13 January 2011

INTC: Income Statement Analysis for the December 2010 Quarter

Intel (NASDAQ: INTC) earned a record $0.59 per diluted share on a GAAP basis in the December-ending fourth quarter of fiscal 2010, up 47 percent from $0.40 in the same three months 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 $0.07 more than our $0.52 EPS estimate, with a substantial amount of the difference attributable to legislation passed in late 2009 that reinstated and extended certain tax credits.

The principal sources for this income statement analysis were the earnings announcement, the CFO's commentary [pdf], and the ensuing conference call (transcript available from Seeking Alpha).

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 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 value of about $120 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).  Intel's newest generation of microprocessors, known as Sandy Bridge, includes a CPU and a Graphics Processing Unit.  This configuration could eventually put pressure on AMD and NVIDIA (NASDAQ: NVDA).

In January 2011, the recently hot rivalry between Intel and NVIDIA cooled when the two chipmakers agreed to end their legal disputes and cross-license certain technologies.

For devices where low power consumption is vital, Intel's Atom processor sells well, but lags behind those built to the ARM Architecture by companies such as Qualcomm (NASDAQ: QCOM) in many markets.  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.

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 December quarter rose 8.4 percent, from $10.57 billion last year to $11.46 billion in the last three months.  The reported amount was consistent with Intel's guidance, issued on 12 October, that fourth-quarter revenue would be in the $11.4 billion, plus or minus $400 million, range.

Revenue in the latest quarter exceeded our $11.25 billion target by 1.8 percent.

Growth was driven by the Data Center Group, where robust sales of servers and related items brought in 24.5 percent more revenue than in 2009's fourth quarter.  The larger PC Client Group experienced a far more modest 3.5 percent increase in revenue.  PC Client's revenue was 70 percent of Intel's total revenue in the quarter.

The average selling price (ASP) for Intel's various microprocessors was "up slightly" when compared to the third quarter.  Revenue associated with the low-cost Atom microprocessor was about the same in the third and fourth quarters

Revenue growth was strongest, over 9 percent, in the Asia-Pacific and Americas regions.  Europe, at less than 4 percent, was the region where Intel's revenue growth was weakest.

The Cost of Goods Sold in the quarter was $3.73 billion, or 32.5 percent of revenue.  This ratio translates into a Gross Margin of 67.5 percent, up an impressive 280 basis points from 64.7 percent of last year's fourth quarter.

The latest Gross Margin exceeded the midpoint of the company's guidance of 67 percent, plus or minus two percent.  We had expected the margin to be 66.5 percent. 

Intel said that the Gross Margin improved over the prior-year percentage because of higher CPU and chipset average selling prices.

Intel's fourth-quarter guidance for the combination of Research and Development and Sales, General, and Administrative (the latter is called Marketing, General and Administrative in Intel's financial reports) costs was $3.2 billion.  The guidance was a little low: the actual figure was $3.38 billion, with R&D at $1.67 billion and SG&A at $1.70 billion.

The reported R&D amount was 1.3 percent more than our $1.65 billion estimate.  As a percentage of revenue, R&D edged down 60 basis points from 15.2 percent of revenue to 14.6 percent.

SG&A was 10 percent more than our $1.55 billion estimate.  We assume costs associated with the recent NVIDIA settlement would explain most, if not all, of the unanticipated SG&A expense.  These additional expenses also caused SG&A to increase from 13.9 percent of revenue from 13.9 percent to 14.9 percent.

Other operating expenses amounted to only $7 million.  In 2009's fourth quarter, Intel recorded a $1.25 billion special charge due to an antitrust settlement with Advanced Micro Devices.

Operating Income, calculated by subtracting the various operating expenses discussed above from revenue, was $4.35 billion.  Operating Income was 74 percent greater than last year's $2.5 billion, which was weighed down by the AMD settlement charge.  If the charge is excluded, Operating Income rose 16 percent.

Better-than-expected Revenue and Gross Margin, offset partially by higher-than-expected SG&A costs, resulted in Operating Income exceeding our $4.27 billion target for the fourth quarter by 1.8 percent.

The PC Client group was responsible for most of the quarter's Operating Income.

Intel recorded a $109 million gain on equity investments, much better than the $10 million gain we expected.  Interest and other non-operating income was $31 million, which also exceeded our target.

Earnings before taxes were $4.49 billion, 4.6 percent more than we had estimated.

The quarter's effective income tax rate of 24.5 percent was significantly less burdensome than Intel's guidance to a expect a 31-percent tax rate in the second half of the year.  The rate was lower because of the reinstatement of U.S. R&D tax credits.  The lower tax rate added about $0.05 to earnings per share inthe fourth quarter.

At the bottom line, Net Income was $3.39 billion ($0.59 per share), which compares favorably to the fourth quarter of 2009 even when the earlier period's $1.25 billion AMD settlement charge is excluded.

Our estimate for the latest quarter was $2.96 billion ($0.52 per share).  The lower-than-expected income tax rate was responsible for $0.05 of the $0.07 difference.

In summary, Intel's results were consistent, or slightly better, that the company's guidance for the quarter.  Operating income was slightly better than we expected because revenue and the gross margin were both strong.  Net income also benefited from gains on equity investments and the retroactive reinstatement of the U.S. R&D tax credit.

Full disclosure: Long INTC at time of writing.

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