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Intel Faces Falling Demand

Alexei Oreskovic

Intel(INTC Quote) met analysts' dampened first-quarter expectations Wednesday but offered a weak outlook for 2006.

The company said that overall sales in 2006 would be down roughly 3% from last year's $38.8 billion in revenue. Earlier this year, Intel had forecast that 2006 sales would increase by 6% to 9%, year over year.

The company cut more than $1 billion from its spending plan for the year and said it was undertaking its most thorough review of internal operations since the mid-1980s.

While Intel, the world's No.1 chipmaker, claimed it managed to stem its market-share loss to rival Advanced Micro Devices(AMD Quote) in the first quarter, it said that slowing PC demand and rising inventory levels are pressuring sales in the short term.

"We believe PC growth rates have moderated over the course of the past few quarters, leading to slower chip-level inventory reductions at our customers and affecting our revenue in the first half of the year," CEO Paul Otellini said in a statement accompanying the results.

The company reported that its customers were holding several million excess chips in inventory, equal to about one to two weeks of consumption.

But Intel's management expressed confidence that things would change in the second half of the year, when the company introduces a trio of new processors that feature a new microarchitecture.

Speaking to analysts in a conference call following the release of the results, Otellini described the upcoming "Conroe" desktop processor as Intel's most significant performance upgrade since the company introduced the original Pentium chip 13 years ago.

"We're preparing to roll out our most competitive and compelling product line in years," said Otellini.

Investors bid up shares of Intel 16 cents, or 0.8%, to at $19.72 in early trading Thursday.

Intel's stock is down about 22% since the start of the year, with shares trading near their 52-week low levels for several weeks.

The company has been in a fierce competition with AMD, which has been slowly chipping away at Intel's dominant share of the PC microprocessor market.

AMD's current lineup of processors is generally considered to provide superior performance and power efficiency over Intel's products.

In March, Intel pared back its projections for first-quarter financial results and scrapped its 2006 outlook, citing weaker-than-expected demand and a slight market-share loss.

At that time, the chip giant said sales in the first quarter would range between $8.7 billion and $9.1 billion rather than its initial projection of $9.1 billion to $9.7 billion.

Intel said Wednesday that first-quarter sales were $8.9 billion, with net income of $1.3 billion, or 23 cents a share, in line with analysts' expectations.

Excluding the effects of share-based compensation, Intel had EPS of 27 cents, compared with 34 cents in the year-ago period.

First-quarter results were bleak across the board. Intel said total microprocessor unit sales in the first quarter were lower than in the previous quarter, as was the average selling price of its processors.

Unit sales of chipset, motherboard and flash memory chips, as well as application processors for cell phones, were also sequentially lower.

Sales were down sequentially in all geographic regions except Japan.

Inventory Clearance

The company's expectations for the current quarter looked equally lackluster, as Intel expects its customers to clear out excess inventory.

The chipmaker said second-quarter sales would be below normal seasonal patterns, coming in at $8 billion to $8.6 billion. Analysts polled by First Call were looking for $8.85 billion.

In the second quarter, gross margins are slated to fall to 49%.

Intel's management ascribed the margin decline to lower revenue from microprocessors, a change in product mix and higher costs as it steps up production of its next-generation chips.

Many analysts believe that Intel is waging a price war in an effort to undercut AMD.

Otellini said that average selling prices dropped "only slightly" in the first quarter, with the most aggressive cuts "toward the bottom of the market, particularly desktops."

As Intel releases its new microprocessors later this year, CFO Andy Bryant said that competitive pricing will still be necessary to regain lost share.

Intel management acknowledged it had lost more market share than it had originally thought in the end of 2005.

And Otellini said the company now views overall 2006 PC industry growth in the high-single-digit range, instead of the 11% or 12% range the company was operating on earlier in the year.

As a result of Intel's lower revenue expectations, the company trimmed its spending projections for the rest of the year, cutting $300 million from capital expenses and $400 million from R&D.

Bryant said the capital spending cuts would not significantly alter production levels or the transition to advanced manufacturing equipment. Rather he described them as "cuts around the edges."

He acknowledged that to meet the new spending goals, there would have to be some staff reductions. But he said those reductions would come from "hiring discipline" rather than layoffs.

Intel pegged its 2006 gross margin at 53%, compared with its previous expectation of 57%.

Intel is conducting an internal review designed to improve the company's competitive position in 2007 and beyond.

Otellini said the "wholesale" evaluation will look at every aspect of the business, from capital efficiency to underperforming businesses.