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Analysis: AMD needs drastic overhaul to lift numbers

Posted: 11 Apr 2008 ?? ?Print Version ?Bookmark and Share

Keywords:AMD fabless model? AMD numbers? manufacturing model?

While a 10-percent job cut already sounds drastic, Advanced Micro Devices Inc. will have to do better than that to fundamentally change its operating structure, including possibly adopting a fabless manufacturing model, if it wants to return to profitability anytime soon.

This is because AMD has one of the highest cost structures in the semiconductor industry, according to an EE Times analysis that shows the company trailing rival Intel Corp. and most other major IC suppliers in such metrics as gross profit, R&D along with selling, general and administrative (SG&A) expenses as measured as a percentage of sales.

Erasing the gap between AMD and Intel won't be achieved simply through layoffs announced by the on Apr. 7 when it projected a revenue shortfall for the first quarter of 2008. It also will require a thorough overhaul of the company's operating model and probably a swift move to an outsourced manufacturing or adoption of a fabless system long promised by AMD.

AMD's financial health has steadily deteriorated over the last five years as the company struggles to keep pace with Intel on technology and products. A key move was the addition of graphics chips through the acquisition of ATI Technologies Inc. The deal helped boost AMD's revenue to a record $6 billion in 2007, from approximately $5.7 billion in 2006 and as low as $3.5 billion in 2003. However, the revenue gains have come at a huge price in the form of higher operating costs.

Not looking good
AMD's SG&A costs rose as a percentage of sales to 23 percent in 2007 from 20 percent one year earlier and a low of 16 percent in 2004. The company's R&D costs soared to 31 percent of total revenue in 2007 from just under 19 percent in 2004.

It gets worse. Total operating expenses as a percentage of revenues have ballooned as the company struggled with the costs of its $5 billion-plus acquisition of ATI.

In 2007, total operating expenses as a share of revenue hit 148 percent, including the $1.61 billion special charge recorded by the company during the year.

Even excluding that "unusual expense," AMD's total operating expense as a percentage of sales was 121 percent for 2007, versus 101 percent in 2006 and 96 percent in 2005. The surge in 2007 was attributable to AMD's higher expenses for R&D, SG&A as well as depreciation/amortization charge related to the ATI transaction.

Intel, on the other hand, managed to reduce SG&A as a percentage of sales to 14 percent in 2007 after it engineered a similar 10 percent workforce reduction in 2006, two years ahead of AMD's move. In 2006, Intel's SG&A expenses as a share of sales were 17 percent, up from 15 percent in 2005.

Intel's R&D costs as a share of sales have also remained relatively flat at about 15 percent, and the company has recently tamped down on total operating costs, dropping these as a percentage of sales to 79 percent in 2007 from 84 percent in 2006.

Rising costs
A review of financial data at other leading semiconductor companies also indicates costs are rising across the board within the industry.

Aside from AMD and Intel, other companies reviewed include STMicroelectronics N.V., Infineon Technologies A.G. and Nvidia Corp., the discrete graphics semiconductor supplier that a few analysts have suggested as a potential acquirer of AMD.

While all these companies have recorded mixed results in their overall cost reduction efforts, they have been mostly successful in bringing down SG&A expenses as a percentage of sales.

At Nvidia, SG&A as a share of sales slipped to 8.3 percent in 2007 from 9.6 percent in the preceding year while R&D costs fell 1 percent to 17 percent and total operating expenses fell to 80 percent of annual revenue versus a high of 98 percent in 2003.

At Infineon, SG&A dropped to 9.1 percent of sales in 2007 from 9.5 percent one year earlier and as high as 11 percent in 2003. Infineon's R&D costs also fell more than half a percentage point in 2007 to 15.2 percent from 15.8 percent in 2006 and a high of 19.1 percent in 2005.

Infineon is struggling to bring total operating expenses under control, however, mainly due to problems at its majority-owned memory supplier, Qimonda AG. The company's operating expenses as a percentage of sales increased to 105 percent in 2007 from 101 percent in 2006 and a recent low of 96 percent in 2004.

Like AMD, Geneva, Switzerland-based ST is also having problems keeping costs under control. The company's SG&A costs rose in 2007 to 11 percent from 10.8 percent in 2006; R&D expenses as a share of sales climbed more than one percentage point to 18 percent from 16.9 percent.

ST's total operating expenses as a percentage of sales jumped in 2007 to 106 percent from 93.1 percent in 2006 after the company took a $1.2 billion special charge.

Fabless model
While our analyses indicated that costs have increased across the industry in recent years as companies tried to leverage their R&D assets to improve competitive position, AMD is definitely at a disadvantage because its sales growth hasn't kept pace with the rising costs, according to analysts.

The company's failure to maintain market share in several product segments could further complicate its ability to return to profitability and benefit from the workforce reduction, Mark Lipacis, an analyst with Morgan Stanley, said in a reent report.

"We believe that AMD likely lost some share to Intel both in the desktop and the server segments during the [first] quarter," Lipacis said. "Without MPUs to compete with at the high end, we think that AMD will need to reduce headcount or shift to a fabless business model in order to conserve cash."

AMD has indicated it is considering a fabless model, but the company has so far hesitated to unveil details of that plan for competitive reasons, according to a spokesman.

With the latest revenue shortfall warning, investors will be pressing AMD chairman and CEO Hector Ruiz for details when the company hosts its quarterly conference call on April 17. They also will likely be grilling Ruiz for a more comprehensive restructuring and cost-reduction plan.

- Bolaji Ojo
EE Times

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