09 May 2009

NVDA: Financial Analysis through April 2009

NVIDIA (NASDAQ: NVDA) lost $201.3 million ($0.37 per share) in the three months that ended on 26 April 2009.  This post provides the GCFR analysis for the period, which was the first quarter of the company's fiscal 2010.

A large chunk of the loss was due an unusual $140 million charge resulting from the company's purchase of stock options from its employees.  The exercise price for the options purchased was at least $17.50 per share, far above the current market price.  We don't have a good understanding of how the $140 million figure was computed -- employee stock option accounting can be extraordinarily complex -- but it makes sense that giving employees money for deep under-water options would be considered a compensation expense.

The earnings announcement included an Income Statement, a condensed Balance Sheet, and some limited Cash Flow data, but no Cash Flow Statement.  Since we need some undisclosed values to compute GCFR gauge scores, we estimated, as an interim solution, the omitted figures.

We will adjust the scores after NVIDIA files a complete 10-Q report with the SEC.

First, we present some background information.

NVIDIA Corporation, based in Santa Clara, CA, builds a variety of specialized Graphics Processing Units.  These devices perform the intensive computations required to produce realistic images for video games and other applications.  NVIDIA, which had its initial public offering in 1999, sells to computer manufacturers such as Hewlett Packard (NYSE: HPQ), Dell (NASDAQ: DELL), and Apple, Inc., (NASDAQ: AAPL).  NVIDIA competes with Intel Corporation (NASDAQ: INTC), Advanced Micro Devices (NYSE: AMD) and other Specialized Semiconductor developers.

The weak global economy caused a "historic collapse," as ChangeWave described it, in corporate information technology spending.  Sales of semiconductors declined industry-wide in 2008, which was the first yearly drop since 2001.  Financially strapped consumers and businesses spent less on IT devices such as personal computers.  The computer manufacturers, not surprisingly, bought fewer chips from NVIDIA.

A green shoot of a faint rebound was detected when the SIA announced a small increase in chip sales in March from February.  Furthermore, one industry observer announced that more GPUs were sold in the first quarter of calendar 2009.  However, PC makers needing to replenish previously depleted inventories may have boosted the sales increase.

In a diversification initiative, NVIDIA has enabled its GPUs to work on non-graphical, but still computationally intense tasks.  In addition, reports have circulated that NVIDIA might augment its product line with general-purpose "x86" microprocessors.  In a February 2009 counter-move, Intel sued NVIDIA over the future applicability of an earlier license that "allowed nVidia to provide chipsets for Intel-based motherboards."

In 2008, NVIDIA recorded a $196 million charge to cover warranty, replacement, and other costs related to faults in certain products for notebook computers.  The faults were said to result from "a weak die/packaging material set" that is no longer used.  It's not clear that this amount will be sufficient when lawsuits are consideredPCWorld reports that owners of Hewlett Packard laptops "continue to complain about defective Nvidia graphics cards that could cause laptops to fail" due to over-heating.

Looking back a few months, we are reminded that Revenue dived a stunning 46.4 percent from the October 2008 quarter to the January 2009 period.  The Net Loss in the January quarter was $148 million (-$0.27/share).  January's results caused the GCFR Overall Gauge to plunge from 55 to 31 of the 100 possible points.  The Value gauge took the biggest tumble, from a perfect 25 points all the way down to 13.

Now, with actual and estimated data for the April 2009 quarter, our gauges display the following scores:
Before examining the factors that affected each gauge, we will examine the latest quarterly Income StatementWe did not publish a formal "look-ahead" advance model of NVIDIA's results, but we did make some internal estimates.
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.


Revenue was 42 percent less than in the comparable year-earlier quarter, but the surprising news was that Revenue jumped 38 percent above the amount in the January 2009 quarter.
The Cost of Goods Sold (i.e., Cost of Revenue) was 69.7 percent of Revenue in the quarter.  This translates into a Gross Margin of 30.3 percent.   Unlike Revenue, the Gross Margin improved only slightly from January's weak 29.4 percent.  The Gross Margin was 40 or more percent in most quarters the last few years.
Research and Development expenses were down 3.7 percent from the year-earlier quarter.  As a percentage of Revenue, however, R&D expenses soared from 19 to 31.8 percent.  NVIDIA can only cut its R&D spending so much because its competitive position depends on continued innovation.
Sales, General, and Administrative expenses were slashed 14 percent.  These expenses were 12.1 percent of Revenue, an increase from last year's 8.1 percent.
As mentioned above, the April 2009 quarter included a $140 million charge associated with the purchase of employee stock options.

Operating Income was a $231 million loss, compared to a gain last year of $203 million.  Note that Operating Income would have been negative even if there had not been a special charge.
Non-operating interest and other income was down from last year, but the amounts involved were not substantial. 

NVIDIA claimed a small income tax benefit, which trimmed the Net Loss for the quarter to $201 million (-$0.37/share). 

Now for the gauges:
Cash ManagementApril 20093 months prior12 months prior
Current Ratio2.92.83.1
LTD/Equity 1.1%1.1%0%
Debt/CFO 0.1 years0.1 years0.0 years
Inventory/CGS 72.6 days79.6 days57.2 days
Finished Goods/Inventory N/A70.1%53.9%
Days of Sales Outstanding (DSO)59.4 days52.5 days46.5 days
Working Capital/Invested Capital 131%119%168%
Cash Conversion Cycle Time65 days74 days48 days
Gauge Score (0 to 25)

With over $1.3 billion in Cash and Short-term Investments and about the same amount in Net Working Capital, NVIDIA has considerable liquidity.   Even if we treat a $25 million long-term lease obligation as Debt, the amount is minimal compared to the NVIDIA's Equity and Cash Flow.

Inventory came down nicely from last quarter's peak level, but it is still much higher than it had been before the sales slump.

The Days of Sales Outstanding, which is based on the Accounts Receivable, seems much too high.  There is reason to believe that sales improved significantly at the end of the quarter, so there might not have been time to receive customer payments.  But, it's also possible that the company relaxed payment terms to give a boost to sales.

GrowthApril 20093 months prior12 months prior
Revenue growth-33.4%-16.4%36.4%
Revenue/Assets 84.0%96.5%133%
CFO growth -78.0%-80.4%36.9%
Net Income growth N/AN/A72.2%
Gauge Score (0 to 25)0
Growth rates are trailing four quarters compared to four previous quarters.

Although the April quarter showed some signs of improvement, and the $140 million special charge makes recent results seem more ominous than necessary, the Growth gauge sees nothing to like when it looks at the last four quarters as a whole.

ProfitabilityApril 20093 months prior12 months prior
Operating Expenses/Revenue 104.8%95.6%79.6%
ROIC -11.9%9.1%70.6%
Free Cash Flow/Invested Capital 2.8%-13.6%67.8%
Accrual Ratio (1)-9.6%-2.1%10.0%
Gauge Score (0 to 25)4517
1. Based on estimated data for the April 2009 quarter.

At over 100 percent, the Operating Expense ratio listed above shows the NVIDIA needs to make more progress at getting its costs under control if it hopes to return to profitability.  Neither the Operating Expense, nor the ROIC, ratios include the $140 million stock option repurchase charge and other special charges.

Free Cash Flow became positive because of better operating performance and greatly reduced capital expenditures.

The Accrual Ratio is suspect until we get access to data in the 10-Q report.

ValueApril 20093 months prior12 months prior
P/E N/AN/A14.4
P/E vs. S&P 500 P/E N/AN/A80%
Enterprise Value/Cash Flow (EV/CFO)
Gauge Score (0 to 25)7

Despite negative earnings, NVIDIA's share price rebounded in the February-to-April period from $7.95 to $11.48.  The price rise under these circumstances as not going to be rewarded by the contrarian Value gauge.

The share price was over $30 between August 2007 and December 2007 -- not that long ago!

NVIDIA's valuation ratios can be compared with other companies in the Specialized Semiconductor industry.

OverallApril 20093 months prior12 months prior
Gauge Score (0 to 100)20

NVIDIA recorded a net loss in the April quarter.  While the loss was magnified by the $140 million special charge, exclusion of the charge would not have made the quarter profitable.

More positively, sales recovered from the disastrous levels of late 2008, and the recovery might have been strongest towards the end of the first quarter, which would give the second quarter a nice starting push. Some sales gains may have been from inventory replacements as PC makers gained confidence their customers hadn't departed forever.

The dramatic drop in the Overall Gauge illustrates the change in NVIDIA's fortunes.  The Value gauge now acts as if the rebound in NVIDIA's share price was excessive, although we understand that investors who bid up the shares are looking more to the future than the past.

We don't view the purchase of under-water employee stock options as a shareholder-friendly action, although we would welcome other opinions on this matter.

NVIDIA's efforts to diversify the uses of its products are promising and have gained some traction.  And, NVIDIA has the financial resources to persist in spite of the weak worldwide economy, but we should not under-estimate the challenges of facing off against formidable and innovative competitors.  We also worry that product quality issues from last year will have longer-term effects on the company's brand.

Full disclosure: Long NVDA at time of writing.

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