08 August 2009

NVDA: Income Statement Analysis for the July 2009 Quarter

NVIDIA (NASDAQ: NVDA) lost $0.19 per share during the three months that ended on 26 July 2009, which was the second quarter of the fiscal year, compared to a loss of $0.22 in the comparable period of 2008. 

On a non-GAAP ("pro forma" or "ex-items") basis, NVIDIA's had positive earnings.  However, net income of $0.13 per share in last year's second quarter fell to $0.07 per share.  GAAP and non-GAAP Net Income differed by $143 million in the latest quarter.  The most substantial item excluded in the non-GAAP results was a $119 million "Net warranty charge against cost of revenue arising from a weak die/packaging material set."  (This was not a new item: July 2008's results included a $196 million charge to cover warranty, replacement, and related costs due to faults in certain products for notebook computers. NVIDIA now says, "the cost of remediation and repair of impacted systems has been higher than originally anticipated.")

This post examines the Income Statement for the quarter and compares it to our "look-ahead" estimates.  Our target for NVIDIA's loss in the latest quarter, at only $0.07 per share, was not as bad as the actual results.

Our principal sources were the earnings announcement and the conference call transcript at Seeking Alpha.  Some background information about NVIDIA and the business environment in which it is currently operating can be found in the look-ahead.

In a second article, we will report NVIDIA's scores as measured by the GCFR Financial Gauges.  The follow-up post will also provide the latest figures for the financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as the 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.

Revenue in the quarter was 13 percent less than in the same period last year, but it was a surprising 17 percent more than the amount in the April 2009 quarter.  We had assumed, heeding the company's guidance voiced in May, that July's Revenue would be about 5 percent greater than April's Revenue.
The business segment that sells Graphics Processing Units for use in desktop and portable personal computers contributed a little less than half of NVIDIA's Revenue in the July quarter.  The other, smaller business segments, which sell more specialized products, generally experienced stronger Revenue growth in the second quarter.
The Cost of Goods Sold (i.e., Cost of Revenue) was 79.8 percent of Revenue in the quarter, which translates into a Gross Margin of 20.2 percent.  On a non-GAAP basis (i.e., excluding the big warranty charge and one small item), NVIDIA achieved a 36.3 percent Gross Margin that surpassed our estimate of 33 percent.  Our target was the middle of the 32-to-34 percent guidance range NVIDIA identified after the April quarter.
NVIDIA attributed margin improvements to more efficient production (i.e., device yields), a better product mix, and additional royalties.
Research and Development expenses were down 9.4 percent from last July and were 3.5 less than our target.  As a percentage of Revenue, however, R&D expenses moved up from 23.9 to 24.8 percent.
Sales, General, and Administrative expenses were slashed 19.6 percent relative to last year.  These expenses were also 7.5 percent less than our estimate.  As a percentage of Revenue, SG&A decreased from 10.4 percent in July 2008 to 9.5 percent.

Operating Income was a $110 million loss, compared to a loss last year of $155 million.  We had estimated that the loss would be $49 million.  Even though Revenue exceeded our expectations, and some costs were lower, the much lower-than-anticipated Gross Margin pushed Operating Income significantly below our target.
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 $105 million (-$0.19/share). 
In conclusion, many semiconductor companies saw their sales drop precipitously in late 2008 and the beginning of 2009.  Industry Revenues have since started to recover and, at NVIDIA, the rate of growth has exceeded expectations.  Margins are now improving because of higher Revenues and cost-cutting actions taken in gloomier times.  Unfortunately for NVIDIA, residual problems associated with an older technology have taken an axe to the company's results for the second consecutive July quarter.  Warranty-related costs led to GAAP operating and net losses in the recent quarter.  The company made money when charges were excluded, but that might fairly be considered faint praise.  NVIDIA needs demonstrate it can turn its current momentum into consistent profitability.

Full disclosure: Long NVDA at time of writing.

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