Mobile and Embedded Devices: New Markets, New Opportunities
Financial Analyst Meeting 2004
July 29, 2004

ANNOUNCER: Ladies and gentlemen, please welcome Senior Vice President, Mobile & Embedded Devices and Communication Sector, Pieter Knook.

PIETER KNOOK: Good afternoon. I have the great joy of bringing all my demos with me in my hand here, so I'm a lucky guy. I don't need a room full of servers to show off what I've got.

One of the things that I will hope to explain by the end of this is why many of you will have a different device in your hands next year when you come back. That's one of my chief goals: to show you how serious we are about the mobile information worker kind of groups specifically, but in general I'm going to start off talking about our overall mobile innovative device business.

Now of course this is the smallest but fastest-growing business, and also the most interesting at Microsoft. We have a good story to tell. So last year was a great year. We achieved some significant milestones. We had some great business growth, which we're very proud of, fueled by a number of different factors. Obviously the set of products that we have, including the embedded operating systems, including some of the applications that are built on top of that, such as the phones, the PDA environment. We overall had a very successful year with $240 million of revenue, which puts us at 58 percent growth, which means we were the fastest-growing business last year; and certainly a much improved loss position, although still an operating loss, which is indicative of the great investment we're making from an R&D perspective.

We also achieved leadership position in some of our device categories, so certainly if you look at the PDA category we are now neck and neck for the Number One position. We're certainly Number One in Europe, we're certainly Number One in Asia. With the withdrawal of Sony from this market, that makes our position even stronger. So in the PDA segment we've certainly demonstrated that as we work hard to get a great product and a great software experience to market, and work well with our hardware partners, we can come from behind and become Number One, which is important because we obviously aspire to the same feat in the phone space. More of that later.

On the embedded front, we've also achieved Number One, in this case in a slightly different vein, because here we're talking about revenue, and we're the Number One revenue generator in the embedded operating system market. So we surpassed all our commercial competitors. And of course Linux doesn't quite fall into the revenue-generating category in quite the same way. More of that, too.

From a product-line standpoint, we released a number of products on the Windows Mobile front. The software that powers our Pocket PCs and Smartphones, we've had a number of releases of that product, which has spurred a large amount of hardware innovation, and you'll see some of that. On the embedded front, we released Windows CE 5.0 just in the last couple of weeks, and that continues our progress on the embedded front, ranging right from the lowest-priced operating system SKU at $3 for very small form factor embedded devices all the way through to the most sophisticated devices, like the Portable Media Center that Will showed this morning, or some of the Pocket PC Phone Edition-type products that I'll show you here in a second; so, great refresh on our product line.

We also added a number of applications and services that are adding value to our core operating system and applications business—MapPoint, which is also part of our business—that really helps to flesh out what we're doing into location—and navigation-type applications, which are increasingly important for our devices.

And we made a lot of progress with customers and partners, certainly on the end-user front. We've seen a large number of end users adopt this operating system platform for many of their embedded devices. So on the point-of-sale side, people like RadioShack. Obviously on the wireless side and the Pocket PC Smartphone category, many new relationships with operators as well as with core OEMs like Motorola and Samsung. So, a lot of progress in the way that our ecosystem comes together, and that's been very exciting for us.

We also announced just recently in the auto space a big project that's underway with Fiat to embed technology into their car display that will make sure that the devices that come into the car will be even more powerful in a Fiat. And obviously with our own devices integrated super well, we really bring to play entertainment and communication scenarios into the car environment. And that Fiat project is a great milestone in demonstrating what we're going to achieve there.

So '04 was a great year from a revenue standpoint, from the strategic position we garnered, and certainly some of the progress we made.

As we look at the opportunity that we face, obviously the number of devices that we're targeting is still huge: 1.4 billion units. You probably can't see all these detailed pie segments, but it's important to note that the categories where, as Bill highlighted, we're likely to be able to make a difference with software. Those are the ones that we're targeting. So obviously phone and PDA, because those are segments where people do need rich software. Increasingly the operators are dependent on transitioning their revenue dependency on voice, on SMS, to other types of services, browsing, e-mail, application download, a variety of different applications and services that are propelling their change in business model. And rich software is really the only way they're going to be able to get at those revenue opportunities.

In the audio space or the video space, as those categories emerge, the whole entertainment idea of selecting, managing and configuring your digital entertainment experience, so we'll demonstrate some of the products that really propel rich software into those categories, whereas in the past we've talked about fairly lightweight experiences when you have a DVD player or a simple TV set-top box. There's really very little opportunity for software to differentiate. Now the environment is changing, and that means that these slices of opportunity become more interesting for Microsoft.

So now at least 60 percent of these devices are devices that are targetable by the kinds of software that we're developing, and that of course multiplied even by a small number of royalty amounts will make for a big business, and that's clearly what we aspire to.

So in a sense this business is interesting just numerically times the royalties. But that's not the end of the story, because we're really thinking not just about this as a device business on a stand-alone basis, but how this device business integrates with the rest of Microsoft.

So when we think about how this security is evolving, there are a number of factors at play here. The first one is this notion that people are increasingly switching how they think about devices. When we're in the car, we're not just interested in a device that moves us from point A to point B. Whilst we're doing that, we want to be entertained; we want communication A car has become a multipurpose device for entertainment and communication, as well as for transportation. The same is true in other categories, where more and more devices maybe optimized for a particular feature, whether that's gaming or entertainment or media or e-mail. You expect those devices to also be able to do other things, like make phone calls or hold some pictures or whatever it is. So there is this trend to more and more multifunction devices. That doesn't mean that everybody's going to carry one device, but it does mean that there are optimized devices that can do more than one thing. The second trend is the one that I think is very clear: there's a move from analog to digital. This is particularly true in the entertainment business, and as that has unfolded, obviously software becomes a bigger and bigger player in the whole entertainment space, and you see us participating with products like Media Center and all the devices that are going to sit around the Media Center like that when you take it outside your home, into your car, when you have the media extender and other products like that that really extend that media experience beyond just the device in your living room, or wherever it may be.

The third trend is a trend from proprietary software to more and more standardized software. And we've seen this as the number of embedded vendors have collapsed into a smaller number of players in this space, and particularly in the consumer electronics space where the value-added software is becoming greater and greater. More and more people are picking a set of platforms to build these devices on top. And certainly that's our strategy with Windows CE:to make that adaptable to a wide range of different products, and make sure it can work in a variety of different devices. And I'll demonstrate some of those. Big trend to 32-bit processors inside these devices. Cost has obviously helped drive that volume. The operating system standardization makes 32-bit processors more and more of a factor.

Application development environment is also an important area. People are starting to realize that the third-party application add-ons with many of these devices are a bigger and bigger factor, and plus there was certainly a big momentum behind Java with seeing that wane as people realized that in fact the notion of write once, run anywhere is really not working, even in the phone space where a lot of this is being most pre-eminent. And people are starting to realize that it is very important to have some consistency in the developer environment. And obviously our developer story had some real strength, which again I'll touch on in a minute.

And then finally the bandwidth component: the notion that all these devices are increasingly connected. That does pose some interesting challenges for embedded devices, where the notion of an embedded device was that it wasn't connected to anywhere, and therefore couldn't be accessible either for bad, malicious purposes or for good intent.

So increasingly in the embedded space people are starting to worry about security, updating, and those kinds of things, which means that a lot of the things that we're doing in the PC ecosystems to update software, put in place firewalls, and all the things that we've talked about there, are coming into the devices space at the same time.

So those are some of the trends. We've changed the shape of my organization a little bit since last year, and I just wanted to reflect on that. Obviously Melvin Flowers came in as our new CFO. He's sitting here, so he's a key participant in our management team—good experience with a public company, so we bring in some good outside knowledge.

The other factor that's changed in our team is, we are a very global business. Obviously the single biggest phone market is not the U.S., unlike PC business, and so we are very diverse as a management team in terms of how do we think about which markets to go after and what kinds of software experiences we need to build.

The other change that we made was to bring together the people that build all the different operating systems and application technologies.The person that ran our research lab in Beijing actually is now running the development group, which combines both the embedded and the Windows Mobile Smartphone and Pocket PC types of devices. Same is true with marketing.

And then we have Tom's group that's really focused on all the applications and services that wrap around these platforms, so all the applications like MapPoint, the additional scenarios, like what happens when you take these devices into an automobile, or what happens when you think about expending some of the media experiences. We have that separated out, both from a business model standpoint as well as technology standpoint.

And then finally the sales force I manage. The underlying sales force that focuses on the device makers, that's an important constituency, obviously, for us. And then we have a focus on the communications sector, all the operators as well as the media and entertainment customers. That's well over a $1 billion business for us these days, and represents really a relationship that we are managing on behalf of all Microsoft with those companies. So when we sit down with a telecom, a Vodafone, a Verizon, or an AT&T Wireless, obviously we're not just talking about devices; we're talking about all the Microsoft businesses. And in fact all these operators have extreme interest in all seven of the Microsoft businesses. So that really means a brand new organization since last year, and has really configured us well to tackle the opportunities that I was pointing out on the previous slide.

So let me turn now to the requirements as we see them of some of our key constituencies that we're dealing with. And here I'm going to focus more on the Windows Mobile side of the house, and I'll talk a little bit about embedded. But really the Windows Mobile side has more complicated constituents, because when you're thinking about the phone PDA space, obviously you're dealing with a device maker, which is true of all of our businesses. And in that the device maker is obviously concerned about differentiation. They want to know how they're going to maintain their margins, how is Samsung going to look different from Motorola, and how are they going to continue to be able to innovate when we're providing a platform. Well, a lot of that is concerned with how did they get the opportunity to add applications and services as well as differentiate. And I'll demonstrate some of that later on.

The mobile operator is obviously an important constituent, and here this is pretty much confined more to the phone PDA space, where the mobile operator subsidizes the device in many countries, including of course the U.S. And their appetite is for these devices to generate more services running on their network. And although we do influence voice revenue outputs, in fact, many of the operators who are running Windows Mobile products in their networks will say that just because people have their Contact list on the device with them, and it's always synchronized with Outlook, people do make more phone calls. So there's positive benefit there.

But really we're focused on the data side, which is what happens when you have a device that can download ring tunes, that can really have a rich media experience, that can synchronize your e-mail, that can browse a lot, and has a great software experience such that the user feels good about using those types of applications. And so driving that R2 up is one of the things that the operators really care about, and we've demonstrated we can do that very well. In fact, our Windows Mobile products on the Orange network show a 275 percent increase in data R2 relative to people who switched from a non-Windows Mobile product.

Obviously the IT professionals are concerned, too. They're concerned about security. They're concerned about the cost of administration. They're concerned about how expensive is it to manage these devices in their enterprise environment. And here again we have some strong things to say. The developer is important. Again, the developer wants to know how many sockets, how consistent are those sockets. Do I have to retest and rebuild my applications each time a different handset or a slightly different form factor device comes out? And that's a big inhibitor from the developer's point of view. They would really rather see a more consistent environment than they've seen for example in the Java ecosystem.

And finally, the end user. And these are important, because obviously if you get through all the gates, and you've satisfied the mobile operator and the enterprise IP is happy, and the device maker is excited about bringing these devices to life, at the end somebody is going to buy one, and they have to feel happy about what they want, and obviously they want the right sets of services and communications. This is also to some extent a fashion industry, so it has to look right, feel right, and all those things.

So it's a complicated business to make sure that we can satisfy all these constituents. And in fact in some cases it's not easy to satisfy constituents who have, to some degree, opposing requirements.

So this is what we do and this is what we say to these constituents. So first of all, to the device maker, we point out the flexibility that the platform provides. When you look at the different form factors of device, I think that's a great indication of how much choice there is in what a device maker can do on these devices.

From the operator's point of view, of course, they care about that R2 uplift and we have great evidence the good software on these devices, particularly with Windows Mobile, really does drive R2 quite significantly, and that's the most concrete evidence that the operator is concerned about.

The IT pro is concerned about how to get a single administration model. In our offering, when you see what is built into Exchange 2003, which is obviously where we're heavily focused, and you see the consistent and single administration models, no separate server installation, no server that takes down the number of mailboxes that you can run in the maximum configuration such as you might have with a RIM solution. When you really focus in to the cost of running a mobile-accessible mailbox, we have by far the lowest TCO. So that's a huge factor in our favor. The administration, the security obviously is completely integrated with standard security protocols, because all our e-mail that passes outside the firewall uses the same mechanism as you would use if you were accessing your mailbox from a kiosk, all SSL base, all the security that you know how to deal with through your firewalls. It's exactly the same set of parameters.

And last, but certainly not unimportant, is the fact that for many IT pros the notion that e-mail might pass through somebody else's gateway is concerning, from a security and everything-else standpoint. We don't have that in our environment, because these Exchange 2003 mailboxes are directly accessible to the device without any intermediary.

From the developer standpoint, they love the fact that we have a single .NET Compact Framework. So this is the same as .NET Framework. Obviously there are some things we don't have on the smaller form factor devices that you would expect on the big PC. Absolutely the same tools can be used to build applications on a PC or on one of these smaller devices. So all these Visual Studio developments that are out there can build applications for these devices, for vertical needs, for the operator's needs, for an end user's needs. Or, if you're an ISV, you can use the same tool sets. That's a tremendously important point, and those applications will run in any Windows Mobile product.

From the end user's point of view, of course choice, form factor, they all matter..

Now, all of this depends on our integration with the rest of Microsoft. And for the mobile information worker, which is arguably one of the most important elements that we extend with our work, I wanted to show you some of the things that we can do with these mobile devices. Now, up until recently we've really not had as much choice as we should have in terms of the form factor of these devices.

So when you look at this device here, this is the iPaq 6300 that has been announced in the last couple of weeks. And this device will start shipping here in the U.S. on the T-Mobile network. As you can see, it has an integrated keyboard. But one of the key innovations of this device is that it has Wi-Fi as well as GPRS capability built in. So on the T-Mobile plan you will get a single integrated plan that will allow you to roam between those two environments.

So when you look at your e-mail box, you can synchronize that and get it up to date either in a Wi-Fi environment or in a GPRS environment, and it will typically pick the Wi-Fi environment as the lower-cost option and the preferred one. So that's important. Obviously as people might recognize with the Windows Mobile product here, when we look at our Inbox, we're seeing the full richness that you would expect with Outlook. In fact here I'm looking at the SMS mailbox. And if I shift over here to the right, I just simply move to my ActiveSync mailbox, which brings in all my Exchange messages. And if I do that one more time, here I have all my Hotmail mailboxes as a result of loading the optional Pocket MSN application that synchronizes my device with the Hotmail environment. So now I have a device that gets me all my e-mail up to date on this device. Of course it has all the rich calendar capability that you'd expect. Full keyboard on the device really makes it great for an e-mail road warrior.

So that is the range of devices. We're seeing some other choices. This is the well-recognized Pocket PC form factor that appears in many different guises. And this one now also has a slide-out keyboard that will allow you also to do exactly the same things. In fact, this one also has Wi-Fi and GPRS. And then there's the other device form factor, which is the Motorola MPX. So this one will work with a keyboard when it's opened one way, and works as a totally traditional phone when opened the other way. So this is a much smaller form factor device, again Wi-Fi as well as GPRS. And these devices provide a degree of choice in how these devices are going to supplement what people are doing.

The other thing I thought I'd show you is what happens when you get a really small-form-factor device. So, here, let me just put my Japanese driving license here on the device, and you can see what happens when you build the world's smallest Smartphone. And so this is a design actually that we came up with for making sure that we get a nice small form factor phone. You can see this is a super thin one. Maybe you can't. Maybe you can see it like this. But this is super thin. This is absolutely the smallest Smartphone that exists.

And the other thing I wanted to show you on here, aside from being a great phone, so it's always going to slip in my pocket—it has all the same applications in terms of e-mail synchronization, calendar appointments and so on—so those all appear on the device. But, like with any of my devices, I can customize this device. In fact, in this case what you're seeing is a home screen on this device that's developed by Orange. And this is how Orange will ship the device. So that's their preference for how they want to show their services. So in fact when I go into these, I launch one of the traditional applications. I can see my appointments here or I can see my SMS items if I go to this. So all of these, the way all of these services are laid out is entirely customizable by the operator.

So that shows the degree of flexibility that we're offering in the platform for the operator to highlight what they want to do, which is to highlight their services, applications and services. So this will launch—this is the Orange SPB C 500 that will launch in Europe this fall. We'll have a couple of other operators that will come on line with this product. It's going to be shipping in Asia, and we expect this to be a high volume shipper—great attributes of factory life, great radio stack—all the functions you'd expect. That of course we're seeing with all the devices I showed before—a VGA camera built in. And that's an increasingly a component for these devices.

So that's where we're at on the phone and PDA space. And for this mobile information worker category, the choice of devices is important, as well as the advances we've made in the IT environment, in how you manage the mailboxes, how you configure those, how it all integrates out of the box when you install Exchange 2003 or your Small Business Server. So we have a great proposition here for the mobile information worker.

I talked a little bit about what we've done with IT pros. That's important. Obviously we're linking with Eric's work in this space. He mentioned SMS and how that figures into how to manage some of these devices in the enterprise sense. I showed you the MSN connection, when you have Hotmail synchronized to your device, the IM client obviously is equally important. In fact, IM is one of our most popular applications on these devices.

Media is important too—not just the kind of media that you're going to see on the phone and PDA, where obviously they are primarily communications devices, but they also play media and full high-fidelity media. And when you insert your SD card you're talking about a gigabyte at least of music storage; so an interesting device.

But you want something that's totally optimized for that media experience and totally focused on that; of course, then we have single-purpose devices like the Portable Media Center that really are even better in that media environment when you want to have a lot of content with a hard disk requirement and a bigger screen and a device that's optimized around video or audio. Location is interesting. In Europe, some of the most popular bundles are around adding GPS and location navigation applications on top of devices. And with our MapPoint unit we're doing the same. In fact, we've just launched a bundle here in the U.S. that brings that same set of attributes to the device. So these are opportunities for us to add application functionality to the devices—same as what happens when you go into the automotive environment, where obviously, when you bring these devices into the car, people want a lower-distraction environment, so that becomes important. And then finally the developers, obviously an important constituency, which we work very closely with Eric's team to satisfy.

So, product road map. We're making a lot of investments, and I thought I'd quickly show you some of the things that we're building on top of these CE and XP embedded operating systems. We start here with a set-top box that's running Windows CE—does full Windows Media decode, both streaming and downlevel. Here is a Windows XP–based router product for satellite networks. Here is a ruggedized CE-based product for surveying. So that's quite a popular application. Another ruggedized application for retail environments. This device is in use by our forces in Afghanistan as a translator device. You speak English into it, and it speaks Pashtun or whatever language you want. Here is a device that does media over Wi-Fi connections, so you stream content into this device. It's always up to date.

Here's a camera with Windows CE-based technology inside it, and a very sophisticated set of APIs that all sorts of developers can use: a thin-client device, very small, that remotes a PC to this device, an automotive process-control logic device, an RFID reader based out of Windows CE, a point-of-sale system with fingerprint verification for credit control access. And this device is focused on heavily disabled people who need help to speak and are able to press buttons on here to have the device speak on their behalf if they are so impaired; so, some great products here. And the key attribute about all these products and our embedded technology is the speed with which developers can bring these products to market, and the speed with which OEMs can bring these products to market. And that's the core of where we're focused with our embedded technology.

So, an exciting product road map. Many exciting new priorities for us for fiscal '05 as we expand the range of devices that you're seeing, and you see us work even closer with many of the OEMs and operators to get those devices out there. Obviously we're well integrated now with the Microsoft field sales force as we pitch our mobile information worker, end-to-end story, as we pitch how we help to take out costs in the enterprise IT shop. We have a big connection with the Microsoft field. The application and device developer environment is important to us, and obviously all of our evangelism through the development conferences plays its part in that.

We're continuing to invest in new scenarios—the location, the car—those are all exciting, brand new areas. We're talking about voice products. If you come over to our booth, you'll see some very exciting innovation in the voice area that I wasn't able to show you here. So there's some new scenarios that are coming as well as just expanding the choice and array of different devices that you see in front of you.

And all of this will come from the attributes around the platform that we're driving. So for us '05 is an exciting prospect. We continue to anticipate that we will be a fast-growing business. We hope we'll be the fastest-growing business. We see lots of opportunity. That continues both in the embedded and the mobile space. And we're starting to see a lot of synergies as we bring together the scenarios around media, around mobile information work, around location, that bring our devices to life and attract a lot of users to those devices because of the benefits they bring.

So we have plenty of ways to spend our R&D. We continue to invest in R&D as we innovate against those scenarios. And obviously we're a big participant in the industry in a number of ways, both with operators, with developers, and with our device makers. So, great year ahead of us, and I look forward to sharing with you the results of that as we reflect on that in a year's time.

Thank you very much.

END

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