Intel Q1 Earnings: Mixed Bag with Lots of Promise - Analyst Blog

Intel Corp. INTC reported first quarter earnings including intangibles amortization and restructuring charges of 41 cents, which were ahead of the Zacks Consensus Estimate of 40 cents on revenues that fell just slightly short.

Not exactly the kind of results that would lead to a 3.2% increase in prices post announcement, but we think that investors welcomed Intel’s decision to cut capex and appreciated the continued strength in high-margin data center. Also, the PC market weakness was also likely priced in since Intel’s lowered its revenue outlook last month.

The results also weren’t too bad considering the fact that both the FX and PC market headwinds continue, channel inventory continues to be worked down to historic lows and demand remains generally weak as customers await the upcoming Windows 10.

Going forward, the Client Computing segment will continue to struggle due to PC market headwinds and mobile margins, but strategically and conceptually, the merging of the segments makes sense. As long as Intel continues to offer information on the various parts (tablet versus other, at least in terms of units if not cost) that is. Data Center, IoT and memory should remain strong through the year.

The $800 million of tablet costs that Intel expects to take out will come from the consolidation of the computing and mobile segments and benefit results mostly in the second half. Volumes will also ramp up then, but won't fall through to profits because Intel will be idling some 22nm capacity as a part of the transition to lower nodes and selling some 22nm inventory, which it will build up next quarter. So the underutilization of capacity and higher-cost inventory will offset some of the margin gains from ramping new processes and higher volumes.

The numbers in detail:

Revenue

Intel’s reported revenue was $12.78 billion, in line with the revised guidance range of $12.8 billion (+/-$300 million) and just short of the Zacks Consensus of $12.83 billion. It previously guided to $13.7 billion (+/- $500 million). Quarterly revenue was down 13.2% sequentialy and consistent with the year-ago quarter.

The newly-formed Client Computing Group that now also includes the loss-making mobile business continues to account for the largest chunk of Intel’s business (58%). Segment revenues were down 16.3% sequentially and 8.4% year over year.

Overall unit volumes dropped 18% sequentially but were up 6% year over year, with average selling prices (ASPs) increasing 1% sequentially and declining 13% from last year. PC units dropped 16% from last year, offset by notebook unit growth of 3% and tablet unit growth of 45%.

While the upcoming Windows 10 launch from Microsoft MSFT is leading to temporary weakness, this was excaerbated by further shrinking of the PC market (as reported by market research firms last week), Intel’s changing approach to the market also also contributed to segment weakness.

The company now targets every price point whereas it had earlier stuck to the high end. This allowed it to make the most of Google’s GOOG Chromebooks as well as other lower-end varieties from hardware makers Hewlett-Packard (HPQ), Dell, Lenovo, etc. This trend should continue going forward given Intel’s closer association with Chinese players of late. We also think that Intel’s dependence on Windows will go down over time as the company ships into more Android/Chrome devices.

Data Center, which generated 29% of quarterly revenue, saw units and ASP up 15% and 5%, respectively from last year, with management attributing the strength to cloud build-outs (adoption of its grantley platform as well as increased support for its custom versions) and increased adoption of Intel architecture by telecom companies. Intel’s dominance in the data center enables it to generate very strong prices here. Segment revenue was down 10.1% sequentially and up 19.2% year over year.

The relatively new segment Internet of Things Group, which also includes Intel’s embedded business segment accounted for 4% of revenue declined 9.8% sequentially while growing 10.6% from last year.

The Software & Services Group generated another 4%, down 4.1% sequentially and 3.4% year over year.

The Other segment, while flat sequentially, jumped 12.8% from last year to 5% of total revenue, as Intel’s NAND business improved yet again, benefiting from increased data center adoption. Intel has a value proposition with next-gen products (3D NAND) that it developed jointly with Micron MU and expects to ship in the second half, ahead of others.

Margins

The gross margin for the quarter was 60.5%, down 488 basis points (bps) sequentially and up 73 bps year over year, roughly in line with the guidance of 60% at the mid-point. The strength in the data center business and the resultant mix improvement are positives for the gross margin.

However, lower volumes and higher costs in the PC business were offsetting factors. The contra revenue or subsidy that Intel is giving tablet makers for the higher cost of using Bay Trail remains an offsetting factor, but volumes management has promised an $800 million cost reduction here, which they intend to take in the back half. 

Operating expenses of $5.01 billion were down 2.0% sequentially and 1.6% from last year. The operating margin was 21.3%, down 935 bps sequentially and up 144 bps year over year. R&D costs as a percentage of sales increased substantially (up 312 bps sequentially and 114 bps year over year). MG&A costs also increased 136 bps sequentially, but were down 68 bps from last year.

The operating margins by segment were as follows: Client Computing 19.0% (down 1,300 bps sequentially, 381 bps year over year), Data Center 46.2% (down 915 bps and up 296 bps, respectively), Internet of Things 16.3% (down 1,363 bps and 754 bps, respectively) and Software & Services 0.6% (down 393 bps and 88 bps, respectively). The Other segment continued to make significant losses.

Net income excluding restructuring charges was $2.10 billion, or 16.4% of sales, compared to $3.72 billion, or 25.3% in the previous quarter and $1.95 billion or 15.3% in the comparable prior-year quarter.

Including restructuring charges of a couple of cents a share, the GAAP EPS was 41 cents in the last quarter, down from 74 cents in the previous quarter and up from 38 cents in the year-ago quarter.

Balance Sheet

Inventories were up 3.4% sequentially with annualized inventory turns moving from 4.8X to around 4.6X. Days sales outstanding (DSOs) went back down from 27 to around 23. The cash, marketable securities and fixed income trading asset balance at quarter-end was $14.12 billion, up $64 million during the quarter.

Intel has $12.11 billion in long-term debt and $1.12 billion in short-term debt, resulting in a net cash balance of $885 million. Cash flow from operations was around $4.4 billion. Important usages of cash in the last quarter included $2.03 billion on capex, $1.14 billion on dividends and $750 million on share repurchases and $57 million on acquisitions net of cash.

Guidance

Intel guided to second-quarter revenue of around $13.2 billion (+/-$500 million), up 3.3% sequentially and down 40.6% from the Jun quarter of 2014 (more or less in line with the consensus estimate of $13.42 billion). The gross margin is expected to be around 62% (+/-2 percentage points). R&D and MG&A expenses are expected to come in at around $4.9 billion. Restructuring charges are expected to be around $120 million.

Management also expects to provide for depreciation of around $2.0 billion and intangibles amortization of around $60 million. Other income/expense and equity investments are expected to result in a net gain of $60 million. Applying the guided annual tax rate of 20% and excluding restructuring charges from calculations, net income comes to around $2.63 billion or 19.9% of revenue, which would be up 25.3% sequentially but down 8.7% from the year-ago quarter.

For 2015, Intel expects revenue to be approximately flat (previous expectations were from a mid-single-digit percentage point increase), a gross margin of 61% (+/-2 percentage points) (previous 62% at the mid-point), opex of $19.7 billion (+/-$400 million) (previous $20.0 billion), intangibles amortization of $250 million (previous $255 million), depreciation of $8.0 billion (+/-$100 million) (previous $8.1 million), a tax rate of 25% (previous 27%) and capex of $8.7 billion (+/-$500 million) (previous $10 billion).

Intel shares carry a Zacks Rank #2 (Buy).

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