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Looking at Intel's 10-Q
by Al Levit (TMF Early)
GLENDALE, CA (May 19, 1999) -- One year ago today, Rob (TMF Oak) told us about an interesting pronouncement from former Merrill Lynch analyst... ahem, sales associate Tom Kurlak. You might remember that at this time last year, Mr. Kurlak was worried that Intel (Nasdaq: INTC) had gotten too good at making microprocessors. The stock dropped 5% on the news.
The Wise can always find some sort of reason to sell a great company. Meanwhile, Foolish buy-and-hold Intel investors have been rewarded with a 48% return over the past twelve months, as the company has continued to make all of the rules in the PC and server chip business. Is Intel poised to continue its success? Tonight, we're going to dive into the company's recently released 10-Q in search of answers.
Once a quarter, we like to check the progress of our Rule Makers -- and we recommend you do the same with each of your holdings. Oftentimes, we look at the earnings press release that accompanies the earnings announcement, as we did with Monday's look at Gap and yesterday's column on Cisco. Many earnings announcements, however, don't contain the balance sheet information that we focus on here in Rule-Maker land. And even the companies that do include a balance sheet will sometimes only include a "rough draft" version. For example, Yahoo!'s first quarter earnings announcement isn't particularly Ranker-friendly. Sometimes, a Ranker done from an earnings press release is just an educated guess, and you really need the 10-Q detail to do much more.
Some of you may be wondering, "What the heck is this cryptically-named 10-Q, anyway?" The short answer is that public U.S. companies are required to file documents with the Securities and Exchange Commission (SEC) once each quarter that describe that quarter's income, balance sheet, cash flow, and a host of additional information. The document filed at the end of the fiscal year must be audited, and it's called the 10-K (or, sometimes the 10-K 405).
All SEC filings are available for free on the Internet, including sites such as FreeEDGAR and, in fact, right here at the Fool. Here's the link to Intel's 10-Q for the first quarter of this year. You may want to either print out this 10-Q or keep this link handy as you go through this report.
Now let's turn to Intel, itself. When the 10-Q comes out, the first thing I like to do is examine the most recent Ranker and see whether any updating is in order. Now that we have a company rankings list (that's growing ever larger), I was quickly able to find that Intel was recently ranked by TMF Verve (in post 2295) through the first quarter of 1999. Matt was able to take the numbers from Intel's earnings release in April and quickly come up with a Top Tier score of 54. In doing my own Ranker for the quarter, I came up with the same excellent score, putting Intel at the top of the list of Rule Makers.
If you compare my ranking to Matt's, you'll notice that where Intel formerly had two direct competitors, it now has only one. On May 5, National Semiconductor (NYSE: NSM) announced that it was getting out of the microprocessor business. In addition, the remaining competitor, Advanced Micro Devices (NYSE: AMD), released their first quarter 1999 10-Q allowing me to include that information in Intel's Ranker as well.
Moving on to the guts of the 10-Q, the first main section, Item 1, begins by showing the financial statements (i.e., the income statement, balance sheet, and statement of cash flows), and then goes on to include many important notes.
In the cash flow statement, Intel exhibits strong free cash flow that actually exceeds its net income. Operating cash flow of $2.7 billion less $0.7 billion of capital spending gives the chip giant more than $2 billion of free cash that can be used to pay dividends, or preferably, repurchase shares.
Moving on to the financial statement notes, I thought the following were of special importance to Rule-Making investors:
Note 2 -- Dividends: The dividend is being raised by 50%. In general, we would prefer to see companies invest in the business or repurchase shares rather than pay dividends. However, given that Intel has consistently been paying dividends for quite some time, I am pleased that they are sufficiently confident in future earnings to raise dividends in this way.
Note 4 -- Comprehensive income: U.S. companies are now required to report income in two ways. Certain items that traditionally have been amortized or excluded from the reporting must now be included in this second method of income reporting known as "comprehensive income." This note shows that Intel's comprehensive income is higher than traditional income, so that there are no skeletons lurking in the closet if analysts decide that comprehensive income is the item that really counts.
Notes 8 and 9 -- Accounting for acquisitions of Shiva and Level One: Both of these acquisitions are being accounted for under the "purchase method," which is generally a more conservative method than the "pooling method" favored by the vast majority of the companies in the high technology industry. The Financial Accounting Standards Board (FASB) has ruled that companies must stop using the pooling method soon, which is causing a lot a concern (particularly to Rule Maker Cisco). Intel does not seem likely to have such worries.
The bottom line conclusion I got from the review of all these notes was that Intel's accounting is more conservative than currently required, which is very comfortable to me a shareholder.
In addition to the notes, the other important part to the 10-Q is Management's Discussion and Analysis, found in Item 2. This is basically divided into two parts. The first part summarizes what happened in the previous quarter. The longer second part shows management's outlook for the coming quarter and beyond.
Highlights from the first quarter included:
- Net revenues for the quarter were up 18% year-over-year. This increase was primarily due to the increase in sales of microprocessors by the Intel Architecture Business Group.
- Gross margin increased to 59% in Q1 1999 from 54% in Q1 1998. This improvement was primarily a result in the mix of microprocessors and lower unit costs.
- The Company's five largest customers accounted for approximately 43% of net revenues for the first quarter of 1999.
Highlights from the outlook for the coming quarter included:
- Intel expects revenue for the second quarter to be flat-to-slightly down from Q1's revenue of $7.1 billion.
- Gross margin for the second quarter is expected to remain at about the same 59% level as the first quarter. The level for the entire year is expected to be 57% plus or minus a few percentage points.
- Capital spending is expected to decrease to about $3 billion for 1999.
- Spending on research and development, and marketing and general and administrative expenses in the second quarter is expected to be approximately six to ten percent higher than first quarter expenses of $1.6 billion.
- The tax rate of 1999 is expected to be 33%.
- A long section of the Outlook was devoted to the status of Year 2000 (Y2K) testing. Internally, Intel was 99.9% Year 2000 compliant by the end of the first quarter and expected to be finished with all internal testing and deployment by the end of the second quarter of 1999. Naturally, Intel could not be as certain about suppliers as it could be about its own internal systems, but it documented a long extensive procedure it was using to make sure that it was as fully protected as possible from Y2K interruptions caused by its suppliers. Finally, the 10-Q devotes several paragraphs to the support and capabilities of Intel products with respect to these issues.
- Finally, the outlook ends with a standard warning that Intel is the subject to various legal proceedings but that company and their internal counsel do not expect the outcome of these proceedings will have an adverse material effect on the Company's financial position. In the annual report for the fiscal year ending December 31, 1998, this warning includes language about the FTC anti-trust investigation. The FTC language was not part of the warning in Intel's first quarter 1999 10-Q.
Finally, for the latest on Intel's strategy for providing the silicon building blocks in a networked world, check out the replay of today's video webcast of Intel's annual shareholders' meeting (lasts two hours) -- and a public thank you to Intel for making this resource available to the public!
Matt's here tomorrow for a long-needed look at Rule-Maker step-child American Express (NYSE: AXP).
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Day Month Year History R-MAKER +0.55% -3.26% 8.43% 37.20% S&P: +0.82% 0.68% 9.67% 35.66% NASDAQ: +0.74% 1.36% 17.55% 55.93% Rule Maker Stocks Rec'd # Security In At Now Change 2/3/98 48 Microsoft 39.13 79.31 102.67% 6/23/98 34 Cisco Syst 58.41 116.56 99.56% 5/1/98 55 Gap Inc. 34.37 60.69 76.57% 2/13/98 44 Intel 42.34 59.69 40.98% 2/3/98 22 Pfizer 82.30 112.94 37.23% 2/17/99 16 Yahoo Inc. 126.31 158.25 25.29% 5/26/98 18 AmExpress 104.07 124.88 20.00% 2/6/98 56 T. Rowe Pr 33.67 39.38 16.93% 2/27/98 27 Coca-Cola 69.11 68.44 -0.97% 8/21/98 44 Schering-P 47.99 47.50 -1.03% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Exxon 64.34 78.69 22.31% 3/12/98 20 Eastman Ko 63.15 74.44 17.88% 3/12/98 15 Chevron 83.34 92.06 10.46% 3/12/98 17 General Mo 72.41 79.69 10.06% Rule Maker Stocks Rec'd # Security In At Value Change 6/23/98 34 Cisco Syst 1985.95 3963.13 $1977.18 2/3/98 48 Microsoft 1878.45 3807.00 $1928.55 5/1/98 55 Gap Inc. 1890.33 3337.81 $1447.48 2/13/98 44 Intel 1862.83 2626.25 $763.42 2/3/98 22 Pfizer 1810.58 2484.63 $674.05 2/17/99 16 Yahoo Inc. 2020.95 2532.00 $511.05 5/26/98 18 AmExpress 1873.20 2247.75 $374.55 2/6/98 56 T. Rowe Pr 1885.70 2205.00 $319.30 2/27/98 27 Coca-Cola 1865.89 1847.81 -$18.08 8/21/98 44 Schering-P 2111.7 2090.00 -$21.70 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Exxon 1286.70 1573.75 $287.05 3/12/98 20 Eastman Ko 1262.95 1488.75 $225.80 3/12/98 15 Chevron 1250.14 1380.94 $130.80 3/12/98 17 General Mo 1230.89 1354.69 $123.80 CASH $70.09 TOTAL $33009.59
Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and
it adds $2,000 in cash (which is soon invested in stocks) every six months.