Updated from 1:02 p.m. EST

By now everyone knows that Advanced Micro Devices ( AMD) and Intel ( INTC) are engaged in a cutthroat price war.

And the deleterious effect of this competition on each company's income statement has been well documented in successive rounds of disappointing earnings reports.

Yet each new quarterly miss seems to come as a complete surprise -- including, it now appears, to AMD's own management.

It was only a month ago that AMD hosted its analysts' conference day in New York, and indicated that the company was shooting for roughly 50% gross margins in 2007, with longer-term margin goals running as high as 56%.

Management still contends that the company is on track for 50% profit margins in 2007. But the fact that management either did not see, or did not warn, that fourth-quarter margins had crumbled to 40% reinforced the impression on Wall Street that the price war has spiraled out of control.

"I can't say why just a month ago they couldn't have better forecasted the upcoming quarter that was ending in a couple weeks," says Romeo Dator, co-manager of US Global Investors' All American Equity Fund.

This poor visibility into margins doesn't give him confidence that the chipmaker has a grasp on pricing and validates his decision to stay out of the microprocessor sector altogether.

"If they can't do two weeks, how can they forecast three months for the March quarter?" wonders Dator.

In midday trading Wednesday, shares of AMD skidded nearly 8%, or $1.34, to $16.17; earlier, the shares set an intraday 52-week low of $15.93.

One Wall Street analyst went as far as labeling AMD's fourth quarter "surreal."

"AMD is getting hit with problems on a multitude of fronts exacerbated by management's apparent naiveté, stubbornness and/or hubris," wrote Nollenberger Capital Partners' Hans Mosesmann, who has a sell rating on the stock.

Even more-optimistic AMD followers threw in the towel, with Credit Suisse, Friedman Billings and American Technology Research downgrading their ratings on AMD to underperform or sell.

Earnings projections, which before Tuesday had called for AMD to record a profit in 2007, now forecast a year of red ink. And price targets on the stock were adjusted accordingly. Friedman Billings cut its price target for AMD to $10.

Adding to the worries is the $3.7 billion mountain of debt hanging over the company, $2.2 billion of which is due to the recent acquisition of graphics-chip maker ATI.

AMD has a couple of arrows in its quiver that should help the company in the coming months, including the transition to 65-nanometer chip production, which will put AMD on more equal footing with Intel when it comes to pricing, and a new quad-core processor, dubbed Barcelona, slated for release in the summer.

But these developments will take months, if not quarters, to have any impact on AMD's earnings, Stifel Nicolaus analyst Cody Acree wrote in a note to investors Wednesday.

In the meantime, AMD will have little ability to improve prices, said Acree, predicting "significant" losses until at least the middle of the year.

The one silver lining in AMD's fourth-quarter report was its notebook chip business, which saw sales surge 41% sequentially while experiencing a "modest" increase in average selling prices.

How tenable this notebook strength can be going forward remains unclear, particularly given AMD's struggle forecasting pricing.

In the capital-intensive chip business, where so many costs are fixed, profit margins are extremely sensitive to changes in product mix and price.

"If one comes down in a short period of time, that can really wreck your margins," says one tech investor, who asked to remain anonymous.

AMD CEO Hector Ruiz confessed in Tuesday's conference call that pricing competition was proving tougher than originally planned.

He also noted that while he was bullish on the long-term impact of Microsoft's ( MSFT) new Vista operating system, the first quarter could be "a little wacky."

Together, these statements suggest continuing uncertainty in AMD's prices and product mix, and consequently the company's profitability.

In the fourth quarter, the drama played out in server processors, where prices apparently collapsed late in the year, according to AMD.

As 2007 gets under way, there's no telling whether a similar fate awaits other parts of the business.

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