COLLEEN HEALY: Welcome back. I hope you're getting what you need out of the day. It's been a pleasure so far hosting you, and we look forward to seeing you later tonight at the reception. We are entering what will be our final presentation, and then an executive discussion with Bill, Steve and Chris. Before we get to that, I want to thank you for filling out the evaluations on CommNet, please do continue to do so. We are at the point in our day, though, where we've picked out winners and I have the pleasure of announcing those.

The winner of our first Zune is Craig Gentry. Congratulations, Craig. Winner of our other Zune is Raymond Scanlan. Now on to the Xbox 360 bundle. Winner of the first Xbox bundle is Kishore Rao, and of the second Xbox 360 bundle is Scott Simpson. Congratulations. Winners can pick up their prizes at the reception desk at the end of the day before you leave.

So with that, it gives me great pleasure to introduce to you Microsoft Chief Financial Officer Chris Liddell.

CHRIS LIDDELL: Thanks, Colleen, and good afternoon everyone. I want to wrap the day up by doing three things. Firstly, I want to report back on what we said we were going to do last year and how we did against that. The second is I want to put a bit of financial meat on all the presentations you've heard today. And the third thing, in particular, I want to really talk about those numbers and help you interpret them in the context of how we think we're driving shareholder value.

To do that, I'm going to take the same framework that I used last year and report back against it. So you recall that I said last year in the discussions that I had with all of you, there were seven common themes to what you wanted to hear about from a shareholder perspective. You wanted to hear about how we're driving growth in our core businesses and what you could expect from that, what our strategy was to win online, how we were driving entertainment profitability and when you could expect to see profitability in that division and what it would look like, what we were doing with the cash that we had in terms of returning it, what our overall margin structures were doing, what discipline we had on the investment inside the company, and finally, how we were communicating with you.

So I want to take those seven key themes and report back on how I feel from a balanced scorecard perspective we've done over the last year, and what you can continue to expect from us going forward.

Let me start with some hard numbers and talk about the report card from a financial perspective. Let's start with revenue first. Obviously, it was a very, very good year for us. We guided to Client revenue of 8 percent to 10 percent, and we came in at 14 percent. So we had not only strong adoption of Windows Vista from a product point of view, we had an extremely good financial result in the Client division.

Server and Tools turned in just another great year of performance, 16 percent, fifth consecutive year of double-digit growth, mostly in the mid-teens. MBD, which is information worker business in particular, again, another great result. Office did particularly well on the retail side, and we saw a 13 percent revenue growth year on year, well above the guidance that we gave you a year ago of 9 percent to 10 percent.

Online Services came in-line, 8 percent, but matched the advertising revenue, which Kevin Johnson mentioned to you, in excess of 20 percent, but in-line with our expectations. Entertainment and Devices also was a bit below the range that we talked about, came in at a very strong 28 percent for the year.

So overall for the company, we had 15 percent revenue growth for the year, and passed the $50 billion of revenue mark for the first time. In terms of how that translates into operating income and earnings per share, I'm showing you two numbers here. I'm showing you with and without the Xbox warranty. So depending on how you treat that from a financial perspective, whether you exclude it from your models or include it, I'm showing both numbers.

And what you see is if we include the number, we made $18.7 billion of operating income, $19.7 billion before the warranty. So above the range in one case, slightly below the range in the other. And similarly, from an earnings per share point of view, before that eight cents per share warranty charge, so we were above the top end of the range from an earnings per share perspective.

Put it another way, that's a 17 percent growth rate on earnings per share. So a very good result from the revenue point of view, a good result from an operating income point of view, and a very good result from an earnings per share point of view.

Probably of more interest at the end of the day is what that looked like from a shareholder point of view, and that translated into the total shareholder return of 28 percent for the year. That's July 1 through June 30, I could have done it from the end of the results period, the day after the results this year, and that would have been 32 percent. And, obviously, some of you will say, well, it was at a low point last year, I could have gone back two years, and it would have been around 25 percent.

But measure it however you like, last year was the best financial year from a shareholder perspective that we've had this decade, at 28 percent. That's the combination of the share price appreciation and the dividend we paid. So it was a good financial results year, it was a good year from a shareholder perspective as well in terms of the absolute return that you saw.

Clearly, though, it's what have you done for me recently, and what can you expect going forward. And that's why we're going to go into the seven investor focus areas to talk a little bit about them, and build on the presentations that you have heard.

Let's start with the growth rate in the core businesses. And I describe those as Client, Server and Tools, and MBD as we support them externally. Last year I said we'd grown $10 billion in the previous three years in those businesses and because of the $5 billion of growth that we saw in one year from those three businesses, we've grown $15 billion in the last four years. So we've actually accelerated the rate of growth relative to when I stood here a year ago.

And we've translated an 11 percent compound annual growth rate to a 12 percent annual compound growth rate over those four years, and are guiding in about that same range of 11 percent to 12 percent going forward. So we're starting from a very strong base. These businesses have a track record of double-digit growth. And the question that people always ask me is: when is the law of big numbers going to actually catch up with you. Clearly it hasn't caught up in the last three years, and is not necessarily going to catch up this year if we meet guidance.

And in terms of the opportunities that we have of growing the businesses, you heard from Kevin and Jeff and Bob and the other Kevin in the Q&A about the opportunities we see. And the framework I really liked is the one that Kevin Turner presented to you about the way that he thinks of selling the opportunities in the business. We, obviously, talk about the products and the technologies, but from a field point of view and a customer point of view, the ability for us to beat the law of big numbers is around two things: Firstly, to grow units in excess of the market, and secondly, to grow revenue in excess of unit growth.

The market growth overall is still very healthy. PC unit growth, growth in corporate spending, growth in servers are still very healthy from an industry point of view. We're in one of the relatively highest-growth industries around in the world. Our ability to grow units is still very good. So Kevin talked to you about, for example, our EA growth and our ability to continue to penetrate and get renewals from our existing companies.

There's clearly an opportunity in terms of fighting piracy to grow units greater than the market growth. But for me, the opportunity really comes in growing revenue faster than units. And that's very much about up-selling, up-selling to premium, and up-selling our customers, and then cross-selling, and cross-selling the suite of products.

I normally keep my charts relatively simple, but this is a chart I love because it gives you a sense of the breadth of the products that we actually have to sell from a customer point of view. And you saw Steve put this chart up. And this is actually a chart from last year; we've got a similar chart for the next few years.

Because of the format that we used this year, we cut back on the presentations and we cut back on the demonstrations. So we didn't have the ability to actually demonstrate a lot of these products. And I use the rule of thumb that I have on product demonstrations that the economic value associated with the product is generally inversely proportional to the excitement it generates from a demonstration point of view.

So, you know, things like SharePoint don't get the pulse racing in an environment like this, but they work very well at CFO conferences. And so what I said to the sales team in our annual sales conference earlier this week that was from my perspective we have the best suite of products we have ever had to sell as a company. Our ability to cross-sell and up-sell has never been higher. So our ability to continue to generate good growth rates in our core businesses is as good as it has ever been.

In terms of our strategy to win online, there's a tension in my mind between progress in the short term and our progress in the long term. And I think Ray and Kevin Johnson did a very good job talking to you about some of the progress we've made in the short term, for example in terms of the products like Silverlight that we're rolling out, some of the markers that Kevin uses inside his business, LIVE IDs, advertising growth that's grown four consecutive quarters. So we've made good progress in the short term.

But from an economic value and shareholder value point of view, what we do over the long term has significantly more relevance to it. And I think, again, Kevin and Ray did an extremely good job of laying out the platform approach that we're taking to the business, not only in terms of the advertising platform in a relatively narrow sense, but the services platform in a wider sense that Ray talked to you about.

And for me, it's about building the online businesses of the future. The economic value that is available in this space is huge. And I think Kevin alluded to that in one of the slides he showed you. There are going to be relatively few winners in this space. The economic value, I believe, is going to gravitate to a relatively small number of players. There will be some niche players who do well, but from a platform perspective, the ability to deliver the platform of the future will be the defining feature of who gets the economic value.

And that's going to be a component of who has the right technology, who has the right I.Q., and who has the right capital. And in my view, there are an extremely small number of companies that are capable of doing that, and we are clearly going to be one of them.

In terms of Entertainment profitability, clearly, it wasn't a good year this year. I think Robbie did a good job of telling you the Xbox story inside the Entertainment Division, and there are obviously, from a Windows Mobile point of view, which as you recall we used to report as a separate division that was profitable last year, there were some other parts of the division that did very well. And the important thing from my perspective, and certainly from the CFO point of view, is that the commitment to profitability remains. So exactly what he told you last year, which is that we will have a loss this year and a profit next year remain the same. We're all disappointed on the extent of the loss that we saw this year, but in terms of the road map to profitability, the marketplace acceptance of our products and what we believe we need to do next year in order to generate profitability, that commitment remains, and that road map remains.

On the cash side, it was an extremely good year from a cash-generation point of view; $18 billion measured on a GAAP basis was an extremely good year from a cash return point of view. So we returned, in terms of buybacks and dividends, $31 billion: $27 billion through buybacks and $4 billion through dividends. That's around 175 percent of the cash we generated.

Now, that excludes some of the cash that we got in from option exercises and in terms of what I control, which is obviously more on the buyback and dividends; this is the approach that we took. We saw it as a big year of return. We started the year, as you recall, by announcing a tender around this time for $20 billion. We had another $20 billion of buybacks. We rolled the unfulfilled tender amount into the rest of the buyback and carried out at a very high rate on a quarter-by-quarter basis for buybacks in the market.

To give you a sense of what that looks like on a year-on-year basis, last year was the biggest year we've ever had from a buyback point of view, $27 billion. I'd like to have said it was the biggest year anyone ever had. I went back and looked, and I saw Exxon did $28 billion one year. The next biggest anyone has ever done is in the mid-teens. From my point of view, it was an extremely good year, $20 billion and $27 billion, and we continue to make progress on dividends as well. It's not as substantial from an economic perspective, and a number of you always ask me my preference to buyback versus dividends; they continue to be — from where I sit and when I look at the value of the company's opportunities- I still have a preference for buyback relative to dividends, but we have gotten much more systematic in our dividend approach.

We don't have a long history; we didn't pay a dividend five or so years ago, like most technology companies which still don't pay a dividend, but we have gotten more systematic and we will be more systematic in the future. So you will see a pattern emerge from the dividends perspective. We don't have a policy that we want to announce as such, but you will see from our behavior that dividends will be a fundamental part of our behavior going forward.

Overall, and this is a number that Steve shared with you, we've done over $100 billion of buybacks and dividends over three years. So to put that in context, that's clearly a huge amount of money. It's about a third of our current market capitalization, it's significantly larger than any other company has ever done in the history of corporate America, or anywhere for that matter, and it has been part of our commitment to shareholders to return not only the cash we had at the start of that period, but the cash that we have generated over that time.

I think it's interesting when you speculate about what we might do going forward to think about this graph, which I also shared with you last year, and talked very much about one of the -- I think the most important business model to Microsoft relative to other companies, which is how we generate cash and what we do with it relative to other companies.

And you recall, I compared us to other large tech companies and also other large non-tech companies like Exxon and GE and Wal-Mart. And, clearly, our need for capital was a lot lower than other non-tech companies, and also relatively modest compared to other large technology companies. And that gave us the free cash flow generation that I was talking about that allowed us to have the massive buybacks that we talked about.

Interesting what's happened to the industry in that time since last year. If you look at large non-tech, it's pretty much the same. What has changed is in the technology space. So you have seen the beginnings of a much more significant use of capital inside technology, clearly in the online space in particular, and a use of acquisitions as a way of funding growth.

So the technology space is now, if you like, caught up with the use of free cash flow as a way of driving growth through capital and acquisition. And we're not that different. So we're still modest compared to most companies in terms of the capital we use, but if you include the aQuantive acquisition -- I've shown it separately because it actually is in fiscal year '08 rather than fiscal year '07, but as you see, it was part of what we did last year. We are clearly using our free cash flow not only from a shareholder buyback point of view, but progressively more as an important, strategic way of driving growth. And when you think about the platform that Ray talked about and the necessity for capital going forward, it is going to be one of the defining characteristics of who is going to build the platform of the future.

It's impossible to tell what the shape of this is going to look like. Would we do another aQuantive? Possibly yes, if we saw the right opportunity. Is it going to be -- we're going to do one a year? It's never going to be as simple as that. We may never do another one of that size. We may do one next month if it was the right one to do. What we are saying is that if we have to use our balance sheet to drive growth, and we will. And I'll put it in another context. Next year will be the first year that we have spent more on acquisitions than we have on R&D.

So it is an interesting dynamic going forward. I think it's an interesting dynamic for the industry overall, and it's certainly an interesting dynamic. What is important from my point of view is the strength of our cash flow. Even with the biggest acquisition that we've done in our history, even with a significant amount of more capital, we are still generating a large amount of free cash flow relative to our overall cash.

Margin structure. I probably find this the most frustrating conversation of all with you as investors because, as I said last year, it makes no sense to look at Microsoft's overall margins in terms of operating income over revenue because we are such a fundamentally different mix of businesses growing at different rates. Despite that, I know that’s the way that you build your models, and so I try and communicate the margin structure as the way that I think about it, which is in our core businesses which has relatively homogenous characteristics, and our margins inside our Online Business and in Entertainment and Devices. And, clearly, they've gone quite different ways.

But if you look at the margin structure inside our core businesses, the collection of Client, Server and Tools, and Office, it's an extremely good story that's, broadly speaking, been able to grow double digits, the rate that I talked about, and maintain a constant margin, broadly speaking, over the last three years. Slight increase from fiscal year '04.

Clearly, in terms of the Online and Entertainment and Devices division, they're a negative. There's a commitment from the Entertainment and Devices division to go positive next year; that commitment remains. The Online business, as I think Kevin Johnson mentioned to you in his presentation, will be negative next year; it will be in an investment phase. That is a business where we are willing to take an investment approach in order to generate the economic value that we see long-term. But overall, if you actually disaggregate our margin structure and look at it on the constituent businesses, I think it's actually a reasonably good story, certainly from a core business point of view.

The other way that I think about margins is, we tend to think about them as operating income over revenue. There's an argument that Steve makes: you should really look at operating income over gross margin, but that's for another day. But the other thing that I look at is operating income to earnings-per-share growth, because that's one thing I certainly have some influence over. And when you look at our earnings per share, over the last three years, we've been able to actually grow our earnings per share faster than our operating income.

There are a couple of reasons for that. One is, principally, the share count impact of our buybacks, so over the last couple of years, we've managed to reduce our share count by 14 percent in total from a high of 10.9 billion shares to a recent low of 9.4 billion at the end of last fiscal year. And clearly that reduction in share count has helped drive our earnings per share relative to our operating income by 3.5 and guidance of 1 percent next year.

The other thing which I don't show on the chart is, our tax rate has aggressively been coming down, and one of the benefits of our international diversification that Kevin Turner talked to you about is not only do we tap into high-growth markets, not only do we get the benefits of the depreciating U.S. dollar, we also generate for the most part in jurisdictions that have lower tax rates than the U.S., so our aggregate tax rate is also declining over time.

So, a combination of all of those factors means that if you think about earnings per share relative to OI, that margin has been appreciating in the last three years.

When I think about investment discipline, there's two ways that I think about it. One is the long term and the second is the short term, and they really have quite different characteristics and quite different disciplines associated with them.

When you look at the long term approach, one of the defining features of Microsoft, which we are not at all defensive about, is our willingness to take a long timeframe. And when I talk about a long timeframe, I'm talking about five to 10 plus years or more, not five to 10 quarters. And I think Bill and Ray and Craig did an excellent job of talking about the visions that we have that are above the investment horizon that most of you have.

Clearly at the end of the day, how good we are at making these decisions is more important than the dollar amount associated with them. The economic value generally speaking is huge, but the quality of the decision-making is really the defining factor we have, and through our strategic planning process is the thing that we focus on the most.

Most of these decisions are not 15 percent IRRs that become 16 or 14. Most of them are winner-takes-all or extremely high net present value decisions if we are successful in the marketplace that we make.

Now, so you have to question what's our ability to not only make good decisions but turn them into economic value over a long term. Clearly Windows and Office are the most obvious examples. That's going back a long time. Go back 10 years and think about the Server and Tools business, which wasn't in existence to any great extent there, which is now one of our fundamentally biggest and most valuable businesses; but then look more recently on some of the businesses that we've created or driven from essentially virtually no amount of revenue to relatively significant over the last five or so years.

So, Windows Server itself, 13 percent CAGR since fiscal year '02, now $4.5 billion; the Xbox business clearly; SQL Server, another one that doesn't lend itself to a great demo, but it's a $2.7 billion business, growing 28 percent over the last few years; the advertising business, Exchange, Dynamics and SharePoint, which Jeff mentioned. Those are great businesses, have extremely good margins for the large part, and they have extremely high growth rates. Most of them were associated with decisions that we made five to 10 years ago that are now coming to fruition.

So, to me our long term approach on the discipline that we have is all about investing in the right businesses and making the right decisions about where we stand for the long term.

But the other dimension, which you can admittedly hold us accountable for, is how well do we then -- what's our accountability relative to what we actually say we will spend from there. And there are two elements I'll show you here. One is headcount. Headcount is the largest single cost that we have, or the costs associated with headcount, and it's probably the primary driver of costs associated with us. So, the more marketing people you have, generally speaking the more marketing money they spend.

So, what you have seen here is the cyclicality in our headcount growth. Clearly, fiscal year '05, increasingly in fiscal year '06 in particular, were large headcount-growth years. We're now at the end of last year relative to the end of the previous year at around 10 percent, so more modest headcount growth. So, you are seeing a moderating headcount growth, and hence a moderating expense associated with it.

The other thing that I was delighted about is where we came in from an overall expense point of view relative to last year. So, I think Kevin Turner in particular has just done a fabulous job in the field, who are the people who have most of the variable costs associated with them, but right across the businesses in coming in where we said we were going to come in from an expense point of view.

So, better than the guidance that we gave you last year with $21.73 billion of operating expense, we came in at $21.75 billion. So, for a cost base of that size to come in within a couple of hundred million dollars, but within less than that, is a fabulous result.

And what that actually means, again to a question that I took in one of the breaks, is all of the gross margin upside that we made effectively went to the bottom line. So, we beat our gross margin guidance by $400 million to $800 million. All of that, if you exclude the Xbox warranty, went straight to the bottom line.

So, we don't have an issue, which I know as investors you've heard in the past, which is that we beat our revenue, but we spend it. To a large extent we have an extremely good discipline around the budgeting process, and extremely good discipline in particular in the field in spending what we allocate from the budget.

When I look at communication, I said last year that we were going to try and increase the amount of communication in between Financial Analyst Meetings, since typically the Financial Analyst Meeting to date has been our single biggest communication, and then there's been a relative lull for the other 11 months of the year.

What you see here is every month since last year we have had an event of some form or other, whether it's obviously the quarterly results or a conference associated with one of the major partners we have, and virtually all of the speakers that you've had today have presented at least once or possibly twice at those presentations.

So, continuous communication, even if we tell you things that you don't like to hear, is critical from my point of view, and continuing to revise the approach that we take. For example, hopefully you found the question and answer sessions from all the presenters today as a slightly different and useful way of presenting. So, we will continue to invest as much time as we possibly think is relevant in you as shareholders and increasing our communication and making sure FAM is not just a once-a-year event, but it's just part of a continuous stream of communication.

If I look at guidance for next year, and then I'll wrap up and give you a chance to ask some questions. These were clearly in the call last week, so they shouldn't be news to you. But if we look at guidance across all of the individual businesses for next year, bearing in mind they're all coming off a very good fiscal year '07, so the comparables are getting harder; you see at the top end of the range double-digit growth between 10 and 20 percent for all of our businesses, and total revenue in this case breaking $55 billion and growing at 11 to 13 percent, so another good year from a revenue generation perspective.

Equally as important is operating income and earnings per share. In this case I'll compare year-on-year growth rates to the top end of our range, so I've excluded the Xbox warranty, the harder comparable, if you like, and we're growing operating income by 12 to 15 percent and earnings per share by 13 to 16 percent. So, not only very good numbers of 13, 15 and 16 percent at the top end of the range, but also a very good trend clearly from a margin perspective and particularly if you look behind the margins but overall for the company a good year as well, 13, 15, and 16.

So, again from my perspective, when is the law of big numbers going to catch up with it? It's not going to be next year.

So, from a scorecard point of view how do I feel about the year, and how do I feel about going forward? When I work around the seven things that you have told me are important to you, I think our growth rate in our core businesses has been extremely good: $5 billion of growth and a continued double-digit growth rate with a margin structure essentially the same year on year, extremely good performance. I've done a green, yellow, red here on the way around; that's the green.

Strategy to win online: I'd like to see more progress in the short term, but what progress we have made I'm happy with. I think even more importantly is getting the fundamentals in place for what I consider to be the important issues in terms of long-term shareholder value creation. So, I'm giving that a green for this year as well.

Entertainment profitability I'd say is yellow; some of you might say a red, given the performance in particular of the Xbox division, but to the extent that we remain on track in my view to profitability next year, I think it's a yellow, somewhere between a yellow and a red. It's clearly an issue where we have a lot of work to do in the next 12 months.

Return of cash: I think even the most tough-minded of you would say it's been a good year in terms of return of cash, $27 billion. It used to be issue number one when I went out and talked to investors. I know it hasn't gone away, I'm sure it's still in the top five or 10 for most of you, but relatively speaking it's probably dropped down from the number one position in terms of what we do with the cash. I think it's been a very good year in terms of that, and hopefully the dividend policy was you'd like to see more I'm sure, again you're starting to see unfold in front of you.

Overall margin structure: a yellow. I could be more a bit positive than that, because I think the margins, in particular on our core businesses, retaining those in a growth year and in an investment year, if you think about the headcount growth we had, was very good; but clearly when we have two businesses which are losing money and hence have negative margins, I don't think that's the position that we want to see as sustainable, and until we get those, at least one of them positive and preferably two of them positive, we can't really claim victory from a margin structure perspective.

Investment discipline: I've been very happy with the progress we've made from an investment discipline perspective, in particular in the short term but also in the long term. I think that the quality of the decisions we're making, the quality of the discussions that we have in our strategic planning process are as good as I've seen and getting better, and when I see the investment discipline in particular in the field, and I talk to people out there about the way that they're running and the accountability structures that we have, I'm very happy with the progress we've made.

And lastly from a communication point of view, you can give me feedback afterwards at the drinks or when I see you over the next few months, but hopefully you are seeing an increasing amount of communication from the company, and hopefully you're seeing the type of communication you want to see as well.

These are the issues you tell us are important. These are the issues that we have addressed to date. You might not be happy with all of our answers, but there's nothing that we are hiding. We're happy to address any issue that you think is important at this day or any other presentation that you see from us.

So, from my point of view, fiscal year '07 was an extremely good year, extremely good year from a financial perspective, an extremely good year from a shareholder perspective. FY '08 is shaping up to be another very good year. And in terms of the balanced scorecard that I use from a shareholder perspective, I feel it's very strong.

So, with that, I'll thank you, I'll thank you for your participation. I know it's been a long day. I hope it's been a very good day in terms of the presentations that you've heard in Q&A. And what I'm going to do is ask Steve and Bill to come out and join me, and we'll have a final Q&A before we have an opportunity to meet afterwards. Thank you, all.

END

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