AMD Misses Its Q3’14 Guidance: Weak Computing & Graphics Performance But Semi-Custom Business Remains Strong

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Advanced Micro Devices

AMD (NYSE:AMD) reported its Q3 2014 earnings on October 16. At $1.43 billion, revenues were below company guidance and declined 2.2% annually. While AMD saw strong growth in its semi-custom business, the computing and graphics segment (which accounts for over 50% of AMD’s revenue) declined 6% sequentially and 15.6% annually, primarily due to lower chipset and GPU sales. On the positive side, the company retained its gross margin at 35% and delivered its fifth straight quarter of non-GAAP profitability. It managed it operating expenses well, reduced inventory and shipped a record number of semi-custom SoCs in Q3 2014. AMD’s Enterprise, Embedded and Semi-Custom (EES) segment delivered sequential and year-over-year revenue and operating profit improvement in the quarter.

Despite short-term weakness, we believe in AMD’s long-term growth potential. The company in still in the midst of its transformation process and remains committed to deliver great products, deepen its customer relationships and continue to simplify and streamline the organization. It plans to reduce its workforce by approximately 7% by the end of Q4 2014 and further streamlining its global real estate assets, which can bring in much needed cash.

Our price estimate of $4.17 for AMD is at a more than 50% discount to the current market price. We are in the process of updating our valuation for the company.

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Weal Performance In Computing & Graphics Slows Growth; AMD Focuses On Improving The Financial Performance Of The Segment

AMD continues to struggle in the Computing and Graphics business due to ongoing weakness in the consumer PC market. The company clearly lost some market share to Intel (NASDAQ:INTC) in Q3 2014, since the latter reported strong growth in PCs despite a relatively flat PC market. (Read: Intel’s Growth In Q3’14 Fueled By Stabilizing PC Demand, Higher PC Market Share & Strong Data Center Performance) Though AMD has significantly lowered its dependence on PCs, it continues to derive a considerable portion of its revenue from the segment.

Earlier this year, AMD laid out several important objectives to improve the financial performance of this segment which includes:  expanding in the commercial client market, improving its mix in consumer notebooks, gaining share in professional graphics and increasing component and AIB (i.e., Add-In Board) channel sales.

The company believes that its increasing focus on the commercial PC segment will help it improve its performance in this segment. AMD has a larger presence in the consumer PC segment, which still remains weak. AMD launched its Pro A-Series APU in Q2 2014 and claims to have met its goal to double the number of AMD-based commercial client design wins from last year, in Q3 2014. New commercial client offerings from Dell, HP, Lenovo have started ramping, resulting in approximately a 50% sequential increase in AMD’s commercial APU shipments.

AMD also claims to have improved its notebook APU mix in the quarter, as its Kaveri processors ramped in mobile design wins and its higher-end mobile processor unit shipments increased nearly 50% sequentially. Mobile discrete GPU unit shipments also increased as new design wins entered production. This week, Apple (NASDAQ:AAPL) announced a number of new iMacs powered by AMDs Radeon GPUs, a trend that AMD believes will play well to its strengths in discrete GPUs.

Although AMD managed to increased its desktop processor unit shipments from the previous quarter, its performance in the component and graphics channel was weak. It witnessed slowing sell-out momentum, particularly in China, and believed there was some downstream inventory build in the quarter, causing distributors to be more cautious managing their inventories. Nevertheless, AMD remains committed to this market and has started taking actions in conjunction with its channel partners to improve sell-through in the coming quarters.

AMD Shipped Record Semi-Custom SoCs In Q3’14

AMD reported  a 20.9% annual and 5.7% sequential increase in Enterprise, Embedded and Semi-Custom revenue, primary driven by strong growth in its semi-custom division. The company shipped a record number of units for its game console customers, as Microsoft (NASDAQ:MSFT) and Sony prepared for the holiday season. Additionally, its secured two new wins, meeting its goal to close one to two semi-custom wins in 2014. The two new semi-custom SoCs are expected to deliver combined total lifetime revenue of approximately $1 billion over approximately three years. Design work for these opportunities has started and AMD anticipates first silicon revenue from these deals in 2016. One of the wins is the first 64-bit ARM-based semi-custom design, building on the company’s growing ARM 64 momentum in the embedded and server markets. The other is an x86 device.

AMD devised a unified gaming strategy in March 2013 that addresses its plan to drive the gaming market across consoles, cloud platforms, tablets and PCs. AMD powers all major next generation consoles including Sony’s PlayStation 4, Nintendo’s Wii U and Microsoft’s Xbox One. The company is diversifying its semi-custom business beyond gaming, and claims that the semi-custom design win pipeline remains strong.

Embedded & Server Business Also Remain Promising

AMD witnessed strong embedded processor revenue growth and secured multiple new design wins across priority markets, in Q3 2014. The company started sampling its first embedded ARM SoC in the quarter. AMD 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. The company intends to take on the different segments in the embedded market by offering its customers a range of solutions to chose from —  from low-power to high-performance — with a broad ecosystem of software and hardware partners supporting multiple operating systems, including Windows and Linux. There is a growing need for more advanced embedded solutions in healthcare, finance, education and retail services. We expect new product launches this year to accelerate AMD’s growth in the embedded market.

After successfully sampling to major ecosystem partners such as firmware, OS, and tools providers, AMD announced the immediate availability of its Opteron 64-bit ARM based processor, code-named Seattle, in Q3 2014. AMD is the only provider to offer the standard ARM Cortex-A57 technology. AMD claims that the ARM-technology based server processors will be faster and more powerful than its existing low-power x86 server processors. In October 2012, the company had announced its collaboration with ARM Holdings to design server processors using the ARM technology in addition to its x86 processors for multiple markets, starting with cloud and data center servers.

The collaboration with ARM makes AMD the only processor provider to bridge the x86 and 64-bit ARM ecosystems. AMD believes that ARM CPUs have the potential to account for 20% of the server market (by volume) by 2016 or 2017. [1] The company continues to build out its 64-bit ARM Server Ecosystem in advance of system launches expected next year.

Q4 2014 Outlook

– Revenue to decrease 13% sequentially, +/- 3%, due to lower semi-custom revenue and a weak PC environment.

– Gross margin to remain flat, at 35%.

– Non-GAAP operating expense of approximately $385 million.

– Interest expense and other to be approximately $46 million.

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AMD’s ARM: A Smart Move?, The Motley Fool, July 29, 2014))
Notes:
  1. AMD reboots server technology strategy with first ARM chips, Tech World, June []