12 October 2010

INTC: Income Statement Analysis for the September 2010 Quarter

Intel (NASDAQ: INTC) earned $0.52 per diluted share on a GAAP basis in fiscal 2010's third quarter, which ended on 25 September.  Earnings per share were 57 percent more than the $0.33 Intel made in the same quarter of 2009.

This post examines Intel's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Reported earnings were $0.02 greater than the $0.50 we had forecast.

The principal sources for the income statement analysis were the earnings announcement and the CFO's commentary [pdf].

In a second article, we will report Intel's scores as measured by the GCFR financial gauges.  The follow-up post will also provide the latest figures for the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Before getting into the details, we will take one step back to introduce the subject of today's analysis.

Intel Corporation is the foremost manufacturer of integrated circuits for computers.  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.

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.

On 19 August 2010, Intel announced it would acquire McAfee (NYSE:MFE), a maker of security software, for $7.7 billion.  Intel management stated that security has joined "energy-efficient performance" and "Internet conductivity" as the three "pillars" that support computing today. 

In a separate transaction, reported on 30 August, 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.  Low-power ARM chips are inside most smartphone and tablets, including those sold by Apple (NASDAQ: AAPL). 

Additional background information about Intel and the business environment in which it is currently operating can be found in the look-ahead.

Please click here to see a normalized depiction of the actual and projected results for the just-concluded quarter, as well as the 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.

Revenue in the September quarter rose 18 percent, from $9.39 billion last year to $11.1 billion (a record quarterly Revenue for Intel) in the last three months.  The reported amount was consistent with Intel's reduced guidance, issued on 27 August, that third-quarter Revenue would be in the $11 billion, plus or minus $200 million, range.

Revenue in the latest quarter exceeded our $11.0 billion target, which was based on the company's latest guidance, by 0.9 percent.

The PC Client and Data Center Groups achieved robust Revenue growth rates of 14 percent and 30 percent, respectively, when compared to 2009's third quarter.  PC Client's Revenue was 73 percent of Intel's total Revenue in the most recent quarter.

Revenue growth was over 20 percent in the Asia-Pacific, Americas, and Japan regions, but it was slightly negative in Europe.

Revenue benefited from corporate customers refreshing their computing assets.  The average selling prices (ASP) for Intel's various microprocessors were "approximately flat" when compared to the second quarter.  The one disappointment might be that revenue associated with the low-cost Atom microprocessor was lower than in the second quarter.

The Cost of Goods Sold in the quarter was $3.78 billion, or 34.1 percent of Revenue.  This ratio translates into a Gross Margin of 65.9 percent.  The Gross Margin was significantly more profitable than the 57.6 percent of last year's third quarter.

Intel said that the Gross Margin improved over the prior-year percentage because of higher CPU and chipset average selling prices, lower CPU and chipset unit costs, no excess capacity charges, and higher sales volume.

The 65.9-percent Gross Margin was near the midpoint of the company's guidance of 66 percent, plus or minus one percent.  We had also expected the margin to be 66 percent in the third quarter. 

Intel's guidance for Research and Development and Sales, General, and Administrative costs in the third quarter was $3.2 billion.  They were close: the actual figure was $3.18 billion.  The R&D expense of $1.68 billion was 4.7 percent more than our $1.6 billion estimate.  Although R&D was 17 percent more than last year, spending edged down 10 basis points from 15.2 percent of Revenue to 15.1 percent.

The SG&A expense of $1.51 billion was 5.9 percent less than our $1.6 billion estimate. The reported expense was 14 percent more than in the third quarter of 2009, and SG&A as a percentage of Revenue decreased 50 basis points, from 14.1 percent to 13.6 percent.

Other operating expenses amounted to only $4 million.  Special items have made the "other" number much larger in some earlier quarters. 

Subtracting the various operating expenses from Revenue yields Operating Income of $4.14 billion, yet-another record for Intel.  Better-than-expected Revenue and lower SG&A costs allowed Operating Income to rise 2.1 percent above our $4.05 billion target for the third quarter.

The PC Client group was responsible for 83 percent of the company's Operating Income.

Intel recorded a $77 million gain on equity investments, whereas we budgeted for a $165 million gain.  Interest and other non-operating income was $38 million, which exceeded the $10 million we expected.

Earnings before taxes were $4.25 billion, less than 1 percent above our estimate.

The quarter's effective income tax rate of 30.5 percent was less burdensome than Intel's guidance to a expect a 32-percent tax rate in the second half of the year.  The company had more of its profits in lower-tax jurisdictions than anticipated.

Net Income was $2.96 billion ($0.52 per share), substantially better than earnings of $1.86 billion ($0.33 per share) in last year's third quarter.  Our estimate for the latest quarter was $2.87 billion ($0.50 per share).  The lower-than-expected income tax rate was responsible for much of the difference.

In summary, Intel's results were consistent, or slightly better, that the company's reduced guidance for the quarter.  Pretax income was just slightly better than we expected, but a low tax rate helped the reported EPS nose above our estimate by $0.02 per share.

Full disclosure: Long INTC at time of writing.

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