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Intel (INTC) Brian M. Krzanich on Q1 2016 Results - Earnings Call Transcript

Q1 2016 Earnings Call

Executives

Mark H. Henninger - Vice President-Finance & Director-IR

Brian M. Krzanich - Chief Executive Officer & Director

Stacy J. Smith - Chief Financial Officer & Executive Vice President

Analysts

Ross C. Seymore - Deutsche Bank Securities, Inc.

Blayne Curtis - Barclays Capital, Inc.

Harlan Sur - JPMorgan Securities LLC

Stacy Aaron Rasgon - Bernstein Research

Romit J. Shah - Nomura Securities International, Inc.

C.J. Muse - Evercore ISI

John William Pitzer - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Amit Daryanani - RBC Capital Markets LLC

Vivek Arya - Bank of America Merrill Lynch

Christopher B. Danely - Citigroup Global Markets, Inc. (Broker)

Ambrish Srivastava - BMO Capital Markets (United States)

David M. Wong - Wells Fargo Securities LLC

Operator

Good day, ladies and gentlemen, and welcome to the Intel Corporation Q1 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference call is being recorded.

I would now like to turn the conference to Mark Henninger, Head of Investor Relations. You may begin.

Mark H. Henninger - Vice President-Finance & Director-IR

Thank you, Nicole, and welcome, everyone, to Intel's first quarter 2016 earnings conference call. By now, you should have received a copy of our earnings release, CFO commentary and the announcement of our restructuring program. If you've not received all three documents, they're available on our investor website, intc.com.

I'm joined today by Brian Krzanich, our CEO; and Stacy Smith, our Chief Financial Officer. In a moment, we'll hear brief remarks from both of them, followed by the Q&A. Before we begin, let me remind everyone that today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially.

And a brief reminder that this quarter, we provided both GAAP and non-GAAP financial measures, following the acquisition of Altera, now our Programmable Solutions Group. Today, we will be speaking to the non-GAAP financial measures. The CFO commentary and earnings release available on intc.com include the full GAAP and non-GAAP reconciliations.

With that out of the way, let me turn it over to Brian.

Brian M. Krzanich - Chief Executive Officer & Director

Thanks, Mark. Our results in Q1 were in the lower half of the range we set in January and reflect an extra work week in the quarter. Revenue increased year-over-year, driven by an expanding business portfolio that now includes the Programmable Solutions Group, formerly known as Altera. Strength in our Data Center, Internet of Things and Programmable Solutions businesses partially offset weaker-than-expected PC revenues in our Client business. I'll take a minute to review our Q1 results before talking about the restructuring program we're announcing today.

CCG revenue grew 2% year-over-year. We saw ongoing declines in the PC TAM, particularly in China and other emerging markets, which also led to greater-than-anticipated reductions in worldwide PC supply chain inventory. Declines in the PC segment were offset by a richer core mix and the 14th work week.

The Data Center business posted another good quarter, growing 9% over last year on strong cloud and comms service provider demand, partially offset by ongoing softness in the enterprise. The Internet of Things Group grew a remarkable 22% year-over-year due largely to the performance of the video and retail verticals. In the Memory business, strong unit growth was offset by pricing declines leading to revenue that was 6% lower year-over-year, and in our Security business, revenue grew 12%, as this team continues to tighten its focus and execution.

And finally the PSG Group, formerly known as Altera, got off to a great start. It delivered a revenue of $359 million. And after adjusting for $100 million in acquisition-related accounting charges, the business achieved mid-single-digit growth. In less than a quarter after the deal closed, we are shipping our first FPGA Xeon co-packaged parts to customers in sample form.

These results tell the story of Intel's ongoing strategic transformation, which is progressing well and will accelerate in 2016. We are evolving from a PC company to a company that powers the cloud and billions of smart connected and computing devices. The Data Center and Internet of Things businesses are now Intel's primary growth engines, and combined with Memory and FPGAs form and fuel a virtuous cycle of growth.

Last year, we achieved record revenue in the Data Center, Internet of Things and Memory businesses. They delivered a combined $2.2 billion in revenue growth and made up 40% of our total revenue and contributed the majority of our operating profit.

Today, we announced a series of actions that will build on the strength of those franchises and accelerate our strategic transformation. Through this initiative, we will intensify our investments in the products and technologies that fuel the growth in the Data Center, IoT, Memory and FPGA businesses. And we expect it will result in an even more profitable Client business.

These changes will reduce our global employment by about 12,000 positions by mid-2017. We'll do this through site consolidation, voluntary and involuntary separations, project reevaluation and an intensified focus on efficiency across a variety of programs. These are not changes we take lightly. We will be saying goodbye to colleagues who have played an important role in Intel's success. Yet acting now gives us flexibility, flexibility to continue to invest in those Client segments that are growing, including 2-in-1, gaming, and home gateway, among others.

Even more importantly, acting now enables us to increase our investments in areas that are critical to our future success. This restructuring program will allow us to expand our investments in the Data Center, the Internet of Things, Memory and connectivity, even as we reduce our spending run rate by roughly $1.4 billion by mid-2017. This is a comprehensive initiative. It's designed to create long-term value by accelerating the fundamental long-term change already happening at the company today. We will emerge as a more collaborative, productive team with broader reach and sharper execution and we expect it to result in the highest revenue per employee in the company's history.

Last, but certainly not least, we have one additional announcement today. I'm happy to share that Stacy Smith will be taking on a broader new role within Intel and reporting to me, leading sales, manufacturing and operations. Stacy has been a great business partner and a world-class CFO and I'm looking forward to continuing the partnership as he brings his leadership, his depth of knowledge, and his breadth into these critically important areas for Intel's future. We expect this transition to occur over the next few months, following a formal CFO search that will assess internal and external candidates. Stacy will remain in his CFO role throughout the search and transition process. Congratulations, Stacy.

And with that, let me turn the call over to you.

Stacy J. Smith - Chief Financial Officer & Executive Vice President

Thank you very much, Brian, and I really appreciate the kind words.

Revenue for the first quarter was $13.8 billion, up 8% year-over-year. The quarter showed year-on-year growth and was in the low end of the range of our prior outlook. Within this, we are seeing growth in the Data Center, Internet of Things, Security and Programmable Solutions Groups, all of which helped offset a weak PC market.

First quarter gross margin of 62.7% was approximately a point higher than our expectations, driven by lower 14 nm costs. R&D and MG&A was $5.4 billion, down over $100 million from our guidance. Operating income of $3.3 billion was up 13% from a year ago. The effective tax rate for the quarter was 18.4%, about seven points lower than our prior outlook. Earnings per share of $0.54 was up 20% from a year ago.

The Client Computing Group had revenue of $7.5 billion, a 2% increase year-over-year. This was below our expectations due to a weaker-than-expected PC market. Operating profit for the Client Computing Group was $1.9 billion, up 34% from a year ago. This improvement is driven by lower 14 nm unit costs on notebooks, lower overall total spending and margin improvements in our mobile products. Data Center Group had revenue of $4 billion, delivering 9% growth on a year-over-year basis. Relative to our expectations, we saw a weaker enterprise business offset by strength in the cloud segment. The Data Center Group had operating profit of $1.8 billion, up 4% year-over-year as we ramp are 14 nm server products.

Our Internet of Things segment achieved revenue of $651 million, with year-over-year growth of 22%. We saw strength in both the retail and video display segments of our business. Internet of Things operating profit was $123 million, up over 40% relative to last year. Our Security business had revenue of $537 million, up 12% year-over-year. Our Memory business had revenue of $557 million, up 6% year-over-year. The segment had an operating loss of $95 million as a result of challenging pricing, increased 3D XPoint spending and startup costs as we ramp 3D NAND in our China factory.

The Programmable Solutions Group had revenue of $359 million. When adjusted for the approximately $100 million of deferred revenue and compared to Altera's results from a year ago, the business achieved mid-single-digit revenue growth. Operating profit was a negative $200 million. This included over $300 million in non-cash charges for deferred revenue and inventory adjustments plus certain acquisition-related charges. Excluding these charges would result in low double-digit operating margin growth for this business.

We generated $4.1 billion of cash from operations in the first quarter. We purchased $1.3 billion in capital assets, paid $1.2 billion in dividends and repurchased approximately $800 million of stock in the first quarter. Total cash balance at the end of the quarter was roughly $15 billion, down $10 billion from the prior quarter as a result of closing the Altera acquisition. Our total debt is approximately $25 billion, consistent with our prior commentary on the financing plan for the Altera acquisition.

As we look forward to the second quarter of 2016, we are forecasting the midpoint of the revenue range at $13.5 billion. After adjusting for the extra work week in the first quarter, this forecast is in the low end of the average seasonal increase for the second quarter. We are forecasting the midpoint of the gross margin range to be 61%, plus or minus a couple of points. This decrease in comparison to the first quarter is driven by lower platform volumes.

Turning to the full year 2016, we expect revenue growth in the mid-single digits from 2015, down from the prior guidance. We are forecasting robust growth rates in the Data Center, Internet of Things, Non-Volatile Memory Solutions and Programmable Solutions Groups, which we expect to offset the decline in the Client Computing Group. We now expect the PC markets to decline in the high single digits in 2016 versus our prior forecast of mid-single-digit decline.

Our projection of the PC market remains more cautions than third-party estimates. We are forecasting the midpoint of the full year gross margin to be 62%, a one-point decrease from the prior outlook driven by lower platform volumes. Our execution of our strategy is driving growth. We are building on our strong position in Client and are investing for growth in the Data Center, Internet of Things markets and disruptive differentiated memory technology.

The trends over the last two years demonstrate that we are well into this transformational journey. From 2013 to 2015, the PC TAM declined 10%, yet Intel's revenue grew 5% and our operating profit grew 14% over this horizon. But as Brian mentioned, we want to accelerate that execution. In order to do that, we're going to go through a significant restructuring over the next several months. The goal is to come out of this more agile, more efficient, with more investment on our key growth initiatives and more

profitable.

When completed by mid-2017, these actions will result in a 12,000-person workforce reduction and a $1.4 billion reduction to our spending run rate. Relative to full year 2016, we are now revising our spending guidance down by over $700 million to $20.6 billion. We expect to realize over half of the total workforce reduction by the end of this year.

In the second quarter of this year, we are taking a $1.2 billion restructuring charge on the GAAP P&L as an estimate for the related actions. These actions are significant and we don't embark on this lightly. But we are confident that they will build on the strong position we have across markets and accelerate the transformation of the company that is already underway.

I would like to end on a brief personal note by saying thank you to Brian for the upcoming new leadership opportunity. Intel changes the world with amazing technology and I'm proud of what we've accomplished and I'm excited about the opportunity that's in front of us.

With that, let me turn it back over to Mark.

Mark H. Henninger - Vice President-Finance & Director-IR

All right, thank you, Brian and Stacy.

Moving on now to the Q&A, as is our normal practice, we would ask each participant to ask one question and just one follow-up, if you have one. Nicole, please go ahead and introduce our first questioner.

Question-and-Answer Session

Operator

Thank you. Our first question comes from the line of Ross Seymore of Deutsche Bank. Your line is now open.

Ross C. Seymore - Deutsche Bank Securities, Inc.

Hi, guys. Thanks for letting me ask the question. I guess first and foremost, B.K., if you can go into a little bit more of what – about what led to the restructuring announcement? Not only the one today, but there's been significant changes in the senior management over the last three months. So if you could just talk us through some of what's changed strategically in the company that's led to such a large amount of turnover so recently?

Brian M. Krzanich - Chief Executive Officer & Director

Well sure. I mean if you take a look at it, so let's step back for a second and just talk about why are we doing the restructuring now, and then we can talk about some of the specifics beyond that.

So the – we've talked about this transformation, that we're moving from a client-centric, Intel's been typically known as the PC company, to a company that is focused more and more on a much broader set of products and really focused around the cloud, right? And the cloud and all the connected devices that connect to that cloud and the connectivity that brings those devices to the cloud. And that includes the PC, but it's much more than that. And so what this effort around the restructuring is, is to say it's time now to try and – we've made enough progress, right? You take a look at it, 40% of our revenue, 60% of our margin comes from areas other than the PC right now. It's time to make this transition and push the company over all the way to that strategy and that strategic direction. So that's why we wanted to do it now.

Let's talk then about the leadership changes. There's really only been three leadership changes, if we just take the last couple of quarters. We had Doug Davis, he is simply retiring. Those are personal reasons. It has nothing to do with his leadership or direction of the company. It's IoT. We've talked about IoT as one of our growth segments that grew 22% this quarter. (16:19) performance in the group is strong. And he's staying until we find a successor, roughly the end of the year we think, something like that. Kirk chose to leave for some outside opportunities.

And the one with Stacy, Stacy and I have been working for several months, actually several quarters, on what does he do next, how do we grow his both exposure to other parts of the company, but also let the rest of the company see his leadership style. And so what we wanted to do is as soon as we'd made the decision to go ahead and start a search and start looking for a CFO replacement, we wanted to be completely transparent, be very open about that and let everyone know. It's just going to be an orderly transition. We are just going to start the search. See if Stacy's solid in the CFO seat in that meantime. But this gives him a chance to see other parts of the company. If you take a look at the group manufacturing operations, which is everything from purchasing to building construction and all, and sales, it's roughly half the company and people, and so it's a really good opportunity to see how the real operations of the company work.

Ross C. Seymore - Deutsche Bank Securities, Inc.

Good. Thanks for all those details. I guess as my follow-up would be the full year guidance of mid-single-digit growth, when I put that together with the high single-digit decline now that you have in the PC business, I am having a little hard time seeing how if you take the seasonality of PCs out of the equation in large part, what would be the lever that would get you there in the back half of the year, considering that a ramp well into the $15 billion range in revenue seems to be a prerequisite? Are there some moving parts you could describe to us that get you comfortable with that number?

Stacy J. Smith - Chief Financial Officer & Executive Vice President

Sure. Let me kind of walk you through how we are viewing the year. And first let me just put that at the highest level, right? What we are projecting for the year is overall growth, and we think we'll see growth in the Data Center...


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