September 5, 1997 1:00 PM PDT

AMD struggles to keep up

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Advanced Micro Devices' (AMD) K6 processor is burdened with ongoing production snags, leading some to wonder whether the company can meet market expectations and really compete with Intel (INTC).

Poor production yields, tepid demand, and overheated sales expectations are conspiring to make the K6 a negative mark on the company's balance sheets. Currently the K6 accounts for less than 20 percent of the company's overall revenues, according to some estimates. The product consumes close to half of the company's research and development budget.

This quarter, the company said, it will make close to 1 million K6 chips. Inefficient manufacturing, however, means that the milestone will result in an overall operating loss for the company.

Morgan Stanley, which is bullish on the company, downgraded its earnings estimate from 20 cents per share to a loss of 3 cents per share as a result of the news. "The third-quarter preannouncement was worse than we anticipated," a company report stated.

The Sunnyvale, California-based semiconductor manufacturer said earlier this week it will report a "small operating loss" for the third quarter because production estimates for its K6 microprocessors are falling below expectations. (See related story.)

And while AMD predicted that it would produce 2 million of the chips in the next quarter, analysts said that an organic overhaul at the company is likely needed before the K6 can live up to its promise as an Intel alternative.

"The rest of the industry wants them to succeed," said Michael Murphy, editor of the California Technology Stock Letter. "It's theirs to lose."

Inefficient manufacturing is AMD's chief Achilles heel. In a nutshell, AMD gets fewer successful microprocessors per silicon wafer, resulting in more waste, higher manufacturing costs, and lower profits. For the current quarter, for example, AMD is getting lower-than-expected yields on the 233-MHz version of the K6, according to Ashok Kumar, an analyst with Southcoast Capital.

"They just can't get the yields here," said Murphy. "Their best hope for cure is the new factory in [Europe]." Unfortunately, the European facility isn't scheduled to come online until 1998, and it will be used primarily for the next generation of AMD microprocessors.

AMD spokesperson David Frink acknowledged that the company experienced low yields during the quarter, but maintained that the problem does not speak to a lingering manufacturing problem for AMD. Most of the problems centered on the company's efforts to make .25-micron chips, which are smaller than the .35-micron chips the company has been using. "The yield issue is largely behind us," he said.

Although Morgan Stanley views the shortfall as a near-term event, the firm does acknowledge that aggressive production forced the company to miss its targets.

In any event, manufacturing will improve when the new facility in Dresden, Germany, becomes operational in late 1998. The facility will contain "mini-environments" within the clean room, he said. Test silicon should emerge from the factory in late 1998, with volume production following in 1999.

AMD also set fairly aggressive targets for itself, according to Frink. The company had hoped to produce between 1.2 million and 1.5 million chips in the quarter, a huge increase over the 350,000 produced the quarter before.

It has not done so. "It's not a company that has delivered on its promises consistently," said Nimal Vallipuram, semiconductor analyst at Bear, Stearns. "Following through on expectations has never been easy for them."

The company's microprocessor releases seem to bear this out. The K5 processor was to be adopted by Compaq (CPQ). Just before the release, which came after several delays, Compaq dropped the chip. Few major manufacturers picked it up in large numbers. Performance and yield issues also plagued the chip.

The K6 didn't have a major computer partner until two months after its release. Then, Digital (DEC) picked it up on the eve of filing a lawsuit against Intel. Since then, IBM (IBM) has adopted the chip, but only in a limited number of computers. While most analysts expect AMD to announce more partnerships before the end of the year, it remains to be seen how broadly the chip will be adopted.

The company currently is actually enjoying more success with its logic, communications, and flash memory products, according to both Murphy and Vallipuram. Yields still remain relatively low compared to competitors, but the company's designs give them added market value.

Margins, however, are lower on these chips, which explains why AMD continues to chase microprocessors, more complex devices that act as the brains of a computer, said Murphy. Arch competitor Cyrix (CYRX) has already announced it will move away from the main microprocessor market, leaving AMD as the chief alternative.

"If AMD can get 15 percent of this business, they can make a lot," Murphy said. But, again, it's theirs to lose.

 

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