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Inside Intel Corp.’s Strong Third-Quarter Earnings Report

By Ashraf Eassa - Updated Oct 30, 2017 at 2:32PM

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This Fool digs into the generally solid business performance that Intel delivered last quarter.

On Oct. 26, Intel (INTC 3.21%) announced its third-quarter financial results. Revenue was $16.1 billion, beating the company's guidance by $400 million, and earnings per share (EPS) was $0.94, crushing the $0.72 guidance that the company gave when it reported its financial results for the quarter.

The back-side and front-side of an Intel desktop processor.

Image source: Intel.

Considering this strength, Intel also raised its full-year financial guidance. Intel had previously guided to revenue of $61.3 billion and earnings per share of $2.66 for the year. Now, Intel expects revenue of $62 billion and earnings per share of $2.93 for the year.

Let's take a closer look at how each of Intel's business units performed in the quarter.

Biggest business stayed flat

Intel's largest business, its client computing group (CCG), saw revenue of $8.9 billion, which was about flat from the year-ago quarter. Intel's investor presentation indicated that year over year, its personal computer-processor business saw revenue contract slightly, but this was offset by growth in sales of cellular modems and other complementary technologies. Its operating profit in this segment, on the other hand, grew from $3.33 billion to $3.6 billion, which the company attributes to "lower unit cost[s]."

Intel's investor presentation didn't go into too much detail as to what drove that reduction in chip manufacturing costs, but it's most likely related to manufacturing yield improvements in the company's 14-nanometer chip technology. Understanding this is simple: A wafer of chips on a manufacturing technology has a reasonably fixed manufacturing cost. Improved manufacturing yields means that a greater percentage of the chips produced can ultimately be sold, which reduces the effective manufacturing cost per salable chip.

Data center group delivers OK, but not great, results

Intel's second-largest business, its data center group (DCG), saw sales up a modest 7%, from $4.5 billion last year to $4.9 billion this year. The company said that it saw strong sales growth from sales to cloud service providers (up 24% year over year) and to communications service providers (up 9% year over year), but that its sales to enterprises and governments plunged 6%, which put a damper on the growth story.

The revenue growth that Intel enjoyed was driven mainly by an increase in platform unit volumes. Intel reports that it shipped 4% more platforms last quarter than it did in the third quarter of last year -- but an average selling price increase of 2% year over year also helped.

Intel reported that its operating income in this segment grew by $200 million, to $2.3 billion, this quarter, though the segment's operating margin percentage -- that is, the percentage of revenue that translated into operating profit -- stayed flat, at 46%.

Intel's long-term revenue growth target in this business is 10% -- though, to be clear, Intel guided to "high single digit" revenue growth in DCG this year -- so it's a little disappointing to see the company still come in below that level, especially considering it recently launched its new Xeon Scalable processor family for this market.

Internet of Things revenue soars, but profitability tanks

CCG and DCG are Intel's two largest businesses, but the company still has three smaller businesses that contribute to its financial results: Internet of Things Group (IoTG), non-volatile memory solutions group (NSG), and programmable solutions group (PSG).

Intel's IoTG enjoyed revenue of $849 million, up 23% year over year, thanks to what Intel describes as "strength in Retail, Industrial and Video" segments. Profitability dropped substantially, though, despite the surge in sales, to just $146 million from $191 million a year earlier. Intel said that this profitability reduction was a result of "higher investments."

Technology companies need to make investments in new products and technologies years before they ultimately ship to customers. Intel's IoTG is investing more today -- and ultimately, harming its overall profitability today -- because the company thinks that such investments can pay off big over the long term. We'll see how that strategy works out for the company.

Memory business sees huge improvement

Intel has been very vocal in its long-term bet on the non-volatile memory market. Intel's heavy investment in future non-volatile memory (NSG) technologies and products has led to substantial losses in recent quarters, but this quarter's results seem to indicate that there's light at the end of the proverbial tunnel.

During the third quarter, NSG enjoyed revenue growth of 37%, to $891 million. Though the segment continued to lose money, NSG's losses narrowed to just $52 million for the quarter -- down from a $134 million loss in the same quarter a year ago.

Intel says that these losses are due to its investments in a new technology known as 3D XPoint that it hopes to deploy as both a storage replacement, as well as a memory replacement in data centers. Its NAND flash business, which generates the bulk of Intel's NSG revenue today, is profitable.

This segment is probably the most volatile of Intel's businesses. The market environment is quite favorable for Intel's NAND flash business given the ongoing booming demand for virtually all memory products, but should the cycle turn, the segment could be back to posting heavy losses.

Altera results looking good

In late 2015, Intel purchased programmable logic vendor Altera and renamed it the Intel Programmable Solutions Group. The reasoning that Intel gave for this purchase ultimately boiled down to the following:

  1. Intel thinks that it can strengthen Altera's competitive positioning by migrating Altera's designs from third-party manufacturing to Intel manufacturing.
  2. Intel thinks it can deliver value by selling products that integrate Altera's programmable logic chips with its own processors.

It's too soon for us to tell whether these broader strategic goals have played out because most of PSG's revenue comes from stand-alone products built on third-party chip-manufacturing technology. Nevertheless, it's important to keep tabs on the performance of this business, especially since Intel paid nearly $17 billion for it.

Last quarter, PSG saw revenue grow to $469, a 10% year-over-year increase that Intel says was "driven by Datacenter, Industrial and Military," but was "partially offset by Wireless and Wireline." Operating income also grew to $113 million from just $78 million a year ago. Perhaps what's most interesting, though, is that Intel claimed that the third quarter was its "largest design win quarter in over 3 years."

This is important because there's generally a long lead time between when design wins for the types of chips that PSG sells are closed and when they begin to generate revenue. The strong design win activity could be an indication that PSG's revenue is set to accelerate, perhaps due to market-share gains, in the years ahead.

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