Updated from 5:41 p.m. EDT

Microsoft ( MSFT) beat the Street's first-quarter earnings expectations by a penny Thursday, but sales and its second-quarter outlook were slightly below analysts' estimates.

The stock fell 37 cents, or 1.5%, in recent after-hours trading to $24.48 on Instinet; shares closed the regular session down 26 cents, or 1%, at $24.85.

The world's largest software maker earned $3.14 billion, or 29 cents a share, in the first quarter, compared to $2.53 billion, or 23 cents a share, in the same period a year ago.

First-quarter earnings this year included a charge of 2 cents a share for a legal settlement with RealNetworks ( RNWK), while last year's results included a charge of 3 cents a share for a legal settlement with Novell ( NOVL).

The consensus estimate gathered by Thomson First Call, which for the first time includes stock-based compensation but did not include the RealNetworks settlement, called for first-quarter earnings of 30 cents a share. When adding back the RealNetworks charge, Microsoft beat the consensus estimate by a penny. The company's guidance called for earnings of 29 cents to 31 cents a share.

First-quarter revenue rose 6% to $9.74 billion from $9.19 billion a year earlier. That was slightly shy of the consensus estimate of $9.78 billion for the first quarter but within the company's targeted range of $9.7 billion to $9.8 billion.

Looking forward, Microsoft said it expects to earn 32 cents to 33 cents a share, including stock compensation, on revenue of $11.9 billion to $12 billion in the second quarter of fiscal 2006, which began Oct. 1. That's short of analyst estimates calling for second-quarter earnings of 35 cents a share including stock charges on $12.29 billion in revenue.

The fiscal second quarter includes the crucial holiday sales season and will feature a couple of major product launches, including the latest version of its SQL Server database and next-generation Xbox 360 video-game console. While Xbox 360 will drive revenue growth, it will be a drag on earnings because Microsoft initially will lose money on every console sold.

In an interview Thursday, Microsoft Chief Accounting Officer Scott Di Valerio said analysts may have thought Xbox 360 sales would be a little heavier in the December quarter than the rest of the fiscal year. But Microsoft is taking a "staged" approach to the launch rather than jamming tons of consoles to retailers initially to give retailers more consistency, he explained.

"We would call it the 'rolling thunder' launch," Di Valerio said. But "we're not anticipating massive shortages on that," he added. Microsoft expects to ship between 4.5 million and 5.5 million Xbox 360 consoles in the full fiscal year, he said.

Microsoft basically reiterated its prior outlook for fiscal 2006, adjusting it just slightly to account for the RealNetworks settlement charge. The company reiterated full-year sales targets of $43.7 billion to $44.5 billion and said earnings would range from $1.26 to $1.30 a share, which translates to $1.28 to $1.32 a share excluding RealNetworks. That raises the low end of previous full-year earnings guidance a penny from $1.27 a share but leaves the top end unchanged.

Analyst expectations call for earnings of $1.31 a share excluding the Real Networks settlement on $44.24 billion in sales for fiscal 2006.

Microsoft also announced plans to accelerate its massive share buyback program by about 18 months, which would mean buying back $19 billion worth of shares by December 2006.

On a post-close conference call, analysts peppered Microsoft executives with questions about how the buyback program fits into the company's guidance. They pointed out that the buyback should result in a lower share count and thus enable Microsoft to raise its earnings targets. Yet, the company has kept those targets virtually unchanged.

CFO Chris Liddell responded that Microsoft already has accelerated buybacks to some degree -- to just more than $3 billion worth of shares last quarter -- and argued that the buyback will result in a more significant effect on earnings in the next fiscal year.

But after the call, Tony Ursillo, an analyst with Loomis, Sayles & Co., pointed to a second piece of the puzzle that should have allowed Microsoft to raise its earnings outlook: The company said its tax rate was lower than expected, at 31%.

"I don't quite see where the offset is for these positive developments," Ursillo said, referring to the share buyback and tax rate. His firm holds Microsoft shares.

Despite such uncertainty, however, Ursillo was generally positive because of Xbox 360 and the launches next year of new versions of Windows and Office. "It doesn't dissuade me from thinking this will be a good stock next year as Xbox takes a leadership position in video games and the big desktop product launches get closer," he said. "I think all of the numbers are going in the right direction."

Despite reiterating full-year guidance, Microsoft raised its outlook for PC shipments in fiscal year 2006 to 9% to 11% growth from prior guidance of 7% to 9% growth. The company forecast PC market growth of 10% to 12% in the second quarter.

Microsoft's Client division benefited from stronger-than-expected PC market growth in the first quarter, which Microsoft estimated at 15% to 17% vs. a prior forecast of 9% to 10%. IDC pegged the market growth at 17.1% due to strong demand for laptops and low-cost desktops.

Thanks in part to that PC market strength, Microsoft registered a 7% year-over-year increase in revenue, to $3.19 billion, in its Client, or Windows, unit. Microsoft's other big division -- Information Worker, or Office -- posted a 4% rise in sales to $2.68 billion.

The Server and Tools unit increased sales 13% to $2.53 billion while MSN posted a modest 1% increase in sales to $564 million.

Although MSN ad revenue grew 20% year over year (which was offset by a 30% decline in Internet access revenue), it was down sequentially, underperforming a 14% sequential increase posted by rival Google ( GOOG) and 6% sequential increase at Yahoo! ( YHOO), Sanford C. Bernstein analyst Charlie Di Bona pointed out on the conference call. Liddell responded that the company is hoping to address that with its launch of its own ad platform, currently being tested in France and Singapore.

Meanwhile, Microsoft's Home and Entertainment Unit, including Xbox, also failed to perform up to expectations, Microsoft execs said. Sales fell 17% from a year ago to $525 million -- a bigger decline than anticipated. The unit's operating loss remained roughly flat at $141 million.

The company's Business Solutions division, representing sales of business applications, posted a 16% jump in sales from a year earlier to $181 million, and its operating loss shrunk to $12 million from $31 million a year ago.

Unearned, or deferred, revenue -- a key measure of how many business customers are renewing their contracts to buy Microsoft software on a subscription basis -- fell to $8.8 billion from $9.17 billion in the previous quarter, which Di Valerio said was in line with the company's expectations. The first quarter is typically not a big one for customers to renew their agreements.

Di Valerio reiterated that Microsoft still expects 8% to 10% growth in the unearned balance by the end of the fiscal year.

The company's operating income, a weak point last quarter, was solid in the first quarter at $4.05 billion, including a $361 million charge for the RealNetworks settlement. Adding back that settlement charge, Microsoft's operating income fell within its guided range of $4.3 billion to $4.5 billion.

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