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ANNOUNCER: Please welcome, President, Entertainment and Devices Division for Microsoft, Robbie Bach. (Applause.)

ROBBIE BACH: Good morning, everybody. Since I was here about a year ago, a few things have changed in my neck of the woods. What was Home and Entertainment Division has become the Entertainment and Devices Division. And in the process of that, we've added mobile and embedded devices; Media Center; responsibility for music, TV, and video; and responsibility for games for Windows into the group.

So what I really wanted to use today to do is to really bring you back in connection with what Entertainment and Devices is, talk about how we did this past year, where we're going in the future, and bring you up to date on the strategy.

One thing that hasn't changed is our focus on the digital lifestyle. When I was here last year, I talked extensively about why we think the digital lifestyle is such a tremendous opportunity for the company and a tremendous opportunity for our group. And whether you're at a PC or in your car or traveling or sitting down in front of the TV, we think we can deliver an amazing connected experience around the digital lifestyle. And so all the things we're going to talk about today are really going to be focused on that, and focused on some of these key scenarios, which my new group owns end to end.

One way to think about our business is to think about it as a set of pillars or cornerstones that we are building for the business. And there really are four cornerstones we're working on. One is productivity. I actually won't talk a lot about productivity today. It's actually a very good business for us, one we continue to grow and invest in. That includes our mice and keyboard business, the work we do on Mac Office. And obviously, in the broader company context, the big play there is Office 2007 and the work that we're driving there in Vista.

I will spend a significant amount of time on gaming communications and entertainment since those are new areas of investment and I think great opportunities for tremendous growth. And the secret to our strategy and the important focus for our success is making sure that each of these cornerstones, by themselves, as independent businesses, are very strong. That's something we're focused on, and I'll go through each of them independently.

But in some ways more importantly, the secret sauce to our strategy is the community and services we are going to use to tie these experiences together, because in the world of digital lifestyles, how people interact with others, the community they build, the services they have access to, really is what's going to lead this business to success. And it's a great place for Microsoft to differentiate itself. So I'll go through each of these elements in turn.

I want to talk about communications. Fiscal year '06 was actually a great year in our mobile and embedded space. The group turned profitable for the first time. As you'll see later, we think that profitability will be sustainable. So we're making great progress from a business perspective; tremendous progress in terms of revenue growth, engagement with partners, both on the operator side and on the OEM device side, and also, I'll point out, in the development side for custom applications on top of the platform.

This is a platform that really has momentum. We're starting to see take-backs from RIM in the enterprise space. We're making progress in connecting this to the work we're doing within Exchange and our unified communications strategy. So this is an area where we've got a business we've been incubating for a long time, and we're starting to see that incubation pay off. And I think as we look to the future, there's a lot of upside in what we're doing here.

Certainly we see the strong growth continuing. Again, operator engagement and device engagement is very high. You see here new devices from Palm, Samsung, and HTC. I have the HTC device right here. This is a very cool slim flip phone. We think it's going to be a big hit. People are using it here and people love the phone. And it's just one example of a number of devices that are making big success. And it really shows that in the phone space, where there is a lot of specificity to what people want, you are going to see a lot of different devices and a lot of different services on top of the platform. And so our platform approach, in working with the operators and working with the hardware manufacturers, really makes sense and really pays off. And our business in the embedded space, again, continues to grow where we're making strong inroads and competing very effectively with Linux.

So overall, in this communications business, our position is one that's ready to break out and grow for the future.

Now, when you look at gaming, I'd say the investment profile here is different than in the communications space, because we've made a bigger bet here. But in many ways, the business is in a similar space, where we've seen tremendous progress. And, in fact, you can argue that we're the largest gaming platform company in the world today. We think, on an average month, we have over 100 million people playing games on our platform, about 80 million playing games on the Windows platform, almost another 30 million playing on our casual game platforms—MSN Games and Messenger Games. And then when you add the great work we've been doing with Xbox over the last five years, culminating in the launch of Xbox 360 this year, we think we are very well-positioned in what we're doing in the marketplace.

Worldwide, as everybody knows, we're at about 5 million consoles—a little over 5 million consoles. Attach rates for games, we've got record levels for a launch at this point in time. And the portfolio games coming up tells me that that is going to continue. We think we have the games for this holiday, and that is very important in this business. This has ultimately become all about content.

We're already in 28 countries. We didn't get to those 28 countries until year three with Xbox one. So think about the expansion we can drive outside of our established markets going forward, with many new big markets still to come online.

And finally, a key area that I'll talk about some more later is online, where we've been tremendously successful with Xbox Live. That is a clear differentiator, a place where neither of our competitors really is making any progress.

So if you think about what we want to do here, I think the stage is set. First of all, we have to launch Windows Vista. That's critical to our gaming platform. This is the first version of Windows in probably four or five years that has significant advancements in gaming technology. This is going to be a great gamers' platform. Traditionally that has done a great job of driving Windows sales. It's also done a great job of driving our gaming business.

We also have to keep growing the Xbox 360 business. This is about building an install base. And now is the time to do that. By the time we reach the end of the calendar year, we think we will have a 10 million-unit console lead in install base, and that is a huge advantage for us relative to our competitors.

I talked earlier about the franchises we're building. I'm going to show you a few of those in a minute. We're also working on broadening the audience faster than we did with Xbox. If we want to break out in this business and really achieve our vision for a big, profitable business, we have to reach beyond the core gamers and we have to start that process early. And Microsoft has to lead the way with some of our games.

I'll also comment that we think there's more opportunity in the casual game space. This is a place where again the demographics are very different. Over half the people playing the casual game space are women. The average age is probably 10 years older than in the console space. So it's really an opportunity for us to reach a new audience. And we have the intellectual property assets in the games themselves already, so it's a great place for us to get leverage and build some new opportunities.

Finally, I will say, while I say the stage is set, this is all about execution. And the next six to 12 months in the industry are going to be an interesting test of execution. Both of our competitors have to launch. They have to launch globally for the first time, the first time they've ever tried that. They have to go through the complexities we went through last year in terms of manufacturing them at work. We have those things behind us. We have the machine running well, and we think we can out-execute them this holiday.

So that's really where that business is. We think it's actually in quite a good space. Now, what I'd like to do is show you a vignette, if you will, the full range of our product portfolio. So we're going to show you three videos of games. We're going to start with animals in the garden. We're then going to go to cars on the roadway, and eventually to big guys with big guns blowing things up. So you're going to get the full range of what we do in the video game space, starting with “Viva Piñata.”

(Video segment.)

ROBBIE BACH: So that's us on the lighter side—a little bit younger audience, a little bit more fun, very engaging game from Rare in the U.K. We think it will be a big hit. It's also going to be supported by a TV show that goes along with the characters on Fox. So we're very excited about that.

Now we move to a little bit more action, “Forza Motorsport,” our second version of that product, big franchise on Xbox one, and again, key in the racing category, especially very important for us in Europe.

(Video segment.)

ROBBIE BACH: That's actually a product that has a pretty broad audience, but it's really designed for the tuner market, and it competes with “Grand Turismo,” which is probably Sony's number one franchise. And we think it's a product that can actually win in that category, and again, can draw people from the PlayStation platform over to the Xbox 360 platform.

Now, my third video is a product called “Gears of War.” “Gears of War” is in the action category. It's a product done by Epic Games, one of the leading independent developers in the world. It is perhaps the most anticipated product in the portfolio for this fall. It's a Microsoft Game Studios title, and we're very excited about it. Here's “Gears of War.”

(Video segment.)

ROBBIE BACH: So there you have it, everything from piñatas in the garden to guys in the alley way with guns, everything in the full portfolio of what we have.

I will say this. When I look at our lineup on the hardware side, I look at our portfolios of new accessories, I look at the game content, both what you've seen today coming from Microsoft and what I see from third parties, we see very strong demand for Xbox 360 continuing. You know, we're at the price points we're at today. We think we can sustain that demand through the holiday. We don't see any changes in the marketplace that will get in the way of that. Certainly our competition will launch, but we think they'll be a little bit capacity-constrained at the beginning. And we think this is an opportunity for us to make tracks and really build a big install base.

So we think the gaming business is in a good space. We have to execute, and we can drive that business forward effectively.

I want to talk a little bit about entertainment, which again is new to my area. And I think one of the interesting things in entertainment is we don't probably get as much credit in this space as we should. Even today, we already have nearly 2 million cable set-top boxes installed with our TV software. We've done a spectacular job in the IPTV space driving trials worldwide. You look at the list of customers we have who are trying our software; it's a who's who of the telecom industry, and we're getting real traction with those and leading those toward commercial trials, which I'll talk about in a moment. And then, on the Windows XP side, with Media Center—over 14 million units of Media Center sold—just continues to drive volume. It is far and away the most preferred way to buy a home PC today, and we think really gaining traction in the marketplace.

When you add that to the fact that there's integration opportunities between what we're doing in IPTV and Xbox 360, and we're already taking advantage of the opportunity to integrate between Media Center and Xbox, you really have in this entertainment space a great position for Microsoft. It's certainly something that's early. There's a lot of change going on in the digital entertainment space right now. But it's moving digital, and that's where software services and our approach to the marketplace really can have a big impact.

Now, if you think about what that means going forward, the key thing for us in the coming year—certainly IPTV deployments is critical. We have key customer launches at AT&T, Deutsche Telekom and British Telecom coming up. SwissCom is already in the marketplace. We need to scale those and support them and build them. We need to scale the team to be able to, frankly, take on the list of customers that want to use our technology and services, so there is a worldwide scaling that we're building to take advantage of the demand we have from being the number one position right now. And there's a lot of innovation we can do in the IPTV space. What we've done so far is just the core platform work. There's the application work that can go on top of that, the advertising model work that can go on top of that that we think can be very powerful for our business and a place where we can really innovate.

Certainly with the launch of Vista, Media Center becomes very important. It's an opportunity for us to up-sell people to the higher-revenue versions of Windows. It provides a great place for us in the home and a centerpiece for that digital connection strategy that I talked about earlier, because that's the place where you're going to store your media, keep all your music, keep all your video, and distribute it around the house.

Finally, one of the things that we just announced last week is a move into the music and video space in portable entertainment, something we call Zune. I want to spend a few moments here talking about Zune and give you a little bit of context. I think the first thing to understand about Zune is that we are taking a more integrated approach to this. Microsoft will be involved in the hardware, in the software, and the services. We think that's important to produce the number one thing that has to happen in this marketplace, which is a great customer experience. And we have to tie those things together in some ways like we have in the Xbox world, where in the hardware, software, and Xbox Live service we have tied things together in a great experience.

It is something that is going to take time. If you want to think about the investment timeline for this, you have to think this is not a six-month initiative and somehow in six months we're going to have captured the marketplace. This is something that's going to be a three, four, five-year investment horizon. We have to look at it that way. We have to invest in it that way. We will start with one product this fall in the United States. We will expand next calendar year into broadening the product line, as well as broadening the geographies we cover. So, it is something that we're going to invest over time.

Now, unlike Xbox, which was just you would think of billions of dollars invested to get into the marketplace, we think of this in the hundreds of millions of dollars in terms of investment over time. So, it's not of the same scale financially because of the way the business model works. But from a strategic perspective, it's very important. It's important for us to have a play in this portable entertainment space in particular relative to music and video, because, as you'll see in a moment, it really completes out the story of what we want to do.

I'll also point out that we're not just introducing Zune to do the same thing that other people do. We think there are real advantages to what Microsoft has to offer here. I think the number one thing I would point to, and I talked about this briefly earlier, is community. When you go to any music site today, what do you do? Well, today, you can buy music, but it's hard to meet your friends there, it's hard to share music there, hard to share music experiences there, hard to find out information about your favorite bands, and what they're doing, and where their next concert is, and how you can get there. That whole community aspect, which is what we do on Xbox Live, absolutely applies in other entertainment spaces as well. And so we think community is a fundamental part of what has to happen here, and a place where we have real experience, both from our Xbox experience, as well as from our Windows Live and MSN experiences, where we can drive some very exciting things here.

We also think discovery is key. Figuring out new ways for people to find their favorite music, certainly, but in some ways more importantly their favorite video. Video now is not just a list of things that are produced by Hollywood, it's video that's produced by individuals around the world. It's family videos. It's friends' videos. It's funny community videos. It's user-created content. And so figuring out how you help people discover the world of what they want, and then enabling them to share it with their friends are two sort of sides of the same coin that are secret to what we have to do with Zune and the services that we're going to drive there.

And then the third secret I'll say is looking at Zune as part of our broader picture. You know, in the case of Apple, they have certainly an iMac business, they have their iPod business, and they've sold a few things in the home that compete with Media Center, although the numbers there are actually quite small. Look at our business: We have a burgeoning IPTV business that we think is going to grow and be successful in the home. We have Media Center in over 14 million units and growing around the world. We have Xbox 360 in place and growing around the world. We have Xbox Live, MSN, and our Windows Live initiatives expanding. Put all of those things together, and then take Zune and put it in the context of that. It enables us to complete the picture. It enables us to have the full entertainment and connected entertainment experience that we want to have. And so that's why Zune is important, and it is a way we're going to differentiate ourselves, because the experience of having Zune in that connected environment is going to be a dramatically better experience than you get just from having a portable music player.

So, that's a little bit about what we're doing in the portable entertainment space. There will obviously be more on that as we go forward in the marketplace, but we're very excited about the entry there.

Now, that brings me—you've heard about the pillars, I talked a little bit about productivity, and then communications, gaming and entertainment. I want to talk about that capstone piece, services, for a moment. Xbox Live today is doing spectacularly well. We're very excited about the momentum we have there. We've gone from 10 percent attach rate on Xbox one to 60 percent attach rate for Xbox 360. And the viral nature of what's going on on Xbox Live really is surprising us. I mean, we thought we had a good product, we thought we had a good position, we thought the dev team had done a great job. When you actually look at what's happening—34 million downloads, 3 million videos—we're getting people coming to us looking for sponsorship opportunities because they see the community there. And so, our job really is to take advantage of that and build that.

One of the statistics that's most stunning, I'll just add to the screen here, over the life of Xbox Live, 2 billion hours of online gaming. Now, think about that. We spent all morning telling you how we're going to increase productivity and give people more free time, and I'm here to tell you, I can use all of it on Xbox Live. And then you expand that to think about what happens when you integrate that with what we're doing in Zune and other spaces, and it really gives you some idea of the customer engagement we can drive in this space. And when you're working with consumers, that's what it's about, customer engagement. So, I think we're in a good position on the services side, and our competition in this space, certainly from Sony and Nintendo, is just not there.

If you look across the next 12 months or so, we think we can double the number of members on Xbox Live. We're going to certainly scale and evolve Arcade. Xbox Live Arcade was something we did that we thought was sort of a small effort in the casual game space; it's turned out to be a much bigger thing, and we're having to do some real work to enable it to expand. We're excited about that work. Live Marketplace is both an opportunity for our customers to have that community I talked about, and it's also an opportunity for us to generate some money, both from a promotional and an advertising perspective.

We're going to add a camera this fall, so you'll be able to see the people you're actually playing against. Think about poker, Texas Hold'em with a camera system on Xbox Live, that will create real community. We've also, as you know, just bought Massive—an advertising agency—to really drive the work that we're doing in in-game advertising. You're going to start to see that roll out over the next 12 months. I think the advertising market here done right is a meaningful market. It's not something that's going to happen literally overnight, but over the next 12 to 24 months, it's going to become a meaningful revenue stream, not just to us, but to our publishing partners. So, we think there's a real opportunity here.

Live Anywhere is an initiative we announced at E3. We're going to see a demo of that in a moment, so I'll come back to that. And obviously integration with Zune, and what we're doing in the Zune services area, is a key part of what we want to drive going forward.

So, services as a whole, as I said earlier, are the capstone for what we're doing. Each of those cornerstone pieces I've described has to be successful on its own, and then we use services and community as the way to tie them together, and really build in a Microsoft difference that people can take advantage of.

Now, to Live Anywhere. I want to give you an example of some of the innovation we can do in this space when you take a bigger picture view. In the gaming space, we've always thought of Xbox Live as just Xbox Live. But then we started saying, hey, wait a second, we've got people on their mobile phones playing games, we've got people on Windows playing games, why do those people not get the same type of experience? In fact, why do I have to have a different account, a different persona, and a different process when I'm on those platforms for Microsoft compared to when I'm on Xbox Live? And so what we've looked at is our Live Anywhere strategy to really broaden the way people think about gaming in the services environment.

So, what I would like to do is bring out Scott Henson who is going to take you on a tour of Live Anywhere. Scott.

SCOTT HENSON: Thanks, Robbie.

All right. Let's take the vision, and let's put it into motion. As millions of gamers know, since we launched Xbox 360, the power of hardware, software, and services when it's truly integrated can be extremely powerful. When I turn on the Xbox 360, from the moment it's turned on, I'm instantly logged in to the service. And hopefully what you'll see here in just a second is, I'm going to power up an Xbox 360 with “Shadowrun” in the console, and you're going to see me on the service, known as Avenger, log in instantly to the service. So, hopefully that's going to happen any second now. Here we go.

And there's nothing extra that you have to do to be plugged into the service. It's just seamless, it's transparent, and this is one of the key tenets, which is simplicity. There I am, Avenger, signed in to Xbox Live. And when I am signed in to Xbox Live, the community is instantly accessible to me, no matter what I'm doing, at the touch of a button. So, in this case, I'm going to be playing a game, right, makes sense on a game console. I bring up the Xbox guide by hitting the guide button, and there's my friends, and there's my messages.

Now, when this friends list comes up, I want you to notice a subtle but powerful difference from what you see on Xbox 360 today. In the future, you're going to see multiple platforms, just as Robbie said; you're going to see mobile devices, you're going to see Windows, and they're doing all kinds of different things. They're connected in their entertainment experiences, and they're also connected whether they're working on their desktops. So, in this case, I've got Major Nelson, one of my friends, who's online Windows working, like a lot of you are today, and that would be a little bit of a shame. Let's get some of that productivity time back and get him back onto Live. I'm going to send a cross-game invitation from my Xbox 360 over to his Windows desktop, using the exact same conventions that we all know and love today, so super-simple, super-easy to extend the Live Anywhere world over to the desktop.

Now what I want to do is I want to switch over to Major Nelson's desktop, and we'll switch over here, and you'll see, yes, indeed, he is working in Outlook. Focus your attention over on the side, what you're going to see is the Windows sidebar, you'll see a couple of interesting things there, his integrated friends list, one friends list, one identity. You'll see me up at the top of that friends list, and his other friends—again, multiple platforms, instant connectivity in the way that he feels comfortable and knows best.

What you'll see below that, right below the friends list is his gamer card on Windows. So we have this really powerful notion of your identity and the achievements, and who you are, and your reputation that will now be brought to the Windows platform. Now, if you remember, when I sent that invitation—here it is now with my gamer card embedded inside of it. Now, he could click accept, and we could just instantly get into the game, or if you remember the guide on Xbox 360, he can select view profile, and here is the guide, tailor-made, custom for the Windows experience.

Now, what you'll notice is he's playing “Shadowrun” on Windows Vista, I'm playing “Shadowrun” on Xbox 360. It's one game, one integrated friends list, and he can do a head-to-head achievements comparison of how he's doing in the game versus me, and once he knows that he's a little bit ahead of me, in terms of our achievements, he can accept. And this is a really key point. He clicks one button and he's instantly into the game with me, playing cross-platform, real-time, voice chatting, using a control that he feels comfortable with, whether it's a keyboard and mouse, or the controller that we've enabled for Windows Vista.

So I think this is a really powerful first step that we'll enable when Windows Vista launches. It's a great way to take existing games and extend the community across the platforms. But, as a guy that works with the game development community, what excites me is re-imagining games and working with that community to rethink them. So what we did is we went to the “Forza Motorsport” team and we said, hey, let's dream the dream, let's fast-forward, and let's put the creators in control, put them at the center, and think about what could actually happen in this Live Anywhere world.

So this is what they came back with. We'll start on Windows Mobile, the last of the platforms that we're going to show you today, and what you'll see when this starts is you'll see my friends list, just like you saw on Xbox 360, and here we'll go into it right now. The same thing, multiple platforms, instant connectivity, in a consistent, familiar way that's tailor-made for the platform.

In this case I've got a message from Major Nelson, again, and he instead of a text or voice message has actually embedded inside of it a car. Now, in this case what I'm going to do with a car, what would I do with that? Well, they've created a little pocket garage. I can change some of the performance characteristics, and then I can save it to the server, and it's accessible to me anywhere where I play, or might want to interact with that car. Another thing I might want to do with the car, as a creator, is change the look and feel. Let's pop back over to the desktop and let's change a few skins with the community, apply that to my car, maybe I like it, maybe I don't.

Maybe I want to take a little bit more control, and add a little bit more customization to it. So I can pull up the color wheel, I can pull up the vinyl select, and I can add my own custom look and feel to that car, and this is what people will see when they race against me on the Live Anywhere service. And here we are in the last part of that, and just like you saw on the mobile phone, we'll save that off to the service. Here you have the mobile phone, in the center you saw Windows Vista, and on the left you see Xbox 360, and we're racing my car. One service, one gamer tag, one message center, unified—and an infinite number of possibilities with respect to what games are going to do with this.

So there you have it, Live Anywhere. (Applause.)

ROBBIE BACH: So you've heard a little bit abut how we did in fiscal year '06. You see some of the products we launched that year, a very important year for us. I've talked a little bit about fiscal year '07, what we're doing in the mobile space, the importance of IPTV deployments, Xbox 360 getting to scale, the Vista launch, Office 2007 you've heard about, and obviously Zune being something new from us. That sort of frames today and the near-term future.

I want to talk a little bit about further out something called connected entertainment, because our ultimate vision here in this space is how do we bring all these things together into an experience that is new and different for people? How do we enable people to have their content—whether it's a movie, a game, a video, a piece of music, someplace in their environment—and be able to get at it from wherever they want, whether they're in their car, whether they're walking on the street, whether they're in their living room, whether they're in the den in front of a PC? That, we think, is a very powerful vision, and the combination of what's going on in the networking space, and the work we're doing with our devices, and our service, much like what you saw in Live Anywhere, we think we can deliver on a very integrated approach to content, that is very powerful not just for us and for our customers, but also for the content providers, because it gives them access to new experiences and to new customers.

We also think, as I said earlier, that community in this connected entertainment is tremendously important. It's a funny irony, as the world has gotten to be a smaller place, and people have moved around more, people's desire to have community has grown dramatically. I look at the generation of kids and young adults who are growing up now: They are more focused on community than I ever was when I grew up.

In some ways my community was the people I could reach on my bicycle. Their community is the people they can reach on their phone, that they can reach online, that they can reach on Xbox. That's not just the friends, and when the friends move away they lose track of them. When they go away to college they keep track of their friends. Their community network expands, it doesn't contract. So the idea that community is central to what we're doing in the entertainment space, and the connected entertainment space, is fundamental. It's something you'll see us invest in and build on from Xbox Live, from the work we're doing in Windows Live, and in MSN.

Finally, we think experiences are incredibly important. To make all this happen and have it be easy, which is fundamental, there has to be innovation in user interface, there has to be innovation in how people interact and connect all these things. It has to be as easy as Scott showed in the demo. You have to be able to press a button and have it happen. If it requires wiring, if it requires a lot of complicated work, it means we still have work to do, because it's not going to get the broad adoption that we think it needs.

So the idea that you're going to have this mixing of media and the ability to have content in any one place does require us to innovate in the experiences space. Five years ago people said we were crazy to have a vision for broadband gaming. They said broadband adoption was going to take too long, people weren't going to get there, it was going to be too complicated, and too expensive. Well, that's happened. So our job is to make that happen across the entertainment space and really drive that future.

I did want to talk a little bit about what E&D looks like from a financial perspective. Given the changes we've made from when I was managing the Home and Entertainment Division, it's important to go through, understand the components of the business, and talk about where we are financially.

So the first business I talked briefly about earlier, our productivity business, this is our mice and keyboard business, our Office for Macintosh business, our consumer software business—actually a very nice, profitable business today, it continues to grow steadily. It is a place where we are doing some reinvestment right now, probably be ready to talk about that, say, a year from now, maybe a little longer, but the basics of that business are very strong and continue to be solid. The key thing to look at there is how we do from a revenue growth perspective, and we think we're excited about the prospects there.

Mobile Embedded Devices, again, profitable in '06. We think that will sustain in '07, '08 and beyond. We are going to try to grow units, and we are going to grow market share, clearly competing with RIM, and ultimately Nokia is important to us. Those are places where we can make tracks.

The opportunity for us in the enterprise and medium and small-business space, we think, is actually quite large. Because it's a space where we're successful with products like Exchange which have to integrate in this phone environment, we think there's tremendous opportunity for us to make progress and to continue to grow this business. So, again, a strong business.

Entertainment in a way is a tale of sort of two cities. On the one hand we have the work we're doing on IPTV, which is something we've been investing in for anywhere from two to 10 years, depending on how you want to do the mathematics on it. And that is now starting to pay off. We're starting to see real deployments, real revenue, real customer commitments, and we think that's driving that business to takeoff scale or to skid velocity.

At the same time, we've made the decision to invest with Zune, which is going to be an investment for a period of years. As I said earlier, you should think of this in the hundreds of millions of dollars over the next few years. So the balance of those things leaves that business probably negative over the next couple of years, but not dramatically negative.

Then we have the gaming business, which you would say in fiscal year '06 did generate a big loss. That was a transition year as we moved from Xbox 1.0 to Xbox 360—a lot of launch costs, a lot of marketing to get that platform off to a good start. We see that making tremendous progress in fiscal year '07. We don't think the gaming business as a whole will get to profitability, but we do think it will get to profitability at fiscal year '08. And we think that is absolutely on the trajectory we set when we got started with Xbox 360 and put the business model in place. So we feel very good about where it's going. We think it's on the right trajectory, and we think fiscal year '08 will be the year that you will see that pay off financially.

When you look at E&D as the total, it sort of mirrors in some ways what's going on in the gaming space, just given the overall financial exposure we have in gaming. And so you are going to see fiscal year '07 we think will be a loss. We think that turns to profit at fiscal year '08. Again, we feel very good. There's a lot of execution work we have to do, a lot of variables relative to competition. So all of those caveats apply. But the business model is on track, the performance metrics we see are on track. We think strategically we've got the right approach. And we think relative to our competition we have the assets in place to make that successful.

So that hopefully gives you some idea of how we think about this from a scorecard perspective.

I also wanted to just close by talking about what is going to enable us achieve that. What are sort of the keys to success, if you will, in making that happen?

The first of those I've talked about a little bit already, which is our portfolio of assets. In each of these businesses they have to be stand-alone in some ways, but they do rely on other things that the company is doing. If you think about what we're doing in Xbox Live, it fundamentally relies on technology that's already been developed by the MSN team, as well as technology that Ray Ozzie and his team are working on around Windows Live. We will take advantage of those assets and utilize them in what we're doing. We're going to do a billing system once. We're going to do an authentication system once. And my group is probably not going to do that work. We'll integrate with work that's done at the platform level. So there are assets we can draw on in many of those areas.

If you look in the mobile space, the opportunity for us to integrate with what's going on in Exchange, and the customer benefit that that brings, is actually quite large.

And broadly in the entertainment space, the idea that IPTV, Xbox, what we're doing in Zune and what we're doing with Media Center fit together, we think, is very powerful. And so in many ways my job is to make sure we drive that integration in an appropriate way while still enabling the individual businesses to do what they have to do to win in their specific marketplaces.

The second thing I'll say is software in services expertise is going to be very important in this space. If you said 10 years ago in the consumer space you would have said—gosh, you would have said consumer electronics—you wouldn't have even said consumer. You would have said consumer electronics. It was primarily a hardware space, a place where hardware companies dominated. We certainly think hardware is important in the future. It's absolutely the amplifier for all of these experiences. But software is what's going to make the digital entertainment age run. And software is a place where Microsoft is very, very strong. I think we demonstrated that with Xbox. We're going to demonstrate it over time with Zune. We're demonstrating it with IPTV, which may be one of the more complicated client server applications ever created. And it's an entertainment experience based on software.

Partners are important in this ecosystem. As much as we talk about in Xbox the fact that we're involved in all aspects of things, as much as we talk about that in Zune, as much as we talk about that in what we're doing in IPTV, all of those ecosystems are partner-based. My job in the gaming space is to make sure that companies like Electronic Arts, Activision, Take-Two, THQ, et cetera, make money. If they make money, my platform is viable; I will make money. If I don't create a healthy ecosystem, the people who are key to bringing customers to that ecosystem will leave. Likewise, with IPTV it's very, very important to me that my communications partners are excited about IPTV, investing in it and bringing the customers to the system.

So a lot of what we have to do is bringing those partners to play. Retail in particular is critical. If you think about Apple, they do over half their sales through their own stores, right? The retailers have sort of a comme-ci-comme-ca view of Apple in that respect. We want retail to be key partners in driving all these things that we do.

I talked earlier about execution. This actually is incredibly important. All of these businesses are actually pretty complicated—I suppose that goes without saying. They involve worldwide supply chains. They involve driving consumer demand and marketing. They involve a lot of execution details. And the secret to success in many ways is in the detail. And so my team has been focused for several years now on making sure we get to operational excellence. And we see that happening in each part of our business. And there are going to be bumps along the way. We've had our bumps over the past two or three years. But we are figuring it out and we're getting very strong here, and we think we're ahead of the game in terms of the future.

And, finally, I'll say it takes experience, leadership, and talent. The team that is driving this is an experienced team. We've been working together now for almost six years. It's not just some people from Microsoft. There are people who have long Microsoft heritage. There are people who have industry expertise we've brought in. People have come in from other industries that I would have never imagined would have been at Microsoft five years ago. And we have melded ourselves together into a great operational team. And if I look across the people who work for me in terms of their leadership skills, their development talent, their vision, I think we have the team to win. And it really is important, because in the end if you look at the things above it, it's the leadership and the team talent that is going to make those things happen.

So, with that, I'm going to pause there. I think the Entertainment and Devices Group is in a great position for the coming year. I think we've got a lot of opportunities going forward.

And I want to introduce Ray Ozzie to talk to you some more. Thanks very much. (Applause.)

END

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