Updated from 5:07 p.m. EDT

Advanced Micro Devices

(AMD) - Get Report

unexpectedly lost money in its first quarter because of weak demand and pricing for its flash memory chips.

In a move to prove that it won't settle for flash memory dragging down its overall results, AMD announced that it will separate out its flash memory unit through an initial public offering. The estimated price range and amount to be raised have yet to be determined.

Shares rose 4% to $17.75 in late trading Wednesday

For the first quarter, AMD lost $17 million, or 4 cents a share, on sales of $1.23 billion. During the same quarter last year, AMD earned $45.1 million, or 12 cents a share, on sales of $1.24 billion.

Analysts had expected earnings of 2 cents a share on sales of $1.21 billion, on average, according to Thomson First Call. At the quarter's start, AMD had predicted that computer chip sales would be flat to down and that flash revenue would decline, but that the overall company would be profitable.

AMD said sales of its computer microprocessors increased across all product categories to $750 million, with an operating profit of $92 million, compared with sales of $571 million and operating income of $67 million in the same quarter last year. The unit even grew from the fourth quarter, typically the year's strongest period, when sales tallied $730 million and operating income was $89 million.

Financial results from memory chips clearly weakened. The memory unit lost $110 million on an operating basis on sales of $447 million compared with income of $14 million on $628 million in the same period last year. In the fourth quarter, the unit lost $39 million on sales of $504 million. Unit shipments of memory chips increased, but prices "declined significantly," offsetting the shipment increase.

For the second quarter, AMD predicted its microprocessor sales would be flat to slightly down, but it did not provide expectations for flash memory because of the planned IPO. Analysts had expected second-quarter earnings of 2 cents a share on sales of $1.21 billion.

The decision to sell the flash memory unit marks a significant shift in strategy for AMD, which only two years ago incorporated its flash operations along with Fujitsu's into a single company, known as Spansion.

Fujitsu and AMD had collaborated on flash memory for 10 years, but the formation of a single company to handle both businesses, with AMD taking a 60% stake, indicated the future importance of the market. At that time in 2003, flash memory represented only a fourth of AMD's revenue. In the most recent quarter, flash represented 36% of AMD's sales.

AMD viewed its majority stake in Spansion as allowing it to speed development and production, lower costs and better coordinate pricing. The company succeeded initially. AMD took the market lead from long-time leader

Intel

(INTC) - Get Report

and introduced some promising technologies.

Late last year, however,

Intel

(INTC) - Get Report

re-engaged in the flash market with increased vigor. AMD's flash operations showed an unexpected loss in the fourth quarter. This prompted pressure by some shareholders on AMD management to

dump the unit if it would not be able to consistently generate profits.

Steve Cullen, an independent memory chip analyst based in Medfield, Mass., says he would have liked AMD to keep its flash unit, but that Intel has clearly demonstrated an ability to squeeze AMD when it wants to. He says ongoing losses in the flash unit would eventually begin to hurt AMD's primary processor business.

"It's always nice to have more than one business, but the problem here is that AMD competes with Intel in both businesses," says Cullen.

AMD has made strides during the past three years on improving its technology and manufacturing capabilities.

AMD beat Intel in introducing chips that work equally well with data in chunks of 32 bits and 64 bits. AMD also signaled first that it would convert its product lines to use more than one processing core on single pieces of silicon. Launches from both companies of dual-core chips are expected any day.

AMD has entered the server market for the first time and has signed up all major hardware vendors except for

Dell

(DELL) - Get Report

, which was seriously considering using AMD's chips as recently as the start of 2005. AMD has also architected a mobile processor from the ground up that it says has power and heat advantages.

Still, AMD remains much in the shadow of industry giant Intel, the world's largest chipmaker. Intel struggled in 2004 with product delays and execution issues, but the company has started this year off strong. Intel surprised investors by trouncing its financial targets in the fourth quarter and it has accelerated its product transition plans.

The differing performances can be seen in the stock prices of the two companies: AMD shares are off this year 23% while Intel shares are down only 2.4%.