Intel Corp (INTC) reported first quarter earnings of 59 cents per share that beat the Zacks Consensus Estimate by 13 cents. Shares soared in response to the news. Solid revenue growth across all segments, and contributions from the McAfee and Infineon acquisitions offset the higher level of expenses to deliver the solid numbers.
Revenue
Intel reported revenue of $ 12.8 billion that was better than management’s original guidance range of $ 11.5 billion (+/- $ 400 million). Revenue for the quarter increased 12.1% sequentially and 24.7% year over year, exceeding the Zacks Consensus estimate by 10.8%.
Intel also touched on the progress in the tablet and smartphone segments. The company launched OakTrail for tablets earlier this month and appears optimistic about design wins across multiple operating systems(Windows, Android and MeeGo). Medfield-based design wins for smartphones appear to be some way off, as the company is still in talks with handset manufacturers.
Inventory in the channel remains normal, although internal inventories are being built in support of Sandy Bridge.
Revenue by Segment
The PC Client segment generated 67% of revenue in the last quarter, up 7.4% sequentially and 12.3% year over year. Sandy Bridge was a major driver of this growth, as distributors built inventory and sell-through was also strong. Distributors had worked down inventories in the previous quarter to make room for Sandy Bridge. The design flaw in the Cooger chipset was corrected in record time and Intel stated that the anticipated $ 300 million hit to revenue did not actually occur. Intel is now shipping more microprocessors per chipset, meaning that chipset growth is not indicative of future growth in microprocessors (as in the past). Since Intel remains optimistic that enterprise refreshes will continue, at least through 2011, that part of the business is expected to remain strong. The consumer side of the business is however expected to be driven by emerging markets, particularly China.
Data Centerwas the second largest group with a 19% revenue share. Segment revenue was down 2.3% sequentially, but up 31.7% year over year. This segment has witnessed very strong double-digit year-over-year growth in each of the last six quarters and 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. Equipment upgrades and the growing demand for online data storage and networking infrastructure are near-term drivers.
The Other Intel Architecture segment generated around 9% of Intel’s revenue in the last quarter, growing 131.2% sequentially and 206.4% from last year. The segment performed particularly well in the last quarter, helped by a 33% increase in the embedded business, 17% increase in NAND and a 129% increase in digital home (STBs, smart TVs, etc).
The Other segment generated 2% of revenue, down 38.8% sequentially and 35.0% from the year-ago quarter.
Overall, microprocessors increased 4.4% sequentially and 19.0% from the March 2010 quarter. Chipsets were stronger, growing 7.9% sequentially and 5.8% year over 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 11.5% and 23.3%, respectively from the previous and year-ago quarters. The Americas was the second largest region, with a 21% contribution, representing sequential and year-over-year increases of 18.2% and 42.4%, respectively. Europe came in third with a 13% revenue share, having increased 4.0% sequentially and 17.2% from last year. Japan stayed at number four, with a 9% contribution, representing an increase of 15.0% from the previous quarter and 11.3% from last year.
Margins
The pro forma gross margin for the quarter was 62.4%, down 221 basis points (bps) sequentially and 97 bps year over year.Gross margins were positively impacted by ASPs, as Sandy Bridge ramped very fast. However, the effect was more than offset by 22nm startup costs, impact of acquisitions and higher unit costs. Intel restated the fourth quarter gross profit number, providing for costs related to the flawed chipset.
Operating expenses of $ 3.7 billion were up 9.3% from the fourth quarter. The operating margin was 33.7%, down 148 bps sequentially and up 19 bps year over year. The gross margin decline was the main factor pulling down the operating margin, as other expenses were flat to down both sequentially and year over year.
The operating margins by segment were as follows—PC Client 41.1% (down 398 bps sequentially), Data Center 49.6% (down 695 bps), Other Intel Architecture -3.1% (down 52 bps) and Other -21.7% (down 253 bps). Operating margins in the Data Center, PC Client and Other Intel Architecture segments were up 14 bps, 497 bps and 460 bps, respectively from the year-ago quarter, while the Other segment declined.
The pro forma net income was $ 3.3 billion, or 25.6% of sales, compared to $ 3.2 billion, or 27.8% in the previous quarter and $ 2.4 billion or a 23.6% in the prior-year quarter. One time-items included intangibles amortization expense and acquisition-related expenses on a tax-adjusted basis. Accordingly, the fully diluted GAAP net income was $ 3.2 billion, or 59 cents a share compared to $ 3.2 billion, or 56 cents per share in the previous quarter and $ 2.4 billion, or 43 cents in the year-ago quarter.
Balance Sheet
Inventories increased 7.2% sequentially and annualized inventory turns went from 4.2X to 4.7X. Days sales outstanding (DSOs) went up slightly from 23 to around 25. The cash, marketable securities and fixed income trading asset balance at quarter-end was $ 12.0 billion, down $ 9.9 billion during the quarter. Intel has $ 2.1 billion in long-term debt and 54 million in short-term debt, resulting in a net cash balance of $ 9.8 billion. Cash flow from operations was around $ 4.0 billion. Important usages of cash in the last quarter included $ 994 million on dividends and $ 4.0 billion on share repurchases.
Second Quarter Guidance
Intel guided to revenue of around $ 12.8 billion (+/-$ 500 million) in the second quarter, flat sequentially and up 18.9% from the June quarter of 2010. The gross margin is expected to around 61% (+/-2 percentage points). Total operating expenses are expected to come in at around $ 3.9 billion. Management also expects to provide for depreciation of around $ 1.2 billion and intangibles amortization of around $ 75 million. Other income/expense is expected to net a gain of around $ 50 million. Applying the guided tax rate of 29%, net income comes to $ 2.8 billion, or 22.0% of revenue, which would be down sequentially, but up year over year.
Guidance for 2011
For the year, Intel guided to a gross margin of 63% (+/- a few percentage points) and operating expenses of $ 15.7 billion (+/- 200 million). The full year tax rate is expected to be 29%, depreciation $ 5 billion (+/- $ 100 million) and capex $ 10.2 billion (+/- $ 400 million), up from $ 9 billion (+/- $ 300 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’s strong performance continued in the last quarter, although helped by acquisitions and Sandy Bridge. 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.
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 if at all. We continue to believe that while some corporate spending may be diverted to mobile devices for employees, it is unlikely that core computing preferences will shift. 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 gaining ground in the smartphone segment also appears to be some way off.
A number of factors will play on the company’s gross margin as well. The first is the growing percentage of emerging market revenue that will negatively impact the ASP, startup costs related to 22nm ramp up (to peak in the second quarter), negative mix in the second quarter and unit costs. Although Japan did not have much impact on the top line and Intel stated that it did not affect the backlog, there will be an impact on unit costs, as component shortages in Japan are raising the cost of some components and alternative manufacturing at the newer fab in China is more expensive.
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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