Updated from Sept. 5

Intel

(INTC) - Get Report

rose in the preopen session Friday after delivering a midquarter update that, while far from upbeat, was nowhere near as bad as some had feared.

The shares were gaining 6% to $16.01 in the Instinet preopen session. The shares were upgraded by equal-weight from underweight by

Lehman

analyst Dan Niles, who said the stock's valuation is more reasonable in light of a selloff that has taken the shares down from close to $20 on Aug. 19.

Intel hewed fast to its gross margins guidance in the call but said revenue for the third quarter would fall below the midpoint of prior guidance. Intel blamed relatively soft microprocessor sales for the revision.

In July, the chipmaker had forecast sales for the current quarter would be between $6.3 billion and $6.9 billion, which would imply sequential growth between zero and 10%.

But today it said sales would fall below the top end of that prediction to a range of $6.3 billion to $6.7 billion.

The current consensus estimates are for third-quarter sales of $6.6 billion, according to Thomson Financial/First Call, and reflect several weeks of downward revisions. Analysts have been speculating that a weak back-to-school season likely would force Intel to push down guidance.

Bad, Bad Microprocessor

The company attributed the narrower guidance to microprocessor unit sales that have trended toward the lower end of the normal seasonal pattern. But President Paul Otellini, who filled in for a vacationing CFO Andy Bryant on the conference call, insisted business was "not outside the boundaries of what we have seen in the last five or six years."

Although it reined in its revenue outlook, Intel stuck firm with prior guidance on gross margins, saying it was still planning to notch 51%.

Some analysts had recently

suggested Intel might have to reduce its gross margin guidance, partly due to weak average selling prices on its microprocessors. They speculated that margins could be hurt if buyers continue to lean toward the cheaper, lower-end Celeron processor (vs. the higher-performance Pentium 4), as they did in the second quarter. By many accounts, the second quarter was somewhat anomalous for that reason.

But during the conference call, Otellini seemed to suggest that the second-quarter mix wasn't so unusual, and added that the product mix was likely to stay about the same. "The mix in terms of the Pentium 4 to Celeron is really not expected to change much from Q2 to Q3. That was built into our expectations prior to this. It remains the foundation of our outlook," he said.

Despite some apparent pressure on ASPs, though, management emphasized that the chipmaker will see gains based on sequential growth in revenue and volume of goods sold, as well as gains from more efficient manufacturing.

The company sometimes does as much as half of its business for the quarter in September, which makes quarterly forecasts a little difficult. But Otellini did say that the beginning of September had shown one promising trend, at least from the unit growth side. In the first week after Intel pushed through steep price cuts on its processors, it had "seen very good, very strong distributor channel sales," he said.

News Flash

Intel also said in its update that its flash business has performed in line with expectations, but that demand for other communications products was still soft. Otellini described the flash business as "flat from our expectations but up from Q2," while characterizing the communications segment as running "flattish at low levels."

Otellini added that for the full year, Intel's gross margins will be around 51% plus or minus a few points, compared with margins of 49% in 2001. Capital spending also remains unchanged, falling between $5 billion and $5.2 billion That compares with $7.3 billion in 2001.

On a geographical basis, demand in the Americas and Europe has been about as expected for the quarter, but Asia and Japan have been tracking slightly below the company's expectations.

Asked to elaborate on recent comments about the second-half outlook made by CEO Craig Barrett, Otellini said, "He didn't change any guidance, didn't give any new data out. He said that we are planning for a seasonal second half and that the fourth-quarter holiday jump-up was not a sure bet. That's a fair statement to make in this environment."

The stock closed Thursday's session down amid heavy technology selling on a day when the Philadelphia Semiconductor Index flirted with levels not seen since October 1998. Thursday, Intel surrendered 6.2% of its value, or $1, to close at $15.11.

Analysts are currently expecting a pro forma profit of 13 cents per share for the third quarter, following on last quarter's pro forma earnings of 9 cents, according to Thomson Financial/First Call.