July 19 (Bloomberg) -- Microsoft Corp., the world's biggest software maker, said fourth-quarter earnings rose 7.3 percent, held back by more than $1 billion in costs to fix faulty Xbox video-game consoles.

Net income increased to $3.04 billion, or 31 cents a share, from $2.83 billion, or 28 cents, a year earlier, the Redmond, Washington-based company said in a statement today. Sales advanced 13 percent to $13.4 billion.

The repair expenses eroded gains from new Office programs. Xbox unit sales fell short of Microsoft's original forecasts for the year, and sales of the Windows Vista operating system met only the company's lowest estimates, raising concern demand isn't picking up fast enough.

``It's the same as it ever was,'' said Tim Allen, who helps manage $11.9 billion, including Microsoft shares at Wentworth, Hauser & Violitch in Seattle. ``Vista is doing OK, but it isn't blowing the doors off. It's a low-risk, low-reward situation.''

Profit met the 31-cent average estimate of 12 analysts surveyed by Bloomberg in the quarter, and sales beat projections of $13.3 billion.

Shares of Microsoft fell 36 cents to $31.15 in extended trading after the report. They had gained 59 cents to $31.51 as of 4 p.m. New York time in Nasdaq Stock Market trading and have risen 5.5 percent this year, lagging behind rivals such as Oracle Corp., Google Inc. and Apple Inc.

Windows, Web Ads

The new Windows Vista and Office, which went on sale broadly on Jan. 30, fostered growth of more than 10 percent in the two biggest divisions. Web advertising revenue exceeded predictions, a signal Chief Executive Officer Steve Ballmer is improving the business even as Google's earnings missed analyst projections.

Xbox has been the laggard, reigniting debate about whether Microsoft should be taking on Sony Corp. and Nintendo Co. Sales in the unit dropped 9.5 percent to $1.16 billion in the quarter.

The company said this month an ``unacceptable'' number of its Xbox 360 machines are experiencing a complete shutdown. Ballmer, 51, extended the warranty and Microsoft is reimbursing users who have already paid for fixes.

The repairs cut profit by about 8 cents a share, said Sarah Friar, an analyst at Goldman, Sachs & Co. in San Francisco. The company has sold 11.6 million consoles as of June 30, missing its forecast for sales of 12 million amid competition from Kyoto, Japan-based Nintendo's Wii.

Forecasts

Microsoft said profit in the quarter that began July 1 will be 38 cents to 40 cents a share on sales of $12.4 billion to $12.6 billion. Analysts anticipated earnings of 38 cents a share and sales of $12.4 billion, the survey showed.

The company raised its forecasts for this year, though the projections still are in line with the estimates. Profit will be $1.69 to $1.73 on sales of $56.8 billion to $57.8 billion, compared with estimates of $1.72 and $57.9 billion. Microsoft in April forecast profit of $1.68 to $1.72 and sales of $56.5 billion to $57.5 billion.

``They lifted the fiscal year forecast a little, but it's still in line with consensus, so no one is going to be excited about that,'' said Charles Di Bona, an analyst at Sanford C. Bernstein & Co. in New York, who rates the shares ``outperform.''

Microsoft raised the forecast partially because unearned revenue, a measure of future sales, exceeded estimates, Chief Financial Officer Chris Liddell said in an interview.

The number, which measures sales from multiyear contracts that are held over for recognition in the future, totaled $12.6 billion, more than the $11.9 billion estimate of UBS AG analyst Heather Bellini.

Renewals

Typically Microsoft is able to renew two-thirds to three- quarters of its three-year agreements. Last quarter, renewals were 75 percent or more, Liddell said. ``It was a very strong customer acceptance,'' he said.

Sales of Windows for personal computers rose 14 percent to $3.08 billion, at the low end of its forecasts. Revenue from server software added 15 percent, missing estimates. Microsoft signed more long-term contracts, where revenue is held over for future quarters, Liddell said.

This year, Microsoft expects Windows growth of 9 percent to 10 percent, including an accounting change that inflates revenue, Liddell said. The forecasts raised concern among investors about the longer-term impact of Vista.

``People should ask some hard questions about Vista adoption based on this number,'' said Tony Ursillo, an analyst at Loomis, Sayles & Co. in Boston, which manages more than $115 billion, including Microsoft shares.

The company's online business gained 19 percent, beating estimates. Revenue from Internet advertising rose 33 percent, beating Microsoft's forecast. This year, Liddell expects a growth rate in the ``mid-20s or higher,'' he said.

Google today said sales rose 63 percent to $2.72 billion. Still, excluding stock-based compensation costs, profit missed the average estimate, sending the shares down.

Microsoft's ``numbers seem fine,'' Di Bona said. ``Fine is good. It's better not to be Google right now.''

To contact the reporter on this story: Dina Bass in Seattle at dbass2@bloomberg.net

Last Updated: July 19, 2007 18:47 EDT