08 September 2010

INTC: Look Ahead to September 2010 Quarterly Results

This post describes our model of Intel Corporation's (NASDAQ: INTC) Income Statement for the quarter that will end on 25 September 2010.

The purpose of the model is to establish a baseline for identifying surprises, positive or negative, in the quarterly results the company will report.  Estimates for each line of the Income Statement are derived from management's guidance, the company's historical financial results, and other publicly available data.

We begin by reviewing background information about Intel and the business environment in which it is currently operating.

Intel is the foremost manufacturer of integrated circuits for computers, servers, hand-held devices, and communication products.  In fiscal 2009, Intel had Net Income of $4.37 billion ($0.77 per share), down 17 percent from $5.29 billion ($0.92 per share) in the previous year.  Revenue slipped 6.5 percent, from $37.6 billion to $35.1 billion.

Intel is included in the Dow Jones Industrial Average and the S&P 500.  It has a market capitalization of about $100 billion.

The company's business is organized around nine product groups.  The two largest groups are PC Client and Data Center.  The PC Client Group sells microprocessors and related products for desktop, notebook, and netbook computers.  It also markets wireless connectivity products.  PC Client was responsible for $26.2 billion of Revenue in 2009, nearly 75 percent of Intel's total Revenue.

The Data Center Group sells microprocessors and related products for servers, workstations, and storage computing equipment.  It also has products for wired network connectivity.  The Data Center Group had Revenue of $6.45 billion in 2009, 18 percent of the company's total sales.

Intel's most direct competitor in the market for microprocessors used in personal computers and servers has long been the scrappy Advanced Micro Devices (NYSE: AMD). 

For devices such as smartphones, where low power consumption is vital, Intel processors are have been eclipsed by those built to the ARM Architecture by companies such as Qualcomm (NASDAQ: QCOM).  ARM chips are inside most smartphone and tablets, including those sold by Apple (NASDAQ: AAPL).

Intel has made two recent acquisitions that could significantly affect the company's future product line and competitive position.  The larger deal, announced on 19 August 2010, is the acquisition of McAfee (NYSE:MFE), a maker of security software, for $7.7 billion.  The company believes that combining McAfee's security expertise with Intel's hardware designs will have long-term benefits. Intel management has stated that security has joined "energy-efficient performance" and "Internet conductivity" as the three "pillars" that support computing today. 

The second transaction, which was publicized on 30 August, is related to the Internet pillar.  Intel agreed to purchase Infineon’s (ETR: IFXA) Wireless Solutions Business for about $1.4 billion in cash.  Intel believes this deal, which includes Infineon's ARM-based offerings, will strengthen its product line in the mobile computing market.
Sales of semiconductors, as reported by the Semiconductor Industry Association, began a precipitous drop in late 2008, when the credit crisis became especially disruptive to the worldwide economy.  Sales bottomed out in the first quarter of 2009 and then recovered at a brisk pace.  Chip sales are still rising, according to data from July, but the rate of growth has slowed.

The SIA reiterated its expectation that "industry growth for 2010 will be in line with our mid-year forecast of 28.4 percent."

Research firm Gartner has trimmed its forecast for the number of personal computers shipped in 2010 from 22 percent more than in 2009 to 19 percent.

In August 2010, Intel settled antitrust charges brought by the Federal Trade Commission by agreeing to "specific behaviors, practices and mechanisms that will govern Intel's sales conduct for the next ten years."  The settlement follows a $1.447 billion fine in May 2009 by the European Commission for antitrust violations and a $1.25 billion payment to AMD to settle an antitrust complaint AMD filed in 2004. 

Intel earned $0.51 per diluted share (a record amount) on a GAAP basis in fiscal 2010's second quarter, which ended on 26 June.  In the same quarter of 2009, Intel reported a $0.07 loss per share, in large part because of the European antitrust fine.  Excluding this special charge, second quarter earnings rose from $0.18 to $0.51 per share.

Readers that want to look back at the June 2010 quarter are referred to our Income Statement and Financial Gauge analyses.

We're now ready to look ahead to Intel's results for the September 2010 quarter.

The starting point is the guidance Intel provided on 13 July 2010 when it announced second-quarter results.

  • Revenue: $11.6 billion, plus or minus $400 million.
  • Gross margin: 67 percent, plus or minus a couple percentage points.
  • R&D plus MG&A spending: Approximately $3.2 billion.
  • Impact of equity investments and interest and other: approximately zero.
  • Depreciation: Approximately $1.1 billion.
  • Tax rate: Approximately 32 percent for the third and fourth quarters, higher than the company’s prior expectation of 31 percent.
However, Intel changed its guidance on 27 August when it announced that Revenue in the third quarter would be less than it first expected because of lower demand for consumer personal computers "in mature markets."  The changes to the guidance are highlighted below:
  • Revenue: $11.0 billion, plus or minus $200 million.
  • Gross margin: 66 percent, plus or minus one percentage point.
  • R&D plus MG&A spending: Approximately $3.2 billion.
  • Impact of equity investments and interest and other: approximately $175 million.
  • Depreciation: Approximately $1.1 billion.

  • Tax rate: Approximately 32 percent for the third and fourth quarters, higher than the company’s prior expectation of 31 percent.
The change to the equity investment gain is due to the partial sale of Intel's investment in SMART Technologies, Inc. (“SMART”)

We often choose a target for Intel's quarterly Revenue that closer to the top than the bottom of the guidance range.  However, for the September 2010 quarter, we will stick with the $11.0 billion midpoint of the revised guidance.  Our caution is a result of the softness seen in the market for personal computers.

This target is 17.2 percent greater than the $9.39 billion of Revenue in the weak, but recovering, September 2009 quarter.

Intel's guidance states that it expects a Gross Margin of 66 percent, plus or minus a percentage point, which would be very good by historical standards.  This percentage would translate into a Cost of Goods Sold (i.e., Cost of Sales) of (1 - 0.66) * $11.0 billion = $3.74 billion.

For R&D and SG&A expenses, the latest guidance is a total expense of $3.2 billion.  It's not unreasonable to split this amount evenly across R&D and SG&A.

We will assume an additional special charge of $10 million for Amortization of acquisition-related intangible assets and other acquisition costs.

With these assumptions, the estimated Operating Income for the quarter is $4.05 billion.  This amount is 57 percent greater than Operating Income of $2.58 billion in the third quarter of 2009.

Intel suggested that equity investments, interest and other non-operating income would amount to $175 million.  Not that it really matters, but we are assuming a $165 million gain on equity investments and a $10 million gain, net, on interest and other income.

For the income tax rate, we have used Intel's estimate of 32 percent.  This leads to a third-quarter Net Income estimate of $2.9 billion (about $0.50 per share).  In the third quarter of 2009, Net Income was $1.86 billion ($0.33 per share).

Note that our model does not include any charges associated with the antitrust settlement or for either recently announced acquisition.

Please click here to see a full-sized, normalized depiction of the projected results next to Intel's quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Full disclosure: Long INTC at time of writing.  No position in any other security mentioned.

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