Analysis: Intel's Earnings Reveal Controversy about Ultrabook Sales

Intel [NASDAQ:INTC] recently reported their second quarter 2012 fiscal numbers. In this analysis we want to focus on some of the statements made by the executives to give a better understanding of the company and the environment in the PC space.

The channel is going strong
During the earnings call Paul Otellini mentioned that this was the best second quarter in the distribution channel in the last five years. When asked about that in the Q&A section, Otellini explained that the reason for this is the transformations the channel underwent in the last years. While five years ago the main sales drivers where desktop CPUs and motherboards for white box manufacturers, nowadays increasingly servers and storage systems are being supplied.

22nm ramp going fine – building up Ivy Bridge inventory
Paul Otellini remarked that the 22nm ramp is ahead of the 32nm ramp in terms of yields compared at the same point of time in the ramp (naturally, Paul did not refer to as how much 22nm process slipped from schedule when compared to the 32nm node). The aggressive ramp drove Intel's CapEx quite a bit, but the executives pointed out that this happens regardless of the economic environment and the demand situation. However, the fast ramp allows them to take some older production lines offline, offsetting the cost a bit. The company wrote off $1.6 billion in depreciation and that trend is set to continue going forward. 

The company executives pointed out that their inventory increased by about $400 million in the process. This is mostly driven by the aggressive Ivy Bridge ramp, slightly offset by reduction of older product inventory. This lead to a cost peak in Q2 as they were putting additional 22nm production lines online. In Q3 and Q4 the unit cost should decline again. In Q2 Ivy Bridge made up about a quarter of their sales volume already, for Q3 they expect it to make up about half of the sales volume.

The recently announced investment in the tools supplier ASML is poised to accelerate the development of 450mm wafer technology and EUV lithography by up to two years.

Intel took back some low-end CPU share
When asked about the situation in the PC market considering AMDs pre-announcement of a 11% revenue decline, the CEO explained that they were probably able to take back a bit of share in the low end segment, while their higher segments remained largely flat. He strained that this was not due to lowered prices, but rather lower performance SKUs targeting those segments. We will closely look at what AMD will tell us today regarding the situation.

Ultrabooks going good – poised to meet targets
Regarding ultrabooks Intel said they hit their sales targets for the first half of the year, without going into detail about where that target specifically was. For the whole year Intel is still confident about hitting their own target of 40% of overall notebook sales to be ultrabooks. Market research outfits Gartner and IDC seem to disagree. An IDC researcher recently claimed Intel might only sell about one million ultrabooks (which would be around 0.4%), though yesterday the numbers got retracted. Gartner seems to estimate the success of these devices a bit higher, just around 5% of overall product mix. However, the Gartner numbers include Apple's MacBook Air, which allegedly makes up a big portion of that 5%. Technically Apple's products can't be called ultrabooks, since Intel owns an actual Ultrabook trademark. But in the end Intel probably doesn't care who buys their chips as long as somebody does.

Breakdown of Intel Ultrabook Design Wins.

Regardless of how many units may or may not get sold, Paul Otellini explained that they have 140 design wins of ultrabooks with Ivy Bridge. Of these, 40 are touch-enabled and a dozen are convertibles, meaning they can also work as a tablet. He also reinforced that this fall the price of ultrabooks should drop as low as $699. So at least even if people don't buy into ultrabooks as expected, nobody could say they didn't have a choice, right?

Currently Intel doesn't see demand for ultrabooks featuring cheaper Celeron and Pentium CPUs, which is why they don't consider them as options. The reasoning behind this – for Intel's executive suite at least – is that tight consumer budgets make people buy higher quality products, i.e. upper midrange and high-end products. The rationale is that these are expected to last longer. Considering we entered another cycle of 'good enough computing' (the first one was netbooks in 2008) a couple of years ago for the majority of customers, we somewhat doubt this proposition. One thing for sure, AMD has a different opinion on that as well.

Intel's efforts getting into tablets
In 2012 Intel doesn't expect substantial sales numbers from tablets and smartphones. They still consider tablets as an incremental device. In the near future, the company expects a slow ramp up in this segment. Nevertheless they are prepared for designs based on Windows 8 and Android.

Regarding the upcoming Surface tablet, Intel is certainly to have Microsoft back as a direct customer. The executives refused to comment on the effect on the OEM ecosystem, considering Microsoft designs and offers this device exclusively on their own.

Otellini kind of dodged the question inquiring as to why there is no Surface design based on Clover Trail. He said Microsoft designed a kind of "no compromise device", which he'd happily buy personally. Design wins of Clover Trail will be announced at the launch, which is expected in the second half of the year, probably coinceding with the launch of Windows 8, that is now officially placed on October 26th.

Speaking of Windows 8, for the third quarter, the CEO doesn't expect a slowdown in sales ahead of the launch of the new OS, since most systems sold now come with coupons which allow customers to upgrade very cost efficiently if they choose to do so.

Xeon Phi customer commitment
Regarding Xeon Phi apart from rehashing what was known before, Paul Otellini pointed out that there are already 40 customers commited to supporting it. Last week we detailed some of the issues with this product which might limit future expansion.

Global economic situation impacts the PC market
Looking at the general situation in the PC market, Intel executives acknowledge that North American and Western European markets didn't recover as previously forecasted. In emerging markets currency fluctuations and GDP adjustments affect an otherwise nice growth. Consequently the inventory replenishment after the HDD crisis didn't go as fast as expected. As a result Intel cut their revenue growth estimates for the year from "high single digit growth" down to a 3-5% range.