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While Intel Intel Corp (INTC - Analyst Report) continues to make progress in the mobile segment, its fortunes are still tied to the PC and data center segments, where market-driven factors and new products like the Xeon E7 family drove results. Growing volumes, better mix and stronger margins therefore led to earnings of 55 cents per share, which was up 44% sequentially and 41% year over year, better than the Zacks Consensus Estimate of 52 cents and management guidance.

 

 

Shares were up less than 1% during the day, but appreciated another 4.4% after the company reported.

Revenue

Intel’s reported revenue was $13.83 billion, better than the guidance range of 13.00 billion (+/-$500 million) and just over the Zacks Consensus of $13.62 billion. This was up 8.4% sequentialy and 8.0% from the year-ago quarter.

The PC Client Group, which continues to account for the largest chunk of Intel’s business (62%), now also includes gateway and STB products. The adjusted revenues for the segment are up 9.1% sequentially and 6.2% year over year.

Overall unit volume jumped 12% sequentially and 9% year over year, offsetting average selling price (ASP) declines of 3% and 4% from the previous and year-ago quarters, respectively. While desktop units have been almost as strong as notebook units over the past year, price declines on the platform were more moderate.

The third straight quarter of year-over-year unit growth was driven by the improving economic environment, PC refreshes in the enterprise and SMB segments, Windows XP end-of-life and the growing number of form factors that Intel is now catering to.

While the consumer side (particularly emerging markets) remains weak, management said that Bay Trail was making some headway. Bay Trail SoCs for desktops and clamshells doubled in the last quarter  to around 60% of Intel’s Pentium and Celeron mix and 20% of its overall notebook mix. Management said that while this was resulting in the significant ASP decline, it was enabling the company to maintain margins at low-end devices like Chromebooks.

Data Center, which generated 25% of quarterly revenue, saw units and ASP up 9% and 11%, respectively from last year, with cloud, networking HPC and enterprise revenue each up more than 15%. Intel’s dominance in the data center enables it to generate very strong prices here. The launch of the new Ivy-Bridge based Xeon E7 family in the last quarter further helped mix and prices. Segment revenue was up 13.7% sequentially and 19.2% year over year.

The secular growth drivers are increasing Internet usage by consumers all over the world and the ongoing move towards virtualization and cloud computing.

The new segment Internet of Things Group also includes Intel’s embedded business. The segment accounted for 4% of revenue, up 11.8% sequentially and 24.2% from last year. Management attributed the increase to retail and manufacturing sectors that were particularly strong in the last quarter.

The Software & Services Group generated another 4%, down 0.9% sequentially and up 2.6% year over year. McAfee revenue grew 5%.

The all-important Mobile & Communications Group generated less than 1% of revenue, with management remaining positive about its 40 million tablet unit target for the year. The optimism stems from the 5 million chips shipped in the first quarter and the 10 million units shipped in the second, the growing number of tablet design wins on Android and Windows platforms to date, and the strategic partnership with China-based Rockchip.

Segment revenue was down 67.3% sequentially and 82.5% year over year, which is mostly because the baseband modem business it inherited from Infineon is increasingly being replaced by 4G LTE solutions, where Qualcomm (QCOM - Analyst Report) has taken the dominant share. Intel’s own integrated solutions are yet to make headway. However, management said that Intel shipped 10 million units for tablets in the last quarter, which puts it squarely on track to meet the 40 million units targeted for the year.

The Other segment, which comprises Intel’s NAND flash memory products generated around 4% of revenue, up 3.2% sequentially and 15.7% year over year.

Margins

The gross margin for the quarter was 64.5%, up 472 basis points (bps) sequentially and up 616 bps year over year, better than the guidance of 63% at the mid-point. Lower-than-expected costs, particularly start-up costs related to the 14nm ramp and higher volumes resulted in the significant gross margin expansion.

The contra revenue or subsidy that it is giving to tablet makers for the higher cost of using Bay Trail remains an offsetting factor, but volumes are helping margins as management predicted. The growing list of foundry customers will further help loading, so gross margin improvements may not go away. 

Operating expenses of $4.99 billion were down 2.0% sequentially and up 9.8% from last year. The operating margin was 28.4%, up 853 bps sequentially and 715 bps year over year. Most of the bnefit to the operating margin was related to the higher fall-through of gross profit, but the 163 bp decline in R&D and 106 bp decline in MG&A also contributed.

The operating margins by segment were as follows—PC Client 43.1% (up 780 bps sequentially), Data Center 51.8% (up 913 bps), Internet of Things 28.8% (up 324 bps) and Software & Services 1.5% (up 273 bps). The other segments continued to make significant losses.

Net income was $2.88 billion, or 20.8% of sales, compared to $1.95 billion, or 15.3% in the previous quarter and $2.00 billion or 15.6% in the comparable prior-year quarter.

Including restructuring charges of a penny a share, the GAAP EPS was 55 cents in the last quarter, down from 38 cents in the previous quarter and 39 cents in the year-ago quarter.

Balance Sheet

Inventories were up 4.8% sequentially with annualized inventory turns moving from 5.5X to around 5.0X. Days sales outstanding (DSOs) were down a couple of days to 23. The cash, marketable securities and fixed income trading asset balance at quarter-end was $17.31 billion, down $1.74 billion during the quarter.

Intel has $13.18 billion in long-term debt and $14 million in short-term debt, resulting in a net cash balance of $4.12 billion. Cash flow from operations was around $5.5 billion. Important usages of cash in the last quarter included $2.83 billion on capex, $1.13 billion on dividends and $2.08 billion on share repurchases.

Guidance

Intel guided to third-quarter revenue of around $14.4 billion (+/-$500 million), up 4.1% sequentially and 6.8% from the Sep quarter of 2013 (lightly better than the consensus estimate of $14.0 billion). The gross margin is expected to be around 66% (+/-2 percentage points). Total operating expenses are expected to come in at around $4.9 billion.

Restructuring charges are expected to be around $20 million. Management also expects to provide for depreciation of around $1.9 billion and intangibles amortization of around $65 million. Other income/expense and equity investments are not expected to have an impact on the quarterly results. Applying the guided annual tax rate of 28%, net income comes to around $3.25 billion or 22.6% of revenue, which would be up both sequentially and year over year.

For 2014, management expects revenue growth of 5% (better than previous expectations of revenues in line with 2013), a gross margin of 63% (+/- a few percentage points, previous mid-point was 61%), operating expenses of $18.9 billion (+/- $200 million, previous was 0.4 million higher), intangibles amortization of $300 million (unchanged), depreciation of $7.4 billion (unchanged), a tax rate of 28% (previous 27%) and capex of $11.0 billion (+/- $500 million, unchanged).

Key Takeaways

Intel’s numbers confirmed the stabilization in the PC market (this was the third straight quarter that units didn’t decline from the year-ago quarter). Microsoft’s (MSFT - Analyst Report) withdrawal of XP support remains a tailwind, which along with the estimated 600 million estimated 4-year-old PCs creates a nice opportunity in this core market. Intel is well positioned to gain from this, whether customers opt for the all-new Win 8, or deflect to chromebooks as Google (GOOGL - Analyst Report) would like. Intel is the leader on the Chrome platform.

Intel is also the dominant force at the data center, but what we will be looking at is its execution in the cloud, since this is where ARM designs are likely to get in. Intel’s investment in Cloudera indicates that the company is taking the bull by the horns, but this is an area worth tracking. The Ivy Bridge Xeon family launched in the last quarter is a tailwind and will drive both volumes and prices.

Mobile execution will be key this year but we don’t expect a lot of profit here, mainly because Intel seems to be a little late with its 14nm process, which of course means it will take longer to take down costs and even longer before a subsidy is no longer required. Management appears optimistic about volumes and we expect a heavier second half.

We expect the new Internet Of Things segment to do well this year, which will support the strength in the data center and stabilization in PC, together providing the cushion required for a very aggressive drive to take share in mobile.

Capex expectations for the year were retained, indicating that Intel expects strong volumes as we move through the year. 2014 could therefore be a big year for Intel, when it starts growing revenues again.

Intel shares carry a Zacks Rank #1 (Strong Buy).

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