Intel Corp (INTC) — Q4 2017 Earnings Call Transcript

Thank you, operator, and welcome everyone to Intel's fourth quarter 2017 earnings conference call. By now, you should have received a copy of our earnings release and the CFO earnings presentation, which replaces the CFO commentary that we previously used. If you've not received both documents, they're available on our Investor website, intc.com. The CFO earnings presentation is also available via the webcast window for those joining us online. I'm joined today by Brian Krzanich, our CEO; and Bob Swan, our Chief Financial Officer. In a moment, we'll hear brief remarks from both of them followed by the 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 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 CFO commentary and earnings release, available on intc.com, include the full GAAP and non-GAAP reconciliations. With that, let me hand it over to Brian.

Thanks Mark. 2017 was a record year for Intel and fourth quarter results were outstanding. Well ahead of the forecast we outlined in October, based on the strength of both our PC-centric and data-centric businesses. I will review our results with you in just a moment, but before I do that I would like to share a few words about security. We've been around the clock with our customers and partners to address the security vulnerability known as Spectre and Meltdown. While we made progress, I'm acutely aware that we have more to do; we've committed to being transparent, keeping our customers and owners appraised of our progress, and through our actions, building trust. Security is a top priority for Intel, foundational to our products, and it's critical to the success of our data-centric strategy. Our near-term focus is on delivering high-quality mitigations to protect our customers' infrastructure from these exploits. We're working to incorporate silicon-based changes to future products that will directly address the Spectre and Meltdown threats in hardware, and those products will begin appearing later this year. However, these circumstances are highly dynamic, and we updated our risk factors to reflect both the evolving nature of these specific threats and litigation as well as the security challenge more broadly. Security has always been a priority for us, and these events reinforce our continuous mission to develop the world's most secure products. This will be an ongoing journey, but we're committed to the task, and I'm confident we’re up to the challenge. To keep you informed, we've created a dedicated website, and we're approaching this work with customer-first urgency. I've assigned some of the very best minds at Intel to work through this, and we're making progress. With that, let's turn to our 2017 and fourth-quarter results. We just wrapped up the best year in Intel's history with the best quarter in Intel history. Revenue was up 4% year-over-year in the fourth quarter, 8% if you exclude McAfee, setting an all-time record. Our data center, IoT, and FPGA businesses each set revenue records. We met or exceeded all of the financial commitments we made to you at the beginning of the year, and our focus on efficiency and profitable growth produced significant leverage, driving non-GAAP operating income up 21%. Our data-centric businesses deliver the technology foundations for the newer data economy, making analysis, storage, and transfer of data possible, giving our customers the ability to turn data into amazing experiences and actionable insights. They are central to our strategy. Data-centric revenue excluding McAfee was up an impressive 21% over the fourth quarter of last year, and I would like to share a few highlights with you starting with DCG. DCG's revenue was up 20% over the fourth quarter. The cloud segment was up 35%, comm service providers were up 16%, enterprise was up 11%, and our adjacency revenue was up 35%. We saw broad-based demand strength with customer preference for high-performance products driving richer ASP mix. Cloud segment results were driven by significant volume growth and continued customer preference for higher performance products. In the comm service provider segment, we continue to take share and grow revenue as customers chose IA-based solutions to virtualize and transform their network. Enterprise segment strength was driven mostly by ASP as customers transitioned to Xeon Scalable products in a seasonally strong fourth quarter, IT buy window. While we continue to see enterprise customers offload workloads to public clouds, we're also seeing those customers prioritize performance solutions for hybrid and on-premise build-outs. Customers across all of our segments are accelerating deployment of the Xeon Scalable processors, which is ramping roughly in line with our historical Xeon transition. We continue to demonstrate leadership and progress in artificial intelligence with the data center, for the edge and from hundreds of watts to megawatts. Our software optimization for the Caffe framework has improved already strong Xeon Scalable ResNet-50 influenced performance by two times, just since the launch in July. The first generation Nervana Neural Network Processor ran on neural network less than two weeks after we received silicon, and we've shipped our first customer unit. At the edge, Google announced its AIY vision kit featuring our Movidius vision processing unit, and Amazon announced the DeepLens, the world's first deep learning enabled video camera for developers, which uses an installed CPU, graphics, and compute libraries for deep neural networks. We're also seeing design wins that combine technology from multiple data-centric business units, reinforcing the idea that we've developed a unique and differentiated collection of capabilities that can address customer challenges together more effectively than any one business could alone. A great example is Darvas' recent announcement of their deep sense product line, which combines core CPU, Intel FPGA-based network video recorders along with Movidius VPU-based cameras, enabling people and automobile detection in smart city applications using artificial intelligence. In the Programmable Solutions Group, we saw strong double-digit growth in the data center, auto, embedded, and advanced product categories, as well as last-time buys of legacy products. That strength was partially offset by softness in the comm's infrastructure. In Q4, we launched the Intel FPGA SDK for OpenCL to dramatically increase productivity for our customers. We also delivered first-to-market leadership innovations in this Stratix 10 product line, including the first SoC FPGA with an ARM processor at more than 1 million logic elements and the industry's first FPGA with integrated HBM2 memory. Our Internet of Things grew 21%, with continuing momentum in retail, video, and in-vehicle infotainment verticals. Wind River saw strong multiyear contractor growth and delivered its most profitable quarter ever for Intel. The memory business grew 9% and achieved profitability in Q4, a strong client volume was partially offset by a one-quarter qualification delay of a data center SSD volume. Last quarter, I shared with you that our leadership technology is resulting in strong customer interest in long-term supply arrangements. That interest has continued to grow. We have since signed additional agreements and now expect prepayments totaling roughly $2 billion over the course of 2018. Mobileye had another strong quarter, and business momentum is growing. Our steady design wins over the course of 2017 and 15 new program launches in 2018 are both increases of 2.5 times over the prior period. We now have level two plus and level three design wins with 11 automakers to collectively represent more than 50% of global vehicle production. These advance program launches over the next two years and they represent a major lead in functionality versus current semi-autonomous distance and our significant step towards saleable level four and level five fully autonomous distance. We reached an important milestone in the fourth quarter, the announcement of our level three to five autonomous driving platform based on EyeQ5 and Atom, which will sample over the next few months. We believe this will be the most advanced, scalable, and efficient platform of its kind. EyeQ5 will deliver 23 tera ops of deep learning performance and a 10-watt power envelope, or about 2.5 times the efficiency of the competition. Just a couple of weeks ago at CES, we announced that by the end of 2018, we expect 2 million EyeQ-equipped cars will be collecting crowd-sourced data for the REM, our road experience management mapping solution. The resulting map will first be utilized in level three getting in 2019. The ability to crowd-source data to build and rapidly update the processing map required for higher levels of automation is a major differentiator in our plan to build out the safest and most affordable autonomous vehicle system. It's also a great example of our data-centric strategy at work. And finally, I would like to touch on our PC-centric businesses, the client computing group. Over the course of the year, the PC market improved, our 14-nanometer manufacturing cost came down, and the competitive environment intensified. Against this backdrop, DCG's focus on innovation and performance, especially in growth segments like gaming, 2-in-1s, thin and notebooks and enterprise, led to record core mix and record i7 volume in the fourth quarter. We also shipped our first low volume 10-nanometer SKU and our modem business grew 26% over the fourth quarter of last year. Intel is undergoing one of the most significant transformations in corporate history, while transitioning from a PC-centric company to a data-centric company. We've made thoughtful, disciplined investments along the way that expanded our TAM to $260 billion. Those same investments have produced a collection of data-centric businesses that are unmatched, growing at double-digit rates and approaching 50% of the Company's revenue. Our opportunity is larger than it's ever been, and we're hungry to compete and win. In 2018, our highest priorities will be executing to our strategy and meeting the commitments we make to our owners and our customers. This concludes our commitment to restoring customer confidence in the security of their data. This year Intel will celebrate a half century of innovation that has profoundly changed the world. Over the last 50 years, we invented the architecture and manufacturing technologies that have made personal computing, the Internet, and the cloud not only possible but pervasive. The journey hasn't been without challenges; nothing worth doing ever is. Our culture has been forged through taking challenges head-on and developing solutions our customers can count on. That includes working directly to address the Spectre and Meltdown security threats. We leave 2017 on a financial high note, but I am even more excited about what's to come with our strategy, producing great products for our customers and great returns for our owners. I see Intel innovation changing the world for another 50 years, and that journey starts with 2018. Over the coming year, we'll bring amazing innovation and performance for the PC market, against the state-of-art in the artificial intelligence, lead the way towards mass 5G deployment, launch the industry's first new memory architecture in two decades, and take another step towards a safer world in which autonomous driving is a reality. Looking back on 2017, I could not be more proud of our team and all they have accomplished. As I look to our 50th year, I am more optimistic and confident than I've ever been about Intel's future. And with that, let me hand it over to Bob.

Thanks, Brian. The fourth quarter was an outstanding close to a record 2017, and we're building real momentum heading into 2018. Revenue for the quarter was $17.1 billion, up 8% year-over-year. Operating income was $5.9 billion, up 21% year-over-year, and EPS of $1.08 was up 37% year-over-year. From a capital allocation perspective, we redeemed $1.6 billion of 2035 convertible debt, reducing our share count by 59 million shares, and repurchased $500 million of higher coupon debt and exchanged $1.8 billion into 30-year debt at a 1% lower coupon rate. On tax reform, our Q4 GAAP earnings reflect a one-time tax impact of $5.4 billion, and our guidance reflects approximately a 7-point improvement in our effective tax rate going forward. To summarize, we had a fantastic quarter and year and are on track to exceed the three-year targets we laid out at our Analyst Day, one full year ahead of schedule. Our Q4 results demonstrate a continued momentum in our transformation from a PC-centric to a data-centric company. Intel's data-centric businesses, those outside of the PC segment, are at an all-time high mix of 47% of our revenue, up from approximately 40% in 2012. We've made significant investments to expand our TAM and do new data-rich markets like memory, programmable solutions, and autonomous driving. These investments are just starting to pay off and will fuel Intel's growth going forward. Our PC-centric business was down 2% in a declining PC market and it continues to be a great source of profitability. DCG delivered its most profitable year since 2011 by focusing on premium and growth segments with industry-leading products. This business generated the cash to fund Intel's investment in new data-centric growth. Moving to Q4 earnings, we generated significant EPS expansion in the quarter, up 37% year-over-year. Our EPS improvement was driven by strong top-line growth, a five-point improvement in operating margin, and significant gains from our ICAP portfolio. Our gross margins expanded two points in the quarter, and outstanding as a percent of revenue declined by 3 points as we delivered $700 million more revenue and $300 million less spending. In terms of operating efficiency, we're well ahead of schedule on meeting our commitment by reducing spending to 30% by 2020. We now expect to achieve this goal no later than 2019. Total spending was down 6% year-over-year in the fourth quarter while we continued to invest in our key priorities, including driving more toward artificial intelligence and autonomous driving. R&D spending as a percent of revenue was down approximately 1 point, and our SG&A costs were down over 2 points as we rationalized our marketing and sales programs and generated significant leverage in our SG&A functions. Let me touch briefly on our segment performance. The Client Computing Group had another strong quarter. Revenue of $9 billion was down 2 points, and operating margins were down 2 points. Operating margins were lower on 10-nanometer transition costs. We saw strength in the commercial gaming business, and we believe the worldwide PC supply chain is operating at a healthy level. The Data Center Group had record revenue of $5.6 billion, up 20% year over year, and operating income of $3 billion grew 59%. Q4 operating margin was 54%. As Brian mentioned earlier, we had strong growth in execution across all segments. Overall, unit volume was up 10%, ASPs were up 8%, and our adjacencies grew 35%. Our ASP strength demonstrates the value customers see in our high-performance products. Xeon Scalable launched in July is ramping well with customers broadly deploying its leadership product family. Revenue scale from leadership products, ASP strength, and the exclusion of 2016 one-time charges drove strong operating income growth for the business. For the full year, revenue was up 11%, and operating margin came in at 44%, both ahead of the expectations we provided at the beginning of the year. The IoT, NSG, and PSG business segments are becoming a larger component of our overall business, collectively growing 19% year over year. Our Internet of Things business achieved record revenue of $879 million, growing 21% year over year, driven by strength in industrial and video and continued momentum in our retail business. Operating profit was $260 million, up 42% year over year. The Mobileye business also had a record quarter and we're on track to our deal thesis. As we called out last quarter, results for the Mobileye acquisition are included in our all other segment and reflect the Q4 integration of Intel's autonomous driving group spending in the Mobileye. Our memory business had revenue of $889 million, up 9% year-over-year, with strong demand for data center FFT solutions and demand signals outpacing supply. This segment was profitable for the quarter, and we expect this segment to be profitable for the full year of 2018. Programmable Solutions Group had record revenue of $568 million with 35% growth driven by strength in data center, automotive, and embedded. Operating profit was $156 million, up 95% year-over-year. The Stratix 10 design win pipeline, which represents FPGAs largest ever, doubled over the last year due to engagements in 5G, cloud computing, and the infrastructure transition to network function virtualization. We laid out our capital allocation priorities early in the year. Invest organically, expand acquisitively, and return capital to our shareholders and do it wisely. For the year, we delivered on our promise. First, we generated strong free cash flow at $10.3 billion in the year and returned $8.7 billion to shareholders through dividends of $5.1 billion and share repurchases of $3.6 billion. Second, we funded a majority of the Mobileye acquisition from the sale of non-core assets during the year including McAfee and the sale of ASML shares. And third, we redeemed $1.6 billion in convertible debt reducing 59 million shares, and we also tendered higher coupon debt for lower coupon debt. Let me expand on the ICAP and treasury related transactions we executed in the quarter. First, we sold 11.4 million shares of ASML Holdings, which generated $2 billion in cash proceeds and a gain of $1.5 billion. Second, we redeemed our 2035 convertible debenture. This redemption created a $2.8 billion cash outflow in a non-cash loss of $385 million, which was tax-deductible. Since this debenture was convertible and therefore dilutive, the redemption effectively acted as a buyback that will reduce diluted share count by 59 million shares. And third, we successfully tendered $2.3 billion of high coupon debt in the quarter. We exchanged $1.9 billion of all debt for $2 billion of 30-year new debt, reducing our coupon rate by 1%. We also redeemed $425 million of all debt for cash. Adding it all up, 2017 was another record year for Intel; revenue of $62.8 billion was up 9% year-over-year, driven by 16% growth in our data-centric business and 3% growth in our PC-centric business. Operating income of $19.6 billion was up 18% on strong execution across the businesses and disciplined spending. Earnings per share of $3.46 was up 26% on excellent operational performance and the benefit of $0.35 from ICAP net gain. With the change to the accounting rules for recognizing price changes on equity investments, we do not expect to see these ICAP gains repeat. Before I turn to guidance, let me provide a little more context on the impact of tax reform on our business. Intel's fourth quarter results reflect a higher GAAP income tax expense of $5.4 billion, as a result of U.S. corporate tax reform enacted in December. This includes a one-time required tax adjustment on previously untaxed foreign earnings able over eight years which was partially offset by the re-measurement of deferred income taxes to the new U.S. statutory tax rate. Looking ahead, we expect the Tax Cuts and Jobs Act will help level the playing field for U.S. manufacturers like Intel that compete in today's global economy. We expect the 2018 tax rate of approximately 14%, driven by the lower U.S. statutory tax rate of 21%, lower tax on foreign income benefits of U.S. exporters, and the continuation of the R&D credit. The change in our tax rate drives approximately $0.28 in 2018 EPS. Intel has a rich history of investing in U.S.-led research and development and U.S. manufacturing. This past year we committed to the setup of our fab 42 facility, creating thousands of jobs at completion. These tax reforms provide further incentive to continue investments like this. Before we turn to our 2018 outlook, I also want to highlight two accounting rule changes. First, new accounting rules for revenue recognition; and second, accounting for equity gains and losses. We do not expect a material impact to revenue from the revenue recognition accounting change. The changes in accounting for equity gains and losses will require the recognition of unrealized price changes each quarter. The equity holdings like our ASML position will see mark-to-market adjustments that will flow through earnings in 2018, which may create greater volatility on a GAAP basis. This change resulted in an impact of $2.7 billion of net unrealized gain at year-end that we booked to equity on January 1, 2018. Now moving to the full-year, we are forecasting the midpoint of the revenue range at $65 billion, up 4% year-over-year. We expect an operating margin of approximately 30%, with gross margins down 2 to 2.5 points and spending as a percent of revenue to be down 1 to 1.5 points. The decline in gross margin is driven by growth in our adjacent businesses as we play in an expanded TAM and transition costs associated with 10-nanometer, both partially offset by higher gross margins from our 14-nanometer products. We expect EPS of $3.55, up 14% excluding the ICAP net gains driven by strong top-line growth and a lower tax rate of approximately 14%, which will increase EPS by approximately $0.28. We expect to net capital deployed at $12 billion. This reflects gross CapEx of $14 billion offset by approximately $2 billion of customer prepayments for memory supply agreements. Increasing CapEx reflects our and our customers' confidence in our memory technology leadership. We expect free cash flow of $13 billion, an increase of approximately 30%, directly contributing to our decision to raise our dividend by a full 10%. As we look to the first quarter of 2018, we're forecasting the midpoint of revenue range at $15 billion, up 5% year-over-year. We expect an operating margin of approximately 27%, flat year-over-year, with a 3-point decline in gross margin offset a 3-point decline in spending. We expect EPS of $0.70, up 11%, excluding ICAP net gain from strong top-line growth and a lower effective tax rate. We believe 2018 will be another record year for Intel, and we feel great about where we are entering year two of our three-year transformation. We've met and exceeded our commitments. Our PC-centric team continues to operate very well in a down market, and our data-centric businesses are up double-digits collectively as we continue to transform the Company to power the cloud and smart connected devices.

Alright, thank you, Brian and Bob. Moving on now to the Q&A as is our normal practice, we would ask each participant to ask one question and just one follow-up if you have one. Operator, please go ahead and introduce our first questioner.

My first question just revolves around the revenue guidance for the March quarter at the midpoint down about 12% sequentially is a lot worse than I guess normal season, and I guess I am trying to figure out kind of the parameters that you guys are using to come up with that number. Was there something in the DCG strength in the calendar first quarter that you don't think is repeatable given your comments around the PC supply chain being healthy, that to me feels a little bit more seasonal than not in the March quarter? So I am just kind of curious as to why the Q1 revenue would be so much below, what is being kind of the five-year medium seasonality for Q1?

John, thanks, it's Bob. There are really two main points to consider. First, the enterprise growth in DCG, as Brian noted, increased by 11% in the fourth quarter, showing exceptionally strong seasonal growth for enterprise. This was slightly more than we anticipated. Secondly, PSG experienced a 35% growth aided by end-of-life sales during the quarter. If we account for a more normalized growth rate in both enterprise and PSG, the results align more closely with typical seasonal dynamics for Q4 and Q1 when those adjustments are made.

And then Brian on my second question revolves around CapEx. I think it was a year ago on this conference call that you kind of mentioned that you thought that calendar year '17 and calendar year '18 would be sort of above churn line CapEx spending for you guys and then you thought it would come down again in calendar year '19 to a more normal trend albeit you didn't quantify the trend. Just given the big uptick in '18 the $14 billion, I realized two of that’s already being covered by prepayments. But how do we think about kind of the trend line CapEx from here especially in light of the changing relationship between yourself and Micron on INFT?

So you know my perspective is, if you take a look at right memory kind of logic on our CapEx scaled with our increase in revenue and kind of our overall growth rate. So that’s felt in line. With memory, we're going to take a look at it really on a year-by-year basis, and I would tell you that Bob's is really doing a good job of helping their business unit look over the capital. And when we have demand enough and people are willing to pay upfront to that demand and reserve the capacity like we done this year, we’re going to go head and put that capacity in place plus what we think what Mark and we can do as distributing across the overall market. And that’s really independent of that changing relationship with Micron; that’s really more about how we're doing development work in time, really that’s actually there are two generations away that been really effect 2018. This was really about what we saw for the overall main memory market plus the additional capital and capacity that people wanted to reserve through that process. We will look at that each year, John, and say, okay as we look out into '19 at the end of '18 will be that same analysis.

Thank you for that evaluation, Brian.

I would like to follow up on Brian's comment. In our view of memory, we have increased confidence in our customers and the technologies we are developing. These relationships will help fund the scaling necessary for business growth, and we aim to align net capital deployment with known customer demand. For 2017, our net capital was approximately $1.5 billion, which we maintained at a similar level in 2018. Our growth capital allocation has increased as we are more confident in our customer base, allowing us to support $2 billion in growth capital. We are focusing on customer adoption of our technology to effectively and efficiently scale the business. Additionally, a year ago, our growth outlook was significantly ahead of expectations, with an implied figure of about $62.2 billion for 2018. Now, with our guidance at $65 billion, we are projecting $2.5 billion more, and this incremental growth is creating similar demand for our logic capacity across 14, 10-nanometer, and as we progress to 7-nanometer.

Could you discuss your operating expenses? You've shown discipline in reducing them, but you also have new initiatives related to discrete graphics. Can you explain the costs involved compared to your competitors? Additionally, you will be investing in NAND, which was previously shared with Micron. Could you clarify the factors at play and whether there are strategies to manage potential increases?

Sure. I’ll start and I’ll let Bob to kind of give you their under-the-cover detail of dollars. But Joe, this really, we’ve already factored all of those things in, so things like the discrete graphics is a ramping spend. The memory R&D spending out in time, so for ’18 has no really effect. And then we’ve given an overall efficiency and all of our R&D spending to offset that. So, increasing in GPU spending, there are some other increases as well around things like autonomous driving and some of the other artificial intelligence in some of the emerging areas. You’re right, overtime will increase spending in NAND in R&D, but those are being offset by efficiencies that were driving into the rest of our product R&D. And we really feel like we’re getting good plays where we can keep the pace of innovation going on our core products, while we fund these new initiatives as well and not to compete from our continued efficiency efforts across spending as a percent of revenue.

Joe, I’ll add some figures to Brian's points. We’ve decreased from 36% to 35% to 34%, and by the second half of 2017, we expect to be around 31% of revenue. This decline has occurred for two main reasons. First, our investments have been yielding higher growth, and second, we are making strategic trade-offs in our spending. Looking ahead to 2018, we anticipate our spending will remain roughly flat compared to our annualized 2017 levels. Additionally, we will continue to enhance efficiencies in sales and marketing as we transition to being more data-centric and leverage our general and administrative functions. We’ve made solid progress over the past couple of years, and we expect to continue this trend while making essential investments in areas like discrete graphics, autonomous driving, artificial intelligence, and advancing Moore's Law.

As you consider the NAND investment, people have asked about the implications of separating from Micron for the long-term strategy. Does this indicate a greater emphasis on proprietary products like 3D XPoint, or is there still a strong commitment to competing in the NAND market?

To clarify, Joe, the separation of development work is projected to be fully realized around 2020, specifically concerning NAND. We will continue collaborating on 3D XPoint, and this should not be seen as a separation of the company or a change in our relationship. Our partnership with Micron remains strong, and I believe it will continue to be so in the future. This is about the direction we are taking with our products, focusing on the data center market and enhancing performance tailored to our customers. The current R&D spending is primarily targeted at NAND, while 3D XPoint remains a joint initiative.

I wanted to go back to DCG specifically on the up margin front. We have not seen the high handle if my model is correct, it's been eight plus quarters. So, can you please speak to the sustainability of the up margin? And kind of what were the drivers that got you to that level? And then I have a follow-up for these things.

Yes, so we came into the year and we indicated that we expected margins for the full year to be in the 40% to 45%, and obviously, we started out low but we said our expectations were that we grow throughout the course of the year. A couple of things in the fourth quarter, obviously, you know growth. So we'll build leverage on our existing investment was a big contributor. Secondly, ASPs were up 8%, so of the 20% growth, ASPs accounted for 8 points of that. And as Brian highlighted, whether it's cloud comps or enterprise, customers in the quarter will really paying for performance and that performance for us was higher ASPs. Third, continued progress on unit costs. And then last year, you may remember last year's fourth quarter, we had some warranty and IP-related charges in that data center business that I think cost was roughly 4 points year ago. So last year's, we're little deflated. But good volume leverage, strong ASPs as customers paid for performance and unit cost improvement.

So we should expect this level going forward Bob?

Yes, I think I wouldn't get too far away from the 40 to 45 to be honest with you. I think as we go into 2018, we think good cloud momentum that’s been consistent performance over the course of the year or last couple of years. Comm, our performance we believe it was real strong in a somewhat sluggish market, so real share gains. But the high kind of seasonal enterprise growth and strong ASPs in the quarter, we think are more seasonal in nature and we are not anticipating enterprise growth to stay at these levels as we go into '18.

In my follow-up regarding next year's gross margin, I noticed you discussed the adjacencies and cost impacts from the 10 RAM but didn’t mention competition. With AMD now having a full year with a product in a space they haven't occupied for a long time, are you experiencing any competition? Are you taking that into account? Additionally, could you quantify the two impacts you've mentioned?

I’d like to emphasize three factors contributing to our decline. First, we've traditionally aimed for gross margins in the range of 55% to 65%. While we expect to remain at the upper end of 60% to 65% this year, our experience with the 14-nanometer process has provided both performance improvements and lower unit costs, which have helped our gross margins. However, as we move into 2018, the profitability from the 14-nanometer process will be modest due to increased competition and a lack of significant average selling price improvements across the board. We anticipate some improvement in 14-nanometer products throughout the year. Secondly, we are significantly growing our adjacent businesses. The investments in our data-centric sectors and modem growth are driving our year-on-year earnings per share growth, but these product lines typically have lower margins, which is impacting our overall gross margins. Lastly, as we transition from the initial phase of 10-nanometer production, we expect the ramp-up costs to negatively affect margins as we scale production in the second half of the year. These are the three main considerations, and if I were to summarize, I'd say we might be looking at a slight upward impact from one area, but approximately two areas will exert downward pressure, leading to a net negative effect overall.

I understand your question about specifically around competition. I think every year we look at it as the competitive environment, and we're out to compete for our customers. And so we factor that in each year appropriately, I think against the competition. So we look at the competitive environment and we believe Xeon Scalable, great performance that has, our overall product roadmap, we think we have a highly competitive roadmap and have adjusted for that in our forecast.

Firstly, can you walk us through your free cash flow waterfall? I can't get your flattish operating income on 4% revenue growth. It was a couple of billion dollar ICAP gains, CapEx I guess maybe flattish with some memory payments. Taxes maybe get to me a third to half of the way there, but where does the rest of the free cash flow come from? Are you just draining the kind of working capital or what? Can you walk us through?

Yes, first $13 billion free cash flow, up roughly 30% year-over-year, first higher cash earnings. Our guide has EPS up roughly 14% in that guide thereis depreciation has grown in '18 relative to 2017. So that has just higher cash earnings. Secondly, we do expect lower working capital as we go through 2018. And third, we have higher strategic customer supply agreements and those three things were all contributed positively. And then obviously, Stacy, the higher growth capital is a bit of an offset; so longer cash earning, better working capital, more strategic supply partially offset by higher CapEx.

I want to ask about the gross projections for next year regarding your adjacent businesses compared to your core businesses. Out of that $65 billion at 4%, how much is expected to come from adjacent areas, primarily memory and modems, versus the core, especially considering the gross margin pressures? Additionally, you mentioned a one quarter delay in data center memories. Was that in reference to XPoint?

No, that was a NAND outage at the start. To answer your question, Stacy, the 3D NAND SSD has been delayed into the fourth quarter, and we are currently addressing that issue. That covers the comment.

And growth on, sorry, go ahead.

I think on your first question. In the $65 billion, we characterize it as roughly low single-digit decline in our PC-centric businesses. So implied to that is, PC may be decline a little bit more and modem adjacency within the CCG segment partially offsetting that. In the overall guide, we said that the data-centric businesses would be growing in the mid-teens; obviously that we believe that would be a strongest segment within the makeup of our data-centric business will be in memory. There would be the function of customer calls that Brian just highlighted, and we expect NSG growth to accelerate throughout the course of 2018. Those single digits decline on PC-centric and mid-team growth on data-centric businesses.

So, what is the memory strength implies for the data and the growth of the DCG growth, unprecedentedly given the strong performance in Q4?

For the most part, the wins for NSG that will go through the data center will be late in 2018 and won't really have an impact on the overall growth rate of that business. So it's primarily about growth of 3D NAND during the course of the year.

I guess a couple of housekeeping questions, if I could kind of put them together. Curious, if you could share with us how you’re thinking about CapEx spend between logic and memory? And then on the 10-nanometer startup, can you share with us when you’re expecting to begin depreciating those costs?

First, regarding capital expenditures, we indicated a gross capital investment of $14 billion for the year, with approximately $2 billion from customer strategic supply agreements. Therefore, our net capital for the year is $12 billion. I can break this down into two parts: there is no change in net capital employed for memory, while logic capital expenditures have increased by roughly $1 billion year-on-year. This increase is primarily due to continued growth in 14-nanometer technology, scaling up 10-nanometer, and investing in the next 7-nanometer node throughout the year. These three factors are driving the $1 billion increase in capital expenditures for logic. As for 10-nanometer, as we bring that equipment online, some of it is currently being depreciated. However, we will begin to ramp that equipment in the second half of the year, at which point we will start depreciating it. We expect our depreciation expenses in the second half of the year to increase, contributing to the gross margin decline as we ramp up production of 10-nanometer technology.

For first one, Brian, I’m curious. Are you baking in any effect on sales of cost of pricing for many resolution on the processor security issues? There is one line of thinking that says, customers might decelerate their purchase, and then you have others industry saying that customers might accelerate that purchase later on. So I’m just curious how you’re looking at the financial implications positive or negative from this issue near-term and longer term?

Sure, so we try and kind of break it into two kind of answers for that, Vivek. From a cost standpoint, we’ve baked in and we've talked about that we don’t expect any material impact of this security exploit on our spending or product cost or any of that. So that’s how we baked that in. From a fourth half standpoint, we actually made our forecast and we've checked it as we go through the first two weeks here of the year against our prior forecast to make sure that the forecasting incorporated any changes or any signs we're seeing up or down. And I would tell you at the highest level, we are not seeing much of the change in those forecasts as a result of that flow. I'd tell you it's pretty balanced right now, so spending not materials and didn’t make any add there; and then our forecast we had a forecast we checked in as we go through the first few weeks of the year and it hasn’t really changed that all as we looked at it. The only other think I'd add for Brian's comment earlier, we kind of go into the year realizing that it's an increasingly competitive environment and our focus is right now continuing to bring the best, highest performance products to market, but also to lots of time and energy to focus on fixing those issues, primarily through software patches as opposed to short-term hardware things.

And as my follow-up. For the full-year, how should we think about a growth in just the DCG business? I understand you gave some color around the entire data centric group which includes memory, than other segments, but just sort of apples-to-apples how should we think about growth in just DCG that had a very strong double-digit growth here in '17?

Throughout the year, we guided for high single-digit growth and executed accordingly. The fourth quarter did not significantly differ from the first three quarters, except for higher seasonal spending in the enterprise sector. This led us to achieve low double-digit growth of 11% for the year. Looking ahead to 2018, we do not expect the same results. We anticipate that enterprise growth will revert to negative single digits and therefore do not foresee a significant deviation in our outlook for the data center group compared to a year ago. As we prepare our plans for the year, we tend to be cautious regarding two areas: the overall PC market and enterprise growth in the data center business. We believe caution is vital to align our costs, and if our market growth assumptions are conservative, we expect to benefit from higher volumes and strong net income flow-through. This is our approach for 2017 and similarly for 2018. Thus, I do not expect a substantial change in data center group growth as we enter 2018, given that we have not anticipated any shift in enterprise CIO spending throughout the year.

Just wanted to go back to the DCG ASPs. You were talking about the ramp of scalable being kind of to plan, but then I think you got a nice tailwind and I think you implied enterprise at a higher percent of scalable. So just wanted to give us talk on broad strokes just where the scalable ramp is here? And how your expectations kind of getting through the year where that could go?

So I'll start and Bob can add some number detail in all. The Xeon Scalable ramp is right in line with prior ramps of similar products on our DCG roadmap. And what you saw when you talked about Q4 was not necessarily more Xeon Scalable, but people buying up the stock on Xeon Scalable which drove the ASP. So, they're buying higher performance, higher priced parts at the beginning. And then they fill out their distribution as other buyers come in and other parts in the market kind of opened up. So, ramps on schedule and aligned with high ramps, and the ASP was more about SKU, they're buying up on higher performance parts than necessarily a volume statement.

I would like to revisit the topic of gross margin for March that you mentioned; the decline is attributed to adjacent businesses and the 10-nanometer process. Clearly, you are indicating a significant ramp in memory, which is not fully realized yet. Bob, could you walk us through the startup costs for the 10-nanometer process as they progress throughout the year, and clarify which of the two factors is more significant in Q1?

So, actually the mix dynamics are going to be a bigger factor overall for the year, both in Q1 and for the rest of the year as our memory and modem business continue to accelerate strong growth. So that's going to be the biggest impact. I think 10-nanometer will have an impact; just right off the gate and will kind of continue throughout the year, as we scale volume, but also need to improve yields during the course of the year. So hopefully that's helpful.

Alright, thank you all for joining us today. Operator, please go ahead and wrap up the call.