Microsoft sees brisk Xbox 360 sales--and big-game losses

Home and Entertainment division quarterly revenue nearly doubles as Xbox 360 installed base reaches 5 million, but division is still deep in the red.

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Software colossus Microsoft today reported its earnings for its fiscal fourth quarter, which ended June 30, 2006. Overall, the tech giant saw $2.3 billion in profits on revenue of $11.8 billion. That was a 24 percent slide from the $3.7 billion in profits on revenue of $10.2 billion it enjoyed during the same quarter in 2005.

The fastest-growing sector of Microsoft's various businesses was its Server and Tools division, which saw $3.18 billion of quarterly income, an 18 percent year-on-year increase. However, another sector closer to gamers' hearts also saw massive revenue increases. Microsoft's Home and Entertainment division, which includes games, saw $1.14 billion in revenue--a 94 percent boost when compared to the $587 million the division earned in 2005. Xbox revenue--which includes sales of the original Xbox and Xbox 360--increased some $503 million, or 129 percent.

Obviously, one big reason for the massive increase in revenue was brisk sales of the Xbox 360, which, after several months of shortages, is now in ample supply. Microsoft was eager to tout the console's success, announcing that it shipped over 1.8 million Xbox 360 units during the quarter, bringing its international installed base to 5 million. Microsoft also took the opportunity to retout the fact that 60 percent of Xbox 360 owners--some three million consumers--use Xbox Live, its online gaming service.

However, despite the jump in sales, the Home & Entertainment division once again lost money--a lot of money. It posted an operating loss of $414 million for the quarter, a 106 percent increase from the previous year. The biggest reason for the increase is the fact that, as Microsoft admits, it loses a significant amount of money on each Xbox 360 sold.

"Home and Entertainment operating loss increased primarily as a result of a $682 million increase in cost of revenue primarily associated with the Xbox 360, partially offset by the revenue growth," the company said in its earnings report. "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."

While such predictions may reassure some, others will find it interesting that Microsoft also still loses money on the original Xbox, which was introduced back in 2001. "The first-generation Xbox consoles continue to have negative margins," said the company. Microsoft also said a 19 percent increase in headcount, in part due to its acquisition of Lionhead Studios, contributed to the division's losses.

By itself, the Home and Entertainment division saw $4.266 billion in revenue for the fiscal year, earning $1.56 billion during the October-December 2005 quarter when the Xbox 360 launched. But, as with the quarterly earnings, H&E's expenditures once again outpaced its revenue. Its operating loss jumped 160 percent from $485 million in FY2005 to $1.262 billion in FY2006.

"Home and Entertainment operating loss increased primarily as a result of a $1.64 billion increase in cost of revenue primarily as a result of the number of Xbox 360 consoles sold and higher Xbox 360 unit costs, partially offset by the revenue growth," said the company. "Our fiscal year 2006 operating loss increase was also attributable to the significant impact of Halo 2 in fiscal year 2005"--the year the game shattered sales records on the original Xbox.

Despite the massive losses of its game division, Microsoft still posted strong overall results for its 2006 fiscal year, which also ended June 30, 2006. The company reported annual revenue of $44.28 billion, an 11 percent increase over its 2005 fiscal year. Net income--that is, profit--for the year was $12.60 billion, versus $12.25 billion the previous year. The company is also planning to buy back some $20 billion in stock in a massive tender offer.

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