(INTC) Intel’s Outlook Overshadows Second Quarter

Intel Corp (INTC) reported first quarter earnings of 56 cents per share that beat the Zacks Consensus Estimate by 4 cents. The nearly-8% surprise was more or less in line with the 8%+ average in the four preceding quarters (note that estimates dropped a penny in the last 7 days). Intel’s commentary was also not overly exciting, so shares barely moved in response.


Intel’s reported revenue was $13.5 billion, in line with management’s guidance range of $$13.6 billion (+/-$500 million). This was up 4.6% sequentially and 3.6% year over year.

While PC inventories are lean, distributor orders remain conservative, mainly due to macro uncertainties and lower sales expectations ahead of the Windows 8 Launch from Microsoft (MSFT). Intel stated that the Ivy Bridge ramp was faster than expected, reaching 25% of PC volumes in the last quarter.

Intel’s longer-term strategy is playing out, with data center and enterprise remaining strong drivers. The emerging BRIC countries also continue to grow strongly, making up for the weakness in mature markets.

Revenue by Segment

The PC Client segment generated 64% of revenue in the last quarter, up 2.8% sequentially and 4.4% year over year. Overall, enterprise remained the driver of growth, while consumer remained soft, which resulted in a better mix of business. Low penetration and a growing per capita income are increasing the popularity of computing devices in emerging markets, especially the BRIC countries.

Data Center was the second largest group with a 21% revenue share. Segment revenue was up 14.3% sequentially and 15.1% year over year, as expected. The strength in the last quarter was largely on account of Romley (Sandy Bridge for servers), since customers had deferred purchases in the last quarter prior to its launch.

The secular growth drivers here are increasing Internet usage by consumers all over the world, and the ongoing move towards virtualization and cloud computing. The high performance computing (HPC) segment is the fastest-growing segment within Intel’s data center business.

The Other Intel Architecture segment generated around 8% of Intel’s revenue in the last quarter, growing 3.1% sequentially and declining 20.2% from last year.

The Software and Services revenue contributed a little more than 4% of total revenue (similar to the last quarter). This was the first quarter that the year-over-year comp did not benefit from the acquisition. In addition to discrete sales, Intel is taking an integrated approach to McAfee’s storage solutions, with the intention of further differentiating its products. This helped the very strong growth in each of the last five quarters.

The Other segment generated 2% of revenue, down 10.4% sequentially and 14.9% from the year-ago quarter.

Revenue by Geography

The Asia/Pacific market remained the largest in the last quarter, with a 58% contribution, with revenues growing 5.5% sequentially and 5.2% from a year ago. The Americas was the second largest region, with a 21% contribution, up 12.9% sequentially and down 0.9% year over year. Europe came in third with a 12% revenue share, representing a sequential decline of 7.1% and an increase of 5.6% from the second quarter of 2011. Japan stayed at number four, with a 9% contribution, representing a sequential decline of 1.2% and a year-over-year increase of 2.1%.


The pro forma gross margin for the quarter was 64.4%, down 69 basis points (bps) sequentially and up 273 bps year over year, better than guidance of 62% at the mid-point. The sequential decline was related to the increase in Ivy Bridge ramp up costs (22nm). Of course, the positive mix related to higher enterprise and data center business and soft consumer sales in mature markets continued to work in its favor, while the strength in emerging markets remains an offsetting factor.

Operating expenses of $4.6 billion were up 6.2% from the first quarter. The operating margin was 30.0%, down 120 bps sequentially and 181 bps year over year. Both R&D and SG&A were flattish as a percentage of sales from the previous quarter. While R&D increased significantly from last year, the increase in SG&A was not so much. Intel expects to contain hiring costs through the rest of the year, which is expected to maintain spending at these levels.

The operating margins by segment were as follows—PC Client 39.3% (down 188 bps sequentially), Data Center 49.5% (up 294 bps), Other Intel Architecture -30.2% (down 121 bps) and Software and Services 2.4% (up 116 bps). The Software and Services margin was up 513 bps from the year-ago quarter, Data Center was up 11 bps, while other segment margins declined.

The pro forma net income was $3.0 billion, or 22.0% of sales, compared to $2.9 billion, or 22.3% in the previous quarter and $3.1 billion or 23.9% in the comparable prior-year quarter. One-time items included intangibles amortization expenses on a tax-adjusted basis.

Accordingly, the fully diluted GAAP net income was $2.8 billion, or 54 cents a share compared to $2.7 billion, or 53 cents per share in the previous quarter and $3.0 billion, or 54 cents in the year-ago quarter.

Balance Sheet

Inventories increased 9.2% sequentially and annualized inventory turns were flat at 4.0X. Days sales outstanding (DSOs) went from 29 back to around 24. The cash, marketable securities and fixed income trading asset balance at quarter-end was $13.6 billion, down $105 million during the quarter. Intel has $7.1 billion in long-term debt and 92 million in short-term debt, resulting in a net cash balance of $6.5 billion.

Cash flow from operations was around $5 billion. Important usages of cash in the last quarter included $2.66 billion on capex, $1.06 billion on dividends, $282 million on acquisitions and $41 million on share repurchases.

Third Quarter Guidance

Intel guided to revenue of around $14.3 billion (+/-$500 million), up 5.9% sequentially and flat with the September quarter of 2011 (slightly short of consensus estimates of $14.6 billion). Gross margin on a GAAP basis is expected to be around 63% (+/-2 percentage points), while on a non-GAAP basis, it is expected to be 64% (+/- 2 percentage points).

Total operating expenses are expected to come in at around $4.6 billion. Management also expects to provide for depreciation of around $1.6 billion and intangibles amortization of around $80 million. Other income/expense and equity investments are expected to be nil. Applying the guided annual tax rate of 28%, net income comes to around $3.3 billion or 22.9% of revenue, which would be up sequentially, while declining year over year.

Guidance for 2012

For the year, Intel guided to a revenue increase of 3-5% from 2011, with the GAAP gross margin at 64% (+/- 2 percentage points) and non GAAP gross margin at 65% (+/- 2 percentage points) and operating expenses of $18.2 billion (+/- 200 million). The gross margin guidance was maintained while the operating margin guidance lowered by a $100 million from previous expectations. The full year tax rate is expected to be 28%, depreciation $6.3 billion (+/- $100 million) and capex $12.5 billion (+/- $400 million).

Our Take

Intel’s top line numbers for the quarter were good, if not excellent. The company remains the leading producer of microprocessors for the PC market and there do not appear to be any near-term challenges to this position. Its innovative prowess has ensured that Intel is well ahead of its closest rival Advanced Micro Devices (AMD). Therefore what affects it mainly is the market itself.

Intel’s strategy has been correct here and the company has positioned itself strongly in emerging markets, from where most of the growth is expected to originate in the next few quarters. The enterprise segment remains a strong growth area for Intel and there should be continued growth here in both emerging and mature markets.

Additionally, the PC client business will see the usual jump in response to Microsoft’s new Windows platform. One thing to note here is the relatively low inventory levels at distributors that are the result of uncertain economic conditions.

Intel also remains totally focused on the mobile segment, which has the potential of eating into its core computing business. While Intel’s ultrabook concept is still a far cry from Apple’s (AAPL) iPad, we may expect some growth this year, with all the new devices from Hewlett Packard Company (HPQ), Dell (DELL), Lenovo and so forth.

Although Microsoft’s Windows 8 (to launch later this year) will also be compatible with ARM architecture, Intel is likely to be one of the major beneficiaries, given the level of its support and the broader reach of its products across the world. We think Intel’s consistent focus on emerging markets will be a key to its growth in the next few quarters.

All that being said, Intel has yet to prove itself in the mobile segment (mainly tablets and smartphones), which continues to weigh on investor sentiments. The fact that ARM devices are also getting into the server segment is also a concern.

However, while the server impact could take a couple of years and Intel could have something to counter this threat by then, Intel really needs to buck up its mobile strategy. Failing to do this will see its revenues dwindling, as tablets continue to cannibalize its core computing market.

The concerns related to the economy, consumer spending and distributor inventory levels are relatively near-term issues and the reasons behind the Zacks #4 Rank (Sell). We also think the company’s fate in the mobile segment is currently hanging in balance, as initial pickup of ultrabooks was slower than expected (likely because of the many new tablets and Windows 8 anticipation).

However, we note that Intel has grown revenues at strong double-digit rates in each of the last two fiscal years despite the fact that it is the leading player in a market going through significant ups and downs. Intel’s initiatives, such as the recent investment in ASML Holding (ASML) to reduce die costs by 30-40%, are the reasons for its technology leadership. We think that strategic planning and resources are things to consider when investing in a company such as Intel. We remain Neutral on a long term (3-6 month) basis.

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