Intel Corp found a defect in one of its chips, hurting its credibility during a major product launch and at a time when demand for microprocessors in PCs is being threatened.

The company said on Monday it stopped shipments of the chip used in personal computers with its most advanced Sandy Bridge line of processors and has already started production of a new version.

For Intel, the world's largest chipmaker, the design flaw is another distraction at a time when it faces sluggish personal computer sales and a major challenge from the exploding popularity of mobile devices, a market dominated by Britain's ARM Holdings.

Does it change the perception of Intel's quality? Yes, probably. You've got real product out there that's been qualified and tested and green-lighted, and then you come back to say there's a problem and you have to recall, said Wedbush analyst Patrick Wang.

(For a Reuters Insider story on Intel:

http://link.reuters.com/buj77r )

Intel has a good history of semiconductor manufacturing but it was criticized in the 1990s after it corrected but did not disclose a flaw in one of its Pentium processors.

Intel cut its first-quarter revenue forecast by $300 million and expects the total cost to repair and replace the chip to be about $700 million. Full-year revenues are seen unaffected.

The Santa Clara, California, company said the defect was discovered after it shipped more than 100,000 of the chips to computer manufacturers getting ready to sell new PC models with the Sandy Bridge processor, which Intel touts as its biggest-ever leap in processing power.

Had the problem gone undiscovered, about 5 percent of PCs using the new chipsets could have failed over a three-year period, Stephen Smith, vice president and director of PC Client Operations at Intel, said on a conference call.

It would be a low and continuing failure rate over the life of the systems, he said.

Intel's shares were down 0.6 percent on the Nasdaq shortly before the close.

Advanced Micro Devices' shares jumped 4.4 percent to $7.82 as investors bet Intel's setback would give its smaller rival an edge.

AMD this year is launching its own new lineup of processors, code-named Fusion, which will compete with Intel's Sandy Bridge chips for PC design wins.

PCs using the chips started shipping on January 9, and Intel said a relatively small number of them are likely to have been bought so far by consumers. It had sent a bit fewer than 8 million of the faulty chips to manufacturers.

While Intel's processors are the brains in 80 percent of the world's PCs, the company has yet to make its mark in mobile gadgets that are increasingly used to surf the Web, manage email and perform other tasks once exclusively the province of PCs.

Some worries about Intel were eased earlier this month when it reported better-than expected revenue and margins for the fourth quarter and gave a rosy outlook for early 2011.

Despite lukewarm growth in PC sales last year, the Semiconductor Industry Association said on Monday worldwide chip sales for 2010 rose 32 percent to a record $298.3 billion. But it warned that this year it expected only moderate single-digit growth for the industry as a whole, as the faltering economy continues to suppress growth in demand.

Intel does not expect the problem with its so-called Cougar Point chipsets, which let the central processor interact with the memory, hard disk drives and other parts of the computer, to hurt its full-year revenue. It will deliver an updated version of the chip in late February.

But since the flaw affected some of the chips shipped in the fourth quarter, Intel plans to take a charge that will reduce gross margin by roughly 4 percentage points for that period.

It will also take a first-quarter charge that will cut gross margin by 2 percentage points.

HIGH VOLTAGE

Intel said its engineers zeroed in on the newest defect last week after manufacturers stress-tested the chips with high voltage and temperatures. The flaw could have stopped computers from being able to communicate with their hard disk drives or DVD drives.

Hewlett-Packard, the world's largest PC maker, and Dell, ranked No. 2, declined to comment.

It's obviously a negative and a surprise. We think they can recover from this very quickly. This product was just being introduced and there's not many in the field, said Kevin Cassidy, an analyst at Stifel Nicolaus.

He said investors should buy shares of Intel if the stock appears under pressure from the Cougar Point problem.

The chip flaw, along with its recently completed acquisition of German chipmaker Infineon Technologies AG's wireless unit and the purchase of security software firm McAfee, expected to close in this quarter, prompted Intel to revise its overall outlook.

Helped by the deals, it expects first-quarter revenue of $11.7 billion, give or take $400 million, compared with its previous expectation of $11.5 billion, give or take $400 million.

As a long-term investor in the stock I won't be changing my perspective on the shares, but in the short term this is a surprise, said Ralph Shive, manager of the $1.7 billion Wasatch-1ST Source Income Equity Fund. The fund owns shares of Intel.

(Additional reporting by Paul Thomasch in New York, editing by Derek Caney, Tim Dobbyn and Matthew Lewis)

Intel Chip Launch