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ANNOUNCER: Please welcome Senior Vice President and Chief Financial Officer Chris Liddell. (Applause.)

CHRIS LIDDELL: Good afternoon. So what's the biggest challenge facing a new CFO at Microsoft? That's probably the question I've been asked most frequently in the eight weeks since I've joined the company. Is it understanding a fundamentally different business model? Is it integrating myself into the senior team? Is it signing off on Sarbanes-Oxley 404 for the company for the first time?

It's actually none of the above; they all pale in comparison to getting to learn the language, in particular the language of acronyms. We have around 230 official acronyms here at the company, and your employees should get to know them all and use at least two or three in every conversation and presentation. So, my challenge today is to give you an AFP, which is an acronym-free presentation. I'm going to do it on a topic which I know is important to you, and is also important to us, and that's driving shareholder value. I'm going to do that by using a simple framework which looks at three interrelated elements and then how they relate to shareholders.

At the top of the framework, you see growth, and you've heard a lot about growth here today. That's our life's blood, growth in earnings, growth in operating income, growth in earnings per share. That drives cash, which in turn we can either return to shareholders or reinvest in the business through investments to drive further growth. Clearly what we're trying to do here is create a virtuous cycle. The more growth we can drive, the more cash we can generate, the more investment we can have, and the higher growth we can have to pay out to shareholders who benefit either directly through cash or indirectly through making that circle bigger.

What I would like to do is apply that framework to our performance over the last five years, and also over the last year, looking forward to the next year, and then also look further out, and perhaps even the presentations that you've heard during the course of the day in that framework.

Let's start with revenue growth. I'll put the same 25 companies that Steve talked about earlier in the day, and looked at their collective revenue growth over the last five years. Those 25 companies have grown by around 36 percent cumulatively over that period. By comparison, we've grown 73 percent, roughly double that, and in an environment that hasn't always been favorable to us. We've also been able to generate very broad-based growth. So, if you look at our three core businesses, you'll see they've grown by around 70 percent on average over that period, and they've added $12 billion of revenue collectively. To put that in perspective, the total revenue for SAP is $10 billion; for Oracle, $11 billion; and for Apple, even with their hardware business, around $10 billion. So, our three core businesses have managed to grow collectively by more than the total revenue of three of our major competitors. We've also seen in our other businesses, they've all grown in triple digits, and have added around $4 billion of revenue over that period. Each of those businesses would be significant businesses in their own right if they were separated outside of Microsoft. That's growth in revenue.

How have we been able to translate that to growth in earnings? The revenue has been relatively constant over the period of the five years. It's been around 12 percent compound annual growth, and adding around $3 billion of revenue each year. By way of comparison, our operating income has grown at an 18 percent compound annual growth rate, and this is our GAP operating income with the one such as legal settlements taken out. And you see here, we managed to grow not only faster than revenue, we've had quite a different structure over that five-year period. The first couple of years investing more significantly in the business, and hence expenses growing faster than revenue, and then a period there afterwards with earnings acceleration accelerating faster than revenue. And that's the sort of pattern you can expect to see from us in the future. There will be periods where we make conscious decisions to invest more than revenue, and there will be other periods where we harvest and get the benefit of that investment.

So, how have we been able to translate that growth into cash? We've generated around $169 billion of cash over that period, and for the purposes I've added investment income into revenue to get up to GAP numbers. And when people ask me what's the single biggest difference between Microsoft and the other companies I've worked in the past, that's pretty simple: it's the ability to turn revenue into free cash flow.

Of that $169 billion, the net cash flow from operations has been about $75 billion over that period. That $75 billion is clearly available for capital expenditure, acquisition or return to shareholders. The biggest difference when you look at ourselves, or other more traditional companies, is the amount that we need to spend on cap ex., or traditional cap ex, are extremely modest. So from that $75 billion we'll spend around $1 billion a year on capital expenditure, $5 billion in total out of $75, so a very small number.

We have invested in acquisitions, again, around $1 billion a year, or $5 over that period, with a view going for targeted, relatively small to medium-sized acquisitions. Generally speaking in market-leading positions, which has also given us great people.

So in terms of our return to shareholders, we've managed to return over that period one of the biggest collective payouts in corporate history, $69 billion. That's been by way of our $33 billion special dividend that we paid out last year, $3 a share, about $30 billion of buybacks over that period, and our regular dividends, which have added up to $6 billion.

I know a lot of you want to know and have talked to me about our general payout policy, but I will point out in this context that virtually all of the free cash flow that we have generated over the last five years we have paid out to shareholders. As I showed you on the previous slide, we spend about $5 on capital expenditure, $5 on acquisitions, we've paid out $69 billion over that period.

We've also been able to do it at a time where we continue to invest in our core businesses. Again, this is one of the fundamental characteristics of ourselves as a business. Our investment happens in the cost line. So we spend almost $100 billion on our cost of goods sold, R&D, sales and marketing, and other costs — in R&D alone $20 billion. That expenditure drives not only current revenues, but also obviously future revenues. It's driven what you've heard a lot about today, which is a huge product pipeline over that period, which fuels the engine of growth for this company, and has created revenues not only in the periods that you see, but revenue going out into the future.

So that's the last five years. What I wanted to look at now is last year and how we performed there. Last year in all contexts was an excellent year. We outperformed on every line, in terms of our expectations. Revenue grew by 8 percent relative to our expectations when John Connors, my predecessor, stood up here a year ago and thought about 4 to 5 percent. Operating income, we managed to beat what our expectations were, despite significantly investing in the future of the company. Investment income was broadly twice what our expectations were, and the sum of those two meant that we were able to achieve earnings per share greater than our expectations.

There was some outstanding performance from some of businesses behind those results as well. Server and tools, for three consecutive years has double-digit growth; 12 consecutive quarters, quarter-by-quarter, double-digit growth. Our Home and Entertainment division, 22 million consoles sold in total, Xbox Live memberships up, and game revenue up.

Our performances in client and information worker, 6 percent growth and 3 percent growth, just like the fact in our information worker business — for example, we had hard comparables compared to the previous year, with our Upgrade Advantage business trailing off. Our Mobile and Embedded business had 36 percent growth, so a great year in every context, and a broad base across all businesses performing well.

We also managed to have some great acquisitions over that period that added to the strength of the company. Groove, which also gave us Ray Ozzie, who you heard earlier today, Giant Software, Sybari, and FrontBridge that we recently announced, although that's still subject to regulatory approval.

We have delivered on unearned income. We're seeing roughly a billion dollars over where we started the year. We launched some great products, and we also met our pro rata commitment on our share buyback with $8 billion of share buybacks during the year. We managed to do those buybacks and still grow cash. And the reason for that is we had another great year from a cash-flow point of view. We generated $17 billion of cash flow from operations, a record for the company. So we're able to take that cash, make our share buyback, and still replenish our total cash to around $48 billion by the end of the year.

That $48 billion we managed conservatively on your behalf, we have some in a strategic portfolio, mainly in telecommunications and in IT companies, but the great bulk of it is in relatively liquid, short-term investments.

We are very happy, however, with our level of performance in that, and one of the reasons why we were able to overdeliver on investment income last year.

Turning to the future and looking at next year, and this is consistent with the guidance and details that we gave out on the earnings call last week, overall we see double-digit growth for next year, 10 to 12 percent. We see that against a backdrop of an economic environment that we think will be relatively stable and give us conditions that were broadly similar to ones that we've had in the last year.

Our client business, we expect to grow 5 to 6 percent based on overall PC growth of 7 to 9 percent, and balanced across all geographies with Asia being double-digit growth.

We see our OEM business growing broadly in line with our market, and non-OEM business improving from what we saw in FY '05.

Server & Tools we expect to grow in line with the general environment, 11 to 13 percent, underpinned by our SQL Server launch and also our Visual Studio launch later this calendar year.

In information worker business we're looking at 5 to 6 percent. Now, normally you would expect a relatively slow year in the year leading up to a major launch such as Office 12, but we expect the breadth of products there and product range to give us higher growth than we would expect, and also despite that business suffering foreign exchange headwinds going into the year.

On Business Solutions we've picked the momentum that they had coming out of the fourth quarter where we saw double digit growth from them last year to continue next year, underpinned in their case also by some product releases, CRN 3.0 and Great Plains 9.0.

In MSN, as you just heard about, a similar pattern to last year, with strong search revenue offset by our Access business which is declining.

Lastly, our home entertainment division, obviously a fantastic year coming up, greater than 50 percent growth with the Xbox 360 launch at Christmas.

We also expect the shape of the year to be different from previous years. We will expect revenue to increase through the year but costs to be relatively front loaded, as we spend in particular marketing money on our launches, for example SQL Server, Visual Studio, and Xbox, and also going into the second half of the year, with Windows Vista and Office 12 next year. So the shape of the year, revenue accelerating, costs relatively flat through the year.

Operating income we expect to grow to $18.3 to $18.8 billion. On a growth-rate basis that's broadly in line with revenue, and also earnings this year, so all of those roughly in the 10 to 12 percent range on a GAAP basis.

So despite the investments that we're making next year, from an operating income point of view, we'll manage to grow that broadly in line with earnings per share.

We always remind you each year that there are some risks factors associated with our guidance, the most obvious one being PC and server shipment growth. I talked of PC growth around 7 to 8 percent, server growth around 11 to 13 percent. That's our expectation, that's in line with third parties out there. So we believe that we're not being overly conservative or overly optimistic; we think they will be reasonable numbers.

Annuity license and renewals, last year was a big year for us, $8.8 billion of annuity license for renewals. Next year will be a more typical year with around $7 billion.

Executing our product launches, clearly we have a huge year from that perspective, and we need to execute not only from a launch point of view, but we also obviously need to connect with our customers to get the revenue growth that we expect.

Linux and noncommercial software, you heard from Kevin how we think we believe we can overcome that challenge.

And finally, foreign exchange risk. Foreign exchange for us has been a benefit over the last couple of years; we've gained around 2 percentage points of growth from foreign exchange benefits. Next year we expect this to be about a 1 percent drag on the revenue, but we have built that into our 10 to 12 percent expectation.

I'd now like to look further forward and summarize what you've heard during the course of the day in terms of what's going to drive our growth engine going forward. You heard from Steve at the start of the day about our overall growth agenda, about how we're going to grow around three core areas of anchor, growing our portfolio and services.

You heard from Bill and Ray around technology and portfolio innovation, looking further afield, and how we expect to get into software services.

You heard from Will about growing your portfolio, recapturing revenue from piracy, expanding markets in anticipation around Windows Vista.

You heard from Jeff about expanding the information world, increasing our revenue- based opportunities, and delivering more products such as Balanced Scorecard Manager, Small Business Accounting and Office 12.

You heard from Kevin about Microsoft's unique value proposition, centered around reliability, total cost of ownership, security and indemnification; from Eric about the momentum we're gaining in terms of marketing share with developer and customers based around Windows Server, SQL, Visual Studio, Exchange and Management; from Doug around the strength we have in business applications, and the benefits that we expect in that area from Office and Small Business Accounting, CRM 3.0, and Great Plains 9.0; from Peter and the momentum we have with device-makers, mobile operators, and connective devices, based on the Windows Mobile platform; Robbie, the convergence of digital lifestyles, and how we expect to take benefits with Xbox games and IPTV; and finally, Yusuf and Blake around how we've driven customer satisfaction in MSN, the global online ad opportunity, and how we're going to drive revenue through MSN Search, MSN Ad Center, MSN Spaces, and Windows OneCare.

So what does that all add up to? It adds up to over the next six months and in future years what we believe is the strongest product pipeline the company's ever had. And it's not only the banner that you would expect, it's right across all businesses, all of which are represented on this slide.

We also expect the product pipeline to fuel revenue growth and to fuel operating income. Steve showed you this slide earlier in the day, and he looked back at the last five years and how the pie for the top 25 that we've compared ourselves to has increased, and how our share of that pie has also increased over that period. We believe the pie will continue to increase, and we see absolutely no reason why we can't have a greater share of that pie.

To do that, we're going to have to make more investments, but we're going to be very disciplined about the investment approach we take. And I'll distinguish between spending more money consciously with investments, and being absolutely as efficient and effective as we possibly can with every dollar that we spend.

We're going to continue to take some big bets, and we're going to continue to have acquisitions as a fundamental part of our growth platform. We're also going to continue on our share buyback plan of $30 billion over four years.

So what does that all add up to, and what can you expect from us in the future? We intend to continue to drive growth, we intend to continue to maximize the cash flow that we can get from our businesses, and we intend to continue to aggressively invest in our future, all of which has a view to driving shareholder value. The performance of this company has been outstanding over the last five years, but we believe there's no reason why the next five years won't be even better.

Thank you.

END

Due to the varying sound quality and subject matter of tapes, the information in this transcript may contain inaccuracies.