Intel Offers Encouraging Outlook - Analyst Blog

Intel Corp (INTC) reported fourth quarter earnings of 60 cents per share that beat the Zacks Consensus Estimate by 7 cents. Shares appreciated 2.11% in after-market trading.

We went into the numbers with primarily three things in mind – the server, client and emerging markets businesses. We noticed that Intel continues to tout these three areas as the drivers of future growth.

However, fourth quarter numbers indicate that while Intel's server business continues to outperform, growth in the client business was unexciting (to put it mildly) and emerging markets growth does not really reflect Intel's optimism yet.

Revenue

Intel reported revenue of $11.5 billion that was right in the middle of maagement's guidance range of $11.4 billion (+/- $400 million). Revenue for the quarter increased 3.2% sequentially and 8.4% year over year. The fall-off in Intel's growth rates in the second half of the year are partially on account of cannibalization of its netbook business by Apple Inc's (AAPL) iPad and partially on account of the satisfaction of pent-up demand in the first half of the year that made for more difficult comparisons.

Intel expressed optimism regarding Atom, which it said was seeing a large number of design wins in not just netbooks and tablets, but also a variety of other devices. Management stated that Atom was driving momentum in the embedded business, with design wins touching 1,700 in 2010 alone and design engagements reaching 4,900.

What was even more encouraging was Intel's statement that many of the design wins were coming at the expense of ARM Holdings (ARMH) and MIPS Technologies (MIPS). Atom remains a good choice for notebook, netbook and the new-age tablet OEMs, since it can be configured to run Windows, Android, Chrome and MeeGo.

Inventory in the channel remains lean, although internal inventories are being built in support of Sandy Bridge.

Revenue by Segment

From the beginning of fiscal year 2010, Intel reorganized its segments, reporting revenue under the PC Client, Data Center, Other Intel Architecture and Other Groups.

The PC Client segment generated 70% of revenue in the last quarter, down 0.3% sequentially and up 3.5% year over year. The weakness was attributed to deferred purchases and inventory cuts by customers in anticipation of Sandy Bridge. 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.

DataCenter was the second largest group with a 22% revenue share. Segment revenue was up 15.4% sequentially and 24.6% year over year. This segment has witnessed very strong double-digit year-over-year growth in each of the last five 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, the ongoing trend 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 4% of Intel's revenue in the last quarter, with prospects continuing to improve for the embedded business. Although revenues were flattish sequentially, they were up 20.6% from last year.

The Other segment generated 3% of revenue, up 10.7% sequentially and 7.1% from the year-ago quarter.

Overall, microprocessors increased 4.4% sequentially and 12.2% from the December 2009 quarter. Chipsets were softer, declining 2.4% sequentially and 7.2% year over year.

Revenue by Geography

The Asia/Pacific market was the largest in the last quarter with a 56% contribution. However, revenues were sluggish, increasing just 1.7% sequentially. Growth from the year-ago quarter was better at 9.2%. The Americas was the second largest region, with a 20% contribution, representing sequential and year-over-year increases of 2.5% and 10.0%, respectively.

Europe rebounded strongly in the last quarter, jumping 19.3% sequentially and 3.8% from last year to generate 14% of quarterly revenue. Japan continued to disappoint, with a 9% contribution, representing a decline of 5.9% from the third quarter, although it increased 7.3% from last year.

Margins

The pro forma gross margin for the quarter was 67.5%, up 153 basis points (bps) sequentially and 275 bps year over year.Gross margins were positively impacted by mix in the last quarter, since the company sold more enterprise and server products that carry higher ASPs and sales of lower-ASP consumer products weakened.

Operating expenses of $3.4 billion were up 6.1% from the third quarter. The operating margin was 38.0%, up 71 bps sequentially and 234 bps year over year. The stronger gross margin was the main reason for margin expansion in the last quarter, although slightly lower R&D expenses (as a percentage of sales) also helped. These positives were, however, partially offset by higher MG&A expenses as a percentage of sales.

The operating margins by segment were as follows -- PC Client 45.1% (up 241 bps sequentially), Data Center 56.5% (up 759 bps), Other Intel Architecture -2.6% (down 262 bps) and Other -19.1% (down 727 bps). Operating margins in the Data Center and PC Client segments were up 852 bps and 203 bps, respectively, from the year-ago quarter, while the other two segments declined.

The pro forma net income was $3.4 billion, or 29.6% of sales, compared to $3.0 billion, or 26.7% in the previous quarter and $3.5 billion or a 33.6% in the prior-year quarter. There were no one-time items (other than a small amount of intangibles amortization expense, which raised the EPS a penny. Accordingly, the fully diluted GAAP net income was 59 cents a share compared to 52 cents per share in the previous quarter and 40 cents in the year-ago quarter. The lower tax rate helped earnings in the last quarter.

Balance Sheet

Inventories increased 11.7% sequentially and annualized inventory turns went from 4.4X to 3.9X. Days sales outstanding (DSOs) went down slightly from 24 to around 23. The cash, marketable securities and fixed income trading asset balance at quarter-end was $21.9 billion, up $1.1 billion during the quarter.

Intel has $2.1 billion in long-term debt, and another $2.4 billion in long-term liabilities, yielding a net cash balance of $17.5 billion. Cash flow from operations was over $16.7 billion. Important usages of cash in the last quarter included $5.2 billion on capex, $3.5 billion on dividends and $1.5 billion on share repurchases.

First Quarter Guidance

Management guided to revenue of around $11.5 billion (+/-$400 million) in the first quarter, flat sequentially and up 11.7% from the March quarter of 2010. The gross margin is expected to around 64% (+/-2 percentage points). Total operating expenses are expected to come in at around $3.4 billion.

Management also expects to provide for depreciation of around $1.2 billion. Other income/expense is expected to net a gain of around $200 million. Applying the guided tax rate of 29%, net income comes to $2.9 billion, or 25.7% of revenue, which would be down sequentially (somewhat better than normal seasonality), but up year over year.

Guidance for 2011

For the year, Intel guided to a gross margin of 65% (+/- a few percentage points) and operating expenses of $13.9 billion (+/- 200 million), of which R&D is expected to be around $7.3 billion. The full-year tax rate is expected to be 29%, depreciation $5 billion (+/- $100 million) and capex $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.

In Summary

We come away with some good feelings about Intel. As mentioned in our preview, we believe that investors are not paying enough attention to the company's continued success in the server segment. 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 is likely to remain.

Of course, there has been some news flow about Apple's iPads making inroads, but we believe these devices belong in the consumer segment for two reasons- first, they run on ARM chips that would not be able to hold a candle to Intel devices that are built for power. Second, 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-based devices taking notable share of core corporate computing spend.

Third, although the consumer business has been impacted by tablets, Intel will soon join the market with its Atom processors. It is encouraging to see that Atom is also gaining ground in the embedded segment.

The only negative (if it can be called a negative) is that stronger consumer and emerging market revenue will negatively impact the ASP, and thereby, the gross margin. Startup costs related to 22nm will be an added negative. This of course is a temporary phenomenon and margins may be expected to increase again as production ramps.

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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