Having incurred losses for several quarters, AMD’s (NASDAQ:AMD) business stabilized as it returned to profitability and delivered positive free cash flow in Q3 2013. Witnessing 100% growth in its graphics and visual computing segment, AMD’s revenue increased by 26%, its highest sequential growth in the last five years. While the computing solutions segment continued to decline on account of lower notebook shipments, the same was more than offset by the incremental demand for AMD’s semi-custom SoCs.
AMD announced a three part restructuring plan in Q3 2012 in an effort to strengthen its competitiveness in the market and better manage its expenses and cash. The first stage – restructuring its operations – is now complete and the company met its $450 million quarterly operating expense goal in the third quarter. In the second stage, AMD intends to focus on executing its new product plan to accelerate growth and expand its new businesses to improve profits.
Though PCs remain an important part of AMD’s overall portfolio, it aims to derive 40%-50% of its revenue from high growth businesses, including semi-custom, ultra-low power client, professional graphics, dense server and embedded solutions, in the next two to three years.
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Another important factor that drove growth in Q3 is AMD’s strong performance in professional graphics. It marked its fifth consecutive quarter of revenue and share growth in the segment. Additionally, the company claims that it is seeing improving demand for its products in the traditional PC market. With renewed demand in its traditional PC segment and growth opportunities in new markets, the company is focusing on improving its financial and operational results.
In Q3 2013, AMD generated over 30% of its revenue from its semi-custom and embedded business, exceeding its target of earning 20% of its revenue from these markets by Q4 2013. AMD believes that the two segments will be important revenue drivers in subsequent quarters as well.
Increasing Presence In Game Consoles Helps Diversify Revenue Base
AMD devised a unified gaming strategy in March this year that addresses its plan to drive the gaming market across consoles, cloud platforms, tablets and PCs. It believes that it is effectively positioned to drive the next revolution in gaming and now powers all major next generation consoles including Sony’s PlayStation 4, Nintendo’s Wii U and Microsoft’s (NASDAQ:MSFT) Xbox One. AMD believes that gaming is one of the key pillars of its semi-custom chip business. It shipped millions of units to support the next-generation Sony and Microsoft game consoles in Q3 and claims to have a strong pipeline of semi-custom design opportunities in the future.
Previously AMD’s graphic technologies were integrated into Microsoft Xbox 360, Nintendo Wii and Nintendo Wii U. AMD has never sold GPUs for game consoles, but received royalties for each console that utilized its graphics technology. However, the next generation Microsoft and Sony game consoles will utilize AMD’s system-on-chip Jaguar core and Radeon HD graphics chips. In short, AMD will now sell chips to these players instead of licenses.
A Broad Embedded Products Portfolio To Target Different Segments
Last month, AMD announced its future road-map for the fast growing embedded computing market. In addition to the new improved x86 processors, the company unveiled its first ARM-technology based processor, extending its ambidextrous strategy to embedded markets. It is now the first company to offer its customers both ARM and x86 architecture based solutions for low-power and high-performance embedded compute designs. The new products lineup will start shipping next year onward.
As per a recent VDC Research report, the market for traditional and intelligent embedded CPU systems will grow 36% in the next few years, from 330 million units in 2013 to over 450 million units by 2016. The x86 and ARM architecture together are estimated to account for 82% of the total addressable market. 
AMD now has a broad range of embedded processors for different segments in its portfolio, offering a number of price, performance and power options to meet the needs of embedded designers. Its strong embedded design pipeline will drive further growth for this business across 2014.
Semi-Custom Business Puts Pressure On Gross Margins
AMD’s gross margins in Q3 declined by 4% sequentially as it earned a higher proportion of its revenue from the semi- custom business. While the game console segment offered good margins for hardware manufacturers historically, it has become a low margin business now and offers lower gross margins compared to the corporate average.
However, AMD claims that the same has comparatively lower operating expenses, and consequently high operating margins, as its customers fund a large portion of the engineering expense. For the next few quarters, AMD expects low double-digit operating margin for this business which it believes will more than offset the impact of lower gross margin. Additionally, as the company ramps up volume, the higher revenue base will ease pressure off the margins. AMD believes that its operating margin will continue to improve as the business gains traction, volume increases and cost improves.
- Revenue to increase 5% sequentially, +/- 3%.
- Non-GAAP gross margin of 35%.
- Capital expenditure for 2013 of approximately $110 million.
We are in the process of updating our price estimate of $3.63 for AMD.Notes: