(Operator direction.)

CURT ANDERSON: Thanks, Elan.

Good morning, everybody, and thank you all for joining us today. This presentation is a pilot for what we hope will become an ongoing series of informative conference calls that cover a wide range of business and technology topics that impact our company. Our first speaker is Martin Taylor, general manager of Platform Strategy. Martin's primary focus is to drive Microsoft's competitive strategy and champion platform initiatives across the company. Martin also leads long-term strategy planning in the Windows Server organization.

In his role, Martin regularly engages with the field and worldwide regions to provide a direct channel for customer and field feedback. This interaction enables customer and field input to be incorporated within Microsoft's forthcoming products and technologies.

Let me cover a few housekeeping items and then we can move on to the discussion.

Today's call will be recorded. Please be aware that if you decide to ask a question, it will be included in both our live transmission, as well as in any future use of the recording. Shareholders and analysts can listen to a live webcast of today's call at the Microsoft Investor Relations website, www.microsoft.com/msft. The transcript will also be made available.

This conference call report is protected by copyright law and international treaties. Unauthorized reproduction or distribution of the report or any portion of it may result in civil and criminal penalties. Any recording or other use or transmission of the text or audio of today's call is not allowed without the express permission of Microsoft.

This call will not be financially oriented, however forward-looking statements may be made during the call. Actual results could differ materially because of factors discussed in the management's discussion and analysis section of our most recent 10Q.

Okay, with that out of the way, I'd like to turn it over to Martin for about 15 minutes of discussion. Martin will discuss our current competitive landscape and climate in the server and desktop markets and will address some of the current market perceptions that we currently face. And then after that, we'll open it up to Q&A. Thanks, Martin.

MARTIN TAYLOR: Thank you.

Good morning, everyone, or good afternoon. I'd like to spend about 15 minutes covering a couple of different topics and hopefully I'll proactively address or answer some of the questions you might have, and then after that, as Curt said, we'd open it up just for some interactive questions on a few different areas.

I should briefly explain my role a bit more in detail, just so you understand my basis of perspective on how we're addressing some of the challenges that we have and the opportunities in the marketplace.

I've been at the company about 11 years. I have worked in our Washington, DC office and in Redmond and in New York in some of our large enterprise and Wall Street firms, as well as general manager down in Latin America. I was Steve Ballmer's chief of staff for a few years, helping with some of our customer and partner satisfaction initiatives and some of our cross-business group organization as we moved to seven different P&Ls.

And then I took this job in the July timeframe, partly because as we think about Linux and Open Source, we know that it's more and more about an integrated platform conversation versus an individual one-off product conversation. And so we wanted to really move to a point where as a company we could talk and address these concerns in a more integrated way and really show one of the strengths of Microsoft, which is our ability to offer solutions for our customers.

And so let me know explain a bit about the market landscape. One of the most interesting things about the Linux and the Open Source world is the amount of hype and noise, religion and emotion that exists when you're having these discussions and dialogues. And so what I'd like to try to do is maybe separate some of the noise from the reality and let you know how we see the market.

The first thing is I'd like to also separate Linux -- and I kind of use Linux as a proxy sometimes for the Open Source stack -- on the server from the desktop, because the two things are very different in terms of both the market landscape as well as how we talk about those things with our customers and how our customers, quite honestly, are talking to us about those things.

And so let's start with the server. And these numbers I'm giving you aren't exact numbers; you should work with IDC and some of the other industry analysts to get exact number. And you guys track the market pretty closely as well, so these numbers shouldn't surprise you amazingly.

Windows has roughly about 55 percent, give or take, of the server market share. And then the other 45 percent is split almost evenly between Novell, Linux and UNIX, with UNIX decreasing, with Novell flat to trending down and, of course, Linux increasing.

Most of the growth of Linux on the server is coming in a few different areas. UNIX migration is definitely an area of Linux growth. We also see Linux on the edge, what we call the edge of the network and so this is being, let's say, a spam filter, a small single-purpose DHCP server or something of that nature, and the we also see Linux in the high-performance computing grid type of environments and also Web hosting environments as well is one that I didn't say on those single purpose servers.

Most of the growth is definitely coming from UNIX migration and so when you kind of look at the numbers coming down in UNIX migration, you see them kind of coming up proportionately with Linux and with Windows, as we are capturing some of that migration as well.

Novell is, I would say, kind of the wild card a little bit with their recent acquisition of SuSe in terms of Novell will become Novell Linux over time and then what happens with their install base is something that we'll see play out. But that's kind of, of the four market leaders in the server space, I'd say that's the one that's a bit of a wild card on how does that move and what do they do with their binaries.

On the desktop it's a very different scenario. The desktop, most figures have Linux penetration on the desktop around 1.3 percent, give or take, and again you should work with industry analysts to get exact figures. I'm kind of giving to you what some of our research has shown from some of the industry analysts that we've worked with as well.

And most of that growth, some of that growth has been actually at the UNIX workstations, so very similar to the UNIX migration on the server. You're also seeing some of those UNIX workstations that do a certain set of functions being done on Linux as well.

And then, of course, you do have some unique environments where people are deploying Linux on the desktop, but it's mostly those enthusiasts and folks of that nature versus any major corporations or people like that looking at Linux broadly on the desktop.

That being said, it is an area that we do really want to make sure that we offer the right value to our customers and we'll speak a bit to that.

Let me speak now just kind of on how we think about the opportunities for us in both of these areas.

On the server side, the first thing that we really wanted to do is to really understand when customers choose Linux, why do they choose Linux and is it more of a marketing discussion, is it more of a technical discussion, what are those things.

And we found a few things to be the case. From a marketing or a perception side, there are three areas, three to four areas where we do think that we've got some perception challenges, Microsoft versus Linux. Those are total cost of ownership, reliability, interoperability and security. And so I'll touch on those four. And our approach to this is to really try to move these conversations from a more emotional and hype-fueled conversation to a more pragmatic, fact-based conversation.

So, for instance, for total cost of ownership we worked with IDC and IDC did a study of five of the most common server workloads, those being Web serving, file, network and security as examples. And from that study that they did comparing Windows 2000 versus Red Hat, Windows was found to have anywhere from 11 to 27 percent greater total cost of ownership than Linux on four or five of those server workloads. The one workload that we didn't have that was on the Web workload, we were like 6 percent disadvantaged or negative 6 percent TCO and we're repurposing that study with Windows Server 2003. But that's a great example on how we've used that data to share with customers and say, hey, let's not get wrapped up in the hype or the emotion; let's really have a fact-based conversation on total cost of ownership.

We also know that people just don't do basic, simple server workloads; they also look to do more application type things. And so working with Giga, we actually did a similar TCO project but it was called "Total Economic Impact" where they measure costs, flexibility, benefit and risk and in a similar type of a TCO model, and they are looking at large and medium organizations building like it was a human resource portal, a transaction based portal. Microsoft was found to have anywhere from 22 to 25 percent TCO advantage versus Linux and it was more so the Linux stack this time. So we looked at Linux as well as BEA, Java on top of IBM, so it was more of a stack oriented solution versus Microsoft.

And so we've done things like that to really help customers differentiate the noise from the actual facts that exist in the marketplace.

That being said, we know that they might take these numbers wholeheartedly and say, okay, now I know, but hopefully it will help us move this to a pragmatic conversation where customers will really go through their own TCO analysis and understand that.

In a similar way that we've moved from free being free to looking at total cost of ownership, a few years ago people really just didn't take free into full concern and so they said, hey, it's free, let's go use Linux. Now people are looking at the total cost of ownership and understanding that from an acquisition cost perspective it's really only 5 to 7 percent of the total cost of ownership.

So we've done a good job moving the conversation from free to total cost of ownership and now we're spending more time helping to understand total cost of ownership and the dimensions. So that's just kind of an example there.

I won't go deep on all three of the pillars that I mentioned, but I'm giving you kind of how we address the challenge from a marketing, perception area.

The other ones I'd mention really quickly. Interoperability is one that we've spent some time on and we recently received some data that we're helping people to understand that interoperability is less about Linux versus Windows but more so about let's call it the stack or the application level where you want your applications to talk to each other, and we've got a good track record there. Roughly about 72 percent of 800 IT professionals in North America all said that Microsoft has done the most versus any other vendor to offer interoperability. And so we're working with things like that to help our customers understand the benefit of Microsoft in those scenarios.

Reliability is an interesting one, because we're finding that it's more and more about people and process and less about technology at the kernel level. As you move up the stack, it becomes more about technology. And so we're working on a few different scenarios to help customers understand that.

And security continues to be a challenge and a priority for the company and for the industry, and I think that you guys hear and read everything that's happening with our security initiatives. The one thing that we've not done a lot of is really help the marketplace understand that, yes, we do have our challenges as a company and we're working diligently to address those challenges for our customers, but also the grass is not greener on the other side in terms of Linux being a more secure platform, and that's a statement about number of vulnerabilities posted, that's a statement about the ability for companies and Linux distributors to deliver patches to those companies, that's a statement about the intentions of the people that maliciously hack websites and hack things. And so we know that we need to get a bit more information out to the community so people can really understand that dimension of it.

That being said, we know that we need to do work there just to kind of level the playing field on the hype and the perception area, but our true value add and the best thing that we can deliver to our customers is what we've always delivered to them, which is new innovative scenarios on how they can build their businesses on top of.

And one of the things that Microsoft continues to have an advantage over Linux, and Open Source for that matter, is our ability to deliver integrated solutions to our customers. And those integrated solutions start at the kernel and go all the way up to ISV and third party applications built on top of our platform, and that's also a statement about our client software and our desktop productivity software interacting with our and other companies' server software.

And so we do know that we have a great value proposition on both stack as well as client and server solutions that we can deliver to our customers. And so we will continue to stay focused on investing our $6.8 billion in R&D in delivering those types of solutions to our customers in a very innovative way.

And so let me stop there, because I can obviously talk on any of these dimensions for quite some time, and maybe just take some of the direct questions that some of you have on some of these concerns.

And, Curt, I'm not sure how you want to manage the Q&A.

CURT ANDERSON: Sure, hey, operator, if you could repeat some Q&A instructions and then we'll go ahead and open it up to Q&A. And if there are enough questions, we'll take them and we'll see where we go.

(Operator direction.)

TOM BERQUIST (Salomon Smith Barney): Thank you. Good morning.

My question really comes down to you as you talked about the comparison of Linux, you mentioned that it's more than just Linux; it includes the rest of the stack. You mentioned a couple of products there on the Java side. What about other Open Source products? Did you look at total cost of ownership in comparison with Apache or some of the others? Is that why the Web economic impact was lower or the total cost of ownership on Web was lower, because they're using more Open Source products?

MARTIN TAYLOR: No, there are two things. The first thing I would say is there's nothing inherent about Open Source products that actually give it greater TCO advantage. As a matter of fact, what we've found is that there's a bit more level of complexity within Open Source projects, only because they're not built to work together necessarily; they're built by different people and then the ownership or responsibility is on the customer to try to bring those two things together, and so that by nature has a set of, let's say, costs associated with it.

On the Web workflow, the reason why primarily we got dinged, let's just say, with Windows 2000, with the older version of IIS as part of that, was simply because when you look at a single purpose server function, which is a simple Web server serving up DHT mail, serving up HTML pages, there was a higher cost in provisioning and getting ours up and running than getting the Apache one up and running on a very simple workload level.

Now, we've done great work with Windows Server 2003 and IIS 6.0 and so I feel very confident that when we get the data back, we'll be in great shape there. However, even with the IIS 5 and the Windows 2000 versus the Apache one, once you tried to do more complex things other than just serving up simple Web pages is where you saw TCO advantages move back in favor of Microsoft.

So it's less about Open Source and more about the fact that it was a single purpose, simple workload server.

TOM BERQUIST: Okay, you did the study, it sounds like, on both the client and the server. Did you look at the other form factors, appliances, wireless devices? It seems like Linux has gotten much more of an advantage sort of off the desktop or off the server than it has on the desktop.

MARTIN TAYLOR: You know, the studies I referenced were specific server-based studies.

TOM BERQUIST: Okay.

MARTIN TAYLOR: One thing that we did do though, we did something called "Total Cost of Development" where we worked with a third party that really went and analyzed the costs associated with building an embedded application using Windows CE as well as Windows XPE versus embedded Linux as well as Java, and in those scenarios we actually had a much quicker time to market, fewer developers and a lower total cost of development in doing that. And so we have that data available as well.

TOM BERQUIST: Okay, thank you.

(Operator direction.)

RICK SHERLUND (Goldman Sachs): Hey, Martin, and thanks for doing the call.

This is kind of a wacky question for you but Red Hat is now charging as much for Linux on the server as you guys charge, maybe a penny less. So the model seems to be shifting from free software to more similar to a Microsoft model I suppose. I wonder why it wouldn't be possible for Microsoft to support the Linux kernel and just move your stack on top of it -- it's not so much a question of pricing anymore -- and kind of get out of the religious war. And I don't know what that means technically to you. I'm sure it's a lot of work and maybe it's a wacky idea, but have you thought about that?

MARTIN TAYLOR: Yeah, well first of all, Rick, I don't think you have any wacky ideas. I'd say a couple of things. First of all, let's talk about the issue you brought up about this kind of commercialization of Linux and the fact that for anyone to sustain a business model they need to find a way to monetize what they're doing and the offerings that they have.

And so I think that in many ways you guys might feel like this is a little bit of déjà vu from the mid '90s when you saw a lot of hype and emotion and excitement about these Internet business models but then things had to play out over time.

I'm not saying it's directly analogous; however, I do think that we're on a similar course where you're seeing Red Hat that at one time had all free offerings, discontinuing their free offering, still having one for a developer version, only offering support on their paid offerings and having a price model that's actually a few pennies more, not less, Rick, and we should get you the exact data, than our products. And so it's an interesting play on how the model is shaping out. And so that is definitely happening.

The reason why we are not porting our applications or our stack over to Linux has nothing to do with the fact that Linux is free or was free or Linux is now paid. It's more so about the long-term bet that we're making on Windows and the value that we know that we can provide to our customers on Windows.

In some ways, for me to basically say I want to move all of our stuff over onto Linux is basically saying that we don't think customers should look at Windows or should use Windows and I think that our current growth rates and our current trajectory is a pretty good statement that the marketplace still sees a lot of value in Windows and thinks it's a great thing that Windows is available to them to do a variety of things.

I think lastly, you can't directly compare Windows and Linux, as Linux is simply a kernel and then there's a set of things that need to go around the kernel that really then shape up to be a full blown operating system, to speak, like Windows. And so some of the management utilities that ship as part of Windows are separate products in the Linux world, some of the security utilities. I mean, you can go all the way up and down, let's just say, the OS stack and you'll see a set of things, the directory stuff that we do, that are part of Windows that are separate things as part of Linux. And so it's not just as easy as saying let's replace kernel for kernel, it's more so about an OS distribution.

RICK SHERLUND: And so you don't really gain anything in terms of being viewed as an Open Source company if there's just something at the kernel that might be open, where Red Hat would say, well, everything is kind of Open Source, even though you can't really go out and get it for free anymore, you have to pay for it, whereas Novell's stack is still proprietary on top of the Linux kernel. All right, so it doesn't sound likely. Thanks.

(Operator direction.)

CHARLES DIBONA (Sanford C. Bernstein): Hi, Martin. Actually it's more of a marketing question. As you see governmental agencies, particularly in some of the less developed countries, promoting Linux actively, what's your response and how do you handle that both from a penetration point of view and also from a pricing point of view?

MARTIN TAYLOR: Yeah, so let me answer them separately and kind of talk about the broader issue of emerging markets and how we think about that. As we really try to understand and spend time with many of these governments to understand how they're thinking about Linux and Open Source and how they're promoting it, we're finding a few things to be true.

First of all, we know that we need to make long-term investments and bets with these governments around the world, that they want Microsoft to be an IT provider but also a partner in helping them build the technical literacy of their countries, to help them enable different types of, let's say, government-to-government business scenarios, help them deliver government to citizens in a technology enabled way, help them drive programs that can fuel PC growth, let's just say, in their countries, and things like that. And so we know that we've got a responsibility to work with these governments around the world on a bunch of different scenarios from a very long-term investment perspective.

Some of their embracing of Linux, let's just say, as you paraphrased it or as you said it, some of it is around the fact that we haven't been spending time with them. We haven't had the resources available to work with all these countries. And so one of the investments that we've made over the last 18 months has been to really add more people to our teams that can spend time in our public sector communities around the world to become more of a partner with some of these governments.

I think that another reason why I would say that they've been looking at Linux has been a little bit of the hype factor of saying, wow, can we build a software industry using Open Source technology and not having to work with Microsoft or other commercial software vendors that maybe don't exist in our country.

And I think that we just recently received a study from Germany, for instance, that spoke to actually the positive economic impact of Microsoft in the country, and so they really understand that commercial software does add a lot of value to their total ecosystem from a technology perspective.

And so I think that we're on a good path to work with those governments in a way that we haven't done historically in the past.

From a pricing perspective, I think one of the most difficult challenges that we work on is to really understand, let's call it this "Big Mac" index in terms of how much does a Big Mac cost in India versus in New York versus in Taipei and how do you map a similar Big Mac index to software. It's a very difficult problem.

We do know that we need to work with these governments so that we do have software and the right offerings priced in a way that's relevant to them and their consumers and their constituencies.

And so I'd say it's one of those areas that we're working diligently on to really understand how we can offer value to many of these countries.

CHARLES DIBONA: Do you have any thoughts on, I mean, the Big Mac index kind of falls apart, because a Big Mac is hard to ship from India to the U.S.

MARTIN TAYLOR: That's exactly right and so that's why I kind of said it's a "Big Mac like thing" that we need to think about but I can't do exactly what McDonalds does on their burgers.

CHARLES DIBONA: Have you gotten any thoughts on sort of where that's going?

MARTIN TAYLOR: Well, no, I think that if you want to take it one level down, so then you say, okay, well, English speaking is an area that we have to really think about and then like except then when you have markets where you have specific languages where it's a little bit easier to do.

And so we've got quite a few different initiatives that we're beginning to work on that we'll be announcing in the coming months on how we're going to work more closely with some of these governments in offering them different types of solutions. I should just probably say it at that.

CHARLES DIBONA: Great. Thanks very much.

(Operator direction.)

GIBBONEY HUSKE (CS First Boston): Thank you. I have really a two-part question.

Just to the role of applications and sort of the development of Linux and how you compete, it seems that one of the things that's influencing sort of UNIX migration to Linux is that it's easier to port older applications onto Linux from UNIX. So just generally sort of what are the competitive dynamics in those situations?

And secondly, in terms of new applications, do you get a sense in terms of new applications being deployed on Linux versus Windows and then looking clearly more at sort of the mission critical application segment of the market?

MARTIN TAYLOR: Yes, so on the first part, there are actually a few different factors that have, let's say, driven or fueled UNIX to Linux faster than UNIX to Windows. Part of is a pure culture climate perspective. When you have UNIX sys admins and even UNIX developers, for that matter, that are more comfortable in a command line interfacing world, that have zero familiarity with Windows, then Linux feels a lot more like UNIX to them and so it's a more natural place for them to think about as they move to port their applications.

There are again some technical issue as well in terms of how do you maintain the same level of speed, reliability, throughput, all those types of things, with the application when you're moving it over to Linux.

Now, we have a product called Services for UNIX. This product is now free. We announced this product, the version 3.5 of this product on January the 15th, and it's a free download that's available, really that allows customers to port UNIX applications UNIX applications over to a Windows environment with minimal rewrite. They can still work in a command line interface, they can still use PERL and some of their other scripting languages. They can run an NFS client, NFS server. There are a bunch of the common things that UNIX administrators need to do and we can enable that functionality directly through Services for UNIX.

And so that's a great example on how from an R&D perspective we've done some things to make that migration easier. We've got quite a few case studies of customers out there that have actually looked and used Services for UNIX as a way to move off of expensive Solaris and expensive RIS machines onto the Intel architecture using Windows through Services for UNIX. Radio Shack has a great example of a customer that is undergoing a pretty significant UNIX migration approach, because of the benefits of Services for UNIX.

And so it's part technology and we're working with some things there with what I've talked about with Services for UNIX, and it's also part climate and culture, and I think that we need to continue to do more to work with the UNIX sys admins out there to let them know the benefits and robustness of Windows.

One thing I've found in talking to many UNIX customers is that their first experience with Windows was with NT 4 nine years ago and they haven't gone back and looked at Windows since then. And so we've come a long way since they first tried Windows and so we know that we need to spend some time with them as well.

GIBBONEY HUSKE: And the second part to the question is regarding sort of new applications being deployed. Do you have a sense of sort of the relative momentum there of you guys versus Linux?

MARTIN TAYLOR: Yeah, I don't have any hard-core run rate numbers to give you that say we're 10 to 1, 20 to 5, which would be 1 to 4 I guess. I don't know off the top of my head how things are from that perspective.

I can tell you from a market momentum perspective we have many, many customers and there's a website actually that I have,
microsoft.com/getthefacts, and on that site it lists quite a few customers that have deployed and are deploying Windows solution in a mission critical way where somebody looked at Linux and chose Microsoft as well.

I think that there are still some things that are at play that are causing customers to, let's say, have to be a bit more thoughtful before deploying Linux in a mission critical way. I'm not saying it's not being done; there are case studies of Linux being deployed in mission critical ways. But you still do have challenges, let's just say, around indemnification in terms of if you deploy Linux in a mission critical way there are still some unknowns out there with regards to that, where, of course, when customers deploy Microsoft they know that we fully indemnify our products for them in that manner.

I think that there are still business models being played out, as we talked about with Red Hat and with Novell and even with IBM that cause reasons for customers to think about it as they deploy mission critical.

And then lastly, mission critical usually denotes a level of either scalability or a level of integration, because you have multiple applications on it and Linux is still driving up the path, let's just say, around the area of scalability and then the integrated solutions that I spoke to earlier.

So is it happening? Yes, it is happening in some areas, but I think that there's still some pretty big concerns out there on customers as they look to deploy it broadly.

GIBBONEY HUSKE: Great. Thank you very much.

(Operator direction.)

KIM CAUGHEY (Parker/Hunter): Hi. Did I understand correctly when you were addressing security that one of your focuses is to show people that Linux is not immune to security challenges rather than kind of focusing on Microsoft improving security?

MARTIN TAYLOR: No, my focus is Microsoft improving security for our customers and that's where we spend the bulk of our time, no question. I think the things that customers have begun to ask me, as I was recently telling the team here, I was on the road 19 weeks out of the first five months or so of this job talking to many, many, many customers. And they asked me two things. First of all, they asked me, "Martin, what are you guys doing to improve your security?" And so I walked them through our security plans.

And then normally they asked me what are your thoughts around Linux in terms of there's a lot of noise in the marketplace that Linux is more secure than Microsoft. And so when I get asked that question so many times, that says to me that I need to do something to put information out there in a very pragmatic and factual based way to share information with customers just so they have some facts in front of them.

KIM CAUGHEY: Got you. That's it.

(Operator direction.)

BRENT WILLIAMS (McDonald Investment): One of the things I've heard is that as part of the opportunity for working with governments and I'm thinking particularly of the Thailand program, you guys are looking at the possibility of putting out maybe you might call it XP light and so we've heard some stuff about that. Can you talk about where you are at this point and where that might evolve?

MARTIN TAYLOR: I'm not at a point to give any details on where we are in that process, except to say that, as I said on the earlier question, we are constantly evaluating and thinking through do we have the right offering in emerging markets and are we offering the right product to both consumers as well as governments and businesses in these countries. And so I'd just like to say that we're continuing to work very diligently on solving that problem.

BRENT WILLIAMS: Okay, and then lastly in thinking about competing on Linux maybe in the server environment, how much of a factor is thinking about 64-bit and if that's a factor where do you really talk about the strength of Microsoft's offering maybe differently than you talk about the strengths of your offerings in the 32-bit world?

MARTIN TAYLOR: I would say that 64-bit I think the market is still kind of being created, let's just say. I think -- and again my numbers are approximate, you should use industry standard numbers from IDC and Gartner and Meta and others -- but I think there are about, give or take, what 100,000 Itanium units that shipped in 2003. And so I think that compared to I gave you a market of roughly about 20 million or so servers out there and give or take and so I think that market is still being created in a broad way.

I think you're definitely seeing 64-bit in some niche areas. So when I mentioned grid computing, some of the HPC, high-performance computing scenarios, that is an area where 64-bit has gotten more traction than, let's just say, in mainstream. As I said, HPC is one of those areas where we have not been as engaged. We have a great reference with Cornell, as an example, but we do know that we've got some work that we need to do to do more with HPC.

So I think that in terms of Microsoft, I think that we've done a good job in working with Intel on our support for Itanium. And as you know, they recently announced their 64-bit extensions for the Xeon. I think we're doing good work with them from an R&D perspective on that as well.

But I think it's weird, there's more excitement on 64-bit from the ecosystem today than necessarily from your mainstream customers today. We're seeing excitement in niche areas from customers today. And I think that we'll continue to work hard from an R&D perspective to make sure that we're helping both drive some of the enthusiasm and then also be prepared to respond to the demands of customers when they exist.

BRENT WILLIAMS: Okay, great, thanks.

(Operator direction.)

VICTOR RAISYS (WR Hambrecht & Co.): Hi, Martin.

A quick question for you. Do you have any updated data or studies on the mean time to fix security issues that compare Windows Server 2003 versus Red Hat's enterprise offerings?

MARTIN TAYLOR: I don't have hard-core data. I'd recommend if you go up onto cert.org, they have a fair amount of that data all available. Their community seems to get upset when I say things and so you should go look on the cert.org site and you can do the math. But I don't have that data on top of my head.

VICTOR RAISYS: Great. All right, thanks.

(Operator direction.)

SANJIV HINGORANI (Oppenheimer & Co): Yeah, two questions. One is, I mean, it's unclear to me what Microsoft can do or is doing in response to the issue of price when it comes to particularly overseas markets and the perception that Open Source is a significantly lower priced version. Even though the TCO argument can be made and you guys are making it, it's unclear that that's enough to put a stop to the bandwagon around Open Source. That's question one.

And then question two is in terms of the whole SCO litigation with IBM and Red Hat, et cetera, what's Microsoft's take on all of that? Clearly it obviously is in Microsoft's favor to create uncertainty and doubt regarding the validity of the GPL, but I was just curious about your opinions.

MARTIN TAYLOR: Well, let me answer the second one first, because it's a short answer, which is I don't comment and have no comment on what SCO is doing in the marketplace. That's nothing that I have anything to do with.

I'm sorry, that was too terse. We are an IP company and so we understand people's need to respect and their IP, let me say it that way.

On the first question, let me address it on a broader scale, if I could, and then maybe work down to your specific concern or your specific issue. The first thing I want to do is give you a little bit of clarity between Open Source and let's just say Linux and/or the products of Open Source.

So Open Source is a model and method of software development. We don't compete with Open Source. We compete with the output of Open Source initiatives at times when our corporate customers in our mainstream market is deciding between Microsoft and, let's just say, an Open Source product like Linux doing one versus the other.

But there are 6,000 or so Open Source projects today on the Microsoft platform, if you go up to SourceForge. And so I want to make sure that people clearly understand that we don't have this competitive approach towards Open Source; we have an approach that says we want to make sure that when our customers are looking to deploy our technology solution, we want them to look at Microsoft and hope that we have the best solution, and if they look at something else, we want to know why and what we need to do to be relevant. And so let me be very clear to separate those two discussions.

Now, that being said, the price issue is an interesting one, because in some ways people want me to say, "Martin, what are you guys doing about the price pressures that Linux and Open Source are putting on the market," and my response is, well, you heard Rick talk about it, but first of all we've had an evolution where business models are playing out where today the Red Hat distribution costs a little bit more than a company of Windows Server, so initial acquisition price really is no longer an issue.

The real issue is are we offering the right solution to the customer at the right price point, and it sounds like kind of a marketing spin conversation but it's actually an R&D priority on how do we really need to think about what are we offering to the marketplace and at what price point.

So let's just say if we're trying to compete with Linux as a Web server, so Apache and Linux as a single purpose Web server, and that has a price point of X, the solution is not for us to take Windows Server and just cut the price by X amount so we can then have a similar price point as the Apache Linux distribution of a Web server. The solution is for us to do some R&D work to create, for instance, the Windows Web server product that we have that then allows us to then have a better matching up of a price point perspective.

We did the same thing, let's say, with Windows Storage Server versus some of the single purpose storage devices that are out there.

We took a similar approach in thinking about Small Business Server and how do we bundle up the right set of server workloads and offer it to the small business marketplace in that scenario.

And so I think it's that level of thinking and mode of thinking that we have to have in really trying to understand, let's say, "price", but I'm kind of putting that in quotes, when we talk to our customers about what they need, what server workloads are they thinking about and what value do we offer them for those various server workloads and then at what price point.

And so it's a complicated thing that we have to work through because it has R&D implications and it has some marketing implications but it's really not a pricing conversation from that perspective.

The one thing that should be noted is free is free, zero is zero, and so whether you're $1 or $100, it kind of makes no difference if somebody wants zero. And so the question though is when you take a look at what people are doing on a broad scale way, you're going to have very few corporations, and that's a medium sized organization all the way to a very large organization, that really are going to invest to build technology solutions on top of something that's not being supported by some vendor in some way, unless they want to take on that support all internally, which a few customers do want to do.

So that being the case, you have to say that, okay, there will be some type of free versions that are out there that people can try and experience and use and play with and get some experience on, but once you now begin to move to more deployment scenarios, there is going to be some cost model associated with that. The cost model from Red Hat is more on support and services and tests and Q&A. Our cost model is more on R&D from that perspective.

CURT ANDERSON: Operator, we have time for one more question.

(Operator direction.)

GUS ZINN (Waddell & Reed): Thanks. I guess maybe if I could ask two quick questions. One is one of the things that Red Hat talks about is the pace of innovation is faster with Linux and they get updates faster to their customers or more frequently. Maybe you could just talk about that.

And then secondly, I read about something called Windows XP reloaded, and I'm wondering if that's a potential server product or just desktop I guess. I don't know if you can comment on that or not. Thanks.

MARTIN TAYLOR: Okay, so I'll answer the second one first. I don't know what Windows XP reloaded is, so I can't comment on that.

And then on the first part, in terms of the pace of innovation, I would say it's interesting, in terms of how you think about the pace of innovation and how you define innovation, you could make an argument that says there is really no true innovation that happens at least from a Linux Red Hat or a Linux distribution perspective, that there's no new scenarios that they're creating, new ways of actually computing, let's just say. What they're doing is innovating on a business model perspective on how to deliver software or how to deliver a kernel and things of that nature.

In terms of the pace of innovation, I think that that's also fairly interesting when you really think about how you want to compare the two, when you take a look at some of the things that Microsoft has to make sure that we do a good job on, such as regression testing, because of our installed base and all the things that we have to do as we evolve our technology.

You can make an argument that says, hey, as Red Hat or other companies increase their population or their installed base, they'll have one of two options. They'll have to also take those things into consideration or they'll just leave those questions kind of off. And I don't know kind of where that is or what the process for that is.

I've seen no inherent data, and the thing I've tried to help you guys understand is my approach to this discussion is as fact-based and data-oriented as possible versus kind of emotional. So I have not seen any data that suggests a pace of innovation that Linux or the Open Source community offers that our software model or our development model does not offer.

From a customer perspective, and you guys I think probably are just as attuned to this as I am, I don't think our customers really want us to innovate in any faster way than we do today. I think today our customers have a challenge with absorbing the current pace that Microsoft has of innovation strategy for them and so it's an interesting dynamic to try to figure out what exactly do we need to do on that dynamic.

But if you do have some data that you'd like to share with me, please get it over to the team, because I'd love to see it.

GUS ZINN: Thanks.

CURT ANDERSON: Great, well thanks, everybody.

Martin, any closing comments?

MARTIN TAYLOR: Yeah, again I'd like to thank you for your time and giving me an opportunity to share with you some of the thoughts that we have on our direction here. I hope I've done an okay job in helping you understand that we're really trying to move these conversations from an emotional, religious conversation to a more pragmatic, fact-based conversation. We know that there are some key areas that we want to help customers and our partners understand the facts versus the hype and the noise around TCO, reliability, interop and security.

That being said, we know our true value add is to continue to deliver innovative scenarios to our customers, and so that's where the bulk of our energy and efforts are always going to continue to be is ensuring that we are building new scenarios for our customers and enabling new ways of doing business for them, which is really what our focus will always continue to be and the mission that we'll continue to be on and how we'll spend our $6.8 billion in investing.

And so from that perspective, I'm excited and enthused about the opportunities ahead of us and if I have an opportunity to talk to you guys again, Curt, I'm more than open and willing to do that.

CURT ANDERSON: Happy to do it, great. And, Martin, would you recommend that folks check out the Get the Facts website?

MARTIN TAYLOR: Yeah, many of the things that I spoke to, the TCO studies and some of the security things and some of the customer references are all up on
microsoft.com/getthefacts and I hope that you can take a look on there and see some of the information that we're sharing with customers and partners.

CURT ANDERSON: Well, Martin, thanks very much and, everybody on the call, thank you for taking time out to hear what we have to say. If you've got any further questions, please give me or any of the IR team a call and we'd be happy to help you out. Thank you.

END

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