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

ROBBIE BACH: Good afternoon, everybody. I wanted to spend some time today talking to you about our connected entertainment strategy and take you through that in a little bit of detail, both in terms of the current fiscal year and the coming fiscal year '08.

As you think about this in the context of what we've been discussing throughout the day, we're going to talk a lot in this about Xbox attach, obviously we're going to talk about Windows Mobile, we're going to talk about online advertising as key areas that are elements of growth and opportunities for us in this business.

I will point out that in the broad context of what we're doing there are other areas of growth as well, but again at the corporate level as we think about this, we think of those as being sort of the three key areas that you're going to hear about in this presentation.

Now, if you think about fiscal year '07 for us, and you look at it sort of at the top-line financial point of view, you'd have to say, Gosh, this wasn't a particularly successful year, particularly if you think about the billion-dollar warranty reserve and the work we've had to do around that. But I do want to give you some color for performance across E&D, because I think it's actually quite different, depending on the various businesses that you look at.

So if you think about our Windows Mobile business, we had a great year -- over 11 million phone-enabled licenses, lots of momentum, some key iconic devices like the BlackJack and the Cube and the Dash -- we made a lot of progress in that business. If you look at our PC hardware business, 33 million units sold worldwide -- mice, keyboards, cameras. Our camera business is now another new profit center for us in the hardware space for cameras attached to a PC -- a lot of good progress there.

Media Center had a huge year. We're now at 45 million Media Center licenses in the marketplace -- big progress in getting Media Center into people's hands and getting people using that. And certainly Embedded business continues double-digit growth this year, and our launch for Office and Windows at retail, which is part of what E&D does, was also very, very successful. So there were some really strong performances in the division.

We also had a couple of businesses I would describe as emerging business -- things we're developing and growing for the future. I'll talk about Zune and Mediaroom -- what you would have heard us call last year IPTV -- in a moment. But both of those businesses really got launched into the mainstream this year. We had good progress and good traction. They weren't blow-out in terms of their success, but good progress, good traction. I feel like those businesses are very much on path.

And then the final thing to talk about is Xbox itself. And certainly if you think about the year and the warranty issues, you have to say, Gosh, that was a tough year and something you're going to have to move beyond. But even in this case I want to make sure people understand some fundamentals of where that business is, since the fundamentals are very strong. Our attach rate is an all-time record at this stage in a life cycle. We are at 6.1 games per console in the U.S., and almost four accessories per console in the U.S. Those are amazing record-setting numbers. If you think about consumer spending on the platform, compare since the launch of the Wii and the PlayStation 3 to date, so a little over, what, seven or eight months, people have spent $2.6 billion in the U.S. on Xbox 360 all up during that period. That's almost double what they spent on either the Wii or PlayStation 3. There's a lot of traction with consumers around this product. We've launched in 11 more countries. We're now in 37 countries worldwide. We're in a very good position on the fundamentals of that business.

If you think about Xbox LIVE, we've now passed the 7 million member mark; 220 million downloads of content -- 45 million of those were for paid arcade games. This is a really strong developing part of our business and a key differentiator that our competitors can't get after.

So as I think about fiscal year '07, I have to say, Gosh, we're going to improve on that, because when you look at that overall picture you say it certainly wasn't a great year. But I think the fundamentals in the businesses are actually quite strong, and I think the opportunity it creates for fiscal year '08 is also quite strong.

So let me talk about that in the context of connected entertainment and what we're doing, and then go through it to the businesses for fiscal year '08.

Connected entertainment, I think as I described to this group last year, is this concept that over time people will be able to think about their entertainment assets and the things they want to experience as something they can get any time, any place, and on the device that they want. So whether they're in the car, in the bedroom, in the living room, at work, traveling, at home, they're going to be able to get access to their music, their video, access to their friends, their games in the environment they want when they want it. Now that's, I would say, a fairly broad vision and one we have to build for. And the idea here is to talk about the things that we need to do to make that happen.

The first of those, if you want to be successful across all these things, and you want to take advantage of the fact that content is now becoming digital, we have to explore new ways for people to think about content. We have to explore new ideas, new content paradigms, new ways for people to experience the content. And you're going to start to see that over time in both simple ways and in more complex ways.

The second thing you have to do for this connected entertainment environment to come about is you have to be good in each of the core elements of the business. There are very few consumers who want the collection of things that are average or OK. They want a great music opportunity, they want a great video experience, they want great communications, they want great gaming. So you have to be strong in each of those core elements of connected entertainments to make this work.

The third thing that's going on here is there are two I think fundamental shifts going on in the core underlying ecosystems that people are going to play with. The first of those is services and the idea that more of the experience is going to happen in the cloud or through services, and things will be a combination of hardware, software and services. That's fundamental to our business, and we have to think of our business as end to end in terms of hardware, software and services.

And the other big change is the predominance of mobile phones and the ability for us to deliver entertainment experiences on those mobile phones. And I think that creates -- because we're in the mobile business in a big way, and have had some success there -- creates another opportunity for us.

The fourth priority, clearly, is we have to turn the business into something that makes money. We have to make connected entertainment not only something that's differentiated for our customers, but also something that's differentiated for our shareholders and drives new profit opportunities, and I'll talk a little more about that.

And, finally, at a philosophical level, we're a believer in what we think of as a managed ecosystem. If you want to compare two worlds, you can compare the open world and you can compare a closed world closer to an Apple model. We want to be in a place where the consumer's experience is managed but where there's openness for a broad variety of partners to participate. And Xbox certainly is in that space today, and you'll see other parts of our business move to that over time as it makes sense.

So that's the broad brush of connected entertainment. Now let me go through each of the core businesses.

In the case of Zune, the year was a good year. We sold about a million units of the product. We feel very good about that actually -- just over a million units. We think this is a business where we're off to a good start. We're about 10 to 12 percent market share in the category where we participate, which is the hard disk-based category. You are going to see us continue to invest in this business. I said last year this was a three- to four- year effort to get us to scale and where we want to be. We feel like we're right on track with that effort. You are going to see more from us in terms of new software, in terms of new devices, in terms of new features. You'll see us broaden our presence in the marketplace for sure going forward. You'll also see us broaden the brand, where today I think the Zune brand is a little bit sort of in the hard-core niche music space. We want to broaden it into the broader music space, and you're going to see that happen again over time.

So that's the idea of where we're headed in music.

Let me talk a little bit about where we're headed in the video space. We have really three video offerings today in the marketplace: Media Center, the work we do with Mediaroom, which is our IPTV product, and Xbox LIVE and the video services we deliver on top of Xbox LIVE.

Media Center, the goal here, as that install base grows to 50 million and beyond, we want to be able to have value-added services that can appear in Media Center, either services we provide or services that other people provide. This is a way for that investment in Media Center to pay off for people and to give them a chance to get new video, and frankly photos and music and other entertainment experiences, on their PC. So we think that's a great area for us to continue to grow.

In the Mediaroom case, this past year was about getting our infrastructure in place with the operators that we signed up, and also getting in trials with new operators. We feel like we've got a great list of customers. We're going to continue to expand that list. But this year the key element for us is how we grow subsidiary subscribers in the customers we have. So if you think about AT&T, British Telecom, Deutsche Telekom, Swisscom and others, we think you're going to see significant growth in our Mediaroom product in those customers and subscriber growth into the millions this year. That's the goal for scaling and building that business up.

In the case of Xbox LIVE Video Marketplace, I suspect I didn't even talk about that here last year. And this has been a little bit of a -- actually I'll say a pleasant surprise for us. We started offering videos on Xbox LIVE Marketplace last holiday to tremendous success. We now have 28 companies who are providing content for us. We just announced that all of Disney's film studios will be joining the Xbox LIVE service and providing their content. You're going to see that continue to grow over time. If you want to get some idea of the scale, we are the leading provider of on-demand high-definition content in the United States, almost twice as much as any cable operator has in terms of high-definition on-demand content. And people download it, they pay. It's a good business. It's a good business for us, it's a good business for the content companies, and it's a very nice integrated experience for our customers who are playing games, watching videos and experiencing broad forms of entertainment.

This year you're going to see us expand that to Europe and Canada. You'll also see us expand the breadth of the content we have available on that and continue to improve the experience for our customers, which we think is super important.

So that's video. So now we've got music, we've gone through video. Let's talk a little bit about communications, because I think this is an area where you're going to see significant growth.

Today we have a lead over RIM in handset sales. Obviously ours are sold through partners. This year we want to expand that lead. We will sell, or there will be sold, over 20 million Windows Mobile-based phone-enabled devices this year. We think that's a significant sign of momentum in the platform. We're getting the best designs from the hardware manufacturers, we're getting great work from the operators to build services around our phones, and you're going to see us continue to expand that over time.

You're also going to see us start to focus a little bit more outside of what I would call the business space. Certainly our strength today is Windows Mobile phones used as a business tool. But the fact is people use their phones for their personal lives as well as their business lives, and it's not like they have two or three phones that they switch depending on what they're doing. And so we are expanding the lifestyle offerings in the Windows Mobile space that we have. You'll see this in terms of the services we offer on top of Windows Mobile, the ability to integrate those services in a nice way -- things we're doing with MSN, with our mapping products, with our search product; and you're going to see new form factors -- I'll show a couple of those just quickly in a moment --that really appeal more to a casual consumer or somebody who's interested in an entertainment phone or something along those lines. So that whole expansion from our core into lifestyle is going to help fuel some of this growth.

The third thing we're focused on, which is perhaps a little bit more technical, but we are now shipping phones based on the Windows Mobile 6 platforms. And this is a big step for us in terms of an experience for customers, because the platform is more secure, it's more stable, it's better performance, it's better than battery, it is just a better fundamental system for phones to be built on. And our operators are taking advantage of that and we're seeing great experiences coming on those phones. So that, as that starts to roll out and become more ubiquitous you're going to see continued focus from us there. You're also going to see us be able to build applications on top of that platform beyond what you might think of typical phone applications, things like CRM, Microsoft Dynamics CRM, Exchange applications and other mobile applications.

The final thing I'll say here in Windows Mobile is we need to build the brand. We need people who are using a Windows Mobile phone to know they're using a Windows Mobile phone, because when they get the next phone -- and there is a high degree of turnover in this marketplace -- we want them to go in and ask for a Windows Mobile phone. We want them to know that the capabilities they have come only with the Windows Mobile phone. And we've started over the past year doing that kind of advertising. You're going to see more of it -- some of it may not be what you think of as traditional advertising. There will be other types of marketing we can do to build that brand. We're certainly working closely with our operators and with the handset manufacturers to enable that as well. And we think we can build that as a differentiating point for us in the future.

So let me just take a quick look, just show you a few phones. And the whole idea here is to just show you the diversity of what we bring out in Windows Mobile. The phone on the right there is an HTC Touch. That actually has a touch interface. You've got full QWERTY keyboards, you've got sliders, you have flip phones. What we find in the phone market is that people do want choice, because they use their phone for different things. Some people want an entertainment phone. Some people want a text-messaging e mail phone. Some people want a phone where it's easy to dial. People want different sets of capabilities, and a bunch of people want a full QWERTY keyboard. And so we have to be able to provide the operating system to the operators and to the handset manufacturers that delivers that diversity, and still do it in a way where the handset designs are cool and where people look at it and say, "Wow, that's a slick design." And that's what's going to help us start to build that brand.

Finally as we go through each of these areas, I want to talk about gaming. I talked earlier about the warranty reserve and the challenges we had there. I'll just talk briefly about that. Certainly a key focus for us right now is quality. Since somebody will ask in the audience, I'll just answer the question, you know, "Tell me about the specific component that failed that caused you to have to do the warranty reserve." And I will tell you that it would have been easier for me from a questioning perspective to tell you that it was a specific component, but it's not. It's a design challenge that we've had to work around and create a new design to solve that problem, and for the interaction of a variety of different components. And so that's a Microsoft design question, not some component manufacturer's problem or our manufacturing partner's problems. It's something we've had to work on. We know we have a much better design in the market now. We verified that. We feel very good about the quality going forward, and we think we're going to be able to deliver on our goals for the year.

The second part of this is about cost reduction. And we are, and have been since the beginning, right on track with where we expected to be with cost reduction. That is a key driver in this business. You have to be able to manage your costs, manage your gross margin, and have the flexibility you need over time to manage price and other variables in the marketplace. Since we've been in the market as the leader we think we're ahead of the curve on that basis, and we feel very good about where we are.

Both of those, certainly on the cost question, is also a big factor in accessories. It turns out we have a great accessories attach rate. It's a business where we make money. It's a good business. We want to continue to see that grow.

And I will answer the question on pricing again, since I think it will just get asked. We have a very specific plan for what we're going to do with pricing; we're just not going to talk about it today. So I'll answer that question for you right up. But understand that we've had a plan since the beginning, we're on that plan, we're tracking to it, and we will do the right thing for what we need to do in the marketplace based on what we see and conditions in the marketplace.

So that's fundamentals.

The second big thing in the Xbox business is content. And this is a place where I think we are hands-down in the driving seat. The holiday lineup for this year, starting with “Madden,” and then going through “Halo,” going through “Grand Theft Auto,” and going through a raft of key triple-A titles, both from Microsoft and from third parties, is very powerful. We are in the stage of the console life cycle where content becomes king, and people are going to buy the platform that has the games they want. And the only place you're going to be able to play “Madden,” “Halo” “and Grand Theft Auto” is Xbox 360. And so we feel like that gives us a significant leg up and really will help drive the business. Certainly “Halo 3” is a big driver for us, both from a market momentum, a console sales space and from a P&L perspective. This is a very big platform for us. It's a very big franchise for us. The early orders are very positive. The feedback we got from people from the online beta was very positive. I think there's good buzz building for the product, and I'll show you a video clip in a moment. I think we've got a great opportunity here.

The final thing I'll say on content is we really do have something for everyone. You are going to see us broaden the portfolio, so that we have literally things like “Halo 3” or “Grand Theft Auto” or “Gears of War” out on one hand, and on the other hand we have titles like “SceneIt,” “Guitar Hero” and “Rock Band” and other fun, casual games that make it easy for the casual player to get on the platform and play. Having that breadth as we expand the audience and expand the install base is very important and we're going to continue to focus on that.

Xbox LIVE will continue to grow. You're going to see as our current estimate is about 10 million members by this time next year, and we feel very good about that number. We're at 7 million now, and the growth rate has continued to be very steady. We are monetizing those people in multiple ways so there's some for subscription who are paying subscriptions for multiplayer games. There's advertising monetization, there's download. It's to me a modern consumer service. It looks at what consumers want, delivers it to them, and enables them to pay in a variety of different fashions for that capability, integrating in, importantly, with the rest of Microsoft's LIVE infrastructure. So we think of that as sort of the leading indicator of what we're capable of doing, not just in games, but in entertainment services overall.

And, finally, we're going to expand games for Windows. We'll have about 60 games for Windows-logoed titles this year. These aren't titles from Microsoft necessarily; these are titles from our third-party partners as well. The big shift there isn't that there's lots of titles for Windows -- that's always been the case; we are now doing a lot of merchandising and careful marketing around the platform, so that when somebody walks in the store there's a Games for Windows section. They can look and say, Oh, I want a game for my PC, that's where I want to go. Oh, I see that logo, I know that game is a solid game and meets a certain type of minimum requirement, and it's an orchestrated purchase experience. So you're going to continue to see us expand that, in particularly building on the strength of Windows Vista in the gaming space, where Windows Vista really is a great gaming system.

Finally I want to talk about services. And I've talked about this actually a fair amount. We are going to continue to evolve our Xbox LIVE service. You'll see that grow, as I said, to over 10 million users. You're going to see it expand in the areas of arcade, in Xbox LIVE Video Marketplace and other types of entertainment services, and you'll see us continue to grow. We've already shipped Games for Windows -- LIVE, which basically brings the same set of services to people who are playing games on Windows, and also enables cross-platform play between Windows gamers and Xbox gamers. We think that's very nice.

In the case of Zune, we have the Zune Marketplace. You're going to see more work from us in Zune Community and other types of services; likewise in video. You should think of "live" as being sort of the capstone for connected entertainment. It's the services that are going to connect these different experiences and enable consumers to have that breadth of experience that I talked about.

Finally -- I talked about this a little bit -- we're going to support multiple business models and continue to build advertising into our P&L. Today that's a nice number but not a super-big number. You're going to see that grow pretty steadily.

Last, I put this slide up last year, and I wanted to repeat basically the exact same slide with actuals for fiscal year '07 and what we're going to do for fiscal year '08. We said last year that we're going to drive this business to profitability in fiscal year '08. We're on path to do exactly that. In our productivity business, which is mice and keyboards, some consumer software, we're right on track for doing that. That's a business today that continues to grow and continues to make money. In Windows Mobile and Embedded likewise, nice growth continuing our process for making money across both of those businesses and really expanding our unit growth in market share. In entertainment -- this would be Zune, things we're doing with Mediaroom and Media Center, there's still going to be the need this coming year to invest some in that business. I told people that was a three- to four-year horizon. I think we're making progress. I feel good about where the P&L is, but it's still going to be a place where we're going to invest this next year.

And in Xbox you're going to see a big turn for us this year as the install base grows, as our gross margin, we continue to manage that, and in particular as our attach rates and sale of games continues to rise. The net of those things is that we will be profitable in fiscal year '08, and we believe we can have sustained profitability going forward. This is very important to what we're doing. It's essential to the business and really something we know we have to do to build for the future.

Now, that's the business. That's connected entertainment. I want to briefly show you a trailer from “Halo 3.” It's a huge franchise for us. It sold over 15 million units worldwide so far. “Halo 3,” coming out Sept. 25 in the U.S., and a few days -- a variety of days right around the 25th depending on the country. This is going to be an amazing game. Just to give you an idea: a billion hours logged on Xbox LIVE playing “Halo 1” and “Halo 2.” So let's take a look at “Halo 3.”

(Video segment.)

ROBBIE BACH: With that introduction, Master Chief and I are available for questions. So let me open it up to the crowd and see if you have any questions. I think I'm looking for panel numbers, I believe. Does anyone have any questions? Number two, go ahead.

QUESTION: Robbie, when you look at operating profit, many in industry have adjusted it, the highest you can get to is the low teens. Can you speak to, while you're not giving a goal, from profitability kind of what levers you can pull, and what you think a right range is long term?

ROBBIE BACH: Well, if you look across the well, let's say two things. One, and I think everybody here knows this, but I'll just say it because we need to make sure everybody is clear. The profit profile of this business compared to the online business, or to the enterprise business, or server business, or Windows, this is going to be different. It's the consumer space, there's hardware involved in some of the businesses. The profit profile is just going to be different. It doesn't mean that it can't be a good profitable business, and a good consumer business, but the profile will be different.

The second thing is that you have to remember that my P&L is a complex combination of a bunch of businesses, some of which have pure software. Media Room, as an example, is a pure software and service business, much like many of the rest of Microsoft's businesses. And then, almost on the opposite extreme, I have something like our mouse and keyboard business, which is almost entirely a pure hardware business.

So it's difficult for me to generalize. I'm not actually sure it's super useful. What I will say, if you look at this space, the people who are good in the consumer business do get to the idea that, hey, we can get double digits, let's say, profit margins over periods of time. And there will be times when we may be higher than that, there may be times when we're lower than that because of where we are in the investment cycle. So, I'm not going to give a specific thing. But it is in that range where you say, hey, we think we've got things clicking in the right way.

Yes. I'm sorry, number two, again.

QUESTION: For the Live Service, do you guys envision DVD to burn, or download to burn services, and how do you guys see the competition rolling out with Netflix and Blockbuster?

ROBBIE BACH: Well, in the short to medium term, I don't really even think about Netflix and Blockbusters as folks we directly compete with, because the scenarios are actually quite different. In the Netflix or Blockbuster case, you've got a list of things you want to watch, it's coming in the mail, or you're going to the store. A lot of our purchase actually tends to be more, hey, I'm on the TV, if I decide I want to watch sometime, I can go immediately and download it. I'm not saying there isn't competition, but it's a little bit different.

I also think that the types of services you talked about, you have to ask yourself the question of whether that's what Microsoft wants to do, or whether we want to be working with partners who are doing those types of services. And I think there will be places here where we will choose to work with partners in areas like that versus doing everything ourselves. The final thing I'll say is, the mix of what we do in download on video actually skews a little bit more toward TV content than movie content today, certainly more than a Blockbuster or a Netflix would, where they're more dominated by full-length movies, and we probably see more comedy, more 20-minute, 30-minute, hour-long shows on our system. Full-length movies do well, but it generally tends to be a slightly different content composition today.

Other questions. Yes, two.

QUESTION: Hey, Robbie, Rick Sherlund.

ROBBIE BACH: Hi, Rick.

QUESTION: Could you talk about the iPhone a little bit. Is that good for Windows Mobile, does it sort of create a catalyst of events that gets your hardware partners to think more broadly about the platform, and how do you take advantage of that opportunity?

ROBBIE BACH: I think, in general, if you think about the iPhone, the awareness it has brought to the category is positive. I think that's good for everybody who is in the category, particularly good for people who are in the category at less than $600, because I think it drives interest. Then people come in and they look at their options and they start to say, I can get what I want, and I can get it for less money. So I do think it drives interest in the category, and it's positive from that perspective. And I think over time you're going to see the operators and the handset manufacturers look at that and say, okay, what does that mean I have to do, and that is an opportunity for us to go work with them even more closely than we do today.

I think historically if you went back three or four years there was sort of this, the handset guys did what the handset guys did, the operators did what the operators did, and we produced an operating system, and sent it to people. And you're seeing that change now. People are saying, gosh, what's the experience I'm going to have on my phone, and I need to work with people really closely to produce a great experience beyond a great telephony experience. And that's a place where we can add a ton of value. So I think it will create opportunity for us to add value in that way.

Yes, number three.

QUESTION: Jumping over to Xbox, if your games are fairly successful, the launch coming up this fall, and you get more profitable, what's your feeling about pricing on the console? Will you cut prices deeper to grab share, or are you going to let the upside flow to the bottom line?

ROBBIE BACH: Gosh, I just was unsuccessful in my presentation. I thought if I talked about it in the presentation I'd get away with not talking about it.

Let me just address this. We will we track, we had a plan that we put in place when we started this generation, and we said, this is the way the costs are going to manage, and we're going to manage hard to those costs, and we've been successful doing that. This is what we think it's going to take, in terms of price points, to get momentum in different marketplaces at different times. We've got multiple SKUs, because we have different agendas, depending on the SKUs. And you're going to see that continue.

It's not like I look at the P&L and I say, gosh, we did 4 percent better, I'm going to do something in price tomorrow. It's much more like we have a broad strategy for the direction we want to take price across the generations, and we're going to manage that strategy. Would we take opportunities if we saw them? Sure, we would, but you've got to remember, you have to think about pricing, and the price cascade over time, and you do have to manage this for a long time.

So if you get to a price point too quickly, that's a problem. If you get to it too slowly that's a problem. Either one of those can be a problem. So we really try to look historically at what the right cadence is, what the right cascade is, and really manage to that. And we're just going to continue to do that. If we get a few extra opportunities, maybe we'll find ways to take advantage of them. But, it's not the focus of what we're doing.

Let me take number two.

QUESTION: Hey, Robbie. Hi, Jason Maynard from Credit Suisse. I had two questions, since I was down at E3, and since then you've had a change within the leadership ranks, and I'm just curious what we should sort of expect with Don coming aboard. And second, you also showed, I think it was for the Scene It game, an alternative console. I'm curious, will the or an alternative controller.

ROBBIE BACH: Controller, right.

QUESTION: Will this change influence maybe the direction that you're going to try and broaden the field to maybe sort of more casual gamers?

ROBBIE BACH: Let me answer the second question first, because then I can speak more to strategy. The product you're discussing is Scene It, which comes with a what I call the president-proof controller, because even the president can use it. Anybody can use it. It's five buttons, it's very simple, it's a great family product. It's shipped with Scene It, there's four controllers in the box.

Other games will be able to take advantage of that controller, and it is an opportunity for us to reach broader audiences, by design. And that is the intent, it's part of why we're driving that so hard, and you're going to see us continue to push that ability to reach into other audiences. And it's not the only type of controller. Guitar Hero has a guitar, and that's the game my 10-year-old daughter plays, and she loves it. So I think you're going to see that for us continue.

To your point about Don and Peter, look, both these guys are great people. Peter has done great work for us in his time here. I'm sure he'll do a great job in what he's going to do at Electronic Arts. And we have a good partnership with EA. I think that will continue. Don brings a different skill set. He comes a little bit more from the product side, where Peter came a little bit more from the marketing and promotional side. So I think you'll see the way they do their job differently, and that will be different. It's something we'll all adapt to internally. I don't think it signals any fundamental change in anything. And as Don digs in he'll look at that more and decide if there's tweaks or changes that he wants to make. But, I think the basics of our strategy don't change as a result of that, the way in which we execute might change a little bit, just based on the people we have making decisions.

Let me go over here to number three.

QUESTION: Yes, just a longer-term question. The original position behind the Xbox seemed more about an entry point into the living room, trying to turn a consumer's wallet. And under your within your segment you actually have a lot of different experiences, whether it's music, gaming, digital TV, or movies.

ROBBIE BACH: Right.

QUESTION: So I'm wondering when is the first time we actually see that device come out that combines all these? The Xbox is combining a little bit of the DVD, but does the next-generation Xbox look just pretty much like the current one, or actually are we going to see a set-top box that provides a little bit of everything?

ROBBIE BACH: Well, let's do two sort of clarifying points. One, even today's Xbox you would say does music, does video, it will we've already announced that we will enable it to be a set-top box for a Media Room service. So it in a way does some of those things, even though its primary purpose will always be to focus on gaming, and making sure it's a great game console.

In terms of is there the search for the one device, I don't actually I'm not actually, myself, a big believer in the one device theory. I think you're going to have multiple different devices, depending on where you are, what you want to do. You're going to want to have access to the same content, but you might use it differently.

You’re going to want access to your music on a mobile phone. You're going to want access to video on a mobile phone. You're going to want access to music on an Xbox, you're going to want access to video on an Xbox. You're going to want access to all of that on a PC. The form in which it takes, the way in which it gets delivered, and the use you make of it probably will vary a little bit by device. And we have to be flexible enough, and design a simple, and integrated experience, so that people can feel comfortable with all that.

I will tell you, from a design perspective, that's a real challenge. But, I think we're on the right path, in particular focusing on services, because they can be delivered to any device. And once the connectivity is available for that, I think you're going to see that start to take off in a big way.

I'm going to go to number one.

QUESTION: Hi, Robbie. Xbox 360 is an outstanding device. There are two things that come to my mind. The first thing is, your over-focus on bringing the cost down. I think instead of that if you kept on focusing on actually spreading the word what the Xbox 360 can do, it's a most inexpensive device for the living room.

If you just compare it with the comparables, like the Digital Entertainer from NetGear, D-Link, whatever they are, Apple TV, and what they can do, and then you look at Sony Playstation 3, and then see what Xbox 360 can do, and the quality of the graphics, I think if the message is sent out the volumes will pick up, and the price will really come down when you have economies of scale, because the component providers are just going to provide an integrated chip, where you need four chips today you could probably get away with one chip. And that's what really is going to bring the price down. And not just over-focus on cost. I think the focus really should be on getting the customer experience message out.

ROBBIE BACH: Well, I don't actually think it's an either/or question. I actually think there's truth in what you say, in terms of our ability to deliver the market message, and communicate to people that it's a game console, but a game console that does other things in a great way. I would salute that, and agree with it, and know that there are things that we're doing in particular in PR and in direct outreach that will try to make that happen. On the other hand, I will say, that cost reduction won't happen unless we're there pushing it. And because the design is a custom design, we have to be very focused on it, because it won't just happen, even based on volume.

So we do need to be focused on cost reduction. That does need to be something we do, not withstanding the fact that I agree with your first point, that there's more we can do to get volumes from people thinking about it as a broader device.

Other questions? I'll officially call on you as number two.

QUESTION: How important is your relationship with the entertainment industry? My sense is that when you came to town late '05 and told people that HD DVD was going to continue, that nobody was going to win that battle, it was a downloaded future, you really shifted everything that was happening in Hollywood. And you have a chance to work with content providers perhaps in a way nobody else does. What share do you wind up getting in the end as a result of the relationship you've built with the entertainment industry?

ROBBIE BACH: Well, I would describe our relationship with the entertainment industry as something that's evolving. I think it's evolving in a positive way, as you point out, but I think it's still evolving. I think historically if you went back five years, the entertainment industry sort of looked at Microsoft as a little bit of a geeky software company that always wanted to come down and talk about technology, and not talk about entertainment, or even better not talk about business and how we help make their business better. And so our focus has been, and will continue to be, how can we work with those content providers to make their business better, and to enable new opportunities for them.

I'm not going to speculate about what that means in terms of the scope of our share in that, in part because the market in that way is so big, I'm not even sure exactly how to define it. I'm not actually sure how to look at it and say, oh, it's going to be X or Y share. I do say this, as digital technology has taken more of a bigger role, as companies are realizing that digital technology is actually an opportunity, not a threat, it does create a better opportunity for us to come in and talk with them about how we can use that capability to make the business better. And the most traction I get with people is when we talk about their business. When we talk about how we reach more customers with the content they're producing, and how we make that content experience better. And that's the place we're going to focus, and I think that's why you see us getting some of the traction we're getting.

Let's see, anybody else? One last question. Let's take one last question right down here. Number two.

QUESTION: On Windows Mobile, you've given out earlier numbers before on things like the number of Mobile Professional apps, the number of hardware manufacturers, the number of carriers offering Windows Mobile devices, could you share some of those to give us a sense of underlying progress around the ecosystem?

ROBBIE BACH: Here's what I will say, I couldn't give you the exact numbers just because there's sort of four or five of them, and I get them interchanged. I will tell you this, the device number is about 140 devices, and what I will say is that the progress there has been positive. Let me put it this way, I think we've reached the point where, among the handset manufacturers, we feel very good about our penetration there. Among the operators, we feel very good about our traction there. And certainly we'd like more, but it's not for me even that's not the most important thing. For me, the most important thing is for us, with each handset manufacturer, and with each operator, to be producing iconic phones, and experiences on those phones that are deep and rich for people. And so it's much more of a continue the breadth of what we offer, but really focus on places where we want to go deep with them, in a deep relationship to produce something great. So I actually think about our partner relationships not so much in terms of numerics, as I do in terms of depth of the relationship, and the type of interaction we have with them.

Two years ago, very transactional, shifting very strongly now to a much more strategic relationship, and I think that's an important thing for us to track.

OK. With that, I'm going to wrap up. I want to thank you very much for your time, and it's my pleasure to introduce Ray Ozzie, who is our Chief Software Architect.

END

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