Advanced Micro Devices Returns To Profitability, Is It Sustainable?

Oct.18.13 | About: Advanced Micro (AMD)

On Thursday in after hours, AMD (NYSE:AMD) announced its quarterly earnings, where it posted a profit of 4 cents per share, beating analyst estimates of 2 cents per share. The company ended up posting a positive cash flow in the quarter, easing worries that it is burning through cash. In addition, AMD revised up its short-term guidance; however, the investors don't seem very happy with the company's results as its shares sold off in the after-hours with strong volume. It looks like investors are still skeptical about the long-term profitability of AMD.

As PC sales continue to decline quarter after quarter, AMD is attempting to diversify its portfolio and reduce its exposure to the PC market by offering more products in other markets, such as the gaming market. Lately, the company won some business from Xbox producer Microsoft (NASDAQ:MSFT), PlayStation producer Sony (NYSE:SNE) and one of the biggest gaming companies in the world, Nintendo. These companies are planning to launch next generation consoles during this year's holiday season, which should help AMD greatly.

On a negative note, the company expects its sequential revenue to rise by only 5% because most of its gains in the gaming market will be offset by the reduced business in the PC market. The analysts are looking for AMD to generate $1.52 billion in revenues next quarter but the company's guidance calls for $1.49 billion. Compared to the 26% sequential gain posted by the company, its guidance of 5% growth was not good enough to satisfy many investors who see the company's revenue growth slowing substantially.

Even though AMD's gross margin fell from 40% to 36%, the company's operating margin improved for the quarter. This is because the company's research, development and marketing budget fell between last quarter and this quarter. Last quarter, AMD spent $308 million on research and development and $171 million on marketing and general administrative expenses. This quarter, the research and development costs fell to $288 million and marketing and general administration expenses fell to $155 million.

AMD's operating income for the quarter was $95 million which corresponds to an operating margin of 6.51%. Last quarter, AMD's operating margin was -2.50% and in the same quarter last year, the company's operating margin was -10.31%. While compared to the last quarter and the same quarter of last year there are a lot of improvements, the company's margins are still thin, which doesn't offer much of a cushioning in case something goes wrong. For the last quarter, AMD's net profit margin was 3.29%.

Investors are also worried about AMD's balance sheet. Last quarter, the company spent $47 million on interest expenses, up from $42 million last quarter. Year to date, AMD's interest expenses totaled $133 million. Excluding the interest expense, AMD's quarterly net income would have doubled and its year to date loss would have been almost wiped out. This is why it's important for the company to keep its debt level down and keep profits in its bank account rather than spending it on servicing debt. Speaking of debt, AMD's current debt totals $2.04 billion which is pretty close to the company's current market value of $2.8 billion. On a positive note, AMD's cash position improved from $968 million to $1.06 billion during the quarter. Year to date, AMD's cash position is up by $58 million and its debt is up by $7 million.

Moving forward, the company will have to generate enough profits from the gaming market to offset its declines in the PC market. In the chip market, there is a lot of competition for already-declining revenues and this is likely to put pressure on the margins in the short and medium term. Recently, the company's management has been doing well on the executing side, but it can't just sit back and rest yet. There is still a lot of work before we can safely say that AMD's recovery is sustainable. It would be fair to say that the company has taken the right steps in the right direction and things are coming along for the company at a slow but steady pace.

Last year, I bought AMD when it was trading above $8 and it was sad to see the share price fall day after day, until it bottomed at prices below $2. Even though I was able to bring the breakeven price down by selling covered calls every month, I ended up selling my shares at a pretty big loss. This year, I don't plan on touching the stock but things are working out well for the investors of AMD, and it might be wise to hold onto these shares for awhile as the company's recovery continues.

To go back to the question in the title, it's too early to tell if AMD's profitability is sustainable but the company is moving in the right direction and it still has a lot of work to do.

Disclosure: I am long MSFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.