NVDA: Look Ahead to July 2010 Quarterly Results

This post describes our model of NVIDIA's (NASDAQ: NVDA) Income Statement for fiscal 2011's second quarter, which will end on 1 August.

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 $6 billion.  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 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.  NVIDIA GPUs are also installed in computers made by Apple (NASDAQ: AAPL), Hewlett Packard (NYSE: HPQ), Dell (NASDAQ: DELL), and now 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 segment 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) has escalated as the two chip-makers eye each other's markets.  NVIDIA has promoted 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 in the summer of 2010.  The FTC and Intel are now discussing a possible settlement to government accusations that Intel engaged in anti-competitive business practices when facing off against AMD and NVIDIA.

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 eventually decided not to introduce discrete graphics product.

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).  There have been reports that Tegra will be in smartphones by the fourth quarter of 2010.  However, Dow Jones questioned whether Tegra is achieving the success so much desired by NVIDIA.

In fiscal 2011's first quarter, which ended on 2 May 2010, NVIDIA earned $0.23 per diluted share on a GAAP basis, compared to a net loss of $0.37 per share in the year-earlier period.  Non-GAAP results rose from a $0.13 per share loss to a $0.23 per share gain.  The non-GAAP figure for the earlier quarter excludes special charges, after tax, of $132 million ($0.24 per share) related to stock option purchases.


We are now ready to look specifically at the fiscal second quarter.

When NVIDIA reported its first quarter results on 13 May,  it provided the following outlook for the second quarter:

Outlook

The outlook for the second quarter of fiscal 2011 is as follows:

• Revenue is expected to be down seasonally 3 to 5 percent from the first quarter.
• GAAP gross margin is expected to increase to 46 to 47 percent.
• GAAP operating expenses are expected to be flat.
• Tax rate of 12 to 14 percent, assuming a renewal of the U.S. R&D tax credit. Otherwise, tax rate of 14 to 16 percent.

The second-quarter outlook was repeated nearly verbatim during the subsequent conference call with financial analysts.  From the transcript at SeekingAlpha.com:

Our outlook for the second quarter of fiscal 2011: Revenue is expected to be down seasonally, 3% to 5%; GAAP gross margin is expected to increase to 46% to 47%; GAAP operating expenses are expected to be flat; our tax rate of 12% to 14%, assuming a renewal of the U.S. R&D tax credit and otherwise a tax rate of 14% to 16%.

Further information can be found in the presentation [pdf] NVIDIA made to financial analysts on 7 April 2010.

Since NVIDIA stated it expected Revenue to fall between three and five percent from the first quarter's $1.0 billion, they were forecasting Revenue between $950 million and $970 million.  We might have been tempted to go towards, or even above, the high end of the range, but Gartner has just lowered its forecast for worldwide spending on information technology in 2010.   As a result, we have decided to use the mid-range figure of $960 million as our target for NVIDIA's second-quarter Revenue.

This figure is nearly 24 percent greater than Revenue of $777 million in 2009's second quarter.

For the Gross Margin, we will use the 46.5-percent midpoint of the guidance range.  In other words, we expect the Cost of Goods Sold in the quarter to equal (1 - 0.465) * $960 million, or $514 million.

The "flat" guidance for Operating expenses covers Research and Development and Sales, General, and Administrative costs.  For these two items, we are, therefore, expecting second-quarter figures that are about the same as those in the first quarter.

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 $136 million.  Special charges in the year-earlier period led to an operating loss of $110 million.

We are estimating $5 million, net, for Interest and other non-operating income and expenses.  This figure brings pretax income up to $141 million.

As far as we know, the Congress has not 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 second quarter.  This rate would result in a tax provision of $21 million, and Net Income of $120 million (about $0.20 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 at time of writing.