ADVANCED MICRO DEVICES INC quarterly report, Q2 FY2017

AMD 2017 Second-Quarter Form 10-Q Summary

Business Context and Reporting Period

Advanced Micro Devices, Inc. is a global semiconductor company providing x86 microprocessors, accelerated processing units, chipsets, discrete and professional graphics processors, server and embedded processors, semi-custom system-on-chip products, game-console technology and intellectual-property licensing. The fiscal quarter and six months ended July 1, 2017 each comprised 13 and 26 weeks, respectively. Comparative periods ended June 25, 2016.

Key Financial Metrics

Metric	Three Months Ended July 1, 2017	Three Months Ended June 25, 2016	Six Months Ended July 1, 2017	Six Months Ended June 25, 2016
Net revenue	$1,222 million	$1,027 million	$2,206 million	$1,859 million
Gross margin	$404 million; 33%	$319 million; 31%	$735 million; 33%	$588 million; 32%
Operating income (loss)	$25 million	$(8) million	$(4) million	$(76) million
Net income (loss)	$(16) million	$69 million	$(89) million	$(40) million
Diluted earnings (loss) per share	$(0.02)	$0.08	$(0.09)	$(0.05)
Net cash used in operating activities	Not separately provided	Not separately provided	$(381) million	$(127) million

Second-quarter revenue increased 19% year over year. Computing and Graphics revenue increased 51% to $659 million, while Enterprise, Embedded and Semi-Custom revenue declined 5% to $563 million.
Computing and Graphics operating results improved to $7 million of income from an $81 million loss, driven by higher revenue, graphics demand and Ryzen desktop processor sales.
Enterprise, Embedded and Semi-Custom operating income declined to $42 million from $84 million, reflecting lower semi-custom and non-recurring engineering revenue and higher operating expenses.
Research and development expense increased 15% in the quarter to $279 million; marketing, general and administrative expense increased 7% to $125 million.
Licensing gains were $25 million in the quarter and $52 million for the first six months, primarily related to the THATIC joint venture. These gains reduced operating expenses through the reported licensing-gain line.
Cash, cash equivalents and marketable securities totaled $844 million at July 1, 2017, down from $1.264 billion at December 31, 2016. Cash and cash equivalents were $760 million and marketable securities were $84 million.
Operating cash flow was negative $381 million for the first six months, primarily because of working-capital increases, including wafer purchases supporting anticipated third-quarter sales. Investing cash flow was negative $122 million, including $35 million of capital expenditures and net purchases of marketable securities.
Inventories increased to $833 million from $751 million at year-end 2016, while accounts receivable increased to $614 million from $311 million.
Debt consisted of approximately $42 million of short-term debt and $1.375 billion of long-term debt on the balance sheet. The company reported approximately $1.42 billion of aggregate debt obligations net of unamortized discounts and issuance costs.
The secured revolving credit facility had $42 million outstanding at 4.75%, $19 million of letters of credit outstanding and up to $249 million available for future borrowings. AMD was in compliance with its covenants.

Material Changes Versus the Prior Comparable Period

Revenue growth and improved product mix increased gross margin to 33% from 31% in the second quarter and to 33% from 32% for the six-month period.
AMD moved from quarterly operating loss to operating income, although it remained marginally loss-making for the first six months.
Net income deteriorated from $69 million of quarterly profit to a $16 million loss. The prior-year quarter benefited from approximately $150 million of net income from the sale of interests in the ATMP joint venture; the 2017 quarter had $3 million of other expense.
Interest expense declined to $32 million from $41 million in the quarter and to $64 million from $81 million for the six-month period, reflecting lower debt and interest rates.
Operating cash use increased substantially, primarily due to higher accounts receivable, inventory and wafer-related working-capital requirements.
AMD repurchased $40 million principal amount of its 7.00% senior notes for $42 million during the second quarter. It also settled portions of other notes with treasury stock during the first quarter.
AMD launched Ryzen 5 and Ryzen PRO desktop processors, Radeon 500-series graphics products and EPYC 7000-series server processors during the quarter.

Guidance, Outlook, Commentary and Risks

Management stated that third-quarter sales were anticipated, but the filing text provided here does not contain a clear numerical revenue or margin guidance figure.
Management expected to meet its 2017 wafer-purchase target under the GLOBALFOUNDRIES agreement. The agreement requires substantial purchases and may require payments if annual targets are not met.
Expected purchases and minimum obligations to GLOBALFOUNDRIES for the remainder of 2017 through 2020 totaled approximately $3.2 billion. Actual future amounts may differ.
The $805 million principal amount of 2.125% convertible notes became convertible at the holders’ option through September 30, 2017. AMD stated that its current intent was to settle conversions with common stock. The notes had an approximately $8.00 conversion price and could dilute existing shareholders.
A warrant held by West Coast Hitech permits the purchase of up to 75 million AMD shares at $5.98 per share through February 2020, subject to ownership limitations. Exercise could dilute existing shareholders.
Major risks include intense competition from Intel and Nvidia, reliance on third-party foundries and assembly providers, manufacturing yields and capacity, semiconductor cyclicality, customer concentration, product execution, inventory and demand volatility, cryptocurrency-related GPU demand volatility, foreign exchange and international operating risks, cybersecurity, intellectual-property disputes and the company’s substantial debt burden.
Sony, Microsoft and HP Inc. collectively represented approximately 49% of consolidated revenue for the quarter, creating material customer-concentration risk.
Pending litigation included the Hatamian securities class action, stayed shareholder derivative actions and the Dickey consumer class action. AMD stated that management currently believed potential liabilities would not materially affect financial condition, cash flows or results of operations. The ZiiLabs patent matter was expected to be dismissed following a non-material settlement and patent license obtained after quarter-end.
AMD stated that substantially all U.S. and Canadian deferred tax assets remained subject to valuation allowances. Gross unrecognized tax benefits increased to $58 million from $42 million in the prior quarter.
The company planned to adopt the new revenue-recognition standard in the first quarter of fiscal 2018 and anticipated a potentially significant change involving accelerated recognition of distributor sales. AMD expected to use the full retrospective method, subject to system readiness and completion of its analysis.

Important Facts for Investors to Verify

Whether Ryzen, Radeon and EPYC launches translate into sustained unit growth, average-selling-price improvement and durable gross-margin expansion.
The magnitude and timing of cash recovery from the elevated accounts receivable and inventory balances and whether third-quarter demand meets management’s expectations.
AMD’s ability to fund operations, capital expenditures, debt service and GLOBALFOUNDRIES commitments while operating cash flow remains negative.
Potential dilution from conversion of the 2.125% notes and exercise of the 75 million-share warrant.
Compliance with GLOBALFOUNDRIES wafer-purchase commitments and any related minimum-payment or excess-inventory exposure.
The effect of distributor revenue-recognition changes upon adoption of the new accounting standard and any restatement of prior periods.
Customer concentration, semi-custom revenue trends, cryptocurrency-driven GPU demand and competitive responses from Intel and Nvidia.
Developments in the disclosed litigation, tax audits and other contingencies, including amounts that may ultimately differ from management’s current assessments.