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Operator
Good afternoon. Thank you for holding. I would now like to turn the call over to Michael Hara, Vice President, Investor Relations. Thank you. Sir, you may begin.
Michael Hara
Thanks, Will. Good afternoon, and welcome to NVIDIA's conference call for the second quarter of fiscal 2011. With me on the call today from NVIDIA are Jen-Hsun Huang, President and Chief Executive Officer; and David White, Chief Financial Officer. After our prepared remarks, we will open up the call to a question-and-answer session. Please limit yourself to one initial question with one follow up.
Before we begin, I would like to remind you that today's call is being webcast live on NVIDIA's Investor Relations website and is also being recorded. A replay of the conference call will be available via telephone until August 19, 2010, and the webcast will be available for replay until our conference call to discuss our financial results for our third quarter of fiscal 2011. The content of today's conference call is NVIDIA's property and cannot be reproduced or transcribed without our prior written consent.
During the course of this call, we may make forward-looking statements based on current expectations. These forward-looking statements are subject to a number of significant risks and uncertainties, and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our Form 10-Q for the fiscal period ended May 2, 2010, and the reports we may file from time to time on Form 8-K filed with the Securities and Exchange Commission.
All of our statements are made as of today, August 12 based on information available to us as of today and except as required by law, we assume no obligation to update any such statements. Unless otherwise noted, all references to market research and market-share numbers throughout the call come from Mercury Research or Jon Peddie Research. With that, let's begin.
Rapidly changing market conditions made Q2 a challenging quarter. We experienced softness in consumer PC demand in Europe and China, our largest GeForce regions. Weak consumer market and the weak euro shifted demand away from the premium experienced PC segment that GeForce serves. At the end of Q1, we began selling our new Fermi based GeForce GTX480 and 470 GPUs into strong demand and saw healthy in-channel sell out for GeForce products across our line-up. We entered Q2 with high expectation. As the quarter progressed, rising memory cost, the weakness of the euro increased end market price of the graphics add-in cards.
In addition, the growing economic concerns in Europe and China began to create pressure on discretionary spending. Because discrete GPU attach rates in Europe and China are among the highest in the world and our share in both these regions are also very high, these factors hit our consumer business particularly hard. Today, we also announced an additional charge to cover cost resulting from a weak die/packaging material set in certain GPU and MCP products shipped before July 2008. This is the same issue we disclosed previously. We’ve provided more detail in the CFO commentary which was released prior to the call.
Although the end markets remain uncertain, we have exciting new products that can drive revenue and share growth. We are continuing to regain our GeForce consumer GPU leadership position across the entire product set. The GTX480 has claimed the top stop in the Enthusiast segment. Our focus is now on the gamer sweet spot, the $199 performance segment.
In July we launched the GTX460. GTX460 uses our second generation Fermi architecture and delivers the perfect balance of price, performance, and power specifically for the $199 segment. The industry reviews underscores that 460’s unrivalled competitive position. (inaudible) “it performs admirably, it’s dead quiet, it tips power, it runs cool, and overclocks like a monster without voltage modification.”
GameStar Hardware explained, “NVIDIA is back. The GTX 460 is fast, really fast and at the same time, enjoy the quiet at much lower power consumption.” Hardware CPU also wrote in a following report, “if our earlier articles have not proved it yet, this one surely put the final nail on the coffin. GTX460 1 gig SLI real world gaming performance is superior to even AMD’s fastest high-end single GPU video card in a CrossFireX configuration.” And nontech put it simply. “NVIDIA’s GeForce GTX460 is a $200 king.”
GTX460 is a showcase of the revolutionary Fermi architecture designed from the ground up for DX11. We are now ramping the rest of the Fermi GPUs from top to bottom and including notebooks and workstations.
At SIGGRAPH, we launched the era of computational visualization for designers, engineers, researchers and animators with the introduction of our Fermi-class Quadro GPUs and new NVIDIA 3D Vision Pro solution. Computational visualization combines the parallel computing power of the Femi architecture with utilization to enable a breakthrough capability for designers. Powered by our new Fermi-class Quadro, artists can create photorealistic imageries for print ads, commercials, and movies in a minutes rather than hours.
Car designers can simultaneously optimize the design for beauty as well as for aerodynamics. The new family for Quadro GPU deliver performance that is up to five times faster for graphics and up to eight times faster performance for computational simulation than our previous Quadro generation. Fermi class Quadro is the biggest discontinuity we have introduced since Quadro FX introduced geometry processing over 10 years ago.
Our workstation partners, Dell, HP, and Lenovo are all racing to engage new markets as well as acquiring the largest out base of Quadro workstations.
Tesla achieved another record quarter and continues to make further inroads into our targeted verticals. Last week DARPA announced that NVIDIA has been awarded a $25 million (inaudible) what the (inaudible) called “a crisis in computing.” Today’s conventional computers are starting to hit practical limits since there can only be so much computation given a certain amount of energy. For DARPA to recognize NVIDIA should take the lead and discover the computing architecture of the future is a recognition of the impact of GPU computing and of NVIDIA contribution to computing.
Under a four-year contract, the team plans to build new class of excess scale super computer that are a thousand times more powerful than today’s supercomputers using similar amounts of energy. Our team includes Cray, Oak Ridge National Laboratory and several top universities.
The enthusiasm for upcoming GPU technology conference in September is another example of the momentum we are seeing behind GPU computing. Last year, we exceeded attendees’ expectations. This year, we have four times the number of papers submitted, three times the sponsorship levels, and are expecting to twice the number of registered attendees. Industry speakers will discuss the use of CUDA in fields ranging from cloud computing, computer vision, energy exploration, life sciences, medical imaging to finance. It is very clear now throughout parallel computing has reached the tipping point since accelerating the discovery on a broad range of important industries.
Finally, in one of our most important initiatives, we need to execute and help our Tegra customers ship their next generation smartphones, tablets, Netbooks and cards. These devices will be the industry’s first off of Tegra’s dual core CPUs and HD resolution graphics and video. We will begin production shipments for some of our customers’ key projects this quarter. We are in the home stretch
Regaining GPU leadership and share, ramping Fermi-based Quadro, continued adoption of Tesla, and shipping Tegra customers, these are the immediate growth opportunities we are focused on.
With that, let me turn the call over to David.
David White
Thanks, Mike. Revenue was $811.2 million, down 19% sequentially. GAAP gross margins was 16.6%. GAAP OpEx was $309.5 million and GAAP net loss was $141 million or $0.25 per share. Reflecting these results is the net charge of $193.3 million related to the weak die/packaging material set.
Non-GAAP net income, which excludes this net charge was $20.1 million or $0.03 per diluted share.
GAAP gross margin of 16.6% for the second quarter was unfavorably impacted by two significant events. First, GAAP gross profit was impacted by the aforementioned charge. Second, the market shift in our consumer GPU business resulted in excess inventory of certain primarily older generation products. As a consequence our second quarter results include charges for a large inventory write-down. Excluding each of these items, gross margin would have exceeded our outlook.
Inventories at the end of the quarter were $434.2 million, up 11.9% over the prior quarter. Notwithstanding the inventory write-down, inventory was up as a result of lower actual revenue than was planned earlier in the first quarter when we made wafer start commitments.
Our manufacturing cycle time is approximately four months. We made appropriate adjustments to our build plans over the course of the second quarter, but we don’t expect these corrections to have a meaningful impact on our inventory levels until the fourth quarter. Net of the inventory write-down we took in the second quarter, we believe the inventory mix in our current pipeline is aligned with current market demand.
Revenue for the GPU business was down 29.5% due to reasons discussed earlier. We do not expect the market conditions to change dramatically, but we expect our competitive position to improve and regain some segment share. We launched our new GTX460 into the $199 performance segment. It has received outstanding industry reviews and continues to sell well and gain share.
Revenue for our Quadro professional solutions and Tesla computing solutions represented 26.5% of total revenue, and was up 13.4% over the prior quarter. Tesla achieved another record quarter. Revenue for the consumer products business was up 46.5% over the first quarter. Substantially all of the increase was attributable to Tegra.
Cash and cash equivalents and marketable securities at the end of the quarter were $1.77 billion, up modestly from the first quarter.
Our outlook for the third quarter of fiscal 2011: Revenue is expected to be up 3% to 5%. GAAP gross margin is expected to increase to 46.5% to 47.5%. GAAP operating expenses are expected to approximately $300 million; a tax rate of 17% to 19%.
That concludes our prepared remarks, and at this point we will now take questions.
Question-and-Answer Session
Operator
Thank you. (Operator instructions) Our first question comes from the line of Raji Gill with Needham & Company. Please proceed with your question.
Raji Gill – Needham & Company
Yes, thank you. Two question, one on the revenue guidance of up to 3% to 5%. May be you could provide a little more color where you see that guidance given kind of the weakness in the PC supply chain. Also, on the margins, significantly – the guidance significantly higher. You know, what gives you confidence that you will be able to get the margins back up to the level, would you not expect price competition to come back into the market? May be just some more details on the gross margin guidance will be helpful. Thank you.
Jen-Hsun Huang
So, we are assuming the consumer PC market to remain uncertain and all of our – all of the growth that we talked about in Mike’s previous comments are the ones that we are focused on. GeForce GTX460 goes into a segment of the marketplace that’s really about gamers and gamers come out to buy new graphics cards when there are new great games. And this last month we saw the launch of StarCraft II, which is arguably one of the most important video games in the entire video game – in the entire PC industry with some 12 million plus gamers around the world. And StarCraft II you know for all the people that are on the phone that knows about it, obviously hasn’t been refreshed since 1998. I think it’s over 12 years or some like that. And so the market has been extremely enthusiastic about it and the sell through has been really fabulous. And so I think this is a pretty good season for gaming graphics cards and GTX460 is really the best graphics card we’ve ever built for gamers in the history of our company. So, that’s one.
The second one is Quadro Fermi. Fermi-based architecture Quadro is just ramping into production now. And the OEMs are really enthusiastic about it. The end users are clamoring for it. And so I think this is an opportunity for us to upgrade the installed base of Quadro workstations around the world with a revolutionary new architecture. Mike already talked about in his comments pretty substantial speed-ups from generation to generation. I don’t think we’ve ever seen a 5X speedup from one generation to another generation. So, this is a very, very big deal.
And then the third thing is Tesla. We had a record quarter in Tesla this last quarter. We’ve got some exciting new products that are going ship into the marketplace imminently and so I think the – this is marketplace that is clamoring for more processing capability and we are not seeing any effect from the consumer marketplace because of it.
And then the last part is Tegra. AS you know, the most important and probably the fastest growing computer market today is the smartphone and tablet market. And Tegra is our entry into that. We are seeing customers trying to pry these chips out of our hands and we’ve got to get these things shipped into production. And there are really exciting new products.
So, those are the four areas where we – we are confident to see growth
GTX460, Quadro – Fermi-based Quadro, Fermi-based Tesla, and our Tegra SoC.
Now, with respect to the gross margins, all of those products that I just mentioned are either at or above the corporate gross margins that David talked about.
Raji Gill – Needham & Company
And if I could follow-up – I appreciate that – just follow-up on the consumer PC that the GTX 460 really driving a lot of this growth. Given the uncertainty in Europe and China, and given that the fact that the – you are talking about attach rates for discrete graphics potentially coming down, or came down this quarter, and the exchange rate, what makes you confident that you can get the attach rates up or improve demand in those two key segments for you?
Jen-Hsun Huang
There is really two GeForce markets. One GeForce market is for gamers is the GeForce GTX market. They are not sold to OEMs. They are not really sold to system builders. They are sold to end users. Most of it is sold through eTail or retail or – a large – the vast majority of it is sold as a retail based add-in card in a way that we can think about GeForce GTX is that it’s the game console within the PC and what really drives the sales of that segment of the marketplace is games.
There is another part of our GeForce business, the lower end GeForce business that is sold to OEMs. The way that the OEMs think about GeForce is in those markets, is that it’s the ultimate, if you will or the premium, the ultimate upgrade or the premium experience PCs. Every PC is built from either AMD or Intel CPUs and various integrated graphics. And if you want to create Pro-Aduct line with basic and competitively priced PC on the bottom, and premium experience PCs on top, the best way to do that is put a high resolution display on it and then maybe you add 3D Blu-ray to it and you have a discrete GPU so that’s really how the vast majority of the PC OEMs as you look around the world differentiate their premium PCs from the commodity of the base line PCs.
And so if you look at that marketplace, that’s what I think is uncertain and we’ll continue to assume that as uncertain until it’s not. We saw it probably – well we saw it before everybody else did. And the reason for that is because we are in the high end consumer PC segment and as memory prices went up and as the euro got weak, and the various end markets got soft, the first thing that people did was shift it down price and into integrated graphics and then of course the – if the weakness persist eventually the number – total number of units of PCs will decline, which is what people are starting to see now. And so think we are taking a relatively conservative posture with respect to the PC OEM business, but the four businesses that I talked about just now I think are businesses that we feel pretty good about.
Raji Gill – Needham & Company
Okay, thank you.
Jen-Hsun Huang
Yes.
Operator
Our next question comes from the line of Hans Mosesmann with Raymond James. Please proceed with your question.
Hans Mosesmann – Raymond James
Yes, thanks. A couple of questions. Can you comment on how you see PC seasonality generally and also can you comment on the prospects of you doing a buyback. Thanks.
Jen-Hsun Huang
The second question, I will just take very quickly. We talk about these topics at our board meeting, every board meeting. And so the use of cash is a topic that comes up on a regular basis. And so we’ll have that conversation again at the next board meeting and do the appropriate thing.
With respect to seasonality, we are – for the overall consumer PC market, we are taking a rather conservative posture about it and we are assuming that what we saw before everybody else this is let’s see we started seeing weaknesses in the end market probably starting in May and May-June timeframe, late May, early June timeframe. And it’s persisted since and I think other people are starting to see it across the board now. We are going to take a relatively conservative posture with respect to that segment of the market.
The four businesses that we see growth in, we feel pretty good about and they are not affected by the end consumer market. The vast majority of that is enterprise business and although the consumer GeForce business or the GeForce GTX business has targeted gamers, what really drives the sales of that is great games. And it’s hard to find a better game than Star Craft II to propel the upgrade of graphics cards for gamers.
And then the last one, smartphone growth and tablet growth, that’s the most important segment of the computer industry today. And it’s a segment that we are entering for the first time, starting this last quarter in a small way and then with this quarter hopefully in a much larger way.
Hans Mosesmann – Raymond James
Thank you.
Jen-Hsun Huang
Yes, thanks a lot, Hans.
Operator
Our next question comes from the line of Daniel Berenbaum with Auriga USA. Please proceed with your question.
Daniel Berenbaum – Auriga USA
Yes, hi guys. Thanks for taking my question. Just to clarify, you talked about gross margin would have been above expectations if not for the inventory charge. What was the inventory charge?
David White
Hans, as any company in our business, we have inventory write-offs every single quarter. And so the question then becomes what’s extraordinary. And rather than be subjected to how we determine that, I think the easiest thing for us to do is simply say that no matter how you might calculate what the exceptional piece was, it was large. And excluding it, we would have exceeded our guidance.
And as far the specific amount it’s – it all depends on how you want to make the calculation.
Daniel Berenbaum – Auriga USA
Okay. So, then just on kind of my rough calculations, if I back you out to kind of get to above 47% gross margin, that sort of gets me to a place [ph] where you’ve had a $75 million inventory charge and your days of inventory would have been around 110 days. Is that the right order of magnitude and the right way to think about it?
David White
It’s in the range.
Daniel Berenbaum – Auriga USA
Okay. And then, just to follow up, you commented that we’ve got these new games, the Star Craft coming out, how do you think about the advent of programs like OnLive, which centralizes all of the computing graphics functions and where I am told that you don’t need a strong GPU at the local desktop or you can stream HD graphics straight to the desktop without actually having a graphics card on your PC. How does that affect how you think about games going forward?
Jen-Hsun Huang
Well, the way to think about OnLive is imagine it’s like subscription TV and many people have subscription TV as well as premium content. The way that OnLive works is fabulous and we are wonderful partners with them. What you see in the servers is a bunch of GeForces. And so we are excited about the work throughout they are doing. We are excited about getting video games to a larger number of people and making video games much more accessible. So, all in all I think it’s a fabulous development to have cloud-based GPU computing, if you will emerge. But the services is – it still needs to reach a much broader audience. Latency matters. And so as OnLive builds out their servers and server farms around the world over the course of the next several years or a decade, people still needs to be able to enjoy games wherever they are. And so I think that’s one factor. The other factor is not all games will be available from OnLive. Start Craft II, for example, is not. And Wii will likely not be. And so if you want to enjoy a broad range of games, having the ability to play the game on your local PC as well as being able to do – serve it off the cloud is a wonderful way to enjoy more games. And so we are a huge proponent of it. And we work closely with them to make the service as good as possible. And in the short term, what we see is a growth opportunity in putting GPUs into the cloud.
Daniel Berenbaum – Auriga USA
Okay, great. Thanks very much.
Jen-Hsun Huang
Yes, thanks a lot, Daniel.
Operator
Our next question comes from the line of Ross Seymore with Deutsche Bank Securities. Please proceed with your question.
Ross Seymore – Deutsche Bank Securities
Hi, guys, can you hear me, okay?
David White
Yes. Wonderful.
Ross Seymore – Deutsche Bank Securities
Just on the inventory charge side of things and the gross margin is the gross margin benefitting at all in the third quarter because of written off inventory?
David White
No. We – you know we wrote off what we anticipated would not be sellable, right, and so it would be inconsistent to assume one quarter that you are going to write it off, the next quarter you are going to sell it. So, we wrote off what we believe was an excess and so our guidance doesn’t include any of that selling through.
Ross Seymore – Deutsche Bank Securities
And I guess I heard you there a question about the – you not really want to sizing things precisely, but could you give us an idea of what the average charge for inventory or write down would have been over the last few quarters just so we can kind of get a ball park estimate about what it was this time?
David White
No, I don’t think we’d disclose that.
Ross Seymore – Deutsche Bank Securities
Okay. May be last question then. A quick one, any help on kind of the graphics side versus the chipset side, any difference in trends in the quarter there sizing the remaining chipset business you have?
Jen-Hsun Huang
The vast majority – our chipset business was okay and I think it’s dynamic as it’s a little bit different than the overall discrete consumer PC GPUs. Our chipset business is predominantly chipset that go into Apple computers. And so that’s one way to see its progress.
Operator
Our next question comes from the line of Rick Schafer with Oppenheimer & Company. Please proceed with your question.
Shawn Simmons – Oppenheimer & Company
Hey guys, this is Shawn Simmons calling in for Rick. Just had a couple of questions here. What do you guys see the impact from the Intel and FTC settlement recently announced? Is that going to help you with your ongoing trial with Intel?
Jen-Hsun Huang
The two different cases are independent and not the same. The first case is obviously the U.S. government finding Intel to have – practice businesses and conducted itself in an improper way. And so whatever it is that the government does to enforce whatever remedies that they’ve suggested to Intel or compelled Intel to follow are all good things to the extent that Intel becomes a much better citizen in the eco system and conducts business in Pro-Aper way. That’s good for the entire eco system. This system is good for us. It’s good for AMD, it’s good for customers, OEMs, it’s ultimately good for consumers.
Our case with Intel is not related to that and it’s strictly related to a contract dispute related to on the one hand chipset license to us and on the other hand, a cross-license to them. And so that particular dispute goes to court, goes to trial I guess towards the end of the year. And so we are looking forward to that.
Shawn Simmons – Oppenheimer & Company
Okay, great. And then and I guess looking at your just core GPU business, you’ve been talking a lot about the consumer side and then the gamer side. Is there any way we can kind of figure out how much percentage of your sales comes from I guess the gamer side and how much you have to the PC OEM side?
Jen-Hsun Huang
It’s – I will say that it fluctuates from time to time. I mean obviously Fermi was late. And GF – GTX470 and GTX480 was about six months late the way that we liked. And so we lost share in the Q1 timeframe. We started gaining share back in Q2 and we are going to gain a lot more share back this quarter with our GeForce GTX business, which is targeted at gamers. And so it’s hard to say based on last several quarters what the percentage is. What we do know is that we are likely to grow into that marketplace and continue to take share for the remainder of the year as far as we can see right now.
Shawn Simmons – Oppenheimer & Company
Okay, great. Thanks, guys.
Jen-Hsun Huang
Yes, thanks a lot.
Operator
Our next question comes from the line of Krishna Shankar with ThinkEquity. Please proceed with your question.
Krishna Shankar – ThinkEquity
Yes, going forward, what do you think is the attach rate of discrete GPUs now in notebooks and desktops and how do you see that trending over the next 12 months or so especially with the coming Sandy Bridge and Fusion platforms targeted at low to mid-range PCs from both Intel and AMD?
Jen-Hsun Huang
The attach rate of discrete GPUs this last quarter I believe actually went up [ph]. The number of GPUs, discrete GPUs in the marketplace was about the same. And so for the last several quarter, I don’t believe what – I was just – I was shown some Mercury numbers, which unfortunately doesn’t account for our fiscal year, our fiscal quarter versus AMD’s calendar quarter. But anyways, the basic math here is still relatively the same that the discrete GPU marketplace is – the number of discrete GPUs totally shipped is about the same from the last several quarters. And our expectation is that it remains the same in the next several quarters. Notebooks is way up. Discrete GPUs for channel desktops was down. We believe that a lot of that has to do with the fact that DRAM prices had gone up. The euro had weakened and so people had SKU down.
And so, looking forward my expectation is that OEMs are going to continue to want to segment their PCs and for the mainstream segment where the basic performance is what comes with integrated graphics, they will continue to be using integrated graphics and for the premium segments – for the premium experience PCs they will want to add a discrete GPU to both differentiate that platform as well as deliver their experience. And so my expectation is that desire by the OEMs to differentiate, to segment, to offer a premium experience is not likely to go away.
Sandy Bridge is going to increase integrated graphics performance just as every generation they have increased integrated graphics performance. And so by the time that Sandy Bridge ships, there is going to be some pretty fabulous discrete GPUs that ranges from the basic levels that we offer today to the high end. And so we’ll see how it turns out, but my expectation is that the OEMs will continue to want to segment and differentiate their platforms.
Krishna Shankar – ThinkEquity
And my follow-on question is on Tegra. Can you give us some sense for the higher volume production here in the October quarter? Is this more smartphones, web tablets, can you give us some color as to the kinds of OEMs you are engaged with?
Jen-Hsun Huang
Yes. Just like you said.
Krishna Shankar – ThinkEquity
So both smartphones and web tablets?
Jen-Hsun Huang
We hope so. They won't be of equal proportion right off the bet, but we’ll see which devices ship first. But whatever devices ship, they are going to be pretty amazing.
Krishna Shankar – ThinkEquity
Great. Thank you.
Jen-Hsun Huang
Yes.
Operator
Our next question comes from the line of Alex Gauna with JMP Securities. Please proceed with your question.
Alex Gauna – JMP Securities
Yes. Thanks very much. Jen-Hsun, I believe you mentioned your confidence that you can take share back in the back half of the year, but you admittedly said that your products are skewed towards the high end; I wouldn't argue that the 460 is going to be a category killer. Can you really take share broadly with your product lineup the way it is or should we expect that we're going to see Fermi get into some of the more mainstream SKUs?
Jen-Hsun Huang
We are ramping Fermi from top to bottom on desktop, on notebook, on workstations. With respect to market share, we lost – we probably lost a couple – two, three million units, if you will, in market share. And that's a lot, that's a lot when you think about it that way. The vast majority, as you mentioned of all of that is low-end discrete. The price of those GPUs are low teens, anywhere from $10 to call it $12, $14. And the gross profit dollars on those devices are not extremely high. And so we know how to go win that business back.
During the first quarter or so, we – because we were so constrained in supply and the market was so robust, we were reluctant to be too aggressive in capturing business that we wouldn't later be able to fill. As it turns out, as the markets softened in the May timeframe and the June timeframe, that turned out to have been a bad decision. And so we are in pretty good posture now and we know how to go take share back in the low end.
And so we'll take some share back in the low end and – but more importantly the profitable segments and the high ASP segments, we just have – we have a great product line. And so that's our basic approach is to offer the best products in the segments that are targeted at gamers. And for the segments that are targeted at OEMs for their premium upgrades and premium experience PCs, we have very price competitive products that we can go take share back with.
Alex Gauna – JMP Securities
In that OEM category, does that start by Q4 or does that wait more until Sandy Bridge in 2011?
Jen-Hsun Huang
It starts right away. I think part of our business is still…
Alex Gauna – JMP Securities
Okay. Thank you very much.
Jen-Hsun Huang
Yes.
Operator
And our next question comes from line of Craig Berger with Friedman, Billings and Ramsey. Please proceed with your question.
Craig Berger – Friedman, Billings and Ramsey
Hey, guys. Thanks for taking my question. I guess, can you help us understand how big your chipset business is at this point and what the – and how that should trail off over the next, say, year or two?
Jen-Hsun Huang
Let’s see – it's less than $200 million a quarter and we’ll remain at that rate for probably through Q1 or maybe even Q2 of next year. And then it will start trailing off, not completely to zero because we will continue to have AMD integrated graphics solutions in the marketplace and our expectation is that we're going to continue to sell those for probably through the end of next year. So that's my expectation of it. It will start declining call it Q2-ish and then decline towards – to something a lot less than that by the end of the year.
Craig Berger – Friedman, Billings and Ramsey
As a follow-up, the workstation business has ramped pretty meaningfully. Is this a sort of run rate sustainable level of business here; is there some catch-up that's benefiting the numbers right now? And then just one last follow-up after that. Thanks.
Jen-Hsun Huang
Our workstation business has been growing consistently quarter-to-quarter, but it hasn't reached the record levels that it was at a couple years ago. And so my expectation is that the workstation business is going to continue to grow. It's going to continue to grow for two reasons, one, more and more people are upgrading to Windows 7 and that upgrade process will affect workstations as well. The second reason is during this time, this last couple of years, we have invested in expanding the reach of our workstation solutions. Whereas it was predominantly used for manufacturing in the past, our workstations are now used for broadcast workstations, for 3D television streaming, for postproduction, for video editing, medical imaging – gosh – the computational simulations of fluid dynamics, there's all kinds of things that our workstations are now being used for. And so, on the one hand, I think that the upgrade cycle is – we're benefiting from the upgrade cycle. And then, secondarily, we’re – we have invested in expanding the reach of our workstations solution. So we're just exposed to a much larger market. And so my expectation is that our workstation business will surely recover to its record highs and go well beyond that.
Craig Berger – Friedman, Billings and Ramsey
The last question is, you guys referenced macro weakness in May and June. Your largest competitor did not have similar commentary and I'm wondering if there's other dynamics at play or what might drive a difference between you guys. Thanks.
Jen-Hsun Huang
I think that – well, first of all, I don't completely know. I mean, we're going to see all of this stuff sort out as we see their Q3s. You have to remember that our business is skewed off by a month and being skewed off by a month in this last quarter is a pretty big deal, as it turns out, because the market softened in the second month of our quarter, which was practically the end of theirs. And so I think we’re going to find out how it really sorted out probably by Q3 timeframe, but we saw market weaknesses, not just for ourselves in the end markets, we saw them for other people. And we were, frankly, surprised by their guidance’s, but so be it, we'll find out when everything sorts out.
Craig Berger – Friedman, Billings and Ramsey
Do you think the weakness is driven by demand or is it supply chain adjustments?
Jen-Hsun Huang
It's end market weakness. I think that at this point, I think most of us believe that Europe in Q2 was soft, that the euro was weak. And that naturally would cause some skew downward. And China, reducing their stimulus to the economy have slowed down the market a bit. Now, of course, our business is – we have a much larger exposure in Europe and China because our brand is so useful and so powerful to help the local OEMs enhance their brand. And also because consumers are much more – find video games and content much more appealing out in the other markets. I think that those are just incredibly important markets to us. And so, our exposure is probably larger than theirs. Overall, I think that we're just going to have to wait and see how their Q3s shake out for us to really know.
Operator
Our next question comes from the line of Glen Yeung with Citigroup. Please proceed with your question.
Glen Yeung – Citigroup
Thanks. Jen-Hsun, can you discuss whether or not in your past experience in periods where the economy seems to be decelerating, whether gamers are resilient to that or do they have to follow the economic conditions?
Jen-Hsun Huang
Hi, Glen. Well, I think that there is some impact surely to the economy, but there's nothing like great games and to the extent that – it's kind of hard to think about Star Craft II as a game. I mean I really think of Star Craft II as an event. I mean this is a once-a-decade refresh to one of the most important video games of all time, I mean this is – Star Craft, as you know is a cultural phenomenon in many countries. They watch Star Craft competition on TV, there's a Star Craft channel, there's Star Craft teams. So in many countries Star Craft is just a very, very big deal. And so this is a very welcome upgrade and the game is absolutely beautiful and GTX460 is perfect for it. And so my sense is that for the $12 million Star Craft players out there, there is some serious upgrading to do. And my sense is that that should far overcome any softness in the marketplace.
Glen Yeung – Citigroup
Okay. Thanks. You also sound quite confident that Tegra will grow in the quarter. And I wonder if that prompts you to adjust your Tegra run rate forecast?
Jen-Hsun Huang
I'm not sure I understand the question.
David White
Glen, I think we've given guidance on that in the past and I think at this point it would be early to call whether we’re going to exceed that or not. So I think we hold to that. We still feel very bullish about the product, obviously.
Operator
Our next question comes from line of Arnab Chanda with Roth Capital Partners. Please proceed with your question.
Arnab Chanda – Roth Capital Partners
Thank you. I have two questions. One is, Jen-Hsun, I know you don't want to give specific guidance, but could you talk a little bit about by the time the chipset business either becomes really small or maybe even goes away, do you think Tegra and Tesla would be big enough to offset that? And I have a follow-up, please.
Jen-Hsun Huang
My sense is that the chipset business will be about half to a quarter its size in Q4 of next year. And so, if you roughly said it was about a quarter of its size, would Tegra and Tesla be able to make up for the difference, both in revenues and surely much, much more in terms of gross profit dollars, my sense is yes.
Arnab Chanda – Roth Capital Partners
Okay. Great. And then one other question about your, sort of, Quadro and Tesla business, do you think that – is Quadro – are you at a point where you have basically kind of completed the penetration in the market and it's really more about Tesla for that entire product line or do you think there's multiple opportunities left in terms of growth in that business?
Jen-Hsun Huang
Quadro has wonderful growth opportunities ahead of it. First of all, where – people buy workstations and upgrade their workstations on the rhythm of the companies themselves. The automobile industry that uses CATIA or the airplane industry or the tennis shoes industry or – they all upgrade on different cycles and they use different packages and more and more industries are using digital approaches to prototype or style or simulate, just like we do. In your industry you use computational finance; in my industry we use EDA simulations and EMI simulations. And we use all kinds of simulations to predict the outcome of our product. And whether it's in design or manufacturing or advertising or in broadcast or in medicine, more and more people are using digital approaches to predict the outcome of the products. And so I think that the market is surely expanding.
The other factor is that – that's really exciting for us and what's so great about Fermi Quadro is that it's such a great discontinuity relative to anything that we've shipped before. And I don't know that we've ever shipped Pro-Aduct that is five times faster in the type of applications that it's used in, from generation to generation. And so we’re looking forward to upgrading the installed base in addition to the natural growth and the natural upgrade of the workstation market. So I'm really excited about Quadro and we're looking forward to seeing how it does in the marketplace.
The OEMs are really excited about it as well. We have HP and Dell and Lenovo all geared up, Fujitsu Siemens all geared up to – these are our workstation partners – geared up to take Quadro Fermi to the market.
Operator
Our next question comes from the line of James Schneider with Goldman Sachs. Please proceed with you question.
James Schneider – Goldman Sachs
Good afternoon. Thanks for taking my question. I guess, just to start off on the notebook GPU business for a second, can you give us a sense, if I just isolate that – you mentioned that the market itself for notebooks was up in the quarter, was your business also up for notebooks in the quarter? And then, do you expect the notebook business in Q3 to be better or worse than your guidance for the corporate in Q3?
Jen-Hsun Huang
What was the last part of the question?
David White
James, are you talking about the Q3 guidance?
James Schneider – Goldman Sachs
Yes. Your Q3 guidance, do you expect notebooks to be up in Q3 or essentially better than your corporate guidance for Q3?
David White
Okay. So if you look at Q2, notebooks and desktop were both down. Obviously, we missed our original guidance by a fairly large amount and both of those were key contributors to that. If you look at our guidance into Q3, we’re expecting both of them to be up, obviously not by a lot, given that we are only guiding 3% to 5%.
James Schneider – Goldman Sachs
Okay. Fair enough. And then it looks like your OpEx ticked down a little bit in the Q2. Can you give us a sense of what expenses you may have cut back on in Q2 and then how we would expect – what markers you look for as business recovers, how you bring back spending incrementally and what are the things you bring back first versus later?
David White
Well, if you look at the expenses that we've worked on reducing and so forth, they cover a broad range of things. They cover things in terms of how we take out products, how we kit prototype for engineering test vehicles. It covers the minutiae things like travel and the things that are not very exciting, but we've been fairly diligent across the entire business trying to figure out how do we reduce waste, how do we economize in terms of our expenses without naturally impacting our development plans and so forth. And going forward – right now certainly in the environment we are in today, we don't see our attention on expenses abating anytime soon. We do have continued efforts in reducing cost; we also have cost pressures going in the other direction. And so our guidance is kind of recognition of the fact that we think, for the time being at least, that the cost reductions that we will implement in the third quarter would offset some of the upward cost increases going in the other direction.
Operator
Our next question comes from the line of Shawn Webster with Macquarie. Please proceed with your question.
Shawn Webster – Macquarie
Yes. Thank you. Within the cost of goods sold for that $181 million, how much of that was due to be product recall charge?
David White
You mean that versus the litigation? Is it what you mean, Shawn?
Shawn Webster – Macquarie
Is there litigation within the cost of goods sold as well?
David White
Yes.
Shawn Webster – Macquarie
Yes. How much were those two combined?
David White
We don't really break that out, but let me be a little bit clearer. When we talk about litigation, there's the cost of the litigation itself, but then there's also the cost of the remedies. Right? And so the remedies have to do with repair costs and so forth. And so there's a piece of it associated with cost of goods that's naturally as a result of the settlement itself. And we don't break that out.
Shawn Webster – Macquarie
Okay. And for your inventories going into Q3, do you expect them to be flat, down or up?
David White
Probably modestly – a modest change, only at this point.
Shawn Webster – Macquarie
A modest change up?
David White
When I say modest, it will be modestly up or modestly down; it's – I’d basically say it's basically flat.
Shawn Webster – Macquarie
Okay, got you. And how – I mean, I understand there is a mix effect happening in the quarter. Can you tell us what your GPU ex-the MCP business; the pricing did sequentially for Q2?
David White
No, we don't disclose that.
Shawn Webster – Macquarie
Okay. How about tax rate? So tax rate is coming up, can you share with us why that's popping up?
David White
Yes. So if you look at our business, our taxes are basically a function of how much income we make. And as our income goes down, some of the jurisdictions where we operate and pay taxes in, that income doesn't necessarily go down. So the taxes there, you might almost view as a fixed cost to the company. And so as our total overall income goes down, those taxes stay flat and hence our rate goes up and vice versa. When our income goes up, the rate goes down.
Operator
Our next question comes from the line of Kevin Cassidy with Thomas Weisel Partners. Please proceed with your question.
Kevin Cassidy – Thomas Weisel Partners
Hi. Just two quick questions, on enterprise, last night, we heard from Cisco saying that they're seeing a slowdown in enterprise. Can you describe what's different, maybe it's the product refreshes causing more demand for your products or maybe if you could describe what's happening geographically?
Jen-Hsun Huang
Well, our enterprise business is a little different than an enterprise desktop or a router, per se. If you look at our workstation business, the workstations are used to create the essential products of those companies. And to that extent that those companies believe that their workstations are no longer high performance enough or capable enough to handle the level of complexity or the amount of simulation they would like to do in simulation, they will naturally upgrade. Frankly, most of these workstations these days, by buying the workstations, you are reducing the cost of development of most of your projects because you are just able to do more of it in a digital world where virtual prototyping is just much more cost effective than real prototyping. And so it's not a clear comparison to us and right now we are not seeing changes in the nature of the business and the various markets. We are frankly too busy right now ramping Quadro based on our Fermi architecture and so the enthusiasm is quite high right now.
Kevin Cassidy – Thomas Weisel Partners
Okay. Great. And maybe if there – do you see any new competition or any changes in the landscape there?
Jen-Hsun Huang
Well, the workstation market is not about a graphics chip, it’s not about a graphics card, and this is something that the vast majority of our competition just no longer understands. People aren't buying our Quadro solution a chip at a time. They're trying to solve Pro-Ablem and it could be that they are trying to ray trace a car so that they could see a photorealistic image of it while they are trading off various designs. It could be that the data set is just absolutely enormous and they need to have the scalability and the scalable solutions that we provide. It could be that somebody's workstations needs to be virtualized and have a Windows XP – excuse me – Windows NT on one or Windows or Linux on the other and both of them has to be accelerated and the fact that we have the best software stack for both Linux as well as Windows in the world makes a huge difference. And so the list of reasons why people choose Quadro is quite deep. This is an area where we have a great deal of passion for and one in which we do an extremely good job. And so the bar is pretty high and we’re not seeing any significant competitive changes out there that we notice right now.
Operator
And our last question comes from the line of Patrick Wang with Wedbush Morgan. Please proceed with your question.
Patrick Wang – Wedbush Morgan
Great. Thanks so much. Hey, Jen-Hsun, can you talk about your – I guess just a high level view of the competitive landscape in graphics, I guess what’s your best sense in terms of the pricing trends? And I guess what kind of pricing you're baking into your gross margin guidance?
Jen-Hsun Huang
What kind of pricing? Well, we have more high end exposure today than we've had in a couple of quarters and so that's a positive thing. On the mainstream product, if we want to go gain share back, we'll sell several million more lower ASP products and so that will have a negative trend on ASPs. And so we'll see how they all add up, but we’re relatively comfortable with the gross margin guidance that David gave earlier.
David White
Yes. The guidance contemplates that.
Patrick Wang – Wedbush Morgan
I see, got you. That's helpful. Okay, and then just for my follow-up, I guess in your prepared comments you stated that channel inventory levels had come down. Can you help us understand how much the product mix of that inventory and how that compares to, I guess, levels that are comfortable or maybe historical for you guys?
David White
So we get inventory reports out of the channel on a fairly regular basis. So I can't tell you, other than from an aggregate standpoint that generally the trend has been down for the last three months. We expect it to go down again in the third quarter. But, even though it is trending down, it's relatively at levels that would be consistent with historical averages in the industry over time, which have been traditionally somewhere around in the seven-eight week type of level. We've certainly had periods when it's been a lot lower than that. We've had periods when it's been well above that. But today, it's relatively close to the historical averages.
Jen-Hsun Huang
And Patrick, if you think about channel inventory, because most of that inventory is traveling by sea for the lowest possible cost freight, some three to four weeks of that seven to eight is material that is sitting in the ocean going across. Right? And so, what’s really available in the channel is about three to four weeks or so. And so I think if we’re sitting at these levels, we all feel pretty good about it.
Operator
And there are no further questions at this time. I’ll now turn the call back over to you, sir.
Michael Hara
Thanks, everyone. We look forward to talking to you about our next quarter results. |
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