Adc Tellecommunications 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

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