Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Advanced Micro Devices, Inc. (NYSE:AMD)

Q2 2013 Earnings Conference Call

July 18, 2013 17:00 ET

Executives

Ruth Cotter - Vice President, Investor Relations

Rory Read - President and Chief Executive Officer

Devinder Kumar - Senior Vice President and Chief Financial Officer

Lisa Su - Senior Vice President and General Manager, Global Business Unit

Analysts

Vivek Arya - Bank of America

Joe Moore - Morgan Stanley

Ross Seymore - Deutsche Bank Securities

John Pitzer - Credit Suisse Securities

David Wong - Wells Fargo

Hans Mosesmann - Raymond James

Christopher Danely - JPMorgan

Stacy Rasgon - Sanford C. Bernstein & Co.

Ambrish Srivastava - BMO

Romit Shah - Nomura

Cody Acree - Williams Financial Group Capital Markets

Jim Covello - Goldman Sachs

Christopher Rolland - Friedman, Billings, Ramsey & Co

Patrick Wang - Evercore

Shawn Webster - Macquarie Securities

Glen Yeung - Citigroup

Operator

Good afternoon. My name is Hughie and I will be your conference operator for today. At this time, I’d like to welcome everyone to AMD’s Second Quarter 2013 Earnings Conference Call. All lines have been placed on a listen-only mode at this time. After the speakers’ remarks, you will be invited to participate in the question-and-answer session. As a reminder, this conference is being recorded today.

I would now like to turn the conference over to Ms. Ruth Cotter, Vice President of Investor Relations for AMD. Please go ahead.

Ruth Cotter

Thank you, and welcome to AMD’s second quarter earnings conference call. By now, you should have had the opportunity to review a copy of our earnings release and the CFO commentary and slides. If you have not reviewed these documents, they can be found on AMD’s website at quarterlyearnings.amd.com.

Our participants on today’s conference call are Rory Read, our President and Chief Executive Officer, Devinder Kumar, our Senior Vice President and Chief Financial Officer, and in addition we have Lisa Su, our Senior Vice President and General Manager of our Global Business Unit who will participate in the question-and-answer session. This is a live call and will be replayed via webcast on amd.com.

And before we start, I’d like to highlight a few dates of interest for you. Matt Skynner, our Corporate Vice President and General Manager of our Graphics Business Unit will attend the Jefferies Semiconductor and Hardware Summit in Chicago on August 28. Lisa will present at Citi’s Global Technology Conference on September 4 in New York. Our third quarter quiet time will begin at the close of business on Friday, September 13th. And lastly, we intend to announce our third quarter earnings on October 17th and dial-in information for that call will be provided in mid-September. Please note we renamed our Graphics segment to Graphics and Visual Solutions. This better reflects the growing importance of gaming and semi-custom offerings to AMD. In addition, please note that non-GAAP financial measures referenced during this call are reconciled to their most directly comparable GAAP financial measures in the release and CFO commentary posted on our website at quarterlyearnings.amd.com.

Before we begin, let me please remind everyone that today’s discussion contains forward-looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date, and as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. You can refer to the cautionary statement in our press release for more information. You will also find detailed discussion about our risk factors in our filings with the SEC, and in particular, AMD’s quarterly report on Form 10-Q for the quarter ended March 30, 2013.

Now, with that, I’d like to hand the call over to Rory. Rory?

Rory Read

Thank you, Ruth. We are making progress on our three-step strategy to restructure, accelerate, and ultimately transform AMD for growth. This progress allowed us to deliver improved results in the second quarter. Revenue of $1.16 billion was higher than our guidance as strong demand helped drive sequential unit shipment increases and market share gains across both of our business segments.

With our restructuring complete, our focus in the second half of the year is on continuing to accelerate our business. We expect a return to profitability in the third quarter based on the midpoint of our revenue guidance. Our traditional PC business is heading into the typically stronger second half of the year with a competitive portfolio of new products and strong mobile design wins, particularly persistent in the $300 to $600 sweet spot of the market. Many of these systems will be the first to bring touch capabilities down into the mainstream price points, where AMD has traditionally been the most successful. We remain on track to deliver more than 20% of our revenue from our semi-custom and embedded businesses in the fourth quarter. With growth in the second half of the year primarily coming from our semicustom SoC products for both the Sony and Microsoft next generation game consoles.

These tailored products are great examples of the opportunities we have to quickly diversify our product portfolio and enter into new markets where our IP and design capabilities provide us with a competitive advantage. Looking more closely at our progress and the PC market, our strategy to gain share by introducing a new set of APUs and winning high volume notebook designs across key customers by region, price point and form factor help drive strong double-digit sequential increases in mobile processor unit shipments.

With our mobility APU launches last quarter we now offer the broadest range of mobile processors in our AMD history. Our new elite mobility APUs scale down below 4 watts, well more than doubling the performance per watt compared to our previous generation. We’re seeing strong adoption of these new APUs. This is particularly true of our high volume Kabini which is powering a number of thin and light touch notebooks that will hit the $400 price point.

Acer, Asus, Dell, HP, Lenovo and Samsung have begun to rollout products based on our latest APUs and we expect many more systems to launch in the second half of the year. We also continue to make progress rebalancing and strengthening our channel business. The introduction of a Richland APU help drive a sequential increase in desktop processor channel revenue. We expect to continue to build on this improving channel trend in the second half.

Turning to our server business, a number of large data center wins in the quarter drove sequential revenue and unit shipment increases. Additionally we continue to gain momentum in the emerging dense server market as customers are choosing AMD SeaMicro offerings for their data centers based on the industry leading energy efficiency, density and bandwidth of our solutions. We intend to have further attack the fast growing portion of the server market in 2014 by introducing our next generation X86 APUs and CPUs as well as our first ARM-based server product.

Our years of enterprise design experience and the ability to integrate our industry leading dense server fabric into the processor provides us with a differentiated product for this new and exciting market.

Now turning to our graphics and visual solutions business. Our strategy to make AMD the de facto standard for game developers continues to gain momentum as we launch the industry’s fastest desktop and mobile graphics chips and cemented our position as the technology provider of choice for all three next generation game consoles. In the high and enthusiast portion of the desktop’s GPU market, the combination of our powerful graphics products and the Never Settle game bundle program drove significant share gain and a richer mix in the channel from the previous quarter. Our professional graphics business also recorded it's four straight quarter of growth delivering record revenue as we continue to aggressively pursue this lucrative market. Looking at second half of the year we believe we have good opportunities for growth based on the PC market strengthening slightly from the first half levels and the ramp of our semi-custom business. Longer term, the 300 million plus unit traditional PC market remains an important part of our core business, especially at the mainstream $300 to $600 system price points that have been traditionally been our sweet spot become an even larger portion of the overall PC market. We will continue transforming AMD, leveraging our design expertise and IP to pursue additional growth opportunities for our semi-custom, ultra-low power client, professional graphics, dense server, and embedded solutions. We expect these high growth businesses will account for 40% to 50% of our revenue in the next two to three years.

In summary, we are pleased with the progress we are making to restructure, accelerate, and ultimately transform AMD as strong demand for our latest products drove improved financial and operational results in the second quarter. We expect to deliver significant revenue growth in the second half of the year as our strong new products position us to gain share in our traditional businesses, and our first semi-custom SoC win allows us to participate in new markets. We are on track to reach our operating expense target of approximately $450 million, and we expect to return to profitability in the third quarter based on the midpoint of our guidance. We are excited about the near-term opportunities to demonstrate our efficient business model, disciplined operational focus, and diversify product strategy that will deliver consistent profitability and growth.

With that, I’d like to turn it over to Devinder. Devinder?

Devinder Kumar

Thank you, Rory. Phase 1 of our three-phase turnaround and transformation strategy is largely behind us. We are now pursuing a diversification of our product and revenue portfolio with a focus on high growth market opportunities. As Rory mentioned, our performance in the second quarter was driven by both traditional PC and new growth opportunities, which support our business model transformation in an evolving PC market. We are on target to generate 20% of our revenue outside of the traditional PC space to semi-custom and embedded products by Q4 2013. The last phase of transformation over the next two to three years is expected to see us transition 40% to 50% of our revenue base to higher growth markets, which include semi-custom, dense server, professional graphics, ultra-low power client, and embedded products.

Revenue for the second quarter of 2013 was $1.16 billion. The 7% sequential increase was driven by a 12% increase in the Computing Solutions segment, which was partially offset by a 5% decrease in the Graphics and Visual Solutions segment. Gross margin was 40%, a decrease of 1 percentage point sequentially and includes an $11 million benefit from the sale of certain products previously reserved in Q3, 2012. You may recall that Q1, 2013 gross margin of 41% included a similar benefit of $20 million. Excluding these benefits, gross margin was flat at 39% for both Q2 and Q1, 2013.

Non-GAAP operating expenses were $479 million, and we remain on track to achieve our operating expense goal of $450 million by the third quarter of this year. Non-GAAP operating loss was $20 million and non-GAAP net loss was $65 million. Non-GAAP loss per share was $0.09 calculated using 752 million basic shares. This loss per share includes a $11 million benefit from the sale of previously reserved products. Adjusted EBITDA was 54 million an increase of 14 million from the prior quarter due to the lower operating loss.

Now switching to the business segments, Computing Solutions segment revenue was $841 million up 12% sequentially due to significantly higher notebook and higher server and desktop unit shipments primarily driven by demand for our new Kabini and Temash offerings as well as our latest Opteron 6300 series of products.

Client product revenue and server microprocessor revenue increased sequentially. Computing Solutions, operating income was $2 million, an improvement from an operating loss of $39 million in the prior quarter.

Graphics and visual solution segment revenue was $320 million, down 5% compared to the prior quarter, primarily due to lower game console royalties. Graphics and visual solution segment operating income was breakeven compared to $16 million in the prior quarter.

We continue to diversify our product portfolio into new markets where the competitive dynamics are different, in the semicustom space for example the market is differentiated from the rest of our business as our customers engage with us very early to jointly define and fund engineering development of customized products. Development revenue and the associated cost are incurred during the development cycle of the given products. When the semicustom products ship to the customer we generate silicon sales and the associated ongoing OpEx is significantly lower than our non-semicustom products due to the Opteron funded development.

The semicustom model has the potential of providing a long term revenue stream based on high volumes which results in gross margin that is lower than the corporate average but has significant revenue and earning power as volumes ramp. Under this model the majority of gross margin dollar’s fall due to operating income and the operating margin for this business will be in the low double-digit range more than offsetting the impact of the lower gross margin. In addition as we transition the shipping silicon products, game console royalty revenue included in the semicustom business is expected to decrease moving forward although the decline will be more than offset by our growing semicustom development and product revenues.

Turning to the balance sheet, our cash, cash equivalents and marketable securities balance including long-term marketable securities was $1.1 billion. During the quarter AMD made a $40 million cash payment to GlobalFoundries related to the 2012 wafer purchase commitment reduction and exit of the quarter and our target optimal cash level and well above the target minimum cash level of 700 million. That as of the end of the quarter was 2 billion flat from the prior quarter.

Inventory was 711 million up 98 million sequentially largely driven by semicustom products and a ramp of new products in the PC space to support growth in the second half of the year. Accounts payable at the end of the quarter was 402 million up 101 million compared to the end of the first quarter of 2013 due to the timing of purchases and payments.

Depreciation and amortization was 54 million down from 62 million in the prior quarter primarily due to the sale and lease back of our Austin, Texas Lone Star Campus.

Now turning to the outlook, for the third quarter of 2013 AMD expects revenue to increase 22% sequentially plus or minus 3%. Gross margin is expected to be approximately 36%, despite expecting revenue to increase significantly quarterly operating expenses I expected to decline approximately 6% sequentially to around 450 million. Expense management will continue to be a focus area for us as we move forward. At the mid-point of revenue guidance, AMD expects to be profitable at the net income level. Inventory is expected to increase sequentially to approximately 800 million largely based on semi-custom product builds. We expect inventory to remain at those levels for the coming quarters consistent with the ramp of our semi-custom business and cash is expected to remain flat sequentially at approximately $1.1 billion.

In summary, in the third quarter, we will build on the strong foundation we have established as we remain laser-focused on execution and returning to profitability in the third quarter and positive free cash flow generation in the second half of the year.

With that, I will turn it back to Ruth. Ruth?

Ruth Cotter

Thank you, Devinder. Operator, we’d be happy to poll the audience for questions now please.

Question-and-Answer Session

Operator

Yes, ma’am. (Operator Instructions) And our first question in queue will come from the line of Vivek Arya with Bank of America. Please go ahead. Your line is now open.

Vivek Arya - Bank of America

Thanks for taking my question. First question, could you help us, Rory, differentiate between the growth prospects for your traditional PC and server segments versus the game console opportunity in Q3, and then if you can give us any initial sense for Q4?

Rory Read

Sure, Vivek. As we look forward, we see a continued opportunity in the PC segment. While we see it only slightly stronger than the first half and I believe down year-to-year, I think there is an opportunity for us with our stronger product portfolio to continue to build on the momentum that we saw in the second quarter. Clearly, the market is moving down into the entry and mainstream price points, where we’ve played very well. And I think this is a very good opportunity for us to continue to build share. Now, having said that, clearly the momentum and acceleration of revenue will come from the new segment as well as off of that initial base, but those SoCs that we want in semi-custom are going to be a key driver moving forward in 3Q as we have guided.

Vivek Arya - Bank of America

So, just one follow-up on that, Rory, I think yesterday Intel guided to about 5% or so sequential growth in their PC and server segment, is that roughly how we should be thinking about your traditional business and then whatever is left is the new opportunity?

Rory Read

Well, I see the overall PC market in the second half growing in the mid-single digit level. And what I would like to do is to achieve that or exceed that so that we could slightly gain share.

Vivek Arya - Bank of America

Got it. And one last one for Devinder, Devinder I think you mentioned low double-digit operating margin from the new wins that you have in consoles, I assume that is exclusive of the royalties and is that an initial profitability level, and does it get better than that or is that sort of a run-rate level over time?

Devinder Kumar

I think we are giving guidance for Q3 and guiding to the low single-digit from a Q3 standpoint. As you can imagine, this business, the semi-custom business and game console, in particular, has a long lifeline and over time the mix between the ASPs and the cost can change, so looking out in the future it’s hard to tell, but at least at the starting point for the next couple of quarters I would target at the low double-digit.

Vivek Arya - Bank of America

Got it. Thank you very much.

Operator

Thank you, sir. And our next question will come from Joe Moore with Morgan Stanley. Please go ahead. Your line is open.

Joe Moore - Morgan Stanley

Great, thank you. Also on the console questions, how does the pricing work to you guys is only good (type issues), is there any kind of yield risk to your profitability there, and I have a follow-up on that?

Lisa Su

Yes, Joe this is Lisa. So, the game console SoCs are really as we would do. There are wafers that we expect good solid yields from. We’ve had very good bring up and so we are looking good with the prospects.

Joe Moore - Morgan Stanley

Okay, great. And then how do you think about the ASPs in that business over the next some of years, is that a volume-based thing, is there a time, are there times when prices come down or just how does the price negotiation work over the course of the next few years, and that (there is one)?

Lisa Su

These are long-term deals that we have with the customers given the range of the length of the design win, so, these are pre-negotiated.

Rory Read

And Joe what you would expect is you would expect what we have seen in the historical trends around game consoles; these generally run somewhere between 5 and 7 years and you would expect that overtime that prices would move lower but obviously expense and cost will move with it. What’s powerful about this business is you can see a significant increase in our revenue quarter-to-quarter as we begin to ramp this at the same time you see our expense level decline by almost $30 million to the 450 level showing the benefit of doing that NRE (ph) customer funded development and how it flows through to the bottom-line at that double-digit level.

Operator

Thank you. And our next question will come from Ross Seymore with Deutsche Bank. Please go ahead. Your line is now open.

Ross Seymore - Deutsche Bank Securities

First question looking back just briefly the upside that you had, can you walk through a little bit what drove that surprise, I know the computing solutions group was up 12%, was that mainly the Temash uptick or anymore color you can give us there would helpful, please.

Rory Read

Yeah I think we saw strong momentum in the new product segment and obviously Temash and Kabini did well. I think Lisa has seen a good uptick in the graphics arena as well and in the desktop channel area. So we basically saw it in every part of our business progress quarter-to-quarter. Now of course we’re building off of that lower base as we saw the market fracture at the end of last year but that’s a good foundation given these new products and the uptick that we’re seeing there.

Ross Seymore - Deutsche Bank Securities

The ASP decline also driven by the new products, so it's a strategic decision in part of addressing those notebook price points that you mentioned earlier Rory?

Rory Read

Well from my perspective what you’re going to see is basically a mix discussion. We saw a very, a good performance in our entry in mainstream price points and I think it's basically a mix area. We’re focused on moving up the stack with the Richland offering as well as balancing that off with the new SoCs from the gaming and server areas. So I would say it's mix Ross.

Ross Seymore - Deutsche Bank Securities

And I guess one final question on the gaming side of things, how do we think about eventual seasonality in that business. Do we have good two, three quarter ramp before we even have to worry about that?

Lisa Su

I think the way to think about game console seasonality is like any consumer business, the first half is usually lower than the second half. Of course we’re in the middle of the ramp process so the second half of this year will be the ramp-up of the consoles but I would expect the first half would be weaker as most consumer cycles are.

Ross Seymore - Deutsche Bank Securities

Even in the first half of ’14 or is the ramp probably going to overcome any seasonality at that point?

Lisa Su

I would still expect a typical consumer seasonality.

Operator

Thank you. Our next question will come from John Pitzer with Credit Suisse. Please go ahead. Your question please.

John Pitzer - Credit Suisse Securities

Lisa maybe a follow-on to that Ross Seymore question, given that we’re early in the ramp phase, anyway of quantifying the sequential ramp and gaming from Q3 to Q4 to kind of hit some of the unit numbers that are out there in the popular press to how many of the gaming systems might be built for the Christmas holidays? Any way to give us some sort of color of how much of that’s falling in Q3 versus Q4?

Lisa Su

Yeah John that’s hard to say given that the customers are really dictating their ramps. I’ll say that as Rory said earlier a strong part of our guidance in the third quarter is as a result of the semicustom ramp and we expect to ship a number of units over board both the third quarter and the fourth quarter.

John Pitzer - Credit Suisse Securities

Helpful and then Rory you guys did a good job kind of helping us understand the profitability in the gaming system. I’m just kind of curious as we see the launch of new products in the core compute and server market you’re slightly above a breakeven operating level in the June quarter, how do we think about profitability in the core business. I know especially given that you gain market share in the second quarter, breakeven was probably a little bit lower than I would have expected, so how does that picks a sort of track through the second half of the year with the new products and market share gains.

Rory Read

Well I’m actually pleased with the progress to move back to profitability at the mid-point guidance, driving to that level is something we’ve talked about over the past three, four quarters and I think we’re executing well to deliver that. You’re seeing a movement in the revenue up and the control of the expense down, and a nice new set of products that are coming out. That I believe we can continue to build on. The PC segment as I talked about earlier in the call, the market is choppy. There is no doubt that market will continue to be choppy the next 12, 18 months. In spite of that, that market is over 300 million plus units. That’s a great opportunity for us and a key component to our future strategy. We want to grow and we want to take share there.

Now, to augment that and to balance off our expense and reuse our IP, let’s take that IP and technology and apply it into these new high growth segments. You are beginning to see the power of that model emerge here in the 3Q quarter. Now, we have to execute and we need to execute through the end of the year, but that’s the fundamental structure of the business model, Devinder and I and the team are creating.

John Pitzer - Credit Suisse Securities

Thank you.

Rory Read

Thanks John.

Operator

Thank you, sir. Our next question will come from David Wong with Wells Fargo. Your line is open.

David Wong - Wells Fargo

Thank you very much. Given the pre-negotiated pricing patterns you have for the game console chips, do you expect once you are at full volumes, do you expect your annual revenues to grow each year or should we expect them to be fairly flat once you are at full volume with unit growth being offset by pricing declines?

Rory Read

Yes, I think what’s important to think about David is we are talking about third quarter guidance next, and as we go through this process, I think what’s best for you is to look at the historical game console trends over time. I think that’s a pretty good indicator of how this business goes. For us, I think there is a very good opportunity for us to build on this. And of course, Lisa and her team are continuing to build the pipeline in the semi-custom business to attack areas in the server segment, in the home segment, areas where graphics and our technology will play. We want to continue to build out this custom momentum. So, it becomes a very substantial portion of our business going forward. And I think it uniquely positions AMD to create differentiated solutions with our customers, David.

David Wong - Wells Fargo

Okay. And sort of related to this, you guys have said low double-digit operating margin for the console chips, does that put gross margin in the mid-teens?

Rory Read

We wouldn’t talk about gross margin at that level of the business. Devinder has got commentary that shows you in the two business segments that we talk about. I think what you are going to see is that, that business is a good business for us with significant revenue growth managing the expense profile moving forward, flowing profitability to the bottom line, and that’s what we have talked about as part of our strategy to diversify the portfolio.

David Wong - Wells Fargo

Okay, great. Thanks so much.

Rory Read

Thanks David.

Operator

Thank you, sir. And now our next question will come from Hans Mosesmann with Raymond James. Please go ahead. Your line is now open.

Hans Mosesmann - Raymond James

Thank you. Congratulations on the outlook. A comment or a question regarding your positioning with Temash and Kabini with one or two quarter lead over the upcoming Bay Trail, what is the competitive positioning or the advantage that you have besides being first to market versus that device that Intel is going to be shipping later in the year? Thanks.

Lisa Su

Yes, Hans, if you look at our Temash and Kabini offerings, I think we are very pleased with overall performance both on the processing side and the graphics side and the adoption through the OEMs. We do have the time to market advantage and that proves good when you look at on the systems that will be on the shelf both starting this quarter and into the summer. And as we go forward, we think we are well positioned versus Bay Trail as well. So, I think this is an important segment for us to continue to grow in and that some are plans.

Hans Mosesmann - Raymond James

Thank you.

Operator

Thank you. Our next question will come from Christopher Danely with JPMorgan. Please go ahead. Your line is open.

Christopher Danely - JPMorgan

Hey, thanks guys. Can you just maybe comment on the expected term line of OpEx after this quarter and then since you are opening up the kimono on the gaming opportunity, maybe talk about your some of your goals for the combined growth and operating margin targets longer term for the company?

Devinder Kumar

I think the way I would look at it Chris is the following, right. We are on target to hit the $450 million in Q3 of 2013, and beyond that, we are going to be laser-focused to look at the mix between the OpEx and the revenue. And as Rory talked about as the revenue evolves over time whether it's a semicustom business or the traditional business that we have we keep an eye on that and if you take for a moment that there is going to be an uplift in revenue, we’re going to watch them very carefully and what I would say is the increase in OpEx if any would be significantly lower than the increase from a viewpoint of the revenue that’s the way I would look at it. This is really moving to a model which is very different than we have had in the past and with the OpEx reduction that you’re seeing in Q3 with a significant increase in revenue it demonstrates the earnings of the model in particular when you’ve a business that can drop low double-digit to the operating margin and obviously the bottom-line from an overall standpoint.

Devinder Kumar

And Chris on the expense side very important to think about how we’re working on our overall processes and execution. The idea of Ambidextrous architecture and reusable IP. This is what you’re seeing, the power of Jaguar as a core showing up in semicustom offerings into server chips, into all the way to client chips. This is the model on the journey that we’re taking to dramatically improve the efficiency of how we create SoCs, leverage our IP and we have been investing to go get some of the best industry talent and Mark Papermaster’s team and Lisa’s team have really build out that technology leadership but it's around that expense part that you want to see us continue to manage this very tightly and we should not be scaling that in a significant way moving forward.

Christopher Danely - JPMorgan

And combined margin targets for the company, would you care to update us on that?

Rory Read

It's 36% this quarter and that’s a mix of the revenue that we have going from Q2 to Q3 and we’re not giving long term guidance of gross margin at this point.

Christopher Danely - JPMorgan

Sure and then just one housekeeping item, you mentioned that you’re ramping the gaming opportunity this quarter, should we think if the gaming opportunity is being the primary driver for growth in Q4 or will the ramp be done by the end of this quarter?

Rory Read

Q2 to Q3 the gaming opportunity is a primary driver, we’re not talking about Q4 at this point.

Operator

Thank you sir. Our next question will come from Stacy Rasgon with Stanford Bernstein. Please go ahead. Your line is open.

Stacy Rasgon - Sanford C. Bernstein & Co.

First you said that you have obviously the game console royalties that are there now rolling off, my understanding that was about on annual basis a $100 million to $150 million a year. So if you’re running with low double-digit operating margins in the console business even at a $1 billion a year in revenue that seems to be just enough basically over the long term to offset the loss in game console royalties, is that the number one I guess as a magnitude of those numbers correct and is that right way to think about this?

Rory Read

I can’t comment on the magnitude of those numbers as you can imagine but what I can tell you is at what time as our business model is transitioning, we’re going to be in the silicon and development NRE (ph) model in the semicustom business and what you should look at it from an overall standpoint whatever you peg the revenue to be for that business the fall through due to the operating margin line because we’re going to be very operating margin focused as opposed to our traditional historical gross margin outlook that everybody has been focused on the AMD model because this is truly a transition going from one business model that we have had in the history of the company to where it's evolving into more focus on operating margin as opposed to gross margin alone.

Stacy Rasgon - Sanford C. Bernstein & Co.

But it is fair to say there is a loss of royalty revenues is going to impact any gains in operating income from the console business.

Rory Read

That depends, it's all speculation depending on how much the increase is in the semicustom and game console business, can’t really speculate on that.

Stacy Rasgon - Sanford C. Bernstein & Co.

Okay great. I have one more quick question, so this has to do with your wafer commitments to GlobalFoundries. I think right now your current commitments for this year $1.15 billion that is flattish to last year and a PC environment that even according to you guys is right now kind of anything but flat. Are all of the console chips we made at TSMC or can any of those console chips actually go to satisfy your wafer commitments to GlobalFoundries and if not is there a risk of a repeated last year where you had a big turf (ph) I think you’re even still on the hook to pay for about $200 million in wafers that you didn’t need in 2012 and pay for those in the first quarter of 2014, what’s the risk around the wafer supply agreement, is it different to the growth?

Rory Read

Many finds (ph) are made and I think the key thing I would leave you with is you know we do have a commitment this year as you called it a $1.15 billion, be on track to meet the commitments. And as we finished half the year here, approximately half of those obligations have been extinguished. The $200 million that you referred to is part of the termination that we did for 2012 and the market took a downturn and that $200 million is due in our Q1 2014.

Stacy Rasgon - Sanford C. Bernstein & Co.

So, does that imply that some of the consoles which actually are being made at GlobalFoundries, because I don’t see how you could have flat way (inaudible)?

Rory Read

We don’t share level of detail in terms of our foundry strategy, where we make products between the foundries.

Stacy Rasgon - Sanford C. Bernstein & Co.

Okay, thank you guys.

Rory Read

Thanks Stacy.

Operator

Thank you, sir. Our next question will come from Ambrish Srivastava with BMO. Please go ahead. Your line is open.

Ambrish Srivastava - BMO

Hi, thank you. I am just curious Devinder and Rory, why would you not answer the long-term operating margin question that Chris was asking, and I understand it that the business is in transition and there are lot of moving parts, but Devinder, you said that you are running the business with operating margin focus, what is that focus, and I get it that the $450 million, you just delivered on the $450 million and the breakeven, but just trying to understand longer term, what are all the uncertainties that prevents you from giving us the longer term target? Thank you.

Devinder Kumar

I wouldn’t classify it as uncertainty, but let’s just go through what we have said from an overall standpoint. We are on target to get the 20% of embedded semi-custom by Q4 of 2013. We have also said very publicly that longer term we are targeting 40% to 50% of our revenue to higher growth markets and some of those businesses have higher than corporate average gross margins. So, you can imagine as you sit here in Q3 in essentially the first quarter, we are transitioning in a significant manner to a mix of revenue that’s very different than what we have had in the past that there is going to be a transition over time, because there is two to three years to get to the 40% to 50% mix and that can obviously has an impact on revenue, ASPs, it can have an impact on the gross margin, and finally the all-important from my standpoint, the operating margin, because that’s what close to the bottom line of the EPS. So, it’s a transition and you are asking for the longer term model to be laid out in the first quarter where the transition is occurring and that’s just difficult to do.

Rory Read

Yes, and you remember, we are executing a three-step turnaround strategy. We did the restructure. We have completed that. Now, we are in the beginning of the turn and the acceleration as we execute the product plan and the move, and then ultimately we transform the company to that 40%, 50% of the mix in a diversified portfolio on those high growth segments. Now, we are about four quarters, three quarters into this transition, and we are right on track on that strategy.

Ambrish Srivastava - BMO

Okay, that’s helpful, that’s helpful. Thank you, guys.

Operator

Thank you, sir. Our next question in queue comes from Romit Shah with Nomura. Please go ahead. Your line is open.

Romit Shah - Nomura

Hey, thanks for taking my question. Just on gross margin, I want to understand if there is more than one moving part, driving gross margins from 39% and 40%, down to 36%, is it just the higher mix of console or are there other factors as well? Thanks.

Rory Read

Yes, I think going from Q2, Q3, primarily it’s the higher mix of the game console business, that’s driving from the 39%, 40% to the 36% guidance that we are providing.

Romit Shah - Nomura

And Devinder for computing, are computing margins going to improve sequentially in the third quarter?

Devinder Kumar

I am not going to give that level of granularity, but I think you can make the assumption that they are generally stable. We have been running in the 39% if you go back and adjust for the benefit we got from the sale of previously reserved inventory, we have been 39% for the last three quarters, and I think if you are making assumption it’s pretty stable.

Romit Shah - Nomura

Okay. And then the final question for Lisa, you referred to the traditional consumer electronics market, I think in reference to your question about seasonality do you guys have any closer insight on how to think about this console business and the ASP declines that you may see in the upcoming year?

Lisa Su

I mean, again if you think about this, these are usually long-life products. And over 5 to 7 years, you will see cost reductions, I am going to place, but I think we have been clear that the business is a long-term business and we will continue to service it over that period of time.

Romit Shah - Nomura

Alright, thanks.

Rory Read

Thank you.

Operator

Thank you sir. Our next question in queue comes from Cody Acree with Williams Financial. Please go ahead. Your line is open.

Cody Acree - Williams Financial Group Capital Markets

Maybe for Lisa on the embedded processing side, I know you guys have been working for quite some time in the console business. Can you just talk about maybe what the next opportunities maybe applications or end markets that you’re targeting and maybe when we might start to see some of those layer?

Lisa Su

Yeah absolutely. So the semicustom and the embedded are both two important growth markets for us. Semicustom has been so far dominated by gaming but we see a lot of other opportunities, we have a strong pipeline that can similarly use our graphics and computing capability and some of the markets are things like other consumer, specialty servers those types of markets. Embedded processing is also important to us and we see in those markets X86 being a very valuable and industrial and medical and other casino gaming type opportunities and so we have been continuing to build that pipeline as well. Those design wins tend to be longer in nature and take about 12 to 18 months to get into production so that will be more of a 2014 phenomenon to see growth.

Cody Acree - Williams Financial Group Capital Markets

Thanks for the help and on X86, so you’re moving forward with both in ARM and X86 strategy forcing Intel do similar on density on X86 so in the server side, if X86 can reach a similar density and power savings, do you believe there is still as large of a need for an ARM alternative?

Lisa Su

I think really we view ARM and X86 as two important eco-systems that are out there in the industry. So X86 will always continue to be very important in both the PC and the server market but we see ARM being important with the new market especially new operating systems as well as some of the high volume data center application. So yes there will be a market for both ARM and X86 and I think that’s one of the unique things that we can bring over the next few years to the marketplace.

Cody Acree - Williams Financial Group Capital Markets

And then just following data then with your multi-pronged server strategy and the reductions in some of the head counts you had to go through. How confident are you that you’re going to be able to address all of those different tracks without stretching your resources to it.

Lisa Su

Yeah that’s a good question and I think the most important thing for us as a company is really the focus that we have been working on over the past 12 to 18 months has been around reuse and getting a strong reuse across our IP portfolio whether you’re looking at our client semicustom embedded or server markets that use the same core technology, the sane graphics technology and we bring that together in our solutions for each market.

Operator

Thank you sir. Our next question comes from Jim Covello with Goldman Sachs. Please go ahead. Your line is open.

Jim Covello - Goldman Sachs

I thought David Wong and Stacy had some good questions. I just wanted to try to follow-up on those little bit if I could, you know maybe another way of asking what they were asking was if you guys do not get other wins with these APUs this is a gross margin dollar neutral transition in gaming is that correct?

Devinder Kumar

I don’t know what you mean by that question.

Jim Covello - Goldman Sachs

Well the point that Stacy is bringing up you lose an operating income and royalties, what you gain in operating income from APUs, so net-net it's a zero operating margin dollar exchange but then theoretically you have the opportunity to leverage these platforms to gain additional opportunities.

Devinder Kumar

Jim we have a real significant opportunity in this high growth segments to drive over the next two to three years to 40% to 50% of our revenue, that means these businesses are going to get significantly bigger and I think there is an opportunity for that to create very accretive and consistent profitability as we move forward.

Jim Covello - Goldman Sachs

Okay so no ability to get any granularity specifically on the first question I asked?

Devinder Kumar

I think we did.

Jim Covello - Goldman Sachs

Okay then thank you, I appreciate it.

Operator

Thank you sir. Our next question will come from Christopher Rolland with Friedman, Billings, Ramsey & Co. Please go ahead. Your line is open.

Christopher Rolland - Friedman, Billings, Ramsey & Co

Sorry to harp on the OpEx stuff but if you could talk about the gaming consoles expenses either on an absolute basis or at least in anecdotal basis what are the R&D and SG&A cost involved in supporting a launch like this and how do we sort of think about that overtime? Thanks.

Rory Read

I think I have stated in my prepared remarks. When you look at the semi-custom model from a game console standpoint, it is a very different model. It’s a model where the costs are upfront funded jointly between the customer and us. You incur the cost, you are going into the product, and then the time of product introduction, you get the sales. It’s lower gross margin than the corporate average, but the majority of the gross margin dollar’s fall to the operating margin, and that’s the benefit that we get at the bottom line from an overall standpoint. As far as the details of the business and how you manage it between the sales marketing, G&A, and R&D, our leads are coming in the second on the R&D and G&A, but from a marketing standpoint, I can tell you that there is not much, because essentially we are selling products to captive customers in this case and based with the marketing for the end product with consumers, and we supply the product. Lisa?

Lisa Su

Yes, so maybe to add a little bit more color to that, the way these products are defined we jointly define it with the customers. We leverage IP that we have across of our base businesses and then there is an engineering recovery done for the specific customization. Really, no measurable sales and marketing expense just given that it’s pretty customer set, so the (inaudible) ratio is substantially lower than our corporate average.

Christopher Rolland - Friedman, Billings, Ramsey & Co

Okay. Also do you guys see some synergies here perhaps with these next-gen consoles with PC gaming sort of driving sales of AMD graphics cards, like for example might some game developers optimize specifically for an AMD GPU or APU or is that sort of a stretch there, are there any sort of network effects here from gaming consoles across the PC?

Lisa Su

Yes, that we definitely believe there is a great synergy between the game console and the overall PC gaming market. I think gaming is one of the key pillars of AMD in our graphics and APU strategy. So, having the game consoles on the same graphics architecture does allow synergies in the software development and the work that we do with ISVs and we are pursuing that quite aggressively.

Rory Read

Yes, and there is no doubt is the PC gaming segment is one of the best performing segments in the overall PC market. And with this move of the game consoles, you see the key game developers writing to the technology first and we should expect better performance and better time to market based on that. This is clearly a franchise business that will spread across and create a network effect.

Christopher Rolland - Friedman, Billings, Ramsey & Co

Thanks guys.

Operator

Thank you, sir. Our next question will come from Patrick Wang with Evercore. Please go ahead. Your line is open.

Patrick Wang - Evercore

Great, thanks a lot. My first question you guided for about $800 million of semi-custom inventory build this quarter, presumably good chunk of that shift in time for the holidays, can you give us some color to help us think about that and perhaps maybe a sense of how much revenue this supports?

Devinder Kumar

Yes, just to correct if that’s what we said, that’s how it intend, it’s not $800 million game console inventory. There is inventory in the traditional business and actually predominantly it is in the traditional business. The growth in the inventory that I talked about going from Q2 to Q3 is primarily in the game console business to support the ramp that we are seeing in the second half of 2013.

Patrick Wang - Evercore

Okay, got you. So, I appreciate the clarification. So, that’s the incremental inventory you would ship by the fourth quarter?

Devinder Kumar

Yes, you committed it to the products that we build for the customers. Obviously, there is a time lag in terms of getting the wafers and taking into the line and shipping with the customer. When you have a steep ramp in revenue like we are seeing from Q2 to Q3 you are going to have the increase in inventory probably ahead of the time of the ramp, and we ship the product essentially after we finish making it to the assembly and test processes.

Patrick Wang - Evercore

Got you. Thanks. Thanks for correcting me there. Secondly, it sounds like you plan to be cash flow positive either I guess this quarter or in the Q4, so a great job turning that around. I am just wondering is this accurate and then how do we think about the timing of your remaining payments to go (inaudible) in the Q1?

Devinder Kumar

Yes, two things I will say about cash. We have said even earlier this year, we plan to be free cash flow positive in the second half of 2013 and we are on target to do that. And the other thing we have been saying consistently is maintaining cash in the $1.1 billion level, optimal range. We have done that for the past several quarters. And in spite of the payment that’s coming up in the Q1 2014 timeframe I can say that we should be maintaining cash as a $1.1 billion optimal zone level through that timeframe and even in the Q1, 2014 timeframe.

Patrick Wang - Evercore

And last question, you know Rory you talked about the dense server focus, obviously some of the challenge you’re getting in SeaMicro, can you talk about the size of that business to-date that you got maybe a few catalyst you see on the horizon and then also when you think that could hit maybe I don’t know 10% of sales.

Rory Read

Patrick from our perspective we comment on the overall server business, we saw a good solid quarter out of that. We believe that we took share in that server segment and key to that growth is the dense SeaMicro solution but we’re really focused as well on the traditional server, there is opportunities with APUs in the dense space and of course our announcement around ARM server. So I think this is a nice combination of server offerings to move forward and build on.

Lisa Su

Operator we will be happy to take two more questions please.

Operator

Yes ma'am. Our next question in queue comes from Shawn Webster with Macquarie Securities. Please go ahead. Your line is open.

Shawn Webster - Macquarie Securities

So for Q2 you guys said that just flat and when I do the kind of bottoms up with the down ASP quarter for your microprocessors I’m getting up something like 15% to 20% sequentially unit growth for Q2 for microprocessors versus the down let’s say 1% for the global PC market. Can you help us understand or pass through maybe how much of that was your channel inventory rebuilding which you sound like some of that was happening, some new wins and anything else or share gains because it seems like a very strong growth for Q2?

Lisa Su

So as we said we did have a good quarter in the computing solutions group. When you look at the breakdown I would say that we had very strong notebook shipments and that was across our new product portfolio, we also had a little bit of pickup in desktop but I would say that that was more modest than notebook side.

Shawn Webster - Macquarie Securities

Can you characterize how you think inventory is sitting right now at your OEMs in your channel?

Lisa Su

I would say they are typical.

Shawn Webster - Macquarie Securities

Normal levels, okay. And then just another final quick one, the written down inventory benefit that you saw in Q2, is most of that out of the system at this point or are there still parts that you can sell at no cost going forward?

Rory Read

There is some left, I mean we had a 100 million that we took as a write-down in Q3, 2012, we had 20 million of that sold in Q1. We sold 11 million (ph) in Q2 and that benefited close to the gross margin. We have about 65 million left, we don’t see anything on the horizon right now but as I said previously the approach that’s taken and if something comes along and somebody wants those parts, will go ahead and sell those parts.

Operator

Thank you sir. And our final question will come from Glen Yeung with Citigroup. Please go ahead. Your line is open.

Glen Yeung - Citigroup

Thank you. Lisa a question for you about the mix you’re seeing in the PC client business just trying to understand if you’re seeing any changes in your mix of product and does that product tell us something about the mix of the PC market and specifically I’m trying to understand if you think it's a down shift for lower price points in PCs?

Lisa Su

Yes Glen so if you look at our mix, we have typically been stronger in those lower price points like call the $300 to $600 system range and we have seen strength in that area. So overall I would say our mix has shifted a little bit to the lower end and I think that’s typical of the overall markets.

Glen Yeung - Citigroup

So just as a follow-up to that, Intel now is kind of openly saying that with Bay Trial they are one going to allocate a bit more sort of resources to that part of the business and perhaps more importantly key it sounds like they are going to focus more in that mid to low range part of the market. If you sense that, one, they will be more competitive there and then two, what are your thoughts around the implication of that to your share in margins in that part of the resource?

Lisa Su

Yeah I mean I think it's fair to say that that’s where the market is focused so the customer focus as we get more Windows 8 based touch systems into that more mainstream price points, so I think that’s a market shift. Clearly it's important to stay competitive in that area and we’re continuing with our new product portfolio to do that. So I think overall we will continue to focus in that area and continue to be quite competitive.

Lisa Su

Operator that concludes our second quarter earnings call and we would like to thank everybody for participating and if you could close the call we would appreciate it.

Operator

Sure. Thank you presenters and thank you ladies and gentlemen. Again this does conclude today’s conference. Thank you for your participation and have a wonderful day. Attendees you may log-off at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Advanced Micro Devices, Inc. (AMD) CEO Discusses Q2 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts