ROBBIE BACH: Good morning. I want to take a few minutes today to update you on our strategy around Entertainment & Devices, give a little bit of a view on how we did in fiscal '08, talk about fiscal '09, and then show you some interesting things we're doing in the mobile space.

From a strategy perspective, Entertainment & Devices is focused on building what we call connected entertainment. And connected entertainment is a pretty simple concept. The idea is that you're going to be able to get your movies, your video, your TV work, games, photos, music -- whatever entertainment asset it is, you're going to be able to get on whatever device you have at the time and place that you want. So whether that's a PC, a TV or some kind of portable screen -- here we show a phone, a music player -- you can put a car screen in that part of the slide as well -- whatever it is, we're going to bring those things together.

Now, that requires a unique combination of hardware work, software work and services work. And we won't do hardware in all cases and in all categories; we'll do it when it makes sense and when it's appropriate for Microsoft. But you will absolutely see us focus on making sure we deliver the best software and services solution in the marketplace.

In this space, you know, our primary competition if you look across connected entertainment is going to be Apple and Sony. In the Apple case they've had some success with some vertical solutions. I think we have a much better approach from a choice perspective, and a much better approach in the software and services part of that business -- in particular on services.

Relative to Sony, I think they're well-known for producing great hardware, and again I think the challenge for them is can they do the software and services part of that, and I think we've demonstrated in the video game space that we can drive leadership with our software and services attributes.

So the strategy is about connected entertainment. Let's look and talk a little bit about how we did in fiscal '08 on connected entertainment. And really across entertainment devices we had a very, very strong year. For the first time the division finished the year profitable. We're very excited about that. That's been a goal I set two years ago at this meeting, that we would be profitable in two years. We've delivered on that. If you look across each of the individual businesses, the gaming business had a very strong year. The install base of Xbox passed the 20 million mark. Xbox Live now over 12 million members, continuing to grow. Our attach is at an industry record for this stage in the life cycle -- some very strong business there. Zune -- we shipped a product now that has over 90 percent customer satisfaction -- a product people really like. We have over two million people on our Zune social site who are sharing their views on music, sharing their playing list and communing in a social connected entertainment context.

If you look at the TV space, again a real success story this year -- now over 120 million Media Centers in the marketplace. On Mediaroom, which is our IPTV product, we have over a million subscribers, and that business is now through the sort of what I'll call incubation phase and really into an opportunity for us to break out and grow that business in a significant way.

If you look in mobile, another strong year. We gained share this year in mobile. We outsold RIM, we outsold Apple. We are producing great software and adding services to that mix, and I'm excited about the business we're doing there.

And then SDA is our Special Devices and Applications area, and this is a place where we have a great ongoing business with our milestone keyboard business and cameras on the PC and our Mac Office product, but where we've also added a lot of innovation in the embedded space, in our Microsoft Auto product -- you've seen the ads and the results from Ford with our Ford Sync product and with Microsoft Surface, which is now in commercial deployment in the marketplace. So overall across the division a very, very strong year.

So let's talk about then how we want to expand that into fiscal '09. And the first thing that we should be clear on is that we plan to continue profitability in the division. We plan to continue to build on what we did last year. We think that's important in the business, and we believe we have businesses that are now at scale where we can continue to drive that.

The second imperative for the year -- Steve mentioned this briefly in his talk -- is Windows Mobile. The opportunity in the mobile space is very, very large. This year about 125 to 150 million Smartphone mobile devices will ship. If you look out three years that number is going to triple or quadruple -- probably approaching 400 to 500 million units in three or four years. So this is a tremendous opportunity for us. It also happens to be strategic to the company in its connection with Windows Live and with Windows itself. So a very important initiative for us -- and I'll come back and talk about that in a moment.

In the gaming space we want to continue to grow on our success. We want to continue to expand that business, in particular by reaching new audiences -- and I'll talk a little bit about that in a moment. But in the case of Xbox the idea is to expand the audience from our core base and to expand the audience from the U.S., in particular to get even stronger in Europe and eventually build strength in Asia. So we think we have an opportunity to expand that business this year

The fourth imperative for our division might surprise you a little bit, but we actually do a lot of work to support and integrate with Windows. So my team, as I said, is responsible for Mediacenter. We're continuing to work on Mediacenter for future versions of Windows. We do a lot of work in the gaming space and we're responsible for games on Windows, working with publishers and developers to make sure that continues to be an engine for growth for the PC. And this year we're going to start to do more work at retail and help work with retailers to improve the shopping process when people are going to buy PCs. So that's actually a significant amount of work and a significant focus for what we do in Entertainment & Devices.

And then finally, while we do plan to continue to be profitable and continue to grow that business, we are still investing in new businesses and we will be pioneering in areas like Surface, which is an investment we have been making now for five years, this year in availability with commercial customers. Hopefully sometime in the future we'll be able to reach out and turn that into a consumer product. That's still TBD. But we're going to continue to invest in areas like that because we think that is the future of building to connected entertainment, and we have to keep doing that.

So what I want to do now with the rest of my time is I want to focus on two of these imperatives. I want to focus on the Windows Mobile business, and I'm going to start with focusing on the gaming business. And I said earlier that the goal in the gaming business was to expand our audience and to reach out to new customers and to new people. And one of the ways which we just announced that we're going to do that is we really are going to create a whole new interface for Xbox. And you see here a graphic representation of multiple screenshots of what that new interface will look like. This is an interface that will be more comfortable for casual gamers, for people who aren't into serious hard-core games, and at the same time will be a great way for serious gamers to have avatars, to create a social experience, to dig deeply into Xbox Live and really reach into the depth that is the Xbox experience. So we are adding avatars, we are adding something called Xbox Live Primetime, which is basically television shows brought to a gaming environment. And the idea that you could play a game like “1 vs. 100” on Xbox Live with other Xbox players is actually a very rich and powerful idea, and we're going to bring that to market later this year.

We've also announced an arrangement to expand our video offering with Netflix. We've announced arrangements with NBC, Universal, and Constantin internationally to expand that in Europe, again expanding the breadth of the customers we can reach and really reaching out to those new audiences.

Now, having said that, that interface is awesome and exciting, and I think it's going to drive a lot of excitement in the marketplace. But it's certainly not enough. This business, as we always said, is about the games themselves. And our game lineup this year is probably the best we've ever had, in part because it starts with these titles which you'll recognize as fabulous core audience titles. We'll never lose that audience. We want to keep building on it. These titles: “Gears of War 2,” “Halo Wars,” “Fable 2,” some third-party titles as well, “Resident Evil,” exclusive content on “Grand Theft Auto” that you'll only be able to get on Xbox Live. This is the kind of content that excites the core audience. It's going to continue to bring them back to buy titles on Xbox 360, continue to get them to buy more consoles. So it's essential for us to do that.

But at a strategy level the new thing this year is the work we're doing to broaden the game lineup. And here you'll see things like seeing it – “Guitar Hero World Tour,” “Viva Pinata,” a new product from Microsoft called “Lips,” another new product called “You're In the Movies” -- a great franchise like “Banjo-Kazooie” done by Rare. These are the titles that are really going to help us expand the audience, reach out and continue to grow the business. Importantly I should highlight “Rock Band 2,” since that will appear exclusively on Xbox 360 when it debuts. If you think about music games, if you think about movie games, if you think about TV-based games, things for family entertainment, things on arcade space on Xbox Live, we are going to do a great job this year delivering on that content. And so the balance of content between a new interface, continued expansion in the Xbox Live business, great core content plus content for a broader audience, we think it makes fiscal '09 a good opportunity for us to continue to expand this business.

Now, the second part of the imperative I wanted to talk about was Windows Mobile. And I think if you look at the past year it was a very successful year. As I said earlier, we gained share, we outsold our two primary competitors, RIM and Apple. We feel very positive about that.

Now, most of that success game in what we would call a business context. People are using Windows Mobile phones for e-mail, integration with Exchange, and using it in a business environment. And we think that will continue. It's the reason we've come out with something called Mobile Device Manager. It's the reason we've come out with great security features. It's the reason we have the richest environment for IT managers to manage phones, because in the enterprise space they are now viewing phones as a strategic asset -- not just as a device that people bring in. We will do better than RIM there. We are much more well-equipped than Apple is in that space, and that's going to continue to grow.

But if we want to take advantage of that opportunity I talked about earlier to reach out to those 400 or 500 million Smartphones, we have to expand from just a work device to being a device for individuals when they're in their personal life as well as in their work life. And that's where you are starting to see some of the work come to market now. We just released Windows Mobile 6.1. It has a new interface on the front, which is the beginning of the work we're doing to make it more approachable, make it easier for people to find things like music and videos and games and other consumer-oriented activities on their device. You're going to see that continue to expand.

You're also going to see us continue to expand on the idea of choice; the idea that there isn't one form factor that is going to work. Because once you get into the consumer market, and you take 10 or 15 consumers, bring them in a room and ask them to put the phone they like on the table, some will want a QWERTY keyboard, some will want a slider, some will want a flip phone, some will want a touch screen, some will want a big screen -- maybe it's a little bulky to carry around, but they're OK with that. Others want the smallest device possible because they want it to fit in their pocket and their purse. You need that diversity, and we are going to continue to expand on that diversity and make sure people have the range of phones that they want to be able to buy.

At the same time, we know that the phone experience for consumers is more than just about the handset itself. It's about the software and services experience they can get on the phone. So you are going to see us continue to expand our work in the software and services area around Windows Mobile. This is the reason we acquired Danger. It's the reason we acquired MOBICOM. This is the reason why we're investing in people talent to build the capability to deliver great consumer services in addition to Exchange and the other business services that we already deliver on Windows Mobile.

So this to us is a very important opportunity. It's one where we're making big investments. And yet it's one where we are very confident that, if we do the right work, the opportunity in the marketplace over the next two or three years is very, very large.

So that's the summary of where we are in the business. What I want to do now is I want to just show you a little bit of the work we're doing on mobile. And what we're going to talk about here is some advertising work we're doing in the mobile space. And typically when we're at these meetings and we talk about advertising we're thinking about search and browser-based advertising. What we're going to talk about today is things that are off the PC -- advertising on Windows Mobile. You'll see a set of things that we're already doing and some new things that are sort of in the labs working. And what I'd like to do is bring Sean Alexander on stage to help us show that. Sean, come on out.

SEAN ALEXANDER: Thanks, Robbie. Good morning. As we all know, mobile advertising is a hot topic right now, and there's a lot of energy and a lot of excitement happening within Microsoft both the work that we're doing today with the properties such as Windows Mobile -- or excuse me, Windows Live for Mobile -- as well as with MSN. So what we thought we'd do today is two things. First of all give you a progress report on where we are in terms of our integration work on getting our services up and running worldwide. And second of all I'll show you a sneak preview of how we're working directly between E&D and Microsoft Advertising to really push the edge of the envelope in terms of end-to-end experiences that provide clear value for both the consumer as well as for the advertiser.

So let's go ahead and start off with where we are today. So do you want to come around here? So here I have Windows Live for Mobile, offering a broad range of different services including news, sports information -- even Hotmail and Messenger directly on my mobile phone. Now, this is accessible on a broad range of different mobile handsets. Any phone that has a data connection and a modern browser is able to experience these services. And one of the things that we've done is ad-enabled this using the integration work that's been happening with our acquisitions with aQuantive, ScreenTonic, and then of course the Microsoft advertising platform.

So what I'd like to do here is I'm going to go in, click on my Hotmail, check on it. The first thing that you'll notice here is I had an interstitial display ad -- so we're supporting a number of different ad formats as a part of the experience. And then up here at the top I have an “Iron Man” promotion, where I can go ahead and click to view a trailer, maybe purchase some tickets or even get directions to my local theater.

ROBBIE BACH: So the trick to doing this in the mobile space over time is figuring out how it's not just a direct translation of what's happened on the PC, but how something can fit in the environment of a mobile phone, in particular given screen size and the user interaction that people have. But the quality of what you're going to be able to do on a handset from a video perspective and from the visuals is increasing so rapidly that you're going to be able to do some amazing advertising formats in this form factor.

SEAN ALEXANDER: Absolutely. In fact, the new services, our display ads are now up and running in eight markets worldwide, and we're already generating over 400 million ad impressions per month just through our mobile services alone. So we're very excited about that, and that's a great base for us to be able to deliver new experiences on top of the Windows Mobile platform.

ROBBIE BACH: So, Sean, why don't you show us some of the stuff that's sort of more in the lab --

SEAN ALEXANDER: Sure.

ROBBIE BACH: -- that's kind of state-of-the-art today -- where are we going?

SEAN ALEXANDER: Exactly. So everything I'm showing from this point forward is proof of concept in terms of sneak preview.

You'll notice here I have an e-mail that I received from my friend Mark. His gamer tag is Cruise Control on Zune Social. I'll go ahead and click on that and here I see he's inviting me to check out an artist's Web page on the Zune experience, maybe download some free music -- again all accreted back to the overall user experience offering value to the consumer.

You'll notice here also he's suggesting that I play this game called “Doritos Fight for Flavor.” Go ahead and click on that. And you'll notice that my browser automatically launches and it's going to go ahead and launch a Microsoft Silverlight mobile application right inside of the browser. So this is an ad-supported game. It's a free download -- I didn't have to go to an app store or anything like that. It just automatically launched, again free of charge in this experience. So I'll go ahead and tap here on the “Fight for Flavor.” The game might look familiar to some folks. Unfortunately I play this about as well as I play “Halo.”

ROBBIE BACH: Get crushed by a chip here in a moment. There you go.

SEAN ALEXANDER: Clippy is the UFO there. (Laughter.) So I'm going to go through and we'll go ahead and shoot a couple more of these Dorito chips and finish out the level.

And that's great, but one of the things that we wanted to do was in order to encourage repeat use, let's incorporate an instant-win opportunity at the completion of each level in this experience. So many of us are familiar with the old quarter scratch-and-win opportunity. So we wanted to take that into the digital age, and here you'll see I won a free bag of nacho cheese Dorito chips. You'll also notice that there's a barcode here down at the bottom. So we're working very closely with partners with the e-couponing space, so that I can go ahead and take this barcode at the local retail register and then be able to go ahead and pick up either my free or discounted bag of chips.

ROBBIE BACH: And you've also got the capability now to go find out where you can go do that, right?

SEAN ALEXANDER: That's right. And that's incorporating our Windows Live services. And software actually runs directly on the Windows Mobile phone. I can go ahead and click to find my location. Even if I don't have GPS built into my phone, we can use location-based services based on your local cell tower. And then here I can see that there's three participating retailers nearby. We'll go ahead and click on the closest one. It looks like it's 7-Eleven -- five-star rating, apparently very popular among Microsofteess. (Laughter.) And here I'll go ahead and click "take me there," and here you can see that's providing me with turn-by-turn directions on how to get to my local retailer.

ROBBIE BACH: So the exciting part about this, in addition to the new ad format and that is that this is an ad that the user participates in. This is not just something that they watch. They participate in the game, they get value from the ad, then they get a coupon from the ad, and there's activity that they can take from that. We can then track that activity, work to show effectiveness to our advertisers, show them the ROI on the ad --literally all the way to the end purchase of that product -- and doing all of that just on a Windows Mobile device. So it really shows the power of what's possible. And if I talked earlier about Windows Mobile being an important opportunity for us just from a volume of handsets and our operating system process, it's certainly a big opportunity for us in the advertising space.

Thanks, Sean, very much. Appreciate it.

SEAN ALEXANDER: Thanks.

ROBBIE BACH: So, just to kind of wrap up, that brings us full circle in the business. We think, if you look across E&D, we are building the right business models for each business. We think we are building the right opportunities to continue to grow that while we invest in new businesses. You are certainly going to see us have a breadth in our business model. We have finished goods, regular retail in parts of our P&L. We have subscription parts of our P&L with Xbox Live, we have advertising portions to our P&L, there's royalty aspects to our P&L. It is a very rich P&L. We think it's something we can continue to build and build another great profitable business for Microsoft. Thank you very much.

Colleen, are you going to come out and do some Q&A?

COLLEEN HEALY: Yes, yes. We're going to take Q&A. And I'm also just going to set expectations here for a bit, because we're running over. What we're going to do is, after Robbie fields some questions, we're going to take a break as planned. And then what we're going to do in this more enterprise-focused section that starts with Kevin Turner and ends with Bob Muglia and Q&A, we're going to put lunch after Bill Veghte, so we'll still have lunch around noon, and we'll end the day about an hour later, which will get us into the reception around 4:00. So hopefully that will work fine for folks.

So, with that, the way that we're going to do Q&A is there are IR people in the aisles. They have paddles. And if you have a question, raise your hand, and they're going to come with the paddle that I need to call out so that the question is picked up on the mike.

Our first question goes to Rick Sherlund there at paddle two.

RICK SHERLUND: Hi, Robbie.

ROBBIE BACH: Hi, Rick.

RICK SHERLUND: Could you -- you said one of your first objectives I think was to focus on margins. Could you give us an idea of what you're looking for in '09 in terms of margin improvement?

ROBBIE BACH: Well, I won't go through the margin discussion in detail. The only thing I'll say is if you look across our business it's -- across E&D -- it's quite tricky to actually make one simple statement about that, because the margin structure in each of the businesses is so radically different and the revenue streams are of different quality and different capability. I mean, even just within the Xbox business you have four or five revenue streams with different margin structures. And likewise when you expand that across the rest of the business you have the same challenge.

What I will say is that we continue to see the business being profitable going forward. We think we're past the overall investment phase, if you want to think about it that way. We're still investing in new things, but we now have enough businesses up to scale that we think we can continue to grow the business.

Anybody else?

COLLEEN HEALY: Down here in front. Paddle number three.

JUSTIN POST: Thank you. Justin Post from Merrill Lynch. How do you gauge or value the Xbox need to kind of drive share this year and maybe lower prices versus your profitability goals? And, you know, do you want to really increase your share as the cycle progresses, or are you more intent on profitability?

ROBBIE BACH: Well, typically the way we think about those issues are a function of a couple of different things. One, it's certainly a function of how we're doing with cost management. We feel good about that -- I'll say that. But, more importantly, what we do is we look at demand. And we try to gauge our pricing structure based on what's selling. Because in the gaming space things go through tiers. And you work through a tier of customers and then you want to reach the next set of customers, and that typically means you need to reach to a new price point.

Right now, as you saw in the third and fourth quarter, demand is very strong. We feel very good about where we are on the demand front. We'll obviously continue to evaluate that as we go forward, but we feel very good about where we are today.

COLLEEN HEALY: Do we have another question? Otherwise we'll wrap. OK, we're going to wrap and take a 15-minute break. We'll see you back here shortly. Thank you.

ROBBIE BACH: Thanks very much.

END

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