COLLEEN HEALY: Great. While we're setting up chairs here for our Q&A, let me just outline how this will work. Like in past years, we'll take some questions from the CommNet that have been pre-submitted, and then walking around the room you'll see members of the Investor Relations team. If you have a question, raise your hand, and one of them will come to you with the microphone.

So, I'm delighted to facilitate this Q&A. With me I have Jeff Raikes, president of the Microsoft Business Division; Kevin Turner, chief operating officer; and joining them Kevin Johnson, president, Platforms and Services Division; and Bob Muglia, senior vice president, Server and Tools.

So I'm going to kick things off by taking a pre-submitted question, and then we'll open it to the floor. First question is for you, Jeff, and that would be, "How do you plan to be successful in the voice over IP business, given Cisco's entrenchment? Is there room for multiple big players, or do you think it tends to gravitate towards a winner-take-all?"

JEFF RAIKES: Well, I think, first of all, this is a very exciting area where it's very clear, when you look at the market, there's a lot of customers that have yet to make the decision on what direction they want to go. There's a lot of investment ahead.

And the second point I would make is customers are truly seeing the magic of software in this context. When we have the opportunity to show customers what we showed today, they get it. They see that they're going to get more capabilities at less cost than the traditional approaches, whether that's any of the existing players. The market today -- Cisco, Nortel, Avaya, Siemens, Alcatel -- there's kind of a traditional approach.

As I've indicated in some of my comments, in the industry this is a market that will transform, much like enterprise computing did, where it rallies around a software platform. In that case, it was the Wintel server platform. In this case, we believe it will be the Microsoft Communications Server platform. And the additional value and the lower cost that customers will get will be the winning formula.

KEVIN TURNER: And the customer is really driving this into the space. I mean, the convergence of voice and data and e-mail in the PC -- I mean, they're the ones driving us into the space in this particular area. They don't like the premiums, this cost today from our competitors. And so it's a huge opportunity. But the customer's driving in the space in a big way.

COLLEEN HEALY: Thank you. Microphone number two, please.

QUESTION: Thanks. A question for Bob as it relates to the server business: Can you just highlight what you think the most important characteristics for Windows Server 2008 for customers to upgrade? And as it relates to virtualization, there's been chatter that key component has been delayed till later from the initial release. Can you talk through the timeline of virtualization and kind of how you're embracing that going forward? Thanks.

BOB MUGLIA: Sure. Windows Server 2008 is, first and foremost, a great release of Windows Server, so it just really builds on all the great things that customers have really liked in Server 2003 and works really well in the environment. It's really helpful in terms of moving into data centers with features like Server Core, so you can really take the operating system and deploy many of the roles in a very small environment, which lowers the footprint and makes it easier to maintain the system. It has a great new set of features in many dimensions. The Terminal Services functionality is improved. Web serving capabilities are dramatically improved. We've had some competitive issues with Apache, particularly in the hosting space, and we eliminate those deficiencies there.

So if you look area by area, you'll see with Windows Server 2008 improvements in the directory service. I mean, if you go area by area that Windows Server is used, there is a long set of improvements.

On the virtual -- there's no question virtualization is one of the key features for Windows Server 2008. We're very much on track to deliver virtualization within the 180 days that we committed to. And we're feeling very strongly that we're going to have a competitive offering with Windows Server 2008 and our management products in the virtualization space.

Virtualization is a key trend in the datacenter in enterprises, and we're going to be introducing this fall a great, very, very competitive management product that really eliminates the biggest deficiency we've had in terms of competitiveness in the virtualization space. This is System Center Virtual Machine Manager. So we have a really great management solution. And, of course, our virtualization capability, in Windows Server 2008, will also be really competitive.

The thing I would say about this is that our focus is really around how we can provide a low-cost solution to customers through virtualization that is very integrated. Customers really don't want to have a whole separate environment for virtualization. And our approach is to build virtualization in across the board. And we feel good about both of those things.

COLLEEN HEALY: Thank you. Mic number three.

QUESTION: Thanks. A question for Kevin Turner: You talked a lot about revenue per socket or dollars per desktop. We can obviously do the math on how that's trended historically, looking at PC installed base and unit growth and desktop revenue. But could you give us a sense of the past trends, present trends, and what your goals and objectives are on a go-forward basis? Are you looking to increase the revenue by a percent, 5 percent, 50 percent, whatever? Anything you're willing to share would be great. And Jeff, if you want to add to that, go for it.

KEVIN TURNER: My partner here, Kevin Johnson, can help me out as well. I mean, we're not announcing any forward-looking trends as it relates to where that's going. I mean, the challenge we have is the strain that as the merging markets, as we continue to go into that, certainly our revenue per license is lower there. And then when you look at the consumer mix as it continues to outpace businesses, that puts pressure on our revenue per license.

So the thing that we're trying to do is get more thoughtful about how to help offset pieces of that. But certainly we believe that in the desktop area, with those two big trends, we've got our hands full, which is why the MDOP, the Microsoft Desktop Optimization Pack, is so important. It's why us figuring out piracy is so important. It's why us making sure that we're selling in value to the desktop in the commercial space specifically and upgrading consumers to premium editions help offset pieces of that. And I think that that's the challenge as we begin to mix and do the modeling. Those are the things that we look at.

Kevin, you might --

KEVIN JOHNSON: I'll just amplify a little bit. We talked about PC shipments growing at 9 to 11 percent. And the fact they're growing faster in emerging market versus developed market means that you'll see one to two points of mix shift of those PCs land in emerging markets versus developed. That puts downward pressure on revenue per unit.

Number two, same trend on Consumer. Consumer PC is growing faster than Business, and the fact that our consumer SKU pricing, that also puts downward pressure.

So what are the things that we drive to then put upward opportunity into that revenue per unit? One is to upsell the premium mix. And in this last fiscal year, we drove a significant shift forward in premium mix. Certainly the premium mix on Consumer does not yield as much as Business. We actually lost a little bit of Business premium mix, but we made it up in Consumer premium mix.

And the other thing that could drive it up then is the work we're doing around Windows Genuine Advantage and helping eliminate or drive counterfeit and piracy down so that we can sell more units. You've got two dynamics that are putting downward pressure on it and a couple of areas putting upward pressure on it, in addition to the volume licensing proposition through Software Assurance and MDOP. Those things help. And so those are the dynamics at play.

COLLEEN HEALY: Thank you. Mic number one.

QUESTION: Hi. It's Adam Holt from JPMorgan.

I had two questions for Jeff about the Office business. The financial metrics have been very good for the last several quarters for Office, and unearned has been growing at better than 20 percent for a while. It was a source of upside from a revenue perspective last quarter. It would certainly seem that the Enterprise upgrade cycle is in full swing for Office, potentially even preceding that of Windows Vista. And I wanted to get your perspective on where you think we are in that upgrade trajectory.

And then, secondly, you hear a lot about AFPs and mix with respect to Vista, but we don't talk about it probably enough with respect to Office. And I wanted to get your perspective on where you think -- what you've seen from a mix perspective thus far and where you think the premium versions of Office can actually drive mix.

JEFF RAIKES: Thanks. So, first point, first question, related to the Enterprise cycle. Really you need to split it out into two pieces. In terms of the actual deployment and adoption, very early on; but keep in mind that a very large percentage of our business is on Enterprise agreements. And so, in terms -- you know, so if you were thinking about it in terms of revenue, one of the nice things about Microsoft Business is it's very predictable and that we've got the Enterprise agreement revenue. That's spread out over the next few years.

As I indicated, renewal rates surprised us positively. We could have easily thought that customers were excited about their Enterprise agreement covering Vista and 2007 Office System in Exchange and said, "OK, I'm licensed and I don't need to renew." In fact, we saw the opposite. We saw that they were excited about the direction that we had with these products and the future road maps, so they are renewing.

So I think when you split it up that way, you could say, "Hmm, you know, we're not going to predict that the renewal rates are going to be the high that we saw in the fourth quarter." We don't think that would be prudent. But it gave us confidence that the historical rates that we've seen are likely to continue. So I would separate the adoption, which we're early in that cycle, from the actual licensing, where you're going to see, I think, steady progress in that regard.

The second question -- really, in a way, it's a follow-up to the previous question about average revenue or revenue per socket. In this part of the business, we think of the socket as the Office license, because that represents the information worker, and life is good in this area. Right now we've been able to hold pretty steady. We have similar factors in terms of emerging-market growth, you know, putting up pressure on the revenue per socket.

On the other hand, we've got a terrific product lineup that helps to add to the overall value that we can deliver to the information worker, whether it be SharePoint or Project or Visio, all businesses that grew substantially in this last year; CRM, another business that grew substantially in this last year. So as I said, life is good. I'm with Kevin Turner. We're not going to make any forward-looking predictions, but I'm very confident that our portfolio of products from the R&D investments that we've made will allow us to continue to have very good success in terms of revenue per socket as well.

KEVIN TURNER: And from customers, Jeff, you know, the No. 1 product that they want to talk about is SharePoint. They want to talk about collaboration and SharePoint. And you showed the growth numbers. That's the No. 1 product that we get the most questions on.

COLLEEN HEALY: Mic two, please.

QUESTION: Hi. Charlie DiBona, Sanford C. Bernstein.

Jeff, could you maybe discuss a little bit about how you intend to handle the potential channel conflicts as you move more services online? And I'm particularly thinking about Microsoft Dynamics, because that's sort of the next one coming up. But could you maybe extend the discussion also as you move some Office functionality online, how you envision handling that?

JEFF RAIKES: Yeah. As Steve said this morning, one of the benefits of being part of Microsoft's history is that we are actually pretty -- we've had a lot of experience in handling multiple business models, multiple channels simultaneously, unlike a lot of our competition. And so the approach that we take is to get out in front with our partners and give them a sense of where we're headed and what opportunities they can invest in. So, for example, a year ago, at the Worldwide Partner Conference, we talked to them about where we were going with Microsoft Dynamics CRM, how we were going to have a live service offering. And so the partners are really very good at figuring out, "OK, this is my new opportunity to add value. This is an opportunity where -- or this is an area where the opportunity to add value is likely to go away." So by getting out in front if it, it's a way to make that better.

At this Worldwide Partner Conference just a few weeks ago, Kevin Turner was there; the team did a very good job of explaining how we have enhanced the business model where partners that are out selling the live version of Microsoft Dynamics CRM are going to be able to be compensated on a subscription basis, so on and so forth. So, in addition, we explained to partners how they're going to be able to build software value on top of it. We explained how partners will be able to host it themselves. We think that that will largely be in a situation where they want to do a special version, like CRM in the healthcare industry, that’s somehow differentiated from the broad, horizontal service offering that we'll have.

But by having the principle of articulating our direction in advance so partners can figure out where they can add value. That formula has worked very well for us.

KEVIN TURNER: And we were very transparent with them at the partner conference, saying, "Look, there's three ways to monetize. We could potentially host it and you can plug into things like Marketplace and be able to write applets around it. It could be on premise at the customer; therefore, you know, that's the model we have today. And then there's the shared and the opportunity for you to actually host some things."

So we were very clear at the partner conference about the different monetization models for our channel partners and what our intentions were with what we knew about. So I feel pretty good about it. It was a really strong showing at the partner conference around this topic.

COLLEEN HEALY: Great. Our last question for this particular section is going to go to mic number three.

QUESTION: Thanks. John DiFucci from Bear Stearns.

A question for Kevin Turner. Kevin, you had -- on one of your slides, it said that the Windows volume licensing annuity penetration was currently only 19 percent. I know it's early, but given the tie of SA to the Enterprise version of Windows Vista, can you tell us what that penetration rate was before the corporate launch of Vista?

KEVIN TURNER: You know, I think -- I don't actually -- it hasn't moved a lot. It's moved a point or so over the last three years that I looked at. But the fact that the opportunity that we have on being able to penetrate those annuity agreements, that's been a fairly constant thing. We saw a good uptick, what you saw. Most of that was in renewals. New was strong as well. But the way we look at it is, look, we've got another 80 percent that we need to figure out how to go sell that value in with a customer and win it over. So it was more of an opportunity slide than what we've transition in the past.

KEVIN JOHNSON: Yeah. And I don't know what the high point was in terms of that penetration. I do know that between Windows XP and Windows Vista, though, we were atrophying in terms of the coverage of Enterprise agreements in that installed base. And in this last year, with Windows Vista and what we've done with Enterprise Edition and MDOP, that is on an uptick. But I know we've been in decline for a few years. This was a year that we had an uptick. And we're optimistic that we've got good value in our Enterprise agreement software for Windows platform.

KEVIN TURNER: Yeah, I think it moved a point or two.

KEVIN JOHNSON: Yeah.

COLLEEN HEALY: What we did on the last call was to really try to break out the volume license portion of unearned just for clients, which is, you know, sort of a new view, and that was over 25 percent, so definitely seen some adoption there.

OK, fantastic. Thank you very much, gentlemen.

So that's all the time we have for that section of Q&A. As the stools are being removed, I'd like to just remind you again that you can pre-submit questions in the comnet if you like. Also, if you'd provide us feedback on that same CommNet site on how the day is going, evaluating our speakers so that we can continually improve the event year in and year out. And again, every time you fill out an eval, you will be automatically in the drawing for prizes, two Zunes and two Xbox bundles.

So with that, I'd like to invite back out onstage Kevin Johnson, president, Platforms and Services Division.

END

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