CHRIS LIDDELL: Great. Good afternoon, everyone. They're actually laughing at me out at the back, and the reason for that is that, as you know, people choose their professions based on their genetic disposition, which is why someone like Kevin Turner is great at leading the field because of his natural optimism and energy; you have Craig Mundie who is great in his role as chief strategy officer because of his ability to synthesize vision. And so what genetic disposition do you need to be a CFO? Essentially, you need to be miserable. You need to be the sort of person who takes drinks away from people at the end of a party. So, you know, my colleagues have been giving you drinks all day, have told me to come out here and take most of them away from you.

Now, I'm not going to do that. I'm not going to do that for a couple reasons. One, I think I did quite a lot of drink taking-away last week; and, secondly, you also need a certain genetic disposition to be either an analyst or a journalist. One group of you, if we give you a drink you only sip it; the other group, we give you a drink, you're deeply suspicious about what's actually in it. And you can figure out which group is which.

But what I would rather do is spend my time this afternoon talking about the world as we see it, which is different from the world of a year ago, when I stood in front of you, and talk about how we see driving shareholder value in that world, and put everything that you've heard today in the context of how we're driving shareholder value over the next few years, in the environment that we believe we're going to have. And to do that I going to talk about this concept of the new normal. And it's a phrase that was coined by Mohamed El-Erian—for those of who know him, he's CEO of PIMCO—you probably know that. What you don't know, he's actually also chairman of our investment advisory committee, our IAC, which is a committee of outsiders that we bring together to help us think about how we manage our own funds, which, as you know, are reasonably substantial. And he's been fantastic in terms of helping us navigate the last year, and it's certainly one of the reasons why, relatively speaking in terms of our own billions of dollars, we've come through the crisis, virtually totally unscathed. And he introduced this concept of new normal to basically say over the next few years, given what we've been through, we are going to go through a fundamental change in societal change, political change, in economic change. So I want to use that concept to say how we think it's going to impact us and say how we are running the business differently in that newer environment to drive shareholder value.

I'm getting a little ahead of myself. I'll start with the report card. We do this every year. So even though it's been a tough year, we will do it again this year, and just tell you about how the results were relative to what we talked about a year ago.

And, not surprisingly, from a revenue point of view, it turned out to be a fundamentally different year than we thought it would. So when I stood up here last year, we thought our revenue would grow 11 to 13 percent; it actually shrank by 3 percent.

Now, when you look across the various divisions, clearly it wasn't a single division that was a concern; it was weakness on relative basis right across the divisions. And that was clearly no surprise to all of you. We found a different macroeconomic environment through the year than certainly what we thought we would have last July. We managed to take operating expenses down, so in terms of the things that we can control relative to that different revenue environment, we took OPEX down, as you know, by just over $3 billion, but it wasn't sufficient to generate the earnings per share. So, again, when we stood here last year, we were giving guidance. We gave you $2.12, to $2.18, and we came in at $1.75. So from a report card point of view, you have to say it was a disappointing year.

Having said that, in terms of the things we can control, and that's what I want to come back to, I feel very good about the year. And when I look at a different type of report card, which is how we did from a shareholder value point of view, you know, it tells a slightly different story. And this is a graph of us relative to the S&P 500 and the NASDAQ—a slightly different story in each case, over the course of the last year, so it's like our relative performance. If you take out a lot of the macroeconomic impacts, which clearly influence revenue, how we look like on a relative basis? And we're in the blue there. And I essentially see it as a year of two halves. The first half, which went through to about February, macroeconomics dominated everything. Essentially, virtually regardless of what we or anyone else did, the macro environment was the driver of shareholder returns, of shareholder value. So we and all the major indices, and to a large extent most of our competitors were broadly following the same track.

Since that time we've introduced a small but not insignificant gap relative to the market. Now, what you see is two trends. Firstly, the NASDAQ has slightly outperformed the S&P 500, so tech to some extent has outperformed as we've come out of what people see as the recession, and we've outperformed tech slightly. So it's certainly early days, but it's a good trend in bringing the fundamentals together that I think are going to be important in the future.

And in terms of why did we slightly outperform, clearly there was a positive reaction to our cost controls in the third quarter; and, secondly, there's been progressively reception not only from customers but from investors in terms of the product wave as it started to come through. So Windows 7, as it became more clear what the feature set looked like and what the timetable looked like, "Project Natal," which Robbie showed you, Bing, obviously coming on and being received very well, helped give us a little bit of a tailwind relative to the market.

So, report card—I certainly can't say this is good; we're still down relative to where we were a year ago, but on a relative basis it was a reasonable year from a shareholder value point of view, given the context of the environment that we had. So what does that mean in terms of going forward? If I talk about how I interpret Mohamed's framework of new normal, it's around a structure like this: Essentially, we've had a historic growth rate for global economies, software industry—choose whatever you like; it's the same basic message—that historic growth rate over, let's say, the last decade, which has been artificially high—as we all know now it was fueled to a large extent by debt—in the form of either home mortgage or credit card, whatever—it was fueled to an artificially high level. And we're going through now is something what Steve calls a "reset." We don't know all what that reset looks like, we don't know quite where it's going to finish, but it certainly is a reset of form. And we have to manage if reset.

But what's probably more important from a shareholder value point of view, is what we have—is how we manage there afterwards. And that requires a view of what it actually is going to look at like afterwards. And in my view there are three different paths it could be. The first new normal could essentially be after the reset, we get back to where we were; we have a parallel line, if you like, between where we were historically off a lower base, we have the same growth. I think that's extremely unlikely. I think the reality is going to be somewhere between path two, which is we're going to grow in terms of global economy and as an industry, about what we should have done, should have done over the last few years if you take into account the reset.

Or we are going to see consumer behavior, which is going to be even more subdued than it would have been otherwise, because people are going to be so scarred by the experience of the crisis that they've been through that you'll see the same sort of things that you've seen, in particular, the Great Depression, which is one outlier. But in other economic recessions, you're going to see people who are naturally risk averse in terms of consumption; they're going to save more than they would otherwise.

So the economic path that we are all going to face, regardless of any industry, is going to be relatively subdued compared to what we've been through. So those companies that are going to drive superior shareholder value in the new environment are not only going to be the ones that manage the reset in a very good way but are going to manage the new normal in a particular way as well. So what I want to talk about is how we have been changing the way we've run the company over the last six months and how we are evolving to take into account what I think is going to be a more interesting environment going forward. In the first and most important—and I think there are essentially five fundamental strategies that any company is going to have to follow, and the weighting on those five is going to differ—but there are five fundamental muscles that every company is going to have to do firstly, survive the reset and, secondly, prosper in the new normal environment we're going to have.

First and foremost is trying to focus on cash flow and the balance sheet. There are going to be people who are not going to survive the reset simply because they don't have the strength or liquidity to do it. So fundamental number one is focus on cash, on the balance sheet.

In terms of what we've been doing, clearly, most of what we talk to you about is operating income, getting income, and after earnings. For the year that we just went through, down 12 percent. So revenue down 3; operating income down 12 percent. In terms of cash flow, what we did, not surprisingly, is focus much more as the crisis unfolded on cash flow. When you look at our cash flow for the year, after CAPEX and after acquisitions, we scaled back on CAPEX, we certainly cut the flow on acquisitions—we're up to 45 percent. Now, okay, that's because to some extent we didn't do any acquisitions, which fuel growth. But in an environment which we saw as being potentially difficult in the reset and potentially also lower afterward, we focused much more on cash flow. And the cash flow for the year, at $15 billion, is up after CAPEX and acquisitions—was up from where it was the previous year. And given we've been through hopefully the worst economic environment that we are going to see in our lifetime, positive cash flow of $15 billion was an extremely successful year in particular, from my perspective.

We also strengthened the balance sheet. Some of this is slightly controversial from your point of view, because from your point of view you would have liked to have seen us actually destrengthen it and buy back more shares. But we took a view certainly six months ago that none of us knew how long the reset is going to be. And even though we're all feeling a bit more comfortable now and a bit more confident about the world, we're still not sure we're totally out of it yet. But we would like to think that certainly relative to where we were six months ago, we're in better shape. But we took a view after Q2 and around November, December that we would actually strengthen the balance sheet because we didn't know what was coming. So after a period of several years, we have been taking cash down. And, as you know, we've been a significant share buy-backer. I think in dollar terms we bought back more shares than any other company in history. We took the view that we would actually strengthen the balance sheet and not do buybacks. Now, in terms of buybacks going forward, as I've said to a number of you, because I know it's of interest, we will still be a net buyer of our shares, we will still look at that net cash flow after CAPEX and acquisitions and weighted for offshore cash, which we have a lot of—we're still going to be a net buyer of shares. But in the period of reset, we took the view that strengthening the balance sheet, and in particular positioning ourselves for the new normal where we think opportunities are going to be significant—from an acquisition point of view, from an investment point of view, the environment over the next few years is going to be a fantastic one for companies who have strong balance sheets. And that's why we took the decision, even though our shares look particularly cheap, we were going to strengthen our balance sheet.

We also had the first entry into the debt markets. Ironically, in the worse debt crisis of the world, we actually had our first entry. The reason for that is quite a simple one. As one of the few AAA companies in the world, we had access to it. We had access to it at unbelievably cheap rates. So we borrowed 5-, 10- and 30-year money at an average after-tax cost of 2.3 percent. We don't think that's ever going to be lower than that, of any significance. We are issuing about $2 billion of commercial paper at an after-tax cost of about 10 basis points.

So our debt has never been cheaper, and I basically have the view that if you're ever going to borrow debt, you do it at the time when you don't need it. It's a fairly fundamental principle of finance.

So it was great time to go into the debt markets for the first time as a company, start to change the structure of our balance sheet, and at the same time provide us even more liquidity in the environment that we're going into.

So, number one, from our point of view, not a big issue, but an important strategic advantage: focus on cash flow and the balance sheet. Number two, clearly streamline the cost structure. In the environment that we're going into, costs are going to be even more fundamental than they've ever been. As you know, we changed fundamentally during the year. So this is OPEX growth—operating expense growth per year over the last few years. And it's cumulative, so each year it's bigger. So it grew from $2 billion in fiscal year '06 to $2.7 to $2.9. And when I stood here last year, we said we were going to grow $4.1 billion, which was clearly a huge amount of money and a huge amount of growth. As it turned out, we grew about $700 million. It's still a growth, but relative to where we started the year, it was a significant change in the way that we thought about running the company and probably one of the most fundamental changes certainly in our history.

And I think what's probably most important is how we did it. And I think it's all important to go back and remember most of us in about the first quarter of last year were still feeling relatively sanguine about the world, and we were still growing expenses. In fact, we grew expenses 18 percent in the first quarter of last year. We grew them 11 percent in Q2. We shrank them by 1 percent in Q3, and shrank them by 12 percent in Q4. And you'll also recall, those of you who were here last year, I had to stand up and explain to you why we're below costs in the fourth quarter. We certainly didn't have that problem in this fourth quarter.

But the other thing I'll point out on this graph is we sat down for the first time as a leadership team and talked about the reality of the situation that we were going into the reset—about November of last year. I think that was when we and most people—it became obvious that we were not just in a mild recession; we were in something that was fundamentally different. I think we, like most people, saw our sales, the pattern of our sales, change fundamentally in about that October-November period last year.

The speed at which we did things relative to the size of the company belies the concept that we don't have agility when we want it. So between November, when we first talked about it as a senior team, and January, when we first announced that we were going to unfortunately lay off 5,000 people and cut back on every cost associated with the company, it was about a six- or seven-week period that we essentially changed the fundamental structure of the company. Clearly we're going to have to do more of that. We still see some growth in costs next year, but it's going to be very modest, and things like costs of goods sold, which is going to be a fundamental part of the business going forward because of the changing nature of the business model that we have—it's going to be an area where we are going to have to put vastly more focus in the future than we have in the past. But again, I point to the fact that when we decide that we wish to do something, we can do it relatively substantially.

Number three is driving operational excellence. Operational excellence means a lot more in a manufacturing environment than it does perhaps in a software company, but I still think it means a lot in this environment. And one thing I would point to in terms of operational excellence in our context of a software company is product delivery. What products do you deliver relative to your schedule?

Now, when I came into the company a few years ago, people used to say continuously how bad we were at delivering products, and of course they would always say Vista is the shining object they would use. What I would like to point out in the last year is when you look at the products that have come out, virtually without exception they have come out in full, on time, which is an old manufacturing term but basically means feature-full, at the time that it was supposed to. And clearly we have Windows 7, Windows Server, and Office, our three landmark products on schedule to come out essentially when we expected them over the course of the next year. So in an environment where despite the fact that we've turned the company on its head and cut costs materially, we still actually delivered all the products that we were supposed to, at the time we were supposed to.

So in terms of operational excellence, which I know Kevin Turner in the field focuses on enormously, when I apply it to the R&D side, the track record of the company over the last year has actually been extremely good.

Number four: capture market share. You've heard a lot about that from all the presenters today. And what I want to do is put that in the context of something historical. Now, we've all become to some extent historians over the last year as we've looked back on previous recessions and seen how bad they are, and what are their implications for how companies are. And I think there are some good learnings, which is part of what I've used in setting this framework up.

And one thing I thought was interesting was how market share affected companies during the Great Depression—just an interesting statistic. So if you go back to 1929, the top 207,000 companies in the U.S.—essentially all the companies that were measured at that stage—had revenue of $68 billion. During the course of the next four years, as the economy contracted something like 30 to 40 percent, revenue shrank to $31 billion, and 139,000 companies survived—I don't think obviously it's going to be as drastic as that here, but it's interesting how that shrank. Over the next four years, as the economy started to recover, albeit at a slower rate, and that even by '37 it wasn't back to '29 rates, companies started to obviously come out and mature, and revenue got to $61 billion. If you look at the revenue per firm, what you see is it shrank from $330,000 per firm, to $220,000—clearly the economy contracted faster than the number of companies that survived it—then, as you came back out, even for a lower level of economic activity, the revenue per firm went up. What's the simple message? It's intuitively obvious but incredibly important that basically over the next few years you were going to have some companies that survive and some that don't. Those that survive are going to be split into the ones that prosper and gain market share, and the ones who don't.

So in terms of the world that I think we're going into, which is going to be lower growth, you are still going to have some companies who outperform, who grab market share, and who actually are able to grow faster than they were able to do previously because the number of competitors is going to be lower, because you're going to see consolidation, and you're going to see a differentiation in the way that customers buy products that's going to allow people to actually do better in a more difficult environment. And that's why there's so much focus internally on capturing market share.

The good news from our point of view, as you've heard all day, is we have never had a better product suite as a company to capture market share with. The products that we have now, and the products that are coming out in the next year, are the best suite of products on a relative basis, relative to our competitors, than we've ever had. So the field's ability to actually sell to customers and gain market share has never been stronger. It's also why there's such a focus internally on market share. And all I've done is capture here—we have commitments, clearly, and what we have is senior leadership commitments—our senior leadership team has commitments—and there is market share: product group commitments market share, subsidiary commitments—all of which are totally aligned to each other. So the way that we are measuring ourselves will be driven to a large extent around market share, which as we come through the reset and go into the new normal, it's going to be absolutely fundamental to how we drive the top-line growth going forward.

Last, but not least, in terms of the five things that I think you need to drive shareholder value, invest in innovation, and, again, intuitively obvious, but you've certainly heard Steve talk a lot about why we invest in innovation. You heard Craig talk about the long term. We still passionately believe that innovation will drive long-term revenue opportunities.

And the other thing to think about is, even in a relatively low GDP environment, a more difficult GDP environment, all the fundamentals that drove IT spend greater than GDP, software spend greater than IT spend, I still think are going to be in place going forward. We're still seeing clearly a shift to a more IT-based economy. IT will still be the great driver of productivity, which is going to be even more important in a lower consumer-based economy than it has been before in terms of driving GDP growth. So we are an incredibly fortunate industry in terms of relative growth.

There's also clearly going to be high growth segments even inside the software industry, which are going to go double digits or more. Now, again, when you look back at previous periods, take the Great Depression again. There were categories of products like national branded products, refrigerators, which grew at double digits even though the economy was shrinking. So our challenge, in terms of the $9.5 billion that we spend, is to make choices around the segments that we're doing.

And if there's one additional healthy thing from my perspective in terms of the real cost discipline that we have, we are really making choices around where we spend money. We are not spending money in some areas, and we're doubling up in other areas. So the environment of cost discipline measured, combined with a focus on high growth segments, has the ability to actually have a double positive.

So when I put all of that together, how do I think about shareholder value in the new normal? I put it in an arch, because I think all of these things support each other. Driving for cash and controlling costs is like the bottom of the arch. Without that, you don't have the fundamentals for success. Driving for market share and operational excellence gets you into a relevant position, and then innovation is the next driver as well. And different companies are going to have different ways in which they use these five leaders. Certainly from my own manufacturing experience, cost was the thing that drove value. When you're in a start-up environment, you don't care about costs; all you're driving for is market share and for innovation.

In the environment that I think we are going to go into, and for the sort of company that we are, and the size we are, having a balanced portfolio across all these five is going to be critical to driving it, which is why we are focusing on all the five and why you've heard about all of them over the course of the day.

And when I take a step back and say, how do I think the last year has been, clearly it was a tough year. Clearly it was difficult from a financial point of view. Clearly we disappointed you in the fourth quarter. It was, relative to the expectations that we had in the quarter, a very tough year. How do I actually feel about what happened below the surface? I think we had some great products come on. I think our sales execution was outstanding, and I thought we actually showed great discipline around the things that we control—in particular, costs. So when I look forward to what does the new normal look like and what are we doing as a company that we need to do, I think we're building new muscle in the areas that are necessary, and I think that in the areas that we've always had muscle, we're actually getting stronger than ever.

So thank you. I hope you've enjoyed the day. I'm going to get some of my other colleagues to come and rejoin me, and I'm looking forward to taking your questions. Thanks very much.

BILL KOEFOED: Great, Chris, why don't you stay up here with me?

END

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