"Year over year" has lost its meaning; "sequentially" is where the hope lies.
At this moment, Intel, NVIDIA, and AMD have all reported their latest quarters. Intel led off; NVIDIA brought up the rear. Because last year's hot market created a high base, all three essentially posted year-over-year declines in both revenue and net income.
Q2 Earnings Comparison:
Intel revenue down 3% year over year, GAAP net income down 17% year over year;
AMD revenue down 13% year over year, GAAP net income down 70% year over year;
NVIDIA revenue down 17% year over year, GAAP net income down 50% year over year.
Yet the three companies' stock price trajectories this year have diverged markedly. AMD is up 60% year to date, while NVIDIA has gained only 12%, lagging the Nasdaq. Intel is worse, with a negative year-to-date return.
Chart source: Futu Securities
After NVIDIA's earnings release today, its shares rose 5.59% in after-hours trading. Let's dig deeper into the quality of this report.
Q2 Earnings Summary
In our interpretation of NVIDIA's previous earnings, "NVIDIA Earnings Interpretation: Back to 2017 or Reliving 2018?," we opined that "this report probably doesn't justify your trillion-dollar market cap," which may have been harsh. But one thing must be clear: Jensen Huang is a master of "expectations management"; don't assume the report is good just because EPS beat estimates.
Source: CNBC — NVIDIA rarely misses EPS even at its worst
NVIDIA Q2 revenue was $2.579B, down 17% year over year, up 16% sequentially;
GAAP net income was $552M, down 50% year over year, up 40% sequentially;
Non-GAAP net income was $762M, down 37% year over year, up 40% sequentially;
GAAP gross margin was 59.8%, down 3.5 percentage points year over year, up 1.4 percentage points sequentially;
Data source: Company Filing
By segment, only data center and professional visualization had yet to recover this quarter. NVIDIA's largest segment, gaming, saw its year-over-year decline decelerate and grew 24.5% sequentially. Automotive was the standout, the only segment with year-over-year revenue growth.
On gross margin, as AMD and Intel stabilized, NVIDIA caught up. Q2 GAAP gross margin was 59.8%, down 3.5 ppts year over year, up 1.4 ppts sequentially, roughly on par with Intel. The margin improvement owes partly to the plunge in DRAM prices on the cost side.
Data source: Company filing
Also interesting: NVIDIA inventory fell 15.6% sequentially, marking two straight quarters of decline. The inventory breakdown shows raw materials down 41% sequentially, work-in-process down 15%, and finished goods down 12%. One naturally thinks of the latest RTX Super and GTX 16 series cards, and again marvels at Huang's precise execution.
Data Center Business Weak, As Expected
As the only one of the CPU/GPU trio with a GPU-only data center business, NVIDIA faces a natural vulnerability similar to Intel's but lacks Intel's data center clout. Therefore we believe NVIDIA's acquisition of Mellanox may not be solely for product diversification; it also reflects a desire to learn from Intel in building a data ecosystem.
Back to the data center segment: as expected, both NVIDIA and Intel saw data center revenue decline again this quarter. Lenovo's earnings yesterday made us sweat for NVIDIA. As a downstream data center customer, Lenovo's latest data center revenue fell 17%.
From that perspective, AMD's data center business truly is "the village's hope." However, while AMD's data center revenue keeps growing, its data center GPU also declined sequentially, whereas NVIDIA's data center (GPU) revenue grew 3.3% sequentially. This suggests the problem isn't NVIDIA-specific; the industry downturn bears the blame.
Automotive Business and Switch Drive Tegra Surge
NVIDIA's Tegra business revenue fell 55% year over year and 12% sequentially last quarter, a severe downtrend. In the current Q2, Tegra revenue was $475M, up 1.7% year over year (vs. -55.2% prior) and up 140% sequentially, a record quarterly high.
Nintendo recently launched the Switch Lite. The Switch is the only console among the three major players using an NVIDIA SoC. According to Nintendo's latest FCC filing in the U.S., both the Switch and Switch Lite have switched to new NVIDIA SoC model numbers and new NAND flash model numbers. The all-new Tegra SoC in the Switch drove sequential revenue growth. The exact contribution to results, however, is unknown.
We are bullish on Tegra SoC performance during the Nintendo Switch shipment peak (Q3 and the Q4 holiday season). Beyond the Switch, the Q2 Tegra surge is more directly tied to the automotive business.
This quarter NVIDIA's automotive business significantly beat expectations, with revenue of $209M, up 29.81% year over year and 25.9% sequentially, a record high. With Intel's Mobileye seeing a sharp year-over-year growth deceleration in Q2, NVIDIA's automotive business surpassed Mobileye for the first time in six quarters. The earnings release shows this strong performance owes much to cooperation agreements with automakers such as Volvo and Toyota.
RTX Helps Gaming Business Modest Recovery
Finally, NVIDIA's core business — gaming. Q2 gaming revenue was $1.313B, down 27.26% year over year, up 24.46% sequentially, mainly driven by strong performance from the new RTX and GTX 16 series.
Source: Steam
According to Steam's July hardware survey, NVIDIA's GPU market share was little changed from June, holding at a high 75.53%.
However, individual GPU model shares shifted significantly. The GTX 10 series saw broad declines; the top-ranked GTX 1060 fell 0.66 percentage points. Notably, RTX products continued steady growth, and the new GTX 16 series received a good market response. The replacement cycle in the gaming GPU market remains huge.
The plunge in DRAM prices may also help margins. In Q2 2019, DRAM vendor revenue fell another 9% sequentially, and the price downtrend is likely to persist. The new RTX Super series did not increase VRAM, so NVIDIA's cost pressure is relatively low.
Overall, the earnings show the notebook GPU market is a significant growth driver for NVIDIA. We also believe the future PC growth driver lies in the notebook market. NVIDIA's Max-Q technology, tailored for thin-and-light notebooks, has greatly narrowed the performance gap between notebook and desktop GPUs, opening a vast market.
Conclusion
In sum, aside from automotive significantly exceeding expectations and a respectable gaming recovery, the Q3 guidance was disappointing.
In "NVIDIA Earnings Interpretation: Back to 2017 or Reliving 2018?," we optimistically assumed FY2020 second-half sequential growth would match the same period in FY2018, yielding full-year revenue down 5% year over year, close to the company's flat-revenue target.
Assuming sequential growth matches FY2018, Q3/FY20 is guidance data
However, the company guided Q3 revenue of $2.9B, implying 12.4% sequential growth (perhaps Huang's usual sandbagging), below our expected 18.2%. Even with 10.4% sequential growth in Q4, full-year revenue would still fall 7%, drifting further from flat. And 10.4% sequential growth in Q4 is nearly impossible, since even at its best (FY19 Q1) revenue barely reached $3.2B.
Unless both gaming and data center strengthen simultaneously, we believe NVIDIA's full-year revenue will most likely decline more than 10 percentage points year over year.