Windows Client: Growth Through Innovation
Financial Analyst Meeting 2004
July 29, 2004

ANNOUNCER: Ladies and gentlemen, please welcome Senior Vice President, Windows Client, Will Poole.

WILL POOLE: Good morning. When I took this new role about 18 months ago, I proudly forwarded mail around to friends and associates in the industry and told them about my new efforts to run the Windows Client business; no small task, something I'm really very excited about. And I got the expected number of congratulations and, you know, "Go get 'em" kind of mail. But a couple of my friends sent me mail saying, "Hey, you know, Will, you're an entrepreneurial kind of guy. You've done a couple of startups in your life. You kind of like doing things that are new and innovative and exciting. What are you doing running this business that's high market-segment share and maybe at the peak of its growth?" And I said, "Well, actually, I believe we've got some good upside in the business," but I couldn't really articulate, though, how. I just said, "Trust me. I think we'll get there."

And actually, with every new customer I've met, every quarter that's gone by, I see more and more opportunity in the Windows Client business. And it's something that's really quite exciting to see what we have in front of us, on top of and building on top of the amazing space that we have out there with the Windows Client business.

So there are five areas I'd like to talk to you about today. The first one is security, and clearly that's something that's at the forefront of our efforts across the company, but particularly in the Windows Client business.

Once we clear security, we'll talk about opportunities for the future and we'll talk about how we can grow the number of PCs that are purchased by existing customers, existing households, existing businesses; talk about how we can help improve and make the ecosystem successful and vibrant for all of our partners; and then look out a little bit further and see what we can do in emerging markets and also to help to capture revenue from the unlicensed PCs that are out there. Before getting into that, I have to take a quick look at revenue. We've got a financial discussion here, and you saw our results announced recently. It's something that we feel very good about for the Windows Client business—$11.5 billion in revenue last fiscal year. That's a growth of $1.1 billion over FY '03, 12.2 percent compound annual growth over the last four years. It feels like a pretty decent growth business to me.

To put the $1.1 billion into context, you all know that's more than half of a Google that we grew last year -- not too bad. John Connors will be talking to you more about what we expect for the future, but I think historically we feel very good about where we've been. And I think you'll see from the strategies and the work we're doing going forward that there's a lot of opportunity for growth in this business.

Now, security, as you know, is something that has been at the forefront of Microsoft's efforts in Trustworthy Computing for a number of years now. And certainly the Windows Client business over the last fiscal year, some of the issues have come to a head. And we really are looking at these efforts in the context of our overall company Trustworthy Computing efforts to improve the isolation and resiliency of all of our products, to improve the rate and quality at which we update our client and server products, to improve the quality that we use to train our engineers to build systems to ensure that the software that we ship in the future is secure. We've actually received a number of industry leadership awards for that and feel very good about it.

We also are looking at how we improve the systems for authentication and access control, again, across a whole network of interconnected devices to ensure that the level of security of an entire enterprise or an entire household is maintained. That's the broad set of efforts that we're doing.

And I want to put in context why those are so important for you, specifically for the Windows client. Now, as you know, today there are a number of different ways that viruses and worms come into people's systems. And they can come in via vulnerabilities in the network software, taking advantage of or exploiting bugs in the code that allow systems to be interconnected on the Internet in a way that people want them to be and traveling quickly between systems without any user intervention.

They use social engineering techniques that come in as what appear to be benign attachments to e-mails, and people click on them. I sometimes call that taking advantage of vulnerabilities in the gray matter between people's ears. But the fact is that it's very hard for anybody to tell today when an attachment is safe to click and when it's not. Many people just simply don't click them for fear of being attacked by a virus.

They also come through compromised Web sites and Web servers. And we saw that recently where Web servers were propagating and then taking advantage of vulnerabilities in the browser to propagate software written to send credit-card numbers to the Russian mafia.

And many of these things that are out there in the wild today are actually getting into the PC by using the so-called buffer overruns as a way to get their code to load and effectively take control of the user's PC directly in the memory and then doing whatever they feel they wish to the user's PC. So that's the situation that we found ourselves and our customers in. And we've been obviously doing everything we can do to update our software, to fix vulnerabilities when we find them, when they get reported to us, for us to look at them and take care of the highest-priority ones, get them out to our enterprise customers, put them on Windows Update for our consumer and small-business customers.

And we realized, particularly when Blaster hit about a year ago, that that just wasn't enough, that the continual effort to improve the quality of the software is just not going to keep us ahead of the bad guys that are attacking our customers, and in fact, that some of the work that we were doing laid out a blueprint for the attackers. We saw people actually using our fixes as the way to determine what they should do next to attack the people who had not been updated with the fixes and the updates that we were releasing.

So this caused us to rethink what we're going to do, and this is really what we're going to get into for Windows XP SP2. It's to look at those attack vectors and to say, "How do we isolate the vectors that are being commonly used and increase the resiliency so that we stop the viruses before they even get to the user's PC, so that we stop the worm from being able to propagate over the network connections, so that the attachment cannot take advantage and trick users into opening it; users have to take a more explicit approach for how they actually go ahead and click an attachment from an e-mail message or instant-messaging software.

So every one of these things is an effort that is going to help us to reduce the rate and severity of the kinds of attacks that are plaguing the PC market or have in the past. But I want to say that there is no silver bullet. And this is another step in a long journey for us and the industry. We think that the work we're doing here will be a tremendous advance, and we're going to encourage all of our customers to update their software as quickly as possible. But again, it's a step on the journey, and it will continue with more and more innovation from us in the future.

So to look specifically at what we're doing to address these problems with XP Service Pack 2, we call that "with advanced security technologies" to highlight the point that we have really added a lot of security technology here, more so than you'd normally expect us to do in a Service Pack for Windows.

Four specific areas we're looking at: In the network, we're looking at making and we have made the firewall tremendously smarter, much more adaptable to how applications use it, and that enables us to turn it on by default so that the machine out of the box is protected by the Windows firewall; it cannot become infected while it's first coming up and getting installed or running, or later when you take a laptop, for example, out to a Starbucks. You don't want it to get infected by the wireless network there.

We've improved the attachment handling so that when the e-mail messages come across, they are appropriately quarantined if there is an unknown data type or a dangerous data type when e-mail attachments come; same thing for attachments to instant-messaging experiences.

We've improved Web browsing substantially. We've followed the lead of others in the industry who've added pop-up blocking and we're putting that into Internet Explorer. We also are, again, following others and looking at how we can improve how the downloadable code, executable code that comes from Web sites can be managed and can put the user back in control of their browsing experience, of their software experience, so that people can't take over and malware can't take over users' PCs.

And finally, we're working very closely with AMD and Intel. We have been for quite some time to improve how the buffer overrun situation is handled. We're taking advantage of new hardware coming out from both of those vendors, and you'll see lots of that shipping this fall and next year. It will help us further protect against the real fundamental area in which the viruses are using to attack systems.

So in summary, we feel very good about the work that we're doing here, and we think it'll take users a long way forward. I'd like to ask Barry Goffe to come up and give you a peak at what SP2 looks like. Barry?

BARRY GOFFE: Thanks, Will. So as Will said, we've done a tremendous amount of work to add these new proactive protection technologies into Windows XP. But we've also done a lot of work to make the security infrastructure in Windows much more manageable, and we provide more and better information to end users so that when end users are faced with a trust decision, they're more likely to do the thing that's going to protect their security and privacy rather than compromise it.

So the first thing that I want to show you is what we've done in Windows firewall. It's formally called ICF or Internet Connection Firewall, but we've made a major update to that infrastructure. And the issue was that end users or customers were faced with a choice. If they turned the firewall on and closed all the ports on the machine, they were safe, but applications that depended upon inbound, unsolicited traffic wouldn't work. So online games in the consumer sense or in the corporate scenario—remote desktop management, peer-to-peer collaboration applications—wouldn't work when I had my firewall on.

So what we've done in Windows firewall is we turn it on by default. We close all the ports by default so you're safe. But we will open up ports for specific applications so those apps will function properly. So here I have an online game and I want to go play against someone on the Internet. Well, that particular scenario requires unsolicited inbound traffic. And what you'll see here is a new dialogue from Windows firewall that says, "Hey, this application is doing something that's inherently unsafe. It's trying to listen on the network. What do you want me to do? Do you want me to open up a port in the firewall or do you want me to block this application?"

In this particular case, I'm just going to play for a little while. And I do, in fact, want to be able to play. And now you can see that my partner has been added here. But if I go down here and I say, "Look at the firewall setting," and I look at the exception list, you'll notice that this off-road racing game has been added now to the list of exceptions. So next time I come in to play this game, I don't have to be bothered by this particular prompt.

What Windows firewall is doing is as soon as it recognizes that this game is running, it will automatically open up the ports in the firewall. And as soon as I shut this game down, Windows firewall will close the appropriate ports. So I really have the best of both worlds. I'm able to protect my machine by closing all the ports, but able to still be productive by opening up just the specific ports that I need in order to communicate.

WILL POOLE: Now, Barry, speaking of productivity, so if I'm your IT manager and I'd really prefer that you not spend your lunch hour opening up the firewall and running multiplayer gaming --

BARRY GOFFE: Right. We would never do that, by the way.

WILL POOLE: How does that work, exactly?

BARRY GOFFE: Well, what I've just shown you is through the end-user experience. But as I mentioned, we tried to make all this technology manageable in Windows. So, in fact, we've added 609 new group policy objects in SP2 alone. That's almost doubling the number of knobs and buttons that are available to IT professionals to manage Windows. And they are all dedicated to security.

So what you're looking at here is the group policy management console that shows me just the group policy objects for Windows firewall. And I can do things like add an exception remotely and centrally for all the people on my network. And I have even more flexibility. I can add an exception where—additional exceptions and say, "Only allow that inbound traffic from a particular subnet, or even a particular IP address in my network. Don't allow that inbound traffic globally from the Internet."

But one other feature that's even more exciting for corporate customers is this concept of multiple operational profiles. I can set my computer up through group policy—in fact, I can set all the computers up through group policy—so there's one policy for when that computer is connected to the domain, like my laptop, and then an alternative profile for when I take my laptop and leave the corporate network. And that's a pretty common scenario. I take my laptop. I go home. I connect to my home network. Or even worse, I go to the airport and connect to the Wi-Fi hot spot there, which isn't protected by any perimeter firewall. I'm basically stuck out in the wild.

So having this alternative profile means that I can lock the machine down completely and automatically for the end user. There's no reboot. There's no relogin. There's no end-user interaction required. I simply push this policy down, and as soon as that person roams outside of the network, they are rendered safe.

The next thing that I want to show you is some of the innovation that we've put into Internet Explorer. Internet Explorer in the past, on one hand, it was really difficult for an IT manager to manage the experience in Internet Explorer. On the other hand, for the end user, it was difficult for me to discern what was just a standard dialogue where I had to make a choice versus some sort of dialogue that might affect my security or my privacy.

So as Will mentioned, we've added a pop-up blocker in Internet Explorer. But more important, we've added this new visual experience here. You see this blue-gold bar up at the top of the browser window? We call this the information bar. So now on Internet Explorer, anytime anything has to do with end-user security, the end user is going to see this information bar. So in this particular case, it's telling me that a pop-up was blocked. And you know pop-ups can be annoying, but they can also be incredibly malicious. We've all probably seen the pop-up that says, "You've just been logged out of your server. Please enter in your user name and password and then click here." And it looks like a Windows dialogue when, in fact, it's just a malicious pop-up. And I wasn't logged out of my server, but now that I've clicked okay, I've just given away all my personal information.

Here, if I wanted to see this particular pop-up, all I do is I click on the information bar, and I have all sorts of options here. Now, one thing to note for corporate users is we don't block pop-ups in the intranet. We only block pop-ups for the Internet.

Now let me go to another Web site here, which is a Web site that talks about automobiles. And I'm going to read the headline article. And while I'm reading, I'm going to get the information bar experience again. And this time it's not telling me that a pop-up was blocked. It's in fact telling me that a control is trying to be downloaded to my machine. And you know apparently there's nothing on here that looks like I need a download control. So I could simply, you know, keep working here. Now, if I wanted to go to the next step, I could in fact say, "Install this control." But one of the things that's important is there are malicious controls that I never want installed on my machine. And in IE previously, it was very difficult to do that. Every time I went to a Web site that had a malicious control, I'd have to say, "Don't install, don't install, don't install."

Now for the first time I have the ability to say, "Never install a control through a particular publisher no matter what Web site I navigate to." That's a really powerful thing, and it's also something that's manageable through group policy, so I don't have to let my end user make that choice. I as an IT professional can make that choice for the end user.

Another thing that I want to show that has to do with Internet Explorer is something that, as financial institutions, a lot of you are probably aware of today, and that's an issue with phishing. Phishing is when you get someone to go to a Web site and you make that Web site look like it's something other than what it really is and you trick an end user into giving you some sort of information.

Here what I'm looking at is an e-mail that came to me with some HTML content in Outlook Express. And now in SP2, just like in Outlook, Outlook Express blocks HTML content. But I can take a look at it if I want to. And we all know that e-mail addresses are pretty easy to spoof. And this e-mail looks like it came from a business that I'm often doing business with called Northwind Traders. And this e-mail from Northwind Traders says, you know, "We need some information about your account. Please navigate to this Web site."

So I'm going to click on the link, and what you'll see is this Web site looks kind of funny. I think there are two URLs here. This funny URL here that doesn't really belong where it's supposed to belong says, "Northwind Traders." But the real URL here is BadGuys.com. If I had been using SP1, what I would have seen is only the Northwind Traders URL. It would have been placed on top of the address bar. I wouldn't have been able to tell as an end user that I was at BadGuys.com. But we've changed a lot of the behaviors in IE in Service Pack 2 to eliminate the capability of bad guys to spoof or to execute these sorts of phishing attacks. So, you know, with a lot of this work, we feel that end users are going to be much, much safer browsing the Internet and less likely to be attacked in these sorts of ways.

Now, the last thing that I want to show you is we've talked about how IT pros have much better manageability of security features. Let's look for a second at how we're making the security features more manageable for consumers. We've added a new control panel application or window called Security Center that takes all the different security-option functions from all around Windows and aggregates them into one centralized place. So now I only have one place to go to manage my security.

More important, though, we've operationalized the Protect Your PC guidance that everyone in the industry acknowledges is what you have to do to keep your machine safe. No. 1, have a firewall running. No. 2, have automatic updates on and make sure the most recent set of updates are installed. And No. 3, have virus protection on and have the most up-to-date signature files installed. As long as I have these three green lights as a consumer, or perhaps a small business, I can feel pretty good that I've done as much as I possibly can do to make sure my machine is safe.

Now, for instance, if something happened like my antivirus software got turned off inadvertently, it would be absolutely apparent to me as an end user that something was wrong with the security of my machine. My Protect Your PC guidance is telling me, "Hey, you've got a red light here." And it tells me exactly what I need to do to fix it. If I go back and turn on my antivirus software, it again tells me, "You're as safe as you possibly can be from a configuration perspective."

WILL POOLE: Now, Barry, this is not Microsoft antivirus software here, right? This is third party, and we're integrated with a number of different products.

BARRY GOFFE: That's right. We've done the work to integrate with the most popular AV vendors around the world, but we've also publicly published a set of APIs on MSDN. It's been out since the end of last year. So the third-party vendors that are perhaps indigenous to a specific geography around the world can plug their AV software into this user interface and make sure that their customers are able to get this level of information.

So in summary, again, we gather all this great proactive protection technology, but we've also tried to make the technology much more manageable for the end user and we provide more and better information for users so that when faced with trust decisions, they're more likely to do the thing that's safe.

WILL POOLE: Thanks, Barry; appreciate it.

BARRY GOFFE: Thanks, Will.

WILL POOLE: So you've probably heard that we're going to ship this in August. We're still going to ship it in August. Things are going well. Stay tuned for the exact plans on that. Also you should know that we're going to push it up primarily via the Web. We're going to use the Windows Update and Automatic Update capabilities that we've been getting people to use for quite some time so that they can easily get SP2 installed on their machines. We're also, of course, going out through all of our Enterprise customer channels to get them to put in testing and to deploy it as rapidly as they can.

So I'd like to now shift gears and talk a little bit more about innovation opportunities. And the first one of these is looking at multiple PCs. You've sold somebody a PC. What's the best thing to do to make some more money? Sell them another PC. Sell them more experiences go to around their PC; make it better so that they can then buy a new PC to do more of those experiences. And really you can look at this in terms of both consumer and business initiatives.

In the home we're going to see in a minute a bunch about the Media Center. We see a lot of opportunities there for growth of the Media Center segment, bringing these very extensive multimedia-oriented experiences together with all the great productivity and communications that a PC can do and using that to help drive upgrades and new sales into the home.

In the office, you're going to see this with notebooks and Tablets, and we'll continue to drive that market forward. And I'll show you some examples of those in a few minutes. We also, of course, are working very closely with partners in the industry around devices that attach to the PCs to make the overall value of owning a PC greater, whether you're in a mobile scenario, a car scenario, or in your workplace or home.

So talking about the Media Center opportunity, you can see a couple of analysts' quotes here. And the first one is from IDC. And here they're forecasting about 20 million Media Centers in 2008. And this is a pretty good number. In fact, we maybe are a little bit even more bullish than that. We're very excited about where Media Center is going, the feedback we've gotten from our partners such as HP and Dell and many others. So there's a lot of upside in this category looking at selling into the home.

And you can see actually Jupiter Research last September pretty much nailed our strategy, which is to drive the Media Center edition product as being the primary or at least the most-sought-after product for home computing. And I think they were maybe a little bit more aggressive than we are in terms of how fast it'll happen, but it is certainly where we're going.

So with that, I'd like to actually show you what we're doing. And, Joe Belfiore,, could you come out and tell us all about Media Center?

JOE BELFIORE: Good to be here. Hello. My name is Joe Belfiore, and I work on Media Center and related products. And I'm going to take you through some of the cool stuff we're doing. I'm going to start out right here. This machine front and center is a Media Center PC that Gateway shipped a few months ago. And we're choosing this kind of PC to demo on because we want to really make the point that we think there's a huge opportunity to tailor the PC both through software but also through hardware to enable great compelling new scenarios and sell people more than one PC for their home.

So if we switch over, you'll notice the first thing that I want to point out is that this PC looks an awful lot like a regular PC. If I click the Start menu, you'll see all the same stuff, because, in fact, this PC has all the full range of power and capability and flexibility that any Windows XP PC has. The thing that's different about it, though, is that it comes with a remote control, very simple remote. And you might be able to tell from there, in the middle of the remote right here is a green button, kind of like the green Start button. This PC has a mode that we think of as entertainment mode or distant-usage mode. As soon as I push that green button, I'm now in this mode, where the PC starts to act like a consumer electronics device. It's very friendly. It's very easy to use. And I'm going to actually walk around here and kind of—

WILL POOLE: Hey, you know, while you're doing that, let's have a show of hands. How many of you either own or have used a Media Center PC? That's a good growth opportunity there in the audience.

JOE BELFIORE: Exactly. I was thinking that, too.

WILL POOLE: Yeah, I think so. But on the other side, how many of you own or have used a Tivo, a Replay or Ultimate TV? Yeah, okay. Well, you all will now see how much better you can get with a Media Center PC.

JOE BELFIORE: So let me sort of walk you through this. I click the green button. I'm looking at—we think of this as the 10-foot or the distant Start menu, because that's how you would use it. And some of the items on here will be very familiar to you if you're a Windows user; My Music, for example. Let's pop in the music. Tons and tons of people are doing digital music on their PCs. But so far today, the form factor is mostly limited to you sitting at your desk.

When I go in here, you can see here's music I've been listening to. If I want to look at all my albums, of course, the PC has a nice big hard drive, fast processor, lots of great stuff you can do. And if I want to pick an album to listen to, I'll pick the Shrek soundtrack. I click OK. Here's the track. I click OK, and now I'm listening to music—very simple, simple enough for pretty much anyone who's used a TV to be able to pick up the remote and use it. And I can control the volume, so if you want to crank this up, I can take advantage of a really high-quality PC experience, or I'll turn it down so you can hear what I'm actually saying.

So that's as simple as it is to play music. And I'm not going to go into this in detail, but you can imagine a very rich, powerful way to deal with music. You can—if you have 8,000 albums, and you want to get to the ones that start with T, you can type T with the remote keypad, and it'll jump down to T. We're really filling this out to make it a great experience for people.

Let's talk about pictures. Another case where the PC is a great device for aggregating content, enabling people to do stuff with digital media. So if you have a digital camera, maybe like me you have thousands of pictures on your PC. But you might find that it's hard to show them to people. You either have to print them or drag them into some room, which is probably a mess with stuff all over the desk, and it's not where you want to sit around and drink coffee anyway. So it's handy to have these things in the room of your house where you really want to show them to people.

I went into a folder of Disneyland vacation pictures. And if you were my friend sitting with me on my couch in my family room, I could just click Play Slide Show, turn up the music, and I've got an instant Ken Burns-style elegant multimedia experience. I don't have to do any authoring work. I don't have to go to any trouble to get this created. And I could even take pictures of us, pull the Compact Flash card out of my camera, plug it directly into the front of the PC, and we'd immediately be enjoying pictures together. And you can print them, correct the red eye, do some very simple things to make your photo-viewing experience really compelling.

So we think that this kind of thing really changes what the PC can do sort of in a social sense. And pictures and music are two examples of things that the PC already does. You might notice on here you can get your own personal videos. You can play DVDs. But I want to show you a little bit about what is possible with the TV function. PCs today have big and growing hard drives. They're connected to the Internet, and they have powerful graphic processors and CPUs. Yeah, this is an interesting choice of channel.

So given that the PC has this hard drive and it's connected to the Internet, there are lots of great things we can do to make the TV experience good. So Media Center has a very rich PVR capability built in. I can pause live TV. I can record shows. There's a programming guide that has 14 days of data. And there's no monthly fee to end users. This model is the model where you, the consumer, buy the device, and you can choose from a really wide range of hardware capability. You can expand it. And there's no monthly fee involved.

So we think this is a very powerful capability. If you want to add more storage, you can just go buy another 1394 USB 2 hard drive, plug it in, and voilà, more space for your TV shows. And I'll talk a little bit later about other ways that the PC provides really unmatched flexibility in dealing with this kind of content.

The last thing that I want to show is that we also know it's the case that we can't provide all the value to consumers that they're going to want, and there's an incredible range of possibility and power that can be delivered by other folks in the industry. So Media Center is also a platform. And I'm going to jump here to Napster. Napster is a service that I subscribe to personally. And we've noticed that the server has been a little bit slow today, so we'll give it a chance to come in here.

WILL POOLE: Now, for those of you who don't know, this is the legitimate new Napster, not the old one. These guys are actually selling product now.

JOE BELFIORE: I'll let our trusty helper type in the password, because I'm not remembering it. Yes, as Will was saying, this is the new, revised Napster. And as a subscriber, what I do—I have this running at my house; it costs me about 10 bucks a month, and I have a PC like this in my family room hooked up to my stereo. I feel like I now have a consumer-electronics device that lets me listen to any song in the world. So what I do, I come home from work and I say, like probably many people, "Well, what's on TV?" Nothing I want to watch. "Well, what do I have recorded?" Lots of good stuff, but I don't really want to watch any of it now.

The next thing that I do is I say, "Oh, I'd like to listen to Van Halen. I heard Van Halen on the radio. I can pop into Napster, listen to every Van Halen track, crank it up, and then look at pictures of my new baby using the slide show, because all these things are nicely integrated. So here you can see—

WILL POOLE: Your baby's shrink may be asking you about this in the future.

JOE BELFIORE: Yeah. So you get the point here. So Napster is the service that really extends what the Media Center PC can do. And one of the things that's also nice about this is that all the folks that build these kinds of services are accustomed to Internet Explorer, tools like Visual Studio, all the languages and runtimes that are available. They don't have to learn anything new. They're still offering for the PC. And all of their existing investments and understanding of the platform is leveraged and useful on Media Center.

WILL POOLE: And what that really means is we've got a PC-rich platform that is delivered into the living room on the television. And there is no other open platform in the living room on television.

JOE BELFIORE: That's right.

WILL POOLE: They're all closed.

JOE BELFIORE: That's right.

WILL POOLE: So here you've got a broadband connection to a PC-programmable platform and a 10-foot user interface with a remote control.

JOE BELFIORE: That's right.

WILL POOLE: We've seen some great innovation so far with Napster and others and we think there’s a lot of opportunity for growth there, too.

JOE BELFIORE: I absolutely feel that way. Our SDK has been available for a while. It's free. People can download it from the Web and start developing now. So everything I've shown you there has sort of been along the lines of the Media Center PC, where in that case it's a hardware form factor that's tailored for the living room. But there are lots and lots of people who have PCs that they don't put in the living room. In fact, by far, most people are doing that today. So I want to show you one of the things that's new technology we've been working on that will be available this fall called Media Center Extender. That's this little device sitting up here on top of the TV. It's totally quiet. It has no fan or hard drive. It'll be inexpensive. And there will be a number of vendors selling these devices this holiday season for customers who have Media Center PCs, which today most Media Center PC customers have desktop PCs in a room where they would normally put a PC.

What this device does is it connects to your home network either via wireless or wired, and it talks to your Media Center PC, and it makes the blue Media Center experience show up on a TV set somewhere else in your house. So the whole time I was doing that demo, this little machine here was also remoting the Media Center onto this TV. And the thing that's really nice about this is that all of the same content—if I have my digital camera, I plug it in, I put the pictures on there—shows up here; all of my music is available here, and all of the same third-party applications also show up here. So if I want to watch TV, of course I can do that. And all of my recorded shows are available on every TV in the house if I have an Extender hooked up. And if I want to go to third-party applications I'll show you a different example; I'm going to this feature we have called Online Spotlight, which is a Web service that we run that allows consumers to discover third-party applications that are written for Media Center. I'll go into the Movies section and I'll choose Movie Link, which is an example of a third party that's written a service for Media Center that lets you view trailers and rent movies for $3 or $4 just by putting your credit card in.

WILL POOLE: Joe, if I'm sitting in my family room trying to get some work done and I've got one Media Center PC in the household and I'm doing some e-mail, editing a document for work, my kid goes over here into the living room and goes to Movie Link, what happens?

JOE BELFIORE: No problem. The Media Center Extender runs simultaneously while you work on your PC. You have concurrent sessions.

WILL POOLE: You're saying their PC would never even know that your kid was watching TV or downloading a movie or listening to music. It's got the volume too loud, but—

JOE BELFIORE: Yeah, other than that. So Media Center Extender will be available this year. And there's also a flavor of that that we're doing for Xbox so that you can buy basically an Xbox title and turn your Xbox into an extender.

The last Media Center thing I want to show is some hardware work we're doing within the industry. We call this Instant On. We're collaborating with hardware partners to make PC form factors like this have a better on-off experience. So watch. Here's this PC. It's off, totally quiet. You hear nothing, no fan. When I push the button to turn it on, voilà, it's on. It's very simple. There's not much to this demo.

What we're trying to do is create the much more consumer-electronics–type experience. And what's actually going on is we've throttled the power down but kept the PC just awake enough to keep recording TV shows or to keep the TV playing so that when you turn it on, you could immediately jump backward in the pause buffer if you wanted to. And this is a technology that we're working on with partners. We expect to have this ready shortly after this holiday season.

So that's sort of a quick look at Media Center. And now what I want to do is give you a look at some related technologies that are also imminently available in terms of the way we're expanding the PC's capability to work with other devices and deliver a great media experience. So I'm going to show you Windows Media Player 10. Windows Media Player 10 is now in technical data and will be available broadly this fall. If you're inclined, you can download it from the Web and try it out right now. And what it's mostly about is enabling an end-to-end experience for consumers and for partners around getting music, buying it from a store or a service, and then being able to take it with you or move it around on lots and lots of portable devices in a very flexible and easy-to-use way.

So you might notice the user interface has been revised, and right here at the top you can get to your library. You can rip your own content, burn CDs, sync devices, and so on. And what I want to do, actually, is show you this feature over here, which is the ability for Media Player to connect consumers to services, to be what we think of as a digital media mall. So the idea is there are lots and lots of sources for people to go and have a commerce relationship with and buy music or subscribe to music, and this feature makes it possible for them to all seamlessly integrate into Windows Media Player.

So I'm going to choose the Napster service here. And Napster, the service gets to set these items up here on the user interface. It's all very nicely integrated. And I'm just going to close that. And now I'm looking at the Napster service. So if I want to purchase some music, I can do that. So, for example, I've been listening to Wilco a lot lately. I can type Wilco in the search box and scroll down here and pick a track. I could sample it, or if I go over here and click "Buy Track," for 99 cents or 79 cents or whatever, I can purchase the track—and I won't bother with that—and it will get downloaded to my PC. And now this wave of Windows Media technologies enables lots of great flexible things that I can do with that downloaded music. So I have a very wide range of services to choose from. I can buy music or subscribe to it, keep it on my machine, manage it with Windows Media Player, and then do great stuff with it. You'll see over here there's an item that shows me my purchased music. So if I'm buying music from more than one service, it's really easy for me to see it, learn about its terms and so on.

The last part of this puzzle, then, is being able once you've got that music on your PC, to do great things with it. I've shown you Extender as one example of doing great things with it. But we also think portable devices are very compelling. So with this wave we have technology that enables any vendor building a portable music device to make it sync very, very easily and also have the digital rights management go with the music onto the portable device so that new business models such as subscriptions are possible. So in theory, I as a Napster subscriber will buy one of these devices, then I can go pick my random Van Halen album or whatever I want to hear, download the track and take it with me on my portable device.

So the last thing I'm going to show is a specific example of one of those portable devices. This is a portable device that we have worked on with some hardware partners. This is called a Portable Media Center, and this is the Creative Zen Portable Media Center, which actually you can now preorder on Amazon if you're inclined. So this will be available this fall and you can preorder it right now. And you can see it's got the green button.

When I click the green button, it looks a lot like Media Center. If I go to My Music, here are all my albums. And as I described, if I was buying music from one of these services or renting it or subscribing to it, I could also take it with me on this device. If I click an album, I can play all those songs, and, voilà, I get all the album art. I get the full experience and so on. It's very easy to use. And if I actually—I can also sync my pictures, which is one of the things that we think is very cool about this particular device. And finally, if I have a Media Center PC, I can also go here—I don't have an example content—but I can also go to My TV, sync my recorded TV shows, and then take them with me in the back of the van and hand this thing to my kids and let them watch “Clifford.”

WILL POOLE: An important point here is that while the experience is best with the Media Center PC, this will work with any Windows XP PC.

JOE BELFIORE: That's absolutely right.

WILL POOLE: It could be a very broad market for Creative and others to sell into, and users will get a choice of what kind of experience they want to have based on what PC they use.

JOE BELFIORE: And we expect to see a really wide range of devices that are both Portable Media Centers and even lower-end, less-expensive digital media players.

WILL POOLE: And this is quite a contrast to the competition that has a single service, a single software player on the PC and a single, small family of great devices, but we have now amazing consumer choice in this area.

JOE BELFIORE: Exactly. All right, well that's it for me. Thank you.

WILL POOLE: All right, great, thanks.

So the other area of innovation I talked to you about was with Tablet PCs. And as you know, we've been working on this for quite some time. Bill showed you some of the great work that's been done this year with the new release of the operating system. I just want to give you an idea of what the new form factors look like that are coming out here.

Now, this one I want you to watch carefully because it's a new NEC. It weighs less than 2 pounds. It is 11 millimeters thick. So if I turn it the right angle, it should almost disappear. What do you think? This is an amazing bit of hardware right here. This is the more tablet or slate form factor, and we find a lot of people are using these in both executive settings as well as in industrial and vertical applications, medical in particular.

Here are two more that I'm very excited about, one from Gateway and one from Averatec. And the interesting thing here is Averatec has hit a price point that is going to move this stuff into volume. These things are available now at Costco up the street here for $1,299. This is the tablet convertible form factor, so we can go between a notebook and a Tablet, and we're now seeing a price point that's going to move this into the mainstream, high-volume notebook categories. We're going to see a number of different vendors come out and try to hit these lower price points. It's a very, very nice device, a nice fit and finish, and an amazing price. I understand from the sales agent up there at Costco that they are flying off the shelves, so it's great to see that happening.

Another area that I've talked about in innovation is the Windows Marketplace. We were very pleased to announce this about two weeks ago about our Worldwide Partner Conference and what this is about is providing a resource for customers of all kinds to come to a Web resource, a site where they can find out about all the different devices that will make their Windows experience what they want. It can give them the most that's possible in a PC experience and that will cover both business scenarios and consumer scenarios.

So we have partnered with CNET and other providers to get a huge amount of content up here. The Windows Marketplace will have over 100,000 products listed when it launches this fall. It will have consumer reviews and opinions that people will be able to put up there, and ratings, and it will be a place, really a resource for people to go and find all the different sources where they can go and buy products to make their Windows experience richer.

Moving on to more growth, emerging markets, well, if you look at the U.S. you've got about a 60 percent PC household penetration, and that number is growing slightly but maybe is starting to level off. Looking over at Western Europe there's clearly some opportunity, but looking in the emerging markets the numbers are, of course, very low and for lots of reasons.

The interesting thing is that while those numbers are low, the number of households that are potentially addressable by PC technologies is huge. Over 400 million households worldwide by 2008 will have the income, the electricity, and the connectivity necessary to make an appropriately tailored PC for their market a desirable product. That's 400 million and more than 200 million of them will be specifically in the core markets that we're going after, which are in the emerging space of Brazil, Russia, India, and China. So those are obviously the big dogs of emerging market opportunities. We're working across the emerging area, but the opportunity there is particularly good.

Now, the way we're going to address this opportunity is in a number of different products and initiatives. The first one is the Windows XP Starter Edition. We've announced pilots of this with the Thai, Malaysian, and Indonesian governments. We've had some work in the market in a couple of those countries already, and you'll see more of that coming out from us over the course of this year.

This is a tailored version of Windows that is designed specifically to be easier to use, easier to support, easier to sell, and to have a lower price that is appropriate for the emerging market needs.

In the longer term we see a number of different opportunities, looking at new, low-cost, environmentally sealed form factors that are maybe a super-small box that's low power, resilient to power fluctuations, low cost, and that will meet the emerging price points. We see the incredible growth in Internet cafés in all the emerging markets, so we can offer again more technology and services into those Internet café environments.

And in rural computing there is quite an opportunity there in helping to really deliver what people need to cross the digital divide and get information that will help them, whether it's farming their fields more effectively or knowing how to price their products when they bring them to market. Another area of revenue growth opportunity for us is in unlicensed PCs. We right now see on a worldwide basis about 36 percent of PCs are unlicensed, using unlicensed versions of Windows, and not surprisingly the number there in the PRC is about 92 percent. So that shows a lot of opportunity, and of course it's not easy to get revenue, particularly given the challenges of respective copyright law there.

On the other hand, you also think about what's going on in the U.S. and here you see about a 22 percent unlicensed rate, and in fact, the numbers of units that we can go after here in the U.S. are actually about 12 million units. That's about the same number of units as what we have available in China, 13 million units unlicensed.

So we see a good revenue opportunity for us to go and try to work with the channel, work with consumers and have them understand the value of buying genuine software; also working in enforcement with the partners, looking at the repeat offenders and making sure that they are being dealt with appropriately under the law; and then with consumers, educating them on the value of genuine software and creating demand for them to come and buy licensed genuine products.

So you should expect to see a number of things that we're doing there over the next year. We've piloted some great work in China with what's called the Microsoft Club where we have a plan to go out to consumers. We launched that in the spring. They'll, for example, get an automatic distribution of the SP2 CD, and we've got quite a few people that have signed up for that since launch, and it's one of many pilots you'll see us doing to help drive our sales into the unlicensed markets.

“Longhorn,” of course, is a very important effort for the company. Bill mentioned this a little bit. It's something that we are looking at both from a business perspective as well as a consumer perspective. It is the next big release of Windows, and for the business we really have made sure that we make this thing manageable and deployable. One of the No. 1 things that we hear from our business customers is that we need to make it easier for them to move the advanced technologies out into their businesses.

We're going to have the amazing new development platform and the technologies that will generate a whole new host of business applications, and together we're expecting to see new levels of productivity in information management and other activities that users do as a result of these richer applications that are provided with “Longhorn.”

Now, on the consumer side what we're hearing is that people aren't interested in just piling on more technology, but they want technology and features woven together in a way that makes them able to use their PC safely and effectively and really accomplish the specific scenarios that are important to them, whether those are around music or communications or digital memories, whatever they may be. They want to pull these things together, make them easy and seamless, and ultimately get more out of the experience they have with their PC.

So “Longhorn” is going to take us a long way toward helping realize more of the opportunity we have in both business and consumer markets over the next couple of years.

If you look at our road map, we have a tremendous amount of innovation coming out. We really feel great about what we're bringing to market this fall, both ourselves and with our partners. We've got the products that you've seen demonstrated today. We've got Media Center Extender; we've got new music devices; we've got, of course, all the security technology for our enterprise customers. Late this year or early next year, we're looking at the 64-bit edition of Windows XP Professional, and next year we'll see the shipment of the beta version of “Longhorn.”

So that's what the road map looks like for Windows, and I hope you've seen that we have really a tremendous opportunity to grow our business through innovation. We'll get through the security issues. At least we'll begin the next leg of that journey in a much stronger position with SP2, and then we'll start going after all these opportunities and delivering multiple PCs and enhancing the ecosystem, doing some pilots in emerging markets, and growing that over the next couple of years and recovering revenue in the unlicensed space.

So with that, thank you very much, and I look forward to chatting with you guys further at lunch.

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