Despite plunging profits and a bleak earnings outlook, Intel executives indicated on Tuesday that they will continue to slash processor prices as they push to replace the Pentium III with the Pentium 4.
"They'll be decimating pricing," said analyst Dan Niles of Lehman Brothers in San Francisco. "They're going to take a beating on margins, which is what's happening already."
In tallying the results of a dour quarter in which net income plummeted 92 percent compared with year ago, Intel executives said yesterday that while processor shipments were up from the first quarter, the company's gross profit margins fell to 48 percent, well below the 60 percent margins of a year ago. For the third quarter, the company forecasted the margins would dip even further.
Paul Otellini, Intel's executive vice president, told analysts during a conference call that the price cuts are part of the company's "single-minded drive" to replace the Pentium III with the Pentium 4 in PC systems priced at $800 and above by the end of the year.
"We have an objective of driving the Pentium 4 farther down into the marketplace than the Pentium III was at this point in its life," Otellini said. "I would categorize this as aggressive a transition as Intel has spearheaded since the 486 Pentium transition."
By moving the Pentium 4 into the "sweet spot" of the market, Intel hopes to eliminate rival AMD's traditional low-price advantage, as well as lure away potential AMD buyers by offering faster clocked chips for the same price, said one analyst.
"But the company will pay a price for that, and has already paid a price as its average selling price [per product] was down 8 percent in the second quarter," said Ashok Kumar, an analyst with US Bancorp Piper Jaffray in Minneapolis.
While higher volume sales could offset lower profit margins, that's unlikely given the current economic climate.
"The issue of price cutting is compounded by the slower spending environment, particularly in the corporate market," Kumar said.
Intel's low-price initiatives are seen as key to its offensive against AMD, which this year increased its overall share of the PC market from the upper teens to about 22 percent.
"Intel is basically going to sacrifice the rest of this year to move ahead of AMD," Kumar said.
But while analyst Jonathan Joseph of Salomon Smith Barney believes Intel will continue to trim prices, he says the cuts will "definitely not" be as dramatic as the ones made in the second quarter.
"I think the outlook is for processor prices to decline only slightly this quarter and then be flat to up in the fourth quarter," said Joseph in San Francisco.
Intel's pricing moves in April highlighted the company's unusually aggressive moves this year. During that month, the chip maker slashed the price on its 1.5GHz Pentium 4 nearly 60 percent. In addition, it also introduced a faster 1.7GHz Pentium 4 that month at $352 in 1,000-unit shipments, well below the $700 to $1,000 price range its highest speed chips were initially offered for last year.
Intel's price-cutting moves not only eroded its own profit margins, but those of AMD as well, which blamed lower earnings last week on the PC processor price war.
"Frankly, we were surprised by the aggressiveness and number of price changes Intel implemented last quarter," Jerry Sanders, AMD's chairman, told analysts at the time. But Sanders vowed the company would continue to strive to match or beat Intel on pricing.
While Intel's price moves may hurt AMD financially, the smaller chip maker will likely remain a strong competitor, observers said.
"Intel may gain a single percentage point in market share," Joseph said, "but they are not going to be driving AMD into the Stone Age."
For the second quarter, Intel posted a net profit of $196 million, or 3 cents per share, down sharply from $3.14bn, or 45 cents per share, in the year-ago quarter. Revenue was down 24 percent from a year ago, coming in at $6.3bn.
Looking ahead, Intel's Otellini said the chip maker is on track to release its new Pentium III mobile chips later this month, code-named Tualatin, that are built using a more advanced manufacturing process that will enable mobile chips to move beyond 1GHz. The new smaller chips will also consume less energy, offering extended battery life.
In the desktop arena, Intel will release a 2GHz Pentium 4 this quarter and move beyond 2GHz by the end of the year, Otellini said.
Possibly most noteworthy, Intel confirmed that it will soon release its 845 chip set, which will enable Pentium 4 users to utilize less costly synchronous DRAM (or SDRAM) memory, rather than the Rambus DRAM (or RDRAM) that Intel's top-performing chip is currently paired with.
"We will begin volume shipments of the 845 within two weeks, well ahead of our original schedule," Otellini said.
The chip set is a crucial component in Intel's plans to move the Pentium 4 into less costly PCs. In addition, the chip set is expected to become the mainstay with Pentium 4 in commercial PCs, since corporate customers have shown a preference for using SDRAM over the more costly RDRAM.
Otellini said his company is "cautiously optimistic" that sales will rebound later this year after months of declining earnings and weak demand blamed largely on a sluggish U.S. economy.
But there is still no solid evidence supporting such a projection, Piper Jaffray's Kumar said.
"There's basically hope, a wish and a prayer that there will be something of a rebound in the second half," he said. "But I don't see people going out and spending their tax rebates on new PCs."
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