20 March 2011

INTC: Look Ahead to March 2011 Quarterly Results

This post describes our model of Intel's (NASDAQ: INTC) Income Statement for fiscal 2011's first quarter, which will end on 26 March 2011.

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 Corporation is a prominent manufacturer of integrated circuits for computers, servers, hand-held devices, and communication products.  The company is included in the Dow Jones Industrial Average and the S&P 500.  It currently has a market value of approximately $115 billion on a fully diluted basis.

Fortune lists Intel as the most admired semiconductor company.

In fiscal 2010, Intel's Net Income rose to $11.7 billion from $4.4 billion the previous year.  Revenue increased from $35.1 billion to $43.6 billion.
Intel's business is organized into nine product groups.  The two largest groups, by far, 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 $31.6 billion of Revenue in 2010, 72.4 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 fast-growing Data Center Group had Revenue of $8.7 billion in 2010, 20 percent of the company's total sales.

Intel developed the x86 microprocessor architecture, which is the foundation for the central processing units that run most personal computers and servers.  The scrappy Advanced Micro Devices (NYSE: AMD) has long been Intel's most direct competitor in the PC microprocessor market. 

The newest generation of Intel microprocessors, known as Sandy Bridge, includes a CPU and a Graphics Processing Unit.  This design could, in theory, reduce the need in some PCs for the dedicated graphical chips built by AMD and NVIDIA (NASDAQ: NVDA).

On 31 January 2011, Intel announced that it had discovered and corrected a flaw in a Cougar Point chip used in conjunction with the Sandy Bridge processor in personal computers.  The cost to the company in lost sales and repairs could reach $1 billion.

Intel's dominance in the market for personal computer CPUs does not extend to smartphones and tablet computers.  These mobile-computing devices, including those sold by Apple (NASDAQ: AAPL), are most often powered by chips designed by ARM Holdings (NASDAQ: ARMH) and its many licensees, which include Samsung, NVIDIA, and Qualcomm (NASDAQ: QCOM).  The ARM designs are valued for their low-power consumption.

Microsoft (NASDAQ: MSFT) has decided to make the next version of Windows compatible with ARM processors to facilitate the use of the company's operating system on greater numbers of tablets and smartphones.  This decision should also make ARM chips more suitable for use in personal computers.  NVIDIA has made known it would develop CPUs using ARM designs for a wide variety of other platforms.

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

Perhaps desiring an opportunity to participate in the demand for ARM technology, Intel purchased Infineon’s (ETR: IFXA) Wireless Solutions Business (now Intel Mobile Communications group) for about $1.4 billion in cash.  This deal, announced on 30 August 2010, includes Infineon's ARM-based offerings.

Intel completed its acquisition of McAfee (NYSE:MFE), a maker of security software, on 28 February 2011.  When this $7.7 billion deal was announced last August, it was considered surprising.  Intel believes that combining McAfee's security expertise with Intel's hardware designs will have long-term benefits.  Others are skeptical about the advantages and the price.

When Intel reported its results for the fourth quarter of fiscal 2010, the company announced earnings of $3.388 billion ($0.59 per diluted share) on a GAAP basis.  Although the calendar had turned to January, Intel added a $300+ million charge ($208 million after tax) to the December quarter's Cost of Goods Sold after the chip flaw was discovered.  The extra expense reduced fourth-quarter earnings to $3.180 billion ($0.56 per share).

Earnings still exceeded our $0.52 EPS estimate, with a substantial amount of the difference attributable to legislation passed in late 2009 that reinstated and extended R&D tax credits.

Readers that want to look back at the December 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 March 2011 quarter.

The starting point is the "business outlook" Intel provided on 13 January 2011 when it announced fourth quarter results.  We then checked the updated guidance Intel provided on 31 January 2011 when it identified the chip design flaw.  This guidance was also revised to address the Infineon and McAfee transactions.
Most companies are conservative when providing sales and earning guidance, which gives them an opportunity to exceed Wall Street expectations.  For this reason, we often set our Revenue target for Intel near the top of the guidance range.  However, we are concerned about softness in the PC market and are uncertain about the effect of the disaster in Japan on Intel's sales.  Therefore, for the March 2011 quarter, we will look for Revenue at the midpoint of the updated guidance, $11.7 billion.

This Revenue target is 13.6 percent greater than Intel's $10.3 billion of Revenue in the March 2010 quarter.

Intel's latest guidance states that it expects a Gross Margin of 61 percent, plus or minus approximately two percent.  Although weighed down by costs associated with the chipset flaw, a Gross Margin over 60 percent is still good by historical standards.  A 61 percent Gross Margin, combined with the Revenue target, translates into a Cost of Goods Sold (i.e., Cost of Sales) of (1 - 0.61) * $11.7 billion = $4.56 billion.  This figure probably includes somewhere around $350 million in extra costs associated with the chipset flaw. 

For R&D and SG&A expenses, the latest guidance is a total expense of $3.6 billion.  We've allocated $1.725 billion to R&D and $1.875 billion to SG&A, with the latter absorbing more of the extra expenses.

We will assume an additional special charge of $50 million for Amortization of acquisition-related intangible assets and other acquisition costs.

With these assumptions, the estimated Operating Income for the quarter is $3.5 billion.  This amount is one percent greater than Operating Income of $3.45 billion in the first quarter of 2010.

Intel advised that equity investments, interest and other non-operating income would amount to $200 million.  This is more than in most recent quarters. 

For the income tax rate, we have used Intel's figure of 29 percent for the year.  This leads to a first-quarter Net Income estimate of $2.6 billion (about $0.46 per share).  In the March 2010 quarter, Net Income was $2.4 billion ($0.43 per share).

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, MSFT, and NVDA at time of writing.  No position in any other security mentioned.

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