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Intel's Q1 A Non-Event - Analyst Blog

By: Zacks.com
Posted: 4/17/2013 10:59:00 AM
Referenced Stocks: AMD;ASP;HPQ;INTC;MSFT

Intel Corp ( INTC ) reported first-quarter earnings of 40 cents per share, missing the Zacks Consensus Estimate by a couple of cents.

Although this was far worse than the 9.1% average positive surprise it reported in the preceding four quarters, it was good considering sentiments post IDC's PC shipment report. Shares were buoyant throughout the day and went up marginally in after-hours trading as well.

The negative surprise was on the gross margin line, which should improve in following quarters.

Revenue

Intel's reported revenue was $12.58 billion, within the guidance range of 12.7 billion (+/-$500 million). This was down 6.7% sequentially and 2.5% 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. Microsoft's ( MSFT ) much-anticipated Windows 8 has not helped sales in the traditional computing segment.

Revenue by Segment

The PC Client segment generated 64% of revenue in the last quarter, down both sequentially and year over year due to the PC market concerns outlined above. The declines in notebook and desktop platforms were about even for Intel, although pricing continues to improve.

Overall volumes for Intel were down 6% and 7%, respectively from the previous and year-ago quarters. The average selling price (ASP) improved 1% from both periods. Intel doesn't expect reduction in prices, channel inventories appear lean and new products are poised to gain momentum.

Therefore, 2013 should shape up better than 2012. Low penetration and a growing per capita income are increasing the popularity of computing devices in emerging markets, especially the BRIC countries, which remains a positive for Intel.

Data Center was the second largest group with a 21% revenue share. Segment revenue was down 6.9% sequentially but up 5.4% year over year. Intel continues to gain from the growing importance of cloud computing and its own new products. As a result, both volumes and ASP were up from the year-ago quarter. Economic factors were responsible for the sequential weakness, although Intel remains well positioned in both storage and networking.

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 8% of Intel's revenue in the last quarter, declining 3.9% sequentially and 9.0% 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, down 7.5% sequentially and up 3.0% 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 10.3% sequentially but up 22.8% from the year-ago quarter.

Intel did not provide additional color on its revenue distribution by geography.

Margins

The gross margin for the quarter was 56.2%, down 183 basis points (bps) sequentially and 787 bps year over year, well below the guidance of 58% at the mid-point. This was mainly because of accelerated Haswell inventory write-down (products that were not qualified), which Intel will recover through the year as products are qualified and sold. Continued declines in older-generation capacity utilization and lower volumes in the PC business also impacted the gross margin for the quarter.

Operating expenses of $4.55 billion were down 2.5% sequentially. The operating margin was 20.0%, down 339 bps sequentially and 950 bps year over year. All expenses increased as a percentage of sales but the gross margin weakness was the main reason for the operating margin decline.

The operating margins by segment were as follows-PC Client 31.4% (down 146 bps sequentially), Data Center 41.7% (down 613 bps), Other Intel Architecture -62.5% (down 1,385 bps) and Software and Services -4.1% (up 158 bps). Operating margins declined significantly on a year-over-year basis across all major segments.

Net income was $2.05 billion, or 16.3% of sales, compared to $2.40 billion, or 17.8% in the previous quarter and $2.66 billion or 20.6% 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 40 cents a share compared to 48 cents per share in the previous quarter and 53 cents in the year-ago quarter.

Balance Sheet

Inventories dropped 7.9% sequentially and annualized inventory turns moving from 4.8X to 5.1X. Days sales outstanding (DSOs) were flat at around 26. The cash, marketable securities and fixed income trading asset balance at quarter-end was $17.07 billion, down $1.09 billion during the quarter.

Intel has $13.14 billion in long-term debt and $88 million in short-term debt, resulting in a net cash balance of $3.84 billion. Cash flow from operations was around $4 billion. Important usages of cash in the last quarter included $2.17 billion on capex, $1.11 billion on dividends and $25 million on share repurchases.

Guidance

Intel guided to second-quarter revenue of around $12.9 billion (+/-$500 million), up 2.5% sequentially and down 4.5% from the Jun quarter of 2012 (in line with consensus estimate of $12.9 billion). The gross margin is expected to be around 58% (+/-2 percentage points). Total operating expenses are expected to come in at around $4.7 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 not expected to have an impact on results. Applying the guided annual tax rate of 27%, net income comes to around $1.98 billion or 15.3% of revenue, which would be down from both the previous and year-ago quarters.

Intel currently expects the 2013 gross margin to be around 60% (+/- 2%), opex $18.9 billion (+/-$200 million), intangibles amortization $300 million, depreciation $6.8 billion (+/-$100 million) and a tax rate of 27%.The company expects to spend $12.0 billion (+/- $500 million) on capex. All except the tax rate and capex expectations for the year were maintained. The tax rate for the year is up from 25%, while capex is down by a billion dollars due to successful redirection of trailing end capacity toward leading edge purposes.

Our Take

Intel's top line numbers for the quarter were slightly better than normal seasonality and ASP continue to be supported by new products, as promised. There was some gross margin pressure in the last quarter, which should alleviate in following quarters.  Product ramp-up costs will contain gross margin expansion this year although utilization should improve.

At the same time, product development spending is likely to remain high, as Intel tries to maintain its process leadership while preparing itself for the emerging mobile segment. We continue to believe that the most important thing to look for in 2013 is volume. If Intel's new products are able to generate much stronger volumes this year, we may see improved profitability.

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 ). 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. Developed markets remain in secular decline and developing markets could soon follow suit.  

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 ) 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. But 2013 should see some changes as Haswell ships, possibly bringing Intel's first major success in the mobile segment.

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

The enterprise segment has for long been a savior for Intel, but growth rates have slowed down in this segment as well. Intel should however continue to gain from the ongoing move to cloud computing.

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



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