Intel earnings ahead of expectations

Intel CEO Paul Otellini's 2006 cost cuts, painful as they were for Intel employees, paid off Tuesday as the company's second-quarter profits rebounded compared with last year.

The chipmaker posted a 47 percent increase in net income during its second quarter, up to $1.3 billion or 22 cents per share. The Wall Street crowd had been expecting 19 cents per share. Intel said it had 90,300 employees during the second quarter, way down from the 102,500 employees it had at this time last year.

Revenue was also a little stronger than had been expected, up 8 percent to $8.7 billion compared with expectations of $8.5 billion. The stronger revenue growth came despite the continuing decline of Intel's average selling prices as a result of strong price competition with Advanced Micro Devices.

The second quarter of the calendar year is almost always the slowest period of the year for the PC industry, so it was no surprise that revenue declined from the first quarter to the second. But profit fell substantially compared with the first quarter. Part of the drop can probably be explained by a benefit of 6 cents a share in tax items applied to first-quarter earnings. The taxman was less kind to Intel in the second quarter, as Tuesday's results only reflect a benefit of 3 cents a share. But Intel also reported lower demand for its flash-memory chips.

Executives will hold a conference call later this afternoon to discuss the results in more detail, and we'll have an updated story that looks at Intel's past quarter as well as the company's outlook for the rest of the year.

UPDATE 4:59 P.M. PDT--Intel CEO Paul Otellini and CFO Andy Bryant said during the conference call that demand for PCs and servers was stronger than expected in the second quarter. Pricing is still tough, apparently, especially in the low end of the PC market, but I can't remember a quarter in the last several years in which that wasn't true.

Intel is trying to be more judicious about the low end of the market, focusing more of its attention lately on servers and notebooks, Otellini said. Those are more profitable categories and Intel is pretty strong as compared with Advanced Micro Devices in those segments, he said.

Intel also saw a better showing from its channel program in the last quarter, Otellini said. Intel and AMD both have channel programs that supply smaller system builders with processors, usually low-cost builders in emerging markets that favor desktop PCs. AMD had trouble with this market in the past couple of quarters due to overcommitments, which would naturally give Intel a boost.

One sore spot for Intel was its gross margin, which contributed to the profit drop mentioned above and a sharp decline in the price of Intel shares during after-hours trading. The company's gross margin percentage (basically revenue minus the cost of making chips) fell to 46.9 percent, lower than expected and very low against Intel's historical margins. Analysts used to be disappointed when Intel fell below 55 percent margins, but the year-long price war has taken its toll on both companies--although AMD's margins were down to 28 percent during its first quarter.

This quarter Intel blamed its shrinking NOR flash memory business for the margin disappointment. The company is currently setting up a joint venture with STMicroelectronics to rid itself of the NOR business, which is losing ground to the faster NAND flash memory made by Samsung and others and used in iPods and cell phones. Demand was soft again this past quarter, Bryant said.

Intel's manufacturing operation has become more efficient over the past year, and so the company is reducing the amount of money it expects to spend on capital expenditures, Bryant said. Inventories are down, and the company is on track to introduce 45-nanometer chips later this year, he said.