微軟 (MSFT) 2008 Q1 法說會逐字稿

Welcome to the Microsoft first quarter earnings conference call. (OPERATOR INSTRUCTIONS). Today's call is being recorded, and if you have any objections you may disconnect at this time. I would now like to turn the meeting over to Colleen Healy, General Manager Investor Relations. Ma'am, you may begin.

Good afternoon everyone. Thanks so much for joining us today. This afternoon I'm joined by Chris Liddell, Senior Vice President and Chief Financial Officer; Frank Brod, Corporate Vice President and Chief Accounting Officer; and John Seethoff, Deputy General Counsel.

Today's call will start with Chris providing some key takeaways for the first quarter of fiscal year 2008 and an overview of expectations for the rest of the fiscal year. I will then provide details around our first quarter results, and then turn it back to Chris for a more detailed discussion of our guidance for the full year and second quarter of fiscal 2008. After that we will take your questions.

We filed our 10-Q today in conjunction with our earnings release; therefore, you have available the earnings release, MD&A, financial statements and footnotes. We have also posted our quarterly financial summary slide deck, which is intended to follow the flow of our prepared remarks in order to assist you. This slide deck offers highlights from the quarter, outlines our guidance and provides a reconciliation of differences between GAAP and non-GAAP financial measures that we will talk about today. You can find the earnings release, the financial highlights, and the quarterly financial summary slide deck on the Investor Relations website at www.microsoft.com/msft.

Today's call will be recorded. Please be aware that if you decide to ask a question it will be included in both our live transmission, as well as any future use of the recording. As always, shareholders and analysts can listen to a live webcast of today's call at the Microsoft Investor Relations website. A replay of the call will be available at this same site through the close of business on October 25, 2008.

This conference call report is protected by copyright law and international treaty. Unauthorized reproduction or distribution of this report, or any portion of it, may result in civil and criminal penalties. Any recording or other uses of the transmission of the text or audio of today's call is not allowed without express permission of Microsoft.

We will be making statements during this call that are forward-looking. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of factors discussed in today's earnings press release, and the comments made during this conference call, and in the Risk Factors section of our 10-Q, our 2007 Form 10-K, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement.

With that, let me turn it over to Chris.

Good afternoon everyone and thanks for joining us. I will start today's call with highlights from our first quarter performance and how we see the rest of fiscal 2008 shaping up.

The first quarter represented an outstanding start to the fiscal year, with every part of the Company performing at or above expectations. In particular, we're very happy that consumer demand across our total product range propelled revenue, operating income and earnings per share growth by 27%, 32% and 29%, respectively.

Also we successfully closed aQuantive, and a number of smaller acquisitions. And we continued setting the platform for future growth with the availability of products and services, such as an updated Live Search, BizTalk Server, Silverlight, PerformancePoint Server, Halo 3, and Office Communications Server.

In terms of our financial performance there are some key trends that I would like to highlight. On the revenue side, the benefits of our multiyear product cycle are obvious. Q1 was our fastest-growing first quarter in seven years, with revenue up 27%, or $3 billion over Q1 of last year. The performance was across all divisions, customer segments, channels and geographies.

Looking specifically at the growth coming from our various geographies, emerging markets continue to be a strength. The nations that make up the G7 grew 29% for the quarter, but even better was the over 40% increase turned in by the combined group of Brazil, Russia, India and China. A quarter like this demonstrates how enlarging our geographic presence has positioned us to benefit from the continued worldwide economic expansion.

We also did a good job this quarter of converting revenue growth into profit growth. Operating income grew 5 percentage points faster than revenue, expanding our operating margin from 41% to 43%. Solid marketing and sales execution, combined with efficiency on operating expenses, kept costs in line with expectations.

Earnings per share was up 29% over last year to $0.45, assisted by our ongoing share buyback program. Given the start in the first quarter, the acquisition of aQuantive, and an improved outlook, we are increasing our revenue, operating income and earnings per share guidance for the year. We now expect revenue growth of 15% to 17% and this will put the top end of our revenue approaching nearly $60 billion, representing a $2 billion increase over our guidance in July. We are also increasing our operating income and earnings per share guidance, the latter to a range of $1.78 to $1.81, $0.08 to $0.09 higher than our previous Outlook.

With those high-level themes for the quarter and 2008, I'm going to turn the call over to Colleen now for more details on how we closed out the first quarter.

As Chris mentioned, we're off to the fastest start for revenue and operating income growth of any recent fiscal year. Let me provide you with details of our financial performance, starting with revenue. I will discuss topline financial and business momentum points, and then follow up with revenue performance for each of the business units. Then I will review the rest of the income statement. All growth comparisons relate to the comparable quarter of last year, unless otherwise specified.

Revenue increased 27% to $13.8 billion, significantly exceeding our expectations by over $1 billion. Every business grew at double-digit rates, with particular strength in Client, the Business Division, and Server and Tools, which grew in excess of 20% combined, as well as growth of over 90% by our Entertainment and Devices Division.

The underlying PC hardware market was strong, with estimated growth of 14% to 16% during the quarter, about 3 points higher than our expectations. From a customer segment standpoint, the business PC shipment growth rate increased almost three times to over 12%, while continuing to be outpaced by the Consumer segment.

From the geographical point of view, PC growth rates in emerging markets continued to outpace that of mature markets, driven by robust growth in Brazil, Russia, India and China, which grew a combined 20%.

Europe and Canada led the mature markets, while we began to see recovery in the U.S. and Japan.

Our mix of product billings for the quarter was approximately 35% from OEMs, 25% from multiyear agreements, 20% from license-only sales, and the balance from our other businesses. Non-annuity sales were particularly robust, which is consistent with the post-product-launch stage for Windows Vista and the 2007 Office System. Strong annuity licensing performance with Enterprise Agreement renewal rates consistent with historical trends drove our unearned revenue balance 15% higher to $11.6 billion.

Our contracted not built balance increased sequentially to over $11 billion. When taken together with reported revenue, total bookings for the Company grew an impressive over 30%.

I will close out the revenue overview by adding that changes in foreign exchange rates added about 2 percentage points to our overall revenue growth, and was slightly above our forecast heading into the quarter. Now I will provide revenue highlights by business segment, starting with Client.

As Windows Vista became available for consumers, Client revenue has grown over 20% on average. This quarter a rapidly expanding personal computer market, progress against software piracy, and three quarters of Windows customers adopting premium versions, drove Client revenue to $4.1 billion, an increase of 25%.

OEM revenue, which makes up over 80% of Client revenue grew 25%. After adjusting for 3 points of revenue recognition from deferred revenue, OEM revenue increased slightly faster than OEM unit shipments of 20% due to a higher mix of premium Windows SKUs.

Consumer premium units grew over 150%, while business premium units grew closer to 11%. As a result, the OEM premium mix increased by 16 points to 75%, driven by a 19 point increase in the Consumer element of premium mix, and partially offset by a 3 point decline in the business element. Because business premium SKUs have a 5 to 1 pricing impact over consumer premium SKUs, these changes in the premium mix have largely offsetting impact to revenue.

Client commercial and retail licensing, which makes up about 20% of Client revenue, increased 23% as business customers continue to add Client products to their annuity agreements. During the quarter we saw a 27% increase in the Client volume licensing portion of the unearned revenue balance. We view this to be a positive leading indicator of intent by businesses to deploy Windows Vista.

Server and Tools revenue increased 16% to $2.9 billion, driven by strong annuity license growth in Windows Server and SQL Server, which we're happy to see ahead of the upcoming new releases. More specifically, we saw healthy unit growth in our Windows Server business, particularly in our premium Enterprise Edition SKU, which grew by over 35%. And SQL Server unit and revenue growth each exceeded 15%.

During the quarter we released Silverlight, a Windows Home Server. We also gained significant product development momentum with beta releases of Visual Studio and SQL Server. Since the availability of the initial release candidate of Windows Server about a month ago, it has been downloaded over 1 million times, indicating high interest in the coming final product.

Our consulting revenue increased 32%, as we have experienced higher utilization rates following the recent business product launches across the Company.

Online Services Business revenue grew 25% to $671 million, including $80 million for the half quarter of aQuantive revenues since close. Excluding aQuantive, consistent with the way we guided you back in July, growth was in line with our expectations. Online advertising growth for the quarter grew 33%, or 25% before aQuantive.

Microsoft Business Division revenue grew 20% to $4.1 billion. As a result of our focus on delivering greater desktop value to business customers we achieved double-digit revenue growth across a broad range of products within our Office System, Unified Communications, and Business Solution areas.

Looking at how the various customer segments performed, revenue from business customers jumped 25% over the prior year. We benefited from strong midmarket transactional sales and good Enterprise demand for business productivity infrastructure, such as SharePoint and Enterprise CAL.

Healthy sales through retailers for the back-to-school season helped drive consumer growth in the quarter.

Entertainment and Devices revenue grew over 90% to $1.9 billion, driven by higher than expected console sales and Halo 3, which achieved the biggest entertainment launch date in history. The strong demand for Halo 3 generated approximately $330 million of Microsoft revenue in the quarter, as well as significant consumer interest for the Xbox 360 console.

Xbox 360 console units increased over 90%, with over 1.8 million units sold. This is driven by our August price cut, excitement around Halo 3 generating console demand, and an earlier ramp up to the holiday season in anticipation of the most compelling lineup of game titles available on any platform.

In addition to the success of Halo 3, Xbox 360 continued to lead third-party game sales against all current generation platforms, which is not only good for us and our gaming audience, but also good for our game developer partners and the Xbox ecosystem.

For example, according to NPD for the U.S., all four of the current generation third-party titles in the top 10 last month were for the Xbox 360. In fact, over the last year game developers have seen their titles hit the top ten list 27 times for Xbox 360, compared to only twice for the PS3 and only once for the Wii. This helped Xbox 360 software attach rates remain at record levels for any console at this stage in its lifecycle.

Now for the rest of the income statement. Cost of revenue increased 3 points to 19% of sales, primarily driven by the high volume of Xbox 360 unit sales, increased consulting business, and expanded Online Services operations. Operating expenses increased 11%, dropping from 43% of sales to 38% of sales. Expense growth was largely aligned to headcount growth, and is tracking to our expectations, despite the higher than expected revenue it generated during the quarter.

Operating income grew faster than revenue at 32% to $5.9 billion, exceeding high-end guidance by $750 million and expanding our operating margin by 2 percentage points. Investment income and other totaled $298 million for the quarter. Our effective tax rate for the quarter was 31%, 0.5 point higher than we previously guided.

Cash flow from operations increased 45% to $5.9 billion. Cash flow from operations outpaced operating income due to collections on the large volume of business closed at the end of the fiscal year.

During the quarter we repurchased 81 million shares, or $2.3 billion of Company stock. $2.9 billion settled in the quarter due to the high volume of repurchases at the end of fiscal year 2007. And we paid out $938 million in dividends to shareholders in the quarter.

Diluted shares outstanding for the quarter were $9.5 billion, down 5% from the prior year as a result of share repurchases. Earnings per share for the quarter were $0.45.

So in summary, we are extremely pleased with this quarter's performance. Revenue for the fiscal year is off to the fastest start in recent history, fueled by strength across our products launched over the last nine months. Operating expenses came in line with expectations, while generating significantly higher than expected revenue. This resulted in operating income growing faster than revenue at an impressive 30% clip.

With that, let me turn it back to Chris, who will provide you with our second quarter guidance and outlook for fiscal 2008.

Before we get into the specific guidance, let me outline some of our key underlying assumptions. First, our fiscal 2008 forecast assumes stable macroeconomic conditions through the remainder of the fiscal year. We remain optimistic about the overall outlook for the IT industry. In mature markets we haven't seen a spillover from problems in other areas of the economy, although clearly the risk of an economic slowdown has increased.

Emerging markets in particular appear healthy to us. Not only are we getting the benefits of strong growth offshore, but it is assisted by stronger international currencies. The FX impact alone we believe will add about 1 point to our yearly revenue growth.

Overall, our business is benefiting from our diversification across products, channels, geographies and customer segments.

We're increasing our expectation for PC unit growth for fiscal 2008 by 1 percentage point, to 10% to 12% for the year, and 11% to 13% for the second quarter. Growth rates in both the Asia-Pacific and EMEA regions appear to be stronger than we thought coming into the year. We estimate that the growth rates will continue to be higher in the Consumer segment than in the Business segment, and recent regional trends should continue, with growth in emerging markets outpacing that of mature markets.

Now let me go through our detailed guidance. For the full year we expect our revenue to come in between $58.8 billion to $59.7 billion, growing 15% to 17%, up 4 percentage points from our last guidance. Full year forecast now includes revenue from aQuantive, which contributed approximately 1 point of revenue growth. The remaining 3 point increase from July is driven by an improved outlook for our three businesses of Client, the Business Division, and Server and Tools.

In the second quarter we expect revenue of $15.6 billion to $16.1 billion, which represents a year-over-year increase of 25% to 28%.

With that, revenue guidance in our divisions is as follows. For Client we expect full year growth to be 12% to 13% and second quarter growth to be 62% to 64%, or 13% to 14% excluding certain revenue deferrals in the prior year. For full year we expect OEM revenue to grow in line with the PC hardware market.

On the commercial and retail side of the business we expect double-digit growth for the year from continued demand through our volume licensing channels. The Client growth rate benefits by 2 percentage points for the full year and by 4 percentage points in Q2 from recognition of undelivered elements, consistent with our guidance in July in both percentage and absolute dollars.

Server and Tools revenue should be up 16% to 18% for the year, and 16% to 17% for the second quarter. We expect double-digit growth across our server platform products and services. The division is completing the new releases of Windows Server, SQL Server and Visual Studio in preparation for the upcoming launch of them starting in February. These products will allow IT departments to be more productive by providing them with secure, trusted and scalable and manageable platforms that will underpin growth in the Server and Tools business over the next several years.

We forecast revenue in the Online Service business to increase 33% to 37% for the year, and 32% to 35% in Q2. This implies Online advertising growth in excess of 30% for the quarter and for the year. This guidance includes the revenue for aQuantive, which adds approximately 25 points of growth for Q2 and for the full year. Organic revenue guidance for the fiscal year is unchanged for both the business group and advertising.

We are aiming to become one of the major players in the Online advertising space, and we are pleased by the progress we're making in putting the building blocks in place. For example, the launch of our new search product with much stronger relevance. Using industry standard measurement methodology our core algorithmic relevance is now on par with the market leader, and better than all other search engines in the U.S. market today.

We saw solid growth, 23%, in our Display business. We saw record growth in our Live IDs, growing 19% to over 400 million. Our partnership, which we announced yesterday with Facebook, and the acquisition and the successful integration of aQuantive during the quarter.

We will continue to invest in this business, as we have told you before. For example, in building differentiated search experience in the four high-value verticals of commerce, local search and mapping, entertainment and health, which collectively represent 40% of all global searches.

Microsoft Business Division revenues should be up 14% to 15% for the year, and 31% to 33% in the second quarter. Normalizing for the impact of the technology guarantee and preshipment deferrals in the prior year, the second quarter growth should be 15% to 16%.

Looking at the implied growth rate from the second half, I will remind you that due to last year's strong sales of the 2007 Microsoft Office system, we will have tough comparisons but are expecting double-digit growth nevertheless.

2008 is another important product launch year for the Business Division as we roll out offerings in the important investment areas of Business Intelligence and Unified Communications. These two areas are projected to have a combined addressable market size of about $65 billion in 2009, representing sizable growth opportunities for the division.

PerformancePoint Server, which is our business intelligence offering, had over 10,000 customers on a CTP program, an amount larger than some competitors' installed bases. In Unified Communications, Office Communications Server, also has been gathering interest was over 80,000 beta downloads of the software.

In the Entertainment and Devices Division we're forecasting revenue growth of 15% to 20% for the full year, and flat to down 8% for Q2. Our Q2 revenue growth, however, should be viewed in conjunction with the earlier than expected ramp up of console sales in Q1 in preparation for the coming holiday season. If you look at our overall for the first six months, that is the first quarter and the second quarter combined, growth would have been above 15%.

(inaudible) in the quarter has historically comprised almost half of industry hardware and software sales. With competitively priced console bundles and accessories, combined with a great first and third-party software title lineup, we feel very good about our position getting into the holidays.

We also look forward to bringing more choice to digital music consumers with our expanded families of Zune devices and updated music Marketplace, and new software updates, such as podcasting support, new wireless [send] and sync functionality and an attractive user interface. And in appreciation of our early Zune adopters, the new software features will be updatable to current owners' devices as well.

Turning back to Companywide performance, operating income for the year is expected to be between $23.3 billion and $23.7 billion, increasing 26% to 28%. Our higher revenue forecast is responsible for the improvement versus our July guidance, as we expect over half the incremental revenue to flow through to operating profit. For the second quarter we expect operating income to be between $5.9 billion and $6.1 billion.

As a result of the higher operating income guidance, we are increasing our full year earnings per share results to $1.78 to $1.81, including $0.01 impact from integration and deal costs associated with aQuantive. This is an increase of $0.08 to $0.09 on a GAAP basis, or $0.09 to $0.10 excluding deal cost. For the second quarter we expect $0.44 to $0.46. These earnings then assume, both for the year and for the quarter, an effective tax rate of 30.5%.

From a balance sheet perspective, we expect that total unearned revenues to finish fiscal 2008 up 8% to 10%, in line with our prior guidance. Excluding deferred revenue for undelivered elements, the remaining portion of unearned revenue should increase 14% to 16%.

When thinking about sequential changes in unearned revenue from Q1 to Q2, we expect the balance to follow historical patterns and remain roughly flat. Contracted not billed should also finish 2008 up from current levels.

It is clearly important, especially in the current environment, that you consider some of the risks of this forecast. These risks include competitors, legal, execution, and general market risks, such as foreign exchange rate movements, fluctuations in PC and server hardware growth rates, and consumer acceptance of our new and existing products. Additionally changes in the mix of our billings between annuity and license-only can have an impact on revenue, operating income and earnings per share by delaying revenue recognition in a future period.

So to wrap up, the first quarter was an outstanding start to the year. A strong PC and hardware market, healthy demand by business customers for our products, and overwhelming consumer response to the launch of Halo 3, helped propel us to the fastest Q1 revenue growth in seven years.

To put that in context, our revenue base is about 2.5 times larger than it was the last time we grew this fast. The fact that we can beat the law of large numbers is a tribute to our product and sales teams.

Product execution and cost discipline allowed the majority of our revenue upside to flow through to operating income. And for the balance of this year we will continue to deliver the strategies for shareholder value we outlined at our financial analyst meeting in July, in particular driving our topline growth, continuing to invest in technology offerings that will provide the platform for future growth, and using our strong cash flow and balance sheet to benefit shareholders through dividends and share repurchases.

With that, I will hand the call over to Colleen so we can get started taking some of your questions. Thank you.

Let's proceed to questions. We want to accommodate as many questions as we can from as many of you, so please avoid multipart questions. And please limit yourselves to just one question.

Operator, can you please repeat your instructions?

(OPERATOR INSTRUCTIONS). Heather Bellini, UBS.

Congratulations on the quarter. I was wondering if you could give us an update on your view of this adoption thus far, and in particular how the uptake of premium SKUs, both on the consumer side, and also with just the Enterprise, are tracking versus your original expectations? And how should we think about that going forward?

Clearly we're very happy with the Client Division overall. As you have seen since we launched Vista the revenue growth has been in excess of 20% three quarters in a row. So the overall hit [line number] very good.

In terms of the premium mix, also very happy about that. In this case premium mix brings in both Visa and XP premium sales as well. And that is tracking in the mid-70s, so 75% for the quarter. And that compares to, I believe, 59% in the equivalent quarter last year. So up 16 points year-over-year. And so we're very happy with the adoption of Vista Premium and also happy with the old XP media sales as well.

The other thing I will point to is on the Client annuity agreements, which is probably the best leading indicator we can think of, of people's intention to adopt, it is still very early in the adoption cycle for businesses, but the volume licensing portion of our business was up 27% in the Client area. So that is a very good leading indicator from our point of view. And sort of finally as a wrapper, the [license]to date sales are now 85 million units for Vista, that compares to about 45 million for XP over the same period. So almost twice as much. It is still early days, but progress we're very happy with so far.

Just on the premium SKUs, would you say that they are tracking above what you guys had expected when you originally launched the product?

Yes.

Adam Holt, JPMorgan.

I will also echo the congratulations. I had two questions on the business uptake. In particular you had a meaningful acceleration on the Client side in terms of business units, and I was hoping maybe you could detail what you thought was behind that acceleration?

And then on the Office front, still another quarter of better than 20% Office growth on the business front. Where do you think we are on the Enterprise upgrade cycle for Office?

We start with Client. The business sales were, to be honest, a function of an underlying demand. So the PC units came in at 14% to 16% for the quarter overall compared to our expectations of around 10% to 12%. We saw a good uplift in overall PC units, and that was both on the consumer and the business side.

I think the benefit that we saw on the business aspect was probably most particular in some of the emerging markets. So we saw good strength in business, and that really helped us with the antipiracy and legalization aspect of our growth. So if PC units grew by 14% to 16%, and our shipped units that we were paid for grew by 20%, and all of that delta was effectively our fight against unlicensed PCs.

So the growth that we saw in the Business segment, in particular internationally, really helped us in terms of overall unit sales. So I felt very good about that. And we still think that consumers will grow faster than businesses but overall a very good story on the Client side.

In terms of the Office, that has a slightly different impact, mainly because it is a much stronger impact from annuity there rather than non-annuity sales. Although interestingly, non-annuity sales, which typically go to smaller businesses, were strong as well, which is a very direct impact with Office.

In the annuity sales, which tend to have a multiyear impact, you recall I spoke last quarter about how we saw a very strong signup for maturing agreements right at the top end of our expectations. And that was really a very good leading indicator of people's acceptance of -- or expectation that they would roll out Office, but also the other products in MBD. So it is clearly strong from our point of view that people are seeing not only a value in Office, but products that are related to Office, for example, in the Unified Communications and Business Intelligence area. So overall we're feeling good about the rollout.

Sarah Friar, Goldman Sachs.

I think everyone is going to say congratulations, but it is quite an amazing quarter you put up. Just following on one more comment on the Client Vista adoption side, I think a lot of folks had thought SP1 would be the catalyst. Why do you think we saw it go up ahead of that, and do you have a timing update on SP1? And then I just have a quick follow-up question if I may after that.

Vista adoption, as I say, is still early. I talked about intention to adopt rather than actual adoption. I think you are right that certainly some businesses will be waiting for SP1 to roll it out. But in terms of their willingness to sign up for the Client element of the multiyear agreements, their intention to roll out is, I guess, signaled by that. So it is still early days as to what the actual adoption numbers are. And we think it will increase during the year, and obviously will be helped to some extent by SP1. But some of the leading indicators are what we feel good about.

Got it. And then just turning to the EDD division, it is in a great quarter. It seems like you do think there was some pull forward on consoles, just based on your guidance. Is there anything implied in your guidance on broader commentary about health of consumer spending in the fourth quarter? Are you leaving yourself a little bit more cushion there?

No, it is principally around the four quarters you mentioned. As I said in my prepared remarks, I tend to look at the business for the first six months rather than the quarters. In particular in the first quarter console sales were 1.8 million units, which is relatively small. It was ahead of our expectations, but it is a quarter where you can beat expectations because the volumes are small. I mean, Halo was obviously a clear beat. But in terms of consoles I would rather think of the volume over that six months, because there's a lot of stocking in anticipation of Christmas going on and movements like that.

I feel good about it. There is no particular signaling on weakness for Christmas. In fact, we feel very good about the lineup we have got, not only from the box itself, but obviously the games associated with it as well.

Charlie DiBona, Sanford Bernstein.

I guess no surprise here, but I'm going to go back to the well on OSB. It was probably the only division that didn't really outperform significantly. Only about 10% growth excluding aQuantive. And the comp score share is back down to the lows that they were in your fiscal Q4.

Especially in light of yesterday's announcement around Facebook, maybe you can give us a little insight into the strategy and execution here. And is there any shift towards buying traffic in community rather than building it internally? And in general how do you go about balancing those two alternatives and valuing those two alternatives?

Sure. First thing to note obviously is we met expectations, so it wasn't a beat, I agree, but it was a meet. So start with that. Underlying business growth or revenue growth, you mentioned the 10%, which is correct. Clearly in this case there is a negative from the Access business going away.

But if you look at underlying revenue growth, underlying advertising revenue growth, it grew in the mid-20s, around 25% for the quarter year-on-year, which we think is acceptable. It is not certainly stellar. We would like to see it higher, but it is acceptable. And it is higher than where we guided at the start of the year roughly speaking.

I think reasonable progress on the organic side of the business. In terms of putting the building blocks in place in how we trade-off organic growth through inorganic growth, it is both. The strategy has been both, and will continue to be both. So we are investing heavily in the organic aspects of the business. So a lot of investment in particular has gone into the search product itself. And we are clearly extremely happy with the improvements we are seeing on aspects like relevance, which are critical going forward.

We are putting a lot of investment into things like data centers, which are creating the platforms of the future and the experience. So we are increasing CapEx by considerably there. We're looking at CapEx overall for the year of $3.2 billion to $3.3 billion, about half of which is going into the OSB area. And we are putting investment in some of the verticals that I talked about on search organically and all the other areas as well, content on the display side.

So there is a strong organic side. There's a strong inorganic side. But clearly aQuantive is the most obvious representation of that. And we're particularly happy that we not only closed aQuantive, but we have retained all the employees. We think that integration has gone extremely well. And we believe that is going to generate some significant benefits going forward.

We also did some other smaller acquisitions, ones which we think are important for the Ad platform, like ECM during the quarter. And then the announcement yesterday on Facebook, which is a willingness on our part to make a commitment to a multiyear agreement with a partner who we think has got some tremendous growth opportunities.

So we're willing to do both. We are quite clearly willing to suffer an operating loss in that division as a result of those commitments, and we have foreshadowed that I think both at our financial analyst meeting and our guidance. But to date in terms of underlying financial metrics, we're on track. In terms of some of the other things that we wanted to do, if anything we're slightly ahead of where we would like to be.

Brent Thill, Citigroup.

Chris, I think your guidance for the fiscal year implies roughly a 40% operating margin, and clearly in Q1 it was higher than 40%. Why do you expect the operating margin will drift to that lower level for the year?

Overall for the year we feel very good about the operating income growth relative to revenue growth, and it will still be an increase year-on-year. So there are some COGS impacts, for example, the mix of COGS during the course of the year. And we just saw an outstanding performance in the first quarter, some really, really strong growth in particular in Client and MBD. So we think that outperformance is going to continue, but not at the same rate.

Operating margins improved, but I think quarter one was just an outstanding one in terms of our ability to take the revenue outperformance and drive it to the bottom line. And as I say, there is a different COGS mix to the rest of the year which impacted it as well.

But overall, we are going to grow operating income faster than revenue growth this year, which means margins are going to expand. And the other impact, which you know I talked to you about, is we expect earnings per share to grow very fast as well. Taking out all of the one-offs, if you like, we think EPS is going to grow faster than 20% this year, which is the benefit of the operating margin expansion and also the benefit of things like share buyback flowing through. At this stage of the cycle for the Company, for a company our size to grow this year greater than 20%, up significantly from where we were, we feel good about as a mix.

Just one quick one, if I could. Relative to Enterprise demand, it sounds like it has improved slightly over the past couple of quarters. Do you think it stabilizes from here or has room to improve even from here?

In terms of renewals, with respect to more traditional levels in the first quarter, and that is the two-thirds to three-quarters rank that we talked about. So we saw a particularly good renewal rate in the fourth quarter. We're back down to some more traditional levels, but levels which we feel obviously very good about. So I don't think -- we're not expecting an outperformance or an increase back to the very, very good levels that we saw in the fourth quarter. But if we can maintain traditional levels, and obviously start to sell the new product range that we have coming through to our existing clients, and hence get the benefits of all of the additional products that we've either launched or are going to launch, that sets us up very well from a business point of view in terms of overall billings growth.

John DiFucci, Bear, Stearns.

Just a follow-up question I guess to Brent. The margins were really impressive here, Chris. And even next quarter you have a meaningful impact -- a meaningful increase in revenue and a pretty, I guess, meaningful decline in operating margin. Is there any reason for us to think that you can't do a lot better than what you're saying here? I understand what you're saying about the COGS, but it looks like it is something that can continue.

Probably the first thing to do is to normalize for aQuantive. So that may be distorting the numbers. But we're bringing that in for the first time, and that is bringing in revenue but no operating income. In fact with the amortization of intangibles, it will be a slight loss for the year. That is probably a drag on the margins that you might want to normalize for, at least give us the benefit of.

If you take that out -- the way that I look at it is, what is our ability to meet our operating expenditure guidance and potentially outperform on the revenue side, as opposed to drive the business on a margin basis? And I would say I'm particularly happy with the fact that we delivered increased revenue in the quarter, while keeping operating expenditures virtually right on guidance.

You recall from last year I was certainly happy that we delivered the whole year right on operating expenditures. So I feel really good about the business groups' discipline, the salesforce discipline, to the large extent keeping operating expenses under control, which will allow us to, to the extent that we beat revenue, to drive it to the bottom line.

I can't promise that is necessarily going to significantly increase margins, but it will increase margins every dollar that drops through. And perhaps if you back out aQuantive that will give you a better comparison.

From a fiscal year on fiscal year, if you're looking at organic, fiscal year '07 you are seeing us sort of a bit above the mid-30s. You pull out aQuantive and legal charges and tax, guaranteed bonds and the rest of it, for the year you are sort of in that 40% range.

And then of course with Q2, given that Xbox, with the hardware such a big driver for holiday, Q2 for the year in terms of the shape of the year you would probably see a dip. But year-on-year when you look at the true underlying organic, pulling out aQuantive and some of those other things, you're going to see I think pretty good margin there.

On aQuantive, to help you, and obviously we have to give more detail as we go on, but aQuantive will add 5 to [$600] million of revenue for the year. We will pull out deal costs and IPR&D that we write-off of close to $100 million. But we will still leave in things like amortization of intangibles, which we know other companies tend to call out. We will leave those in, which means that will be a drag on the operating income of close to a couple of hundred million dollars for this year. So perhaps that will help you normalize for that.

Kash Rangan, Merrill Lynch.

Good to see a quarter like that, and more particularly the stock breakout into a multiyear high. It's got to look good. I just had a question on the Online business. It looks like you have done a good job restoring -- or bringing profitability to let's say to the Entertainment and Devices business. At what point are we in making similar progress in the profitability of the Online business, especially with aQuantive being integrated into the operations of the Company?

And as follow-on, I was just also curious to get your thoughts on the Client side. I know you do sell-in, and correct me if I'm wrong and there has been some concerns in certain segments of Wall Street that there might be an inventory issue on Wall Street, especially on the PC side, and that Intel had a good quarter, or you guys had a good quarter, but with retail -- if that is sort of weakening or at least suspected to weaken during the holiday season, who knows. I am just wondering if you share that concern? And if you don't, what specifically sort of makes you feel that this inventory buildup could actually lead to sell-through in the Christmas holiday season?

Sure. Entertainment and Devices and OSB are really at different parts of their business cycle. So it was a very strong commitment from our point of view to try and drive profitability in the Entertainment and Devices Division this year. And we feel like we are on track for that. So they are on, if you like, an upswing to a part of their business cycle where we believe we can be profitable.

In the OSB case that isn't the primary driver of the business at the moment. The primary driver is to invest in the right areas and create the platform for a very strong growth in economic value over the next few years. So it is not one where we are [fettered] but if we were profitable, but it is one where it is not going to be our primary determinant of success this year.

I will be keen to ensure that the expenses come in where they are. I will obviously be keen to see that our revenue growth is in line with expectations. But assuming we meet those two things, it is going to be a loss for the year. So they are just different. The businesses are at different parts of their business cycle, and so we have different tests against them.

On the Client side, we are not seeing any significant inventory issues that we're aware of. So from our point of view, if you look at the guidance, we feel good about PC unit growth guidance of 11% to 13%. Anything in double digits or greater we think is good. That is like a sell-in number, using your terminology. We think that is good, and we think we should be able to drive OEM units in our area around that same level. There is no particular issues of significance that we're aware of.

It just looks like the emerging markets in the BRIC countries, perhaps business there is accelerating, and that is why your OEM units are looking better than they have in the last few quarters.

That is absolutely right. Those countries really did an outstanding job. Countries like Russia, the business overall grew there by greater than 100% in the OEM area, and Client grew by something like 50%. Some of those countries are growing at a tremendous rate, which is a function of the underlying economies growing well, but as we see business growth in those areas and a greater desire to obviously be -- have legitimate PCs, we are seeing good progress on piracy as well. And that is really helping us with our overall OEM units.

We have time for one, maybe two more questions please.

Kirk Materne, Banc of America.

Maybe I might be jumping ahead a little bit here, but clearly you guys haven't seen any slowdown in terms of demand around either SQL Server or Windows Server 2008 in front of those launches. What is your expectation in terms of the impact of those launches on the growth rates? Do you think that we will see demand come in at a steady pace, or do you expect that as we get into the back half of the year that can help accelerate the growth rates in that division?

I think it will help continue the sort of growth rates that we have seen to a large extent. You have to realize that the structure of our business really has matured significantly to one that is driven much more around multiyear expectations. So people are -- to the extent we are seeing strength in annuity agreements now, it is an anticipation of those products. The fact those products launch [winding] itself drive an enormous amount of accounting activity. We will see that over a slow burden.

So that is the same phenomenon we talked about with Vista. These things will happen over time as people adapt and adopt the particular systems. But from a revenue and economic point of view, our relationship with our customers, our ability to continue to sign them up and drive growth is much more of a multi-tiered route than a single event-based phenomena. We just think a continuation of very strong products rolling out continuously quarter after quarter or year after year is the best way of driving that business.

Just a really quick follow-up on Windows Server 2008. Is the beta for Veridian still expected to be released with a full-blown version released 180 days afterwards? Is that still on track?

Yes, that's correct.

Thanks so much. And our last question please, operator.

Brendan Barnicle, Pacific Crest Securities.

I just had two quick ones. Chris, first on Premium Edition, obviously a great move year-over-year, up 75%. As we have SP1 Comm, where we potentially get more Enterprises pulling in, can we see that Premium Edition even move up higher still?

And then just secondly, over on aQuantive have you given any thoughts again to the agency business, and whether that is something that stays within the business or else needs to be divested?

We're very happy with the agency business. That is continuing to do a great job. I mentioned before, I think the integration has gone extremely well. As far as we can tell the employees are very happy. We are running the agency business in particular on a fairly independent basis, and really letting them continue getting on with their lives. And we think it is a very good business, and no intentions to do anything other than continue to run it. On the Client side, just go over it quickly again. Sorry.

The Premium Edition. You know 75%, very impressive, can we see it go to 85%?

We are just looking -- in terms of our guidance and our thoughts and what is embedded, we believe we can continue to drive that at over 70%. But it is too early to predict anything higher than that.

Would SP1 have any impact on accelerating that?

It might help, but those rates, 70%, are very high. So it might assist, but it may do simply -- just help us continue at that sort of rate. We're not predicting a particular pick-up as a result of that alliance.

Great. Thank you very much.

Thanks everyone for joining us today. If you have any further questions, please feel free to call me or my team directly. As I mentioned at the beginning of this call, this conference call will be available on replay at our Investor Relations website through close of business, October 25, 2008.

In addition, you can hear the replay by dialing 800-835-8067, or for international calls please dial 203-369-3354. The dial-in replay will be available through the close of business, November 2, 2007. Thanks again everyone for joining us today.

That concludes today's call. Thank you for joining.