Who: Peter Klein, Chief Financial Officer
When: Wednesday, March 2, 2011
Where: Morgan Stanley Technology, Media and Telecom Conference - San Francisco, CA
ADAM HOLT: My name is Adam Holt. I run software research at Morgan Stanley. We're
basically at the halfway point of the conference this year. And as I think about some of the
messages, and some of the things that we've learned over the last few days, you can argue
that we're at an incredibly exciting point in not just technology, but also software. The
applications market is accelerating after years of under-spending. We're seeing a major
trend towards business intelligence resurging with analytics being on the forefront. Cloud
computing has clearly been a trend that's been important for the last few years, but it's
really inflecting, as is virtualization on both the server and the desktop side. Additionally,
the proliferation of new devices is creating a lot of opportunity.
And as I think about the company that has as many different plays on these markets, and
these opportunities as any we'll see at the conference, Microsoft is that company. We have
today the chief financial officer Peter Klein. We're going to have a discussion. We'll open it
up for Q&A that you all may have, and as always the disclosures for Morgan Stanley are at
MorganStanley.com/researchdisclosures.
So, with that, Peter, thanks so much for joining.
Why don't I start with a pretty broad-brush question. As I said, you know, you participate
currently in a number of what I think are accelerating trends. You've got a variety of very
strong product cycles right now. How are you viewing the confluence of secular demand
and product cycles heading into Calendar '11?
PETER KLEIN: Yes. It's been great. Obviously, at a high level, our objective has been to
deliver great products that customers love across the spectrum of our product cycle, and to
deliver financial results as a result of that. And one of the things we talked about, you
know, a year-and-a-half ago, probably at this conference last year when we were here, is
that confluence, our strongest product cycle ever, and some rebound in business spend, and
just generally in the sort of the tech macro sector.
And over the course of the last year, probably since we were here, I think we feel very
encouraged, and very good about our progress against our objectives. It really has been
our strongest product cycle ever. I'll highlight a few things that I think we've seen most
recently, and I think we've delivered against the financial results as a result.
If I look back to our most recently concluded fiscal quarter, I'll highlight a couple of things.
I'm sure I'll have a chance to talk about a bunch of different things. Clearly, Office 2010
was a very strong product for us. The launch has done very well. It's probably fair to say,
it's exceeded most people's expectations, and the growth has been phenomenal and really
drove a lot of top line growth, both for the Microsoft Business Division, and for the company
all up in our Fiscal Q2. So, that was really exciting.
More on the consumer side, we launched the Kinect for Xbox 360, and that was obviously a
very hot, a phenomenal product this holiday season. More broadly over the course of the
last several quarters in Xbox, and Xbox 360 have sort of established the leadership position
in gaming. And it's really interesting looking forward to think about what that can do for TV
more broadly, and sort of our position in the family room or the living room as well as what
motion detection does for computing user interface going forward.
So, there have been a lot of exciting things over the course of the last year, a lot of exciting
things in the course of the last quarter. And the last thing I'll add that is just encouraging
to me, and that we're particularly proud of is our ability to manage our cloud structure, and
grow our operating margins, and our operating margin percentage every quarter for the last
year. So, that confluence has really delivered the kind of financial results that I think we
want. And I think going forward there's still a lot of opportunity in those businesses that we
talked about, Office 2010, Xbox 360, and of course the cloud remains the largest trend
opportunity going forward.
ADAM HOLT: I want to build on in each one of those businesses, but why don't we start
with Windows, because that's obviously one of your cornerstone franchises. A tremendous
release in Windows 7. The corporate upgrade cycle in our view, is really just the beginning.
But what is your sense for where we are in the corporate upgrade cycle, and where we are
in the Windows 7 product cycle?
PETER KLEIN: I think it has been great. And we've noted in the last couple of earnings
and calls that the business upgrade cycle is happening, and we expect it to continue to
happen. So, I would say we're in the middle of it, and it remains a great growth engine for
us, and really a strength for the Windows 7 release.
ADAM HOLT: And how are corporates adapting? Are you seeing any change in terms of
software assurance? Are you seeing a migration towards the higher end products? What
are the characteristics of the upgrades?
PETER KLEIN: Yes. We're seeing encouraging trends across all those dimensions. We're
seeing an increased intent to deploy Windows 7 in businesses, so it's going faster than in
previous releases. As a result, we are seeing stronger growth in our software assurance,
and that commercial side of the business. It's small relative to the OEM piece of the
business, but we are seeing upside in that. And, as a result, when the business mix is high,
when people are deploying the product, that does have positive impacts on the premium
mix, and what that does for our overall ASP.
ADAM HOLT: If you look around a room like this, you see a lot of tablets, and you see a
lot of devices that I think people probably bought themselves.
PETER KLEIN: I see a lot of laptops, too.
ADAM HOLT: We see a lot of laptops as well. The question is, do you think there's any
impact from either the bring-from-home device in the corporate landscape, or the tablet in
the corporate landscape in terms of impacting the trajectory of the upgrade?
PETER KLEIN: Yes. There's no question that tablets provide a really exciting opportunity
for the market all up. I think we've seen more of that in the sort of consumer secondary
device than we've seen in businesses, although you are starting to see it come into
business. And I think going forward, that's really an opportunity for us.
When I think about the strength of Windows, and what Windows can bring to the tablet
form factor, particularly in businesses, whether that's access to mission critical applications,
whether that's different UIs like a pen, and the ability to write and draw on the tablet, I
think that's a really interesting opportunity. So, I think it's nascent, but incredibly
interesting going forward how tablets are used within businesses.
ADAM HOLT: And let's talk about that a little bit. As you think about your evolving tablet
strategy, what do you see as bring the key areas where you hope to differentiate over time?
PETER KLEIN: Well, there are a couple of things. I just talked about some of the user
interface things that we can bring, some of the applications that you can use, and really our
experience as an enterprise vendor to really understand what business users want. So, I
think that's a great thing.
And so, at CES this year, we obviously talked about a couple of things. We showed some
Windows 7 tablet devices that are coming to market that I think are really exciting with
differentiated user interface experiences, and we also talked about the opportunity to build
on system-on-a-chip architecture for the next version of Windows, and I think that will be a
really exciting development for us, and allow us to get some of the advantage you get from
that architecture in power management, as well as delivering on some of our traditionally
differentiating characteristics within businesses.
So, I think those things taken together are pretty exciting for us for Windows tablets, both
now and in the future.
ADAM HOLT: Let's talk a little bit about Windows 8. I know you're not going to give
release details, and a whole lot of detail about what the product is going to look like, but at
a very high level, in the conversations that I have there's a view, at least my perception of a
view, that Windows 8 is way off in the future, and the ARM version may be even further off
in the future.
Can you talk a little bit about how should we be thinking about the cadence of the release,
and how much progress you've made to date already on the ARM environment?
PETER KLEIN: Well, what I'll say on timing is exactly what we said, which is 24 to 36
months from the previous release of Windows. So, we have nothing more to announce, or
add to that.
And I think if you look at some of the things that we showed at CES, you can probably
imagine that there's been already some great progress on what we've done on some of the
new architectures if you look at what we've demonstrated, so I think people should take
from that that there's been some good work done to date, and as we have more to
announce, we'll certainly announce it.
ADAM HOLT: How should we, again, at a high level think about application compatibility
on Windows 8, and in particular Windows 8 in an ARM environment? Should we assume
that Office works well on 8 and on ARM?
PETER KLEIN: It's a complicated topic. It's probably best not to sort of go into that detail,
obviously it's something we're focused a lot on, and I think as we have more details to
share on that, we'll be able to do that for people. But, that's obviously a key part of the
work that we're doing in preparation for the next version of Windows.
ADAM HOLT: If you look at the PC market, a lot of the growth is coming in markets that
historically your attach and opportunity to drive monetization hasn't been that high, China
for one. You talk about some of the things that you're doing to drive attach up and what
you envision seeing piracy do, say, over a multi-year period?
PETER KLEIN: It's always hard to predict. In general, historically, we've made sort of
gradual progress against piracy, not sort of uniformly. It tends to go up and down quarter
by quarter, but the general trajectory has been up, although probably more limited in places
like China. And the approach is multi-faceted.
As you know it's a very complicated problem and we try and approach it against multiple
dimensions. There's a lot we're trying to do with just the value proposition of the product.
There's a lot we do on distribution, whether that's with OEMs or retail. And, of course,
we're always working on policy issues, and government issues related to the protection of
intellectual property, and there seems to be some positive momentum there, but it's a very
complicated thing. So, it's one of those things that is a tremendous opportunity. It's
incredibly challenging. It always has been, but we continue to address it against every
dimension that we think we can.
ADAM HOLT: Last question for me on Windows. I happen to think, and said earlier, that
your cloud story is very interesting, it's very differentiated, and obviously we'll get into that
further detail. But, the question I get a lot is, as applications move into the cloud does that
ultimately change the role of the operating system on the device? And I'd love to get your
perspective on how you think about that balance, say, over a three-to-five-year period.
PETER KLEIN: Yes, I think there's a couple of things. Obviously, and we'll talk more
about the cloud generally, we embrace that and think that's a huge opportunity for us sort
of all up. And we think sort of end to end from the data center, to the data, to the
application is what that means. But, I also think there's always going to be a need for
smart devices interacting with the cloud. And we think that is a great opportunity.
So, we take a very holistic -- we think one of our differentiations is to take a very holistic
view from the data center, whether that's a public cloud all the way to sort of behind the
firewall, and from the sort of server to the desktop. And I think holistically it's a great
opportunity. And I think there's always going to be an opportunity for some intelligence on
the devices that informs the cloud. I think the cloud's full potential is realized as it gets
smarter, and as devices sort of feed into that intelligence.
ADAM HOLT: Let's shift to MBD, and talk a little bit about Office and the related
businesses. As you know, Office is an area that we spend a lot of time looking at, and think
people probably don't focus on enough. It's been an area of strength the last couple of
quarters. Maybe talk about what you think is really driving the performance in Office.
PETER KLEIN: I think it's in the related businesses, and I'll get into that. Coming into the
release we had sort of a pretty straightforward goal, and strategy, with the next version of
Office. We wanted to continue to innovate and create a great customer experience on the
Office Suite of applications themselves, Word, Excel, PowerPoint, et cetera. And we also
wanted to improve the integration that you got with the infrastructure that supports Office,
think of the communications and collaboration technologies, which is products like Exchange
and SharePoint, and Lync, which is our unified communications capability that we've been
investing in and building over the last several years.
I think across both of those dimensions we've really realized what we've set out to do. I
think if you look at the strength of the Office applications themselves, broadly, from
consumers all the way up through large enterprises, we've seen strength across all
customer segments, which I think speaks to the customer experience that people are
having with Office 2010.
At the same time, we're also seeing strength in our overall enterprise business for all the
related products, related to Office, including Exchange, SharePoint, and Lync, and especially
Lync, which really had some of the biggest increase and capabilities that I think you see in
the 2010 release, and that is a very compelling value proposition. When we talk to
customers, that's a great conversation to have. I know personally our usage of Lync within
Microsoft has really saved us a lot of money. So, the total cost of ownership story and the
ROI is very strong, in addition to all the productivity you gain from it.
So, across both of those objectives, in the enterprise, with communications and
collaboration tightly integrated with Office, as well as just a consumer experience with the
Office applications, we sort of achieved their objective.
ADAM HOLT: So, as you're able to bundle more effectively, and some of the opportunities
that you described around SharePoint, Lync, for example, those are much, much less
penetrated. So, you're actually seeing a larger customers renew, and renew at higher
levels. So, the footprint, and the average selling price, and deal size are increasing?
PETER KLEIN: Exactly right. You've seen that over the last several years with SharePoint.
We talked a lot about that over the last several years. Now you're sort of starting, you're
sort of at the beginning stages of seeing the same thing with Lync, which continues to sort
of accelerate those businesses, which are sort of at scale. They're at the sweet spot I like
to think of it. They're sort of at scale, but still accelerating, which is really exciting for the
Office Business all up.
ADAM HOLT: There's a view on the Windows side that one of the reasons Windows 7 is
going to be so successful is the uptake on the enterprise front for Vista was lower. As you
think about the comparison between Office 2010 and Office 2007, is there a similar dynamic
there?
PETER KLEIN: We'll have to see. It's a little earlier with Office than it is with Windows 7.
I think that opportunity exists, for sure. I think the data to date is encouraging. We've had
a great couple of quarters with Office, across all customer segments. So, I think there is a
renewed opportunity for people to accelerate their adoption of Office 2010, and in
enterprises is really what you're talking about. That's where you see the value of those
related technologies.
ADAM HOLT: Office is an area that's quickly moving into the cloud. You've just announced
Office 365. Can you talk a little bit about what moving Office into a software-as-a-service
environment means, from a business model perspective and from an opportunity
perspective?
PETER KLEIN: No, it's really exciting. And that's the place we're really starting to see a
lot of momentum. I think the opportunity for taking Office and Exchange, and SharePoint,
and Lync into the cloud, really opens us up to new revenue streams that we haven't had
access to before, and not simply just the revenue we get from delivering the service, right.
Since we deliver the service at scale we can replace money that companies are spending
today on people and hardware and other infrastructure. And that's a good cost savings for
them, and a good revenue stream for us.
But, it really gives us access to new scenarios, new customers segments, where we really
don't have much penetration today. One of which is the mid-market, not too much for
Office, although that's an opportunity, but for things like Exchange and SharePoint, where
today we don't have much penetration. It's a very challenging market. Mid-market
companies have the needs of a large enterprise, but not the resources or the capabilities.
And the cloud is perfectly suited to deliver that in a really cost-effective way, so that mid-
market companies can get the value of those capabilities. And Office 365 is the perfect
vehicle for doing that.
So, that's one example. But, there are multiple examples, whether it's kiosk for desk-less
workers in large enterprises, or whether it's entirely new scenarios and experiences that will
be developed natively and uniquely for the cloud. I think it's an incredible growth
opportunity for us.
ADAM HOLT: I asked about piracy on Windows, but presumably as you move to more of a
service delivery with Office, there's the potential to produce piracy, as well. And piracy is
actually higher with Office than it is for Windows. What do you think happens there?
PETER KLEIN: I think broadly speaking delivering a service, where you're delivering that
value every month, I think, has a great opportunity to reduce churn, which is sort of
another way of saying sort of, decrease piracy, I think. I think services, absolutely, have
the opportunity to do that, but we'll have to see how that plays out.
ADAM HOLT: When we think, we sort of the investment community, think about moving to
a service model, moving to a subscription model, that sort of delivery, think about more
ratable revenue, but revenue that maybe goes down and is spread out over a longer period
of time, and potentially a lower margin structure. Is that the case? Do you see a business
model transition here, or how do you think about the model evolving as you move to more
cloud-based services?
PETER KLEIN: On the revenue side in businesses it's actually not very different from the
annuity business that we have today. So, the annuity business is recognized ratably and so
as that moves to more of a subscription service that actually has very little impact on the
revenue. In fact, the revenue will go up, because the revenue is higher in a service model
than it is in just a software license model.
From a margin perspective, it definitely has a different margin characteristic, in terms of the
percent of gross margins, although it's positive from a "total-absolute-dollars" of gross
margin. So, there is a sort of shift in the dynamics, but it's positive from the total gross
margin dollars. But, to your first question, from a revenue recognition perspective, that
transition should be relatively muted, because our annuity business today. If you look at,
say, MBD for example, 60 percent of our revenue today is annuity, which has the same sort
of revenue recognition characteristics as the subscription would.
ADAM HOLT: Let's shift to the server business, and I'll also use this as a touch point to get
into your cloud strategy. But, I'll just ask a baseline question that I've already been asked
twice this morning, and so I'll ask you and get your response. But, how dependent is
Microsoft on the server market directly? I mean, you've obviously got 70 percent share on
the OS front. If servers decelerate, what's the correlation between your business?
PETER KLEIN: I would say somewhat. I mean, there's definitely some correlation to how
businesses are investing in server hardware, and related sort of server software that's
directly related to that new hardware. So, that's a piece of it. But I think one of the
strengths of our server, and server and tools business is we have been gaining share in sort
of places outside of just sort of hardware shipments, things like database, things like
systems management, and so I think we have an opportunity to continue to grow our share,
and continue to grow revenue at a pretty good rate. But, there is some correlation between
the hardware market, and if you look at sort of how we give our outlook and our guidance,
we talk about sort of the transactional piece of the business, and how that relates to the
server hardware market, and that's generally in line with that.
ADAM HOLT: And one of the other pieces that's an influence here is your ability to drive
average selling prices higher by either more bundling, or seeing a mix shift towards your
premium suites. Where are you in that migration now, and where do you think you can go
ultimately in terms of driving --
PETER KLEIN: It's been a big growth driver for us, as you know. We've had sort of
double-digit growth in our premium version of both Windows and System Center. And I
think that remains a big opportunity. That was kind of early on in that, and I think that is
definitely a growth driver for the Server and Tools Business.
ADAM HOLT: We've had a number of companies here talk about virtualization, server
virtualization, desktop virtualization. We have the view in my group that core server
virtualization may actually accelerate the penetration as Tier 1 and Tier 2 workloads actually
move into virtual environments. You all have been a net share gainer in the virtualization
market, but at very low price points. Do you feel like you're effectively monetizing your
virtualization story?
PETER KLEIN: I do. I think we've got a good balance between gaining share and having
good revenue growth in the Server and Tools Business. So, we feel great about the
capabilities, we feel great about our sort of market position, and our ability to continue to
grow that market position. And we also feel great about, if you take sort of a longer-term
big picture view, sort of what that means all up. We had a holistic view of not only
virtualization, but ultimately that's really the cloud conversation, right, because it's how do
these capabilities ultimately get instantiated and delivered.
So, we feel great about our products, we feel great about our market position. We feel
great about our revenue growth. And then we feel very good about the long-term strategy
sort of across anything from public cloud to private cloud, to whatever goes more slowly
and stays on premise in the data center.
ADAM HOLT: So, let's talk about that a little bit. I've heard you say that cloud, and your
platform business, and your Azure business, could be the biggest incremental new
opportunity for you over the next call it three to five years. Explain your thinking around
that, what sort of parameters you put around sizing that opportunity, and why you believe
that?
PETER KLEIN: I mean, at the highest level, think about the size of the market for how IT
invests in infrastructure. It's probably the single biggest piece of the enterprise IT market.
And so, if you think about the opportunity to be a leader in the transformation of how
infrastructure and platform gets built by enterprises, that's life itself. That's all goodness.
It's sort of what we've always been focused on, and that's what Windows Azure is all about.
ADAM HOLT: And as you think about your story in this market, what do you see as your
real area of differentiation, or your areas of differentiation?
PETER KLEIN: We feel like we're relatively -- not relatively, we are unique in the range of
capabilities that we can provide. Certainly at the infrastructure level, we're one of very few
companies that have the kind of scale data center infrastructure that we've been delivering
at scale to really be able to have a good value proposition for customers. At the same time,
we feel we're unique at the platform layer in terms of systems management, in terms of a
set of tools that developers are used to working on. And we can go all the way up, not only
from infrastructure, to platform, but to software applications.
And so if you think about sort of a matrix of infrastructure, and platform as a service, and
software as a service across the dimension of a seamless and ongoing transition from
today's on premise world to whether it's a private cloud or appliance all the way to a public
cloud infrastructure, we can offer all of that, and I don't think anybody sort of has that
range of capabilities, and can manage the migration of the customer from a set of
applications all the way from on premise to the public cloud.
ADAM HOLT: I think most people understand the value proposition of moving workloads to
the cloud. And we've seen a lot of finished application providers, software as a service
providers, like Salesforce, and SuccessFactors be very successful from a growth trajectory,
but I think that there's a bridge we have to cross in terms of getting proprietary workloads,
and new kinds of workloads into the cloud. How do you get folks comfortable with crossing
that bridge and getting from finished applications today to building applications in the cloud,
and moving a broader set of workloads?
PETER KLEIN: That's a great question, and that's really the bulk of the work that we're
doing today. We're spending a ton of time with the ecosystem, with developers and ISVs,
and corporate IT developers to really understand the range of applications and how they
move to the cloud. And I think you're going to see stages of how things move to the cloud.
But, the most important thing now is really getting the ecosystem to understand the value
of that, and to get comfortable with that, and understand what applications, whether it's
existing legacy applications, Tier 1, Tier 2, or other workloads migrate to the cloud, and
whether it's building a whole new sort of generation of applications that are uniquely suited
and built from the ground up for the cloud. And so we're doing both of those things. I think
that's critically important to establish our position in the marketplace.
ADAM HOLT: And how material do you think this business is for you over the next few
years? I think Bob Muglia, at one point, maybe at the Analyst Day last year, said it could be
a $1 to $2 billion business within three years. Is that how you're thinking about it, or could
it grow even faster than that?
PETER KLEIN: So, rather than make a sort of specific projection, I would say over time, it
is a huge opportunity for us, and it is incredibly important. And I think what we'll just have
to do is watch the pace at which it goes. My general feeling about these things is, they
start off a little bit more slowly, and then hit an inflection point and pick up. And we'll make
sure and let everybody know when we hit that inflection point.
ADAM HOLT: Just on the topic of Bob, there's been a management change in the Server
and Tools Business. Can you talk a little bit about that transition, and the drivers there?
PETER KLEIN: Yes, absolutely. Certainly, at the macro level, the most important thing we
need to do is make sure we have the right leaders running all of our businesses. I think
we've done a great job in setting up all of our businesses with the right leadership. I think
that's been manifested in the performance that we've had both from a product delivery
perspective and a financial perspective. Bob did a wonderful job with the Server and Tools
Business, and I think we thought that going forward into the future, you know, bringing
somebody in that had deep expertise in the cloud, and who just built sort of one of the
biggest cloud infrastructures in the world was a really important thing to take the Server
and Tools Business to the next level, and really accelerate that growth over the next three
to five years. And Satya is a wonderful leader. He's a wonderful technology leader. He's a
wonderful business leader.
ADAM HOLT: It may be actually worth spending, in some of the conversations I've had,
not everyone is fully up to speed on his resume. It might be worth spending a minute just
saying what he has done, and how that translates.
PETER KLEIN: Yes. He's done a couple of amazing things. And I've had the opportunity
to work closely with him, and I'm really thrilled for him. He's a long-time Microsoft
employee, about 20 years. He ran our Microsoft Business Solutions, so our business
applications business, before going over to run the Online Services Business, and building
out the infrastructure for Bing. Basically, over the last ten years, he's led and built the
Dynamics Business, and the Online Services Business. So, he has a great understanding of
business applications, great understanding of cloud infrastructure, and a great
understanding of our company and our customers. So, I think he's an ideal fit for that job.
ADAM HOLT: I'm going to hit -- we've got about six minutes to hit search, mobile, Kinect,
and margin.
PETER KLEIN: I'll try and talk fast.
ADAM HOLT: Let's do search next. So, you've shown steady share gains with Bing. The
Yahoo! deal is now online. Do you think that you have an opportunity to accelerate share
gains in the top line trajectory of the search business?
PETER KLEIN: It's certainly an opportunity. I think we're focused on making sure we're
building the best product, getting the customer engagement that we need, and we'll
continue to do that. I think there is an opportunity, if you build awareness and build
consumer engagement, that that can accelerate. But, you know, having said that, that's
something we can track every month. You can follow along with us. We're certainly
pleased with the trajectory. We're certainly pleased with the product. And hopefully that
will continue.
ADAM HOLT: And how are you thinking about costs in that business? Obviously, you're
still spending a lot of money there. It's a net diluted to the margins. How should we be
thinking about the cost story there going forward?
PETER KLEIN: Yes, we've talked a little bit about it before. Obviously, the dynamics of
that business, the high entry fixed costs, which makes obviously barriers to entry. So, we
feel like there's limited people that can do that. But, really it's a scale business and so once
you invest the capital up front to get in, most of the incremental margin flows to the bottom
line. And that's sort of where we are now. There's a little bit of incremental investment,
getting the Yahoo! integration up and running, but beyond that, you see that as we grow
share and as we grow our revenue per search, that will be very positive to the margins of
that business, over the next year or two.
ADAM HOLT: Let's shift to mobile, and I'll go straight to Nokia. Actually, I'm going to go
straight to Windows Phone 7, before we touch on Nokia. How is the release tracking,
relative to your expectations, ex-Nokia?
PETER KLEIN: Yes, we're very pleased with the product. As we headed into it we said,
look, the most important thing is we have to build a product that customers really like, and
we have to get developers building applications and getting excited about the platform.
Those are the most important things out of the gate. And we really feel good about what
was accomplished there. It's a really good product. Customer satisfaction is very high.
Reviews are very good. And just to sort of segue into the Nokia conversation.
I think that's a big part of our ability to get such a strong partnership with Nokia. And the
reason that's so exciting is it really brings together a set of complimentary assets to build a
unique, and strong, third ecosystem in the marketplace. The thing that we need, now that
we've got the product that we want, to get the kind of distribution, get scale geographically,
get diversity of price points, relationships with the operators on a global scale, as well as
some other great assets like local is really exciting. So, we think we've got great
momentum with the product. Now, we've got the partnership that really accelerates the
market position of the product.
ADAM HOLT: I know you haven't given a lot of financial details on the deal, but there's
been an awful lot of back and forth in the press about what you all might have had to give
up for this deal, there's been speculation that you had to pay a ton of money up front, that
you have to give an enormous commitment over time, you had to give the keys to your
house. And I guess the question is, at a very high level, to us it looks like a deal where
there's a lot of financial upside. Walk us through how you're thinking about the economics
of the transaction over, say, a multi-year period, to the extent that you can.
PETER KLEIN: Yes, obviously we haven't talked about the economics of the transaction.
What I would say is, it is a long-term multi-faceted deal, and in success it is a very mutually
beneficial deal, economically for both companies.
ADAM HOLT: It's hard to think about your mobile business model over the net two to
three years. Do you think that the licensing piece is going to be the most significant piece
of the pie? Do you think it will be search? Do you think it's other in areas like games? How
do you see the business model in mobile evolving?
PETER KLEIN: It's everything. It's everything. It's the license royalty. It's the services,
whether that's search or other services. And that's the thing we've been talking about. We
love that business model, and I think it's both or all of them.
ADAM HOLT: Switch to Kinect, and then I'll touch on the model, and then we've got a
couple of minutes for some questions in the audience. So, 8 million units right out of the
gate, Kinect could be your next multi-billion business. How big do you think Kinect can be,
and what should we look to as a set of, say, instructions, or a roadmap as to how to think
about things like game attach, and penetration, and Xbox Live around Kinect?
PETER KLEIN: I'll sort of extend the question and the answer to the Xbox 360 business all
up. In the course of the last year we've really expanded that business. We shipped a new
console last summer, which really started our momentum in the business, and it really,
really accelerated with Kinect, which was just a great, and interesting innovation. The way
to think about it, and this is part of the intent of the Kinect technology, was to really
broaden our user base to more than just hardcore gamers. I think we're seeing early signs
of that. How big that can be is anybody's guess. Then we've given some indication of what
we think the growth in the E&D business will be, sort of after this year.
So, obviously that was a pretty bullish sign, and we think it remains incredibly exciting, but
certainly the intent was to grow our addressable market, which seems to be working so far.
We'll just have to see how it goes over time.
ADAM HOLT: Okay. You've done, I think, a terrific job on the OPEX side over the last few
years. It's clearly an area of focus that's had continuity. It's not just a passing fad. As we
look forward, why shouldn't we think that there's an opportunity for you all to expand
margins over a multi-year period of time?
PETER KLEIN: Well, I'll let you sort of do the model and figure that out. The one thing I
will say, and I agree with you, it remains a focus area for us, and our approach to that, and
our philosophy on that hasn't changed, and what that means to margins. You can figure out
when we have more to say going forward about what to expect on the cost side, we'll let
you know. But, I would say you're absolutely right, it's a continuing focus area for us.
ADAM HOLT: So, companies your scale, I mean, what are the right guideposts for what
operating expenses should grow over, say, a multi-year period? Is there any reason that
your OPEX should grow faster than GDP?
PETER KLEIN: I'm not going to make comments guiding on operating expenses until later
when I do.
ADAM HOLT: I always try.
PETER KLEIN: Good effort.
ADAM HOLT: My last question, and then we'll get the microphones ready, over the last
three quarters you bought back $13-14 billion worth of stock. At current levels buy-backs
obviously accrete to stocks center values. Is that the direction that you're going to continue
to move, in terms of your capital return strategy, or do you think you'll do something more
aggressive with the dividend, or will it be a balance of both?
PETER KLEIN: I think we'll be consistent. We've had a pretty consistent philosophy over
time, maybe not quarter by quarter, but certainly over the long-term of delivering cash back
in the form of buy-backs and dividends. We did increase our dividend 23 percent last year.
So, I think we've had a pretty aggressive strategy over the last several years, and our
philosophy and approach to returning cash to shareholders aggressively remains the same.
ADAM HOLT: All right, time for a couple of questions. We've got one in the back right.
QUESTION: Thanks, Peter, a couple of quick questions for you. First, on the tablet side, I
wonder if you could maybe give us a view on how you might differentiate in the tablet
market, if you have to wait for Windows 8 that's an awfully long time, and we'll probably
see iPad 3 by then. But, because of your presence in the enterprise market, is there
something unique you think you can leverage off of to create some differentiation for
yourself in the tablet market? And separately, we saw Salesforce's Chatter the other day,
which is kind of like Facebook for collaboration within an enterprise. As you move to the
cloud, might we see things other than what we've seen on the desktop ported to the cloud,
but some new things that might expand your market.
PETER KLEIN: Yes, on the first question, we have Windows 7 tablets out now, we continue
to work with our OEMs and see more products come to market. And I think you are starting
to see some differentiation, particularly on the user interface side, in terms of the ability to
write with a pen, and take notes, and do other things that I think can be very compelling,
particularly for businesses, and so I think you should expect that we'll continue to innovate
and work on the Windows 7 side, while at the same time we're starting to talk about what
you might expect to see with the next version of Windows. I think that's going to be very
exciting going forward.
In terms of your second question on the cloud, I think sort of broadly speaking, yes, I think
there's a lot of interesting opportunities that syncs into the cloud, and understanding the
dynamics there for building whole new classes of experiences in applications, and what that
means for us, we'll have to work through from a partnership and other perspective.
ADAM HOLT: Question here on the left?
QUESTION: I just wanted to follow up on the last question that Adam asked, regarding
cash. Have you ever disclosed how much is offshore and kind of interesting, in comparing
that with your strategy on taking debt and leveraging the company?
PETER KLEIN: What we've said is most of our cash is offshore.
ADAM HOLT: And I think the second part was, what's the philosophy around potentially
getting more leverage.
PETER KLEIN: It's always part of the thinking. Obviously, we have leverage today, and
we're always thinking holistically about what's our right strategy for delivering cash back to
shareholders, and what the best capital structure is. So, it's always part of our thinking.
We've seen willingness, obviously in the past, to take some leverage to do that.
ADAM HOLT: We've got time for one more question. It's going to be mine, then. I get
asked all the time, again, this goes back to the cash, does it make sense for Microsoft to be
more aggressive on the M&A side? Does it make sense for Microsoft to buy Nokia? Does it
make sense for Microsoft to buy RIM? Does it make sense for Microsoft to buy Adobe?
Does it make sense for Microsoft to buy my entire coverage universe? And so I guess the
question is, in all seriousness, historically there have been a few big deal salvos around SAP
and Yahoo!, but you've been more tactical, and sort of smaller strategic, I'll call it, with the
M&A strategy. Has the philosophy changed?
PETER KLEIN: No, I think our philosophy is consistent. We want to make sure we are
very clear about the businesses that we're in and the strategies that we have, and then
within those strategies we always want to look at what's the best way to execute against
those. Sometimes it's organic. Sometimes it's inorganic. The one thing I would say, and
sometimes we look at sort of big things, but those are sort of few and far between, and
complicated, and large. We do smaller things that I think have impact on our bottom line.
Maybe it's not as visible as some.
If you think about what we've done just in the last couple of years, while they may not be
acquisitions, both the Yahoo! partnership and the Nokia partnership are very significant
transactions, and to some degree have a lot of the same characteristics, maybe not
economically, but certainly operationally, as large acquisition. If you look at the work we're
doing with Yahoo!, that's incredibly important. We love the structure of the deal, and we
love what we're doing. I think Nokia is sort of the same thing.
So, I think you don't have to do a big acquisition to accomplish some of the things we want
to accomplish from a strategic perspective.
ADAM HOLT: All right. Well, with that we're out of time. Thank you all. Thanks for
joining us this morning, and thanks, Peter.
END