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Advanced Micro Devices, Inc. (NASDAQ:AMD)

Q3 2007 Earnings Call

October 18, 2007 5:00 pm ET

Executives

Hector Ruiz - CEO

Dirk Meyer - President, COO

Bob Rivet - CFO

Mike Haase - IR

Analysts

Krishna Shankar - JMP Securities

Chris Danely - JP Morgan

JoAnne Feeney - FTN Midwest

Tim Luke - Lehman Brothers

Doug Freedman - Am Tech Research

John Pitzer - Credit Suisse

David Wu - Global Crown Market

Uche Orji - UBS New York

Srini Pajjuri - Merrill Lynch

Sumit Dhanda - Banc of AmericaSecurities

Glen Yeung - Citigroup

Ross Seymore - Deutsche Bank

Cody Acree - Stifel Nicolaus

Kate Kotlarsky - Goldman Sachs

Operator

I would like to welcome everyone to the AMD third quarter 2007earnings conference call. (Operator Instructions) I would now like to turn theconference over to Mr. Michael Haase, Director of Investor Relations for AMD.Please go ahead, sir.

Mike Haase

Thank you and welcome to AMD's third quarter earningsconference call. Our participants today are Hector Ruiz, our Chairman of theBoard and CEO; Dirk Meyer, our President and COO; and Bob Rivet, our CFO.

This is call is a live broadcast and will be replayed at AMD.com.The telephone replay number is 800.642.1687. Outside of the United States, the number is 706.645.9291. Theaccess code for both is 18461849. The telephone replay will be available forthe next ten days starting this evening.

I would like to call to your attention that our Q4 2007earnings quiet time will begin at the close of business Friday, December 14th.Also, we are hosting our financial analyst day on Thursday, December 13th in New York City. Additional details will be provided as weget closer to the day.

Before we begin today's call, I would like to cautioneveryone that we will be making forward-looking statements about management'sexpectations. Investors are cautioned that our forward-looking statements arebased on current beliefs, assumptions and expectations, speak only as of thecurrent date, and involve risks and uncertainties that could cause actualresults to differ materially from our current expectations as set forth in theforward-looking statements.

The semiconductor industry is generally volatile and marketconditions are particularly difficult to forecast. Because our actual resultsmay differ materially from our plans and expectations today, I encourage you toreview our filings with the SEC where we discuss in detail our business andrisk factors, setting forth information that could cause actual results todiffer materially from those in our forward-looking statements. You will find detailed discussions in our mostrecent SEC filing, AMD's quarterly report on Form 10-Q for the quarter ended June 30, 2007.

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

Dirk Meyer

Thank you, Mike. We're encouraged by the progress we made inthe third quarter. We improved our gross margins; we cut our operating loss bymore than half and improved our cash flow. We executed well across each of ourmajor lines of business and in all of the key components of our plan, including:growing the top line, increasing internal efficiencies and continuing ourtransition to new technologies.

Our revenue was up 18% sequentially, fueled by a steady flowof new products and robust demand for our offerings. We saw another quarter ofgreat demand for AMD mobile processors. Mobile processor revenues were up 43%sequentially, to an all time record due to strong customer response to the AMDvalue proposition and our innovative brand strategies.

We saw continued strong performance in our desktop processorbusiness, particularly in the channel, where we sold record unit volume in thequarter. We began shipping our new quad-core AMD Opteron processors in thequarter with customer excitement and demand quite high. While our initialproduction ramp of quad-core Opterons has been slower than anticipated, weexpect quad-core Opteron will be widely available by the middle of this quarter;and, we expect to ship hundreds of thousands of quad-core processors thisquarter into the server and desktop segments.

GPU revenues grew 29% sequentially, led by robust adoptionof our ATI Radeon HD 2000 family. We're encouraged by the widespread andgrowing customer response to AMD-based platforms. A great example of this is thecombination of our processors and AMD 690 chipsets in systems from HP, Lenovo,NEC, Packard Bell, Samsung and Toshiba and we're particularly pleased withToshiba's announcement this week to introduce commercial notebooks based on theAMD Turion 64 processors and our AMD 690 chipset.

Looking ahead, customer and end user anticipation is growingfor our upcoming Spider platform, the ultimate gaming enthusiast platformfeaturing AMD Phenom processors, RD 790 chipsets and RV 670 graphics cards. TheSpider platform is proof positive of AMD's commitment to deliver the ultimatevisual experience and remains on track for launch in November.

In the area of increasing internal efficiencies,manufacturing performance in fab 36 inDresden remained strong, exceedingtargets for output, yield and cycle time. We remain on schedule to shutdown fab30 before the end of this year in preparation for transitioning that facilityto 300 millimeter.

Our supply chain transformation efforts are starting toproduce results, where we did a particularly good job matching product deliveryto customer demands while at the same time reducing inventories.

We have controlled the growth of operating expenses and willcontinue to focus on increasing the efficiency of all areas of the company,including R&D, sales, marketing and administration.

Finally, we continued our transition to new technologies ineach of our businesses. We completed the transition to 65 nanometer technologyin fab 36 in Q2,and as I said, will be transitioning fab 30 this quarter to a 300 millimeter tool set and asa result, our mainstream processor business will be based on 65 nanometer 300 millimeter technology aswe leave this year. We're looking forward to ramping 45 nanometer product productionin the first half of next year, and in our graphics processor business, we willlaunch the RV 670, the world's first 55 nanometer GPU in the fourth quarter.

For the second quarter in a row, we grew our revenues and believewe gained CPU market share. We introduced new products, we drove increasedefficiencies in manufacturing and will continue to do so across the entirety ofour business.

In summary, we made good strides to put AMD on course toapproach profitable operating performance in the current quarter, and we willnot be satisfied until we achieve sustained profitability, but were encouragedby the past quarter's improvement and by our continued strong customerrelationships.

With that, I'll turn it over to Bob.

Bob Rivet

Thank you, Dirk. We improved our performance in the thirdquarter, improving the gross margin and significantly reducing our operatingloss, as planned. We also reduced our operating expenses while establishingall-time records in microprocessor unit shipments, microprocessor unitshipments into the distribution channel, notebook processor sales, and notebookprocessor unit shipments.

These records drove AMD's third quarter revenue to $1.362billion, up 18% sequentially and up 23% compared to the third quarter of 2006.We recorded a net loss of $0.71 per share in the quarter. This loss includescharges of:

(1) $76 million or $0.14 per share from ATIacquisition-related integration and severance charges, which I call ARC; and

(2) $42 million or $0.08 per share charge associated withthe impairment of our holding and the common stock of Spansion.

Excluding ARC, we had an operating loss of $148 million inthe quarter, a 61% improvement from the prior quarter. As detailed in our pressrelease, third quarter gross margin increased to 41%. This compares to a grossmargin of 33% in the second quarter of 2007. The 8 point increase in the priorquarter was largely driven by record microprocessor shipments, improvedmanufacturing efficiencies, inventory management, and a richer microprocessorand graphic product mix.

As I outlined last quarter, gross margin was negativelyimpact by an inventory charge of $30 million, or 2 percentage points, for oldergeneration microprocessor material. Therefore, operational third quarter grossmargin improved by 6 percentage points from the last quarter.

As guided, total operating expenses which include R&Dand SG&A were down $21 million from the prior quarter. Cash flow fromoperation was a positive $223 million for the quarter, a significantimprovement from last quarter; and adjusted EBITDA was positive $60 million,another solid improvement over our second quarter performance. A reconciliationto operating loss and EBITDA in accordance with GAAP is available in our pressrelease.

Now, switching to the business segments. Computing solutionsrevenue was $1.283 billion, up 17% from the prior quarter, primarily driven bya 19% increase in microprocessor revenue. Microprocessor unit shipmentsincreased 16% sequentially. We achieved sequential double-digit revenueincreases for our notebook and desktop product lines. Notebook processor unitshipments growth remained strong, increasing 41% sequentially and 68%year-over-year. We significantly reduced our operating loss in the computingsolutions segment to $112 million in the third quarter, $146 million less thanlast quarter.

Switching to the graphic segment. Revenue of $252 milliongrew solidly compared to the second quarter. Sales of the ATI Radeon HD 2000series were strong, representing more than half of the graphic processor salesfor the quarter. Design win momentum continues to be strong. Operating loss inthe graphic segment was $3 million, a $47 million improvement from lastquarter.

Consumer electronics segment revenue was $97 million, up $12million from the prior quarter. Handheld sales were higher than prior quarterand gaming console royalties increased. Third quarter operating loss was $3million, a $19 million improvement from the prior quarter.

Now let's turn to the balance sheet. Cash and marketablesecurities balance at the end of the quarter was $1.528 billion, down $66million from the second quarter. This includes $118 million representing thevalue of our holding in Spansion common stock, which has been reclassified forlong-term investments to marketable securities, and we netted $1.48 billionfrom our 5.75% convertible debt offering in the third quarter, and used theproceeds with additional cash of $200 million to repay in full the $1.7 billionoutstanding balance of the term loan used to acquire ATI.

As previously outlined during the last earning call, we hadapproximately $800 million in non-operational cash generating opportunities. Wecollected approximately $200 million in the third quarter through the sale of aportion of our Spansion investment; 200 millimeter tool sales; andadministrative asset sales. We expect to execute our plan to capture theremaining amount in the coming quarters.

Total inventory at the end of the third quarter was $839million, down $53 million from the prior quarter. Days of inventory outstandingfinished at 80 days, an improvement of nine days from the second quarter. Ourinventory is fresh with the vast majority of microprocessor inventory DDR2compatible and more than 70% of our GPU inventory comprised of the new HD 2000family.

Now let's talk about the outlook. AMD's outlook statementfor the fourth quarter is based on current expectations. The followingstatements are forward-looking and actual results could differ materially fromcurrent expectations.

In a seasonally up fourth quarter, AMD expects revenue toincrease in line with seasonality. Operating expenses, which include R&D,SG&A, and employee stock-based compensation are expected to be up approximately6% compared to the third quarter, primarily driven by investments in newprocess technology.

ARC charges are expected to be approximately $75 million. Weexpect to have a tax expense of approximately $25 million. Depreciation andamortization are expected to be about $290 million, and capital expendituresare expected to be approximately $300 million. For the year, we expect capitalexpenditures to be approximately $1.7 billion.

In summary, we made good progress in the third quarter andwe look forward to continuing to move the needle in the right direction in thefourth quarter.

With that, I'll turn it over to Hector for some finalremarks.

Hector Ruiz

Thank you, Bob. As you heard today, we have made solidprogress on our plan toward a profitable model while continuing to invest inthe products and technology for our long-term success. We will continue toexercise operating cost control and accelerate our efficiency thrust across theboard.

We expect continued improvement in gross margins whilemaintaining our momentum on the development and ramp of new technologies. Wesold record units through the microprocessor channel and launched a new productcycle in each of our major business units.

While we still have much more important work to do, ourprogress on each of these fronts is significant and gives us additionalconfidence to continue the wholesale industry transformation that I outlined inthe last quarter.

Demand for the AMD value proposition is strong and customerscontinue to want more; more products that much their needs and valuepropositions, more integrated platforms and solutions and more customer-centricinnovation and more competition. Our customers want choice and their decisionto involve AMD in their business is very strategic.

Nearly a year after our acquisition of ATI Technologies, theresults of the industry change and action are both real and demonstrable in thestrength of our evolving relationship with key customers like Dell, HP, IBM,Sun, Acer and now Toshiba, in a growing portfolio of breakthrough products likeour Radeon HD 2000 series, the AMD 690 and upcoming RD 790 chipsets; theunprecedented performance, and performance characteristic of our AMD quad-coreOpteron processors and soon to be released AMD Phenom quad-core desktopprocessors; in the form of game-changing platforms like our upcoming Spideroffering, our forthcoming Puma platforms and the promise of fusion in anexciting new future of accelerated computing.

Every one of our business units is entering an exciting newproduct cycle, with the added opportunity to deliver increasing value to ourcustomers.

We are very encouraged by our progress, but are dissatisfiedwith our financial results. We're working diligently to bring this company backto profitability as soon as possible. But as I mentioned last time, we remaincommitted to our unique opportunity for industry leadership and to thestrategic course that we have set to achieve that end. We're making strongprogress in new products, in R&D, in our technology transitions.

Finally, I know that you are all interested in learningabout the progress we're making on our asset life strategy. We have a bold andsubstantive plan and we have made significant progress in validating it.Meanwhile, as I have told you before, for competitive and business relationshipreasons we will not be presenting details of our plan in progress until we putthat plan in action.

What I can report to you today is that we have madeconsiderable progress in our preparations and I'm personally very excited aboutit. We are positioned for success and have an exciting future ahead of us.

Once again, I want to thank our customers for their support,our investors for their confidence, and most of all our employees for their unwaveringcommitment to help us win.

Now back to Mike for the Q&A.

Mike Haase

Thanks, Hector.Operator, can we begin the Q&A process, please?

Question-and-AnswerSession

Operator

Your first question comes from Krishna Shankar - JMPSecurities.

Krishna Shankar - JMP Securities

Congratulations on the good progress in the quarter. Can youtalk about the server business? What that did in Q2 and the outlook for growthin the server business in Q3? You mentioned hundreds of thousands of quad-core,but I wanted to get a sense for how the older Opteron business did in Q2 andthe growth trajectory in Q3.

Secondly for Bob, the trajectory for gross margins in Q4,given you have a better mix and seasonality in Q4.

Dirk Meyer

First of all, I think when you were referring to Q2, youactually meant Q3?

Krishna Shankar - JMP Securities

That's correct.

Dirk Meyer

We shipped tens of thousands of quad-core Opterons in Q3. Thatdidn't have a material contribution to the overall server business in Q3 so asa result, Q2 to Q3 we were roughly flat to down a little bit. As I said, weexpected to ship hundreds of thousands of quad-core CPUs in both server anddesktop in Q4, and we'll substantially increase the number of quad-core server processorsshipped in Q4.

Bob Rivet

To the question of gross margin, clearly, we're pleased withour results in the third quarter. Fourth quarter is seasonally up in additionto the new product offerings that Dirk just talked about of continuing on theback of the GPU offering that we saw some significant progress in the third. Thequad-core offerings that will continue in the fourth quarter, we expect grossmargin to improve but it won't be at the same rate you saw the improvement fromsecond quarter to third quarter; butdirectionally, up.

Operator

Your next question comes from Chris Danely – JP Morgan.

Chris Danely - JP Morgan

Can you just sketch out a path to profitability and give usa sense of what sort of revenue level or what sort of milestones you need tohit to become profitable?

Bob Rivet

To me, to repeat where I was a quarter ago is, clearly ourgoal is to make money in any given quarter. But clearly as I talked aboutthere, we needed to be approaching the $2 billion revenue level and north of40% gross margin to achieve that kind of goal since we're not going to cut ourway to make the bottom line happen.

We're on a path. We made good progress in the third quarter,got above the 40% on the gross margin. Clearly not there in the sales level.We'll see in fourth quarter. Our goal is to breakeven, and maybe we have a shotat it but to me, the directional path we're going is still approaching a $2 billion top linenumber to drive a bottom line of breakeven.

Chris Danely - JP Morgan

When do you guys expect to start shipping either at 2.4GHzor 2.5GHz Barcelona?

Dirk Meyer

The plans that we have haven't changed from what we talkedabout around the timeframe of the Barcelonalaunch, which is to ship the 2.5GHz product in the middle of this quarter.

Operator

Your next question comes from Joanne Feeney - FTN Midwest.

JoAnne Feeney - FTN Midwest

Congratulations on a nice quarter. A couple of questions onthe breakdown of sales if we could talk about that for a minute. Could youdescribe, perhaps, your ASPs by desktop and notebook? It looks like in theaggregate they went up by about 3 percentage points, but did you see anydifference really between the notebook and the desktop space there?

Bob Rivet

Joanne, this is Bob. In the client space, whether it was inthe notebook or desktop, we actually saw improvement in ASP in both categories.A slight decline in the server space, but it drove the overall to be up. Bothclients were up quarter on quarter.

JoAnne Feeney - FTN Midwest

So in the notebook space, it sounds like if the pricecompetition that Intel spoke about really sounds like it was confined to theconsumer space then. Is that right?

Bob Rivet

Well, that's theplace we mostly play in. We continue to try to expand in the commercial space,but our notebook offering sits squarely in the consumer space.

JoAnne Feeney - FTN Midwest

Others have been concerned about double booking. Are youfolks seeing any evidence of that going into the fourth quarter?

Bob Rivet

No, not at all. Theindications from the current quarter were a lot of sellthrough, particularly inthe distribution channel. We're at a very low level of weeks of inventory andthe signals we continue to get from OEMs is very bullish and strong that unitsare moving quite quickly. So, we don't feel there's any overbooking at all.

JoAnne Feeney - FTN Midwest

Then if I look atyour breakeven path here, it does seem that given the trajectory we're seeingso far in gross margins, even if that does tail off a bit for the fourthquarter, if you guys continue at the pace you're going into terms of unitshipments and gross margin improvements, even if that's a little slower, itdoes seem if I have the math right, then it looks more likely that you'll breakevenin Q4 than a quarter ago. Is that right?

Bob Rivet

Thank you. I can't argue with your math. Like I said,everything needs to work, it is not just one business that drives thatequation. It is all of the businesses moving at the appropriate speed. Some ofthem are different in the seasonality of the fourth quarter but clearly if weget to $2 billion, I think we can do it.

JoAnne Feeney - FTN Midwest

Finally if I could, just on the graphics side, it is aneglected part of a business often in these discussions, but it does seems likeyou've been doing better in the mainstream. Do you feel like going into thefourth quarter that you're getting more traction in the mainstream, and do youthink you can really break in at the high-end enthusiast segment?

Dirk Meyer

We're actually feeling pretty good about the graphicsbusiness, first, based on very good OEM design win momentum, a lot of whichturns into business late this year and muchof it actually next year. A lot of the business that we did this quarter was inthe channel where the response has been pretty strong. Based on the upcomingrelease of the RV 670, we're pretty bullish about being able to participate ina bigger and more profitable piece of the business.

Operator

Your next question comes from Tim Luke - Lehman Brothers.

Tim Luke - Lehman Brothers

Nice job on theexecution. I was wondering if you could just remind us of the 45 nanometer roadmap and the movement there? I think you talked about the first half of '08.

Dirk Meyer

First, we are on track relative to having basic yields inplace in our factories on material that we're running today. We're building 45nanometer microprocessors as we speak and those two facts give us increasingconfidence in the public statements we've been making for some time around ourintent to be starting our production ramp of 45 nanometer processors in thefirst half of next year.

Tim Luke - Lehman Brothers

Any clarity within how you define first half with respect to the second quarter?

Dirk Meyer

No, other than tojust stop at the words “first half”.

Tim Luke - Lehman Brothers

Bob, on your inventory level lower in the third quarter, howdo you see that developing going forward and where do you want that to be?

Bob Rivet

Well, it is hard to imagine with the seasonal strength ofthe fourth quarter that we won't -- even if we try real hard -- that inventories won't decline. I expect to go out of the year with lessinventory than I have today and then try to repeat that pattern as we gothrough next year. Inventories I expect to drain in the fourth quarter.

Operator

Your next question comes from Doug Freedman - Am TechResearch.

Doug Freedman - Am Tech Research

Thanks for taking my questions. One of them was just touchedon, and that is the progress of the 45 nanometer ramp. Is there any more coloryou can offer as far as where you see those products targeted, where we shouldsee the 45 nanometer products first?

Dirk Meyer

I think we'll providemore detail when we have the analyst conference in December but roughlyspeaking, server and desktop will be the first to benefit.

Doug Freedman - Am Tech Research

In the past you've talked about Bobcat and Bulldozer. Anyprogress and update on where those cores are at and how that progress isprogressing?

Dirk Meyer

It is tough to providemeaningful detail in this call. That's probably something better left for ananalyst conference as well.

Doug Freedman - Am Tech Research

Let me try one more then. With the ATI progress and the magnitude of improvement, should weconsider that what we saw in September, is that a full quarter of improvement? Shouldwe expect that to continue to accelerate in the December quarter?

Bob Rivet

No. Particularly inthe GPU business you're seeing a full quarter of improvement. We launched thatnew series of products in mid spring so wedidn't have a full second quarter impact, we had a full third quarter impact. Maybeyou don't realize, but seasonally actually, the fourth quarter is not strong inthe GPU marketplace. It is actually typically flat to slightly down. We'll haveto work real hard to grow sales quarter on quarter, which we'll do, but it ishard to make a lot of progress if you don't have it from the top line.

Doug Freedman - Am Tech Research

In your commentary you stated that some of the charges wererelated to severance and asset impairment. Can you help us understand exactlywhat actions? I know there's been some action plans put in place. Maybe sinceyou don't want to talk about things that are forward-looking, can you give ussome idea about what actions have taken place already?

Bob Rivet

Well, we've had a multiple-prong attack to addressintegration issues, integration opportunities where we had redundancy indifferent categories where we needed to eliminate those resources. Then we'vebeen proactive in, I'll call it performance management, to step up and dealwith some people who weren't doing as well as we thought they should. So thosetwo actions have yielded over the last two quarters, we've actually reducedsome to allow us to upgrade the organization as we go forward or to eliminatethe redundancies in the G&A areas where you just didn't need to have thesame people doing the same thing because of two public companies.

You're seeing that in the acquisition of intangible assets andintegration charges line on the P&L, which is right above operating income.Unfortunately, in some of those cases people actually had to leave the company.

Hector Ruiz

Bob, the comments on asset impairment?

Bob Rivet

The asset impairment, which is below operating income whichended up being $42 million, that's just reflecting the value of the Spansionstock which has been more permanently impaired since it has been sitting around$8 for quite a long period of time, which was more than our current book valuewhen we wrote it down to the appropriate level and took the non-cash charge inthe quarter.

Doug Freedman - Am Tech Research

One last one on just the pricing outlook. We heard yourmajor competitor there say that there's actually a possibility that they can'thandle more upside. They burned a ton of inventory in the quarter. What's youroutlook as far as the overall pricing environment? What are you seeing outthere? How competitive is it for new business?

Dirk Meyer

First of all, we didn't see a qualitative change in theenvironment from Q2 to Q3. Where we compete with the other guy, I would call italways competitive, but it didn't change Q2 to Q3, and we're not expecting muchof a change Q3 to Q4.

Operator

Your next question comes from John Pitzer - Credit Suisse.

John Pitzer - Credit Suisse

On the top line guidance for the calendar fourth quarter, givenhow strong and how much above seasonality Q3 was, why the confidence aroundnormal seasonal for Q4?

Hector Ruiz

First of all, across the board, we're going into a quarterwith optimism on one hand and some cautious concerns on the other. Let meoutline those for you. First of all, the demand for products from all of theregions around the world, particularly in the emerging markets, is very, verysolid; very strong.

But when we look at what our customers are telling us, noneof them have changed -- at least as of today -- their plans. They're telling usthat they also have a concern on three areas: One is there are spotty places where plastic appears to be inshortage. There are also spotty places where they see displays being difficultto obtain. That also applies to a concern they have over the fact that the majorfire in Japan where the battery factory pretty much got put out of business, allof that has caused a little bit of uncertainty into the quarter.

But other than those three issues which are yet to bequantified by any of our customers, the optimism into the quarter is strong andparticularly strong in the emerging regions.

John Pitzer - Credit Suisse

Hector, above seasonal Q3, in line seasonal Q4, any view onwhat that might do to the first half of next year? Are we setting up for abelow seasonal correction in Q1 or do you think there's offsets?

Hector Ruiz

I think that's prettyhard to predict. We will try to create it to our liking, but I can't tell youright now. I think if those three issues I talked about don’t impact the consumptionof product in the fourth quarter, we will go into a reasonably normal firstquarter.

John Pitzer - Credit Suisse

With Penron coming out here in mid-November, how do youthink that might impact Barcelonaadoption and volume ramps there? Or do you feel like the 2.4GHz and 2.5GHzparts will offset the introduction here?

Dirk Meyer

Based on the inputwe're getting from our customers and end users, there is a lot of demand for Barcelona,I tell you. We're just seeing people licking their chops and ready to get theirhands on the product. Clearly, going from two cores to four cores is a bigincremental increase in capability in the Opteron line that we think is goingto provide some benefit to the business here

John Pitzer - Credit Suisse

CapEx currently going to move fab 30 to 300 millimeter. If you look atthe plan for next year, how should we think about CapEx from the $1.7 billionlevel?

Bob Rivet

I don't want to get into discussing 2008 forecast at thispoint in time. That's what I'll set up in the December analyst conference. Togive you at least a directional, right now I would say it is flat to down fornext year for capital expenditures.

Operator

Your next question comes from David Wu - Global CrownCapital.

David Wu - Global Crown Market

Can you clarify two points for me, please? The first one is,did you say the operating expenses would be increasing 6% quarter on quarter inQ4? If so, what happened to the 500 headcount reduction savings that hasoccurred or should be occurring at this point?

A second one I have is regarding the RV 670 launch, which iswell anticipated to be next month, when does it really hit your revenue line? SinceQ4, I guess it is a little late to have much of an impact for Q4.

Bob Rivet

Let me tackle your first one. And then Dirk can handle thesecond one. The first one is yes, youheard me correctly. Expenses for R&D and SG&A will be up from the thirdquarter around 6%. That includes stock option expense.

To your question of, so where is the savings we have talkedabout? You saw some of it in the current quarter. A lot of that increase in thefourth quarter as I made in my prepared remarks is for process technologydevelopment as we continue to prepare for that 45 nanometer transition thatDirk talked about. So it isn't people-related it is more experiment-related. Wecontinue to backfill those people that we had performance issues with, withbetter employees.

Our goal is to continue to invest appropriately in theR&D line and to prepare ourselves for the next process technologymigration.

David Wu - Global Crown Market

While you're answeringthat question, can you answer a dictionary question -- what on Earth is atypical seasonal fourth quarter?

Hector Ruiz

Unfortunately, we're in an environment today, as Bob pointedout in some of his remarks, with the GPU business as an example where it isvery strong third quarter and not as strong fourth quarter; and the CPUbusiness, which tends to be actually the opposite, you are right. It gets a lottougher for us to anticipate what seasonality really means.

What we intended to say was if the market grows at X percentin the fourth quarter, then generally for the business in which we participate,we expect to be in that range.

Dirk Meyer

On the RV 670 question, when we launch the product weanticipate doing so with cards available in channels and therefore, we willdrive revenue in the quarter. Obviously, with a mid-quarter launch and on a quarter-billionrevenue basis, that's not going to contribute materially to the quarter but itwill provide some upside.

David Wu - Global Crown Market

Could it offset a seasonally weak fourth quarter in thatkind of business?

Dirk Meyer

Sure.

Operator

Your next question comes from Uche Orji - UBS.

Uche Orji - UBS

Congratulations on a very strong performance. Just veryquickly on the graphics, a little bit more clarity for me. It may seempresumptuous for me to conclude that you took a significant amount of marketshare. Did you get a sense that you took some share? If you can just clarifyfor me how much confidence you have going forward that level of performance is sustainableand not just pent up demand for the products that you launched?

Dirk Meyer

First of all, I'll say it is hard for us at this point toreally make confident proclamations on GPU share fluctuations, just because ofthe way that business works, in particular the way the add-in board businessworks as an ecosystem.

With respect to the second part of your question, a lot ofour view of the forward-looking potential in the business comes from the designwin activity that we generate with our OEMs. That's a leading signal as to howcompetitive our products will be when they come out. As I said in the preparedremarks, we're pretty optimistic based on those interactions.

Uche Orji - UBS

Just another question on R&D, if you're going to beramping 45 nanometer in the first half, how should we think of R&D spendingsubsequent to that ramp for the rest of 2008 and beyond? Should we expect thatto start to tail off?

Bob Rivet

Again, I'll provide a lot more color at the December analystmeeting, but I view it this way. 45 then turns into 32. So, you're continuingto always make investments in process technology with bumps, so there's that. Wecontinue to enhance our capabilities in design, so it is hard to call at thispoint exactly where I would peg those numbers. I'll give you more in December. But we don'twant R&D investment to go down per sae.

Uche Orji - UBS

Just on the gross margins, the fall through sequentially wasquite significant. How much of that was 65 nanometer contributing on the costside, or how much of that was early demand from Barcelonaor just servers in general? If you can just explain it in terms of 65 nanometerproducts and just help me understand.

Bob Rivet

Back to my prepared remarks, we had record microprocessorunit shipments; that helped. That was very little affected by the Barcelonalaunch so there's very few units of Barcelonain there. We improved the ASP quarter on quarter. We had more 65 nanometer thanthe prior quarter. Manufacturing continues to get higher yields, moreefficiency. We improved inventory management. So it really was no singularitem. It was a lot of little things by each of the business, whether it was theGPU business or the CPU business that yielded that 6 point operational improvementquarter on quarter. Hard to sustain, as you said which I wouldn't say anybodyshould forecast at that kind of rate.

Uche Orji - UBS

Finally back again on graphics in terms of RV 670, what kindof early feel are you getting from the customer base for this product?

Dirk Meyer

Customers are goingto love it.

Operator

Your next question comes from Srini Pajjuri - Merrill Lynch.

Srini Pajjuri - Merrill Lynch

You said you expect to grow in line with the end demand in Q4.You've been gaining share in notebooks and it also looks you at least have acouple of new products that you expect to take further share in. I'm justcurious, is there anything else that you're seeing that makes you morecautious? Why don't you expect to grow faster than the end demand in Q4?

Hector Ruiz

Let's just be totally candid here. Why would we want tostick our neck out on a number that frankly is very difficult to predict rightnow in the fourth quarter? We want to continue to increase our shareparticipation in the mobile space, we believe we can. But I don't think it isprudent at all to try to pick a number, other than to tell you that it is ourgoal to continuously increase and improve our participation in that space.

Srini Pajjuri - Merrill Lynch

Fair enough. One question on the CapEx. You mentioned itwill be flat to down. I remember on the analyst day you put out a chart thatshowed some capacity in terms of unit numbers. Given the efficiency that you'reachieving in manufacturing and also the demand that you're seeing, is there anychange to that outlook in terms of your capacity that you expect to have in2008?

Bob Rivet

Again, I don't want to get into the details of 2008, but wecontinue to toggle how much capability we want to have in place to produceunits. Right now, I would say probably we're less than we were a year ago atthat point in time in how many units we expect to produce in 2008. We'llquantify that more in December.

Srini Pajjuri - Merrill Lynch

Just so I understand, as you have achieve more efficiencies,you expect to put that money back on to your balance sheet?

Bob Rivet

Correct. Instead of just building inventory for the sake ofbuilding inventory, we would like to build inventory and turn around and sellit. Clearly, we'll take the advantages we see from manufacturing and let thatflow through the business whether it is the balance sheet or the P&L.

Srini Pajjuri - Merrill Lynch

Just one clarification on the OpEx side. Is there a steadystate or normalized number for OpEx? I washoping it would come down a bit more. I'm wondering after you ran the 45nanometer, should we expect a steady state now for OpEx?

Bob Rivet

I guess the simple answer is no. I mean, we continue tobelieve we have a business model that will gain share and grow the top line,and therefore we will continue to invest appropriately. We will see thepercentages of cost as a percentage of revenue to decline. Absolute dollars isdependent on the business conditions in that moment in time. So there is nosteady state.

Hector Ruiz

This is not a steady state business.

Operator

Your next question comes from Sumit Dhanda - Banc of AmericaSecurities.

Sumit Dhanda - Banc of America Securities

Bob, you talked about -- again, not to belabor the point --but talked about reducing discretionary spending, headcount. But as I look atit assuming a normal quarter here in Q4, it will be up to about $1.8 billion,$1.9 billion in revenues give or take; but the operating expenses are stillrunning about $100 million or so higher than where they were when you wereregistering comparable revenues last year.

I'm unclear as to exactly what measures you've taken andmore importantly, how they've really impacted the operating expense structureto drive profitability.

Bob Rivet

Well as we've said all along, we're not going to cut our wayto prosperity. It is about growing the top line and getting the appropriatemargin from the manufacturing organization and making appropriate investments in R&D to pull usinto even higher growth rates.

We continue to invest in process technology development andin R&D for the multitude of products that you see coming out right now andyou'll see coming out near term and then long term. So we continue to try tooptimize the situation, but we're not backing off on our spending in R&D.

Dirk Meyer

One furtherclarification. A year-on-year comparison Q4 this year to Q4 last year, you haveto be careful because we didn't have the former ATI businesses as part of thecompany for all 13 weeks of the quarter in Q4, point 1.

Point 2 being we came out of 2006 growing pretty rapidly.Our people and resources and capability in the CPU business and it reallyflattened out that growth, starting late in the first half of this year.

Srini Pajjuri - Merrill Lynch

I wasn't comparing Q4. My point here would be that while ATIis part of your business now. It's a moot point whether you had it then or youdidn't. I guess I'm a littledisappointed that the cost cuts aren't coming faster than anticipated. We'lljust let that go.

Dirk, I had a question for you. On the Barcelonaramp you said it materialized a little slower than anticipated and your speedgrades haven't been targeting the top end right off the bat. There has beensome speculation that perhaps your yields on 65 nanometer specifically as itrelates to Barcelona is the issuehere.

Any comments you would want to make or a differentexplanation you would want to offer up on why Barcelona'sspeed grades aren't as fast as you would like them to be?

Dirk Meyer

First of all, I'll say that the basic silicon yields of Barcelonaare right where we expected them to be. They're right line on line with theprevious 65 nanometer products from a deep activity and overall yieldperspective.

The issue has been simply one of tuning the design to thetechnology so as to support a high volume ramp. It is that particular issuethat caused us to take a few extra weeks before we turn on the high volume rampin the middle of this quarter.

Sumit Dhanda - Banc of America Securities

In other words, there's nothing endemic to your processtechnology that is problematic or which might spill over to your 45 nanometerramp?

Dirk Meyer

No. The minor issueswe've been experiencing have nothing to do with the process technology or themanufacturing capabilities. It is all a matter of wedding the design to thetechnology so as to be able to ship in volume.

Sumit Dhanda - Banc of America Securities

Anything else you could share along those lines in terms ofdetails as what the issues have been in wedding your designs with your processtechnology?

Dirk Meyer

I don't think in thisforum.

Operator

Your next question comes from Glen Yeung - Citi.

Glen Yeung - Citigroup

Just to follow up onthe last question, you made the point about defect density. Is your defectdensity the same per unit or per square inch of silicon?

Dirk Meyer

Per square inch ofsilicon.

Glen Yeung - Citigroup

I know we're all trying to pinpoint you to a number here, butwhen you say fourth quarter is growing relative to whatever seasonality isgoing to be, is the current view that the demand outlook looks pretty normalversus normal seasonality? Because your competitor did not guide for normalseasonal. I wonder if you're benchmarking to them or benchmarking to what onemight call more normalized growth.

Bob Rivet

You can't ignore the market leader comments and statementsso to some degree, they're setting the tone and have a much broader view ofwhat's going on in the market place because they're still the dominant player.So, I think they're the best indication of seasonality.

Glen Yeung - Citigroup

The other question I want to ask, and I'm not asking you fora number per sae, but can you give us a sense as to utilization now? Is it a highnumber for you net? Do you feel like you're running your factories pretty full?What's the potential that you don't have enough capacity as you move into allof 2008, really?

Hector Ruiz

The philosophy we have in running our factories is that wehave been ramping fab 36 incapability for quite some time. We're not yet at its maximum capacity. As weramp, as we continue to add capability for fab 36, we continue to utilize it.We don't ramp it and not use it.

So from that perspective, we use the capacity reasonablywell. But on the other side is as you heard today, is we have shut down fab 30,we are transitioning out to fab 38, and we're doing it in such a way that fab 38is going to be like a race car idling in the pit stop. I mean, we will beprepared to ramp that quickly, should we need extra capacity in that space; whichfrankly, we hope we do.

But at this point in time, we're planning to have fab 38 at modest activity in 2008.

Glen Yeung - Citigroup

You remind me of yourFerrari laptops. Hector, you're basically saying you feel like you have someflexibility in the way you're managing your capacity for next year, andobviously there's some lag between your expectation of capacity needs and whatmay actually materialize. But you feel like you've got enough flexibility tomanage; you're not materially over or undersupplying.

Hector Ruiz

That's correct.

Operator

Your next question comes from Ross Seymore - Deutsche Bank.

Ross Seymore - Deutsche Bank

You mentioned that the interest level for the new Barcelonachip is quite high. How can we gauge the success of that in replacing existingcustomers? Were they upgrade versus bringing new customers in to switch over toyour platforms? If you could just discuss the success you're seeing on thosetwo vectors, please.

Dirk Meyer

First, when you use the term customer you may mean somethingdifferent than what we mean when we say customer. To me, the customers are thepeople we sell the chip to, which is the OEMs. At this point, we've got a broadassortment of Opteron-based systems from all of the major OEMs already and Barcelonawill just provide a seamless upgrade path into those systems.

Perhaps you meant interest at the end user level.

Ross Seymore - Deutsche Bank

Actually, both.

Dirk Meyer

At the end user level, we're seeing a lot of interest bothamongst installations that are already Opteron installations and newopportunities. As I said, we've already got a broad assortment of OEM serverproducts across blades, 2p, 4p racks and so on.

Ross Seymore - Deutsche Bank

As I think about the ASP side of that equation, how should Ijudge the ASP bump you may or may not get because of Barcelonacoming into your server mix? If you want to talk about it in a relative term,if you can contrast that versus the ASP bump you got when you put Opteron outin the first place.

Dirk Meyer

Honestly, it is more difficult to predict the ASP effectwithin the server line. It depends on the effect of the competition, thecompetitiveness on the competition’s part. But in terms of overall effect onour ASP, the extent we drive more server business, we drive a richer mix ofproduct overall and drive up ASPs for the microprocessor product line overallas a result, which is a good thing.

Ross Seymore - Deutsche Bank

That brings over all mix, but it is still up in the airwhether Barcelona's launch willincrease the server segment ASPs. Is that a summary of what you just said?

Dirk Meyer

Yes I would say that, although I would also say we alreadyhave a relatively dominant position in the highest ASP area of servers which isfour-socket servers. And the incremental opportunity for Barcelonais in the two-socket space.

Ross Seymore - Deutsche Bank

In the last question on the ASP side you talked about in thelast quarter that both your desktop and notebook ASPs went up, which I thinkthat's the first time that's happened in a while. Congratulations on that.Could you give us a little more color as to what was happening with that? Is itless pricing pressure at that low end, or are you moving up the stack, or whatdynamic is driving the ASP up?

Dirk Meyer

I would say it was just reasonably good discipline on ourpart in terms of identifying the business we thought was good and taking it, somodest mix up shift.

Ross Seymore - Deutsche Bank

Hector, you mentioned that you weren't going to go into anydetails about the fab strategy quite yet. Could you give us any rough idea ofwhen we might be expecting to hear some more details from you?

Hector Ruiz

I'm going to have totell you that I'm going to do that when we actually do it. I'm sorry.

Ross Seymore - Deutsche Bank

Is it fair to assume we might get a little bit at theanalyst day in December or is it just wait and see?

Hector Ruiz

If it is appropriate,you will get some information.

Operator

Your next question comes from Cody Acree - Stifel Nicolaus.

Cody Acree - Stifel Nicolaus

Let me follow up on Ross's question on the ASP mix. Can youlook into Q4 and maybe talk about how you expect the mix with normalseasonality to impact the new products coming in, to impact the total ASPs?

Dirk Meyer

I'll just be extremely qualitative. We'll be introducingPhenom quad-core product into price points that we don't participate in todayand we expect to sell at those price points. On the server side, really theopportunity is to drive more server business and therefore increase therichness of the mix for the overall product line.

Cody Acree - Stifel Nicolaus

So would you expect ASPs to run roughly flat, or do youthink there's some room for improvement next quarter?

Dirk Meyer

Across the productline, there's some room for improvement.

Bob Rivet

I would make sure you realize this is a client-orientedquarter, too. I mean most of the seasonality is in the clients and clearly theclients are of much lesser ASP than the server. Not trying to diminish the Barcelonaimpact, but that's just the reality.

Cody Acree - Stifel Nicolaus

With thin inventories in the channel, it sounds like OEMinventories are relatively thin as well, your inventory coming down a bit. Wegot shortages in a lot of other parts. How do you feel about your mix ofinventory and what you have available? Ifwe have a decent seasonal period are there any potential constraints on yourpart?

Bob Rivet

To me, we've done a good job of transitioning to have veryfresh inventory, a lot of 65 nanometer inventories. I mean, everything ismoving in the right direction from a microprocessor standpoint. We're furtheralong or even richer in the mix of all new products in the GPU business. So wefeel like we're well-positioned to deliver on what we need to in the fourthquarter and first quarter, because first quarter you're already preparing forthat.

As Hector outlined, we have flexibility to toggle up ifdemand continues to be at this high rate that we're currently seeing in thethird quarter and fourth quarter.

Operator

Your final question comes from Kate Kotlarsky - GoldmanSachs.

Kate Kotlarsky - Goldman Sachs

A quick question on just your share gains during thequarter. I was wondering if you could help us understand whether you've gainedshare across all of your market segments on the processor side -- so indesktops, notebooks and servers -- or was there more share gain in one segmentversus the other? Because it seems like your units grew relatively in line withthe market and so I was just curious what the dynamics are between thedifferent segments.

Bob Rivet

Well, we don't have all of the data to confirm by segment butbased on the data we have heard from our competitors and knowing our own data,we clearly gained share in mobile. We probably lost a little share in serverfrom a unit perspective. Desktop is too close to call. We held. So that's how Iwould call it at this point.

Kate Kotlarsky - Goldman Sachs

Any way to maybe comment on the magnitude of share loss inservers? Is it 1 or 2 points, or do you think it is more than that?

Bob Rivet

It is probably in thezero to 1% kind of level. So, it's a relatively small number. Again, this isall really before Barcelona hasmuch impact.

Mike Haase

Thank you very much. That will conclude the call.

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