Advanced Micro Devices (AMD) reported third quarter earnings of 13 cents a share, beating the Zacks Consensus Estimate by 3 cents.The shares jumped 10.51% in after-market trading are maintaining a 10%+ increase in the pre-market.
Revenue
AMD’s revenues in the last quarter came in at $1.69 billion, up 7.4% and 4.4% from the previous and year-ago quarters, respectively. While supply constraints prevented the company from meeting its guidance of a 10% sequential increase (at the mid-point), revenues came in higher than consensus expectations of $1.65 billion.
AMD clearly benefited from strength in its new products (Brazos and Llano). However, contrary to our expectations, it does not look as if the company was able to pick up share from archrival Intel Corp (INTC) mainly due to issues at Globalfoundries.
Revenue by Segment
Computing Solutions was 76% of AMD’s sales in the last quarter, up 6.5% sequentially and 4.9% from the year-ago quarter. The increases in the last quarter are particularly encouraging, given the concerns related to the computing market right now. However, AMD’s progress is attributable to gains in mobile and servers.
Management sounded extremely optimistic about share gains in the notebook segment and growth in China (MCU revenue up 23%). The server business jumped 27% sequentially, helped by shipments from its strategic partner Cray Inc (CRAY), as well as other national and international players.
AMD also stated that it was well positioned to gain from the growth in cloud computing and that new products from Hewlett Packard Company (HPQ) and Dell Inc (DELL) would be launched during the current quarter. AMD obviously lost ground in traditional computing systems, which may not be such a big concern, given the current trends.
AMD’s graphics business generated the remaining 24% of its sales, up 9.8% sequentially and 3.3% from a year ago. The Radeon HD chips are growing in popularity, driving revenues for the company. However, sequential strength in the last quarter was attributed to seasonality, as AMD no doubt gained from the uptick in game consoles heading into the holiday season.
Margins
AMD reported a pro forma gross margin of 44.7%, down 101 basis points (bps) from the previous quarter and 94 bps from the year-ago quarter. The gross margin is closely linked to the conditions AMD is seeing at Globalfoundries. AMD is attempting to squeeze out as many 32 nm chips as possible, which are higher-priced and therefore, higher-margin.
But 45nm production is taking a hit in the process, driving up underutilization charges for the company. The net effect is lower-than-expected production of both categories, meaning higher-than-expected costs and lower-than-expected pricing for the company.
Operating expenses of $610 million declined less than 1% sequentially and increased just 2.5% from last year. The operating margin expanded 140 bps sequentially, while contracting 26 bps year over year to 8.6%.
The sequential improvement was primarily attributable to lower R&D as a percentage of sales, helped by lower SG&A and offset by higher cost of sales However, R&D was the only expense to decline from the year-ago quarter, not enough to offset the increases in cost of sales and G&A.
The two core segments—Computing Solutions and Graphics—had mixed results. Computing Solutions generated an operating margin of 11.6%, down 18 bps sequentially. However, management tone remained positive as operating profit dollars increased, benefiting from higher server ASPs and higher mix of APUs.
Graphics generated an operating margin of 3.0%, up 489 bps sequentially. Mix and pricing were also positives for the graphics business, but here, higher volumes also played a part.
Net Profit
On a pro forma basis, AMD generated a net profit of $95 million, or a 5.6% net profit margin, compared to a profit of $70 million, or 4.4% in the previous quarter and $84 million, or 5.2% in the prior-year quarter.
Including intangibles amortization charges, the fully diluted GAAP net income was $87 million, or 12 cents per share compared to income of $61 million, or 8 cents a share in the previous quarter and a loss of $118 million, or 17 cents a share in the year-ago quarter.
Balance Sheet
AMD has done a really good job reshaping the balance sheet over the past year. With cash flows improving in the last quarter, the company made some opportunistic repurchases of its debt. As a result, the long term debt dropped to $1.57 billion in the last quarter from 2.20 billion at the end of the June quarter. Net debt at quarter-end was $253 million, compared to $338 million at the end of the June quarter and $462 million at the end of the September 2010 quarter.
AMD ended with a debt to total capitalization ratio of 48.4%. The cash and short term investments balance at quarter-end was $1.8 billion, down 54 million during the quarter.
Working capital metrics remained strong in the last quarter, with inventories dropping 15.9% sequentially to $540 million and inventory turns increasing from 5.3X to 6.9X. Days sales outstanding (DSOs) increased from 44 to 49.
During the quarter, AMD generated $189 million of cash in operations, spending $58 million on capex and $153 million on repayments of debt and capital lease obligations. Management expects debt repayments to continue.
Guidance
AMD guided to third quarter sequential revenue increase of 3% (+/- 2%) and operating expenses of around $620 million. Guidance is stronger than consensus expectations at this point, which are at $1.71 billion, or a 1.2% sequential increase.
To Conclude
AMD started off the year reasonably well, if not in flamboyant style. We believe there are several things that should interest investors at this point. The first of these is execution.
We feel very good about a company that has been consistently delivering on its promises over the past few quarters, whether with respect to building its product portfolio, or with respect to cleaning up its balance sheet. The separation of Globalfoundries freed AMD from manufacturing pressures, enabling it to focus on R&D instead.
The current challenges with respect to Globalfoundries are no doubt a temporary setback, as it is scrambling to take market share in the evolving mobile segment. We think the company would generate significantly higher profits once this issue is resolved, but we doubt that there is a quick-fix. We therefore see margins under pressure in the near term.
Also, while AMD’s products are being launched on schedule and it does look as if it will take some share from Intel, we need to bear in mind that Intel also has some new products lined up, which along with its growing capacity and lead at 22nm, should keep it ahead of AMD.
Cost efficiencies can only do so much; real expansion of margins is dependent on superior technology. AMD is on the right track and it appears to be doing things right. But there seems to still be a ways to go.
AMD shares currently carry a Zacks rank of #4, implying a Sell recommendation in the short term (1-3 months). We are Neutral on a long-term (3-6 month) basis.
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