Microsoft Corp smashed Wall Street's profit and sales expectations on Friday, sending its shares up 9 percent, as the PC market showed signs of stabilizing and sales of its Windows software and Xbox game consoles held up much better than expected.

The strong results top a successful week for the world's largest software company, which launched its Windows 7 operating system to positive reviews on Thursday, as it looks to regain leadership in the technology sector from rivals Apple Inc and Google Inc .

Microsoft is back. They are able to succeed despite heightened competition from Apple's share gain and Google's great brand, said Katherine Egbert, an analyst with Jefferies & Co. The numbers were unbelievable. An absolutely blowout.

Microsoft's shares reached their highest level since June 2008. The results follow better-than-expected earnings from technology bellwethers Intel Corp , Google and Apple.

Microsoft said fiscal first-quarter profit fell 18 percent to $3.57 billion, or 40 cents per share, compared with $4.37 billion, or 48 cents per share, in the year-ago quarter.

Wall Street had expected much worse, calling for profit of 32 cents per share, on average, according to Thomson Reuters I/B/E/S.

Sales fell 14 percent to $12.92 billion, partly reduced by a deferral of $1.47 billion in revenue to future quarters related to Microsoft's free upgrade to Windows 7 for recent buyers of the predecessor Vista system. That beat analysts' average forecast of $12.31 billion.

Microsoft's results are closely tied to sales of PCs, which rose in the latest quarter by about 2 percent after two quarters of declines.

The company did not include any pre-sales of Windows 7 in its latest results, offering the hope that the current quarter will show a boost in sales from the new system.

You are seeing some of the benefit of the improvement in PCs that we have heard about, said Brendan Barnicle at Pacific Crest Securities. This is a trend. They've got some good momentum behind them and it's just going to get accelerated now that you have Windows 7 out in the market.

Microsoft shares were up 9 percent, or $2.46, to $29.05 in early Nasdaq trading.

(Additional reporting by Jim Finkle and Juan Lagorio; Editing by Derek Caney)

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