Mobile phone maker Sony Ericsson <6758.T> swung to a surprise first-quarter profit as its push into the growing smartphone market and hefty cost cuts boosted margins.

Sony Ericsson saw its phone sales drop 28 percent from a year ago and analysts warned cost control and a sharper focus did not spell the end of difficulties for the company, which had been in the red for seven straight quarters.

It is very positive that they have made a profit and that their average selling price is going up, Michael Andersson, analyst at brokerage Evli, said.

But it comes at the price of focusing on fewer models -- volumes are down much more than expected. There is no doubt that Sony Ericsson has a lot of tough challenges ahead of it.

Sony Ericsson, whose Xperia X10 and Vivaz phones started shipping at the end of the quarter, sold just 10.5 million phones in the period, down 28 percent from a year ago and missing analysts forecasts which ranged from 11.5 million to 15.7 million.

After a dismal 2009 in which the handset market contracted amid the global downturn, many analysts believe the outlook for the industry has improved in recent months, though Sony Ericsson stuck to its cautious forecast of only slight market growth in handset sales this year.

Analysts expect mobile phone sales to rise 10.8 percent this year.

Sony Ericsson reported a pretax profit of 18 million euros ($25.2 million), beating all forecasts from 26 analysts polled by Reuters, all of whom had forecast a pretax loss.

BRIGHT SPOT

The company, which made a 370 million euro loss a year ago, said its gross margin was 31 percent, well above forecasts as costs fell sharply and it sold more higher-price smartphones offering PC-like functions and links to websites such as Twitter and Facebook.

Smartphones were the bright spot in the gloomy market last year and industry researcher Gartner has said the sector will grow 46 percent this year from the 172.4 million phones sold in 2009, boosted by cheaper models.

Sony Ericsson President Bert Nordberg said the firm's latest phones which had started shipping toward the end of the first quarter had been well received by customers.

Operating costs were down 20 percent in the quarter, with the biggest reduction in the R&D budget. The company said the full benefit of its efficiency program -- aimed at cutting annual costs by 880 million euros -- would come through in the second half of the year.

Bottom-line I think this confirms that they have now managed the turnaround from a cost perspective, said Nicolas von Stackelberg, analyst at Macquarie Research.

And now we need to hear from them how they want to go about regaining market share, which is of course critical given that it has now dwindled to 4 percent.

Analysts said Sony Ericsson could have slipped down the global handset maker rankings from the fourth place it had at the end of 2009, when it was narrowly ahead of Motorola .

Sony Ericsson, which also said it had appointed former Sony Vice President William Glaser as chief financial officer, replacing Ulf Lilja who will return to Ericsson, is the first major handset maker to report January-March results.

Nokia Oyj is due to report on April 22 and others later in April.

Shares in Sony Ericsson parent Ericsson were up 0.1 percent at 0815 GMT, in line with the wider Stockholm market <.OMXS30>. Sony closed down 1.8 percent in Tokyo, in line with the market <.N225>.

(Additional reporting by Helena Soderpalm, Sven Nordenstam, Niklas Pollard and Tarmo Virki; Editing by David Holmes)

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