Given how strong the growth of major cloud computing companies is, it’s a bit surprising how bad it is Intel Corporation‘s (INTC -8.56%) Data center work was carried out during the second quarter.
Intel’s enterprise customer base is much broader than that of cloud computing providers, and recession fears are beginning to affect purchasing decisions and companies’ expansion. But the company wasn’t even in the ballpark of expectations.
Intel’s data center and artificial intelligence (AI) division generated $4.65 billion in revenue in the second quarter, down 16% year over year. Analyst Vivek Arya American bank (buck 1.47%) Merrill Lynch noted during the earnings call that this performance missed expectations by 25%, which was likely a major reason for the stock’s decline of about 9% by Friday afternoon.
There were several factors that led to the collapse of Intel’s highly profitable data center business. First, just like in the PC market, Intel data center customers are adjusting their inventory levels to better reflect current market conditions. Companies that sell servers don’t want to hold a significant amount of component inventory in the face of uncertain demand, and customers who use Intel data center chips for their data centers may adjust upgrade and expansion plans as the economy weakens.
Second, Intel is having some trouble getting the components it needs, including the Ethernet components and the power supply. Supply chain constraints still hold back the semiconductor industry, although lower demand could go a long way toward solving this problem.
Finally, Intel has acknowledged some implementation issues with its Sapphire Rapids data center CPUs. An extra step, essentially a design change, has been made on the production line as the company aims to keep the “quality level high,” according to CEO Pat Gelsinger. Production of Sapphire Rapids core CPUs won’t be ramped up until the end of this year and into next year, denting some revenue.
Over the course of the entire year, Intel lowered its forecast for its overall market for addressable servers to reflect slower growth. The company also expects to grow more slowly than the overall data center market as it rebuilds its product portfolio. Intel is the market leader, but it faces pressure from competing products from competitors Advanced Micro Devices (AMD 3.05%).
Why is transformation so important
Intel’s data center business is a profitable cow, or at least it has been. In 2020, for example, the data center segment generated operating income of $10.6 billion on $26.1 billion of revenue. This is an operating margin of about 40%.
The headwinds Intel faces in the data center business caused operating profit to fall in the second quarter. The segment generated operating income of just $214 million, down from $2.1 billion in the same period last year. This 90% decrease was due to a combination of factors, including advanced manufacturing contract start-up costs, investments in a product roadmap, and fees related to pre-production of Sapphire Rapids CPUs.
Intel is optimistic that Sapphire Rapids will be a successful product line, but Gelsinger admitted during the earnings call that the company’s execution around it wasn’t its “best time” to execute, adding, “We’re rebuilding our execution machine.”
Intel expects that its opportunity in the data center market will grow by at least the average percentage of teens annually over the long term. Sapphire Rapids, as well as ancillary products like the Arctic Sound-M data center GPU, will help capitalize on this growth once you get the ducks in a row.
Bank of America is an advertising partner of The Ascent, the Motley Fool Company. Timothy Green holds positions at Bank of America and Intel. Motley Fool has positions at Advanced Micro Devices and Intel and recommends. Motley Fool recommends the following options: long calls in January 2023 worth $57.50 on Intel and $57.50 in January 2023 on Intel. Motley Fool has a disclosure policy.