Good afternoon. My name is Huey, and I'll be your conference operator for today. At this time, I'd like to welcome everyone to AMD's third quarter 2012 earnings conference call. All lines have been placed on a listen-only mode. After the speaker's remarks, you'll be invited to participate in the question-and-answer session. As a reminder, this conference is being recorded today. I would now like to turn the conference over to Ms. Ruth Cotter, Vice President of Investor Relations for AMD. Please go ahead.
Thank you, Huey. Welcome to AMD's third quarter earnings conference call. By now, you should have had the opportunity to review a copy of our earnings press release and CFO commentary. If you have not reviewed these documents, they can be found on AMD's website at quarterlyearnings.amd.com. Participants on today's conference call are Rory Read, our President and Chief Executive Officer, Devinder Kumar, Senior Vice President, Corporate Controller, and interim Chief Financial Officer, and Lisa Su, our Senior Vice President and General Manager, Global Business Unit, and she will be present for the question-and-answer portion of the call. This is a live call and will be replayed via webcast on amd.com. I'd like to take this opportunity to highlight a few dates of note for you. Rory Read will present at the Credit Suisse Technology Conference on November 27th.
Devinder Kumar will present at the Raymond James Conference on December 10th, and our fourth quarter earnings quiet time will begin at the close of business on Friday, December 14th. Lastly, we intend to announce our fourth quarter and fiscal 2012 earnings on January 17th, 2013. Dial-in information for that call will be provided in mid-December of this year. Please note, non-GAAP financial measures referenced during this call are reconciled to their most directly comparable GAAP financial measures in the written CFO commentary posted on our website at quarterlyearnings.amd.com. Before we begin today, let me remind everyone that today's discussions contain 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 statement in our press release 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 30th, 2012. Now with that, I'll hand the call over to Rory. Rory?
Thank you, Ruth. Our third quarter financial performance fell significantly short of our expectations. We understand the dynamics behind the shortfall, and we are taking decisive actions to address the core issues. To help return the company to profitability, we also announced a restructuring plan designed to strengthen AMD's competitive positioning and reduce our expense structure. I will cover that plan in greater detail shortly, but first, I wanted to discuss our third quarter results. Broader macroeconomic issues are impacting consumer PC spend. OEMs are also taking a cautious approach to managing inventory in advance of the Windows 8 launch, and tablets continue to grow as a consumer device of choice. As a result, we faced a very challenging selling environment, especially in the lower end of the consumer client space. Yet, against this backdrop, we saw continued consumer adoption of our Trinity APU in the quarter.
Trinity notebook unit shipments increased more than 70% sequentially and accounted for nearly one-third of our total notebook shipments in the third quarter. Although Trinity is targeted at mainstream price points, ultra-thin notebooks featuring the low-power APU are also competing effectively at higher system price points. As a result, we believe we gained share in the $600-$799 retail notebook price band globally in the third quarter. More than 125 AMD-based systems are expected to launch with Windows 8, including tablets and several new ultra-thins. We look forward to the introduction of Win 8, the fourth quarter will continue to be challenging, and we do not expect PC market conditions to improve for several quarters. Our graphics business performed in line with our expectations. Despite market softness, we continued to see improvements in our desktop discrete channel business and game console revenue increased.
Our industry-leading graphics technologies remain a cornerstone of our end-to-end product strategy, and we plan to further invest in our graphics business to drive differentiation and future growth across the entire product portfolio. Now let's turn to the changes in the market and how they are affecting our business and the steps we are taking to address them. Shortly after joining AMD, I talked about the fundamental changes occurring in the PC industry. These trends are occurring now at an even faster rate than previously anticipated. We underestimated the speed of change in our industry, and we expected to have several years to transform the AMD business. We must implement our transformation on a more aggressive timeline. Here is what we will do. First, we are restructuring our business and building a more efficient operating model.
This reset will put in place a business model capable of delivering consistent profitability at lower breakeven revenue points. Second, we must diversify beyond the traditional PC market and become a leader in fast-growing and adjacent markets where we can differentiate and create leadership. Our restructuring will simplify our product development cycles without jeopardizing our ability to innovate or deliver products in a timely manner. We will do this primarily by building reusable IP blocks that will help lower development costs and improve our speed of execution. The restructuring plan is expected to lower our expense base by approximately 25%. This will result in an annualized cost savings of approximately $190 million. A large portion of these savings will come from a headcount reduction of approximately 15%.
These are difficult but necessary steps to ensure our plan has the right scale and scope to address the market and competitive challenges we now face. In addition, we are resetting to a new business model designed to deliver breakeven results with approximately $1.3 billion of quarterly revenue. We expect to hit this level by the third quarter of 2013. As we move through 2013, we will see the results of our work with a more efficient business and a portfolio of powerful new products. There is strong customer interest in our next-generation offerings. Design win momentum is solid, and we see opportunity to regain share in 2013. We already have working silicon for many of our new 2013 products in-house, including our next-generation 28-nanometer Kabini APU, which is the successor to our highly successful Brazos platform and our first true SoC design.
We are making good progress with the bringup of Kabini, which remains on track to launch in the first half of next year. Our long-term strategy will rebalance our business towards faster-growing segments of the market. Today, approximately 85% of our business is focused on the legacy PC portion of the market projected to have slowing growth over the next several years. We intend to drive 40%-50% of our portfolio to faster-growth markets where our IP is a key differentiator. We have strong opportunities in three fast-growing areas. First, in server. The dense cloud market is one of the fastest-growing parts of the data center market. Our long-term path to success is in providing customers with disruptive technologies and choice, just as we did when we brought 64-bit computing to the mainstream server market with AMD64.
We will look to leverage AMD's full suite of processor and graphics IP, third-party processor cores, and SeaMicro's innovative SuperCompute Fabric to deliver differentiated solutions with industry-leading performance per watt. Second, our low-power APUs, graphics IP, and reusable design blocks give us a distinct advantage to build semi-custom APUs for new embedded markets. We are focused on growing our share in targeted embedded markets. These include communications, industrial, and gaming, which will outpace the PC industry growth for the foreseeable future. Our semi-custom APUs already have a number of confidential, high-volume design wins in place. We plan for our embedded business to comprise approximately 20% of our quarterly revenue by the fourth quarter of 2013, up from 5% today. Finally, as we noted earlier, we will continue to focus on driving down into the ultra-portable and ultra-low power form factors that continue to grow rapidly.
APUs are ideally suited for these new products, from ultra-thins and tablets to a new breed of entry-level notebooks that will drive growth in the emerging markets. In summary, we are facing the challenges in the global IT market head on. We are resetting and restructuring our business to reduce our cost base from earlier this year by 25%. We are targeting a $1.3 billion revenue breakeven point by third quarter 2013. We are also delivering powerful new APUs in 2013. Finally, we are aggressively pursuing fast-growing adjacent markets where our IP provides differentiation and the opportunity for AMD to grow share. These include dense serving, new embedded markets, and new lower power form factors. Together, these actions will return AMD to profitable growth. With that, I'd like to turn the call over to our interim CFO, Devinder, to discuss our financial results for the third quarter.
Devinder is an experienced financial executive with more than 28 years of experience at AMD. He has served as the company's corporate controller since 2001. Devinder?
Thank you, Rory. Revenue for the third quarter of 2012 was $1.27 billion, down 10% sequentially, driven by an 11% decline in the Computing Solution segment and a 7% decline in the graphics segment revenue. Gross margin was 31%, down 15% sequentially, partially due to the $100 million inventory write-down, which adversely impacted gross margin by eight percentage points. This write-down was the result of lower than anticipated future demand for certain products and mainly comprised of the first generation A-Series APUs, code-named Llano. Third quarter gross margin was also negatively impacted by weaker than expected demand in the quarter. This contributed to lower ASPs for microprocessor products, as well as lower utilization of our assembly and test manufacturing facilities. Non-GAAP operating expenses were $516 million, 8% less than prior guidance, primarily due to tight spending controls and lower bonus and commission expenses.
R&D was $328 million, 26% of net revenue. SG&A was $188 million, 15% of net revenue. Non-GAAP net loss was $150 million, and non-GAAP operating loss was $124 million, both of which include the aforementioned $100 million inventory write-down. Interest expense was $44 million, flat compared to the prior quarter. The tax provision for the quarter was zero, compared to a $6 million tax benefit in the prior quarter. Non-GAAP loss per share, including the impact of the $100 million inventory write-down, was $0.20, calculated using 745 million basic shares. Adjusted EBITDA was negative $35 million, down $208 million from the prior quarter due to an operating loss, which resulted from lower revenue in the third quarter, as well as the $100 million inventory write-down.
Computing solution segment revenue was $927 million, down 11% sequentially due to lower ASPs, driven primarily by weaker than expected demand, as well as lower unit shipments. Client product revenue declined 11% sequentially due to lower unit shipments and ASPs in the third quarter, especially for desktop processors. We shipped a record number of Trinity-based products in the third quarter, and Trinity is a growing portion of our client product mix. In addition, we made substantial progress in the desktop channel, reducing Llano inventory in the third quarter. Our server processor revenue declined from the prior quarter, mainly due to lower unit shipments and an ongoing mix change away from higher density servers. Chipset revenue declined sequentially, primarily due to lower unit shipments in the quarter.
Computing Solution Segment operating loss was $114 million, down $196 million sequentially, primarily due to lower revenue in the quarter and the previously mentioned $100 million inventory write-down. Graphics segment revenue was $342 million, down 7% compared to the prior quarter due to lower GPU unit shipments to OEMs, partially offset by higher channel sales and royalties. Game console royalty revenue was up sequentially. Graphics segment operating income was $18 million, down $13 million from the prior quarter, primarily due to a decline in revenue. Turning to the balance sheet, cash equivalents, and marketable securities, including long-term securities, ended the quarter at $1.5 billion. Cash declined $279 million compared to the previous quarter, which was primarily the result of operational cash flows. Given the reduced size of our current business and OpEx reductions, we are adjusting our optimal cash balance from $1.5 billion to approximately $1.1 billion.
Additional cash outflows that will occur in the fourth quarter of 2012 include a $50 million cash payment to GlobalFoundries in the fourth quarter related to the 28-nanometer product limited waiver of exclusivity, as provided in the 2012 amendment to the wafer supply agreement, with the final payment of $175 million related to the waiver to be paid by December 31st, 2012. Debt as of the end of the quarter was $2.04 billion. In the third quarter, AMD repaid in full all of the outstanding principal and accrued interest of the company's 5.75% convertible senior notes due 2012, or approximately $499 million, and issued a $500 million aggregate principal amount, 7.5% senior notes due 2022. Accounts receivable at the end of the quarter was $683 million, down $61 million compared to the end of the second quarter of 2012 due to lower revenue.
Inventory was $744 million exiting the quarter, down $89 million, primarily as a result of the $100 million inventory write-down. Turning to the outlook. For the fourth quarter of 2012, AMD expects revenue to decrease 9% sequentially, ±4%. Operating expenses are expected to be approximately flat sequentially. As Rory stated in his opening remarks, we are realigning our company with the business realities of today. We are reducing our workforce by approximately 15% in the fourth quarter, and we will have a restructuring charge of approximately $18 million in the fourth quarter of 2012, primarily consisting of severance charges. Cash expenditures related to the fourth quarter restructuring will be paid almost entirely in the fourth quarter of 2012 and the first quarter of 2013. We are taking additional actions to reduce our expense base and align our cost structure with lower anticipated revenue.
Our skills and capabilities must be realigned with our market opportunities in order to position AMD to execute our strategic priorities, while focusing on returning to profitability. We continue to evaluate our cost structure and anticipate restructuring actions in the first half of 2013, which will result in additional restructuring charges. We are currently unable to quantify these amounts. As part of our financial reset, the company is targeting to break even at the operating income level at a $1.3 billion quarterly revenue and quarterly operating expenses of approximately $450 million by the third quarter of 2013. With that, I'll turn it back to Ruth. Ruth? Thank you, Devinder. Operator, we'd now like to open the call to questions and answers, please.
Yes, ma'am. Ladies and gentlemen on the phone lines, to queue up for a question, please press star then one on your touch tone phone. If your question has been answered or was to remove yourself from the queue, you may press the pound key. Again, if you would like to ask a question at this time, please press star then one on your touch tone phone. One moment for questioners to queue. Our first questioner in queue comes from the line of Ross Seymore with Deutsche Bank. Please go ahead. Your line is open.
Hi, Rory. First a question on the restructuring actions. What's the math or the thought process behind choosing the $1.3 billion revenue level to get to break even? It seems about 20% roughly above the fourth quarter guidance. It seems like you're baking in some pretty good news that's going to happen between now and then. Can you just talk about how that revenue level was chosen?
We basically looked at how the market was beginning to change and how we could refocus, Ross, in terms of where the growth opportunities would be across the next 12 months. We think by focusing to take down cost is the right approach here in the tactical timeframe because it's clear the trends that are reshaping the PC industry are clearly occurring faster than everyone anticipated. We'll continue to look at that, Ross, as we go through next year and make assessments as we see the year unfold, we clearly wanted to set a break-even point at a lower level than we've been running and to be able to consider those opportunities as we move forward in those new growth areas, which we're going to target where we see bigger growth.
I guess as the one follow-up, Devinder or Rory, whomever wants to answer it, how should we think about the OpEx trajectory to get to that total savings number you gave next year? Especially considering you said you're going to have costs lowered in the fourth quarter, you're guiding OpEx to be flat.
Ross, what we've talked about is from earlier in the year, we've driven a set of programs and restructuring to reset the company at a 25% lower expense structure. We believe that will position us to move forward at this lower break-even point. Just to remind you, as Rory said, the cost structure, if you go back and look at the OpEx in Q1, was right about the $600 million level. We have taken it down to about 500-plus.
To your specific question about Q3 or Q4 being flat, there are some offsets, in particular in the engineering area related to some 28-nanometer product tape outs and other R&D expenses. There was some timing between Q3 and Q4, and in particular, given the holiday season that's coming up, we have some marketing campaigns for which we're going to go spend some money. There were some offsets there. If you read through the press release, we've said that with the restructuring actions that we are taking, we'll save about $20 million this quarter, and then on a quarterly basis, that'll be $40 million on a go-forward standpoint.
That'll start in one Q from an absolute perspective, quarter-over-quarter?
Yes. That'll start in one Q on an absolute basis. Then, as Rory said earlier, we're going to continue to drive the cost structure down to get to the $450 million OpEx structure by Q3 of 2013.
Great. Thank you.
Thank you. Our next question in the queue comes from the line of Hans Mosesmann with Raymond James. Please go ahead.
Yeah. Hey, Rory, you mentioned as part of your new strategy that you would be incorporating third-party cores in. If you can just clarify the third-party cores, would that be for the server cloud market, or is it more broad?
We're clearly focused in terms of bringing those cores into the SeaMicro Freedom Fabric, the Supercompute Fabric. I think that's very important in terms of building that basis in which to lower the cost of those cloud compute environments, Hans. Maybe, Lisa, you want to add a little bit to that?
Yeah, let me just add some color to that. I think we've said from our strategy all along that we believe we want to build into the larger ecosystems in the industry. We'll continue to build x86 products. As we've announced before, we also have a partnership with Arm in the TrustZone security area. We'll continue to look at how we incorporate more third-party IP over time to address some of these higher growing markets.
Okay, as a follow-on, the timing for these types of products hitting the market, is that the end of 2013, 2014?
It'll probably be in the 2014 timeframe.
Great. Thank you.
Thank you. Our next question in the queue comes from JoAnne Feeney with Longbow Research. Please go ahead. Your line is open.
Yeah, thanks. I was hoping perhaps you could help us understand how you accomplish two seemingly divergent goals, one being to accelerate the transition to these new adjacent faster-growing markets, while at the same time cutting your expense basis. Given all the recent cuts there've been at the company, that's really brought things down to some very efficient levels, it would seem. It seems now you're going to be stuck cutting more of the creative talent. I'm just wondering how you're thinking about doing both at the same time, two things that seem kind of contradictory.
Yeah. Thanks, JoAnne. I think what's important is to look at terms of how we're simplifying our product development cycles. We've talked about this before in terms of creating the reusable IP blocks to create the structure in order to streamline our development and also to lower our cost of that development. We believe with the work of many talented engineers across AMD, their focus is to really streamline that activity, lower that cost, and deliver our base set of offerings. Then to build off of that with our reusable IP base in order to go attack those markets. They're adjacent, JoAnne. They're not fundamentally different. These are APU graphics-oriented opportunities that allow us to take solutions like Kabini and like our APU base into those segments at a lower cost base and across the portfolio.
That's helpful. Thanks, Rory. Then perhaps related to that is you've talked about moving more into the embedded space, and you say you have some design wins in place now that you're not at liberty to reveal. Could you perhaps let us know, you have a target for something like 20% of the business. How far along are you to that 20%? How many design wins? What's the state of the design wins in place now that gives you visibility to are you halfway there, a third of the way there? How many more design wins you have to get in place? Because that tends to be a longer design-in process, so I'm just wondering where you feel like you are there.
Thanks, JoAnne. From a standpoint of the market, today, 85% of our core business is focused on the legacy PC market, that's obviously a slowing segment. We believe those market trends that are affecting that are going to continue for the foreseeable future. This embedded opportunity is one we've been working on for some time. It's also around semi-custom. These opportunities are areas that are going to be significantly higher growth for this foreseeable future. Those confidential design wins are in place. We have silicon in play already coming back to AMD that gives us the basis to execute those plans. We believe that we're on pace to deliver those objectives in the second half of next year.
Okay, great. Thanks a lot. Appreciate the help.
Thanks, JoAnne.
Thank you. Next question in the queue comes from C.J. Muse with Barclays. Please go ahead. Your line is open.
Yeah, good afternoon. Thank you for taking my question. I guess first question, running through the numbers on your new breakeven of $1.3 billion and $450 OpEx, it would appear that your target here gross margin-wise is 35%-36%. Curious, are we seeing a permanent reset on the gross margin side? Or how should we think about that?
Let me answer that. That's not true. We are not giving guidance either, and that's not a statement on either profitability or gross margin. It is really putting in place an expense structure that allows us to break even at the operating income level at $1.3 billion by Q3 2013.
Right, you told us $450 in OpEx, just doing the math suggests 35%-36%. I guess, is there something that we should be thinking about in terms of your agreement with GlobalFoundries, or what's driving that lower run rate?
No, I think what you take away from that is, at the $1.3 billion revenue level, we will have an expense structure at the OpEx level of $450 million.
Okay. Thank you. If I could just quickly follow up, on the gaming side, you talked about impressive wins there. Can you comment on what the margin profile should look like in that business relative to the overall business?
No, we're not going to give that kind of guidance at this time.
Okay, thank you.
Thank you, sir. Next question in the queue comes from the line of Stacy Rasgon with Sanford Bernstein. Please go ahead. Your line is open.
Hi, guys. Thanks for taking my questions. One on the embedded growth. You've got embedded at about 5% today at in the ballpark of $1.3 billion in revenues. You think you'll be to 25% of revenues by Q4 of next year. In Q3 of next year, you expect to be at the same revenue level, about $1.3 billion. I guess it implies two things. One is a pretty big ramp of embedded over that time. Second, it seems like a permanent haircut to your outlook for your own PC and graphics revenue. I just was wondering if you could comment a little bit on, I guess, the long-term outlook for your current business, and the trajectory that you think you have on those embedded wins.
Sure, Stacy Rasgon. We talked about 20% in fourth quarter of 2013. There's no doubt that the PC market trends that are obviously occurring are happening much faster than people had anticipated. I think it's our judgment to make sure that we put in place the structure and the game plan, that break-even point that reflects our understanding of the market as we see it today. That visibility is difficult at this point, and we need to see how Windows 8 rolls out, how we enter into next year. The embedded, that's in terms of this market step down. We do see the PC market as one that will continue to be under pressure for the foreseeable next several quarters. In terms of the embedded and semi-custom space, this is obviously a key area.
It's an area that leverages the graphics and the APUs and allows us to move that technology, which we've invested a huge amount of effort on with the talented engineers across AMD, into an adjacent space that has a better competitive profile for us. Lisa Su, did you want to add anything around the semi-custom or embedded segment?
Yeah, I think to the question of Stacy Rasgon, how long does it take? They really are different segments, whether you're talking about consumer or you're talking about communications and industrials. As Rory Read stated, we're targeting about 20% of our revenue in the second half of 2013, and we'll continue to grow that business as we go forward.
I guess along those lines, though, if you're going to get back to $1.3 billion by Q3, Q4 is obviously pretty bad. Q1 would typically be seasonally down, and Q2, usually not much better. That implies a pretty big, healthy ramp seasonally into Q3 of next year to get there. At the same time, if you're talking about your presence in PCs, your focus on PCs declining and moving toward embedded, what is actually driving that big ramp into the back half of next year to get even back to your break-even revenue?
Well, let me take that question. I think you're taking away from the statement on the break-even plan that we are targeting or guiding you towards a $1.3 billion revenue plan in Q3 2013. That's not true. We have given guidance for Q4. As you heard Rory talk about the challenge in the PC market and some opportunities that we are pursuing. We are not, at this time, giving any guidance on revenue either for Q1 or Q2, and definitely not for Q3 of 2013. What we are talking about is an expense structure whereby at the $1.3 billion revenue level, we have an OpEx structure in place at $450 million. One is an OpEx statement, and the other one is about a revenue statement in terms of what you can do the math on the gross margin.
I don't think the two are directly linked, if you go and make some assumptions about the gross margin, you can draw your own conclusions in terms of either what the revenue levels would be or what the profitability levels would be.
Got it. One last quickly, if I could. In terms of your expense cuts in OpEx to get to $450, how much of that's coming from R&D versus SG&A? Are you holding more of your engineers in place and cutting sales and administrative, or where are those cuts coming from?
After the actions we take in Q4, we're obviously going to continue to assess the situation, but we're not going to give the granularity in terms of where the cuts are coming from. Overall, we're going to continue to assess. We're going to look at areas, in particular with a reduced labor base. There might be some opportunities to do some consolidations at certain sites or facilities. That may trigger some savings, but we're not going to go ahead and give granularity in terms of how much is R&D and SG&A.
Well, just at a gross level, can you give us some feeling for at least is more of it coming from one category versus the other, if you don't want to give any specific numbers?
It's across all functions and globally.
Okay. Thank you, guys.
Thank you, sir. Our next questioner is Joseph Moore with Morgan Stanley. Please go ahead. Your line is open
Great. Thank you. As I've talked to your OEM and ODM customers really throughout the year, it seems like there's a fair amount of enthusiasm for the products. It's also clear that the enthusiasm, there's some reluctance to build product lines around some of the products. Trinity brings some unique capabilities to the market, but with a tough environment and maybe people who had a lot of issues last year, they haven't been as fully committed as maybe I'd like to see. When I talk to IT people about Opteron, there's a lot of excitement around the product, but there's also issues of, is there enough OEM support? There's not a clear line of when they're going to implement Opteron-based servers, even though it's good for a lot of the workloads. My question is, how does that gap get closed?
Is there a risk when you talk about restructuring and financial strains of cutbacks that situation of getting that credibility gets tougher?
I'd like to talk a little bit about both segments. If you look at the client or PC market, we have had actually very strong product success with Trinity, and we continue to believe that we'll see strong ramps as we go into the holiday season into 2013. With Windows 8, we'll see over 125 systems that will come out with AMD-based processors. We do have to continue to build our execution credibility, and all of the focus is on executing both our current products as well as our 2013 products. That is job one from the product side. On the Opteron side, similarly, we continue to build stronger relationships with the OEMs as well as the end customer base. On the product side, I think there is a lot of focus on execution, and we continue to build that momentum with the customer set.
Joe, we're interested to see the customer momentum around Win 8. As I mentioned earlier in the prepared remarks, we have over 125 platforms launching with Win 8 across tablet, ultra-thin, and across all the traditional space. I think that's a good reflection of the interest and the dynamics we have in place.
Okay. Second question to follow up on Stacy's, the cuts that you're making, you don't want to be specific about where they're coming from, and I can understand that. Are there any of the major initiatives that you guys talked about at the analyst meeting and talked about through the year, is everything there still a priority, or are there any activity-based things that you want to take out?
Yeah. From the perspective of what we've done in terms of our business plan and roadmap and technologies, this company is an engineering-based company. There's no doubt about that. Our focus is to create those set of products that allow us to move forward. As I mentioned with Kabini, we already have most of the silicon in-house for our launches for 2013, and we believe that's a strong portfolio and positions us well. We've continued to identify and hire new talent to the corporation to build our engineering and our bench strength across the portfolio.
Great. Thank you very much.
Thank you, Joseph.
Thank you, sir. The next questioner is John Pitzer with Credit Suisse. Please go ahead.
Good afternoon, guys. Thanks for letting me ask the question. I guess, Rory, on the embedded target of going from 5% today to 20% by, I guess, the fourth quarter of next year, can you just help me understand a little bit about the visibility around that? Is that just mostly gaming of some of the rumored wins you guys already have? Or do you think by the time you get to 20%, you're broad-based among many end markets? Or is it concentrated? If you could help me there, that'd be helpful.
John, I think Lisa will go into this in a little bit of detail, but the main point here is this is a segment, it's an area that we can leverage our IP and the APU and the graphics prowess that we have. This is important because this segment will grow faster. It's also got a better competitive framework, and we have the design wins in place, on pace to deliver that objective in 4Q. We've got to continue to execute and continue to build that market. We're not done there. We need to continue to grow that segment as we move forward. Lisa, some additional thoughts?
John, I think, to your question of do we have good visibility into what needs to happen to ramp those design wins, I think the answer is yes. I think there's execution to be done on our side, but we have good visibility. Our goal is to broaden into more end markets, some of the other markets take a little bit longer in terms of developing. We are creating vertical industry teams to attack some of those other verticals as well.
Great. You guys did a good job explaining the GlobalFoundries payments through the balance of this year. As we think about next year, if I remember correctly, if nothing happens, the contract reverts back to cost plus? Can you help me understand the GlobalFoundries relationships beyond the calendar fourth quarter?
From a GlobalFoundries perspective, John, we've seen an improving relationship and partnership with this key partner across 2012. We've also seen an improving environment around their execution, and we appreciate that. As we've talked about previously, we're in ongoing discussions around the WSA, both for 2012 and 2013. Devinder?
Yes. I can add, I've been involved, as you might know, with the WSA discussions for several years now, having worked on the deal from the inception when we formed GlobalFoundries in 2009. We continue to discuss with our partners. Many times, as you have seen over the last couple of years, we have worked through some difficult situations in the spirit of partnership, but also what is mutually beneficial for both companies. The 2013 take-up WSA, as well as the 20-
2012 WSA, as well as the 2013 WSA discussions are ongoing. We continue those discussions. They're not yet complete, but from my standpoint, they're going very well.
Great. Thanks, guys.
Thank you, sir. Our next question in our queue comes from the line of Christopher Danely with JP Morgan. Please go ahead.
Hey, thanks, guys. Are there any plans to sell the written-down inventory?
When you go ahead and take inventory write-down from an overall standpoint, accounting-wise, what happens is, we have a product transition from Llano to Trinity. Trinity, as you heard Rory say, up 70% quarter-on-quarter, doing well. With the market conditions, from an accounting standpoint, you also evaluate the inventory against the future demand and in particular, customer commitments. We did that in the early part of this quarter after Q3 ended, and we took the incremental inventory write-down. Typically, in these situations, it's not a plan to go ahead and sell that inventory.
Oh, okay, great. Then if you could just follow up on how you think gross margins can trend, and can you get back to the 45% mark you hit a few quarters ago?
We're not giving guidance at that level, but I can tell you from a Q4 standpoint at least, especially given the market conditions, there are some factors that could be positive or negative, right? You have a weak macro environment. We are in a consumer-based holiday season quarter. Then there is some low-end competition from an overall standpoint, obviously those are negative factors. The Trinity product being accretive to the margin especially with a higher mix of the product, in Q4 is going to be helpful. Then the other thing is the Win 8 launch. Beyond that, given especially the uncertainty, we are focused on our break-even model, as I discussed earlier, $1.3 billion at the $450 million OpEx number and not looking at it from a gross margin standpoint.
I can add that, just to explain that further, if you take the $1.3 billion and the $450 million, if revenue is higher, obviously we could do better than break even. If gross margin is higher, we could do better than break even, better than the 35% that was computed earlier. Then if both are higher, we could go ahead and be better than break even. We are prepared, in particular with the trending that's occurring, to assess the situation, work specifically on the cost structure, especially with the uncertainty that's out there, we want to stay nimble and be prepared to react as the case might be. This is not a guidance for Q3 2013 revenue. It is not a guidance for Q3 2013 gross margin.
It is just an expense statement as to how we're going to drive the expenses from where we are today to the $450 million by Q3 of next year.
Just to be clear, are you not telling us where your gross margins can go because you don't think they can get to 45%, or you just don't want to tell us?
I'm just not saying anything at this point.
Got it. Just for my last question, a quick clarification, I believe, on John's question on the embedded opportunity. Is it safe to say that, by the end of next year, most of that revenue will be coming from the gaming industry, or what about between the comm and the industrial side?
There's no doubt that this is a set of confidential wins, and we can't get into any of those specifics. We're clearly targeting industrial communications, gaming, those areas where the APUs and our graphics IP make the most sense. We can't announce them. We'll announce them in due course, over the course of the coming quarters.
Fair enough. Thanks, guys.
Thank you. Our next question in our queue comes from the line of Mark Lipacis with Jefferies. Please go ahead. Your line is open.
Thanks for taking my question. My question is, in Q2, my understanding of the original miss in Q2 was driven in large part because you had supply issues, you shorted the channel in favor of the OEMs, and you lost traction with the channel because of that. I guess my question is, where do you think you are in winning back the channel? What do you have to do to win them back, and where do you think you are in that process? Thank you.
Sure, Mark. We saw the channel stabilize in the third quarter, at the 2Q levels, and we also began to work down the inventory that we discussed in that period. We saw an improvement in sales out velocity. That means the rate of sell-through through the channel. We're going to continue to work on improving that sell-through rate and reducing that inventory in the coming quarters. As we mentioned last quarter, that was a multi-quarter effort to go forward. The progress and the stabilization of the channel in 3Q was a good step forward.
Thank you.
Thank you, sir. Next question in queue comes from the line of Kevin Cassidy with Stifel Nicolaus. Please go ahead. Your line is open.
Hello, this is Dean Grumlose calling in for Kevin. It seems that when you look at the PC industry lately, there's a number of moving parts of potential share erosion to tablets and smartphones, Windows 8, and a general macro decline. As you have talked to your customers around the world, could you please expand your views on how you may allocate share, if you will, or blame amongst these various factors to what makes up the current declining situation?
There's no doubt, Dean, that we're seeing three significant factors, as we mentioned in our earlier remarks, that are affecting the overall PC industry. These trends are definitely occurring at a faster rate than the industry had anticipated. You're right to note that the macro environment is soft, and it's different across different geographies, and that weakness is likely to continue for the foreseeable future. We also saw OEMs in the market take a rather conservative approach to inventory in the lead up to Windows 8. This will be an interesting fourth quarter in terms of how Windows 8 moves forward. We think it's an interesting and important event, but this is one we need to see play out.
Clearly, tablets have taken an important point in the consumer's mindset, both in the experience that the tablet creates, but also becoming an interesting device of choice at that lower end of the consumer client space. I think all three of these factors have accelerated this fundamental shift in the PC market, and we expect this shift and these pressures to continue for the next several quarters.
When you look at the impact of smartphones and tablets, do you think this is temporary and can be reset by perhaps some more compelling portable solutions? Do you think this is a permanent shift in demand, particularly in the mature developed economies?
A statement like that is clearly hard to predict out in time. I do believe the PC market is a market that will be here for the next decade. I don't think there's any question about that. The dynamics of it and its growth rates are really fundamentally shifting right now. A lot of the historical forecast and trend lines have broken over the past two quarters, and we need to see this reset stabilize and move forward. I think what's most important is to innovate, to continue to create solutions that match the customers and the commercial market's needs. All-day battery life, touch, the right kinds of experiences with the graphical capabilities that we deliver are all important in this segment. I think that's key.
At the same time, while this is somewhat unpredictable, let's take our outstanding IP and engineering resources and focus those on areas we know will continue to grow and grow faster than a legacy PC market. That's core to our strategy moving forward, and we need to accelerate that strategy based on these shifting trends.
Thank you very much. Very helpful.
Thank you, sir. Next question in queue comes from the line of Tristan Gerra, Robert W. Baird. Please go ahead. Your line is open.
Thank you. Thanks for getting me in. Rory, thanks for the details. Been very helpful. Maybe I ask for a couple more. You've given this target of 40%-50% of revenue from IP differential products. Can you maybe talk about a timeline? I think Lisa said some of the new products probably wouldn't really be impactful until 2014. Is that correct? Can you draw a path between here and there?
No, I think we've laid out the basic concepts here across the call. Clearly, in the tactical timeframe, continue to build on the semi-custom embedded market. This is a good opportunity. It's where our IP and APUs play well. It's near adjacent segment, so it's easy to move there. I like the competitive market there much better than the PC market, which is dominated by a single player in a big way. I think also as we move forward, there's opportunities in dense serving. That market will continue to evolve as low power and cloud serving becomes even more prevalent. This will be the fastest-growing segment going forward, and I think the SeaMicro acquisition and the work Lisa and her team are doing to build that out will occur over the next one, two, three years.
At the same time, how do we take our deep engineering capability into the new low-power, ultra-portable, emerging form factors in the traditional client space? This is an opportunity that is already presenting itself with our next generation APU called Kabini, replacing our highly successful Brazos. We'll follow that on with a series of other solutions. Lisa, would you like to add anything more?
Yeah, I think the best way to describe it is it's a portfolio that we're managing. We've talked about semi-custom and embedded, having good visibility towards the end of 2013, and then as we get into some of the dense serving spaces beyond that, because it takes a little bit longer in those markets. We're trying to build a portfolio to really enhance the growth prospects of our business.
Lisa, on the microserver side, it's pretty nascent for you and for everyone from an ecosystem standpoint. I guess, what are the hurdles? What are the, I guess, some of the marks that you need to hit or that the industry needs to hit to get through to make this more of a mainstream product?
We continue to work with our differentiated IP base. The SeaMicro acquisition has been helpful in terms of our work with the large data center customers, and then we continue to need to build out the ecosystem to really build broad-based support. I think it's a several-year journey, but it's certainly one that we're very committed to and continue to build out all the aspects of the ecosystem.
I guess, Lisa, more specifically on that ecosystem, are there certain elements that need to be knocked over first that could start to see adoption, knowing it's going to take several years to get it fully built out? Are there certain hurdles that need to be met in the near term?
Certainly there are, and they come with both the hardware and the software ecosystem as well as the ODM ecosystem. All of those are aspects that we are working on.
Lastly, on the pricing side, Intel was pretty adamant that they were actually seeing some stability in pricing, which doesn't really seem to make a lot of sense given the backdrop. Rory, I think you were pretty adamant that pricing has been competitive. What would you expect given what you're looking at the backdrop?
As we talked about several times on the call, the market dynamics that are occurring now are going to continue. Those macroeconomic factors, the Windows 8 launch, as well as the tablet phenomena, will continue to impact the PC market. I expect the market to be competitive, and I expect the market to continue to fall under pressure for the foreseeable future, the next several quarters.
Okay. Thanks, guys. Good luck.
Thank you, sir. Our next question in queue comes from the line of Chris Caso with Susquehanna. Please go ahead.
Yes, thank you. Just returning to some of the discussion about the break-even point, understand you're not providing revenue guidance going forward. Could you talk perhaps in principle, and given the uncertainty in revenue and some of the strategic changes that need to be made, what further actions can you take or perhaps are contemplating to protect cash flow and prevent from going into a money-losing situation if the transformation takes longer than what you expect?
Actually, we are very focused on the free cash flow breakeven and actually trying to get back to positive free cash flow. The restructuring actions that were announced today in the call will help. The OpEx reduction on a go-forward standpoint will help. I also referenced earlier about the continuing discussions of the WSA related to the 2012 take or pay and the 2013 WSA discussions that are ongoing, and that will obviously have an impact on the free cash flow on a go-forward standpoint. We are laser-focused on getting to free cash flow breakeven at lower revenue levels, but we're not giving guidance from a standpoint of the revenue on a go-forward basis, except for the Q4 guidance that we have given.
As a follow-up to that, is there anything you could say about cash flow over the next several quarters? Should we expect cash flow to still come down as the cost cuts are being implemented? Or what's your view there?
I think related to the restructuring actions, with the savings that we will have on a quarterly basis and for the year in 2013, for sure the cash needs will come down, and therefore, that will help the cash flow. On the guidance for 2013, we're not prepared to talk about it right now because a lot of open items that we need to go through, in particular, as I talked about the WSA discussions that are going on. It's really too early to tell. Once we sort through those things and we look at where things fall, both from an expense standpoint and the WSA and the reduced cost structure, we can come back and give the guidance from a free cash flow standpoint on a go-forward standpoint.
Okay, thank you.
Thank you, sir. Next question in queue comes from the line of Jim Covello. Please go ahead. Your line is open.
Great. I was just hoping to go back to the, a little bit of a follow-up from some of the other questions about pricing. I guess, what kind of pricing environment are you assuming in the restructuring actions that you're taking? Both for yourself, in other words, how much leeway are you leaving yourself for your prices to come down and still hit these targets? What are you assuming in the way of pricing and aggression from Intel in that regard as well?
I believe as we've talked about several times on the call, Jim, we believe it'll be a competitive pricing market, not unlike what we've seen over the past several quarters. What we're doing is basically restructuring our cost structure to position us for break even at a lower revenue level. We'll continue to assess that as we move through the next several quarters and make the appropriate adjustments.
I had heard you said that before on the call, I guess maybe with some granularity. The pricing the last couple of years has been abnormally high, there's two ways to think about what's gone on the last couple of quarters. It's sort of the beginning of a resumption of a trend that would put us back on a trend line of lower pricing, that was the new normal, the better pricing, what we're seeing these last couple of quarters is just sort of temporary. Which one of those do you think is the case as you begin to think about these restructuring actions?
Yeah. As we've talked about earlier, I think what's clear is the market trends that are driving the PC market right now have accelerated faster than we expected and clearly affected the trend lines and forecasting. Visibility is difficult right now, and I think, Jim, what we have to do is look at how each of the next several quarters unfold. There's clearly pressure in the market, and there will be competition.
Thank you.
Thank you. Our next question in queue comes from the line of Patrick Wang with Evercore. Please go ahead.
Great, thanks. Two quick ones and then a longer one. The first of all, just a quick clarification, can you help us understand which buckets are being defocused in your actions right now?
Patrick, from a standpoint is what we're trying to do with the restructuring efforts is to reduce and simplify our development cycles and development processes across our portfolio, as well as simplify our global structure. I think that's clear in terms of the focus we have in terms of reusable IP, how we're going to use the system, the Heterogeneous Systems Architecture. All of those strategies that we've talked about are reducing our complexity and shortening the development cycles, and we have to push for more efficiency on that. That's the basis of what we're trying to accomplish.
Okay, there aren't any particular product lines or anything that was ongoing that's getting killed or canceled?
Nope, we're not changing anything on that activity at this point.
Okay. Just a second quick one, Devinder. Just some clarification on the wafer supply agreement. Can you disclose or walk us through what's left of your commitments for the fourth quarter? I think you guys had disclosed $700 million or so for the second half of the year.
The way I frame that is for 2012, we had a take-or-pay agreement for a certain number of wafers, and what we disclosed is the total cost of that will be $1.5 billion. We have paid approximately $1 billion of that, so half a billion dollars remain. The question is the time period at which we take those wafers, which is the basis of the discussions we continue to have with our partners. I think you have to look at it in terms of the remaining 2012 take-or-pay, there's half a billion dollars left, and what timeframe are the wafers going to be taken, and what timeframe the cash is going to go out, if that's what you're asking. The second thing we are discussing, as we typically do on a yearly basis, is go ahead and discuss the 2013 WSA.
Both of them taken together is what we're trying to get to a conclusion to with our partners at GlobalFoundries.
Okay, got it. Just last question, I guess, Rory or Lisa, can you talk about the competition in this newfound embedded space and maybe perhaps where you feel your key advantage is with system on chip? Thank you.
Yeah, let me take that. I think the key differentiation we have is really in the high-performance design methodology, the microprocessor technology, as well as the graphics IP that we have. We're really going after high-volume opportunities that can really use this IP in adjacent markets. I think it's a very unique capability that doesn't exist in many other places, and we really need to continue to build that model out over the next few years.
Okay. Can you also quickly just mention a couple of the key competitors that are currently in that space today?
I think you're familiar with many of our competition. I think our ability to be flexible and really put a semi-custom approach in place is something that's unique to our capability.
Okay. I'll go do some homework. Thanks so much.
Thank you. Next question in queue comes from the line of Vivek Arya with Bank of America. Please go ahead, your line is now open.
Thanks for taking my question. I'm wondering how we should think about CapEx for next year. I think, Devinder, you did describe how you expect to break even on an operating basis, but how do you break even on a cash flow basis? What are your CapEx plans?
I think it's really too early to get into 2013 at this point. I think most likely, if you come back in about a quarter at the call that we have for the Q4 results, we could probably give you some visibility into the early part of 2013, then give you the guidance from that standpoint.
Right. Maybe Rory, one for you. What's going on on the discrete graphics side? NVIDIA has had a strong product with their Kepler architecture for a few quarters. Is that a segment you think would be de-emphasized going forward, or is that still a priority business for you?
As I mentioned in my earlier remarks, Vivek, that business performed in line with our expectations for the quarter, the graphics business remains a cornerstone for our technology portfolio across AMD. I think Lisa probably is the best person to take that question.
Yeah, let me give you some color around the graphics business. The graphics business is actually a fairly stable portion of our portfolio. We continue to believe it's one of our key differentiators. In the third quarter, we had the macro effects that affected the PC industry that also affected graphics. We actually grew quarter-to-quarter in the discrete AIB channel. I think we believe that our products are quite competitive, we'll continue to invest in the graphics area to ensure that competitiveness.
Got it. One last one, Rory. In case things stay soft in the PCA next year, is there a plan B? Are there other partnership or M&A arrangements that you can pursue or you can think about? Because I think that's really the focus of a lot of these questions on the call, because the PC market is slowing substantially, and you have a very large competitor with very significant competitive advantages. Beyond just breaking even, how do you position AMD and how do you reward shareholders going forward?
Vivek, I think it's around what we talked about. There's two steps that we need to take here. One, restructure and reset AMD, reduce our cost structure, and improve our efficiency by lowering our break-even point on lower revenue. As we've talked about several times in the call, we'll continue to assess that as the market unfolds. Second, take our IP and our differentiation in graphics and across our engineering portfolio and take them to the high-growth segments. We talked about driving, over the next several years, 40%-50% of our portfolio on those growth segments. We had planned this strategy.
What we've seen now with the trends accelerating, that we need to move in a more aggressive path to tackle that now, both in the high-growth, ultra-low power new clients, that dense server space, and of course in the embedded semi-custom space, all around the capabilities and IP that we have in AMD.
Great. Thank you.
Operator, we'll take two more questions, please.
Sure thing. Next question in queue comes from the line of Steven Um with UBS. Please go ahead.
Yes, thank you. I have a couple questions for Lisa. First question, I'm trying to understand this reusable IP strategy. When I think about what that means from a P&L point of view, I just think of it as a shift of OpEx into COGS because if you're going to cut staff, you're going to have compromises in terms of the IP blocks you can develop, and as a result, you're going to have some give up some die size, especially as you try to recover for some of the lost performance for those compromises that you're making. Can you help me understand if I'm thinking about that correctly or if I'm missing something?
Yeah. Let me describe it this way. I think what we mean by reusable IP is really getting to a much more system-on-chip infrastructure so that we're able to spin products faster as well as customize them for the various markets. I wouldn't see it as a shift from R&D to COGS, but more as building a foundation so that we can move quickly into new markets as they develop. That's a very key thing for us. We still will invest very heavily in our differentiating IP, such as the graphics IP that we talked about, as well as our microprocessor IP. That part doesn't change.
Okay. As a second question here, just thinking more philosophically about your APU strategy, and you have differentiating graphics, yet when look at the third-party market research data, you're not getting paid for it, at least when we look at what was done with Llano. I'm trying to understand if there's something we're missing in terms of maybe you are starting to get some of that uplift on Trinity and you'll get more with Kaveri, or is there perhaps a basis for rethinking your strategy and focusing, instead of higher performance GPUs on smaller die sizes that could get your gross margin back to the mid to upper 40s where it's been your goal?
Yeah, I think the question around the APUs is a good one. We are very clear that the APU strategy is the right strategy for us. Now, in terms of ensuring that we get the value for it's not just the piece of silicon, but it's also what we can do in the solutions environment. We have been doing a lot of work to ensure that the applications can take advantage of all of the compute that we have on the silicon. You can see that with some of the moves that we've made with the Heterogeneous Systems Architecture, creating industry consortium around the heterogeneous compute, and we've had a number of new members. We talked about Qualcomm and Samsung joining, as well as Arm and Imagination.
I think it's evolution over time, but it's clear that the APU strategy is the right strategy and we need to get more of the applications taking advantage of the APUs over time.
Just as a final follow-up, when do you think that will show up in the average selling price data?
We continue to work on the APU evolution over time.
Okay, thank you.
Thank you. Our final questioner for today comes from the line of Craig Berger with FBR. Please go ahead.
Hey, guys. Thanks for taking my question. Just in looking at your core business, do you have any idea where end consumption is relative to what your fourth quarter guidance is? Is there channel inventory declines baked in? Where's a bottom for this business as you're down 35% year-over-year?
Yeah, Craig, from a standpoint, as I commented earlier on the channel business, we've seen that business stabilize in Q2 and Q3 at the levels that we saw there. That is also continuing to work off that inventory that I talked about in the previous earnings call that was down channel from a sellout perspective, and we're going to continue to work that. I think we're making good progress there. In the overall PC market, there's no doubt that these trends have occurred.
They've accelerated. We believe they will affect the market for the next several quarters for the foreseeable future. We're taking clear and decisive action to restructure our business, lower our cost structure to enable us to hit break-even at a lower revenue base, which we think is prudent given the market trend.
Just as a follow-up on the gross margins, I guess we should be assuming that they continue to move lower from the normalized non-inventory write-down level that you printed in Q3. Is there a reason for the decreased transparency?
We're just not giving guidance for gross margin at this point. The market environment, as you observed and many have observed, is uncertain.
Okay, thank you. Good luck.
Operator, thank you. That concludes the call.
Thank you. Again, ladies and gentlemen, this does conclude today's conference. Thank you for your participation and have a wonderful day. Attendees, you may disconnect at this time.