⚙️ NVIDIA: Graphics, AI and beyond
⚙️ NVIDIA: Graphics, AI and beyond
The gaming slowdown is here, but for how much longer?
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NVIDIA (NVDA) reported its Q3 FY23 earnings report (ending October 2022).
Today, we’ll cover the following:
NVIDIA Q3 FY23.
Recent business highlights.
Key quotes from the earnings call.
What to watch looking forward.
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Today we're talking about NVIDIA, the world's leading graphics and AI company.
They make advanced tech that powers everything from your favorite video games to self-driving cars. NVIDIA uses its expertise in graphics processing to create some of the most advanced AI systems out there. It's used to do everything from making movies to solving complex scientific problems.
It's the world's top producer of discrete graphics processing units (GPUs) for PCs and data centers (discrete meaning with its own dedicated memory). GPUs have been used to accelerate calculations involving large amounts of data (a need that will increase over time).
But NVIDIA isn't just about the future - they're also driving the present. Their graphics cards are the go-to choice for gamers, and they're also used in all sorts of other applications.
In short, NVIDIA is making some seriously impressive tech and is at the forefront of the AI revolution. They are targeting a $1 trillion market opportunity.
The semiconductor industry is very cyclical. Periods of high demand cause supply shortages, followed by gluts. And that’s precisely what is happening in the gaming segment this year. So we’ll take a look at it.
Before we start, let’s discuss how NVIDIA makes money.
Revenue has two reportable segments:
Graphics (~60% of overall revenue).
GeForce GPUs for gaming and PCs.
GeForce NOW game streaming service and solutions for gaming platforms.
Quadro/NVIDIA RTX GPUs for enterprise workstation graphics.
Virtual GPU, or vGPU, software for cloud-based visual and virtual computing.
Automotive platforms for infotainment systems.
Omniverse software for building 3D designs and virtual worlds.
Compute & Networking (~40% of overall revenue).
Data Center platforms and systems for AI, high-performance computing, and accelerated computing.
Mellanox networking and interconnect solutions.
Automotive AI Cockpit, autonomous driving development agreements, and autonomous vehicle solutions.
Cryptocurrency mining processors, or CMP.
Jetson for robotics and other embedded platforms.
NVIDIA AI Enterprise and other software.
Note that more than 80% of revenue comes from outside of the US.
Revenue is usually presented based on five primary markets:
Data Center (~65% of overall revenue).
Gaming (~27% of overall revenue).
Professional Visualization (~3% of overall revenue).
Automotive (~4% of overall revenue).
OEM & Others (~1% of overall revenue).
Data Center has been a critical driver of the revenue growth (+55% five-year CAGR). The overall trend of the business has been up and to the right. However, it recently hit a roadblock with headwinds in the gaming segment (as illustrated below).
Costs and expenses include:
Cost of revenue: Primarily the cost of semiconductors, including wafer fabrication, assembly, testing and packaging, board and device costs, manufacturing support costs, final test yield fallout, inventory and warranty provisions, memory and component costs, tariffs, and shipping costs.
Research & development expenses: Product development headcounts and infrastructure costs.
Sales, general & administrative expenses: Sales and marketing, finance and accounting, legal, internal audit, human resources, and management information systems personnel.
Margins:
The gross margin has trended upward in the past decade and is expected to be in the mid-60s. However, it recently dropped due to inventory challenges (more on that in a second).
The operating margin has been above 20% in the past six years. Given the cyclical nature of the semiconductor industry, it may be subject to volatility. It recently dropped alongside the gross margin.
Let’s look at the most recent quarter!
1. NVIDIA Q3 FY23
Income statement:
Here is a bird’s-eye view of the income statement.
Main highlights:
Revenue declined -17% Y/Y and -12% Q/Q to $5.9 billion ($110 million beat).
Data Center grew +1% Q/Q to $3.8 billion.
Gaming declined -23% Q/Q to $1.6 billion.
Professional Visualization declined -60% Q/Q to $0.2 billion.
Automotive grew +14% Q/Q to $0.3 billion.
OEM & Other declined -48% to $0.1 billion.
Gross margin was 54% (+10pp Q/Q), short of the ~62% guidance.
Operating margin was 10% (+3pp Q/Q).
EPS was $0.58 ($0.12 miss).
I’m focusing on sequential growth (Q/Q) to show how things are improving (or not) in the current year. Below is a table that also shows Y/Y variations, which paint a very challenging time caused by the decline in the gaming segment.
Cash flow:
Operating cash flow was $0.4 billion (7% margin, -14pp Y/Y).
Free cash flow was ($156) million (down $1.4 billion Y/Y).
Balance sheet:
Cash and cash equivalent: $13.1 billion.
Debt: $10.9 billion.
Q4 FY23Guidance:
Revenue to grow +1% Q/Q to $6.0 billion ($0.14 billion miss).
Gross margin 63%.
So what to make of all this?
Revenue came ahead of relatively low expectations.
Data Center showed resiliency, growing sequentially despite a challenging environment.
Gaming and Professional Visualization continued to face headwinds (gluts following last year’s shortages).
The OEM & Other category was affected by the crypto winter with less demand for mining.
Q4 FY23 revenue guidance was a slight miss, representing a decline of -21% Y/Y.
The company missed its gross margin guidance, partially due to inventory challenges, including lower data center demand in China ($702 million inventory charge). However, these *should* be temporary issues.
Operating expenses grew +30% Y/Y, primarily due to higher compensation expenses. In short, the company is making continued investments in R&D while revenue declined, causing the operating margin to shrink.
Management expects profitability to increase from here. It was encouraging to see an improvement compared to Q2 FY23.
Is the business sustainable?
The company has a positive net cash position and has maintained positive operating cash flow through a challenging part of the cycle.
Management repurchased 28 million shares for $3.65 billion in the past three months and 56 million shares for $8.99 billion in the past nine months. There is $8.3 billion remaining under the current share repurchase program through December 2023.
As of this writing, buybacks have not been the best use of capital this year, but we’ll have to revisit in a few years.
2. Recent business highlights.
Gaming remains in a tough spot
The gaming revenue collapsed by -51% Y/Y and -23% Q/Q. It reflects lower shipments while the company helps align channel inventory (products already on shelves).
A combination of huge demand and limited supply caused the 2021’s chip shortage. In the wake of the global pandemic, the unprecedented desire for at-home entertainment caused shortages of the latest games consoles and graphics cards well beyond the usual launch window rush.
Now we are on the other side of these shortages, and inventory levels need to go down before shipments can resume at a normal pace. So the gaming segment may be hitting a low part of the cycle, but it will take a few quarters to find out.
Successful launch of the NVIDIA Ada Lovelace Architecture
The Ada Lovelace GPU architecture is designed to deliver outstanding gaming and creating, professional graphics, AI, and compute performance. For example, GeForce 40 Series GPUs deliver up to 4x the performance of the previous generation. It launched in October 2022 to tremendous demand and positive feedback.
New Data Center products and partnerships
The next few quarters are packed with new Data Center products:
H100 GPU (the most powerful AI-focused GPU Nvidia has ever made).
Bluefield-3 DPU (Data Processing Unit).
Grace CPU Superchip (high performance).
NVIDIA announced a partnership with Microsoft last month to build one of the most powerful AI supercomputers.
So what’s the deal with this inventory write-off in China?
Here is the two-part story:
October 2022: the US Commerce Department's Bureau of Industry and Security issued rules restricting China's ability to obtain cutting-edge tech, such as the A100 GPU by NVIDIA.
November 2022: NVIDIA launched a new chip in China (A800 GPU) that adheres to the latest export rules. It’s an alternative to the A100 GPU.
While the company was able to find a solution fast and be first to market with a chip that meets new trade rules, the ban led to a write-down of the existing A100 inventory.
Dominating the world’s supercomputer list
NVIDIA is present in five of the top 10 supercomputers in the world, according to the TOP500 ranking released last month.
3. Key quotes from the earnings call
CFO Colette Kress touched on Data Center growth (+1% Q/Q and +31% Y/Y):
“This reflects very solid performance in the face of macroeconomic challenges, new export controls and lingering supply chain disruptions. Year-on-year growth was driven primarily by leading U.S. cloud providers and a broadening set of consumer internet companies for workloads such as large language models, recommendation systems and generative AI.”
About restrictions impacting exports to China, she explained:
“During the quarter, the U.S. government announced new restrictions impacting exports of our A100 and H100 based products to China, and any product destined for certain systems or entities in China. These restrictions impacted third quarter revenue, largely offset by sales of alternative products into China. That said, demand in China more broadly remains soft, and we expect that to continue in the current quarter.”
About channel inventory for gaming:
“We believe Channel inventories are on track to approach normal levels as we exit Q4.”
So while gaming has faced challenging comps and inventory challenges this year, the company might be turning the corner as soon as early 2023.
Founder-CEO Jensen Huang touched on crypto mining:
“We don’t expect to see blockchain being an important part of our business down the road. There is always a resell market. […] And the inventory is never zero. And when the inventory is larger than usual, like all supply demand, it would likely drift lower price and affect the lower ends of our market.”
He also touched on the Ada launch:
“The Ada launch was a homerun […] we shipped a large volume of 4090s because as you know, we were prepared for it. And yet within minutes, they were sold out around the world. And so, the reception of 4090 and the reception of 4080 today has been off the charts. And that says something about the strength and the health and the vibrancy of the gaming market. So, we’re super enthusiastic about the Ada launch. We have many more Ada products to come.”
4. What to watch looking forward
Gaming rebound
We’ll want to see if the gross margin improves in FY24, which would show an improvement in the inventory levels.
While gaming is in the challenging part of the cycle, the industry at large remains on a multi-decade secular uptrend. The younger generations spend more hours per week playing games, and the overall number of PC gamers and content creators continues to expand.
Automotive, the “next billion-dollar business”
Autonomous driving is the next frontier of innovation. NVIDIA is a critical participant in this space, from infrastructure, hardware and software, to its advanced chip DRIVE Thor. Automotive is a small segment today, but the long-term potential is what matters. The estimated addressable market is 3X larger than gaming.
The giant opportunity ahead
Management highlights a $1 trillion opportunity (yes, trillion, with a T) when combining all markets NVIDIA touches. While I don’t look at this number too closely, the runway ahead remains gigantic.
For example, according to Research and Market, the global data center accelerator market alone was valued at $14B in 2021 and is anticipated to reach $65B by 2026, growing at a CAGR of 37%.
So what’s the upside potential?
NVIDIA made $27 billion in revenue in FY22. So it wouldn’t have to take a large piece of its addressable market to unlock tremendous growth from here. Of course, many competitors are vying for a share of the pie, but many winners can emerge.
Watching the story play out in the coming years will be fascinating, with a close eye on product innovation and the ebb and flow of the demand cycle.
That’s it for today!
Stay healthy and invest on!
Disclosure: I am long NVDA in the App Economy Portfolio. I share my ratings (BUY, SELL or HOLD) with App Economy Portfolio members here.
Thanks for the nice article. I like AMD, Intel, NVIDIA. NVIDIA is too expensive for me now. I believe Intel will go back to his old glory. From my point of view, ASML, KLAC, AMAT and LRCX are more suitable for my investment. So I bought shares in these US companies probably at a good time (October, 14th).
I would like to read about these companies from you. :-)
Just wondering (newbie here), why does NVIDIA’s Fiscal Year a year ahead of calendar year? Anyone have the idea of this? Thank you