Is Intel 3 an opportunity? (Intel 3Q4 conference call)

Intel released its fourth quarter earnings report for 2023 (ending in December 2023) after the US stock market on the morning of January 26, 2024. The key points of the conference call are as follows:

Below is a summary of Intel's fourth quarter earnings conference call in 2023. For an interpretation of the earnings report, please refer to "Intel: No Longer the King of Processors, AI Battle Fails" (link: Intel: No Longer the King of Processors, AI Battle Fails).

I. Review of Core Financial Information:

Core Data: The data exceeded expectations, and the actual operating performance met expectations. In the fourth quarter of 2023, Intel achieved revenue of $15.4 billion, slightly exceeding market expectations ($15.2 billion). The revenue continued to increase compared to the previous quarter, mainly due to the recovery of the PC client business. In the fourth quarter of 2023, Intel's net profit was $2.669 billion, turning a loss into a profit compared to the same period last year, exceeding market expectations ($957 million). The improvement in profitability was mainly due to restructuring and other expense changes.

Business Performance: Improvement in the client business, limited growth in data centers. The client business and data center & AI business are the company's largest sources of revenue, accounting for over 80% of the total.

Client Business: Benefiting from the recovery of the PC market, the company's PC client business also experienced significant growth. The revenue from the client business in this quarter was $8.844 billion, a year-on-year increase of 33.5%, exceeding market expectations ($8.455 billion).

Data Center & AI: Despite the booming data center market, Intel's growth in this area has been limited, maintaining a revenue level of $4 billion. The potential market for CPUs is shrinking, and the company is also facing competition pressure and inventory adjustments. With competitors entering the market one after another, the company's competitive pressure continues to increase.

Intel's Performance Guidance: For the first quarter of 2024, the expected revenue is $12.2-13.2 billion (market expectation: $14.27 billion), and the gross margin is 40.7% (market expectation: 42.5%).

Overview:

II. Detailed Content of Intel's Earnings Conference Call

2.1 Executive Statements of Core Information:

Q4 was the highlight of the year for IDM 2.0 transformation, achieving significant progress.

The company continues to execute its plans, rebuilding its leadership position in processes, further expanding capacity and establishing foundries, greatly improving product execution, and beginning to widely apply AI in various product areas.

The company's performance in the fourth quarter was solid, with revenue meeting expectations, and strong earnings growth due to continued operational leverage and expense management.

The company achieved its previously committed $3 billion cost savings target in 2023.

2024 will be another year of achieving expected goals.

The core business performed well, but was impacted by the exits of Mobileye, PSG, and other businesses, resulting in lower-than-expected revenue in the first quarter.

The company expects continuous and year-on-year growth in revenue and earnings per share in each quarter of the 2024 fiscal year.

Momentum and enthusiasm for new products and businesses remain strong as we enter the new year and will strengthen over time.

The company is proud of its execution on the technology roadmap in 2023, becoming the first manufacturer in the US and Europe to mass-produce logic devices using EUV, and actively increasing the yield of Core Ultra on Intel 4.

2.2 Q&A Analyst Questions and Answers

Q: Why was the core business at a seasonal low in the first quarter? Why did market demand show a trend below the seasonal cycle when cyclical pressures were easing? Why should some market trends favor you rather than worsen? What confidence do you have that future seasonal cycles will exceed normal levels?

A: The company's performance in the first quarter was at a seasonal low, which may be due to the wide range of historical seasonal cycles, ranging from 3% to 20%. The company feels that its product line is strong, inventory is in good condition, and it is gaining momentum. The company's forecasts are consistent with those of customers and channel partners, but there were also some special events that had a greater impact than expected. The company's core business appears to be healthy, with no signs of market share loss and products continuously improving. Over time, the company is improving in each quarter, including revenue and profit margins, and has carefully examined the outlook for this year. With the launch of new products over time, growth momentum in areas like AIPC, and good cost discipline, the company continues to improve throughout the year. The company is satisfied with its performance in the first quarter and is confident in the performance improvement for the rest of the year.

**Q: Does the company have confidence in achieving five manufacturing nodes within four years? This customer is doubling down on maintaining its leadership position, how does the company maintain its own leadership position? How does the company ensure that 18A becomes a leading node? The company seems to be using this customer as a foundry partner for heterogeneous products, such as Arrow Lake or Lunar Lake. If the company has a leadership position, why not produce these products internally? A: The company is closely monitoring the progress of the 18A manufacturing node on a daily basis and has conducted a thorough review of its health. The completion of Clearwater Forests has given the company great confidence, indicating that 18A is in good health. The appearance of the fourth customer this quarter, as well as the affirmation of the process technology competitiveness by the IP provider, further strengthens the company's confidence. In terms of process technology, the company's roadmap is very strong. The company uses external foundries, which has grown as the company faces challenges to its own process competitiveness. As the business becomes more concentrated, more wafers will enter Intel's internal factory network. In the long term, the company will continue to use external foundries to supplement and manage the capital needed for its work, and ensure that the team always builds the best products in the industry and uses the best technology to achieve this goal. Overall, the company is very satisfied with its strategy and will continue to utilize both external foundries and internal factory network as the situation requires. The use of external foundries is one of the five pillars of the company's smart capital strategy. Although the company will strive to do more work internally, based on smart capital considerations, the company will continue to use external foundries.

Q: The gross margin performed well in the December and March guidance, does this include the sale of previously impaired inventory? Can this provide us with a clean gross margin figure? Is the figure for March fairly clean, and can we extrapolate it for the whole year?

A: The company believes that a decline in gross margin is a reasonable rule of thumb. Gross margin will fluctuate each quarter, mainly due to the impact of some one-time factors. In the fourth quarter, the gross margin decline was better, mainly due to the sale of previously reserved products. In addition, there were also improvements in factory expenses and output, which benefited the company to some extent. In the first quarter, the company expects the decline in gross margin to be slightly more challenging. This is mainly due to the disappearance of some factors. In the long term, the company will strive to achieve the desired 60% gross margin. However, in the short term, the company is dealing with many costs associated with the five nodes within four years, which are significant start-up costs. In fact, the company may reach its peak start-up costs in 2024, which will be a major obstacle that the company needs to address.

Q: Will achieving a 60% gross margin face ongoing challenges, especially in terms of capacity utilization? Are there plans to move production in-house (starting from Panther Lake), but this plan will not truly achieve high volume until 2026? Is the company managing the utilization of its internal capacity to achieve a 60% gross margin?

A: Achieving a 60% gross margin will be influenced by multiple factors, including revenue growth, capacity utilization, leadership in nodes and products, and the internal foundry model. The company is managing its capital expenditure and investment to ensure the appropriate utilization of capacity. Some improvements are expected as the company breaks through last year's low point and enters the new year. The internal foundry model will bring significant savings to the company, and the product group is now more focused on test time and sample activities, while the factories are more focused on capacity utilization and capital investment related to capacity. The company expects to save $4 billion to $5 billion from the internal foundry model, which is another important step towards achieving a 60% gross margin. The company also announced a partnership with UMC to use old factories for long-term foundry business, improving operational discipline and long-term utilization of the factory network. We believe that a 60% gross margin is their goal for driving business growth and we believe they will achieve this goal.

Q: What is the reason for the decline in data center business in the first quarter? How much is this decline related to the previously mentioned FPGA weakness? How is the cloud and server environment in the first quarter?

A: The data center business is seasonal, and the situation varies from quarter to quarter. The demand from server customers is strong, and the enterprise server business is doing well, with continuous improvement in the company's product line. It is expected that the data center business will achieve year-on-year growth, and market share will remain stable. With the launch of the fourth and fifth generation products, as well as the progress of Granite Rapids and Sierra Forest, overall momentum is strengthening. The rapid development of AI will drive AI inference to be deployed locally, and the company is well positioned in this area. Despite the existence of public clouds for over 20 years and more than 60% of computing happening in the cloud, over 80% of data still remains on-premises. Customers want to realize the value of local data through AI, and this is where Intel's advantage lies. These trends bring very favorable prospects for the whole year, and the first quarter performance guidance was not unexpected. The company will focus on surpassing these numbers and further developing the momentum of product line improvements.

Q: Can you talk about the details of Sierra Forest and Granite Rapids? How do you view the long-term combination of these two products (Sierra Forest and Granite Rapids)? What kind of demand or acceptance do you see for Sierra Forest and Granite Rapids? How is the high core count design of Sierra Forest?

A: We are very excited about the Sierra Forest and Granite Rapids products and are committed to accelerating their entry into the market. Sierra Forest is a large-scale mainstream product designed for high core counts, primarily used for processing heavy workloads. Granite Rapids, on the other hand, offers higher performance, features, and capabilities. We expect that the majority of the market will stay with products like Granite Rapids, especially in 2024 and 2025. As we move towards the launch of the Clearwater Forest product in 2025, the usage between the two will steadily increase, forming a healthy balance. For enterprise customers, they will choose P-core products. Sierra Forest, Clearwater Forest, and their subsequent products will become mainstream cloud products focused on TCO (Total Cost of Ownership). We are very satisfied with the company's product portfolio (including P-cores and E-cores), which we believe will enable them to expand their product line and cover the entire range from high performance to optimal TCO, thereby regaining market share in the core data center market.

Q: Can you clarify the trend of gross margin for the full year and the expected YoY growth rate?

A: We should compare the full-year gross margin for 2023 (approximately 43.5%) with the gross margin for the current quarter. In this way, we can see an overall improvement in gross margin throughout the year. However, there is some volatility in gross margin between each quarter, making it difficult to accurately predict the gross margin for each quarter. Therefore, it is best to avoid overly precise predictions of gross margin for each quarter.

Q: Can you provide more details on the revenue situation in the client market? What gives you such confidence in the recovery of the client market?

A: First, the company expects the client market to grow by a few percentage points this year compared to last year, with slight growth expected. This is in line with the company's market forecast. The company's market share is very stable, with good execution of market share last year, and this year's product line is even better, with many favorable factors. Therefore, overall, the company believes that the client business will be very solid this year. However, at the beginning of the year, everyone is managing their first quarter outlook, although the business will become stronger over time. Some of these favorable factors will only start to show in the second quarter and the second half of the year. Currently, AI PC is just beginning to develop, Windows 10 EOS will take effect, and customers are starting to consider device upgrades in the post-pandemic era. These benefits will gradually become apparent over time. However, the company's position in the gaming and commercial fields is overall very strong. The company sees the tremendous potential of AI PC. This is the most influential innovation since the launch of Wi-Fi more than twenty years ago. AI PC will bring years of growth cycles, excellent ISVs, new use cases, and a leading product line in this field.

Q: After one year of deployment of generative AI, what is your view on the capital expenditure of cloud customers between traditional servers and AI servers? Considering the growth of competitors' GPU revenue, is there enough room for growth in the CPU business?

A: First, high-end cloud service providers are maximizing their training environments, which is an accelerator market and provides growth momentum for Intel's top node business. However, as the market shifts from high-end training to inference, Intel's product line becomes more substantial in this area. For the enterprise data center market, it will play a crucial role in on-premises environments, leveraging existing data pools for inference. This is an area where Intel has a competitive advantage, and we are starting to see this in conversations with OEM customers. Additionally, in meetings with customers at events such as the World Economic Forum, Davos, and CES, there has been an absolute consensus response from customers regarding the deployment of AI in on-premises data centers. Xeons and Intel's on-premises products are the preferred way for customers to utilize these capabilities within their data centers, considering existing TCO, power consumption, network management, and integration. Intel needs to be more involved in the accelerator field and sees growth opportunities in the pipeline. In Q4, despite the small base, revenue showed good growth, with strong customer response to the launch of Gaudi 3. Overall, Intel will focus more on competition in the high-end accelerator field, but the information for 2024 indicates that inference will be ubiquitous and will appear in areas where Intel has a stronger presence, such as edge, AI PC, and enterprise data centers.

Q: Can you provide information on the scale of IFS in the first quarter? How to quantify the long-term benefits brought by the 18A technology, especially its impact on 2024, 2025, and 2026? Does the mentioned $10 billion lifetime revenue specifically refer to the 18A technology? What does Intel's external foundry business mean for the prospects in 2024 or 2025 compared to the $130 billion annual foundry market?

A: The decrease in the scale of IFS in the first quarter is due to the natural end of traditional packaging volume and the company's shift of focus from traditional packaging business to advanced packaging business with differentiated technology. The foundry equipment business also declined between Q4 and Q1, similar to the situation of companies like ASML. The growth of 18A foundry customers' business will take several quarters to achieve, while wafer customers will take several years. Therefore, the company believes that the lifetime transaction value is the best indicator to measure the growth of this business. The company is actively pursuing larger business scale and regularly updating investors with relevant information. Additionally, the company emphasizes that this figure only involves external foundry business. The company's internal business will drive factory construction, bring economies of scale, and attract more external customers. The contract terms for these transactions may be one or two years, or even longer. The company aims to provide some business visibility and transparency, and the rapidly growing lifetime transaction value is a good way to describe the prospects of this business. On February 21st, the company will hold a large industry ecosystem event called IFS Direct Connect, where it will engage with the ecosystem and customers, and invite analysts to participate and learn about the important information to be disclosed.

Q: What technical challenges were faced during the transition to 18A technology? How were these challenges overcome? What feedback was received from customers? How confident are you in delivering products within the specified time?

A: In transitioning to EUV technology, the company has achieved high-volume production with Intel 4 and Intel 3 technology nodes, reducing the risk of EUV technology. In terms of back-end power, the company conducted testing on internal nodes and performed extensive experiments using Intel 3 technology node to ensure the reliability of back-end power. In terms of Gate-All-Around transistors, the 18A technology node combines back-end power with Gate-All-Around transistors. Customers have started to leverage the advantages of back-end power and have seen good performance and area benefits. The 18A technology node has been successfully applied in production, marking an important milestone in both product and technology. H igh-NA (next-generation EUV) technology is not part of the 18A technology node, but rather the next major node. The company will further discuss this technology at the Intel Foundry Day on February 21st. The company has always been cautious in managing risks when introducing new processes, ensuring the reliability and scalability of the technology. The company has carefully managed the risks and has been rebuilding its momentum. With confidence, the company aims to launch five nodes within four years, delivering products as planned, regaining a leading position in process technology, and establishing significant foundry opportunities for the industry, rebuilding the Western supply chain and factory network. The company is excited about the momentum of its entire business, achieving success in areas such as products, operations and financial performance, manufacturing technology, and foundry design.

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