Intel's Q3 2021: PCs Down, Servers Up, The Forecast is Uninspiring

For many consecutive quarters, Intel's revenue has beat estimates. The company's gross margins were high due to strong demand for premium products and conservative spending, whereas the outlook was consistently optimistic as far as revenues and margins were concerned. But this was not quite the case with Intel's third quarter results.

Good Results, Moderate Outlook

Fuelled by strong demand for its datacenter and higher-end client products, Intel's revenue increased to $19.2 billion in Q3 FY2021, some $870 million (or 3%) increase over the same period in FY2020. Meanwhile, Intel's adjusted revenue that excludes its divested NAND storage business totalled $18.1 billion, which fell short of analysts' revenue forecasts of $18.24 billion as well as Intel's own guidance of around $18.2 billion. 

Intel's gross margin in Q3 2021 was 56% (57.8% if NAND business is excluded), up from 53.1% in the same quarter a year ago, but down from historical highs of over 60%. The chipmaker's net income totalled $6.8 billion, down from $7 billion in Q3 2020. 

Yet, investors were disappointed with Intel not only because of lower net income, but due to several other reasons. Intel's results were affected by global components shortage that slowed sales of both client and datacenter parts. Furthermore, the company lost some 20% of cloud datacenter revenue, a direct hit to margins.

"Despite the highly constrained industry-wide supply environment, Q3 revenue was $18.1 billion, slightly below our guidance due to shipping and supply constraints that impacted our businesses," said George Davies, CFO of Intel. 

Given the challenging environment, Intel said it expected revenue of $19.2 billion ($18.3 billion excluding storage business) and a 51.4% gross margin in the fourth quarter. The company maintained its rather bullish revenue forecast for the year at $77.7 billion ($73.5 billion excluding storage unit), but said that its gross margin will decrease to 55% (from 56% in 2020). 

In fact, Intel advised its investors to expect a 51% ~ 53% gross margin for the next two to three years as profitability will be constrained by massive increases of CapEx, R&D, and MG&A spending. For example, this year Intel's CapEx is expected to total $18 billion – $19 billion. But next year the company will increase CapEx to $25 billion – $28 billion, which will be on par with TSMC's and Samsung Foundry's spending on semiconductor production facilities. 

Client Computing Group: Volumes Down, ASPs Up

Intel's Client Computing Group (CCG) remains the company's biggest revenue source. In the third quarter 2021, the business unit earned $9 billion revenue, up $200 million from the same period a year ago. Operating income of the BU was $3.3 billion, down from $3.6 billion in Q3 2022.

"Demand remains strong in our PC business with particular strength in commercial, desktop, and higher end consumer notebooks offset by inventory digestion in lower end consumer and education," said Davies.

During the quarter Intel sold 16% more chips for desktop PCs (including CPUs and chipsets, but excluding various adjacencies) than in the same quarter a year ago and their average selling prices (ASPs) were 4% higher. Yet, unit sales of the company's notebook chips dropped 14% year-over-year and 26% quarter-over-quarter, while their ASPs increased 10%. To some degree, Intel's mobile CPU shipments were affected by Apple's move to its own SoCs, but industry-wide problems perhaps had an even more significant impact.

"CCG revenue was $9.7 billion [including adjacencies], down 2% year over year on a challenging environment and continued industry-wide component shortages that are restricting lower-end system sales," the CFO said. "Note that when excluding the impact of ramping down our Apple CPU and modem businesses, CCG revenue is up approximately 10% year over year."

Intel executed quite well and quickly ramped up its Tiger Lake processor for notebooks in 2020. So far, the company has supplied over 70 million of Tiger Lake CPUs and in Q3 2021 Intel had plenty of competitive chips to sell. Yet PC makers like Dell, HP, and Lenovo did not buy all the CPUs they could have bought due to insufficient supply of other components required to build a PC. On the bright side, Intel sold more high-end processors and enjoyed higher ASPs as computer makers focus on premium models. Yet on the other hand, this means that there are a surplus of lower-end parts in stock.

Datacenter Group: Growth Slowing, ASPs Down

Intel's Datacenter Group has been the jewel in Intel's crown for quite a while. Due to growing demand from hyperscale cloud service providers, strong ecosystem, weak competition from AMD, and little to no competition from other developers. In the last couple of years AMD's Epyc platform and ecosystem became significantly stronger, which is why Intel's share in sales of datacenter processors is dropping. Yet, DCG continues to post strong results.

In Q3 DCG's sales were $5.7 billion (excluding Optane, AI accelerator, Ethernet, and silicon photonics products), up from $5.2 billion in the same timeframe a year ago. Operating income of the business unit was $2.1 billion, up $200 million year-over-year. 

"These results were slightly below expectations due to industry-wide components supply constraints that primarily impacted our enterprise customers and areas of softness in PRC, including cloud as customers adapt to new regulations," said Davies.

Unit shipments of Intel's Xeon Scalable processors surged 8% YoY and ASPs grew 3% YoY. The company shipped over a million of Ice Lake-SP products since April, which probably had a positive effect on margins. 

"Our 3rd Gen Xeon Scalable processor 'Ice Lake' has shipped over a million units since launching in April," said Pat Gelsinger, chief executive of Intel. We expect to ship over one million units again in Q4 alone. All of our OEMs are currently shipping systems, and we expect all our major cloud customers to have announced [Ice Lake-based] instances by the end of the year."

During the quarter Intel's sales to enterprise and governments customers increased by 70% YoY, whereas shipments to hyperscalers dropped by 20%. Intel attributes this drop to new regulations in China, but considering the fact that its rival AMD is gaining share particularly in the cloud datacenter space, it is obvious that AMD is eating Intel's lunch.

Another significant challenge for Intel is that even some server vendors were affected by the shortages, which limited their ability to ship systems and lowered their CPU procurements. Nonetheless, Intel remains very optimistic about its long-term datacenter prospects.

"I remain confident about the long-term of the data center," said Gelsinger. "Despite regulatory changes in China and short-term ecosystem supply constraints impacting some customers, customers continue to choose Intel for the datacenter needs," 

CapEx Spending to Increase: $25 - $28 Billion in 2022

Intel's focus is on high-margin CPU products. Great yields of CPUs on 14nm nodes, and conservative spending on new manufacturing capacities drove Intel's gross margins above 60%. But this is going to change as Intel deploys its IDM 2.0 business model that includes in-house manufacturing, outsourcing, and contract production of chips for third-parties. 

To be competitive against TSMC and Samsung Foundry, Intel will need to invest heavily in new fabs. Next year the company will spend up to $28 billion on new production facilities and it looks like the chip giant will not hesitate to invest even more if it needs to. This will hit margins, but in a bid to be competitive both with chip designers like AMD and Nvidia as well as with foundries like TSMC, Intel needs these investments. 

"We are repositioning the company for long-term growth and we are analyzing the investment plans required to achieve our goals and provide attractive long-term results for our shareholders," said the head of Intel. "It is abundantly clear to us that we must invest in our future right now to accelerate past the rest of the industry and regain unquestioned leadership in what we do. Our investment plan is aligned with our IDM 2.0 strategy to rapidly build our manufacturing capacity and response to the expanding market, grow our share, and accelerate innovation, enabling Intel to leap ahead with new businesses and capabilities." 

Good news is that Intel's Foundry Services unit is developing fast and in Q3 it even shipped some products for revenue as it provided advanced packaging services to AWS.  

"Since March, we have shipped our first IFS packaging units for revenue and engaged with well over a hundred potential customers, including several large customers who are working with us on our leading-edge Intel 18A [node]," said Gelsinger.

Summary

While Intel missed its revenue guidance for Q3 2021, the company still posted higher YoY revenue and profits. Unfortunately for the company, its financial results were affected by industry-wide shortage of components that constrained CPU sales to PC and server makers, which adds uncertainty to Intel's short-term business prospects. Meanwhile, as Intel's partners focus on higher-end products, Intel's ASPs remain high. 

As Intel is deploying its capital-intensive IDM 2.0 business model, the company's CapEx spending will surge and so will R&D expenses, which will affect the company's margins. Intel assures investors that its gross margin will not drop below 50%, though only time will tell whether IDM 2.0 model will be financially successful for Intel. Meanwhile, Intel's CEO is very confident that the company will be able to leapfrog the whole industry and set new records in profitability. 

"Leadership products beget leadership pricing, which begets leadership margins," said the head of Intel.