• Chart: Finances By Business Segment

Widening losses in consumer businesses were the most notable feature of Microsoft's latest 10-Q filing with the U.S. Securities and Exchange Commission, in which the company reported financial results for each of its seven business segments in the quarter ended Dec. 31, 2002 (Q2'03). Windows desktops and desktop applications such as Office maintained their position as the most profitable Microsoft businesses, with margins of about 80%. Windows servers and server applications showed lower profitability, and losses continued in all the company's other business areas. (For complete results, see the chart "Finances by Business Segment".)

Connors Defends Xbox, MSN

As expected, the holiday season saw higher losses for the Home and Entertainment segment, which includes Xbox. The company sold around 800,000 units in Dec. 2002—its best month ever—but because it loses money on each unit sold, this business segment's losses almost doubled from the previous quarter, rising from US$177 million to US$348 million. Microsoft plans to spend US$2 billion over the next five years on Xbox research and development and building the Xbox Live online gaming service, and has not said when it expects the business to begin generating an operating profit.

The other segment that showed a notable difference from the previous quarter was MSN. Despite selling more than US$10 billion worth of products through MSN shopping sites, the unit's revenue for the busiest retail quarter of the year grew only 7% from last quarter, from US$531 million to US$569 million. Meanwhile, launching MSN 8 was expensive, helping the unit's losses balloon from US$97 million to US$157 million—an increase of more than 60%.

The widening losses are a disappointing start to Microsoft's latest MSN strategy, which focuses on using the MSN 8 client software to jump-start its Internet access business and attract "bring your own access" subscribers who pay a monthly fee of US$10 to use the software with their own Internet provider.

Despite the mounting losses, Microsoft Chief Financial Officer John Connors said in a recent speech to financial analysts that the company was happy with the financial performance of Xbox and MSN, and wondered why "anybody would even ask" whether the company plans to keep supporting these businesses.

He defended Xbox as a long-term play for the home entertainment market, noting that consumers are increasing the amount of money they spend on home-based entertainment (as opposed to movies, for example) and suggesting that the console would evolve to include TV-like features such as digital video recording. To succeed, said Connors, "We've got to make that Xbox console something that is critical to a home entertainment hub."

Connors also said MSN still hopes to convert the millions of visitors to its free Web sites and services to monthly fee-based services: "If you think about a software subscription model with a couple hundred million users, you don't have to get a huge amount per user to build a decent business."

The filing also noted that Microsoft had "unconditionally guaranteed" the repayment of "yen-denominated bank loans…of unconsolidated equity investee," which could possibly amount to US$559 million. Although not confirmed, the company in question is probably Jupiter Telecommunications, a Japanese cable company of which Microsoft owns 24%.

Microsoft's latest 10-Q filing is available as a Word document at www.microsoft.com/msft/download/MSFTQ03-2_10-Q.doc

For more details on Microsoft's business segments and what their financial results say about the company's strategy, see "Desktop Central to Microsoft Profits" on page 26 of the Jan. 2003 Update.