Intel thread
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A Solid Third Quarter for Intel
By Phil Weiss (TMF Grape)
TOWACO, NJ (Oct. 13, 1999) -- Judging by the
initial reaction in after-hours trading, the sky must
have been falling on Intel (Nasdaq: INTC) after it
released earnings last night. After all, our Rule
Making company had the nerve to miss the
published earnings estimates of the Wise by two
cents. Even worse, it missed the so-called
whisper number by a nickel. Look out below.
Barron's was right -- Intel is overvalued. Better sell
your shares now and ask questions later.
If you approach the market with a short-term
perspective, you might have had thoughts like
those after reading Intel's earnings release.
However, as an Intel investor with a Rule Maker
approach, I'm quite content with this quarter's
results. Intel's strong financial statements confirm
that the business is still intact. Like here in Rule
Maker Land, the Drip Portfolio -- in last night's Drip
Report -- also took a positive long-term
perspective on Intel's earnings.
Even under the microscope of our Rule Maker
Ranker spreadsheet (linked at bottom), it's hard to
find fault with Intel's quarter. Fellow Fool TMF Tribe
-- who must have the fastest spreadsheets in the
West -- cranked Intel's results through the Ranker
before I had a chance to do it myself. Intel posted
its highest score to date, an impressive 54 out of
61, which places it in the elite top tier of all Rule
Makers. To see how the scoring stacked up,
check out Intel's RM ranking. (By the way, our RM
Master List now includes the rankings of nearly
100 companies. That list is posted monthly, and is
available via a permanent link that resides below
messages on the Rule Maker Companies board.)
What I'd like to do next is take you through the
numbers for a firsthand look at how Intel's
business fared during the quarter. Per the usual,
we'll look at the five financial criteria that we
consider most important to Rule Maker investors.
My comments will be based upon both the
material found in the press release as well as
Intel's earnings conference call (linked at bottom).
Sales Growth of at Least 10% -- Unfortunately, Intel fell a little bit short of this
guideline. In absolute terms, sales grew by 9% over the same quarter a year
ago. If you exclude the impact of the two most significant acquisitions that
closed during the quarter (Dialogic and Level One), sales grew only 7%. Even
so, sales growth was stronger than Intel had predicted during its second quarter
conference call. The one disappointment here was that although Q3 sales
volume reached record levels, there was a further decline in the average selling
price (ASP) of its products. The rate of price decline was slower than in
previous quarters, but it still had an impact on revenues. This is the most likely
reason that revenues fell about 3% short of the expectations of the Wise.
There were a couple of reasons given for the decline in ASP. One was that
Intel gained additional share in the value PC section of the processor market by
selling more Celeron chips. Additionally, there were some delays in ramping up
its 0.18 micron processors. This had a negative impact on Intel's ability to make
and sell high-end processors. There were also some glitches related to a flaw in
its Xeon chips. All of these occurrences are disappointing but not unexpected in
an environment where a company is regularly cannibalizing its product line by
introducing new and improved products. Eventually, these changes will have a
positive impact on Intel's gross margins.
On a geographic basis, demand in all regions and business segments
remained strong. In the Asia Pacific region, China and Korea saw increased
demand, while Taiwan was strong as well. In Europe, Intel benefited from a
stabilization of PC prices and a strong retail market. Pentium III processors
represented 50% of retail sales for all of Europe. Japan was the only region in
which third quarter sales were less than those in the second quarter. However, it
is believed that Internet-related PC demand should lead to improvement in
Japan. The Americas are on track for seasonal second-half growth as well.
One of the most interesting things that I learned on the call was some additional
detail about Intel's revenue recognition policy. As you may know, Intel often sells
products through distributors. I was quite happy to learn that Intel does not
recognize revenues related to these products until the distributors ship them to
the end user. This conservative way of recognizing sales is music to this Fool's
ears.
Gross Margins of at Least 50% -- Intel's gross margins for the quarter rang in at
59%, which was essentially flat with the prior quarter's results. However, it was
up strongly from the 53% figure in the third quarter of 1998. During the conference
call, Intel said that it expected gross margins to increase by about two
percentage points during the fourth quarter. Interestingly enough, as happened
one other time in the past, Intel's gross margins for the quarter were also hurt by
the fact that its 0.18 micron manufacturing process is more efficient than
expected. This means that its cost of goods sold is lower, which places a lower
carrying value on the inventory found on its balance sheet. The good news is
that when the products are sold in the future, Intel will realize more profit on their
sale. Hence, the expected uptick in margins in the future.
Net Margins Greater Than 7% -- Intel reported a robust net margin of 26%,
which is essentially flat when compared to last quarter, but an impressive
six-percentage-point improvement over the third quarter of last year.
Cash-to-Debt Ratio of at Least 1.5 -- Intel now has nearly $12 billion of cash
and equivalents, and only a little more than $1 billion in short- and long-term
debt. That gives it a cash-to-debt ratio of over 11, which is a solid result and a
slight increase over the year-ago figure. Quite simply, Intel's business continues
to throw off significant cash.
Flow Ratio of Less Than 1.25 -- Intel continues to show improvement in this
area as its flowie fell to 0.97. That's down from 1.19 year ago and 1.18 last
quarter. A look at the balance sheet tells us this improvement was achieved
through improved collection of accounts receivable, which was down 4% from
the same quarter a year ago. Days sales outstanding (DSO) declined from 52
days to 45. Another positive was that inventory increased only 3% from a year
ago. During the call, Intel did say that it would like to see its inventory level
increase a little from where it presently stands. All told, however, the declining
flow ratio tells us that Intel's working capital management is getting ever more
efficient. That means more cash in the bank -- and we love that.
Intel also offered some news that relates to one of the more subjective Rule
Maker criteria -- expanding possibilities. Intel's next generation chips are still on
schedule for release in the second half of 2000. According to Paul Otellini,
executive vice president of the Architecture Business Group, Intel is pleased
with its first Itanium (formerly code-named Merced) silicon. Itanium is currently
being sampled by original equipment manufacturers (OEMs) on Win64, IBM
Monterrey, Linux, and HP Unix systems.
In addition, Intel is pleased with the launch of Intel Online Services, which offers
Web hosting. So far, two facilities are open and Intel is signing up customers at
an impressive pace. The early success of this business has exceeded Intel's
expectations.
Finally, there were some comments during the call related to Taiwan and the
recent earthquake there. While chipset supplies are in tight demand, all of Intel's
Taiwan suppliers are meeting commitments for product. There has been some
increase in DRAM prices and graphics chips, but Intel is not yet sure of the
cause for these increases.
For investors focusing on the long term, I don't see anything that's particularly
troubling about the quarter's results. This also marks the third straight quarter in
which Intel's results have exceeded those of the same quarter a year ago. The
financial statements indicate that Intel is running its business even more
efficiently. Meanwhile, the most meaningful competitor, Advanced Micro
Devices (NYSE: AMD), is sinking in red ink.
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