Intel Corp (INTC) — Q1 2019 Earnings Call Transcript

Good day, ladies and gentlemen, and welcome to the First Quarter 2019 Intel Corporation Earnings Conference Call. As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Mr. Mark Henninger, Head of Investor Relations. Thank you, operator, and welcome, everyone, to Intel's First Quarter 2019 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 Bob Swan, our interim CEO and Chief Financial Officer; Murthy Renduchintala, Group President of the Technology, Systems Architecture and Client Group and Chief Engineering Officer; as well as Navin Shenoy, Executive Vice President and General Manager of the Data Center Group. In a moment, we'll hear brief remarks from Bob followed by Q&A. We're having technical difficulties. Let me jump back in here. I'm joined today by our CEO, Bob Swan; our CFO, George Davis; and 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 GAAP and non-GAAP financial measures. Today, we will be speaking to the non-GAAP financial measures when we describe 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, Mark. With the interim introduction, I thought on our outlook I was getting demoted already. But look, coming off a record 2018, our top line results came in slightly higher than expectations, with upsides in the PC and IoT segments, offset by incremental NAND pricing weakness. Total revenue of $16.1 billion was flat year-over-year, as our PC-centric business grew 4% and our data-centric businesses were down 5%. The team executed well, though underlying trends are concerning, and as a result, we've revised our expectations down for the full year. I'll give you some insight into the customer trends informing our outlook, but first, I'd like to take a few minutes to recap the progress we've made over the first quarter. It's been just under 3 months since I was honored with the best job in the world. At that time, I said that our leadership team would focus relentlessly on delivering for our customers to take advantage of the biggest opportunity in our company's history. We're making important progress by intensifying our focus in 3 key areas: expanding our TAM, accelerating innovation and improving our execution while evolving our culture. I'd like to spend a few minutes talking about our philosophy and progress in each of those areas. First, expanding our TAM. We are transforming from a PC-centric company to a data-centric company, and our ambitions are bigger than they've ever been. Our aim is to identify and capitalize on key technology inflections that set us up to play a larger role in our customers' success while improving returns for our owners. You can see the impact of this approach in our Q1 execution. For example, our first-ever data-centric portfolio launch marked an important milestone in our efforts to capitalize on the AI opportunity and undisputed technology inflection. Our new second-generation Xeon Scalable is the only processor in the industry with built-in artificial intelligence acceleration. Not only did we deliver a 14x generation-over-generation performance improvement, but we also showed CPU performance beating GPU performance on major AI workloads like recommendation engines. And we worked closely with the software industry ahead of the launch to deliver a great out-of-the-box experience for customers like Siemens. They're collaborating with us on a breakthrough AI-based cardiac MRI model. This application has the potential to provide real-time diagnosis using the DL Boost technology in our newest Xeon Scalable processor. Another TAM-expanding business that continues to gain traction is Mobileye, with 8 new global ADAS designs in the first quarter alone, including our first win in India. Mobileye's real-time crowd-sourced mapping technology, Road Experience Management or REM, continues to build momentum with a major North American automaker adopting this breakthrough data-centric capability. Autonomous driving is a technology inflection that we're ready to lead. 2019 will be a foundational year for another disruptive technology, 5G. As you know, we recently sharpened our 5G focus. When it became apparent that we don't have a clear path to profitability in 5G smartphone modems, we acted. We are now winding down that business and conducting a strategic assessment of 5G modems for the PC and IoT sectors while continuing to meet our current 4G customer commitments. By acting now, we focus our 5G efforts on the transformation of the wireless network and edge infrastructure, where we have a clear technology advantage, market share to win and a strategic role to play with customers. At Mobile World Congress, we demonstrated a range of 5G products under development, including the 5G-ready N3000 FPGA acceleration card and the new 10-nanometer-based Snow Ridge network SoC for use in 5G base stations. As networks cloudify, Intel is in a great position to win in this base station segment, where we expect to grow to 40% market segment share by 2022. The vast majority of the 5G market opportunity and profit is in the transformation of network and edge infrastructure, where we are now laser focused. Next, accelerating innovation. Successfully competing in a bigger TAM requires a broad range of products and technologies. Only Intel has the breadth of IP to deliver leadership products across increasingly diverse workloads for the data-centric era. Harnessing data for discovery, invention and business value is not a one-size-fits-all computing challenge. That's why we are investing in 6 important pillars of innovation: process technology, architecture, memory, interconnect, security features and software. Already this year, we've introduced incredible examples of this approach to innovation across the business. Let me take a minute to talk about a few. We are currently architecting what we expect will be the United States' first exascale supercomputer for the U.S. Department of Energy's Argonne National Laboratory. This supercomputer, called Aurora, will be delivered in 2021 and powered by Intel technologies designed specifically for the convergence of artificial intelligence and high-performance computing. These include a future generation of the Intel Xeon Scalable processor, Intel's Xe compute architecture, a future generation of Optane persistent memory and Intel's One API software. It's a great example of how our data-centric products architected together can deliver technology breakthroughs for our customers. We are also accelerating innovation in our PC-centric business. For example, our team is hard at work with our OEM customers to define and deliver a stunning new class of next-generation laptops. We call this Project Athena, and the first of these sleek, beautiful designs are coming in the second half of 2019. And just this week, we launched the most powerful generation of Intel Core mobile processors ever, designed for gamers and content creators. On the process technology front, our teams executed well in Q1 and our velocity is increasing. We remain on track to have volume client systems on shelves for the holiday selling season. And over the past 4 months, the organization drove a nearly 2x improvement in the rate at which 10-nanometer products moved through our factories. Finally, execution and culture. This is about concentrating our resources on the vital few programs that will have an impact on our customers' success and our owners' return, rather than the trivial many. Over the last couple of years, that focus has resulted in exiting the McAfee and wearables business, shutting down Saffron and divesting Wind River. And our spending as a percentage of revenue has gone from approximately 36% to about 30% this quarter. It has allowed us to invest more of our resources, and just as importantly, our collective attention and focus, where it really counts. By doing fewer things, we'll execute better at the things that matter most. Specific areas where we need to improve execution include meeting customer demand and delivering on our 10-nanometer lineup of products, and we are making progress. Our supply constraints have had a disruptive impact on our customers and ecosystem. We've committed never again to be a constraint on our customers' growth. We've increased capacity to improve our position in the second half, although product mix will continue to be a challenge in the third quarter as our teams align available supply with customer demand. As I shared earlier, our confidence in 10-nanometer is also improving. In addition to the manufacturing velocity improvement I described earlier, we expect to qualify our first volume 10-nanometer product, Icelake, this quarter and are increasing our 10-nanometer volume goals for the year. I'll shift now to our full year outlook. Going forward, George will deliver our forecast. But given this is his third week with us, I'll share my thoughts on our full year reset and he'll review our first quarter results and second quarter guide. Our conversations with customers and partners across our PC and data-centric businesses over the past couple of months have made several trends clear. The decline in memory pricing has intensified. The data center inventory and capacity digestion that we described in January is more pronounced than we expected, and China headwinds have increased, leading to a more cautious IT spending environment. And yet those same customer conversations reinforce our confidence that demand will improve in the second half. So we've reassessed our '19 expectations based on the challenges we're seeing. Our full year outlook is now $69 billion in revenue, down 3% year-over-year and down approximately $2.5 billion from our previous estimate. Given the magnitude of change, we'll be somewhat more granular in explaining the drivers. We now see data-centric revenue down low single digits year-over-year, with DCG down mid-single digits year-over-year off a tough compare, continued China weakness and inventory and capacity absorption. We are also anticipating an incrementally more challenging NAND pricing environment. Our PC-centric forecast remains unchanged at low single digits. We are forecasting operating margin to be 32%, down approximately 3 points year-over-year and down approximately 2 points from our previous guide. This outlook reflects lower full year revenue and a year-over-year decline in gross margins as a result of the 10-nanometer ramp and NAND pricing. We continue to see good discipline on spending and expect our exit from the 5G smartphone modem segment, annualized in 2018 spending actions, and incremental spending efficiencies to reduce OpEx by approximately $1 billion year-over-year, partially offsetting the impact of lower gross margin. We now forecast full year EPS at $4.35 per share, down approximately 5% year-over-year and $0.25 from our previous guide. We now expect our full year tax rate to be 12%, up 1 point year-over-year and down 1.5 points versus our prior guide, largely as a result of lower pretax income. Before I hand the call over to George, I'd like to welcome him as Intel's new CFO. I've known George for a long time from his CFO days at Applied Materials while I was a board member. He brings deep industry knowledge from prior roles. He's a true team player and he cares deeply about people development and diversity. George will review our first quarter financials and second quarter guide, then we'll get to your questions.

Thanks, Bob, and good afternoon, everyone. I'm delighted to be at Intel and look forward to regularly engaging with our key stakeholders. Revenue for our first quarter came in at $16.1 billion, flat year-on-year and slightly higher than our guide. Data-centric revenue was $7.5 billion, down 5%; and PC-centric revenue was $8.6 billion, up 4% year-on-year. Q1 operating margin was 28%, down 2 points due to cost of our 10-nanometer ramp and NAND reserves, partially offset by platform ASP strength as supply constraints at the low end in CCG led to an especially rich mix as well as lower spending overall. Q1 EPS came in at $0.89, up 2% versus the prior year and $0.02 over what we guided for the quarter. Year-to-date, we have generated $1.6 billion of free cash flow; returned $3.9 billion to shareholders, including dividends of $1.4 billion; and repurchased approximately 49 million shares. We are pleased with the team's focused execution for the quarter. We anticipated a challenging start to 2019, and that's what we have encountered. We also knew that the timing of our 10-nanometer ramp would pressure margins in the first quarter. And while we continue to make progress on the roadmap, that pressure remains a factor. We see customers becoming more cautious in their buying patterns, with the most acute deceleration happening in China. Demand pressure is particularly evident in our data center business, where we are seeing a continuing inventory correction in enterprise and comms and capacity digestion among cloud service providers who ramped consumption strongly in 2018. Non-GAAP EPS was up 2% year-over-year driven by strength in our client and IoT ASPs, lower spending, lower shares outstanding and the McAfee dividend received in the quarter. Offsetting factors were continued NAND pricing pressure, 10-nanometer ramp cost and weak enterprise and government data center demand. Our tax rate came in at 12.5%, up almost 1 point year-over-year due to nonrecurring benefits in Q1 of 2018. We continue to improve our operating efficiency year-over-year from 32.4% to 30.3% spending as a percent of revenue. Total spending was down 7% year-over-year in the quarter as we drove efficiencies in our SG&A spending and kept R&D spending flat compared to the prior year. Within that overall flat R&D spend, we are making thoughtful trade-offs so that we can amplify the investments into key priorities to grow the business. This has resulted in more investment in 10-nanometer and 7-nanometer process technology and accelerating road maps in DCG and CCG and in key growth areas like autonomous driving, AI and 5G network infrastructure. Let me now break down our performance by segment. Our Data Center Group ended the quarter with revenue of $4.9 billion, down 6% from the prior year and 19% sequentially within our expected range of sequential decline, given the headwinds we noted last quarter. Against the challenging year-over-year compare, platform units were down 8%. We saw record Xeon ASPs as customers continue to select high-performance products. We also saw a strong ramp of network SoCs, resulting in moderation of our blended platform ASP. Non-CPU adjacencies were up 2% driven by strength in network ASICs and silicon photonics. Cloud revenue grew 5% year-over-year in the first quarter as cloud service providers absorbed capacity put in place in 2018. Enterprise and government revenue declined by 21%, and comms service provider revenue declined 4% year-over-year in the first quarter as both enterprise and comms customers worked through inventory and China demand weakened. Overall, our data-centric businesses were flat year-over-year. Our IoT businesses saw 19% revenue growth adjusted for Wind River and operating income growth of 11% year-on-year due to a mix shift to higher core products in the quarter, with the growth of compute-intensive applications like AI and computer vision. Mobileye had record revenue, up 38% due to an expanded product portfolio and customer base. Our memory business was down 12% due to continued NAND pricing pressures, offset by NAND data center and client bit growth. Operating income for this group is down driven by NAND ASP deterioration and demand softness, resulting in inventory revaluations. The PSG group declined 2% year-over-year due to weakness in cloud and enterprise, partially offset by strength in wireless and advanced node products. The Client Computing Group showed continued growth, with revenue up 4% year-over-year. Platform revenue was up 3% driven by strength in large commercial and gaming. Modem drove the majority of strength in the adjacencies, resulting in a 26% increase over the prior year. We have added supply capacity and continue working closely with our customers to align our available supply to their demand. However, supply of our PC processors and chipsets remains tight, particularly for our small core products as we prioritize big core. We saw strong ASP growth in desktop and notebook, in part due to the small core constraints, but also on strong performance in gaming. Constraints were also responsible for the year-over-year decline in volume. This quarter, we generated $5 billion in operating cash flow, and we invested $3.3 billion to expand our 14-nanometer capacity and ramp 10-nanometer. We raised the dividend by 5% and repurchased 49 million shares. Let me wrap up with our Q2 outlook. We expect Q2 revenue to be $15.6 billion, down 8% year-over-year. Our data-centric businesses are expected to decline in the high single digits year-over-year as memory pricing declines weigh on our NAND business and DCG customers continue to consume inventory and absorb capacity. We expect DCG to be approximately flat sequentially. The PC-centric segment is expected to decline in the high single digits on declining PC ASPs on a relative mix of more small core units. Operating margin in Q2 is expected to be 29%, down 4 points year-over-year on lower platform revenue, the 4G modem ramp and NAND pricing. We forecast earnings per share of $0.89, flat sequentially and down $0.15 year-over-year. We expect the non-GAAP tax rate in the quarter to be 11.5%. I will conclude here and turn the call back to Mark.

Great. Thank you, George. After that eventful start to the call, we'll now move on to the Q&A. Operator, please go ahead and introduce our first caller.

Yes, as we think about the gross margin trajectory through the course of the year, I'm wondering if you could help us understand the delta between the impact of 10-nanometer ramping relative to kind of the impact that you're seeing. It seems like it's going to persist, related to NAND flash.

Yes, there’s significant movement in our gross margin. In our guidance for the first half, we’re indicating about 60%, which suggests a slight increase from Q1. Our full-year guidance also approaches 60%. Despite the fluctuations, we anticipate a fair amount of consistency. It's important to note that Q1 will probably be the lowest point since, as I mentioned earlier, we plan to qualify the 10-nanometer product in the second quarter. This means that in the first quarter, all costs related to the 10-nanometer process are included in our cost of sales. Once we qualify, those costs will be accounted for on the balance sheet, and when we sell the previously reserved units in Q3, those units will carry no cost. This setup indicates lower margins in Q1 and stronger performance in Q3, while overall, we expect to maintain around a 60% level. Regarding the year-on-year decline, NSG pricing is significantly affecting us. We forecast that NSG will drop nearly 10% this year due to major changes in pricing dynamics throughout the year, which will act as a headwind. Additionally, we expect to have systems available in the fourth quarter for the holiday season, and with the advancements made on the 10-nanometer process, we plan to shift more units in Q4 than we had initially expected. Consequently, this suggests that Q4 could be slightly lower than our full-year guidance.

Regarding DCG's mid-single-digit decline for the year, I understand the challenges faced in the first half. However, it seems the cloud sector has performed reasonably well, and I anticipated a stronger rebound in the second half. Could you elaborate on the dynamics, particularly concerning the cloud segment and any inventory they may hold of your components?

Yes. Joe, as you know, we came off a very strong 2018, up 21%. As we came into the year, implied in our guide, particularly in Q1, was our expectations that we'd be in quite a digestion period, both for enterprise and government but cloud as well and that, that would really impact our Q1. Look, what we're highlighting today as it relates to cloud is two things: that we expect the digestion to continue into Q2; that demand is going to be soft in Q2. And it's even exacerbated in China where, if you'll remember, through the third quarter last year, our demand for cloud players in China was close to triple digits. That was negative in the first quarter. So overall, they're still in a digestion period, the cloud guys. And in China is even more dramatic in the first quarter and the first couple weeks here in the second quarter. That being said, when we ask that, when we look at end demand in this data-centric environment, when we're looking at end demand, it still seems relatively strong. And in our dialogues with our customers, they are implying an uptick as we move from first half into second half.

I had a question on your enterprise business within DCG. I was a little bit surprised by the magnitude of the decline in Q1. Bob, in your view and based on what you know, what you hear from customers, how much of that decline is tied to true end demand versus inventory dynamics at your customers? And I ask that question because some of your customers may have pre-bought in fear of supply constraints.

Yes, it's a great question. Truly, we believe that there's the end demand, and forget about which segment, but end demand remains relatively strong. But by segment, enterprise and government year-on-year decline was not way off what we expected because we didn't have a real robust guide for Q1, but we have seen it continue into the second quarter. And I just think that the ordering ahead or the digestion of last year's strong growth, we expect now just to continue in enterprise and government through the first half and even a little more into the second half as it relates to E&G.

I wanted to know, of the mid-single-digit decline for data center, how much of that do you think is units versus pricing? I would have expected, with the new platform launch, we might have seen better. And obviously, you have the inventory in digestion, but there's also competition that's coming in the second half. So how do you see units versus pricing declining within the envelope of your down mid-single digits for the business overall?

Yes, as we updated our guidance, it now focuses more on unit sales. When we started the year in January, we anticipated that average selling prices would be under pressure in the data center group for two main reasons: first, we expected increased competition in the second half, and second, as 5G system-on-chips start to ramp up in the fourth quarter, they typically come with lower average selling prices. While we expect product improvements, these will be countered by a more competitive landscape and the product mix for communication service providers. The significant change since January is primarily a unit-based adjustment, and we feel we have accurately projected the average selling prices as of that timeframe. That perspective has not altered.

I have a question regarding the modem aspect of your business. As you reduce focus on that area, will the cost savings be redirected or will they contribute directly to profits? Additionally, could you share your insights on what the cost savings might look like and the timeline for when we can expect to see them?

Yes, let me take a moment and ask George to join in as well. We announced our decision to exit the 5G smartphone business and plan to explore the 5G modem for other uses, such as in PCs and IoT, while we assess our options for the overall 5G modem. The updated guidance reflects our expectation of reduced spending on 5G smartphones as we progress through the year. This is part of the decreased expenditure we mentioned for the second half of the year. However, we have not yet finalized our evaluation regarding how to handle the valuable intellectual property we've developed, our strong team, and the various opportunities available to us, whether in network infrastructure, where we see significant potential in 5G, or in how the 5G modem can be utilized in non-smartphone applications. We're diligently working on finding the best approach to manage the technologies we've created, the capabilities we possess, and the impact this will have on our cost structure moving into the second half of the year and next year. This process is still ongoing.

And C.J., I want to point out that while we mention a decrease in spending of $1 billion year-over-year, I estimate that the anticipated reduction in 5G spending or declining 5G smartphone expenditures related to our current decision-making process is possibly around 20% to 30% of that total. Therefore, we have not yet seen significant evidence in the spending rate related to the 5G Modem business.

I know you would like us to focus a little bit more on op margin than gross margin, but I just want to go back to the gross margin line. As far as I can remember, with an in line revenue quarter for March, this is the most significant gross margin miss to Street estimates that I can remember for the company. And I know you've talked about 10-nanometer volumes being higher than you expected this year. Can you talk a little bit about the yield curve and kind of the cost of 10-nanometer? And I guess really importantly, if the long-term sort of upper range of your gross margin had been 60% to 65%, do you still think that that's the right sort of higher-end range as we go to the 10-nanometer node for CPUs, notwithstanding that some of the adjacencies are lower gross margin?

Thank you, John. In the first quarter, there were two key factors that affected our gross margin. The first we anticipated and played out as expected, while the second took us by surprise. We anticipated that as we ramped our 10-nanometer product, the costs would flow through to cost of sales until we qualify the product, which we expect to achieve in the second quarter. During the initial ramp stages before qualification, this does put pressure on gross margins. This scenario unfolded as we had predicted, and I noted in my earlier remarks that our progress and yield improvements on the 10-nanometer process were in line with our expectations, slightly better actually, which gives us confidence in increasing volume by year-end. However, Q1's dynamics involved ramp costs impacting cost of sales, which we had planned for. On the other hand, the unexpected factor was a more significant decline in average selling prices (ASP) for NSG than we had forecasted. We anticipated a decline in the mid-20s to 30%, but the reality was closer to the mid-40s. Consequently, we had to lower our cost or market reserve against our inventory, which impacted gross margins by over one percentage point, a scenario we did not foresee. Overall, Q1 gross margins were in line with our projections aside from the unexpected inventory reserves we had to account for. In Q2, we expect improvement over Q1 as we start to recapture costs due to the progress on our 10-nanometer production. Regarding the long-term outlook for gross and operating margins, we might need to delay that discussion until our meeting on May 8, when we will review our longer-term planning.

Bob, I wanted to ask you just a question strategically about memory. And I wanted to understand, obviously, you need to make cost point, but relative to NAND, why the need to make NAND on your own? It seems like you could sell the factory and maybe strike some sort of a supply agreement and save a lot of free cash flow, particularly after a quarter rotation can cost you 100 basis points.

Yes. First, let me provide some context regarding our expanded total addressable market (TAM). We evaluate technology inflections where we believe we hold a true advantage, whether through process manufacturing or performance-oriented design that is worth pursuing. Additionally, we aim to play a significant role in our customers' success and seek areas where we can deliver attractive returns for our investors. These are the three criteria we apply, and we will increasingly focus on achieving those attractive returns. In terms of memory, we have a high-performance Optane product that we believe is distinct, along with our CPUs that excel in industry standards, especially as we strive to match the growing performance demands of CPU processing. This is a strategic priority, and we see a genuine technical advantage here. Furthermore, we are optimistic about achieving good returns. Regarding NAND, we believe we possess a process technology advantage, having progressed from 32-layer to 64-layer. The profitability of our NAND business was decent last year before the significant decline in average selling prices as we ramped up the business. Moving forward, our challenge will be to enhance our execution in the NAND sector to ensure we meet our third criterion of delivering attractive returns for our investors. It's crucial to approach decisions thoughtfully, especially in a declining market, rather than jumping to conclusions. However, it’s clear we must improve returns in our NAND operations, and our team is dedicated to making this happen. If partnerships arise that could boost our likelihood of success or speed up progress, we will assess those partnerships to enhance our performance in the memory market.

Bob, given your stance on concentration of resources, what are you thinking with regard to Intel developing a term GPU product? And if you are pressing ahead with this, can give us an update on where you are and when we might see the first Intel GPUs?

Yes. First, as we consider the key technologies that we believe will become increasingly important, I previously mentioned them, and we view them as our six pillars of technology differentiation. Process technology is a crucial component; secondly, architectures, which I will elaborate on; thirdly, memory; fourth, interconnect; fifth, security; and sixth, software. How we integrate these six elements, which no one else in the industry can match, is what we believe will enable us to thrive in a more data-centric world. Regarding architecture, as we gain more insight into how workloads are evolving and the growing significance of artificial intelligence and parallel processing, we believe that architectures beyond the CPU, such as GPU, FPGA, AI, and other accelerators, will become increasingly essential. Therefore, we have decided to invest in discrete GPUs. We are excited to announce that we will launch a new integrated GPU in the near future. For discrete GPUs, we plan to introduce them around 2020 for both client and data center applications. With increased workloads, we intend to leverage the integrated technology we have enhanced and invest in discrete GPUs because we believe this architecture is vital. We think we can create some compelling products based on our existing core architecture.

Bob, I had a question about the progress on 10-nanometer technology and how the competition is shaping up in the server sector. I understand your team is becoming more confident about 10-nanometer for client products. I am interested in the development of 10-nanometer technology for the server side, and how your customers are responding to a competitor's new products being released later this year. Your offerings will be available next year. What feedback are you getting from customers regarding their thoughts on the next generation of server CPUs and the potential interest in diversifying their suppliers?

First, regarding 10-nanometer for servers, we have indicated that client systems will be available for the holiday season, and we expect server CPUs to follow shortly after. Historically, there has been a 12- to 18-month gap between client and server releases, but for 10-nanometer, this gap will be much shorter. We expect server systems to launch in 2020, and we aim for an earlier rather than a later release. In terms of competitive positioning, our Xeon Scalable product, which we launched last year and enhanced a few weeks ago with Cascade Lake, offers increased performance. It features AI acceleration, is paired with Optane memory, and has a core count of 56. The performance of this product, along with our understanding of customer environments, demonstrates our competitive edge, even though it is still based on 14-nanometer technology. We are confident that this product aligns with the six pillars we've previously discussed. We expect it to ramp up quickly, similar to our past launches, and we believe it will position us well in the competitive landscape during the latter half of the year, despite facing increased competition ahead of the 10-nanometer launch in 2020. Overall, we are optimistic about the 10-nanometer process and will be quick to follow with server products in 2020. In the meantime, the Cascade Lake product offers significant performance improvements derived from our deep understanding of our customers' needs. While we anticipate a more competitive environment, we are feeling positive and have done our best to reflect that in our outlook for 2019.

5G network connectivity is very strong and projected to continue to accelerate on a go-forward basis. Korea, China, U.S., all starting to fire. You guys have a great lineup of products, Xeon D, full-blown Xeon, base station ASICs, FPGAs and so on. So help us understand, given all these dynamics, why did the comms service provider segment decline year-over-year in Q1? And maybe more importantly, just given the strong 5G lineup that you have, do you see comms service provider contributing to the strong second half implied growth in your data-centric segment guidance for the full year?

Yes, we believe we have an excellent product lineup ready for the 5G launch. Our current position is strong, and we anticipate that 5G will enhance that across a wide range of our products and technologies. In the first quarter, we expect an increase in demand, although it may come a bit later in the year. While we expect FPGA demand to arise sooner, we foresee Xeon demand following later this year and even more significantly in 2020. We predict a modest improvement in the second half, but nothing dramatic. Additionally, we have a solid customer base in China in the communications sector. Like the trends we observed in cloud, enterprise, and government, the growth in communications has likely been influenced by the strong growth experienced last year, which is now being digested in the initial quarters of this year. A major customer in China also contributes to the previous query regarding advance purchasing and digestion, impacting the communications growth in the first quarter. Despite this, we are optimistic about the demand signals we are observing and the relationships we've established for 5G, which we believe will play a crucial role in our future growth.

Bob, I was wondering if you could provide more information on the DCG operating margin. We haven't seen this low a number in around 6 to 8 quarters, which is 38%. You mentioned three reasons, but it appears to be disproportionately lower compared to the revenue decline. Can you clarify this further? More importantly, how should we expect this to trend as the year progresses?

Yes, I mean I think the things we flagged, obviously, unit volume declines on a high-margin business worked against us. Secondly, it's really DCG now. I talked to you about the fast follow of DCG on 10-nanometer after client launch. So as a result, they're just now beginning to bear some of the brunt of the cost of sales that all went through the P&L in the first quarter until those products qualify. And then third, this is a big growth area for us and we're going to continue to make investments. So those 3 things are really what drove the op margin decline in the quarter. As you know, just from historical trends, data center margins tend to be a little bit lower in the first quarter. And obviously, implied in our guide first half to second half, second half is a little stronger. And with that strength on unit volumes despite maybe more intense ASP environment, we expect operating margins to kind of improve in line with revenue growth in the second half. Those trends are fairly consistent with how the quarterly dynamics of DCG operating margins go. They're just more exacerbated in Q1 with the 10-nanometer cost of sales starting to impact the business.

Just one more on gross margin, if possible, and I know you don't want to comment on '20. But I'm just trying to understand the trajectory here, because it seems like your 10-nanometer has been delayed. You're ramping it now. It does seem like it's on a portion of the product line, not like the old days, where it would flip over all of client. So I'm just trying to understand, if you look at the impact you saw this year, why is it incorrect to think about that you should see a similar impact next year?

We expect that as we begin scaling up high-volume manufacturing, we will see improved yields and better performance in our units-to-die throughout the year as we increase production. Therefore, we anticipate an increase in yields moving forward. However, transitioning to a new technology node typically puts some initial pressure on gross margins until we achieve more stability. While I prefer not to speculate on 2020, it's common for the early stages of a new node transition to exert downward pressure on gross margins.

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