For years, bears have worried that graphics chip specialist NVIDIA (NASDAQ:NVDA) would be crushed by two trends. First, the improvement of integrated graphics processors from Intel and Advanced Micro Devices was expected to make NVIDIA's "discrete" GPUs all but obsolete. Second, bears expected NVIDIA to suffer (along with the rest of the PC industry) from the cannibalization of PCs by tablets.
In order to counteract some of these trends, NVIDIA has poured a substantial amount of research and development into the creation of the Tegra mobile processor for smartphones and tablets. The company also bought Icera, a start-up that designed software-defined modems, and NVIDIA has now introduced its first integrated mobile processor. With these moves, NVIDIA hopes to turn the growth of mobile computing to its advantage.
However, NVIDIA's recent Q1 earnings report highlighted the choppiness of growth in the Tegra mobile business. Tegra revenue was down 22% year-over-year, and down more than 50% compared to the prior quarter. Nevertheless the company managed to deliver better-than-expected earnings, with GAAP EPS of $0.13, despite a horrendous PC market. NVIDIA's strong earnings demonstrated that by focusing on the high end of the computing market, the company is almost entirely insulated from the negative trends affecting the rest of the PC industry.
Areas of strength
The main driver of NVIDIA's stronger profitability was a record-high GAAP gross margin of 54.3%, up from 50.1% in the prior year quarter. By contrast, revenue of $954.7 million was only up slightly year over year, and was down 13.7% sequentially. NVIDIA has built a leadership position in high-end graphics processors, including high-end GeForce GPUs for gamers, Quadro workstation graphics cards for professional designers, and Tesla GPUs for supercomputing tasks. For example, while top graphics competitor AMD recently introduced a new high-end gaming card, most reviewers have concluded that NVIDIA's competing offerings provide better overall performance.
On NVIDIA's recent earnings call, executives highlighted strong sales of the recently released GeForce GTX Titan GPU, a $1,000 high-end gaming card. The card was introduced in February and NVIDIA has been able to sell them as fast as it can produce them. Meanwhile, Tesla revenue increased 55% year-over-year, and Quadro has rebounded from some weakness it suffered last year. All of these high-end businesses produce stellar margins for NVIDIA.
NVIDIA is not resting on its laurels, nor is it putting all of its eggs in the "mobile" basket -- although the company does have a significant opportunity there. Within the Tegra business, automotive customers are becoming an increasingly important revenue source. Tegra processors power the infotainment and navigation systems and the instrument cluster of the new Tesla Motors Model S sedan. Audi is also rolling out Tegra-powered infotainment systems on a global basis. NVIDIA's ability to win business from these two luxury automakers is a testament to Tegra's performance.
Within the traditional GPU business, NVIDIA has begun marketing its GeForce GRID servers. This initiative will eventually allow NVIDIA to more efficiently deliver computing power for both enterprise and gaming customers. For example, by handling graphics loads in the cloud, GRID allows customers to perform workstation-level graphic design work on laptops. NVIDIA believes that this addressable market could be worth $3 billion. Future iterations of GeForce GRID for gaming and software-as-a-service applications will expand the addressable market even further.
Foolish bottom line
According to IDC, the PC market declined 14% year-over-year last quarter; Gartner pegged the drop at 11%. Nevertheless, NVIDIA was able to grow its GPU revenue and profitability due to its strength in the high end of the market. Hardcore gamers cannot just switch to tablets, and rapid improvements in screen resolution and game complexity create a constant demand for more graphics processing power. Similarly, enterprises using Quadro-equipped workstations need state-of-the-art graphics capabilities to excel in their fields, while supercomputers can always benefit from more efficient and more powerful processors.
If NVIDIA can continue to produce high quality GPUs for these markets while attacking new growth segments like mobile, auto, and cloud, it should continue to thrive in spite of the PC's decline.
Fool contributor Adam Levine-Weinberg owns shares of NVIDIA. The Motley Fool recommends Intel, NVIDIA, and Tesla Motors. The Motley Fool owns shares of Intel and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.