微軟 (MSFT) 2008 Q2 法說會逐字稿

Welcome to the Microsoft second-quarter earnings call.

(OPERATOR INSTRUCTIONS).

Today's call is being recorded.

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.

Thank you and good afternoon, everyone.

Thanks for joining us today.

This afternoon I am 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 second quarter of fiscal year 2008 and an overview of expectations for the rest of the fiscal year.

I will then provide detail around our second-quarter results and then turn it back to Chris for a more detailed discussion of our guidance for the full year and third 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.

The 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 January 26, 2009.

This conference call report is protected by copyright law and international treaties.

Unauthorized reproduction or distribution of this report or any portion of it may result in civil and criminal penalties.

Any recording or other use or transmission of the text or audio of today's call is not allowed without the 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, in 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 statements.

With that, let me now turn it over to Chris.

Thanks, Colleen, and good afternoon, everyone.

I will begin today's call by providing you with the highlights from our second-quarter results and discuss our outlook for the remainder of fiscal 2008.

Results for the quarter were outstanding.

Revenues surpassed our previous record high by $2 billion, and at $16.4 billion, it exceeded the high-end of our expectations by over $300 million.

We are benefiting from the investments we have made over recent years, plus excellent execution performance from our field sales force.

Revenue in the quarter grew 30% or 15% adjusted for the technology guarantees in the comparable period last year.

Besides just the sheer size and pace of growth, the breadth was notable as we saw strength across all customer segments, divisions, channels and geographies.

For example, demand from enterprise customers, combined with healthy holiday consumer spending for Windows Vista and the 2007 Microsoft Office System, drove revenue for the business groups a combined 18% for the quarter.

Server and Tools once again delivered double-digit revenue growth in the quarter, the 22nd in a row.

Healthy enterprise agreement signings across the Company drove our unearned revenue balance up over $0.5 billion, $500 million above our guidance.

The successful integration of our aQuantive acquisition, plus good organic growth, helped our Online business grow 38%, and a compelling lineup of Xbox games drove our performance for our Entertainment and Devices division.

[D&D] had its second consecutive quarter in the black on its way to our target of full-year profitability.

From a geographic perspective, over 60% of our sales are from users in regions outside of the US.

Revenue in those regions continue to drive growth for the Company with non-US mature markets up over 20% for the first half of the year and emerging markets up nearly 30%.

During the quarter we combined revenue growth with cost efficiencies, resulting in operating income growth of 27%, even adjusted for the tech guarantees of last year.

Operating margins during the quarter were a healthy 40%.

Lastly, earnings per share growth of 32%, after adjusting for last year's tech guarantee, continued to benefit from the combination of strong operating performance and execution of our share repurchase program.

So overall the quarter and half one performance demonstrates that we are realizing the benefits from our expanding business lines, product SKUs and global presence.

The investments we have made, including in our sales force and new product offerings, have positioned us well to offer the right product in the right markets worldwide.

And during the quarter, we refreshed and bolstered our product lineup with releases of Microsoft Dynamics CRM, Visual Studio 2008, new Zune devices and progress towards the upcoming server offerings, including release candidate one of Windows Server 2008 and a beta of our server virtualization technology, Hyper-V.

In light of the strong second quarter, we are increasing our revenue, operating income and earnings per share guidance for the year.

We now expect revenue growth of 17 to 18% and operating income growth of 31 to 32%.

And finally, we're raising our earnings per share forecast by $0.07 for the year to $1.85 to $1.88, a growth of 30 to 32%.

With those high-level themes, I'm going to turn the call over to Colleen for more details on our second-quarter performance.

Thanks, Chris.

The strong momentum that kicked off our fiscal year continued in our second quarter.

As Chris mentioned, revenue exceeded the high-end of our expectations by $300 million during the quarter.

This was driven by demand for our flagship products of Windows Vista and Office 2007, as well as a good holiday season for our Xbox franchise.

This revenue outperformance, combined with decreasing Xbox 360 console costs, flowed through to operating incomes and earnings per share.

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 relates to the comparable quarter of last year unless otherwise specified.

Revenue was $16.4 billion, an increase of 30%.

Adjusting the year ago quarter by the $1.6 billion of revenue deferrals primarily related to the technology guarantee program for Windows and Office, total revenue grew 15%.

With business and consumer PCs each experiencing double-digit growth rates, the underlying PC hardware market increased an estimated 14 to 16% during the quarter, about 3 points higher than our expectations.

PC growth rates in emerging markets continued to outpace that of mature markets.

Europe led the mature markets, and we again saw significant improvement in the US and especially in Japan.

Our mix of product billings for the quarter was approximately 30% from OEMs, 30% from multiyear agreements, 20% from license-only sales and the balance from our other businesses.

Annuity sales were robust, particularly for Server and Tools, in anticipation of the major product releases scheduled for the second half.

This, combined with enterprise agreement renewal rates consistent with historical trends, drove our our unearned revenue balance over $0.5 billion above our guidance to $12.2 billion, up 20% year-over-year normalizing for the impact of the tech guarantee deferral.

Our contracted not billed balance increased sequentially to over $11.5 billion, up well over $1 billion from where we started the fiscal year.

When taken together with reported revenue, total bookings for the Company grew almost 20%.

Now I will provide revenue highlights by business segment, starting with Client.

A robust personal computer market and progress against software piracy drove Client revenue to $4.3 billion, up 68% or 16% after adjusting for tech guarantees.

Over 80% of Client revenue comes from our OEM business.

During the quarter we grew our OEM unit shipments at 18%, approximately 3 percentage points faster than the overall hardware market.

Curbing software piracy has been a significant investment area for the Company over the last several years, and those investments are paying off.

OEM revenue grew 80% or 18% when normalized for the tech guarantees and in line with our OEM unit growth rate.

In terms of premium mix, three out of every four Windows customers adopted premium versions during the quarter.

Consumer premium units grew over 50%, while business premium units grew 12%.

As a result, the OEM premium mix increased by 8 points to 75%, driven by an 11 point increase in the consumer element of the mix and offset by a 3 point decline in the business portion.

Due to the pricing differences between business premium and consumer premium SKUs, these changes in the premium mix had largely offseting impacts to revenue.

The commercial and retail licensing portion of the business increased 18%, up 8% adjusted for tech guarantees as business customers continue to add client products to their annuity agreements.

Next week will mark the one week anniversary of the general availability of Windows Vista.

We feel extremely good about the performance it has driven this first year.

Specifically Client revenue has grown on average over 40%, up over 20% adjusted for tech guarantees.

Client volume licensing portion of the unearned revenue balance has increased 29% year-over-year, and sales of Windows Vista have surpassed 800 million licenses -- 100 million licenses.

That is sales of Windows Vista have surpassed 100 million licenses.

Server and Tools revenue increased 15% to $3.3 billion, driven by double-digit revenue growth in each of the Windows Server and SQL Server businesses.

Coupled with the significant shift in our billings to annuity licensing in advance of the upcoming product releases, this resulted in the Server and Tools portion of the unearned revenue balance increasing by over $1 billion, up by over 35% year-over-year.

License growth for Windows Server and SQL Server grew at healthy double-digit rates in the quarter.

Our premium SKU, Windows Server Enterprise Addition, with its virtualization capabilities grew 35%.

Our consulting revenue increased 28% as we have experienced higher demand following the recent business product launches across the Company.

Online Services Business revenue grew 38% to $863 million, including $154 million from the addition of aQuantive.

Online advertising growth for the quarter was also 38%, up 26% excluding aQuantive.

Our online audience continues to grow.

Windows Live usage broadened as Live IDs increased over 20% to 427 million, and the Windows Live Suite was downloaded 45 million times since its launch in November.

We also continued to expand our advertising and content partnership.

During the quarter we became the exclusive third-party advertising partner on a worldwide basis for Facebook, and we announced strategic alliances with Viacom and CNBC.

Since we announced our acquisition of aQuantive, 60 new publishers have switched to the Atlas Publisher Suite offering.

Microsoft Business Division revenue was $4.8 billion, up 37% or 20% normalized for tech guarantees.

Returns on our investment in field sales specialists were evident as they contributed to double-digit revenue growth across a broad range of productivity offerings.

Revenue from Business customers was up 23% in the quarter on continued broad-based demand, for not only versions of Office 2007 but also for SharePoint, Exchange, Office Communications Server and the Dynamics products.

SharePoint and Office Communications Server had a great quarter with each experiencing growth in excess of 50%, and Dynamics customer billings were up 26%.

Consumer revenue grew 10% adjusted for tech guarantees.

Entertainment and Devices revenue grew 3% to $3.1 billion, over $90 million above our high-end guidance driven by an abundance of high demand game titles which contributed to setting a record lifetime to date software attach rate of 7.0.

In addition to normalized for the impact -- in order to normalize for the impact retailers advancing some of their holiday console purchases into Q1 deferred by the September launch of Halo 3, performance of the two quarters should be assessed together.

With that in mind, Entertainment and Devices revenue grew 25% in the first half of the fiscal year.

Exiting the calendar year, life to date sales of Xbox 360 console hit 17.7 million units.

Based on US NPD data released last week, Xbox 360 sold over 1 million more consoles than PS3 in the holiday quarter.

From a share of wallet perspective, consumers spent 27% more on Xbox 360 consoles, games and accessories than on the Wii and twice as much than on the PS3.

Xbox 360 had four titles that sold over 1 million copies in the quarter compared to three for the Wii and none for PS3.

Xbox LIVE rapidly achieved its 10 million members goal six months ahead of schedule.

On the music scene, we're pleased by the favorable editorial reviews received by the second generation of Zune.

1.5 million people joined the Zune Social online community during the holiday season, and music downloads from our marketplace approximately doubled from last year.

Now for the rest of the income statement.

Cost of revenues decreased by $75 million, primarily driven by lower Xbox 360 component costs that were partially offset by growth in our Consulting business, expansion of datacenter operations and the addition of aQuantive costs.

After adjusting prior year second quarter for the impact of tech guarantees, cost of revenue decreased by 4 points to 22% of sales.

Operating expenses increased 16%.

Expense growth was slightly higher than headcount growth due to legal charges taken in the quarter.

Operating income grew at a faster rate than revenue to $6.5 billion.

Adjusting for prior year for the tech guarantees, cost of revenue improvements drove margin expansion, increasing our operating margins by 4 points to 40%.

Investment income and other totaled $339 million for the quarter.

Our effective tax rate for the quarter was 31%, .5 point higher than we previously guided.

Cash flow from operations increased 124% to $4.6 billion.

During the quarter we repurchased 120 million shares or $4.1 billion of Company stock and paid out over $1 billion in dividends to shareholders.

Diluted shares outstanding for the quarter were 9.5 billion, down 4% from the prior year as a result of share repurchases, but flat sequentially primarily due to stock options exercised in the quarter.

Earnings per share for the quarter was $0.50, which was $0.04 above our high-end guidance driven by the revenue outperformance.

So, in summary, we're extremely pleased with this quarter's revenue performance.

When combined with decreasing cost of revenue, operating income and EPS growth were also impressive.

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

Thank you.

So let me turn to the details of our forecast for the third quarter and the full-year beginning with some of the key underlying assumptions.

For our fiscal 2008 forecast, we will assume the following macroeconomic conditions for the remainder of the year.

As I mentioned before, over 60% of our business originates from countries outside of the US, and we expect the overall software spending environment to remain healthy on a global basis.

In US markets, although clearly the risk of an economic slowdown exists, we have not seen any significant spillover to our businesses, and lastly, we continue to benefit from strong underlying growth in non-US and emerging markets, which has also been assisted by stronger international currencies.

No company is immune from their macroeconomic factors, but overall we believe our business is extremely well-positioned in the technology industry with diversification across a broad set of products, channels, geographies, currencies and customer segments, supported by excellent product value and sales execution.

For PC hardware units, we expect growth of 11 to 13% for the fiscal year, an increase of 1 percentage point from our prior outlook, reflecting the upside we saw in the quarter.

Third-quarter growth is forecasted to be 9% to 11%, slightly lower the year because of the difficult prior year comparable from the launch of Windows Vista.

We expect PC hardware unit shipments to decline sequentially from the first half to the second half of the fiscal year, in line with historic seasonality.

Growth will continue to be driven by strength in emerging markets, and we expect growth rates in the Consumer segment to outface that in the Business segment.

In terms of our detailed guidance, we expect fiscal year revenue to be in the range of 59.9 to $60.5 billion, growing 17 to 18%, which is an increase of over $700 million from our prior forecast based on the strong exit from Q2.

We expect revenue in the third quarter of 14.3 to $14.6 billion, up 12 to 15% excluding the impact of the technology guaranteed deferrals in the prior year.

And with that, I will provide details of this guidance by segment.

Starting with client, we expect full-year growth to be 13% to 14% with OEM revenue growing roughly in line with the PC market.

For the third quarter, growth should be 3% to 5%, excluding the impact from tech guarantees.

When thinking about the third-quarter revenue growth for Client, keep in mind that the strong customer reception for the launch of Windows Vista in the year ago period makes it a difficult comparable.

Server total revenue should grow 17 to 18% for the full year and 17 to 19% for the third quarter.

We expect continued corporate demand for our Server products, which will drive double-digit growth across the breadth of our Server platform products and services.

We're forecasting the billings mix of Server and Tools to continue to shift towards annuity agreements ahead of the upcoming releases.

Next month marks an important milestone for the group with the commencement of the joint launch activities for Windows Server 2008, SQL Server 2008 and Visual Studio 2008.

Together these products will allow IT departments to be more productive in providing them with secure, trusted and manageable platforms and which will underpin growth in the Server and Tools business over the next several years.

For the Online Services business, we forecast revenue to grow between 37 and 40% for the year and to be up 40 to 45% in the third quarter.

Online advertising is expected to grow approximately 35% for both the quarter and the full year.

The Microsoft Business division continues to be truly outstanding financial performance.

We've raised our full-year revenue guidance to 16 to 17% for the year and 11% to 12% for the third quarter when normalizing for last year's tech guarantee.

Growth in the second half of the year will be largely driven by the same factors that made the first half a success.

We expect to see continued demand for the 2007 Office Suite, and SharePoint and Office Communications Server should continue to grow double-digits.

When thinking about growth in the second half of the year for the Business Division, bear in mind the robust retail demand for the Office 2007 last year creates a tough comparable.

Our guidance does not include any impacts on the recently announced acquisition of Fast, which we anticipate to close during our fourth quarter of the fiscal year, and it is not expected to have a material impact on earnings per share during this fiscal year.

For the Entertainment and Devices division, expect revenue growth of 21 to 24% for the full year and 25 to 30% for the third quarter.

We have raised the full-year and second-half revenue forecast to reflect the record software attach rates and strengthened Xbox console sales we experienced in the first half of the year.

Turning back to Companywide performance, operating income for the year is expected to be between 24.2 and $24.4 billion, up 31 to 32% for the year and an increase of 3 to 4 points from our outlook in October.

Our higher revenue forecast is responsible for the increase in operating income since we expect greater than 75% of the incremental revenue to flow through to operating profit.

For the third quarter, we expect operating income to be between 5.6 and $5.7 billion.

As a result of the higher operating income guidance, we are increasing our full-year earnings per share results to be $1.85 to $1.88, an increase of $0.07 from our previous guidance.

For the third quarter, we expect earnings per share of $0.43 to $0.45.

Thus, guidance assumes an effective tax rate of 30.5% for the full year.

From a balance sheet perspective, total unearned revenue should finish fiscal 2008 up 14 to 16%, 6 points or about $750 million above our October guidance, driven by stronger annuity billings and our core businesses of Client, MBD and Server and Tools, as well as an increase in our annuity licensing mix.

Excluding deferred revenue from undelivered elements, the remaining portion of the unearned revenue should increase 20 to 23%.

When thinking about sequential changes in unearned revenue from Q2 to Q3, we expect the balance to follow historical patterns and remain roughly flat.

Contracted not billed should also finish 2008 up from current levels.

As always, I will remind you to think about the guidance we have provided, you must also consider risks.

These risks include competitors, legal, execution and general market risks such as foreign exchange rate movements, fluctuations in PC and server hardware growth rates, IT spending and customer 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 into future periods.

Before moving onto questions, let me mention a few things.

Firstly, I would like to welcome Stephen Elop to Microsoft.

Stephen has a wealth of experience from both an operational and leadership perspective, and he will add a new dimension to our leadership team.

However, I also personally will miss working with Jeff Raikes who will retire from the Company in September.

He has done a fantastic job over the years and leaves us not only with a strong Office franchise, but he has redefined the role of business productivity software at Microsoft by expanding the business into new areas of productivity offerings such as collaboration, unified communications, business intelligence, EIP and CRM, resulting in a near doubling of MBD annual revenue since the year 2000.

It is notable that MBD is now the largest division of Microsoft in size of revenue.

Lastly, I will look forward to seeing a number of you a week from Monday in New York where Steve Ballmer and I will provide you an update on the strategic direction of the Company.

For those of you who are unable to join us for this, we will make available a live webcast, as well as on-demand replay of the presentation.

So with those comments, I will hand the call back to Colleen so we can get started taking your questions.

Great.

Thanks, Chris.

Let's now proceed to questions.

We want to accommodate questions from as many people as possible, so please avoid multipart questions and limit yourself to just one question.

Operator, will you repeat your instructions please?

(OPERATOR INSTRUCTIONS).

Heather Bellini, UBS.

Excuse my voice.

Good afternoon, everybody.

Chris, I was wondering you have shown a lot of impressive topline performance over the last few quarters and in particular some nice upside in operating income.

I guess my question is, after the past few years when we have seen operating margins contract, do you feel now you are in a position where you have made some of the big catchup investments you discussed in April of '06, and now looking forward the spending will be more incremental in nature?

And then I just have a follow-up to that when you are done.

Sure.

As I have said in previous calls and certainly at financial analyst meetings, I think you have to look at the Company in three parts -- the core businesses, the Entertainment and Devices business and the Online business -- because the dynamics from a margin perspective are quite different in each of those, and obviously the Company is an amalgam of the three.

In the core businesses, if you put them together collectively, certainly the operating margin has remained an impressively constant, in fact, slightly up over the last few years.

And so we see revenue growth broadly in line with operating income growth -- operating expense growth in those.

The Entertainment and Devices division has moved from a loss to a profit, so clearly the margins have improved there.

On the Online business, it has been and will continue certainly for the foreseeable future to be in investment mode.

So that has a different dynamic altogether.

When you put those two or those three together, then the operating margin for the Company will be very good this year, and you can see that thought in our guidance for the year.

So overall we are not making any predictions clearly on the call at the moment about past the next couple of quarters, but the operating margin performance as an average of those three trends is good for this year.

Okay.

That was my follow-up, is really you have been in operating margin contraction mode for the past few years.

You finally seem to be kicking it into high gear there where you are going to have well over 100 basis points.

So should we expect Steve when he is in town in two weeks to kind of discuss an operating plan for the Company going forward where we might hear more about the increased leverage in the business?

Yes, I want to qualify the purpose of the February call.

We have always seen that as a good chance to talk about the strategic direction of the Company.

So you can certainly expect to hear the investment theme.

But, as you know, we are a quarter ahead of most companies in terms of giving our fiscal year guidance by doing it in April.

And what I don't want to do is start raising expectations that certainly we're going to start doing that in February, and then maybe we will start doing it in November, and then we will do it a year ahead of time.

It is a time to talk about the strategy of the Company and the strategic themes and at a very high-level that will give some indication of our thoughts about where we will invest.

But it is not going to be a financial guidance exercise.

Sarah Friar, Goldman Sachs.

Good quarter.

So following on that ending comment there, Chris, about areas where you will invest, if you will look at the online services business, it is still relatively small, the growth kind of ex aQuantive, is still not quite at the levels you might see from competitors.

How are you thinking about strategically where you need to go with that business?

What are some of the big milestones we should be looking for over the next couple of quarters and maybe over the next year?

Well, we certainly see it as a multiyear journey that we're going on, and so we are investing with an expectation of hoping to be at a critical mass in several years.

I'm happy if you look at the quarter with -- if you like the incremental progress we have made of revenue growth of 38% ex aQuantive in the mid-20s, it is certainly very respectful.

You are right in the sense it is not at the size or critical mass we would like, and we're building a business which we believe and hope will be a critical mass in the next few years.

But I come back to the theme that we have talked about on several calls and certainly the financial analyst meetings.

We make decisions on investments now which have multiyear implications.

And when you look at the revenue performance over the last couple of quarters, that did not happen by accident.

That happened as a result of investments that we made several years ago.

So you have to look back two or three years to look at the leading indicators of how we have been able to drive revenue growth at extremely good levels and higher than most people's expectations in the last couple of quarters.

So when you look forward in the Online business, you have to think about the revenue several years out and the infrastructure we're building for that.

And fortunately, from a financial perspective, that means investment now.

But that is the way we think about the Company, and that is the way that we will continue to run it.

And just a follow-up on that, so that has been an area where you have definitely been willing to look for inorganic growth, successfully with aQuantive and so on.

Is that also part of the ongoing strategy there?

Could we expect to see some more acquisitions go on for OSB that are of size?

Yes, we obviously don't speculate on acquisitions in any particular area.

We have been willing to drive inorganic growth really across all the divisions.

It probably gets a little bit more attention in the Online business because of its nature, but, in fact, when you look at the acquisitions we have made there across the broad spreads, Server and Tools, you know the Fast acquisition that we made in the enterprise search area, some we have made in the Entertainment and Devices division.

So we have been willing to use our balance sheet to drive inorganic growth right across the Company.

I don't expect that to not continue.

I think that trend will continue, and again we have signaled -- I think both Steve and I have signaled our willingness to do acquisitions over the last couple of years.

I don't think you will necessarily see some dramatic increase in the number that we do.

They have been going along at about a couple of months for the last couple of years.

Where we see opportunities and where the situation is right, we will look to use acquisitions.

Charlie DiBona, Sanford Bernstein.

Chris, for the last two quarters, you have called out anti-piracy as a driver in the Client business.

Could you maybe give a little more color on the sort of specific impact that has had and how you see that playing out as a driver for Client going forward?

And maybe also touch on some of the other divisions.

I'm thinking particularly the MBD division with Office where anti-piracy has some potential to affect results as well.

Sure.

It is an interesting trend, and it is a good one to callout.

Historically we have seen the difference between the unit shipments we have relative to the overall PC market a benefit in our anti-piracy of 1% to 2%.

So our sales, if you like, grow 1% to 2% faster than the market as a result of taking piracy away.

Over the last couple of quarters, that has picked up.

It was around 5% in the first quarter and around 3% in the second quarter.

So that is giving us the confidence to raise in terms of our expectations that sort of 1 to 2%, more like 2 to 3% going forward.

If you say, why is that happening, there is a few factors.

Firstly, better enforcement.

So we've had a significant enforcement activity over the last few quarters, something like 74 legal actions in 22 countries.

So working with local governments who are becoming much more sensitive to this as an issue and very strong government partnerships from us.

We have seen some of the technology advances in Vista helping us relative to previous editions of Windows.

And also we have seen a shift to laptops and in particular sell-through multinational OEMs who typically have a lower piracy rate.

Now not all of those factors are beneficial from a revenue point of view.

For example, the average selling price through large multinational OEMs is typically lower than in the smaller entities.

But overall from a unit perspective, it is helping us about 3%, and it is offsetting some of the mix shift that we see in some of the other factors.

So it has just been a very good trend, and it certainly in the last two to three quarters has picked up from what we have seen in the previous two to three years.

And I would say, as a broader theme, the Company is focused on piracy really across all of our software offerings, including Office and MBD as you also asked about.

With Office it is tougher to quantify that we can with Client because with Office we sell through so many different channels, volume licensing, retail, as well as OEMs.

We estimate about half of the worldwide base out there is pirated, so there's opportunities to make gains there as well.

And we're doing a lot of those same sort of partnering with governments and educating people on the value of genuine software and keeping an eye really on retail sales of Office to see how that is progressing.

And it has been very robust since the launch of Office 2007.

But unlike Client we cannot give you as specific of a number in terms of how we are doing on piracy.

Adam Holt, JPMorgan.

I wanted to drill down on the strength in MBD and Office, which has been a consistent theme over the last several quarters.

Another quarter of better than 20% revenue growth in Business Office and related.

I wanted to see if that is primarily unit driven at this point or whether you're actually starting to see an ASP uplift on the Office side.

How long do you think you can sustain better than 20% growth for business revenue?

Yes, firstly, specifically it is very much around units.

It is not ASP-driven.

And I would pick out a couple of themes in particular.

One is just customer acceptance of the Office product itself, which has been extremely good.

It is right at the top end of our expectations.

So when you talk to people their like of the product is extremely high.

And we have seen that manifest itself from a financial perspective in very strong license sales right across the board.

So from consumer to small business to large business, the underlying Office business and the Office product has been a real success since launch.

That is number one.

Number two is some of the other products are starting to become significant in their own right.

So when you look at SharePoint growing over 20 to 30% year on year, that is over $1 billion business now.

So it's a significant business in its own right, and it is incredibly successful again in terms of customer acceptance and rollout through the enterprise.

Unified Communications, a similar story.

Some of the Dynamics products, CRM and ERP, which do not get a lot of attention because we've focused on the big parts, but also growing at 30, 40% rates.

So you are seeing a very strong portfolio of products anchored around the Office product but with some extremely good secondary ones as well making a big contribution.

You know, how long can that last?

Well, we will start to let the launch of Office 2007, so that impact won't be necessarily as significant going forward.

But if you look at the second half guidance, we certainly see a lot of the same factors for the first half continuing to the second half.

If I could actually just ask a follow-up on that.

You mentioned in your prepared comments that you're taking a little bit more of a conservative view on spending in the US for the second half.

As we think about the back half guidance, how should we -- where do you think that is being reflected?

It looks like you're being conservative against a tough comp on the PC growth expectations.

Where else are you reflecting that conservatism in the guidance?

Well, I don't think it is -- when you look at the growth rates, they are still very healthy in the second half.

So when we think about product portfolio, we actually feel very optimistic for the second half.

Certainly there's a substantial economic slowdown, and you can see PC growth rates coming down.

But we're guiding for the second half in 11 to 13% or thereabouts.

So it is still very healthy growth from an overall perspective.

If you look at individual verticals, probably we can find a couple of soft spots.

But each of those individual verticals represents less than 5% of our sales, and they are made up for strength in other areas.

So when you look at the combined portfolio of our products, whilst we are being cautious like everyone else about what might happen in the US economy, when you look at the overall suite of products we have and the overall growth rates we have, we actually feel very optimistic.

Kash Rangan, Merrill Lynch.

When I look at the double-digit operating profit percentage that you reported in the Entertainment and Devices business, despite having a record Xbox unit quarter, how should we think about the margin profile of this business going into the next fiscal year?

Are you at the point where the console costs have been driven low enough and you're getting a healthier mix of software due to attached pricing attach rates.

It looks to me that the business (inaudible) for a breakout in operating margins.

But how do you think about that looking into the next three to four quarters?

Well, the first thing to note, as we have talked about before, the first time we start talking about fiscal year '09 is in April.

So I'm happy to make some comments about it then.

In these quarterly calls, we really try and focus on this fiscal year as the main purpose.

In terms of some of the underlying drivers though that you can think about when you start to populate your model, one of the things to point out is a very, very good attach rate for Xbox.

So we're looking at a live to date average attach of seven games per console.

It is interesting when you look at that now people on average are spending more in terms of the software and accessories than they are on the underlying console itself.

So that model of selling the console as a way of generating future revenue is really paying off.

That seven on average is well above anything historically or on a previous console.

So that is a very healthy leading indicator.

But the Entertainment and Devices division is much more than just the Xbox.

There is obviously a music player in there.

There is some Windows for Mac and various other parts of it as well.

So there is other Dynamics, Windows Mobile, that are going to play in terms of our investment in the future.

So we're not making any long-term predictions about the margin structure.

The one thing that is positive is it is clearly profitable, and we believe on target to be profitable for the year, which is the commitment we made some 18 months ago.

And also one metric that you gave us last quarter was the billings growth -- bookings growth rate in the core business being 25%.

What was the same number this quarter?

I do see that the overall bookings growth rate was 20%, but I am just curious about the core business.

That is it.

Thanks.

Yes, greater than 20%.

I will look if I can give you a more detailed number after the call, but certainly off the top of my head, it is greater than 20%.

John DiFucci, Bear Stearns.

Chris, you talked a little bit about US risk, and I think you were quoted in Reuters I think after the close today saying something similar.

Did you see any of it this quarter?

The aggregate results were obviously pretty impressive, but the Server and Tools division was a little bit below your expectations.

That is really enterprise infrastructure software in aggregate.

Did you see it, and is that what you're seeing now?

Is that an area where we might be seeing a little bit more pressure than perhaps some of the other areas?

Actually you have to look really hard to find any weakness in our results in the first half.

So in terms of Server and Tools, there was actually a shift to an annuity mix.

So that may be what you are looking at.

In fact, that is a positive trend because it means that our unearned is up significantly, which we reported, as you know, over $500 million higher than expectations.

And it is a reflection of our Company's commitment to our products as a platform in anticipation of some of the server products coming up.

So, from an accounting point of view, you notice a difference.

From an underlying business point of view, that is an incredibly positive trend.

But if you look at the first half of the year, I mentioned that over 60% of our sales come from customers outside the US.

If you look at non-US, it grew over 20%, non-US mature markets.

If you look at emerging markets, it grew at almost 30%.

But the interesting fact that I did not say, which I am happy to say, is that US market grew at 15%.

So that is in total our sales in the US for the first half grew by 15%.

Now clearly there is softness going forward that would impact that, but that is still a very healthy growth rate from our point of view.

Yes, but I would think that you would expect that shift to an annuity at the beginning of the quarter when you gave guidance, and it was a little bit shy there.

But you just -- are you saying you just did not expect that, and it was customer-driven?

Yes, absolutely.

There is vast number of contracts that come up for renewal every quarter and the nature of how those renewals flows through can move the annuity mix quite significantly quarter on quarter.

But yes, it was an unexpected positive surprise.

You are seeing on the low-end on Server and Tools of revenue is about a $20 million net, and on the unearned balance, you're talking hundreds of millions.

So net net on a booking point, Server and Tools, although the mix was different, the business was just healthier actually than we had expected.

Brent Thill, Citigroup Investment Research.

Chris, can you characterize any meaningful differences in consumer versus enterprise demand?

Are you seeing any changes in patterns in each of those two divisions?

No, they are broadly in line with our expectations.

In terms of the enterprise, as I mentioned and Colleen just referred to, the unearned balance was extremely good, and so we're feeling good about the relative commitment of our enterprise customers to multiyear agreements.

So that is good.

On the -- I mentioned about Office and the strength there.

A lot of very good license-only sales in the Office area right across the spectrum of businesses from small, medium and large businesses.

And lastly, on the Xbox side, the consumer sales were very good.

That is a good leading indicator of consumer acceptance.

And I guess the last one would be PC sales.

They were all -- which 14 to 16% in the quarter was ahead of our expectations.

So really everything was slightly better than what we had hoped for.

But there was not any significant mix change, if you like.

All those factors were good.

And just as a quick follow-up.

Just as you look at the second half of this calendar year, how would you characterize your visibility and I guess the confidence this macro overhang in the US does not catch up?

I think you mentioned there were a couple of soft spots.

What gives you confidence that does not spillover into some of the other sectors in the US and catch up with you later in the year?

Well, we have just gone through our midyear reviews where we go country by country and segment by segment across the world and the sales force so the people who are in charge of delivering the results, sitting in on all of those and listening to them certainly is factored into our guidance.

And you have to state, we are not obviously giving fiscal year '09 guidance.

But again, you have to take a step back and look at the overall environment that we're selling into.

The next six months we feel very good about.

In terms of more general factors, we are a global Company.

I talked about the sales mix.

I feel good about global GDP over the medium to long-term.

I think software spending is going to be faster than global GDP, and I think we're going to grow faster than overall global software spending.

So could we be impacted by a global slowdown?

Of course we could.

But if you look at the overall growth rate from the products that we have and in the markets that we compete, we still feel very good if we think about our business on a multiyear basis.

We have time for one or two questions.

Operator, our next question, please.

Jason Maynard, Credit Suisse.

I had a little different tack on the questioning.

I'm just curious to get your opinion on how you expect the recent EU commission I guess new investigations to play out, and what impact you think that may have on not only Vista but I guess perhaps the not yet released Office 7, or excuse me, Windows 7 product that is being talked about?

Yes, sure.

Overall obviously we will cooperate fully with the commission's investigation and provide any and all information necessary.

We are pretty committed to ensuring that we are in full compliance with the law and our obligations as established by the court.

So I don't really not have any other sort of general business comments.

I'm happy to leave it at that.

Is this -- post the settlement I guess is like three or four months ago.

Is this in any way, shape or form, though, impacting perhaps your M&A strategy or maybe decisions to do something bigger within the Online Services area?

No, not at all.

Brendan Barnicle, Pacific Crest Securities.

I had two quick follow-up questions on the Online business.

Specifically where it is it you're spending the money for the investments you're making now?

Is that around infrastructure or R&D sales?

And then secondly, where do you envision that going?

Is it just always going to be an online advertising business, or do you see at a point where maybe you charge for content or applications, music, any of these other potential revenue streams?

Yes, the investments are across a broad spectrum.

So we believe to be successful in that business you really need to commit substantially across the whole gamut of investments.

So we are investing in search, improving the relevancy of our search results, focusing on some key verticals like commerce, local, entertainment, health.

We are obviously investing in the Advertiser and Publisher tools.

After our aQuantive acquisition, that has given us a substantial leg up in the advertising platform area, so we're continuing to build on that.

We are investing in content and services through Windows Live and other live services through the MSN portal.

And then lastly, but not leastly, in operational infrastructure.

So a lot of CapEx going into data centers to improve performance and reliability and generate global scale for the business.

And some of those costs are feeding through in terms of depreciation.

So there is no one particular area that we are focused on.

We are focused on all the areas, and we think to be successful in that business going forward that is the approach you're going to have to take.

And on the second question, on envisioning where it goes?

Yes, just go over that one again.

Yes, is it -- I mean do you ever see a point where you may charge for content, charge for applications, or is it always going to be basically an online advertising and advertising-driven type model?

Well, we are obviously moving to a software plus services world.

So there are certainly areas of products that we have where you can see us moving from a license-only to a on-demand situation.

We already are.

In terms of the basic online advertising business, as you think about OSB, to a large extent that is going to be an advertising-driven, advertising supported business.

But there will be other parts of the business you know as we already are with CRM delivered online and charged for on a subscription basis where it will not be advertising-driven.

So we will live in a multibusiness model world going forward.

Great.

Thanks a lot and thanks, everyone, for your participation in today's call.

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 to close of business, January 26, 2009.

In addition, you can hear the replay by dialing 1-800-297-0771, or for international calls, dial 203-369-3238.

The dial-in replay will be available through the close of business, February 1, 2008.

Thanks again for joining us today.

That concludes today's call.

Please disconnect your lines at this time.