Intel's Q3 results and outlook for the next quarter are positive, with a strong after-hours surge of 8% despite the lack of growth in server chips.

On Thursday, October 26th, Intel, the chip giant that traditionally dominates the personal computer CPU market, released its third-quarter earnings report for 2023.

Due to better-than-expected third-quarter revenue, profit, and fourth-quarter guidance, Intel's stock rose more than 8% after hours.

The CEO optimistically predicted that Intel's 3-nanometer processors are expected to be put into use by the end of the year. The data center market is showing signs of returning to normal, and the current demand for processors in the personal computer market is 270 million units, which is expected to increase to about 300 million units.

After falling more than 2% on Thursday, Intel's stock closed down nearly 1%, reaching a three-month low. However, it has risen 23% year-to-date. During the same period, the S&P 500 rose nearly 8%, the Nasdaq rose more than 21%, and the Philadelphia Semiconductor Index rose 26%. In contrast, competitors Nvidia rose 176% and AMD rose more than 44% year-to-date.

Prior to the release of the earnings report, among the 31 analysts surveyed by institutions, 20 rated Intel as "hold," 6 recommended "buy," and 5 recommended "sell." The average target price is $36.67, representing a potential increase of about 12% in the next year.

Intel's revenue continues to decline year-on-year for the seventh consecutive quarter, but both revenue and profit exceed expectations, and the outlook for the fourth quarter is a return to growth.

Wall Street generally believes that the rebound in PC sales and Intel's data center business will be the focus of the earnings report. Intel is the first major chip manufacturer to announce its earnings report, and some analysts have expressed concerns about the company's profit margin next year.

The earnings report shows that Intel's total revenue in the third quarter fell 8% year-on-year to $14.16 billion, marking the seventh consecutive quarter of declining sales, but still higher than the market's expected $13.53 billion. In the second quarter, revenue fell 15% year-on-year. The company expects revenue to return to growth in the fourth quarter.

Adjusted earnings per share were $0.41, far exceeding the expected $0.22. This is a significant decrease of 30% compared to the earnings per share of $0.59 in the same period last year, but it is much better than the loss per share of $0.04 in the first quarter of this year and the earnings per share of $0.13 in the second quarter.

The first quarter was the largest loss in Intel's history, and the second quarter marked the first return to profitability after two consecutive quarters of losses. Intel's official forecast for the third quarter was adjusted earnings per share of $0.20 and a revenue midpoint of $13.4 billion, both of which exceeded the best expectations.

The company stated that the third-quarter gross margin of 45.8% remained unchanged from last year and expressed confidence in achieving a gross margin of 60% again. The key indicators in the third-quarter report benefited from strong operating leverage and cost discipline, and achieved key milestones in processes and products, chip manufacturing, and artificial intelligence. Intel CEO Pat Gelsinger reiterated that the company will cut costs by about $3 billion this year. CFO David Zinsner stated that operating expenses in the third quarter decreased by 15% YoY, and the total number of employees decreased from 131,500 last year to 120,300.

The market has always focused on Intel's guidance for the next quarter. The company expects adjusted earnings per share of $0.44 and revenue in the range of $14.6 billion to $15.6 billion for the fourth quarter, both higher than market expectations of $0.32 per share and revenue of $14.31 billion.

PC department revenue YoY decline is only one-third of the expected decline, but server chip growth has not yet recovered, admitting to competitive pressure.

Intel's financial report before the second quarter of this year was disappointing, mainly due to the poor performance of the PC market in the past two years. Due to the pandemic, consumers purchased a large number of laptops and desktops for work and entertainment, resulting in a lack of demand for upgrades for a long time. However, research firm Gartner believes that the PC market will recover in the fourth quarter, which may benefit Intel and other chip manufacturers.

In the third quarter, Intel's "Client Computing" department, which includes laptop and desktop processors, saw a YoY decline of 3% to $7.9 billion, far better than the expected decline of 9.2% to $7.4 billion. The market also expects a recovery to YoY growth of 15.7% in the fourth quarter.

Mobileye, the autonomous driving business that focuses on AI and has already gone public, saw a YoY increase in sales of 18% to $530 million, which is a highlight of the financial report. The "Foundry Services" department, which specializes in third-party chip manufacturing, saw a sharp increase in revenue of nearly 300% to $311 million. The company stated that "a major customer has committed to using Intel's production capacity and has made a prepayment."

The "Network and Edge" business unit, which includes IoT and other frontier businesses, saw a YoY decline in revenue of 32% to $1.5 billion. More importantly, the server chip division, called the "Data Center and AI Business," has not yet recovered its growth. Revenue in the third quarter declined by 10% YoY to $3.8 billion, falling short of the expected decline of 7.4% to $3.9 billion.

However, this is an improvement compared to the double-digit YoY decline in the past two quarters. Intel acknowledges that it faces competitive pressure, and the overall market size of server processors is shrinking.

The company still believes that its chips will contribute to AI, especially in running models on local devices rather than in the cloud. However, there are indeed some server customers who are transitioning from Intel CPUs to AI chips from companies like NVIDIA. In addition, the company's management stated that the goal is still to catch up with TSMC's chip manufacturing capabilities by 2026, enabling it to bid for the production of the most advanced mobile processors for other companies. This is referred to as the "Four-Year Five-Node" ambitious transformation strategy.

Intel CEO believes that the shortage of Arm architecture PC chips is not a concern, but it presents a potential opportunity for contract manufacturing.

Some analysts pointed out that after losing to long-term competitor AMD in the personal computer CPU field, Intel has also suffered heavy blows due to its inability to match Nvidia's high-end AI chips. Intel's stock fell nearly 7% in the first four trading days of this week, which is related to this.

This week, there have been reports that Nvidia and AMD, with the help of Microsoft, are developing PC computer Windows operating system CPU chips based on the Arm architecture, directly targeting and attacking Intel's x86-based PC central processors.

Qualcomm has also launched a new Snapdragon X Elite chip based on the Arm architecture for Windows laptops, which outperforms Intel's i9 in gaming and Apple's high-end self-developed Arm-based chip M2. It can also be used for AI operations and can process large language models with up to 13 billion parameters.

Some analysts believe that Microsoft has been working with Qualcomm since 2016 to migrate the Windows operating system to the underlying processor architecture of Arm, which has long been providing power for smartphones and smaller batteries. The development of Arm-based chips by Nvidia, AMD, and Qualcomm may disrupt Intel's long-standing dominance in the personal computer PC industry because Arm architecture chips are more energy-efficient.

The Motley Fool, a US stock research website, bluntly stated:

"If these new Arm architecture chips succeed, even to a moderate degree, it will be devastating for Intel.

Intel is seeking to regain its technological leadership, establish a new AI platform through the Gaudi accelerator, and build chip foundries to catch up with its competitors. However, its financial resources depend on the cash flow from its PC chip business, which has a wide moat.

After a few years of sluggishness in the PC market, Intel now has to face more severe problems, such as the possible breakthrough of the moat of x86 architecture PC chips, which may further limit its financial capabilities and make it more difficult for CEO Gelsinger to execute his transformation plan."

In response, the Intel CEO stated that based on historical experience, Arm chips have not been widely used in the PC market, and although Intel takes all competition seriously, "Arm-based PC chips are still not important overall." However, Intel sees the manufacturing of Arm-based PC chips as a potential opportunity.

What to expect in the future: How Intel will win the battle in the AI era

Some people are concerned about the poor third-quarter revenue and guidance from Texas Instruments this week, which revealed weak industrial demand and issued a warning to the entire chip industry.

Intel also issued a warning in its second-quarter report, stating that "all business units will continue to be weak until the end of the year." Server chip sales are expected to recover in the fourth quarter, and cloud service providers are more focused on purchasing AI-related GPUs rather than Intel CPUs.

Moreover, Intel's second-quarter financial report showed improvement and turned losses into profits, mainly due to progress in cutting costs by $3 billion this year. The company had significantly reduced dividends earlier this year, announced plans to save $10 billion annually by 2025, and implemented layoffs.

However, Intel has been catching up in the "arms race" of artificial intelligence this year. According to recent reports from technology media, Intel is helping certain clients of Boston Consulting Group (BCG) who lack technical capabilities to build their own ChatGPT-style applications and sell "application development software" to enterprise customers.

At the same time, Intel released a new artificial intelligence chip called "Falcon Shores" in May, which will provide the memory and computing power required for intensive workloads of AI tools such as ChatGPT. However, it will not be available until 2025, indicating that there is still a considerable gap between Intel and dominant competitors like Nvidia in the field of AI chips.

This week, Intel also announced a close collaboration with Lenovo to bring AI to everyone:

AI will fundamentally change and reshape the PC experience. Intel is positioning itself for the arrival of the new era and will launch the Intel Core Ultra processor, codenamed "Meteor Lake." This is Intel's first processor with an integrated neural network processor (NPU), which can bring high-efficiency AI acceleration and local inference experience to PCs. On December 14th of this year, Intel will also release the first fifth-generation Intel Xeon processor and Core Ultra processor, jointly promoting the scalable application of AI in all workloads on the client, edge, network, and cloud.