AMD (NYSE:AMD), which manufactures and markets microprocessors and graphics processors used in PCs, servers and gaming systems, reported its Q4 2013 earnings on January 21. Having incurred losses for several quarters, the company only returned to profitability and positive cash flow last quarter. But the momentum continued into year end as its net income increased by 85% sequentially in Q4 2014. At $1.6 billion for the year-end quarter, AMD's revenue expanded by 8.8% quarter over quarter and 37.6% year over year, mainly driven by the strong growth in its graphics and visual solutions business, which was offset by lower computing solutions revenue. Computing Solutions revenues were down 9% sequentially and 13% year to year, as the company continued to lose market share to Intel. Clearly, other markets (discussed below) are driving growth. For full year 2013, AMD reported a 2.3% decline in revenues.
AMD announced a three-part restructuring plan in Q3 2012 in an effort to strengthen its competitiveness in the market, and better manage its expenses and cash. In 2013, the company completed the restructuring phase, which helped generate strong revenue growth and a return to profitability in the second half of the year (by successfully ramping strong and diverse set of new products). AMD claims to have lowered its operating expenses by more than 20% in the latter part of 2013, compared to the Q1 2013 level, and exceeded its target of deriving over 20% of its revenue from semi-custom and embedded products.
In 2014, AMD aims to further diversify its portfolio and derive a larger share of its revenue from high growth markets, including semi-custom and ultra-low power processors, professional graphics processors, as well as processors for dense server and embedded solutions. However, since AMD continues to derive a significant portion of its revenue from the PC market, it remains highly sensitive to any adverse development in the industry.
Our price estimate of $3.55 for AMD is at a discount of approximately 15% to the current market price. We are in the process of updating our valuation.
Strong Game Consoles Sales Drove Growth In Q4 2013
AMD's graphics solution group witnessed a 29% sequential and a 165% annual growth in Q4 2013, which was primarily driven by higher demand for game console semi-custom SOCs, as well as new R7 and R9 series of GPU products.
AMD devised a unified gaming strategy in March 2013 that addresses its plan to drive the gaming market across consoles, cloud platforms, tablets and PCs. It believes that it is effectively positioned to drive the next revolution in gaming and now powers all major next generation consoles including Sony's (NYSE:SNE) PlayStation 4, Nintendo's (OTCPK:NTDOY) Wii U and Microsoft's (NASDAQ:MSFT) Xbox One. Sony and Microsoft together sold more than 7 million units in less than two months, more than double the number of prior generation consoles sold in their first quarter of introduction. 
AMD believes that gaming is one of the key pillars of its semi-custom chip business. It shipped millions of units to support the next-generation Sony and Microsoft game consoles in Q3 2013 and Q4 2013, which utilize AMD's system-on-chip Jaguar core and Radeon HD graphics chips. It expects the positive momentum to continue with the rise in game console SOC shipments and new wins from its semi-custom design pipeline.
2013 Was A Record Year For Professional Graphics
AMD currently accounts for 21% of the professional GPU market, which is dominated by Nvidia. Strong performance in professional graphics was an important factor that drove AMD's growth in the last six months. It marked its sixth consecutive quarter of revenue and share growth in the professional graphics business segment, which accounts for approximately 7% of its valuation (as per our estimate).
AMD believes that it can drive additional growth in the professional graphics segment based on the incremental focus and investments it is making to strengthen its product portfolio, expand its work with key software developers and secure more design wins.
Apple (NASDAQ:AAPL) has used AMD's dual FirePro professional graphics solutions in its recently launched Mac Pro desktop. Digitimes reports the deal could increase AMD's professional GPU market share to 30% by the end of 2014. 
A Broad Embedded Products Portfolio To Target Different Segments
In September 2013, AMD announced its future road-map for the fast growing embedded computing market. In addition to the new improved x86 processors, the company unveiled its first ARM-technology based processor, extending its ambidextrous strategy to embedded markets. It is now the first company to offer its customers both ARM and x86 architecture based solutions for low-power and high-performance embedded compute designs.
As per a recent VDC Research report, the market for traditional and intelligent embedded CPU systems will grow 36% in the next few years, from 330 million units in 2013 to over 450 million units by 2016. The x86 and ARM architecture together are estimated to account for 82% of the total addressable market. 
AMD's embedded business grew sequentially throughout 2013. The company has a broad range of embedded processors for different segments in its portfolio, offering a number of price, performance and power options to meet the needs of embedded designers. Its strong embedded design pipeline will drive growth for this business across 2014.
Collaboration With ARM To Help Tap Growth In Servers
In October 2012, AMD announced its collaboration with ARM Holdings to design server processors using the ARM technology in addition to its x86 processors for multiple markets, starting with cloud and data center servers. The collaboration with ARM makes AMD the only processor provider to bridge the x86 and 64-bit ARM ecosystems. AMD believes that ARM CPUs have the potential to account for 20% of the server market by 2016 or 2017. 
AMD remains on track on sampling the industry's first 64-bit ARM server SOCs in Q1 2014 and claims to be seeing strong interest from both traditional server OEMs and end customers like cloud providers. By offering manufacturers and data-center operators cheaper and more power-efficient processors, we believe that AMD will manage to re-gain some of its market share from Intel.
Q1 2014 Outlook
- Revenue to decline by 16% sequentially, plus or minus 3%.
- Computing solutions segment revenue to be down in line with seasonality. Graphics and visual solutions revenue to decline sequentially due to a strong Q4 for semicustom SOCs.
- Non-GAAP gross margin of 35% and non-GAAP operating expenses of approximately $420 million.
- Revenue to rise year over year.
- Non-GAAP operating expenses to be in the range of $420-$450 million.
- Taxes of approximately $3 million per quarter.
- Capex of approximately $120 million.
Disclosure: No positions.