Why Intel Corp.'s PC Profits Surged

By Markets Fool.com

Chris Walker, Intel vice president for its client computing group and general manager of notebook product marketing. Image source: Intel.

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After market close on Oct. 18, microprocessor giant Intel (NASDAQ: INTC) reported its financial results for the third quarter of the year. One part of this generally strong report that stood out was the fact that the company's operating profit in its client computing group, or CCG for short, jumped substantially year over year.

In the third quarter of 2015, Intel's CCG reported $2.433 billion in operating profit, representing a substantial plunge from $3.053 billion in the year prior. This year, not only was CCG able to make up for the decline that it saw last year, but it actually managed to push past the profit levels seen in the third quarter of 2014, achieving a whopping $3.327 billion in operating profit (up 36.74%).

Stacy Smith,Intel's EVP of manufacturing, operations, and sales, attributed this growth to three key factors: increased revenue, lower product costs, and lower investment levels. Let's take a closer look at each of these drivers.

Revenue leverage

The first factor is simply that Intel's CCG took in more revenue last quarter than it did a year ago. Sales were up from $8.506 billion in the same quarter last year to $8.892 billion. All else being equal (operating expenses, gross profit margins), greater revenue is going to translate into higher profits.

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Better product manufacturing costs

Investors may recall that last year, Intel transitioned a large portion of the products that it sold into the personal computer market from its older, mature 22-nanometer manufacturing technology to its newer, less healthy 14-nanometer technology.

Although the move to 14 nanometers helped the company deliver better products for both notebooks and desktops, Intel faced significant manufacturing yield challenges in trying to build chips on this technology. This manifested itself as increased chip manufacturing costs that ultimately hurt Intel's gross profit margins, since Intel couldn't just pass those increased costs onto its customers.

A year later, Intel's 14-nanometer technology is much more mature and manufacturing yields have improved a great deal. This has manifested itself as lower product costs, which means that year-over-year gross profit margins in this product segment have gotten better -- helping to bolster the segment's operating profits.

Reduced operating expenses

Operating profit doesn't just depend on gross profit margins, which are a function of production costs and average selling prices. Operating expenses in the form of research and development and marketing costs play an important role in determining operating margin.

Intel announced a fairly dramatic restructuring program back in April of this year designed to lower the company's operating expenses pretty significantly. Since the company indicated that it actually planned to increase its investments in faster-growing areas such as the data center, non-volatile memory, and Internet of Things, it's likely that the bulk of the cost-cutting came from CCG.

Indeed, Intel specifically said that one of the key drivers of the operating margin improvement in CCG was that "investment levels declined."

Where does this business go from here?

Although this business has seen robust profit growth throughout 2016, that outsized profit growth relative to revenue has largely been due to factors that only really come into play once.

I don't expect Intel to make further significant operating expense reductions in this segment (cut spending too much and it's hard to deliver leadership products at a rapid cadence), and I doubt that revenue will grow much from here given the state of the personal computer market (flat to down).

What I do anticipate is that, going forward, CCG will see roughly flat revenue -- up some years, down some other years, but no big moves -- and fairly stable and substantial operating income.

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Ashraf Eassa owns shares of Intel. The Motley Fool recommends 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.