COLLEEN HEALY: We've got the IR folks in the aisles, so that's good. And it is my pleasure to invite back out to the stage Kevin Turner, Bill Veghte, Stephen Elop, and Bob Muglia. So if you've got a question, please just raise your hand, and someone from the IR team will come over.

KEVIN TURNER: We've got paddle 2 over here, paddle 2.

QUESTION: Bill, question for you about the Vista enterprise cycle here. You say that Vista is sort of tracking like XP, but XP came out hot on the heels of Windows 2000, which was a pretty good enterprise release. You had some durability there. Are you satisfied that you're really getting to your enterprise customers well, and what are you doing to really market to them, because all the feedback everyone hears in surveys and such is that there's a lot of reluctance to adopt it. Maybe it's economic activity, but it's also, I think, perception of the product, and how are you getting to the enterprise guys differently than you have for the last year where you've sort of lost momentum with them?

BILL VEGHTE: I think there's two different dimensions to it. One is the quality of the experience and the value propositions we deliver. The work that Kevin Turner and his organization are driving in terms of the basic value prop of Windows Vista, be it security or lower TCO, is strong. We're not having any problems, and you see that in our annuity sales.

The next element of it is, do those customers then how are they going to realize that value, and how quickly are they going to? I think the application compatibility work that we've done, device support work that we've done is critical. And the Vista guys cited, those over 250 enterprise apps use those examples, commercial apps. That's a big deal because it's unlocked well over 7 million enterprise desktops that we can track directly.

You take that work, you do the work that we've done with some of the outsourcing to some integrators, so they've got application compatibility factories where for their line of business apps, we can provide a very smooth process against it. That work says: a) value proposition; b) smooth and easy migration relative. Shipping Service Pack 1 is a big deal because in some fashion it sort of says, okay, you've delivered your service pack.

Now it's just getting with those enterprises

KEVIN TURNER: And let me pick up from there, because we've just recently had a completely new in market training materials, reference materials, everything with the sellers in the last two weeks, and with the partner channel. We've just really mobilized them, Bill, to support. The Service Pack 1, post Service Pack 1, we have a far different story to tell than pre Service Pack 1. And so it's a very good story when you get in there about saving money, fewer security patches, hot patching, TCO, green IT. You know, power management wise it saves a lot of electricity. So there's a lot of those things that are just now hitting the marketplace.

The goes for the field, and the partner channel was, give the facts about Vista a megaphone, and really amplify the story that we have to tell. And that's what we're doing right now.

COLLEEN HEALY: Great. Thanks, Terry, for that question. We'll go to paddle 2, please.

QUESTION: Stephen, a question on the core business. When you look at your operating margin, you've been in the luxury of having the second largest operating margin in the company. When you look at the potential levers that you still have left as it relates to operating margins, can you walk through what you're seeing, and how much more room you have left?

STEPHEN ELOP: Yes. I mean, it's certainly the case that it's a good position to be in. It's a well-run business that I inherited, so I'm very pleased with that. I think one of my basic principles in any of these companies, or in any of these situations, is to make sure that we are very clear about those battles that we intend to fight, and where we can get more focus. And to the extent that you can focus resources in a particular area, you have an opportunity not only to build revenue because you're going further faster in those targeted areas, but at the same time perhaps you can drive some margin improvement that either get reinvested into the business, or returned to the shareholders. And that's a decision that we have to make at every step along the way.

But I believe that a company the size of Microsoft, and certainly the size of the business division, there may be opportunities to say, hey, let's get a bit more aligned, a bit more focused, and drive improvements that ultimately will affect the financials. So I look at that and say, that's something that I'm focused on within MBD.

COLLEEN HEALY: Great. Thank you very much. We'll go to paddle 1 over here, please.

ADAM HOLT: Hi, it's Adam Holt with Morgan Stanley. I had a couple of questions on the server side. You noted in your presentation, Bob, that you've been able to outpace the market, and obviously that's a good driver of growth. But you have much higher market share heading into the 2008 cycle than you did in the last Windows cycle, and I wanted to see where you thought the opportunities to continue to sort of accelerate market share gains were, what degree you think you'll be able to continue to add share. And then, on the average selling price side, how should we be thinking about that? There's been obviously pressure on data center spending. How big do you think the ASP opportunity is?

BOB MUGLIA: So we are projecting continued increase in overall market share as we go into the next fiscal year. So we feel pretty good about how we look relative to the overall market today, being able to take share from a number of different competitors. And so even though we've grown overall, we have a lot of opportunity to continue to grow. That's true both because people are, in general, in developed countries are choosing Windows Server. It's also true that as piracy starts to come down in some of the BRIC countries, we're able to gain some share in those spaces from unlicensed copies, where Windows Server has extremely high share, but not very high paid share. So there's a huge opportunity as those countries do more legalization for us to grow share in there. And we see that trend happening, particularly now in geos like Russia, which have really matured quite a bit in that space over the last few years. So that's a good possibility there.

KEVIN TURNER: I mean, we're clearly all going to be goaled on growing share this next year, including all the sales force, all the services, and everybody associated with it. I think it's absolutely imperative that we continue to drive and have an expectation that we're going to take share or win share in that space. I mean, Bob has given us the tools to do it, and certainly from a pricing standpoint we really like where we're positioned in the marketplace right now.

BOB MUGLIA: You asked about our sense of our revenue per server, and actually as we ended the last fiscal year, we had really our strongest period of revenue per server ever that we've had. So we see that actually growing. The trend towards virtualization is increasing our average revenue per server, because what's happening is, companies are buying larger servers, and they are buying the higher end editions of Windows Server, which has a much, much higher revenue than our standard edition does. So we're seeing improvements in our overall RPS. That's true certainly for Windows Server, and that's also true of products like SQL Server, where our enterprise edition is growing very strongly.

KEVIN TURNER: Bob, your management tools have improved so much with Systems Center and where we're headed there, and we should continue to expect to see that revenue per server continue to climb if we do a good job with the up sell, and that also is a big driver for us.

BOB MUGLIA: And one of the things that on the management space is that we have an offering that we just brought to market really at the beginning of this calendar year, which is a license and enterprise server license, which takes our entire management portfolio, our entire suite, and provides it to customers at about a $700, $6-700 price. And that price point is incredibly competitive when you look at something like VMware, which would be several thousand dollars for just the virtualization capability, and for that you get the physical management, the virtualization management, the applications management, and backup. And it's almost the same price as you pay for backup, really, and you get it all for one price. So we have a very good selling opportunity.

COLLEEN HEALY: Great. Thanks, Adam, for that question.

We'll go to Heather at paddle 2.

HEATHER BELLINI: Thank you. Two questions, one is about the premium SKU mix that's been a big driver of growth for both Windows and Office. I was wondering, when you look ahead to the next releases, what other kind of tricks up your sleeve do you have to drive the same type of success that you did during this last product cycle with premium SKU mix. And then the second question was around Windows 7. I guess I was wondering what you could do differently to make sure that the product has a better reception out of the gate than what we've had so far with Vista.

STEPHEN ELOP: Let me take the first part of that question as it relates to Office and SKU mix. You know, it is very clear that there's a lot of work that we are doing and can continue to do as it relates to the elasticity curve, and where we land on that. We're getting far, far better on a region by region, country by country basis as to how to properly price, position, and package those products. And when I put up that graph that showed that retail attach, which is just exploding as one example, you look at something like that and say, boy, there's a lot of opportunity there to get more people into the Office family. And clearly when you break it down further and start looking into the emerging markets you realize, boy, we're really making a dent in piracy, as well. There are some good things happening there.

So I think there's still tremendous opportunity ahead to work with the P&Qs, price and quantity and so forth, to get it just right. I'm certain we're not done, if you like, working the elasticity curve to get optimal SKU mixes going there. So there's a lot of opportunity there.

Bill, did you want to talk about 7?

BILL VEGHTE: You bet. So in the context of on the Windows side of the business, when you think about the premium, think about it, there's consumer and there's business. We've seen huge gains, obviously, this year, Heather, in the consumer premium mix that we've been able to achieve. As I look ahead, that's something that we expect to sustain. But, as Stephen highlighted, it's as much about the attach opportunity that we see, where we're not where we still have many opportunities to attach Genuine Windows, as opposed to a pirated version.

On the business side, as some of you have noted, we'll continue to see a little erosion as businesses opt between Business Edition versus Windows Vista Home Premium, but as you look at that, and as we set up for Windows 7, that's an opportunity. Then you have a lot of customers, as Kevin looks at the conversations we have in enterprises, and then down into that upper segment of midmarket, that don't have a software assurance type relationship with us on the Windows desktop. And the work that Bob and I do around the Microsoft Desktop Optimization pack, as an example, represents a huge opportunity for us that is still relatively untapped in that segment of the marketplace.

KEVIN TURNER: I'll tell you, the big seller for us in the business space, largely on the up-sell side of things, is going to be around BitLocker, and being able to have that extra level of security, and encryption, and the things in laptops. I read recently there's like 10,000 laptops a week stolen around the world. And when you think about that, the big opportunity that we have with the multiple layers of security that's built into BitLocker, which are tied to that Premium Edition is a really good up-sell opportunity for us long-term.

BILL VEGHTE: Right. As I think about some of the lessons relative to the launch and delivery of Windows Vista, and setting up, and learning on Windows 7, I think one of the key things is, as we look at the platform investments, Heather, that I outlined, and the breadth and depth of those investments, we needed to make those investments on, for example, security or networking. Those are investments that then we can continue to leverage in Windows 7, not have to do that. And deliver a much higher, much, much higher degree of compatibility. So you don't you take that issue, effectively, off the table.

The other thing I think is important is having a sustained conversation into the marketplace, whether it be with our direct sales force, through our partners, or with end users, about the opportunities afforded by Windows, the opportunities afforded with a specific version. And as I alluded to, that's a conversation that we'll start having here this fall, and then sustained and continued through the Windows 7 launch activities that we do.

KEVIN TURNER: And Bill is absolutely right on the compatibility issues, hardware, software, we're not going to repeat the mistakes and opportunities we've had in that particular area. We don't regret it. We're glad that Service Pack 1 is in the marketplace so we can move past it. But, certainly as we think about 7, you guys are doing some incredible things around scenarios, PC, phone, and Web.

BILL VEGHTE: Yes.

KEVIN TURNER: So it will be much different, as it relates to how you land that product in the marketplace.

COLLEEN HEALY: Thanks for the question, Heather. We'll go to paddle two, with Sarah.

SARAH: Terrific, thanks a lot.

Bob, a similar question to what Brent asked, about MBD, but on your margins in Server and Tools. It's been a great margin-expanding business, is there an ability to start taking operating margins there to a greater than 35 percent-type level as you look forward, if you look at a competitor Oracle, over 40? Then a quick follow-up on desktop virtualization, you talk a lot to server, but what are you guys thinking about on the desktop side, vis-à-vis a Citrix, for example?

BOB MUGLIA: So, in terms of our margins, our margins continue to grow, and we continue to do better, and yes, I think we will continue to grow this. There are some fundamental costs, in terms of selling enterprise products that are different than, say, our Office business, our Windows Business, but we'll continue to see, I think, good margin growth. We've been very focused on our costs, and that's true in both Kevin's area, and his overall sales costs, as well as in my area. And as these products continue to grow, in terms of their overall revenue, our margins will grow with that. So we feel good about that.

In terms of the desktop, and desktop virtualization, we have a good set of products in the market today, between Bill's team and my team, with Vista, and Hyper-V as a core foundation to do desktop virtualization. We are partnering closely with Citrix to provide a complete solution for customers there. So Citrix has a product, Xen Desktop, that they are running on top of Hyper-V, and together we see that as a and of course, using Vista. And together we see that as a great opportunity to drive a new capability into the market. And that's generally revenue positive for us. That's a revenue positive product for us.

COLLEEN HEALY: Great. So we're going to Brad, and then Kash, and that will probably be all the time we have. So we'll see. What paddles do you have? Oh, it's John. Okay. Paddle one with John.

JOHN DIFUCCI: Thanks, John DiFucci from JP Morgan. Kevin, this is a follow-up to one of Heather's, but you last year had said, I believe, that about 19 percent of what you call the addressable Vista enterprise market was on Software Assurance, or something to that effect. I was just wondering if you can bring us up to speed as to about where that might be, or do you have any kind of metrics you can tell us about that?

KEVIN TURNER: It continues to grow, and I would say that it's up over 20 comfortably now, and it continues to expand. And it's something that we see a lot of optimism in, going forward.

COLLEEN HEALY: Okay. Paddle two.

KASH RANGAN: Hi, thanks a lot. Kash Rangan at Merrill Lynch. A question for Steve on the MBD side, it's certainly a crown jewel of the company, a very high operating margin. So when you look at the opportunities and threats ahead that Steve talked about this morning, software as a service, or software and services, as you want to put it, what steps are you taking to move your business model, how aggressive are the steps, rather, to change the business model from packaged licenses to software and services? I guess on one side, the rewards seem to be tremendous, you get more revenue per customer, because you're taking on more responsibility, but I also look at the other side of the equation, the tradeoffs, the upfront investments, the depreciation, the build out of the huge CAPEX in the data centers, et cetera. How do you gauge the tradeoffs involved in this transition?

STEPHEN ELOP: I think engaging tradeoffs you have to start all the way back with the customers. And when the customers say, hey, our businesses and expectations are changing, this is what we need from Microsoft, that's what we have to respond to. So you start from the firm belief that to best serve our customers we have to support them, whether it's in an on-premise deployment, a hosted deployment, or whatever the case may be.

Part of the reason that we're engaging in hosting applications ourselves, though, is the clear recognition that to be as cost-effective as possible you have to have scale. This is part of the point that Steve was making earlier today. There are very few companies who can build the hosting capacity, the data centers, the pipes and everything big enough, such that you can actually drive the costs down, so that they are as competitive as they possibly can be. So Microsoft is clearly committed to that, for a number of its businesses. So that's actually a huge advantage to MBD, because Microsoft is doing that, they're making those investments, and that's something that I can take advantage of.

Something else that I can also take advantage of is not just the physical infrastructure, but when Steve talks so much about the importance of being good at advertising, the search capabilities, and everything that comes along with that, that's important for me, because when I say that MBD intends to fully embrace software plus services, that implies that some of what we will do will be ad-funded. That's one of the business models that you would expect in that environment. And there are some early examples of that already in tests that have been reported on in the press. That implies that necessarily MBD is dependent on advertising, as well, and therefore is a major supporter of, and rooter for the work that needs to be done around online advertising.

KASH RANGAN: (Off mike.)

STEPHEN ELOP: That is a fine line that we have to because the microphone wasn't there people couldn't hear, how should we think about margins as you go through that. Clearly, part of my challenge is to manage those margins. When I look at the pressures on my margin, part of the pressures are around the investments that we have to make in infrastructure and supporting the company at large.

That being said, I get huge benefit from the fact that the company has to do that, and is doing that on a much larger scale. So it's something that works to our advantage relative to any of our competitors as a division.

KEVIN TURNER: And the services aspect also helps in the piracy front as well. So we get some help and some relief there. And that's a pretty substantial part.

STEPHEN ELOP: Actually, just to put a finer point on that, when you think about customers of any type moving into a software plus services environment, some of those customers will be pirates who today are contributing no revenue to us, but that are engaging with us in a services environment, where maybe there's some advertising revenue over time, and so forth. So indirectly they're contributing in a way they can't. So when we run our numbers, you can see challenges in some areas, but you can see tremendous opportunity. We definitely look at this as a net positive for us over time.

COLLEEN HEALY: Thank you, Kevin, Stephen, Bob and Bill. That concludes this Q&A. Thank you so much.

END

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