Do you own shares of NVIDIA (NASDAQ:NVDA)? How about Sony (NYSE:SNE), Nintendo, or Microsoft (NASDAQ:MSFT)? If so, you'll want to tune in to tomorrow's news from NVIDIA rival ATI Technologies (NASDAQ:ATYT). The former will supply graphics chips to Sony's upcoming Playstation 3 gaming console, and the latter has claimed Nintendo's Wii and already services Microsoft's Xbox 360. To fully understand the lay of the game-playing land, you need to watch all the players.

What analysts say:

  • Buy, sell, or waffle? An astonishing 33 analysts follow ATI today, but only one of them thinks you should sell the stock. Nine hedge with hold ratings, and fully 23 think you should buy the stock.
  • Revenues. Analysts will be looking for 25% sales growth in tomorrow's Q3 2006 report. $664.7 million is the target.
  • Earnings. Impressive as that would be, the profits expectation is even higher. Wall Street will be looking for profits to quintuple to $0.15 per share.

What management says:
ATI's 6-K filings with the SEC (the equivalent of a domestic company's 8-Ks) contain a wealth of information about the business, even if management is pretty sparing with sound bite quotes that would help put the information in context.

The most recent filing, dating from March 30, reported pretty miserable results on the PC front (declining revenues and declining margins on those revenues), but much better news in the firm's smaller Consumer Segment, which covers the company's handheld devices, gaming consoles, and digital television segments. In stark contrast to the 2% sales decline in PC products, sales in the Consumer Segment are booming. Unfortunately, these better sales numbers still account for just 20% of ATI's total business.

What management does:
With the bulk of ATI's business in decline, it's not surprising, then, that margins continue to suffer. On a rolling basis, gross margins have declined 700 basis points over the last 18 months, operating margins are fast approaching breakeven (in a bad way), and net margins are firmly in the red.

Margins %

11/04

2/05

5/05

8/05

11/05

2/06

Gross

34.5

34.4

33

30.7

29.2

27.5

Op.

12.9

12.8

10.3

6.1

3.2

1.9

Net

9.7

10.6

9

1.9

(0.7)

(2.1)
All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
ATI's primary problem appears to be the same one highlighted by fellow Fool Nathan Parmelee one year ago: inventories. Simply put, ATI has too much of them and is holding on to them too long -- with the result that they become obsolete and must be written down in value and/or sold at lower price points.

Although we've known for a year that this is a problem at ATI, the company appears to have done little to fix the problem. Through the end of H1 2006, for example, ATI has managed to increase its total revenues by about 3%. Meanwhile, inventories have jumped 15%. This is doing nothing good for ATI's cash flow, either. Although the firm is free-cash-flow positive year to date, the $5 million in free cash flow it generated is a far cry from the $89 million produced in H1 2005.

My Take: If you've got time to examine just one thing in tomorrow's earnings release, make sure it's the inventories. They're the surest predictor of whether ATI is going to be able to get its margins rising again and start earning some respectable profits for its shareholders.

Competitors:

  • Broadcom (NASDAQ:BRCM)
  • Freescale (NYSE:FSL)
  • Motorola (NYSE:MOT)

One year ago, Nathan Parmelee had high hopes that ATI could get back in the game. Has the company lived up to his expectations? Click through and decide for yourself.

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Fool contributor Rich Smith does not own shares of any company named above.