Nvidia (NVDA)  on Thursday after the closing bell reported a top- and bottom-line beat with its fiscal fourth quarter 2020 results. Revenue of $3.105 billion (+41% YoY) outpaced the $2.964 billion consensus, while adjusted earnings per share of $1.89 (+136% YoY) blew past expectations of $1.67 per share. 

On the margin front, Nvidia outperformed its own guidance with adjusted gross margins coming in at a strong 65.4% (+940bps YoY, +13obps QoQ), a solid beat vs. prior guidance of 64.5% +/-50bps.

The annual increase was "primarily driven by reduced inventory charges in Gaming and a more favorable mix within Data Center," said management on the release. In addition, the sequential expansion reflects a higher revenue contribution of data center products, said management, noting that it was partially offset by lower sales of components that were earlier written off.

"Adoption of Nvidia accelerated computing drove excellent results, with record data center revenue," said CEO Jensen Huang on the release. "Our initiatives are achieving great success."

Huang also spoke to Nvidia's exposure to so many of the powerful technology trends that are set to impact every aspect of our lives in the coming decade.

"We are well positioned for the greatest technology trends of our time," he said, noting that Nvidia RTX ray tracing is "reinventing" computer graphics and driving adoption across gaming, virtual reality and design markets. At the time same, Huang said, the ray tracing technology is creating new opportunities in rendering and cloud gaming. 

Ray tracing, for those unfamiliar, is a technology that makes computer graphics appear more lifelike, especially in how shadows and reflections appear.

Nvidia's artificial intelligence technology, added Huang, is "enabling breakthroughs in language understanding, conversational AI and recommendation engines ― the core algorithms that power the internet today. And new Nvidia computing applications in 5G, genomics, robotics and autonomous vehicles enable us to continue important work that has great impact."

This exposure to technology trends is a reason we're so bullish on shares over the long-term, even if we acknowledge that the semiconductor space is inherently volatile on smaller time frames given the reliance on spending cycles.

Guidance

In the upcoming quarter management expects revenue in the range of $3 billion +/-2%, which at the midpoint is well ahead of the $2.849 billion consensus coming into the quarter. Moreover, while management acknowledged that the full effect of the coronavirus outbreak is "difficult to estimate," the guidance provided was cut down by $100 million compared to what it would have been in an attempt to factor in the outbreak.

As for margins, management expects adjusted gross margins for FY1Q21 to come in the range of 65.4% +/- 50bps, a strong forecast vs. the 63.95% consensus heading into the print. Adjusted operating expense guidance of $835 million, better than the $901 million expected, however, up slightly from fourth-quarter's adjusted operating expenses of $810 million, which was roughly in line with the $811 million we were looking for.

Capital Allocation

On the capital return front, management paid $98 million in the form of dividends, bringing the total payout for FY2020 to $390 million. Looking ahead, Nvidia will pay its next quarterly cash dividend of $0.16 per share on March 20 to all shareholders of record on Feb. 28. The company reiterated that buybacks are on pause as the top priority right now is the purchase of Mellanox Technologies (MLNX) , stating, buybacks will resume after closing the acquisition.

On that note, regarding the Mellanox acquisition, management noted that

Guidance does not include any contribution from Mellanox, said management, who repeated that the deal is expected to close "in the early part of calendar 2020."

Gaming

Gaming saw revenue of $1.491 billion (+56% YoY), missing consensus of $1.517 billion. While the annual increase reflects higher sales of GeForce GPUs and SoCs -- system on a chip -- for gaming platforms, the segment saw a 10% sequential decrease due to seasonally lower sales of GeForce notebook GPUs and SoCs for gaming platforms that was partly offset by an increase in sales of GeForce desktop GPUs.

While the segment may have come up short vs. expectations, there is no denying that the annual increase on an absolute basis is impressive and we're happy see that the shortfall in gaming was more than accounted for in the key data center segment, which given weakness the last time around, was a key focus area for investors on the current release and as noted above also aided margin performance.

Data Center

Nvidia reported Data Center revenue of $968 million (+43% YoY) that crushed the $826 million consensus, thanks to strength coming from the hyperscale and vertical industry end markets.

As noted above, the Data Center was point of weakness on the prior release, but the stock was forgiven.

"We expect strong sequential growth in Data Center, offset by a seasonal decline in GeForce notebook GPUs and SoC modules for gaming platforms," management noted on the release.

Moreover, CFO Colette Kress, noted on the third-quarter earnings call, "Our hyperscale revenue grew both sequentially and year-on-year, and we believe our visibility is improving. Hyperscale activity is being driven by conversational AI, the ability for computers to engage in human-like dialogue, capturing context and providing intelligent responses."

The company didn't disappoint: Sales surged 33% on a sequential basis driven stronger vertical industry and hyperscale sales.

Pro Visualization

Professional Visualization revenue of $331 million (+13% YoY) outpaced expectations of $328 million with the annual increase resulting from "strength in desktop and notebook workstations," and the 2% sequential increase coming from "desktop workstations partially offset by notebook workstations."

Importantly, while the segment is a relatively smaller portion of revenue we expect its share to grow over time as Kress noted on the call "ProVis accelerated in Q4 as the rollout of more RTX-enabled applications is driving strong upgrade cycle for our Turing GPUs. RTX is also opening up new market segment opportunities, such as rendering and studio for freelance creative."

Automotive

Automotive revenue of $163 million (unchanged YoY), missed expectations of $169 million. Sequentially the segment increased 1%, however, on a full year basis, the segment saw a 9% increase "reflecting growth in AI cockpit solutions and development services agreements."

While a miss is never good, we aren't overly concerned with the results on this front as automotive-related revenues were never part of our near-term investment thesis. Rather, the automotive segment is one we have always viewed as a longer-term opportunity that will become more material as we advance toward fully autonomous vehicles over the next decade. At the moment, the bulk of the work in this field is still taking place in the data center.

OEM and the Rest Beat

Lastly, OEM and other revenue of $152 million (+31% YoY) came in above expectations of $128 million and with bot the annual increase and the 6% sequential increase being "primarily due to growth in entry level GPUs for PC OEMs."

The Flywheel

As we did the last time around, we want to remind our members that one of the great things about Nvidia's business model is that -- because its technology is so crucial both inside and outside the data center -- a flywheel effect taking place. This is likely a key reason for management's strong desire to double down on the data center with the acquisition of Mellanox.

On the autonomous vehicle front, this comes into play as the deep learning aspect of self-driving is step one on the road to autonomous vehicles. After this, the cars themselves are equipped with Nvidia chips during the inferencing phase, when cars hit the road and must make rapid, real-time decisions. But while the decisions may be made outside of the data center, the data collected is then sent back to the data center, forming a loop of continuous improvements. So, start in the data center, go to the real world, then back to the data center for further refinement, back to the real world and so on.

This same dynamic can be applied to conversational AI and recommendation systems, such as those used to enhance search capabilities or when streaming platforms recommend new content. The systems are trained, sent out into the real world, and then data is recalled for further analysis and continuous improvement. As the amount of data grows, so too does the need for Nvidia's various data center and edge-based devices.

As Google Cloud CEO Thomas Kurian called out at the Goldman Sachs Internet and Technology conference earlier this week, "If you look at Intel server shipments, which is a proxy for Compute, in 2018 and 2019, 80% of the shipments still went to on-premise data centers. That is not counting the percentage of servers already sitting there that are amortizing. So if you assume that, that is a proxy for where the estate of IT sits, it's super early stages, No. 1."

Kurian's statement was in response to a question about the runway left on the cloud computing front -- specifically if it was too late for Google to gain shares given the lead of Microsoft's (MSFT) Azure and Amazon (AMZN) Web Services.

The point: Cloud computing has plenty room left to grow and as a result, so too does Nvidia's datacenter business. Remember, cloud computing relies on Nvidia for "GPU-acceleration" now that we are at the end of Moore's Law and CPUs alone are simply no longer to advance at a fast enough pace to keep up with the massive amount of data that needs processing.

That in mind, we also noted that these advancements and our belief that digitization and the use of cloud computing will only continue to grow in coming years is one of the reason we're so bullish on 5G. The ability to transmit all of this data from individual automobiles to the data center and back again, is but one example of a technology that relies on 5G wireless connections as, especially in the case of self-driving vehicles, split-second decisions can literally mean the difference between life and death.

Bottom Line: The Overall Trends to Keep in Mind

All in, while gaming came up a tad short, the data center was the focus area this time around and is the key reason behind the after-hours advance we're seeing. Though gaming is a crucial segment for the company, we don't view the results indicative of any fundamental issues on the gaming front and believe that the end market remains the fastest growing segment of the media and entertainment space. As gaming continues to advance in terms of complexity and graphics, we believe there remains plenty of room for Nvidia's gaming segment to grow.

Speaking to this rapidly growing industry, Kress noted on the call, "From the Single's Day shopping event in China through the Christmas season in the West, channel demand was strong for our entire stack. Fueling this were new blockbuster games like "Call of Duty: Modern Warfare," continued eSports momentum and new RTX super products. With RTX price points as low as $299, ray tracing is now the sweet spot for PC gamers. Gaming is driving, and gamers prefer GeForce. The global phenomenon of eSports keeps gaming momentum with an audience now exceeding 440 million, up over 30% in just two years.... The "League of Legends" world championship brought more than 100 million viewers, on par with this month's Super Bowl. Ray tracing titles continue to come to market, and GeForce RTX GPUs are the only ones that support this important technology"

The data center is at the heart of cloud computing (which we believe to be a secular growth trend) and believe Nvidia to remain absolutely critical when it comes to processing massive amounts of data thanks to its GPU-acceleration solutions.

As Kress noted on the call: "The industry continues to do groundbreaking AI work for Nvidia. For example, Microsoft's biggest quality improvements made over the past year in its Bing search engine stem from its use of Nvidia GPUs and software for training and inference of its natural language understanding models." 

Conversational AI, said Kress, "is a major new workload," requiring GPUs for inference to achieve high throughput within the desired low latency.

Kress also pointed out that Microsoft researchers announced a new "breakthrough in natural language processing" with the largest publicized model trained on Nvidia DGX-2. "This advances the state of the art for AI assistance and tasks, such as answering questions, summarization and natural language generation."

Now admittedly, that's a lot of technical jargon (to be expected from a team as smart and forward looking as this) but the takeaway is simple: Processing the massive amounts of data that need to be processed in the data center to perform processes such as recommending content and search results, or creating smart assistants capable of conversational interactions on a human level simply would not be possible without Nvidia's solutions.

As for pro visualization and automotive, while these remain small for the time being, we believe the opportunity to be material to future growth.

On the pro visualization front, we believe Nvidia's solutions will continue to displace traditional solutions -- recall, we previously informed members, here, that RTX GPUs mean that for the first time in history, computer generated images (CGI) can be done on GPUs, rather than large CPU render farms, which until now have been the only solution.

As for autonomous driving, the opportunity is huge when we consider the potential of fully autonomous vehicles that would in essence be so advanced that there would be no need for steering wheels or gas or brake pedals and disrupt everything from personal transport to cross country delivery -- not to mention the impact on the data center.

Lastly, as we have done in the past, we will leave members with Huang's closing remarks from the call (though we highly recommend checking out the conference call in its entirety, here, as the current trends and vision for the future that Huang and Kress layout are truly incredible):

"We had an excellent quarter with strong demand for Nvidia RTX graphics and Nvidia AI platforms and record data center revenue. Nvidia RTX is reinventing computer graphics, and the market's response is excellent, driving a powerful upgrade cycle in both gaming and professional graphics while opening whole new opportunities for us to serve the huge community of independent creative workers and social content creators and new markets in rendering and cloud gaming. Our data center business is enjoying a new wave of growth, powered by three key trends in AI: Natural language understanding, conversational AI, deep recommenders are changing the way people interact with the Internet. The public cloud demand for AI is growing rapidly. And as AI shifts from development to production, our inference business is gaining momentum."

Members can be assured that we will certainly be paying close attention to next month's GTC conference in San Jose and provide updates on the biggest announcements. Finally, despite the strength of the quarter, we maintain our Two rating due to the phenomenal run shares have seen into the quarter (even prior to the after hours moves we're seeing). Our price target is under review.