Advanced Micro Devices, Inc.
Q3 2014 Earnings Call Transcript

Published: 17 Oct 2014

[Operator:]

Good day, ladies and gentlemen. Thank you for standing by. And welcome to the AMD third quarter 2014 earnings conference call. (Operator Instructions) I'd now like to turn the conference to our host, [Technical Difficulty]. Ma'am, you may begin.

[Ruth Cotter:]

Thank you, and welcome to AMD's third quarter earnings conference call. By now you should have had the opportunity to review a copy of our earnings release and the CFO commentary and slides. If you have not reviewed these documents, they can be found on AMD's website at ir.amd.com. Participants on today's call are Lisa Su, our President and Chief Executive Officer; and Devinder Kumar, our Senior Vice President and Chief Financial Officer. This is a live call and will be replayed via webcast on amd.com. I'd like to take this opportunity before the call begins to highlight several dates for you. Matt Skynner, our Corporate Vice President and General Manager of the Graphics Business Unit will present at the UBS Technology Conference on November 18 in California. Devinder Kumar will present at the Credit Suisse Technology Conference on December 3, in Arizona; and at the Raymond James IT Supply Chain Conference on December 8 in New York. Mark Papermaster, our Senior Vice President and Chief Technology Officer will present at the Barclays Global Technology, Media and Telecommunication Conference on December 8 in San Francisco. Our fourth quarter quiet time will begin at the close of business on Friday, December 12. And lastly, we expect to announce our fourth quarter earnings results on January 20, 2015. Please note that we are now reporting two new financial segments beginning the third quarter. Computing and Graphic segment, primarily include desktop and notebook processors and chipsets, discrete GPUs and professional graphic; and the Enterprise, Embedded and Semi-Custom segment, primarily include server and embedded processors, dense servers, semi-custom SoC products, engineering services and royalties. Additionally note, that non-GAAP financial measures referenced during this call are reconciled to most directly comparable GAAP financial measure in the press release and CFO commentary, which are posted on our websites at quarterlyearnings.amd.com. Before we begin, let me remind everyone that today's discussion contains forward looking statements based on the environment as we currently see it. Those statements are based on current beliefs, assumptions and expectations, speak only as of the current date, and as such involve risks and uncertainties that could cause actual results to differ materially from our current expectations. Please refer to the cautionary statements in today's earnings press release and CFO commentary for more information. You'll also find detailed discussions about our risk factors in our filings with the SEC, and in particular AMD's quarterly report on Form 10-Q for the quarter ended June 28, 2014. Now, with that, I'd like to hand the call over to Lisa. Lisa? Lisa Su Thank you, Ruth, and good afternoon to all those listening in today. I am pleased to be here on my first earnings call as CEO. In addition to covering our quarterly results, I also want to use this opportunity to provide some details on my initial priorities and the steps we are taking to continue transforming and strengthening AMD. Our third quarter results highlight the progress we have made in diversifying our business, as we delivered our fifth straight quarter of non-GAAP profitability. While our Enterprise, Embedded and Semi-Custom segment had a strong quarter, we did face some challenges in our Computing and Graphics business due to ongoing weakness in the consumer PC market. We know what we need to do to improve performance going forward and are taking the appropriate actions. So let me give you some more color on each of the segments. Our Enterprise, Embedded and Semi-Custom segment delivered sequential and year-over-year revenue and operating profit improvement. We had strong embedded processor revenue growth and secured multiple new design wins across our priority markets. For instance, Arista, a leader in software-driven cloud networking, began ramping production of new switches powered by our embedded G-Series SoC. Our customers also began ramping a number of new retail in educational digital signage wins in the third quarter. We also started sampling our first embedded ARM SoC in the quarter, and at ARM's TechCon Conference we demo the industry's first ever 64-bit ARM-powered network function virtualization solution. The demo won best in show software product and is a great example of how our leadership, ARM and x86 offerings are generating increased interest from telecom and networking customer. Our work to lead the industry's transition to 64-bit ARM servers also gained momentum in the quarter. After ceding Opteron A-Series development kits with key ecosystem partners earlier this year, we expanded availability to software developers and system integrators. We continue building out the 64-bit ARM Server Ecosystem in advance of system launches expected next year. This quarter we also had public demonstrations of community versions of Red Hat's Fedora and SUSE'S OpenSUSE 64-bit ARM Linux operating systems running Oracle JDK and enterprise-class Java platform on our upcoming Opteron A-Series SoC. Based on the wide-spread availability and silicon status of our Seattle development board, we are also seeing a number of our partners and customers using the AMD platform as their lead ARM 64 development vehicle. The highlight of our quarter was in our strong semi-custom business, where we shipped a record number of units for our game console customers. Q3 will be our peak unit shipment quarter for the year, as Microsoft and Sony prepare for the holiday season. And relative to our new semi-custom design win pipeline, I am very pleased to announce that we have secured two new wins, accomplishing our goal to close one to two semi-custom wins this year. These new semi-custom SoCs are expected to deliver combined total lifetime revenue of approximately $1 billion over approximately three years. Design work for these opportunities has started and we anticipate first silicon revenue in 2016. Although, I can't go into details on the customers or the specific products, it is important to note that we are diversifying our semi-custom business beyond gaming. These wins also mark another significant milestone for us, as one of the wins is our first 64-bit ARM-based semi-custom design, building on our growing ARM 64 momentum in the embedded and server markets. Our semi-custom design win pipeline remain strong and we continue to have good opportunities to deliver future growth for this important part of our business. Now, turning to our Computing and Graphics segment. The Computing and Graphics business remains very important to us and is an evolving area of the company, where we have started a substantial amount of work to transform and strengthen this business. Earlier this year, we laid out several important objectives to improve the financial performance of this segment. These include expanding in the commercial client market, improving our mix in consumer notebooks, gaining share in professional graphics and increasing component and AIB channel sales. We've met our goal to double our commercial client design wins from last year, and are pleased with the initial progress we are making to build a richer mix in our PC business. New commercial client offerings from Dell, HP, Lenovo have started ramping, resulting in approximately a 50% increase in our commercial APU shipments from the second quarter. We also improved our notebook APU mix in the quarter, as our Kaveri processors ramped in mobile design wins and our higher-end mobile processor unit shipments increased nearly 50% from the second quarter. Mobile discrete GPU unit shipments also increased from the second quarter, as new design wins entered production. And earlier today, Apple announced a number of new iMacs powered by our Radeon GPUs. Included in the wins is the new 27-inch iMac with 5K retina resolution, which highlights the ongoing move to higher resolution displays. This trend plays well to our strengths in discrete GPUs. And in the professional graphics market, we believe this remains an area where we see the opportunity for ongoing growth. In the third quarter, channel sales increased sequentially and we secured several new design wins with Dell and HP that will reach market early next year. Now, turning to the desktop processor and graphics performance in the quarter. Although, we increased overall desktop processor unit shipments from the previous quarter, our performance in the component and graphics channel was weak. We saw sell-out momentum slow, particularly in China, and believed there was some downstream inventory build in the quarter, causing our distributors to be more cautious managing their inventories. We are committed to these markets and have started taking actions in conjunction with our channel partners to improve sell-through in the coming quarters. Now, let me turn to some of my initial priorities and our strategic actions. As I said on our call last week, the strategy we outlined two years ago remains the right one for AMD. But to strengthen AMD and better position us for success, we must take some targeted restructuring actions to align our investments and resources with our highest priority opportunities. These actions are not about how we manage the business in the short-term, but about how we reengineer the company for the long-term, and position both of our Computing and Graphics and Enterprise, Embedded and Semi-Custom segments for profitability and growth. As part of the plan, you will see us continue to invest in the talent and skills required to develop our world-class technologies and products, as well as add new skills in areas like software and application engineering that will help us drive into new markets. While we will protect our engineering investments, we will also take the opportunity to streamline parts of the organization to better align them with our highest priority opportunities. Reducing headcount is never easy, but these actions will enable us to become a stronger and more nimble company. In summary, as I step into the role of CEO, I firmly believe we are one of the few companies with the market position and capabilities to deliver world-class technologies and great products that will lead the industry forward. My near-term priorities are very clear. First and foremost, we will focus our energy on delivering great products. We will also ensure that we continue to deepen our customer relationships and continue to simplify and streamline our organization. We have a unique opportunity in front of us, and I am very much looking forward to the future. Now, I'd like to turn the call over to Devinder to provide some additional color on our third quarter financial performance, fourth quarter guidance and details of our transformation plan. Devinder?

[Devinder Kumar:]

Thank you, Lisa, and good afternoon to all those listening in today. We continue to make progress on our strategic transformation and delivered non-GAAP profitability for the fifth straight quarter, despite a weak consumer PC environment. We managed operating expense, reduced inventory and shipped record quarterly semi-custom SoCs. Now, let me cover the specifics of the third quarter. Revenue was $1.43 billion, flat sequentially and down 2% year-over-year, primarily driven by lower chipset and GPU sales, partially offset by increased sales of semi-custom SoCs. Third quarter revenue included $27 million related to the licensing of technology. Gross margin was 35%, flat from the prior quarter and included $27 million or a 2% benefit from revenue related to licensing technology. Non-GAAP operating expenses in the third quarter were $428 million, down $3 million from the prior quarter. For the fifth quarter in a row, non-GAAP operating expense to revenue ratio was 30% or better. Non-GAAP operating income was $66 million and non-GAAP net income was $20 million, with non-GAAP earnings per share of $0.03, calculated using 785 million diluted shares. Third quarter non-GAAP earnings per share excludes amortization of acquired intangible assets of $3 million. Interest expense, taxes and other expenses were $46 million in the quarter. During the quarter, AMD entered into interest rate swap transactions. These transactions effectively converted $250 million of AMD's fixed rate 6.75% senior notes due 2019 to a variable interest rate. Based on current interest rates, we anticipate quarterly interest savings from these transactions to be approximately $1 million beginning in the fourth quarter of 2014. The remaining $250 million portion of AMD's 6.75% 2019 debt as well as all other term debt on the balance sheet has a weighted average fixed interest rate of 7.1%. Adjusted EBITDA was $133 million, down $4 million from the prior quarter. And for the trailing four quarters, adjusted EBITDA was $574 million. Now, turning to the business segments. Computing and Graphics revenue was $781 million, down 6% sequentially, primarily due to lower chipset and GPU sales. Computing and Graphics operating loss was $17 million compared to a $6 million loss in the prior quarter. This was driven primarily by lower revenue. Enterprise, Embedded and Semi-Custom revenue was $648 million, up $35 million or 6% from the prior quarter, primarily due to an increase in sales of our semi-custom SoCs. Operating income was $108 million, up from $97 million in the prior quarter, primarily driven by higher sales of our semi-custom SoCs. Turning to the balance sheet. Our cash, cash equivalents and marketable securities balance totaled $938 million at the end of the quarter, essentially flat from the prior quarter. Inventory was $897 million, down $63 million or 7% from the prior quarter. We remain focused on maintaining appropriate levels of inventory and plan to manage inventory levels down, again in the fourth quarter. Debt as of the end of the quarter was $2.2 billion. Accounts payable at the end of the third quarter was $498 million, down slightly from $511 million in the second quarter. We had negative free cash flow of $11 million in Q3 2014, an improvement of $40 million from the prior quarter. As Lisa stated in her opening remarks, we are working to build a stronger and diversified company, as we continue our strategic transformation. We are ensuring, we have the right resources deployed in concert with the evolution of our business model, as we right size and strengthen our Computing and Graphics segment resources in line with the market realities of today, and further invest in our Enterprise, Embedded and Semi-Custom segment focused on our growth opportunities. To that end, we are taking actions and implementing operational efficiencies, while also reducing headcount and further streamlining our global real estate assets. We expect to reduce our workforce by approximately 7%, with the majority of actions completed by the end of the fourth quarter. We anticipate aligning our real estate foot print starting in the fourth quarter and continuing into the first half of 2015. Associated with these actions, we expect to record restructuring and impairment charges of approximately $57 million in the fourth quarter of 2014, consisting primarily of severance-related charges and approximately $13 million in the first half of 2015, primarily related to real estate actions. We expect to make cash payments of approximately $34 million in the fourth quarter of 2014 and approximately $20 million in the first half of 2015, associated with these actions. Based on these actions, we anticipate operational savings, primarily in operating expenses of approximately $9 million in the fourth quarter of 2014 and approximately $85 million in 2015. Now, turning to the outlook and guidance for the fourth quarter of 2014. AMD expects revenue to decrease 13% sequentially, plus or minus 3%, due to lower semi-custom revenue and a weak consumer PC environment. Gross margin is expected to be approximately 35%. Non-GAAP operating expenses are expected to be approximately $385 million, below our prior 2014 quarterly operating expense guidance range of approximately $420 million to $450 million, in line with expected revenue and savings from our restructuring and transformation initiatives. Interest expense and other to be approximately $46 million. Inventory is expected to decrease from third quarter levels. And finally, free cash flow is expected to be positive in the fourth quarter; and for the full year 2014, negative in the range of $200 million to $250 million, including the impact of the $200 million special payment to GlobalFoundries earlier this year. In summary, while there is more work to be done, as we continue our transformation journey, we are positioning AMD to execute our current set of strategic transformation priorities, while focusing on sustainable profitability and driving enhanced returns for our shareholders. With that, I'll turn it back to Ruth. Ruth?

[Ruth Cotter:]

Thank you, Devinder. Operator, we'd be happy for you to poll the audience for questions, please.

[Operator:]

(Operator Instructions) And our first question comes from Vivek Arya from Bank of America Merrill Lynch.

[Vivek Arya:]

My question is on the restructuring that you are doing. Which areas will you deep prioritize, given this restructuring? Do you think you can afford to focus on the same number of markets or is it time to narrow the focus?

[Lisa Su:]

Relative to the restructuring, we have been looking at all of our markets across the company and all of the things that we do, both from an engineering side and a go-to-market side. From this standpoint, we are very much protecting the key engineering skills and key engineering investments. But as we look across our businesses and as we diversify from being a pure PC company into much more diversified business, and we found opportunities to streamline particularly on the Computing and Graphics side as we look at our go-to-market and our infrastructure around that. So as always, I think it's difficult to take these actions, but these will certainly be important steps to help us simplify and operate more efficiently.

[Vivek Arya:]

And as a follow-up, I understand the semi-custom wins should start helping you in 2016, and maybe it's a little early to talk about 2015, but I am just curious that if the semi-custom only heads from 2016, what happens in 2015 as you continue to see a somewhat sluggish PC and graphics market? How do you plan to manage the business in that timeframe? And maybe as part B of that question for Devinder, are there any implications, if the PC and graphics market stays the way it is, are there any implications on your wafer supply agreement with GlobalFoundries?

[Lisa Su:]

Let me take the first part of that, Vivek, and Devinder will take the second part. So relative to how we're managing the business, I mean certainly if you look at it, we've been very focused on improving the operational performance of the business. I think we have made strong progress in 2014, and we will continue to do that in the coming years. In terms of the markets that we're in, the semi-custom wins are exciting and important for us, that they are part of our long-term growth strategy. We also have growth that we highlighted in embedded and professional graphics, and some of our other growth markets. And in the traditional PC market, the key areas for us are really changing the mix of the product and focusing on the places where we're more differentiated. So commercial is an early start for us, and we're starting from a low base, but we have seen progress there and we expect that into 2015 as well, as well as some of the work that we're doing in the graphics space, like you saw with the Apple win today. So again, I think from overall market standpoint, we know where to focus and we're going to continue focusing on those areas that play to our differentiation.

[Devinder Kumar:]

Thank you, Lisa. Vivek, good question on the business. I think what you have seen even over the last couple of years, as we had the difficulties in the 2012 timeframe that we have shown the ability to manage the business, in line with revenue to manage the operating expenses, focus on the areas that Lisa talked about as priorities, and continue to diversify our revenue, but at the same time, making sure that we protect our investments in the core IP and technologies, which is really going to fuel the future growth and long-term profitability of the company. Your question on GlobalFoundries, and whether from an inventory standpoint, we're on track. You know, very much on-track, as we end the third quarter here. And as I said in the prepared remarks, we'll be on-track to meet those obligations, inventories down Q2 to Q3, and I expect that it will be down in Q4, despite the lower revenue between Q3 and Q4.

[Operator:]

Our next question comes from Mark Lipacis from Jefferies.

[Mark Lipacis:]

Devinder, maybe for you, couple of the income statement questions. The 13% decline that you expect for next quarter, you mentioned I think computing and the embedded business, both declining, is that split evenly between the two? Is it both business you expect to decline about that much or will it be weighted one or the other? And when you look at your OpEx savings you expect of $85 million next year, is that a $21 million a quarter or does that kind of ramp through the year, and you exit the year something higher than that?

[Devinder Kumar:]

The first question, I think if you ask me overall from a viewpoint of the decline of 13%, given the peak quarter that we had in semi-custom is weighted towards the semi-custom. So you know as you look at our segment reporting, which has changed effective this quarter, Computing and Graphics and the Embedded, Enterprise and Semi-Custom, I would say, that the decline quarter-on-quarter is more weighted towards the EESC segment as opposed to Computing and Graphics. And as far as the OpEx is concerned, I can share with you Q4. I'll tell you that in Q4, as you look at Q3 to Q4, the decline in OpEx is about $40 million-plus. Some of it comes from the transformation initiatives that we've been working on. Lisa talked about simplification of our structures within the company. We're getting closer to the customer. We also have actions that we took today, and that's going to save about $9 million within the quarter. We had some product tape outs in Q3 that don't repeat in Q4, that's some savings. And overall, we've been very focused on managing the OpEx in line with our revenue expectations and revenue profile, and that is where the rest of the savings are coming from. You tried to get the 2015, and maybe asked the question about that, but I am not prepared to get into the 2015 discussion at that point. We can have a little bit more of a discussion about 2015, when we come to the Q4 earnings call in January.

[Mark Lipacis:]

And then if I may one more on the computing side. In 2013, the computing business was running around $900 million a quarter, and this year it's $800 million a quarter, it's just running lower than that, exiting this year. And given, Lisa, that you seem to be streamlining more on the computing side, should we think about this business as being an x growth business or a low-double digit growth or a low-single digit growth or a low single-digit decline business?

[Lisa Su:]

So Mark, your question on the Computing and Graphics segment, look it's a very important for us. I think it's a little early to talk about longer term guidance for the business. Clearly, our goal is to strengthen it and improve its profitability, particularly in the couple of areas that I talked about earlier.

[Devinder Kumar:]

And I'll add, Mark, I think you talked about the numbers in terms of the revenue ranges in the 2013 and 2014, you're exactly right. If you look at the detail that we have provided, whereby we have not only provided the new segment information for Q3, 2014, but also recast the historical data, Computing And Graphics on the one hand and Enterprise, Embedded and Semi-Custom on the other. And if you go look at the year-to-date numbers, 2013 nine months versus 2014 nine months, the revenue is down, as you observed from the $900 million to the $800 million-plus, 13% down. But the losses, there were loses in the first three quarters of 2013, it was close about $90 million and if you add up the last three quarters of 2014, its more in the $20 million range, so we have improved the financial performance, and the action that we are taking today and the focus that we are bringing in the Computing and Graphics business is obviously focused on continuing to improving the financial performance, in line with whatever revenue expectations there are.

[Operator:]

Our next question comes from David Wong of Wells Fargo.

[David Wong:]

Devinder, do any of the restructuring actions that you're planning bring cash into AMD? For example, might you get any meaningful amounts of cash on real estate to other asset sales?

[Devinder Kumar:]

They might, David. They might. I think some of the restructuring actions, as I talked in the prepared remarks, 2015 first half, and as you can imagine most of the assets in our case, we don't own the assets, but there are some that we own, those projects are in flight, too early to tell whether they'd bring in cash and how much they bring in, but at least we quantify in terms of this first half of 2014, what the actions would be of getting out of the space, because we know the obligations are, whether they are sitting on our balance sheet or the lease expenses, so too early to tell. And I think as we get to the 2015 timeframe, because the headcount actions have to be taken before we can act on the real estate part as you can imagine, so it will be in the 2015 timeframe that I'll able to share more detail on that.

[David Wong:]

And Lisa, you have touched on this, but just to ask the question explicitly, will the restructuring involve discontinuing future development of any specific product line that you know about at the moment?

[Lisa Su:]

Yes, David, I think that's really around streamlining our investments and ensuring that we're on the highest growth opportunities. So relative to discontinuing a particular product line, we are not discontinuing a particular product line at this time.

[Operator:]

Our next question comes from Hans Mosesmann from Raymond James.

[Hans Mosesmann:]

Lisa, can you comment about your larger competitor talking about normal seasonality going into the end of the year. You're saying that there is significant consumer weakness. What's driving the different view of the markets and are you just losing market share?

[Lisa Su:]

Sure, Hans. So I think the way to think about the market, because when we look at the market, there is certain segmentation. So when we look overall, clearly the strength in the PC market has been around commercial primarily. When we look at consumer, it's still choppy and we see, it's weak, and there is a competitive dynamic in there. From our standpoint, we tend to have more exposure to some of the emerging geographies, particularly in the channel. And so we are seeing some weakness in China, in the emerging geographies. Relative to our MNC business or the large OEMs, I think that business is relatively as expected. So I think it's our view. Our segmentation in the PC market is different from our competitors. And if you look at normal seasonality, I think Q4 is usually a high sellout quarter, but from a selling standpoint, it is typically a little bit down.

[Hans Mosesmann:]

And if I can follow-up with one more. Your competitor on the tablet side has a very ambitious and aggressive strategy, and they're in some cases perhaps giving away these chips for free in tablets. Is that impacting perhaps some part of your business, maybe it's the low-end of the consumer PC market.

[Lisa Su:]

Yes. Hans, we have discussed this a little bit before. I think it is definitely true that there are some aggressive competitive dynamics, particularly in the low-end. Couple of quarters ago, we made a decision about how we're managing that. We are certainly competing in the low-end, but we are not going after business that's not profitable. And so if you look at the mix of our business, you see our ASPs up in mobile. And the reason for that is we're actually making good progress at the higher end of the product stack, and at the very, very low-end, we are choosing not to go after a bad business.

[Operator:]

Our next question comes from JoAnne Feeney of ABR Investment Strategy.

[JoAnne Feeney:]

I was hoping you could give us a little bit more detail on the graphics business, particularly the consumer graphics business and how that works out for you in the third quarter? And what you're seeing into the fourth, because typically the fourth is a bit seasonally stronger. Wondering, if that's what you're seeing or if the new offerings out by your competitor has given you a more cautions outlook on this quarter?

[Lisa Su:]

So overall in graphics, I think we've made progress in certain segments of the graphics market, certainly in mobile for sure. And you see that with some of our OEM wins, as well as the recent announcements. On the AIB channel, it has been a little bit weak for us, and if you recall AIB started in the first quarter very strong around cryptocurrency. And then as we went into the second quarter with some of that the market dynamics there, it was weaker. Relative to the competitive environment, I would agree that Q4 tends to be a stronger seasonal month, a seasonal quarter for our graphics, as we go into the holiday season. We've certainly adjusted to some of the competitive dynamics, and we have made some positioning changes as well as some new marketing activities that you will see from us in the fourth quarter.

[JoAnne Feeney:]

So does that suggest that you're looking for it to be up or to be down in terms of consumer graphics in the fourth quarter?

[Lisa Su:]

Well, when we look overall at the CG business, we've said that it will be down. I think there are certain segments within the business that will be up, based on the seasonality.

[JoAnne Feeney:]

And then, Devinder, I'm curious about your latest move with the interest swaps. Obviously, it's a benefit shorter terms to switch to variable interest rates to that $250 million. But it seems like you're taking a risk here with the U.S. economies improving, that interest rate will be going up. And if I heard you correctly, you don't get a benefit from that until the end of the 2015 year. So do you plan to be able to pay that back before that risk really becomes a concern, or are you assuming that these marketing interest will stay low for long enough for you to payback eventually?

[Devinder Kumar:]

Thank you, JoAnne. That's a good question. I think overall from the way we have crafted that interest rate swap transaction, there is a benefit at the way we have set it up to the tune of about $1 million a quarter. And what you talked the increased interest rates from some standpoint, there is no risk for the life of that that we have on the balance sheet for $250 million of the fixed rate, that we have on the 2019. We have presently swapped that out. And there is some hedging that gets into place. I can get into the details offline with you to go ahead and explain to you how it works, and the confidence level that we have from a view point of where we sit with that particular that transaction.

[JoAnne Feeney:]

And then if I could sneak in one last question. With the reorganization of the two segments, I was hoping perhaps you could give us a sense of how gross margins compare across those segments? And also how perhaps operating expenses compare. The Compute and Graphic segments obviously are showing loses for most of the last eight quarters -- sorry, most of the last five quarters or six quarters. I am wondering whether that's attributable to gross margin difference or if it's really the R&D expense on the C&G side that's driving that and where you think that's going to go over time?

[Devinder Kumar:]

I think it's a combination of factors, so I am not going to provide, JoAnne, unfortunately granularity from a gross margin at a segment level. We do share the revenue and the operating income. The thing that you probably know based on the business model for the semi-custom in particular, we have been clear that that is below the corporate average from a gross margin standpoint, but that's where you get the benefit from the NRE model of how products are designed together with the customers, how we get the funding for those products. And then when go to silicon production, there are no sales and marketing dollars. There is a little bit of warranty on an ongoing basis, and the G&A is essentially a fixed cost, so you scale the revenue, the operating margin benefits, and that's why you have seen the results as you observed for the EESC segment whereby there is profitability at the 15%, 16%, 17% of operating income level. As far the Computer and Graphics, you are right. If you look back the last five quarters, two of the five quarters we made money, and three quarters we lost money. Revenue is down as the previous question observed and that's what we are doing in terms of managing for long-term profitability at the company-level and redistributing the resources and redeploying resources potentially from one segment to another, but by the same token, managing them in line with the revenue expectations for the future.

[JoAnne Feeney:]

Quick follow-up to that. Just wondering whether there is room in the C&G segment to make the kinds of cuts you need to make to turn that profitable, or if the competitive pressure under is constraining your prices so much and the demands on the research side are so much that you really in a difficult spot to cut those cost and raise that operating profit. Can you speak to how you would get that done?

[Devinder Kumar:]

Yes, I can address that and I'll ask Lisa to address how we are -- this is really methodical. I think you probably recall, and maybe that's what you're referring to couple of years ago when the PC market went down pretty dramatically in the 2012 timeframe, we did reset restructure. And I would say having participated in both of those at the CFO level, those were more across the board, but these are very targeted and very methodical, protecting the core technology, as I talked about, and making sure that we do not in any way disrupt the future technology and making sure that the long-term growth at the company level is assured and protecting the technology. Lisa, you want to comment on that.

[Lisa Su:]

Yes, JoAnne, this is a really important point. So when you look our strategy and the model that we are trying to build, it really is around developing leadership IP, so that's core CPU and graphics IPs, it's actually used across both segments, and that's very critical and it's being entirely protected in this restructuring action. When we look specifically in the Computing and Graphics business, relative to the overall infrastructure that was built around these two businesses, the businesses are smaller than they were before, and so there is significant opportunity to streamline how we operate, how we go to market, and just the overall infrastructure that we have. So from an R&D standpoint, very clear that those are the most important investments, and ones that will fuel long-term growth in both segments. And so those will continue. And we do believe that there is opportunity to streamline in the operational side.

[Operator:]

Our next question comes from Ian Ing from MKM Partners.

[Ian Ing:]

First question is in GPU inventories. Looks like the AIBs aren't really reselling or refurbishing their returns. Looks like they don't want to put excess product into the market, so I read the filings, they're grading implications on price protections as the AIBs try to monetize their inventories?

[Lisa Su:]

Maybe I'll start with that Ian. So very relative to the AIBs, we work closely, very closely with all the channel partners. I did mention that there was some cautiousness in the distribution channel, as we were going through the third quarter. Part of that was just, the new products from both ourselves, as well from our competitor. We see that fourth quarter is typically a stronger quarter for the AIB channel and we would expect that the distributors will have the inventory on hand necessary for the holiday season.

[Ian Ing:]

There's not an excess level of price protection?

[Lisa Su:]

There is nothing unusual.

[Ian Ing:]

And then, Lisa, more of a high level question. So now that you're the CEO of the AMD, I mean what should we think of as your imprint on the company, the strategy is not changing too much? Is it really executing to the product roadmaps?. Is there any sort of senior management you'd like to bring on board to help meet your goals?

[Lisa Su:]

Well, I think, Ian, thanks for that question. The strategy is something that I believe very much in, it's something that we put together as a leadership team, and it really is about taking the technology assets that we have, as a company, and applying them to higher growth segments. So at a high level that is absolutely what we're doing. Now, relative to what I would like to do, I am really going to focus on the leadership products and differentiation. I mean that is the core of what I think will make us successful, as a company, as well as our deeper customer relationships and the simplification we've talked about. I think there is a lot of opportunity here. This is a multi-year transformation that we're going through, but relative to some of the technology bets that we are making, they will payoff in the next couple of years. So I think you'll see perhaps a little bit more focus on the technology and the products.

[Operator:]

Our next question comes from Christopher Rolland from FBR Capital Markets.

[Christopher Rolland:]

First, Fairchild -- I apologize we're in the middle of a fire drill. Fairchild said today that Microsoft really had ordered all their components ahead of 4Q that build and that they really weren't reordering. So APUs might be a different story here, I understand that, but are there any sort of shadows in the story there? Are you seeing a pretty marked sort of decrease in builds in 4Q?

[Lisa Su:]

Thanks for the question Chris. So relative to Microsoft, they are actually the game console customers. Our lead times are fairly long for the APUs. And so we synchronized our forecast with the customer forecast in that time period. So we don't see anything unusual. I think our expectations for the fourth quarter are very much in line with the customer demands.

[Christopher Rolland:]

And then also if we could talk about the Bitcoin mining situation, I guess you guys said you thought that that was going to be a one quarter event. Basically, we're sort of wondering here, we do see some channel inventory out there, some parts on eBay and stuff like that in the grey market. Would you say that you guys are still through that or would you say that there is maybe a few more quarters to go here?

[Lisa Su:]

Yes. I think Chris, if I just take the overall channel, both the desktop and GPU channel; I think there is some dynamics in there. I think the Bitcoin or the cryptocurrency thing really started in the second quarter, flowed through the third quarter. There were some used or secondhand cards that were out there in the market. I would say that what we're looking at now is really working through some of the product positioning as we go into the fourth quarter. So with most channel inventory issues, it does take a couple of quarters to work through, and we are working through those. But I think relative to the cryptocurrency, I think that's lesser of a factor at this point in time.

[Operator:]

Our next question comes from Matt Ramsay of Canaccord Genuity.

[Matt Ramsay:]

Lisa, I wanted to ask a quick question about sort of the foundry side with 14-nanometer launching from your competitor. You guys are in a position now for a period of time, where some products could be a couple nodes behind. I just want a comment on how that's affecting you, when your interface with customers and partners, and how you think that set you up in a competitive position for the next several quarters until FinFET gets launched as your foundry partner?

[Lisa Su:]

Sure, Matt. So on the technology side, it's certainly important and we are doing active designs in FinFET for sure. From our product differentiation standpoint, so if you look at the APUs, it tends to be more of an architectural statement versus a process technology statement. So with our launch of Kaveri and the amount of compute cores that we have on Kaveri, I think that's something that has been attractive to the market. And as we go into our next generation APUs in 2015, they will have added features and functions, some of our heterogeneous software architecture as well. So I think the net of it is, clearly the technology is important, and we're designing in FinFET and they are going to be an important node for us, as we go forward. But there are many things that we're doing on the architectural and power management side to ensure that we provide differentiated products.

[Matt Ramsay:]

And then, as a follow-up, you talked about the gaming business being down in 4Q, which you had talked about last quarter. And I think the stance, obviously, it's too early to guide a lot of things for next year, but I think the stance the company had taken is as distribution of the gaming console sort of ramped from your partners there that that business should grow on a year-over-year basis next year. Maybe you could talk to the detail that you can about, what can we expect in the gaming business for seasonality in Q1 and what next year looks like on an annualized basis, and the fact that the new wins that you've just got are 2016 revenue?

[Lisa Su:]

So let me try to frame it in this way, it is a little bit early to talk about 2015 revenue in units. What I will say is that from what we see, the gaming console business looks strong. We just had a one of our partners Microsoft launch in China, and that looked like it was successful. I think everything that we see is shaping up to be a solid holiday season. Relative to 2015 seasonality, it is a consumer business, and so we would expect that the first half would be lower than the second half. And we'll have to see how all of that shakes out through this holiday season.

[Operator:]

Our next question comes from Kevin Cassidy of Stifel Nicolaus.

[Dean Grumlose:]

This is Dean Grumlose calling in for Kevin. Thank you very much for taking my call. But could you comment on your traction in profession and server GPU markets?

[Lisa Su:]

Sure. So the professional graphics market is important to us. I think in this quarter we certainly improved in the channels, we had some quarter-over-quarter growth in the channel in professional graphics as well as some new design wins from several of the large OEMs. I think in general, professional graphics is a longer sell cycle than some of the consumer graphics. And so we're spending quite a bit of effort in both business development and software and ISB development to ensure that we grow that business on a go-forward basis.

[Dean Grumlose:]

And as a follow-up, going forward what you view as your key differentiating advantages in various GPU markets?

[Lisa Su:]

Again, I think on the graphics side, it is about graphics, performance, performance per watt, and compute capability. So there is certainly a competitive market, but from our standpoint I think we have very competitive products. And as in professional graphics, the ISB certifications are quite important. It's really about the investments in those ISB certifications.

[Operator:]

Our next question comes from Srini Pajjuri from CLSA.

[Srini Pajjuri:]

Lisa, just wondering the game console business, as we look into the next year, when do your prizes typically get reset? And also are you expecting any process node transitions in 2015? And in general, I am just trying to understand, how I should think about the overall profitability versus this year, assuming that units are relatively flat?

[Lisa Su:]

Sure. So the ASPs that we negotiate with the customers are negotiated in advance, so they are certainly booked into our business model. There are ASP declines year-on-year. And then relative -- I'm sorry, you said, relative to operating profits, I think we will of course work very hard on ensuring that we get the cost reductions relative to the ASP reductions as well. So I think from overall game console business, we view it as a very strong business for us.

[Srini Pajjuri:]

And then are you expecting any process node migrations in this business?

[Lisa Su:]

There will be process node migrations. And we'll talk about them at the appropriate time.

[Srini Pajjuri:]

And then you mentioned the two new design wins, they are expect to ramp sometime in 2016. Is there a way to think about the overall opportunity relative to what you are getting from the semi-custom business today?

[Lisa Su:]

So the two new semi-custom design wins that we talked about, relative opportunity around $1 billion over a three-year lifetime. The reason we really like these types of businesses, obviously, is because they're sticky once you win them, the recurring revenue is there. I view that there is quite a bit of opportunity for us in semi-custom. The pipeline is strong. It's across a variety of different markets, and it's an area that we will continue to differentiate given our IP and SoC design capability.

[Srini Pajjuri:]

And do you expect the margin profile and the profitability to look similar?

[Lisa Su:]

So if you look at the overall business, I think we would like to talk about the EESC business versus specific design wins. And the EESC business you can see has good profitability and we will continue to work on improving that.

[Ruth Cotter:]

Operator, we would like to take two more questions, please.

[Operator:]

Our next question comes from Michael McConnell of Pacific Crest Securities.

[Michael McConnell:]

I just wanted to clarify on the graphic side with your sell-through commentary, and the on-board market and the inventory commentary, is that a market issue or is that an AMD issue?

[Lisa Su:]

So relative to the AIB channel, I thought the commentary, the third quarter was slow, some of that was market and some of that was sort of our product positioning. As we look into the fourth quarter, we think the market will be a normal quarter and certainly we view the opportunity to improve in the AIB channel.

[Michael McConnell:]

And you just clarified, you did say channel inventory will be -- you're expecting channel inventory overall for the market to be normalized by Q4?

[Lisa Su:]

No. I think what we said was that there was nothing unusual in the channel inventory relative to the third quarter. The previous question was about whether the distributors would have enough inventory to support the fourth quarter. Relative to overall channel inventories, our goal is to normalize channel inventories over the next several quarters.

[Operator:]

And our final question comes from Sanjay Chaurasia from Nomura.

[Sanjay Chaurasia:]

Lisa, I have question on servers. As you have laid out your strategy, and the fact you have moved servers into semi-custom business, could you talk about how would you defend for my estimates more than $0.5 billion in server revenue. It does look like based on this cost cuts, there's not much significant focus on improving x86 performance as it relates to servers. So what happens to this business? Is it defendable or does it continue to go down?

[Lisa Su:]

So maybe let me talk about servers a little bit more generally, and then we can clarify some of the specifics. From a general standpoint, the server market is a big large TAM, and so we are certainly interested in growing in servers. From where we are today, our product portfolio in x86 is several years old. And we are certainly looking at updating that over the next couple of years. And then as we look at the opportunity in server, particularly in dense server, I think there's an opportunity for both x86 and ARM. And so we are going after the newer markets in server versus some of the traditional enterprise.

[Sanjay Chaurasia:]

And as a follow-up, if I exclude your gaming business and semi-custom, what would the mix of x86 and ARM in your semi-custom design wins? And also the two new design wins you talked about, are these x86-based or ARM-based?

[Lisa Su:]

So if you are asking about the semi-custom revenue today, the semi-custom revenue today is all x86-based. As we move forward, we believe ARM will become more important in that business. And then specific to the two new semi-custom opportunities one of them is in ARM and one is an x86.

[Ruth Cotter:]

Operator, thank you. That concludes today's call. If you could wrap it up, we'd appreciate it. Thank you.

[Operator:]

Ladies and gentlemen, this concludes today's conference. Thank you for your attendance. You may now disconnect. Everyone, have a great day.