COLLEEN HEALY: We're going to go to our last Q&A, and it gives me great pleasure to welcome back to the stage Microsoft CEO Steve Ballmer, and CFO Chris Liddell.

We'll have the mics here. If you have a question, go ahead and raise your hands. We'll go with Heather first here at paddle two, please.

HEATHER BELLINI: One question was related to the kind of catch-22 that you have in the search business. You mentioned that you're focused on driving an increase in queries. And I think one of the things that people would say is that to get that big increase in queries, you're maybe going to need to have better search relevancy in terms of -and then you've got the conundrum of how do you get the relevant ads because the advertisers want to see more query share before you get a bigger pool of what they're willing to spend. So it seems like it's somewhat of a circular reference. I guess I'm just wondering how you can change the paradigm a little bit to have the network effect work in your favor.

STEVE BALLMER: Yes, there's three things on a search page. There's the so-called algorithmically generated results, where we feel quite confident in where we are, actually, today, in blind tests, so to speak, and where we're going. There's actually the brand on the top of the page. We're going to have to invest to build brand reputation, because obviously the market leader always has the best brand reputation. Then there's the relevance of the ads.

I feel good about one. I feel like we have kind of straightforward tools available to deal with number two, not that it's going to be easy, but they're fairly straightforward. And then the third question is, what do you do about ad relevance. And it is a little bit of a catch-22, and we have some ideas about that. We have some ideas about that. We may have to get kind of way out of the box in order to get back in the box. The most important thing right now is to make sure we work on the relevance of those ads, and the team is exploring two or three, actually, different concepts to get there. But, I don't choose to chat about it today.

COLLEEN HEALY: Our next question, Charlie DiBona has got a hand up there. That goes to paddle three.

CHARLES DI BONA: Steve, I know you're not going to talk about who you're going to hire to run OSP, but could you give us a little color, maybe, on kind of characteristics you're thinking about? It seems like you have a strategy that you haven't -at least are putting in place about organic growth now. Are you looking for somebody to really execute on that strategy, or are you looking to bring somebody in to really shake things up a little bit, and maybe refocus your strategy.

STEVE BALLMER: I like our strategy. I don't think you anybody you put in a job, whether it's internal or external, is going to have some of their own viewpoints. I think it's kind of silly to put a senior person into a job and tell them, now just go execute. I wouldn't want that done to me, because there's an accountability that the person has. With that said, a lot of really smart people here spent a lot of really good time thinking a lot about the strategy, and I think it's pretty compelling, given our current kind of market position. So we'll decide internally or externally. Certainly I'll tell you in any interim period, Satya, Brian, other folks in that team, me, we all like the strategy, and we're just moving forward, and when we make our appointment, we'll make our appointment.

COLLEEN HEALY: Thank you.

STEVE BALLMER: How about number one, right here.

COLLEEN HEALY: Thank you. Paddle one, please.

QUESTION: Thank you. I just have some questions on the timeline here, sort of when Yahoo! collapsed. On May 3rd you disclosed your offer price of $33, on May 6th there was a quote from one of Yahoo!'s largest shareholders saying he was extremely disappointed with them. May 13th Icahn had bought a block of share. May 15th he had his board slate nominated, and my guess is by May 16th all of Yahoo!'s largest shareholders had told them that they would consider voting for the Icahn slate, and would be willing to sell for $33 a share. So that's just 13 days. It doesn't seem plausible that the asset depreciated that much in those 13 days. What really happened that made you decide not to pursue it at that point?

STEVE BALLMER: I'm glad you have the timeline, I lived it, but I don't have it sort of noted here in quite that detail. But we had a date we were going to make a decision. We came fully prepared to work. We didn't converge. There was no further I don't know, May 15th, 17th, some place in the teens, there was no it was over. The discussions stopped. Somebody wanted to sell us the business on May 15th, 17th, whatever some day was, it was unknown to me. We had a discussion. We had a discussion with the CEO of the company. We couldn't reach a deal. You move on.

The fact of the matter is, and Chris went through all of the rationale, I think, actually much more eloquently, in fact, than I did earlier in the day, and certainly much more crisply. You go through all of it, the market has changed, lots of things have changed. But we had a deadline based upon kind of what we wanted to accomplish, and time to market, and the deadline passed. And then we started looking at additional alternatives, and I know by Memorial Day we were having some discussions about a search deal, which was fine, and those, too, didn't work out. But by that time, we were really on to the search field.

CHRIS LIDDELL: I don't want to keep rewriting history, and the he said/she said sort of discussion that we've had way too much of. But when we launched the bid, we launched it with an anticipation that we would get serious engagement very quickly, and a decision very quickly. We -and if you had told me that May was going to be that point, I would have said, that's way too long. I think we made it very clear, right through the early stage of the acquisition, that something like March would have been great. The end of April suddenly became a drop-dead date. And at some point is the tipping point in all of these where it no longer makes sense to engage on the principle thing. I think we were clear right the way along.

STEVE BALLMER: It is a little weird. You could say Chris is a little bit crisper about these things than I am. But, man, we had an offer out that was 100 percent premium on the operating business of the company, and there wasn't really even a serious price negotiation until the beginning of May, which is three months later. Okay, that's just the way these things work. And yet, we had priced -you could say, why did you come in with an offer that was 100 percent premium on the operating business, but taking out the Asian assets. And the answer was, so we could get it done quickly. Chris still relatively new to tech, he said, are you kidding? No other business in the world would have this kind of patience. And yet, I think we've dealt a little bit with founders, and we wanted to give the thing some time. But at some point, as Chris said, you move on.

COLLEEN HEALY: We'll go up here to John DiFucci at paddle 2.

JOHN DI FUCCI: Thanks. Chris, you gave guidance for '09, and just trying to gauge a little bit, what's behind that guidance, because assume that guidance is sans -without Yahoo!, Steve's talked a couple of times today about things he's not going to talk about today. Along those lines, whatever those things are, if you don't do those things, and you don't do Yahoo!, is that what is implied in the guidance, because when you guys come to New York, whenever you come, the beginning of the year, calendar year, I'm just wondering how much of a probability we might see an increase in expenses again, another bump up, if you don't do any other acquisition in this business.

CHRIS LIDDELL: A couple of thoughts. Firstly, on the Yahoo!, look, even if something happened tomorrow, and I'm not saying yes or not. Regulatory period would mean that any financial impact would be in fiscal year '10. So you can essentially take that out of the equation regardless.

The other critical point is, we manage -we guide to the way that we manage the company. We don't manage the company to the way that we guide. Could we make some decisions where we want to invest more in online and anything else? Could we do an acquisition tomorrow that would change our guidance? Absolutely we could.

STEVE BALLMER: Now, if we thought it was likely, we probably would approach different body English. We many times have told you we're willing to spend more. Today we told you we have pretty good plans to spend a lot.

CHRIS LIDDELL: Guidance is always the best estimate of what we believe is likely to happen both on the revenue and the operating expense side. I can never say to you during the course of the year that that isn't going to change. It will only ever change because we think it's the sensible thing to do. But would I stop doing an acquisition in six months time that we might talk to you about in January that might have an up-front accounting charge that is a dilution on EPS for fiscal year '09 because we gave you guidance in July that didn't have it in? No, I wouldn't.

QUESTION: (Off mic.)

CHRIS LIDDELL: And the guidance is everything that we know about the operating cost structure of the company today.

COLLEEN HEALY: Thanks, John. Let's go to Kash at paddle 2.

KASH RANGAN: Thank you very much. Kash Rangan with Merrill Lynch. A question for you, Steve, you look at the Win 7 cycle starting 2010, I would be surprised if you had any hardware or software compatibility problems, because that's clearly what you're targeting. But from a functionality perspective, what is going to be new about Win 7 from a user experience, or value, et cetera? Of course, the Vista demos looked really, really good the last couple of years, but it turned out that the compatibility issues trumped the user interface. So what's Win 7 going to look like, what is going to be so exciting about it for the consumer and the enterprise to upgrade without the issues we've had in the past.

STEVE BALLMER: It's going to look great. It's going to look great. It's going to be quite compatible. I mean, come on, if I wanted to start selling Win 7 today, we'd start selling Win 7 today, and then you'd complain we're selling Win 7, we're not selling enough Vista, and EOAs, and blah-de-blah-de-blah. Come on, that's a no-win answer. We're hard at work. And we've got a great group of folks doing great work on Windows 7, and the design point is compatible from the get-go in large measure.

COLLEEN HEALY: There you have it. Paddle one.

QUESTION: All right. Well, I guess I need to be careful about how I frame this question. Without sounding like a bean counter, I have two other questions on the outlook. One is on the client guidance for fiscal '09. Throughout the day we've seen a lot of presentations where it sounds like, and I don't want to read too much into things, but you may be a little bit more optimistic about where we are in the enterprise upgrade cycle for Vista. It also sounds like you're optimistic about your ability to continue to make improvements against piracy. We know that growth outside of mature markets is a negative for pricing, but could you just remind us, what are the elements in the guidance that would represent such a big difference between the expected PC growth, and your revenue growth? It would seem like you're not baking a whole lot of, for example, piracy improvement, or business acceleration into the numbers.

And then I had a question on the buyback after.

CHRIS LIDDELL: So on the enterprise side, about 80 percent of our revenue on the client business comes through our OEM sales, about 20 percent comes through what we've described as commercial and retail. The enterprise agreement element of clients sits inside the 20 percent, it's about half of that, so about 10 percent. So we're seeing a really nice acceleration in enterprise agreements associated with client. It's growing at about 20 percent per year. But it in itself isn't significant enough to really drive the overall client business. And I walk through most quarters on exactly how that moves. But even if we saw really good acceleration, that would be fabulous from a long-term health perspective, it wouldn't drive a lot of short-term accounting.

On the difference between revenue growth and underlying PC growth

STEVE BALLMER: Just one other thing on the enterprise, just one thing. If you look at today, and you look at all of the copies of the business versions of Windows that we're shipping, almost half of them are Vista today. I mean, I know people think there's no up-take, it is two different things to say people are upgrading PCs in the field with enterprise- type agreements, and it's a separate thing to say what are people actually buying. And almost half the PCs that our business and enterprise customers are buying actually come with a Vista license.

CHRIS LIDDELL: Yes. On the revenue growth in the 80 percent, which is the more significant relative to PC unit growth, the big delta, I start with PC unit growth for the world, we would expect to grow units 2 to 3 percentage points faster than overall worldwide PC growth because of principally our anti-piracy. So go from the PC market growth, add to the 3 percent, then as a result of that growth being in emerging markets rather than mature markets, because of lower ASP, and consumer rather than business, and in generally speaking the large OEMs relative to small system builders, all of those things tend to have a margin depression relative to overall units. So you get 2 to 3 percent points lift on the units, then you get probably next year -I'm trying to remember the exact guidance we gave, but I believe around a 4 to 5 percent depressant on the overall margin.

It's still good news because it's growth, but it's just in the lower ASPs generally. So that's how you get from the overall PC market to our revenue growth. You had a buyback

QUESTION: Yes, just quickly on the buyback. You know, I'm not going to ask you to sort of preannounce a new buyback program, that would be ridiculous, but in terms of thinking about next year, what is in the earnings guidance with respect to projected buyback activity? And I guess the other question, and maybe just sort of generally

CHRIS LIDDELL: I thought you weren't going to ask me.

QUESTION: I'm just saying. Is there no buyback activity in the numbers, or is there a little bit?

CHRIS LIDDELL: There's the buyback activity that we expect to do. I mean, I can't answer that question without answering the things that you said you weren't going to ask me. There is an element of fourth-quarter buyback, and then the flow through of that, and that had some positive implications in the guidance during April and July. Every quarter we make a decision on how much we buyback, and we flow that through. Clearly, there is some anticipated buyback, but we've been quite consciously -I'm a little bit facetious, and I apologize. We have quite consciously said, wait, I'm not going to preannounce each quarter how much we're going to buyback. We anticipate how much it is, and that's one of the variables that we have in guidance, along with investment income, and so forth. But by answering the first question, you can effectively back engineer how much we're likely to do. All I can say is, clearly, with the share price where it is, the fact that we have good cash-flow generation, absent any sort of acquisition, which is not currently in my mind, you know, we'll continue to be a net buyer.

COLLEEN HEALY: Paddle two, Rick.

RICK SHERLUND: Thanks, Steve, and Chris. As I look out to let's call it February and the New York meeting with the analysts, we'll be within 8 months to 12 months of launching Windows 7 and Office 14. So that I would anticipate would be a good meeting, and probably as we talk about the outlook that should be reasonably positive. But, I'm thinking back to your comments about we're going to invest in the online business, and a year or two ago when we were all kind of shocked, and we thought you were kind of going nuts with a lead foot on the spending accelerator, can you put some bounds on what we might expect in terms of when you say invest? Is it kind of consistent in magnitude with what we're seeing now, in terms of the ramp up in spending, or is there something more wild that we should be apprehensive about?

STEVE BALLMER: Well, before I make you apprehensive, which I hope I don't do, let me also remind people, sure, we'll have new products, Windows 7, Office 14, but our business, as Chris I think explained earlier today, is very different than our business used to be. We don't have big launch spikes in quite the same way that we used to, in terms of revenue. Things are far smoother. So I don't want people to start baking some big spike because of a Windows 7, Office 14 launch. There may be a little spike, but relative to our total revenue today the little launch spike is not nearly what it would have been when our revenue was much smaller.

Should you be apprehensive? No, you shouldn't be apprehensive. I told you everything that's on my mind today, everything. I mean, I talked about, I think, tried to give you some characterization of what I thought that ante was. I talked a little bit about that. I talked about the potential of investing something like 5 to 10 percent of operating income for a period of time in order to go after it. It kind of gives you a little bit of a feel. We were between 5 and 10 percent this year. You could say it doesn't give you a precise feel. I'm never precise about things that are forward looking, because it doesn't seem to be all that useful, unless we're willing to be super-precise, and that's what we call guidance.

So I don't want people to be apprehensive. I talked about a strong level of investment. We're serious about a strong level of investment. I gave you the best kind of thinking on my mind, and Chris, and I, and the team, and our online group has kind of thought that through. And if it changes we'll certainly let you know.

I hope Chris' comments fairly clearly removed whatever the specter was of some kind of large Yahoo! transaction. I thought Chris was just about as black and white on that topic as we've ever been. And I think there's nothing to be "apprehensive" about. You kind of have everything we can give you to think about, and we're off to the races on our strategy.

COLLEEN HEALY: We are nearing our conclusion. Let's go to paddle two.

QUESTION: Hi, Steve, it's Jason Maynard from Credit Suisse. A question about your competition with Apple, and the memo that you put out internally yesterday, you talked a little bit about changing the way you do business with the hardware vendors. And it was sort of an open-ended, I guess, comment, or quote in the memo. What are you thinking about in terms of, as you combat Apple with their I think you called it "narrow, but complete strategy"? What are you thinking about in terms of sort of replicating that rich user experience, where Apple controls all elements, and it's seamless, and works together, with the traditional model that you've had with the IHVs, and does that have any implication for pricing for the OS?

STEVE BALLMER: I wouldn't think it has any pricing implications. The truth of the matter is, the greatest choice, the most applications, the most choice in hardware, the most choice in peripherals, the most choice in price point, in machine types, in configuration is clearly in the Windows world. Because Apple does everything end-to-end there are a few places where they would offer what I call choice without compromise. And generally there's some choice with compromise. And we're educating and working with our OEMs to kind of show them where sometimes we and they are making compromises, and pointing to some additional choices that they can make.

You can take the same laptop, oftentimes, and pre-configure it one way and you get almost instantaneous boot, and fantastic battery life. If you pre-configure it with software in another way you get long boots, and much less battery life. That kind of education, discussion, dialogue we find our OEMs appreciate. It doesn't mean they always follow our advice, and we certainly respect their right, under our consent decree and everything else, to preload any software they want to on those machines. But, we're trying to at least help people understand the opportunity to not only offer fantastic choice, low prices, different margins, but also some of our OEMs, I know, are going to step up and do a lot more to complete the end-to-end experience, software, hardware, et cetera. And that will be a great thing.

COLLEEN HEALY: Thanks, Jason.

This is going to be our last question. Do you have one there, Kevin? No. Okay. So that's-

STEVE BALLMER: There's a gentleman here.

STEVE BALLMER: Okay. Eric, Eric is down here, so paddle two.

QUESTION: Thanks. First I'd like to thank Chris for the best, and most cogent financial presentation I've seen in a long time. My question has to do with the Internet interfaces you have with portals. One of the advantages that Google seems to have is it's one face, it's one brand. And at Microsoft you have three or four Internet brands, and portals. How much of a priority is it for you to integrate those, so you have one common brand, and one common interface that takes advantage of all your capabilities, so that the world can see that you have better tools than they do, and you can finally win?

STEVE BALLMER: Getting -I talked earlier about fantastic marketing, and fantastic brand. I think there are many ways to approach that. We are where we are, and we move forward in that context. The real question is not a brand -in my opinion, is not a brand question. The real question is, when you type www.whatevermicrosoftwantsyoutoseefirst.com, that's not a brand that's a logical statement, what does that page look like, and what's the appropriate brand.

I don't think it's going to be a blank page. I don't think that makes sense, not for us, and from where we come from. I think given the monetization model it's got to prominently feature search, but at the same time it should have a range of content that is tailored, and directed at you. I think we do need -whatever that page is called, we do need an identity to talk about our search, and yet when you go www.oursearchidentity.com, it's still not clear to me that you want to get a blank page. So there's a couple of things of that ilk that we are processing through. As we resolve them, then naming and branding, and URLs all become a lot simpler.

I will say that that was one of the things that we put on, what should I say, short-term hold during the course of the discussions we were having, or at least the offer we made to Yahoo!, because the way we would have approached that problem would be quite a bit different if we had purchased Yahoo! than not purchasing Yahoo! And now the question is to sort of quickly resolve in the context we live today, and move forward.

COLLEEN HEALY: Thank you very much, Steve, and Chris, and thanks to all of you for attending. And for those on the webcast we'll look forward to seeing you over at our reception. Thank you so much.

END

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