09 July 2009

NVDA: Look Ahead to July 2009 Quarterly Results

NVIDIA (NASDAQ: NVDA) lost $201 million ($0.37 per share) in the three months that ended on 26 April 2009.  The GCFR Overall Gauge for NVIDIA fell from 31 of the 100 possible points to 20, a very weak score.

Our initial and updated analysis reports examined the April quarter, which was the first quarter of the company's fiscal 2010, in some detail.  In summary, a large chunk of the loss was due a $140 million charge related to the company's purchase of underwater employee stock options.  The quarter would not, however, have been profitable if the charge had been excluded. 

While Revenue was 42 percent less than in the April 2008 quarter, it was encouraging that sales recovered substantially from the disastrous levels of late 2008.  PC makers replenishing their inventories once the IT market showed sign of stabilizing earlier this year might have boosted the rise.

We have now modeled NVIDIA's Income Statement for fiscal 2010's second quarter, which will end on 26 July 2009.  The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data the company will announce in August.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we set the stage with some background information about NVIDIA and the business environment in which it is currently operating.  Readers that keep close tabs on the company are invited to skip ahead.

NVIDIA Corporation designs powerful Graphics Processing Units that rapidly perform the intensive calculations required to produce hyper-realistic images for computers and video games.  Hewlett Packard (NYSE: HPQ), Dell (NASDAQ: DELL), and Apple, Inc., (NASDAQ: AAPL) are among the various manufacturers that use NVIDIA GPUs in their products.  [The status of relations between Apple and NVIDIA has recently been the subject of rumors.]

Advanced Micro Devices (NYSE: AMD) bought ATI Technologies in 2006 and became NVIDIA's most direct rival in the marketplace for high-end GPUs on video cards.  Intel (NASDAQ: INTC) also makes numerous chips that perform graphical processing. 

Sales of semiconductors, which include GPUs, are down sharply because financially strapped consumers and businesses are spending less on information technology.  Sales of semiconductors were less in 2008 than 2007, which was the first yearly drop since 2001.  The SIA forecasts an even steeper decline in 2009.  However, a ChangeWave survey in May determined that "U.S. corporate IT spending in the process of rapidly stabilizing."

NVIDIA is zealously promoting "GPU computing" as an alternative to general-purpose microprocessors for some tasks.  The company has developed technology making it easier to take advantage of the GPU's parallel-processing design.  NVIDIA has even discussed designing its own general-purpose x86 microprocessor.  Intel might have had this rivalry in mind when they sued NVIDIA in February 2009 over licensing.  With Larrabee, expected in 2010, Intel will have its own potent entry in the competition for general-purpose GPUs.

The market for handheld devices has not escaped NVIDIA's notice.  Reports indicate that the company's Tegra "computer on a chip" will power the Zune HD from Microsoft (NASDAQ: MSFT).  Other reports indicate the Tegra will soon be found in smart phones.

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.  PCWorld reported in April that owners of Hewlett Packard laptops "continue to complain about defective Nvidia graphics cards that could cause laptops to fail" due to over-heating.

We are now ready to look ahead.

Our starting point was the transcript at SeekingAlpha from NVIDIA's conference call with financial analysts on 7 May 2009.  The following is a summary of the guidance the company offered for the current quarter.

"... we expect revenue to be up quarter over quarter in the range of 5%. As for gross margin, while we are not expecting any near-term improvement in demand in the workstation market, we do believe cost reduction efforts will allow us to improve margins. Accordingly, we expect our GAAP margins to be in the range of 32% to 34%.

"We expect GAAP operating expenses to be in the range of $280 million.

"We estimate stock-based compensation expense in the second quarter to be $25 million, and deprecation and amortization and capital expenditures to be approximately flat when compared to the first quarter. Basic shares for the second quarter are expected to be about 548 million."

Similar, but less quantitative, statements were included in NVIDIA's 10-Q for the April quarter.

"We expect revenue to increase slightly during the second quarter of fiscal year 2010 as compared to the first quarter of fiscal year 2010. [...]

"we expect gross margin to increase during the second quarter of fiscal year 2010 as compared to the first quarter of fiscal year 2010.

"We expect operating expenses to decrease in the second quarter of fiscal year 2010 compared to the first quarter of fiscal year 2010.

Because NVIDIA's Revenue in the April 2009 quarter was $664 million, the first part of the guidance implies an expectation of Revenue in the July 2009 quarter of about 1.05 * $664 million = $697.2 million.  We will round this up to $700 million and call it our target.

For the Gross Margin, we will use the midpoint of the guidance range, 33 percent, as our target for the July quarter.  In other words, we expect to see the Cost of Goods Sold (CGS) of (1 - 0.33) * $700 million, which is $469 million.

NVIDIA said they would reduce the quarter's Operating Expenses, by which they mean Research and Development and Sales, General, and Administrative costs, to about $280 million.  This seems achievable.  We have allocated the expense as $200 million for R&D and the remaining $80 million for SG&A.

If there will be neither restructuring, nor asset impairment charges, Operating Income would be negative $49 million in the July 2009 quarter.  Operating income was negative $155 million one year earlier, after the $196 million warranty, etc., charge.

For Interest and other non-operating income, our estimate is $5 million.  This figure is consistent with the results of the previous few quarters.  It brings the pretax loss to $44 million.

If the tax benefit, on a percentage basis, mirrors that of the April quarter, Net Income will be -$39 million (minus $0.07 per share), compared to -$121 million (minus $0.22 per share) in the July 2008 quarter.

Please click here to see a full-sized, normalized depiction of the projected results next to NVIDIA's quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Full disclosure:  Long NVDA, INTC, and MSFT at time of writing.  No position in any other security mentioned

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