Intel (INTC) Q3 revenue of $19.2 billion beat its own guidance of $18 billion by $1.2 billion. This $1.2 billion excess revenue came as PC demand grew faster than expected and Chinese data center customers stockpiled ahead of tariffs. However, the Intel CPU supply shortages hurt its PC business. The company’s revenue was flat on a YoY (year-over-year) basis but up 16% sequentially.
The company earned 84% of its revenue from CCG (Client Computing Group) and DCG (Data Center Group) businesses. If we look at the ASP (average selling price) and volumes of CCG, higher ASP was the key growth driver.
Supply shortage hits Intel’s revenue
Intel’s CCG revenue fell 5% YoY to $9.7 billion in the third quarter. Client Computing is made up of Intel’s desktop and notebook CPUs and adjacency like mobile modems and connectivity solutions. Its revenue from CPUs fell 7.1% YoY to $8.4 billion as its volumes fells faster than ASP (average selling price). It’s desktop and notebook ASP rose by 3% and 4%, respectively, whereas its volume fell by 11% and 10%, respectively, on a YoY basis.
Intel’s CPU volumes fell as its 14nm CPU supply shortage, which started in September 2018, continued in the third quarter. At the third-quarter earnings call, Intel CFO George Davis said that the firm faced supply constraints, ”particularly at the value end of the market as higher than expected PC demand strength continues to outpace our supply.”
This opened a window of opportunity for rival Advanced Micro Devices (AMD) to sell its Ryzen CPUs. Gartner data showed that global PC shipments rose 1.1% YoY in the third quarter as AMD and Qualcomm filled the gap created by Intel’s supply shortage.
Intel CEO’s strategy to address the CPU supply shortage
Intel CEO Bob Swan said that in the last 12 months, the company grew its CPU capacity by 25%. Its unit volume rose by double digits. However, this capacity build was not enough to satisfy the exponential growth in PC demand. Also, the company used up its inventory buffer to satisfy demand of PC customers. Swan said that Intel’s CPU supply shortage will continue in the fourth quarter.
Gartner noted that Microsoft (MSFT) is ending support for Windows 7 from next year, encouraging businesses to shift to Windows 10 systems. This PC demand will probably fade in 2020. Even Bob Swan expects the PC demand growth to slow next year.
Despite this, Intel plans to increase 14nm and 10nm capacity by 25% next year, with PC CPU unit volumes up by mid-to-high single-digits. He explained that the company plans to have an adequate capacity that meets customer demand. Also, he wants to rebuild its inventory buffer that got depleted in the last few months.
Intel’s client computing adjacencies
Intel’s CPU revenue decline was partially offset by 10% YoY growth in adjacency thanks to modem orders from Apple (AAPL). Intel left the 5G modem business in April and sold it to Apple in July. This deal will close by the end of the year.
The exit from low-margin modem business will prove as a tailwind for Intel’s gross margin next year. Early signs were visible in the third quarter. Its CCG operating margin was flat YoY at 44%. Shrinking revenues were offset by lower spending in the 5G smartphone modem.
Competition from AMD
Earlier, we talked about how Intel’s CPU supply shortage opens a window of opportunity for AMD. AMD launched its 7 nm Ryzen 3000 series desktop CPUs in July while Intel continued to struggle with the supply shortage of its 14nm CPUs. There has been a lot of noise around how AMD is gaining share from Intel in the CPU market.
Intel even acknowledged the rising competition from AMD. In early October, Intel announced its Cascade Lake-X HEDT (high-end desktop) CPUs at half the price of its predecessor, SkyLake-X. At the earnings call, Bob Swan said that the world has become more competitive but the competition was in line with its expectations.
He said that Intel is addressing growing competition by “expanding the product, the architectures, the packaging technologies, the process capabilities and the software that we build… But we’re not complacent by any means in terms of an increased competitive environment as we go into 2020.”
Bob Swan did acknowledge that “competitive impacts on ASPs” will pull down its gross margin next year. What does this imply? In early October, Intel lowered Cascade Lake HEDT CPU price by 40%-50% to compete with AMD’s Ryzen Threadripper in price-to-performance. Such a steep price cut will impact its desktop ASP and therefore its CCG revenue and margins.
Rumors that Intel will extend price cuts in other CPUs
There are rumors that Intel will also lower the price of its 9 Gen SkyLake-X HEDT CPU. While watching the CPU process, the German website ComputerBase noted that Intel almost halved the price of its Skylake-X CPs in the European market. The site believes that Intel will cut prices on other CPU models in the near future.
Commenting on this rumor, a Wccftech article noted that it is inevitable for Intel to cut the price of SkyLake-X CPUs. When more powerful CascadeLake CPUs hit the shelves at half the price, they will cannibalize sales of SkyLake-X. Retailers will have no choice but to sell these previous generation CPUs at a lower price. ComputerBase noted that there is limited stock of Skylake-X CPUs. This suggests that Intel restricted the supply to mitigate the impact of price cuts.
Intel announces new CPU price cut
Intel made no official announcement on SkyLake-X price cuts. Tom’s Hardware reached out to Intel. In response, Intel said, “As with any product transition, we are working with partners on programs to prepare for the introduction of the next generation product.” In this statement, it neither confirmed nor denied the rumor.
This is the first time in Intel’s history that it is launching a new CPU at half the price of its predecessor. Hence, we do not know how the company plans to move ahead with its pricing strategy. Tom’s Hardware said that Intel admitted to Skylake-X’s fall behind AMD’s Ryzen Threadripper in price-to-performance. If Intel is looking to beat AMD at price-to-performance, then a SkyLake-X price cut is inevitable. What would be interesting is if Intel extends price cuts to other models. That is where Intel will feel the impact on its margins.