Shares of chip giant Intel (NASDAQ:INTC) jumped in after-hours trading on July 15 after the company reported its second-quarter earnings. Intel managed to beat analyst estimates for both revenue and EPS, and its guidance for the rest of the third quarter and for the rest of the year was better than expected.
But the details of Intel's earnings report tell a very different story.
On the surface, Intel's reported EPS of $0.55 for the quarter looks pretty good. It was five cents better than analysts were expecting, and flat year over year. Given the turmoil in the PC market, flat profits are a miracle.
The problem is that Intel's profits weren't really flat. The company's tax rate plunged from 28.7% during the second quarter of 2014 to just 9.3% during the second quarter of 2015, driven by a one-time refund claim and Intel's decision to indefinitely reinvest certain prior years' non-U.S. earnings.
In other words, the decline in the tax rate is temporary, and Intel even guided for a tax rate of 26% for the third and fourth quarters. This abnormally low tax rate, along with share buybacks over the past year, allowed Intel to report flat EPS. In reality, operating income collapsed, falling by 24% year over year. Had Intel's tax rate remained flat compared with the second quarter of 2014, the company's EPS would have been $0.43, well below analyst estimates.
Margins fell in the data-center segment
The data-center segment is Intel's highest-margin segment, and it has been growing at a breakneck pace in recent years. During the second quarter, data-center revenue rose 10% year over year, a bit slower compared with recent quarters, but still an impressive growth rate nonetheless. Both volumes and average selling price rose 5% year-over-year.
Even though the data-center segment grew, operating income was flat. During the second quarter of 2014, the data-center segment managed an operating margin of 52.5%. This figure fell to 47.9% during the second quarter of 2015.
That may not seem all that bad, since an operating margin near 50% is still incredibly high. This isn't the first time margins in the data-center segment declined year over year -- it happened during the second quarter of 2013 as well. The difference is that the segment barely grew at all during the second quarter of 2013, while it grew by a double-digit percentage in the second quarter of 2015.
Intel has a near-monopoly in the server-chip market, and margins declining as revenue rises brings up some questions regarding the health of the segment. The recent downgrade from Bernstein, which cited a possible slowdown in server-chip sales as a concern, may ultimately prove to be correct.
PCs were awful
The terrible performance of Intel's PC business during the quarter was widely expected, given the weak PC market. Notebook volumes fell by 11% year over year, while desktop volumes plummeted by 22%. Average selling prices were down 2% and 6%, respectively.
Since Intel combined the PC and mobile business into the client computing segment, it's difficult to parse out how much of the decline in revenue and profits can be attributed to the PC. The mobile business was heavily subsidized during 2014, posting multibillion-dollar losses.
Revenue from the client computing segment declined by 13.5% year over year, with operating profit slumping 38%. With the data-center segment unable to make up for this decline, Intel's total operating profit tumbled.
Adjusted for the one-time reduction in the tax rate, Intel's earnings were far worse than the company reported, and well short of analyst estimates. Margins in the data-center segment are declining, a sign that demand may be weakening. And the PC business, while it may improve following the launch of Windows 10 and Skylake later this year, was abysmal during the second quarter. Why Intel's stock rose following the company's earnings report is truly beyond me.