Intel Shares Turn Lower

The stock dips almost 5% on lackluster gross margins.
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Updated from July 17

Shares of

Intel

(INTC) - Get Report

slumped early Wednesday after the chipmaker's second-quarter earnings report revealed weaker-than-expected margins.

The stock was off $1.14, or 4.3%, to $25.19, dashing the high hopes that buoyed the stock ahead of the earnings report.

Intel's stock has risen almost 25% in the past three months on expectations that the chipmaker's turnaround was starting to bear fruit, thanks to an improved lineup of microprocessors and a restructuring that has eliminated 10% of its workforce and $2 billion in costs.

"Even though we believe the company is making pretty steady progress in its turnaround, expectations were so high that it was going to take inarguable upside in Q2 results and better Q3 guidance to keep the stock moving," said Stifel Nicolaus analyst Cody Acree, who rates Intel a buy. The firm makes a market in Intel shares and has provided Intel with noninvestment banking services in the last 12 months.

On the top line, Intel showed some real progress in the second quarter, posting its first year-on-year sales gain since the fourth quarter of 2005.

Sales in the three months ended June 30 were $8.7 billion, at the high end of its own guidance, and slightly ahead of the $8.5 billion expected by analysts. At this time last year, Intel had sales of $8 billion.

Intel reported net income of $1.3 billion, or 22 cents a share, vs. $885 million, or 15 cents a share in the year-ago period. Excluding tax items that increased EPS by 3 cents, Intel EPS was in line with the average analyst expectation of 19 cents.

Intel executives said the company benefited from a strong product line-up and improvements in its manufacturing operations.

Servers and notebook PC microprocessors were Intel's strongest businesses during the second quarter.

Shipments of Intel's

quad-core Xeon server processor doubled in the quarter, with more than 1 million units shipped since the products release in November. And Intel said its mobile processor revenue surged 22% year-over-year to $2.4 billion.

Intel said higher overall unit shipments of microprocessors were offset by lower average selling prices, and executives acknowledged that prices declined more than they had anticipated.

"While demand for computers was strong, pricing remained competitive, notably in the low end of the PC marketplace," said CEO Paul Otellini. He said the price erosion was affecting not only desktop PC microprocessors, but also the chips destined for low-end consumer laptops.

Intel and rival

Advanced Micro Devices

(AMD) - Get Report

have aggressively slashed prices over the past year in order to win market share. The price war has taken a toll on gross margins at both companies.

Intel said its second-quarter gross margin was 46.9% -- its lowest level in years and below the midpoint of the company's guidance of 48% plus or minus a few percentage points.

Despite the second quarter's lackluster gross margin, Intel stuck to its forecast of 51% gross margin for the full year, and matched analyst expectations of 52% gross margin in the current quarter.

The company's lower gross margins were also dented by the company's flash memory business, which posted another quarterly loss. The prime culprit was weak demand for so-called NOR flash memory chips.

Intel announced in May that it was

transferring its NOR flash assets into a joint venture with

ST Microelectronics

(STM) - Get Report

, a move many consider a first step to exiting the NOR flash business so that Intel can focus on the faster-growing NAND flash market.

The company projected revenue between $9 billion and $9.6 billion in the current quarter. Analysts polled by Thomson Financial were looking for $9.4 billion in sales with EPS of 27 cents.

CFO Andy Bryant said Intel's guidance anticipates a seasonal third quarter, although the company expects pricing to continue to be competitive going forward.

The company reaffirmed that it was on track to ship its new family of Penryn microprocessors, which feature 45-nanometer circuits rather than today's 65-nanomer circuits, by the end of the year. Smaller circuits allow Intel to reduce its costs while increasing the chip's performance.

Intel's Otellini said the company planned to defend itself from fierce price competition by focusing on products that differentiate Intel. He added that Intel will be more selective in accepting low-margin business at the low-end segments of the desktop market going forward.

"We have no intention of walking away from any segment of the computing market," said Otellini.

"You'll see us engage where we think it makes prudent sense and leave some stuff on the table where we think it doesn't," said Otellini.