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Here’s Why Intel Corporation’s Biggest Business Saw Profits Soar

By Ashraf Eassa - Apr 29, 2016 at 10:45AM

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Cost cutting and yield improvements.

Image credit: Intel.

Intel (INTC 2.46%) reported that, during its first quarter, profits in its Client Computing Group -- which principally sells processors targeted at notebook and desktop PCs -- soared year-over-year, rising from $1.411 billion to $1.885 billion. Revenues were up slightly at $7.549 billion, from $7.420 billion a year prior.

According to Intel CFO Stacy Smith, this improvement was "driven by lower 14 [nanometer] unit costs on notebooks, lower overall total spending, and margin improvements in [Intel's] mobile products."

Let's take a closer look at these individual factors.

The lower 14-nanometer unit costs
At the company's investor meeting last November, management talked about how manufacturing yields on its 14-nanometer manufacturing technology were significantly lower than what the company had originally expected.

Lower manufacturing yields given fixed silicon wafer costs means higher manufacturing costs. Since Intel cannot significantly raise prices on its customers (since those costs would likely be passed on to consumers, negatively impacting demand in an already weak personal computer environment), it winds up taking a hit on margins.

In the first quarter of 2015, Intel had begun seriously ramping chips aimed at notebooks built on its 14-nanometer manufacturing technology. The low yields made it so that these chips were far more expensive than the prior generation chips built on the more mature 22-nanometer process, significantly impacting operating profit.

A year later, however, yields have apparently gotten significantly better. This means that Intel's effective manufacturing costs have come down, driving an improvement in gross profit -- and ultimately operating -- margin.

At the aforementioned investor meeting, Intel said that 14-nanometer costs should continue to come down over 2016 (as yields rise), with costs in the final quarter of 2016 coming in significantly lower than full-year 2016 costs .

Lower overall total spending
Intel has made it clear that it's significantly reducing spending in its Client Computing Group. Its investment in tablets and smartphones is expected to be down by about $1 billion in 2016 relative to levels seen in 2014, and its spending in personal computers from 2014 to 2016 is expected to be down, too (though not as dramatically as phones/tablets ).

These spending cuts are starting to show up in the company's Client Computing Group results, which certainly helped to boost the company's operating profit in this segment.

It's worth noting that Intel's recently announced restructuring efforts should bring down Client Computing Group spending even further in the coming quarters.

The mobile margin improvements
In 2014, Intel was essentially shipping tablet products in some cases at negative revenues per unit (Intel's mobile unit revenue in the fourth quarter of 2014 was negative $6 million) as it provided tablet customers with "contra-revenue" dollars.

Intel began scaling back its contra-revenue payments per unit in 2015 and it looks as though they are coming down further in 2016. By providing much lower, if essentially no, contra-revenue payments per unit shipped, Intel's effective average selling prices per chip (since contra-revenues are subtracted from revenue) go up. Gross profit margins per unit should be substantially up, as well. 

Client Computing Group is now a cash cow
Intel seems to be treating its Client Computing Group as a cash cow. The segment still brings in most of the company's revenue and much of its operating profit, but its growth prospects are quite dim as the PC market continues to struggle. 

The fact that Intel is optimizing this business segment for maximum profitability is the right move for the company and its stockholders. 

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