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Microsoft Lifts Off

Shares surge 12% on a strong sales performance.
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Updated from Oct. 25



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, after the software giant saw its shares surge 12% in early action Friday following a stronger-than-expected first-quarter earnings report.

The Redmond, Wash., software company said revenue was $13.76 billion, up 27.3% from $10.8 billion a year ago. Analysts were expecting a top line of $12.57 billion, according to Thomson Financial.

The company said EPS was 45 cents on net income of $4.3 billion, vs. EPS of 35 cents, on a net of $3.5 billion in the same quarter of last year. Analysts were expecting 39 cents a share.

The stock jumped more than 10% in after-hours trading to $35.33. On anticipation of a solid report, shares hit a new 52-week high of $32.22 during the regular session.

The first quarter was "the fastest growing in seven years," CFO Chris Liddell said on a conference call. "Performance was across all divisions, customer channels and geographies." Growth was fastest in Brazil, Russia, India and China.

Operating margin rose 2 percentage points, to 43%, Liddell said.

"Operating income grew faster than revenue at an impressive 30% clip," said Colleen Healy, manager of investor relations.

Charly Tracy, Microsoft's senior finance manager, attributed the strong earnings to demand across the company's many product lines, but especially in its

Halo 3

video game and premium versions of the Vista operating system.

Customers opt for premium versions of both Windows Vista and XP operating systems 75% of the time, up from 59% year on year, according to Liddell.

Business client software was up 25%, to $4.14 billion, growing 10 percentage points faster than worldwide PC shipments for the quarter, Tracy said in an interview. Converting users of pirated software to buyers was a factor, as was faster sales to volume licensors.

Microsoft views an increase in unearned revenue in the client software business "as positive intent by business to deploy Windows Vista," Liddell said.

The business division grew 20% on the strength of Office 2007 and the company's new collaboration software, Tracy said. Microsoft's Dynamics CRM software line grew 18%.

Across divisions, total bookings grew 30%, Healy said.

The entertainment and devices division, which has historically taken losses, swung to a profit of $165 million, largely on the basis of sales of

Halo 3

in the final days of the quarter. Revenue grew 91% to $1.93 billion.

But sales of Xbox consoles also ticked up in anticipation of the game's launch and as retailers began to build inventory for the holiday season. The company sold 1.8 million Xboxes in the period, up 90% from a year earlier, Healy said.

The online services business, which took in $671 million in revenue, showed a wider loss of $264 million in the quarter, year on year. Microsoft closed on the $6 billion acquisition of the aQuantive online advertising business.

aQuantive is expected to add between $500 million and $600 million in revenue in the coming year, but it will not be profitable initially, Liddell said. During 2008, the acquisition "will be a drag on operating income of a couple of hundred million dollars." But Microsoft expects aQuantive to bring significant benefits going forward, he added.

"On the strength of a great first quarter, we're raising our full-year guidance" by $2 billion in revenue and by 8 to 9 cents in EPS for the year, Tracy said.

Microsoft said second-quarter revenue would range from $15.6 billion to $16.1 billion and EPS would be 44 cents to 46 cents. Analysts were expecting revenue of $15.64 billion and earnings of 45 cents a share.

The company said fiscal 2008 revenue would be $58.8 billion to $59.7 billion and EPS would be $1.78 to $1.81. Analysts were projecting revenue of $57.4 billion and EPS of $1.73.

On Wednesday, the company said it had taken a 1.6% stake in social networking site Facebook for $240 million. Microsoft will be the exclusive third-party advertising platform partner for Facebook and will sell ads for Facebook internationally.

Tracy said the company was happy to become Facebook's exclusive advertising platform because of the site's large and growing member base.

Deferred, or unearned, revenue rose 14% year over year, to end the quarter at $11.6 billion, Tracy said. Deferred revenue had been expected to drop 10% sequentially from the end of fiscal 2007, but declined by only 8.5%, a difference of nearly $200 million, he said.