Surface books third straight quarter in the black

But Microsoft's tablet contributed a tiny portion -- less than 1% -- of the company's total Q1 gross profit

Microsoft Surface Pro 3
Michael Homnick

Microsoft on Thursday reported the third-consecutive quarter of gross profit for its Surface tablet line, with revenue up 44% compared to the same period the year before.

For the three months ending March 31, Microsoft recorded $713 million in revenue for the Surface line. That's a significant increase over the $494 million for the same quarter in 2014, but down 35% from the December 2014 quarter's record $1.1 billion in holiday season sales.

The vast bulk of first-quarter revenue was from the Surface Pro 3, as the Surface 2 -- the tablet powered by the now-abandoned Windows RT -- was withdrawn part-way through the quarter; sales of the latter's replacement, dubbed Surface 3, won't start until next month.

Using information in Microsoft's Thursday filing with the U.S. Securities and Exchange Commission (SEC) and data from earlier quarters, Computerworld calculated the first quarter's cost of revenue at $576 million, leaving a gross profit of $137 million. Cost of revenue is what is spent to make and sell a product, but excludes expenses such as advertising and R&D.

The $137 million in gross profit was more than half the previous quarter's $210 million. More importantly, it was $182 million above the first quarter of 2014, when the Surface lost approximately $45 million. The gross profit turn-around hints that Microsoft has Surface costs under better control.

A big part of that cost savings could be the dumping of the flailing Surface 2 and the resulting focus on the mature Surface Pro 3, which launched almost a year ago. If so, the question -- one without an answer at this point -- is whether the appearance of the Surface 3 will, like its predecessor, prove to be a profit drag. That's certainly possible, since product introductions typically take a hammer to profits because of tooling expenses and initial low volumes.

Microsoft's second-quarter earnings, which will be revealed in July, should be informative: If gross profit as a percentage of revenue, also called "gross margin," drops significantly, the Surface 3 will take the blame.

Computerworld's estimate pegged the Q1 gross margin at 19.2%, almost identical to the 19% of the December quarter, perhaps another signal that Microsoft has costs in hand. But that was still far under Microsoft's usual software-only margins, which remain north of 90%.

Jan Dawson, chief analyst at Jackdaw Research, also regularly uses Microsoft's SEC filings to come up with his own estimates of the tablets' cost of revenue and gross margin. For the March quarter, he pegged the latter at 18.2%, slightly lower than Computerworld's calculation.

But while the numbers are in the black -- as opposed to the multiple quarters prior, when the Surface simply bled -- it is important to remember that, for all of Microsoft's aggressive marketing of the Surface and the attention the 2-in-1 gets in the media, including at Computerworld, its impact is minuscule.

For example, the $713 million in revenue, the one figure that Microsoft clearly acknowledged in its 10-Q with the SEC, amounted to just 3.3% of the company's total revenue for the quarter of $21.7 billion. In comparison, Apple's iPad accounted for 11.6% of the Cupertino, Calif. firm's December quarter revenue, the latest available.

The Surface's gross profit played an even smaller part on Microsoft's balance sheet: For the March quarter, the estimated $137 million in gross profit amounted to only 0.9% of Microsoft's $14.6 billion total.

That's almost a rounding error.

Copyright © 2015 IDG Communications, Inc.

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