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NVIDIA Corp. (NVDA - Analyst Report) reported second quarter fiscal 2014 earnings of 16 cents per share, which beat the Zacks Consensus Estimate by 3 cents. Excluding stock based compensation and other one-time items, earnings were 23 cents, which decreased 14.8% from the year-ago quarter but jumped 27.8% from the previous quarter.

The year-over-year decline in earnings was primarily attributed to the top line’s fall from the year-ago quarter and higher operating expenses that fully offset the gross margin expansion. On the other hand, the sequential growth was primarily driven by strong top-line growth and gross margin expansion.

Revenues

Revenues decreased 6.4% year over year, but increased 2.4% sequentially to $977.2 million. The sequential growth was slightly higher than management’s outlook. However, revenues lagged the Zacks Consensus Estimate of $980.0 million.

Revenues generated by the company’s gaming GPUs moved up 24.0% year over year and 9.3% quarter over quarter to $858.6 million. The strong growth was driven by robust performance in desktop, workstation and server market segments, partially offset by slight decrease in notebook.

NVIDIA’s GeForce (for desktops) revenues climbed 3.9% year over year and jumped 13.8% sequentially. Quadro (for workstations) revenues surged 14.3% year over year and 8.5% sequentially, while Tesla (for server) soared 127.5% from the year-ago quarter and 25.3% from the previous quarter.

NVIDIA introduced Kepler-based products during the quarter, which drove this strong growth in both the segments. Revenues from Notebook GPUs declined 1.7% year over year and 3.6% sequentially due to lower shipments.

As expected, revenues from the Tegra Processor segment plunged 70.7% from the year-ago quarter and 49.0% from the previous quarter to $52.6 million. The decline was primarily attributed to lower shipment for Tegra 3 processors.

NVIDIA ramped up production of its next generation processor Tegra 4 during the quarter. The company also started shipment of its new branded gaming and entertainment device “SHIELD” during the quarter.

SHIELD has received positive response. Being an open platform, the device can access anything available to Google’s android-based tablets. The device can be used as a web-browser as well as to update Facebook (FB - Analyst Report).

All other revenues, which primarily comprises license revenues from agreements with Intel Corp (INTC - Analyst Report), were $66.0 million in the quarter, flat both on a year-over-year and sequential basis.

Margins

Gross margin expanded 430 basis points (“bps”) from the year-ago quarter and 170 bps from the previous quarter to 56.3%, primarily due to favourable product mix.

Operating expenses as percentage of revenues increased sharply to 41.0% from 32.8% reported in the year-ago quarter. The increase was due to higher compensation expense. Sequentially, operating expenses as percentage of revenues improved 50 bps in the quarter.

Net Income margin contracted 270 bps from the year-ago quarter due to higher operating expenses. Sequentially, net income margin increased 170 bps.

Balance Sheet & Cash Flow

NVIDIA exited the quarter with cash, cash equivalents and marketable securities of $2.94 billion, down from $3.71 billion in the previous quarter. Free cash flow in the quarter was $11.5 million, down from $109.9 million in the previous quarter.

Guidance

For the third quarter of 2014, NVIDIA expects revenues to be approximately $1.05 billion (+/-2.0%). Non-GAAP gross margin is expected to be in the range of 56.0% - 56.3%, flat on a sequential basis. Non-GAAP operating expenses are expected to be approximately $418.0 million.

For the upcoming quarter, depreciation & amortization is expected to be approximately $62.0 million to $64.0 million. Capital expenditures are expected to be in the range of $60.0 million to $70.0 million.

Recommendation

NVIDIA’s innovative product pipeline that consists of recently introduced SHIELD and the upcoming Mobile processor Logan Tegra 4 processors will boost top-line growth going forward. However, higher operating expenses and significant competition is expected to hurt profitability in the near term.

NVIDIA has a Zacks Rank #4 (Sell).

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