After Stunning Earnings Report Drop: Are 'AI Servers' Really Unprofitable?

The AI sector is buzzing with news, but not all of it is positive, as highlighted by AMD's recent performance. On Tuesday, the server manufacturer AMD released its earnings report for the fourth quarter, revealing mixed results: revenues exceeded expectations, but both gross margin and earnings per share (EPS) fell short.

Here's a breakdown of the figures:

- Revenue: For Q4, AMD reported revenues of $5.31 billion, a remarkable year-on-year increase of 143.6%.

- EPS: The Q4 EPS came in at $6.25, up 78.1% from the previous year, but below the anticipated $8.14.

- Gross Margin: The gross margin for Q4 was 11.2%, marking a decline of 5.8 percentage points from the prior year.

Despite surpassing revenue expectations, the disappointing EPS and declining gross margins led to a volatile end to trading, with AMD's stock initially rising before plummeting by more than 10% in after-hours trading.

AMD entered the AI arena with its server products, capitalizing on the growing demand for AI technologies. This year, as demand for AI servers surged, the company's stock price has doubled, and it has been included in major indices like the S&P 500 and Nasdaq 100. Furthermore, AMD projected revenues to reach between $26 billion and $30 billion for the fiscal year ending June 30, 2025, with analysts estimating around $23.6 billion.

While the revenue outlook appears promising, Wall Street is increasingly concerned about AMD's long-term profitability. Intense price competition with rivals such as Dell and HP has significantly pressured AMD's margins, which have declined by 580 basis points year-over-year (and 430 basis points sequentially) to just 11.3%. AMD executives noted that this drop in gross margin was impacted by investments in new liquid cooling server technologies and the pricing negotiations with large clients, who typically secure better rates for substantial orders. AMD aims to achieve a gross margin target of 14% to 17% by expanding its product lines and manufacturing capabilities in Taiwan and Malaysia.

However, analysts remain skeptical, pointing out the challenges AMD faced in meeting its profitability targets last quarter, which further heightens concerns on Wall Street. The struggle for profitability is not exclusive to AMD; competitors like HP and Dell have also reported issues in this area. For example, Dell's Q1 earnings report indicated a projected decline of nearly 150 basis points in adjusted gross margin for fiscal year 2025, with an adjusted EPS forecast between $1.55 and $1.75, falling short of the $1.84 anticipated by analysts. Dell's management has warned that high costs associated with AI server production may pressure overall margins as the year progresses.

HP also faced challenges, reporting a gross margin of 33% for Q2, which represents a year-over-year drop of 3 percentage points and a 3.4 percentage point decrease from the previous quarter. The declining margins across AI server providers like AMD, Dell, and HP reflect not only increased investments to capture market share in the booming AI sector but also the aggressive pricing strategies competition has prompted. Despite these challenges, leadership at these companies remains optimistic about the future potential within the AI market. AMD CEO Charles Liang expressed confidence, stating, "We are prepared to become the largest IT infrastructure company."