Processor giant Intel (NASDAQ:INTC) reported bumper numbers last night for its first-quarter earnings report, as the immediate global need for telecommuting, remote education, and remote medicine has led to surges in demand for both notebook computers and data center servers.

However, Intel's second-quarter earnings-per-share guidance came in lower than expected, and shares fell about 6% after hours Thursday night. Since many other technology stocks take their cues from Intel, many related tech stocks fell in sympathy.

But when you look under the hood, Intel's guidance wasn't nearly as bad as investors seemed to believe. Here's why.

A robotic arm holds a processor in a part of a manufacturing process.

Image source: Getty Images.

Intel's guidance

As you can see, Intel guided to sequential declines from its huge first quarter. However, this was largely expected. As you can see, the lower guidance would still amount to about 12.1% revenue growth over the prior-year quarter. It's the earnings number, at only 4% growth, that disappointed. 

Metric

Q1 2020

Q2 2020 Guidance

Q2 2019

Revenue

$19.8 billion

$18.5 billion

$16.5 billion

Earnings per share

$1.45

$1.10

$1.06

Data source: Intel earnings releases and presentations.

While EPS guidance came in below the $1.17 analysts were expecting, revenue guidance was actually higher than analyst estimates of $18.1 billion. That doesn't seem to indicate that demand is slowing. Additionally, when you consider that first-quarter revenue already handily beat expectations of just $18.7 billion, it seems that demand is actually quite strong.

Why Intel's margins are declining

The main reason behind the profit shortfall could actually be viewed as a positive. Intel forecasts that gross margins will decline from 62% to 56%, but that's because the company will take extra costs related to production of its latest 10-nanometer processors, which are now in higher-than-expected demand.

Due to some technical considerations, Intel's 10nm chip is roughly equivalent to the 7nm chips of rival Advanced Micro Devices (NASDAQ:AMD). They are Intel's most advanced chips.

When Intel introduces a new chip, it takes a single qualification reserve, which depresses gross margins. In this case Intel will prequalify its Tiger Lake client CPU, its second-generation 10nm chip (Ice Lake is the first 10nm CPU). The prequalification reserves will account for about half the gross margin decline in the second quarter.

In addition, Intel is accelerating production of its current 10nm Ice Lake Client CPUs and 5G systems on a chip due to strong demand. As yields start to increase on new nodes, gross margins are generally lower until the yields get to a mature state, when margins expand. On a conference call with analysts, CEO Bob Swan said, "Obviously, when we transition from a mature node to a new node, margins tend to come down." 

These two factors, plus the slightly lower revenue, account for the profit shortfall. But since the added costs are due to higher demand for the latest chips, it shouldn't necessarily be viewed as a negative. Swan elaborated, "We're well on track from the plans we laid out and feel pretty good about a dynamite first quarter and an outlook for the second quarter in line or better than what we expected." 

Leading-edge nodes should be in strong demand

Intel's strong earnings follow the trend established by many other top tech companies reporting in recent days: Demand for leading-edge processors is still strong, due to the buildout of 5G infrastructure and high-performance computing applications.

As the stay-at-home economy continues, demand for this technology should continue to be strong. Thus companies making the most advanced processors, graphics, and memory chips should be in decent shape, even as the broader economy declines this year.