19 February 2011

NVDA: Income Statement Analysis for the January 2011 Quarter

NVIDIA (NASDAQ: NVDA) earned $0.29 per diluted share on a GAAP basis in the January-ending fourth quarter of fiscal 2011, up 27 percent from $0.23 in the same three months of the previous year. 

The latest quarter included a $57 million ($37 million after taxes) benefit related to a legal settlement.  Non-GAAP earnings, which exclude special items, were $0.23 per share.  Non-GAAP earnings per share were also $0.23 in the year-earlier quarter.

This post examines NVIDIA's Income Statement for the latest quarter and compares the entries on each line to our "look-ahead" estimates.  Because of the legal settlement, tax matters, and other reasons discussed below, reported earnings surpassed our forecast of $0.17 per share. 

The principal sources for the income statement analysis were the earnings announcement, the Chief Financial Officer's commentary [pdf], and the conference call transcript (available from Seeking Alpha).

In a second article, we will report NVIDIA's scores as measured by the GCFR financial gauges.  The follow-up post will also provide the latest figures for the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

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

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

The company's share price shot up earlier this year in a favorable response to announcements NVIDIA made in conjunction with the Consumer Electronics Show in Las Vegas.  NVIDIA proclaimed its latest chips for mobile devices, such as the dual-core Tegra 2, are being used in increasing numbers of notebook computers, tablets, and smartphones. 

NVIDIA also made known it would develop CPUs using technology from ARM Holdings (NASDAQ: ARMH) for a wide variety of other platforms.  This latter disclosure is significant because Microsoft (NASDAQ: MSFT) decided to enable a future version of the Windows operating system to work on ARM chips, allowing these devices to compete directly against the x86 devices developed by Intel (NASDAQ: INTC).

NVIDIA has promoted the use of its parallel-processing GPUs for applications now run on Intel's general-purpose microprocessors

In January 2011, the temperature of the rivalry between Intel and NVIDIA cooled when the two chipmakers agreed to end their legal disputes and cross-license certain technologies.  NVIDIA will receive $1.5 billion from Intel over a five-year period.

Intel's latest generation of microprocessors, known as Sandy Bridge, includes sophisticated graphics capabilities.  NVIDIA has products that complement Sandy Bridge, but features built into the microprocessor might eventually cut into sales of the discrete GPUs made by NVIDIA and Advanced Micro Devices (NYSE: AMD).

In fiscal 2011, which ended on 30 January, NVIDIA earned $253 million on revenue of $3.5 billion.  The latest annual results constitute a turnaround for the company that lost $30 million and $68 million in fiscal 2009 and fiscal 2010, respectively.

NVIDIA's market value slid from $23 billion in late 2007 to as low as $5 billion in 2009.  The latest spike in the share price has carried the market value to $15 billion.

For financial reporting purposes, NVIDIA has three principal businesses: GPU, Professional Solutions, and Consumer Products.  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.

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 in fiscal 2009, but this business is now dwindling.  Consumer Products took in $164 million from the sale and licensing of products that are embedded in tablets, smartphones, personal media players, and other consumer electronics devices.

In March 2010, NVIDIA extended for three years a program for repurchasing up to $2.7 billion of its common shares.

Please click here to see a normalized depiction of the actual and projected results for the just-concluded quarter, as well as the 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.

Revenue in the January quarter decreased 9.8 percent, from $982 million last year to $886 million in the most recent three months.  The latest Revenue amount surpassed our $880 million estimate by less than one percent.

When compared to the October 2010 quarter, Revenue rose 5.0 percent.  In its guidance three months ago, the company predicted it would achieve sequential Revenue growth between 3 percent and 5 percent.

The GPU business brought in Revenue of $614 million, 69 percent of the total, in the quarter.  Discrete GPUs, including newly launched products, were in demand for both desktop and notebook computers.

Revenue for the Professional Solutions business, 23 percent of total revenue in the quarter, was slowed by the transition to a new series of products.

Although the Consumer Products business was only responsible for 8 percent of quarterly Revenue, sales increased a healthy 32.6 percent sequentially.  The company expects Tegra processor shipments to "ramp aggressively" when its customers begin full-scale production of new smartphones and tablets.

The Cost of Goods Sold (i.e., Cost of Revenue) fell from $544 million in the January 2010 period to $460 million.  The latter amount equals 51.9 percent of the quarter's Revenue, which translates into a Gross Margin of 48.1 percent.  This Gross Margin exceeded  NVIDIA's earlier guidance to expect a margin "flat" relative to October's 46.5 percent.

We expected the Gross Margin to be 47 percent of Revenue, which NVIDIA surpassed by 110 basis points.

Research and Development spending was essentially unchanged from last year at $216 million.  R&D was, therefore, $6 million (3 percent) more than the $210 million we expected.

R&D expenses rose from 22.0 percent of Revenue to 24.3 percent.

Sales, General, and Administrative expenses, $88 million, were also unchanged from the January 2010 quarter.  As a percentage of Revenue, SG&A increased from 9.0 percent to 9.9 percent.

The reported SG&A amount was $2 million less than our $90 million estimate.

NVIDIA reported a $57 million benefit from the legal settlement it reached with Intel.  We didn't expect this special item.

Subtracting the various operating expenses described above from Revenue yields Operating Income of $180 million, 34 percent more than in the same quarter of last year. 

Excluding the legal benefit, Operating Income was $123 million, which exceeded our $114 million estimate by 8 percent. 

Non-operating items (interest and other) summed to income of $6 million.  We had expected $5 million.

The effective income tax rate was a mere 7.7 percent, compared to the 19 percent we expected.  The rate was extraordinarily low because of "the retroactive reenactment of the U.S. federal R&D tax credit." 
At the bottom line, GAAP Net Income was $172 million ($0.29 per share), compared to a gain of $131 million ($0.23 per share) in the year-earlier quarter.

The legal settlement added about $0.06 per share to NVIDIA's earnings in the latest quarter.  The lower-than-expected tax rate added -- this is an estimate -- another $0.04 to $0.05 per share.  If these two items are excluded, NVIDIA earnings were closer to $0.18 to $0.19.  Therefore, the company still surpassed our $96 million ($0.17 share) estimate.  Revenue and the Gross Margin were both a little better than we had expected. 

Full disclosure: Long NVDA at time of writing.

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