Intel's (NASDAQ:INTC) "contra revenue" effort with its bay trail chips aims to aggressively push these chips into low-end tablets by subsidizing the increased bill-of-materials imposed on manufacturers who use bay trail instead of a more integrated solution from another supplier. What kind of toll will this effort have on Intel's bottom line? A few straight forward calculations give us an idea.
During the first quarter 2014 earnings report, Intel guided to Q2 revenue of about $13 billion and a Q2 gross margin of about 63%. In his commentary on the first-quarter results, CFO Stacy Smith indicates that tablet contra revenue (actually it is described as tablet impact which I infer means contra revenue) will have a -0.5% impact on Q2 gross margin. Gross margin is defined as:
Percentage Gross Margin = 100*[Revenue - (Cost Of Goods Sold)]/Revenue
Contra revenue is a negative contribution to revenue and doesn't affect the cost of goods sold. Holding cost of goods sold constant and solving for the revenue Intel would have guided to without the -0.5% impact caused by tablet contra-revenue yields $13.178 billion.
So, we can conclude that contra revenue will have a $178 million impact on Intel's Q2 revenues. This revenue would have carried over directly to Intel's bottom line, so the contra revenue will reduce Q2 earnings by about the same amount. That is about 3.5 cents per share or about a 10% hit to forecasted Q2 earnings per share of about 40 cents.
In the short term, contra revenue will have a very negative impact on Intel's earnings. However, investors should expect a nice bump to Intel's bottom line when contra revenue goes away later this year into next as Intel transitions to more integrated tablet solutions on its 14-nm node.
Disclosure: I am long INTC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.