The AMD Corporate Responsibility Program and Activities Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance during today's call, you may press star then zero on your touchtone telephone for a live operator. As a reminder, today's conference may be recorded. It is now my pleasure to turn the floor over to Alina Ostrovsky, Senior Analyst, Investor Relations. Please go ahead, ma'am.
Thank you. Welcome to AMD's Corporate Responsibility Program and Activities Conference Call. On today's call, we will provide a brief overview of AMD's corporate responsibility program, activities, and strategy. Participants on today's conference call are Tim Mohin, our Director of Corporate Responsibility, and Ruth Cotter, our Corporate Vice President, Investor Relations. Heather O'Cleary, Senior Manager of Corporate Responsibility, will be present for the Q&A portion of the call. This is a live call and will be replayed via webcast on amd.com. Please note that non-GAAP financial measures referenced during this call are reconciled to their most directly comparable GAAP financial measures in the accompanying presentation posted on our website, ir.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, as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. You will also find detailed discussions about our risk factors in our filings with the SEC, in particular, AMD's quarterly report on Form 10-Q for the quarter ended June 29th, 2013. With that, I will hand the call over to Ruth. Ruth?
Thank you, Elena. Welcome everybody this afternoon to our conference call. I am pleased today to be joined by my colleagues, Tim and Heather. Here in the next slide, you will just see very briefly an overview of our cautionary statement to cover our remarks today. What I would really like to talk about is the outline, where we will have a brief overview from our CEO, Rory Read, then I will do a deeper dive into AMD's strategy, products, and financial performance to date. Then Tim will give a deeper dive into the crux of the call, which is really an overview of our corporate responsibility programs and activities here at AMD, which are very important to us. Corporate responsibility really matters to AMD. It is really at the core of our culture, and we perceive it to be part of the inherent DNA of the organization.
Rory Read, our CEO and President, along with the board of directors and the executive management team, are deeply invested and committed to AMD's efforts, be it in the area of community volunteering, products and customers, supplier responsibility, governance and ethics, and stakeholder engagement. It's very important to AMD, and we believe it's an imperative as well as being a key business differentiator for our company. Before we get into the details of the strategy that we have here at AMD as it pertains to corporate responsibility, I'd like to just give a quick purview into the company, and then Tim can dovetail his remarks into that. AMD is currently in the midst of a 3-step transformational program in place. The first portion of that strategy to reset and restructure is largely completed.
Our goal is to reach operating expenses of $450 million, down from about $590 million in the first quarter of 2012. We've made significant progress over the last many quarters. We've reduced headcount by about 14%, and we're very focused on managing cash, which I'll get into further in the call, as well as inventory management. At the moment, we're currently in phase 2, which is accelerate and execute to the plan. It's critical that we execute to our 2013 roadmap and deliver on the products that we have brought to market, including Temash in the tablet space, Kabini, and Richland. Later this year, we will be shipping a higher-end desktop product called Kaveri.
Also deliver our commitments in terms of our semi-custom product portfolio, embedded, and launch latest generation of graphics capability, which we did earlier this year on the GPU side. Obviously our low-power server offerings as well through SeaMicro acquisition we did, that is also important. In this phase, it's critical we return to profitability, which is the plan for the third quarter of this year based on the midpoint of guidance we provided for the quarter. Obviously, focusing on positive free cash flow achievement here in the second half of the year is what we're executing towards. As we transition into 2014 and beyond, which will be the phase 3 of our transformation, we'll really hone on building leadership IP, in particular in the areas of low power.
When it pertains to server, we are conducting an ambidextrous strategy by introducing X86 and ARM-based processors in this space to our customer base, also really leveraging the differentiated graphics IP and capabilities we have from our competitive portfolio. We're also in the midst of transitioning 40%-50% of our business to what we call high-growth adjacent markets, where we can reuse our current IP portfolio. These areas include ultra-low power client, which is essentially tablets, the embedded market, which is lower-end processors into devices such as digital signage, medical imaging devices, Las Vegas gaming type of machines. Semi-custom business, which currently has two design wins based on the next generation game consoles from very leadership OEMs who are partners on that front, Sony and Microsoft. Professional graphics, we see as a good growth trajectory for the organization, along with the dense server space.
When we think about the product portfolio we've laid out here in 2013, we are showing we are a leader in discrete graphics. We've launched the new family of products here in the first half of the year, we will be capitalizing on the success and embrace how the market has embraced those products here in the back half of the year. We gained share in this segment of the market in the second quarter, we look forward to continuing that trajectory here in the back half of the year. When we look at ultra-thins in terms of very sleek notebooks and also in the desktop space, we have our Richland product, which did very well in the channel in this most recent quarter, Q2, we will be launching Kaveri in terms of shipments and shipping product to customers in the fourth quarter of this year.
In the mainstream ultra-thin notebook space and smaller PC environments, we launched Kabini here in the first half of the year, that's helped us drive gains of up to three points of share in the second quarter in the notebook space. Last but not least, we have launched Temash in the second quarter to address our true performance capability in tablets. This part is in the market well ahead of the competition, we're excited about the opportunities for that. Just to do a briefer dive into some of the areas that I talked about, if we look at client, essentially notebook and desktop, it's all about low power, thin portability and tablets, and that's where we are focusing our IP and product capability.
We drive differentiation into volume segments of the market by our leadership and unique IPs through what we call our APU processors, coupled with our graphics IP. This differentiates us from all our competitors in having leading-edge X86 microprocessor capability and coupling that with our graphics IP. Much so, as I mentioned, we have gained three points of share in the notebook space in the second quarter, according to Mercury Research, two points of desktop share. We're very pleased about the progress we've made and expect to continue to make progress here in the second half of the year on that front. On the graphics space, it really is recognizing and driving our IP in that segment to become the de facto standard for gaming development across the globe.
You see AMD leadership in terms of online gaming, leadership in terms of desktop hardcore gamers, as well as the game console environment. We're pleased, again, with how we're moving on that front. In the second quarter, thanks to the new family of products we launched earlier this year, we have the fastest desktop and notebook graphics solution in the market today. When we think about dense servers, it's all about low power and leveraging the differentiated IP we have there through the acquisition of SeaMicro. We have over 80 customers in market today with thousands of systems already proven and working in the market, which differentiates us significantly from the competition in that space.
We're uniquely positioned in this market because we offer both X86, and next year, we will bring our first ARM-based 64-bit server solutions to market, which we're very excited and pleased about. That will allow us to continue to grow this segment of the market. Last but not least, we have our semi-custom and embedded portions of the business, which we expect to be 20%, if not north of 20%, of our revenue in the fourth quarter of this year. As I had mentioned, we're targeting in the embedded space, it's a low-end processors. It's attractive business because it's long in terms of design wins. Design wins can last beyond five years. However, the design win cycle and securing design wins is up to 18 months.
There's a lot of ahead-of-time work that goes into that segment of the market. Over coming quarters, we hope to report progress on that front. The semi-custom business, which you've heard a lot of talk about recently, where we've secured marquee design wins from our two critical partners in this space, Sony for their next generation PlayStation 4 and Microsoft for their next generation Xbox One. As we think about AMD's financial focus through the remainder of this year, it really is honing in on reaching that operating expense target of $450 million by this current quarter, Q3. That will be important. Liquidity is a strong focus for us. Linearity in terms of supply to the customer, along with in-depth inventory management is obviously important.
What's critical is that we maintain our optimal cash balance at about $1.1 billion for the next several quarters. We have confidence that we will do that. Transitioning portion of our business to being focused on semi-custom and embedded to be about 20% by the fourth quarter of this year is on track. We continue to drive forward on that front. Obviously, as we execute our new operating model to achieve profitable growth, we expect to be profitable here in the third quarter when we announce our results in October, and free cash flow positive for the second year. In terms of what progress was made in the second quarter of the year, here is a brief overview. You saw that sales were up.
Gross margin was down a point quarter-over-quarter, largely driven by some previously reserved inventory that we sold in the quarter. Operating expenses continued to come down in the right direction. That's positive to see. We maintained cash at the $1.1 billion. You did see inventory go up some in the second quarter. This was largely based on the build for our semi-custom business and for the new product portfolio that we launched through the new offerings in the APU space. We expect that inventory will go up to about $800 million in the third quarter of this year. That's largely based on the products we are building for the semi-custom business. AMD has about $2 billion of debt. When we think about what's critical to the phases of transformation here at AMD, as I mentioned, operating expenses is very important.
As you can see here on this chart, we've brought operating expenses down from a high of $590 million in the first quarter of 2012, not only driven by headcount reductions, but we've done a lot of site consolidation. Reusing our IP across a broad set of product portfolios has also brought some savings in terms of the R&D segment. For example, the Jaguar core on which our Kabini APU is based, you'll also find that in our embedded product portfolio. You'll also find that in our semi-custom product portfolio, for example. Look out for AMD to continue to show more examples of that IP reuse to help manage operating expenses. What's critical is obviously liquidity to AMD. The minimum threshold to run the business is approximately $700 million.
We believe the optimal zone is $1.1 billion, and what we mean by that is enough of a cushion between $700 million and $1.1 billion to facilitate the company if any unforeseen circumstances were to occur. We expect to stay in this $1.1 billion range for the next several quarters. Another unusual fact about AMD is that between 90%-95% of our cash is actually held domestically, which is very attractive. Even if you think about cash burn over the next several quarters, we have one large payment to one of our foundry suppliers in the first quarter of 2014 of $200 million. Notwithstanding that payment, we still believe we can stay in the $1.1 billion cash range.
Before I hand off to Tim to give you a deeper dive in terms of our corporate responsibility update, I just wanted to reiterate that the three-phase turnaround plan is being executed, and we are in the second phase of this plan. Maintaining optimal liquidity is very important, and we remain on track and have proven that we have stayed in that zone since last year. We're diversifying beyond the traditional PC market as we transition up to 50% of our business to these new adjacent high-growth markets. The way we will do that is by continuing to invest in differentiated IP. Now, with that, I'd like to hand over to Tim. Tim?
Thank you, Ruth. It's a great pleasure to be here today with my colleagues to talk about corporate responsibility. It's particularly appropriate to present along with the presentation you just heard from Ruth on strategy, products, and financials, because as Ruth said, here at AMD, it's all connected. It's part of our DNA, and as you'll see as I go through this, it's also part of our business value proposition. The first thing I want to do on slide 15 is tell you a little bit about what corporate responsibility encompasses here at AMD. It's a very broad scope, and as you'll see as I get through this presentation, it touches most of our business. Let me just give you a brief overview. Our philanthropy programs are managed through our AMD Foundation, and primarily we invest in science, technology, engineering, and math or STEM education.
I'll talk a little bit about our signature program, AMD Changing the Game, a little bit later. As you might imagine, STEM education is vitally important, not only for our country, but for AMD. We hire the best and brightest engineers, and of course, having education that supports that is in our business interest. Like many companies, we support our communities through volunteering and giving, and we'll have some statistics on that. Environment is at the top of mind for many people these days. AMD has a long history of both setting and meeting commitments on reducing our footprint for the environment. As you'll see as I go through this, we're not just stopping there. We're working to try to influence the entire industry to reduce their footprint as well.
Governance and ethics is something that a lot of people don't think of as within the scope of corporate responsibility, it is, and it's something that we report on and hopefully you can see in our latest corporate responsibility report. Our products and our customers are vitally important, of course. Since we sell to mainly OEM computer makers and game console makers, many of these companies have very robust corporate responsibility programs, and they hold us accountable for the same. In terms of our products, we are concerned about what's in our products, how much power they use, what kind of packaging is around them, and we work very hard on those topics. A lot of times when we're successful there, it also has obvious business value to the company.
Supplier responsibility is an area we'll dive into a little bit later. As our company has changed our business model and focused more on outsourced manufacturing, the issue of how those manufacturers do their business has become more and more important to AMD, and we've taken a very strong stand on that. Stakeholder engagement is how we make sure that our programs are continuously improved. We consider everybody on this call to be a stakeholder, but we also have a formal stakeholder engagement panel, which I'll talk about in a later slide. Lastly, all of this gets wrapped up into our corporate responsibility report. If you haven't done so, I urge you to look at it. It's online and available. Transitioning to the next slide, we have done this for many, many years, almost two decades now.
This, in fact, is our 18th consecutive annual corporate responsibility report. This year it's a little different. We've issued it in four different formats. We've issued a short magazine, a 24-page summary of our progress and programs. We've taken that summary, and we've put it in a tablet application that you can download for iOS or Android devices. We continue to publish our full report, which is mainly used by our analysts who track our company and want to know all of the details. That report has been graded by the Global Reporting Initiative as Application Level A, which is the highest level of transparency. Of course, all of this is also available in the fourth format, which is on the web. This year, we've also decided to publish reports in three different regions, China, Brazil, and Malaysia.
The report has been translated into local language, but it also includes additional local content. Next, as I mentioned before, we like to influence beyond our own four walls. This year, AMD was elected to chair the Electronic Industry Citizenship Coalition. For those of you who don't know the EICC, it's an organization that's focused on labor and environmental issues throughout the electronics supply chain, currently made up of 84 member companies representing over $1.7 trillion in combined annual revenue. It's quite a large organization, and as chairman of the board of that organization, we are able to influence and move the needle throughout the entire industry on these very important issues. In terms of our own operations, there are many data points in the report, but just one for you. We opened a new data center in Atlanta, which is powered by 100% renewable energy.
In terms of our products, AMD's SeaMicro line of servers use one-quarter of the power and one-sixth of the space of traditional servers. As you might imagine with many of these proof points, AMD continues to be recognized for our leadership and corporate responsibility, and I'll get into this in the next slide, but just a couple. We were added to the 100 Best Corporate Citizens list this year and the EPA Green Power Partnership Leadership Club. Lastly, we'll dive a little deeper on this one, conflict minerals. Conflict minerals is a very hot topic these days within the scope of corporate responsibility. AMD has been a leader on this even before this issue was passed into law, and we continue to lead not only in policy, but in implementation.
On the next slide, you'll see many of the different rewards and recognitions that we have received recently. I won't go into all of these. Certainly, you can read them on your own. Let me just make a couple of points. One is that AMD continues to be recognized for our responsibility leadership ahead of much larger companies that invest far more in these issues. That's a testament to what Ruth said, which is this is really part of who we are at AMD. Another point I would make on this slide is that many of these awards are specific to the socially responsible investment community. As you can see, AMD has been on the Dow Jones Sustainability Index since its inception, and we're on the North American index today.
We were added to the U.K. index called FTSE4Good in 2012, we're on the Morgan Stanley list for environment, social, and governance. Finally, in the bottom left, we were selected by Triodos Bank in 2012 and ranked third in our sector for sustainability performance. To give you a couple of highlights on our programs, again, there's far more detail in the report, and I look forward to any of your questions on all of this that we're presenting today. Supplier responsibility, I mentioned earlier, is a much more important issue in the new AMD. We take a slightly different approach than other companies to this issue. We look beyond just auditing, and we've really tried to integrate supplier responsibility into our business relationships with our suppliers.
To do this, we actually do a scorecard for our direct suppliers. That scorecard is part of our supplier business reviews. Our suppliers know that their performance on corporate responsibility issues is a part of their relationship with AMD. We also recognize our suppliers for good performance. We had some supplier recognitions at our supplier day recently. Finally, some of our suppliers are bigger than others. I think most people know that TSMC and GlobalFoundries are our fabrication partners. Because they represent a good deal of our environmental footprint, we work very closely with these suppliers. On a quarterly basis, we do a deep dive on their environmental, social, and governance objectives and targets and progress against those.
I already mentioned our leadership in EICC. We really feel that by collaborating with others, both competitors, customers, and partners, we're able to really move the needle not just at AMD, but across the entire industry. Conflict minerals. AMD engaged in this issue well before there was a Dodd-Frank law that made this a requirement in 2010. In fact, we co-chair a multi-stakeholder coalition with an activist group called the Enough Project. Through that coalition, filed no less than five separate comment letters to the SEC on the policy. We're referred to many times in the final rule issued by SEC. We're also one of the few companies that stepped up to testify at the roundtable that SEC held in developing the final rule. For our own implementation progress, we've actually identified well over 100 individual smelters in our supply chain.
You can see our progress and our policy on the web link provided on this slide. One last word about conflict minerals, an external perspective from the Enough Project. They issued a report about a year ago that ranked AMD fifth in progress on both policy and implementation on this very important issue. On the next slide, we talk about environmental performance. Environmental performance is, of course, top of mind for many. As I mentioned, we have a long history of both making and meeting commitments on environmental performance. In this case, we have set goals for air, water, and waste for our own operations. We've split some of those goals between our non-manufacturing sites and our manufacturing sites, because obviously they handle these materials quite differently.
The good news is that we're ahead of schedule or on track for each one of these goals. You can see the detailed data in our report. I mentioned AMD Changing the Game. This, in fact, is our signature philanthropic project. It is a global project. It's very unique and innovative in that it takes something that young people already love, which is gaming, and uses it to teach them science, technology, engineering, and math or STEM skills. It's not just by playing games. The children who go through this curriculum actually develop their own games. In developing those games, they learn these STEM skills. We're very proud that this program is global. It's in seven countries around the world. There are more than 25 technology centers that have been opened under this program.
My favorite statistic on this slide is that more than 200,000 students have been reached by this program thus far. Employee engagement. Employee engagement is important to every company. We know that engaged employees are the most productive, the most innovative, the most creative. What we've found here at AMD, because this is a strong part of our culture, is that corporate responsibility really helps to engage our employees. We've seen it time and time again in the employees that we recruit and the employees that are here who get involved. There's a lot of data on this slide, and I won't go through all of this with you, but just to pick up on a couple of points. One is marriage equality. In a somewhat unusual step, AMD stepped out to support an amicus brief for the Supreme Court case on marriage equality.
Why did we do that? The first answer is that it's part of our culture. We believe in fairness and equality for all, and that's in our worldwide standards of business conduct. Second is business value. We want to make sure that we're competitive, and we can attract and retain the best and brightest employees. By treating everybody fairly, we know that we can. The second point I would make is on the lower left of the slide, South by Southwest. Most people know that brand as a very fun festival here in Austin, but they also hold an environmental conference called South by Southwest Eco. Again, following the theme of trying to influence beyond our own four walls, AMD got involved with South by Southwest Eco last year. At most conferences, people network over coffee or wine and cheese.
We said, why not take the participants outside the conference and have them volunteer in the community? That way, they could not only network, but they could actually contribute to the local community. It was a runaway success with over 150 people participating. We took our show on the road, and we wrote a white paper that allows any event planner to learn the things that we learned in putting on this event. We're going to do it again in the 2013 conference, which is coming up here rapidly, and we're expecting over 3,000 participants at that conference. Stakeholder engagement. It's one thing to feel like you're doing a great job. It's another thing to check in with knowledgeable stakeholders from across the spectrum and have them take a look at your programs.
We have done that through an organization called Ceres, many of you may be familiar with. Ceres has pulled together a stakeholder panel for us, made up of NGOs, academics, and socially responsible investors. We meet with this panel periodically, and they provide us perspective on our performance, help us identify trends and issues, and help us focus on the most salient issues. They also have commented on our corporate responsibility report, and we've included those comments verbatim in our report as well. On the right side of the slide, you see some of the examples of the feedback that we've been given from this panel. Not to go through all of these, but there are several areas of focus that we've been looking at. For example, focus on governance, which I'll talk about on the next slide, and transparency and disclosure.
In fact, one of the comments was to communicate more with social investors, which we are doing today. On the next slide, we do talk about governance. We manage corporate responsibility at AMD through a cross-functional council called the Corporate Responsibility Council. As you can see from this slide, we have executive representation from just about every business group throughout AMD. Through these meetings, we are able to establish priorities, set goals, and track our progress against those goals. We do not stop there. We also have an executive sponsor who is the general counsel and corporate secretary, and we report our progress and our goals to the executive team and the AMD Board of Directors. In fact, we have made presentations to both those bodies just this summer. Where are we going from here? Obviously, as budgets have been constrained lately, we have pulled back on some things.
As you can tell from the awards and recognition that we have had, we continue to make progress in our corporate responsibility programs. That is because these programs are deeply embedded in our culture, in our policies, and our programs. For example, our Changing the Game program continues to produce results. Supply chain environment and all of the programs that I mentioned continue to produce great results. As the company returns to profitability, we anticipate refreshing many of our programs, but we are doing so with a different lens. We are looking at it from the concept of shared value. There is a great paper on that written by Michael Porter and Mark Kramer of Harvard Business School, which essentially says that the best kind of corporate responsibility looks at value, not just to society, but to the business.
We are planning to take a look at that, at all of our programs through that lens, in the upcoming year. Of course, we welcome your feedback and I look forward to the Q&A session that is coming. Just to leave you with one perspective, you have been listening to me for 15 minutes or so, and I wanted to leave you with the perspective of one other person about AMD's corporate responsibility programs. This is from Mindy Lubber, who is the CEO of Ceres, an organization I mentioned earlier, after a meeting she had with AMD CEO, Rory Read, last October. She said that it is clear that AMD's executive team has made a deep commitment to sustainability and is looking for ways to extend the company's leadership in this area. This commitment runs deep because it makes good business sense. AMD's leadership is impressive.
Thank you very much for your time and attention today. Again, I look forward to the dialogue.
Great. Thank you, Tim. I think that was a very good and solid, robust overview of our corporate responsibility at AMD, but also how it dovetails and leverages from the broader organization and how the two are very much married together. Thanks for that. Operator, we would be happy to poll the audience for any questions that might be had at this time.
Sure thing. Ladies and gentlemen on the phone lines, to queue up for a phone question, you may press star then one on your touchtone phone. If your question has been answered or wish to remove yourself from the phone queue, you may press the pound key. Again, if you would like to queue up for a phone question at this time, you may press star then one on your touchtone phone. One moment for questioners to queue. Once again, ladies and gentlemen, if you would like to queue up for a phone question, you may press star then one on your touchtone phone. Presenters, there appears to be no phone line questions at this time.
Thank you, operator. This concludes today's webcast, and we thank everybody who's on the web. There's quite a lot of you this afternoon viewing the slides and listening to us. We thank those of you who dialed in, and this webcast will be posted on amd.com for the next several months. I'm sure we'll have people regularly checking in to get abreast of the strategy. Obviously, Tim Mohin, our Director of Corporate Responsibility, and myself, Ruth Cotter in Investor Relations, are very happy to any outreach that you would be interested in providing on either the corporate visibility along with our CSR activities here at AMD. With that operator, we'll conclude the call. Thank you.
Yes, ma'am. Thank you, presenters, and thank you, ladies and gentlemen. Again, this does conclude today's call. Thank you for your participation and have a wonderful day. Attendees, you may log off at this time.