Intel Reports A Strong 2014; Though Weak Gross Margin Outlook Disappoints Investors

As pointed out in our earnings preview article, leading PC chipmaker Intel (NASDAQ:INTC) closed fiscal 2014 on a strong note. At $14.7 billion, Q4 2014 revenue was in line with company as well as analyst expectations. Gross margin (65.4%) in the quarter grew o.4 percentage points sequentially and 3.4 points year to year, driven by higher platform average selling prices for the PC Client Group and Data Center Group microprocessors and chipsets. Owing to the re-enactment of the US R&D tax credit, Intel’s Q4 2014 tax rate stood at 21.4%, much below the 28% guidance the company provided at the start of the quarter. Consequently, Intel reported diluted earnings of $0.74 per share, which beat analysts estimate by a wide margin. For full year 2014, revenue, operating income and earnings per share came in at $55.9 billion (up 6%), $15.3 billion (up 25%) and $2.31 (up 22%).

Despite the strong results, Intel’s stock was down marginally after the 2014 earnings release, on account of the weak gross margin guidance. For Q1 2015, Intel expects gross margin to decline to 60% (+/- a couple of points). The drastic decline is primarily driven by higher platform unit costs on 14 nanometer products, higher factory start-up costs and lower platform volumes. However, Intel expects its gross margin to increase in the second half of the year. As 14-nanometer becomes a larger mix of its portfolio, the company expects cost to come down and catch-up to prior technologies.

Intel claims to be in a very different place today than it was a year back, as the company is participating in a broader range of devices and emerging segments. It intends to remain focused on building on the trend in 2015 as well.

Our price estimate of $34 for Intel is slightly below the current market price. We are in the process of updating our model for the Q1 2015 earnings release.

See our complete analysis for Intel

Stabilizing PC Business

For 2014, Intel’s goal was to stabilize the decline in its PC business.  The company expected revenue to be down by a low single digit percentage and for operating profit to be roughly flat year-over-year. However, the company’s focus on re-inventing the computing experience, and on serving the low-end to the high-end of the market, helped it exceed its PC target for the year. It closed 2014 with a 4% increase in PC revenue and a 25% increase in operating profit. In comparison, the global PC shipments declined marginally in 2014. For Q4 2014, Intel’s PC revenue was up 3% and operating profit up 18% on a year-over-year basis. Intel claims that the PC supply chain appears to be healthy with appropriate inventory levels, as it enters Q1 2015.

At the 2015 Consumer Electronics Show (CES), Intel launched the full lineup of its 14 nm fifth generation core line of Broadwell processors, which is the most energy-efficient Core processor in Intel’s history. Broadwell offers up to a 22% improvement in 3D graphics performance and video conversion runs 50% faster. Intel claims a system with a Broadwell chip can run up to 1.5 hours longer on battery than one powered by the Haswell chip. ^[1] Intel will launch about a dozen new systems, based on Broadwell, in the current quarter. These designs include the thinnest, lightest and most energy efficient notebooks, 2-in-1s, Ultrabooks, Chromebooks and mainly PCs. Apple (NASDAQ:AAPL) has been widely rumored to be waiting for Intel to ship Broadwell in order to begin production of a new, redesigned MacBook Air. ^[2]

Strong Growth In Data Center Driven By The Cloud Build-Up & Data Analytics

At the start of 2014, Intel aimed to capitalize on the growth of the cloud and big data by diversifying customer segments and product leadership. The company expected its efforts to generate data center revenue growth in the low to mid teens with operating profit growing faster than revenue. The company exceeded its guidance on both parameters in 2014, with server revenue and operating profit expanding by 18% and 31% respectively.

Intel’s data center business continues to see robust growth as a result of the build-out of the cloud, data analytics and a strong product portfolio. Towards the end of last year, Intel launched the new Xeon E5 processors (Grantley), which provides leadership, features and performance for compute, storage and network workloads, respectively. The Grantley Xeon CPU is seeing strong uptake and is already 10% of Intel’s DP (i.e., Dual Processor) or two-socket volume. ^[3] Intel’s data center team is customizing its Xeon products for specific customers and workloads. Over the last year volume from custom SKUs has grown at three times the rate of Intel’s off-the-shelf products. Facebook, eBay, Microsoft, and other Web giants have been avid buyers of custom Intel server CPUs. ^[4]

Mobile & Communication Group

Although Intel’s Mobile and Communications Group revenue declined drastically in 2014, the company in fact  gained market share in the segment. Intel had set a target to ship 40 million tablets in 2014 but ended up shipping 46 million tablets, becoming one of the industries largest merchant silicon providers in tablets. The ramp up in its tablet volumes is being offset by an increase in contra revenue dollars — hence the decline in revenues. With contra revenue, Intel is paying tablet makers to cover the additional bill of materials (BOM) costs of switching from ARM-based processors. The goal was to establish Intel architecture in the marketplace and scale the supply chain and the chart developers.

For 2015, Intel’s key goal is to improve its profitability in the segment as the company believes that it has done a good job establishing itself as one of the top producers of silicon in tablets. It qualified the first SoC in its SoFIA lineup last quarter.  (SoFIA is a low-cost integrated application processor and baseband chip.) As the SoC ramps, it will progressively reduce the building material cost that have adversely affected its gross margins in the mobile business. Intel believes that it will no longer have to pay the subsidies for the SoFIA products. It has got several design wins for SOFIA 3G. The LTE version will be out in the the first half of next year.

Intel targets to drive $800 million out of its mobile business in 2015.

Increasing Focus To Leverage Growth In IoT

Intel’s Internet-of-Things (IoT) Group grew 19% through 2014, passing the $2 billion mark for the first time. Intel is keen to become an early entrant in this segment, not wanting to repeat the mistake it made in being late to realize the mobile revolution. Gartner estimates the market will grow almost 30 times, from an installed base of 0.9 billion in 2009 to 26 billion by 2020. It will result in $1.9 trillion in global economic value-add through sales into diverse end markets. ^[5]

In August 2014, Intel signed a definitivee agreement to acquire LSI’s Axxia networking business and related assets from Singapore-based Avago, a vendor of analog semiconductor devices, for $650 million in an all-cash deal. The deal can aid Intel’s foray into the IoT market and other emerging technologies. Additionally, Intel has been investing in a wide range of start-ups in the wearables space, and has also tied up with some fashion houses to market wearable gear as a fashion accessory rather than just a device that monitors your health (and more).

Q1 2015 Outlook

– Midpoint of the revenue range at $13.7 billion, +/- $500 million.

– Midpoint of the gross margin range at 60%, +/- a couple of points.

2015 Outlook

– Revenue to grow in the mid single digits.

– Midpoint of the gross margin range at 62%, +/- a couple of points.

– R&D and MG&A spending of $20 billion, +/- $400 million.

– Capital spending of $10 billion, +/- $500 million.

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1. Intel touts tardy Broadwell Core CPUs for laptops, PCs, The Register, January 5, 2015 [↩]
2. Intel officially unveils full Broadwell-based Intel Core CPU lineup, appleinsider, January 5, 2015 [↩]
3. Intel’s (INTC) CEO Brian Krzanish on Q3 2014 Results – Earnings Call Transcript, Seeking Alpha, October 14, 2014 [↩]
4. Intel talks server demand and mobile profits on CC; AMD and MU higher, Seeking Alpha, October 14, 2014 [↩]
5. Gartner Says the Internet of Things Installed Base Will Grow to 26 Billion Units By 2020, Gartner Newsroom, December 12, 2013 [↩]