Reporting earnings of $0.20 per share, Nvidia (NASDAQ:NVDA) beat the Wall Street consensus estimate for fiscal Q3 2014 by a penny. At $1.05 billion, the company’s revenue grew 7.9% sequentially but declined 12.5% from the prior year due to a major product transition with its Tegra Tablet/Smart Phone processor. (Fiscal years end with Janaury.) Nvidia saw its Tegra revenue decline significantly in fiscal 2014 as part of transition from the highly successful Tegra 3. Management made a conscious decision to delay the launch of the Tegra 4 in order to pull up the production of the Tegra 4i processor. However, Tegra revenues more than doubled sequentially, demonstrating the success of the newer products. Additionally, despite declining PC shipments, Nvidia’s leadership in visual computing, gaming and professional graphics, as well as its positive performance in data center, drove the strong sequential revenue growth in the quarter as well.
Nvidia’s GPU business grew 2% quarter over quarter as a it saw a marginal rise in desktop GeForce GPU revenue. Contributors were a stronger mix in the mainstream segment as well as the price re-positioning of its high-end GeForce products. Although the company’s notebook GPU revenue declined, due to lower volumes at the low-end, high-end notebooks witnessed strong growth. Price changes in the high-end GeForce also helped to improve the gross margin to 55.4% in the quarter.
Though Nvidia maintains a flat outlook for the current quarter, we believe its long-term growth potential is appealing. Strong sales of its high-end GPUs for PC gaming, increasing acceptance of the Kepler architecture in PCs, increasing Tegra revenues, and deeper penetration in the data center, should all drive the company’s future growth.
Our price estimate of $16.42 for Nvidia is within 10% of the current market price of $15. We are in the process of updating our valuation for the company.
Tegra Revenues More Than Doubled Sequentially
At $111 million, Nvidia’s Tegra revenues grew by over 110% in quarter over quarter. Tegra processor revenues declined significantly in the first half of fiscal 2014 and 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.
Nvidia significantly expanded its line of Tegra-4 powered devices last month. It saw the launch of the first phone (Xiaomi Mi3) based on its Tegra 4 processor. It also introduced the Tegra Note, a reference platform for Android-based tablets. And it announced that Microsoft’s (NASDAQ:MSFT) next-generation Surface 2 tablet will be powered by its Tegra 4 processor. During Q3, Tegra 4 shipped in more than 15 different mobile devices including those manufactured by Xiaomi, HP, Microsoft, Asus, Toshiba, Acer, and others.
Tegra Q3 2014 revenues were driven by strong sales of the Xiaomi smartphone in China, the Microsoft Surface 2, the Shield gaming device, and growth in Nvidia’s tablet products across several platforms. Nvidia expects Tegra revenues to further increase this quarter as its continues to ramp existing designs and its customers introduce new devices into the market.
With Tegra 4, Nvidia also aims to expand its reach to other large markets where visual computing matters, including auto navigation systems, TV set-top boxes, and new desktop form factors like all-in-ones and smart monitors. The automotive segment currently accounts for approximately 25% of total Tegra revenues and Nvidia expects this level to increase in the future, in line with the intensity of automotive electronics. 
PC Gaming Remains An Important Growth Driver
Nvidia’s growing presence in the specialty PC market (gaming PCs, workstation PCs, and high performance computing PCs) somewhat insulates it from the declining trend in the mainstream PC market.
Nvidia sells its PC graphics processors (GPUs) into two key segments that require intensive and sharp graphics: PC Original Equipment Manufacturers (OEMs) providing high-end gaming PCs and and Graphics card manufactures suppling the aftermarket. While lower-end PC shipments to OEMs have slowed, the robust PC gaming market has contributed to higher GPU shipments, starting in fiscal 2013 and continuing in fiscal 2014 as well. In video, Nvidia’s GPU gaming revenues are up 6% year-to-date compared to the same period last year while mobile GPU gaming has more than doubled in the last two years.
In Q3 2014, Nvidia launched a number of products specifically targeted at the gaming market. It recently unveiled its fastest gaming GPU ever (the GeForce GTX 780 Ti) and launched NVIDIA G-SYNC technology, which enables near-perfect synchronization between the GPU and the display, solving the decades old problem of on-screen tearing, stuttering and lag. It also introduced GeForce ShadowPlay, a software platform that lets gamers record, stream and share their best gaming moments.
PC gaming represents almost 40% of the worldwide gaming market, which is higher than consoles, phones, tablets or any other gaming segment, and we believe it will continue to drive Nvidia’s GPU shipments. 
Driven by the release of new Kepler-based GPUs, Nvidia saw another quarter of strong Quadro and Tesla sales. Quadro enterprise revenue increased by 5% quarter over quarter and 24% year over year, whereas Tesla revenues climbed by 6% and 43% over the same time frames, respectively.
Gross Margins Growth Will Not Sustain In The Current Quarter
Nvidia’s gross margins increased from 52.9% in Q3 2013 to 55.4% in Q3 2014 driven by the price revision in its high-end GeForce desktop products. Additionally, the decline in Nvidia’s mainstream PC OEM business reduced the lower end of the gross margin mix while the stronger gross-margin notebook GTX line grew. However, the company anticipates its gross margins will decline in the current quarter as it expects higher revenue growth from Tegra processors, which command gross margins below the corporate average.
Q4 2013 Outlook
- Revenues of $1.06 billion, flat quarter over quarter, as the success in GPU business is offset by a decline in mainstream GPUs.
- GAAP and non-GAAP gross margins to be approximately 64.2% and 54.5%, respectively.
- GPU business gross margins to remain stable.
- GAAP and non-GAAP operating expenses of $450 million and $410 million, respectively.Notes:
- Nvidia’s CEO Discusses F3Q 2014 Results – Earnings Call Transcript, Seeking Alpha, November 7, 2013 [↩] [↩]