FIU ACG 6175 Financial Reporting and Analysis Week 1 – Group Project Chapter Linkage Overview The group project requires you to select a company and write a financial analysis document encompassing five areas of analysis: (1) strategic analysis, (2) accounting analysis, (3) financial analysis, (4) forecasting, and (5) valuation. The course readings and case assignments explore each of these areas. When turning in project components, select one person from your group to turn in all materials. Week 2 Readings—Project Section No. 1 • Chapter 1 in Palepu describes the nature of financial accounting and reporting, and how that information is used in business analysis. The chapter essentially describes the nature and content of this course. • Evaluation of the financial statements of a company is, in many respects, an attempt to discern whether the enterprise is doing the right things the right way, doing the right things the wrong way, or doing the wrong things. It is not possible, therefore, to competently evaluate the financial statements of a company outside of the competitive context that gave rise to them. Thus, the first component of the group project is a strategic analysis of the company’s markets and competition. Chapter 2 in Palepu provides a framework for that strategic analysis. Week 2 Readings—Project Section No. 2 • The next step in evaluating a company is to assess and, if necessary, recast the information in the financial statements. Chapter 3 provides an overview of this exercise and chapter 4 describes specific areas that may be interest to the analyst. Week 5 Readings—Project Section No. 3 • After we have gained an understanding of the company’s strategic opportunities and challenges, and evaluated (and, if necessary, adjusted) the accounting principles employed in creating the financial reports, we need to find some benchmark against which to measure the company’s performance. Financial—or ratio—analysis of the company’s performance in comparison to that of its major competitors yields that measurement. Chapter 5 in Palepu provides a background and methods for conducting this analysis. Week 7 Readings—Project Section No. 4 • Chapter 6 in Palepu provides a basic framework for forecasting corporate performance using financial statements. Week 7 Readings—Project Section No. 5 • Chapters 7 and 8 in Palepu describe how to use forecasts to value corporate entities. Criteria for Company Selection In terms of company selection, you must abide by these five criteria: 1. At least $50 million of pre-tax earnings 2. Consistent earnings power and dividend history 3. Good returns on equity with limited or no debt 4. Management in place 2014 Florida International University Page 1 of 3 FIU ACG 6175 Financial Reporting and Analysis 5. Simple, non-techno-mumbo-jumbo business Organization of Paper The paper should follow the outline shown in the “Grading Criteria” (below). Additional guidelines include: • The Executive Summary should be followed by a Table of Contents that includes page numbers for the referenced sections and subsections. • The discussion (text) should be double spaced. • The font should be reasonably sized (11 – 13 point depending on the type chosen). • References should be inserted in the text or as footnotes (not endnotes). • Tables and figures should be included in the body of the document, generally following the paragraph where they are (first) mentioned. 2014 Florida International University Page 2 of 3 FIU ACG 6175 Financial Reporting and Analysis Grading Criteria % of Grade Executive Summary Overall Recommendation Summary Rational for recommendation 5 Specific considerations Strategy Assessment of SWOT, Societal Expectations & Corporate Culture 10 Accounting Analysis Summary of Key Accounting Policies 10 Accounting Adjustments as necessary Financial Analysis - Multiyear Analysis/Comparisons Multiyear ROE Decomposition - Co. and Major Competitors 20 General Ratio Comparisons to Competitors and Industry Averages Forecasting List of Specific Assumptions used in forecasts 15 Forecasts for a 5 year time horizon Valuation Components of the WACC (with sources referenced) (5 pts) DCF Model - Optimistic, Pessimistic & Expected (2 pts) 10 DAE Model - Optimistic, Pessimistic & Expected (2 pts) DAROE Model - Optimistic, Pessimistic & Expected (1 pts) Assessment of Solvency Calculation of Altman's Z Estimate of Bond Rating based on ratios 10 Actual Bond Rating (if applicable) Conclusions Internal Consistency (recommendation must match analysis) 5 Recommendation (Buy-Sell-Hold) Overall Presentation Thoroughness/Depth of Analysis Sentence Structure, Grammar, Syntax 15 Format and Graphical Presentations 2014 Florida International University Page 3 of 3 Financial  Reporting  and  Analysis  of:     Intel  Corporation     Stock  symbol:  INTC   Listed  on  the:   National  Association  of  Securities  Dealers  Automated  Quotation  (NASDAQ)     Prepared  for:   Dr.  Clark  Wheatley   Florida  International  University     In  partial  fulfillment  of  the  requirements  of  the  course:   ACG6175             Table  of  Contents   Page   Executive  Summary  .....................................................................................................................................  3 Strategic  Analysis  .........................................................................................................................................  4 Company  Overview  ..................................................................................................................................  4 Industry  Analysis  ......................................................................................................................................  5 Competitive  Environment  ........................................................................................................................  7 Competitive  Advantage  .........................................................................................................................  10 SWOT  Analysis  .......................................................................................................................................  11 Values  of  Key  Personnel  ........................................................................................................................  14 Societal  Expectation  ..............................................................................................................................  15 Accounting  Analysis  ...................................................................................................................................  16 Policies  ...................................................................................................................................................  16 Flexibility  ................................................................................................................................................  19 Strategy  ..................................................................................................................................................  22 Disclosure  Quality  ..................................................................................................................................  24 Red  Flags  ................................................................................................................................................  25 Distortions  .............................................................................................................................................  26 Financial  Analysis  .......................................................................................................................................  27 Return  on  Equity  Decomposition  ...........................................................................................................  27 Profitability  ............................................................................................................................................  31 Asset  Management  ................................................................................................................................  34 Liquidity  .................................................................................................................................................  36 Debt  &  Coverage  ....................................................................................................................................  39 Sustainable  Growth  ...............................................................................................................................  42 Forecasting  ................................................................................................................................................  43 Sales  .......................................................................................................................................................  44 Income  ...................................................................................................................................................  45 Balance  Sheet  ........................................................................................................................................  48 Valuation  ...................................................................................................................................................  49 Price  Multiples  .......................................................................................................................................  50 Discounted  Free  Cash  Flow  ....................................................................................................................  51 Discounted  Abnormal  Earnings  .............................................................................................................  53 Discounted  Abnormal  Return  on  Equity  ................................................................................................  54 Earnings  Growth  (Buffet’s  Model)  .........................................................................................................  54 Assessment  Of  Solvency  ............................................................................................................................  56 Calculation  of  Altman  Z-­‐Score  Model  ....................................................................................................  57 Estimate  of  Debt  Rating  .........................................................................................................................  58 Actual  Bond  Rating  ................................................................................................................................  59 Conclusion  .................................................................................................................................................  60     2   Executive  Summary     Based  on  Strategy,  Accounting,  Financial,  Credit  and  Prospective  analysis  of  Intel   Corporation,  it  is  undervalued  at  current  price  levels  and  is  a  BUY.    The  analysis  suggests  Intel's   sustainable  growth  rate  is  12%,  with  an  expected  earnings  per  share  growth  of  35%  over  the   next  10  years  and  year-­‐over-­‐year  value  creation  of  6.5%  to  14.7%.    Finally,  with  85%+  of  the   microprocessor  market,  Intel  is  consumer  monopoly  allowing  it  to  command  a  premium  for  its   products  resulting  in  profit  margins  well  above  industry  norms.     3   Strategic  Analysis   Company  Overview     Intel  Corporation  (Intel)  is  a  multinational  semiconductor  chip  maker  headquartered  in   Santa  Clara,  California.    Founded  by  semiconductor  pioneers  Robert  Noyce  and  Gordon  Moore   and  associated  with  visionary  Andrew  Grove,  Intel  combines  advanced  chip  design  capability   with  state-­‐of-­‐the-­‐art  manufacturing  capability1.    Incorporated  in  1968,  Intel's  core  business  is   designing  and  manufacturing  integrated  digital  technology  platforms  consisting  of   microprocessors  and  chipsets2.    These  platforms  are  used  in  various  computing  applications   including  tablets,  smartphones,  laptops,  desktops,  servers,  automobile  systems,  medical   devices  and  factory  machines.    The  company  also  provides  mobile  components  such  as  WiFi   products,  radio  frequency  transceivers,  Bluetooth  products,  power  management  chips  and   global  navigation  satellite  system  components.    In  addition,  through  various  company   acquisitions,  Intel  offers  network  and  content  security  as  well  as  security  software  products  for   consumer,  mobile,  and  corporate  environments.    Intel  sells  its  products  primarily  to   manufacturers  in  the  computing  and  communications  industries.    Intel  has  over  107,000   employees  and  is  the  largest  publicly  traded  semiconductor  manufacturer  by  revenues  with   sales  of  over  $52  billion  last  year3.    The  following  sections  analyze  the  elements  of  Intel's   success.                                                                                                                           1  en.wikipedia.org/wiki/Intel   2  www.reuters.com/finance/stocks/companyProfile?symbol=INTC.O   3  finance.yahoo.com/q?s=intc     4   Industry  Analysis     In  order  to  understand  the  strategic  avenues  Intel  may  pursue,  one  must  understand   the  context  of  the  semiconductor  industry.    The  number  of  semiconductor  components  used  in   our  daily  lives  is  constantly  expanding.    Chips  form  the  core  of  the  newest  technological  devices   such  as  smartphones  and  tablets.    Semiconductors  are  also  becoming  more  common  in   automotive  and  industrial  markets  as  well  as  consumer  goods  such  as  televisions  and   appliances.    As  a  consequence,  the  semiconductor  industry  has  been  growing  for  over  40  years,   in  spite  of  economic  downturns,  the  bursting  of  the  internet  bubble  and  the  2008–2009   financial  crisis,  with  industry  annual  revenues  of  over  $200  billion4.    As  shown  below,  two   companies  dominate  the  semiconductor  industry5.                                                                                                                             4  www.pwc.com/gx/en/technology/publications/semiconductor-­‐industry-­‐analysis-­‐and-­‐projections.jhtml   5  www.isuppli.com/Semiconductor-­‐Value-­‐Chain/News/Pages/Semiconductor-­‐Sales-­‐Recover-­‐in-­‐2013-­‐;-­‐Micron-­‐ Surges-­‐to-­‐Fourth-­‐Place-­‐in-­‐Global-­‐Chip-­‐Market.aspx     5     It  should  be  noted,  however,  that  the  semiconductor  space  is  very  complex.    The   semiconductor  industry  is  made  up  of  four  main  product  categories:    memory,  microprocessors,   integrated  circuits  and  complex  "Systems  on  a  Chip",  where  a  single  integrated  circuit  chip  has   an  entire  system's  capability  on  it.    Not  all  manufacturers  participate  in  all  categories.    For   example,  with  the  exception  of  Advanced  Micro  Devices  (AMD),  Intel  dominates  the   microprocessor  segment  with  over  85%  of  the  market  share6.     Due  to  fierce  competition  and  new  technologies  that  lower  the  cost  of  producing   semiconductors,  there  is  a  constant  need  for  semiconductor  manufacturers  to  come  up  with   new  and  cheaper  products.    Thus,  the  semiconductor  industry  is  characterized  by  rapid   technological  innovation.    Another  characteristic  of  the  semiconductor  industry  is  the  high   capital  expenditures  needed  to  support  both  growth  and  technological  progress.    Specifically,   the  fixed  costs  and  minimum  scale  associated  with  building  a  new  chip  fabrication  facility  is  in   the  billions7.    Finally,  the  semiconductor  industry  has  been  characterized  as  being  cyclical.    This   occurs  because  semiconductor  manufacturers  face  booms  and  busts  in  semiconductor  demand.     This  cycle  coincides  with  demand  for  various  electronic  devices  such  as  personal  computers  and   smartphones,  which  is  in  synch  with  consumer  spending  patterns.    In  other  words,  when  the   economy  is  good,  semiconductor  manufacturers  generally  produce  at  capacity.    However,  when   the  economy  is  struggling  and  computer  sales  are  slow,  the  semiconductor  manufacturers   struggle  too8.                                                                                                                           6  McGrath,  D.  (2011-­‐08-­‐02).  IDC  cuts  PC  microprocessor  forecast,  EE  Times,  retrieved  from  www.eetimes.com   7  www.valueline.com/Stocks/Industries/Industry_Analysis__Semiconductor.aspx   8  www.investopedia.com/features/industryhandbook/semiconductor.asp     6   Competitive  Environment   In  this  section,  Porter's  Model9  is  used  to  analyze  the  semiconductor  industry.    The     model  is  based  on  five  forces  including  Rivalry  Among  Competition,  Threat  Of  Substitution,   Threat  Of  New  Entrants,  Bargaining  Power  Of  Buyers  and  Bargaining  Power  Of  Suppliers,  each   of  which  is  addressed  in  the  following  paragraphs.     RIVALRY  AMONG  COMPETITION-­‐-­‐The  semiconductor  industry  is  characterized  by   intense  rivalry  between  a  few  companies.    Firms  in  the  semiconductor  industry  compete  to   manufacture  products  that  are  smaller,  faster  and  cheaper10.    This  is  the  result  of  a  short   product  cycle  that  is  associated  with  PC  components  such  as  microprocessors  and  memory  that   are  near  obsolescence  shortly  after  being  released.    The  semiconductor  industry  changes   rapidly  as  technology  demands  change.    This  change  keeps  the  industry  competitive  as  each   company  tries  to  get  to  market  first  with  differentiated  products.    The  result  is  an  industry  that   is  always  on  the  cutting-­‐edge.    The  technology  is  constantly  changing  into  something  better  so   it  is  hard  for  one  company  to  remain  on  top.    What  tends  to  happen  with  this  type  of  rivalry  is   that  there  are  several  industry  players  with  similar  size  that  rise  as  the  larger  players.    This   happens  because  no  one  firm  can  always  be  the  one  with  the  newest,  fastest  and  cheapest   product  available11.                                                                                                                           9  Porter,  M.  (1996).  “What  is  strategy?”  Harvard  Business  Review  74:  61-­‐78.   10  www.investopedia.com/features/industryhandbook/semiconductor.asp   11  Banks,  W.,  (2011).  Semiconductor  Industry  Analysis  &  Competitive  Analysis.    Goizueta  Business  School,  Emory   University.     7     THREAT  OF  SUBSTITUTION-­‐-­‐The  threat  of  substitutes  in  the  semiconductor  industry   depends  on  the  segment12.    In  general,  there  is  no  substitute  for  semiconductors  for  use  in   electronic  products  needing  microprocessors  or  memory.    That  being  said,  new  techniques  to   produce  semiconductor  products  are  possible.    However,  the  rivalry  in  the  semiconductor   industry  has  enabled  the  industry  to  change  manufacturing  lines  in  a  very  short  time.    This   ability  takes  away  opportunities  for  others  to  compete  in  the  market.    The  semiconductor   industry  would  respond  quickly  to  any  successful  substitute  process,  limiting  the  advantage  that   particular  substitute  approach  may  have  had.    Additionally,  given  the  research  and   development  costs,  as  well  as  manufacturing  plant  cost  constraints,  semiconductor  firms  can   find  themselves  spending  significant  amounts  of  money  to  research  and  develop  new  products   just  to  find  that  their  competition  has  already  beat  them  to  it.    This  industry  tension,  keeps  the   semiconductor  business  environment  volatile  and  difficult  for  any  substitutes  to  remain   competitive13.     THREAT  OF  NEW  ENTRANTS-­‐-­‐Setting  up  a  chip  fabrication  facility  requires  billions  of   dollars.    This  high  cost  makes  entry  near  impossible  except  for  the  largest  firms.    Thus,  the   established  semiconductor  firms  have  an  enormous  advantage  over  any  new  entrants.    Another   related  barrier  is  the  short  product  cycle  of  semiconductors.    It  would  require  a  new  entrant  to   the  semiconductor  industry  several  products,  just  to  recoup  the  cost  of  the  manufacturing   plant.    "Fabless”  chip  companies  that  outsource  manufacturing  have  started  to  be  contenders   in  niche  areas.    However,  the  speed  at  which  the  semiconductor  industry  can  adapt  has  limited                                                                                                                           12  www.investopedia.com/features/industryhandbook/semiconductor.asp   13  Banks,  W.,  (2011).  Semiconductor  Industry  Analysis  &  Competitive  Analysis.    Goizueta  Business  School,  Emory   University     8   the  success  of  these  "Fabless”  firms.    Another  potential  threat  is  if  a  business  that  uses   semiconductors  in  their  products  decides  to  backward  integrate  (e.g.,  Apple).    Another   potential  threat  is  indirect  competition  from  governments  that  subsidize  firms  in  their  country,   giving  them  an  unfair  advantage  in  the  market  place.    Finally,  counterfeit  semiconductors  can   also  create  unfair  competitive  forces14.     BARGAINING  POWER  OF  BUYERS-­‐-­‐The  semiconductor  industry  is  dominated  by  a  small   number  of  large  firms.    On  the  other  hand,  there  are  numerous  buyers  ranging  from  PC  makers   to  electronic  do-­‐it-­‐yourselfers.    In  general,  this  means  buyers  have  little  bargaining  power.     However,  there  are  some  exceptions.    Large  PC  and  electronic  device  makers  do  have  some   influence  due  to  the  shear  volume  of  products  they  sell.    Their  consistent  large  purchase   volumes  give  some  computer  and  device  manufacturers  (e.g.,  Dell  and  Hewlett-­‐Packard)   considerable  leverage.    Additionally,  these  high  volumes  help  semiconductor  manufactures   lower  their  per  unit  fixed  costs.    Thus,  there  is  a  symbiotic  relationship  between  the   semiconductors  manufactures  and  the  major  computer  and  device  manufacturers14.     BARGAINING  POWER  OF  SUPPLIERS-­‐-­‐There  are  a  small  number  of  semiconductor   manufacturers  but  a  large  number  of  suppliers.    This  allows  the  semiconductor  firms  to  assert   influence  and  reduce  the  bargaining  power  of  each  individual  supplier  to  a  minimum15.     However,  for  some  niche  services  such  as  fabrication  plant  operation  or  foundries,  "Fabless"   firms,  who  only  design  chips  and  have  others  firms  manufacturer  them,  are  becoming                                                                                                                           14  Banks,  W.,  (2011).  Semiconductor  Industry  Analysis  &  Competitive  Analysis.    Goizueta  Business  School,  Emory   University   15  www.investopedia.com/features/industryhandbook/semiconductor.asp     9   increasingly  dependent  on  a  handful  of  large  foundries.    As  the  suppliers  of  cutting-­‐edge   equipment  and  production  skills,  these  foundries  are  gaining  considerable  bargaining  influence.   Competitive  Advantage     Most  types  of  semiconductors  are  fungible,  forcing  semiconductor  manufactures  to   pursue  a  competitive  strategy  based  on  differentiation.    For  differentiation  to  be  successful,  a   firm  must  achieve  three  things:  1)  identify  attributes  of  a  product  that  customers  value,  2)   position  to  meet  the  customer  need  in  a  unique  manner,  and  3)  achieve  differentiation  at  a  cost   lower  than  the  price  the  customer  is  willing  to  pay16.     Intel  is  the  world's  fifth  most  valuable  brand  worth  $35  billion  and  its  microprocessors   drive  almost  90%  of  the  world's  personal  computers.    Intel  is  able  to  achieve  this  success  by   dominating  the  above  three  elements  of  a  differentiation  strategy.    First,  Intel  employs   anthropologists  who  study  how  people  use  technology  in  their  lives.    Intel  also  uses  focus   groups  to  find  out  what  customers  think  of  future  scenarios  that  Intel  anticipates  such  as   lifestyle  developments.    This  information  helps  Intel's  designers  and  engineers  understand  what   customer  want.    Second,  Intel  doesn't  just  sell  its  semiconductors.    Intel's  approach  is  to  create   many  types  of  chips  and  software,  and  then  combine  them  into  platforms,  where  a  platform  is   an  integrated  set  of  proven  technologies  designed  from  the  start  to  work  together.    These   platforms  enhance  performance  bringing  added  value  for  consumers.    Finally,  Intel  is  a   'manufacturing  monster'  having  invested  billions  of  dollars  in  manufacturing  plants  that  can   produce  more  processors  in  a  day  than  some  of  Intel  rivals  can  produce  in  a  year.    Intel  can                                                                                                                           16  Palepu,  K  &,  Healy,  P  (2007).    Title  Business  Analysis  and  Valuation:  Using  Financial  Statements.    Edition  4.     Publisher  Cengage  Learning.     10   develop  and  bring  a  product  to  market  faster  than  anyone  else.    By  leveraging  this   manufacturing  capability,  Intel  can  increase  production  to  bring  a  product  to  market  in  large   volumes.    This  agility  allows  Intel  to  deliver  a  product  that  consumers  want  at  price  customers   value17.   SWOT  Analysis     A  SWOT  analysis  is  a  structured  planning  framework  to  evaluate  the  strengths,   weaknesses,  opportunities,  and  threats  for  a  firm.    Specifically,  strengths  address  business   characteristics  that  give  the  firm  an  advantage  over  others;  weaknesses  identify  company   characteristics  that  place  the  firm  at  a  disadvantage  relative  to  others;  opportunities  are   circumstances  the  firm  could  exploit  to  its  advantage;  and  finally,  threats  are  conditions  that   could  cause  trouble  for  the  firm.    The  following  paragraphs  apply  the  SWOT  framework  to  Intel.     STRENGTHS-­‐-­‐Intel  is  an  industry  leader.    Intel  controls  over  85%  of  the  microprocessor   market  and  over  50%  of  the  graphics  chip  market.    Intel  is  also  a  big  player  in  the  memory  and   motherboard  market.    This  leadership  position  gives  Intel  more  latitude  to  invest  in  research   and  development,  which  translates  into  increased  efficiency  of  design  and  manufacturing.    Intel   also  has  a  strong  company  network.    Intel  controls  the  entire  production  process  for  most  of  its   products.    This  network  of  manufacturing  facilities  and  assembly/test  facilities  gives  Intel  a   powerful  competitive  advantage.    It  allows  Intel  to  have  more  direct  control  over  processes,   quality  control,  product  cost,  volume,  and  timing  of  production.    Further,  Intel  has  strong  brand   recognition.    Intel  is  the  world's  fifth  most  valuable  brand  worth  over  $35  billion.    This  strong   brand  recognition  coupled  with  strong  market  position  enhances  Intel's  investor  confidence.                                                                                                                             17  businesscasestudies.co.uk/intel/     11   Additionally,  Intel  has  strategic  partnerships  with  prominent  technology  players  such  as  IBM,   Microsoft,  LG,  AT&T  and  Nokia.    This  allows  Intel  to  launch  new  services,  reach  more   customers,  and  improve  their  expertise  in  niche  areas.    These  strategic  collaborations  enable   Intel  to  expand  its  customer  base  and  product  portfolio,  enhancing  their  competitive   advantage.    Another  strength  is  that  Intel's  research  and  development  capabilities  are  second   to  none.    The  company  consistently  spends  over  $5  billion  a  year  on  research  and  development.     The  result  is  a  consistent  line  of  innovative  products  and  advanced  technologies.    Finally,  Intel   offers  a  broad  portfolio  of  microprocessors.    They  have  microprocessors  and  chipsets  for   notebooks,  netbooks  and  desktops.    Intel  also  supplies  products  for  data  center  and  cloud   computing  environments.    Additionally,  Intel  provides  chips  at  variety  of  price  and  performance   points18  to  meet  various  customer  needs.     WEAKNESSES-­‐-­‐Given  the  fungible  nature  of  semiconductors,  Intel  faces  a  never-­‐ending   battle  with  competitors  trying  to  take  its  leadership  spot.    In  some  niche  areas,  competitors,   such  as  AMD  with  its  64-­‐bit  processor,  are  catching  up  to  Intel.    In  other  areas,  such  as  flash   memory,  companies  like  Samsung  have  overtaken  Intel.    These  challenges  will  likely  continue.     Another  issue  is  the  volatility  of  the  semiconductor  industry.    Overall,  the  industry  is  very   cyclical  with  the  general  health  of  the  economy  dictating  demand  for  semiconductor   components.    Unexpected  changes  in  the  global  economy  can  have  an  extremely  negative   effect  on  Intel  and  the  semiconductor  industry.    Additionally,  in  Intel's  ongoing  pursuit  to   expand  its  customer  base,  it  often  ventures  into  products  like  wireless  chipsets  and   communications.    While  these  offering  expand  Intel's  portfolio,  most  of  Intel’s  revenue  still                                                                                                                           18  www.datamonitor.com     12   comes  from  microprocessor  and  motherboard  products.    Thus,  expanding  into  these  non-­‐core   areas,  requires  capital  with  a  disproportionate  return.    Finally,  Intel  is  dependent  on  a  few   customers  for  a  significant  proportion  of  its  revenues.    Intel's  largest  two  customers,  Hewlett-­‐ Packard  and  Dell,  account  for  over  a  third  of  its  revenues.    This  high  dependence  on  a  few   customers  could  reduce  Intel's  bargaining  power  and  increases  its  business  risk19.     OPPORTUNITIES-­‐-­‐Intel  has  acquired  various  companies  to  expand  beyond  its  traditional   PC  and  server  markets.    For  example,  McAfee,  now  a  wholly-­‐owned  subsidiary  of  Intel,  has  a   suite  of  software-­‐related  security  solutions  and  services  that  help  in  protecting  internet-­‐ connected  devices  and  networks  from  malicious  content  and  unsecured  communications.     Another  expansion  example  is  Intel's  purchase  Infineon's  Wireless  Solutions  business.    This   acquisition  further  strengthened  Intel’s  internet  connectivity  strategy  enabling  it  to  offer  a   portfolio  of  products  that  spans  across  a  range  of  wireless  options  from  Wi-­‐Fi  and  3G,  to   WiMAX  and  LTE.    Another  potential  area  for  growth  is  telehealth  and  home  health  monitoring.     Telehealth  is  a  $10  billion  market  and  growing.    Intel  already  offers  technology-­‐enabled   products  that  are  designed  to  reduce  healthcare  costs  and  connect  people  and  information  to   improve  patient  care  and  safety.    To  get  in  on  this  growing  market,  Intel  has  aligned  with  GE  to   market  and  develop  various  home  based  health  technologies.    Finally,  there  is  increasing   demand  for  cloud  computing  infrastructure.    Intel  is  well  positioned  to  benefit  from  this   growing  market.    Specifically,  Intel  offers  products  that  are  incorporated  into  servers,  storage,   workstations,  and  other  products  that  make  up  the  infrastructure  for  data  center  and  cloud                                                                                                                           19  www.datamonitor.com     13   computing  environments.    Intel  has  also  invested  heavily  in  various  cloud  computing   companies20.     THREATS-­‐-­‐Due  to  its  domination  in  the  microprocessor  market,  Intel  faces  various  issues   including  antitrust  and  unfair  business  practice  inquires  with  regulatory  commissions  in  Europe,   Asia  and  the  U.S.    Further,  staying  one  step  ahead  of  the  competition  is  what  gives  Intel  its   edge.    Because  of  this,  Intel  is  subject  to  various  security  related  issues,  including  theft  and   misuse  of  its  intellectual  property.    If  successful,  these  attempts  could  harm  Intel's  leadership   position  and  reputation20.   Values  of  Key  Personnel     Intel  values  themselves  as  a  global  technology  and  business  leader.    To  this  end,  they   are  committed  to  doing  the  right  things,  the  right  way.    Intel  sees  corporate  responsibility  as   good  business.    In  their  annual  report,  Intel  outlines  their  strategic  priorities  and  performance   on  a  range  of  environmental,  social  and  governance  factors,  including  workplace  practices,   community  engagement,  and  supply  chain  responsibility21.    Innovation  is  an  integral  part  of   Intel’s  culture.    At  the  heart  of  this  innovation  and  Intel's  business  success  are  its  people.    One   of  the  six  Intel  Values  is  “Great  Place  to  Work,”  which  reinforces  Intel's  strategic  importance  on   investing  in  their  people.    Intel  supports  this  ethos  by  ensuring  a  safe,  respectful  and  ethical   work  environment  that  enables  employees  to  thrive  on  the  job  and  in  their  communities22.     Intel  also  believes  that  technology  plays  a  fundamental  role  in  finding  solutions  to  the  world’s                                                                                                                           20  www.datamonitor.com   21  www.intel.com/go/responsibility   22  www.intel.com/jobs     14   environmental  challenges.    Intel  is  a  recognized  leader  in  sustainability  for  the  ways  they  work   to  minimize  the  environmental  impacts  of  their  operations.    Additionally,  Intel  designs  products   that  are  increasingly  energy  efficient.    In  2012,  for  the  fifth  year  in  a  row,  Intel  was  the  largest   voluntary  purchaser  of  green  power  according  to  the  U.S.  Environmental  Protection  Agency.    To   underscore  the  importance  of  sustainability  to  their  business,  Intel  includes  an  environmental   component  in  the  formula  used  to  determine  the  payout  for  employee  and  executive  variable   compensation.    Intel  has  also  continued  to  collaborate  with  others  to  drive  global  standards  for   products  and  manufacturing  that  ensure  energy-­‐efficient  performance23.    Finally,  Intel  believes   education  is  the  foundation  of  innovation,  and  as  a  technology  company,  Intel  believes  their   success  rests  on  the  availability  of  skilled  workers,  a  healthy  technology  ecosystem,  and   knowledgeable  customers.    Intel  believes  this  requires  access  to  technology  and  quality   education.    Intel  strives  to  transform  education  through  their  Intel  Foundation  to  collaborate   with  governments  and  educators  and  invests  approximately  $100  million  annually  in  education   programs  around  the  world24.   Societal  Expectation     Intel  is  a  business  leader  controlling  over  85  percent  of  the  microprocessor  market  and   has  the  world's  fifth  most  valuable  brand.    As  a  business  leader,  Intel  is  committed  to  the   highest  standards  of  business  ethics  and  corporate  governance.    Intel  captures  these  values  in   their  Code  of  Conduct25  which  serves  as  a  compass  guiding  the  actions  of  Intel  employees,                                                                                                                           23  www.intel.com/go/environment   24  www.intel.com/educate   25  www.intel.com/content/www/us/en/policy/policy-­‐code-­‐conduct-­‐corporate-­‐information.html     15   directors,  and  business  partners,  ensuring  consistent  and  uncompromising  integrity.    Further,   Intel  is  dedicated  to  caring  for  people  and  natural  resources  by  designing  safe,  energy-­‐efficient   products  that  minimize  impact  to  the  environment.    To  this  end,  Intel  has  documented  policies   on  Environmental,  Health,  and  Safety;  Climate  Change;  and  Water  use.    Finally,  Intel  is   committed  to  ethical  and  legal  business,  environmental,  human  rights,  and  labor  practices  on  a   worldwide  basis  with  annual  report  statements  related  to  support  for  Human  Rights,  their   stance  against  Human  Trafficking  &  Slavery  and  policy  on  Conflict  Minerals26.    While  most   company  annual  reports  contain  this  type  of  altruistic  language,  a  review  of  Intel  news  releases   for  the  last  year  suggests  Intel's  actions  are  consistent  with  their  commitments.   Accounting  Analysis     The  purpose  of  this  section  is  to  evaluate  the  degree  to  which  Intel's  accounting   captures  its  true  business  practices.    Specifically,  this  section  will  examine  places  where  Intel   has  accounting  flexibility.    Additionally,  this  section  will  evaluate  the  appropriateness  of  Intel's   accounting  policies  and  estimating  techniques.    Together,  these  provide  an  indication  of  the   credibility  behind  Intel's  numbers.   Policies   Intel's  annual  report  outlines  all  of  its  accounting  policies27  which  include  specific     policies  on  Use  of  Estimates,  Fair  Value,  Fair  Value  Hierarchy,  Cash  Equivalents,  Trading  Assets,   Available-­‐for-­‐Sale  Investments,  Non-­‐Marketable  and  Other  Equity  Investments,  Other-­‐Than-­‐ Temporary  Impairment,  Derivative  Financial  Instruments,  Measurement  of  Effectiveness,                                                                                                                           26  www.intel.com/go/governance   27  www.intc.com/intel-­‐annual-­‐report/2013/10K/57-­‐accounting-­‐policies.html     16   Securities  Lending,  Loans  Receivable,  Inventories,  Property,  Plant  and  Equipment,  Goodwill,   Identified  Intangible  Assets,  Product  Warranty,  Revenue  Recognition,  Advertising,  Employee   Equity  Incentive  Plans,  and  Income  Taxes.    Most  of  these  contain  'boilerplate'  language  that  is   similar  to  the  policies  stated  in  Texas  Instruments  (TXN)  and  Advanced  Micro  Devices  (AMD)   annual  reports.    The  following  paragraphs  highlight  some  of  the  most  notable  policies  as  they   relate  to  the  credibility  of  Intel  financial  statements.     Use  of  Estimates  -­‐  Intel  makes  extensive  use  of  estimates  throughout  its  financial   statements.    These  include  subjective  judgments  on  the  valuation  of  non-­‐marketable  equity   investments,  assessments  on  the  recoverability  of  long-­‐lived  assets,  recognition  and   measurement  of  current  and  deferred  income  taxes,  valuation  of  inventory,  and  recognition  &   measurement  of  loss  contingencies.    While  TXN  and  AMD  make  similar  statements,  these  areas   where  estimates  are  used  warrant  further  investigation  when  examining  the  statements.     Fair  Value  -­‐  Fair  value  is  the  price  that  would  be  received  from  selling  an  asset  or  paid  to   transfer  a  liability  in  an  orderly  transaction  between  market  participants  at  the  measurement   date28.    When  determining  fair  value,  Intel  considers  the  principal  or  most  advantageous   market  in  which  they  would  transact.    The  TXN  and  AMD  reports  contain  nebulous  statements   about  fair  value.    Intel,  at  least  states  they  use  an  optimistic,  but  perhaps  not  realistic,   estimation  methodology.     Inventories  -­‐  Intel  computes  inventory  cost  on  a  first-­‐in,  first-­‐out  basis,  which  is   consistent  with  TXN  and  AMD.    This  industry  first-­‐in,  first-­‐out  inventory  policy  makes  sense   given  the  short  life  of  semiconductor  products.    However,  this  first-­‐in,  first-­‐out  process  suggests                                                                                                                           28  www.intc.com/intel-­‐annual-­‐report/2013/10K/57-­‐accounting-­‐policies.html     17   eventually  one  of  these  firms  winds  up  having  some  obsolete  inventory  that  will  have  to  written   off.     Goodwill  -­‐  Goodwill  represents  the  excess  of  the  purchase  price  over  the  fair  value  of   net  tangible  and  identifiable  intangible  assets  acquired.    Neither  Intel,  TXN  nor  AMD  amortize   goodwill,  but  test  periodically  for  impairment.    They  all  evaluate  whether  goodwill  has  been   impaired  by  determining  if  the  estimated  fair  value  of  the  acquisition  is  less  than  the  carrying   value.    The  implied  fair  value  is  determined  through  the  use  of  industry  valuation  models.    Any   differences  are  expensed.    This  topic  will  be  discussed  further  under  Long-­‐Lived  Assets.     Revenue  Recognition  -­‐  Intel's  revenue  recognition  is  quite  complex  due  to  its  different   business  segments  and  its  variety  of  end-­‐users.    For  example,  Intel  recognizes  revenue  from   products  sold  directly  to  end-­‐consumers  when  delivery  has  occurred.    For  sales  made  to   distributors,  Intel  defers  product  revenue  and  related  costs  of  sales  until  the  distributors  sell   the  merchandise.    This  is  done  primarily  to  give  the  distributor  price  protection  because  of   frequent  sales  price  reductions  and  rapid  technology  obsolescence  in  the  industry.    Intel  also   receives  revenue  from  license  agreements  primarily  with  the  McAfee  segment.    Revenue  from   these  agreements  is  deferred  and  recognized  over  the  performance  of  the  agreement  period.     Similarly,  revenue  Intel  derives  from  online  subscription  products  is  deferred  and  recognized   over  the  subscription  periods.    For  Intel  professional  services,  revenue  is  recognized  as  services   are  performed.    To  make  revenue  recognition  even  more  complicated,  Intel  has  numerous   relationships  where  all  of  these  elements  are  being  provided  to  a  single  customer.    In  these   cases,  revenue  is  allocated  across  the  separately  identified  deliverables  and  may  be  recognized   or  deferred.    Costs  associated  with  all  of  these  revenue  generating  activities  are  deferred  and     18   amortized  over  the  same  period  that  the  related  revenue  is  recognized29.    While  revenue   recognition  is  not  directly  comparable  for  TXN  and  AMD,  for  basic  components  they  use  similar   revenue  recognition  policies.    Revenue  Recognition  is  an  area  of  accounting  flexibility  that  will   be  discussed  further  in  the  paragraphs  below.   Flexibility     In  the  Management's  Discussion  &  Analysis  section  of  the  annual  report,  Intel  is  very   forthcoming  about  the  extensive  use  of  subjective  estimates  in  their  financial  reporting30.    The   key  areas  include  the  valuation  of  non-­‐marketable  equity  investments,  assessment  on   recoverability  of  long-­‐lived  assets,  recognition  and  measurement  of  current  and  deferred   income  taxes,  the  valuation  of  inventory  and  recognition  and  measurement  of  loss   contingencies.    The  gist  of  these  estimates  are  to  identify  the  fair  value  of  an  asset.    The   estimate  methodologies  provide  ample  accounting  flexibility  for  Intel  and  are  covered  in  more   detail  in  the  following  paragraphs.     Non-­‐Marketable  Equity  Investments  -­‐  Intel  invests  in  non-­‐marketable  equity   instruments  of  private  companies  ranging  from  start-­‐ups  to  mature  companies  with  established   revenue  streams  and  business  models.    At  the  end  of  December  2013,  the  value  of  these  types   of  investments  was  valued  at  $2.3  billion.    Since  these  equity  stakes  are  non-­‐marketable,  Intel   has  to  estimate  their  value.    Intel  uses  two  estimating  approaches.    The  first  is  based  on  using   financial  metrics,  such  as  projected  revenue,  projected  earnings,  and  financial  ratios  of   comparable  public  companies.    The  selection  of  companies  for  comparison  is  an  art  since  the                                                                                                                           29  www.intc.com/intel-­‐annual-­‐report/2013/10K/57-­‐accounting-­‐policies.html   30  www.intc.com/intel-­‐annual-­‐report/2013/10K/28-­‐critical-­‐accounting-­‐estimates.html     19   start-­‐up  often  has  a  unique  product  and  service.    Generally,  however,  it  is  based  on  factors   including  company  size,  growth  rate,  industry,  and  development  stage.    For  more  mature   companies,  Intel  uses  a  discounted  cash  flow  model,  which  requires  significant  estimates   regarding  the  company's  revenue,  costs,  and  discount  rates  based  on  the  risk  profile  of   comparable  companies.    Estimates  of  revenue  and  costs  are  developed  using  available  market,   historical,  and  forecasted  data.    If  Intel  determines  the  fair  value  of  an  investment  is  below  the   carrying  value,  Intel  writes  down  the  investment  to  its  fair  value.    It  is  interesting  to  note  that   these  impairments  of  non-­‐marketable  equity  investments  were  $112  million  in  2013,  $104   million  in  2012  and  $63  million  in  2011.    Assuming  the  estimates  are  correct,  Intel's  losses  on   these  types  of  investments  has  doubled  over  the  2  year  period,  although  the  $112  million  only   represents  about  5%  of  the  entire  $2.3  billion  portfolio.     Long-­‐Lived  Assets  -­‐  Property,  Plant,  Equipment,  Goodwill  and  other  Identified   Intangibles  all  follow  an  estimating  approach  similar  to  Non-­‐Marketable  Equity  Investments.     Specifically,  Intel  tries  to  find  comparables  based  on  groupings  of  like  assets.    If  the  assets  are   directly  producing  a  revenue  stream,  then  a  cash  flow  model  is  used.    However,  even  when  a   cash  flow  model  is  used,  considerable  subjective  judgments  regarding  the  remaining  useful  lives   of  assets  have  to  be  made.    In  general,  the  assumptions  and  estimates  used  to  determine  future   values  and  remaining  useful  lives  of  Intel's  long-­‐lived  assets  are  complex,  subjective  and   influenced  by  numerous  external  factors  such  as  industry  and  economic  trends.    Overall,  these   impairments  are  small  relative  to  the  size  of  Intel.    In  2013,  impairment  charges  were  $17     20   million  ($21  million  in  2012  and  $10  million  in  2011).    It  should  be  noted,  however,  these  values   are  small  only  if  you  assume  the  estimates  are  correct31.     Income  Taxes  -­‐  Intel  makes  various  estimates  and  judgments  in  determining  the   provision  for  taxes  related  to  calculation  of  tax  credits,  benefits,  and  deductions.    Further   judgments  are  required  in  the  calculation  of  certain  tax  assets  and  liabilities  that  arise  from   differences  in  the  revenue  and  expense  recognition  timing.    Changes  in  the  assumptions  behind   these  estimates  may  result  in  an  increase  or  decrease  to  Intel's  tax  provisions.    These  tax   related  assumptions  also  provide  another  accounting  flexibility  knob.     Inventory  -­‐  Semiconductor-­‐based  products  can  be  considered  end-­‐products  at  various   stages  of  development.    Intel  has  to  decide  at  what  point  product  costs  change  from  R&D   expenditures,  which  would  be  expensed  in  the  current  period,  to  cost  of  sales,  which  could  be   deferred.    This  point  may  be  different  for  different  customers  providing  Intel  some  flexibility   regarding  how  to  expense  costs.    Intel's  inventory  valuation  is  another  area  providing   accounting  flexibility.    Their  inventory  is  valued  at  the  lower  of  cost  or  market  based  upon   assumptions  concerning  future  demand  and  market  conditions.    Some  of  the  factors  considered   are:  customer  base,  stage  of  the  product  life  cycle,  consumer  confidence,  customer  acceptance   and  an  assessment  of  selling  price  in  relation  to  product  cost.    If  the  estimated  value  of  the   inventory  is  less  than  the  carrying  value,  Intel  writes  down  the  inventory  and  records  the   difference  as  a  charge  to  cost  of  sales.    A  final  aspect  on  inventory  concerns  obsolete  inventory.     Intel's  valuation  of  inventory  requires  an  estimation  of  obsolete  inventory.    To  do  this,  a   demand  forecast  is  utilized.    This  is  then  compared  to  inventory  levels.    If  the  demand  forecast                                                                                                                           31  www.intc.com/intel-­‐annual-­‐report/2013/10K/28-­‐critical-­‐accounting-­‐estimates.html     21   for  specific  products  is  less  than  inventory  levels,  the  excess  products  are  written  off.    These   estimation  models  are  highly  sensitive  to  assumptions,  giving  Intel  plenty  of  accounting   flexibility  by  designating  'obsolete'  inventory.     Loss  Contingencies  -­‐  This  final  area  also  gives  Intel  considerable  accounting  flexibility.    As   a  leader  in  the  industry,  Intel  is  constantly  subjected  to  various  legal  and  administrative   proceedings  with  potential  financial  claims.    Further,  there  is  always  the  potential  that  product   issues  will  occur  while  they  are  still  under  warranty.    Based  on  these  potential  claims,  Intel   estimates  a  loss  recognized  as  a  charge  to  income,  even  if  the  loss  has  not  occurred  (and  may   not  occur).    This  is  similar  to  making  an  allowance  for  uncollected  accounts.    The  amount  set-­‐ aside  for  loss  contingencies  is  highly  subjective  and  is  definitely  another  'tool'  Intel  could  use  to   smooth  earnings.   Strategy     As  demonstrated  above,  Intel  has  significant  accounting  flexibility.    The  question,   however,  is  whether  or  not  they  are  using  this  flexibility  to  accurately  communicate  Intel's   economic  situation  or  using  it  to  hide  something.    By  comparing  Intel's  policies  to  others  in  the   industry,  we  can  get  a  first  look  at  potential  irregularities.    As  noted  in  the  Policies  section,   Intel's  accounting  policies  are  in  alignment  with  other  companies  in  the  semiconductor  industry   such  as  TXN  and  AMD.     Managers  could  also  be  tempted  to  use  this  flexibility  to  manage  earnings.    Intel   managers,  however,  would  not  be  doing  this  to  avoid  triggering  debt  covenants,  since  Intel  has   more  than  enough  cash  to  pay  off  their  long-­‐term  debt.    One  possibility,  however,  is   accounting-­‐based  compensation.    Over  the  last  3-­‐years,  the  top  7  executives  at  Intel  had     22   compensation  of  $187  million.    Most  of  this  was  in  the  form  of  stock  and  stock  options  ($130   million)32.    Clearly,  there  is  motive  for  these  managers  to  keep  the  stock  climbing.    Another   motive  for  Intel's  accounting  practices  is  to  minimize  the  tax  burden.    Intel  is  pretty  open  about   this,  stating  that  profits  made  in  another  country  will  stay  there  for  reinvestment  purposes   versus  bring  the  profits  back  to  the  U.S.  where  they  would  be  taxed.   There  were  several  accounting  changes  in  2011  and  201233.    In  2011,  Intel  adopted  a     policy  concerning  revenue  recognition  related  to  multiple  deliverables.    This  change  simply   allowed  Intel  to  modify  the  method  by  which  revenue  is  allocated  to  the  separately  identified   deliverables  (recurring  software  subscription  versus  a  one  time  hardware  purchase  by  the  same   customer).    According  to  Intel,  this  change  had  no  material  impact.    There  were  two  other   changes,  one  in  2011  and  one  in  2012,  that  had  no  material  impact,  but  paved  the  way  for  more   accounting  flexibility.    Specifically,  the  changes  allow  Intel  to  assess  qualitative  factors  in   determining  whether  the  fair  value  of  an  asset's  goodwill  and  long-­‐lived  assets  are  going  to  be   less  than  its  carrying  value.    These  qualitative  factors  add  to  the  subjectivity  in  assessing  the  fair   value  of  these  items.     Overall,  the  accounting  strategy  used  by  Intel  seems  to  accurately  represent  the   company’s  financial  activity  and  health.    Their  policies  and  estimates  seem  realistic  and  no   business  transactions  seem  out  of  place.    While  it  still  remains  true  that  Intel  has  significant   accounting  flexibility,  Intel  uses  a  conservative  approach  in  alignment  with  industry  norms.     Finally,  the  auditor  (Ernest  &  Young)  has  this  to  say,  "...the  financial  statements  referred  to                                                                                                                           32  www.intc.com/IntelProxy2014/58-­‐execitive-­‐compensation.html   33  www.intc.com/intel-­‐annual-­‐report/2013/10K/58-­‐accounting-­‐changes.html     23   above  present  fairly,  in  all  material  respects,  the  consolidated  financial  position  of  Intel   Corporation  at  December  28,  2013  and  December  29,  2012".    Additionally,  they  state,  "Intel   Corporation  maintained,  in  all  material  respects,  effective  internal  control  over  financial   reporting  as  of  December  28,  2013".   Disclosure  Quality     Annual  reports  can  be  over  a  100  pages.    The  latest  from  Intel  is  140  pages.    Within   those  pages,  companies  have  a  choice  on  making  it  more  or  less  easy  for  someone  to  assess  the   company's  accounting  quality  and  use  the  statements  to  understand  the  business  reality  of  the   firm.    Overall,  Intel  appears  to  make  an  attempt  to  be  as  transparent  as  possible  with  their   financial  reporting.    While  some  aspects  of  the  accounting  procedures  are  subjective  and   accounting  changes  made  in  2011  and  2012  increase  this  qualitative  approach,  this  seems  to   have  been  done  to  increase  the  level  of  fidelity  into  specific  elements  of  revenue  streams   versus  just  aggregating  them  in  one  number  that  is  reported.     The  Executive  Letters  accompanying  Intel's  annual  report  are  primarily  cheerleading  and   motivational  speech.    However,  the  Management's  Discussion  and  Analysis  of  Financial   Condition  and  Results  (MD&A)  section  is  comprehensive  and  detailed.    The  MD&A  does  an   excellent  job  of  laying  out  the  industry  conditions,  Intel's  competitive  position  and  Intel's  plans   for  the  future.     Early  in  the  MD&A  section,  Intel  lays  out  the  Critical  Accounting  Estimates.    While  this  is   also  true  for  TXN  and  AMD,  Intel  provides  more  than  GAAP  "requires  us  to  make  estimates  and   judgments".    Intel  characterizes  the  main  areas  where  estimates  and  judgments  are  involved   and  then  provides  detailed  information  on  each  of  these  areas.    Further,  Intel  makes  use  of  the     24   footnotes  to  explain  the  accounting  policies  and  assumptions  for  the  way  the  data  are   presented.    Intel  also  does  a  good  job  of  explaining  the  rationale  behind  various  accounting   changes  and  their  impact  on  the  presentation  of  financial  results.     Intel  has  grown  beyond  just  being  a  semiconductor  chip  maker.    The  company  also   provides  mobile  components  such  as  WiFi  products,  radio  frequency  transceivers,  Bluetooth   products,  power  management  chips  and  global  navigation  satellite  system  components.    In   addition,  through  various  company  acquisitions,  Intel  now  offers  network  and  content  security   as  well  as  security  software  products  for  consumer,  mobile,  and  corporate  environments.    Each   of  these  segments  has  different  accounting  practices.    Intel  provides  excellent  discussion  and   breaks  down  the  overall  top-­‐line,  providing  insight  into  the  health  of  each  of  its  business   segments.     Finally,  Intel  has  an  extensive  Investor  Relations  site.    It  contains  the  latest  Intel   corporate  events,  news  releases  and  financial  statements.    Further,  it  contains  an  archive  of   past  news  and  financial  releases.    It  is  also  the  location  where  Intel  posts  the  latest  quarterly   financial  releases.    Overall,  Intel  has  a  high  quality  of  disclosure  and  does  a  great  job  of   explaining  their  assumptions,  accounting  policies  behind  the  numbers  throughout  their   financial  statements;  and  then  making  this  information  available.   Red  Flags     As  just  noted,  the  Intel  Financial  Statements  provide  a  very  high  level  of  disclosure   quality.    Based  on  this,  there  are  few  areas  where  the  accounting  should  be  called  into   question.    Specifically,  there  were  no  unexplained  increases  in  contingencies  or  significant  off-­‐   25   balance-­‐sheet  arrangements.    Further,  the  only  changes  in  accounting  were  to  increase  the   financial  transparency  related  to  revenue  streams  in  different  business  segments.     Before  discounting  any  potential  Red  Flags,  a  couple  of  quantitative  checks  can  be   performed.    The  following  table  shows  a  comparison  of  2009  to  2013  for:  accounts  receivable  in   relation  to  sales  increases,  inventories  in  relation  to  sales  increases,  reported  income  and  cash   flow  from  operating  activities  and  reported  income  and  taxable  income.   Accoutning Analysis Indicators Receivables to Sales Inventories to Sales Net Income to Cash Flow Net Income to Pre-Taxable Income   2009 2010 2011 2012 6.47% 8.36% 31.9% 76.6% 6.57% 8.61% 55.6% 71.4% 6.82% 7.59% 53.9% 72.8% 7.57% 8.87% 49.7% 74.0% 2013 6.99% 7.92% 46.8% 76.3%   The  first  indicator,  Receivables  to  Sales,  can  provide  insight  on  if  the  company  is  relaxing   its  credit  policies  or  artificially  loading  up  its  distribution  channels.    The  above  numbers  for  Intel   don't  suggest  this  happening.    The  second  indicator,  Inventories  to  Sales,  could  be  an  indicator   that  demand  for  products  are  slowing.    Again,  the  above  numbers  don't  suggest  this  is  the  case.     The  third  indicator,  Net  Income  to  Cash  Flow,  could  indicate  changes  in  the  firm's  accrual   estimates.    It  is  assumed  that  the  2009  number  is  due  to  the  recession;  otherwise  the  numbers   are  fairly  consistent  year-­‐over-­‐year.    Finally,  Net  Income  to  Pre-­‐Tax  Income  increases  could   indicate  that  financial  reporting  to  shareholders  has  become  more  aggressive.    All  of  these   qualitative  and  quantitative  measures  provide  no  warning  of  Red  Flags  on  Intel's  Financial   Statements.   Distortions     The  purpose  of  this  section  was  to  evaluate  the  degree  to  which  Intel's  accounting   captures  its  true  business  practices  and  to  provide  an  indication  of  the  credibility  behind  Intel's     26   numbers.    After  analyzing  Intel's  Financial  Statements,  the  analysis  suggests  the  data  in  Intel's   financial  reports  clearly  and  accurately  reflect  the  financial  health  of  the  firm.    There  were  no   questionable  practices  that  would  lead  one  to  believe  that  Intel’s  management  was  trying  to   misrepresent  the  numbers.    All  changes  in  accounting  were  documented  with  the  rationale  and   the  impact  on  the  financial  statements.    While  Intel's  accounting  policies  provide  ample   accounting  flexibility,  the  accounting  analysis  suggests  Intel  is  applying  these  policies   responsibly  while  documenting  their  actions  and  logic  in  the  footnotes.    Because  of  the  above   findings,  no  adjustments  to  the  financial  statements  are  necessary.   Financial  Analysis     The  financial  statements  of  a  company  contain  information  that  reveal  the  company’s   financial  position.    This  information  can  be  combined  using  various  ratios  to  assess  the   company’s  financial  health.    This  section  is  focused  on  using  the  financial  information  in  Intel’s   financial  statements,  as  well  as  Intel's  primary  competitors  (Advanced  Micro  Devices  (AMD)  &   Texas  Instruments  (TXN)),  to  see  where  Intel  stands  with  respect  to  those  competitors  and  the   industry  (average  of  INTC,  AMD  &  TXN).    The  key  areas  examined  are:  Return  on  Equity   Decomposition,  Profitability,  Asset  Management,  Liquidity,  Debt  &  Coverage  and  Sustainable   Growth.    The  data  examined  covers  31  Dec  2004  to  31  Dec  2013.   Return  on  Equity  Decomposition     This  section  will  breakdown  Intel's  Return  on  Equity  (ROE)  into  its  building  blocks  to   yield  a  deeper  understanding  of  Intel's  strategic,  investment  and  financing  decisions.    These   basic  building  blocks  for  Intel  will  also  be  compared  to  the  build  blocks  for  two  of  Intel's   competitors  (TXN  and  AMD).    The  breakdown  of  ROE  is  as  follows:     27   ROE   =  (Income/Equity)       =  (income/assets)  x  (assets/equity)     =  (income/sales)  x  (sales/assets)  x  (assets/equity)   The  following  tables  show  the  ROE  breakdown  for  Intel  as  well  as  TXN  and  AMD.   INTC ($ millions) Net Income Sales Net Profit Margin (ROS) Total Assets Asset Turnover Return on Assets Shareholders Equity Financial Leverage Return on Equity 2004 7,516 34,209 21.97% 48,143 0.71 15.61% 38,579 1.25 19.48% AMD ($ millions) Net Income Sales Net Profit Margin (ROS) Total Assets Asset Turnover Return on Assets Shareholders Equity Financial Leverage Return on Equity 2004 TXN ($ millions) Net Income Sales Net Profit Margin (ROS) Total Assets Asset Turnover Return on Assets Shareholders Equity Financial Leverage Return on Equity 2004   91 5,001 1.82% 7,844 0.64 1.16% 3,010 2.61 3.03% 1,861 12,580 14.79% 16,299 0.77 11.42% 13,063 1.25 14.25% 2005 2006 8,664 38,826 22.31% 48,314 0.80 17.93% 36,182 1.34 23.95% 2005 2007 5,044 35,382 14.26% 48,368 0.73 10.43% 36,752 1.32 13.72% 2006 165 5,848 2.83% 7,288 0.80 2.27% 3,352 2.17 4.94% 2005 2007 -166 5,649 -2.94% 13,147 0.43 -1.26% 5,785 2.27 -2.87% 2006 2,324 13,392 17.35% 15,063 0.89 15.43% 11,937 1.26 19.47% 6,976 38,334 18.20% 55,651 0.69 12.54% 42,762 1.30 16.31% 5,292 37,586 14.08% 50,715 0.74 10.43% 39,088 1.30 13.54% 2008 -3,379 -3,098 6,013 5,808 -56.19% -53.34% 11,550 7,675 0.52 0.76 -29.26% -40.36% 2,990 -82 3.86 -93.60 -113.01% 3778.05% 2007 4,341 14,195 30.58% 13,930 1.02 31.16% 11,360 1.23 38.21% 2008 2,657 13,835 19.20% 12,667 1.09 20.98% 9,975 1.27 26.64% 2008 1,920 12,501 15.36% 11,923 1.05 16.10% 9,326 1.28 20.59% 2009 2010 4,369 35,127 12.44% 53,095 0.66 8.23% 41,704 1.27 10.48% 2009 2011 11,464 43,623 26.28% 63,186 0.69 18.14% 49,430 1.28 23.19% 2010 376 5,403 6.96% 9,078 0.60 4.14% 648 14.01 58.02% 2009 2011 471 6,494 7.25% 4,964 1.31 9.49% 1,013 4.90 46.50% 2010 1,470 10,427 14.10% 12,119 0.86 12.13% 9,722 1.25 15.12% 12,942 53,999 23.97% 71,119 0.76 18.20% 45,911 1.55 28.19% 491 6,568 7.48% 4,954 1.33 9.91% 1,590 3.12 30.88% 2011 3,228 13,966 23.11% 13,401 1.04 24.09% 10,437 1.28 30.93% 2,236 13,697 16.32% 20,497 0.67 10.91% 10,952 1.87 20.42% 2012 11,005 53,341 20.63% 84,351 0.63 13.05% 51,203 1.65 21.49% 2012 -1,183 5,422 -21.82% 4,000 1.36 -29.58% 538 7.43 -219.89% 2012 1,759 12,690 13.86% 20,021 0.63 8.79% 10,961 1.83 16.05% 2013 9,620 52,708 18.25% 92,358 0.57 10.42% 58,256 1.59 16.51%   2013 -83 5,299 -1.57% 4,337 1.22 -1.91% 544 7.97 -15.26%   2013 2,162 12,205 17.71% 18,938 0.64 11.42% 10,807 1.75 20.01%   What  follows  is  a  comparison  of  Net  Profit  Margin,  Asset  Turnover  and  Financial   Leverage  across  Intel,  TXN,  AMD  as  well  as  the  industry  average.    Return  on  Equity  and  Return   on  Assets  will  not  be  covered  here  since  they  will  be  covered  in  a  later  section.    The  following  is   the  data  for  Net  Profit  Margin  for  the  10  year  period.   Net Profit Margin INTC AMD TXN Industry 2004 2005 2006 22% 22% 14% 2% 3% -3% 15% 17% 31% 13% 14% 14% 2007 2008 2009 2010 18% 14% 12% 26% -56% -53% 7% 7% 19% 15% 14% 23% -6% -8% 11% 19% 2011 2012 2013 24% 21% 18% 7% -22% -2% 16% 14% 18% 16% 4% 11%     28   40% 30% 20% 10% 0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 INTC -10% AMD TXN -20% Industry -30% -40% -50% -60% -70%     Net  Profit  Margin  is  an  indication  of  how  much  the  firm  keeps  as  profits  for  every  dollar   in  revenue.    The  above  chart  is  not  as  clear  cut  as  Gross  Profit  Margin.    However,  the  above   chart  does  show  that  Intel  consistently  leads  the  industry  over  the  entire  timeframe.    Overall,   Intel  is  consistent  with  TXN  over  this  timeframe  with  an  average  Gross  Profit  Margin  of  19%.     This  consistency  lends  strong  credibility  to  Intel's  management  that  they  will  continue  to   convert  sales  in  to  profits.     Next,  the  Asset  Turnover  data  for  the  10  year  period  is  as  follows.   Asset Turnover INTC AMD TXN Industry 2004 2005 0.71 0.64 0.77 0.71 0.80 0.80 0.89 0.83 2006 2007 2008 2009 2010 2011 2012 0.73 0.43 1.02 0.73 0.69 0.52 1.09 0.77 0.74 0.76 1.05 0.85 0.66 0.60 0.86 0.71 0.69 1.31 1.04 1.01 0.76 1.33 0.67 0.92 0.63 1.36 0.63 0.87 2013 0.57 1.22 0.64 0.81     29   1.60 1.40 1.20 1.00 INTC AMD 0.80 TXN Industry 0.60 0.40 0.20 0.00 2004   2005 2006 2007 2008 2009 2010 2011 2012 2013   The  Asset  Turnover  indicates  how  many  sales  dollars  the  firm  is  able  to  generate  for   each  dollar  in  assets.    At  first  glance,  this  appears  to  be  the  first  indicator  where  Intel  does  not   dominate  or  at  least  perform  in  the  top  of  the  industry.    This  seems  at  odds  with  all  of  the  other   data  and  may  be  the  result  of  several  factors.    Specifically,  as  noted  in  the  Strategy  section,  Intel   dominates  the  semiconductor  industry  through  a  strategy  of  differentiation  where  the   company  spends  over  $5  billion  a  year  on  research  and  development.    Additionally,  Intel  is  a   semiconductor  manufacturing  powerhouse.    While  Intel  may  be  tremendously  successful  in   manufacturing  state-­‐of-­‐the-­‐art  semiconductors  at  scale,  it  isn't  cheap.    The  above  data  could   suggest  that  it  is  expensive  to  be  and  stay  at  the  top.     The  final  indicator  will  be  Financial  Leverage  with  data  for  the  10  year  period  as  follows.   Financial Leverage INTC AMD TXN Industry 2004 1.25 2.61 1.25 1.70 2005 1.34 2.17 1.26 1.59 2006 1.32 2.27 1.23 1.60 2007 1.30 3.86 1.27 2.14 2008 2009 1.30 1.27 1.28 1.29 1.25 1.26 2010 1.28 4.90 1.28 2.49 2011 1.55 3.12 1.87 2.18 2012 1.65 7.43 1.83 3.64 2013 1.59 7.97 1.75 3.77     30   9.00 8.00 7.00 6.00 INTC 5.00 AMD TXN 4.00 Industry 3.00 2.00 1.00 0.00 2004   2005 2006 2007 2008 2009 2010 2011 2012 2013   Financial  leverage  indicates  how  many  dollars  of  assets  the  firm  is  able  to  deploy  for   each  dollar  invested  by  shareholders.    As  can  be  seen  in  the  chart,  AMD's  financial  leverage  is   quite  volatile  and  two  years  (2008  and  2009)  had  to  be  removed  to  accurately  see  the  data  for   Intel  and  TXN.    Intel's  financial  leverage,  on  the  other  hand,  is  very  consistent  over  the  10-­‐year   period,  but  did  see  a  jump  in  2011  associated  with  various  acquisitions.    This  suggests  Intel   follows  a  very  disciplined  approach  to  using  leverage  for  growth.   Profitability     For  profitability,  three  ratios  are  investigated:    Return  on  Equity,  Return  on  Assets  and   Gross  Profit  Margin.    The  Return  on  Equity  data  for  the  10  year  period  is  shown  below.   Return on Common Equity INTC AMD TXN Industry NA = Not available 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 NA 23% 14% 18% 13% 11% 25% 27% 23% 18% NA 5% -4% -77% -213% 107% 57% 38% -111% -15% NA 19% 37% 25% 20% 15% 32% 21% 16% 20% NA 16% 16% -12% -60% 45% 38% 29% -24% 7%     31   150% 100% 50% 0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 INTC AMD -50% TXN Industry -100% -150% -200% -250%     Return  on  Equity  (ROE)  is  a  comprehensive  indicator  of  a  firms  performance  because  it  provides   an  indication  of  how  well  managers  are  employing  the  funds  invested  by  the  firm's  shareholders  to   generate  returns.    The  above  data  show  INTC  had  a  positive  ROE  over  the  entire  timeframe.     Additionally,  the  INTC  average  ROE  over  the  time  frame  was  19%  compared  with  the  industry  average  of   6%.    Also  of  note  is  that  the  variability  of  the  INTC  ROE  is  lower  than  both  TXN  and  AMD.    This  low   variability,  positive  ROE  suggests  a  well  thought  out  strategy  is  being  consistently  applied  by  INTC   management.     Next,  the  Return  on  Assets  data  for  the  10  year  period  is  as  follows.   Return on Total Assets INTC AMD TXN Industry NA = Not available 2004 NA NA NA NA 2005 2006 18% 10% 7% 3% 15% 30% 13% 14% 2007 2008 2009 2010 13% 10% 9% 20% -22% -27% 21% 9% 20% 16% 4% 0% 15% 15% 2011 2012 2013 19% 14% 11% 14% -23% 2% 13% 9% 11% 15% 0% 8%     32   40% 30% 20% INTC 10% AMD TXN 0% Industry 2005 2006 2007 2008 2009 2010 2011 2012 2013 -10% -20% -30%     Return  on  Assets  (ROA)  tells  how  much  profit  a  company  is  able  to  generate  for  each  dollar  of   assets  invested.    ROA  is  generally  seen  as  a  barometer  of  how  efficient  management  is  at  using  its  assets   to  generate  earnings.    The  above  data  show  INTC  had  a  positive  ROA  over  the  entire  timeframe.     Additionally,  the  INTC  average  ROA  over  the  time  frame  was  14%  compared  with  the  industry  average  of   9%.    Also  of  note,  is  that  the  variability  of  the  INTC  ROA  is  lower  than  both  TXN  and  AMD.    Similar  to  the   ROE  insight,  this  low  variability,  positive  ROA  is  a  confirmation  indicator  suggesting  a  well  thought  out   strategy  is  being  consistently  applied  by  INTC  management.     The  final  profitability  measure  examined  in  this  section  is  Gross  Profit  Margin.    The  Gross  Profit   Margin  data  for  the  10  year  period  is  as  follows.   Gross Profit Margin INTC AMD TXN Industry 2004 2005 72% 64% 57% 64% 71% 62% 59% 64% 2006 2007 2008 65% 63% 59% 63% 65% 55% 61% 60% 68% 59% 59% 62% 2009 70% 62% 57% 63% 2010 77% 48% 60% 62% 2011 2012 74% 49% 57% 60% 76% 44% 57% 59% 2013 74% 40% 60% 58%     33   90% 80% 70% 60% INTC 50% AMD TXN 40% Industry 30% 20% 10% 0% 2004   2005 2006 2007 2008 2009 2010 2011 2012 2013   Gross  Profit  Margin  is  an  indication  of  the  extant  to  which  revenues  exceed  direct  costs   associated  wi...
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