Intel Corporation

Ladies and gentlemen, thank you for standing by and welcome to the fourth quarter 2019 Intel Corporation Earnings Conference call. At this time all participants are in listen only mode. After the speaker's presentation there will be a question and answer session. To ask a question during the session you'll need to press star one on your telephone. As a reminder today's program is being recorded. And now I'd like to introduce your host for today's program, Drake Campbell, Head of Invest Relations. I'll start you off, please go ahead.

Rader, and welcome everyone to Intel's fourth 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 that 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 can 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.

Thanks Trey. We exceeded our expectations for Q4-19 capping off a fourth consecutive record year. In Q4 we generated $20.2 billion in revenue and $1.52 in earnings per share, exceeding our guidance by $1.0 billion and $0.28 respectively. For the full year we delivered $72 billion in revenue and $4.87 in EPS. The PC, data center, IoT, memory and mobile eye businesses each set all time annual revenue records. Several years ago we began a transformation to reposition the company to take advantage of the data revolution that is reshaping computing. Exiting this quarter we now have greater than 50% of our revenue coming from our data-centric collection of businesses. But our journey is just beginning. To reach our multi-year goals we will continuously focus on three key priorities. Accelerating growth, improving execution and deploying our capital for attractive returns. I'd like to share our progress against these priorities over the last 90 days. We are accelerating growth by expanding the capabilities of our workload optimized platforms and playing a larger role in our customers' success. Demand for our Intel Xeon scalable processors is very strong as customers continue to make Xeon the foundation for their AI-infused data center workloads. One of the reasons Cascade Lake is our fastest-ramping Xeon CPU is its unrivaled AI performance. Xeon's AI performance will take another step in the first half of 2020 when our third generation Xeon scalable processor, Cooper Lake, debuts. Cooper Lake features new Intel DL Boost extensions for built-in AI training acceleration, providing up to a 60% increase in training performance over the previous family. Additionally, we've been expanding beyond the CPU and the data center with products such as Optane Persistent Memory, Custom ASICs, Ethernet and Silicon Photonics. In Q4, data center-adjacent products grew more than 30% -over-year. In client computing, we are seeing excellent momentum for our first 10-nanometer mobile CPU, Ice Lake, with 44 system designs already shipping. In addition to our CPU capabilities, we continue to deliver leadership PC platform connectivity. With Wi-Fi 6, we're delivering gig-plus speeds, and for wired connectivity, we just announced Thunderbolt 4 for platforms in 2020. At CES, we also showed customer momentum for our Project Athena Innovation Program, including the first Project Athena verified Chromebooks. Project Athena verified laptops have been tuned, tested and verified to deliver fantastic system-level innovation and benefit spanning battery life, consistent responsiveness, instant wake, application compatibility and more. We verified 26 Project Athena designs to date and expect 50 more devices across Windows and Chrome to be verified this year. In addition to strengthening our largest businesses, we're investing to win key data-driven technology inflections. These inflections include the rise of artificial intelligence, the transformation of networks and emergence of the intelligent and autonomous edge. The market for AI-based silicon is growing and evolving quickly. New workloads are emerging and existing workloads, like high-performance computing, are converging with AI. In 2019, we generated $3.8 billion in AI-based revenue. The AI market opportunity is expected to be $25 billion by 2024, and we're investing to lead with a strong portfolio of products. In addition to integrating AI into all our leading products, we've introduced and acquired new capabilities that deepen an already unparalleled portfolio of AI assets. We announced the acquisition of Habana Labs, a leading developer of programmable deep learning accelerators for the data center. Habana, combined with Intel's existing AI ASICs and software expertise, will advance our AI offerings for the data center with high-performance training and inference processors and a standards-based programming environment to address evolving AI workloads. Delivering the optimal AI silicon architecture is critical, but not sufficient to solve customers' problems. That's why we launched the OneAPI industry initiative to deliver a unified and simplified programming model for application development across heterogeneous processing architectures. OneAPI marks a game-changing evolution from today's limiting proprietary program approaches to an open standards-based model for cross-architecture developer engagement and innovation. As expected, our networking business reached $5 billion in revenue in 2019. We've grown our business by helping our customers transform their networks by consolidating and virtualizing workloads on Intel architecture-based servers. Now, as we advance into the 5G era, we see our momentum and design-win pipeline accelerating as we're positioned to win significant share in base stations. This quarter, we announced a strategic agreement with Alibaba to support both the Tokyo and Beijing Olympics, building out 5G infrastructure utilizing Xeon Scalable, Optane Persistent Memory and Intel software. These data-optimized 5G networks will support amazing experiences such as immersive 8K VR, cloud 3D stadium simulations, and cloud broadcasting. We also delivered almost $5 billion in annual revenue from our IoT slash Edge portfolio of products. In November, we disclosed our next-gen Movidia's vision processing unit, TeamBay. TeamBay is highly optimized for edge inference with groundbreaking leaps forward and power-efficient performance, delivering up to 4x the performance or 6x the performance per watt over comparable competitive solutions. It's been over two years since the acquisition of Mobileye, and we couldn't be more excited about the team's progress. This quarter, we announced several exciting new engagements. We established an agreement for REM data harvesting with SAIC Motor, and embarked on a strategic partnership with NEO to deploy Mobileye's self-driving system as the full-stack solution for NEO's consumer AV. We also continued to accelerate the commercialization of driverless mobility as a service with two new partnerships, RATP in Paris and Daegu City in South Korea. In Q4, we were also excited to host analysts and investors at Mobileye's headquarters to discuss our strategy to win the more than $70 billion opportunity for ADAS, AV, and data, and to expand our aspirations to an even larger role in the $160 billion opportunity for Mobileye as a service. Our guests had the chance to test-drive our technology on the demanding roads of Jerusalem as we demonstrated industry's leading AV solution stack navigating a wide variety of driving complexities and delivering unmatched agility and safety. We have significant opportunities, but realizing them requires improved execution, starting with delivering more supply for our customers. In response to continued strong demand, we invested record levels of CAPEX in 2018 and 2019. That added capacity allowed us to increase our second half 2019 PCCPU supply by $1.5 double digits relative to the first half. However, demand has continued to outpace PC supply and supply remains tight in our PC business. We're continuing to add capacity so we're not constraining our customers' growth. Across our 14 and 10 nanometer nodes, we're adding 25% wafer capacity this year to deliver a high single-digit increase in PC unit volume. This will enable us to meet market demand, deliver our 2020 financial plan, and increase inventory to more normalized levels. Our near-term challenge is working with our customers to support their desired product mix. Our process technology execution continues to improve. In Q4, we ramped our 10 nanometer production and continue to see yields improve. We are planning nine new product releases on 10 nanometer this year, including our next gen mobile CPU, a 5G base station SoC, an AI inference accelerator, our first discrete GPU, and Xeon for server, storage, and networking. We're also on track to deliver 10 nanometer plus this year, our first performance upgrade on 10 nanometer. Our 7 nanometer process remains on track to deliver our lead 7 nanometer product, Pontevecchio, at the end of 2021, with CPU products following shortly after in 2022. We are also driving innovation in the next generation of computing. At CES, we provided a first look at our next gen Intel Core mobile processor, code named Tiger Lake, which is designed to offer groundbreaking advancements when it ships later this year. Tiger Lake, built on Intel's 10 nanometer plus process, will deliver significant gains in compute, AI, graphics, and interconnect over the prior generation. We will also deliver initial production shipments on our first 10 nanometer base Xeon scalable product, Ice Lake, in the latter part of 2020. We're also investing to lead the next wave of technology breakthroughs, such as quantum computing. Our investment in quantum computing covers the full hardware and software stack in pursuit of a practical, commercially viable quantum system. For example, last month we unveiled a first of its kind cryogenic control chip, HorseRidge, that will speed up development of full stack quantum computing systems. We made good progress this quarter, but will continue to be laser focused on improving our execution. That means delivering the supply, leadership process technology, and product innovations that allow us to play a larger role in our customer success. Our third priority is to thoughtfully deploy your capital to deliver attractive returns. That means first investing in the R&D and capex necessary to drive our long-term business plan. Since 2015, we have grown revenue by more than $16 billion, while reducing spending by $500 million. Spending as a percentage of revenue is down nine points, while over the same period we've increased R&D spending by $1.2 billion. We acquired Habana Labs, a fantastic company that will accelerate our AI plans, while also making thoughtful disinvestments. We closed both the 5G smartphone modem exit and the sale of IMFT in the quarter. We are confident in our future, and consistent with that, our board has approved a 5% increase in our dividend to $1.32 per share. Last quarter, we announced a commitment to execute $20 billion in share repurchases over the next 15 to 18 months. And three months into that window, we've already repurchased $3.5 billion in shares. Finally, our role goes beyond delivering strong results to being a great corporate citizen that has real impact on the world around us and in the communities where we work. I'm proud of the many outside recognitions we've received for our responsible business practices. This reflects our culture and the efforts of our ,000-plus employees around the world. Also, we continue to believe that a diverse workforce and inclusive culture are essential for executing our growth strategy, which is why we released detailed workforce representation data that raises the bar on ourselves and others for continued improvement. And it's important to us to be a leader in environmental sustainability, and we're investing to continue to increase the energy efficiency of our operations and our products. And we're also making significant progress on our goal of restoring 100% of our global water use by 2025. Back at our May Analyst Day, we told you that the industry was at an inflection point where the exponential growth of data is fueling massive expansion in multi-cloud environments, transforming networks, and catalyzing the intelligent edge. We believe we are well positioned to lead this data revolution, and we expect to generate $85 billion in revenue and $6 in earnings per share in the next three to four years. One year into that plan, we are tracking well ahead of our commitment. We have $3 billion more revenue, and we've earned an additional 52 cents in earnings versus our May expectations. Our expectation is to continue to make deposits towards our multi-year goal every 90 days. In summary, our priorities are to accelerate growth, improve execution, and thoughtfully deploy our capital on behalf of our owners like you. I'm excited by the opportunities in front of us and appreciate your continued support. I'll now hand the call over to George for details on our Q4 results and business outlook.

George? Thanks Bob, and good afternoon everyone. Q4 marked an outstanding finish to another record year with $20.2 billion in revenue, up 8% year on year, and $1 billion higher than guide. We saw record data-centric revenue of $10.2 billion, representing over 50% of our total revenue, an all-time high. CCG and Mobileye both achieved record revenue in the quarter. Q4 PC-centric revenue was $10 billion, up 2% year on year, tapping CCG's fourth consecutive year of revenue growth. Q4 operating margin was approximately 36%, two points ahead of our guide on higher gross margin and spending leverage. Gross margin for the quarter was 60.1%, beating expectations due to strong flow-through of higher DCG revenue. Q4 EPS was $1.52, 28 cents above our guide, primarily due to strong operational performance and further boosted by gains from our ICAP portfolio. These results demonstrate the strong demand for our leadership products and solid execution to achieve a record-breaking year. As a result, full-year EPS of $4.87 was up 6% year on year. We generated $16.9 billion of free cash flow, up 19%, and returned $19.2 billion to shareholders. We anticipate another record year in 2020 and are raising the dividend by 5%. Moving to more details on Q4 performance. Operating margin of 36% in the quarter was up over half a point versus last year, as higher volume and ASP strength in our data-centric portfolio and lower spending were partly offset by the ramp of our 10-nanometer process and NAND pricing degradation. EPS was up 19%, or 24 cents year over year, on higher operating margin, equity gains driven by our ICAP portfolio, and a lower share count partially offset by a higher tax rate. Our non-GAAP tax rate in Q4 was .6% in line with expectations and up 5.0 over year due to tax benefits from tax reform and discrete items in Q4-18. Let's move to segment performance. Our data center group had record revenue at $7.2 billion, up 19% from the prior year. These results beat our expectations with platform volumes up 12% and platform ASPs up 5% year over year on strong cloud demand and continued adoption of our highest performance 2nd Gen Xeon scalable products. In Q4, cloud revenue was up 48% year over year as cloud service providers continue building capacity to serve customer demand. Enterprise and government revenue was down 7%, while communications service providers revenue grew 14% as customers continue to adopt IA-based solutions to transform their networks and transition to the 5G era. All three segments exceeded our expectations for the quarter. Our other data-centric businesses were up 6% year over year in Q4. IoTG achieved another double-digit growth quarter with revenue up 13% and operating income up 29% year over year as customers increasingly adopt Intel AI-infused products to power the growing intelligent edge. Mobile eye revenue and operating income were up 31% and 54% respectively, driven by the industry-leading IQ products, which offer unmatched computer vision and mapping capabilities and continue to win in a fast-growing ADAS market. IQ revenue was up 41% year over year. NSG revenue grew 10% on continued bit growth, partially offset by year over year pricing declines. NSG reported an operating loss of $96 million as NAND cost improvements were more than offset by pricing declines. PSG revenue declined 17% year over year on softness in the embedded segment, primarily driven by lower last-time buys versus Q4 18, partially offset by strength in wireless. Operating income was down 48% on lower revenue and segment product mix. TCG revenue was $10 billion in the fourth quarter, up 2% year over year, driven by higher PC and modem volumes. PC unit volumes were up 1% on continued market strength and increased capacity. Adjacencies, which include modems and wireless and wired connectivity solutions, grew 13% year over year, driven by strong demand for modems and a better mix of connectivity solutions. Operating margin was 41%, up 4 points year on year on higher revenue and lower spending, driven by the 5G smartphone modem exit. As a result, CCG achieved record operating income in 2019. In 2019, we generated $33.1 billion in operating cash flow and invested $16.2 billion in capbacks. We also returned 113% of free cash flow to shareholders through dividends and buybacks. During the quarter, we purchased 63 million shares at an average price of $55.32 per share. Total 2019 share purchases were $272 million, and in 2020 we expect to return in excess of 100% of free cash flow to shareholders under the $20 billion buyback program announced last quarter and the increased dividend announced today. Let's move to Outlook. 2020 is expected to be another record year for the company. We are forecasting revenue of $73.5 billion and EPS of approximately $5. We expect our PC-centric business to be down low single digits year over year on a slightly down PC-TAM. Within 2020, we expect to see a strong first half and a moderating second half dynamic due to lower modem revenue and expected lower PC-TAM in the second half of 2020 as the Windows 10 commercial refresh matures. We expect revenue from our data-centric businesses to be up high single digits for the full year as we capitalize on the secular trends that Bob outlined. We are expecting an exceptionally strong Q1 as cloud customers continue to build capacity and adopt our highest performing products. This would mark three quarters of strong cloud build out, and we expect more modest capacity expansion for the remainder of the year as CFPs move to a digestion phase. We are also planning for an increasingly competitive environment as we move through the year. As a result of these dynamics, we expect total revenue to be more front-end loaded in the first half than we've seen historically. Gross margin is expected to be 59% for the year, down a point versus 2019 on both mix of products and the impact of 10 nanometer costs. Spending for the year is expected to be approximately $19 billion or 26% of revenue, down one point, resulting in a flat operating margin of approximately 33%. We expect 2020 CapEx of approximately $17 billion, more than half of which is comprised of investments in fab space and 7 and 5 nanometer equipment. Free cash flow is expected to be approximately $16.5 billion as the flow through from revenue growth and higher depreciation is offset by higher CapEx and rebuilding of critical product inventory back to more normal operating levels. Let's turn to Q1. We anticipate a particularly strong start to another record year with Q1 revenue of $19 billion, up 18% year over year, and well above normal seasonal patterns. This is being driven in particular by data-centric revenue growth, expected to be above 25% year over year on continued cloud build-out and nan-bit growth. With Q1 revenue growth, our PC-centric business is also contributing and is expected to be up more than 10% year over year on continued PC market strength, additional supply, and higher modem revenue. With strong top-line growth and mix, we expect Q1 gross margin of approximately 61%, up three points year over year. Q1 operating margin is expected to be approximately 35%, up seven points versus last year on higher gross margin and spending leverage on higher revenue. Tax rate is expected to be 13%, and EPS is expected to be $1.30, up 46% year over year. In summary, 2019 was Intel's best year ever, and we expect a strong start to 2020 on the way to another record year. With that, let me turn it back over to Trey. All right.

Thank you, George. Moving on now to the Q&A, as is our normal practice, we would ask each participant to ask just one question. Operator, please go ahead and introduce our first caller.

Certainly. Our first question comes from the line of Ross Seymour from Deutsche Bank. Your question, please.

Hi, guys. Thanks for letting me ask a question. Congrats on the strong end to last year and start to this year. George or Bob, whichever of you want to answer this, I want to go a little bit into the trajectory of revenues. George, you gave some great color there on the two different segments, PC-centric and data-centric. But it appears by the end of this year, you could even be going negative in both of those segments year over year, so it seems like it's a pretty significant drop. I appreciate conservatism and the end of life on the window side of things. But how do you factor in the increased competition that you mentioned and the fact that shortages should go away so you could actually have some market share gains?

Thanks, Ross. Let me start, George, and you can chime in. First, thank you for the compliment on our fourth quarter results. When we look at 2020 demand cycles, we kind of have three things going on that impact the first half, the second half outlook. And George touched on a few of these. But first, at the macro level, the sensational appetite for data and the processing resources that need to go to make that data relevant, those trends continue. And we feel very good about how we're positioned to capitalize on this increased demand. Second, as you know, from a cloud perspective, which now is a bigger and bigger part of our overall DCG revenue, we expect them to continue to benefit from the trajectories that I mentioned initially. At the same time, you'll remember from last year our ability to predict the CSP's purchasing and then kind of digestion patterns is relatively hard. So we look at first half, the second half, Q1 will be the, in essence, the third quarter in a row of real strong consumption patterns from the cloud folks. So we know from history that at some point they go into digestion mode and the buying patterns begin to slow down. And it doesn't impact medium or long term trends, but it does impact cyclical trends during the course of the year. And we've tried to, based on our past learnings, take that into account as much as we can. So hopefully we're wrong. Hopefully we're conservative. But at this stage of the game, that's kind of how we've looked at cloud purchases first half to the second half. The second thing, PCTAM, we think is going to be flat down a little bit this year. And the expectation is the first half will continue to be Windows 10 refresh that George flagged. And we expect that to slow down in the second half. And then the third item is modem. As we go into the second half of the year, we expect modem volume to be lower as we phase out of that business, as smartphone modem moves to the 5G world. So those three things have us looking at the full year of kind of 2% growth. And inherent in that is we know we've got a much more competitive environment. And our intentions during the course of the year is to compete vigorously to protect our position, while continue to expand as compute moves further and further away from the cloud out to the network and to the edge.

Yeah, and I guess I would just add that we feel really good about the year overall. It's just going to be a little flatter in terms of the pattern than certainly than we saw last year, and certainly different than our normal seasonal pattern. But good strength growth in all of the businesses, really outside of the PC, which is coming across some headwinds from TAM. But we still expect it to work on gaining back share in some areas where it's had difficulties in the past as we can start to provide more units.

And one last comment. I apologize. But I think just on a -over-year basis, the comps in the first half of 2020 are going to be easier. And then after a very strong second half of 2019, comps are a bit tougher in the second half of the year. But net-net, as George shaped it up, we're looking for another record year in 2020. Thanks, Ross.

Thank you. Thank you. Our next question comes from the line of Vivek Arya from Bank of America. Your question, please.

Thanks for taking my question. And congratulations on the strong results and especially the buybacks, nearly 10% of shares retired in the last two years. Question, Bob, on 10 nanometer. I saw in the slides you mentioned 10 nanometer years ahead of expectations, and you mentioned nine product releases on 10. Can you help put that in context? What does it imply in terms of the range of desktop and server SKUs? I think there is some speculation that maybe 10 nanometer might be a small node rather than a regular node. Or I guess, you know, asked in a different way, what percentage of your sales do you expect to be on 10 nanometer this year and maybe even next year? Thank you.

Well, first, we continue to make real good progress on yields on 10 nanometer. And that's been, after all the challenges we've had, that's been kind of a consistent theme over the last four to six quarters just on yields for 10. So we feel very good exiting the year and coming into this year on where we are in yields. Second, in terms of the product roadmap, you know, we have we launched Iceflake for Client in the fourth quarter. We launched FPGA's Agilex products on 10 nanometer in the fourth quarter. And then through the course of this year, we're going to have successive products of AI inference accelerator, 5G SOC that we're really excited about for the 5G network, GPU launched and then, you know, last and certainly not least, bringing out Iceflake server product at the back end of the year. So we've launched it. Yields are good. Designs across our portfolio products are good and we'll ramp them up during the course of the year. But primarily in terms of volume, we'll still be, you know, the client business is the one we're going to ramp the fastest. It'll ramp during the course of the year. It'll be on our second gen of 10 nanometer or what we'll call 10 plus the second half of the year, which introduces a whole new level of performance for that product. But in the aggregate, we won't have a huge percentage of our overall company volume in the second half of the year. We'll grow as we exit the year and become a much bigger part of our overall volume in 2021. And then last, I just say that, you know, our intention back in May and we reiterated again today is that we want to get back to a two to two and a half year cadence. And, you know, shortly after launching 10, our expectations is we'll have our first our first seven nanometer product launched in the latter part of 2021 with DPUs to closely follow. So 10 is ramping. We'll go to 10 plus for clients and we'll ramp seven out of two year cadence in 2021.

Thank you.

Thanks a lot.

Thank you. Our next question comes to the line of Blaine Curtis from Barclays. Your question, please.

Hey, guys. Thanks for taking my question and I'll let you go. Congrats. The great results. But maybe just following on that, I remember two quarters ago you talked about isolating out for servers in the first half. And, you know, there's a lot of different milestones that gets confusing. When you say second half, you actually is that a volume ramp or is that when you actually expect the 10 nanometer servers to be out?

Yeah, it's a good question. Just a few things. I think first in terms of how we deploy the technology, you know, today our ecosystem partners have already received isolate server samples. So that's that's kind of the first first step for us. And then what we indicated is we'll start production wafers in the first half of this year and that that'll translate into production of shipments in the latter part of 2020. So that's a sequence of events. So production, we load wafers, we deliver samples. Jack, we load wafers first half, we deliver production output latter part of the year. So that's been pretty consistent with how we've been trying to ramp this over the last several quarters.

Thanks for that. And then just a clarity on the client side, I'm surprised by the seasonality, but I guess I understand with Win 10, with that growth or the strong year of year you're seeing Q1, are you still shorting the market? I guess.

Yeah, yeah, you know, first, you know, the very, you know, we came into 2019 looking at kind of a flat PCTAM. And when all was said and done, we end the year with about three percent growth overall and even stronger in the fourth quarter. So we've had a real strong the market has had a real strong year in 2019. At the end of the year, as we indicated, we were we were we were still constraining our PC customers. And there's I'd say there's we left some backlog on the table that we are, you know, quickly trying to fill as we come in to the come into the first quarter. So that that's that obviously a disappointment in terms of our serving customers at the end of the year, but adds to volume in the first first quarter, first half. As we go through the course of the year, just from a macro level, you know, we spent record capital in 18 again, record capital in 19 as George as George laid out and his prepared remarks. We'll spend we'll have record capital in 2020. And it's really geared to ensure that we never constrain our customers growth and our expectations in 2020 is that we'll have high single digit PC unit volume and against a market that we expect to be flat to down slightly. So we are we are going to be in good position to meet customer the market demand in 2020 to live to deliver on our full year outlook and to begin to build the inventory levels to more natural positions so that the mixed dynamics of what product we're selling when we can manage the volatility in that much better than we have been able to in the fourth quarter. So supply constraints, we are maniacal about eliminate eliminating those so that we can meet customer demand and they don't have to worry about it.

And we'll expect to see more small core in the second half, which may be part of the dynamic. We haven't really been able to serve that end of the market in the way that we'd like to. So that may be part of what you're looking at.

Thank you. Thank you. And as a reminder, ladies and gentlemen, please limit yourselves to one question. Our next question comes from the line of John Pitzer from Credit Suisse. Your question, please.

Yeah, good afternoon, Bob George. Let me add my congratulations to the solid results. I guess I've got a similar question to Ross's first question on revenue, but mine's going to be on gross margin. If you just sort of look at the Q1 guide of 61% versus the full year of 59, I'm just trying to understand kind of the puts and takes that brings gross margin down throughout the year. And explicitly how much of this is kind of you guys baking in some increased competition or how much of this is a pull forward of 7 nanometer? Because 59 is pretty close to what you talked about, the analyst A kind of flat issue on year, but it is slightly lower. And you were pretty explicit about gross margins going down in calendar year 21. I'm just kind of curious as to whether or not we're getting a pull forward of the 7 here or what are the puts and takes as you think about gross margins throughout the year?

Yeah. So as we tell me to start with a full year, because I think that'll be helpful, as at the highest level, what you're really seeing is an impact of largely related to 10 nanometer costs that are coming into the system during this year and increasing as we go into the second half for all the reasons that Bob laid out. We're actually getting some help that is moderating the impact of that from improving NAN pricing year over year. That's actually going to help us on gross margin and lower modem mix, particularly in the second half of the year, but in the year overall. So those are the big drivers of modems. That nets out to about a 1% reduction. And in Q1, what you're really seeing is lower modem and lower variable comp being the reason that we're moving up a point, say, from Q4. And so nothing unusual other than normally you would have expected to see a much bigger drop in Q1 gross margin because of the mix of products as it's obviously the seasonally down quarter for many of our businesses.

Hey, George. The only thing that I would add is we do inherent in our guide is our expectations for lower ASPs. And it's a function of two things, one that George mentioned, which is we will eliminate the supply constraints and begin to get more volume on small core, which as you know, is lower ASPs. And secondly, we're anticipating a more competitive environment as we go through the course of the year. So to kind of bring it back, ramping 10 is great. And we're ramping 10 in the second half of the year. And in parallel with that, we are investing in seven in 2020 and in 2021. And those are the things that we flagged back in May at the Analyst Day. And I'd say the one thing that's really changed since then is that our yields on 10 are just a little bit better. And they're a contributor to slightly better gross margin in the second half of 2019. And we expect that to continue to be a contributor this year.

Perfect.

Thanks, guys.

Thank you. Our next question comes to the line of Harlan Serve from JPMorgan. Your question, please.

Good afternoon and great job on the quarterly execution. On the full year guide for data-centric, up high single digits, I appreciate the first half, second half profile on DCG, but how are you guys thinking about growth of DCG within that framework for the full year? Is it in line with the sort of high single digits growth for data-centric? And then within that framework, how do you see the growth trends in other DCG segments, i.e., enterprise and comm service provider? Thank you.

Yeah, so the way we would look at DCG, I would say the growth rate would be modestly lower than the overall growth rate. You've got some very high growers contributing to pulling that up a little bit. So a little below the average, but still attractive growth in the year.

Harlan.

Thank you. Our next question comes to the line of Stacey Raston from Birdseed Research. Your question, please.

Hi, guys. Thanks for taking my question. I wanted to ask a bit about the capacity additions. So I kind of get this. Adding 25% wafer capacity to support your own volumes going up high single digits in a market that you think is down. Does that imply that you're actually going to be overshipping the market this year as you sort of rebuild those channel inventories? No, Stacey. What does that imply if you're going forward into 2021 where the PC market itself may still be in decline and you'll have higher capacity and ideally die shrink at that point? How do we think about that?

Yeah, I hear your point. One of the things that we mentioned is we are going to be producing in order to build inventory levels back up in the year. And so in the second half of the year, we would expect to be able to bring both our server products and most importantly our PC products back to a more normalized inventory level. So we are being up in the high single digits is meant to allow us to not only satisfy our customers but also rebuild the inventory. So your math is correct.

So that's your own inventory or are you going to be selling that to the customers or keeping it on your books?

It'll be our own inventories. And then we'll have to see. If you look at some of the channel information, you might see customers trying to build some inventory as well. But when we're talking about building inventory, it's our inventory level. I'd

also say the channel inventories exiting the year for PC I'd say are relatively low. And that's on us. So I do expect during the course of the year we will build our inventory levels to more deal with, you know, bikes in demand. But at the same time, we expect the channel to be at more healthy levels as we exit 2020 and enter 2021. And then just the one thing I'd mention is we think about the business overall and kind of the demand signals. And, you know, we continue to make really good progress on the comms sector, particularly with the growth in the network and the role that we play in the transition to 5G. And, you know, we characterize as the intelligent edge. We've delivered double digit growth with IoT for the last several years. And, you know, network and IoT are bigger and bigger parts of our business that we think we're very well positioned. So when you think about, you know, PC volume up or down over time, you know, we got this bigger growing aspect of our business that places demand on our manufacturing footprint. So that's the only other thing that I would add, Stacey. Thanks.

Thank you. Our next question comes from the line of Joe Moore from Morgan Stanley. Your question, please.

Yeah, thank you. I guess going back to the PC constraints that you're seeing, you know, you'd like to build your inventory back up in, I think you said, early in the year. But it seems like we're just a few weeks from you going out to customers and telling them that you would be short. So, you know, at what point can they start to add inventory? Are you forecasting that would happen in the second half, in the first half? And then, you know, do you feel like when those constraints are eased that you'll be able to take back unit share on the client side?

Yeah, I think, you know, first it was middle of, you know, middle of November, I should say, that we went out and, you know, we want to be able to provide as much advance notice to our customer base as possible if supply is going to constrain their ability to grow, to give them time to deal with it. And in November, with strong data center growth, PC demand continuing to grow, and factory excursion, combination of those things, we felt it was very important to get out to our customers as soon as possible. I think as we close the year, one of the favorable things was we got more output from our factories. And because of the capacity we put in place in 18, 19, and going into 20, we're really beginning to build back the capacity to meet the demand. So our expectations are we'll have sufficient supply in the first quarter, or I should say sufficient supply throughout the year. I think our challenge is really going to be on two things, particularly in Q2 with PCs, and that is linearity, getting not just the supply in the quarter, but, you know, week on week supply as our customers are hoping for. And then second, you know, particular SKUs or product mix, making sure that we have the right product mix. So we'll have enough capacity. I think Q2 will be a little challenging as we try to deal with product mix and linearity. But overall, we really plan to be out of this supply constraint environment in 2020.

Okay. And are the shortages anywhere other than client? Is it entirely client? Are there anything in server or any other products?

No, we're in pretty good shape on server. And, you know, I think that, you know, going with 19% growth in fourth quarter depleted our inventory level. So we're not, you know, you have that kind of spike in demand. We're not perfect across all products or all SKUs, but, you know, server CPUs, we really prioritize that and try to put ourselves in a position where we're not constrained. And we're in pretty good shape. So we're in pretty great shape, macro, micro, a few challenges here and there. But server CPU supply is pretty good.

Thank you. Our next question comes from the line of Christopher Rowland from Sheshguahana. Your question, please.

Hey, guys. Thanks for the question. On CAPEX specifically, you know, 17 billion, you mentioned some of the parts there. But how do we divide that up between kind of seven and five versus, you know, what you're doing with 10? And I don't know if you're still adding some 14 even. And as we think about CAPEX moving forward and capacity here, how do you guys feel about outsourcing non-CPU products? Like, for example, PSG, could you outsource that to foundries? How are you thinking about CAPEX going forward? Thanks, guys.

Sure. Maybe I'll take CAPEX. And, Bob, you can cover the outsourcing piece. So on CAPEX, part of the reason we're expecting 17 billion this year is we're building more space, some of the longer lead time items. And just one of the things that's really impacted us in terms of closing the gap on customer demand and our ability to support it has been not enough space available to fill with equipment, which you can do in a much shorter timeframe if you already have a space in place. So we said, you know, over half is going to be for space and then for seven and five nanometer equipment, as you know, where we've got all three nodes right on top of each other. And so we're going to be perhaps a little less capital efficient when you combine that with the fact that we are trying to close the gap on meeting our customers' requirements. And I think all of those things add up to 17. But we also, we're building for the future to make sure we have the kind of capacity, shelf space in place where we can quickly add capacity to meet demand if necessary.

Yeah. And I just, the one other thing is, you know, maybe with the exception of LISO, the reuse from one node to the next is still relatively high. So what we put in place for a 10 or a seven, for the most part, we can continue to reuse those tools for next generation. On the second part, the second part of your question, you know, we've historically, you know, leveraged third party foundries for a long time. And it's always been in the probably 20 to 25 percent of our of our overall supply we get from from third party foundries. And, you know, we continue to look at particularly in the non IA non CPU products, we continue to evaluate where is, you know, in a capital intense business, where's the best place to have these things manufactured. That's an ongoing process. And I would say, you know, all else equal the broader the breadth of our portfolio as we play a larger and larger role in our customer success. We build more products. And with that, the evaluation of what we do inside and what we do outside is is a full time effort at our end. So we'll continue to do it. We'll continue to prioritize, you know, where we can get the best, most efficient output and make those decisions over time.

Great. Thanks, guys.

Jonathan, I think we have time for one more question and then we'll turn the call back over to Bob to wrap things up.

Certainly. Our final question then for the day comes from the line of Timothy from UBS. Your question, please.

Thanks a lot. George, I want to go back to gross margin. I think last quarter we were talking about 60% for this year and we're now 59% for the year on a little bit better revenue. And yes, it's only a hundred basis points less, but obviously people are concerned about the, you know, about the competitive environment. So can you just talk specifically to what changed and maybe as you exit the year, it looks like that number has to be in the 57, 57.5 range, which is about where you said next year would be 2021. So is that still the right number for next year, too?

Thanks. Yeah, Tim, you know, let me just kind of correct the history just a little bit. What we said over the last couple quarters was when the question was, hey, when we look at 58, which is what we quoted for Q4, does that mean, is that the number that we should be expecting for 2020? And also with 57 on the table for 21, is that where we are? And I said we'll be closer to 60 than we will be to either of those numbers. And so 59 is very much in line with what we believe we were guiding. So I don't I don't really feel like we're down a point. But, you know, clearly there the factors that we talked about everything from product makes to 10 nanometer mix. Those are all things that are having an effect, particularly as the year plays out. And also the shape of the year. Bob talked about some of the things where we're will be in the mix in the first half is going to be much richer than we would normally have seen. And we may see a little less rich mix in the second half. So I think really nothing more than those type of movements, which are very much in line with what we were thinking we would see this year.

Awesome, George. Thanks so

much.

Thanks, Tim.

Maybe,

Troy, maybe just to wrap up first. Thanks for thanks for joining us. We feel great about how we wrapped up the year, our best quarter in the company's history, 2019, the best year in our company's history and our outlook for 2020 is it'll is we'll we'll do it again. We expect it to be another record year. And, you know, our, you know, our ambitions have just never been greater. As you know, we're going after a larger TAM. We're expanding the role that we play in our customers success. We're leveraging our CPU architecture, but also evolving beyond the CPU to GPUs and visual processing units as workloads continue to evolve. And given the overall dynamics of the industry, we feel very good about where we stand and we realize it's an increasingly competitive world. And we we feel like we're well positioned to deal with it. So thanks again for joining us. Our focus is on obsessing about how we serve our customers best. And if we can, we expect to do that better and better. And that'll be what really drives the growth of the company. So thanks and we look forward to another deposit 90 days from now.

Thanks, Bob and George. And thank you all for joining us today. Operator, could you please go ahead and wrap up the call?

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