requirements, enhance existing products, develop and introduce new products and achieve market acceptance of such products. This process grows more challenging as the pace of change continues to accelerate. Open source software, new computing devices, new microprocessor architectures, the Internet, and Web-based computing models are among the competitive challenges the Company must meet. If Microsoft does not successfully identify new product opportunities and develop and bring new products to market in a timely and cost-efficient manner, the Company’s business growth will suffer and demand for its products will decrease. 

Future Initiatives 

The Company plans to continue to make significant investments in software research and development including Microsoft .NET, “HailStorm”, Xbox, wireless technologies, digital devices, television, and small business. It is anticipated that these investments in research and development will increase over historical spending levels. Significant revenue from these product opportunities may not be achieved for a number of years, if at all. 

PC Growth Rates 

The nature of the PC marketplace is changing in ways that may reduce Microsoft’s software sales and revenue growth. Overall market demand for PCs can significantly impact Microsoft’s revenue growth. Recently, manufacturers have sought to reach more consumers by developing and producing lower cost PCs – PCs that come without pre-installed software or contain software with reduced functionality. In addition to the influx of low-cost PCs, a market for handheld computing and communication devices has developed. While these devices are not as powerful or versatile as PCs, they threaten to erode sales growth in the market for PCs with pre-installed software. This may affect Microsoft’s revenue growth because manufacturers may choose not to install Microsoft software in these low-cost PCs or consumers may purchase alternative intelligent devices that do not use Microsoft software. These lower-priced devices require Microsoft to provide lower-priced software with a subset of the original functionality. As a result, the Company may generate less revenue from the sale of software produced for these devices than from the sale of software for PCs. 

Product Development 

The software industry is inherently complex. New products and product enhancements can require long development and testing periods. Significant delays in new product releases or significant problems in creating new products could damage Microsoft’s business. The Company anticipates that Windows XP and Xbox will be released in fiscal 2002. Delays in either product may adversely affect revenue and net income. 

Prices 

The competitive factors described above may require Microsoft to lower product prices to meet competition, reducing the Company’s revenue and 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. Ratable revenue recognition may be required for additional products, depending on specific license terms and conditions. Also, maintenance and new