Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the consolidated financial statements as of December 28, 2019 and December 29, 2018 and for each of the three years in the period ended December 28, 2019 and related notes, which are included in this Annual Report on Form 10-K as well as with the other sections of this Annual Report on Form 10-K, including “Part I, Item 1: Business,” “Part II, Item 6: Selected Financial Data” and “Part II, Item 8: Financial Statements and Supplementary Data.”

Introduction

In this section, we will describe the general financial condition and the results of operations of Advanced Micro Devices, Inc. and its wholly-owned subsidiaries (collectively, “us,” “our” or “AMD”), including a discussion of our results of operations for 2019 compared to 2018, an analysis of changes in our financial condition and a discussion of our contractual obligations and off-balance sheet arrangements. Discussions of 2017 items and year-to-year comparisons between 2018 and 2017 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 29, 2018.

Overview

2019 marked a milestone in our multi-year journey with the launch of our 7 nanometer (nm) product portfolio. We executed our product roadmap and introduced a number of high-performance products in 2019. For the PC market, we introduced the 3rd Gen AMD Ryzen™ desktop processor family based on the new Zen 2 core architecture with AMD chiplet design approach. In addition to our mainstream PC product family, we introduced the next generation of the Ryzen™ Threadripper™ product line designed for the high-end desktop segment for creators and enthusiasts. We announced our second-generation AMD Ryzen™ 3000 Series notebook processors, powering ultrathin, commercial and gaming notebooks.

A number of high-performance graphics products were also launched in 2019. We introduced the AMD Radeon™ VII, a premium graphics card for gamers, creators and enthusiasts. We also announced the availability of the AMD Radeon™ RX 5700-series gaming graphics card family, the AMD Radeon™ RX 5500 series that will be available in desktop PCs from major PC manufacturers as well as the Radeon™ 5500M GPU for notebook PCs. Our AMD Radeon™ Pro Vega II GPU is designed to power demanding professional applications. We also announced the AMD Radeon™ Pro W5700, a 7nm professional PC workstation graphics card that enables 3D professionals to visualize and interact with their designs in real time.

For the server market, we introduced the 2nd Gen AMD EPYC™ family of processors that feature up to 64 “Zen 2” cores in 7nm process technology for performance and are designed to reduce total cost of ownership (TOC) by up to 50%.

Net revenue for 2019 was $6.7 billion, an increase of 4% compared to 2018 net revenue of $6.5 billion. Gross margin, as a percentage of net revenue for 2019, was 43%, compared to 38% in 2018. Our operating income for 2019 improved to $631 million compared to operating income of $451 million for 2018. Our net income for 2019 improved to $341 million compared to $337 million in the prior year.

Cash, cash equivalents and marketable securities as of December 28, 2019 were $1.5 billion, up from $1.2 billion at the end of 2018. We made significant progress towards improving our balance sheet in 2019 as we reduced our debt. Principal amount of total debt as of December 28, 2019 was $563 million, compared to $1.5 billion as of December 29, 2018.

We intend the discussion of our financial condition and results of operations that follows to provide information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from period to period, the primary factors that resulted in those changes, and how certain accounting principles, policies and estimates affect our financial statements.

Critical Accounting Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP). The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts in our consolidated financial statements. We evaluate our estimates on an on-going basis, including those related to our revenue, inventories, goodwill impairments and income taxes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Although actual results have historically been reasonably consistent with management’s expectations, the actual results may differ from these estimates or our estimates may be affected by different assumptions or conditions.

Management believes the following critical accounting estimates are the most significant to the presentation of our financial statements and require the most difficult, subjective and complex judgments.

Revenue recognition. We recognize revenue upon the shipment of the product to our distributors (sell-in), rather than upon the resale of the product by our distributors to their customers (sell-through). Accordingly, we have established provisions for rights of return and price protection on unsold product held by our distributors.

Revenue Allowances. We record a provision for estimated sales returns and allowances on product sales for estimated future price reductions and other customer incentives in the same period that the related revenues are recorded. We base these estimates on actual historical sales returns, historical allowances, historical price reductions, market activity and other known or anticipated trends and factors. These estimates are subject to management’s judgment and actual provisions could be different from our estimates and current provisions, resulting in future adjustments to our revenue and operating results.

Inventory Valuation. At each balance sheet date, we evaluate our ending inventories for excess quantities and obsolescence based on projected sales outlook. This evaluation includes analysis of historical sales levels by product and projections of future demand. These projections assist us in determining the carrying value of our inventory. In addition, we write off inventories that we consider obsolete. We adjust the remaining specific inventory balances to approximate the lower of our actual cost or estimated net realizable value. Among other factors, management considers recent historical activity as well as anticipated or forecasted demand, estimates of future selling prices, competitiveness of product offerings, market and industry conditions, customer requirements and product life cycles when determining excess, obsolescence and net realizable value in relation to the inventory on hand. If in any period we anticipate future demand or market conditions to be less favorable than our previous estimates, additional inventory write-downs may be required and would be reflected in cost of sales in the period the revision is made. This would have a negative impact on our gross margin in that period. If in any period we are able to sell inventories that were not valued or that had been written down in a previous period, related revenues would be recorded without any offsetting charge to cost of sales resulting in a net benefit to our gross margin in that period.

Goodwill. We perform our goodwill impairment analysis as of the first day of the fourth quarter of each year and, if certain events or circumstances indicate that an impairment loss may have been incurred, on a more frequent basis. The analysis may include both qualitative and quantitative factors to assess the likelihood of an impairment.

Qualitative factors include industry and market consideration, overall financial performance, share price trends and market capitalization and Company-specific events. We first analyze qualitative factors. If we conclude it is more likely than not that the fair value of a reporting unit exceeds its carrying amount, we do not proceed to perform a quantitative impairment test.

If we conclude it is more likely than not that the fair value of the reporting unit is less than its carrying value, a quantitative goodwill impairment test will be performed by comparing the fair value of each reporting unit to its carrying value. A quantitative impairment analysis, if necessary, considers the income approach, which requires estimates of the present value of expected future cash flows to determine a reporting unit’s fair value. Significant estimates include revenue growth rates and operating margins used to calculate projected future cash flows, discount rates, and future economic and market conditions.

A goodwill impairment charge is recognized for the amount by which the reporting unit’s fair value is less than its carrying value. Any loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.

Income Taxes. In determining taxable income for financial statement reporting purposes, we must make certain estimates and judgments. These estimates and judgments are applied in the calculation of certain tax liabilities and in the determination of the recoverability of deferred tax assets which arise from temporary differences between the recognition of assets and liabilities for tax and financial statement reporting purposes.

We must assess the likelihood that we will be able to recover our deferred tax assets. Unless recovery is considered more-likely-than-not (a probability level of more than 50%), we will record a charge to income tax expense in the form of a valuation allowance for the deferred tax assets that we estimate will not ultimately be recoverable or maintain the valuation allowance recorded in prior periods. In determining the need to establish or maintain a valuation allowance, we consider multiple factors including past performance, the reversal of deferred tax liabilities, tax planning strategies, and future expected taxable income. When considering all available evidence, if it is determined we can more-likely-than-not realize our deferred tax assets, we will reverse the existing valuation allowance, which would result in a credit to income tax expense and the establishment of an asset in the period of reversal.

In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax rules and the potential for future adjustment of our uncertain tax positions by the Internal Revenue Service or other taxing authorities. If our estimates of these taxes are greater or less than actual results, an additional tax benefit or charge will result. We recognize the interest and penalties related to unrecognized tax benefits as interest expense and income tax expense, respectively.

Results of Operations

We report our financial performance based on the following two reportable segments: the Computing and Graphics segment and the Enterprise, Embedded and Semi-Custom segment.

Additional information on our reportable segments is contained in Note 15: Segment Reporting of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).

Our operating results tend to vary seasonally. Historically, our net revenue has been generally higher in the second half of the year than in the first half of the year, although market conditions and product transitions could impact these trends.

The following table provides a summary of net revenue and operating income (loss) by segment for 2019, 2018 and 2017.

	2019				2018				2017
	(In millions)
Net revenue:
Computing and Graphics	$	4,709			$	4,125			$	2,977
Enterprise, Embedded and Semi-Custom	2,022				2,350				2,276
Total net revenue	$	6,731			$	6,475			$	5,253
Operating income (loss):
Computing and Graphics	$	577			$	470			$	92
Enterprise, Embedded and Semi-Custom	263				163				132
All Other	(209		)		(182		)		(97		)
Total operating income	$	631			$	451			$	127

Computing and Graphics

Computing and Graphics net revenue of $4.7 billion in 2019 increased by 14%, compared to $4.1 billion in 2018, primarily as a result of a 22% increase in average selling price and a 4% increase in unit shipments. The increase in average selling price was primarily driven by a richer mix of client processors due to strong demand of our Ryzen processors. The increase in unit shipments was primarily due to higher demand for our Ryzen processors, partially offset by lower demand for our Radeon graphics products.

Computing and Graphics operating income was $577 million in 2019 compared to operating income of $470 million in 2018. The increase in operating income was primarily driven by higher sales, partially offset by a $194 million increase in operating expenses. Operating expenses increased for the reasons outlined under “Expenses” below.

Enterprise, Embedded and Semi-Custom

Enterprise, Embedded and Semi-Custom net revenue of $2.0 billion in 2019 decreased by 14% compared to net revenue of $2.4 billion in 2018, primarily as a result of lower semi-custom product revenue, partially offset by higher sales of our EPYC server processors.

Enterprise, Embedded and Semi-Custom operating income was $263 million in 2019 compared to operating income of $163 million in 2018. The increase in operating income was due primarily to higher sales of our EPYC server processor and a licensing

gain of $60 million recognized in the first quarter of 2019, partially offset by lower semi-custom product revenue and a $37 million increase in operating expenses. Operating expenses increased for the reasons outlined under “Expenses” below.

All Other

All Other operating loss of $209 million in 2019 included $197 million of stock-based compensation expense and a $12 million contingent loss accrual on a legal matter.

All Other operating loss of $182 million in 2018 included $137 million of stock-based compensation expense and an impairment of technology licenses of $45 million.

Comparison of Gross Margin, Expenses, Licensing Gain, Interest Expense, Other Expense and Income Taxes

The following is a summary of certain consolidated statement of operations data for 2019, 2018 and 2017:

	2019				2018				2017
	(In millions, except for percentages)
Cost of sales	$	3,863			$	4,028			$	3,466
Gross profit	2,868				2,447				1,787
Gross margin percentage	43		%		38		%		34		%
Research and development	1,547				1,434				1,196
Marketing, general and administrative	750				562				516
Licensing gain	(60		)		—				(52		)
Interest expense	(94		)		(121		)		(126		)
Other expense, net	(165		)		—				(9		)
Provision for (benefit from) income taxes	31				(9		)		18

Gross Margin

Gross margin as a percentage of net revenue was 43% in 2019 compared to 38% in 2018. The improvement in gross margin was primarily driven by higher sales of Ryzen and EPYC processors, which have a higher gross margin than the corporate average.

Expenses

Research and Development Expenses

Research and development expenses of $1.5 billion in 2019 increased by $113 million, or 8%, compared to $1.4 billion in 2018. The increase was primarily due to an increase in product development costs in both the Computing and Graphics and Enterprise, Embedded and Semi-Custom segments as well as an increase in stock-based compensation expense.

Marketing, General and Administrative Expenses

Marketing, general and administrative expenses of $750 million in 2019 increased by $188 million, or 33%, compared to $562 million in 2018. The increase was primarily due to an increase in go-to-market activities in both the Computing and Graphics and Enterprise, Embedded and Semi-Custom segments, as well as an increase in stock-based compensation expense.

Licensing Gain

During 2019, we recognized $60 million as licensing gain associated with the licensed IP to THATIC JV. See Note 4 of “Notes to Consolidated Financial Statements” for additional information.

Interest Expense

Interest expense of $94 million in 2019 decreased by $27 million compared to $121 million in 2018, primarily due to lower debt balances.

Other Expense, Net

Other expense, net increased in 2019 by $165 million from net of zero in 2018. The change from 2018 to 2019 was primarily due to $176 million of loss on redemption, repurchases and conversions of debt in 2019.

Provision For (Benefit From) Income Taxes

We recorded an income tax provision of $31 million in 2019 and income tax benefit of $9 million in 2018.

The income tax provision in 2019 was primarily due to $22 million of withholding taxes related to cross-border transactions and $22 million of foreign income taxes in profitable locations partially offset by a $13 million benefit for a reduction of U.S. income taxes accrued in the prior year.

The income tax benefit in 2018 was primarily due to a $36 million refund of withholding tax from a foreign jurisdiction related to a legal settlement from 2010, offset by $13 million of U.S. income taxes resulting from the Tax Reform Act, $7 million tax provision in foreign locations and $7 million of withholding taxes on cross-border transactions.

As we continue to make progress in our business resulting in improved financial results, our future reassessment could possibly result in a determination that a valuation allowance is no longer required. The impact of the determination would result in the release of the valuation allowance and significant financial impact in a future reporting period with a material non-cash income tax benefit and the recording of additional deferred tax assets on our consolidated balance sheet.

International Sales

International sales as a percentage of net revenue were 74% in 2019 and 80% in 2018. We expect that international sales will continue to be a significant portion of total sales in the foreseeable future. Substantially all of our sales transactions are denominated in U.S. dollars.

FINANCIAL CONDITION

Liquidity and Capital Resources

As of December 28, 2019, our cash, cash equivalents and marketable securities were $1.5 billion compared to $1.2 billion as of December 29, 2018. The percentage of cash and cash equivalents held domestically was 90% as of December 28, 2019, and 88% as of December 29, 2018. Our operating, investing and financing activities for fiscal 2019, 2018 and 2017 were as follows:

	2019				2018				2017
	(In millions)
Net cash provided by (used in):
Operating activities	$	493			$	34			$	12
Investing activities	(149		)		(170		)		(54		)
Financing activities	43				28				(33		)
Net increase (decrease) in cash and cash equivalents, and restricted cash	$	387			$	(108	)		$	(75	)

Our aggregate principal debt obligations were $0.6 billion and $1.5 billion as of December 28, 2019 and December 29, 2018, respectively.

We believe our cash, cash equivalents and marketable securities balance along with our Secured Revolving Facility entered into in June 2019 (refer to Note 7 of “Notes to Consolidated Financial Statements for additional information) will be sufficient to fund operations, including capital expenditures, over the next 12 months. We believe we will be able to access the capital markets should we require additional funds. However, we cannot assure that such funds will be available on favorable terms, or at all.

Operating Activities

Net cash provided by operating activities was $493 million in 2019 compared to net cash provided by operating activities of $34 million in 2018. The increase in net cash provided by operating activities was primarily due to changes in working capital, largely driven by higher cash collections, partially offset by timing of accounts payable payments and higher wafer purchases and payroll.

Investing Activities

Net cash used in investing activities was $149 million in 2019, which primarily consisted of $217 million for purchases of property and equipment, partially offset by a net cash inflow from purchases and maturities of available-for-sale debt securities of $41 million.

Net cash used in investing activities was $170 million in 2018, which primarily consisted of $163 million for purchases of property and equipment and a net cash outflow from purchases and maturities of available-for-sale debt securities of $78 million.

Financing Activities

Net cash provided by financing activities was $43 million in 2019, which primarily consisted of a cash inflow of $449 million from the warrant exercised by West Coast Hitech L.P. (WCH) and $74 million from the issuance of common stock under our stock-based compensation equity plans, partially offset by $473 million of cash used for debt reduction activities during the year.

Net cash provided by financing activities was $28 million in 2018, which consisted of a net cash inflow of $70 million from the issuance of common stock through employee equity incentive plans, partially offset by $41 million of cash used for debt reduction activities in 2018.

Contractual Obligations

The following table summarizes our consolidated principal contractual cash obligations, as of December 28, 2019, and is supplemented by the discussion following the table:

	Payment due by period
(In millions)	Total				2020				2021				2022				2023				2024				2025 and thereafter
Term debt	$	563			$	—			$	—			$	312			$	—			$	—			$	251
Aggregate interest obligation (1)	102				30				30				21				6				6				9
Other long-term liabilities (2)	155				54				50				48				1				—				2
Operating leases	287				54				48				44				37				33				71
Purchase obligations (3)	2,290				1,677				592				10				4				2				5
Total contractual obligations (4)	$	3,397			$	1,815			$	720			$	435			$	48			$	41			$	338

(1)		Represents interest obligations, payable in cash, for our outstanding debt.
(2)		Amounts primarily represent future fixed and non-cancellable cash payments associated with software technology and licenses and IP licenses, including the payments due within the next 12 months.
(3)		Represents purchase obligations for goods and services where payments are based, in part, on the volume or type of services we acquire. In those cases, we only included the minimum volume of purchase obligations in the table above. Purchase orders for goods and services that are cancellable upon notice and without significant penalties are not included in the amounts above.
(4)		Total amount excludes contractual obligations already recorded on our consolidated balance sheets except for debt obligations and other liabilities related to software and technology licenses and IP licenses.

The expected timing of payments of the obligations in the preceding table is estimated based on current information. Timing of payments and actual amounts paid may be different, depending on the timing of receipt of goods or services, or changes to agreed-upon amounts for some obligations.

Term Debt

7.50% Senior Notes Due 2022

On August 15, 2012, we issued $500 million of the 7.50% Senior Notes due 2022 (7.50% Notes). The 7.50% Notes are our general unsecured senior obligations. Interest is payable on February 15 and August 15 of each year beginning February 15, 2013 until the maturity date of August 15, 2022. The 7.50% Notes are governed by the terms of an indenture (the 7.50% Indenture) dated August 15, 2012 between us and Wells Fargo Bank, N.A., as trustee.

In 2014, we repurchased $25 million in aggregate principal amount of the 7.50% Notes in open market transactions for $24 million. In 2016, we repurchased $125 million in aggregate principal amount of the 7.50% Notes pursuant to a partial tender offer for $135 million. In 2017, we settled $3 million in aggregate principal amount of the 7.50% Notes in treasury stock. In 2018, we settled $10 million in aggregate principal amount of the 7.50% Notes in treasury stock at a weighted-average cost of $9.01 per share. During 2019, we repurchased $25 million in aggregate principal amount of the 7.50% Notes in cash. As of December 28, 2019, the outstanding aggregate principal amount of the 7.50% Notes was $312 million.

2.125% Convertible Senior Notes Due 2026

In September 2016, we issued $805 million in aggregate principal amount of 2.125% Convertible Senior Notes due 2026 (2.125% Notes). The 2.125% Notes are our general unsecured senior obligations. The interest is payable semi-annually in March and September of each year, commencing in March 2017.

The 2.125% Notes mature on September 1, 2026. However, as outlined in the indenture governing the 2.125% Notes, holders of the 2.125% Notes may convert them at their option during certain time periods and upon the occurrence of one of the following circumstances:

(1) during any calendar quarter commencing after the calendar quarter ending on September 30, 2016 (and only during such calendar quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day (equivalent to an initial conversion price of approximately $8.00 per share of common stock);

(2) during the five business day period after any ten consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such trading day; or

(3) upon the occurrence of specified corporate events.

On or after June 1, 2026 and until the close of business on the business day immediately preceding the maturity date, holders may convert their notes at any time regardless of the foregoing circumstances. Upon conversion, we will pay or deliver, as the case may be, cash, shares of our common stock or a combination of cash and shares of our common stock at our election.

The event described in (1) above was met during the fourth calendar quarter of 2019 and, as a result, the 2.125% Notes are convertible at the option of the holder from January 1, 2020 and remain convertible until March 31, 2020.

During 2019, we converted $554 million principal amount of the 2.125% Notes through the issuance of approximately 69 million shares of our common stock at the conversion price of $8.00 per share and an aggregate cash payment of $56 million. As of December 28, 2019, we had $251 million principal of 2.125% Notes outstanding.

See Note 7 of “Notes to Consolidated Financial Statements” below for additional information regarding our 7.50% Notes and 2.125% Notes.

Operating Leases

We lease certain of our facilities under non-cancellable lease agreements that expire at various dates through 2028. In addition, we lease certain office equipment for terms ranging from one to five years. Total future non-cancellable lease obligations as of December 28, 2019 were $287 million, including future lease payments related to leases in Santa Clara, California; Austin, Texas; Markham, Canada and Shanghai, China.

Off-Balance Sheet Arrangements

As of December 28, 2019, we had no off-balance sheet arrangements.