<THE RULE MAKER PORTFOLIO>
Perspective on Intel Earnings
By Phil Weiss (TMF Grape)
TOWACO, NJ (July 15, 1999) -- One of the biggest advantages to investing in Rule Makers is that whenever we want we can tend to the most important things in our lives. We don't have to watch the daily price movements of our investments or keep up with the latest news like hawks. Best of all, this even applies when earnings are released. This means that in true Rule Maker form, I'm willing to bet that I'm one of the last people to write about Intel's (Nasdaq: INTC) second quarter earnings release of Tuesday night.
You see, while I could have been working on this column on Tuesday for publication last night, I chose to play with my two-year old son and watch the best part of this year's baseball All-Star game with him. I gave some thought to reporting on Intel's earnings yesterday, but the more important things in my life, like spending time with my family, matter more. Intel's business is certainly stable enough to wait a day.
The highlight for me the other night was watching the introduction of players from the "team of the century." I'm a big Yankees fan and my son is already following in my footsteps in that area, as anything baseball is Yankees to him. My first real memory of baseball was the 1970 World Series in which Brooks Robinson of the Orioles was a vacuum cleaner at third base robbing many of the Reds (particularly Lee May) of hits.
As a kid, my appetite for anything sports, particularly baseball, was insatiable. All the players that I saw introduced on Tuesday night I have either watched or read about. The top moment of the night for me was seeing Ted Williams come out on the field to throw out the first pitch. The way all the players fawned all over him was special. The fact that I watched this while my son sat in my lap eating a peach that I had cut up for him clinched the deal. As for the game of baseball, it may do many things wrong, but the way it did the pre-game show Tuesday night was absolutely perfect.
After my son was off to sleep, and I'd watched a little of the game, I finally checked in on Intel's earnings. I also decided to listen in to the conference call replay. The call lasted 51 minutes, but for this long-tem investor, all I needed to hear was covered in the first 15 minutes when Intel's CFO, Andy Bryant, and Paul Otellini, Executive Vice President and General Manager, Intel Architecture Business Group, spoke. I have to say that I was pleasantly surprised by the optimism that they expressed for Intel for the rest of the year.
I was pretty amazed by the lack of depth that could be found in the questions of the Wise during the Q&A session. Not one question that I recall was directed towards anything beyond the next two quarters. I didn't hear one question related to Intel's server farms, something that I would like to learn more about as I have read both positive and negative commentary about that endeavor.
The majority of the analysts' questions related to number of units sold, the average selling price of chips, the product mix and the like. It was actually refreshing to me that Intel did not provide any specifics with regards to questions on these subjects -- no matter how many different ways the Wise tried to ask them. A lot of time was also spent going over Intel's "other income," which fell $10 million short of earlier guidance and was guided a bit lower still next quarter. These Wise guys should really know that it's hard to precisely estimate what kind of return you're going to get from securities that you buy, sell or hold, and that's what makes up at least part of the assets that generates this "other income" for Intel.
There were even multiple questions related to the $400 million appearing in the "all other" category that's discussed in the last sentence of the earnings press release. If you're interested, it related primarily to intercompany accounting issues.
In the Tuesday and Wednesday Drip reports, Jeff Fischer did a great job of summarizing the important information in the earnings release and call, so I'll skip over that part and look at how Intel performed from a Rule Maker perspective.
In last week's Back to Basics series (Parts 1, 2, 3, 4) on Rule Maker Essentials, Matt went through the basic criteria that we look for in our Rule Maker companies. I'll spend the rest of tonight's report looking at Intel in that context.
1. Dominant Brand -- Intel's biggest business is in microprocessors. It has over 80% of the microprocessor market, and it's been taking back some of the share that it recently lost to Advanced Micro Devices (NYSE: AMD). Enough said.
2. Repeat Purchase Business -- In the short-term, the answer to this one is "no." Although I use my PC just about every day, I don't buy a new one as frequently as I buy something like a bottle of Diet Coke.
4. Expanding possibilities -- Intel's next generation chips that use 64-bit architecture are being prepared for sampling later this quarter. These chips, beginning with the Merced model, will enhance Intel's ability to compete in the server market, where higher average selling prices (ASPs) lead to higher gross and net margins. Guidance from Intel is that research & development expense will be 20% higher than it was last year. That R&D is helping the company to expand into new product lines (such as networking-related gear) and make continual improvements in the efficiency its manufacturing process. To me, these are all good indicators of continued future success for this Rule Maker.
5. Your familiarity and interest -- I use Intel's products nearly every day. When it comes to new technology, I'm usually what's considered an early adopter, so it's enjoyable for me to keep up with Intel's latest developments and learn about what its future may hold.
The next five steps take us through the numbers. By the way, you can download an Excel spreadsheet of Intel's quarterly financials by clicking this link. If you're unfamiliar with any of these terms, just refer to the links below.
6. Sales growth (our standard: 10% or more on a comparable quarter basis) -- Last year's Q2 sales were $5,927 million. This quarter, they were $6,746, which is an increase of 14%.
7. Gross Margins (our standard: 50% or more) -- This quarter, gross margins rang in at 59%, which is the same as the first quarter of this year and a 10-point improvement over the same quarter last year. Especially impressive was the fact that gross margins were the same as last quarter even though ASPs came down. This is attributable to the success of cost cutting efforts and the increased efficiency of the manufacturing process.
8. Net Margins (our standard: at least 7%) -- Intel comes in with a robust 26%, which is a 6-point improvement over the second quarter of 1998.
9. Cash-to-Debt (our standard: 1.5 or greater) -- Intel has $10,609 million of cash & equivalents, $135 million of short-term debt and $666 million of long-term debt. That gives it a ratio of over 13, which is a solid result.
10. Flow Ratio (our standard: 1.25 or less) -- Intel just makes it under the wire on this one, as its Flowie is 1.18. While this is an improvement over last year's Q2 showing of 1.41, it is an increase from the first quarter Flowie of 0.97. We'd like to see this metric come down some, but it's certainly not a bad score.
For a Rule Maker investor, I don't see anything that's not to like about this quarter. The company fares well under our investment criteria both locationally and directionally. Both quarters this year have represented solid improvements over the same two quarters last year. Intel is running its business more efficiently, and it is most definitely the dominant player in its primary business. Fellow Fool TMF Tribe ran Intel through our Rule Maker Ranker spreadsheet and got a Top Tier score for this quarter's results.
That's all for me tonight. Rob will be here tomorrow to talk about Coca-Cola's (NYSE: KO) earnings report that came out earlier today. The beverage giant reported profits in-line with analysts' estimates (which were reduced several weeks ago), but 21% below year-ago levels due to continued global economic woes. We'll have more tomorrow.
Phil Weiss, Fool
Day Month Year History R-MAKER +0.81% 2.86% 17.00% 48.04% S&P: +0.82% 2.69% 15.25% 42.51% NASDAQ: +0.76% 5.72% 29.49% 71.78% Rule Maker Stocks Rec'd # Security In At Now Change 2/3/98 48 Microsoft 39.13 94.38 141.16% 6/23/98 68 Cisco Syst 29.21 66.56 127.91% 5/1/98 82.5 Gap Inc. 22.91 50.75 121.49% 2/13/98 44 Intel 42.34 67.69 59.88% 2/3/98 66 Pfizer 27.43 37.69 37.38% 5/26/98 18 AmExpress 104.07 134.25 29.00% 2/17/99 16 Yahoo Inc. 126.31 154.44 22.27% 8/21/98 44 Schering-P 47.99 54.06 12.65% 2/6/98 56 T. Rowe Pr 33.67 36.63 8.77% 2/27/98 27 Coca-Cola 69.11 64.00 -7.39% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Exxon 64.34 78.94 22.70% 3/12/98 15 Chevron 83.34 96.94 16.31% 3/12/98 20 Eastman Ko 63.15 72.13 14.22% 3/12/98 17 General Mo 72.41 68.06 -6.00% Rule Maker Stocks Rec'd # Security In At Value Change 2/3/98 48 Microsoft 1878.45 4530.00 $2651.55 6/23/98 68 Cisco Syst 1985.95 4526.25 $2540.30 5/1/98 82.5 Gap Inc. 1890.33 4186.88 $2296.55 2/13/98 44 Intel 1862.83 2978.25 $1115.42 2/3/98 66 Pfizer 1810.58 2487.38 $676.80 5/26/98 18 AmExpress 1873.20 2416.50 $543.30 2/17/99 16 Yahoo Inc. 2020.95 2471.00 $450.05 8/21/98 44 Schering-P 2111.7 2378.75 $267.05 2/6/98 56 T. Rowe Pr 1885.70 2051.00 $165.30 2/27/98 27 Coca-Cola 1865.89 1728.00 -$137.89 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Exxon 1286.70 1578.75 $292.05 3/12/98 15 Chevron 1250.14 1454.06 $203.92 3/12/98 20 Eastman Ko 1262.95 1442.50 $179.55 3/12/98 17 General Mo 1230.89 1157.06 -$73.83 CASH $232.29 TOTAL $35618.67
Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999. Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.