微軟 (MSFT) 2009 Q4 法說會逐字稿

Welcome to the Microsoft fourth quarter 2009 fiscal year conference call.

At this time, all participants are in a listen-only mode.

(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 call over to Mr.

Bill Koefoed, General Manager Investor Relations.

Sir, you may begin.

Thank you, Barb, and thanks, everyone, for joining us today for our fourth quarter earnings call.

As usual, here with me are 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, Chris will start with takeaways for the fourth quarter and our 2009 fiscal year.

Then I'll get into the details of our fourth quarter and hand it back to Chris, who will discuss our business outlook.

After that, we'll take your questions.

Our earnings release today includes an addendum of financial highlights, which contains more about financial expenses and other items.

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.

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.

You can replay the call at the Microsoft investor relations website until July 23, 2010.

This conference call is covered by copyright law and international treaty.

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.

Assumptions that are subject to risks and uncertainties.

Actual results could differ materially because of factors discussed in today's earnings press release and the comments made during this conference call and in the risk factors section in our Form 10-K, Form 10-Q and other reports and filings with the Securities and Exchange Commission.

We do not undertake any duty to update any forward-looking statements.

Okay.

Now, let's hear from Chris .

Thanks, Bill, and good afternoon, everyone.

The fourth quarter marks the end of one of the most difficult and in some ways encouraging fiscal years in the company's history.

Our absolute results were disappointing due to the poor macroeconomic environment, and as you saw, revenue in the fourth quarter was down 17% year over year and down 3% for the full year.

However, I do feel better about our relative performance of fiscal 2009, than I did in fiscal 2008.

We actually executed much better than in preceding years across almost all aspects of our business.

We have great products shipments and strong sales execution and new level of internal discipline shown by the speed and efficiency with which we cut costs.

In my mind, we are a stronger company than we were a year ago.

However, the economy continues to be challenging and we need to lift our game to another level to fiscal 2010.

As I said a quarter ago, we see the economy making its way through a reset and we expect tough year-over-year comparables for the rest of this calendar year.

Having said that, there are some signs that we have at least seen the worst.

We began to see sequential stabilization in some of our key businesses.

For example, we saw sequential unit increases in both Windows and Windows server for the first time in a year.

I'm also very pleased in the way we're responding to the environment.

In the fourth quarter, for example, we cut costs an additional $800 million below the low end guidance we provided in the third quarter, and ended up spending $900 million less than the prior year, adjusted for certain charges.

Overall we pulled back over $3 billion of spending from our original fiscal 2009 guidance.

The slight cut in costs we also brought to market strong wave of products, in full and on time.

We released SQL Server 2008, Office Communications Server R2, Exchange Online, SharePoint Online and Bing, a major advance in our search product offering.

Over the next 12 months we will deliver releases in each of our core franchises of Windows, Windows Server, and Office.

So in summary, market conditions were clearly difficult in the quarter but we successfully offset most of the impact focusing on factors inside our control.

Looking forward, we do not expect trading conditions to improve much, but neither in the short term do we expect them to worsen.

They should remain difficult for the balance of this calendar year, with a potential for improvement as we look ahead to calendar year 2010.

With that, I'll turn the call over to Bill for more details on the fourth quarter.

Thanks, Chris.

I'll start with the company all-up view, and then go through revenue performance for each of our business units.

All of the growth comparisons relate to the corresponding quarter of last year, unless I tell you otherwise.

Overall, revenue declined 17% because of continued weakness in global demand, especially in the business PC and server hardware markets.

On top of the economic reset we've all experienced this year, remember that we had especially high prior-year comparables for our client and entertainment and devices segment.

The foreign exchange impact on overall revenue was a negative $220 million, or about 1 percentage point in the fourth quarter.

Revenue for the quarter was also impacted by $276 million in deferrals for the Windows 7 technology guarantee program, which is near at the high end of the guidance we provided in June.

The weak hardware markets continue to weigh heavily on OEM and license-only revenue, while multi year annuity licensing grew single-digits, in line with what we provided last quarter.

Our product mix continued to shift toward our annuity licensing, which was up a few points from last year to about 45%.

OEM billings accounted for about 25%, license-only sales, were about 15%, and the balance came from other businesses.

Within our customer segments, we generally saw last quarter's trends continue.

Specifically, small and mid-market customers are still the hardest hit by the economy, and as a result, we're seeing lower overall buying activity.

In the consumer segment, we're still seeing healthy volumes in our lower-price offerings with softness in our premium offerings.

Our enterprise customer segment remains relatively healthy with EA renewal rates in line with our historical range.

As you might expect, the average deal size has been pressured by reduced IT budgets and enterprise employment levels, though we haven't seen any unnatural discounting.

We also experienced some sales cycles, which pushed deals out of the fiscal year.

Our sales force closed many of these deals a few days after our fiscal close, but in line with our normal field calendar, which differs slightly from our fiscal calendar.

Taking into consideration the impact of these bookings, our unearned revenue and contracted not-billed balances were roughly flat year-over-year.

We're very happy with this result considering the economy relative to a year ago.

Okay.

Now, let's move on to the revenue and business drivers by segment beginning with our thoughts on the PC market.

We estimate the overall PC hardware market declined 5 to 7% from last year.

Within that, we estimate traditional or non-netbook PCs were down 16 to 18% compared to the year ago quarter.

We've seen substantial weakness in the business PC market, as reduced IT budgets have reduced hardware purchases and refresh cycles.

The netbook category remains strong, representing about 11% of the total PC market this quarter.

With the growth of net books, we estimate the consumer PC market was flat to down slightly, year over year.

On a sequential basis, we estimate the PC market was up low single-digits.

From a geographic perspective, the market was strong in Asia-Pacific, particularly China, as a result of stimulus programs.

In North America, the demand appears to have normalized with sequential sales in line with historic seasonality, and in EMEA we saw demand continue to deteriorate.

With that factor, look at Windows clients.

Client revenue was down 22% from last year when adjusting for the Windows 7 tech guarantee.

The decline was primarily driven by the underlying PC market dynamics I discussed combined with the impact of a difficult comparable to last year.

Overall, OEM unit sales declined 10%, a few points under the overall PC market due to year-to-year inventory fluctuations.

If you recall, our fourth quarter of 2008 represents a tough comparable as OEMs built inventory above historic levels.

Our attach rates were relatively stable year-over-year.

Strong attach rate gains on netbooks were offset by some attach rate pressure on traditional PCs due to the geographic mix of the PC markets, particularly in China, where attach rates are lower.

Again here, I want to note some sequential trends.

Sequentially, our OEM units grew slightly ahead of the underlying PC market, mainly driven by netbook growth.

This was the first sequential unit growth since the September quarter, so we're pleased to see some stabilization in the market, even though it's in lower-priced units.

Overall, OEM revenue was down 24%, adjusting for the tech guarantee, driven by the PC market dynamic and the mix shift toward our lower priced netbook offerings.

Specifically, sales of premium SKUs declined over 25%, mainly due to the lower sales of business PCs I covered earlier.

The commercial and retail portion of the Client business was down 16%, driven by declines in retail sales prior to the Windows 7 launch.

We saw an exciting level of interest in Windows 7 during the preorder period, although revenue for these sales won't be recognized until Windows 7's general availability.

We continue to have healthy growth in our client enterprise annuity business, which was up single digits in the fourth quarter.

Yesterday, Windows 7 was released to manufacturing.

This is an exciting milestone for our R&D teams and our partners, delivering not only a terrific product, but one that's nicely ahead of the schedule we committed to almost three years ago.

As we've announced, Windows 7 general availability will be October 22nd.

Now let's move to server and tools, where revenue declined 6%.

Our license only and OEM business declined slightly less than the estimated 24% drop in the underlying X86 server hardware market.

On a sequential basis, we were pleased to see that Windows server units were up after falling the prior two quarters.

Annuity revenue was up single-digits in line with guidance framework we gave last you're.

FX rate changes were 2 point head winds to revenue during the period.

We're still seeing great adoptions of our virtualization solutions which drove growth of the premium editions of Windows Server and System Center to healthy double-digits.

On the products front, yesterday we announced Windows Server 2008 R2 release to manufacturing, which builds on the value of Windows server, with live migration and high availability, and together with Windows 7 Enterprise edition provides new capabilities, including direct access and branch cache.

In addition, during the quarter, we released SilverLight 3 which adds new functionality to run SilverLight applications off-line.

Moving on to the on-line services business, revenue declined 13%.

On-line advertising revenue was down 14%, mainly due to the significant decline in display advertising rates across the industry.

Partially offsetting this was continued growth in page views.

Search revenue for the quarter was flat year-over-year despite industry-wide monetization declines.

FX rate changes were a headwind of 5 points to online advertising revenue and 3 points to total OSB revenue.

Most significantly for this business, during the quarter we launched Bing, our new search engine, which has had positive early momentum.

Unique users of Bing.com grew 15%.

We've seen particular strength in the areas of shopping and travel as visitors to Bing shopping almost tripled and Bing travel traffic was up 90% month over month since launch.

It's still early but we're executing and we're optimistic about the future of this business.

The Microsoft business division revenue was down 13% due to declines in consumer and business purchasing.

Our consumer OEM and retail portions of the business continue to be impacted by slower PC sales as well as lower ASPs.

Pricing promotions drove higher attach rates but overall consumer revenue declined 30%.

Business revenue was down 10%, driven by an over 35% decline in our license-only sales.

The annuity portion of this business was up single-digits, in line with the outlook we provided last quarter.

Within the MBD product, we continue to see double-digit growth in SharePoint, Office Communications Servers and CRM products.

CRM received the 1 million seat milestone this quarter.

Our Notes conversions remained strong.

For the year, we converted 4.7 million Notes users to Exchange and SharePoint.

We've seen more and more customers choosing our on-line business services, which include hosted communication and collaboration solutions like Exchange Online and SharePoint Online.

For example, during Q4, we had significant customer wins of over 200,000 seats moving to Exchange end SharePoint Online.

In the entertainment and devices division, revenue decreased 25%.

The Xbox 360 business had a solid quarter, selling about 1.2 million consoles, which is down on a year-over-year basis due to inventory restocking last year.

Overall this year, we've sold approximately 11 million consoles, 28% above last year.

Xbox attach rates are still the best in the industry, growing to 8.6 software titles for each console sold.

For the year Xbox Live grew over 50% to more than 20 million members, and in the last six months, the number of paid Xbox live downloads has jumped 73% year-over-year.

Now, for the rest of the income statement.

Cost of revenue was down 10% or $280 million, driven by lower Xbox 360 console costs and reduced costs from our consulting and support services, partially offset by increased on-line distribution costs.

Operating expenses decreased $766 million or 11%.

This quarter's results were impacted by $193 million of legal charges and $40 million of additional employee severance charges.

Expenses were reduced by the capitalization of $105 million of certain R&D costs related to Windows 7 technical feasibility.

Adjusting for these items, operating expenses were down about $900 million for Q4.

The savings were driven by a combination of strong operational execution, the impact from lower revenue-driven expenses and rigorous cost controls across the company.

For the year, as Chris mentioned, we took out over $3 billion of operating expenses compared to our original guidance.

Other income and expenses was a gain of $155 million and includes $108 million of impairments on investments as a result of the market declines earlier this year.

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 5% from the prior year.

Earnings per share were $0.34, after excluding the net impacts from the legal charges, severance charges and capitalization of R&D costs, and investment impairments, EPS was $0.36.

The Windows 7 tech guarantee revenue deferral resulted in an additional $0.02 per share impact on EPS.

To wrap up, while the environment clearly remains challenging, we are executing diligently on the areas we can control, and in the fourth quarter, we delivered meaningful cost savings, and outstanding progress on our product pipeline.

Lastly, one housekeeping item before I turn the call back over to Chris.

We have included an additional slide in our earnings presentation to help you model some recent organizational and reporting changes we have made, which are effective for fiscal year 2010.

With that, I'll hand it back to Chris, who is going to discuss our business outlooks.

Thanks, Bill.

For the rest of the call, I'll cover our broad expectations for the first quarter and trends for fiscal 2010.

So let's begin with some of the key assumptions on the industry and the economy.

We generally expect the economic conditions we saw in the third and fourth quarter of fiscal 2009 to continue through the first and second quarters of fiscal 2010.

We believe the spending environment is stabilizing on a sequential basis but remain substantially below year ago levels.

We see the potential for improvement in calendar year 2010 and acceleration there afterwards but clearly exact timing is uncertain.

Regardless of the macroeconomic conditions we feel extremely good about our relative position and our product delivery plans.

Macroeconomics may be the winner in the short term, but product quality will drive medium-term growth.

The shape of the year will therefore be probably the most interesting of any year in recent memory.

While we all will remain cautious overall, particularly in the short term.

We expect to exit the fiscal year with combined momentum with improving economy, potentially improving business spend and outstanding product lineup.

With those macro themes, I'll turn to segment expectations.

In the first quarter, client revenue is expected to align to traditional PC shipments excluding the impact of the tech guarantee program.

We expect those traditional PC shipments to decline on an year-over-year basis in the first quarter but be up sequentially, continuing the trend we saw in the fourth quarter last year.

In the first quarter we expect to defer between $1.1 billion and $1.3 billion from the Windows 7 tech guarantee program, and presales.

The majority of which will be recognized in the second quarter of the fiscal year.

For the full year we expect Client revenue to align with the total PC market which factors in the launch of Windows 7 and resulting impact to retail sales combined with the anniversary of netbooks in the year ago comparison.

This implies that we could see Client revenue growing faster than PC shipments by the end of the fiscal year.

Boxtop division revenue, which is approximately 20% consumer and 80% business, is correlated to both the underlying PC market and IT spend.

We expect consumer revenue in the first quarter to lag traditionally PC shipments by several points, continuing the trends in the third and fourth quarters, but also impacted by inventory level in the year ago period.

For the full year, we also face a normal cyclical slow-down in the next version of Office which we'll release to manufacturing in the second half of the fiscal year.

The business portion of the Microsoft business division includes non-annuity and annuity licensing.

Business non-annuity sales, approximately 20% of the division, will lag business PC shipments by several points, but in the quarter and full year as a result of general market weakness of small and mid-market customers, as well as headwinds in advance of the next product cycle.

The dynamics of the remaining annuity business will be broadly flat for the full year and the quarter.

This helps us buffer through the reset.

There will be a transition year for MBD, and I don't believe we see overall revenue growth until we see a recovery in the small and medium business and consumer sectors, combined with impact of Office 2010.

The Server and Tools business includes non-annuity components, long term contractual agreements and our enterprise services business.

Which represents approximately 30, 50 and 20% of revenue respectively.

In the first quarter, we expect non-annuity revenue to continue to reflect weakness in the server hardware market, which external analysts expect to on year-over-year basis through the calendar year and improve in calendar 2010.

We expect Server and Tools annuity revenue mid to low single-digits in the first quarter and the full year.

Enterprise services revenue should be broadly flat this coming year.

On-line service business revenue excluding our latest EXS business should mirror the advertising market, which we expect to remain weak in the first quarter and potentially through the year.

Display monetization rates should reflect the head winds seen in broader industry trends but volumes of increased usage should be healthy.

We also hope to see progress in the search market share as the year proceeds.

The entertainment devices division is being resistant to the declines in the gaming industry to date, and clearly was a stand out in fiscal 2009.

Looking forward, weak consumer markets means that we expect industry console sales and attach revenue to moderate by the first quarter end of full year.

These segments represent 60 to 65% of revenue.

The balance in our gaming business will be impacted by continuing weakness in the underlying PC market.

Turning to COGS, which next year should increase as the result of three factors.

Firstly, we're changing our business model in a number of areas as we transition to the cloud.

This means investment up front to fill out the infrastructure necessary to win what is clearly a significant area of opportunity.

We're also paying for increased distribution in our on-line offerings.

We also expect increases as a result of increased unit volume from the product launch cycle next year.

Offsetting these increases, we've identified and expect to achieve several hundreds of millions of dollars of savings through an internal program focused on efficiencies.

The combined impact of these factors will increase COGS as a percentage of revenue by a couple of percentage points.

And now to our expectation of full-year operating expenses.

Full-year operating expenses we believe will be between $26.6 billion to $26.9 billion, down from the $27.4 billion I communicated in April.

And next year we remain committed to expense control.

Our effective tax rate next year we expect to be between 25 and 26%, depending on the final mix of revenue and reflecting the downward trend we've seen in recent years.

Our balance sheet remains extremely strong despite the economic turmoil this past year.

This quarter we utilized our triple A credit rating, and issued $3.75 billion, a long-term debt, and extremely low after tax cost of 2.3%.

We will remain focused on customer credit issues and to date have had an extremely good collection experience.

We expect fiscal 2010 CapEx to be about $2 billion, down from the $3.1 billion in fiscal 2009, and to stay at or below that level in fiscal 2011 as we continue to focus on cash flow.

In fiscal 2010, CapEx spend will be below depreciation expense for the first time in years.

Helping continue the recent trend of free cash flow being greater than net income.

As I call out in April, capital strength and flexibility will continue to be a focus area for fiscal 2010, but we remain committed to returning capital to shareholders through share repurchases and dividends.

So in summary, like all customers, we're adapting to a new and more challenging economy.

We remain extremely optimistic about the long-term outlook of our industry and our relative position, and we're taking significant actions to strengthen the company while at the same time investing in critical areas and delivering on a significant wave of new products.

The company is in my belief, the best shape that I've seen.

With that, we look forward to seeing many of you next week at our financial analysts meeting, with Steve and the senior leadership team will provide more details about our long-term strategy.

I'll turn it over to Bill so we can start taking your questions.

Operator, let's get going on questions.

Can you please hold people to just one question, and let's go ahead and go.

Thank you.

(Operator Instructions).

It will be one moment, please.

And our first question comes from Adam Holt with Morgan Stanley.

Good afternoon.

My question is about average selling prices as we head into the upcoming Windows cycle.

The premium mix 59% in the quarter was obviously down quite a bit.

As you head into the next year, Chris, I believe you talked about the potential to outpace the PC market which would suggest average selling prices can actually start go back up.

How do you get there?

Do you expect to see mix improvement on the consumer side?

Are you expecting to see a corporate upgrade cycle.

Maybe walk us through, A what you're expecting and B how you get there.

Sure, that is a great question.

On the down side, if I start there and then talk about the upside, on the down side, as we've seen weak markets in the last couple of quarters in the last year and in particular the last quarter, average PC sales are sort of down in the traditional market 16 to 18% and business was disproportionately badly affected.

And because business is typically our highest ASP from a mix point of view, that hurt us on the down side.

On the upside, as we go into next year, if we start to see, which is certainly my hope, if we start to see the economy improve, business spending improve, and we start to see a refresh cycle in the business PC side of things, you know, which Windows 7 should obviously help facilitate, then you start to see the reverse impact.

So, hopefully business PC growth will be at or greater than consumer, and so what you'll start to see is that our higher average selling price units will be at a higher growth rate and, hence, ASPs will go up.

Hopefully we'll see a double impact of a better PC market year-over-year and a better mix in terms of the types of PCs that we're selling, relative to average selling price.

Terrific.

If I could ask a quick follow-up.

The commentary on expenses for next year, do you anticipate the incremental OpEx cost controls to offset the increased in cost of goods sold?

No, they're two different dynamics.

We certainly have taken some money out of OpEx, and relative to where we started from.

Certainly quite considerable.

I certainly see the focus continuing in that area, but we're managing OpEx to a large extent different from COGS.

Now, we do actually have a project going looking at COGS' opportunities, and as I mentioned, I think we have the opportunity to take several hundreds of millions of dollars out of our cost of goods sold through that project.

But then we have a dynamic of changing business models going on and also volume related activities.

So that is really a different dynamic from OpEx which is driven from people costs in particular.

Great, thank you.

Operator, next question.

Next question comes from Brent Thill with Citi.

Chris, just on the margins coming into the mid-30's, do you feel like margins have now bottomed now considering the ASP expansion as well as your strict operating expense controls for next year?

It comes back to the -- to some of the commentary I mentioned in my prepared remarks, Brent, which is really around the shape of the year.

I still would share -- will see a relatively different difficult economy for certainly the balance of this calendar year and despite the fact that we have done a great job on expenses it is hard with the margin structure to take expenses out proportional to the revenue we lost.

So I'd like to think that the expense control were at the top end of people's expectations but we still saw margin compression because of the macroeconomics.

That's going to be probably a continuation of that trend in the short term.

In the medium term, I certainly think the discipline we're showing on costs, as we continue through the next calendar year, and beyond, with an improving business cycle, with all of the products coming on stream and some of the ASP factors that I mentioned, then certainly we've got the promise of margin expansion there afterwards, but I wouldn't -- I wouldn't promise that in the short term.

Okay.

And just a quick follow-up, the buy-back you now have a cash position above $30 billion again.

Can you just comment on why the last two quarters you chose not to buy back stock?

Basically look to obviously relatively conservative because in the last couple of quarters, we felt we wouldn't necessarily see the bottom.

I think that at least we are seeing signs now of the bottom, so we're feeling more confident looking forward in the outlook, even though as I said, I see it going down to the bottom for some period of time.

I was more conservative from a financial point of view six months ago and even three months ago, if you recall my remarks.

I said it is going to be tough for the rest of the calendar year, and we're really still not sure we're out of the woods.

Now, I'll still say that, but I guess we're feeling better about the economic environment.

But in that last six months conservatives have won over natural desire to buy back shares and we did accelerate the buy-back to some extent the first six months of the year.

So even this fiscal year in total we bought back $8 billion of shares, which was, you know, close to our net free cash flow.

So we front-ended in the first six months of the year and then took a conservative stand in the second half.

Operator, next question and, guys, let's stick to one question, please.

And the next question comes from Sarah Friar from Goldman-Sachs.

Terrific.

Thanks a lot, guys.

Could you give us a little bit of commentary on what you heard from customers in terms of both their willingness to start a Windows 7 upgrades.

You're clearing signing a lot of ELAs this quarter, they must have been talking about that.

Secondarily, in server and tools, do you feel like there was any pent-up demand ahead of the product update cycle in the June quarter and you have that launch now if you look into September.

Server and tools first.

The market is still very weak and Bill mentioned server shipments were down, it was 24% for the quarter.

So I don't think we are yet seeing too much pent-up demand in the server area.

As it turned out, even though our results were relatively weak, they were better than the server shipment numbers.

So the division lost 6% in revenue, but that 6% is relative toward 24% decline in server shipments.

So we are certainly feeling good about our relative position, but I would contrast that and say we don't see a lot of pent-up demand in that area.

Going into next year, sure.

But it's really macro conditions are going to continue to trump everything.

We really need to see an increase in IT spending before I feel confident that we're really going to see an acceleration back in the server and tools area.

Now, I've seen your forecast and everyone else's, and I think most people are saying we're probably at about the bottom in the server area.

We're probably going to be that way for a quarter or two, and then things improve next year.

That's internally consistent with the way that we see things as well and plus then we start to get the benefit of, of the new server product and the new SQL product.

It is a consistent product in the server area as it is in the PC area.

When you go to PCs, we haven't heard a lot of early discussion about how people are going to put Windows 7 in, but again it is that same general sense of optimism that once we get through this year, people start to reshift their budgets for next year.

Clearly a lot of businesses have extended their refresh cycle because of overall economics.

They can only do that for so long, as they start to look into next year, hopefully a slightly better economic outlook, they start to look at refreshing their PCs, and they have Windows 7 availability, then you start to get into a much more virtuous cycle.

So this similar commentary to what we see in server and tools, nothing immediately on the horizon, but potentially got to see some positives next year.

Thank you.

Operator, next question, please.

Next is Brad Reback with Oppenheimer.

Hi, guys, how are you?

Good.

Chris, to clarify a point, as you talk about the economic rebound or expected rebind and volume rebound in the back half of the fiscal year, just to be clear on the expense side of the equation, is the organization at a place where we can be fairly confident that the upside is not reinvested into the business as we've seen in other cycles?

Yes, certainly for this fiscal year, I don't see any potential for us to, significantly vary from the numbers that I gave you.

The only reason why it would be something outside of our control, foreign exchange, some of our expenses are outside of the US where we saw significant change in the FX rate then I can't influence that.

And things like some of our volume related expenses.

So if we saw a really strong pickup in some of our enterprise sales, some of our revenue-driven expenses might increase.

But in terms of things which was the great bulk of the expenses, which are totally inside our control I don't see any potential for us to lower expenses this year.

Great.

Thanks very much.

Operator , next

Next is Brendan Barnicle with Pacific Crest Securities.

Thank you.

Chris, you talked about September client revenue growing in line with traditional PCs and in the most recent quarter we saw you guys declined about 600 basis points more than traditional PCs, what accounts for the difference from this quarter to the next quarter that would raise back up to the decline in traditional PC rate?

Biggest single factor is inventory changes.

We saw inventory contraction in the fourth quarter, the one we just finished, relative to a year ago.

So as some of the other parties out there, positive inventory, we're relatively light in the circle, so we saw inventory contraction, and that cost us a lot of that 600 points you mentioned year-over-year.

As we start to go into this year and clearly Windows 7 is just around the corner, then we start to see that inventory position stabilize, you know, and even potentially over the course of the year to actually get better on a year-over-year basis, which is one of the reasons why I start -- I feel better not only about the first quarter but how we might exit the year, as well.

Operator, next question.

And next is Phil Winslow with Credit Suisse.

Hi, guys, I just had a question back on expenses, again.

If you guys X out some of those one-time charges, legal charges, severance, et cetera, and add back R&D costs, you're at OpEx at 25.5 this year and obviously you are getting 26.6, 26.9 next year.

Most head count reductions occurred in the second half of the fiscal year, how should I think that increase in OpEx that you're guiding for, is it conservatism or as a result of product launches you're coming out, marketing investments, sales, how should I think about that increase?

We set our budget a month or two ago, before we saw some of the savings in the fourth quarter.

In terms of the year-over-year, the fact is that you're likely to see an increase as you mentioned, we've got some fairly significant product launches next year so we do have some marketing associated with those, that we are intending to spend.

We are seeing some other factors like non-cash charges associated with depreciation.

Even though CapEx has gone down next year, some of the depreciation from the increasing CapEx is starting to see through stock comp, which is also non-cash is going up as we layer in Vista.

Acquisition amortization if we do any acquisitions which we provide for some of the non-cash amortization will impact expenses next year, as well.

And then we have a bell way from pay raises last year.

So we've got no pay raises this year, but we had pay raises last year, so the full impact of those.

So there is a series of relatively small items, which add up to the increases that you're seeing.

But we did, as I mentioned, we did actually cut back expenses for next year despite all of those things which are likely to happen.

We cut them back from where they originally were.

Operator, next question.

And next is Todd with Deutsche Bank.

Hey, guys, I just want to dig back into unearned revenue.

I didn't quite understand the discussion in terms of timing that was flat year-over-year.

So if you could just touch on that.

And if you just talk about the annuity business in general, are you seeing any indications that the annuity business is decelerating even ahead of Windows 7 cycle?

Yes, we have a slight difference in timing for the field year relative to our fiscal year.

Our fiscal year is June 30, but field year can be a day or two shorter than that or day or two longer than that, depending on when they close their books.

So from a fiscal year point of view, it is down, but if you include it to a couple days after the fiscal year to when the field closes their books, then it was basically flat, and that's how we tend to look at it internally because that's the field cycle is what essentially drives customer behavior.

So essentially flat is either half full or half empty depending how you look at it.

Half empty is zero is down from double-digits that we were getting in previous years.

The half full is getting flat bookings in the current in the current environment.

which is the worse economic contraction of our lifetime is actually heroic in terms of our field sales.

So inside that flat bookings or flat billings, you're basically seeing two dynamics.

The renewal rate is similar to what we have been receiving traditionally so that two-thirds, to three-quarters renewal rate that we quoted in previous years actually held true this year, which was a very good performance from the field.

What you're seeing that is different, is that the people are not increasing the number of seats that they're taking, so clearly an environment that we've got.

Most businesses are flat in head count or even contracting, so you're not seeing that uplift from the increased number of seats.

And people are much more conservative with what they're buying.

So we're getting certainly good growth in things like SharePoint but that's really just holding the line in terms of, you know, keeping them dollar per dollar with the rate at which they're coming off.

So average, on a contract by contract basis, the number that we renewed in line with history, what's changing is the dollar value of those contracts, which is leading to a sort of flat year-over-year performance.

Operator, next question.

And next is Kash Rangan with Merrill Lynch.

Hi, thank you very much.

When I look at the deferred revenues, it looks like we definitely got a sequential improvement, so that's got to give you some visibility.

Chris, you also talked about the transactional revenues which I think you quantified to be down 20% year-over-year in the March quarter.

I was wondering how that metric fared in the June quarter and should we think about that metric in the June quarter as potentially the bottom because the other pieces the business are fairly coming off the balance sheet, if you will, so I'm wondering whatever that transactional growth was or contraction was in the quarter, do you think that this could be the bottom and that transaction growth could actually pick up in the September quarter and beyond?

Yes, the transactional business extends whether you talk about client server--

Everything combined.

Yes, it is in the 20s or 25% contraction, if you do all of those combined.

So you think about overall PCs down sort of that 18, 16, 18%, you see server and tools -- server hardware down 24%, then the transactional business is really follows those quite closely adjusted for things like inventory, like I mentioned before.

So if you think on average that our underlying hardware shipment increases were in the 20 to 25% range on average, then that's what the transactional business was as well, plus or minus a little bit.

So do I think that is the bottom?

Yes, I do think that is the bottom.

As I said in my prepared remarks, I think it's probably going to continue to be tough for a quarter or two.

So I wouldn't necessarily promise that it is going to be significantly better, but if you look at a combination and of say first and second quarter, that is the first half of the year, then that is probably a good surrogate for the transactional business for the second half of the calendar year, the first half of the fiscal year, and the confidence of that is really in terms of that sequential trend that we mentioned in our prepared remarks.

Okay.

Does that help?

Clarification on the COGS, you said you're working on initiative to drive the COGS down and transition that the COGS is going up by 200 basis points, are you talking net or gross?

In other words, COGS go up by 200 basis points but you have internal initiatives that could drive COGS down by hundreds of millions of dollars, should the next number be lower than the 2% of revenue effect?

That's it.

The 2% is net of the initiatives we've seen.

Clearly, if we outperform on that we'll offset it by more, but that was a net figure I was giving you, so the combination of infrastructure costs associated with that, some of the distribution deals that we've done, the volume related, because clearly was the Windows 7 launch that has a lot of COGS associated with it.

Is offset by the things I talked about to give the 2% decrease.

Got it.

Increase, you mean.

Increase , decrease in gross

Got it thanks.

Operator, next question, please.

The next is John DiFucci with JPMorgan.

Thank you, follow up to Brendan's question, question on the channel section on client.

Two quarters ago you said client was negatively affected by two percentage points and then last quarter I think you said there was a slight negative effect.

Now this quarter it sounds like it is the majority of that 6 percentage point delta between OEM and PC shipments.

Two things here, first I would think that this is a cumulative effect, so when it comes back and it does reverse, how would you think this will come in?

Will it come in over a long period of time when inventory is built or is this going to come in relatively quick many.

I know you're suggesting it is not coming in any time soon.

The economy is weak is out there.

It sounds like some of the component vendors benefited from inventory restocking this quarter, so why wouldn't you say you guys are later and you lagged but why would it be a long lag?

First to start with the underlying math.

Assuming the inventory went through and three quarters ago and stayed down, then year-over-year, you know, you're always going to have a negative.

So the fact that it's negative quarter after quarter doesn't mean that it's continuing to contract.

It just means it contracted and stayed down.

Having said that, in the fourth quarter contracted a bit more, and you're right, that the two or three basis points of slippage that we saw in the second and third quarter were more like three or four percent, so the majority of that 6% in the fourth quarter.

So it was a little bit higher there, but also we're always talking about year-over-year.

So just recall that.

To the second half of your question, you are correct.

It could come back quite quickly, and in our modeling is likely to in the first and second quarter.

So we will see a positive impact on that.

The reason why I say that in the first quarter, revenues more likely to be close to underlying market growth is that even though we get positive inventory, I don't think we'll start to get the positive ASP benefit from business sales, that I talked about, so that will still potentially be a slight negative.

And that won't start coming back until let's say the first half of next year, then you get into the first half of next year and then you get the inventory go back up and it will stay back up and you get the business cycle and you start getting the both of them positive rather than offsetting.

Does that make sense?

Yes, that's very helpful.

Thanks.

Operator, next question ,

Next is Tim Klasell with Thomas Weisel Partners.

Good afternoon, everybody.

My question has to do with the Office 2010 launch.

I think you have the whole productivity staff launching next year.

Can you sort of guide us through of how you think that will affect revenues?

Will there be a burst afterwards like we see in Windows 7, or can you sort of help us sort of think about our models going into next year with the business decision?

Given that it is going to launch in fall of next year, I don't really see a significant impact in 2010 as a result of it.

In fact, again, we could start to -- it could be a headwind for the first half, and then start to turn around in the second half and then you start to see a very good situation in terms of 2011.

But if you're trying to model 2010, it's not going to be a significant positive.

It will certainly help in terms of annuity side, and help mitigate some of the negative transactional impacts that we're seeing.

So some of the signing up, annuities that I mentioned , that people are looking forward to Office 2010 for the new business that we're signing, as well sass some of the other products that are coming out, for example, SharePoint and Office Communications Server, so it will be a slow burn in terms of MBD.

I think we'll see a more positive earlier trend in Server and Tools and Client, but MBD to my mind is pretty much a 2011 story, not

Very good, thank you.

Operator, next question, please.

Next is Katherine Egbert with Jefferies.

Hi, good afternoon.

Could you give pretty tight range of guidance for operating expenditures for fiscal 2010 especially given how much costs you took out in the back half of fiscal 2009.

I'm struggling -- is revenue going to grow next year and can you handicap why that range is so tight?

What happens if revenue is significantly better or worse?

Will it still stay there?

As I mentioned, we have a very what I'll call is a tight rein on costs.

I think you saw that on the performance this year.

So I'm feeling very good about the organization's ability to keep a tight control on costs across the board in term of things like head count, which we look at on a month by month basis, in terms of cost per head, alary increases which is zero this year, it is going to be hard to vary much from zero.

Costs per head in terms of travel and entertainment.

The things that we can control through a very good cost control mechanism, I think we have a good handle on, and therefore, I don't feel exposed in terms of teaching or troughing much from it.

In terms of some of the areas where we don't control, revenue driven expenses, for example, money that we might pay our partners, if they outperform on revenue, you suppose could go up and therefore that number could go up and that range is as a result of that.

I guess I would say if that's the case, and revenue outperforms and it costs us a little more expenses is probably a positive thing and we'll explain it at the time.

But in terms of the great bulk of expenses which are very much around our people internally I feel good that we have a handle on those.

Very good, thanks.

Operator, next question.

Next is [Sandy Bagural] with Collins Stewart.

Thanks for taking my question.

Chris, I have one platform-related question .

As you know, Google announced the launch of Chrome OS for netbook for 2010.

In your view is there really a need for an OS that can handle online service cloud computing better than Windows, and how is Microsoft going to respond to that

Sure, we've been fighting free OS in the client area for quite some time, as you all know.

And I would point to the the general value that we think that Windows have, in particular, around Windows 7, which we think is going to be our best ever operating system.

And we still believe that the very, very, very large majority of people are going to want both a client and an internet based experience on their PCs.

So of course people want to surf the internet and access it, they can do that quite freely with Windows, and all the Internet Explorer and all of the choices they have.

A browser only based like software may have applicability as it does with LINUX based systems already, but we don't see that significantly changing just because of Chrome OS coming out.

Operator, let's have one final question.

And the last question comes from Robert Breza with RBC Capital Markets.

Hi, Chris, just wanted to get your thoughts as you look out here, do you see much change from a geographic perspective?

I mean, I would love just to just get your thoughts from an economic perspective as you're looking out across the different geographies, do you see much variance between North America, Europe, and how we should think about going that from the first half into the second half of the year?

Thanks.

If I cluster the areas into, I guess, four.

Let us do it in four.

Europe, North America, Asia, non-Japan and Japan, and I would say that we're most encouraged in Asia and general developed markets.

We're starting to see reasonable growth in those areas.

Now, that tends to be our lowest ASP market, so it is not helping us enormously, but nevertheless when we look out, we would say to the extent that we come out of a global recession, those are the areas that are going to be the first to come out of it and we see positive growth.

Next in line would be North America, which is still obviously very tough, but relative to say Europe and Japan, you're just looking in better shape, and that's as much anecdotal as it is macroeconomic, just in terms of our sales force, and in talking to them, and looking at our budgeting for next year.

I would rank order them, emerging markets, North America, and at the tail end, Western Europe, and Japan.

Thank you.

Okay.

So that will wrap up our Q&A portion of our today's earnings call.

Remember you can access this call on the Microsoft Investor Central website at www.Microsoft.com/MSFT.

Thanks again for joining us today and we look forward to seeing you next week at our financial analyst meeting here in Redmond.

That concludes today's call.

Please disconnect your lines at this time.