Xbox Division Sees Higher Losses on 360; Shipment Target Increased

April 28, 2006 | By: James Brightman

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Sony isn't the only company being hurt by next-gen console investments. Losses within Microsoft's Home and Entertainment division were way up thanks to the Xbox 360. That said revenues were also much higher and the company now expects to ship 5 to 5.5 million consoles through June.

Microsoft has announced its third quarter fiscal results for the period ended March 31, 2006, and while the company as a whole experienced increases in revenue and profit, the Home and Entertainment Division, which includes the Xbox business, had much higher losses year-over-year.

Microsoft reported revenue of $10.90 billion (a 13 percent increase) and profit of $3.89 billion (a 17 percent increase). Demand for "recently released products for business and consumer customers drove robust performance during the quarter in the Home and Entertainment, Microsoft Business Solutions and Server and Tools groups," the company said.

One of those products, of course, was the Xbox 360, which drove Home and Entertainment revenue up by 80 percent. The division reported $1.06 billion in revenue as compared with the $571 million posted during the same period last year. Even with the boost in revenue, however, Xbox 360 expenses led to losses being more than doubled. Losses jumped from $175 million to $388 million. Microsoft estimated that the Xbox 360 cost them $665 million during the third quarter. The company also revealed that more than 3.2 million 360s have been sold (1.8 million in North America), and that the shipment target has been increased slightly to 5 - 5.5 million units by June 30.

"Home and Entertainment revenue increased for the first nine months of fiscal year 2006 driven by the launch of Xbox 360 and the strength of new PC games, especially Age of Empires III. Revenue from the 3.25 million Xbox 360 consoles shipped since its launch more than offset the approximate $300 million impact of Halo 2 sales in fiscal year 2005," Microsoft said in its 10-Q.

The company further explained, "Home and Entertainment operating loss in the third quarter and first nine months of fiscal year 2006 increased primarily due to an increase in product costs and sales and marketing expenses related to the Xbox 360 and due to the significant margin generated by Halo2 in fiscal year 2005. Our business model anticipates that while we currently sell Xbox 360 consoles at a negative margin, product cost reductions and the future margins on sales of games and other products will enable us to achieve a positive margin over the Xbox 360 console lifecycle."

Part of this cost reduction is expected to come from the CPU. Last week Microsoft announced that it reached an agreement with Chartered Semiconductor to reduce the CPU from 90-nm to 65-nm by the first quarter of 2007. That said, even at this stage in the game Microsoft said that "the first generation Xbox consoles continue to have negative margins."

For the current quarter ending June 30, Microsoft expects revenue to be in the range of $11.5 billion to $11.7 billion and operating income is expected to be in the range of $4.0 billion to $4.2 billion. For the fiscal year ending June 30, 2007, the company offered guidance of revenue in the range of $49.5 billion to $50.5 billion and operating income in the range of $18.7 billion to $19.3 billion.

Wall Street was not very pleased with the outlook, as Microsoft said greater investments to take on rivals such as Google could hurt future earnings. Shares plunged 11 percent on Friday, the biggest drop in over 5 years.