BILL KOEFOED: Okay. This will be our first Q&A session. If you have a question you would like to ask, please raise your hand and an IR team member will come up and assist you with a paddle, and we'll call on you at that time.

Number two right here. Paddle three right there, did you have a --

QUESTION: Hi, Robbie. You got your business to profitability, albeit low-single-digit profitability, in the last two years. Considering the investments you need to make in mobile and considering there are expected price cuts from your competitors in the hardware side, can you just give us a sense of how you were thinking about the year for the business and how you think about the long term for the profitability of the business?

ROBBIE BACH: Well, certainly our long-term perspective, as I talked about in my talk about scaling the business, our long-term perspective is to scale the profitability of the business. That's certainly the direction we want to go. As you point out, we have to make some more progress in mobile, and there are some other places where we can drive more profit. Certainly we think the Xbox business can continue to grow and continue to build profitability as well. So, I think the long-term vision on that is quite clear.

Next year, tough for me to speculate on what's going to happen. I think some people are speculating that there will be price cuts from our competition just based on their unit forecasts and how many units they've shipped already in their fiscal year and what they'd have to do to finish the year. And I think that's probably reasonable speculation. And we'll see how that plays out. But, you know, we think this year we've got a great lineup on Xbox. I'm excited about Windows Mobile 6.5. I think Mediaroom is going to continue to make progress, and we're going to continue to try to build the business.

The hard wild card in all this is the economy. And E&D is lucky in one way, because things like Xbox are a little less sensitive to the economy because people actually transfer things to local entertainment when the economy gets tougher. So, we get people who buy more consoles, actually this last year because the economy was a little tougher. But even in Xbox, people bought fewer games. And so with the economy, depending how the economy goes, that's going to have a reasonably big impact in how we're going to finish the year.

BILL KOEFOED: Who has the next question? Paddle two.

QUESTION: Just wondering if you think the arrival of X86 in the handheld will be a significant event? And, if so, how are you planning your road map to meet that event?

ROBBIE BACH: Well, I can comment on that, and then Craig can comment more from the technology.

In fact, Craig, why don't you start on the technology side and then I will talk about it from a market side?

CRAIG MUNDIE: Intel has been working diligently for quite a few years to reduce the power of some of their cores. And that's been key to them, not just in their aspiration to come down into consumer electronics and ultimately the phone segments, but it's the basis of how they are going to do the high-core-count microprocessors that would be the basis of the room like I just talked about.

For us, the X86 environment is one that we know well and have an easy time supporting. Clearly, adapting that to the environment that we have in the embedded and the phone business would take some work. But it's not a monumental amount of work, as it would be if it was an architecture that the company didn't already have a heavy investment on. So, I think our view, and Robbie and the business team will have to make the call as to how we see that evolving.

But, you know, in the Embedded Business, for example, we always have supported the X86 and many of the underlying operating system technologies. The Windows CE technology is used in Windows Mobile as well as in our historical embedded line. So, the technical transfer is not a big leap for us. It will really just be a business decision of timing.

ROBBIE BACH: That's right. And from a business perspective, the way we think about this is we're going to see how the market evolves. As Craig said, there's obviously some work we have to do, but we have a ton of technology already in that space, so it is work that's manageable. And as we see that evolve, we'll decide where that goes. Some of it depends on what devices those chips will go into. Some of them might go in the devices where we're more of an embedded player, and there X86 is straightforward. If they go into phones, then there's probably a little bit of work for us to do. But we have a pretty good handle on the X86 environment, and we can make a business decision based on volume and what our customers, both end-user customers and our operator customers, are looking for.

BILL KOEFOED: Great. Who has the next question? Paddle two again.

QUESTION: You didn't mention anything about the Kindle. And I'm just wondering what you're thinking about from a book reader.

ROBBIE BACH: Yeah, book reading is an interesting category. In fact, there's a number of what I will call specialized devices categories, of which book reading is one. You can actually put the TV in that category as well, because TVs are going to have more intelligence in them, more software, more chip technology going forward. You can put intelligent photo frames in that category; a number of them, what I would call specialized devices. And our primary approach to that is the work we do on Windows Embedded. That is in my division. It's actually a successful part of the business, something that's growing. And those will be the types of divisions from an embedded operating perspective, those specialized devices that we will continue to target and try to sell to.

From a first-party perspective, so for Microsoft producing a device, we're actually pretty selective about which ones we want to get into, in part because we know what it takes to scale hardware businesses like that. And, you know, so we are going to pick areas— you know, if and when we do devices, we're going to pick areas where we know there's big scale. So, take "Project Natal," for example. That's, in fact, another specialized device that connects to our Xbox. That's a place where we know we can scale it; we're going to invest heavily. There are other places where we'll choose to invest as an operating system provider.

CRAIG MUNDIE: I think I'll add two comments to that. One is, clearly reading is going to be an important scenario, whether it's in education or other environments.

ROBBIE BACH: That's absolutely right.

CRAIG MUNDIE: Our general view is, at the rate at which the— you could say the size, weight, and battery life are increasing in the mainline PC capability— you know, the netbook phenomenon, as Steve talked about it, is driving the industry to create two classes of computers— you know, one that is essentially sort of thin, light, and perhaps not capable of doing the super-highest heavy lifting in computing, but the book reader may fall into that category.

One of the things we've often asked ourselves is, as a stand-alone, dedicated device, you know, and if it turned out you had a full PC capability whose ergonomics weren't substantially different than what you get out of the book reader, would it essentially flip over and people say, "Look, I do the book reading on either the Tablet version or some super-thin flip-around version of a PC"?

So I think one of the reasons we hesitate to jump in and say that's a specialty category that makes the same grade as the other three screens where we have a Microsoft SKU strategy is we can support them all today if they emerge using the embedded toolkits. And we still always have the option of taking those services and putting them on full PCs. We're pretty optimistic about the decline in cost, size, and improved battery life for the PC itself.

BILL KOEFOED: Who has the next question? Paddle two again.

QUESTION: The "Project Natal" obviously is really, really cool. I'm interested, going forward. There are a lot of changes going on in terms of the types of silicon that Intel and EDM are producing. And it occurs to me that "Project Natal" looks like it's really laser-focused, the type of vector computing and stream processing, as AMD calls it. Does Microsoft see that kind of processor being more or less prominent than it has in the past?

CRAIG MUNDIE: The way I describe it is, it's called single-instruction, multiple-data-type computing— and it can be done in a variety of ways, vectors and other things— is already very prominent in computers today. They're called GPUs— graphic processing units. And that's how we make the graphics that people see today, whether it's on your TV screen, the Xbox, or the PC.

What's happening is that those architectures are being made more generalized. And so NVIDIA and some of the other companies that have come up from that space have been working with us and even independently to create general-purpose programming tools for those accelerated capabilities. I think the natural situation is that they are going to converge more. And a lot of the work we've done, even in Windows 7, but certainly in the things we would contemplate in the next generation of Windows and the full sort of three-screen product line, is to do that.

If you look at the architecture of Xbox, in each of its generations it had a very big focus on this super-powerful graphics processing capability, because that was part and parcel of the high-quality gaming experience. We think more and more of these things will generally be required. In a demo that I gave, the idea of doing machine learning, machine vision, voice synthesis, voice recognition, and ultimately high-quality robotic presentation of images— every one of those is essentially a compute-intensive task and will be acceleratable using those kind of architectures. So, we think they'll be done in different ways, but that's clearly going to be a bigger part of the game in the future.

ROBBIE BACH: Yeah. And just to put it another way, in the next six to 12 months, you know, a normally priced, let's say, mobile phone will do graphics that you would have seen on an original Xbox— full 3-D graphics, accelerated processing. The price/performance is getting to the point where you get some amazing things on small devices.

BILL KOEFOED: Who has the next question? Paddle four.

QUESTION: Thanks a lot. Robbie, on the mobile side, again, to come back there, two questions for you. Since you're starting to see kind of PCs coincide with smartphone technology, MIDs and netbooks, and so on, does it make sense to have a mobile operating system to be part of an end-to-end Windows when you get to Windows 8? What do you think about that?

And then, second question, as 6.5 and 7 come out, clearly one of the weaknesses is, I think, it's supporting too many platforms, so a real inconsistency of the user experience. Is there something you guys can do to focus the SKU count, for example, to stop that inconsistency?

ROBBIE BACH: Well, let me address the second one first, because it's the more immediate question. Part of what I was trying to communicate in my strategy discussion in our work with hardware manufacturers, is that it's not a SKU count problem in the sense that we actually do believe in diversity of phones. I actually like a lot of different styles and types of phones. It is: what is the underlying plumbing and architecture of each of those phones that we have to reduce?

Today there is just a plethora of diversity, much of which has nothing to do with what the user ever experiences. And so the focus with us with our OEM partners has been on really specifying what architectures we want to support, being very specific about what we want in the phones and want in every phone so that our software, instead of being lowest-common-denominator software, can be highest-common-denominator software because we know what's going to be in every device. And you will absolutely see that show up in our devices going forward, and you will start to see consistency in what I will call architecture and plumbing.

Now, from the hardware manufacturers, this is actually a good thing, because it helps their cost base pretty significantly. And there are still tons of ways for them to innovate, so they can innovate on design. They can innovate on keyboards, they can innovate on graphics, they can innovate in a number of ways, so it's a good thing for them.

Our operators actually like it as well because, from a testing perspective, today's mobile environment is a real pain in the neck for them on their network because they have to test all these different configurations. But the core technology is the same. The testing goes faster. Products get to market faster. It's better from a product support perspective. So, all that are things we absolutely are focused on and are driving and already well-engaged with both sets of partners on making that happen.

To your second question, today we actually already share components between what we do in the Windows space and the Windows Mobile space. You're going to see more of that sharing continue over time, and you will see us accelerate that and do more of it as we can. Understand that historically that was tough, because the underlying architectures were actually quite different.

But to Craig's point about GPUs and CPUs and the underlying chip architecture, as those get more similar, it absolutely makes it easier for us to share more. And you'll certainly see that, whether it's work we're doing in a browser, work we're doing on development tools, a number of other places where we will be able to do more of that sharing. That's baked into our plan.

BILL KOEFOED: Great. And we've got time for one final question. Paddle three in the back.

QUESTION: Thank you. I'm with Global Equities Research. I was wondering— a question for Craig. The R&D dollars that you are spending: how do you make sure you are putting in the right opportunities versus choosing the various fads? An example in hand is about a year, year and half, mash-ups were the big thing on the Internet, and today Google has shut down its Google mash-up editor and Microsoft is in the process of shutting down its Popfly tools. So, how do we know that what you show today is a potential real opportunity and not something that will fade away probably next year? Thank you.

CRAIG MUNDIE: Well, in our company, we make a pretty strong distinction between the R and the D. Many people, they say those things like R&D are one thing. And in most companies it is, because they don't really do any R— alright, or very, very little. Bill Gates— 17, 18 years ago— made the decision we were really going to try to do real computer science research.

The research teams do not actually work on short-term activities. They do not take assignments from the business groups to go— you know, "Go think about this one or build this thing up." So we actually have— you know, I tell people my job and the researchers' job is sort of a three- to 20-year horizon. And so many of the technologies that we produce are investigated in order to give us insight as to what the fad may become in the future and how we can either move it ourselves or respond to it if it really emerges.

The decision to productize— that is with the product group. So, the D is fully distributed throughout the different business groups. And, in fact, their value-add, you could say, in this process, is to take many of the assets that we have in research, their own advanced development thinking, and their understanding of the market, and they say, "I'm going to make a product." We don't get them right all the time, but many times we look at things and say, "We have the technology but we don't think the market is going to be all that big," and so we don't actually enter, because we've learned that our real value is when we can do things that really do scale and have a lot of popularity. And so we don't chase every fad. And clearly in the research area, we don't chase fads at all.

ROBBIE BACH: Great. Thanks, guys.

CRAIG MUNDIE: Thanks, everyone. (Applause.)

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