Portfolio holding Advanced Micro Devices (AMD) reported a very slightly better-than-expected second quarter results Tuesday after the closing bell. 

Revenue increased 70% year over year to $6.55 billion, beating estimates of about $6.53 billion, according to FactSet. Adjusted gross margins expanded 640 basis points year over year to 54%, beating expectations of about 53.5%. And adjusted earnings per share climbed 67% year over year to $1.05, edging analyst expectations of $1.03 per share. 

Breaking down the results

This was the first quarter in which AMD reported its revenues through four segments. They are: 

• Data Center which includes server CPUs, data center GPUs, Pensando and Xilinx data center products.

• Client segment which is desktop and notebook PC processors and chipsets.

• Gaming segment which is discrete graphics processors and semi-custom game console products (that go into Microsoft’s Xbox and Sony’s PlayStation) 

• Embedded segment includes AMD and Xilinx embedded products.

Since this was the first quarter of AMD’s new reporting style, unfortunately we do not have consensus estimates to compare the results to. 

Data Center revenues increased 83% year over year to $1.5 billion thanks to strong sales of EPYC server processors from both cloud and enterprise customers. Management said its upcoming launch and production ramp of Genoa, what the company called the industry’s highest performance general purpose server CPU, is on track later this year. Management believes this positions the data center business for more growth and share gains.

There was an interesting moment on the conference call when an analyst at Jefferies estimated that AMD took 6.6% share from Intel in the quarter, up from about 6% in the prior quarter. This shows AMD’s share gain story is still very much intact. Operating income in the segment was $472 million, representing 32% of revenue. That’s up from $204 million, or 25% of revenue, one year ago. 

Client segment revenue was $2.2 billion, an increase of 25% year over year driven by Ryzen mobile processor sales. Client processor average selling prices (ASP) were up year over year thanks to an increased mix of Ryzen mobile processor sales. AMD believes it gained client processor revenue share for the ninth straight quarter. Operating income was $676 million, or 32% of revenue. 

Gaming segment revenue was $1.7 billion, up 32% year over year, driven by higher semi-custom product sales, partially offset by a decline in gaming graphics revenue. AMD continues to expect record Semi-Customer annual revenue this year. Operating income was $187 million, or 11% of revenue. 

Embedded segment revenues were up significantly year over year at $1.3 billion, driven by the inclusion of Xilinx’s business. Notably, AMD said it accelerated Xilinx’s product sales in the quarter thanks to the additional manufacturing scale and resources of AMD. Operating income was $641 million, or 51% of revenue. 

Guidance

For the full year, AMD continues to expect approximately $26.3 billion in revenue, representing growth of 60% year over year. The company still expects adjusted gross margins to be approximately 54% for the year, and that’s slightly below estimates of about 54.8%, 

For the third quarter, AMD expects revenue of approximately $6.7 billion, plus or minus $200 million, representing an increase of 55% year over year, with growth from Data Center and the Embedded segment leading the way. This outlook is slightly below estimates of $6.836 billion. Non-GAAP gross margins are expected to be approximately 54%, which is slightly below estimates of about 54.6%. 

On the conference call, management explained that the third quarter outlook includes more of a conservative view on the PC business. Previously, AMD saw its PC business declining in the high single digits, and now guidance is baking in a mid-teens decline. 

Cash flow and capital allocation 

In the quarter, AMD generated a record $1.04 billion of cash flow operations, well below estimates of $2.057 billion. Free cash flow was also lighter than expected at $906 million compared to estimates of $1.795 billion. This was a big disappointment, but there were several factors that explained the discrepancy between AMD’s significant revenue growth but limited cash flow growth. Some of the reasons for the difference include higher working capital, increased cash taxes, the timing of certain shipments, and an increase investment in capacity in the form of prepayments. 

The company repurchased $920 million worth of stock, down from $1.9 billion in the prior quarter. Approximately $7.4 billion remains in the current authorization. 

Bottom line 

Instead of the usually big earnings-per-share beats and raised outlooks that AMD gave in the past, the company provided a lower-than-expected view of the third quarter and reiterated its full-year outlook this evening. We think this is one of the reasons why the stock traded lower after hours. 

However, if we look under the hood of the quarter, our long-term thesis in AMD remains intact. One of the main reasons why AMD could not raise numbers was because of its more conservative view of its PC business. This has more to do with the weak macro environment than simply AMD. More importantly, AMD’s data center business was up strongly, is still taking tons of share from Intel (INTC), and good things are on the way with the launch of its Genoa chip later this year. Plus, AMD accelerated Xilinx’s embedded revenues, and that’s always great to see in the early days of an acquisition. 

In order to explain the ~5% decline in after-hour trading, we also have to understand where the shares were coming from. AMD climbed from ~$70/share in June to touching $100/share just before the earnings report, an incredible 42% rally from the lows in just ~1 month's time. As a result, giving back ~5% is nothing, and one can view it as merely some profit-taking. We advise clients to hold the name, and wait for shares to come down a bit more before adding.