A quick accounting, answers, and some points to note:
You may wish to read the last section on quick accounting.
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Michael Potter Thanks for the email. I did not work in Columbia. I worked through Allied as a subcontractor for McDonald Douglas on MD11 comm. systems. That division was disected and absorbed by various parts and none of my coleagues are there anymore. Still nice to hear from you.
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Joe C, you said:
Sun Tzu, Totally opposed to your suggestion about TDFX management getting involved in the Chat Rooms. These forums are for people to discuss their opinions, facts, fiction, fanatasy etc. Management's responsibility to their stockholders should be handled more rofesionally and formally through public statements, interviews and the like
Ok, perhaps a chat room presence is not such a good idea. This is why I discuss things here instead of calling the company at any thought. What did you think of the rest of the ideas?
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Jeff Lins, you said:
On the All Games Network, which runs a streamed video "TV show" about gaming, Tony Tomasi, who works for TDFX, stated that TDFX "should ship its 5Millionth chip this quarter" (not an exact quote). This was in June, Q2. Doing some quick math, this would have resulted in a bout 2M chips shipped in Q2. This would have blown away earnings, and even the .80 estimate. The fact that a TDFX rep. said this, coupled with the fact that TDFX's estimate of 15-20% growth prediction held little weight based on past history, made eighty cents look reasonable to many. Unfortunately, TDFX did not correct this error until very near July 15th. Tomasi meant Q3... I was quite upset and found this error to be inexcusable. TDFX is usually quite tight lipped about any kind of numbers, so when they go on the record I, and many others, give it credibility. Not happy...BTW, whats with "a more reasonable assumption would have been that the previous quarter would eaten away some of the Q2 sales"??? In which quarter will sales NOT eat into the following quarters sales?
Jeff I did not hear Tomasi's remarks because I mainly focus on official press releases (perhaps I should not), but even if I had, I still would have checked with the commpany before making any bets. Even so, let's go through the numbers. We are Monday quarterbacking here but the excersize is still useful.
(1) In the Q1 conference call the company indicated that ASP (average selling prices for all units combined) was ~$42. This combined with the revenue of $50M for the quarter, meant that about 1.2M units were shipped during Q1, which seems to be consistent with what we know of fiscal '97 (see below).
(2) There was a press release on May 5 (http://biz.yahoo.com/prnews/980505/ca_3dfx_pl_1.html) which said there will be 4 million units shipped by the end of May (total V1, VR, and V2 for 97+98) and that there was 1.5M units shipped during '97.
From these two items we can conclude that in April and May of 98 there would have been a total of 1.3 Million units of V1, VR, and V2 shipped. Extrapolating this into June (always dangerous but let us indulge ourselves), there should have been a total of 1.95M (say 2M) units shipped for the quarter. This would make the toal units shipped overall to be 4.7 Million units (2+1.2+1.5) Which is somewhat less than the 5 million number, but obviously Tony was telling us that things are little better than our expectations and that they will ship 2.3M units instead (which did not happen, but we'll get to that later)
From the Q1 conference call (check the transcript at the Fool) we know that ASPs will be falling because 3Dfx will drop V1 prices to ~$22 from the then ~$30something, say $35. This is a 37% drop and and V1 made 55% of the revenue in Q1 (V2 made 35%, VR 10%) so it would be too enthusiastic to assume the ASP will not be significantly affected (as it turns out, V2 demand was so strong that it made up for the bulk of the ASP stabilization, but you could not have been sure of that ahead of time). So let's say the ASP would drop by 12% ie less than a third of the 37% drop in V1 prices (keep in mind that V1 and V2 are competing products in some segments of the market so as the price of V1 drops, it takes market share from V2) and we get ASP of $38 (I believe the ASP is now around $39~40 again due to stronger than expected mix of V2)
From all this we can conclude that the revenue for Q2 should have been around $87M, if Tomasi's comments were on the mark, which we should have checked with the company as it was not an official press release.
So how much earnings could we have expected from this optimistic revenue forecast? Well, the company reported 43.5 cents per share operating income on 15M shares for revenues of 50M. So keeping all things the same, the best estimate for earnings would have been (87/50 *43.5) = 75.7 cents and *not* 80 cents. But wait there's more :D
All things were not the same for Q2 and Q1. To begin with there was 17.5M shares outstanding instead of 15M, ~16.5% more. So we should reduce those expected earnings by ~17% to get 62.8 cents per share. On top of that, the Q1 conference told us that the gross margins will be falling from their then current 51%. And that the tax rate will be rising from 20% to 28% (so the net margins will be falling even faster than the gross margins by a few percentage points) we can add all this up to be good for say a 5% deterioration and we get an expectation of 59.7 cents per share under the best circumstances, and not 80 cents.
This has of course been a quick back of the envelope calculation that you could do in 10 minutes. Every engineer knows that if you design your system (or in this case you earnings expectations) for perfection, then you are headed for disaster and disappointment. So you should always allow a margin of safety and error. In other words, the 60 cent estimate under the best case was not very realistic.
As for my other comment on V2 sales in Q1 eating the sales in Q2, of course that did not happen, but how would you have known that ahead of time? V2 was a brand new product and as much as you may like the look of your games on it, the size of that market and the acceptance of the product should have been a subject of debate in your mind. If you come to expect perfection, then you set yourself up of disappointment. If you moderate your expectations and still see that the stock is worth it (as TDFX defenitly would have been) then you stand a fair chance of being happily surprised. This is also why you should try to moderate the expectations of your fellow share holders, so that the will not dump their shares because the company did not beat the estimates by 67%.
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While we are on the topic of earnings, note the following:
(1) 3Dfx's margins and ASP will be falling slightly in this and next quarter.
(2) The tax rate will increase from Q2 of 28% to Q3 & Q4 of 32% and will continue to increase until it reaches 35%
(3) The number of shares that was used to calculate Q2 earnings was less than expected, in part due to the falling stock price which meant some of the employee options were out of money and were excluded from the calculations. Once the stock price moves up, so will the average number of shares outstanding. What is also likely is that the company will drop the strike price of those options so as to keep its engineers happy. So the number of shares will go up regardless.
(4) I was on the trading floor of one of my clients (read major Wall St. firm) and checked IBES on TDFX. The IBES estimates for 9/98 is $0.47 and for 12/98 is $0.50 which I think is too low but is worth noting. I also noticed that during the past 4 weeks one analyst has raised his 9/98 estimates but almost all analysts (including the one who raised his 9/98 est.) have dropped their estimates for 12/98 by 1 to 4 cents per share. This is not as bad as you may think as the valuations are still cheap.
(5) for those who think TDFX is not on the radar screen, I counted no less than 6 analysts following the firm.
Regards,
Sun Tzu |
