Nvidia's Q2 Results Point Towards Stronger Growth In The Back Half Of 2013

| About: NVIDIA Corporation (NVDA)

Quick Take

  • Despite strong headwinds from Tegra processors, Nvidia’s Q2 2013 earnings beat company expectation on account of strong demand for high end GPUs.
  • With strengthening GPU sales for PC gaming, greater acceptance of the Kepler architecture in PCs and beyond, and the introduction of Shield gaming device and next generation Tegra mobile processor, we expect Nvidia’s growth to accelerate in the latter part of 2013.
  • Nvidia’s growing presence in the specialty PC market such as gaming PCs, workstations PCs and high performance computing PCs insulates it from the declining trend in the mainstream PC market.
  • The company believes that open platforms such as PCs and Android are outgrowing the traditional console market. The PC gaming software market is expected to grow from $17 billion in 2012 to over $20 billion by 2015.
  • Nvidia’s GeForce, which is the gamers’ choice of GPUs, may benefit from the trend.
  • With Tegra 4 devices (including Shield), Tegra 4i certification underway and its next generation mobile processor, growth in Tegra shipments will accelerate in the second half of 2013 and beyond.

Nvidia (NASDAQ:NVDA) reported its Q2 2014 earnings on August 8, and as anticipated, macro factors, declining PC shipments and lower Tegra sales resulted in a 6.4% and 19% decline in revenues and net income, respectively. However, growing by 2.4% sequentially, the Q2 sales ($977 million) were slightly better than what Nvidia has initially projected as it saw strong demand in the high end segments of its GPU business across desktops, workstations and servers. Additionally, strengthening demand in high-margin GPU segments, particularly desktops and workstations, improved Nvidia’s gross margins from 54.3% in Q1 2014 to 55.8% in Q2 2014.

With its leadership in visual computing, Nvidia expects to see stable growth in its GPU business for the rest of the year. While the drastic decline in Tegra revenues was a strong headwind for Nvidia last quarter, the company expects to see significant growth in Tegra processors in the next two quarters and beyond.

We expect Nvidia’s growth to accelerate in the latter part of 2013. Strong sales of its high-end GPUs for PC gaming, increasing acceptance of the Kepler architecture in PCs and beyond, the introduction of Shield and its next generation Tegra mobile processor are some key factors that reiterate our belief in Nvidia’s long-term growth potential. It also started shipping the GRID virtualized graphics which extends the power of Nvidia GPUs into the datacenter.

Growing Strength In The GPU Segment Attributed To Gaming, Workstations, Quadro and Tesla GPUs

Despite efforts to expand operations in alternate growth markets, Nvidia still derives a majority of its revenues from the PC market and is impacted by declining PC shipments. PC sales dropped marginally in 2012, and research firm IDC estimates the downward trend to continue this year as well. However, Nvidia’s growing presence in the specialty PC market – gaming PCs, workstations PCs and high performance computing PCs – somewhat insulates it from the declining trend in the mainstream PC market.

Nvidia sells its PC graphics to two key segments – PC Original Equipment Manufacturers (OEMs) and gaming enthusiasts – to generate realistic and interactive graphics on PCs. While PC shipments to OEMs have slowed, the robust PC gaming market contributed to higher GPU shipments in 2012 and the positive trend continued in the first half of 2013 as well.

Driven by the release of new Kepler-based GPUs, Nvidia’s GPU business marked 9% q-o-q and 8% y-o-y growth in Q2 2014. Kepler is Nvidia’s most efficient GPU architecture to date and is now available top to bottom for workstations and servers. It claims that the introduction of Kepler has translated into higher market share and margins for the company.

Q2 2013 was the strongest quarter for Tesla which was driven by application based deals as customers using off-the-shelf applications turned to Tesla to accelerate them. Quadro also marked strong growth in the quarter as Nvidia launched the Quadro K6000 to complete its Kepler lineup.

Sales of specialty PCs like gaming systems and work stations continue to grow. PC gaming helped increase Nvidia’s GPU revenues and drive margin growth in Q2 2014. We can expect the trend to continue for the rest of the year as gamers prepare their systems for a number of games coming this fall, including blockbuster franchises such as Call of Duty, Ghosts, Grand Theft Auto V and Assassin’s Creed IV.

Nvidia believes that open platforms such as PCs and Android are outgrowing the traditional console market. The PC game revenues is expected to reach $20 billion annually by 2015, whereas the total for both PlayStations will be less than $10 billion. [1] The PC gaming software market is expected to increase from $17 billion in 2012 to over $20 billion by 2015. [2] Since Nvidia’s GeForce is the gamers’ choice of GPUs by a margin of almost 2:1, we expect the company to benefit from the above trend. [3]

Tegra Processors Remain A Long-Term Growth Driver

Nvidia’s Q2 2014 Tegra processor revenues were down 49% sequentially and 71% annually. Much of the decline can be attributed to the ramp down of Tegra 3 products and the company’s conscious decision to delay the launch of Tegra 4 by one quarter in order to pull up the production of Tegra 4i chips. The total decline in Tegra revenues so far has been higher than Nvidia’s earlier expectation and it estimates its 2013 revenue from the division to decline by $200-$300 million.

Nevertheless, leveraging its Tegra processors to tap growth in mobile computing is a key long-term growth strategy for Nvidia. With Tegra 4 devices (including Shield) and Tegra 4i certification underway (expected in Q3), we expect growth in Tegra shipments to accelerate in the second half of 2013. Additionally, the company has started sampling its next generation mobile processor, code-named Logan, based on the Kepler architecture. It promises that the new mobile graphics processor will be more powerful than the PS3 and offer around three times the performance of the iPad 4 GPU.

We expect Tegra to be an important revenue stream for Nvidia in the future. With Tegra 4 the company aims to expand its reach to other large markets where visual computing matters, such as auto navigation systems, TV set top boxes and new desktop foreign factors like all-in-one and smart monitors.

We are in the process of updating our model for the Q2 2014 earnings release.

Notes:

  1. Nvidia’s CEO Discusses F2Q 2014 Results – Earnings Call Transcript, Seeking Alpha, August 8, 2013
  2. Nvidia’s CEO Discusses F1Q 2014 Results – Earnings Call Transcript, Seeking Alpha, May 9, 2013
  3. Nvidia Corporation’s CEO Discusses F4Q13 Results – Earnings Call Transcript, Seeking Alpha, February 13, 2013

Disclosure: No positions