Advanced Micro Devices (AMD) reported second quarter earnings of 6 cents a share, missing the Zacks Consensus Estimate by a penny. The stock fell 13% in regular Friday trading.
Revenue
AMD’s revenues in the last quarter came in at $1.41 billion, down 10.9% sequentially and 10.2% year over year, in line with its revised guidance of an 11% sequential decline (at the mid-point). Revenues were also in line with consensus expectations of $1.41 billion.
Revenue by Segment
Computing Solutions was 74% of AMD’s sales in the last quarter, down 13.1% sequentially and 13.3% from the year-ago quarter. While AMD was no doubt hit by weakening demand in China and Europe, it appears that the company was unable to anticipate channel conditions, leading to inventory imbalances related to its Llano processor. Intel (INTC) appears to have done a better job at this, going by its results reported earlier this week.
Cannibalization by tablets continued as expected, impacting the notebook business and deferrals related to Microsoft’s Windows 8 made matters worse. On the positive side, adoption of APUs remained strong, which led to continued growth at OEMs.
The server side of the business was also below expectations due to lower units and ASPs, declining sequentially and increasing from the year-ago quarter. Bulldozer clearly helped the growth from the year-ago quarter and its sales tapering off in the second quarter is what impacted the sequential comparison. AMD is clearly seeing some tough competition although management remains optimistic about a few points of share gain later in the year.
AMD’s Graphics business generated the remaining 26% of its sales, down 3.9% sequentially and consistent with the year-ago quarter. The graphics business is currently under some pressure due to the weakness in console sales and the PC market slowdown.
Margins
AMD reported a pro forma gross margin of 45.5%, down 55 basis points (bps) from the previous quarter and 24 bps from the year-ago quarter. Lower volumes impacted the margin in the last quarter.
Operating expenses of $557 million were down 6.9% sequentially and 8.1% year over year. The operating margin shrunk 224 bps sequentially and 116 bps year over year to 6.1%. Higher R&D expenses (as a percentage of sales) was the major driver of the decline from both the previous and year-ago quarters.
The two segments—Computing Solutions and Graphics—generated operating margins of 7.8% and 8.4%, respectively. Computing Solutions declined 247 bps sequentially and 393 bps year over year. Graphics declined 45 bps sequentially while increasing 1,0.35 bps from last year.
Net Profit
On a pro forma basis, AMD generated a net income of $46 million, or a 3.3% net margin, compared to a profit of $86 million, or 5.4% in the previous quarter and $70 million, or 4.4% in the year-ago quarter.
Including a legal settlement and intangibles amortization charges, the fully diluted GAAP net loss was $37 million, or 5 cents per share compared to loss of $590 million, or 80 cents a share in the previous quarter and income of $61 million, or 8 cents a share in the year-ago quarter.
Balance Sheet
AMD has done a really good job of reshaping the balance sheet. The long term debt was flattish at around $1.53 billion in the last quarter. The net debt at quarter-end was $442 million compared to $475 million at the end of the March quarter. Including long-term liabilities, AMD’s debt to total capitalization ratio was 64.9% at quarter-end. The cash and short term investments balance at quarter-end was $1.6 billion, up 35 million during the quarter.
Inventories were up 42.4% sequentially (partly a build for new product launches) to $833 million with inventory turns dropping from 5.8X to 3.7X. Days sales outstanding (DSOs) fell from 55 to 48.
During the quarter, AMD generated $81 million of cash from operations, spending $39 million on capex.
Guidance
AMD guided to third quarter sequential revenue decline of 1% (+/- 3%), implying $1.40 billion at the mid-point, lower than the Consensus of $1.50 billion. The gross margin is expected to be 44% and operating expenses are of around $560 million.
Our Take
AMD reported a disappointing second quarter, with both revenue and earnings declining significantly. Additionally, while revenue just about reached the guidance, earnings fell sharply. A more conducive market, new products (Brazos, Llano and Bulldozer), growing position in graphics and good execution were the reasons for the earnings surprise.
AMD expects better yields to drive continued gross margin expansion this year, although we remain a bit cautious given the many new products and potential issues related to the transition to smaller geometries.
The company has also dissolved its remaining stake in Globalfoundries and is using Taiwan Semiconductor (TSM). While this allows it to focus on R&D, one wonders how fast it would be able to ramp new products, especially since it has been having issues with 32nm.
That said, we cant help but feel good about a company that has been consistently delivering on its promises, whether with respect to building its product portfolio, or with respect to cleaning up its balance sheet. Therefore, considering the fact that customer response remains strong and design wins continue to pour in, AMD may be expected to see some gains in the next quarter.
Of course, 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 its new products are already helping. But there seems to still be a ways to go.
Given the above, we maintain our long-term Neutral rating on AMD shares. The Zacks Rank for AMD is #4, implying a Sell recommendation in the near term (1-3 months).
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