Nvidia’s Fiscal Q3 earnings report was spectacular on all accounts. The data center growth for this quarter was bonkers againbonkers again with growth of 279% year-over-year. The FQ4 guide implies data center growth that will accelerate to roughly 370% next quarter.
Overall revenue beat by $2 billion this quarter for $18.12B in revenue, up 206%. For next quarter, the guide beat by another $2 billion for guidance of $20B compared to $17.9B expected.
EPS of $4.02 compares to $3.39 expected. Gross margin grew to 74% compared to 71.5% expected.
Yet, the stock is down 1.5% after hours. In our pre-earnings write-up that was published this morning in our free newsletter, I had stated: “The topping-out scenario is that Nvidia’s buying is exhausted, and there isn’t one fundamental analyst on earth that can help investors figure out when this will happen.” I explained this is best left to technical analysts as there are many forces which weigh on a stock. It was unlikely Nvidia missed due to the CFO’s visibility on supply, yet the win-win scenario is that we don’t need the market to continue to reward Nvidia. It already has rewarded Nvidia, and if the market is getting tired of Nvidia’s exceptional results, then we will simply take gains and buy again lower.
Essentially, what we are seeing after hours has nothing to do with the company’s financials. When buyers become exhausted, it means a story is well-known. It’s not logical, it’s merely what makes a market.
The flaw in Nvidia’s report is the loss of China revenue. It can be deceiving because demand is so high, that Nvidia will absorb those losses in the upcoming quarter. However, there are implications in the medium-term, which we had also written about in our pre-earnings report.
The long-term thesis is very much intact, which is that Nvidia is on its way to become the world’s most valuable company someday. Data center GPUs are only part of the story. Automotive has the potential to exceed data center GPUs, and there’s also software which we covered here.
In the near-term, Nvidia investors should keep an eye on the broader semiconductor sector, which looks weak, and there’s a chance the China impact drags on FY2025/FY2026 estimates until we get a new fiscal year guide next quarter. I also touch base on a few positives that are important to keep an eye on.
Revenue and EPS:
Nvidia reported revenue of $18.1B, up 206% Y/Y and well above consensus of $16.1B and above guidance of $16B. However, the magnitude of the revenue beat of 12% was smaller than the 22% beat in the July quarter. Non-GAAP EPS was $4.02, well above consensus of $3.39.
Revenue Segments:
- Data Center revenue of $14.5B, up 279% YoY and up 41% QoQ
- Gaming revenue of $2.9B, up 81% YoY and up 15% QoQ
- Pro Visualization revenue of $416M, up 108% YoY and up 10% QoQ
- Automotive revenue of $261M, up 4% YoY and up 3% QoQ
- OEM & Other Revenue of $73M, flattish YoY and up 11% Q/Q
Nvidia provided revenue guidance of $20B +/- + 2% above consensus of $17.9B with adjusted GM guidance of 75.5% and Non-GAAP Operating Margin guidance of 64.5%.
More on Data Center Segment:
Our pre-earnings report highlighted the release of the H200. Major cloud players such as AWS, Google Cloud, Microsoft Azure, and Oracle cloud will be among the first CSPs to offer H200 inferences starting in Q2 of 2024. The H200 is likely to come with a higher ASP than the H100 due to HBM3e memory. The H100 has an ASP in the $30,000 to $40,000 range. The higher ASP may not contribute to margins necessarily, as HBM3e is costly.
At $40,000 per H100, that equals $29B in H100 sales alone, and when you add the A100 and other data center sales at a current run rate of $15B, the Data Center segment could report total revenue of $44B in FY24 (CY23). When you equal this out across the upcoming quarters, it looks something like this based on our estimates and Piper Sandler estimates.
Nvidia is expected to report approximately $16.5B in revenue for the January quarter. Keybanc has data center revenue at $101 billion for next year. If we assume China is $20 billion of this (and worst case, doesn’t get absorbed) then it will look something like this:
Scenario 1:
Q1 FY25: $18B
Q2 FY25: $19.5B
Q3 FY25: $21B
Q4 FY25: $23B
However, it’s likely the China revenue does get absorbed even if analysts are forced to revise estimates for now. This means that estimates may go down this quarter, and then be revised up again when management discusses the fiscal year guide. If so, it would look more like this:
Scenario 2:
Q1 FY25: $20B
Q2 FY25: $24B
Q3 FY25: $27B
Q4 FY25: $30B
That’s based on Keybanc’s fairly optimistic estimate of over $100B next year in data center revenue. Here are data center revenue numbers that are more conservative from Piper Sandler. Due to the QoQ growth in this model, next quarter’s fiscal year guide is paramount for us Nvidia bulls.
Scenario 3:
My opinion is that Scenario 1 is a safe assumption as it combines continued growth in the data center with some China impact.
Margins:
Gross margin of 74% beat guidance of 71.5%. As stated in our pre-ER write-up, these are historic margins for Nvidia.
The company reported an operating margin of 57.5% for income of $10.4 billion. The adjusted operating margin of 63.8% compares to a margin of 26.4% last quarter.
Net income of $9.2 billion represents a margin of 51% compared to 11.5% net margin in the year ago quarter. This is a combination of data center strength and being at the cyclical trough last year for gaming.
Cash:
Cash flow margins are the best in the Mag 7 at 40.5% operating cash flow this quarter and 38.9% in free cash flow margin. Meta has the second best FCF margin at 34.7% followed by Apple at 29.7%.
Nvidia had $18.3B in cash and marketable securities, up from $16.0B last quarter and debt of $9.7B in-line with the July quarter of $9.7B.
The company utilized cash of $3.91 billion towards shareholder returns, including $3.81 billion in share repurchases and $99 million in cash dividends. Last quarter, an additional $25 billion was authorized for share repurchases.
Earnings Call:
The China Impact:
We had written the following in our pre-earnings report:
“The Red Scare:
What’s not to be forgotten in the excitement of the product road map is China, which has been the predominant risk for semiconductor stocks dating back to 2018. Last year, the government restricted Nvidia from selling its two most powerful chips to China, the A100 and H100. To circumvent these restrictions, Nvidia designed slightly less powerful chips called the A800 and H800. As reported by Reuters, the H800 has as much computing power as the H100 in certain settings. For the United States, these chips are important to block as they strengthen China’s military.
Last month, the U.S. Department of Commerce announced updated rules focuses on computing performance by removing the bandwidth parameter and focusing exclusively on how powerful a chip is, as well as performance density, which will prevent companies from working loopholes. According to an official who spoke to Reuters, “the U.S. will require companies to notify the government about semiconductors whose performance is just below the guidelines before they are shipped to China.”
Although this is a medium-term issue for Nvidia, analysts believe the demand is high enough today that the company shouldn’t have any issues absorbing the 20% to 25% loss in its data center segment from tighter export restrictions to China. Looking further out for FY2025, Keybanc sees a $5 impact to Nvidia’s $25.62 EPS estimate, and up to a $20B impact to its data center segment with current estimates at $101B for the data center in FY2025.
Eventually, demand may settle – especially as more competitors step up – and investors should pencil-in losing China revenue as a risk that is materializing now, with the revenue impact likely to be felt in FY2025.”
It’s tempting to shrug off the loss of revenue given Nvidia beat/raised next quarter, which is the quarter when 20% to 25% of revenue from China and other restricted countries will be cut off. However, the Street is likely to be cautious tomorrow because FQ4 will be seen as an outlier where demand can absorb the 20% to 25%. Basically, the outsized demand will be transitory whereas the U.S. Department of Commerce is cutting off 20% to 25% permanently. There was some talk about Nvidia serving these countries with a less powerful chip, but the restrictions are blacklisting Nvidia’s AI chips (specifically) so this workaround won’t be an easy feat.
By the time Nvidia comes up with a workaround, even if it’s acceptable, those countries will have designed their own domestic silicon. Even if this eventually does get absorbed, analysts will likely revised down their estimates for a few quarters out in FY2025 or next fiscal year FY2026. This may, in turn, impact Nvidia’s valuation. Per the CFO: “The export controls will have a negative effect on our China business, and we do not have good visibility into the magnitude of that impact even over the long term.”
This does not derail Nvidia’s thesis by any means and the timing could not have been better with the restrictions happening during a period of outsized demand. As pointed out on the call, Nvidia will be tapped by many countries that are not blacklisted into the foreseeable future: “National investment in compute capacity is a new economic imperative, and serving the sovereign AI infrastructure market represents a multibillion-dollar opportunity over the next few years.”
InfiniBand up 500% YoY:
We covered InfiniBand a few years back when our site covered the Mellanox acquisition. Mellanox was an important acquisition as it helped Nvidia align its architecture with speed by supporting Virtual Protocol Interconnect (VPI), which allows the ubiquitous Ethernet to provide bandwidth as cheap as possible, and InfiniBand to deliver higher throughput and fewer bottlenecks during high loads. Today, this acquisition is paying off.
Per the opening remarks: “Networking now exceeds a $10 billion annualized revenue run-rate. Strong growth was driven by exceptional demand for InfiniBand, which grew fivefold year-on-year […] Azure uses over 29,000 miles of InfiniBand tabling, enough to circle the globe.”
InfiniBand growing five-fold exceeds overall data center revenue given the $15B in total data center revenue last fiscal year is expected to grow 200% to $45 billion at the exit of this fiscal year. Networking revenue tripled and data center compute grew four-fold.
The discussion on the call is that companies are standardizing with InfiniBand as the “computing fabric” increases the effectiveness of AI infrastructure by 20% to 30%. InfiniBand is nearly ubiquitous in supercomputing and is becoming popular with AI/Big Data applications on a large scale for high performance clusters. The benefits of the software defined fabric is that it’s low latency, high bandwidth and low management cost.
Recurring Software Revenue at $1 Billion:
Going off what we know, recuring software revenue may have doubled over the past few quarters CFO had stated: “hundreds of millions of dollars annually” and it’s now being stated the standalone software business will be worth $1 billion next quarter: “We are on track to exit the year at an annualized revenue run-rate of $1 billion for our recurring software support and services offerings.”
Keep an eye on this as it’s likely to be the leading story over the next few years – especially as automotive ramps.
AI Factories:
This was probably the most important question in terms of Nvidia’s growth potential. There’s nothing revelatory being said, per se, but it’s nice to hear some of the bigger picture repeated.
Question: “Because when I just look at the trajectory of your Data Center, it will be close to nearly 30% of all the spending in Data Center next year. So what metrics are you keeping an eye on to inform you that you can continue to grow? Just where are we in the adoption curve of your products into the generative AI market?” -Vivek Arya, Bank of America
Answer: “Generative AI is the largest TAM expansion of software and hardware that we've seen in several decades. At the core of it, what's really exciting is that what was largely a retrieval-based computing approach – almost everything that you do is retrieved off of storage somewhere – has been augmented now, added with a generative method. And its changed almost everything. […]
And one of the areas that is really impactful is the software industry, which is about $1 trillion or so, has been building tools that are manually used over the last couple decades. And now, there's a whole new segment of software called co-pilots and assistants. Instead of manually used, these tools will have co- pilots to help you use it, and so instead of licensing software – we will continue to do that of course, but we will also hire co-pilots and assistants to help us use the software. […]
But there's a new class of data centers, and this new class of data centers, unlike the data centers of the past, where you have a lot of applications running used by a great many people that are different tenants that are using the same infrastructure, and that data center stores a lot of files. These new data centers are very few applications, if not one application, used by basically one tenant, and it processes data. It trains models, and it generates tokens. It generates AI. And we call these new data centers AI factories.”
Translation: If you separate AI from traditional data centers (and where data centers are headed), then Nvidia represents far more than 30%.
Conclusion:
We are tracking TSM, semiconductor indexes, and Nvidia’s chart for signs of exhaustion as outlined here. We are seeking a win-win scenario where we can lock-in gains, and then use that cash to buy Nvidia again at lower levels. As stated, Nvidia’s thesis is firmly intact. Rather, the issue is the market is seeing very narrow leadership and Nvidia is the defacto leader within that narrow leadership. The saying in Wall Street is that pigs get slaughtered. That’s a rough way of saying 200% gains YTD should be approached carefully as the goal is to make real money, not paper money. Of course, 200% will be nothing by the time we are done with this position. But for this year, it’s good enough.
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