Microsoft Cops to Xbox Flaws - TheStreet

Microsoft Cops to Xbox Flaws

The software titan expects to shell out more than $1 billion in warranty-related charges.
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Updated from 4:57 p.m. EDT

After months of denying that it has a problem with the Xbox 360 console,

Microsoft

(MSFT) - Get Report

is finally coming clean.

The company said that as a result of the "unacceptable number of repairs to Xbox 360 consoles," it is expanding the global warranty coverage for the product.

Microsoft will extend its warranty from a year to three years from the date of purchase to cover a hardware problem that manifests itself as three flashing red lights on the console.

Microsoft will take a $1.05 billion to $1.15 billion pretax charge to earnings for the quarter ended June 30 for anticipated costs under its current and enhanced Xbox 360 policies, the company said.

The charge covers the possibility of repairing all consoles shipped till date, said Microsoft CFO Chris Liddell.

The move, which is likely to satisfy thousands of users who have been complaining about the Xbox 360 console's high rate of failure, comes at a hefty price tag to Microsoft and raises questions about how sizable the dent is in the division's profitability.

Microsoft said that the latest decision will not affect the entertainment division's profitability. The Redmond, Wash.-based company has forecast a fiscal 2008 profitability target for the division and the console.

The company, however, already seems to be falling shy of some of its estimates. The company said it is likely to ship around 11.6 million Xbox 360 consoles compared with the 12 million devices it had forecast by the end of June.

Shares of Microsoft were off 8 cents to $29.91 in extended after-hours trading.

So far, Microsoft hasn't shared any details about the reasons for the hardware failure.

"For little of the first year, the issue wasn't visible at all," Robbie Bach, president of Microsoft's entertainment and devices division, told analysts on a conference call.

"But in the last couple of months, we started to see significant increases in repair requests, call volume and attention from people so we geared up to respond appropriately," he said.

Additionally, Microsoft said it will reimburse any customer who has previously paid for repair expenses related to the three flashing lights error message on the Xbox 360 console.

Despite a number of user complaints on online forums and a report from the

BBC's

Watchdog

television show about the Xbox 360's hardware problems in February, Microsoft maintained that the failure rates were "within normal range" for electronic products.

But the company's extension of the warranty indicates that the problems may have been much more extensive.

Though Microsoft declined to offer any details on the failure rate for the consoles, Bach characterized the problems as a "Microsoft design challenge."

At the same time, he assured analysts that Microsoft has figured out a way to "engineer around" the issues.

"We are not going to discuss return rates or specific number of units with problems," said Bach. "Suffice to say, it is a meaningful number and one that clearly has our attention. We understand the issues and have our hands around it on the engineering level."

The Xbox 360 was launched in November 2005 and is first of the three consoles that form the next-generation systems.

Sony's

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PlayStation 3 and

Nintendo's

Wii complete the troika.

In December 2006, Microsoft extended the warranty on the consoles from 90 days to a year.

The $1.05 billion to $1.15 billion pretax charge that the company has announced now is in addition to the costs that it incurred when the warranty was extended to a year.

Microsoft now offers the longest warranty among its rivals. Both Nintendo and Sony offer a year-long warranty for their latest products.