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Microsoft again writes off Surface inventory, renews profitability doubts

Gregg Keizer | July 24, 2014
Omits cost of revenue for Surface in latest SEC filing, but acknowledges a write-off to cover the Surface Mini that didn't launch.

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.)

The Surface Mini adjustment, of course, was reminiscent of the massive $900 million write-off the company took a year ago after over-producing and under-selling the original Surface RT tablet. It suggested that Microsoft has made a second costly mistake on the Surface by taking the Mini almost to the release line, then balking at pushing it across.

So, did the Surface line lose money again? Without more information -- which may appear in a follow-up document Microsoft is required to file with the SEC -- it's impossible to positively, absolutely answer affirmatively.

"I think there's a good chance that it did lose money again, especially as they will have spent on marketing Surface Pro 3 in June without seeing a lot of sales yet," said Jan Dawson, chief analyst at Jackdaw Research, in an email reply to questions Wednesday. "That's not necessarily covered in cost of sales, but would affect contribution margin. At low volumes, it's also likely that gross margins would have been low or negative."

If the Surface ran into the red in the June quarter, as the available data strongly suggested, it would not be a shock: Microsoft has yet to turn a profit on its first stab at computing hardware. Prior to the June quarter, Microsoft had acknowledged a total loss of $1.2 billion on the Surface in other filings with the SEC.

The company has been making progress, though, at least for the three quarters of Q3 and Q4 2013, and Q1 2014, as the losses in the last two of the threesome were significantly less ($39 million and $45 million, respectively) than the first ($216 million).

But the undisclosed amount of the adjustment Microsoft called out for the Surface Mini could easily throttle that progress.

By virtue of the adjustment, it seems very unlikely that Microsoft will ever release the Surface Mini, at least the version that it designed and probably manufactured in some volume before deciding not to sell it. If it planned to simply warehouse those devices until, say, a more favorable moment, it would not have had to announce the adjustment.


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