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Advanced Micro Devices, Inc. (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 America Securities

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 2007 earnings conference call. (Operator Instructions) I would now like to turn the conference 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 earnings conference call. Our participants today are Hector Ruiz, our Chairman of the Board 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. The access code for both is 18461849. The telephone replay will be available for the next ten days starting this evening.

I would like to call to your attention that our Q4 2007 earnings 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 we get closer to the day.

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 will find detailed discussions in our most recent 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 in the third quarter. We improved our gross margins; we cut our operating loss by more than half and improved our cash flow. We executed well across each of our major lines of business and in all of the key components of our plan, including: growing the top line, increasing internal efficiencies and continuing our transition to new technologies.

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

We saw continued strong performance in our desktop processor business, particularly in the channel, where we sold record unit volume in the quarter. We began shipping our new quad-core AMD Opteron processors in the quarter with customer excitement and demand quite high. While our initial production ramp of quad-core Opterons has been slower than anticipated, we expect 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 this quarter into the server and desktop segments.

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

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

In the area of increasing internal efficiencies, manufacturing performance in fab 36 inDresden remained strong, exceeding targets for output, yield and cycle time. We remain on schedule to shutdown fab 30 before the end of this year in preparation for transitioning that facility to 300 millimeter.

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

We have controlled the growth of operating expenses and will continue 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 in each of our businesses. We completed the transition to 65 nanometer technology in fab 36 in Q2, and as I said, will be transitioning fab 30 this quarter to a 300 millimeter tool set and as a result, our mainstream processor business will be based on 65 nanometer 300 millimeter technology as we leave this year. We're looking forward to ramping 45 nanometer product production in the first half of next year, and in our graphics processor business, we will launch 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 believe we gained CPU market share. We introduced new products, we drove increased efficiencies in manufacturing and will continue to do so across the entirety of our business.

In summary, we made good strides to put AMD on course to approach profitable operating performance in the current quarter, and we will not be satisfied until we achieve sustained profitability, but were encouraged by the past quarter's improvement and by our continued strong customer relationships.

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

Bob Rivet

Thank you, Dirk. We improved our performance in the third quarter, improving the gross margin and significantly reducing our operating loss, as planned. We also reduced our operating expenses while establishing all-time records in microprocessor unit shipments, microprocessor unit shipments into the distribution channel, notebook processor sales, and notebook processor unit shipments.

These records drove AMD's third quarter revenue to $1.362 billion, 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 includes charges of:

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

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

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

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

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

Now, switching to the business segments. Computing solutions revenue was $1.283 billion, up 17% from the prior quarter, primarily driven by a 19% increase in microprocessor revenue. Microprocessor unit shipments increased 16% sequentially. We achieved sequential double-digit revenue increases for our notebook and desktop product lines. Notebook processor unit shipments growth remained strong, increasing 41% sequentially and 68% year-over-year. We significantly reduced our operating loss in the computing solutions segment to $112 million in the third quarter, $146 million less than last quarter.

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

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

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

As previously outlined during the last earning call, we had approximately $800 million in non-operational cash generating opportunities. We collected approximately $200 million in the third quarter through the sale of a portion of our Spansion investment; 200 millimeter tool sales; and administrative asset sales. We expect to execute our plan to capture the remaining amount in the coming quarters.

Total inventory at the end of the third quarter was $839 million, down $53 million from the prior quarter. Days of inventory outstanding finished at 80 days, an improvement of nine days from the second quarter. Our inventory is fresh with the vast majority of microprocessor inventory DDR2 compatible and more than 70% of our GPU inventory comprised of the new HD 2000 family.

Now let's talk about the outlook. AMD's outlook statement for the fourth quarter is based on current expectations. The following statements are forward-looking and actual results could differ materially from current expectations.

In a seasonally up fourth quarter, AMD expects revenue to increase in line with seasonality. Operating expenses, which include R&D, SG&A, and employee stock-based compensation are expected to be up approximately 6% compared to the third quarter, primarily driven by investments in new process technology.

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

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

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

Hector Ruiz

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

We expect continued improvement in gross margins while maintaining our momentum on the development and ramp of new technologies. We sold record units through the microprocessor channel and launched a new product cycle in each of our major business units.

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

Demand for the AMD value proposition is strong and customers continue to want more; more products that much their needs and value propositions, more integrated platforms and solutions and more customer-centric innovation and more competition. Our customers want choice and their decision to involve AMD in their business is very strategic.

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

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

We are very encouraged by our progress, but are dissatisfied with our financial results. We're working diligently to bring this company back to profitability as soon as possible. But as I mentioned last time, we remain committed to our unique opportunity for industry leadership and to the strategic course that we have set to achieve that end. We're making strong progress in new products, in R&D, in our technology transitions.

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

What I can report to you today is that we have made considerable progress in our preparations and I'm personally very excited about it. 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 unwavering commitment 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-Answer Session

Operator

Your first question comes from Krishna Shankar - JMP Securities.

Krishna Shankar - JMP Securities

Congratulations on the good progress in the quarter. Can you talk about the server business? What that did in Q2 and the outlook for growth in 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 and the 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, you actually meant Q3?

Krishna Shankar - JMP Securities

That's correct.

Dirk Meyer

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

Bob Rivet

To the question of gross margin, clearly, we're pleased with our results in the third quarter. Fourth quarter is seasonally up in addition to the new product offerings that Dirk just talked about of continuing on the back of the GPU offering that we saw some significant progress in the third. The quad-core offerings that will continue in the fourth quarter, we expect gross margin to improve but it won't be at the same rate you saw the improvement from second quarter to third quarter; but directionally, 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 us a sense of what sort of revenue level or what sort of milestones you need to hit to become profitable?

Bob Rivet

To me, to repeat where I was a quarter ago is, clearly our goal is to make money in any given quarter. But clearly as I talked about there, we needed to be approaching the $2 billion revenue level and north of 40% gross margin to achieve that kind of goal since we're not going to cut our way 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 shot at it but to me, the directional path we're going is still approaching a $2 billion top line number to drive a bottom line of breakeven.

Chris Danely - JP Morgan

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

Dirk Meyer

The plans that we have haven't changed from what we talked about around the timeframe of the Barcelona launch, 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 on the breakdown of sales if we could talk about that for a minute. Could you describe, perhaps, your ASPs by desktop and notebook? It looks like in the aggregate they went up by about 3 percentage points, but did you see any difference really between the notebook and the desktop space there?

Bob Rivet

Joanne, this is Bob. In the client space, whether it was in the 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. Both clients were up quarter on quarter.

JoAnne Feeney - FTN Midwest

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

Bob Rivet

Well, that's the place 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 you folks seeing any evidence of that going into the fourth quarter?

Bob Rivet

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

JoAnne Feeney - FTN Midwest

Then if I look at your breakeven path here, it does seem that given the trajectory we're seeing so far in gross margins, even if that does tail off a bit for the fourth quarter, if you guys continue at the pace you're going into terms of unit shipments and gross margin improvements, even if that's a little slower, it does seem if I have the math right, then it looks more likely that you'll breakeven in 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 that equation. It is all of the businesses moving at the appropriate speed. Some of them are different in the seasonality of the fourth quarter but clearly if we get to $2 billion, I think we can do it.

JoAnne Feeney - FTN Midwest

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

Dirk Meyer

We're actually feeling pretty good about the graphics business, first, based on very good OEM design win momentum, a lot of which turns into business late this year and much of it actually next year. A lot of the business that we did this quarter was in the channel where the response has been pretty strong. Based on the upcoming release of the RV 670, we're pretty bullish about being able to participate in a 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 the execution. I was wondering if you could just remind us of the 45 nanometer road map 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 in place in our factories on material that we're running today. We're building 45 nanometer microprocessors as we speak and those two facts give us increasing confidence in the public statements we've been making for some time around our intent to be starting our production ramp of 45 nanometer processors in the first 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 to just stop at the words “first half”.

Tim Luke - Lehman Brothers

Bob, on your inventory level lower in the third quarter, how do 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 of the 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 less inventory than I have today and then try to repeat that pattern as we go through next year. Inventories I expect to drain in the fourth quarter.

Operator

Your next question comes from Doug Freedman - Am Tech Research.

Doug Freedman - Am Tech Research

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

Dirk Meyer

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

Doug Freedman - Am Tech Research

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

Dirk Meyer

It is tough to provide meaningful detail in this call. That's probably something better left for an analyst conference as well.

Doug Freedman - Am Tech Research

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

Bob Rivet

No. Particularly in the GPU business you're seeing a full quarter of improvement. We launched that new series of products in mid spring so we didn't have a full second quarter impact, we had a full third quarter impact. Maybe you don't realize, but seasonally actually, the fourth quarter is not strong in the GPU marketplace. It is actually typically flat to slightly down. We'll have to work real hard to grow sales quarter on quarter, which we'll do, but it is hard 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 were related to severance and asset impairment. Can you help us understand exactly what actions? I know there's been some action plans put in place. Maybe since you don't want to talk about things that are forward-looking, can you give us some idea about what actions have taken place already?

Bob Rivet

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

You're seeing that in the acquisition of intangible assets and integration 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 which ended up being $42 million, that's just reflecting the value of the Spansion stock 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 value when we wrote it down to the appropriate level and took the non-cash charge in the quarter.

Doug Freedman - Am Tech Research

One last one on just the pricing outlook. We heard your major competitor there say that there's actually a possibility that they can't handle more upside. They burned a ton of inventory in the quarter. What's your outlook as far as the overall pricing environment? What are you seeing out there? How competitive is it for new business?

Dirk Meyer

First of all, we didn't see a qualitative change in the environment from Q2 to Q3. Where we compete with the other guy, I would call it always competitive, but it didn't change Q2 to Q3, and we're not expecting much of 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, given how strong and how much above seasonality Q3 was, why the confidence around normal seasonal for Q4?

Hector Ruiz

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

But when we look at what our customers are telling us, none of them have changed -- at least as of today -- their plans. They're telling us that they also have a concern on three areas: One is there are spotty places where plastic appears to be in shortage. There are also spotty places where they see displays being difficult to obtain. That also applies to a concern they have over the fact that the major fire in Japan where the battery factory pretty much got put out of business, all of that has caused a little bit of uncertainty into the quarter.

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

John Pitzer - Credit Suisse

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

Hector Ruiz

I think that's pretty hard to predict. We will try to create it to our liking, but I can't tell you right now. I think if those three issues I talked about don’t impact the consumption of product in the fourth quarter, we will go into a reasonably normal first quarter.

John Pitzer - Credit Suisse

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

Dirk Meyer

Based on the input we'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 their hands on the product. Clearly, going from two cores to four cores is a big incremental increase in capability in the Opteron line that we think is going to provide some benefit to the business here

John Pitzer - Credit Suisse

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

Bob Rivet

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

Operator

Your next question comes from David Wu - Global Crown Capital.

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 in Q4? If so, what happened to the 500 headcount reduction savings that has occurred or should be occurring at this point?

A second one I have is regarding the RV 670 launch, which is well anticipated to be next month, when does it really hit your revenue line? Since Q4, 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 the second one. The first one is yes, you heard me correctly. Expenses for R&D and SG&A will be up from the third quarter around 6%. That includes stock option expense.

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

Our goal is to continue to invest appropriately in the R&D line and to prepare ourselves for the next process technology migration.

David Wu - Global Crown Market

While you're answering that question, can you answer a dictionary question -- what on Earth is a typical seasonal fourth quarter?

Hector Ruiz

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

What we intended to say was if the market grows at X percent in 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 we anticipate doing so with cards available in channels and therefore, we will drive revenue in the quarter. Obviously, with a mid-quarter launch and on a quarter-billion revenue basis, that's not going to contribute materially to the quarter but it will provide some upside.

David Wu - Global Crown Market

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

Dirk Meyer

Sure.

Operator

Your next question comes from Uche Orji - UBS.

Uche Orji - UBS

Congratulations on a very strong performance. Just very quickly on the graphics, a little bit more clarity for me. It may seem presumptuous for me to conclude that you took a significant amount of market share. Did you get a sense that you took some share? If you can just clarify for me how much confidence you have going forward that level of performance is sustainable and 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 to really make confident proclamations on GPU share fluctuations, just because of the way that business works, in particular the way the add-in board business works as an ecosystem.

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

Uche Orji - UBS

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

Bob Rivet

Again, I'll provide a lot more color at the December analyst meeting, but I view it this way. 45 then turns into 32. So, you're continuing to always make investments in process technology with bumps, so there's that. We continue to enhance our capabilities in design, so it is hard to call at this point exactly where I would peg those numbers. I'll give you more in December. But we don't want R&D investment to go down per sae.

Uche Orji - UBS

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

Bob Rivet

Back to my prepared remarks, we had record microprocessor unit shipments; that helped. That was very little affected by the Barcelona launch so there's very few units of Barcelona in there. We improved the ASP quarter on quarter. We had more 65 nanometer than the prior quarter. Manufacturing continues to get higher yields, more efficiency. We improved inventory management. So it really was no singular item. It was a lot of little things by each of the business, whether it was the GPU business or the CPU business that yielded that 6 point operational improvement quarter on quarter. Hard to sustain, as you said which I wouldn't say anybody should forecast at that kind of rate.

Uche Orji - UBS

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

Dirk Meyer

Customers are going to 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 a couple of new products that you expect to take further share in. I'm just curious, is there anything else that you're seeing that makes you more cautious? 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 to stick our neck out on a number that frankly is very difficult to predict right now in the fourth quarter? We want to continue to increase our share participation in the mobile space, we believe we can. But I don't think it is prudent at all to try to pick a number, other than to tell you that it is our goal to continuously increase and improve our participation in that space.

Srini Pajjuri - Merrill Lynch

Fair enough. One question on the CapEx. You mentioned it will be flat to down. I remember on the analyst day you put out a chart that showed some capacity in terms of unit numbers. Given the efficiency that you're achieving in manufacturing and also the demand that you're seeing, is there any change to that outlook in terms of your capacity that you expect to have in 2008?

Bob Rivet

Again, I don't want to get into the details of 2008, but we continue to toggle how much capability we want to have in place to produce units. Right now, I would say probably we're less than we were a year ago at that point in time in how many units we expect to produce in 2008. We'll quantify 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 of building inventory, we would like to build inventory and turn around and sell it. Clearly, we'll take the advantages we see from manufacturing and let that flow 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 steady state or normalized number for OpEx? I was hoping it would come down a bit more. I'm wondering after you ran the 45 nanometer, should we expect a steady state now for OpEx?

Bob Rivet

I guess the simple answer is no. I mean, we continue to believe 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 the percentages of cost as a percentage of revenue to decline. Absolute dollars is dependent on the business conditions in that moment in time. So there is no steady state.

Hector Ruiz

This is not a steady state business.

Operator

Your next question comes from Sumit Dhanda - Banc of America Securities.

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 at it 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 still running about $100 million or so higher than where they were when you were registering comparable revenues last year.

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

Bob Rivet

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

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

Dirk Meyer

One further clarification. A year-on-year comparison Q4 this year to Q4 last year, you have to be careful because we didn't have the former ATI businesses as part of the company 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 really flattened 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 ATI is part of your business now. It's a moot point whether you had it then or you didn't. I guess I'm a little disappointed that the cost cuts aren't coming faster than anticipated. We'll just let that go.

Dirk, I had a question for you. On the Barcelona ramp you said it materialized a little slower than anticipated and your speed grades haven't been targeting the top end right off the bat. There has been some speculation that perhaps your yields on 65 nanometer specifically as it relates to Barcelona is the issue here.

Any comments you would want to make or a different explanation you would want to offer up on why Barcelona's speed 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 Barcelona are right where we expected them to be. They're right line on line with the previous 65 nanometer products from a deep activity and overall yield perspective.

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

Sumit Dhanda - Banc of America Securities

In other words, there's nothing endemic to your process technology that is problematic or which might spill over to your 45 nanometer ramp?

Dirk Meyer

No. The minor issues we've been experiencing have nothing to do with the process technology or the manufacturing capabilities. It is all a matter of wedding the design to the technology 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 of details as what the issues have been in wedding your designs with your process technology?

Dirk Meyer

I don't think in this forum.

Operator

Your next question comes from Glen Yeung - Citi.

Glen Yeung - Citigroup

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

Dirk Meyer

Per square inch of silicon.

Glen Yeung - Citigroup

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

Bob Rivet

You can't ignore the market leader comments and statements so to some degree, they're setting the tone and have a much broader view of what'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 for a number per sae, but can you give us a sense as to utilization now? Is it a high number 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 all of 2008, really?

Hector Ruiz

The philosophy we have in running our factories is that we have been ramping fab 36 in capability for quite some time. We're not yet at its maximum capacity. As we ramp, 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 reasonably well. 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 38 is going to be like a race car idling in the pit stop. I mean, we will be prepared to ramp that quickly, should we need extra capacity in that space; which frankly, 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 your Ferrari laptops. Hector, you're basically saying you feel like you have some flexibility in the way you're managing your capacity for next year, and obviously there's some lag between your expectation of capacity needs and what may actually materialize. But you feel like you've got enough flexibility to manage; 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 Barcelona chip is quite high. How can we gauge the success of that in replacing existing customers? Were they upgrade versus bringing new customers in to switch over to your platforms? If you could just discuss the success you're seeing on those two vectors, please.

Dirk Meyer

First, when you use the term customer you may mean something different than what we mean when we say customer. To me, the customers are the people we sell the chip to, which is the OEMs. At this point, we've got a broad assortment of Opteron-based systems from all of the major OEMs already and Barcelona will 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 both amongst installations that are already Opteron installations and new opportunities. As I said, we've already got a broad assortment of OEM server products across blades, 2p, 4p racks and so on.

Ross Seymore - Deutsche Bank

As I think about the ASP side of that equation, how should I judge the ASP bump you may or may not get because of Barcelona coming 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 out in the first place.

Dirk Meyer

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

Ross Seymore - Deutsche Bank

That brings over all mix, but it is still up in the air whether Barcelona's launch will increase 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 already have a relatively dominant position in the highest ASP area of servers which is four-socket servers. And the incremental opportunity for Barcelona is in the two-socket space.

Ross Seymore - Deutsche Bank

In the last question on the ASP side you talked about in the last quarter that both your desktop and notebook ASPs went up, which I think that'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 it less pricing pressure at that low end, or are you moving up the stack, or what dynamic is driving the ASP up?

Dirk Meyer

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

Ross Seymore - Deutsche Bank

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

Hector Ruiz

I'm going to have to tell 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 the analyst 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 you look into Q4 and maybe talk about how you expect the mix with normal seasonality to impact the new products coming in, to impact the total ASPs?

Dirk Meyer

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

Cody Acree - Stifel Nicolaus

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

Dirk Meyer

Across the product line, there's some room for improvement.

Bob Rivet

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

Cody Acree - Stifel Nicolaus

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

Bob Rivet

To me, we've done a good job of transitioning to have very fresh inventory, a lot of 65 nanometer inventories. I mean, everything is moving in the right direction from a microprocessor standpoint. We're further along or even richer in the mix of all new products in the GPU business. So we feel like we're well-positioned to deliver on what we need to in the fourth quarter and first quarter, because first quarter you're already preparing for that.

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

Operator

Your final question comes from Kate Kotlarsky - Goldman Sachs.

Kate Kotlarsky - Goldman Sachs

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

Bob Rivet

Well, we don't have all of the data to confirm by segment but based 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 server from a unit perspective. Desktop is too close to call. We held. So that's how I would call it at this point.

Kate Kotlarsky - Goldman Sachs

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

Bob Rivet

It is probably in the zero to 1% kind of level. So, it's a relatively small number. Again, this is all really before Barcelona has much impact.

Mike Haase

Thank you very much. That will conclude the call.

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