(Corrects paragraph 14 to say Motorola was expected to rank seventh in the global mobile phone market, not fourth)

NEW YORK - Motorola Inc reported a surprising quarterly profit on better-than-expected demand for its higher-margin smartphones, so far vindicating its strategy of relying on Google Inc's Android software system.

Strength in Motorola's other units including network equipment and fewer sales of unprofitable, cheaper phones also bolstered the company's profit.

Motorola also forecast current-quarter earnings per share in a range that could beat average analysts' estimates.

Its shares rose 3 percent on Thursday and have gained 18 percent since January as more investors were willing to bet on its turnaround despite stiff competition from rivals like Apple Inc's iPhone.

Now the market is set to become even more crowded with the entrance of Hewlett-Packard Co, which on Wednesday announced a deal to buy Palm Inc.

I think (Motorola is) doing the best they can in a very competitive market, RBC Capital Markets analyst Mark Sue said, adding that investors were encouraged that Motorola was accelerating its exit from less advanced phones.

Some analysts said Motorola's share rise may have been muted by the Palm news. Sanjay Jha, Motorola's co-chief executive said the Palm deal may change the market dynamic but wouldn't alter Motorola's task of making stand-out phones.

Jha told an analyst conference call that the phone unit would post its first profit in years in the fourth quarter.

The mobile devices division still posted an operating loss of $192 million in the first quarter, but this was much narrower than its loss of $545 million a year earlier.

While Motorola smartphone sales rose to 2.3 million from 2 million in the fourth quarter its overall phone sales fell to 8.5 million phones from 12 million in the last quarter.

This was short of the average forecast of 10.2 million from nine analysts contacted by Reuters but Jha said the sales decline made the unit's progress all the more impressive.

To see that contraction in shipments ... and yet improve our operating loss (in mobile phones) is a hell of a feat Sanjay Jha, Motorola's Co-chief executive who heads mobile devices told Reuters.

I see this as a sign we're turning the mobile devices business around and making great headway in probably the most important segment of the mobile devices market which is smartphones, he said.

In the global market Motorola is expected to rank seventh in the first quarter, behind Nokia, Samsung Electronics and LG Electronics.

But Jha estimated that it held its third place ranking in the North American smartphone market, putting it behind only iPhone and BlackBerry from Research In Motion.

He said that while total phone volumes would decline again this quarter, smartphones sales will increase sequentially, resulting in an improvement in operating losses.

Jha predicted growth for this quarter as Motorola's distribution expands. He also predicted that its new phones would do well, particularly in China.

NORTH AMERICA AND CHINA

It posted a first-quarter profit of $69 million, or 3 cents per share, compared with a loss of $231 million, or 10 cents a share, in the same quarter the year before.

Excluding items, profit per share was 2 cents compared with average analyst expectations for a loss of 1 cent per share, according to Thomson Reuters I/B/E/S.

As well as strong phone sales in North America and China Motorola said the profit was helped by a better-than-expected profit in Motorola's network equipment business, which increased operating earnings to $112 million from $62 million in the same quarter the year before.

Avian Securities analyst Matthew Thornton said some investors expected worse after a weak report from Nokia.

It was a good quarter in the face of cautious expectations, he said, adding that Motorola's cash generation of $455 million was a good sign ahead of its plan to separate into two companies early next year.

Revenue fell 6 percent from a year ago to $5.04 billion, and compared with Wall St expectations for $5.098 billion.

Motorola forecast current-quarter earnings per share of 3 cents to 5 cents, including expenses for stock-based compensation and amortization of intangibles. That compares with the average Street forecast of 3 cents per share according to Thomson Reuters I/B/E/S.

The company tweaked its target for 2010 smartphone sales to a range of 12 million to 14 million from its previous guidance of 11 million to 14 million. Motorola shares rose 21 cents, or 3 percent, to $7.13 on New York Stock Exchange.

(Reporting by Sinead Carew; editing by Derek Caney and Maureen Bavdek)

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