CPU Failures Hurt Intel's Bottom Line

Intel revealed during its Q4 2016 earnings call that unspecified CPU failures have affected its bottom line. The company enjoyed record Q4 revenue and a record $59.4 billion in overall 2016 revenue, but CPU failures reduced the Data Center Group's financial performance. 

Intel's Robert Holmes Swan, the new CFO and executive vice president, vaguely defined the failures as he explained why the Data Center Group's (DCG) profit declined 14% year-over-year to $1.9 billion. Swan listed the 14nm transition and a one-time long-term cross-licensing agreement as issues that contributed to the decline, but also mentioned undefined CPU failures as a drag on financials (via Seeking Alpha):

"But secondly, and a little bit more significant, we were observing a product quality issue in the fourth quarter with slightly higher expected failure rates under certain use and time constraints, and we established a reserve to deal with that. We think we have it relatively well-bounded with a minor design fix that we're working with our clients to resolve. So, those two one-timers in the fourth quarter weighed on DCG [Data Center Group] margins, and we do not expect that to continue in 2017."

Intel's Data Center Group produces numerous products that fall into a wide range of segments, such as CPUs, networking, and storage, so we followed up with Intel for more clarity on the nature of the failures. Intel replied that the failures are limited to the Intel Atom Processor C2000 product family, which is used primarily for storage and networking infrastructure.

Intel has launched a concerted campaign to extend its data center CPU stranglehold (it occupies over 99% of the world's servers) to other lucrative "adjacencies," such as the networking and storage segments where it has relatively low market penetration. Due to Intel's efforts in these areas, it has reduced the DCG's reliance on the traditional enterprise CPU market, which now only accounts for 50% of its earnings. Unfortunately, the CPU failures are confined to two of the areas that Intel defines as key growth drivers.

Intel indicated that it has an immediate workaround that addresses the issue, as well as a "minor" silicon fix that solves the problem entirely. As noted in the earnings call, the problem is of enough import that Intel had to establish a reserve to address the issue, so frankly, Intel may be downplaying the problem. Any new silicon revision requires significant expenditures and engineering effort, as proven by the drag on DCG's bottom line.

Intel doesn't consider the failures to have a long-term impact on its financial performance, and, for now, the still-undefined issue appears to be limited to the C2000 Atom family. We're following up for more specific information on the failures, and will update as needed.