24 August 2008

NVDA: Financial Analysis through July 2008

We have analyzed NVIDIA's financial statements through the fiscal quarter that ended on 27 July 2008.

Since we had not examined this company previously, we first collected the 10-Q and 10-K reports NVIDIA submitted to the SEC since its initial public offering in 1999.  We converted the financial statements in these filings into the normalized forms used for GCFR analyses.  We coped with restatements, acquisitions, stock splits, and changes in accounting rules to build a 35-quarter historical record that is as consistent as we could make it.  However, readers should be aware that misleading results are possible when financial data from one period are compared with another.

NVIDIA Corporation (NVDA), based in Santa Clara, CA, builds a variety of specialized Graphics Processing UnitsThese devices perform computationally intense tasks required to produce realistic images for video games and other applications.
The company competes with firms such as Intel Corporation (INTC) and Advanced Micro Devices (AMD).

NVIDIA has increased Revenue significantly over the years, but sales in the July 2008 quarter were 5 percent lower than in the July 2007 quarter.  NVIDIA attributes the slowdown to reduced sales of GPUs for desktop computers and to a "miscalculation of competitive price position." 

The company's problems in the quarter were compounded by a $196 million charge related to faults in certain products for notebook computers.  This led to a $121 million loss in the quarter.  As best we can determine, this was only the second quarter NVIDIA in its current form recorded a loss.

Not surprisingly, NVIDIA's missteps have damaged the company's shares, which are now trading at a price almost 2/3 below the 52-week high.  To help stem the tide, the company recently added $1 billion to its stock repurchase program.

The deep slide in the share price has a positive effect on our gauges of NVIDIA's financials.

Before examining the factors that affected each gauge, we will review the latest quarterly Income Statement.
Please note that the tabular format below, which we use for all analyses, can and often does differ in material respects from company-used formats.  A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.

($M) July 2008
July 2007
Revenue 893 935
Op expenses
CGS (1) (547) (511)
R&D (213) (158)
SG&A (92) (81)
Other (2) (196) (0)
Operating Income (155) 185
Other income
Investments 0 0
Interest, etc. (3) 9 16
Pretax income (147) 201
Income tax 26 (28)
Net Income (121) 173
($0.22)/sh $0.29/sh
Shares outstanding 555 604
(1) Cost of Revenue
(2) Repair and replacement costs.
(3) interest and other income (expense)

Revenue in the July 2008 quarter was 4.5 percent less than in the year-earlier quarter.  However, Revenue in the most recent four quarters exceeded Revenue in the four previous quarters by 25 percent.
NVIDIA achieved a Gross Margin of 38.7 percent in the quarter, compared to 45.3 percent of Revenue in July 2007.  Note that we excluded the $196 million charge to CGS in this calculation.
Research and Development (R&D) expenses were 23.9 percent of Revenue, up from 16.9 percent in the year-earlier quarter.  It shouldn't be surprising that this ratio would increase in a period of declining sales.  The company needs to keep its labs humming to avoid a further deterioration of its competitive position.
Sales, General, and Administrative (SG&A) expenses were 10.4 percent of Revenue, an increase from last year's 8.7 percent.

For all of these reasons, Operating Income in the quarter swung from a $185 million gain to a $155 million loss.
Non-operating interest and other income slipped by $7 million. 
The company was able to recover some of the Operating loss with a $26 million income tax benefit.  Still, Net Income was a sizable $121 million loss.

Cash Management. This gauge increased from 15 points in April to 17 points now.
3 months
12 months
Current Ratio2.53.13.5
LTD/Equity 0%0%0%
Inventory/CGS 53.0 days57.2 days61.1 days
Finished Goods/Inventory 52.9%53.9%64.4%
Days of Sales Outstanding (DSO)49.7 days46.5 days50.8 days
Working Capital/Market Capitalization  26.4%15.4%9.3%
Cash Conversion Cycle Time (CCCT)
49.1 days47.9 days57.3 days

NVIDIA's Balance Sheet is strong.  The company has over $1.6 billion in Cash and Short-term Investments.  With the recent drop in Market Value, the Working Capital ratio is especially high.  Given the challenges of the second quarter, one might have expected a bloated Inventory, but just the opposite is true.   Days of Sales Outstanding is up from April, but down from July 2007.

Growth. This gauge fell from 13 points in April to 2 points now.
3 months
12 months
Revenue growth25.5%36.4%34.5%
Revenue/Assets 110%116%115%
CFO growth-21.6%36.9%197.9%
Net Income growth -4.6%72.2%69.2%
Growth rates are trailing four quarters compared to four previous quarters.

As indicated by the weak score, there isn't much good to report here.  Under other circumstances, a 25 percent year-over-year increase in Revenue would be celebrated, but the fact that sales are decelerating is obvious.

Profitability. This gauge decreased from 14 points in April to 8 points now.
3 months
12 months
Operating Expenses/Revenue 82.7%79.6%83.3%
ROIC 34.7%40.7%39.2%
Accrual Ratio10.3%8.8%-2.1%

Although the ROIC figure is impressive, we see the effect of declining Cash Flow from Operations on the FCF/Equity Ratio and the Accrual Ratio.  The latter measure of Earnings Quality, tells us by increasing that less of the company's Net Income is due to CFO, and, therefore, more is due to changes in non-operational Balance Sheet accruals. 

The Operating Expense ratio does not include the large charge in the recent quarter.

Value. NVIDIA shares decreased in price from $20.55 on 30 April to $11.44 on 31 July. (The share price has since edged up on news that the quarter wasn't worse and on the additional share repurchases.)  The Value gauge, based on the July-end price, pegged the Value gauge at 25 of 25 points.
July 20083 months
12 months
P/E 11.614.432.029.0
P/E to S&P 500 average P/E 66%80%201%166%
Enterprise Value/Cash Flow (EV/CFO)5.39.415.018.5
NVIDIA's valuation ratios can be compared with other companies in the Specialized Semiconductor industry.

Former high-flier NVIDIA stumbled badly, and it has been punished severely.  Its shares are selling at a significant discount to their historic norms, which has led to a very good Overall Gauge score of 64 points, of 100 possible points.  Of course, our backward-looking gauge scores are blind to future changes in demand for new computers, and they are equally unaware of alterations in the relative standing of NVIDIA's products compared to its formidable competitors.  MarketWatch recently reported on one analyst's opinion that Advanced Micro Devices (AMD) is gaining ground on both Intel (INTC) and NVIDIA.

Investors have to ask themselves if "normal" conditions at NVIDIA will return.  If they do, the shares today will look inexpensive.

1 comment:

  1. For a discussion of NVIDIA's ambitions, the following article is illuminating: