Intel’s Internet of Things Business Was Outstanding Last Quarter

A wafer of Intel processors.

One of the business segments that chip giant Intel (NASDAQ:INTC) is investing in as it pursues its so-called “data-centric” strategy is its Internet of Things (IoT) group. This segment, according to the company in its most recent quarterly filing, “develops and sells high-performance Internet of Things [computing] solutions for retail, automotive, industrial, and video surveillance market segments, along with a broad range of other embedded applications.”

Although the segment is small — during 2017, it made up just 5.05% of Intel’s sales — it’s both fast-growing and profitable.

Significant revenue and profit growth

During the second quarter of 2018, Intel reported that its IoT group raked in $880 million in revenue, up 22.2% year over year. That revenue growth, the company explained in its quarterly filing, came from “strength across the retail, industrial, and other market segments.”

Operating profit for the segment handily outpaced revenue growth, climbing 74.8% year over year. On the conference call accompanying the earnings release, CFO and interim CEO Bob Swan said that this operating profit surge was due to “higher revenue and flat spending.”

Since spending in this business was flat year over year, it’s likely that all the gross profit associated with the increased revenue translated into operating income. It’s not hard to check this with some simple calculations.

Let’s assume the revenue that Intel’s Internet of Things group generates carries a gross profit margin percentage that’s roughly in line with the corporate average, which came in at 63% on a non-GAAP basis during the quarter. The total increase in IoT revenue that Intel reported was $160 million, which would suggest an increase in gross profit of almost $101 million — just $3 million shy of the year-over-year operating profit increase that the company reported in the segment.

It’s worth pointing out that in 2017, this business segment enjoyed roughly 20.1% revenue growth, but operating growth was roughly 11.1%. The company indicated that this segment’s 2017 operating income grew slower than its revenue thanks to “higher investment in growth areas such as automotive, and by increased share of technology and [marketing, general, and administrative] costs.”

Wind River divestiture creates revenue headwind

In 2009, Intel acquired Wind River systems. At the time, Intel described Wind River as “a leading software vendor in embedded devices [which] will become part of Intel’s strategy to grow its processor and software presence outside the traditional PC and server market segments into embedded systems and mobile handheld devices.”

In April 2018, Intel decided to divest itself of Wind River, selling it to TPG Capital (the same private equity firm that took 51% of McAfee off Intel’s hands in April 2017).

“This move is designed to sharpen our focus on growth opportunities that align to Intel’s data-centric strategy,” Intel’s IoT group leader Tom Lantzsch said in the press release that announced the Wind River divestiture.

Getting rid of Wind River, which was previously part of Intel’s IoT group, is set to “have a negative impact to [IoT] revenue of approximately $150 million,” Swan said.

The reason Swan pointed this out is that with the exclusion of the Wind River revenue during the second half of 2018, the year-over-year growth that the company reports will be negatively impacted. By quantifying that impact, investors will be able to figure out how the business, excluding Wind River, is performing.

Investor takeaway

Intel’s Internet of Things business performed well last quarter, with its 22%-plus revenue growth accelerating from the roughly 16.5% growth that it enjoyed in the first quarter of the year. Operating profit growth of approximately 75% slowed from the roughly 116% rate it saw in the first quarter, but this was, nonetheless, a solid showing.

Moreover, while the company’s IoT business still represents a small percentage of Intel’s overall revenue, it has steadily become a larger part of that top-line, as the table below illustrates:

Year 2017 2016 2015 2014 2013
Internet of Things Group revenue as percentage Intel’s total revenue 5.05% 4.44% 4.15% 3.83% 3.42%

After its outstanding quarter, and given its modest but steady rise in overall revenue importance, Intel’s Internet of Things group is one business segment investors should continue to watch closely.

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