05 January 2010

NVDA: Look Ahead to January 2009 Quarterly Results

NVIDIA (NASDAQ: NVDA) earned $0.19 per share in the third quarter of fiscal 2010, which ended on 25 October 2009, up from $0.11 in the same quarter of last year.  On a non-GAAP ("pro forma" or "ex-items") basis, earnings fell from $0.20 to $0.19 per share.  A $25 million insurance reimbursement, a $23 million stock-based compensation expense, and the tax impacts of these two items are excluded from non-GAAP Net Income in the October 2009 quarter.

In November, we examined NVDIA's Income Statement for the October quarter and compared the entries on each line to our "look-ahead" estimates.  We later performed a financial gauge analysis of NVIDIA, which determined that the GCFR Overall gauge rose from 20 to 31 (recomputed) of the 100 possible points.

We have now modeled NVIDIA's Income Statement for fiscal 2010's 14-week fourth quarter, which will end on 31 January 2010.  The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data that the company will announce in February.  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.

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) integrate NVIDIA GPUs into their products.

Advanced Micro Devices (NYSE: AMD) bought ATI Technologies in 2006 and became NVIDIA's most direct rival in the marketplace for discrete GPUs and the computer graphics cards built around them. 

Intel (NASDAQ: INTC), which already has graphics-capable chipsets integrated with its CPUs, had planned to enter the market for high-end graphic cards with the multi-core Larrabee processor.  However, Intel decided in December 2009 to delay Larrabee indefinitely.  This action was widely seen as a boon to NVIDIA and AMD.

Larrabee was one facet of escalating tension between Intel and NVIDIA.  NVIDIA has developed technology enabling a GPU's parallel-processing design to be used computing tasks now performed by general-purpose microprocessors, the product category dominated by Intel. NVIDIA's zealous promotion of "GPU computing" has even led it to discuss designing its own general-purpose x86 microprocessor.

The market for mobile devices has not escaped NVIDIA's notice.  The company's Tegra "computer on a chip" is inside the Zune HD from Microsoft (NASDAQ: MSFT).  NVIDIA recently confirmed that it is "working closely with Google" to have Tegra support Chrome operating system for netbooks, and other reports indicate the Tegra will soon be found in smartphones.

According to Gartner, financially strapped consumers and businesses spent about 5 percent less on information technology in 2009, but spending is expected to rebound 3 percent in 2010.  The Semiconductor Industry Association reported that worldwide sales of semiconductors during the first 10 months of 2009 were 16.6 percent less than sales during the equivalent period of 2008.

In 2008, NVIDIA recorded a $196 million charge to cover warranty, replacement, and other costs related to faults in certain products for notebook computers.  Another $119 million charge was recorded in 2009 for this same problem.  The faults were said to result from "a weak die/packaging material set" that is no longer used.

We are now ready to look specifically at the current quarter.

When NVIDIA reported third-quarter results last November, it provided the following outlook for the fourth quarter:
  • Revenue is expected to be up slightly, approximately 2 percent, from the third quarter.
  • GAAP gross margin is expected to be in the range of 40 to 42 percent.
  • GAAP operating expenses are expected to be approximately $305 million.
The outlook was also discussed during the subsequent conference call with financial analysts.  From the transcript at SeekingAlpha.com:

Our outlook for the fourth quarter of fiscal 2010 is as follows -- revenue is expected to be up slightly, approximately 2% from the third quarter. While revenue for 40-nanometer products is expected to grow significantly quarter over quarter, we expect 40-nanometer products to be supply constrained throughout the quarter; GAAP gross margin is expected to be 40% to 42%, essentially flat with Q3 excluding the insurance reimbursement; GAAP operating expenses are expected to be in the range of $305 million. This is up from the third quarter due primarily to our fourth quarter comprising 14 weeks versus the usual 13 weeks, as well as costs relating to a record number of product bring-ups.

Two-percent sequential growth, as mentioned above, would result in Revenue of $921.3 million in the January 2010 quarter.  However, this seems light because of the improving trends in semiconductor sales and the quarter's extra week.  Therefore, we are setting our target at $930 million.  This amount nearly doubles the $481 million in the horrid January 2009 period.

For the Gross Margin, we will use the 41-percent midpoint of the guidance range.  In other words, we expect the Cost of Goods Sold in the October quarter to equal (1 - 0.41) * $930 million, or $549 million.

NVIDIA indicated the quarter's Operating Expenses would increase to about $305 million.  We have allocated the expense as $215 million for Research and Development and $90 million for Sales, General, and Administrative costs.

If additional operating charges (for, say, restructuring, asset impairments, or warranties) are avoided, Operating Income will be $76 million in the quarter.  NVIDIA had an operating loss of $175 million in last year's fourth quarter.

We're estimating $5 million for Interest and other non-operating income and expenses.  This figure brings pretax income up to $79 million.

We don't have a good basis for estimating income taxes because the tax rate was only 2.4 percent last quarter and the company had pretax losses earlier in the year.  If we guess 5 percent, the tax provision would be $4 million.  Net Income would then be $77 million ($0.14 per share), compared to a loss of $148 million ($0.27 per share) in the January 2009 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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