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Intel Corporation (NASDAQ:INTC)

Q3 2007 Earnings Call

October 16, 2007 5:30 pm ET

Executives

Kevin Sellers - IR

Paul Otellini - CEO

Andy Bryant - CAO

Stacy Smith - CFO

Analysts

John Pitzer - Credit Suisse

Chris Danely – JP Morgan

Sumit Dhanda - Banc of America Securities

Uche Orji - UBS New York

Srini Pajjuri - Merrill Lynch

Glen Yeung - Citigroup

Tim Luke - Lehman Brothers

Ross Seymore - Deutsche Bank

Hans Mosesmann - Raymond James

Gurinder Kalra - Bear Stearns

Joanne Feeney - FTN Midwest

Operator

Welcome to the Intel third quarter earnings conference call. (Operator Instructions) I will now hand the call over to Mr. Kevin Sellers, Intel’s Director of Investor Relations. Please proceed, sir.

Kevin Sellers

Thank you and welcome, everyone to Intel's Q3 2007 earnings conference call. Joining me on today's call are Paul Otellini, our Chief Executive Officer; Andy Bryant, our Chief Financial Officer; and Stacy Smith, our Assistant Chief Financial Officer.

In a moment we'll hear some brief prepared remarks from Paul and Andy. Paul will talk about the highlights of the quarter and add some commentary bout the progress we are making to our strategic objectives. Andy will then provide more details on our financial performance in Q3 as well as the business outlook for the fourth quarter. Following Andy's comments, we'll be happy to take questions.

As we begin our call, let me point out a few important items about our earnings release today. First, we've posted our earnings release 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 that website as well.

Lastly, a replay of today's call will be posted on our investor website at around 5:00 Pacific time and will remain there for approximately two months.

Also, 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.

With that, now let me turn the call over to Paul.

Paul Otellini

Thanks, Kevin. Thank you all for joining us today. In the third quarter Intel turned in very strong financial performance as we enjoyed robust demand for our leading edge processors and chipsets. Not only was demand strong overall, but it strengthened as the quarter progressed. The market strength was broad based, cutting across all geographies and business segments. Additionally, our strong product lineup allowed us to hold microprocessor ASPs flat sequentially.

A little over a year ago we laid out a three prong strategy to regain product leadership, leverage our world-class process technology and manufacturing and restructure the company to become lean and efficient. We are pleased that our third quarter performance showed such strong gains in year-over-year revenue and operating income, as this demonstrates the significant progress we've made in all three of our strategic objectives. Our focus going forward is to continue to improve on these pillars.

Now let me take a minute and review each of our major business units. First I want to comment on quad-core. We launched our first quad-core processor in November of last year, and by the second quarter had shipped our first million units. With demand for our quad-core products accelerating, we shipped over 2 million units in the third quarter alone. We now offer over 20 unique quad-core processor designs.

In servers, we shipped a record number of units in the third quarter and enjoyed double-digit revenue gains over a year ago. We also launched our first quad-core product designed for high end, multi processor servers which delivers twice the performance and three times the performance per watt of our previous generation MP product. This introduction now completes Intel's transition to the core microarchitecture across all our product lines.

In mobile, we continue to see a shift to mobility with revenues in this segment growing greater than 30% year over year, and 20% sequentially during the quarter. We are pleased with the acceptance of our Santa Rosa platform and our Centrino brand continues to be widely accepted as the brand of choice for notebook PCs.

In the desktop, both our consumer and corporate desktop products had very good performance this quarter with increases in units, ASPs, and revenues quarter over quarter and year over year. vPro, our branded platform offering for corporate desktops, is ramping extremely well and offers truly unique and compelling value for IT managers.

In chipsets we had a record unit and revenue quarter. As the quarter progressed, we saw chipset orders strengthen and we enter Q4 with confidence of a strong demand environment.

Our flash results improved sequentially. The NAND business saw an increase in revenue driven by increased densities, offset by lower unit volumes. Our NOR business saw higher volumes, but lower ASPs.

Moving on to technology, I want to highlight a couple of things. First, we continue to be very pleased with the execution of our manufacturing network and its ability to respond rapidly to the demand upside we have seen. Our network of factories remains a strong source of competitive differentiation for us.

Second, we have announced that on November 12 we will be launching a new family of products based upon our break through High-k metal gate 45-nanometer process technology. We are excited about the advances we're bringing to the market with this new process and believe this will extend even further our technology leadership.

In addition, we've demonstrated working silicon of our next generation Nehalem microarchitecture which is booting multiple operating systems and is scheduled for production in the second half of 2008.

I would like to close with a mention about the unique value of our platform strategy and what it brings to our customers. vPro is our PC platform designed for corporate environments. We recently launched our second generation platform called Weybridge for this segment and we are very pleased with its ramp and acceptance. The vPro platform is a terrific example of the benefits we bring by offering our customers higher levels of integration. By combining processor, chipset and LAN we now have the ability to truly solve business problems for the user; in this case, the IT manager.

Security, manageability, and virtualization are most robust when implemented through an integrated platform. We are delighted with the progress of our platform strategy as it continues to create incremental revenue opportunities for us and deliver increased benefits to end users.

Let me now turn the call over to Andy for a detailed look at our financial performance as well as our business outlook for the fourth quarter.

Andy Bryant

Thanks, Paul. Higher revenue and improving productivity combined in the third quarter to produce exceptional growth and profits. There was a marked acceleration of year to year growth in revenue and unusually high seasonal growth. Gross margin was higher both in absolute dollars and as a percent of revenue. Spending continued its downward trend as a percent of revenue and operating profits were up more than 60% from both the second quarter of 2007 and the third quarter of 2006. Earnings per share for the same periods grew by 41%. We are expecting sequential revenue growth again in the fourth quarter and also double-digit year-to-year growth.

With lower unit costs, a successful ramp of the 45-nanometer manufacturing process and good demand for our products, gross margin in the fourth quarter should be nearly 5 points higher than the third quarter and we have raised our forecast for the full year.

Revenue for the third quarter was $10.1 billion, up approximately 16% from the second quarter of 2007 and 15% from the third quarter of 2006. The sequential growth in revenue is more than double the average increase for this period in the last ten years, and the highest sequential growth for any quarter in the last ten years. In the last month of the quarter we saw particularly strong growth in chipsets and Flash memory.

Total microprocessor revenue for the quarter grew at about the same rate as total revenue. The total number of microprocessor units was up from the second quarter to a new record, and the average selling prices were flat. Unit volumes of chipsets and Flash memory products were higher than in the second quarter and unit volumes in motherboards were lower.

Revenue was up approximately 20% from the second quarter for the mobility group, and up 12% for the digital enterprise group with higher revenue for microprocessors and chipsets in the desktop, notebook, and server computing segments. The Flash memory group achieved sequential growth of approximately 12%, primarily due to growth in revenue from higher density NAND memory products.

Gross margin percentage of 52.4% was more than 5 points higher in the second quarter. The key components of the change were largely as we anticipated in July. Higher unit volumes and lower unit costs for microprocessors and lower startup costs for new manufacturing processors substantially improved the gross margin percentage.

Offsetting this were the inventory write-offs we took as we ramped a new 45 nanometer process and built products that did not qualify for sale in the third quarter and therefore could not be classified as inventory.

We had expected overall average selling prices to be down a little bit in a competitive environment, but these were held flat. Gross margin percentage was about 0.5 point below the midpoint of the September update. While unit demand and overall pricing for microprocessors was better than anticipated in September, demand for chipsets and Flash memory during the month, and particularly through the end of the month, also exceeded expectations and grew at a faster rate than microprocessors. The result was a product mix with a higher than expected proportion of products with margins lower than microprocessors.

The impact of the increase in revenue was about the same as that in the change in mix. In addition, we sold more high end products within desktop processors and within chipsets, resulting in a higher average cost per unit.

R&D and MG&A were approximately $2.9 billion; higher than the second quarter and higher than our outlook. Most of the sequential increase came from R&D on the 32 nanometer manufacturing process, and higher revenue in profit-dependent expenses.

In a separate category from R&D and MG&A, restructuring and asset impairment charges were $125 million, following charges of $82 million in the second quarter. As a percent of revenue, spending this quarter is down 1.5 points from the previous quarter and more than 3 points from the third quarter of 2006. For the year-to-date, spending as a percent of revenue is down nearly 6 points from 2006.

The number of employees is down by more than 2,000 during the quarter to approximately 88,000. The lower headcount is a sequential decrease of more than 2% and a year-to-year decrease of nearly 12%. Operating income for the quarter was approximately 22% of revenue, about 7 points higher than both the previous quarter and the quarter a year ago. Operating income was 33% of revenue in the mobility group and 26% of revenue in the digital enterprise group.

On the balance sheet, total inventories were down from the second quarter by approximately $600 million, or 14%. Raw materials, work in process, and finished goods were all down, with the biggest change in work in process. The level of inventories is lower than I would like given the current outlook for demand, capacity utilization and the ramp of the 45 nanometer process, my goal is a small increase in inventories in the fourth quarter.

Total cash investments comprised of cash, short term investments, and fixed income trading assets ended the quarter at $12.5 billion, $2.3 billion higher than the second quarter. Higher net cash provided by operating activities accounted for most of the increase. The largest uses of cash were for capital spending of $1.1 billion, dividend payments of $650 million, and stock repurchases of $750 million.

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

We are planning for revenue to be between $10.5 billion and $11.1 billion. The midpoint of this range represents year-to-year growth of 11%. The growth from the third quarter of 7% would be at the low end of historical patterns for this period, following an unusually strong sequential growth in the third quarter.

Our outlook for gross margin percentage in the fourth quarter is 57%, plus or minus a couple of points. Most of the increase of nearly 5 points from the third quarter should come from two major categories. The first is lower unit costs for microprocessors, chipsets, and Flash memory which will account for the largest portion of the improvement. The second is product qualification for the new manufacturing process where we expect a higher portion of production spending to result in parts valued as inventory.

Spending for R&D and MG&A in the fourth quarter is forecasted to be approximately $2.8 billion to $3.0 billion, flat with the third quarter. In addition, in the separate category for restructuring and asset impairment charges, we expect expenses of approximately $130 million. We expect to continue to incur charges as we restructure to improve financial performance. These charges are likely to vary quarter to quarter and to decline over time.

For the full year, we are raising our outlook for gross margin to 52% plus or minus 1 point. We have increased the outlook for the full year for spending on R&D and MG&A. R&D is now forecast to be approximately $5.8 billion and MG&A is forecast to be approximately $5.3 billion. Plans are to reduce headcount again in the fourth quarter by approximately 2,000 employees. Total headcount by the end of the year should approach 86,000 down from 94,000 at the end of 2006.

The outlook for capital spending remains $4.9 billion, plus or minus $200 million. The outlook for depreciation is also unchanged at $4.6 billion, plus or minus $100 million. Our forecast for the effective tax rate for the fourth quarter is 29%.

The results for the year-to-date, combined with our fourth quarter outlook point to a year with revenue that is approximately 9% higher than 2006, capital spending that is 16% lower, spending that is 5 points lower as a percent of revenue and the operating profit that is nearly 50% higher. The results reflect excellent progress and our determination over the last year-and-a-half to become more competitive and more productive.

While proud of what employees have achieved, we are also mindful that the business remains competitive, the economy is always uncertain, and we have more work to do in the year ahead to deliver on commitments to our stockholders.

It is imperative that we stay focused on our priorities. The results announced today do not mark the end of recovery, but are a milestone in a larger program. We are building a foundation that will enable us to continue to deliver continuing improvement with better products, more innovative technology, and leadership in costs.

With that let me turn it back to Paul.

Paul Otellini

Thanks, Andy. Just one more thing I'd like to cover before turning it to questions. Today we are announcing that Stacy Smith is being promoted to Chief Financial Officer. Stacy has been our Assistant CFO and has been at Intel for 19 years with a career spanning finance, sales and marketing, and information technology. At the same time, Andy Bryant is being appointed Chief Administrative Officer with Stacy reporting to him.

These moves are part of our long-term management succession planning. Andy has been our CFO since 1994 and has been our longest-serving CFO ever. We want to thank him for his outstanding results and look forward to many further contributions in his new role.

Kevin Sellers

Thanks, Paul. Operator, we'll now open up the line for questions and answers.

Question-and-Answer Session

Operator

Your first question comes from John Pitzer - Credit Suisse.

John Pitzer - Credit Suisse

Paul, when you saw ASPs flat sequentially in the quarter, was that a change in the competitive environment, a change in the product mix, or a little bit of both? What is your outlook for pricing as we move into the calendar fourth quarter?

Paul Otellini

I think it's a reflection of the product portfolio more than anything else. You saw record numbers in servers, you saw record numbers in mobile, the two hottest parts in the marketplace; and you saw, if you derive the numbers, an increase in average selling price in desktop, which really reflects the strength of the core brand on the dual and quad-core processors.

One of the things that Andy talked about in his margin comments was that our mix in desktop processors towards quad-core over the course of the quarter actually improved, which drove costs up a bit, but also drove revenue up.

John Pitzer - Credit Suisse

If you look at the suite of products that are coming down the pipeline, the sweet spot that you're going to hit with Penryn and Nehalem. If the pricing environment improves, oftentimes you guys have seen gross margins well above 60%. Is that something we can look forward to as we go through the balance of calendar year '08?

Paul Otellini

I don't think we're in a position to forecast '08 margins. We'll do that three months from today.

Operator

Your next question comes from Chris Danely – JP Morgan.

Chris Danely - JP Morgan

Congratulations on a very good quarter. Paul, there's been a lot of talk out there about softening demand in Q4 out of Taiwan and double ordering and triple ordering, and who knows, maybe even quadruple ordering. Can you just give us your sense on the overall demand environment right now and are you concerned about any sort of component stocking out there?

Paul Otellini

I have read those reports, but we sure haven't seen it in the marketplace or in the requests from our customers. One of the things that we were particularly pleased to see was the strengthening in the chipset business over the quarter, particularly the second half of September. Chipsets, as you know, tend to lead microprocessors in terms of purchases because they get put onto a motherboard before the processor does and the lead time tends to be four to ten weeks, depending on the customer and the transit type that he's picked.

So my view is that people would not have continued to buy and demand chipsets for our microprocessors at that rate if we'd seen a slowdown coming or people were trying to do panic buying. So no, we've seen no signs of this. We saw strength in Europe. We saw record in Asia Pacific. Good solid results in Japan and the United States; so it's pretty broad based with no sign of abatement.

Chris Danely - JP Morgan

Now that the cash position is rebuilding, can you talk about uses of cash and can we expect to see a little bit more aggressive buyback here?

Andy Bryant

As a matter of policy we don't comment on the future level of buybacks. We do have a $16 billion program that's been authorized that we're operating under. If you look at the third quarter, what you saw is that we did increase the buyback to $750 million. In addition, we paid a dividend of about $650 million, and on top of that we grew the cash level by $2.3 billion. I won't comment specifically on Q4, but our strategy is unchanged of distributing cash to the shareholders via a combination of both buybacks and dividends and that's what you saw us do in Q3.

Operator

Your next question comes from Sumit Dhanda - Banc of America Securities.

Sumit Dhanda - Banc of America Securities

The first question I had was back to Q3 gross margins. I understand your point about a big jump in growth in chipsets and Flash which are lower margin products. I am still trying to reconcile a little bit versus the original guidance, your revenues actually came in $700 million higher versus the midpoint of the original guidance. Is all of that upside in revenues offset by a more diluted mix or is there more of an explanation to this than you offered up earlier?

Andy Bryant

It will be a pretty simple explanation. If you look at the revenue growth from Q2 to Q3, it came almost in normal mix, the same mix as we had in Q2. But as a result, even though I have shipped 500 million more microprocessors and I got higher revenue for those, I also shipped 300 million more of the lower margin products and the margin percentage hasn't changed; absolute margins does. On $1.4 billion of revenue increase, you pick up $1.2 billion in gross margin improvement.

As you've seen in the past in these periods, when revenue spikes it only spikes in processors which tends to give you a mix benefit. So all we saw this quarter was basically an even distribution of growth in all the pipelines. We saw the good news we expected in lower startup costs and we saw a little bit of bad news offsetting that with the write-offs on the 45-nanometer products that aren't yet qualified for shipment.

Sumit Dhanda - Banc of America Securities

On that last point, was that drag as anticipated? I think you had said it was 1 to 2 points of a drag.

Andy Bryant

At the end of the quarter we said 1 to 2 points there. It was almost in the very middle of the 1 to 2 point range so no change at all. In fact, if we look at our midpoint of 57% in the fourth quarter, that's 3 to 4 points of lower unit costs and 1 to 2 points of improvement for the evaluation on the 45-nanometer products.

We are seeing the full factories, but the full factories costs are coming down much better than I anticipated even three or four months ago, and that is driving 3 to 4 points of margin improvement in the fourth quarter.

Sumit Dhanda - Banc of America Securities

The improvement that you talk about on gross margins, the bulk of it you attributed to lower unit costs, is that also being aided by better fab loading? Is that engrained in that reduction in unit costs?

Andy Bryant

In the fourth quarter that's a big part of it, because we typically carry around 90 days of inventory. You can almost say what you build in Q3 is what you're going to ship in Q4. We know what we're building now is full factories; full factories are driving costs lower. We are also getting some efficiency out of the program we launched, so the manufacturing folks are doing a wonderful job of getting more output per person, more output per machine. The combination of those things absolutely is giving us a wonderful cost per unit surprise in the fourth quarter.

Sumit Dhanda - Banc of America Securities

A question on ASPs. You talked about the strength in mobile servers, higher ASP products, and then high-end desktops. Why was there not an actual sequential improvement in ASPs? Is the strategy here to try to get as much volume while keeping the ASPs flat?

Paul Otellini

As I talked about last time, we're trying to be smart and selective about the business we take and we executed that, I think, very well over the course of this quarter. If you do the math, desktop ASPs are up and desktop is where much of the ASP erosion in the last year, year-and-a-half had occurred. So the fact that our mix there was generating better pricing I think was really something we liked.

At the same time that happened, we walked from a lot of low end business on the desktop and the notebook at prices that we just didn't think made sense to us. So you'll see us continue to take, I think, a very selective approach to this.

Sumit Dhanda - Banc of America Securities

I understand the comment that you repurchased $750 million worth of stock, but it didn't seem to offset the dilution in the quarter. Is the plan to be perhaps a little more aggressive going forward given the building cash balance?

Paul Otellini

Again, I'm not going to give you a forecast for Q4. We did bring up the buyback in Q3 and our strategy is to return cash to shareholders via both buybacks and dividends. You're going to see us continue to do that.

Operator

Your next question comes from Uche Orji - UBS.

Uche Orji - UBS

You mentioned inventory being at a level below where you are comfortable with now. What is a normal level of inventory you want to get to? The reason I ask this question is if I look back at 2005 when you said to rebuild inventory, so this time around the first question is, what is a normal level for you and how do you prevent overshooting on the upside?

Andy Bryant

I wish there were a simple answer to normal. What inventory needs to be varies depending on prior transitions and varies depending on the quarters you are coming into. Right now we have a product transition. We told you at the analyst meeting earlier this year we hoped to build a little extra inventory which you always do in case your products don't qualify. So I would liked to have had a little cushion for that. At the same time, we know that the fourth quarter is typically our high revenue quarter. I would have liked to have had extra inventory for that.

The simple answer is I'd like more in the back half of the year, a little less during the first half of the year and I'd like to get through my product transition comfortably from one generation to the next with a little bit of cushion.

In terms of how do we ensure we don't overshoot, I can't guarantee you that. I said a few minutes ago our blueprint time in our factories, it's not 90 days. We reduced it a fair amount, but it's still a fairly lengthy process. Given you're making revenue forecast for six months out, particularly in the strong demand environment you have to err a little bit on the upside.

So I can almost assure you that if the market softens, we will end up with extra inventory and then we will patiently and systematically work it down to a level we're comfortable with. It's better in this business to use your fixed assets and have a little extra inventory than to go short to your customers.

Uche Orji - UBS

Just on a different topic, if I look at digital enterprise, the operating margins in digital enterprise were very strong this quarter and I know you've talked about quad-core and many other factors driving that. If you had to break it down between units, mix, and maybe market share gain, where do you think the biggest upside to operating margins in digital enterprise came from?

Stacy Smith

This is Stacy. The top line for the digital enterprise group it was very strong. We saw units strong, as Paul mentioned; we saw ASP up a bit. We saw costs come down a bit in the third quarter so that all added to the operating margin improvement.

In addition, we saw their spending drop a bit. Some of the startup costs associated with 45 nanometer dropped and some of their portion of the spending on next generation process technology came down. So you really saw improvement across the board.

Uche Orji - UBS

Are these levels which you think will be sustainable over the next 12 months? I know it's difficult to say with any amount of exact figures as to what things will be like, but should we expect this operating margins level for digital enterprise to be at least sustainable, all things being equal, for the next 12 months?

Andy Bryant

We don't typically forecast operating margin going forward. You can look at the overall improvement in gross margin from Q3 to Q4 where we add another 5 points of gross margin improvement. I think you can take from that that we're expecting pretty broad based general business improvement, but I'm not going to break it out between digital enterprise group and the other segments.

Operator

Your next question comes from Srini Pajjuri - Merrill Lynch.

Srini Pajjuri - Merrill Lynch

Andy, just a clarification. On the mobility group, revenues went up quite a bit yet the operating margin declined. I'm just wondering if this is all pricing or if there is something else there?

Andy Bryant

Why don't we let Stacy take that one? He's in the digital enterprise and knew this one was coming.

Stacy Smith

Two sides of the same coin. Let me explain the other side of what's happening in the segments. Andy, you will have to bear with me. The mobility group story is a little bit more complicated than the digital enterprise story.

The first effect that you see is that we've shifted our advertising from core 2 based advertising to Centrino advertising, so they're now picking up a fairly large bill associated with the advertising costs.

You can see in our results that the chipset volume was exceptionally strong in the mobility segment, so you see a little bit of a mix effect because those chipsets carry an overall gross margin percent.

The third thing that's happening in the mobility group is the offset to what's happening in the digital enterprise group. As mobility grows as a larger percent of our total business, they now are attracting a larger amount of spending for next generation process technology, for example, and those kinds of things.

The fourth effect, and the least effect frankly in that group, is that the ASPs were down a little bit quarter on quarter. So you have those four things that all hit the mobility group in the third quarter.

Srini Pajjuri - Merrill Lynch

Just a follow-up to that, given the ramps at Santa Rosa and the strong demand, I would have expected ASPs in the mobility to be more stable than down. I'm just curious as to what's going on there?

Andy Bryant

I think this is coming back to the point that Paul made. While our product strength is leading to a very good overall result of flat ASPs, there are still segments of the market that are very, very competitive and I would say the low end segment of the notebook market is one of those.

Srini Pajjuri - Merrill Lynch

Paul, clearly this year is unusual compared to your historic seasonal trends and my question is, is there something structurally changing about the business that we are going to see this pull in from Q4 into Q3 going forward? Or any insight that you can call out as to why we are seeing such a strong Q3 this year versus previous years?

Paul Otellini

No. We don't see that at all and I don't think there's a pull-in. I would not at all categorize it as that. We saw demand building over the course of the quarter, that's the opposite of a pull-in. I think the overarching thing we're seeing is that notebooks as a generic product type have really ignited in markets around the world. That was the principal reason we think we saw such strength in Europe.

One of the things you're going to see that is inevitable is that as notebook volumes grow, notebook prices will come down, particularly in the consumer segments. In the grand scheme of things that's good for us, because while they're still coming down from where they were, they're a heck of a lot better than where the desktop is. Having a secular long-term growth in notebooks I think is the best thing for our industry right now.

Srini Pajjuri - Merrill Lynch

Well, if that trend is going to continue then why wouldn't you see a normal Q4, is my question?

Paul Otellini

Well, we're forecasting a Q4 which is at the low end of seasonal norms and it's inside the normal range by definition. The low end tends to happen in those years when we see a better than average Q3. So it's very identical to prior patterns.

Srini Pajjuri - Merrill Lynch

Andy, you said your headcount is going to come down again in Q4. Does that mean your OpEx will come down as well beyond Q4? I'm just looking for modeling purposes.

Andy Bryant

What we said for the fourth quarter was OpEx was flat as we saved some money through the efficiency program, through resources, at the same time we expect higher revenue and higher profit-dependent expenses. The real answer is what we've said is we would like to see spending probably trail revenue, trend towards flat to up a little bit next year. That's what we would look at right now.

Our plan is not done yet. We need to get that done. That's our bias going in. We'll see what projects come forward and if we want to change that, we'll let you know.

Operator

Your next question comes from Glen Yeung - Citigroup.

Glen Yeung - Citigroup

It looks like you've got headcount down to 88,000 going to 86,000 employees. When you originally announced the headcount, I think the target was closer to the low 90s. Are you actually expecting more headcount reduction than you originally had planned?

The follow-on to that is you talked about $1 billion in savings for '08. Is that number going to be a higher number as a result?

Andy Bryant

We would expect headcount to be a little bit lower than we originally planned. Note when we began this program -- actually, I probably should let Stacy take this -- when we began this program we were on a two to three-year program. We only gave you a headcount number for about halfway through. So we did expect to continue to drive it lower. It was included in this expected $1 billion savings for '08. We think we're essentially on -- maybe a little ahead -- in terms of headcount reduction.

Stacy Smith

I would just add overall in terms of the restructuring numbers we gave you at the beginning, we had said $2 billion of savings and efficiencies for 2007 and another $1 billion for 2008. The headcount trend is pretty much right on, maybe a little bit ahead, and in general we're on track for that level of savings by the end of next year.

Glen Yeung - Citigroup

One other statement that you made, I think at the spring analyst day, was talking about unit costs for 2008 looking flattish. I think you gave us a chart, not numbers, so it was kind of hard to tell; but eyeballing it, it looked flat to slightly up in 2008 versus 2007. Now that you've seen the '07 back half of your unit costs look a little bit better, is there any change to that unit cost outlook for '08?

Andy Bryant

There may be but that's a tough one to get to right now. What I would tell you is in Q4, because of the loadings in the factories, I think it's a little lower than what we had said. What we had said in the analyst meetings in the first quarter it would spike up a little bit because the cost of 45 nanometer wafers in the beginning of the ramp would be higher and then they would go back down in the back half of next year.

I think we'll see the same pattern. If the factories stay full, we'll just see it off of a lower starting point. So Q4 would be a little lower than we expected. You'd still see a little bit of round up in the first half and right back down in the second half.

Glen Yeung - Citigroup

No change in the relative magnitude, in other words, right? Lower starting point but the magnitude of increase in the first quarter is largely the same?

Andy Bryant

Well, really I haven't modeled those, so I don't want to start making up numbers here on the call. I will say the same direction. I don't want to speak to magnitude.

Glen Yeung - Citigroup

When you look in your fourth quarter, Andy, you suggested that inventories would be slightly up. Do you think you will be back at levels at which you're comfortable at that point, or do you think they actually need to move higher still?

Andy Bryant

Assuming we meet the midpoint of our revenue range we will be below our comfort level.

Glen Yeung - Citigroup

After Q4, below the comfort level of inventories?

Andy Bryant

Yes.

Glen Yeung - Citigroup

Thanks. Congratulations, by the way, on all the promotions.

Operator

Your next question comes from Tim Luke - Lehman Brothers.

Tim Luke - Lehman Brothers

Nice job on the quarter and congratulations to Stacy and Andy. Just to follow-on with respect to elements that may influence the shape of the margin expectation in the beginning of the first half of '08, could you just remind us, Andy, of some of the elements there? Obviously you seem to be suggesting that the cost per unit may be up a bit in the beginning of '08, but could you just give us a reminder of some of the gross margin framework that you'd outlined?

Andy Bryant

Let's begin by saying I'm not giving a gross margin forecast for the first quarter yet, but the thing I want you to be careful about in the assumption you just made, when I showed that cost curve, it says costs per unit produced will go up in the first quarter. It doesn't mean cost per unit sold will. We have this 90-day inventory funnel so what you build in one quarter gets sold in the next, and I expect Q4 to be a very good cost-producing quarter. It means in the costs of sale line you'll see it rising up more towards the second quarter as opposed to the first quarter.

The second most important thing for our costs would be what happens with demand? If our factories stay full it will be a good cost year. If it is overheated and if it slows down some, then it changes. I can actually build a case it can go lots of different ways. We are looking at the sale of our NOR Flash business. If that happens, it would help margin percentages.

We're going to continue to drive product technology, continue to improve our road map. Those things all tend to help. The most important variable though, to keep watching is the worldwide economy. I really want to emphasize worldwide. We tend to get focused on the U.S. retail and how did the Christmas season do? In our business now, that's much less important than how the worldwide economies are performing.

Tim Luke - Lehman Brothers

With respect to that, Paul, you talked about the U.S. Do you see any difference between U.S. consumer, U.S. enterprise in terms of the way you've seen demand?

Paul Otellini

No, we haven't. In fact, I think there was a lot of nervousness associated with the credit market crunch and would that impact consumer spending? We really haven't seen that at all. I don't know if you guys have seen the San Jose Mercury but there's a wonderful survey they did today that people rate for Christmas. They ask for Christmas, what is the number one thing you want? PCs trumped happiness and peace.

Tim Luke - Lehman Brothers

With respect to the NOR disposal, could you just remind us what the date is for that and how we should model that in terms of inclusion and exclusion?

Stacy Smith

The expectation is that we close it in Q4. In terms of how to model it, again the elements that will change is you'll see the NOR revenue coming out, the associated cost of sales coming out, spending will get a little bit better and then we pick up our piece of the gain or loss from the company as an interest and other charge.

The expectation that you should model is once this closes it's 1 to 2 points of gross margin. Right now, the thing we're waiting on is after we see it, we have to file our response and then we hope to get good news back.

Tim Luke - Lehman Brothers

But the revenue guide includes a full quarter of NOR?

Paul Otellini

Yes.

Stacy Smith

What you see in Q4 is modeling that it's here for the full quarter and we're working like heck to get the deal done.

Tim Luke - Lehman Brothers

Lastly, just on this gross margin, it is a significant uptick, but does that assume that pricing continues to stabilize or are there different elements of the assumption for ASPs there?

Andy Bryant

As always, we assume a relatively competitive environment out there. We plan to sell our product and compete in the marketplace.

Operator

Your next question comes from Ross Seymore - Deutsche Bank.

Ross Seymore - Deutsche Bank

The strength that you're seeing recently Paul, without Andy having reported yet, of course, how would you constitute it? A strong general market for PCs versus market share gains, even if it's only in the markets you really choose to participate in?

Paul Otellini

Well, given our relative position I have to conclude it's a strong general market.

Ross Seymore - Deutsche Bank

Have you seen any change in the competitive dynamic out there, whether it be in your ability to cherry pick the markets because of your superior products or any strategic shifts out there that you're seeing?

Paul Otellini

Well, the biggest shift in the last six months certainly is our ability to participate very aggressively in servers. I mean, the fact that we have record server unit numbers is a very good leading indicator of Intel back in its game across the board. Servers have always been a very good business for us and I think we're outgrowing the industry right now, so this is good.

As we look forward, one of the reasons we are developing families of products like the ones I showed you at the analyst meeting called Silverthorn and the follow-on products is so that we can address these ultra low price points with very good margin products.

Ross Seymore - Deutsche Bank

A slightly related question; there are a lot of worries out in the market similar to some of the other questions that you've already answered about excess MPU processors being shipped into the market versus overall PC demand. Clearly, the strength that you've seen now addresses some of those, but channel inventory as a whole, have you seen that coming down in aggregate? It appears there wouldn't be a ton of Intel inventory, but in general, what comments do you have on channel inventory?

Paul Otellini

You mean finished units? Finished systems?

Ross Seymore - Deutsche Bank

Correct. Microprocessors, motherboards, whatever stage of the completion you want to talk about.

Paul Otellini

All we can look at is our inventory, particularly our distributor inventories and they're in very good shape. In fact, I'd like to have a little bit more inside than outside if we had them. In terms of the inventory at our customers, I think you have to ask them what their position is. We don't see any backup at all.

Operator

Your next question comes from Hans Mosesmann - Raymond James.

Hans Mosesmann - Raymond James

At this pace, quad-core is in a mix of desktops. What do you expect the mix to be a year from now? Right now it's probably in the low single-digits, low double-digits, as a percent of your desktop shipments?

Paul Otellini

Well, that's a demand question. The supply can be almost anything we want it to be. So it really is a function of how the demand grows at certain price points and what the competitive environment for quad or for things greater than 2 core are. Right now we see quad tending to populate the price points for microprocessors that are sort of 150 and above, and that tends to be a double-digit percent of the market but not 50% of the market.

Hans Mosesmann - Raymond James

So, like a quarter of your business or less?

Paul Otellini

I'm not going to let you tie me down that closely; I can't. Because part of this thing is competitive modeling, part of it is how the demand shifts over the year.

Hans Mosesmann - Raymond James

The timing of chipset sales, strong sales in September, does that give us a sense that Q1 visibility is improving in an unusual fashion at this time of the year?

Andy Bryant

I wouldn't go that far. The same thing Paul said earlier. When you see strong chipset sales for the last two weeks of the quarter, it means the motherboard manufacturers are preparing to meet demand in the fourth quarter. It's certainly a better sign than if they were sitting on the sideline.

Paul Otellini

Our chipset attach rate, the percent of our processors that end up getting an Intel chipset has been going up over the second half of this year, driven by the shift in mobility and the success of vPro. That dynamic is inside this as well.

Operator

Your next question comes from Gurinder Kalra - Bear Stearns.

Gurinder Kalra - Bear Stearns

Do you think mobility is describing a step function increase in PC unit growth, given the strength you have seen in Q3 and Q4? How long is this going to last, or does the strength in Q3 and Q4 just make you a lot more apprehensive about Q1?

Paul Otellini

Well, I'm not necessarily apprehensive about Q1. At this point it's too soon to call it, but I would be surprised if it's other than seasonal. I'll give you two data points. The first is that most of the third-party analysts are still forecasting a growth next year, 2008, in the sort of 12% to 14% range. Second of all, we continue to track onto a projection that we gave you at the analyst meeting of Intel mobile unit shipments crossing over desktop unit shipments in 2009. I think that both of those dynamics are working to our advantage still.

Operator

Your final question comes from Joanne Feeney – FTN Midwest.

Joanne Feeney - FTN Midwest

Just a question to finalize the discussion of ASPs, and then a quick follow-up. You remarked that ASPs in desktops were up; notebooks slightly down. Can you tell us about the server ASPs?

Andy Bryant

We're not going to go through all the detail on ASPs.

Joanne Feeney - FTN Midwest

Just on capacity and your ability to further ramp production, I'm wondering if the forecast for next quarter of about 7% revenue growth might reflect some capacity utilization topping out you have right now and your concerns about raising inventory back to comfortable levels. Is it just too costly at this point to try to push capacity a bit further to do better than 7% and raise your inventory back up to comfortable levels?

Andy Bryant

No, it's not a cost issue at all. The strength of the third quarter was above what we expected. As we said we were lower on inventory levels than we would like. We're currently meeting our customer commitments for Q4, but if demand is significantly above the range that we're expecting we'll be hard pressed to go above it from the standpoint of exceeding the revenue range.

So not a cost issue. We're just moving as fast as we can to keep up with the market.

Kevin Sellers

As we wrap up the call, I want to turn the time over to Paul briefly for some closing comments.

Paul Otellini

Thanks, Kevin. In closing, I want to say that while we've made great progress on our strategy to deliver new and exciting leadership products, to leverage our manufacturing and silicon processing leadership and to restructure the company, we're not standing still. We're well along in our development of a robust 32-nanometer technology and have demonstrated our next generation, Nehalem microarchitecture just a couple of weeks after we saw First Silicon.

These demonstrations are proof that our tick-tock strategy continues its relentless march, allowing us to push innovation forward in new and exciting ways. I want to thank all of you for joining our call today. Good evening.

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Source: Intel Q3 2007 Earnings Call Transcript
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