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By Ina Fried, 28 April 2006 09:10

NEWS

Microsoft on Thursday reported third-quarter sales and profits that were below what some analysts were expecting and said future profits will be dented as it aims to boost its Windows Live internet services and other new businesses.

For the three months ended 31 March, the software maker said it racked up profits of $2.98bn, or 29 cents per share, on revenue of $10.9bn. That compares with profits of $2.56bn, or 23 cents per share, on sales of $9.62bn for the same period a year ago.

The third-quarter profits were dented by legal costs that amounted to 3 cents per share, while the year-ago numbers were impacted by 5 cents per share related to legal costs.

Analysts were expecting the company to make profits of 33 cents per share on revenue of $11.04bn, according to First Call. Microsoft said in January to expect $10.9bn to $11.2bn, with per-share profits of 32 cents or 33 cents.

Colleen Healy, a general manager in Microsoft's investor relations unit, told silicon.com sister site CNET News.com that the weaker profits came as Microsoft invested money in its services push and also as it tried to ramp up production of the Xbox 360 games console.

The company also offered a sales forecast for the current quarter and next fiscal year that was largely in line with what analysts were expecting. But it did say profits would come in lower, as it invests in its services push, as well as in the launch of Windows Vista and Office 2007.

Microsoft's three main business units, which sell desktop and server versions of Windows, all saw both profits and sales grow during the quarter.

However, Microsoft saw its MSN unit dip into the red, as revenue dropped from a year earlier. The Home and Entertainment unit, whose chief product is the Xbox, saw its revenue grow to $1.06bn, from $571m a year ago, as the company boosted shipments of the Xbox 360. However, as the initial units ship at a loss, Microsoft saw its operating loss in the unit grow to $388m, from $175m in the year-ago quarter.

The Microsoft Business Solutions unit, which has been losing money but produced an operating profit in the December quarter, dipped back into the red in the last quarter. It lost $13m, though its revenue grew to $216m, from $179m in the year-ago quarter.

The mobile and embedded devices unit, which includes the Windows Mobile software for handhelds and mobile phones, saw its operating loss widen to $14m from $9m a year ago, as sales climbed to $89m from $61m a year ago.

For the current fourth quarter, Microsoft said to expect revenue of between $11.5bn and $11.7bn, with operating income between $4bn and $4.2bn and per-share profits of around 30 cents. Analysts had been predicting profits of 34 cents per share, on revenue of $11.64bn.

Healy said Microsoft wants to continue investing in adding people to its services unit, as well as spending on physical hardware and continued improvement of its search algorithms. "We see that we have an opportunity out there and we are going to aggressively go after it," she said.

The software maker also gave its preliminary guidance for the new fiscal year, which starts in July. Microsoft said to expect revenue of $49.5bn to $50.5bn and per-share profits in the range of $1.36 to $1.41.

In addition to continued investment in services, Healy said Microsoft plans to spend money to market the launch of Windows Vista and Office 2007. Both products were originally slated to launch late this year but are now set for a mainstream release in January.

Bernstein Research analyst Charles Di Bona said in a research note this week that he expects revenue for the coming year to be $50.48bn and per-share profits for the fiscal year of $1.54.

Microsoft's stock dropped in after-hours trading after the report. Shares changed hands recently at $25.66, down more than five per cent after ending the regular session at $27.25.

On a conference call with analysts, Microsoft said its search revenue was lower than expected as the company continues to shift from Yahoo!'s ad-serving technology to its own AdCenter product. The company saw more searches done on MSN but its revenue per search failed to match the amounts the company saw in the prior year. For the coming quarter, Microsoft predicted sales will fall between four per cent and five per cent as it continues its move to AdCenter.

Ina Fried writes for CNET News.com