03 September 2007

INTC: Looking ahead to 3Q results

When we evaluated Intel after the second quarter, we found a tug-of-war between the positive forces of Revenue Growth and the negative forces of a lower Gross Margin. The deciding factor turned out to be a temporarily lower tax rate, which enabled profits to beat estimates. Our Four Gauges were unimpressed by tax factors and the effect the surging stock price was having on valuation. As a result, the Overall Gauge score was a mere 20 points.

Intel shares, which were up 24 percent in the second quarter, moved up another 8.5 percent in the July and August despite the market turmoil. Market conditions might even have contributed to the price rise, as well-capitalized high-tech companies were seen as being insulated from the stormy financial and housing industries. There's also little doubt that Intel's stock has been helped by favorable reviews given to Intel's newest products and predictions that Intel will regain market share from steadfast competitor Advanced Micro Devices (AMD).

When looking ahead, our normal approach is to extrapolate from the past and to make some adjustments based on credible current conditions and forecasts. In their second quarter report, Intel was quite specific, with appropriate caveats, about their expectations for the third quarter. Since management knows their business infinitely better than we do, we can rely less on our own extrapolations.

Revenue in the June 2007 quarter broke a succession of quarters in which sales were less than in the year-earlier quarter, although revenue was still down when measured on a year-over-year basis. In July, Intel estimated that revenue in the September quarter would be between $9.0 and $9.6 billion. The midpoint of this range, $9.3 billion, would equate to a 6.4-percent gain over the year-earlier quarter. Year-over-year revenue growth would be a modest 1.8 percent, but at least it would be positive (a welcome change). Professional analysts have also centered their aim just a tad above the midpoint value of the range announced by the company; their revenue predictions average $9.36 billion.

In the face of intense competition, Intel's gross margin has dropped from percentages in the high 50's to the high 40's. Intel signaled that the gross margin in the third quarter would be 52 percent, plus or minus a couple of percentage points. A five percent increase in gross margin from the second quarter (47 percent) to the third quarter seems too optimistic to us. We would be happy to see the figure get back above 50 percent. However, we're going to give the company the benefit of the doubt. Given the revenue estimate above, Intel is telling us to expect a cost of goods sold of 0.48 * 9.3 = $4.5 billion.

After a year or so where R&D and SG&A expenses had each inched up to about 17 percent of revenue, Intel has had some recent success in bringing these costs back down toward historic levels. We're assuming these two expenses will each be about 15 percent of revenue, or $1.4 billion for each expense. Left to our own devices, we would have made provisions for an additional $90 million of operating charges, which is the average value for the last 10 quarters. However, Intel told us to expect $150 million of these expenses, so that's what we will do.

The aforementioned assumptions lead to an estimated Operating Income of $1.9 billion, a hefty 38 percent gain over the year-earlier figure.

If we had used historic averages for gains on investment, net interest, and other income, we would have estimated $230 million for non-operating income. However, the company told us to expect $320 million. This would result in a predicted level of Income before Taxes of $2.2 billion.

Effective income tax rates shouldn't change dramatically from quarter to quarter, but the resolution of a dispute with the IRS led to wide swings as Intel was allowed to reverse some previously accrued taxes. This caused the first and second quarter tax rates to be abnormally low. For the tax rate in the third quarter, we'll use Intel's estimate of a more typical 29 percent.

With all these assumptions, Net income in the third quarter will be $1.6 billion ($0.27/share), up from $1.3 billion in the year-earlier quarter. Analysts are assuming $0.28.

A reminder: the company's estimates for gross margin, special operating changes, and non-operating income are all higher than we would have assumed based on historical data.


Sept 2007
Sept 2006

Op expenses




Op income

Other income


Interest, etc.
Pretax income

Income tax

Net income



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