Nvidia: Dodging a Hail of Bullets

Can the chip wizard fight off rivals and the SEC?

In the shoot-'em-up business of graphics chips, Nvidia Corp. (NVDA ) has rocketed from obscurity in just four years to become the fastest gunslinger in town. To the delight of gamers worldwide, the company has consistently delivered technology that brings dazzling, movielike digital graphics to computers and game consoles. That helped Nvidia rank as the best-performing stock in the Standard & Poor's 500-stock index last year, with its shares up 308%, to $66.90.

Now, however, the Santa Clara (Calif.) company is dodging a hail of bullets engraved with its name. PC sales are stagnating. Competition from rivals such as ATI Technologies Inc. (ATYT ) and Intel Corp. (INTC ) is intensifying. Manufacturing problems are threatening to delay Nvidia's next-generation chip. Just to top things off, the Securities & Exchange Commission is digging into the company's accounting practices. No wonder Nvidia stock is down 68%, to $21 this year. "For the first time in a long time, Nvidia is being challenged," says analyst Joseph Osha of Merrill Lynch & Co.

Chief Executive Jen-Hsun Huang is trying to beat back the challenges. As sales slow in the company's core desktop-PC market, he's pushing into new markets, including graphics chips for high-end notebooks and such low-end products as set-top boxes. On July 16, Nvidia released a new set of chips aimed at low-end PCs and set-top boxes. And Huang is striving to make sure Nvidia's next-generation chip, code-named NV30, hits the market later this year, right on time. "We're gaining traction in every single market we're serving," Huang says.

Still, Nvidia's problems look like they're going to get worse before they get better. The company is having a tough time penetrating the new markets it has targeted. In low-end graphics chips, for example, Intel is pricing so aggressively that it is expected to grab 40% of the market by mid-2003, up from 17% now. Worse, ATI introduced its new Radeon graphics chip on July 17, and industry analysts say it's a step ahead of Nvidia's current top-line GeForce4 chip in speed and graphics quality. Losing its title as the performance king in graphics chips will probably cause a slowdown in Nvidia's sales growth this year. Merrill Lynch's Osha estimates Nvidia's revenues will rise 54%, to $2.1 billion, in the fiscal year ending in January, with net income of $275 million. That's a hefty retreat from last year's 87% revenue growth.

How Nvidia fares in the long term will depend on the NV30. If the company can get the chip out in volume later this year, Nvidia will recover its performance advantage over ATI and should do well next year. If, however, the NV30 is delayed several months, the company's fortunes could spiral downward. Its profits could fall, forcing cuts in critical research and development. "It's going to be a tremendous squeaker, and in this business, you don't like squeakers," says Osha, one of six analysts who recently downgraded the company's stock. For the fiscal year ending in January of 2004, Osha predicts revenues will climb only 7%.

Why the squeaker? In trying to outperform ATI's new chip, analysts and rivals say Nvidia was several weeks late in sending its design specifications to Taiwan Semiconductor Manufacturing Co. (TSM ), its manufacturing partner. Complicating matters, TSMC is having problems with the new process Nvidia is switching to for its high-power chip. Nvidia is working on the problems, but it won't guarantee full production volumes for the holiday shopping season.

The sudden pessimism is a far cry from last year's glory days, when Nvidia was enjoying the gamer's equivalent of a bonus round. Last fall, Nvidia's shares rose on expectations of a strong launch for Microsoft Corp.'s Xbox, because it supplies graphics chips for the game player. In the latest quarter, Xbox accounted for 22% of Nvidia's revenues. But Xbox also marked the starting point of the company's troubles. In November, 11 company engineers were charged by the SEC with trading on knowledge of the Xbox deal before it was formally announced. Nvidia says some employees were fired, but a spokesman declined to say how many were fired and what disciplinary action, if any, was taken against others.

During that investigation, the SEC uncovered the potential accounting troubles. The commission is looking into whether the company double-booked revenues and improperly accounted for reserves. To preempt any SEC action, Nvidia restated its financials, boosting profits by $1.3 million, and removed its chief financial officer, Christine B. Hoberg. Hoberg, who is expected to take another position with the company, could not be reached for comment. The SEC inquiry is still open.

For now, Nvidia has a little breathing room. The expense and engineering expertise required to develop new chips are stiff barriers for potential new entrants. But to beat back reinvigorated rivals, Nvidia must restore its focus on the high-end markets that elevated the company to its previous heights. Otherwise, Nvidia will find its pistol empty in the most important shootout of its life.

By Cliff Edwards in Santa Clara, Calif.

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