In early July, Microsoft extended the Xbox 360's warranty to three years after too many succumbed to "general hardware failure." The company said it has fixed manufacturing problems but would not say what caused console deaths.
The move cut profits by $1.06 billion, or 8 cents per share. Excluding this charge, the world's largest software maker earned 39 cents per share, in line with analysts' expectations, according to Thomson Financial.
Shares fell 63 cents, or 2%, to $30.88 at the open of trading Friday.
Revenue grew 13% to $13.37 billion from $11.80 billion last year, just ahead of Wall Street's estimate of $13.27 billion.
Sales in the division responsible for Office 2007, which works with Vista and its predecessor Windows XP, jumped 19% to $4.63 billion. In comparison, the division responsible for Windows saw sales rise 14% to $3.81 billion.
"There's not much that Microsoft can do to affect the revenue growth of that business," because most consumers and businesses are only upgrading to Vista when they buy a new PC, said Matt Rosoff, an analyst with Directions on Microsoft.
Web advertising revenue rose 33% to $544 million, but the online services division overall widened its loss to $239 million from $187 million last year. Microsoft still trails Google and Yahoo in U.S. search traffic.
A drop in Xbox 360 and PC video game sales pushed down revenue in that division by 10% to $1.16 billion. Industry watchers wonder whether Microsoft will lower Xbox 360 prices, following the lead of Sony , which cut the price of its PlayStation 3 console this month.
"We have a pricing strategy for the next 12 to 24 months, and a console strategy, and those two are related to each other," said Chief Financial Officer Christopher Liddell, in a conference call. He did not elaborate.
Analysts were pleased with an increase in Microsoft's "unearned revenue," or money businesses have pledged to spend in coming years on licenses for Windows, Office and server software.
"It suggests that the wave of business products released in 2007 and the forthcoming products in fiscal 2008 ... are really going to help the company convince enterprises to sign multiyear agreements," Rosoff said.
For the full fiscal year, Redmond-based Microsoft earned $14.07 billion, or $1.42 per share, on $51.12 billion in sales.
Microsoft is counting on several big product launches, including updated server software and the much-anticipated "Halo 3" video game, to spark double-digit growth next year.
For the current quarter ending Sept. 30, Microsoft said it expects to earn 38 cents to 40 cents per share on $12.4 billion to $12.6 billion in sales.
For fiscal 2008, the company raised earnings-per-share expectations by a penny, to $1.69 to $1.73, and boosted its revenue forecast to $56.8 billion to $57.8 billion. Previously, the company estimated revenue at $56.5 billion to $57.5 billion.