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Advanced Micro Devices, Inc. (AMD)

F1Q06 Earnings Conference Call

April 12, 2006, 5:30 p.m. EST

Executives

Mike Haase - Director-IR

Hector Ruiz - Chairman, CEO

Derrick Meyer - President, COO

Bob Rivet - CFO

Henri Richard - EVP, Chief Sales & Marketing Officer

Analysts

Joanne Feeney - Punk Ziegel & Co.

Michael McConnell - Pacific Crest Securities

Mark Lipacis - Prudential

Tim Luke - Lehman Brothers

Adam Parker - Sanford Bernstein

Jim Covello - Goldman Sachs

Mark Edelstone - Morgan Stanley

Krishna Shankar - JMP Securities

Tom Thornhill - UBS

Ben Lynch - Deutsche Bank

Michael Masdea - Credit Suisse

David Wong - A.G. Edwards

Joe Osha - Merrill Lynch

Chris Stanley - JP Morgan

John Lau - Jefferies & Co.

Glen Yeung - Smith Barney Citigroup

Presentation

Operator

Good afternoon and welcome to the Advanced Micro Devices first quarter 2006 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Mike Haase, Director of IR. Sir, you may begin your conference.

Mike Haase

Thank you and welcome to AMD's first quarter earnings conference call. Our participants are Hector Ruiz, Chairman of the Board and CEO; Derrick Meyer, President and COO; Bob Rivet, our CFO; and Henri Richard, our Chief Sales and Marketing Officer.

This call is a live broadcast and will be replayed at amd.com. The telephone replay number is 877-519-4471. Outside of the United States, the number is 973-341-3080. The access code for both is 7188392. The telephone replay will be available for the next ten days starting at 5 p.m. Pacific Time tonight. In addition, I would like to call to your attention that our second quarter 2006 earnings quiet time will begin at the close of business Friday, June 16.

I would also like to remind everyone that our next Technology Analysts Day is scheduled for the morning of June 1 at our Sunnyvale location. Additional details will be provided as we get closer to the event.

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 involve risks and uncertainties that could cause actual results to differ materially from our current expectations as set forth in the forward-looking statements.

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

You'll find detailed discussions in our most recent SEC filings, AMD's annual report on Form 10-K for the year ended December 25, 2005. During the call we will be referencing certain non-GAAP financial measures. You can find our presentation of the most directly comparable GAAP financial measure together with a reconciliation to GAAP on the investor relations page of our website, AMD.com. With that, I'll turn the call over to Hector Ruiz.

Hector Ruiz

Thank you, Mike. Today's call we are doing a little bit differently. I have the pleasure of introducing to you our newly appointed President and COO, Derrick Meyer. He is a University of Illinois graduate and better known in AMD for having led the troops in the creation of our Athlon product line as well as our current AMD 64 architecture. So it is indeed an honor for me to share the leadership of the Company with Derrick, and I am thrilled to introduce him to you today.

He will talk about the operations of the Company. He will be followed by Bob Rivet, who will describe the financials of the Corporation, and then I will come back at the end before our Q&A to give some closing remarks and some comments on the outlook. With that, let me turn it over to Derrick.

Derrick Meyer

Hector, thank you very much for that kind introduction. I am very happy to be more actively involved in telling the AMD story to those of you in the investment community. The first quarter was yet another in a series characterized by solid growth and improving fundamental business execution. The result of great, across-the-board execution by an increasingly focused and motivated team.

In a nutshell, the quarter was highlighted by record AMD Opteron sales, record gross margin, continued strong adoption of our platforms by leading OEMs and key channel partners, solid progress in the strengthening of our balance sheet, and continued manufacturing excellence.

Once again, we did what we said we would do. We have posted year-on-year growth in excess of 20% for 11 consecutive quarters, and in the last two quarters posted greater than 70% year-over-year growth.

Further, continued ASP improvement in the quarter confirms the rise of AMD as a premium brand for both consumer and commercial customers. As an example, it was another quarter of record revenue for the AMD Opteron processor family.

With Opteron, AMD set the performance standard that the competition is now chasing: performance per watt leadership, a more relevant or customer-centric measure of system performance. And, our unique direct-connect architecture will help us continue to set the bar for system-level performance for years to come.

We are really very pleased to be named by Fortune magazine as one of the top 10 most-admired companies for innovation, and a leader in the category of innovation among semiconductor companies in 2005. That innovation continues to open up broader market opportunities with global OEMs, regional powerhouses and channel leaders throughout our growing ecosystem.

As examples, HP, IBM and Sun Microsystems incorporated our newest AMD dual-core Opteron processors in their server offerings. China's third-largest computer manufacturer, and the second-largest home PC brand, Tsinghua Tongfang introduced a new series of computer systems powered by AMD Athlon 64, Turion 64 and Centron processors. We took a very strong step forward in our relationship with Lenovo with the worldwide launch of a new line of professional client PCs. This builds on the considerable success AMD and Lenovo have shared during the last two years in China.

More than 500 new participants have joined the growing ranks of the AMD commercial systems channel program, a worldwide community of solutions integrators, value-added resellers and distributors with over 20,000 channel sales and technical reps.

Finally, AMD welcomed Super Micro Computer, Tyan Computer Corporation and Uniwide Technologies to our validated server program, expanding that program worldwide.

In Dresden, our Fab 36 team began first revenue shipments in March. Yields are outstanding, and we remain on track for production shipments of 65 nanometer product in the second half of this year.

To summarize, we continue to execute successfully against our technology, manufacturing and customer acquisition strategies. Now, I would like to ask Bob to review the results of the quarter as well as the outlook going forward.

Bob Rivet

Thanks, Derrick. AMD had an excellent first quarter. Major highlights in the quarter included: 71% sales growth year-over-year, and the 11th quarter of significantly better sales growth compared to our competitor. Our share gains continue. We had record gross margin of 58.5%. We set another new record of AMD Opteron processor unit and dollar sales. Generated free cash flow of $275 million in the quarter; and, significantly improved our debt to capital ratio to 12%.

As a result of the Spansion IPO last December, my comments comparing the first quarter of 2006 to historical periods do not include the results from what was our memory product segment.

The first quarter sales of $1.33 billion were flat compared to the fourth quarter of 2005, and up 71% compared to the first quarter of 2005. Server, mobile and desktop processor sales mix improved in the first quarter, with desktop and mobile ASPs increasing.

We established another new sales record for our Opteron processor family, driven by increased customer adoption of dual-core processors. Client sales were seasonally down, however Turion 64 and Athlon 64 dual-core units and sales increased over the fourth quarter.

Geographically, processors sales were especially strong in Greater China, Russia, South Asia and Latin America. Overall, we believe that once again we took dollar share across server, mobile and desktop product offerings.

Gross margin was a record 58.5%, up from 57.3% in the fourth quarter of 2005, largely due to product mix improvements, increased ASPs and manufacturing efficiencies. Operating income of $259 million in the quarter remained at approximately the same levels as to the prior quarter, and increased significantly from the first quarter of 2005. First quarter operating income comprehends a full quarter of depreciation for Fab 36.

Total operating expenses, which includes R&D and SG&A, were up 3% from the prior quarter, and we continue to make progress toward our long-term goals with R&D and SG&A both approximately 19% of sales in the quarter.

Net income for the quarter was $185 million, or $0.38 per share. These results included a non-cash stock-based compensation expense of $15 million or $0.03 per share due to FASB-123; an expense of $20 million, or $0.04 per share associated with the redemption of $210 million of senior debt; a 15% effective tax rate and an $18 million loss associated with our 37.9% ownership in Spansion.

Now let me turn to the balance sheet with a few highlights. Our cash balance increased to $2.6 billion in the quarter, up $800 million compared to the fourth quarter due to a few large items: over $560 million of cash flow from operation, including positive free cash flow of $275 million; a successful $500 million equity offering, which we partially used to pay off $210 million of our senior 7 ¾% debt.

Inventories were $337 million, and they declined 13% from fourth quarter levels, with days of inventory at 55 days, down six days from the prior quarter. We have made significant progress to our long-term debt to capital structure target of 20%, ending the quarter at 12% due to the $500 million equity offering, conversion of the $500 million on a convertible note from debt to equity, and we paid down $210 million of our 7 ¾ senior note.

Now let's talk outlook. AMD's outlook statement for the second quarter is based on current expectation. The following statements are forward-looking, and actual results could differ materially depending on market conditions.

AMD expects second quarter sales to be flat to slightly down seasonally from the first quarter of 2006. If achieved, this would be approximately a 65% increase from comparable sales in the second quarter of 2005. As a reminder, in contrast to our typical 13-week quarters, the second quarter of 2006 will have 14 weeks.

Operating expenses for the second quarter are expected to increase by approximately 8% quarter on quarter. Stock compensation expense in the second quarter is expected to be approximately $20 million at the current share price. Depreciation and amortization will be approximately $825 million for the year, with second quarter depreciation increasing by at least 10% from the first quarter.

We are raising our 2006 CapEx forecast based on unit demand increases for AMD products. We expect it to be approximately $1.7 billion as we accelerate our 300mm ramp. Based on our forecast, we expect our 2006 tax rate to be approximately 15%.

We had a good quarter and in summary, AMD continues to execute its strategies and focuses on sustainable, profitable growth. Now I will turn it over to Hector.

Hector Ruiz

Thank you, Bob. AMD's impressive growth story continued in the first quarter. If you look at where the growth has occurred, you see that it is in places that represent some of the highest quality revenues in the industry. In enterprise data centers, in power efficient Blade servers, in mobile platforms, in our world-class dual-core products, and in high-growth regions such as China, Russia, Latin America and India.

We continue to show the capacity to achieve significant share gains in our industry's most important competitive arenas, reflecting a growing loyalty to the AMD brand. Imagine what we could do with without the daily interference of monopolistic practices in an environment of fair and open competition.

Our strategy is working. We're well on our way towards reinventing the competitive dynamics of our industry. But I suggest you look beyond the numbers. As CEO, these are the things about which I am most pleased to report.

When you look at this Company I would encourage you to examine the footprint that we have created, a footprint defined by an expanded set of world-class OEM partners, starting with Sun, HP and IBM, and growing power houses such as Lenovo, Tongfang and Sahara. AMD's opportunity with these great companies is rapidly expanded, a testimonial to our differentiated and value proposition, and delivering on our promise of customer centric innovation.

We encourage you to monitor this platform expansion as the leading indicator of the quality of our partnership and the sustainability of our success. Take a look at the breadth and depth of the relationships we continue to build in the software and hardware community. We have become a top tier partner to many of the world's leading hardware and software companies, Microsoft, NVIDIA, Oracle, ATI, collaborating on next-generation technologies, including virtualization, security, and digital entertainment solutions.

Most important, I would encourage you to monitor the quality of the people that we continue to attract and retain. Our executive team is populated with ex-CEOs and other seasoned professionals that have earned their stripes in world-class technology leaders. Our design team has tripled since 2003, and AMD has become a magnet for world-class people looking to create the next generation of industry-leading innovations. In addition, our manufacturing team continues to set the bar for fab performance on leading-edge technologies.

I personally believe we have assembled the strongest talent pool in the microprocessor industry, and that trend is only accelerating. Everyone on this team is highly motivated by their once-in-a-lifetime opportunity to truly change the shape of one of the world's most important industries.

Our technology leadership remains solid, grounded in real customer needs. Our manufacturing execution continues on track and on time and we're confident in our capacity to maintain our unprecedented momentum. We remain highly motivated by the promise of a marketplace that is better for our customers, partners and end-users around the world. I am committed to work with Derrick and the rest of the management team as we strive to deliver great results in the coming years. Finally, I would like to thank AMD employees everywhere for their commitment and their excellence.

Now let me give it back to Mike Haase for the beginning of the Q&A.

Mike Haase

Operator, if we could start the polling for the Q&A please.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Joanne Feeney with Punk Ziegel & Co.

Joanne Feeney - Punk Ziegel & Co.

Good evening and congratulations on a great quarter. I had a question regarding the profit-sharing relative to Q4 when we thought it was pretty high. I am wondering how that changed sequentially from Q4 to this quarter.

Bob Rivet

It is about the same. Profit sharing is a function of profits, and since profits were about the same, it is relatively the same number.

Joanne Feeney - Punk Ziegel & Co.

So there wasn't an adjustment then of the incentive plans that dictates that payout?

Bob Rivet

Well you asked profit-sharing. Profit-sharing is what we pay to the general employee base. Incentive bonus stuff clearly is a different angle, if you're asking that question. That is lower than it was in the fourth quarter, based upon new expectations we set for the management team.

Joanne Feeney - Punk Ziegel & Co.

Can you give us a sense of how much lower that is? How much of an impact that would have on the relative EPS of the two quarters?

Bob Rivet

No, I'm not going to give you that kind of granularity.

Joanne Feeney - Punk Ziegel & Co.

If I could follow up, regarding the expenses in R&D and SG&A, Hector noted that you made some investments to beef up the design team, and so your percentage costs of both SG&A and R&D have gone up to around 19%. Is that something we should expect to see maintained at that level, or do you intend to make further investments in the R&D design teams?

Bob Rivet

We will continue to play through our attraction of talent to increase the design teams to work on further customer centric innovation. But we also believe the top line will continue to grow at even a faster rate, so that we will see dilution as time goes on of R&D as a percent of sales.

Joanne Feeney - Punk Ziegel & Co.

Given that next quarter is going to be flat, do you expect that dilution then not to kick in until the second half?

Bob Rivet

Again, that was a long-term statement not a short-term statement. Flat sales, and with a guidance I gave, says that will be challenged in the second quarter.

Operator

Our next question comes from Michael McConnell with Pacific Crest Securities.

Michael McConnell - Pacific Crest Securities

Congratulations on a nice quarter. Looking at Q2 there has been a lot of talk about your competitors' price cuts. Could you comment on the margin outlook for Q2 on gross margins and operating margins?

Hector Ruiz

We think that right now we're facing an interesting situation where we believe that our product road maps, our technology transitions and our customers’ indications to us of expanding our footprint with them continue to be very positive and attractive.

What is hard for us to tell, frankly, is what the competition is going to do about the situation that they created for themselves. Therefore I believe it is prudent at this point in time, despite our highly confident scenario relative to products and customers, that we should be cautious in the second quarter. Bob, anything you want to add on the margin side?

Bob Rivet

No, the only comment I would make is the comment that I tried to outline in the November Analyst Conference is that our margin goal is in the 55% to 60% range, and we will continue to try to live in that range as time moves on.

Michael McConnell - Pacific Crest Securities

Should we think about the margin then on the gross margin line being closer to that 55% in Q2?

Bob Rivet

I'm not going to comment on that kind of direction.

Michael McConnell - Pacific Crest Securities

If we looked at Q2 could you comment on what impact, if any, you feel in the channel and/or the OEMs on the desktop side, the improved availability of your competitors' chipsets will have, if any?

Henri Richard

This is Henri. As far as the channel is concerned, we have seen a lot of activity from our competitor at the low end. Clearly they seem to have more availability in that space. It doesn't seem to be affecting certainly our demand supply situation. For the record, we run a very lean channel. Our inventories are between four and five weeks. I don't have any further comment.

Operator

Our next question comes from Mark Lipacis with Prudential.

Mark Lipacis - Prudential

Thanks a lot for taking my call. Two questions if I may. Bob, I think on the January conference call you had a forecast of $825 million in depreciation expense, but it would be front-end loaded. I think you may have suggested that it may have been higher by 10% in the first half of the year versus the second half of the year. Based on what you reported and what you just guided, it seems like that almost is reversing, that depreciation expense would be back half loaded. Did I get that right, and can you help me explain what happened?

Bob Rivet

Depreciation is a function of the tools you put in place to run in the manufacturing environment. Clearly it is a complex equation when you're starting up a 300 mm facility. Right now the current expectation is you will see increased depreciation in the second quarter and beyond as time goes on, as we continue to install more productive capacity in Fab 36.

Mark Lipacis - Prudential

Fair enough. Can you quantify, or just rank order -- you said you had growth in servers, notebooks and desktops. Could you help us by quantifying any of that and by any extent give us a range, or hopefully maybe just rank order which ones grew the fastest?

Henri Richard

Sure. This is Henri. Obviously server continues to be the leader here, followed by mobile and we had a very decent quarter in the desktop space. But clearly server is the engine of growth, with triple-digit growth year-on-year.

Mark Lipacis - Prudential

Thank you very much.

Operator

Our next question comes from Tim Luke with Lehman Brothers.

Tim Luke - Lehman Brothers

Thank you. I was wondering if, without getting into specifics, you would be share with us some of the factors that we should be thinking and framing our expectation for gross margin? In terms of maybe the depreciation elements or different elements on the gross margin.

I was also wondering whether you might have been able to give any comment on how you had seen the linearity as you moved through the March period. Obviously your ASPs were up again in the quarter. Is that something that one should continue to expect in terms of mix?

Henri Richard

I will talk first about the linearity. We run a very tight engine at AMD, and have a very linear quarter. We actually had a very robust January and February. I know that there was a lot of noise in the marketplace that the quarter had started slowly. We obviously saw the traditional acceleration in March, which I think is a sign of a very robust market, at least from our perspective.

With regards to ASP, our ASP continued to increase in the quarter across particularly the mobile segment and our dual-core offering. We will continue to manage our brands in order to drive to our long-term objective of crossing the $100 bar for our ASP.

Bob Rivet

With what Henri said, so again in my simple language, server, mobile desktop, with particular emphasis in the commercial space, and Fab 36 always becoming more productive every day we move through time, clearly that puts us in a range of living within that 55% to 60% zone. I would love to think that some time in the future we will punch through the 60%, but in this world we are in, I will stay at the statement of 55% to 60%.

Tim Luke - Lehman Brothers

Henri or Bob, in terms of the guidance, you have your extra week this quarter, and obviously you have a lot of share momentum. Could you give us any elements that you think are key to focus on in terms of guiding what might be perceived as the usual seasonality of flat to slightly lower, notwithstanding the extra week perhaps?

Hector Ruiz

As I mentioned earlier, we actually feel very optimistic about the relationships and the expanded footprint with our customers. We are executing our road maps well. Our manufacturing is going well. So it all points to, I think, a very positive outlook for the year.

But frankly it is difficult for us to judge at this point in time, given that the two players in the industry and the other one that has 85% of the market has got some issues they have to deal with. We need to understand that better before we get more crisper in what we think is going to happen in the near term.

Over the longer-term nothing changes for us. We still believe we will continue to outpace the growth of our competition. We will continue to gain share. We still are bullish where we think we going to be in the next three to five years, and reaching 35% of the market.

Tim Luke - Lehman Brothers

Thanks so much, Hector.

Operator

Our next question comes from Adam Parker with Sanford Bernstein.

Adam Parker - Sanford Bernstein

Just a clarification. Henri, I think you said you had a "very robust" January and February and then obviously you saw a traditional acceleration in March. My question is, does that mean the quarter finished in March more strongly then you previously anticipated, meaning you didn't see any impact from Intel at the low end desktop? Or can you just throw a little more color on that statement please?

Bob Rivet

The quarter finished as strongly as we expected.

Adam Parker - Sanford Bernstein

So all three months then were --.

Henri Richard

Again, I made a statement on our linearity. We are very proud in the way we run our business. So don't see in my comment that March was extraordinarily strong. We had a very good quarter throughout the quarter, with the normal acceleration in the last three weeks of the quarter.

Adam Parker - Sanford Bernstein

In terms of the server, mobile and desktop breakdown, if your revenue is flat and you said your ASPs were up and all three segments, correct?

Henri Richard

No, no. I said they were up in mobile and in desktop. You probably took notice of a change in pricing strategy that was planned in our Opteron lineup that took place in February. We have a strategy to drive a very aggressive penetration of our dual-core 2P offering. That strategy worked, with a very sharp increase in units.

Adam Parker - Sanford Bernstein

I'm just trying to get a little more color around the sequential unit growth in server versus the price decline. Given that you had record revenues, obviously it netted out positive. But is there any extra color you can give on, did you have double-digit unit growth, and therefore double-digit pricing decline, or it is there any additional color you can give there?

Henri Richard

Not really.

Adam Parker - Sanford Bernstein

Really? Okay. I'm trying to understand the depreciation schedule a little bit. I know somebody asked about it, but a year ago your depreciation was higher in AMD excluding memory than it is now despite the Fab 36 ramp. Maybe I don't understand what happened a year ago. Was there something different about how you were allocating depreciation to memory versus processors a year ago? Or am I wrong in thinking that the whole new fab should have brought about more depreciation now a year later?

Bob Rivet

You've got two lines going in different directions. The Fab 30, which has been our only asset in the microprocessor space, is starting to roll off fairly significantly on the depreciation schedule and Fab 36 is just coming on. Like I said, we put on the first full toolset in the January timeframe. We will continue to add additional tools to expand that capacity every day, week, quarter here on out. You can't crossover between the two.

Adam Parker - Sanford Bernstein

Sorry, one last high-level question. I don't know who wants to answer it, but do you think the PC market is setting up for a below normal seasonal Q2, kind of given your statements and your clear innuendo about Intel?

Hector Ruiz

If I do a 360 around the world, frankly in the first quarter the only market that was a little weaker than I think everybody expected was Europe. As we walk into 2Q it is always a difficult quarter for Europe. So that is the only uncertainty that I see around the world. The U.S. market was very strong.

Of course, all the high-growth markets will continue to look very healthy. So the only guidance that I would give you is Western Europe in particular seems to have not completely recovered from a glut of inventory carried over from Q4, frankly, from our competitor.

Adam Parker - Sanford Bernstein

I think what we are all trying to do is figure out how you guys guided with an extra week at flat to slightly down. We think Intel is not going to be that great. Your guidance implies you're going to continue to gain share, yet the overall market is still kind of in line with normal seasonal. I am just trying to figure that out.

Hector Ruiz

I think you're going to get a chance to probably clarify some of that next week, I'm sure, when you talk to the other guy.

Adam Parker - Sanford Bernstein

Thanks.

Operator

Our next question comes from Jim Covello with Goldman Sachs.

Jim Covello - Goldman Sachs

Good afternoon, thanks so much. Can you offer some perspective on how you see the competitive environment in the second half of the year as your competitor introduces some new products, which at least from the technical community have gotten some better reviews, after several quarters of you having a far superior product?

Derrick Meyer

This is Derrick. I will first observe that certainly our competitor's future road map has gotten a lot of attention lately. It is interesting, our sales and marketing teams have meanwhile been very focused on selling our current products, and hence maybe mainly some of the disparity in noise on the future.

I will say that certainly the competition is aggressively trying to follow the lead we have established with the AMD 64 products. They are a good company, and I expect the competitive situation to tighten in the second half of the year.

How to quantify that? I can't. The products aren't shipping. What I can say is our customers, who have the benefit of seeing both companies' road maps, have continued to expand their AMD-based platform offering, which I think speaks very well to our potential in the second half.

In addition, Hector mentioned on the call that we have tripled our design teams over the last three years and we will have an opportunity to share with you the proof of that investment in our June Analyst Conference, where we will give you a bunch more detail on our future road map.

Jim Covello - Goldman Sachs

Yes, but a quick follow-up to that is, would you expect the admittedly increased competitive environment in the second half to result more in a margin issue or more in a revenue issue? In other words, could your competitor theoretically be more aggressive on pricing in the lower end of the market, and that maybe has a little bit more of an impact if the product is more competitive, or you still don't think the pricing is the real driver of the decision-making?

Derrick Meyer

Well, you know, it is hard to speculate on that. What I will remind you is we are such a small part of the market that we believe we have got huge opportunity for growth in areas like commercial, where we're way under-represented. Our opportunity is not solely one of product, it is just ability to complete in the market, which we have had increasingly the ability to do.

Jim Covello - Goldman Sachs

Operator

Our next question comes from Mark Edelstone with Morgan Stanley.

Mark Edelstone - Morgan Stanley

Good quarter. Three quick questions, if I could. The first one would be for Henri. Henri, you talked about the ASP increase. Can you quantify on average what kind of ASP increase you saw sequentially?

Henri Richard

Sure. About 7%.

Mark Edelstone - Morgan Stanley

Okay, great. And then two questions for Bob. First one is the 8% sequential increase in OpEx, how much of that is coming from the extra week? Are you having basically a linear increase in expenses to add in that extra week? If so, what does that imply for your third quarter type of OpEx run rate?

Bob Rivet

You're right, obviously we will have almost in round numbers a 7% increase due to just having the extra week on the docket for the second quarter. With a little bit more than that as we continue to try to expand, in particular, our design resource capabilities and appropriate investments in marketing as we go forward.

Third quarter, obviously that 7% issue will go away. But you'll have continued investments for the back half of the year on technology and marketing investments. You won't get a 7% decline from second quarter to third quarter. But I'm not going to give you exactly the number, but kind of give you the flavor.

Mark Edelstone - Morgan Stanley

That's great. And just the last question for you, Bob. I am pretty impressed with the decline in inventory in dollars, given the ramp of Fab 36. Can you just talk about what factors drove that? I would have thought there would have been some level of inventory build as you're bringing on that type of fab, and basically running material through.

Bob Rivet

As Henri alluded to, we run our demand supply very tight. We will continue to do that, as we even continue to exercise Fab 36. To me, we continually want to have as lean an inventory as possible. As a matter of fact, we call it the lean process. So we're just going to run inventories very tight.

Mark Edelstone - Morgan Stanley

I guess, can you just talk about what the accounting methodology that you use as you're ramping a fab? Are you taking pretty aggressive write-downs as that material is moving through the fab?

Bob Rivet

Yes, we are conservative in our evaluation. We think that is appropriate, and so we shoot ahead of the duck. We value the inventory at a conservative of where we think we are going to be, not where we're at exactly at that moment in time.

One of the benefits we're having is we are seeing mature yield right from the get go on Fab 36. That takes a lot of the guesswork out of the equation to figure out how to value the die, or value the wafers that are in the line.

Mark Edelstone - Morgan Stanley

It would certainly sound like as that fab continues to ramp there's obviously going to be leverage as you start reaching more of a steady-state in that facility.

Bob Rivet

Just think of it this way, for everyone's benefit, it will become a bigger and bigger productive asset for AMD. It will be a significant portion of our output when we get to the fourth quarter of this year. So it will be a highly productive asset as we continue to move through time.

Mark Edelstone - Morgan Stanley

Thanks a lot.

Operator

Our next question comes from Krishna Shankar with JMP Securities.

Krishna Shankar - JMP Securities

Congratulations on a good quarter. Do you have any capacity constraints in the quarter in terms of meeting demand? Can you give us a sense for the ramp pace of Fab 36, will that be sort of a step up in output here in Q2, or is this going to be a fairly linear production ramp?

Derrick Meyer

This is Derrick here. The second one first. The ramp will be pretty linear over the course of this year and into next year. With respect to the first question, in aggregate we were not capacity constrained for the quarter.

There were occasions where demand for, as an example, leading-edge product exceeded our forecast. In our efforts to meet that forecast we were occasionally supply constrained, for example, on package substrates. In aggregate across the quarter we were not capacity constrained.

Krishna Shankar - JMP Securities

Given the sequential slight decline in several ASPs with your competitor trying to ship a lot of their existing generation of server product before they ramp up the newer generation in the second half, do you anticipate continuing pressure on server ASPs as they attempt to work down the inventory of their current generation?

Derrick Meyer

It is Derrick here. My response to that one is to remind you that our server ASPs decreased, but not as a reaction to the competitive environment, rather we decided to take an offensive stance relative to our pricing, given the capability of the product, the technology leadership on the product, and price in order to increase the size of our footprint in the marketplace, i.e., gain share. So what we did was not a reaction.

Krishna Shankar - JMP Securities

Thank you.

Operator

Our next question comes from Tom Thornhill with UBS.

Tom Thornhill - UBS

Given that Fab 36 is ramping and strongly, or it sounds like, and you're looking for a linear trend there, and Fab 30 has been running according to some of the trade press very strong, above some expectations. Do you see demand such that you will need to use Charter in the second half of the year, or do you still intend to use Charter in the second half of the year?

Derrick Meyer

Derrick again here. Our plan remains to use Charter in the second half of the year. We expect to get outputs in that facility in the third quarter. One of the benefits of our approach with Charter is that we can flex our output based on demand as it materializes.

Tom Thornhill - UBS

Do you have an estimate of what percentage of your requirements you would expect to satisfy out of that relationship?

Derrick Meyer

Yes. We prefer not to give you that level of granularity.

Tom Thornhill - UBS

Any granularity at all on that, or is this going to be token?

Henri Richard

No, it is not going to be token, but it is really not something we would like to discuss today.

Tom Thornhill - UBS

Okay. One question on gross margins. The previous guidance had been a range of 51% to 57%. Are you at this point officially moving that range to now 55% to 60% as was mentioned earlier in the call?

Bob Rivet

Yes.

Tom Thornhill - UBS

Very good. Congratulations on a great performance for the whole team.

Operator

Our next question comes from Ben Lynch with Deutsche Bank.

Ben Lynch - Deutsche Bank

I congratulate you as well. I understand that there are reasons to be reluctant to be very explicit on Q2, given the, I think, well-known issues at Intel. Could you comment on whether you are seeing some signs of it being more aggressive, and that is why you are reluctant to be explicit on commentary, or you just suspect that they will be more aggressive?

Henri Richard

This is Henri. I'm not going to speculate on what the competition is going to do or not going to do. Frankly, we're focused at continuing to execute our strategy, which seems to be working well. As Derrick pointed out, we did what we said we would do.

We're being cautious for the second quarter because, again, historically it is the most difficult quarter for our industry. As I pointed out earlier, Western Europe seemed to be a little weak in the first quarter. It is an important market, and so it is just reasonable to be cautious. Now this said again, we're going to continue to execute the strategies that we had in the first quarter, and we think it is differentiated from our competitor.

Ben Lynch - Deutsche Bank

So, Henri, if you are already seeing actions then it wouldn't be speculative to comment on them. If you're not seeing any then it would of course be speculation. I take your answer to mean that you're not seeing actions.

Henri Richard

I'm seeing -- no, that would be unfair. I am seeing a lot of low-end products, and I am seeing drastic price cuts on products that people don't want to buy.

Ben Lynch - Deutsche Bank

Great. Bob, this may be a question for you. You have bumped up by a healthy amount the '06 CapEx, and left the full year depreciation unchanged. It this just ramp rate or this is something which would more affect the '07 depreciation number?

Bob Rivet

Based on our current expectations and requirements we're getting for our customer for our products, we feel it is appropriate to accelerate the ramp. So we actually take off in '07 at a little bit faster pace. Most of that depreciation will happen in '07 when it is actually put in place and turned on.

Ben Lynch - Deutsche Bank

Just the last question I had. We have seen some reviews on the AM2 socket, which as far as we know, maybe you'll give us more information on the Tech Analyst Day, seems to be the major upgrade to the desktop offering this year. It doesn't seem to be in those independent reviews showing any performance improvement. Is this something which we should think about in terms of your competitiveness in desktop this year?

Derrick Meyer

Yes, this is Derrick. We will be transitioning our desktop, mobile and server offerings all from DDR1-based technologies to DDR2-based technologies. We feel that is the right time, because that is the rough timeframe where the price transition will occur between DDR1 and DDR2. To your point, there is not a huge incremental performance benefit to be had as a result of that transition, though there is some. We will be, along with the transition, introducing higher capability product as well that are kind of independent of the DRAM technology.

Ben Lynch - Deutsche Bank

Great. Thank you.

Operator

Our next question comes from Michael Masdea with Credit Suisse.

Michael Masdea - Credit Suisse

There were some comments earlier about the commercial market. To me it seems like that is a real important piece here of what you're doing there, and one way to kind of get around some of the tactics of Intel. Walk us through kind of how you get from A to B there.

I know you talked a little bit about a Commercial Systems Channel, what do you guys have to do to actually execute and get these OEMs to actually build boxes in this commercial market based on AMD?

Henri Richard

This is Henri. First, as we pointed out in our last analyst meeting, there is a very sharp increase in the number platforms being made available by strategic OEMs in both clients and server. To give you a little color, and maybe do something we haven't done yet, which is give you more granularity on the segmentations of our business.

I'm thinking some of the verticals out of the Forbes 500 list. We have asked customers, eight of the top 10 aerospace and defense companies in that list, 10 of the 12 top conglomerates, 18 of the 19 consumer durables companies in that list, 12 of the 14 drugs and biotechnologies in that list, 10 out of 12 the media groups in that list, 30 out of the 44 oil and gas operations in that list, 15 out of the 18 technology hardware and equipment in that list, and 22 out of the 29 telecommunication services companies in that list.

That is the type of footprint that Hector is talking about. This is in a very short -- by enterprise standards -- 2.5 years at present. I believe that we will continue to gain steady lead across those segments. We're being very methodical and going down the list and looking at the verticals, putting the software stack and the hardware stack together to address the needs of our customers in collaborations with our key OEMs.

Michael Masdea - Credit Suisse

Those are pretty big numbers. Are we pretty early in those deployments at those various different verticals?

Henri Richard

Of course, of course. That is why we're fairly optimistic in our ability to continue to grow share.

Michael Masdea - Credit Suisse

Got it. Great. Then just a quick one on the depreciation side. The Fab 36, was there any change to the depreciation schedule for the equipment, or is this pretty in line with what you did for Fab 30?

Bob Rivet

No, I think I commented on that before. Fab 30 was a five-year depreciation schedule. Fab 36 is a six-year depreciation schedule. Based on all the data we looked at, it made more sense that that huge asset would have a longer life.

Michael Masdea - Credit Suisse

Thanks.

Operator

Our next question comes from David Wong with A.G. Edwards.

David Wong - A.G. Edwards

When you said that your ASPs increased, was that all mix related, or did your prices actually go up in some places, in particular in desktops? Can you give us an idea as to your list price changes? It looks like the desktop list price has in fact grown?

Henri Richard

Just to comment on the end of your question. We did a slight readjustment of our stack. We do this periodically, consulting with our customers and partners to make sure that we adapt the value proposition of our product to market conditions. With regards the early part of your question, as we indicated earlier, our ASP went up in the mobile segments and in the desktop segment. But I'm not going to give you more granularity than that.

David Wong - A.G. Edwards

Thank you.

Operator

Our next question comes from Joe Osha with Merrill Lynch.

Joe Osha - Merrill Lynch

Congratulations. The first question in terms of products. There has been some discussion, Hector, of maybe a more optimized notebook, mobile architecture as you guys begin to deploy 65 nanometer. Can you comment on that?

Hector Ruiz

We're going to do quite a bit of discussion of our technology and product plans at the June Analyst meeting. At this point we're not yet prepared to go into any more detail than that. But I will repeat what I have said to you before. It is important for us to win in mobile.

We have plans, ideas to continue the growing trend that we demonstrated. As Henri pointed out, that we have in the last few quarters actually grown considerably in the mobile segment. And that I'm kind of hopeful that by the time June comes around for the Analyst Day, we will be able to be a little more explicit about our thinking.

Joe Osha - Merrill Lynch

That's as specific as I can ask for. Bob, if I look, again the math that I'm doing suggests that there is about an incremental $75 million in depreciation in the first quarter from Fab 36. And as I work through this, it seems like that run rate should go to between 125 and 150 a quarter by the end of the year. Is that roughly correct?

Bob Rivet

I'm going to need to get back to you on that math, Joe. I don't have that granularity in front of me. It doesn't seem completely out of line.

Joe Osha - Merrill Lynch

You can figure out that processors only was $100 million in Q4. It was $175 million in Q1. Then looking at the four year guidance and backing into it, it seems like you add maybe $50 million to that Fab 36 run rate. That is how I'm getting there.

Bob Rivet

Okay. That sounds reasonable.

Joe Osha - Merrill Lynch

That sounds reasonable? Okay. Great. And then last question on the profit-sharing, you did at one point disclose about a $66 million other item a couple of quarters ago that you were kind enough to say was all sort of the profit-sharing and incentive bonus. Then you did say at that point that once the number was reset that that number would roughly be cut in half. Might I think about that sort of incremental benefit Q4 to Q1 being in the $30 million to $40 million range?

Bob Rivet

That is kind of high from that perspective. But, yes, as I am sure happens to you personally, your bogey gets reset every year --

Joe Osha - Merrill Lynch

No, mine just goes down. Thank you very much.

Operator

Our next question comes from Chris Stanley with JP Morgan.

Chris Stanley - JP Morgan

Good quarter. Two quick questions. The first one is on inventory. It sounds like you're going to a pretty lean inventory here. Do you feel comfortable with that, or do you think that that will trend up throughout the year?

Hector Ruiz

We love lean inventory. As a matter of fact, we're so passionate about that that we just created a huge task force in the Company, frankly, to continue working to see how much better we could get. We love lean inventory.

Chris Stanley - JP Morgan

Great. And with this 55 days, that could go even lower throughout the year?

Bob Rivet

Each quarter is dependent. As an example, and again, not losing the thought Hector had that we're going continue to push on this issue. But it is hard for me to imagine we wouldn't try to build inventory in third quarter in anticipation of fourth since there is such a huge growth rate from third to forth, and we want to be in a position to service all of the demand.

We will work our way through it. Obviously we like to be lean as possible, but we will strategically build inventory in anticipation of stronger demand than the factories can handle in one given period.

Chris Stanley - JP Morgan

Got it. That make sense. I guess, Hector, a philosophical question for you. It sounds like Intel, we have seen them do this before, where they can get a little bit crazy in terms of pricing. I guess if it comes down to it in the second half of the year, and they do get crazy again like they have in the past, will you choose to maintain market share and perhaps see the margins suffer, or would you choose to lose a little bit of market share and preserve margins?

Hector Ruiz

First of all, none of us can anticipate what the competition might or might not do. What we intend to do is we are very committed. The world has changed a lot for today, so let me first of all give some context to the answer I'm going to give you.

Four years ago we had a very strong presence in the desktop consumer world. It was challenging, of course, to deal with the price and the strategy of the competitor in that space. When you look at it today, at our footprint which is server, a desktop, mobile across both consumer and commercial, and across a broad range of customers around the world, we feel we're in a position to continue to price to value. We believe we offer a tremendous value in our products. It is our current thinking to not deviate from that, and that is our plan.

Mike Haase

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

Operator

Our next question comes from John Lau with Jefferies & Co.

John Lau - Jefferies & Co.

Back onto the server question again. I was hoping you can give us a little more clarity. There has been a mix shift towards your dual-core chips on the server side. I think that you are shipping the final -- phasing out the single-core Opteron soon. Yet during Q1 your ASPs were down for the servers. I was wondering how that dynamic worked?

Henri Richard

First, we're not going to phase out our single-core processors as long as customers want them. It is true that we expect to exit the year with over 90% of the demand in the server space being dual-core. In fact there is some long-range embedded design that may require those type of processors. So that is the first point I wanted to clarify for you.

Secondly, as Derrick pointed out, we have a strategy to increase the penetration of dual-core technology as fast as possible in certain segments of the server market. We repositioned our stack at the beginning of February in order to drive that strategy, and it worked out exactly the way we planned. And so the overall decline in ASP is first anticipated, and secondly, absolutely centered around our two key offerings.

John Lau - Jefferies & Co.

As a final note, with regard to some of the actions, there are a lot of questions in the marketplace. Have you seen any change in the PC demand dynamics as a result of some of the competitive actions with the marketplace?

Henri Richard

No, I really thing that there is a big question mark, which is the available elasticity. And I personally believe that actually pricing is not the right answer. The answer is to make products that customers want to buy.

John Lau - Jefferies & Co.

There wasn't any stall or anything that you can see as it related to the marketplace?

Henri Richard

The only stall that has been rumored in the market is the fact that there was an excess of inventory carryover from Q4 to Q1, mainly by our competitor in the mobile space.

John Lau - Jefferies & Co.

Thank you.

Operator

Our next question comes from Glen Yeung with Citigroup.

Glen Yeung - Smith Barney Citigroup

I guess the first question may be for Henri. When you look at the second quarter and you think about the desktop and notebook space, should we expect the mix to continue to favor an ASP increase, i.e., do you find that your products continually move sort of upstream a little bit in terms of sophistication from the client perspective?

Henri Richard

That is a good question. We are seeing clearly that our dual-core offering is positioned as the premium offering today in the desktop space. I would like to remind you that we're going to launch our dual-core mobile offering in the quarter. We will expect of course a positive impact to our dual-core launch on the mobile space as well in terms of ASP.

This being said, there's a lot of potential in the high-growth markets. In those markets there's a lot of demand for lower-priced products, and we don't intend to do not service demand of our customers. So that has a dampening factor. Overall the strength of our dual-core offering will continue to drive our premium brands. And I expect those brands to grow faster than the volume parts of our offering.

Glen Yeung - Smith Barney Citigroup

That is understood, thanks. And then with respect to AM2, should we expect to see a price increase when that product is introduced?

Bob Rivet

Absolutely not. That is not what our customers are asking for.

Glen Yeung - Smith Barney Citigroup

Fair enough. And then, Hector, this last question is for you. It may be a little difficult to answer, so any thoughts you can give around this would be helpful. It really focuses on brand equity that AMD has built up over the course of the last year, year-and-a-half, two years.

When you think about the second half of this year, or for that matter any of the future quarters, if we make the assumption -- and whether this is true or not remains to be seen -- but if we make the assumption that Intel is in fact more competitive, to what extent does AMD gain share anyway?

Because you built up some kind of brand equity, whether that is because your customers just want to have a competitive offering, or they enjoy working with you, or they find it less expensive to work with you -- whether or not Intel is more competitive. To what extent does AMD continue to gain share anyways?

Hector Ruiz

That is a great question. First of all, as Derrick pointed out, we expected, we had planned that our competitor would eventually have to follow and react to what we have done and get better. It will be interesting to see the things that we're going to do later, which will again continue to force them to react and figure out what else to do next. We don't intend to in any shape or form give any leeway in our leadership relative to product and technology.

Having said that, you're right, in the last two or three years we have built up a very strong equity in the marketplace with customers. One of the things customers have learned in the last two or three years is the value of having a fair and open competition marketplace where they can choose their supplier based on a number of attributes. Product, being one of them, the other ones being service, the other ones being reliability, trustworthiness, etc.

I believe that we have built a strong equity in that space. I believe that customers are delighted to see a new environment in which they can make choices. As a result of that, we place a lot of value on that, and we intend to exploit it. As a result of that in addition to our great products and technology, we expect to continue to gain share throughout the next several years.

Mike Haase

Thank you. On behalf of the management team, thank you too all for participating. We look forward to seeing you on June 1 here in California. Thank you.

Operator

Thank you. This concludes today's Advanced Micro Devices conference call. You may now disconnect.

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Source: Advanced Micro Devices, Inc. F1Q06 (Qtr Ending Mar 25, 2006) Earnings Conference Call Transcript (AMD)
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