Graphics Save AMD's Day - Analyst Blog

Advanced Micro Devices (AMD) reported fourth quarter earnings of 14 cents a share, beating the Zacks Consensus Estimate of 11 cents.The positive surprise was nowhere near the levels noticed in the four preceding quarters. Share prices traded 1.13% higher during the day, but dropped off 0.25% after-hours, reflecting disappointment in the performance.

AMD definitely lost ground to Intel Corp. (INTC) in the server area and it really looks as if aggressive pricing also impacted the business. Similar to Intel, the company was also hit by the softeness on the consumer side of the business. The silver lining was the gaming business, which had a seasonlly stronger quarter, helping AMD to turn in revenue in line with the Zacks Consensus.

AMD stated that beginning in 2011, the company would start reporting the foundry business under the cost method, given that its share in Globalfoundries has now shrunk to 14%.

Revenue

Revenue of $1.65 billion was up 1.9% sequentially and flat year over year. AMD's guidance for the quarter was cautious after the bad miss in the last quarter. Consequently, results were slightly better than expectations. The revenue increase was entirely on account of the graphics business as offset by declines in the other two segments.

AMD launched its second generation DX11 graphics processing units (GPUs), and management is optimistic about growth prospects with these chips. The first products for Microsoft Corp's (MSFT) DX11 technology (included in Windows 7) were launched early in 2010. They have been popular because of their energy efficiency, superior functionality and greater memory bandwidth.

Despite this positive, we think AMD will see stiff competition as Microsoft teams up with ARM Holdings (ARMH) to target the mobile computing space.

Revenue by Segment

Computing Solutions was 74% of sales, down 0.6% sequentially and 0.1% from the year-ago quarter. Weaker demand in mobile, share losses in server and a steadier desktop business combined to generate the results. Average selling prices (ASPs) were down by AMD's own admission.

Graphics was 26% of sales, an increase of 8.7% sequentially and 0.7% from last year. The graphics business benefited from a double-digit volume increase, fueled by DX-11 enabled chips, as well as AMD's Radeon HD 6800 and 6900 series chips.

Seasonally higher game console revenues also helped. AMD also launched the Ontario chip, targeted at the ultra-thin mobile category. Game console strength is a seasonal phenomenon and sustained growth in graphics will actually come from AMD's ability to compete in the mobile and general purpose GPU segments.  

Margins

The pro forma gross margin was 45.1%, down 62 basis points (bps) from the previous quarter and up 381 bps from the year-ago period. The sequential decline was on account of weaker pricing, lower utilization rates and possible share losses in the high-margin server business.

AMD stated that Llano, its 32 nm chips were sampling in volume and products incorporating the devices would start shipping in the second quarter. While there will be an ultimate increase in margins on  acount of the transition, startup costs will hit the company, with a corresponding negative impact on margins.

Operating expenses of $602 million were up 1.2% sequentially. The operating margin dropped 35 bps sequentially to 8.6%. SG&A increased and R&D declined as a percentage of sales for the second straight quarter, which in combination with the lower gross margin resulted in the decline.

The two core segments -- Computing Solutions and Graphics -- had mixed results. Computing Solutions generated an operating margin of 7.5%, down 591 bps sequentially, while Graphics generated an operating margin 16.0%, up 1,578 bps sequentially. The Computing margin was impacted by pricing and utilization, while graphics benefited from higher volumes.

Net Profit

On a pro forma basis, AMD generated a net profit of $105 million, or a 6.4% net profit margin, compared to a profit of $84 million, or 5.2% in the previous quarter and $10 million 0.6% in the prior-year quarter.

Including intangibles amortization charges, a legal settlement with Amazon.com (AMZN) and Global foundries-related adjustments, the fully diluted GAAP net income was $375 million, or 49 cents per share compared to loss of $118 million, or 17 cents a share in the previous quarter and loss of $1.18 billion, or $1.49 a share in the year-ago quarter. The year-ago quarter included the $1.25 billion received from Intel.

Balance Sheet

AMD has done a really good job reshaping balance sheet over the past year. Inventories in the last quarter increased just 1.6% sequentially to $632 million, despite the weak demand. As a result, annualized inventory turns were flat at around 5.7X. Days sales outstanding (DSOs) increased from 43 to 53, most likely because of the back-end loaded quarter.

The company ended with a cash and short term investments balance of $1.79 billion, up 63 million from the September quarter. AMD has around $2.2 billion in long term debt and $89 million in long term liabilities, yielding a net debt balance of $488 million at quarter-end, down from $590 million at the beginning of the quarter. The net debt position has declined steadily right through the year and is down from $2.47 billion at the beginning of 2010.

During the quarter, AMD used $213 million of cash in operations, spent $38 million on capex and repaid $16 million of debt. Management expects debt repayments to continue.

Guidance

AMD guided first quarter revenues flat to slightly down (still limited and quite vague). Additionally, no further light was shed on any other items, including the EPS. We note that the Zacks Consensus expectation for the first quarter is pegged at 6 cents, or a sequential decline of 8 cents.

To Conclude

Despite the soft fourth quarter, we cannot help but be impressed at the way AMD performed through the year. The company saw very strong revenue growth, significant gross and operating margin expansion and reduced its debt.

Although behind Intel, AMD also started sampling its 32nm products. We are also waiting to see where it can go with its first Fusion chip, which AMD says has been met with enthusiasm. We would like to see more on the product front, as well as better strategic direction to compete with the likes of Intel or NVIDIA Corp (NVDA), or for that matter ARM.

AMD shares have been allotted a Zacks Rank of #3, implying a short-term Hold recommendation.