Having incurred losses for several quarters, microprocessors and graphic processors manufacturer AMD (NASDAQ:AMD), returned to profitability and positive cash flow in Q3 2013. The company has built on the momentum gained in the second half of 2013 with a strong start to its fiscal 2014. Its Q1 2014 revenue declined by 12% sequentially but registered a 28% annual growth. The results beat both company guidance and analyst estimates and were primarily driven by GPU and semi-custom APU sales. However, on account of the rising revenue contribution from the semi-custom business, AMD's gross profit declined to 34.9% in Q1 2014, compared to 40.9% in Q1 2013, as the segment offers lower gross margin compared to company wide margin.
Renewed demand in its traditional PC segment and growth opportunities in new markets have helped AMD improve its financial and operational performance in the last few quarters. AMD completed its restructuring phase in 2013 and management claims that the strategy of transforming the company is working well. Its focus on alternate growth markets has helped reverse, to some extent, the continuing decline in PC shipments. AMD claims to be on track with its goal of deriving 50% 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, by the end of 2015.
With the renewed wafer supply agreement with GlobalFoundries and re-profiling of its near term debt, AMD feels confident of accomplishing its financial goals for 2014 and beyond.
Our price estimate of $3.72 for AMD is in line with the current market price. We are in the process of updating our price estimate to incorporate the Q1 2014 earnings.
Stabilizing PC Market
Having grown at a robust rate for many years, PC sales started declining 2011 onward. As per research firm IDC, PC shipments declined 3.7% and 10.3% in 2012 and 2013, respectively. The rate of decline dropped down to 4.4% in Q1 2014 as Windows XP migration (to machines running newer operating systems) and commercial spending helped offset the weak consumer PC demand.  The industry is witnessing strengthening consumer demand from emerging markets even though consumer demand in the rest of the world remains weak.
AMD witnessed a 8% sequential and 12% annual decline in its computing solutions group on account of lower desktop and chipset revenue, partially offset by higher notebook revenue. However, lower operating expenses improved the segment's operating income, both sequentially and year to year. Growth in notebook shipments was driven by rising customer demand for AMD's Beamer and Kaveri APUs.
Though AMD has significantly lowered its dependence on the PC market, it continues to derive a considerable portion of its revenue from the segment (including GPUs and APUs). The company expects overall PC shipments to decline 7% to 10% in 2014. It intends to focus on growing in segments where it is under-represented, such as the commercial PC business. It claims to have a new set of commercial products in its pipeline with which it aims to drive growth in the segment in 2014. It has a number of design wins which will ramp up in the second half of the year.
New Design Wins In Game Consoles To Drive Growth
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 PlayStation 4, Nintendo's Wii U and Microsoft's (NASDAQ:MSFT) Xbox One.
Strong demand for game consoles was a key factor behind AMD's growth in Q1 2014 as the company shipped millions of units to support the next-generation Sony (NYSE:SNE) and Microsoft game consoles. Sony and Microsoft together sold more than 7 million units so far, more than double the number of prior generation consoles sold in their first quarter of introduction.  AMD expects its semi-custom business to continue growing strongly as game consoles ramp up throughout the year. It claims to be on track to win 1-2 new semi-custom designs this year.
AMD Gains Additional Market Share in Professional Graphics
AMD currently accounts for 21% of the professional GPU market, which is dominated by Nvidia (NASDAQ:NVDA). Strong performance in professional graphics was an important factor that drove AMD's growth in the last few quarters. In Q1 2014, it marked its seventh 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). Much of the growth was driven by the launch of Apple's (NASDAQ:AAPL) Mac Pro desktop, which uses AMD's dual FirePro professional graphics solutions.
AMD believes that it is under-represented in the professional graphics segment and thus is increasing its investment in the area to build a stronger relationship with key customers.
Q2 2014 Outlook
- Revenue to increase 3% sequentially, +/- 3%.
- Gross profit of 35%, flat sequentially.
- Non-GAAP operating expenses of $435 million.
- Cash and cash equivalents of $1 billion.
Disclosure: No positions.