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prod_ArcTouchSurface_WebMicrosoft this afternoon posted record revenue of $24.5 billion for the December quarter, an increase of 14 percent. And yet the company’s profits were up just 2 percent, to $6.56 billion.

So what’s going on? A quick glance at Microsoft’s Devices & Consumer segment helps to explain what’s happening — and illustrates how the company is being reshaped by its expansion into hardware.

Revenue in the Devices & Consumer segment was up 13 percent, to $11.9 billion, driven by strong sales of the Xbox One and Surface tablets. However, the segment’s gross profit declined to $5.8 billion — a decrease of 14 percent from the same quarter a year ago.

That decline was also driven, in part, by strong sales of the Xbox One and Surface.

As explained in Microsoft’s quarterly SEC filing this afternoon, the decline reflects higher costs associated with producing the new Xbox One console, and a higher volume of Surface tablets sold during the quarter. Hardware, by its nature, doesn’t result in the high profit margins that Microsoft has traditionally enjoyed in its software business.

A decline in consumer Windows PC revenue also was a factor, in addition to the fact that Halo 4 was launched in the same quarter a year ago.

Bottom line: Microsoft isn’t just software company anymore, and increasingly that fact will be reflected in its financial results, particularly as it acquires Nokia’s smartphone business. That deal is expected to close in the current quarter, as reiterated by Nokia executives this morning.

Microsoft hasn’t announced any news about its CEO search this afternoon, but this is one of the challenges that will be faced by Steve Ballmer’s successor — whomever he or she turns out to be.

PreviouslyMicrosoft posts record revenue of $24.5B, beats earnings expectations in holiday quarter

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