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

ROBBIE BACH: Good morning, everyone. I'm going to spend some time with you this morning talking about the state of the Entertainment and Devices Division. I thought I'd walk you through Fiscal Year '09, and then talk a little bit about our strategy going forward, and showing you a little bit from our product portfolio as well.

If you look at the state of our business, as you know, there is really four segments in that business. So, I think I will go through each segment. First of all, in Windows Mobile, I think, as Steve pointed out, we had a challenging year from a share perspective. We did lose a little bit of share. We actually did grow our volume this year. So, we feel quite good about that. We had reasonable traction in enterprise and actually some good growth internationally. Much tougher competition in the U.S. and certainly there is plenty of competition in this space. And I will come back and talk a little bit about our mobile strategy in details in particular. But a year in which, basically, our unit volume was just slightly up and we lost a little bit of share.

If you move across then to the TV and music space with Zune and Media Room, here's a place where we're continuing to make good progress. We have now almost 3.5 million subscribers who are using the Mediaroom service across all of our partners, and we've seen very good growth there. I think, certainly, the economy probably slowed the growth a little bit from what we might have expected. But in talking with our operators, we think the coming year is going to be quite positive in that space, and we're going to continue to see that grow.

And as you've seen from our announcements with our Zune HD device as well as bringing Zune to Xbox, we continue to expand the brand presence for Zune and continue to build our capability in the music and video delivery marketplace. You are going to see that continue to expand.

I will also point out that in the Mediaroom case, we are now the number one IPTV provider. And we think that there's going to be a continued process of upgrading to that technology across our telco operators and maybe across some other operators. So, we are quite positive about the future in that whole area.

When you go down to the bottom left-hand corner here, our specialized devices and applications group, this is where you'd think of our mice and keyboard business, our Mac Office business, and our embedded operating system business. This is a division that, again, contributed significant profits to E&D. It was a very strong year from that perspective. We gained share in the mice and keyboard space, probably up a point, point-and-a-half, depending on the markets you're in. But certainly of all the businesses in E&D, this is probably the place where the economy had the most impact because we are dependent on PC sales, we are dependent on Mac sales, and we are dependent in the embedded space on enterprise purchases for embedded software; and all of those softened in the economic situation in the second half of the year.

So a year in which the division actually performed quite well from an operating perspective, but we saw in the second half of the year, tail off in the business due to the economy.

And then, finally, you get to Xbox and this is a year where I think we had a very, very strong year on Xbox. We made tremendous progress in share in Europe and Japan, continued success in the U.S. Our install base is now past 30 million consoles. And in my mind sort of most importantly, we set a record for console sales this year, 11.2 million consoles, almost a 30 percent increase over where we were last year. And that's in probably the worst economy in the last 70 years. So, we feel very good about that. Our attach rate continues to outperform the competition.

On the Xbox LIVE side, now 20 million LIVE members worldwide. It is the largest social network on the TV, and we're going to expand that. We are adding Facebook and Twitter to that service. Our paid download services expanded, up about 75 percent this year. And we're going to continue to expand video as well, with sales in Europe, with Canal+ and BSkyB, as well as, I said earlier, bringing Zune to the Xbox.

So, this is an area where we felt like we had a very good year in the marketplace. We gained share in a difficult economy. There certainly was some fall-off in titles sold across all consoles in the marketplace, but that was true for Xbox, as well. Consumers were a little bit more discriminating in terms of how many titles they bought. So, big triple-A titles sold super well and some medium-range content didn't sell quite as well.

A very good year with Xbox now, and year-to-date in calendar 2009 the only console to show year-over-year sales growth, we feel positive about the position we have here. And when I show you some of the technology we have coming in the future, I think you will see the future is quite bright in that business as well.

So, if I summarize that, you'd say across the year, I would say it was a year where we did pretty well executionally. I feel good about the way we operated the business. The economy was challenging. We have some challenges in the mobile space, which I'll talk about in a moment. And the result was another profitable year for E&D, less than last year, but still profitable in a very tough economy. So, we feel good about the position of the business going forward.

Now, I think if you were analyzing the business, you'd say, well, gosh, there are two or three big questions we should need to answer. And the first of those questions is; how across E&D are we going to build scale and build competitive advantage? If you look back across the last three, four years, we made a lot of progress in the business. We took a business that was a pure investment business, turned it into a business that's been making money. But, we still have to answer the question how we're going to scale and how we're going to be competitive on an ongoing basis across all of our properties and how we bring all the properties together in a coherent way.

The second question we have to answer is, how do we succeed in the mobile space? I'm going to talk about that in some detail. And, third, if you want to be in this space, you have to be driving real innovation on a continuous basis. So, I want to talk about innovation and some of the things we have in the pipeline so that you understand the direction we're going.

So, let's address that first question about what we're doing from a building scale and competitive advantage. And the way we think about this is in the context of our strategy called three screens and cloud. As Steve talked earlier about this, the whole concept here is how do we deliver entertainment experiences, social experiences across the TV, the PC, and the phone, and connect those with cloud-based services.

And for us, we're in this process all the time. We've started this process over the last two years. You're seeing the connections steadily being built. This won't ship on one day. It's something that we will build over two or three years. And we are partway through that process, and you're going to see even more coming into the market in this context.

To give you the concrete sort of example, I'm a tennis player. And if you want to watch Wimbledon, it is a little bit of a challenge, because the tennis starts actually when you're at home. So, maybe you're watching it on your TV at home. Then maybe you're on the subway, you're on a bus, you want to watch it on the way to work, you want to have that on a mobile device. Then maybe, when you get to work, you're going to sneak some time and watch it on your TV. And you want to be able to do that in the context of being connected to your friends, being connected to all of your other media, being connected to your entire entertainment experience.

That's what we're about delivering. And that is a powerful proposition that I would argue is something that can differentiate us from people like Apple and from Google. Apple is very strong on the device side. They have a good brand. But, not anywhere near as strong on thinking about services, thinking about the cloud, and thinking about how they're going to deliver that at-scale. Google, on the other hand, a little stronger on the cloud side, obviously strong in search, but not as strong on the device side and the local delivery. And to do this you have to be able to do both.

And Microsoft is uniquely positioned to do both of those things. We have tremendous assets both in E&D and across the company in the cloud, and certainly we're building traction. On the PC, we have it. On the TV, we're building it strongly. And as I'll talk in a minute, we have a plan to build it in the mobile space.

So, I think this three screens and the cloud approach is how we are going to build scale and be differentiated in the long term. And you're going to see us execute on that, not just this year or next year, but the next three to five years. So, that's question number one.

Now, let's move to question number two and talk about mobile and how we're going to make progress in the mobile space. Now, the slide that you see here, the marbles that you see on the slide depict volume for the latest quarter's results, based on the four or five largest guys in the marketplace. And the arrow across the bottom indicates sort of market position, let's say, by who is the target audience, or the people who are generally buying those devices.

And the basic trends you've seen are the following. Nokia has been leader in the space for a long time. But, as the market has shifted to smartphones, their share has declined in the smartphone space. They have some particular challenges in the U.S. So, they have interesting things to work on and manage. RIM would have started on the left in the business space. They've actually grown their volumes pretty successfully in the last year by expanding across more into the customer space. Apple, obviously a relatively new entrant over the last 18 months, but has been successfully building from the consumer side. And Google is small here because they only have one or two devices in the market, plenty of rumors and announcements about things that are coming this fall. We'll see how the marble grows in size over time.

For Microsoft, our success has predominantly been on the business side. And certainly we know that in the marketplace people no longer think about things as a business phone versus a consumer phone. They just want their phone, and the phone has to do very well for what they do in business and very well for what they do in their personal life. So, our strategy has to be based on taking the success we've had in business and continuing to grow that, and then expanding that success across to consumer scenarios. So, that we can both move that marble to the right as well as grow the size of the marble and gain share.

And when you think about this, this is not something that's going to play out over three or six months. Smartphones today are about 15 percent of the total phone market. So, this is something that's going to play out over the next three to five years. Certainly, there's plenty going on now. I think there's going to be a lot going on next year, the year after that and the year after that. It's going to be a very competitive marketplace, one where we will have to work very hard to be successful, but one that is very important to our strategy, where we will invest to be successful in the future.

So, let's talk about the specific strategy itself. The fundamentals of our strategy are based on the idea of choice and selection. It's our view that one model, one type of phone is not going to build volume into that critical mass that we think we need to make the business successful. We have people who are going to want QWERTY keyboards. We're going to have people who want touch keyboards. People are going to want a big screen, people who want small screens. People are going to make trade offs on battery life to be able to do media. People are going to want different configurations for the phone.

So it's our view that we need to work closely with Samsung, LG, HTC, HP, Sony Ericsson, and others to build a broad selection of phones that really deliver choice, at different price points, with different functionality, and different capability. And as you can see, in the phones on the slide here that we will be delivering in October when Windows Mobile 6.5 comes to market, you can see some of the diversity, different sizes, different screen sizes, different approaches for input, etc. So, that's the fundamental pillar of our strategy.

The second pillar of our strategy is around experiences. And if I have a critique of our phones today, it's that our experiences are very good in the business case. If you want to do e-mail, and Outlook, and connect to Exchange, and move data around in that environment ,we're actually quite good. But, if you're in the consumer space, and you have consumer scenarios, you want to do more browsing, you want to do more media, you want to do more video, you want to do those types of things, our experiences aren't as rich as they need to be. And starting with 6.5 and then going forward, you're going to see us expand those experiences dramatically, and you're going to see us think about those more as end-to-end experiences where Microsoft makes sure that the experience works from start to finish.

So, in 6.5, let's just pick an example, you'll see our browsing experience get dramatically better. So, you will have a very rich browsing experience on 6.5 devices that will give you access to more Web sites than you will be able to get to on an iPhone, that will work actively and work well. It really is a much better experience. We will have to continue to enhance that because the browser world is advancing very quickly. But, that's an experience people expect to work and that's just one example of many experiences that we're building to expand in that area, so choice in selection, great end-to-end experiences.

The third thing we're going to focus on is what I talked about in our core strategy around three screens and cloud innovation. Cloud innovation is very important in the space because people are always connected with their phone, and they always want to be able to have access to other things, and the cloud is going to be able to provide those capabilities.

The example in 6.5 is a new service we are providing called My Phone, which effectively enables you to back up your phone instantly through the cloud, enables you to transfer media from your phone to the cloud, and always have access to it. If you lose your phone, you haven't lost all your data. Not only have you not lost your data but the cloud can help you find your phone. So, there's a whole set of those types of services that we want to expand into, and I think those cloud-based services brought to the phone as well as to the PC and the TV are going to be quite powerful.

Fourth element of the strategy is around the brand, and you will see on the slide it says Windows phones. We are going to invest and build on the brand of Windows phones. One of the challenges we have when we talk to consumers today is they see a Windows phone experience and they ask how do I get that and we haven't had something to call it where we'd say, oh, go into the store and ask for a Windows phone. And that's an area where we are going to invest in building. We will invest in that with our operators. We will invest in that with retail and we'll invest in it with our own advertising money to make sure people understand when they see those types of experiences that that's a Microsoft experience delivered on a Windows phone. It may come from HTC, it may come from Samsung, Sony-Ericsson, HP, others, but it's going to be a great experience, and they'll know what they're going to get.

The final part of the strategy is we have to do a better job executing, and a better job in operating our business. I think there are two areas I would like to highlight. The first of those is in our integration with hardware manufacturers. If you're on a strategy that's about choice and selection, you have to do a great job integrating with the hardware because all these experiences are about all the hardware and the software interact, and then how that combination interacts with the cloud.

And, to date, we haven't done as good a job as I would like in building the relationships and getting the right level of integration with our hardware OEMs. And so, you will see us investing in that. We have already started that process. Obviously phones take time to develop, so that won't happen overnight, but you're going to see a dramatic improvement in the integration between what we do in the software and what our hardware partners do on the hardware side.

And then the second part of better execution is strengthening the team doing the work. And we have over the last 12 months done a significant investment from a people perspective, and I'm not talking about head count, I'm talking about quality talent, of moving quality talent onto the team. People who have built successful businesses in Exchange; people who build successful businesses in our mouse and keyboard division; people who build successful businesses as part of Windows; and moving them to Windows Mobile to make sure we have the best quality talent in the company working on this key initiative. And those people are now in place.

Windows Mobile 6.5 shipped within four days of its original ship date when we sent it to the hardware manufacturers. That's a great performance in any market, and in a market where you are talking about phones, which is a very complicated release process, we are quite proud of that. And I think you're going to see as we go forward into the future, see our execution rhythm both pick up and the quality of that execution rhythm improve.

So, that's the Windows Mobile strategy. It really is about choice and selection, and great experiences. Those experiences are going to include connectivity to the cloud, connectivity to the PC, and to other things, and it is going to be about building the brand and better execution.

Now, in a way, you could think about that as bringing innovation certainly to the mobile phone, and we are definitely going to do that starting with 6.5 but in particular going forward. But we're also doing that in other areas. And when we think about innovation, we think about it in three parts. We think about it from a business perspective. So, we want to innovate in the business model. That means figuring out how we build better subscription businesses. And Xbox LIVE has done a good job of that. We have a good subscription business there. And we built that from scratch. How do we expand that? How do we broaden that? How do we do a better job in advertising on our properties and platforms? We've, again, started that on Xbox. And we need to do a better job of that across the rest of our business.

Marketplace, we now have marketplaces on Zune; a marketplace on Windows Mobile 6.5; a marketplace on Xbox. These are all places that enable us to innovate in the business models, and to create business models for our partners. And that's an important thing for us to do. That's one type of innovation.

Second type of innovation is what we would call experience innovation. An experience innovation, again to point to Xbox LIVE, think about what we do to create a social network on the TV: That's an experience. You can get online gaming for free and people pay us every year for it. And the reason they pay us for it is because they're always connected, it always works, it's a personal service to them, and it is a social experience. And so figuring out how we bring experience to play across all three screens and across our cloud services is critical to our strategy.

And, finally, the last area is what you might traditionally think of as innovation, which you would call pure technology innovation. And this is a space where clearly—Craig Mundie is going to come on stage in a few moments, and he's going to talk about some of the pure technology work we're doing going forward. It's a place where the company is investing hundreds of millions of dollars, billions of dollars, to produce the type of technology can build next generation experiences.

With that in mind, I want to talk about some of the things we have done to innovate in the Xbox business, and in particular talk about something called about Project Natal. Now, Project Natal is sort of a combination of technology innovation and experience innovation. I happen to think it will lead to a bigger and better business as well. But it is certainly an opportunity for us to build something new.

And the basic concept behind Project Natal is, we want to enable people to play games and have an entertainment experience who don't have coordinated thumbs. And we want to take the controller out of the experience and let people use themselves as the controller, and have a very natural interaction and natural entertainment experience.

So what I want to do is, I think in Natal a picture is worth 10,000 words. So, what I'm going to do is actually show this to you. And this will be a physical activity for me, so if I'm out of breath at the end, I am actually in pretty good shape, but this may stretch my capabilities.

So I'm going to come over here and stand in front of the Natal camera. Now, you see it has recognized me as Robbie, so it does facial recognition. It also, as I move my hands and feet and arms, it does all the motions that I do. And so, my avatar is part of me on the screen, and can actually reflect all the things that I do. Now, I can go then into what's called the Xbox Dashboard, and you can see I can naturally navigate through this. I can navigate up, I can navigate down, navigate to all the different parts of the Xbox Dashboard. So, it does facial recognition, it does gestures. It also does voice recognition.

So I'm going to, in a moment here, play a video, and I'm going to use voice recognition to do that. And this video will show you some of the other amazing things that Natal is capable of doing.

Play video.

(Video segment.)

So, now that gives you an idea what Project Natal is capable of. Now some of you in the audience may be skeptical and say, well, you can do a lot of things in video. But let's actually see it in action. So, I'm going to actually play a game here called Ricochet. And you can feel free to cheer along with me, or hope that I don't die in the game. It comes in, it recognizes me. The ball is there. And now I'm going to knock the blocks off. Cheap executive tricks. First round, 83, that's pretty good. All right, here we go. Oh, right through the legs. Bad, come on. All right, you're seeing my game skills here. Oh, there we go. 147, that's a subpar performance.

Anyway, you get the idea of what Natal can do. It is highly interactive, highly social, and completely differentiated. This is something Sony, Nintendo, or anybody else is going to have a very hard time competing with. So, I look at this and I say, first of all, it's gotten me out of breath. And I will say, secondly, it is truly differentiated. This is innovation at the next level. So, we look at it and believe that our Xbox business, as an example, really is doing very well today and has a chance to drive that to a much higher level tomorrow.

So, let me wrap-up by just talking a little bit about, back to where we started, three screens and cloud. Really we look at this and say, hey, we have a very strong franchise on the PC, that's a device we think we have a good position on in entertainment, productivity, and communications across the board. We have challenges but a real opportunity on the phone. Smartphones are going to grow dramatically over the next two, three, four years. There is an opportunity for us to be successful and to build a good business on the phone.

And third, you've already seen us make great progress on the TV, with Mediaroom, with Xbox, and you have seen some of the technologies we're bringing in the future. Then if you think across Microsoft, from a cloud perspective, we're very well positioned, not because E&D is doing much of the work, but because Azure is doing the work, Windows Live Services is doing the work, the Bing team is doing the work. We're going to take advantage of all of those services, integrate them into our three-screen experience, and create new offerings, and new opportunities for customers in entertainment.

That's why I think we're going to be successful in this space. That's why I think the future is bright in Entertainment and Devices. Thank you very much. (Applause)

What I would like to do, I'm going to come back in a few moments for Q&A, but what I'd like you to do is please welcome Craig Mundie, our Chief Research and Strategy Officer. He's going to talk about the future of natural user interface.

Craig.

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