Technology

Intel Says PC Demand 'Bottomed'


Intel beats profit expectations by cutting production, inventories, and jobs, and CEO Otellini says the worst is over, but are investors sure?

The worst of the damage that has beset the PC industry is over, says Paul Otellini, chief executive of the world's biggest chipmaker, Intel (INTC).

Reporting first-quarter earnings that beat analysts' expectations, Otellini boldly said PC sales had "bottomed out" in the first quarter, adding that the industry is "returning to normal seasonal patterns."

Intel reported a profit of $647 million, or 11¢ a share, on sales of $7.1 billion for the three months that ended in March. Analysts had expected a profit of 3¢ a share, and sales of $6.98 billion.

Otellini's comments are one of the earliest signals that tech is poised to rebound from a several-quarter slump. A maelstrom caused by the mortgage market meltdown and financial crisis sliced demand for everything from chips and computers to consumer electronics and enterprise software and hardware; even Internet advertising dropped. In response, tech companies across the board curtailed production, reset sales forecasts, and eliminated tens of thousands of jobs.

Falling Inventories

Intel's results also suggest the company adjusted well to the drop in demand. "PC manufacturers saw that orders weren't materializing, and so they acted accordingly and stopped ordering new chips," says Dean McCarron, an analyst at Mercury Research, a chip industry consulting firm based in Cave Creek, Ariz. Intel and No. 2 chipmaker Advanced Micro Devices (AMD) reported disappointing earnings in January.

To cope, Intel slowed production and controlled other expenses. "While the global economy continues to be weak and uncertain, our execution this quarter was outstanding," Otellini said on a conference call. "We have adjusted quickly to this new environment where demand remained difficult to predict, and order lead times have contracted." One result: Inventories dropped by $700 million.

Wafer starts, a key metric of manufacturing activity, were reduced by a "significant" level, resulting in a 19% drop in inventory levels from the fourth quarter, Otellini said. Intel chose to forgo the cost of carrying more chips than it could expect to sell and opted instead to bear the costs of idling some of its factory lines. "Management sent the message that they were going to keep their powder dry and that is exactly what they have done," says Doug Freedman of Broadpoint AmTech Research in San Francisco. Chief Financial Officer Stacy Smith said six percentage points of gross margin were lost because of the underutilization of manufacturing capacity.

More Job Cuts

As hopeful as Intel may be about demand, the company refrained from issuing a profit forecast for the current quarter and said sales would be "flat" compared with the first quarter. And its results, while better than expected, showed that the recession continued to take a toll in the first quarter. Profit tumbled 55% from a year earlier and gross margin dropped 7.5 percentage points, to 45.6%, from the fourth quarter. This quarter, gross margin will remain in the "mid-40s," Intel said.

Reflecting the unease over Intel's outlook, the stock dropped in extended trading after the results were released. Intel shares declined 90¢, or more than 5%, after closing at 16.01, up 3¢. Shares of AMD fell more than 3% after hours. Freedman rates Intel a "buy" with a price target of 17. "The numbers are going to move higher through the balance of the year," he says.

To make sure it meets such expectations, Intel is pushing full speed ahead with a revision of its manufacturing technology, which will let it build chips with features of 32 nanometers in size, a leap from its previous generation of 45-nanometer technology. Costs associated with that transition are contributing to the decline in gross margin. Smith said he expects the costs of the manufacturing transitions to peak during the second quarter. Then gross margins will return to what he called a "normal" range of 50% to 60% in the second half.

Additionally there will be more cost cuts. Otellini said the company reduced headcount by 1,400 during the quarter, and expects to cut more jobs this year in line with the large-scale restructuring he announced in 2006.

Despite the lack of a concrete profit forecast, analysts were encouraged by the prospect that PC demand has hit a trough. It won't be easy to chart the "slope of growth…going into the recovery," says Ashok Kumar, an analyst at Collins Stewart (CLST.L). "At least it can be said that the worst is over."

Hesseldahl is a reporter for BusinessWeek.com.

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