Intel Earnings Call: What You Need to Know

Intel (Nasdaq: INTC) reported second-quarter earnings this week and hosted an investor call. Here's a Foolish digest for current or prospective Intel investors.

First, a look at four hand-picked fundamental criteria to measure growth rates, margins, and overall financial health, mixed with two data points from our Motley Fool CAPS community:

Besides Intel investors, who should care about this report?
Shareholders of Intel's fierce competitor, AMD (NYSE: AMD), which reported earnings after the bell today.

Further news and analysis on Intel:

• Intel's Best Quarter Ever? Yes, Indeed! (Fool.com)
• Freer Budgets Help Intel's Best-in-a-Decade Profit (Associated Press)
• Intel Posts Biggest Quarterly Profit in a Decade (Associated Press)

What follows is a lightly edited transcript of the conference call.

Kevin Sellers, Intel Corporation, Vice President of Investor Relations
A few important items before we begin. We posted our earnings release, CFO commentary, and updated financial statements to our investor website INTC.com for anyone who still needs access to that information. Also, if during this call we use any non-GAAP financial measures or references, we will we will post the appropriate GAAP financial reconciliations to our website INTC.com. Following some brief prepared remarks from both Paul and Stacy we'll take questions. 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. I also want to remind you of our annual Intel developers forum scheduled for September 13-15 in San Francisco, and hope to see many of you there. For information on this event, please visit our website or contact Intel Investor Relations directly. With that, let me now hand it over to Paul.

Paul Otellini, Intel Corporation, President & CEO
Thanks, Kevin. In Q2, Intel posted its best quarterly results ever as the economies of the world continue to reflect renewed economic momentum. Intel growth continues to run ahead of economic growth, reflecting what we believe is a fundamental shift driven by Internet adoption. Our second quarter was up 5% from Q1 versus a seasonal norm of down 2%. In addition to continuing year-over-year growth in the consumer segments, this quarter we benefited from a broad-based return of the enterprise and small business segments. Our server business had a record quarter, showing strong sequential unit growth and strength from customers opting for richer configurations that drove an improved mix within the server category. The return on investment that our new server offerings deliver is extremely compelling and is a major reason for the strong demand we are experiencing. One example of the surging demand for servers is in the IP Data Center segment which grew 170% over Q2 of last year. As Internet traffic continues to boom, the cloud build-out is accelerating in order to keep pace. In addition to servers, we also saw companies including small businesses refreshing their PCs. Like servers, this too was broad-based and was an important driver of improving product mix within our PC business last quarter. Our Atom business also performed very well, growing 16% sequentially. Two important drivers were responsible. First, there was an inventory correction in Q1 that is now normalized. And seconds, we introduced dual core versions of Atom, which help drive incremental demand and improve our mix within the Atom category. Since launching the Atom processor two years ago, we've shipped approximately 75 million Atoms, and we still expect the industry to ship around 40 million netbooks this year. In terms of global demand for PCs, many third-party analysts are now projecting annual unit growth of around 20%. Our plans are consistent with this number. For the last five quarters, we have seen PC sales driven by consumer purchases, particularly Notebooks. This trend is continuing. And in Q2 we saw a return of corporate purchases that offset seasonal and geographic patterns in the consumer segment. Our outlook for the year remains robust and we are planning for a seasonal second half.

One quick word about the status of inventories. Across the supply chain we are very comfortable with the levels of inventory. In the channel we saw a marked decline in inventories as currency volatility caused distributors to cut back on orders so inventories in the channel are very lean. As for inventories on our balance sheet, the increase was both conscious and important. Over 100% of the increase was from leading-edge 32 nm processors in anticipation of a seasonally stronger second half. At our Investor Day back in May, we talked a lot about the advantages we have with an integrated business model of both product design and manufacturing. Those advantages were very evident in our second quarter financial results. Our product costs continue to decline very nicely, and when combined with the innovative product lineup we have developed, we are able to enjoy healthy financial returns. Our process technology is and will continue to be a very important source of differentiation and earnings power for the company.

In closing, I want to mention our upcoming product family, code-named Sandy Bridge. Last quarter I mentioned that we were broadly sampling this product to our customers. I am more excited about Sandy Bridge that I have been in any product that the company has launched in a number years. Due to the very strong reception of Sandy Bridge, we have accelerated our 32 nm factory ramp and have raised our CAPEX guidance to meet the anticipated demand. We look forward to seeing many of you at our September IDF Conference in San Francisco where we will share more details about this new architecture. With that, let me turn the meeting over to Stacy.

Stacy Smith, Intel Corporation, CFO
Thanks, Paul. A leadership product portfolio across servers, notebooks, netbooks, and desktops, coupled with our best-ever platform unit costs, and a growing PC and server end-market, led to our best ever results. Revenue, gross margin, operating profit, and earnings per share were all records. Revenue of $10.8 billion was up 34% from a year ago and gross margin of 67% was up four points from the first quarter. Operating profit rose to $4 billion, and as a percent of revenue, reached 37%. The improvements we have made in our productivity can be seen in revenue per employee of $134,000, also our best ever. Our financial results in the second quarter were a result of the strong product mix with the continued ramp of our new 32 nm products. Microprocessor unit sales increased slightly above seasonal, and average selling prices for microprocessors were up slightly quarter-on-quarter. All geographies performed better than normal seasonal patterns. The server market segment was particularly strong, with customer demand for our new products leading to a richer mix. The Data Center Group achieved revenue of $2.1 billion and operating profit of $1.1 billion, which was the first time operating profit exceeded $1 billion in this segment. Second quarter gross margin of 67% was higher than our expectation due to higher platform revenue and better-than-expected costs. The factory network delivered our lowest ever platform costs while accelerating the 32 nm process technology ramp as customers continued to demand a richer mix of our latest generation microprocessors.

We generated approximately $3.5 billion of cash flow from operations in the second quarter. Total cash investments grew by $1.4 billion to approximately $18 billion. We paid nearly $900 million in dividends and purchased over $1 billion in capital assets. Additionally, we increased total inventories by $350 million. The midpoint of our forecast for the third quarter is $11.6 million. The forecasted revenue increase of 8% in the third quarter is slightly below the average seasonal increase. We are forecasting the midpoint of the gross margin range to be flat to the second quarter at 67%. For 2010, we are forecasting a record annual gross margin with the midpoint of our annual forecast increasing from 64% to 66%. At our May Investor Day meeting, we reviewed how we have transformed the company's cost structure. The second quarter demonstrates the powerful financial results that can be generated when leadership products in a world-class cost structure are coupled with an overall healthy end market. Our business was strong in the first half, and our forecast for the rest of the year is that the second half is seasonally stronger and that the strength of our product portfolio and our cost structure will allow us to achieve our most profitable year ever. With that, let me turn it back over to Kevin.

Kevin Sellers
OK, thanks Paul and Stacy. We'll now move to a Q and A, and as has been our practice we would like to ask each participant to limit themselves to one question and then one follow-up if you have one. So, Chastity, please introduce our first questioner.

Uche Orji, UBS
Thank you very much. Paul, let me just start off by asking you about the comments you made about distribution and inventory channel. Given all the currency of people, have we seen any pickup now, especially in Europe, which has been quite a concern for some people? Any commentary as to how you see things tracking now in the third quarter within the distribution channels for inventory?

Paul Otellini
Well, so far so good. We give guidance to a very robust third-quarter. As Stacy said, it was basically seasonal or just slightly below the midpoint of seasonality. We don't see any inventory issues out there. The prices in Europe obviously on a euro basis, would be up slightly. But what we're seeing is people are altering configurations as they free up the cash to build these machines. Distributors principally build the machines to order. Some SKUs are less memory figuration, some are taking discrete graphics out, just to try to keep the price points constant in the channel in that retail.

Uche Orji
Just one follow-up. On the Atom, one of the questions that's been around if you look at tablet PCs now starting to take off and whether that will cannibalize netbooks. Just as you look at category and look at it vis-a-vis netbooks, two questions here: how do you see the net impact, and how do you see the positioning of Atom within this category?

Paul Otellini
Well, I think we're in the early stages of tablets, obviously, there's just one really shipping in volume today. At this point, my view hasn't really changed in the last quarter or so. I think this is an additive category of computing, much like netbooks were an additive category of computing. I haven't changed my view on tablets in the last three or four months since the launch of the iPad. I think they are an additive category to the market, much like we saw netbooks being additive. Netbooks, in fact, had a higher potential to cannibalize and they didn't. I don't see tablets cannibalizing the PC market. I think people used it for different kinds of reasons. In terms of Intel participating in the tablet market, we remain very optimistic about this. At Computex last month, there were over 30 varieties of tablets shown based upon Atom configurations. The advantage of obviously Intel in this segment is you can run a number of operating systems. You can run Windows, you can run Android, you can run Chrome, and you can run MeeGo or the other versions of Linux. So we feel pretty good about our opportunity to participate in the growth as it happens.

Ross Seymore, Deutsche Bank
Yes, congrats on the strong results. One question on the inventory on your balance sheets. It was up about 12% sequentially. Can you give us a little color on units versus dollars?

Stacy Smith
Sure. This is Stacy, I'll be happy to. It was both. We got some units in place on 32 nm; that was our strategy. It's also as we're seeing those first wavers coming out of the first couple of factories on 32 nm, it tends to be just a little more expensive than inventory. So both units and dollars per unit were up, and dollars were up some.

If I was kind of talk about inventory now as we go forward. The inventory that we have in place is appropriate relative to where we are 32 nm ramp and relative to how we see demand in the second half. And I expect it to flatten out as we get into the second half of this year, it should be pretty flat third-quarter as we go forward.

Ross Seymore
And then one follow-up on the pricing side specific to the server side. With the Data Center Group up as strongly as it was in server shipping, I would think the pricing could have been up 8 to 10% in that segment. Is that mix dynamic - is my assumption correct, and am I in the ballpark on the pricing side?

Stacy Smith
Yes, it's a level of granularity we're not going to go to. We definitely saw the mix better servers and that led to an ASP positive impact. We also saw that server as a percent of total business was higher. They had a very good quarter, and so we saw a little bit of a mix just based on more server shipments just relative to everything else. Those two things both led to the mix good news we saw in the quarter.

John Pitzer, Credit Suisse
Yeah, congratulations, guys. Maybe a follow-up on the ASP question. Stacy, you've been guiding future gross margin most of the year under the assumption of kind of normal price declines. I'm kind of curious, when you look at the 67% guidance for September, then the full-year guidance of 66%, are you expecting kind of normal historical price decline? Did you think you'll continue to see the positive mix that you've kind of seen in the first couple quarters?

Stacy Smith
Well, I think you can really see that in the fact that from last quarter, I came up from 64% to 66% for the year, and almost all of that is associated with the impact I just talked about. It's just a richer mix of products than I was expecting. The other thing I'll point you to is in my Q2 to Q3 margin, which I can go through for you if you want, ASP isn't one of the drivers. So you can kind of get a sense that I'm not expecting it to be a big driver as we go into the third quarter.

John Pitzer
As I guess as my follow-up, Paul, as you think about the second-half revenue being seasonal and your product portfolio, I'm kind of curious if you break it down to three big buckets, you know, client versus server, consumer versus corporate, and then sort of the desktop notebook Atom bucket. Can you talk about what you expect to be better than seasonal, maybe, or are you expecting any seasonal softness anywhere?

Paul Otellini
We're not planning for any seasonal softness. And when I told you we were endorsing 20% as a planning number, it's hard to find any softness in a 20% year-on-year number, right? Let me try and give you some granularity, though. Clearly, you know, we said for time and we showed you at the analysts meeting that something like 70% of our business is consumer on a world-wide basis, and some of that's small business built into that. I don't see that shifting. So I think that that level of participation in the consumer segments will be reflected and will be seasonal first-half versus second-half. I don't see a change there. I think it will continue to be driven by notebooks, and I think servers will continue to be strong, if I had to guess at this point in time. I see no reason not to. There's two trends inside the server movement. One is the capacity needs coming off the Internet data center build-out, and I gave you some data on that as part of my commentary. And the other is the return on investment that you can get at enterprise data centers by swapping out old versus new equipment in terms of both capacity and power savings, electricity cost savings. I think those are very big drivers this year that are going to be overlaid on top of this. The last comment I'd make on your question is on Atom, which is I really don't see the -- I gave you my number for the year for netbooks. I don't see that part of the Atom business taking off much higher than it already is. It's good year-on-year growth. I think the new growth in Atom over this year is going to be in embedded and in products like the Google TV products that were launched last month. We didn't talk about that in the last conference call because it wasn't announced yet, but I can tell you that a number of companies are now moving towards production on Atom-based televisions, set-top boxes, DVD players and so forth around that particular construct. And to me, that is one of the bigger things to watch for the holiday season as those products break market and see what happens.

Gus Richard, Piper Jaffray
Yes, congratulations on a good quarter. Could you talk a little bit about the -- You said that you saw strength regionally everywhere. Were there any areas like Europe that was weak, or Brazil or China that was particularly strong?

Paul Otellini
Well, every geography was up above our seasonal norm. At least in terms of Intel revenue. We don't have all the sales out data yet. We've got two months of it. But the trend so far that are on a year-on-year basis, everything was up. And in particular, on the commercial or enterprise side of the business. In terms of China, it was a little slow-going early in the quarter and it got good towards the end. Similar in Europe. You know, we had the volcano in the beginning and some currency disturbances in volatility in the middle, and things settled down in both geographies by the end of the quarter. The net was, year-over-year, everything was nicely up.

Stacy Smith
If I may add, you can see it in the results. We saw particular strength in the enterprise segment, and if you look at the geographic breakdown you see that Americas and Europe were both the best in terms of seasonality and that's because they have a larger component of those markets are large companies in enterprise segment. So the enterprise strength really helped drive those results.

Gus Richard
Then on the enterprise segment, you are definitely beginning to see the beginning uptake of a corporate upgrade cycle, of an enterprise upgrade cycle on the client side?

Paul Otellini
It appears that way. We knew for some time that this phenomena had to happen, that the machines were just costing more to keep on the books than they were worth, in terms of out of warranty and repairs and those kinds of things. And the desire, the strong desire to upgrade to Win7. So I think now that corporations have some breathing room in the economy and their budgets, you're starting to see that those machines that are four and five years old get refreshed. I can't comment on the rate of refresh. My sense is you're going to see sort of one year every year for the next couple of years. But that will be an accelerant.

Glen Yeung, Citi
Either Paul or Stacy. If we talked to, for example, a notebook ODM about their outlook for the third quarter, they're talking about a low seasonal forecast, and you guys are below that just slightly. Any way to reconcile the difference in those two views? Is it perhaps what you're seeing in corporate relative to what they may be building?

Paul Otellini
Well, what I'll tell you is our number is where we're comfortable giving publicly. This is the data that we have inside the company, and data from our backlog and what our customers are asking us for. So I don't know that any of our customers have yet commented publicly on the third quarter. They'll do that when they do their earnings, and no one's announced yet. So I don't know that there's an anomaly at this point.

Glen Yeung
OK, thanks, fair enough. And then the second question really revolves around 32 nm. You make the point that you're accelerating it. But maybe in a sense, first of all, obviously I think it's faster than your expectations. What do you expect mix of 32 nm to be relative to your prior expectations in the second half of the year? And then, what will the mix be relative to the first half of the year?

Paul Otellini
It depends on how prior you want to go. We're building more 32 in the second half that we had planned say, six months ago. We're also building more 45 in the second half than we planned six months ago. The net result is that we will have more 45 longer than we first thought, even though 32 is going faster and bigger than we first thought. The basic answer here is that the market's bigger than we had first been planning on for the year.

Christopher Danely, JPMorgan
Thanks, guys. Question for Stacy. Stacy, you told us that inventory would be up this quarter. Was it up any more than you originally thought it would be? And what does that mean for your utilization rates in the second half of the year, are they going to stay flat, or go up, or go down?

Stacy Smith
No, our inventory is up, you know, on the order of what I expected in the second quarter. And as we showed at the investor meeting, we're in the range where we're kind of in that sweet spot of loading. The factories are nicely loaded. We're getting a great cost out of them. We have the ability to do a bit of upside, as Paul said in his written remarks, the place where accelerating a bit here is getting some more 32 nm capacity in place in the second half in anticipation of the demand for Sandy Bridge based on what we're hearing from the customers as they kick the tires of that product line. So I think we're healthy from a utilization standpoint, and I'm comfortable with where we are from an inventory standpoint in the second quarter.

Christopher Danely
Great. And if things do end up slowing down in the second half of the year, what would the reaction be from you guys? Would you, you know, start to hit the brakes, or would you just treat it as a temporary anomaly and maybe keep the utilization rates flat?

Stacy Smith
I think the best way to answer that question is to look at what happened when we got hit by the, you know, kind of massive downturn of 2009. When that hit, the supply chain across the industry reacted very quickly, much more quickly than they had in prior cycles. We took aggressive action to reduce the loading in our factories and not put inventory in place, and then we took advantage of that to roll forward some of the capacity we had on 45 to offset some of the investment that we knew we had to make on 32, which drove a great capital efficiency number. So I'd expect that if you got into the case where get hit with another big recession area kind of scenario like we saw last year, the reaction would be very similar to that.

David Wong, Wells Fargo
Thank you very much. Paul, you mentioned that were very excited about Sandy Bridge and this was one of the reasons for accelerating 32 nm. Does this mean that you're planning to bring out Sandy Bridge earlier than scheduled? And when might we expect to see fast launches of systems that have Sandy Bridge in them?

Paul Otellini
Well, we'll talk more about the product in a lot detail at IDF in a couple of months. In terms of product granularity, I really don't want to get more granular than we have been, which is that we will ship Sandy Bridge for revenue this year, late this year.

David Wong
Great, thanks. And further on the CAPEX question. When you have higher CAPEX this year, does that represent a pulling from 2011 reducing what might otherwise have been spent in 2011, or is it just extra spending?

Stacy Smith
Yes, that's the right way to think about it, although we haven't put a forecast out for 2011 yet, so you don't know how to do the plus or minus to that. But to just piggyback on what Paul said, you know, based on what we're hearing on Sandy Bridge, we're now anticipating a faster ramp of the product. So some of the capital that I thought we could spend in the first half of next year we're going to put in place now so that we can ramp the product out of the chute faster than we anticipated. So it should be plus this year and a bit of a minus to next year.

Jim Covello, Goldman Sachs
Thanks very much for taking the question, and congratulations on the terrific results. Paul, you mentioned both in Europe and China some hesitation at the beginning of the quarter and then things kind of returned to more normal levels at the end of the quarter. How much of that do you think was sort of normal seasonal trend versus kind of macro disruption? And do you see -- What kind of seasonal trend on the shorter term basis do you see during the third quarter?

Paul Otellini
It's hard to tell, Jim. My sense is that - You have two different things going - You have three things going on. In Europe you had the volcano, and then the debt crisis. And in China mid-quarter you had the change in the housing stance which dampened down GDP a bit. I think all those are being worked through now, I mean. To me, if you look through that, through the lens of that smoke, what you see is computers are important, independent of the economy cycle. You know, it happened all last year, to the surprise of many, and it's happening now. And the difference now is that corporations are buying in addition to consumers. Computers are fundamental to people's lives nowadays.

Jim Covello
And then for my follow-up if I could ask. Relative to the enterprise strength, do you have any way of estimating at all how much of that is share gain versus overall market strength?

Paul Otellini
Not for a week or so. But my sense is it's principally the market growing year-on-year so much faster, and then Intel taking perhaps a slightly larger share. But the bulk of it is market growth. Remember a year ago in servers it was still pretty dark.

Tim Luke, Barclays Capital
Thanks so much. Paul, I was wondering, after delivering such a strong quarter, with the chip sets being lower sequentially while guiding overseas fairly close to normal seasonal going forward, the chips sets in the past have been for the PC era as a leading indicator, can you just give some commentary with respect to that and how you might expect to see that going forward? And after such a big first half, people might have thought you might have a slightly less than seasonal second half, but clearly you're saying we don't really expect that, and what's your gut on that?

Paul Otellini
Well, you know, we had a very robust Q1 on chip sets. And the second quarter it was very good. I mean, our chip sets shipments in Q2 always run - not always, normally run ahead of our microprocessors because of the cycle for back-to-school. That happened this quarter as well. But even inside that, I don't see any cutting back. I mean, there's some - Each OEM has their own strategy, TIm. Some are accelerating the use of ocean because they want a lower cost. Some are accelerating the use of air because they want flexibility. And I think that as they all integrate, we don't see chip sets bump in either direction as a leading indicator here at this time. It's mostly just normal.

Tim Luke
A follow-up, then. It seems there's a lot of focus on the inventory this year, and you're saying it's much lower in the channel. On hand it's at 86 days which is at the upper end of the normal range. Last quarter you said part of that was refracted in just more 32 nm in the inventory bank on hand. Can you just comment on that, and why it is that this appears to be the upper end of your normal level, Stacy. Thanks

Stacy Smith
Sure. You know, it's normal for us as we go through as significant a transition as we're going through on 32 nm products to have - you know, to put some inventory in place in advance of those ramps, in particular, as we look into the demand of the second half. So just to maybe help you a little bit in terms of how to think about it. If you go back to mid-2008, which was the last time - it was when we were going through the 45 nm transition. We had a similar amount of inventory in place. Our business levels at that time, so Q2 of 2008, was like $1.3 billion less than our business levels today. So you know, when you look at it in that context, it says we're still running pretty healthy appropriate level of inventory given the 32 nm transition and the level of demand that we're seeing.

Craig Berger, FBR Capital Markets
Hey, guys, congratulations on the extremely strong results. I guess my first question is on the sustainability of your gross margin. As I talk to people out there, your investors, they say how sustainable are these margins, and why. And I know you recently increased your normal range to 55 to 65, and now you're guiding ahead of that. And so how do we think about the sustainability here? Thanks.

Paul Otellini
I think we shared a lot back in May about the transformation that we've gone through and our cost structure, our capital efficiency, the improvements we've made in some of our memory businesses, you know, overall cost per unit. That data still is what I stand behind. I think we have moved the gross margin range for the company up. We're at a period of time right now, because of our specific product mix, that we're a bit above that. You know, you tend to have a few quarters above, and perhaps some that are below. But as we look across the rest of this year, you know, we're at 67% in Q2, and I'm forecasting 67% for Q3, and frankly, I'd expect to be in that range in the fourth quarter as well, when you do that math, that's how you get to 66% for the year.

Craig Berger
The follow-up question is that Europe has been running at about $7 billion a year in revs, at the downturn it fell to 5. It's only going to do about 5, 5-and-a-half this year. If you run-rate it, I mean, is a macro correction already baked into that European consumption number, in your opinion? Could there actually be upside opportunities there? How much risk to forward demand deterioration could we see?

Paul Otellini
Yes, it's really important. You're not looking at consumption there. What you're looking at is our billings. And you've seen a couple of secular shifts in Europe that is causing the billings number to decline, which you have to keep separate from the overall consumption market. One is the ship to notebooks means that more of the product is being built outside of Europe and imported in, so that's one of the big drivers, and that's probably the largest. The second is that the multinationals are taking some share against the smaller players and again, that's if they bill in many cases outside of Europe and then import the product into Europe. So you have to separate that from the strength of the end markets.

Mark Lipacis, Morgan Stanley
Thanks for taking my question. First question, correct me if I'm wrong. My understanding is that historically when you guys went through a process node transition, you'd build inventory of older products and then switched over, and that often translated into risk and maybe some inventory write-downs. And this time it seems like you're still building inventories of the newer products. So I guess my question is, was my recollection of history wrong, or is there something different with your business process that's enabled you to do this?

Paul Otellini
You're not wrong, but there's two shoes to this story. So the first is, we do try to build a little bit of inventory on the older products in advance of the process technology ramp. And then based on how fast we're now ramping the new products and across a very wide range of different price points and different products within a product family, we also try to get some inventory in place on the new stuff. So we do both.

Mark Lipacis
OK, fair enough. The follow-up is, if I look over time on the microprocessors, the erosion follows something like a 6% annual ASP erosion. The one time you bucked that trend, I think, was when you introduced Centrino where you could argue you were delivering more functionality so you could take the price up. Are you guys of the opinion that you take yourself off that 6% annual ASP erosion? Are your products coming out with accelerated functionality, what be it power, better power, or some processing capability that can take you off that 6% ASP erosion? Thanks.

Paul Otellini
You're right, it really is all about mix at the end of the day. And to some extent, Centrino was about up-mixing to mobile in the early days. What you're seeing now, we're very, very happy with the launch ramp and product acceptance in the market of the Core I-357 series that launched in January. That has become kind of the mainstream of desktops and notebooks now, and that brand momentum has really given - is part of the lift you see in terms of selling up from Pentium or Celeron. I think that as we move into the second half and into next year, it's the same kind of thing. We will continue to use technology, feature-driven technology, to put platform ingredients together that we think will command a premium. And when that happens, it's good for Intel and it's good for our customers, and ultimately good for the buyers of the technology.

Stacy Smith
If I may just add. You know, as we've shown you several times, it becomes really important to start looking at ASP and margin per segment of the business. And you know, what we're seeing right now is that in the high end segment of the business, we're doing really well, we're getting paid for those features. I think if you think about our business over a long period of time, what you've seen is that emerging markets have grown more quickly than the rest of the business. The consumer market has grown to be a very large percentage of our business. And so over time there's that mix effect that does bring pricing down. And so the key for us is to be able to bifurcate our cost structure so that in each of those segments of the business we can deliver a very compelling product margin. And I think you're really seeing that play out right now in our business. We've got strong features at the high end. We've got a great cost structure for emerging markets and for the less feature-driven consumer segment of the market. And that all helps us achieve 67% gross margin in the second quarter.

Stacy Rasgon, Sanford Bernstein
Hi, guys, thanks for taking my question. As you look at the gross margin guidance for Q3, it looked to be mostly on higher revenues which was offset by more of your inventory write-offs from Sandy Bridge. Just given what you've said about what looks to be hopefully a building enterprise recovery into the second half, would it be out of line to maybe even see the potential for some further mix related upside the gross margins in the back? It doesn't look like you're guiding to anything like that.

Stacy Smith
Yes, let me just walk you through the Q3 gross margin and I'll also give you a little color commentary on Q4 so you can get a sense of what (inaudible) for that. As you said, as we go from Q2 to Q3, based on the midpoint of the revenue guidance that we just set, we'd expect about half a point of gross margin good news associated with higher platform revenue. That's offset by about a point of inventory write-offs for the Sandy Bridge product that's being built prior to qualification for sale. You know, normal what we see in these product transitions. And there's another half a point of relatively small items, and just in an environment where our factories are running pretty full, where demand looks good, and we don't have a lot of reserves and those kinds of things, you know, you tend to see a lot of small things that will give me another half a point of gross margin in my forecast. And that's what keeps me flat at 67%. Could it be higher? Sure. It'd be kind of foolish to say it couldn't based on the miss that we had in Q2. But based on everything we know and the fact that Q3 tends to be a seasonally stronger consumer quarter, I think we're in the right space. And we'd have to have a pretty significant revenue miss based on ASP for that gross margin to be higher, and likewise, if the markets fall apart on us, it could be a little bit lower. But this is our best information at this time.

Stacy Rasgon
That's helpful. Go ahead, I'm sorry.

Stacy Smith
Well, I was going to take you to Q4, if you want.

Stacy Rasgon
Yes, please do.

Stacy Smith
I'll do the traditional puts and takes as I go into Q4. Again, I'd expect it to be a seasonally higher revenue quarter, so that's going to give me a little bit of a tailwind to gross margin. Assuming the qualification goes well for Sandy Bridge, which our history says is likely, we'll have some write-off good news in Q4 because we'll be selling some of that material because it's been disqualified for sale. And then I have a bit of an offset to that based on an increase in unit cost. And I'll take you back to what I showed in May at the investor meeting. If you recall, I showed a unit class graph by quarter, and it showed a little bit of an uptake in Q4 and then more of an uptake in Q1 and Q2 due to the next big 32nm factory coming on line. It's a very large factory with a high wafer capacity. The first wafers that come out of that factory are pretty expensive, so that gives me a bit of a mix-up in cost. That's normal if you look at our history. Every two years we see that. As we're pulling in 32nm I'm now expecting that cost impact to be a little more in Q4 and probably less in Q1 and Q2. So that gives me a little bit of a tailwind to gross margin. When I net all that out, I think I'm in kind of the same range as I was in Q2 actuals and my projection for Q3, I think I'm kind of still in that basic range.

Stacy Rasgon
That's helpful, thank you very much. For my follow-up, I think the follow on that into 2011, just if you could give us a little more color on the 22nm start-up costs. To my recollection, I believe those start to hit in the first half of 2011? Number one, is that correct? Secondly, can you give us some feeling for the amount of magnitude or basis points of margin and the impact that could have over maybe the first half of 2011?

Stacy Smith
Sure. Actually, as opposed to taking time on the call, what I'll do is - If you go back to the investor meeting materials, that still is my prediction of kind of the shape of start-up costs. And we actually broke it out by quarter for you so you can kind of get a sense of our best guess. It hasn't changed. And you're right, at a basic level, I'd expect it to start kicking in and accelerating in the first half of next year. It could peak in Q2, and then it comes down from there.

Doug Freedman, Gleacher & Company
Thanks so much for taking my question, guys, and congrats again. Can you talk a little bit about what the up-taking server might mean in the enterprise market, and if you've seen in the past history when server strength was so strong. Is there sort of a follow-through where the client will - the enterprise will start spending more on clients later?

Paul Otellini
You're right, that has been the pattern in the past. It was the big enterprise apps and that drove the server upgrade and that drove ultimately a client upgrade. I don't think it's going to apply. It normally works that way. It broadly works that way anymore, Doug. My sense is now so many of the apps in the enterprise are web-based, that once you put the infrastructure in, that's not what drives it. What drives it is the new operation system environment of the client that will drive an upgrade. A new class of applications where people are putting in some of the cloud-based apps inside the enterprise. And a new phenomena that wasn't really true in the last couple of rounds of these things, which is the return on investment thesis around the energy and space savings. And that is really new. So I guess in the aggregate, I don't see that pattern. It probably exists but it's probably not the driver.

Doug Freedman
Great, and if I could go back a little bit to sort of the flexibility in the business model. I know there have been a few questions on this topic. But, Stacy, can you focus in on - I mean, with these numbers that you're putting up, is it safe to assume that your profit-sharing plan is going to be sort of at a record-high level? And as growth flows into the next year, does that come down to a more nominal level?

Stacy Smith
Well, it will seem anemic to those of you that work in the financial services industry. But, yes, if you look at the spending increase that we have now put out for the year, the largest single component of that is revenue and profit dependent. It just says our view of the year has just kind of improved quarter by quarter. It's more than half of the annual increase and is really driving that spending increase from what we thought.

Doug Freedman
And it applies to all employees, not management-driven set of dollars?

Stacy Smith
Right, every employee participates in the plan, and it's solely based on our earnings performance, and so as our view of the year improves, or any performance, plus the metrics that we have - but as our view of the year improves, then it pulls a few more dollars through.

Sumit Dhanda, Banc of America Merrill Lynch
Yes, hi. A couple of questions. Stacy, you know, the ASPs again benefiting you in the second quarter. You're clearly not expecting a benefit in the second half of the year. But is there the potential that you continue to see a tailwind as there's more maturation into the transition to the Core-based platforms, or is most of that benefit now reflected in your mix of processors?

Stacy Smith
So I'd be foolish to say there's no possibility given how my view of the year has changed just over the last two quarters. I think when we started the year we were at 61%. You know, we're at 67%. That's just a phenomenal gross margin for us. It's an all-time record. It says that we're doing a lot of things right from a cost standpoint, and the market's participating along with us. Could we be a little bit better then; could I be under-calling it? I could, but my prediction is that ASP is not a big driver. One way or the other as we go into the third quarter, so you should take from that I'm not anticipating a big movement up or down. And Q3 does tend to be seasonally stronger in the consumer segment of the business, and so you can kind of do the math on that.

Sumit Dhanda
OK, but I guess the question specifically was that, you know, how far along are you in terms of the benefit from the transition to the core platform, because that seems to have surprised you consistently over the last two or three quarters?

Stacy Smith
Are you kind of asking where we are in 32 nm in terms of bringing out the different products?

Sumit Dhanda
Exactly.

Stacy Smith
I'll probably kick that one over to Paul.

Paul Otellini
It's still pretty much in the core family. We are shipping some Pentiums on 32 nm now. Most of the server products are on 32. But we won't take it down into Pentium and Celeron until either late this year or early next year. And of course the Atom products are on 32.

Alex Gauna, JMP Securities
First off, congratulations, you just crushed it. Nice job. I wonder if I could start by asking if you could characterize maybe how far into the core I upgrade cycle are you? And you just touched on 32 nm and where it's going. But how far into the conversion process are we from your perspective?

Paul Otellini
I'm sorry, the conversion of our old core to our new core?

Alex Gauna
Well, in terms of driving sales right now, are we benefiting from the mix being less than 50%, getting towards 50%?

Paul Otellini
Well, the premium part of our product line, you know, the old core products, Core Duo and those kinds of things, and now the Core I-357. It's not the majority of our units. If it was, we'd have margins in excess of what Stacy's been talking about. I won't give you the exact number, but it tends to be slightly less than 50%. And then we fill in the mix with other products, in terms of price points, from Atom to Celeron to Pentium. And it's not so much a -- You know, of course we satisfy all the available demand from the top. You naturally do that. So we believe we're satisfying demand. We are seeing a mix-up, which is based upon the goodness of the products and the feature sets. And so that's what we talked about last quarter and it's part of the news this quarter. We anticipate a similar kind of embracing of Sandy Bridge when that product comes out, to keep that mix fairly rich.

Alex Gauna
OK. And you touched upon emerging markets, your ability to serve, I believe, lower price points in emerging markets. And I was wondering if you could talk about maybe the appetite or the ability for you to up-sell in some of those markets.

Paul Otellini
Well, there's no monolithic market. If you look at China, in the tier one, and to some extent now the tier two cities, the markets there are as sophisticated in mix and purchasing knowledge than as you get in the United States or Western Europe or even Japan. It's when you get out into the places where the incomes are more constrained, into your three, four, five, six cities in China, that you start seeing that phenomena. And what we've done there is we've worked with our customers and with the distributor channel to products that we -- We've done versions of Atom-based motherboards where the Atom chip is soldered onto the motherboard so it becomes a very affordable unit of computing that meets those price points. So there really is not a China market, per se. The China market, if I look at the east coast cities, it's probably a richer mix than we sell in Manhattan.

Kevin Cassidy, Stifel Nicolaus
Thanks for taking my question. I guess along those lines of the Atom chips you had mentioned and netbooks you think you'll ship about 40 million this year. And I'm wondering, what is your percentage outside of the netbooks for Atom? You had mentioned Google TV, when do you think that will become a significant portion of the Atom revenue?

Paul Otellini
I think the non-netbook Atoms start moving the needle next year. There'll be products out this year, both in tablets and handsets and Google TV kinds of products, consumer electronic kind of products. Actually, our growth in embedded Atom was significant this quarter, but it was still a fairly small number as embedded designs take two years to get designed in and then they run for three or four years. So all these things start coming to flush out that family in terms of revenue, I think, in higher volume next years.

Kevin Cassidy
OK, thanks. And maybe just one other completely different topic. IM-Flash, any decisions there on the CAPEX spending?

Stacy Smith
No, as we articulated before on the call, we're doing a couple of things. One is we're continuing to drive the financial performance of the business. I think they executed great in the second quarter. We have processing knowledge and leadership. We've got a great cost structure. The market seems pretty benign right now. So all of those things is helpful. We're making a little money in the business as opposed to losing money. That's nice. And then we're taking a cautious view to the capacity addition. We're going to have to make the decision on our participation in Singapore sometime this year. We haven't made it yet and we continue to analyze it and look at it fairly cautiously.

Daniel Berenbaum, Auriga USA
Hi, guys, thanks for sneaking me in there. Just to follow up a little bit on mix. It looks right now the Data Center is about 20% of sales. Do you think that as the server cycle plays out and as Nehalem continues penetration there, do you have a target? Do you think the Data Center could go to 25% of sales, or do you have some mixed number in mind?

Stacy Smith
Well, I have a mixed number in mind. I'm not prepared to share it. But to some extent, we don't look at it that way. I mean, I know you guys do because that's the easiest way to drive the math. But we look at it as what is the rate of growth of Internet traffic, what is the rate of growth of replacements, and try to maximize that server number, for the obvious reasons. And what that is is a percent of the client revenue. It's really not something -- As the earlier question came to me earlier, it's not something that really is relevant anymore. I think they're independent decisions.

Daniel Berenbaum
Well, then let me maybe rephrase that. What do you think the growth rate of the Data Center is over the next say year, year-and-a-half, versus client?

Stacy Smith
I'm comfortable saying I think we're strong double-digits. And I don't think I want to go more granular than that. But you know I gave you one really interesting fact in my commentary, 170% year-on-year growth in Internet Data Center Xeons. Those are the ones that go into the Googles, Facebooks, Amazons, MSN, those kinds of things. That stuff is growing like a hose. And as people do more picture serving and more video serving, that's going to continue to grow. So to some extent, you've got that triple-digit growth in the Internet Data Centers, and then you have to model out the ROI for corporations doing the upgrade versus capacity needs.

Kevin Sellers
OK, thank you all for joining our call today. As a reminder, our quiet period for the third quarter will begin at the close of business on Friday, August 27, and our third quarter earnings conference call is scheduled for Tuesday, October 12, 2010. Thank you and good night.