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Did Microsoft Surface sales sink more than thought?

(MoneyWatch) There's news on the Microsoft (MSFT) Surface tablet front. The company will announce its new Surface products on Monday. Meanwhile, back at Microsoft's online store, the company has started a new program: Trade in an old iPad for store credit. And Microsoft really hopes consumers will use it to buy a Surface.

A new SEC filing by Microsoft shows why: According to some reworked financials, the increasingly important hardware part of the business actually shrank since the introduction of the Surface tablet line. How will Microsoft pull off its devices-and-service strategy if it can't get people to buy the devices?

Microsoft has refashioned its strategy, focusing on a combination of devices and services and reorganizing the company around them. According to the 8-K filed Thursday with the SEC, "The changes are intended to enable the Company to innovate with greater speed, efficiency, and capability."

The new structure has two main divisions: Devices and Consumer on one side and Commercial on the other. Commercial includes server products, corporate volume licensing of Windows (not including licensing to hardware manufacturers), consulting services, cloud services, and other products aimed at a commercial market.

Devices and Consumer, or D&C as the company calls it, includes licensing of Windows to consumers whether through hardware manufacturers or direct, non-volume Microsoft Office licenses, Windows Phone, Xbox gaming consoles and games, PC accessories, and, of course, Surface.

Microsoft introduced Surface in mid-June 2012. The Windows RT version was available by late October 2012, with the Pro (full Windows 8) model out in early February 2013. That puts the product solidly into Microsoft's 2013 fiscal year, as Microsoft works on a July 1 through June 30 basis.

As part of its 8-K, Microsoft reworked its financials for the past two fiscal years under the new operating structure. The table below shows the revenue by area:


Notice the hardware section of devices and consumer. That should scare any investor or Microsoft loyalist. In FY 2012, before the introduction of Surface, Microsoft grossed $6.7 billion. That would count Xbox-related hardware and Windows Phone, though not Skype, which used to be included in the old Entertainment and Services division. (In the old structure, Entertainment and Services had about $9.6 billion in revenue for FY 2012. It was $10.2 billion for FY 2013.)

In FY 2013, even with the addition of Surface, revenue dropped to $6.5 billion. Unless Xbox sales completely tanked as gamers were waiting for the new generation of consoles, it seems Surface did next to nothing for the company. The $900 million Surface RT inventory write-down last quarter would suggest that performance was bad, but this is concrete evidence that Surface as a whole was a flop.

That makes Monday's announcement, and Microsoft's follow-through, even more critical. Unless it can reverse downward momentum, the company's new strategy, devised by a CEO who is on his way out, will be challenged, to put it mildly.

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