On Intel's (NASDAQ:INTC) most recent earnings call, CFO Robert Swan provided some insight into the company's gross profit margin guidance for the full year of 2017.
Intel guided to full-year gross profit margin of 62% on a GAAP basis for 2017 -- a 110 basis point (1.1%) improvement from the 60.9% gross profit margin that it reported for 2016.
Interestingly, Intel tells investors to expect gross profit margin of 62% in the first quarter of 2017, which suggests that the company isn't expecting margins to improve throughout the year. This is a little bit surprising, as Intel usually enjoys the benefit of revenue leverage during the second half of any given year relative to the first half, since industrywide personal computer sales tend to be higher in the second half of the year compared to the first.
Swan explained what's going on, and from that explanation, the chipmaker appears to be betting on having won cellular modem orders for the next-generation Apple (NASDAQ:AAPL) iPhone.
The CFO speaks
Swan said that "headwinds" to the company's gross profit margin in 2017 compared to 2016 will come in the form of increased non-volatile memory product sales, as well as from modem sales. The executive was quick to explain that increased memory and modem sales lead to "good growth, increasing profitability, [and] good earnings." That said, he also conceded that those products carry lower gross profit margins than the rest of the company's business.
The way to think about it is this: It's generally better for a company to sell $100 worth of product at 60% gross profit margin and $30 worth of product at 30% gross profit margin -- diluting the average gross profit margin percentage to 53% -- than to just sell the $100 worth of product at 60% gross profit margin, assuming all else is equal.
What does this have to do with the iPhone 8?
Circling back to the topic at hand, let's go over why this commentary might suggest that Intel is inside the next iPhone.
If we look at the trend in Intel's cellular modem revenue, we see that the company saw an initial ramp-up of shipments during its third quarter, with sales accelerating in the fourth quarter. This is consistent with Apple's iPhone ramp-up plans: it builds a bunch of phones in anticipation of the launch, sells even more phones in the quarter following the launch, and then it sees iPhone sales cool off in the following quarters -- until the cycle begins anew.
If Intel doesn't expect to be in the next-generation iPhone, then investors should expect the company to see a substantial drop in cellular modem revenue during the second half of 2017. (In this case, Intel would only be shipping modems into older, discounted iPhone 7 models.)
In that case, cellular modems wouldn't be a headwind to gross profit margin improvement for Intel during the second half of 2017 relative to the first half of 2017, since its cellular modem volumes/revenue would naturally decline -- proving a tailwind to average gross profit margin, not a headwind.
It seems likely, then, that Intel expects to be inside of at least some of Apple's next-generation iPhone models.
Ashraf Eassa owns shares of Intel. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends Intel. The Motley Fool has a disclosure policy.
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