WE SEE POTENTIAL

2002 Annual Report

For everyone, everywhere: www.microsoft.com/msft

0902 Part No. 098-95609

AND IT’S ALL YOURS.

Each of us has a dream.A notion of what wemight achieve and whowe might become. Inbusinesses large andsmall. Among teachersand students. At homeand at work. From thecommonplace to theremarkable. We atMicrosoft are passionateabout helping peoplerealize their full potential.

INSPIRING NEW

EXPERIENCES—FROM

WINDOWS TO XBOX

Microsoft® Windows® XPenables people to usedigital technology withmore ease and reliability—from playing music tocommunicating with

friends and family tocreating home videos.That’s one reason itenjoyed a faster adop-tion than any operatingsystem in PC history.

And we’re continuing toinvest for the long termto unlock the possibilitiesof digital technology. Forexample, this fall will seethe debut of WindowsPowered Smart Displays,cordless monitors thatextend the Windows XPexperience to any roomin the house. SeveralMicrosoft partners willbe introducing nextgeneration PCs that useMicrosoft Windows XPMedia Center Editionto integrate a varietyof digital entertainmentexperiences with theconvenience of remotecontrol. And the next ver-sion of Windows Media™will store and transmit

high-quality video andaudio with 20 percentless file space andbandwidth.

We help people realizetheir potential for purefun, too. With Xbox™,the most powerful consolegame system ever built.In the near future, weplan to launch Xbox Live,a groundbreaking onlinegaming service that willlet broadband users playmultiplayer Xbox gameson the Internet.

HELPING PEOPLE ENJOY

ALL THE INTERNET

HAS TO OFFER

As more people turn tothe Web for information,entertainment, and com-munication, we continueto improve MSN® to make

the Web even moreuseful. These ongoingimprovements havehelped MSN become themost popular service onthe Internet, with morethan 270 million uniqueusers worldwide eachmonth. MSN also hasa growing subscriptionbusiness: more thaneight million subscribersuse MSN for Internet ac-cess and other services.

The next version of MSN,coming this fall, will offerbetter online safetyfeatures, valuable com-munication services,and advanced browsingand productivity softwarethat will help peopleaccomplish even moreon the Internet.

It doesn’t matter who you are. It doesn’t matterwhere you live or what you do. When your potentialis pointed in the right direction, it can lead youanywhere. At Microsoft, we see no limits to thepotential we all might reach because we see nolimits to human imagination. That is what inspiresus. And that is why we create software that helpspeople and businesses reach their potential.It’s not just our purpose. It’s our passion.

In today’s global andincreasingly digitaleconomy, the businessesthat are best positionedfor success are thosethat can respond withagility to a dynamicmarketplace. We’rehelping them with soft-ware that delivers highbusiness value whiledriving down the totalcost of ownership.

BUILDING A FOUNDATION

FOR BUSINESSES OF

ALL SIZES

Available early next year,the Windows .NET Server

2003 family will providea solid foundation forincreasing businessconnectivity and effi-ciency. The Windows .NETServer 2003 operatingsystem provides a robustinfrastructure platformfor powering connectedapplications, networks,and Web Services fromthe workgroup to thedata center. This newline of servers securelyconnects businesseswith their customers andpartners and integratesa powerful new applica-tion environment for

developing XML WebServices and solutionsto dramatically improvebusiness processes.

The Windows .NETServer 2003 family joinsa comprehensive rangeof Microsoft server prod-ucts, including MicrosoftSQL Server™ 2000, theworld’s fastest database,which has receivedacclaim for its reliableperformance, scalability,and positive impact oncost of ownership.

BOOSTING PRODUCTIVITY

THROUGH INNOVATIVE

TECHNOLOGIES

In 2003, we will launchseveral new productsaimed at increasinginformation worker pro-ductivity and helpingbusinesses grow.

The next generationof Microsoft Office willtake full advantage ofXML, allowing for morefully integrated businessprocesses. It will also in-clude a greatly enhancedversion of Microsoft Out-look®, which will improvethe management of

FOR YOUR BUSINESS.

personal information andenable better communi-cation and collaboration.

And a new generationof mobile devices—fromTablet PCs to Pocket PCsto Smartphones—willallow for greater produc-tivity and connectivityfrom virtually anywhere.

PROVIDING BUSINESSES

WITH SOLUTIONS, NOT

JUST SOFTWARE

In July we introducedMicrosoft BusinessSolutions, which pro-vides businesses withproven technology

and experienced profes-sional resources.

For example, MicrosoftBusiness Solutions offersbusiness applicationsthat automate financialand operational pro-cesses and allow small-and mid-market compa-nies to extend informationto employees, customers,suppliers, and partners.

Our recent acquisitionof Navision a/s furtherenhances our ability toserve these companiesglobally and under-scores our commitmentto our customers.

We’re excited to be partof a technology industrythat is fundamental tothe way people live,work, and play. Andwe’re dedicated tosupporting it and creat-ing opportunity for thepartners and developersthat comprise it.

CREATING THE FUTURE

THROUGH INNOVATION

Our commitment toconstant innovation isreflected in our ongoinginvestment in researchand development. Infact, we have investedmore than $23 billionover the last ten yearsto develop innovativesolutions to the tech-nology problems oftoday and tomorrow.

Through the MicrosoftResearch group, we areexploring new worlds ofsoftware technology,user-interface design,language understanding,and digital media.

DEVELOPING A BETTER

WAY TO CONNECT

In an online world filledwith constellations ofPCs, servers, smart de-vices, and Internet-basedservices, Microsoft .NETmakes it possible toconnect all of themseamlessly. .NET isMicrosoft software forconnecting information,people, systems, anddevices. Built on XMLWeb service standards,.NET enables both newand existing applicationsto connect with softwareand services across plat-forms, applications, andprogramming languages.

In February 2002, welaunched Visual Studio®

.NET, the first develop-ment environment builtfrom the ground up thatenables software devel-opers to create and inte-grate XML Web Servicesand connected Windows-based applications.

WORKING TOGETHER

TO BUILD THE FUTURE

Our industry, perhapsmore than any other,depends on the coop-eration of its membersto enable people toreach their potential.That’s why we havejoined a broad group oftechnology companiesto form the Web ServicesInteroperability (WS-I)Organization. Thisalliance is designed

to accelerate the devel-opment and deploymentof interoperable Webservices across a varietyof platforms, applications,and programminglanguages.

We’ve also embarkedon a long-term initiativewe call TrustworthyComputing, which aimsto bring an unparalleledlevel of security, privacy,reliability, and businessintegrity to computersystems. It’s the highestpriority for every one ofour product teams, anda core mission for theentire company.

FOR THE INDUSTRY.

FOR OUR COMMUNITIES.

Motivated by the beliefthat amazing thingshappen when peopleare provided with theresources they need,we have been usingtechnology to unlockthe potential in individu-als and communitiessince 1983. Last yearalone, Microsoft andits employees contrib-uted more than $246

million to 5,000 non-profit organizationsaround the world tohelp underrepresentedcommunities.

INVESTING IN

YOUTH THROUGHOUT

THE WORLD

In Soweto, South Africa,students in two localhigh schools have beentrained in computerliteracy and subjectsranging from accountingto economics throughthe Microsoft andInternational YouthFoundation Initiative.

Designed to equip youngpeople with technologyskills through educationand training, the program

has targeted projectsin South Africa, Poland,and the Philippines.Additional resourcesfrom Microsoft expandedthe program into Russia,additional Asian coun-tries, and Latin America.

GIVING KIDS

THE TECHNOLOGY

TOOLS THEY NEED

Club Tech is a five-year,$100 million collabora-tion between Microsoftand Boys & Girls Clubsof America to “technol-ogy enable” every clubby providing softwareand technology training.

More than 700 clubsacross the country arenow part of Club Tech.Kids from Boston toOrlando to Phoenixare spending timeusing technology toconnect with eachother and learn moreabout their world.

EMPOWERING

NONPROFIT

ORGANIZATIONS

The Microsoft & NPowerNational Partnershipcreated an affiliationof nonprofit-focused

technology assistanceorganizations thatprovide low-cost andno-cost technologyassistance to othernonprofit organizations,improving their abilityto respond to issues intheir communities.

The $25 million Micro-soft & NPower NationalPartnership establishedaffiliates in seven majorcities across the UnitedStates this year, with agoal of creating fivemore NPower affiliatesin 2003.

CLOSING THE

DIGITAL DIVIDE

By providing much-neededfunding and software tononprofit organizations,libraries, and communi-ties, we hope to helpbridge the “digital divide”that limits opportunitiesfor success and prosper-ity. It’s our convictionthat the true measureof our success is notin the power of our soft-ware, but in the powerit unleashes in us all.

TO OUR SHAREHOLDERS, CUSTOMERS, PARTNERS, AND EMPLOYEES:

Fiscal 2002 was a year of solid revenue growth,significant product releases, and a continuedfocus on developing new technologies thatposition Microsoft for the future. Despitea challenging economic climate, revenuesfor the year increased by $3.07 billion to$28.37 billion, and operating income grewby $190 million to $11.91 billion.

Strong demand for Windows XPand other desktop softwarecontributed to our positive per-formance. Revenue from en-terprise software outpaced thehighly competitive server mar-ket by a wide margin. And ourconsumer businesses saw adramatic rise in sales, with thelaunch of the Xbox video gamesystem and strong growth inMSN subscription income.

During the coming year, Micro-soft will launch several impor-tant new products, includingWindows XP Tablet PC Editionand Windows .NET Servers,and we plan to increasespending on research anddevelopment by 20 percent,

to $5.2 billion. To reflect ourrole as an industry leaderand to focus our efforts onthe opportunities ahead, wehave embraced a new corpo-rate mission: to enable peopleand businesses throughoutthe world to realize their fullpotential. Delivering on thismission requires a clearly de-fined set of values and tenets,which are described on thenext two pages. We are work-ing to integrate these prin-ciples into everything we do.

INNOVATIVE PLATFORM

LEADERSHIP

A highlight of the past yearwas the overwhelming

market acceptance thatgreeted the launch ofWindows XP, which bringsenhanced reliability, security,and performance to PC usersat home and work. The yearalso saw sustained momen-tum for Office XP, with morethan 60 million licenses soldin the 12 months after itslaunch in May 2001. A newversion of Office, scheduledfor release in 2003, willenable users to communi-cate and collaborate in newways with even greater ease.

Delivering on our vision ofsoftware that empowerspeople any time, any place,and on any device, we

launched new versionsof Windows for small andmobile devices, includingPocket PCs and set-topboxes for digital cableTV. Fall 2002 brings thelaunch of the first TabletPCs, designed to boostproductivity by combiningthe power and speed ofa full-featured desktopcomputer with the flexi-bility and portabilityof a notepad.

One of our key goals is toexpand our role as a pro-vider of software solutionsfor small- and mid-sizedbusinesses. In July 2002,we acquired Navision,

98

a leading global providerof integrated software forfinancial management andother business processes.Combining Navision withMicrosoft Great Plains toform Microsoft BusinessSolutions, we now offer awide range of applicationsand services that enablecompanies to reduce costs,streamline operations, andimprove service. We areplanning many new productsfor this market, includinga solution for customerrelationship managementthat will launch thisfiscal year.

THE PROMISE OF .NET

AND XML WEB SERVICES

A significant portion of thecompany’s revenue growthover the next five years willcome from Microsoft’s .NETarchitecture, which holdsenormous potential to con-nect information, people,systems, and devices infundamentally new andimportant ways. Usingcommon industry standardsbased on XML, a universallanguage for describingand exchanging data, our

goal is to enable seamlesssharing of informationacross many platforms andprogramming languages,and over the Internet,with XML Web Services.

The potential of Web ser-vices is gaining wide supportamong software developersand leading technologyproviders. For example,the Web Services Inter-operability Organization,formed by Microsoft andother industry leaders inearly 2002 to provide guid-ance and best practicesfor developing XML Webservices, now has more than120 companies as members.

To provide software develop-ers with the tools and infra-structure for building anddeploying XML Web servicesand other .NET-connectedsolutions, we launchedVisual Studio .NET and the.NET Framework in February2002. In fiscal 2003 we planto launch Windows .NETServers, which will providethe most compelling plat-form for developing andhosting Web services andbusiness solutions.

Companies that are helpingto test the promising betaversion of Windows .NETServers foresee many ben-efits. JetBlue Airways, forexample, plans to use itas the platform for a newreservations system and tosecure access to its comput-ers and facilities with finger-print biometrics embeddedin smart cards. The youngairline has achieved a“paperless cockpit” by pro-viding pilots with electronicversions of flight manualsthat are automatically up-dated with an applicationthat JetBlue developerswrote using Microsoft VisualStudio .NET. JetBlue creditsMicrosoft technology withhelping it to limit spendingon information technologyto about 1.5 percent ofrevenues, in an industrywhere the average isabout 5 percent.

DELIGHTING CONSUMERS

Our strategic investmentsin new consumer businessesbrought gratifying resultsthis past year, with more tocome in 2003. In the eightmonths after our Xbox video

game system launched inNovember 2001, 3.9 millionconsoles and 20 millionXbox games were sold.MSN, already the mostpopular portal destinationon the Web, is now also theleading provider of broad-band Internet access.

Microsoft and more thana dozen leading electronicsmanufacturers have devel-oped a new line of flat-panel,cordless displays that enableconsumers to extend theirWindows XP experience toanywhere in the house.These Smart Displays willstart appearing in storesin time for the 2002 holidayshopping season, as will PCsrunning our new Windows XPMedia Center Edition, provid-ing remote-control accessto digital music, movies,and a built-in personalvideo recorder.

INVESTING IN THE FUTURE

We are focused on long-termsuccess for Microsoft as abusiness, for our 50,000 em-ployees, our shareholders,our industry, our customers,and the communities where

we do business. Looking tothe future, a few develop-ments are noteworthy.

Antitrust LawsuitIn November 2001, Microsoftand the Department ofJustice announced a settle-ment of the three-year-oldantitrust dispute. Nine stateattorneys general joined inthe settlement, while nineothers decided to continuewith the case. The settle-ment requires significantchanges in how we do busi-ness, and Microsoft is fullycommitted to carrying outthese responsibilities. Theconsent decree is a toughbut reasonable compromisethat is good for the industry,good for consumers, andgood for the economy.

Trustworthy ComputingIn January 2002, we outlinedfor employees what we be-lieve is the highest priorityfor the company and for ourindustry over the next de-cade: building a computingenvironment for customersthat is as reliable as theelectricity that lights ourhomes. As a first step inachieving higher levels of

reliability, security, privacy,and business integrity,Microsoft made manychanges in our operationaland business practices.Thousands of our engineersreceived special trainingin writing secure software.And we conducted intensivesecurity analyses of everyline of source code forWindows and other products.

These efforts are startingto show results. Securityupdates of Microsoft Out-look, for instance, werefollowed by a dramatic dropin the number of e-mailvirus incidents. But giventhe complexity of computingand the fast pace of techno-logical change, achievingtruly Trustworthy Computingwill take many years.

An Agile Business SystemTo streamline internaldecision making, enhanceentrepreneurship withinMicrosoft’s key businesses,and increase collaborationacross groups, we instituteda number of changes tointernal business systems.One of the most significantchanges was giving the

leaders of our key busi-nesses the tools, resources,and responsibility formaking the importantdecisions around productdevelopment, sales,marketing, and financialperformance.

Business IntegrityDuring the past year, anumber of major corpora-tions were rocked by finan-cial scandals that damagedshareholder wealth and con-fidence. At Microsoft, wetake our responsibilitiesto shareholders, customers,partners, and employeesvery seriously. We aim tobe open and candid aboutthe condition of our busi-ness and the risks we face.We seek to properly assessassets so they are neverovervalued, and we lookhard for any costs orliabilities that should bereflected in our financialresults. Consistent withthe values of honesty andintegrity that we strive tolive by, we have long dis-closed complete detailsof the diluting effect ofemployee stock optionson Microsoft’s earnings.

Great People with Great ValuesDelivering on our missionrequires great people whoare bright, creative, andenergetic, and who sharethe following values:

• Integrity and honesty• Passion for customers,

partners, and technology• Open and respectful with

others and dedicated tomaking them better

• Willingness to take onbig challenges and seethem through

• Self critical, questioning, andcommitted to personal excel-lence and self improvement

• Accountable for commit-ments, results, and qualityto customers, shareholders,partners, and employees

Enabling People to Do New ThingsBroadening choices for custom-ers by identifying new areas ofbusiness; incubating new prod-ucts; integrating new customerscenarios into existing busi-nesses; exploring acquisitionsof key talent and experience;and integrating more deeplywith new and existing partners.

Innovative and ResponsiblePlatform LeadershipExpanding platform innovation,benefits, and opportunities forcustomers and partners; open-ness in discussing our futuredirections; getting feedback;and working with others to en-sure that their products and ourplatforms work well together.

MICROSOFT’S MISSIONTo enable people andbusinesses throughoutthe world to realize theirfull potential

MICROSOFT’S VISIONEmpowering peoplethrough great software—any time, any place,and on any device

DELIVERING ON OUR MISSIONThe tenets central to accom-plishing our mission include:

Broad Customer ConnectionConnecting with customers,understanding their needs andhow they use technology, andproviding value through infor-mation and support to helpthem realize their potential.

A Global, Inclusive ApproachThinking and acting globally,enabling a multicultural work-force that generates innovativedecision-making for a diverseuniverse of customers andpartners, innovating to lowerthe costs of technology, andshowing leadership in support-ing the communities in whichwe work and live.

Stock options are an impor-tant way that Microsoft at-tracts and encourages greatemployees. For the two ofus, the vast majority of ourindividual net worth is in-vested in stock ownershipof the business. Since Micro-soft went public in 1986,we have never taken stockoptions, and we never will.We hope this provides fur-ther assurance that our per-sonal interests are directlyaligned with the long-terminterests of all shareholders.

Finally, on a personal level,we feel incredibly privilegedto play a role in bringingto life the technologiesthat will enable peopleand businesses to realizetheir full potential. Thankyou for your support.

Bill GatesChairman andChief Software Architect

Steven A. BallmerChief Executive Officer

1110

ExcellenceIn everything we do.

Trustworthy ComputingDeepening customer trustthrough the quality of ourproducts and services, ourresponsiveness and account-ability, and our predictabilityin everything we do.

WE SEE POTENTIAL

2002 Annual Report

For everyone, everywhere: www.microsoft.com/msft

0902 Part No. 098-95609