Microsoft Corp's results smashed Wall Street expectations on Friday, sending its shares up 7 percent, as the PC market improved and sales of its Windows software and Halo video game were stronger than expected.

The results top a big 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.

With their biggest one-day jump since April, Microsoft's shares hit their highest level since June 2008, helping the Nasdaq pare losses. The results follow better-than-expected earnings from technology bellwethers IBM , Intel Corp , Google and Apple.

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, the first time the software maker had done so in a year.

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.

The Redmond, Washington-based company played down hopes for a quick recovery from the worst recession in decades, sticking with a characteristically cautious outlook.

The fourth quarter of fiscal 2009 (which ended June 30) may well have been the bottom of the economic reset, said Chief Financial Officer Christopher Liddell on a conference call on Friday.

He repeated his view that technology spending should recover gradually in 2010. We are not seeing a large rebound, but we'd like to think, certainly as we go into next calendar year, we'll start to see businesses spending again, he said.

The company, which is tightening its belt in the economic slowdown, also cut its outlook for operating expenses for the full fiscal year to $26.2 billion from its previous target of $26.5 billion.

Quarterly profit fell in Microsoft's main units, producing the Windows operating system and Office suite of applications. Profit rose in its server unit and its entertainment and devices unit, which makes the Xbox console and Halo video game series. Its loss-making online services unit, which includes the new Bing search engine, reported a wider loss than a year ago.

Microsoft shares were up 7.6 percent, or $1.99, at $28.58 on Nasdaq. They have risen 92 percent since hitting a more-than 10 year low in March.

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

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