Graphics processor veteran NVIDIA (NASDAQ:NVDA) reported second-quarter results on Wednesday, Aug. 19. The results edged out analyst expectations and the headlines highlighted the fact that data center sales outweighed gaming products for the first time in NVIDIA's history.

If you look a little closer at NVIDIA's report and earnings call, you'll find evidence of an even more significant change to the company's business model. Yes, semiconductor designs are still at the core of NVIDIA's day-to-day operations, but the company is also growing its software sales. That road points to wider profit margins and more reliable revenue streams in the long run because most of NVIDIA's software sales are tied to long-term subscription packages.

A computer rendering of a green NVIDIA logo.

Image source: NVIDIA.

Three types of NVIDIA software

The company is not yet ready to break out software sales and operating profits into separate line items in its quarterly reports. Instead, we have to look for clues like management comments in order to see the business category gaining momentum.

The software sales largely fall into three separate buckets.

  • AI: NVIDIA supports several software frameworks for artificial intelligence (AI) number-crunching, all optimized to take full advantage of GeForce graphics chips and Tesla (NASDAQ:TSLA) high-performance computing processors. The NVIDIA DIGITS neural network training system is an in-house solution for which NVIDIA offers enterprise-grade support services.
  • Self-driving cars: The NVIDIA DRIVE AGX Orin platform is a self-driving car system that's both built around NVIDIA's high-performance math processors and designed like a modular software product. Upgrades, bug fixes, and new features can be added through over-the-air software updates, and many features are available under subscription-style licensing terms. The Mercedes-Benz division of German automaker Daimler AG (OTC:DMLR.Y) (OTC:DDAI.F) recently committed to a DRIVE AGX partnership that will put NVIDIA-powered Mercedes cars on the road by 2024.
  • Data center networking: Through the recent acquisitions of Mellanox and Cumulus Networks, NVIDIA has become a significant force in the market for software-defined data center networks. This ultra-flexible network management approach comes with multiyear license and support agreements, pushing NVIDIA even further into the realm of software-based business.

NVIDIA loves the data center

The AI and data center networking efforts are really two sides of the same ambitious enterprise computing coin. NVIDIA's management is putting together a top-to-bottom data center framework that should generate strong growth for years to come. It's all based on software-defined virtual computing services, which, in turn, depend on NVIDIA's processors. Building the best processors or the fastest computer systems isn't the name of the game anymore. It's more about managing an entire data center like a single unit that can be split up and directed to various services with the help of systems management software.

"Going forward, you optimize at the data center scale," said NVIDIA CEO Jensen Huang. "And the reason why I know this for a fact is because if you're a software engineer, you would be sitting at home right now and you would write a piece of software that runs on the entire data center in the cloud. You have no idea what's underneath it, nor do you care."

Rows and rows of server racks in a modern data center.

Image source: Getty Images.

The architecture starts with great microchips, but Huang sees software taking the whole system to another level.

"Now we take this thing all the way through systems, the system software, algorithms, networking, all the way up to the entire data center. And the difference is absolutely shocking," he said. "You know, we built our data center, Selene, and it took us four weeks ... It is the seventh-fastest supercomputer in the world, one of the fastest AI supercomputers in the world."

And the software focus isn't exactly a new idea for NVIDIA. The market success you see today started with development efforts and design decisions many years ago.

"NVIDIA is a software-defined company today," Huang said, "with rich software content like GeForce NOW, NVIDIA virtual workstation in the cloud, NVIDIA AI, and NVIDIA Drive that will add recurring software revenue to our business model."

The times, they are a-changin'

It should be pretty clear from this report that NVIDIA is leaning into subscription-based software sales in a big way. The company is following the lead of pretty much every enterprise software giant on the market, all of whom have been trading in their old single-sale software licenses for repeatable subscription sales in recent years. Many things can be sold as a service these days, including NVIDIA's data center networking tools and artificial intelligence platforms.

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