FINANCIAL RISKS

>    The Company’s cash and short-term investment portfolio is diversified and consists primarily of investment grade securities. Investments are held with high-quality financial institutions, government and government agencies, and corporations, thereby reducing credit risk concentrations. Interest rate fluctuations impact the carrying value of the portfolio. The Company routinely hedges the portfolio’s return with options in the event of a catastrophic increase in interest rates. At June 30, 1999, the notional amount of the options outstanding was $4.0 billion. The fair value and premiums paid for the options were not material. Much of the Company’s equity security portfolio is highly volatile, so certain positions are hedged.
     Finished goods sales to international customers in Europe, Japan, Canada, and Australia are primarily billed in local currencies. Payment cycles are relatively short, generally less than 90 days. Certain international manufacturing and operational costs are disbursed in local currencies. Local currency cash balances in excess of short-term operating needs are generally converted into U.S. dollar cash and short-term investments on receipt. Although foreign exchange rate fluctuations generally do not create a risk of material balance sheet gains or losses, the Company hedges a portion of accounts receivable balances denominated in local currencies, primarily with purchased options. At June 30, 1999, the notional amount of options outstanding was $662 million. The fair value and premiums paid for the options were not material.
     Foreign exchange rates affect the translated results of operations of the Company’s foreign subsidiaries. The Company hedges a portion of planned international revenue with purchased options. The notional amount of the options outstanding at June 30, 1999 was $2.25 billion. The fair value and premiums paid for the options were not material.
     At June 30, 1998 and 1999, approximately 40% and 50% of accounts receivable represented amounts due from 10 customers. One customer accounted for approximately 12%, 8%, and 11% of revenue in 1997, 1998, and 1999.
     Microsoft lends certain fixed income and equity securities to enhance investment income. Adequate collateral and/or security interest is determined based upon the underlying security and the credit worthiness of the borrower.

CASH AND SHORT-TERM INVESTMENTS

PROPERTY AND EQUIPMENT

     During 1997, 1998, and 1999, depreciation expense, of which the majority related to computer equipment, was $353 million, $528 million, and $483 million; disposals were not material.