During Intel's (NASDAQ:INTC) investor meeting held on Nov. 20, the company issued its revenue and gross margin outlook for 2015. On the positive side, the company is guiding to "mid-single digit" revenue growth, but offsetting that good news somewhat is gross margin guidance of 62%. Given that the company has been hitting gross margins of 64%+ during the last couple of quarters, investors may be slightly disappointed at this guidance.
While 2015 has yet to play out, and Intel's guidance could ultimately prove conservative as it did during 2014, it's worth digging a little deeper into just why the company expects margins to come under some pressure next year.
The culprit? 14-nanometer yields
During Bill Holt's presentation on manufacturing technology, the executive discussed how problematic the 14-nanometer manufacturing process has been for the company. In fact, take a look at the image below to see exactly what the problem is:
While the technology apparently meets the company's reliability goals, the yields -- or the percentage of good chips that come from a given wafer -- still aren't as robust as the yields Intel achieved with its 22-nanometer process at the same point in its development. Given that Intel plans to ramp a number of 14-nanometer products during 2015, this has a meaningful impact on the company's product cost structure.
What's the impact?
Intel CFO Stacy Smith showed the following helpful chart illustrating the company's relative product costs per segment of the PC market:
Due to the lower-than-expected yields of the 14-nanometer manufacturing technology, Intel is now projecting a cost increase across all segments of the PC market. Intel likely isn't going to be able to raise prices on its customers, so it's going to need to absorb that increased cost, negatively impacting margins.
Things get better throughout 2015
Below is a chart that's illustrating how Intel expects the costs of its Broadwell product to trend over several quarters. It also shows the costs relative to the two major 22-nanometer PC products – Ivy Bridge and Haswell:
During the beginning of 2015, it looks as though Broadwell will be in worse shape than the first 22-nanometer product -- Ivy Bridge -- was at the same point in its ramp. However, Intel expects that by the third quarter of 2015, 14-nanometer Broadwell becomes Intel's lowest-cost PC platform. Keep in mind, though, that this seems contingent upon 14-nanometer yields improving as expected.
The good news for Skylake and 2016
The good news, though, is that this should set Intel up for a pretty good 2015 with respect to margins. I'd be surprised if Intel didn't have its 14-nanometer yields all figured out by the end of 2015. Further, Intel's Kirk Skaugen indicated that the company would launch its follow-on architecture to Broadwell, known as Skylake, during the second half of 2015.
By then, the 14-nanometer process should be in solid shape and, more importantly, Intel will begin lowering the unit costs of those products during 2015. This means that Skylake, which is likely to dominate Intel's processor mix during 2016, should have a very good cost structure for most of 2016. This could potentially mean a gross margin increase in 2016 relative to 2015, which would be very welcome news to Intel investors.
Ashraf Eassa owns shares of Intel. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.