Feb. 20 (Bloomberg) -- Hewlett-Packard Co., the world's largest personal-computer maker, said first-quarter profit rose 26 percent after the company cut notebook PC prices to win consumer sales from Dell Inc.

Net income increased to $1.55 billion, or 55 cents a share, from $1.23 billion, or 42 cents, a year earlier, Palo Alto, California-based Hewlett-Packard said today in a statement. Sales in the quarter ended Jan. 31 rose 11 percent to $25.1 billion.

Hewlett-Packard topped Dell in PC sales for the second straight quarter by offering low-priced notebook computers through retailers as Dell continued to rely on mail-order and online sales. While earnings topped analysts' estimates, investors were disappointed by a drop in the overall profit margin, which shrank to 7.3 percent from 7.7 percent in the previous three months.

``The big thing that stands out is the margins,'' said Joseph Eshoo, who helps oversee $20 billion in investments, including Hewlett-Packard shares, at HighMark Capital Management in San Francisco. ``The story behind the stock has been margin expansion. All of a sudden you've got a sequential quarter where it declined.''

Hewlett-Packard's shares, which are trading at their highest level in six years, declined 56 cents to $42.57 after the announcement. They rose 36 cents to $43.13 at 4 p.m. in New York Stock Exchange composite trading.

Unusual Forecast

Chief Executive Officer Mark Hurd has exceeded analysts' profit expectations in every quarter since taking over in April 2005. Excluding some costs, first-quarter profit was 65 cents, beating the 63 cents expected on average by analysts.

Profit this quarter, excluding some costs, will be 63 cents to 64 cents a share on sales of $24.5 billion. Analysts had expected profit of 64 cents, the average of 22 estimates compiled by Bloomberg, on sales of $24.1 billion.

The forecast shows an ``unusual seasonal decline of 2.5 percent in sales,'' said Brent Bracelin, an analyst at Pacific Securities in Portland, Oregon. He rates the stock ``sector perform'' and doesn't own it.

Hewlett-Packard's second-quarter sales are usually unchanged or slightly higher than in the first quarter. The forecast of a drop raises concern the company may not be able to sustain PC market gains as Dell works to win back orders, Bracelin said. Hewlett-Packard also may be carrying expensive inventory, which could undercut margins if the price of PC parts such as memory declines, Bracelin said.

``We feel good about the freshness of the inventory,'' Hurd said on a call with analysts.

Additional Cuts

Hewlett-Packard raised its full-year revenue forecast to as much as $99 billion, up from about $97 billion previously.

In the first quarter, PC sales rose 17 percent to $8.72 billion on a 19 percent jump in shipments. Notebook sales rose more than 40 percent, while desktop revenue fell 1 percent. Earnings at the PC unit surged to $414 million, widening its profit margin, or profit as a percentage of sales, to 4.7 percent.

The printing division, the company's most profitable group, had earnings of $1.07 billion, a rise from $973 million a year earlier. Sales, buoyed by orders for supplies such as ink, climbed 6.9 percent to $7 billion. Profit margins widened to 15.3 percent from 14.9 percent a year earlier. Supplies revenue rose 11 percent to $4.07 billion.

Hurd, 50, continued to reap the benefits of job cuts and office closures during the period. He has used the cost savings to undercut the prices of rivals, including Round Rock, Texas- based Dell, while preserving profit margins.

`More Flexibility'

``Our cost structure has improved and given us more flexibility,'' Hurd said today on a conference call with reporters. More cuts are planned, he said. ``We can be a better company than we are today.''

The company also announced an early-retirement program and said it would use an estimated $500 million in savings from changes to its pension plan to offset the cost of the program.

``It's an attempt to get our benefit structure in line with the industry,'' Hurd said. ``It's a long-term move.''

Hewlett-Packard's PC shipments jumped 24 percent last quarter while Dell's dropped 8.4 percent, according to Framingham, Massachusetts-based researcher IDC.

`Fierce' Competition

Most of the demand was driven by consumers buying notebook PCs through stores, giving Hewlett-Packard an edge over Dell, said David Daoud, a PC analyst with IDC. Consumer orders only account for about 15 percent of sales at Dell.

Hurd also is capitalizing on customer dissatisfaction with Dell, which alienated U.S. consumers with poor customer service. Founder Michael Dell reclaimed the CEO title last month and is working to revive sales and profit.

``The competitors are fierce,'' Dell told employees in a Feb. 2 e-mail. Dell, 41, last week hired former Motorola Inc. executive Ron Garriques to run a new consumer group tasked with overseeing product design. He also combined manufacturing, supply chain and purchasing into one division that will be run by former Solectron Corp. CEO Michael Cannon.

(To listen to a replay of the company's conference call, see http://www.hp.com/investor/q12007webcast.)

To contact the reporter on this story: Connie Guglielmo in San Francisco at cguglielmo1@bloomberg.net

Last Updated: February 20, 2007 20:39 EST