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Intel Promises Much, Says Little

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Intel Corp (INTC - Free Report) reported second-quarter earnings of 39 cents per share, missing the Zacks Consensus Estimate by a penny.

Intel has reported a 6.4% average positive surprise in the four preceding quarters, so the results were disappointing. The company also took down its guidance for the year (but probably not enough given core issues). In any case, it was not surprising that the shares lost 3.48% in after-hours trading.

The negative surprise was the other income line, which had a negative impact of 1 cent on earnings (Intel had guided to no impact).


Intel’s reported revenue was $12.81 billion, within the guidance range of $12.9 billion (+/-$500 million). This was up 1.8% sequentially and down 5.1% year over year.

Weaker-than-expected PC demand stemming from tablet cannibalization and restrained consumer buying due to tighter budgets continued in the last quarter. As a result, buying patterns remain cautious. Additionally, Microsoft’s (MSFT - Free Report) Windows 8 has not helped sales in the traditional computing segment. Intel was unable to make good this loss with growth in other areas.

Revenue by Segment

The PC Client segment generated 63% of revenue in the last quarter, up 1.4% sequentially and down 4.7% year over year due to the PC market concerns outlined above. Notebook and desktop volumes dropped 7% and 3%, respectively from the previous and year-ago quarters. Pricing was a little more encouraging – notebook down 4% and desktop up 6%.

Intel’s internal inventories grew after two quarters of decline despite management commentary about Haswell-related inventory-filling in the channel. It is possible that Haswell uptake has been lower than Intel expected. Low penetration and a growing per capita income are increasing the popularity of computing devices in emerging markets, especially the BRIC countries; however here too, mobile remains a key factor for Intel’s growth.

Data Center was the second largest group with a 21% revenue share. Segment revenue was up 6.1% sequentially and 14.1% year over year. Intel continues to gain from the growing importance of cloud computing and its own new products. Intel remains very optimistic about the business, saying that its cloud and storage businesses were both up more than 40% from the year-ago quarter, with networking growing more than 20%.

Its high performance computing (HPC) technology made it into 98% of the top 500 new systems in the world. As a result, both volumes jumped 6% in the last quarter, although the ASP was down 1% from the year-ago quarter.

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 HPC segment is the fastest-growing segment within Intel’s data center business.

The Other Intel Architecture segment generated 7% of Intel’s revenue in the last quarter, declining 3.7% sequentially and 12.4% from last year. It is apparent that Intel’s efforts in the embedded and mobile (phone and tablets) segments are not generating enough to offset declines in netbooks.

The Software and Services segment contributed around 5% of total revenue, up 3.7% sequentially and 4.1% from last year. In addition to discrete sales, Intel is taking an integrated approach to McAfee’s storage solutions, with the intention of further differentiating its products.   

The Other segment, which comprises Intel’s NAND flash memory products, generated around 3% of revenue, down 4.8% sequentially but up 30.4% from the year-ago quarter.


The gross margin for the quarter was 58.3%, up 214 basis points (bps) sequentially and down 505 bps year over year, in line with the guidance of 58% at the mid-point. The qualification of Haswell products for sale and higher volumes were ppositives for the gross margin, contributing to the sequential expansion. However, lower under-utilization charges were more than offset by 14nm startup costs, resulting in the unfavorable year-over-year comparison.

Operating expenses of $4.75 billion were up 4.5% sequentially. The operating margin was 21.2%, up 120 bps sequentially and down 716 bps year over year. On a sequential basis, the higher SG&A as a percentage of sales was offset by a lower gross margin and flattish R&D. However, all expenses increased as a percentage of sales from the year-ago quarter, with cost of sales increasing the most and R&D and SG&A about even.

The operating margins by segment were as follows: PC Client 32.8% (up 138 bps sequentially), Data Center 44.8% (up 310 bps), Other Intel Architecture -64.5% (down 207 bps) and Software and Services -1.3% (up 277 bps). Operating margins declined significantly on a year-over-year basis across all major segments.

Net income was $2.00 billion, or 15.6% of sales, compared to $2.05 billion, or 16.3% in the previous quarter and $2.83 billion or 20.9% in the comparable prior-year quarter. There were no one-time adjustments in the last quarter, so the GAAP net income was was the same as the pro forma net income of 39 cents a share compared to 40 cents per share in the previous quarter and 54 cents in the year-ago quarter.

Balance Sheet

Inventories jumped 4.2% sequentially with annualized inventory turns moving from 5.1X to 4.7X. Days sales outstanding (DSOs) were down slightly from 26 to around 25. The cash, marketable securities and fixed income trading asset balance at quarter-end was $17.35 billion, up $277 million during the quarter.

Intel has $13.15 billion in long-term debt and $263 million in short-term debt, resulting in a net cash balance of $3.94 billion. Cash flow from operations was around $5 billion. Important usages of cash in the last quarter included $2.72 billion on capex, $1.12 billion on dividends and $23 million on share repurchases.


Intel guided to second-quarter revenue of around $13.5 billion (+/-$500 million), up 5.4% sequentially and 0.3% from the Sep quarter of 2012 (in line with consensus estimate of $12.9 billion). The gross margin is expected to be around 61% (+/-2 percentage points). Total operating expenses are expected to come in at around $4.8 billion.

Management also expects to provide for depreciation of around $1.7 billion and intangibles amortization of around $70 million. Other income/expense and equity investments are expected to be a net gain of $400 million. Applying the guided annual tax rate of 26%, net income comes to around $2.79 billion or 20.6% of revenue, which would be up sequentially but down year over year.

Intel currently expects 2013 revenue to be consistent with the prior year (previously guided up low single-digits) gross margin to be around 59% (+/- 2%) compared to 60% guided previously, opex $18.7 billion (+/-$200 million), which was a $200 million improvement, intangibles amortization $300 million (unchanged), depreciation $6.8 billion (+/-$100 million) (unchanged) and a tax rate of 26% (down from 27%).

The company expects to spend $11.0 billion (+/- $500 million) on capex, which has been reduced by a billion. The reduction in capex likely reflects continued redirection of trailing end capacity toward leading edge purposes.

Our Take

Management commentary did not really increase our understanding of what is to come in the second half of the year and the focus has now shifted to the Analyst Day in November when they are likely to share more on the mobile roadmap.

Considering Intel’s performance in the last quarter and management commentary, it appears that ASP pressures will increase through the year, as the company ships more low-ASP Atom processors in a bid to build a position in the mobile segment. This will impact the mix of business and have a corresponding negative impact on the gross margin.

The below-seasonal revenue guide for the next quarter and flat revenue for the year indicates a very strong fourth quarter. This is only possible with significant traction on the mobile platform that offsets traditional computing. As such, the guidance could prove too aggressive. The capex reduction makes perfect sense under the circumstances.

For now, the company remains the leading producer of microprocessors for the PC market. Its innovative prowess has ensured that Intel is well ahead of its closest rival Advanced Micro Devices (AMD - Free Report) . 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 years.

Intel has also increased focus on the ultra-mobile, ultra-thin computing segment with its ultrabook concept that has been welcomed by Hewlett Packard (HPQ - Free Report) and Dell, among others. Adoption of new technology is naturally much slower in an uncertain economy and the ultrabook’s success has also been limited by a plethora of tablets and growing number of hybrid devices.

2013 should see some changes, as Haswell and Bay Trail get into a range of devices. Management has stated that Intel has increased focus on the Atom line and will speed up its progress to the leading edge and also increasingly integrate graphics, communications and other components. The concern here is that its own lowest-end Core processors could be cannibalized.

In the meantime, tablets that run on ARM devices will continue to eat into notebooks, which have been taking share from desktops. Therefore, Intel’s core computing business will remain under pressure.

Intel has a strong position in a declining market, but continues to display a technology lead and solid execution, which should help it through the year. Intel shares therefore carry a Zacks Rank #3 (Hold).

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