To our shareholders, customers, partners, and employees:

A worldwide economic recession that created the most difficult business environment since the Great Depression made fiscal 2009 a challenging year for Microsoft Corp. But thanks to our fiscal strength and prudent approach to investment, a strong pipeline of products, and a renewed focus on efficiency, we responded to the changing economic environment with speed and success. Fiscal 2009 was also a year in which the company made important progress in key areas of product development and technology innovation that position us for strong growth in the years ahead.

The global recession had a major impact on the financial performance of companies around the world in virtually every industry in 2009, and Microsoft was no exception. As consumers and businesses reset their spending at lower levels, PC sales and corporate IT investments fell. As a result, Microsoft saw its first-ever drop in annual revenue, from $60.4 billion in fiscal 2008 to $58.4 billion in fiscal 2009, a decline of 3 percent. Operating income was $20.4 billion, down 9 percent. Earnings per share fell 13 percent to $1.62.

Despite the difficult economic conditions, we introduced an impressive range of innovative new software to the marketplace. Fiscal 2009 saw the successful launch of key products including Microsoft® SQL Server 2008, Microsoft Internet Explorer® 8, and Bing, the newest version of our Web search technology. With Silverlight™ 2, Microsoft Business Productivity Online Suite, Microsoft Exchange Online, and Microsoft SharePoint® Online we strengthened our position as a leader in software plus services and cloud computing. New and updated offerings for business customers included Windows® Small Business Server 2008, Windows Essential Business Server 2008, and Microsoft BizTalk®Server 2009. We also delivered pioneering new products that are fundamentally changing the way people use digital technology, including Microsoft Photosynth™, Microsoft Robotics Developer Studio 2008, and Microsoft Amalga™ Life Sciences 2009.

During fiscal 2009, we made a number of strategic acquisitions, including the interactive online gaming company BigPark; DATAllegro, a provider of breakthrough data warehouse technologies; and Zoomix, which develops software that automates the delivery and synchronization of enterprise data. We also acquired Powerset, a pioneer of the use of natural language processing in online search, and Greenfield Online, a leader in comparison shopping technology.

A Strong Response to a Difficult Economic Climate

The global recession created difficult challenges for Microsoft, and for our industry as a whole. But it also created significant opportunities.

Because we offer a wide range of affordable, high-quality products today that enable companies to improve productivity and reduce costs, Microsoft is well-positioned to weather the economic downturn and gain market share. As the global economy begins to recover, this will create new opportunities to increase revenue.

In addition, employees and company leaders responded to the economic downturn by sharpening Microsoft’s focus on our most important opportunities for growth now and in the future, and on finding opportunities to cut costs and use resources more effectively. All told, we reduced expenses by more than $3 billion compared with our original fiscal 2009 plan and we remain committed to controlling costs in fiscal 2010.

During fiscal 2009, we also made important adjustments to our cost structure through strategic job eliminations. The decision to eliminate up to 5,000 jobs was very difficult, but it was the right move because it has enabled us to focus resources where they can deliver the greatest results for the company. And we continue to recruit and hire the best talent from around the globe.

The company’s fiscal strength was an important factor in Microsoft’s ability to successfully weather the difficult financial markets that prevailed for most of fiscal 2009. Thanks to our excellent financial position, we announced a new $40 billion program in early fiscal 2009 to repurchase shares of our stock and increased the quarterly dividend. We also returned nearly $14 billion to shareholders through stock buybacks and dividends during the fiscal year.

We also took advantage of favorable market conditions in fiscal 2009 to authorize a $3.75 billion debt offering. As part of the debt authorization, Microsoft received a AAA credit rating from Standard & Poor’s, becoming the first U.S. corporation in a decade to be assigned S&P’s highest rating.

These steps have made Microsoft a stronger company — we are more efficient, agile, and competitive today than we were before the recession began.

Commitment to Innovation and an Unprecedented Pipeline of Products

The recession has not changed our fundamental approach to our business. Technological innovation has always been the foundation of Microsoft’s growth and success. We invest more in research and development to drive innovation than any other company in our industry, and the breadth and depth of our engineering and scientific talent is unmatched.

Despite the difficult economic conditions, we maintained our commitment to smart, long-term investment in research and development in fiscal 2009. During the year, we opened a new Microsoft Research lab in Cambridge, Massachusetts, and we launched our new Search Technology Center in Europe. All told, we invested $9 billion in research and development in fiscal 2009, an increase of about 10 percent.

Fiscal year 2009 saw many examples of how our emphasis on long-term innovation delivers value to customers and the company. In October, we introduced technical previews of Windows Azure, our new operating system for cloud computing, and the Azure Services Platform, which is a comprehensive set of storage, computing, and networking infrastructure services. These technologies — which allow developers to build applications that enable people to store and share information easily and securely in the cloud and access it on any device from any location — are key to Microsoft’s software plus services strategy and our future success.

Another example is Bing, which goes beyond what people have come to think of as search by delivering a powerful set of tools that enable people to make faster, more informed decisions.

We also unveiled “Project Natal” for Xbox 360®. This groundbreaking technology uses special sensors and software to track body movements, recognize faces, and respond to spoken directions and even changes in tone of voice.

The value of our approach can also be seen in the unprecedented pipeline of innovative products that reached significant development milestones during fiscal 2009 and are scheduled to be released in fiscal 2010.

In the coming year, we’ll roll out Windows 7, Office 2010, Windows Azure, Windows Server® 2008 R2, Windows Mobile® 6.5, and Silverlight 3.0. These are all important releases for the company, our partners, and our customers. Windows 7, in particular, is highly anticipated. This new version of our flagship desktop operating system has already received excellent reviews from the media, industry analysts, and thousands of customers who have tested pre-release versions.

Driving Future Transformation

Even as we moved forward with development of a new generation of software products in fiscal 2009 for release in fiscal 2010, scientists and engineers at Microsoft Research, Live Labs, Office Labs and other groups at Microsoft continued to focus on long-term research aimed at pioneering the next generation of breakthrough technologies.

Some of the areas that we believe offer the most important opportunities to deliver value and benefit to customers and partners while driving future profitable growth for Microsoft include:

  • Cloud computing and software plus services: The ability to combine the power of desktop and server software with the reach of the Internet is creating important opportunities for growth in almost every one of our businesses. We are focused on delivering end-to-end experiences that connect users to information, communications, entertainment, and people in new and compelling ways across their lives at home, at work, and the broadest-possible range of mobile scenarios.
  • Natural user interfaces: The next few years will also see dramatic changes in the way people interact with technology, as touch, gestures, handwriting, and speech recognition become a normal part of how we control devices. This will make technology more accessible and simpler to use and will create opportunities to reach new markets and deliver new kinds of computing experiences.
  • Natural language processing: As computing power increases, our ability to build software that understands users’ intentions based on what they have done in the past and then anticipate their future needs is rapidly improving. This will enable us to deliver a new generation of software that has the knowledge and intelligence to respond to simple natural language input and quickly carry out complex tasks in a way that accurately reflects users’ needs and preferences.
  • New scenario innovation: We are entering a period where continuing improvement in the power of computers and devices and the speed and ubiquity of networks is creating opportunities to address significant global issues including healthcare, environmental sustainability, and education. Software that enables people without specialized programming skills to quickly create models and simulations will transform scientific research and have a dramatic impact on a wide range of industries, from financial services, to engineering, aerospace, manufacturing, more.

    In the coming years, we will also see a dramatic transformation in the way people access and use digital technology at home, at work, and while traveling. Ubiquitous connectivity across devices will enable people to utilize data, applications, and social networks anywhere and at anytime. Rich client productivity tools, Web-based applications, unified communication solutions, and integrated business productivity servers and services will open the door to dramatic productivity gains. A new generation of software and services for the enterprise will enable information technology departments to automate the management and delivery of services and capabilities to employees and customers to dynamically match changing business requirements.

Investing in Communities and Fostering Opportunity

Our commitment to using the power of technology to help communities thrive and enable people around the world achieve their potential continues to drive our work at Microsoft. One of our most important goals is to expand access to the benefits of digital technology beyond the 1 billion people who use computers on a regular basis today.

We do this through Unlimited Potential, which offers programs such as the one that supports 37,000 technology training centers in 102 countries; and Partners in Learning, which has helped provide access to technology and technology training for more than 4 million teachers and 90 million students in over 100 countries.

We also offer special versions of our development software to students and entrepreneurs. Through DreamSpark™, high school and college students around the world can use and learn about cutting-edge software and Internet development technologies for free. In fiscal 2009, we launched BizSpark™, which provides startup companies with fast and easy access to Microsoft development tools and server products with no upfront costs, and offers special technical support and marketing programs that can help them succeed.

In fiscal 2009, we also launched Elevate America, a program designed to help U.S. workers who have been affected by the economic recession gain the skills needed to succeed in a technology- and information-driven economy.

A Catalyst for Productivity

A difficult economic climate made fiscal 2009 a challenging year for Microsoft and our entire industry. But our core values — fiscal conservatism, a long-term approach to research and development, and a deep commitment to the power of technology to improve people’s lives — have served the company well.

Although the economic climate is likely to remain challenging in fiscal 2010, our opportunities are greater than ever. We believe future economic growth around the world will be driven by productivity gains that come from continuing advances in software and digital technology.

Microsoft is in a great position to lead the way. With a superb pipeline of products and ongoing long-term investments in key technology areas such as cloud computing, natural user interfaces, scientific computing, and much more, we will continue to deliver innovations that help people lead richer, more productive, more creative, and more connected lives.

Your support enables us to pursue these opportunities to help people around the globe to achieve their potential. Thank you.

Steven A. BallmerSeptember 1, 2009
Chief Executive Officer