Chapter 2
2.16
(a)
FIFO is probably used for the rest of Kennametal's inventories. Companies using LIFO must disclose the
value of those inventories as if FIFO had been used, which Kennametal has done in this case.
(b)
Finished goods refers to those inventories that are complete and ready for sale. Work in process and
powder blends are inventories currently in the manufacturing process, but not yet complete. Raw materials and
supplies have not been put in the manufacturing process. The amount closest to current cost would be the FIFO
inventory value. Under FIFO, the first goods purchased are assumed sold, so the last goods purchased would be
included in the inventory valuation and would have been purchased at amounts closest to current costs. The LIFO
valuation reduction is a result of the impact of inflation on inventory values. Since the first goods purchased using
LIFO remain in inventory, LIFO inventories would be valued at a lower amount than FIFO inventories during an
inflationary period. Kennametal's inventories are lower in 2007, ($403,613) than they would have been if reported
using FIFO ($469,584).
2.17
2.18
(a)
$60,000
 $12,000 per year
5
(b)
Year 1
$60,000 x 2/5 = $24,000
Year 2
($60,000 - $24,000) x 2/5 = $14,400
Using the equation from Chapter 2, the calculations to determine dividends are as follows:
Beginning retained
earnings
2008
2009
2010
2.25
700
890
1,045
+
net income
-
dividends
=Ending retained earnings
+
250
-
60
=
890
+
225
-
70
=
1,045
+
40
-
75
=
1,010
1.
Del Monte Foods
Common Size Balance Sheet
April 29 and 30,
ASSETS
2007
2006
Current Assets
Cash and cash equivalents
--%
Restricted cash
--
1
Trade accounts receivable, net of allowance
6
7
18
21
3
3
27%
45%
Property, plant and equipment, net
16
17
Goodwill
30
21
Intangible assets, net
26
16
1
1
100%
100%
Inventories
Prepaid expenses and other current assets
Total Current Assets
Other assets, net
Total Assets
13%
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued expenses
11%
12%
Short-term borrowings
--
--
Current portion of long-term debt
1
2
Total Current Liabilities
12%
14%
43
35
8
6
Long-term debt
Deferred tax liabilities
Other non-current liabilities
5
9
68%
64%
--
--
Additional paid-in capital
22
27
Treasury stock, at cost
(3)
(4)
1
--
1212
13 13
Total Liabilities
Stockholders' Equity
Common stock
Accumulated other comprehensive income (loss)
Retained earnings
Total Stockholders' Equity
Total Liabilities and Stockholders' Equity
32%
36%
100%
100%
2.
The asset structure of Del Monte Foods has changed from 2006 to 2007. Current assets have
decreased from 45% to 27% of total assets. Most of the decline is a result of the cash account
decreasing, although inventories have declined by 3%, also. It is probable that the cash was used to
purchase Meow Mix and Milk-Bone. A significant part of the purchase price was for goodwill and
intangible assets and as can be seen on the common size balance sheet, these two accounts are the
most significant to Del Monte in 2007, making up 56% of total assets, an increase of 19% from 2006.
Changes in the debt and equity structure of Del Monte Foods are not as drastic. Current liabilities are
stable and only make up 12% of total assets in 2007. The main change in the liability structure is the
increase in long-term debt, most likely attributable to the purchase of meow Mix and Milk-Bone.
Because of the change in liabilities the additional paid-in capital and retained earnings percentages have
declined relative to assets in 2007 compared to 2006, even though the dollar amounts have increased.
The debt structure of Del Monte is somewhat risky. Large amounts of money have been paid to acquire
two companies. If the acquisitions deliver above average profits for Del Monte, there should not be a
problem, however, if the acquisitions turn out to be a poor strategic decision, Del Monte could have
trouble paying back amounts borrowed. Most of the assets purchased are intangible, not tangible.
3.
Investors and creditors would be concerned about the ability of the firm to generate enough
cash to pay the large amounts of debt that will ultimately come due. Most resources are tied up in
goodwill and intangible assets, items not immediately saleable if cash is needed.
4.
Investors and creditors would want to look at all other financial statements, the notes to the
financial statements, the management discussion and analysis, the auditor's report and stock price
information. SEC documents, Form 10-K, Form 10-Q and Form 8-K reports, would be a good source of
both financial and nonfinancial information. Financial information of competitors would be useful for
comparison purposes. Nonfinancial information from newspapers and periodicals would also be useful.
In particular, investors and creditors would want to determine the prospects of Del Monte Foods for the
future by researching the food industry.
CHAPTER 3
3.11
Sales growth
2009 to 2010
2008 to 2009
21.0%
62.5%
Operating expense growth
22.2%
2010
Cost of goods sold
Gross profit margin
Operating profit margin
Average tax rate
Net profit margin
78.8 %
21.2
11.9
42.9
6.8
63.6%
2009
76.9 %
23.1
13.8
42.6
7.9
2008
70.8 %
29.2
20.0
43.8
11.3
Sales growth over the three-year period is strong, but the rate of increase decreased 2009-2010 relative
to 2008-2009. Sales growth could be the result of price increases, volume increases, or both. The
reduction in the gross profit margin indicates problems with inventory cost controls, the pricing of
products, or a combination of these factors. The decrease in the operating profit margin is partly a flowthrough from the gross profit margin and the result of increasing operating expenses; operating
expenses are increasing at a slightly faster rate than sales. Finally, the combination of problems with
inventory management, pricing, and control of operating expenses has produced a deteriorating net
profit margin. Tax expense has not been a contributing factor because the average tax rate decreased
between 2008 and 2010.
3.12
Jackrabbit, Inc.
Income Statement for the Year
Net sales
$1,840,000
Cost of goods sold
1,072,000
Gross profit
768,000
Selling expenses
270,000
General and administrative expenses
155,000
Depreciation expense
24,000
Operating profit
319,000
Other Income (expense)
Gain on sale of equipment
15,000
Equity losses
(9,000)
Interest income
13,000
Interest expense
(16,000)
Pre-tax income
322,000
Income tax expense
96,000
Net income
$226,000
3.13
Yarrick Company
Common Size Income Statement (in percent
For the Years Ended December 31, 2010, 2009, and 2008
2010
2009
2008
Net sales
Cost of goods sold
Gross profit margin
Selling, gen. & admin.
Research & develop.
Operating profit margin
Income tax expense
Net profit margin
100.0
58.2
41.8
17.7
16.0
8.1
3.0
5.1
100.0
54.2
45.8
20.0
21.3
4.5
1.3
3.2
100.0
53.7
46.3
29.1
40.3
(23.1)
(8.2)
(14.9)
Sales have increased 15.7 percent from 2008 to 2009 and 52.9 percent from 2009 to 2010 for
Yarrick Company. This increase is the result of volume or price increases. The gross profit margin has
declined each year. Yarrick has either lowered selling prices or costs of goods sold have risen and the
company has not passed on those increases to their customers.
Operating profit margin has surprisingly increased despite the decline in gross profit margin. This has
been achieved by significant reductions in selling, general, and administrative and research and
development expenses in 2009. In dollars these expenses increased in 2010, but from a percentage
standpoint decreased due to the large sales growth. The reduction in these expenses is concerning. To
stay on the cutting edge of their industry it is important for Yarrick to spend enough in research and
development. Cuts in this area may be detrimental to sales growth in the long-run. If advertising is
being reduced or key productive, personnel are being laid off to achieve the cost reductions in selling,
general and administrative expenses, this, too, can negatively impact the company's sales and profits. If
Yarrick has been able to reduce costs through the elimination of waste, this would be a quality change.
Net profit has increased from a loss of $20 to a profit of $12 from 2008 to 2010 due to the above
mentioned changes in operating expenses. Tax expense has not had a significant impact on the net
profit of the firm.
3.14
(a)
Gross profit margin:
2010
2009
2008
Tickets
45.1%
48.0%
51.0%
Concessions
91.2%
90.0%
88.3%
Total
59.5%
60.4%
61.0%
(b)
The overall gross profit margin of LA Theaters is declining. The cause of this decline is the result
of tickets rather than concessions. If the cost of acquiring films is increasing, then ticket prices have not
been raised proportionately, otherwise ticket prices have been reduced without a corresponding
decrease in cost of films. Concessions gross profit margin is increasing each year which has mitigated the
decline in overall gross profit margin. Concessions prices have been raised without corresponding
increases in costs or the costs of concessions have been declining without a change in prices.
LA Theaters should focus on selling as many concessions as possible since the profit margin is
quite high on these items. If ticket prices cannot be raised to compensate for increased costs, the
management should be sure that the theaters are filled to capacity as volume increases in ticket
revenues will result in higher gross profit margins. The cost of acquiring films is fixed, but does not
change proportionately with the volume of ticket sales
3.20
1.
The format of the income statement is similar to a single-step format. Revenues and expenses
are not separated by operating or nonoperating activities and intermediate profit figures are not shown.
This format does not allow the analyst to assess the core operations of the firm separate from the
investing and financing activities of the firm. By using a multiple-step format, the analyst can assess the
core operations and also identify strengths and weaknesses of the company by analyzing the
intermediate profit numbers--gross profit, operating profit and income before taxes, as well as net
profit.
2.
Sara Lee
Common Size Income Statement
(Percent)
Net Sales
Cost of sales
Gross profit
2007
2006
2005
100.0
100.0
100.0
61.5
61.3
59.9
38.5
38.7
40.1
Selling, general and administrative expenses
32.8
33.6
32.4
0.8
0.8
0.4
1.4
1.7
0.0
(1.0)
(1.0)
(1.0)
4.5
3.6
8.3
Interest expense
(2.2)
(2.7)
(2.5)
Interest income
1.0
0.7
0.7
3.3
1.6
6.5
(0.1)
1.4
1.1
Income from continuing operations
3.4
0.2
5.4
Net income from discontinued operations, net of tax
0.5
1.1
0.9
Gain on sale of discontinued operations, net of tax
0.2
3.5
0.0
4.1
4.8
6.3
Net charges for exit activities, asst and business dispositions
Impairment charges
Contingent sale proceeds
Operating profit
Income from continuing operations before income taxes
Income tax (benefit) expense
Net Income
(b)
2006-2007
2005-2006
Sales growth
7.1%
1.0%
Operating cost growth*
6.2%
6.1%
*Includes Cost of goods sold.
Effective tax rate
2007
2006
2005
(1.6%)
83.5%
17.6%
The analyst must decide which items on the income statement to include in the calculation of operating
profit and which items are nonoperating. There are many choices that could be made in reformatting
the income statement. Interest expense and interest income are financing and investing activities,
respectively and should definitely not be included in operating profit. Net charges for exit activities,
asset and business dispositions and impairment charges could be included as operating or nonoperating,
depending on how these items are viewed by the analyst. If these items appear to be items that occur
annually as part of the business operations then they should be part of operating profit. If, however, it is
believed these items are not reoccurring as part of daily operations, then it could be argued that they
should be included on the income statement after the operating profit calculation. The contingent sale
proceeds are an offset to expenses caused by a business transaction and therefore, have been included
as part of operating profit. The effective tax rates were copied from Note 23.
3.
Sara Lee's sales and operating cost growth have increased in both 2006 and 2007, but not
proportionately. Costs grew at about the same rate, but sales increased less than costs in 2006 causing
operating profit to drop. In 2007, sales increased faster than costs causing operating profit to increase
compared to 2006. Increases in sales could have been caused by either volume increases or price
increases.
Gross profit margin declined in all years. Possible causes of the decrease are a reduction in prices, an
increase in costs or a decrease in volume if there are significant fixed costs within cost of goods sold.
Other operating expenses are stable. Selling, general and administrative expenses increased slightly in
2006, but decreased in 2007. The contingent sales proceeds have also been stable year to year.
Interest expense increased in 2006, but decreased in 2007. These changes are the result of either
changes in the levels of debt and/or changes in interest rates.
The income tax rate is volatile. Sara Lee generates taxable losses in the United States, but profits in
foreign countries. When Sara Lee moves monies from foreign countries to the United States, tax is
incurred on the repatriation of earnings. Additional taxes were paid as a result of repatriation, especially
in 2006, which is the main explanation for the tax rate of 83.5%. Foreign taxes are lower than United
States taxes so this has reduced the effective tax rate all years. The favorable outcome of tax reviews
and audits in foreign countries also reduced taxes significantly all three years. In addition, in 2007, the
tax benefit is explained not only by lower foreign tax rates and benefits from audits, but also by
deductions related to the sale of capital assets.
Net income and a gain from the sale of discontinued operations added positively to the bottom line. This
is a one-time item which will not appear in future years. Net income from continuing operations
followed the same pattern as operating profit, decreasing in 2006 and then increasing in 2007.
Sara Lee operates in a highly competitive environment. The transformation plan the firm has
undertaken to improve operational efficiency, if successful, should help in controlling costs and
maintaining or slightly improving profit margins in future years. The increase in oil prices and ultimately
food prices will be a factor
CHAPTER 4
4.11
Little Bit, Inc.
Statement of Cash Flows
For Year Ended December 31, 2009
Cash flow from operating activities
Net income
$ 5,500
Non-cash expenses included in net income:
Depreciation
Deferred income taxes
18,000
500
Cash provided by (used for) current assets and liabilities
Accounts receivable
(6,500)
Inventory
(8,500)
Prepaid expenses
(4,000)
Accounts payable
2,000
Accrued liabilities
(16,000)
Net cash used by operating activities
($ 9,000
)
Cash flows from investing activities
Purchase of plant and equipment
(6,000)
Purchase of long-term investments
(1,000)
Net cash used by investing activities
Cash flows from financing activities
($ 7,000
)
Additions to long-term debt
17,000
Sale of common stock
15,000
Net cash provided by financing activities
$ 32,000
Increase in cash
$ 16,000
Analysis
Inflows
$
%
Long-term debt
17,000
53
Sale of common stock
15,000
47
Total
32,000
100
Operating activities
9,000
56
Purchase of property and equipment
6,000
38
Purchase of long-term investments
1,000
6
16,000
100
Outflows
Total
Little Bit, Inc. failed to generate cash from operating activities due primarily to growth in inventories,
receivables and prepaid expenses, combined with the payment of accrued liabilities. The firm may be
expanding as evidenced by the increase in capital assets.
The expansion is being supported primarily by long-term debt and the sale of common stock. It would
appear that Little Bit is using long-term debt only for the acquisition of plant and equipment, but also to
cover the negative cash flow from operations. This is generally not good to match long-term debt
maturities with the financing of current assets.
It is essential that Little Bit generate cash flow in the future to lessen the
need for debt, perhaps by controlling the growth of inventories and receivables.
4.12
(a)
Cash provided by operations in 2009 is considerably less than net income. The major reason is
the $288.2 million increase in accounts receivable. Inventory also increased substantially ($159.4
million) but the growth in inventory was comparable to what the firm experienced in 2008. Additions to
plant and equipment were about the same in 2009 as 2008, so the increase in receivables appears out of
line with overall expansion. Techno may be loosening credit to customers in order to stimulate sales
and income (note increase in net income between 2008 and 2009), but the result of the receivables
management is a sharp reduction in operating cash flow. If the firm continues to build receivables at the
same pace, Techno will likely experience negative operating cash flow in 2010.
(b)
2009
2008
Inflows
$
%
$
%
Operations
24,525
8.2
177,387
78.1
Investment activities
14,408
4.8
0
0
Short-term borrowings
125,248
41.8
45,067
19.9
Add. to long-term borrowings
135,249
45.2
4,610
2.0
299,430
100.0
227,064
100.0
94,176
49.8
93,136
21.2
0
0
34,771
7.9
Purchase of treasury stock
45,854
24.2
39,267
8.9
Dividends
49,290
26.0
22,523
5.1
0
0
250,564
56.9
189,320
100.0
440,261
100.0
Outflows
Add. to plant and equipment
Investment activities
Repay long-term borrowings
Change in cash
110,110
(213,197)
In 2008 Techno generated most of its cash (78%) internally through operations. About 20% came from
short-term borrowings, apparently to finance working capital. As the result of a strong operating cash
flow and a large cash account balance ($291 million) Techno was able to expand plant and equipment
while reducing by $250.5 million its long-term borrowings and to add long-term investments. A sharply
reduced cash flow from operations in 2009 (see discussion in "a" above) resulted in the need for heavy
long-term and short-term borrowings to support growth in receivables, inventory, and plant and
equipment. The apparent use of some long-term borrowing for working capital needs could be a
problem in the future. Techno also more than doubled its payment of dividends in spite of the decrease
in operating cash flow. Given, however, that Techno ended the year with a cash balance of $188.2
million, the firm does not appear to have any immediate liquidity problems. The analyst would want to
explore the cause of the buildup in receivables in 2009.
4.18
1.
Avnet, Inc.
Statement of Cash Flows Summary Analysis
For the Years Ended June 30, July 1, and July 2,
(dollars in thousands)
2007
%
2006
%
2005
%
Cash from operations
724,639
52
0
0
461,836
98
Issuance of notes in public
offerings
593,169
42
246,483
62
0
0
0
0
89,511
22
0
0
69,512
5
30,991
8
2,274
0
Cash proceeds from sales of
PPE
2,774
0
4,368
1
7,271
2
Cash proceeds from
divestitures
3,445
0
22,779
6
0
0
Effect of exchange rate
7,925
1
3,353
1
0
0
1,401,464
100.0
397,485
100.0
471,381
100.0
Inflows:
Proceeds from bank debt
Other financing, net
Total Inflows
Outflows:
Cash from operations
0
0
19,114
2
0
0
Repayment of notes
505,035
45
369,965
49
89,589
61
Repayment of bank debt
122,999
11
0
0
10,789
7
780
0
643
0
86
0
58,782
5
51,803
7
31,338
22
433,231
39
317,114
42
3,563
3
0
0
0
0
10,816
7
1,120,827
100.0
758,639
100.0
146,181
100.0
Payment of other debt
Purchases of PPE
Acquisitions and investments,
net
Effect of exchange rate
Total Outflows
Change in cash
280,637
(361,154)
325,200
Avnet has generated an increasing and positive dollar amount of net income from 2005 to 2007.
Cash from operations (CFO) was greater than net income in 2005 and 2007, but in 2006 the firm
generated a negative CFO. Increasing accounts receivable and decreasing accrued expenses caused CFO
to be lower, especially in 2006. Accounts payable increased significantly each year and inventories
decreased in 2005 and 2007 which helped increase the CFO amount. Inventories, however, increased in
2006 negatively impacting CFO that year. If sales growth is particularly high each year this could explain
the increasing accounts receivable and accounts payable.
Avnet generated 98 percent of cash from operations in 2005, but in 2006 negative CFO caused the firm
to rely on issuance of notes and bank debt to generate cash. The firm also received cash from
divestitures. CFO supplied over half the cash in 2007, with the balance mainly from issuance of notes
and other financing.
Much of the firm's excess cash is used to pay down the notes and bank debt which is a good sign that
Avnet is able to quickly reduce this debt. Purchases of property, plant and equipment are relatively
minor, as Avnet has been making acquisitions and investments in 2006 and 2007. These two items
explain the large amount of borrowings in the same years.
The acquisitions may also explain the increases in accounts receivable, inventories and accounts payable
that occurred. Overall it appears that Avnet will not have trouble generating cash in the future and
paying off debt. CFO was positive all years, except 2006, which is likely to be an aberration.
2.
Avnet is successful in generating positive CFO and has so far been able to make payments on
debt. They would be a good credit risk.
3.
Balance sheet information that would be useful includes:




the proportion of short-term versus long-term debt,
detail of types of debt outstanding (from notes),
amounts of debt due in the next five years (from notes), and
operating lease and other commitments the firm may have (from notes).
4.19
1.
Agilysys, Inc.
Statement of Cash Flows Summary Analysis
For the Years Ended March 31,
(dollars in thousands)
2007
%
2006
%
2005
%
152,648
23
0
0
25,692
26
0
0
788
1
0
0
1,147
0
0
0
0
0
485,000
75
0
0
0
0
423
0
0
0
0
0
10,107
2
5,442
7
4,007
4
1,854
0
0
0
0
0
Effect of exchange rate
0
0
367
0
810
1
Operating cash flowsdiscontinued operations
0
0
74,767
92
67,128
69
651,179
100.0
81,364
100.0
97,637
100.0
Cash from operations
0
0
25,902
15
0
0
Purchase of marketable
securities
0
0
6,822
4
0
0
10,613
5
27,964
16
0
0
Inflows:
Cash from operations
Proceeds-sale of invest.
Proceeds from marketable
securities
Proceeds from sale of business
Proceeds from escrow
settlement
Issuance of common shares
Excess tax benefit
Total Inflows
Outflows:
Acquisition of business
Purchase of PPE
Redemption of Prf. Sec.
Principal payment
Dividends paid
Effect of exchange rate
Operating cash flowsdiscontinued operations
Investing cash flows-investing
operations
Total Outflows
Change in cash
6,250
3
3,252
2
1,213
21
0
0
107,536
61
0
0
59,567
31
286
0
375
7
3,675
2
3,608
2
3,330
59
97
0
0
0
0
0
114,087
59
0
0
0
0
73
0
24
0
742
13
194,362
100.0
175,394
100.0
5,660
100.0
456,817
(94,030)
91,977
Agilysys, Inc. has volatile cash flow from operating activities (CFO) over the three years from
2005 to 2007. The firm experienced net losses from continuing operations all three years, although
income was positive when discontinued operations are included. Cash from operating and investing
activities has been separated between continuing and discontinued operations on the statement of cash
flows. CFO was positive in 2005 and 2007 despite the net losses; however, CFO in 2006 was negative.
In 2005, accounts receivable decreased and accounts payable increased causing CFO to be positive. Just
the opposite occurred in 2006. The increase in accounts receivable and decrease in accounts payable
contributed to the negative CFO being larger than the net loss. In 2007, the large increases in accounts
payable and accrued liabilities caused CFO to be positive, however, the firm will have to pay down those
balances in the near future.
Agilysys generated 95% of cash inflows in 2005, from operations if both continuing and discontinued
operations are included. The other 5% of cash was generated from the issuance of common stock and
changes in the foreign exchange rate. While no CFO was generated from continuing operations in 2006,
discontinued operations contributed 92% to cash inflows with 7% coming from the issuance of stock. In
2007, only 23% of cash came from CFO from continuing operations because 75% was cash received from
selling the firm's distribution-related business.
Cash outflows vary significantly each year. In 2005, a relatively small dollar amount of cash was used.
Dividends were the main use followed by purchases of property and equipment, investing related to the
now discontinued operations and repayment of long-term obligations. Redemption of mandatorily
redeemable preferred securities was the key use of cash in 2006. The firm made significant acquisitions
in 2006 and had negative CFO which contributed to the overall outflows of cash. In 2007, the
discontinued operations generated negative CFO. Agilysys was able to use cash from the sale of their
business to pay down a large portion of long-term debt and continued to acquire other businesses for
cash.
As noted in the excerpts the company has completed its transformation from its distribution business to
its computer systems business through acquisitions and divestitures. If this new strategy is successful,
Agilysys will hopefully begin to generate positive CFO. In the meantime, the firm has extra cash to use
from the sale of the business in 2007. Capital expenditures should be insignificant in the future and the
firm retired its long-term debt in 2007, so cash outflows will most likely consist of acquisitions and
dividends. If good acquisitions are made, the firm should be able to position itself well with respect to
cash.
2.
The statement of cash flows is extremely useful in making credit decisions. Although the
statement of cash flows is prepared from the balance sheet and income statement, it presents
information in a way that reveals how the firm is generating cash and how the cash is being used, over a
period of time. The volatility of CFO for Agilysys cannot be observed by looking at only the income
statement or the balance sheet. The reasons for this volatility can be determined fairly quickly by
looking at the statement of cash flows.
Chapter 5
5.1
Six items should be considered when assessing the area of revenue:






premature revenue recognition,
use of the gross versus the net basis of recording revenue,
vendor financing,
charges to the allowance for doubtful accounts,
price versus volume changes, and
real versus nominal growth of sales.
5.2
Depending on which inventory valuation method a firm uses, determines the value of cost of
goods sold on the income statement and ending inventory balances on the balance sheet. If
there is inflation or deflation of the products being valued, then cost of goods sold and ending
inventory using FIFO or LIFO will be higher or lower depending on the direction of price changes.
This in turn will impact whether net income is higher or lower.
If a firm uses the LIFO method of inventory valuation during inflationary times, it is possible to
record paper profits if more inventory is sold than is purchased or manufactured.
Understanding the inventory valuation methods, will allow the user of financial statements to
understand what changes in these numbers are real versus which changes have occurred only
on paper as a result of the choice of a particular method.
5.3
While writing down an asset's value results in lower net income in the period of the write-down,
relative to the next accounting period, net income will be higher. Companies that purposely
write-down assets or write-down more than is necessary may be trying to show positive
earnings growth in the following accounting period in hopes of impressing investors.
5.4
Restructuring charges could be either an operating or a nonoperating expense, depending on
the circumstances. If the restructuring charge is truly a one-time item that is not expected to
recur, then it could be viewed as nonoperating. Firms, who record restructuring charges often,
are more than likely recording items that are ordinary operating expenses in the course of their
business.
5.5
Purchasing treasury stock for investment purposes would be appropriate for firms that believe
the market has undervalued their stock price. Some firms also purchase their own common
stock in order to reissue it for employee stock programs. This is appropriate for preventing the
dilution of the stock price for current investors. It would be a poor decision to purchase
treasury stock for the sole purpose of trying to boost earnings per share, especially if the firm
does not have enough cash to cover daily operating needs and long-term needs such as
purchasing property, plant and equipment and repaying debt.
5.6
Rather than viewing this as a one-time event, analysts should consider the implications of such a
charge. DMR should have been writing off accounts of customers who were unlikely to pay on a
yearly basis. The one-time charge in such a large amount should be a red flag that either the
firm's accounting department is not competent, or that there is the possibility of manipulation
of the reserve account, allowance for doubtful accounts.
5.7
The gross profit margin could increase as a result of selling price increases or decreases in the
costs of obtaining inventories. A third reason could be due to high fixed costs in the firm which
do not increase or decrease with demand, such as depreciation of plant and equipment. With a
20 percent sales growth rate, excess capacity could be used without a corresponding increase in
cost of goods sold. These would all be plausible reasons for the higher gross profit margin.
If a firm had written down a significant amount of inventory in the prior year, the following year,
there would not be a corresponding write-down of inventory and gross profit margin would look
higher relative to the prior year's number. This would be a quality issue that the analyst would
want to take into consideration when analyzing a firm's financial statements.
5.8
Salaries and wages are generally not considered to be discretionary expenses, however, paying
higher salaries than is the norm, could be considered as partly discretionary. It appears that
Costco is choosing to pay higher salaries and offer better benefits to their employees than WalMart. By doing this, Costco appears to be operating more efficiently and effectively than WalMart. Employee turnover is quite a bit lower at Costco and sales per square foot, profits per
employee, and operating income growth are better at Costco.
5.9
Students will have a variety of answers to this question, but an example of a possible
response follows:
Conflicts of interest can arise between what management wants investors and creditors
to see and the economic reality of transactions even when the accounting rules are followed.
For example, firms may legally record leases as operating leases, whereby information about the
obligations are revealed only in the notes, instead of directly on the balance sheet. By
negotiating lease agreements that meet the criteria for operating leases as prescribed by the
FASB, management can make sure the obligation is not shown as a liability, similar to a capital
lease.
The timing of revenues and expenses can be planned so that the recording of the item occurs in
one year as opposed to another year. In a year in which net income is lower than expected,
management could choose to sell assets in order to report gains on sale. While there is nothing
wrong with completing the sales transaction per se, the intent of selling the asset when it can
mask an otherwise poor year would be considered poor quality of financial reporting.
5.10
There is no response presented here as a variety of firms could be chosen.
5.11
Since the SEC homepage changes as updates are made, students may find different items
available each semester.
5.12
The quality of financial reporting for Intel is good. Intel has explained items well in their
management discussion and analysis and the notes to the financial statements. One
questionable area that was discussed in Chapter 2 is whether the allowance for doubtful
accounts may have been overestimated. Intel does use off-balance sheet financing and has a
few potential liabilities, but these items are discussed as they should be and given Intel's solid
financial position, the firm has no reason to purposely try to hide information.
5.13
(a) I.
1.
Premature revenue recognition
Sales
According to Note 1, "Significant Accounting Policies", Kodak records revenue correctly. Detailed
explanations are given by Kodak with regard to how all different types of revenue are recorded. (Note 1
of Form 10-K)
2.
Gross vs. net basis
This item does not affect Kodak.
3.
Allowance for doubtful accounts
The following is an analysis of the relationship between sales, accounts receivable and the allowance for
doubtful accounts for Kodak.
(in millions)
2007
2006
$10,301
$10,568
(2.5)
Accounts receivable, gross
2,053
2,206
(6.9)
Less: allowance for doubtful accounts
(114)
(134)
(14.9)
$1,939
$2,072
Sales
Accounts receivable, net
% change
The relationship between sales, accounts receivable and the allowance for doubtful accounts is normal.
As the percentage of sales has decreased, accounts receivable and the allowance account have also
decreased. The percentage of the allowance account relative to total accounts receivable seems
reasonable at 5.6 percent and 6.1 percent, respectively, for 2007 and 2006. Amounts actually written off
have declined in 2007 compared to prior years, so a lower allowance for doubtful accounts balance
makes sense.
4.
Price vs. volume changes
Sales decreased 2.5 percent from 2006 to 2007. The overall decrease was a result lower volume of sales
in traditional businesses. The Graphic Communications Group is the only segment that experienced
increasing sales due to volume and favorable foreign exchange.
5.
Real vs. nominal growth
Sales (in millions)
As reported (nominal)
Adjusted (real)
2007
2006
$10,301
$10,568
(2.5)
10,301
10,867
(5.2)
Using base period CPI (1982-1984 = 100)
(2007 CPI/2006 CPI)
x
2006 sales
=
Adjusted sales
(207.3/201.6)
x
10,568
=
10,867
Adjusting for inflation indicates that sales decreased more than the nominal decrease in sales.
% change
II.
Cost of goods sold
6.
Cost-flow assumption for inventory
Kodak uses FIFO or average cost for all of its inventories. FIFO produces lower quality earnings, but an
inventory value on the balance sheet closest to current cost.
7.
Base LIFO layer liquidation
This item does not affect Kodak.
8.
Loss recognition on write-down of inventories
Kodak indicates in Note 1 that the firm provides reserves for obsolete inventories. The amount of any
write-downs in 2007 has been combined with asset impairments in Note 17.
III.
Operating Expense
9.
Discretionary expenses
Kodak has the following discretionary expenses:
(in millions)
2007
2006
2005
Advertising expense (from Note 1)
$394
$366
$460
535
578
739
Research and development
Kodak decreased advertising expenses in 2006. There is no specific explanation provided in the
management discussion and analysis for the decline in advertising, but it could be a result of elimination
of traditional products. In 2007 Kodak has increased advertising for new products. If the reduction was
in the film area only this is probably a good place to cut costs, but if advertising is not being maintained
or increasing for digital products, this could negatively impact future sales.
Research and development (R&D) costs have declined each year. According to management, the
reductions in 2007 are a result of realignment of resources and the timing of development projects. In
2006, the decrease was attributed to significant spending reductions related to traditional product lines
and integration synergies within the GCG segment. Also contributing to the decline in 2006 is that
purchased in-process R&D was written off in 2005 as part of the R&D amount, instead of as a separate
line item, causing 2005 R&D to be higher than normal. It is poor quality reporting to combine purchased
in-process R&D with actual ongoing research and development.
10.
Depreciation
Kodak uses the straight-line method of depreciation which is generally of lower quality.
11.
Asset impairment
Kodak reports $282 million of asset impairments in Note 17 but has combined the number with
inventory write-downs. Other intangible asset impairments are recorded in Note 14 in the amount of
$46 million for 2007.
12.
Reserves
Kodak has reserve accounts for the allowance for doubtful accounts, restructuring charges, warranty
costs and environmental liabilities (See Notes 2, 10, 11 and 12.)
13.
In-process research and development
As noted in 9 above, Kodak has not reported this item separately, but as part of the R&D expense
overall. This is poor quality of financial reporting.
14.
Pension accounting-interest rate assumption
Kodak recorded net pension income of $181 million for U.S. pension plans and net pension expense of
$50 million for non-U.S. pension plans in 2007. Kodak's U.S. pension plans are currently overfunded by
$2,135 million, but the non-U.S. pension plans are underfunded by $595 million. Kodak has maintained
an assumed long-term rate of return on plan assets of 8.99% on U.S. plans, but has increased the rate on
non-U.S. plans from 7.99% to 8.10%. Since the actual returns on plan assets have been higher than the
expected returns, the assumed rate is reasonable. Of concern is the underfunded non-U.S. pension
plans combined with the large amounts accrued for other postretirement benefits of $2,524 million.
IV.
Non-operating Revenue and Expense
15.
Gains (losses) from sale of assets
Gains from sales of assets were recorded in 2007, 2006, and 2005, in the amounts of $139, $70, and $65
million, respectively, according to Note 14. There is also a gain from a sale of a business in 2007 in the
amount of $19 million.
16.
Interest income
Amounts for interest income are included in Note 15 and the amounts have increased each year from
$24 million in 2005 to $59 and $95 million in 2006 and 2007.
17.
Equity income
Equity income is included in Note 15, however, Kodak has sold their equity investments. The $5 million
amount shown in Note 15 related to one of the equity investments is actually an impairment charge on
the investment.
18.
Income taxes
Kodak's effective tax rate has been volatile (benefit of 20 percent in 2007 and a provision of
approximately 37 percent in 2006 and 2007) due largely to the effects of the valuation allowance
account.
Net deferred tax assets are shown for both 2007 and 2006, however the valuation allowance is large
which indicates that Kodak is not currently expecting to be able to use all the deferred benefits.
Pensions and postretirement obligations, foreign tax credits and tax loss carryforwards have caused the
largest amount of deferred tax assets.
19.
Unusual items
Kodak does not have this category on their income statement.
20.
Discontinued operations
Kodak has earnings from discontinued operations of $881 million in 2007. Note 23 shows the details of
the amounts shown on the income statement.
21.
Extraordinary items
Kodak does not have these items.
V.
Other issues
22.
Material changes in number of shares outstanding
The number of common shares outstanding has been relatively stable.
23.
Operating earnings, a.k.a. core earnings, pro forma earnings or EBITDA
Kodak shows pro-forma financial information in Note 22 to show the effects of acquisitions as if they
had occurred at the beginning of the periods presented.
Quality of Financial Reporting -- The Balance Sheet
Kodak has included "Commitments and Contingencies" (Note 11) on the face of their balance
sheet, but also has guarantees that should be considered when assessing the potential
obligations of the firm. These items are discussed in Note 12. According to Notes 11 and 12,
Kodak has commitments and potential obligations totaling $1,659 million not reported directly
on the balance sheet. These items are as follows (in millions):



Operational commitments - $1,130
Operating leases - $412
Guarantees - $117
Quality of Financial Reporting -- The Statement of Cash Flows
There are no apparent problems of quality of financial reporting revealed on the statement of
cash flows.
(b)
A variety of answers is possible depending on the overall objective in adjusting net
earnings. The following is one possible solution:
(in millions)
Net earnings as reported in 2007
$676
Adjustments
c. add back loss recognized on write-down
of assets
328
h. deduct gain from sale of assets
(158)
j. add back impairment charge on equity investment
5
m. deduct gain from discontinued operations
(881)
($30)
29
Chapter 6
6.1
The credit analyst is concerned with the ability of the borrower to repay interest and
principal on loans. Questions raised in a credit analysis would focus on the borrowing cause, the
firm's capital structure, and the source of the debt repayment. The investment analyst attempts
to estimate the future earnings stream in order to attach a value to the securities being
considered. Questions raised in an investment analysis would focus on the company's
performance record, future expectations and the firm's competitive position, risk in the capital
structure and the expected returns.
6.2
Financial ratios can serve as screening devices, indicate areas of potential strength or
weakness, and reveal matters that need further investigation. But financial ratios do not provide
answers in and of themselves, and they are not predictive. Financial ratios should be used with
caution and common sense, and they should be used in combination with other elements of
financial analysis. It should also be noted that there is no one definitive set of key financial ratios,
there is no uniform definition for all ratios, and there is no standard that should be met for each
ratio. Finally, there are no “rules of thumb” that apply to the interpretation of financial ratios.
Each situation should be evaluated within the context of the particular firm, industry, and
economic environment.
6.3 Liquidity ratios measure a firm’s ability to meet cash needs as they
arise. Activity ratios measure the liquidity of specific assets and the
efficiency of managing assets. Leverage ratios measure the extent of a firm’s
financing with debt relative to equity and its ability to cover interest and
other fixed charges. Profitability ratios measure the overall performance of a
firm and its efficiency in managing assets, liabilities, and equity. Market
ratios measure returns to stockholders and the value the marketplace puts on
a company’s stock.
6.4 The Du Pont System helps the analyst see how the firm's decisions
and activities over the course of an accounting period interact to produce an
overall return to the firm's shareholders. By reviewing the relationships of a
series of financial ratios, the analyst can identify strengths and weaknesses
as well as trace potential causes of any problems in the overall financial
condition and performance of the firm.
30
The ratios which are looked at include the return on investment (profit
generated from the overall investment in assets) which is a product of the net
profit margin (profit generated from sales) and the total asset turnover (the
firm’s ability to produce sales from its assets). Extending the analysis the
return on equity (overall return to shareholders, the firm’s owners) is derived
from the product of return on investment and financial leverage (proportion
of debt in the capital structure). Using this system, the analyst can evaluate
changes in the firm’s condition and performance, whether they are indicative
of improvement or deterioration or some combination. The evaluation can
then focus on specific areas contributing to the changes.
6.5
Current Ratio
725,000
1.53 times
475,000
Quick Ratio
400,000
0.84 times
475,000
Average Collection Period
275,000
67 days
1,500,000/365
Inventory Turnover
1,200,000
3.69 times
325,000
Fixed Asset Turnover
1,500,000
3.57 times
420,000
Total Asset Turnover
1,500,000
1,145,000
31
1.31 times
Debt Ratio
875,000
76.4 %
1,145,000
Times Interest Earned
200,000
2.78 times
72,000
Gross Profit Margin
300,000
20.0 %
1,500,000
Operating Profit Margin
200,000
13.3 %
1,500,000
Net Profit Margin
76,800
5.1 %
1,500,000
Return on Total Assets
76,800
6.7 %
1,145,000
Return on Equity
76,800
28.4 %
270,000
The current position is deteriorating, as measured by the current and quick ratios, and is below
the industry average. The average collection period has increased and is slightly longer than the
industry average, indicating potential weakness in credit and/or collection policies. The
inventory turnover has slowed and is well below competitors' levels. Eleanor's Computers is
apparently overstocked with inventory due to inventory management problems and/or sluggish
sales.
32
Capital asset efficiency is in good shape, as evidenced by an improving and above average fixed
asset turnover. The efficient management of fixed assets approximately offsets the poor
inventory turnover, and the total asset turnover is only slightly weaker than the industry.
The inventory has apparently been financed with debt, resulting in an increasing debt ratio,
which is well above industry standards. A combination of too much debt and low profit is
producing difficulty in covering interest payments, shown by times interest earned.
The gross profit margin has slipped due either to lack of cost controls for products sold, the
need to sell products at discounts, or both. The operating profit margin, however, reflects good
control of operating expense. The overall return, as measured by the net profit margin, has
fallen because of the combination of cost/pricing policies and high interest charges.
The return on investment, which has declined and is below the industry average, reflects
decreasing profitability and the overstocking of inventory. Return on equity is above the
industry average and is trending upward. Although the high debt ratio improves the return on
equity, it also increases risk. The increased use of financial leverage has more than offset the
decrease in profitability:
Net Profit
x
Margin
Total Asset
=
Turnover
Return on
Investment
5.12
x
1.31
=
6.71
Return on
x
Financial
=
Return on
Investment
Leverage
33
Equity
6.71
x
4.24
=
28.44
6.6
Luna's current ratio has increased and is above the industry average, the average
collection period has shortened and is less than the industry average, and the inventory
turnover ratio has improved; the ratios indicate that Luna has no obvious problems with
liquidity or the management of inventory and receivables. Both the total asset turnover and
fixed asset turnover ratios have declined, however, and are below the industry. Problems with
asset utilization are apparently caused by the management of capital assets. Luna's expansion
of capital assets has been more rapid than sales growth, given the declining ratio; the firm may
be underutilizing its plant and equipment or may not yet be benefiting from asset growth.
Luna's debt ratio is stable and below the industry, while interest coverage is above industry; the
declining fixed charge coverage implies that lease payments for Luna are excessive. The
decreasing net profit margin is apparently attributable to escalating operating costs rather than
cost of goods sold, and the operating expenses are traceable to costs associated with the capital
asset expansion and lease payments. These problems have adversely affected the overall
returns.
6.7
(a) FIFO
(b) LIFO
Gross profit margin
53.33 %
25.83 %
Operating profit margin
33.33 %
5.83 %
Net profit margin
19.93 %
2.06 %
Current ratio
1.61
1.10
Quick ratio
0.77
0.77
(c)
The ratios calculated using FIFO give the appearance that Rare Metals, Inc. is doing well,
while the ratios calculated using LIFO give the opposite effect. Based on the cost of goods sold
(COGS) and ending inventory amounts, prices of the metal have been increasing. The first goods
purchased, which are the lower priced items, are included in COGS under FIFO. Using LIFO,
however, a better match is made with current cost and revenues and a more realistic picture of
profitability is illustrated. The company will most likely have to replace goods sold at the higher
34
price in the future. The difference in profit margins has resulted from a “paper” profit recorded
under the FIFO method.
Ending inventory is undervalued when LIFO is used during inflation. The FIFO valuation is a
better reflection of the current market price of Rare Metals, Inc.’s inventory. As a result the
current ratio of 1.61 is a more accurate representation than 1.10. The quick ratios are identical
because inventory has been eliminated from the calculation, and inventory is the only difference
in the numbers being compared.
(d)
Yes, cash flow from operating activities will differ due to the difference in taxes paid.
Assuming that the inventory method is the only cause of differences in amounts on the income
statement, the amount of tax expense is greater when FIFO rather than LIFO is used. Although
tax expense may not be identical to cash paid for taxes, if in this case it is assumed that taxable
income and earnings before taxes are the same, Rare Metals Inc. would have paid $289 million
more in taxes if they chose the FIFO method instead of the LIFO method. While profit margins
would be higher using FIFO, cash flow from operations would be higher using LIFO. It is
important to note that it is cash, not profit or earnings, which must be used to pay the bills!
6.8
(a)
XYZ is more liquid than ABC. XYZ’s current and quick ratios are both above one and the
cash-flow liquidity ratio is close to one, indicating the company should be able to pay current
liabilities as they come due. ABC’s liquidity ratios are all below one. It appears that ABC must
find external funding in the short-term to be able to pay current liabilities. XYZ generated more
than 2.5 times the cash from operations in compared to ABC.
Total asset turnover is the same for both firms with ABC showing better inventory efficiency
than XYZ, but XYZ is managing accounts receivable and fixed assets better than ABC.
ABC is highly leveraged compared to XYZ. This is not surprising given the differences seen in the
liquidity area between the two firms. The cash flow adequacy ratio is over one for XYZ, which
means the firm has no trouble covering capital expenditures, debt repayment and dividends
with cash from operations. ABC is only covering $0.43 on every dollar of these same items with
cash generated from their operations.
35
ABC generates higher operating and net profits than XYZ, and therefore has higher return on
assets and equity ratios. The return on equity ratio is extremely high due to the fact that ABC
uses a significant amount of debt (76%) and is generating sufficient returns to cover the cost of
the debt. XYZ, while not as profitable, is translating their profits into cash much better than
ABC.
(b)
ABC
XYZ
$41
$35
$4.59
$1.19
8.9
29.4
Stock Price
EPS
PE Ratio
The PE ratio indicates the value being placed by the stock market on a company’s earnings. A
higher value is being placed on XYZ compared to the value placed on ABC. Investors may be
placing a higher value on XYZ, because they understand the importance of cash flow from
operations and view it as a better measure than accrual-based profits.
6.9
Current
Quick
Net Wk. Capital
Debt
(a)
D
N
N
I
(b)
N
N
N
N
(c)
I
I
I
D
(d)
D
D
D
N
(e)
D
N
D
I
(f)
N
N
N
N
(g)
I
I
I
I
(h)
I
I
I
D
(i)
N
N
N
D
(j)
N
D
N
N
36
(k)
D
D
N
I
(l)
I
N
N
D
The instructor might want to discuss why a firm would make a specific transaction at the end of
the period to affect certain ratios. For example, consider item (l). If the objective is to increase
the current ratio and decrease the debt ratio, perhaps to meet requirements in a loan covenant,
the firm could pay cash to a supplier to reduce payables at the end of the accounting period.
6.10
(a)
Debt
Equity
40+10
Debt Ratio*
40
= 50%
90+10
= 40%
90+10
18
18
Times Interest Earned*
= 2.86 x
= 3.75x
4.8+1.5
4.8
Operating Profit
18,000,000
18,000,000
Interest Expense
6,300,000
4,800,000
11,700,000
13,200,000
Income tax exp. (40%)
4,680,000
5,280,000
Net Income
7,020,000
7,920,000
Shares Outstanding
800,000
1,000,000
Earnings per share
$8.78
$7.92
Earnings before tax
7,020
7,920
Return on Equity
= 14.04%
50,000
37
= 13.20%
60,000
7,020+6,300(1-0.4)
Return on Assets (adjusted)
7,920+4,800(1-0.4)
= 10.80
100,000
= 10.80
100,000
14.04
13.20
Financial Leverage Index
= 1.3
10.80
= 1.2
10.80
*Numbers are in millions
(b)
Use of debt would increase the debt ratios from 44% to 50%, while equity financing
would reduce the debt ratio to 40%. Interest coverage would decline from 3.1 times to 2.86
times if debt is employed; times interest earned would increase to 3.75 times with stock
financing. Earnings per share would be higher with the debt financing. The financial leverage
index is greater than 1, indicating the successful use of financial leverage under either
alternative, but is higher with debt financing.
The Board would want to consider each of these ratios and other factors as well. The additional
risk resulting from adding debt would likely exert downward pressure on the price to earning
ratio and thus could result in a decreased share price. The Board would want to review the
reasonableness of the projection for operating profit, including the stability and predictability of
the firm's earnings stream in the past. Other factors would include the marketability of stock
relative to the current and future availability of credit; interest rate expectations; the effect of
each alternative on the cost of capital; and the amount and timing of planned future expansions.
6.11 At first glance, it appears that Wal-Mart has poor short-term liquidity. The current, quick
and cash flow liquidity ratios are all below 1.0 and decreasing from 2007 to 2008. This means
the firm does not have as many current assets or liquid items to cover current liabilities. The
cash conversion cycle, however, offers a much better picture of the firm. The average collection
period is insignificant at 4 days which makes sense. Wal-Mart takes bank credit cards such as
MasterCard and Visa and is, therefore, not at risk if customers default. Days inventory held has
improved by two days and is currently at 45 days which does not seem too large for a giant
retailer. The days payable outstanding is stable at 39 days which indicates that Wal-Mart pays
suppliers in a timely manner. The cash conversion cycle has dropped one day to ten days in 2008
38
which is a relatively short conversion period. The fact that Wal-Mart is able to convert sales into
cash so quickly may explain why they are successful with a current ratio below one. Further
evidence that Wal-Mart does not have liquidity problems is the positive and increasing cash
from operations number.
Operating efficiency is good as evidenced not only by the cash conversion cycle, but also by the
fixed and total asset turnover ratios which are stable.
6.12 AMC had a risky capital structure in 2006, with over 70 percent debt, most of which was
long-term. It is good, however, that AMC has been able to reduce their risk by reducing debt in
2007. The debt ratio of 66.1% is high, but not nearly as risky. The interest (accrual-based and
cash-based) and fixed charge coverage ratios are low, but have improved from 2006 to 2007. An
increase in operating profit appears to have also contributed to an increase in cash flow from
operations. In addition, the lower debt most likely caused interest expense to be smaller in
2007. Cash flow adequacy is also low and below one, indicating that AMC cannot cover capital
expenditures, debt repayments and dividends with cash generated from operations. The ratio
has improved in 2007 which is a positive sign.
The profitability of AMC is improving. The gross profit margin has improved due to better cost
control or an increase in prices. Operating profit has benefited from the improved gross profit
margin, but also from reduction of other operating costs as well. Net profit is higher than
operating profit in 2007 and has improved from a loss in 2006 to a profit in 2007. This may be a
result of the reduction in debt causing lower interest expense. Return on assets and return on
equity were negative in 2006 and because of the improved profitability in 2007, are now
positive. Return on equity is almost three times greater than return on assets due to the high
leverage of AMC. The cash return on assets has improved significantly over the past year.
AMC has clearly made the appropriate strategic moves to improve the capital structure and the
profitability of the firm from 2006 to 2007. Long-term solvency at this point is not a concern.
6.13 Writers of the 2010 annual report will probably want to emphasize
rebounding in 2010 from an abnormal year in 2009. They will want to point
out reasons for the improvement in 2010, showing how the company is
39
building for continued success. The "Summary of Analysis" section at the
end of Chapter 5 provides an overview of the positive aspects of R.E.C.,
Inc.'s performance and outlook. The annual report will focus on strengths:
sales growth, well-managed expansion, increased profit, positive cash flow,
effective cost controls, improvement in receivables and inventory
management, overall favorable outlook for economy, industry and
geographic location. There will be some need to explain the identified
problems, such as the negative cash flow in 2009 and how the firm has
recovered, which is actually a major plus.
6.14 There is no solution presented for this problem since students will choose different
industries. Having students share what they have learned from their research can lead to
interesting discussions.
6.15 There is no solution presented for this problem since students will choose different
industries. Having students share what they have learned from their research can lead to
interesting discussions.
40
6.16
(a) and (b)
2007
2006
2005
Ind.
Avg.*
Short-term liquidity
Current ratio
2.79
2.15
2.2
Quick ratio
2.39
1.64
1.1
Cash flow liquidity ratio*
3.27
2.42
Average collection period
25 days
28 days
53 days
Days inventory held
67 days
92 days
81 days
Days payable outstanding
47 days
48 days
38 days
Cash conversion cycle
45 days
72 days
96 days
Operating efficiency
Accounts receivable turnover
14.88
13.06
7.0
Inventory turnover
5.46
3.98
4.5
Accounts payable turnover
7.81
7.61
9.5
Fixed asset turnover
2.27
2.01
9.1
Total asset turnover
.69
.73
1.1
Leverage
Debt ratio
23.16%
24.02%
53.9%
Long-term debt to total
capitalization
4.43%
4.79%
Debt to equity
0.30
0.32
0.8
Financial leverage index
1.30
1.31
Times interest earned
548 times 236 times 636 times 6.1 times
Cash interest coverage
1,027 times 523 times 669 times
Fixed charge coverage
50 times 32 times
72 times
Cash flow adequacy**
1.65 times 1.20 times 1.89 times
Profitability
Gross profit margin
51.92%
51.49%
59.36%
34.2%
Operating profit margin
21.43%
15.97%
31.14%
4.6%
Net profit margin
18.20%
14.26%
22.31%
Cash flow margin
32.93%
30.02%
38.18%
Return on total assets
12.54%
10.43%
Return on equity
16.31%
13.72%
Cash return on assets
22.69%
21.96%
*includes trading assets
**includes short-term debt
41
Market measures
Earnings per share
PE ratio
Based on closing price
Dividend payout rate
Dividend yield
Based on closing price
2007
2006
2005
$1.20
$0.87
$1.42
22.30
37.50%
23.28
45.98%
26.76%
20.25%
Ind.
Avg.
* Industry average is from The Risk Management Association, Annual Statement Studies, 2007;
SIC #3674
(c)
As requested, an evaluation of Intel has been completed. The following report includes an
evaluation of short-term liquidity, capital structure and long-term solvency, operating efficiency and
profitability, market measures and quality of financial reporting issues. Strengths and weaknesses are
identified and the investment potential and creditworthiness of the firm are assessed.
Short-term Liquidity
Intel's short-term liquidity is impressive. The current and quick ratios are both increasing due to
the increase in cash, short-term investments and trading assets, while current liabilities are
stable. The current and quick ratios in 2007 are above the industry average. The cash-flow
liquidity ratio increased as well due to the increases in liquid assets and increasing cash from
operations. Intel has a significant amount of cash and short-term investments and therefore,
should not have problems paying debt as it comes due. In fact, cash and short-term
investments are 28% of total assets. This company has no problem generating cash from
operations as evidenced by the statement of cash flows.
Accounts receivable are decreasing despite an increase in sales which is positive for Intel since
this means the firm is probably collecting cash efficiently from its credit customers. The
collection period has improved by three days and is less than half the industry average. One
concern is that two customers account for 35% of accounts receivable and sales and a default by
either customer would be significant to the company. The two customers are Dell and HewlettPackard so the risk of default is probably small. It appears that in 2005 the firm may have
overestimated the allowance for doubtful accounts. The account balance at the end of 2005 was
much larger than it needed to be and Intel has reversed the charges in 2006 and 2007, thus
increasing net income in those two years. Intel actually had net recoveries of bad debts in 2007
42
in the amount of $1 million indicating that the firm does a superb job collecting on accounts
receivable. At the end of 2007 the allowance account seems to be in line with what it should be
given the low rate of defaults that Intel experiences.
Days inventory held has decreased significantly and is now below the industry average. This is
good because of the rapid obsolescence of products in the high technology industry. According
to the management discussion and analysis (MDA) the reduction of inventories was a result of
lower product costs and reclassification of inventories associated with an anticipated
divestiture.
Days payable outstanding has decreased by one day indicating Intel is paying suppliers faster,
however, Intel takes longer to pay than the competition. At 47 days this is probably not a
concern. It is possible that Intel, due to its excellent short-term liquidity, is better able than its
competitors to obtain more favorable credit terms from its suppliers.
The cash conversion cycle has improved by 27 days due to the large decrease in days inventory
held and the better collection period.
Overall the short-term liquidity of Intel is excellent. Compared to the industry Intel operates
within, their ratios and account balances are better than their competitors. Intel has higher
amounts of cash and investments than the competition.
Operating Efficiency
As discussed under short-term liquidity, Intel has improved the turnover of accounts receivable
and inventory and is also paying accounts payable faster.
The fixed and total asset turnover ratios for Intel are low compared to the competition. Intel
invests heavily in fixed assets to increase capacity, while keeping inventory levels low, a strategy
opposite their competition. The fixed asset turnover increased due to increasing sales and
decreasing net property, plant and equipment. The total asset turnover declined. This is not a
result of the poor utilization of working capital or fixed assets, but rather a result of the large
increase in cash and investments.
43
Capital structure and long-term solvency
Intel has little debt, especially when compared to their competition. Most of the company's
debt is short-term and all debt can be covered with the current levels of cash and short-term
investments. Liabilities make up approximately 23 percent of total assets, making Intel's capital
structure low risk.
Intel is generating profits and a large amount of cash from operations, allowing the company to
cover interest and lease payments easily. Cash flow adequacy is over one meaning Intel
generates a lot of excess cash each year. The financial leverage index indicates Intel is using
debt successfully in both 2007 and 2006. Should Intel need to borrow in the future, the large
equity cushion will allow them to obtain financing readily.
Profitability
Revenues for Intel increased in 2007 after a decline in 2006. Operating costs increased in 2006
causing a significant decline in profitability, however, in 2007 operating costs did not increase
proportionately with revenue, therefore, profitability increased. Digital Enterprise Group revenues
increased due to higher volume and higher average selling prices. The Mobility Group revenues
increased due to volume, as selling prices decreased.
The gross profit margin decreased significantly over the three year period, although it increased
slightly from 2006 to 2007. The MDA explains that the drop in gross margin was largely a result
of the implementation of the FASB rule requiring the firm to record share-based compensation.
The numbers are not comparable to 2005 as share-based compensation was not reported prior to
2006. Intel is projecting that their gross profit margin will return to higher levels (around 57%) in
2008 due to lower costs and the elimination of lower margin businesses.
Operating profit decreased significantly from 2005 to 2006, as a result of the implementation of
the FASB rule requiring share-based compensation be recorded. From 2006 to 2007 operating
profit increased as a result of changes in the operating expenses other than cost of goods sold.
Research and development costs (R&D) declined in 2007 due to lower development process costs
as Intel transitioned from R&D to manufacturing using the 45nm process technology. Marketing,
general and administrative expenses also declined in 2007 as a result of lower headcount, lower
share-based compensation and lower advertising expenses. The lower costs are attributed to the
restructuring program Intel has undertaken to increase efficiency and improve cost structure. The
firm is beginning to see these results in 2007 as evidenced by the increased profit numbers.
Amortization expense has declined in 2007 as a result of fully amortized intangible assets.
44
Intel has net overall gains from equity investments in 2006 and 2007 although the amount is
insignificant. Interest income and other, net, is a combination of gains from divestitures and
interest income. Divestiture gains were less in 2007 compared to 2006; however, interest income
was higher due to higher investment balances and higher interest rates.
Intel's effective tax rate is relatively low compared to the statutory rate of 35 percent. The firm
has benefited from lower foreign tax rates, export sales benefits, domestic manufacturing benefits
and research and development credits. The exceptionally low rate in 2007 was a result of
settlements which will probably not occur in future years, therefore, one could expect future
effective tax rates to be around 28%.
Net profits are healthy and increasing. The return on assets (both accrual-based and cash-based)
and return on equity have improved in 2007 as a result of the increasing profits without a
proportional increase in assets and equity. If costs are managed well, profits should continue to
trend upward. To continue to be successful, Intel must maintain good control of expenses, while
continuing to develop cutting edge products.
Market Measures
Earnings per share decreased in 2006, but has increased in 2007. The increasing sales and profits
have not caused the PE ratio to increase which is surprising. The PE ratio dropped slightly in
2007 indicating that the marketplace is not placing as high a value on Intel despite the excellent
year Intel had in 2007. This could be due to the riskiness of the high technology industry
combined with the concerns about the general economy, in particular rising oil prices and the
housing and mortgage crisis.
The dividend yield offers a good return for investors. Intel has chosen to increase their dividends
every year while also repurchasing their common stock. The amount of common stock being
repurchased each year has declined from 2005 to 2007.
Quality of Financial Reporting
Intel has disclosed key information as required in their annual report and Form 10-K. The only
questionable item is whether Intel in prior years had overstated their allowance for doubtful
45
accounts, a reserve account that can be manipulated. This account appears appropriate in
2007. Overall, the quality of financial reporting is good.
Strengths
Strong cash flow from operations
Solid short-term liquidity
Better receivables, inventory and fixed asset management
Low debt levels
Increasing sales and profits
Increasing dividends
Weaknesses
Reliance on two customers
Riskiness and competitiveness of high technology industry
Investment potential
Intel's stock prices have dropped due to the overall economic downturn. Since revenues and
profits are increasing and Intel's financial position is excellent, Intel's stock may be a good value
at this time. Investors may have to be patient and willing to wait for a turnaround in both the
general economy and the technology industry, so the investment would not be recommended
for those investors wanting a quick profit.
Creditworthiness
Intel's solid short-term and long-term solvency combined with strong cash flow from operations
and a low debt ratio make this company a good credit risk.
46
6.17
47
Eastman Kodak
(EK / NYSE)
Summary of Financial Statement Ratios
2007
Liquidity Ratios:
Current ratio
Quick ratio
Cash flow liquidity
1.36 times
1.15 times
0.74 times
Average collection period
Days inventory held
Days payable outstanding
Cash conversion cycle
69
45
58
56
Activity Ratios:
Accounts receivable turnover
Inventory turnover
Payables turnover
Fixed asset turnover
Total asset turnover
Leverage Ratios:
Debt ratio
Long-term debt to total capitalization
Debt to equity
Financial leverage (FL)
Times interest earned
Cash interest coverage
Fixed charge coverage
Cash flow adequacy
Profitability Ratios:
Gross profit margin
Operating profit margin
Net profit margin
Cash flow margin
Return on assets (ROA)
or Return on investment (ROI)
Return on equity (ROE)
Cash return on assets
Market Ratios:
Earnings per share
Price-to-earnings
Dividend payout
Dividend yield
Results for the Years Ending December 31
2006
$
1.22 times
1.00 times
0.47 times
days
days
days
days
72
45
41
76
days
days
days
days
5.31
8.26
6.31
5.69
0.75
times
times
times
times
times
5.10
8.15
9.01
4.06
0.74
times
times
times
times
times
77.82
29.85
3.51
4.51
-2.04
4.63
-0.41
0.20
%
%
times
times
times
times
times
times
90.31
66.16
9.32
10.32
-2.77
4.06
-0.95
0.33
%
%
times
times
times
times
times
times
24.42
-2.23
6.56
3.41
%
%
%
%
22.80
-4.50
-5.69
6.48
%
%
%
%
4.95 %
-4.20 %
22.32 %
2.57 %
-43.30 %
4.78 %
(0.71)
0.00 N/M
-70.42 %
2.29 %
$
(2.80)
0.00 N/M
-17.86 %
1.94 %
NOTES: If a ratio's numerator and/or denominator equals zero, no ratio is displayed.
"N/M" indicates a calculated ratio is not meaningful for analysis
48
2005
-7.72
5.84
-3.21
0.30
22.21
-9.42
-11.07
6.34
$
times
times
times
times
%
%
%
%
(5.76)
0.00 N/M
-8.68 %
2.14 %
Analysis of Eastman Kodak - 2007
Eastman Kodak (Kodak) has just completed a major restructuring to move out of its traditional
area of business, film, and into the digital area and high technology industry. The competition in
the technology industry is probably far greater than Kodak has ever experienced in the film
industry. In recent years the firm has not had impressive financial results although they are
improving. A discussion of the financial well-being of Kodak follows, as well as recommendations
for investors and creditors.
Short-term liquidity
Kodak's short-term liquidity is improving. The current and quick ratios are above one and have
improved from 2006 to 2007. This is a result of an increase in cash and cash equivalents while
current liabilities have been stable. The cash flow liquidity ratio is increasing for the same
reason.
The average collection period has decreased three days but is still fairly long at 69 days. This
should be monitored. Inventory days held is stable and an acceptable amount at 45 days. Kodak
is taking significantly longer to pay suppliers. At 58 days this is probably not a problem yet, but
the firm needs to be sure that bills continue to be paid on time. The lengthening of the days
payable outstanding is the main reason that the cash conversion cycle declined 20 days. This has
allowed Kodak to be more efficient which is good.
The decreasing cash from operating activities is mainly the result of discontinued operations and
the payment on liabilities. These items should not have as a great an impact in future years, so it
can be expected that Kodak's cash from operations will increase.
Operating efficiency
The accounts receivable, inventory and payables turnovers were discussed under short-term
liquidity. Fixed and total asset turnovers have increased which is good. This is a result of the
large reduction in fixed assets due to downsizing. Total asset turnover only increased slightly
which has to do with the large increase in cash and cash equivalents.
49
Capital Structure
Kodak's debt structure is risky, but improving. The firm now has 78 percent debt in 2007,
compared to 90 percent debt in 2006. Long-term debt has declined the most as Kodak used
cash from discontinued operations to help pay down debt.
The times interest earned and fixed charge coverage ratios are negative due to the operating
losses Kodak has generated. Because these are accrual-based ratios, it is important to assess the
cash situation of Kodak. In 2004, Kodak generated an operating loss. The cash interest coverage
ratio is positive and increasing so it appears that Kodak can certainly make their contractual
payments of interest and leases. Interest expense dropped in 2007 due to the reduction in debt
which is good for the firm and has improved the coverage ratios.
Cash flow adequacy is low and below one. This is a result of both the relatively low cash from
operations amount and the large debt repayments the firm must make. Kodak has been
reducing capital expenditures, but still continues to pay dividends each year. Continuing to focus
on reducing debt will help improve this ratio.
Profitability
Eastman Kodak (Kodak) has experienced decreasing sales from 2005 to 2007 mainly due to
volume declines in traditional businesses. The Graphic Communications Group is the only
segment that increased sales over the three year period. Kodak's operating costs declined more
than sales which positively impacted operating profit by reducing the amount of Kodak's
operating loss each year.
Overall gross profit margin has increased as a result of cost reduction initiatives and favorable
foreign exchange rates. The Consumer Digital Imaging Group (CDG) had declining sales as a
result of traditional products, but newer digital product lines increased 7%. Gross profit margin
for CDG increased as a result of cost reductions and favorable foreign exchange. The Film
50
Products Group (FPG) sales were expected to decline given the movement away from film.
Increasing costs related to manufacturing, changes in depreciation, and silver costs caused the
gross profit margin of FPG to decline from 43.5% to 36.9% in 2006, however, gross profit margin
was stable in 2007 compared to 2006. The Graphic Communications Group (GCG) positively
contributed to revenues, however, gross profit margin which increased in 2006, decreased in
2007. The increase in 2006 was a result of reduced costs and favorable price/mix as a result of
acquisitions. In 2007, increased aluminum costs for manufacturing and an unfavorable price/mix
of products caused the drop in gross profit margin.
Kodak has generated operating losses in all three years; however, the loss is diminishing in size
each year. Kodak has successfully decreased selling, general and administrative costs through
their restructuring efforts and cost reduction initiatives. Advertising costs were cut in 2006, but
have been partially restored in 2007. This is a positive sign as Kodak needs to advertise new
product lines and maintain its positive brand recognition.
Research and development (R&D) costs have declined each year. According to management, the
reductions in 2007 are a result of realignment of resources and the timing of development
projects. In 2006, the decrease was attributed to significant spending reductions related to
traditional product lines and integration synergies within the GCG segment. Also contributing to
the decline in 2006 is that purchased in-process R&D was written off in 2005 as part of the R&D
amount, instead of as a separate line item, causing 2005 R&D to be higher than normal. While
the cuts made in R&D appear to be appropriate, it will be important for Kodak to commit an
appropriate amount of funds to R&D in the future to remain innovative.
Restructuring costs have been significant each year as Kodak transitions from film to digital
products. The company has laid off large numbers of employees and sold plant and equipment.
As of the end of 2007, most of the restructuring is complete and as Kodak moves into 2008, the
firm should begin to realize more significant cost savings. According to management only
modest charges in this area should occur in 2008 and beyond. Kodak should realize an operating
profit in 2008 as a result of their restructuring efforts.
Other income and expenses include gains and losses on sales of capital assets, as well as
impairments to assets. These amounts should be minimal in the future as a result of the
completion of the restructuring program. Lower interest expense in 2007 is a result of Kodak
paying down debt.
51
In 2007, Kodak realized a tax benefit as a result of losses and settlements with tax authorities
that resulted in benefits. The firm's tax rate will most likely be higher in the future assuming
Kodak becomes more profitable and stable after the many years of restructuring.
Net profit margin improved all three years. The positive net profit margin in 2007 is a result of a
one-time gain from discontinued operations of the Health Group segment. Without this gain
Kodak would have reported a net loss. Kodak has worked to overcome challenges related to
their transition to a high technology area. Their strategy appears to be beneficial in terms of
profitability. Future cost savings should allow Kodak to generate profits in 2008.
Market Measures
Due to the net losses from continuing operations the PE ratio is not meaningful. In 2006 Kodak's
closing stock price was higher than at the end of 2005, but by the end of 2007, the stock had
dropped below 2005 year-end's price. Much of this decline could be attributed to general
economic conditions. With both the sharp spike in oil prices and the subprime mortgage crisis,
sales of luxury items would most likely decline as consumers tend to delay purchases of items
such as digital cameras and the types of products that Kodak sells. Kodak has improved its
financial position immensely, even though the firm still has a risky capital structure.
Quality of financial reporting
Overall Kodak has delivered the required financial information. Mixing in-process R&D with the
recurring amounts of R&D is misleading, however, that appears to be the most significant
example of poor quality reporting found in the report.
Strengths
Improving short-term liquidity
Fixed asset turnover increasing
Long-term debt decreasing
Restructuring and transition from film to digital area near completion
Improving profit margins
Weaknesses
52
Long average collection period
Risky debt structure
Operating and net losses from continuing operations
Competitive industry
Negative economic conditions
Investment Potential
Kodak's stock price has declined since 2005, but appears to be partly the result of weak general
economic conditions. The firm has made significant improvements in their financial structure as
a result of their restructuring. Management is looking to rebuild the firm by finding high return
products to replace the loss of the formerly profitable film market. Investing in Kodak in the
short-term is not recommended. There is potential stock price growth in the long-term,
however, if management succeeds. This stock is not for risk averse investors.
Creditworthiness
Kodak's already high debt ratio combined with its off-balance sheet commitments does not
make it a good credit risk. Kodak needs to increase profits and CFO before taking on more debt.
53
6.18
1.
Please enter data on this sheet before entering financial statement information.
The 'Analysis ToolPak' add-in must be installed and active.
Company Name: Target Corporation
Stock Ticker Symbol:
TGT
U.S. Stock Exchange:
NYSE
12/31/2000
2/2/2008
Year End Dates for Financial Statements:
Financial Reports Rounded to :
Variable
2/3/2007
1/28/2006
2007
2006
Millions
Supplemental Ratio Requirements:
2008
Rent expense (in millions): $
165
$
158
$
154
Dividends per share: $
End of year stock price (adjusted for splits ): $
0.54
$
0.46
$
0.38
57.05
$
62.03
$
54.17
Marketwatch.com URL for stock prices: http://marketwatch.com/tools/qu
http://marketwatch.com/tools/qu
otes/historical.asp?date=02%2F otes/historical.asp?date=02%2F
01%2F2008&symb=TGT&siteid 02%2F2007&symb=TGT&siteid
=mktw
=mktw
Check Figures:
Balance Sheet
Current Assets: $
18,906
$
14,706
Total Assets: $
44,560
$
37,349
Income Statement
Cash Flow
Current Liabilities: $
11,782
$
11,117
Total Stockholders' Equity: $
15,307
$
15,633
http://marketwatch.com/tools/qu
otes/historical.asp?date=01%2F
27%2F2006&symb=TGT&siteid
=mktw
Gross Profit: $
21,472
$
20,091
$
17,693
Operating Profit: $
5,272
$
5,069
$
4,323
Net Profit: $
2,849
$
2,787
$
2,408
4,125
$
4,862
$
Net Flows from Operations: $
Net Flows from Investing Activity: $
(6,195) $
Net Flows from Financing Activity: $
3,707
54
$
4,451
(4,693) $
(4,149)
(1,004) $
(899)
Target Corporation
(TGT / NYSE)
Annual Consolidated Balance Sheet
Amounts Rounded to : Millions
Results as of
Feb 2, 2008
Feb 3, 2007
ASSETS
Current Assets:
Cash and cash equivalents
Short-term investments
$
Total cash and short-term investments
2,450
$
813
2,450
813
Accounts receivable, net
Inventories, net
Current deferred taxes
Other current assets
8,054
6,780
556
1,066
6,194
6,254
427
1,018
Total current assets
18,906
14,706
31,982
7,887
28,381
6,950
24,095
21,431
60
148
60
152
Property, plant, and equipment
Less: accumulated depreciation
Net property, plant, and equipment
Long-term investments
Goodwill, net
Other intangibles, net
Other deferred taxes
Other assets
1,351
Total assets
1,000
$
44,560
$
37,349
$
6,721
$
6,575
LIABILITIES
Current Liabilities:
Accounts payable
Short-term debt
Current portion of long-term debt
Accrued liabilities
Income taxes payable
Other current liabilities
Total current liabilities
Long-term debt
Deferred income taxes payable
Other deferred liabilities
Other liabilities
Total liabilities
1,964
3,097
1,362
3,180
11,782
11,117
15,126
470
8,675
577
1,875
1,347
29,253
21,716
2,724
12,761
2,459
13,417
Minority interest
STOCKHOLDERS' EQUITY
Preferred stock
Common stock, par value plus additional paid-in capital
Retained earnings (accumulated deficit)
Treasury stock
Accumulated other comprehensive income (loss)
Other stockholders' equity
(178)
Total stockholders' equity
(243)
15,307
Total liabilities and stockholders' equity
$
55
44,560
15,633
$
37,349
Target Corporation
(TGT / NYSE)
Annual Common Size Balance Sheet
Summary percentages in italics will not foot due to rounding
Results as of
Feb 2, 2008
Feb 3, 2007
ASSETS
Current Assets:
Cash and cash equivalents
Short-term investments
5.5%
0.0%
Total cash and short-term investments
2.2%
0.0%
5.5%
2.2%
Accounts receivable, net
Inventories, net
Current deferred taxes
Other current assets
18.1%
15.2%
1.2%
2.4%
16.6%
16.7%
1.1%
2.7%
Total current assets
42.4%
39.4%
71.8%
17.7%
76.0%
18.6%
54.1%
57.4%
0.0%
0.1%
0.3%
0.0%
3.0%
0.0%
0.2%
0.4%
0.0%
2.7%
100.0%
100.0%
15.1%
0.0%
4.4%
7.0%
0.0%
0.0%
17.6%
0.0%
3.6%
8.5%
0.0%
0.0%
26.4%
29.8%
33.9%
1.1%
0.0%
4.2%
23.2%
1.5%
0.0%
3.6%
65.6%
58.1%
0.0%
0.0%
0.0%
6.1%
28.6%
0.0%
-0.4%
0.0%
0.0%
6.6%
35.9%
0.0%
-0.7%
0.0%
34.4%
41.9%
100.0%
100.0%
Property, plant, and equipment
Less: accumulated depreciation
Net property, plant, and equipment
Long-term investments
Goodwill, net
Other intangibles, net
Other deferred taxes
Other assets
Total assets
LIABILITIES
Current Liabilities:
Accounts payable
Short-term debt
Current portion of long-term debt
Accrued liabilities
Income taxes payable
Other current liabilities
Total current liabilities
Long-term debt
Deferred income taxes payable
Other deferred liabilities
Other liabilities
Total liabilities
Minority interest
STOCKHOLDERS' EQUITY
Preferred stock
Common stock, par value plus additional paid-in capital
Retained earnings (accumulated deficit)
Treasury stock
Accumulated other comprehensive income (loss)
Other stockholders' equity
Total stockholders' equity
Total liabilities and stockholders' equity
56
Target Corporation
(TGT / NYSE)
Annual Consolidated Income Statement
Amounts Rounded to : Millions
(except per share amounts)
Results for the Years Ending
Feb 2, 2008
Feb 3, 2007
Jan 28, 2006
Net sales
Less: Cost of goods sold
$
Gross profit
Sales, general and administrative
Research and development (R&D)
Restructuring, impairment, and amortization
Purchased in-process R&D
Other operating expenses
63,367
41,895
$
59,490
39,399
$
52,620
34,927
21,472
20,091
17,693
13,704
12,819
11,185
1,659
1,496
1,409
837
707
776
Total operating expenses
16,200
15,022
13,370
Operating profit (loss)
5,272
5,069
4,323
22
25
27
5,294
5,094
4,350
669
597
490
4,625
4,497
3,860
1,776
1,710
1,452
2,849
2,787
2,408
Other income (expenses), net excluding interest expense
Earnings (loss) before interest and taxes
Interest expense
Earnings (loss) before taxes
Provision for (benefit from) income taxes
Earnings (loss) after taxes
Extraordinary items, net
Discontinued operations, net
Cumulative effect of changes in accounting principles, net
Other after-tax income (loss), net
Net profit (loss)
Basic earnings per common share
57
$
2,849
$
2,787
$
2,408
$
3.37
$
3.23
$
2.73
Target Corporation
(TGT / NYSE)
Annual Common Size Income Statement
Summary percentages in italics will not foot due to rounding
Results for the Years Ending
Feb 2, 2008
Feb 3, 2007
Jan 28, 2006
Net sales
Less: Cost of goods sold
100.0%
66.1%
Gross profit
100.0%
66.2%
100.0%
66.4%
33.9%
33.8%
33.6%
21.6%
0.0%
2.6%
0.0%
1.3%
21.5%
0.0%
2.5%
0.0%
1.2%
21.3%
0.0%
2.7%
0.0%
1.5%
Total operating expenses
25.6%
25.3%
25.4%
Operating profit (loss)
8.3%
8.5%
8.2%
0.0%
0.0%
0.1%
8.4%
8.6%
8.3%
1.1%
1.0%
0.9%
7.3%
7.6%
7.3%
2.8%
2.9%
2.8%
4.5%
4.7%
4.6%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
4.5%
4.7%
4.6%
38.4%
38.0%
37.6%
Sales, general and administrative
Research and development (R&D)
Restructuring, impairment, and amortization
Purchased in-process R&D
Other operating expenses
Other income (expenses), net excluding interest expense
Earnings (loss) before interest and taxes
Interest expense
Earnings (loss) before taxes
Provision for (benefit from) income taxes
Earnings (loss) after taxes
Extraordinary items, net
Discontinued operations, net
Cumulative effect of changes in accounting principles, net
Other after-tax income (loss), net
Net profit (loss)
Effective tax rate
58
Target Corporation
(TGT / NYSE)
Annual Consolidated Statement of Cash Flows
Amounts Rounded to : Millions
Results for the Years Ending
Feb 2, 2008
Feb 3, 2007
Jan 28, 2006
Cash flows from operating activities:
Income (loss) from continuing operations
Adjustments to reconcile to net cash provided by operating activities:
Restructuring charges
Impairment charges
Depreciation and amortization
(Gain) loss on sales of investments, acquisitions, and securities
(Gain) loss on sales of property, plant, and equipment
Increase (decrease) in provision for deferred income taxes
Other non-cash items, net
Changes in assets and liabilities:
(Increase) decrease in receivables
(Increase) decrease in inventories
(Increase) decrease in other current assets
Increase (decrease) in accounts payable,
accrued liabilities, and income taxes payable
Increase (decrease) in deferred liabilities
Other assets and liabilities, net
$
2,849
$
1,659
Net cash provided by (used in ) operating activities
Cash flows from investing activities:
Purchases of property, plant, and equipment
Sales of property, plant, and equipment
Purchases of marketable securities and short-term investments
Sales of marketable securities and short-term investments
Acquisitions, net of cash acquired
Other investing activities, net
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Short-term borrowings, net
Proceeds from long-term borrowings
Payment of long-term borrowings
Proceeds from sales of common stock
Repurchase of common stock / treasury stock
Dividends to shareholders
Other financing activities, net
Net cash provided by (used in) financing activities
2,787
$
1,496
2,408
1,409
28
(70)
606
53
(201)
444
70
(122)
509
(602)
(525)
(139)
(226)
(431)
(30)
(244)
(454)
(28)
173
865
910
146
105
4,125
4,862
4,451
(7)
(4,369)
95
(3,928)
62
(3,388)
58
(1,921)
(827)
(819)
(6,195)
(4,693)
(4,149)
500
7,617
(1,326)
210
(2,477)
(442)
(375)
1,256
(1,155)
181
(901)
(380)
(5)
913
(527)
231
(1,197)
(318)
(1)
3,707
(1,004)
(899)
1,637
813
(835)
1,648
(597)
2,245
Net cash provided by (used for) discontinued operations
Effect of exchange rate changes on cash, net
Net increase (decrease) in cash and equivalents for period
Cash and equivalents, beginning of period
Cash and equivalents, end of period
$
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest
Income taxes (refunded)
2,450
633
1,734
59
$
813
584
1,823
$
1,648
468
1,448
Target Corporation
(TGT / NYSE)
Annual Summary Analysis Statement of Cash Flows
Summary percentages in italics do not foot due to rounding differences
Feb 2, 2008
Inflows
Proceeds from operating activities
Sales of property, plant, and equipment
Sales of marketable securities and short-term investments
Divestiture of acquisitions, net of cash acquired
Proceeds from other investing activities, net
Proceeds from short-term borrowings, net
Proceeds from long-term borrowings
Proceeds from sales of common stock
Proceeds from other financing activities, net
Proceeds from discontinued operations
Gains from effect of exchange rate changes on cash, net
Total Inflows
$
Outflows
Losses from operating activities
Purchases of property, plant, and equipment
Purchases of marketable securities and short-term investments
Acquisitions, net of cash acquired
Losses from other investing activities, net
Payment of short-term borrowings, net
Payment of long-term borrowings
Repurchase of common stock / treasury stock
Payment of dividends to shareholders
Payment of other financing activities, net
Losses from discontinued operations
Losses from effect of exchange rate changes on cash, net
$
4,125
95
500
7,617
210
-
32.9
0.7
12,547
100.0
$
$
4,862
62
1,256
181
-
76.4
1.0
6,361
100.0
19.7
2.9
$
4,369
1,921
1,326
2,477
442
375
10,910
Net increase (decrease) in cash and cash equivalents
3,928
827
1,155
901
380
5
-
17.6
12.2
22.7
4.1
3.4
$
7,196
1,637
Target Corporation
$
78.7
1.0
5,653
100.0
16.2
4.1
3,388
819
527
1,197
318
1
-
54.6
11.5
16.0
12.5
5.3
0.1
100.0
(835)
$
54.2
13.1
8.4
19.2
5.1
-
6,250
100.0
(597)
(TGT / NYSE)
Additional Ratio Analysis
Growth Rate Comparisons Between
2008 vs. 2007
2007 vs. 2006
Selected Income Statement Growth Rates:
Sales growth rate
Gross profit growth rate
Operating expenses growth rate
Operating profit growth rate
Net profit growth rate
6.52
6.87
7.84
4.00
2.22
Accounts Receivable Analysis
Sales growth rate
Gross accounts receivable growth rate
Accounts receivable allowance growth rate
%
%
%
%
%
6.52 %
28.51 %
10.25 %
13.06
13.55
12.36
17.26
15.74
%
%
%
%
%
13.06 %
Results for the Years Ending
Feb 2, 2008
Feb 3, 2007
6.61 %
7.70 %
Allowance as a % of gross accounts receivable
NOTES: If a ratio's denominator equals zero, no ratio is displayed.
"N/M" indicates a calculated ratio is not meaningful for analysis
60
%
4,451
58
913
231
-
$
40.0
100.0
Jan 28, 2006
$
4.0
60.7
1.7
$
Total Outflows
Results for the Years Ending
Feb 3, 2007
%
%
$
Target Corporation
(TGT / NYSE)
Summary of Financial Statement Ratios
Feb 2, 2008
Liquidity Ratios:
Current ratio
Quick ratio
Cash flow liquidity
1.60 times
1.03 times
0.56 times
Average collection period
Days inventory held
Days payable outstanding
Cash conversion cycle
47
60
59
48
Activity Ratios:
Accounts receivable turnover
Inventory turnover
Payables turnover
Fixed asset turnover
Total asset turnover
Leverage Ratios:
Debt ratio
Long-term debt to total capitalization
Debt to equity
Financial leverage (FL)
Times interest earned
Cash interest coverage
Fixed charge coverage
Cash flow adequacy
Profitability Ratios:
Gross profit margin
Operating profit margin
Net profit margin
Cash flow margin
Return on assets (ROA)
or Return on investment (ROI)
Return on equity (ROE)
Cash return on assets
Market Ratios:
Earnings per share
Price-to-earnings
Dividend payout
Dividend yield
Results for the Years Ending
Feb 3, 2007
$
Jan 28, 2006
1.32 times
0.76 times
0.51 times
days
days
days
days
39
58
61
36
days
days
days
days
7.87
6.18
6.23
2.63
1.42
times
times
times
times
times
9.60
6.30
5.99
2.78
1.59
times
times
times
times
times
65.65
49.70
1.91
2.91
7.88
10.26
6.52
0.67
%
%
times
times
times
times
times
times
58.14
35.69
1.39
2.39
8.49
12.45
6.92
0.89
%
%
times
times
times
times
times
times
8.82
13.60
6.95
1.05
times
times
times
times
33.89
8.32
4.50
6.51
%
%
%
%
33.77
8.52
4.68
8.17
%
%
%
%
33.62
8.22
4.58
8.46
%
%
%
%
6.39 %
7.46 %
18.61 %
9.26 %
17.83 %
13.02 %
3.37
16.93 0
16.02 %
0.95 %
$
3.23
19.20 0
14.24 %
0.74 %
NOTES: If a ratio's numerator and/or denominator equals zero, no ratio is displayed.
"N/M" indicates a calculated ratio is not meaningful for analysis
61
$
2.73
19.84 0
13.92 %
0.70 %
Please note that the year-end for Target is at the end of January each year. The years ended in
2008, 2007 and 2006 are referred to in the analysis as 2007, 2006 and 2005 since most months
of the fiscal year fall within those actual years.
Short-term liquidity
Target's current, quick and cash flow liquidity ratios are all increasing. Cash and cash equivalents
and accounts receivable both increased while accounts payable and accrued liabilities
decreased. The cash flow liquidity ratio did not increase nearly as much as the current and quick
ratio as a result of cash from operations (CFO) decreasing from 2006 to 2007. The drop was a
result in increasing current assets.
The cash conversion cycle has increased 12 days. This is a result of the average collection period
increasing eight days, the inventory days held increasing two days and days payable outstanding
decreasing two days. The increase in the collection period is not a good trend. As mentioned in
the management's discussion and analysis, the industry has experienced a decline in payment
rates. This may result in much larger bad debts if customers are having trouble paying their bills.
Target's sales, accounts receivable and allowance for doubtful accounts have increased,
however, accounts receivable have increased more than either the sales or the allowance
account increase. The increase in accounts receivable is attributed to offering more credit
through Target Visa cards. Even though these accounts have been given to higher-credit quality
customers, the general economic conditions could still negatively impact any of these
customers, causing Target to have increased bad debts. Overall the percentage of the allowance
account relative total accounts receivable has dropped by about one percentage point.
Overall the short-term liquidity is adequate, but the accounts receivable and allowance account
should be closely monitored.
Operating efficiency
The discussion in the prior section of the cash conversion cycle explained the reasons for the
changes in the accounts receivable, inventory and accounts payable turnover ratios. The fixed
and total asset turnover ratios have decreased slightly as a result of fixed assets increasing faster
than sales. In addition the decreases in accounts receivable and inventory turnovers have also
negatively impacted the total asset turnover.
62
Capital structure and long-term solvency
The capital structure of Target is risky when both on-balance sheet and off-balance sheet
financing is considered. The debt ratio has increased to above 65% as a result of increasing longterm debt. It appears that the borrowing has been used to support capital expenditures,
repurchase of stock and other investing activities.
Items not included on the balance sheet, but still requiring outlays of cash include operating
lease payments that total $3,694 million. Adding this amount to the total liabilities on the
balance sheet results in future obligations representing 74 percent of total assets.
The coverage ratios, both accrual and cash-based, have all declined due to the increase in
interest expense and rent expense, as well as the decrease in CFO. The cash flow adequacy ratio
once above one in 2005 is now dropping rapidly each year and is now below one. The
decreasing CFO combined with increasing amounts spent on capital expenditures, dividends and
debt repayments is responsible for the decline in this ratio.
Target needs to begin paying down debt in order to reverse this trend and reduce the risk on the
balance sheet.
Profitability
The profitability of Target is stable. Gross profit margin has increased slightly, while operating
and net profit margins have decreased slightly from 2006 to 2007. Sales increased 6.52% and
this is most likely due to the increased credit offered and could also be a result of new store
openings as evidenced by the increased capital expenditures. The actual sales increase from
2006 is larger because 2006 was a 53 week year compared to 2007 which had only 52 weeks.
Unfortunately operating expenses grew 7.84% explaining the decrease in operating profit.
The slight increase in gross profit margin is the result of higher selling prices or lower cost of
goods sold.
All other operating expenses have increased slightly in 2007. This is possibly due to inflationary
reasons associated with the general economy.
63
Net profit margin has followed the same pattern as operating profit margin. Interest expense
has increased as a result of the increase in long-term debt, however, the tax provision has
decreased slightly in 2007. The effective tax rate is stable.
Cash flow margin has decreased due to the decreasing CFO which was previously discussed. In
addition, the return on assets and cash return on assets have both decreased as Target has
increased assets without a proportional increase in profits. The return on equity has increased a
bit in 2007 due to the increased leverage.
Target needs to reverse the downward trends discussed by reducing debt and making sure they
are able to collect on their credit card sales. It appears they do a good job passing on price
increases to customers and maintaining stable profit margins. They do not have any immediate
concerns with liquidity, but current economic conditions could change this quickly.
Market Measures
Even though Target has an increasing earnings per share number the price to earnings ratio
indicates that the marketplace has not rewarded Target for this in 2007. Target pays a minimal
dividend, so investors would be looking for stock price appreciation to earn a high return. If
Target can reduce their risk on their balance sheet, the stock price should rise in the future.
2.
Strengths
Weaknesses
Short-term liquidity ratios are increasing
Accounts receivable have increased
Cash flow from operations is
Risky capital structure due to debt and
operating leases
positive
Profit margins are stable
Declining CFO
Economic conditions
3.
The investment potential is poor. Target's financial position is headed in the wrong
direction. The company has increasing accounts receivable and long-term debt. The stock price
is falling and given the current economic conditions sales could be negatively impacted in the
64
future. Customers may be more prone to default which would negatively impact Target as they
have increased offerings of credit.
The creditworthiness of the firm is also poor. Although CFO is still a positive number it did
decline in 2007. The debt on the balance sheet has increased and the firm has off-balance sheet
commitments causing a risky capital structure. It is not recommended that more loans be given
to this company.
65
6.19
Please enter data on this sheet before entering financial statement information.
The 'Analysis ToolPak' add-in must be installed and active.
Company Name: Candela Corporation
Stock Ticker Symbol:
CLZR
U.S. Stock Exchange:
NASDAQ
12/31/2000
6/30/2007
Year End Dates for Financial Statements:
Financial Reports Rounded to :
Variable
7/1/2006
7/2/2005
Thousands
Supplemental Ratio Requirements:
2007
2006
2005
Rent expense (in thousands): $
1,200
$
900
Dividends per share:
End of year stock price (adjusted for splits ): $
11.58
$
15.86
Marketwatch.com URL for stock prices: http://marketwatch.com/tools/qu
http://marketwatch.com/tools/qu
otes/historical.asp?date=06%2F otes/historical.asp?date=07%2F
29%2F2007&symb=CLZR&sitei 30%2F2006&symb=CLZR&sitei
d=mktw
d=mktw
Check Figures:
Balance Sheet
Current Assets: $
106,957
$
125,326
Total Assets: $
150,230
$
149,656
Current Liabilities: $
40,183
$
43,416
Total Stockholders' Equity: $
101,510
$
100,012
Income Statement
Cash Flow
1,400
$
10.93
http://marketwatch.com/tools/qu
otes/historical.asp?date=07%2F
01%2F2005&symb=CLZR&sitei
d=mktw
Gross Profit: $
75,063
$
73,849
$
55,919
Operating Profit: $
3,355
$
20,673
$
8,091
Net Profit: $
6,256
$
14,934
$
7,323
14,386
$
18,974
Net Flows from Operations: $
(7,419) $
Net Flows from Investing Activity: $
1.
$
2,173
Net Flows from Financing Activity: $
$
(8,352) $
66
(40,000) $
8,933
$
(635)
960
Candela Corporation
(CLZR / NASDAQ)
Annual Consolidated Balance Sheet
Amounts Rounded to : Thousands
Results as of
Jun 30, 2007
Jul 1, 2006
ASSETS
Current Assets:
Cash and cash equivalents
Short-term investments
$
Total cash and short-term investments
27,152
11,773
$
40,194
27,332
38,925
67,526
Accounts receivable, net
Inventories, net
Current deferred taxes
Other current assets
38,455
21,368
34,273
16,666
8,209
6,861
Total current assets
106,957
125,326
11,720
8,241
10,759
7,457
Property, plant, and equipment
Less: accumulated depreciation
Net property, plant, and equipment
Long-term investments
Goodwill, net
Other intangibles, net
Other deferred taxes
Other assets
Total assets
3,479
3,302
12,260
10,997
8,151
6,146
2,240
11,953
5,294
3,781
$
150,230
$
149,656
$
6,922
$
15,968
LIABILITIES
Current Liabilities:
Accounts payable
Short-term debt
Current portion of long-term debt
Accrued liabilities
Income taxes payable
Other current liabilities
22,004
Total current liabilities
Long-term debt
Deferred income taxes payable
Other deferred liabilities
Other liabilities
Total liabilities
11,257
16,886
933
9,629
40,183
43,416
2,659
3,751
2,127
480
1,987
3,761
48,720
49,644
69,727
54,536
(22,458)
(295)
64,493
48,280
(12,997)
236
101,510
100,012
Minority interest
STOCKHOLDERS' EQUITY
Preferred stock
Common stock, par value plus additional paid-in capital
Retained earnings (accumulated deficit)
Treasury stock
Accumulated other comprehensive income (loss)
Other stockholders' equity
Total stockholders' equity
Total liabilities and stockholders' equity
$
67
150,230
$
149,656
68
Candela Corporation
(CLZR / NASDAQ)
Annual Common Size Balance Sheet
Summary percentages in italics will not foot due to rounding
Results as of
Jun 30, 2007
Jul 1, 2006
ASSETS
Current Assets:
Cash and cash equivalents
Short-term investments
Total cash and short-term investments
18.1%
7.8%
26.9%
18.3%
25.9%
45.1%
Accounts receivable, net
Inventories, net
Current deferred taxes
Other current assets
25.6%
14.2%
0.0%
5.5%
22.9%
11.1%
0.0%
4.6%
Total current assets
71.2%
83.7%
7.8%
5.5%
7.2%
5.0%
2.3%
2.2%
8.2%
7.3%
5.4%
4.1%
1.5%
8.0%
0.0%
0.0%
3.5%
2.5%
100.0%
100.0%
4.6%
0.0%
0.0%
14.6%
0.0%
7.5%
10.7%
0.0%
0.0%
11.3%
0.6%
6.4%
26.7%
29.0%
0.0%
1.8%
2.5%
1.4%
0.0%
0.3%
1.3%
2.5%
32.4%
33.2%
0.0%
0.0%
0.0%
46.4%
36.3%
-14.9%
-0.2%
0.0%
0.0%
43.1%
32.3%
-8.7%
0.2%
0.0%
Property, plant, and equipment
Less: accumulated depreciation
Net property, plant, and equipment
Long-term investments
Goodwill, net
Other intangibles, net
Other deferred taxes
Other assets
Total assets
LIABILITIES
Current Liabilities:
Accounts payable
Short-term debt
Current portion of long-term debt
Accrued liabilities
Income taxes payable
Other current liabilities
Total current liabilities
Long-term debt
Deferred income taxes payable
Other deferred liabilities
Other liabilities
Total liabilities
Minority interest
STOCKHOLDERS' EQUITY
Preferred stock
Common stock, par value plus additional paid-in capital
Retained earnings (accumulated deficit)
Treasury stock
Accumulated other comprehensive income (loss)
Other stockholders' equity
Total stockholders' equity
Total liabilities and stockholders' equity
69
67.6%
66.8%
100.0%
100.0%
Candela Corporation
(CLZR / NASDAQ)
Annual Consolidated Income Statement
Amounts Rounded to : Thousands
(except per share amounts)
Results for the Years Ending
Jun 30, 2007
Jul 1, 2006
Jul 2, 2005
Net sales
Less: Cost of goods sold
$
Gross profit
148,557
73,494
$
149,466
75,617
$
123,901
67,982
75,063
73,849
55,919
53,562
18,146
44,297
8,879
40,165
6,890
Total operating expenses
71,708
53,176
47,828
Operating profit (loss)
3,355
20,673
8,091
6,444
1,729
567
9,799
22,402
8,658
9,799
22,402
8,658
3,543
7,468
2,194
6,256
14,934
6,464
Sales, general and administrative
Research and development (R&D)
Restructuring, impairment, and amortization
Purchased in-process R&D
Other operating expenses
773
Other income (expenses), net excluding interest expense
Earnings (loss) before interest and taxes
Interest expense
Earnings (loss) before taxes
Provision for (benefit from) income taxes
Earnings (loss) after taxes
Extraordinary items, net
Discontinued operations, net
Cumulative effect of changes in accounting principles, net
Other after-tax income (loss), net
859
Net profit (loss)
Basic earnings per common share
70
$
6,256
$
14,934
$
7,323
$
0.27
$
0.65
$
0.33
Candela Corporation
(CLZR / NASDAQ)
Annual Common Size Income Statement
Summary percentages in italics will not foot due to rounding
Results for the Years Ending
Jun 30, 2007
Jul 1, 2006
Jul 2, 2005
Net sales
Less: Cost of goods sold
100.0%
49.5%
Gross profit
100.0%
50.6%
100.0%
54.9%
50.5%
49.4%
45.1%
36.1%
12.2%
0.0%
0.0%
0.0%
29.6%
5.9%
0.0%
0.0%
0.0%
32.4%
5.6%
0.0%
0.0%
0.6%
Total operating expenses
48.3%
35.6%
38.6%
Operating profit (loss)
2.3%
13.8%
6.5%
4.3%
1.2%
0.5%
6.6%
15.0%
7.0%
0.0%
0.0%
0.0%
6.6%
15.0%
7.0%
2.4%
5.0%
1.8%
4.2%
10.0%
5.2%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.7%
0.0%
0.0%
4.2%
10.0%
5.9%
36.2%
33.3%
25.3%
Sales, general and administrative
Research and development (R&D)
Restructuring, impairment, and amortization
Purchased in-process R&D
Other operating expenses
Other income (expenses), net excluding interest expense
Earnings (loss) before interest and taxes
Interest expense
Earnings (loss) before taxes
Provision for (benefit from) income taxes
Earnings (loss) after taxes
Extraordinary items, net
Discontinued operations, net
Cumulative effect of changes in accounting principles, net
Other after-tax income (loss), net
Net profit (loss)
Effective tax rate
71
Candela Corporation
(CLZR / NASDAQ)
Annual Common Size Multiple Source Revenue & COGS
Summary percentages in italics will not foot due to rounding
Results for the Years Ending
Jun 30, 2007
Jul 1, 2006
Jul 2, 2005
Revenues by Source as a % of Net Sales
Lasers and other products
Product-related service
Replace with source3 title
Replace with source4 title
Other revenues
Summary of revenue sources as a % of net sales
76.2%
23.8%
0.0%
0.0%
0.0%
81.5%
18.5%
0.0%
0.0%
0.0%
82.6%
17.4%
0.0%
0.0%
0.0%
100.0%
100.0%
100.0%
43.5%
68.5%
#DIV/0!
#DIV/0!
#DIV/0!
44.9%
75.5%
#DIV/0!
#DIV/0!
#DIV/0!
48.9%
83.0%
#DIV/0!
#DIV/0!
#DIV/0!
COGS as a % of Associated Revenue Source
Lasers and other products
Product-related service
Replace with source3 title
Replace with source4 title
Other cost of goods sold
Gross Profit Margin for Associated Revenue Source
Lasers and other products
Product-related service
56.5%
31.5%
72
55.1%
24.5%
51.1%
17.0%
Candela Corporation
(CLZR / NASDAQ)
Annual Consolidated Statement of Cash Flows
Amounts Rounded to : Thousands
Results for the Years Ending
Jun 30, 2007
Jul 1, 2006
Jul 2, 2005
Cash flows from operating activities:
Income (loss) from continuing operations
Adjustments to reconcile to net cash provided by operating activities:
Restructuring charges
Impairment charges
Depreciation and amortization
(Gain) loss on sales of investments, acquisitions, and securities
(Gain) loss on sales of property, plant, and equipment
Increase (decrease) in provision for deferred income taxes
Other non-cash items, net
Changes in assets and liabilities:
(Increase) decrease in receivables
(Increase) decrease in inventories
(Increase) decrease in other current assets
Increase (decrease) in accounts payable,
accrued liabilities, and income taxes payable
Increase (decrease) in deferred liabilities
Other assets and liabilities, net
$
6,256
$
1,631
Net cash provided by (used in ) operating activities
Cash flows from investing activities:
Purchases of property, plant, and equipment
Sales of property, plant, and equipment
Purchases of marketable securities and short-term investments
Sales of marketable securities and short-term investments
Acquisitions, net of cash acquired
Other investing activities, net
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Short-term borrowings, net
Proceeds from long-term borrowings
Payment of long-term borrowings
Proceeds from sales of common stock
Repurchase of common stock / treasury stock
Dividends to shareholders
Other financing activities, net
(4,943)
(4,702)
320
(681)
(3,561)
(769)
(1,801)
719
1,316
(10,019)
$
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest
Income taxes (refunded)
4,078
7,679
2,243
(2,684)
2,731
427
(7,419)
14,386
18,974
(763)
(715)
(17,706)
37,014
(15,986)
(386)
(43,654)
4,369
2,173
(40,000)
(635)
843
(9,461)
8,122
960
27,152
5,451
73
233
451
3,422
(977)
(635)
811
8,933
960
492
(13,042)
40,194
Cash and equivalents, end of period
755
(2,399)
2,654
556
Net increase (decrease) in cash and equivalents for period
Cash and equivalents, beginning of period
6,464
45
1,548
(8,352)
Net cash provided by (used for) discontinued operations
Effect of exchange rate changes on cash, net
$
571
266
Net cash provided by (used in) financing activities
14,934
(55)
(16,189)
56,383
$
40,194
9,834
19,244
37,139
$
56,383
2,269
Candela Corporation
(CLZR / NASDAQ)
Annual Summary Analysis Statement of Cash Flows
Summary percentages in italics do not foot due to rounding differences
Jun 30, 2007
Inflows
Proceeds from operating activities
Sales of property, plant, and equipment
Sales of marketable securities and short-term investments
Divestiture of acquisitions, net of cash acquired
Proceeds from other investing activities, net
Proceeds from short-term borrowings, net
Proceeds from long-term borrowings
Proceeds from sales of common stock
Proceeds from other financing activities, net
Proceeds from discontinued operations
Gains from effect of exchange rate changes on cash, net
$
37,014
843
266
556
Total Inflows
$
Outflows
Losses from operating activities
Purchases of property, plant, and equipment
Purchases of marketable securities and short-term investments
Acquisitions, net of cash acquired
Losses from other investing activities, net
Payment of short-term borrowings, net
Payment of long-term borrowings
Repurchase of common stock / treasury stock
Payment of dividends to shareholders
Payment of other financing activities, net
Losses from discontinued operations
Losses from effect of exchange rate changes on cash, net
2.2
0.7
1.4
38,679
100.0
$
Net increase (decrease) in cash and cash equivalents
$
51.1
14.3
1.5
34.2
30.9
0.8
51,721
100.0
28,180
100.0
15.5
28.8
2.9
1.7
$
95.2
19,934
100.0
4.8
715
43,654
-
18.3
$
44,369
635
55
1.6
98.4
100.0
$
(16,189)
92.0
8.0
690
100.0
19,244
(CLZR / NASDAQ)
Additional Ratio Analysis
Growth Rate Comparisons Between
2007 vs. 2006
2006 vs. 2005
Selected Income Statement Growth Rates:
Sales growth rate
Gross profit growth rate
Operating expenses growth rate
Operating profit growth rate
Net profit growth rate
-0.61
1.64
34.85
-83.77
-58.11
Accounts Receivable Analysis
Sales growth rate
Gross accounts receivable growth rate
Accounts receivable allowance growth rate
-0.61 %
10.42 %
-22.88 %
Allowance as a % of gross accounts receivable
%
%
%
%
%
20.63
32.06
11.18
155.51
103.93
%
%
%
%
%
20.63 %
Results for the Years Ending
Jun 30, 2007
Jul 1, 2006
3.54 %
5.07 %
NOTES: If a ratio's denominator equals zero, no ratio is displayed.
"N/M" indicates a calculated ratio is not meaningful for analysis
74
%
18,974
960
-
$
(13,042)
Candela Corporation
14,386
4,369
8,122
811
492
$
7,419
763
17,706
15,986
386
9,461
-
Jul 2, 2005
$
95.7
$
Total Outflows
Results for the Years Ending
Jul 1, 2006
%
%
$
75
Candela Corporation
(CLZR / NASDAQ)
Summary of Financial Statement Ratios
Jun 30, 2007
Liquidity Ratios:
Current ratio
Quick ratio
Cash flow liquidity
Results for the Years Ending
Jul 1, 2006
2.66 times
2.13 times
0.78 times
Average collection period
Days inventory held
Days payable outstanding
Cash conversion cycle
95
107
35
167
Jul 2, 2005
2.89 times
2.50 times
1.89 times
days
days
days
days
84
81
78
87
days
days
days
days
Activity Ratios:
Accounts receivable turnover
Inventory turnover
Payables turnover
Fixed asset turnover
Total asset turnover
3.86
3.44
10.62
42.70
0.99
times
times
times
times
times
4.36
4.54
4.74
45.27
1.00
times
times
times
times
times
Leverage Ratios:
Debt ratio
Long-term debt to total capitalization
Debt to equity
Financial leverage (FL)
Times interest earned
Cash interest coverage
Fixed charge coverage
Cash flow adequacy
32.43
0.00
0.48
1.48
0.00
0.00
3.80
-9.72
%
0
times
times
0
0
times
times
33.17
0.00
0.50
1.50
0.00
0.00
23.97
20.12
%
0
times
times
0
0
times
times
0.00
0.00
6.78
29.88
0
0
times
times
50.53
2.26
4.21
-4.99
%
%
%
%
49.41
13.83
9.99
9.62
%
%
%
%
45.13
6.53
5.91
15.31
%
%
%
%
Profitability Ratios:
Gross profit margin
Operating profit margin
Net profit margin
Cash flow margin
Return on assets (ROA)
or Return on investment (ROI)
Return on equity (ROE)
Cash return on assets
Market Ratios:
Earnings per share
Price-to-earnings
Dividend payout
Dividend yield
$
4.16 %
9.98 %
6.16 %
-4.94 %
14.93 %
9.61 %
0.27
42.89 0
0.00 0
0.00 0
$
0.65
24.40 0
0.00 0
0.00 0
NOTES: If a ratio's numerator and/or denominator equals zero, no ratio is displayed.
"N/M" indicates a calculated ratio is not meaningful for analysis
76
$
0.33
33.12 0
0.00 0
0.00 0
Short-term liquidity
Candela's short-term liquidity is adequate even though the current, quick and cash flow liquidity ratios
are decreasing. Cash and short-term investments decreased significantly, but for good reason. Candela
made acquisitions which used cash, but if the acquisitions are successful, sales and profits will hopefully
increase in the future, generating more cash. The notes on acquisitions show that over 65% of the
purchase price was goodwill and management of Candela believes the goodwill is warranted because of
the potential to utilize intellectual properties of the acquired company into Candela's own products, as
well as offer up-sell and cross-sell opportunities for Candela products. The firm was profitable in 2007,
however cash from operations (CFO) was negative as a result of changes in working capital.
Candela paid a significant amount of accounts payable which contributed to the negative CFO. Accounts
receivable and inventories also increased which caused a further deterioration in CFO. The increase in
accounts receivable is due to increased international credit sales which have longer payment terms.
Inventories increased as a result of the firm's inability to ship new products. The implication is that the
products have been ordered, but no explanation is offered as to why Candela was unable to ship the
products. Assuming the receivables are collected and the products shipped, Candela should be able to
return to a positive CFO number in the future.
The average collection period increased 11 days due to the increase in accounts receivable. The increase
in receivables occurred when sales were stable and actually decreased less than one percent. In addition,
the allowance for doubtful accounts declined by a relatively large amount. Because the allowance
account has been declining each year it is now at a balance about equal to the actual write-offs in 2007.
In future years it would be expected that the charge for bad debt expense would be larger than it was in
2005 and 2006. It is possible that Candela chose not to record as many bad debts in order to increase net
income in a year when profits were lower than the prior year.
The increase in accounts receivable and inventories and decrease in accounts payable not only
contributed to the negative CFO, but also the increase in the cash conversion cycle of 80 days. Candela is
paying suppliers in 35 days in 2007 compared to 78 days in 2006. This could be the result of suppliers
tightening credit. Candela needs to assess their own credit policies compared to their suppliers' credit
policies in order to manage their cash as efficiently as possible.
Operating efficiency
77
The operating efficiency of accounts receivable, inventory and accounts payable was discussed in the
short-term liquidity section. Fixed asset turnover and total asset turnover have declined as a result of
increases in fixed assets while sales declined slightly. Total asset turnover was also negatively impacted
by the accounts receivable and inventory turnovers.
Capital structure and long-term solvency
Candela does not have a risky capital structure. The firm has no long-term debt and an acceptable
amount of operating lease obligations. With no debt, there are no interest payments necessary. Fixed
charge coverage dropped in 2007 as operating profit declined and lease payments increased.
Cash flow adequacy was excellent in 2005 and 2006 since Candela generated positive CFO both years
and has no long-term debt and does not pay dividends. In 2007, the cash flow adequacy is a negative
number since CFO was negative. This should not be a problem as long as Candela is able to return to
positive CFO in the next year.
Profitability
Sales are stable at Candela with a slight decrease of .61%. Sales may have been negatively impacted in
2007 because of the firm's inability to ship product. Gross profit margin has improved all years for both
products and services that Candela sells. This is a result of either an increase in prices or a reduction in
cost of sales.
Operating expenses grew almost 35% in 2007 while sales decreased, resulting in a decline in operating
profit. In 2007, Candela has spent much more for research and development for new products. This is an
appropriate expense and should result in increased future sales. It would be expected as new products
are introduced that research and development costs would decrease the following year. Other operating
expenses that have increased include higher commissions, stock-based compensation, marketing, legal
and professional expenses. Candela is spending dollars to offer customer-related work shops, trade
shows and advertising, all of which should ultimately benefit the firm. As long as these expenses result in
higher sales and profits in the future, the increase this year should not be a concern.
Net profit margin is decreasing, but not as much as operating profit margin due to other income. In 2007,
Candela realized a one-time gain on the exchange of common stock related to an acquisition. The
effective tax rate has increased each year. The firm was able to utilize deferred tax assets in 2005 that
78
reduced the tax rate relative to later years. In 2006, the firm had lower taxes as a result of lower foreign
tax rates.
The drop in profit and the negative CFO in 2007 have caused all of the return ratios to also decrease. As
mentioned in the analysis, if the acquisitions deliver above average profits as anticipated, Candela
collects accounts receivable and ships inventories that were delayed in 2007 the firm should be able to
generate higher profits and positive CFO in 2008.
Market measures
Even though earnings per share decreased in 2007, the stock price of Candela did not drop
proportionately, causing a higher PE ratio. Investors may view the acquisitions favorably, while also not
being overly concerned about the increased accounts receivables, inventories, lower profits and negative
CFO in 2007.
2.
Reasons for investment in Candela common stock






Good short-term liquidity
Capital structure is not risky
No long-term debt
Gross profit margin increasing all years
Potential of acquisitions to increase sales and profits
Demand for Candela products and services, especially from financially sound consumers
Reasons against investment in Candela common stock







3.
Stock price is high relative to earnings per share
Candela sells a "luxury" product which could be negatively impacted by weak economic
conditions
Increasing accounts receivable, inventory, cash conversion cycle
Negative CFO in 2007
Sales not increasing
Operating and net profit margins decreasing
Government regulations
Reasons for loaning Candela additional funds


No long-term debt
Capital structure is not risky
79


Short-term liquidity is good
Future potential to generate cash based on acquisitions
Reasons against loaning Candela additional funds




Negative CFO in 2007 could be start of downward trend
Operating and net profit margins decreasing
Increasing accounts receivable, inventory and cash conversion cycle
Weak economic conditions causing reduced demand of Candela products
80