Intel in the Groove

Before Intel (Nasdaq: INTC) released its third-quarter results last week, the company's stock price had fallen more than 50% on the heels of an earnings warning. Since the release, Intel is up more than 15%.

As long-term investors, we don't get excited about the day-to-day fluctuations of a company's stock price, but this time I think the numbers have meaning. If we look at things from a Rule Maker perspective, we gain insight into why Intel's stock price moved up after the earnings release.

Here's a table showing the results (all numbers in millions):

                      Q3     Q3
                     '00    '99  Change
Sales               8,731  7,328   19%
Cost of Sales       3,148  3,026    4%
Gross Margin        63.9%  58.7%    9%
Operating Income    2,857  2,056   39%
Tax @31.8%            909    654   39%
Net Income          1,948  1,402   39%
Net Margin          22.3%  19.1%   17%
Flow Ratio           0.92   0.97   -5%
Cash-to-Debt Ratio  14.81  11.35   30%

As an Intel shareholder that likes to use our Rule Maker metrics to gauge performance, I find absolutely nothing to complain about when looking at those numbers. They're all solid in terms of location and direction.

I removed the impact of the investment gains realized by Intel Capital for the quarter. To do this, I applied the 31.8% effective tax rate provided in Intel's earnings press release to its operating income. Note that we won't be able to calculate Intel's Cash King Margin until its 10-Q is released in November.

Intel's financial statements have improved significantly year-over-year. That's exactly what we want to see when we check in on our investments. More importantly, as Brian Lund pointed out in this story last week, Intel still looks a lot stronger than rival Advanced Micro Devices (NYSE: AMD).

Of course, this doesn't necessarily mean that Intel is running like a well-oiled machine. There were certainly issues that led Intel to preannounce a revenue shortfall. As discussed repeatedly during its conference call, a slowdown in European sales forced the warning.

What happened? When Intel released its Q2 earnings, management believed Q3 European sales would grow 20-25%, the kind of growth we usually see in the fourth quarter. It was on-track to meet this goal through the first part of September, and then sales slowed down. Unfortunately, Intel didn't provide much in the way of an explanation as to why this happened, so it's left up to the investor to put the pieces together.

The explanation I've seen bandied about (and one Intel mentioned, too) is devaluation of the euro and its related effects. For example, some Europeans picketed local gas stations due to the high price of fuel. How does this impact Intel? The cost of PCs has increased.

In addition, there hasn't been much reason of late for Intel's primary customers (corporations) to upgrade existing computers, and AMD has had a few customer wins in the consumer segment of the European market. Put it all together, and it adds up to a slowdown.

The question that needs asking is whether the slowdown is a sign of things to come or an isolated event? Intel's actions say it's an isolated event, since it continues investing heavily in the future. Let's take a look at where some of this investment is focused:

• Intel's plans to invest in new chip fabrication plants (fabs) show no signs of slowing down;
  
  
• Intel is trying to bring on capacity as fast as possible to enable it to build more premium products. It now has six fabs utilizing 0.18-micron manufacturing technology up and running. A seventh is expected to come online in the fourth quarter, and an eighth in the first quarter of next year;
  
  
• Intel's Pentium IV processor, which will ultimately replace the Pentium III, will launch in the fourth quarter. Hundreds of thousands of chips should ship this quarter. Intel expects that, starting in the first quarter of next year, it will ramp faster than the Pentium II.

Intel's third quarter produced record revenues. Let's also take a look at what's behind those sales:

• Record sales of flash memory chips
  
  
• Record sales of Fast Ethernet and Gigabit Ethernet products
  
  
• Record sales of network communication products (expected to grow by more than 50% over last year's results)
  
  
• Record sales of motherboards

Also, microprocessor sales were flat with the second-quarter results. All regions of the world performed well, but the problems in Europe held down the overall number.

Intel also stated on the conference call that it intends to gain market share in the fourth quarter. With AMD's recent success, it will be interesting to see whether it is able to achieve this. However, its financial strength certainly gives it a leg up on AMD.

Phil Weiss, TMF Grape on the Discussion Boards