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Originally published January 25, 2008 at 12:00 AM | Page modified January 25, 2008 at 9:32 AM

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Turbocharged Microsoft delivers sweet surprise

Despite storm clouds gathering over the U.S. economy, Microsoft has managed to exceed Wall Street expectations and its own rosiest forecasts...

Seattle Times technology reporter

Despite storm clouds gathering over the U.S. economy, Microsoft has managed to exceed Wall Street expectations and its own rosiest forecasts for the second quarter in a row.

The world's financial markets focused Thursday afternoon on Redmond for Microsoft's latest quarterly report because the company not only is a bellwether in the technology industry but also provides a broad measure of economic conditions.

It sells to everyone, from teenagers to huge corporations in practically every industry and does business in more than 100 countries.

The software giant delivered a positive surprise, with revenue for the three months ended Dec. 31 of nearly $16.4 billion, which translates to profit of 50 cents a share. Wall Street analysts had expected 46 cents a share, the high end of Microsoft's forecast issued in October.

Company executives credited strength across the board.

Holiday shoppers gobbled up Xbox 360s and PCs loaded with Microsoft software. Large businesses signed multiyear licensing deals for servers and other tools, indicating confidence in their long-term prospects.

And Microsoft's growth in international markets, which now represent more than 60 percent of its sales, outpaced a still-strong U.S. market, said Chief Financial Officer Chris Liddell.

"We expect the overall software-spending environment to remain healthy on a global basis," he said in a conference call with financial analysts. "In U.S. markets — although clearly the risk of an economic slowdown exists — we have not seen any significant spillover to our businesses."

Liddell later added, "You have to look really hard to find any weakness in our results in the first half" of the fiscal year.

Microsoft is so sanguine that Liddell and other executives further increased financial targets for the rest of the fiscal year, which ends June 30.

That's in contrast to other major technology companies including Apple, Intel and Motorola, which recently issued forecasts that fell short of Wall Street expectations.

After tumbling with the broader stock market earlier this week, Microsoft shares gained $1.32 to $33.25 in regular trading before its earnings were announced, a 4.1 percent increase.

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After the announcement, shares climbed $1.50 more, or 4.5 percent, to finish at $34.75 in extended trading.

"The Street's on pins and needles right now looking for any sign of a slowdown and Microsoft, in my view, did not offer any real hint that there was a slowdown occurring — as of yet," said Israel Hernandez, an analyst with Lehman Brothers. "This is a very fluid situation."

Solid results in the software industry are unlikely to be an all-clear signal to investors.

"If a slowdown started in January, the software guys might not see it until March or perhaps June," said Hernandez, whose employer does investment-banking business with Microsoft.

For now, with other tech companies reporting slower results, Microsoft is bucking the trend. Here are some reasons why:

• Its two biggest products, Windows Vista and Office 2007, are hitting their strides after being on the market for a year. The company has sold more than 100 million licenses for Vista, and a package of updates due by the end of March is expected to spur more businesses to switch to the new operating system.

"These products are the hard work of everyone at the company for such a long time, and now they're finally reaping the benefit of all that hard work," said Brent Thill, director of software research at Citi Investment Research.

• Computer sales in the past quarter grew faster than expected. Most of the money Microsoft makes selling Windows comes through new PC sales, which stood at close to 270 million worldwide in 2007.

The company is not predicting a significant decline in that growth rate — apart from normal seasonal trends — which is widely viewed as a measure of the tech sector's health.

• Another major product, Windows Server 2008, is due to hit the market in late February.

Many large companies buy Microsoft software through long-term agreements that give them rights to new products as soon as they're available. The company recorded an increase in those deals as customers looked ahead to the new server software, Liddell said.

Thill, whose employer owns stock in Microsoft and does banking business with the company, said that's also a broader sign of optimism.

"Customers are making multiyear commitments," he said. "It's not just a one-time sale."

• Microsoft's Xbox video-game business has turned a profit for the second straight quarter. The cost of producing the console has come down and people are buying more games, including the popular "Halo 3," which are more profitable than the hardware.

Through the end of 2007, Microsoft had sold 17.7 million Xbox 360s.

• The company's broad reach internationally helps it withstand slumps in any particular geographic market.

Also, the weaker dollar makes Microsoft products cheaper to foreign buyers and the company earns more, in dollars, on overseas sales. (Currency exchange rates benefited Microsoft's revenue to the tune of $410 million in the last quarter alone.)

If there is a weakness, it is the company's online-services efforts, including Internet search and digital advertising. This is the market where it faces off with Google.

Microsoft again lost money in this part of its business during the quarter, but Liddell said that's expected as the company attempts to grow this business.

"We certainly see it as a multiyear journey that we're going on," he said.

Microsoft is investing billions in improving its search capabilities; building data centers around the world to handle e-mail, instant messaging and other online services; and expanding its offerings for digital advertisers and publishers. It spent $6 billion last year to acquire Seattle-based digital advertising leader aQuantive.

Bob Toomey, chief equity strategist at E.K. Riley Investments in Seattle, said Microsoft's success against an uncertain economic backdrop bodes well for the region.

"One of the strongest tech companies in the world is really executing very well and is experiencing very strong business," he said.

Along with other major Northwest companies, that could help insulate the local economy from a broader downturn, said Toomey, who owns stock in Microsoft.

"Look at Boeing and Microsoft and Costco and companies like that and they're all chugging along," he said.

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

Copyright © 2008 The Seattle Times Company

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