billion loss for the year on revenue of $3.21 billion.

"There had been a bump in spending already built into the preliminary guidance, so this is a pretty high pile now," said Charlie Di Bona, analyst at Sanford C. Bernstein & Co. "I don't think that's necessarily bad, but it is incumbent on them to do a pretty good job of explaining to their shareholders what they're spending this on and what they expect to get out of it."

An incremental $500 million may look paltry next to the $47.5 billion Microsoft was prepared to spend at one time earlier this year to buy Yahoo and accelerate its online strategy.

Di Bona said that the difference is the Yahoo strategy was clear. "In the absence of Yahoo, none of it's clear anymore," he said.

The outcome of Microsoft's 5 ½ month pursuit of Yahoo is still to be determined. The company made another proposal to buy just Yahoo's search business last weekend. It was promptly rejected, and both sides have squabbled in the media about the details and motivations of the offer.

Yahoo's Aug. 1 shareholder meeting could be decisive if the company's investors elect a board amenable to a Microsoft deal.

Meanwhile, Liddell sought to address investor concerns about where the incremental spending is going. To start, he said, the short-term investments give the company the opportunity to participate in an online advertising market Microsoft expects to be worth $80 billion by 2012.

"This area represents one of the largest growth opportunities for the company," he said.

Specifically, Microsoft wants to drive increased awareness and search traffic to its Live Search engine; continue building its advertising platform; improve communications and social-networking tools across the phone, PC and Web; and enhance its MSN portal.

He said success will be measured by overall advertising revenue, as well as the company's ability to hit "aggressive growth targets" in the next five to 10 years for Microsoft's share of Internet searches and worldwide page views, among other things. He didn't say what those targets were.

Di Bona said the explanation was a start, but he expects to hear more at Microsoft's annual Financial Analyst Meeting on Thursday.

"With the stock where it is and obviously the investor skepticism that's embedded in that stock price, I think they need to be fairly explicit," he said.

While Microsoft dialed back its full-year profit forecast by a penny to between $2.12 and $2.18 a share, reflecting the increased spending, the company actually increased its sales expectations to between $67.3 billion to $68.1 billion. Liddell gave little indication that Microsoft expects trouble in the U.S. economy to hinder sales.

Microsoft's fourth-quarter result resembled the forecast for the current fiscal year.

Sales were strong in the core businesses, with client revenue of $4.37 billion, up 15 percent from a year ago, and Windows Vista hitting 180 million licenses in the market. That put to rest some concerns about Vista after Microsoft's fiscal third quarter report in April.

The company's server business had its 24th consecutive quarter of double-digit growth, turning in $3.74 billion in operating income.

But profit was slowed by spending, and by the slimmer margins on its Xbox 360 and consulting businesses.

The Entertainment and Devices Division, which produces the Xbox 360, met its goal of profitability with operating income of $426 million for the full fiscal year, a first. But the company stumbled to the finish with a $188 million loss in the quarter.

Microsoft also bought back $5 billion of its stock in the quarter and accelerating the pace of hiring.

Colleen Healy, investor-relations manager, said about half of the operating-expense increases in the fourth quarter, about $250 million, went to aggressive recruiting.

Benjamin J. Romano: 206-464-2149 or bromano@seattletimes.com