Intel Corp (INTC) reported strong third-quarter earnings that resulted from stronger volumes, good cost control and a lower share count that were however offset by a weaker-than-expected gross margin.
While Intel continues to make progress in the mobile segment, its fortunes are still tied to the PC and data center segments, where market stabilization, increasing form factors, share gains and new products were positives.
Intel’s earnings of 66 cents a share were up 17.9% sequentially and 13.8% year over year and better than the Zacks Consensus Estimate of 65 cents. Shares appreciated 2.1% during the day in anticipation and another 2.6% after-hours in response.
Revenue
Intel’s reported revenue was $14.55 billion, better than the guidance range of $14.4 billion (+/-$500 million) and just over the Zacks Consensus of $14.38 billion. This was up 5.2% sequentialy and 7.9% from the year-ago quarter.
The PC Client Group, which continues to account for the largest chunk of Intel’s business (63%), now also includes gateway and STB products. The adjusted revenues for the segment are up 6.0% sequentially and 8.9% year over year.
Overall unit volume jumped 7% sequentially and 15% year over year, offsetting average selling price (ASP) declines of 2% and 5% from the previous and year-ago quarters, respectively.
The fourth straight quarter of year-over-year unit growth was driven by the strng growth in notebooks and particularly, convertibles. Management said that Intel was gaining share at the low end with Bay Trail. PC refreshes in the enterprise and SMB segments, Windows XP end-of-life and the growing number of form factors that Intel is now catering to also helped.
Data Center, which generated 25% of quarterly revenue, saw units and ASP up 6% and 9%, respectively from last year, with cloud, HPC, networking and enterprise revenue up 34%, 22%, 16% and 11%, respectively. Intel’s dominance in the data center enables it to generate very strong prices here. Uptake of the recently-launched Xeon E5 (Grantley) was strong. Segment revenue was up 5.4% sequentially and 16.4% year over year.
The secular growth drivers are increasing Internet usage by consumers all over the world and the ongoing move towards virtualization and cloud computing.
The new segment Internet of Things Group also includes Intel’s embedded business. The segment accounted for 4% of revenue, down 1.7% sequentially and up 14.2% from last year.
The Software & Services Group generated another 4%, up 1.8% sequentially and 2.4% year over year.
The all-important Mobile & Communications Group generated less than 1% of revenue, with management remaining positive about its 40 million tablet unit target for the year. The optimism stems from the 5 million units shipped in the first quarter that went up to 10 million units in the second and 15 million units in the third. The growing number of tablet design wins on both Android and Windows platforms and key design wins at Samsung were also encouraging.
Segment revenue was down substantially from both the previous and year-ago quarters. Management said that the importance of the LTE technology developed for phones is growing in importance because of its application in tablets. Management estimates that by 2015, baseband attach rates on tablets will double and PC attach rates will be around 15% by then (due to increasing WLAN connectivity). Qualcomm (QCOM) remains the leader here with its 4G LTE solutions having taken the dominant share. But Intel’s strategy of innovation and collaboration is likely to help the company gain share.
The Other segment, which comprises Intel’s NAND flash memory products generated around 4% of revenue, up 11.2% sequentially and 14.3% year over year.
Margins
The gross margin for the quarter was 65.0%, up 51 basis points (bps) sequentially and up 258 bps year over year, lower than the guidance of 66% at the mid-point. Lower costs and higher volumes at 22 nm processes as offset by higher costs at 14nm resulted in the expansion. The contra revenue or subsidy that it is giving to tablet makers for the higher cost of using Bay Trail remains an offsetting factor, but volumes are helping margins as management predicted. The growing list of foundry customers will further help loading, so gross margin improvements may not go away.
Operating expenses of $4.90 billion were down 1.9% sequentially and consistent with last year. The operating margin was 31.3%, up 295 bps sequentially and 534 bps year over year. Most of the cost control was on the MG&A side (down 138 bps sequentially, 101 bps year over year) although R&D also declined (114 bps sequentially, 81 bps year over year). The gross margin improvement also helped.
The operating margins by segment were as follows—PC Client 44.8% (up 641 bps sequentially), Data Center 51.8% (down 3 bps), Internet of Things 28.9% (up 11 bps) and Software & Services 5.2% (up 501 bps). The other segments continued to make significant losses.
Net income was $3.34 billion, or 22.9% of sales, compared to $2.88 billion, or 20.8% in the previous quarter and $2.95 billion or 21.9% in the comparable prior-year quarter.
Including restructuring charges of less than a penny a share, the GAAP EPS was 66 cents in the last quarter, up from 55 cents in the previous quarter and 58 cents in the year-ago quarter.
Balance Sheet
Inventories were up 5.4% sequentially with annualized inventory turns moving from 5.0X to around 4.9X. Days sales outstanding (DSOs) were flattish at around 23. The cash, marketable securities and fixed income trading asset balance at quarter-end was $15.59 billion, down $1.72 billion during the quarter.
Intel has $13.19 billion in long-term debt and $79 million in short-term debt, resulting in a net cash balance of $2.33 billion. Cash flow from operations was around $5.7 billion. Important usages of cash in the last quarter included $2.45 billion on capex, $1.10 billion on dividends and $4.17 billion on share repurchases.
Guidance
Intel guided to third-quarter revenue of around $14.7 billion (+/-$500 million), up 1.0% sequentially and 6.3% from the Dec quarter of 2013 (slightly better than the consensus estimate of $14.5 billion). The gross margin is expected to be around 64% (+/-2 percentage points). Total operating expenses are expected to come in at around $4.9 billion. Restructuring charges are expected to be around $45 million.
Management also expects to provide for depreciation of around $1.9 billion and intangibles amortization of around $65 million. Other income/expense and equity investments are expected to total a net gain of $175 million. Applying the guided annual tax rate of 28%, net income comes to around $3.33 billion or 22.6% of revenue, which would be flattish sequentially but up from the year-ago quarter.
Key Takeaways
The continued stabilization in Intel’s core PC market, its growing position at new form factors (notebooks, 2-in-1s, tablets), new innovative products such as the Grantley platform and progress at the 14nm process are all positive indicators of its future growth.
While Microsoft’s (MSFT) withdrawal of XP support was less of a factor in the last quarter, management remains positive about the estimated 600 million 4-year-old PCs that create a nice opportunity in this core market. Intel is well-positioned to gain from this, whether customers opt for the all-new Win 8, or deflect to chromebooks as Google (GOOGL) would like. Intel is the leader on the Chrome platform.
Intel is also the dominant force at the data center, but what we will be looking at is its execution in the cloud, since this is where ARM designs are likely to get in. Intel’s investment in Cloudera indicates that the company is taking the bull by the horns, but this is an area worth tracking. The recently-launched Ivy Bridge Xeon family is a tailwind and will drive both volumes and prices.
We expect the new Internet Of Things segment to do well going forward, which will support the strength in the data center and stabilization in PCs, together providing the cushion required for a very aggressive drive to take share in mobile.
Intel shares carry a Zacks Rank #3 (Hold).
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