NVIDIA Corp (NVDA) — Q4 2019 Earnings Call Transcript

Thank you. Good afternoon, everyone. And welcome to NVIDIA's conference call for the fourth quarter of fiscal 2019. With me on the call today from NVIDIA are Jen-Hsun Huang, President and Chief Executive Officer, and Colette Kress, Executive Vice President and Chief Financial Officer. I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. The webcast will be available for replay until the conference call to discuss our financial results for the first quarter of fiscal 2020. The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Forms 10-K and 10-Q, and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, February 14, 2019, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. With that, I'd like to turn the call over to Colette.

Thanks, Simona. As you know, we lowered fourth quarter guidance for January 28th, and the results are in line with our pre-announcement. Q4 revenue was $2.21 billion, down 24% from a year earlier, driven primarily by a 45% year-on-year decline in gaming. Full year revenue was $11.72 billion, up 21% from the previous year. Starting with our gaming business, revenue of $954 million was down 45% year-on-year and down 46% sequentially, weaker than our expectations heading into the quarter. Full year revenue was up 13% to $6.25 billion. Three factors contributed to the Q4 gaming revenue decline. First, post-crypto inventory of GPUs in the channel caused us to reduce shipments in order to allow excess channel inventory to sell through. We expect channel inventory to normalize in Q1 in line with the one to two quarter timeline we had outlined on our previous earnings call. Second, deteriorating macroeconomic conditions, particularly in China, impacted consumer demand for our GPUs; and third, sales of certain high-end GPUs using our new Turing architecture, including the GeForce RTX 2080 and 2070, were lower than we expected for the launch of a new architecture. These products deliver a revolutionary leap in performance and innovation with real-time ray tracing and AI, but some customers may have delayed their purchase while waiting for lower price points or further demonstrations of the RTX technology and actual gains. The significant volatility in our gaming business over the last few quarters has been challenging to model. Crypto mining demand and its aftereffects have distorted the quarter-to-quarter trends in the gaming business and obscured its underlying trend line. Let me try to give you some visibility into what we believe the long-term business looks like. As you know, our gaming business consists of desktop gaming, notebook gaming, and gaming console products. To get a sense of the underlying run rate in our gaming business last year, it is helpful to look at desktop gaming revenue across the period that doesn't include crypto demand. Let's look at the four quarters starting from Q2 of last year to the current quarter or Q1 of this year. In Q2 and Q3 of last year with the benefit of hindsight, we shipped a higher amount of desktop gaming products relative to where end demand turned out to be. To allow the channel to work down that excess channel inventory, we shipped a lower amount relative to end demand in Q4 and will do so again in Q1. Therefore, exiting Q1, we expect channel inventories to be at normal levels. On average, our desktop gaming revenue across these four quarters is about $900 million. We believe this represents the normalized level of desktop gaming for this period. Notebook gaming and gaming consoles have averaged close to $500 million per quarter over these same four quarters. Thus, in total we believe our normalized gaming business revenue run rate is approximately $1.4 billion. As we look past Q1, we expect the channel inventory correction to be behind us and our business to have bottomed. On a full year basis, we expect our gaming business to be down slightly given the tough first half compares with growth in Turing and notebook gaming. At CES last month, we launched into the recovery of our gaming business. We announced the GeForce RTX 2060 at the mid-range price point of $349. The 2060 delivers a 60% performance improvement over the GTX 1060 while also bringing Turing's real-time ray tracing and AI features to the mass market for the first time. The 2060 has received rave reviews and is off to a great start. In addition, we announced a record of 40 plus new Turing-based gaming laptops, which became available on January 29th. This is more than double the number of GeForce-powered notebooks in the market last year. Featuring the energy efficiency of the Turing architecture, the laptops are able to deliver the performance of desktop gaming PCs. We expect GeForce laptops to continue to be the fastest growing segment of gaming. We're also pleased to see growing momentum in the RTX ecosystem. As more game developers are creating content to take advantage of the Turing architecture's amazing capabilities, just this week, DLSS technology is becoming available in two blockbuster games, Battlefield 5 and Metro Exodus, and Anthem coming soon. In addition, at CES, Justice and Atomic Heart showed demos featuring ray tracing and DLSS, and the large pipeline of games plans to integrate RTX technology. Pairing DLSS with ray tracing can provide comparable frame rates to traditional rasterization but also much more beautiful cinematic visuals, the best of both worlds. This is the next generation of gaming. While this was a challenging quarter in our gaming business, we look forward to putting the channel inventory correction behind us and building on the solid foundation of our Turing architecture. Moving to the data center, revenue was $679 million, up 12% year-on-year and down 14% sequentially. Full year data center revenue was $2.93 billion, up a strong 52%. The Q4 sales decline was broad-based across verticals and markets and geographies. As the quarter progressed, customers around the world became increasingly cautious due to rising economic uncertainty, and the number of deals did not close in January. In addition, hyperscale and cloud purchases declined both sequentially and year-on-year as several customers paused at the end of the year. We believe the pause is temporary. The strength of NVIDIA's accelerated computing platform remains intact. We continue to lead the industry in performance for scientific computing and deep learning. And with CUDA's programmability, we can continue to expand the value of our platform. For example, we recently announced RAPIDS, our CUDA acceleration stack for data analytics and machine learning. In December, the first objective third-party AI benchmark called MLPerf became available. And NVIDIA captured the top spots in the six test categories for training deep learning models that we competed in. And in January, Google Cloud announced that NVIDIA T4 Tensor Core GPUs are now available in beta in its data centers in the U.S., Europe, Brazil, India, Singapore, and Tokyo. The T4 is a universal cloud GPU that accelerates a variety of workloads, including high-performance computing, deep learning training and inference, broader machine learning, data analytics, and graphics. Our visibility remains low in the current cautious spending environment, and we don't forecast a meaningful recovery in the data center segment until later in the year. However, we are working closely with hyperscales around the world to integrate NVIDIA TensorRT software and Tensor Core GPUs into their inference production flow. Inference currently drives less than 10% of our data center business, while representing a significant expansion of our addressable market opportunity going forward. We have also strengthened our product portfolio and go-to-market capabilities to address vertical industries that have enormous data and analytics requirements, such as automotive, financial services, retail, healthcare, and consumer Internet services. With our RAPIDS software stack, NVIDIA can accelerate data analytics and machine learning as we have done in deep learning. And we made it easier for customers to adopt our technology by partnering with Cisco, IBM, NetApp, and Pure Storage to create pre-integrated systems that can be sold through their global IT channels. Moving to pro visualization, revenue reached $293 million, up 15% from the prior year and down 4% sequentially. Full year revenue was $1.13 billion, up 21% year-on-year. New applications like data science, AI, and VR, as well as the need for thin and light mobile workstations remain key growth drivers for the business. We had key wins in the quarter, including Boeing, Google, LinkedIn, and Toyota for applications including AI and robotics. This past week with our partners HP, Dell, and Lenovo, we announced the availability of Quadro RTX workstations. Quadro RTX is the most significant workstation GPU upgrade in 10 years. It will enable millions of designers and creative artists for the first time to work interactively with super high-resolution media and photorealistic 3D rendering, enabling them to be creative with dramatically improved productivity. Finally, turning to automotive, Q4 revenue was $163 million, up 23% from a year ago and down 5% sequentially. Full year revenue reached $641 million, up 15%. The sequential decline was largely seasonal. The year-on-year growth was driven by the increasing adoption of next-generation AI cockpit solutions and autonomous vehicle development deals, partially offset by declines in legacy infotainment. Last month at CES, we announced DRIVE AutoPilot, the world's first commercially available level two plus self-driving car computer. This system offers sophisticated automated driving features that far surpass today's ADAS offerings, increasing the vehicles' performance, functionality, and road safety while the driver remains in control. To deliver these capabilities, DRIVE AutoPilot uses multiple deep neural networks for surrounding camera perception both in and outside of the car and significant AI processing capability. Systems from our Tier 1 partners, including Bosch, Continental, Veoneer, and ZF were all on display at our booths. Although, as announced back in October, it was our first level two plus design win with cars slated for production in the early 2020s. Mercedes-Benz has also chosen NVIDIA for its next generation autonomous vehicle and cockpit computer. This centralized AI computing system replaces dozens of smaller processors inside current cars. DRIVE AutoPilot is a major milestone for NVIDIA and takes our high-functioning self-driving capabilities into the mass market. This will be an important year for robo-taxi pilots and initial level two design wins. Moving to the rest of the P&L and balance sheet. Q4 GAAP gross margins were 54.7% and non-GAAP was 56%, down sequentially and year-on-year, primarily due to a $128 million charge for DRAM and other components associated with our lower than expected Q4 revenue and current market conditions. GAAP operating expenses were $913 million and non-GAAP operating expenses were $755 million, up 25% and 24% year-on-year, respectively. The GAAP EPS was $0.92, down 48% from a year earlier. Full year GAAP EPS was $6.63, up 38% from the prior year. Non-GAAP EPS was $0.80, down 53% from a year ago. Full year non-GAAP EPS was $6.64, up 35% from the prior year. We returned $1.95 billion to shareholders in the fiscal year through a combination of quarterly dividends and share repurchases. As we announced last quarter, we plan to return $3 billion to shareholders through the end of fiscal 2020 in the form of dividends and buybacks. We repurchased $700 million during the fourth quarter of fiscal 2019. With that, let me turn to the outlook for the first quarter of fiscal 2020; we expect revenue to be $2.2 billion plus or minus 2%; GAAP and non-GAAP gross margins are expected to be 58.8% and 59% respectively plus or minus 50 basis points; GAAP and non-GAAP operating expenses are expected to be approximately $930 million and $755 million respectively. GAAP and non-GAAP OI&E are both expected to be an income of $20 million; GAAP and non-GAAP tax rates are both expected to be 10% plus or minus 1%, excluding discrete items; capital expenditures are expected to be approximately $150 million to $170 million. For fiscal 2020, we expect Q1 to mark the bottom as we pass the inventory correction in gaming. We expect total revenue for the year to be flat to down slightly with growth in our four end markets compensating for the absence of crypto revenue and the excess selling for most of the year. We plan to grow OpEx in the high single digits this year, and we continue to invest in our focus growth areas of graphics, AI, and self-driving cars. Further financial details are included in the CFO commentary, and other information is available on our IR website. In closing, I'd like to highlight upcoming events for the financial community; we will be presenting at the Morgan Stanley Technology, Media and Telecom conference on February 26; and our next earnings call to discuss our financial results for the quarter of fiscal 2020 will take place on May 15th. We will now open the call for questions.

I had two questions. First, Colette, you talked about the weakness you saw in the 2070 and the 2080 in the quarter. I guess this question is more for Jen-Hsun. Are you concerned at all about your ability to convince and incentivize gamers? And the second question is inventory was up on the balance sheet. Colette, if you can just provide some color there and expectations going forward. Thank you.

When we launched the 2070 and 2080, it was the first time we've ever launched a new generation where the only available SKUs were very high-end. In addition to that, the early boards that came out into the marketplace were the special edition and the overclocked versions. The MSRP versions didn't show up for some time after, a couple of months after. And so the conditions weren't ideal, if you will. We weren't able to launch into the mainstream segment with the 2060 for all the reasons that I think everybody understands now. And so I think that the situation wasn't ideal. When you take a look at our situation now, every single graphics card has the best performance at its price point, and it remains so today. I think that right out of the box, it delivered excellent performance. It is true that everybody was hoping to see more games with RTX on day one. But it's such a new technology with ray tracing and AI for image processing that it's only really possible to make available with new games, which is tied to the schedules of new games. And now they're starting to come out. Battlefield 5, Metro Exodus, I think that the reviews from this week are just spectacular. People are finally realizing what it is that we were talking about and that it's possible with RTX technology, the combination of applying ray tracing and AI for us to deliver much more beautiful images without sacrificing performance. I think people are starting to understand now the benefits of the RTX technology, and we just needed some time to demonstrate it. The takeaway is simply this: RTX is the best graphics card at every single price point without using ray tracing technology, and for new games that are coming out, each one of the new games that come out in the future will apply ray tracing. We work with developers to apply ray tracing technology; I think everybody agrees that it is surely the next generation. And then probably one of the biggest stories that came out just last week is that Unreal Engine and Unity, both of the game engines, are going to incorporate RTX and ray tracing technology in the engine itself. And so all future games will be able to take advantage of that, so that's really big news and I'm excited about that.

So Toshiya, to answer your second question regarding our inventory balance. Our inventory dollars at the end of Q4 rose just due to the weaker than expected finish to Q4. Inventory right now is primarily related to Turing, Volta, and DGX. We don't expect any further write-downs as we have incorporated approximately $128 million of write-downs within the current Q4.

I guess on the commentary regarding a pause in spending in data center and a handful of deals that got delayed. Can you give a little bit more color in terms of what you're seeing across enterprise cloud, high-performance compute, and I guess within that, how you're seeing the ramp of T4? And I guess if you can then speak to, I'm sure embedded in the fiscal '20 guidance is a pretty nice ramp into the second half. What are the key drivers, key milestones that you're looking for to see that business reaccelerate higher as we go through the year?

The slowdown is broad-based. We saw it across every vertical, every geography. There was just a level of cautiousness among all of the enterprise customers and the cloud service providers that we've not experienced in a while. I think it has to be temporary. The computing needs of the world have not been satisfied with what was shipped last quarter. I think that the demand will return and customers will return. Our situation in data centers is dramatically better year-over-year. If you take a look at where we are, our deep learning solution is unquestionably the best in the world. We introduced T4 with inference capability; it's the world's first universal cloud GPU. It does everything that NVIDIA does, all in one GPU and 75 watts. It fits into every hyperscale data center. We're engaged with internet service providers around the world, optimizing and porting their high production models networks so that we can deploy them into production. So we now have four different new growth drivers for our data center in addition to deep learning and scientific computing; we have inference that we're actively working on; we have data analytics that's called RAPIDS; some people call it Big Data; but data analytics and machine learning; third is rendering. And because of the partnerships that we've developed and the excitement that people see around enterprises, we’ve developed partnerships with large IT companies to pre-configure systems that make it easier for enterprises to adopt our technology. So we have four new ways for us to grow our enterprise business. We're looking forward to when the pause releases and we’ll get back to growing.

I just had a clarification and a question. On the clarification, gross margins. Colette, what is the normalized run rate for gross margins? As you get to your sales back to normalized levels, how should we think about the trajectory of gross margins? And will there be any impact from the balance sheet inventory? And then on the question Jen-Hsun, can you give us more reassurance that gaming is still a growth business? I understand that over the last year, there's been a lot of confusion, there's been macro issues. But if you look at the number of gamers and the mix of product that they are buying, essentially to sell through to gamers, has that been on an upward trajectory? And as part of that, when do you think we could see Turing exceed the demand you saw for Pascal? Thank you.

On gross margin, our gross margin, the largest contributor to our absolute gross margin is really just the mix of our product. The mix of our products is based on our market platforms, but also the mix of our products within the data center, as well as within gaming. We provided guidance for Q1, which has a good level of confidence from us, and we'll see how it goes from there.

The fundamentals of gaming have not changed. There are more gamers than ever. Games are better than ever. There's been a recent shift in the popularity of multiplayer competitive e-sports games, which is good for hardware. It lowers the barrier to entry because it's free to play with the exception of downloadable content. The excitement around Fortnite and recently with Apex Legends and PUBG is still strong; League of Legends is still popular. This genre of games is both competitive, requires great hardware, and attracts a lot more players because it's social, making it stickier. If you take the methodology that Colette described earlier and you average out our underlying gaming business and compare that to a year before, it surely grew. If you also compare the rate at which our gaming notebook is growing, I think that’s pretty exciting. Our gaming notebook business grew 50% year-over-year. And just at CES, the number of new notebook designs that came out with Turing, due to an invention we created called Max-Q and the energy efficiency of the Turing architecture allows the creation of high-performing notebooks. The dynamics are the same, and gaming will continue to be a growth business.

Colette, I appreciate all the data you gave us on trying to size normalized demand for gaming. What I have to ask though is if you’re going through channel inventory and working out in the fiscal first quarter, it seems like to hit your full year guide, the expectation is for gaming revenue to accelerate well above that normalized level you talked about. Am I doing the math right? And if I am, what gives you confidence throughout the year that you can see that gaming growth off of these numbers?

I’ll start, and then I’ll let Jen-Hsun finish that question. So along the lines of Jen-Hsun's response in terms of what we do believe are the key drivers of gaming, everything's still intact in terms of gaming, both with our Turing architecture and growth expected, as well as the growth from the notebook. We do believe will be great drivers as we head into the rest of the year. We’ll have to wait and see in terms of how that plays out, but that is really the underlying reason why the growth will continue.

I think your math isn't wrong. The part that you probably didn't consider is the notebook. Our GeForce notebook business is quite large.

Building on the discussion around the Turing platform and particularly to the gaming market, I'm curious you mentioned in your prepared comments that pricing of these new solutions is a bit of an inhibitor. Has the company invoked any changes in your pricing strategy around Turing? And then also I'd be interested to hear how important China is to the gaming segment, and whether or not you're assuming that the China market rebounds in your annual assumptions?

First of all, on the pricing part, the biggest inhibitor was that we couldn't launch our mid-range segment. The ability to launch the 2060 was a big inhibitor for us, but we did so at CES. The launch was a great success. The reviews are fantastic. People love the 2060, and the price point is great. We now have a great stack from the mid-range all the way to enthusiasts. China is an important market, and it's an important gaming market. I am confident this market is going to rebound.

First, I wanted to get the mix, this is a question for Colette. You had said that the mix was going to be the primary driver of your gross margins. I know that sequentially they're up. But if I correct for the inventory write down in Q4, the normalized gross margin this quarter was 61.7. You’re guiding it to 59, so it's down 270 basis points sequentially on flat revenues. Do I take from that guidance, if that's an indicator of the mix between the businesses, is the primary driver of that gross margin degradation, or is there something else going on that we should be aware of?

We'll start with that first question on gross margin. You're correct. Mix is still the primary driver of our gross margin every single quarter. You’ve correctly changed our Q4 numbers to remove the overall inventory write down. When you look at Q1, there is a mix around our products that we plan on shipping by platforms. But also within our gaming business and within our data center business, we also have different gross margins that would influence. These are our best estimates of what we have at this time, and we'll see as we move through the year.

So what do you think the bigger driver between those two is, whether it's intra-business mix or inter-business mix? Which one of those is the biggest driver of the gross margin degradation sequentially into Q1?

I think it's more on the inter-business side. Keep in mind our Q4 had a very low percentage of gaming as a total, and then then a different mix within there as we moved into the next quarter as well.

So I don't want to poke too many holes on the memory side and the downturn in gaming due to crypto inventory. But if I think about the gross margin profile, you guys almost reached 65%. So if I look out let's call it a year or even 18 months to make it more of a long-term target. Is there any reason why you guys can't get back up to the mid-60s level?

On your gross margin question, yes, we still have drivers within the mix of our products that allow us to grow our gross margin over the long-term. There's definitely a goal for us to continue doing that. We will focus on both the cost components of what we do, but also moving the entire portfolio to the higher value-added platforms that we sell. So over the long term, absolutely all of those things are still in place and intact that we can do. We'll look quarter-to-quarter to give the best guidance that we can to help you see that.

On the China gaming weakness, is it the slower economic environment or is it government policy related? Because we know that the Chinese government has had a freeze on new gaming approvals, probably recently started to approve new games. This ban has been in place since the first half of last year. Given what you know about the business, how much of the China weakness is coming from gaming bans versus just an overall slower economic environment?

I don't know that we could tease that apart, Harlan. We just know that the consumer market in China is relatively slow towards the end of the year. The China economy is in the final analysis a growth economy, and so we're looking forward to it recovering. Gaming is one of the most important pastimes in their culture, and so I'm excited about our prospects there. All the things that we're seeing in the near term, Colette has done a good job of describing. As we leave the bottom and address this inventory issue behind us, we're in a very strong position. We have a full stack of RTX. The Turing architecture is fantastic. It is unquestionably the best in the world. We have the best performance at every single price point. We have great notebooks that the market can now buy. I'm looking forward to reporting our status with you guys as the year goes on. It should be a good year.

2018 was a record year, but it was a disappointing finish. This quarter, we expect to put the channel inventory issue behind us and get back on track. As the pioneer of accelerated computing, our position is unique and strong. The opportunities ahead in graphics, high-performance computing, AI, and autonomous machines remain enormous. We are as enthusiastic about these growth opportunities as ever. Thanks everyone for joining us today.