Intel defends aggressive capital spending

Intel will boost capital spending to twice as much as what it spent in 1999 - at a time of declining sales. A serious case of the 'Field of Dreams' syndrom or just good planning ahead?

Despite a pessimistic first-quarter outlook, internal budget tightening and an admission that economic uncertainty is clouding its forecasting, Intel Corp. executives say one thing remains clear -- the chip maker must spend billions to modernize its manufacturing.

Intel's decision to boost capital expenditures to $7.5 billion this year, a 12 percent annual increase and more than double the $3.4 billion spent in 1999, caught several industry analysts off guard yesterday evening.

In fact, some analysts had speculated recently that the company would curtail such spending as it struggles with declining sales. But despite Intel's determined stand, others contend that economic hard times will force Intel to make such cuts, including possibly laying off workers.

"It was shocking what kind of number they gave for capital expenditures given how bad things look for the first half of the year," said Dan Niles, an analyst with Lehman Brothers in San Francisco, who had expected Intel to reduce that part of its budget. "This is just a very large spending ramp."

Analyst Jonathan Joseph of Salomon Smith Barney in San Francisco admitted that he was also puzzled by the chip maker's decision.

"Why the aggressive capital spending plan if things look like they're slowing?" he asked. "Are they being too aggressive or do they expect things to pick up quickly?" Andy Bryant, Intel's chief financial officer, strongly defended the company's decision, which was the first issue he was grilled about in an earnings conference call with analysts Tuesday.

"As we reduce budgets across the company, we will not make any cuts that compromise Intel's future," he said, despite admitting that "our comfort with precise forecasting is as low as it has been in years."

Regardless of fears that the global economy is weakening, Bryant argued that Intel must spend now to update its equipment and deploy new manufacturing technologies.

"Intel has been through many downturns since its founding in 1968," Bryant said. "Through each downturn, the company assured its success by continuing to invest in technology, focusing on reducing non-essential spending and preparing to meet customers' requirements when the economy strengthens. Our response to this down trend will be similar to others in our history."

In particular, Bryant said, Intel needs to spend the money to assure a rapid transition to the smaller 0.13 micron manufacturing process it will begin switching to this year from the current 0.18 process. The newer process enables smaller and faster chips and saves Intel money by enabling it to make more processors per silicon wafer.

In addition, the company is building a new facility to produce 300mm silicon wafers, which are 30 percent larger than those currently produced and enable Intel to produce more processors per wafer. While agreeing the moves could make Intel "leaner and meaner," analyst Ashok Kumar said the surge in spending highlights the chip maker's erratic spending history.

"It's really feast or famine with them," said Kumar, of US Bancorp Piper Jaffray in Minneapolis. "If you go back a couple of years, it was essentially famine. Last year, they grew capital expenditures more than 90 percent, and now they're upping it again."

The spending also reveals some wishful thinking on Intel's part, he said.

"I think that they have somewhat of a "Field of Dreams" trajectory. Sort of 'Build it and they will come,'" Kumar said, referring to the popular movie and Intel's apparent hope that its increased capacity will coincide with a surge in demand.

Some analysts said privately that they still expect Intel to cut capital spending, but declined to be quoted publicly.

"I don't doubt that they want to meet those budget projections, but I think that come March or April they'll quietly announce that they're scaling back a bit," said one analyst who asked not to be named. But while Intel remains optimistic about meeting its longer-term capital spending goals, it offered a much bleaker outlook for the short term, with company executives painting a less-than-rosy picture for the first three months of the year.

For the fourth quarter, the chip maker posted earnings largely in keeping with its recently lowered projections, reporting net income of $2.6 billion, or 38 cents a share, 1 cent higher than Wall Street consensus estimates, according to First Call.

However, earnings were down 13 percent from the previous quarter, reflecting a steep drop in PC sales during what is traditionally the strongest quarter of the year. Compared to a year ago, quarterly earnings edged up about 4 percent.

But while Intel met its lowered earnings goals issued in a Dec. 7 warning to investors, the chip maker further fueled fears of an industry slowdown by projecting that revenue will fall 15 percent in the first three months of the year compared to the fourth quarter, far steeper than most Wall Street analysts had forecasted.

"The fourth quarter was in line with our outlook, but the first quarter outlook was significantly weaker than what we expected," said Mark Edelstone, an analyst with Morgan Stanley Dean Witter in New York.

Expressing his own wariness of Intel's forecast, Edelstone speculated that the company may have offered the cautious projection as a "worst-case scenario," essentially setting the bar low so it can be sure of meeting expectations.

"It feels low to me," he said. "It would not be a surprise to see it closer to 10 percent."

Niles, of Lehman Brothers, said that while it's possible Intel was "low balling," or underestimating what its revenue will be, he's inclined to believe the worst.

"I would hope that they're low balling ... but if you look at things overall they're pretty bleak," he said. "Everything was a lot worse than I had imagined in terms of the forecast, and I had thought it would be pretty bad."

"It's a pretty bad macro environment out there," he added. "We've gotten the gloomy results from Gateway already. We haven't heard from Compaq and Dell yet, but it doesn't sound like things for them are all that great either."

Last week, Gateway Inc. reported it lost $94.3 million for the fourth quarter amid a 15 percent drop in PC sales. The company predicted its revenues would continue to decline in the first half and announced plans to streamline operations and lay off more than 3,000 workers, or slightly more than 12 percent of its total employees. Intel also revealed yesterday that it had initiated a cost-cutting program, curtailing hiring and halting nearly all office building projects. In addition, the company said it will close a board manufacturing plant in Puerto Rico by the middle of this year. Currently, about 1,360 people work at that facility.

While Intel CFO Bryant stressed that the plant closing wasn't due to worsening global economic conditions, he noted that "it has added a sense of urgency" to the company's efforts to maintain the "most competitive" manufacturing facilities.

But even with the plant closing and apparent freeze on hiring, Intel may be forced to follow the lead of other major high-tech companies and reduce its work force, Kumar said.

While Intel is optimistic that it can reduce its staffing through normal attrition, Kumar said the company is actually finding that workers are less inclined to leave now compared to last year.

"Their attrition rate was lower than normal in the fourth quarter," Kumar said. "In the second half of last year, they saw the exodus of workers to the dot-coms. But the dot-com business has imploded, so I think they're going to have to force attrition."

Looking into their admittedly cloudy crystal ball for the next 12 months, Intel executives projected that after a difficult first half, computer sales will pick up in the second half of the year.

"Assuming the economic situation improves, we would expect and are planning for a seasonal strengthening in the second half," said Intel Executive Vice President Paul Otellini. "In addition, we believe we'll see a renewal in PC demand growth as the PC becomes increasingly recognized and tuned to become the center of a new digital world in consumer and business applications."

But despite Intel's optimism about a stronger second half, one analyst said that there are still many too many questions that have yet to be answered before people can look for a rebound.

"It's anybody's guess," Niles said. "Do you think Alan Greenspan's interest rate cut has any impact, and if so how much? Another question is, how bad do you think Japan's economy is getting? What do you think is going to happen in Europe? We just don't know yet."

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