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Intel: In the Chips

By Cliff Edwards It's starting to look like a very good year for PC makers and their suppliers. Continuing a trend among tech stalwarts, giant Intel (INTC) on July 19 reported record second-quarter chip sales that rose 15% year-over-year, to $9.2 billion, as consumers continued to snap up its notebook offerings.

Wall Street reacted with little joy to the news, sending Intel's stock down $1.01 in afterhours trading, to $27.70 a share. The chipmaker's solid earnings of $2 billion, or 33 cents a share, had been expected after Apple (AAPL), Advanced Micro Devices (AMD), and IBM (IBM) reported in the past week their own boffo earnings. On July 19, disk-drive maker Seagate (STX) also reported record revenue and net income.

DESKTOPS DOWN. Taken together, tech outfits are poised to enjoy a very strong back-to-school third quarter and, potentially, another period of solid year-on-year growth. Indeed, Intel's sales growth dovetailed with Gartner's (IT) July 19 report that worldwide PC shipments in the second quarter jumped 14.8% year over year on higher notebook shipments and aggressive pricing among PC makers.

Notebook sales in the U.S. are now outpacing desktops by a 6-to-1 margin because of rapid price declines. Top-tier PC makers Dell (DELL) and Hewlett-Packard (HPQ) are facing increased sales competition from such value leaders as Gateway (GTW) and Averatec, as well as a resurgent Apple.

The report prompted Merrill Lynch analyst Steven Milunovich to boost his forecast for annual PC shipment growth to 10%, from 9%. "Many investors thought [the latter was] too aggressive coming into the year," Milunovich noted in his report.

XBOX FACTOR. The strong earnings among tech giants stand in stark contrast to a surprisingly mixed first quarter. Companies that disappointed Wall Street in the previous quarter blamed their troubles on delayed corporate purchases. But much of the demand in the second quarter appears to be driven by a near-insatiable consumer demand for all-things digital, including PCs, digital video recorders, music players like the iPod, and GPS systems.

"The first-half demand was stronger than we expected going in," says Andy Bryant, Intel's chief financial officer Andy Bryant. "The momentum appears to be continuing."

Intel predicted third-quarter revenue would rise to about $9.8 billion, with juicy gross margins of 60% -- up from 56.4% -- on its products in the most recent quarter. Second-quarter gross margins fell below expectations as Intel boosted production of chips for Microsoft's Xbox game console (MSFT), which is doing brisk business.

PRICING PRESSURE. Intel's earnings came a week after rival AMD also reported unexpectedly strong earnings. CEO Hector Ruiz reported Opteron server chip sales rose a remarkable 89% sequentially, and he noted the company logged record notebook-chip sales as well. AMD is suing Intel for allegedly coercing and paying customers to keep AMD from becoming a bigger world presence (see BW Online, 7/11/05, "Sweet Deals -- Or Strong-Arm Tactics").

AMD's earnings had raised questions about whether it is gaining share against Intel, or whether the overall PC market is growing amid stronger-than-expected demand. The results indicate it may be a little of both. CFO Bryant has said the chipmaker's factories have been unable to keep up with demand for certain products.

But Bryant also acknowledged more competition from AMD, whose cheaper server chips have been hailed as technically superior to Intel's offering. "We are facing pricing pressure in the server space," Bryant says.

AMD'S AMBITIONS. Server makers Sun (SUNW), HP, and IBM (IBM) rolled out new AMD dual-core platforms in the past quarter. And AMD appeared to be gaining ground with top PC makers in the all-important notebook segment.

In June, HP rolled out several notebooks for consumers and the small- and midsize business market, using AMD's 64-bit Turion and Sempron chips. Intel CEO Paul Otellini noted that the outfit plans to refresh its server line through the second half of the year to fend off AMD's strong challenge in the dual-core space. "As I look forward in the server line," he says, "I see us getting increasingly competitive."

Meanwhile, Intel and AMD keep slugging it out for flash-memory sales. Intel reported sales in that category dipped to $528 million, from $587 million a year earlier. AMD's Spansion flash memory unit, a joint venture with Fujitsu, recorded a 19% operating loss as the chipmaker readies it for a spinout or initial public offering later this year. AMD gets hurt more, because flash memory counts for a higher percentage of potential profits and losses. Edwards is a correspondent in BusinessWeek's San Mateo bureau

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