Welcome to Microsoft's Fiscal Year 2012 First Quarter Earnings Conference Call. [Operator Instructions] Today's call is being recorded. If anyone has any objections, you may disconnect at this time. I would now like to turn the call over to Bill Koefoed, General Manager of Investor Relations. Bill, you may begin.

Thank you, Carol, and thank you, everyone, for joining us this afternoon. As usual, with me today are Peter Klein, Chief Financial Officer; Frank Brod, Chief Accounting Officer; and John Seethoff, Deputy General Counsel. On our website is our financial summary slide deck, which is intended to follow our prepared remarks and provides a reconciliation of differences between GAAP and non-GAAP financial measures. This information is available at microsoft.com/investor. As a reminder, we will post today's prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and any future use of the recording. You can replay the call and view the transcript at the Microsoft Investor Relations website until October 20, 2012. During this call, we will be making forward-looking statements. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the Risk Factors sections of 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 statement. Okay, and with that, I'll turn the call over to Peter.

Thanks, Bill, and thanks, everyone, for joining us. Today, I’m pleased to share with you our first quarter financial results. We’ve started fiscal year 2012 with good momentum. We have great products in market, customer satisfaction is high, and we have important strategic investments and alliances to position us well for long-term growth. This quarter, we saw revenue growth across all of our segments. Similar to prior periods, we continued to see broad-based demand across geographies, including Europe. Within our segments, the Microsoft Business Division continued its momentum with revenue of $5.6 billion, growth of 8%. Despite the best efforts of competitors, Office remains the overwhelming choice for productivity, evolving with our customers and posting impressive revenues. We are extremely pleased by the market reception to Office 2010 this far into the launch cycle. We’re 15 months post-launch, but we still saw an increase in the consumer PC attach rate for Office this quarter. And, for businesses, Office 2010 remains a top priority. Just as important, businesses are also adopting our productivity server applications including Lync, SharePoint and Exchange, either on-premise or in the cloud with Office 365. The early success of Office 365 has surpassed our expectations. Businesses around the world, and of all sizes, are making the commitment to Microsoft’s cloud services. Our business infrastructure offerings, including Windows Server, Hyper-V and System Center, are a top priority for enterprises. The flexibility, performance, scalability, and price advantage of our private cloud products uniquely meet the needs of the market. And with Windows Azure, we enable our customers to build new applications and extend their existing private cloud assets to the public cloud. As we discussed at our Financial Analyst Meeting, we are increasingly delivering integrated experiences across multiple devices, from the phone to the Xbox and TV and to…

Thanks, Peter. First, I'm going to review our overall results and then move on to the details by business segment. Revenue for the quarter was $17.4 billion, up $1.2 billion or 7% year-over-year. Operating income was $7.2 billion, cash flow from operations was $8.5 billion and earnings per share was $0.68, an increase of 10%. Foreign exchange did not materially impact our net income during the quarter. Coming off a record Q4, enterprise demand for our products remained strong, and our customers continued to add both products and seats to their enterprise agreements. At the end of the quarter, unearned revenue was $15.7 billion, and our contracted not billed remained over $18.5 billion. Turning to the PC market, we estimate that the overall market grew 1% to 3%. Within that, PC sales to emerging markets continued to outpace developed markets. Business PCs grew 5% to a quarterly record of almost 35 million PCs. And consumer PCs were flat, primarily impacted by weakness in netbook sales. Now I'll move on to the results for the Windows and Windows Live Division, where revenue was up 2% and grew in line with the PC market. As usual, you'll find the OEM revenue bridge in our earnings slide deck. Overall, the Windows business continued to show momentum. During the quarter, we surpassed 450 million copies of Windows 7 sold since launch, and enterprise deployments of Windows 7 progressed. This quarter, OEM licenses grew 4%, and within that, business licenses grew 6%. While we have seen the cannibalization of netbooks, sales of Windows licenses on traditional consumer PCs showed healthy growth of 14%. As we look towards the holiday season, we are particularly excited about the lineup of impressive Ultrabooks that will be in market from our OEM partners. Now I'll move on to the…

Thanks, Bill. For the remainder of the call, I'll discuss our expectations for the second quarter and full year, beginning with the Windows and Windows Live Divisions. We expect revenue to continue to be impacted by market dynamics similar to what we experienced in the past several quarters, with PC growth in emerging markets significantly outpacing growth in developed markets. Turning to the Microsoft Business Division. Transactional revenue, approximately 40% of the division's total, will likely lag the overall PC market for both the second quarter and full fiscal year, reflecting a higher mix of PC shipments to emerging markets and the prior-year launch impact. In addition, when updating your models, remember that last year, we recognized $224 million of revenue related to the Office 2010 Tech Guarantee. Multiyear licensing revenue, approximately 60% of the division's total, should grow mid- to high-single digits for the second quarter and low double digits for the full fiscal year. Moving to Server & Tools. Approximately 30% of the division's revenue comes from transactional licensing, 50% from multiyear licensing and 20% from Enterprise Services. For the second quarter and full fiscal year, we expect transactional revenue to generally track with the hardware market. Multiyear licensing revenue should grow low double digits, and Enterprise Services revenue should grow about 20%. Turning to the Online Services Division. We are focused on improving the financial performance of our Search business. Our #1 priority is to resolve the monetization challenges of the combined ad platform. We are working very closely with Yahoo! on bridging the RPS gap. As we improve RPS, revenue should track the online advertising market more closely. Moving onto the Entertainment & Devices Division. Including Skype, we now expect revenue to grow low double digits for the second quarter and high teens for the full…

Thanks, Peter. [Operator Instructions] Carol, can you please go ahead and repeat your instructions?

[Operator Instructions] Our first question is from Adam Holt, Morgan Stanley.

My question is about Skype. Is 100% of the Skype revenue going to be in the E&D segment? And if it is, it looks like the revenue and earnings contribution or OpEx contribution is a little bit lower than I would have expected. Are there any write-downs or any shifts or any kind of transitional issues that we should be thinking about in terms of the run rate for Skype, relative to what it was historically?

Well, there's going to be integration associated costs, some amortization of IP, things like that, that you may or may not be considering. But yes, it'll all appear in E&D.

The next question is from Rick Sherlund, Nomura.

On Skype, Peter, can you just talk a little bit about the model for Skype? What are you going to do different to get the revenues up? How do you monetize Skype? And then also just on Ultrabooks, you had that issue in Thailand with the floods that Western Digital said is going to take out a lot of production. Are you anticipating any problem in PCs? And maybe that shifts the market over to solid-state, and these Ultrabooks look kind of interesting. Any reasonable leads that we could see some actual acceleration in the market from adoption of Ultrabooks? Or are you thinking we might see some slowdown because of what we've seen in Thailand?

Let me -- I'll start with the Skype question, and then we'll get to the other question. Obviously, we -- the first thing I'll say is we closed the deal last week, so we're real-time doing a lot of the great work on the product integration planning. We've got folks here sort of in the building as we speak really working hard on what the plans are going to be, and so I think, over time, it will become more clear. I think as we've been talking about since we announced the acquisition, the opportunities are incredibly exciting across the portfolio of our products, whether it's Lync or Windows Live Messenger or Xbox or on the phone. And so I think not only are there great opportunities to integrate across our product portfolio but, as they were working on even before we announced the acquisition, new revenue opportunities related to advertising and premium services, so all of that's coming together as we speak. And mostly, we're incredibly excited to get to work together more fully now that the deal has closed. In terms of your question about Thailand, first thing I want to say, obviously, is our thoughts go out to all the individuals that are affected there, and we're thinking about them. In terms of the impact of that, you're correct, it doesn't impact solid-state, which is good. And I would say this about, overall, the impact. I think, historically, the global supply chain has been pretty resilient to occurrences like this. And so over time, we'll have to watch this very carefully to see kind of what the overall impact is.

The next question is from Heather Bellini, Goldman Sachs.

Peter, I was just wondering, the Windows attach and inventory boost was a nice tick up this quarter. And I'm just wondering, is it -- if you could kind of give us a sense of how you're doing from a piracy standpoint in terms of the -- in terms of that's what helped the quarter, did you actually see more inventory build?

We saw both. So with some inventory and some attach, we're definitely seeing improvements in attach sort of across-the-board, so definitely making some improvements on piracy, and then some of that improvement was a little bit of inventory build as we head into the holiday. But to your point, we are definitely seeing improvements in attach this quarter, which was a big driver.

Walter Pritchard, Citi.

Bill, I'm wondering, as you look at the OSD loss this year, you actually lost less money than we thought on a revenue number that was lower. Just first wondering if you could comment going forward if we should expect that this level of losses is what we should sustain. And then as you look at the model overall, we saw lower losses, but that didn't flow through as much to the bottom line as we might have expected. How are you thinking about any upside that comes through the lower losses in OSD and impacting the bottom line and the company overall?

As we've been saying, the key to this profitability of this business is to continue to grow our revenue, and to do that, we have to continue to grow share and grow our revenue for Search, and that's certainly what we're focused on. Obviously, it's a high fixed-cost business. Within that, we have been managing the expenses, and so we are taking every opportunity to manage the profitability of that business, but by far, the most important thing to continue to increase the profitability is to make sure we can continue to grow the revenue, and to do that, we need to make sure we get the revenue for Search up. So that's what we're laser focused on. That's what we've got people working closely with Yahoo! on every day, and we'll continue to focus on that, and that's the most leveraged thing we can do for OSD profitability and, ultimately, the company's bottom line.

Kash Rangan, Merrill Lynch.

Just wanted to drill into the Skype contribution a little bit more. Just wondering if there are some products you're going to be discontinuing, certain services or new things, conversely, that you're going to be adding. And also this onetime transition-type expenses, Peter, if you could quantify how much of that will impact the P&L that you've already guided to in the quarter just to get an understanding of how much will go away as you settle into a steady state on the Skype business.

Clearly, it's a little premature to talk about sort of changes and what we're going to do with the products. As I said, mostly, we've seen this week is an incredibly excitement with their engineering people and our engineering people getting together to talk about all the opportunities. As we flesh those plans out, obviously, we'll have a lot more to say about that. And in terms of the expense side, what I would say is everything that's included there is included in our guidance framework that we gave you, so that's probably the best guidance I can give you on those expenses.

Philip Winslow, Crédit Suisse.

Just wanted to focus back on MBD. You guys have been trending at or above, frankly, the PC shipments for several quarters now. Where do you think we stand in just sort of the adoption cycle, particularly in a large enterprise of Office 2010, and especially when we think about rolling sort of the ecosystem out? Where are we in that? And also, Bill, just one quick follow-up. I think you gave the transactional revenue growth for MBD, but I'm not sure if you gave that for Server & Tools.

Yes, on the last question, the transactional revenue for Server & Tools should track the hardware market.

Sorry, I meant this quarter.

This quarter, sorry. I'll answer the question. On MBD, it's really interesting. There's a couple of things going on, particularly in the enterprise that really provide sustenance for the ongoing business. One is the great sort of traction we get from the integration of SharePoint and Exchange and Lync with Office 2010. So not only is there really good resonance for the Office application, but increasingly, as Bill talked about, customers are deploying communications and collaboration technology with that. And there is a lot of legs to go on the productivity server applications piece of the business. Second thing I would add is the cloud. Increasingly, every time we go in and talk to enterprises about productivity, they want to have a conversation about public cloud services, not necessarily because they want to deploy public cloud tomorrow, but they really want to understand the roadmap and understand where that's leading, and we found that creates an incredibly good conversation that then leads to a broader conversation of a long-term commitment to our platform and applications. And I think, obviously, that's a long-term phenomenon with a lot of room still to go. So the way I think about it, yes, for the Office application, particularly on the transactional side, coming off of launch here, there's some difficult comparables. But on the enterprise side, with the additional products and the cloud, that's really been the driver of our growth, and it is really a long-term catalyst.

And Phil, transactional for STB was low-single digits, which we believe was roughly in line with the server hardware market, as Peter mentioned.

Brendon Barnicle, Pacific Crest Securities.

I had 2 quick ones on the guidance. Peter, first on the Windows and Windows Live. In the previous quarters, you've talked about business PCs no longer outpacing consumer. That language isn't in. Is that no longer as big a factor? And then second, on the Server & Tools, you've pretty substantially increased your guidance around the Enterprise Services revenue. Wondering what's accounting for that uptick, and we saw good strength in that in the quarter as well.

Yes, we are still seeing business outpacing consumer, so thank you for that. And on the Enterprise Services, it's interesting, we're really seeing healthy demand for our consulting services to help people architect and deploy sort of the next generation of the products that we're bringing to market, both in Server & Tools and MBD. You can see the connection there, right, Server & Tools continuing to grow double digits. People are really investing in their data centers and in the private cloud, and we're helping people do that and also think about and contemplate what that's going to mean to migrate to the public cloud ultimately. Same thing is true with the productivity server applications. How do you start deploying Lync and SharePoint? How do you think about transitioning to Office 365 over time? So we're really seeing -- we've got a strong pipeline of business there, and that's why you're seeing the growth, both in the cost, frankly, to service demand because, obviously, it's a variable cost business.

Brent Thill, UBS.

Peter, just on the enterprise business, any changes in customer behavior as the quarter progressed? Or as you look at your pipeline, I think there's obviously been some concern over some more scrutiny around some larger deal sizes. Was just curious in terms of what you're seeing.

No, we didn't see any changes in that flavor throughout the quarter.

And I would just add, I mean, unearned came in kind of right in line with our expectations, so we continue to execute well on the annuity side for sure.

Mark Moerdler, Bernstein.

Want to drill in a little bit on the hosting costs, which on MBD was a big chunk of the increase in cost of revenue. How much do you think this is pointing to a lower margin? Has Office 365 and Dynamics Online gained traction? If so, what do you think we should be modeling against?

Yes, no, a great question. Obviously, specifically in the short run, delivering a service has a different margin profile than delivering software. It's going to have a lower gross margin percentage but, ultimately, should have a higher gross profit dollar. So what you should be thinking about is as we scale, you see accelerated revenue growth at a lower gross margin percentage and a higher gross profit dollars.

But I would add, we're such in early days there that I don't think it's had a big impact on our business performance to date.

That is correct. That was a long-term business model perspective, but it's not material today.

John DiFucci, JPMC.

Peter, I think bookings were flat this quarter from a year ago, and I assume you got some benefits from foreign exchange, so on a constant currency basis, they were probably down a little bit. This is after some 4 quarters of some really nice growth here. I think the last time it was flat or down was during the recession. Is this simply a sign of some difficult macro -- of a difficult macro environment? Or was it just a difficult comp year-over-year or even a strong quarter last quarter that might have pulled some business forward?

Exactly. It's definitely more of the latter. Across-the-board, all of our metrics for revenue, transactional, unearned, CMBs, all what we expected, and it's really just a function of sort of the year-over-year comps and the strong Q4 that we had, and we're excited about the pipeline as we head into Q2. And as you know, Q1 is probably our lowest sort of selling quarter anyway during the year seasonally. So we feel good as we head into Q2.

Well, and we reflected that in our unearned guidance that we gave you last quarter, which was we expected sequential kind of Q4 to Q1 but sequential -- sequentially, it would decline a little bit more than normal. So I'd say, it kind of came in line with what we had expected it to be, as I said earlier.

Colin Gillis, BGC Financial.

Peter, can you just update us on the percentage of cash that's offshore? And just give us a sense as to how much onshore cash you need to have to comfortably run operations?

Yes, of our cash, about $51 billion is offshore.

Okay. And what percentage of cash do you need to keep onshore just to keep the lights on and the dividends getting paid?

Yes, that's not how we think about it. We've got plenty of cash. It's not an issue.

Brad Reback, Oppenheimer.

Peter, as we think about the Xbox LIVE business, you've greatly expanded the content available there. Are there opportunities here for additional premium service contracts with people? Or is it going to be mainly transactional to get that content?

Well, without being specific about this particular case, I think from a business model perspective, you're thinking about it right. There's lots of opportunities to think about how you might monetize delivering unique and compelling entertainment experiences, and that's clearly kind of how we think about it. That's sort of been the strategy with Xbox business all along, right? Once you get that incredible installed base of engaged users, how can you deliver a set of interactive entertainment experiences sort of across-the-board and what that means, and sort of from a business model perspective, there's lots of interesting ways to monetize that.

Yes, I mean, I would just add, as you've seen in our results, the Xbox LIVE has been phenomenal, both in terms of growth of users, growth in revenues. The content that we have coming out this holiday season is going to be super exciting, and obviously, as I mentioned in my remarks, that we're going to have over 70 games out this holiday season. So we believe that we have the most compelling entertainment experience in the living room. And hopefully, for those of you who don't have it, you should go out and check it out this holiday season because it's going to be pretty exciting.

Ed Maguire, CLSA. Edward Maguire - Credit Agricole Securities (USA) Inc., Research Division I just wanted to ask a question following the announcement of your Samsung deal. What your assumptions are for royalties around mobile phones? And also, whether you've built in any assumptions from phone into Entertainment & Devices?

So in terms of the deal, we haven't announced any of the specific terms of the deal. We talked conceptually about the deal, and we're super excited about their commitment to the platform and all of that, related to that, is included in the Entertainment & Devices Division.

Gregg Moskowitz, Cowen.

I just had a follow-up to Adam's question. You raised your guidance, Peter, for the EDD business this year to high teens growth although, of course, it now includes Skype. So a couple of questions around that. First, do you still expect to see mid-teens growth for the EDD business organically? And second, I don't know that there are that many long-term Skype subscribers, but is there going to be a deferred revenue write-down for Skype? And if so, how much?

I think it's -- why don't we -- the second question, we'll talk to you about when we actually report Skype results after the next quarter because we disclosed that last week. And I -- on the E&D business, I would say generally, yes, our guidance is in line with guidance we've given before.

Tim Klasell, Stifel, Nicolaus.

A follow-on question to Brendon's comment about business PCs growing faster than, I think, consumer PCs. Where do you think we are in the enterprise Windows 7 upgrade cycle? Are we middle innings, we getting towards the end? How do you feel about that?

Yes, no, I think we're middle innings. I think we expect that dynamic of business PCs growing faster to last throughout this fiscal year at least, so I would say middle innings.

[Operator Instructions] And Jason Maynard, Wells Fargo.

Since fixing the Yahoo! RPS challenges, obviously an issue for improving OSD, how do you guys go about sort of ensuring that there won't be any disruption to your efforts, given all of the, call it, market talk about what's happening with Yahoo!? Because clearly if it's a quieter [ph] split-up, there's also sorts of potential outcomes that could cause maybe more disruption to what you're trying to accomplish. So how do you kind of preserve the process, if you will?

We've got a really good relationship with Yahoo!. This is a long-term alliance. Everybody is working really well together. We're super focused on what we need to do, and no matter what, that's the goal at hand. And the teams are working really well together to do that. So that's kind of how we're approaching it and focused on it. Okay, so that will wrap up our Q&A portion of today's earnings call. Thanks again for joining us today, and have a good afternoon.

Thank you. This concludes today's presentation. You may disconnect at this time.