Wednesday, July 15, 1998
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An Investment Opinion
by Dale Wettlaufer

Intel Misses Estimate, Doesn't Disappoint

Intel (Nasdaq: INTC) gained $1 15/16 to $82 5/8 this morning after announcing second quarter earnings after the bell last night. Quarterly revenues stayed roughly flat at $5.93 billion, while operating income dropped to $1.606 billion from $2.34 billion one year ago and $1.78 billion last quarter. As expected, gross margin dropped to 49%, below last quarter's 51% but well within the company's oft-stated historical goal of 50% plus or minus a few points. The market has come to price in that reality after considerable angst over a number of quarters. The upshot of the quarter is that the company came in with a return on beginning invested capital of nearly 28% (annualized) for the quarter, which puts it firmly in the upper echelon of S&P 500 companies in terms of capital productivity.

The margin that investors should focus on is operating margin, anyway. While gross margin tells the tale of production efficiency and pricing, it doesn't tell you all you need to know about keeping the product pipeline going and getting the products to the customer. To that end, research and development at a company like Intel or Microsoft (Nasdaq: MSFT) is a hugely important line item on the income statement. In fact, one might make the case that it should go into cost of goods sold, capitalizing R&D and charging off a pro-rata amount per unit shipped. Without R&D, things would stop within a few years at both of these companies. R&D and some other operating expenses are vital in delivering goods to the customer, which is pretty much what cost of goods sold is supposed to reflect. But without rearranging the income statement regime for these two companies, Intel ran an excellent operating margin for the quarter at 27% of revenues.

Combined with the company's guidance for an increase in revenues for the next half of the year and an increase in gross margin by a couple of points, the forward estimates of $3.11 per share for fiscal 1998 look to be solid. In fact, subject to some tweaking as the third quarter rolls along and the Christmas season comes up, those estimates could be subject to some upside adjustments. In the meantime, Intel proves that you don't need earnings growth to offer value to investors. By some tired old methods, the value of the company would be nil if its earnings weren't growing, which is obviously not the case. The company's excellent return on capital performance in a down quarter shows its staying power and continuing dominance over nags like Advanced Micro Devices (NYSE: AMD). At around 25 times trailing and forward earnings and 9.5 times invested capital, Intel isn't overwhelmingly cheap. But if it continues to put in performances like this in down quarters and rakes in the cash in huge amounts in good quarters, it is not overvalued, the historical valuation numbers be damned. The company continues to be a rock and should put in a good performance through the end of the year.


Photographic film giant Eastman Kodak (NYSE: EK) surged $7 1/4 to $81 after reporting second quarter earnings of $1.51 per share, compared with $1.11 a year ago and crushing estimates of $1.13. However, the company's revenues declined nearly 5% year over year due to the loss of revenue associated with the formation of Kodak Polychrome Graphics, reclassification of certain promotional expenses, and the strong U.S. dollar. Adjusting for these factors, sales fell 1%. Morgan Stanley Dean Witter upgraded its rating on the company to "outperform" from "neutral."

Media conglomerate Time Warner (NYSE: TWX) gained $3 7/16 to $94 11/16 after reporting Q2 EPS of $0.04, an improvement from last year's loss of $0.09 and surprising analysts who had expected a loss of $0.04. The earnings growth was fueled by record quarters at the company's Turner Cable Networks, HBO, Time Warner Cable, Time Inc., and Warner Bros. divisions.

After meeting estimates yesterday, Johnson & Johnson (NYSE: JNJ) added $2 1/16 to $76 5/16 after Merrill Lynch raised its short-term rating on the drug and healthcare products maker to "buy" from "accumulate" and named it a "focus stock" of the week. Merrill kept its long-term "buy" rating on the company.

Telecommunications company WorldCom (Nasdaq: WCOM) climbed another $1 1/4 to $54 following news that merger partner MCI Communications (Nasdaq: MCIC) will sell all of its Internet business to Cable & Wireless (NYSE: CWP), thus moving the companies closer to attaining regulatory approval for their merger. Lehman Brothers reiterated its "buy" rating on WorldCom and MCI, which gained $1 11/16 to $66.

Personal care and tissue maker Kimberly-Clark (NYSE: KMB) gained $2 7/16 to $48 after Paine Webber raised its rating on the company to "buy" from "neutral."

Aluminum titan Alcoa, a.k.a. Aluminum Co. of America (NYSE: AA), rose $2 3/4 to $71 3/8 after Chairman Paul O'Neill told analysts that the company aims to cut costs by $1.1 billion by Jan. 1, 2001. Lehman Brothers upgraded its rating on the company to "buy" from "outperform," while Bear Stearns raised its rating to a "buy" from "attractive."

Remote-access and networking products maker Ascend Communications (Nasdaq: ASND) gained $1 5/8 to $51 3/16 after reporting Q2 EPS of $0.29 compared with a loss of $0.26 in the year-earlier period and beating expectations by a penny. The company said it is "comfortable" with analysts' estimates for the rest of this year and next year. Ascend also dispelled yesterday's rumors that it was in talks to acquire Advanced Fibre Communications (Nasdaq: AFCI), which lost $2 3/4 to $22 11/16.

Independent music company Platinum Entertainment (Nasdaq: PTET) shot up $4 to $11 3/8 after announcing a strategic alliance with Liquid Audio, a developer of secure online music delivery systems. This will allow Platinum to offer its catalog of more than 13,000 songs and select titles from its distributed labels for download from the Internet.

High-speed chip-to-chip interface technology developer Rambus Inc. (Nasdaq: RMBS) jumped $6 9/16 to $65 5/16 after reporting Q3 EPS of $0.07, up from to $0.02 last year and in line with estimates. Earnings were flat sequentially due to the company's previously announced expectation of a seasonal decline in the shipment of Rambus integrated circuits for use in Nintendo 64 video games.

Wireless communications company Nextel Communications (Nasdaq: NXTL) rang up $1 9/16 to $31 5/16 after reporting a Q2 loss of $1.14 (before charges) compared with analysts' mean estimate of a loss of $1.61.

Telecommunications chipset maker DSP Communications (NYSE: DSP) picked up $1 15/16 to $17 1/4 after reporting Q2 EPS of $0.19, up from $0.02 last year and topping the analysts' mean estimate by $0.02. The company said that based on orders received, it expects a "significant" ramp-up in sales of its CDMA and TDMA chipsets in the second half of the year.

Splash Technology (Nasdaq: SPLH) soared $5 7/8 to $24 7/8 after reporting Q2 EPS of $0.34, beating estimates of $0.28. BT Alex. Brown raised its rating on the company to "strong buy" from "buy."


Number two U.S. automaker Ford Motor Co. (NYSE: F) fell $1 13/16 to $58 11/16 after reporting fiscal Q2 EPS of $1.91, or $1.82 excluding gains from the spin-off of its Associates First Capital Corp. (NYSE: AFS) unit. The results beat the First Call mean estimate of $1.81 per share. The company said it cut costs by $900 million in the quarter and by $1.3 billion in the first half of fiscal 1998. However, marketing costs rose in the quarter to 10.9% of revenues from 9.2% of revenues a year ago.

Construction and heavy equipment maker Caterpillar (NYSE: CAT) dropped $2 1/2 to $53 3/4 after reporting fiscal Q2 EPS of $1.20, beating the $1.13 earned last year but short of the Street's estimate of $1.24. The company said weak sales in the Asian region and higher costs overshadowed strong demand for its products from the U.S. market during the period.

The world's largest PC maker Compaq Computer (NYSE: CPQ) lost $1 1/8 to $32 9/16 after reporting second quarter earnings of $0.02 per share (excluding charges), beating expectations of breakeven results but down from $0.30 per share in the year-earlier period. With charges, Compaq lost $2.33 a share. Credit Suisse First Boston started coverage of the company with a "buy" rating.

Appliance maker Whirlpool Corp. (NYSE: WHR) was hung out to dry this morning, falling $5 3/16 to $64 1/8 after reporting fiscal Q2 earnings from continuing operations of $1.05 per share. The results beat last year's $0.81 per share and the Street's estimate of $1.02 per share. Sales were up 25% in the quarter to $2.6 billion, but unfavorable economic conditions in Brazil hurt earnings from Latin America. Full-year shipments in that region are expected to be down 20% from their levels a year ago.

Disk drive maker Seagate Technology (NYSE: SEG) was spun for a $1 1/4 loss to $25 1/4 after reporting fiscal Q4 EPS (before charges) of $0.11 compared to operating EPS of $0.61 a year ago. Revenues slid 25.5% to $1.58 billion in the period.

Transportation and food materials handling equipment maker Gencor Industries (AMEX: GX) lost $3 15/16 to $20 1/2 after saying fiscal Q3 earnings will fall below the $1.27 per share First Call mean estimate due to "severe citrus crop problems" in Brazil and the Asian financial crisis. The company also called off a proposed offering of 3.6 million common shares because "the current stock price is not reflective of the company's true value."

Healthcare management software developer HBO & Co. (Nasdaq: HBOC) slipped $1 13/16 to $30 1/4 after healthcare supplies distributor McKesson Corp. (NYSE: MCK) said it called off discussions with the company regarding a "potential business combination." HBO & Co. said the combo would have been non-dilutive, but offered no further details. McKesson gained $13/16 to $87 7/16.

Phone network constructor and operator Able Telecom Holding Corp. (Nasdaq: ABTE) dropped $1 3/8 to $12 5/8 after announcing yesterday that it is trying to restructure $20 million in financing related to its acquisition of MFS Network Technologies. Last week, the company completed the purchase of MFS from WorldCom (Nasdaq: WCOM).

Cable-based information and Internet services provider Source Media (Nasdaq: SRCM) lost $2 7/16 to $29 13/16 after jumping yesterday on rumors that either America Online (NYSE: AOL) or Microsoft (Nasdaq: MSFT) was close to acquiring the company. The firm said in a press release this morning that it could not explain the recent run-up in its share price.

Outdoor footwear maker Rocky Shoes & Boots (Nasdaq: RCKY) stumbled $2 1/16 to $10 3/4 after saying its fiscal Q2 net sales are seen coming in around $21.4 million, or 3% less than a year ago, due to mild temperatures last winter, which delayed some new orders. The company also said it experienced a $1.7 million reduction in sales to an unspecified private label customer.

Seafood restaurant operator Landry's Seafood Restaurants (Nasdaq: LDRY) tanked $1 1/16 to $14 11/16 after Morgan Stanley Dean Witter downgraded the firm to "neutral" from "outperform."


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Alex Schay (TMF Nexus6), Fool, too
Dale Wettlaufer (TMF Ralegh), Final Fool

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