Welcome to Microsoft's Fiscal Year 2012 Fourth Quarter Earnings Conference Call. All lines have been placed on a listen-only mode until the question-and-answer session. 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 Bill Koefoed, General Manager of Investor Relations. Bill, you may begin.

Thanks, Sharon, 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, microsoft.com/investor, 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. Note that all growth comparisons we make on the call today will relate to the corresponding period of last year. Unless specified otherwise, all impacted numbers for the current quarter have been adjusted for the $540 million revenue deferral related to the Windows upgrade offer and the previously announced $6.2 billion goodwill impairment charge. 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 July 19, 2013. During this call, we will be making forward-looking statements that are predictions, projections or other statements about future events. 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 and the comments made during this conference call and in the risk factors section 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. And with that I’ll turn the call over to Peter.

Thank, Bill, and thanks everyone for joining us. We started the fiscal year with good momentum and closed with a solid finish. Throughout the year we delivered top line growth and remained disciplined on cost management while continuing to execute on our product roadmap. Our enterprise products and services remain a top priority for CIOs as they navigate macroeconomic challenges. They are adopting our solutions for increased productivity, manageability, and security at an overall lower total cost of ownership. Windows 7 and Office 2010 both reached new milestones as enterprises benefit from our business desktop offerings. Today over 50% of enterprise desktops worldwide are running Windows 7 and software assurance attach rates are at an all-time high. And even two years after launch, Office 2010 attach continues to grow as businesses make long-term commitments to the Office platform. Our productivity server offerings continue to perform very well with double-digit growth. Our newest server offering, Lync, grew over 45% this quarter, and we are excited about the unified communication scenarios that are enabled by new voice, video and social capabilities. Office remains the number one productivity application and today is on more than 1 billion PCs worldwide. On Monday we released a customer preview of the new Office, which puts mobility, social and cloud at the forefront. Combined with the power of Windows 8, we are enabling a new platform of computing that gives the end-user unparalleled choice for consumption and productivity. Our Server & Tools products deliver on the vision of the modern data center by enabling multi-tenancy, scalability and continuous services, all while using a single pane of glass for management. No other technology company can offer the hybrid cloud solutions that give customers the ability to manage and scale their applications, data and processes across both public and…

Thanks, Peter. First, I'm going to review our overall results and then I'll move on to the details by business segment. Revenue for the quarter was $18.6 billion, up 7% or $1.2 billion. Operating income was $6.9 billion, up 12%. Earnings per share was $0.73, up 6%. Cash flow from operations was $7.7 billion, up 29%, and for the full year it was a record $31.6 billion. Foreign exchange did not materially impact our net income this quarter. From a geographic perspective, developed markets grew mid-single digits and we saw continued double-digit growth in emerging markets. We delivered solid financial results despite a tough economic environment which demonstrates the strength and breadth of our businesses. Our compelling product portfolio across Windows Server and Tools in the Microsoft Business Division is driving strong demand from small businesses to the largest global enterprises. Multi-year licensing revenue grew 14% and made up over 40% of our total revenue for the quarter. Unearned revenue was a record $19.5 billion, up 14% and our contracted-not-billed balance was over $19.5 billion. Turning to the PC market, we estimate that the worldwide PC market was roughly flat this quarter with approximately 85 million PCs sold. Business PCs were up 1% and consumer PCs were down 2%. Next, I'll move on to the results for the Windows & Windows Live Division, where revenue was generally in line with the PC market. As in past quarters, you will find the OEM revenue bridge in our earnings slide deck. Adoption of Windows 7 remained strong especially among enterprises, which are benefiting from the security and management capabilities that come with the operating system. This quarter volume licensing revenue grew double-digits. During the quarter, we launched the release preview of Windows 8 to a positive reception, and we recently announced that…

Thanks, Bill. For the remainder of the call, I'll discuss our expectations for the first quarter and full fiscal year 2013. As we look forward, we expect many of the trends from 2012 to continue. Companies will prioritize the transition to the modern desktop. CIOs will continue to invest in cloud solutions to deliver productivity, scalability to their business. Consumers will increasingly leverage cloud services to ensure their content is always available across any of their devices. Rapid innovation will continue in hardware, services and the underlying infrastructure that is needed to support mobile computing. With our current portfolio and roadmap we believe we are well positioned to capitalize on these trends. Now turning to our outlook by business. For Windows, in the first quarter we expect to defer $1.0 billion to $1.2 billion related to the Windows upgrade offer and presales of Windows 8 to OEMs prior to general availability. Just a reminder that amounts deferred for the Windows upgrade offer will get recognized upon the earlier of redemption or the expiration of the program on February 28, 2013. We expect the current dynamics of the PC marketplace to continue in the first quarter. Excluding the impact of the deferrals associated with the Windows Upgrade Offer and pre-sales, we expect Windows revenue to slightly trail the PC market for the quarter. With new touch-enabled features in Windows 8 and new form factors hitting the market this fall, we expect Windows 8 to drive the PC ecosystem forward. Excluding the deferrals from fiscal year 2012, for the year we expect Windows revenue to be roughly in line with the PC market. Note that this does not include the impact of Surface PCs which we will update you on in the coming months. In the Microsoft Business Division, multi-year licensing revenue,…

Thanks Peter. We want to get the questions from as many of you as possible, so please stick to just one question and avoid long or multi part questions. Sharon, can you please go ahead and repeat your instructions.

Thank you. (Operator Instructions) Our first question comes from Adam Holt with Morgan Stanley. Your line is open.

In past Windows cycles, commercial and retail licensing and inventory rebuild have enabled you to outpace the PC market, how should we think about those factors around Windows 8, and are you including OEM related tablet sales in your PC market forecast for next year or should we be excluding those like Surface. Thank you.

Well the first question I will go back to the guidance we gave for how we expect Windows to really ignite the PC market and how we (inaudible) to do relative to the PC market. Obviously, we said it was going to lag a little bit in the first quarter prelaunch and for the full-year, would be roughly in line, so obviously that means for the remainder of the year slightly ahead. And also think about some of our emerging markets versus developed markets and what that means for the overall growth of Windows relative to the hardware market. On the second question on the PC market, I’d say when we talk about the PC market we are largely consistent with how the third parties would report on the PC market traditionally.

Next we have Rick Sherlund with Nomura. Your line is open.

On Office 365, I’m kind of curious how we should be thinking about how that revenue ramps up. You haven’t really talked much yet about the availability of Office 365. I know it's included with the WinRT, should we expect then that it's broadly available in the market with October 26th launch date of Windows 8?

I think generally you're characterizing it correctly. We were really excited about the new Office and what that means for Office 365 being broadly available for both consumers and enterprises, and we do think this is a real accelerant for the business. Today, it's been a really compelling part of the overall Office story. We talk with every customer about the cloud roadmap, and that’s one of the drivers of what we're seeing broadly across MBD, not just in Office, but in SharePoint, Lync and Exchange. And I think you’re thinking about this right that when we get to the new Office in conjunction with Windows 8 we really accelerate what we are doing for both consumers as well as businesses of all sizes.

Next we have Mark Moerdler from Sanford Bernstein. Your line is open.

Yahoo! in their earnings call on Tuesday reported that the revenue per search they are getting from Microsoft is below the Microsoft guarantee threshold and that the guarantee expires Q1 2013 I guess, Q1 2013. CFO alluded to a clause in the search agreement because Yahoo! went out that there is no parity, first, is this correct? And second, what if any impact would this have on the search strategy if they decided to break this agreement?

What I’ll tell you Mark we are sort of laser-beam focused on the partnership that we have with Yahoo! We’ve be very encouraged with the year-over-year improvements we have seen over the last several quarters. And to be honest 100% of our focus right now is on making sure we continue to drive those gains which will benefit both parties of the partnership and make sure that’s successful for both companies because it’s obviously very strategic for both of us.

Next question is from Heather Bellini with Goldman Sachs. Your line is open.

Peter, you mentioned on the call the increase in Server and Tools multi-year licensing revenue as a percentage of the total segment. I was wondering if you could walk us through kind of what the biggest drivers are behind that and should we expect kind of the trajectory you are seeing here to continue?

The biggest piece of that we are seeing is SQL and we are getting so much great traction with big enterprises really starting to make progress in tier 1 applications and what we are seeing now is many more long-term multi-year agreements for SQL, which used to be more of a transactional business, but now as bigger companies are making their commitment to our data platform, putting their mission-critical applications on it, they are signing more of a new kind of licensing that we had just for SQL for multi-year licensing agreements. So by far the biggest impact is in SQL, and yes with the new version of SQL Server 2012 we expect that to continue.

Just to add on I mentioned in my script that year-over-year revenue for SQL was up over $0.5 billion. So, just awesome momentum in SQL in the database business and our competitive strategy in the marketplace has just really been playing out.

Next we have Walter Pritchard of Citigroup. Your line is open.

I wanted to just ask a follow-up or ask a question on the contracted backlog. I know we are accustomed to looking at that with the unearned number. But it looks like that number, if I look at the sequential trend there it was a little wide of what we have seen on similar Q4s where you have seen a more robust quarter-over-quarter growth. I’m just wondering, was there something about the shape of the enterprise annuity business or what you saw in the quarter that caused that?

No, as you pointed out, we tend to look at it all up on our annuity business, both contracted as well as the unearned and taken as a whole. We’re obviously very pleased with what we are doing. We’re pleased with the performance we’ve had with our customers, we’re pleased with the renewal rates, we’re pleased with the trend that we just talked about with SQL. I wouldn’t highlight anything unusual there.

I’d just add on that our enterprise agreement renewal rate was certainly within if not at the higher end of our historical range. So, we feel really good about the execution of the sales force this quarter and I think that that definitely played out towards the end of the fiscal year.

Next we have Phil Winslow with Credit Suisse. Your line is open.

Just want to focus go back on the EDD division, you talked about relatively flattish revenue. You gave a lot of color on your mix in terms of the revenue contributions there. But when you think about the operating expenses and the profitability of that business, what would you expect this coming fiscal year and this point in the cycle?

When I think about E&D, I feel really good about the evolution of the business model for the entertainment business, you have seen us really add the content partners that we have and grow the Xbox LIVE business. And so historically the profitability has been largely sensitive to the console market and that’s still a big piece of it, but as we broadened our business, we now are at different revenue streams. And obviously the other thing I’d say is with Halo 4 coming later this year, having a really high first-party title is always a great thing from a profit perspective. So, when you think about the business model going forward, I feel great about some of the content is coming. I feel great about the subscription with Xbox LIVE and some of the access and discoverability we have with Kinect and Bing as well.

Next we have Brent Thill with UBS. Your line is open.

Peter you had really strong multi-year operating margin improvement in the Server business and I was just curious if you could give us a sense of what you are seeing that’s causing that and how should we think about that going forward in terms of that trajectory?

As that business has really accelerated and shown great revenue growth. We are obviously getting the benefits of the scale that you get right, because a lot of the expenses are R&D expense and so, we’ve really been able to improve those margins at the same that we have been building out, both the public and private cloud assets as well. And you heard me talk about before, we’re really encouraged by the trajectory of that business and we think there is continued headroom from that perspective.

I’d just add on, I think as when (inaudible) spoke at one of the conferences this past year, I think he just talked about the fact that our roadmap there is something that enterprises are really buying into because, I mean use this term hybrid cloud and he talked about, this as a strategy of working with enterprises to focus on their on-premise capability, as well as their public cloud capability and being able to offer the opportunity for people to kind of manage that interchangeably. And we really feel like we’ve got just a unique set of capabilities there, and as Peter said, we’ve been making a lot of investment there and you are really seeing that show up in our revenue growth.

Next we have Kash Rangan with Merrill Lynch. Your line is open.

Is the PC market, if you were to include the Windows OEM tablet, as well, Windows tablet really grow faster than conventional PCs. Would you be able to stick to your comment that Windows revenue would grow in line with the PC market?

Let me take that. So, I mean I think Peter talked about this just a second ago, but there is just a whole bunch of kind of moving pieces in there. He talked about there is emerging markets that are growing faster than developed markets. Obviously, there is a different pricing, we have different prices in emerging markets than we do in developed markets. Obviously, there is also some upgrade revenue that we’d be recognizing during this year. I think Kash to your point, there could be some tablet growth. I mean to be honest, it could grow faster but at the same time these best estimates that we have is that we’re going to grow in line with all the information that we have available.

Next we have John DiFucci with JPMorgan. Your line is open.

My question has to do with the Server and Tools business. I guess when I back into what the transactional business is, I guess the question is did it decline this quarter, and when I look at the guidance you are giving. Peter, why would the transactional business slightly lag the hardware market? I think that sort of implies that you are losing share now? I think that that's what’s happening out there. Can you help me a little bit with this?

You are right. It's not losing share, but it's transitioning to the multi-year licensing business for both Windows Server and SQL Server. So that's really what we are seeing, and Bill gave you some of the numbers when he was talking about some of the growth in SQL Server revenue and just all-out multi-year licensing business for the Server & Tools business. It's really just a mix to the multi-year agreements which we love, because it’s people making longer-term commitments to the platform.

So these are people that had been buying transactional that are moving to multi-year, because it sounded a little bit like they were large enterprises that might have been shifting and buying more Windows than they would have brought other stuff in the past?

In general, in total when people are buying new Server & Tools products, they are more often going to multiyear licensing agreements than transaction where that wasn’t as much the case in the past.

Brendan Barnicle with Pacific Crest. Your line is open.

You mentioned that in SQL Server 2012, you’re going to have Hadoop support. I was wondering if you could give us anymore details on what you are planning there and what we might look for in terms of functionality that's going to be enhanced with the Hadoop support edition?

Brendan, neither Peter and I are probably technically savvy enough to be able to offer a great answer on that one, but we are happy to get somebody from the Server & Tools business who can go deep on the technology and we’d love to talk about what we are doing around that and certainly arrange a follow-up call with you in the future if so. Thanks for the question and we’ll follow-up with you.

Raimo Lenschow with Barclays Capital. Your line is open.

Going back to Adam’s question at the beginning, if you think about the timing of the Windows 8 launch and the impact it has on the financials, is there anything that we should think differently this time given that you have like new form factors, the tablets are coming in, your OEM partners still need to come up. So, if you try to model this financial impact, do we need to be aware of a slight delay there compared to previous cycles?

Well, I’d refer you to the guidance that I gave when we look forward and the general answer would be like in previous launches we are incredibly excited about their capabilities, probably more excited about what we are doing with Windows 8 and reimagining what you can do with Windows. And in particular what we are doing and what our OEM partners are doing to deliver really cool devices and really exciting form factors. So, the general answer is, no we are probably more excited about this launch than any launch in a long time.

Colin Gillis with BGC Financials. Your line is open.

I just want to follow-up on the transition from transactional to long-term agreements and also the success with the renewals, can you just give a few factors for this? Is it the product roadmap? Is it cost savings?

It's actually all of those things. Certainly the product roadmap and the new capabilities that we have across the board whether that's System Center 2012 and SQL Server 2012 which is now and what’s coming in Windows Server later this year as well as the public-private cloud story which really, really resonates. So what people are investing in is that roadmap, because they see where they are going long-term and they are partnering with us to get where they need to get long-term through their increased capabilities and our technology. And I’d add that total cost of ownership does play a big piece of that particularly on the SQL side.

Ed Maguire with CLSA. Your line is open.

I’d like to come back to Server & Tools. You mentioned Lync was growing 45%. What's behind that? Is it competitive wins or new implementations or attach in multi-component deals and also if you could address the impact of some of the licensing changes on the growth in SQL Server?

So, let me start with Lync. And I will try and tame myself because I just love Lync. The reason it's growing so fast is because of the capabilities that it provides as well as the cost savings it provides for a company. It's really compelling and it really resonates well with customers. It’s a lot of new implementation, some of its competitive, some of its just new application that people think of really reimagining how communications happens. We are really excited at one place where Skype acquisition plays in and kind of what we showed a little bit this week with how we are really reimagining communications broadly for all of our customers. And that story really resonates very well. It's very easy to sell. It's very easy to see. The capabilities are very easy to show. So, that's just a great product, a great set of capability, a great value proposition for CIOs and end-users alike. And as Bill said, we think unified communication is a really big market opportunity for us, and we felt that for a longtime, and we are really starting to see it with this version of Lync, and what we are doing going forward.

Next we have Gregg Moskowitz with Cowen. Your line is open.

The premium mix went down 6 points sequentially and was lower than we have seen in a while. Just wondering if you think a fair amount of this was perhaps driven by the Windows 8 program, where users can pay one price upgrade regardless of what Win 7 SKU that they buy or was it due to emerging markets and other factors?

Mostly emerging markets. You are right about that.

Brad Reback with Stifel Nicolaus. Your line is open.

Peter, you talked about CapEx being about 3 billion. It's been running at about 2, 2.3 the last couple of years so about a 30% increase. What's that predominantly related to?

Mostly related to the increase in our cloud businesses across the boards, and some we’re getting good adoption and acceleration. So, it's a little bit of an increased related across the board as Office 365 capacity.

Okay, great. So, that will wrap up our Q&A portion of today’s earnings call. We hope you all have a great summer. We look forward to seeing many of you at the numerous conferences in which we will be participating this quarter. For those of you unable to attend in person, you will be able to follow our comments at microsoft.com/investor. Please contact us if you need any additional details. And thanks again for joining the call today and have a great day.

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