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Intel Corp. Boosts Research and Development, Slashes Marketing

By Ashraf Eassa - Oct 31, 2017 at 8:32AM

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This Fool takes a look inside Intel's quest to improve its structural profitability.

Chip giant Intel (INTC -2.86%) is one of the most profitable chip companies on the planet. Last quarter, it generated about $5.1 billion in operating income -- a figure that many chipmakers would dream to see over the course of a full year.

Nevertheless, the company has indicated that it wants to reduce its operating expenses -- the sum of the company's expenses for both research and development (R&D), as well as marketing, general, and administrative (MG&A) needs -- as a percentage of its total revenue to about 30% from nearly 36% in 2016.

An Intel AI chip.

Image source: Intel.

Part of that is expected to come from revenue growth. If Intel can grow revenue faster than it grows operating expenses, that percentage will come down. But part of it seems to be set to come from operating expense adjustments and reductions.

Intel's most recent quarterly results show the latter in action.

R&D up slightly

Last quarter, Intel's R&D spending grew slightly year over year to $3.22 billion, from $3.07 billion in the prior year. That's nearly a 5% year-over-year increase. However, as a percentage of its total revenue for the quarter, R&D spending was 19.7%, up just 0.2% from the same period a year ago.

The company indicated that it increased R&D spending in areas such as chip manufacturing technology, artificial intelligence, automotive applications, and non-volatile memory -- all areas that the company's management team thinks will be important for future growth.

Offsetting those spending increases, though, was "continued progress on R&D efficiencies and roadmap rationalization."

"R&D efficiencies" is a euphemism for cost reductions, including lowering headcounts, shifting jobs to geographies where people will work for less, and so on. "Roadmap rationalization" seems to indicate that the company is cancelling products that it doesn't think will generate acceptable risk-adjusted returns.

Big reduction in MG&A

Last quarter, Intel seems to have taken a hatchet to its MG&A expenses. Not only was its spending here down as a percentage of revenue -- it was 12.7% in the same quarter a year ago and just 9.9% last quarter -- but it was down in absolute terms from $2 billion to $1.67 billion.

The company indicated that this reduction was driven by several factors. First, the company said it "further aligned sales force to growth priorities," which sounds to me like a euphemism for headcount reductions in the sales teams responsible for non-growth areas.

Next, the company claims to have made some changes to its marketing programs to "drive efficiencies." Intel CFO Robert Swan said this change in Intel's marketing programs led to a 2% reduction in client computing group sales and a 0.5% reduction in data-center droup sales, but that those reductions were accompanied by operating expense declines that ultimately meant these changes were operating income-neutral.

Finally, Intel said it "eliminated redundancies and streamlined management layers" to achieve its MG&A spending reduction.

Foolish takeaway

From the perspective of an Intel stockholder, these spending reductions -- either in absolute terms or in terms of being more careful about spending increases -- can potentially be a good thing. If Intel doesn't sacrifice its ability to develop products that customers want or its ability to persuade customers to buy those products, then cutting costs should help boost earnings in both the near term and the long term.

But investors need to be mindful of the risk that Intel cuts too much. To be clear, Intel spends a lot of money on both R&D and MG&A, but that spending supports a lot of revenue. If Intel cuts too deeply, or if it simply cuts in the wrong places, then it risks improving its earnings in the short term to the detriment of its long-term financial performance.

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