14 October 2010

NVDA: Look Ahead to October 2010 Quarterly Results

This post describes our model of NVIDIA's (NASDAQ: NVDA) Income Statement for fiscal 2011's third quarter, which will end on 31 October 2010.

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

NVIDIA reported net losses of $30 million and $68 million in fiscal 2009 and fiscal 2010, respectively.  Annual Revenue slipped from $3.4 billion to $3.3 billion.  Results in the more recent year were weighed down by a $140 million charge associated with the repurchase of stock options from employees and a $119 million warranty charge.

The market value of the company is currently around $6.5 billion, roughly one quarter of its peak in 2007.  In March 2010, NVIDIA extended for three years a program for repurchasing up to $2.7 billion of its common shares.

Prior to fiscal 2011 (the current year), NVIDIA's operations were divided for financial reporting purposes into four businesses: GPU, Professional Solutions, Media and Communications Processors, and Consumer Products.  The GPU and MCP segments have since been consolidated.

The GPU business, which had Revenue of $1.7 billion in fiscal 2010 (53 percent of the total), sells products for desktop and notebook personal computers.  NVIDIA GPUs are installed in computers made by Apple (NASDAQ: AAPL), Hewlett Packard (NYSE: HPQ), Dell (NASDAQ: DELL), and Lenovo

Advanced Micro Devices (NYSE: 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.

The Professional Solutions business had Revenue of $510 million in fiscal 2010 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) escalated as the two chip-makers eyed each other's markets.  A licensing dispute between the two companies highlighted the friction.  NVIDIA has promoted the use of its parallel-processing GPUs for computations now performed by Intel's general-purpose microprocessors.  Intel, which already has graphics-capable chipsets integrated with its CPUs, is interested in selling devices featuring advanced graphics.

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.

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).  There have been published reports that the second generation of the Tegra chipset will be used in the smartphones and tablets produced by several major manufacturers.

NVIDIA 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.

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

When NVIDIA reported its second-quarter results on 12 August,  it provided the following guidance for the current quarter:

The outlook for the third quarter of fiscal 2011 is as follows:
  • Revenue is expected to be up 3 to 5 percent from the second quarter.
  • GAAP gross margin is expected to increase to 46.5 to 47.5 percent.
  • GAAP operating expenses are expected to be approximately $300 million.
  • GAAP tax rate of 17 to 19 percent.

Since NVIDIA forecast a 3-to-5 percent Revenue gain relative to the second quarter's $811 million, they were effectively estimating that Revenue would be between $836 million and $852 million.  We are using the mid-range figure of $845 million as our estimate for NVIDIA's third-quarter Revenue.

This target value is 6 percent less than Revenue of $903 million in the year-earlier quarter.

For the Gross Margin, we will use the 47-percent midpoint of the guidance range.  In other words, we expect the Cost of Goods Sold in the quarter to equal (1 - 0.47) * $845 million, or $448 million.

The $300 million guidance for Operating expenses covers Research and Development and Sales, General, and Administrative costs.  We have divided the $300 million figure into $212 million for R&D and $88 million for SG&A.

Subtracting the estimated operating costs from the Revenue target, and assuming no special operating charges (for, say, restructuring, asset impairments, or warranties), yields a projected Operating Income of $97 million.  This estimate is 10 percent is less than Operating Income of $108 million in the year-earlier quarter.

We are estimating $5 million, net, for Interest and other non-operating income and expenses.  This figure brings pretax income up to $102 million.

Applying an 18 percent income tax rate would result in a tax provision of $18 million, and Net Income of $84 million (about $0.14 per share). 

Please click here to see a 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 at time of writing. 

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