EDWARD WILLIAMS: Up next we're excited to have with us Microsoft. And as you know, Microsoft is launching the next generation of game consoles in two weeks with the Xbox 360. So to get us started and give us a glimpse as to what the 360 will do to videogaming in the household and I think more than that, just media and entertainment in general, we have Bryan Lee. Thank you, Bryan.

BRYAN LEE: Thank you.

Good morning, everyone. From where I sit and what we've been doing with the Xbox business, kind of the word that word that jumps to mind is wow. It's a wow for a lot of reasons. If you're at Microsoft, it's kind of a wow year when you think about all the products that are going to be coming to market. We certainly have a product we're very proud of with Xbox 360. We're also going to launch the next version of Windows, which could be fairly impactful for our business, a new version of Office; we have products coming from all of our business groups, so it's a very exciting time in the Microsoft portfolio.

It's certainly an exciting time for us in 360 because we've been planning what's going on in this space for years. Really since the launch of Xbox we've been thinking about how to bring this successor platform to market, how to work off the assets we've built, and then really how to improve some of the things that maybe we could have done a little bit better the last time.

And certainly for the industry, as you've heard a lot of people talk about, this is a great opportunity to grow, to grow the entire pie. You're going to see graphics which are amazing, you're going to see new media scenarios, you're going to see new models that take products to consumers in interesting ways, be it things like online. You're going to see opportunities to grow in markets where we haven't really been before. So it's really an exciting time, a fantastic time to be out there.

Now, coming down a little bit, a little housekeeping, just to make sure everyone is aware, actual results may vary, so read it and you know what you're doing.

To talk about it again, 360, we've really gone off and we've said what did we do well with the Xbox business, what assets did we create, what are the things we could learn from, what are the opportunities to really amplify, and then how does this fit into consumer trends. How does this fit into macro trends that are going on in terms of display technologies, in terms of storage, in terms of personal aspects about what consumers are looking for.

So we've tried to map all this together and figure out how we could participate for ourselves and for all of our partners here in the room to really create a lot of great consumer value.

So to do that, let's take a quick second and let's go back and look at where we are in the Xbox business. This really won't be new information for anyone, but it's a good foundation.

We feel very proud about having sold over 20 million consoles in the market. We are really firmly established as the number two player. And since we launched our first product less than four years ago, we feel pretty good about what we've done in this space.

We've got some franchises, which we're awfully proud of: Project Gotham Racing, which we'll be bringing to market with the launch of 360; a little title called Halo, which seems to be doing pretty well in the market. So we feel really good about some of the IP we've built.

One of the other things we're extremely excited about is where we've innovated, and you can take a look at something like Xbox Live and see that it's a place where we really tried to get out ahead of the market in a lot of ways. If you remember when we were pulling it together and we started talked about being broadband only, people thought we were crazy, they thought there was no chance that would be successful; luckily, we read that industry trend right, so we feel very good about that.

It's led to tremendous innovation in the industry, it's led to new opportunities for a lot of publishers, it's helped define some franchises in new and exciting ways for consumers. So it's an area that we've seen as a great differentiator and a great opportunity as we move to the next segment.

And then we certainly with the Xbox business feel great about where it is. We're going to be selling, as we said, well into next year. There are hundreds of games in development, there's a lot of excitement in this space, so we feel very good about this as a foundational asset that really sets us up, that we've used the line before, that this is where we've proved we can play; now the chance is to prove that we can lead.

And that then leads us into how we think about Xbox 360, so I'm going to walk you through a variety of things. We're going to talk a little bit about the product, we're certainly going to talk about games, and we're going to see some game footage. We're going to talk about other opportunities with broader media.

But the first thing I'm going to do is actually show you something, which is a little bit different for us. It's an advertising and if you've followed the Xbox business, you saw that most of our advertising, practically all of our advertising around Xbox was really around products. We advertised the games; it's a great way to sell the game and a great way to sell the platform.

Well, one of the things that's certainly obvious on the existing platform is that we have a brand, we've established a brand, and it means certain things to certain people. To a lot of people it means technology, it means amazing power; it can also be limited in some ways that it means a little intimidation or a little first person shooter. So a lot of our goal is to make sure that we establish a brand and we bring consumer value to a lot more people.

So where previous generations of consoles have been a little bit more introspective, they've been a bit solitary, playing in the back room by yourself, we really want to embrace the social aspect.

So I'm going to show you a couple of ads, which introduce the notion of social gaming, and really how we want to make sure that that's a linchpin of the Xbox 360.

(Video segment.)

BRYAN LEE: So as you can see, our invitation is to jump in, it's to really share the experience with your friends, share the experience with someone you want to compete against, but really share and enjoy a very social aspect.

And these ads, by the way, have been running for about a week in cinemas here in the U.S., so you may have actually seen some and I believe the debut on television will be tomorrow night on Lost we'll be running one of these. So you'll start to see this as the momentum builds around the brand awareness.

Also we've taken an approach where we want to make sure that everyone gets to understand what the technology can do, but here we wanted to also show these in a more interesting brand friendly open environment. So we're going to show you a proof of concept—now, this is a working version so give it a little leeway on the way it might look—a proof of concept on how you can see actually what high definition is going to look like. Pay close attention, I think you're going to be pretty amazed.

(Video segment.)

BRYAN LEE: So it's one thing to talk about high def as a technology, it's another thing to see something like that. So you'll see these spots running probably in local cable, think MTV, think Comedy Channel for ads like this.

We also have done a few where we want to demonstrate what it means to be online. And again these are really designed to show not just a technology discussion but how do I apply it to my life. So let's take a look at this one.

(Video segment.)

BRYAN LEE: So there you get a grasp of the global community aspect, and a little bit of kind of the fun, competitive atmosphere that online can give you. I think these are going to be a lot of fun.

So I want to take a second now and talk about—we talked a little bit about the past, about some of the things we've established with Xbox, but I want to talk now about some of the themes that we've really focused on around the 360.

And as I said a couple of times, the planning process has been going on for quite a while, so what we've tried to do is really weave a lot of these themes through everything that we're doing so that you'll see ad campaigns that make sense relative to games, that make sense relative to the industrial design, the story about future media. We may not get it perfect but that's really been the approach.

And for a little more context going backwards, I think most everyone is aware, but when Microsoft decided to get into the Xbox business, the time between the decision and the real approval by Bill and Steve to get in the business and having products on shelf was only about 18 months. So that caused us to take an approach, which was based on speed. A lot of people like myself were kind of novices to the game space, there was a lot of learning on the fly, and it's pretty easy to see that when you look backwards. But now that we've had the time, we've had the ability to try to weave things in. Hopefully you're going to see that through a lot of what we do.

The most obvious example of that is the industrial design itself. So we'll talk about it a little bit more in a second, kind of how we arrived at the 360 design, but it's strikingly different from the Xbox and it's an example of where that time and that integrated design effort really paid off.

Then there were three trends, which we saw kind of happening in the industry, that we really wanted to make sure were weaved into everything that we did. The themes of personalization and customization: Anyone like me that has teenage kids, you know that everything is about being included but also being personal, how do I take my own devices, my own experiences and make them mine, yet fit into the broader environment, how do you strike that balance.

Certainly from a technology standpoint I spoke about broadband a moment ago, but its increasingly pervasive nature is just growing. So by the end of this year there will be 40 million households in the U.S. that will have broadband. Other countries have an even greater penetration. It continues to grow, it continues to push out and that just opens more and more possibilities for all types of media, particularly interactive.

And then you think about high def graphics, you saw a glimpse of that a moment ago, and we'll go through that again, but when you think about what's happening in that space, high-def displays, how they're pushing out in the market, how many are out there now and how many are coming, that's a great industry trend.

And as we've said before, there's the potential for growth in the overall market is amazing. While we're very proud of the growth in the game space, we're still not in more than half the households, even in markets like the U.S.

So how do we get into half the markets, how do we get into three-quarters of the markets, of the homes, how do we get into 90 percent of the homes, how do we get into markets that really haven't seen this kind of opportunity yet like China, India, those places? The opportunity in this space is enormous, and so we see it just as a fantastic opportunity for growth.

Now, let's go into some of these more specifically. We talked about the industrial design and on the Xbox you might say there were some opportunities for improvement. It's a little bit big, a little clunky, not that friendly.

So when we started to think about how to do the Xbox 360, the design team went off and thought about four axes to work from. They thought about a contrast between wild and mild and they thought about a contrast between architectural and organic.

And the way they described it to someone like me is they suggest thinking about automobiles. So in the architectural and wild you might see something like a Hummer, very firm, very strong, very distinct in its lines. A slightly milder version would be a Range Rover. Moving across you can see more curves, more of an organic nature in a Porsche 911 or a Lotus Elite.

So when we compared the industrial design of the two, it's pretty easy to put the Xbox up in the upper right and think of it as the Hummer, and that appealed to a certain group of people but it wasn't nearly broad enough.

So when we looked, the group really focused on how to create something that was more sleek in its design, something which really had more of an international appeal, something that could appeal to a broad set of media experiences, and they landed on the design that you've seen here on the screen, you've seen in other places, and we have one here today.

The device was created on a worldwide basis. We engaged design firms from around the world. We ended up working with a group out of Japan and a group out of San Francisco and they jointly developed the final version that you see here.

And one of the interesting anecdotes, given that we've had a little challenge in this space, and given that we've also had some challenges in Japan specifically, when the group was doing consumer research and obviously there were no brandings, but they were showing the device to a group of gamers in Japan, and there was a lot of excitement, people felt like it was a very good design. And then one of the questions was who do you think designed this device. And one of the great quotes, a young man said, "Well, there are only two companies in the world that could have potentially designed something like this: Apple or Sony." So hats off to our friends at Sony, thank you for blazing the trail, and we feel pretty good about being in your company, so we're pretty excited about the improvement there.

And then what's under the hood is also equally as impressive. You probably have all seen these stats before. The CPU is a three-core, 3.2 gigahertz CPU produced by IBM, running off a Power PC architecture. When you combine that with the memory, with the front side bus, with the graphics, this really will be the best device out in the world. If you were thinking in terms of what a PC with this kind of functionality might cost, you might pay $2,000, something like that. Just the graphics card alone, comparable graphics cards would be selling in the hundreds of dollars. So the firepower that's sitting under the hood on this thing is pretty amazing.

There's also been a lot of debate about who has the greater power, this device or what Sony has suggested about the PS3. We won't really debate it that much; it's probably the way to think about it is they're both Ferraris. They're both amazing machines. We probably have a slight edge in a few categories, they have a slight edge in a couple of categories, but both of them are going to be amazing devices, which is good for everyone in the room. It's a great piece of technology that's coming out that's really going to push the advent of what's going on.

Now, it's going to push it because there are amazingly two macro trends, which now converge. So Moore's Law will take devices like this and just make them generationally better. This device, relative to the Xbox, is amazingly better. The PS3, according to its specs, will also be a good device relative to the PS2. So we're pushing a lot, but when you take that and you combine it with the technology around displays, high def, you actually get a two generational jump in what's happening, if you think about it from the consumer perspective. As a consumer, you now see not only the jump in technology but how it gets displayed.

So we talked about high def TVs before. It is really the future of displays. There are millions out there and projections are that by 2008 there will be over 100 million high def displays out in the world.

For those of you that already have one, if you're like me, you can't imagine actually watching on a standard def. If you have a standard def, certainly gaming will expand, but if you think about this, it's an amazing opportunity to take the experience to the next level.

So we see this as just a phenomenal opportunity for all the brilliant game developers to take advantage of and really wow consumers.

So let's talk about the games for a second now. We'll try to go through this pretty quickly, but from a game standpoint we do have support really from every publisher out in the world, every independent publisher on this name, they're all excited about what's going on with the 360, they all see tremendous opportunities.

And what they're bringing to the market, if you think about the titles that will come out in the launch window, from launch through holiday let's say, it's a phenomenal list and probably is the best list ever seen in gaming.

This is an example of some of the titles that you'll see. You'll see exclusives obviously from Microsoft Games Studios with Kameo, Project Gotham Racing, Perfect Dark Zero. You'll see exclusives from some of our partners like Dead or Alive 4, Call of Duty 2. And then you'll see just amazing support from a lot of other publishers. You'll see a lot of titles from EA, our friends at Take-Two. There's a lot of people up there that are throwing a lot of support behind what's going on in this space.

Now, it's one thing to see it on slides; why don't we take a quick look at what the games actually look like.

(Video segment.)

BRYAN LEE: So those are just stunning. I'm going to take a minute and walk through a few other games here to give you a little deeper insight into those. First we're going to take a look at Kameo, which comes from Microsoft Games Studios and was developed by Rare, our studio in the UK. And here pay attention to the depth of the experience, it's incredible, and think of this as also a game which I talked about broadening a little bit. This is a game which has the ability to appeal to a lot of people. It's set in a different environment than you've seen a lot of Microsoft games. We're very excited about this game and the franchise that it's building. So let's take a look at it.

(Video segment.)

BRYAN LEE: Kameo promises to be the next great franchise from the talented group at Rare. After that, we have Project Gotham Racing 3, which is another Microsoft Studio project, it comes from Bizarre Creations. It really takes racing as you've seen in the prior versions to a whole different level. So, life begins at 170 miles an hour. Let's take a look.

(Video segment.)

BRYAN LEE: Also from Rare we have Perfect Dark Zero. This picks up the Joanna character and actually is a prequel to where you've seen her before. This establishes a lot of her back story. It's a very exciting game coming our friends at Rare. Let's take a look at this one.

(Video segment.)

BRYAN LEE: Perfect Dark Zero, Project Gotham Racing 3, and Kameo will all be part of the launch line-up, so we're really excited about those. I'm going to show you one more game, and this game will be coming out a little bit later, and it's a game that we showed at E3, and this is an updated build, an updated version, but the game had so much attention at E3 for a game that's coming out later that it really warrants paying close attention to. So, let's take a look at Gears of War from our friends at Epic.

(Video segment.)

BRYAN LEE: So, as you can see from these examples, the next generation of gaming is here. It is being delivered through the Xbox 360 right now, and it will be in consumer's hands in just a couple of weeks. I want to take a minute and talk about Xbox Live, and how that improved through the next generation 360. Live's been a great asset. We have well over two million consumers that are just loving the experience, games like Halo 2, I forget the exact number, but I think the amount of aggregate hours online playing Halo 2 is somewhere just off of 300 million now. So, it's a phenomenal amount of hours played. It really shows you how engrossing the experience can be.

With Xbox 360 the experience gets improved. We've talked about offering a silver or free level so that consumers can just plug and play, and start to take advantage of the experience. They can take advantage of marketplace, which I'll show you in just a moment, and they can take advantage of the ability to participate in some community, and enjoy downloads if that's something that they want to pursue. So, it's going to continue to evolve. We're going to have spectator mode, we're going to have a lot of innovation. And because Live is fundamentally about software and a platform, innovation can roll out on a very regular basis, as you've seen through this cycle.

I want to take a second now and walk you through some other cool things. We're actually going to fire up an Xbox here, and we're going to take a look at what it's like, what the blades look like, and here we go.

So, this is the home page. You'll see different blades here, we'll go through those. This is running off the Xbox, running off the controller right here. So, I am, for those of you who know, I grew up in the South. I went to Old Miss, so they made me Rebel Yell for today, Old Miss Rebel. But, the cool thing is, you can personalize this. This is my game page here. As I play through, this is a new box, but all the achievements that I've earned on any game will show up here. So whatever my personal accomplishments are will be catalogued, they'll always show up. The games that I've played in the past will show up here. There will be a long running list of anything that I've played. Xbox Live Arcade, which I will show in a second, but let's talk about how I can personalize the experience.

So, that was me, but it turns out I don't like that picture that much. So, what I want to look like, what kind of picture do I want to exemplify me. I don't know, I'll be a happy guy today. So, I can change my profile, and as gamers see me, they see this version of me. A lot of you publishers are actually already supplying some pictures that are actually themed around your games, and we're going to expect to see a lot of that roll out over time.

So, another thing that I can do is, if I'm talking about themes, is, I can always push the Xbox button here in the middle and pull up me. That's who I am. And let's say I like to change some of the way that the screen looks. I want to personalize it, so I go to themes. We just saw PGR, why don't we change it so that the entire experience has a PGR feel to it. So, now you'll see the background on all the screens have picked up PGR. So, this is a small example of how consumers can take the experience and make it what they want. It's essentially a revenue opportunity for publishers. There's no reason this stuff can't be sold if consumers are willing to pay for it. We're happy to enable that. So, it's really just an opportunity at the platform.

I want to go and take just a second and show you Live Arcade. We've announced that there will be 21, I think the number is, Live Arcade games, and these are mini games that are just nice examples of things that you might want to play that might broaden the audience. So, my wife, my 10-year-old daughter, they may not be into Halo, they may like other games. So, my son has been enjoying playing Hexic lately. So, let's just pull up Hexic and see how easy these games are and, again, it grows the experience. Some of them will be free, Hexic will actually come loaded on the hard drive. Others can be sold, and another opportunity for all of our partners.

Let's just go real quickly, go Hexic, I'm not that good at it, but my six-year-old thinks I am, so we won't tell him. So, this small game is very digestible, very easy, a couple of minutes in, a couple of minutes out, so that's the experience there. And if you think about 20 or so games like that, they really round out a lot of the opportunities for lots of fun.

Let's go back to the dashboard. Let's take a look at the Live blade for a second. One of the things I mentioned, going back to the high level about kind of the integration, as you'll notice the curves on the blade, they kind of have that concave look which maps out very well with the console. It's again a part of the theme of what we've been trying to do. So, this is my Live experience, this device is not hooked up, so we're not online right now, but I can keep up with my messages, I can receive any kind of messages. There will be voice messages that gamers can leave me. I can get game invites. I can do a variety of things there.

Marketplace we talked about a minute ago. So this is the opportunity to keep your device fresh. There will be free content up there, game trailers. So, if publishers are interested in posting trailers, getting out showing the consumers what's coming, they can do that. This can also be a commercial enterprise, think about the easy ideas of I want to sell a new car, I want to sell a new track, I want to sell a new sword, all of those area available here through Marketplace, and publishers can now find new and interesting ways to drive extra income.

I'm going to jump over now to the Media blade. This one is kind of interesting because, certainly, our target audience likes to do a lot in media. They like games, but they also like their music, they like their photos. So, when we designed the 360, we wanted to make sure that it was really a media amplifier. So, I listen to, I have an iRiver that I carry, this runs off Microsoft technologies WMA. So, you say, okay, that's pretty cool. I can just plug in my iRiver, and the music can stream off here. You might say, hey, Bryan, you're a Microsoft guy, that's an iRiver, but there's this other device called an iPod, and people kind of like that. What can you do there? So, we've hooked up a Nano, it's right here, it's simply plugged into the USB port.

We're going to go into music. I can play music a variety of ways. You can rip to the hard drive here, you can put your CDs in. You can also stream off your computer if you have an XP computer in your home, and you have a wired or wireless network, you can stream all your music very simply off that. So, if you think about this very logical scenario going forward where your 360 sits with now your best entertainment components, where it sits with your hi-def TV, it sits with your stereo that's running 5.1 or even 7.1, your music sits on your computer. This is a very easy way to actually consume it fitting through your real entertainment experience.

We're going to run it off the iPod. So, it's read that the Nano is there. If I unplug it and plug it back in, it would just take it off. It instantly resets there. So, we're going to run the Nano, and all the music is there literally reading off that. So, why don't we, U2, so let's play U2. One of the cool little things is, if you are into visualization, you can pop this out. This is actually being controlled by me. I can move it around in this experience through the joystick. I can flip to a different version. There are lots and lots of them on here. So, if you're into parties, or whatever you might happen to be into, it's a cool little feature.

In addition to being able to run music, photos are equally easy. Now, the other day I bought my kids this cool little movie player called a PSP, and they're enjoying it, and also you can store some photos on there. So, I what I thought we'd also do is show how you can take a look at pictures. And here, again, I can pull it from the computer. I can pull it from the Nano, if there happen to be pictures stored on there, or in this case the portable device that it's reading as the PSP.

We took a couple of pictures, I've actually got a combination, you're going to see the Lee family vacation, and then a couple of pictures we took this morning out in the lobby here. So you'll see it's just reading the photos as a slideshow. They had a good time, a very good time. Then we just popped these this morning. The key here is that it's simple and that it's broad. I intentionally showed you two devices which are not necessarily part of the Microsoft family. I showed you an iPod and I showed you a PSP. Certainly it can run with a multitude of devices, a multitude of integration.

The key story that we've been telling for a while is we believe that consumers should have a lot of flexibility, that a lot of your media is best stored, best edited, and best managed on a PC, but best consumed through other devices. So think of the 360 as your great digital amplifier, that takes all your media which you might have around your home and a way to project it in the environment which is most enjoyable for that.

I'm going to show you one more thing here in the systems settings. This is where you set up, you do few things. But, I really want to show you family settings, because our industry is taking a lot of pressure right now about how to manage things where we allow content creators to produce content that they want, and then we allow parents and consumers of age to decide what kind of content they choose.

So one of the things that's been important for us is to make sure parents have control over this. So in family settings you as the parent can go in and do two things, or three things. You can set up the console itself, if you choose in game ratings, game play, to have your console only play games of a certain rating, you have the flexibility to do this. So I can set this device so it will only play games rated E or below, and also think of equivalent ratings outside the U.S. I could set it for M if that's what I chose. I, as the parent, am in control.

Also, since we play DVDs, a similar type structure here, I can set it up so that any DVD is playable, or if for some reason this is a DVD my kids have, and I only want them watching PG movies, or softer ratings, I have the control over that. So we think this is a very good opportunity for the industry overall to show how serious we are about ensuring that parents have control.

Another area that scares people in some ways is going online. So similarly, I as the parent can control who is allowed, who my kids are allowed to interact with online, I can make it just their friends, I can make it anyone, I can choose to turn off VOIP, I have a lot of control as a parent.

We probably need to go deeper into different settings, but that's just an example of the four different ways that we have now, how we can control the system, our media, our game experience, and Xbox Live. Also, because it's software, we have the opportunity over time to update this, to add new features. It's really a wonderful system that way.

We're going to get out of the Xbox now, and then try to finish up and let you get to some questions here. I'm going to wrap up with just a little bit of the excitement. You've got the CFO, I'm not the most dynamic guy here, but we've got a lot going on around excitement. This is an example of how we're building momentum in the business, how we're building momentum with consumers, a lot of magazine spots. As I said, you're going to start seeing TV spots this week. Around the brand you'll start to see game spots. Point of purchase material is up in most retail. We have thousands of kiosks out already, and thousands more to come. So the momentum is really building, and that really sets us up for our launch.

As I believe all of you know, we are going with a worldwide launch, effectively, on November 22nd in North America, December 2nd in Europe, December 10th in Japan, and that's a first for the industry. We thought, we've been designing this business for a few years, as I said, and we always looked at the opportunity of this holiday, and wanting to be out there in every major market. We couldn't think of any market where we didn't want to offer consumers a chance to get a 360 this holiday.

It's been hard. We're building a lot right now, so if anyone is confused about where we are in production, we're building thousands, and thousands, and thousands of 360s every day. They are on boats, they are on planes, they're in distribution centers. They are hitting retail. They're fanning out throughout the world. Our supply chain is strong, it's healthy, this is a complicated logistical exercise, there's no doubt, but everything is really set up for success.

There's been some confusion about whether we are supplying the market, there's been some concern about quantity. I just want to make sure everyone understands, our philosophy from the beginning, from the beginning has been about have a great number for launch, but then consistently resupply. Retail has been working with us for over a year, telling us they'd much rather have a model like that than some model where we dump a lot on day one, and then we have to shut down and resupply. So there will be plenty for launch, and then there will be strong resupply coming through after that.

To show that, we've told you before that we think for our fiscal year we expect to ship, sell, between 4-1/2 and 5-1/2 million consoles. We didn't give guidance on the upcoming quarter, because the period is so short, it's very truncated, and we didn't think that it was a great example of where things are going.

But, today let me give you another thing. I'm very proud to announce that we think through the first 90 days of launch, which we think is a very good indicator of really the trajectory, the health of how things are going, we expect to have sold 2.75 to 3 million consoles worldwide. Now, when you get your pencils and your calculators out, and you start doing some math and say, is this a good number or a bad number, let me give you one way to think about it.

When you think about what consumers are going to be spending on consoles, and then you think about the games that they're going to buy along with them, you think about the peripherals, the accessories they're going to want, you think about the Live subscriptions they're going to want, the total spending by consumers will be well over $1-1/2 billion in that first 90 days, $1-1/2 billion. I can't think of really many other, if any other products that have had an initial launch that have sold $1-1/2 billion to consumers in their first 90 days. I can't think of another console, I can't think of another consumer electronics device, I personally couldn't think of any product out in the world.

So are we excited about where we are? You'd better believe it. Is it going to be hard? You'd better believe that, as well. But, are we going to do okay? I think we're going to do better than okay.

So I'm going to wrap up here and then we'll open it up for some Q&A? In summary, we feel very good about the assets that we've built. We've been in the gaming business for four years. Xbox Live has been out for three years. We've established ourselves as the number two in the market. We've really proven that innovation is a great way to push the industry. We've invested through this cycle. So for those of you who were Microsoft shareholders, we've invested to build this business.

In the end it's going to prove to be a very good investment, but Xbox 360 is no longer about investing, it's about building a very profitable business. So we are focused on profits. We've reiterated time and time again, we are designing a console which will not be a subsidized product over life. We feel very good about that. We feel very good about the profitability that can flow from our own franchises, as well as our friends. We see great opportunities to expand the market. We see expansion in terms of digital media. We see expansion in terms of geographies. So we are very excited about where the market sits, and the opportunities going forward.

Very excited, happy and ready to go. So with that, I guess we'll open it up for questions.

QUESTION: Let me ask you about manufacturing, currently on the Xbox how many are you manufacturing a month, and with regard to the Xbox 360 what is your optimal goal of manufacturing, and where are you at that range right about now?

BRYAN LEE: Where we are, we haven't disclosed how many we're manufacturing on a regular cycle, so I'll just kind of talk about it in general. Right now we're up and running with the 360 with two contract manufacturers, Flextronics, Wistron, they both have multiple lines running. We're bringing up a third contract manufacturer in the new year, I don't think we've announced it to date, Celestia.

So those are all world-class manufacturing partners. We are building them as fast as is humanly possible, and when you think about the cutting edge technology that we have, we have CPUs, and GPUs which didn't exist in the world a few months ago, and now we're trying to produce them in mass quantities. There's a lot of excitement about that. We have production lines which didn't exist just a few months ago, so those are up and running.

So things are going well. Do I wish we had more, do I wish we were going faster? I always do, because I always like to push for more. But, we feel very comfortable. We're really within our plan, if you go back a couple of years ago, like I said, and think about how many we wanted, what we thought we'd build, we're really within the bandwidth of where we thought we'd be. So overall the system is very healthy. We're very excited about it. We're doing very well.

QUESTION: What do you expect the attach rate to be for Xbox Live maybe two years out, by the end of the cycle? How are you guys thinking about that attach rate, before it was 10 percent, 12 percent, what do you see. And secondly, what are the economics behind making games using Live?

BRYAN LEE: So on the attach rate of Live, I'll tell you I do a few things in my job really well, and I do a lot of things in my job really poorly, and one of them is projecting what our Live install base is going to be.

If you've followed what we've done over the last couple of years, we've continually updated our guidance and improved it as we've seen things happen, which means I don't know. It's really going to depend on whether we hit the tipping point. We really hit a tipping point with gamers. They really love it. What's going to happen when the new media capabilities are out there, and you can sit and watch a movie and talk to your friends while you're watching a movie. There's all kinds of new media experiences that are coming with 360.

We've said that we'd like over time to see half of the 360s attached to Live in one form or another. It seems to be kind of a good yardstick. We don't know if that number is right, if that number is wrong, we don't know how many will be on the silver versus a gold package, but it felt directionally correct, and I think appropriately aspirational for how we feel about the business.

I'm sorry, your second question was around—so that's probably a great question to ask them as they come and go during the day, because they're the best ones to speak about that. Examples of what we've seen are a lot of games fundamentally hold their price point longer. The game is fresher. The game feels more exciting.

So if I've got online play, the game is very rich, I don't have to drop prices maybe as quickly. When you think about opportunities going forward you certainly think about supplemental content that can be downloadable. So how do I keep a game fresh by supplying a new level, by supplying maybe a new storyline. You can really kind of blur the lines between packaged goods and MMOs or something like that, by actually extending the life.

We did this at Microsoft with Halo 2, where we sold supplemental maps, and consumers just couldn't wait to get their hands on those. Halo 2 may be a slight abnormality, but it certainly shows what can happen in this space. Selling micro-transactions and storage, all those things are capable, if the publisher sees it as an extension of their business.

QUESTION: Can you talk about the economics surrounding those micro-transactions, what will Microsoft be charging the publishers, and what do you think publishers might be charging consumers?

BRYAN LEE: Well, what they charge consumers is their own affair, I don't get a say on that. As far as our relationship with them, really think of it just like any other piece of content, where there is a platform component, we're investing in building a platform, so we need some type of royalty to make the economics square on that. And if we provide the service for them, we need our costs reimbursed, but other than that it's the publisher's content, it's the publisher's money, we're happy to pass it along.

EDWARD WILLIAMS: We can do one more.

BRYAN LEE: Okay. Ed says one more.

QUESTION: There's other revenue sources being generated for games, than for platforms and one of them is advertising. Where does Microsoft stand on the issue working with the folks like IGA and the other folks out there, or are you guys working on something internally?

BRYAN LEE: Well, we're very excited about the possibilities that advertising holds. When you think about it it's another place where software and a software platform can enable a lot of scenarios. We've actually got a couple of games out in the market now on the Xbox platform where we're trialing some ads and we've been working with Massive on those couple of games. Would we work with other people or other opportunities? We're happy to do those, as well, and we feel very excited about advertising as a potential growth opportunity for the business.

That's another way when you think about markets outside of North America, the fundamentals of our business may not hold, consumers may not be accustomed to paying $50 for software and buying a $200, $300 or $400 device, an ad model may be a way to augment to kind of make the economics work for everyone.

QUESTION: Thanks.

BRYAN LEE: All right. Thank you. (Applause.)

END

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