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January 19, 2006

Tech Lays an Egg
by Chad Hudson

Fourth quarter earnings season started with a bang. On Tuesday, Intel and Yahoo! reported fourth quarter results that missed analysts' forecasts. Additionally, both companies said that first quarter earnings would not be as robust as analysts currently anticipated. On Wednesday, Apple and Ebay disappointed investors.

Intel reported earnings per share of $0.41, which was two cents lower than analysts' estimates. The primary reason for the earnings shortfall was lower than expected revenue. Intel reported fourth quarter revenue of $10.2 billion compared to estimates of $10.5 billion. The company said that it lost one point of market share. The lower revenue also caused some SG&A deleveraging, compressing gross margin to 61.8%. The company had guided that gross margin would be 63%, plus or minus a point. More importantly, the company said that earnings for the first quarter and for the full year would be lower than current analysts' forecasts. Plus gross margins are expected to drop further. The company guided full year gross margin to 57%. Earnings for the first quarter of 2006 will be hindered as the company works down inventory of lower priced processors. While business conditions were difficult, Intel stepped up its capital spending plans. It now expects to spend $6.9 billion this year, compared to $5.8 billion last year. The company is also planning on spending more on R&D as well, $6.5 billion compared to $5.1 billion. What growth Intel is experienced came from overseas. Sales in the in the Americas were off 3.5%, with the decline happening in the US, which was partially offset by growth in Latin America. Sales in Europe increased 14%, while Asia Pacific sales were flat.

Advanced Micro Devices has clearly taken market share from Intel. During its conference call, the semiconductor company said it has 15.3% of the market compared to 9.6% last year. Revenue increased 45% to a record $1.84 billion during the fourth quarter; this was almost $200 million more than Wall Street estimates. The company expects revenue to increase almost 70% during the first quarter of 2006.

Fourth quarter results at IBM were much better, even though revenues were lower than expected. Revenues declined 1%, excluding the PC business, and were $400 million lighter than analysts' forecasts. But due to cost cutting, the company was able to increase earnings by 26% to $2.11 per share, which was 17 cents higher than analysts expected. This was the second consecutive quarter that IBM posted lower than expected revenues but managed to beat earnings estimates. Additionally, IBM's service revenue declined year-over-year in the fourth quarter, this was the first decline since 2002 and only the second time since 1994. While cost cutting can certainly work in the short-term, investors will likely grow impatient if revenues continue to stagnate.

Internet companies Yahoo! and Ebay reported fourth quarter earnings this week. Yahoo reported that it earned $0.16 per share, which was a penny less than analysts' estimates. Search and fee revenue, up 10% and 9% respectively from the third quarter, were both less than expected. International revenues increased only 3%. Branded advertising was the only segment that investors were satisfied with, up 25%. Additionally, while revenue guidance for 2006 is in line with estimates, EBITDA guidance was lower. Obviously, Google is cutting into Yahoo!'s business. Ebay earned $0.24, two cents higher than investors anticipated, but warned that first and second quarter earnings would be lower than current estimates. The projected revenue shortfall only amounts to a total of about $30 million combined between both quarters and the company didn't lower earnings guidance for the full year.

Apple Computer exceeded analysts' earnings estimates, but warned that revenue and earnings would be below analyst forecasts. During the fourth quarter, Apple earned $0.68 per share, almost twice the $0.35 per share last year, on a 65% increase in revenue. Unfortunately, the company was cautious regarding the first quarter. The company said it expects revenue of $4.3 billion and earnings of $0.38 per share, which is significantly less than the current forecast of $0.48 per share. The company expects a seasonal drop in iPod sales and a pause in Mac sales as the company transitions to Intel based computers. Of course, Apple does have a history of being overly conservative regarding forecasts. Initial guidance that Apple gave at the beginning of the quarter was for $4.7 billion in revenue, $1 billion less than it actually brought in.

Besides the start of earnings season, there was a lot of economic data released over the past week as well. Retail sales rose 0.7% in December. Most of the strength was in auto sales. Excluding auto sales, the increase was only 0.1%. This was below the 0.4% economists were expecting. Compared to last December, sales were up 6.2% and 7.4% excluding autos. General merchandisers clearly lagged, sales were up only 3.6% compared to last year, and the slowest since February 2005. This is obviously a result from Wal-Mart having poor December results. Building materials sales were up 8.2%. This was the first single-digit gain since July. Interestingly, non-store retailers posted gains of 9.1%, this was the slowest increase since July.

Producer prices rose 0.9% in December, more than twice the 0.4% increase economists expected. For the full year, producer prices increased 5.4%. This was the highest yearly increase since 1990. Contrary to producer prices, consumer prices declined 0.1%, and were up 3.4% from last December. Most of this decline was due to a drop in energy prices. Energy prices dropped 2.2% December, which followed an 8% decline in November. Considering oil has already jumped back to $65 per barrel, it is likely that consumer prices will trend back up.

The manufacturing sector continued to expand in December. Industrial production rose 0.6% in December and 2.8% over the past year. The Commerce Department also reported that capacity utilization increased 0.2% to 80.7%. This was the highest utilization rate since November 2000.

The Beige Book reported that all twelve districts reported that the economy expanded. There was not much change compared to past reports. The manufacturing sector continued to expand along with consumer spending. Residential real estate has cooled, but "commercial real estate activity generally continued to improve." Labor markets were reported as tight and wage increases were moderate, but "nonlabor-input-costs continued to concern companies." Most of this pressure was felt on producers. Competitive markets are preventing pricing to work through to the consumer. If this dynamic continues, corporate profit margins will come under pressure.

Chad Hudson
Mid-Week Analysis
PrudentBear.com

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