Edited Transcript of Intel Q3 2014 Earnings Conference Call..
Company: Intel Corp (INTC)
Event Name: Q3 2014 Results Earnings Conference Call
Date: October 14, 2014 5:00 PM ET
Operator: Good day ladies and gentlemen and welcome to the third quarter 2014 Intel Corporation earnings conference call. (Operator Instructions) As a reminder, today’s conference is being recorded.
I would now like to turn the call over to Mark Henninger, Head of Intel Investor Relations. Please go ahead sir.
Mark Henninger – Head of Intel IR
Thank you, Jamie. And welcome everyone to Intel’s third quarter 2014 earnings conference call.
By now, you should have received a copy of our earnings release and the CFO commentary that goes along with it. If you’ve not received both documents, they are available on our investor website intc.com.
I’m joined today by Brian Krzanich, our CEO; and Stacy Smith, our Chief Financial Officer. In a moment, we’ll hear brief remarks from both of them followed by Q&A.
Before 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.
Also, if during this call we use any non-GAAP financial measures or references, we’ll post the appropriate GAAP financial reconciliation to our investor website intc.com.
And finally, I’d like to remind everyone that we’ll be hosting our annual investor meeting here in our Santa Clara headquarters on Thursday, November 20. If you have questions about the event or logistics, please contact Investor Relations.
So with that, let me hand it over to Brian.
Brian Krzanich – CEO
Thanks, Mark. Our third quarter results were consistent with our expectations and included a number of important milestones.
Revenue and earnings per share both set new records with strong performances from the PC and the Data Center groups. The trends we observed in the PC market last quarter continued with stability in mature markets, offset by ongoing declines in emerging markets.
The PC Client Group launched Core M, a new family of products with full core performance in both compute and graphics in a fanless design, enabling breakthrough designs and form factors. The first of these systems will be available by the end of this month.
In the Data Center, we saw a double-digit revenue growth across all four major market segments: Enterprise grew 11%; networking grew 16%; and HPC and cloud service providers grew 22% and 34%, respectively.
We also launched the new Xeon E5 processor, formerly known as Grantley. This product family provides leadership features and performance for compute, storage and network workloads. Formally launched just five weeks ago, E5 is already 10% of our DP or two-socket volume.
In the mobile communications group, losses declined sequentially and that’s the trend we need to see continue. Tablet volume was nearly 15 million units and we remain on track to our 40 million unit goal for 2014.
Third parties estimate that we are now the second largest tablet SoC vendor worldwide and the largest among merchant suppliers.
In addition, Samsung chose our Cat6 LTE modem with carrier aggregation known as the 7260, for its recently announced Galaxy Alpha and Galaxy Note 4. The strategic importance of these capabilities continues to grow.
Our LTE technology, which we originally developed for phone, is becoming increasingly valuable in tablets and even PCs as wireless wide area network connectivity becomes increasingly common. We estimate, for example, that by 2018 the rate of baseband attached to tablets will roughly double and that PCs will rise to more than 15%.
Overall we’ve made some good progress during this quarter. Yet, we have important work left to do. Within our factory network, 14-nanometer yields improved meaningfully, but we’re behind where we expect it to be. These challenges highlight just how difficult it has become to ramp advanced process technology.
I’m most pleased that our strategy for growth is beginning to yield results across a remarkably wide range of products. We sold record volumes of PC, server, Internet of Things, phone and tablet products. The diversity and scale of our products uniquely position us across the breadth of devices that compute and connect.
Importantly, our results demonstrate that we are building on our success in the PC and Data Center segments to successfully pursue adjacent opportunities. These businesses are the source of tremendous intellectual property and that IP creates valuable and important synergies that position us to compete in an increasingly diverse computing market.
Let me share a few examples. At IDF, I showed the world’s thinnest tablet. A Dell Venue with Intel RealSense technology. It has an industry first 3D camera that enables features like after the fact focusing, and a host of capabilities that have the potential to change how people engage with their photography. That technology was first developed for PCs and was adapted for tablets. In this case we’re in a position to differentiate in tablets precisely because we invested in next generation technology for PCs.
Another example of IP synergy is the Atom microarchitecture. We first brought Atom to market as an extension of the PC product family. We’ve purposely evolved that IP to the point that it now spans from smartphones to tablets and mainstream PCs and from storage, networking and compute devices in the data center to the Internet of Things.
Lastly, I’m excited about the moves we’re making to engage the ecosystem in new and potentially disruptive ways. We’re establishing our position and capabilities in emerging sectors like wearables before they become mainstream.
The data center team is customizing our Xeon products for specific customers and workloads. Custom SKUs now number roughly 35 and over the last year volume from custom SKUs has grown at 3x the rate of our off-the-shelf product.
And we’re also striking groundbreaking strategic agreement. Our recently announced collaborations with Rockchip and more recently, Spreadtrum will provide new sources of innovation and a new set of partners that will work with us to scale Intel architecture. Our vision is that if it’s smart and connected, it’s best with Intel. The breadth of our results this quarter, our progress against our strategic goals and the changes we’re making in our approach to end markets, leave me convinced that our strategy is working.
With that, let me turn the call over to Stacy.
Stacy Smith – CFO
Thanks, Brian. The third quarter was the highest revenue in the company’s history, with overall results demonstrating solid financial growth as we approach the end of this year.
Focusing on our third quarter results. Revenue came in at $14.6 billion, up 8% from a year ago. Both the PC Client Group and the Data Center Group achieved better growth than we expected at the beginning of the quarter.
PC Client Group revenue was up 9% from a year ago. We saw PC Client Group platform unit volumes growth 15% year-over-year and inclusive of tablets, we saw almost 30% unit growth. Of note, our notebook platform units grew over 20% year-over-year as we were enabling innovative two-in-one devices and growing our market segment share with Bay Trail at lower price points.
Our Data Center Group revenue grew 16% from a year ago with platform volumes up 6% and platform average selling prices up 9%. We are seeing robust growth rates across all the segments of our data center business.
Operating income for the third quarter was $4.5 billion, up $1 billion and 30% from a year ago. Operating income in the PC Client Group was $4.1 billion and in the Data Center Group operating income was $1.9 billion.
The Mobile and Communications Group had $1 billion of loss, which is an $81 million improvement from the second quarter. The company generated $3.3 billion of net income for the third quarter, up 12% from a year ago. And earnings per share was $0.66, up 14% from a year ago.
Our net inventory levels rose modestly quarter-over-quarter as we were efficiently managing capacity while ramping Broadwell on 14-nanometer. The worldwide PC supply chain appears to be healthy with inventory levels appropriate in anticipation of the fourth quarter retail cycle.
Moving to gross margin. Third quarter gross margin of 65% was up 0.5 point from the second quarter and down 1 point from our guidance. The increase from the second quarter was primarily due to lower platform unit costs on 22-nanometer and higher platform volume, mostly offset by higher production costs on 14-nanometer products.
Spending came in at $4.8 billion, $100 million lower than our outlook. The overall decrease in spending was driven by efficiencies and one-time events like capital asset sales, partially offset by higher profit dependent expenses.
The business continued to generate significant cash with over $5.7 billion of cash from operations in Q3. We purchased $2.4 billion in capital assets, paid $1.1 billion in dividends and repurchased over $4 billion of stock.
Total cash balance at the end of the quarter was roughly $16 billion, down approximately $1.7 billion from the prior quarter. Our net cash balance, total cash less debt, is approximately $2 billion, and inclusive of our other longer term investments, it is more than $6 billion. This is down by almost $2 billion from the second quarter.
As we look forward to the fourth quarter 2014, we are forecasting the midpoint of the revenue range at $14.7 billion, up 1% from the third quarter. This forecast is in line with the historical average seasonal increase for the fourth quarter. We are forecasting the midpoint of the gross margin range for the fourth quarter to be 64%. The one point decrease from the third quarter is driven by higher platform unit costs, higher factory start-up costs, primarily offset by lower production costs on 14-nanometer.
As we enter the fourth quarter, we are seeing our strategy play out in our financial results. In the third quarter, we grew revenue 8% and grew operating profit 30% versus last year. We also shipped over 100 million units for the first time in our history across a widening range of devices.
In the Client segment, we are seeing robust growth in the PC segment as a result of innovation and enabling lower price point.
We have grown to be the largest merchant supplier of tablet silicon and we are winning large designs with our LTE communications product. And our Internet of Things business is ramping out of its products and growing.
In the Data Center, we continued to innovate our products, bring increased differentiation and value to our customers. And underlying all of this is our manufacturing leadership. We have led the world to 14-nanometer and plan to do the same with 10-nanometer process technology.
With that, let me turn it back over to Mark.
Mark Henninger – Head of Intel IR
All right. Moving on to Q&A, as is our normal practice, we would ask each participant to ask one question and just one follow-up if you have one. Jamie, please go ahead and introduce our first questioner.
Operator: Our first question comes from Ross Seymore from Deutsche Bank.
Ross Seymore – Analyst, Deutsche Bank
Congrats on the strong results. So, one bigger question then a smaller picture one for my second follow-up please. On the bigger picture one, your units in the PC Client Group being up 15% year-over-year, can you talk a little bit about what you think is driving that in the PC market that I think most of the third party data provider says is flat? And do you think that delta can actually stay that large for a bit longer?
Stacy Smith: Hi Ross, this is Stacy, I’ll take — I’ll start it and I think Brian will fill in some of the colored commentary about what we’re seeing in the end markets. So yes, we’ve seen some of the third party data. When you adjust for some of the other form factors like Core-based tablets and things, I’d say our view of the end market compared to say an IDC isn’t terribly different in terms of growth rate, we would both say it’s relatively flat year-on-year in the third quarter.
In terms of our billing results, I think there is couple of things driving that. First, we saw in Q2 that we gained a relatively significant amount of share once everybody had reported. If I had to branch predict, that we probably continued to gain some share in Q3, as is for usual, we’ll wait to see all the third party results come in to know for sure, but our sense is that we gained some share in the third quarter, so that helped.
And then we’re also seeing our customers putting in place a normal supply line in anticipation of a consumer led seasonal fourth quarter and that’s different than what we saw a year ago where people were managing inventory levels very low in anticipation of a very muted fourth quarter. So, I think the combination of those two things does our billing results ahead of the IDC, but feels like it’s pretty appropriate based on what I said.
Brian Krzanich: I think Stacy you covered it well, I think from what we’ve seen probably it covers most of the gap between the two numbers.
Ross Seymore – Analyst, Deutsche Bank
And I guess as my follow-up well it’s not really meaningful to the revenue side it surely is to the bottom-line and that’s your mobile and communications group. Can you talk a little bit about how we should expect that contra revenue impact to trend over time? And I believe in the past you said that you didn’t think you’d get to profitability next year, but any sort of clues that you could provide on how we should expect either the revenue or the profitability to trend as we get into next year? Thank you.
Brian Krzanich: Sure. I’ll start and then Stacy can kind of jump in because how you look at kind of how we’re adjusting the products in engineering is a little bit ahead of where you see the financials move. And so we’ll give you another two sides of that equation.
So from a product standpoint, you saw throughout this year we did a very good job of — as we figure out how to get into this market and work with our customers and partners, how to reduce the cost just on the general bomb picking the right p-mix, the right board layout. So reducing our part counts, all of those kinds of just fundamental engineering efforts is what we focus on. As we got to the end of the year, then we had brought out the Bay Trail cost reduce part which is really focused on — the first part that was really focused on this segment of the market. We’re starting to see systems come on to the shelves as we go through the holiday season with Bay Trail CR and that part will start to have really a designed in cost reduced effort.
We said that we’d have SoFIA, the 3G version out at the end of this year. We’re on schedule. We’ve got SoFIA in the labs running, it’s going – starting its validation effort. We said we’d have SoFIA LTE in the first half of next year. That’s on schedule. And then we announced several partnerships: two main ones, Rockchip and then more recently Spreadtrum which are focused around the SoFIA architecture bringing parts for this mobile space really designed by people who are in that ecosystem are very cost efficient and are connected into both the China market and the worldwide market. You’ll see those parts come out as we go through next year. So when we look at the end of next year, we’ll look how the model SoFIA has built to have no contra revenue.
And so when you go through the next year, again, it will be somewhat mixed dependent as our parts shift the mix and Stacy will talk to you a little bit about that, that’s why it’s a bit hard to predict exactly when. But you will see us mix Bay Trail cost reduce Cherry Trail and then a lot of SoFIA coming in, in both the tablet and phone space and that really is what drives the contra kind of out of this system.
Stacy Smith: Yes. So Ross, let me just — as Brian said, the way the contra accounting works is, the contra dollars that we recognize are associated with the platforms as they actually ship. And so what you’re seeing right now is the majority of our shipments, our products that are carrying a fairly high contra dollar per unit. As we ramp the Bay Trail CR and then the SoFIA products, you’ll start to see the contra dollars per unit to come down. I’m not going to provide a specific forecast at this time for 2015. I’ll stand-by in the prior statements. We plan to make a substantial improvement in the profitability of the segment next year, but don’t get too far ahead of your SKUs. We’re not at a point that we’ll be profitable next year, it is still our goal, but it will take a little time to get there.
Operator: The next question comes from Blayne Curtis from Barclays.
Blayne Curtis – Analyst, Barclays Capital
Stacy, I just want to follow-up; you talked about the more normal kind of supply chain this year and helping Q2, Q3. You’re actually not guiding to down December, so it seems like you’re staying at that elevated rate. I mean just some thoughts on seasonality, you also have Broadwell kind of launches in a typical point of year. Is there any sort of catch up before you kind of ramp Broadwell into late first half next year?
Stacy Smith:So I want to make sure I’m answering the right question. You had one question on seasonality and I’m not sure I understood the Broadwell question. So, let me go to the seasonality and I’ll give it back over to you or if you want to clarify it now, that’s also fine.
Blayne Curtis – Analyst, Barclays Capital
I just was pointing out that you’re launching a platform. Usually you launch it for back-to-school and holiday, and it’s coming, the majority of the Broadwell squeeze is coming in the first half of the year, so it’s just atypical timing? So just thinking about seasonality. And then just wanted to clarify your comments. You said the supply chain was building ahead, but it doesn’t seem like it’s pulling back particularly much in Q4, just thoughts there.
Stacy Smith: Yes. So just to clarify on the supply chain and seasonality for Q4. I wouldn’t term it as building ahead, what I’d say is appropriate amount of inventory in anticipation of a seasonal Q4. And if you go back here to Q3 of 2013, if you recall we were talking about unusually low inventory levels based on our customers, I think I used the word muted, having muted expectations about the fourth quarter. Today, I’d say they have kind of normal expectations about the third quarter. And so — and our guidance for Q4 would be consistent with that. We’re guiding 1% up, if you take midpoint of our guidance that’s kind of the seasonality we’ve seen over the last several years. So it’s pretty much in line with normal seasonality.
In terms of Broadwell and the impact of 2015 seasonality, I’m not providing a forecast yet for 2015. We’ll talk more about 2015 when we get to the Investor Meeting which is just a few weeks away.
Blayne Curtis – Analyst, Barclays Capital
Okay. Just a follow-up on the gross margin given your full year guidance, you were looking at a step down in December and now it looks like the gross margin sustains quite nicely. Just what changed in that outlook and does any of those factors carry into first half of next year?
Stacy Smith: Yes, so as you rightly pointed out, the gross margin forecast for the year is pretty much on — we were a little light in Q3, we look a little better in Q4 based on the algebra that I gave you on the last call. In essence, we’re seeing more of the 14-nanometer cost coming through in the third quarter versus the fourth quarter. And that’s why you see that shift between quarters and the year staying on track. And again, it sounded little bit like a broken record. In terms of 2015, we’re only a few weeks away from the Investor Meeting and that’s a great forum for us to talk about longer-term trend. So, we’re going to hold off on the 2015 questions until we get to the November Investor Meeting.
Operator: The next question comes from Harlan Sur from JP Morgan.
Harlan Sur – Analyst, JP Morgan
Thank you for taking my question and congratulations on the solid quarterly execution. DCG was up strongly in Q2 and again here in Q3 up 16% year-to-year, strong growth in all end markets. Do you expect the breadth of spend to continue across the different customer base in Q4? I know cloud tends to be a bit lumpy. And then do you expect to see continued double-digit growth in DCG in the fourth quarter?
Brian Krzanich: Sure, this is Brian. I think what we said was, we believe we can grow this business around 15% year-over-year. And you kind of framed it correctly that we do especially in the cloud space it tends to be lumpy, but if you take a look at what we’re projecting for the fourth quarter, we’re projecting right in line for that 15% for the year. And it’s got the normal mix of what we see across the enterprise and the cloud and HPC and other data centers. So, we’re expecting Q4 to kind of just progress from Q3 and we’re not changing our forward-looking what we believe we can grow this business at.
Harlan Sur – Analyst, JP Morgan
And then I guess part of the reason for the lower gross margin profile in the fourth quarter is the ramp of 14-nanometer across multiple fabs. I think you said on the last call, it takes a couple of quarters to ramp up to full manufacturing capability after which time you would see ramp cost starting to come down. Is that how you still see it?
Stacy Smith: Yes. I think I said you see highly elevated cost for a couple of quarters then it starts coming down, but it takes a period of time for it to come down. That’s the normal trend. We’re certainly seeing those elevated costs in Q3. You can see it in the gross margin recon. You’ll still see high sell-through costs as those products are selling through in the fourth quarter. For 2015 I’ll get a lot more specific on some of the unit cost trends next month at the investor meeting.
Operator: The next question comes from Jim Covello from Goldman Sachs.
Jim Covello – Analyst, Goldman Sachs
Hey guys. Thanks so much. I appreciate it. You guys referenced the opportunity for consumer buying in the fourth quarter. We saw a really good demand in the third quarter from consumers driven by the new products that you and Microsoft combined introduced. They were great new products and the consumer uptick of them is very good. Do you think that impacts the fourth quarter versus third quarter buying at all?
And then I’ll kind of make my follow-up as part of this question. Do you see the iPhone 6 cannibalizing any kind of a notebook demand just given the price points are the same, obviously the functionality isn’t the same. But given that most of the top 10 selling notebooks are right around that same price point as the notebooks. Do you think there is any cannibalizing going on there as you get to the fourth quarter, or is that part of the guidance? Thanks a lot.
Brian Krzanich: Let me start just on a kind of a general basis and Stacy can jump in. I’d say in general again we’re predicting, we’re forecasting a fourth quarter that’s seasonal. So what we saw in the third quarter, plus as you said about 1% growth as we go into the fourth quarter, which is pretty typical if you go back over the last three years of what we see Q3 to Q4. So we’re seeing that same trend in consumer kind of being flat. It’s a normal years of performance whole through the fourth quarter.
Your question about iPhone 6, no, we don’t really see, but typically we see a separation in that space between consumers going out and buying phones versus PCs. And as you say, there is a big difference in the functionality and usage models between those two. And I think people when they want the usage model and the functionality of the PC, they look at that cost. And as you said, it’s very similar cost. I didn’t say this is a really good value for the functionality on getting it, we typically haven’t seen a cross between those two from a demand standpoint.
Stacy Smith: Can I just come back and – as a question. I don’t think we saw extraordinary consumer demand in the third quarter. If you go back to the strength of end markets, I think we’re pretty aligned with the third-party, it was pretty flat. From an end market standpoint, it was pretty flat. We didn’t see anything unusual there. What we saw was some share gain, which caused us to have a nice bump in billings and we saw kind of a normal amount of inventory being put in, in the system relative to last year, at the same time where people were managing inventory levels low. So, I’d term it more stable PC markets and people betting on a normal consumer fourth quarter.
Operator: The next question comes from John Pitzer from Credit Suisse.
John Pitzer – Analyst, Credit Suisse
First question is for Stacy. Stacy when you look at the revenue in the PC Client Group, I think year-to-date you’re up about $1.1 billion and yet operating profits are up I think about twice that. I’m just wondering if you can talk a little bit about what you’re doing in OpEx in that business around profitability and I guess how much more do you have left to drive profitability in the core PC Client Group?
Stacy Smith: So I’ll answer the question in regards to this year and again I’ll probably hold off on the discussion about ‘15 until we get to the investor meeting. But I think what you see going on this year is probably three things that are all contributing to the operating profit.
First, they’ve got a great product portfolio. And so when you look at where we’re seeing growth, we’re seeing nice growth in kind of the Core i5, i7 segments of the market. And then we’ve brought in some really good technology that’s got a good cost structure at the low-end of the market that gives them a nice cost structure and allows them to go after a unit growth. So I think this really all starts with the product portfolio.
Adding to that I think we have a couple of tailwinds on gross margin in 2014. Our 22-nanometer processors are just spectacular. And we’re at the low-end of the cycle in terms of how much start-up cost flows through and PC Client Group picks up the majority of those. And I also think the leadership of that team has done a nice job of prioritizing investments. So we’ve been making investments in the new areas where Brian and I thought it was pretty important. And so they’ve had a bit of a constrained budget. And I think they’ve done a nice job of bringing out technology that really helps our business while prioritizing within a pretty constrained budget. So that’s what happened in ‘14 and ‘15 discussion will be part of the investor meeting next month.
John Pitzer – Analyst, Credit Suisse
And as my follow-up for Brian. Brian, you guys have been talking about a stabilizing PC market for the last couple of quarters, but over the last couple of quarters you’ve been laying a little more heavily on developed versus developing and corporate versus consumer. When you look at kind of the Q3 results and especially on the ASP line and your guidance for Q4, is this just seasonal consumer strength or do you actually think that both in the developed and developing market, you can now start talking about turning a corner relative to tablet cannibalization and perhaps PC stabilization in emerging market consumer?
Brian Krzanich: I think what we would phrase this as or what we did phrase this as is, it’s seasonal. And so we’re not saying that there is — in fact we said that the consumer we believe is flat. There is seasonal growth as we move into the fourth quarter. We’re still seeing that mature versus emerging market trends that we talked about in the previous quarters where the mature markets are a bit stronger, the U.S. especially, Western Europe though as well and the emerging markets China, Latin America and some of the others are still soft. And so those trends are continuing. And when you look at the consumer as we go into the fourth quarter, we’ve forecasted a seasonal growth for the consumer side.
Operator: The next question comes from Joe Moore from Morgan Stanley.
Joe Moore – Analyst, Morgan Stanley
I wonder if I could just push a little bit more on the gap between sort of 15% unit growth versus the market. I think you attributed it to three factors to share gains to the core base tablet and to the inventory environment a year ago. Which of those factors do you think is most important just because it’s such a wide gap between the numbers?
Stacy Smith: I actually think they’re all sizeable numbers and it’s not unusual for us to have those kinds of differences from the third parties. I think coming back to the prior question we’ve had sustained share gains I think over a period of time. So it’s probably a slightly larger number and then kind of a normal amount of inventory you put in the system, you do that math with the third element being the Core based tablets which I think is going to be relatively smaller.
Joe Moore – Analyst, Morgan Stanley
Okay, great. And then just so I understand the tablet differential, if it’s got anything that has a Bay Trail M or Core is considered a PC unit the way that you’re classifying, is that right?
Brian Krzanich: It’s more of the Core. So products that have a core, I used the Microsoft Surface as a great example, we classify that in a PC side. That’s probably the cleanest example.
Stacy Smith: And IDC would classify that in a different category. So that’s the adjustment you’ll always have to make. I’d also say there is a piece. We tend to have a difference with the third parties on an ongoing basis. And I think it comes down to the breadth of tracking in the white box deep in the emerging markets, the tier 3 tier 4, very hard to get your arms around that holistically. And so we tend to see over long periods of time, we have a slightly higher billing number than they show as the market number and the best we can tell it’s just hard to get your arms around the diversity of the market when you get into white box channel in emerging markets. So that’s always going to be a difference between them.
Operator: The next question comes from Stacy Rasgon from Sanford Bernstein.
Stacy Rasgon – Analyst, Sanford Bernstein
I am sorry to harp on it but I want to go back to this as well. So I understand you’re saying for your own business you think consumer is kind of seasonal and I guess flattish for the year in Q4. But obviously you must — you and I guess your channel partners must be expecting a much bigger ramp of consumer in Q4 given how much inventory you must have built in the channel in Q3. So I guess how do you get comfort that that consumer sell-through is going to be there in Q4 and what’s going to be the consequence if that consumer sell-through is not there? Is the corporate uptake still there; is that going to be enough to offset or like how do we I guess judge the potential scenarios around consumer demand in Q4 and the sensitivity of your guidance around that?
Stacy Smith: Well, that’s a lot of different questions in one. Let me take a shot here though. I’d say first inventory — this is Stacy by the way and Brian will jump in. But I think the inventory levels, what we see is when you look at it in terms of weeks of inventory, it’s appropriate levels of inventory, it’s kind of right in the range of what we’d expect. So you termed it as excessive inventory; I think we’re not seeing that.
As always, if demand doesn’t materialize, then customers adjust their buying pattern and bring inventory levels down. But what we see is kind of normal levels of inventory and it’s sufficient with seasonal Q4 that’s what our customers think will happen and that’s I think what we think will happen in terms of our seasonal results.
You also had a question on consumer versus enterprise and the strength of enterprise, I’ll let Brian talk about those market trends.
Brian Krzanich: Yes, in fact, I’d just take it back to the inventory comments as well. We do what I believe is a really good job of watching our whole supply chain from below us looking at things like the motherboard ordering pattern at the ODMs in Asia and what’s happening there is really the pulls from our inventory hubs and a lot of our — more than half our product ships out hub now and we actually control the inventory on it, so the OEM pulls it at the last moment of use. So we see the actual usage rates there.
Two what’s flying out the shelves at the point of sale? So we’re watching all of those and I think we’ve demonstrated in the past back in the variety of market moves, it will react very quickly. So as Stacy said, current inventory is very typical for this 1% seasonal growth that we’re forecasting for the fourth quarter. And I’m comfortable and I’m also even more comfortable that we’ll be watching it. And if something did happen, we could adjust in either direction. The comment about consumer versus enterprise, as we said, we forecasted a standard seasonal consumer. So, we’re expecting not a great holiday season, not a bad holiday season, a standard holiday season for the consumer in the PC segment.
We continue to see enterprise strength that’s shifting, it was strong in desktops earlier in the year, it’s kind of moved to notebooks as we move to the second half of the year as some of the markets have shifted a little bit. But overall the enterprise all the way from large enterprise to small and medium businesses stayed fairly strong through this year, still seeing mature market versus emerging markets trend, mature being stronger than the emerging. But those trends have stayed and we’ve just forecasted a seasonal consumer. So, I’m pretty comfortable with where we’re at and I think we’ve got the right tools in place to watch this.
Stacy Rasgon – Analyst, Sanford Bernstein
Got it. So my follow-up, let me ask the question a different way then. How much did the weeks of inventory in the channel go up in Q3 to keep — to bring them to levels that you would now classify as sort of healthy and appropriate for the Q4 patterns that you’re talking about?
Stacy Smith: I’m going to hold up on quantifying that Stacy, but I’d say we look at a range of inventory in terms of forward looking weeks. And we’re well within the normal band with that range. So, we’re not seeing anything that’s out of it there.
Operator: The next question comes from C.J. Muse from ISI Group.
C.J. Muse – Analyst, ISI Group
I guess first question, curious in terms of whether your guidance changed at all in the last two to three weeks given growing macro concerns, decline in commodity price because of that weakness in Europe et cetera. Anything in terms of your guide changed with the vision that seasonality may be something little better, would love to hear your thoughts?
Stacy Smith: No, I mean the only guide we provided is the one we provided a couple of hours ago. So, we watch the markets all the time. I think if your question is – have we been kind of showing and doing triple check after seeing some of the like the microchip results and things like that we did, we’re not seeing anything that’s unusual out there. So again, it’s not a surprising forecast for Q4, it’s kind of seasonally up on the back of a more or less seasonal Q3.
C.J. Muse – Analyst, ISI Group
And I guess as my follow-up question, curious if you can comment on operating leverage. If we go back to your initial guide for the year at flat revenues and now up around 6% at the midpoint of your guide, during that same time you’ve grown your OpEx by 5% and in your prepared remarks you talked about IP synergy. Curious how we should think about operating leverage going forward.
Stacy Smith: Yes. It’s a long-term, short-term phenomenon that we’ve talked about and we will absolutely go into this more in November. But we’re still committed, Brian and I are still committed to bringing our spending as a percent of revenue down. We will be down a little bit, this year just by dent of the increase in revenue. On the flip side, this is very much a transitional time for us and we’ve been making some incremental investments over the course of the last year in areas where we felt like we needed to and where we would generate a long-term return. So, we’re glad we’re able to bring it down a little bit, particularly the back half of 2014 is better than the first half. We’ll continue to bring it down, but we knew we were doing during a time where we were making some elevated investments that we felt we needed to make.
Operator: The next question comes from Vivek Arya from Bank of America.
Vivek Arya – Analyst, Bank of America Merrill Lynch
Thanks for taking my question. Can you talk about the carrier certification and some of the competitive landscape you’re seeing in LTE based bands? And I guess the bigger question, Brian, there is that other than this rollup off of the tablet, the contra revenues, are there other actions you can take to reduce losses in the mobile division?
Brian Krzanich: Sure. Let me try and answer your question. There is I believe two questions kind of built in there. The first was around where are we with certifications on our LTE, so where are we relative to our LTE roadmap? What I would tell you is our 7260, as you heard has had several design wins. We’ve publicly said two of them with Samsung. There are others in the works that we’re working on right now.
As far as certifications with the carriers, we’ve begun certifications across the world. And you will see the systems in almost every geography as they come out. We’ve been shipping with a variety of products throughout this year in a variety of other markets especially in Asia. So, we feel fairly strong; we also see there is only — there is only two people out shipping Cat6 LTE modems right now and we’re one of those two. So we feel good about our roadmap, and our roadmap moving forward, going beyond Cat6 that we feel is highly competitive and keeps us at or near the leading edge. So from a modem standpoint, we feel very strong right now.
You asked, is there other things that we can do to reduce our MCG spending, I think there is. If you take a look at what we’re driving on our phone strategy, we’re really driving a strategy that rather than go and push on our own into the phone space, we’re really going with strong partners that are in that space already and have the linkages and the customer relationships. And really that spectrum is the most, I’d say, perfect example of that where they’re strong in China, they’re strong in other parts of the world, they are great supplier to several of the OEMs. And us bringing our SoFIA platform, our base I8 along with modem technology and then over time we’ll likely come into our silicon as well. That gives us them and them a competitive advantage and a cost advantage we believe and a way to get into those markets a very cost effective efficient way.
Stacy Smith: If I could just add one thing, I think Brian talked about — the first step is great product, second step is getting the right investment level. And I think one of the things you’re seeing from and in the company is a lot of innovation in terms of how we go to market. There is a third piece here too which is I think increasingly we’re going to see that the IP that we’re creating for the mobile group is useful and in fact becomes a competitive advantage across the breadth of our product line. And Brian talked in his prepared remarks, if as we think happens over time more of the computers of the world, the notebook computers of the world are connecting via Wireless LAN and we’re one of the companies that has that IP, there is a lot of company synergy associated with us investing and leading in that technology?
Brian Krzanich: I think that’s a great point. You’re going to need those modems in IOT. We’ve said that roughly 15% of the PCs in a couple of years will need them. And then there is that synergy of, we’re going to try and even down in this space bring some of that innovation and IP like the RealSense cameras and all the way through the mobile space as well, which will help us differentiate our products and working with our partners allow them to differentiate as well.
Operator: The next question comes from Doug Freedman from RBC Capital Markets.
Doug Freedman – Analyst, RBC Capital Markets
Hi guys, thanks so much for allowing me to ask you question and congrats on the strong results as well. If I could dig in a little bit on what’s going on in your tablet goal, it does seem I heard a 15 million number for the quarter that you shipped. That would mean that you need to ship actually I believe if I have added up right about 10 million next quarter. Does that mean that the subsidies have peaked in the third quarter or do you think you are going to exceed your tablet shipment goal by an equal amount?
Brian Krzanich: So, let me answer the question on volume and I’ll let Stacy talk about the subsidies. Your numbers are very close, you rightly hit about 15 million, we think got 10 million to 12 million for Q4. We’re not going to necessarily try and blow the number out, but we’re also not going to miss it by 1 million or 2 million. So, my guess is somewhere between 40 million and 45 million is where we’ll end up. Exactly where that is we’ll make sure we’re passed the 40, but not there is no need to go well above that.
As we said that puts us the largest merchant supplier to the tablet business. And we’re really trying to move that space now as both our cost reductions but also differentiating with products like the Dell Venue which we believe is unfinished. And I have a lot of innovation with the first of the RealSense, lot of other products with our other OEM partners like Lenovo moving forward. I’ll let Stacy talk about what that means for our subsidies or our contra.
Stacy Smith: Yes. So the contra answer is a little bit complex, because keep in mind it has to do with the volume and the mix of what we’re shipping for the earlier answer to the question about the different platforms come with different subsidy dollars per unit. I’d expect net of all of that we’re going to see revenue results in the segment, they are not terribly dissimilar from what we saw in Q3 and then we’ll start to see reductions as we move into next year.
Doug Freedman – Analyst, RBC Capital Markets
If I could for my follow-up, just one on some start up accounting. Clearly it did impact gross margin this quarter and your guidance. Is there any color that you can offer us on sort of what your outlook is sort in the way in which you think you’re going to ramp 10-nanometer? It appears as though the 14-nanometer, the magnitude of ramp with the Broadwell platform is a little less than you might have expected as we entered the year. Is that something that you think might repeat on future nodes?
Stacy Smith: Yes. And apologies. This is Stacy, broken record, Smith. I’ll talk more about gross margin trends for ‘15 next month when we get to the investor meeting. But you are seeing in the fourth quarter, you’re seeing the front edge of the startup cost associated with the 10-nanometer and that’s kind of right in line with the historical timing of what you’d expect. We’ll go through more next month where we talk about how that might look over the next couple of years but we’re seeing at least the front edge at the time I think you’d expect and that’s about a point of gross margin next quarter.
Mark Henninger: Thanks Doug. Operator, if you could go ahead introduce our last question please.
Operator: Our final question comes from Mark Lipacis from Jefferies.
Mark Lipacis – Analyst, Jefferies
The first question I had was on the tablet market. When you look at the units that you have shipped so far this year and as you look into what you’re expecting to ship next year, to what extent are the tablets that you’re shipping into, are they Android versus Windows tablets? And has that played out differently than you expected that mix as Microsoft seems to have cut the price of the bundle of Windows and Office?
Brian Krzanich: The mix of Android versus Windows has pretty much played out as we forecasted. Probably 80% plus Android, it’s ours’ mix represents pretty much what you see in the marketplace. So if you walk into any store. So, there hasn’t been really any shift that has been through.
Mark Lipacis – Analyst, Jefferies
And then the second question if I may, there is a view out there that the PC growth that you’ve been seeing has been driven by mostly a Windows XP upgrade cycle. Could you update us on your thoughts on that topic? Do you feel better about the idea that it’s not just Windows XP but rather innovation driving the demand? Thank you.
Stacy Smith: Yes. This is Stacy. There is no data that’s going to prove the point one way or the other. But based on what we see in our surveys, there is a variety of things that are causing people to go and upgrade their PCs. Certainly the Windows refresh is one of them. But it’s also form factors, it’s the age of the PCs and the price points, I think all of that is playing in. And I think when we look across the breadth of our SKUs and knowing which of those are going into, there is large enterprise, small and medium consumer, we get a sense of we’re seeing growth that’s more broadly than just something where people are upgrading Windows.
I’d tell you the second part of your question in terms of where are we, we – in the back half of the year believe that the impact that we are seeing with XP is probably less than it was in the front half of the year. But there is likely a pretty long tail that has some positive impact on the market for a while to come when you just look at the age of the install base and how many of those are now in supported operating systems.
Mark Henninger: Great. Thanks Mark. All right, thank you all for joining us today. Jamie, please go ahead and wrap up the call.
Operator: Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a great day.
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