Article Chosen: http://money.cnn.com/2007/07/19/technology/microsoft/

Articles Referenced: http://www.forbes.com/2007/07/05/msft-xbox-charge-tech-media-cx_rr_0705techmsft.html

http://www.microsoft.com/en-us/news/press/2007/jul07/07-05warrantyextentionpr.aspx

I chose this article for my blog entry because it deals directly with a major issue that Microsoft faced in 2007.  One of the company’s top selling products, the Xbox 360 underwent severe malfunctions which caused frustration and complaint amongst millions of users of the popular game console. The malfunctions also lead to a billion dollar expense for the company during its 2007 fiscal year.

In July 2007, Microsoft announced that it will be incurring a $1.06 expense as a result of several components that make up the Xbox 360 charge. Microsoft initially had hoped to repair many of the defective consoles that were returned to the company by users for repairs, after their initial one year warranty had expired.  The defect on the consoles became known as the “Red Ring of Death” due to a flashing ring on the Xbox console that signaled the malfunction. The damage to the consoles was so severe in most cases that Microsoft was not able to return these consoles to users. They were also not able to repair and resell them. The company had to revalue the defective consoles (for a much lower value than their original) and wrote down this inventory on its balance sheet. The inventory write down of the X-box consoles represented about 35% of the $1.06 billion charge.

The larger component of the Xbox charge was an improvement in Microsoft’s warranty for existing users of the console, as well as for new users. Microsoft’s original warranty for the Xbox console was one year. However, after all of the complaints and malfunctions that occurred, the company extended the warranty to a 3 year policy which included replacement of the consoles. This warranty charge cost Microsoft over $70 million.

During its July 2007 conference call with analysts, Microsoft’s CFO at the time, Chris Liddell alerted investors of the Xbox charge, and also pointed out how earnings and revenue for the fourth fiscal quarter would have looked if the charge didn’t occur. Liddell informed investors that the charge was a one-time only occurrence that was not indicative of the company’s past or future performance. Without the Xbox charge in 2007,  diluted earnings per share for Microsoft would have been $0.39 for the quarter as opposed to $0.31 with the charge. Additionally, operating income for the quarter would have been $5 billion as opposed to $4 billion.

It is definitely wise to investigate the financial and accounting implications that occur when a company undergoes a major, unusual charge. It is also helpful to understand that companies often incur “one-time only” charges that do not indicate their true earning potential. The Xbox Charge in 2007 was  an example of this type of charge.