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Executives

Yusuf Mehdi - Corporate Vice President, IEB Marketing and Strategy

Analysts

Walter Pritchard - Citigroup

Microsoft Corporation (MSFT) Citi Global Technology Conference September 3, 2013 3:50 PM ET

Walter Pritchard - Citigroup

I am Walter Pritchard the software analyst here at Citi. I have Yusuf Mehdi he is the Corporate Vice President of the Interactive Entertainment Business, which is I think for the best part, specifically around marketing and strategy. We are probably not going to discuss much the Nokia transaction. I know that’s hot on everybody’s mind and obviously was announced this morning kind of, we had the whole line up here ranged before that. So I don’t want to disappoint anybody but I want to make sure we have that expectation.

Before we get going I will just kind of read the Safe Harbor statement. Microsoft would like to remind you that this presentation contains forward-looking statements, which are any projections, predictions and other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties.

Actual results could materially differ because of factors discussed in this presentation and in the risk factor section of Microsoft’s Form 10-K, Form 10-Q, and other reports and filings with the Securities and Exchange Commission. Microsoft does not undertake any duty to update any forward-looking statement.

Yusuf Mehdi

Well said.

Walter Pritchard - Citigroup

I have practice. Okay, go ahead, have a sit. So again, thanks for coming out. I guess it’s been a pretty busy several months for you in the Xbox world, we would love to just get an update on where we are, you know the console's November 18th is the day or November…

Yusuf Mehdi

We haven't, we are going to announce it.

Walter Pritchard - Citigroup

Okay. So I wasn’t trying to squeeze it out of you, I know that’s over the world, and I guess could just give us an update on where things are and what we should look at specifically as investors as we get in that console one cycle and beyond?

Yusuf Mehdi

Sure. Yeah, there is lot of talk back in yeah, in the short summer and then [inaudible]. In terms of just Xbox One's going, we’re on track for launch the November. We will announce the launch date shortly. We recently just went into full production. We are now producing in mass the Xbox One console.

We had a real good progress on the system, in fact we just updated the CPU performance, to 1.5 megahertz on top of the graphic…

Walter Pritchard - Citigroup

Gigahertz.

Yusuf Mehdi

Gigahertz, sorry, on top of the graphic performance improvement, so the system is really going to shine, the games on that system look pretty incredible. We had a bunch of trade shows that we have come and seen them in, and we had the best line up of any console game.

On the game side that was probably very good. From a market demand perspective we’ve been sold out on pre-orders of Xbox for couple of weeks now. It is -- we’ve built more than we’ve built for an Xbox launch. We are on track to have the biggest launch we've ever done by a wide margin for console…

Walter Pritchard - Citigroup

Most units shipped.

Yusuf Mehdi

Most units shipped at launch and I expect there will be multiple millions of people enjoying Xbox through the holiday as we get to the holiday.

So feeling very good about the progress still lot of work but we are feeling pretty good about it.

Walter Pritchard – Citigroup

Okay, great. And may be if you could step back and talk about this broader, there is a lot of debate, and we have been engaged in some of this debate around does Microsoft need to be in the consumer business and [inaudible] but there is a, I think there is a lot of debate around the living room, and how important is the living room, which devices are converging into living room? Could you talk about what Microsoft is looking accomplish in the way they are coming out with Xbox One?

Yusuf Mehdi

Sure, yeah. I mean a couple of things. The vision for Microsoft is a family of devices and services that target high value customer needs for consumers. And we talk about there is also for gaming we talk about [serious] point. So if you talk about my teenage boy, his point is that he can finish that Assassin's Creed and that’s a serious point. And for other people that's enjoying that movie that they want to watch on the night that it's opening up.

So we are trying to, with Xbox One, we are trying to provide a central device in your living room that can for the first time unify all forms of entertainment in with one simple to use effort. Today you have got family game consoles, you’ve got streamers that can stream movies on-demand. And then you have got things that will pull out your tablets and…

Well this pulls all that together and does Live TV and the vision of Xbox One is not to unify it but then allow literally with your voice to control your television. So you can basically say change ESPN, snap my fantasy team next to the game. And that what you will able to do with Xbox One.

It becomes, you think about the [fold over] smartphones that were in regular times and then a smartphone command you say wow this is mobile computing device and we think that TV’s are going to truly become smart TVs. So you can browse you can do Skype communications you can do interact that television, Xbox One is opening up an entire world of next generation entertainment.

Walter Pritchard - Citigroup

Got it. I want to return and talk a bit about that scenario in a minute. Just next one to talk a bit about, I love to just point them out and you can still in the years numbers and I know you won’t do that so I guess would just like to talk a bit about sort of how we should be thinking about, it’s been what eight years seven years since you have been console, so a lot in the world had changed since then, obviously the world is, there are more people, there is more TVs there is more Big TVs so it’s about, in a sense should help the cycle.

On the other hand I think there's the onsite we import of the game console in our house in a couple of years, but it's got different tablets and they are notes to games on. And so is the console market that you were going to write seven or eight ago at launch, is it smaller than it was seven or eight years ago, how should we just at a high level we think about that?

Yusuf Mehdi

Yeah, we put the [inaudible] and you can even go and see them on our site but there is, basically one account for all five generations of consoles every generation of consoles has been bigger than the last. So if you take that last three you have a 100 million units, 200 million, this generation is 300 million units.

We think the next generation will be bigger than that. We see it in all the -- research we do we see it in all the talk about the industry. The world for gaming is growing. It's the fastest growing segment of all of entertainment in terms of our views as well as dollars spend. And we think that that is going to continue grow in this generation.

If you look at it just as a standalone game console, Xbox One's pretty unique relative to the rest of our competition because it's a game console, A and it's the number one entertainment service. So we think that potentially broadens the market even beyond what you might expect for the next this next generation.

Walter Pritchard - Citigroup

We think console gaming is actually bigger, like I said I agree that gaming for sure is bigger, the console gaming.

Yusuf Mehdi

Console gaming for sure has been bigger every successive generation and we see it in all the customer research we do, we talk to thousands of customers in the analysis of who wants to buy. And we see a bigger growth in this market, which is 300 million to-date for this generation.

Walter Pritchard - Citigroup

Got it and did you make -- I guess we are trying to get a sense of with all of these different functionalities converging on the Xbox One, mainly this sort of TV viewing experience the media consumer experience with the gaming experience, does your research suggest that people will buy this product for all features other than gaming or is it 90% 95% of people who will buy that gaming console.

Yusuf Mehdi

Clearly in the beginning, it is primarily gaming console and that's going to be the primary buyer. In all the research we have seen there will be tens of millions of buyers in the first year and in the research we do over 90% of them are owned and existing consoles. So I think there is going to be supply constraints in the beginning and I think all of those purchases are going to be gamers. And I think the value prop for the game is incredibly clear. I think the entertainment value prop we are [tonight], things like the NFL unique on our box, interactive NFL ability to do some other kind of interactive television shows we are working on. But predominantly it is primarily focused on being an incredible gaming device in the first version.

Walter Pritchard - Citigroup

Got it and you alluded to sort of the content with NFL. In terms of just various other eco-system players in this world you have the cable companies, you have the, I think at this point the TV is somewhat of a commodity it doesn’t matter what TV you have. But the cable company being the mains sort of player there's been lots in the press about lot of other tech companies trying to come to market with a box that fits under the TV and not being able to figure out how to deal with the content problem with cable.

How does like Xbox One give us that and is the position of that player eco-system change at all with this new generation of boxes?

Yusuf Mehdi

It will change some, now historically we had the number of relationships with the cable and the TV providers. And they provide their apps on our platforms. So you can get on demand movies and in some cases get live TV. For example we just announced last week that Time Warner Cable is bringing their live television channel for the Xbox. So now you can buy an Xbox and get live television channels through Time Warner Cable.

Walter Pritchard - Citigroup

So it’s through the cable boxes or really what?

Yusuf Mehdi

Well the way that we think about it we want to work with an eco-system. So we are partner fairly we are not taking position on cable box or not. But Xbox One will work great with your Set-top box. You literally can just with one ATMI cable plug in and now have live TV.

So our model is to be partner friendly and to work with the operator and to add value on top and that’s we are -- and the value on top that we added interactivity, voice control, new generation of content, gestures with the connect that is a big part of our differentiation.

Walter Pritchard - Citigroup

Is there any business model difference there? I mean I’m assuming I am still going to pay Comcast way too much for a subscription that I can plug into my Xbox in the Microsoft interface with it in new ways? Is that -- are there economics in terms of your relationships with them that maybe different than what we’ve been used to in the past?

Yusuf Mehdi

Nothing has significantly changed. We don’t comment a lot on the relations that we have with the cable companies. We got mutually beneficial relations with them. But like Xbox One, we’re not changing that dynamic a lot, we’re going to continue to work to be great distributors of their content.

We’re also as I said going to make it easy to get their content on live TV now on Xbox One. And over time, we think we can create new opportunities with the interactivity but that’s probably further down the line.

Walter Pritchard - Citigroup

Okay. And then sort of a similar question and not to go too far off on a tangent but you did mention the NFL.

Yusuf Mehdi

Yeah.

Walter Pritchard - Citigroup

And I think you could probably become almost a content aggregator yourself and sign deals with the NFL and other sort of very sought after very, sort of fortunes of the content stream to the point that somebody sort of looks at that boxes as providing them a cable service. What’s the thinking there from a strategic perspective about how much of a content aggregation role the company will play versus bringing something like NFL that’s just kind of a nice headline that grabs some attention?

Yusuf Mehdi

Yeah. So the way we think of it is I think twofold. So the first is that I would say today we are a great content distributor for our partners, NFL, NBTV, other content companies that you think like HBO GO. We’re a fantastic service for those people who want to distribute and aiming for the game provider to sell games and don't what to sell, people want to sell to the team add on. We’re a great provider for that capability.

But in addition, our focus is to kind of go beyond, to do some differentiated things with interactive. And so what we’re doing with NFL, that deal is primarily about two things. One is about getting to an interactive version of NFL and that’s we work together to try and get, for example your fantasy team live and you are watching the television and be able to see the stats, scores, live updates and then to make that much different on the TV where you have to go to separate device.

And then to work with them on the field, using our surface technology to help better map the plays that are going on. Today NFL uses [paper] to see replays. We’re going to work with them on tablets so that you can see instant replays live on video.

And so it’s about the technical differentiation, not just distribution of content. So that is similar to what we’ve done with the cable companies although something like NFL would be done at a much more granular level, something like Time Warner Cable might be interactive cable guys, something like that would be literally at the field level with plays and with things like that.

Walter Pritchard - Citigroup

Yeah, okay. So on the pricing on Xbox One, I think it was and still sort of in our minds and just in Citi research, $500 is kind of sticker shock, that seems like a lot of money, especially it doesn’t seem like consumer spending has ever returned to where it was in ‘08 and ‘09, how did you think about that pricing? And it's $100 I think more than the previous intro price on the last generation, and what are the chances you price the product too high?

Yusuf Mehdi

Yeah. So the way we think about it, we always thought to price product super competitive in terms of being close to breakeven or low margin so that we can as large distribution as possible. In this version, we made a couple of big bets. We said that there are a lot of low end simple casual game boxes. We wanted to have them to really differentiate and let you plays games and let you play movies. We wanted to bring that.

We wanted to break the barrier of being able to voice control your television. And to do that we added a lot of capability. And so the view we feel is that for our 499, our price point, we think the value that we provide for that is a very good deal. Obviously different people will kind of make their choices but we feel that we’ve done the right balance.

And if you look at either the pre-orders that we’ve been sold out for weeks, or the largest we ever build, or you do price adjusted inflation on say the 360…

Walter Pritchard - Citigroup

Sure.

Yusuf Mehdi

That you look at the price point, it’s actually pretty comparable.

Walter Pritchard - Citigroup

And so, I guess I may be just burned by some of the surface pricing that ended up too high and came down. And I understand there were some potentially structural issues in that market about OEMs of price security and undercut the OEMs. Is this a similar model to the past where you’re sort of making minimal money on hardware upfront and hope to cost reduce in the future and bringing the price down? I’m not asking you, I guess to comment on the profit and pricing, just trying to understand if the strategy the same as it’s been in the past?

Yusuf Mehdi

Yeah. So the strategy will continue which is that we -- as I said, we’re looking to be breakeven or low margin at worse on hardware and then we make money selling additional games, provide service and other capabilities on top. And as we can cost reduce our box as we’ve done with 360 we’ll do that to continue to price reducing debt even more competitive with our offering.

Walter Pritchard – Citigroup

And then if we look at you mentioned at launch and I think it makes sense that the hardcore gamer I mean some of them will pay a $1000 for consoles doesn't matter when you get further into the cycle it does feel like while something like Apple TV hasn’t shipped enormous volume it does seem like there is quite a bit utility in something that small cheap and gives me 60% over 50% over 40% of what I get with an Xbox One.

What is the thinking around and it also expands your footprint for sure into a down market? What are the thoughts about that segment of the market and the potential entry into that market in the future?

Yusuf Mehdi

Well I mean we always look at the market, look at customer feedback to see what we again should be doing I think the 360 continue to price reduce we are down to $199 now on that console which does much, much more than what you would do for example on Apple TV with our smart glass technology where you have to pay extra you choose any device you own of any manufacturer to do interactive things and control the television.

So we feel like we are trying to target that market and we’ll keep watching to see these to go further down for now we see a lot of demand at the market where people want the very best of game experience.

Walter Pritchard – Citigroup

Got it. so I have a tons of questions still but it’s the kind of people here in the room as well so I wanted to just pause for a second if there are any questions we can go ahead and bring a microphone turnaround I think. Here we go, two over here.

Unidentified Analyst

You talked about the, your thought process in terms of the economics going forward kind of the razor and razor blade model. This was talked about previously as well the revenues at least in the division have continued to increase yet the profitability has been volatile it has not shown the same pattern on that we would expect from a razor and razor blade model. So would not know why it happened as it did and why should it be any different in the future that’s an oasis that keeps on being a mirage?

Yusuf Mehdi

Yeah so I think without giving all the details I think you've seen over the years I think constantly consistently focused on profitability and improving sort of year-over-year. It’s hard to break upon and I weren’t going all the details but there are different points in the cycle of when you invest in new hardware for example they have passed on their development cost in desktop, if you look at 360 that’s up unless if you had for seven to eight years and it’s going to go for another three years.

It’s incredibly possible now to tell so some of these things take some time in the launch year in which you invest. And then they play out a bit over time. So without giving all that detail but our focus very much on profitability we’re seeing our Xbox Live subscription service continue to grow up 48 million members now on that platform, obviously with more games than we have done before.

Those are the things I look to say hey we can grow not just top line revenue but also profitability.

Walter Pritchard - Citigroup

Question right there behind him.

Unidentified Analyst

Thanks for the presentation. It seems like Microsoft has clearly put a lot of thought and effort into designing of Xbox One. But as you said most of the buyers in the first year or so will be hardcore gamers to some point and while there has been boys on both sides of the aisle Microsoft and so it seems like that the specs purely from a gaming perspective for this current generation seems very similar.

And I just wonder if that convergence if you will towards a sort of AMD based gaming platform that sort of like a PC, really means that people that will be choosing one instead of having in the past people buying perhaps both especially since they came out in separate years. Wondering if you could just comment on that?

Yusuf Mehdi

Sure, well I think couple of comments on that. First is I do think it’s incredible time for gamer. So one of the things that never happened that we go head to head with a competitor on the console launch. I mean that’s going to bring a lot of energy to the overall gaming market and a lot of focus and attention and I think that’s going to further grow the market.

So I think in general it’s a good time to be a gamer. We feel good about our business within that. Competitively speaking I feel so far, I feel like even much better more complete value prop. We do think that our standard of the platform with a kind of huge piece of differentiation. As I said before the fact that we do entertainment and gaming and then even if you are just a gamer, hard core gamer -- people buy, gamers buy for the game. They don’t buy for step-on it. And if you look at the games we have are kind of most industry expects now a better line of a game, our award that we won at the E-3 game show are bigger than both of our competitors combined with over 111 awards won.

And we’ve some very unique titles which for those of you who are gamers know and for those of you who won’t you should try the Solitaire. But in addition things like Halo, Titan Fall which is the most regard title of the time, of our E-3 but also a bunch of other game titles. So I think competitively speaking we are feeling very optimistic about how we compete even is though it will be a great market in general.

Walter Pritchard - Citigroup

Okay, question in the back.

Unidentified Analyst

From an industry perspective is there a technology hurdle that we do overcome to for IP TV to find a home for dynamic add personalization?

Yusuf Mehdi

Is there a hurdle to find. You know ironically a lot of the hurdles I spend a lot of time with our ad center, ad platforms about five year ago and the hurdles actually don’t ended being technological. The hurdles are actually they ended being more business and cost of doing business.

So what happens a lot with advertisers, and I saw that having spent a lot of time with Bing and Adware until you can make it so simple to buy and take your existing effort and do it at volume even if they are pieces of advertisements that they can deliver better returns, advertisers don’t find it work that extra effort to go do that work. They rather just apply more volume and optimize what they do know today.

So I think we'll at some point get there and I think part of what we have to do is really make it simple to have the reporting to have the ability to create and populate that through a number of systems. And that eight platform that has enough scale to make that worth the time and investment, that's really what I personally believe in the best, to hold back again the game and break through on interactive advertising.

Unidentified Analyst

Okay. And can you, is it fairly premature maybe you mentioned it before I came in the room. But can you talk a little bit about the mobile device space and how that relates to Xbox in terms of the longer term strategy may be that coming out is your analyst day I don’t know.

Yusuf Mehdi

I'll tell you again. Sure we are going to address the Nokia, the whole [buffer] so I think that’s fair game.

The other in the back the question was can you address the how the mobile device plays with Xbox?

So I think a couple of things number one we are absolutely living in a multi-device world. In the research we see -- you think any demographic could take 18 to 34, 80% of the people are on a device while they are watching television a preliminary tablet. And you got guys more than anybody probably experienced the same thing because you are always checking.

So well ADG in terms of our content information. And with that thing out I will tell you that people are actually searching for information on the show they are looking for additional details when there is a break they wanted to just among the information whether you are sport junkie and you are looking for stats.

We’ve seen that and our approach to that is a couple fold. One is unlike others who say hey we are going to build a dedicated companion device, a new device that’s another $100 of our hardware device for gaming and accessories, we've built a software approach that’s call extra smart class that lets you take any device you own whether it’s from Microsoft and a windows phone which we prefer or an iPhone or an Android phone.

And you can download smart class and use that device to now control your television to be able to be view interactive content. If you are watching a movie we can stream content to that device. And so we want to really get after and tackle we see consumer today which is a disjoint out gaming experience and living there.

Now clearly with Windows phone we plan to build a best experience of cost when I think we’ll differentiate on that because we care a lot about it because the Windows operating system will run on your phone and on your television and you can use things like snap you can use things like the movies video experience more seamlessly integrated.

And so we are going to build some great scenarios and we do think it’s a critical control. Because sometimes it is nice to control your TV with your voice and sometimes the kid's just sleeping you don’t want to be yelling to TV. So it would be nice that you don’t have to hunt for the remote you can pull out your phone and just with the phone control the TV that will do those sense of scenario.

Unidentified Analyst

So we will be seeing advertising to that effect sometime in the next few months?

Yusuf Mehdi

When you say advertising what do you mean?

Unidentified Analyst

I mean integrating the functionality of a Windows-based phone or tablet with your Xbox or the TV?

Yusuf Mehdi

Yes I think we do some of that today with Xbox 360 already. And there I think are multiple different scenarios of how advertising works. A couple of examples we have talked about in the past with 360 has been where you are watching a football game and that comes up for Domino’s and you say I am hungry. One of the things you could do is the simplest thing just send the URL of that ad to your tablet and if you could just repopulate an order right there.

So there are different scenarios of how you could integrate things where they don’t interact with the television or they make it more enhanced that are dong, are being done today. And I think we’ll see that more of that over time.

Walter Pritchard – Citigroup

Any questions out there?

Unidentified Analyst

Hello, so thank you. What’s been in the works for your Xbox console in the works for quite a while but we had this major re-org at Microsoft and has anything changed in what you are doing or your focus with this, the larger changes at Microsoft?

Yusuf Mehdi

It's sort of, I think the answer is sort of little bit of yes or no. No in the sense that we are kind of in the fourth quarter shipping Xbox One out the door we had a meet with Steve Ballmer about three, four weeks ago. And he said hey you full steam ahead if there are any issues with the re-org that you think will hamper it let me know right now because there is no excuses for you guys doing your jobs and doing it well.

So in classic form and so we said okay let’s go through what we need to make sure that we deliver. And so we are full steam ahead. And in that respect myself and the collective leadership team on Xbox and the development teams are completely focused on that. And so we are full steam ahead and feel good about that.

Longer term of course we are thinking about hey, how do we start get more synergy between all our efforts. And so question on the phone is just one of many for example about how are we thinking about, how these two products come together, how does the operating system get more main streamed. So some of that we are having the national conversation which I think are fantastic because that’s allowing us to re-pivot that and really think about a broader family of devices versus each individual.

Unidentified Analyst

Can you talk about the role of first party content is I mean you now have the obviously when the Xbox originally came out Halo was sort of the reason to buy it. And now you have library games, third-party games got other reasons to buy it. The investment that Microsoft has put in first party content actually doesn’t seem like it’s pulled back and it’s actually doing now like a Halo TV show.

What is now the role of first party content is it, is this an area that the company is potentially sort of over investing and it doesn’t need to spend as much as it is?

Yusuf Mehdi

Well I think for us the role of first party content is kind of multiple fold. One is absolutely to be a profit driver. So Halo for example is a great profitable enterprise for us but it’s also to help showcase the platform. And so one of the things that we can do with our first party is we can ask them and say hey we would like you to re-showcase connect. We would like you to showcase how the future of interactive TV might look. And so but still some shows but still from entertainment and games that differentiate that.

And so our first party studio has a tough job because they are trying to both do something that you might not do when you are trying to just maximize some profits. And at the same time they are pioneering for the greater good because then can flow through the rest of our platforms our Xbox Live service.

So we are, we got here a great studio and our expanded studios for game. And recently started an entertainment studio down in California and they are the team that doing NFL work, there are also as we announced they’re going to do a movie with Halo. And so those are two of the projects and we will hear more about the projects as we go forward.

Walter Pritchard - Citigroup

Another question here.

Just keep ongoing. I am curious a little bit about the decision whether to build to outsource and just a little bit of your thoughts around the development of the hardware.

Yusuf Mehdi

Yeah, in terms of whether we would build or outsource the hardware?

Walter Pritchard - Citigroup

Right, little bit around the decision and then would that change over time just how you look at that?

Yusuf Mehdi

Sure, one of the things I think that we have seen over time we have been break it’s in the shareholder letter. And the news of today should make it clear. We are very convinced on being a company that excellent in devices and consumer services. And one of the things that we’ve learned really well Xbox not going back for number of years as that you can really build some breakthrough products when you could bring the software and the silicon design and the hardware design together.

And we’ve seen it a lot because there are tradeoffs that you make in terms of say the software that taxes the power supply or the heat factor in how you design a box and being able to have that together, you get efficiencies and you’re able to build some breakthrough experiences. And so we’re full steam ahead if anything, we have some of the best hardware designers and pioneers in Xbox now and at Microsoft.

I’ve seen some other work that we’re doing we haven’t talked about yet, it’s really going to payoff for us now, so really have that software, hardware coming together. I see us only continue to invest in that regard.

Walter Pritchard - Citigroup

Question over here?

Unidentified Analyst

What role do you think gaming as a service will play going forward?

Walter Pritchard - Citigroup

Yeah, so gaming, I think gaming will do a couple of things as a service. I think first of all, games are as I said; it’s actually one of the fastest growing sources of entertainment content in the world. So if you look at movies, television, music, gaming is growing faster than any of those in the entertainment space in terms of the revenue and usage perspective.

Second of all, the gaming market today depends on how you connect the 11 billion to 12 billion of profit, about 4 billion to 5 billion is console gaming, you’ve got a couple of billion in casual gaming and then you’ve got a couple companies in Korea, in Japan, in China that their own unique things.

But when you look at those, it’s a pretty big and growing profitable business. We’re going to continue to invest in gaming to grow it, because we think it’s such a great business that consumers want more and more of and we think it can drive a profitable business for Microsoft. We also think that it’s a thing that will differentiate our hardware, and not just Xbox but over time, phones and tablets. We think that we can bring unique games and unique experiences that will differentiate our hardware as a result.

Unidentified Analyst

(Inaudible Question).

Yusuf Mehdi

Okay. So, for people there, the question was on cloud gaming. We definitely are a believer in digital and digital games and some of the excitement from the summer, post Q3 we have had a lot of questions about our vision for digital. I think we’re a pioneer in thinking about digital. There is a lot of benefits for the digital system. Let me talk about that before I hit the cloud.

So some of the questions for example that came up that why digital games, why not disk spacing? Our view is that what happened to movies and music and it’s happening to casual games on phones and tablets is going to full games, which is that five years ago you drive down the blockbuster, burn a DVD, drive home, stick it in and watch the movie. And now, you just turn your TV on, check the digital library and stream the movie and maybe you may subscribe to it you may need to pay for it. That’s the benefit of digital.

You can roam through a device and you can still have the content. That’s the vision we have for Xbox One for full game. And we are delivering a big chunk of that on day one, specifically you can now buy any of the game that we ship day in digitally through the store, you can go your friend’s house, login with your ID and have him connect with your entire games library.

So our digital vision has never changed, never wavered from what we announced at E-3. What we did do is we added back some capabilities, which is the ability to disk spacing. So, if you still want to have disk spacing, which as I can just loan it to my friend and he can use it, you can do that too.

Cloud gaming is another implementation on top of that digital platform. We think cloud gaming is something that’s very exciting, very compelling, but it still feels like it has ways to go technically before we’re, challenges there are latency in particular and then some of the bandwidth.

So you can do game trials and game demos, but to do full game where you’re not at disadvantage to your friend who’s playing locally, and that’s a big barrier if you’re a gamer. That is still going to take a bit time technically. So, I’d say I’m long term bullish, but short term, I it needs more work.

Walter Pritchard - Citigroup

Yusuf, for the first time you don’t have backward compatibility of games, you have to buy a brand new game for Xbox One. So maybe you can help us understand what are the reasons for that.

Yusuf Mehdi

Sure. I think the biggest challenge of backward comparability was primarily the fact that on the game itself the architecture of the Xbox One is so different. And so, it really was impossible to make a simple way to have all those games work in a backward compatible way. I think you’ve seen the same thing from other players as well in the industry. That’s the thing we wrestled with.

We do care a lot about the investments that consumers have made in their Xbox. Something we’re going to carry forward through Xbox Live service carries over Xbox One. So, one service works across both devices, you don’t have to buy any one. And obviously as you start to get the games that are digital, both will work across devices.

But there is a challenge with getting the backward compatibility ---

Right down there is just a challenge was getting to back with compatibility and all that. One of thing we are going to do try and help ameliorate some of the challenges we are going to continue to invest in Xbox 360 and the two devices can work in concert. So it is just like the day we shipped Xbox one your 360 won't work we will continue to support it. In fact we are going to shift over a 100 new games on Xbox 360. So you will be able to still play your games just not on the same exact box.

Walter Pritchard - Citigroup

Yusuf on getting to the first party discussion, and you know I think we were a bit surprised at the surface launch you know surface RT and then surface I guess less relevant for pro. That there wasn’t a given the off-set from the studio there wasn’t a Halo surface to make up an amp.

Can you talk about sort of how that worked and how that may work going forward and are there incentives to I guess was your mandate and are there incentives to substantially use to help the first party content on these devices that’s clearly the Microsoft Office experience on surface to the extent that they did sell I think that was one reason why they did sell.

Yusuf Mehdi

Yeah correct. No we absolutely don't want to do that. Now I think that’s part of that’s absolutely part of that vision going forward it’s to see more of our entertainment assets show up on the surface and games and entertainment and differentiate the device then in compelling ways.

I think for the original launch it's just an issue of timing, the timing didn’t line up. But our strategy going forward is to build more and you saw some of the things we did with windows phone. We did a recent promotion of Halo -- we brought that game to phone and tablet.

And partnered with Verizon to differentiate a little bit at launch. You saw a little bit of that earlier in the summer and even to see a lot more of that as we go forward.

Walter Pritchard - Citigroup

Okay. And then on Xbox Live should we think about the attach rate of the paid live subscriptions increasing they increased from original Xbox to Xbox 360 the increase to the life time of the console as you add in more value. I mean is it something as we look forward in our modeling that we should see that continued increase and attach rate around Xbox Live although we had at some sort of point there should be a periodical maximum here that we can go above it.

Yusuf Mehdi

It’s hard to say I mean that from our perspective we are going to we are really focused on doing it an amazing Xbox like goal. It’s been a huge success and really, people really sought after we are putting more and more value into it. One of the things we announced this summer is our [inaudible] games and goals what we give away three games that exactly keeping -- discussion we are doing a two month.

And these are big game including the Assassin's Creed and then earlier version of Halo. So we are going to continue to invest in that we’ve seen a lot of demand. Our Live usage now is up to, the average Xbox Live user in the U.S. Xbox Live Gold user in the U.S. averages 87 hours a month. So we are talking three hours a day of usage. And people are really into that and that’s for gaming and for few mean of movies.

As we bring on live TV and we add additional capabilities so you we never have to be away from it we think that the hours usage can been drive up and I think that value prop is going to pull that broader audience.

Walter Pritchard - Citigroup

And then around you said it’s related to Xbox Live we saw in the last quarter CapEx really for the overall company really spiked up. And I know there is a variety of services being built out across the company from when the services supporting windows all the way down to Xbox Live.

Can you talk about the capital intensive, capital intensiveness of new Xbox one on the service side versus what you’ve seen in the past with the 360? Our understanding is with Window 8 that one the search volumes have been driven by that platform versus when Window 8. Is there anything like that in the new Xbox?

Yusuf Mehdi

Yeah there is and that’s one of the great things about the opportunity about now just with this recent re-organization we are able to kind of more unify effort. One of the things we are doing with Xbox One is we are really passing into the Agile cloud service we got. And we have about 300,000 servers now that are available for game developers to create their games so that we can do a lot of cloud compute for the gaming.

And the benefit of that is in the past and with other systems what the people do is they do kind of client side hosted boxes. They look in hack sheets that and then cheat to win in gaming. So these servers now if you are a game developer you don’t know how to -- you can’t afford to build out all this service that you don’t know if people are going to use this service. And it explodes you can’t go do now we are allowing people to actually tap the cloud to going use of services.

So that’s 300,000 servers and we talk about Call of Duty now taking revenge of its Titan Fall, not a big gaming effect advantage of it. just a bit a little differentiator for us and it’s going to be valuable things for the company as we leverage all of those servers and the Azure cloud to power our productivity and entertainment services.

Walter Pritchard - Citigroup

You don’t actually monetize it directly you monetize it through better games.

Yusuf Mehdi

Correct

Walter Pritchard - Citigroup

Okay, all right I think we are getting the yellow light here, so we will wrap up. Yusuf thanks a lot for coming and thanks everybody for your attendance.

Question-and-Answer Session

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