Brad Smith: Microsoft News Teleconference with U.S. Journalists and Analysts Regarding European Court of First Instance Order On Interim Measures

Brad Smith, Senior Vice President and General Counsel, Microsoft Corporation

December 22, 2004

STACY DRAKE: Thank you. Hi. It’s Stacy Drake with Microsoft. Thank you all for joining us this morning.

As you know, we have received the decision from the European Court of First Instance today regarding our request for the suspension of the remedies in the European Commission case.

I’m joined on the call by Brad Smith, our general counsel and senior vice president. Brad will start by making a few comments and then we’ll open it up and take questions from you.

So at this time, I’ll hand it over to Brad.

BRAD SMITH: Thank you, Stacy, and thanks to everyone who’s joining in on the call.

Obviously, we received the Court of First Instance’s decision a few hours ago. It’s a lengthy decision and it will take us some time to really completely have a chance to review it, but we certainly wanted to give you now our initial reactions to it.

I would say overall the decision means three things for Microsoft. First, we obviously need to go forward as a first order of business and comply with today’s decision. The court obviously ruled against our request for interim measures, and instead it decided that we must go forward and comply with the European Commission’s decision.

The basis for the court’s decision was its conclusion that these remedies will not cause any irreparable harm to Microsoft. In other words, in the court’s view, any harm that will be caused to the company from the imposition of these remedies can be repaired later on, if or when we win the case on the merits.

This really means that we will now go forward and do two things: First, we’re going forward immediately to activate a Web page later today to provide others in our industry, including our competitors, with information as to how they can license the communications protocols from us that are covered by today’s decision.

As you know, we’ve been licensing under the U.S. Consent Decree for over two years the communications protocols in our Windows client and, in fact, we have license agreements in place with over 20 companies as a result of that program.

Today’s decision applies both to that set of protocols and to the communications protocols in our Windows Server product. We’ll now be going forward to make information available about how companies can license those protocols from us. There will be a process that companies will go through. We’ve obviously had the chance to learn a lot from the process in the U.S. We will now apply that learning, as well as the results of our discussions with the European Commission staff on this issue.

We recognize that the European Commission will continue to review each step we take with respect to this implementation. We fully respect that role and we look forward to continuing to work with the Commission’s staff, as we have these last several months, in a constructive way regarding this.

In addition, we’re moving forward immediately with the remaining work to bring to the marketplace in Europe an additional version of Windows that will have the Windows Media Player code removed from it. Under a timetable that has been agreed upon with the European Commission staff, we will go forward with the final testing for that product. It will be made available to PC manufacturers in Europe in January. It will make its way to the entire distribution channel, including software resellers, by February.

So that really is our first priority, to ensure that we comply fully with the court’s decision, and we will go forward and do that.

The second implication of today’s decision really relates to the longer-term aspects of the litigation itself. Today’s decision was all about whether the remedies will take effect while the litigation moves forward, but, importantly, part of the decision also addressed the merits of the case, and ultimately it is the merits of the case that will determine the outcome of the litigation.

We do find substantial cause for optimism in a number of aspects of the court’s reasoning today. For example, the court discusses the Windows Media Player side of the case and it recognizes that we have important arguments that will need to be assessed by the five-judge panel that will decide the merits of the case. These include the benefits created by our design philosophy in Windows. It includes the fact that, as the court observed today, our design philosophy and our integration of new features into Windows is not the kind of conduct that by its nature is likely to restrict competition. It also reflects the court’s recognition that competitors and content providers continue to have a variety of media formats from which to choose, a fact the decision notes that has not been rebutted by the European Commission.

So these types of points give us optimism about our prospects for prevailing down the road.

Similarly, in discussing the compulsory-licensing side of the case, the court’s decision today recognizes that there is valuable technology at issue here, something that differentiates this case from other cases in which the court has permitted compulsory licensing by the European Commission, the decision acknowledges that the court will have to assess the substantial intellectual property rights that we have in this technology and the decision recognizes the important argument we have made that competitors do not need access to this technology in order to bring their products to market.

So here, too, we see cause for optimism about our prospects for success down the road.

The exact timetable will be determined by the court, of course. It is likely to be a process that is measured in months and even years. It wouldn’t be unusual for this type of case to take us into 2006 before we get a determination on the merits from the Court of First Instance and, of course, even after that point each side will have the opportunity, if it wishes, to appeal a decision to the European Court of Justice.

As we’ve been saying in recent weeks, only 17 percent of the cases that go before the Court of First Instance result in requests for interim measures being granted. Today’s decision means that our case falls into the 83 percent of cases for which interim measures are not granted, but we also know that the European Commission does not win 83 percent of its cases before the Court of First Instance when the day comes for a determination on the merits. So it’s on that determination on the merits that our litigation and legal team will now focus.

Finally I would note that our view on the best way forward in this case remains what it always has been; throughout the six years of this case, we have said consistently that we believe the best path forward is a path based on all parties sitting down around a table and working this out through constructive face-to-face direct discussion. That was our view last month, it was our view yesterday, it remains our view today and I’m sure it will remain our view next year as well.

We obviously don’t get to control whether discussions take place, but certainly as we head into the new year, we remain committed to pursuing all constructive dialogue and all opportunities that may emerge to do that.

Certainly it remains our view that the version of Windows that we’re now required to make available to consumers in Europe is, in fact, a version that will provide consumers with less value rather than more, it will work less well than the version of Windows that consumers have available to them today. We have always been skeptical that there would be significant consumer interest in this product. Now we’ll all find out as the months unfold. But certainly we continue to believe that there are alternative and better paths forward, there are paths that would provide consumers and competitors with more value and more opportunity than the path taken in the Commission’s decision, and should the opportunity arise in the future to discuss those types of possibilities, we’d welcome the chance to sit down and have that type of conversation.

So with that, let me open it up for questions.

QUESTION: Brad, as a practical matter, have any OEMs expressed an interest in licensing Windows with the Media Player removed?

BRAD SMITH: I don’t believe we’ve heard from any OEMs to date expressing any such interest in licensing this version of Windows. I can’t say, Rick, that I’m always in the loop on every conversation we have with OEMs, but I have not heard of any OEMs expressing any interest in this to date. Obviously we’ll see if that should change as the remedy now takes effect, but so far that’s the state of affairs.

QUESTION: It seems like as a practical matter it’s kind of a lame remedy, and it just seems like what they were really interested in was something they repeatedly made note of, which is a precedent. So I kind of wanted to ask whether the precedent has been set or is that only after you’ve gone through this Court of First Instance and that’s several years away, so if it’s search or antivirus or something else that they object to, can they claim that, “Well, gee, we have a precedent that we’ve already established here to rely on”?

BRAD SMITH: Good question. I think the reality is that today the only precedent that has really been set is the court has determined that a remedy that removes features from Windows is not likely to cause irreparable harm to Microsoft but that doesn’t go at all to the issues that will decide the merits of the case, and the truth is we’re all going to have to wait until the merits of the case are decided before there is any judicial precedent in Europe.

And, in fact, from our perspective, I would say that the court has important language that recognizes the significant arguments that we have when it comes to the merits of the case, so we are encouraged by that aspect of the decision and we’re all going to have to wait until those aspects of the case are addressed by the five-judge panel that will decide them before we have any type of precedent that will apply more generally to Windows and features in Windows.

QUESTION: OK. And this issue with the server code, didn’t you already license that to Sun and Novell, who had been originally the companies that objected to not getting that code?

BRAD SMITH: Our agreement with Sun Microsystems did contain a reciprocal promise where we each have licensed to each other a variety of technologies, including the communications protocols that are covered in today’s decision, so Sun Microsystems has already had access to this. They are by far. I would say. the company in the industry that has had the greatest interest in licensing these technologies from us.

Ultimately, Novell reached a settlement with us that did not include any provision for licensing these technologies or IP rights. Novell can certainly now if it wants avail itself of the rights it will have under this decision, there’s nothing to stop it from doing so under our settlement, but I think one can draw certain inferences from the fact that Novell was prepared to settle with us without insisting on these kinds of licensing obligations.

QUESTION: Hi. Let me clarify two things. Regarding the new version of Windows, do you have any plans to make this stripped version of Windows available in some other countries, such as Japan or in the United States, instead of only in European countries?

Secondly, regarding the communication protocol, will this new program of communication protocol also be available for Japanese manufacturers?

BRAD SMITH: Good questions. Let me take the second question first. The licensing program is available to companies of all nationalities, so it doesn’t matter where companies are headquartered or where they reside. It is the case, however, that under the court’s order the license rights that are provided are confined to what’s called the European Economic Area. It’s basically the European Union and Switzerland, as well as, I guess, Norway. So that means that any company located anywhere can obtain a license from Microsoft, but ultimately in order to use that license under the terms of the order, the software will have to be developed in the European Economic Area and can be distributed only in the European Economic Area. The decision does not give rights to companies to develop software elsewhere or distribute software it develops in Europe in other parts of the world. So that will obviously be one aspect that people will probably want to think about.

Second, with respect to the stripped down version of Windows, we have no plans to offer this version of Windows outside of the European Economic Area at this time, and I don’t expect we’ll have any such plans in the future. The court’s order is confined to the European Economic Area because the European Commission’s decision is confined to that area.

This is, I think, indisputably a version of Windows that offers consumers less value than the version that they get from Microsoft today. In fact, it even offers most developers of competing media players less value than the version of Windows that we offer today. This is because we design Windows so that even the developers of competing media players can use the multimedia functionality in the Windows product and many popular media players do so.

This is why we’ve always said in the proceeding that we were skeptical that consumers would be interested in this product and even that competitors would be interested in this product. And ultimately it’s that skepticism and that rationale that played an important part in the court deciding to let the remedy take effect. It’s that reasoning that in part led the court to conclude that the remedy will cause no irreparable harm to Microsoft. We’ll all now learn whether we’re right; over the course of the next number of months we’ll all have the opportunity to observe firsthand whether there is any interest in the marketplace for this version of Windows. But given this assessment of where we stand, it wouldn’t make much sense for us to go forward and offer in even more countries and languages a version of Windows that we do not believe people will want.

QUESTION: Hi. I’m here in Washington. I wondered if you could quickly run back to the January and February deadlines or plan that you mentioned, what was going to happen in January and then February? And then I have a question.

BRAD SMITH: Well, sure. First on the timetable, we have an agreed-upon timetable with the European Commission for the release of this version of Windows in Europe that will have the Windows Media Player code removed from it. And under that timetable, this additional version of Windows will be made available to PC manufacturers in January and it will make its way to all of the other parts of our distribution channel, including resellers, by the month of February.

I should note that we are permitted under the order and under the Commission’s decision to continue to offer, as we do today, the full functioning version of Windows. We don’t have to take anything off the market, we don’t have to change that product; it will continue to be offered in exactly the form it is today. There is an additional version of Windows that will now be made available as well.

QUESTION: My question is — thanks. The impression that I have is that the president’s language from the court is not any different than is habitually used in these kinds of instances. Do you see a difference there?

BRAD SMITH: I would say that there are a lot of similarities and then there are some parts that I would say are probably particularly distinctive. The reality is that the vast majority of decisions from the president hold against the private company when it comes to the issue of irreparable harm, and that’s what today’s decision does. It’s also the case that at least the majority of decisions tend to be more favorable when it comes to the actual merits and whether a prima-facie case has been established, and I would say that that is the case in this decision as well.

What I would say is perhaps more distinctive is some of the language in what I would call paragraphs 400 through 403, which address the Windows Media Player side of the case, because that text really does two things. One, it’s fairly typical in the sense that it uses somewhat circumspect language to say that there is a prima-facie case, but in addition it also includes the president’s own observations to the effect that this is not the type of conduct that by its nature would restrict competition, that there’s a comment, for example, in paragraph 403 that notes one of the points that we have been making all along, that this type of integration of features into an operating system is something that has been long part of the development practices not only of Microsoft but all of the other developers of operating systems in the market.

So if one reads those paragraphs carefully, I think one can discern both a very clear articulation of the questions the court is going to have to address, which is very helpful for us, those are exactly the questions that we hoped the court would address and that would determine the outcome of the case, and in addition in framing those questions the president offers his own views on some of the facts that are at issue.

I’d also note, for example, that I believe it’s in paragraph 402 the president notes that some of our points, for example, about the fact that competing media formats continue to be available is a fact he observes that the Commission has not rebutted.

So those kinds of things I think are features that do give us considerable cause for optimism going forward.

QUESTION: A couple questions. I’m inferring from all of the presentations you’ve made today that you’re not planning to appeal the interim measures order, is that right?

BRAD SMITH: I’d actually say it’s probably premature for us to make that decision, Jonathan. I mean, we’ve literally only had several hours to read this and it’s a 90-page decision that we’ve had to read very hastily. So we actually have two months to decide whether to file an appeal of today’s decision. I wouldn’t expect it to take two months for us to make a decision, but we’ll at least read it more carefully and get at least a little bit of sleep before we make that judgment call.

QUESTION: But that is —

BRAD SMITH: Either way the litigation on the merits proceeds. That’s not part of the appeal of today’s decisions, that’s just the normal litigation of the case.

QUESTION: Right, right. And either way you are going to proceed with your compliance plans?

BRAD SMITH: Absolutely.

QUESTION: OK.

BRAD SMITH: I would really say that for us today priority No. 1 is doing an excellent job of complying with the court’s decision.

QUESTION: So to that end, and given your statements about the value to customers of the stripped down version of Windows, are you anticipating that it will be offered at a lower price both to consumers and OEMs?

BRAD SMITH: No. I am anticipating that it will be offered on exactly the terms that the court’s — I should say that the Commission’s — decision permits it to be offered, which is the same price as the version of Windows that we offer today.

The Commission’s decision from last March was I think explicit in two ways. First, it says that we cannot offer the stripped down version of Windows at a higher price than the version of Windows we offer today, we certainly won’t do that; but second, it acknowledges, and this was clarified by Commission statements after the decision as issued in March, that we are permitted to offer it at the same price as the version of Windows we offer today, and that’s what I expect would be the case.

QUESTION: Given that the Commission has said today that they think that this decision puts them in a good posture to win the case, would Microsoft be willing in order to move settlement talks to a successful conclusion, to make any settlement have precedential legal value?

BRAD SMITH: Well, a couple of thoughts, Jim. I have not been able to read a word-for-word transcript of the Commission’s statements at its press briefing in Brussels. I have seen a summary of it. I actually didn’t see it put quite the way you put it here. So give us a chance to see what the Commission is saying, and I’m sure we’ll have the opportunity to talk to them directly as we go forward.

Second, we certainly remain committed, as I said, to pursuing constructive, face-to-face discussions. I think it would be premature to talk today about what types of discussions might ensue or what kinds of solutions would emerge. We’ll just have to see first of all whether there’s interest in pursuing those kinds of discussions on the other side of the table and that we’d have to see what options there are.

I will say this: We continue to believe that the remedy imposed in the Commission’s decision is going to offer very little if any value to consumers and we continue to believe that it would be possible to address the issues the Commission has raised in a more constructive and beneficial way. But as to the specifics, I think we’ll just have to take this one step at a time and we’ll take it from there.

QUESTION: As a quick follow-up, would you speculate on whether you think the language that’s helpful to your cause in the opinion would be an inducement for them to be open to a settlement?

BRAD SMITH: It’s not my place to speculate on how people at the European Commission are likely to think about this. I think people will need some time all around to digest this. Everybody’s first reaction tends to be, of course, the fact that the remedies will now take effect, what does that mean. Over time, the passage of a few weeks of months, people will focus more on the merits of the case. That’s just sort of the nature of these kinds of processes. That’s the part of the litigation that remains ahead of us rather than behind us. As people focus more on the merits of the case, they’ll read again and they’ll think more about what the court said about the merits today. I think that’s something that will be helpful to us. As to the precise impact that will have on people’s minds, we’ll just have to see.

QUESTION: Hi. Yeah, I’m just trying to figure out what types of companies do you anticipate are going to take you up on this licensing of the server software information? Is it Sun-type companies, or is it anybody who’d be developing software in the communications space?

BRAD SMITH: Well, the remedy is designed to facilitate the development of competing server software, especially server operating systems. As to who may or may not be interested in it, it’s a little hard to say entirely. I do think we can make a few observations. First, Sun Microsystems already has this option available to them, so this does not give Sun anything they don’t already have. And they are the company that has long been the most interested in having access to this kind of technology, they were the only company that was actually a complainant officially in the case.

Second, there’s, of course, Novell. Novell participated as an intervener. At the same time, Novell was obviously comfortable making a decision deciding to settle the case without securing these kinds of license rights. They settled their U.S. antitrust claims with us. It doesn’t mean that they’ll necessarily forego the opportunity now to utilize the European program but one can obviously draw some inferences from their decision to settle in that manner.

Third, I would note that the Commission’s decision in March, and indeed the European Commission’s comments at its press briefing today, did acknowledge one other aspect that’s just a fact of life, as it should be, under the decision, which is while we’re obligated now to license these communications protocols to others, we are permitted to charge a royalty and a license fee. And so the developers of certain free software products will have to assess that. They said in the hearing in Luxembourg that they were likely to be interested in a license only if it gave them all of our technology and intellectual property for free. I think for pretty common-sensical reasons the people in government in Europe and elsewhere around the world have not felt it appropriate to require companies to take some of their most valuable intellectual property rights and technologies and give them to competitors for free and that may well have some bearing on whether those developers, in fact, are interested in taking a license.

QUESTION: And there are you referring to like, say, Real Networks where you can download the player for free? Would they then be charged on every download or they would just be charged some sort of a flat rate —

BRAD SMITH: No, I’m referring here to the developers of Linux and server operating systems. Companies — or it’s not really companies, it’s developers that have a development model and a license agreement, in their case the GPL or General Public License that is predicated on the principle that their software must be distributed for free.

Companies that have commercial business models such as Real Networks are much more likely I think to be able to find a way to take these kinds of licenses and incorporate them into their business model. But obviously it’s a challenge if somebody has a business model based on the premise that their software must always be free to think about this kind of license. The terms of the GPL are a bit different. So we’ll just have to see how people think about that.

There are probably creative ways for people to do certain things but each developer or each company is going to have to think about what this means for its own products and its own business model.

QUESTION: OK, and one quick follow-up, so is this type of information useful to a company like Real Networks, or is it only if you’re building servers that you want to sell that you want to have them talk to other Microsoft servers, that’s really the only time you’d want it?

BRAD SMITH: I don’t honestly know offhand whether any of these communications protocols would be of interest to Real Networks. Their participation in the case has really not been focused on this part of the case, their focus has been on the Media Player side and that doesn’t turn or doesn’t involve the licensing of IP rights or communications protocols in this way. This part of the case has been the part that has been followed and has been of interest to companies that make server operating systems, especially Sun Microsystems and them more recently Novell.

QUESTION: Hi, Brad. A couple questions, more questions on the server side.

BRAD SMITH: Sure.

QUESTION: First, can you give us some kind of idea what the licenses might cost or at least how you’re going to structure that?

And secondly, in your argument for irreparable harm in Luxembourg, you said that obviously any time you disclose any intellectual property like this, that that’s automatically harm that can’t be undone, but more tangibly than that, what impact do you think this might have on Microsoft’s server business in Europe?

BRAD SMITH : Let me start with the latter part first, Joe. I’d say first and probably foremost there’s nothing in today’s decision that eliminates our opportunity to continue to develop the best, what we believe is the best server operating system on the market. And as long as we continue to do that, I expect we’d have the opportunity to continue to be successful.

This does mean, of course, that we’re going to have to take certain aspects of that server software, namely the communications protocols, and make those available for a fee to our competitors as well.

And we certainly did argue in Luxembourg, as you know, that we were generally of the view that when one licenses intellectual property rights and shares technical information that is protected as a trade secret with other companies, you just simply can’t unring the bell later on if you win, you can’t expect everyone to simply forget everything they have learned.

That argument obviously did not prevail. If there is a silver lining in that aspect, I would say that it is in part some discussion by the court where the president recognizes that we can include certain contractual safeguards and so there are some additional steps we may be able to take to safeguard our IP rights and our technology and we’ll have to take a close look at that, we’ll just have to see.

In terms of the pricing and the terms, I’d rather not get into that now. We’ll have a process that we’ve worked out with the European Commission staff, we know they’re going to continue to want to review it, but we’ll have a very matter of fact process that interested licensees can go through. We will definitely benefit in that process from all of the learning that has emerged from the two-plus years of experience we have the similar technologies in our desktop operating systems under the U.S. Consent Decree. So we will I think apply what we’d call the best practices that have emerged from that program and apply them in this program as well.

STACY DRAKE: Great. OK, that will be the last question. I want to thank you all for joining.

You’ll be able to call in and listen to a replay of this call by dialing 888.568.0876. We will also post a transcript of the call to our PressPass site and there are some other materials on that site as well, such as a statement from us.

And with that, we will end the call. Thank you.

BRAD SMITH: Thank you. Bye.