Adc Telecommunications Financial Ratio Analasis Accounting 6000 Financial Statement Analysis ADC Telecommunications October 29, 2000 Corporate Background ADC Telecommunications (ADCT) is a communication equipment manufacturer located in Minneapolis, Minnesota, USA. Since 1952, the company has successfully weathered the tumultuous transformation process of technology. Today, ADC Telecommunications exclusively focuses on manufacturing computer-networking equipment. Increasing demand for fiber optic transmission systems like asynchronous transfer mode (ATM), synchronous optical networks (SONET) and most wireless communications systems, provide significant opportunities for ADCT. The company currently focuses on enabling communications service providers to deliver high-speed services to residential and commercial customers. The following is an annual analysis of ADCT’s financial ratios of years 1995-1999.

Overall Performance Measures The averaged price/earnings (P/E) ratios for ADCT are 36, 36.3, 39.4, 27.5, and 64.1 for years 1995-1999 respectively. The P/E ratio for ADCT is very stable from 1995 to 1997. In 1998, the P/E ratio fell over 43% to 27.5. The P/E ratio then rocketed to 64.1 in 1999, a 57% increase in one year. This dramatic increase indicates current investors are placing more value on future earnings as compared to previous years. One-reason ADCT investors pay more to own the stock is the growth potential in the communication equipment sector. For example, Internet traffic doubles every 100 days, illustrating the growth potential for ADCT’s sales and bottom line earnings (Annual Report, 1999).

Investors are currently willing to buy the stock at an inflated price due to two main reasons, the company’s future earning potential and present growth rate in the industry. The returns on assets (ROA) ratios for ADCT are 9.20%, 11.40%, 11.60%, 11.30% and 5.20 for the years 1995-1999. There were no ROA industry averages in the Almanac of Business and Financial Ratios, written by Leo Troy. ADCT’s ROA ratios remain constant (around11%) from 1995 -1998. In 1999, ROA dropped 54% to 5.20.

This decline indicates that ADCT may not be utilizing its assets properly. One explanation for the 1999 decrease is ADCT’s acquisitions. For example, ADCT purchased Broadband Access Systems for 2.25 billion exchange of stock (Datek, 2000). Recent acquisitions require additional long-term debt and are reflected in the ROA reduction in 1999. However, this trend is recent and may be viewed only as a temporary adjustment until the 2000 financial statements are released. There were no return on shareholders equity (ROE) industry averages in the Almanac of Business and Financial Ratios, written by Leo Troy.

ADCT’s ROE ratios are 10.8%, 14.2%, 14.5%, 16.0% and 7.0% for the years of 1995-1999 respectively. One notable trend in the ROE ratios is the 56% drop from 1998 to 1999. One explanation for this is found on ADCT’s income statement. There is a significant drop in net income in 1999 verses 1998. Non-reoccurring charges were 148,977,000 and 9,168,000 for years 1999 and 1998 respectively. These increased expansion costs decrease net income, thus reducing the ROE ratio for 1999.

ADCT must focus on revenue generation from these recent acquisitions to improve the return on shareholders equity. This recent drop in ROE needs to be compared to 2000 ROE ratios to provide a more complete picture of future returns for ADCT investors. Profitability Measures The gross margin percentages for ADCT are 52.5%, 50.4%, 50.0%, 50.5% and 51.7% for the years 1995-1999. The industry comparisons of gross margin averages are 43.1%, 40.3%, 41.2%, 40.4% and 40.6% for the same years. One noticeable difference is ADCT’s gross margin percentages are consistently 10% higher than industry comparisons. One reason for exceptional gross margin performance is ADCT’s sales mixes, sales volume, lower component costs and consolidation through acquisitions.

ADCT’s gross margin is 10 percent higher than the industry average, illustrating another aspect of the company’s high profitability. ADCT’s profit margins are 9.4%, 10.6, 9.3, 10.6 and 4.5 for 1995-1999 respectively. There were no profit margin industry averages in the Almanac of Business and Financial Ratios, written by Leo Troy. Profit Margins have remained stable at 10% until a 1999-drop to 4.5%. This sudden drop in 1999 can be attributed to the previously mentioned decrease in net income in 1999 due to non-reoccurring charges. This drop in 1999 can be viewed as a temporary decline until compared to the 2000 financial statements for ADCT.

Earnings per share (EPS) for ADCT are $.45, .69, .90, 1.16 and .58 for the years 1995-1999 respectively. There were no EPS industry averages in the Almanac of Business and Financial Ratios, written by Leo Troy. The EPS trend is a gradual increase from 1995-1998 and a sudden drop in 1999. These figures reflect ADCT’s reduced net income due to increased non-reoccurring expenses and the issuance of 45,000 shares on the NASDAQ market to raise additional revenue for expenses. Industry leader Cisco has a $.17, .30, .34 and .44 cents of EPS for 1995-1998. ADCT has consistently returned more EPS than the industry leader Cisco, reflecting ADCT’s superior profitability.

Despite expansion expenses, ADCT still remains very profitable. Both gross margins and EPS indicate strong profitability. A weak profitability margin in 1999 reflects increased expansion expenses and can be viewed as temporary until the 2000 Annual Report is available. Investment Utilization ADCT’s asset turnover ratios are .97, 1.1, 1.2, 1.1 and 1.2 for years 1995-1999 respectively. Industry asset turnover ratios are 1.6, 1.9, 1.7, 1.8 and 1.7 for the same time period.

ADCT’s asset turnover ratio trend remains constantly lower than industry averages. This suggests that ADCT is not properly using its assets to generate sales revenues. Competitors are more efficient by creating more revenues with fewer assets, as compared to ADCT. An increased profit margin would improve the current use of assets and improve income generation. Day’s receivable for ADCT are 67 days, 72, 77, 97 and 83 for 1995-1999 respectively.

There were no comparable day’s receivable industry averages in the Almanac of Business and Financial Ratios, written by Leo Troy. The averages used in Troy conflicted with the methods of the Anthony, Hawkins and Merchant textbook. A 30% noticeable trend increase occurs between 1995-1998. This indicates the time it takes ADCT to receive cash from customers is increasing, making the company tie up assets for longer periods of time. This is considered a negative trend and needs further investigation to determine the cause.

Day’s inventory for ADCT is 113 days, 116, 105, 94 and 96 for 1995-1999 respectively. No comparable industry averages were presented. A noticeable decline indicates ADCT is taking less time to sell its inventory. ADCT is improving the time it takes to convert inventory into sales revenues. This trend is considered a positive trend for ADCT.

However, since day’s receivable’s is increasing, cash flows from day’s inventory are being realized later, due to extended credit payment deadlines. ADCT’s inventory turnover ratios are 4.5, 3.8, 3.9, 4.0 and 4.4 while industry standards are 4.5, 3.8, 3.8, 4.4 and 4.9 for years 1995-1999 respectively. ACDT ratios directly reflect industry averages. Inventory at ADCT turns over every four months or three times a year. The inventory turnover trend can be viewed as a positive trend. ADCT’s current ratios are 5.1, 4.0, 3.1, 2.3 and 2.5 while industry averages are 2.3, 2.0, 2.2, 2.1 and 2.0 for 1995-1999 respectively. ADCT has higher current ratios than industry standards.

This trend can be viewed as both a positive and a negative trend. For example, a high current ratio indicates ADCT can easily pay its debt, 3 times more than in industry standard in 1995 (excess current assets). However, this also indicates that ADCT is not using its assets efficiently. By taking on more debt, the company could increase spending on research & development or acquisitions/mergers. Since 1997, ADCT has been inline with industry standards concerning current ratios, increasing profitability possibilities. ADCT quick ratios are 2.7, 1.3, .6, .8, .4 while industry standards are 1.4, 1.2,1.4, 1.1 and 1.1 for 1995-1999 respectively. ADCT’s short-term debt paying ability has been decreasing since 1997 when compared to industry standards.

This suggests ADCT may have excess inventories on hand or reduced its immediate available cash more than it should have. ADCT must improve its short-term debt paying ability or it may risk becoming an acquisition target. ADCT may also find it more difficult to issue bonds at a low rate or utilize other financing activities with a low quick ratio. This is a negative trend in ADCT’s profitability possibilities. Financial Condition ADCT’s financial leverage ratios are 1.1, 1.2,1.2, 1.4 and 1.3 for 1995-1999. There are no industry comparisons available.

The trend is constant with little variation. ADCT’s debt/equity ratios are 17.7% 24.5, 24.7, 42.2 and 34.0 for 1995-1999. There are no comparison ratios. There was a dramatic increase in 1998. This increase reflects ADCT’s 1998 decision to sell additional stock in the NASDAQ exchange. ADCT has used the raised capitol to invest in operating activities and is reflected in the reduction of this ratio in 1999. Cash flow/ debt ratios for ADCT are 49.1%, 42, 43, 21 and 81 for 1995-1999.

There is a dramatic increase in 1999. This increase is due to increased expenses in 1999, reducing cash generated by operating expenses. ADCT also issued stock in 1998, increasing the total debt of the company. ADCT must use its newly acquired debt to generate more cash flow to improve the financial condition of the company. Tests of Dividend Policy ADC Telecommunications pay no dividends. Bibliography ADC Telecommunications Financial Ratio Analasis (1995-1999) Business.