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Intel Corporation (NASDAQ:INTC)

Q4 2006 Earnings Call

January 16, 2007 5:30 pm ET

Executives

Alex Lenke - Investor Relations

Paul Otellini - Chief Executive Officer

Andy Bryant - Chief Financial Officer

Analysts

Glen Yeung - Citigroup

Tim Luke - Lehman Brothers

Sumit Dhanda - Banc of America Securities

Joseph Osha - Merrill Lynch

Hans Mosesmann - Nollenberger Capital

John Lau - Jefferies & Company

David Wong - A.G. Edwards & Sons, Inc.

Cody Acree - Stifel Nicolaus

Jim Covello - Goldman Sachs

Adam Parker - Sanford Bernstein

Chris Danely - J.P. Morgan

Mark Edelstone - Morgan Stanley

Michael Masdea - Credit Suisse

Charlie Glavin - Needham & Company

Uche Orji - UBS

Mark Lipacis - Prudential Equity Group

Gus Richard - First Albany Capital

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the Intel fourth quarter 2006 earnings conference call. My name is Latitia and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference.

(Operator Instructions)

At this time, I will now turn the presentation over to Mr. Alex Lenke, Manager, Investor Relations. Please proceed, sir.

Alex Lenke

Welcome to the Intel fourth quarter earnings conference call. Attending from Intel are CEO Paul Otellini and CFO Andy Bryant. Before we begin, please bear with me while I read our safe harbor language.

The fourth quarter earnings report discusses Intel's business outlook and contains forward-looking statements. These particular forward-looking statements and all other statements that may be made on this call that are not historical fact are subject to a number of risks and uncertainties, and actual results may differ materially. Please refer to our press release for more information on the risk factors that could cause actual results to differ. The specific forward-looking statements cover expectations for product mix and demand, revenue, gross margin, expenses, tax rate, interest and other income, R&D spending, capital spending, and depreciation. These statements do not reflect the potential impact of any mergers, acquisitions, divestitures, investments or other business combinations that may be completed after January 15, 2007.

Lastly, if during this call we use any non-GAAP financial measure as defined by the SEC in Reg G, you will find on our website, intc.com, the required reconciliation to our most directly comparable GAAP financial measure.

With that, let me turn it over to Paul.

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Paul Otellini

Thanks, Alex. In the fourth quarter, revenue was at the top of the range we set in October, driven by a strong mix shift to our new core microarchitecture in servers, mobile and the desktop.

Microprocessor units came in about as expected and set an all-time record, with unit and revenue records in both server and mobile.

For the year, Intel achieved record mobile and server processor units, FLASH units, and chipset billings. Our 65-nanometer transition was superbly executed, with more than 70 million units shipped during the year. 65-nanometer leadership allowed us to drive down the cost of dual-core computing, boosting dual-core volumes to over 50% of total Q4 microprocessor shipments. In mobile, we took dual-core from zero to over 90% of the performance mix in the course of one year.

We continued to advance our technology in Q4 by launching the industry’s first quad-core processors for volume servers and PCs. We launched nine different versions, including the first Core 2 Quad processors for mainstream PCs, and we are well on track to deliver 1 million quad-core processors by the middle of next year.

We also completed the development of our 45-nanometer technology, which is scheduled for production in the second-half of this year. I am pleased to announce that we have working samples of Penryn, our first 45-nanometer microprocessor, and have booted four different operating systems on this first silicon.

In mobile, we saw record units and revenue on the strength of our product line. We look forward to launching our new Santa Rosa platform later in the first-half, which supports new integrated graphics, our Robson NAND Flash technology, and our 802.11n WiFi technology, which has already begun to ship.

During the quarter, we demonstrated our first mobile WiMAX silicon and are developing products that work on both WiMAX and WiFi networks, automatically giving users the best available broadband connection.

Desktop revenues were higher on the strength of Core 2 Dual, while overall units were below seasonal, as desktop growth continued to be offset by the demand shift to mobile.

The digital home business had record units and revenue, driven by the ramp of our VIV technology.

Our server business had record units, while strong demand for new products led to record revenue of over $1 billion. The energy-efficient Woodcrest processor exceeded 50% of total server units and Itanium revenues were at record levels.

Our Clovertown quad-core processor extended the industry records set by Woodcrest, with energy performance 60% higher than Woodcrest and up to two-and-a-half times the competition’s best.

Chipset units were approximately flat from the third quarter, and billings set a record for the year. Our Flash business set a new unit record, with growth in NOR as well as in our new NAND business. We also began volume shipments of the first 65-nanometer NOR memories that can store a gigabit of data on every chip.

During the quarter, we continued to take significant actions to increase our operating efficiency and reduce ongoing costs. Our employee headcount ended the year at 94,100 people, down from 102,500 at mid-year. Our spending is trending lower, as Andy will discuss, and our capital forecasts now reflect savings identified in our structure and efficiency review.

In summary, 2006 was a challenging year and our response was to drive for product and technology leadership aligned with the fastest growing segments of the marketplace. We were pleased to end the year with strong market acceptance of our advanced technologies, including the new Core 2 Dual and Xeon processors.

In 2007, we will continue to drive technology, including quad-core and 45-nanometer, while further increasing our operating efficiencies across the company.

Let me now turn the call over to Andy.

Andy Bryant

Thanks, Paul. The fourth quarter was a strong ending to a difficult year. Revenue was higher than the third quarter in all geographies, led by revenue for server, mobile and desktop processors, which together were up 14% sequentially. For the second quarter in a row, the server business delivered double-digit sequential and year-to-year growth.

Gains from a divestiture, less asset impairment charges caused by this divestiture, contributed a net gain of about $0.025 to earnings per share. Diluted shares for the year were down 5% from the prior year. Headcount is lower by nearly 6% for the quarter and the year.

As we look ahead to 2007, we are on target to generate savings in costs and operating expenses of approximately $2 billion.

Revenue for the fourth quarter was $9.7 billion, at the top of the range we forecast in October, and up 11% from the third quarter. The growth came from higher average selling prices and unit volumes of microprocessors and from higher revenue from Flash memory.

As was the case in the third quarter, the server business led the percentage growth in revenue with higher units and higher average selling prices. The mobility group led the dollar growth, with higher revenue for microprocessors, wireless and chipsets.

Microprocessor revenue in the digital enterprise group of $3.9 billion grew 9%, its strongest sequential growth rate in eight quarters. The mobility group achieved growth in microprocessors of 19%, its best sequential growth in over eight quarters.

Revenue from chipsets, motherboards, and other products in the digital enterprise group was $1.3 billion, down 8% from the third quarter, while revenue for chipsets and other products in the mobility group was $925 million, up 14%.

In a year-to-year comparison, quarterly revenue was down approximately 5%. Lower revenue in digital enterprise group more than offset growth in the mobility group. Among the geographies, the only year-to-year revenue growth came from the Americas region.

Gross margin dollars, including the effect of share-based compensation of $94 million, were $4.8 billion, 12% higher than in the third quarter. Gross margin percentage was in line with our forecast and approximately flat with the third quarter. The percentage was 49.6% on a GAAP basis and 50.6% excluding share-based compensation.

Under-load charges on the 90-nanometer network and the factories lowered gross margin from the third quarter by about two points. Write-downs and other gross margin reductions in the Flash memory business took nearly an additional point. These charges and Flash results offset much of the contribution to gross profit provided by higher average selling prices and unit volumes for microprocessors.

In a year-to-year comparison, gross margin percentage, excluding share-based compensation, is approximately 11 points lower than the fourth quarter of 2005, primarily a result of lower average selling prices for microprocessors.

We continue to bring spending down as a percentage of revenue during the quarter, and we significantly lowered headcount. R&D and MG&A were approximately $2.9 billion. Excluding share-based compensation of $240 million, spending was approximately $2.6 billion, a little higher than in the third quarter and just above our forecast in October.

Compared to a year ago, spending excluding the impact of share-based compensation decreased approximately 12%. As Paul mentioned, the number of employees is down nearly 6,000 to 94,000.

During the quarter, we completed the sale of certain assets of the company’s communications and application processor business. The financial impact of this transaction are reflected in two categories of the income statement. A gain of $483 million is included in interest and other income. With the sale of this business, we plan to deconstruct facilities and to sell a factory, resulting in charges for asset impairments of $317 million that are included in restructuring and asset impairment charges.

Total restructuring charges and asset impairments were $457 million, consisting of the impairments related to the divestiture in employee severance charges from the efficiency program.

Fully diluted earnings per share were $0.26. Excluding share-based compensation, earnings per share is $0.30. The gain from the divestiture plus the related impairments resulted in a net gain in earnings per share of approximately $0.025.

On the balance sheet, inventory declined during the quarter by $163 million, or 4%, to $4.3 billion. Work in process and finished goods are lower than the third quarter, driven primarily by reduced wafer starts to control inventories.

Total cash investments, comprised of cash, short-term investments, and fixed income trading assets, ended the quarter at $9.6 billion, an increase of $1.8 billion from the third quarter. Most of the increase came from cash flow from operations and proceeds from divestitures.

Capital spending was $1.1 billion, stock repurchases were $150 million, and dividend payments were nearly $600 million.

As we now turn to the outlook for the first quarter, please keep in mind that unless otherwise specified, the forecasts do not include the effect of any new acquisitions, divestitures, or similar transactions that may be completed after January 15th. I will use the midpoint of forecast ranges when making comparisons to specific periods.

We are planning for revenue, which is typically lower in the first quarter, to be between $8.7 billion and $9.3 billion, a decrease of approximately 7%.

Our expectation for gross margin percentage, including the effects of share-based compensation in the first quarter, is 49%, plus or minus a couple of points. This is nearly a point lower than the fourth quarter. Lower revenue than the fourth quarter will lower gross margin. Start-up costs related to the 45-nanometer process will reduce gross margin percentage by just under three additional points from the fourth quarter.

Fewer write-downs versus the fourth quarter and lower unit cost of microprocessors will partially offset the margin declines listed above.

Spending, R&D plus MG&A, including share-based compensation, should be approximately $2.6 billion to $2.7 billion, down approximately 7% from the fourth quarter, due primarily to lower operating and marketing expenses. In addition, in a separate category for restructuring and asset impairments, we expect expenses of approximately $50 million, down from $457 million in the fourth quarter.

We are on track with the previously announced plan to reduce headcount to approximately 92,000 by mid-year, which will be 10,500, or 10% lower than the middle of 2006.

Looking ahead to the full-year, we are planning for gross margin percentage of approximately 50% plus or minus a few points, including share-based compensation. We expect start-up costs to amount to about two points worth of gross margin compared to 2006 and under-load charges beyond the first quarter to be minimal.

Cost-saving actions in 2006 will be reflected in significantly lower spending in 2007. The forecast for research and development is approximately $5.4 billion, almost $500 million lower than 2006. Total spending, including R&D and MG&A, but not restructuring charges, is forecasted to be $10.7 billion, down 11% or $1.3 billion from 2006.

Efficiency efforts will also lower capital spending, which is targeted at $5.5 billion, plus or minus $200 million.

In summary, outstanding new products, leadership in manufacturing technology, comprehensive cost savings, and disciplined execution have delivered a solid second-half and built a strong foundation for 2007. Business remains competitive and we remain focused on doing the right things in the year ahead -- delivering compelling products, competing for sales, attacking costs, executing superbly with 45-nanometers, and pushing ahead with the next generation.

With that, let me turn it over to Alex for Q&A.

Alex Lenke

Thanks, Andy. We will now open the conference call for Q&A. We will attempt to take questions from as many participants as possible. To help in this process, we ask that you please limit yourself to only one question and no more than one brief follow-up. Thank you. Operator, go ahead.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Glen Yeung with Citigroup. Please proceed.

Glen Yeung - Citigroup

Thanks for letting me ask a question here. I guess I have two questions, both of them are focused on gross margin, so Andy, maybe best for you. Looking at your ’07 guidance of 50%, really not a lot of improvement, even off of the fourth quarter number that you just printed. I wonder if you could talk to us as you have in the past about -- and you mentioned start-up costs, but what start-up costs are expected to be, what unit costs are expected to do, and what you think ASPs will do in ’07?

Andy Bryant

I will almost answer all those. On start-up costs, first, a little tutorial. In the Intel business, you always have some level of start-up costs. We always have a new process or a new factory or a process changing from a factory, so in general, you would expect us in a year to have about two points of margin dedicated to start-up costs. In 2007, we will have approximately four points of margin deterioration because of start-up costs, because of the start-up for the 45-nanometer process. So that is step one.

The other thing I would tell you, even though it was not asked, 70% approximately of those start-up costs will be in the first-half of the year, so it is a front-end loaded cost.

Now, in terms of unit costs, we are seeing lower unit cost of microprocessors in the first quarter. That is one of the things that keeps margin actually a little higher than you would expect with this revenue drop. I expect to see unit costs continue down through the year, so I think I will have a very good progress through 2007 on unit costs of microprocessors.

The one I can’t give you is we will not do an ASP forecast today. What I would tell you is we do anticipate a continued competitive business environment.

Glen Yeung - Citigroup

Okay, and part of your answer segues into the second question, which is the pattern of gross margins in ’07, particularly given your statements about where we will see the start-up costs over the course of the year. It sounds like it is relatively safe to assume that it is low in the first-half, much stronger in the second-half, and is it fair to say that start-up costs kind of revert back to normal in ’08?

Andy Bryant

Yes, but let me be careful. If you talk about start-up costs, it is high in the first-half, lower in the second-half.

Glen Yeung - Citigroup

Right, I’m sorry, gross margins is what I am referring to.

Andy Bryant

Okay, gross margin then flips on that, so I wanted to make sure we go that one. At this point, I would expect ’08 to revert to normal, yes.

Glen Yeung - Citigroup

Okay, great, thanks.

Operator

Your next question comes from the line of Tim Luke with Lehman Brothers. Please proceed.

Tim Luke - Lehman Brothers

Thank you. Andy, just as a follow-up to that, as you plan your 50% gross margin guidance for the full year, and given your commentary on the first-half impact of the start-up costs, should we logically see some sequential progression through each quarter of the year, or with seasonal decline in revenue, would it be sort of flattish or lower in the second quarter?

Andy Bryant

I really do not want to make a second quarter forecast yet. What we did say is in the first quarter, you should see just under three points margin deterioration from the fourth quarter for start-up costs. We said the full year has a two point effect, approximately 70% of the full year is in the first-half, and other than that, I really do not want to do much more talking about the second quarter.

Tim Luke - Lehman Brothers

As a follow-up, I might then ask, you referred to your expenses being somewhat above your forecast. Could you give some clarification there, and on the assumptions for the $2 billion in cost-cutting? Thank you.

Andy Bryant

Sure. The expenses were a bit above the range I gave at the beginning of the quarter. There were three reasons for that. One is with higher revenue, we had slightly higher Intel Inside accrual expenses. Two, with higher profits than we anticipated, we had a little bit higher profit dependent expenses, and then the third effect is even though I am 1,000 heads lower than I expected to be, the rate at which they left the company was later in the quarter, so I had a little bit more expense because of that.

What was the second?

Tim Luke - Lehman Brothers

$2 billion.

Andy Bryant

On the $2 billion, you can actually see it if you do a year over year on the spending, you see it down $1.3 billion. The tougher part to see is in manufacturing. You will have to take my word for it. We actually could show you some of the programs at the analysts meeting, give you a sense for the very specific programs that lead to easily $0.5 billion. I could give you some more detail there on the savings that we expect to see out of the capital budget as well.

I am pretty comfortable. I have seen $2 billion and it will surprise me if I didn’t get a little bit more.

Operator

Your next question comes from the line of Sumit Dhanda with Banc of America Securities. Please proceed.

Sumit Dhanda - Banc of America Securities

Hi, Andy, I guess this question is for you again. I just want to be clear on the start-up cost impact. Are you suggesting the gross impact is four points, which equates to something close to $1.5 billion in start-up costs? Is that all just 45-nanometer related, or does that include start-up costs from [inaudible], and if so, what is the breakout?

Andy Bryant

So you’re thinking of the full year?

Sumit Dhanda - Banc of America Securities

Yes.

Andy Bryant

So in the general running of Intel's business, there are about two points of gross margin, two percentage points. I am letting you pick your revenue number, so you multiply that by two percentage points and you get the baseline. There will be an additional two points of margin deterioration in 2007 due to the high cost of the 45-nanometer start-up, so yes, take whatever your revenue is, 4% is equal to -- actually, not whatever yours is but whatever ours is, and it will be close enough. We will not be that far off. 4% of that cost is the total start-up cost for the company, approximately, in 2007.

Sumit Dhanda - Banc of America Securities

But the incremental deterioration is only two points versus 2006, correct?

Andy Bryant

That is absolutely correct. It is an incremental two points, of which you start to see that in the first quarter. The first quarter itself has, as I said, just under three points increased deterioration to margin due to start-up costs. The first-half of the year has 70% of those costs.

Sumit Dhanda - Banc of America Securities

I guess as a follow-up to this, what I am unclear on is as you think about the cost side of the equation, clearly the start-up costs are a bit of a headwind, and you do have slightly higher depreciation, but I would have anticipated more of a benefit from lower labor costs due to the reduction in manufacturing, headcount, and then on the materials line, at least as a percentage of costs trending down, given better unit costs.

I am just trying to figure out why this does not equate to better gross margins, despite the start-up cost headwind that you have.

Andy Bryant

Again, we could each have different models. We do believe it is still going to be a competitive business environment and we are going to have to fight to win orders.

Sumit Dhanda - Banc of America Securities

Okay, let me just ask a final question. If you were to think about where there is the biggest delta to your gross margin forecast, what line item would that be?

Andy Bryant

The biggest risk to my forecast, is that the question?

Sumit Dhanda - Banc of America Securities

Risk, positive or negative.

Andy Bryant

So the start-up costs are pretty predictable, so I will not bring that as a positive or a negative. As is always the case, price has the biggest effect because it starts with a bigger number. Cost of unit, how full the factories are probably the second biggest variable.

Sumit Dhanda - Banc of America Securities

So what kind of a price decline have you built into your forecasting? This is my last question.

Andy Bryant

At least you are saving the one for last you knew that I would duck. We are trying not to make a full-year revenue forecast. We are trying not to make an ASP forecast this year.

Operator

Your next question comes from the line of Joseph Osha with Merrill Lynch. Please proceed.

Joseph Osha - Merrill Lynch

Hi there. Two questions. First, are you able to say whether you expect inventories to be down in the first quarter or not? What is your thought there?

Andy Bryant

What I would expect, Joe, with revenue being down some, if we can kind of stay flat, I would be pretty satisfied with that result. That would be a goal.

Joseph Osha - Merrill Lynch

So flat, do you think?

Andy Bryant

That is the goal. It is tough to hold it in a declining revenue environment, but I think we have a shot at it.

Joseph Osha - Merrill Lynch

Secondly, on the start-up costs issue, I just for the heck of it while you have been talking here, I went back and found your comments from the fourth quarter of ’05, and you talked about start-up costs for 65-nanometer being an issue. I guess I am just wondering whether we are in an environment now where you are going to have to deliver process innovations at an increasing rate in order to compete, and whether we should necessarily think about there being a point at which this kind of start-up cost treadmill ends.

Andy Bryant

I do not think so, Joe. We are pretty consistent on our two-year treadmill that we have been on for years and years and years. We think we stay on it. We do not accelerate it. We also think we do not drift back from it. So I do think that leaves us with every two years, a new generation of start-up spike.

We did look back at ’05 to see if it is in the same magnitude. Quite frankly, it is similar to the magnitude we are seeing for ’07. I had hoped it would be a little less because we are ramping three factories instead of four. The difference is the equipment is a little more expensive, so the costs per factory is up a little bit. It turns out to be about the same dollars.

Joseph Osha - Merrill Lynch

So you think you can jump off of this treadmill in ’08, at least briefly?

Andy Bryant

Well, we did in ’06, so yes, if you look at ’06, it was what I would call the standard load. If you look at ’08, I see no reason that we can’t get back to the standard load.

Joseph Osha - Merrill Lynch

Okay, thank you.

Operator

Your next question comes from the line of Hans Mosesmann with Nollenberger Capital. Please proceed.

Hans Mosesmann - Nollenberger Capital

Thanks. Paul, a question on Vista. There is a lot of anticipation about this operating system. What is your observation regarding the launch and how it has impacted Q4 and perhaps the first-half of the calendar year? Thanks.

Paul Otellini

Well, we are optimistic about the launch and the prospects for Vista, particularly in the consumer markets. I think it is going to be instant adoption for new machines right out of the chute, and that is particularly important when you think about the fourth quarter, where the action was. The action in the fourth quarter was in consumer notebooks and they sold at record numbers despite the spectre of a Vista launch in January.

I am optimistic that Vista will help us across the board in consumer sales, including the hottest part of the market, which is notebooks right now.

Hans Mosesmann - Nollenberger Capital

Has it changed the linearity at all for Q1, based on historicals?

Paul Otellini

Not from our perspective. Our loading with our customers is in normal linearity in terms of the backlog by month.

Hans Mosesmann - Nollenberger Capital

Okay. Thank you very much.

Operator

Your next question comes from the line of John Lau with Jefferies & Company. Please proceed.

John Lau - Jefferies & Company

Great, thank you. I wanted to circle back to the server area. You had mentioned that you had record units and ASPs for your server unit. Given the competition has indicated that they are much lower, it would imply that you have gained a significant amount of market share going forward.

The gross margin is a little bit lower. You are guiding down almost a percentage lower than you did last quarter. Do we take that to assume that you will continue to be very price sensitive and competitive in that marketplace to continue gaining market share? Thank you.

Paul Otellini

Maybe I will answer the first part of the question, and Andy can speak again to the gross margin, but we do not give and we are not going to give a gross margin by product segment, at least in terms of forecast.

You are right. We did have record units in servers. It was not a record ASP. It was a sequentially increased ASP, and we are very comfortable with that. That reflects rapid adoption of Woodcrest and some of the quad-core products.

In terms of market segment share, I think it is a little premature to answer that question, but we are optimistic that our surge in Q4 in servers will reflect our market share as the numbers are calculated.

John Lau - Jefferies & Company

Going forward, are you, with the gross margin overall, I am not asking about the specific server area, but if you are guiding gross margins to be lower about a percentage point, some of that is start-up costs, of course, but are you going to maintain that competitive pressure to gain back the market share that you may have lost in 2006? Is that part of your goal?

Paul Otellini

I continue to believe that our shareholders are best served by Intel using its capacity to retake market share that we lost this year. Nothing has changed there, except that we perhaps now have a much better product portfolio to do that with. The flexibility and the breadth of that product portfolio gives us a number of pricing options.

John Lau - Jefferies & Company

Great, thank you very much.

Operator

Your next question comes from the line of David Wong with A.G. Edwards. Please proceed.

David Wong - A.G. Edwards & Sons, Inc.

Thank you very much. Could you give us an indication of your gross margin guidance, how much of that is impacted by NAND start-up costs and any other assumptions associated with NAND? Are you assuming any NAND write-downs in 2007?

Andy Bryant

I do not know that I am assuming any NAND write-downs in 2007. The product is just launching and getting started. There are start-up costs in the routine part of the business associated with NAND.

One of the things that happened from the third quarter to the fourth quarter, the reason margin did not rise as much as we would have expected with that kind of revenue growth is we did have additional NAND start-up costs and we did have some write-downs of some flash inventory.

There is nothing baked in that is remarkably different. It is a ramping business. It is a new business. New factories are being brought to bear and as those come online, you will see start-up costs for those as well.

David Wong - A.G. Edwards & Sons, Inc.

One further one, if I might. Could further divestitures change either revenue or your gross margin or op-ex guidance for 2007, or have you pretty much done all the things that might have a big impact on 2007 income statements?

Andy Bryant

Well, certainly everything we have done is reflected in the outlook we provide you and I cannot comment on anything that is being considered.

Operator

Your next question comes from the line of Cody Acree with Stifel Nicolaus. Please proceed.

Cody Acree - Stifel Nicolaus

Thanks. Andy, could you talk about where you stand on the crossover for the new microarchitecture?

Andy Bryant

As far as production?

Cody Acree - Stifel Nicolaus

Yes.

Andy Bryant

It is essentially done. If I look at the inventories I have in the processor space, it is almost completely transitioned. So essentially think of processors on the new 65-nanometer silicon chipsets rapidly getting to be 100% of the 90-nanometer.

Cody Acree - Stifel Nicolaus

So what variable or I guess what incremental impact do you have as you go into the next couple of quarters of utilization rates and yields and manufacturing? If we are already all the way over to the new microarchitecture, how much of an impact can that have outside of just these fluctuations in the start-up costs?

Andy Bryant

Well, you know, we show you the traditional quarterly cost per unit chart at the analyst meeting. I think what you will see is a pretty solid progress throughout 2007 on that. The same thing will happen in the chipset spaces. We are bringing Crestline into the 90-nanometer 12-inch factories. You will start to see some benefit there.

If demand went up and the factories were more loaded, you would see some benefit there. Quite frankly, if demand softens, you would see more under-load charges.

Paul Otellini

There is one other factor, which I think is the mix of quad versus dual versus single core processors over the course of the year. Our roadmap would have us continuing to ramp the quad-core, which effectively utilizes more capacity than the dual-core, and the dual-core will continue to move down in our price stack over the course of the year, which effectively gives us more capacity in the single-core. We think that is a very cost-effective and competitive move, given the 65-nanometer die sizes.

Cody Acree - Stifel Nicolaus

So you mentioned, Andy, the internal inventories into Q1, the target is to try to keep them about flat, regardless of the revenue trends. Are you comfortable then at that inventory level? Or as we move on into a revenue growth period, are you hopeful that you can work those down any further?

Andy Bryant

I hate to make an inventory forecast out through the year. I would guess it would still come down a little bit, to be honest. I am in a situation now, we said we took about two points of under-load charges in the fourth quarter, which was more than we expected as the quarter began. We did cut back wafer starts in the 90-nanometer factories. I have under-load charges in the first quarter as well, again in the 90-nanometer factories.

From that point through the rest of the year, I think I am in pretty good shape, so yes, I would like to manage my inventories not to grow. I would like to manage them to be down some. If revenues are up seasonally in the second quarter, it makes it a little bit tough, but that would be a good goal, and then to get some benefits in the back-half of the year.

Cody Acree - Stifel Nicolaus

All right, and lastly, do you want to take a shot at where you stood with market share here at the end of the year?

Andy Bryant

Not really. We have frequently speculated before we have seen final numbers and it is a guessing game. We would just as soon wait and see what actually gets published from the people who have the numbers.

Cody Acree - Stifel Nicolaus

Any places you feel you definitely gained share?

Andy Bryant

Again, the speculation game has not worked very well, so I think we will just wait and see what gets published.

Operator

Your next question comes from the line of Jim Covello with Goldman Sachs. Please proceed.

Jim Covello - Goldman Sachs

Good afternoon, guys. Thanks so much. Andy, could you update us on the plans through the strategy with the NOR flash business at this point going forward?

Andy Bryant

The plans with the NOR strategy with Flash is Paul and I keep reminding them we expect to see quarterly improvements in pre-tax. I would say we made some last year, we kind of flipped back a little in the fourth quarter, which was disappointing to us, but there is no question the team is dedicated to turn that thing around and we are driving as hard as we can.

Jim Covello - Goldman Sachs

What do you think will ultimately drive the go or no-go decision there?

Andy Bryant

Well, right now, there is only a go decision, and the go says make money and if you don’t make money, we have to figure out whether we have to resize the business or whether there is some way to restructure it to make it make more sense for us.

Jim Covello - Goldman Sachs

You think that at some point during ’07, you would have to make that decision if the results did not turn around?

Andy Bryant

I guess I could say yes to that, but I would rather say I think Brian and the team are going to turn the results around. That is the goal.

Jim Covello - Goldman Sachs

Got it. If I could just ask a quick question on the follow-up on the cap-ex. Obviously a lot of the cap-ex spending is for 45-nanometer. Any breakdown between equipment percentages in ’06 and ’07 versus just non-equipment?

Andy Bryant

I will give you that later, but the equipment percentage is higher than normal. What you will see when we show it in the analyst meeting is it is one of the higher percentages we have had towards advanced 45-nanometer type equipment than we have seen in a long, long time. We have savings across almost every other bucket. We saved, as headcount came down, I can save on office construction, as the efficiency program really targeted heavily. In similar terms, I can save on some of the equipment we buy back there.

So what you are seeing is, will see is a higher percentage in equipment than we have historically had, and historically we have said it is about a third fab equipment.

Jim Covello - Goldman Sachs

Right, terrific. Thanks so much.

Operator

Your next question comes from the line of Adam Parker with Sanford Bernstein. Please proceed.

Adam Parker - Sanford Bernstein

Hi. Do you guys think you under-shipped consumption in the fourth quarter? I know you talked about having some channel inventory you needed to burn down. Did you accomplish what you needed there in Q4? I guess just more macro, do you think given the overall demand environment, economically speaking, that that supports having the best MPU quarter in the last eight or more quarters?

Andy Bryant

This is a two-sided question. We talked -- you should talk to our customers and see what they think about their inventories. All information we have says their inventories are under control and it is a null issue. If you look at our channel inventory, it is normal. It is dead flat with the third quarter, and about where we expected it to be.

What we really are concerned about is that there may be somebody else’s parts in the channel that could cause it to slow down a little bit in the first part of the first quarter.

Adam Parker - Sanford Bernstein

So okay, and then just economically, you are comfortable that you did not over-ship at all?

Andy Bryant

We do not think we did at all. We do not think we over-shipped at all.

Adam Parker - Sanford Bernstein

Okay, the only other question I have would be about pricing for processors. Could you talk at all about how you would characterize the pricing environment now, maybe versus a few months ago? Was it more competitive into the second quarter of ’06 than it was in the second quarter of ’04? Maybe a little bit on desktop versus notebook in that regard.

Paul Otellini

It remains competitive, Adam, but you have to remember over the course of this year, we probably have the biggest single series of price moves we have 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 have never had that broad base of new products hit us all at once.

As you bring the new products in, you drop the prices on the old products and price the new ones just to hit the sweet spots of the volume, so the effective thrash in pricing was really much more a function of new product technologies coming in than anything else.

From a competitive perspective, I think that --

Adam Parker - Sanford Bernstein

But you have had new products in the past and not taken the same cut.

Paul Otellini

Not across the board. Not in all three segments at once. It is the first time we have introduced top to bottom.

Adam Parker - Sanford Bernstein

So that implies a much more benign environment going forward then.

Paul Otellini

Well, there were 40 new products this year. I said part of this was a competitive environment and I do not think that is changing. Part of it was also the magnitude of bringing 40 new products out.

Adam Parker - Sanford Bernstein

Any desktop versus notebook distinction there, or no?

Paul Otellini

It was much more acute and more competitive in desktop.

Adam Parker - Sanford Bernstein

And that is your forecast going forward as well, or you do not want to give that?

Paul Otellini

We are not doing a forecast.

Adam Parker - Sanford Bernstein

But I mean, the reason people keep asking is because the single most important variable for your company is pricing for processors, so that is why we think about it.

Paul Otellini

We recognize that.

Adam Parker - Sanford Bernstein

All right, thanks, guys.

Operator

Your next question comes from the line of Chris Danely with J.P. Morgan. Please proceed.

Chris Danely - J.P. Morgan

Thanks, guys, nice job on the share gains. With the $5.5 billion in cap-ex, could you just give us a sense of how much you expect your unit output to increase?

Andy Bryant

I will duck that one. What I will tell you is when asked that question, we are kind of directing people to look at the market forecasters to see what they think overall units will do. Most of them are saying 8% to 10%, and then the question becomes can we take some share or not. But it gives you a ballpark for what we are thinking of.

Chris Danely - J.P. Morgan

On the inventory, in the past it has trended between sort of 60 to 70 days, and it looks like we are going to set the bottom here around 75 to 80 days, and it was up to 100 days. Do you feel comfortable with this 80 to 100 day new range of inventory, or do we expect to look at a different range next year?

Andy Bryant

As always, I like it to be a little bit lower. We have to be careful. In the past, I have gotten it too low and we have been burned by it, so like I said, my goal would be to kind of hold it flat to a down revenue period, a seasonally down revenue period, and then hopefully as revenue kicks up, I can have inventory come down a little bit.

Chris Danely - J.P. Morgan

I guess the gist of my question is with this inventory range, do you think your gross margins can get back to the low 60% range?

Andy Bryant

I do not think I want to make long-term gross margin forecasts today.

Chris Danely - J.P. Morgan

Okay. Thanks.

Operator

Your next question comes from the line of Mark Edelstone with Morgan Stanley. Please proceed.

Mark Edelstone - Morgan Stanley

Thanks a lot guys. Andy, I might have missed it, but what is the under-loading charges expected to be in the first quarter?

Andy Bryant

It was about two points of margin worth in the fourth quarter and I expect it to be approximately the same in the first quarter, and then I think that is it for the year.

Mark Edelstone - Morgan Stanley

Okay, great, and then a question for you, Paul. Santa Rosa obviously is coming in the second quarter, but I think you have had a one-month delay here as of late. Could you just talk about the factors that caused that push-out?

Paul Otellini

We have not delayed the product. It is on the same schedule it had from the day we set it, which is we have always planned to launch it in the first-half. It is in the second-half of the first-half, and we have never given a specific month, but there is no delay on it, Mark.

Mark Edelstone - Morgan Stanley

Okay, so basically it is a May launch now, is that correct?

Paul Otellini

I did not give a date. I am just saying there is no delay.

Mark Edelstone - Morgan Stanley

Okay, fair enough. I guess from both a marketing perspective as well as from a technical perspective, everything is on track to basically get that launch date?

Paul Otellini

Yes, the processor obviously is shipping already. The chipset is in the middle of the final tuning on the graphics, and I already told you we have begun shipments on the 802.11n product.

Operator

Your next question comes from the line of Michael Masdea with Credit Suisse.

Michael Masdea - Credit Suisse

Thanks a lot. Just kind of a high-level question. You talked, I think you said record a record number of times in your opening preamble, so clearly you are getting some momentum in a lot of areas, but your EPS here is about, if I look at it on a comparable basis, about 25% of the peak that you saw in December of ’05. What closes that gap beyond what you have already talked about on the cost side? How can you really get there, or have we really seen at least a near-term peak in what you guys can earn, given the market?

Andy Bryant

Again, now we are looking to start making long-term EPS forecasts. I cannot do that. We know that we are down versus a year ago for two reasons. One, revenue is down. Margins are down about 11 points, I said, and that is almost all ASP. We know it has been a very tough pricing year. Hopefully we have laid the foundation with, as Paul said, the 40 new products. We have 45-nanometer coming out later this year. We have another set of new products coming out later this year. We feel pretty good about the position we put ourselves in and we think it is our job to execute and the business will come out the way the business will come out.

Michael Masdea - Credit Suisse

Okay, maybe another piece of that. You talked about moving more to quad-core and dual-core and that will take up more of the capacity, et cetera. Silicon size obviously is inherently going up in what you are saying there. Do you feel confident that the ASP side will offset that and mitigate that? In other words, you can get higher prices for the multi-core, or does the strategy remain to offer it at the high-end of what the prior generation was?

Paul Otellini

We brought the quad-core in the same price range as our prior dual-core extremes. We brought the quad-core mainstream products in at the same price as our prior dual-core high-end products, so that model will continue.

We will give you an update on the overall product costs at the analyst meeting, but we remain very comfortable that the product costs will continue to come down over the course of the year, average product costs.

Michael Masdea - Credit Suisse

In line at least with the overall ASP increase -- I mean, the silicon size increase, at least?

Paul Otellini

It gets back to the mix and the average, which we really are not going to go at.

Operator

Your next question comes from the line of Charlie Glavin with Needham & Company. Please proceed.

Charlie Glavin - Needham & Company

Thanks. Paul, going back to a comment that you made right at the end of your opening remarks about capital forecast now being in line post your savings and efficiency review, could you give a little more clarity? Given the divestitures that you have done, has there been a change to the prior 8-K statement about $1 billion in deferred cap-ex for ’08?

Andy Bryant

So what you are asking is are we still on track to save $1 billion from the ’08 forecast we never gave you, right?

Charlie Glavin - Needham & Company

Right.

Andy Bryant

Boy, that’s an easy one. The answer is we have seen capital savings out of this program earlier than we anticipated, but it does not mean we said it is pulled in. Our expectation is to go and find $1 billion in addition in ’08. So whatever savings I get before then, we are going to take to the bank and then we are going to go and see if we can still get another $1 billion.

We have been pleasantly surprised that as you start to accumulate savings in this program, more seems to start to appear. We are pretty comfortable that we will continue to derive capital efficiency as well as other types of efficiency in the company.

Charlie Glavin - Needham & Company

Andy or Paul, is there any disconnect between the motherboard unit shipments being down, chipsets being relatively flat, but the higher end microprocessors being up in terms of either market share, rebalancing of shortages that occurred coming out of the summer? If you could give a little more clarity. Thanks.

Paul Otellini

I think there are a couple of things. I think that there was potentially a little bit of chipset double-ordering after the announced acquisition of ATI. That sort of created a bit of an earlier surge than probably would have ordinarily happened for the fourth quarter, which always leads the PC sales. That combined with the fact that we are now seeing people were buying in December for January, February sales, and that is seasonally down from the fourth quarter. So it is really a bit of both things to hit the chipset business that cause it to be flat.

Charlie Glavin - Needham & Company

Thanks, Paul.

Operator

Your next question comes from the line of Uche Orji with UBS. Please proceed.

Uche Orji - UBS

Thank you very much for the time. Just a quick question. If I look at the industry, and this is for Paul, for the PC industry for 2007, taking into account corporate spending and the consumer situation, could you just share with us your thoughts as to how you see this industry developing for 2007 please?

Paul Otellini

We are not going to give a forecast for ’07 in terms of the units.

Uche Orji - UBS

Just qualitatively.

Paul Otellini

I am personally very comfortable with the projections out of the big analytical firms and the 8% to 10% unit range. I think that it is going to be, the trends we are likely to see, that we are banking on, are Vista helping consumer sales, particularly in notebooks, and the secular trend where the overall growth in the Internet is driving more servers because there is more data to be stored. Those two trends are not going to go away.

The question that we do not know yet is whether the combination of Vista plus the vPro product line out of Intel will create a change in the refresh rate of enterprise-based PCs outside of notebooks. That is just a bit of an unknown at this point.

Uche Orji - UBS

That is helpful. Just, if I look at 45-nanometer, could you just remind us how much you think will get in 2007, with the percentage of your total allowance for 45-nanometer space?

Andy Bryant

Premature to give that since we have not really announced the ship date of the first product, so again, that is one of those things you would expect to get some kind of insight on at the analyst meeting.

Uche Orji - UBS

Just one last question, back to NOR Flash. I know you said it slipped back in Q4 and you said you have not decided if you are still looking at a go decision at this point. If I look into 2007 for NOR Flash, could you just give us an idea as to how this business will trend? Should we expect it to kind of come back to the levels we have seen recently, of the break-even levels? What kind of trend are we seeing today, given all the issues in the handset sector? Could you just give us an idea how to think about this?

Andy Bryant

In general, we do not make forecasts by sub-segments, but the NOR Flash business revenue was up nicely in the fourth quarter. Historically, it is seasonally down in the first quarter, as you would expect. We have dedicated a specific factory to that business, which we think should lead to an opportunity to have more market penetration. The key is we have to make sure we have the products in the marketplace and we have to go and win orders, just like we do in every other part of our business.

There is a possibility for nice growth there. Again, it comes down to the fact that we just have to execute. Probably more than any time in recent history we feel like we are in a good position across the board and we have to go execute.

Alex Lenke

Operator, two more questions, please.

Operator

Your next question comes from the line of Mark Lipacis with Prudential. Please proceed.

Mark Lipacis - Prudential Equity Group

Thank you very much for taking the question. You mentioned higher ASPs. Hoping that you would be willing to perhaps quantify how much better the ASPs were this quarter, and also could you help us understand to what extent was the higher ASPs driven by just having a phenomenal quarter with your servers? Or within the individual segments, are customers now walking themselves back up the price stack and paying a higher ASP in desktop and a higher ASP in notebook, for example? Thanks.

Paul Otellini

Well, there certainly was some improvement in mix to servers and notebooks in Q4 versus Q3, which gives you a better overall average. ASPs in server were up sequentially. ASPs in notebooks or mobile were up sequentially. ASPs in desktop were approximately flat.

Mark Lipacis - Prudential Equity Group

Okay, thank you. That is real helpful. The other follow-up question, it seems like the dual-core is ramping, is penetrating quite rapidly. How should we expect the quad-core to ramp? Would you expect a similar pace of penetration of quad-core into the market as dual-core, or would you expect something a little bit slower? Thank you.

Paul Otellini

I think in the performance intensive parts of the market, which are the gamers and the workstation parts of the market, and DP servers, quad-core will have a very strong penetration. It will not have a widespread consumer penetration until we get quad-core into the notebook, because that again is the fastest growing part of the market. It is still priced, while it has moved down nicely for the mainstream desktop, it is not down into the highest volume price points of the retail segment yet, and I do not really see it getting there over the course of at least the first-half of ’07.

Mark Lipacis - Prudential Equity Group

Great, thank you very much.

Operator

Your final question comes from the line of Gus Richard with First Albany Capital. Please proceed.

Gus Richard - First Albany Capital

Thanks for taking my question. Could you just talk a little bit about cutting server just slightly differently, the Bensley platform. What percentage of revenue was that in the fourth quarter? What do you see it being in the first?

Paul Otellini

I do not think we are in a position to give you that level of granularity, Gus. I’m sorry.

Gus Richard - First Albany Capital

You had mentioned the shipments of Woodcrest in the fourth quarter. Could you just repeat that for me, please?

Paul Otellini

I said that Woodcrest was over 50% of the DP servers in Q4, which is its second quarter of production.

Gus Richard - First Albany Capital

Okay, and you expect that to continue to ramp going forward, I’m sure?

Paul Otellini

Yes, it will displace -- it will be essentially our only DP product line, that and the quad-core versions of it, very soon.

Gus Richard - First Albany Capital

Okay, and just to finish up --

Paul Otellini

The only thing that is retarding that is customer conversion rates. In servers, they tend to have a long tail on some of the conversions.

Gus Richard - First Albany Capital

Right. That switch-over should finish up in what, the next two quarters? Is that reasonable?

Paul Otellini

Sure.

Gus Richard - First Albany Capital

Okay, appreciate it. Thank you.

Operator

Ladies and gentlemen, this now concludes the question-and-answer session. At this time, I will turn the call over to Mr. Lenke for closing remarks.

Alex Lenke

We would like to thank everyone for listening to today’s call. A recorded playback of this call will be available at approximately 5:00 p.m. Pacific time tonight. Those interested should dial 1-888-286-8010, and reference passcode 53842511. Thank you.

Operator

Thank you for your participation in today’s conference. Ladies and gentlemen, this concludes the presentation. You may all disconnect and have a good day.

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