AMD Fights Back, But Still Treads Water

It was a quarter where AMD shipped more product than ever in its history, with 68% more mobile processors headed for trucking than at this time last year, and graphics processors adding substantially to that mix. It regained a full eight points of gross margin over the prior quarter, and reaped 22.9% greater revenue over the third quarter of 2006. And yet...

AMD still posted a loss last quarter, not as great as the prior quarter but a loss nonetheless: $386 million in red ink, on revenue of $1.63 billion. What's going on? Operating expenses are still extremely high.

Why aren't operating expenses declining as rapidly as the company had earlier promised, asked a Merrill Lynch analyst during yesterday's quarterly AMD conference call to analysts. Or to use his language, will there ever be a steady state for op-ex, or will it always be as variable as this?

"I guess the simple answer is no," answered CFO Bob Rivet, reflecting some of the underlying uncertainty behind the otherwise "steady-as-she-goes" type language he and his fellow executives exhibited earlier in the call.

"We continue to believe we have a business model that will gain share," Rivet continued, "and grow the top line, and therefore we will continue to invest appropriately." Whether cost as a percentage of revenue can continue to decline in absolute dollars, he added, "is dependent on the business conditions at that moment in time. So there's no 'steady state;' this is not a steady-state business."

It's not very comforting language, and it was not the tone of the entire call - though it did come out in the later portions, as analysts chipped away at the veneer of modestly good-sounding news, and after they noticed a near dearth of data for fourth-quarter guidance.

"In a seasonally up fourth quarter, AMD expects revenue to increase in line with seasonality," Rivet stated earlier. Operating expenses including research and development would continue to increase, however, by 6% as the company continues its investments in new process technology. Besides some other subsidiary data, that was the company's guidance for the remainder of the year...which isn't generally a good sign.

In search of normalcy

In any business tied with sales to consumers, the fourth quarter of the year is typically the busiest and the most productive. But in the current economic environment where a barrel of oil can trade above $90, "normalcy" is not a steady state either. So "in line with seasonality" could be bad news if that line tends to curve down.

So which way is it going, a Credit Suisse analyst asked? "We're going into a quarter with optimism on one hand and some cautious concerns on the other," responded AMD CEO Hector Ruiz. "First of all, the demand for products in the PC space, from all the regions around the world and particularly in the emerging markets, is very, very solid, very strong. But when we look at what our customers are telling us -- and none of them has changed, as of today, their plans -- they're telling us they also have a concern in three areas.

One is, there are spotty places where plastic appears to be in shortage. There are also spotty places where they see displays being difficult to obtain, and that also applies to a concern they have over that major fire in Japan, where a battery factory pretty much got put out of business. All of that has caused a little bit of uncertainty in the quarter; but other than those three issues that have yet to be quantified by any of our customers, the optimism for the quarter is strong, particularly in the emerging regions."

Ruiz may be getting some of his data from iSuppli, which earlier this month noted supply shortages for LCD monitors due to high demand, and other factors. That's good news for the LCD manufacturers, which can charge a premium - but that's bad news for OEMs that build desktop PCs and that outsource for their notebook PC displays. When they can't pledge to build enough systems, the demand for those systems' parts goes down. And now, that affects AMD doubly since its acquisition of ATI.

What are some of the "other factors" in play here? Believe it or not, the credit crunch is also to blame, iSuppli analysts believe. When credit is tighter, new home sales fall. So there's less demand for decorating those new homes, and the biggest new home decoration is a big-screen TV. That drives larger LCD demand down while, ironically, smaller LCD demand is rising. You might think that balances out, but what it ends up meaning is that LCD manufacturers charge customers more to compensate for the margins they're not earning in the big-screen department. And that drives PC system prices up.

With such factors as oil trading prices and home decorating industry demands having direct impacts on CPU sales, how can AMD -- or anyone else -- define a normal seasonal quarter - enough to be able to pin its entire fourth quarter performance guidance on that normality?

There's an unfortunate answer to that question, but AMD was never a company to hide the realities of business. "You can't ignore the market leader," said Bob Rivet at one point, referring to Intel, "[and its] comments and statements. To some degree, they're setting the tone, and have a much broader view of what's going on in the marketplace because they're still the dominant player. So I think they're the best indication of seasonality."

And what's Intel's indication? It's just finished a banner quarter, at the tail end of the most critical restructuring period in its history - one which history will show may have been the most successfully engineered in the history of US business. Intel earned $1.9 billion in the last quarter on revenue of $10.1 billion, 15% higher than for the third quarter of last year. Its gross margin was an extremely healthy 52.4%, meaning its ordinary costs of doing business totaled less than half of its revenue.

For its fourth quarter, Intel sees revenue between $10.5 and $11.1 billion, on a gross margin of 57%. That means that while Intel's income will be higher, "seasonality" won't be the upward-pointing spike that it typically is - perhaps more like a bump.

Can AMD ever reap $2 billion per quarter?

Given the obstacles ahead, what's AMD's path to profitability? CFO Bob Rivet said he also expects gross margin to improve, as it apparently will for Intel, but not by eight points - so we're still looking at well below 50%.

Imagine a car that's in second gear and has to go faster. It can promise getting to third gear, but it can't quite promise a fourth.

"Our goal is to make money in any given quarter," Rivet said at one point, in an attempt to mask any absence of fourth gear, "but...we need to be approaching the $2 billion revenue level, and north of 40% gross margin, to achieve that kind of goal, since we're not going to cut our way to make the bottom line happen. We're on a path, we made progress...we got above the 40 [percent mark], we're clearly not there in the sales level. We'll see in the fourth quarter. Our goal is to break even, and maybe we have a shot at it."

AMD COO Dirk Meyer promised the company was remaining on track to deliver its first 45 nm CPUs during the second half of 2008. When asked twice to give further "color" over what that meant (January? July?), Meyer declined.

Those skeptical questions may have come in the wake of news from a quarterly conference call from the manufacturer of immersion lithography tools used in fabrication facilities. ASMR will be called upon to provide those tools for CPU manufacturers and others who are retooling their fabrication facilities for successive generations. As FabTech reported on Wednesday, the CEO of that company reported that, based on the orders he was getting from NAND flash manufacturers and CPU manufacturers (AMD) alike, he believed the latter group would be adopting new immersion tools as much as 18 months behind the former group.

That would place AMD's 45 nm "ramp up" closer to 2009, perhaps a generation and a half behind Intel, assuming it keeps to its current roadmap.

Normally a fairly talkative fellow, AMD CEO Hector Ruiz was tight-lipped yesterday on a number of issues, including when the company plans to unveil its "asset-light" strategy - which may mean the outsourcing of some of its production to other facilities, maybe including IBM. It was not a very colorful report for AMD overall, which may in a strange way be seasonal. Like the oddly warm weather in many parts of this country, perhaps for AMD, it's beginning to look not a lot like Christmas.