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Advanced Micro Devices (AMD - Analyst Report) reported third quarter loss of 20 cents a share, missing the Zacks Consensus Estimate by 4 cents.Shares slid 5.4% during the day and another 3.3% in extended trading hours.

Revenue

AMD’s revenues in the last quarter came in at $1.27 billion, down 10.2% sequentially and 24.9% year over year, more or less in line with its revised guidance of a 10% sequential decline (at the mid-point). Revenues were also in line with consensus expectations of $1.28 billion.

Revenue by Segment

Computing Solutions was 73% of AMD’s sales in the last quarter, down 11.4% sequentially and 27.9% from the year-ago quarter. The third quarter was a continuation of softening trends noticed in the second, both as a result of macro conditions that impacted consumer spending and on account of inventory rebalancing at OEMs ahead of Microsoft’s Windows 8 launch. The consumer client side of the business appears to be the worst hit and AMD is taking a beating since it is more dependent on this area. The only positive was the Trinity APU, which management stated increased 17% sequentially and made up a third of the company’s notebook-related sales.  

AMD’s Graphics business generated the remaining 27% of its sales, down 6.8% sequentially and 15.1% from the year-ago quarter. The graphics business is currently under some pressure due to the PC market slowdown. AMD stated that the discrete business for desktops and consoles grew in the last quarter.

Margins

AMD reported a pro forma gross margin of 30.9%, down 1,462 basis points (bps) from the previous quarter and 1,384 bps from the year-ago quarter. Lower volumes impacted the margin in the last quarter. AMD also wrote down $100 million of Llano inventory that it was unable to sell due to weak market conditions. This impacted the mix of business, pulling down overall prices and thus affecting the margin. Utilization of backend facilities also declined, another negative for the quarter.

Operating expenses of $516 million were down 7.4% sequentially and 15.4% year over year. However, the operating margin shrunk 1,586 bps sequentially and 1,841 bps year over year to -9.8% mainly on account of high cost of sales (as discussed above) and helped by higher R&D expenses (as a percentage of sales).

The two segments—Computing Solutions and Graphics—generated operating margins of -12.3% and 5.3%, respectively. Computing Solutions declined 2,014 bps sequentially and 2,388 bps year over year. Graphics declined 318 bps sequentially while increasing 229 bps from last year.

Net Profit

On a pro forma basis, AMD generated a net loss of $150 million, or a -11.8% net margin, compared to a profit of $46 million, or 3.3% in the previous quarter and $95 million, or 5.6% in the year-ago quarter.

Including a legal settlement and intangibles amortization charges, the fully diluted GAAP net loss was $157 million, or 21 cents per share compared to profit of $37 million, or 5 cents a share in the previous quarter and income of $87 million, or 12 cents a share in the year-ago quarter.

Balance Sheet

The long term debt was $2.04 billion, up around $500 million during the quarter, which was used to retire its 5-3/4% convertibles. The net debt at quarter-end was $1.19 billion compared to $442 million at the end of the June quarter. Including long-term liabilities, AMD’s debt to total capitalization ratio was 67.7% at quarter-end. The cash and short term investments balance at quarter-end was $1.3 billion, down $279 million during the quarter.

Inventories were down 10.7% sequentially to $744 million (AMD wrote down $100 million), with inventory turns rising from 3.7X to 4.7X. Days sales outstanding (DSOs) went from 48 to 59.

During the quarter, AMD used $240 million of cash in operations, spending $32 million on capex.

Guidance

AMD provided limited guidance, which seems to highlight management caution. The company guided to a fourth quarter sequential revenue decline of 9% (+/- 4%), or $1.16 billion at the mid-point, lower than the Consensus of $1.33 billion. Operating expenses are expected to be flat sequentially.

Our Take

AMD had a very poor third quarter, with a significant net loss that was the combined effect of weak demand, an inventory write-down and productivity issues. A more conducive market, adoption of new products, position in graphics and good execution are the only things that can pull the company out of the current situation.

For this purpose, AMD has announced a massive restructuring to align the cost structure with current demand trends. Management currently expects the initiative to reduce the cost base by 25% and generate total annualized cost savings of around $190 million. The new structure will enable the company to break even in the third quarter of 2013 at a quarterly revenue level of $1.3 billion. Management expects to regain some market share in 2013.

Management optimism notwithstanding, we encourage investors to avoid AMD shares for now, as represented in the Zacks Rank of #5, implying a Strong Sell recommendation in the near term (1-3 months).

This is because of the significant challenges that we expect the company to see in a market that is being increasingly cannibalized by tablets from well-established players, such as Apple (AAPL - Analyst Report), Samsung, Microsoft (MSFT - Analyst Report), Hewlett Packard (HPQ - Analyst Report) and Dell among others. Intel’s (INTC - Analyst Report) Ultrabook concept is going to further fragment the market, making things that much more difficult for AMD. Intel has so far been more focused at the high end, which helped AMD pick up share at the low end. However, considering Intel’s deep pockets and innovative prowess, the company looks set to take share from AMD.

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