Advanced Micro Devices' (AMD) CEO Rory Read on Q2 2014 Results - Earnings Call Transcript

| About: Advanced Micro (AMD)

Advanced Micro Devices, Inc. (NASDAQ:AMD)

Q2 2014 Earnings Conference Call

July 17, 2014 05:30 PM ET

Executives

Ruth Cotter - CVP of IR

Rory Read - President and CEO

Devinder Kumar - SVP and CFO

Lisa Su - SVP and COO

Analysts

Mark Lipacis - Jefferies & Company

David Wong - Wells Fargo

John Pitzer - Credit Suisse

Ross Seymore - Deutsche Bank

Christopher Rolland - FBR Capital Markets

Joe Moore - Morgan Stanley

Stacy Rasgon - Sanford Bernstein

Matt Ramsay - Canaccord Genuity

Betsy Van Hees - Wedbush Securities

Romit Shah - Nomura

Jim Covello - Goldman Sachs

Mike McConnell - Pacific Crest

Operator

Good day ladies and gentlemen. Thank you for standing by. And welcome to the Advanced Micro Devices’ Q2 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference to our host Ms. Ruth Cotter, Corporate Vice President of Investor Relations.

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’ve not reviewed these documents, they can be found on AMD’s Web site at ir.amd.com.

Speakers on today's conference call are Rory Read, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President and Chief Financial Officer. Lisa Su, our Senior Vice President and Chief Operating Officer will be present for the QA portion of the call.

This is a live call and will be replayed via webcast on amd.com.

I’d like to take the opportunity to highlight a few dates for you. Devinder Kumar will attend the Jefferies Semiconductors, Hardware & Communications Infrastructure Summit on August 27th in Chicago. Rory Read will attend the Deutsche Bank Technology Conference on September 9th in Las Vegas. Our third quarter quiet time will begin at the close of business on Friday, September 12th and lastly we intend to announce third quarter earnings on October 16th.

Please note that non-GAAP financial measures referenced during this call are reconciled to their most directly comparable GAAP financial measure in the press release and CFO commentary posted on our Web site at quarterlyearnings.amd.com.

Before we begin, let me remind everyone that today’s discussions 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.

Please refer to the cautionary statements in today’s earnings press release and CFO commentary for more information. You’ll also find detailed discussions around our risk factors in our filings with the SEC and in particular AMD’s quarterly report on Form 10-Quarter for the quarter ended March 29, 2014.

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

Rory Read

Thank you, Ruth. The second quarter capped off a solid first half of the year for AMD. We have made significant progress in transforming our Company. This was highlighted by our second quarter results including; revenue of $1.44 billion, an increase of 24% from the year ago period; and non-GAAP EPS of $0.02, an improvement of $0.11 compared to the same period last year.

We are clearly executing our strategy, building a stronger AMD business model and enhancing our ability to deliver consistent performance. We have diligently managed expense and lowered our cost structure, significantly reducing operating expense, while strategically investing in innovations that will fuel our future growth. At the same time we have relentlessly focused on improving and consistently executing, hitting our key products, milestones and ensuring we deliver on our commitments to our customers.

We have improved our balance sheet by re-profiling debt at lower rates, which we expect will reduce our interest expense with no significant debt coming due until 2019. We have driven our AMD leadership processing and graphics technology into new markets. And we are currently on track to generate approximately 40% of our revenue from these high growth markets for the full year 2014. And we also remained on track to deliver 50% of our revenue from these high growth markets by year-end 2015.

As a result, for the first six months of 2014, AMD’s revenue increased 26% and our non-GAAP EPS improved by $0.26 compared to the first half of 2013. We have now delivered four consecutive quarters of non-GAAP profitability and we remained on track to deliver on our commitment of non-GAAP profitability and revenue growth for the full year 2014.

Now let’s turn our attention to our business achievements in the second quarter. Semi-custom SoC shipments increased from the prior quarter as we continued to see strong demand for AMD-powered game consoles. We had record semi-custom unit shipments in the second quarter, and we expect to continue to ramp shipments into the third quarter, our peak quarter as Microsoft and Sony prepare for the holiday cycle.

In our embedded business, revenue increased by double-digit percentage from the previous quarter as new design wins started to ramp in this key growth market. We launched several new products in the quarter and announced win with HP’s thin clients, as well as Boeing’s next generation advanced cockpit display systems to name just a few.

Most importantly looking at our embedded pipeline, our design win momentum accelerated in the first half of this year across our key target markets of thin client, gaming and industrial controls.

In our professional graphics business, unit shipments increased significantly from the prior period as we continue to grow our FirePro business with Apple, Dell and HP. We look forward to driving either more share gains in this margin accretive market.

In our dense server business, first half 2014 revenues more than doubled compared to the year ago period. And we are actively sampling Seattle, the industry’s first 28-nanometer 64-bit ARM server processor and remain on track for launch in the fourth quarter.

Now let’s turn to the PC market. The overall PC market has shown signs of improvement, largely driven by the commercial refresh cycle. However, the consumer market remains under pressure. And we expect the overall PC market is going to continue to be down by 5% to 7% for the year 2014. In the second quarter AMD’s overall microprocessor unit shipments increased sequentially for the first time in four quarters, driven by the introduction of new notebook from Acer, Dell, HP, Lenovo and others powered by our latest Vima and Kaveri APUs. We also launched AMD’s Pro A-Series APU in the quarter and remain on track to more than double the number of AMD-based commercial offerings available by the end of the year. HP has already announced a full range of elite commercial offerings powered by AMD and additional OEMs will begin rolling out AMD-powered commercial offerings this quarter.

In the desktop space, demand for our desktop APUs was strong from our OEMs; however, the desktop component channel was softer than we expected. We believe that with the expansion of our A-series APU portfolio and continued ramp of our first lower-powered socketed desktop APU, this business was strengthened over the coming quarters. Overall, we saw the first sequential revenue increase for our computing solution segment in four quarters. Our PC strategy remains focused on developing profitability by diversifying into the commercial stabilizing the overall PC business and leveraging the channel to deliver profitability.

Now let’s turn to graphics. In graphics, we saw a strong growth in our notebook GPUs as OEM design wins began to ramp in the quarter. This was offset by a decline for our enthusiast class offering in the AIB channel as demand from cryptocurrency miners abated. We expect to increase GPU shipments this quarter as market pricing for our R7 and R9 offerings become more consistent and as we head into the, what is typically the stronger second half of the year for GPUs. Regaining graphics market share remain a priority and we are confidence that our products go-to-market programs and design wins can drive gains throughout the coming quarters.

Today, we are more than half ways through our three-step transformational strategy. I am pleased with the progress that we have made as shown by the significant turnaround in our results and our strong continued momentum. We still have more work to do. In the second half of the year, we are focusing on delivering non-GAAP profitability into 2014 and full year revenue growth by continuing the following. The ongoing ramp of our semi-custom SOCs to meet the strong game console demand, driving sales for the expanded number of design wins we have secured in the commercial space, which is the clearly the strongest performing part of the PC market.

Return growth in our channel business and gain share and discrete graphics and continued growth in the embedded and professional graphics markets and securing additional design wins. We also remain on track to secure one to two additional semi-custom design wins that will help to accelerate our transformation throughout the coming years. So in summary, we are demonstrating that our three-step transformation is driving solid progress and result at AMD. To help drive continued success in the next space of our transformation, last month we realigned several internal functions to create a single market focus team design to strengthen our traditional PC business and drive future growth in adjacent markets where our leadership IP provides AMD with a competitive advantage.

We appointed Lisa Su as Chief Operating Officer to lead this new organization and she will oversee daily operations of our product roadmap strategy and execution to help drive long-term growth. Our three-step transformation will take us through 2015 at which time a different AMD will have a diversified portfolio, consistent execution, and our next generation technology which will take us to the next space. Our strategy is working and we look forward to updating you on our progress and success as we forward you head.

With that, let me turn the call over to Devinder, Devinder?

Devinder Kumar

Thank you, Rory, and good afternoon to tall those listening today. We had good financial performance in the second half quarter, capping off a solid first half of 2014. We grew revenue sequentially and realized our fourth straight quarter of non-GAAP net income. We also continue to make progress on our strategy to transform AMD and saw traction in our growth businesses as evidenced by the strong performance of our semi-custom, professional graphics and embedded products.

Turning to the specifics for the second quarter, revenue was $1.44 billion, up 3% sequentially, driven primarily by strong sales of our semi-custom SoC and notebook offerings and up 24% year-over-year, primarily driven by strong sales of our semi-customs SoC offerings? Gross margin was 35%, flat from the prior quarter despite higher semi-custom SoC sales which have a lower than corporate average gross margin, offset by a richer mix of notebook products. Non-GAAP operating expenses in the second quarter were $431 million, up 10 million from the prior quarter. We continue to manage operating expenses in line with revenue to meet our profitability goals and for the fourth quarter in a row the non-GAAP operating expense to revenue ratio was 30% or better.

Non-GAAP operating income was $67 million and non-GAAP net income was $17 million with non-GAAP earnings per share of $0.02, calculated using $764 million diluted shares. Second quarter non-GAAP earnings per share excludes $49 million of loss from debt redemption in the quarter. Adjusted EBITDA was $137 million, down $2 million from the prior quarter and for the trailing four quarters adjusted EBITDA was $594 million.

Now turning to the business segments. Computing Solutions segment revenue was $669 million, up 1% sequentially due to higher notebook and embedded process sales, offset by lower desktop, processor and chipset sales. Computing solutions operating income was $9 million, an improvement from an operating loss of $3 million in the first quarter. This was driven primarily by improved gross margin from a richer mix of notebook processors.

Graphics and Visual Solutions segment revenue was $772 million, up $38 million or 5% from the prior quarter, primarily due to an increase in sales of our semi-custom SoCs. Operating income was $82 million, compared to an operating income of $91 million in the prior quarter, primarily driven by lower GPU revenue.

Turning to the balance sheet. Our cash, cash equivalents and marketable securities balance totaled $948 million at the end of the quarter, down $34 million sequentially, primarily due to the timing of sales and related collections during the quarter. Inventory was $960 million, up $91 million, primarily driven by increased level of our latest 28 nanometer microprocessor products and lower shipments to channel distributors. We remain focused on maintaining appropriate levels of inventory and plan to manage inventory levels down throughout the rest of the year.

Debt as of the end of the quarter was $2.2 billion, up $72 million from the prior quarter due to our most recent debt re-profiling activities. In the second quarter, we issued $500 million in principal amount of 7% senior notes due in July 2024, utilizing the proceeds to fully extinguish our 8% and 18% notes due in December 2017. By executing these debt transactions, we have further extended our term debt maturities and have no significant term debt maturities for approximately five years.

Additionally, we expect to reduce interest expense by approximately $3 million per quarter starting in Q3, 2014. One housekeeping note, the remaining $41 million net of our 6% convertible senior notes due in May 2015 has now been reclassified as short-term debt on the balance sheet.

Accounts payable at the end of the quarter was $511 million, up slightly from $483 million in the first quarter. We had negative free cash flow of $51 million in Q2, 2014, an improvement from the first quarter of 2014 which included a $200 million cash payment to global foundries related to the reduction of the take or pay wafer obligation commitments for 2012.

Now turning to the outlook. The overall PC market has strengthened, largely driven by the commercial space although there is continued weakness in the consumer PC market. In our semi-custom business, based on our strong first half shipments, we anticipate semi-custom revenue been more evenly spread across the year.

Guidance for the third quarter of 2014 is as follows; AMD expects revenue to increase 2% sequentially, plus or minus 3%; gross margin is expected to be approximately 35%; non-GAAP operating expenses are expected to approximate $435 million; interest expense to be approximately $42 million and the total of interest expense, taxes and other is expected to be approximately $50 million; and inventory is expected to decrease from second quarter levels.

In summary, we are pleased with the performance we delivered in the first half of 2014 in line with our commitments and a singularly focus on continuing to transform the company by executing the plans we have outlined. We remain on track to meeting the financial commitments we set for the year including; continued operating expense discipline while growing revenue year-over-year; achieving non-GAAP net income profitability; and positive free cash flow generation for 2014.

With that, I’ll turn it back to Ruth. Ruth?

Ruth Cotter

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

Question-And-Answer Session

Operator

(Operator Instructions) And our first question comes from Mark Lipacis from Jefferies. Please go ahead.

Mark Lipacis - Jefferies & Company

Thanks for taking my question. The first question I guess is on the seasonality of the game console business. I guess if you look at historically the shipments of the game consoles they’re more backend weighted in the year, maybe two thirds, one third or something like this. But it sounds like you are expecting the revenues from game consoles to be even through the year. So I was hoping you could help me reconcile that. Thank you.

Rory Read

Yes, one of the things Mark we focused on was to create a more balanced business execution throughout the year. You saw strength in our first half results because there was clearly some pent up demand in terms of the gaming, the new country launches. And obviously, that launch was in the second half of last year. This year is it’s gone very well in terms of the semi-custom game console work, it’s strong, it’s up, it’s going to continue to ramp in third quarter. But we’re seeing a more balanced kind of role. You’ll see a little bit more strength in 3Q, but we did profit and take advantage of a more balanced first half of the year.

Lisa, did you want to add anymore color?

Lisa Su

Yes. No, Mark, I would say that since we’re still in the first three or four quarters of the game console ramp, it’s really hard to call seasonality as they’re still bringing on new game titles in new region. So the best way to look at it is as a whole the semi-custom business is going to be a strong business for us. We’re going to see great growth year-over-year. You will see more systems ship in the second half of the year versus the first half of the year. There is bit of a timing phenomena between when we ship and then what our customers manufacture and sell-through. So, overall, strong business but a little bit more balanced than what you might expect three or four years from now.

Mark Lipacis - Jefferies & Company

Thank you. That’s helpful. And follow up question if I may. On the semi-custom programs could you give us a sense of how many you have in the pipeline? Last time you talked about the potential to announce one or two more this year. Where are the most likely areas where we could see your success in that business? Thank you.

Lisa Su

Yes, absolutely. So, on the semi-custom pipeline, we continue to make good positive progress in the quarter. We are on track to announce one or two confidential design wins in 2014. I think in terms of markets, the traditional market where we’re quite strong is obviously gaming. But we’ve seen a lot of activity in mobility as well as several new opportunities in networking that are quite interesting as well.

Rory Read

And there is definitely a market trend and interest in terms of this capability. So we’ve seen an increase in the pipeline over the past 12 months. I don’t think there is any question about that. And we’re moving those through with good interaction and good communications with those customers. So again we’re on track for one to two wins in 2014.

Mark Lipacis - Jefferies & Company

Thank you.

Operator

Our next question comes from David Wong of Wells Fargo. Please go ahead.

David Wong - Wells Fargo

Thanks very much. Do you have any major new computing solution processor family launch is scheduled for the second half of this year?

Rory Read

We’ve seen a really good uptake David in terms of what we did with Vima and Kaveri in the first half. They have been very nice launches. That's part of the reason we’ve seen that stabilization in our PC business. As you know David, the PC market is more positive; I got that, but overall still down. That positive drive is from the commercial part, we’re over indexed to consumer obviously. Those new products we’re introducing are giving us that stability. And that's something I think all of you’ve been looking for over the past almost two years for us to show that stabilization of that business. And the strategy for us to go after commercial, I think Lisa can add some nice color in terms of the progress that we’re making there. It’s a more balanced set of PC solutions that we’re delivering, and then Lisa also maybe David in terms of the follow on introductions in the channel for the stock parts and any other family processors you want to add.

Lisa Su

Yes, absolutely David. So in terms of what we’re doing in the overall computing solutions business, we just in the second quarter launched our Beema, Kaveri, Kaveri Mobile, Mullins product lines. Those are doing very, very well. Kaveri in particular in mobile is going into our commercial solutions, so we’ve talked about the AMD Pro A-Series. That has gone nicely. HP announced to set up EliteBooks around that and you will see more systems in the second half of the year. You will see us announce more channel offerings as well in the desktop panel as we fill out our APU product line there.

And then on the server side, we talked about sampling Seattle earlier this year and you will see that moved to the production stage towards the end of the year.

David Wong - Wells Fargo

Okay great. And the quick one for Devinder, Devinder if I understand correctly your guidance suggest cash balances will go up in the third quarter?

Devinder Kumar

I didn’t give cash balances in up for the third quarter, but David you can assume with the guidance that we have given that will be close to optimal zone of about $1 billion from that standpoint.

David Wong - Wells Fargo

Okay great. Thank you.

Operator

Our next question comes from John Pitzer of Credit Suisse. Please go ahead.

John Pitzer - Credit Suisse

Yes, good afternoon guys. Thanks for letting me ask the question. Rory first just a clarification to make sure I heard you right. I think in your prepared comments you called out Q3 is the peak quarter, but I’m sure if you were just referring to the custom gaming or the overall business? And in general, how do we think about seasonality between Q3 and Q4 especially given that you’re in the midst of this gaming ramp?

Rory Read

Hi John. The comment was based on the semi-custom game console in terms of where that is. You would expect us to ship into those key suppliers, Sony and Microsoft in that late quarter kind of very early fourth quarter in terms of the peak. That's why I commented on that. If you look at business what we’re trying to do and what we’ve been very focused on is to try and create consistent revenue across each quarter so that we can deliver profitability. That's really important to the strategy to be able to consistently deliver that revenue that matches the cost structure and gives us the base to consistently deliver the bottom-line. And I think that's what's nice about the diversification of what we’ve been doing in terms of getting that nice mix of growth businesses with the traditional. That gives us buffer and support if one part of the business is a little bit different in a particular quarter, but because of the diversity we get the mix.

In terms of seasonality, we wanted to focus on 3Q here. We’ll talk about 4Q in the next one. But clearly we would expect the PC business to continue to traditionally be the same or slightly up. You can piece together each piece of it, but the peak for gaming is definitely in 3Q.

John Pitzer - Credit Suisse

That's helpful, Rory. And then guys maybe as my follow-up for either Rory or Lisa, just conceptionally relative to the repositioning of the company, how important now going forward is kind of the Moore’s Law of treadmill. And I sort of asked the question because perception is perhaps that you’re not moving down node just quickly. I know that you’ve talked about kind of your 20 nanometer roadmap, but you really haven’t said much, at least to my knowledge on FinFET and I guess given some of the difficulties or puts and takes that we hear out and the investment community hear going through with what foundry is doing what and having success at FinFET. I’d be kind of curious, how important going forward to your success is kind of that Moore’s Law curve and how do you guys think about 20 FinFET and beyond?

Lisa Su

Hello John, so let me take a step at that. I think when you look at what's important to us, I mean clearly process technology is an important element but we have invested quite a bit in architecture, design techniques, new IP software. So, I wouldn’t say that process technology is the first and primary determinants for us. It is important that we are on competitive technology, so we have said before and I will say again that 20 nanometer is an important note for us. We will be shipping products in 20 nanometer next year and as we move forward obviously a FinFET is also important. So, if you look at our business, it is quite a bit more balanced between the semi-custom, embedded sort of commercial PRO Graphics growth portions as well as the more traditional sort of client and graphics pieces of our business. So technology plays in all of those businesses.

Rory Read

Yes, and we are going to move down the curve, John, there’s not a question. But there is a lot of lengths in 28, you are going to see a nice mix across it because of the nice price points you can get there in terms of the business and the mix that we are driving but clearly we know that we are going to move 2020 to nice incremental improvement in terms of its technology and things are obviously going to play a key role in terms of as we move. But we want to make sure that it’s not just technology for technology that we get the balance, the crossover point between the profitability, the cost of the technology and the cost of the product that we can sell, so that we are delivering the bottom line and the balance results that we have talked about.

Operator

Our next question comes from Ross Seymore of Deutsche Bank. Please go ahead.

Ross Seymore - Deutsche Bank

Hi, thanks for letting me ask the question. I guess when we look into the third quarter guidance, the first question is, can you give us a little bit idea the puts and takes of what your expectations are for your computing solutions group and then your standalone traditional graphics business and kind of sequential growth, how that builds into your overall guidance et cetera?

Rory Read

Yes, so one of the things, Ross, that we talked about is that we see the stabilization actually some improvement in the coming quarters in the compute. We like the technology that we brought to market with Beema, Mullins, the Kaveri solution, the movement into commercial. I think those are positive puts and you saw that in terms of notebook space. The area that we saw softness in the sector quarter and I think continues a little bit into third quarter, is in the Graphics segment and particularly in the enthusiast. We saw that crypto currency as we have expected to a bay but it was sharp because of the failure of some of those exchanges. And we also saw then because of its sharpness a follow-up in terms of second hand cards flooding into the market in that period of time based on that whole crypto of that.

Now on the PC side I think there is no question that the PC channel also was softer than we expected. We think with the introduction of the products that we are talking about, Lisa touched on them a second ago on the earlier question that we will position for that to improve. But I think what you are seeing is for us, it’s mostly about consumer that’s still a tough tight market with the new parts of the business that we are going in like commercial it’s early really nice signs, some really nice marquee wins. We are going to see that continue but we have got to be realistic in terms of how fast that ramps and then we got that channel to start to move in a positive direction again on both parts, both graphics, enthusiast and on the desktop channel. That’s kind of the puts and takes and that’s kind of why you see that kind of move in a positive but muted direction.

Ross Seymore - Deutsche Bank

I guess this is my follow-up on the gross margin side of things. To the extent you are guiding it flat sequentially, what are the dynamics that allows that to happen because it seems like mix is going to move very largely in favor of your semi-custom gaming SoCs, is that still carrying a substantially lower gross margin or is the gross margin improving on that side or is there some other mix dynamic we need to appreciate?

Rory Read

Only thing I want to be careful in that I want to say that there is a major shift in gaming. We have had a very strong gaming business all year along and we expect it will be strong and it’s going to peak in 3Q but I wouldn’t major. That’s not the right terminology. And I think because we have got a nice balanced business there, we are not seeing some of the changes in terms of the mix and like nice balanced mix from quarter to quarter to quarter, so that we can maintain that. Devinder do you want to add some color?

Devinder Kumar

Sure, as Rory said earlier we do see the peak from a semi-custom unit standpoint in Q3 and obviously as you observed the gross margin is lower than corporate average. However, we do have the offset of the products that Lisa just talked about, Embedded be a momentum, Professional Graphics be a momentum some commercial PC and that obviously offsets it and that allows us to guide to a flat close margin compared to the last quarter.

Rory Read

Again it’s really about driving a consistent execution of a consistent operations, that’s what we’re trying to create, a different AMD with a diverse set of portfolios and that’s why the strategy is working.

Operator

Our next question comes from Christopher Rolland of FBR Capital Markets. Please go ahead.

Christopher Rolland - FBR Capital Markets

So I guess when it comes to the GPU side, is it fair to say that we’ll see double-digit sequential growth in gaming APUs and double-digit declines on the GPU side due to the coin meltdown?

Lisa Su

Let me start with that Chris, the way we should think about the different businesses, so let’s talk about GPUs themselves and the transitions there. When we looked at the GPU market we have desktop and notebook GPUs, then we have the channel market and then we have the pro graphics business. We’ve actually made very nice progress in the desktop and notebook GPUs, we saw a ramp of some of design wins that we told you about earlier in the year happened in the second quarter, we see that continuing as we go into the second half for the year. The AIB or the cryptocurrency mining thing is a very specific phenomena around that enthusiast segment.

We saw some Rory mentioned earlier some instability in the market as the quarter progressed because we had a bunch of let’s call it a use cards come into the market and that added to the inventory in place. We do see that lessening as we go into the second half of the year and our focus is on really getting the gamers and showing that the gamers are very much on Radeon graphics.

And then on pro graphics we see that as a growth opportunity. We saw some improvement in the second quarter and we expect to see some improvement in the second half. The GPU business has a bunch of different components; I think we’ve made progress in certain areas. The desktop AIB channel will continue to improve in the second half of the year. Relative to the APUs that you are asking about. I think Beema and Kaveri APUs; we believe that those will do well as those businesses continue to ramp in the second half of the year.

Christopher Rolland - FBR Capital Markets

And perhaps you guys can size up the odds on the semi-custom parts. Maybe the first one that you guys might announce. Is it closer to a Beema Mullins type of semi-custom part here with a smaller dye size? Or should we think of something closer to the gaming GPU, APUs the console APUs. And would the margin structure on the smaller parts, could you still hit something resembling your gaming console APUs?

Rory Read

One of the things that’s really important the semi-custom space is these are confidential. The customer really wants to create a differentiated solution. As I talked about the first wins, several quarters ago. I talked about them as confidential wins. We really can’t get into that specific and it’s because this is a real customer advantage that they’re building.

I think it’s fair to say that each of those areas we’re making very good progress in terms of the kinds of pipeline opportunities we’ll look at both in the traditional strength of gaming but also in the living room, also in other parts of the segment, and that looks interesting. Lisa on the margin thing, one of the key things that you have been focused on is mixing potentially up, it’s not necessary thing where traditionally has been.

Lisa Su

Yes the best way to think about it is the margin structure will somewhat reflect the market where the semi-custom SoC is going into. So I mentioned a couple of the markets where the opportunities are today in gaming, mobility and several opportunities in networking. You’d expect a different margin profile depending on which market they are in.

Operator

Our next question comes from Joe Moore of Morgan Stanley. Please go ahead.

Joe Moore - Morgan Stanley

For your existing console businesses, can you give us some idea of the pricing trajectory over time? Is it over the next 12 months is that going to stay constant as there is some downward pressure and if there is downward pressure how does it work? Is there a volume step function that we should think about or just generally how should we think about pricing?

Lisa Su

Joe I think the best way to think about pricing as these are long-term agreements that we have with our customers, so we have a cost takedown curve. I think we’re motivating to help our customer, get the cost out of the system and so on the way you should think about as it is quite predicable for us and we continue to work on improving yields and test times and all of the things to ensure that we can improve margins.

Rory Read

And usually, Joe, based on history what you’ve seen in the other previous gaming ramps is the peak in terms of volume tends to be in a year, two and half, three and half out, so we are still very early in this ramp just to year end.

Joe Moore - Morgan Stanley

Okay great and then secondly when you talked about the new GlobalFoundries agreement, you have talked about moving more GPUs and consoles to GlobalFoundries can you give a status update on what’s happening there?

Devinder Kumar

As of right now GlobalFoundries is shipping both the GPU products and semi-custom game console products.

Operator

Our next question comes from Stacy Rasgon from Sanford Bernstein. Please go ahead.

Stacy Rasgon - Sanford Bernstein

Hi, guys, thanks for letting me ask some questions. First, I wanted to just take a look at the guidance from a high level basically you’re guiding Q3 flat year-over-year since the annualize the start of your console ramp with PCs in your core business worse than they were and it seems like it’s heading south from here, I guess given that start up how should we be thinking about growth form here going forward. Does this really have to become a [indiscernible], on growth in semi-custom, growth in OEM service, growth in professional graphics and alike, I guess as the business as it’s stand today does that form enough of a basis stable enough I guess to get the growth out there is no opportunity and how can we get some I guess degree of confidence that the business itself the core business since it actually is going to provide that sort of stability?

Rory Read

So, Stacy, if you look at the business from year-to-year, yes, we definitely began that fully year in terms the semi-custom game console. As we talk about that, that is still historically peaks out in year two and half, there and half, so there is still opportunity there. From a standpoint of the PC, what we were looking for and I think everyone on this call has been looking that stabilization. We have introduced the set of new products. We have seen improvement in notebook and what we’re also doing is diversifying the portfolio going into commercial and that’s a good move. We like to see that in terms of we said in the previous call that we like to see that improve over the next couple of quarters, but that you got to keep that in a muted kind of way.

We will also continue to build out the embedded business, the prographics business. These are all new businesses and we’re seeing progress in all of those. You’re not going to have the huge impact of the gigantic semi-custom that we saw that drove the major turn. What you now want to do is you got into business to a profitability level, a consistent level of performance. We’re efficiently managing the expense. We are delivering more consistently both in terms of the roadmap in the supply and then we augment that over the next several quarters and over the next several years with these new businesses and then ultimately as we complete the transformation we introduce the next generation technology at the finish of this in 2016. That then positions us for the next phase as we move forward that’s exactly the strategy we have been on and that’s how it’s playing out.

Stacy Rasgon - Sanford Bernstein

Got, I understand that, but I mean you’ve talked about PCs stability though. The PC business is not stable I mean you’re down 20% year-over-year. Your competitors are up 6% on the similar trends quarter over quarter. I guess you need stability in that PC business in order to harvest the fruit of the other businesses. What does the economics look like going forward if the trends that we’re seeing in the PC market continue?

Rory Read

Yes, but when you’re looking and we see start to see -- remember last quarter, we talked about we began to see more seasonality in terms of our PC business quarter-to-quarter. We saw again more stability. We saw it improved. That’s a significant of that. I got it that from the year-to-year there was still pressure because of the over indexing to consumer, that’s not a new of that. It clearly makes it easier as you move through as that becomes a more stable base to work from. And that I think as part of the strategy to introduce the things like commercial where that’s a Greenfield opportunity and go look some of the progress that we wake over the next two quarters in that space that’s a fast growing segment, but that clearly having that more stable that definitely creates a better base to work from.

Devinder Kumar

And the other thing I would add Rory just that a point that, that you made about down 20% as if you look at the 20% revenue, that’s fair, move from a year ago period, but with profitability and we’ll maintain that from a property standpoint with that segment and albeit small but it’s still profitable and we are managing for profitability from a viewpoint of the diversification that we are talking about. And they are obviously the two groups that we have created and that’s exactly in line with the strategy that we are deploying.

Stacy Rasgon - Sanford Bernstein

Got it, okay. If I can ask one quick follow up, how do you manage inventory down next quarter with the flattish revenue guide and payable to GlobalFoundries that was up 38% this quarter?

Devinder Kumar

GlobalFoundries if you look at the numbers this year with the take or pay, we are at the halfway mark of the year and we’ve taken approximately half the wafers on GlobalFoundries. And as we go forward into Q3 as you look at the Q2 numbers, Q2 is a seasonally low quarter. Typically, if you go back and look historically inventory is up in Q2 in preparation for Q3 and Q4. And as we said earlier as we work through the GPU ARB channel, returning to normal business conditions, the desktop channel business improves from our standpoint. We expect to ship more in this business. From an overall standpoint, that allows us to manage our inventory down for the rest of the year.

Operator

Our next question comes from Matt Ramsay of Canaccord Genuity. Please go ahead.

Matt Ramsay - Canaccord Genuity

I guess the question I would ask I mean there is something quite a few points made here about managing this business for operating margins. And I guess in the GVS business revenue was up, operating margin was down a bit. Obviously there was the stuff that happened with some of the currency things on GPU in that market. But maybe you could talk a little bit about where the operating margins are from the semi-custom business today and where they go as that business ramps in units but there might be some ASP down takes with cost coming out?

Devinder Kumar

We don’t typically haven’t talk specifically at the level of granularity that you’re looking from a semi-custom standpoint for the operating margin. You are right. If you look quarter-on-quarter from a viewpoint of looking at the profitability is on about $9 million but we did have the impact as Rory and Lisa talked about on the currency. And as you look through that we’ll see how it checks out from a Q3 standpoint. But not going to get into the specifics of the segment or even the business within the segment for the operating margin.

Lisa Su

Yes, the only thing I would add to that Matt is I think you should takeaways that the semi-custom margins are consistent with what we expect. We understand the ASPs. We understand the cost reduction roadmap. And so, we expect to be consistent.

Matt Ramsay - Canaccord Genuity

That’s helpful. And just a follow up from me, maybe backing up and looking at things on a bigger picture, from a ambidextrous strategy point of view in the ARM server space. There is now need to be I guess some investments to doing a custom ARM core for the server market versus license ports in the past. And is the goal is to sort of manage operating expense growth and keep it to a minimum. I guess where are the puts and takes and where you’re drawing those investments from and what effect that have on some of the core businesses where actually the fixed [ph] ports are more peripheral [ph]?

Rory Read

From a standpoint of the expense, I think we’ve done a very good job in terms of driving more efficiency with reuse, driving the organization in terms of where we’re the key focus. I think what you should look for over the next couple of years is to continue to focus on efficiency there. I think there is still more opportunity while investing in the key focus growth areas to continue to drive efficiency on the cost. It’s not going to be as drastic as we’ve seen in the past. But I think there is continued opportunity to be efficient there. Because we’re simplifying the number of process technologies. We’re reusing the IP base. We’re really doubling down on those IP blocks that are truly the ones that differentiate. That’s creating the ability to allow us to attack both the ARM core and the x86 core those are two big blocks they’re important and we’re going to lead in that. We’re going to lead on the graphic side. Some of the secondary IP we’re going to led that have less investment and I think that’s the right kind of strategy as we move forward. Based on that I still think there is more efficiency we can drive out over the next year or two.

Operator

Our next question comes from Betsy Van Hees of Wedbush Securities. Please go ahead.

Betsy Van Hees - Wedbush Securities

Good afternoon. Rory you talked about marquee design wins in commercial and that you guys are still heavily weight to this consumer. When are we going to see that inflection point in your business when we really see the commercial side to start to take some really meaningful revenue for you? That’s my first question. Thanks.

Rory Read

Sure, I think commercially you just saw the introduction in the second quarter with HP. You will see other OEMs as we go through the balance of the year. I think that people have been both inside and outside of AMD impressed with the kinds of uptake we’ve gotten from the customers in terms of the competition and the design wins that we’ve gotten. They will begin to roll out over the coming quarters. I think what you should think about is going back to the early question from Stacy, that’s a key part of that ability to stabilize our PC business and to move it up. That’s a big change guys from where we were a year ago. And that’s key in terms of the second half of this year into next year. Any ramp you look at takes a little bit of it in terms of ramping up. But then point you should get out of this Betsy is that it’s a good product. The people are very interested in it and you should go talk to HP and see what happens in the marketplace. But that EliteBooks is off to a really nice start.

Betsy Van Hees - Wedbush Securities

And then Devinder, gross margin guidance of 35% and Rory mentioned that this is the peak quarter for the gaming console business. So is it fair to say that we could see some gross margin expansion in the December quarter you’re going to have a better product mix with less of the gaming?

Devinder Kumar

Betsy, that’s good try. I am here to talk about Q3, I am not about to give guidance for Q4.

Betsy Van Hees - Wedbush Securities

Oh, come on. Little help

Devinder Kumar

I will say semi-custom as you know is lower than company average, we’ve been pretty consistent about that and we will talk about Q4 when we meet again in about 90 days.

Betsy Van Hees - Wedbush Securities

And then speaking about OpEx on another great job of keeping OpEx down, is there any more room for improvement when we could get to an even lower level of OpEx, is there any places that you guys could take some -- make some cuts there?

Rory Read

Yes, as I kind of commented just a second ago Betsy, I do think that there is continued room. I think we’ve done good work over the past two years on that one. I think from an OpEx standpoint, it’s balanced in terms of -- we're going to invest in those key areas that we think are going to drive growth. There are parts of our business that are expanding their OpEx base and Lisa is making those decisions as a COO. Devinder is looking for efficiencies and I still -- well I don’t think it will be at the same rate of decline we saw over the past 18 or 24 months. I think there is opportunity for us over the next 12 and 24 months for sure.

Operator

Our next question comes from Romit Shah from Nomura. Please go ahead.

Romit Shah - Nomura

Could you guys just talk a little bit about the desktop processor business? It looks like it was weak in Q2. I think you lost share in Q1 as well. So what’s the state of that business, your level of investment and how you see it performing from here?

Lisa Su

Yes, sure Romit. Let me answer that. So desktop channel was softer than we expected in Q2. If you take a look at underneath that and through the dynamics under that, we did see some impact of the cryptocurrency mining phenomena in CPUs as well as GPUs, because if you think about it when you put together one of those mining rigs, you need both the processor and the graphics card. It was a softer quarter in terms of the market as well and so we saw the distributors were a bit more cautious on taking on inventory. As we look forward, the desktop channel is an important market for us; it’s a place where we’ve traditionally done well. So I don’t see anything fundamental there. I would say that we will continue to expand our APU portfolio through the stacks; you will see a couple of more products come out in the second half of the year and we will continue to focus in that area.

Romit Shah - Nomura

On that one to two semi-custom design wins. Can you guys quantify the size of those opportunities for us?

Lisa Su

Sure. So what we’ve said in the past and is consistent is these opportunities tend to be very unique, but the size of the opportunities that we are looking at are typically in the range of $250 million to $500 million life time revenue overall.

Rory Read

Operator, we’d be happy to take two more folks please?

Operator

Our next question comes from Jim Covello of Goldman Sachs. Please go ahead.

Jim Covello - Goldman Sachs

You guys have helpful slide on page 4 of the presentation where you just kind of go through what the revenue has looked like in traditional markets versus growth markets overtime and kind of culminating in the 50-50 split in 2015. Is there any way to give us a very high level of breakdown of what that chart might look like broken down by end market as opposed to just kind of high level of traditional versus growth markets? Thank you.

Rory Read

And what do you mean, Jim, by end market? Sorry.

Jim Covello - Goldman Sachs

Vertical. Computing, gaming, et cetera.

Rory Read

We really haven’t thought about that in a lot of detail, so you got to give us a second here. In the high growth markets professional graphics, dense server, 50% of the business, you’re going to see in that 2016 timeframe our next generation technology be introduced with the advanced node work. End market; let us take a work on that, Jim. I don’t think we have that prepared here for this discussion.

Jim Covello - Goldman Sachs

Okay. That's great. Thanks. I could always follow-up on that. And then just in terms of your outlook on the PC market in total which is helpful, you guys are talking about maybe a down 5% to 7%, understanding that you’re a lot more geared toward consumer and that market is a little weaker than enterprise. I think other folks have a more or flattish kind of view on the market and that's inclusive of both the enterprise and consumer. Would you just expect that maybe the numbers for the, your expectations for those folks who were thinking the market is flatter to come down a little bit or maybe some of it is just mixed shift and it’s kind of hard to tell or how can you help us on that one a little bit? Thanks very much.

Rory Read

Yes, no problem Jim. So I think in terms of the market, I don’t think there is any question that commercial has been stronger than everyone anticipated. There is no doubt that's partially driven by the XP Refresh, that's for sure. There is also some pent-up commercial demand, we’re starting to see and feel a little bit of that as we’ve now introduced the product. I think it’s going to be stronger than expected, but the real debate has to be in our minds is that where is that peaking in terms of that. Was that the XP things through that April and kind of trails off into the second half of the year, our thoughts are it’s still positive and it’s going to be good, but we’ve got to see a little bit more data on where that commercials going to go in terms of it’s going to be as robust as it was in this middle part of the year.

On the consumer side I think consumer is actually pretty tough, I don’t think consumer is just slightly down, I think consumer is a tough spot in terms of traditional consumer notebook space. If you’re going to add in some of the newer form factor stuff like some of the kind of tablet stuff that mixes in between, you could highly get to a little higher number. So I really think it matters what you count.

If you look at the tablet stuff, people talk about 285, you look at the PC stuff somewhere around 300, that's a lot of units compared to where we were even two, three years ago. Tablets were much less probably under a 100 at that time and PCs were around what 365. So I think where you get differing opinion is what do you put in there, do you call those Window tablets and put them in PCs, you took the phablets and put that in there. We still see the traditional market have pressure in consumer; we think it’s significant that's definitely tough.

And then from the standpoint of commercial, that's definitely the stronger one. The real question there is, does that Refresh continue through the full year. Make sense, Jim?

Jim Covello - Goldman Sachs

It’s really helpful color. Thank you so much.

Rory Read

No problem, any time sir.

Operator

And our final question comes from Mike McConnell of Pacific Crest. Please go ahead.

Mike McConnell - Pacific Crest

Thanks. Going back to kind of Stacy’s line of questioning, I do understand relative to share your competitors much higher exposure to corporate and your exposure to consumer being part of this. But I guess one thing that’s a little concerning is kind of the progress and the share gain they’re making in the low-end of the market with date trail. And I wanted to kind of get your comfort specific to that segment of the market that you guys have higher relative exposure that if we have game consoles peaking here in Q3 that that isn’t going to be the peak also for your year in terms of quarterly revenue. How do we get some comfort that there is not more here than just the exposure between corporate and consumer particularly in that low-end where you have pretty decent amount of market share?

Rory Read

One of things I think you want to look at is, we could chase some of that pressure in the low end, it tends to be lower ASPs and given some of the market dynamics, it’s not terribly profitable. We’re going to go and complete in some of that, but we’ve talked about a strategy to mix up and I think Lisa can add some color in terms of the ASP trends that we have seen, the kinds of progress we’ve made with the A8 and A10; this is one of the strategies. In the past I think AMD would have chased that down, gone for share sake, we want some of that, but we want to balance to across the portfolio as we mix up so that it makes sense for us, yes. And there is no doubt there’s pressure, but there are still businesses for us to get there and then as we mix up look at the ASP work, perhaps Lisa some color?

Lisa Su

Yes. Mike, I think the way to think about our PC business is sort of strategy here, I mean it is very much around being deliberate about where we think we’re most differentiated and we can get a strong sort of profitable growth in that standpoint. So if you take a look at U.S. specifically about Baytrail and we certainly see Baytrail no question about it, we see them at, very, very low entry price points going up into the mainstream of the notebook and desktop market. And there are places where we chose not to compete because it’s just not profitable business. We are looking at, how to improve our mix, if you take a look at our ASPs both sequentially and year-over-year. You see a very nice trend there and that’s very deliberate on ensuring that we are selling our product where they actually valued. And that’s different from sort of our PC business a year ago. And those are the some dynamics that help us stabilize the business model and get to more profitable growth, that sort of thing.

Mike McConnell - Pacific Crest

Okay. One very quick follow-up Lisa I just want to make sure I heard you correctly. So the discrete graphics what was down has to be roughly double digits in Q2 and you said you’re expecting it to be down again in Q3 I just want to make sure that’s accurate?

Lisa Su

Yes. Though I did not say. So we said the discrete graphics was down in Q2 and that was the mix of the ARD channel in particular coming off of a strong Q1. We do expect to gain share of discrete graphics that has been a clear goal. And if you look at the mix of the business going forward, we see opportunities to do that.

Mike McConnell - Pacific Crest

Okay. What do you think about discrete graphic for Q3 I guess sequentially?

Lisa Su

Again, we don’t go into segment detail in terms of guidance but directionally we expect to grow share.

Mike McConnell - Pacific Crest

Okay. Thank you.

Lisa Su

Great. Operator that concludes AMD second quarter earnings conference call. If you could ramp it up. We would appreciate it. Thank you.

Operator

Ladies and gentlemen this concludes today’s call. Thank you for your attendance, you may now disconnect. Have a great day.

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