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earnings_call

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Corporate Participants
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* Trey Campbell
Intel Corporation - Head of IR
* Robert H. Swan
Intel Corporation - CEO & Director
* George S. Davis
Intel Corporation - Executive VP & CFO

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Conference Call Participiants
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* Vivek Arya
BofA Merrill Lynch, Research Division - Director
* Joseph Lawrence Moore
Morgan Stanley, Research Division - Executive Director
* Stacy Aaron Rasgon
Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst
* Ambrish Srivastava
BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst
* Ross Clark Seymore
Deutsche Bank AG, Research Division - MD
* Timothy Michael Arcuri
UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment
* Harlan Sur
JP Morgan Chase & Co, Research Division - Senior Analyst
* Pierre C. Ferragu
New Street Research LLP - Global Team Head of Technology Infrastructure
* Christopher James Muse
Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst
* John William Pitzer
Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head

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Presentation
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Operator [1]
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Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter 2019 Intel Corporation Earnings Conference Call. (Operator Instructions) As a reminder, today's program is being recorded.

And now I'd like to introduce your host for today's program, Trey Campbell, Head of Investor Relations. Please go ahead, sir.

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Trey Campbell, Intel Corporation - Head of IR [2]
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Thank you, operator, and welcome, everyone, to Intel's third quarter earnings conference call.

By now, you should have received a copy of our earnings release and the earnings presentation. If you've not received both documents, they're available on our investor website, intc.com. The earnings presentation is also available in the webcast window for those joining us online.

I'm joined today by our CEO, Bob Swan; and our CFO, George Davis. In a moment, we'll hear brief remarks from both of them, followed by Q&A.

Before we begin, let me remind everyone, today's discussion contains forward-looking statements based on the environment as we currently see it and, as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially.

A brief reminder that, this quarter, we have provided both GAAP and non-GAAP financial measures. Today, we will be speaking to the non-GAAP financial measures when describing our consolidated results. The earnings presentation and earnings release available on intc.com include the full GAAP and non-GAAP reconciliations.

With that, let me hand it over to Bob.

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Robert H. Swan, Intel Corporation - CEO & Director [3]
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Thanks, Trey. Q3 2019 was the best quarter in our company's history. We generated $19.2 billion in revenue and $1.42 in non-GAAP EPS, exceeding our guidance by $1.2 billion and $0.18, respectively. We achieved record revenue both overall and in our data-centric businesses while making continued progress on our strategic priorities. Simply put, our ambitions have never been greater. We are growing share in a large and expanding $300 billion market opportunity fueled by the exponential growth of data, which is reshaping computing.

I want to start with a recap of our May Analyst Day and our 3 priorities: Accelerating growth, improving execution and deploying capital for attractive returns. First, growth. It starts with a core belief. We are at a key inflection point with the exponential growth of data creating massive demand for semiconductors. Cloud workloads are diversifying. Networks are transforming. And more computing performance is moving to the edge.

We've been on a multiyear journey to reposition the company's portfolio to take advantage of this industry catalyst. Today, we have the product and technology leadership that uniquely positions us to capitalize on these trends and will invest in the IP required to help our customers win the inflections of the future.

The opportunity is massive. As we told you in May, we expect to generate $85 billion in revenue and $6 in EPS in 3 to 4 years. But that doesn't happen just by saying it. Achieving this goal means delivering on our operational and financial priorities every 90 days.

Growth starts with our Core business where our workload-optimized platforms are winning in a highly competitive marketplace. It's now been 9 quarters since the first Xeon Scalable processor launched, and we're proud to have delivered over 23 million units as customers rely on Xeon to power their data-centric workloads.

In the third quarter, leading cloud customers ramped our second-generation Xeon Scalable processors with AWS, Google and Alibaba deploying instances based on Cascade Lake. Customers including BP and TU Darmstadt selected our highest-performance Xeon Scalable platform, the 9200 series, for their most demanding workloads. One key reason customers are choosing Xeon Scalable is the platform's built-in workload acceleration for AI. With the combination of Intel Deep Learning Boost and AVX-512 technologies, we're seeing advantages of up to 9x in AI inference versus competitor CPUs.

We also see cloud and enterprise momentum building for our break-through memory technology, Intel Optane. This quarter, we announced a strategic collaboration with Oracle. Oracle is incorporating the high-performance capabilities of Intel Optane DC persistent memory into its next-generation Exadata platform, which powers high-performance database infrastructure at most of the world's leading banks, telecoms and retailers. And in client computing, we're excited that all our major PC OEM customers have Ice Lake designs, with 18 already shipping out of a total of 30 expected to launch this year.

We recently announced the next generation of Intel Xeon W and X-series processors for high-end desktops. These platforms lead the industry in bringing Intel Deep Learning Boost-powered AI acceleration into high-end PCs and mainstream workstations for the first time. Available soon, these products deliver performance and value that give enthusiasts and creators more reasons to keep choosing Intel.

We've also embarked on a multiyear program, called Project Athena, that charts a course for the PC ecosystem to raise the bar on laptop innovation. Amazing devices like the Dell XPS 13 2-in-1 and the HP Elite Dragonfly that meet the Project Athena spec are already available.

Our PC and server franchises are vital, but our ambitions are even greater. We're extending our product leadership to power an increasingly 5G- and AI-enabled world. We have multibillion-dollar networking and IoT/Edge businesses delivering double-digit growth, and AI is driving significant revenue across our product portfolio.

We began investing 10 years ago in network IP, SoC capabilities and software so that we could drive workload convergence on Intel's silicon. Today, we achieved #1 share in the network and silicon market with expected 2019 revenue of more than $5 billion, growing at 12% this year. We're also well-positioned for 5G deployments in 2020 and expect to grow our market segment share in wireless base stations to 40% by 2022. And we're ready for the next market inflection as 5G enables significant new IoT and Edge growth opportunities that extend from in-network and on-premise Edge equipment to smart connected endpoints.

Winning here means blending the right compute performance per watt with the emerging killer apps of the Edge, Computer Vision and AI inference acceleration. These are the differentiating capabilities that have propelled our IOTG and Mobileye businesses to leadership share and the combined annual revenues approaching $5 billion. The businesses are also growing quickly, up 18% year-to-date, excluding Wind River. We're only at the bend of the curve in the Edge opportunity, and we're investing to lead.

Finally, artificial intelligence. AI is becoming a pervasive use case. According to IDC, 75% of enterprise applications will use AI by 2021, and that's why we're infusing AI in everything we build. But this isn't just about the future. We are driving meaningful AI revenue inside Intel now. With products spanning from the data center to the edge, we expect to generate more than $3.5 billion in AI-driven data-centric revenue in 2019, up more than 20% year-over-year.

We're confident in our growth, but we also need to improve our execution on multiple fronts. First, supply. We've increased our output in response to stronger-than-expected demand. We've invested record levels of CapEx the last 2 years to expand our capacity and support our customers' growth. With that investment, we've increased our 14-nanometer capacity 25% this year while also ramping 10-nanometer production. We expect our second half PC Client supply will be up double digits compared to the first half, and we expect to further increase our PC Client supply by mid- to high single digits in 2020. But that growth hasn't been sufficient. We're letting our customers down, and they're expecting more from us.

PC demand has exceeded our expectations and surpassed third-party forecasts. We now think the market is stronger than we forecasted back in Q2, which has made building inventory buffers difficult. We are working hard to regain supply/demand balance, but we expect to continue to be challenged in the fourth quarter.

Our manufacturing process node execution is also improving. We have fabs in Oregon and Israel in volume production on 10-nanometer and will soon start 10-nanometer production in Arizona. Yields are improving ahead of expectations for both client and data center products. The Intel 10-nanometer product era has begun, and our new 10th Gen Core Ice Lake processors are leading the way.

In Q3, we also shipped our first 10-nanometer Agilex FPGAs. And in 2020, we'll continue to expand our 10-nanometer portfolio with exciting new products, including an AI inference accelerator, 5G base station SoC, Xeon CPUs for server storage and network, and a discrete GPU. This quarter, we've achieved power-on exits for our first discrete GPU, DG1, an important milestone.

As we discussed at the May investor meeting, we are accelerating the pace of process node introductions and moving back to a 2- to 2.5-year cadence. Our process technology and design engineering teams are working closely to ease process design complexity and balance schedule, performance, power and cost. We are on track to launch our first 7-nanometer-based product, a data center-focused discrete GPU, in 2021, 2 years after the launch of 10-nanometer. We are also well down the engineering path on 5-nanometer.

Last, a few thoughts on our capital deployment priorities. We are confident in our future, and our Board has approved an additional $20 billion share buyback authorization. We have an excellent balance sheet, generate strong free cash flow and continue to invest in R&D and CapEx to grow. We've also returned 100% free cash flow to shareholders over the last 10 years.

At the same time, we're making tradeoffs. While we've increased R&D spending by more than $1 billion since 2015, we have reduced our total spending by 9 points over the same period.

Additionally, we have established clear criteria for our big bets like Mobileye, 5G, and memory and storage. Our ambitions are to play a larger role in our customers' success and generate attractive returns for our shareholders. And if we can't do both, we'll take swift action.

We are making great progress with our Mobileye acquisition. We've now shipped over 12 million EyeQ devices this year, up more than 40% over the same period last year. And in the third quarter, we delivered record revenue and secured 6 major new design wins, totaling nearly 10 million lifetime units.

We've increased our investment in 5G, but we've also announced our 5G smartphone modem exit and the sale of the IMFT fab to Micron. We expect those to close in the fourth quarter. And we continue to take steps to improve 3D NAND profitability and reduce memory CapEx investments while evaluating a variety of partnership options that can accelerate the path to profitability and improve returns.

We are confident in our multiyear business plan. And consistent with that, we are increasing our buyback commitment. We expect to repurchase approximately 20 billion shares over the next 15 to 18 months. We'll fund the buyback from proceeds we generate from partnerships and/or noncore asset dispositions and by returning approximately 100% of 2020 free cash flow to investors.

In summary, our energies are focused on accelerating our growth, improving our execution and allocating our capital wisely. Thanks to the team for a great quarter.

And now I'll hand the call over to George for more details on our Q3 results and business outlook.

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George S. Davis, Intel Corporation - Executive VP & CFO [4]
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Thanks, Bob, and good afternoon, everyone.

We had an outstanding Q3 with record revenue of $19.2 billion, approximately flat year-on-year and $1.2 billion higher than guide. We saw record data-centric revenue of $9.5 billion, representing just under 50% of our total revenue, an all-time high. DCG, IOTG, NSG and Mobileye all individually achieved record revenue in the quarter. PC-centric revenue was down 5% year-on-year on a very tough compare.

Q3 operating margin was approximately 36%, 1 point ahead of our guide on revenue strength and spending leverage. Gross margin for the quarter was 60.4%, modestly below expectations as strong flow-through of higher DCG revenue was more than offset by mix effects of higher-than-expected NAND revenues and onetime impacts in NSG, including the absence of an expected grant associated with our NAND factory.

Q3 EPS was $1.42, $0.18 above our guide. The results demonstrate strong top line performance, expense discipline, increased share buybacks as well as nonoperational factors like lower tax rate offset by the onetime items in our NSG business. Year-to-date, we have generated $11.7 billion of free cash flow and returned $14.3 billion to shareholders.

Operating margin of 36% in quarter was down approximately 4 points versus last year as ASP strength in our server and client businesses and lower spending were more than offset by NAND pricing degradation, changes in modem reserves, platform volume declines and higher cost as we ramp our 10-nanometer client products.

EPS was up 1% or $0.02 year-over-year as lower operating margin was offset by lower share count, the absence of onetime impairments related to the IMFT joint venture and a lower tax rate. Our non-GAAP tax rate in Q3 was approximately 11%, down 1 point versus last year and below our 13% guide as we reported a better-than-expected tax benefit related to our non-U.S. sales on our recently filed 2018 U.S. tax return as well as for the 2019 tax year.

Let's move to segment performance. Our Data Center Group had record revenue at $6.4 billion, up 4% from the prior year and up 28% sequentially. These results beat our expectations with platform ASPs up 9% year-over-year on strong adoption of our highest performance 2nd Gen Xeon Scalable products. Against a tough year-over-year compare, platform units were down 6% while DCG adjacencies achieved 12% revenue growth driven by our connectivity solutions. DCG growth segments, cloud and comms, now represent over 2/3 of total DCG revenue.

Cloud revenue was up 3% year-over-year, returning to growth after a historic 2018 platform refresh as cloud service providers exited a 3-quarter capacity absorption cycle. Enterprise and government revenue came in ahead of expectations, growing 1% on strong mix and better China demand, while communication service providers revenue increased 11% on continued adoption and share gains of IA-based solutions.

We estimate in Q3 that the enterprise and government and communication service provider segments benefited from trade-related demand pull-ins of approximately $200 million in revenue from Q4. As a result of the strong top line performance, DCG achieved record quarterly operating income, and operating margin of 49% was up 13 points sequentially.

Our other data-centric businesses were up 13% year-over-year, and Q3 marked IOTG's first $1 billion revenue quarter, up 9% year-over-year, underscoring Intel's expanding opportunity at the Edge. IOTG operating income was down 4% year-over-year due to lower benefits from inventory reserves and a mix shift to lower-margin products. Mobileye revenue and operating income were up year-over-year, 20% and 29%, respectively, on continued ADAS penetration and new program launches.

NSG revenue returned to growth, up 19% on continued bit growth, partially offset by year-over-year pricing declines. These pricing declines, along with the onetime impacts discussed earlier, contributed to NSG's operating loss of approximately $500 million. PSG revenue grew 2% year-over-year on continued strength in wireless, partially offset by softness in cloud and enterprise, and operating income was down 13% on segment product mix.

CCG revenue was $9.7 billion, down 5% year-over-year, as ASP strength partially offset lower platform volume. PC unit volumes were down 10% versus Q3 '18 where we benefited from drawing down internal inventory to satisfy demand. We continue to be supply-constrained in Q3, particularly at the value end of the market as higher-than-expected PC demand strength continues to outpace our supply despite the capacity additions that Bob discussed earlier.

Adjacencies grew 10% year-over-year driven by strong demand for modems and connectivity solutions. Operating margin was 44%, flat year-on-year, as lower revenue was offset by lower spending driven by the 5G smartphone modem exit.

Year-to-date, we have generated $23.3 billion dollars in operating cash flow and invested $11.5 billion in CapEx. We also returned 122% of free cash flow to shareholders through dividends and buybacks. During the quarter, we ramped buybacks, purchasing 92 million shares at an average price of $48.78 per share.

Now moving to the full year outlook. As a result of our strong Q3 operating performance and momentum into Q4, we are increasing our revenue outlook for 2019 by $1.5 billion to $71 billion. We expect revenue from our data-centric businesses to be flat to slightly up for the full year and expect our PC-centric business to be flat to slightly down, both improving versus prior guidance.

Operating margin for the year is expected to be approximately 32.5%, up 0.5 points from our prior guide. Full year expectations for gross margin are unchanged at approximately 60%. We expect Q4 gross margin to be down 2 to 2.5 points sequentially as we continue to ramp 10-nanometer and will have sold through the previously reserved inventory, consistent with prior expectations. Expectations for full year spending are unchanged, down approximately $900 million year-on-year.

As a result, non-GAAP EPS for the year is now expected to be $4.60, up $0.20 from our July guide on strong top line performance and tight expense control. We are raising gross CapEx by $0.5 billion to $16 billion as a result of increased 10-nanometer and 7-nanometer investment. And we are raising our free cash flow guide by $1 billion to $16 billion.

Let's turn to Q4. After adjusting for the impact of trade-related pull-ins in DCG, we expect Q4 revenue of $19.2 billion, up 3% year-over-year and flat sequentially. Our data-centric businesses are expected to be up 6% to 8% year-over-year on continued cloud recovery and sequential NAND pricing growth. Our PC-centric business is expected to be flat to slightly down year-over-year. We expect Q4 operating margin of approximately 33.5% and a tax rate of 13.5%. EPS is expected to be $1.24, down sequentially on lower gross margin, lower below-the-line nonoperational benefits and a higher tax rate.

In summary, we are very pleased with the company's strong operating performance, and we will be very focused over the quarter on delivering a record year.

With that, let me turn it back over to Trey.

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Trey Campbell, Intel Corporation - Head of IR [5]
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All right. Thank you, George. Moving on now to the Q&A. (Operator Instructions) Operator, please go ahead and introduce our first caller.

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Questions and Answers
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Operator [1]
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Our first question comes from the line of C.J. Muse from Evercore.

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Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [2]
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I guess a question on the data center side. It's just -- to clear up the numbers, it looks like you're suggesting DCG up maybe 5% year-on-year. So can you speak to the accuracy of that? And then, I guess, bigger picture, the comms service provider side, clearly, a very large source of strength for you guys, up 11% year-on-year and now representing more than 40% of the mix. So curious if you can kind of speak to the most important drivers of that business and how you're thinking about growth over the next 1, 2, 3 years?

Yes. Thanks, C.J. First, we gave a DC-centric guide of 6% to 8%. And yes, I would -- we didn't give DCG specifically, but I would say it's a little bit lower than our 6% to 8% data center growth, so you're in the ballpark.

On comms service, the comms -- this has been an extremely important aspect of the business for a number of years now where we've seen the programmability at the networks with NFV and software-defined networks an opportunity for us to migrate the networking environment to IA architecture. So we've been doing this for a number of years. It's been a fulsome growth for us over time. And in the quarter, the 11% growth was significant in and of itself, but remember, last year's third quarter was also up in the mid- to high 20s. So we continue to make good -- great progress.

What we see going forward in this business is really a big opportunity in 5G. So next year, you're going to see -- our good progress has been on 3G and 4G. Next year, we see real design wins that we've achieved, real growth as we go into that 5G world where we continue to see what we characterize as cloudification the network, more and more compute moving from the cloud and data centers out to a network and Edge. And that's been an opportunity for us that we've been investing in over the past, and we expect to be a big source of growth for us going forward.

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Operator [4]
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Our next question comes from the line of John Pitzer from Credit Suisse.

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John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [5]
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Congratulations on the solid results. I want to stick with DCG, Bob. If you look, impressive, but ASPs were up 9% year-over-year, especially as the mix shifted towards the comms business, which I believe tends to be lower ASPs. It's also happening in the quarter where you're seeing your competitor ramping their next-generation chips. So I guess I'm trying to understand what's the power of the Xeon Scalable upgrade cycle you referred to in your prepared comments? What inning are we in, in your mind? How much of an ASP lift can that give you? And do you anticipate any unusual pricing action as competition heats up in this market?

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Robert H. Swan, Intel Corporation - CEO & Director [6]
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Oh, boy. Was that your one question, John?

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John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [7]
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Multiple parts.

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Robert H. Swan, Intel Corporation - CEO & Director [8]
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Yes. Okay. So first, I'd say in our -- obviously, we're well into Skylake, but the transition now is into Cascade Lake, and that's a higher performance SKU. In the quarter, the high ASPs were really driven by particularly cloud customers really moving to the highest end product within the Cascade Lake family. So we're seeing the transition from Skylake to Cascade Lake, and within Cascade Lake, real high-performance SKU that's our highest performance ASP. So that mix dynamic in Q3, I don't expect that to stay where it is. I think we'll go to more of a balance as we're into Q4 next year.

In terms of competitive dynamics, I would just say that we got a great lineup of products. We got Skylake to Cascade Lake. First half to next year, we're looking at Cooper Lake. As we talked before, we're really excited about Ice Lake server coming out in the second half of next year. And we realize it will be a more competitive environment, and we've tried to capture that in essence in how we think about 2020 for both demand equation but also the margins that we've flagged a little bit on the -- on our Q2 call back at Analyst Day, I think.

So good quarter, good momentum first half to second half; high performance SKUs driving real high ASPs even though, you're right, that the ASPs with comms have a tendency to be a little bit lower.

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Operator [9]
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Our next question comes from the line of Joe Moore from Morgan Stanley.

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Joseph Lawrence Moore, Morgan Stanley, Research Division - Executive Director [10]
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I wonder if you could talk to the shortages a little bit more and, I guess, in the context of how much you said you brought 14-nanometer capacity up. And I realize demand is better, but it seems like it's a few points better, and yet the shortages are intensifying. Can you just talk a little bit about that? And when do you think we'll be in a position where you don't have those tensions in your business anymore?

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Robert H. Swan, Intel Corporation - CEO & Director [11]
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Yes. Thanks, Joe. First, just kind of try to put it in to context. Over the course of the last 3 years, I guess, we've grown the business by about 20%, so $13 billion in revenue over the last 3 years. And the practical reality is we didn't anticipate that kind of explosive growth 3 years ago. So we didn't have the capacity in place to deal with it. We've been working our tails off for the last 12 months to ensure for our customers that we wouldn't be a constraint on their growth. From the last 2 years, I think, as you know, we've spent over $30 billion in CapEx to both have more capacity for 14 while we also begin to ramp 10.

In my prepared comments, I said we added 25% wafer start capacity 2018 to 2019. Our first half to second half unit volume will be up double digit, so we're making good progress throughout the course of the year, but our expectations were in the second half we will be back in a supply/demand equilibrium. And the fact of the matter is we're not there because the demand profile that's resulting in our $1.5 billion higher revenue is just higher than we had anticipated. So we have more work to do to meet our customers' demands in the fourth quarter and going into '20.

As we see fourth quarter, we're still going to be constrained in our customers' growth, which is absolutely where we do not want to be, but with the higher demand, we will be constraining the growth in the fourth quarter. But as we go into 2020, our expectations are we'll add another 25% capacity both for 14 and 10 and that we will have -- particularly for PC Client, we expect to be able to do mid- to high single-digit unit volume growth next year. And that -- we don't expect the market to grow that fast, but we got to have just more inventory buffers so we're there when our customers need us. So Q4 will be a little challenging, and in 2020, we expect to be able to rectify things.

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Operator [12]
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Our next question comes from the line of Ambrish Srivastava from BMO Bank of Montreal.

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Ambrish Srivastava, BMO Capital Markets Equity Research - MD of Semiconductor Research & Senior Research Analyst [13]
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Bob, I wanted to go through the priority and the cadence that you talked about, bringing it back to 2, 2.5 here. Is that -- because my understanding is that they were just simply laws of physics that were causing the cadence to stretch out. So what problems have the engineers and the process folks solved out there? Or is it just limited to the 7-nanometer, and then you would revisit that again?

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Robert H. Swan, Intel Corporation - CEO & Director [14]
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Yes. It's a good question. Last -- back in our Analyst Day, we tried to go through this in quite a bit of detail, both, one, kind of our lessons learned coming out of the challenges we had with 10 and how we're capturing those lessons learned as we think about the next 2 generations. But first, our focus and energy is, right now, we're on scaling 10. And as we said, we feel very good about the capacity we put in place, the products we have coming down the pipeline and the yields that we're achieving, almost week-on-week improvement over the last 6 months. So for 10, we feel really good.

Second, we -- when we put the design rules in for 7-nanometer, we were less aggressive in terms of density. Our learning from going from 14 to 10 is -- with the benefit of hindsight, we were just -- we tried to scale at a 2.7 factor, and that was -- that ended up putting too much indention or revolutionary nodes into the fab environment to meet those kind of hurdles. And the learning from that is we just can't hit those kind of really aggressive targets when, to your point, the dynamics are getting increasingly challenging, so lots of learnings out of 10.

Our transition to 10 that we incorporated into 7, the design rules, there's less complexity. And for the last couple years, we've been working with EUV. Litho has been the challenge. We've had EUV that we've been working with for a few years now. And we expect to use EUV as we scale 7. And we indicated that our first product will be 2 years from this quarter, so fourth quarter of 2021, our first 7-nanometer product will come out. And our expectation is we'll get back on a 2-year cadence in 7 and beyond. So lots of learnings out of 10-nanometer that we've incorporated. And we said back in May and we reiterated today, we expect to be back to a 2- to 2.5-year cadence going forward, at least for the next few nodes.

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Operator [15]
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Our next question comes from the line of Pierre Ferragu from New Street Research.

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Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [16]
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I'll ask one question that (technical difficulty)

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Trey Campbell, Intel Corporation - Head of IR [17]
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Pierre, you're breaking up.

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Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [18]
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Okay. Let me -- a little better now?

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Trey Campbell, Intel Corporation - Head of IR [19]
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A little bit.

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Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [20]
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Okay. So my question is really about your competitive landscape. So your main competitor [indicate 86] ecosystem has produced in the last 10 months or 9 (technical difficulty) that's why it's not even impressive in the data center and also (technical difficulty). And so my question is what's your perception on the evolution of your competitive landscape in the last 3 months? Are things [being mainly] in line with what you had in mind and what you are expecting when we spoke over the summer? And then how much of like the footprint you have in the data-centric you think you can produce competition with that in mind?

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Trey Campbell, Intel Corporation - Head of IR [21]
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Pierre, let me kind of reframe that maybe. I think you were talking about competition and how we feel about that now maybe...

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George S. Davis, Intel Corporation - Executive VP & CFO [22]
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Both at the PC and the data center level. And I'll -- maybe I'll jump in on the PC because I think the year-over-year compare in Q3 is -- could be causing some concern. Just a reminder, in Q3 of last year, we had basically drawn down more than 1.5 weeks of inventory that -- which went into the channel. And so when you do compares year-over-year on Q3, PC looks a little bit light on demand.

Really, as we look over the last 90 days, we haven't seen any difference in our view of the competitive dynamics. We are clearly being impacted significantly on the value end of the market, which is a supply issue for us. It's one of the reasons why we're building volume capacity -- continuing to build volume capacity into 2020 because we think it gives us an opportunity to compete for those units again next year.

Bob, I don't know if you want to comment on the DCG side.

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Robert H. Swan, Intel Corporation - CEO & Director [23]
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Yes. I'll try because I'm not exactly sure I got the question, but yes, in terms of competitiveness, if that's the...

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George S. Davis, Intel Corporation - Executive VP & CFO [24]
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That was it.

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Robert H. Swan, Intel Corporation - CEO & Director [25]
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The question. Look, it's a more competitive world. And in that world, we just raised our full year outlook by $1.5 billion and increased our operating margin. So yes, I think, competitively, nothing's really changed in the last 3, 6, 9 months relative to what we expected, and our -- the only thing that's really changed is our performance. But we do know that, going into next year, that our role is to dramatically expand the role we play in our customers' success. So we're expanding the product, the architectures, the packaging technologies, the process capabilities and the software that we build so we can continue to deliver better and better product performance for our customers. And I'd just say that we feel really good about where we are, but we're not complacent by any means in terms of an increased competitive environment as we go into 2020.

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Operator [26]
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Our next question comes from the line of Stacy Rasgon from Bernstein Research.

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Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [27]
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I was wondering if you could tell us, within your enterprise, cloud and comm businesses in DCG, in the quarter, how much of each of those was driven by China? And given the 200-millimeter -- $200 million pull-forward across enterprise and cloud that you mentioned -- enterprise and comm that you mentioned, was that beating enterprise relative to your expectations more or less than $200 million?

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George S. Davis, Intel Corporation - Executive VP & CFO [28]
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Yes. I think, Stacy, you've got the numbers right. $200 million was on the enterprise and government and comms area. And that's -- I would say it was more in line with our expectations. Once you take out that $200 million number, we had expected it to come up a little bit. The growth year-over-year was definitely above our expectations and...

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Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [29]
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So by more than $200 million?

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George S. Davis, Intel Corporation - Executive VP & CFO [30]
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Yes, that was a fairly big number for us relative to our expectations.

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Stacy Aaron Rasgon, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [31]
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So how much of enterprise was China then?

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Robert H. Swan, Intel Corporation - CEO & Director [32]
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Yes. Look, I think in terms of the makeup of the business, for data center, you got roughly 2/3 is cloud and comms and roughly 1/3 is enterprise and government. So that, as you know, has changed dramatically over the years as we've continued to grow our presence in the cloud, and as I mentioned earlier to Joe's question, I think, gained share in comms. So now we're in kind of 2/3, 1/3 state. And enterprise and government was -- across the board in DCG in the quarter, the strength was much higher than we anticipated back in July. We had a first half to second half acceleration, but the acceleration was just more than we expected. And yes, I would say we saw strength across the board.

But as we look at the E&G growth in particular, we're trying to determine what is kind of -- what has the tendency to like pull in versus what can we count on as we project things forward. And our best guess on our stronger performance is that the $1.2 billion that we are over, roughly $200 million of that was particularly related to enterprise and government than particularly related to China.

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Operator [33]
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Our next question comes from the line of Timothy Arcuri from UBS.

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Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [34]
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Bob, it sounds like -- for 10-nanometer, it sounds like Ice Lake is still on track for the second half of next year. And it sounds like the 7-nanometer GPGPU is still on track for 2021. You did talk about, for the first time, about 5-nanometer. So can you talk a little bit about how you think of make versus outsource? And really what I'm after is, is sort of anything sacred? Or if going to a foundry partner to make CPU or maybe even like a chiplet strategy, if that would eliminate a significant piece of your competitive disadvantage, would you consider that? Or is that sort of off the table for now?

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Robert H. Swan, Intel Corporation - CEO & Director [35]
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Yes. I mean, first, to the comment, yes, the -- nothing new about process relative to what we said at Analyst Day, ramp 10, 2-year cadence for 7 and our expectations that the cadence going forward will be more like 2- to 2.5-year time frame. So intently focused on 10 now and 7 for the product you mentioned in the fourth quarter. So we're investing to recapture process leadership going forward.

At the same time, we're going to be extremely open-minded about how do we ensure that we're building the best products, and where we build them is something that we'll always evaluate. I think, as you know with the other foundry players, they've been a source of our capacities over the years. And our expectation is, to the extent that they can do something to support our growth better and/or for peak kind of demands, we're always going to look at how do we evaluate the opportunity set that's going to position us best to meet our customers' demand for the growing diversity of products that we have in our portfolio.

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Operator [36]
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Our next question comes from the line of Ross Seymore from Deutsche Bank.

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Ross Clark Seymore, Deutsche Bank AG, Research Division - MD [37]
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I wanted to ask on gross margin. A year ago in your third quarter call, Bob, you gave some directional commentary on what you thought for the out-year, for 2019. Today, as we look into 2020, you have a lot of moving parts with 2 nodes ramping, 10-nanometer, 7-nanometer, yields, competition, lots of moving parts, admittedly. But I was hoping, at least versus maybe the fourth quarter exit rate this year, that you could give some puts and takes on how you're feeling about next year's gross margin.

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George S. Davis, Intel Corporation - Executive VP & CFO [38]
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Ross, this is George. Maybe I'll take that. Actually, with respect to 2020, there's no material change to my characterization on the last call where we were talking about a 58% outlook for Q4 and 57% in 2021. And the question was, well, should that -- is there -- are those good proxies for 2020? And my point was we think we'll be closer to 60% than to those numbers.

But if you want to think about tailwinds and headwinds going into 2020 that we looked at as we think about that number, so tailwinds will be, obviously, we're going to have lower modem in the mix next year. Memory is starting to come out of that deep-down ASP period, and we think volumes are going to be up as we get a little better supply and demand situation.

The headwinds that we're very mindful of is, obviously, 10-nanometer ramping is -- can be a little bit of a headwind on margins and also competitive impact on ASP. So those are the things that we'll continue to look at. But as we look at those today, no material change at all from my previous comments.

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Robert H. Swan, Intel Corporation - CEO & Director [39]
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Yes. I would probably just, I guess, echo. In all the complexity and all the moving parts, George kind of flagged -- what I'd characterize the 4 things that we're really dialing in on. One, going into next year, mix is going to be better because our modem volume will be lower and our NSG profitability will be better. So mix is going to have a -- mix has been a drag on 2019's gross margin, and it will be a big contributor as we go into 2020.

And secondly, on the first half of 2019, we had a lot of the on [O] costs, your cost of sales related to pre-PRQ 10-nanometer product. So that will not repeat itself. So those 2 things are good, favorable things.

The third thing is just -- George flagged this, I'd just simplify this node transition. And for us, node transition next year is going to be -- 14-nanometer will be a little better in terms of its profitability. Yields won't be dramatically different because we're extremely mature, but depreciation levels will be lower because a lot of these tools have been fully depreciated there because we've been on that node for so long.

But for the node transition, 14 will be a little bit better. Our expectation is 10-nanometer yields will continue to improve, but at the same time, the mix of 10 versus 14 will be a little bit of a wait. So node transition will work against us. And we also -- we've tried to, as best we can, take into account competitive dynamics as we exit this year and go into next year. In our quest to play a bigger role in our customers' success, we're going to compete to protect our position and expand the role we play.

So those are the 4 things and lots of complexity and lots of moving parts, but we -- a year ago, we dialed in 2019 pretty well. Now we've got to dial in 2020 as well.

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Operator [40]
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Our next question comes from the line of Vivek Arya from Bank of America.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [41]
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Bob, you mentioned you're still facing some capacity shortages. I wanted to understand how you're planning capacity for next year. What proportion will be 14? What will be 10? And will that mix require a higher or similar level of capital intensity as we saw this year?

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Robert H. Swan, Intel Corporation - CEO & Director [42]
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Yes. I mean our intention next year is to not be a constraint on our customers' growth, first and foremost. And given that, what I indicated is we expect to increase capacity by 25% next year, which is the same kind of level that we did this year. We expect to do that again. So we believe that data center, we've been in pretty decent shape. But for client, we just want to get to mid-single-digit kind of unit output -- mid- to high single-digit unit output so, one, we can meet what we expect customer demand profiles to be but also so we can rebuild buffer levels of inventory so we can deal with these peaks, et cetera. So we're trying to put the capacity in place, but we think we'll meet the customer demand and try to give us the inventory buffer that has been depleted over the course of the last 9 months or so.

In terms of capital, I would just say we'll probably give you more detail on that come January, but George kind of laid out back in May a multiyear view of capital. There wasn't any dramatic changes from kind of where we are now. So obviously, that'll be a function of growth.

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George S. Davis, Intel Corporation - Executive VP & CFO [43]
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I would just add one thing to remind everybody is that, in 2019, we made a major shift from spending capital in the memory area to moving that capital over to expand our -- both our 10-nanometer and some 14-nanometer. We continue to add capacity in 14-nanometer and began adding capacity at 7-nanometer as well. So we're very focused on getting the capacity in place that will allow us to take the word shortage out of our quarterly discussions.

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Operator [44]
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Our final question for today then comes from the line of Harlan Sur from JPMorgan.

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Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [45]
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Great job on the quarterly execution. Last time we had a cloud and enterprise spending digestion pause was first half of 2017. It's kind of the same setup as this past, right? Similar to 2017, DCG had strong second half growth. And in fact, back in 2017, it kicked off what was a 4- or 5-quarter period of strong spending by your cloud customers. Do you guys get a sense in discussions with your customers that the spending reacceleration is sustainable for the next few quarters? I mean if I look at things like compute workload growth, that continues at a strong pace. Workload themselves are getting more complex. And so just wanted to get your views on sustainability of the strong growth profile in DCG into next year.

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Robert H. Swan, Intel Corporation - CEO & Director [46]
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Yes. I think the trends -- the macro trends that we see haven't subsided at all, and that is this insatiable appetite for the creation of data and the need to compute, process, store, move, make that data more relevant. Those macro trends have been very attractive for the long -- for a while, and we expect those to continue.

But to your point, the -- our experience with the cloud providers is they go through big buying cycles and then relatively long digestion periods. What we did experience last year was a gangbuster year, but it's been 3 quarters coming into the third quarter where they went through digestions. And what we started to see in the third quarter was, particularly for high-performance compute, start to see them come back into the market to really begin to purchase a little bit more. So how long that cycle lasts is going to be a function of several variables, but their end demand seems to continue to be relatively strong. And therefore, the need to add capacity, we think, will follow their end demand given they've been out of the market a little bit for about 3 quarters now up 'til Q3.

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Trey Campbell, Intel Corporation - Head of IR [47]
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Thanks, Harlan. We're going to hand the call back over to Bob for some closing comments.

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Robert H. Swan, Intel Corporation - CEO & Director [48]
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Yes. Look, thanks for joining us. We feel great about the quarter. It's -- we're looking at -- we had a record quarter result, raising our outlook for the full year. The market we see, the trends we see are as big as they've ever been. And we're really focused on continuing to deliver for our customers.

10-nanometer era is now. We're ramping a multitude of products. We have increased confidence in 5-nanometer. And as we mentioned for 7 and 5 getting back to a 2.5-, 2-year cadence is what we're focused on. And we're confident in the future. And you're seeing both in the first 9 months of the year as well as with our higher share buyback that we're putting your money where -- to work to reduce the float because we think there's a disconnect between the intrinsic value of the plan we shared with you back in May and how we're trading. So with our balance sheet, we're taking advantage of that.

So thanks for joining us. Thanks for your questions. And we'll talk to you soon.

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Trey Campbell, Intel Corporation - Head of IR [49]
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Thanks, Bob and George, and thank you, everyone, for joining the call today. Operator, could you please go ahead and wrap up the call?

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Operator [50]
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Certainly. Thank you. And thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.

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