05 September 2010

NVDA: Financial Gauge Analysis for the July 2010 Quarter

NVIDIA (NASDAQ: NVDA) lost $0.25 per diluted share on a GAAP basis in fiscal 2011's second quarter, which ended on 1 August 2010.  In last year's comparable quarter, NVIDIA incurred a net loss of $0.19 per share.  Both periods included substantial charges due to product failures caused by the same "weak die/packaging material set."

Excluding special items in both periods, non-GAAP earnings per share rose from $0.02 to $0.03.

A previous article examined NVIDIA's Income Statement for the July quarter.  Our earnings estimate of $0.06 per share proved to be far too optimistic because we hadn't anticipated the loss-causing special charges.  Non-GAAP earnings were $0.03 below our earnings target.

We have now updated the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.  This post reports on the metrics for NVIDIA and the associated financial gauge scores.  The metrics were calculated using data from NVIDIA's current and historical financial statements, including those in the latest 10-Q.

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

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.

Prior to fiscal 2011 (the current year), NVIDIA's business was divided for reporting purposes into four segments: GPU, Professional Solutions, Media and Communications Processors, and Consumer Products.  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.

On 12 August 2010, NVIDIA reached a licensing agreement with Rambus (NASDAQ: RMBS) in which the latter grants NVIDIA "a non-exclusive, non-transferable, worldwide license for certain memory controllers."  This agreement comes after a fair amount of litigation between the two companies, and it does not necessarily settle all existing disputes.

Additional background information about NVIDIA and the business environment in which it is currently operating can be found in the look-ahead.

In summary, NVIDIA's latest quarterly results produced the following changes to the gauge scores:

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.  Readers are encouraged to verify these figures and calculate others as they see fit using the filings available at the SEC's web site and elsewhere.

Cash Management01 Aug 201002 May 201026 Jul 20095-Yr Avg
Current Ratio3.
LTD to Equity0.9%0.8%1.1%0.3%
Debt/CFO (years)
Inventory/CGS (days)59.555.783.768.0
Finished Goods/Inventory58.4%54.7%57.2%55.9%
Days of Sales Outstanding (days)40.539.058.650.3
Working Capital/Revenue44.6%42.2%50.6%43.3%
Cash Conversion Cycle Time (days)48.643.075.060.6
Gauge Score (0 to 25)1918713

NVIDIA holds nearly $1.8 billion in Cash and Short-term Investments, up from $1.5 billion one year earlier.  Working Capital edged down from $2.0 billion (a record high) on 2 May 2010 to $1.8 billion.  Current Assets are an ample 3.2 times Current Liabilities -- last quarter's Current Ratio of 3.6 seemed excessive.

The company doesn't have any significant Short-term or Long-term Debt.  NVIDIA does have about $25 million in long-term capital lease obligations.

The gauge score also benefited from improved cash flow efficiency.  The days of Inventory held, the Days of Sales Outstanding, and the Cash Conversion Cycle Time are all much less than they were one year ago.  However, these three metrics all backtracked marginally during the latest quarter.  In other words, a portion of the earlier efficiency improvements were given back during the latest quarter. 

The buildup of Inventory, as measured in days of Cost of Goods Sold, bears watching.

Growth01 Aug 201002 May 201026 Jul 20095-Yr Avg
Revenue Growth31.2%24.8%-35.4%16.8%
Operating Profit Growth9.4%16.2%4.8%21.5%
CFO Growth-20.3%38.2%-65.8%149.8%
Net Income GrowthN/AN/AN/A18.0%
Gauge Score (0 to 25)1520011
Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.  The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.

Although Revenue in the most recent quarter disappointed with a tiny 4.5 percent increase over the same quarter of last year, the trailing-year Revenue growth rate still improved.  The rate is a little misleading in that the prior-year results were especially weak and most of the growth was achieved in just two of the last four quarters.

In the most recent quarter, NVIDIA blamed weak revenue on "increased memory costs and economic weakness in Europe and China [... that ...] led to a greater-than-expected shift to lower-priced GPUs and PCs with integrated graphics."

Revenue in the last four quarters was 105 percent of Assets, up significantly from 78 percent last year.  However, this ratio was over 130 percent as recently as 2008.

Cash Flow from Operations has been very weak in the last year, down 20 percent from a period in which Cash Flow was hardly robust.  In the first six months of the current fiscal year, Cash Flow from Operations was only $29 million, compared to $277 million in the first half of the prior fiscal year.  Cash Flow has been negatively affected by poor earnings, the inventory buildup, and other changes to operating assets and liabilities.

Although Net Income in the last four quarter was positive, the growth rate is N/A because of a loss in the prior year.  The results in both years were undermined by special charges.

Profitability01 Aug 201002 May 201026 Jul 20095-Yr Avg
Operating Expense/Revenue89.0%89.1%106.1%89.2%
Free Cash Flow/Invested Capital16.0%25.1%12.1%52.2%
Accrual Ratio14.8%13.1%-15.0%2.9%
Gauge Score (0 to 25)2022615

The Profitability gauge score seems too high given the company's recent stumbles.  There are two reasons for the better-than-expected score.  (1) The year-earlier figures were mostly awful, making more recent results appear stellar in comparison; and (1) We exclude special gains and losses when calculating some of the ratios on the theory that these items don't reflect the essential profitability of the business.

NVIDIA has recorded enormous special charges recently.  In the last quarter, charges totaling $194 million were incurred because of product failures caused by "weak die/packaging material set."  This problem had been blamed previously for net charges of $282 million.

The charges have had a huge impact on reported earnings (and losses), but they are not included in the figures above for Operating Expenses and Return on Invested Capital.  The company's core business is much more profitable than the bottom-line numbers suggest.

The increase in the Accrual Ratio is a concern.   It raises a question about whether Cash Flow from Operations will be strong enough to sustain earnings.

Value01 Aug 201002 May 201026 Jul 20095-Yr Avg
P/E vs. S&P 500 P/E 1.41.9N/A1.5
Enterprise Value/Cash Flow (EV/CFO)14.722.218.714.8
Gauge Score (0 to 25)12359
Share Price ($)$9.19$15.71$12.93-

When the Value gauge score dropped to 3 points after quarter ending on 2 May, it was a warning that the $15.71 price per NVIDIA share was not justified by the company's historical results.  The gauge finds the share price now, after a 40 percent decline, to be more appropriate.

The latest Price-to-Sales ratio seems especially appealing.  However, there is much uncertainty about future Revenue projections for NVIDIA.

Overall01 Aug 201002 May 201026 Jul 20095-Yr Avg
Gauge Score (0 to 100)64532048

The Overall gauge jumped because the recovery in the double-weighted Value gauge was strong enough to overcome smaller Growth and Profitability declines.  However, the Profitability figures would have been much worse had we included the large special charges related to particular type of product failure. 

The bigger concern now might be whether the steps backward (e.g., Inventory growth, weak Cash Flow) in the last quarter were anomalous or the start of downward trends in NVIDIA's business.  In addition, since the year-on-year comparisons are going to get more difficult, Growth will get harder to achieve.

Full disclosure: Long NVDA at time of writing.

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