Microsoft profits up--but Xbox still in red

Just hours after its rival Sony reported its quarterly earnings, software giant Microsoft announced its own results for its third financial quarter.

For the three-month period ending March 31, 2006, the company had income of $10.9 billion, which yielded it $2.98 billion in profits. That was a 13 percent increase in profits from the same period in 2005, which saw it take in $2.56 billion profitwise.

While a kingly sum by any standard, Microsoft's earnings were below analysts' estimates. They had estimated it to bank $11.04 billion in revenue, a figure consistent with Microsoft's own guidance of $10.9 billion to $11.2 billion in quarterly income.

One factor for Microsoft's earnings can be summed up in two words: Xbox 360. The company is spending a lot of money to get the next-gen console into gamers' living rooms, sparing no expense in increasing production of the once-scarce machine. "We extended our market leadership position in next-generation gaming and turned a major corner in the quarter with our Xbox 360 console supply," Microsoft CFO Chris Liddell told analysts during the postannouncement conference call. "We are now in nearly 30 countries, and console supply is ramping up significantly."

But as a result of increased production and marketing costs of the Xbox 360, on which Microsoft currently loses an estimated $126 per unit, its Home and Entertainment division found itself in an unenviable position. Despite the fact the division's quarterly revenue went from $571 million in 2005 to $1.056 billion in 2006, all its new income evaporated. Its quarterly operating loss went from $175 million in 2005 to $388 million in 2006.

"While [overall Microsoft] revenue increased 13 perecent during the quarter, cost of revenue increased 49 percent, due primarily to Xbox 360 console volumes," Liddel told analysts. "The majority of the variance from our forecast was driven by strong Xbox 360 unit shipments, with the rest due in higher console costs."

The Xbox 360 hardware paradox will likely lead to another set of higher-revenue, higher-loss numbers. "We also expect increasing growth from Home & Entertainment with the improving supply of Xbox 360 consoles," said Liddel of the current quarter, the fourth in Microsoft's fiscal year.

However, Microsoft's losses on Xbox hardware will eventually narrow. The company has already revealed that later this year it will begin making Xbox 360s with the more cost-effective 65-nanometer process, versus the 90-nanometer process currently used. However, 360s featuring chips made with the new process won't be on sale until the calendar year 2007.

Unsurprisingly, Microsoft was bullish on the Xbox 360's performance so far. He reminded analysts that the console's "life-to-date attach in the US through March for software and peripherals was 4.5 and three per console, respectively, higher than any other gaming console at this point in its lifecycle." He also announced that Xbox Live Marketplace downloads have passed the 10 million mark, 4 million of which were Xbox Live Arcade games.

As for the 360's future, Liddel promised the console's library would expand to 80 titles worldwide "by the end of June."