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Intel Q2 Earnings Beat, Data Center Concern is Overblown
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Intel Corp (INTC - Free Report) reported a mixed second-quarter with revenue coming in line with the Zacks Consensus Estimate and earnings exceeding. The restructuring charge was somewhat higher than expected, COGS was also higher but the tax rate lower. Opex was in line with expectations.
This isn’t the kind of result that calls for pessimism, but investors reacted to a seemingly sluggish data center business, sending shares down more than 3% in after-hours trading.
The company bundles PCs, notebooks, 2-in-1s, tablets and other computing devices under the Client segment, which actually helps comparison with the PC market numbers provided by IDC and Gartner. Therefore, it’s heartening to see that despite being the giant supplier to the PC market, Intel’s revenues from the market continue to beat PC market trends. This is a clear indication of the company gaining share in the emerging, connected, computing device market. Strength in these devices is offsetting declines in the core PC market. Another encouraging sign is the segment operating profit, which increased from both the previous and year-ago quarters indicating an improving mix of products in this segment.
Client and Data Center together accounted for 84% of the company’s revenue in the last quarter. Moreover, data center is the segment that is expected to significantly boost Intel’s revenues going forward. Management earlier said that segment revenue would grow 15% this year, so on the face of it, the 4.5% growth in the last quarter is disappointing. Particularly so since investors are already jittery about new entrants into the space like Qualcomm (QCOM - Free Report) using ARM designs and companies like Facebook and Google trying to second source, perhaps with the help of International Business Machine (IBM - Free Report) designs. But it’s also important to note that management is building inventory of server chips with the expectations of a very strong second half. The enterprise weakness started moderating in the last quarter and Intel appears poised for growth in the second half. Cloud, networking and communications segments all strengthened in the last quarter. Another emerging growth area is HPC, where prospects are bright for the company’s latest Xeon Phi accelerator (8X 2015 revenue in the last six months).
IoT, Security, PSG and Memory make up smaller parts of revenue and Intel has unique opportunities in each. New memory products are unlikely to make a meaningful contribution until next year. Growth in IoT and Security continues.
Capital spending estimates didn’t change in the last quarter, with 10nm, 3D NAND and 3D XPoint technologies, and data center, IoT and memory segments remaining the main areas of investment.
The numbers in detail-
Revenue
Intel’s reported revenue was $13.53 billion, within the guided range of $13.5 billion (+/-$500 million) and missing the Zacks Consensus of $14.80 billion. Segment revenue share was as follows: Client Computing 54%, Data Center 30%, IoT 4%, Non Volatile Memory Solutions 4%, Intel Security 4% and Programmable Solutions 3%. Intel also has a residual segment, which includes results of operations from the recently formed New Technology Group and other adjustments. Because of the extra week in the first quarter, the sequential comparison is actually better than appears.
Inventories: This discussion has become a little more complex given the multiple markets that Intel is now serving. So on the PC front, management said that the market itself has gotten stronger meaning lower inventory burn in the channel and at customers. Continuing customer caution and expectations for a stronger second half in this market led to management optimism about healthy inventory levels exiting the quarter. As far as IoT is concerned, very strong purchasing at customers in the first quarter led to some inventory accumulation, which was burned off in the second quarter. Internal inventory spiked again and management said that while yields continued to improve, inventory units didn’t really increase in the last quarter. On the other hand, more expensive Skylake and server chips in the mix raised inventory value. Altera related inventory adjustments were an offsetting factor.
Client Computing Group revenues were down 2.8% sequentially and 2.6% year over year. 2-in-1s and enthusiast PCs continues to grow in the last quarter, partially offsetting weakness in the traditional business. Kaby Lake and the 7360 modem started shipping.
Overall unit volumes were down 1% sequentially and 15% year over year. PC and notebook units dropped a respective 7% and 5% from last year, but the most disappointing was tablet units, which dropped 49%.
Average selling prices (ASPs) dropped 3% sequentially but were up 13% from last year. The year-over-year increase came from both PCs and notebooks, which were up 1% and 2%, respectively.
Data Center units dropped 3% sequentially but increased 5% from the year-ago quarter. ASP was up 4% sequentially but down 1% from year-ago quarter (attributed to significant share gains in the low end of the networking infrastructure mrket). This led to sequential and year-over-year increases of 0.7% and 4.5%, respectively. Management said that a 9% increase at cloud services providers and 10% increase at communications service providers were partially offset by a 1% decline at enterprise customers. Management expressed confidence of share gains in networking infrastructure, saying that “Intel architecture [is becoming] the solution of choice for the transformation of the network to SDN, NFV and 5G”.
The Internet of Things Group declined 12.1% sequentially but this was still 2.3% above year-ago levels. Strength in industrial and video applications were offset by inventory burn at customers across the board. Management also said that the agreement with BMW and Mobileye extended beyond autonomous cars. With BMW in particular, Intel silicon will find its way into a wide range of IoT products from door locks to the data center. As a reminder, Intel’s focus areas in IoT are the autonomous vehicle, industrial and retail segments, where there will be increased scope because of the incorporation of machine learning and increasingly, 5G connectivity. This is also expected to be strategically important because of its tie-in with the data center back-end.
Non Volatile Memory Solutions Group revenue was down 0.5% sequentially and 20.4% year over year. Memory is a commodity-type business, so prices vary widely depending on available supply. In the last quarter, a competitive pricing environment led to weakness in this business. But encouragingly, management pointed to 3D NAND production at the Dalian factory in China, which started ahead of schedule toward the end of the last quarter. 3D XPoint is also expected to ship by yearend. This is encouraging news because these products bring the kind of differentiation to Intel’s memory business that could help it generate stable memory demand and pricing in an otherwise commodity-type market. The goal is to take these technologies to data center and enterprise customers, where they will generate solid revenue and profits. XPoint is likely to have broader application.
The Altera business is now the Programmable Solutions Group, growing 29.5% sequentially to generate $465 million in revenue in the last quarter. Revenues are up 12% from what Altera generated last year, helped by the communications infrastructure market and some channel fill. It’s also encouraging to note that the segment will ship 14nm Stratix 10 samples this year.
Intel Security sales were flat sequentially and up 10.0% year over year to 4% of revenue. Restructuring actions continue in this segment.
The AllOther segment was down from both the previous and year-ago quarters with revenue contribution at less than 1%.
Margins
The gross margin for the quarter was 58.9%, down 42 basis points (bps) sequentially and 359 bps year over year, much weaker than the guided 61% (+/-2%).
Operating expenses of $5.24 billion were down 5.8% sequentially and up 2.7% from last year.
The operating margin was 20.2%, up 145 bps sequentially and down 364 bps year over year. R&D and MG&A costs as a percentage of sales were down 45 bps and 142 bps, respectively on a sequential basis with R&D also down 16 bps from a year ago.
Segment margins — Client Computing 26.0% (up 107 bps sequentially, up 477 bps year over year), Data Center 43.8% (down 28 bps and 402 bps, respectively), Internet of Things 15.6% (down 333 bps and 1,056 bps, respectively), non volatile memory -40.4% (down 2,338 bps and 5,365 bps, respectively) and Intel Security 18.1% (up 223 bps and 1,356 bps, respectively). Programmable Solutions and Other made losses. The IoT operating profit would have increased significantly from both previous and year-ago quarters if $160 million in inventory charges were excluded from calculations.
Net income of $2.74 billion, or 20.3% of sales was down from $2.05 billion, or 14.9% in the previous quarter and $2.95 billion or 22.4% in the comparable prior-year quarter.
The GAAP EPS was 27 cents in the last quarter compared to 42 cents in the previous quarter and 55 cents in the year-ago quarter.
Balance Sheet
Inventories were up 0.9% sequentially with annualized inventory turns moving from 4.1X to around 3.9X. Days sales outstanding (DSOs) went from 28 to around 30. The cash, marketable securities and fixed income trading asset balance at quarter-end was $17.69 billion, up $2.60 billion during the quarter.
Intel has $24.05 billion in long-term debt now as well as $4.56 billion in short-term debt, which has led to a net debt balance of $10.92 billion. Cash flow from operations was around $3.8 billion. Important usages of cash in the last quarter included $50 million on acquisitions, $2.29 billion on capex, $1.23 billion on dividends and $804 million on share repurchases.
Guidance for Q3
Intel guided to third-quarter revenue of around $14.9 billion (+/-$500 million), up 10.1% sequentially and 3.0% from the Jun quarter of 2015 (better than the Zacks Consensus Estimate of $14.58 billion). The non GAAP gross margin is expected to be around 62% (+/-2 percentage points).
R&D and MG&A expenses are expected to come in at around $5.1 billion. Non operating items including impact of equity investments will amount to a net gain of $75 million. Depreciation will be $1.5 billion.
Applying the Q3 and Q4 tax rate of 21%, net income comes to $2.33 billion or 22.3% of sales, up sequentially and more or less consistent with the year-ago quarter.
2016 Guidance
For 2016, management expects Intel to grow revenue in the mid single digits. Gross margin is expected to be 62% (+/- 2 percentage points). Operating expenses are now projected at $20.7 billion (+/- $400 million) (previous $20.6 billion, +/- $400 million). An extra week of operation this year will increase expenses relative to 2015.
Depreciation is currently forecast to be $6.3 billion (+/- $200M).
The tax rate will be 21% in each of the remaining quarters (previous 22%).
Full-year capex is now expected to be $9.5 billion (+/-$500 million) (unchanged) up $2.2 billion from 2015.
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Intel Q2 Earnings Beat, Data Center Concern is Overblown
Intel Corp (INTC - Free Report) reported a mixed second-quarter with revenue coming in line with the Zacks Consensus Estimate and earnings exceeding. The restructuring charge was somewhat higher than expected, COGS was also higher but the tax rate lower. Opex was in line with expectations.
This isn’t the kind of result that calls for pessimism, but investors reacted to a seemingly sluggish data center business, sending shares down more than 3% in after-hours trading.
The company bundles PCs, notebooks, 2-in-1s, tablets and other computing devices under the Client segment, which actually helps comparison with the PC market numbers provided by IDC and Gartner. Therefore, it’s heartening to see that despite being the giant supplier to the PC market, Intel’s revenues from the market continue to beat PC market trends. This is a clear indication of the company gaining share in the emerging, connected, computing device market. Strength in these devices is offsetting declines in the core PC market. Another encouraging sign is the segment operating profit, which increased from both the previous and year-ago quarters indicating an improving mix of products in this segment.
Client and Data Center together accounted for 84% of the company’s revenue in the last quarter. Moreover, data center is the segment that is expected to significantly boost Intel’s revenues going forward. Management earlier said that segment revenue would grow 15% this year, so on the face of it, the 4.5% growth in the last quarter is disappointing. Particularly so since investors are already jittery about new entrants into the space like Qualcomm (QCOM - Free Report) using ARM designs and companies like Facebook and Google trying to second source, perhaps with the help of International Business Machine (IBM - Free Report) designs. But it’s also important to note that management is building inventory of server chips with the expectations of a very strong second half. The enterprise weakness started moderating in the last quarter and Intel appears poised for growth in the second half. Cloud, networking and communications segments all strengthened in the last quarter. Another emerging growth area is HPC, where prospects are bright for the company’s latest Xeon Phi accelerator (8X 2015 revenue in the last six months).
IoT, Security, PSG and Memory make up smaller parts of revenue and Intel has unique opportunities in each. New memory products are unlikely to make a meaningful contribution until next year. Growth in IoT and Security continues.
Capital spending estimates didn’t change in the last quarter, with 10nm, 3D NAND and 3D XPoint technologies, and data center, IoT and memory segments remaining the main areas of investment.
The numbers in detail-
Revenue
Intel’s reported revenue was $13.53 billion, within the guided range of $13.5 billion (+/-$500 million) and missing the Zacks Consensus of $14.80 billion. Segment revenue share was as follows: Client Computing 54%, Data Center 30%, IoT 4%, Non Volatile Memory Solutions 4%, Intel Security 4% and Programmable Solutions 3%. Intel also has a residual segment, which includes results of operations from the recently formed New Technology Group and other adjustments. Because of the extra week in the first quarter, the sequential comparison is actually better than appears.
Inventories: This discussion has become a little more complex given the multiple markets that Intel is now serving. So on the PC front, management said that the market itself has gotten stronger meaning lower inventory burn in the channel and at customers. Continuing customer caution and expectations for a stronger second half in this market led to management optimism about healthy inventory levels exiting the quarter. As far as IoT is concerned, very strong purchasing at customers in the first quarter led to some inventory accumulation, which was burned off in the second quarter. Internal inventory spiked again and management said that while yields continued to improve, inventory units didn’t really increase in the last quarter. On the other hand, more expensive Skylake and server chips in the mix raised inventory value. Altera related inventory adjustments were an offsetting factor.
Client Computing Group revenues were down 2.8% sequentially and 2.6% year over year. 2-in-1s and enthusiast PCs continues to grow in the last quarter, partially offsetting weakness in the traditional business. Kaby Lake and the 7360 modem started shipping.
Overall unit volumes were down 1% sequentially and 15% year over year. PC and notebook units dropped a respective 7% and 5% from last year, but the most disappointing was tablet units, which dropped 49%.
Average selling prices (ASPs) dropped 3% sequentially but were up 13% from last year. The year-over-year increase came from both PCs and notebooks, which were up 1% and 2%, respectively.
Data Center units dropped 3% sequentially but increased 5% from the year-ago quarter. ASP was up 4% sequentially but down 1% from year-ago quarter (attributed to significant share gains in the low end of the networking infrastructure mrket). This led to sequential and year-over-year increases of 0.7% and 4.5%, respectively. Management said that a 9% increase at cloud services providers and 10% increase at communications service providers were partially offset by a 1% decline at enterprise customers. Management expressed confidence of share gains in networking infrastructure, saying that “Intel architecture [is becoming] the solution of choice for the transformation of the network to SDN, NFV and 5G”.
The Internet of Things Group declined 12.1% sequentially but this was still 2.3% above year-ago levels. Strength in industrial and video applications were offset by inventory burn at customers across the board. Management also said that the agreement with BMW and Mobileye extended beyond autonomous cars. With BMW in particular, Intel silicon will find its way into a wide range of IoT products from door locks to the data center. As a reminder, Intel’s focus areas in IoT are the autonomous vehicle, industrial and retail segments, where there will be increased scope because of the incorporation of machine learning and increasingly, 5G connectivity. This is also expected to be strategically important because of its tie-in with the data center back-end.
Non Volatile Memory Solutions Group revenue was down 0.5% sequentially and 20.4% year over year. Memory is a commodity-type business, so prices vary widely depending on available supply. In the last quarter, a competitive pricing environment led to weakness in this business. But encouragingly, management pointed to 3D NAND production at the Dalian factory in China, which started ahead of schedule toward the end of the last quarter. 3D XPoint is also expected to ship by yearend. This is encouraging news because these products bring the kind of differentiation to Intel’s memory business that could help it generate stable memory demand and pricing in an otherwise commodity-type market. The goal is to take these technologies to data center and enterprise customers, where they will generate solid revenue and profits. XPoint is likely to have broader application.
The Altera business is now the Programmable Solutions Group, growing 29.5% sequentially to generate $465 million in revenue in the last quarter. Revenues are up 12% from what Altera generated last year, helped by the communications infrastructure market and some channel fill. It’s also encouraging to note that the segment will ship 14nm Stratix 10 samples this year.
Intel Security sales were flat sequentially and up 10.0% year over year to 4% of revenue. Restructuring actions continue in this segment.
The All Other segment was down from both the previous and year-ago quarters with revenue contribution at less than 1%.
Margins
The gross margin for the quarter was 58.9%, down 42 basis points (bps) sequentially and 359 bps year over year, much weaker than the guided 61% (+/-2%).
Operating expenses of $5.24 billion were down 5.8% sequentially and up 2.7% from last year.
The operating margin was 20.2%, up 145 bps sequentially and down 364 bps year over year. R&D and MG&A costs as a percentage of sales were down 45 bps and 142 bps, respectively on a sequential basis with R&D also down 16 bps from a year ago.
Segment margins — Client Computing 26.0% (up 107 bps sequentially, up 477 bps year over year), Data Center 43.8% (down 28 bps and 402 bps, respectively), Internet of Things 15.6% (down 333 bps and 1,056 bps, respectively), non volatile memory -40.4% (down 2,338 bps and 5,365 bps, respectively) and Intel Security 18.1% (up 223 bps and 1,356 bps, respectively). Programmable Solutions and Other made losses. The IoT operating profit would have increased significantly from both previous and year-ago quarters if $160 million in inventory charges were excluded from calculations.
Net income of $2.74 billion, or 20.3% of sales was down from $2.05 billion, or 14.9% in the previous quarter and $2.95 billion or 22.4% in the comparable prior-year quarter.
The GAAP EPS was 27 cents in the last quarter compared to 42 cents in the previous quarter and 55 cents in the year-ago quarter.
Balance Sheet
Inventories were up 0.9% sequentially with annualized inventory turns moving from 4.1X to around 3.9X. Days sales outstanding (DSOs) went from 28 to around 30. The cash, marketable securities and fixed income trading asset balance at quarter-end was $17.69 billion, up $2.60 billion during the quarter.
Intel has $24.05 billion in long-term debt now as well as $4.56 billion in short-term debt, which has led to a net debt balance of $10.92 billion. Cash flow from operations was around $3.8 billion. Important usages of cash in the last quarter included $50 million on acquisitions, $2.29 billion on capex, $1.23 billion on dividends and $804 million on share repurchases.
Guidance for Q3
Intel guided to third-quarter revenue of around $14.9 billion (+/-$500 million), up 10.1% sequentially and 3.0% from the Jun quarter of 2015 (better than the Zacks Consensus Estimate of $14.58 billion). The non GAAP gross margin is expected to be around 62% (+/-2 percentage points).
R&D and MG&A expenses are expected to come in at around $5.1 billion. Non operating items including impact of equity investments will amount to a net gain of $75 million. Depreciation will be $1.5 billion.
Applying the Q3 and Q4 tax rate of 21%, net income comes to $2.33 billion or 22.3% of sales, up sequentially and more or less consistent with the year-ago quarter.
2016 Guidance
For 2016, management expects Intel to grow revenue in the mid single digits. Gross margin is expected to be 62% (+/- 2 percentage points). Operating expenses are now projected at $20.7 billion (+/- $400 million) (previous $20.6 billion, +/- $400 million). An extra week of operation this year will increase expenses relative to 2015.
Depreciation is currently forecast to be $6.3 billion (+/- $200M).
The tax rate will be 21% in each of the remaining quarters (previous 22%).
Full-year capex is now expected to be $9.5 billion (+/-$500 million) (unchanged) up $2.2 billion from 2015.
INTEL CORP Price, Consensus and EPS Surprise
INTEL CORP Price, Consensus and EPS Surprise | INTEL CORP Quote
Recommendation
Intel shares carry a Zacks Rank #2 (Buy).
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