Financial Discipline Is NVIDIA Corporation's New Mantra

NVIDIA Corporation (NASDAQ: NVDA  ) has experienced a rebound in revenue and gross profit since the Great Recession, but profit growth has stalled out in the last few years.

The problem has been that while NVIDIA is growing again, it has been spending an ever-increasing sum on research and development to drive future growth. R&D expenses have risen almost as quickly as its revenue.

NVIDIA's R&D spending has skyrocketed in the past few years.

However, NVIDIA finally seems to be reining in its spending. In the past few quarters, revenue has continued to rise but operating expense growth has slowed dramatically. This is finally producing strong earnings growth.

NVIDIA's big opportunity
In recent years, NVIDIA has benefited greatly from the weakness of longtime rival Advanced Micro Devices (NASDAQ: AMD  ) . Not too long ago, the two companies had a roughly even split of the high-margin market for discrete graphics cards, but NVIDIA has held a steady 65%-35% advantage over AMD recently.

One key reason for this growing dominance at the high end of the market is its superior financial resources. AMD has slashed its R&D spending in the past few years to remain solvent as falling PC sales decimated its traditional CPU business. Despite competing with Intel (NASDAQ: INTC  ) in the CPU market as well as NVIDIA in the GPU market, AMD now spends less money on R&D than either one.

NVIDIA is trying to convert its bigger wallet into a long-term competitive advantage over AMD by rapidly investing in key growth areas. In addition to boosting the efficiency of its traditional gaming GPUs, NVIDIA has been solidifying its early lead in GPUs for high-performance computing and developing a platform for server-based GPUs called GRID.

The price of growth
NVIDIA's investments in these new cutting-edge GPU technologies -- as well as its entry into the mobile system-on-a-chip market -- have enabled its recent revenue growth. However, the increases in R&D spending have outpaced gross profit growth for the past several years.

NVDA Revenue (TTM) Chart

NVDA Gross Profit vs. OpEx data. Source: YCharts.

In FY11, NVIDIA spent just $849 million on research and development activities, representing 60% of its $1.41 billion in gross profit. By FY14, gross profit soared to $2.27 billion on the back of revenue and gross margin increases.

However, R&D expense rose to $1.34 billion, or 59% of gross profit, by then -- down just fractionally as a percentage of revenue from three years earlier. The result is that net income has not grown since mid-2011.

NVDA Net Income (TTM) Chart

NVDA Net Income (TTM) data. Source: YCharts.

The return of cost discipline
Late last year, NVIDIA finally hired a new permanent CFO -- Collette Kress -- after a multiyear search process. Her arrival appears to have sparked a change in the company's financial planning, making it more frugal. Most notably, in February it indefinitely postponed plans to build a new corporate campus in Santa Clara.

While it could be a coincidence, NVIDIA has also clamped down on operating expense growth since Kress arrived last fall. On the company's recent conference call, she stated that non-GAAP operating expenses should total about $1.65 billion this year, which would be up just 2.5% from $1.61 billion last year.

That's a far cry from the double-digit operating expense growth rates it has experienced in recent years. Moreover, it has reliably hit the expense targets Kress has provided so far, which adds credibility to the full-year target.

Foolish final thoughts
With top competitor AMD on the ropes, NVIDIA has invested heavily in cutting-edge R&D to build a long-term moat for itself in the GPU market. However, its R&D investments have been so heavy in recent years that they have eaten up all of the incremental gross profit NVIDIA has generated. As a result, net income plateaued starting three years ago.

Going forward, NVIDIA's newfound financial discipline should allow it to strike a better balance between growth investments and profitability. This will probably drive stronger stock performance for shareholders.

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  • Report this Comment On May 13, 2014, at 1:57 PM, ToxyFool wrote:

    The problem is, AMD isn't on the ropes at all. Last quarter AMD Graphics and Visual Solutions (GPUs & custom SoCs) segment had a huge year-over-year increase of 118%. That was at nVidia's expense. Microsoft also kicked them to the curb and went with Qualcomm for the Surface Mini instead of Tegra. The Titan Z GPU has been delayed for unspecified reasons. Don't kid yourself- Nvidia is in trouble.

  • Report this Comment On May 14, 2014, at 10:20 AM, TMFGemHunter wrote:

    There's a big difference between revenue and profit. AMD is getting lots of low margin revenue from game consoles. NVIDIA instead decided to try to disrupt the whole game console market by making Android into a viable gaming platform. I think NVIDIA is likely to win this battle in the long run.

    Considering the Surface's sales track record, I don't see this as a big loss for NVIDIA. In any case, NVIDIA is refocusing on a few discrete markets for Tegra: auto, mobile gaming, and high-performance phones/tablets. Definitely less ambitious than the plans of a year or two ago, but also more realistic.


  • Report this Comment On May 14, 2014, at 2:56 PM, H2323 wrote:

    Nvidia is just playing a game that artificially keeps the stock inflated as revenue grinds to a halt, margins decrease, and the PC space shrinks.

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Adam Levine-Weinberg

Adam Levine-Weinberg is a senior Industrials/Consumer Goods specialist with The Motley Fool. He is an avid stock-market watcher and a value investor at heart. He primarily covers airline, auto, retail, and tech stocks. Follow him on Twitter for the latest news and commentary on the airline industry!

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