Intel Cranks Up Earnings in Q2, Boosted By Flash

by Timothy Prickett Morgan

Chip juggernaut Intel yesterday reported its second quarter financial results, which were nearly a carbon copy of the first quarter of the year with $8.05 billion in sales and $1.8 billion in net income. Sales were up 18% compared to the second quarter of 2003, while net income nearly doubled. This is all good news, and in fact, this was the best first half Intel has had since 1997. But, Santa Clara, we have a problem.

Ironically, the ramp up of Intel's 300 millimeter wafer and 90 nanometer processes is yielding better than expected, and this is causing Intel some problems going forward. Paul Otellini, Intel's president and chief operating officer, said that late in the quarter, Intel decided to back off on wafer starts because chip inventories are starting to build up.

This is going to have an effect on the cost of making a given processor, since the cost of labor and chip plants have to be spread over a smaller number of chips. Intel has just announced that Fab 24 in Ireland will be its third plant making chips on 300 mm wafers with 90 nanometer technology. The game now for Intel, which was the first vendor to ship products using 90 nanometer technologies, is to get as many products as possible--microprocessors, chipsets, flash, and other components--into production using these facilities.

"We have to find a way to use this 300 mm capacity," Andy Bryant, Intel's chief financial officer, told Wall Street analysts during a conference call, "and we will."

Intel's stated goal is to have 90 percent of its processors on the 300 mm/90 nanometer processes by the end of the year, and given the higher yields Intel is getting compared to expectations, it will apparently have excess capacity left over. This all assumes that demand in the IT business continues to grow modestly. Intel has to also contend with pricing pressures from competition in the microprocessor business and a shift to lower-margin chipset, motherboard, and flash products that Intel is aggressively chasing to gain revenue market share and boost its absolute profits in a quarter.

In the second quarter, Intel sold $5.75 billion in desktop, mobile, and server processors, up 40 percent compared to the second quarter of 2003, but down a bit from the first quarter of 2004 when Intel sold just under $6 billion in chips. The company sold just over $1 billion in motherboards in Q2, a level of sales that is consistent with past quarters, and sold $587 million in flash memory (used in cell phones, PDAs, cameras, and other devices), up 43 percent from last year's second quarter. Intel brought in another $688 million from other areas, including venture capital investments.

Looking forward into the third quarter, Bryant said that Intel was expecting that sales would be in the range of $8.6 billion to $9.2 billion, which is 11 percent growth over Q3 2003 at the midpoint of those high and low sales estimates. He said historically over the past five years, the third quarter has grown anywhere from 3 percent to 15 percent, and the average was 7 percent. Bryant said that Intel expected that microprocessor sales should accelerate a little bit more than normal, and the company would continue to push sales of chipsets, motherboards, and flash to boost sales.

But Wall Street will be concerned about profits. For the second half of the year, Bryant says that Intel expects steady growth for microprocessors and higher growth for flash, and other products. He said that Intel was shooting for double-digit revenue growth for the full year and "higher levels of profit." He would not be specific about profit targets with so many factors up in the air--and understandably so.

But, to keep the analysts on Wall Street from going out on ledges, Otellini said that he expected the third quarter of this year to have "normal seasonality," and Bryant added that "everything out there is behaving normal to slightly positive." As for the recent spate of shortfalls by some major software players, Otellini said that Intel was watching and of course was somewhat concerned. "Inside our business," he said, "we are seeing no evidence of a problem."