Gates, speaking before more than 350 financial analysts, reporters and investors at Microsoft's annual analysts meeting at its headquarters, said Microsoft is on track to release a test version of its Web services technology, called HailStorm, late this year.
HailStorm is central to Microsoft's .Net strategy to conjoin its applications with Internet services. The company envisions tying content delivery, shopping, banking and entertainment through a variety of devices--including cell phones, PCs and handhelds--through HailStorm, which relies on Microsoft's Passport authentication system.
Gates also said the company has increased its research and development budget to $5.3 billion in the new fiscal year begun last month, up from the $4.4 billion it spent last year. The company will spend the money on its Windows operating system and Office productivity software, e-business software for companies to conduct trades, and consumer products, such as its forthcoming Xbox video game console.
Despite the bullish forecast, Microsoft executives also said the company isn't immune to the economic slowdown. President Rick Belluzzo said Microsoft will hire about 4,000 employees this year, about half the number it hired last year.
Gates said some of the new hires will staff the company's R&D initiatives. "We are increasing R&D head count this year, but as a percentage, more moderately than in years past."
Belluzzo said goals for the coming year include generating more revenue from services and from its family of e-business software. He also said Microsoft will invest heavily in its target markets and will sell businesses that are no longer part of the company's plans. Belluzzo cited the recent sale of the Expedia travel Web site as an example but did not elaborate on other possible areas up for sale.
In his speech, Gates said Microsoft is on track with its .Net strategy to make its Windows operating system and other software available over the Internet to traditional PCs and handheld devices, such as cell phones and handheld computers. The goal is to tie all computing devices to the Net, allowing people to access their e-mail, calendars and important files, regardless of what device they use.
"We think software will be more important and magical the next decade than in the last 25 years," Gates said. "Driven by some of the vision we had during the last 25 years, we now have the opportunity to implement scenarios that weren't possible before."
At the heart of the strategy is XML (Extensible Markup Language), a Web standard for data exchange that Microsoft is building into every one of its products, Gates said. For example, he said, the company's next version of its SQL Server database software and Office productivity software is built "top to bottom" with XML, he said.
Gates compared XML to the importance of graphical user interfaces for computing in the late 1980s and early 1990s and of HTML to Web sites in the late 1990s. "It really is changing the architecture of all of our products," he said.
Gates said another driver for the move to Web services is the adoption of high-speed Net access in businesses, giving people the bandwidth they need to use new services. One potential hitch, he said, is the consumer market, where broadband Internet access isn't being adopted as quickly.
"In terms of the hardware (over) the next five years, it's more than adequate (for) what we need for (our) scenarios," he said. "The piece that is a little bit of concern is the cost of broadband. The forecasts average about 25 percent household penetration. Broadband will hold things (back) somewhat in the consumer arena."
As a result, Gates said, storing information on local hard drives, rather than on the Internet, will still play a key role. Microsoft needs to "support offline connectivity. We can't assume high-speed connectivity will always be present," he said.
Gates reiterated that speech and handwriting recognition and forthcoming tablet devices will come out during the second half of next year, allowing people to read books and magazines and take notes electronically. "You have to make the reading experience comfortable enough (and) as good on an LCD-type display as it is on paper," he said.
Gates also hawked advances in videoconferencing software, allowing people to archive meetings. That way, people who want to watch only a specific portion of a meeting can fast-forward to the part they are interested in, he said.
"All these things are extremely inefficient today, but just a 10 to 15 percent improvement in efficiency is a substantial savings," he said.
Microsoft executives also trumpeted their consumer businesses during the meeting.
Microsoft is redesigning MSN's home page this fall to coincide with America Online's release of version 7 of its software, said Yusuf Mehdi, vice president of Microsoft's MSN and consumer services. Microsoft also expects to offer subscription services that could tie MSN with the XP operating system. As an example of how that would work, the company might charge 75 cents a month for family members to share their personal calendars.
On the gaming front, Microsoft's Xbox video game console will have 15 to 20 games available when the product is released Nov. 8, with a total of 100 games by the end of the fiscal year, said John O'Rourke, Xbox's marketing director. Of those, 80 will be exclusive to Xbox, he said.
Microsoft executives also added that the company will release in the next 12 months new versions of the Windows operating systems for handheld and embedded devices. In the next 18 months, nine automakers will ship cars with built-in devices that use the Windows CE operating system, allowing drivers to check their calendars or stock portfolio with voice commands.
Meanwhile, the company has been disappointed with sales of UltimateTV, which combines Web access with a DirecTV satellite receiver and a digital video recorder. "We wish the advanced set-top boxes were moving faster," said Bill Veghte, vice president of Microsoft's device and hardware platforms.
Windows XP on the hot seat
While Microsoft executives touted the progress of the company's software initiatives, controversy continued to swirl around the company's much-anticipated Windows XP operating system.
The company said the second release candidate, or trial version, of Windows XP will be released Friday or over the weekend. The final release is scheduled to ship Oct. 25.
Microsoft faces growing pressure on many fronts, with government officials and competitors scrutinizing critical features in Windows XP.
On Thursday, a group of privacy organizations detailed a complaint it plans to submit to the Federal Trade Commission, charging Microsoft with inadequate security and privacy provisions in the forthcoming Windows XP and alleging unfair and deceptive trade practices.
On Tuesday, Sen. Charles Schumer, a New York Democrat and member of the Senate Judiciary Committee, asked federal and state trustbusters to consider taking action that would delay Windows XP's release. He also called on Judiciary Committee Chairman Sen. Patrick Leahy, a Vermont Democrat, to hold hearings on the matter.
Also Tuesday, software maker InterTrust amended an existing lawsuit against Microsoft, asking for an injunction against Windows XP. The Santa Clara, Calif.-based company charges that controversial product-activation technology found in Windows XP violates four InterTrust patents.
Previously, state attorneys general said they, too, would consider an injunction to delay Windows XP's launch so the U.S. District Court for the District of Columbia could probe potential consumer harm and anti-competitive issues posed by the new operating system.
Microsoft is pushing hard for settlement talks as it scrambles to get Windows XP to PC makers ahead of schedule. Microsoft executives and Justice Department officials were said to have began preliminary settlement negotiations this week.
During a question-and-answer session, Microsoft chief executive Steve Ballmer sidestepped a question on whether Microsoft is worried about the efforts of some legislators to have the ship date of Windows XP delayed.
"We're doing our jobs building a product, doing our final testing and preparing for shipment," Ballmer said. "There's nothing else for us to do but that. We'll comply with any request to show up and discuss the matter anytime, but our job is to finish a great product."
As for the antitrust case, Ballmer repeated that the company is willing to settle with the government. In the meantime, he said, Microsoft is attempting to prove to its customers and partners that the company is trustworthy.
"We continue to earn the trust of our industry," Ballmer said. "This company behaved (with the) highest integrity (and best) interest of our customers and our partners. Windows XP continues down the same path. I'm shocked and dismayed by some of the criticism" of XP.
Ballmer also dismissed criticism that .Net could give the company too much access to consumer information. People say, 'Ooooh, is there some big plot here?'"
But he emphasized that the "consumer gets to choose how their data is use...We're going to make them opt in to everything they do."
CNET News.com's Scott Ard contributed to this report.