Intel cuts 2006 capex, R&D targets after 2Q shortfall

July 20, 2006 – Price cuts and rising inventory dented Intel Corp.’s 2Q06 performance, and the company has responded by cutting its capital spending and R&D targets for the rest of the year.

For its 2Q06, Intel posted revenues of $8.01 billion, at the bottom end of its $8.0-$8.6 billion range projected in April, and down 10% from 1Q06 and 13% from 2Q05. Net income was just $885 million (including about $200 million in share-based compensation), vs. $1.34 billion in the prior quarter, and $2.04 billion a year ago. Gross margins came in at 52.1%, better than a midquarter expectation of 49%. In just the past six months, Intel has seen its sales drop more than 20%, and profits shrink by nearly 65%. Sales are at their lowest levels in two years, and the chipmaker’s profits fell below $1 billion for the first time since 2Q03, to a level not seen since the fall of 2002 — although it’s worth noting that share-based compensation wasn’t included prior to this year. “It’s clearly turning out to be somewhat of a train wreck,” said Eric Ross, analyst at ThinkEquity Partners, quoted by MarketWatch.

Lower-than expected-microprocessor average selling prices (ASPs) were to blame for the poor performance, as customers move to reduce processor inventory levels “in a highly competitive pricing environment,” the chipmaker stated. Only the company’s flash memory units showed growth during the quarter. Sales were down sequentially in every region vs. normal seasonal patterns.

During the conference call Q&A, Intel CEO Paul Otellini noted the inventory buildup has been due to in part to faster-than-expected qualification of 65nm products including Conroe, but cautioned against worries that Intel will find itself in a similar position it was in late 2004 and early 2005, where it had to burn off lots of inventory following excessive buildup. “The last time we built inventory, we jerked down factories, created shortages of chipsets, which affected our microprocessor business,” he said. “We don’t want to overreact to a one-quarter inventory build, particularly since we feel we built all the right stuff.”

Intel said its outlook for the next quarter is improving, projecting a 3%-11% increase in 3Q06 sales to a range of $8.3-$8.9 billion. Gross are still expected to be down a little bit, at 49% plus or minus a couple of points, compared with nearly 60% a year ago. But following the disappointing 2Q results, Intel cut its targets for full-year 2006 — capital spending (including spending on IM Flash, the Intel-Micron flash JV) is now budgeted at $6.0-$6.4 billion, down 6% from a range of $6.4-$6.8 billion projected three months ago. R&D expenditures also were lowered, to approximately $6.0 billion, vs. $6.1 billion estimated in 1Q06, while FY06 gross margins are now expected to come in at 51%, down from 53% expected last quarter. Intel execs wouldn’t give numerical estimates on FY06 revenue projections, which last quarter had been set at $38.8 billion (down 3% Y-Y), but stated that FY06 sales would “follow normal seasonal patterns.”

In the conference call Q&A, Intel execs noted that half the $400 million cutback in capital spending is due to a slowdown in construction spending, while the other half was due to the company finding efficiency improvements in its backend/test processes, with “ways to increase loadings into that equipment.” Capacity and utilization rates haven’t changed, the execs said, but the company does want to keep finding ways to better use the capacity it has — “we hope to find six more ways to save money.”

Intel also noted that it is beginning to see efficiencies out of its NOR flash division, several weeks after it broke out other flash-related manufacturing technology development work to be part of the NOR division. The unit posted a $149 million operating loss in 2Q and $253 million for 1H06, but the execs said those losses were due in part to startup costs and would be reduced, adding that next year NOR revenues might be “meaningful” as a percent of overall sales, vs. the current 6.7% level.

In response to sagging business, earlier this year Intel said it would closely examine all areas of the business, in an effort to maximize efficiencies, identify and eliminate redundancies and underperforming areas, and ultimately save $1 billion in costs. That effort already has resulted in the $600 million sale of its communications and applications processor business to Marvell Technology Group, and just last week the company said it would lay off 1000 managers, about 1% of its workforce.

Meanwhile, the Associated Press reports Intel has shuffled more top management ranks, starting with its mobility group, moving EVP Sean Maloney from co-manager of its mobility group to lead the sales and marketing group, and leaving SVP David Perlmutter to lead the mobility group on his own. Anand Chandrasekher, SVP and joint head of the sales team, will be moved to manage a new unit targeting “ultramobile PCs” (i.e., smaller than laptops but bigger than handheld devices), while counterpart Eric Kim will become GM of Intel’s digital home group, overseeing the Viiv PC platform and other A/V products. Don MacDonald, who formerly led the digital group, will become VP of corporate brands. In addition, two top executives announced their retirement: Bill Siu, GM of channel platforms, and Richard Wirt, co-GM of software solutions.


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