NVIDIA F2Q10 (Qtr End 7/26/09) Earnings Call Transcript

| About: NVIDIA Corporation (NVDA)

NVIDIA Corporation (NASDAQ:NVDA)

F2Q10 Earnings Call

August 6, 2009 5:00 pm ET

Executives

Michael Hara - Investor Relations

Jen-Hsun Huang - President, Chief Executive Officer and Director

David White - Chief Financial Officer

Analysts

Rick Schaeffer - Oppenheimer

Craig Berger - Friedman, Billings, Ramsay

Tim Luke - Barclays Capital

Joanne Feeney - FTN Capital

Patrick Wang - Wedbush Morgan

Suji DeSilva - Kaufman Brothers

David Wu - Global Crown Capital

Shawn Webster - J.P. Morgan

Operator

Good afternoon. Thank you for holding. I would now like to turn the call over to Michael Hara, Vice President, Investor Relations. Thank you, sir. You may begin.

Michael Hara

Thank you. Good afternoon and welcome to NVIDIA's conference call for the second quarter of fiscal 2010. With me on the call today from NVIDIA are Jen-Hsun Huang, NVIDIA's President and Chief Executive Officer; and David White, Chief Financial Officer.

After our prepared remarks, we will open up the call for a question-and-answer session. Please limit yourself to one initial question with one follow-up.

Before we begin, I would like to remind you today’s call is being webcast live on NVIDIA's investor relations website and is also being recorded. A replay of the conference call will be available via telephone until August 14, 2009 and the webcast will be available for replay until our conference call to discuss our financial results for the third quarter of fiscal 2010.

The content of today’s conference call is NVIDIA's property and cannot be reproduced or transcribed without our prior written consent.

During the course of this call, we may make forward-looking statements based on current expectations. These forward-looking statements are subject to a number of significant risks and uncertainties and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today’s earnings release, our Form 10-Q for the fiscal period ended April 26, 2009, and the reports on Form 8-K filed with the Securities and Exchange Commission. All of our looking statements are made as of today, August 6, 2009, based on information available to us today and except as required by law, we assume no obligation to update any such statements.

Unless otherwise noted, all references to research market and market share numbers throughout the call come from Mercury Research or John Petty Research.

During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our financial release, which is posted on our website.

With that, I will turn the call over to Jen-Hsun.

Jen-Hsun Huang

Thanks, Mike. Good afternoon, everyone and thank you for joining us. We are pleased to report revenue of $777 million, representing sequential growth of 17% from Q1. We reported a GAAP net loss of $0.19, which included an additional net charge of approximately $119 million to cover costs related to the die packaging material set issue which we previously disclosed in July 2008.

Although the number of systems impacted by this remains consistent with our initial estimates, the costs of remediation and repair has been higher than originally anticipated.

Non-GAAP gross margin, which excludes the additional charge and stock-based compensation, was 36.3%, an improvement of 560 basis points over last quarter. On a non-GAAP basis, net income was $0.07 per share. We reduced inventory by another $48 million, which now stands at 51 days on a non-GAAP basis. We made good progress managing down operating expenses through efficiency projects. I also want to acknowledge the sacrifices NVIDIA employees are making so that our company can continue to invest in the important initiatives that we are passionate about.

Strategically, we are focused on two major game changing ideas. First, computing is evolving from central processing on the CPU to co-processing on the CPU and GPU. To enable this new computing paradigm, we invented the CUDA parallel computing architecture that is now shipping in over 100 million GeForce ion quadro and Tesla GPUs, representing a significant installed base for application developers.

After three years of evangelizing, GPU computing has surely reached the tipping point. CUDA has been adopted in a wide range of applications. In consumer applications, nearly every major consumer video application has been or will be accelerated by CUDA. We estimate there are over 1200 research papers based on CUDA. We’ve highlighted 500 of them on CUDAZone.com.

CUDA now accelerates Amber, an important molecular dynamic simulation program used by more than 60,000 researchers in academia and pharmaceutical companies worldwide to accelerate new drug discovery. CUDA sped up Amber 50 times.

For the financial market, numerics and compatible announced CUDA support for their new counter party risk application and achieved an 18 times speed-up. Numerics is used by approximately 375 financial institutions.

There are broad ranging uses for CUDA including astro physics, computational biology and chemistry, fluid dynamic simulation, electromagnetic interference, CT [image reconstruction], seismic analysis, raytracing and more.

Another indicator of CUDA adoption is the ramp of our new TESLA GPU for computing business. There are now more than 700 GPU clusters installed around the world with new Fortune 500 customers ranging from Schlumberger and Chevron in the energy sector to BNP Paribas in banking.

And starting this fall with the launch of Microsoft’s Windows 7 and Apple’s Snow Leopard, GPU computing will go mainstream. In these new operating systems, the GPU will not only be the graphics processor but also a general purpose parallel processor accessible to any application.

Our second major initiative is mobile and embedded computing. It is increasingly clear that the combination of rich applications on the Internet and ultra low power computing technology will trigger the next computing revolution. Rich applications on the Internet can be connected to tiny yet powerful computers to enable amazing new experiences. Apple’s iPhone, the poster child of such an experience, has revolutionized the phone as we know it. The Amazon Kindle has revolutionized how we enjoy books.

These are surly the first of many devices to be created that will require small form factor, energy efficient yet powerful processors. Some call this cloud computing, some call it web 2.0 but all agree it will revolutionize nearly every industry.

We created TEGRA to enable the next generation of these connected devices, one that will deliver the full high definition Internet connected experience. TEGRA is the industry’s first ultra low power HD processor. TEGRA has been chosen for many next generation smartphones, smartbooks, smartpads, media players, TVs, and cars.

Let me now comment on each of our four businesses -- GeForce and Ion, Quadro, TESLA, and TEGRA.

GeForce and Ion overall grew a combined 11% quarter to quarter. GeForce offers unique capabilities that will define the next generation visual computing experiences like CUDA, which makes video and imaging applications like Cyberlink Motion DSP and Nero many times better. We estimate there are hundreds of millions of users of these applications to create, enhance, and enjoy movies from sharing videos to Facebook to transferring TV shows onto their mobile devices to be enjoyed later. With CUDA, video is the new killer consumer application for the GPU.

Second, PhsyX is a CUDA software engine that does physical world simulation and brings a new level of dynamics to games. Just today [inaudible] highly anticipated Batman Arkham Asylum announced support for PhsyX.

And then there is 3D Vision Stereo -- is quickly becoming the next big thing. From games to movies to photography, there is a groundswell of activity that will burst into the scenes in the near future.

We have announced 26 Ion designs to date. We currently have 9 Ion designs shipping with 17 more in Q3 and Q4. Ion is about bringing great visual experience to even the smallest, lowest power and most affordable PCs. The market wants a great experience on all PCs, irrespective of size or price. We have an exciting Ion roadmap and we look forward to announcing it when ready.

The GPU computing revolution has reached a tipping point. With the new operating systems, the GPU will be a general purpose parallel processor for any application. In Windows 7, GPU computing interface is called Direct Compute and OpenCL for OS10 Snow Leopard. And although the upcoming CPUs and chipsets may include integrated graphics, these graphics controllers lack the general purpose parallel processing capabilities needed by the new operating systems.

Recently John Petty, a leading industry analyst, forecast the global graphics market to grow nearly 22% in 2010, based in part to the rise of the GPU as a co-processor. The report states the continued expansion and development of heterogeneous computing and GPU compute will stimulate growth in 2010, enabled by Apple’s and Microsoft’s new operating system, new programming capabilities using OpenCL, Direct Compute, and NVIDIA's CUDA architecture will remove barriers to the exploitation of the GPU as a serious economical and powerful co-processor in all levels of PCs.

Quadro is our professional visualization solution and the standard for professional designers and creators. Revenue which has declined nearly 40% due to the broader economy affecting the automotive and other industries, was essentially flat from Q1 and appears to have reached bottom. Irrespective of current demand, we continue to innovate amazing new capabilities. This week we announced Axe, or Application Acceleration Engines.

Our suite of GPU accelerated software engines that are vital to software companies all over the world including Autodesk, [Desso], and RTT to name a few. AXE includes PhsyX for accurate physics simulation used in CAD to simulate contact of physical objects, a multi-GPU rendering engine and tools for managing large data sets.

One of the most exciting AXE engines is Optics, the world’s first interactive raytracing engine used to generate photorealistic images. For the first time, designers can study and interact with a photorealistic rendering of their design. Optics is a must see to believe new visualization capability. We are currently engaged with 40 beta sites that are actively using our Optics raytracing module. When deployed, each Optics application will be powered by rendering servers with CUDA GPUs.

This week we also announced Quadroplex SVS, a plug-and-play solution for scaleable visualization. Quadro SVS will revolutionize the way professionals interact with 3D models and analyze large volumes of data in fields such as energy exploration, architectural design, medical research, and consumer packaged goods.

Any application can be distributed seamlessly to run on over four GPUs and displayed across eight displays to create an astounding 32 million pixels of resolution. We estimate that the total addressable market for Quadroplex SVS is approximately $100 million per year, growing at 10% to 20% per year.

TESLA is the industry’s first GPU for high performance computing. The TESLA solution consists of compilers, tools, libraries, as well as the largest team of parallel computing experts to assist in software development.

TESLA is available as a module, a desk side personal super-computer or server for high performance computing clusters. TESLA achieved its first significant quarter of revenue with approximately $10 million in sales. Virtually every major OEM, including [Cray], Dell, HP, IBM, Lenovo, Silicon Graphics, or excuse me, SGI, Sun, and Super Micro now offers TESLA based solutions.

TESLA computing servers are installed in over 700 sites around the world. This quarter we supplied our largest single cluster to date with over 4,000 GPUs. To put this into context, this cluster would be the 12th fastest super computer on the top 500 list.

We have over 50 HPC specialized VARS currently selling TESLA today. We estimate there are approximately 1,000 VARS actively involved in the HPC market which we have yet to engage.

We estimate TESLA to address a $5 billion market opportunity for us over the next three years.

TEGRA is our mobile and embedded processor. We are very excited that our first TEGRA project has entered production. As reported in the press, TEGRA is the processor at the heart of Microsoft’s new Zune HD. There are many more innovative devices in the works. There are 50 active TEGRA designs and many more in evaluation, currently ranging from smartphones and media players, 35 smartbooks and mobile Internet devices, and a growing number of embedded designs for IPTVs and cars.

We estimate that TEGRA will address a $4.5 billion market by 2010 and position us at the epicenter of the next personal computing revolution.

Let me now hand it over to David to discuss our financial details.

David White

Thanks, Jen-Hsun. As Jen-Hsun indicated in his opening comments, revenue for the second quarter of fiscal 2010 was $776.5 million, up 17% from $664 million in the prior quarter and also higher than our estimate of up 5% sequentially.

Our second quarter has historically been a seasonally weak quarter for the industry, so we are pleased with our quarter over quarter growth.

We reported a GAAP net loss of $105.3 million, or $0.19 per share. This included additional net charge of $119 million to cover costs related to a weak die packaging material set that was previously identified and used in certain versions of our previous generation chips. This compares to a GAAP net loss of $0.37 per share in the prior quarter, which included a one-time charge of $140 million associated with a cash tender offer for the purchase of certain employee stock options.

Excluding this $119 million net charge, as well as stock-based related compensation, we reported non-GAAP net income for the quarter of $37.7 million, or $0.07 per share. This compares with a $0.09 non-GAAP net loss per share in the prior quarter.

Let me now turn to our individual businesses -- our GPU business, which includes desktop, notebook, and memory -- represented 48% of our total revenue. In absolute dollars, it was up 5% quarter over quarter. The desktop segment of our GPU business was also up approximately 5% quarter over quarter with continued strength across almost all GeForce product lines, particularly in the higher end performance and enthusiast segments.

The proportion of our desktop revenue sold into the channel was consistent with last quarter with channel inventories remaining at approximately one month’s supply on hand.

The notebook segment of our GPU business was down approximately 5% quarter over quarter. We lost some share in Q2 as the commercial Montevino refresh platform ramped. We expect to regain share as we ramp into the fall platform with our new 40-nanometer GPUs that are in full volume shipments.

Our MCP business, which represented 31% of our total revenue during the quarter, was up approximately 27% quarter over quarter. Consistent with our first quarter, demand was primarily driven by our chipset products designed for the mainstream AMD integrated desktop segment, which was up 55%. It was also driven by chipset products designed for the Intel-based notebook segment, including Ion, which was up 33%.

Revenue for our professional business, which includes workstation graphics and computing, represented 15% of total revenue and was up 10% quarter over quarter. Substantially all of this increase was attributable to TESLA.

As for Quadro, corporate demand, which comprised a substantial percentage of this business, appears to have bottomed at the levels we are currently at with signs that we may be in the early stages of an economic recovery.

Our consumer products business, which includes TEGRA as well as embedded entertainment, represented 6% of our total revenue. It was up in absolute dollar terms almost three-fold quarter over quarter. TEGRA and game consoles both saw significant increases.

Looking at the business as a whole, GAAP gross margin for the second quarter was 20.2%. Excluding the net charges associated with the weak material die set, as well as stock-based compensation, non-GAAP gross margin was 36.3%. Our non-GAAP gross margin exceeded our estimates as a result of several factors.

First, we experienced better 55-nanometer yields during the quarter and our mix of 55-nanometer revenue also improved.

Secondly, our consumer business, which carries higher margins because it includes royalties from game consoles, was up as demand resumed on the consumption of excess consumer channel inventories in the first quarter.

And finally, margin in our MCP business was also up as a result of more favorable product mix.

GAAP operating expenses for the second quarter were $267 million. That’s down $25 million from the previous quarter when you exclude the one-time charge for the stock option tender offer. This quarter-over-quarter reduction was primarily related to lower stock compensation expense resulting from the stock option tender offer we completed in Q1, the full quarter effect of wage reductions implemented in Q1, and lower legal expenses related to ongoing litigation, as well as numerous other cost reduction initiatives we have undertaken to improve the efficiencies of our operations.

NVIDIA's worldwide employment at the end of the second quarter stood at 5,506, essentially flat from the first quarter.

Turning to the balance sheet, accounts receivable at the end of the quarter were $352 million, which equated to a DSO of approximately 41 days, an improvement of 1 day from the prior quarter.

Inventories at the end of the quarter were $279 million, down $48 million, or 15% quarter over quarter. Inventory days at quarter end were 51. This compares with 64 days at the end of the first quarter and 144 days at the end of the fourth quarter.

Depreciation and amortization expense for the second quarter amounted to approximately $49 million, down slightly from $51 million in the first quarter. Capital expenditures were $18 million, which as a result of cost reduction efforts were down slightly from the $21 million we spent in the prior quarter.

Accounts payable at the end of the quarter were $276 million, up approximately $50 million from the prior quarter, driven largely by our higher volumes. And our free cash flow for the second quarter was a positive $117 million.

Cash and cash equivalents, marketable securities at the end of the quarter were approximately $1.47 billion, up approximately $128 million from the first quarter, with the principal contributors being cash earnings and lower inventories.

In closing, let me briefly comment on our outlook for the third quarter of fiscal 2010. We expect revenue to be up 5% to 7% from the second quarter. As for gross margin, we expect GAAP gross margin to increase in the range of 36% to 38%. The primary factors for this improvement are lower overall costs, 40-nanometer volumes, and form higher gross margin products like TESLA and TEGRA as they continue to ramp.

We expect GAAP operating expenses to be in the range of $280 million. This is up from the prior quarter as a result of increased tape-out and prototype activity, as well as increased litigation expenses.

We estimate stock-based compensation expenses in the third quarter to be $23 million and deprecation and amortization and capital expenditures to be approximately flat when compared to the second quarter.

Diluted shares for the third quarter are expected to be in the range of 565 million to 570 million.

This concludes our formal remarks. At this time, we’d like to open the call up for questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Rick Schaeffer with Oppenheimer.

Rick Schaeffer - Oppenheimer

Nice quarter. I have a couple of questions -- just one real quick, could you give us a little more like maybe incremental color on the $119 million charge? Maybe your confidence level that this sort of puts the [bump metal] issue to rest and if so, do you think this is going to make it easier for you guys to win notebook business, retake share going into the back half of the year?

Jen-Hsun Huang

Rick, if you go back a year ago when the company first recognized this issue and we recorded a charge in the second quarter same time a year ago, that was based upon an estimate at that time that -- it included a number of factors that the company had to estimate and didn’t have a lot of data on it at that point. At that point, we only had one OEM customer that we entered into negotiations with but here we stand a year later and we’ve substantially negotiated agreements with almost all of the affected OEMs. We have more specific information as it relates to what the repair costs will be, not only our customers but other parties that are part of the ecosystem for supplying those products. So today we feel much more confident about our estimate, the range around that estimate. It is still an estimate. I won't say it will never change but we feel pretty good about the data we have today and our ability to estimate it at this point.

As it relates to the second part of your question, if you look at the people that are focused on the [bump crack] issue, it’s really a small, very small portion of the company. The company -- the vast majority of the company are really focusing on the future of our business with very little distraction by [bump crack]. Certainly it’s a distraction for some of our customers and so forth. It really isn’t impacting the company or our ability to launch new products and for those products to be accepted in the marketplace.

Rick Schaeffer - Oppenheimer

So it really hasn’t been much of a headwind for you the last quarter, I guess?

Jen-Hsun Huang

No.

Rick Schaeffer - Oppenheimer

Okay. And then just a follow-up -- could you quantify maybe how much of the second quarter gross margin improvement was related to better mix within GPU, you know, give us a number maybe? And also as part of that, how do you guys look at your market share in discrete going forward? I mean, are you guys sort of more focused on improving gross margin in the back half of the year there or do you expect to see sort of continued pricing pressure as you try to increase share there?

David White

So on your first question as it relates to GPU margins, you know, we -- as I indicated in my comments, we have a number of products that cut across a number of different process nodes and this quarter, we were able to move more of our business into the 55-nanometer process node, so that changed the mix. And probably overall, it was at least a point you might say in the improvement we saw quarter over quarter.

Jen-Hsun Huang

And as we ramp up, Rick, as we ramp up our other businesses like TESLA and TEGRA, which are inherently higher gross margin products, our gross margin is going to continue to improve but the major factor is as you recall, several quarters ago we had nearly 150 days worth of inventory and a lot of that inventory was in 65-nanometer and the company has been really focused on making sure that we work through that 65-nanometer inventory and now we by and large worked through it and as we are now ramping aggressively 55- and 40-nanometer products and they are all fresh products, the gross margins are going to be much, much better with that.

Related to increasing margins or increasing share, the answer is yes on both. I mean, we believe we can increase margins by driving efficiency in our company and even though the velocity of this -- of the GPU business is incredibly high, we believe that extraordinary excellence can improve margins and you’ve seen us do that before.

And on the other hand, we can increase the premium of our products in the marketplace above where it is today. Almost every single segment, there’s a premium on our product and yet we continue to capture a very significant part of the market share and the reason for that is because our products have a much better reputation and it’s always -- it’s had a history of delivering wonderful experiences and this is a much more desirable brand. And so we focus on making sure that the GeForce brand comes with it unique capabilities that other people don’t offer beyond just your basic graphics chip. And so you know that GeForce has the parallel computing capability called CUDA. It has PhsyX processing so that games could be much more dynamic and beautiful, and also this 3D vision investment that we are making that we’ve been talking about. It’s going to turn into a watershed event towards the end of the year [and over to the next]. And this is -- you know that the entire film industry is moving towards stereovision and everybody is looking for ways to bring that capability or that experience to the home. And 3D vision is a pioneer in that space and from a technology investment perspective, we’re just miles and miles ahead.

And so these kinds of innovative ideas are going to continue to help us drive our value in the marketplace and yet still grow our share.

Rick Schaeffer - Oppenheimer

Great, thanks. Congrats, guys.

Operator

Our next question comes from the line of Craig Berger with Friedman, Billings, Ramsay.

Craig Berger - Friedman, Billings, Ramsay

Thanks for taking the question. Nice job on the results. Can you talk about what you are seeing out there on the attach rates for discrete GPUs today in this recessionary environment and where they might be going over the next year?

Jen-Hsun Huang

We’ve not noticed a shift, if you will, in attach rates per se. We know we have stronger attach rates in certain segments of the market than others for good reasons. For example, you heard in the comments that channel inventory is low. We keep our eyes on channel inventory because a vast majority of our discrete GPUs come from the channel, so although only 50% or maybe 40% of the world’s PCs come from tier two providers, system builders, and channel integrators. The vast majority of the discrete GPUs come from those 40% and the reason for that is because the system builders and the system integrators rely on NVIDIA's brand and the additional capabilities that our chip provides, our processor provides, to offset the tier one brands that they compete against, whereas the tier ones tend to focus on the benefits of their own brand and utilize lower cost components related to, in this particular case, integrated graphics.

So our attach has historically been higher in system builders than the OEMs anyhow but -- and that really -- hasn’t really shifted or changed for our perspective.

And going forward, I think that all of the road signs are starting to become more clear. We’ve been evangelizing this idea called GPU computing for some time and it’s a very logical and common-sensical idea that they have to use the right tool or the right processor for the right job. And programs, modern applications today have a lot of instruction parallel parts of the software program but there’s an enormous amount of data parallel parts of the program. And in the data parallel processor part of it, which could have been 3D graphics which we offloaded immediately and historically onto the GPU, but increasingly it’s related to video and images and search and those kind of -- types of applications, in which case we created a parallel processor, a general purpose architecture called CUDA so that applications can offload that.

And so you are now starting to see more and more people talk about GPU computing. In fact, I think that there’s almost no one that I know of in the computer industry who would tell you now that GPU computing or in general called heterogeneous computing is not the future of the computer architecture from industry analysts to Microsoft to Apple Computer -- you know, almost anyone who is developing the future of the computer architecture will openly admit that heterogeneous computing is finally here and it’s the right approach going forward.

Craig Berger - Friedman, Billings, Ramsay

As a follow-up, can you guys talk about where you are at with 40-nanometer? What portion of your output it might be over the next six -- you know, over the next couple of quarters and what the gross margin impacts there are as you pay more for wafers and potentially get more die per wafer? Thank you.

Jen-Hsun Huang

I think the general buzz around the industry is that we are by far the largest producers of 40-nanometer today and I think that that’s probably consistent. We have shipped more and earlier than just about anybody, and we haven’t spoken a lot about our 40-nanometer products because we have fabulous products that we are currently shipping and so we tend not to pre-announce products until the customers are really shipping themselves, and so we are ramping our 40-nanometer product now. By Q4, it will represent a very large portion of our revenue. It certainly won't represent the vast majority of it.

Early next year I think it will continue to grow and my expectation is by about the Q3 timeframe, it will represent the vast majority of our products -- Q3 time for next year.

Craig Berger - Friedman, Billings, Ramsay

What’s the gross margin impact on 40-nanometer versus 55?

Jen-Hsun Huang

Our gross margins are higher on 40-nanometer products because they are fresher products and the die sizes are lower, are smaller and so they tend to be -- they tend to be more cost effective for us.

Craig Berger - Friedman, Billings, Ramsay

Thank you.

Operator

Our next question comes from the line of Tim Luke with Barclays Capital.

Tim Luke - Barclays Capital

Thank you. David, as you look forward and you have obviously seen a significant progression in the gross margin in the July quarter and you are guiding for it to be up again in October, how do you see this moving into the fourth quarter and next year? Should we think about you having the potential as you move to more 40-nanometer to be able to continue this upward trajectory by 100 basis points for the next few quarters, or how should we think about that? And at the same time, could you give us some feel for how we should plan and think about your OpEx going forward as you -- can you hold this 280 level or should we think about it beginning to grow now as the revenue begins to come back? Thank you.

David White

On the gross margin outlook, there’s probably three or so significant pieces of our strategy going forward to increase that. Certainly as you mentioned the 40-nanometer ramp will be an important element of that as Jen-Hsun just commented on a second ago.

The second will be the ramp of TEGRA and TESLA, which are both relatively two new platforms for the company, as they become a larger piece of our mix, their margins today and we expect to continue to be above what our corporate average is and so they will tend to lift the overall margins for the company.

Quadro at the same time carries higher margins than the aggregate for the company and so as the economic climate of our economy and so forth rebounds and as those two products, TESLA and TEGRA ramp, our overall mix is going to be very favorably impacted in our favor.

So we should see our margins continue to improve over the foreseeable -- you know, next four quarters or so. Will there necessarily be hiccups in the way? No one can guarantee that there won't be but clearly those are the important elements of our strategy and as they get executed on and we think that our [inaudible] will continue to make progress.

On the operating expense side, we’ve indicated previously that our objectives were to get our total operating expense down in the $265 million-ish range. Today we ended roughly at that level but in our guidance, we obviously said it was going to go back up and so when you look at some of the reasons for that going back up, they are dictated by some of the litigation expenses that are going on which clearly won't go on forever. It’s dictated by a convergence of a number of new products offerings that are all happening at the same time which obviously increased some of our expenses in the current quarter.

So I think we will continue to see expenses to come down from the 280 level but it will probably just be a little bit slower than what we initially anticipated it would be.

Tim Luke - Barclays Capital

Just two quick follow-ups -- [Quadro] was up a lot. Could you give us a feel for what piece of that is beginning to be TEGRA and how should we think about that for the calendar fourth quarter? And then it looked like workstation was fairly flattish. Is it beginning to show some improvement in the quarter market in workstation? Should we begin to anticipate that for the second calendar half of the year?

And maybe Jen-Hsun, with the introduction of Windows 7, how have you seen that or not impacting the market?

Jen-Hsun Huang

I will just take a couple of pieces of that. I think they are in general related to gross margin and such. Our Quadro business appears to have normalized or stabilized and certainly the feeling that we are getting from our enterprise customers reflects what other people are seeing out in the marketplace, that the general economy appears to have stabilized some an that the automobile industry, which is a very large consumer of workstations appears to be in better health.

There are other growth markets now for the workstation market. Medical imaging is a very large part of it. Medical is -- and medical research benefits a great deal from a lot of recent attention.

We also aren’t just waiting for the overall economy to come back, as I’ve discussed earlier. We are creating new products that allow people to do new things that weren’t possible before. This Optics raytracing engine, real-time raytracing engine that runs on CUDA GPUs is really a groundbreaking idea, is a groundbreaking capability. We have 40 beta sites going there and when they deploy, they deploy in relatively large configurations because it’s -- the type of models or the visualization task is quite significant. And those could -- those 40 beta sites are just as many as we can support. You know, the number of companies out there who would like to accelerate their time to market through better visualization of their designs is -- well, you could imagine how many that would be. It literally would be every single company in the world would like to do that.

And so this is something that is of great importance and we’re driving that pretty hard.

We also know that high resolution displays and projectors are becoming more affordable than ever. The Sony 4K projectors, digital projectors are very affordable and people need scalable resolution, scalable visualization solutions to be able to address that and so we created a new product called Quadro SVS. And the Quadro SVS virtualizes both the application as well as the display, so you could literally run one application across up to four GPUs completely virtualized and invisibly, and then you can take the output of that and literally drive it up to 32 million pixels without the application ever knowing anything about it. And so this virtualization technology both at the GPU level as well as the display level is a groundbreaking idea and it’s something that we are really excited about.

So we’re going to try to -- we believe that innovation drives growth and we can drive growth irrespective of the economy but the economy certainly has stabilized. So that’s certainly a very important part of our growth factors.

In terms of TESLA, the computing market is a multi-billion dollar market. The reason why TESLA has been adopted by literally every single computer company in the world is because they see the same opportunity we see. People are evaluating and developing software now for TESLA for broad deployment all over the globe and people are looking for ways to improve their computational horsepower per dollar to reduce cost or more importantly to reduce power. TESLA servers consumers nearly 20 times less power than a conventional CPU server and the reason for that is because of the amount of performance that you get out of it.

You know, when I said earlier doing the right job with the right tool, it’s an efficiency statement. If you do that, you will reduce power, you will reduce cost, and you will get things done faster.

And so I think TESLA is going to be a very important growth driver for us as well for next year.

And then on Windows 7, Windows 7 is -- my expectation is that the adoption of GPUs will go up and the adoption of GPUs will go up because very simply that if the operating system allows applications to take advantage of the parallel processor in your PC, they will take advantage of it and when they take advantage of it, the GPU is the right answer.

Tim Luke - Barclays Capital

Thank you, guys.

Operator

Our next question comes from the line of Joanne Feeney with FTN Capital.

Joanne Feeney - FTN Capital

Good afternoon. A question following up on the last one, actually -- so in terms of the value of the GPU for Windows 7 and others that will take advantage of that, what are you guys thinking, what are you assuming about the future of attach rates or of the chipset business once Intel starts to deploy their [Capella] which combines the CPU and the GPU?

Jen-Hsun Huang

Yeah, in fact, Joanne, thanks for that question. It’s probably the greatest opportunity I have seen in the GPU business in the last 10 years. And the reason for that is because, and we’ve said this as a high level theme for some time, it just had to play out.

You know, the challenge of integrating graphics into a chipset or into a CPU that has very long design cycles is that by definition, you’ll have to integrate many year old technology into a single chip. And this GPU computing idea that we’ve been evangelizing for three years, some companies really, really didn’t believe it. They really believed in central processing. And as a result of that, they under-invested in the graphics technology that goes into these Capellas and future CPUs with integrated graphics.

And so Windows 7 has direct compute. OS 10 has OpenCL. Linux and others have CUDA. And people are developing parallel computing applications all over the world. You see it, we see it, and every OEM sees it and so the only way to really accelerate or even do a reasonable job at those applications is to add a GPU next to it.

So it doesn’t really matter where the display comes from. The display just drives the monitor. The basic 2D graphics or the basic 3D graphics just drives the monitor. The parallel processing, the programmable shading and all of those other things will come from another processor and we just call that processor the GPU.

So I think the adoption is in fact going to be quite high when the CPUs integrate basic graphics that are not good enough for the modern operating systems.

Joanne Feeney - FTN Capital

Okay, so what would we have to assume, or what are you guys assuming the attach rate would have to rise to in order to offset the potential loss of the basic chipset business? What kind of attach rates do you envision arising over the next year or so?

Jen-Hsun Huang

Well, we don’t actually expect much loss in our chipset business next year. We have quite a few exciting projects that we are still working on and people are pushing us really hard to get more chipsets done. So we’re not expecting the decline of it but we are expecting adoption to increase for GPUs next year.

Joanne Feeney - FTN Capital

Okay. Can you comment at all -- probably not, but can you address at all the issue of the legal dispute over the way you can in the future connect your chipset to the system with Intel arguing that you don’t have this particular license that you need?

Jen-Hsun Huang

Well, you didn’t say -- in your question about chipsets, you didn’t ask specifically about the future and neither did I comment about that and so it’s not related -- it’s just not related.

We’re not -- let me just -- we’re not necessarily building chipsets for future Intel buses. We’ve not commented anything on that and so you are just going to have to wait to see what we come up with and I think that, Joanna, you’ve known us for quite a long time now and the one thing that you can probably say about our company is we are pretty darn clever. There is a lot of ways to skin the cat and we are going to show you more ways to skin the cat than you can shake at and so you just have to wait.

Unfortunately, I can't give you the punch line and you just have to wait for the big surprise.

Joanne Feeney - FTN Capital

Okay, we’ll wait. Thank you.

Operator

Our next question comes from the line of Patrick Wang with Wedbush Morgan.

Patrick Wang - Wedbush Morgan

Thanks for the question and great job on the quarter. First, just on MCP for chipset, I know that you guys had some good -- some positive trends for AMD based chipsets there and then Ion, I was just hoping you could talk in a little bit more detail about how we should think about those kind of going forward to the next quarter or two.

Jen-Hsun Huang

Well, we have Ion projects that are still coming to market and ramping into production, so my sense is that Ion will still be a growth business for us and so we are going to have to just wait and see how the market adoptions are. We have quite a few projects that we are still ramping.

The chipset business, the definition of a chipset is just a companion processor or a companion chip to the CPU and we have a lot of companion chips to the CPU that enhances the overall experience.

You know, our focus is really very simple -- to enhance the computing experience over the baseline capabilities that Intel or AMD provides, and so if I generalized a statement like that, the smart people will come up with all kinds of great ideas and we have some really exciting things that we are doing for next year.

Patrick Wang - Wedbush Morgan

Okay, but if we think about -- you know, I mean, you guys have clearly seen strong orders just on some of the AMD based shipments into Asia, I mean, is that something that we should expect to kind of continue or is that -- or is Ion going to be able to more than offset that type of decline?

Jen-Hsun Huang

It’s actually kind of interesting -- in a way, we only do well on AMD chipsets when AMD’s low-end CPUs or mainstream CPUs do well. And so our -- part of that question, part of the answer for that question depends on how well AMD does. And so we are rooting for them and we’d like them to do well.

On the other hand, we have Ion processors that are companions to Intel CPUs and so we are rooting for them too. And so we are just rooting for everybody.

Patrick Wang - Wedbush Morgan

Okay, no, that’s helpful. And then just two quick ones here -- you know, there’s been a lot of concern about desktop pricing intensifying in the back half of the year here -- just curious what -- how you are thinking about that, what’s your sense in terms of how that is going to track and potentially the impact to margins?

Jen-Hsun Huang

Well, we are always going to compete for the business out there and we follow two basic, maybe three basic rules -- one is that we always look for ways to innovate. The competition has a basic graphics chip and they’ll sell it at the lowest possible price to gain share. We will tend to take a slightly different strategy all the time. We are always looking to innovate and create new value that we can bring to the users and in exchange hope that they would reward us with a higher premium. The GeForce brand across the board has a higher premium almost at every single segment and we hope that they will recognize the benefits of the work that we’ve done with 3D stereo and CUDA and PhsyX so that they will continue to reward us for the value that we bring.

On the other hand, we’ll fight hard for business and we’ve had to be competitive out there and we are realistic about market conditions and we are realistic about the competition and so we’ll continue to fight for our business.

And then the last lever is continue to drive costs down in our company and do the things that are in the control of our company to improve our margins.

Patrick Wang - Wedbush Morgan

I see. That’s helpful. And then just a last one, I was hoping you could --

Michael Hara

Patrick, we have guys waiting, can we move on to the next one?

Patrick Wang - Wedbush Morgan

Okay, great. Thanks so much.

Operator

Our next question comes from the line of Suji DeSilva with Kaufman Brothers.

Suji DeSilva - Kaufman Brothers

Nice job on the quarter. On the professional segment, you guys gave a sense that the orders were ones that were kind of embargoed for a while and are now coming back or there’s new business -- is there any sense of that talking to the sales folks?

Jen-Hsun Huang

Suji, what does embargoed mean?

Suji DeSilva - Kaufman Brothers

I just mean they put them off, basically because of the economic downturn and they were delayed until now. Is that the sense of where these orders are coming from?

Jen-Hsun Huang

It must be. It’s got to be. My sense is that the requirement for design tools to create products to solve problems in research to discover new signs, you know, I think that those -- the demand didn’t perish. I’m certain we didn’t lose any market share and so it must be because demand was held up, our spending was held up because of cost containment reasons.

We are starting to feel the benefits and some of the early signs of the stimulus program kicking in, and so I think whether it’s in industry or in science, in the academia, we are starting to feel much, much more positive energy relating to upgrades and new machines.

But we are also, like I said earlier, we are going to innovate our way out of it either way and if the market comes back, we’ll just get the double whammy and I can't wait until Quadro goes back to our historical levels of $200 million, $250 million a quarter. And if we add that, add to that all of the new capabilities that we are creating, as well as TESLA, I think our enterprise business could be really, really significant and so -- but we are just going to focus on innovation and when the purchasing power comes back, they are going to have a lot of new things to buy.

Suji DeSilva - Kaufman Brothers

One other quick question, Jen-Hsun -- the Montevino share that you lost and now you are recapturing, can you kind of remind us of the dynamics of that share shift and why you think that won't necessarily recur going forward? Thanks.

Jen-Hsun Huang

Well, the notebook business is very competitive and it’s a combination of a lot of things and I forget exactly what the reason was when we lost some share. Sometimes we don’t have the appetite to go for the prices that are needed to win, sometimes the competition just has a better offering, or sometimes the competition is already designed in and so it was just easier to transition to the new platform.

So there’s a variety of different reasons that -- and there’s only one way to win and about 10,000 ways to lose, and so looking forward, we know what sockets we’ve already won and the ramp of 40-nanometers will play a big role and hopefully we come back, and so we are looking forward to that.

And then going forward, we just have to invent new ideas and new capabilities that really delight our customers and break new ground, and we’ll win [inaudible] as a result of that.

Suji DeSilva - Kaufman Brothers

Thanks, guys.

Operator

Our next question comes from the line of David Wu with Global Crown.

David Wu - Global Crown Capital

Good afternoon. Can you talk a little bit about your guidance in terms of revenues? I know you had some pretty good seasonal demand, better than seasonal demand in Q2 but Q3 it happens to be your -- if I recall, the seasonally best quarter of the year and with 40-nanometer based products coming on-stream, why would the sequential growth be such low levels, admittedly from a higher base for FY -- the first quarter of this fiscal year? And I have a quick question, follow-on, too.

Jen-Hsun Huang

Well, I think we -- we’re not particularly -- we don’t have any particular better insight into the economy than you do but I think that the notion of seasonality really needs to be challenged or reset with the new economy. Thinking about the previous season and these seasons, just it makes no sense. It’s a new world out there now and so we are just looking at business every single day and we guide to what we think is the most prudent and the best of our ability and it is what it is. Compared to what some other companies have guided, it appears to be quite good and so we’re just going to have to play it out and see how it turns out.

David Wu - Global Crown Capital

Okay. This week has been a Siggraph week and I understand that our friends at Intel have been talking about Larabie. Are there any things that they have revealed to the world I guess this week that is a meaningful surprise or departure from what your understanding was prior to Siggraph this week?

Jen-Hsun Huang

This is the third Siggraph that they’ve talked about Larabie and we paid attention to the last two. I have to admit that I didn’t pay much attention this time. Not because I don’t care -- we were just really busy. So if you hear anything, let me know but I’ve not heard anything from the grapevines.

The important thing is that they -- they now recognize that parallel computing is too important not to invest in and it’s also clear that parallel computing is very hard otherwise they would have taken so long to build it. And to efficiently auto parallelize applications and make it easy for programmers to achieve the level of parallelism that is inherently possible in the silicon is really, really hard work and it’s something that we’ve spent the last 15 years of our company and for many of us, many of the industry, many of the experts in our company, some 30 years of their careers working on this problem. And so it’s not something that just because somebody wants to throw a bunch of CPUs together is going to make it happen, and so I think one, they recognize the importance of it; two, it apparently is very hard; and then three, I can’t wait to see Larabie like anybody else. After all this talk, I’m just dying to see it and so when I see it, you’ll be the first to know.

David Wu - Global Crown Capital

Just one quick -- I’ll sneak one quick one in; what is the tax rate we should be using for this, the rest of this fiscal year or next year? On a pro forma basis?

David White

Probably for this year somewhere in the 4% or 5% range. Next year, well, it’s anyone’s guess depending on what happens with tax legislation but I think it would still be in the 10% type of range.

David Wu - Global Crown Capital

Thank you.

Operator

Our next question comes from the line of Shawn Webster with J.P. Morgan.

Shawn Webster - J.P. Morgan

Thanks for taking my question. Can you talk a little bit about the -- I guess the overall demand environment, you laid some context that the economy is still a little bit uncertain. That kind of colored your outlook for Q3 but based on your order trends, what segments do you think will be the strongest and the weakest? And can you give us some flavor on what units and pricing for your GPU business did during the quarter?

Jen-Hsun Huang

I’ll let David take the second part and I’ll just take the first part real quick because that one is easy -- we’re seeing strength right now pretty much across the board. David.

David White

Shawn, can you repeat the second piece of it?

Jen-Hsun Huang

It has to do with price -- ASPs and units --

Shawn Webster - J.P. Morgan

Yes, units and pricing.

David White

Well they are both obviously up quarter over quarter and if you’re looking from an outlook standpoint, we’re anticipating them being up again as well. From an ASP standpoint, it’s kind of -- our ASPs are kind of a -- greatly influenced by the mix of the product that we are selling and so we tend to -- we tend to have product shifts that tend to maintain ASP in each of the three mainstream performance enthusiast categories we try and support.

So I don’t know that there’s necessarily a strong indicator directionally one way or the other as it relates to ASPs in the GPU segment.

Shawn Webster - J.P. Morgan

Okay, but the ASPs were up, you said?

David White

You know, when you look at it from a mix standpoint, the mix factors into that so when you look at it by those three segments that I was saying, yes, they are up in two of those segments and modestly down in the third.

Shawn Webster - J.P. Morgan

Okay, and then my last one, did you have any benefit from the sale of the inventory you wrote down in prior quarters?

David White

No -- immaterial.

Shawn Webster - J.P. Morgan

Okay. Thank you very much.

Operator

There are no more questions at this time. I will now turn the call over to Jen-Hsun. Please go ahead.

Jen-Hsun Huang

Thank you all for joining us today and we look forward to reporting our results for Q3.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you all for your participation and we ask that you please disconnect your lines. Have a great day, everyone.

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