July 3 (Bloomberg) -- Nvidia Corp., the second-biggest maker of computer-graphics chips, fell the most in four years in Nasdaq trading after a drop in demand and increased competition forced the company to cut its second-quarter sales forecast.

Sales this quarter will fall to between $875 million and $975 million, Santa Clara, California-based Nvidia said yesterday in a statement. The company had said in May that revenue would decline 5 percent from the previous period's $1.15 billion, indicating about $1.1 billion. Nvidia will also record costs of as much as $200 million because of a defect in some laptop chips.

Chief Executive Officer Jen-Hsun Huang has trimmed chip prices to cope with fresh competition from Advanced Micro Devices Inc.'s ATI unit. Nvidia lost sales of laptop chips in the first three months of the year after ATI introduced less costly products, according to UBS AG analyst Uche Orji. The company faces another attack from Intel Corp., which is developing stand- alone graphics processors, a market Nvidia dominates.

Nvidia is dealing with a ``reinvigorated ATI,'' as well as slowing demand, said Jon Peddie, head of Jon Peddie Research in Tiburon, California. ``The economy is in the doldrums, the price of oil is driving everyone nuts, and people are holding back purchases.''

Nvidia tumbled $5.54, or 31 percent, to $12.49 at 1 p.m. New York time on the Nasdaq Stock Market, the biggest drop since August 2004. U.S. exchanges closed early today because of the July 4 holiday. The shares have declined 63 percent this year.

Rating Cuts

Analysts at JPMorgan Securities Inc. and Needham & Co. cut their ratings on the shares, while Lehman Brothers lowered its price target to $17 from $25. Oppenheimer & Co.'s Rick Schafer in Denver raised his rating to ``outperform'' from ``perform,'' saying Nvidia would eventually win out over ATI.

``We would use expected weakness today as an opportunity to build positions in a still solid long-term story,'' he wrote today in a note to investors.

In the past six weeks, prices of graphics cards for personal computers with Nvidia's 9800GTX chip have fallen to $200 from as much as $275, said Blake Fischer, an analyst with Stifel Nicolaus & Co. in Dallas. He recommends buying the shares, which he doesn't own.

Nvidia also said it will be less profitable than previously estimated, without providing details. In May, the company forecast that gross margin, the percentage of sales left after production costs, would widen 1 percentage point from 44.6 percent in the first quarter. The second quarter ends July 31.

Packaging Defect

The problem with the laptop chip was caused by packaging material, Nvidia said. The company must pay repair, return, replacement and warranty costs. Nvidia has been trying to reduce manufacturing expenses to boost profitability.

The sales decline will have a bigger impact on profit because Nvidia has already increased spending on developing new products, Fischer said. Those expenses rose 38 percent to $218.8 million in the first quarter, while sales climbed 37 percent.

``You're looking at a miss on revenue becoming a multiple of that miss on the earnings,'' Fischer said. Analysts will have to reduce their profit estimates, he said.

Analysts had projected second-quarter net income of $163.7 million, or 28 cents a share, the average of estimates in a Bloomberg survey. Last year, second-quarter profit doubled to $172.7 million, or 43 cents, after Nvidia grabbed market share from Sunnyvale, California-based AMD.

Santa Clara-based Intel, the world's largest semiconductor maker, is the biggest seller of graphics chips, mainly because it includes graphics capabilities in its other products. Intel has said it will increase the performance of some its chips 10-fold by 2010, a claim Huang dismissed as ``extremely crazy.''

Intel Market Share

Intel had 43 percent of the graphics-chip market in the first quarter, followed by 33 percent for Nvidia and 19 percent for AMD, based on units sold, according to Jon Peddie Research. Overall sales totaled $2.4 billion.

Peddie predicted in April that graphics-chip sales might ``drop significantly'' as the U.S. economy slowed.

Nvidia introduced a chip last month that it says offers a 50 percent improvement in processing power over previous models. Graphics cards with the chip, called the GeForce GTX 280, would cost as much as $649, the company said at the time.

That price may drop to about to $599, Fischer said. Meanwhile, AMD has introduced chips that it says provide more performance for less money.

The question now is how much of Nvidia's shortfall stemmed from slower demand industrywide and ``what percentage of the problem is caused by a more competitive AMD,'' Fischer said.

To contact the reporter on this story: Vivek Shankar in San Francisco at vshankar3@bloomberg.net

Last Updated: July 3, 2008 13:13 EDT