Intense Competition Hurts Profits at Intel and AMD

Published: October 24, 2006

by Timothy Prickett Morgan

Late last year, many in the IT industry were predicting that rival chip makers Intel and Advanced Micro Devices would be getting into a price war in 2006. Some naysayers said that neither company wanted to do that, mainly because no one ever wins a price war. That may be true, but as the most recent financial results from these two companies show, that doesn't mean you can stop the shooting.

And, to be fair, Intel and AMD are engaged in more than a price war--it is an all-out war, where technology, price, and partnerships are three weapons that they are each deploying as they do battle. Price is clearly a big component, however, because if chip volumes are up (meaning demand is good for chips) and profits are down, then price is the major lever. It is probably best to think of technology as the ante in the game these days--you need 64-bits, virtualization, dual-core, and low power just to be in the game. Then, you have to compete on price.

Intel last week said that in the third quarter ended September 30, it had sales of $8.7 billion, a decrease of 12 percent compared to the third quarter of 2005. The fact that revenues were down in a quarter with a record number of chip shipments for server and mobile processors, and increases in motherboard and chipsets, too, is particularly telling. Intel also had to write off $100 million of older chip inventories that it knew it was not going to sell. Intel said during its call with Wall Street analysts after it announced its financials that it has sold more than 40 million processors based on its 65 nanometer chip making processes, and that over 6 million processors based on the Core architecture have been sold, too. The company said that the first of its 45 nanometer chips will be designed and ready to fab by the end of the year, and that it has 14 other 45 nanometer designs in the works. Intel also said that it was shipping for revenue its quasi-quad core chips for servers and workstations; these are two of its dual-core Xeon and Core chips put side-by-side in a single chip socket package. True quad-core chips from AMD and Intel hit the streets next year.

Even with cost cutting and layoffs, Intel had a 56 percent decline in operating income, which fell to $1.4 billion in the quarter, and net income came in at $1.3 billion, down 35 percent, only because Intel sold $130 million of its holdings in memory chip maker Micron Technology during the quarter. Paul Otellini, Intel's president and chief executive officer, said in a statement that he was pleased with the results in the third quarter, but that can't be true. No one running a public company with such numbers would be characterized as "pleased." Relieved that it was better than the second quarter--to be sure. Pleasure might come at some future date. Then again, given the competitive pressure AMD is bringing to bear, maybe not.

Of course, AMD has its own problems, as its financial results for the third quarter ended October 1 show. AMD's processor shipments during the quarter grew 18 percent, and overall revenues (minus memory products, which were spun out earlier this year) grew by an astonishing 32 percent. However, overall revenues, when you take into account the memory products from last year, were actually down. And AMD got out of the memory biz to get rid of a unit that was not as profitable as its core processor business is supposed to be by now. So, surprise surprise, in the third quarter of this year, operating income actually fell by 8 percent to $119 million, gross margins dropped by 4 points to 51.4 percent, and some gains on investments and getting some tax money back, net income came to $134 million, up 77 percent.

AMD says that it was caught flat-footed by the demand for its mobile processors, but the truth is much bigger and it is this: the company is also now feeling the competitive squeeze from Intel. While CPU shipments were up 18 percent, and sales were up 33 percent to $1.29 billion, operating income for processors fell from $149 million in the year-ago quarter to $133 million in this quarter--a drop of 11 points. Research and development costs were up 28 percent to $277; sales, general, and administration costs were up 34 percent to $286 million. While Turon mobile and Opteron server and workstation chips had record shipments and improved average selling prices, the company spent a lot more money to keep going.