GIBBONEY HUSKE: We are very pleased to have Microsoft back as one of our keynote speakers and particularly pleased to have Kevin Johnson, who is their Executive Vice President of Worldwide Sales, Services, Sales, Marketing and Services, to give a sense of what's going out there in the software world. So I'm going to go ahead and kick it off with Kevin and then after about 45 minutes we'll open it up to questions.

KEVIN JOHNSON: Great. Well, good afternoon. It's a pleasure to be here. As I prepared for this particular conference, I thought of potentially some of the questions that might be on your minds: How are we doing versus Linux; are we making progress in the area of security, are customers renewing Software Assurance agreements and how will we grow.

Well, today I'd like to take perhaps 45 minutes and share some answers to those questions from my perspective and the perspective I want to take is one very much of the customer in the field versus an in-depth analysis of the numbers. I'll share some numbers and some perspective but I spend a significant amount of my time traveling around the world working with customers, partners and our field organization and so I want to really share a view with you of what I see happening around the world in the field.

Now, before I begin, just a couple comments; in this discussion, I want to just start by reminding you that during this presentation I'll be making some statements that are forward-looking. These statements are based on current expectations and assumptions that are subject to risks and uncertainty. Certainly our actual results could differ materially because of factors discussed in our 2004 form 10-k. So we do not take any duty to update any forward-looking statement.

With that reminder, I want to start by focusing on the journey that we as a company have been on. This journey started about three years ago with the change in our mission statement, the change to enable people and business around the world to realize their full potential.

As part of that journey, we established seven business groups, we reengineered our field organization so that we had a common subsidiary blueprint and a clear connection between our business groups and our field so that we could strengthen the customer connection.

In the enterprise segment we aligned our enterprise selling teams more around industry verticals versus the geographies that they used to cover. In the small and mid-market segment, we brought together the Microsoft Business Solutions sales force with our small and medium business sales force to create a single organization so we could do a better job delivering value and a great Customer and Partner Experience.

I show you here the seven business groups performance in fiscal year '04. Every one of those business groups grew and as part of our journey we continue to improve and enhance the way that we are operating in a way that puts the customer first and enables us to really focus on the value we create for customers and partners.

Now, clearly this value comes from innovation. The innovation that takes place in each of these business group is core to the strategy of our company.

Now, from a field standpoint the goals and the priorities are very simple and very clear. At the heart of it is what we call integrated innovation. Integrated innovation means the innovation that takes place not just in one business group but across business groups, the scenarios that we can create for customers and partners.

From a field standpoint the goals revolve around three areas: win customers, drive satisfaction and grow the business. Now, we do this to take a balanced approach to the market. Certainly in the area of win customers it's about share, it's about units and usage, it's about ensuring that we have a compelling value proposition and that we fundamentally are competitive against today's Linux and Open Source alternatives, in addition to the traditional commercial competitors that we all know about. That's what winning customers is.

In the area of drive satisfaction it's about delivering a great Customer and Partner Experience.

And certainly in the area of grow the business it's about driving the revenue and delivering the financial results.

Now, we take this balanced approach with our field because we want to ensure that as we grow we're doing it in a way that's adding value to customers and creating a great Customer and Partner Experience.

I want to frame my discussion here over the next several minutes around these three areas. I want to start in the area of drive satisfaction, give you a little perspective on what we're doing and the progress we've made, I then want to transition to win customers and how we're doing relative to Linux and Open Source and then I want to spend most of the time on grow the business and help answer some of the questions about the growth opportunities in the future.

So let me begin with driving satisfaction. I'd say it was about three or four years ago that as a company we took a step back and said we have an opportunity to do a much, much better job in the area of customer and partner satisfaction. Certainly it was in the period where we had launched Licensing 6.0, there were a number of viruses, security issues that hit customers, Nimda and Code Red, a number of things came together to create the environment where we had some significant satisfaction challenges and it was three or four years ago that we said, look, we are really going to make a commitment to step up and drive some improvements in the area of customer satisfaction.

Today, we have an end-to-end Customer and Partner Experience plan for the entire company. We have a set of global focus areas. Every business group, every business unit, every subsidiary around the world has a CPE plan. That plan includes things like Broad Customer Connection, the investments we've made to reach out to developers and IT pros in a much more proactive way, both with on site seminars, on site engagement but also using Microsoft.com and the communities of newsgroups and workgroups that we can create a global electronic community of these audiences.

It includes the work we focused on around customer value, getting our business groups more connected to the customers and the work in the field, so that as we do innovation we can do it in a way that really is delivering clear value to our customers.

This is where in the area of the enterprise we've aligned by industry vertical, we've strengthened our industry sales teams and industry expertise, and we’ve strengthened the partnerships that we have around industry vertical solutions. In the small and mid-market segment we've merged the sales forces, we've invested in the reengineering the partner program, reaching out to the channel. The Microsoft Partner Program that we launched a year ago now has over 160,000 partners worldwide signed up and registered for that. Each of those partner entities has a number of employees that are all focused on building skills and capabilities, service offerings and value around the Microsoft platform to our joint customers.

Certainly in the area of the Customer and Partner Experience we're doing a lot of work to enhance our relationships with enterprise customers as well as small and mid-market customers. In the area of relationship excellence, for example, our account teams sit down with every customer and they do what we call a conditions of satisfaction where we get feedback directly from the customer on what they define as their satisfaction and that becomes the scorecard or the work card for our account teams to really focus.

We've implemented programs and incentives to ensure that we have longer account manager tenure on an account. We understand that the longer we can have that relationship between an account manager and an account team and their customer, the more satisfied the customer is.

In the area of the Microsoft Partner Program, this year we are investing over $1.6 billion really around enhancing the partner experience, helping our partners build skills and competencies, providing them the service and support they need to be effective, and helping them generate demand with through-partner marketing.

And finally it's about listen and respond. In the last three years we've implemented a system called Response Management where every one of our employees, if they identify a customer or a partner satisfaction issue, they load that into Response Management and we have a team and a process where we follow up on every one of those incidents, every one of those issues. We've solved thousands of individual customer issues and we've used that feedback to create a database of all these customer issues so that we can focus on the ones that are systemic, where we need to make major change at a policy or a program level within the company to ensure that we are making positive progress.

Every year we survey our customers and partners for their overall levels of satisfaction and over the last two years we've seen positive increases in the overall levels of satisfaction.

We've reengineered our compensation plans, our goals for our people and are really going through a cultural change to ensure that we do take a balanced approach where Customer and Partner Experience is core to what we are doing.

Now, the big question that comes in says, well, what are we doing in the area of security. Security clearly is a top area of feedback we've gotten from our customers, it's an area that is an industry wide issue and it's an area that we as a company are taking a leadership position in reaching out to our partners and our customers to help provide solutions.

How are we doing in the area of security? Well, there's kind of five core pillars of the plan and the execution model that we have in place. In the area of innovation we've innovated with new technologies around isolation and resiliency. With Windows XP Service Pack 2 providing firewall protection, providing protect the perimeter to protection with Active Protection Technologies that prevent viruses or malware entering a personal computer, whether it's over e-mail, browsing the Web or just over application connectivity. To date over 130 million customers around the world have downloaded and installed Windows XP Service Pack 2 and we see that trend continuing.

There's more innovation and more work we're doing in the area of isolation and resiliency and the first wave of that innovation has come out in the area of Windows XP Service Pack 2 and the ISA Server 2004.

In the area of advanced updating, we've been very focused on automating the software update process for customers. Certainly that was an area that created many challenges, keeping the software updated and especially when it involved security updates.

So with the work that we've done with Software Update Server and then the superset of that in SMS product we're now helping customers dramatically reduce the cost and complexity of deploying software updates.

With Software Update Server we now have over 160,000 daily connections to Microsoft where we are streaming software updates out to our business customers into their firewall. They then with Software Update Server and SMS can configure those deployments to distribute that software within their company.

On the consumer side we have over 120 million unique computers that get automatic updates from our Windows Update site.

We continue to work on the management technologies and the management platform to further automate software distribution.

In the area of authentication, authorization and access control, new technologies and new partnerships. One thing I would highlight is the work that we've done in the area of the Government Security Program. We took feedback from many governments around the world that had concerns about security and specific to Microsoft requests such as being able to access and review our source code, being able to have a direct relationship into Microsoft for security related issues that might affect critical national infrastructure.

To date we have signed over 34 Government Security Program agreements with countries around the world. We continue to enhance this program, enhance the relationship, and so when you look at things like PKI, approved by Federal Bridge Certificate Authority, the work we're doing with each government entity around the world to ensure that they have the appropriate level of technology and security to satisfy the needs of government; in addition to that, technologies like rights management and Active Directory have been enhanced.

In the area of engineering excellence, our fourth pillar, we've really focused on a variety of things. We've taken all our software developers and trained them around writing secure code. Microsoft Research developed a set of technology tools that allows us to read source code, software that will read source code and identify potential security vulnerabilities before a product is released. We've enhanced our software testing process to ensure that we are identifying and fixing more of these issues before a product is shipped.

Now, we've seen progress. In the area of Windows Server 2003 we've seen nearly 70 percent fewer critical and important security alerts when compared to Windows Server 2000.

And then finally in the area of reaching out to customers and partners we've focused on a set of guidance, tools and a response infrastructure. We've trained now over 600,000 IT professionals on how to configure and deploy a more secure technology infrastructure. We set up a community of chief security advisers that connect in with Microsoft and we've created a community where we're sharing best practices across customers and partners and Microsoft, and we have a continued dialogue with the individuals around the world in their organization.

Now, this has helped, I think, strengthen not only the relationships we've had with customers but also make improvements in helping customers ensure that they have a secure, trustworthy platform to run their computing infrastructure on.

Security is a journey and these are a set of steps. When Bill Gates launched the Trustworthy Computing initiative three years ago, we've executed against that, we continue to execute against that and we see this as a long term journey that we are very committed to and will continue to make a priority.

Let me move now from driving satisfaction to win customers and the question how are we doing versus Linux. Let me start by framing a perspective of how the dialogue has shifted with customers. I would say three to four years ago, the dialogue around Linux was really much more of an emotional debate over software development methodologies of Open Source versus the commercial software methodology. Today, that dialogue has shifted to a very logical analysis of the business value.

Customers are looking for business value and what is the business value they look for? I highlight just five of the potential areas here.

Number one, total cost of ownership. Many customers perceive that since Open Source software such as Linux has a software acquisition cost of zero, that it must be lower total cost of ownership. If you look at the facts though, they don't support that. On our Web site, www.getthefacts.com, we have over 17 industry analysts and over 100 customers who have gone through the experience of either trying Linux and finding that total cost of ownership was higher than it is on Windows or doing the analysis. For example, the IDC study showed that Windows was between 11 and 22 percent lower total cost of ownership than Linux over a five-year period.

Now, customers have experienced this. One customer, Grand Expeditions, is in the luxury travel business. They're based in Florida. After September 11th when the travel industry fell off significantly, they were looking for ways to cut their operating costs. They made a decision to go to Linux, with the view that that would help them lower their overall costs. After two years of struggling and increased costs of trying to manage and keep that system up and running, they made the decision to switch back to Windows. And it was really a decision based on a better total cost of ownership.

The other areas are equally as important: developer productivity. The backlog of applications and projects that customers have now is at a significant high point, given the tightening of IT spend over the last several years. They're looking for ways to enable these new applications in a very efficient, productive way, and they want these applications to interoperate with their existing IT infrastructure.

Jupiter Research did a study. They surveyed IT professionals. Seventy-two percent of those IT professionals rated Microsoft number one in the area of interoperability in their existing environments.

Giga did a study around developer productivity. They benchmarked building an application using J2EE on Linux and building the same application on .NET on the Microsoft platform. They found that the .NET application could be built not only faster but it could be built, deployed and maintained over a four-year period between 25 and 28 percent lower cost than the Linux solution built with J2EE.

So we see more professional developers using .NET now to build XML Web Services than using J2EE and that's a trend that has continued here over the last three years and now we're at the point where more professional developers on a worldwide basis are developing with .NET as their primary development platform versus J2EE.

I was in Tokyo a few weeks ago. JR East, the company that runs the bullet trains in Japan, certainly they're building their bullet train applications using XML Web Services and .NET. It's one example of customers getting the business value of developer productivity and interoperability from the Microsoft platform.

Now, the final two areas fall in the category of risk management. Customers will look and say security is a top priority and certainly with the large installed base of Microsoft products, they look and say, "Microsoft, we want to make sure that not only are you focused on security but do you provide us the best value around security."

In a recent study done by Forrester benchmarking Linux distributions relative to a number of different parameters on security as compared to Windows, they found that Microsoft provides the lowest average all days of risk. They also found in that study that Microsoft had better responsiveness and more completeness in addressing critical and important security vulnerabilities than the Linux distributions that they studied.

The final area is one that we've had many questions from customers as we enter into discussions with them and their questions are around intellectual property. Certainly they want to make sure that when they license software from Microsoft, that they are protected on all aspects of intellectual property, whether it's patents, copyrights, trademarks, et cetera.

And so as part of the response to that, we've listened to our customers and we've significantly enhanced the overall IP indemnification in our offering. I think a year ago we announced full IP indemnification in our volume licensing and in the last month we've announced we've announced we've now extended that to all license types so that all of our users of our software can be assured that we stand behind our product and we stand behind the intellectual property protection that our customers expect and deserve. And we feel like this is a significant differentiation point because that is not something that is available today in the Linux and the Open Source platform.

Now, if you put all of these things together, what does it mean in the market? What are customers actually buying? Well, let me just highlight a few trends for you. I'll show you three things here from our fiscal year '04 results. The first is around server shipments. In the area of server shipments -- this is based on our own internal analysis and data -- but fundamentally what we saw was Windows Server units grew faster than server shipments and gained 2 points of share. We also admit and look at the analysis that Linux also gained 2 points of share. So who was losing share? If Windows gained and Linux gained, who was losing? Well, it's clear that UNIX is declining in share, as is Netware.

And so what customers are looking at as they are making these platform decisions, they are making decisions to switch from UNIX and Netware and either move to a Linux platform or a Windows platform on the server. As they do this analysis, they're certainly taking into account all of the factual attributes that I just highlighted on our Get the Facts campaign: total cost of ownership, developer productivity, certainly interoperability, security, as well as IP indemnification.

Now, what we see fundamentally on the server side is many customers that have a line of business application on UNIX, when they look to make that change, oftentimes they'll look and say, well, it's easier to move an application from UNIX to Linux, therefore I should go to Linux.

The interesting thing was though in the last year we ran a campaign around UNIX migration and in the first 60 days of that campaign we had a pipeline of about 300 opportunities. Of those 300 opportunities, a little over 100 of them were actually Linux to Windows migration. So even in cases where some customers have moved an application from UNIX to Linux, we believe that that may just be a short term interim step that they are taking as they look at how they standardize their infrastructure and standardize their server platform.

So we will continue to be focused on how we grow our Windows Server units faster than server shipments and continue to gain share.

In the area of PCs, PC shipments, Gartner did an analysis that showed in terms of PC shipment usage over this last year that fundamentally there was no change. Certainly we acknowledge that there are some projects or pilots people are looking at Linux on the desktop but fundamentally we have not seen adoption of that start to take place and I think the statistics here confirm that as well.

The final area would be in some studies that were done by a third party management insight group really looking at the value added provider channel. These are our partners, hundreds of thousands of partners around the world and they survey them on preferences and attitudes looking out over the next fiscal year. And they ask them where they see the markets moving or where are their preferences in terms of the platform decisions that they are engaging in discussion with customers.

And fundamentally the Windows platform out of that survey had gained 7 points in this last study, which we think is a leading indicator that just reflects the fact that customers as they've tried Linux, some of the things perhaps they've perceived about it have turned out to not be true and the reality of what it takes to run a critical infrastructure computing environment in an efficient way is setting in, and so our partners and our customers are seeing that when you make the decisions based on business value, that the Microsoft platform delivers significant value, is differentiated from Linux and is supported by evidence and facts.

Now, I talked a little bit about drive satisfaction, win customers; I now want to shift to grow the business and this is an area that many of you would ask the question, you know, "Microsoft, how will you grow." And I want to start by just looking at some of the data on IT spend trend.

Certainly coming out of Y2K and the dot-com bubble, there was a decline in IT spend. In fact, in 2001 IT spend decreased. Now, for the years 2001, 2002, there were decreases in overall IT spend in the corporate community. 2003 was relatively flat from 2002, so this year, 2004 is the first year in four years that we have seen an increase in IT spend. The forecast by various industry analysts looking at 2005 IT spending patterns show that they anticipate that will grow; some think it's as low as 3 to 5 percent, others say it's 6 to 7 percent, so it's kind of mid single digits is what industry analysts are projecting in 2005.

But the fact is with this decline in IT spend there are a couple of key trends that customers have focused on. Number one, how can they run their IT infrastructure more efficiently, how can they invest in projects that help them gain efficiency long term. So projects like server consolidation, systems management, automating software distribution all fall into that category.

Number two, security has been a top priority, so projects related to security become very, very key. And that security may be refreshing old infrastructure that perhaps is not in a situation to create a secure, easy to manage infrastructure platform or it may be new products and new technologies to help protect the perimeter, help filter spam, help with different areas that relate to security.

Number three is new applications. The application backlog has grown significantly over this last four-year period. Line of business executives and line of business decision-makers have business needs, they need applications to help connect back-end systems, help them reach out to new customers and new markets, and in many cases those applications have been on hold.

Now, there is some other analysis that was done that's fairly interesting. Mckinsey did a study that basically showed what they referred to as the Y2K effect. 2001 showed the first decline in IT capital expenditure since the year 1958, a very significant event, and everybody recognizes it was the significant capital expense investment that took place in the late 1990s preparing for Y2K and related to the dot-com bubble.

In 2004 they did the analysis of over 100 customers and they saw that depreciation expenses were actually decreasing by 6 percentage points in their budget, freeing up fundamentally 6 percent points in their operating expense that could either be utilized to drop to the bottom line for profitability or it could be reinvested in either additional capital expenditures or operating expenses to reduce the project backlog.

Now, that becomes fairly significant when you think about the opportunities for growth going forward and where customers are thinking about their investments and the level of spend that they may have.

Now, frankly, I don't anticipate we will see a big spike in infrastructure refresh. What I see customers doing is being thoughtful about the long term, they are engaging in infrastructure refresh today but it's a very structured process and a very fluid one. I don't think we will see a spike, I think we will see a continued focus on a long term refresh cycle that customers build into their ongoing IT plans and strategies and one that I think is underway today.

Now, how has Microsoft fared during this period? Well, I plotted Microsoft revenue growth overall as a percentage during this period, so clearly we too coming off of Y2K saw declines in our growth rates but our growth rates have maintained themselves well above IT spend growth rates and since the year 2001 our overall top line revenue growth has increased growth year on year from 2001 to '2 to '3 into our fiscal year '04.

Now, if you look at that data and you say what are the opportunities for growth, I want to kind of frame a little model for you that will help you perhaps think about the growth opportunities ahead.

That model starts with the install based of devices and I include personal computers, Tablet PCs, servers, cell phones, embedded devices, as well as TV set-top boxes, Xboxes in that particular comment.

And if you look at the install base, the install base becomes very important. I think in a lot of cases people are focused on shipments but the install base is equally important. It is a market for us to sell software to. Now, that install base, if you look at personal computers, for example, represents about 600-plus million personal computers around the world, projected to grow to over a billion PCs install base by the year 2010.

Certainly server install base continues to grow. Server shipments we project will grow in the range of 13 to 15 percent this year. That install base continues to grow.

In the area of cell phones, there are about 600 million cell phones being used around the world today, 25 million of which are able to use Windows Smart Phone or Smart Phone technology. Analysts anticipate that 600 million cell phones growing to perhaps nearly a billion cell phones by 2008 and they expect that the share of those that will be Smart Phone capable will be in the 100 to 150 million range.

Embedded devices: 1.4 billion embedded devices with 32-bit microprocessors. That's the projection for calendar year 2006.

Xboxes: There are 15.5 million Xboxes installed at the end of our fiscal year '04. We project that growing to 20 million Xbox installations by the end of this fiscal year.

TVs: 1.6 billion TVs. By 2008, 738 million of those are projected to be pay TV with some kind of set-top box and connection to those.

Now, this is important. Because this install base of devices continues to grow, it grows because there's customer value, value that's being created, whether it's for consumers or businesses, to want to invest in these new devices and these new technologies, and with more devices out there it creates opportunity for the software industry. Every one of these devices runs software.

Now, when we think about our growth opportunities in the area of software, it's a couple of things. Certainly there are existing scenarios. An existing scenario example would be I highlighted sort of our Windows Server versus Linux and the set of scenarios that Windows Server enables in the infrastructure. One part of the growth opportunity is to continue to gain share. The more we gain share both in units and the attach of new products and new workloads, that's an opportunity to grow.

But the wonderful thing about software and the magic of software is that we can also enable new scenarios. These new scenarios will come through the innovation and the creativity of our R&D organization and of the work that we do with our partners.

Let me just take a little opportunity and walk through this model and focus on some of the areas that are relevant to this growth opportunity.

First I want to start with PCs, 600-plus million PCs install base worldwide, projected to grow to over 1 billion PCs by 2010. IDC did a study that showed fundamentally the PC household penetration U.S. at about 60 percent, Western Europe at 30 percent and they looked at many of the emerging markets such as China, Russia, India and Brazil and certainly in those countries the PC household penetration is much, much smaller. If you look at where that growth in install base will take place over the next five years, over 50 percent of it will take place in these types of emerging markets.

Now, certainly that has implications. Many people will say those emerging markets have some perhaps different dynamics in the marketplace and those emerging markets tend to have higher rates of software piracy than other markets. So let me just highlight a couple of more statistics and the work that we're doing here.

Let's just compare the U.S. to two emerging markets, India and China; the U.S. with a population of about 300 million people and about 96 million households and India and China with about 1 billion people in India, 1.3 billion in China, and they represent about 37 percent of the world's population.

When we looked at the data from World Bank that showed annual household income, you start to see some dramatic differences. The percentage of households that have annual household income above $5,000 to $6,000 per year is very, very small relative to total households in India and China where it's relatively high in the U.S.

In the studies we've done in India and China we think it's about the $5,000 to $6,000 per household income level that creates the opportunity for households to purchase PCs and to increase PC penetration.

So the opportunity is how do we reach those households at about the $5,000 to $6,000 per year level, what do we do in terms of digital inclusion and initiatives that we can take to be creative about reaching the broad set of population that is below the $5,000 to $6,000 per year annual income and then finally how do we work on software piracy.

Well, let me just start with a set of things that we are doing in these emerging markets that we've announced here recently. The first is something called Windows XP Starter Edition. This is a new product that we are piloting that is a direct result of our partnership with governments in some emerging markets to really focus on digital inclusion, partnerships with governments such as Thailand, Malaysia and Indonesia, and we worked where we engaged with hundreds of customers that fall into these categories in these countries to really understand their needs, what would they use the personal computer for, what kinds of scenarios, and we've really tried to tailor and localize this Windows product for consumers so that it is, number one, economical; number two, it is really tailored for first time PC buyers. This is not a product that an experienced PC user would want, it's a product really tailored for first time PC buyers. It is compatible with Windows applications and devices and it's the opportunity for us to reach out and deliver a new product and new creative scenario to some of these emerging markets.

As I mentioned, there were some partnerships we struck with government to help focus on this as part of our citizenship and digital inclusion efforts and in the pilot markets we now are running pilots in five countries: Thailand, Malaysia, Indonesia, India and Russia.

Now, the Starter Edition is one example of the work we are doing; the partnerships with government are very important as well. As we've worked on these emerging markets and we've worked on winning customers broadly, we've recognized that we've had to really step up our efforts in the public sector. We've established a globally managed public sector vertical, we've dramatically increased the sales resource in the field so that we are reaching out to governments on the set of priorities that government have, whether it's national security, whether it's education, whether it's digital inclusion, healthcare or many, many other issues that governments are focused on.

So, for example, in working with governments, like we now have over 74 countries we've signed agreements called Partners in Learning where we are also delivering technologies to under-served school systems and educational institutions to help them in their educational systems get access to technology.

Windows Starter Edition is an example of the work we're doing in the area of digital inclusion. I'd like to just play a very short video that gives you a sense of the types of people and the scenarios that Windows Starter Edition enables.

(Video segment.)

KEVIN JOHNSON: So clearly this is a product that we've worked in this particular pilot to reach out and understand the types of scenarios that these people utilize these computers in, in a first time usage in a home. It's a combination of education, entertainment with games and things they do and many of them are also running a small business somehow and using this as a tool or technology as a way to enhance that.

She also mentioned other areas in the video, things like Internet cafes. We have many pilots and work underway in China to help expand the number of Internet cafes. In India we've got a center for rural computing where we're working with kiosk manufacturers and new ways to bring technology to market.

So the emerging markets are very, very key.

A big part of the work there and worldwide is the area of piracy. Now, certainly software piracy is a worldwide problem for the industry. Worldwide it's estimated that piracy costs worldwide economies $29 billion per year. Worldwide studies show that potentially 36 percent of users run some form of pirated software. Just in the U.S., for example, 23 percent of PCs in the U.S. in certain studies have shown some form of software that is not genuine.

So this is a big opportunity and it's one that we are approaching in a way that puts the customer first and is very much focused on the value proposition to customers.

Number one, it's about education. In many ways, customers don't know whether or not they're running genuine Windows or not. So we've launched a new program called Windows Genuine Advantage, a pilot that we started, which is really about building customer awareness and preference for genuine Windows. Now, it's done in a way that enables customers to go onto Microsoft.com and validate that they are running genuine Windows. They can either go onto the Genuine Windows site where there is a download center and they get to opt in. They go and they validate and it tells them whether or not they're running genuine Windows. If they're not running genuine Windows, it gives them some information that they can take back to their reseller so that they can have the discussion and seek redress if they thought that they purchased a legitimate copy of genuine Windows.

But for those that are on genuine Windows, we want to differentiate and show the value proposition, so we are enhancing on the Microsoft.com Web site an area for downloads for customers that are running genuine Windows, things that would enable them to take advantage of new software, whether it's Photo Story or discounts on games from MSN or a holiday fun pack, and we're piloting this right now.

It's an opt-in infrastructure, a pilot is under way. When we first launched it, we thought we would have 20,000 or so people opt in. Well, shortly after we launched it, we found we had nearly 900,000 people that went though and validated that they had genuine Windows and opted in.

As part of the Windows Genuine Advantage we're also reaching out to train the channel partners, train them on how they can tell whether or not it's genuine Windows and how they can sell the value of genuine Windows.

So we're trying to take a very pro-customer approach to enhancing the value of genuine Windows and do it through a good job of doing education, reaching out to the channel and enhancing the value proposition of genuine Windows.

This is a pilot that we are running today and we expect to roll it out more broadly after the first of the year. I think right now we're planning to roll out broadly in English in January and in all EU languages in February. It's a very important part of the work that we are doing to help enhance the value proposition of genuine Windows and do it in a way that creates a great Customer and Partner Experience.

Now, growth. So much of the growth in the install base you look at may come in the area of emerging markets for personal computers but there are also existing scenarios and the work that we do to gain share.

Now, many of you ask the question, "What do you get for $6 billion invested in research and development?" Well, we took a look over the last 12 months in our fiscal year '04 and we had over 60-plus product upgrades coming from every one of the seven business groups, so many different product upgrades. Every one of those product upgrades is based on feedback from customers and ways that we can enhance the value proposition, utilize new innovation and continuously improve. So when we launch these new product updates, it's our opportunity from a sales and marketing standpoint to go out, sell that value proposition and take share.

The investment in R&D also generated 45-plus new products. These are new products that enable new scenarios and new value for customers. So that investment in R&D is creating opportunity through new innovation.

Now, from a sales and marketing standpoint, we've got to look at those 60-plus upgrades of products and the 45-plus new products and translate that integrated innovation into a compelling, simple value proposition to customers.

This is an area that we've reengineered here over the last year. In fiscal year '04 we were focused on what we were calling go-to-markets and we'd have perhaps seven to ten different go-to-markets that would change very quarter. Now, you can think of the go-to-market as a marketing campaign and a selling initiative where we launch in the market a clear value proposition, we do some demand generation, whether it's through advertising seminars, and we send the sales force out to go create opportunities and drive the pipeline.

What we've done to really change that is really oriented around five global go-to-markets with the clear value propositions. One is in the area of our Windows client business around “Experience More.” In the business it's about enhancing security and for the consumers it's about digital entertainment and new scenarios. You've seen our launch of Windows Media Player, our MSN download service, the new Portable Media Center device, the new release of Media Center Edition 2005, all around that particular go-to-market.

Each of these go-to-markets has multiple products from different business groups that make up the solution. In the area of enterprise customers or corporate business customers, “Doing More with Less,” helping them take costs out of their IT infrastructure. So the work we're doing with Windows Server System and enhancing the value proposition as part of that go-to-market.

For the information worker and productivity, “New Ways to Work,” with Office System 2003 and with the work we're doing on the server side with SharePoint and Windows SharePoint Services we're enabling new scenarios, real time collaboration, new scenarios such as Live Meeting.

In the area of developers really focusing on how to quickly “Build and Efficiently Maintain Connected Systems.”

And then certainly for the budget decision-makers, “Business Insight,” whether it's business intelligence scenarios or the work we're doing in Microsoft Business Solutions.

So this customer value from a sales and marketing standpoint really is trying to aggregate all these technologies and products in some compelling value propositions and simple solutions that we can do a better job reaching out to customers and frankly really reaching out in a way that enables us to upsell and to attach new products. Upsell may be upselling from a standard edition of server to enterprise addition. Attach may be saying for every customer that buys Office we should also sell them OneNote. And so this creates an opportunity for the sales force to have some levers in terms of how they're selling and how they're working to grow the business.

Now, the final area of growth is around new scenarios. There are many new scenarios; some of those are driven purely by product, some of those new scenarios are driven by new services. I'll highlight just a few examples of some of the new service scenarios and how that may relate to the growth opportunity.

First of all, for Microsoft Office we have now 48 million visitors per month to Office Online and we have over 120 million users in the install base that connect to Windows Update. This service is now enhancing the experience that they get from those products.

Xbox Live: The Xbox Live service, a subscription service, now has 1 million plus subscribers and with the launch of Halo 2, it is helping drive more subscribers to Xbox Live. Halo 2 marked the biggest 24 hours in entertainment retail industry with over $125 million in sales. We now have over 150 games that are, quote, "Live enabled."

A new area, I mentioned earlier around install base of devices around TVs. Now, Microsoft TV, we've been working on many technologies from an R&D standpoint for many years. In the last year we've signed 13 new cable company and telco company customers to new pilots and initiatives. For example, Comcast is now launching a pilot in Washington State based on the Foundation Edition of Microsoft TV. This is technology that runs in a set-top box and technologies that run in the server at the cable company to enable companies to deliver these digital cable services and technologies using on-demand services and the technologies that we can build through software to run on these devices.

The model for it is the subscription model. We work with these cable companies and telco providers to provide not only the initial subscription per user but an ongoing maintenance subscription.

SBC recently announced a consumer trial of IP-TV. Where the cables are focusing on delivering their TV services as well as broadband connection through cable modems and their digital entertainment services, the telcos are focused on how they can enhance the relationship they have with customers that have their phone service to expand it to DSL broadband and now are working to deliver TV services over IP.

And SBC announced the work with Microsoft TV for an IP-TV consumer trial. This was announced as a $400-plus million agreement over the next ten years for this trial and we anticipate that these trials and these pilots will expand and create additional opportunities for us.

And finally I'll highlight MSN. With over 350 million visitors per month, it is an ad-funded business model, it's one that last year we turned the profitability corner and it's one that people expect the online advertising market to continue to grow. I think they anticipate that being a $9.3 billion market this particular year.

These are examples of services that we're getting in that either enhance existing product scenarios or create new scenarios both for consumers and for businesses, and I think when we think about the opportunities to grow the size of the software industry, it will come through new innovative scenarios that we do and our partners do and others in the software industry and I highlight just three or four here for examples for you to think about.

Now, I want to wrap up here but I just want to summarize that what I've kind of done is really focused on how we as a company have reengineered ourselves around these seven business groups with the key focus on innovation, how that innovation really translates to customer value and that with our mission and focus we put the customer first and from a field standpoint we focus on our three priorities or goals: winning customers, driving satisfaction and grow the business.

So with that, I guess I'd like to open it up for questions and discussion on topics that may be of interest to you, so I'll turn it over to you. Thank you.

END

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