|Why Intel's inventory really rose|
Commentary: More parts sitting around, at a lower cost
By Herb Greenberg, CBS MarketWatch.com
Last Update: 12:54 PM ET Oct. 13, 2004
SAN DIEGO (CBS.MW) -- Intel's claim that inventory fell by $43 million last quarter from the second quarter may really be little more than smoke-and-mirrors.
While the dollar amount of inventory may have fallen, the number of parts gathering dust may have ballooned -- and not necessarily by a small amount.
The actual number is impossible to tell because as I noted Tuesday night in Herb Greenberg's RealityCheck, Intel CFO Andy Bryant went out of his way not to disclose the size of an inventory write-off and a higher-than-expected inventory reserve.
Bryant said he couldn't give a specific number because the reserve and write-off (or product "revaluation," as he put it) involve more than one item.
Not that that makes sense. "This is a company that makes microprocessors," says longtime Intel (INTC: news, chart, profile) bear Bill Fleckenstein of Fleckenstein Capital. "Are they telling us they can't add?"
Actually, it may be telling you they can add, but don't want to shine a spotlight on the number because it's so large and would likely raise other questions.
Try between $400 million to $500 million -- or $472 million, to be exact. That's the amount of increase in cost of sales, which is where Intel records inventory write-offs and reserves. After hovering at around $3.2 billion for at least four quarters, it shot up last quarter by nearly 15 percent to $3.75 billion. In a business where costs are fairly stable, it would appear most of the rise is related to the write-off and reserves.
Beyond that, it's impossible to tell how much was a write-off and how much was reserves.
By obfuscating the issue, the company can make it appear as though its inventory problems under control. But Fleckenstein believes it also diverts attention from a more serious issue: Not only are customers saturated with too much inventory -- and not only is Intel facing competitive pressure from Advanced Micro Devices (AMD: news, chart, profile) -- but it appears the company simply has too much manufacturing capacity. (This has been Fleckenstein's argument for quite some time.) Indeed, in its 10-K, Intel says, "If our demand forecast for specific products is greater than actual demand and we fail to reduce manufacturing output accordingly, we could be required to record additional inventory reserves, which would have a negative impact on our gross margins."
That appears to be just what's happening now. But the disclosure also suggests Intel could be forced to start making fewer chips, which translates into lower revenue and profits -- or perhaps no profits, depending on the size of any production cutback. A reduction by 25 percent, says Fleckenstein, would "wipe out" profits. That's before taking into account the impact of selling chips that based on the "revaluation" are being discounted.
As for the higher-than-expected reserve, Fleckenstein is suspicious. Reserves would imply the company believes that going forward it will continue to be stuck with too much inventory that either can't be sold without a steep discount or are simply obsolete. (And to think this is the time of year sales should be perking up.)
But taking an unusually high reserve could be a way for Intel to slowly leak the discounted inventory into the marketplace in coming quarters without taking a one-time, big-bath hit.
Either way, the lack of Intel's willingness to provide details about the write-off and reserve, with management dancing around the issue, suggests what you see is definitely not what you get. Houdini would be proud.
Herb Greenberg is senior columnist for CBS MarketWatch.com, based in San Diego. He does not own stocks (except for shares of his employer, MarketWatch.com), and he does not sell stocks short or invest in hedge funds.