Last week I gave my initial thoughts on Intel's (NASDAQ:INTC) Q4. Revenues for Intel are only expected to increase a few percentages and gross margins are actually expected to decline from 62% to 60%. Yet operating expenses are also projected to increase 4%. What really caught my eye and has provoked me to take a closer look was the massive $13B of capital spending that Intel has planned for 2013. I know that Intel has massive operating cash flow, but can Intel really afford to do this much capital spending, pay its dividend and buy back stock?

The thing we need to look at is the FY 2013 outlook provided by Intel:

## Full-Year 2013

Revenue: low single-digit percentage increase.Gross margin percentage: 60 percent, plus or minus a few percentage points.R&D plus MG&A spending: $18.9 billion, plus or minus $200 million.Amortization of acquisition-related intangibles: approximately $300 million.Depreciation: $6.8 billion, plus or minus $100 million.Impact of equity investments and interest and other: net gain of approximately $100 million.Tax Rate: approximately 25 percent.Full-year capital spending: $13.0 billion, plus or minus $500 million.

It may not look like much, but there is a major amount of information in this outlook. Now, in this analysis, I will be using both the "best case" and "worst case" numbers and "midpoint" numbers:

Revenue: FY 2012 revenue came in at $53.3B. A "low single-digit" increase could be any number from 1-5. I will use 5 for the best case and 1 for the worst case and 3 for the midpoint. Multiplying $53.3B by 1.05 gives us an estimated $55.96B in 2013 best case revenue. Multiplying $53.3B by 1.01 gives us an estimated $53.83B in 2013 worst case revenue. Multiplying $53.3B by 1.03 gives us an estimated $54.90B in 2013 midpoint revenue.

Gross margin percentages: The 2013 outlook for gross margin is 60 percent, plus or minus a few percentage points. A "few" percentage points could be almost any single digit number. For my analysis, I will be using 58% for the worst case gross margin and 62% for the best case margin and 60% for the midpoint. Using the best case margin and revenue, we arrive at $34.70B in gross margin. Using the worst case margin and revenue, we arrive at $31.22B in gross margin. Using the midpoint margin and revenue, we arrive at $32.94B in gross margin.

Operating expenses: The 2013 outlook for R&D plus MG&A spending is $18.9 billion, plus or minus $200 million. Amortization of acquisition-related intangibles for 2013 are estimated to be approximately $300 million. For the worst case operating expenses, I will be using $19.1B in R&D plus MG&A and $0.3B in amortization, for a total of $19.4B in operating expenses. For the best case operating expenses, I will be using $18.7B in R&D plus MG&A and $0.3B in amortization, for a total of $19.0B in operating expenses. For the midpoint operating expenses, I will be using $18.9B in R&D plus MG&A and $0.3B in amortization, for a total of $19.2B in operating expenses.

Depreciation: The 2013 outlook for depreciation is $6.8 billion, plus or minus $100 million. For the best case number, I will be using the $6.9B in depreciation. For the worst case number, I will be using the $6.7B in depreciation. For the midpoint number, I will be using the $6.8B in depreciation.

Impact of equity investments and interest and other: I will be using the 2013 outlook of a net gain of approximately $100 million for all three projections.

Tax Rate: I will be using the 2013 outlook of 25 percent for all three projections.

Capital spending: The 2013 outlook for capital spending is $13.0 billion, plus or minus $500 million. For the best case number, I will be using the $12.5B in capital spending. For the worst case number, I will be using the $13.5B in capital spending. For the midpoint number, I will be using the $13B in capital spending.

Now that we got these numbers, let us figure out some other key metrics:

Operating Income: Using the best case gross margin of $34.70B and subtracting the best case operating expenses of $19.0B, we arrive at the best case operating income of $15.7B. Using the worst case gross margin of $31.22B and subtracting the worst case operating expenses of $19.4B, we arrive at the worst case operating income of $11.82B. Using the midpoint gross margin of $32.94B and subtracting the midpoint operating expenses of $19.2B, we arrive at the midpoint operating income of $13.74B.

Taxable income: For this, we only need to add $100 million to the operating income for all three projections. For the best case, this leads to $15.8B. For the worst case, this leads to $11.92B. For the midpoint, this leads to $13.84B.

Taxes: For all three projections, we are using the 25% tax rate. For the best case, this leads to $3.95B in taxes. For the worst case, this leads to $2.98B in taxes. For the midpoint, this leads to $3.46B in taxes.

Net income: We arrive at net income by subtracting taxes from taxable income. Using the best case operating income of $15.7B and subtracting the best case taxes of $3.95B, we arrive at the best case net income of $11.75B. Using the worst case operating income of $11.82B and subtracting the worst case taxes of $2.98B, we arrive at the worst case net income of $8.84B. Using the midpoint operating income of $13.74B and subtracting the midpoint taxes of $3.46B, we arrive at the midpoint net income of $10.28B.

Operating Cash Flow: We arrive at operating cash flow by adding net income and depreciation. Using the best case net income of $11.75B and adding the best case depreciation of $6.9B, we arrive at the best case operating cash flow of $18.65B. Using the worst case net income of $8.84B and adding the worst case depreciation of $6.7B, we arrive at the worst case operating cash flow of $15.54B. Using the midpoint net income of $10.28B and adding the midpoint depreciation of $6.8B, we arrive at the midpoint operating cash flow of $17.08B. Operating cash flow is a key figure, as it is used to pay dividends, capital spending and share buybacks.

Earnings per share: Using the Q4 shares outstanding of 5.095B, we can also estimate Intel's EPS. The best case EPS would be $2.31. The worst case EPS would be $1.74. The midpoint EPS would be $2.02. Note that announced share buybacks will inflate this number.

Free cash flow: We arrive at free cash flow by subtracting capital spending from operating cash flow. Using the best case operating cash flow of $18.65B and subtracting the best case capital spending of $12.5B, we arrive at the best case free cash flow of $6.15B. Using the worst case operating cash flow of $15.54B and subtracting the worst case capital spending of $13.5B, we arrive at the worst case free cash flow of $2.04B. Using the midpoint operating cash flow of $17.08B and subtracting the midpoint capital spending of $13B, we arrive at the best case free cash flow of $4.08B. Free cash flow is the cash that is left over to make dividend payments and share buybacks.

Summary:

*(click to enlarge)*

As of Q4, Intel had 5.095 billion shares outstanding. Intel's current annual dividend is $0.90 per share. This means Intel needs to make about $4.58B per year in dividend payments. Only the "best case" FCF numbers have Intel cover the dividend, and only then barely. It is no wonder Intel needed to issue debt to pay for the previously announced share buyback program. It is very likely that Intel will be spending more cash than it generates in 2013 and will therefore be FCF negative.

## Conclusion

I can now see why Intel's stock dropped so sharply on Friday. Using the midpoint of Intel's own 2013 estimates, we can see that EPS would fall 5%. Using the worst case scenario, EPS would fall 19% from 2012 levels. Only the best case scenario would see an EPS increase of 8%. The average analyst estimate for FY 2013 EPS is actually $1.93. The prospect of negative free cash flow is also not appealing. However, I do not think Intel's dividend is in danger. As of Q4, Intel had $8.5B in cash and $4B in short term assets. That being said, I do think that a large dividend increase for 2013 is now unlikely. Intel will, in my opinion, give instead a token increase of the dividend (less than 5%).

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