Intel Q2 Earnings Call Transcript

123jump.com Staff
28 Jul, 2010
New York City

The semiconductor chip maker quarterly revenue rose 34.3% to $10.77 billion from $8.02 billion a year ago. Net income in the quarter was $2.89 billion or 51 cents per diluted share compared to a net loss of $398.0 million or 7 cents per share a year ago.

Intel Corporation ((INTC))
Q2 2010 Earnings Call Transcript
July 13, 2010 5:30 pm ET

Executives

Kevin Sellers – VP, IR
Paul Otellini – President and CEO
Stacy Smith – SVP and CFO

Analysts

Uche Orji – UBS
Ross Seymore – Deutsche Bank
John Pitzer – Credit Suisse
Gus Richard – Piper Jaffray
Glen Yeung – Citi
Christopher Danely – JP Morgan
David Wong – Wells Fargo
Jim Covello – Goldman Sachs
Tim Luke – Barclays Capital
Craig Berger – FBR Capital Markets
Mark Lipacis – Morgan Stanley
Stacy Rasgon – Sanford Bernstein
Doug Freedman – Gleacher & Company
Sumit Dhanda – Banc of America/Merrill Lynch
Alex Gauna – JMP Securities
Kevin Cassidy – Stifel Nicolaus
Daniel Berenbaum – Auriga USA

Presentation

Operator

Good day, ladies and gentlemen. Welcome to the Q2 2010 Intel corporation earnings conference call. My name s Cassidy and I will be your coordinator for today. All lines have been placed on mute to prevent any back ground noise. After the speakers remark, there will be a Question and Answer session. If you would like to ask a question during this time, simply press star then number one on your telephone keypad. If you would like to withdraw your question press the pound key. As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today’s call Mr. Kevin Sellers, VP of Investor Relation. Please proceed sir.

Kevin Sellers

Thank you, Cassidy, and welcome everyone to Intel’s second quarter 2010 earnings conference call. I am joined today by Paul Otellini, our President and CEO and Stacy Smith, our Chief Financial Officer.

A few important items before we begin. We posted our earnings release, CFO commentary and updated financial statements to our investor website, intc.com, for anyone who still needs access to that information. Also if, during this call, we use any non-GAAP financial measures or references, we will post the appropriate GAAP financial reconciliations to our website intc.com. Following some brief prepared remarks from both Paul and Stacy we will take questions.

As we begin, let me remind everyone that today’s discussion contains forward-looking statements based on the environment as we currently see it and as such does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. I also want to remind you of our Annual Intel Developers Forum is scheduled for September 13th through the 15th in San Francisco, and hope to see many of you there. For information on this event, please visit our website or contact Intel Investor Relations directly.

With that, let me now hand it over to Paul.

Paul Otellini

Thanks Kevin. In Q2, Intel posted its best quarterly results ever as the economics of the world continue to reflect renewed economic momentum. Intel growth continues to run ahead of economic growth, reflecting what we believe is a fundamental shift driven by internet adoption. Our second quarter was up 5% from Q1 versus a seasonal norm of down 2%.

In addition to continuing year-over-year growth in the consumer segments, this quarter we benefited from a broad-based return of the enterprise and small business segments. Our server business had a record quarter showing strong sequential unit growth and strength from customers opting for richer configurations that drove an improved mix within the server category.

The return on investment that our new server offerings deliver is extremely compelling and is a major reason for the strong demand we are experiencing. One example of the surging demand for servers is in the IP data centre segment, which grew 170% over Q2 of last year. As internet traffic continues to boom, the cloud build out is accelerating in order to keep pace.

In addition to servers, we also saw companies including small businesses refreshing their PC. Like servers, this too was broad-based and was an important driver of improving product mix within our PC business last quarter. Our Atom business also performed very well growing 16% sequentially. Two important drivers were responsible. First, there was an inventory correction in Q1 that has now normalized and second, we introduced dual core versions of Atom, which helped drive incremental demand and improve our mix within the Atom category. Since launching the Atom processor two years ago, we have shipped approximately 75 million Atoms and we still expect the industry to ship around 40 million net books this year. In terms of global demand for PCs, many third-party analysts are now projecting annual unit growth of around 20%. Our plans are consistent with this number. With the last five quarters we have seen PC sales, driven by consumer purchases, particularly notebooks. This trend is continuing, and in Q2 we saw a return of corporate purchases that offset seasonal and geographic patterns in the consumer segment.

Our outlook for the year remains robust and we are planning for a seasonal second half. One quick word about the status of inventories; Across the supply chain, we are very comfortably with the levels of inventory. In the channel, we saw a marked decline in inventories as currency volatility caused distributors to cut back on orders so inventories in the channel are very lean. As for inventories on our balance sheet, the increase was both conscious and important. Over 100% of the increase was from leading edge 32nm processors in anticipation of a seasonally stronger second half.

At our investor day back in May, we talked a lot about the advantages we have with an integrated business model of both product design and manufacturing. Those advantages were very evident in our second-quarter financial results. Our product costs continued to decline very nicely, and when combined with the innovative product line up we have developed, we were able to enjoy healthy financial returns. Our process technology is and will continue to be a very important source of differentiation and earnings power for the company.

In closing, I want to mention our upcoming product family codenamed Sandy Bridge. Last quarter I mentioned that we were broadly sampling this product to our customers. I am more excited about Sandy Bridge than I have been on any product that the company has launched in a number of years.

Due to the very strong reception of Sandy Bridge, we have accelerated our 32nm factory ramp, and have raised our CapEx guidance to enable us to meet the anticipated demand. We look forward to seeing many of you at our September IDF Conference in San Francisco, where we will share more details about this new architecture. With that, let me turn the meeting over to Stacy.

Stacy Smith

Thanks Paul. Our leadership product portfolio across servers, notebooks, net books and desktops, coupled with our best ever platform unit costs and a growing PC and server end market led to our best ever results. Revenue, gross margin, operating profits and earnings per share were all records. Revenue of $10.8 billion was up 34% from a year ago and gross margin of 67% was up four points from the first quarter.

Operating profit rose to $4 billion, and as a percent of revenue reached 37%. The improvements we have made in our productivity can be seen in revenue per employee of a $134,000, also our best. Our financial results in the second quarter were a result of a strong product mix with the continued ramp of our new 32 nm products. Microprocessor unit sales increased slightly above seasonal and average selling prices for microprocessors were up slightly quarter-on-quarter. All geographies performed better than normal seasonal patterns.

The server market segment was particularly strong with customer demand for our new products leading to a richer mix. The data centre group achieved revenue of $2.1 billion and operating profit of $1.1 billion, which was the first time operating profit, exceeded $1 billion in this segment. Second quarter gross margin of 67% was higher than our expectation due to higher platform revenue and better than expected costs. The factory networks delivered our lowest ever platform cost, while accelerating the 32 nm process technology ramp because customers continue to demand a richer mix of our latest generation microprocessors.

We generated approximately $3.5 billion of cash flow from operations in the second quarter. Total cash investments grew by $1.4 billion to approximately $18 billion. We paid nearly $900 million in dividends and purchased over $1 billion in capital assets. Additionally, we increased total inventories by $350 million. The midpoint of our forecast for the third quarter is at $11.6 billion. The forecasted revenue increase of 8% in the third quarter is slightly below the average seasonal increase. We are forecasting the midpoint of the gross margin range to be flat to the second quarter at 67%.

For 2010, we are forecasting a record annual gross margin with the midpoint of our annual forecast increasing from 64% to 66%. At our May Investor Day meeting, we reviewed how we have transformed the company’s cost structure. The second quarter demonstrates the powerful financial results that can be generated when leadership products and a world-class cost structure are coupled with an overall healthy end market. Our business was strong in the first-half and our forecast for the rest of the year is that the second half is seasonally stronger and that the strength of our product portfolio and our cost structure will allow us to achieve our most profitable year ever. With that, let me turn it back over to Kevin.

Kevin Sellers

Okay, thanks Paul and Stacy. We will now move to Q&A and as has been our practice; we would like to ask each participant to limit themselves to one question and then one follow-up if you have one. So Cassidy, please introduce our first questioner.

Question-and-Answer Session

Operator

Thank you. Once again, to ask a question, please press star then the number one on your telephone keypad. Our first question comes from the line of Uche Orji with UBS.

Uche Orji – UBS

Thank you very much. Paul, let me just start off by asking you about the comment you made about distribution and inventory channel given all the currency upheaval, have we seen any pickup now, you know, especially in Europe, which has been quite a concern to some people. Any commentary as to how you see things tracking now in the third quarter within the distribution channels for inventory?

Paul Otellini

Well, so far so good. We gave guidance to a fairly robust third quarter. As Stacy said it was basically seasonal or just slightly below the midpoint of seasonality. We don’t see any inventory issues out there. The prices in Europe obviously on a euro basis would be up slightly, but what we are seeing is people are altering configurations as they free up the cash to build these machines. Distributors principally build the machines to order. Some SKUs are less memory configurations, some are taking discrete graphics out, just to try to keep the price points constant in the channel in that retail.

Uche Orji – UBS

Just one follow-up, on the Atom, I mean one of the questions has been around if you look at tablet PCs now starting to take up and whether that will cannibalize net books. Just as you look at this category and look at it vis-a-vis net books, two questions here, how do you see the net impacts and how do you see the positioning of Atom within this category?

Stacy Smith

Well, I think we are in the early stages of tablets obviously. There is just one really shipping in volume today. At this point, my view really hasn’t changed in the last quarter or so. I think this is an additive category of computing much like net books were an additive category.

Kevin Sellers

Hi Cassidy, you are there?

Operator

Yes sir. I am actually sure that it is coming from the participants’ line on the other end.

Kevin Sellers

Okay. It looks like it is gone now.

Paul Otellini

We will keep going.

Stacy Smith

I am sorry, Uche. We will start again. I haven’t changed my view on tablets in the last three or four months since the launch of the iPad. I think they are an additive category to the market, much like we saw net books being additive. Net books in fact had a higher potential to cannibalize and they didn’t. I don’t see tablets cannibalizing the PC market. I think people used it for different kinds of reasons.

In terms of Intel participating in the tablet market, we remain very optimistic about this. At Computex last month, there were over thirty varieties of tablets shown based upon Atom configurations. The advantage of obviously Intel in this segment is you can run a number of operating systems. You can run Windows, you can run android, you can run chrome, and you can run MeeGo or the other versions of Linux. So we feel pretty good about our opportunity to participate in the growth as it happens.

Kevin Sellers

Thanks Uche. Cassidy, we will take next question.

Operator

Thank you. Our next question comes from the line of Ross Seymore with Deutsche Bank.

Ross Seymore – Deutsche Bank

Just congrats on the strong results. One question on the inventory in your own balance sheets, it was up about 12% sequentially, can you give us a little color on units versus dollars?

Stacy Smith

Sure. This is Stacy, I will be happy to. It was both. We got some units in place on 32 nm. That was our strategy. It is also, as we are seeing those first wafers coming out of the first couple of factories on 32 nm, it tends to be just a little bit more expensive inventory. So both units and dollars, dollars per unit were up and dollars were up some.

Paul Otellini

Yeah, if I just kind of talk about inventory now as we go forward, the inventory that we have in place is appropriate relative to where we are in the 32 nm ramp and relative to how we see demand in the second half and I expect it to flatten out as we get into the second half of this year. It should be pretty flat in the third quarter as we go forward.

Ross Seymore – Deutsche Bank

And then one follow-up on the pricing side specific to the server side, I guess, with the data centre group up as strongly as it was in the act shipping, I would think that the pricing could have been up 8% to 10% in that segment, is that mix dynamic, is my assumption on that correct, and am I in the ballpark in the pricing side?

Paul Otellini

Yes, it is a level of granularity we are not going to go to. We definitely saw the mix better in servers and that led to ASP positive impact and then we also saw that server as a percent of the total business was higher. They had a very good quarter and so we saw a little bit of a mix just based on more server shipments relative to everything else. Those two things both led to the mix goodness we saw in the quarter.

Operator

Thank you. Our next question comes from the line of John Pitzer with Credit Suisse.

John Pitzer – Credit Suisse

Yeah. Congratulations guys. Maybe a follow up on the ASP question, Stacy you have been guiding future gross margin most of the year under the assumption of kind of normal price declines. I am kind of curious when you look at the 67% guidance for September, then the full-year guidance of 66%, are you expecting kind of normal historical price declines or do you think you will continue to see that the positive mix that you have kind of seen in the first couple of quarters?

Stacy Smith

Well, I think you can really see that in the fact that from last quarter, I came up from 64% to 66% for the year, and almost all of that is associated with the impact I just talked about. It is just a richer mix of products than I was expecting. The other thing I will point you to is in my Q2 to Q3 margin, well I can take you through Q4 if you want, ASP is not one of the drivers. So you can kind of get a sense that I am not expecting it to be a big driver as we go into the third quarter.

John Pitzer – Credit Suisse

And I guess as my follow-up Paul, as you think about second half revenue being seasonal in your product portfolio, we are kind of curious if you kind of break it down to three big buckets, you know, client versus server, consumer versus corporate and then sort of the desktop, notebook Atom bucket, you know, which one of those – can you talk a little bit about what you expect to be better than seasonal, maybe are you expecting any seasonal softness anywhere?

Paul Otellini

We are not planning for any seasonal softness. When I told you we are endorsing 20% as a planning number, it is hard to find any softness in the 20% year-on-year number, right. Let me try and give you some granularity though, clearly we said for some time and we showed you at the analyst meeting that something like 70% of our business is consumer on a worldwide basis. Some of that is small business built into that. I don’t see that shifting. So I think that level of participation in the consumer segments will be reflected, and will be seasonal first-half versus second half. I don’t see it change there.

I think it will continue to be driven by notebooks, and I think servers will continue to be strong if I had to guess at this point in time, I see no reason not to. There are two trends inside the server movement. One is the capacity needs coming off the internet data centre build out, and I gave you some data on that as part of my commentary, and the other is the return on investment that you can get in enterprise data centers by swapping out old versus new equipment in terms of both capacity and power savings, electricity cost savings. I think those are very big drivers this year that are going to be overlaid on top of this.

The last comment I would make on your question is on Atom, which is, I gave you my number for the year for net books. I don’t see that part of the Atom business taking off much higher than it already is. It is good year-on-year growth. I think the growth in Atom over the course – the new growth in Atom this year is going to be in embedded and in products like the Google TV product that were launched last month.

We didn’t talk about that in the last conference call because it wasn’t announced yet, but I can tell you that a number of companies are now moving towards production on Atom based television, set-top boxes, DVD players and so forth around that particular construct, and to me that is one of the bigger things to watch for the holiday season as those products break market and see what happens.

Operator

Thank you. Our next question comes from the line of Gus Richard with Piper Jaffray.

Gus Richard – Piper Jaffray

Yes. Congratulations on a good quarter. Could you talk a little bit about the – you saw strength regionally everywhere, where there any areas like Europe that was weak or Brazil or China that was particularly strong?

Paul Otellini

Well, every geography was up above our seasonal norms, right, at least in terms of Intel revenue. We don’t have all the sales data yet, we have got two months of it, but the trend so for that on a year-on-year basis everything was up, and in particular on the commercial or enterprise side of the business. In terms of China, it was a little slow going early in the quarter, and it got good towards the end. Similar in Europe, we had the volcano in the beginning and some currency disturbances and volatility in the middle, and things settled down in both geographies by the end of the quarter. The net was year-over-year, everything was nicely up.

Stacy Smith

If I may add, you can see it in the results, we saw particular strength in the enterprise segment and if you look at the geographic breakdown, you see that America and Europe were both the best in terms of seasonality, and that is just because they have a larger component of those markets are large companies in the enterprise segment. So the enterprise strength really helped drive those results.

Gus Richard – Piper Jaffray

And then on the enterprise segment you are definitely beginning to see the beginning uptake of a corporate upgrade cycle or an enterprise upgrade cycle on the client side?

Paul Otellini

It appears that way. I mean, we look some time that this phenomena had to happen that the machines were just costing more to keep on the books than they were worth in terms of out of warranty and repairs and those kinds of things, and the strong desire to upgrade to Win 7. And so I think now that corporations have some breathing room in the economy and their budgets, we are starting to see that those machines that are four and five years old get refreshed. I can’t comment on the rate of refresh. My sense is you are going to see sort of one year-over-year for the next couple of years, but that will be an accelerant.

Operator

Thank you. Our next question comes from the line of Glen Yeung with Citi.

Glen Yeung – Citi

Thanks. Either Paul or Stacy, you know if we talk to, for example the notebook ODMs about their outlook for the third quarter, they are talking about a low seasonal forecast, and you guys are below it just slightly. Anyway to reconcile the difference in those two views, is it perhaps what you are seeing in corporate relative to what they may be building.

Paul Otellini

Well, what I will tell you is our numbers is what we are comfortable with giving publicly. This is the data that we have inside the company and data from our backlog, and what our customers are asking us for. So I don’t know that any of our customers have yet commented publicly on the third quarter. They will do that when they do their earnings, and no one has announced yet. So I don’t know that there is an anomaly at this point.

Glen Yeung – Citi

Okay. Fair enough. Thanks for that. And then second question really revolves around 32 nm, you make the point that you are accelerating it, but maybe a sense, first of all obviously I think it is faster than your expectations, what do you expect mix of 32 nm to be relative to your prior expectations in the second half of the year, and then what will the mix be relative to the first half of the year?

Paul Otellini

Well, it depends on how prior you want to go, right. We are building more 32 in the second half than we had planned say six months ago. We are also building more 45 in the second half we planned six months ago. The net result is that we will have more 45 longer than we first thought, even though 32 is growing faster and bigger than we first thought. The basic answer here is that the market is bigger than we had first done planning on for the year.

Operator

Thank you. Our next question comes from the line of Christopher Danely with JP Morgan.

Christopher Danely – JP Morgan

Hey, thanks guys. A question for Stacy, Stacy you told us that inventory would be up this quarter, was it up any more than you originally thought it would be, and what does that mean for your utilization rates in the second half of the year. Are they going to stay flat or go up or go down?

Stacy Smith

No, our inventory is up on the order of what I expected in the second quarter, and as we showed at the investor meeting, we are in the range where we are kind in that sweet spot of loading, the factories are nicely loaded. We are getting great costs out of them. We have the ability to do a bit of upside. As Paul said in his written remarks, the place where we are accelerating a bit here is getting some more 32 nm capacity in place in the second half in anticipation of the demand for Sandy Bridge based on what we are hearing from the customers as they get to kick the tires of that product line.

So, I think we are healthy from a utilization standpoint and I am, you know, comfortable with where we are from an inventory standpoint on the second quarter.

Christopher Danely – JP Morgan

Great. And if things do end up slowing up in the second half of the year what would the reaction be from you guys, would you start to hit the brakes or would you just treat as a temporary anomaly and maybe keep the utilization rates flat?

Stacy Smith

I think the best way to answer that question is to look at what happened when we got hit by the kind of massive downturn of 2009, when that hit the supply chain, across the industry reacted very quickly, much more quickly than they had in prior cycles. We took aggressive action to reduce the loading in our factories to not put inventory in place. And then we took advantage of that to roll forward some of the capacity we had on 45 to offset some of the investment that we had to make on 32, which drove a great capital efficiency number. So I would expect if you get into the case, where we got hit with another big recessionary kind of scenario like we saw last year, the reaction would be very similar to that.

Operator

Thank you. Our next question comes from the line of David Wong with Wells Fargo.

David Wong – Wells Fargo

Thank you very much. Paul, you mentioned that you are very excited about Sandy Bridge and this was one of the reasons for accelerating 32 nm, does this mean that you are planning to bring out Sandy Bridge earlier than scheduled, and when might we expect to see first launches of systems that have Sandy Bridge in them?

Paul Otellini

Well, we will talk more about the product in a lot of detail at IDF in a couple of months. In terms of product granularity, I really don’t want to get more granular than we have been which is that we will ship Sandy Bridge for revenue this year, late this year.

David Wong – Wells Fargo

Great, thanks. And further on the CapEx question, when you have higher CapEx this year, does that represent a pull in from 2011, reducing what might otherwise have been spent in 2011, or is it just extra spending?

Stacy Smith

Yes, that is the right way to think about it, although we haven’t put a forecast out for 2011 yet. So we don’t know how to do the plus or minus to that, but to just piggyback on what Paul said, you know, based on what we are hearing on Sandy Bridge, we are now anticipating a faster ramp of the product, so some of the capital that I thought we could spend in the first half of next year, we are going to put in place now so that we can ramp the product out of the shoot faster than we anticipated. So it should be plus this year and a bit of minus to next year.

Operator

Thank you. Our next question comes from the line of Jim Covello with Goldman Sachs.

Jim Covello – Goldman Sachs

Great, thanks very much for taking the question guys, and congratulations on the terrific results. Paul, you mentioned both in Europe and China some hesitation at the beginning of the quarter and then things kind of returned to more normal levels at the end of the quarter. How much of that do you think was sort of normal seasonal trend versus kind of macro disruption, and do you see what kind of seasonal trends on the shorter term basis do you see during the third quarter?

Paul Otellini

It is hard to tell Jim. My sense is that you have two different things going; we had three things going on. In Europe you had the volcano, and then the debt crisis, and in China mid-quarter you had the change in the housing stance, which dampened down GDP a bit. I think all of those are being worked through now. I mean to me if you look through that to the length of that smoke what you see is computers are important independent of the economy cycle. They happened all last year to the surprise of many and it is happening now, and the difference now is that corporations are buying in addition to consumers. Computers are fundamental to people’s lives nowadays.

Jim Covello – Goldman Sachs

And then for follow up, if I could ask, relative to the enterprise strength, do you have any way of estimating at all, how much of that is share gain versus overall market strength?

Paul Otellini

Not for a week or so. But my sense is it is principally the market growing year-on-year so much faster and then Intel taking perhaps a slightly larger share. But the bulk of it is market growth. Remember a year ago in servers it was still pretty dark.

Operator

Thank you. Our next question comes from the line of Tim Luke with Barclays Capital.

Tim Luke – Barclays Capital

Thanks so much. Paul, I was wondering after delivering such a strong quarter with the chipsets being low sequentially while guiding obviously fairly close to normal seasonal going forward, the chipsets in the past have been for the PC is seen as a leading indicator. Can you just give some commentary with respect to that and how you might expect to see that going forward and after such a big first half people might have thought you might have a slight less than seasonal second half, but clearly you were saying we never really expect that and what is your gut on that?

Paul Otellini

Well, you know we had a very robust Q1 on chipsets. In the second quarter it was very good, I mean, our chipset shipments in Q2 always run, not that always, normally run ahead of our microprocessors because of the cycle for back to school. That happened this quarter as well. But even inside that, I don’t see any cutting back; and then there is some – each OEM has their own strategy, Tim. You know, some are accelerating the use of ocean, because they want to lower cost, some are accelerating the use of air because they want flexibility, and I think that as it all integrates, we don’t see a chipset bump in either direction as a leading indicator here, at this time it is mostly normal.

Tim Luke – Barclays Capital

As a follow-up then, it seems there is a lot of focus on the inventory issue, and do you think it is much lower in the channel? On hand it is at 86 days, which is at the upper end of the normal range. Last quarter you said part of that was refracted in just more 32 nm in the inventory bank on hand. Can you just comment on that and why it is that this appears to be the upper end of your normal level, Stacy? Thanks a lot.

Stacy Smith

Sure. It is normal for us as we go through a significant transition as we are going through on 32 nm products to have, to put some inventory in place to answer those ramps and in particular, as we look into the demand of the second half. So just to maybe help you a little bit in terms of how to think about it, if you go back to mid-2008, which was the last highest when we were going through the 45 nm transition, we had a similar amount of inventory in place, our business levels at that time. So, Q2 of 2008 was like 1.3 billion less than our business levels today. So, you know, when you look at it in that context it is as we’re still running pretty healthy appropriate level of inventory given the 32 nm transition, and the level of demand that we are seeing.

Operator

Thank you. Our next question comes from the line of Craig Berger with FBR Capital Markets.

Craig Berger – FBR Capital Markets

Hi Guys. Congratulations on the extremely strong results. I guess, my first question is on the sustainability of your gross margins. When I talk to people out there, your investors, they say how sustainable are these margins and wow! And I know you recently increased your normal range to 55 to 65 and now you are guiding ahead of that, so how do we think about the sustainability here, thanks?

Stacy Smith

I think we shared a lot back in May about the transformation that we have gone through in our cost structure, our capital efficiency, the improvements we have made in some of our memory businesses in the overall cost per unit. That data still is what I stand behind. I think we have moved the gross margin range for the company up. We are at a period of time right now because of our specific product mix that we are a bit above that. You know, you tend to have a few quarters above; you have some that are below. But as we look across the rest of this year, we are 67% in Q2. I am forecasting 67% for Q3, and frankly I would expect to be in that range in the fourth quarter as well. When you do that math that is how you get to 66% for the year.

Craig Berger – FBR Capital Markets

The follow-up question is that Europe has been running at about seven – was running at about $7 billion a year in revenue, in the downturn it fell to 5. It is only going to do about 5 to 5.5 this year if you run rate it. I mean, is a macro correction already baked into that so that European consumption number in your opinion, could there actually be upside opportunities there, how much risk to forward demand deterioration could we see?

Stacy Smith

Yes, it is really important. You are not looking at consumption there, what you are looking at is our billings. And you have seen a couple of secular shifts in Europe that is causing the billings number to decline, which you have to keep separate from the overall consumption market. One is the shift to notebooks means that more of the product is being built outside of Europe and imported in. So that is one of the big drivers, and that is probably the largest.

The second is that the multinationals are taking some share against the smaller players and again, that is if they deal in many cases outside of Europe, and then import the product into Europe. So you have to separate that from the strength of the end markets.

Operator

Thank you. Our next question comes from the line of Mark Lipacis with Morgan Stanley.

Mark Lipacis – Morgan Stanley

Thanks for taking my question. First question, correct me if I am wrong, my understanding is that historically, when you guys went through a process no transition, you built inventory of older products and then switched over and that often translated into risk and maybe some inventory write downs, and this time it seems like you guys are also building inventories on the newer products. So, I guess my question is was my recollection of history wrong or is there something different with your business process that has enabled you to do this?

Paul Otellini

No, you are not wrong but it is – there are two issues to this story. So the first is, we do try to build a little bit of inventory on the older products, in advance of the process technology ramp. And then based on how fast we are now ramping the new products and across a very wide range of different price points and different products within our product family, we also try to get some inventory in place on the new stuff. So we do both.

Mark Lipacis – Morgan Stanley

Okay, fair enough. The follow up is you know, if I look over time on the microprocessor ASP, the erosion followed something like 6% annual ASP erosion. The one time you bucked that trend I think was when you introduced Centrino where you could argue you are delivering more functionality so you could take the price up. Are you guys of the opinion that you take yourself off that 6% annual ASP erosion, are your products coming out with accelerated functionality, be it power, better power or some processing capabilities that can take you off that 6% ASP erosion, thanks?

Paul Otellini

You are right. It really is all about mix at the end of the day and to some extent, Centrino was about up mixing to mobile in the early days. What you are seeing now, we are very, very happy with the launch, ramp and product acceptance in the market of the core i3, i5, i7 series that we had launched in January that has become kind of the mainstream of desktops and notebooks now in that brand momentum is really a part of the lift you see in terms of selling up from Pentium or Celeron. I think that as we move into the second half and into next year it is the same kind of thing, we will continue to use technology, feature driven technology to put platform ingredients together that we think will command a premium. And when that happens it is good for Intel and it is good for our customers, and ultimately good for the buyers of the technology.

Stacy Smith

If I may just add, as we have shown you several times, it becomes really important to start looking at ASP and margin per segment of the business. And, you know, what we are seeing right now is that in the high end segment of the business we are doing really well. We are getting paid for those features. I think if you think about our business over a long period of time, what you are seeing is that emerging markets have grown more quickly than the rest of the business; the consumer market has grown to be a very large percentage of our business.

And so, over time there is that mix effect that does bring pricing down and so the key for us is to be able to bifurcate our cost structure, so that in each of those segments of the business we can deliver a very compelling product margin, and I think you are really seeing that play out right now in our business. We have got strong features at the high end, we have got a great cost structure for emerging markets and for the less feature driven consumer segment of the market, and that all helps us achieve 67% gross margin in the second quarter.

Operator

Thank you. Our next question comes from the line of Stacy Rasgon with Sanford Bernstein.

Stacy Rasgon – Sanford Bernstein

Hi guys, thanks for taking my question. So if I take a look that in that gross margin guidance for Q3, it looked to be on mostly on the higher revenues, which was offset by more of your inventory write-offs from Sandy Bridge. Just given what you said about what looks to be hopefully a building enterprise recovery into the second half, would it be out of line to maybe even see the potential for some further mix related upside to gross margins in the back half? It doesn’t look like your guiding to anything like that?

Stacy Smith

Yeah, let me just walk you through the Q3 gross margin, and I will also give you a little color commentary on Q4 so you can get a sense of what I am doing in that aspect. But as you said, as we open from Q2 to Q3 based on the midpoint of the revenue guidance that we just set, we would expect about 0.5 point of gross margin good news associated with higher platform revenue. That is offset by about a point of inventory write-offs for the Sandy Bridge product that is being built prior to qualification for sale. That is normal what we see on these products transitions.

And then there is another 0.5 point of relatively small items, and just in an environment where our factories are running pretty full, where demand looks good and we don’t have a lot of reserves and those kinds of things and you tend to see a lot of small things that will give me another 0.5 point of gross margin in my forecast, and that is what keeps me flat at 67%.

Could it be higher? Sure. It would be kind of foolish to say it couldn’t based on the miss that we had in Q2, but based on everything we know and the fact that Q3 tends to be a seasonally stronger consumer quarter and I think we are in the right space, and we would have to have a pretty significant revenue miss based on ASP for that gross margin to be higher and likewise if the markets fall apart, it could be a little bit lower. But this is our best information at this time.

Stacy Rasgon – Sanford Bernstein

Go ahead, I’m sorry.

Stacy Smith

Well, I was going to take you to Q4 if you want.

Stacy Rasgon – Sanford Bernstein

Oh, yes please.

Stacy Smith

Okay. So, I will do the traditional puts and takes as I go into Q4. Again, I would expect it to be a seasonally higher revenue quarter. So that can give me a little bit of a tailwind to gross margin. Assuming the qualification goes well for Sandy Bridge, which our history says is likely, we will have some write-off good news in Q4, because we will be selling some of that material because it is qualified for sale.

And then I have a bit of an offset to that based on an increase in unit cost, and I will take you back to what I showed in May at the investor meeting. If you recall, I showed a unit cost graph by quarter, and it showed a little bit of an uptick in Q4, and then more of an uptick in Q1 and Q2 due to the next big 32 nm factory coming online. It is a very large factory with a high wafer capacity. The first wafers to come out of that factory are pretty expensive.

So that gives me a bit of a mix up in cost. That is normal. If you look at our history every two years we see that. As we are pulling in 32 nm, I am now expecting that cost impact to be a little more in Q4 and probably a bit less in Q1 and Q2. So that gives me a bit of a tailwind to gross margin. When I net all that out, I think I am in kind of a same range as I was in Q2 actuals and my projection for Q3, I think I’m kind of still in that basic range.

Stacy Rasgon – Sanford Bernstein

That was helpful. Thank you very much. For my follow up I think the follow-on that into 2011, just if you could give us a little more color on the 22 nm startup cost. To my recollection, I believe those start to hit in the first half of 2011. Number one, is that correct? Secondly can you give us some feeling for the, I guess the amount of magnitude or basis points of margin impact that that could have over the, maybe the first half of 2011?

Stacy Smith

Sure. Actually, as opposed to taking time on the call, if you go back to the investor meeting materials that still is my prediction of kind of the shape of start-up costs, and we actually broke it out by quarter for you, so you can kind of get a sense our best guess. It hasn’t changed.

And you are right; at a basic level, I would expect it to start kicking in and accelerating in the first-half of next year. It would peak in Q2 and then it comes down from that.

Operator

Thank you. Our next question comes from the line of Doug Freedman with Gleacher & Company.

Doug Freedman – Gleacher & Company

Great, thanks so much for taking my question guys, and congrats again. Can you talk a little bit about what the uptick in server might mean in the enterprise market, and if you have seen in the past history when server strength was so strong, if there is sort of a follow through where the client will, the enterprise will start spending more on clients later?

Paul Otellini

You are right. That has been the pattern in the past. It was the big enterprise apps, and it drove the server upgrade and that drove ultimately a client upgrade. I don’t think it is going to apply, it normally works that way, broadly works that way anymore Doug. My sense is now so many of the apps in the enterprise are web-based that once you put the infrastructure in that is not what drives it. What drives it is the new operating system environment on the client. That will drive an upgrade. A new class of applications where people are putting in some of the cloud based apps inside the enterprise. And a new phenomenon that wasn’t really true in the last couple of rounds of these things, which is the return on investment thesis around the energy and space savings. And that is really new. So, I guess in the aggregate, I don’t see that pattern being – it probably exists, but it is probably not the driver.

Doug Freedman – Gleacher & Company

All right, great, and if I could go back a little bit to sort of the flexibility in the business model, I know there have been a few questions on this topic, but Stacy, can you focus in on, I mean, with these numbers that you are putting up, is it safe to assume that your profit sharing plan is going to be sort of at a record high level, and that as growth goes into the next year that that comes down to a more nominal level?

Stacy Smith

Well, it will see anemic to those of you that work in the financial services industry that, yeah, if you look at the spending increase that we have now put out for the year, the largest single component of that is revenue and profit dependant. It is just our view of the year has just kind of improved quarter-by-quarter. It is more than half of the annual increase, and is really driving that spending increase from what we thought.

Doug Freedman – Gleacher & Company

And it applies to all employees, management driven set of dollars.

Stacy Smith

Right, yeah, every employee participates in the plan and that is solely based on our earnings performance, and so as our view of the year improves, our earnings performance plus the metrics that we have – that is our view of the year improves than it pulls a few more dollars through.

Operator

Thank you. Our next question comes from the line of Sumit Dhanda with Banc of America/Merrill Lynch.

Sumit Dhanda – Banc of America/Merrill Lynch

Yes, hi. A couple of questions, Stacy, you know, the ASP is again benefiting you in the second quarter. You are clearly not expecting a benefit in the second half of the year, but is there you know, the potential that you continue to see a tailwind as there is more maturation into the transition to the core base platforms or is most of that benefit now reflected in your mix of processors?

Stacy Smith

Yes, I would be foolish to say there is no possibility given how my view of the year has changed just over the last two quarters. I think when we started the year we were at 61%. We are at 67%. That is just a phenomenal gross margin for us. It is an all-time record. It says that we are doing a lot of things right from cost standpoint and the market is participating along with us. Could we be a little bit better, because I would be under calling it? I could, but my prediction is that ASP is not a big driver one way or the other as we go into the third quarter. So you should take from that I am not anticipating a big movement up or down and Quarter3 does tend to be seasonally stronger in the consumer segment of the business, and so you can kind of do the math on that.

Sumit Dhanda – Banc of America/Merrill Lynch

Okay, but I guess the question specifically was that, you know, how far or long are you in terms of the benefit from the transition to the core platform because that seems to have surprised you consistently over the last two or three quarters?

Stacy Smith

Are you kind of asking where are we in 32 nm in terms of bringing out the different products?

Sumit Dhanda – Banc of America/Merrill Lynch

Exactly.

Stacy Smith

I will probably kick that over to Paul.

Paul Otellini

It is still pretty much in the core family. We just – we are stepping some Pentiums on 32 nm now. Most of the server products are on 32. But we won’t take it down into the Pentium and Celeron until either late this year or early next year and of course the Atom products are on 32.

Operator

Thank you. Our next question comes from the line of Alex Gauna with JMP Securities.

Alex Gauna – JMP Securities

Okay, first off congratulations. You just crushed it, nice job. One, if I could start by asking if you could characterize may be how far into the Core i upgrade cycle are you, and you just touched on 32 nm and where it’s going, but how far into the conversion process are we from your perspective?

Paul Otellini

I am sorry, the conversion of our old core to our new core?

Alex Gauna – JMP Securities

Well, in terms of driving saves right now, are we benefiting from the mix being less than 50% getting towards 50%?

Paul Otellini

Well, the premium part of our product line, you know, the old core products, core duo and those kinds of things and now the core i3, i5, i7 it is not the majority of our units. But it was, we have margins in excess of what Stacy has been talking about, right, so they tend to – I won’t give you the exact number but it tends to be slightly less than 50%. And then we fill in the mix with other products in terms of price points from Atom, to Celeron, to Pentium, and it is not so much a – of course, we satisfy all the available demand from the top.

You would naturally do that. So, we believe we are satisfying demand. We are seeing a mix up, which is based upon the goodness of the products and the feature sets. And that is what we talked about last quarter, and it is part of the news this quarter. We anticipate a similar kind of embracing of Sandy Bridge, when that product comes out to keep that mix fairly rich.

Alex Gauna – JMP Securities

Okay, and you touched upon emerging markets, your ability to serve I believe lower price points in emerging markets, and I was wondering if you could talk about maybe the appetite or the ability for you to up sell in some of those markets?

Paul Otellini

Well, there is no monolithic market. You know, if you look at China in the Tier 1, and to some extent now the Tier II cities, the markets there are as sophisticated in mix and purchasing knowledge that as you get in the United States or Western Europe or even Japan. And so it is when you get out into the places where the incomes are more constrained in Tier 3, 4, 5, 6 cities in China that you start seeing that phenomena, and what we have done that to work with our customers and with the distributor channel to produce products that we have new versions of Atom based motherboards, where the Atom chip is soldered onto the motherboard. So, it becomes a very affordable unit of computing that meets those price points.

There really is not a China market per se; the China market, if I look at the east coast cities, is probably a richer mix than we sell in Manhattan.

Kevin Sellers

Hey, Cassidy, we are going to take two more questions if we could.

Operator

Certainly, sir. Your next question comes from the line of Kevin Cassidy with Stifel Nicolaus.

Kevin Cassidy – Stifel Nicolaus

Thanks for taking my question. I guess along those lines of the Atom chips you had mentioned net books you think will ship about 40 million this year, and I am wondering what is your percentage outside of the net books for Atom. You had mentioned Google TV when do you think that will become a significant portion of the Atom revenue?

Stacy Smith

I think the non-net book Atom will start moving the mind next year. I mean there will be products out this year both in tablets and in handsets and Google TV kinds of products, consumer electronic kind of products. Actually our growth in embedded Atom was significant this quarter, but it was still a fairly small number as embedded designs take two years to get designed in and then they run for 3 or 4 years. So all these things start coming to flush out that family in terms of revenue I think in higher volume next year.

Kevin Cassidy – Stifel Nicolaus

Okay, thanks, and maybe just one other completely different topic, IM flash, any decisions there on the CapEx spending?

Paul Otellini

No, as we have articulated before on the call, we are doing a couple of things. One is we are continuing to drive the financial performance of the business. I think they executed great in the second quarter. Our process technology leadership has got a great cost structure. You know, the market seems pretty benign right now. So, all of those things are helpful. We are making a little money in the business as opposed to losing money. That is nice.

And then we are taking a cautious view to the capacity addition. We have to make the decision on our participation in Singapore sometime this year. We haven’t made it yet, and, you know, we continue to analyze it and look at it fairly cautiously.

Kevin Cassidy – Stifel Nicolaus

Okay, thank you. Congratulations.

Operator

Thank you. Our next question comes from the line of Daniel Berenbaum with Auriga USA.

Daniel Berenbaum – Auriga USA

Yes, hi guys. Thanks for sneaking me in there. Just to follow up a little bit on mix, I mean, it looks right now the data center is about 20% of sales. Do you think that as the server cycle plays out and as Nehalem continues penetration there you know, do you have a target you think that data center could go to 25% of sales or do you have some mixed number in mind?

Stacy Smith

Well, I have a mix number in mind. I am not prepared to share it. But you know to some extent, we don’t look at it that way. I mean, I know you guys do because that is the easiest way to drive the math, but we look at it as what is the rate of growth of internet traffic, what is the rate of growth of replacements and try to maximize that server number for the obvious reasons and what that is as a percent of client revenue is really not something. As the earlier question came to me, it is not something that really is relevant anymore. I think they are independent decisions.

Daniel Berenbaum – Auriga USA

Well, let me maybe rephrase that. What do you think the growth rate of the data center is over the next say year, year and a half versus client?

Stacy Smith

I am comfortable saying I think we are strong double digits and I don’t think I want to go more granular than that. But I gave you one really interesting fact in my commentary, a 170% year-on-year growth in internet data center, right, those are the ones that go into the googles, facebooks, amazons, MSN, those kinds of things. That stuff is growing like a host, and as people do more picture serving and more video serving that is going to continue to grow.

So to some extent you have got that triple digit growth in the internet data centers and then you have to model out the ROI for corporations doing the upgrade versus capacity needs.

Kevin Sellers

Okay, thank you all for joining our call today. As a reminder, our quiet period for the third quarter will begin at the close of business on Friday, August 27. And our third quarter earnings conference call is scheduled for Tuesday, October 12, 2010. Thank you and good night.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.