Brad Smith, Senior Vice President, General Counsel and Corporate Secretary, Microsoft Corporation
News Teleconference with European-based Journalists Regarding European Commission Decision
March 24, 2004

PATRICK DE SMEDT: Welcome, everybody, and thank you for joining us here today. My name is Patrick de Smedt and I'm chairman of Microsoft Europe, Middle East and Africa. We also have on the call from Microsoft Horacio Gutierrez, who is the associate general counsel for Microsoft Europe, Middle East, Africa, and also Brad Smith, who is senior vice president, legal and general counsel for Microsoft Corporation.

I'm glad to have this opportunity to provide some thoughts and perspective on the European Commission decision that was announced earlier today here in Brussels. I have a great deal of respect for the Commission, its authority and its process.

As a company, we've worked extremely hard with the Commission over many months to arrive at the positive resolution of this case. During that time, we developed a strong professional and constructive relationship with the Commission services involved and explored the number of potential proposals and settlement options, which contained significant concessions in an effort to address the issues raised by the Commission. In the end, although we had agreed on steps to address all the issues in the current case, the Commission decided to adopt a negative decision.

While we hope to settle, we respect the Commission's decision and we will move forward with the next steps in the process.

Frankly, we remain hopeful that at some point we may be able to resume those discussions and to reach a mutual resolution of these issues.

I would now like to hand over to Brad Smith, who, as I said, is the senior vice president and general counsel, to talk you through our thoughts on the Commission decision.

BRAD SMITH: Thank you, Patrick, and good afternoon, everyone.

I'd like to provide you just a few additional initial perspectives on today's decision and then would be happy to answer questions.

Obviously, we think that today's decision is unfortunate, but we respect the Commission's decision and will now move forward with the next steps in this process. Frankly, as Patrick noted, we remain hopeful that at some point we may be able to resume the kinds of discussions we had last week and perhaps in the future will be able to reach a mutual resolution of these issues.

We do believe that the settlement proposals we made in recent weeks would have gone much further to protect consumer choice and provide greater opportunity for European software developers than the decision announced today by the Commission.

Microsoft made significant concessions in developing proposals that met the Commission's key concerns regarding interoperability and the integration of Media Player functionality into Windows.

Under our proposals, Microsoft would have provided competitors with unprecedented access to our technology to enable and promote even greater interoperability. In addition, every Windows PC would have included three competing media players, an offer that would have led to the distribution of more than 1 billion competing media players over the next three years.

In today's world, a media player is an important part of Windows and other operating systems, and we fully responded to the Commission's concerns by offering to carry competing media players, along with our own, making today's action and decision unnecessary.

In addition, the settlement provisions that we offered would have applied worldwide, as the Commission requested, even though today's decision appears to apply only to the European economic area.

So we think that when people look at the facts, they will realize that the settlement that we proposed was a much better solution for consumers and for the future of our industry than what the Commission has announced today.

There is an important principle at stake in this case. We believe that every company should have the ability to improve its products to meet the needs of consumers. The settlement we proposed would have done so while also preserving our ability to enhance the multimedia capabilities in Windows.

Our research shows that a broad majority of European consumers believe that Windows Media Player should be included with Windows. Similarly, European consumers want greater functionality and greater ease of use, not less.

The European Commission's remedy announced today was not, in our view, likely to provide the potential distribution that the Commission seeks and instead is more likely to punish consumers and developers.

The removal of Windows Media Player-related code, pursuant to the remedy announced today, would break not only the Media Player but other features in Windows, as well as Web sites and third-party applications. We documented this thoroughly before the Commission, so they have had that information available to them, and in our view, even if one installs RealNetworks RealPlayer on top of a version of Windows that has the Media Player code removed, there will still be over 20 features in Windows and in other popular Web sites and applications that simply will not work, and this includes a number, just to give you an example, a number of Web sites that are very well-known across Europe, the Web sites for BSKyB [British Sky Broadcasting], for the Italian parliament, for Swedish Broadcasting and for many others.

As the legal review process now moves forward, we nonetheless remain 100-percent committed to working with our customers, our partners and governments in Europe. We will obviously continue to invest in new technologies that address the needs of people and businesses everywhere and we will continue to work with European governments on a wide variety of issues like security, privacy, education and protecting our children online.

You can rest assured that while we go forward with these legal proceedings we will respect and fully comply with European law, as well as with any orders of the European Court of First Instance.

So with that, let me open it up for questions and I'd be happy to answer and address any point that you'd like to raise.

(Operator direction.)

QUESTION: Hi, Brad. Two things. Thanks for that information. Firstly, what do you mean by resuming discussions? Is this separate to an appeal? And secondly, I've just spoken, come off the line with legal representatives for Sun Microsystems, who say they're laying out their options and legal action is clearly something that [they will pursue ?], and all members, a few others were mentioned, they come to Britain as well on the back of similar cases [off mike] and they're being brought in the [off mike] in the UK.

So firstly, what do you mean by resumption, and secondly, what do you think of legal action?

BRAD SMITH: Well, I'd say a couple things. First, we will go forward and seek legal review of this decision in the European Court of First Instance. We have made that decision. We will need to review the decision carefully, but certainly we will ask the Court of First Instance to stay or suspend at least some of the sanctions that were announced today. I do expect that we'll ask the court to suspend the part of the order that would require us to produce a second version of Windows that has the Media Player code stripped out of it. So we'll ask for that and probably other parts of the remedy to be suspended.

There are no discussions ongoing with the European Commission. I don't expect any in at least the coming weeks.

I do think that it's quite possible that we'll see a scenario play out in Europe similar to what happened in the United States. In the United States we had extensive settlement negotiations in 1999, we worked very hard to try to reach an agreement but ultimately that was not successful. The case went forward to the courts and once the Court of Appeals spoke in 2001 we all benefited from the clarity that that decision provided and then we were able to reach an agreement four months later.

Similarly, I am hopeful that we will get added clarity from the Court of First Instance, perhaps as early as this year, as they address the issue of whether to stay the sanctions. And if we do get the benefit of that clarity, there may well be an opportunity to talk again.

QUESTION: And that's to stay on the sanctions, both the 120 day and the 90 day for the service?

BRAD SMITH: Well, the sanctions take effect in 90 days and 120 days, but our brief will need to be filed in the Court of First Instance in 70 days, so that will happen first. And as we file our brief, I would expect that at that date or very shortly thereafter we would file the request for the court to stay the sanctions.

QUESTION: On both the server and the Media Player, yeah.

BRAD SMITH: In all probability. We really need to read the decision to know precisely what we'll ask the court to suspend, but I do expect that we will ask the court to suspend sanctions in both areas.

With respect to what this means for other cases in other courts, personally I think that's going to turn on what the Court of First Instance says. If the Court of First Instance issues a decision that affirms our interpretation of the law, then I would expect that that would be obviously beneficial to our interests and any other potential cases.

So I think at the end of the day the European Commission has the first word but the European courts have the final word, and the final word is going to carry the day.

QUESTION: So that could be how long away?

BRAD SMITH: Well, unless this case does settle at some stage, I would anticipate that this case has another four or five years of litigation ahead of it.

(Operator direction.)

QUESTION: Hi, Brad. I was wondering if you could tell me a little bit more about the surveys that you said that you've done, saying a broad majority of European consumers think that WMP should be included with Windows, and whether you can tell us a bit more about how those features in things like the Italian parliament, BSkyB and Swedish broadcasting don't work?

BRAD SMITH: Sure, Dan.

I think, like every large company, we periodically survey our customers to get a sense of what they expect from us in our products and other things that we do, and we've done that again recently. And while I wouldn't want to get into the specifics, one thing did come through loud and clear, which is that consumers expect a media player to be part of an operating system. They recognize that the reality today is that computers are designed for multimedia functionality and an operating system needs to be designed to make that functionality work well. So we've gotten feedback loud and clear that consumers do want to see media players in an operating system.

If you look at then, if you compare, for example, what we offered last week in settlements to what the commission is doing today, you see a clear dichotomy. What we offered last week was a solution that would have preserved the media- playing capabilities in Windows while also ensuring that 300 million competing media players would be shipped to consumers each and every year. That was a solution that would have given consumers more choice and better value for their Euro.

The solution that the Commission has proposed today really takes the opposite effect. It tries to take value out of the Windows operating system, even while it's telling us, in effect, to continue to deliver both of these products at the same price. So this is a path that gives consumers less value for their Euro rather than more.

Your second question, Dan, I'm forgetting. What was it? Oh, how do the Web sites break?

Well, basically, a lot of Web sites today design their pages so that when you go to the page, the video will simply play in a subset of the screen, so it won't have to launch a separate application. Web site operators prefer that because you can just read the text and click on the video and the video will play or may even play automatically when you go to that Web page. Certainly, if someone were to use this new software that the Commission has ordered us to create, if you went to that Web page, these features would not function properly. And so that is one aspect of this.

A second thing that would, in effect, break is software applications that rely on the Media Player code in Windows. There are a number of European software developers that have created applications that call on this code in Windows. And so if one were to use their application and use it on a PC with this new version of software that the Commission has ordered us to create, their products would not work properly. A good example is other media players that call on Media Player code in Windows. There's a company called Terra Lycos that has its Sonique media player. That media player won't work properly if it's used on a computer that has this new operating system that the Commission has ordered us to create.

There are other features in Windows that will not work properly. If you get a new PC and you open it up out of the box today, what you'll find is that there's voice narration that explains to people how to use the computer and how to use Windows. That won't work on the kind of operating system that the Commission has ordered us to create.

We build a number of features into Windows to make computers easier for people who are visually impaired or who are deaf or who are hearing impaired. Some of those features won't work. For example, we've created a feature in Windows that enables closed-captioned text to appear on the screen for people who are hearing impaired. Even if you take the version of Windows that the Commission is ordering us to create and you add the RealPlayer in the kind of demo that Real Networks has been doing for a number of you, that feature won't work.

So in short, there are a number of technologies and third-party Web sites and applications that rely on Media Player code being in the product, and in effect what the Commission is doing is not only freezing the operating system where it exists today, but it's taking the consumer experience backwards by breaking important features that meet the critical needs of a number of important groups of consumers.

(Operator direction.)

QUESTION: Hi, Brad. The question I have is you said that in everything that you feel like this certainly appears to be affected only in Europe. I'm just kind of wondering if you are looking for more guidance on that or why you said "appeared" only in Europe.

BRAD SMITH: Well, good questions, Allison.

The text itself in the part of the negative decision that we have received, and we've only received a small part of it so far, does not explicitly refer to any particular geographic area. And Commissioner Monti noted in his press conference that the text does not explicitly refer to any worldwide scope. He then said in the press conference that it was confined to the European economic area. So based on his comments, we are interpreting this as requiring us to make available this new version of software only in the European economic area.

That having been said, we'll definitely want to talk to the Commission to make sure that we're understanding this correctly, and we're not basing this on any misinterpretation or possible miscommunication.

I will say that even if we are required only to make available this software in the European economic area, it's obvious to everybody that given the global nature of the Internet, software crosses borders all the time. And so one of the things that concerns us is the risk of consumer confusion. And that's a risk that I think we have to recognize applies not only in the European economic area but anywhere that this software could move to and software moves across borders every day.

(Operator direction.)

QUESTION: Hi. Good afternoon. I'd like to understand, because you said that during your proposition to settle the case, you offered a possibility to include three media players in Windows. So, OK, but did you offer any possibility that in the future for any new feature that you could provide and include in Windows that you could add competing products if those competing products have been existed at this time or was your probable settlement only focused on the Media Player software?

BRAD SMITH: The proposals that we discussed last week were focused only on Media Player, but that's because there's only one issue in this case and that's Media Player. The Commission's decision today applies to only one product or feature and that's Media Player technology in Windows. The Commission's decision today does not apply any more broadly than that. And I believe that when we have the full text of the Commission's decision, we'll see that the Commission's decision in all of its reasoning really applies only to Media Player as well.

I do think it's ironic that we were told last week that the Commission could not settle because it needed to set a precedent and yet we heard today that the Commission is not breaking any new legal grounds. We also heard today that the Commission's decision does not apply more broadly than Media Player itself.

Given all of that, it is just crystal clear to us that it would have been far more productive to reach an agreement last week. That agreement would have taken effect immediately rather than four or five years from now. We would have had a clear understanding about what to do with respect to Media Player. We would have started a process to make available 300 million competing media players to consumers every year. We would have offered consumers more value rather than less. And we would have avoided all of the legal uncertainty that will apply not only to us but to our industry, to consumers and even for governments itself, because the reality is none of us now are really going to get the kind of clarity that people say they need until the European courts have spoke and that is the process that easily could last four or five years. So instead of getting immediate action in 2004, we are now on a path to get a result in 2009.

(Operator direction.)

QUESTION: I just wanted to ask something about the issue of sharing out your computer programming information. Do you consider that this ruling is effective compulsory licensing and would it be on those grounds that you would challenge the decision?

BRAD SMITH: Certainly an important part of the basis on which we will seek legal review is based on our firm belief that the Commission today is ordering the broadest compulsory licensing of intellectual property rights since the European Community was founded more than 50 years ago. And this applies in both parts of the case.

The Commission order with respect to interoperability clearly amounts to a broad compulsory license of our copyrights, our patent rights and our trade-secret rights. And one of the bases on which we'll ask the Court of First Instance to suspend these sanctions is because you cannot require someone to license something out and then pull it back later if the company wins on appeal, and for that reason we think there's a very good probability that an objective, fair-minded reviewer of this would conclude that that sanction should be postponed until it can be reviewed completely by the courts.

But it's also, I think, critical to recognize that the code-removal remedy, the creation of this second version of Windows, is also a very broad compulsory license in and of itself in many, many respects. I'll give you one, which is the Windows trademark. The whole purpose of a trademark under European law, as well as the law elsewhere, is to ensure that consumers are able to associate a particular trademark name with particular features of a product and a particular quality standard for a product. Whatever the Commission is ordering us to produce today in terms of a new operating system, it is not Windows. Windows today is a state-of-the-art operating system designed for state-of-the-art PCs. By definition, that includes the full range of multimedia capabilities that a PC offers to consumers.

It amounts to a compulsory license of the Windows trademark to order us to apply that branded and legally protected name to a product that lacks the characteristics and lacks the quality of the Windows product that we offer on the market today.

Similarly, the code removal remedy operates as a broad compulsory license of our copyrights. Our copyright gives to us, just as it gives to every other copyright holder in the European Union, the exclusive right to create adaptations or derivative works. And what the Commission is doing today is seeking a compulsory license and deciding for itself what kinds of derivative works are going to be created.

So both with respect to trademark and with respect to copyright, we believe that this operates as a compulsory license of our intellectual property rights in Europe. We believe that that will infringe our IP rights in Europe and it also violates the European Union's international treaty obligations pursuant to its membership in the WTO or World Trade Organization. And so we will argue that this not only goes far too far and runs afoul of European law; it also runs afoul of the European Commission's obligations to respect the WTO's TRIPS agreement or agreement on Trade Related Aspects of Intellectual Property Rights.

(Operator direction.)

QUESTION: What do you say to criticism that Microsoft in developing products like Media Player have not innovated? And this is a clear point that Mario Monti was making today. In his belief, he is safeguarding innovation. And the criticism runs that Microsoft in innovating has simply taken other company's products and then basically given them away as part of Windows, thus stopping them from being able to compete fairly.

BRAD SMITH: Well, I think there are a few facts worth noting. First, Microsoft was the first company to innovate by adding multimedia capabilities into the operating system, or at a minimum you would say that Microsoft and Apple were basically doing this at the same time in the early 1990s.

We recognized very early on that there was the opportunity to make computers much more useful for people in their homes if we could make them more robust multimedia appliances. And so we started innovating in this space long before there was a company called RealNetworks or any other offering, something that was considered to be a stand-alone media player. We started early, and we've kept at it in a very sustained way.

Each and every year we have brought to the market new technologies that have made the personal computer each year a better and better multimedia appliance for people in their homes. In fact, if you just think about the way you might use a PC yourself at home, or your acquaintances, so much of what they use a PC for involves multimedia capabilities in one way or another.

And after there appeared media players in the mid '90s, we continued to innovate. And if you look at our success, if you look at the popularity of our Media Player product, I think you would find that the popularity of its usage correlates more closely than anything else to the product reviews of the Media Player product. If you read the product reviews and you see the number of times in which journalists are saying that we offer the highest quality media player on the market today, I think you'll see that that's probably the single best explanation for the popularity and widespread usage of our media technology.

All that having been said, this has not for a moment stopped other companies from improving multimedia technology, it has not for a moment stopped other companies from distributing their media player software very widely. RealNetworks says today that it has over 300 million users of its software in the world. I think people have to stop and ask themselves if we are living in an environment where we're able to make the operating system better, if we're able to improve the technology ourselves, if other people are able to do so as well, if they are able to distribute their software each year to hundreds of millions of people, then why is this type of action necessary.

And if any action is necessary at all, wouldn't it have been far better to allow innovation to go forward in a manner that would have involved the distribution to consumers of additional media players, rather than taking the kind of step today that seeks to freeze technology, hobble the operating system and provide consumers with less value for their Euro rather than more.

(Operator direction.)

QUESTION: My question is, is this decision by the Commission a threat to Microsoft's long-term strategy in the sense that you keep adding advanced functions like Media Player, as you have done previously?

BRAD SMITH: I think that today's decision is a setback not only for Microsoft but ultimately for our entire industry and especially for consumers, because it reflects a decision by an important governmental body to try to step into the marketplace and solve an issue that concerns it, not by making it easier for other people to get their products to consumers but by trying to restrict the innovations themselves. And we think that's an unwarranted and ill-considered step.

As we've said, if the Commission felt it was necessary to take action, it would have been far better to pursue a path that would have had immediate effect and offered consumers more media players, rather than a step that in effect requires us to produce a second version of our software, take features out of it, reduce its quality, and yet will make it available at the same price as the full-featured version that works well, given the terms of the Commission's decision today, which in effect will require that both products be made available at the same price.

(Operator direction.)

QUESTION: Yeah, hi, Brad. My question is, will the decision of the Commission have any influence of the roadmap of Microsoft in the development of the Longhorn version of Windows or will Redmond go on like business as usual?

BRAD SMITH: Well, I don't think there's -- I think business as usual already involves very careful legal review and very careful legal analysis. So we've had our lawyers working with the product development teams and we feel that the kinds of innovation that we are making in Longhorn are demonstrably innovations that will bring important benefits to consumers. They are also innovations that will ensure that there continues to be competition on the merits, they will also ensure that competitors continue to have the kinds of very broad opportunities they should have to build on top of our technology and to provide their software to consumers as well.

We'll obviously continue to give careful legal advice to our product development teams. But as Commissioner Monti noted today, the Commission is in effect applying a rule of reason test. We'll need to read the decision to understand it carefully. But I would expect that we'll, of course, take due account of all of the Commission's statements, we'll continue to give careful legal advice, but based on the work that we've done so far, it's our sense that the kinds of innovations that we have planned and shared with many of you for Longhorn are innovations that pass muster under European law, as well as the law elsewhere in the world.