Dell Inc forecast lower gross margins in the July quarter as demand has shifted toward cheaper computers such as netbooks, while prices of components are rising, sending its shares down 4 percent.

Dell, which has been working through a painful turnaround effort, on Monday estimated a modest decline in fiscal second-quarter gross margins but did not give a specific forecast. It also said it expects a slight sequential increase in revenue for the quarter.

We continue to believe that customers are deferring IT purchases, and that we will see demand return to more typical levels at some point, Chief Financial Officer Brian Gladden said in a statement.

The outlook from the world's No. 2 maker of personal computers came on the eve of its analyst day in Austin, Texas. Dell has not been providing forecasts in its quarterly earnings reports, so the announcement provided Wall Street with its first financial targets in some time.

Dell's story has been all about profitability over growth, so if the product mix is shifting to the low end and that's impacting profitability, then that really hurts Dell's value proposition, said Collins Stewart analyst Ashok Kumar.

Dell, like other PC makers, has been hurt by slumping tech demand during the global recession, with one of the only bright spots being cheap netbook computers that analysts say offer thinner profit margins.

Components costs, which fell steeply due to oversupply last year, have also recovered in recent months as suppliers have cut back on capacity during the global recession.

While Gladden said demand for Dell's products and services seems to have stabilized, he noted that that varied significantly by segment and geography.

Kaufman Bros analyst Shaw Wu said Dell's second-quarter outlook was in-line to a little below what Wall Street was expecting. The average analyst forecast was for revenue of $12.6 billion, which would be up 2 percent sequentially, according to Reuters Estimates.

Wu said the shares were likely reacting to the gross margin forecast, which Dell said was the result of higher component costs, a competitive pricing environment, and an unfavorable mix of product and business-segment demand.

This forecast is a little lighter than what people thought, Wu said.

Dell, which is in danger of being surpassed by Acer Inc <2353.TW> in the global PC market, saw revenue fall 23 percent from a year ago to $12.3 billion in the first quarter. Gross margin slid to 17.6 percent, or an adjusted 18.1 percent.

LOOKING TO BUY

The company is banking on companies replacing aging and outdated hardware in 2010 to help boost sales.

It is targeting in the long term 5 to 7 percent compound annual sales growth, operating income at or above 7 percent of revenue, and cash flow from operations exceeding net income.

Kumar of Collins Stewart said the long-term forecast is less important to Wall Street. People care about visibility in the coming weeks and months, he added.

Dell also said it is on track to cut annual costs by more than $4 billion by the end of fiscal 2011.

The company is seeking to diversify its revenue base to better compete with larger rivals Hewlett-Packard Co and International Business Machines Corp . It has been upfront in its desire to be acquisitive and Wall Street is hoping for hints on its strategy at the analyst meeting on Tuesday.

Already sitting on $10 billion in cash and short-term investments, Dell recently sold $1 billion in notes and hired IBM's M&A chief.

Analysts expect the company to focus on acquisitions in software, services and storage as it looks to become less reliant on its commodity PC and hardware businesses. Potential targets include Acer, smartphone maker Palm Inc , storage equipment company NetApp Inc , infrastructure software maker Citrix Systems Inc and services provider Computer Sciences Corp .

Many analysts believe Dell is on the hunt for a deal size of around $1 billion or less. Its largest-ever buy was data storage network company EqualLogic for $1.4 billion in 2007.

You'd get a higher return on the investment by making smaller acquisitions that are easier to integrate and that they can more immediately sell into their install base or generate cross selling opportunities, said Pacific Crest Securities analysts Andy Hargreaves.

Shares of Dell fell to $12.52 in after-hours trading, from their Nasdaq close of 13.02.

(Reporting by Gabriel Madway; Additional reporting by Tiffany Wu; Editing by Richard Chang)

Dell