Nvidia has faced this type of decline before, and it seems to have a specific target this time

The financial results of Nvidia Corp. were somewhat of a surprise to investors, and not in a good way, with product stocks doubling to a record high as the chip company prepares for a questionable holiday season.

Nvidia reported earnings for its fiscal third quarter that was slightly better than analysts’ lowered expectations on Wednesday, but the numbers weren’t that big. Revenue fell 17% to $5.9 billion, while profits were halved thanks to a $702 million inventory charge, largely related to slower demand for data centers in China.

Gaming revenue in the quarter fell 51% to $1.57 billion. Nvidia said it is working with its retail partners to help move high channel inventories.

While the company was writing off inventory for China, its own inventory of new products was growing. Nvidia
NVDA,
-4.54%

reported that its overall product inventory nearly doubled to $4.45 billion in the fiscal third quarter, compared with $2.23 billion a year ago and $3.89 billion in the prior quarter. Executives cited upcoming product launches designed around the new Ada and Hopper architectures when asked about inventory gains.

In the semiconductor industry, large inventories can unnerve investors, especially since the industry has had so many supply constraints in recent years that it quickly turned into a chip glut in 2022. With doubts about demand for playing cards and consumer willingness to spend amid sky – high inflation during the holiday season, having all these products on hand only adds to the nerves.

Full revenue coverage: Nvidia profit halved, but changed servers for China offset earlier $400m warning

Chief Financial Officer Colette Kress told MarketWatch in a phone interview Wednesday that the company’s high level of inventory is commensurate with high levels of revenue.

“I believe that … this is our highest level of inventory,” she said. “They go hand in hand.” Kress said she is confident in the success of Nvidia’s upcoming product launches.

Nvidia’s revenue peaked in the April 2022 quarter at $8.3 billion, and in the past two quarters revenue has slowed, with gaming demand weak amid the transition to a new cycle and a drop in demand for data centers in China due to COVID-19 lockdowns and US government restrictions.

For its data center customers, the new architectures promise big advances in computing power and artificial intelligence features, with Nvidia planning to ship the equivalent of a supercomputer in a box with its new products next year. These types of advanced products weigh even more heavily on the total stock, Kress said, because of the cost of the total package.

“It’s about the complexity of the system that we’re building, that’s what drives the inventory, the pieces of it together,” Kress said.

Bernstein Research analyst Stacey Rasgon believes Hopper-based products will start shipping in the next few quarters, “at significantly higher price points.” He said in a recent note that he thought Nvidia’s numbers probably bottomed this quarter.

“We remain positive on Hopper’s upside next year and believe the numbers at this point have likely bottomed out, with new cycles maturing and an attractive secular story, even without China potential,” Rasgon said Tuesday in a note to preview earnings.

Read also: Warren Buffett’s buying of chips is a classic example of why you want to be “greedy only when others are fearful”

Nvidia CEO Jensen Huang reminded investors on a conference call that the company’s stock is “never at zero” and said everyone is excited about the upcoming launches. But it doesn’t take much memory to imagine the time Nvidia went on vacation with an inventory backlog that included a new architecture and sorely disappointed investors: Four years ago, Huang had to cut its holiday earnings forecast in half among “crypto hangover” with a similar dynamic to the current moment

Investors need faith that this holiday season won’t be the same, even as demand for some video game products slumps after a pandemic boom, just as the cryptocurrency market — some of which are mined with Nvidia products — is entering a rough patch. Huang said Nvidia’s RTX 4080 and 4090 graphics cards, based on the Ada Lovelace architecture, had an “exceptional launch” and sold out.

Shares of Nvidia gained more than 2% in after-hours trading on Wednesday, suggesting some are betting this time will be different. That enthusiasm needs to translate into earnings for Nvidia so that this big gain in stock doesn’t end up being part of another write-down at some point in the future.

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