A few days ago, AMD announced their Q3 2012 earnings and they were not pretty. During the earnings call, the executives gave detailed insight as to why the company is stumbling as well as their plans for a better future. We took the time to analyze their statements in broad detail.
The Current Business – Trinity Adoption Going Well
Sales of Trinity in the notebook segment increased by 70% sequentially and comprise almost one third of AMDs total notebook APU sales. The company also believes to have gained some share with ultrathins in the $600-799 price bracket.
For the upcoming launch of Windows 8, they are happy to report more than 125 design wins, which includes some tablets and several ultrathins. The company is looking forward to Windows 8, but Rory Read made it clear that the fourth quarter will be challenging nonetheless. AMD does not expect PC market conditions to improve for at least a few more quarters.
Still, AMD believes that ultraportable and ultra low power form factors are a growth area they want to focus on with their APU technology. This includes ultrathins and tablets as well as a new breed of entry-level notebooks slated to be successful in emerging markets. This sounds a lot like a rehash of netbooks.
According to the interim CFO, AMD made substantial progress in the desktop channel, which lead to a reduction in Llano inventory in the third quarter. The CEO explained that the relationship with the channel is recovering, which already materialized in improved sell-through. The company aims to continue improving that situation in the coming quarters.
With respect to AMD’s inventory, it should be said that overall it increased a bit. While its value went down by $89 million, this includes the $100 million write-off with respect to Llano, so it increased a bit on other products. It is important to understand that the continued sell-through of Llano inventory in the channel is unrelated to the Llano inventory at AMD, which the company had to write off. While the company strives to sell any remaining inventory in the channel, currently it has no plans to sell the inventory they have themselves, hence the write-off.
The New Operating Model of AMD
Part one of their restructuring plan is a new, efficient operating model that aims at delivering consistent profits at lower break-even revenue levels. According to the executives, this break-even point will be at $1.3 billion at a capital expenditure of $450 million per quarter. According to current plans, the company aims to reach that structure by Q3 2013.
This does not mean they want to settle at this revenue level, they are just sizing their business expenses in a way that would let them reach break-even at about this level. This is an important clarification, as some analysts were concerned that this break-even point would also mean their gross margin would drop to around 35%, which is significantly lower than the last quarter?s high 40% range. At this point, the company does not have any guidance on revenue beyond the fourth quarter of 2012 and it remains to be seen how their new strategy will play out over the course of 2013.
Reusable IP Blocks & Kabini APU Already Taped Out
They primarily want to focus on building reusable IP blocks which should help lower development costs as well as streamline the development process and improve AMD?s speed of execution. Using these IP blocks, AMD wants to design new products to attack adjacent markets. The CEO specifically mentioned APU graphics-oriented opportunities which are clearly one of the strengths of AMD?s current portfolio. He specifically mentioned the upcoming Kabini APU, a 28nm quad-core successor to the hugely successful 40nm Bobcat-based products, which is out due in the first half of 2013. According to AMD?s CEO, the upcoming APU chip has already been taped out.
During the call, CEO Rory Read said: ?We already have working silicon for many of our new 2013 products in-house, including our next-generation 28-nanometer Kabini APU…? and continued, ?We are making good progress with the bring up of Kabini, which remains on track to launch in the first half of next year.?
Restructuring ? Further Layoffs?
Once the restructuring measures are implemented, the AMD executives are aiming for a 25% lower expense base, which amounts to yearly savings of $190 million. Most of these savings
come from layoffs of about 15% of their workforce, which is a difficult but necessary step according to the CEO.
According to the interim CFO there will be further restructuring actions throughout the first half of 2013, which will cause additional restructuring charges. While he was not specific about the reasoning or amount of these future restructuring expenses, he noted that most of the anticipated $80 million restructuring charges projected for Q4 2012 are related to severance packages. In other words, we would not be surprised if there are further layoffs during the first half of 2013, but the charges could be related to other expenses as well.
New Target Markets
Rory talked about the changes in the PC industry when he joined the company. These trends are now happening faster than initially anticipated, which the company clearly underestimated. Company execs believed they would have several years for these transitions. The CEO was quite frank about the situation AMD currently is in. 85% of their core business is focused on what he called ?the legacy PC market?, that is slowing down. Read admitted that competing in the PC space is hard because it is dominated by one company ? Intel.
As a result, AMD is working on entering new market segments, which are adjacent to some of the segments they already operate in, but have a much more interesting competitive environment for AMD. The semi-custom embedded segment was specifically mentioned. AMD sees significantly higher growth potential in this segment. Currently, only approximately 5% of their business happens in this space and the CEO wants to make that number 20% by the fourth quarter of 2013. In the long term, they are aiming for up to 40-50% of their portfolio to appeal to those segments.
Another segment AMD wants to address more aggressively is dense servers. That was one of the reasons the company acquired SeaMicro in the first quarter of 2012. AMD believes that low power and cloud serving will continue to gain traction and is poised to become the fastest growing segment in the future. We believe it will take some more work to compete effectively in this space. The previously announced Opteron board for the SM15000 dense compute server is a good first step, but this product line could still be expanded quite a bit.
Regarding the 20% figure the CEO threw out as the share of these new business segments they expect to have by the fourth quarter of 2013, it is currently unknown how the company will reach that goal. Rory Read disclosed that they have a set of confidential design wins, which he does not want to detail at this point. He only states that the segments they are targeting are in industrial, communications, and gaming segments, where their APU and graphics IP make the most sense. At least with respect to the gaming segment, it seems to be referring to game consoles. Allegedly AMD scored licensing deals with all major players in this space.
Definite announcements should be expected o
ver the coming quarters, but regarding the other segments at this moment one can only speculate. Since the upcoming Kabini-APU was mentioned numerous times during the call when it came to that topic, it is a safe bet that they are using it to target the embedded space, which they already did to a degree with Brazos.
According to Lisa Su, senior vice president and general manager of Global Business Unit at AMD, products incorporating ARM-IP should be expected no earlier than 2014. While this will be another interesting category of products, it should be understood that these are not primarily related to what AMD has planned for adjacent markets in 2013.
Part of AMDs restructuring will also affect their financials. Currently they have a cash balance of about $1.5 billion, which they aim to reduce to around $1.1 billion which they consider appropriate given their reduced business and operating expense footprint. In the fourth quarter, AMD will make the final payments to GLOBALFOUNDRIES as announced in their amended Wafer Supply Agreement. This includes a $50 million payment during the quarter and the final $175 million payment due by December 31st. So at least on a GAAP basis, based on this information it should be expected that AMD posts another net loss in the next quarter.
Speaking of the WSA, the interim CFO revealed that the company is currently negotiating a new WSA for 2013 and according to him the negotiations are going very well. Rory Read stated that over the course of 2012 AMD enjoyed an improving relationship with their foundry spin-off. This is certainly good news considering the shenanigans of last year. As part of the negotiations it will be determined when AMD will take $500 million worth of wafers, which are still part of their previous contract as well as further commitments going forward. Originally AMD committed to a wafer volume of $1.5 billion overall, $0.5 billion of which are not yet taken. Given the timeframes of previous announcements, it would be sound to expect a new WSA announcement in the March-April 2013 timeframe.
PC Market Situation
With respect to the PC market development, AMD kind of sees the same issues as Intel reported a couple of days ago. The macroeconomic environment is still challenging and Rory Read points out that OEMs took a rather conservative approach to inventories considering the impending launch of Windows 8. Rory Read specifically used the word ?cautious? in this regard. This is kind of the same thing Intel observed with the lean inventory management throughout the industry.
AMD also acknowledges some cannibalization by smartphones and tablets and expects all of these difficulties to continue for the next several quarters. On the other hand, the CEO is positive the PC market will still exist in a decade from now, but its growth dynamics are clearly stalling. These developments lead to the new alignment of AMD as part of their restructuring.