JASON MAYNARD: Hi. Good morning, everybody, and thanks for joining us. We're very excited today to have Microsoft on with us to talk a little bit about one of the new and emerging opportunities within the Microsoft franchise. Today we're going to talk about Microsoft and television.

Joining us we have Ed Graczyk, who's the director of marketing and communications within the Microsoft TV Division, and Joe Binz from investor relations, as well as Glen Campbell, our telecom and cable analyst to serve as the moderator, given his expertise in this area.

The call should run approximately an hour with ample time for Q&A and I'm going to pass the baton over to Glen as he will serve as our moderator here and lead with some questions and direct the Q&A from the audience. Glen?

GLEN CAMPBELL: Thanks very much, Jason, and thanks to everyone for joining us.

For people following the telecom and cable space, there's no question that some of the themes we've been talking about, everything over IP are becoming increasingly important and we think one of the companies that has the potential to play a very important role here is Microsoft with its TV offering. We'll hear on this call about the product, about how it fits in with Microsoft's strategy about how it can help both customers and carriers.

With that, I'll turn it over to Ed Graczyk, director of marketing for MSTV. I would remind the audience that there are slides to accompany the presentation and if you haven't pulled them up already, they're on http://researchmedia.ml.com, that's researchmedia.ml.com and the event code is MSTV.

Ed?

ED GRACZYK: Great, thank you and thanks for having me this morning.

As Glen said, I'm part of the Microsoft TV division here at Microsoft and wanted to take the opportunity to update you on some of the technologies that we're working on here in TV land, so to speak.

But before we begin, I want to call your attention to our legal disclaimer on slide two and just make sure you're aware that we may be making some forward-looking statements during this presentation but you should refer to our SEC filings for the risk factors relating to our business. You can find all that information on the Microsoft.com investor relations site.

So as we move into slide four, the agenda, the rough order of what I was hoping to talk about, and again leaving plenty of time for questions at the end, is really to provide an overview of what Microsoft TV is and how do we fit within the broader Microsoft organization, talk a bit about the changing landscape we're seeing in the pay TV distribution space and then drill down in particular into an emerging area called Internet Protocol television or IPTV, define what that is, more importantly what it isn't, and then talk about the solution that Microsoft has created and some of the customers we're working with to bring a new generation of TV services to consumers in conjunction with our network operator partners; and then finally we'll touch a bit upon how we look at the IPTV market opportunity.

As we move to slide number five, this gives you a bit of a view of where Microsoft TV fits within the Microsoft corporate organization. Recently Microsoft organized itself into seven main business units. There's the Windows Client business, the Information Worker business which includes products like Microsoft Office and Publisher, the Microsoft Business Solutions division which is our Great Plains and Navision business, our Server and Tools division, our Mobile and Embedded Devices division, our MSN division and then finally Home and Entertainment and Home and Entertainment is where Microsoft TV fits.

The other key areas within Home and Entertainment are, of course, our games business, both the Xbox console and peripherals, the Xbox Live online service, all the Xbox games, as well as our PC gaming business all fall into the games organization.

The second part of the Home and Entertainment division is our home and retail business and that's where we develop all of our consumer software applications like Encarta, like Microsoft Money. It's also where we develop our Macintosh applications like Mac Office and our consumer hardware, for example keyboards and mice and joysticks, et cetera.

And then the third part of the Home and Entertainment division is Microsoft TV. And Microsoft TV is both the name of our division and the name of our product family. We're a business-to-business type of organization where we deliver software products for TV network distributors. So our customers are not consumers, though the end user of our product is the consumer, but the customer, the people we license our software to are network operators like cable companies like Comcast as well as telecommunications companies like SBC here in the states.

Within the Microsoft TV family there are two main product lines. We have our Microsoft TV Foundation Edition product line, which is a solution that's targeted at North and South American cable operators specifically, and it's a software platform that's designed to run on top of the existing cable video distribution networks and set-top box devices that are already in people's homes today. So if you have digital cable at home and you're running, for example your service is powered by the TV Guide interactive program guide, our Foundation Edition software is a replacement for that. And, in fact, Comcast, the leading cable operator here in the states, is in the midst of beginning their deployments of roughly five million units of Foundation Edition across their network, upgrading those TV guide set-tops with Microsoft TV foundation.

Our second product and the one we'll focus on today is our newest product. It's called the Microsoft TV IPTV platform and it's a product that we announced not quite a year ago. We announced it in October at a large telecommunications conference in Geneva called ITU Telecom.

And as its name implies, it's a software platform for delivering TV services over IP-based networks, so it's a solution for both cable operators and telecommunication providers and ultimately any broadband network provider who wants to deliver competitive pay-TV services over their IP-based broadband networks.

As we move into slide six, I wanted to talk a little bit about how we see the marketplace evolving, in particular the evolution of technology and digital media in the home. And clearly we live today in a world that has changed. No longer are the various devices that we all rely on for our day-to-day lives, no longer are they these islands of proprietary technology that don't communicate with each other; we're now instead living in a world where media of all types have either gone or are quickly going digital. The devices we're using to consume that media are increasingly powerful, much more intelligent, they're connected and addressable. And we're also seeing the emergence of new types of devices that help consumers experience media in different ways, so some obvious examples here are the evolution of the digital video recorder, the new Personal Media Centers that are just coming out as we speak, more and more powerful mobile phones with multimedia capabilities, et cetera.

So Microsoft obviously looks at this as a huge opportunity for us to help bring new value to these devices, to the consumer as well as to the network providers that are delivering services to these devices through software.

And when we talk about Microsoft's consumer strategy, it's helpful to think about it as really a three-pronged approach to Microsoft in the home. Core to that strategy, of course, is the PC and in particular the Media Center PC. We're obviously big believers in the PC and we feel that the PC is the workhorse device, if you will, that people will use primarily to manage the connected home environment, it's uniquely suited to a lot of tasks like personal productivity, it's a great device for storing and managing your personal media such as digital photos, digital music, your own personal digital videos, and we also think it's the best suited device for managing that home network and the other devices connecting to the home.

So while we do feel that the PC is core and central to this strategy, that doesn't necessarily imply that in every home, in every geography, in every marketplace that you won't have other devices that are also core to the home environment and in particular the home network.

The other two pillars to our consumer strategy are, of course, Xbox so the Xbox is a high-end gaming console and also offers an associated online service, so it becomes a device that's connected up to the home network, that connects up to that Media Center PC at the core of the home network, and the focus of the Xbox is to deliver a premium gaming experience, both a standalone gaming experience as well as an online gaming experience through the Xbox Live environment.

And then the third pillar of that strategy is, of course, the television and in particular the Microsoft TV software platform.

So again the role for Microsoft TV is to bring the TV together with all these other devices in the home and help us and our customers and partners deliver connected home experiences across a range of these devices.

So a central part of this strategy is what we call integrated innovation, and the concept here is that with all these devices powered by Microsoft software, we and, as I said, our partners can deliver a superior experience to a household where the devices happen to be powered by solutions from a myriad of different companies.

So the basic idea is that if you're a household with a Windows XP PC and a set-top box running Microsoft TV and an Xbox and a Smart Phone with the Microsoft Smart Phone software, that the experience we can deliver and our partners can deliver and the cross-device services that we can seamlessly deliver across those devices would be vastly superior to your neighbor's home who might happen to be a Macintosh based household running set-tops powered by other software solutions, Sony PlayStation devices, Palm Pilots, et cetera.

So again this concept of integrated innovation is really a key focus for Microsoft in this area and it's our fervent belief that software is really the secret sauce that enables this. We're seeing a tremendous amount of innovation among the hardware community as new types of hardware devices, new form factors, we're seeing the integration of all kinds of devices and the convergence of services and technologies across these devices, but what really sets it apart from both the service delivery perspective and the consumer experience perspective is not the hardware as much as the software and the software that takes advantage of the innovations and all these devices to deliver new types of experiences to the consumer.

So as we move into slide seven, we'll talk a little bit about the forces that we see shaping the future of television. And people have been talking about the changing evolution of TV for a long, long time. We are seeing the stars aligning recently in a number of different areas that are making Internet Protocol Television or IPTV a feasible product to be offering at this point in time.

Certainly we're seeing the proliferation of broadband IP networks all around the world, broadband penetration is increasing at a rapid rate, broadband connectivity speeds into the homes are dramatically increasing; in fact, in parts of the world today, notably in Asia, it's not unusual to have a 56-megabit per second connection, even 100-megabit per second DSL connection into the household. So we're seeing a lot of movement and broadband coming to households, enabling a big, fat pipe into the home to deliver these new services.

We're also seeing, of course, a lot of innovation and cost reduction in technology and consumer devices in particular. This is driven not only by Moore's Law but also by a growing number of hardware providers that are getting into the consumer electronics space. So no longer is it only companies like Sony and Philips that are developing consumer electronics devices but we're seeing companies like HP and Dell get into that environment as well, so that's driving a lot of innovation, driving innovation up and driving costs down fairly dramatically.

On the video technology front we've seen some great advances in video compression technology. Today with technologies like Windows Media 9 you can fit roughly three times as much content in the same amount of bandwidth as is required using MPEG 2, which is the much older video compression technology used in most video distribution networks today.

So the combination of better video compression and higher speed broadband networks means that it's now feasible to deliver very high quality video content, including high-definition content into consumer homes over the networks that are out there in place today.

We're also seeing a lot of innovation and changes around content in advertising models, content providers are looking at new ways of monetizing their content, delivering it to all these different devices that are now able to consume rich media, including live video.

And then finally we're seeing both a regulatory environment that's making it more and more favorable for telecommunication companies to make the network investments needed to deploy video services and from a competitive perspective the market dynamics have changed dramatically in the last few years between cable, satellite and telcos. So today you can get voice services from your cable provider, you can get video services from your telephone company in some marketplaces and really all of these communication companies are morphing into being a multi-service communications provider, they're no longer the phone company or the cable company but they want to provide really the range of services that you as a consumer are interested in.

So it's this confluence of all these different dynamics going on in the market that are really driving IPTV to become a reality today.

So let's move on to slide number eight and here we talk about IPTV and what it is. And as I said, it stands for Internet Protocol Television but it's important for people to understand that this doesn't mean that we're talking about delivering TV over the broad Internet, we're not talking about watching television on your PC for the most part -- there will, of course, be some niche applications for that -- we're not talking about best efforts video services, but what we are talking about is delivering a very highly capable, competitive pay TV offering that would compete with any incumbent pay TV distribution network in the world today, and where that service just happens to be delivered over a different network architecture than what is typically used for cable video and satellite video today.

So instead of being delivered on a closed, proprietary, primarily one-way broadcast infrastructure like cable and satellite, in an IPTV world this is delivered over a closed, managed, broadband network supporting high-speed two-way services, but it's important to note that this is a managed network. This is a network that companies like SBC own and control, they can manage quality of service, they can ensure that they're able to guarantee high quality video and the other services through the home, so this isn't again kind of delivering video over the wooly world of the Internet to a PC.

As you see from the diagram here, IPTV encompasses the range of TV services that people have become used to today, so with products like the Microsoft TV platform we're able to deliver linear broadcast video channels, on-demand media, digital video recorded media, all integrated in a seamless way across that network.

And the Microsoft TV platform I should point out is an end-to-end platform that we'll get to in a couple of slides in a little more detail, but we're a solution that a network operator like SBC can use to handle the entire service delivery environment from the point the content is ingested in the network all the way through to display on the set-top box.

So as we move into slide nine, here we talk a little bit more about the benefits of the Microsoft TV, IPTV platform. And we like to kind of look at IPTV and the benefits we're able to bring to our customers in four basic areas. First and foremost is what we call better TV. And, of course, it's unfortunate on a conference call like this that we're not able to do a demonstration, but to actually see an IPTV solution like ours side by side with some of the legacy systems that are out there today, you notice immediately that there are some just core improvements over the basic television viewing experience.

One of the things that gets people most excited ironically is just instant channel changing. And if any of you have digital cable or digital satellite at home today, you've become used to this 1 to 2-second delay as you tune from one channel to another. Well, with the IPTV platform that we've developed, we actually tune channels about as quick as you blink an eye, it's about 150 milliseconds. And so that gives us an ability to just, as I said, improve on the core consumer experience.

Because this technology is also based on open standards, it's a marketplace where you'll have many companies providing set-top boxes, a lot of innovation around the consumer premises equipment, and because it's sitting on a broadband network we're also able to do a lot of the processing in the network as opposed to having to do it in the set-top box, though the set-top boxes for IPTV that are emerging are pretty dramatically more powerful than the typical set-top boxes people are familiar with in their homes today with cable and satellite.

So that combination of more powerful consumer hardware as well as the ability to do a lot of the processing in the network very efficiently means that we can also dramatically improve the customer experience, and later on in the presentation are a couple of screen shots to just give you an idea of what I'm talking about there.

So on top of better TV, what really gets the operators excited though about IPTV is this concept of connected TV, meaning the TV in an IPTV world because it uses the same technologies as these other devices in your home, because it sits on the same network and speaks the same protocols, in an IPTV world your TV now becomes part of your home network. It becomes a device that can share services and information and media with these other devices in and outside your home, and it makes possible these connected scenarios that aren't possible in today's proprietary TV environments.

And it's really this connected TV scenario, as I mentioned, that is where a lot of our customers are seeing their big competitive advantage. Certainly if you're a telco and you want to get into the TV business today, you have to have an offering that stands on its own as a competitive TV offering that people are going to go to. We're talking markets where TV penetration is incredibly high, these aren't Greenfield markets where you're going to be acquiring new customers that don't have pay TV services today.

So in order to do a competitive switch kind of offering you've got to have not only a product that's better than what's out there but something that really sets itself apart from the services available and it's these connected TV scenarios that enable that. And again we'll talk a little bit more about that in a couple slides and I'll show you a couple of examples of what some of these connected scenarios can be.

The third big benefit for the Microsoft TV, IPTV platform is, as I mentioned a little earlier, the fact that we are a full end-to-end video delivery system. We're really the only system out there that was designed from the ground up to be this end-to-end platform. Most of the companies we compete with in this space fall into one of two camps; they're either small companies that provide one piece of the platform, for example, the client software piece or the video on-demand service piece but they don't provide the full suite of services in the end-to-end delivery platform; or the second type of competitor is a company that is creating an end-to-end platform but where that's being cobbled together through acquisitions and partnerships with other third parties. So you have an end-to-end platform on paper but not one that was designed from the ground up to provide the seamless delivery of broadcast video, video on-demand, digital video recording, interactive program guides and everything else that a solution like Microsoft TV provides.

And then finally the fourth big benefit is, of course, the fact that this is a solution that's developed in house and backed by Microsoft, we're able to take advantage of the massive research and development that we do as a company, we're able to coordinate with other technologies within the division like our Windows CE client software, our Windows 2003 Server software, our Windows Media encryption and Digital Rights Management software and really leverage the best of all these investments that other divisions in the company are making to build this end-to-end vertical platform.

So as we move into slide ten, this gives you a fairly high level view of the architecture. This is a simplified view of the architecture. As I mentioned, it's a true end-to-end platform. It handles everything from the point that the video is ingested and encoded all the way through distribution across the network into the home onto the TV device.

You'll see also noted on this slide a number of the partners that we're working with, so part of the value that Microsoft can bring to this space is building up this ecosystem of third party companies who deliver technologies and solutions that add value to our platform and help bring more value to our customers; so working with companies like Tandberg and Harmonic who are leaders in the video encoding space, we're working with companies like Juniper and Lucent who provide various components of the network access pieces. For example, we were showing at a recent trade show the delivery of multi-TV services over a single DSL modem, taking advantage of the Lucent DSLAM and DSL modem technologies, so one modem powering two TV devices over a single broadband connection into the home.

On the set-top front we're working with companies like Thompson and Pace who make set-top boxes, but we're also working with companies like Intel and STMicro who make chips that go into these next generation of set-top boxes, and in particular working with them to create what we call a system on a chip, which is a single piece of silicon that can be embedded in devices to effectively turn that device into an IPTV set-top box.

So companies like STMicro will have these new chips available initially about midpoint next year and volume deployments by the end of the year. And when these are available, this will be one of the key components that helps drive down dramatically the cost of an IPTV set-top box. Today the rough bill of materials costs for a basic IPTV set-top box is roughly $150 U.S. The combination of advances in technology, Moore's Law and with the more competitive set-top marketplace, along with the availability of these systems on a chip, we believe will drive the bill of materials cost of an IPTV set-top box down to below $50 by about 2007.

The availability of this system on a chip will also mean that a number of devices could be embedded with this system on a chip to effectively turn that device into an IPTV set-top box. So certainly we're seeing standard set-top type form factors emerging but over time we expect that this technology would be embedded in TV sets themselves, gaming consoles, DVD players and other devices that physically connect up to the TV set.

Moving on to the next couple slides, I'll give you just a couple of examples of what the user experience can look like and slide 11 is where we talk about the better viewing experience. And hopefully you can see it in the slide here itself but you've got just a richer user interface, the ability to do things like this rich multimedia program guide that includes in the lower left part of the screen is actually a live picture-in-picture window. So as you're navigating across the various channels listed in the IPG, that picture-in-picture instantly changes over to show you what's going on on those other channels.

As I mentioned, we can integrate broadcast video on-demand and DVR based content seamlessly integrated. So today if you're a cable customer with video on-demand, chances are the VOD system that you have access to is really a totally separate environment from the broadcast linear channels that you see in your guide, so you don't even have the ability, for example, to do a search where you can search across your linear broadcast, your VOD and your DVR based programming that's available to you. Well, in an IPTV environment, again because it's all designed from the ground up to enable this seamless integration, you are able to offer that integrated search.

Things like fast scrolling and navigation are just inherent in the platform where, as I said, we're running on more powerful set-top boxes, we're able to do a lot of processing of the network, so just the overall responsiveness of the system is very quick.

And one of the important things to point out here because it's a key driver of the consumer experience as well as the low cost devices is software based channel tuning. So in today's world if you have a system that supports picture-in-picture or an application that supports picture-in-picture, that's enabled by having two physical hardware tuners in your set-top box or TV device. Well, with our IPTV platform we have some patent pending technology where we do all of the tuning in software, so this means not only does it give us the ability to do instant channel changing faster than the blink of an eye, as I mentioned, but it also means that we can offer multi-tuner applications at a much lower cost than what would be possible in a conventional TV system that requires hardware tuners, which, of course, add costs to those hardware devices.

As we move into the next slide, we talk a little bit here about better TV navigation and it's going to be a little hard to see without seeing the demo but the platform has a much richer interface with a lot of nice just esthetic elements around translucency, graphical overlays, cinematic fades that make the environment just a much nicer environment to navigate around and it's just a much kind of cooler, more friendly, more responsive interface.

We talked a bit about instant channel changing and search and browse.

What you see on this screen is where you're tuned to one channel and you're using the up or down arrows to browse ahead to another channel, so instead of tuning with the channel button you're staying tuned to one channel but you're browsing ahead, and here's another way where we can incorporate that live picture-in-picture capability. So as you tune from channel four to channel five you get that live picture-in-picture window that shows you what's on on channel five.

Let's move on to the next slide, number 13, and here we talk about some of the new types of applications and services that are possible with IPTV. Because again it's based on the same standards as the Internet, it also means that we can integrate Web-based services very seamlessly into this environment.

What you're looking at on this screen is actually what we call the online spotlight. These are all services that are available today on the Internet -- Napster, MovieLink, MSN TV, for example -- and with IPTV a network operator can offer those services as part of this managed experience that they deliver to the consumer very easily because again we're able to essentially just pull in those services from the Internet. It's a way where the network operator can really turn the triple play from what's today just a marketing bundle into really a competitive advantage where you're offering the integration of services and applications and programming across these different devices.

The next couple slides are a quick glimpse at some of the future scenarios we're working on. Slide 15 shows you an idea of what photo and music sharing or in this case photo sharing would look like in a connected TV environment, so again here's an example where IPTV can really stand apart from the legacy TV systems out there.

So the scenario here is you've got photos, digital photos stored on another device in the home like a PC in the den and because your IPTV set-top box is on that same home network, because it's addressable, we're able to pull up those photos or play the digital music that's stored on these other devices in the home. So we think it's new concepts like this that will really help set IPTV services apart from some of the legacy environments.

The next slide, number 16, shows you an innovative use of the multiple picture-in-picture capability, and again we're able to do this through software not through hardware. So if you think of a multi-camera angle sporting event, we're able to do this without again having tuners where essentially we're able to send four different video streams down to that set-top box to give the viewer the option of watching in this case a soccer game from one of four different camera angles.

Slide 17 talks about a little more advanced kind of service that really illustrates the integration of the triple play, and the scenario here is imagine you're traveling and, in fact, this week is the week that a lot of the new TV season starts, so imagine you're out of town on the road and on your mobile phone you get a notification from HBO or MTV or whoever you sign up with about the premier of a new event, a new show on their network is airing tonight and they even send you a little video clip to give you a taste for what it's like. And you think well that sounds interesting but I won't be home to watch it, I wish I could record it on my digital video recorder.

Well, it's relatively easy in an environment like this to enable that kind of remote DVR recording functionality from your mobile phone or from a PC you log into the Internet. In the scenario I outlined you get the notification, you watch the video clip and with a press of the button on your mobile phone you're able to send a message back over the Internet to your set-top box to record that show that's premiering tonight that you would otherwise have missed.

The next slide I want to talk just quickly about has some of the companies we're working with. As I mentioned, we announced this product less than a year ago. We actually have agreements and are in trial with quite a number of the world's leading telecommunications companies in North America, Europe and Asia Pacific. Five of those companies have gone public with their plans; those are the ones you see here: Bell Canada, SBC Communications, SwissCom, Reliance Infocom in India and Telecom Italia, which is our newest announced customer as of two weeks ago.

On top of these customers shown here, we also have agreements and are in trial with multiple other operators in North America, multiple other operators in Europe and multiple other operators in Asia Pacific. All of them I'll say are brand name, tier one telcos that are also trialing IPTV services.

Then the last slide here is a little glimpse at kind of why we're excited about this opportunity and we really look at TV from two perspectives. One is just the sheer opportunity of providing software to TV sets themselves. So there's roughly 1.3 billion, 1.5 billion TVs in the world today. The vast majority of those are not connected up, that vast majority don't have the value of software there helping improve the TV experience.

Digital TV growth is moving along at a healthy clip. According to In-Stat/MDR there will be roughly 224 million digital TV subscribers in 2008, which represents about an 18 percent annual growth rate between 2003 and 2008.

When you look at IPTV, In-Stat's forecasting 14 million IPTV subscribers in 2008, up from less than 2 million or so right now and that's a pretty incredible 82 percent average annual growth. I've seen research that actually is substantially higher than this. One of the research companies recently was forecasting I think 26 million or 24 million IPTV set-top boxes in roughly that same timeframe; so a lot of opportunity there and virtually every major telco in the world is very seriously looking at, if not already trialing or deploying IPTV services.

So that's the kind of units perspective but also we look at TV from the strategic perspective. And I mentioned it's one of the three pillars of our consumer strategy. On top of the sheer volume of TVs in the world today, it's also an incredibly important device that people rely on for their day-to-day lives to be informed, to be entertained and increasingly a device that they can use to communicate with the outside world.

And software, as I said, is really the magic that helps bring these new services and this new value to the devices.

So we see IPTV as an opportunity for Microsoft to bring more value to our customers, to our partners, to the consumers but also where having the TV as a participating member of that home network helps bring value to other parts of Microsoft like the devices we talked about, the Portable Media Centers and Media Center PCs and Smart Phones and Xboxes, et cetera.

So with that, I went a little longer than I thought I would but it does leave us some time, I'm happy to answer any questions people have.

GLEN CAMPBELL: Thanks. That was a terrific overview. Maybe I'll start with one question and then we'll go to the audience, if that's all right. Really a two part question; the first, Digital Rights Management, it's been a real sort of source of worry for Hollywood, the possibility of losing control over their content as it goes beyond, say, standard broadcast distribution into new multiple devices, IPs, PCs and so on. Could you talk about how the solution addresses that?

And secondly, could you talk a little bit about what the product does now as opposed to what you'd like to see it able to do in one to two years, in other words what product enhancements are being implemented sort of as we speak?

ED GRACZYK: Sure. So on the first question about Digital Rights Management or DRM, it's actually today TV content is fairly restricted in how it can be used. There are just a couple of basic business models. For the most part it's secure and, of course, we're definitely looking at the Napsterization of digital media that goes far beyond just audio. You can go up to Web sites today and download movies that are in theatres and movies that have come out on DVD and what have you.

There are some great technology solutions to that. I think the bigger question is really around the business models. And when you look at Digital Rights Management in particular, one of the really valuable things about a modern DRM versus the conditional access security technology used in cable and satellite today is that the network operator like Comcast or SBC, as well as the content provider like Viacom or Paramount or whomever has a lot more flexibility in the way they deliver content. DRM enables all kinds of different scenarios far beyond the three basic scenarios you have today, which are either content is free or you pay a monthly subscription or you pay a one-time use fee. So if you think of TV-based media, those are basically the three ways you can license content as a consumer today.

But with DRM you can create scenarios that let you download and run a movie, for example, watch it as many times as you want over a 30-day period before it expires or you can set up business models that let you copy a movie once over to a DVD so you can play it on other devices or transfer a video once over to a new portable Media Center and watch it for 30 days before it expires. So the reality of DRM is that the content provider has a lot more flexibility in terms of how they can offer their content for consumption.

In terms of the second question around futures, what we support today is all the core video services that people are used to. We support linear channels, we support video on-demand, we support digital video recording, the product includes an IPG; we support both standard definition and high-definition programming.

So in terms of the better TV scenario I outlined it's there today in the product, we're going into, in fact, one of our customers, SwissCom just a couple weeks ago announced that they're moving into the consumer trial phase, which is the step just before broad commercial deployment. They're the first of our customers to move into consumer trial and in September they started rolling their service out in Switzerland, offering video on-demand, broadcast TV, digital video recording with standard definition video, initially rolling out to about 600 households.

Where we're moving in the future is some of the kind of future looking scenarios I showed you, the multi-camera angle applications, more of the connected home types of scenarios, things like network DVR where you don't have a hard disk in the set-top box but you have a hard disk that's owned by the network operator in the network and it's functionality that like that that we expect to see moving out on this platform in the next year or so.

GLEN CAMPBELL: Okay, thanks very much, Ed.

Bill, could we queue up the audience questions, please?

(Operator Direction.)

QUESTION: I was wondering if you could just review the architectures for a second. When you look at cable, you look at it as a fat pipe where everybody kind of taps into the same multicast stream, how does that work in the DSL world? Where is that multicast and where is the consumer tap into that, because at 3 megabits to the home I'm trying to understand how you can deliver as many channels to the home?

ED GRACZYK: Well, it's actually one of the big advantages of IPTV over a broadcast environment like cable or satellite. Today if you've got digital cable you've got probably 200 channels available to you and those are taking up room on that pipe into your home, even though you're only tuned to one channel at a time on the TV set-top box. So you've got these 199 other channels that are using up that bandwidth.

Well, in an IPTV world we can unicast channels to your set-top box so instead of having to broadcast and use up spectrum for all 200 channels, we can send individual channels down to your device. So the experience is you still go to an IPG, you can still see hundreds of channels available. In fact, in an IPTV world because there's no effective bandwidth limitation, you could have thousands of channels available. But whether you have one channel or a thousand available in that IPG, it doesn't affect the bandwidth needed into your home in order to deliver an individual channel.

For example, SwissCom with their trial that just started they're delivering standard definition video over a 1.5 megabit per second DSL connection.

QUESTION: Yeah, but I guess I'm wondering on the back end, I mean, if you have one signal that's being pushed out, you could have one to a million simultaneous users all kind of feeding off of that trough, if you will, whereas you have a million individual, discrete users all on the same channel; at that point doesn't it become less efficient to be in a unicast environment when you look at the concurrency loads?

ED GRACZYK: Well, it kind of depends on what your network design is and the point I was trying to make is that we need relatively low bandwidth into the home, the last mile in order to deliver standard definition quality video. But, of course, we're working with our customers on their network beyond the last mile because, as you say, I mean you're pumping out this video from deeper points in the network and you've got to have the capacity in the network in order to enable that.

The reality is that there's a lot more bandwidth possible out there in the marketplace than what is being delivered into consumer homes today and in part that's because these network operators are looking for services that justify increasing the bandwidth into the home.

In Japan, you talk to people in Japan and say that you've got a 1-megabit per second DSL or 3-megabit per second cable modem connection in your home and they laugh at you because they're used to having 25-megabits per second. The technology is there and the capacity and the backbone is there; I think the challenge is beyond just making sure you architect your network correctly for all of this is to create the value or the applications that the consumers are willing to pay for to justify increasing the bandwidth for that last mile.

QUESTION: And I guess just the last question on the business model issue, most of the pay guys that's distributed currently over cable have various output deals with studios to acquire content, and I'm just wondering how are the telco guys planning on getting access to movie content without disrupting relationships, preexisting relationships that HBO has with Time Warner, et cetera, since this could be another distribution path that may be viewed at the very last as a major competitive issue?

ED GRACZYK: Well, it's absolutely a major competitor, it's definitely a disruptive technology from a marketplace perspective because you're talking about now these new entrants into the digital video delivery space.

But just like HBO provides programming to Time Warner and Comcast at the same time they provide to Echostar and DirecTV, companies like that are interested in getting their content out as broadly as possible. So our customers, the network operators are working with the content community to establish those relationships.

In some cases, like Bell Canada, who actually is in the video delivery business today, they have a satellite-based service in Canada called Express View, so they've got the content relationships, they're distributing content via satellite to a lot of consumers already.

Most of the other customers, of course, have to establish those relationships and the role that Microsoft plays is kind of twofold. On the one hand, we're out working with the content community, evangelizing and educating them on IPTV and what's possible, making sure they're comfortable with the technology from a security perspective and a Digital Rights Management perspective; and at the same time in some cases we can help facilitate those discussions between a network operator and the content community, so really just leveraging our relationships and bringing the two together.

But we're not in the content business, we're not in the content distribution or aggregation business, it's not something we're planning to do with Microsoft TV, so it's really more of a facilitator role that we're taking on there.

QUESTION: Thank you.

(Operator Direction.)

QUESTION: Thank you. A question: There is I guess an analysis put out recently by a company out in the UK or in Europe called Canalys and they basically talk about the net present value of offering an IPTV service that seems to decrease the value of the network because of the cost much more to offer, the cap-ex to create the overall infrastructure for the server and the operator head-end, et cetera, et cetera. Any thoughts about the business model for rolling out IPTV?

ED GRACZYK: Well, I haven't seen this particular research you've talked about, but I just took a note here to look into it.

You know, in general I think there are certainly costs involved in this and maybe the best way to explain this is to kind of paraphrase what Ed Whitacre said, the CEO of SBC, in June at the SUPERCOMM conference, where he announced SBC's massive network investments and the fact that they're going to be rolling out these IPTV services.

And IPTV was positioned there in the context of a much bigger network investment, so SBC is putting four to six billion dollars into their network to bring fiber closer to the home, in most cases it's fiber to the node or the neighborhood, in some cases in greenfield development fiber all the way to the home.

And the purpose there, as Mr. Whitacre said, was to increase bandwidth into the home so that they can deliver these new IP-based services and IPTV is just one of them, though, of course, that's kind of the big new service that these operators are looking at aggressively. But it's really in the context of these bigger network investments that companies are already making, already planning to make.

So when we look at IPTV from kind of a cost return basis, it scores different for every single operator and there's a very sophisticated financial model that we sit down with our customers and they can plug in their own numbers and figure out the details, but the basics are these operators are looking at payback periods that aren't terribly long, assuming that the network upgrades have already been made, because in almost all cases that's already been in the plan and they're looking at now that they've got these network upgrades what other services like IPTV can they deliver over the network in order to extract more value.

QUESTION: Another question: Is the network a synchronous or asynchronous network and is there a requirement for a certain amount of upstream bandwidth?

ED GRACZYK: Well, there is a requirement, of course, bandwidth requirements both upstream and downstream. They vary depending on what the network operator wants to offer.

The rough rules of thumb are you need about 1 to 1.5-megabits per second to deliver standard definition video to one TV in the household, you need 4 to 6 megabits per second to deliver high definition TV to one TV in the household. If you want to deliver to multiple TV sets simultaneously then you double or triple those figures. If you want to offer the triple play, which all these customers want to offer, then, of course, you have to factor in additional bandwidth for high-speed data and voice over IP. So it's that kind of math that the operator goes through to determine what kind of bandwidth they need to have into the home. And kind of our only piece of that puzzle is really the bandwidth requirements that we have for delivering the video.

The other thing I forgot to mention on the cap-ex equation too is that one of the big differences in this marketplace versus the cable marketplace in particular today is the set-top box. And today a company like Comcast, because of the way the U.S. set-top marketplace evolved, it's basically a duopoly market, there are two makers of set-top boxes, they're closed, proprietary architectures, they're not available at retail and a set-top box, a basic digital set-top box like the DCT 2000, there's something like 23 million of those in people's homes already today, costs a company like Comcast about $200 even though they buy in million-unit quantities.

Now, you contrast that to a cable modem which ironically kind of entered the market around the same time as digital cable set-top boxes that was priced around the same price at the beginning as digital cable set-top boxes but went a different route. Cable modems were manufactured by multiple companies, available at retail, based on an open standard, non-proprietary technology and now you can get a cable modem for $40. So we went from a couple hundred bucks to 40 in the cable modem space and a couple hundred bucks to a couple hundred bucks in the set-top box space and it's that same kind of open retail model that we're expecting with IPTV. So not only will the cost of these devices be a lot lower but the network operator won't be incurring the cap-ex associated with that because the consumers will be buying these devices at retail.

JOE BINZ: Operator, we have time for one more question.

(Operator Direction.)

QUESTION: Thank you. You mentioned key suppliers being Texas Instruments and STMicro. I've seen several press releases involving Sigma designs and with them supplying Windows Media 9, H.264 and MPEG. Can you also discuss their role in your rollout?

ED GRACZYK: Sure. So the partners I showed on that slide were the partners that we Microsoft TV are working with specifically and those are largely driven by the partners our customers are telling us to work with because they're the solutions that they've chosen.

Now, of course, Microsoft is a big company, we've got other divisions like the digital media division, the division that makes Windows CE and they, of course, work with other companies as well. So Sigma is a good example of a company that develops chips that run the same Windows Media software that we're using here in our IPTV platform, they're chipsets that could show up in IPTV set-top boxes that run Microsoft TV as well. I didn't mean to exclude them but I was just focusing on the customers that we specifically in MSTV have announced we're working with on behalf of customers.

QUESTION: Okay, thank you.

GLEN CAMPBELL: Okay, well, I think that wraps up our call. Again, thanks to everyone for joining and thanks especially to Ed and Joe from Microsoft for what was a very informative call.

For those of you who missed part of the call, there is a replay number that will be available for seven days. The dial-in number is 888.286.8010 and the pass code is 90561161. Again, thanks very much.

ED GRACZYK: Thank you, everyone.

END

Due to the varying sound quality and subject matter of tapes, the information in this transcript may contain inaccuracies.