3 Things to Know About AMD

Advanced Micro Devices (NASDAQ: AMD) failed to impress Wall Street in late October despite posting strong third-quarter results and a decent outlook, with revenue jumping 25% year over year and net income skyrocketing to $110 million from last year's $27 million. AMD shares plunged 13% the day after the results came out as the company didn't provide much clarity about future sales.

The company skipped providing details about a recently closed patent licensing deal, keeping investors in the dark about how much it is contributing to its revenue and earnings. This sparked speculation that AMD's new chips aren't selling as well as expected, and it might have missed estimates if there was no licensing deal in place.

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But there was enough in AMD's latest earnings report to indicate that the company is progressing in the right direction to enhance its revenue and earnings in the long run. Let's take a closer look at the three important points made by management.

AMD is moving closer to sustained profitability

AMD posted GAAP net income of $71 million during the third quarter as compared to a massive loss of $406 million in the prior-year period. This was the chipmaker's first profitable quarter in three years (barring the second quarter of 2016 when asset sales inflated earnings), and was driven by the company's strategy of targeting the high-end PC market.

More specifically, high-end GPUs account for less than15% of sales, but they bring in 66% of the margins. On the other hand, server processors present another potentially fertile ground for AMD as chips in this space sell for a premium.

The average selling price (ASP) of AMD's processors rose last quarter thanks to the introduction of Ryzen CPUs (central processing units). Similarly, the newly introduced Vega line-up led to a "significant" increase in graphics processing unit (GPU) ASP.

The higher ASP helped AMD increase its non-GAAP gross margin by 4 percentage points from the year-ago quarter to 35%. Furthermore, the company's operating margin shot up to 9.4% last quarter from just 5.3% in the year-ago period despite an 18% jump in operating expenses. Therefore, AMD's new product line-up is helping it make a dent in high-end chips and pushing the company closer toward sustained profitability.

The data center business is set to get better

AMD launched the EPYC server chip with much fanfare earlier this year to challenge Intel's dominance in this space, and it looks like the company is making good progress.

"In a short period, three of the Super 7 mega data center providers have publicly announced plans to deploy EPYC-based products into their Hyperscale environments, including Baidu, Microsoft Azure and Tencent," according to CEO Lisa Su. The CEO went on to add that "HP Enterprise and Dell are in the process of bringing their first EPYC-based platforms to market in Q4."

And AMD's chips have been chosen by five of the biggest data center and cloud service providers. This includes cloud computing leader Amazon, which recently decided to move away from NVIDIA by using AMD's FirePro server GPUs for the AppStream 2.0 service. Therefore, AMD's datacenter business looks set to get better thanks to its recent design wins in both server CPUs and GPUs.

AMD's improving traction in the data center business should eventually help it boost its enterprise, embedded, and semi-custom business that struggled last quarter. Revenue from this segment was flat year over year, but operating income nosedived 38% as sales of semi-custom processors to console manufacturers Sony and Microsoft took a hit due to seasonality.

Looking ahead, semi-custom chip sales are expected to continue struggling in the fourth quarter, but the launch of EPYC datacenter platforms by HP and Dell could help AMD offset some of that weakness.

The computing and graphics business has new catalysts

AMD's computing and graphics revenue surged 74% year-over-year last quarter, and investors can expect its terrific momentum to continue thanks to a couple of new catalysts. First, AMD has now started shipping its Ryzen CPUs for the notebook market. It expects to have a full-fledged Ryzen-based notebook lineup on the market by the first quarter of 2018.

This puts AMD in a strong position to benefit from the laptop market's growth, where shipments are expected to jump more than 8% over the next two years.

Second, AMD's Vega GPUs can get a lift from blockchain applications. Blockchain is a distributed database that holds information across several locations. This makes it difficult for hackers to breach the database as they would have to corrupt millions of computers at a go.

GPUs are expected to play a key role in this technology, as a blockchain system can buy spare computing power from a large number of users to power the platform, instead of buying all the hardware from just one source. This could boost GPU sales as users would want to boost their computing power so they could sell surplus power to the blockchain provider.

The blockchain market is expected to grow at an annual rate of over 61% until 2021. It is expected to hit a size of over $2.3 billion thanks to its growing application in various verticals such as financial services, banking, and retail.

The Foolish bottom line

AMD's execution has remained top notch as the improving traction of its new products shows, and this has given a substantial boost to its revenue and earnings. The company doesn't have any shortage of long-term catalysts, so it could keep growing its business in a profitable manner by selling higher-margin products.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and Baidu. The Motley Fool has a disclosure policy.