Intel Beats Again, Outlook Strong

Zacks Investment Research
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Posted: Jul 21, 2011 11:59 PM

Intel Corp (INTC) reported first quarter earnings of 57 cents per share, which beat the Zacks Consensus Estimate by 6 cents. The surprise was driven by higher revenue and a lower tax rate.

Revenue

Intel reported revenue of $13.0 billion, which was within management’s guidance of $12.8 billion (+/-$500 million). Revenue for the quarter increased 1.4% sequentially and 21.1% year over year. Revenue growth was driven by the data center and embedded businesses, as well as McAfee. PC client business was soft as expected, mainly on account of the consumer, partially offset by enterprise refresh and emerging markets. 

Intel’s longer-term strategy is playing out, with data center continuing to show additional opportunity, long-cycle wins in the embedded segment gathering momentum and emerging markets displaying strong growth trends.

Both internal inventories and that at distributors declined.

Revenue by Segment

The PC Client segment generated 64% of revenue in the last quarter, down 3.5% sequentially and up 6.1% year over year. Sandy Bridge was a major driver of growth in the last quarter, with the ramp rate 20% higher than the previous generation product. Overall, enterprise remained the driver of growth, while consumer remained soft in developed markets.

The main positive here was the strength in emerging markets (Turkey and Indonesia witnessing shipment growth of more than 70% from last year, India 17%, Russia 15%, China 14% and Latin America led by Brazil 12%). Low penetration and a growing per capita income are making computing devices more popular in these regions. Intel expects PCs to grow 8-10% this year, with enterprise growth resulting in a richer mix. This will of course be somewhat offset by the strength in emerging markets, where Intel’s consumer business continues to do well.

DataCenter was the second largest group with a 19% revenue share. Segment revenue was down 1.1% sequentially, but up 15.2% year over year. This segment has witnessed very strong double-digit year-over-year growth in each of the last seven quarters and, although the growth rate dropped off in the last quarter, there is every reason to believe that it will grow into one of the most important drivers of Intel’s business. The secular growth drivers here are increasing Internet usage by consumers all over the world, and the ongoing move towards virtualization and cloud computing.

Cloud applications were up 50% in the last quarter. Equipment upgrades and the growing demand for online data storage and networking infrastructure are near-term drivers. For instance, Intel reported that second-quarter microprocessor shipments for storage applications grew 38% year over year, while networking grew 40%.

The Other Intel Architecture segment generated around 11% of Intel’s revenue in the last quarter, growing 20.9% sequentially and 233.1% from last year. The embedded business did extremely well in the last quarter, with over one million units of Atom processors being sold, up 76% from a year ago. Medical imaging was up 50%, Prit imaging up 48%, communications up 40% and industrial applications up 20%.

Management started breaking out Software and Services revenue separately, which went from $65 million in the year-ago quarter to $511 million in the last quarter, mainly due to the addition of McAfee in corporate results. McAfee had a record second quarter and Intel stated that the number of large deal wins doubled from the first quarter. An integrated Intel-McAfee solution is expected to launch later this year.

The Other segment generated 4% of revenue, flat sequentially but up 13.6% from the year-ago quarter.

Overall, total microprocessors and chipsets declined 3.3% and 1.4%, respectively from the first quarter, although they were up 8.0% and 8.8%, respectively from last year.

Revenue by Geography

The Asia/Pacific market was the largest in the last quarter with a 57% contribution. Revenue growth was strong, particularly in China, leading to increases of 1.8% and 19.9%, respectively, from the previous and year-ago quarters. The Americas was the second largest region, with a 22% contribution, representing sequential and year-over-year increases of 7.1% and 33.9%, respectively. Europe came in third with a 12% revenue share, having declined 4.9% sequentially and increased 20.9% from last year. Japan stayed at number four, with a 9% contribution, representing a decline of 4.7% from the previous quarter and an increase of 3.2% from last year.

Margins

The pro forma gross margin for the quarter was 61.7%, down 75 basis points (bps) sequentially and 553 bps year over year, better than guided. This was the fourth straight quarter of sequential decline in gross margin and the third quarter of year-over-year decline. The reason for the decline in the last quarter was largely on account of 22 nm ramp up costs that peaked in the last quarter. Utilization was also lower, as additional 32nm capacity came online. Of course, a stronger mix of enterprise business remained a positive factor, although this will continue to be offset by strength in emerging markets.

Operating expenses of $3.9 billion were up 5.4% from the first quarter. The operating margin was 31.8%, down 187 bps sequentially and 520 bps year over year. The gross margin decline was the main factor hurting the year-over-year comparison, as operating expenses declined. Sequentially, all expenses increased slightly as a percentage of sales.

The operating margins by segment were as follows—PC Client 39.5% (down 163 bps sequentially), Data Center 49.4% (down 17 bps), Software and Services -2.4% and Other -2.7%. Operating margins in the Data Center and PC Client were down 426 bps and 91 bps, respectively, from the year-ago quarter, while Software and Services margin was up 194 bps.

The pro forma net income was $3.1 billion, or 23.9% of sales, compared to $3.3 billion, or 25.6% in the previous quarter and $2.9 billion or 26.9% in the prior-year quarter. One time-items included intangibles amortization expenses on a tax-adjusted basis. Accordingly, the fully diluted GAAP net income was $2.9 billion, or 54 cents per share compared to $3.2 billion, or 56 cents per share in the previous quarter and $2.9 billion, or 51 cents in the year-ago quarter.

Balance Sheet

Inventories declined 1.7% sequentially and annualized inventory turns went from 4.7X to 5.0X. Days sales outstanding (DSOs) went up slightly from 25 to around 24. The cash, marketable securities and fixed income trading asset balance at quarter-end was $11.5 billion, down $431 million during the quarter. Intel has $2.1 billion in long-term debt and 71 million in short-term debt, resulting in a net cash balance of $9.4 billion. Cash flow from operations was around $4.0 billion. Important usages of cash in the last quarter included $2.5 billion on capex and $2 billion on share repurchases.

Third Quarter Guidance

Intel guided revenue of around $14.0 billion (+/-$500 million) in the third quarter, up 7.4% sequentially and 26.1% from the September quarter of 2010. Gross margin on a GAAP basis is expected to be around 64% (+/-2 percentage points), while on a non-GAAP basis, it is expected to be 65% (+/- 2 percentage points). Total operating expenses are expected to come in at around $4.3 billion.

Management also expects to provide for depreciation of around $1.3 billion and intangibles amortization of around $75 million. Other income/expense is expected to net a gain of around $100 million. Applying the guided tax rate of 28%, net income comes to around $3.5 billion or 25.2% of revenue, which would be up sequentially, but down year over year.

Guidance for 2011

For the year, Intel guided to a gross margin of 63% (+/- 2 percentage points), non GAAP gross margin of 64% (+/- 2 percentage points) and operating expenses of $16.2 billion (+/- 200 million). The full year tax rate is expected to be 28% (down from 29%), depreciation $5.2 billion (+/- $100 million) and capex $10.5 billion (+/- $400 million). The significantly higher capex expectation is because Intel intends to bring the fourth high volume facility online to drive 22nm production and meet growing demand.

Our Take

Intel reported strong second quarter results and provided an outlook in line with normal seasonality, which was better than our expectations. Segment performance for the last quarter was not too different from what we had expected. 

We reiterate that the low-power devices currently selling like hot cakes are more dependent than ever on strong server chips. Additionally, data centers are upgrading and Intel’s powerful devices are the obvious choice. With its tick-tock strategy, we believe that Intel is way ahead of the competition in terms of technology. So its supremacy in servers is likely to be sustained.

Additionally, Intel mentioned some encouraging numbers for other data center applications, such as storage, which is very encouraging. We think the move toward cloud computing will particularly benefit the company

The next segment to consider is corporate buyers that are steadily replacing PC fleets. Given Microsoft Corp’s (MSFT) Windows 7 and Intel’s new processor families, the Wintel domination here would change very gradually. Note that Intel’s newer chips are also more energy efficient. We just don’t see any ARM Holdings (ARMH)-based devices taking notable share of core corporate computing spend yet.

The sore point for Intel remains the consumer segment, where it appears to be losing ground to ARM-based devices from Apple Inc. (AAPL). Intel appears to be very much behind in the race, without any compelling product for the fast-growing tablet market. Additionally, the company’s promise of progress in the smartphone segment also appears to be some way off.

While the Ultrabook concept and hardware partnerships are encouraging, there are other factors (mainly features, software) that typically drive growth in a market segment such as this. Intel could play on the security angle, since awareness and threat of securities have both increased and the company has promised to announce Intel-McAfee integrated solutions at its developer conference in September. 

Gross margin expectations were also better than expected, we think because the bulk of the 22nm ramp up charges were taken in the second quarter as well as the new growth opportunities in embedded and a strong software business.

Intel shares carry a Zacks rank of #3, implying a short term Hold recommendation. We also have a long term (3-6 months) rating of Neutral on the shares.


 
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