Tech Earnings: The Highs and the Lows

On the eve of earnings season, companies in some sectors are warning that fourth-quarter results may miss the mark. Others are ready for their close-up

Too bad Apple (AAPL) Chief Executive Steve Jobs can't spread a little of the buzz generated by the introduction of the sleek iPhone over the rest of techdom. That way, at least the earnings outlook for companies across all sectors of high tech might be more consistent—and positive, of course.

Instead, as technology companies head into earnings season the results will vary depending very much on the sector. For companies in the chip, mobile-phone, or personal computing businesses, for example, aggressive pricing is expected to take a heavy toll on earnings. But for tech companies that depend on consulting or Internet advertising for most of their revenue, the yearend results—and much of 2007—looks healthier.

For constant combatants Intel (INTC) and Advanced Micro Devices (AMD), the latest round of price wars over chips sold to the personal computer and server markets prompted AMD to issue a warning on Jan. 11 that its fourth-quarter earnings would suffer as average selling prices on chips were "significantly lower" than had been forecast. The warning caused investors to punish AMD stock ahead of its Jan. 23 earnings report and prompted a round of downgrades from analysts (see, 1/12/07, "AMD Skids Amid Lower Forecast").

Waking "the Sleeping Giant"

The warning marked a significant turnaround in the fortunes of AMD, which started 2006 with a lot of momentum, having won considerable market share with chips that were widely seen as technically superior to those of Intel. With new business from Dell (DELL), which had previously used Intel as its sole supplier of microprocessors, AMD was seen as besting Intel throughout much of 2006.

But it wasn't long before Intel responded with a new round of chips that challenged AMD technically and with its long-favored weapon of choice: price cuts. "AMD took too much share from Intel too quickly and woke the sleeping giant," says Doug Freedman, an analyst with American Technology Research in San Francisco.

Intel, which reports earnings after the markets close on Jan. 16, isn't without its own set of challenges. CEO Paul Otellini has shaken things up at the chipmaker, rebranding Intel's flagship line of chips, spinning off the company's wireless chip division to Marvell Technology (MRVL) for $600 million, and laying off 10,000 workers for an estimated cost savings of $2 billion by the end of 2007. Eric Ross, an analyst at ThinkEquity Partners, expects Intel to report sales in the lower end of the range of its forecast for the quarter, which was $9.1 billion to $9.7 billion. "Mostly, the issue is that production really fell pretty hard in December," Ross says. He also says sales to big PC makers such Dell and Hewlett-Packard (HPQ) may have suffered while sales to other, smaller PC makers improved.

Wireless Woes

The one major event that might spark a wide-ranging upgrade in the PC market—and a boost in the fortunes of computer and chipmakers—is Microsoft's (MSFT) release of its new operating system Windows Vista. The problem is that the hoped-for effect doesn't seem to be materializing, says Chris Danely, analyst with JPMorgan (JPM). "Our checks in the end market and at IT distributors indicate Vista will have no positive effect on PC demand during the first half of 2007," he wrote in a research note issued Jan. 12. Danely says the PC supply chain was built up in anticipation of Vista sparking demand, but now he expects companies to work off excess inventories. That means bad news for several chip companies with exposure to the PC business, including Intel, AMD, ON Semiconductor (ONNN), and National Semiconductor (NSM), among others, according to Danely.

There's also worry in the wireless sector. On Jan. 4, Motorola (MOT) warned that its sales for the quarter would be lower than previous estimates, coming in at $11.6 billion to $11.8 billion, vs. the previous forecast that topped out at $12.1 billion. Exactly how bad will become clear on Jan. 19 when Motorola reports earnings. Price cuts on its popular RAZR phone hammered results, and now the company is looking for a follow-up success with a new phone called the RIZR, which CEO Ed Zander showed on Jan 8 at the Consumer Electronics Show. Bill Choi at Jefferies & Co. (JEF) downgraded the stock on the warning, saying that pressure on the average selling prices of handsets will limit margin growth.

Meanwhile, any buzz Zander hoped to generate with a new phone was quickly overshadowed by Apple's announcement of the iPhone, which despite a trademark dispute with Cisco Systems (CSCO) was widely hailed as the Next Big Thing in wireless. And though the iPhone won't be on the market until June at the earliest, Apple's December quarter has historically been strong since the dawn of the iPod era. "We had been leading more toward moving to the sidelines with our buy rating after strong December quarter results and Macworld," wrote David Bailey of Goldman Sachs (GS) in a research note issued Jan. 9. "The iPhone has summarily changed our view, strengthening Apple's growth prospects and setting the bar higher for competitors to hurdle." Apple reports earnings on Jan. 17.

Where else in tech are expectations high for earnings? Benjamin Reitzes of UBS (UBS) upgraded IBM (IBM) from neutral to buy in a note issued on Jan. 8, based on improved fundamentals in IBM's core businesses and the belief that past and future software acquisitions will accelerate organic growth and improve margins. He also raised his price target from $100 to $118. He's not alone. IBM has also recently seen upgrades from AG Edwards, and the consensus estimate suggest that revenue for the quarter will come in at $25.6 billion, and expectations are that it may beat that number. Reitzes raised his forecast on revenues from $95.3 billion to $95.9 billion.

Bullish on Google

Analysts also expect Internet companies that depend on advertising to post solid fourth-quarter earnings. Indeed, the Web ad market is expected to hit $18.3 billion this year and grow to a healthy $25.2 billion business by 2010, reckons research firm eMarketer.

The higher-than-expected online advertising revenues should benefit the search and advertising giant Google. Analysts expect that Google (GOOG) will not disappoint when it reports earnings on Jan. 31. The Street conservatively predicts Google will report that revenues rose 17% to 20% over the previous quarter, when it reported sales of $2.7 billion. "We are pretty bullish on Google," says Piper Jaffray (PGC) senior analyst Safa Rashtchy, who is predicting a 20% sales increase.

Most of that growth, Rashtchy says, will stem from computer users performing more searches, thus enabling Google to serve more ads for those same users to click on. He also expects the company to benefit from a slight increase in rates it charges for pay-per-click advertisements. The average click price may have risen from about 45 cents to as much as 60 cents, says Rashtchy.

Looking ahead, analysts are optimistic about Google's ability to bring in additional revenue from some of its recent ventures like selling excess ad space on radio stations and in print publications and its October acquisition of video-sharing service YouTube (see, 1/30/06, "Google: Searching for an Edge in Ads"). "I think it is early days for radio, print, and even YouTube," says Wolk. "But they all showed tremendous promise, and it is certainly an element in our growth projections," says Marianne Wolk, a senior Internet analyst at Susquehanna Financial Group.

Analysts expect that Yahoo! (YHOO), which reports on Jan. 23, will also have a solid quarter, given that the company set the bar low. During the company's third-quarter call, Yahoo lowered expectations for its fourth quarter from about $1.27 billion to roughly $1.15 billion. It blamed the miss on decreased spending from a few major advertisers. Many analysts, however, maintained that Yahoo's inability to provide highly targeted search ads, due to delays with its Panama advertising platform, was causing the company to suffer. Others said that competition for lower-cost advertising inventory was hurting Yahoo (see, 9/21/06, "Yahoo's Ad Slump").

Wolk predicts Yahoo will see 20% year-over-year growth in branded advertising and 5% growth in search. Most analysts are not expecting Yahoo's search advertising revenue to grow impressively until Panama, the company's new targeted advertising platform, is fully launched and has had several months to operate. Yahoo executives have repeatedly said that Panama will fully launch in the first quarter of 2007. "If Panama is launched by February, we should have a notable increase [in revenue] by Q2/07," says Rashtchy.

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