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Advanced Micro Devices, Inc. (NYSE:AMD)

Q4 2006 Earnings Call

January 23, 2007 5:00 pm ET

Executives

Mike Haase - Investor Relations

Robert J. Rivet - Chief Financial Officer, Senior Vice President

Dirk R. Meyer - President, Chief Operating Officer

Hector J. Ruiz - Chairman of the Board, Chief Executive Officer

Henri P. Richard - Executive Vice President of Worldwide Sales and Marketing

Analysts

Uche Orji - UBS Warburg

Adam Parker - Sanford Bernstein

Mark Edelstone - Morgan Stanley

Tim Luke - Lehman Brothers

Michael Masdea - Credit Suisse

David Wong - A.G. Edwards

JoAnne Feeney - Midwest Research

Glen Yeung - Citigroup

Chris Danely - JP Morgan

Jim Covello - Goldman Sachs

Krishna Shankar - JMP Securities

Ross Seymore - Deutsche Bank

Presentation

Operator

Good afternoon. My name is Jeanne and I will be your conference operator today. At this time, I would like to welcome everyone to the Advanced Micro Devices Inc. fourth quarter 2006 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer period.

(Operator Instructions)

It is now with great pleasure I turn the floor over to your host, Mr. Mike Haase. Sir, you may begin your conference.

Mike Haase

Thank you, and welcome to AMD's fourth quarter 2006 earnings conference call. Our participants today are Hector Ruiz, our Chairman and CEO; Dirk Meyer, our President and COO; Bob Rivet, our Chief Financial Officer; and Henri Richard, our Chief Sales and Marketing Officer.

This call is a live broadcast and will be replayed at amd.com. The telephone replay number is 877-519-4471. Outside of the United States, the number is 973-341-3080. The access code for both is 8264808. Telephone replay will be available for the next ten days, starting later tonight.

In addition, I would like to call to your attention that our Q1 2007 earnings quiet time will begin at the close of business Friday, March 16th.

Before I begin today’s call, I would like to caution everyone that we will be making forward-looking statements about management’s expectations. Investors are cautioned that our forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from our current expectations as set forth in the forward-looking statements.

The semiconductor industry is generally volatile, and market conditions are particularly difficult to forecast. Because our actual results may differ materially from our plans and expectations today, I encourage you to review our filings with the SEC where we discuss in detail our business and risk factors, setting forth information that could cause actual results to differ materially from those in our forward-looking statements.

You’ll find detailed discussion in our most recent SEC filings, including AMD's annual report on Form 10-K for the year ended December 25, 2005, and AMD’s quarterly report on Form 10-Q, for the quarter ended October 1, 2006.

With that, I would like to turn the call over to Bob Rivet.

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Robert J. Rivet

Thanks, Mike. Good afternoon. First, I would like to point out that as a result of AMD's acquisition of ATI, fourth quarter financials include results from the former ATI operation beginning October 25, 2006.

Because comparison of the fourth quarter consolidated financial results to previous periods do not correlate directly, AMD had provided non-GAAP financial information for historical AMD in our press release. Management believes this non-GAAP presentation will aid investors by presenting current and historical results in a comparable format. In addition, financial comparisons to 2005 do not include the results from our former memory product segment. Let’s start.

AMD's revenue in the fourth quarter of 2006 was $1.77 billion, including approximately $50 million in royalty and patent license revenue. Loss per share for the fourth quarter was $1.08. This includes $550 million, or $1.04 per share, from ATI acquisition related and integration charges. From here forward, I’ll refer to them as ARC charges. And another $27 million, or $0.05 per share, from employee stock-based compensation expense.

Fourth quarter operating profits were $50 million, excluding ARC charges and stock-based compensation expense.

Fourth quarter 2006 gross margin was 40%, excluding ARC charges and stock-based compensation expense, compared to 52% in the third quarter of 2006. The decrease from the prior quarter was largely due to significantly lower server processor ASPs, and the inclusion of ATI operations.

AMD historical business generated revenue of $1.37 billion, up 2% from the fourth quarter of 2005 and up 3% from the third quarter of 2006.

Operating income for the period was $63 million, compared to $142 million in the third quarter.

Now I’ll switch to the business segments. Computation product revenue was $1.34 billion, up 3% from the prior quarter, and units increased by 19% sequentially. Our mobile and desktop processor sales were strong, and we believe we gained unit share.

Mobile unit shipments and revenue increased 41% sequentially. Desktop processor unit shipments increased 14% and revenue 8% sequentially. The drop in desktop ASPs were driven primarily by a shift in customer mix. Server processor unit shipments were essentially flat quarter over quarter, and ASPs declined significantly.

Operating income for computation products was $73 million.

For the former ATI operation segments, revenue for the period October 25 through December 31, 2006, or 68 days of the fourth quarter, total $398 million, at the high-end of our guidance.

Revenue in the graphics and chipset segment was $278 million, with an operating loss of $33 million.

The consumer electronic segment achieved revenue of $120 million, and an operating income of $20 million.

Now I’ll turn to the balance sheet. After completing the acquisition of ATI through a combination of cash, debt and stock, we ended the quarter with a cash balance of $1.5 billion. Total debt of $3.8 billion includes $2.2 billion associated with the ATI acquisition. Total inventory of $814 million includes $314 million from former ATI operations. Inventory for the historical AMD business increased $34 million, as we continue to ramp FAB 36 65-nanometer products.

Fourth quarter capital expenditures were $668 million.

As I laid out at our analyst day last month, in the fourth quarter, AMD's reported segments include Computation Products, Embedded Products, Graphics and Chipsets, and Consumer Electronics.

Beginning in our first quarter of 2007, we will report three business segments:

  • Computing Solutions, which will include microprocessors, chipsets, and embedded products;
  • Graphic Solutions; and
  • Consumer Electronic Solutions.

Now let’s turn to the outlook. AMD's outlook statement for the first quarter are based on current expectations. The following statements are forward-looking and actual results could differ materially from our current expectations. Because the first quarter will be our first full quarter including the former ATI businesses, we are providing ranges for revenue and operating expenses for the period.

In a seasonally down first quarter, AMD expects revenue to be in the range of $1.6 billion to $1.7 billion.

Operating expenses, which include R&D and SG&A, will be in the range of $710 million to $760 million.

Employee stock-based compensation expense in the first quarter is expected to be approximately $32 million at the current share price, and first quarter ARC charges will be approximately $120 million, of which $30 million will have cost of sales.

In summary, 2006 was a very good year. We made significant strides in taking additional market share in our computation products business, and our customers are responding positively to the acquisition of ATI.

With that, I will turn it over to Dirk.

Dirk R. Meyer

Thank you, Bob. We are not satisfied with our financial performance in Q4, and we need to improve our results in the future, but it is important to acknowledge the strategic success that 2006 represented for AMD.

We gained processor share in every quarter, finishing the year with another record quarter for unit shipments. Compared to 2005, we grew our annual processor unit shipments 135% in our server business, 78% in our mobile business, and 35% overall. Clearly the marketplace demands choice.

We made good progress on our customer acquisition strategy. In greater China, Founder and Tongfang chose to become AMD customers, and Lenovo expanded their business with us.

IBM expanded their AMD-based platform portfolio, HP broadened their agreements with us, and Dell began shipping AMD-based server, desktop, and mobile products.

All of this great progress in the marketplace has allowed us to fund some new investments, one of which was our acquisition of ATI technologies. We closed the deal in Q4, and the integration is already largely behind us. This new company has phenomenal assets. We have assembled world-class talent in every discipline, and the acquisition adds 5,000 great people spanning every major area of the business.

We have a portfolio of customers and partners that place us at the confluence of the computing and consumer electronics industries, all looking to AMD to support them as a customer-centric processing powerhouse and strategic partner.

We have technology leadership in key product areas , X86 CPUs and associated chipsets, graphics and video processing. We have world-class manufacturing capability and a flex fab strategy designed to serve the desires of our customers as well as our shareholders.

Looking forward, our priorities are simple: to acquire new customers, to serve our current customers increasingly well, and to provide long-term value to our shareholders.

Understanding what it takes to satisfy our customers is pretty simple. They want good products delivered in volume at the time and the place they need them.

On the product side, as evidenced by our continued share gains, our customers like the products we’re shipping to them today, but they are even more excited about the opportunities presented in our roadmap. Our improved X86 architecture and the family of products which is its base, such as Barcelona, our quad-core offering in the server space, will introduce new levels of performance and power efficiency.

Likewise, our GPU technology provides the ultimate Vista experience today, and the R600 family, our next generation graphics engine, will delight customers and end users worldwide.

On the supply side, we will continue to ramp our capacity by building out assets like FAB 36, and by converting FAB 30 to a 300-millimeter tool set. We will complete our conversion to 65-nanometer technology this year, and lay the groundwork for a transition to 45-nanometers in the first-half of next year.

At the same time, we will continue to optimize our supply chain to give customers what they want when they want it.

We need to improve our financial performance relative to what we delivered in Q4. We will do so by delivering improved products, lowering our manufacturing costs, increasing our operating efficiencies across all disciplines, and continuing to grow share.

As we look back at the last few years, we feel we have made great progress. The assets we have assembled and our plans to use them with and for our customers together make for a very bright future.

With that, I would like to turn it over to Hector for some closing remarks.

Hector J. Ruiz

Thank you, Dirk. You know, I normally read from a prepared script in this conference. This time, I’m not going to do that. I’m going to talk to you from the gut.

What I want to tell you is a little bit of history and put it in the context that I believe will show you why I am incredibly optimistic and excited by the future of this company, more than I have been in the seven years that I have been with this company.

First of all, we made the decision a few years back to really base everything we do on the mantra of our company that we call customer-centric innovation. We started that journey when we launched Opteron in early 2003. The elegance of that product was in its simplicity, a direct connect architecture that today continues to serve our customers extremely well, and an extension to 64-bit of the X86 instruction tech, which was exactly what customers in the market really wanted.

That allows us to go at the most difficult part of the industry in trying to establish credibility and confidence in our team to be able to deliver to them the kind of products and technology they needed. That was very successful. As a matter of fact, we went from being almost nowhere in the server enterprise space to finish in 2006 with approximately a share number in the mid-20s. We believe that is quite an accomplishment.

That credibility that we built and the confidence that customers began to have in us also led us to an expansion of our business with them in the client space. That opportunity opened up for us a huge window through which we could acquire customers, and we embarked on a customer acquisition strategy that today continues.

As Dirk pointed out, we were able to convince customers such as IBM, Sun, HP, and others, and eventually Dell, to really adopt our technologies across the board.

For three consecutive years, we have grown market share, from going in the mid-teens back three years ago to end in 2006 also in the 20s.

You know, the strategy turned out to be pretty simple. All it meant is that we had to focus on innovation that was truly relevant to our customers, the marketplace and the industry. In doing so, we came up with customer-specific metrics, customer-specific products, and customer-specific technologies.

Some of the examples is a tremendous opportunity we saw in the large urban data centers, when their consumption of power was increasing at a non-sustainable space. That opportunity allows us to redefine the data centers value proposition, and turn it to being just from raw performance to performance per watt, and our Opteron and direct connect architecture established a leadership position.

Just as an example of customer-specific products, we used this wonderful architecture to also address the very unique space of the enthusiast and gaming community. Our technology led us to the creation of a family of products that we’d refer to as FX. That technology and those products has been so successful for several years that it allows us in the fourth quarter of last year to ship a record number of FX products into that segment.

We also had customer-centric technologies, because we recognize that the industry’s addiction to single-core clock frequency was something that was past due, and that we had to introduce the industry and our customers to a new way of looking at how to innovate by looking at workflow and application-specific performance. Therefore, we introduced the first ever dual-core server product into the marketplace, an X86 instruction.

I have to say that after such a major change in the industry, that the competition has followed suit and created also their own extension to X86 and their own multi-core technology roadmaps. But it’s more than just about cores.

It really is about mapping technology to specific usages. For example, GP/GPU, [inaudible] and Fusion, those are the technologies that you heard us talk about in our analyst day.

By now, you can see how beautiful the ATI acquisition fits in our long-term strategy.

We see the opportunity to exploit Moore’s laws in a very intelligent fashion, by focusing on what’s relevant to our customers. Because of the acquisition of the ATI cadre of people, technology, and products, we are the only company that is positioned to truly be able to deliver on this. As I said before, it’s more than just about cores. It is true that Moore’s law is allowing some people to claim that putting 64 cores, or even 128 cores on one piece of silicon can be the future of this industry. I beg to differ.

As a matter of fact, I think those products and technologies are going to find their rightful place in the Pentium where Pentium 4 at 10 gigahertz lies.

Our customer-centric innovation strategy is working, and the ATI acquisition is a phenomenal asset that is going to allow us to take it to another level. As we said in our analyst meeting, we’re really intensely focusing on continuing to drive energy efficient leadership in computing, to delivering the ultimate visual experience, and to enable affordable Internet usage across the world.

The demand for our technology is greater than our current share of the business, and largely the limiting factor has been the monopoly behavior that’s been abusive by our competitor. Our customers want us to win and increase the share of their business. They like choice and demand more choice, and they want us to have the capacity to offer that choice and continue to offer the kind of innovation that we have provided, and of course, to help drive growth.

They are demanding that we fight for share, and we will. We will continue to expand our capacity in response to this customer need.

The interesting thing that in doing these things that I just talked about, we have actually forced the competition to become more efficient. But in doing so, it makes us realize that we have to raise our own efficiency to a higher level, so we are focusing a flawless execution on completing our 65-nanometer transition by this summer, and we’re looking at accelerating 45-nanometer and closing the gap with our competitor.

We will carefully manage costs, but we also believe that we’re going to have to tweak our business model because we believe we have to achieve prosperity in an environment where pricing competition is going to be tougher than perhaps we had originally planned.

We will do whatever it takes to continue on our path to deliver customer-centric innovation this year and beyond.

You know, after all, we have been, are, and will continue to be the company that offers the best value proposition to our customers. We will accomplish this by continuing to attract and retain the best and brightest people in the industry, and by having our now 15,000 or so AMD’rs intensely focused on customer-centric innovation. We thank our employees.

Now, let me turn it back to Mike for the Q&A.

Mike Haase

Thanks, Hector. Operator, let’s start the polling process for Q&A, please.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question is coming from Uche Orji of UBS New York. Please go ahead.

Uche Orji - UBS Warburg

Just a couple of questions. First of all, for Bob, if I look at the gross margin you reported this quarter, can you just give us an idea how to think about gross margin for next year? If you can also tell us what that means for your cash flow, given that you gave us a guidance of negative $500 million free cash flow for 2007 at the analyst day.

Robert J. Rivet

Sure. First, I’d like to start, to answer that question, everything we talked about at the analyst day, we still truly believe. There is no backing off of that, of that perspective. So a lot of the guidance I gave at the analyst day, we are still trying to execute as we begin this year. So the 50% gross margin plus or minus a few is still our goal for 2007. As we talked about, that will take a while to get there as we integrate the ATI operation and adjust accordingly, and as we transition in our microprocessor business to full 65-nanometer, fill up the factory. We will continue to show improvement in our cost structure to improve our gross margin.

We also see improvement in our mix of products, so we’re not backing off anything we talk to you about at the conference, with the maniacal focus, as Hector said, of even maybe turning up the notches a couple more notches in cost reduction efforts to make sure that we can achieve those targets.

From a cash flow perspective, the same thing. We’re still going to spend $2.5 billion on capital expenditures this year to increase our capacity based on what our customers are telling us they want us to do. That will generate a negative cash flow, but as you can see from the balance sheet, we’re prepared for that.

Uche Orji - UBS Warburg

Right. Just one more question, given that you’re getting a full quarter of ATI, is it possible for you to give us more color on the revenue guidance for Q1? Given that we had just basically two months of ATI in Q4, and now we have a full quarter, it’s a bit hard for me to reconcile what ATI is going to do next quarter and what that means also for AMD core business.

Hector J. Ruiz

First of all, the ATI business, when you look at it from the perspective of the customers, they are customers that are heavily involved in the consumer electronic business -- digital television, handsets, et cetera. From that perspective, their strongest quarter that ATI normally has is the fourth quarter that we just finished. So looking at that fourth quarter and trying to do some extrapolation and analysis for the first quarter frankly becomes very difficult, because historically the first quarter is the weakest quarter those particular segments also have.

We have done the best we can in trying to anticipate how we think the first quarter might look. Frankly, we are getting mixed signals from our customers, both in the consumer electronics space as well as the PC space. The market seems to be a little uncertain. The uncertainty around Vista is still there, even though we’re very, very bullish on what Vista is going to do for the whole year, but the first quarter impact is rather questionable.

The other piece is that pricing is incredibly challenging. We expect it to be for at least all of the year, but in particular for the first-half of the year.

When you combine all that, we’re taking a very cautious approach to the first quarter.

Uche Orji - UBS Warburg

This is kind of slightly different from what you said at the analyst day about a benign pricing scenario. In our assumptions, should we then assume that ASPs will be down for 2007?

Hector J. Ruiz

No. As Bob pointed out, there are a number of things occurring. One of them is our product mix continues to move to spaces in which we did not participate before, and these are particularly the client commercial space. The consumer electronic business has got a lot of potential, and we believe it has a phenomenal opportunity to grow at decent margins. Also, the momentum to convert to mobile continues. We believe that what occurred in the fourth quarter will continue throughout 2007.

When you combine all those things, we believe that we still have the opportunity to be slightly up in ASPs in 2007.

Uche Orji - UBS Warburg

Finally, could you just remind us of the timing of the delivery of the RF contract hurtles from ATI?

Henri P. Richard

We’re still planning to bring to market the RF600 product in the first quarter.

Operator

Your next question is coming from Adam Parker of Sanford Bernstein. Please go ahead.

Adam Parker - Sanford Bernstein

I just have two questions, or two general areas here. One, Hector, your customers, or Bob, I guess, either one, your customers are telling you to spend cap-ex. How will you know when you’re at the point that the customers just want you to add capacity to create excess? Are they really ever going to tell you to stop adding capacity?

Hector J. Ruiz

I certainly understand why you asked that question, Adam, but I think what our customers are asking us is that they want to increase their share of the business that they do with AMD. They’re not necessarily just adding capacity, period. They want an AMD portfolio that is expanding.

As we mentioned earlier, we’ve been on a customer acquisition strategy for quite some time. Well, we’re not through. As a matter of fact, we still have major customers around the world that have yet to buy the phenomenal value that AMD offers. So we still have even other customers yet to acquire, so we believe that these customers, what they’re telling us we want to increase the share of our business with you. We want to buy more product from you. It is good for us, it is good for the industry, it is good for our customers. I think we are a long way off from ever being able to see a scenario where we think we should back off.

Adam Parker - Sanford Bernstein

All right, maybe just then the follow-up, or the question related to that would be on the server business. It seems pretty clear, at least for the last two quarters, that Intel has gained a lot of revenue share in server, and their pricing is way up and yours is way down. To what do you attribute that? How can you remedy it? What’s your sales pitch here on the one and two-way server space? Could you help at all with that? I think the surprise here is just really up to six months ago is how your server ASPs have trended versus Intel’s in the second-half of ’06.

Henri P. Richard

First, I would like to remind you that our ASPs in the server space were higher than Intel’s, so there was a correction, certainly, as they came with a more competitive product.

Secondly, it’s clear that particularly in the fourth quarter, the competition became very severe in the last month. As you know, it’s an enterprise-driven business, a lot of the deals are back-end loaded. There was a lot of headwind in terms of closing some of the large businesses that were out there.

Coupled with the fact that we had some new product introductions that frankly were not executed by the customers as well as we expected, and the fact that we will introduce a new architecture next year, and some customers are waiting for that to --

Adam Parker - Sanford Bernstein

Next year, you said?

Henri P. Richard

I mean this year, sorry. And some customers are waiting to see what sort of performance improvements they’re going to see from that introduction.

Adam Parker - Sanford Bernstein

So you’d expect this trend to last at least one more quarter in servers, is that fair?

Henri P. Richard

I think that, as we stated at the analyst meeting, we expect the first-half of the year to be extremely competitive. Now, as you pointed out, there are segments where we have opportunities to grow. Clearly we still have, in a lot of the markets outside Europe and the U.S. a growth opportunity in the traditional server space. We had very low footprint into one key server space, so we have some opportunity to grow, but we expect the environment to be extremely competitive and there’s clearly a targeted action from the competition on that segment.

Adam Parker - Sanford Bernstein

Henri, what’s the sales pitch in the first-half of the year in the one-way server space?

Henri P. Richard

Best value in the industry.

Adam Parker - Sanford Bernstein

All right. I’ll leave you guys alone. Thanks.

Operator

Your next question is coming from Mark Edelstone of Morgan Stanley. Please go ahead.

Mark Edelstone - Morgan Stanley

Thanks, guys, a couple questions. First, Bob, there’s obviously some of the charges that you’re taking for ATI that were pulled out of non-GAAP gross margin. I just wanted to get the review of that, if I could, in terms of what of the charges listed there are actually being pulled out to come to that 40% number?

Robert J. Rivet

Sure, Mark. It’s the $62 million we highlighted, which is part of the acquisition related charges associated with the gross up you need to do in inventory for GAAP. That will burn off over the fourth quarter and first quarter as the $30 million I just talked about in my script a little while ago.

Mark Edelstone - Morgan Stanley

Got it. Okay, and then the other -- [multiple speakers] -- charges that you have for amortization and integration charges, where are those showing up in the P&L?

Robert J. Rivet

They’re all on a separate line item. The rest are all at a separate line item, as you see on the P&L just before operating income.

Mark Edelstone - Morgan Stanley

Okay, got it. Perfect. Then, could you just walk us through maybe, Henri or Hector, what type of decline you saw in server ASPs in the quarter? Then also, what type of decline you might have seen in the PC client side of the business as well?

Hector J. Ruiz

Henri will comment on the server piece. You know, we did not see any major shift in the desktop client pricing. We actually saw a modest improvement in the mobile space. So all of our issues with pricing were related to the server segment.

As Henri pointed out, it was a very competitive scenario. We expect it to continue to be. We’re making plans to adjust to that for at least the first two quarters of the year. As Henri also pointed out, we think that will also begin to change as we introduce our new architecture in the summer.

Mark Edelstone - Morgan Stanley

Henri, what was the actual decline you saw in server ASPs?

Henri P. Richard

I’m not going to go there, Mark, but I will add something to what Hector described, which his we did start a strategy -- you know, we have an architectural advantage in four socket servers, and it’s also a direct plug-in of our new technology in those four socket environments.

We have an aggressive commercial strategy to move a certain portion of the market that’s been impaired until now by both hardware costs and software licensing costs to move from 2P to 4P. Some of the ASP decline is related to that strategy of moving the market to four socket systems.

Mark Edelstone - Morgan Stanley

Okay, and maybe just one last final question on the environment, again either for Hector or Henri. Hector, you sort of talked about some of the near-term uncertainties in the PC market, but maybe just give us your broad sense of how you think the health of the market looks right now, especially coming off of 19% sequential unit growth for you in Q4? Maybe some thoughts on how inventories look out there in the broad marketplace of your products?

Hector J. Ruiz

I’ll make a general comment, Mark, that we are frankly, unit-wise, we’re quite bullish about 2007. I acknowledge that there are a number of reasons why the first quarter is a little wacky, but 2007 to us looks very healthy. We truly believe, and as we have had our own experiences ourselves, that Vista will provide impetus to unit demand in 2007 and beyond. We think it’s going to be a great innovation that will bring a lot of value to the marketplace.

We see an expansion of PCs in spaces where we’re beginning to see -- 2007 will be the beginning of that. It will start to occur. An example of that is we believe that this year will be the first time that our 50 by 50 initiative will actually ship several million pieces in 2007.

All in all, from a unit perspective, we feel pretty bullish.

Henri P. Richard

If I may add, just on the question of inventory, Mark, as you know, we were lower than we would have liked in terms of channel inventory in the third and fourth quarter. We were able to restore that at the very end of the fourth quarter in order to position ourselves in a much better velocity for the first quarter.

But at the same time, we also took a prudent approach to the channel inventory in the graphics business, where we think that there’s model improvement that we intend to execute in the first and second quarter of ’07.

Operator

Your next question comes from Tim Luke of Lehman Brothers. Please go ahead.

Tim Luke - Lehman Brothers

Thanks very much. Just for Bob, with the sequentially lower revenue guidance that you’ve provided, we should be thinking about the gross margin moving sequentially lower before improving through the year. Is that the right framework?

Robert J. Rivet

No, I think you have that backwards. Even though revenue we’re guiding to be lower than fourth quarter, with the improvement of 65-nanometer, more of that output continuing to come on board, servicing the channel as Henri just talked about a minute ago, we believe gross margins will actually improve quarter on quarter. In particular, the microprocessor business.

We also believe so in the former ATI businesses too, as we continue to execute the game plans there.

Tim Luke - Lehman Brothers

That’s very helpful. Do you have a framework for thinking about the basis point degree we should think about improvement?

Robert J. Rivet

Probably not ready to give that kind of guidance. I just would say it will improve from the current level.

Tim Luke - Lehman Brothers

Just a clarification on the tax rate, what should we be thinking about?

Robert J. Rivet

Still holding to the guidance I gave at the analyst conference, which we are working desperately to figure out how to lower that guidance, but at this point, the guidance is unchanged. It will be a little choppy, of course, but -- so unchanged at this point.

Tim Luke - Lehman Brothers

Just on the market, maybe for Henri just to follow-up on Mark’s question, with respect to units in the first quarter, could you give us some sense of how you’ve historically seen the seasonality, and obviously Hector was talking about a little bit of uncertainty in the first quarter, ahead of Vista, how you think that it would compare to normal seasonality in terms of the units, given what seems to have been for you a pretty decent unit number in the fourth quarter? Thank you.

Henri P. Richard

I will place your question in the context of microprocessors, right?

Tim Luke - Lehman Brothers

Yes, okay.

Henri P. Richard

Typically, the seasonality in the first quarter is down about 4% at the midpoint. I think one of the factors that I want to underline that Hector mentioned is that there is a certain amount of added uncertainty with regard to Vista -- its rapid adoption, any problem at launch, how will it affect inventories. That is another factor that makes the first quarter a little more complex than I would say the average first quarter, because Microsoft does not launch a new operating system every other year.

That’s the guidance I can give you. I think we are going to have a seasonal quarter from that perspective, but there are certain uncertainties in the marketplace in terms of the impact of Vista and how will it drive consumer behaviors.

Tim Luke - Lehman Brothers

The notebook ASP was up, actually. Could you clarify what the desktop ASP did?

Henri P. Richard

Well, the mobile ASP was slightly up and the desktop ASP was slightly down, but marginal.

Tim Luke - Lehman Brothers

Thank you.

Operator

Your next question comes from Michael Masdea of Credit Suisse. Please go ahead.

Michael Masdea - Credit Suisse

Thanks a lot. I just want to ask you, your competitor seems to be talking a lot about using a strategy of basically offering more silicon, more cores at the same price as the prior generation. Is that fundamentally something that’s got to change before you can drive your profitability, or are there other ways to get around that?

Dirk R. Meyer

I don’t know what you mean by “got to change”, but if you look at what’s happening in the marketplace, it is similar to what’s always happened in our business. That is to say, new features, new capabilities get introduced at the top of the price stack and slowly over time get rolled down the price stack, and that’s in fact what you see with dual core. That’s what we’ve been doing, that’s what the competition’s doing, so from that perspective, nothing new.

Michael Masdea - Credit Suisse

Maybe another way to ask -- what steps are you taking to drive that mix? What should we, from a tangible perspective, look for? What are you doing on the enterprise side, and what else are you doing to really improve the mix over the course of the next year-and-a-half?

Dirk R. Meyer

Yes, improve the mix is again a funny one. Just for reference though, dual-core mix in our product line in Q4 was roughly about a third. We’ve got an opportunity to accelerate that as a percentage of our overall product line going forward. Probably more rapidly then, the product gets pushed down the price stack as we go to an increasing fraction of 300-millimeter manufacturing and 65-nanometer technology. So I actually think that increased dual-core mix for us represents an ASP and margin upside in the near-term.

Michael Masdea - Credit Suisse

Any update on the legal front that we should be looking out for, or any timing in terms of the various legal actions that have been going against Intel from your perspective?

Hector J. Ruiz

No, other than to repeat that we’re in discovery. We are continuing. The process continues. It’s slow, but we continue to be very confident of where we want to go and that the outcome will be very positive for us.

Michael Masdea - Credit Suisse

Thank you.

Operator

Your next question comes from David Wong of A.G. Edwards. Please go ahead.

David Wong - A.G. Edwards

Thank you very much. In terms of your attitude to the pricing environment, do you anticipate that you’ll have to take pricing actions to maintain market share, or are you saying that you’re going to be focused on profitability, and therefore you’ll back away from taking a lot of pricing action?

Hector J. Ruiz

There is no backing away from anything. We’re committed to serving our customers. Our customers want our product, and we’ll fight hard to continue to provide them the opportunity to enjoy AMD technology.

David Wong - A.G. Edwards

Related to that, has there in recent quarters been any special initial pricing you’ve given to big customers to capture initial business that might help you in pricing going forward, once the initial pricing agreements sort of pass by?

Hector J. Ruiz

We cannot comment on specific agreements. On a general comment, I would like Henri to comment on that, but on specific by customer, we can’t.

Henri P. Richard

I would just like to reiterate what Dirk said, which is we have an opportunity in terms of increasing our dual-core mix as a percentage of total. We can accelerate that. That will help ASPs. Also, we have had a certain number of strategic customer acquisitions through the year, which probably brought our channel business to a lower percentage than its historically been, and we have an opportunity to grow our channel business. So those are two positives in the overall environment.

David Wong - A.G. Edwards

Final question, will you bring out quad-core servers first or quad-core desktops?

Dirk R. Meyer

Servers.

Operator

Your next question comes from JoAnne Feeney from FTN Midwest. Please go ahead.

JoAnne Feeney - Midwest Research

Good afternoon. A couple of questions, if I could, please. Following up on the last one, really, about the servers and the quad-core. There are certainly a lot of questions about the potential for AMD to reacquire the performance lead. I know there is some dispute about whether that lead exists currently, but let’s suppose that in a number of applications, your competitor does have a performance lead. We’re all looking to see whether Barcelona and the follow-ons will enable you to recapture that performance lead in enough of a degree, really, to offset the marketing push of your competitor.

Since you are reluctant to give away a lot of details on the roadmap, understandably, perhaps you could shed some light on what you think your OEMs would say about your potential in that regard.

Dirk R. Meyer

Well, I don’t want to speak for our OEMs, and of course, you know who they are, so I encourage you to ask them. However, based on what we know about our product and everything we understand about our competitor’s roadmap from all sources, we’re very bullish that when we introduce our native quad-core in the middle of the year, we’ll capture definitively the performance and performance [lead] and, by the way, do so in a way that doesn’t require new platform investments on the part of our OEM customers. The platforms are there today.

JoAnne Feeney - Midwest Research

A follow-up, sort of separately on the cash and financing situation, perhaps for you, Bob. Obviously $2.5 billion of cap-ex is a pretty big number, and given this past quarter’s sort of higher than expected costs, lower than expected ASPs, and next quarter’s sort of muted outlook, I guess one might be a bit more concerned about the cash flow implications over the year. I think we’re all wondering whether you will feel the need to go back and do some more financing, really, to help you get through this rather large capital expenditure over the next year.

Robert J. Rivet

JoAnne, as I’ve said before, I’ve kind of outlined our process to fund the corporation and the appropriate investments, starting with cash flow from operations, monetizing the expansion investment and monetizing the tools in Dresden, Germany at the 200-millimeter level. We think that will be sufficient to keep the appropriate cash balance levels and fund the capital expenditures.

In addition, as I also pointed out, there’s grant money associated with spending that $2.5 billion we’ll collect also.

We still feel pretty comfortable with our game plan. Clearly my job is to make sure we’ve got the appropriate funds to execute the strategies of whether it’s additional customer acquisition, design teams or capital.

JoAnne Feeney - Midwest Research

Is the grant money you just referred to from strictly Dresden, or does it also include some of the New York State incentives?

Robert J. Rivet

Just Dresden, just from Europe and Dresden.

JoAnne Feeney - Midwest Research

So I suppose we might, if we were to look at a contingency of -- if say operating cash flow did not materialize in Q1 and Q2, then we might anticipate a situation where you would need to go do some financing?

Robert J. Rivet

I’m not going to speculate with you on that. Like I said, we have a good game plan.

JoAnne Feeney - Midwest Research

Okay. Thanks, Bob.

Operator

Your next question comes from Glen Yeung of Citigroup. Please go ahead.

Glen Yeung - Citigroup

Thanks. You know, when we look out into the first quarter, you’ve talked about what you characterize as still a competitive environment. In that statement, are you expecting incremental pressure on server pricing, or do you think it’s going to stay down where it is?

Henri P. Richard

It’s very difficult for me to speculate on what the competition is going to do, but it’s going to remain a very competitive environment. I won’t give you anymore guidance than that.

Glen Yeung - Citigroup

Okay. How about on desktop and notebook, in as much as clearly you’re going to see some benefit here from a mix shift towards more dual-core. Within that outlook, how about part for part pricing in the first-half or in the first quarter? Can you comment on that?

Henri P. Richard

Yes, I think there is, to elaborate a little bit on what Dirk was saying, there is a [defortation], from my perspective, in our market, where the server market is going to continue to be driven by introducing new features, you know, faster, better processors, in a very traditional way.

I think in the client space, Vista is introducing a lot more of a platform and balanced performance opportunity. So think of what the best platform is, maybe in the past was whatever the best processor was. It’s not going to be true anymore. As such, I think AMD is uniquely positioned to provide customers with great value proposition around a portfolio of products that enable them to first differentiate in the marketplace and second, bring the best user experience.

Glen Yeung - Citigroup

When we look at the bundled solutions that we can see from various vendors and we think about how that bundling, I mean, the pricing looks pretty attractive, how that impacts AMD, is that actually a good margin for you to bundle that way, if you were to sort of collectivize all those parts?

Henri P. Richard

We’re not planning to do any bundling, but we’re obviously offering some synergies, simply because it’s a lower cost of engagement for an OEM to look at a complete platform.

Glen Yeung - Citigroup

Right, okay. That makes sense. Okay, last question, which is I think I heard somebody mention that first-half ’07, obviously a competitive environment, but some view that second-half ’07 may be not quite as competitive. I think you’re alluding to the fact that you’ll have different parts to be competitive with in the second-half of the year. I wanted to just confirm that that’s an accurate read.

Secondly, is that to suggest that if you have a better part, you feel like that may ease some of the concerns that we’re facing in the first-half?

Dirk R. Meyer

I would certainly say that what you say is true in parts of the markets we participate in, and in particular in server, as Henri said, where it’s still much more of a CPU-centric performance buy in some of the server segments. Clearly, relative to product technology, we’ve got good products, as evidenced by our share gains. At the bleeding edge, there’s an ebb and flow, back and forth as to who has the best in any given quarter, so that’s driving some of our segments about the back-half of the year.

Glen Yeung - Citigroup

That makes sense. Thanks, I appreciate it.

Operator

Your next question comes from Chris Danely from J.P. Morgan. Please go ahead.

Chris Danely - JP Morgan

Thanks, guys. Just a few quick housekeeping items. Have you given out a depreciation target for ’07?

Robert J. Rivet

Yes, I did at the conference. I will reiterate it. $1.3 billion for ’07.

Chris Danely - JP Morgan

Okay, and then, can you give us a sense of what percent of revenues were ascribed to server, desktop and laptop in Q4?

Robert J. Rivet

No, we don’t give that kind of granularity.

Chris Danely - JP Morgan

That’s fine. How about a breakout of AMD versus ATI gross margins in Q4 and what you expect for Q1?

Robert J. Rivet

No, I’m not breaking those out either, but I did in the press release at least try to get your a true operating type level gross margin for the company.

Chris Danely - JP Morgan

Yes, that’s fine. If depreciation is going up and pricing is going to remain competitive, do you expect gross margins to go up by switching to 65-nanometer and also a mix? Is that how we should look at it?

Robert J. Rivet

That’s correct.

Chris Danely - JP Morgan

Okay, thanks.

Operator

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

Jim Covello - Goldman Sachs

Thanks very much. First question, does the op-ex guidance that you gave include or exclude those restructuring charges you were talking about.

Robert J. Rivet

Exclude.

Jim Covello - Goldman Sachs

Okay, so the 710 to 760 excludes the $120 million or whatever, $90 million in restructuring charges?

Robert J. Rivet

Yes, it excludes -- just to be perfectly clear -- it excludes stock option expense and it excludes the ARC charges I talked about.

Jim Covello - Goldman Sachs

Great, thanks. Second question, and I hate to be so theoretical, but I think it’s kind of important. It seems like your goals as a company are at a little bit odds here. Getting new customers and creating value for shareholders hasn’t been something that have worked well with one another for the last few quarters. And it’s not going to turn around, as long as both you and Intel continue to add so much capacity and fight one another.

What is it going to take for you to change the strategy? How bad does it have to get before the strategy can change? I understand that you guys aren’t changing the strategy today, but for shareholders, they are looking for the answer of how it’s going to turn around. Other than you guys gaining a lot of share, which Intel is going to try to fight, how does it turn around? And if it doesn’t turn around soon, what would cause you to change the spending strategy?

Dirk R. Meyer

Well, we’ve been pretty clear for quarters and years, and that is that we compete against a monopolist who has a dominant share, and long-term, the best returns we can generate for our shareholders involve breaking that monopoly.

Jim Covello - Goldman Sachs

Can I ask a question about that? You guys were doing incredibly well before you really decided to ramp the spending and gain share. I mean, your model was incredibly profitable. Your balance sheet was great. You were picking up share in small segments. Then you decided to really ramp it in a big, big way, and now the spending is such that you’re losing a bunch of money.

You’ve been very profitable competing against the monopoly before, and now you’re not. Is there any thought of going back to the model that allowed you to be so profitable over the last 18 months, excluding the last couple quarters?

Dirk R. Meyer

Well, you know, we’ve thought long and hard about this, and concluded that there is no model that’s stable over the long-term that allows us to be profitable in a niche. The level of investment required is too large, and the only way for us to maintain profits on a sustained basis is to be large and engage in a material way with strategic OEM customers. That’s what they want to see from us. That’s what they demand from us, and that’s what we’re going to do.

Jim Covello - Goldman Sachs

Okay, so then the second part of the question though, is there a point at which you say well, I can’t afford to do this, even if it’s what the customers want?

Robert J. Rivet

Hopefully you’ve picked up from both Dirk’s comments and Hector’s comments too is we are maniacally focused on cost. You will see us continue to push what it cost to make an XYZ product within the portfolio at lower and lower levels.

We’ve always been lower on the ASP totem pole. We understand that environment. We’ll push that cost equation even harder. So we’ll have a business model that will enjoy and deliver the appropriate returns on a long-term basis -- this is not a short-term game -- on a long-term basis as we continue to provide choice into the marketplace, and the marketplace gets to the appropriate balance.

Jim Covello - Goldman Sachs

Terrific. Thanks so much.

Operator

Your next question comes from Krishna Shankar of JMP Securities. Please go ahead.

Krishna Shankar - JMP Securities

Can you give us an indication of your profits on mix in terms of corporate versus consumer client? What types of programs do you have now that ATI is part of AMD to tackle the mobile and corporate desktop platform market with bundled solutions that your competitor does?

Henri P. Richard

I’m not going to give you a precise answer, but suffice it to say that obviously our commercial segment is growing faster than our consumer segment.

With regard to the second part of your question, we have a much deeper engagement model in the enterprise and the commercial space, in the former AMD, than ATI had. Obviously there is going to be a benefit, in particular in the workstation marketplace, where the relationship that we’ve established with global 2000 companies that use workstation type technology are going to afford us some opportunities for presenting our new core product portfolio.

Krishna Shankar - JMP Securities

Can you also elaborate on, you didn’t call it bundling, but you said some synergistic areas where you can provide a complete solution for the customer. Can you elaborate on that some more, please?

Henri P. Richard

If you look at the environment today, you’ve got companies that really believe that they’re best served by transferring the most amount of bottom costs to the CPU. Other companies think that the best model is when the GPU takes most of the bottom costs, and there is one company that’s uniquely positioned to offer the customer a portfolio of balanced technology that enable them to A, differentiate, and B, have the best end-user experience, and that’s us.

Krishna Shankar - JMP Securities

Thank you. Finally, Bob, can you give us an indication of interest payments over the next four quarters?

Robert J. Rivet

Well, let me give you just a framework. The current fourth quarter that we just completed was not a full quarter in the interest payments, because obviously we didn’t borrow the money until the 24th of October, so that number will scale up a little bit from the current number that you see recorded, but not by a lot. There’s not that many days left in the quarter. So it will be a little bit higher than the fourth quarter, is the answer.

Krishna Shankar - JMP Securities

Thank you.

Mike Haase

Operator, we’re going to take one more question, please.

Operator

Thank you. Your final question is coming from Ross Seymore of Deutsche Bank. Please go ahead.

Ross Seymore - Deutsche Bank

Thanks for squeezing me in, guys. A lot of the questions have been asked, but given the importance of the server market to your overall profitability, as we look forward to Barcelona and what your competitor, it looks like they’re doing in pricing quad-core at the same level as dual-core, how should we think about the profitability going to Barcelona can really deliver to your server product line heading into the second-half of this year?

Dirk R. Meyer

Of course, it’s hard for me to speak to precisely what the pricing environment will be, but from a cost basis, you can think about Barcelona being not that much different than the introductory dual-core Opterons.

Ross Seymore - Deutsche Bank

Okay, but directionally from that then, would it be safe to say, given the price competition has been so severe as this last quarter illustrated, that the price points you’re going to be able to get through Barcelona, even though the cost is the same, the price point is going to be much lower than you got in the first round on the Opteron side. Is that a fair assertion?

Dirk R. Meyer

You know, the pricing environment is so dynamic that it’s hard for me to speculate what will happen as we introduce new products.

Ross Seymore - Deutsche Bank

Okay, and then I guess the last question here, more for Bob, is getting from that 40% to the 50% gross margin, you talked a little bit about what’s going to happen, you believe, in the first quarter. Are there any other dynamics throughout the year that are going to kick in that are going to allow you to get up from that 40% to 50% level?

Robert J. Rivet

Well, I think we’ve kind of hit on them all, from mix of the business more toward commercial, more dual-core, less single-core, servicing the channel, more consumer electronic business, better penetration in both graphics and AMD chipsets.

I think that through the analyst day and what we covered today, I think we covered it all, but it’s a waterfall of things, I’ll call it, on products and ASP, and then maniacal focus on cost reductions, primarily through the 65-nanometer node, but there’s plenty of other things in packages, test time reductions, et cetera, that you’ll see take place.

Last but not least is the synergy of the two companies.

Ross Seymore - Deutsche Bank

So if I put it all together and nothing’s really changed since the analyst day, given the fact that you talked about pricing being a little more aggressive than you had thought, is it really that you think you can take more costs out than we talked about at the analyst day? What is the lever that allows that sort of flexibility, given that pricing has been more competitive?

Robert J. Rivet

I would probably have to handicap it. That’s where we’re focused right now. Just not knowing where pricing will land at different moments in time, we will control what we know how to control, which is our cost structure.

Ross Seymore - Deutsche Bank

Thank you.

Mike Haase

All right. Thank you very much. We’ll conclude the call now.

Operator

This concludes today’s Advanced Micro Devices Incorporate fourth quarter 2006 earnings conference call. You may now disconnect your lines at this time and have a wonderful evening.

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