Arik Hesseldahl

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Intel to Slow Down in Q4 Until Demand for Chips Picks Up

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Given the bleak picture that it painted last month, Intel’s reports certainly could have been worse, but that doesn’t mean they were good.

Earnings per share were 60 cents on sales of $13.5 billion, both of which were better than what analysts had expected: 50 cents on sales of $13.2 billion. But that’s after Intel disclosed that sales were looking a lot slower than it and analysts had expected.

Expect Intel to give its clearest view yet on what it sees ahead for the markets it controls — chips for PCs and servers — and to attack the markets where its inroads as yet are minimal: Smartphones and tablets. Also expect some color on whether or not Microsoft’s Windows 8 will be much of a catalyst for PCs. As yet, the expectations are pretty low.

Update: The call is now over. Much of the discussion focused on Intel’s decision to slow down product at its many factories, or fabs, for the time being until demand for PCs and the chips inside them picks up.

It’s not a small thing. Chip fabs are expensive to build and expensive to operate, so generally speaking you want them to be running as close to full capacity as possible. But when demand is so slack that your inventory of chips begins to pile up, you have to choose when to slow down and wait for demand to pick back up again.

Also, Intel is using the slowdown as an opportunity to get under way with the transition to 14-nanometer manufacturing technology. This is one of those moments where Moore’s Law is made real, when the elements on a chip get smaller, the chips get smaller, so more of them can be made for every silicon wafer, and they consume less power. Or you can cram more transistors into the same space, and thus get more computing work done for the same cost as before.

That is sort of Intel’s ace in the hole during periods when demand drops off. Eventually it picks up if only because the PC makers need to refresh their products with the latest stuff, especially after a process shrink. It virtually guarantees that demand will pick up again eventually.

2:05 pm: CEO Paul Otellini is speaking. He says to expect PC sales to grow at half the rate seen historically.

Now he’s talking about Ultrabooks and says many will be $699 or less. Also 20 tablets running Clovertail, the latest version of the Atom processor.

Otellini: Talking about Haswell, the next generation of processor. He says previously it had been expected to come in at a power envelope of 15 watts. Some advances have allowed Intel to expect it to run at 10 watts. That’s good news because the lower the wattage, the better the shot Intel has at getting into handsets and tablets.

2:08 pm: Now CFO Stacy Smith is speaking.

Smith: As a result of weaker than expected demand environment, factory loadings have been cut. Factory utilization rates have been taken down. This will reduce operating costs by $500 million. Also capital spending has been cut to $11.3 billion in Q4.

Smith: Gross margin in Q4 57 percent, which is lower than typical for Intel. Ouch. A lot of that is from the cut in capex and utilization.

Smith: We are taking aggressive actions to reduce inventories.

Smith: We continue to expect a benefit from the build out of the cloud.

And now begins the Q&A:

2:13 pm: Question from RBC Capital: Stacy, you gave a number at the analyst day for FY 13 gross margin?

Smith: We’ll provide it in Janurary. Premature to provide that. We need to fight through Q4 first. There’s a few things for 2013. We’re starting up 14 nanometer so that’s worth a few points of gross margin. No excess capacity charges after Q2 in 2013. Beyond that I’ll wait until January.

2:16 pm: Question for Otellini: Assess the PC market? Is it all macroeconomy or Windows 8 pent-up demand?

Otellini: It’s both. China has turned weaker on us. However we do believer that PC consumption did grow at about half the normal seasonal rate. How much that is is TBD, we’ll know a lot more 90 days from now after the Windows 8 launch. We’ll try to quantify that for you in 90 days, but right now it’s a bit of each.

Question for Smith: Is this cut in capex going to save you what you saved in 2009?

Smith: You can see capex in 2012 is down $1.2 billion from what we thought before. We’ll talk about 2013 in January.

Question: Are you seeing any Ivy Bridge tablet designs? Any Haswell tablets?

Otellini: A handful, five to eight on Ivy Bridge. Haswell, it’s too soon to tell.

Otellini: Those tablets tend to skew toward the enterprise. That is where you will see the Ivy Bridge ones migrate. Clover Trail will be more consumer focused.

2:21 pm: Question from Chris Danely of J.P. Morgan: What will it take to pull the PC industry out of this funk? Is this a permanent state?

Otellini: Since we don’t know how much is flatness because of which condition, it’s hard not to know if we’ll return to normal growth in a good economy. That tablet is not the end state of computing. What I can’t predict is which form factor is going to win. These things that have the best of both worlds are likely to be the things that are the most high volume runners.

2:24 pm: Smith speaking about inventory: We’re too high today. That’s why we’re bringing the utilization down. (What this means is that Intel’s factories won’t be running at full tilt pace, and some production lines will be running slower or idled for the time being until demand comes back. It’s kind of a big deal for Intel to do this because letting a factory sit idle is sort of an expensive proposition.)

Wow. Smith just said that utilization rate has been taken down to below 50 percent. Part of that will make room for the new technology, 14 nanometers. But some of it will be idle. Again, ouch.

Question about utilization again: Are you mothballing one building?

Smith: We’re trying to match our capacity that is in place. We were putting in capacity for the second half that is bigger than we got. Our planning model is we’re always looking to have the ability to respond to upsides. We call that “white space.” The risk of being caught short is greater than being caught long. If you’re short it can take two years to get caught back up. If you get caught long, it’s six months.

2:29 pm: Question about inventory again. Does pricing come into play on the PC side? Is that helping? Is there anything else that Intel can be doing to spur demand? Microsoft is taking things into its own hands.

Otellini: The short answer is no on pricing. We think it was priced aggressively. In the PC group, Average Selling Prices were flat. That was us going after some incremental market share at the bottom of the market. That is more the driver.

In terms of demand stimulation: A lot of what we’re doing right now is consistent with where the market was. We’re up to 40 machines that are touch enabled. We’re working with the glass manufacturers to bring the cost of the touch enabled glass down.

Question about competitor AMD. Are you seeing lower pricing from AMD and is that affecting you?

Smith: Ask them. Last quarter and this quarter we believe we have won some share at the lower end of the market.

Question from Goldman Sachs: About profit margins. Is there anything you see to make the profit margin decline worse than you usually see during a demand downturn?

Smith: Historically, the time it took to get things realigned has taken longer than two quarters. Compare now to 2009, when we were in the mid to high 40s on gross margins, now we’re in the high 50s. It’s faster and our margins are higher than in 2009.

Question about ARM-based server players. Are you seeing any competition from ARM chips in servers?

Otellini: They need to add features to be considered like 64 bits. You can look at some of the workloads like Hadoop. They can be handled by micro-servers, and those can be served by Atom.

2:35 pm: Question about mix of demand geographically. Give us more color on demand for PCs from consumers and businesses.

Otellini: The inventory thing is straight. Our OEMs are running very lean. Any kind of demand blip could cause us to reduce even more. In terms of mix, U.S. and Western Europe are soft for consumers. The enterprise PC has gone flat, and that’s a reflection of large corporations making hard decisions.

Otellini: We’ll see how that sorts out over the next quarter. In China, the slowdown there was in consumer notebooks.

Smith: We saw PC units up 1 percent in the quarter. PC ASPs (average selling price per chip) were down 1 percent and server ASPs were down 7 percent.

Question about China: Question about demand from data center customers.

Otellini: Data center ASPs were down a bit year on year. The mix is quite good. Two-way machines versus four-way machines. One of the fastest growing segments is high performance computing (supercomputers). I see the current mix being an anomaly as the result of the soft market for corporate data centers.

2:41 pm: As you think about manufacturing capacity for 2013, what kind of PC environment are you expecting?

Smith: I’m going to hold off on a unit growth or capital forecast. Capital forecast will depend a lot on Q4.

Final question: Inventories are lean and you expect less than half of normal growth. Why are customers choosing to take inventories down further?

Smith: It’s caution. Our customers are being cautious.

And that’s it. A nice short conference call.

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