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SUBJECT: The HD Era: A Time of Change

As we head into the New Year and close out what has been a historic holiday season for the games industry in general, and the Xbox 360 in particular, I wanted to take a quick retrospective look back. Five years ago, we burst onto the scene and quickly became industry thought leaders who dared to challenge the conventional thinking around how games are developed, played and enjoyed.

Now Xbox 360 is driving a sea change. And we're redefining how people think about entertainment.

This past holiday, you couldn't escape the fervor surrounding Xbox 360. It became more than a product; it became a global sensation that put us well on our way to becoming the fastest selling console in history, shipping 4.5 to 5.5 million consoles by the end of June. Now, we have a huge responsibility to get more consoles into the global marketplace so more people can get their hands on an Xbox 360. In order to facilitate this increase in output, I am pleased to announce that early next month Celestica will join Wistron and Flextronics to start producing Xbox 360 consoles so we can meet this incredible demand.

Consumers around the world that have secured an Xbox 360 are flocking to Xbox Live. In fact, more than half of them are connecting to the Xbox Live community, a monumental leap from the one out of every 10 people that enjoyed online multiplayer games on the original Xbox.

Today, Xbox Live is the undisputed leader in the online games race, but it's not just about multiplayer games anymore. Since November 22, Xbox Live members have downloaded more than 4 million pieces of high definition games, music, and movie content from new partners such as Paramount Pictures, 20th Century Fox, and Epic Records. Similarly, Xbox Live Arcade is distributing fun, bite-sized games such as Joust, Bejewled 2 and Geometry Wars; and our partners love our Microsoft Points system, with which 60 percent of Xbox Live members are using this virtual currency to purchase premium content.

During the past year, you have heard us talk a lot about the HD Era. Well, Xbox 360 has truly ushered it in. According to research conducted by Penn, Schoen, Berland & Associates, Xbox 360 is a high-definition growth engine for Microsoft and our entertainment, broadband provider, consumer electronic, and retail partners. Tonight I will stand on stage at the Consumer Electronics Show (CES) with our chairman Bill Gates to declare Xbox 360 is the killer app for HDTV sales. I invite all employees to tune into the live CES keynote webcast tonight at 6:30 p.m. at http://msweb/C2/C16/StudioCast/default.aspx. In addition, Larry Hryb will post a CES podcast on http://majornelson.com immediately following tonight's keynote.

Here's a sample of the some of the data and news I will be sharing:

o 90% of Xbox 360 owners either own or intend to purchase an HDTV in the next six months
o Of those people who intend to purchase an HDTV, 9 out of 10 say Xbox 360 is the primary reason for this purchase.
o 10% of those who own an HDTV purchased HDTV and Xbox 360 at the same time

Accelerating this shift to high definition, tonight we'll also announce the Xbox 360 External HD-DVD Drive, available later this year, so millions of people can easily enjoy HD-DVD movies through a high-definition optical drive.

And last, but certainly not least, are the Xbox 360 games. This holiday, we proved that we had the strongest launch line-up of games ever. We're most proud that in the US, Xbox 360 achieved the highest ever attach rate for a console launch at approximately four games for every console sold, while attaching one first-party game for every system.

Microsoft Game Studios has garnered accolades from the year-end awards including PGR3 being named Xbox 360 Game of the Year by Official Xbox Magazine; PDZ recently winning IGN's awards for best Xbox 360, Xbox Live and best Xbox 360 offline multiplayer games awards; and Kameo winning IGN's award for Best Artistic Design and GameSpy's honor for the Best Xbox 360 Platformer of the Year.

Couple this with a powerhouse lineup of third-party titles like Bethesda's Elder Scrolls IV: Oblivion, Ubisoft's Tom Clancy's Ghost Recon Advanced Warfighter, and EA Sports' Fight Night: Round 3 scheduled for spring, we are well on our way to delivering more than 50 Xbox 360 high-definition games by the end of June.

As was recently communicated by Robbie, at the same time that we're betting big with Xbox 360, we're also doubling down on our commitment to Windows as a games platform this year with the release of Windows Vista. Symbolic of our commitment, tonight at CES we will unveil the next-generation of Flight Simulator. This next version is the culmination of 25 years of development, and the early sneak peek is nothing short of stunning. If you squint, you can only imagine what Vista games will look like once running on DirectX 10 hardware later in the year. Combined with innovative platform developments and other stellar third party games planned for prime-time showings at major trade shows later this year, there's no question that it's a good time to be a Windows gamer.
As more and more people flock to games, we also need to feed the consumer's seemingly insatiable appetite for interactive entertainment. The explosion of casual content highlights a fundamental shift of perception of games as not only a hardcore pastime but also a casual endeavor. Microsoft Casual Games is taking casual games to multiple devices and platforms such as MSN Games, Messenger Games, MSN Games for Mobile, Xbox Live Arcade and Windows, enabling players from around the world to compete, collaborate and socialize on the platform of their choice. We've got people playing games like Hexic, Bejeweled, and Zuma across multiple Microsoft platforms, and having great experiences on all of them.
The coming year is one that will forever be remembered as a pivotal year in games and entertainment history. Consumers will demand more of us than ever before. They will want more high definition entertainment, more connectivity, and more choice.

The rate of change will be incredible and we will be at the forefront of this change.

So long as we remain emboldened in our constant pursuit of new ideas, as well as sharing innovations across platforms and with our partners, and not take lightly the challenges our competitors will throw our way, we have the amazing opportunity to make interactive entertainment the leading form of all entertainment.

Thanks to all of you for your wonderful efforts during 2005. Here's to a terrific 2006 and beyondŠ

Cheers,
Peter