AMD hits a roadblock in road to recovery

AMD's second-quarter results were affected by poor profit margins

Advanced Micro Devices hit a roadblock on its path to profitability during the second fiscal quarter, with an aging inventory of old chips and falling PC prices holding the company hostage, analysts said on Wednesday.

AMD on Tuesday narrowed its net loss during the second fiscal quarter of 2009 compared to last year, but the company's revenue was flat over the first quarter--a relevant comparison since last year AMD owned a manufacturing unit that was spun off into a separate company. Analysts said that AMD underperformed, especially when compared to archrival Intel, which a few days earlier reported a sequential revenue increase of US$879 million.

Pricing pressure, factory underutilization and an inventory of aging chips partly affected profit margins, said Dirk Meyer, AMD's CEO, during a conference call on Tuesday to discuss the results. The company exceeded revenue expectations, but the gross margin "was disappointing," Meyer said.

Gross margins are an important measure for chip makers as they show a company's profitability after absorbing business costs. Weak gross margins reflect poor profit margins on products, and that could delay AMD's efforts to become profitable, analysts said.

"Advanced Micro Devices reported disappointing second quarter results yesterday due to unusually weak gross margins," said Craig Berger and Robert Pikover, financial analysts at FBR Capital Markets, in a research note issued on Wednesday.

The recession has forced many consumers to trade down to inexpensive laptops, which has affected the pricing of microprocessors, said David Wu, an analyst with Global Crown Capital. That has materially affected the margins of chip companies like AMD and Intel, but Intel has deeper pockets to bear the brunt of such an impact, he said.

AMD is also feeling the pressure of reduced laptop shipments, said John Spooner, senior analyst at Technology Business Research. Because the demand for laptops has slowed, chip makers like AMD have dropped chip prices to attract more buyers.

"Even more difficult for [chip] companies is end-users are purchasing less notebooks in general. It reflects on the margins," Spooner said. But the good news is AMD could see shipments increase as it is getting more chip orders from PC makers, he said.

Margins also took a hit because of sales of aging chips, which dominated AMD's shipments, analysts said. The company unloaded old chips manufactured using the 65-nanometer process, causing a drop in margins, analysts said. The company is still moving operations to the upgraded 45-nanometer process, which should lead to faster and more power-efficient chips at a lower cost.

Intel on the other hand has already moved to the 45-nanometer process, and is on track for the 32-nm process by the end of this year. Intel's lead in manufacturing technology could continue to pressure AMD's pricing in CPUs and graphics processing units (GPUs), wrote Doug Freedman, an analyst with Broadpoint AmTech, in a research report issued on Wednesday.

AMD said 65-nm parts could still account for 40 percent to 50 percent of chips shipped during the third quarter. But the company ultimately wants to replace older chips with 45-nm CPUs as it ramps up its Tigris mainstream laptop platform and Neo chips for ultrathin laptops. AMD also hopes to record the full financial impact of its latest six-core Istanbul server chips, which were launched in June.

In addition to aging chips, a low utilization rate of factories affected AMD's margins with an additional cost for production of chips, analysts from FBR Capital Markets said. Although AMD no longer owns its manufacturing facilities, its books still reflect some chip manufacturing cost incurred by spin-off GlobalFoundries.

The factory utilization rates could increase in the third and fourth quarters as demand for chips stabilizes, AMD officials said. The company also will reduce its responsibility for GlobalFoundries' manufacturing costs as the spin-off gains more customers. AMD is still the only customer for GlobalFoundries, which is set to announce its first non-AMD customer in the next 30 days.

AMD in the first quarter unloaded close to $1.1 billion in debt from its books by spinning off its manufacturing assets to GlobalFoundries. GlobalFoundries is a joint venture between AMD and Advanced Technology Investment Company, which is owned by the Abu Dhabi government.

Though disappointed by the results, analysts said AMD's future looks positive as it transitions to focusing exclusively on chip design. A full transition to the 45-nm process could beef up AMD's margins, and the new slate of products could put AMD chips on more desks. The company also needs to get rid of the manufacturing costs associated with GlobalFoundries, analysts said.

AMD has recorded more than two consecutive years of financial losses and has taken a number of steps in an effort to reach profitability. Last year the company cut staff and divested its digital TV assets to focus on profitable markets, including the graphics space through its ATI acquisition in 2006.

But AMD seems to realize that selling products in this recession isn't easy, and no chip company is safe in this economic environment, Spooner said.

"AMD's going to have a tough year, but it's going to be a tough year for everybody," Spooner said.

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