What's behind AMD's earnings warning?

The warning results from significantly lower microprocessor selling prices during the quarter
Written by John G. Spooner, Contributor

AMD’s fourth quarter 2006 earnings warning is all about chip pricing.

First, the background:  AMD said in a Jan. 11 statement that its fourth quarter 2006 (4Q06) revenue, excluding its newly-acquired ATI business  segments, would increase by 3% from the $1.33 billion it reported for 3Q06.

But AMD had previously set expectations for strong seasonal growth. Based on what company executives said on October 18, 2006, when AMD announced its third quarter (3Q06) earnings, AMD-watchers were expecting it to post growth of about 10% or possibly more. That would have amounted to a strong quarter, as AMD's quarter-to-quarter growth is generally about 10% for the fourth quarter. AMD also said its 4Q06 profit—in this case, its operating income, less its ATI-related segments and acquisition-related charges—will be lower than that of its 3Q06. That’s a worrisome thing for AMD watchers who want the company to turn a healthy profit each quarter. Pricing was the cause of the changes from its expectations earlier in the quarter, AMD said.

That translates to stiff competition between AMD and Intel during the period. Each of the companies faces a choice when it comes to pricing. It can try to take in more profit and risk selling fewer chips by asking for higher prices. Or, it can charge less, take in less profit and hope that higher numbers of chips sold will make up the difference. Trouble comes when a company sells fewer chips for lower prices or when it has to cut prices more than it expected to in order to keep its shipments up. AMD appears to have cut prices more than expected to, likely in response to aggressive pricing by Intel. The cuts appear to have sapped a good deal of AMD’s quarterly profit.

But the news wasn’t all bad for AMD. The chipmaker did see a significant processor unit shipment increase for the quarter. That means demand for its products was healthy, overall, and that it simply needs to get its pricing back up. Although, if AMD saw shipments start to slide toward the end of the quarter and responded by cutting prices to motivate purchases by customers, it could imply its first quarter may see similarly lackluster demand. We’ll hear more on Jan. 23, when AMD reports its earnings. Overall, however, I believe that AMD’s outlook remains positive.

Intel was certainly in a more competitive position in 4Q06 that it was in 4Q05. But the sky is not falling for AMD. The company continues to receive strong support from PC manufacturers, having signed Dell in mid-2006, as well as end-purchasers. However, AMD’s 65-nanometer manufacturing process—which it began rolling out late last year—and the increasing capacity of its Fab 36 chip plant will play a major role in just how well things go for AMD in calendar 2007. Most immediately, the combination of Fab 36 and 65nm allows AMD weather price competition by cutting its per-chip manufacturing costs. (The combination of Fab 36’s larger-sized wafers and smaller chips made possible by the 65nm process increases AMD’s output, lowering the cost of producing each chip.) But what AMD really wants is to be able to charge more for its processors. The 65nm process makes that possible as well as well by paving the way for it to launch its quad-core processors.

The process’ ability to knit-together smaller circuits and also to help cut power consumption lets AMD fit all four cores into a single piece of silicon without increasing power consumption of the processor. Thus, once it delivers its quad-core processors for servers, I believe that AMD will be in a much better position in terms of competitiveness with Intel. Given their position as premium products, AMD will be able to fetch premium prices for its quad-core chips and thus use them to increase its selling price for a chip. It’s first quad-core processor, “Barcelona” for servers, is currently scheduled for a mid-calendar 2007 release. But as far as I am concerned, the sooner it comes out the better.

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