Updated from July 19

Intel ( INTC) beat lackluster profit expectations for the second quarter by a couple cents, but the company's guidance suggests the chipmaker's comeback is still a work in progress.

Net income for the quarter ended July 1 plunged 57% from the same time last year, coming in at $885 million, or 19 cents a share, on revenue of $8 billion. Excluding stock option compensation expenses, Intel earned 15 cents a share.

Analysts polled by Thomson First Call were looking for Intel to earn 13 cents a share on $8.26 billion in sales.

In early Thursday trading, shares of Intel were off 3.6%, or 67 cents, to $17.82.

CEO Paul Otellini said Intel made progress on a number of fronts during the second quarter.

"In April, I said the second quarter would be a time to work with our customers on inventory levels and prepare to launch a next generation of microprocessors," Otellini told analysts in a conference call following the earnings release. "We achieved those objectives during Q2 and are well positioned for the second half."

From the look of the financial statement, though, it was an abysmal quarter for Santa Clara, Calif.-based Intel, which is facing stiff competition from rival AMD ( AMD) and an overall softening in demand for personal computers.

Revenue came in at the low end of Intel's guided range of $8 billion to $8.6 billion and represented a 10% sequential decline (last year, the company's second-quarter sales were only 2% below the first quarter total). Sales were down in every region except Japan.

Unit sales of microprocessors and PC motherboards declined in the second quarter, while chipset unit sales were flat. Flash memory unit sales were higher.

Otellini said he believed Intel may have lost a bit of market share on a "billings" basis during the quarter, but gained share on a "consumption" basis.

The $1.1 billion in operating income was 60% below last year's level. Still, the profit shortfall could have been even worse. Gross margin in the second quarter was 52.1%, compared with the 49% level the company had initially forecast.

According to Intel, the profit upside was due to better-than-expected microprocessor and chipset unit costs and inventory valuation, despite lower-than-expected average selling prices for microprocessors.

While by far the world's dominant microprocessor company, Intel has lost market share to during the past year to AMD, whose processors have gained a following for their performance and energy-efficiency.

Intel is in the midst of unleashing a volley of new microprocessors, designed to recapture the performance crown. And Intel is aggressively slashing prices on its products to trim down the inventory that has accumulated among its customers.

That pricing pressure caused AMD to lower its second-quarter revenue outlook earlier this month .

But while investors expected the second quarter to mark the low-water-mark for Intel, Wednesday's financial report offered a less-than-reassuring outlook, once again falling short of Wall Street expectations.

Intel pegged its third-quarter revenue between $8.3 billion and $8.9 billion, while analysts were expecting $9 billion. Intel now expects gross margins in the third quarter to be 49%.

And the company reduced its 2006 gross margin estimate to 51%, plus or minus a few points, compared with the 53% level it set earlier this year.

Finance chief Andy Bryant noted that 2006 revenue would likely be below the previous guidance of $38.8 billion, which already represented a 3% decrease from 2005 sales.

Intel executives brushed off concerns voiced by some analysts regarding the ballooning inventory within the company. Intel's inventory in the second quarter jumped to $4.3 billion, compared to $3.6 billion in the first quarter.

The increase, said CEO Paul Otellini, was a natural step as the company stocks up on its new generation of microprocessors.

"I don't think we're running up inventory or creating a problem," said Otellini. "If I made one mistake in the last year it was that we didn't build enough chipset inventory at the right time."

Otellini also unveiled a new strategy leveraging the company's Pentium processors, which many assumed were destined for extinction following the recent release of Intel's new generation of Core microprocessors.

Intel will shift nearly all of its direct advertising to the new, high-end Core microprocessors in the second half of the year. And the company will continue to sell its value line of Celeron processors, said Otellini.

But Intel will now have a third, middle-tier brand of microprocessors, for which it has cast the Pentium. Otellini said lowering the price of the Pentium will make it an ideal product for countries with developing economies, where Intel hopes much of its future growth will come from.

Executives said the company was about halfway though the internal reorganization process announced in April. Thus far, the company has sold off its struggling handheld application processor business and announced the layoffs of 1,000 managers.

These moves will bring the company's headcount to less than 100,000 employees by the end of the year, according to CFO Bryant. He hinted that further layoffs could be in the offing, saying that the company was considering "a variety of decisions" over the next few months "which would take the headcount down even lower."

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