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Nvidia - 8 Points to Ponder

This article was originally published on Twitter

I’m gratified by the response I received on my previous thread highlighting Nvidia’s (NVDA) accounting tricks and buyback shenanigans.

Q3 was more of the same. Let's get into it.

Rather than re-hashing the previous arguments, which the bulls will willfully ignore and the skeptics already know, I’ll leave you with 8 points to ponder.

(1) If demand is so strong the product is flying off the shelves, why is the company unable to collect cash from customers?

Over the last 10 quarters, revenue has increased by $12.46 billion while accounts receivable has increased by $5.28 billion. 42.4% of the incremental revenue has not (yet) translated into actual cash received from customers.

Said differently, credit to customers equals 42 days of sales in the most recent quarter.

Why such generous credit terms at a time of peak demand?

License and development arrangements, cloud services, and support revenues are received upfront and booked over the contract term.

The company does not provide revenue split by product and services, but it’s safe to assume days sales outstanding would be higher considering only product sales.

(2) Revenue concentration

28% of last quarter revenue and 27% of last 9 months revenue is attributable to two end customers.

39% of Q2 revenue and 32% of first half revenue came from just two customers, of which one is a distributor.

(3) Excessive Inventory

The company has high inventory levels.

And has committed to more purchases. Off-balance sheet purchase obligations have grown at a faster pace than revenue.

The company ended the last quarter with $21.54 billion in off-balance sheet obligations.

These consist of

  1. inventory purchase and long-term supply and capacity obligations, and

  2. non-inventory obligations including cloud services, primarily for R&D purposes.

Backing out the non-inventory commitments, the company has sufficient current inventory and purchase commitments to satisfy 4.65 quarters worth of demand at last quarter’s revenue run rate. This inventory build-up is striking when considering the company took a $2.17 billion inventory impairment charge just last year!

The purchase commitments indicate that NVDA has visibility into several quarters’ worth of future demand. Yet, they do not provide guidance beyond the immediate quarter.

Do they deliberately withhold revenue guidance, or are they ordering inventory with no actual visibility into future demand? Either explanation is suspect.

(4) China demand has been pulled forward.

Tencent says it has enough Nvidia chips to last several generations. Are they the only Chinese customer to have foreseen the chip ban?

Last quarter, Nvidia had to break out sales to Singapore as a separate line item.

Sales to Singapore customers accounted for 15% of revenue. This is widely seen as a proxy for China sales.

With sanctions in place, this source of demand is no more.

(5) Every Nvidia customer is a competitor for subsequent quarterly sales.

Unlike an iPhone or a car, Nvidia’s customers are not buying the GPUs for personal consumption (except for “gaming” which is a misnomer).

The GPUs remain in use for 3-5 years. After Nvidia has booked the sale, end customers can:

  1. Buy the chips outright via product resellers,

  2. Lease the use of these chips from data centers,

  3. Obtain the services of these chips indirectly through cloud service providers.

Also, chips which were erstwhile used for Ethereum mining are now trying to find a new home. Ethereum transitioned to proof-of-stake in September 2022, making this use case redundant.

There is a finite limit to how much NVDA can grow sales even if end demand continues to grow.

While bulls like to say Nvidia has pricing power due to current high demand, this is not true. Higher prices will bring about higher supply from current holders of Nvidia’s products.

The company's 74% gross margin is not sustainable.

(6) Nvidia’s current business is not resilient to an economic downturn.

Nvidia estimates its products cater to 30,000 global customers, of which half are start-ups. When they run out of seed funding, Nvidia's data center customers will lose revenue and demand will collapse.

When the growth stops, the inventory write-downs will start. Nvidia will also need to write down accounts receivable if its immediate customers face declining demand and go bankrupt.

Nvidia has sold at least $2.3 billion worth of chips to a customer (CoreWeave) who purchased it using a credit line. It is rumored that the customer (in which Nvidia owns an equity stake that remains undisclosed in their quarterly filings) has subsequently engaged in a sale and leaseback transaction with Nvidia.

While it is unclear to what extent Nvidia will be unable to convert receivables into cash in a downturn, this possibility exists.

(7) The curious case of the missing taxes

In the Q2 filing, NVDA said the company will be paying $3.81 billion in deferred income taxes in Q3. According to the Q3 cash flow statement, actual deferred taxes paid amounted to $530 million. Was this part of the $3.81 billion?

Deferred tax assets on the balance sheet grew by $584 million during the quarter. Was this $530 million payment part of that growth?

The footnotes provide no explanation for this curiosity.

The supplemental cash flow information shows that the company paid $4.35 billion in income taxes in Q3, but a cash walk-through from Q2 to Q3 fails to turn up that number.

(8) Inventory Accounting

The company charges provisions on inventory and inventory write-offs (non-cash expenses), and cash paid to settle off-balance sheet obligations (actual cash expenses), against cost of goods sold. This has the effect of hiding impairment charges and write-offs in both the P&L statement and the cash flow statement.

It is also misleading because the company is paying cash to decrease a hidden, off the books contractual obligation while providing no context for evaluating the company’s remaining obligations. If demand sinks, there is no way to know how much cash Nvidia will need to pay out to contract manufacturers when they cancel orders. With $21.54 billion in contingent liabilities, this could become a huge problem down the line.

And if you thought CoreWeave was the only self-dealing, here's an even more bizarre one. Nvidia is round tripping revenue with zero disclosure.

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