Dell Inc forecast lower gross margins for the July quarter, citing higher component costs and an unfavorable product mix, sending its shares down 3 percent

The world's second-largest maker of personal computers also said on Monday, the eve of its analyst day in Austin, Texas, that it expects to report a slight sequential increase in revenue for its fiscal second quarter ending July 31.

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 the statement.

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

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

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, Collins Stewart analyst Ashok Kumar.

Kaufman Bros analyst Shaw Wu said Dell's second-quarter outlook was in-line to a little below what Wall Street was expecting.

He 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 said 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.

The company added that it is on track to cut annual costs by more than $4 billion by the end of fiscal 2011.

Battered by plunging PC sales and working its way through a painful turnaround, Dell has been focusing on profitability as sales continue to slide.

Dell's revenue fell 23 percent from a year earlier to $12.3 billion in its fiscal first quarter, while gross margin slid to 17.6 percent, or an adjusted 18.1 percent.

As for the fiscal second quarter, analysts were expecting revenue of $12.6 billion, which would be up 2 percent sequentially but down 24 percent year on year, according to Reuters Estimates.

The company is seeking to diversify its revenue base to better compete with larger rivals Hewlett-Packard and International Business Machines . 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 International Business Machines Corp's M&A chief.

Shares of Dell fell to $12.63 in after-hours trading, from their Nasdaq close of 13.02.

(Reporting by Gabriel Madway, writing by Tiffany Wu, editing by Richard Chang)