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AMD Finds Big Time Tough

Alexei Oreskovic

Advanced Micro Devices(AMD) fought for years to put its chips inside Dell(DELL) PCs. Now it's being stung by its ascent into the big leagues.

With first-quarter sales now expected to lag initial forecasts, AMD CEO Hector Ruiz ascribed the shortfall to problems in adapting to the rapid shift in the profile of its customers.

Essentially, explained Ruiz at the Morgan Stanley Technology conference Monday in San Francisco, AMD neglected its traditional base of channel customers -- a catch-all term that includes regional PC resellers and makers of "white box" systems -- in favor of top-tier PC makers.

The problem is that the top-tier PC makers, or original-equipment manufacturers, saw less demand than initially expected, and AMD was unable to recoup the sales shortfall from its channel customers.

"We took a risk on how we shifted our capacity to serve our customers, and unfortunately some of our customers were not able to meet those very aggressive growth rates they had," Ruiz said.

According to AMD, the company is "unlikely" to meet its first-quarter revenue estimate of $1.6 billion to $1.7 billion.

Analysts polled by Thomson Financial were looking for AMD to report $1.66 billion in sales with a loss of 25 cents a share.

The announcement sent AMD shares to fresh 52-week lows -- the stock finished Monday's regular session down 1.6%, or 23 cents, at $13.95.

While Ruiz said the company was undergoing a quarter or two of "adjustments," the CEO said he was confident that the second half of the year would be strong, with AMD releasing its long-awaited quad-core processor for servers and desktop PCs.

"We think we're going to have a significant opportunity to distance ourselves from the competition," Ruiz said, noting that the performance and energy efficiency of its forthcoming Barcelona processor could bring about a 30% to 40% improvement over its current products.

Overall unit demand for microprocessors looks good for the rest of the year, Ruiz said. "So other than this first-quarter unit glitch, as we're trying to move from OEM to distribution, we feel very good."

Ruiz did not name any particular OEMs for the demand shortfall. Of course, with Hewlett-Packard's(HPQ) PC and industry standard server business both posting strong growth recently, the problem would appear to lie more with Dell, which reported a year-on-year sales decline last week.

Dell began offering PCs with AMD processors last year, ending a practice of offering only Intel(INTC)-based systems.

"Given the fact that Dell has had a shortfall, it would make sense that Dell probably wasn't hitting the volumes" that AMD was counting on, says Stifel Nicolaus analyst Cody Acree.

But Acree believes AMD's troubles aren't solely linked to Dell. Both Dell and H-P appear to be demanding steep discounts on processors prices, says Acree. And the so-so release of Microsoft's(MSFT) Vista operating system is also not helping things.

AMD has been engaged in a fierce price war with rival Intel during the past several months, denting profit margins at both companies. In the fourth quarter, AMD reported a net loss of $574 million, due to charges related to its acquisition of graphics-chip maker ATI as well as declining prices for AMD's server processors.

Speaking at the conference Monday, Ruiz said that pricing remained "very competitive," but he declined to provide details or to comment on profitability expectations.

Ruiz said that in order to sustain the company's long-term target of 50% gross margins, AMD must achieve at least 30% market share. In the fourth quarter, market research firm Mercury Research reported that AMD had achieved total market share of 25%, its highest level ever.

But Ruiz noted that AMD has lost market share in the channel recently, as it reserved much of its chip production for original equipment manufacturers such as H-P and Dell.

Todd Swank, the director of marketing at Nor-Tech, which sells branded and white-box PCs to resellers, said that there had been some shortages of AMD chips in the channel in the fourth quarter, but that things appeared to have improved recently.

AMD is "making a lot of effort to make up with channel right now," says Swank.

Historically, AMD relied on channel customers to get its chips into the market, as the top-tier PC makers generally offered only machines with Intel chips.

It was a perfect arrangement for the smaller PC resellers, since they could differentiate themselves with machines featuring an AMD processor that was considered superior to Intel's yet that was not available from the top-tier PC makers.

Things have changed as Intel has improved its line of processors and stepped up its efforts to woo channel partners.

AMD now sells the majority of its chips to OEMs, rather than channel partners, says Ruiz. But he the channel will continue to be a strong part of the company's business going forward, particularly in overseas markets like Russia.

As AMD garners more sales from international markets, particularly in emerging economies, Ruiz said he believed microprocessor sales could grow at 20% levels in the coming years.

"Although, the PC industry in general, and the microprocessor industry in particular, are referred to as a very mature industry, it's sill in some ways in its infancy," Ruiz said.