Surface Watch

Microsoft again writes off Surface inventory, renews profitability doubts

Omits cost of revenue for Surface in latest SEC filing, but acknowledges a write-off to cover the Surface Mini that didn't launch

Microsoft again took a hit on its Surface business, the company acknowledged Tuesday, although the extent of the damage was unclear.

For the June quarter, Microsoft said Surface had booked $409 million in revenue, a 16% decline from the previous quarter. Microsoft has never said what revenue it recorded in the 2013 June quarter -- instead it lumped that quarter with two others, Q4 2012 and Q1 2013, tallied the trio and came up with $853 million -- so a year-over-year comparison was impossible.

But unlike the past two quarters, Microsoft has not revealed the cost of revenue associated with the Surface for the June period, at least in the 8-K document filed with the U.S. Securities and Exchange Commission yesterday.

Even so, Microsoft did admit to losses in the prepared remarks read by chief financial officer Amy Hood during the call with Wall Street analysts yesterday, as well as in the 8-K.

"During the quarter, we reassessed our product roadmap and decided not to ship a new form factor that was under development," Hood said, referring obliquely to the Surface Mini, which Microsoft was going to launch alongside the Surface Pro 3 in May, but then changed its mind at the last moment. "Combined with the transition of production towards our latest Surface offering, we made inventory adjustments which impacted our gross margins."

In the SEC filing, Microsoft said much the same, but didn't add any additional detail. "Current year cost of revenue included Surface inventory adjustments resulting from our transition to newer generation devices and a decision to not ship a new form factor," the company stated.

The company did not reveal the extent of the "inventory adjustments" that "impacted gross margins."

To make Microsoft's financials even more difficult to decipher, it has essentially masked the profit, if any, of the tablet/notebook hydrid by grouping the line with the Xbox video game console in the "Computing and Gaming Hardware" (C&G Hardware) group.

The company did spell out the gross margin of the group, however. "Gross margin" is the difference between revenue and cost of goods and production, but does not take into account other expenses, such as marketing or research and development.

The gross margin of C&G Hardware was just $18 million on revenue of $1.44 billion. The latter figure was up $274 million or 23%, compared to the same quarter of 2013, when the group, called "Devices and Consumer Hardware" until now, booked $1.17 billion in sales.

Nor was Tuesday's earnings call any help: None of the analysts who asked questions of Hood or CEO Satya Nadella, who was on the conference call for the second straight quarter, brought up the Surface.

Bottom line, however, was the fact that, after accounting for the adjustments Microsoft needed to make for the switch to the Surface Pro 3 and for the abandonment of the Surface Mini, the C&G Hardware group -- again, including the Xbox console line -- managed a gross margin of just $18 million.

In Microsoft money, $18 million is a drop in the proverbial bucket: The company had revenue of $23.4 billion, and net income -- profit in other words -- of $4.6 billion. The $18 million in gross margin for C&G Hardware was just 0.4%, or four one-thousandths, of the firm's total net income.

Surface profitability chart
Microsoft's tablet may have been profitable in the second quarter, but another write-down strongly suggests it was not. (Data: Microsoft, SEC filings.)
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