Intel Slips on Mixed Quarter, Sales Outlook

Updated from 9:28 a.m. EDT

Intel ( INTC) shares dippedin early trading, as investors were unimpressed over a largely in-line quarter.

In recent trading the stock was down 21 cents, or0.8%, to $27.46.

Late Tuesday the chipmaker posted an 89% gain inprofit from the year-ago quarter andsaid profit levels will stay about the same in thequarter now under way. On the downside, the midpointof its broad sales guidance fell a touch below theWall Street consensus estimate, and the companyadmitted to a slight buildup in inventory.

At Deutsche Bank, analyst Ben Lynch called Intel'sfirst-quarter results "relatively uninspiring." The upsidein the first-quarter gross margin was overshadowed bydisappointing second-quarter guidance, he noted. Relatively little new information on PC trendsemerged, other than that desktop demand is running asexpected and excess notebook inventory has beencleared.

He cut his second-quarter EPS estimate to 25 centsfrom 27 cents, while offering a few words of caution."We continue to believe the market has overestimatedIntel's 2005 gross margin potential, and specificallythe risk from a more competitive AMD ( AMD)," he wrote.

Still, he has a buy rating on the stock,explaining that although Intel is no longer a momentum play,it "remains the quality semi stock" in light of itsrelatively low valuation and strong cash flow andreturns. Deutsche Bank has done investment banking forIntel.

On a more upbeat note, Fulcrum's Clark Fuhs says he favors the higher end of second-quarter guidance because he believes Intel management is beingconservative. "Demand from increased corporatespending should help the PC and server markets thisyear," he wrote. He believes semiconductor makers arelikely to see the usual late-summer pickup in demandoccur earlier than usual, perhaps as early as June orJuly, because supply is relatively tight this year.

For that reason, he predicts Intel's Junemidquarter update will be a positive catalyst for thestock.

"I think the numbers were pretty much in line," said Tai Nguyen, an analyst at Susquehanna. "The gross margin for the first quarter is good. If you exclude the charge, it's about 62%."

Referring to the slight decline in the stock, "they may just have some negative bias in the near term, but I don't think it would fall much lower," he said. "It seems like there's strong support in the low-$27 range." (Nguyen has a net positive rating on the stock; Susquehanna doesn't do investment banking.)

No major brokerages changed their rating on the stock Wednesday morning, although CSFB cut its 2004 earnings estimate by a penny to $1.14 a share and Morgan Stanley lowered its estimate to $1.25 a share from $1.27 a share.

On March 4, Intel signaled a slight slowdown in business in a midquarter update, prompting analysts to revise their estimates a bit downward; the news has continued to weigh on the stock, which was down 14% year to date as of Monday's close.

After the bell Tuesday, Intel said its first-quarter profit stood at $1.730 billion, or 26 cents per share, just below the consensus Wall Street estimate for 27 cents.

However, the nominal earnings shortfall reflected a legal charge rather than any shortfall in underlying business. On March 30, Intel agreed to pay $225 million to Intergraph to end an ongoing chip-patent suit, resulting in a first-quarter charge that reduced its earnings per share by about 1.7 cents.

Intel's first-quarter sales totaled $8.091 billion, up 20% from last year's levels. Though it's a rounding error, that's a tiny bit short of the analyst mean estimate for sales of $8.164 billion.

Gross margin stood at 60.2%.

Intel management acknowledged the company had built $277 million in inventory in the first quarter, which one analyst noted on the conference call appears to be the highest increase since 1995.

Chief Financial Officer Andy Bryant said the buildup had occurred because manufacturing yields had turned out to be much better than expected, as the company shifted to more advanced chipmaking technology. Bryant noted that inventory amounts to only a week or 10 days' worth, which the company should have no trouble working through -- assuming normal seasonal patterns. He said the slight buildup is better than lousy yields.

"Any time inventory goes up, it raises an eyebrow," said Kevin Rottinghaus, an analyst at Midwest Research. "But it looks like yields were just better than people had planned. I don't think it was necessarily a bad thing."

Rottinghaus added that Intel's revenue turned out to be "a little lighter than we had been looking for. We'd thought it would be more towards the high end" of the guidance range of $8 billion to $8.2 billion. Still, he has a buy rating on the stock, anticipating that enterprise spending will pick up later this year; his firm doesn't do investment banking.

But others sounded a warier note. "We believeIntel needs above-seasonal revenue growth during thesecond half of '04 in order to avoid either aninventory writedown or lower utilization rates,"warned J.P. Morgan's Chris Danely in a Wednesdaymorning note. At 79 days, inventory is the highestit's been since 1995, he noted. Danely said theinventory build poses a risk to gross margins, sincethe company might have to clear it out by cuttingprices or write down its current inventory.

J.P. Morgan hasn't done banking for Intel.

In other first-quarter details, operating income in Intel's flagship microprocessor line jumped 58% year on year, to $3.015 billion. Unit sales of microprocessors were lower in the first quarter but the average selling price was slightly higher.

Meanwhile, Intel's communications group -- which now includes flash memory, wireless connectivity products, and cell-phone processors -- posted a loss of $219 million, nearly identical to last year's $218 million loss.

Intel said second-quarter revenue is expected to fall to between $7.6 billion and $8.2 billion, reflecting a range from a decline of 6% to a 1% increase in sales. The midpoint of sales guidance, $7.9 billion, is slightly below analyst expectations for $8.087 billion.

Gross margin should remain at about 60%, plus or minus a couple of points, for the second quarter, the company said.

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