Intel Corporation — Q2 2016 Form 10-Q
Reporting period: Three and six months ended July 2, 2016; comparative periods ended June 27, 2015. Amounts are in U.S. dollars. Intel’s fiscal 2016 is a 53-week year; the first six months of 2016 included an extra workweek versus the comparable 2015 period. Results are unaudited.
Business context and performance
Intel described its strategy as shifting from a PC-centered business toward cloud computing and smart, connected devices. It completed the Altera acquisition in December 2015; Altera’s results are reported in the new Programmable Solutions Group (PSG). In Q2, management said CCG and DCG revenue was somewhat better than expected, partly offset by weakness in NSG and IOTG.
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $13.533B | $13.195B | $27.235B | $25.976B |
| Gross margin | $7.973B | $8.248B | $16.103B | $15.978B |
| Gross margin percentage | 58.9% | 62.5% | 59.1% | 61.5% |
| Operating income | $1.318B | $2.896B | $3.886B | $5.511B |
| Net income | $1.330B | $2.706B | $3.376B | $4.698B |
| Diluted EPS | $0.27 | $0.55 | $0.69 | $0.96 |
| Operating cash flow | Not separately stated here | Not separately stated here | $7.900B | $7.855B |
Q2 revenue grew 3% year over year, while operating income fell 54% and net income fell 51%. The decline reflected principally $1.414B of restructuring charges and acquisition-related amortization, as well as lower gross margin. Gross margin included approximately 3.0 percentage points of Altera and other non-cash acquisition-related charges. Six-month revenue rose 5%, but operating income and net income declined year over year.
Segments and material changes
- CCG: Q2 revenue fell 3% to $7.338B, while operating income rose 19% to $1.911B. Platform unit sales declined 15%, partly offset by a 13% rise in average selling prices.
- DCG: Q2 revenue increased 5% to $4.027B; operating income decreased 4% to $1.765B. Cloud and communications service provider demand supported revenue.
- IOTG: Q2 revenue increased 2% to $572M; operating income declined 39% to $89M, principally on higher operating expense.
- NSG: Q2 revenue declined 20% to $554M and the segment recorded a $224M operating loss, versus $92M operating income a year earlier. Competitive pricing, 3D NAND ramp costs and 3D XPoint investment weighed on results.
- Intel Security Group: Q2 revenue grew 10% to $537M and operating income increased to $97M.
- PSG: Q2 revenue was $465M and operating loss was $62M. The loss included $161M of acquisition-related inventory valuation charges. For the first six months, PSG revenue was $824M and operating loss was $262M; purchase accounting also reduced reported revenue and contributed charges.
Cash flow, liquidity and debt
For the first six months, operating cash flow was $7.900B, investing cash outflow was $19.690B, and financing cash inflow was $367M. Investing outflow included $14.619B for acquisitions, primarily Altera, and $3.632B of capital expenditures. Intel paid $2.461B in dividends and repurchased $1.597B of common stock during the period.
At July 2, cash and cash equivalents were $3.885B; short-term investments were $4.301B and trading assets were $9.503B. These three categories totaled $17.689B, down from $25.313B at December 26, 2015, principally due to the Altera acquisition. Intel reported total debt of $28.613B, versus $22.670B at year-end; debt was 46.6% of permanent stockholders’ equity, compared with 37.1%. Q2 included issuance of $2.8B in senior notes to refinance existing debt. Management said it had sufficient resources for business needs over the next 12 months. However, $14.8B of the $17.7B in cash, short-term investments and trading assets was held by non-U.S. subsidiaries; approximately $1.4B of that amount was available for U.S. use without additional U.S. tax beyond amounts already accrued.
Outlook, management commentary and unusual items
- Management said its Q2 2016 revenue was in line with the April Business Outlook and gross margin was 0.9 percentage points above the prior outlook midpoint of 58.0%. The filing refers investors to the July 20, 2016 earnings release and Investor Relations website for Q3 and full-year 2016 outlook; it does not provide clear numerical Q3 or full-year guidance in the filing text.
- The 2016 restructuring program is intended to support the strategic shift toward cloud and connected devices. Intel recorded $1.414B of charges, primarily employee severance and benefits, and expected to reduce approximately 12,000 positions globally. Management targeted about $1.6B of annual savings, expected full realization by mid-2017, and substantial completion of actions by Q2 2017. It had paid $604M by July 2 and accrued $732M for restructuring.
- A change in estimated wafer-fabrication equipment useful lives from four to five years increased Q2 operating income by approximately $300M and net income by approximately $200M; six-month operating income rose approximately $500M and net income approximately $350M as a result.
- Net gains on equity investments included $407M of realized gains from selling part of Intel’s ASML interest. Q2 equity-investment gains were $478M. Q2 effective tax rate was 20.4%, versus 9.3% a year earlier; the filing attributes much of the increase to prior-year one-time tax settlements and the decision to indefinitely reinvest prior non-U.S. earnings.
- Intel’s marketable equity portfolio was concentrated in ASML, valued at approximately $5.3B. Management estimated a 35% market-price decline could reduce the portfolio’s aggregate value by about $1.9B after hedges and offsets. Foreign currency and interest-rate movements were also identified as market risks.
- Legal contingencies include the pending appeal of the European Commission competition decision and an appeal in McAfee shareholder litigation for which Intel said it could not reasonably estimate potential loss, if any. Intel stated that adverse outcomes in legal matters could include substantial damages or business restrictions. The filing also added Brexit to its identified global-risk factors.
Important facts for investors to verify
- Whether Intel achieves the announced approximately $1.6B annual restructuring savings and roughly 12,000-position reduction, and how execution affects operating costs and product investment.
- Whether gross-margin pressure from NSG pricing, manufacturing ramps, and Altera purchase-accounting charges eases, and how much reported earnings benefit from the longer equipment-life estimate persists.
- Whether DCG growth can offset softness in client platforms and memory, and whether NSG returns to profitability amid 3D NAND and 3D XPoint investment.
- How Intel funds dividends, buybacks, capital spending and future acquisitions while managing higher debt and the geographic availability of cash.
- Developments in the European competition appeal, McAfee litigation, and other contingencies, including any financial or operational consequences.