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Friday, October 26, 2007 - Page updated at 12:00 AM

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Microsoft quarter brings back boom

Seattle Times technology reporter

Stellar first-quarter results and a substantially improved outlook spurred Microsoft shares to levels not seen since July 2001.

Investors and analysts cheered the company's report, delivered after the markets closed Thursday, of $13.76 billion in sales, up 27.3 percent from the year-earlier period. The news sent the stock up 11 percent to $35.50 in extended trading.

Microsoft posted a profit of 45 cents a share, up 28.6 percent, and a solid 6 cents over the average prediction of Wall Street analysts polled by Thomson Financial.

It attributed the success to strong consumer demand for its flagship products, Windows Vista, Office 2007 and "Halo 3," but all of its business segments had double-digit growth.

Microsoft executives see no end to the good times during the 2008 fiscal year. The company expects revenue of $58.8 billion to $59.7 billion, about $2 billion more than the forecast in mid-July.

Chief Financial Officer Chris Liddell called it an "outstanding start to the fiscal year," noting the company has not seen a first-quarter growth rate this fast since 1999.

But that year, the company was growing on a base of only $3.13 billion.

"The fact that we can beat the law of large numbers is a tribute to our product and sales teams," Liddell said.

Israel Hernandez, an analyst with Lehman Brothers, said "long-suffering Microsoft shareholders" are being "duly rewarded for their patience."

He called the better-than-expected results, "so out of character for Microsoft, that it's really got the aftermarket in a bit of a frenzy."

Typically, Microsoft manages Wall Street well and meets or slightly beats expectations, said Hernandez, whose employer does investment-banking business with the company.

"I think this [quarterly report] will probably lead to some reset in how investors will value the company from multiple perspectives," he said.

The companywide success impressed analysts including Sid Parakh, of McAdams Wright Ragen in Seattle.

"That's a great quarter," said Parakh, who had a $35-per-share price target on the stock. "Just the fact that it wasn't specifically one single division — it was across the board, across all their divisions."

The one exception was the Online Services Business, where Microsoft battles Google most directly.

Analysts pointed out that the online segment grew only about 10 percent in the quarter, excluding revenue added through the acquisition of Seattle digital advertising firm aQuantive, and that Microsoft gave back its modest summer gains in Internet search market share.

Liddell reiterated Microsoft will continue investing in the business both internally and through acquisitions and partnerships.

"We are quite clearly willing to suffer operating loss in that division as a result of those commitments," he said.

Losses in the online-services business more than doubled from the same period last year to $264 million.

The company plans to spend around $1.6 billion related to online services this year — about half of its total capital spending — including improvements to its search technology and new data centers, Liddell said.

The $6 billion for aQuantive is the most prominent example of Microsoft's willingness to spend big to grow through acquisitions and partnerships.

"We're particularly happy that we not only closed aQuantive, but we've retained all of the employees," Liddell said. "We think that integration has gone extremely well and we believe that's going to generate some significant benefits going forward."

One key executive retained is Brian McAndrews, aQuantive's chief executive and now Microsoft's senior vice president of advertiser and publisher solutions.

There was speculation Thursday that McAndrews played a key role in the high-profile partnership and investment deal Microsoft landed Wednesday with social-networking powerhouse Facebook.

Microsoft won the deal over Google.

The other laggard of Microsoft's five operating segments has been the Entertainment and Devices Division.

Executives have committed to make that division profitable this fiscal year, and the first quarter indicates Microsoft is well on its way.

The division swung from a loss to an operating profit of $165 million for the quarter on the strength of "Halo 3," the blockbuster game launched Sept. 25.

Even though the game was on sale for only the very end of the quarter, it generated $330 million in first-week sales, almost a fifth of the division's revenue.

Microsoft also sold a better-than-expected 1.8 million Xbox 360 consoles in the quarter, bringing the total sold since it released the product in November 2005 to 13.4 million.

The three pillars of Microsoft's business — Windows, Office and server and tools — all had revenues increase close to 20 percent in the quarter.

Growth in global PC sales of 14 to 16 percent was well above what Microsoft had expected.

Three-quarters of customers buying Windows Vista are choosing premium versions, which generate more revenue for Microsoft.

Liddell said the company has sold 85 million units of the new operating system, which was released broadly Jan. 30.

The fastest-growing markets continue to be in the developing world.

While Microsoft's business in mature economies such as Western Europe, the U.S. and Canada grew 27 percent on the quarter, the so-called BRIC countries — Brazil, Russia, India and China — grew 40 percent, Liddell said.

"A quarter like this demonstrates how enlarging our geographic presence has positioned us to benefit from the continued worldwide economic expansion," he said.

Benjamin J. Romano: 206-464-2149 or bromano@seattletimes.com

Copyright © 2007 The Seattle Times Company

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