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JULY 14, 2004
By Cliff Edwards Intel's Rising Pile of Chips The tech giant's inventories are climbing, fueling investor fears that the sector's turnaround may be running out of steam Is the tech recovery in jeopardy? Investors trying to read the tea leaves from bellwether Intel's (INTC ) quarterly earnings announcement on July 13 found little to ease their growing concern that a malaise affecting the software sector is spreading to hardware makers. The Santa Clara (Calif.) chipmaker lived up to Wall Street expectations for second-quarter profits, posting net income of $1.76 billion, or 27 cents a share, on revenue of $8.05 billion for the three months ended June 26. While those results squarely matched analysts' consensus estimate for earnings per share, they fell $600 million short of revenue predictions. For the first time in several quarters, gross margins slipped below 60%, after Intel incurred a $38 million charge relating to production glitches in a new chipset that began shipping in June. WORRIES IN THE WAREHOUSE. Those numbers are hardly paltry -- and the chipmaker's second quarter is typically one of its weakest. But the earnings statement is sure to set off alarm bells because of its slower-than-expected outlook for the second half. Intel's chip inventories, which jumped 11% in the first quarter, added another $427 million in processors during the second -- mainly consisting of its higher-priced PC and server chips. As a result, Chief Financial Officer Andy Bryant now expects gross margins in the third quarter of 60%, about three percentage points below the Street's expectations. Intel also forecasts a "slight reduction" in microprocessor selling prices, suggesting that customers are buying less profitable desktop or notebook processors. Analysts have become increasingly concerned that tech inventories are growing and will eventually have to be unloaded at steep discounts. On July 12, brokerage Merrill Lynch downgraded the entire chip sector on fears that the recovery already has peaked. In regular trading on July 13, Intel shares slipped 10 cents, to $26.14, and the fall-off accelerated in after-hours trading, with a further 4.97% drop, to $24.84. CELLULAR BRIGHT SPOT. Part of the bad news may be specific to Intel. When it saw PC chip inventories rise sharply in the first quarter, it blamed the increase on faster-than-expected yield improvements that came from switching to 90-nanometer circuit lines on 300-millimeter wafers. When Intel offered a midquarter update in May, Bryant suggested that strong world demand in the second half would help work off the excess. But as inventories swelled in the second quarter to greater than what's usually maintained in the period, executives didn't slow production until late June. "We had our foot on the accelerator," Bryant says. "With hindsight, I can certainly look at it and say I wished I had figured it out a month or so earlier." Both Intel President Paul Otellini and Bryant sidestepped analysts' questions about overall tech demand. Their comments suggested that a continued bright spot continues to be the cellular-handset business, with flash-memory sales in Intel's communications business jumping 47%, to $587 million. "Inside our business, we're seeing no evidence yet of a problem," Bryant said. STOP AND GO. Indeed, all the news hasn't been so glum. Maker of handsets and chip equipment speaking at this week's annual Semicon West forum say they've seen no sign of a nascent slowdown and that business actually has been accelerating. Intel execs point to continued strong demand in developing economies such as China and Russia. Even Japan, which struggled through years of economic malaise, is showing growth. Still, the problems affecting Intel and the software sector as a whole point to U.S. corporations' continued reluctance to upgrade aging equipment. And overall business PC demand continues to come in fits and starts. Intel reported that revenues declined 10% sequentially in the Americas and were flat year-over-year. Otellini suggested that consumption trends in the U.S. are being understated because many PCs and servers are now built in Asia, but tracking firms have found little evidence of that. The confusion has led to led to concern that as the developing countries' infrastructure rollouts wind down, the tech rebound again may turn to slow or negative growth. It may take weeks to sort out who's right, but expect a roller-coaster ride for tech stocks in the meantime.  Edwards covers Intel from the San Mateo bureau of BusinessWeek.
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