Huge Xbox 360 Sales Boost Microsoft Revenue

When Reuters sounded alarm bells that Microsoft net income may have fallen by as much as 28% (if it had done the math correctly, it should have come up with 25.5%), it was a bit premature: Microsoft chose to defer about $1.64 billion of revenue from sales of Windows Vista during the last quarter, which came in the form of coupons that customers will redeem this quarter.

As a result, a company whose operating income gains would probably come in at about 10%, in line with estimates, ended up looking like one whose income had plunged in the wake of last year’s Vista delay. Microsoft stock traded generally lower on the day, experiencing a hump followed by a lull in late trading after earnings numbers were reported, ending the day down over 2% in value on the NASDAQ.

While Microsoft posted a $12.5 billion quarter, most likely its best ever, from a profit perspective, the cost of doing business – while still steep – may be coming under control. Operating income for the entire company fell just over 25%, taking the deferral into account. But even though total revenue gained for the quarter by an annual rate of 5.95%, income for the company’s core business divisions (excluding overall cost of business) rose by a combined rate of about 11%.

The divisional breakdown shows only modest seasonal gains in Microsoft’s Business Division, with $3.5 billion in revenue in the year-end quarter versus $3.4 billion in the previous quarter, a gain of just 2.5% from the prior quarter, and an actual decline of 4.8% over the year-ago quarter. Revenue from the Client division, which accounts for Windows, would have been up 9% for the quarter had it not been for the deferral; as written, revenue for that segment is actually down 25% over the prior quarter.

The effect of Vista on XP is difficult to gauge here, though you can do it with a little effort: Customers who purchased new systems with Vista coupons are also Vista customers, although the Vista portion of their contributions to the company’s bottom line won’t be monetized until April. A 9% gain for the fourth calendar quarter is right in line with “seasonality” – the fact that sales naturally rise toward the end of the year. So just as hardware vendors have timidly predicted in recent weeks, Vista may end up being a wash.

This assessment could be verified by Chief Financial Officer Chris Liddell’s statement to an analyst that the situation for Vista, well, could have been better, could have been worse. “[In] the Quarter 2 results,” Liddell said, “we’re certainly heartened by the fact that the tech guarantee [the Vista coupon] appeared to avoid any stalling of sales in that quarter.”

The star of the day was the Entertainment and Devices division. Unaffected by the Vista coupon purchase deferral, its revenue over the holiday season went through the roof: just under $3 billion, a gain of 187% over the prior quarter (that is not a typo), and a gain of nearly 76% over the 2005 holiday season. But Entertainment and Devices posted an operating income loss of $289 million. With the development money on Xbox 360 already having been spent, you’d think that cost would have been attributed to Zune.

But the word “Zune” was heard from the lips of Microsoft officials only once, from Investor Relations General Manager Colleen Healy: “During the quarter, we launched the Zune digital media player in the United States, which furthers our strategy of connected entertainment.” The latter part trailed off like a footnote, or like a booth announcer for a drug commercial reminding viewers of the risks one takes when mixing it with alcohol.

The Vista deferral accounts for a good portion of Microsoft’s overall income decline, yet that amount will inevitably be taken into consideration when Microsoft posts a huge increase in Client division income next quarter. Chris Liddell advised that during his company’s fiscal third quarter, ending in March, operating income for the Client division will most likely be posted with an annual gain of an astonishing 54 – 56%. About 38 points of that gain will be due to the deferral.

Next: Reduced sales projections for Xbox 360 in Q3