Intel Corp (INTC) reported third quarter earnings of 66 cents per share that beat the Zacks Consensus Estimate by 5 cents, or 8.2%. Revenue also came in higher, beating the Zacks Consensus by 3.3%. The surprise was driven by very strong revenue growth across geographies and particular strength in the client business. Shares jumped 4.4% in after-market trading.
Revenue
Intel reported revenue of $14.2 billion (including deferred revenue of $59 million) within management’s guidance range of $14.0 billion (+/-$500 million). Revenue for the quarter increased 9.2% sequentially and 28.2% year over year.
The increase from the prior year was helped by acquisitions, which accounted for $1.1 billion of the revenue in the last quarter. The PC client business came in surprisingly strong, with data center up modestly and the software business declining on a sequential basis.
Intel’s longer-term strategy is playing out, with data center contining to show additional opportunity, long-cycle wins in the embedded segment and emerging markets displaying strong growth trends. Additionally, the enterprise strength appears to be continuing in the developed markets of North America and Europe.
Intel stated that channel inventories were being tightly managed, although some buildup for the holiday season is no doubt baked in. Internal inventories declined.
Revenue by Segment
The PC Client segment generated 66% of revenue in the last quarter, up 13.2% sequentially and 16.9% year over year. Overall, enterprise remained the driver of growth in developed markets, while consumer remained drove emerging markets strength. China was up 12%, India 21%, Turkey 14% and Indonesia 23%.
Intel stated that China has now become the largest consumer of PCs, while Brazil has emerged as the third largest market. Low penetration and a growing per capita income are making computing devices more popular in these regions. Intel probably did gain from Advanced Micro Devices (AMD) in the last quarter, but management currently expects that this did not account for more than $50-100 million of revenue.
Data Center was the second largest group with a little less than 18% revenue share. Segment revenue grew 3.1% sequentially and 14.9% year over year. This segment has witnessed very strong double-digit year-over-year growth in each of the last eight quarters and although the growth rate has slowed down this year, there is every reason to believe that it is growing into one of the most important drivers of Intel’s business.
Intel indicated that the company was gaining ground in the storage area. The Sandy Bridge based Romley also started shipping, with management expressing extreme optimism that the device would ramp 20X faster than Nehalem. The secular growth drivers here are increasing Internet usage by consumers all over the world, and the ongoing move towards virtualization and cloud computing.
While management did not provide exact numbers, its longer-term strategy of a platform approach, including all aspects from storage to networking appears to be on track. Intel also closed the Fulcrum Systems acquisition, which is expected to solidify its position in the cloud.
The Other Intel Architecture segment generated around 10% of Intel’s revenue in the last quarter, declining 1.5% sequentially, but jumping 176.4% from last year. Acquisitions pulled up results from the year-ago quarter. Management stated that integrated offerings may be expected soon and that the agreement with Google Inc (GOOG) would shorten the time to market of Intel’s Medfield-based devices running Android.
Software and Services accounted for just 4% of third quarter revenue, but the segment has grown very strongly over the past few quarters, going from $66 million in the year-ago quarter to $541 million in the last quarter, mainly due to the addition of McAfee in corporate results. An integrated Intel-McAfee solution (Deep Defender) launched yesterday.
Overall, total microprocessors and chipsets grew 12.3% and 5.5%, respectively from the second quarter and 18.2% and 9.6%, respectively from last year.
Revenue by Geography
The geographic distribution of Intel’s revenue highlights continued growth in the Asia/Pacific, steady demand in North America and notable strengthening in Europe. Japan also came back strongly, indicating that the impact of the natural disaster is wearing off. Accordingly, the Asia/Pacific market accounted for around 57% of revenue (similar to the second quarter), representing sequential and year-over-year increases of 8.9% and 25.7%, respectively.
Revenue growth was strong, particularly in China and India. The Americas remains the second largest region, with a 21% contribution, representing sequential and year-over-year increases of 3.7% and 34.7%, respectively. Europe came in third with a 13% revenue share, having grown 16.0% sequentially and 36.8% from last year. Japan stayed at number four, with a 9% contribution increasing 15.8% from the previous quarter and 19.4% from last year.
Margins
The pro forma gross margin for the quarter was 64.3%, up 263 basis points (bps) sequentially and down 163 bps year over year, slightly better than guided. The sequential increase in gross margin was the first after four quarters of decline.
The positive impact on the gross margin was due to a combination of factors, including higher volumes, better utilization of 32nm facilities, lower startup costs related to the commencement of 22nm production and lower Cougar Point-related charges. Of course, a stronger mix of enterprise business remained a positive factor, although this will continue to be offset by strength in emerging markets. Pricing was stable sequentially.
Operating expenses of $4.2 billion were up 6.8% from the second quarter. The operating margin was 35.1%, up 328 bps sequentially and down 219 bps year over year. The gross margin decline was the main factor hurting the year-over-year comparison, although slightly higher SG&A expenses (as a percentage of sales) also contributed.
The operating margins by segment were as follows—PC Client 42.6% (up 316 bps sequentially), Data Center 48.6% (down 17 bps), Software and Services had a reported operating margin of 3.3%. Operating margins in the Data Center and PC Client markets were up 4 bps and 34 bps, respectively, from the year-ago quarter, while Software and Services margin was up 1,519 bps.
The pro forma net income was $3.7 billion, or 25.8% of sales, compared to $3.1 billion, or 23.9% in the previous quarter and $3.0 billion or 26.7% in the prior-year quarter. Including one time-items such as intangibles amortization expenses on a tax-adjusted basis, the fully diluted GAAP net income was $3.5 billion, or 65 cents a share compared to $3.0 billion, or 54 cents per share in the previous quarter and $3.0 billion, or 52 cents in the year-ago quarter.
Balance Sheet
Inventories declined 1.8% sequentially and annualized inventory turns went from 5.0X to 5.1X. Days sales outstanding (DSOs) went down slightly from 23 to around 24. The cash, marketable securities and fixed income trading asset balance at quarter-end was $15.2 billion, up $3.7 million during the quarter (mainly because of the debt raised during the quarter.
Intel has $7.1 billion in long-term debt (up $5.0 billion during the quarter) and 66 million in short-term debt, resulting in a net cash balance of $8.1 billion. Cash flow from operations was very strong at around $6.3 billion. Important usages of cash in the last quarter included $1.1 billion on dividends, $2.7 billion on capex and $186 million on share repurchases.
Guidance
Intel guided to revenue of around $14.7 billion (+/-$500 million) in the third quarter, up 3.3% sequentially and 28.3% from the December quarter of 2010. Consensus expectations were at $14.2 billion, Gross margin on a GAAP basis is expected to be around 65% (+/-2 percentage points), while on a non-GAAP basis, it is expected to be 66% (+/- 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 $1.4 billion and intangibles amortization of around $75 million. Other income/expenses are expected to be a net gain of around $30 million. Applying the guided tax rate of 28%, net income comes to around $3.9 billion or 26.6% of revenue, which would be up sequentially, but flattish year over year.
Intel’s full-year capex expectations were $10.5 billion (+/- $300 million). The high capex 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 third quarter results with growth expectations for the next quarter better than the preceding five-year average for the December quarter and better than the Zacks Consensus.
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. Intel currently expects that Microsoft Corp’s (MSFT) Windows 8 will again have a positive impact on its revenue, as Intel’s support system, especially for enterprise customers is likely to be better than any competitors building processors on designs from ARM Holdings (ARMH). Intel’s new processor families, its consistent quality and its ability to fulfill orders are likely to tilt the scales in its favor.
The sore point for Intel remains the consumer segment, where it appears to be losing ground to ARM-based tablets from Apple Inc. (AAPL). Intel appears to be very much behind in the race, with its Medfield processor remaining to be sampled and unlikely to enter the market until the middle of 2012. Of course, its agreement with Google is expected to hasten adoption of Medfield on Android devices.
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 is focused on the security angle, since awareness and threat of securities have both increased and an Intel-McAfee integrated solution has already launched.
Overall, we feel very much more positive about Intel in the next few quarters, although we expect competition to increase in the days ahead.
Intel shares carry a Zacks #3 Rank, 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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