the finished goods channels.  Unit sales under licensing programs may continue to increase.



Earnings process

An increasingly higher percentage of the Company’s revenue is subject to ratable recognition, which impacts the timing of revenue and earnings recognition.  This policy may be required for additional products, depending on specific license terms and conditions.  Also, maintenance and other subscription programs may continue to increase in popularity, particularly with organizations.



Channel mix

Average revenue per license is lower from OEM licenses than from retail versions, reflecting the relatively lower direct costs of operations in the OEM channel.  An increasingly higher percentage of revenue was achieved through the OEM channel during 1998 and 1999.

	

Cost of revenue

Decreases in cost of revenue as a percentage of revenue in 1998 and 1999 were due to general shifts from packaged products to OEM and organizational licenses, from lower-margin products to higher-margin products, and from disks to CD-ROMs.  These shifts may not continue.  Direct costs of product support; services such as consulting and training and certification of system integrators; and online operations comprise the majority of cost of revenue and are not likely to decrease.  The trend of declining cost of revenue as a percentage of revenue is unlikely to continue in 2000.



Employee compensation

Microsoft employees currently receive salaries, incentive bonuses, other benefits, and stock options.  Fiscal 2000 salaries will be enhanced, with the mid-point salary range raised from the 50th to the 65th percentile of competitive positions.  Additionally, new  government regulations, poor stock price performance, or other factors could diminish the value of the option program to current and prospective employees and force the Company into more of a cash compensation model.  Had the Company paid employees in cash the equivalent of the Black-Scholes value of options vested in 1997, 1998, and 1999, the incremental pretax expense would have been approximately $620 million, $850 million, and $1.10 billion.



Long-term R&D investment cycle

Developing and localizing software is expensive, and the investment in product development often involves a long payback cycle.  The Company plans to continue significant investments in software research and development, including online initiatives.  Significant revenue from these product opportunities is not anticipated for a number of years.  Total spending for R&D in 2000 will increase over spending in 1999.



Sales and marketing investments

The Company’s plans for 2000 include accelerated investments in its sales groups, customer satisfaction, and marketing activities.



International operations

Much of the Company’s operations are conducted outside of the United States, and a large percentage of sales, costs of manufacturing, and marketing is transacted in local currencies.  As a result, the Company’s international results of operations are subject to local economic environments and foreign exchange rate fluctuations.



Market risk

The Company is exposed to foreign currency, interest rate, and equity price