It used to be that you could hear or read about Intel's quarterly earnings call and readily see how they were doing.
Ranked among the hype-meisters of Silicon Valley, Intel was very low on the totem pole. Intel's "spin" was never in the
same leagues as "artful" dodgers John Chambers or the Sun brain trust or Jerry Sanders in his heyday.
Maybe it was because Gordon Moore, and later Andy Grove, were so focused on the long-term that they didn't see the point
in "spinning" something as trivial as quarterly results. Maybe Moore and Grove owned so many options the near-term performance
was less-relevant to them. Maybe it was because Intel consistently did so well for so long in the 80's and 90's they never
developed the knack.
Judging by this week's report, Intel management is taking a crash course in "baffling them with bull..."
CBS Marketwatch reports(*), Intel met expectations but, "cut its full-year gross margin target two percentage points to
60 percent and announced a 15 percent sequential jump in inventory to $3.2 billion."
Followed by, "business could increase in the third quarter more than is typical."
OK, I am not an accountant (as several of you have graciously pointed out) but so far I can understand what's going on.
I don't necessarily believe 3Q04 will roar back, but I understand Intel's statements.
Then it gets a little confusing, "The gross margin reduction is due, Intel said, to better-than-expected manufacturing
efficiencies for its computer chips which have, in turn, resulted in more chips than needed."
That's funny, it sounds like a cousin of what Cisco said in May when they implied inventory accumulation was in anticipation
of stronger sales. Sorry, growth in inventory is growth in inventory.
As Fred Hickey observed a month or two ago, Intel's costs are mostly fixed from quarter-to-quarter. Intel's gross margin
goes up when they build more units and down when they build fewer. Running close to capacity amortizes Intel's nearly-fixed
costs across more parts, improving gross margins. Unsold inventory nominally enjoys the same gross margin improvement --assuming
its value does not decline by the time it is sold!!
If there is anything we could all agree on about the semiconductor business it is probably the idea that unit prices decline
over time. A CPU or flash IC or whatever will sell for a lower price six months from now than what it did yesterday. (Occasional
bouts of allocation notwithstanding.) Intel's "planned obsolescence" with continuous speed improvements or feature enhancements
has built this concept into their business model for over a decade.
Incredibly, Intel blamed the inventory growth not on the lack of a corporate replacement cycle in North America and Europe
or weak IT spending growth or on a slow-down in the laptop business in Taiwan or even on a flattening of cell phone production
in China. Instead they blamed it on "a new generation of computer chip making equipment (which) is manufacturing its chips
at a better rate, or yield, than previously expected."
You have to give them credit. It's the first time I've ever heard that excuse for growing inventory in my 24 years in the
business. What's next? Will Intel blame future inventory increases on improvements in test yields? Or assembly efficiency?
Or faster airplanes?
"If we had realized yields would be as solid as they were in the first half, we could've ramped at a different rate," said
CFO Andy Bryant. Bryant has been crowing about margin expansion for the last three or four quarters. It has been the "story"
used by the touts to push the stock.
The margin reduction is a red herring. A corporation like Intel can charge or not charge so many items as costs of production,
they can, within limits, control the final margin numbers every quarter. Intel realized they would have to works off this
inventory and their sales margins were likely to decrease in the next couple quarters. They very visibly took a little of
the margin-reduction medicine now in hopes of taking our eye of the inventory growth.
Bryant was followed by CEO-in-waiting Paul Otellini who, "noted the reduced gross margin does not mean the company's profitability
will decline. As sales grow, so will Intel's profits." "We are in this business to grow overall profit dollars, not our percent,"
he said. Oh, NOW you tell us...
I don't mean to pick on the article which is dutifully reporting the "spin." However, it goes on to say, "as production
is scaled back from Intel's primary computer chips, Intel will try to use the resulting factory space by producing chipsets,
motherboards and flash memory."
When you stop and think about it, Intel now explicitly plans to build fewer CPUs in their product mix!?! None of their
production "replacements" has anywhere near the margin of the CPU business. Even accepting Intel just accidentally built too
many CPUs, changing to more non-CPU production tells us Intel's margin on production is also going to be lower for awhile
to come.
The article, and presumably the conference call, started out with, "business could increase in the third quarter more than
is typical." Yet later commented, "Inventory reductions will occur through the end of the year, with most of the reductions
occurring in the fourth quarter."
So which is it? Business will pop back up 3Q04? (Is this the same as admitting 2Q04 was soft?) If so, why will it be 4Q04
before the inventory is worked off? Or will there just be a 4Q04 fire sale to blow out the excess by year-end?
The article concluded with, " 'Higher yields are encouraging, but the resulting actions to lower inventory will lower profit
margins in the months ahead,' Bryant said."
This is the best example of double-speak I have seen in a long time. It implies the only reason for the margin decline
is the yield improvement.
Intel's margin declined because they are starting to work off inventory accumulated over the last two or three quarters.
This problem probably has a good chance of getting worse over the next two or three quarters but they're hoping for a sales
rebound or other un-forecasted event to hold their margins up.
Inventory is inventory.
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The above is not intended to be advice to buy or sell any stock, bond or other security. The information cited is taken
from what are believed to be reliable source but the author rejects any responsibility for any errors or misstatements.
