require Microsoft to lower product prices to meet competition, reducing the Company’s net income.



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 new subscription programs such as the application service provider (ASP) model are increasing in popularity.



Employee Compensation

Microsoft employees currently receive salaries, incentive bonuses, other benefits, and stock options.  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.



International Operations

Microsoft develops and sells products throughout the world.  The prices of the Company’s products in countries outside of the United States are generally higher than the Company’s prices in the United States because of the costs incurred in localizing software for non-U.S. markets.  The costs of producing and selling the Company’s products in these countries are also higher.  Pressure to globalize Microsoft’s pricing structure might require that the Company reduce the sales price of its software in other countries, even though the costs of the software continue to be higher than in the United States.  Negative changes in software “piracy” trade protection laws, policies and measures and other regulatory requirements affecting trade and investment; unexpected changes in regulatory requirements for software; social, political, labor or economic conditions in a specific country or region; difficulties in staffing and managing foreign operations; and potential adverse foreign tax consequences; among other factors, could also have an impact on the Company’s business and results of operations outside of the United States.



Market Risk

The Company is exposed to foreign currency, interest rate, and securities price risks.  A portion of these risks is hedged, but fluctuations could impact the Company’s results of operations and financial position.  The Company hedges the exposure of accounts receivable and a portion of anticipated revenue to foreign currency fluctuations, primarily with option contracts.  The Company monitors its foreign currency exposures daily to maximize the overall effectiveness of its foreign currency hedge positions.  Principal currencies hedged include the Euro, Japanese yen, British pound, and Canadian dollar.  Fixed income securities are subject to interest rate risk.  The portfolio is diversified and consists primarily of investment grade securities to minimize credit risk.  The Company routinely uses options to hedge its exposure to interest rate risk in the event of a catastrophic increase in interest rates.  Many securities held in the Company’s equity and other investments portfolio are subject to price risk.  The Company uses options to hedge its price risk on certain highly volatile equity securities.

The Company uses a value-at-risk (VAR)