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Advanced Micro Devices, Inc. (AMD)

Q2 2007 Earnings Call

July 19, 2007 5:00 pm ET

Executives

Mike Haase - Investor Relations

Dirk R. Meyer - President, Chief Operating Officer

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

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

Henri P. Richard - Executive Vice President, Chief Sales and Marketing Officer

Analysts

Uche Orji - UBS Warburg

Krishna Shankar - JMP Securities

Doug Freedman - American Technology Research

Tim Luke - Lehman Brothers

Glen Yeung - Citigroup

JoAnne Feeney - Midwest Research

Bob Gerardi - Deutsche Bank

Chris Danely - JP Morgan

Michael Masdea - Credit Suisse

Kevin Rottinghaus - Cleveland Research

Presentation

Operator

Good afternoon. My name is Henry and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Advanced Micro Devices’ second quarter 2007 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Mike Haase, Director of Investor Relations. Sir, you may begin your conference.

Mike Haase

Thank you and welcome to AMD's second quarter earnings conference call. Our participants today are: Hector Ruiz, our Chairman and CEO; Dirk Meyer, our President and COO; Bob Rivet, our CFO; 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 8926606. A telephone replay will be available for the next 10 days starting later this evening.

I would like to call to your attention that our third quarter 2007 earnings quiet time will begin at the close of business Friday, September 14th. Also, as a reminder, next week we are hosting our technology analyst day on Thursday, July 26th, from our Sunnyvale, California campus. It will also be video webcast on AMD.com.

Before we 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 are based on current beliefs, assumptions and expectations, speak only as of the current date, and 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 discussions in our most recent SEC filing and the quarterly report on Form 10-Q for the quarter ended March 31, 2007.

With that, I will turn the call over to Dirk Meyer.

Dirk R. Meyer

Thank you, Mike. In a seasonally down second quarter, we grew our revenues and regained CPU market share and, while pleased with our progress on the top line, our bottom line results are obviously unacceptable. We will improve these results going forward.

We did make significant progress on the game plan that we outlined last quarter. We grew the top line by winning new customers, like Toshiba who selected AMD-based platforms for an exciting new line of satellite notebook PCs. And now, for the first time ever, each of the world’s five largest PC OEMs offer AMD-based platforms.

We also expanded our business with existing customers, like Dell who expanded their AMD-based commercial offering with the addition of 10 new PowerEdge servers as well as two new Dell Inspiron desktop systems.

SUN introduced its new Blade 6000 server built on AMD Opteron processors and HP launched two new AMD Athlon-based Blade PCs in the quarter.

In addition, LG Electronics selected our AMD Imageon 2282 media processor to drive their stunning new designer phone -- proof of our ability to empower meaningful differentiation in our customers’ offerings.

We made good progress in the channel. We restored our value proposition, established positive sales momentum, and managed our overall channel inventory to appropriate levels. We continue to execute on our platform, product and technology roadmaps.

Our Fab 36 conversion to 65-nanometers is complete, with yields exceeding expectations and we now turn all our attention to 45-nanometer. Our recently launched ATI Radeon HD 2000 CPU family has been very well-received by our distribution and OEM customers. Barcelona, the industry’s first native X86 quad-core processor, will ship this quarter in both standard and low-power versions and our next generation Puma Notebook platform design is generating a lot of customer excitement for its value and media rich platform features.

We are on a path to bring our gross margins and operating expenses back into a reasonable balance and improve our cash flow. We will continue to grow our revenues. The new R600 family will fuel growth of our GPU business. Our digital TV division enjoys a great footprint with top tier CE companies entering the seasonally strong second-half of this year, and in our computing solutions business, we enjoy solid customer relationships and a strong position in the fast-growing consumer PC segment, and an expanding portfolio of commercial designs. And finally, we have the promise of new product introductions starting with Barcelona this quarter.

Relative to manufacturing costs, as I said Fab 36 output is now all 65-nanometers, Fab 30 winds down output of 90-nanometer 200-millimeter material in the second-half and, as a result, we’ll ship an expanded mix of 65-nanometer CPUs from 300-millimiter wafers in the second-half of this year. Furthermore, we will lead the GPU industry in our deployment of 65-nanometer products.

Overall as a company, our spending levels will decrease going forward and, as a result of outstanding execution in Fab 36, we see the opportunity to further reduce our CapEx plans by slowing the rate of ramp of Fab 38. As a result, we expect to significantly reduce our operating losses on a continuous basis with an eye towards breaking even as we exit this year.

In summary, we are a company with great assets, a truly unparalleled portfolio of CPU, GPU, and media-centric processing IP. Customer and partner relationships with the elite companies in the IT and CE sectors all hungry for partnership, innovation and choice, and people with the will and a passion to reinvent our industry and bring innovative solutions to our customers and to end users worldwide.

With that, I’ll turn it over to Bob.

Robert J. Rivet

Thanks, Dirk. AMD's revenue in the second quarter of 2007 was $1.378 billion, up 12% sequentially and up 13% compared to the second quarter of 2006. We recorded a net loss of $1.09 per share in the quarter. This loss includes charges of $99 million, or $0.18 a share, from the following: ATI acquisition related and integration charges, which I call ARC, of $78 million; employee severance charges for workforce reductions of $16 million; and debt issuance charges of $5 million associated with the $500 million loan pay down.

Excluding ARC and the severance charges, we had an operating loss of $363 million in the quarter, 7% less than the prior quarter. As detailed in our press release, second quarter gross margin increased to 34% excluding ARC, severance charges and stock-based compensation expense. This compares to a gross margin of 31% in the first quarter of 2007. The three point increase in the prior quarter was largely driven by increased 65-nanometer microprocessor shipments.

The second quarter gross margin was negatively impacted by an inventory write-down charge of approximately $30 million, or two percentage points of gross margin associated with older generation microprocessor inventory.

Total operating expenses, which include R&D and SG&A, were up $73 million from the prior quarter. Increased costs were driven mainly by: one, engineering supporting new product launches; two, marketing supporting higher sales than the prior quarter in the form of demand generation programs in both the distribution and consumer channels; and severance charges. The costs benefits associated with our headcount actions will begin to show up in our expenses in the third quarter.

Now, switching to the business segment; computing solutions revenue was $1.098 billion, up 20% from the prior quarter. Microprocessor unit sales increased 38% quarter on quarter. We believe we won back market share on both a unit and dollar basis. Overall microprocessor ASPs were down, driven by a decline in desktop ASPs offset somewhat by increased ASPs in mobile and server. We achieved sequential double-digit revenue increases from our server, mobile and desktop product lines. Chipset revenue declined 13% in the quarter, driven by a decline in our Intel business offset somewhat by increased AMD chipset revenue. And we recorded an operating loss for the computing solutions segment of $258 million in the second quarter, 20% less than the prior quarter.

Switching to the graphic segment, in a seasonally down quarter, revenue of $195 million was flat compared to the first quarter. Initial sales of the ATI Radeon HD 2000 family of graphic processors were strong in the channel and design win momentum with key mobile and desktop OEMs continues to grow. Operating loss in the graphic segment was $50 million, up $15 million from the prior quarter.

And in the consumer electronic segment, revenue was $85 million, down from the previous quarter. Handheld sales were significantly lower, offset somewhat by increased DTV sales. Second quarter operating loss increased by $18 million from the prior quarter, driven by the lower sales from handheld products.

Now turning to the balance sheet, cash balance at the end of the quarter was $1.6 billion. During the quarter, we netted $1.5 billion from the $2.2 billion convertible offering, paying down some debt and putting a cap call in place. In addition, we did not receive any cash for the sale of our 200-millimeter tools, our Spansion investment, or from the sale of administrative land and buildings in the quarter. These items represent in excess of $800 million of cash generating opportunities in the future.

Total inventory at the end of the second quarter was $892 million, down $46 million from the prior quarter. Deferred income on shipments to distributors almost halved in the quarter to $92 million, reflecting the work we accomplished with our distribution business as Dirk discussed earlier. Second quarter capital expenditures were $414 million.

Turning to the outlook, AMD's outlook statements for the third quarter are based on current expectations. The following statements are forward-looking and actual results could differ materially from current expectations.

In a seasonally up third quarter, AMD expects revenues to increase in line with seasonality. Operating expenses, which include R&D and SG&A, will be down slightly compared to the second quarter. Employee stock-based compensation expense is expected to be approximately $35 million for the third quarter. ARC charges will be approximately $85 million. We expect gross margin to improve from the second quarter. We expect to have a tax expense of $25 million in the third quarter. Third quarter depreciation and amortization is expected to be in the range of $290 million, and finally, we will continue to fine tune our capital expenditure plan and we now expect 2007 CapEx to be approximately $1.8 billion. This is a $200 million reduction from prior guidance.

In summary, we made progress on the top line in the second quarter but clearly we are not happy with our bottom line performance. Aligning our cost structure to our business model is our near-term focus and you will see some progress starting in the second quarter.

With that, I will turn it back to Hector.

Hector de J. Ruiz

Thank you, Bob. The second quarter was an important one for AMD because taking a moment to look past our financial performance, the quarter confirmed our convictions about our industry.

First, customers want us to succeed. The unit growth and new customer acquisitions just reported are clear indications of this. Large OEMs, distributors, enterprise IT decision makers and users of PCs and other digital technologies around the world agree that competition in the processor industry is good and healthy for our industry. They like what AMD is doing, have a taste of what things are like with a stronger AMD, and crave the innovation and choice that we bring to the table.

Second, our industry is going through a major transformation and our acquisition of ATI is perfectly timed to ride this wave of change in our industry -- a restructuring like nothing we have seen today. No longer are customers satisfied with generic value propositions and artificial measures of raw processor performance. The business has matured and even with maturity comes unprecedented stratification of segments, value propositions and new value creation opportunities. Customers want choice and AMD is hardwired to enable it.

Third, with fair and open competition comes the natural forces that unleash real customer-centric innovation, processing solutions that satisfy the needs of what today’s consumers are looking to do with their digital technologies and a healthy mechanism for directing more of our attention to where and how we innovate and most important, it will lead to a complete recalibration of our business model.

We are unafraid of this transformation and in fact welcome it, as it will lead to new waves of value creation across the IT and CE industries that we serve.

The processor industry has been artificially restrained from this natural evolution and as I mentioned last quarter, we at AMD are laser focused on enabling it.

I know that I have conveyed our strong conviction that we are driving change for the industry that is good for the industry, good for our customer, and good for the end user but let me make something very clear; we’re not distracted and we know that at the end of the day, these changes must and will result in improving AMD shareholder value. In order to position ourselves to accomplish this and benefit from all the changes that we are driving, we are taking the following actions to improve profitability as well as our balance sheet:

We are slowing the ramp of Fab 38 that would reduce our CapEx requirements by $200 million in this calendar year, in addition to the previously announced reductions earlier last quarter;

Build a new product momentum starting with our new R600 GPU family and continuing with Barcelona and AMD Phantom, growing unit volumes and improving our mix while keeping expenses flat to our current run-rate;

We will be monetizing assets, such as the 200-millimeter equipment, buildings and land and the orderly disposition of Spansion stock, all of which are expected to bring nearly $1 billion;

Advancing our asset light strategy with which I am very pleased with the progress to date, but don’t believe for competitive reasons that it is in our best interest to share details of our progress at this point. We will do so as soon as it is appropriate;

Restructuring our sales and marketing efforts to maintain our strong position in consumer, continue our customer acquisition efforts, advance our unique platform advantages to provide customer opportunity for distinctiveness, re-empower the brands and our shared vision for a computer world where the real user comes first;

And empower our regions to more effectively serve our customers and optimize our spending;.

I want to thank our customers for their support, our investors for their confidence, but most of all our employees for their unwavering commitment to help us win.

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

Mike Haase

Thanks, Hector. Operator, let’s begin the polling for the 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

Thank you very much. Can you hear me? I have just a couple of questions. The first is for Bob. When I look at your gross margin guidance, given the strong jump we’ve seen sequentially in the second quarter, how should we calibrate the statement that you expect it to improve in the next quarter? What kind of improvement are we expecting?

Also, if you can give us some clarity as to how you view, what is the seasonal growth in the third quarter? How do you explain what seasonal means? We haven’t had regular seasonality in a while, so when you say seasonal, what do you mean?

Robert J. Rivet

Let me start at the top from the market sales and then kind of walk through it, but I think our competitor kind of said the same thing but seasonality is some place in the 8% to 10% in our current view in the PC space. The second-half looks pretty strong so that’s kind of the way we see the world right now, from that perspective and that’s what our big customer in the channel was telling us. So that’s a good environment.

Clearly new products, new products in both the CPU world and the GPU world. As Dirk said, more 65-nanometer, it continues to be a higher proportion of what we ship. And that includes the GP world, where the more R600 type product we sell, which is in 65-nanometer, that helps the equation too. And clearly the inventory write-off we had in the current quarter we don’t expect to ever happen again. So add those three things up, I’m not going to give granularity but we expect gross margin to improve from the current levels.

Uche Orji - UBS Warburg

Let me just draw attention a bit to the op-ex line. If I recall, I think when I look at your statement about op-ex down slightly, maybe I’m wrong but I thought we were expecting a big drop in the second-half in terms of op-ex. Is that a change in guidance?

Robert J. Rivet

No, we never said big drop. We said it would be declining at a rate from the first-half to the second-half, as we took some actions and we moved some things around but I’m not sure I ever said big drop.

Uche Orji - UBS Warburg

All right, fair enough. And just one last question then on ASP; is it fair for me to -- it looks like we have some drops in the area of 10% sequentially. Is that the right number? If we look into the second-half of 2007, your competitor was talking about still pricing pressure on the low end. Can you just give me an idea of how you look at the pricing data mix into the second-half and specifically if there is any expectation as to what Barcelona could do for ASP? If you can give some guidance on that, that would be helpful, please.

Henri P. Richard

With regard to ASP, we had close to 10% decrease in the desktop space but we had significant stability in the other segment, actually growth in the server market so there is competition in the desktop right now and this is a CPU statement. We had actually stability in a lot of the other businesses, particularly in the GPU business and in the chipset business.

And then you were asking about the competitive nature of the second-half of the year and this focus on potentially the value space. Well, clearly the value space is an increasing percentage of the total shipments. We are very well-positioned in that space. I’ve seen a second quarter that was stable relative to the first quarter price pressure. I don’t think that the situation has deteriorated. And I think it is going to continue to be a very competitive environment but of course, as Bob was pointing out, we are introducing a whole slew of new products that are better positioned than our existing products in terms of competing and so I think that will afford us some opportunity for at least a stable environment.

Uche Orji - UBS Warburg

Just one last question on Barcelona; given that the lower speed version you launched so far and then we are expecting a higher speed version in Q4, any insight into how your customer base is reacting so far to this phased introduction? I know you are sampling it at the moment. What kind of feedback are you getting at this moment in terms of the customer reception of this product?

Henri P. Richard

As you know, and Hector was pointing this out as well, the focus in the data center switched quite a bit from absolute performance to performance per watt and we were at the forefront of this change and you will see that the performance of Barcelona in its 68-watt version is extremely satisfactory. Our customers can’t wait to ship it. They are really excited about the opportunity.

We’ll continue to scale up the performance in the various thermal envelopes that this product will be available through the end of the year, so right now we’re qualifying the product, customers are working hard at getting their systems to the market in the third quarter and we are very confident about the future of this product line.

Uche Orji - UBS Warburg

Thank you very much.

Operator

The next question is coming from Krishna Shankar of JMP Securities. Please go ahead.

Krishna Shankar - JMP Securities

A couple of questions, just following up on Barcelona, can you give us some of -- is it , the design or is it the yield, and then also the initial version you said would be up to 2 gigs. Can you give us some of the challenges around the Barcelona performance roadmap and how you plan to improve that over the next several quarters, both from a design iteration and a manufacturing viewpoint?

Dirk R. Meyer

The beginning of your question was “is it the design or it is the yield” -- I’m not sure what it is. Could you clarify?

Krishna Shankar - JMP Securities

I just wanted to get a sense for -- it sounds like there was some delay here and I wanted to get a sense for the challenges and how you plan to scale up the performance to address the various performance segments in the market.

Dirk R. Meyer

I better understand, thank you. First of all, we’re very happy with our 65-nanometer yields across all products, including Barcelona, so no issue there. The fact of the matter, Barcelona, while being an absolutely great product, is complicated and it’s taking a little bit more design work than we anticipated getting the final rim in place.

Krishna Shankar - JMP Securities

And then the second question, I guess going back to Hector’s point in terms of manufacturing flexibility and looking to slow down capital spending and potentially outsourcing, can you give us a little more clarity on the scope of that program and whether the slowdown in Fab 38 hinders your market share goal plans?

Hector de J. Ruiz

Well, first of all, let me start at the high level. Our manufacturing strategy has not changed and our aspirations for continuing to gain share over time have not changed either. In the near term, we’ve had an outstanding performer out of Fab 36. The ramp as well as the yield, as Dirk mentioned, on 65-nanometer have been phenomenal, been outstanding. The flexibility we’ve had with charter semiconductor as an additional place to manufacture has given us an opportunity to reduce our capital outlay this year and expand somewhat the rate at which we ramp Fab 38. So I think we’re taking advantage of some good news scenario out of Fab 36 to be able to accomplish that.

But in now way are we taking our eye off the goal of continuously increased market share for the foreseeable future. That in no way has changed.

As far as I mentioned earlier on the asset light strategy, I am very happy with our very -- what I believe is a very appropriate strategy for us to pursue, the progress that we’ve made, but I’ve come to the conclusion that it is not in my best interest and the best interest of AMD to share the details of the progress at this point in time. At the appropriate time, we’ll disclose what we’ve done in that area.

Krishna Shankar - JMP Securities

My final question for Bob, can you just walk us through the balance sheet in terms of the operating cash burn, how much you actually put on the balance sheet net from the convert rate and how the cash flow looked like?

Robert J. Rivet

Clearly we had negative cash flow from operations with the magnitude of the loss we had and we continue to invest in the capacity of Fab 36, so free cash flow, those two components chewed up some cash in the current quarter. We expect that to decline through the actions that both Dirk and Hector have talked about, of modifying the business model, changing the capital expenditures in the back-half of the year, et cetera, to get that more in line to be I’ll call it neutral, less burning from that perspective with the maniacal focus on the profitability part of the equation.

From a balance sheet perspective, just to reiterate what I said is the $2.2 billion convertible we did in the quarter only netted us $1.5 billion, because we took some of that money and directed it to pay down loans and also to buy a cap call because of our bullishness in the value of the company. So anyway, that kind of walks you through again what I said.

Krishna Shankar - JMP Securities

Thank you.

Operator

The next question is coming from Doug Freedman of American Technology Research. Please go ahead.

Doug Freedman - American Technology Research

Great, thanks, guys. If you could sort of focus a little bit longer term, you made a comment about getting close to break-even by the end of the year. What are the aspects that are going to help you get there? Is this where we are looking for revenue growth that might be better than seasonal, or is it a product mix? If there are the aspects that you could walk through, it would be very helpful.

Robert J. Rivet

Well, I think -- clearly as we’ve stated in the past, we’re not wavering from that. Our goal is to gain market share, particularly in the CPU business but really in every business we participate in. And we believe with the lineup of new products that have launched or will launch, we’ll be in very good position to continue to demonstrate the kind of performance we had in the second quarter. I’m not sure it can exactly be as good as it has in the second quarter compared to our competition but clearly our goal is every quarter we should be gaining share, both from a revenue and a unit perspective.

Also, with new products comes more enhancement of gross margin so as we’ve said before, we’re not going to cut our way to success but it is a combination of growing the top line through a combination of things I just talked about and modifying and controlling our cost structure so that we get to the right point of having a balanced business model that will throw off the appropriate profits and cash.

Doug Freedman - American Technology Research

Six months ago we had the winter analyst day -- I’m looking to the analyst day coming up -- where you laid out a gross margin plan that was much higher. Is that plan still something that you think you might be able to get to in 2008? Is that the type of gross margin expansion we should be looking for? Anything you can do on the longer term horizon? What contributes to that? Is it that ATI revenue is coming back help that? Any granularity you can offer?

Robert J. Rivet

As of right now, we’re not prepared to change that business model. Thank you for reminding everyone that’s a long-term model, not a short-term model. So the 50% gross margin level we talked about as a corporation is still what we are focused on pre asset light. Asset light clearly could change some of those dynamics and we’re not prepared, as Hector said, to talk about that in any specificity. So that’s still what we’re aiming for, is respectable gross margins that will yield the appropriate money to make the appropriate engineering and marketing investments to get the right returns. We are still focused on that.

Realities do have to play into the equation, though. Clearly we dug ourselves a hole in the first quarter. Hopefully we’re demonstrating we are working our way out of that hole. What I hope we’ll deliver and you will see is continued progress in sales and gross margin as we walk our way through time.

Doug Freedman - American Technology Research

All right and then, the one last thing I would like to focus on is I was a little surprised to see the expenses come up as much as they did in the June quarter. I recognize that some of them were one-timers and severance charges, but even headcount rose. To get back to have the back-half of the year have lower expenses than the front, we need to somewhat see a reversal in those trends. Any help you can offer on what magnitude of reversal we should see and is it going to be very much the December quarter where we see it, and whether it breaks down between R&D and SG&A would be helpful. I’ll leave that as my last question.

Robert J. Rivet

Obviously the severance charges that we booked in the quarter was associated with actions we took. They were late in the quarter. Some of that headcount is actually still on the payroll and it’s working its way out, so the headcount reductions that we’ve done, which is in the tune of around 500 people, will start to yield benefit and roll off the senses as we get into the third quarter.

We’re in an interesting balancing act of trying to maintain the appropriate R&D investment while we continue to trim our cost structure, so you will see -- I’ll call it in aggregate of those two numbers, some decline in the third quarter, some decline in the fourth quarter but with I’ll call it some variation of plus/minus between them. I’m not going to give you specificity of how much is in R&D versus in SG&A but we’re not trying to cut our way to success. It’s really a combination of both top line and the cost structure and gross margin.

Doug Freedman - American Technology Research

Terrific. Thank you.

Operator

Thank you. Your next question is coming from Tim Luke of Lehman Brothers. Please go ahead.

Tim Luke - Lehman Brothers

Thanks so much. I was wondering if you might be able to give us some color on when you would see contributions from Barcelona and Phenom, particularly in the higher end of the high-performance desktop market, whether that’s something that one would be potentially able to see as you go into the calendar fourth quarter?

Dirk R. Meyer

Your question is specific to desktop then, yes?

Tim Luke - Lehman Brothers

Yes.

Dirk R. Meyer

We’ll be shipping the Phenom variance of the new product in Q4 but frankly, that’s going to be late enough in Q4 that while there’ll be some contribution to the bottom line, it won’t be substantial.

Tim Luke - Lehman Brothers

And in guiding for seasonal improvement in microprocessor, should we think about broadly similar seasonality for the three areas of server, desktop and notebook? Or do you think there will be some variation there?

Henri P. Richard

Clearly everybody understands the dynamics that exist right now in the mobile space, so the mobile marketplace is not following traditional seasonality. I think as an aggregate, because there is a lot of the waterfall effect between desktop and mobile these days, as Bob was pointing out we are looking at a solid PC industry right now. What I hear from the channel partners is that the inventories out there are healthy, both in the component channel and in the retail channel and that end user demand so far has been pretty strong.

I think that we are facing traditional seasonality and that’s the best I can tell you at this point.

Tim Luke - Lehman Brothers

Perhaps I could just follow-up on the ATI side, it looked like you saw some softness in the chipset, consumer and GPU sequentially, and you also had some management change there. Can you talk about how we should think about the trends there in the second-half of the year?

Henri P. Richard

The chipset business is a design cycle business, so our design is actually extremely solid. As Bob was pointing out, we see a decline because as you know, the Intel business is basically rolling off but we are growing very quickly the AMD-based chipset business. So I’m very confident with the health of our chipset business.

With regard to GPU, we started to ship in volume the HD 2000 series toward the end of the quarter. The initial demand is very strong and so the third quarter is really where the proof is going to be in the pudding in terms of how much velocity we are going to get, because really we hit the shelves in that marketplace really in June.

Tim Luke - Lehman Brothers

Thank you, guys.

Operator

Thank you. Your next question is coming from Glen Yeung of Citigroup. Please go ahead.

Glen Yeung - Citigroup

Thanks. Bob, just a housekeeping to start; did you actually quantify what the write-off, inventory write-off was in the quarter?

Robert J. Rivet

$30 million.

Glen Yeung - Citigroup

$30 million, okay, thanks. May I ask a question just about the way to think about your mix of products as we go into the second-half and the impact that has on your blended ASP, forgetting about what may happen on quarter to quarter, part for part price declines but should we see the mix just benefit your ASP as we move into third and fourth quarter?

Henri P. Richard

Well, clearly today the conversion of some of the business from desktop to mobile is helping our ASP and the launch of Barcelona will reinvigorate our server business, which will also from a mix perspective, mechanical mix perspective will benefit the ASP, so I think you are correct.

Glen Yeung - Citigroup

What about things like the move towards Barcelona from Opteron to ultimately Phenom from your other -- I mean, just as we see the new products roll out, are they coming in at a higher price point I guess is what I’m asking?

Henri P. Richard

Yes, but as Dirk pointed out, you will see the benefit of the new generation of Opteron products based on the Barcelona core in the second-half of the year. Phenom comes really late and so I think the benefit of Phenom in terms of ASP elevation you will see in the first quarter of ’08.

Glen Yeung - Citigroup

So in reality, we have some legs here then in other words, right and we’ll see some benefit from server, then from desktop, then from notebook over the course of several quarters?

Robert J. Rivet

Correct.

Henri P. Richard

Correct.

Robert J. Rivet

You kind of stage it out, server first, desktop second, mobile third, with both Puma and Griffin working its way into the ecosystem in the quarters of ’08.

Glen Yeung - Citigroup

All right, so let me come away from the pricing/revenue side and look a little bit on the cost side and maybe just to start with, you make the point that you could be back at break-even exiting Q4 -- am I to read that as Q4 or are you just thinking you might not actually be break-even by Q4 but as you turn the year, you are on that run-rate?

Robert J. Rivet

We would really like Q4 to be break-even, or to be specific, not just the month of December but definitely Q4.

Glen Yeung - Citigroup

Okay, I just wanted to clarify that. And then, Bob, when you think about that, and you don’t -- I mean, I’m not asking you to give guidance for Q4, although if you want to that’s fine, but what I would like to know is what does the break-even model look like for AMD? How should we think about where gross margins need to be and where operating margins need to be in order for you to be at break-even?

Robert J. Rivet

It’s actually too much data, Glen. I appreciate the question but clearly we have to have quite a bit of altitude in the top line from where we are today. Gross margin needs to probably get a four in the first position, just to give you a sense of direction. Clearly we want to make both of those big numbers but it’s hard to make the machinery work if you are not pushing a big number with a two and pushing a four.

Glen Yeung - Citigroup

Okay, that’s interesting. All right, and then the last that I had here was really thinking about SOI as a technology for AMD and the importance that that has obviously on the performance of your chip at the high-end but whether or not you feel like it’s still important for you at the low-end, given that there’s obviously a cost penalty, so to speak, for using SOI at low-end chips.

Dirk R. Meyer

That’s a very good question and through the 45-nanometer generation of classic PC products, there’s no question 45-nanometers is our plan and it’s a fine plan for SOI. As we always do, for the 32-nanometer generation we’re evaluating the choice and mix of SOI versus bulk and that work is still in progress.

Glen Yeung - Citigroup

That’s really helpful, thanks.

Operator

Thank you. The next question is coming from JoAnne Feeney from Midwest Research. Please go ahead.

JoAnne Feeney - Midwest Research

Good afternoon, folks. A couple of questions, really, about your new design wins. Toshiba obviously a major win here and our contacts are suggesting that your share at Toshiba may even be as high as 35% or more. Can you comment on what kind of ramp you are seeing at Toshiba and for how long you’ve been shipping product?

Henri P. Richard

Thank you for your question but you know I won’t answer that one.

JoAnne Feeney - Midwest Research

I had to try. Okay, and perhaps though you could talk about the timing. You’ve listed several design wins and so the timing of these may help us to better predict your unit growth, and if these are just rolling out now, that does give you quite a bit of legs to carry unit growth into the second-half. Can you describe the timing at all of those things?

Henri P. Richard

I think that what you are seeing is again a shift of relevance around the PC platform between the various components that make the user experience and that’s why frankly the acquisition of ATI was so important. If you look today, a large portion of our success in the mobile space is tied to the fact that we’ve got excellent chipsets, both from our company and our partners. They deliver a superior experience. The processors that we install in those platforms are great processors. They provide all the performance you need and when coupled with discreet graphics, they actually respond to the type of computing experience that the new generation is expecting, for example, from mobile device.

So this balanced platform has always been a value proposition of AMD. It’s much stronger now that we have the complete portfolio solution. And what you are seeing in our design win momentum, since you seem to be very well-informed with what is going on in the marketplace, is the reality that today people are looking beyond the microprocessor into the entire platform to make choices.

Hector de J. Ruiz

The only thing I would add, and I think that was one of the questions that you were trying to address, is that we did not ship yet to this new design that you were referring to for the whole second quarter. We got only a partial quarter to take into account in the win and therefore we are somewhat bullish about the expectation in the second-half.

JoAnne Feeney - Midwest Research

Okay, that’s really helpful. I guess the second question, it’s been a while since you’ve talked about the lawsuit with Intel. I’m wondering how that’s progressing, if there is any new information there and how you see it impacting the competitive environment, both here and globally?

Hector de J. Ruiz

We’re really well into this process. The discovery is intense and frankly we’re really pleased with the way things are going for us. We believe this is something that we are going to win hands down. We feel confident about it and the feedback from customers around the world if anything has strengthened in terms of their desire to make sure that this thing opens even further this fair and open competition space.

We feel pretty good.

JoAnne Feeney - Midwest Research

Finally, if I could, just on Barcelona, are your OEMs ready for Barcelona? Are they ready with the more modernized motherboards that would take advantage of all the different capabilities, like split power play, for example? Are the complementary parts out there so that when you do launch, customers that desire it can get the full benefit of Barcelona?

Dirk R. Meyer

Generally the answer to that is yes, although the platforms will generally be released in a staged way. So when we released the initial product this quarter, a subset of the OEM platforms will be released with that and then over the course of the next weeks and months, other platforms will be released as well.

Henri P. Richard

If I may add, let’s all remember that one of the great attributes of the AMD platform is that it is backwards compatible. So one of the beauties of Barcelona is that you can plug it in existing infrastructure. So some of our partners are going to have actually mixed product lines where they immediately introduce all the new features, the split power play and all the benefits of the new architecture while still leveraging some of the existing product line so that we will have a much broader set of products available immediately to the market than we had three years ago when we launched our first Opteron product.

JoAnne Feeney - Midwest Research

Thanks very much.

Operator

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

Bob Gerardi - Deutsche Bank

This is Bob [Gerardi] for Ross Seymore. Thanks for taking my question. Bob, I know you gave guidance for depreciation and amortization. Would you mind splitting out just the depreciation guidance for Q3 for me?

Robert J. Rivet

Of how much was depreciation and amortization?

Bob Gerardi - Deutsche Bank

Just depreciation for 3Q.

Robert J. Rivet

No, we don’t give that detail.

Bob Gerardi - Deutsche Bank

A little bit about the write-down, I mean, could you explain when are you forced to do a write-down? Is it mostly when there are price cuts in the market and in that relationship to your costs? And if I assume further price cuts in the second-half by maybe your competitor or maybe by yourself, why would I not assume there might be some other inventory write-downs in the second-half?

Dirk R. Meyer

That’s a good question. The products that we wrote down on the CPU side in Q2 were all DDR1 specific products. As you know, our microprocessors have embedded memory controllers and also, as you know, the DRAM pricing has become very aggressive and DDR2 prices have plummeted, and DDR1 being the older technology, less available. Actually, the prices stayed up there so we found based on that dynamic in the ecosystem, it didn’t make sense to try to push the older DDR1 product, so the small amount we had left on the shelf we chose to write off. Looking forward, all the product we have is DDR2 capable.

Bob Gerardi - Deutsche Bank

Makes sense, and if I could just have more of a philosophical question; It seems like at least in this quarter, I mean, I look at the flow through and there wasn’t that much, and philosophically, it’s a high fixed cost business, low variable cost. What are your thoughts about running the business as cash versus running it for profit? What are the trade-offs there?

Robert J. Rivet

To be honest, we clearly, if you put it in a priority, if I have to pick between one and two, cash is first and P&L is second from that perspective, and we never forget that. Cash is king so you have to work it from that perspective. But clearly you are balancing long-term needs of your capital investment to make sure you have the capacity so you can have the top line and enjoy it.

I would remind you though that a big portion of our portfolio is now purchased. We purchase all the manufacturing from our friends in the -- from the TSMCs of the world or the sub-cons of the world, so it isn’t -- you can’t just use the same model of the past to the company today because it is a blend between the two businesses.

Bob Gerardi - Deutsche Bank

Fair enough. Could I just do a quick follow-up on that comment, Bob? Do you find that when you go in and do a price negotiation with a customer, whoever it may be, that the fact that the graphic business is variable, do you feel like you are in a better position to push prices higher or avoid business you don’t think is a fair trade-off for what you are bringing to the table?

Robert J. Rivet

You clearly don’t want to -- again, managing for cash you don’t want to lose cash on any transaction. Clearly in a GPU business where cash is what it cost to buy the product, you’re not going to go below that unless it’s really a fringe strategic type thing or it’s drawing a lot of volume from your microprocessor side of the house. So you have to balance it between the two occasions.

Clearly in the microprocessor side of the house, you can, you have a little more latitude from a cash basis because a fairly large component of the manufacturing of the product cost is fixed, so you’ve got a lot more room to move up and down, particularly if you are in different parts of the cycle or attacking different parts of the marketplace.

Bob Gerardi - Deutsche Bank

Got it. Thanks a lot.

Operator

Thank you. Your next question is coming from Chris Danely of JP Morgan. Please go ahead.

Chris Danely - JP Morgan

Given the massive amount of market share gain in Q2, why wouldn’t you guide to an above seasonal Q3?

Robert J. Rivet

We’re just cautiously optimistic. At this point in time, I don’t feel like it’s worth it.

Chris Danely - JP Morgan

That makes sense. I guess if this keeps up where you continue to gain a lot of share but you end up losing money still say in three or four quarters, would you guys choose to maybe pull back a little bit and focus more on your more profitable segments and less on market share? How does that sort of work out?

Robert J. Rivet

The only good factory is a full factory. I think I probably say that every conference call, and so the mission is to sell the factory out and get the most revenue you can for that output.

A niche strategy doesn’t work in our business when you own that kind of machinery, plus it doesn’t work against the kind of competitor we’re dealing with and leaving profit pools un-attacked. So we have to work our way through that. Clearly our goal is to have unit share, dollar share and profit share.

Chris Danely - JP Morgan

And if the choice comes down to profitability versus market share, would it still be on market share then?

Dirk R. Meyer

Maybe I could try to answer the question in a slightly different way. Given the flex fab strategy that we now have employed on the CPU side of the business, the way we look at things really is what sort of R&D investments do we need to make on the product side in order to have the relevance to our customers that we need to? The conclusion is we’ve got to have winning and capable server, desktop, mobile products, GPU products and media processing technologies so as to be a broad supplier. So really, when we think about how much business we need, it’s how much revenue do we need to generate sufficient gross margins to cover our product R&D and maintain an increased relevance to our customer base, more so than filling a particular factory.

Chris Danely - JP Morgan

Got it. That makes sense. And on that note, you guys are trimming the CapEx here and talking about asset light. Can we assume that the plans for the Albany fab are going to be scrapped?

Hector de J. Ruiz

Not at all. You know, as I mentioned earlier, our manufacturing strategy has not changed. Our ambition -- you know what, this is tied a little bit to your first question, frankly. We’re not yet in a two player environment. This is a unique segment of the market where we still haven’t yet broken through what we’d like to do. I think we’ve made progress every year. We’re getting closer to having a real bona fide two-player segment of the market and in doing so, our ambition is to get to a share number that by definition requires more capacity. We are looking forward to benefiting from our plans in New York but we still have until the summer of 2009 to be able to make that decision.

Chris Danely - JP Morgan

Got it. Okay, thanks, guys.

Mike Haase

Operator, we’re going to take two more questions, please.

Operator

Thank you. Your next question is coming from Michael Masdea of Credit Suisse. Please go ahead.

Michael Masdea - Credit Suisse

Thanks a lot. I think maybe Henri is not going to answer this question, but I’ll ask it; Intel clearly is pretty much hitting on most of the cylinders right now and you could argue that you guys are shipping more of your legacy models with new models coming out right now. It seems despite that, you’ve got pretty damn good market share this quarter. What are we really missing about what’s being valued out there and what are we overlooking when we compare a lot of the specs and manufacturing between the two companies and get what should be a different answer for the market share shifts?

Henri P. Richard

I think we all look at this industry as experts and the reality is that there are billions of people out there that look at it as something they want to buy and use and they have a very different view of what matters to them.

I don’t know of any IT manager that ever asked what was the nanometer in this processor and I don’t know of any student walking into a store and really wondering what the die size of a processor, let alone in some cases what’s the frequency? What they do is they look at more and more what is this machine going to do for me? How does this look? Is it a fashion statement? Is it responding to my needs?

So as you focus on the end-user need, as you focus on the experience and as you focus on empowering your customers to differentiate their brands and bring innovation and distinctiveness in the marketplace, what you do is you help first expand the marketplace and we were seeing that the PC business right now is fairly healthy, and you shift away from just technology to user experience.

And that’s why despite all the hype on the core technology, and we have great products as well, what really ultimately matters and what you are seeing in the market share is the fact that people appreciate choice and we help our customers have distinctive products in the marketplace.

Michael Masdea - Credit Suisse

How far along do you feel like you are in coupling the non-CPU part of that whole equation with the CPU part and how effective do you think you’ve been so far?

Henri P. Richard

I think that there is a natural level of comfort for a certain type of conservative customers to have a one-stop shopping experience. On the engineering side, I’m not going to talk for Dirk, but clearly there’s a lot of things that you can do once you have the entire portfolio of technology and some of the features of the Puma platform will demonstrate that.

From my perspective, what the customers like to do is to have this opportunity to look at a complete AMD solution. But as you know, we are doing this with an open platform state of mind and we continue to welcome or partners adding value to the AMD platform. So that diversity is actually very important because it allows again our customers to differentiate their products.

Michael Masdea - Credit Suisse

One quick follow-up for Dirk maybe; Intel made a comment which made my ears perk up a little bit, talking about reducing cycle times, something which they just don’t typically talk about as much and maybe they are doing some behind the scenes, but they made a point of saying that this time.

I guess my question is what are you guys doing, both on the internal side and on the foundry side, to try to do that? Does that seem like it is something out of the norm from your competition to make strides in reducing the cycle time?

Dirk R. Meyer

I heard that comment and actually it sounded like AMD-ers making the comment because we actually have been driving into our Dresden factories for several years and working on cycle time and increased output as well. I think that is actually becoming an increasing trend for the semiconductor business, that is to look more carefully at the applying lean techniques in the wafer fabs.

Michael Masdea - Credit Suisse

Is that something you can influence on the foundry side too or are you more stuck there in terms of your cycle times?

Dirk R. Meyer

Certainly in the spirit of partnerships, we aim to also deploy lean back up our supply chain.

Hector de J. Ruiz

Just to add a little bit as an example of -- our factory in Germany has been benchmarked by a third party’s benchmark fab as being number one in the industry and one of them includes the ability to turn the inventory fast in terms of cycle time per mass layer, which is another way of saying cycle time efficiency. And it is continuously benchmarked as the best fab in the world, so we believe as Dirk point out, that our efforts in this area have actually been going for quite some time.

As a matter of fact, this year we are tasking a group of executives to take it to the next level. Maybe you can call it AMD 2.0 relative to cycle times.

Michael Masdea - Credit Suisse

Thanks, everybody.

Operator

Thank you. Your final question is coming from Kevin Rottinghaus of Cleveland Research. Please go ahead.

Kevin Rottinghaus - Cleveland Research

Thank you. Just to clarify gross margins, up quarter over quarter; does that include the $30 million write-downs? If you strip the $30 million write-down out and margins were 36, would they still be up from there or is it just up from the 34 level?

Robert J. Rivet

Up from the 34 level, so the 34 included the $30 million write-down, so if we didn’t have it, if luck would be in that direction, it would have been two percentage points higher for the total company.

Kevin Rottinghaus - Cleveland Research

Okay, but up from 34?

Robert J. Rivet

Yes.

Kevin Rottinghaus - Cleveland Research

The design cycle, Henri, that you talked about in chipsets, could you talk about where you are and when you expect the new chipsets to start to flow through and maybe see further share gains with the new product launch?

Henri P. Richard

Typically right now we are active at designing the next generation chipset, which we have a whole new set of platforms coming on the mobile space, codename Puma. We’re in the full work on qualifying those platforms. We have our next generation Discreet chipsets for desktop, codenamed 780. We are in the full specs on that one, 780 and 790. And then of course, we have new technologies coming both on Discreet mobile GPU and desktop Discreet GPUs, and those we are starting to work on.

Typically right now, we are working on the products that will come to market in the first and second quarter of ’08.

Kevin Rottinghaus - Cleveland Research

What about the just launched products in the May timeframe?

Henri P. Richard

I’m sorry, I’m not sure I understand your question.

Kevin Rottinghaus - Cleveland Research

You talked a little bit about the graphic shipments getting started. How much of that was already done and how much of that is still to come?

Henri P. Richard

Yes, as I said, the Radeon, the new generation Radeon products were really hitting the shelves in June, so very little contribution towards the second quarter and full production and high demand in this third quarter.

Kevin Rottinghaus - Cleveland Research

My last question -- could you compare the Barcelona launch being faced with step-ups in the speeds versus how you launched Opteron? Was there a phased rollout with Opteron as well or could you I guess compare what is different between the rollouts of the two products?

Dirk R. Meyer

The rollout is going to be very different in that when we introduced Opteron, we did so with almost no global tier one OEM platform support and we’ll be launching Barcelona in pin compatible form to pre-existing Opteron product into platforms that are ready for it from every top tier OEM in the world, so very different.

Kevin Rottinghaus - Cleveland Research

Thank you.

Mike Haase

Okay, great. Well, that concludes the call and we look forward to seeing everyone next week at our analyst day. Thank you.

Operator

Thank you. This does conclude today’s teleconference. You may now disconnect your lines at this time and have a wonderful day.

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Source: AMD Q2 2007 Earnings Call Transcript
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