On July 26, chip giant Intel (NASDAQ: INTC) announced its earnings results for the second quarter of 2018 and updated its financial guidance for the full year. The company had boosted its financial guidance back in June, calling for $16.9 billion in revenue and $0.99 in earnings per share, and managed to beat that new guidance by reporting revenue of $17 billion and earnings per share of $1.05.
Not only did Intel beat expectations for the quarter, but it significantly raised its revenue and profit guidance for the full year. The company had previously guided for revenue of $67.5 billion and earnings per share of $3.85, but those numbers were revised up to $69.5 billion and $4.15, respectively.
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Following the earnings release, Intel hosted a conference call with financial analysts. Here are five things from that call that I think any current and prospective Intel investors should pay attention to.
1. A 10-nanometer update
Back in April, Intel told investors that volume production of chips using its upcoming 10-nanometer manufacturing technology would be pushed out from the second half of 2018 to sometime in 2019. On the call, the company provided more precise expectations for 10-nanometer production.
According to interim CEO and CFO Robert Swan, the yield rate of its 10-nanometer technology — that’s a measure of what proportion of manufactured chips are actually salable — is “improving consistent with the timeline we shared in April,” and the company’s planning to have computers using Intel’s 10-nanometer products “on shelves for the 2019 holiday season.”
While Intel tries to get 10-nanometer ready for volume production, the company will continue to sell products based on its increasingly mature 14-nanometer technology.
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“So as we look at 2019 across both the client and data center space, we feel very good about the product competitiveness of our 14-nanometer program,” Intel chief engineering officer Murthy Renduchintala said during the call. “So 14-nanometer, I think through the rest of this year and through 2019, continues, we believe, to drive product leadership across all our portfolio in client and server.”
2. Capacity crunch
During the prepared remarks made by Swan, the executive said that Intel’s “biggest challenge in the second half [of 2018] will be meeting additional demand” and that the company is “working intently with customers and factories to be prepared so we are not constraining customers’ growth.”
Although Swan indicated that Intel is optimistic about meeting the demand implied by its new financial guidance, he did say that the company needs “to work with customers and fabs [fabrication plants] to make sure that we continue to have the capacity to fill demand to the extent that it rises beyond the $69.5 billion level.”
It’s worth noting that Intel raised its capital expenditure forecast for the year by $500 million to $15 billion (with net capital deployed being $13 billion, because the company is receiving $2 billion in prepayments for memory products). That capital expenditure increase is in “response to the stronger demand.”
3. Beyond 10-nanometer
Although Intel hasn’t yet managed to put its 10-nanometer technology into mass production, analyst Blayne Curtis asked: “So, maybe you could talk about what you’ve learned on 10-nanometer, how you’re applying it to 7-nanometer, and any indications of that development, how it’s going?”
In response, Renduchintala, whose role was expanded back in February to include the company’s chip manufacturing efforts, had some interesting insights to offer. He noted that the company has made “some fairly judicious choices in defining 7-nanometer” that incorporate the lessons the company learned from what happened with 10-nanometer.
“And we’re focusing on an optimum balance point between density, power and performance, and schedule predictability,” Renduchintala said. “So I think what you’ll see is a more balanced approach across those three vectors.”
Renduchintala further said that Intel is “focusing on being much more precise in [its] ability to launch” new manufacturing technologies.
“And as we monitor progress on 7-nanometer just as closely as we are on 10-nanometer, I feel those lessons are being well absorbed into our progress, and we’re lining up to support our product plans as our roadmap dictates,” he explained.
4. The modem business
For a few years, Intel has supplied cellular modems to Apple (NASDAQ: AAPL) in support of the iPhone product line, which has helped it generate a nice chunk of additional revenue. For the two iPhone product generations that Intel has supplied modems for (iPhone 7 and iPhone 8/X), Intel has been one of two suppliers, with the other being wireless-chip giant Qualcomm (NASDAQ: QCOM).
However, on Qualcomm’s most recent earnings call, that company’s management admitted that it wouldn’t be supplying modems into Apple’s upcoming iPhones. This means Intel will provide the modems for all of the new iPhones that Apple introduces later this year. “We have a great product that’s getting good traction in the modem space, so that product is accelerating,” Swan said.
Another thing that’s worth mentioning is that Swan provided some insight into the gross profit margins of Intel’s modem business. Although the executive conceded that the margins on its modems aren’t in the “60-plus percent” range (Intel’s consolidated gross profit margin on a non-GAAP basis was 63% last quarter), he did explain that margins on its modem products are improving.
“We do expect to improve gross margins for our modem business … with our 7560 product that will begin to ship in the second half,” Swan said. “But also, as we migrate to a 5G world, we expect margins in the modem business to improve.”
5. Gross margin
On the call, analyst Stacy Rasgon observed that the company’s gross profit margin percentage, based on the full-year guidance that Intel provided, could drop to around 59% during the fourth quarter of the year, which he characterized as a “very significant deceleration.” He asked management to explain the drivers behind that decline.
Swan explained that during the second half of 2018, Intel expects to see an acceleration in the growth rates of both its modem business and its nonvolatile memory business (e.g., NAND flash and 3D XPoint). Such products don’t carry gross profit margins as high as Intel’s core CPU products do, so that’s part of what’s driving margin dilution.
On top of that, Swan said that Intel isn’t expecting “the continued strong [average selling price] performance” that the company saw during the first half of 2018. During the first half of 2018, Intel reported that average selling prices for its notebook computer chips were up 1% year over year, with that figure coming in at 10% for desktop processors and 15% for its data center platforms.
Another driver of the lower margins, per Swan, was that Intel is “ramping up 10-nanometer to improve the yield”; that will “weigh on gross margins for the fourth quarter as well.”
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Ashraf Eassa owns shares of Qualcomm. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of Qualcomm and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.
