For quite some time, chip giant Intel (NASDAQ: INTC) has resigned itself to the fact that the personal computer market -- its largest market by far -- isn't going to be a growth business over the long term.
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Intel has fundamentally changed its strategy to one of profit maximization. That's not to say it isn't going to invest in new products, but it means being much more careful with its investments as well as shifting shared financial burdens to higher-growth segments.
Image source: Intel.
To see this shift in action, we need to look no further than the company's freshly announced first-quarter financial results.
A major profit boost
In the first quarter of 2017, Intel's Client Computing Group (which largely consists of sales of personal computer chips and related components) saw revenue rise modestly from $7.2 billion in the prior year to $7.4 billion.
Operating profit, on the other hand, grew from $1.89 billion in the year-ago quarter to an astonishing $3.03 billion, good for an operating margin of about 41% and year-over-year growth of 60.3%.
Of course, it should immediately raise some eyebrows when such a modest increase in revenue leads to such a dramatic surge in profitability. Let's examine the results in more detail to understand exactly what drove that substantial boost.
The many factors behind the boost
Intel CFO Robert Swan explained that this operating profit expansion was driven by several factors. He said that the business "continues to execute and benefit from continued in 14-nanometer unit cost, richer product mix and lower spending, primarily from the client business having a decreased share of technology development and [sales, general, and administrative] allocations."
The first one is straightforward -- Intel's manufacturing yields on its 14-nanometer technology weren't great out of the gate and have continued to improve over the last year. Higher manufacturing yields means that for a given silicon wafer (which has a largely fixed cost), more salable chips are produced, lowering the average cost to manufacture a chip.
The "richer product mix" simply means that Intel is selling a greater proportion of higher-value chips. Those higher-value chips contribute more gross profit dollars than lower-value chips do (even if one assumed a fixed gross profit margin percentage), so selling a greater proportion of such chips relative to the year-ago quarter would naturally help to boost total profit.
Finally -- and I think this is the big one -- Intel lowered the operating expenses associated with CCG by shifting that burden onto other businesses (primarily its Data Center Group, or DCG).
The idea here is simple: Intel builds a lot of technology that's shared between the different business units. These shared expenses are substantial and include things like manufacturing technology development, intellectual property development, and so on.
Intel must allocate the operating expenses associated with building all that shared technology somehow. In the past, Intel put the brunt of the manufacturing technology development expenses on CCG, since that group was the first to use Intel's newest chip manufacturing technologies.
However, going forward, Intel plans to use its latest manufacturing technologies to build data center chips first, with other products following later. Due to that change, DCG now gets a greater share of the manufacturing technology development expenses and CCG gets a smaller share -- ultimately adding to DCG's operating expenses and reducing its margins, but reducing CCG's operating expenses and helping to boost its margins.
What this means is this: Don't expect CCG's operating profit to continue to dramatically outperform its revenue growth in the years ahead as we saw last quarter.
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