by foreign exchange rates.  Approximately 32%, 29%, and 30% of the Company’s revenue was collected in foreign currencies during 1998, 1999, and 2000.  Since a portion of local currency revenue is hedged and much of the Company’s international manufacturing costs and operating expenses are also incurred in local currencies, the impact of exchange rates is partially mitigated.





Operating Expenses



Cost of Revenue

Cost of revenue as a percent of revenue was 16.1% in 1998, 14.3% in 1999, and 13.1% in 2000.  Cost of revenue in fiscal 2000 reflected lower costs associated with WebTV Networks’ operations, partially offset by the growth in hardware peripherals costs.  The percentage decreases in fiscal 1999 and 1998 resulted primarily from the trend in mix shift to OEM and organizational licenses.  The decreases were also due to the shifts in mix to CD-ROMs, which carry lower cost of goods than floppy disks, and higher-margin Windows NT Server, other servers, and client access licenses in the BackOffice® product family.  Additionally, cost of revenue in 1999 was positively impacted by a reduction in estimates of obsolete inventory and other manufacturing costs of $67 million.  As discussed previously, the Company’s business model continues to evolve toward licensing from sales of packaged products through distribution channels.  Consequently, risks associated with manufacturing and holding physical product have declined.



Research and Development

Microsoft continued to invest heavily in the future by funding research and development (R&D).  The increase in fiscal 2000 was driven primarily by higher headcount-related costs.  The increase in fiscal 1999 reflected higher development headcount-related costs offset by lower infrastructure and third-party development costs.  Fiscal 1998 expenses were driven primarily by higher development headcount-related costs and third-party development costs.

In fiscal 1998, the Company acquired WebTV Networks, Inc., an online service that enables consumers to experience the Internet through their televisions via set-top terminals.  Microsoft paid $425 million in stock and cash.  The accompanying fiscal 1998 income statement reflects a one-time write-off of in-process technologies under development by WebTV Networks of $296 million.



Sales and Marketing

In fiscal 2000, sales and marketing expenses as a percentage of revenue increased due to higher relative marketing costs associated with new product releases and online marketing.  In fiscal 1999, sales and marketing expense as a percentage of revenue decreased due to lower relative sales expenses and lower relative marketing costs.  In fiscal 1998, the sales and marketing expense as a percent of revenue decreased due to lower relative sales expenses.



General and Administrative

Fiscal 2000 general and administrative expenses included a charge for the settlement of a lawsuit with Caldera, Inc. and also reflected increased legal fees and certain employee stock option-related expenses.  The increase in fiscal years 1999 and 1998 were attributable to higher legal fees, settlement costs, and headcount-related costs necessary to support the Company’s