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Intel earnings fall short

Cheap PCs take their toll on Intel's profits as second-quarter earnings dip to $1.7 billion, or 51 cents a share, below the consensus estimate of 53 cents.

Cheap PCs took their toll on Intel's second-quarter profits as the chipmaking giant reported earnings of $1.7 billion, or 51 cents a share, below the consensus estimate of 53 cents.

The disappointing showing had been eagerly awaited by investors, who were split over whether ongoing processor and PC price wars were affecting the company's bottom line. Some said Intel's aggressive pricing and the popularity of its low-cost Celeron chips would dent earnings.

Others speculated that sales of server chips would neutralize any damage caused in the desktop arena.

This time, caution proved correct. In the second quarter, Intel cut costs, sustained its margins, and sold roughly the number of processors analysts expected it would in a seasonally slow quarter. In fact, the company gained market share in the retail segment.

Unfortunately, prices also slipped.

"The average selling price fell below the narrow range we had seen for the last year or so," said Paul Otellini, general manager of the Intel architecture business group.

Revenue for the second quarter came to $6.75 billion, below the $6.9 billion expected by many analysts. On the other hand, cost-cutting moves such as developing less costly chip packages played a crucial role in lifting gross margins, the company said.

The figures represent a rise from last year's second quarter, when Intel was contending with a worldwide PC glut, but are down from earnings and revenues for the previous quarter. Second-quarter 1999 earnings were up 49 percent over the 1998 figure, which came to $1.2 billion, or 33 cents a share. Second-quarter revenue was also up 14 percent from second quarter 1998 revenue of $5.9 billion.

Last quarter, however, the company reported net income of $2 billion, meaning the current figures represent a 13 percent decline. First-quarter revenue was also 5 percent higher at $7.1 billion. Historically, second-quarter numbers are lower than first-quarter figures.

"We are pleased with our accomplishments this quarter," Craig Barrett, CEO of Intel, said in a statement. "We made progress positioning Intel for the evolving Internet economy. The Pentium III processor is on track to be our fastest ramping processor ever.

"In addition, we regained market segment share in the value PC segment with the Intel Celeron processor. As expected, second-quarter revenue reflected a seasonal slowdown, and we look forward to a strong second half."

Both Otellini and Andy Bryant, Intel's CFO, echoed Barrett's comments.

"We believe we will see a strong second half," said Otellini, adding: "We continue to see no impact of the Y2K disruption in the purchasing patterns."

For his part, Bryant added that gross margins would likely grow in the second half as more cost-cutting moves, such as cheaper chip packaging and more advanced manufacturing techniques, are imposed.

"Although [microprocessor] unit prices declined, this was offset by declining costs," he added.

Analyst Ashok Kumar of USBancorp Piper Jaffray characterized the earnings shortfall as a divot. Prices fell, but otherwise Intel hit its goals. The market share gains should also lead to stable, and even higher, processor prices in the future, because computer makers will be reluctant to switch back again to AMD.

"It is a small price the company paid to regain market share," Kumar said.

Gaining back market share in the low-cost (or so-called value) PC segment with Celeron has been a major goal of the company for the entire year. Rival AMD took a substantial chunk of the market for processors for retail PCs in 1998 and surpassed Intel in certain market segments earlier this year.

Intel shot back by advancing price cuts and chip speeds. By April, Intel had regained the lead in the retail segment but at a cost, as Celeron chips sell for less than Pentium III processors.

Dan Niles, analyst with BancBoston Robertson Stephens, theorized that the average selling price for Intel's chips declined to around $212 this quarter from $219.

AMD, of course, has been hurt even more by the aggressive price war. After reporting a profit for the fourth quarter of 1998, the company lost $128 million in the first quarter and is expected to report a $200 million loss tomorrow when it shares its second-quarter numbers. Company executives have blamed the bleeding on Intel's price moves.

A major issue for the second half of the year will likely be whether traditionally stronger demand in that period will neutralize ongoing price declines. Analysts will also be watching to see if the price war will abate.

Generally, opinions are split on these issues. AMD has released its K7 processor, which will compete against the Pentium III. Some believe that the K7 could spur price cuts across the entire range of processors. Others have said that Intel will not risk substantially cutting prices on its mainstream products, at least until the K7 comes out in significant numbers.

Other analysts have also stated that Intel's shift into networking and other factors will buoy the company. Increased sales of Xeon processors, expensive processors that get incorporated into servers, will also help.

Currently, Intel is "sizing themselves up for next year," said Charlie Glavin, an analyst with Credit Suisse First Boston, before the conference call.

Still, Glavin, among others, has said that Intel needs to bring some excitement back to the PC platform. Tangible reasons for consumers to upgrade to Pentium III systems have yet to materialize. Delays to the more advanced "Coppermine" Pentium III and the "Geyserville" battery conservation technology for notebooks haven't helped either.