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Drop in Intel profits expected

The chip giant is expected to report a dip in year-by-year profitability, but analysts wonder how the company will fare in the future.

Intel (INTC) is expected to report revenues of $6 billion and earnings around 72 cents a share today, an unalarming dip in year-by-year profitability, but the issue on analysts' minds is how the company will fare in the future.

Revenues and earnings per share are expected to stay flat during the current quarter while gross margins are expected to drop as pricing pressure increases in the desktop processor market. In addition, Intel may warn analysts in its financial conference call today at 2:30 p.m. PT that margin pressures may continue.

As a result, earnings estimates for 1998 and 1999 will likely inch downward. (Intel is an investor in CNET: The Computer Network.)

"I think they are likely to talk about margin pressure continuing throughout the year as opposed to just hitting its maximum inflection point in Q2," said Dan Niles, semiconductor analyst with BancAmerica Robertson Stephens and columnist for CNET's NEWS.COM.

"The stock is not a buy at all," Intel's market fallout added Ashok Kumar, semiconductor analyst at Piper Jaffray. "The gross margins are down to 53 percent in the first quarter. For Q2, units are flat sequentially, gross margins will be flat sequentially. We see 70 cents earnings per share for Q2.

"You are going to see gross margin erosion and that will continue for the foreseeable future. It will stabilize at 51 percent."

The questions surrounding Intel's earnings largely stem from the changes taking place in the computing world in general. First consumers and now corporate buyers are demanding that computers cost less than $1,000--sometimes even less than $800. The drop in PC prices in turn has prompted Intel to develop lower-cost chips, as well as continue cutting prices for processors destined for higher-end machines.

On average, Intel processors come to market at prices substantially lower than they did even a year ago. Lower prices generally mean lower margins and profits.

The company is also facing increasing competition from Advanced Micro Devices and Cyrix in the sub-$1,000 segment. Demand for PCs is also likely to slow this year, according to International Data Corporation.

To counter the drop in desktop processor profits, Intel will more strongly emphasize processors for mobile computers workstations and servers, analysts have said. The first "Slot 2" processors, which will be aimed at servers and workstations, will come out in the second half of the year and likely sell around $2,000 and higher, according to a number of sources. The price is a substantial boost over the $583 that Intel charges for the 333-MHz Pentium II, its current top-line chip.

"These markets are very small compared to the desktop processor market," pointed out Charles Boucher, semiconductor analyst with Donaldson, Lufkin, and Jenrette. "The profitability is continuing to fall in desktop processors, and that's a problem."

Nonetheless, Boucher, Niles, and others did not state that this situation points to a mounting crisis. On the contrary, Intel will continue to report relatively strong numbers. To wit, Niles pointed out that the stock is selling for more than it did before the year began, despite the fact that Intel said earlier that first-quarter sales would be 10 percent below expectations.

For the quarter, earnings per share will come to about 72 cents a share--roughly $3.21 for the year, according to a consensus of First Call analysts. Earnings per share for the fiscal year is expected to be $3.97. Estimates were revised downward earlier in the quarter as a result of Intel's warning that sales would be off this quarter.

Others were more dour than the consensus estimate. Rob Chaplinsky, semiconductor analyst for Hambrecht & Quist, expects per-share estimates for 1999 to be $3.85, an upgrade from an earlier estimate of $3.62. Kumar, meanwhile, said that per-share earnings for 1998 will come to $3.05, while 1999 earnings will come to $3.45. The lowest First Call estimate puts earnings at $2.80 for 1998.