Twenty years ago, the MS-DOS®-based IBM PC had a tiny processor, a minuscule amount of memory, an even smaller amount of storage, and sold for $1,595–equivalent to more than $3,000 in today’s dollars. Even so, it was a remarkable advance in technology. Today, a PC that is thousands of times more powerful sells for less than $800. But it’s not just the power and the price that have changed so dramatically over the last two decades. What’s most remarkable is how software advances have made the PC an increasingly indispensable and versatile tool in the workplace, at home and at school.

Other electronic advances of this century, like the radio, the TV and the fax machine–while breakthroughs to be sure–have but one use. Software makes the PC, by comparison, a multi-talented workhorse. Software powers the operations of the world’s largest businesses. It enables people to shop for cars, books, music or just about anything else from the convenience of their home. Software facilitates instantaneous communication between people living in Sydney and São Paulo. And it helps junior high school students in New York do research for their classes.

Even more amazing are the opportunities ahead. As software grows increasingly dynamic, flexible and responsive, the PC is becoming the hub of an expanding universe of software-connected devices that will enable businesses and people to realize their potential.

2001

Fiscal 2001 was a year of solid customer enthusiasm for Microsoft products and services– all the more significant considering the challenging economic climate and turbulence in the technology industry. Revenues increased by $2.34 billion to $25.3 billion, and operating income increased by $710 million to $11.72 billion.

The Windows family of products turned in a strong performance, led by brisk sales of Windows 2000 Professional. Microsoft SQL Server™ 2000 and Exchange 2000 Server drove record revenues for Microsoft’s rapidly growing enterprise server business. Our productivity and business-services offerings expanded significantly with the launch of Office XP–the newest version of Microsoft’s business productivity suite–and the acquisition of Great Plains Software, Inc., a leading supplier of mid-market business applications. Microsoft’s consumer software and services business, led by MSN momentum, grew at an impressive 20 percent rate, despite a rugged environment in the online space.

2002

Building on Microsoft .NET–the company’s platform for next-generation software and services–fiscal 2002 promises to be a year of continued growth for Microsoft in five key areas:

• Expanding on the power and flexibility of the personal computer and taking the PC experience to the next level of opportunity for customers and the IT industry;

• Meeting the needs of business customers–from the enterprise to medium and small businesses–with a new generation of mission-critical servers and business applications;

• Taking advantage of key market opportunities in the consumer space with emerging businesses such as MSN, devices and games;

• Partnering with developers around the globe to create next-generation XML-based software applications, solutions and experiences;

• Capitalizing on the enormous potential of services delivered over the Internet and across an expanding range of devices.

Major product developments in Fiscal 2002 will include the launch of Windows XP–the most significant new desktop operating system product since Windows 95, and Xbox, Microsoft’s future-generation videogame system. We will extend and advance the range and abilities of Microsoft’s Windows .NET Server operating systems and .NET Enterprise Server applications, and deploy new solution offerings that help businesses connect with customers, integrate seamlessly with partners, enable employees and extend into new business opportunities. We will see continued adoption of our flagship Office XP suite for knowledge workers, and expansion of our Great Plains® business applications. The developer community is eagerly anticipating the release of Visual Studio® .NET, Microsoft’s rapid application-development tool for building next-generation Web applications and XML Web services. And we will continue to see significant growth in MSN Internet access and network services.

Microsoft .NET and XML Web Services

In addition to these major new product launches, Microsoft is laying a solid framework for the future with a projected investment of approximately $5 billion in research and development in fiscal 2002. At the center of our R&D efforts is Microsoft .NET, an innovative effort as significant in the development of computing as the graphical user interface and the introduction of the Internet. .NET is Microsoft’s platform for a new computing model built around XML Web Services. Just as the Web revolutionized how users interact with content, XML is revolutionizing how applications communicate with data and how computers and devices communicate–by providing a universal data format that lets information be easily shared, adapted or transformed. .NET will create new opportunities for Microsoft and for thousands of developers and industry partners by enabling constellations of PCs, servers, smart devices and Internet-based services to collaborate seamlessly. Businesses will be able to integrate their processes, share data and join forces to offer customers much more dynamic, personalized and productive experiences–across the PC and an expanding universe of devices–than are available today.

In 1995, Microsoft’s primary business and revenue stream was from our desktop products–Windows and Office. In 2002, desktop products will still provide the majority of our revenue, although our server and enterprise business is a rapidly growing contributor to our overall revenues, and MSN, Xbox and other emerging businesses continue to expand our foundation for the future. Over the next five years, as we infuse XML Web Services into all our businesses, we see the opportunities for growth continuing. This transformation is key to expanding our revenue stream moving forward.

People

As we expect to grow this year to more than 50,000 employees, we will continue to put a high priority on developing our next generation of business leaders, and ensuring that we have the appropriate management initiatives and tools to enable and empower a creative work environment. Our attrition rate–at 8 percent annually–is less than half the average of the overall software and IT-services industry. Meanwhile, we continue to explore new ways to foster a progressive work environment that attracts and inspires bright, passionate people who are committed to continuously improving our products, and to creating a collaborative work environment where individual excellence and teamwork is rewarded. Facilitating a diverse workforce at Microsoft and within our industry continues to be an important priority.

The Antitrust Lawsuit

Microsoft is committed to continuing to deliver innovations to customers and new opportunities for partners and the technology industry as a whole. The U.S. Court of Appeals ruling in the antitrust lawsuit significantly narrowed a lower court ruling that threatened to stifle industry innovation. We are continuing to work vigorously to resolve the remaining issues in the case in a manner that will provide clarity to Microsoft and the marketplace while enabling Microsoft to meet the needs of consumers and the industry.

Industry Leadership

As a successful company, we understand that we have a responsibility to provide leadership in the broader industry. Particularly given the difficult economic times, it’s important that our industry work together to build on the technological advances that have fueled productivity and growth over the last decade. Our work on .NET, XML Web Services and open industry standards are examples of the deep industry engagement to which Microsoft is dedicated. While vigorous competition will always be a healthy hallmark of our industry, we are also committed to building relationships–with partners and even competitors.

Two years ago, we outlined a set of values that have evolved since Microsoft’s founding and which capture the spirit of our business practices (microsoft.com/mscorp/values.htm). As we look to the future, the cultural assets that have been such an important part of Microsoft’s success over the past 25 years will continue to evolve. One of the most fundamental of these cultural attributes is our commitment to accountability. Accountability to customers by continuing to improve product satisfaction. Accountability to partners, including smaller businesses and start-ups,who share the vision of affordable, connected computing. Accountability to the technical community through support of resources that enable software developers to create the next generation of products and grow successful businesses. Accountability to shareholders by continuing to invest in growth opportunities for the future, while staying focused on managing our business today.

The Digital Decade

Over the past 20 years the personal computer has transformed the way people work, communicate, learn and play. It has stimulated productivity and collaboration in the workplace, connected people around the world, and become a powerful and affordable tool for learning and entertainment.

Yet even greater technological advances are just ahead. XML Web Services will open up new possibilities in e-commerce, business planning, and customer service. Document and workflow management will become simpler and more comprehensive. Technologies such as the advanced speech and handwriting-recognition capabilities of the next-generation Tablet PC will transform the workplace for knowledge workers. Inexpensive, high-capacity disk drives, powerful audio and video capabilities and easy-to-use digital cameras will make the PC an entertainment and information hub for the home.

More than 500 million PCs are already in use around the world, and another 130 million or more will be purchased in calendar 2001–more than the number of TVs that will likely be purchased this year. Increasingly, the PC is moving to the center of an ever-expanding network of smart, connected devices–from mobile phones to televisions and handheld devices, even household appliances. There has never been a more exciting time in the history of our industry.

The coming digital decade will be a time of enormous opportunity: for consumers, for the technology industry, and for Microsoft as we realize the vision of empowering people through great software–any time, any place and on any device.

Bill Gates Chairman and Chief Software Architect

Steven A. Ballmer Chief Executive Officer