United States Securities and Exchange Commission

Washington, D.C. 20549

FORM 10-K

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED JUNE 30, 20062009

OR

^¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM             TO             

COMMISSION FILE NUMBER 0-14278

MICROSOFT CORPORATION

ONE MICROSOFT WAY, REDMOND, WASHINGTON 98052-6399

(425) 882-8080

www.microsoft.com/msft

Securities registered pursuant to Section 12(b) of the Act:

COMMON STOCK                                          NASDAQ

Securities registered pursuant to Section 12(g) of the Act:

NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes x    No¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes ¨    Nox

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x    No¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes ¨    No¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.¨x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a non-accelerated filer.smaller reporting company. See definitionthe definitions of “large accelerated filer,” “accelerated filerfiler” and large accelerated filer”“smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x            Accelerated filer ¨            Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ¨    Nox

As of December 31, 2005,2008, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $233,926,876,964$149,769,380,603 based on the closing sale price as reported on the NASDAQ National Market System. As of August 18, 2006,July 27, 2009, there were 9,969,991,8008,910,673,817 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held on November 14, 200619, 2009 are incorporated by reference into Part III.

Microsoft Corporation

FORM 10-K

For The Fiscal Year Ended June 30, 20062009

INDEX

 Part I 

Item 1

Special Note About Forward-Looking Statements

Certain statements in this report, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may appear throughout this report, including without limitation, the following sections: “Business”, “Management’s Discussion and Analysis”, and “Risk Factors.” These forward-looking statements generally are identified by the words “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “future,” “opportunity,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in the section entitled “Risk Factors” (refer to Part I, Item 1A). We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.

PART I

ITEM 1.    BUSINESS

GENERAL

Our mission is to enable people and businesses throughout the world to realize their full potential. We workSince the company was founded in 1975, we have worked to achieve ourthis mission throughby creating technology that transforms the way people work, play, and communicate. Since our founding in 1975, we have been a leader in this transformation. We develop and market software, services, hardware, and solutions that we believe deliver new opportunity,opportunities, greater convenience, and enhanced value to people’s lives. We do business throughout the world and have offices in more than 100 countries.

We generate revenue by developing, manufacturing, licensing, and supporting a wide range of software products and services for many different types of computing devices. Our software products and services include operating systems for servers, personal computers, and intelligent devices; server applications for distributed computing environments; information worker productivity applications; business solutionsolutions applications; high-performance computing applications, andapplications; software development tools.tools; and video games. We provide consulting and product and solution support services, and we train and certify computer system integrators and developers. We also design and sell hardware including the Xbox 360 video game console, the Zune digital music and games, PC games,entertainment device, and peripherals. Online offerings and information are delivered through ourBing, Windows Live, Office Live, andour MSN portals and channels.channels, and the Microsoft Online Services platform which includes offerings for businesses such as Microsoft Dynamics CRM Online, Exchange Hosted Services, Exchange Online, and SharePoint Online. We enable the delivery of online advertising across our broad range of digital media properties and on Bing through our proprietary adCenter platform.

We also conduct research and develop advanced technologies for future software products.products and services. We believe that delivering breakthrough innovation and high-value solutions through our integrated software platform is the key to meeting our customers’ needs and to our future growth. We believe that over the past few years we have laidwill continue to lay the foundation for long-term growth by delivering innovative new products and services, creating new opportunities for partners, improving customer satisfaction, putting many of our most significant legal challenges behind us, and improving our internal processes. Our focus is to build on this foundation by continuing to innovate onthrough ongoing innovation in our integrated software platform,platforms; by delivering compelling value propositions to customers,customers; by responding effectively to customer and partner needs,needs; and by continuing to focus internally onemphasize the importance of product excellence, business efficacy, and accountability. Our research and development facilities are located primarily in Redmond, Washington. We also have smaller research facilities in other parts of the United States and around the world, including, but not limited to, China, Denmark, England, India, Ireland, and Israel.

OPERATING SEGMENTS

We have five operating segments: Client, Server and Tools, Online Services Business, Microsoft Business Division, and Entertainment and Devices Division. Our segments provide management with a comprehensive financial view of our key businesses. The segments provide a framework forenable the alignment of strategies and objectives across the development, sales, marketing, and services organizations, and they provide a framework for the timely and rational allocation of development, sales, marketing, and services resources within businesses. The segments also help focus strategic planning efforts on key objectives and initiatives across our businesses.

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Due to our integrated business structure, operating costs included in one segment may benefit other segments. Therefore, these segments are not designed to measure operating income or loss that is directly related to the products and services included in each segment. Inter-segment cost commissions are estimated by management and used to compensate or charge each segment for such shared costs and to motivate shared effort. Segments should not be viewed as discrete or easily separable businesses.

For the fiscal years covered by this filing, our seven segments were: Client; Server and Tools; Information Worker; Microsoft Business Solutions; MSN; Mobile and Embedded Devices; and Home and Entertainment. See Note 18 – Segment Information of the Notes to Financial Statements for financial information regarding segment reporting. On July 17, 2006, we announced a change in our operating segments reflecting the culmination of the business realignment announced in September 2005. These changes will be effective for fiscal year 2007; the seven segments discussed in this section are presented in the way we internally managed and monitored performance at the business group level in fiscal year 2006, 2005, and 2004.

Client

Client has overall responsibility for the technical architecture, engineering, and product delivery of our Windows product family and is also responsible for our relationships with personal computer manufacturers, including multinational and regional original equipment manufacturers (“OEMs”). The segment includes sales and marketing expenses for the Windows client operating system and product development efforts for the Windows platform. Client revenue growth is correlated with thedirectly impacted by growth of PC purchases of personal computers from OEMs that pre-install versions of Windows operating systems because the OEM channel accounts for over 80% of total Client revenue. The differences between unit growth rates and revenue growth rates from year to year are affected primarily by changes in the mix of OEM Windows premium edition operating systems licensed as a percentage of total OEM Windows operating systems licensed (“OEM premium mix”). Additional differences in growth rates result from the impact from lower cost netbook PCs, which are sold with a lower cost version of Windows, changes in geographic mix, and changes in the channel mix of products sold by large, multi-national OEMs versus those sold by local and regional system builders.

The next generationmajority of revenue in fiscal year 2009 came from sales of Windows Vista, which was released in fiscal year 2007. Windows XP operating systems reached end-of-life for most editions and sales channels (Windows XP Home Edition will continue to be available on netbooks and other Windows XP editions will continue to be available in China). Windows 7, the latest version of Windows, was released to manufacturing in July 2009 and is expected to be generally available on October 22, 2009.

Client offerings consist of premium and standard edition Windows operating system,systems. Premium editions are those that include additional functionality and are sold at a price above our standard editions.

Products:    Windows Vista, is under development. This development phase represents a major investment that we expect will result in a significantly more manageableincluding Home Basic, Home Premium, Ultimate, Business, Enterprise, and powerful PC operating system than previously released by Microsoft. Windows Vista will include advances in security, digital media, user interfaces, and other areas that will enhance the user and developer experience.

Products:Starter Edition; Windows XP, including Professional, and Home;Home, Media Center, Edition;and Tablet PC Edition; and other standard Windows operating systems.

Competition

Client faces strong competition from well-established companies with differing approaches to the PC market. Competing commercial software products, including variants of Unix, are supplied by competitors such as Apple, Computer, Hewlett-Packard, IBM,Canonical, and Sun Microsystems.Red Hat. Apple takes an integrated approach to the PC experience and has made inroads in share, particularly in the U.S. and in the consumer segment. The Linux operating system, which is also derived from Unix and is available without payment under a General Public License, has gained some acceptance, especially in emerging markets, as competitive pressures lead PC OEMs to reduce costs. costs and new, lower-price PC form-factors gain adoption. Partners such as Hewlett-Packard and Intel have been actively working with alternative Linux-based operating systems.

The Windows operating system also faces competition from alternative platforms and new devices that may reduce consumer demand for traditional personal computers.PCs. Competitors such as Apple, Google, Mozilla, and Opera Software Company offer software that competes with the Internet Explorer Web browsing capabilities of Windows products. Apple Computer, Real Networks,User and others competeusage volumes on mobile devices are increasing around the world relative to the PC. OEMs have been working to make the Google Android mobile operating system more compatible with Windows Media Player. small form-factor PCs or netbooks.

Our operating system products compete effectively by delivering innovative software, giving customers choice and flexibility, a familiar, easy-to-use interface, compatibility with a broad range of hardware and software applications, and the largest support network for any operating system.

Server and Tools

Server and Tools develops and markets software server products, software developer tools, services, and solutions. Windows Server products, including Windows Server operating systems. Windows ServerServer-based products are integrated server infrastructure and middleware software that are designed to support end-to-end software applications and tools built on the Windows Server 2003 operating system. Windows ServerServer-based products include the server platform including targeted segment solutions, database, storage, management and operations, service-oriented

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architecture platform, and security applications and collaborationidentity software. The segment also builds standalone and software development lifecycle tools for software architects, developers, testers, and project managers. Server products can be run on-site, in a partner-hosted environment, or in a Microsoft-hosted environment.

We offer a broad range of consulting services and provide product support services. The segmentservices that assist customers in developing, deploying, and managing Microsoft server and desktop solutions. We also providesprovide training and certification to developers and information technology professionals about our Server and PCTools, Microsoft Business Division, and Client platform products.

Approximately 50% of Server and Tools also includes the Enterprise Partner Group, which is responsible for sales, partner management and partner programs for medium and large organizations; and the Public Sector sales and marketing organization.

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Approximately half of Server revenue comes from multi-year licensing agreements, one thirdapproximately 20% is purchased through fully packaged product and transactional volume licensing programs, and approximately 10% comes from licenses sold to OEMs. Approximately 15%The remainder of Server and Tools revenue comes from consulting and product and solution support services.

Windows Server 2008 R2, the latest version of the Windows Server operating system was released to manufacturing in July 2009 and is expected to be generally available in September 2009.

Products and Services:Services:    Windows Server operating system; Microsoft SQL Server; Exchange Server; Microsoft Consulting Services; product support services; Visual Studio; Silverlight; System Center products; Forefront security family of products; and Biz Talk Server, among others.Server; Microsoft Consulting Services; Premier product support services; and other products and services.

Competition

Our server operating system products face intense competition from a wide variety of server operating systems and server applications, offered by companies with a variety of market approaches. Vertically integrated computer manufacturers such as Hewlett-Packard, IBM, and Sun Microsystems offer their own variantversions of the Unix operating system preinstalled on server hardware. Nearly all computer manufacturers offer server hardware for the Linux operating system. IBM’s endorsementsystem and many contribute to Linux operating system development. The competitive position of Linux has aided the acceptance of Linux as an alternative to Unix and Windows server operating systems. Linux’s competitive position has also benefited from the large number of compatible applications now produced by many leading commercial software developers and non-commercial software developers. A number of companies supply versions of Linux, including Novell and Red Hat.

We have entered into business and technical collaboration agreements with Novell and other Linux providers to build, market, and support a series of solutions to enhance the interoperability of our products with their virtualization, management, and network security solutions, and to provide each other’s customers with patent coverage for their respective products.

We compete in the business of providingto provide enterprise-wide computing solutions with several companies that provideoffer solutions and middleware technology platforms. IBM, Oracle, and Sun Microsystems lead a group of companies focused on the Java 2 Platform Enterprise Edition (J2EE). Commercial software developers that provide competing server applications for PC-based distributed client/server environments include CA, Inc., IBM, and Oracle. Our Web application platform software competes with open source software such as Apache, Linux, MySQL, and PHP, and we compete against Java middleware such as Geronimo, JBoss, and Spring Framework.

Numerous commercial software vendors offer competing commercial software applications for connectivity (both Internet and intranet), security, hosting, and e-business servers. System Center competes with server management and server virtualization platform providers, such as BMC, CA, Inc., Hewlett-Packard, IBM, and IBMVMWare in the Managementmanagement of IT infrastructures, whileinformation technology infrastructures. Forefront Security competessecurity products compete with McAfee, Symantec, and Trend Micro in protecting both client and server applications. In addition, IBM has a large installed base of Lotus Notes and cc:Mail, both of which compete with our collaboration and e-mail products. Non-commercial software products, including the widely-deployed Apache Web Server, also compete with our solutions. Our products for software developers compete against offerings from Adobe, BEA Systems, Borland, IBM, Oracle, Sun Microsystems, other companies, and other companies.open-source projects. Open source projects include Eclipse (sponsored by CA, IBM, Oracle, and SAP), PHP, and Ruby on Rails, among others. We believe that our server products provide customers with advantages in innovation, performance, total costs of ownership, and productivity by delivering superior applications, development tools, and development environment, compatibility with a broad base of hardware and software applications, security, and manageability.

Information WorkerOnline Services Business

Information WorkerThe Online Services Business (“OSB”) consists of an online advertising platform with offerings for both publishers and advertisers, online information offerings such as Bing, MSN Portals and channels, and personal communications services such as email and instant messaging around the Microsoft Office system of programs,world. We earn revenue primarily from online advertising, including search, display, and email and messaging services. Revenue is also generated through subscriptions and transactions generated from online paid services, from advertiser and software solutions designedpublisher tools, and digital marketing and advertising agency services. We continue to increase personal, team,launch updated and organization productivity. The Office systemnew online offerings generate over 85% of Information Worker revenue. Revenue growth depends on our ability to add value to the core Office product set and expect to continue to expand our product offeringsdo so in other information worker areas such as enterprise content management, collaboration, unified messaging, and business intelligence.

Approximately 40% of Information Worker revenue has come from multi-year license agreements with large enterprises. Revenues from these licenses generally depend upon the number of information workers in a licensed enterprise. Revenue from this category of agreements is therefore relatively independent of the number of PCs sold in a given year. Consequently, general employment levels, particularly in North America and Europe, significantly affect Information Worker revenue. Approximately 40% of Information Worker revenue comes fromfuture. During fiscal year 2009, we launched new licenses acquired through fully packaged product and volume licensing programs to individual consumers and enterprises of all sizes. Most of this revenue is sensitive to information technology budgets, which often depend on general economic conditions. The remaining approximately 20% of Information Worker revenue comes from licenses to OEMs for new PCs and is affected by the level of PC shipments. The next wavereleases of our flagship product, the 2007 Microsoft Office system, is currently under development.proprietary advertising platforms, adCenter

Products:    Microsoft Office; Microsoft Project; Microsoft Visio; SharePoint Portal Server CAL; Microsoft Live Meeting; One Note; and Office Communication Server.

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Competition

and local application developers in EuropeadExpert, and Asia. IBM (Smartsuite)launched a new release of our search engine named Bing. We also updated behavioral targeting tools, launched new releases of MSN properties globally, and Corel (WordPerfect Suite) have measurable installed bases with their office productivity products. Apple may distribute certain of their application software products with various models of their PCs. The OpenOffice.org project provides a freely downloadable cross-platform application that also has been adapted by various commercial software vendors to sell under their brands, including IBM, Novell, Red Hat, and Sun. Corel’s suite and many local software suites around the world are aggressively priced for OEMs to preinstall on low-priced PCs. In addition to traditional client-sideadded applications Web-based offerings such as AjaxWrite, gOffice, iNetOffice, SimDesk, ThinkFree, wikiCalc, or other small projects competing with individual applications, can also provide an alternative to Microsoft Office system products. Google has announced spreadsheet and word processing applications as web-based offerings and also provides an enterprise search offering that competes with SharePoint and our new enterprise search product. IBM has many different points of competition with Office system products with its Notes and Workplace offerings.

As we continue to respond to market demand for additional functionality and products, we will compete with additional vendors, most notably in enterprise content management, collaboration tools, unified messaging, and business intelligence. These competitors include WebEx, and a number of business intelligence vendors such as Business Objects, Cognos, and Hyperion.

Microsoft Business Solutions

Microsoft Business Solutions is responsible for Microsoft Dynamics brand business applications for small and mid-size businesses, large organizations and divisions of global enterprises. It offers financial management, customer relationship management, supply chain management, and analytics applications. Revenue is derived from software and services sales, with software sales representing a large majority of total revenue. Software revenues include both new software licenses and enhancement plans, which provide customers with future software upgrades and on-line training over the period of the plan. The solutions are delivered through a worldwide network of channel partners and independent software vendors that provide services, additional related software, and local support.to our existing Windows Live suite.

Products:Products and Services:    Bing; Microsoft Dynamics AX;adCenter/adExpert; Microsoft Dynamics CRM; Microsoft Dynamics GP; Microsoft Dynamics NAV; Microsoft Dynamics SL; Microsoft Dynamics Retail Management System; Microsoft Partner Program; and Microsoft Office Small Business Accounting.

Competition

Our competition varies based upon the size and geographic location of the customer for whom we are competing. We compete with well-known vendors such as Intuit and Sage in the market focused on providing solutions for small and mid-sized businesses. The market for large organizations and divisions of global enterprises continues to be intensely competitive with a small number of primary vendors including Oracle and SAP. Additionally, these large enterprise-focused vendors are repositioning some of their business applications to focus on small and mid-sized businesses. We believe our products compete effectively with these vendors based on our strategy of providing integrated, adaptable solutions that work like and with Microsoft technologies our customers already have.

MSN

MSN provides personal communications services, such as e-mail and instant messaging, and online information offerings such as MSN Search, MapPoint, and theMedia Network (MMN); MSN portals, channels, and channels around the world. MSN also provides a variety of online paid offerings. MSN manages many of its own properties, including health, autos, and shopping. MSN also creates alliances with third parties for many channels, including CareerBuilder.com, Expedia.com, Foxsports.com, Match.com, and MSNBC.com.

MSN generates revenue primarily from advertisers on MSN, from consumers and partners through subscriptions and transactions, and from MSN narrowband Internet access subscribers. In fiscal year 2006, we launched MSN adCenter – our internally developed advertising platform – in certain international markets and throughout the U.S. where it now serves 100 percent of paid search traffic on our online properties. We believe MSN adCenter will enable us to increase both display and search advertising revenues by reducing our reliance on third parties for delivering

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ads. In fiscal year 2006, we announced Windows Live™, a set of Internet services and software designed to improve the users’ connected experience and we releasedmobile services; Windows Live Messenger to consumers in 58 countries.

Products:    MSN Search; MapPoint; MSN Internet Access;suite of applications and mobile services; Atlas online tools for advertisers and publishers; MSN Premium Web Services (consisting of MSN Internet Software Subscription, MSN Hotmail Plus, MSN Bill Pay, and MSN Radio Plus)Software Services); Windows Live; and MSN Mobile Services.Razorfish media agency services.

Competition

MSNOSB competes with AOL, Google, Yahoo!, and a wide array of Web sites and portals that provide content and online offerings of all types to end users. We compete with these organizations to provide advertising opportunities for merchants. MSN also competes for narrowband Internet access users with AOL, Earthlink, and other ISPs for dial-up internet access in the United States. Due to the continuing trend of consumers migrating from narrowband to broadband Internet access, we expect our narrowband Internet access subscriber base to continue to decline as we de-emphasize this portion of our business. The Internet advertising industry has grown significantly over the past several years, and we anticipate that this trend will continue.continue long-term. Competitors are aggressively developing Internet offerings that seek to provide more effective ways of connecting advertisers with audiences through enhanced functionality in communication services, improvements in information services such as Internet search, improvements in communication services, and improved advertising infrastructure and support services. We have developedbelieve our own algorithmic search engine, to provide endBing, helps users withmake faster, more informed decisions by providing more relevant search results, expanded search services, and a broader selection of content, and expandedcontent. We have also enhanced the user interface to bring a richer search services.experience, which we believe will differentiate us from our competitors. To support the growth of our advertising business, we also are investing in improving the scale of our advertising platform, seamless integration of content and offerings to the mobile platform, rich and relevant content for wider consumer reach, enhanced communication services, technology, and operations, andalong with sustained sales efforts. We will continue to introduce new products and services, including the Windows Live set of services that are aimed at attracting additional users through improvements in the user online experience. We believe that we can compete effectively across the breadth of our Internet services by providing users with software innovation in the form of information and communication services that help them find discover, and experience whatuse the information and experiences they want online and by providing merchants with effective advertising results through improved systems and sales support.

MobileMicrosoft Business Division

Microsoft Business Division (“MBD”) offerings consist of the Microsoft Office system and Embedded Devices

MobileMicrosoft Dynamics business solutions. Microsoft Office system products are designed to increase personal, team, and Embedded Devices developsorganization productivity through a range of programs, services, and markets products that extendsoftware solutions. Growth of revenue from the Windows platformMicrosoft Office system offerings, which generate over 90% of MBD revenue, depends on our ability to mobile devicesadd value to the core Office product set and to continue to expand our product offerings in other information worker areas such as PDAscontent management, enterprise search, collaboration, unified communications, and phones,business intelligence. Microsoft Dynamics products provide business solutions for financial management, customer relationship management, supply chain management, and to embedded devices. Microsoft’s visionanalytics applications for mobile devices is rooted insmall and mid-size businesses, large organizations, and divisions of global enterprises.

We evaluate MBD results based upon the convergencenature of the computingend user in two primary parts: business revenue, which includes Microsoft Office system revenue generated through volume licensing agreements and wireless industries,Microsoft Dynamics revenue; and consumer revenue, which we believe creates new opportunities to improve communication and information access for customers. We see software as a key differentiator in making smart devices and wireless data services valuable to customers through rich experiences such as mobile messaging, location-based services, media, and speech recognition. We are working closely with mobile operators and with hardware and software partners to accelerate the development and availability of smart devices and services, and to provide a broad range of choices for customers. The segment is also responsible for managing our company-wideincludes revenue from retail packaged product sales and customer relations with device manufacturersOEM revenue. Approximately 80% of MBD revenue is generated from sales to businesses. Revenue from this category generally depends upon the number of information workers in a licensed enterprise and other communication-sector customers, which includes network service providersis therefore relatively independent of the number of PCs sold in a given year. Approximately 20% of MBD revenue is derived from sales to consumers. Most of this revenue is generated from new licenses acquired through fully packaged products and medialicenses sold through OEMs for new PCs and entertainment companies. Windows Embedded is a suitegenerally affected by the level of operating systems, tools,PC shipments and technologies that are specifically designed for today’s advanced embedded devices.product launches.

Products:Products:    Windows Mobile software platform; Windows Embedded device operating system;Microsoft Office; Microsoft Office Project; Microsoft Office Visio; Microsoft Office SharePoint Server; FAST ESP; Microsoft Exchange Server; Microsoft Exchange Hosted Services; Microsoft Office Live Meeting; Microsoft Office Communications Server; Microsoft Office Communicator; Microsoft Tellme Service; Microsoft Dynamics ERP products including AX, NAV, GP, SL, Retail Management System, and Windows Automotive.

Competition

Windows Mobile software faces substantial competition from Nokia, Openwave Systems, Palm, QUALCOMM, Research In Motion,Point of Sale; Microsoft Dynamics CRM; and Symbian. The embedded operating system segment is highly fragmented with many competitive offerings. Key competitors include IBM, Wind River, and versions of embeddable Linux from commercial Linux vendors such as Metrowerks and MontaVista Software. The telematics market is also highly fragmented, with competitive offerings from IBM and automotive suppliers building on various real-time operating system platforms from commercial Linux vendors, QNX Software Systems, Wind River, and others. We believe that our products compete effectively by providing a familiar development framework, which enables developers to easily write and deploy innovative applications for mobile or embedded devices. We also compete by providing a flexible platform that allows customers and partners to build differentiated and profitable business models, and by providing end users with benefits such as ease of use, personal productivity, and better information management and control.Microsoft Dynamics CRM Online.

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Home and EntertainmentCompetition

HomeCompetitors to the Microsoft Office system include many software application vendors such as Adobe, Apple, Corel, Google, IBM, Novell, Oracle, Red Hat, Zoho, and local application developers in Asia and Europe. Apple may distribute certain versions of its application software products with various models of its PCs and through its mobile devices. Corel (WordPerfect Suite) and IBM (Smartsuite) have measurable installed bases with their office productivity products. Corel’s suites, and many local software suites around the world, are aggressively priced for OEMs to preinstall them on low-priced PCs. Google provides Google Apps, a hosted messaging and productivity suite that competes with Microsoft Office, Microsoft Exchange, and Microsoft SharePoint Server, and also provides an enterprise search offering that competes with Microsoft Search Server. IBM competes with Office system products with its Notes and Workplace offerings. The OpenOffice.org project provides a freely downloadable cross-platform application that also has been adapted by various commercial software vendors to sell under their brands, including IBM, Novell, Red Hat, and Sun Microsystems. Web-based offerings such as 37Signals, Adobe, AjaxWrite, gOffice, ShareOffice, Socialtext, ThinkFree, Zoho, or other small projects competing with individual applications, can also provide an alternative to Microsoft Office system products. Our Microsoft Dynamics products compete with well-known vendors such as Intuit and Sage in the market focused on providing solutions for small and mid-sized businesses. The market for large organizations and divisions of global enterprises is intensely competitive with a small number of primary vendors including Oracle and SAP. Additionally, Salesforce.com’s on-demand customer relationship management offerings compete directly with Microsoft Dynamics CRM Online and Microsoft Dynamic CRM’s on-premise offerings.

As we continue to respond to market demand for additional functionality and products, we will compete with additional vendors, most notably in content management and enterprise search, collaboration tools, unified communications, and business intelligence. These competitors include Autonomy, Cisco, Endeca, Google, IBM, Oracle, and SAP. We believe our products compete effectively with all of these vendors based on our strategy of providing flexible, easy to use solutions that work well with technologies our customers already have.

Entertainment and Devices Division

The Entertainment and Devices Division (“EDD”) is responsible for development, production,developing, producing, and marketing for the Xbox video game system, including consoles and accessories, third-party games, games published under the Microsoft brand, and Xbox Live operations, as well as research, and sales, and support.support of those products. In addition to Xbox, we offer several types ofEDD offers the Zune digital music and entertainment products, includingdevice and accessories; PC software games,games; online games,games; Mediaroom, our Internet protocol television software; the Microsoft Surface computing platform; and other devices. The segmentmobile and embedded device platforms. EDD also leads the development efforts of our Consumer Productivity Experience Group (“CPxG”) which includes Microsoft’s line of consumer software and hardware products such as the Encarta line of learning products and services,including application software for Macintosh computers and Microsoft PC hardware products, such as mice and keyboards. In addition, the segment carries outis responsible for all retail sales and marketing for Microsoft Office and the Windows operating systems (for which it receives an inter-segment commission), Xbox, PC games, and CPxG products. It also is responsible for the development, sales, and deployment of Microsoft’s TV platform products for the interactive television industry, including MSTV Foundation Edition and Internet Protocol TV products.systems.

Products:Products:    Xbox 360; Xbox;360 console and games; Xbox Live; CPxG (consumerZune; Mediaroom; numerous consumer software and hardware products)products (such as mice and keyboards); Windows Mobile software and IPTV.services platform; Windows Embedded device operating system; Windows Automotive; and the Microsoft Surface computing platform.

Competition

The homeEntertainment and entertainment business isdevices businesses are highly competitive, characterized by rapid product life cycles, frequent introductions of new products and titles, and the development of new technologies. The markets for our products are characterized by significant price competition. We anticipate continued pricing pressure from our competitors. From time to time, we have responded to this pressure by reducing prices on certain products. Our competitors vary in size from very small companies with limited resources to very large, diversified corporations with substantial financial and marketing resources. We compete primarily on the basis of product innovation, quality and variety, timing of product releases, and effectiveness of distribution and marketing.

Our Xbox hardware business competes with console platforms from Nintendo and Sony, both of which have a large, established base of customers. The lifecycle for video game consoles averages 5five to 710 years. We released Xbox 360, our nextsecond generation console, in November 2005. Nintendo and Sony have also announcedreleased new versions of their game consoles which have not been released. Success in late 2006. We believe the transition to the next generationsuccess of video game consoles will depend onis determined by the availability of games for the console, providing exclusive game content that gamers seek, the computational power and reliability of the console, and the ability to create new revenue sources such as advertisingexperiences via online services, downloadable content, and downloadable content.peripherals. We believe

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think the Xbox 360 is positioned well against competitive console products based on significant innovation in hardware architecture, new developer tools, expanded revenue sources,online gaming services, and continued strong exclusive content from our own game franchises such as Halo.franchises.

In addition to competing against software published for non-Xbox platforms, our games business also competes with numerous companies that we have licensed to develop and publish software for the Xbox consoles. Zune competes with Apple and other manufacturers of digital music and entertainment devices. Our PC hardware products face aggressive competition from computer and other hardware manufacturers, many of which are also current or potential partners. Our MSTV businessMediaroom faces competition primarily from ad hoc solutionsa variety of competitors that address sub-segmentsprovide elements of the TVan Internet protocol television delivery platform, but that do not provide end-to-end solutions for the network operator. Windows Mobile software and services faces substantial competition from Apple, Google, Nokia, Openwave Systems, Palm, QUALCOMM, Research In Motion, and Symbian. The embedded operating system business is highly fragmented with many competitive offerings. Key competitors include IBM, Intel, and versions of embeddable Linux from commercial Linux vendors such as Metrowerks and MontaVista Software.

OPERATIONS

To serve the needs of customers around the world and to improve the quality and usability of products in international markets, we “localize”localize many of our products to reflect local languages and conventions. Localizing a product may require modifying the user interface, altering dialog boxes, and translating text.

Our operational centers support all operations in their regions, including customer contract and order processing, credit and collections, information processing, and vendor management and logistics. The regional center in Ireland supports the EMEAEuropean, Middle Eastern, and African region; the center in Singapore supports the Japan, Greater China and Asia-Pacific region; and the centers in Fargo, North Dakota, Fort Lauderdale, Florida, Puerto Rico, Redmond, Washington, and Reno, and RedmondNevada support NorthLatin America and LatinNorth America. In addition to the operational centers, we also operate data centers throughout the United States and in Europe.

We contract most of our manufacturing activities to third parties who produce thefor Xbox 360 and related games, Zune, various retail software packaged products, and Microsoft hardware.hardware to third parties. Our products may include some components that are available from only one or limited sources. Our Xbox 360 console includes certain key components that are supplied by a single source. The central processing unit is purchased from IBM and the graphics chips and embedded dynamic random access memory chips for the graphics processing unit are purchased from Taiwan Semiconductor Manufacturing Company and NEC Corporation, respectively.Company. Although we have chosen to initially source these key Xbox 360 components from

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a single supplier, we are under no obligation to exclusively source components from these vendors in the future. Beyond the exceptions noted, we generally have the ability to use other custom manufacturers if the current vendor becomes unavailable. We generally have multiple sources for raw materials, supplies, and components, and are often able to acquire component parts and materials on a volume discount basis.

PRODUCTRESEARCH AND DEVELOPMENT

During fiscal years 2006, 2005,2009, 2008, and 2004,2007, research and development expense was $6.58$9.0 billion, $6.10$8.2 billion, and $7.74$7.1 billion, respectively. ThoseThese amounts represented 14.9%15%, 15.3%14%, and 21.0%14%, respectively, of revenue in each of those years. We plan to continue to make significant investmentinvestments in a broad range of research and product development.development efforts.

MostWhile most of our software products are developed internally. Weinternally, we also purchase technology, license intellectual property rights, and oversee third-party development and localization of certain products. We believe we are not materially dependent upon licenses and other agreements with third parties relating to the development of our products. Internal development allows us to maintain closer technical control over our products. It also gives us the freedom to decide which modifications and enhancements are most important and when they should be implemented. Generally, we also create product documentation internally. We strive to obtain information at the earliestas early as possible time about changing usage patterns and hardware advances that may affect software design. Before releasing new software platforms, we provide application vendors with a range of resources and guidelines for development, training, and testing.

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Investing in Business and Product Development Strategy.

Innovation is a key factor affectingthe foundation for Microsoft’s growth. In fiscal year 2006,success. Our model for growth is based on our ability to initiate and embrace disruptive technology trends, to enter new markets, both in terms of geographies and product areas, and to drive broad adoption of the products and services we received our 5,000^th patent.develop and market. We continuemaintain our long-term commitment to research and development including advanced work aimed at innovations inacross a wide spectrum of technologies:technologies, tools, and platforms;platforms spanning communication collaboration and expression;collaboration; information access and organization; entertainment; business and e-commerce; advertising; and devices. Through innovations in these areas,

Increasingly, we expectare taking a global approach to grow revenue via three principal strategies:

Leading the Software Services Transformation

Internet-based servicesexample, computing will connect personal health information to medical research and help make healthcare more preventive, personalized, and cost-effective. Today, Microsoft products such as HealthVault and Amalga help individuals manage their personal health and enable healthcare professionals to integrate research and health information so they can deliver more effective care. We also believe that we are transforming the way people create, deploy, manage and use technology. We are committed to playingentering a leadershipperiod where personal computers will play an increasingly important role in the software services transformation through our efforts to create our services platform for the next generationvirtually every field of applications, communications,scientific research and commerce. Across the company, software services are at the core of our development efforts.discovery.

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In fiscal year 2006, we introduced Windows Live and Office Live, which provides small businesses with affordable Internet-based business services hosted by Microsoft. We rolled out new search services, including beta releases of Windows Live Search and Windows Live Academic Search. We introduced new and enhanced services for computer safety and computer maintenance (Windows Live SafetyCenter and Windows Live OneCare), communications (Windows Live Mail and Windows Live Messenger), and entertainment (Xbox Live). We also created Live Labs, an applied research program that targets Internet products and services.

Intelligent computing

As computing power increases, our advertising engine for Windows Live, MSN and other online offerings. We will deploy new service-based solutions, including Dynamics CRM Live, which we announced in July 2006. We will also continueability to build out our services infrastructure, providingsoftware that has the intelligence to understand a user’s preferences based on the tools and information they have accessed in the past and anticipate their future needs is rapidly improving. This development will enable us to deliver a new toolsgeneration of software solutions that make people more productive by enabling them to help partnersfocus more on what they want to accomplish and businesses create and host services, and adding new data centersless on the steps needed to meet growing consumer demand for services.use technology.

DISTRIBUTION, SALES, AND MARKETING

We distribute our products primarily through the following channels: OEM; distributors and resellers; and online.

OEM.    Our operating systems are licensed primarilyOEM

We license our software to OEMs under agreements that grantfor distribution as pre-installed software on new PCs. The most significant part of the OEMsOEM business for us is licensing of the right to build computing devices based on ourWindows operating systems, principally PCs. Under similar arrangements, wesystem. We also market and license certain server operating systems, desktop applications hardware devices,such as our Office productivity suite, and consumer software products and we market hardware devices, and software as services including our Windows Live Essentials suite to OEMs. We have OEM agreements covering one or more of our products with virtually all of the major PC OEMs, including Acer, ASUSTek, Dell, Fujitsu, Fujitsu Siemens Computers, Gateway, Hewlett-Packard, Lenovo, NEC, Samsung, Sony, and Toshiba. A substantial amount of OEM business is also conducted with system builders, which are low-volume, customized PC vendors operating in local markets.

Distributors and Resellers.Resellers

We license software to organizations under arrangements that allow the end-user customer to acquire multiple licenses of products. Organizations license our products primarily through large account resellers (“LARs”), direct market resellers, and value-added resellers (“VARs”). Many organizations that license products through enterprise agreements (“EAs”) transact directly with us, with sales support from our Enterprise Software Advisor channel partners. These Enterprise Software Advisors typically are also authorized as LARs and operate as resellers for our other licensing programs. Although each type of reselling partner reaches organizations of all sizes, LARs are primarily engaged with large organizations and VARs typically reach the breadth of small- and medium-sized organizations. Some of our distributors include Ingram Micro and Tech Data, and some of our largest resellers include CDW, Dell, Insight Enterprises, Software House International, and Software Spectrum.Insight Enterprises. Our business solutionsMicrosoft Dynamics software offerings are licensed to enterprises through a global network of channel partners providing vertical solutions and specialized services. We distribute our finished goods products primarily through independent non-exclusive distributors, authorized replicators, resellers, and retail outlets. Individual consumers obtain our products primarily through retail outlets, including Best Buy, Target, and Wal-Mart. We have a network of field sales representatives and field support personnel that solicits orders from distributors and resellers and provides product training and sales support.

Our arrangements for organizations to acquire multiple licenses of products are designed to provide them with a means of doing so without having to acquire separate packaged product through retail channels. In delivering organizational licensing arrangements to the market, we use different programs designed to provide flexibility for organizations of various sizes. While these programs may differ in various parts of the world, generally they include:

Open.Open licensing

Designed primarily for small-to-medium organizations (5 to over 250 licenses), this program allowsthese programs allow customers to acquire perpetual or subscription licenses and, at the customer’s election, rights to future versions of software products over a specified time period (generally two years)(two or three years depending on the Open program used). The offering that conveys rights to future versions of certain software productproducts over the contract period is called software assurance. Software Assurance. Software Assuranceassurance also provides support, tools, and training to help customers deploy and use software efficiently. Under the Open program, customers can acquire licenses only, or licenses with Software Assurance.software assurance. They can also renew Software Assurancesoftware assurance upon the expiration of existing volume licensing agreements.

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Select.Select licensing

Designed primarily for medium-to-large organizations (greater than 250 licenses), this program allows customers to acquire perpetual licenses and, at the customer’s election, Software Assurance, which consists of rights to future versions of certain software products, support, tools, and trainingassurance over a specified time period (generally three years)years or less to align to the end of the agreement term). Similar to the Open program, the Select program allows customers canto acquire licenses only, acquire licenses with Software Assurance,software assurance, or renew Software Assurancesoftware assurance upon the expiration of existing volume licensing agreements.

Enterprise agreement licensing

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Enterprise Agreement.    The Enterprise Agreement isagreements are targeted at medium and large organizations (greater than 250 licenses) that want to acquire perpetual licenses to software products, along with software assurance, for all or substantial parts of their enterprise, along with rightsenterprise. Enterprises can elect to future versions of certain software products, support, tools, and training overeither acquire perpetual licenses or, under the Enterprise Subscription program, can acquire non-perpetual, subscription agreements for a specified time period (generally three years).

Online

Online Services.We have an expanding portfolio of products, services, and solutions that we distribute online. We provide online content and services through Bing, Windows Live, Office Live, our MSN portals and other online channels. MSN delivers Internet accesschannels, and the Microsoft Online Services platform, which includes offerings for businesses such as cloud-hosted Exchange, SharePoint, and Office Communications. OSB provides various premium services to consumers and tools to consumers. MSN also delivers online e-mailbusinesses, such as email and messaging communication services and information servicestools such as online search, advertising, and premium content. Home and Entertainment operatesEDD offers the Xbox Live service which allows customers to participate in the gaming experience online with other subscribers online. Microsoft Business Solutions operatessubscribers. We also offer the Microsoft Small Business Center portal which is delivered online. This portal provides tools and expertise for small-business owners to build, market, and manage their businesses online. Other services delivered online include Microsoft Developer Networks subscription content and updates, periodic product updates, and online technical and practice readiness resources to support our partners in developing and selling our products and solutions.

CUSTOMERS

Our customers include individual consumers, small and medium-sized organizations, enterprises, governmental institutions, educational institutions, Internet Service Providers,service providers, application developers, and OEMs. Consumers and small- and medium-sized organizations obtain our products primarily through resellers and OEMs. SalesNo sales to Dell and its subsidiaries in the aggregatean individual customer accounted for approximately 11%more than 10% of fiscal year 2006 and 10% in each of fiscal year 2005 and 20042009, 2008, or 2007 revenue. These sales were made primarily through our OEM and volume licensing channels and cover a broad array of products including Windows PC operating systems, Microsoft Office, and server products. Our practice is to ship our products promptly upon receipt of purchase orders from customers; consequently, backlog is not significant.

EXECUTIVE OFFICERS OF THE REGISTRANT

Our executive officers as of August 25, 2006July 29, 2009 were as follows:

Mr. Gates co-founded Microsoft in 1975 and served as its Chief Executive Officer from the time the original partnership was incorporated in 1981 until January 2000, when he resigned as Chief Executive Officer and assumed the position of Chief Software Architect. In June 2006, Mr. Gates stepped down as Chief Software Architect and announced a two-year transition plan out of a day-to-day role in the Company. Mr. Gates has served as Chairman since our incorporation.

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Mr. Ballmer was appointed Chief Executive Officer in January 2000. He served as President from July 1998 to February 2001. Previously, he had served as Executive Vice President, Sales and Support since February 1992. HeMr. Ballmer joined Microsoft in 1980.

Mr. Bach was named President, Microsoft Entertainment and Devices Division in September 2005. He had been Senior Vice President, Home and Entertainment since March 2000. Before holding that position, he had been Vice President, Home and Retail since March 1999, and Vice President, Learning, Entertainment and Productivity since 1997, and Vice President, Desktop Applications Marketing since 1996. Mr. Bach joined Microsoft in 1988.

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Ms. Brummel was named Senior Vice President, Human Resources in December 2005. She had been Corporate Vice President, Human Resources since AprilMay 2005. From 1995May 2000 to AprilMay 2005, she had been Corporate Vice President of the Home & Retail Division. Since joining Microsoft in 1989, Ms. Brummel has held a number of management positions at Microsoft, including general manager of Consumer Productivity business, product unit manager of the Kids business, and product unit manager of Desktop and Decision reference products.

Mr. JohnsonElop was named Co-President,President, Microsoft Platforms and ServicesBusiness Division in SeptemberJanuary 2008. Prior to joining the Company, Mr. Elop served as Chief Operating Officer of Juniper Networks, Inc. from January 2007 to January 2008. From December 2005 to December 2006, he served as President of Worldwide Field Operations at Adobe Systems Inc. Mr. Elop joined Adobe following the 2005 acquisition of Macromedia Inc., where he was President and Chief Executive Officer from January 2005 to December 2005. He had been GroupDuring his almost eight-year tenure at Macromedia, Mr. Elop held many senior positions, including Chief Operating Officer, Executive Vice President of Worldwide Sales, MarketingField Operations and Services since March 2003. Before that position, he had been Senior Vice President, Microsoft Americas since February 2002 and Senior Vice President, U.S. Sales, Marketing, and Services since August 2001, and prior to assuming that role, he had been Vice President, U.S. Sales, Marketing and Services. He joined Microsoft in 1992.General Manager of Macromedia’s eBusiness division.

Mr. Liddell was named Senior Vice President and Chief Financial Officer of the Company in May 2005. Mr. Liddell served as Senior Vice President and Chief Financial Officer of International Paper Company sincefrom March 2003 through April 2005, and prior to becoming Chief Financial Officer, he held the positions of Vice President-Finance and Controller. Mr. Liddell served as Chief Executive Officer of Carter Holt Harvey Limited, an affiliate of International Paper, from 1999 to 2002 and Chief Financial Officer from 1995 to 1998.

Dr. Lu joined Microsoft in January 2009 as President, Online Services Division. Prior to joining the Company, Dr. Lu was a senior executive at Yahoo!, Inc. for 10 years. His roles included serving as Executive Vice President of Engineering for Yahoo!’s Search and Advertising Technology Group and Vice President of Engineering.

Mr. RaikesMuglia was named President, MicrosoftServer and Tools Business Division in September 2005.January 2009. He had been GroupSenior Vice President, Information WorkerServer and Tools Business since June 2004.October 2005. Before holding that position, he had beena number of leadership positions at Microsoft, including Senior Vice President, Enterprise Storage Division since November 2001, Group Vice President, Productivity and BusinessPersonal Services Group since August 2000, and Group Vice President, SalesBusiness Productivity since December 1999, Senior Vice President, Business Productivity since March 1999, Senior Vice President, Applications and SupportTools since July 1998.February 1998, and Corporate Vice President, Server Applications since 1997. Mr. RaikesMuglia joined Microsoft in 1981.1988.

Mr. Mundie was named Chief Research and Strategy Officer in June 2006. He had been Senior Vice President and Chief Technical Officer, Advanced Strategies and Policy since August 2001. He was named Senior Vice President, Consumer Platforms in February 1996. Mr. Mundie joined Microsoft in 1992.

Mr. Ozzie was named Chief Software Architect in June 2006. He had been Chief Technical Officer from April 2005 to June 2006. He assumed that role in April 2005 after Microsoft acquired Groove Networks, a collaboration software company he formed in 1997.

Mr. Sinofsky was named President, Windows Division in July 2009. He served as Senior Vice President of the Windows and Windows Live Engineering Group since December 2006 and Senior Vice President, Office from December 1999 to December 2006. He had been Vice President, Office since December 1998. Mr. Sinofsky joined the Office team in 1994, increasing his responsibility with each subsequent release of the desktop suite. Mr. Sinofsky joined Microsoft in 1989.

Mr. Smith was appointednamed Senior Vice President, Legal and Corporate Affairs, General Counsel, and Secretary in November 2001. Mr. Smith was also named Chief Compliance Officer effective July 2002. He had been Deputy General Counsel for Worldwide Sales and previously was responsible for managing the European Law and Corporate Affairs Group, based in Paris. HeMr. Smith joined Microsoft in 1993.

Mr. Turner was appointednamed Chief Operating Officer in September 2005. Before joining Microsoft, he was Executive Vice President of Wal-Mart Stores, Inc. and President and Chief Executive Officer of the Sam’s Club division of Wal-Mart Stores, Inc.division. From September 2001 to August 2002, he served as Executive Vice President and Chief Information Officer of Wal-Mart’s Information Systems Division. From March 2000 to September 2001, he served as its Senior Vice President and Chief Information Officer of the Information Systems Division.

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EMPLOYEES

As of June 30, 2006,2009, we employed approximately 71,00093,000 people on a full-time basis, 44,00056,000 in the United States and 27,00037,000 internationally. Of the total, 28,00036,000 were in product research and development, 21,00026,000 in sales and marketing, 13,00017,000 in product support and consulting services, 2,0005,000 in manufacturing and distribution, and 7,0009,000 in general and administration. Our success is highly dependent on our ability to attract and retain qualified employees. None of our employees are subject to collective bargaining agreements.

AVAILABLE INFORMATION

Our Company Internet address is www.microsoft.com. ThereAt our Investor Relations Web site, www.microsoft.com/msft, we make available free of charge oura variety of information for investors. Our goal is to maintain the Investor Relations Web site as a portal through which investors can easily find or navigate to pertinent information about us, including:

The information found on our Web site is not part of this or any other report we file with or furnish to the SEC.

ITEM 1A.    RISK FACTORS

Our operations and financial results are subject to various risks and uncertainties, including those described below, that could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock.

Challenges to our business model may reduce our revenues and operating margins.    Our business model has been based upon customers paying a fee to license software that we developeddevelop and distributed.distribute. Under this license-based software model, software developers bear the costs of converting original ideas into software products through investments in research and development, offsetting these costs with the revenue received from the distribution of their products. We believe the license-based software model has had substantial benefits for users of software, allowing them to rely on our expertise and the expertise of other software developers that have powerful incentives to develop innovative software that is useful, reliable, and compatible with other software and hardware. In recent years

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certainCertain “open source” software business models have evolved into a growing challenge to our license-based software model. Open source commonly refers to software whose source code is subject to a license allowing it to be modified, combined with other software and redistributed, subject to restrictions set forth in the license. A number of commercial firms compete with us using an open source business model by modifying and then distributing open source software to end users at nominal cost and earning revenue on complementary services and products. These firms do not have to bear the full costs of research and development for the software. A prominent exampleSome of open source software is the Linux operating system. Whilethese firms may build upon Microsoft ideas that we believeprovide to them free or at low royalties in connection with our products provide customers with significant advantages in security and productivity, and generally have a lower total cost of ownership than open source software, the popularization of the open source software model continues to pose a significant challenge to our business model, including continuing efforts by proponents of open source software to convince governments worldwide to mandate the use of open source software in their purchase and deployment of software products.interoperability initiatives. To the extent open source software gains increasing market acceptance, sales of our products may decline, we may have to reduce the prices we charge for our products, andsales, revenue, and operating margins may consequently decline.

Another development is the software-as-a-service business model byunder which companies provide content, and software in the form of applications, data, and related services, over the Internet. Providers useInternet in exchange for revenues primarily from advertising or subscription-based revenue models. Recent advancessubscriptions. An example of an advertising-funded business model is Internet search, where providing a robust

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alternative is particularly important and challenging due to the scale effects enjoyed by a single market dominant competitor. Advances in computing and communications technologies have made this model viable and enabled the rapid growth of some of our competitors. We are devoting significant resources toward developing our own software-as-a-service strategies.competing software plus services strategies including the Windows Azure Platform, our hosted computing platform designed to facilitate the rapid, flexible and scalable development of cloud-based services. It is uncertain whether these strategies will provebe successful.

An important element of our business model has been to create platform-based ecosystems on which many participants can build diverse solutions. A competing vertically-integrated model, in which a single firm controls both the software and hardware elements of a product, has been successful with certain consumer products such as personal computers, mobile phones, and digital music players. We also offer vertically-integrated hardware and software products; however, efforts to compete with the vertically integrated model may increase our cost of sales and reduce our operating margins.

We face intense competition.    We continue to experience intense competition across all markets for our products and services. Our competitors range in size from Fortune 100 companies to small, specialized single-product businesses and open source community-based projects. WhileAlthough we believe the breadth of our businesses and product portfolio offers benefits to our customers that areis a competitive advantage, our competitors that are focused on a narrower product linelines may be more effective in devoting technical, marketing, and financial resources to compete with us. In addition, barriers to entry in our businesses generally are low. The Internet as a distribution channellow and the non-commercial software model described above have reduced barriers to entry even further.products, once developed, can be distributed broadly and quickly at relatively low cost. Open source software vendors are devoting considerable efforts to developing software that mimics the features and functionality of our products.products, in some cases on the basis of technical specifications for Microsoft technologies that we make available at little or no cost. In response to competitive factors,competition, we are developing versions of our products with basic functionality that are sold at lower prices than the standard versions. These competitive pressures may result in decreased sales volumes, price reductions, and/or increased operating costs, such as for marketing and sales incentives, resulting in lower revenue, gross margins, and operating income.

We may not be able to adequately protect our intellectual property rights against piracy, infringement ofrights.    Protecting our patents by third parties, or declining legal protection for intellectual property.    We defend ourglobal intellectual property rights and combatcombating unlicensed copying and use of software and other intellectual property rights through a variety of techniques. Preventing unauthorized use or infringement of our rights is difficult. Piracy of our products represents a loss of revenue to us. While thispiracy adversely affects U.S. revenue, the impact on revenue from outside the United StatesU.S. is more significant, particularly in countries where laws are less protective of intellectual property rights. Similarly, the absence of harmonized patent laws makes it more difficult to ensure consistent respect for patent rights. Future legal changes could make this even more challenging. Throughout the world, we actively educate consumers about the benefits of licensing genuine products and obtaining indemnification benefits for intellectual property risks, and we educate lawmakers about the advantages of a business climate where intellectual property rights are protected. However, continued educational and enforcement efforts may fail to enhance revenue. Reductions in the legal protection for software intellectual property rights or compliance with additional intellectual property obligations impacting the rights of software developers could both adversely affect revenue.

Third parties may claim we infringe their intellectual property rights.    From time to time we receive notices from others claiming we infringe their intellectual property rights. The number of these claims may grow. Responding toTo resolve these claims we may require us to enter into royalty and licensing agreements on less favorable terms, require us to stop selling or to redesign affected products, or to pay damages or to satisfy indemnification commitments with our customers including contractual provisions under various license arrangements. If we are required to enter into suchcustomers. Such agreements or take such actions, ourmay cause operating margins may decline as a result.to decline. We have made and expect to continue making significant expenditures to settle claims related to the use of technology and intellectual property rights as part of our strategy to manage this risk.

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We may not be able to protect our source code from copying if there is an unauthorized disclosure of source code.    Source code, the detailed program commands for our operating systems and other software programs, is critical to our business. WhileAlthough we license certain portions of our source code for various software programsapplication and operating systemssystem source code to a number of licensees, we take significant measures to protect the secrecy of large portions of our source code. If an unauthorized disclosure of a significant portion of our source code occurs, we could potentially lose future trade secret protection for that source code. The loss of future trade secret protectionThis could make it easier for third parties to compete with our products by copying functionality, which could adversely affect our revenue and operating margins. Unauthorized disclosure of source code also could also increase certainthe security risks described in the next paragraph.

Security vulnerabilities in our products could lead to reduced revenues or to liability claims.    Maintaining the security of computers and computer networks is a critical issue for us and our customers. Hackers develop and deploy viruses, worms, and other malicious software programs that attack our products. WhileAlthough this is an industry-wide problem that affects computers across all platforms, it affects our products in particular because hackers tend

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to focus their efforts on the most popular operating systems and programs and we expect them to continue to do so. We devote significant resources to address these critical issues. We focus on security vulnerabilities through:

The cost of these steps could reduce our operating margins. Despite these efforts, actual or perceived security vulnerabilities in our products could lead some customers to seek to return products, to reduce or delay future purchases, or to use competing products. Customers may also increase their expenditures on protecting their existing computer systems from attack, which could delay adoption of new technologies. Any of these actions by customers could adversely affect our revenue. In addition, actual or perceived vulnerabilities may lead to claims against us. WhileAlthough our license agreements typically contain provisions that eliminate or limit our exposure to such liability, there is no assurance these provisions will be held effective under applicable laws and judicial decisions.withstand all legal challenges.

We are subject to government litigation and regulatory activity that affects how we design and market our products.    As a leading global software maker, we receive close scrutiny from government agencies under U.S. and foreign competition laws. Some jurisdictions also provide private rights of action for competitors or consumers based on allegedto assert claims of anti-competitive conduct. For example, we have been involved in the following actions.

Lawsuits brought by the U.S. Department of Justice, 18 states, and the District of Columbia in two separate actions were resolved through a Consent Decree that took effect in November 2001 and a Final Judgment entered in November 2002. These proceedings imposed regulatoryvarious constraints on our Windows operating system businesses, includingbusinesses. These constraints include limits on certain contracting practices, requiredmandated disclosure of certain software program interfaces limits on Microsoft’s abilityand protocols, and rights for computer manufacturers to ensurelimit the visibility of certain Windows features in new PCs, and required licensing of certain communications protocols. While wePCs. We believe we currently are in full compliance with the Decree and Judgment,these rules. However, if we fail to comply with them, in the future additional restrictions could be imposed on us that would adversely affect our business.

The European Commission closely scrutinizes the design of high-volume Microsoft products and the terms on which we make certain technologies used in these products, such as file formats, programming interfaces, and protocols, available to other companies. In March 2004, the European Commission determined that we mustordered us to create new versions of Windows that do not include certain multimedia technologies many of which are required for certain Web sites, software applications and other aspects of Windows to function properly, and we must provide our competitors with specifications for how to implement certain proprietary Windows communications protocols supported in Windows. Microsoft has appealed both determinationstheir own products. The Commission’s impact on product design may limit our ability to European courts. As a resultinnovate in Windows or other products in the future, diminish the developer appeal of the Commission decision, we have incurredWindows platform, and will (absent a reversal of this ruling) continue to incur duplicativeincrease our product development costs. The Commission ruling obligates Microsoft to make available specifications for certain Windows communications protocol technologies on licensing terms that are closely regulated by the Commission. The availability of these licenses related to protocols and file formats may enable competitors to develop software products that better mimic the functionality of Microsoft’sour own products which could result in a reduction indecreased sales of our products. Pending resolution of Microsoft’s appeal, there will remain uncertainty about the legal principles that govern

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product design issues for future releases of Microsoft products in Europe. These uncertainties could cause Microsoft to modify product design and delay release dates for Windows or other products.

In December 2005, the Korean Fair Trade Commission (“KFTC”) completed an investigation of whether including streaming media technology or instant messenger technology in Windows, or including Windows Media Services as an optional component of Windows Server, violates the Korean Fair Trade Law. The KFTC ruled that we had violated the law and issued a remedial order requiring us to offer two versions of Windows PC operating systems, one with Windows Media Player and Instant Messenger removed and another with those functionalities but also including opportunities for OEMs to install competing media player and instant messenger programs. If upheld on appeal, these remedies could adversely affect the utility and competitive position of Windows PC operating systems in the Korean market.

We believe our integrated approach to delivery of product innovation benefits consumers and business. Current or future governmentGovernment regulatory effortsactions and court decisions such as these may hinder or delay our ability to provide thesethe benefits of our software to consumers and businesses, thereby reducing the attractiveness of our products and the revenues that come from them. Moreover, there always remains the risk of new legal action,New actions could be initiated at any time, either by these or other governments or private claimants, including with respect to productsnew versions of Windows or features that haven’t been scrutinized or been the subject of objections in the past.other Microsoft products. The outcome of such legal actions, or steps taken to avoid them, could adversely affect us in a variety of ways, including:

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Our software and services online offerings are subject to government regulation of the Internet domestically and internationally in many areas, such asincluding user privacy, telecommunications, data protection, and online content. The application of these laws and regulations to our business is often unclear and sometimes may conflict. Compliance with these regulations may involve significant costs or require changes in business practices that result in reduced revenue. Noncompliance could result in penalties being imposed on us or orders that we cease conductingstop doing the alleged noncompliant activity.

Our business depends largely on our ability to attract and retain talented employees.    Our business is based on successfully attracting and retaining talented employees. The market for highly skilled workers and leaders in our industry is extremely competitive. We are limited in our ability to recruit internationally by restrictive domestic immigration laws. If we are less successful in our recruiting efforts, or if we are unable to retain key employees, our ability to develop and deliver successful products and services may be adversely affected. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution.

Delays in product development schedules may adversely affect our revenues.    The development of software products is a complex and time-consuming process. New products and enhancements to existing products can require long development and testing periods. Our increasing focus on software plus services also presents new and complex development issues. Significant delays in new product or service releases or significant problems in creating new products or services could adversely affect our revenue.

We make significant investments in new products and services that may not be profitable.    Our growth depends on our ability to innovate by offering new, and adding value to our existing, software and service offerings. We have made and will continue to make significant investments in research, development, and marketing for new products, services, and technologies, including the Windows Vista,PC operating system, the 2007 Microsoft Office system, Xbox 360, MSNLive Search, Windows Server, Zune, Windows Live, the Windows Azure Services platform, and Windows Live.other software plus services offerings. Investments in new technology are inherently speculative. Commercial success depends on many factors, including innovativeness, developer support, and effective distribution and marketing. SignificantIf customers do not perceive our latest offerings as providing significant new functionality or other value, they may reduce their purchases of new software products or upgrades, unfavorably impacting revenue. We may not achieve significant revenue from new product and service investments may not be achieved for a number of years, if at all. Moreover, new products and services may not be profitable, and even if they are profitable, operating margins for new products and businesses may not be as high as the margins we have experienced historically.

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DeclinesAdverse economic conditions may harm our business.    Unfavorable changes in demand for software could occur.economic conditions, including inflation, recession, or other changes in economic conditions, may result in lower information technology spending and adversely affect our revenue. If overall market demand for PCs, servers, and other computing devices declines, significantly, or consumer or corporatebusiness spending for suchthose products declines, our revenue will be adversely affected. In addition,Our product distribution system also relies on an extensive partner network. The impact of economic conditions on our revenue wouldpartners, such as the bankruptcy of a major distributor, could result in sales channel disruption. Challenging economic conditions also may impair the ability of our customers to pay for products and services they have purchased. As a result, reserves for doubtful accounts and write-offs of accounts receivable may increase. We maintain an investment portfolio of various holdings, types, and maturities. These investments are subject to general credit, liquidity, market, and interest rate risks, which may be unfavorably impacted if customers reduce their purchasesexacerbated by unusual events that have affected global financial markets. If global credit and equity markets experience prolonged periods of new software products or upgrades to existing products because new product offerings are not perceived as providing significant new functionality or other value to prospective purchasers. We are making significant investments in Windows Vista and the 2007 Microsoft Office system. If these products are not perceived as offering significant new functionality or value to prospective purchasers,decline, our revenue and operating margins couldinvestment portfolio may be adversely affected.impacted and we could determine that more of our investments have experienced an other-than-temporary decline in fair value, requiring impairment charges that could adversely impact our financial results.

We have claims and lawsuits against us that may result in adverse outcomes.    We are subject to a variety of claims and lawsuits. Adverse outcomes in some or all of thethese claims pending against us may result in significant monetary damages or injunctive relief against us that could adversely affect our ability to conduct our business. WhileAlthough management currently believes that resolving all of these matters, individually or in the aggregate, will not have a material adverse impact on our financial position, or results of operations, or cash flows, the litigation and other claims are subject to inherent uncertainties and management’s view of these matters may change in the future. There exists the possibility of aA material adverse impact on our financial position, and the results of operations, or cash flows also could occur for the period in which the effect of an unfavorable final outcome becomes probable and reasonably estimable.

 Part I 

Item 1A

We may have additional tax liabilities.    We are subject to income taxes in both the United States and numerousmany foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We regularly are regularly under audit by tax authorities. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from our historical income tax provisions and accruals. Based on theThe results of an audit or litigation could have a material effect on our income tax provision, net incomefinancial position, results of operations, or cash flows in the period or periods for which that determination is mademade. In addition, there have been proposals to reform U.S. tax laws that would significantly impact how U.S. multinational corporations are taxed on foreign earnings. We earn a substantial portion of our income in foreign countries. Although we cannot predict whether or in what form this proposed legislation will pass, if enacted it could result.have a material adverse impact on our tax expense and cash flow.

WeOur vertically-integrated hardware and software products may be at risk of having insufficient supplies of certain Xbox 360 componentsexperience quality or console inventory.supply problems    Some components of.    Our hardware products such as the Xbox 360 console are obtainedhighly complex and can have defects in design, manufacture, or associated software. We could incur significant expenses, lost revenue, and reputational harm if we fail to detect or effectively address such issues through design, testing, or warranty repairs. We obtain some components of our hardware devices from a single supplier and others may be subject to an industry-wide supply shortage.sole suppliers. If a component delivery from a sole-source supplier is delayed or becomes unavailable or industry shortages occur, we may be unable to obtain timely replacement supplies, on a timely basis, resulting in reduced console and game sales. Components are ordered based on forecasted console demand so we may experienceEither component shortages for the Xbox 360 or alternatively, excess consoleor obsolete inventory that may require us to record charges to cost of revenue. Xbox 360 consoles will beare assembled in Asia; disruptions in the supply chain may result in console shortages that would affect our revenues and operating margins. These same risks would apply to any other vertically-integrated hardware and software products we may offer.

If our goodwill or amortizable intangible assets become impaired we may be required to record a significant charge to earnings.    Under generally accepted accounting principles, we review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. Factors that may be considered a change in circumstances, indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a decline in stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in our industry. We may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively impacting our results of operations.

Changes in accounting may affect our reported earnings and operating income.    Generally accepted accounting principles and accompanying accounting pronouncements, implementation guidelines, and interpretations for many aspects of our business, such as revenue recognition for software, accounting for investments, and treatment of goodwill or amortizable intangible assets, are highly complex and involve subjective judgments. Changes in these rules or their interpretation or changes in our products or business could significantly change our reported earnings and operating income and could add significant volatility to those measures, without a comparable underlying change in cash flow from operations. See Note 1 in “Item 8. Financial Statements and Supplementary Data” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” of this report.

We operate a global business that exposes us to additional risks.    We operate in over 100 countries and a significant part of our revenue comes from international sales. Pressure to make our pricing structure uniform might

 Part I 

Item 1A

require that we reduce the sales price of our software in the United States and other countries. Operations outside of the United States may be affected by changes in trade protection laws, policies and measures, and other regulatory requirements affecting trade and investment; unexpectedinvestment, including the Foreign Corrupt Practices Act and local laws prohibiting corrupt payments; and changes in regulatory requirements for software;software. Emerging markets are a significant focus of our international growth strategy. The developing nature of these markets presents a number of risks. Deterioration of social, political, labor, or economic conditions in a specific country or region;region and difficulties in staffing and managing foreign operations. Whileoperations may also adversely affect our operations or financial results. Although we hedge a portion of our international currency exposure, significant fluctuations in exchange rates between the U.S. dollar and foreign currencies may adversely affect our net revenues.

General economic and geo-political risks may affect our revenue and profitability.    Inflation, softness in corporate information technology spending, or other changes in general economic conditions that affect demand for computer hardware or software could adversely affect our revenue or our investment portfolio. Abrupt political change, terrorist activity, and armed conflict pose a risk of general economic disruption in affected countries or generally and could require changes in our operations and security arrangements, thus increasing our operating costs. These conditions may lend additional uncertainty to the timing and budget for technology investment decisions by our customers.

Catastrophic events or geo-political conditions may disrupt our business.    We are a highly automated business and aA disruption or failure of our systems or operations in the event of a major earthquake, weather event, cyber-attack, terrorist attack, or other catastrophic event could cause delays in completing sales, and providing services.services, or performing other mission-critical functions. Our corporate headquarters, a significant portion of our research and development activities, and certain other critical business operations are located in the Seattle, Washington area, and we have other business operations in the Silicon Valley area of California, both of which are near major earthquake faults. A catastrophic event that results in the destruction or disruption of any of our critical business or information technology systems could severely affectharm our ability to conduct normal business operations and asour operating results. Abrupt political change, terrorist activity, and armed conflict pose a result,risk of general economic disruption in affected countries, which may increase our future operating results could be adversely affected.costs. These conditions also may add uncertainty to the timing and budget for technology investment decisions by our customers.

 Part I 

Item 1A, 1B, 2, 3, 4

Acquisitions and joint ventures may have an adverse effect on our business.    We expect to continue making acquisitions or entering into joint ventures as part of our long-term business strategy. These transactions involve significant challenges and risks including that the transaction does not advance our business strategy, that we don’t realize a satisfactory return on theour investment, we make, or that we may experience difficulty in the integration of new employees, business systems, and technology, or diversion of management’s attention from our other businesses. These factorsevents could adversely affectharm our operating results or financial condition.

We have limited insurance.    We maintain third party insurance coverage against various liability risks and risks of property loss. Because of the unavailability or high cost of conventional insurance arrangements, we have entered into captive insurance arrangements for the purpose of protecting against possible catastrophic and other risks not covered by traditional insurance markets. As of June 30, 2006, the face value of captive insurance arrangements was $2.0 billion. Actual value at any particular time will vary due to deductibles, exclusions, other restrictions, and claims. While we believe these arrangements are an effective way to insure against liability and property damage risks, the potential liabilities associated with the risks discussed in this report or other events could exceed the coverage provided by such arrangements.

Improper disclosure of personal data could result in liability and harm our reputation.    We store and process significantlarge amounts of personally identifiable information as we offer a large array of products and services to our customers.information. It is possible that our security controls over personal data, our training of employees and vendors on data security, and other practices we follow may not prevent the improper disclosure of personally identifiable information. Such disclosure could harm our reputation and subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. Our software products and services also enable our customers to store and process personal data. Perceptions that our products or services do not adequately protect the privacy of personal information could inhibit sales of our products.

Other risks thatWe may affectexperience outages and disruptions of our business.online services if we fail to maintain an adequate operations infrastructure.    Other factors that may affectOur increasing user traffic and complexity of our performance may include:

 Part I current and potential users, subscribers, and advertisers, harming our operating results and financial condition.

Item 1B, 2, 3, 4

ITEM 1B.    UNRESOLVED STAFF COMMENTS

We have received no written comments regarding our periodic or current reports from the staff of the SEC that were issued 180 days or more preceding the end of our fiscal year 20062009 that remain unresolved.

ITEM 2.    PROPERTIES

Our corporate offices consist of approximately 11.015 million square feet of office building space located in King County, Washington: 8.5ten million square feet of owned space that is situated on approximately 500 acres of land we own inat our corporate campus in Redmond, Washington and approximately 2.5five million square feet of space we lease. We own approximately 533,000two million square feet of office buildingand datacenter space domestically (outside of the Puget Sound corporate campus) and lease many sites domestically totaling approximately 2.7four million square feet of office buildingand datacenter space.

We occupy many sites internationally, totaling approximately 6.9two million square feet that is leasedowned and approximately 883,000nine million square feet that is owned. These facilitiesleased. Facilities that we own include our European Operations Center that leases a 187,000 square foot campus in Dublin, Ireland,Ireland; the India Development Center in Hyderabad, India; and a 56,000 square footfacility in Reading, UK. The largest leased office spaces include the following locations: Beijing and Shanghai, China; Bangalore, India; Dublin, Ireland; Tokyo, Japan; Mississauga, Canada; Taipei, Taiwan; Seoul, Korea; Sydney, Australia; and Milan, Italy. In addition to the above locations, we have a disk duplication and digital distribution facility in Humacao, Puerto Rico, and a 159,000 square foot facility in Singapore for our Asia Pacific Operations Center and Regional headquarters. Leased office building space includes the following locations: Tokyo, Japan 408,000 square feet; Unterschleissheim, Germany 381,000 square feet; Les Ulis, France 262,000 square feet; Reading, England 241,000 square feet;headquarters, and Mississauga, Canada 161,000 square feet. In addition to the above locations, we have various product development facilities, both domestically and internationally, as described in “Operations”the “Research and Development” section above.

Our facilities are fully used for current operations of all segments, and suitable additional space isspaces are available to accommodate expansion needs. We own 63 acres of land in Issaquah, Washington, which can accommodate 1.2 million square feet of office space and we have ana development agreement with the City of Redmond under which we may currently develop an additional 2.2approximately 1.6 million square feet of additional facilities at our corporate campus in Redmond, Washington. In addition, we own 63 acres of undeveloped land in Issaquah, Washington, that can accommodate approximately one million square feet of office space.

ITEM 3.    LEGAL PROCEEDINGS

On May 22, 2006, the Korean Fair Trade Commission (“KFTC”) denied our motion for reconsideration of the formal written ruling against us in its competition law investigation of the company. As part of its decision, however, the KFTC dropped the requirement prohibiting us from including Windows Media Player or Windows Messenger, or any feature with similar functionality, in any product other than the Windows client operating system for which we have a 50% or greater market share. Our request to stay the KFTC corrective order was denied on July 31, 2006. Our appeal of the KFTC’s decision to the Seoul High Court is still pending.

On July 12, 2006, the European Commission announced its determination that we had not complied with the technical documentation requirements in its 2004 Decision against us, and levied a fine of€281 million ($351 million). We intend to appeal this fine to the Court of First Instance. We have completed the written and oral procedures in our appeal of the Commission’s underlying March 2004 decision finding Microsoft in violation of European competition law and accompanying€497 million ($605 million) fine and are awaiting a decision by the Court of First Instance.

See Note 17 – Contingencies in “Item 8.of the Notes to Financial Statements and Supplementary Data”(Part II, Item 8) for information regarding other legal proceedings in which we are involved.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 2006.2009.

 Part II 

Item 5

PART II

ITEM 5.    MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is traded on Thethe NASDAQ Stock Market under the symbol MSFT. On August 18, 2006,July 27, 2009, there were 148,993142,468 registered holders of record of our common stock. The high and low common stock sales prices per share were as follows:

DIVIDENDS AND SHARE REPURCHASES

See Note 1218 – Stockholders’ Equity of the Notes to Financial Statements (Item(Part II, Item 8) for information regarding dividends approved by our Board of Directors in fiscal years 2006 and 2005.

On July 20, 2006, we announced the completion of the repurchase program approved by our Board of Directors on July 20, 2004, to buy back up to $30 billion in Microsoft common stock. The repurchases were made using our cash resources. We repurchased common stock in each quarter of fiscal year 2006 as follows:share repurchases.

Common stock repurchases in the fourth quarter of fiscal year 2006 were as follows:

On July 20, 2006, we announced that our Board of Directors authorized two new share repurchase programs: a $20 billion tender offer which was completed on August 17, 2006; and authorization for up to an additional $20 billion ongoing share repurchase program with an expiration of June 30, 2011. Under the tender offer, we repurchased approximately 155 million shares of common stock, or 1.5% of our common shares outstanding, for approximately $3.8 billion at a price per share of $24.75.

 Part II 

Item 5, 6

ITEM 6.    SELECTED FINANCIAL DATA

FINANCIAL HIGHLIGHTS

 Part II 

Item 7

ITEM 7.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS FOR FISCAL YEARS 2006, 2005,2009, 2008, AND 20042007

OVERVIEWOverview

The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand the results of operations and financial condition of Microsoft Corporation. MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes to the financial statements (“Notes”).

We develop, manufacture, license,generate revenue by developing, manufacturing, licensing, and supportsupporting a wide range of software products and services for many different types of computing devices. Our software products and services include operating systems for personal computers, servers, PCs, and intelligent devices; server applications for distributed computing environments; information worker productivity applications; business solutions applications; andhigh-performance computing applications; software development tools.tools; and video games. We provide consulting and product support services, and we train and certify computer system integrators and developers. We also design and sell hardware, including the Xbox 360 video game console, the Zune digital music and games, PC games,entertainment device, and PC peripherals. Online communicationofferings and information services are delivered through Bing, Windows Live, Office Live, our MSN portals and channels, aroundand the world.Microsoft Online Services platform, which includes offerings for businesses, such as Microsoft Dynamics CRM Online, Exchange Hosted Services, Exchange Online, and SharePoint Online. We enable the delivery of online advertising across our broad range of digital media properties and on Bing through our proprietary adCenter platform.

Our revenue historically has fluctuated quarterly and has generally been the highest in the second quarter of our fiscal year due to corporate calendar year-end spending trends in our major markets and holiday season spending by consumers. Our HomeEntertainment and Entertainment segmentDevices Division is particularly subject to seasonalityseasonal as its products are aimed at the consumer market and are in highest demand during the holiday shopping season. Typically, Homethe Entertainment and EntertainmentDevices Division has generated overapproximately 40% of its yearlyannual segment revenues in our second fiscal quarter. We believeIn fiscal year 2007, our revenue was highest in the seasonalitythird quarter due to the recognition of $1.7 billion of revenue previously deferred from the Express Upgrade to Windows Vista and Microsoft Office Technology Guarantee programs and pre-shipments of Windows Vista and the 2007 Microsoft Office system. The technology guarantee programs provided customers who purchased current products with free or discounted rights to Windows Vista and the 2007 Microsoft Office system when those products became available to consumers.

The unfavorable global economic environment adversely affected our business in fiscal year 2009 as consumers and businesses cut back on spending, which reduced PC shipments and IT investments. But because we offer a wide range of products that enable companies to improve productivity and reduce costs, and because we have a strong pipeline of products, including new versions of Windows and Office planned for release in fiscal year 2010, we believe that Microsoft is likelywell-positioned to continueweather the economic downturn. As the global economy improves, this will create new opportunities to increase revenue. To further help weather the economic downturn, in fiscal year 2009 we made important adjustments to our cost structure and streamlined internal business processes.

Technological innovation is the future.

Wefoundation of our long-term growth and we intend to sustain the long-term growth ofmaintain our businesses through technological innovation,commitment to investment in research and development, engineering excellence, and a commitment to delivering high-quality products and services to customers and partners. Recognizing that one of our primary challengesbusiness objectives is to help accelerate worldwide PC adoption and software upgrades, we continue to advance the functionality, security, and value of Windows operating systems. We also are increasingremain focused on selling our focus onproducts in emerging markets and reducing the amount of unlicensed software used in those markets. In addition, we

We also continue to develop innovative software applications and solutions that we believe will enhance theinformation worker productivity, of information workers, improve communication and collaboration in work groups, aid business intelligence, and streamline processes for small and mid-sized businesses. To sustain growth in the growthface of our Server and Tools business amid competition from other vendors of both proprietary and open source software, our goal is to deliver products that provide the best platform for network computing – thesoftware that is easiest to deploy and manage, and that is most secure – with the lowest total cost of ownership.

WeIn addition, we continue to invest in research and development in existing and new lines of business, including cloud computing, search, online solutions, business solutions, mobile computing, communication, entertainment,

 Part II 

Item 7

and othersother areas that we believe may contribute to our long-term growth. We also invest in research and developdevelopment of advanced technologies for future software products. We believe that delivering innovative and high-value solutions through our integrated platform is the key to meeting customer needs and to our future growth.

We believe that over the last few years we have laidThis long-term focus on investment in research and development has enabled us to lay a foundation for long-termfuture growth by delivering innovative products, creating opportunities for partners, and improving customer satisfaction with key audiences, putting some of our most significant legal cases behind us, and improving our internal business processes.satisfaction. Our focus in fiscal year 20072010 is buildingto build on this foundation and executingto continue to execute well in key areas including continuing to innovatethrough ongoing innovation on our integrated software platform, by responding effectively to customer and partner needs, and continuing to focusby focusing internally on product excellence, business efficacy, and accountability across the company.

Key market opportunities include:

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Item 7

Worldwide macroeconomic factors have a strong correlation to business and consumer demand for our software, services, games and Internet service offerings. We expect a broad continuation in the economic conditions and demand in fiscal year 2007 as compared to fiscal year 2006.

As open source software development and distribution evolves, we continue to seek to differentiate our products from competing products that are based on open source software. We believe that Microsoft’s share of server unit operating systems increased in fiscal year 2006.

Summary of Results for Fiscal Years 2006, 2005,2009, 2008, and 20042007

Our revenue growth forFiscal year 2009 compared with fiscal year 2006 was2008

Revenue declined across most segments primarily driven primarily by growth in SQL Server following the launch of SQL Server 2005weakness in the second quarter, Windows Serverglobal PC market and other server applications, increased Xbox revenue resulting from the Xbox 360 launch in the second quarter, growth in licensing of Windows client operating systems through OEMs, and increased licensing of Office and other Information Worker products. Based on our estimates, total worldwide PC shipments from all sources grew approximately 12% to 14% and total server hardware shipments grew approximately 11% to 13% during fiscal year 2006.unfavorable economic environment. Foreign currency exchange rates did not haveaccounted for a significant impact on consolidated$486 million or operating segment revenue duringone percentage point increase in revenue. Primary factors contributing to the fiscal year.decline include the following:

The above declines were partially offset by increased server and server hardware shipments. The worldwide PC shipment growth rateapplication revenue, reflecting recognition of deferred revenue from all sources was estimated at 13%previously signed agreements and continued adoption of the Windows server shipment was estimated at 18% in fiscal year 2004 as compared to fiscal year 2003. The net impact of foreign exchange rates on revenue was positive in fiscal year 2004 due to a relative strengthening of most foreign currencies versus the U.S. dollar. This resulted in approximately $1.10 billion growth in total revenue.Server Platform and applications through SQL Server, Enterprise CAL Suites, and System Center products.

Operating income for fiscal year 2006 increaseddecreased primarily reflecting thedecreased revenue. Operating expenses were flat with decreased general and administrative and sales and marketing expenses offset by increased headcount-related expenses, cost of revenue, increase and a $991 million decrease inemployee severance charges.

In January 2009, we announced and implemented a resource management program to reduce discretionary operating expenses, employee headcount, and capital expenditures. As part of $562 million related to increased salary and benefits for new and existing headcount. General and administrative expenses related to major litigation declined in fiscal year 2005 due tothis program, we announced the $2.53 billion of charges related to the settlement of Sun

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Item 7

elimination of up to 5,000 positions in research and development, marketing, sales, finance, legal, human resources, and information technology by June 30, 2010. During the fine imposed bytwelve months ended June 30, 2009, we recorded employee severance charges of $330 million for the European Commissionexpected reduction in fiscal year 2004. This effect wasemployee headcount.

Diluted earnings per share declined primarily reflecting decreased net income, partially offset by legal expenses of $2.08 billion related to settlementsshare repurchases during the past 12 months. We repurchased 318 million shares during the twelve months ended June 30, 2009.

Fiscal year 2008 compared with IBM, Novell, Gateway, and end-user class action plaintiffs to resolve antitrust issues and other matters. In fiscal year 2004, the operating income decline2007

Revenue growth was causeddriven primarily by $2.53increased licensing of the 2007 Microsoft Office system, increased Xbox 360 platform sales, increased revenue associated with Windows Server and SQL Server, and increased licensing of Windows Vista. Foreign currency exchange rates accounted for a $1.6 billion or three percentage point increase in revenue during fiscal year 2008.

Operating income increased primarily reflecting increased revenue, partially offset by increased headcount-related expenses, increased costs for legal settlements and legal contingencies, and increased cost of revenue. Headcount-related expenses increased 12%, reflecting an increase in headcount during fiscal year 2008. We incurred $1.8 billion of legal charges and $2.21 billion of stock-based compensation expenseduring fiscal year 2008 primarily related to the European Commission fine of $1.4 billion (€899 million) as compared with $511 million of legal charges during fiscal year 2007. Cost of revenue increased $905 million or 8%, reflecting increased data center and equipment costs, online content expenses, and increased costs associated with the growth in our employee stock option transfer program, mainlyconsulting services, partially offset by an increase in revenue.

We implemented changes in employee compensation in fiscal year 2004 whereby employees are granted stock awards rather than stock options. We also completed an employee stock option transfer program indecreased Xbox 360 costs. The decreased Xbox 360 costs reflect the second quarter of fiscal year 2004 in which employees could elect to transfer all of their vested and unvested stock options with a strike price of $33.00 or higher to JPMorgan Chase Bank (“JPMorgan”). The unvested options that were transferred to JPMorgan became vested upon the transfer. A total of 345 million of the 621 million eligible options were transferred, which resulted in additional stock-based compensation expense of $2.21$1.1 billion in the second quarter of fiscal year 2004. As a result of these changes, stock-based compensation expense decreased in fiscal years 2006 and 2005, and we expect stock-based compensation expense related to stock options to continue to decrease in fiscal year 2007.

Fiscal Year 2007 Outlook

In fiscal year 2007, we expect continued double digit revenue growth primarily as a result of the upcoming launches of Windows Vista and the 2007 Microsoft Office system. We estimate worldwide PC shipments will grow between 8% and 10%. We expect that PC unit growth rates will be higher in the consumer segment than in the business segment and higher in emerging markets than in mature markets. We estimate worldwide server unit shipments will grow between 10% and 12%charge in fiscal year 2007 as comparedrelated to fiscal year 2006. We do not expect a significant impact from year-over-year foreign currency exchange ratesthe expansion of our Xbox 360 warranty, partially offset by increased Xbox 360 product costs reflecting growth in unit console sales.

The diluted earnings per share growth was impacted by the $1.1 billion Xbox 360 charge in fiscal year 2007.2007 and share repurchases during fiscal year 2008.

We expectFiscal Year 2010 Outlook

Global macroeconomic factors have a strong correlation to demand for our operating income growth ratesoftware, services, hardware, and online offerings. While we see the potential for improvement in calendar year 2010, we are unable to lagpredict the actual timing. In the meantime, we are positive about our revenue growth raterelative market position and our product delivery plans. In addition, we remain focused on executing in the first halfareas we can control by continuing to provide high value products at the lowest total cost of fiscal year 2007 due to an increasing mix of Xbox 360 console revenue and related costs, coupled with significant investments in preparation for the launches ofownership while managing our flagship products. We expect this trend to reverse in the second half of the fiscal year when we expect operating income to grow faster than revenue.expenses.

SEGMENT PRODUCT REVENUE/OPERATING INCOME (LOSS)

Our seven segments were Client; Server and Tools; Information Worker; Microsoft Business Solutions; MSN; Mobile and Embedded Devices; and Home and Entertainment. On July 17, 2006, we announced a change in our operating segments reflecting the culmination of our realignment announced in September 2005. These changes will be effective for fiscal year 2007; the seven segments discussed in this analysis are presented the way we internally managed and monitored performance at the business group level in fiscal years 2006, 2005, and 2004.

The revenue and operating income/income (loss) amounts in this section are presented on a basis consistent with accounting principles generally accepted in the United States (“U.S. Generally Accepted Accounting Principles (“GAAP”) and include certain reconciling items attributable to each of the segments. The segmentSegment information appearing in Note 1822 – Segment Information and Geographic Data of the Notes to Financial Statements (Part II, Item 8) is presented on a basis consistent with the Company’sour current internal management reporting, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 131,Disclosures about Segments of an Enterprise and Related Information. Certain corporate level expenses havecorporate-level activity has been excluded from our segment operating results and areis analyzed separately. Fiscal years 2005 and 2004Prior period amounts have been restated for certain internal reorganizations andrecast to conform to the fiscal year 2006 presentation.way we internally managed and monitored performance at the segment level during the current period.

Client

Client offerings consist of premium and standard edition Windows operating systems. Premium editions are those that include additional functionality and are sold at a price above our standard editions. Premium editions include Windows Vista Business, Windows Vista Home Premium, Windows Vista Ultimate, Windows Vista Enterprise,

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Item 7

Windows XP Professional, Windows XP Media Center, Edition, Tablet PC Edition, and other standard Windows operating systems, including Windows XP Home. Premium offerings areTablet PC. Standard editions include Windows operating systems sold at a premium aboveVista Home Basic and Windows XP Home. Client revenue growth correlates with theis directly impacted by growth of PC purchases of PCs from OEMsoriginal equipment manufacturers (“OEMs”) that pre-install versions of Windows operating systems because the OEM channel accounts for over 80% of total Client revenue.

Client revenue increased in fiscal year 2006 reflecting $1.18 billion or 12% growth in OEM revenue driven by 17% growth in OEM license units from increased PC unit shipments, partially offset by a $118 million or 6% decrease in revenue from commercial and retail licensing of Windows operating systems. During the year, the mix of OEM Windows operating systems licensed with premium edition operating systems as a percentage of total OEM Windows operating systems licensed (“OEM Premium Mix”) increased two percentage points to 52%. OEM revenue growth included an increase to revenue of $89 million resulting from the alignment of our billings associated with OEM distributors in our system builder channel with both industry standards and other Microsoft channels. The differences between unit growth rates and revenue growth rates from year to year are affected primarily by changes in the mix of OEM Premium Mix,Windows premium edition operating systems licensed as a percentage of total OEM Windows operating systems licensed (“OEM premium mix”). Additional differences in growth rates result from the impact from lower cost netbook PCs, which are sold with a lower cost version of Windows, changes in the geographicalgeographic mix, and changes in the channel mix of products sold by large, multi-national OEMs versus those sold by local and regional system builders.

Fiscal year 2009 compared with fiscal year 2008

Client revenue decreased primarily as a result of PC market weakness, especially PCs sold to businesses. OEM revenue decreased $2.3 billion or 16% while OEM license units declined 2%. The decline in OEM revenue reflects a 10 percentage point decline in the OEM premium mix to 64%. Based on our estimates, total worldwide PC shipments from all sources experienced a decline of approximately 1% to growth of approximately 2%, driven by changes in demand in emerging and developed markets.

Client operating income decreased primarily reflecting decreased revenue and increased sales and marketing expenses. Sales and marketing expenses increased $122 million or 7%, primarily reflecting increased advertising and marketing.

Fiscal year 2008 compared with fiscal year 2007

Client revenue increased reflecting growth in licensing of Windows Vista. By the end of fiscal year 20052008, more than 180 million Windows Vista licenses had been sold (approximately 130 million were sold during fiscal year 2008) and millions of enterprise seats had been deployed. OEM revenue increased $1.8 billion or 14%, driven by 12%16% growth in OEM license units and $886 million or 10% growth in OEM revenue from increased PC unit shipments, partially offset by a $198 million or 9% decrease in revenueunits. Revenue from commercial and retail licensing of Windows operating systems. The OEM Premium Mix remained flat at 50% of total OEM Windows operating systems as compared to the previous year. Revenue earnedincreased $202 million or 9%, primarily from Upgrade Advantage declined by $99 millionEnterprise Agreements and anti-piracy efforts in emerging markets. During fiscal year 2005 contributing2008, the OEM premium mix increased seven percentage points to the decrease74%, reflecting strong demand for Windows Vista Home Premium. We estimate total worldwide PC shipments from all sources grew approximately 12% to 14%, driven by demand in commercialboth emerging and retail licensing revenue.mature markets.

Client operating income increased in fiscal year 2006 reflecting the increase in OEMincreased revenue, partially offset by a $224 million increase inincreased sales and marketing expenses excluding headcount-related costs, mainly driven by increased investments in partner marketing and Windows Vista pre-launch programs. Headcount-related costs increased 6% in fiscal year 2006 reflecting both a 13% increase in headcount primarily associated with Windows Vista and further investments in our sales and marketing organization, and an increase in salaries and benefits for existing headcount, partially offset by a decrease in stock-based compensation expense. Client operating income increased in fiscal year 2005 primarily due to an increase in OEM revenue and a $444 million decrease in stock-based compensation expense. These factors were partially offset by an increase in salescost of revenue. Sales and marketing expenses increased $106 million or 7%, primarily reflecting increased expenses associated with “Start Something,” a globally launched advertising campaign, marketing for security initiatives,our corporate sales force. Cost of revenue increased $116 million or 14%, primarily driven by Windows Vista product costs.

Other

The segment information discussed above is presented the way we internally managed and an increasemonitored performance at the business group level in salaryfiscal years 2009, 2008, and benefits for new2007. Effective July 1, 2009, we reorganized the Windows Live operations from Online Services Business to Client to better align our strategies and existing headcount. The additional headcount for research and development was primarily devoted to the continued development of Windows Vista.focus in those areas.

Server and Tools

Server and Tools consistslicenses products, applications, tools, content, and services that are designed to make information technology professionals and developers more productive and efficient. Server and Tools offerings consist of server software licenses and client access licenses (“CAL”) for Windows Server, Microsoft SQL Server, Exchange Server and other server products. ItWe also includesoffer developer tools, training, certification, Microsoft Press, Premier and Professional product support services, and Microsoft Consulting Services. Server and Tools concentrates on licensing products applications, tools, content and services that make information technology professionals and developers more productive and efficient. The segment usescan be run on-site, in a partner-hosted environment, or in a Microsoft-

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hosted environment. We use multiple channels for licensing, including pre-installed OEM versions, licenses through partners, and licenses directly to end customers. TheWe sell licenses are sold both as one-time licenses and as multi-year volume licenses. Server and Tools uses product innovation and partnerships

Fiscal year 2009 compared with information technology professionals to drive the adoption and sales growth of its products.fiscal year 2008

Server and Tools revenue increased during fiscal year 2006 mainlyreflecting growth in both product and services revenue. Server and server application revenue (including CAL) and developer tools revenue increased $809 million or 8%, primarily driven by growth in SQL Server, Enterprise CAL Suites, and System Center revenue. This growth reflects recognition of deferred revenue from previously signed agreements and continued adoption of the Windows Server Platform and Core CAL. SQL Server 2005applications. Consulting and Visual Studio 2005 were launched in the second quarter of fiscal year 2006 and produced revenue growth in these product lines. Revenue is impacted by overall server hardware shipments which we estimate grew 11% to 13% in fiscal year 2006. Server and Server applications revenue, including CAL revenue, and developer tools, training and certification revenue grew $1.31 billion or 16% during fiscal year 2006. The results reflect broad adoption of Windows Server products, especially SQL Server, which grew over 30% for

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the year. Consulting, Premier and Professional product support services revenue increased $218$215 million or 15%8%, primarily due to higher demand for services. In fiscal year 2005, Server and Server application revenue including CAL revenue, grew $1.10 billion or 17%. Consulting, Premier, and Professional productfrom annuity support services revenue increased $241 million or 19% compared to the previous year.agreements. Foreign currency exchange rate changesrates accounted for $284a $140 million or threeone percentage points of total Server and Tools revenue growth, which was offset by a $314 million decline in Upgrade Advantage revenue earned.

Server and Tools operating income increased during fiscal year 2006 primarily reflecting increased revenue, partially offset by increased sales and marketing expenses. Excluding headcount-related costs, sales and marketing expenses increased $274 million due to additional spending to support long-term strategies and marketing expenses primarily related to the launch of SQL Server 2005 and Visual Studio 2005. Total Server and Tools headcount-related costs increased 5% related to both an 11%point increase in headcount and an increase in salaries and benefits for existing headcount, partially offset by a decrease in stock-based compensation expense. In fiscal year 2005, revenue.

Server and Tools operating income increased primarily due to growth in product revenue, partially offset by increased research and development expenses and cost of revenue. Research and development expenses increased $168 million or 9%, primarily driven by increased headcount-related expenses. Cost of revenue increased $84 million or 3%, reflecting the growth in support, online, and consulting services.

Fiscal year 2008 compared with fiscal year 2007

Server and Tools revenue increased reflecting growth in product and services revenue and included a $1.07favorable impact from foreign currency exchange rates of $464 million or four percentage points. Server and server application revenue (including CAL revenue) and developer tools revenue increased $1.4 billion decreaseor 16%, primarily driven by growth in stock-based compensation expense.volume licensing of Windows Server and SQL Server products. This increase wasgrowth reflects broad adoption of the Windows Platform and applications with the releases of Windows Server 2008 and Visual Studio 2008 during fiscal year 2008. Consulting and Premier product support services revenue increased $593 million or 29%, primarily due to higher demand for consulting and support services by corporate enterprises.

Server and Tools operating income increased primarily due to growth in product revenue, partially offset by increased sales and marketing expenses, cost of revenue, and research and development expenses. Sales and marketing expenses increased $458 million or 13%, due to higher expenses associated with our corporate sales force. Cost of revenue increased $404 million or 19%, reflecting the growth in Consulting and Premier product support services. Research and development expenses increased $177 million or 10%, primarily driven by increased headcount-related expenses. Headcount-related expenses increased 6%, driven by an increase in sales and marketing costs and headcount-related costs as a result of increased headcount and an increase in salaries and benefits for existing headcount.from the prior year-end.

Information WorkerOnline Services Business

Information Worker primarilyOnline Services Business (“OSB”) consists of the Microsoft Office system of programs, servers, solutions,an online advertising platform with offerings for both publishers and services designed to increaseadvertisers, personal team, and organization productivity. Information Worker includes Microsoft Office, Microsoft Project, Microsoft Visio, SharePoint Portal Server CAL, and other information worker products including Office Communications Server and OneNote. Revenue growth depends on the ability to add value to the core Office product set and expand our product offerings in other information worker areascommunications services, such as enterprise content management, collaboration, unified communications,email and business intelligence.

Information Workerinstant messaging, online information offerings, such as Bing, and the MSN portals and channels around the world. We earn revenue increased inprimarily from online advertising, including search, display, email, messaging services, and advertiser and publisher tools. Revenue is also generated through subscriptions and transactions generated from online paid services digital marketing and advertising agency services, and from MSN narrowband Internet access subscribers (“Access”). During the first quarter of fiscal year 2006 primarily reflecting2008, we completed our acquisition of aQuantive, Inc. (“aQuantive”), a $521 million or 5% increase in volume licensing, retail packaged products, and preinstalled versionsdigital marketing business. aQuantive was consolidated into our results of Office in Japan, while OEM revenue increased $66 million or 4%. Information Worker revenue increased in fiscal year 2005 primarily reflecting a $269 million or 3% increase in volume licensing, retail packaged product, and pre-installed versions of Office in Japan, a $91 million or 6% increase in OEM revenue, andoperations starting August 10, 2007, the impact of foreign currency exchange rates, partially offset by reduced Upgrade Advantage earned revenue. Changes in foreign currency exchange rates accounted for approximately $367 million or three percentage points of the revenue growth for fiscal year 2005, offset by a $663 million decline in Upgrade Advantage earned revenue.acquisition date.

Information Worker operating income increased in fiscal year 2006 primarily due to the revenue growth, partially offset by a $283 million or 15% increase in sales and marketing expenses related to supporting field sales efforts and a $71 million or 10% increase in research and development expenses. Headcount-related costs increased 14% during fiscal year 2006 reflecting both an 18% increase in headcount related to supporting field sales efforts and research and development investments in future products and an increase in salaries and benefits for existing headcount, partially offset by a decrease in stock-based compensation expense. Information Worker operating income growth for fiscal year 2005 was primarily due to the revenue growth and a $304 million decrease in stock-based compensation expense. Operating expenses were also impacted by a reduction in marketing campaign costs from the previous period associated with the launch of Office 2003. This decline was offset by an increase in headcount-related costs as a result of an increase in headcount and an increase in salaries and benefits for existing headcount.

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Microsoft Business Solutions

Microsoft Business Solutions provides business management software solutions targeted to businesses of varying sizes. The main products consist of enterprise resource planning (“ERP”) solutions, customer relationship management (“CRM”) software, retail solutions, Microsoft Partner Program (“MSPP”), and related services. Microsoft Business Solutions also includes the Small and Mid-market Solutions and Partners (“SMS&P”), which focuses on sales to customers and partners in the small and mid-market customer segments. Revenue is derived from software and services sales,Fiscal year 2009 compared with software sales representing a significant amount of total revenue. Software revenues include both new software licenses and enhancement plans, which provide customers with future software upgrades over the period of the plan. Our solutions are delivered through a worldwide network of channel partners that provide services and local support.

Microsoft Business Solutions revenue increased in fiscal year 2006 driven by new users for Microsoft CRM and existing Dynamics ERP customers purchasing functionality and user licenses. The increase in Microsoft Business Solutions2008

OSB revenue in fiscal year 2005 was mainly due to 10% revenue growth in software partially offset by 25% decline in services revenue. The software revenue increase was driven by 9% growth in license revenue and 16% growth in enhancement revenue and was attributed to growth in ERP and CRM solutions and an increase in MSPP subscriptions.

Microsoft Business Solutions operating income increased in fiscal year 2006 reflecting the increase in revenue accompanied by a $56 million decrease in sales and marketing expensedecreased primarily as a result of decreased net SMS&P spending.online advertising and access revenue. Online advertising revenue decreased $73 million or 3%, to $2.3 billion, reflecting a decrease in display advertising, partially offset by an increase in search advertising. Access revenue decreased $72 million or 28%, reflecting continued migration of subscribers to broadband or other competitively-priced service providers. Foreign currency exchange rates accounted for a $28 million or one percentage point decrease in revenue.

OSB operating loss increased due to increased cost of revenue and research and development expenses, and decreased revenue. Cost of revenue increased $692 million or 36%, primarily driven by increased online traffic acquisition, data center and equipment, and headcount-related costs. Research and development expenses increased $149 million or 13%, primarily due to increased headcount-related expenses.

Fiscal year 2008 compared with fiscal year 2007

OSB revenue increased driven by increased online advertising revenue and the inclusion of aQuantive revenue, partially offset by decreased access revenue. Online advertising revenue increased $550 million or 31%, to $2.3 billion. This increase reflects growth in our existing online advertising business and includes aQuantive online advertising revenue of $161 million. Agency revenue, which is solely derived from aQuantive, was $345 million during fiscal year 2008. Access revenue decreased $98 million or 28%, to $256 million, reflecting migration of subscribers to broadband or other competitively-priced service providers.

OSB operating loss increased driven by increased cost of revenue and other operating expenses, partially offset by increased revenue. Cost of revenue increased $796 million or 71%, primarily driven by increased data center and equipment costs, online content expenses, and aQuantive-related expenses. Sales and marketing expenses increased $311 million or 37%, primarily due to increased amortization of customer-related intangible assets of $94 million, increased headcount-related expenses, and increased marketing costs. Research and development expenses increased $177 million or 17%, and general and administrative expenses increased $114 million or 178%, primarily reflecting increased headcount-related expenses and merger and acquisition-related expenses. Headcount-related costsexpenses increased 3% reflecting both a 10%24%, driven by an increase in headcount from the prior year-end.

Other

The segment information discussed above is presented the way we internally managed and an increase in salaries and benefits for existing headcount, partially offset by a decrease in stock-based compensation expense. Microsoft Business Solutions operating loss declinedmonitored performance at the business group level in fiscal year 2005 primarily due to a $175 million decline in stock-based compensation expense, an increase in product revenue,years 2009, 2008, and a decline in amortization of acquired intangibles. The reduction in operating loss was partially offset by a net increase in sales and marketing expense driven by incremental costs in the SMS&P organization. In addition, we increased our marketing and product development spending in our ERP and CRM portfolios.

MSN

MSN includes personal communications services, such as e-mail and instant messaging, and online information offerings, such as MSN Search, and the MSN portals and channels around the world. MSN also provides a variety of online paid services in addition to MSN Internet Access and MSN Premium Web Services. Revenue is derived primarily from advertisers on MSN, from consumers and partners through subscriptions and transactions generated from online paid services, and from MSN narrowband Internet access subscribers. In fiscal year 2006, we launched MSN adCenter – our internally developed advertising platform – in certain international markets and throughout the U.S. where it now serves 100 percent of paid search traffic on our online properties. We believe MSN adCenter will enable us to increase both display and search advertising revenues by reducing our reliance on third parties for delivering ads.2007. Effective July 1, 2005, functions related2009, we reorganized the Windows Live operations from OSB to MapPoint previously reportedClient to better align our strategies and focus in Mobilethose areas.

On July 29, 2009, we announced that we entered into a 10-year agreement with Yahoo! Inc. (“Yahoo”). Under terms of the agreement, Microsoft will provide the exclusive algorithmic and Embeddedpaid search platform for Yahoo websites. We believe this agreementwill allow us over time to improve the effectiveness and increase the value of our search offering through greater scale in search queries and an expanded and more competitive search and advertising marketplace. The transaction is subject to regulatory review. Both parties anticipate entering into more detailed definitive agreements prior to closing the transaction which is expected in calendar year 2010. See Note 24 – Subsequent Event of the Notes to Financial Statements (Part II, Item 8).

Microsoft Business Division

Microsoft Business Division (“MBD”) offerings consist of the Microsoft Office system and Microsoft Dynamics business solutions. Microsoft Office system products are designed to increase personal, team, and organization productivity through a range of programs, services, and software solutions. Growth of revenue from the Microsoft Office system

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offerings, which generate over 90% of MBD revenue, depends on our ability to MSN. Mobileadd value to the core Office product set and Embedded Devicesto continue to expand our product offerings in other information worker areas such as content management, enterprise search, collaboration, unified communications, and MSN operatingbusiness intelligence. Microsoft Dynamics products provide business solutions for financial management, customer relationship management, supply chain management, and analytics applications for small and mid-size businesses, large organizations, and divisions of global enterprises. We evaluate our results forbased upon the prior periods have been restated for this reorganization. We announcednature of the end user in two primary parts: business revenue, which includes Microsoft Office system revenue generated through volume licensing agreements and Microsoft Dynamics revenue; and consumer revenue, which includes revenue from retail packaged product sales and OEM revenue.

Fiscal year 2009 compared with fiscal year 2006, Windows Live™,2008

MBD revenue was flat reflecting decreased consumer revenue offset by increased business revenue, and included a setfavorable impact from foreign currency exchange rates of Internet services and software designed to improve the users’ connected experience, including Windows Live™ Local and Windows Live Messenger.

MSN$378 million or two percentage points. Consumer revenue decreased in fiscal year 2006 primarily reflecting a $195$525 million or 28% decline in access revenue, partially offset by a $126 million or 9% increase in advertising revenue and a $23 million or 9% increase in revenue from subscription and transaction services other than access. As of June 30, 2006, MSN had 2.1 million access subscribers compared with 2.7 million at June 30, 2005. In addition, MSN had over 261 million active Hotmail accounts and over 243 million active Messenger accounts as of June 30, 2006. The increase in advertising revenue reflects growth in display advertising for portals, channels, email, and messaging services, which was partially offset by a decline in search revenue due to the transition to adCenter. In fiscal year 2005, MSN revenue increased reflecting $193 million or 16% growth in advertising revenue14%, primarily as a result of industryPC market weakness, a shift to lower-priced products, and marketpricing promotions on the 2007 Microsoft Office system. Business revenue increased $490 million or 3%, primarily reflecting growth and continued growth of MSN display advertisingin volume licensing agreement revenue and $84 million or 88%included a 7% decrease in Microsoft Dynamics customer billings. The growth in subscriptionvolume licensing agreement revenue primarily reflects recognition of deferred revenue from previously signed agreements.

MBD operating income decreased reflecting increased cost of revenue and transaction services revenue. These increases wereresearch and development expenses, partially offset by the search claritydecreased sales and marketing expenses. Cost of revenue increased $135 million or 14% primarily driven by expenses associated with Fast Search & Transfer ASA (“FAST”) which we acquired in advertising program, the impactApril 2008, as well as online services infrastructure costs. Research and development expenses increased $119 million or 8%, primarily driven by an increase in headcount-related expenses associated with FAST. Sales and marketing expenses decreased $90 million or 2%, primarily driven by a decrease in corporate marketing activities and headcount-related costs associated with our corporate sales force.

Fiscal year 2008 compared with fiscal year 2007

MBD revenue increased reflecting growth in licensing of the homepage redesign,2007 Microsoft Office system and included a declinefavorable impact from foreign currency exchange rates of $219$724 million or 24%four percentage points. Business revenue increased $2.6 billion or 21%, primarily as a result of growth in accessvolume licensing agreement revenue driven byand strong transactional license sales to businesses. The increase in business revenue also included a 21% increase in Microsoft Dynamics customer billings. Consumer revenue decreased $131 million or 3%, reflecting the continued migrationconsumer launch of Internet Access subscribers to broadband or other competitively priced Internet service providers.

MSN operating income decreasedthe 2007 Microsoft Office system in fiscal year 2006 due to a $230 million or 39% increase2007.

MBD operating income increased reflecting growth in research and development costs, a $126 million or 22% increase inrevenue, partially offset by increased sales and marketing expenses, research and development expenses, and cost of revenue. Sales and marketing expenses increased $446 million or 13%, reflecting increased expenses associated with our corporate sales force. Research and development expenses increased $229 million or 18%, primarily driven by an increase in headcount-related expenses and a $67$35 million in-process research and development expense related to the acquisition of FAST. Cost of revenue increased $214 million or 9%27%, primarily driven by an increase in cost of revenue as we continueonline services infrastructure costs and product costs related to invest in MSN adCenter, Windows Live, and other new platforms.retail packaged product sales. Headcount-related costsexpenses increased 25% reflecting a 44%10%, driven by an increase in headcount and increased salaries and benefits for existing employees, partially offset by a decrease in stock-based compensation. In fiscal year 2005, MSN operating income increased mainly due to a $241 million decrease in stock-based compensation expense, reduced costs associated withfrom the Internet Access business, and increased advertising and subscription revenue. Partially offsetting the decreased expenses were increased headcount-related costs as a result of increased headcount and an increase in salaries and benefits for existing headcount.prior year-end.

MobileEntertainment and Embedded Devices Division

Entertainment and Devices Division (“EDD”) offerings include the Xbox 360 platform (which includes the Microsoft Xbox 360 video game console system, Xbox 360 video games, Xbox Live, and Xbox 360 accessories), the Zune

Mobile and Embedded Devices includes Windows Mobile software, Windows Embedded operating systems, and Windows Automotive. These products extend the advantages of the Windows platform to mobile devices such as PDAs, phones, and a wide range of embedded devices. The business is also responsible for managing sales and customer relationships for Microsoft overall with device manufacturers and communication sector customers. The communication sector includes network service providers (such as wireless, wireline and cable operators) and media and entertainment companies. The market for products in these segments is intensely competitive. Competitive alternatives vary based on product lines and include product offerings from commercial and non-commercial mobile operating system providers, and proprietary software developed by OEMs and mobile operators. Effective July 1, 2005, functions related to MapPoint previously reported in Mobile and Embedded Devices were moved to MSN. Mobile and Embedded Devices and MSN operating results for the prior periods have been restated for this reorganization.

Mobile and Embedded Devices revenue increased in fiscal year 2006 primarily due to unit volume increases in major product lines, especially Windows Mobile software sales and Windows Embedded operating systems. Increased revenue for Windows Mobile software was primarily driven by increased market demand for phone-enabled devices, partially offset by a decline in shipments for stand-alone PDAs. In fiscal year 2006, revenue for Windows Mobile software increased $55 million or 37% while revenue for Windows Embedded operating systems increased $49 million or 47%, which was primarily due to the product being included in new product designs for both new and existing customers. Unit volume increases in major product lines drove revenue growth for fiscal year 2005 over fiscal

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digital music and entertainment platform, PC software games, online games and services, Mediaroom (our Internet protocol television software), the Microsoft Surface computing platform, mobile and embedded device platforms, and other devices. EDD leads the development efforts for phone-enabled devices,our line of consumer software and increased growth in shipmentshardware products including application software for standalone PDAs. In fiscal year 2005, revenueApple’s Macintosh computers and Microsoft PC hardware products, and is responsible for Windows Mobile software increased $46 million or 45% and revenue for Windows Embedded operating systems increased $19 million or 21%. Unit volume increases in major product lines drove revenue growth for fiscal year 2005 over fiscal year 2004, primarily driven by increased market demand for phone-enabled devices, and increased growth in shipments for standalone PDAs.

Mobile and Embedded Devices generated operating income for fiscal year 2006 as opposed to the operating loss in fiscal year 2005 primarily due to increased revenue, partially offset by a $42 million or 21% increase in both research and development and general and administrative expenses. Headcount-related costs increased 15% reflecting both a 24% increase in headcount and an increase in salaries and benefits for existing headcount, partially offset by a decrease in stock-based compensation expense. The operating loss for fiscal year 2005 decreased compared to fiscal year 2004 primarily due to a $95 million decrease in stock-based compensation, as well as the growth in revenue and a decrease inall retail sales and marketing expense. This improvement wasfor Microsoft Office and Windows operating systems.

Fiscal year 2009 compared with fiscal year 2008

EDD revenue decreased across most lines of business. Revenue from our non-gaming business decreased $292 million or 12%, primarily reflecting decreased Zune and PC hardware product revenue. Xbox 360 platform and PC game revenue decreased $161 million or 3%, primarily as a result of decreased revenue per Xbox 360 console due to price reductions during the past 12 months, partially offset by increased salary and benefit costs from increased headcount, and increased investment in research and development.

Home and Entertainment

Home and Entertainment includes the Microsoft Xbox video game console system, PC games, CPxG (consumer software and hardware products), and TV platform products for the interactive television industry. The success of video game consoles is determined by console innovation, the portfolio of video game content for the console, online offerings, and the market share of the console. Our Xbox business is transitioning to a new console, the Xbox 360, which launched in the second quarter of fiscal year 2006. We believe that the functionality of our new console, games portfolio, and online offerings are well-positioned relative to forthcoming competitive consoles. We also believe launching in advance of competitive consoles will provide a strategic advantage for the long-term success of Xbox 360. Revenue from the first generation of Xbox products has declined and is expected to continue to decline as a result of the introduction of Xbox 360.

Home and Entertainment revenue increased in fiscal year 2006 primarily due to the launch of the Xbox 360 console partially offset by a decline in first partysales and increased Xbox game sales primarily resulting from the significant impact of Halo 2 in fiscal year 2005.Live revenue. We sold approximately 5shipped 11.2 million Xbox 360 consoles during fiscal year 2006. The revenue growth was also attributable to $1402009, compared with 8.7 million Xbox 360 consoles during fiscal year 2008. Foreign currency exchange rates accounted for a $74 million or 15% growth from our other product lines,one percentage point decrease in revenue.

EDD operating income decreased primarily due to decreased revenue and increased research and development expenses, partially offset by decreased cost of revenue. Research and development expenses increased $252 million or 16%, primarily reflecting increased headcount-related expenses associated with the Windows Mobile device platform, driven by recent acquisitions. Cost of revenue decreased $326 million or 7%, primarily due to decreased Xbox 360 platform costs.

Fiscal year 2008 compared with fiscal year 2007

EDD revenue increased primarily due to increased Xbox 360 platform sales. Xbox 360 platform and PC game revenue increased $1.7 billion or 41% as a result of an increase in PC gamesincreased Xbox 360 console sales, video game sales led by Halo 3, Xbox Live revenue, and Xbox 360 accessory sales. We shipped 8.7 million Xbox 360 consoles during fiscal year 2008, compared with 6.6 million Xbox 360 consoles during fiscal year 2007.

EDD operating income increased primarily due to significant new game releases, especially “Ageincreased revenue and decreased cost of Empires III”revenue, partially offset by increased research and development expenses and sales and marketing expenses. Cost of revenue decreased $684 million or 13%, and an increase in MSTV revenue due to deploymentsreflecting the impact of the $1.1 billion Xbox 360 charge in fiscal year 2006. Revenue increased in fiscal year 20052007 (which primarily duerelated to significant new product launches, which resulted in a $416 million or 23% increase in Xbox revenue. Halo 2 was introduced in the second quarter of fiscal year 2005 and generated over $300 million in revenue in fiscal year 2005. Revenue from consumer hardware and software, PC games, and TV platforms declined $50 million or 5% compared to fiscal year 2004 due to lower PC games software sales.

Home and Entertainment operating loss increased in fiscal year 2006 primarily as a result of a $1.64 billion increase in cost of revenue resulting from the number of Xbox 360 consoles sold and higher Xbox 360 unit costs,warranty expansion), partially offset by the revenue growth. Our fiscal year 2006 operating loss increased dueXbox 360 product costs related to increased unit console sales. Research and development expenses increased $242 million or 18%, primarily reflecting increased headcount-related expenses and costs related to the significant impactacquisition of Halo 2 in fiscal year 2005.Danger, including a $24 million in-process research and development expense. Sales and marketing expenses increased $89 million or 7%, primarily reflecting increased headcount-related expenses and increased bad debt expense. Headcount-related costsexpenses increased 5% reflecting both a 19% increase in headcount and an increase in salaries and benefits for existing headcount, partially offset by a decrease in stock-based compensation expense. The fiscal year 2005 operating loss decreased primarily due to an increase in high margin Xbox software sales, lower Xbox console units costs, a $90 million lower-of-cost-or-market inventory adjustment recorded in fiscal year 2004, and a $219 million decrease in stock-based compensation expense. The decrease was partially offset22%, driven by an increase in costs associated with Xbox 360 console development and related launch efforts.

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headcount from the prior year-end.

Corporate-Level Activity

Certain corporate-level expenses areactivity is not allocated to our segments. Those results include expenses primarily include corporate operations related tosuch as broad-based sales and marketing, product support services, human resources, legal, finance, information technology, corporate development and procurement activities, research and development and other costs, and legal settlements and contingencies.contingencies, and employee severance.

Fiscal year 2009 compared with fiscal year 2008

Corporate-level expenses decreased in fiscal year 2006, primarily reflecting a $991 million decrease in costs for legal settlements and legal contingencies partially offset by an $84 million increase in headcount-related costs. We incurred $1.32 billion in legal charges during fiscal year 2006 including settlement expense of $361 million related to our settlement with RealNetworks, Inc. as well as other intellectual property and antitrust matters, and the€281 million ($351 million) fine imposed by the European Commission in July 2006 related to its 2004 decision in its competition law investigation of Microsoft, as compared to $2.31 billion in legal charges incurred during the prior year primarily related to settlements with Novell, Inc., Gateway, IBM, and other antitrust and competition law matters. Headcount-related costs increased 5% during the twelve months ended June 30, 20062009, primarily reflecting both a 23% increase in headcountdecreased general and an increase in salariesadministrative and benefits for existing headcount,sales and marketing expenses, partially offset by a decrease in stock-based compensation.

Corporate-levelemployee severance charges of $330 million. General and administrative expenses decreased in fiscal year 2005,$1.4 billion or 28%, primarily as a result of a $736 million reduction in stock-based compensation expense anddue to decreased costs for legal settlements and legal contingencies. In fiscal year 2005, we recognized $2.31 billion inWe incurred $283 million of legal charges as compared to $2.53 billion in fiscal year 2004 which included a $1.92 billion charge for a settlement withduring the Sun Microsystems, Inc., and the fine of€497 million ($605 million) imposed by the European Commission.

Change to Financial Reporting Structure

On July 17, 2006, we announced that effective the first quarter of fiscal year 2007, we will report our businesses under five operating segments, reflecting completion of the previously announced changes in our organizational structure and how we will manage our business beginning in fiscal year 2007. Each of the five segments will be organized under one of the three operating divisions announced earlier in fiscal year 2006:twelve months ended

The five operating segments are described below. The first three of these will comprise the Platforms and Services Division.

Client    will include the former Client segment. Products will include Windows XP Professional and Home, Media Center Edition, Tablet PC Edition, and other standard Windows operating systems.

Server and Tools    will include the former Server and Tools segment, excluding the Exchange Server business and certain client access licenses related to products residing in the Microsoft Business Division. Products will include the Windows Server operating system, Microsoft SQL Server, Microsoft Consulting Services, product support services, Visual Studio, System Center products, the Forefront security family of products, and Biz Talk Server, among others.

Online ServicesBusiness    will include the former MSN segment and Windows Live. Products will include MSN Search, MapPoint, MSN Internet Access, MSN Premium Web Services, MSN Mobile Services, and Windows Live.

Microsoft Business Division    will include the former Information Worker and Microsoft Business Solutions segments, as well as the Exchange Server business and certain client access licenses, formerly included in the Server and Tools segment. Products will include Microsoft Office, Microsoft Project, Microsoft Visio, SharePoint Portal Server CAL, Microsoft Live Meeting, One Note, Office Communication Server, Microsoft Dynamics AX, Microsoft

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Dynamics CRM, Microsoft Dynamics GP, Microsoft Dynamics NAV, Microsoft Dynamics SL, Microsoft Dynamics Retail Management System, Microsoft Partner Program, and Microsoft Office Small Business Accounting.

Entertainment and Devices Division    will include the former Home and Entertainment and Mobile and Embedded Devices segments. Products will include Xbox 360, Xbox, Xbox Live, CPxG (consumer software and hardware products), IPTV, Windows Mobile software platform, Windows Embedded device operating system, and Windows Automotive.

Our historical results under this new segmentation for the four quarters in fiscal years 2006 and 2005 were as follows:

Revenue

Operating Income / (Loss)

Our outlook for fiscal year 2007 based on the five operating segments is as follows:

Client    We expect revenue to grow reflecting improvement in the commercial and retail portion of the business due to our upcoming launch of Windows Vista. We expect revenue generated from OEMs to grow slower than the PC hardware market due to increased concentration among larger OEMs, consumer hardware shipments growing faster than business shipments, and relatively faster growth in emerging markets. We expect PC shipments to grow 8% to 10% for fiscal year 2007. We believe that PC unit growth rates will be higher in the consumer segment than in the business segment and higher in emerging markets than in mature markets.

Server and Tools    We expect continued momentum from recent product launches and the expansion of our products in security, management and designer tools will help drive our overall revenue growth in fiscal year 2007. We estimate overall server hardware unit shipments will grow 10% to 12% in fiscal year 2007. However, we face competition from Linux-based, Unix, and other server operating systems as well as competition in server applications.