Impact of Intel’s restructuring on profitability
Intel (INTC) is undergoing restructuring in which it plans to eliminate 15,000 jobs and spin off its Intel Security Group business. The restructuring has cost the company $2.3 billion, but it’s on track to generate $1.6 billion in savings. Despite these savings, the company’s operating expenses rose in fiscal 2016.
The benefits are expected to be seen in fiscal 2017 when Intel expects its non-GAAP (generally accepted accounting principles) EPS (earnings per share) to rise 3.0% to $2.80. But these gains are less than analysts’ estimates of mid-single-digit growth from benefits arising from the restructuring. That’s because the company is increasing its spending in the high-growth segments of IoT (Internet of Things), memory, and data center adjacencies.
2016 gross margin
Intel’s non-GAAP gross margin fell from 65.0% in fiscal 3Q16 to 63.0% in fiscal 4Q16 despite a strong product mix. That’s due to two one-time costs the company incurred during the quarter.
The first cost was a $315.0 million fee for a long-term cross-license and patent purchase agreement, largely related to communications technology. It doesn’t relate to any execution challenges but rather to an expense that could save the company from potential patent litigation.
The second cost was bigger and related to a product quality issue. In its fiscal 4Q16 earnings call, Intel’s chief financial officer Bob Swan said the company faced “slightly higher expected failure rates under certain use and time constraints.” He assured investors that it was just a design flaw. The company is working on it with its customers and has created a separate reserve so it doesn’t affect its 2017 margins.
Gross margin estimates
Intel’s non-GAAP gross margin was almost flat at 63.2% in fiscal 2016. The company expects the margin to remain flat at around 63.0% in fiscal 2017. Even if there’s an improvement in ASP (average selling price) and unit costs, the product mix would pose a challenge in 2017. The unit cost of PCs (personal computers) would fall, but the cost of DCG (Data Center Group) would rise as the company transitions from 22nm (nanometer) to 14nm. It’s worth noting that Micron Technology’s (MU) costs rose when it transitioned to 14nm.
The factory ramp-up of 10nm and memory as well as the high cost of IoT, modem, and data center adjacencies would offset the higher ASPs in memory and DCG. So Intel expects its gross margin to fall slightly over the next three years.
However, things could be slightly better on the operations front. We’ll look at Intel’s operating margins in the next part of the series.