Updated from Aug. 7

Nvidia

(NVDA) - Get Report

got walloped in trading after reporting weaker-than-expected third-quarter guidance and projecting a possible slide in already-depressed profit margins. Shares of the graphics chipmaker were plunging $3.95 or 20.5% to $15.35 in recent trading.

Analysts said the results supported bearish views on the stock.

Nvidia's guidance seems to reflect expectations for weak growth in its core business in what is usually a strong quarter for PCs, said Bear Stearns' Gurinder Kalra in a morning note. "Despite the recent decline in the stock price (down 25% over the past two months), we believe the stock has little potential upside from current levels, as we fail to see any near-term catalyst."

Kalra, who has a hold rating on the stock, cut his fiscal year 2004 EPS slightly from 63 cents to 57 cents because of lower margin expectations. Bear Stearns has no banking relationship with Nvidia.

At Desjardins Securities, Paul Howbold reiterated a sell rating on the stock, explaining, "Over the longer term, we view the shift in consumer preference from desktops to mobile as working at Nvidia's expense (and in

rival

ATI

(ATYT)

's favor)." His firm has no banking with Nvidia.

For the just-ended July quarter, sales of $459.8 million were up 8% from last year's levels and in line with the company's update of only a week ago, when it

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reduced its outlook. On July 28 Nvidia revised downward its initial forecast for sales to reach as high as $478 million, explaining that it was having trouble manufacturing a cutting-edge new chip.

On a related front, the company reported today that July quarter gross margins fell to 28.3% from 31.3% in the prior quarter.

Net income totaled $24.2 million, up from $5.3 million a year ago. Earnings amounted to 14 cents per share, well above the 11-cent consensus estimate.

Until Nvidia's recent update, analysts had been expecting 14 cents a share, however.

In the second quarter, Xbox sales accounted for just under 19% of revenue. Nvidia said Xbox revenues increased as expected; Xbox shipments are expected to rise through the current quarter and taper off towards the end of the year.

The chipmaker expects revenues to grow 5% to 6% in the quarter now under way, helped by an increase in both Xbox revenues and its core product lines. The guidance doesn't reflect sales from its

just-announced acquisition of MediaQ. On the basis of July quarter revenue, the latest guidance would suggest sales of $482.8 million to $487.4 million, well below the consensus target of $494.5 million.

Likewise, the company startled Wall Street by saying it expects its profit margin to be flat to slightly down. "We're very focused on the need to improve gross margins," acknowledged chief financial officer Marv Burkett.

"I was surprised that the gross margins were not improving," said Brian Alger, an analyst for Pacific Growth Equities. "We had expected them to improve sequentially. Officially we were looking for 31% in the October quarter, but we felt that might be a little high."

"To come in flat to down in terms of guidance

from a base of 28.3% was surprisingly more negative or cautious than we expected. It doesn't really indicate that the earnings power of the company is being captured just yet." Alger currently has an equal-weight rating on Nvidia; his firm hasn't done any banking for the company.

The reason for the margin shortfall is likely related to the next-generation manufacturing process that Nvidia has begun using for much of its silicon, which still costs more than the more standard process. Besides that, sales of integrated chipsets and mobile chips appear weaker than expected, says Alger. "So two of their higher gross margin subsegments weren't as strong in the quarter. And I think the higher percent of Xbox as a percent of sales probably didn't help."

In other news, Nvidia management said that MediaQ is currently unprofitable, but that it expects it to be accretive to earnings by this time next year.