Weak Desktop Sales Impact Intel’s Q1’15 Earnings; Data Center, IoT & NAND Witness Double Digit Growth

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Leading PC chipmaker Intel (NASDAQ:INTC) reported its Q1 2015 earnings on April 14th. At $12.8 billion, the company’s Q1 2015 revenue was flat year-on-year and in line with its revised guidance, but missed analyst consensus estimate. Last month, Intel lowered the midpoint of its Q1 2015 revenue guidance from $13.7 billion, plus or minus $500 million, to $12.8 billion, plus or minus $300 million on account of weakening PC sales. Intel’s gross margin declined to 60.5% primarily driven by higher platform unit costs on 14 nm products, higher factory start-up costs and lower platform volumes. The company reported diluted earnings per share (EPS) of $0.41.

In addition to lower PC shipments, the challenging macroeconomic conditions and an appreciating U.S. dollar weighed on Intel’s business and important geographic markets. However, the company continued to see double-digit growth in its data center, Internet-of-Things (IoT) and the NAND businesses.

Intel strives to use its manufacturing leadership to transform the company by developing leadership products across a broad range of end-markets. In Q1 2015, the data center, IoT and NAND businesses accounted for approximately 40% of Intel’s total revenue and two-thirds of its overall operating profit. Innovating in its client business, improving mobile profitability, and investing in and growing profitable adjacent markets remain key focus areas for Intel going forward.

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Our current price of $34 for Intel is approximately 10% higher than the the current market price. We are in the process of updating our valuation for the Q1 2015 earnings.

See our complete analysis for Intel

Starting Q1 2015, Intel has changed its reporting structure, combining the PC Client and Mobile and Communications Groups into a single Client Computing Group. In Q1 2015, the newly created Client Computing Group reported revenues of $7.4 billion, an 8% decline year over year, driven by a 16% decline in desktop unit volumes (particularly in small and medium business), partially offset by a 3% increase in notebook volumes. Intel’s notebook volume grew year  over year for the fifth consecutive quarter in Q1 2015. Tablet unit volumes were over 7 million units, up 45% year over year. Operating profit for the division stood at $1.4 billion, down 24% year on year. The decrease was driven primarily by lower desktop revenue and higher unit costs.

PC Sales To Remain Weak In Q2’15, Demand Expected To Pick Up In the Second Half Of The Year

Having stabilized in the second half of the year, the PC market is seeing signs of weakness on account of lower than expected Windows XP refresh in small and medium business and increasingly challenging macroeconomic and currency conditions, particularly in Europe. According to research firm IDC, “Although portions of the market saw genuine improvements in demand during the second half of 2014, part of the 4Q14 volume was inflated by an inventory build-up of “Windows 8.1 + Bing” systems in anticipation of Microsoft scaling back subsidies in early 2015″. ((IDC Lowers PC Outlook for 2015, While the Long-Term Outlook Improves Slightly, IDC Press Release, March 12, 2015))

Intel believes that there was an inventory burn across the worldwide PC supply-chain in the first quarter and expects to see a further reduction in inventory supply-chain levels in the current quarter in anticipation of the Windows 10 launch in summer. The company expects the PC market to remain challenging this year, leading to a mid single-digit decline in PC shipments, which is line with IDC’s estimate of a 3.3% decline in PC shipments in 2015. IDC believes that significant product refreshes from Intel and Microsoft will shift OEM product updates and consumer interest toward the latter part of the year. The firm recently lowered the rate of decline in PC shipments for 2016 and 2017, and now forecast PC unit sales to decline to 291 million by 2019.

Intel is expected to launch its Skylake platform, Broadwell’s successor, in the second half of 2015. Skylake is said to be based on a completely new 14nm core and will feature several architectural enhancements. It also will be supported by a new chipset. The company claims that the percentage mix of the 14 nm processors is ahead of its expectations. New platforms and designs can help spur PC demand in the long-run.

Intel On Track To Improve Mobile Profitability By $800 Million

In mobile devices, Intel expanded its product portfolio with a range of price points and form factors in Q1 2015. This includes the Intel Atom X5 and X7 for mainstream and premium tablet, formerly called, Cherry Trail, which is powering the new Microsoft Surface 3. The company also started  shipping the Atom X3, formerly SoFIA 3G, its first single-chip integrated baseband and apps processor designed for entry in value-smartphones and tablets. Intel claims to be on track to achieve its annual goal of improving mobile profitability by $800 million. In 2014, the mobile division reported operating loss in excess to $4 billion because of the impact of contra revenue charges that result from heavy discounting at the present node.  This is expected to abate in the coming year with a move to the next less costly node, boosting results considerably.

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

At $3.7 billion, Intel’s Data Center Group witnessed a 19% growth on a year-over-year basis in Q1 2015, driven by 15% unit growth. The Data Center Group reported operating profit of $1.7 billion, up 27% year over year, driven by unit growth, a richer mix and lower unit costs. 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 features and performance that are optimized for compute, storage and network workloads, respectively. The Grantley Xeon CPU is seeing strong uptake and is already 50% of Intel’s two-socket volume. Approximately 50% of the 19% growth in Intel’s data center business in Q1 2015 was driven by Grantley.

New products like Grantley and Intel’s increased support of custom versions of the product are helping to drive growth in cloud revenue. 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. [1]

Intel states that many of the secular trends underpinning its growth in the data center also benefit its NAND business, which grew 14% year over year in Q1 2015. Just a few weeks ago, Intel and Micron announced their jointly developed 3D NAND technology. Intel 3D NAND will be available in the second-half of the year, and offers roughly three-times the stated capacity of current technologies.

Q2 2015 Outlook

– Midpoint of the revenue range at $13.2 billion, up 3% sequentially.

– Gross margin to increase to 62%, +/- a couple of points.

2015 Outlook

– Revenue to be approximately flat compared to 2014, down from the prior guidance of mid-single-digit percentage growth.

– Mid-single digit decline in the overall PC market and robust growth in the Data Center, IoT and NAND businesses.

– Gross margins of 61%, down 1 point from the initial guidance as a result of temporarily lower utilization rates and lower platform volumes.

– R&D and MG&A spending of $19.7 billion, down $300 million from the prior outlook.

– Capital expenditure of $8.7 billion ($1.3 billion lower than the initial outlook), at the mid point of the guided range.

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Notes:
  1. Intel talks server demand and mobile profits on CC; AMD and MU higher, Seeking Alpha, October 14, 2014 []