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Advanced Micro Devices (AMD) reported first quarter earnings of 7 cents a share, beating the Zacks Consensus Estimate of 5 cents.The shares are likely to remain buoyant, as results did not disapppoint.

Results were, however, not as exceptional as rival Intel Corp’s (INTC), as AMD remains a step behind with its product introductions. However, there were some bright spots, such as its growing involvement with Apple Inc (AAPL).

AMD is now operating as a product company, reporting the foundry business under the cost method, given that its share in Globalfoundries has shrunk to 14%.

Revenue

AMD’s revenues in the last quarter came in at $1.61 billion, 2.5% over the year-ago level, but down 2.2% sequentially on account of seasonality.  This may be considered to be in line with AMD’s expectations of flat to slightly down revenues for the quarter and in line with the Zacks Consensus Estimate.

AMD’s revenues in the quarter benefited from the ramp-up of Brazos chips and management stated that the chips made up roughly half of notebook shipments for the quarter. The first Fusion APUs also shipped during the quarter, with Llano expected to be in volume production next quarter.

Revenue by Segment

Computing Solutions was 74% of AMD’s sales in the last quarter, down 1.6% sequentially, although up 3.4% from the year-ago quarter. While AMD’s desktop business continues to grow, the quarter’s weakness stemmed from continued declines in average selling prices (ASPs).

AMD did see growing engagement from leading players in the mobile segment, including Hewlett Packard Company (HPQ), Dell Inc (DELL), Acer and Sony Corp (SNE) but it still remains largely relegated to the lower-end segment of the computing market overall.

AMD’s graphics business continues to generate the remaining 26% of its sales, down 2.6% sequentially based on seasonality (graphics devices for gaming systems are typically extremely strong during the holiday season, so there is always a falloff in the first quarter). Additionally, ASPs in this segment also underwent a decline.

Margins

AMD reported pro forma gross margin was 44.6%, down 42 basis points (bps) from the previous quarter and up 194 bps from the year-ago period. The gross margin was impacted by the weaker ASP and mix of legacy products that largely offset the positive impact of lower-than-expected startup costs related to 32nm manufacturing (Llano) and ramp up of higher-margin APUs. The sequential comparison was also hurt by lower volumes (as the previous quarter benefited from the seasonal pickup in gaming).

Operating expenses of $628 million were up 4.3% sequentially and 15.9% from last year. The operating margin dropped 285 bps sequentially and 256 bps year over year to 5.7%. R&D and SG&A were up as a percentage of sales, almost equally responsible for the declines from both the sequential and year-ago quarters.

The two core segments—Computing Solutions and Graphics—had mixed results. Computing Solutions generated an operating margin of 8.3%, up 87 bps sequentially, while Graphics generated an operating margin of 4.6%, down 1,144 bps sequentially. The Computing margin was impacted by negative pricing and positive costs, while graphics suffered the impact of lower volumes.

Net Profit

On a pro forma basis, AMD generated a net profit of $56 million, or a 3.5% net profit margin, compared to a profit of $105 million, or 6.4% in the previous quarter and $63 million, or 4.0% in the prior-year quarter.

Including intangibles amortization charges, legal settlement charges and a payment to Globalfoundries, the fully diluted GAAP net income was $510 million, or 67 cents per share compared to income of $375 million, or 49 cents a share in the previous quarter and $257 million, or 34 cents a share in the year-ago quarter.

Balance Sheet

AMD has done a really good job reshaping the balance sheet over the past year.

Inventories in the last quarter increased 2.5% sequentially to $648 million, with inventory turns dropping slightly from 5.7X to 5.5X. Days sales outstanding (DSOs) declined from 53 to 45, a more normal level.

The company ended with a cash and short term investments balance of $1.75 billion, down 44 million from the December quarter. AMD has around $2.2 billion in long term debt, $34 million in short-term debt and $84 million in long term liabilities, yielding a net debt balance of $565 million at quarter-end. This is up slightly since the beginning of the year, but nearly half the levels of the year-ago quarter.

During the quarter, AMD used $168 million of cash in operations and spent $38 million on capex. Management expects debt repayments to continue.

Guidance

AMD guided second 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 second quarter is pegged at 8 cents, similar to the first quarter.

To Conclude

AMD started off the year reasonably well, if not in flamboyant stile. We believe there are several things that should interest investors at this point. The first of these is execution. We feel really good about a company that has been consistently delivering on its promises over the past few quarters, whether with respect to building its product portfolio, or with respect to cleaning up its balance sheet. The separation of Globalfoundries freed AMD from manufacturing pressures, enabling it to focus on R&D instead. We think the company is poised to generate significant improvement in profits, both as a result of its improving product lineup and cost control.

However, while the individual analysis does look positive, the comparative analysis doesn’t look as great. While AMD’s products are being launched on schedule, we think the company still has a ways to go here, because it is still playing catch-up with Intel. Market share has shrunk in some areas (particularly servers) and AMD has not seen much progress in higher-end categories overall. Cost efficiencies can only do so much; real expansion of margins is dependent on superior technology. AMD is on the right track and it appears to be doing things right. But the absence of a CEO at this crucial juncture could be a setback for the company.

AMD shares currently carry a Zacks rank of #3, implying a Hold recommendation in the short term (1-3 months).

 
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