Good afternoon, and welcome to the Microsoft 2007 fiscal year first quarter conference call. (Operator Instructions) I would now like to turn the call over to Ms. Colleen Healy, General Manager, Investor Relations. Please go ahead.

Thank you. Good afternoon, everyone and thank you for joining us today. This afternoon I am joined by Chris Liddell, Senior Vice President and Chief Financial Officer; Frank Brod, Corporate Vice President of Finance and Administration and Chief Accounting Officer; and John Seethoff, Deputy General Counsel. Today's call will start with Chris providing some key takeaways for the first quarter of fiscal year 2007 and an overview of expectations for the rest of the fiscal year. I will then provide detail around our first quarter results, and then turn it back to Chris for a more detailed discussion of our guidance for the full year and the second quarter of fiscal 2007. After that, we'll take your questions. We filed our 10-Q today in conjunction with our earnings release. Therefore, you have available the earnings release, MD&A, financial statements and footnotes. We have also posted our quarterly financial summary slide deck, which is intended to follow the flow of our prepared remarks in order to assist you. The slide deck offers highlights from the quarter, outlines our guidance, and provides a reconciliation of differences between GAAP and non-GAAP financial measures that we will talk about today. You can find the earnings release, the 10-Q, and the quarterly financial summary slide deck on the investor relations website, at www.Microsoft.com/MSFT. Today's call will be recorded. Please be aware that if you decide to ask a question, it will be included in both our live transmission as well as any future use of the recording. As always, shareholders and analysts can listen to a live webcast of today's call at the Microsoft investor relations website. A replay of the call will be available at this same site through the close of business on October 26, 2007. This conference call report is protected by copyright law and international treaties. Unauthorized reproduction or distribution of this report, or any portion of it, may result in civil and criminal penalties. Any recording or other use or transmission of the text or audio of today's call is not allowed without the express permission of Microsoft. We will be making statements during this call that are forward-looking. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of factors discussed in today's earnings press release, and the comments made during this conference call, and in the risk factors section of our 10-Q, our 2006 Form 10-K, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. With that, let me now turn it over to Chris.

Thanks, Colleen, and good afternoon, everyone. We're pleased to be with you today to share our first quarter results and talk with you about how we see the rest of fiscal 2007 shaping up. Looking back over the first quarter, I would characterize it as a very good start to what we are expecting to be an excellent year. All aspects of our financial performance came in at or above the high end of our guidance. Our product groups made considerable progress executing on major product milestones towards their launches in quarter two and beyond, and we continued our progress on returning cash to shareholders, including through our tender offer. Looking back to our first quarter financial performance, revenue came in at the high-end of our guidance, growing 11%, which represents over $1 billion in absolute revenue growth. Server and Tools and our Entertainment and Devices division were particularly strong in the quarter, benefiting from continued customer demand for SQL Server and the Xbox 360. Operating income benefited from both the strong revenue growth, as well as lower spending, primarily on marketing programs, which we shifted out of quarter one and into the rest of the year. Combining that with increased investment income, as we increased liquidity in preparation for the tender offer, our earnings per share results were excellent. This was an important quarter for our business groups, as we made significant progress towards a number of milestones leading up to our product launches in coming months. During the quarter we rolled out Release Candidate 1 of Windows Vista, a Beta 2 technical refresh of the 2007 Office system, a Beta of Exchange Server 2007, and announced the upcoming launch of Zune. To date, these trial versions have been made available to about 5 million Windows Vista users and over 3 million 2007 Office System users. We've been receiving encouraging feedback from partners and customers who are using the betas, which are the most widely-tested releases in the history of these products. We also continue to be active on the acquisition front, averaging more than one a month. This quarter the bulk of our acquisitions were companies that augment the offerings of our Server and Tools business. Our acquisitions focused on the areas of systems recovery and data protection, virtualization, and security. Finally, on the capital structure front, we continue to make steady progress. We finished our prior $30 billion repurchase plan, as we shared with you on the last earnings call, announced a new authorization that runs through July 2011, completed our tender offer, made additional share repurchases outside of the tender offer in the quarter, and increased our quarterly dividend. Moving now to the full fiscal year, 2007 is shaping up well. We will be delivering the second major installment on our multi-year product cycle, helping to fuel revenue growth for the Company. So, let me make a couple of key points about fiscal 2007. First, we continue to expect full-year double-digit revenue growth. In terms of quarterly trends, revenue growth will be impacted by the deferral of approximately $1.5 billion of Client and MBD revenue out of the second quarter and into our third quarter, as a result of the recently-announced technology guarantee programs. As we discussed on the call hosted by Frank and Scott earlier in the week, this movement has no impact on our full-year numbers. Second, growth in operating income in the first half of the year will be impacted by the increasing mix of Xbox 360 console revenue and related costs, coupled with significant investments to support the launches of our flagship products, and the accounting impact of the technology guarantee programs. This trend should reverse in the second half of the year, when we expect operating income will grow considerably faster than revenue. Finally, excluding legal charges in the prior year, we will grow earnings per share 13% to 15% while launching major products and continuing to invest in the future growth opportunities in all our business divisions. I'm particularly happy that we've been able to broadly maintain our full year earnings per share guidance. Better business performance and higher investment income have helped offset the impact of lower share repurchases in our tender offer and the higher effective tax rate. With those high level things for the quarter and the full year 2007, I'm going to turn the call over to Colleen now for more details on our first quarter performance.

Thanks, Chris. In the interest of providing more time for your questions, I'm going to keep my remarks regarding the fiscal first quarter brief. Overall, we are off to a good start in what is a significant year for the Company. Specifically during the quarter, we delivered revenue, operating income and EPS growth at or above the high end of our guidance. We made significant progress on development and launch readiness for key products in the pipeline, including Windows Vista, Office 2007, Exchange Server 2007, and Zune. We returned $7.9 million in capital to shareholders in the form of dividends and share repurchases. I will now provide more detail on our financial performance, starting with revenue. I will discuss top line financial and business momentum points, and then follow up with revenue performance for each of the business units. All growth comparisons I mention relate to the comparable quarter of last year unless otherwise specified. Revenue growth for the quarter was 11%, driven primarily by the business groups significant product launches over the past 12 months, as our new product cycles have been well received by customers. Specifically, Entertainment and Devices and Server and Tools accounted for over 70% of the absolute revenue growth in the quarter. Healthy PC and server hardware market growth were also key contributors to our results. The PC market grew 8% to 10% in the quarter, driven by a good back-to-school sales season. Consumer growth outpaced that of business, consistent with the trend of the past several quarters. Geographically, we saw double-digit growth in Asia and Latin America, with the remaining regions growing at single digits. Server hardware shipment growth was consistent with our full-year estimate of 10% to 12%. Our mix of product billings was approximately 40% from OEMs; 25% from multi-year licensing agreements; 20% from license-only sales; and the balance from our other businesses. These results were generally consistent with the prior year. We had a good quarter from a volume licensing perspective and saw strong performance in our small and medium business channel in particular. In terms of enterprise agreements, we highlighted in July that there was a relatively small amount of EA contract value up for renewals in the first quarter, which would impact EA. Of the business that was up for renewal, we continued to see EA renewal rates within our historical range of 66% to 75%. Non-annuity growth was relatively weak, as expected, in front of major product launches later this year. Our unearned revenue balance ended the quarter at $10.1 billion, up 15% over the prior year and slightly stronger than we expected. The sequential decline in the unearned balance in the first quarter was driven by the absolute size of our fiscal Q4 annuity billings relative to Q1, as well as the small amount of EA contract value up for renewal, as previously discussed. Our contracted not-billed balance at the end of September was sequentially lower, but continues to exceed $9 billion. Now I'd like to provide revenue highlights by business segment. Starting with Client, revenue for the quarter grew 4% to $3.3 billion. OEM revenue growth of 4% resulted from 11% growth in license units. The 7 percentage point difference between OEM license unit growth and revenue growth was caused primarily by increasing volumes in emerging markets, the relative strength of the consumer segment of the market, and a $45 million revenue deferral related to the Express upgrade to Windows Vista program. We were particularly pleased with the continued adoption of Windows Media Center Edition, which represented over 15% of OEM license mix in the quarter, and has now sold over 20 million units to date. Client, commercial and retail licensing product growth of 5% was primarily driven by growth in multi-year contract agreements in front of the Windows Vista launch. We made significant progress on Windows Vista development during the quarter, as evidenced by the recent availability of the second release candidate. We made pre-release versions of Windows Vista available to over 5 million customers worldwide. Server and Tools revenue growth of 17% represents the 17th consecutive quarter of double-digit revenue growth for the segment. Results for the quarter were driven by broad adoption of our Server and Tools product line, particularly SQL Server, which grew over 30%, Windows Server and Digital Studio. During the quarter we completed the acquisition of Softricity, Whale Communications, Winternals Software and DesktopStandard, which will strengthen our growing Server business around virtualization, enterprise security and management. Revenue for our Online Service business was down 4% to $539 million, with 5% advertising growth and a 30% decline in access revenue. Increased advertising revenue was driven by growth in display advertising, offset by lower search revenues. With respect to search, although our search queries grew, our search pricing was below the prior-year levels as a result of the transition to our new adCenter platform, which began in earnest during the December quarter. We experienced sequential growth in revenue per search as we increased the number of advertisers on our platform. During the quarter we also released a number of new or updated Internet services, including Live.com, Live Search, Live Local Search and Live Spaces. Microsoft Business division revenue grew 4% to $3.4 billion, a good result in front of the upcoming product launches of Office 2007 and Exchange Server 2007, and in line with our expectations entering the quarter. As with Windows Vista, we also made considerable progress on the development of the 2007 Office system. We released the Beta 2 technical refresh of the product during the quarter and over 3 million customers have pre-release versions of Office 2007. Business momentum and customer interest for both Office 2007 and Exchange Server 2007 remains strong, leading us to the launches later this year. We also delivered strong performance in our Dynamic business in the first quarter, with customer billings growth of 19%. Lastly, Entertainment and Devices growth of 70% for the quarter was driven by strong performance across all of its businesses. Interactive gaming revenue in particular more than doubled as a result of Xbox 360 platform momentum. We have sold 6 million consoles life to date, and Xbox 360 software and accessory attach rates have remained at record levels in the U.S. relative to any previous console launches from competitors. Momentum for Xbox Live continued to build as well, passing the 4 million member mark during the quarter. In addition to strength in gaming, our Mobile and Embedded Device business recorded its sixth consecutive quarter of revenue growth in excess of 40%, as licenses for Windows mobile-based phones more than tripled. Finally, we announced the next step in our Connected Entertainment division with the coming availability of the Zune digital media player and online service for U.S. consumers starting on November 14. Now for the rest of the income statement. While revenue increased 11% for the quarter, the cost of revenue increased 35%, due primarily to Xbox 360. As a result, gross margin relative to the prior year was down 3 percentage points for the quarter, consistent with the guidance we provided in July. First quarter operating expenses, other than cost of revenue, increased $560 million, or 14%, excluding certain legal charges in the prior year quarter. While we continue to invest aggressively in both R&D and sales and marketing to drive future growth, expenses this quarter were lighter than we expected, primarily due to the timing of marketing program spend. Operating income for the quarter was $4.5 billion, up modestly from the prior year excluding certain legal charges in that year-ago quarter. Investment income and other totaled $567 million, driven by larger than expected gains on investment sales to fund our tender offer during the quarter. Our effective tax rate came in at 31%, slightly higher than the estimate provided to you in our guidance last call, due to the change in the mix of earnings in various tax jurisdictions. During the quarter we continued to execute against our strategy of returning capital to shareholders. We repurchased $7 billion of company stock, including nearly $4 billion through our tender offer, and paid out $9 million in dividends during the quarter. Diluted shares outstanding were 10 billion, down 7% from the prior year as a result of execution against our share repurchase program. Earnings per share for the quarter were $0.35, $0.03 above the high end of the range we provided in July. So, in summary, Q1 was a good start to fiscal 2007. The solid revenue results for the quarter were at the top end of our expectations, and EPS exceeded our expectations with an exciting and important fiscal year now underway. Chris will now provide you with our expectations for the second quarter and fiscal year 2007.

Thanks, Colleen. I'm going to spend my remaining time on the call talking about what we see coming for the full year and the second quarter. Before we get into the specific guidance, let me outline some of our key assumptions. Our fiscal 2007 forecast assumes no major changes in the economic conditions and demand from where we exited the first quarter, and we are not forecasting any significant impacts from foreign exchange rate movements. We expect PC unit growth for fiscal 2007 to be 8% to 10% for the year, in line with the guidance we gave you last quarter, and between 6% and 8% for the second quarter. We continue to estimate that PC unit growth rates will be higher in the Consumer segment than in the Business segment, and higher in emerging markets than in mature markets. On the server hardware front, we remain comfortable with our estimates for total market growth of 10% to 12% for the year. Now let me go through our detailed guidance. For the full year we expect our revenue to come in between $50 billion and $50.9 billion, growing 13% to 15%. We are bringing up our revenue range to reflect how we finished quarter one, as well as also raising the top slightly. Our growth is driven by forward-based revenue growth across our five segments. For the second quarter we expect revenue of $11.8 billion to $12.4 billion, which represents quarterly growth of flat to up 5%. There are a couple of items to note when you consider our second-quarter revenue. First, the revenue figures for the second quarter include the impact of us deferring approximately $1.5 billion, primarily from our technology guarantee programs. Again, this simply defers the recognition of revenue from the second quarter into the third quarter. There is no full-year impact of these programs on revenue. Before these impacts, revenue guidance would have been $13.3 billion to $13.9 billion, which represents growth of 12% to 17%. Second, we expect PC unit growth in the second quarter to remain healthy, but moderate from the growth rate we saw in our fiscal first quarter, as well as from the growth rates we saw last year in second quarter. With that, revenue guidance in our five business units is as follows: For Client, we expect full-year growth to be 9% to 10% and second-quarter growth to be down 25% to 27%. This full-year guidance includes the impact of revenue recognition changes for Windows Vista, as was discussed on our call on Tuesday. Our second quarter guidance includes the deferral of approximately $1 billion in revenue out of the quarter and into the third quarter. $1 billion covers revenue associated with both our technology guarantee program, as well as amounts for Windows Vista pre-shipments into the channel ahead of launch. If you were to normalize for the $1 billion of deferrals, second-quarter revenue would be growing 4% to 6%. Looking at the full-year growth, the commercial and retail portion of the Client segment should pick up in the second half due to our launch of Windows Vista targeted for volume licensing customers in November, and with broad availability in January. We expect Client OEM revenue to grow slightly below the PC hardware market for the year, due to increased concentration among larger OEMs, consumer hardware shipments growing faster than business shipments, and relatively faster growth in emerging markets. Server and Tools revenue should grow 15% to 16% for the year and 14% to 15% for the second quarter. We continue to expect double-digit growth throughout the year from the sustained momentum of SQL Server and from growth in Windows Server, developer tools, our application business, and enterprise services. As we approach the anniversary of the SQL Server and Visual Studio launches, quarterly performance in the second half of the year will face tougher year-over-year comparables. We forecast revenue in the Online Services business to grow between 7% and 11% for the year and to be up 3% to 5% in quarter two. The full-year growth number implies significant year-over-year growth in the second half, based upon growth in both search and display advertising revenues. While we continue to make investments in various aspects of the business, we did make progress on a number of fronts in the quarter. For example, we rolled out the Live Search, which now powers searches on both MSN.com and Live.com, moved our Live Local Search out of beta and into final availability in both the U.S. and the UK, continued to grow and broaden our social networking presence with spaces and the recent beta rollout of Soapbox, and we're making good progress getting advertisers on adCenter, as well as looking at opportunities to extend our reach through partnerships. Microsoft Business division revenues should grow 8% to 9% for the year and be down 8% to 10% in the second quarter. The full year guidance now includes the impact of Dynamics revenue recognition we talked about earlier in the week, and that's close to what we gave you in July. Our second quarter revenue guidance includes approximately $500 million being deferred out of the second quarter and into the third quarter, due to both our technology guarantee program as well as a small amount of revenue associated with Office 2007 pre-shipments into the channel. If you were to normalize for the impact of the technology guarantee program, revenue growth for quarter two would be 3% to 5%. Fiscal 2007 is MBD's biggest year ever for product launches, with major releases in all areas of the business: Office, Exchange, Dynamics, and Office Live. For the Entertainment and Devices division, we're forecasting full year revenue growth of 33% to 46% and second quarter growth of 50% to 75%. With 6 million Xbox 360 consoles sold life to date and a portfolio of 160 high-definition games by the end of the year, we remain optimistic that we will exit the holiday having sold over 10 million units since launch and end our fiscal year having sold 13 million to 15 million units since launch. Operating income for the year is expected to be between $19.1 billion and $19.5 billion, growing 9% to 11%, excluding legal charges taken in fiscal 2006. In the second quarter we expect operating income to be between $2.9 billion and $3.1 billion, including approximately $1.5 billion of impact from revenue deferred from our technology guarantee and preshipment. The $1.5 billion results from revenue recognition that is deferred from the second quarter into the third quarter and there's no full year impact to this program to operating income, as we've mentioned. Excluding the impact of the technology guarantee, operating income for the second quarter would be between $4.4 billion and $4.7 billion. Second quarter operating income includes the impact of higher overall mix of lower-margin hardware revenue from Xbox 360 and Zune, increased costs associated with the Online Services group, as well as operating costs in preparation for the launches of Windows Vista and the 2007 Office system. On our last earnings call we gave you additional color and guidance on cost of goods sold, given the evolving mix of our businesses. Even though we may not always do so each quarter, let me give you an update on COGS today. Cost of goods sold as a percentage of revenue for the second quarter should increase by $0.08 to $0.09 over quarter two of last year. The increase results from a larger number of Xbox 360 consoles, plus the inclusion of Zune units. We're remaining with our previous guidance on the full year being up one to two points. We're also updating our guidance on our effective tax rate for the year. In July we estimated the full year effective tax rate of 30.5%, but due to a change in the mix of earnings in various tax jurisdictions, we are now estimating a full year tax rate of 31%, consistent with what we saw in the first quarter. Diluted earnings per share for the year are expected to come in at $1.43 to $1.46, and $0.22 to $0.24 for the second quarter. Second quarter EPS, excluding the impact of the technology guarantee, would have been $0.33 to $0.35. I'm pleased that, as a result of better business results and investment income, we have been able to keep our guidance largely in line with the full year guidance we gave you in July. I'd like to take a moment now to drill down a bit on the makeup of our full-year EPS numbers. We told you back in July that we estimated the impact of the full completion of our tender offer would be $0.05 to $0.06 for the full fiscal year. Since only a portion of the shares were tendered, I wanted to do a quick reconciliation from our full year guidance in July to what we're giving you today. First, instead of buying the previously contemplated $20 billion worth of shares during the quarter through our tender offer, we repurchased a total of $4.8 billion, which comprised of $3.8 billion worth of stock through our tender offer, plus an additional $1 billion we made in open market purchases during the quarter. The lower repurchases will reduce our estimate by approximately $0.03 to both our low and high ranges. Second, offsetting that decrease would be higher operating income associated with better revenue growth, higher investment income for the year, negated somewhat by a higher effective tax rate. We estimate the net impact to add approximately $0.02 on the low-end and $0.01 on the high-end. Finally, the remaining $0.01 improvement to both our low and high end EPS guidance comes from our ongoing buyback activity. As with past practice, we do not intend to share the expected pace of our prospective buyback execution, and it could differ from our expectations embedded in the guidance. We expect unearned revenues to finish fiscal 2007 up 5% to 7%. Contracts not-billed should also finish 2007 up from where we exited fiscal 2006. In thinking about sequential changes in unearned revenue from quarter one to quarter two, we expect seasonality similar to last year, plus the addition of the 1.5 in revenue associated primarily with our technology guarantee programs. For our full-year unearned revenue guidance, we're modeling a moderation in the recent annuity mix of our billings, as both Office 2007 and Windows Vista will be available to customers in the second half of the year. As we think about our guidance for the rest of the year, many of the risks and opportunities I talked about last quarter still exist. Aside from our normal competitive, legal and general market risks, in particular, PC and server growth rates, we have our share of execution risks in the year. Our plan relies on execution on a number of important product launches starting in the second quarter and extending through the rest of the fiscal year. Customer acceptance of our new products is uncertain and, in particular, customer acceptance of our products such as Xbox 360 and Zune, are particularly difficult to predict during the holiday sales season. Also, the cost of acquiring and serving customers in our online business could increase. Potential upside to our guidance in some cases is a mirror image of our risks. For example, customer acceptance and demand for Windows Vista, the Office 2007 system, Xbox 360 and Zune could exceed our expectations. Customer demand for our hardware products like Xbox 360 and Zune units with a fiscal revenue growth but not necessarily operating income growth. And finally, PC and server hardware shipments could grow faster than we anticipate. Before moving to Q&A, then, I'd like to make a couple of quick comments. We continue to execute well against our strategy for delivering long-term shareholder value. We are committed, and continue to be, to growth through innovation. By investing in innovation across a broad array of high-growth markets, as well as in the development of a services capability to complement our current software offerings, we are positioning the Company to grow operating income faster than our technology peers over the long term. With profitable growth, we generate significant operating cash flow, which enables two very important outcomes: First, it unleashes the virtuous cycle of reinvestment back into our business for further growth. Second, it allows us to advance our financial strategy of returning capital to shareholders. Overall we remain optimistic about our ability to innovate, to generate growth, and as a result of those, to create long-term shareholder value. That wraps up my financial comments. I'd like to hand the call over to Colleen so we can get started with your questions.

Thanks, Chris. Let's now proceed to questions. We want to accommodate questions from as many people as possible, so please avoid multi-part questions and limit yourself to just one question. Operator, will you please repeat your instructions?

(Operator Instructions) Your first question comes from Heather Bellini - UBS.

Hi, thank you. Good afternoon. I was wondering if you could give us an idea, what was the premium SKU mix for the first 12 months of the Windows XP launch? What's implicit in your guidance for Vista? As a follow-up, what do you view as negating factors of whether or not Client growth will be faster than PC shipment growth in calendar '07?

Thanks very much. In terms of premium SKU mix, we're sticking with what Kevin Johnson told you at FAM, which is we're looking at 52% to 54% I believe, is what he quoted for the year. That's this fiscal year, so we still feel good about that. Obviously it was higher than in the first quarter. But at this stage we're certainly comfortable with that number. In terms of the calendar year growth, I think, which was the second half of your question, clearly, we are feeling good about growth in revenue in the Client area relative to PC units. So, in the first quarter and the second quarter, revenue growth will lag PC units. But then in the second half of the year, it's actually going to be at or above it, and equal to for the full year. So, we're looking at fiscal year '07, PC units growing at 8% to 10%, and Client revenue growing in fact slightly higher than that, 9% to 10%. That's a result of not only good unit shipments, obviously, but also the positive impacts of our commercial and retail part of the Client business. In terms of XP and premium mix, I'll get one of my colleagues to grab that number. I don't have that at hand straightaway.

Your next question comes from Adam Holt - J.P. Morgan.

Two questions on the cost structure for the second quarter. You mentioned that you're going to be able to get some improvements in the Xbox margins. I was wondering if that's coming from software attach or component pricing? Secondly, as we look at the cost that shifted out of the first quarter, it looks like the operating margins, net the impact of the deferrals, were a little bit lower than I was looking for in Q2. Should we assume that entire amount falls in the second quarter, and then that's going to go in the marketing line? Thank you.

Sure, Adam. In terms of the better margin for Xbox, it's both those impacts. So, we are seeing lower cost per console, we're coming down the manufacturing cost line, and in fact, we're doing better than what we had hoped for. So, last year we saw slightly higher costs to console than we were expecting; this year, certainly to date, we're experiencing better costs per console. We're sticking, clearly, with our view of being cost-neutral over the console life. This year is shaping up very well. On top of that, we did also get good software attach. So, we saw software attach, I believe, over five for the quarter, which when you spread over the number of units that we sold, meant that our revenue per unit for software was very good in the quarter. We continue to be very pleased with that. Also from some of the other sources of revenue, they're not as significant, but, obviously, with the number of people that we're seeing on Xbox Live, we're starting to see some benefit from that. So, all of those are helping with the Xbox margins. In terms of the second half of your question, which was on the operating costs, most of that marketing spend was a shift from quarter one to quarter two. So, you are correct; to the extent that we saved some revenue on OpEx, to a large extent you'll see that in the second quarter. As you'll see from our full year guidance, that's still intact. exactly the same from an overall OpEx point of view. So, there's some spread, I believe, in the third and fourth quarter, but it's primarily a quarter one to quarter two shift.

Your next question comes from Charles DiBona - Sanford Bernstein.

Chris, you sound pretty upbeat about the online services group, even though the numbers seem to be going pretty much sideways. Could you give us some insight, other than the product launches, to some of the metrics that you're looking at that give you confidence that this is really headed in the right direction? Maybe it's conversion rates or share or the size of the advertising community, but something that underlies your confidence in that group.

The revenue per search is, clearly, the one that we've got closest on our eye at the moment. We look at probably 10 to 12 metrics across that group fairly closely. But in terms of the revenue per search, that is going up sequentially as we get more advertisers onto the adCenter platform. We're close to now lapping where we were when we came off the Overture platform from last year. So, with the revenue expectations that we have in the back half of the year, I am expecting us certainly in the U.S. anyway to equal or go above our revenue per search on a year-over-year basis, not just a quarter-over-quarter basis, and that will help drive revenue in the second half. On the display advertising side, we obviously look at both the volume and the monetization there. Both those figures again, we look at the back half of the year and are expecting that to be pretty good, but from our point of view, those numbers are reasonable as well.

Your next question comes from Rick Sherlund - Goldman Sachs.

Chris, if I could take you back to the call you did a couple days ago on the change in accounting for the undelivered elements for Windows versus the Dynamics, where you're going to move to ratable recognition. I wasn't on that call; I was in the air, but I just wanted a chance to come back to that issue. If you could clarify that. So, for Dynamics, starting in the third quarter, we're going to shift to ratable recognition?

No, it's in the first quarter for Dynamics.

First quarter of next year?

No, the first quarter of this year. There's a full-year impact for this year. And then obviously, only a couple quarters of impact on the Vista side.

I'm curious about how big that is, because I would think that the Windows change is bigger than the Dynamics change.

In absolute terms going forward, in particular as you look forward to fiscal year '08, you'll be absolutely correct. In terms of fiscal year '07, because one is for a full year and the other is only for a part year as the product phases in, then they basically offset each other. As we look to fiscal year '08, you'll see a much more significant impact from the Vista change relative to the Dynamics, obviously, because of the scale of those businesses. When we give you guidance for next year, we will absolutely call that out and be transparent about it. Because as you know, it's purely an accounting change; it doesn't change the underlying economics. So, we will tell you exactly how much of the guidance for next year we anticipate with both of them. And you are right; it will be much more significant for Windows than it will be for Dynamics in fiscal year '08.

The reason for the change in Dynamics, should I anticipate that you're going to move to an on-demand, software-as-a-service model, where you can charge over time and you'd be relatively indifferent from a revenue recognition standpoint, whether it was on premise or on demand?

Because it's more in the accounting area, let me just hand over to Frank and he'll give you the technical answer.

We have actually changed the way we are marketing the licenses there. In the past we've licensed on a per-module basis. Our new licensing program actually licenses on a per-seat basis. So with that, because all future software and upgrades and functionality are available to the new licensees, we will actually move to a ratable recognition rather than an up-front recognition.

Your next question comes from Kash Rangan - Merrill Lynch.

Just a quick clarification on the EPS guidance. So, the tender offer, the shortfall in the buyback on account of that is balanced by the investment income, right? Is that how you get to pretty much the same EPS guidance as before, or am I missing something? I just wanted to clarify that.

There's three elements that help us get back. Two downward elements and three upward elements. One is the lower tender, we also have a slightly higher tax rate that we're anticipating for the year. So those, all other things being equal, would lower our EPS guidance for the year. In terms of upward impacts which offset that, we are obviously continuing to buy back shares during the course of the year. We have a better investment income, as you mentioned. But also, we have got better operating income. So, we are guiding to higher revenue, and the benefits of that higher revenues are flowing through to operating income. So, I primarily call out better business performance, which is helping offset some of the lower earnings per share impacts of buyback.

Your next question comes from Brent Thill - Citigroup.

With the new stiff antipiracy features in Vista, are you assuming similar piracy as in past cycle, or are you expecting a slight improvement with the Vista launch?

We're certainly looking at the back half of the fiscal year which is the only one at this stage, clearly, that we're guiding to, to OEM unit sales being higher than PC units as a result of our antipiracy. So, we're looking at, I believe, for the full year something like a 1% to 2% benefit as a result of that. So, we're not looking at significantly different rates relative to XP. Clearly, as we go into fiscal year '08 and onwards, we'll give you some guidance at that stage. But certainly it is helping, but we're already seeing some positive benefits from what we're doing on the XP side.

Okay. And the blended ASP, is that fair that 6% to 8% with Vista? Is that a fair rate, or do you think it's a little lower?

I'm not sure where you're getting the 16% from, to be honest.

No, I'm sorry. 6% to 8%; would that be a fair blended ASP increase with Vista versus XP? Would that be a fair range to assume for an ASP lift?

Look, obviously, we're giving or talking about the individual products. At this stage we're not talking about blended rates. We're talking about the premium mix that we expect. But we'll let the market determine what that's going to be in the second half of the year. We have some anticipation in the guidance we've given, but I don't want to comment on a specific number for ASP.

Your next question comes from Jason Maynard - Credit Suisse.

Just a question about use of cash. There's a lot of acquisitions going on at fairly high prices in the online property space. I'm just curious, what are your parameters around contemplating a transaction like that, and how you think about some of those larger deals? And also, just maybe as the flip-side of this is what are your plans for CapEx for this fiscal year, and have they changed at all since last quarter?

We are very rigorous on the acquisition side. We bought 23 companies last year, and as Colleen mentioned in her statement, we bought four in the first quarter. But we have an incredibly disciplined process for acquisitions that go through a number of stages, and clearly they need to be ROI and economic value-positive. So, you are correct that we are seeing some price inflation in some of the acquisitions that we're talking about. For every one we do, we probably turn down one or two. So, we don't buy everything that we look at and we are selective on not only what we buy, but how much we pay for it. In terms of our attitude going forward on acquisitions, I think we've said a number of times at financial analyst meetings and outside of that, we do see acquisitions playing a role in our growth. So, I would certainly expect us to still buy companies. In the first quarter it tended to be more in the Server and Tools area. Going forward it could well be in the online services area, in particularly with the speed of how that market is developing and some of the opportunities we're being shown, obviously that's a possibility. But we are not going to buy anything that we don't think creates economic value. In terms of CapEx, it's very much in line with what we guided you to in July. So, we're looking at just over $2 billion for the year. I believe we spent $400 million in the first quarter. In terms of online spend on CapEx, which is one of the areas people are primarily interested in, we're looking at around $700 million for the full year, and we spent about $150 million in the first quarter.

Your next question comes from John McPeake - Prudential.

Back on the undelivered elements, you're now going to be recognizing that revenue versus deferring it. Could you talk a little bit about the give and takes there, with the fact that Vista Enterprise in particular is only available to customers with some sort of an SA or an EA that covers Client, and historically they've been able to buy that from the OEMs? I'm trying to get a sense as to how those two dynamics play out in the unearned over the course of the year.

Your question is about the undelivered elements and the enterprise agreements?

In terms of enterprise agreements, we'll still, obviously, ratably spread enterprise agreement income over the life of the contract. So, that won't change. It will only be for the undelivered elements of sales through, in particular, OEMs of the Vista software, where it's not delivered under a software assurance program; it's delivered under a sale of a PC. When we sell under the sale of a PC, those undelivered elements will not be deferred as they were in XP. So, it doesn't really influence the enterprise agreement recognition, if I'm understanding your question correctly.

That's correct. So, you've got about 15% that used to be deferred in the OEM agreements that's now being recognized. But you also have new SKUs that can only be purchased for the Client business. So, Vista Enterprise in particular, you need to have that covered by an SA. And that's a new thing for Microsoft, so I'm trying to get a sense as to whether that's going to have an incremental positive impact, potentially, over the course of the year to your unearned. So, you have a new SKU that is a Client SKU.

If more users find that particular SKU, which you can only get under an SA, very compelling, then yes, you would see more unearned. That's a big assumption to make. But certainly, the accounting there has not changed. To the extent that we see more business done through volume licensing, you would continue to expect to see that same impact on unearned and contracted not-billed.

Your next question comes from Peter Misek - Canaccord Adams.

Just one quick question on other product cycles. We haven't heard an update recently on how the Longhorn server cycle appears to be progressing. Clearly, we're coming to the end of the Vista launch cycle. Can you provide us any update on that product cycle, please?

That's still on track for the second half of next calendar year. So, no change for that.

Thanks so much. We probably have time for just one or two more questions.

Your next question comes from Kevin Buttigieg - A.G. Edwards.

On the forecast for the Server and Tools unit revenue growth of 10% to 12%, I was wondering if you could talk a little bit about how you see the impact of virtualization on that growth rate? Obviously, you have Microsoft Virtual Server, but perhaps offsetting that might be some lower unit sales of Windows Server. Could you just sort of help form the parameters around virtualization's impact on that business?

Our thinking around virtualization is that it's good for customers. We feel like our offerings address those well. The industry is going there, and that's reflected in the hardware server numbers that you see from the Company. We feel like our pricing is very competitive, especially to other pricing out there; pretty easy to understand, pretty competitive. We think that we're well positioned there, and we welcome ushering it in, and we've got good products there.

So, 10% to 12% seems like it sustainable, then, even in light of virtualization's adoption rate?

Today we're giving you second quarter fiscal year '07 guidance. But virtualization, we think, is a good thing for the industry. Just like with Moore's Law, getting more power out of your hardware is a good thing for the ecosystem. Great, thanks so much. Time for one last question, please.

Your next question comes from Laura Lederman - William Blair.

I have two quick questions. One is, can you give us an update on cash flow, what your expectations are for this year? And also, a phenomenal result for SQL Server. Can you talk about where you're particularly seeing strength in that product? Thank you.

On the cash flow side, it will follow traditional patterns. Clearly, cash flows for the quarter and the second quarter are impacted to some extent by inventory builds for Xbox, but that will wash itself out through the system. So, when you look at our cash flow for the year, the only real elements of significance are probably slightly higher CapEx. But in the overall scheme of Microsoft, that's not huge. But spending just over $2 billion of CapEx will clearly be an impact on cash flow. Our inventory and working capital should be broadly in line with historic patterns. And then the buyback is the last thing, which will depend to some extent on what we buy in the second half of the year. But other than that, cash flow trends will be typical from what you've seen in previous years.

SQL Server was a great result. Where are you particularly seeing strength? Vertical markets, company size, applications? Just give us some context on why that growth rate is still so strong.

I'll take out one, Lauren. So, SQL strong really across the board, as evidenced by 30% growth, really means you do need to have some nice broad strength. We've been particularly delighted in the larger enterprises really looking to SQL for their critical applications. We continue to do well in the mid-size space as well. So, really it's been nice, broad strength there.

What about U.S. versus international?

Again, with nice 30% growth, you're going to see really good adoption, really, across the board. Thanks, Laura. And thank you, everyone, for your participation in today's call. If you have any further questions, please feel free to call me or my team directly. As I mentioned at the beginning of this call, this conference call will be available on replay at our investor relations website through close of business October 26, 2007. In addition, you can hear the replay by dialing 866-505-6378, or for international calls, dial 203-369-1866. The dial-in replay will be available through the close of business November 2, 2006. Thanks again for joining us today.

Thank you. This does conclude today's conference call. We thank you for your participation.