15 December 2010

NVDA: Financial Gauge Analysis for the October 2010 Quarter

NVIDIA (NASDAQ: NVDA) earned $0.15 per diluted share on a GAAP basis in the October-ending third quarter of fiscal 2011, down 22 percent from $0.19 in the same three months of last year. 

The earlier period benefited from a $24 million ($0.06 per share) insurance settlement. 

A previous article examined NVIDIA's Income Statement for the July quarter.  Reported GAAP earnings were $0.01 better than the $0.14 per share we had forecast. 

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

The market value of the company is currently around $8.5 billion.  In March 2010, NVIDIA extended for three years a program for repurchasing up to $2.7 billion of its common shares.

NVIDIA's operations are divided for financial reporting purposes into three businesses: GPU, Professional Solutions, and Consumer Products.  The GPU business, which in fiscal 2010 had Revenue of $1.7 billion (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) is NVIDIA's most direct competitor.  However, Intel's (NASDAQ: INTC) Sandy Bride generation of microprocessors, expected early in 2011, includes a CPU and a Graphics Processing Unit.  This chip could raise the stakes in Intel's rivalry with NVIDIA. 

NVIDIA has promoted the use of its parallel-processing GPUs for computations now performed by Intel's general-purpose microprocessors

The company is starting to gain traction in the market for smartphones and other mobile devices.  NVIDIA's Tegra chips are becoming a popular choice for tablet computers produced by several major manufacturers, according to a DigiTimes report.

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:
  • Overall: 51 of 100 (down from 63)

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 Management31 Oct 201001 Aug 201025 Oct 20095-Yr Avg
Current Ratio3.
LTD to Equity0.8%0.9%1.0%0.4%
Debt/CFO (years)
Inventory/CGS (days)64.858.977.367.2
Finished Goods/Inventory58.6%58.4%51.8%56.1%
Days of Sales Outstanding (days)42.140.551.249.9
Working Capital/Revenue49.2%44.6%49.1%43.7%
Cash Conversion Cycle Time (days)51.148.562.959.6
Gauge Score (0 to 25)17191113

The Cash Management gauge edged down a couple of points, but its score remains strong.  Small rises in the Inventory, Days of Sales Outstanding, and Working Capital to Revenue ratio were mainly responsible for the slippage.

NVIDIA holds nearly $2.0 billion in Cash and Short-term Investments, up from $1.6 billion one year earlier.  Working Capital also increased from $1.5 billion to $2.0 billion (a record high), which seems more than enough to meet day-to-day business needs.  Current Assets increased to an ample 3.4 times Current Liabilities.

The company doesn't have significant Short-term or Long-term Debt.  NVIDIA does have about $23 million in long-term capital lease obligations.

The days of Inventory held, which had fallen nicely after a surge in 2009, started to rise again in the latest quarter.  We generally prefer to see a leaner inventory, but sometimes a company will stock up on parts and other inventory in anticipation of new product launch.

The Days of Sales Outstanding increased in the last quarter, but the latest calculation is still much better than it was last year at the same time.

The situation was similar with the Cash Conversion Cycle Time.

Growth31 Oct 201001 Aug 201025 Oct 20095-Yr Avg
Revenue Growth28.8%31.2%-31.9%8.0%
Operating Profit Growth-14.3%-22.2%-12.3%12.3%
CFO Growth-22.2%-20.3%-23.6%2.7%
Net Income GrowthN/AN/AN/A6.3%
Gauge Score (0 to 25)1414111
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.

The Growth gauge steadied at a decent 14 points.  Strong Revenue growth was balanced by declining Cash Flow from Operations.

Revenue in the most recent quarter actually decreased 6.6 percent, from $903 million in the three months ended October 2009 to $844 million.  The latest Revenue amount was tantalizingly close to our $845 million estimate.   The strong trailing-year growth rate is due to especially weak results in the earlier four-quarter period.

Revenue in the last four quarters was 99 percent of Assets, up significantly from 79 percent last year.  However, this ratio was over 130 percent as recently as 2008.

Cash Flow from Operations has been very weak. In the first nine months of the fiscal year, CFO fell from $418.6 million to $241.1 million in the current year.

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 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.

Profitability31 Oct 201001 Aug 201025 Oct 20095-Yr Avg
Operating Expense/Revenue88.9%89.6%105.4%89.3%
Free Cash Flow/Invested Capital24.2%16.0%30.1%61.1%
Accrual Ratio13.4%14.8%-13.8%3.2%
Gauge Score (0 to 25)20201015

The Profitability gauge score held onto a stellar 20 point score, which seems too high given the company's recent stumbles.  This gauge is currently benefiting from easy comparisons with 2009's results and the exclusion of unusual losses.

NVIDIA has recorded some enormous special charges.  In the August 2010 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.

Value31 Oct 201001 Aug 201025 Oct 20095-Yr Avg
P/E vs. S&P 500 P/E 2.21.5N/A1.6
Enterprise Value/Cash Flow (EV/CFO)16.214.714.914.2
Gauge Score (0 to 25)51258
Share Price ($)$12.02$9.19$13.15-

The 30 percent rise in just the last quarter, when earnings were hardly robust, explains the big drop in the Value gauge score.

The high P/E multiple clearly reflects optimism about the future more than earnings actually achieved.

The Price-to-Sales ratio still seems appealing. 

The decline in Cash Flow from Operations has inflated the EV/CFO ratio, which is looking pricey.

Overall31 Oct 201001 Aug 201025 Oct 20095-Yr Avg
Gauge Score (0 to 100)51632946

The Overall gauge gave up some of its recent gains because of weakness in the double-weighted Value gauge.  However, the score remained above the 50-point threshold.

The expanding inventory, which might be worrisome in other circumstances, could very well be a sign the company is gearing up for sales of new products.  Advanced chips for smartphones and tablet computers are a likely possibility.

Full disclosure: Long NVDA at time of writing.

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