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Advanced Micro Devices

(AMD) - Get Advanced Micro Devices, Inc. Report

said Wednesday that it grew its sales sequentially 9% in the third quarter, beating Wall Street estimates and matching rival


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pace of growth during the same period.

But the ongoing price war between AMD and Intel took a toll on profit margins, sending the company's shares down more than 10%.

AMD was slumping $2.67 to $21.56 in early trading Thursday, setting the stock up to potentially be one of the worst big-cap performers of the session.

AMD said it generated $1.33 billion in sales for the three months ended Oct. 1, with a net income of $134.4 million, or 27 cents a share. Those results included $16.5 million of stock option compensation expenses.

The average analyst expectation called for AMD to earn 23 cents a share on sales of $1.3 billion.

AMD said its operating income was down 8% year over year, adjusting its 2005 third-quarter results to exclude the contribution of its memory business, which it has since spun off. Gross profit margin fell to 51.4% compared with 55.4% at this time last year.

AMD blamed the eroding margins on lower desktop processor prices, which dragged down the company's overall average selling prices.

While AMD had previously indicated that it would sooner walk away form certain business than get caught up in a price war, executives acknowledged that the chipmaker had opted to make its prices a little more competitive in the third quarter.

In a postearnings conference call, CEO Hector Ruiz also said the company operated under a "phenomenal burden" during the quarter, as it transitioned its products to newer technology and misgauged demand for notebook processors.

Ruiz said the company's gross margins were dented by two percentage points due to lost efficiencies, as AMD scrambled to meet demand for notebook processors from large, multinational PC vendors.

Ruiz called the environment a "very challenging" one in which to try to adjust the product "mix within the quarter."

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AMD executives said those issues were now behind the company, and they were confident AMD would regain those margin points in the current quarter.

And while executives said that the company was unable to predict or control future pricing in the microprocessor market, they stressed that the transition to advanced manufacturing equipment and processes will drive down costs in the quarters ahead.

Executives at the chipmaker said the company's continued goal is gross margins between 55% and 60%.

Shares of AMD, which were halted ahead of earnings, were off 9.2%, or $2.23, to $22 after hours.

The results come a day after Intel reported that its sales grew 9% sequentially to $8.7 billion during the third quarter. For the past year, smaller AMD has managed to outgrow Intel and steal market share.

Intel Interference

At the end of the second quarter, Intel controlled 72.9% of the microprocessor market, while AMD had a 21.6% share, according to Mercury Research.

Now it appears that demand for each company's chips is running neck-and-neck, with both AMD and Intel reporting brisk sales for server and notebook chips.

Of course, the seasonally strong third quarter, which benefits from back-to-school sales and preparation for the holidays, is helping both companies.

AMD said total microprocessor unit shipments increased 18% sequentially during the quarter.

While AMD has traditionally lagged Intel when it comes to notebook processors, the company said sales of notebook processors surged by 50% during the third quarter, while average prices for the mobile chips also increased.

Ruiz said the company does not believe it lost any market share in server processors, the company's most profitable product, although he said that sales growth for AMD's Opteron server chips during the third quarter was not in the double digits.

AMD President Dirk Meyer acknowledged that the company is facing greater competition in the market for servers that feature two processors since Intel introduced its new Woodcrest processor this summer.

On Tuesday, Intel CEO Paul Otellini said he believed the company had retaken market share thanks to record shipments of server and mobile processors.

Looking ahead, AMD said it expects demand for its products to be seasonally strong in the fourth quarter and for sales to increase sequentially. AMD said a seasonal fourth quarter ranges from 6% to 13% sequential growth, with 10% being a likely average.

Analysts polled by Thomson Financial were looking for $1.44 billion in sales, implying 8.2% sequential growth, with 33 cents EPS.

The company projected that operating expenses will increase about 10% sequentially, with roughly $700 million in capital expenditures.