1998



Letter to shareholders

We had a huge effect on the Internet. And it had a huge effect on us.During Microsoft's 21-year history, the pace of innovation has been quite rapid. This past year stands out both for the exciting new products and the broad recognition that computers will revolutionize communications. Windows® 95 was launched, and 40 million people were introduced to its benefits: ease of use, 32-bit applications, and increased productivity. Windows NT® established phenomenal sales momentum and gained widespread acceptance as the foundation for the enterprise market and a new generation of corporate intranets and Web servers. 

The Internet came of age, and Microsoft embraced the opportunity by enhancing its entire range of products and services to create the best Web experience for everyone from the casual Web surfer to the corporate IT manager. Microsoft is betting that over the next decade Internet use will grow dramatically. Next year research and development spending, broadly defined, will grow to more than $2 billion, at a growth rate faster than sales. Our R&D is driven by customer feedback and our belief that there are many breakthroughs in software that we can achieve by taking a long-term approach. 

In our dialog with the financial community, we go out of our way to point out the challenges of maintaining or increasing our profitability. This conservatism is part of our culture. Despite this, we feel the prospects for our business over the next decade are very strong. 

I want to thank our employees, customers, partners, and shareholders for all of their support in building Microsoft.

MANAGEMENT'S DISCUSSION AND ANALYSIS

RESULTS OF OPERATIONS FOR 1996, 1997, AND 1998



Microsoft develops, manufactures, licenses, and supports a wide range of

software products, including scalable operating systems for intelligent devices,

personal computers (PCs), and servers; server applications for client/server

environments; business and consumer productivity applications; software

development tools; and Internet and intranet software and technologies.  The

Company's interactive efforts include entertainment and information software

programs; MSN, the Microsoft Network online service; Internet-based services;

and alliances with companies involved with various forms of digital

interactivity.  Microsoft also sells personal computer input devices and books,

and researches and develops advanced technologies for future software products.



REVENUE

The Company's revenue growth rate continued to slow, from 46% in the fiscal year

ended June 30, 1996 and 31% in fiscal 1997 to 28% in fiscal 1998.  Revenue

growth was particularly strong in 1996 due to the retail introduction of the

Microsoft Windows 95 operating system.  The 1997 and 1998 growth rates, although

slower than that of 1996, reflected the continued adoption of Windows 32-bit

operating systems and Microsoft Office 97, particularly as Microsoft software is

deployed across entire corporate, academic, and governmental organizations.

Software license volume increases have been the principal factor in Microsoft's

revenue growth.  The average selling price per