Group Project 3 [example--under construction]
Executive Summary
Dell: Overall Rations 7. Key concerns include stock
options, use of Treasury stock and poor working capital. Dell had slightly
more current liabilities than current assets (current ratio is 99.9%), STock
options are equal to over 13% or outstanding shares & treating these
as an expense reduced net income by 77% (for 2002). Dell has over $2 billion
in Treasury stock rather than paying dividends; substantial stock options
given to senior executives in 2002. None of these concerns is considered
serious. [Note that balance sheet & income statement numbers from
2003 earnings announcement; other information from 2002 10-K and 2002 Proxy
Statement.]
Gateway: Overall Rating 2, RF: By April 3, 2003 Gateway
had not reported their 2002 10-K, beyond the 90 day limit allowed by the
SEC. Also note major operating problems.
Apple: Overall Rating 6. Key concerns include corporate
governance issues, problems with sales levels & profitability, and
stock options. Corporate board practices have been poor in the past,
but improving based on new regulations. Stock options represent diluton
of over 30%, while treating options as expense would result in Apple recording
loss of $164 million rather than net income of $65 million. Minor concern
with Jeremy York as CEO of major customer. Some concern with compensation
for Steve Jobs and insider trading by executives. Other issues:
Ingram Micro represents almost 11% of outstanding receivables; purchases
of Treasury stock; high SGA & R&D; special charges recorded each
of the last six years; limited industrial segment disclosures & loss
at US Retail, high non-audit fees to KPMG.
Appendix
Accounting Analysis
| Issue | Dell* | Gateway**** | Apple |
| Balance Sheet Issues |
Not yet completed--2002 10-K not yet available |
||
| Overview Issues |
High cash level, but poor working capital;
relatively high leverage. |
Despite huge losses, balance sheet looks quite
good: substantial cash, working calpital & equity. |
High cash balance, current assets & working
capital; low inventory & receivables; relatively low leverage |
| Cash & Marketable Securities | $4.2 billion in cash (47.4% of CA), MS of $406 million (4.5% of CA, available for sale). | $466 million in cash (23.8%); MS of $601 (30.7%, available-for-sale****). |
$2.3 billion in cash (41.8% of CA); $2.1 billion in MS (available-for-sale);
small gain of $7 million, reported as OCI |
| Inventory, Accounts Receivable | FIFO, $306 million (3.4% of CA), 3 days inventory; AR, $2.6 billion (29.0 % of CA), 28 days receivable. | FIFO,**** $89 million (4.6% of CA); AR, $198 million (10.1% of
CA). |
FIFO, $45 million (0.8% of CA), 2.5 days of inventory; AR 10.5%
of CA, 32.9 days receivable, bad debtrs of $51 million (8.3% of gross recv.),
10.8% of receivables from 1 customer, Ingram Micro |
| Property, Plant & Equipment, Depreciation | $913 million (5.9% of TA), relatively new fixed assets (average age - 2.4 years; average age % 42.6%), straight-line depr. ** | $481 million (19.2% of TA) |
9.9% of TA, average age 3.7 years; capitalized software development
costs of $184 million (26.6% of ending gross investment), part of PPE |
| Intangibles |
None reported |
$23 million |
$119 million (see business combinations) |
| Long-term Investment, Debt & Equity |
$5.3 billion (34.0% of TA) |
$39 million, combining both debt & equity. |
|
| Accounts Payable, Other Current Liabilities |
$6.0 billion (67.0% of CL), 68 days payable;
other 33.0% |
$279 million (29.7% of CL). |
AP 54.9% of CL, 54.5 days payable; Other Liab.
of $275 million (5.1% of CA); accrued expenses of $747 million. |
| Long-term Liabilities |
$1.7 billion |
$127 million (11.9% of TL). |
$316 million ($300 milion in 6.5% unsecured notes,
due in 2004), $229 million deferred tax |
| Warranties |
$484 million (3.6% of TA)** |
$745 million accrued (1.1% of TA), $69 million
actual cost in 2002. |
|
| Commitments, Contingencies |
Minor ** |
Commitments from contract manufacturers for components,
$525 million outstanding; lawsuits outstanding, considered immaterial |
|
| Operating Leases, other off-balance-sheet items |
Ops. leases of $14 million, (equivalent oto
0.1% of TA).** |
Operating lease obligations 9.4% of total assets
(some earnings management potential). |
Ops leases of $464 million (equivalent to 7.4%
of TA) |
| Equity, Composition |
Paid-in capital, treasury stock, retained earnings,
other comprehensive income; no dividends paid, equity down 16.5% from previous
year.** |
Paid-in capital, retained earnings, acquisition-related
deferred stock, other comprehensive income, No dividends paid; equity has
increased over the last six years. |
|
| Treasury stock |
$2.2 billion (reduced equity to $4.7 billion),
52 million shares (2.0% of outstanding shares). ** |
$116 million, reported under paid-in capital
in 1999; forward purchase of 1.5 million shares for Sept. 2003. |
|
| Other Comprehensive Income |
$38 million (0.8% of equity). |
Negative $49 million (1.2% of equity) |
|
| Income Statement Issues |
|||
| Overview |
The cost leader & most profitable PC company,
with both revenues above and net income close to 2000 levels. |
Serious problems trying to compete, large drop
in sales & net losses continue from previous year**** |
Major struggle to maintain market share &
profitability over the last 2 years (after a successful 2000), Net loss
in 2001, followed by a net income in 2002. |
| Revenue Recognition | Conservative, meets industry standards (products revenue recognized on delivery, services when services provided (consistent with SAB 101)** | Conservative, meets industry standards: products on delivery, services when services provided (consistent with SAB 101) | Conservative: product delivered once it has been shipped & title & risk transferred & revenue recognized (consistent with SAB 101) |
| Revenues |
$35.4 billion, up 13.6% from 2002 & the best
level in the history of the company. |
$4.2 billion, down from $6.1 billion in 2001. |
$5.7 billion in 2002, up 7.1% from 2001; however,
revenues were almost $8 billion in 2000 |
| Evidence of aggressive revenue recognition |
None** |
None**** |
None |
| Cost of Sales |
$29.1 billion, 82.1% of revenues, gross profit
$6.3 billion. |
$3.6 billion, 86.4% of sales (down from $5.2 billion
in 2001); gross profit, $566 million. |
$4.1 billion, 72.1% of revenues, gross profit,
$1.6 billion. |
| Operating expenses |
$3.5 billion; SG&A, $3.1 billion (8.6% of
revenues), R&D, $455 million (1.3% of revenues); Special charges, 0
in 2003 ($482 million in 2002, restructuring). |
SG&A $1.1 billion, down from $2.0 in 2001;
operating income, $-511 million ($-1.2 billion in 2001). |
$1.6 billion; major expense categories: R&D,
$446 million (7.8% of rev.), SG&A, $1.1 billion (19.3%), higher than
Dell, emphasized in MD&A; & special charges (0.5%), restructuring.
Special charges recorded in each of the last 6 years. |
| EBIT | EBIT estimated at $3.1 billion, return on sales of 8.8% (compated with NI return of 6.0%) | EBIT loss of $999 million (similar to net loss) RF **** | EBIT of $98 million (51% above NI); EBITDA of $216 million (232%
above NI). |
| Capitalizing Costs | None reported** |
Consistent with industry--software capitalization; write-down of long-lived assets, $19 million **** | Capitalizes software development costs, $25 million (6% of R&D). |
| Income Tax | 29.9% effective tax rate | Income before tax negative & provision for tax also negative (ops loss carryforwards) | $22 million, 25.3% effective tax tax ($87 million income beofre
tax); Operating loss carryforwards of $72 million. |
| Non-recurring Items |
None for 2003; Nonrecurring charge of $105 million for job
reduction & consolidation of facilities in 2002. |
Restructuring charge of $62 million. |
None in 2002, $12 million gain in 2001, adopting SAB 101. |
| Net Income |
$2.1 billion (6.0% of revenues); excellent growth
trends, except for down year 2002 (net income $1.2 billion). |
Net loss of 298 million (down from $1.0 billion
in 2001). |
$65 million (1.1% of sales), up from $25 million
loss in 2001; erratic pattern last 6 years & in recent quarters: losses
for both Sept. & DEc. 2002 quarters. |
| Cash Flow Statement |
CFO of $3.8 billion (205% above NI); free cash flows of $1.5
billion (CFO-CFI)** |
CFO of $89 million (36.9% above NI); free cash flows of $-252
million (CFO-CFI) |
|
| Special Topics |
|||
| Business Combinations |
None reported. ** |
3 in 2002, total $107 million (1.7% of TA), $68 million allocated
to goodwill (64%), $27.7 million to "real net assets (26%)," $11.3
million to in-process R&D (11%). |
|
| Equity Method, Joint Ventures |
JV with Tyco International for computer financing ** |
None reported |
|
| Retirement | 401(k) plan, no long-term obligations** | 401(k) plan, no long-term obligations**** | 401(k) plan, $19 million contribution, no long-term obligations. |
| OPEB | None reported** | None reported**** | None reported |
| Segment Reporting | Industry segments: business 8.6% operating return on sales; consumers 5.8% operating return on sales** | Operating segments--U.S. market: business 9.0% operating return on sales; consumers 0.5% operating return on sales.**** | Limited disclosure; only sales for industrial segments listed
(in MD&A), no performance data available for analysis. |
| Geographic Reporting | Operates in Americas, Europe & Japan. Operating margins for foreign operations below U.S. margins (U.S.,8.0%; Europe, 5.9%; Asia, 5.1%)** | Large negative operating return on sales for foreign oprations (-23.1% Europe; -11.9% Asia) RF.**** | America's largest at $3.1 billion (54% of total sales, return
on sales 9.1%), US, Retail -7.85% return on sales RF, Europe, 9.8%;
Japan, 19.7%, other, 21.5%. |
| Risk Management, Credit Risk |
Hedging using derivatives; Altman's Z-score 1.88,
gray area. ** |
Hedging, using derivatives; large % of receivables
not covered by collateral or credit insurance; Altman's Z-score, 7.15,
healthy. |
|
| Derivatives | Forward foreign currency hedging, interest rate swaps, equity options, forward contracts & put obligations on Dell stock.** | Forward currency contracts until 3rd quarter: discontinued foreign operations, no longer in currency mkts.**** | Uses foreign currency hedging, interest rate swaps (none outstanting at year-end). |
| Special Purpose Entities, etc. | SPE established as part of JV with Tyco for computer financing** | None reported**** | None reported |
| Corporate Governance |
Michael Dell, founder, CEO; 11 bember board; 4 committees, including
Audit & Compensation. *** |
Small board (6 members, Al Gore elected March 19), Jeremy
York, CEO of Micro Warehourse (major Apple custumer) on the board;
board & committee structure improving. |
|
| Compensation, Related |
Base salary, bonuses, stock options, perks; substantial
options awarded in 2002 (1-5+ million options to each senior executive).***
|
Base salary, bonuses, stock options, perks: Jobs
given a Gulfstream airplane as a perk (1999) + tax assistance (2002);
insider trading--selling Apple stock by several senior executives in April
& May 2002. |
|
| Stock Options |
350 million options outstaning, 13.2%
of outstanding shares; net income-reported, $1.2 billion, net income-pro
forma, $282 million, % difference 77.4%. ** |
109 million options outstanding, 30.4% of outstanding
shares; net income-reported, $65 million; net income-pro forma,
$-164 million (RF), % difference 352.3%. Steve Jobs reissued 7.5
million stock options to replace "underwater" options. |
|
| Audit Report | PWC - Unqualified, non-audit fees of $4.2 million (64.5% of total fees) *** | PWC - Unqualified | KPMG - Unqualified, report issued 15 days after end of fiscal year; non-audit fees of $16.1 million (90% of total fees). |
| Other | None |
Strategic alliance with AOL for sales & distribution channels | None |
| Rating for Accounting Issues | 7--concerns include stock option dilution, poor working capital (current ratio below 1), use of Treasury stock (no dividends). | 2--RF, 2002 10-K not yet available |
6--key concerns include corporate governance issues, problems
with sales levels & profits, segment reporting & stock options. |
****Gateway had not yet submitted the 2002 10-K; Most financial information
is based on 2002 earnings announcement of January 29, 2003; most detailed
accounting information comes from the 2001 10-K (marked with ****) or 2002
Proxy Statement (*****).
Note: The PC companies do not include all accounting issues. Therefore, other examples are presented below for other specific issues.
Pension Plans & OPEB
General Electric, Pension Plans: Defined benefit Plans: funded
status, $14.6 billion; amount recognized on balance sheet, $12.4 billion
net asset position (overfunded); "income from pensions," $2.1 billion
(this includes expected return of $4.3 billion on plan assets); actual return
on plan assets, actual return: $2.9 billion loss. Net difference
between "pension income" reported & "real cost," negative $7.2 billion.
General Electric, Other Post-employement Benefits: Amount recognized
on the balance sheet, liability of $2.7 billion. OPEB expense
reported, $615 million.
Equity Method, Joint Ventures
Coca-Cola: Coca-Cola does no bottling--all bottling companies have
been spun-off with Coca-Cola holding less then 50%, to use the equity method.
For example, Coca-Cola Enterprises was spun-off in 1986, taking considerable
debt with it (CCE's debt-to-equity was 7.4x in 2001). Equity method
represented $5.1 billion in Coca-Cola investments in 2001 (22.9% of total
assets), fair value, $8.4 billion.
Du Pont: Du Pont has several affiliates, where Du Pont ownes 50% as a JV. The emphasis is on foreign operations, such as Du Pont Elastomers LLC or Du Pont Sabanci
Hilton has a number of hotel JVs associated with the operations of hotel
properties, including Hilton Reservations Worldwide (50% ownership by Hilton).