Xbox division posts $165 million Q1 profit despite 12% 360 sales drop

This afternoon, Microsoft reported its financial results for the January-March quarter, the third of its fiscal year. For the three months ending March 31, the software giant posted record revenue of $14.50 billion, a 6 percent increase over the same period in 2009. Profits for the quarter jumped 35 percent to $4.01 billion, for $0.45 earnings per share.

Microsoft's Entertainment and Devices division had a less spectacular quarter, with revenues rising just 2 percent year-over-year to $1.67 billion in revenue. The division saw operating income rise from a loss of $41 million in January-March 2009 to $165 million during the same period this year.

The profit was in large part due to a $62 million windfall resulting from foreign currency exchange rates. Microsoft also called out increased revenue from Xbox Live as a factor, as well as a $199 million decrease in the cost of revenue "resulting primarily from lower Xbox 360 console costs." The drop in manufacturing costs for the console will likely further fuel speculation that Microsoft has developed an Xbox 360 Slim, which would require fewer materials to make and cost less to ship.

That said, both Xbox 360 hardware and software revenues were down during the quarter. Microsoft only sold 1.5 million consoles from January to March, down 12 percent from 1.7 million during the same period the year prior.

Though the company said the slip was "in-line with overall market decline," its impact was compounded by the lower price commanded by Microsoft's consoles, which now sell for $200 (Arcade) and $300 (Elite). First-party Xbox 360 software sales were also down, comparing unfavorably due to the release of the hit Halo Wars during the same quarter in 2009.

Non-gaming revenue in the Entertainment and Devices Division, which also makes the Zune, was up 14 percent. Looking ahead until the end of its fiscal year on June 30, Microsoft expects EDD revenues to remain largely flat, which executives said would mean a "significant uptick" in gaming revenues during the April-June quarter.

For the nine months ending March 31, Xbox 360 and PC game revenue decreased $240 million, or 5 percent. This was in part due to console sales falling from 10 million to 8.8 million. The loss was compounded by the fact that Microsoft cut into its own bottom line to boost sales, slashing the price of the Xbox 360 Elite in August and releasing a $300 Halo 3: ODST/Forza 3 Elite bundle in March.

Curiously, though, Entertainment and Devices Division profits more than doubled, rising 242 percent from $249 million to $851 million. Part of this was due to increased Xbox Live revenue, but the main reason was, again, cost of revenue reductions--this time to the tune of $779 million, or 19 percent. This was in large part due to lower manufacturing costs for the Xbox 360, which also saw sales and marketing costs drop $60 million, or 6 percent.

Finally, the EDD division found savings by reducing research and development expenses during the nine month period by 6 percent, or $82 million. The cutback is curious, given that Microsoft spent the period hard at work developing its motion-sensing system Project Natal, which it plans on launching this holiday season with as much hype as it would console.