Intel's 2007: Lower Revenues, Cost Cuts

Intel has spent the better part of its history in restructuring - in fact, long-time employees have learned to live with it as part of the evolutionary course of business. But now, CEO Paul Otellini and company have a new challenge ahead of them in fiscal 2007: completing this latest round of restructuring so Intel can, at last, redefine "normalcy."

The company plans to do this while, at the same time, rolling out the first of its 45 nm processor parts - the replacements to the revolutionary Core 2 Duo CPUs it introduced to the world just last July.

While analysts yesterday appeared to anticipate the "wrapping up" portion of Otellini's restructuring program, announced early last year, Intel CFO Andy Bryant revealed that he's still looking for another $1 billion in capital expenditures savings improvement through the implementation of additional "efficiencies."

Bryant admitted at first that "we have seen capital savings out of this program earlier than we anticipated. But it doesn't mean we've said it's pulled in. Our expectation is to go and find a billion dollars in addition in '08. So whatever savings I get before then, we're going to take to the bank, and then we're going to go see if we can still get another billion dollars."

This is in addition to a savings of $2 billion that Bryant estimates the company has already accumulated, due partly to the divestiture of its network applications hardware business to Santa Rosa neighbor Marvell, and a headcount reduction of 8,300 workers. That reduction process won't stop going into '07, Bryant said, with an additional 2,100 workers likely to be invited to join the company's attrition program before the end of the first half.

This continued round of cost cutting, coupled with a period of rapid technology acceleration, will continue to have an impact on Intel's bottom line going into 2007, Bryant warned. However, he indicated, that may be the end of the bad news. Fiscal fourth quarter revenue for Intel came in at $9.7 billion, an 11% gain over the previous quarter (which was a bad quarter) but, more importantly, a 5% decline over the fourth quarter of 2005.

Net income came in at $1.5 billion for the quarter, a 39% drop over the year-ago quarter. This at a time when the company is reportedly shipping the greatest number of CPUs, NAND and NOR flash memories, and chipsets in its history.

But the revenue downturn was anticipated - in fact, the numbers were not as bad as Intel has earlier warned they might have been. Restructuring, in short, costs. The trick of financial management is spreading out those costs.

As expected, pricing pressures in a highly competitive market with AMD were to blame.

"It remains competitive," admitted Paul Otellini, "but you have to remember, over the course of this year, we probably had the biggest single series of price moves we've ever had, and that had to do with us resetting our entire price stack in servers, desktop, and notebooks for the introduction of the new products, for all three lines which came in essentially over the course of the summer. We've never had that broad base of new products hit us all at once, so as you bring the new product in, you drop the prices of the old products and price the new ones to hit the sweet spots of the volume."

Never in Intel's history, Otellini added, had the company implemented a sweeping new technology across-the-board, all at once. As Bryant acknowledged, a reduction in earnings per share for the quarter (to 26 cents, down 35% from the year-ago quarter) was caused by the double-whammy of lower revenue and lower margins, down as much as 11 points. "We know it's been a very tough pricing year," he said.

But throughout the first half of 2007, Intel's planning a repeat performance, as it prepares to reveal a new line of 45 nm processors top-to-bottom, substituting in phases for the 65 nm models introduced just the previous summer.

Imagine that 11-point margin drop in your mind for a moment. How much of it is due to price declines in the overall market, and how much due to startup costs for ramping up new technologies? Andy Bryant didn't work out the formula in front of everybody's noses, but he did provide analysts with all the necessary math.

"First, a little tutorial: In Intel's business, you always have some level of startup cost," Bryant began. "We always have a new process or a new factory or a process changing for a factory. So in general, you would expect us in a year to have about two points of margin dedicated to startup costs. In 2007, we will have approximately four points of margin deterioration because of startup costs, because of the startup for the 45 nm processor. So that's step one." A full 70% of those startup costs, Bryant added, would be incurred during the first half of 2007.

But step two is to recoup some of those costs in savings from production. The cost of producing CPUs will actually decline, perhaps markedly, in the first quarter of '07, said Bryant, helping even out those margins. With the seasonal downturn coming on, Intel's goal will be to continue to hold the line on inventory at roughly what it is now - about a month's availability on-hand. "That'd be a goal," Bryant projected. "It's tough to hold it in a declining revenue environment, but I think we have a shot at it."

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