Earnings Call Transcript - AMD Q3 2022

Operator, Operator

Hello. And welcome to the AMD Third Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It’s now my pleasure to turn the call over to Ruth Cotter. Please go ahead, Ruth.

Ruth Cotter, Corporate Vice President of Global Investor Relations

Thank you. And welcome to AMD’s third quarter 2022 financial results conference call. By now, you should have had the opportunity to review a copy of our earnings press release and accompanying slideware. If you do not receive these documents, they can be found on the Investor Relations page of amd.com. We will refer primarily to non-GAAP financial measures during this call. The full non-GAAP to GAAP reconciliations are available in today’s press release and slides, which are posted on amd.com as mentioned. Participants on today’s conference call are Dr. Lisa Su, our Chair and Chief Executive Officer; and Devinder Kumar, our Executive Vice President and Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on our website. Before we begin today, I would like to note that Mark Papermaster, Chief Technology Officer and Executive Vice President, Technology and Engineering, will attend the Wells Fargo Technology, Media and Telecommunications Summit on Wednesday, November 30th. And our fourth quarter quiet time is expected to begin at the close of business on Friday, December 16th. Today’s discussion contains forward-looking statements based on current beliefs, assumptions and expectations, speak only as of today, 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 on the factors that could cause actual results to differ materially. Now with that, I’d like to hand the call over to Lisa. Lisa?

Dr. Lisa Su, CEO

Thank you, Ruth, and good afternoon to all those listening in today. Our third quarter revenue and gross margin came in below our expectations due to softening PC demand and substantial inventory reduction actions across the PC supply chain. Despite the macro backdrop, overall revenue grew 29% year-over-year to $5.6 billion as our Data Center, Gaming and Embedded segments, each delivered significant year-over-year growth and performed in line with our expectations. We also expanded gross margin and grew net income year-over-year, highlighting the strength of our business. Turning to the business results, starting with our Data Center segment. Revenue increased 45% year-over-year and 8% sequentially to $1.6 billion. We delivered our 10th straight quarter of record server processor sales, driven by strong demand for third-gen EPYC processors and initial shipments of our next-generation Genoa CPU to select customers. Cloud revenue more than doubled year-over-year and increased sequentially as multiple hyperscalers expanded deployments of EPYC processors to power their internal properties and more than 70 new AMD instances were launched by Microsoft Azure, Amazon, Tencent, Baidu and others in the quarter. In enterprise, OEM revenue was down sequentially as server OEMs continued working through match set issues and some business slowed the pace or scale of their purchases based on the macro uncertainties. Looking at the broader competitive landscape, our third-gen EPYC CPUs in market today are the highest performant and most energy efficient x86 server CPUs available, and we expect to further extend that lead with our next-generation 5-nanometer Genoa processors, which deliver significant performance, energy efficiency and TCO advantages for both hyperscale and enterprise workloads. We will publicly launch Genoa next week and are ramping production to support initial cloud deployments and the introduction of fourth-gen EPYC processor platforms by HP Enterprise, Dell, Lenovo, Super Micro and others. Looking at our broader Data Center portfolio, as expected, Data Center GPU sales were down significantly from a year ago when we had substantial shipments supporting the build-out of the Frontier exascale supercomputer. We made good progress with our Data Center GPU software enablement work in the quarter, including announcing our role as a founding member of the PyTorch Foundation. We look forward to working closely with the largest cloud providers as we drive a standards based approach to the development of popular PyTorch deep learning software framework. Demand from Data Center customers for our adaptive, SmartNIC and DPU products was strong during the quarter. We had record sales of our Xilinx FPGA and networking Data Center products, led by demand from cloud and financial customers. Sales of our Pensando DPUs also ramped significantly from the prior quarter driven by cloud adoption. The addition of Pensando DPUs to our product portfolio has been very well received by customers, highlighted by our enterprise customer pipeline doubling in the few months since the acquisition closed. We were excited to support VMware’s launch of its next-generation cloud virtualization platform in the quarter. Our Pensando DPUs will be included in the first validated server and HCI solutions, supporting the new VMware virtualization offerings from Dell, HPE and others, that will make it much easier for enterprise customers to build more performant and secure Data Centers powered by our industry-leading DPUs. Taking a step back, we have built significant momentum in our Data Center business as we have consistently executed our server CPU roadmap and expanded our solutions capabilities with the addition of the Xilinx and Pensando products to our portfolio. We remain on track to further expand our product portfolio in 2023 with the launches of our edge and telco optimized Siena and cloud optimized Bergamo processors. With 128 cores and 256 threads per socket, we expect Bergamo will further extend our performance and energy efficiency leadership in cloud workloads. Customer response has been very strong based on the performance, features and software compatibility Bergamo delivers. We believe our broad family of leadership CPUs, GPUs, FPGAs, adaptive SoCs and DPUs position us well for long-term growth and share gains in the Data Center. Now turning to our Client segment. Revenue declined 40% year-over-year to $1 billion. Our Client processor shipments were below PC consumption in the third quarter as we worked closely with our customers to reduce downstream inventory. Desktop channel sell-through increased from the prior quarter, driven by increased demand for our Ryzen 5000 Series CPUs and the launch of our Ryzen 7000 Series processors and AM5 platform in September. We launched our 5-nanometer Ryzen 7000 Series processors to strong reviews based on delivering leadership performance in gaming, productivity and content creation applications. We expect Ryzen 7000 CPU sales to ramp this quarter aligned with the launches of a broader range of mainstream and enthusiast AM5 motherboards. Now turning to our Gaming segment, revenue increased 14% year-over-year to $1.6 billion as strong semi-custom sales offset a decline in gaming graphics. We delivered our sixth straight quarter of record semi-custom SoC sales as demand for the latest game consoles remained strong, and Sony and Microsoft prepare for the holiday season. Gaming graphics revenue declined in the quarter based on soft consumer demand and our focus on reducing downstream GPU inventory. We will launch our next-generation RDNA 3 GPUs later this week that combine our most advanced gaming graphics architecture with 5-nanometer chiplet designs. Our high-end RDNA 3 GPUs will deliver strong increases in performance and performance per watt compared to our current products and include new features supporting high resolution, high frame rate gaming. We look forward to sharing more details later this week. Looking at our Embedded segment, revenue increased significantly year-over-year to a record $1.3 billion, driven by growth from aerospace and defense, industrial and communications customers. Demand across our core markets remained very strong. We had record sales to aerospace and defense and automotive customers who are increasingly using our FPGA and adaptive SoC products to enable differentiated capabilities and features in their products. Record communications market revenue was driven by growth from both wired and wireless customers. We saw particular strength in North America led by new 5G wireless installations and expanded wired infrastructure deployments. Overall demand for our Xilinx products remains strong as we continue to leverage AMD’s scale to secure additional supply to address this demand. Longer term, we are very excited about the growth opportunities in our Embedded business. We closed multiple high revenue design wins in the quarter with automotive, networking, emulation and prototyping, communications and aerospace and defense customers. We are also seeing new design win opportunities and deeper engagements with many of our Embedded customers based on the expanded breadth of our adaptive SoC, FPGA, CPU, GPU and DPU product portfolio. In summary, we are well-positioned to navigate the current market dynamics based on our leadership product portfolio, strong balance sheet and growth in our Data Center and Embedded segments. We have three clear priorities guiding us. First and foremost, we are focused on executing our road maps and delivering our next generation of leadership products. Second, we are building even deeper relationships with our customers as we make AMD a fundamental enabler of their success. And lastly, we remain very disciplined in how we manage the business. We will continue to invest in our strategic priorities around the Data Center, Embedded and Commercial markets, while tightening expenses across the rest of the business and aligning our supply chain with the current demand outlook. The secular trends driving increased demand for high performance and adaptive computing in the cloud, at the edge and across intelligent end devices remain unchanged and provide a strong backdrop for long-term growth. Now I’d like to turn the call over to Devinder to provide some additional color on our third quarter financial performance. Devinder?

Devinder Kumar, CFO

Thank you, Lisa, and good afternoon, everyone. AMD reported third quarter results in line with the preliminary results we announced last month. While we are pleased with the performance of our Data Center, Gaming and Embedded segments, each of which grew significantly year-over-year, our third quarter results also reflect lower than expected Client segment revenue. Third quarter revenue was $5.6 billion, up 29% from a year ago. Gross margin was 50%, up 150 basis points from a year ago, primarily driven by higher revenue in the Embedded and Data Center segments, partially offset by lower Client revenue and $160 million of inventory, pricing and related charges in the graphics and client businesses. Operating expenses were $1.5 billion, compared to $1 billion a year ago as we continue to scale the company. Operating income was up 20% from a year ago to $1.3 billion, driven by revenue growth and higher gross margin. Operating margin was 23%, compared to 24% a year ago, due to higher operating expenses. Net income was $1.1 billion, up $202 million from a year ago. Earnings per share was $0.67 per share, compared to $0.73 per share a year ago, primarily due to lower Client segment revenue. Now turning to our reportable segments. Starting with the Data Center segment, revenue was $1.6 billion, up 45% year-over-year, driven by strong growth in third-generation EPYC server processor revenue. Data Center operating income was $505 million or 31% of revenue, compared to $308 million or 28% a year ago. Higher operating income was driven primarily by stronger revenue, partially offset by higher operating expenses. Client segment revenue was $1 billion, down 40% year-over-year, due to reduced process shipments resulting from a weak PC market and a significant inventory correction across the PC supply chain. Client operating loss was $26 million, compared to operating income of $490 million or 29% of revenue a year ago, primarily due to lower revenue. Gaming segment revenue was $1.6 billion, up 14% year-over-year, driven by higher semi-custom product sales, partially offset by lower gaming graphics revenue. Gaming operating income was $142 million or 9% of revenue, compared to $231 million or 16% a year ago. The decrease was primarily due to lower graphics revenue and inventory pricing and related charges. Embedded segment revenue was $1.3 billion, up $1.2 billion from a year ago, primarily due to the inclusion of Xilinx’s embedded product revenue. Embedded operating income was $635 million or 49% of revenue, compared to $23 million or 30% a year ago, driven primarily by higher revenue. Turning to the balance sheet. Cash, cash equivalents and short-term investments were $5.6 billion at the end of the third quarter. During the quarter, we repaid the 7.5% senior notes totaling $312 million that matured in August and deployed $617 million to repurchase common stock. We have $6.8 billion in remaining authorization for stock repurchases. Cash from operations was $965 million and free cash flow was $842 million, compared to $764 million in the same quarter last year. Inventory was $3.4 billion, up approximately $721 million from the prior quarter, driven primarily by client products and new products ramping in the second half of the year. Now turning to our financial outlook, today’s outlook is based on current expectations and contemplates the near-term macroeconomic environment. For the fourth quarter of 2022, we expect revenue to be approximately $5.5 billion, plus or minus $300 million, an increase of approximately 14% year-over-year and flat sequentially. The year-over-year growth is driven by Embedded and Data Center segments, partially offset by a decline in the Client and Gaming segments. On a sequential basis, Embedded and Data Center segments are expected to grow, offset by declines in the Client and Gaming segments. In addition, for Q4 2022, we expect non-GAAP gross margin to be approximately 51%, non-GAAP operating expenses to be approximately $1.55 billion or 28% of revenue, non-GAAP interest expense, taxes and other to be approximately $175 million based on a 13% effective tax rate, and diluted share count to be approximately 1.62 billion shares. For the full year, we expect revenue to be approximately $23.5 billion, plus or minus $300 million, an increase of approximately 43%, led by growth in the Embedded and Data Center segments. We expect non-GAAP gross margin to be approximately 52%. In closing, we continue to focus on executing our long-term strategy, while navigating current market conditions. We will prioritize the key investments for our product roadmaps and long-term growth, while taking several near-term cost management actions, including prudently controlling operating expenses and headcount growth, while actively managing inventory in line with our revenue expectations. With that, let me turn the call over to Ruth for our Q&A session. Ruth?

Ruth Cotter, Corporate Vice President of Global Investor Relations

Thank you, Devinder. Kevin, if you could please poll the audience for questions.

Operator, Operator

Certainly. Our first question today is coming from Aaron Rakers from Wells Fargo. Your line is now live.

Aaron Rakers, Analyst

Yeah. Thanks for taking the question. I have one question and one quick follow-up. I guess, as we look at your Client piece of the business being down sequentially in the current quarter, as we work through inventory digestion at your customers. I am curious just how you are thinking about the clearing out of that inventory, do you think we find a bottom coming out of the December quarter or any kind of thoughts of just that kind of full expectation of a flushing of inventory in the PC market for you guys?

Dr. Lisa Su, CEO

Sure, Aaron. Thanks for the question. The PC business has been quite unstable and did not perform well for us in the third quarter. As we approach the fourth quarter, we expect that PCs will again decline. We anticipate that this will significantly help in reducing inventory between the third and fourth quarters. Of course, we will keep an eye on the overall market conditions, but we believe we will finish the year in a stronger position.

Aaron Rakers, Analyst

Yeah. And then as a quick follow-up on the service side of the business, I think, in the past, you have talked about your ability to shift being somewhat supply constrained. I am just curious if you have an update on the supply situation in the server CPU, especially as we look towards the Genoa processor ramp in the next quarter or two?

Dr. Lisa Su, CEO

Sure. We have been increasing our overall supply on the server side and have made good progress throughout the year. We have more supply in the fourth quarter than we had earlier in the year, and some of our investments are starting to come online now. As we move into 2023 with the Genoa launch, we do not expect to face supply constraints based on our current outlook.

Aaron Rakers, Analyst

Yeah. Fair enough. Thank you.

Operator, Operator

Thank you. Next question is coming from Toshiya Hari from Goldman Sachs. Your line is now live.

Toshiya Hari, Analyst

Thanks so much for taking the question. Lisa, I wanted to ask a question on the outlook for 2023, specifically in the server CPU business. I know it’s early and difficult to predict, but given the supply comment that you just made, given what you are hearing from customers, both on the cloud side, as well as the enterprise side and the ramp of your new products. How are you thinking about the positives there versus the macro, which continues to be a headwind? I think many of us have your business growing in Data Center kind of in the 20% to 30% range, is that a fair place to be or is that a little too optimistic given what you know today?

Dr. Lisa Su, CEO

It's a bit early to discuss 2023 in detail, but I can provide some insight into the current state of the Data Center market. In the short term, we are facing several macro challenges that are impacting all markets, including Data Centers. However, there are differences across segments. North America cloud is the most resilient area within the Data Center market, and this is where AMD excels. We have made significant progress with North American cloud vendors, and while there may be some near-term adjustments in efficiencies at individual cloud providers, we anticipate growth as we move into 2023, especially as customers increase their workloads on AMD due to our strong product portfolio and the upcoming Genoa launch. On the other hand, the situation in China has been weak in 2022, and we don't expect a substantial recovery in 2023. The enterprise sector has also been quite affected by the macro environment, with customers taking longer to make decisions and being more cautious with capital expenditures. Nevertheless, we are confident in our value proposition and product offerings and believe we can gain market share even in a somewhat unstable market. Overall, our Data Center trends are promising, and we must navigate the macro challenges like everyone else.

Toshiya Hari, Analyst

That’s helpful. And then as my follow-up, a question on gross margins, maybe for Devinder. So you are guiding Q4 gross margins up about 100 basis points, which is good to see, but you are still 300 basis points below where you were in Q2, and since then, obviously, Client is down significantly, your Data Center business is very resilient and so is the classic Xilinx business. So from a mix perspective, you should be in a better place. What’s driving down gross margins in Q4, I guess, versus Q2, are you recognizing another inventory hit or is it something else? Thank you.

Devinder Kumar, CFO

No inventory hit, first of all, Toshi. On the gross margin, as you said, Q2 54%, if you go all the way to Q4 51% primarily is the weak PC market and Client margins coming down. For example, if you look at Q3, all other businesses were in line with expectations and Client margins came in lower. We also have in the Data Center, a place cloud weightage, which has lower ASPs. So that also has an impact on margins. And then as Lisa mentioned earlier, some of the new capacity that we have from a supply standpoint, there are some additional costs from the supply capacity agreements and those are all baked in into the Q4 51% margin guidance.

Toshiya Hari, Analyst

Thank you.

Operator, Operator

Thank you. The next question is coming from Stacy Rasgon from Bernstein Research. Your line is now live.

Stacy Rasgon, Analyst

Hi, everyone. I appreciate you taking my questions. My first question is about the additional week in Q4. How much overall revenue did that generate, and specifically for the Data Center? Is there a significant impact from that extra week considering how linear that business tends to be?

Dr. Lisa Su, CEO

We are not expecting a significant impact from the extra week. While there are various factors to consider in the quarter, our guidance for Q4 focuses on a decrease in PCs and Gaming, and with the holiday season, we don’t anticipate much from those areas. On the other hand, we expect the Data Center and Embedded segments to perform better, but we don’t believe the extra week will have a substantial influence.

Stacy Rasgon, Analyst

Got it. Thank you. For my follow-up, I wanted to ask about units versus pricing in Q3 and Q4. I know in Q3, you specifically mentioned pricing has an impact and it sounds like you are suggesting Client margins are coming down. I don’t know if that’s just a cost or if there’s a pricing impact as well, but like what did units and pricing do in Client in Q3 and what are you expecting in Q4?

Dr. Lisa Su, CEO

Sure, Stacy. In the third quarter, there were many factors affecting the Client business. The market was weak, especially in the consumer segment, where we have a larger presence. As a result, we saw a decrease in units sold and a sequential decline in average selling prices. However, on a year-over-year basis, average selling prices were still higher. We have maintained a disciplined approach to pricing in this environment. During the quarter, we encountered some pricing pressures and avoided unprofitable business, and we will continue to monitor that situation. These were the factors influencing Client average selling prices. Looking ahead to the fourth quarter, we anticipate a competitive environment due to the ongoing market weakness, and that expectation is reflected in our guidance.

Stacy Rasgon, Analyst

Got it. That’s helpful. Thank you, guys.

Operator, Operator

Thank you. Next question is coming from Vivek Arya from Bank of America. Your line is now live.

Vivek Arya, Analyst

Thank you for taking my question. I wanted to clarify the client revenue we should expect for Q4, is it $800 million, $900 million? Any assistance with that? Additionally, Lisa, I'm curious about the overall client recovery. Will we return to the $2 billion quarterly rate or get to $1.5 billion? I'm asking because a competitor suggested that next year the PC total addressable market would only decline by 4% or 5%, which seems a bit optimistic. What does AMD anticipate regarding the PC total addressable market for next year, so we can understand the de-risk model from a PC perspective?

Dr. Lisa Su, CEO

Yeah. So, a couple of different points, Vivek. Let me just answer the sort of the expectations around Q4. I would say, we are guiding, let’s call it, modestly down for Client and Gaming, and obviously, we are coming off of what is already a low base in Q3. We want to do that to correct the sort of the inventory situation as quickly as possible, and as a result, we are going to under ship consumption again in the fourth quarter to do that. As it relates to next year, I think, there are a lot of factors. I mean this year PCs will be down quite a bit, let’s call it, high-teens, close to 20%. As we go into next year, I think, the industry is calling mid-single digits. I think that would be a good case. I think we should model down to minus 10%. And again, within our PC business, we expect as we get through this inventory correction, I mean, we have very good products, and I feel very good about our product portfolio and very good about our platforms overall. So I do think the PC business will recover as we go into 2023, but we will have to work through these dynamics over the next quarter or so.

Vivek Arya, Analyst

Understood. For my follow-up, Devinder, I have a question regarding gross margins. How much of the write-offs and pricing actions you implemented in Q3 and are continuing in Q4 will be recoverable in Q1? Assuming Q1 revenue remains the same as Q4 revenue, what are the potential gross margins, how much of the actions are recoverable, and how do you plan to return to the previous trend of 54% gross margin, with the long-term target being over 57%? If client revenues don't grow significantly, are there steps you can take to regain your previous gross margin trajectory? Thank you.

Devinder Kumar, CFO

Let me try to answer it this way. If you look at Q3 by itself, we had a gross margin of about 50%. We incurred $160 million in charges related to inventory pricing. Adjusting for those charges, the margin for Q3 is roughly 52%. We guided to 54%, but we ended up at 52%, mainly for two reasons: the weak PC market is affecting Client margins. As I mentioned earlier, the rest of the business is expected to perform as planned. We need to navigate the current conditions of the PC market over this quarter, next quarter, and possibly into early 2023 before we can reassess the margins. I am optimistic about the new products we are launching and believe there is potential to improve margins from the current guidance of 51% upward.

Vivek Arya, Analyst

But is the $160 million recoverable, I guess that’s really my question?

Devinder Kumar, CFO

Those were mostly inventory rights or pricing actions we would take. Largely, I would say, not recoverable, if that’s what you are asking.

Vivek Arya, Analyst

I mean can you get back to the 52% that you would have been normalized, like, I expect if you don’t take these actions in Q1, then should you be at a higher gross margin in Q1 versus Q4?

Devinder Kumar, CFO

I won’t guide Q1, but what I will say is from the 51% that we have in Q4, we can improve from there.

Vivek Arya, Analyst

Thank you.

Operator, Operator

Thank you. Next question is coming from Matt Ramsay from Cowen. Your line is now live.

Matt Ramsay, Analyst

Thank you very much. Good afternoon. I have a question regarding the Data Center segment and a follow-up on Client. In the Data Center business, looking back at the pre-announcement from a month ago, it seems you were slightly below our modeling expectations. I have quite a few questions about that, especially regarding your comments about cloud revenue more than doubling year-over-year, which I want to confirm I understood correctly. Could you help us break down your Data Center business, particularly the strength in cloud, which I expect to continue given the CapEx commentary we've heard? However, it's clear there were some challenges from the enterprise side and from HPC in both CPU and GPU. It would be helpful to break this down further, as I was surprised by the strength of cloud revenue given the quarter's overall numbers. Thank you.

Dr. Lisa Su, CEO

In the third quarter, our cloud revenue increased more than double, while enterprise revenue saw a decline. On the GPU side, we experienced a decrease as well, which may not have aligned with your expectations due to a strong performance in the third quarter of 2021. Overall, North America cloud remains the strongest segment within our Data Center business, although macro factors are having some impact, notably a slight reduction in capital expenditure. Despite this, our market share in that area is robust, and we anticipate continued growth. As our business shifts more towards cloud solutions, there may be slight downward pressure on margins. However, our current focus is on expanding our presence in both cloud and enterprise sectors. Even amidst a challenging enterprise market in the upcoming quarters, we are confident in our positioning and the platform solutions we are developing with our OEM partners. While specific quarter-to-quarter models may not perfectly predict outcomes, the strength of our product portfolio and capabilities should support our long-term market share growth.

Matt Ramsay, Analyst

Okay. Thank you, Lisa. That’s helpful. I think to highlight the cloud momentum continuing. I guess as my follow-up, I wanted to kind of revisit what we have learned over the last three months or four months in the PC market. It’s super dynamic times out there, and obviously, things have changed in demand really, really quickly from when you guys guided back at the beginning of August until the pre-announcement. And I just kind of wanted to walk back through sort of the dynamics of how the quarter progressed from when you guys gave the original guidance, I guess, obviously, the market went down, there was inventory corrections and whatnot. But just how quickly did you guys see that and I guess the real question coming out of this is, how are you thinking about changes you might make in monitoring inventory levels or working with your channel partners? Just any changes you are thinking about making operationally to the business to sort of protect from this kind of thing coming and, I guess, going forward? Thanks very much. Any color there would be really helpful.

Dr. Lisa Su, CEO

Sure, Matt. In the third quarter, the PC market was quite unpredictable. We anticipated a weak market, but it turned out to be even weaker than expected, particularly in the consumer sector where we have a significant presence. One notable trend we've observed is that as the broader economy has declined, customers have generally become more cautious. While they have been selling off their inventory, they haven't been restocking to previous levels. Previously, we were in a situation where there was more demand than supply, and in the first half of the year, companies were trying to accumulate inventory. It's a very fluid situation. We have strong partnerships throughout the supply chain and I feel optimistic about our visibility. I expect the market to remain volatile, but we are inclined to decrease inventory levels so that we can respond more effectively to market conditions. I hope this provides some clarity.

Matt Ramsay, Analyst

Yeah. No. Definitely appreciate that Lisa.

Operator, Operator

Thank you. Next question is coming from Joe Moore from Morgan Stanley. Your line is now live.

Joe Moore, Analyst

Great. Thank you. I wonder if you could talk a little bit about your visibility in the Xilinx part of the business to the extent that we have seen some weakening in kind of broader markets here and there, but generally, it’s okay. Like can you just talk about how long your visibility extends there, how you feel about growth into next year?

Dr. Lisa Su, CEO

Yes, Joe. The Xilinx business, specifically our Embedded segment, has been performing exceptionally well. We had a very strong quarter in Q3 and we're anticipating growth into the fourth quarter. We've been closely monitoring the different sub-segments. One of the advantageous aspects of this business is its broad base. We've seen growth in communications, aerospace and defense, and automotive during the third quarter. However, there were some areas of weakness, particularly in consumer and certain sub-segments of industrial, like test and measurement. Despite these fluctuations, I would say the business shows strong visibility. We are still facing supply constraints in certain nodes, especially some of the legacy nodes, but we've made significant progress in this area. We're expecting additional supply in Q4, which gives us confidence for that quarter. Looking ahead to the first half, we have multiple quarters of visibility thanks to the lead times in this sector, and we will be monitoring it closely. Overall, the product portfolio remains strong, and we've also gained some market share.

Joe Moore, Analyst

Great. Thank you very much.

Dr. Lisa Su, CEO

Thanks.

Operator, Operator

Thank you. Next question today is coming from Ross Seymore from Deutsche Bank. Your line is now live.

Ross Seymore, Analyst

Everybody, thanks. So let me ask a couple of questions quickly here. Lisa, if you could give us a little color, you talked about the fourth quarter being, I guess, down modestly in Client and Gaming. Can you give relatively similar color for Data Center and Embedded, just because the volatility between segments, obviously, has been huge over the last couple of quarters?

Dr. Lisa Su, CEO

Sure, Ross. In terms of absolute figures, we see a slight decline from Q3 to Q4, with numbers at 5.5 compared to 5.56. There is a modest decrease in Client and Gaming. Specifically for Gaming, we anticipate a drop in console sales in the fourth quarter following their peak in Q3. However, this will be somewhat balanced by our upcoming graphics launch scheduled for the next few weeks. Regarding Data Center and Embedded, we expect similar performance, so let's say modest growth moving forward. We believe cloud services will outperform enterprise, which ties into some of the margin dynamics mentioned earlier. Additionally, as we obtain more supply, we anticipate a slight increase in Embedded as well.

Ross Seymore, Analyst

Great. That’s perfect. And then as my follow-up, one for either you or Devinder. As we think about OpEx for next year, how do you guys philosophically balance the desire to stick to your business model that you laid out at your most recent Analyst Day versus the desire to continue to spend, continue to gain market share, put out the great new products and execute that you have done so well, are those kind of buffers conflicting against each other, and how, if so, do you reconcile that confliction?

Devinder Kumar, CFO

Yeah. I think the key thing is we continue to invest in the strategic areas, in Data Center and Embedded and the product roadmaps. The macro environment has weakened soft PCs and we are taking actions to reduce expenses especially in the rest of the business besides what I talked about earlier in terms of the areas of focus and we have slowed down hiring. So you are right, Q4, if you look at E2R business is high, but we are very disciplined in terms of what we are going to do. Expense actions do take time to kick in and we expect that as we go out into 2023, the E2R comes more in balance with the revenue and we manage it in line with the revenue out in time.

Dr. Lisa Su, CEO

I think we have the opportunity to make several adjustments in operational expenses. We will maintain a disciplined approach, as Devinder mentioned. With that in mind, we are confident in our strategic focus on Data Center, Embedded, and the commercial markets. We will continue to invest in these areas while being more cautious with the consumer-facing segments of our business, and that will guide our management through 2023.

Operator, Operator

Thank you. Next question is coming from Ambrish Srivastava from BMO. Your line is now live.

Ambrish Srivastava, Analyst

Hi. Thank you very much. Lisa, I wanted to come back to the PC business. There’s such a big disparity between your 3Q guide and what Intel guided to or reported versus what they are guiding to in 4Q and usually things normalize over a longer period of time. But I just wanted to understand, is it a case of they took their medicine earlier and AMD continued to over ship versus demand? Just kind of help us understand and there seems to be also a dynamic that Intel is raising pricing in 4Q, so there was some pull-in ahead of that. And I have been getting a lot of questions myself. I don’t understand specific disparity. So any help would be very helpful?

Dr. Lisa Su, CEO

Sure, Ambrish. Let me provide some insights on our business. As we finished the first half of the year, we anticipated a stable PC market for the second half. Typically, the third quarter performs better than the first half, and both the third and fourth quarters usually see seasonal increases, which is what we were preparing for along with our customers. However, market softness and general caution led to different behaviors among stakeholders, requiring us to collaborate with our customers on managing inventory. There have been some temporary issues that we are aware of, including aggressive pricing strategies that we chose not to adopt, which was a conscious decision on our part. Additionally, some companies might be executing temporary optimizations. I believe there’s nothing fundamentally wrong; our product portfolio is robust, and we have strong platforms in place to navigate this situation. While it is a challenging market environment, I am confident we will manage to work through it.

Ambrish Srivastava, Analyst

Thank you, Devinder. Can you discuss the capacity availability at the foundries? We talked about the impact on free cash flow due to your need to secure capacity during the Analyst Day. Will this situation improve in the upcoming quarters as more capacity becomes available, especially since the demand on the PC side should be less than what it was a few quarters ago? Thank you.

Devinder Kumar, CFO

The capacity agreement we were working on has some benefits, particularly in the service area, as Lisa mentioned earlier. These long-term agreements are intended to support the growth of the business. In light of the current market conditions, we are actively collaborating with our suppliers to align supply with revenue timing and product ramp-up. This has provided us with some overall flexibility, which we plan to navigate over the next two to three quarters.

Operator, Operator

Thank you. Next question is coming from Harlan Sur from JPMorgan. Your line is now live.

Harlan Sur, Analyst

Good afternoon. Thanks for taking my question. In Data Center, the team continues to expand the number of compute instances with your cloud customers on Milan. It seems like the momentum is carrying up through the ramp of your fourth generation Genoa platforms. I think this is a very good dynamic. I assume you guys have good visibility here. So how long does the Milan momentum continue into next year and are your cloud customers already qualifying Genoa and when do you expect Genoa to start to kick into high-volume ramp?

Dr. Lisa Su, CEO

Yeah. Thanks for the question, Harlan. So, yes, look, we are very happy with our Milan sort of workload ramp. We are continuing to ramp Milan here this year and then into next year as well. As it relates to Genoa, we did start initial shipments of Genoa to our strategic customers in the third quarter. That is continuing in the fourth quarter. So we are ramping production in the fourth quarter. A lot of the, let’s call it, the qualifications or the first instances are being qualified here in the fourth quarter into the first quarter. And what we have said before is that, Milan and Genoa are going to actually coexist for quite some time, just given how competitive both are. Genoa is a new platform. It is new DDR5 and PCIe 5.0, and that takes a bit longer for people to qualify. So we would expect both to continue to ramp in 2023 and that’s how we are planning the business.

Harlan Sur, Analyst

Great. Thank you. And despite the macro concerns, and as you mentioned, some near-term workload optimization, your North American cloud customers, I mean, they are still growing their cloud services business at a strong 30%, 40% year-over-year growth rate and I assume that these types of growth rates like the consumption of compute networking, storage workloads and therefore, installed utilization, like, this is all quite strong in driving the need to build out more compute capacity. Is this what’s driving the team’s sort of strong mid-term outlook for this segment or is it more a function of your strong product lineup with Genoa and continuing to capture greater compute share or both?

Dr. Lisa Su, CEO

Yeah. Right. Harlan, I would say, it’s a little bit of both and I think you said it well. In the very near-term, there is a little bit of optimization that each cloud vendor is doing. But in the medium-term, what our customers are telling us is they need more compute. And the more compute is for additional workloads building out. It’s also for upgrade of, let’s call it, older compute, given our new products have very strong TCO, power efficiency, given the cost of power and energy around the world. We are actually seeing that also be a driver for some of the conversion to AMD in the cloud as we go into 2023.

Harlan Sur, Analyst

Thank you, Lisa.

Dr. Lisa Su, CEO

Thanks, Harlan.

Operator, Operator

Thank you. Next question is coming from Chris Danely from Citi. Your line is now live.

Chris Danely, Analyst

Thank you. So if we take the macro out of it, can you just go through your share expectations in desktop, notebook and server, let’s just say, for the next 12 months or so?

Dr. Lisa Su, CEO

I am trying to think about how to remove the macro factors. Your question is to set aside the actual total addressable market and simply discuss our share expectations, is that correct?

Chris Danely, Analyst

Yeah. You can say relatively where you expect to gain more or less.

Dr. Lisa Su, CEO

I got it. I got it. Okay. Yeah. I want to be responsive to the question. Well, let’s start with the Data Center. I think in the Data Center, we believe that we will continue to gain share. We expect to continue to gain share in both cloud and enterprise. We are more underrepresented in enterprise, and so, again, that’s a key focus for us. But as we just stated in the last few questions, I think, North America cloud, in particular, I think, we see line of sight to significant new deployments based on our current roadmap. In the desktop and notebook business, our focus is on certain segments. So we are very focused on premium. We are very focused on gaming and we are focused on commercial. I think in those areas, there are, again, opportunities for us to continue to gain share. I think in desktop DIY business or sort of the desktop channel business, we have a strong lineup. We just launched the new Ryzen 7000 Series. We have additional products that we will launch next year as well and that’s sort of the puts and takes in the various businesses.

Chris Danely, Analyst

Sure. And then as my follow-up, I guess, just getting back into the macros that you mentioned that ASPs are getting a little or at least pricing is getting a little tough on CPUs. If this downturn in PCs continues into next year and if it spreads into the Data Center market, how do you think of pricing going forward and would you choose to maybe give up some share if your competitor remains aggressive on price and the environment stays difficult?

Dr. Lisa Su, CEO

Chris, we have a very strong value proposition. Our strategy is not to focus on leading with price. In the Data Center, although price is a factor, we find it is not the most important factor in most decisions. We have work to do in workload optimization, which has been a big focus in the Data Center. I hope that answers your question. Regarding the PC business, it is more price-sensitive, and we have noticed it becoming increasingly so. However, where we offer a strong value proposition, we will remain competitive. A year ago, we chose not to compete in the Chrome market because it wasn't profitable for us, and we will be disciplined in ensuring that we pursue profitable business.

Chris Danely, Analyst

Got it. Thanks, Lisa.

Dr. Lisa Su, CEO

Thank you.

Operator, Operator

Thank you. Next question is coming from Timothy Arcuri from UBS. Your line is now live.

Timothy Arcuri, Analyst

Hi. Thanks a lot. I had two. Lisa, first, I wanted to ask about U.S.-China trade and I guess the recent restrictions, they didn’t seem to have too much direct impact on you, but the direction of travel seems pretty clear and you report China as 25% of revenue, but that’s sell-in. So I am wondering if maybe you can help us with what China is on a consumption basis and kind of how you handicap where your China TAM is going. When you are making these investment decisions, how do you think about the U.S.-China trade and the direction of travel? And I had a follow-up, too. Thanks.

Dr. Lisa Su, CEO

Yeah. Sure, Tim. So we are certainly watching the situation very closely. Upon reviewing all of the new regulations as they have gone into effect, it is minimal impact on our revenue in the near-term. We are certainly working very closely with commerce and the rest of the U.S. Government on how those are rolling out. And then I think on a medium-term basis, again, my view on these things is, we will always follow the U.S. regulations and understand the need for national security. The majority of our China business is, let’s call it, non-Data Center. So it’s more in the PC business, as well as in some of the consumer facing businesses. So we are paying attention to that as we go forward in the business. But for the near-term, we have not seen any significant impacts, and we will continue to follow it very closely.

Timothy Arcuri, Analyst

Thank you, Lisa. And then, I guess, I wanted to ask a question about PCs. So you guided in late July and it seemed like things were fine and then we lost basically $1 billion basically in two months. It would seem like those were massively weak months, and I would think that, maybe there’s been some improvement in the run rate when you kind of head into Q4. Does that mean inventory has sort of leaned out a little bit? I mean the market probably only absorbed, I don’t know, 58 million units in Q3, and if you annualize that, you are at 200 million units a year. It’s like hard to get PCs that bad next year. So I am just kind of wondering if you can comment on sort of the run rate, because August and September must have been terrible months? Thanks.

Dr. Lisa Su, CEO

The PC market was certainly volatile in the third quarter. We successfully reduced a significant amount of inventory during that period. Our guidance shows a goal to decrease even more inventory in the fourth quarter, and I believe we will make progress in that area. However, it all depends on the macroeconomic conditions over the next couple of months. As I mentioned, we have good visibility into various market factors, and we are preparing for a weaker PC environment in the fourth quarter.

Ruth Cotter, Corporate Vice President of Global Investor Relations

Thank you, Tim.

Operator, Operator

Certainly. Our next question is coming from Blayne Curtis from Barclays. Your line is now live.

Blayne Curtis, Analyst

Hey. Thanks for taking the question. I want to go back to just the pricing question prior. If you look at the decline in your Client business a little over 50%, is there a way to think about units versus pricing there and I think there’s a couple of factors. I’d be curious your thoughts mix away from the high end, but then you mentioned competition, just kind of your thoughts as to that impact to pricing as well?

Dr. Lisa Su, CEO

Yeah. So, Blayne, it was certainly more units. I think Stacy asked the question earlier. ASPs were down sequentially, but they were up year-over-year. So the decline was more driven by units, but there was an ASP factor on a sequential basis. And then in terms of what we see in the market, I would say that as the market weakened, there was sort of more pressure at the high end in terms of just velocity and desire to clear inventory. And so the mix did mix towards lower ASPs and towards more incentives to clear that inventory. As it relates to longer term, though, I don’t feel like there’s a longer term significant mix change, if that’s what you were asking.

Blayne Curtis, Analyst

I would like to know why core margins declined by 100 basis points from Q3 to Q4, considering that gross margins are down, but the mix seems to be favorable with Data Center and Embedded. It appears that PCs are not significantly down, suggesting that pricing might not be too bad.

Dr. Lisa Su, CEO

Sure. Let me explain. Considering our business outlook, there are a few key aspects. Excluding the $160 million in charges we discussed for Q3, we were at about 52%, and we are projecting 51%. The client market remains weak, and we want to ensure that we clear additional inventories. In the Data Center sector, when there is a higher mix for North American cloud, it typically results in lower average selling prices due to the current business environment. Additionally, as Devinder mentioned, as we expand capacity, especially in the server market, there is some extra capacity becoming available, which does have a cost impact. These factors contribute to the projection of 51%.

Blayne Curtis, Analyst

Thanks.

Dr. Lisa Su, CEO

Sure.

Operator, Operator

Thank you. Our final question today is coming from Harsh Kumar from Piper Sandler. Your line is now live.

Harsh Kumar, Analyst

Thank you for accommodating me. Lisa, I would like to ask about your short to medium-term outlook for the data center market. Do you believe the data center market will grow in the December quarter, independent of AMD's performance, or do you think your growth is primarily driven by the launch of Genoa? Additionally, you mentioned some dislocations in the cloud and data center sectors. Can you specify what trends you are observing? Are you experiencing a slowdown in growth, or is there excess inventory? I also have a follow-up question.

Dr. Lisa Su, CEO

What I would say is that, on a very specific level, the overall data center market isn't necessarily showing growth. Due to macroeconomic factors, there is some effect on overall spending. In terms of our business, we have a strong presence in the North America cloud market, which is the most resilient part of the market. Regarding market conditions, enterprises are experiencing weakness, and businesses are becoming more cautious. China has been weak all year. In the cloud sector, each customer has unique needs; some are optimizing inventory, others are reducing their footprint, and some are still in the process of expansion. I wouldn't describe this as a unified market, but rather as individual situations for each customer. What's beneficial for us is that our discussions focus not just on Q4 but also on their needs for all of 2023. We are coming from a supply-constrained position, so we are preparing for the necessary capacity and analyzing which workloads are transitioning and their timelines. This provides us with insight into their spending plans for 2023.

Harsh Kumar, Analyst

Very helpful, Lisa. And then for my last follow-up, can you talk about the gaming market in general? Of course, September, you mentioned was the peak quarter. So December will be off some. But is this also the peak Gaming year in 2022 and should we be thinking that Gaming will be down or just because these things are still so hard to get, to try to go buy PS5, you still can’t get your hands on it easily. So do you think there’s more legs left to the growth next year?

Dr. Lisa Su, CEO

Yeah. So, Harsh, we do believe that there is still some pent-up demand, especially coming into this holiday season. So Q3 was the peak for us this year. Q4 is down seasonally as you might expect. Going into next year, I think, there are puts and takes. I would say the best way to model at this point is to model Gaming segment flattish and let’s see how the holiday season goes, but that would be the way we would call it at this point.

Ruth Cotter, Corporate Vice President of Global Investor Relations

Thank you. We have reached end of our question-and-answer session. I would like to turn the floor back over for any further or closing comments. Thanks, Kevin. Thank you everybody for tuning in today and we look forward to connecting with you all throughout the quarter. And we have two important product launches coming up here in the next 10 days, so we will look forward to that engagement. Thanks, everyone. This concludes the call.

Operator, Operator

Thank you. You may now disconnect and have a wonderful day. We thank you for your participation today.