Seeking Alpha
Long/short equity, contrarian, independent research, tech
Profile| Send Message|
( followers)  

Advanced Micro Devices (NYSE:AMD) announced preliminary financial results on 10/11, noting that it would see a 10% sequential drop in revenues against the guided 1% drop, +/- 3%. Further, the company announced that its gross margins would be around 31%, rather than the previously guided 44%, due to both a $100M inventory write down, as well as lower than expected selling prices.

With the weakness in the PC space suggested by Intel's (NASDAQ:INTC) pre-announcement, coupled with HP (NYSE:HPQ) and Dell's (NASDAQ:DELL) fairly weak results in their most recent quarters, it was natural to expect that AMD would also suffer some weakness. The problem here is that AMD's guidance for the current quarter was already particularly weak (whereas Intel's was quite bullish and revised down to bearish), so a warning on top of an already weak guidance is particularly painful.

A Net Loss Expected In The Quarter

With this updated guidance, it is now certain that the company will experience a net loss. With gross margins of 31%, revenues 10% down from the previous quarter to roughly $1.26B, and operating expenses down 7% from the prior quarter's $557M, the operating loss will likely be about $128M, or -$0.18/share. Assuming flat interest expense compared to the prior quarter of $43M, the net loss should be even wider than the straight operating loss.

Q4 Guide - Unlikely To Be Good

With the company writing down $100M of inventory, it is unlikely that the Q4 guide will be particularly strong. On the previous call, the company had assured investors that the majority of the new inventory that had been built up was next generation "Trinity" products and not, as feared, the previous generation "Llano" products. However, the inventory that had already been built -- especially on the desktop chip side -- remained.

AMD attempted to hold off the coming of the next generation "Trinity" parts on the desktop in order to clear inventories, but it seems that the company was unable to do so. A part of this is likely due to the fact that AMD had created something of an "Osborne Effect" by talking up its upcoming products while its new products had just hit the shelves. This likely had a material effect on the demand for its current products, as AMD created the perception that better stuff was perpetually "just around the corner." Another problem, of course, is that Intel is seemingly more aggressively competing in the low end that AMD seems to dominate.

In the mobile space, it is somewhat surprising to hear that weakness continued, as the company had indicated on the previous call that shipments of its "Trinity" APUs in the mobile space had been quite healthy. Even with broad PC weakness, AMD's market share is fairly small compared to Intel's, so it was not inconceivable that the company would be able to take market share. Apparently, though, the preliminary numbers suggest that Intel may have actually gained share. The problem here is that Intel already owns about 80% of the consumer PC CPU market, so it is unfortunate that even in light of a contracting PC market, AMD is unable to make inroads.

Finally, even though AMD holds a scant 5.5% of market share in the server space, it seems that the company was unable to take share in the quarter. In its warning, Intel reported that its data center growth remained on track. Unfortunately, AMD is apparently not riding that wave.

CEO's Job In Jeopardy?

While this quarter's warn won't kill AMD -- its debt and cash positions will be able to take the net loss without causing liquidity problems -- two earnings misses in a row reflects poorly on CEO Rory Read, who has been with the company since August 2011. While the newcomer has admirably managed to cut operating expenses, the company continually misses its already conservative revenue targets.

Now, in Mr. Read's defense, the roadmap and products that are being put out now were likely not developed under his watch -- CPUs take about four years to develop -- so he is working with what he was given. Further, the broad weakness in the PC space is undeniable, and even Intel was not immune.

I suspect Read will keep his job in the near- to medium-term, but the company's strategy and its management will continue to be under severe scrutiny.

Conclusion - Stay Away For Now

I hate to admit that I was wrong, but I have to caution all but the most risk-tolerant investors to stay away from AMD until after the conference call and forward guidance are given. If Q4 guidance is even worse (and Q4, is unfortunately, historically worse than Q3 -- and the inventory write down seems to confirm this), then expect some even more selling pressure on the stock.

If you insist on jumping in, buy in stages -- don't initiate the whole position at once. If you are already holding the stock (as I am), averaging down would not be wise until the dust settles -- the stock was hit after the last warning, and then hit again after the Q2 results came. Sell anything you need to if you need the money in the near- to immediate-term, and make sure that you do not hold a significant margin balance while owning this stock.

Source: Advanced Micro Devices Warns On Weak Demand: What's Next?