24 July 2007

PEP: Financial Analysis through June 2007

We have analyzed PepsiCo's (PEP) financial statements, as reported in a 10-Q filed with the SEC, for the quarter that ended on 16 June 2007. The relatively minor changes between the formal financial statements and those in the preliminary press release didn't change the analysis results, nor our gauge scores.

PepsiCo is a leading global purveyor of beverages and snacks. The company is known for good management, steady growth, significant international exposure, and the defensive characteristics of the food and beverage industries. While famously locked in a battle with Coca-Cola for the soft-drink market, PepsiCo's snack food business results in a more diversified company. In the North American markets, the Frito-Lay division takes in more revenue and contributes more to operating profit than the Pepsi Bottling division.

When we analyzed PepsiCo after the March quarter, the Overall score was a good (for this company) 39 points. Of the four individual gauges that fed into this composite result, Growth was the strongest at a powerful 23 points. The important Value gauge was weakest at 5 points. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]

Now, with the available data from the June 2007 quarter, our gauges display the following scores:

Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations.


($M)
June 2007
(actual)
 June 2007
(predicted)
 June 2006
(actual)
Revenue
9607
 9323
8714
Op expenses




CGS (4342)
 (4196)
(3862)

SG&A (3295)
 (3356)
(3016)

Amortization (11)
 (52)
 (36)
Operating Income
1959 1719
1800
Other income




Equity income
 173
 133
161

Interest, etc.
 (15) (20)
(33)
Pretax income
2117 1832
 1928
Income tax
(560)
 (513)
 (553)
Net Income
1557 1319
1375


0.94/sh
 0.79/sh
0.81/sh






Revenue was 3 percent above our estimate. However, this overstates the revenue "surprise." We expected Revenue in the recently concluded quarter to be 8.4 percent greater than in the year-earlier quarter. However, the company restated the year-earlier revenue from $8.599 billion to $8.714 billion. If we had assumed 8.4 percent growth over $8.714 billion, our prediction would have been $9.446 billion. Actual revenues beat this recalculated prediction by 1.7 percent.

In addition, we thought the Cost of Goods Sold (CGS) would be 45 percent of Revenue, and the actual value was 45.2 percent. Sales, General, and Administrative (SG&A) expenses were 34.3 percent of Revenue, compared to our forecast of 36 percent.

The net effect of the higher Revenue, lower SG&A expenses, and $40 million less amortization expense was Operating Income 14 percent above the forecast value.

Non-operating income was $45 million greater than expected. The Income Tax Rate was 26.5 percent, instead of the predicted 28 percent. As a result, Net Income exceeded our prediction by 18 percent!


Cash Management. This gauge increased from 8 points in March to 13 points.

The measures that helped the gauge were:
  • LTD/Equity = 20.5%, up from 16.7 percent a year ago, but quite manageable
  • Finished Goods/Inventory = 44 percent, down from 49 percent last quarter
  • Cash Conversion Cycle Time (CCCT) = -46 days; we're not sure what to make of a negative value for this measure of efficiency, but it has to be good.
  • Debt/CFO = 0.6 years, an insignificant level that compares to 0.4 and 0.7 years 3 and 12 months ago, respectively.
The measures that hurt the gauge were:
The Inventory increase (something we watch closely) would worry us, except that increases in the June quarter are the norm. The reduction in the percentage of inventory that is product ready for sale confirms this view. Output was not piling up unsold.

Growth. This gauge decreased from 23 points in March to 20 points.

The measures that helped the gauge were:
  • Revenue/Assets = 114 percent, up from 107 percent in a year; sales efficiency is improving
  • Net Income growth = 38 percent (!), up from -3 percent in a year
  • CFO growth = 20 percent, up from -10 percent in a year
Net income benefited greatly from a drop in the income tax rate from 35.5 to 18.5 percent.

The measures that hurt the gauge were:

Profitability. This gauge held steady at 13 points from March to June.

The measures that helped the gauge were:
  • ROIC = 30 percent, up from 22 percent in a year
  • FCF/Equity = 27 percent, up from 22 percent in a year
The measures that hurt the gauge were:
The increasing Accrual Ratio tells us that less of the company's Net Income is due to CFO, and, therefore, more is due to changes in non-operational Balance Sheet accruals.


Value. PepsiCo's stock price inched up over the quarter from $63.56 to $64.85. The Value gauge, based on the latter price, matched last quarter's 5 points three months ago.

The measures that helped the gauge were:
The measures that hurt the gauge were:
  • Price/Revenue ratio = 3.0, about the same as the five-year median of 3.1.
The average P/E for the Non-alcoholic Beverages industry is currently a more expensive 22. The average Price/Revenue for the industry is currently 3.7.


Now at a solid 42 out of 100 possible points, the Overall gauge has been steadily increasing.

We've noticed a strange anomaly with our gauge scores for PepsiCo. The figures never get very high and, therefore, make the company appear weak. However, the scores over a seven-year period (28 quarters) actually correlated well (corr. coefficient = 0.65) with future stock price gains. In other words, rising scores have presaged price increases; the gauges just don't seem to rise very high. The Overall Gauge peaked at 43 points in September 2002, when the stock price was in the mid $30s. Shares sold in the mid $40s a year later, and you know the rest of the story.
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21 July 2007

BUD: Looking forward to 2Q results

Anheuser-Busch (BUD) will report second quarter earnings on 25 July. Our calculations after the first quarter resulted in gauge scores that fell below the previous levels that were already weak. We saw high debt, growing inventory, tepid revenue growth, declining cash flow, and valuation measures more typical of a faster growing company. And, yet, there is speculation the company is a possible takeover target. Our only explanation for the bullish view held by others is the increasing proportion of revenue from non-U.S. operations -- Rest of World (ROW).

After the first quarter, the company provided financial guidance for the remainder of 2007. One worrisome item was the expectation that revenue per barrel of beer would increase by less than the cost of producing each barrel. This suggests that Gross Margin will remain under pressure. On the other hand, there was the good news that Equity Income would increase by more than 20 percent.

More recently, the company announced that it "is on track to meet its 2007 earnings-per-share growth target of 7 percent to 10 percent, but ... second-quarter profit would come in below Wall Street's current projections."

Revenue projections were not included in either of these announcements. Year-over-year Revenue growth has recently been about 4 percent, after a year or so of much weaker growth. Given the aforementioned guidance, we're going to look for second quarter Revenue of $4.52 billion. This figure is 6 percent greater than the Revenue in the comparable year-earlier quarter, and it translates into year-over-year Revenue growth of 4 percent.

We're assuming the Gross Margin will be about 36 percent of Revenue because of the company's guidance. Thus, the Cost of Goods Sold (CGS) should be about 64 percent of $4.52 billion, or $2.9 billion.

Sales, General, and Administrative (SG&A) expenses have been around 17.5 percent of Revenue, which would work out to be $790 million in the second quarter. This could prove to be an underestimate, since the company indicated that marketing costs would be stepped up.

These figures would result in Operating Income of $836 million in the quarter.

Given the optimistic guidance about Equity Income, we expect this value to be a little over $200 million. If we assume a Net Interest expense of $110 million, pre-tax income will be $930 million. (Strictly speaking, the equity income shouldn't be included in this figure since it is net-of-tax.)

With normal Income Tax Rates applying, we can assume $288 million in income tax. This would leave us with Net Income of $642 million ($0.83 per share).


($M)
2Q-2007
(predicted)
2Q-2006
(actual)
Revenue
4518 4256
Op expenses



CGS (2892) (2601)

SG&A (791) (714)

Other 0 0
Operating Income
836 881
Other income



Equity income 204 170

Interest, etc. (110) (-117)
Pretax income
930 935
Income tax
(288) (297)
Net Income
642 638


0.83/sh 0.82/sh




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17 July 2007

INTC: Financial Analysis through June 2007

We have analyzed Intel's (INTC) preliminary financial results for the quarter ending on 30 June 2007. Our evaluation will be updated after the company formally submits a 10-Q report to the SEC. The company's report includes a reasonably complete Income Statement and Balance Sheet, but only limited Cash Flow information. Most notably, Net Cash from Operations (CFO) isn't indicated and has to be estimated from other data.

Intel (INTC) manufactures integrated circuits for computers, servers, handheld devices, and communication products.

After a year in which Intel was the worst performer in the Dow Jones Industrial Average, the stock price started a significant recovery in April 2007. Outpacing the broader market, investors decided that rosier times were ahead for Intel. Favorable reviews given to Intel's newest products led to predictions that Intel will regain market share from steadfast competitor Advanced Micro Devices (AMD).

When we analyzed Intel after the first quarter, the Overall score was a dismal 18 points, indicating we saw no premonitions of the subsequent turnaround. Of the four individual gauges that fed into this composite result, Cash Management was the strongest at 7 points. Growth was weakest at zero points. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]

Now, with the available data from the June 2007 quarter, our gauges display the following scores:

Before we examine each gauge, let's compare the actual Income Statement to our expectations.


($M)
2Q-2007
(actual)
 2Q-2007
(predicted)
 2Q-2006
(actual)
Revenue
8680
 8500
 8009
Op expenses




CGS (4605)
 (4250)
 (3838)

R&D (1353)
 (1360)
 (1496)

SG&A (1284)
 (1360)
 (1593)

Other (88)
 (84)
 (10)
Operating Income
1350
 1446
 1072
Other income




Investments
 (1)
 20
 37

Interest, etc.
 180
 207
 144
Pretax income
1529
 1672
 1253
Income tax
(251)
 (518)
 (368)
Net Income
1278
 1154
 885


0.22/sh
 0.20/sh
 0.15/sh






Revenue was 2 percent were higher than we expected, and 8 percent higher than the June 2007 quarter. We thought the Cost of Goods Sold (CGS) would be 50 percent of Revenue, and the actual value was 53 percent. In other words, the Gross Margin was 3 percent less than expected, mostly likely due to competitive pressures keeping prices in check. Research and Development (R&D) expenses were 15.6 percent of Revenue, a shade less than our 16 percent estimate. Sales, General, and Administrative (SG&A) expenses were 14.8 percent of Revenue, more than a point better than our forecast.

The higher CGS outweighed the better-than-expected Revenue, and the good control over R&D and SG&A expenses, resulting in lower-than-forecast Operating Income.

Non-operating income was $48 million less than expected. However, the Income Tax Rate was only 16.4 percent. Intel had predicted 31 percent. They now say that second quarter results benefited by $0.03/share for tax items, and they expect a tax rate going forward of 29 percent.

The low tax rate was the only reason that Net Income beat our prediction.


Cash Management. This gauge increased from 7 points in March to 10 points.

The measures that helped the gauge were:

The measures that hurt the gauge were:

Taken together, the two inventory ratios hint at sales problems, despite the higher revenue figures.


Growth. This gauge increased from 0 points in March to 3 points.

The measures that helped the gauge were:
  • Net Income growth = -15 percent, awful but better than recent quarters, driven by tax rate

The measures that hurt the gauge were:

We're not sure about CFO growth since the latest figure wasn't reported. For what it's worth, we would guess that CFO was down about 4 percent year over; not good, but a much more decline than recent experience.


Profitability. This gauge increased from 5 points in March to 9 points.

The measures that helped the gauge were:
  • FCF/Equity = 16 percent, depends on our estimate for current quarter
  • Accrual Ratio = -1 percent, down from +2 percent

The decreasing Accrual Ratio tells us that more of the company's Net Income is due to cash flow, and, therefore, less is due to changes in non-operational Balance Sheet accruals. This needs to be confirmed.

The measures that hurt the gauge were:

The big factor in the increase in operating expenses was the decrease in Gross Margin.


Value. Intel's stock price rose over the course of the quarter from $19.13 to $23.74. The Value gauge, based on the latter price, dropped to a weak 1 point, compared to 4 and 15 points three and twelve months ago, respectively.

There was no good news in the measures for this gauge.

The average P/E for the Semiconductor industry is a more expensive 28. The average Price/Sales for the industry is 5.2.


Now at a disappointing 21 out of 100 possible points, the Overall gauge stirred ever so slightly.
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15 July 2007

COP: Looking ahead to 2Q Results

Shares of energy behemoth ConocoPhillips (COP) have been surging. In the second quarter, the price per share rose from $68.35 to $78.50, but the upward move didn't stop there. The shares recently closed above $90, a gain of more than $11.50 in two weeks.

Billionaire extraordinaire Warren Buffett must be smiling. Berkshire Hathaway owns about 18 million shares of Conoco.

The gain occurred despite the company's disagreement with the Venezuelan government, which will cause Conoco to record "a complete impairment of its entire interest in its oil projects in Venezuela of approximately $4.5 billion, before- and after-tax, in its second-quarter financial results." While a $4.5 billion write-off for a company with $173 billion in assets is not a cause for panic, its failure to have a negative impact on the stock prices says something about the momentum in energy sector.

Of course, $70/barrel of oil didn't hurt. A new $15 billion program to repurchase company stock through 2008 also helped the stock.

Conoco's initial guidance for the second quarter indicated that maintenance and asset disposals would cut production. No estimates of revenue and income were given. In an update earlier this month, Conoco provided numerous details about business conditions but, again, revenue and income data were lacking. Given this murky guidance, the situation in Venezuela, and the fact that quarterly revenue peaked in December 2005 at $51 billion, we were tempted to forecast second quarter revenue at, or below, the first quarter's $41 billion. However, we have to believe that surging oil prices will have some positive effect on revenues. We're just not sure how much of an effect.

We turned to Yahoo Finance to see the estimates of professional analysts, but we left disappointed since exactly one analyst had the nerve to predict Conoco's revenue for the second quarter. This intrepid soul forecast the revenue at $61.64 billion, which seems incredible even with the current price of oil. Can revenues for a gargantuan company rise 50 percent in one quarter? We'll believe it when we see it.

Instead, we're going to set a more modest $45 billion target, without a whole lot of conviction, for second quarter revenues.

Conoco's Gross Margin has edged up over the last couple of years from about 25 percent of revenue to just over 30 percent. Since the company indicated that worldwide refining and marketing margins would be significantly higher in the second quarter than the first, we will assume a 33 percent gross margin in the second quarter. In other words, we're guessing the cost of goods sold will be 67 percent of $45 billion or $30.15 billion.

We'll also assume, based on historic data, a depreciation expense of 4.5 percent of revenue, or $2.025 billion. Similarly, we'll estimate SG&A expenses at 11 percent of revenue, or just under $5 billion. Per company guidance, we need to throw in another $270 million for exploration expenses. We'll assume $100 million for non-recurring operating charges, although this is probably where we will see the $4.5 billion Venezuela impairment charge. Let's take that elephant off the table for the moment.

These figures would result in an operating income of $7.5 billion.

We then need to consider non-operating income and expenses, such as equity in the earnings of affiliates, minority interests, and interest. Our normal extrapolations of historical data would suggest an estimate of $900 million net non-operating income. However, we're going to round that up to $1 billion because of the industry's current profitability. This pushes our estimate of pre-tax income to $8.5 billion

Conoco's effective income tax rate is generally between 42 and 46 percent, so we'll split the difference and assume 44 percent for the second quarter. With this assumption, the tax bill would be $3.74 billion.

Our estimate for net income is, therefore, $4.76 billion ($2.87 per share). Note that the Venezuelan charge would essentially wipe this out.

Since we have little confidence in the $45 billion revenue estimate, we ran the numbers again with $40 and $50 billion for this figure. With all the same assumptions described above, net income ranges between $4.27 billion ($2.58/share) to $5.25 billion ($3.17 per share).


($M)
2Q-2007
(predicted)
2Q-2006
(actual)
Revenue
45000
 47149
Op expenses



CGS (30150)
 (32142)

Depreciation
 (2025)
 (1965)

Exploration (270)
 (134)

SG&A (4950)
 (5031)

Other
 (100)
 (141)
Op income
7505
 7736
Other income



Equity income
 1000
 1143

Interest, etc.
 0
 (197)
Pretax income
8505
 8682
Income tax
(3742) (3496)
Net income
4763
 5186


2.87/sh
 3.09/sh




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11 July 2007

PEP: Looking Forward to 2Q Results

PepsiCo (PEP) will report second-quarter earnings on 24 July. Our assessment of PepsiCo after the first quarter was generally positive, but we also raised two cautionary flags. We pointed out that gains in net income were inflated by a favorable tax settlement, which lowered last year's effective tax rate. Second, we were concerned that financial data reporting changes (involving international operations) were skewing then-and-now comparisons.

By most accounts, PepsiCo is one of the better managed companies in the country. Their shares have been advancing steadily for almost three years, from below $50 to almost $70 before falling back a few points. The company has also paid a dividend of about 2 percent. We've noticed a strange anomaly with our gauge scores for PepsiCo. The figures never get very high and make the company appear weak. However, the scores over a seven-year period (28 quarters) actually correlate well (corr. coefficient = 0.65) with future stock price gains. In other words, rising scores have presaged price increases; the gauges just don't seem to rise very high. The overall gauge peaked at 43 points in September 2002, when the stock price was in the mid $30s. Shares sold in the mid $40s a year later, and you know the rest of the story.

As usual, prior to the release of another quarter's earnings, we want to establish expectations to which we can compare the new results.

We start with information published by the company itself. In February, PepsiCo provided guidance for 2007 indicating "the Company expects mid-single-digit volume and net revenue growth, with revenue growth outpacing volume growth." With this in mind, we're looking for second-quarter revenues of $9.3 billion. This figure would equate to 7 percent year-over-year revenue growth and an 8 percent increase over the June 2006 quarter.

The gross margin for PepsiCo always seems to be about 55 percent of revenue, so we're comfortable estimating the cost of goods sold at $4.2 billion. Similarly, SG&A expenses are usually right around 36 percent of revenue, so our assumption for these costs in the second quarter is $2.6 billion. We'll also assume a flat $52 million charge for amortization of intangible assets.

Bottler equity income is usually more significant. Unfortunately, we don't see any particular quarter-to-quarter pattern in the results. Therefore, we have simply chosen the 10-quarter average of $133 million for our estimate of this income in the second quarter. Similarly, a $20 million charge for net interest expenses seems reasonable given recent history.

The income tax rate presents another complication. The company indicated that tax rate volatility will continue, but they are assuming that the average for year will be 27.7 percent. Since the rate in the first quarter came in somewhat below this target, we will assume 28 percent for the second quarter, or $513 million.

Rolling up these estimates, we're looking for net income of $1.319 billion ($0.79) for the quarter. As you can see, we're not looking for much more that a flat quarter. However, we have to note that our net income prediction is much less than the estimates of professional analysts. The difference might be the result of our tendency to be conservative with our numbers. However, the magnitude of the difference is surprising because PepsiCo's operating expenses are fairly constant as a percentage of revenue, and we have some guidance from the company concerning the revenue. Amortization expenses and bottler equity income are the values of which we are most unsure. We used historic averages for these figures, but, perhaps, the professional analysts have better information at their disposal.


($M)
2Q-2007
(predicted)
2Q-2006
(actual)
Revenue
9323
 8599
Op expenses



CGS 4196
 3809

SG&A 3356
 2992

Amortization 52
 36
Op income
1719
 1762
Other income



Equity income
 133
 176

Interest, etc.
 -20
 -33
Pretax income
1832
 1905
Income tax
513
 547
Net income
1319
 1358


0.79/sh
 0.80/sh




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08 July 2007

TDW: Looking Back and Ahead

On July 26, Tidewater (TDW) will announce its results for the quarter that ended on 30 June 2007, which was officially the first quarter of the company's fiscal 2008.

GCFR first discussed Tidewater on 26 November 2006, which was the weekend of the Thanksgiving holiday. Little did we know then how thankful Tidewater would make us. Analyzing the results from the quarter that ended the previous September, our Overall Gauge score clocked a superlative 73 points for Tidewater. The stock price was then $52.80, which was up almost 20 percent in less than two months. We thought the shares were still cheap, but we fretted that the big move had been missed. In January, when the results from the December quarter became available, we found that Tidewater's gauge scores had defied gravity and had gone up another notch while the stock price had fallen below $50. There was no reason not to act at that point. Actually, there was one very big reason. Out of nowhere, an influential analyst issued a sell recommendation, which caused Tidewater stock to drop from $46.50 to $43.78. Buyers that day are the most thankful of all since Tidewater stock closed last Friday at $73.90 per share.

When we analyzed Tidewater after the March 2007 quarter, the company racked up another set of very good scores, although down from their peak values. The Overall gauge read a robust 66 points; it would have been 61 points if calculated according to our updated methodology. No matter, the bottom line is that Tidewater did a better job at keeping costs under control than we had hoped.

Now what? Have the shares outpaced the growth in profits and cash flow, or, despite their meteoric rise, does Tidewater stock still hold great value?

The pace of growth has already started to slow, which is perfectly natural given that the earlier increases were built on a much smaller base. Also, there are practical ceilings on how fast new ships can be deployed, how much lease rates can rise, and how close the utilization rate can get to 100 percent.

Revenue started to surge at Tidewater in late 2004, after a couple years of flat (or declining) performance. The growth peak was in June 2006, when quarterly revenues were 40 percent greater than the year-earlier period. By comparison, revenues in March 2007 quarter (the most recent one for which data is available) were 19 percent higher than in March 2006.

Our task is to make sure that the growth rates and profitability measures don't slow too much too fast, in comparison to the stock price. And, our gauges will help us keep score.

We will pore over the soon-to-be-released June 2007 results to gauge the latest corporate performance. To give us a basis for comparison, as we do for many of the companies analyzed in GCFR, we are predicting what the earnings will look like if the company stays on track. When the actual results become available, it will be easy to see the ways in which the company's performance surpassed or lagged expectations.

Because the June 2006 quarter was so superlative, we will view revenue growth in the latest quarter of 14-15 percent as good. Our prediction for the June 2007 quarter is $309 million, compared to $270 million in the earlier period.

Tidewater's gross margin has been increasing steadily, from about 35 percent to almost 55 percent of revenue. No slippage has yet been seen, so we're optimistically assuming 54 percent for the June quarter. Given our revenue estimate, we're looking for a cost of goods sold of $142 million.

Depreciation has been about 11 percent of revenue in recent quarters. So, our forecast for this expense is $34 million. Similarly, if trends continue, SG&A expense should be about 9 percent of revenue. This equates to $28 million.

As a result, operating income of $105 million seems attainable. If we guess an additional $10 million in income from asset sales and interest, and a 21 percent income tax rate, our estimate for net income become $91 million.


($M)
2Q-2007
(predicted)
2Q-2006
(actual)
Revenue
309
 270
Op expenses



CGS 142
 130

Depreciation 34
 28

SG&A 28
 24
Op income
105
 89
Other income



Asset sales
 5
 3

Interest, etc.
 5
 4
Pretax income
115
 95
Income tax
24
 24
Net income
91
 71


1.62/sh
 1.23/sh




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07 July 2007

MSFT: Looking Ahead to 2Q Results

In the first quarter of this calendar year, Microsoft (MSFT) launched the consumer version of its Vista operating system. This event resulted in quarterly revenues surging 32 percent over the value attained in the period ending March 2006. Quarterly net income increased an impressive 65 percent, although the increase was a tepid 3 percent when assessed on a year-over-year basis, which is our usual practice.

Our Overall Gauge for Microsoft bounced up after the first quarter results. We reported the score to be a solid, but unspectacular, 48 points at the time. With our latest tweaks to gauges, the score would have been a slightly more encouraging 51 points.

Microsoft shares, after years of stagnant performance, moved up nicely in anticipation of the release and a massive stock buyback. The shares retreated somewhat after Steve Ballmer threw cold water on the most optimistic expectations, but the shares were subsequently carried back up toward their January highs when the overall market rallied.

More recently, when the company announced that they would set aside $1 billion to repair faulty Xbox games, the shares fell a dramatic -- scratch that -- the shares fell a minuscule $0.02. Tuppence. What does that say?

Microsoft will announce on 19 July their results for the quarter and fiscal year that ended on 30 June 2007. We're looking forward to this announcement because the results could make the shares look quite attractive. When the previous quarter's results were published, Microsoft provided guidance that revenues in the June quarter would be between $13.1 and 13.4 billion. We were surprised to see them guide revenue estimates so much below the $14.4 billion of revenue amassed in the March quarter. Evidently, the new product launch leads to a spike in sales that quickly ebbs. Perhaps, this is a low bar for the company to get over?

On the assumption that Microsoft knows their business better than we do, we'll assume $13.3 billion of revenue in the quarter that ended on 30 June.

Microsoft's Gross Margin is typically 80+ percent (!). If we set the target at 82 percent, the cost of goods sold in the recent quarter were $2.4 billion. R&D expenses are usually around 15 percent of revenue, but we're going to assume one percentage point less, or 14 percent, given where they are in the product release cycle. Therefore, we see R&D expenses of around $1.86 billion. SG&A expenses were probably around 30 percent of revenue, or $4.0 billion, if the historic pattern remained valid. These assumptions place operating expenses at about the same level as last year, which might be somewhat optimistic.

If we ignore the special charge due to the faulty Xbox's, the estimates above would translate into an operating income of about $5.05 billion.

The reduction in Microsoft's cash hoard due to share repurchases undoubtedly cut into interest income, but this might have been partially compensated for rising interest rates. For convenience, we'll assume net interest income was $400 million.

We'll also assume an income tax rate of 31 percent, which leads to a net income value of $3.763 billion ($0.38/share), less the special charges. Net income was $2.83 billion in the year-earlier quarter.



($M)
2Q-2007
(predicted)		2Q-2006
(actual)
Revenue
1330011804
Op expenses



CGS23942130

R&D18621861

SG&A39903932

Other?0
Op income
50543881
Other income



Investments00

Interest, etc.400377
Pretax income
54544258
Income tax
16911430
Net income
37632828


0.38/sh0.28/sh




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04 July 2007

NOK: Looking Ahead to 2Q Results

We saw some good in Nokia's financial results for the first quarter of 2007. However, a more substantial increase in the stock price had driven the Value gauge down to a single point, which depressed the Overall gauge score into the mid-30's. We concluded at the time that Nokia should be put aside until a market correction made the valuation more appealing.

That was a mistake. During the second quarter, Nokia ADR's shot up from $22.92 to $28.11. As was the case for Intel, which we discussed a few days ago, the market perceived that business conditions at Nokia had passed through an inflection point this Spring, and rosier times were ahead. The company stoked these feelings with an announcement that its share of the mobile phone market was increasing. Alas, our gauges can't detect these inflections until after they are visible in the financial statements. However, once this has occurred, we can measure the extent of the break from historical precedent and assess whether the stock price fairly reflects the new circumstances.

In early August, Nokia will report its second quarter results. Revenue projections are difficult because their quarter-to-quarter revenue pattern has been somewhat erratic, and they don't issue any revenue guidance. We're leaning towards €11.29 billion, which would be 15 percent higher than the year-earlier quarter. It would also equate to 13 percent year-over-year revenue growth. Analysts are expecting the second quarter revenue figure to be $16.64 billion (€12.2 billion).

Tougher competition has been steadily eating at Nokia's gross margin for the last several years. We're assuming improving market conditions will cause the figure to bounce back, but we don't see more than a slight improvement because the company seems to be emphasizing market share over profitability. Our estimate is, therefore, 34 percent. Matching this with our revenue projection, we're looking at a cost of goods sold of €7.451 billion.

R&D and SG&A expenses have each been about 10 percent of revenue recently, and we will assume these percentages hold true in the second quarter. Therefore, we're estimating them at €1.129 billion each in the second quarter. If we assume another €10 million in miscellaneous operating charges, the estimate for operating income turns out to be €1.571 billion.

Investment and interest income/expenses are tough to predict, but the figures are not especially material for Nokia. For the record, we're assuming 55 million net non-operating income. If we subtract €406 million for income taxes, assuming an effective 25 percent tax rate, the prediction for net income is €1.219 billion (€0.30/share).


(€M)
2Q-2007
(predicted)
 2Q-2006
(actual)
Revenue
11290
 9813
Op expenses



CGS 7451
 6573

R&D 1129
 981

SG&A 1129 1019

Other 10
 (262)
Op income
1571
 1502
Other income



Investments
 (14)
 (16)

Interest, etc.
 69
 55
Pretax income
1626
 1541
Income tax
406
 401
Net income
1219
 1140


0.30/sh
 0.28/sh




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01 July 2007

INTC: Looking Ahead to 2Q Results

When we last looked at INTC, after the end of the first quarter, we didn't see many reasons for optimism. Revenue, Net Income, and CFO had all declined on a year-over-year basis. ROIC was down substantially, and operating expenses were up.

Yet, in a move we certainly didn't anticipate, Intel's stock price shot up 24 percent in the second quarter from $19.13 to $23.74. Since the broader market only advanced 5.8 percent over this period, investors were clearly anticipating rosier time ahead for Intel. The improved stock performance might be due favorable reviews given to Intel's newest products and predictions that Intel will regain market share from steadfast competitor Advanced Micro Devices (AMD).

Revenue in each of the last five quarters was less than the revenue in the year-earlier quarter. However, the steepness of the declines has been softening. At this point, we're comfortable believing the revenue trend will reverse with a modest quarter-over-quarter increase. Intel, in their Business Outlook for the second quarter, indicated that they expect revenue to be between $8.2 to $8.8 billion. The midpoint, $8.5 billion, would equate to a 6-percent gain over the year-earlier quarter. Year-over-year revenues would still be down 4 percent. The $8.5 billion figure would represent 24 percent of revenues in the last year, which approximates Intel's average for second quarters. Professional analysts have also centered their aim on or about the midpoint value; their revenue predictions average $8.52 billion, with the estimates varying between $8.34 and $8.64 billion.

In the face of intense competition, Intel's gross margin has dropped from percentages in the high 50's to an even 50 percent. Intel signaled that the gross margin in the second quarter would be 48 percent, plus or minus a couple of percentage points. On this score, we decided to give them the benefit of the doubt and assume the gross margin would hit the nice round number of 50 percent. Given our revenue prediction, this would equate to a cost of goods sold of $4.25 billion.

Extrapolating from the recent past, we're assuming R&D and SG&A expenses will each be about 16 percent of revenue, or $1.36 billion for each expense. If we make provisions for an additional $84 million of operating charges, which is the average value for the last 10 quarters, the estimated Operating Income turns out to be $1.446 billion.

If we use historic averages for gains on investment, net interest, and other income, we get a predicted level of Income before Taxes of $1.672 billion.

Effective income tax rates don't normally change dramatically from quarter to quarter, but the resolution of a dispute with the IRS allowed Intel to reverse $300 million of previously accrued taxes. This caused the first quarter tax rate to plunge below 13 percent. For the tax rate in the second quarter, we'll use a more normal 31 percent, which is what Intel itself estimated.

With all these assumptions, Net income in the second would be $1.154 billion ($0.20/share), up from 885 million in the year-earlier quarter. Analysts are assuming $0.19.


($M)

2Q-2007
(predicted)
2Q-2006
(actual)
Revenue

8500
8009
Op expenses




CGS4250
3838

R&D1360
1496

SG&A1360
1593

Other84
10
Op income

1446
1072
Other income




Investments
20
37

Interest, etc.
207
144
Pretax income

1672
1253
Income tax

518
368
Net income

1154
885


0.20/sh
0.15/sh




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