The decline in sales of computer chips, which was painfully evident in late 2008, continued into 2009. Intel's Revenue in the first quarter was 26 percent less than in the March 2008 period. The resulting inefficiencies ("factory underutilization") brought the Gross Margin down to 45.3 percent, which was a shade lower than the September 2001 quarter and the worst since 1994. Net Income dropped 56 percent, and the fall would have been steeper if there had not been significant tax benefits (the income tax rate was zero). In the last four quarters, Cash Flow from Operations tumbled 31.6 percent, and Free Cash Flow dived from 30 percent of Invested Capital to 11 percent.
We have now modeled Intel's Income Statement for the quarter that will end on 27 June 2009. The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data that the company will announce on 17 July. GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.
First, we present some background information.
Intel Corporation is the foremost manufacturer of integrated circuits for computers, servers, hand-held devices, and communication products.
The company's most direct competitor in the market for general-purpose microprocessors has long been the scrappy, smaller, and now financially stressed, Advanced Micro Devices (NYSE: AMD). However, NVIDIA (NASDAQ: NVDA) has also emerged as a competitor as new uses are being found for high-power Graphics Processing Units. NVIDIA is fostering this view, and has even discussed making its own general-purpose x86 microprocessor.
With Larrabee, expected in 2010, Intel will have its own potent entry in the competition for general-purpose GPUs.
With financially strapped consumers and businesses buying fewer computers, the semiconductor industry has been one of the casualties of the ailing worldwide economy. Hewlett Packard (NYSE: HPQ) and Dell (NASDAQ: DELL) are Intel's two largest customers. According to an IDC report quoted in eWeek.com,
"Worldwide PC shipments—including desktop and portable PCs, but excluding x86 servers—were down 7.1 percent" in the first quarter of 2009, relative to the same period of the previous year.
The Semiconductor Industry Association reported that sales declined year-over-year in 2008 for the first time since 2001. In the first quarter of 2009, semiconductor sales were 29.9 percent less than in year-earlier period.
Many of the popular, low-priced netbook PCs are built around an Intel Atom CPU. Although the Atom is helping to lift Intel's share of the microprocessor market, this device is less profitable for Intel than the more capable microprocessors in its product line.
Intel has faced antitrust charges for many years and in many jurisdictions. In May of this year, the European Union fined Intel more than 1 billion Euros for anti-competitive actions.
When Intel announced its first quarter results, it provided the following quantitative guidance for the second quarter of 2009:
- Due to continued economic uncertainty and limited visibility, Intel is not providing a revenue outlook at this time. For internal purposes, the company is currently planning for revenue approximately flat to the first quarter.
- Gross margin percentage: Expected to be in the mid-40s.
- Spending (R&D plus MG&A): Approximately flat to the first quarter.
- Restructuring and asset impairment charges: Approximately $115 million.
- Net loss from equity investments and interest and other: Approximately $150 million.
- Depreciation: Approximately $1.2 billion.
Intel had good reasons to be cautious about the Revenue outlook, but we currently believe it is more likely than not (i.e., we guess) Revenue will be somewhat higher in the second quarter than in the first. For one thing, as mentioned above, worldwide semiconductor sales were extraordinarily weak in the first three months of 2009. However, sales in March were 3.3 percent more than in February. While a one-month improvement is hardly a sure sign of recovery, Paul Otellini, Intel President and CEO, stated:
“We believe PC sales bottomed out during the first quarter and that the industry is returning to normal seasonal patterns."
The latest reports of Dell, HP, and NVIDIA, which have quarters that extend into April, tell a mixed story.
Given this sketchy information, we will set a 5-percent target for Revenue growth over the first quarter's $7.145 billion. Our $7.5 billion estimate might seem optimistic, but it is 21 percent less than Revenue in the second quarter of 2008.
The guidance from Intel indicates they expect a Gross Margin percentage in "the mid-40s," which is a relative low figure for Intel. Revenue uncertainty also makes it difficult to project the Gross Margin because diminished sales lead to production inefficiencies. We assume the Gross Margin will be one point higher than the first-quarter's very weak 45.3 percent. Given the Revenue estimate above, our target for CGS is (1 - 0.463) * $7.5 billion = $4.0 billion.
R&D and SG&A costs in the first quarter totaled $2.5 billion, and Intel's guidance implies the amount will be similar in the second quarter. Lacking any better information, we will assume the second-quarter values for these two expense categories will match the first quarter values.
We will also accept without change the company's $115 million estimate for restructuring and asset impairments charges.
With these assumptions, the estimated Operating Income for the quarter is $842 million. This amount would be down 63 percent from the June 2008 quarter. However, the estimate is 30 percent greater than Operating Income in the first quarter of 2009.
Intel's guidance for equity investments, interest and other non-operating income is a net loss of $150 million. To fit this within our presentation, we partition the loss as a $250 million loss on equity investments and a $100 million gain on interest and other income.
The non-operating figures would drop Pre-tax Income to $692 million. For the income tax rate, we have used Intel's estimate of 24 percent.
Therefore, we end up with a second-quarter Net Income estimate of $526 million ($0.09 per share). In the second quarter of 2008, Net Income was $1.6 billion ($0.28 per share).
Please note that the Income Statement presentation format we use for all analyses may differ in material respects from company-used formats and terminology. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
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Full disclosure: Long INTC at time of writing.