Nvidia Tops Estimates, But Tegra Makes for Risky 2H (NVDA: NEUTRAL)

Nvidia reported results near the top of guidance and ahead of expectations ($955M vs. $940M, and $0.13 vs. $0.10 GAAP) even as Tegra revenues dropped more steeply than we had expected ($103M vs. $125M); the company was helped by relative strength in graphics which supported sales and gave gross margin a lift.

• Guidance is weaker than expected as another steep decline in the Tegra segment reflects the winding down of Tegra 3 builds. The delay in Tegra 4 accounts for this gap in revenues this year compared to last and so Tegra sales look to drop below $70M (down 34% Q/Q), a level not seen since the early days of the effort (F4Q11 – Jan 2011). GPU is expected to rise on desktop GPU strength even as notebook GPU declines (up 7% Q/Q).
• Tegra 4’s ramp in 2H is critical: Tegra 4 is slated for tablets, other Android devices, Shield, gaming systems, autos, and other consumer electronics applications (not phones), and is expected to begin to ramp at the start of the October quarter. The company expects Tegra revenues in FY14 to match those of FY13 ($764M), but to do this, given the F2Q outlook, would require 2H revenues close to $600M, a 31% increase over F2H13 Tegra sales and nearly 250% 2H/1H. Uncertainty in design wins, and in the success of these among consumers, clouds forecasts and leads us to discount management’s outlook.
• GPU share topped out: Nvidia’s share gains last year (esp. in notebook) still have some life in 2013 as Intel keeps Ivy Bridge in play longer than expected, but Haswell’s better graphics and AMD’s recent efforts suggest that the PC side of Nvidia’s GPU business is likely to stagnate. On the professional side, we expect more growth through Tesla and GPGPU in servers, and perhaps even a slight rebound in workstation graphics on the mediocre macro recovery.

Key Drivers, New Estimates, and Recommendations:

Forecast Implications:

• OpEx rises again this quarter and this pushes EPS lower even on higher sales: we see $0.12 GAAP EPS on $975M in sales with Tegra at $68M; EPS helped by aggressive buyback program.
• For the year, the uncertainty regarding commercial success of unknown Tegra 4 design wins (our checks reveal no major wins thus far) leads us to discount management’s view by ~25%.  This leads us to our FY14 sales estimate of $4.20B for EPS of $0.73.

Critical Upcoming Drivers and Recommendations:

• Nvidia’s smartphone entrant depends on certification of the Tegra 4i,  this is underway now at AT&T, and the first status update on the data-only 500i should be coming at the beginning of the next quarter; should be a strong signal on T4i.
• We are remaining NEUTRAL on Nvidia shares in the face of high risk to F2H13 Tegra 4 sales and in front of a critical milestone for Nvidia’s Tegra program (carrier certification). We are, however, becoming more positive on long-term opportunities and see Nvidia getting closer to capitalizing on the advantages of its GPU technology beyond the PC.

NVDA: F1Q14 Recap and Outlook

• Automotive applications: NVDA sees more designs, ramping faster than in FY13 and notes that it would be selling the entire module, rather than just the single chip. Higher ASPs in these applications help support its strong 2H view.
• Project Shield: a tablet/handheld gaming console, Shield would sell at hardware prices and some have estimated that the cost of such a system would be in the several hundred dollars. The concern here is market acceptance. If Nvidia is counting on volume sales of such a system, the 2H forecast makes some sense. But we remain concerned about the consumer’s willingness to pay for such a specialized device—especially at a time on continuing macro sluggishness.
• Tablets: no major wins this year, but Nvidia appears to be hoping that a wider variety of less noticeable wins makes its 2H prospects less risky, rather than more.
• Mysterious other device wins: Nvidia is hinting at a multitude of additional Android-based devices; we are likely to learn more next month at Computex.

We remain cautious regarding the potential for 250% 2H/1H growth in the Tegra business and are applying a 25% discount to that outlook. We have yet to see Shield, to learn of its price, and to assess Nvidia’s margins on such a product. Automotive may very well be the bright spot in the business: such wins would likely bring higher-than-corporate gross margins and lengthy product cycles. Tablet potential may be limited at the high end by the dominance of Apple and Samsung, and by lower-cost IC providers at the low end. We expect to see solid wins this year, but too little to support a 350% 2H expansion in sales.

GPU Strength Depends on Professional Apps from Here Forward: Nvidia has done well in PCs and took significant share in notebooks over the last year, but with Haswell on the way, and AMD making a bit of a comeback, that share will likely retreat towards 55% once again. This combined with a shrinking notebook GPU market (e.g. Apple abandoning discrete add-ins) makes the PC prospects less exciting than those likely developing in professional applications. We look this year for expansion of Tesla and GPGPU, and the introduction of programs for more creative applications of high-end desktops which would push demand higher for discrete GPUs.

Margins: Operating expenses continued to climb last quarter and will again this quarter, but then the company sees spending flattening through year end. That makes FY15 the first potential opportunity for Nvidia to leverage its extensive investments in the Tegra business. For now, operating expenses are running at 42% of sales; by next year, we see those dropping to 38%, which leaves still a lot of room for improvement. Gross margin improved a bit on a higher mix of high-end GPUs last quarter and will hold that lien this quarter, but look for GM to dip slightly in 2H as Tegra ramps.

Returning Cash to Shareholders: Nvidia is maintaining its $0.075/Q dividend and has committed to using $750M to repurchase shares during the course of FY14. At current prices, and excluding the dilution from stock-based compensation, this would reduce share count by 54M and add $0.05 in EPS for the year.

FULL REPORT Available to Clients upon request. Email: joanne@highpeaksanalytics.com