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Intel's Broken Record

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By Tim Beyers
January 13, 2005

It's no secret that I've been a vocal critic of Intel (Nasdaq: INTC) in recent months. All for good reasons, of course. From product delays to pandering optimism, Intel fell all over itself during 2004. Ironically, that's what makes Tuesday's earnings report impressive.

Yep, I mean it. Intel did well. For the fiscal year, Intel booked $34.2 billion in sales, 13.5% higher than in 2003 and a new annual record for the company. Net income was up 33% over last year to $7.5 billion, or $1.17 per share.

The good news brightened investors' spirits, and the stock is up nearly 3% since the report. Intel's own continued optimism hasn't hurt. Late last year, the company announced a dividend increase that takes effect this month.

By now, you might be wondering why I'm not eating crow for my Halloween recommendation of shorting Intel. Well, not so fast, bucko. Take a look at the quarterly numbers. Yes, sales were a record $9.6 billion, up 10% year-over-year. But over the same period, profits were -- wait for it -- down 2.3%. And quarterly net income came in $50 million lower than during last year's fourth quarter. (Profits were flat on a per-share basis.)

What happened? For one, Intel's cost of goods skyrocketed by almost $500 million for the second quarter in a row. It's anybody's guess what actually caused the rise, but a warning from rival Advanced Micro Devices (NYSE: AMD) could provide a clue.

AMD said this week that its fourth-quarter sales would come in well below estimates because of intense pricing pressure from Intel in the NOR flash market. ("NOR" is short for "not or," a Boolean logic operator and one of the two types of flash memory, the other being "NAND," for "not and.") As if in confirmation, Intel said in its earnings report that it had regained market leadership in NOR flash because of "continued strong growth." But it's not that simple, folks. Though year-over-year flash sales were up more than 60%, Intel's flash revenue sequentially rose less than 1%.

Now look at the gross profit numbers: Year-over-year, revenue rose by $857 million, while the cost of producing those sales increased by $1.04 billion. Look at that again, because it's hugely important. For every dollar of new sales in 2004, Intel spent $1.21.

No sane person would say that Intel's operations experts have gone missing. This company is too good and too well-run for this apparent inefficiency to be an accident. So what the heck happened? AMD happened, that's what. Take the AMD Opteron 32/64-bit combo chip, for example, which has scored a flood of design wins and has led to rumors of a deal with Dell (Nasdaq: DELL). Such successes by AMD have put rival Intel in an odd place: It has forced new investments, and more spending.

Intel ought to be applauded for a record-breaking year. But the chipmaker paid a high price to do so well. And if it continues, 2005 won't be any better than 2004. In fact, it could be a whole lot worse.

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Fool contributor Tim Beyers thinks there are better chip stocks out there than either Intel or AMD. Perhaps that's why he owns shares in neither of them. To see what's in Tim's portfolio, check out his Fool profile. The Motley Fool has a disclosure policy.