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If Intel's Earnings Disappoint, Blame Microsoft -- What You Need to Know About Today's Intel Earnings Report


Intel is playing catch-up with mobile, and the promise of a new touch-centered operating system is not helping PC sales.

MINYANVILLE ORIGINAL Intel (INTC), the leading semiconductor chip company that spends billions every year to keep Moore's Law a reality, might disappoint investors with its second-quarter earnings announcement today after market close. After a record year of profits in 2011, Intel's stock price has fallen by double digits over the course of the past quarter as macroeconomic factors, consumers' love affair with tablets and smartphones, and the wait for Microsoft's new operating system weigh on revenue. Intel and its peers' performance this year will tell us whether the floodgates are holding off PC sales until later or consumers and business have moved permanently to other devices.

PC Market

After the short-lived reign of the netbook, the Intel-powered portable laptops with frustratingly tiny screens and keyboards that went extinct when the Apple (AAPL) iPad hit the earth like a meteor, Intel and its OEM partners have been counting on the success of Ultrabooks. "Ultrabook" is a brand of light, portable PCs with longer battery life and a litigation-inviting similarity to the Apple MacBook Air. Advanced Micro Devices (AMD) and Hewlett-Packard (HPQ) have their own version of exactly the same thing, called Sleekbooks.

Unfortunately, whatever you call it, these fancy Windows laptops aren't doing much to keep up revenue growth for PC and semiconductor makers.

Weak PC sales data could be the main driver of a revenue disappointment this afternoon. According to International Data Corp Worldwide, an intelligence provider for the PC and IT industries, PC shipments fell 0.1% on a yearly basis in the second quarter.

Part of the reason for slow 2Q12 sales was disappointing sell-out of distribution channels during the first quarter. There is limited demand from channels that are wary of building inventory ahead of new product launches this fall. Moreover, consumers remained reluctant about purchasing PCs in this environment of tech transition and soft economics. Ultrabooks have not yet produced a significant rise in volumes – in part due to anticipation of improvements such as Windows 8, which is expected later this year, but also due to pricing.

Advanced Micro Devices, a key competitor for Intel, lowered its revenue guidance last week, sending the chip-maker's stock down about 10%. AMD expected a 3% sequential gain, and revised it down to an 11% drop, citing "softer-than-expected channel sales in China and Europe" as the main cause for the guidance downgrade.

US sales have been the worst off. Even with Apple's announcement of a new line of high-end laptops, sales of PCs have slumped by 10.6%, which is more than twice what was expected.


This time, Intel and others might not be able to count on gangbusters growth in Asian markets to offset disappointments in the US.

According to Intel's latest 10-K filing, the share of revenue from operations in the Asia-Pacific region has increased from 31% in 2001 to 57% in 2011. Asia's revenue share stayed the same in the first quarter of 2012, but this hardly budged from the previous year's revenue. IDC says that this segment "saw growth drop slightly below zero, thereby removing a key driver of global growth. Slower shipments in China and India were major factors, but other key markets also were slightly below expectations."

Waiting for Windows 8

Three months ago today, when Intel reported its first quarter earnings, Walter Mossberg wrote a column for AllThingsD that basically said that the wise PC or Mac buyer should wait before choosing a machine. Mossberg's reasoning is basically a reflection of the Osborne effect. Even though Intel and its various OEM partners have produced new lines of Ultrabooks, consumers and businesses know that the the software running them is going to be obsolete soon enough. Most new PCs ship with Windows 7, and Microsoft (MSFT) has already announced a radically redesigned Windows 8 operating system that will not become available until the fall. A new computer bought today has a pretty short half life, especially when touch-enabled notebooks start popping up.

In the last earnings call, Intel CEO Paul Otellini suggested that the coming Windows 8 will likely make this full year another good one for Intel, but clearly not until later. As he said:

I'll remind you that we are going into a new -- a year where we have a new version of Microsoft operating system, and that traditionally has been very strong for the industry. And this particular version gives us the opportunity to participate with a mainstream operating system around touch, and I'm very excited about that. So you add those things up, and I think the battle for the consumer dollars even in a soft consumer environment can be -- is not going to be as clear anti-PC as it perhaps was last year.

Intel and the Windows ecosystem have been married to the same basic x86 chip architecture. This ensures software compatibility for the most part. Microsoft seems be straying from its monogamy with Intel. The Microsoft Surface, the new touch-enabled tablet/laptop that was recently unveiled several weeks ago, will come in an x86 flavor, but will debut with Windows RT, with chips licensed by ARM Holdings (ARMH). ARM architecture is not compatible with a single piece of Windows software to date, and Microsoft is trying hard to get third-party developers to build software for Windows RT before the launch.

ARM chips are weaker than Intel's but they are known for being less power-intensive and cooler. This makes ARM the chip architecture of choice for smartphones and tablets. Apple iOS devices and Samsung (SSNLF) offerings running the popular Android operating system from Google (GOOG) use ARM's architecture.

New to Smartphones

The decline in the PC market is partly attributable to macroeconomic factors, but customers are increasingly putting off PC purchases to buy smartphones.

Mikako Kitagawa, an analyst at Gartner, says that especially in mature markets like the US, "Consumers are less interested in spending on PCs as there are other technology product and services, such as the latest smartphones and media tablets that they are purchasing."

Intel's journey into the smartphone market began in the second quarter. Intel chips appear in three different phones. That might surprise even hardcore microprocessor nerds in the US because we have never seen these things, but they can be found in the UK, France, India, and China. Prototypes for touch-enabled tablet/laptop hybrids that will run with Windows 8 have appeared on the horizon over the past few months, but haven't hit the market yet. In a previous conference call, Otellini suggested that Intel is open to producing chips for Samsung and Apple portable devices.

What Intel Investors Should Know Today

Analysts have gotten bearish on Intel in the past few weeks, especially following the 2Q PC sales numbers and AMD's guidance revision. Cody Acree, Director of Equity Capital Markets for Williams Financial Group, is one of them, but with some caveats. Acree, who has negatively revised estimates for Intel twice in the past two weeks and rates Intel as a "Hold," expects Intel to report earnings per share of $0.52 today. Acree is expecting a revision of Intel's PC market projections today, and he thinks that the bad news is already priced in.

"Intel's shares are already factoring in a good portion of the growing pessimism regarding the health of the PC sector, having declined about 14% since its recent highs in early May. However, we caution investors that further downside is likely, in our opinion, depending on the magnitude of Intel's negative revision and how badly margins may be impacted by what looks to be aggressive Intel pricing," he said in a July 16 note.

Twitter: @vincent_trivett
No positions in stocks mentioned.
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