AMD

Q3 22’ SUMMARY

AMD generated strong revenue growth driven by momentum in data center CapEx, increased end-consumer demand for devices embedded with semiconductors, and sustained demand for new gaming consoles. AMD’s performance was offset by sharp inventory corrections across the PC market as well as softness in the PC gaming market.

AMD gained significant market share as many competitors continued to suffer negative growth. AMD’s product position in the high-end of every market served insulated the business from headwinds in the data center, gaming, and embedded end-markets. The PC market was the only area of relative weakness as AMD’s high-end product position exposed the business to above-average weakness as these premium products faced sharper inventory corrections than the average quality semiconductor experienced.

AMD’s business model continued to drive above-average results that led to share gains. The business’ product strategy of innovation delivered through regular product releases created tailwinds across several end-markets, especially the data center and embedded markets.

Overall, the semiconductor market has a massive TAM driven by perpetually increasing global demand across many sectors of the global economy. The data explosion created by the modern world creates a continuous need for semiconductors as data is unable to be created, stored, and transferred without semiconductors. This has created several megatrends including cloud computing, AI and ML-based applications, and immense video consumption.

The semiconductor industry’s demand will outlast the recent volatility created by post-COVID consumer behavior normalization and corresponding inventory corrections. Importantly, AMD is well-positioned to continue growing through the headwinds in 22’/23’.

Key Takeaways from Q3 22’

Key Takeaway 1- industry leading product roadmap

• AMD drove demand from new products tailored to the data center market. This led to over 100% revenue growth in the hyperscale segment of the data center market.

• Embedded revenues were driven by the addition of an entirely new business (Xilinx) combined with new products that apply AMD’s technology to Xilinx products.

• Semi-custom gaming revenues were driven by new consoles, which incorporate AMD’s most recent designs.

Key Takeaway 2- PC AND PC GAMING END-MARKET VOLATILITY

• Explosion of PC demand during pandemic (20’ and 21’) led OEM’s to chase demand via sharp supply increases. Demand pullback from elevated levels drove OEM’s to initiate massive inventory correction actions.

• The PC gaming market also experienced a surge in demand during the pandemic. Normalization has led to lower demand relative to 21’ levels. AMD’s new products designed for the PC gaming market helped to offset some of the PC gaming weakness.

Key Takeaway 3- MASSIVE SEMICONDUCTOR TAM

• Data center CapEx, gaming spend, and embedded devices are projected to expand in 23’ and beyond.

• PC shipments are projected to pullback in 23’ followed by a return to growth in 24’.

• Market research firms expect cross-currents to persist into 23’, which is expected to be characterized by high variability in growth between end-markets.

GROWTH TRENDS

growth Factor 1- scaling data center business

AMD’s data center business has been increasing in importance relative to the other markets AMD serves. This has resulted in the data center business driving a material portion of AMD’s total revenue growth. AMD’s high performance products are adopted by customers because the products help optimize performance and efficiency. The company’s products are helping AMD take share in the data center market as competitors have repeatedly failed to deliver innovation on a time scale customers demand.

AMD cited material strength in the hyperscale segment of the data center market as the global explosion of data has driven mass migration to cloud computing, which is supported by hyperscale data centers. This megatrend places enormous pressure on data centers to expand capacity to support the sharp increases in workloads. These data center operators must spend billions of dollars in CapEx to facilitate the expansion of capacity. AMD’s innovation has created a leading product roadmap that has given data center customers confidence in partnering with AMD over the long-term.

• In Q3 22’, revenue from hyperscale data centers more than doubled compared to Q3 21’.

• AMD products were used in 70 new instances within several hyperscale data centers operated by Azure, AWS, Tencent, Baidu, and others.

• AMD’s new EPYC server processor products were cited as growth drivers as data center customers strongly adopted these new products.

• AMD experienced weakness in the enterprise segment of the data center market as these customers reduced CapEx spend to see how the macro environment developed.

growth Factor 2- accretive embedded acquisition

AMD’s embedded business has driven material growth for the company, which has offset headwinds in the PC and gaming businesses. The embedded business has enabled AMD to materially diversify end markets served effectively expanding AMD’s reach well-beyond core end-markets. AMD’s decision to scale their embedded business through acquiring Xilinx was a great strategic move as it positioned AMD to capture some of the immense demand across many end-markets that have integrated high-tech into their products. The product set ranges from Tesla cars to the Mars rover. The global demand for high-performance semiconductors in the embedded market adds considerable size to AM'D’s TAM.

• AMD saw continued demand across sectors, especially aerospace, defense, and auto.

• Demand continues to outpace supply on the lower node side of AMD’s product portfolio, which creates a long runway for growth.

• AMD’s premium technological design combined with legacy Xilinx products helped the business gain share in the embedded market in Q3 22’.

growth Factor 3- Client (PC) and gaming headwinds

AMD’s client (PC) business has historically been a major portion of the company’s revenues as the consumer PC market was the company’s primary area of business. This was especially the case during 20’ and 21’ when consumer demand for PC’s surged in response to pandemic conditions. The client business did not fare well in Q3 22’ as a result of headwinds from a material pullback in demand from OEM’s and channel partners due to consumer demand regressing from 21’ levels. This pullback as well as AMD’s strategic advancements in the data center and embedded markets have caused the client business’ contribution to AMD’s total revenue has decreased materially. While the headwinds were severe in Q3 22’ and expected to continue in Q4 22’, AMD’s leadership position is firmly intact as the company’s roadmap ensures AMD’s leadership position in the high end of the product category remains solid.

• OEM’s and channel partners had trouble meeting demand as recently as 1H 22’, which drove these players to aggressively build up inventory at the same time.

• The inventory build up combined with demand pullback led OEM’s and channel partners to pause inventory replenishment in Q3 22’.

• The high-end of the PC segment was hit harder than the other segments, which disproportionately affects AMD.

• In Q3 22’, AMD reported that ASP’s were actually up y-o-y while unit sales were down sharply compared to Q3 21’.

• AMD continued to innovate with the introduction of leading 5nm products, which positions AMD well for the recovery.

The gaming market is massive with billions of gamers across the world that use both widely available consoles (Playstation, XBox, Nintendo) as well as PC’s fitted to play games requiring high compute power. The market relies heavily on AMD to continuously produce high performance GPU’s that efficiently render high-resolution graphics, which enable and enhance the gaming experience. AMD’s product market fit has made the gaming business a critical component of AMD’s total revenues.

AMD captured significant demand during the pandemic due to a surge in gaming activity. While there have been headwinds due to base effects, this market has been much more resilient than the PC market has been. Additionally, AMD’s leadership position with console manufacturers has generated considerable revenues that have more than offset declines in the core GPU (pc-based gaming) products business. Overall, AMD has maintained the company’s leadership position through continued advancement of the product roadmap.

• There was a divergence of trends within the gaming business that was characterized by semi-custom revenues increasing and graphics revenues decreasing.

• Launched leading edge 5nm GPU product to advance product leadership within the gaming market.

• Prepared to launch new products with gaming application in 23’ to advance leadership position.

OPERATIONAL EFFICIENCIES

AMD is a highly profitable business with significant efficiencies to be unlocked. The profitability profile has drastically improved due to operating leverage, product mix shift to higher margin products, and ASP increases due to sharp increases in demand. AMD has defied margin stagnation that plagues mature businesses by continuing to deliver high-performance products that command higher ASP’s from increasing numbers of customers. Additionally, management has a laser focus on efficient growth, which is necessary for any business to drive profitability.

AMD’s cost structure is a product of the company’s business model that is based on outsourcing manufacturing in order to focus on developing the most innovation products possible. This translates to COGS being the most significant cost category as AMD relies on other companies to manufacture their chips, which is a highly variable expense. AMD’s focus on development has made R&D the second most significant cost category as AMD continues to increase R&D investments to drive future revenue growth. This is a non-discretionary expense activity as AMD’s business model is based on continuous innovation in the form of regular product performance upgrades. Lastly, AMD does not need to spend as much on SG&A as the business’ brand in the semiconductor industry enables the company to have lean SG&A spend.

In Q3 22’, adjusted gross margin expanded due to product mix shift to higher margin embedded and data center products, which carry higher margins than client and gaming products. This efficiency was offset by higher opex spend, especially R&D activities as AMD continues to develop next-gen products. Overall, AMD’s cost structure is designed to enable the company to continue driving leverage, which will be derived from continued mix shift to data center and embedded.

INDUSTRY TAILWINDS

The semi-conductor industry experienced a massive boom in 20’ and 21’ that has continued in 22’. This abnormal activity created massive forecasting problems for end-market purchasers, which led to supply build-ups that now exceed the level needed to meet present demand. As a result, inventory corrective actions are being taken in many end-markets such as PC’s, gaming, and even within the data center.

Even still, the semi-conductor CAGR remains well above pre-pandemic levels. Importantly, near-term headwinds are unable to outlast the megatrends that underpin the semi-conductor industry’s critical role in the global economy. These megatrends are all shaped in some way by the massive explosion in data creation, storing, sharing, and consumption. Semi-conductors are needed to facilitate these activities, which creates a powerful flywheel that drives semi-conductors long-term growth. Lastly, leading players are positioned to continue taking share from lagging players as the business that delivers innovation will win much more share than those that fall behind.

• Frost and Sullivan is forecasting data center spend (CapEx) to increase 17% in 22’ followed by compounding growth of ~10% through 26’.

• Frost and Sullivan is forecasting hyperscale growth to drive most of the data center spend.

• Statista is forecasting that network and online gaming users will decrease in the low single digits in 22’ followed by a material return to growth in 23’.

• Statista is forecasting that gaming spend will decrease less than usage followed by a much stronger return to growth in 23’.

• Gartner is forecasting that PC shipments have decreased -15% in Q3 22’. The market research firm is forecasting shipments to fall -1% in 23’ followed by a 4% increase in 24’.

• Gartner is forecasting all of the end-market demand to translate to a 7% increase in 22’ followed by a modest pullback in 23’, which is forecasted to increase over 7% each year from 24’ to 26’.

FORECAST AND VALUATION

AMD’s growth in Q4 22’ is highly likely to reflect the cross-currents experienced in Q3 22’. On the positive side, AMD is positioned to continue growing from data center, embedded, and semi-custom gaming trends. On the negative side, AMD is positioned to continue facing headwinds from client and graphics (PC gaming) market contractions. While the severity of client contraction was not anticipated ahead of the Q3 22’ results, the reality of the headwinds are now accounted for in the Q4 22’ forecast.

AMD’s efficiency is likely to fall in Q4 22’ as the company continues to invest in innovation via R&D expenditures as well as SG&A to a lesser extent. These investments during a period of revenue growth deceleration causes efficiency to materially pullback. Importantly, AMD is positioned to resume strong growth entering 23’ as majority of the PC inventory correction is expected to have occurred in 2H 22’. While the margin compression is not ideal, AMD’s commitment to product roadmap execution is a clear indicator that management is focused on maintaining the business’ product leadership. This commitment is the reason that customers engage in long-term business with AMD as they are able to build their own systems with the confidence that AMD will continue delivering the advancements necessary to continue expanding capacity.

AMD’s stock has continued to fall since the most recent research note as the stock market continued to be characterized by intense negativity. This sentiment has had a disproportionate affect on the semiconductor industry as a whole, which led to a severe depression on AMD’s stock. This has started to reverse in a strong way now that the forecast updates have been made and the most recent CPI print indicated peak inflation is underway. Even with the downward earnings revision, AMD’s stock has material growth ahead due to positive macro sentiment that is likely to drive multiples in the direction of AMD’s historical averages. Additionally, the decline in stock price sets the stock up for bigger returns from a lower base. The key catalyst will be continued indication that inflation is falling, which will trigger the market to rush back into stocks that were sharply discounted during 22’.