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Intel Corporation (NASDAQ:INTC)

Q2 2008 Earnings Call

July 15, 2008 5:30 pm ET

Executives

R. Kevin Sellers - Vice President, Investor Relations

Paul S. Otellini - President, Chief Executive Officer, Director

Stacy J. Smith - Chief Financial Officer, Vice President

Analysts

John Pitzer - Credit Suisse

Tim Luke - Lehman Brothers

Glen Yeung - Citigroup

Ross Seymore - Deutsche Bank

James Covello - Goldman Sachs

Sumit Dhanda - Banc of America

David Wong - Wachovia

Uche Orji - UBS

Chris Danely - J.P. Morgan

Hans Mosesmann - Raymond James

John Barton - Cowen & Company

Cody Acree - Stifel Nicolaus

John Lau - Jefferies & Company

Srini Pajjuri - Merrill Lynch

Michael McConnell - Pacific Crest Securities

Brian Piccioni - BMO Capital Markets

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2008 Intel Corporation earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s conference, Mr. Kevin Sellers, Vice President of Investor Relations. Please proceed, sir.

R. Kevin Sellers

Thank you and welcome everyone to Intel's Q2 2008 earnings conference call. Joining me on today’s call are Chief Executive Officer Paul Otellini and Chief Financial Officer Stacy Smith. This call is being webcast live and a replay will be posted to our website at approximately 5:00 p.m. Pacific Time and will remain there for approximately two months.

As usual, Paul will be discussing the highlights and progress of the quarter and Stacy will then provide details of our financial performance in Q2 as well as the outlook for both the third quarter and full year 2008. Following Stacy’s comments, we’ll be happy to take questions.

A few important items before we begin; first, the press release of our earnings went out at approximately 1:15 Pacific Time and is now posted on our investor website, intc.com, along with updated financial statements 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 put the appropriate GAAP financial reconciliations to our investor website.

As we begin, let me remind everyone that today’s discussion contains forward-looking statements based on the environment as we currently see it and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially.

So with that, let me now hand it over to Paul.

Paul S. Otellini

Thanks, Kevin. Our second quarter results were very positive on a number of fronts. First, revenue for the quarter was a record, the fourth quarter in a row that we achieved such a result. Demand for our leading edge computing products around the world continues to be strong, with revenue and unit shipments toward the high end of the seasonal norm, when factoring in the divestiture of the NOR business. We realized record unit shipments in mobile microprocessors, chipsets and wireless communication units in the second quarter. Our focus on lowering costs and improving efficiency continues to provide considerable operating leverage, with operating income growing 67% from a year ago.

For the second quarter in a row, we bought back $2.5 billion worth of stock, returning cash to our stockholders.

Our 45-nanometer manufacturing process is performing superbly. We remain on track to ship over 100 million units before the end of the year on this process technology. At this stage of our process ramp, yields and throughput times are better then at the same time on our 65-nanometer ramp. These results are lowering unit costs ahead of our original plans and are providing us with increased flexibility in meeting diverse customer requirements.

We will reach the 45-nanometer shipment crossover point for microprocessors during this, the third quarter.

Now let me briefly discuss a few product highlights. In servers we had record channel shipments. This demonstrates the demand for our products coming from small and medium businesses around the world continues to be healthy. We also enjoyed some noteworthy design wins at both Cray and DreamWorks, reflecting that our current and future product roadmaps are delivering the performance that meets the most demanding customer requirements.

In mobile, we enjoyed very strong unit growth, both sequentially and year over year. As notebook computers continue to decline in price, we see demand growing in response. We saw notebook unit shipments cross over desktop in the overall client PC category in the second quarter. That’s sooner than we had expected.

We launched our new Atom processor during the second quarter and are exceeding our ramp targets as demand for this new product is very robust. We expect unit shipments of Atom processors to grow sharply in the second half.

In summary, we were very pleased with our second quarter results. The strategic direction we laid out two years ago at our investor meeting coupled with our restructuring efforts are coming together and yielding tangible results that we committed to our stockholders. Our product line is superbly positioned. Our new growth initiatives are ramping and showing promise, and our manufacturing execution is outstanding.

In the third quarter we plan to bring exciting new products to market, such as our new Centrino 2 platform launched just yesterday, as well as Dunnington, our six-core server processor targeted at high-end server workloads scheduled to launch later this quarter.

These are the kinds of innovations that create real differentiation for our customers and allow us to maintain product leadership.

A final word on the economic environment; we are very aware of the global economic issues that dominate the financial markets these days. We are watching these very carefully. In the first-half of 2008, we saw order patterns play out as anticipated at the beginning of the year. Inventories remain at healthy levels and our global footprint is helping us benefit from demand for internet computing. As we look into the third quarter, we see continued healthy demand for our products leading us to the third quarter outlook that we provided.

Let me now turn this call over to Stacy.

Stacy J. Smith

Thanks, Paul. Intel delivered strong financial results in the second quarter. Better-than-expected demand in the microprocessor and chipset businesses led to record second quarter revenue of $9.5 billion. Compared to the second quarter of 2007, revenue grew 9%, with gross margin up more than eight points. Operating profit was up 67% year over year and operating income as a percentage of revenue was up eight points year over year to 24%.

Revenue for the second quarter was above the midpoint of the range forecasted in April and down 2% from the first quarter. Excluding the revenue associated with the NOR business, revenue was flat to the first quarter at the high-end of the seasonal range. Microprocessor unit sales were above the seasonal pattern and average selling prices were lower.

More than half of total revenue, $5.4 billion, came from the Digital Enterprise Group. Revenue from this group was flat compared to the first quarter and up 11% from the prior year. Microprocessor revenue in the Digital Enterprise Group showed particular strength, with revenue up 14% from the second quarter of 2007. The Mobility Group accounted for more than a third of total revenue. This revenue of $3.8 billion was up 3% from the first quarter and up 15% from the prior year.

Looking at a geographical breakout, all geographies experienced year-over-year growth in the second quarter. After adjusting for the impact of the NOR Flash divesture and supply agreement with Numonyx, all geographies performed a little better than average seasonality.

Gross margin dollars were $5.2 billion, flat compared to the first quarter.

Gross margin percentage of 55.4% was up over one-and-a-half points from the first quarter and up over eight points from the second quarter of 2007. Versus the midpoint of the outlook range set in April, second quarter gross margin was down half-a-point. A little less than a point decline came from average selling prices being lower, primarily due to the growth in shipments and the lower-priced segments of the notebook market.

R&D and MG&A were approximately $2.9 billion, within the forecasted range of $2.8 billion to $2.9 billion and up 3% from the first quarter. In addition, we had restructuring and asset impairment charges of $96 million, which was lower than the outlook that we provided of approximately $250 million as an assessment of capacity resulted in less restructuring and asset impairment charges.

The number of employees is down by 2,700 from the first quarter to below 82,000, primarily due to employees transferred to Numonyx. As we complete the second year of the restructuring program announced in 2006, the number of employees is down more than 20,000 from the second quarter of 2006.

Gains, losses on equity investments, and interest and other income of $58 million was lower than our outlook of $75 million and lower than the first quarter of $109 million. Relative to the first quarter, improvements in the trading asset portfolio were offset by lower interest income and impairments of marketable equity securities.

The provision for taxes in the second quarter was at a 31% effective tax rate, lower than the 33% previously forecasted due to tax settlements.

On the balance sheet, total inventories were flat to the first quarter at $3.3 billion.

Total cash investments comprised of cash, short-term investments, and fixed income trading assets, ended the quarter at $11.5 billion, $1.7 billion less than the first quarter.

Cash flow from operations was over $2.5 billion.

Capital spending was $1.2 billion, dividend payments were $800 million, and stock repurchases were $2.5 billion.

As we turn now to the outlook for the third quarter, please keep in mind, unless otherwise specified, the forecasts do not include the effects of any new acquisitions, divestitures, or similar transactions that may be completed after July 14th.

I will use the midpoint of the forecast ranges when making comparisons to specific periods.

We are planning for revenue to be between $10 billion and $10.6 billion. The midpoint of this range would be an increase of 9% from the second quarter. On a year-to-year basis, the outlook anticipates revenue growth of 2%. Excluding the decline in NOR revenue, the growth would be approximately 6% year over year.

Our expectation for gross margin percentage in the third quarter is 58%, plus or minus a couple of points, 2.5 points higher than the second quarter as microprocessor unit volume increases in the seasonally up third quarter and as unit costs decline on 45-nanometer products.

Looking beyond the third quarter as volume increases and costs decline, we expect gross margin to improve further in the fourth quarter.

Spending for R&D and MG&A in the third quarter should be approximately $2.9 billion.

Additionally, in a separate category for restructuring and asset impairment charges, we expect expenses of approximately $60 million.

Depreciation is forecasted to be approximately $1.1 billion.

Our estimate for gains and losses from equity investments and interest and other income is a net loss of $30 million.

We maintain the midpoint of our outlook for gross margin for the full year at 57% and have narrowed the outlook range to plus or minus a couple of points.

Spending for R&D and MG&A for the full year is now forecasted to be approximately $11.7 billion. R&D spending is forecasted to be approximately $6 billion, flat to the prior forecast, and MG&A spending is forecasted to be approximately $5.7 billion, up $200 million from the prior forecast, primarily due to legal and profit dependent expenses.

The tax rate for each of the remaining quarters in the year is expected to be 33%, unchanged from our prior outlook.

Second quarter revenue growth of 9% and operating profit growth of 67% year over year marks the end of a strong first-half. As we look into the second-half of the year, we are planning for growth and improving financial results, driven by our product leadership, the ramp of the Atom processor, the build-out of three 45-nanometer high volume factories, declining unit costs, and the impact of our restructuring program.

With that, let me turn it back to Kevin for Q&A.

R. Kevin Sellers

Okay, thanks, Stacy and Paul. Before we begin our Q&A segment, I want to remind the financial community of our upcoming Intel developer forum taking place on August 19th through the 21st in San Francisco.

There will be seven keynotes during the forum, covering a wide range of technology trends and Intel product plans from the digital enterprise to mobility to software. We will also hold a number of briefings for investors and analysts as well. For registration and other information, please go to intel.com/idf.

We will now be happy to take your questions. In order to allow more of you to participate on this call, we will limit each person to one question and one follow-up, if you have one. The operator will introduce you and -- will introduce each of you and prompt your question. I will then ask if you have a follow-up. The operator will then introduce the next questioner. We’re now ready for our first question.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Mr. John Pitzer with Credit Suisse. Please proceed.

John Pitzer - Credit Suisse

Yes, thank you. Good afternoon, guys. Guys, just quickly on gross margins for the June quarter being below midpoint, you are kind of pointing to the low-end notebook market. Was that all Atom driven or were you still selling some Celeron to that market? And if it was all Atom, how do we get comfortable about gross margin progression in September as Atom ramps and becomes an even bigger percentage of the overall mix?

Stacy J. Smith

Yeah, it was not Atom. Atom launched in the second quarter but the units shipped on Atom were pretty small in the second quarter. We expect it to ramp rapidly into the second-half of the year. It was what I would call the traditional notebook market, as Paul said, as that is now more than 50% of the market we’re seeing a lot of unit growth in emerging markets. We’re seeing growth in channels such as the retail channels. That growth is good for us but it tends to be at a lower price point. So you are seeing TAM expansion at some of these lower price points and that brought the average price down in the second quarter from what we expected.

R. Kevin Sellers

John, do you have something else?

John Pitzer - Credit Suisse

Yes, just real quick, guys -- just given the buy-backs through the first-half of the year, what can we expect in the back-half? You guys are going at a pretty significant clip relative to what you did in 2006 and 2007. What’s the philosophy there?

Stacy J. Smith

I had said back in Q1 that the cash balance was a little higher than we were targeting. We brought down the cash balance by about $3 billion over the course of the first-half and we’ve done about - we’ve done $5 billion worth of buy-backs between Q1 and Q2. Cash balance is getting more into the range of what I'm targeting. At this point, I'm not going to give a buy-back forecast, nor am I going to give a cash forecast for Q3.

John Pitzer - Credit Suisse

Thanks, guys.

R. Kevin Sellers

Thanks, John. Next question.

Operator

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

Tim Luke - Lehman Brothers

Thanks so much. Stacy, just in guiding a fairly solid revenue outlook in the 10 to 10.6, could you give us some framework for how you perceive the desktop area to be proceeding? Again, it sounds like you are expecting a fairly robust notebook and perhaps even, as on the lower-end notebook forecast, could you give us some color on desktop, notebook, server?

Stacy J. Smith

Yeah, I guess I would point back to what we’ve seen so far in the first-half. We really have seen demand holding up across the different segments of the computing-related business, with particular strength in the notebook growth that we spoke about at some of these price points.

And then in the server market, I think the strength of our product line really benefited us in Q1. Q2 tends to be a seasonally lower quarter for servers but I would expect that to also be strong as we get into the second-half.

I think underlying your question is demand. We saw demand pretty normal through the second quarter across the segments of our business and across the different geographies.

R. Kevin Sellers

Tim, do you have a follow-up?

John Pitzer - Credit Suisse

Just as a follow-up, obviously you are holding the gross margin for the full year guidance and guiding it up fairly meaningfully in the third quarter to the 58% range. Could you just provide a little bit more color on what gets you there, given the strength you are seeing in the lower end notebook segment and the mix there? Thanks.

Stacy J. Smith

Sure. It’s a -- it’s a pretty simple margin reconciliation going from Q2 to Q3. There are two elements that are worth roughly the same amount of gross margin improvement. We see our costs improve quarter on quarter pretty dramatically as we go from Q2 to Q3, and then we see volume in the CPU segment up seasonally, and those two things get you to 58%.

Operator

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

Glen Yeung - Citigroup

Thanks. A question about the outlook for revenues; it’s good in Q2. You’re guiding strongly in Q3. To what extent is your confidence being helped by share gain and/or the Montevina launch? Does that give you some confidence in how you look at Q3?

Paul S. Otellini

Glen, I think it’s a combination of things. You know, what we’ve seen from our customers is -- I think the overarching comment is on the notebook market accelerating around the globe at multiple price points. We also expect and we’ll see more of Atom-based notebooks in the third and fourth quarters, and that is why we’ll continue to -- we will break those numbers out for you in our commentary so that you can draw some trend lines around those. But in general we were able to cover the shipment shortfall on Montevina in Q2 with Santa Rosa. We replaced all that volume so our customers were able to keep on shipping, and now Montevina is ramping very rapidly in the consumer segments that were launched today or yesterday.

I won’t comment on share gain but -- you know, we’ll let the numbers speak for themselves when they all come out but it has to be pretty clear that with the kind of mobile volumes we had in the second quarter that we did pretty well.

Glen Yeung - Citigroup

Okay, thanks.

R. Kevin Sellers

Glen, you had something as a follow-up?

Glen Yeung - Citigroup

Yeah, I guess maybe just going on from that response, you talked about the low-end of the notebook market sort of taking some mix in Q2, but now you’ve got Montevina coming forward for you in Q3. Does that sort of stem the shift towards low-end or do you think it’s really more a function of emerging markets versus Western markets?

Paul S. Otellini

I think it’s a bunch of things and a lot of this is dependent on the economy. You know, the prime purchaser of notebooks still remains as a segment business, large enterprise, and they tend to buy relatively high-end notebooks and Montevina will start shipping into that segment later this quarter when we launch the Centrino 2 Pro product line. So that is one that we’ve got fairly -- we’re fairly bullish about for the second half as that ramps and replaces the pre-existing SKUs that are out there.

But in general, I think what we are seeing is just a fundamental shift to notebooks. We’ve been seeing it for years and you know, the crossover happened six months sooner than we thought.

R. Kevin Sellers

Glen, thanks. We’ll take our next questioner.

Operator

Your next question comes from the line of Ross Seymore with Deutsche Bank. Please proceed.

Ross Seymore - Deutsche Bank

Excuse me, I have a bit of a cold here, but you talked about the pricing on the notebook side of the market. Can you tell a little bit about what’s going on in pricing in desktops and servers, please?

Paul S. Otellini

Sure. We aren’t going to give you any ASP granularity in each of those areas but in servers, we had a very strong Q1 in MP and in Q2, DP was a bit more -- a bit heavier, so that tends to drive the mix a little bit to the lower priced numbers. I would expect MP to pick up in the second-half of the year, as is traditional. The fourth quarter is normally the big server quarter but as you can tell, we are being a little bit cautious about that given the overall economic environment.

In terms of desktop, there’s two trends. There’s a continuing trend in emerging markets of lower-priced desktops but there is also a trend for refresh rates in corporate around our vPro product line, which have above average selling prices, so the combination of the two has kept the desktop pricing on average relatively constant.

R. Kevin Sellers

Ross, you had something else?

Ross Seymore - Deutsche Bank

Yeah, just really quick on the ESO line -- it seems like year over year, your headcount is down a lot but the stock comp expense keeps going up. Can you give us a little bit of the background as to why that would happen and what your expectations are for that line going forward?

Stacy J. Smith

I think as we run the model -- I’d actually have to go back and double-check this, Ross, but I think it’s as we run the model, as volatility goes up a bit, the stock option expense goes up a bit. You’re right -- we have quite a few fewer employees and we have not expanded the stock option program in terms of number of options granted per employee, so I think it’s just the volatility.

Ross Seymore - Deutsche Bank

Thank you.

R. Kevin Sellers

Thanks, Ross. We’ll take our next questioner.

Operator

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

James Covello - Goldman Sachs

Good afternoon, guys. Thanks so much. First question; Paul, last quarter you gave us a little bit of color about the NAND business and your thoughts around either fixing it or -- fixing it one way or the other. I wonder if you could update us on where we are there?

Paul S. Otellini

Well, I won’t give you a lot more color than I gave you last quarter, James, but we are taking some actions to limit the amount of supply growth in this environment. As you know, the NAND pricing continues to still be very weak, so we’re focusing on supply and on costs. At the same time, we are focused on trying to get a better pricing environment for our products by shifting some of it to more innovative stacking products into SoCs. At the same time we’re doing that, we’re still looking for longer term solutions. I have not wavered in my commitment to have this business not be a long-term drag on our P&L.

R. Kevin Sellers

Jim, you had something else?

James Covello - Goldman Sachs

Yeah, if I could just follow-up; on the DreamWorks win, could you just help us understand in the competitive situation there, was that your products versus AMD’s old products before they introduced say the new Barcelona chip, or was that decision made before AMD was able to ramp the new chip?

Paul S. Otellini

It was based upon our roadmap going forward versus their assessment of competitive roadmaps going forward. They don’t make a one -- they don’t make a one-quarter or even a one-year decision because the tremendous amount of the effort here is involved in software optimization, and the software optimization around Intel is relatively unique versus other vendors’ products.

So I consider this a multi-year win; it’s a multi-year framework that binds it together. It’s software and hardware and it is I think reflective of the very competitive roadmap we have, not just in servers but also in workstations as Larrabee comes on.

James Covello - Goldman Sachs

Terrific. Thank you so much.

R. Kevin Sellers

Thanks, Jim. Next question, please.

Operator

Your next question comes from the line of Sumit Dhanda. Please proceed.

Sumit Dhanda - Banc of America

Yes, hi. First question for Stacy; Stacy, you noted that part of the -- call it the small miss on gross margins was because of one point incremental drag from lower ASPs. Was that incremental to your expectations? Because my recollection is a couple of one-timers were disappearing your inventory reserves on chipsets, NOR flash was obviously contributing to better margins and you did have a better unit cost structure into the quarter, so I was just curious about that.

Stacy J. Smith

Yes, it was slightly less than a point and it was to the outlook that I set. If you look at this from a quarter-on-quarter basis, with the exception of the ASP, we got the good news from the two areas I was expecting. We had articulated we have some good news as we had chipsets that qualified for sale in the quarter and we were shipping them in the second quarter, so we got good news there. And we got good news from the NOR divestiture. The piece that was unexpected to the outlook was being a little bit down in ASP.

R. Kevin Sellers

Sumit, any follow-up?

Sumit Dhanda - Banc of America

I just have one, a separate follow-up. On Atom, you know, there’s been talk about constraints with respect to supplying the existing demand. Could you update us on what your sense is versus market expectations on your supply? And is that constraining your outlook for Q3 in any way, shape or form?

Paul S. Otellini

The short answer is no, it’s not constraining our outlook for Q3. It is well within the bounds of the 10 to 10.6 that we gave you. We have been increasing our production, planned production of Atom for this year and next every 40 days since the beginning of --actually, since last November as demand continues to roll up, and not just in NetBook segments but also in embedded and consumer electronics segments. It looks like the design wins are really quite robust.

And so we continue to add more and more zeroes to the numbers we are building for this year and next year. I don’t expect it to be any kind of limiter for revenue growth this year at all.

Stacy J. Smith

Sumit, if I can just add on that -- the supply constraints we’re seeing with Atom are specifically the back-end, the test constraints and things. We have plenty of die and as Paul said, it’s well contained inside the revenue guidance we gave. But as demand is going up kind of month by month, we’re jumping to keep enough test capacity in place for the demand we see.

Paul S. Otellini

And then the other part of that, Sumit, is to make sure we have enough chipsets. I mean, at the same time the Atom processor growth is jumping up, we have to also be able to build a chipset for each of those, which is one of the reasons you saw our factory utilization assessment go up over time in this quarter, rather than down.

R. Kevin Sellers

Thanks, Sumit. Next question, please.

Operator

Your next question comes from the line of Mr. David Wong with Wachovia. Please proceed.

David Wong - Wachovia

Thank you very much. Following up from the earlier question, as the Atom ramps in volume over the next two quarters, presumably primarily for notebooks, is the Atom below gross -- is the Atom gross margin below, above, or roughly equal to overall corporate gross margin?

Stacy J. Smith

Just to make sure it’s clear, I think it is, but to make sure it’s clear; the ramp of Atom’s encompassed in a 58% gross margin in Q3 and what I expect to be a higher gross margin in Q4. My view of Atom hasn’t changed from what I showed at the analyst meeting. If you’ll recall, I was showing the Atom platform -- I used end of 2009 as the comparison point because at that point, we had ramped Atom volume, we had ramped quad-core volume to be a fairly significant percent of the total, and what I showed you at the time was inclusive of the chipset, so the CPU plus the chipset. I expected the Atom platform to be about 10 product margin points lower than the mainstream of the product line, which was dual-core, and quad-core to be about 10 product margin points higher than that. So my view hasn’t changed and I’ll update that again in Q1 next year when we have the investor meeting.

R. Kevin Sellers

David, do you have anything else?

David Wong - Wachovia

Great, yeah, one other thing -- did the MP server processors, and specifically Tigerton, processor shipments grow sequentially in June?

Paul S. Otellini

I don’t think I want to give you that granularity. The Tigerton -- it probably did, I don’t have the number at the tip of my fingers but given that it was -- it’s a relatively new product, it continues to ramp. What I was talking about earlier was the mix between MP and DP and that was encompassing both old and new products.

David Wong - Wachovia

Great, thanks.

R. Kevin Sellers

Thanks, David. Next question, please.

Operator

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

Uche Orji - UBS

Yes, thank you very much. Paul, just a quick question on Atom -- what is the relative gross margin of Atom versus Celeron? And as we ramp this product in the second-half, do you see this possibly replacing the low-end Celeron products in notebooks? And if so, what will the impact be on the net gross margins?

Paul S. Otellini

Let me answer the second part of that and I’ll throw it back to Stacy for the first part, which I think he’s already answered but he can try it again. At this point in time, we do not see it replacing Celeron. If you look at the products that are being built, the NetBook products that are being built around Atom, they are all lower priced, lower features, smaller screen size notebooks aimed at first-time buyers or the second, third or fourth machine in a household and I don’t see it cannibalizing, at least in terms of current sales out, and I think we really have hit on a new product category here.

Over time, we’re still sorting out the brand activity in our mainstream notebooks. It is clearly Centrino and Core is where the thrust is going to be, and we’re trying to -- we will sort out and ultimately talk about where Pentium-based notebooks and Celeron-based notebooks live as these categories sort themselves out. But I think it’s premature to say that, except that we don’t see any cannibalization.

Stacy J. Smith

Uche, unfortunately I’m not going to go into any more granularity than I did at the last analyst meeting. We expect this to be a very healthy product margin product. What we are seeing today is demand that’s exceeding our expectations and it’s kind of all in to my gross margin forecast for the year and for Q3.

R. Kevin Sellers

Uche, do you have anything else?

Uche Orji - UBS

Yes, I do actually and let me just circle back a little bit to Montevina. We saw a slight push-out. Obviously that doesn’t -- shouldn’t have impacted this quarter but is it possible, however, that in terms of the back-to-school build, that we may have missed, you may have missed some business as a consequence from Montevina? And is that that something you would hope to recapture in Q3, hence the gross margin impact that we see remaining strong?

I mean, I just wanted to first of all understand, and maybe you can also help us fully understand what really happened with that push-out? I understand it was something to do with the radial. If it’s possible to clarify that, that would be helpful. Thanks.

Paul S. Otellini

Well, the principal reason was graphics and integrated graphics and then the radial as well, but the combination of those two was about a 30-day slip on the consumer SKUs.

A couple things on back-to-school -- first of all, as the industry has gotten more efficient over the last few years, particularly in notebook manufacturing, the cycle times have come down both from a transit standpoint and an assembly standpoint, and our customers are all using hubs and so forth nowadays as manufacturing techniques. So the amount of -- the earliness that you used to see in shipping semiconductors into manufacturers to hit something like back-to-school weekends is a lot shorter than it used to be.

As a result, I don’t think we missed much, if any, of the back-to-school cycle. Number one, some of our customers are doing multiple SKUs and will have multiple back-to-school refreshes and Montevina will be prominent in those second rounds. And I think the goodness of the product stands for itself. There are still not really benchmarks coming out on our new products versus competition’s new products, but when they come out, given our testing internally, I expect we will do very, very well.

Uche Orji - UBS

Thank you very much.

R. Kevin Sellers

Yeah, I appreciate that. Next caller, please.

Operator

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

Chris Danely - J.P. Morgan

Thanks, guys. I guess just a question or a curiosity on the ASP trends in laptops. It seems that the emerging markets are what drove the downward trend in ASPs but it seems to me that emerging markets have always been the big driver there, so I guess I’m wondering why now would it cause this sudden downward trend in ASPs and why wouldn’t that continue?

Paul S. Otellini

I didn’t say emerging market. If we did, I misspoke. What I -- what’s happening in the notebook business, and we showed this graphically at the analyst meeting, is that consumer purchases of notebooks as a percent of consumer PC purchases has grown from 15%, 20% up to 50%-ish, which is roughly where corporate is. Corporate is a little bit higher than that. So what’s happened is the consumer market on a worldwide basis and for PCs is shifting to notebooks. And consumer price points on notebooks are lower than consumer price -- than enterprise price points on notebooks because of the typical configurations and the builds behind them. So I think it’s nothing more than price/volume expansion of the consumer portion of the business on a worldwide basis.

As NetBooks ramp up in the second-half of this year, those I do expect to be predominantly focused on emerging markets but we are just seeing the beginning of that now.

Chris Danely - J.P. Morgan

Okay, thanks. And so Paul, why wouldn’t that continue or why wouldn’t you still have ASP pressure going forward?

Paul S. Otellini

Well, that’s why we’re going to give you some color on Atom over time as a separate line item because I don’t want it to, if you will, color the overall ASP of the core business. So we’ll give you some guidance on that as it gets to be a big number.

Chris Danely - J.P. Morgan

Okay, thanks and I guess for my follow-up, Paul, could you just give us your sense on demand out there? I mean, we all read the papers and stuff like that. It seems like we all understand what is going on in the U.S. What are you seeing in particular out there in China as far as demand goes?

Paul S. Otellini

Well, specifically in China, the quarter had an early interruption, obviously, with the Chengdu earthquake and Intel and virtually everyone that I know that operates in China had some impact early in the quarter from the disruption of sales for essentially a big part of the country, the western part of the country. But having -- and that notwithstanding, the other trends in China are very good. Olympics build-up has got a lot of excitement. There’s WiMAX trials on notebooks in China for the yachting events and a lot of excitement around that. So I would expect that as the replacement machines and rebuilding schools and so forth happen in China, that there will be some recovery from the demand that was lost earlier this quarter.

R. Kevin Sellers

All right, thanks, Chris. We’ll go to our next caller, please.

Operator

Your next question comes from the line Hans Mosesmann with Raymond James. Please proceed.

Hans Mosesmann - Raymond James

Thanks. Paul, can you explain what the direction is going forward in terms of chipset support by third parties? Historically, there used to be various players like Avia, Asus, and ATI, and even NVIDIA. Now that some of those guys can’t do that for lots of reasons, what is the strategy going forward?

Paul S. Otellini

Well, our overall strategy on chipsets is to continue to build the best in the world and to drive as high a percentage of our microprocessors with chipsets as the market demands. And we’ve done exceptionally well in notebooks and have historically done well in servers and okay in desktop. A lot of the companies you talked about in your litany there were desktop suppliers, low-end desktop suppliers in particular and they have made economic decisions to not participate in that marketplace.

There are some structural changes coming up in terms of the kinds of busses that we’ll expose publicly with the Nehalem generation. Much has been written about that. You’ll see more about that at IDF but I was very pleased to see this week that NVidia announced they will do SLI support for Nehalem using the PCI Express bus, which is an open and non-proprietary bus.

R. Kevin Sellers

Do you have a follow-up, Hans?

Hans Mosesmann - Raymond James

Yes -- can you remind us in terms of the tick-tock hit that you get in terms of gross margins when you ramp early next year the 32-nanometer node in terms of what’s the usual or kind of the gross margin hit in terms of points that you would expect because of that?

Stacy J. Smith

What I showed you at the analyst meeting is still how I’m viewing this, which is in the year in which we launch a new process technology, so 2009 will be the year in which we launch 32-nanometer process technology, we tend to see a couple of points of elevation in other cost of sales off of a base of a couple of points. That’s over the year and it can spike a little bit more than that in a specific quarter but it tends to be a couple of points of gross margin. Now keep in mind, some of that is a classification of the research and development hedge in the year in which they are working on a process that’s going in production. They are classified as other cost of sales and the year in which they are working on a process that is not going in production, they are classified as R&D. That’s one of the reasons you saw our spending this year go up, was that classification. That was about a couple hundred million dollars worth of spending in 2008.

Hans Mosesmann - Raymond James

Okay so it’s a couple of points basically in the first-half of next year?

Stacy J. Smith

It’s a couple of points on the year and it will vary.

Hans Mosesmann - Raymond James

Okay, but front-end loaded?

Stacy J. Smith

The graph I showed you at the analyst meeting showed yeah, it will be higher in the first-half of 2009.

Hans Mosesmann - Raymond James

Very well. Thanks.

R. Kevin Sellers

Thanks, Hans. Next questioner.

Operator

Your next question comes from the line of John Barton with Cowen. Please proceed.

John Barton - Cowen & Company

Thank you very much. Paul, you talked about better-than-expected strength from the Atom processor. When I think about sources of demand, I put it in basically three buckets: so incremental first-time buyers from lower price points; increased number of notebook PCs per person; and then thirdly, potential substitution. I think you already touched on the fact you don’t believe any substitution is happening, but the demand in those first two buckets, how would you split that out?

Paul S. Otellini

I wouldn’t use your second category. It’s not PCs per person -- PCs per household. In many households, you’re going from one PC to multiple PCs with these machines and that was some of the early purchases and those purchases happened actually in the affluent cities or the tier 1 cities of some of the emerging market countries like China, where it became sort of a fashion item or machines for the kids. I think that in -- you know, who the heck knows but my guess is that this year, year one of NetBooks, 80% to 90% of the volume will fall in those first two categories and then maybe some substitution. And in year two and year three, I think it’s just too soon to call but our view is that these new price points, combined with a limited amount of features, which is required to enable the price points, are likely to generate a new segment in the business.

R. Kevin Sellers

John, do you have a follow up?

John Barton - Cowen & Company

I do; so if you think about the basic metrics of semiconductors, right, you’ve got the price lever, the computing performance lever, and then the power consumption lever, I think what I just heard you say is a major catalyst for adoption of Atom is certainly the price at a reduced computing performance. How much has the computing performance limited adoption and how do you --

Paul S. Otellini

You know, this is sort of less than a third of the performance of our Centrino, so you are dealing with something which is not -- you know, most of us wouldn’t use and you are dealing with something that is principally designed for net access, for web access, not really to run robust applications and I think it’s likely to stay that way for quite some time. As a comparative, you would not want to run YouTube video on these things all day long. You would not want to do any photo editing on these all day long, or even for a little bit of time.

So I really think it’s a first-time buyer kind of thing and it will sort itself out, just like there is a different market for lower priced, lower performing cars than higher end cars.

Stacy J. Smith

I think that is specific to the PC segment where Atom plays. When you get out into 2009 and it is playing in the broader segments, you know, the power characteristics of Atom are likely to be --

Paul S. Otellini

Into handheld.

Stacy J. Smith

Into the handheld business, we’ll be just as defining.

John Barton - Cowen & Company

Thank you.

R. Kevin Sellers

Thanks, John, appreciate it. Next questioner.

Operator

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

Cody Acree - Stifel Nicolaus

Thanks, guys, for taking the questions and congratulations. Back on the Atom acceptance, obviously coming in very strong. Can you talk, maybe Stacy, about the offsets of Atom’s adoption, the curve of that pricing versus what you are seeing in the upside to 45-nanometer cost cuts?

Stacy J. Smith

Cody, I have to admit, I am not sure I understand your question.

Cody Acree - Stifel Nicolaus

So you are getting an improvement to gross margins because of cost reductions coming down with the 45-nanometer ramp; Atom is coming up, it’s got a lesser gross margin mix impact, so how do those two offset each other maybe as we look into the next few quarters?

Stacy J. Smith

Well, I guess the answer I’d have to give to that is they’re in the 58% gross margin that I have forecasted for Q3, so even with the Atom ramp, yeah, that’ll bring costs down; it’s likely to ship at a lower average selling price. But when I focus on the traditional, what I’ll call the microprocessor business without Atom, my costs come down in that segment of the business as well, so what I did is quantify for you the overall costs. I think it’s probably more on the traditional microprocessor business and less on Atom as we go across at least the second-half of this year.

Cody Acree - Stifel Nicolaus

And so that even with the Atom adoption, even with the overall cost reductions coming, price -- ASPs coming down, you’re still well out-running those?

Stacy J. Smith

Yeah, let me say it a different way -- even if I didn’t have Atom in the second-half of the year, my costs would be coming down nicely. I see my factories are running pretty full, my 45-nanometer process is healthy, I’m running good yields and product characteristics so my costs would be coming down even without the effect of Atom.

Cody Acree - Stifel Nicolaus

And then lastly, can you -- I know that you said you would start to characterize as Atom starts to become more meaningful, just getting into a ramp but Atom is getting a lot of attention here and will likely continue. Can you characterize even weeks ahead, months ahead of where you thought you’d be, percentage ahead of where you thought you’d be or when we might be able to get a little more data?

Paul S. Otellini

Well, it depends on what points you start from. You know, versus last November, we’re 5X, 6X the volume for the year we thought we would -- since a month ago, we’re 10% above it.

Stacy J. Smith

Right.

Cody Acree - Stifel Nicolaus

But versus maybe your expectations going into the quarter?

Stacy J. Smith

Going into the quarter, it would be -- for Q2, it came in about as we expected. Remember, Q2 was the launch quarter for this thing so it’s just we knew how much we --how the builds ramped and that’s pretty much what we sold. When you get into the Q3 again, as Paul said, it depends on what time period you choose but I guess from the beginning of Q2, outlook in Q3 is probably 50% higher than we expected, something in that order.

Cody Acree - Stifel Nicolaus

Great. Thanks, guys.

R. Kevin Sellers

Thanks, Cody. Next questioner.

Operator

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

John Lau - Jefferies & Company

Great, thanks. Paul, in taking a step back, your guidance was very strong, especially in light of the uncertainty out there. Can you give us what the normal seasonality is? And more importantly, whether that guidance is based on the feedback that you get? I guess how comfortable are you with the visibility this year versus the prior years, given the uncertainty? Thank you.

Paul S. Otellini

Well, we are equally on the hook this year versus other years, so we are relatively -- we’re very comfortable with the guidance we’ve given out. Normal seasonality is about 9% I think, Q2 to Q3 typically.

One of the things that gives me comfort is our chipset shipments in Q2. We said the chipsets were a record in Q2. Chipsets, as you may know, are a leading indicator of microprocessor or PC assembly. They get soldered on -- they get purchased and then soldered onto motherboards multiple weeks ahead of the microprocessor, typically four to six weeks depending on the vendor. So the fact that we had very strong chipset shipments, record shipments and strong over the course of the quarter I think is a very good kind of a pointer for Q3, in addition to all of the other data we have.

Stacy J. Smith

If I can just add to that, just to -- you know, for Q2, we would typically see the second quarter down a couple of percent, and if you strip out the impact of the NOR business divestiture, we were flat and for Q3, as Paul said, normal seasonality is 8.5% to 9%, in that kind of a range, and that’s consistent with our outlook. The midpoint of our outlook is right in there.

R. Kevin Sellers

John, anything else?

John Lau - Jefferies & Company

Yeah, and I know that there has been a lot of questions on [inaudible] but can you just give us a quick schedule of the Larrabee, is that still on track with your expectations and sampling at the end of this year? Is that how that’s working out? Thank you.

Paul S. Otellini

Yes, it’s on -- Larrabee is on track. We haven’t changed any schedules there.

John Lau - Jefferies & Company

Great. Thank you.

R. Kevin Sellers

Thanks, John. Next questioner.

Operator

Your next question comes from the line of Srini Pajjuri with Merrill Lynch. Please proceed.

Srini Pajjuri - Merrill Lynch

Thank you. Stacy, a couple of clarifications on the gross margin; first on the NAND side, what kind of an impact is NAND having on your gross margins now? I mean, if you were to exit NAND today, how will that impact your gross margin?

Stacy J. Smith

Our gross margin would be higher.

Srini Pajjuri - Merrill Lynch

Well, by how much, is my question.

Stacy J. Smith

Sorry, that was tongue-in-cheek. As you know I think from prior calls, we don’t break it out to that level of granularity. I will give you a little color commentary on what we saw and in Q2, and what I expect over the course of the rest of this year; the pricing environment continues to be weak. NAND for us in Q2 came in as we expected. The gross margin impact didn’t worsen from Q1 so it kind of stayed the same. We have costs coming down as the pricing comes down, which helps us and frankly, that’s what I expect into the second half. I expect a continued weak pricing environment but my costs come down nicely, so I think it doesn’t have either a positive or negative effect on the overall corporate gross margin.

Srini Pajjuri - Merrill Lynch

Okay, and then my follow-up is I guess pretty much all of last year and earlier this year, you saw a pretty good benefit from makeshift to notebooks and now it seems like the notebook CPU pricing is probably close or even below the pricing of the desktop CPUs. So my question is are the margins still better in notebooks for you compared to your desktop segment?

Paul S. Otellini

Well, the notebook prices are still nicely above the desktop prices and I don’t see them converging frankly anytime on the horizon, simply because there is a premium associated with the power performance characteristics on those product lines, vis-à-vis the desktop. So while they are coming down, I think we’ve said this in the last couple of calls, this is something we expect. It’s a natural consequence of price volume expansion of the market and they are not moving to intercept desktop anytime soon from our perspective. And one of the ways that we are going to mitigate that is with Atom and NetBooks coming in, give us a much lower cost structure to be able to ride this curve than we did during the equivalent expansion of the desktop cycle five, six years ago.

R. Kevin Sellers

Thanks, Srini. We’re going to take two more questions, if you could, two questioners.

Operator

Your next question comes from the line of Michael McConnell with Pacific Crest Securities. Please proceed.

Michael McConnell - Pacific Crest Securities

Thank you. If we look at the gross margin guidance for the year, 57% and the implied margins of 58% and then 60% in Q4, how much is built in those forecasts that corporate adoption of Montevina will be healthy and kind of the same level that we see with Santa Rosa?

Stacy J. Smith

You know, if you’re asking me am I baking in an ASP increase to get there, that would be pretty unusual. The big drivers of gross margin as we go from Q2 to Q3 are, as I said, the costs coming down and the volume, and I expect my costs to come down again in Q4 and volume to be up again in Q4. Those are really the drivers. I’m not anticipating a mix shift to the high end or anything like that.

Michael McConnell - Pacific Crest Securities

Well let me ask this another way, Stacy; so if your mix on notebooks is similar to what you saw in Q2, can you still get to 57% for the year?

Stacy J. Smith

Sure.

Paul S. Otellini

In fact, I’d expect notebooks will continue to grow as a percent of our output.

Stacy J. Smith

Yeah.

Michael McConnell - Pacific Crest Securities

Okay, and then Paul, one last comment just on the healthy chipset strength you saw in Q2; any comments on what you are seeing in Q3?

Paul S. Otellini

Not in a leading -- nothing strange. Everything we see so far in terms of demand for chipsets is equally strong from the strength we saw in Q2. We’ll know a lot more three months from now when we see what the shipments are lining up for the fourth quarter, but right now in terms of the mix, particularly towards the newer chipsets, the demand is very strong.

Michael McConnell - Pacific Crest Securities

Thank you.

R. Kevin Sellers

Thanks, Mike. This will be our last questioner. Thanks.

Operator

And your last question comes from the line of Mr. Brian Piccioni with BMO Capital Markets. Please proceed.

Brian Piccioni - BMO Capital Markets

Thank you for taking my question. Obviously Atom has been a lot of the questions of this call. We mostly focused on the NetBook market for Atom. I’m sort of curious -- what do you expect the embedded market to be relative to NetBook sales? And as a follow-on, wondering if you have to make any ASP compromises for embedded applications.

Paul S. Otellini

The second part of the question is no. At this point in time, the budget areas we’re putting out for embedded applications are in the same range as the desktop version, the higher power version of Atom that we are shipping in the PC space. And that’s because it’s essentially they’re using it -- they are being used as PC processors. Most of these things will run Windows or Linux. They’re Internet connections, general purpose reprogrammable machines, embedded market’s moving pretty rapidly in that direction.

In terms of the mix, gosh, that’s hard to say. The problem is that, as you may know, the time from design win to production ramp at an embedded design, particularly some of these ones that are in regulated environments, can be one to two years. And so if we add up all of the design wins, it’s very strong.

I don’t think that it would out-ship PC applications, PC uses but I think it will be a very strong part of the product line.

Brian Piccioni - BMO Capital Markets

Super. Thank you very much.

R. Kevin Sellers

Brian, any follow-ups? You good?

Brian Piccioni - BMO Capital Markets

Yes, thank you.

R. Kevin Sellers

Okay, thanks, Brian and thank you all for joining the call today. As a reminder, our quiet period for the third quarter will begin at the close of business on August 29th and our third quarter earnings conference call is scheduled for Tuesday, October 14th. Again, thank you all and good night.

Operator

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

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