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Here's Why Intel Corporation Didn't Guide Margin Higher

On July 27, chip giant Intel (NASDAQ: INTC) raised its full-year revenue guidance by $1.3 billion, from $60 billion to $61.3 billion.

That increase in revenue also drove an increase in the company's full-year (non-GAAP) earnings-per-share guidance to $3.00, up from $2.85.

Image source: Intel.

During the question-and-answer portion of Intel's earnings conference call, analyst Ross Seymore asked, "As we think about the full year, with revenues going up, why isn't gross margin changing at all?"

For context, Intel's previous guidance called for a non-GAAP gross profit margin percentage of 63%, and that guidance remains unchanged.

Additionally, the analyst likely asked this question because companies often see gross profit margin leverage with increased revenue. This is particularly true for companies that own and operate manufacturing plants, as gross margin tends to increase with factory utilization rates.

Let's look at what Intel management had to say in response to Seymore.

Some good news and some bad news

Intel CFO Robert Swan said that the management team expects "[average selling price improvements], good unit cost performance, [and] volume leverage working through the fab" to continue to help the company's results.

Swan then pointed to fast growth in the company's non-volatile memory business, the continued growth in Intel's cellular modem business, and the costs associated with ramping up the company's 10-nanometer manufacturing technology into volume production as "partial offsets" to the positive gross margin drivers.

This isn't surprising. Even in the current strong pricing environment for memory products (both DRAM, which Intel doesn't participate in, and NAND, which Intel does participate in), memory product margin generally isn't as high as Intel's processor product margin.

So the better Intel's memory business performs, the more it'll dilute the company's average gross profit margin percentage.

It's important to keep in mind that even if the average gross margin percentage comes down, the company's total gross profits go up.

Here's an example: Assuming all else is equal, is it better for a business to sell $100 worth of product at 60% gross margin and $30 worth of product at 30% gross margin, or to just sell $100 worth of product at 60% gross margin?

The answer is clearly the former, since it would result in greater total profit for the company and thus more value for stockholders.

The same story goes for cellular modems. Mobile chips generally carry lower gross margin than Intel's processor products, and I wouldn't be surprised if Intel's margin on its cellular modem shipments -- shipments that are primarily to Apple, which is known for driving hard bargains because of its sheer scale -- was in the high 20% or low 30% range.

Again, just as with the increase in NAND revenue, the ramp-up of Intel's modem shipment sales should be a net win for the company's total gross profit dollars. But that same ramp-up serves to dilute the company's average gross margin percentage.

Finally, Intel has historically suffered high costs associated with bringing new manufacturing technologies online, so it's not surprising to see the company's ramp-up of 10-nanometer technology also taking a bit of the wind out of Intel's sails vis-a-vis its gross profit margin.

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Ashraf Eassa owns shares of Intel. The Motley Fool owns shares of and recommends Apple. The Motley Fool recommends Intel. The Motley Fool has a disclosure policy.