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Intel layoffs portend future

Things are not turning out exactly the way Intel planned.

Things are not turning out exactly the way Intel (INTC) had planned.

Overheated expectations, combined with a slowdown in sales and a decline in computer and processor prices, conspired to deliver one of the more dismal first quarters for the chip giant in a while. As a result, Intel will take the rare step of reducing its employment base by 3,000 people--close to 5 percent of its workforce.

Moreover, things will get worse before they get better. Revenues will stay flat for the current quarter while gross margins will decline due to faltering demand Intel stumbles and high costs associated with the production of Pentium II chips, according to Paul Otellini, executive vice president at Intel. The chip giant's financial performance in the second quarter has historically been flat to up compared with the previous quarter, analysts said.

While Otellini maintains that revenue will recover in the second half of the year, some financial analysts have said that margins will continue to decline because of pricing pressure.

"We still believe that there is growth in the PC industry, but it is less growth than we anticipated a few quarters ago," Otellini noted during an analysts' conference call.

Sales were clearly off for the first quarter with North America, Europe and Japan getting hit, the company said. Only the Asia-Pacific market showed growth in earnings, mostly attributed to sales of chipsets and motherboards.

Another dark cloud was that the sales decline was not confined to a few computer vendors, but rather was fairly widespread among Intel's customer base, the company added. (Intel is an investor in CNET: The Computer Network.)

In addition, Otellini admitted that the average selling price for its microprocessors declined slightly in the quarter. The new "sweet spot" for computers, he added, was $1,200--marking a further decline of the average price for computers and processors. Margins on these chips declined as well because of the additional cost of producing Pentium II chips.

"The stock is not a buy at all," said Ashok Kumar, semiconductor analyst at Piper Jaffray, who noted that Intel was off in every major sector.

"The gross margins are down to 53 percent in the first quarter. For Q2, units are flat sequentially, and 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," he added. "It will stabilize at 51 percent."

To account for the drop in prices, Intel has launched various cost reduction programs as well as cut back employees via attrition from its worldwide workforce of 65,000 full-time employees.

Although these cuts come as chip equipment makers like Lam Research and Silicon Valley Group have initiated layoffs of 6 to 10 percent in the past couple of months, analysts said Intel's reduction does not mark a "tip of the iceberg" scenario for chip makers.

"AMD and National Semiconductor did not make money in the first quarter, but they won't be losing as much money in the second quarter," said David Wu, an analyst with ABN AMRO. "Chipmakers will do better in the second half of the year. They did so bad in the first half that it's hard not to improve."

In Intel's case, C.B. Lee, an analyst with Sutro & Company, said the company will benefit in the current quarter from the release of the 350- and 400-MHz Pentium II that it will release tomorrow.

Lee also noted that Intel historically has had a stronger third and fourth quarter that is also bolstered by computer makers ramping up for Christmas sales.

But as for the second quarter, Lee described the situation as a "bottoming-out" for Intel.