Steve Ballmer, Chief Executive Officer

Bill Gates, Chairman and Chief Software Architect

John Connors, Senior Vice President and Chief Financial Officer

Brad Smith, Senior Vice President and General Counsel

MARK MURRAY: Great. Thanks, everyone, for joining. We realize that this is a late afternoon announcement, particularly for those of you who are on the East Coast, so we’re going to try to be very crisp and move through it very quickly. We did have to wait for a few minutes because there was a large volume of people calling into the call that were not able to get in, so we’ve resolved that.

I’m joined here by Bill Gates, our chairman and chief software architect; Steve Ballmer, our chief executive officer; John Connors, our chief financial officer, and Brad Smith, our general counsel.

We’re going to have some opening remarks led off by Steve Ballmer and then we’re going to try to leave as much time as possible for questions.

So, Steve, hold on for just a moment. Before we get started, I do want to remind everyone that this call deals only with the dividend and buyback plans that were announced by the board earlier today. We will not be providing any information or addressing any questions related to our financial results for fourth quarter of fiscal year ’04 or guidance for fiscal year ’05. Those issues will be discussed at our regularly scheduled earnings call on Thursday afternoon of this week.

Today’s announcement is the result of a lot of hard work, a lot of extensive analysis and careful deliberation by management and the board itself. The timing of this announcement was a result of board scheduling issues. We recognize that many of you are eager to hear the earnings and FY ’05 guidance, but we ask you to hold off on those issues until our call on Thursday.

And with that, I’ll turn it over to Steve Ballmer for some introductory remarks.

STEVE BALLMER: Thanks. Thanks all of you for your time. We’re delighted to have this opportunity today to announce the plan to return capital to our shareholders. We’re very happy to be in this position to return almost $75 billion of capital to our shareholders over the next four years, and particularly as that comes after the last five-year period in which we almost doubled or over doubled our operating profit and returned over $30 billion to our shareholders through a combination of dividends and buybacks.

We’re also pleased to be able to say we think that we have put many of our legal issues in the rear-view mirror, so to speak, which affords us this opportunity to move forward with the cash management plan that we announced today.

There is a very important point I want to make. Today’s action is the direct result of the innovation and hard work and passion of Microsoft employees, and we wanted to ensure that we take their interest into account as part of this capital management plan. Our employee stock options did not envision a large, one-time special dividend, so we are proposing some adjustments to our stock plans to ensure that our employees will not be unfairly disadvantaged by the payment of the one-time special dividend.

Based on simple mathematics, the payment of a large, special, one-time dividend causes a company’s stock price to fall by a similar amount once the X dividend date has passed. As part of today’s action, the board has approved adjustments, subject to shareholder approval, to address the situation. We think the adjustments are a fair and logical way to ensure that our employees, who are so critical to the current and future success of Microsoft, are not inadvertently disadvantaged in this process.

As we look forward, I think we’re very excited about the opportunities to continue to really make a difference through software that enables people and businesses around the world to realize their full potential. Bill Gates is going to talk about the excitement we have over the innovation that’s going on here at Microsoft. And while we’re certainly realistic about the fact that there is great competition for us in the market, we’re confident that we have in front of us great prospects to grow, to succeed as a company, and that this plan for cash management is consistent with our thinking about how to continue to grow our business as we move forward.

And with that, I want to turn things over to Brad Smith, our general counsel, to make a few remarks on the legal front.

BRAD SMITH: Thanks, Steve.

As Steve indicated, over the past two years or so, we’ve been focused on resolving our legal issues from the past, on developing stronger relationships with the industry and with government, and focusing on the future. For example, we resolved the major antitrust case here in the United States, and the recent Court of Appeals ruling sent a clear and emphatic message that our settlement is a fair and appropriate resolution of those issues.

We’ve resolved three-quarters of the state class action cases in the United States, either through settlement or by winning in the courts.

We’ve resolved the largest private lawsuits pending against the company, such as AOL-Time Warner, Sun Microsystems and Intertrust.

While we still face several legal issues and we take them seriously, we have significantly reduced the legal risks facing the company. We also have a much clearer understanding of the potential risks involved in the cases that remain, such as the European Commission case, which has moved into the appeals process.

The company has always said that reducing our legal and associated business risks was a prerequisite to addressing our cash management plans. With so many of our cases resolved and the legal uncertainties so much better defined and narrowed, we are now in a position where we can return significant resources to our shareholders.

Let me turn it over to John Connors, who will talk a little bit more about our announcement today.

JOHN CONNORS: Thanks, Brad.

What I thought I’d do is just share the philosophies and the priorities that were the foundation for our action today. As Steve has mentioned and Bill will talk about in a moment, we will continue to invest very heavily in driving innovation, improving customer satisfaction and working to provide great returns for shareholders. We are going to continue to aggressively fund R & D and all the breakthroughs across all of our businesses. We will look for strategic investments and acquisitions to complement our own innovation and to provide new growth opportunities.

So starting from that point, our first priority for our cash management plan is to continue to grow our regular dividend. This is another example of the confidence we see for our business on a go-forward basis.

As you know, we only started a dividend program 15 months ago. Today’s announcement puts us on a course to be one of the largest dividend payers in any industry, amounting to about $3.5 billion a year at the current quarterly dividend rate we announced.

Our second priority is to increase our plans to repurchase our stock. Under the action approved by the board earlier today, we plan to repurchase up to $30 billion of our stock over the next four years. We do believe we’ve got great opportunities in front of us and this buyback program affirms that belief. We believe it is a prudent level of buyback that will allow us to repurchase a very significant amount over that four-year time span.

After considering those two steps, our projected capital needs and reviewing the resolution of so much of our legal uncertainty, we believe there is additional cash that can be returned to shareholders in the near term. As a result, we will be making a $3 per share, one-time special dividend, subject to shareholder approval.

As we’ve stated, taken together, these steps represent a combined total value to shareholders of up to 75 billion over the next four years, if our regular quarterly dividend remains at this current level.

Let me turn it over to Bill for some closing comments from our chairman before we take questions.

BILL GATES: Well, Microsoft has always been about long term investment and having great people and building great software products. And it’s a pretty exciting milestone to be here today and not only have this over $30 billion one-time dividend but an overall financial plan that provides return to shareholders in total of over $75 billion over the next four years.

That belief, that investing in software and driving innovation cannot only create a great business and great returns for shareholders but also do great things for our customers, changing the way they work and entertain themselves, that belief is stronger today than it’s ever been.

And so you might say, what’s next for us, and the answer is record investment in innovation. One way to look at that is over the next year we’ll file for over 3,000 patents and that’s up very dramatically and would put us certainly in one of the top companies in the world in terms of innovative activities.

You’ll see a lot more from us on our product roadmap when we have our financial analyst get-together that’s a week from Thursday, but even here in the near term you’ve got Windows XP SP 2 focusing on security issues, next year you’ve got SQL Server and a major new release of Visual Studio, and on an ongoing basis our online properties, including our search properties, will be improving in a pretty dramatic way.

Looking out further, we have breakthroughs like “Longhorn” and how it delivers a storage paradigm that lets you do dramatic new things, we have the move of the industry towards Web services and the way our tools and platforms are leading in that, we have breakthroughs like speech recognition that we’re seeing the beginning of with the shipments in our Speech Server product that came out just this year; so lots of opportunity.

The wonderful thing is that as we make these investments in software, we have had the ability to generate profits, as well as through a high-volume, low-price model have a very broad and dramatic positive impact.

MARK MURRAY: Great. Operator, I think we’re now through with the announcement portion of the call, so we’re ready to take questions.

(Operator Direction.)

QUESTION: Hi. I guess I have two questions for Steve or John. One is could you go into a little bit more detail about your rationale for splitting the distribution between a buyback and a special dividend? And from John it sounded like some of this might have been reflecting sort of administrative or process concerns that you have about the size of the distribution.

And then could you also, now that you’ve doubled your annual dividend again, could you maybe elaborate on your ongoing dividend policy or your plans to articulate a concrete dividend policy going forward?

JOHN CONNORS: Yeah, thanks, Charlie.

In terms of the distribution of the buyback versus the special dividend, there really is no perfect right answer. We looked at a broad range of scenarios and thought that the decision we reached is something for everybody. Some investors had wanted us to return cash so they could make the decisions they wanted about whether to buy more of our stock or others. Some wanted an all-buyback, and then we’ve heard from a large number of income-oriented investors that they would like to see an increase in the regular ongoing dividend. And we think we’ve achieved reaching the input of all three of those constituencies, and we’re doing something that is large scale in every way. So we think that we’ve reached a good balance amongst the various inputs we received.

In terms of the ongoing dividend, we have now doubled the dividend twice since announcing it and we will have a yield that starts to approach the S & P 500 on an X dividend date. The board will consider annually what the company should do and if we do a great job we’ll have a high class problem for the board to decide each summer.

But we don’t have anything more to announce today.

QUESTION: Thanks.

John, could you give us a sense for what you think the net impact of this will be on EPS, given that you’re giving up some interest-earning cash? And also would you expect the stock to drop $3 the day after you pay out the cash distribution?

JOHN CONNORS: Yeah, and, Rick, we’ll give an update on Thursday about our EPS expectations, but clearly we will have lower investment income as a result of the distribution.

The second question, mathematically the stock should drop after the X dividend date by the amount of the dividend, and there would be a series of factors, how we’re performing, how the market is performing, but we would expect the stock to drop after that X dividend date.

That’s why it’s so important for us to ask for shareholder approval for the amendment of our employee stock option program, as well as our new stock award program we announced last year.

STEVE BALLMER: How that price relates to today’s price, who knows. That’s kind of other folks’ jobs than ours.

QUESTION: Hi. Thank you. Actually, I was focused on the same thing that Rick was. One thing I guess maybe, if you could touch on, cash that you do have overseas, could you give us a sense of what percentage of your cash would you have to repatriate back and the tax implication, I guess?

JOHN CONNORS: Yeah, there is no tax or repatriation consideration in what we’ve announced today and so we’re actively following what Congress is considering in future tax bills, but that doesn’t impact today’s decision.

QUESTION: Thank you very much. I just had a question on sort of the legal preface that you went through, to where you felt comfortable in going ahead and stepping up with sort of the cash distribution, and specifically I mean the EU still is under appeal and who knows the outcome, but if you take into account sort of the potential implications for “Longhorn” as to the ultimate outcome of what happens in the EU and sort of the risks that you see in terms of that having an impact on sort of the integrated innovation you plan for “Longhorn.”

BRAD SMITH: This is Brad Smith. I think there were a couple of considerations that were of most importance. One was the EU case, as you mentioned. Obviously that remains a case of very substantial importance for the company. However, we are at a stage in the process where there is a negative decision, which means that the issues in the case have been clarified, we know exactly what’s inside the case and we know what is not in the case. And as we have the opportunity to go forward with an appeal, we hope that we’ll have the opportunity to be persuasive in court and if we are, then the case will get better from the company’s perspective.

But one of the attributes of the appellate process in Europe is the case will either remain where it is or it will get better; the case won’t get worse because there will be no opportunity for additional issues to be added. That’s just the nature of the appellate process. That gave us the certainty I think that the board was looking for in terms of understanding what was at stake.

And then the second thing was just the milestone reached on June 30th with the Court of Appeals decision in the United States. It’s worth keeping in mind that the issues involved in that case were even far broader than in Europe. The remedies that Massachusetts had been seeking remain far broader. And so getting that issue clarified, especially in the unanimous way by the Court of Appeals, really was a significant milestone in terms of making it possible to move forward with this decision today.

QUESTION: Yeah, good afternoon. I was wondering longer term in terms of adjusting your capital structure, assuming a favorable interest rate environment, if Microsoft would seriously consider perhaps taking on some long-term debt at low interest rates and using the proceeds to buy back stock, from a longer term perspective.

STEVE BALLMER: This is Steve. No. Fundamentally I don’t see a need for us to borrow money on behalf of our shareholders. If shareholders want to buy stock, we certainly welcome them, but I don’t see us borrowing money in order to buy shares essentially for the shareholders.

QUESTION: Hi, Steve. Given your recent note on keeping an eye on costs, as well as the newly stated dividend policy, I mean, can you speak to what stage you and other executives at Microsoft consider the company to be at? Is Microsoft now a fairly mature company where we can expect more modest rates of growth? I mean, what do some of these recent events really speak to, the stage at which Microsoft is at?

STEVE BALLMER: Well, the word “stage” is kind of a loaded question. As I look out for the next several years, with respect to the fact that if we don’t execute, if we don’t compete well, we’ve got lots of issues. But when we look out over the next several years, I’m confident we have some of the greatest dollar growth prospects in front of us of any company in the world, full stop, period, without question it’s there.

Now, we have to execute well. We have good competitors, good competition that we’ve got to work against, and we’re going to talk a little bit about this at our Financial Analyst Meeting.

But when I look at the potential for growth in our company over the next several years, I think you would be hard pressed to find any company that’s got that kind of dollar growth prospects over the next several years. So I think of us as very much in a phase of great opportunity and a phase, frankly, of significant growth.

QUESTION: Good afternoon. Just one quick question, which was with the special dividend of $32 billion, you end up with about $24 billion of cash on the balance sheet and the buyback and future dividends should be met out of free cash flow. Can you give me a sense of: A) how you decided on the level of special dividend, and B) any thoughts on what you intend to do with that remaining quite significant cash balance?

JOHN CONNORS: Yeah, you know, the company does have two separate considerations. One was our current balance sheet profile and secondly the ongoing cash we generate. We do think we’ve made a significant commitment to shareholders today for the next four years.

We will have a substantial balance sheet on an ongoing basis, provided our business performs well, which we expect it to, and there’s a variety of things that that cash is available for. First of all, it’s available for acquisitions. Secondly, it’s available for opportunistic investments. And then finally, I think that we will also be a company that is relatively conservative in keeping enough financial resources available for any unforeseen circumstances we might see.

So we’ve made a big commitment today. If we execute well, the board will have opportunities for future capital decisions as we go forward.

QUESTION: And is 24 about the level that you would be comfortable with going forward?

JOHN CONNORS: Yeah, that’s probably a range that is not unreasonable.

QUESTION: Good afternoon. Historically you’ve bought back between $6 [billion] and $6.5 billion a year to offset options. Would the new buyback be additive to or encapsulating what you’re already doing?

STEVE BALLMER: It would be encapsulating what we’re already doing.

QUESTION: And would that be entirely in the open market or, as we saw in the most recent quarter, a combination of open market and private-party transactions?

JOHN CONNORS: I don’t know. There’s no related-party transactions. They’re all in the open market purchases.

QUESTION: Terrific. Thank you.

STEVE BALLMER: One thing I’d just like to add, I mean, we have — as I say, between buyback and dividends we’ve had about $30 billion flow out of the company over the last five years. And certainly the program we announced today is a significant step up in aggregate in terms of return of capital to shareholders versus what we’ve been doing, and so I think that’s probably the apples to apples comparison to take a look at.

QUESTION: As I look at this, it looks about 70 percent — the amount that you’re returning in this year’s dividend, if we annualize it, as well as with the buyback, is about 70 percent of free cash flow, a little more than that. Is that an appropriate metric to look at as a percentage of free cash flow on a going forward basis?

STEVE BALLMER: Let me comment philosophically and then John can comment numerically. I think that’s not really a very good way to look at it at all. We call it the one-time dividend and one-time dividend because we think of it very much as a one-time dividend. We will continuously evaluate what cash needs we have in the business. We wanted to be clear what our plan is, at least for the next several years, although the board retains discretion to, of course, look at the dividends each quarter.

The thing that you can think of as perhaps we’ll be able to regularize more would be in the regular dividend and the buyback, but even then we wake up smarter as we move into the future and I’m sure the board will revisit all issues at least annually, as John highlighted.

JOHN CONNORS: Yeah, and Brendan, I would think that it would be unlikely that we would get to a payout ratio that high on an ongoing basis. We’ll likely be in absolute dollars a very large distributor across any industry but our ratio would not get that high. That would be very unlikely.

STEVE BALLMER: Each of you, of course, can check the numbers on your own but our read is probably the top U.S. company in terms of capital return to shareholders between buyback and dividends over the last five years would have returned someplace between $50 and $60 billion over five years to its shareholders. We expect or suspect that this cash management plan will make us the number one company on that dimension in the United States for the next four-year period.

QUESTION: Hi. I just kind of wanted to follow up a little bit on the questions people had about the cash that you’re holding and kind of the spending. Can you give us any sense of kind of how much cash you expect to be generating over the next few years or kind of what you see in terms of are we still going to see the sort of very strong growth in the cash?

JOHN CONNORS: We haven’t provided any projections for cash flow over a multiyear period and we won’t be today. I think we have good prospects for the company because of our innovation pipeline and our product roadmap and if we execute well we should develop a pretty good profit profile and good cash flow but we don’t have any projections that are numeric.

QUESTION: Hi, guys. Could you discuss the adjustments that you’re planning to make for the employee stock plans? Are you talking about more options? And also what sort of costs will you incur by making those adjustments?

STEVE BALLMER: Yeah, this is Steve. Let me talk a little bit about that. The goal is to make appropriate adjustments, both for our option holders as well as our stock award holders, to essentially deliver to them the same value they had expected to receive before this special, one-time dividend. It’s a complicated formula but in the case of the option holders essentially we keep the Black-Scholes value being delivered to those employees constant through the change in the number of options and the price of the options that they receive. In the case of the stock award holders, the amount of total value they would have received will be adjusted as of the X dividend date to keep them whole. Of course, the stock will then continue to move up and down from that point forward.

From an accounting perspective, we don’t think there is an impact to this because we’ve already recognized the Black-Scholes value of the options are recognized on our books and, of course, the stock award value being delivered is the same as it was beforehand, so there shouldn’t be any change to financial projections based upon that modification.

We think that’s a pretty, what shall I say, fair deal, good for the shareholders to do this return and also fair and appropriate relative to the hard work and good work our employees have done.

QUESTION: Thanks, Steve. So that means that award holders would then get more shares, basically just a few more shares?

STEVE BALLMER: Well, more shares, enough additional shares to make sure that the value of the award is essentially the same before the X dividend date and after the X dividend date.

QUESTION: A few quick questions. One, can you talk about the EU, how long you expect that to drag on and any odds or hope for settlement? And separately, in terms of the dividend, would you expect over time to move above the S & P yield, just any thoughts on that? Thank you.

STEVE BALLMER: This is Steve. I just don’t think there’s any — we’re not going to speculate in any way about the future of the dividend. The board has the right to evaluate that as we go forward. We certainly give them all of the comparative benchmarks and we’ll evaluate that in its time. And I’ll let Brad talk to the EU.

BRAD SMITH: With respect to the EU case, it really is a multiyear process, as we have said. We anticipate that the hearing will take place perhaps in September, certainly this fall, on interim measures. That will decide whether the sanctions take effect while the case is litigated or whether they’re suspended until later. Typically a case takes two to three years to go through the Court of First Instance. If there is an appeal, it can add another couple of years to the process. So it could be quite a long road.

With respect to settlement, as we’ve always said, we’re always open to an effort to explore a reasonable and amicable resolution. There are no discussions going on at the moment, but over the course of a number of years, obviously things can happen.

QUESTION: Hi. I’m just wondering if you can address what your plans are for the $15 billion of strategic investments you have still.

JOHN CONNORS: Yeah, there is no change in plans. The treasury group reviews the portfolio, including that, on a regular, ongoing basis, so nothing to announce today.

QUESTION: So there’s nothing you can say about liquidating that at all or anything like that?

JOHN CONNORS: Yeah, nothing specific to talk about with the strategic equities.

STEVE BALLMER: Yeah, more precisely nothing new, so no new plans, nothing to say about additional acquisitions nor dispersals.

BILL GATES: Yeah, this plan gives us plenty of flexibility to maintain or add to those strategic investments as we see best.

QUESTION: Yes, hi, good afternoon. Maybe, John, you can help us. Can you just give us a sense of what the interest rate assumption you guys were using in terms of just kind of what you were yielding off your cash?

JOHN CONNORS: Yeah, you know, we’ll have a chance to talk more on Thursday about what we think the impact will be for FY ’05, but there is no assumption to talk about today.

QUESTION: OK, great, and then just maybe a quick follow-up is if you guys, it sounds to be, based upon what Steve was saying — and, Steve, correct me if I’m wrong — it sounds like the way you’re going to true-up the employees is basically Treasury method, add more shares to share count to kind of make them whole on that portion of the dilution, and then with the buyback taking place, this is about what you were buying back I think in fiscal year ’03, you bought back 7.5 billion. Is this kind of taking care of that dilution by the 7.5 billion or will the 7.5 billion end up being accretive to the share count?

STEVE BALLMER: A couple things. I think, if I understood you correctly, the answer on your first question is, yes, you’ve got it basically right, we’ll be issuing more options and more stock awards. It’s a little bit more complicated than I as a layman first thought about, because what you’re trying to do is adjust both the price and the number of shares to preserve both the money value and the Black-Scholes value to the employee, so it’s a little bit more complicated than some of the adjustments that people would anticipate.

In terms of your second question, I mean, people have to run through the numbers, we’ve got to see what the share prices are, the share price obviously affects how many shares we wind up actually buying back, but net I would expect that this buyback will result in a reduction in total number of shares outstanding, of course.

QUESTION: Yeah, thank you. So the buyback amounts to just about over a billion shares at current prices or roughly 9.5 percent of total shares outstanding. Could you give us some indication as to how much of this buyback might be offset by employee stock options or grants that are currently unvested or restricted as well as additional stock grants over the ensuing years? In other words, the total share base won’t actually decline by 9.5 percent but some amount that’s less than that. Could you give us an indication as to what that percentage might be?

JOHN CONNORS: Yeah, probably the best way to analyze that is to go back to last year’s 10(k) and see the outstanding options and then get this year’s 10(k) and that would reflect outstanding options after our option transfer program was executed in this fiscal year and that also would pick up the stock awards.

We do feel that the $30 billion that we’ve announced is significantly more than any dilution from our option or award program, so we would expect, depending on the price of the repurchase of shares, to reduce the number of outstanding shares over the next four years.

MARK MURRAY: Great, thanks very much, everyone, for your questions.

I do want to note that for those of you who had trouble getting on the very beginning of this call that the call will be replayed starting about an hour from now. Call-in information is on the media alert that we issued around 1:00 but the call-in information for those of you in the United States is 888.315.6116 and the pass code is Microsoft. For those of you outside the United States the call-in number is 712.257.2114 and again the pass code is Microsoft. That audio replay will be available until midnight on July 28th, 2004.

So with that, we’re going to conclude the conference call. If you have additional questions, please feel free to contact Microsoft Corporate Communications or Microsoft Investor Relations.

Thanks very much, everyone.