Chip giant Intel (INTC -2.40%) is struggling as demand for PC and server chips tumbles. The company saw total revenue crash 32% year over year in the fourth quarter of 2022, and it expects a worse decline in the first quarter of 2023. Intel sees revenue coming in between $10.5 billion and $11.5 billion in the first quarter, down from $18.4 billion in the prior-year period.
Intel has already announced a broad cost-cutting initiative to help the company cope with lower demand this year. The plan is to knock down costs by $3 billion in 2023, with that total rising to $8 billion to $10 billion by the end of 2025. Layoffs will likely be part of the equation as Intel looks to weather one of the worst demand environments in its history.
An accounting tweak
In addition to that plan to slash annual costs by as much as $10 billion over the next few years, Intel disclosed a seemingly minor accounting change that will significantly impact its bottom line. Effective Jan. 23, Intel has increased the estimated useful life of some production machinery and equipment from five years to eight years.
When you're a company like Intel, which pours many billions of dollars each year into equipment necessary to manufacture semiconductors, a change like this will have an enormous impact on the income statement. Intel expects this accounting change to result in a $4.2 billion reduction in total depreciation expense in 2023. You read that right -- $4.2 billion.
That depreciation reduction will be spread between a $2.6 billion increase in gross profit, a $400 million decrease in R&D expense, and a $1.2 billion decrease in ending inventory values. By stretching out the lifetime of its equipment, Intel will spend less to make each chip, at least on an accounting basis.
Intel is making this change to better reflect the real useful lifetimes of its manufacturing equipment now that the company is making chips for third parties. Lifetime deal value has topped $4 billion in Intel's foundry services business, allowing the company to use equipment longer than it would if it were only making its own chips.
Another factor is Intel's planned move to a disaggregated CPU architecture. Starting with Meteor Lake later this year, Intel will move away from a monolithic design in favor of chips composed of multiple tiles. Each tile can be manufactured on a different process node, opening the door to using mature, older, and less expensive nodes for tiles that won't benefit from the most advanced techniques. Rival AMD is already doing this, although AMD outsources manufacturing.
This won't help cash flow
While this accounting change will impact Intel's income statement, it won't help the company produce additional cash flow. Depreciation is certainly a real expense, but it's not a cash expense.
With Intel facing severe headwinds across PC and server chips, the company's free-cash-flow generation is taking a beating. The company posted a free-cash-flow loss of $4.1 billion in 2022, driven by weak sales and heavy spending on growing its manufacturing capacity. Intel will have no choice but to pare down its capital spending a bit as it weathers the current environment. But the company will continue spending heavily over the next few years as it tries to bring its foundry ambitions to fruition.
In the first half of 2023, Intel now expects to produce negative free cash flow, with free-cash-flow generation expected to improve in the second half. In the long run, Intel aims to convert around 20% of its revenue into free cash flow. Though, that's not going to happen anytime soon, given how things are going now.
While Intel's accounting change will help make its earnings look better than they otherwise would in 2023, it may be 2024 before the company is able to stage a real recovery as demand for PC and server chips stabilizes.
