Analyst Conference Summary

conference date: October 25, 2007 @ 2:30 PM Pacific Time
for quarter ending: September 30, 2007 (Q1 fiscal 2008)

Forward-looking statements

Overview: Best quarter in a while.

Basic data:

$13.76 billion in revenue, up 3% sequentially from $13.37 billion and up 27% from $10.8 billion in the year-earlier quarter.

Net income was $4.29 billion, up 41% sequentially from $3.04 billion and up 23% from $3.48 billion year-earlier.

EPS (earnings per share) were $0.45, up 45% sequentially from $0.31 and up 29% from $0.35 year-earlier.

Guidance:

December (2nd fiscal) quarter revenue is expected between $15.6 and $16.1 billion. Operating income between $5.9 and $6.1 billion. EPS $0.44 to $0.46.

For full fiscal 2008 (ending June 2008) revenues between $58.8 billion and $59.7 billion. Operating income $23.3 to $23.7 billion. EPS $1.78 to $1.81.

Conference Highlights:

Outstanding start to fiscal year. Fastest growth since 1999. Demand was robust and broad. Expectations were exceeded by $1 billion of revenue.

Operating income was $5.92 billion.

Cost of revenue was $2.7 billion, R&D $1.8 billion, S&M $2.6 billion, G&A $0.7 billion. Income tax provision $4.3 billion.

Cash and short-term investments ended at $21.57 billion. Net cash from operations was $5.88 billion.

Consumer demand was strong across total product range. Emerging markets were strong. Operating margin expanded from 41% to 43%.

14 to 16% growth in PC hardware in quarter, higher than we expected. Emerging markets grew fastest in Brazil, Russia, India and China.

Revenues 35% OEM 25% multi-year agreements 20% license only.

$11 billion contracted not built.

Client segment revenue $4.1 billion, up 25% (y/y). OEM unit shipments increased 20%. OEM premium mix grew to 75%. Leading indicators are positive for business Vista deployment.

Server and tools revenues were $2.9 billion, up 16%. Windows Server saw unit growth. SQL over 15% revenue and unit growth.

Business division revenue was $4.1 billion, up 20% y/y. But expect only 14 to 16% growth in fiscal 2008. Will have new Business Intelligence offering in 2008.

Consulting revenue up 32%.

Online services revenue $671 million. Excluding aQuantive was in line with guidance, and which is expected to add 25% to growth in fiscal 2008 full year. Improved algorithms for search.

$1.9 billion entertainment division revenues, up 90%, driven by Halo 3 and XBox 360. 1.8 million XBox units sold.

Cost of revenue was 19% of sales, up 3% due mainly to Xbox.

81 million shares or $2.3 billion stock repurchases. 9.5 billion shares outstanding, down 5% from year-earlier.

2008 PC unit growth of 10 to 12% for year, higher in emerging markets.

Q&A:

Premium skews versus expectations? Happy with Vista Launch. Very happy about premium mix, around 75%. Client annuity agreements were up 27%, a very good leading indicator. That is above our original expectations.

Where are we in Office cycle? We saw a good uplift in PC units on both consumer and business side. Shipped units grew even faster because of doing better against unlicensed PCs. Office is more impacted by annuity sales. Customers see value in Office and tie-ins, so we feel good about the rollout.

Why so good before SP1 for Vista? Still early in adoption cycle, some will wait for SP1 for rollout, but they are already signing up for multi-year agreements.

Game concoles? Quarter was ahead of expectations, but think will do well for Christmas as well.

Online still seems relatively weak? We did meet expectations. Underlying ad revenue grew around 20% year-over-year, which is reasonable progress on organic side. Getting better relevence results on search now. A lot of capital expense is going into online segment. Facebook partnership shows commitment to online segment.

Operating margin guidance? Q1 was outstanding, just don't want to project that forward too much. Will grow margins this year.

aQuantive brings in revenue ($500 million for year) but no operating income because of amortization of intangibles, at least in 2008.

Online business profitability target? We are not driving for immediate profitability, we are investing for 2 or 3 years down the line. Expect a loss in that segment in 2008.

Client inventory issues? Not seeing any from our end. Russian OEM revenues grew 100%.

Windows Server and SQL Server demand? Introductions will help with growth rate. But again we are selling annuity agreements now which guarantee they can adopt when they are ready. That smooths out revenues, rather than having bumps at introductions.

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