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Slow PC Market Catches Up with Intel

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Intel Corp (INTC - Free Report) reported third quarter earnings of 60 cents per share that beat the Zacks Consensus Estimate by 10 cents. The Zacks Consensus dropped a penny since Intel lowered its revenue and gross margin expectations for the quarter.

The 16.7% surprise was far better than the 5.3% it averaged in the four preceding quarters. The resultant 2.9% increase in share prices in after-hours trading nearly made up for the 3.3% decline during the day.


Intel’s reported revenue was $13.5 billion, at the high end of the revised guidance range of $$13.2 billion (+/-$300 million). This was down 0.3% sequentially and 5.5% year over year.

Weaker-than-expected PC demand stemming from tablet cannibalization, restrained consumer buying both due to tighter budgets (in developed markets) and in anticipation of the Windows 8 Launch from Microsoft (MSFT - Free Report) and softening enterprise demand combined to generate these results. Pricing pressure also played a part. 

Revenue by Segment

The PC Client segment generated 64% of revenue in the last quarter. The flattish sequential comparison was due to a slight increase in demand in September, compared with softer demand in the first two months of the quarter. The average selling price (ASP) was a negative, as traditional computing devices that are currently powered with Intel’s chips were hurt by increasing cannibalization from tablets.

Units and prices were down 4% each from the year-ago quarter, impacted by an 8% decline in ASPs for the notebook platform and a 6% decline in volumes for the desktop platform. Low penetration and a growing per capita income are increasing the popularity of computing devices in emerging markets, especially the BRIC countries, which is a longer term driver for Intel.

Data Center was the second largest group with a 20% revenue share. Segment revenue was down 5.3% sequentially and up 5.7% year over year. The corporate segment was the dampener in the last quarter, with cloud-related purchases growing 50% from last year and storage growing 27%.

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 9% of Intel’s revenue in the last quarter, growing 6.2% sequentially and declining 14.0% from last year.

The Software and Services segment contributed a little more than 4% of total revenue (similar to the last quarter). Segment revenue was flat sequentially and up 8.7% year over 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 generated 3% of revenue, up 27.0% sequentially and 2.5% from the year-ago quarter.

Revenue by Geography

The Asia/Pacific region remained the largest in the last quarter, with a 57% contribution, with revenues declining 1.0% sequentially and 4.4% from a year ago. The Americas was the second largest region, with a 21% contribution, down 1.1% sequentially and 5.5% year over year.

Europe came in third with a 13% revenue share, representing a sequential increase of 7.4% and decline of 2.1% from the third quarter of 2011. Japan stayed at number four, with an 8% contribution, representing sequential and year-over-year declines of 4.9% and 16.1%, respectively.


The pro forma gross margin for the quarter was 64.3%, down 9 basis points (bps) sequentially and 2 bps year over year, better than the revised guidance of 62% at the mid-point. The sequential decline, although small, is not a good sign, as it is the result of lower capacity utilization and weaker pricing.

Operating expenses of $4.6 billion were flat sequentially. The operating margin was 30.1%, up 13 bps sequentially and down 496 bps year over year. The sequential increase in R&D as a percentage of sales was small. However, it was up very significantly from last year. SG&A actually declined sequentially as a percentage of sales, while increasing slightly from last year.

The operating margins by segment were as follows—PC Client 38.7% (down 68 bps sequentially), Data Center 45.7% (down 387 bps), Other Intel Architecture -20.0% (up 1,027 bps) and Software and Services 0.7% (down 171 bps). Operating margins declined significantly on a year-over-year basis across all segments.

The pro forma net income was $3.1 billion, or 23.1% of sales, compared to $3.0 billion, or 22.0% in the previous quarter and $3.6 billion or 25.5% 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 $3.0 billion, or 58 cents a share compared to $2.8 billion, or 54 cents per share in the previous quarter and $3.5 billion, or 65 cents in the year-ago quarter.

Balance Sheet

Inventories increased 8.5% sequentially and annualized inventory turns went down from 3.9X to 3.6X. Days sales outstanding (DSOs) went from 24 to around 27. The cash, marketable securities and fixed income trading asset balance at quarter-end was $10.5 billion, down $3.2 billion during the quarter due to its equity investment in ASML Holding (ASML - Free Report) .

Intel has $7.1 billion in long-term debt and 56 million in short-term debt, resulting in a net cash balance of $6.5 billion. Cash flow from operations was around $3.3 billion. Important usages of cash in the last quarter included $2.89 billion on capex, $1.12 billion on dividends, $3.22 billion on acquisitions and $1.17 billion on share repurchases.

Fourth Quarter Guidance

Intel guided to revenue of around $13.6 billion (+/-$500 million), up 1.1% sequentially and down 2.1% from the December quarter of 2011 (better than consensus estimates of $13.2 billion). Gross margin on a GAAP basis is expected to be around 57% (+/-2 percentage points), while on a non-GAAP basis, it is expected to be 58% (+/- 2 percentage points).

Total operating expenses are expected to come in at around $4.5 billion. Management also expects to provide for depreciation of around $1.6 billion and intangibles amortization of around $75 million. Other income/expense and equity investments are expected to be $75 million. Applying the guided annual tax rate of 27%, net income comes to around $2.5 billion or 18.6% of revenue, which would be down from both the previous and year-ago quarters.

Intel expects to spend $11.3 billion (+/- $300 million) on capex in 2012.

Our Take

Intel’s top line numbers for the quarter were below-seasonal, but not too bad considering market conditions. 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 quarters. Whether Intel’s success in these regions is able to offset share losses to tablets remains in question.

Tablets, particularly from Apple (AAPL - Free Report) are no longer limited to netbook cannibalization, but have progressed to notebooks, which have for long been taking share from desktops. Therefore, Intel’s core computing business is now under real pressure. The new Ultrabooks from Hewlett Packard Company (HPQ - Free Report) , Dell (DELL - Free Report) , Lenovo and others may help and Wintel devices on mobile platforms may help, but both these are untested, so there will be an initial amount of uncertainty regarding adoption.

The enterprise segment has for long been a savior for Intel, but growth rates have slowed down in this segment as well. Intel should continue to gain from the ongoing move to cloud computing, but in the immediate future, we see soft demand from the corporate sector.

On the cost front, we see lower utilization rates and pricing pressure impacting gross margins. We also believe that R&D investments will remain significant, as Intel strives to maintain its technology lead.

Therefore, despite its market position, technology lead and solid execution, we expect the shares to remain under pressure in the next couple of quarters. Intel shares therefore carry a Zacks Rank of #5, implying a short-term Strong Sell rating. Our long term (3-6 month) rating is also Underperform.