微軟 (MSFT) 2009 Q3 法說會逐字稿

Welcome to the Microsoft third-quarter 2009 fiscal year conference 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 Mr. Bill Koefoed, General Manager, Investor Relations. Sir, you may begin.

Thanks everyone for joining us today on our third-quarter earnings call. I am joined today 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.

The format for today's call will be as follows. Chris will summarize some of the key takeaways for the quarter. I will then provide details around our third-quarter results, and then hand it back to Chris for a more detailed discussion of our business outlook. After that we will take your questions.

Please be aware that we filed our Form 10-Q today in conjunction with our earnings release. We have also posted our quarterly financial summary slide deck, which is intended to follow the flow of our prepared remarks, as well as provide a reconciliation of differences between GAAP and non-GAAP financial measures that we will talk about today. You can find these documents at the Investor Relations website at www.Microsoft.com/MSFT.

Today's call will be webcast live and 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. A replay of the call will be available at the Microsoft Investor Relations website through the close of business on April 22, 2010.

This conference call report is protected by copyright law and international treaties. Unauthorized reproduction or distribution of this report or any portion of it, without the express permission of Microsoft, may result in civil and criminal penalties.

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 Form 10-Q, our most recent 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.

And now I will turn the call over to Chris.

Our third-quarter results reflect a combination of two forces. Firstly, the most difficult economic environment the Company has faced in our 30 year history, but offset by Company specific factors.

On the macroeconomic front we saw a broad-based slowdown across virtually all product lines and geographies. Our transactional revenues, for example, in our emerging markets in particular were impacted by the economic reset that we are all seeing, with demand down as much as 15% to 20%.

Against that backdrop, while I can't be happy with any quarter where our revenue and earnings per share decreased, I was actually pleased with our relative performance. First, our annuity licensing held up well, reflecting the strength of our diversified business model. Second, we managed expenses significantly below our expectations going into the quarter, which is a credit to our employees' ability to adapt to a new reality.

Third, despite all the distractions, including the first significant layoff the Company has ever implemented, we executed on our product development milestones.

Globally overall IT spend, and in particular business hardware purchasing, continued to slow from the levels seen in the second quarter, and severely impacted transactional license sales in our Client, Microsoft Business Division and Server and Tools businesses.

We did see some pockets of strength, reflecting consumers' desire to purchase down the price point. For example, we saw healthy unit volumes at netbooks, Office Suites at retail and Xbox 360 consoles.

Geographically mature markets slowed noticeably, while emerging markets, which has historically have been sources of strong revenue growth for us, reported even deeper declines than mature markets.

Our annuity business is clearly our bright spot. With strong sales execution, corporate customers are renewing their long-term commitment with us, which reflects both the value of our current product portfolio and anticipated future product innovation.

On the expense side we executed against cost saving initiatives with production down across the board, marketing, vendor costs and other discretionary spend, as well as a reduction in headcount and headcount related costs, and lower capital expenditure.

We ended the quarter with 800 less employees than we started the quarter with. And importantly we are also seeing our people focus on efficiency and the need for fiscal discipline.

We accomplished this while also focusing on operational excellence. This quarter we made significant product development progress towards the next wave of products and services. Over the next 18 months we will be delivering updates to our core franchises, namely Windows 7, Windows Server, and Office 2010, as well as bringing new services, like Windows Azure, to market.

So in summary we ran cautious, but more cautious than most about the state of the world economy. Our globally diversified business gives us insight into a world where economic pressures are both broad and deep. While we would all like to think that our recovery will be soon and painless, we unfortunately believe that it will be slow and gradual.

We expect trading conditions to remain very difficult through the next quarter, and potentially through the balance of this calendar year. Against that backdrop we have to focus on our relative performance. We have the benefit of a strong annuity business, which partially insulates us. We can continue to be tight on costs. We can continue to focus on maximizing what is the strongest cash flow of any company in the industry. And we will continue to launch a countercyclical wave of products over the next 12 to 18 months, which will help growth in fiscal year '10 and beyond.

So with those high-level themes, I will turn the call over to Bill for more details on the third quarter.

As Chris mentioned, our revenue results were impacted by a weak macroeconomic environment, however strong execution on our cost initiatives helped to offset the impact to operating income.

I'm going to provide you with details on our financial performance. I will start with the overall Company business and financial momentum points, and then follow-up with revenue performance for each of the business units. All growth comparisons I mention relate to the comparable year of last year, unless otherwise specified.

Overall, revenue declined 6% to $13.6 billion, due to continued weakness in global demand, particularly in the business PC and server hardware markets. Despite this revenue shortfall, excluding the $0.06 of charges related to severance and investment impairments, earnings per share for the quarter were $0.39, in line with expectations.

Within the business results the transactional portions of our business are down substantially as a result of weakness in the associated markets, while our annuity business remains healthy. Within our customer segment, small and midmarket customers remain the most severely impacted by the current economic condition. In the consumer segment we have seen healthy volumes in the lower priced products, but experienced weakness in the higher priced SKUs, as can be expected in this environment.

The enterprise customer segment has held up, and renewal rates were stable and within our historical range. Driven by these dynamics our product billing mix continues to shift toward our annuity licensing, which is up 5 percentage points from the prior year to about 35%.

The remaining billing mix was approximately 30% from OEMs, 15% from transactional license only sales, with the balance from our other businesses. Unearned revenue grew 1% year over year to $12.3 billion. Our contract and not billed balance exceeds $12.5 billion, and was also up year-over-year.

Overall total bookings for the Company declined 15%, driven by the declines in the transactional portions of our business. Foreign exchange rate fluctuations did not materially impact overall revenue growth this quarter.

Now let me move to the revenue and business drivers by segment, beginning with Windows Client. I will start with some commentary on the PC market. We saw continued deterioration in the overall PC hardware market, which we estimate to have declined back 7% to 9%. Traditional or non-netbook PCs were down 15% to 17% compared with the year ago quarter. We have seen continued weakness in the business segment of the PC market as companies cut their IT hardware spending and extended hardware refresh cycles.

The small notebook PCs, or netbook category of the market, continued its growth and represented about 10% of the total PC shipments for the quarter. Unit sales in the consumer segment of the market benefited from the growth in the netbook category, and were about flat year-over-year.

So with that market context, let me move on to Client. Client revenue was $3.4 billion, down 16% from a year ago. This decline is consistent with the framework we provided to you last quarter, with Client revenue declining in line with the traditional portion of the PC hardware market. Overall OEM unit sales declined 6%, performing slightly better than the overall PC market due to a tax rate improvement. The particularly strong attach rate in netbooks illustrates that customers continue to prefer Windows.

OEM revenue was down 19%, driven by the dynamics in the underlying PC market. Specifically sales of premium SKUs were down over 20%, primarily due to the declines in the traditional business PC market I mentioned. Particularly offsetting the decline -- partially offsetting the decline in premium units was strong growth in our lower-priced netbook software.

The commercial and retail portion of the Client business grew 1%. The enterprise annuity business continued to have healthy growth. This growth was partially offset by lower retail sales attributable to general consumer spending softness, as well as some normal slowing ahead of a major product release.

Against the current economic backdrop, the Client revenue remained -- the Client division remains focused on execution and delivering on the product pipeline. During the quarter we released the public beta of Windows 7. We feel very good about the response we are getting to Windows 7 beta testers, and our progress against the next milestone, which is the release candidate.

We also delivered significant innovations to browser, with the release of Internet Explorer 8, which has also received strong press and analyst reviews. We remain very positive about the client product pipeline and its ability to drive long-term growth for the Company.

On the marketing side we have seen a measurable perception increase for Windows from our recent advertising campaign. Specifically our research shows a 10% increase in preference for Windows PCs since these campaigns launched.

Now let's move to Server and Tools, where revenues grew 7% to $3.5 billion. Revenue was driven by double-digit growth in our enterprise annuity business from sales of premium editions of Windows Server 2008 and SQL Server 2008, in addition to strong growth in System Center Management Suites.

The consulting and support services portion of Server and Tools revenue grew 6%. Revenue from the transactional and OEM portions of the business declined over 15% during the quarter, in line with the estimates for the underlying x86 Server hardware market.

Industry analysts continued to publish healthy market share performance for Windows Server 2008, a validation of the competitive benefits it provides to customers. On the product front, the Server and Tools division delivered the beta release of Windows Server 2008 R2, which builds on the value of Windows Server, with new features like Live Migration. In addition, we released a beta version of Silverlight 3, which delivers new functionality to run Silverlight applications off-line.

Moving onto the Online Services Business, revenue declined $122 million, or 14%. Online advertising revenue was down 16%, primarily due to the significant decline in display advertising rates across the industry. Partially offsetting this was continued growth in both page views and search queries.

The Microsoft Business Division had revenue of $4.5 billion, which declined 5%, due to declines in non-annuity licensing. This transactional revenue was primarily impacted by the traditional PC market decline. We increased attach with pricing promotions, but due to the lower prices and PC sales, overall transactional revenue declined more than 25%. This decline was partially offset by healthy 15% revenue growth from our annuity business.

In the quarter we continued to see strong demand in our SharePoint, Office Communications Server, and CRM products, which all grew more than 20%. On the product front, during the quarter we released a new version of our Unified Communications offering with Office Communications Server 2007 R2.

Additionally, last week we announced a timeline for our next release of Office 2010, and made available the beta version of Exchange 2010, which will be for sale in the second half of calendar 2009.

Moving to the Entertainment and Devices Division, revenue decreased 2% to $1.6 billion. The Xbox 360 business had a very strong quarter, selling over 1.7 million consoles. This represents growth of almost 30% over the prior year. This fiscal year to date we have already sold approximately 10 million consoles, about 15% more than we sold in all of last year.

Attach rates for Xbox continue to lead the industry with software attach rates growing to 8.3, and accessories attach rates growing to 3.9. In addition, Xbox Live is a key differentiator for our platform. For example, 1 million Xbox Live Gold numbers have activated Netflix for the on Xbox LIVE. You will hear more about our Xbox Live progress at E3 in June.

During the quarter we unveiled Windows Mobile 6.5, the next version of our Windows Mobile software platform. You can expect to see phones running Windows Mobile 6.5 by the fourth quarter of this calendar year.

Now for the rest of the income statement. Cost of revenue increased 12%, primarily given by increased distribution and data center costs. Operating expenses decreased $1.3 billion, or 16%. This year's results were impacted by $290 million of employee severance charges as a result of our announced plans to eliminate up to 5,000 positions. Prior year's results included [$1.4 billion] (corrected by company after the call) in certain legal charges. Adjusting for these items, operating expenses were down 2% year-over-year, and 10% sequentially due to our focus on efficiency that Chris described earlier.

Operating income of $4.4 billion was up 3%, but down 17% after adjusting for impact of the employee severance and legal charges from the current and prior years. Other income and expense was a net loss of $388 million, and includes $420 million of impairment charges on investments, primarily due to the continued declines in the markets.

Given the uncertainty and volatility of market conditions, we remain focused on cash and working capital management. The company Generated $5.4 billion, or $0.61 per share in free cash flow this quarter, reflecting moderated operating expenses and capital expenditures. We have maintained our AAA debt rating, and rebuilt cash to over $25 billion, while returning $1.2 billion in cash to shareholders through dividend.

Our effective tax rate was 26.5% for the quarter, in line with the guidance we provided. Diluted shares outstanding for the quarter were $8.9 billion, down back 6% from the prior year. As I mentioned earlier, excluding the severance and impairment charges of $0.06, earnings per share for the quarter were $0.39, meeting expectations.

In summary, we remain focused in the areas we can control, and in the third quarter delivering meaningful cost savings and significant progress on our product pipeline. With that, let me turn it back to Chris, who will provide you with more insight into our business outlook.

The remainder of the call I will speak to our broad expectations for the fourth quarter and our preliminary view of fiscal year '10. As I mentioned in the opening remarks, we witnessed a deterioration of spending levels through the third quarter as macro factors pressured hardware markets, IT budgets and advertising spend.

In the fourth quarter we expect the overall spending environment to remain difficult. Given the numerous ongoing trends though, rather than providing a static quantitative revenue and earnings per share guidance, we recommend that you look at the market drivers of our business using the following framework.

In the Client business PC shipments remain the primary driver of revenue, and we expect traditional PC shipments, those excluding netbook, to remain weak. In the fourth quarter we expect Client revenue to be in line with or slightly below the growth rate in the traditional PC market, based on a year ago comparable which had higher than normal levels of inventory at OEM and at retail, and continued weakness of business PC demand, which has a higher associated selling price. We expect the netbook mix of total PCs to follow the trend seen in Q3.

In the Microsoft Business Division, traditional consumer and business PC shipments remain the primary drivers of approximately 40% of the segment's revenue, which is transactional in nature. This revenue is the most susceptible to the volatile market conditions. In the fourth quarter we expect this part of the revenue to lag traditional PC shipments by several points, a result of general purchasing power weakness from small and midmarket customers, and continued inventory contraction at retail and OEM.

The remaining 60% of MBD revenue is from annuity licensing, which has been supported by the strength of new growth businesses like SharePoint and Unified Communications. In the fourth quarter we expect positive annuity growth of single digits, slightly ahead of overall IT spend.

The pipeline for annuity contracts in the fourth quarter includes a large renewal wave, which we are optimistic on closing given our year-to-date performance, but there are clearly risks from lengthening sales cycles.

Like MBD, the Server and Tools segment includes both transactional and annuity licensing components. We expect the transactional portion of the business, which is about 30% of the total, to generally align to the server hardware markets. Third-party analysts expect those server hardware shipments to be consistent with the third quarter, and then therefore remain weak. The remaining annuity licensing and Enterprise Services portions of the Server and Tools segment will trend towards overall IT spend.

Our OSB revenue, excluding our legacy Access business, should mirror the online advertising spending market. Volumes should continue to increase. But monetization rates in particular, the display advertising portion of our business, will remain under pressure.

The Entertainment and Devices Division's primary driver remains consumer sentiment and spending. Our overall market position in volumes remain very good, but console revenue, representing 30% of the segment, should decline in the fourth quarter as a result of our earlier pricing actions and a mix shift to lower-priced consoles.

Console attach rate of revenue, representing another 30% of revenue, should benefit on a year-over-year basis from the increased installed base of consoles, partially offset by moderating attach rates. The other non-gaming portions of the business should still be impacted by the underlying PC market and overall consumer spending behavior.

In summary, the transactional consumer and advertising revenue will remain under significant pressure until market conditions improve, offset by annuity revenue, which will start to converse with, but still outperform, overall IT spend.

With those things on revenue, I will turn to our expectations of fourth-quarter operating expenses. Given the progress made on cost reductions in the first quarter, we have further reducing our full-year operating expense guidance by up to $1 billion from the guidance we provided to you last quarter of $27.4 billion. This is on top of the $1.5 billion decrease we forecast in our January call, so it totals up to $2.5 billion in savings from our original July guidance last year.

We now expect fiscal 2009 operating expenses to be between $26.7 billion and $26.9 billion. This forecast includes the $290 million in severance charges which were not in the prior forecast.

We also now expect capital expenditures to come in at $3.1 billion, an additional $200 million below our January guidance, and some $900 million lower than our expectations at the beginning of the year.

Looking to the other drivers of earnings per share, we continue to expect an effective tax rate of 26.5% for the fourth quarter. Other income will be largely dependent on market movements.

I would like to spend a few minutes looking ahead to fiscal year '10. Our planning expectation is that macro conditions remain very challenging through the remainder of this 2009 calendar year, which covers the first half of our fiscal year.

Third-party analysts generally expect continued decline in the demand for PC and server hardware, which as I called out earlier, will largely impact the non-annuity component of our Microsoft Business Division, Client and Server and Tools segments. Growth in the annuities portions of our business should still outperform non-annuity, although moderate reflecting the lower growth rate in bookings. We expect the volatility seen in emerging markets to continue.

In calendar year 2010 there is some potential for market conditions to improve, but it is clearly too soon to call. Many third-party economists are predicting the reemergence of GDP growth, which should favorably impact IT spend, hardware markets and advertising spend.

We will also begin to benefit from favorable year-over-year comparables in the second half of fiscal 2010. And finally, we will begin to see the impact from the next wave of new products coming to market.

As for COGS, cost of goods sold, next year we should expect to see continued growth, driven by increasing costs as the distribution deals we signed in fiscal year '09 ramps, and more of our business goes towards the software plus services model.

In January we shared with you a preliminary estimate for operating expenses in fiscal year '10 of $27.4 billion. We are currently in the process of finalizing next year's budget, and while we are looking for additional opportunities to save, we will provide you with an updated view of fiscal year '10 operating expense in July.

The headcount, as I mentioned in last quarter's call, we are committed to eliminating 5,000 positions by July 2010. In addition, we said we would make cuts in our cost of goods sold staffing. We are making progress on that plan and remain committed to implementing it as soon as practical.

As we also said in January, we will add 2,000 to 3,000 new jobs in new high-growth areas over the next 18 months. The vast majority of these will be US workers, but we are also committed to hiring the best employees from around the world. So we will continue our visa program, albeit at a lower rate, with overall applications for H1B visas down from 20% and new hire visas down 40%.

Cash maximization will continue to be a focus area in fiscal year '10, given our view of the economy. We are fortunate to have a business model that is exceptionally strong in cash generation. Despite the turbulent economic conditions, we are generating net cash flow from operations at an annualized rate of approximately $20 billion.

We expect free cash flow to continue to exceed operating income. And this will be assisted by significantly lower CapEx spending in fiscal year '10. Capital expenditures are expected to decrease from the $3.1 billion I mentioned earlier at this fiscal year to approximately $2 billion next year.

We are very vigilant on customer credit issues and to date have had an extremely good collection experience.

Finally, we remain committed on returning capital to shareholders. And while stock repurchase will vary from quarter to quarter, we will remain a net purchaser of stock over the long term and a committed payer of dividends.

So in summary, it was a tough quarter, but I am pleased with the organization's response by managing costs and executing on our product portfolio. Over the next 18 months we will bringing a large wave of products and services to market and as such, while in the short-term our results will be impacted by the current economic conditions, we believe the long-term outlook for technology and our relative position remains very strong.

So with those comments, what I'm going to do is hand it back to Bill, and very happy to take your questions.

Let's now proceed to questions. We want to accommodate questions from as many people as possible, so please avoid lengthy and multipart questions. And I will strictly limit you to just one question. Barb, will you please repeat your instructions?

(Operator Instructions). Heather Bellini, UBS.

Chris, I would just follow up on your COGS comment before. You said -- I believe you said we should expect to see continued growth, given the deals signed in fiscal year '09 ramp. I am just trying to get a sense, should we expect the -- I mean, the gross margin I think were a little bit disappointing to people this quarter. I thought that was an area where Steve mentioned at the event that you could actually expect to get a little bit of an improvement there.

We are -- relative to Steve's comment, we are looking for opportunities to make efficiency savings in that area. In fact, we've got a task force looking at that over the next quarter.

Having said that, that is efficiencies against a generally increasing trend as the mix of business shifts in that direction. We have clearly been make in some fairly significant investments in our data center infrastructure as we shift to a more online business and more software services. So that will start to flow through in terms of depreciation. And we have also been making some distribution transactions which I think we have announced. So you will start to see the costs care.

That is going to start growing faster than -- it is going to be growing still faster than sales?

Yes, I would think in particular in this environment, because we're going to see a relatively subdued environment certainly for the first half of the fiscal year. So, yes, you can assume that is the case.

Adam Holt, Morgan Stanley.

I had a question about the Client commentary heading into the fourth quarter. I believe you mentioned that we should expect units and revenue to be in line maybe with revenue a little bit below units. And I guess I was wondering, given that the delta in this quarter between the licensing and units being pretty wide, should we expect to see that similar kind of delta as average selling prices are under pressure, do you expect that to close as we get into the quarter?

And then just as we look a little bit further towards Win 7, what would you expect to see with the commercial and retail licensing business as we get a little bit closer to the release? I would think it would probably drop off. Thanks.

Good points. In quarter four I would say you're going to see broadly the same trends as we saw in Q3. The introduction of netbooks makes it difficult for us to do our normal walk through of units and revenue, but the rule of thumb that we gave you last quarter is, if you look at the non-netbooks growth, or in this case decline, that would broadly approximate the revenue in the Client business. So the negatives we are seeing on ASP would be made up for the positives that we get from netbooks' growth.

I think that is a reasonable rule of thumb going forward. The same sort of trends we will see, in terms of lower ASPs netbook growth you could expect to see. The only thing that you -- I think we will see in the fourth quarter that is probably slightly different from the third quarter is a continued pressure on the Business segment, which the Pro, which is our highest revenue generator, so we might see a little bit of a gap there.

And also in the finished goods area, which you asked about for fiscal year '10, but I will just start with the fourth quarter. I think that will be a tough comparable because we had a very good performance in the fourth quarter of last year. So that might be a -- that might drag the overall growth rate down a touch as well.

Going into next year then the finished goods area, in particular [SBP], in the second half of the year when we start to see the Windows 7 impact, that will start to look more favorable. We are going to see a declining trend for a while, improving as we get to the back end of next fiscal year.

Brad Reback, Oppenheimer.

Chris, you had talked about annuity rates, renewal rates, being pretty stable over the course of the quarter, and the expectation that they remain that way. Could you give us any sense of what pricing trends look like, and what you might expect them to be for the remainder of the fiscal year?

The first comment I will make is that third quarter is a relatively quiet quarter for us. Fourth quarter is a very big quarter. So this will be an important quarter for us in terms of renewals, and that will feed through to what happens in fiscal year '10.

The experience to date is that we have seen what we described as no unnatural discounting. We are certainly seeing customers being very price conscious. But to date our renewals have been broadly in line with the revenue that is falling off from previous contracts that have been renewed at about the same rate.

Now what we are losing is perhaps some of the upside that we saw in previous years. So typically when we renew a contract we take the opportunity to upsell, put some of the new products into the mix. Hopefully for most customers we have seen them with more seats at the end of three years than they started it with, more employees.

Clearly that trend is more difficult, so we are seeing customers with the same or even less employees than where they were three years ago. And while we will still be offering the new products, we might be losing some, picking up something from the new products, so overall a wash.

The general sort of environment that we are seeing is good renewal rates, no unnatural price discounting. But we have lost some of the upside, so therefore our renewals and our billings are sort of trending down to low single digits from the sort of mid double digits that we are experiencing in the last few years.

So still overall what I have described, in particular in this environment, is very healthy, but not sort of double digit rates we would have loved to have seen.

Phil Winslow, Credit Suisse.

I just wanted to dig in to cost of goods sold just a little bit further, you commented on next year. I am just wondering if you could give us a sense of quarter to quarter there just what your expectations are? And that's it.

Sure. We are not giving out guidance on cost of goods sold. We will certainly give you some more color in July. But if you see the trends that have been happening in the last few quarters and extrapolate those, you can expect that to continue.

Now you have to look a little bit deeper to the underlying trends. So for example, we have hardware cost of goods sold. They tend to move very much with Xbox sales. So that is one dynamic. Then you have the online cost of goods sold, and they are tending to go up as we depreciate some of the infrastructure we have put in. That tends to follow the capital expenditure that we have been talking about over the last couple of years.

And then you've got general cost of goods sold, and things like distribution deals, which are starting to ramp up with the announcements that we have made over the last few months. So if you take those three trends and combine together and extrapolate them, you will get some sense of what fiscal year '10 will look like.

Brendan Barnicle, Pacific Crest.

Chris, as you are starting to think about Windows 7 and how that may be released, and we start to think about modeling that, should we look at that as the same sort of tech guarantee program that we had with Vista, and as a result that same impact on deferred revenue, or would there be any change maybe more like what was done in earlier OS releases?

We obviously haven't finalized all those details. It is not unreasonable to assume that we would do a tech guarantee at some stage. But the exact timing of that will depend on clearly the release time of the product itself. And that could cause some interquarter accounting recognition issues, but not a significant issue. Obviously, it will wash out over the course of the year.

Yes, you can assume that from a modeling point of view, if you are looking over the long-term, it won't have any impact.

Might it be -- see its effect in the shorter period than we saw with Vista?

Too early to tell. I think that a similar period is how I would assume.

Sarah Friar, Goldman Sachs.

Chris, if I could just take you back more to sort of a macro view, I feel like you've given us more color than last quarter. Is there anything in the linearity of the quarter that made you feel a little bit better as you got towards the end of March?

And in particular, as I kind of think of even just the guidance you have given us, you have clearly given us a lot more color this time around than you gave us back in January. It feels like you are signaling that maybe you feel you have your arms around it better. Is that a fair or unfair way to think about it?

A couple of comments. Firstly, this is the quarter we typically start to talk about fiscal year '10. So I am give you a little bit more color, because I'm trying to give you some sense of the fiscal year for next year, as opposed to what is just happening for the next quarter. So you are picking up that.

The second, in terms of linearity, (inaudible) learning things like second derivatives and what they mean. How do I feel about the shape of the quarter? I didn't see any improvement at the end of the quarter that gives me encouragement that we are at a bottom and coming out of it.

I would like to think that trading conditions will not get any worse than where they were in the third quarter. But hopefully my commentary gives you some sense that we expect them to continue in the fourth quarter and second half of the year, a little bit early to tell, but probably continue to be tough as well.

If you like, during the quarter they stopped getting worse. But that is different from they started getting better. And I think that is a safe assumption for the fourth quarter.

And US versus Europe, just the two very major geographies, any particular differences between the two?

No, not between US and Europe, or Western Europe anyway. Eastern Europe very weak, places like Russia, particularly weak. Japan very weak. Brazil very weak. So some of the areas where a year ago we were talking about extremely good growth rates, countries like Russia, particularly had extremely good growth rates a year ago have gone the other way.

So the US and Western Europe, a very similar picture, weak, but not significantly. When you go into Eastern Europe and emerging markets, the picture is generally worse.

John DiFucci, JPMorgan.

Chris, last quarter you said that Client saw a 2% headwind, because the channel inventories were below normal levels. It looks like the OEM license unit growth was about 2% better than PC unit growth. I am just curious, is that all inventory making up for the inventory last channel and were the inventory today, or is there something else happening there also?

There is a combination effect. It is inventories, one of them. Attach weights rates were actually quite good in the quarter. So not only because of the netbooks impact, we have an exceptionally high netbooks attach now, above 90%, I believe. But we also saw good attach in the non-netbooks segment as well.

There is a few variables moving there, inventory being one of them. I think was a slight negative (inaudible) inventory, but attach rate was particularly positive. That led to the impact that you have seen.

So just to be clear though, so inventory had the 2% headwind last quarter, and you saw another small headwind again this quarter as an inventory levels actually got a little lower?

Correct.

Brent Thill, Citigroup.

Your expense controls are significantly ahead of your plan you just gave just two months ago. How do you think about the next phase of expense control? And I know you mentioned you're not going to give 2010 guidance, but I think the way that you guys mentioned to think about it is that it would be flat in '09 with 2010. I think we are assuming that number that you have given us now is flat for 2010.

Can you just help us clarify if there is anything else that you plan to spend ahead of some of these major launches that would change that trajectory that you just gave us two months ago?

I will give you a bit of overall context about how I think about the savings in general, and then I can answer your question specifically. I think you have probably heard me say that in this Company and in the previous companies I worked in, I have always felt that the best cost savings programs are ones that are a combination of our how I describe it top-down and bottom-up. Top-down being basically, we are going to cut headcount by X. We are going to cut travel expenditure by Y. And these are the new rules.

The bottom-up is how then employees actually apply those rules to how they run the business. Now when I gave you the numbers a couple of months or three months ago effectively for this year, that was the sum total of our top-down initiatives.

So if employees implemented them exactly how -- implemented the rules exactly how we told them, effectively you would have had that number. The fact that we have been able to achieve operating expense savings in excess of that is really a credit to people implementing them in an even more extreme fashions. So they had traveled even less than what we have asked them to. They have taken vendor cost savings even more than what we have asked them. And we have ramped headcount even slower than what we were anticipating.

So I don't bank the bottom-up on a continual basis. I only bank what I have described as the top-down. So my starting position for fiscal year '10 remains where it was in dollar terms a quarter ago.

Having said that, if we get a cultural change and employees continue to have fiscal responsibility and implement the rules in a very efficient fashion, then we could see a lower number.

I'm not going to promise that to you at this quarter. That will be part of what we do in the budgeting round. But I would be starting next year with the number I gave you last quarter. And hopefully we can beat that when we talk to you about it in three months' time.

Tim Klasell, Thomas Weisel Partners.

I just wanted to go over to the Microsoft Business Division, where you said on Office you had a higher attach rate but lower ASPs and lower units. Is that lower unit -- excuse me, lower ASP and higher attach rate going to be something you will want to do permanently, i.e., if units begin to pick back up, we can model it like that? Or do you think we might see the ASPs begin to increase after the release of some of the next version or if the economy gets better?

There was two impacts last quarter that had ASP, and what (technical difficulty) (inaudible) talk about how you could expect them going forward. The first was that we just had a price decrease, where we took the opportunity to have a special price. And that certainly, we've got a volume pickup as a result of that, but a lower ASP. You won't see that as a permanent basis. That was something that we did for a quarter or so. That was one thing.

The second was that we generally saw a continued buying activity in the lower price points, and less buying activity in the higher price points, because of the worst business PC growth. So if you like, you saw a mix change to a lower SKU. Again, that is really going to be driven in the future by not our action, but by how PCs -- business PCs recover through next year. I think it is going to continue to be relatively weak for the foreseeable future. And I think I foreshadowed that in my overall comments.

Going into the releases the next calendar year, I would like to think that business PC demand is hopefully going to be picking back up by then. Plus we will have the new release, so you will start to see that trend come back the other way. But it is going to be some time.

Kash Rangan, Merrill Lynch.

Chris, you made a comment earlier that you are looking forward to launching a countercyclical wave of products the next 18 to 24 months. I was wondering if you could expand upon that, and also talk about, to the extent that you can on a quarterly earnings conference call, what kind of changes we should anticipate to the business model as well, and associated with that. Thanks.

Sure. It is difficult to be launching a massive wave of products into a weakening demand. So that is why I have described as the countercyclical. But when you look across virtually all of our businesses, there is going to be a major release of some form or other in the next year. The most obvious is Windows 7, clearly, which has been well foreshadowed. Office will be coming out with a new version. Exchange will be coming out with a new version. We've got a potentially new search product coming out in the foreseeable future.

So you will see in all of our major products a significant release in the next, let's say, 12 months. Now that is going to be into a soft demand environment potentially. But we think it is absolutely the right thing to do. And clearly that is an investment that is driven around our product development portfolio, not the economic cycle. But once we start to get economic pickup, we think that we will outperform that economic pickup.

At the moment it is really about surviving the economic reset, going into a growth period, which will I like to think is going to be around the corner at some stage. We will actually be going into that growth pickup with a very, very good set of new products. And so the environment one to two years out starts to look much more interesting.

Also, the business model changes associated with that product rollout?

The ones that I mentioned that might be a significant business model are the ones that you will see -- the Windows Azure, also will be generally released over that period. So that will start to change the business model. You will start to see more online driven versions of some of our key products. So that will start to change the business model.

But the revenue impacts of that are going to be relatively modest, certainly in fiscal year '10. That is more of a fiscal year '11 and '12 impact in terms of significance.

Robert Breza, RBC Capital Markets.

Chris, just a follow-up to Sarah's question about the geography weakness that you mentioned in some of those countries. Are you specifically talking about the transaction business, the annuity business or both? Just kind of follow-up on that. Thanks.

I tend to look at the transactional business, because it is probably more of an indicator of the instantaneous economic activity in their particular country, although the blended rate is also the same basic trend. But my comments were in particular around transactional.

So you tend to obviously see in countries like Russia, it is more driven around transactional anyway. There isn't a strong enterprise agreement driven part of that economy yet. So the transactional tends to be a higher component. And particularly when I was mentioning countries I was thinking about that.

Operator, let's take one more question.

Katherine Egbert, Jefferies.

Chris, you didn't repurchase any stock this quarter. Can you talk about your approach to capital? Is this environmental driven or is there another reason?

It is generally environmental. I think I foreshadowed that at the last call that we would be generally more cautious in this current environment in terms of building up our cash reserves.

I'm happy on the flip side to lower share repurchases to have built cash and investment back over $25 billion. So we put back around $9 billion of stock this fiscal year, and paid out around $3 billion of dividends. So we have returned about $12 billion.

Going forward, as I think I have said consistently, we still will be a net purchaser of our shares. We are still committed to paying dividends, so we are still committed to repaying our cash as much as possible.

But it is going to vary quarter by quarter. And it is going to depend enormously on the environment we find ourselves in, and things like our working capital management as well. But overall one of the great positives of the Company, which I mentioned briefly in my prepared remarks, is just the overall cash flow. We are generating free cash flow at around a $20 billion annualized rate, which is tremendous in this environment. So there is no reason to suspect that over the medium to long term we won't continue to be net buyers of our shares.

That will wrap up the Q&A portion of today's earnings call. Remember that you can access this call on the Microsoft Investor Central website at www.Microsoft.com/MSFT. Again, thanks for joining us, and have a good day.

That concludes today's call. Please disconnect your lines at this time.