15 April 2010

NVDA: Look Ahead to April 2010 Quarterly Results

This post describes our model of NVIDIA's (NASDAQ: NVDA) Income Statement for the first quarter of fiscal 2011, which will end on 2 May.

The purpose of the model is to establish a baseline for identifying surprises, positive or negative, in the quarterly results the company will report.  Estimates for each line of the Income Statement are derived from management's guidance, the company's historical financial results, and other publicly available data.

We begin by reviewing background information about NVIDIA and the business environment in which it is currently operating.

NVIDIA is best known for the powerful Graphics Processing Units that rapidly perform the huge numbers of calculations required to produce hyper-realistic images for computers and video games.

NVIDIA lost $68 million on Revenue of $3.3 billion in fiscal 2010, which ended on 31 January.  In fiscal 2009, NVIDIA lost $30 million on Revenue of $3.4 billion.  Fiscal 2010 included a $140 million charge associated with the repurchase of stock options from employees, and it also included a $119 million warranty charge.

The company's current market capitalization is about $10 billion.  In March, NVIDIA extended for three years a program for repurchasing up to $2.7 billion of its common shares

Until the current fiscal 2011, NVIDIA's business was divided for reporting purposes into four segments: GPU, Professional Solutions, Media and Communications Processors, and Consumer Products business.  The GPU and MCP segments have since been consolidated.

The GPU segment, which had Revenue of $1.7 billion in fiscal 2010 (53 percent of the total), sells products for desktop and notebook personal computers, including Apple's (NASDAQ: AAPL) latest MacBook Pros.  NVIDIA GPU's are also installed in computers made by Hewlett Packard (NYSE: HPQ), Dell (NASDAQ: DELL), and now Lenovo!  The Professional Solutions segment had Revenue of $510 million from sales of products used by graphic professionals (such as broadcasters) and for high-performance computing.  Media and Communications Processors had Revenue of $872 million.  Consumer Products took in $164 million from the sale and licensing of products that support tablets and smartbooks, smartphones, video games, and other consumer electronics devices.

A rivalry between NVIDIA and Intel (NASDAQ: INTC) has been escalating as the two illustrious chip-makers eye each other's markets.  NVIDIA has been promoting the use of its parallel-processing GPUs for computations now performed by Intel's general-purpose microprocessors, and Intel has taken steps to enter the market for high-end graphical processors.  A licensing dispute between the two companies is moving towards a court date.  The FTC has accused Intel of antitrust violations in its actions involving graphical chips.

Intel, 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 in an action seen as a boon to NVIDIA and Advanced Micro Devices (NYSE: AMD).  AMD, by purchasing ATI Technologies in 2006, became NVIDIA's most direct competitor in the marketplace for discrete GPUs and the computer graphics cards built around them.

NVIDIA is also involved in a patent dispute with Rambus.  The U.S. International Trade Commission is reviewing patent validity and infringement claims.

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 confirmed that it is "working closely with Google" to have Tegra support Chrome operating system for netbooks, and other reports indicate the Tegra will be in smartphones by the fourth quarter of 2010.

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

When NVIDIA, in February 2010, reported results for the fourth quarter of fiscal 2010, it provided the following outlook for the current quarter:


The outlook for the first quarter of fiscal 2011 is as follows:
  • Revenue is expected to be flat from the fourth quarter.
  • GAAP gross margin is expected to be in the range of 44 to 45 percent.
  • GAAP operating expenses are expected to be flat, at approximately $305 million.
  • Tax rate of 12% to 14% assuming a renewal of the U.S. R&D tax credit, 14% to 16% otherwise.
The first-quarter outlook was also discussed during the subsequent conference call with financial analysts.  From the transcript at SeekingAlpha.com:

Our outlook for the first quarter of fiscal 2011; revenue is expected to be flat, constrained by supply; GAAP gross margin is expected to be in the range of 44% to 45%; GAAP operating expenses are expected to be flat.

The outlook was expanded when NVIDIA met with financial analysts on 7 April 2010.  See this Financial Analysis presentation [pdf] for the specifics. 

Given the guidance for "flat" Revenue growth, we could have set the April target at $982.5 million, which was the amount in the last quarter of fiscal 2010.  However, it seems clear now that IT sales have been more robust than expected.  We have, therefore, bumped up the target to an even $1.0 billion.  This figure is more than 50 percent greater than Revenue in the April 2009 quarter.

For the Gross Margin, we will use the 44.5-percent midpoint of the guidance range.  In other words, we expect the Cost of Goods Sold in the April quarter to equal (1 - 0.445) * $1.0 billion, or $555 million.

NVIDIA indicated the quarter's Operating Expenses would stay near $305 million.  We have allocated this amount as $215 million for Research and Development and $90 million for Sales, General, and Administrative costs.

Subtracting the estimated costs from the Revenue target, and assuming no special operating charges (for, say, restructuring, asset impairments, or warranties), yields a projected Operating Income of $140 million.  NVIDIA had an operating loss of $231 million in the year-earlier quarter.

We're estimating $5 million, net, for Interest and other non-operating income and expenses.  This figure brings pretax income up to $145 million.

As far as we know, the Congress has not, as yet, extended the R&D tax credit for 2010 (H.R. 422?).  We will, therefore, use 15 percent as an estimate for the effective income tax rate in the first quarter.  This rate would result in a tax provision of $22 million, and Net Income of $123 million (about $0.21 per share). 

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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