On Intel's (NASDAQ:INTC) most recent earnings call, the company disclosed that it would be making a fairly significant change to a key aspect of its financials. In particular, CFO Stacy Smith said that the company would be "extending the depreciable life of equipment in [Intel's] factories from four to five years."
Let's take a closer look at what this ultimately means for Intel's financials and for investors.
Capital spending and depreciation: A quick overview
One often talked about aspect of Intel's business is the amount of capital expenditures it lays out each year. Unlike many of its peers in the semiconductor industry, Intel doesn't outsource the production of its processors to third-party chip manufacturers. It builds factories and equips them with the very pricey tools required to actually manufacture the chips.
When Intel spends this money, it doesn't flow through to its income statement as a large, one-time hit. Instead, the amount spent flows through to either cost of goods sold or to operating expenses over a number of years. (According to one financial blog, depreciation of manufacturing-related equipment flows to cost of goods sold while depreciation of non-manufacturing equipment flows to operating expenses; most of Intel's capital expenditures are for manufacturing equipment.)
Generally speaking, the longer a period of time over which a piece of equipment is depreciated, the less the impact the depreciation of that equipment is in any given quarter/year (although its impact will be felt for longer). Indeed, as a result of this change, Intel lowered its depreciation forecast for 2016 by $1.5 billion from prior guidance.
Let's dig into just why Intel chose to lengthen the depreciation cycle of its manufacturing equipment.
A look under the covers
On the call, analyst Joe Moore inquired as to what drove Intel to change the depreciable life of its manufacturing equipment. Smith said that the company "did an in-depth analysis based on the cadence of moving from one process technology node to the next," which ultimately drove it to change the pace at which it depreciates equipment.
Additionally, during the call, analyst Stacy Rasgon asked management to explain the implications of this move on Intel's view of how quickly it plans to move to new chip manufacturing technologies in the future.
CEO Brian Krzanich argued that whether Intel moves through manufacturing nodes at a rate of two years, two and a half, or three years per node, "it was not going to dramatically shift that life expectancy [of equipment] like this."
In other words, he's saying the two things are fairly decoupled.
Krzanich went on to argue that this move is "more about the amount of [equipment] reuse and the efficiency and speed" at which Intel would be able to repurpose tools to build newer chip technologies, claiming that "both of those numbers have improved."
Smith chimed in after Krzanich finished his explanation, noting that this improved ability to repurpose older equipment "is something that has been shifting over time and it gives [Intel] a lot of economic benefit."
Does this impact the fundamentals of the company?
At the end of the day, this change is essentially a change in accounting than anything else. From a cash flow perspective, the money that Intel spends buying chip manufacturing equipment is spent when the company buys those tools.
This is just one of the many reasons that I generally prefer to use free cash flow from operations when evaluating the financial health of a company than even generally accepted accounting principles, or GAAP, earnings.