Intel Posts Lukewarm Q1 - Analyst Blog

Intel Corp INTC reported first-quarter earnings of 38 cents per share, just over the Zacks Consensus Estimate of 37 cents but somewhat lower than guidance indicated. The better than-expected gross margin drove the surprise.

Intel has reported roughly in line with expectations in the last four quarters, so the last quarter was not too different. Guidance was in line with expectations.

Shares were up less than 1% during the day, but appreciated another 1.5% after the company reported.

Revenue

Intel's reported revenue was $12.76 billion, within the guidance range of 12.8 billion (+/-$500 million) and in line with the Zacks Consensus of $12.8 billion. This was down 7.7% sequentially and up 1.5% from the year-ago quarter.

The company restructured reporting segments, providing historical numbers for comparison-

The PC Client Group, which continues to account for the largest chunk of Intel's business (62%), now also includes gateway and STB products. The adjusted revenues for the segment are down 7.8% sequentially and 1.4% year over year. The decline from the year-ago quarter is significantly lower than last year, indicating stabilization in the PC market in line with Gartner and IDC observations.

Overall unit volume was up 1%, from the previous and year-ago quarters, with the average selling price ASP down 3%. The volume increase was driven by notebooks as desktops were flattish. This is very encouraging since mobile computing revenues have been flat to down in the last seven quarters.

Intel appears to be doing well in the convertible category, where revenues increased 20% according to management. The desktop ASP growth of 4% partially offset the 8% decline in notebook ASP. Desktops continue to gain from improving mix.

Data Center, which generated 24% of quarterly revenue, saw units and ASP up 3% and 8%, respectively from last year, with cloud, networking and storage each up more than 20%. Intel's dominance in the data center enables it to generate very strong prices here. Last quarter, Intel made a sizeable investment in Cloudera to pick up a major share of the company that develops Hadoop code.

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 10.4% sequentially but up 32.1% from last year. Management attributed the increase to in-vehicle infotainment and retail, as well as a doubling in IoT atom revenue.

The Software & Services Group generated another 4%, down 6.4% sequentially and up 6.3% year over year. McAfee saw an 8% increase in consumer sales with record bookings.

The all-important Mobile & Communications Group generated a mere 1% of revenue, but management stated that Intel was on track to achieve the 40 million unit target for 2014. The optimism stems from the 5 million chips shipped in the last quarter and 90 tablet design wins on Android and Windows platforms to date.

Segment revenue was down 52.1% sequentially and 61.4% year over year, which is mostly because the baseband modem business it inherited from Infineon is increasingly being replaced by 4G LTE solutions, where Qualcomm QCOM has taken the dominant share. Intel's own integrated solutions are yet to make headway.

The Other segment, which comprises Intel's NAND flash memory products, generated around 4% of revenue, down 8.1% sequentially and up 8.9% year over year.

Margins

The gross margin for the quarter was 59.7%, down 221 basis points (bps) sequentially and up 358 bps year over year, better than the guidance of 59% at the mid-point. The 14nm startup costs appear to be much lower than expected, particularly if you take out the extra $100 charged for litigation. Another factor impacting margins is the contra revenue or subsidy that it is giving to tablet makers for the higher cost of using Bay Trail.  

Operating expenses of $5.09 billion were up 1.4% sequentially and 11.9% from last year. The operating margin was 19.8%, down 581 bps sequentially and 18 bps year over year. There was a very significant 780 bp increase in R&D as a percentage of sales, with along with the 221 bp increase in COGS more than offset the 447 bp decline in MG&A.

The operating margins by segment were as follows—PC Client 35.3% (down 387 bps sequentially), Data Center 42.7% (down 648 bps) and Internet of Things 25.5% (down 1,314 bps). The other segments continued to make significant losses.

Net income was $1.95 billion, or 15.3% of sales, compared to $2.63 billion, or 19.0% in the previous quarter and $2.05 billion or 16.3% in the comparable prior-year quarter. This resulted in earnings of 38 cents in the last quarter, down from 51 cents in the previous quarter and 40 cents in the year-ago quarter.

Balance Sheet

Inventories dropped 9.8% sequentially with annualized inventory turns moving from 5.0X to 5.5X. Days sales outstanding (DSOs) were up by a day to 25. The cash, marketable securities and fixed income trading asset balance at quarter-end was $19.05 billion, down $1.04 billion during the quarter.

Intel has $13.17 billion in long-term debt and $36 million in short-term debt, resulting in a net cash balance of $5.84 billion. Cash flow from operations was around $3.5 billion. Important usages of cash in the last quarter included $2.69 billion on capex, $1.12 billion on dividends and $545 million on share repurchases.

Guidance

Intel guided to second-quarter revenue of around $13.0 billion (+/-$500 million), up 1.8% sequentially and 1.5% from the Jun quarter of 2013 (in line with the consensus estimate of $13.0 billion). The gross margin is expected to be around 63% (+/-2 percentage points). Total operating expenses are expected to come in at around $4.8 billion. Restructuring and asset impairment charges are expected to be around $100 million.

Management also expects to provide for depreciation of around $1.9 billion and intangibles amortization of around $75 million. Other income/expense and equity investments are expected to be $75 million. Applying the guided annual tax rate of 27%, net income comes to around $2.40 billion or 18.5% of revenue, which would be up both sequentially and year over year.

For 2014, management expects revenue that is consistent with the 2013 level, a gross margin of 61% (+/- a few percentage points), operating expenses of $18.9 billion (+/- $200 million), intangibles amortization of $300 million, depreciation of $7.4 billion, a tax rate of 27% and capex of $11.0 billion (+/- $500 million). All except opex expectations were the reiterated. Opex is up from $18.6 billion.

Key Takeaways

Intel's numbers confirmed the stabilization in the PC market (this was the second straight quarter that units didn't decline from the year-ago quarter). Tailwind for the PC business will be Microsoft's MSFT withdrawal of XP support, forcing upgrades. 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. Management stated that Intel was the leader on the Chrome platform.

Intel is 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.

Mobile execution will be key this year but we don't expect a lot of profit here, mainly because Intel seems to be a little late with its 14nm process, which of course means it will take longer to take down costs and even longer before a subsidy is no longer required. Management appears optimistic about volumes and we expect a heavier second half.

We expect the new Internet Of Things segment to do well this year, which will support the strength in the data center and stabilization in PC, together providing the cushion required for a very aggressive drive to take share in mobile.

Capex expectations for the year were retained, indicating that Intel expects strong volumes as we move through the year. 2014 could therefore be a big year for Intel, when it starts growing revenues again.

Intel shares carry a Zacks Rank #3 (Hold).