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Income, Stocks  | February 18, 2019

After the bell on Thursday, shares of chip company Nvidia (NVDA) rallied strongly after the company reported fiscal fourth-quarter results. While it appears that the market sees this report as not being as bad as it could have been given prior warnings, the stock already has surged a bit from its recent lows. After looking at the numbers announced, I just do not see why the Street is so positive currently.

Fourth-quarter revenues of $2.21 billion were about as expected, but remember that this was only because the company issued terrible guidance a few months ago and then issued a massive warning a few weeks ago. This was a drop of more than 24% for the top line over the prior-year period, hurt by the cryptocurrency bubble from late 2017/early 2018. Having a number of high revenue growth quarters in a row sent the bar much higher, and now things are certainly coming off the peak.

There seemed to be a lot of optimism because the company crushed expectations on the bottom line. However, we really need to examine why that actually happened. First, go back to the company's warning and take a look at the guidance provided. In the end, non-GAAP gross margins were as expected, while GAAP gross margins were below the midpoint. Operating expenses and other income items were mostly in line. So why the major beat? Take a look at the image below taken from the earnings release.

So the company guided to a 8% midpoint tax rate, but it reported a GAAP tax benefit of $243 million on just $324 million of pre-tax income! Thus, roughly three-sevenths of the GAAP profit was from a tax benefit, not due to the company beating on margins or coming in lower than expected on operating expenses. Had the company's GAAP tax rate met guidance, earnings per share would have been roughly $0.48, or about half of the $0.92 that was reported. Thus, the bottom line beat comes with a major asterisk, in my opinion.

Another reason why investors seem to be sending shares higher in the after-hours is that guidance for the full year was for flat to "slightly down" revenues. Since the Street was expecting perhaps a 3-5% decline, this guidance would seem to be positive. However, management just proved in recent months that it didn't know how bad things truly were, so I'm not sure how we can be confident in a full-year forecast at this point.

In fact, guidance for the current quarter was a bit worse than expected. Revenues are expected to come in at $2.20 billion, plus or minus 2%, but the Street was looking for $2.32 billion, so this is a bit weak yet again. In fact, if we compare this to last year's value of $3.21 billion, it means that the company is guiding for a revenue decline of roughly 34%. Take a look at how growth has quickly evaporated for the name.

One item that continues to worry me is the company's inventory. I mentioned a quarter ago that I was worried about the rise from just under $800 million at the end of the previous fiscal year to more than $1.4 billion at the end of fiscal Q3, detailed in this 10-Q filing. Despite management giving a much weaker forecast for Q4 originally than expected, it didn't do much to improve the inventory situation. Thanks to the sales shortfall, inventories finished Q4 at $1.575 billion, a sequential rise of $158 million. Just think about this in terms of Q1 guidance:

  • Last year the company guided to $2.9 billion of revenues for Q1 while starting at less than $800 million in inventories.
  • This year the guidance is for $2.2 billion while starting the period with almost $1.58 billion in inventory, nearly double.

It's going to take a while to get inventory levels back down to more normal levels, which worries me when it comes to meeting sales targets moving forward. Should the China trade war not come to a positive resolution very soon, you are likely going to see a lot of discounts to clear this inventory, and that will certainly impact margins. Full-year guidance may eventually be cut in this scenario, and remember that the only reason why the forecast isn't as bad is because the Q4 comp is down 24% for the top line. When we get to the point where revenues are plunging by 25-30% or more in a quarter, it makes the future bar much easier to hurdle.

Nvidia's shares are up more than $11 in the after-hours session, but I think that's a bit of a stretch. The Q4 results weren't great, considering weak original guidance and a massive warning, with the earnings beat only thanks to a massive tax benefit. Guidance for Q1 was not impressive, and a continuation of the inventory build worries me moving forward. In the end, I'd be hesitant to rush in currently and buy shares that are now up more than 33% from their recent low. Let's get another quarter in the books and some China trade war progress and then see if things are starting to improve.


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