Analysis Team:
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Trevor Arras
trevor.arras@tttu.edu
Amanda Landrus
amanda.landrus@ttu.edu
Kyu Lim
tek793@yahoo.com
Jeff Zoch
jeff.zoch@ttu.edu
Table of Contents Executive Summary....................................................................................................................................... 7 Industry Analysis ....................................................................................................................................... 9 Accounting Analysis ................................................................................................................................ 10 Financial Analysis .................................................................................................................................... 11 Valuation Executive Summary ............................................................................................................ 12 Business and Industry Analysis ................................................................................................................... 13 Firm Overview ......................................................................................................................................... 13 Industry Overview ....................................................................................................................................... 15 Five Forces Model ................................................................................................................................... 17 Rivalry among Existing Firms .................................................................................................................. 19 Introduction ........................................................................................................................................ 19 Industry Growth .................................................................................................................................. 19 Concentration and Balance of Competitors ........................................................................................... 22 Differentiation..................................................................................................................................... 24 Switching Costs ................................................................................................................................... 25 Economies of Scale ............................................................................................................................. 27 Ratio of Fixed to Variable Costs .......................................................................................................... 28 Excess Capacity ................................................................................................................................... 29 Exit Barriers ......................................................................................................................................... 30 Threat of New Entrants........................................................................................................................... 30 Introduction ........................................................................................................................................ 30 Economies of Scale ............................................................................................................................. 31 First Mover Advantage........................................................................................................................ 31 Access to Channels of Distribution and Relationships ........................................................................ 33 Legal Barriers....................................................................................................................................... 34 Conclusion ........................................................................................................................................... 34 Threat of Substitute Products ................................................................................................................. 35 Introduction ........................................................................................................................................ 35 Relative Price and Performance.......................................................................................................... 36
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Customer’s Willingness to switch ....................................................................................................... 36 Conclusion ........................................................................................................................................... 37 Bargaining Power of Customers ............................................................................................................. 37 Differentiation..................................................................................................................................... 38 Importance of Product for Cost and Quality....................................................................................... 39 Number of Customers ......................................................................................................................... 40 Volume per Customer ......................................................................................................................... 41 Switching Cost ..................................................................................................................................... 42 Conclusion ........................................................................................................................................... 42 Bargaining Power of Suppliers ................................................................................................................ 43 Differentiation..................................................................................................................................... 44 Importance of Product for Cost and Quality....................................................................................... 45 Number of Suppliers ........................................................................................................................... 45 Volume per Suppliers .......................................................................................................................... 47 Switching Cost ..................................................................................................................................... 48 Conclusion ........................................................................................................................................... 48 Firm Competitive Advantage Analysis ........................................................................................................ 50 Cost Leadership....................................................................................................................................... 51 Economies of Scale ............................................................................................................................. 51 Economies of Scope ............................................................................................................................ 52 Manufacturing Efficiency .................................................................................................................... 52 Tight Cost Control ............................................................................................................................... 53 Differentiation..................................................................................................................................... 54 Superior Product Quality .................................................................................................................... 55 Superior Product Variety..................................................................................................................... 56 More Flexible Delivery ........................................................................................................................ 56 Investment in Research and Development ......................................................................................... 57 Organization Promotes Creativity and Innovation ............................................................................. 58 Conclusion ........................................................................................................................................... 58 Key Success Factors..................................................................................................................................... 59 Superior Product Quality .................................................................................................................... 59 Superior Product Variety..................................................................................................................... 60
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Focus on Creativity .............................................................................................................................. 60 Economies of Scale and Scope ............................................................................................................ 61 Conclusion ........................................................................................................................................... 61 Accounting Analysis .................................................................................................................................... 62 Identify Key Accounting Policies (KAP) ................................................................................................... 63 Type 1 Key Accounting Policies ........................................................................................................... 64 Type 2 Key Accounting Policies ............................................................................................................... 66 Introduction ........................................................................................................................................ 66 Research and Development ................................................................................................................ 66 Foreign Currency ................................................................................................................................. 67 Operating Leases................................................................................................................................. 69 Pension Plan ...................................................................................................................................... 69 Goodwill.............................................................................................................................................. 71 Degree of Potential Accounting Flexibility.............................................................................................. 72 Introduction ........................................................................................................................................ 72 Research and Development ................................................................................................................ 73 Foreign Currency Risk ......................................................................................................................... 74 Operating Leases................................................................................................................................. 74 Goodwill .............................................................................................................................................. 75 Evaluation of Actual Accounting Strategy .............................................................................................. 75 Introduction ........................................................................................................................................ 76 Research and Development ................................................................................................................ 76 Foreign Currency Risk ......................................................................................................................... 77 Operating Leases................................................................................................................................. 78 Goodwill.............................................................................................................................................. 79 Quality of Disclosure ............................................................................................................................... 81 Introduction ........................................................................................................................................ 81 Research and Development ................................................................................................................ 82 Foreign Currency ................................................................................................................................. 82 Operating Leases................................................................................................................................. 82 Goodwill .............................................................................................................................................. 83
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Quantitative Analysis .............................................................................................................................. 83 Sales Manipulation Diagnostics .......................................................................................................... 84 Net Sales / Cash from Sales ............................................................................................................ 84 Net Sales / Accounts Receivable .................................................................................................... 86 Net Sales / Inventory ....................................................................................................................... 88 Conclusion.......................................................................................................................................... 90 Asset Turnover .................................................................................................................................. 90 CFFO / Operating Income ............................................................................................................... 93 CFFO / Net Operating Assets .......................................................................................................... 95 Total Accruals / Sales ....................................................................................................................... 97 Conclusion.......................................................................................................................................... 99 Sales Conclusion................................................................................................................................ 100 Potential Red Flags................................................................................................................................ 101 Introduction ...................................................................................................................................... 101 Operating Leases............................................................................................................................... 101 Research and Development .............................................................................................................. 102 Goodwill ............................................................................................................................................ 102 Undoing Accounting Distortions ........................................................................................................... 104 Introduction ...................................................................................................................................... 104 Research and Development .............................................................................................................. 104 Operating Leases............................................................................................................................... 107 Goodwill ............................................................................................................................................ 109 FINACIAL STATEMENTS ......................................................................................................................... 111 Income Statement............................................................................................................................. 111 BALANCE SHEET ................................................................................................................................ 113 RESTATED FINANCIAL STATEMENTS ..................................................................................................... 114 Trial Balance ...................................................................................................................................... 114 Statement of Cash Flows ...................................................................................................................... 120 Restated Statement of Cash Flows ....................................................................................................... 123 Conclusion ......................................................................................................................................... 158 Cost of Equity ........................................................................................................................................ 158
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Size Adjusted ..................................................................................................................................... 160 Alternative cost of equity.................................................................................................................. 160 Cost of Debt ...................................................................................................................................... 161 Weighted Average Cost of Capital (WACC) ....................................................................................... 163 Firm Valuation........................................................................................................................................... 184 Method of Comparables ....................................................................................................................... 184 Price to Earnings Ratio (Trailing) ....................................................................................................... 185 Price to Earnings Ratio (Forward) ..................................................................................................... 185 Price / Book ....................................................................................................................................... 185 Dividends / Price ............................................................................................................................... 186 Price / EBITDA ................................................................................................................................... 187 Price / Free Cash Flows ..................................................................................................................... 188 Enterprise Value/EBITDA .................................................................................................................. 188 Enterprise Value / Free Cash Flows .................................................................................................. 189 Intrinsic Valuation Models .................................................................................................................... 191 Discounted Dividends Model ............................................................................................................ 191 Residual Income Model .................................................................................................................... 192 Discounted Free Cash Flows Model .................................................................................................. 194 Abnormal Earnings Growth............................................................................................................... 195 Long Run Residual Income ................................................................................................................ 198 Conclusion ......................................................................................................................................... 200 Appendix ............................................................................................................................................... 201
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Executive Summary Investor Recommendation: Overvalued - HOLD (6/1/2009)
ISIL - NYSE (6/1/2009) $13.00 Altman Z-Scores 52 Week Range: 2004 2005 2006 2007 2008 $7.18 - $26.70 Revenue: $ 769.68 (Mil.)Initial Z-Score: 0.6 0.7 1 1 -3.2 Market Capitalization: $ 1,588.86 (Mil.)Adjusted Z-Score:3.6 4 4.4 4.4 9.3 Shares Outstanding: 122.22 (Mil.) Current Market Share Price (6/1/2009) $13.00 Stated Restated Book Value Per Share: $8.39 $11.18 Financial Based Valuations Return on Equity: -46.34% -9.54% As Stated Restated Return on Assets:-43.14% -4.90% Trailing P/E: N/A N/A Forward P/E: N/A N /A Cost of Capital Dividends to Price: $ 16.17 $ 7.77 Estimated R-Squared Beta Ke Price to Book: $ 21.41 $ 20.14 3-Month 0.29119 1.09787 13.28P.E.G. Ratio: N/A N/A 1-Year 0.29249 1.09909 12.984Price to EBITDA: $ 9.51 $ 16.20 2-Year 0.29212 1.09879 12.843EV/EBITDA: $ 11.72 $ 19.92 5-Year 0.39547 1.09851 12.323Price to FCF: $ 19.13 $ 38.18 10-Year 0.29246 1.09832 11.925
Published Beta: Estimated Beta:
1.06 1.099
Size Adj. Cost of Equity: Cost of Debt (BT): Cost of Debt (AT): WACC (BT):
12.5%
WACC (AT):
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6.5% 4.6% 11.9%
11.7%
Intrinsic Valuations As Stated Restated Discounted Dividends: $4.81 Free Cash Flows: Residual Income: Long Run Residual Income: Abnormal Earnings Growth:
$17.27 $14.39 $7.43 $0.38 $7.61 $14.34 $6.36 $1.15
Screen clipping taken: 6/27/2009, 10:07 AM
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Industry Analysis Intersil is in an industry of Analog Integrated Circuits (IC). This Intersil employs over 1,500 employs within their firm and has grown to become and internationally recognized industry later in the High-Quality-Analog (HQA) Integrated Circuit (IC) industry. In this industry there is a broad range of products which include bridge driver power management ICs, broadband power management ICs, cellular base stations, DVD recorders, GPS systems, and many more electronic products. The analog industry is a very specialized industry but at the same time many products are created from this industry. The majority of Intersil’s revenues come from international operations. Last year, 2008, international revenues composed 82% percent of Intersil’s net revenues. About half of their sales are sold to original equipment manufacturers and the other half are sold to private distributors and resellers.
Competitive Force
Degree of Competition
Rivalry Among Existing Firms
Moderate
Threat of New Entrants
Low
Threat of Substitute Products
Moderate
Bargaining Power of Customers
Low
Bargaining Power of Suppliers
Moderately-High
To first value a firm one must understand the industry and which it competes in. The best way to do this is by using a five force model analysis. The five forces model covers topics over rivalry among existing firms, threat of new entrants, threat of substitute product, bargaining power of buyers, and bargaining power of suppliers. The chart shows the different degree of competition we decided each competitive force 9|Page
should have. The firm Intersil’s main competitors are Maxim, Analog Devices, Linear Technology, and Texas Instruments. All of these firms are compete in the analog IC industry. Each one of these companies compete to make the fastest, best quality, and smallest chip out on the market. To create a high quality product a big portion is invested in R&D which is imperative to remaining competitive. This industry does not really have to worry about the threat of new entrants. For a new firm to come into this industry they must overcome many barriers. On the other hand the threat of substitute products exists in this industry due newer and better products that come in to the market. In this industry innovative products are constantly created which eventually push out older products from the market. The bargaining power of customers is consider low in the industry because the performance of the product dictates the price. In the Analog IC industry supplies are used such as raw wafers, chemicals, liquefied gases, poly-silicon, silicon wafers, pure metals, lead frames, molding compounds, as well as subcontracting work such as epitaxial growth, a portion of wafer fabrication, and ion implantation. In the industry there is a moderately to high degree of competition when it comes to bargaining power of suppliers. The numbers of suppliers are high; however, firms receive a majority of their supplies from single suppliers and subcontractors. Due to their dependency on certain suppliers, suppliers have pricing and term bargaining power.
Accounting Analysis Accounting analysis is a key step in the valuation process. In order to determine if a firm’s financial statements accurately represent reality, one must be aware of a firms’ principal accounting policies and be able to identify and “red flag” instances in which excessive accounting flexibility or accounting distortion might be present. While analyzing ISIL’s financial statements, we felt that their accounting strategy led to 10 | P a g e
financial reports that degraded our opinion of the firm. After analyzing ISIL’s actual accounting strategy, we felt that restating these accounts would better represent the firm’s underlying business reality. The key areas that we targeted as red flags were their recording of impairment of goodwill, expensing of research and development, and their strategy of using operating leases instead of capital leases. After computing amortization tables related to these accounts, we completed a trial balance which depicted the year by year adjustments that we applied to actual financial statements in order to produce restated statements that we felt were a better representation of the firm. After obtaining restated financials, we were able calculated a number of restated financial ratios which clearly represented the impact that varying accounting strategies on investors’ perception of the firm. For example, prior to restating the financial statements, Intersil’s computed Altman Z-Score indicated that the firm was at high risk of bankruptcy. However, after calculating the same ratio using the restated financials, we determined that the firm was not only not in financial distress, but rather had healthy margin of safety above the “grey zone.”
Financial Analysis The financial analysis is computed to measure viability, profitability, and stability of firm using financial ratios. These ratios are used to measure the performance of a firm to their competitors. The purpose of a financial analysis of a firm is to measure a firm’s performance against its competitors. The three main types of ratio categories firms’ use are liquidity, profitability, and capital structure. Liquidity ratios are used to measure if a firm has enough cash to meets its future obligations and determines the credit risk of a company. The next major ratio is profitability and is used to see how efficient the firm operates. The third ratio is capital structure, this ratio is important because they provide insight into the firms default risk.
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Valuation Executive Summary To determine the value of ISIL it is necessary to use both relative financial ratio valuation and intrinsic valuation models. To explain the method of comparables it is a bunch of ratios that have different aspects of the firm which is designed to estimate current stock prices. There are five forms of valuation models, discounted dividends, free cash flow, residual income, AEG, and long run residual income. Discounted dividends bases its valuation based on a firm’s dividend issuance. Free cash flow does not take into consideration the first year, (time zero) and is based on wishful thinking rather than theory or tangible assets. The free cash flows model is the only model that uses WACC instead of Ke. The third model, residual income is based in theory and can explain up to 90%. Discounted dividends only explains the portion of the firms price that correlates to dividends. The next model is the AEG. Similar to the residual income, it correlates with the residual income and typically finds very similar results with high explanatory power. The last valuation model is the long run residual income. This is a sensitivity analysis to test how the firms return on equity, growth rate and cost of equity. This displays the volatility of the price and how price shifts according to growth, ROE, and Ke.
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Business and Industry Analysis In order to establish a foundation upon which we will draw upon a firms’ publicly available financial statements, and through thorough analysis, emulate “insider information” for the purpose of measuring and forecasting firm performance, we must first establish expert knowledge of the firm and the industry in which it operates.
Firm Overview Formed in 1999, Intersil Corporation’s (ISIL) “…mission is to provide differentiated, high-performance analog ICs that meet (their) customers’ needs and exceed (their) expectations.” (Intersil 10-K) Intersil is a part of the analog integrated circuit semiconductor industry. Intersil’s roots go as far back as the 1950s when three companies merged to create the Harris Corporation. In 1999, Harris was acquired by Intersil. As of January 2009, Intersil employs over 1,500 employees and has grown to become an internationally recognized industry leader in the High-Quality-Analog (HQA) Integrated Circuit (IC) industry. Intersil develops and manufactures high-performance analog integrated circuits. Intersil has had many years of analog experience, and has built a secure foundation. Intersil’s HQA ICs can be found in a broad range of products including some of the following: bridge driver power management ICs, broadband power management ICs, cellular base stations, DVD recorders, GPS systems, high speed converters, hot plug power management, line drivers, MP3 players, multiplexers, operational amplifiers, and smart cell phones. “Their product strategy is focused on broadening our portfolio of Application-Specific Products (“ASSP”) and General Purpose Proprietary Products 13 | P a g e
(“GPPP”) which are targeted within the high-end consumer, industrial, computing and communications markets.” (Intersil 10-K) Intersil designed their business strategy to focus on key factors such as focusing on large vertical markets, broadening their product portfolio, maintaining technological superiority and providing excellent customer service, and partnering with leaders in the semiconductor markets, products and services. Intersil strives to introduce new products to the market before their competitors, and to do so they incur high research and development costs, averaging $134.8 million annual R&D expense over the past three years. The majority of Intersil’s revenues come from international operations. Last year, 2008, international revenues composed 82% percent of Intersil’s net revenues. On average, about half of their products are sold to original equipment manufacturers (OEMs), and the other half are sold to private distributors and resellers. The following table shows Intersil’s total assets, net sales and comparable sales growth for the past six years. The ne sales has had steady growth for the past six years, and the sales growth has grown on average 6.24% during the past six years.
Intersil Corp -Total Assets, Net Sales, and Comparable Sales Growth 2004
2006
2005
2007
2008
ASSETS
$
2,587.57
$
2,583.72
$
2,559.13
$
2,404.99
$
1,133.59
REVENUES
$
535.78
$
600.26
$
740.60
$
756.97
$
769.68
% ChgRev
5.53%
12.03%
23.38%
2.21%
1.68%
Intersil’s primary competitors are Analog devices (ADI), Maxim integrated products (MXIM), Linear Technology Corp (LLTC), and Texas Instruments (TXN). Intersil is traded on the Nasdaq market and their current market cap is $1.52 billion.
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Industry Overview The industry of Analog Integrated Circuits is a very specialized industry but at the same time could provide a wide range of products. An Analog IC is a miniaturized circuit which has been manufactured in the surface of a thin substrate of semiconductor material. These chips known as Analog IC are used throughout pretty much all types of electronics which creates a very broad range of products for this industry. These Analog ICs are used in products such as automobiles to cell phones. The Analog ICs play a role of vacuum tubes which have been used in the past. However these are much smaller than vacuum tubes which allow mass production possible, which has had a tremendous impact on technology and the way it is used by people today. The costs of producing these chips are relatively low because they are printed as a unit by photolithography and they are not constructed by hand on transistor one at a time. The performance for these chips are very high because information is processed quickly and the components are small and close together which allows these chips to create advance technological products for its customers.
Total assets (millions)
2004
2005
2006
2007
2008
Intersil Corporation
2,587.57
2,583.72
2,559.13
2,404.99
1,133.59
Analog Devices Inc.
4,723.27
4,583.21
3,986.85
2,970.94
3,090.99
Maxim Integrated Products Inc.
2,549.46
3,059.94
3,286.54
3,606.78
3,708.39
Texas Instruments Inc.
5,257.00
6,016.00
7,259.00
7,369.00
6,245.00
2004
2005
2006
2007
2008
Intersil Corporation
298.62
334.7
424.86
431.59
399.4
Analog Devices Inc.
1,553.80
1,281.32
1,393.60
1,508.28
1,577.28
960.34
1,172.02
1,218.40
1,216.43
1,238.39
Gross Profit (millions)
Maxim Integrated Products Inc. Texas Instruments Inc.
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16,299.00 15,063.00 13,930.00 12,667.00 11,923.00
Firms competing against Intersil Corp. (ISIL) consist of Analog Devices Inc. (ADI), Maxim Integrated Products Inc. (MXIM), and Texas Instruments (TXN). In 2008 these four firms produced $15,138 million in Gross Profit combined. In this industry Texas Instrument holds the greatest market share. The firms compared to the one listed here are closely related in the products they offer. Kerry Grace reports “Global semiconductor sales fell 29% in January from a year earlier, as the recession continues to slam the industry� (Global Chip Sales Fell 29% in January, WSJ). You can see that Gross profit has not had changed much in the five years shown in the chart. However in 2009 sales have dropped considerably and profits will suffer in 2009 if sales continue to stay this way. In an Analog IC industry R&D plays a huge role in maintaining up to date technology and creating innovative products for its customers. Without R&D and firm will not be able to survive in the industry because this industry moves at a very rapid and aggressive rate to create the best product on the market in order to be the leader of the industry. After the industry has created an innovative product it could protect the product or idea by placing a patent. The Semiconductor Chip Protection Act of 1984 provides a copyright protection for chips layouts. This act made it illegal for competing chips to use identical layouts for its products. According to SIA the industry has grown up $249 billion as of 2008. $20 billion dollars have been used in R&D which is equal to 17% of sales. Ultimately, the industry of Analog Integrated Circuits heavily relies on the innovative products the firms produce. In order for firms to survive and profit in the industry, firms will need to spend a significant amount on R&D. Without R&D products will not advance in technology leaving the products out of date. To keep up with technology in this industry is a key and is a great factor firms must consider. Overall, the industry is a very specialized industry and requires exceptional skills to continuously produce products in the industry. 16 | P a g e
Five Forces Model The five forces model is a tool used to break down and analyze industry competition, threat of new competition, and the relationship between a firm and the suppliers and customers of the industry. It is divided into two main segments, the degree of actual and potential competition and bargaining power in input and output markets. The first segment is divided into three categories, rivalry among existing firms, threat of new entrants, and threat of substitute products. Rivarly among existing firms takes into consideration industry growth, concentration, differentiation, switching cost, economies of scale, learning economies, fixed to variable cost, excess capacity and exit barrier in order to determine the level of competition in the industry and the pricing of products. Threat of new entrants analyzes scale economies, first mover advantage, distribution access, relationships and legal barriers to conclude the ability of new firms to enter the industry. Threat of substitute products takes into account relative price and performance as well as buyer’s willingness to switch in order to determine how pricing competition impacts pricing. The second portion of the five forces analysis is sub-divided into two main segments, bargaining power of customers, and bargaining power of suppliers. It determines through switching cost, differentiation, importance of product cost, importance of product quality, number of customers and suppliers and volume per customer and supplier to derive if customers or suppliers dictate prices and terms. This model takes into consideration the industry as a whole, rather than simply individual firms. By doing so, it allows us to analyze what the trends are of the industry and how the firm implements the competitive strategies of the industry into their business practices. 17 | P a g e
Source: Yahoo Images The following table summarizes our analysis of the five factors and the degree of competition produced by each segment:
Competitive Force
Degree of Competition
Rivalry Among Existing Firms
Moderate
Threat of New Entrants
Low
Threat of Substitute Products
Moderate
Bargaining Power of Customers
Low
Bargaining Power of Suppliers
Moderately-High
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Rivalry among Existing Firms
Introduction When evaluating competition within the Analog IC industry, it is necessary to reflect on the rivalry among the existing firms. Recognizing the rivalry among the existing firms allows a firm to help differentiate themselves from others in the industry. In the analog integrated circuit semiconductor industry, it is critical for firms to be ahead of the game, to maintain their market share and hopefully increase their market share. The analog IC semiconductor industry takes pride in their ability to innovate. In such a differentiated industry, there is heavy price competition. This industry spends a lot of their time and money on research and development to maintain stable growth. In order to better understand the environment related to rivalry among existing firms, one can separate the various factors inherent to the competitive landscape such as industry growth, concentration, differentiation, switching costs, scale/learning economies, fixedvariable costs, excess capacity, and exit barriers.
Industry Growth Understanding the size of the industry and the industry growth rate allows us to market competition. In a fast growing industry, the firms are more focused on new innovations and attracting new customers, then their portion of market share. On the other hand, a slow growing industry focuses on price competition and strives to take market share from their competitors. A good way to measure industry growth is to
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analyze the net sales of the industry. Below is a table of the analog IC semiconductor industry sales and graph to show the revenue in this industry over the past six years.
Industry Sales (Thousands) 2003
2004
2005
2006
2007
2008
ISIL
$507,687
$535,775
$600,255
$740,597
$756,966
$769,675
ADI
$2,047,268
$2,633,800
$2,388,808
$2,250,100
$2,464,721
$2,582,931
MXIM
$1,153,219
$1,439,263
$1,671,713
$1,856,945
$2,009,124
$2,052,783
TXN
$7,240,000
$8,345,000
$11,829,000
$13,730,000
$4,927,000*
$4,857,000
$606,570
$807,280
$1,049,690
$1,092,980
$1,083,080
$1,175,150
$11,554,744
$13,761,118
$17,539,466
$19,670,622
$11,240,891
$11,437,539
LLTC TOTAL
*TXN changed their segmented data year 2007
Industry Sales $25,000,000
$20,000,000
$15,000,000 Industry
$10,000,000
$5,000,000
$2003
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2004
2005
2006
2007
2008
Industry Sales Growth 2003
2004
2005
2006
2007
2008
ISL
17.36%
5.24%
10.74%
18.95%
2.16%
1.65%
ADI
16.60%
22.27%
-10.26%
-6.16%
8.71%
4.58%
MXIM
11.11%
19.87%
13.90%
9.98%
7.57%
2.13%
TXN
14.75%
21.82%
6.06%
6.85%
-3.03%
-10.67%
LLTC
16.72%
24.86%
23.09%
3.96%
-0.11
7.83%
TOTAL
15.31%
18.81%
8.71%
6.71%
3.06%
1.10%
Industry Sales Growth 20% 18% 16% 14% 12% 10% Industry
8% 6% 4% 2% 0% 2003
2004
2005
2006
2007
2008
The sales growth rate has been decreasing gradually over the past six years. The analog IC semiconductor industry has averaged an overall 8.95% sales growth over the past six years. The sales in an analog IC semiconductor industry are reliant on 21 | P a g e
demand from the telecommunications and computer products. Throughout the past couple month’s experts forecast a dramatic decrease in the growth of this industry, due to the recession. But with recent news from the month of April, sales were surprisingly better then forecasted. “The better-than-expected 6.4 percent sequential increase in April sales was driven by moderate improvements in a number of end-demand drivers and inventory replenishment” quoted by the SIA president (www.sia-online.org). The PC and cell phone account for 60% of the semiconductor industry sales. In order for the industry growth rate to improve or remain steady the firms will have to continue to produce innovative and differentiated products.
Concentration and Balance of Competitors The number and size of firms help define the concentration of the industry. When analyzing an industries competitive environment, it is necessary to fully understand the industry’s direct competitors, the distribution of market share in the industry, the size of the industry, and the market capitalization of the competitors within the industry. Principal “elements of competition within this industry include: technical innovation, service and support; time to market; product performance and features; quality and reliability; product pricing and delivery capabilities; customized design and applications; business relationship with customers; and manufacturing competence and inventory management”(MXM 10-K 2008). The larger the firm, the more control they have over setting prices and formulating business strategies. The participants in the analog IC semiconductor industry are still specialized no matter their size. Intersil’s specialty is “designing, developing, manufacturing, and marketing high-performance analog integrated circuits.” (Intersil 10-K) Intersil’s primary competitors include Analog Devices (ADI), Maxim Integrated Products (MXIM), Linear Technology Corp (LLTC), and Texas Instruments (TXN). Larger firms can more easily dictate the level of industry price competition than smaller firm. Larger firms generally have greater access and capital 22 | P a g e
which may lead a firm to choose to exit an industry or particular segment of an industry rather than try to have a price-war which generally results in a decreased profit margin. In times of economic turmoil, small firms in financial distress often become acquisition targets for larger firms. This is an ongoing trend in the analog IC industry. The following table and pie chart displays the market share between ISIL and its peer group. Market Share (as a % of total sales) 2003
2004
2005
2006
2007
2008
ISIL
10.07%
3.25%
3.42%
3.76%
6.73%
6.72%
ADI
40.63%
16.01%
13.62%
11.44%
21.92%
22.58%
MXIM
22.89%
8.75%
9.53%
9.44%
17.87%
17.95%
TXN
14.37%
67.08%
67.44%
69.79%
43.83%
42.46%%
LLTC
12.03%
4.91%
5.98%
5.55%
9.64%
10.27%
$13,570,262
$17,253,318
$18,193,118
$19,102,642
$19,065,811
$17,906,389
TOTAL
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Market Share 2004-2008 80% 70% 60% Intersil
50%
Analog Devices
40%
Maxim 30%
Texas Instruments
20%
Linear Tech
10% 0% 2004
.
2005
2006
2007
2008
From the chart above, notice when Texas Instruments changed their segmented
data in their 10-K, they lose about 20% of the Analog IC industry market share. Intersil’s market share ratio is significantly smaller then Texas Instruments and any of their other competitors, so as a result Intersil must follow the lead of their competition. Intersil market share is less then all their other competitors, one reason being they don’t have as many product lines as their competitors.
Differentiation
A firm can achieve competitive advantage by one of two ways, either cost leadership or differentiation. Cost leadership involves producing a product at the lowest cost, maintaining efficient production, simpler product designs, lower input costs, lowcost distribution, having a tight cost control system and allocating less money to research and development or brand advertising. The ladder approach, differentiation, is essentially how a firm can distinguish itself from its competitors. If the product lines within the industry are similar, then the industry should be described with low degrees 24 | P a g e
of differentiation. A firm can achieve this through a superior product quality and variety, superior customer service, more flexible delivery, investment in brand image and advertising, allocating money towards research and development, and by having a system based on creativity and innovation. Therefore, if the product lines within the industry vary, then the industry should be described with high degrees of differentiation. The Analog IC semiconductor industry is classified as an effective differentiation industry. If any firm in this industry wants to survive it is necessary to invest a significant amount in research in development. On average, the Analog ICs puts approximately 20% of their revenues back into research and development. In to stay competitive in this industry, firms need to constantly be on top of the latest technology and continually introducing new innovative products. Firms have a large product portfolio, some consisting of over 20,000 different products. Lately, customers are demanding high processing technology; such as high-definition televisions, digital cameras, and more technologically advanced computer processors, firms must keep up with their customers’ technological demands. If the firms fail to keep up with manufacturing new products the customers want, there will be an evident reaction in the success relatively soon. This makes it difficult to for new firms to enter the market. In an industry where time is money, new firms must pour millions of dollars into research in development for product design. Next, they must maintain a large variety of products and patent, (for instance Intersil owns the rights to over 1,000 patents). New firms must master all of these competitive advantages in a timely fashion. Thus, differentiation inhibits new entrants on entering the industry.
Switching Costs
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When a firm decides they want to discontinue the direction they are going and enter into another industry, the costs of the switch are called switching costs. Low switching costs are when a firm can switch industries without spending a lot of money on raw materials. High switching costs are when a firm switches industries; they will encounter spending a considerable amount of money on raw materials which makes it more difficult to switch industries. If a firm decides to switch, there is a high possibility of it destroying their firm. The amount of money the Analog IC industry spends on research and development makes the industry encounter high switching costs if they choose to switch industries. Below is a graph is demonstrate how much research and development the industry spends relative to their revenues. The industry averagely spends about 20% of their sales on research and development.
R&D as a Percentage of Revenues 35.0% 30.0% ISIL
25.0%
TXN
20.0%
ADI
15.0%
LLTC
10.0%
MXIM
5.0%
Industry
0.0% 2003
2004
2005
2006
2007
2008
Being in a differentiation industry, which is the price you pay if you decide to leave the industry. The industry would have a very complicated time finding substitute uses for their products. Once the firm has entered this industry and built a foundation, it is best that they stay and if they are having problems, just try to improve their product to the best of their ability.
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Economies of Scale To have an industry with a steep learning curve presents that the firms are usually larger and generally more profitable in the industry. The Analog IC industry is considered to have a steep learning curve because of the specialized skills that are needed to create such technology. The scale of economies must be large to survive in the industry. One way Intersil Corp. shows large scale of economies is that the firm competes in the industry by utilizing outsourcing of the manufacturing side of the firm. Intersil will have seasonal variations and to have outsourcing available when demand is high is a key factor in the way they stay competitive among the industry.
Total Assets by Firm (in Millions) $18,000.0 $16,000.0 $14,000.0 $12,000.0 $10,000.0 $8,000.0 $6,000.0 $4,000.0 $2,000.0 $-
ISIL TXN ADI LLTC MXIM Industry 2003
2004
2005
2006
2007
2008
The total assets show the range of capital needed for such an industry. The scale of economies must be fairly large here to stay competitive in the industry. Firms must obtain strategies in expanding their business in order to gain cost advantages. Texas Instruments is a dominant leader in the industry and
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Ratio of Fixed to Variable Costs A high fixed to variable cost influences the firms to reduce price and utilize installed capacity. In an industry of Analog IC there are high fixed costs mainly from R&D because of this the industry results in a high fixed to variable cost ratio. Variable costs in the industry are considered to be low compared to the fixed costs that are required in generating new products.
Total Cost / Sales (Change) ? -> Fixed to Variable Costs 2004
2005
2006
2007
2008
ISIL
-70.5%
42.0%
50.1%
159.2%
450.9%
126.3%
TXN
40.0%
11.5%
22.9%
220.5%
53.6%
69.7%
ADI
36.7%
65.0%
161.5%
66.7%
71.5%
80.3%
LLTC
10.8%
33.0%
174.6%
-449.1%
36.4%
-38.8%
151.9%
27.3%
231.4%
372.2%
-14.1%
153.7%
33.8%
35.7%
128.1%
73.9%
119.6%
78.2%
FIRM
MXIM Industry
AVG
Intersil maintains low variable costs by outsourcing a substantial portion of their silicon wafer demand to third party foundries. In addition, the equipment required to produce higher end ICs is extremely expensive, therefore, Intersil controls costs by outsourcing a significant portion of final product assembly. “This reduces our capital requirements and enhances our flexibility in managing our ever-changing business�. (Intersil 10-K) Rather than allocating funds to manufacturing and PP&E, the industry trends towards increased investment in R8D. Firms in the HQA IC industry seek to compete through differentiation and high focus on R&D enhances their core competency of developing new and innovative technologies and unique products that are valued by its customers. 28 | P a g e
CGS / PP&E 3.50 3.00 2.50
ISIL
2.00
TXN
1.50
ADI
1.00
LLTC
0.50
MXIM
0.00 2003
2004
2005
2006
2007
2008
Excess Capacity If an industry has an excess capacity it will cause firms to cut price to fill capacity. The analog IC industry, however, is a very specialized industry. Due to the fact that this industry is highly specialized, demand normally will be greater than capacity. In the industry demand is very high for new innovative products and excess capacity will rarely be a problem for reduced prices. However, there is one factor to consider; if the firm does not produce innovative products, capacity could take over the demand of their products if they are behind in the industry. To minimize the risk of excess capacity large investments in R&D could play a key role in increasing demands. According to Grace in January 2009 “Semiconductor analysts have expressed concern about inventory levels as the effects of a lackluster holiday season, which typically is the industry's strongest time of year, work their way up the supply chain� (Global Chip Sales Fell 29% in January, WSJ). This is unusual in the industry but at the same time the economy has also had severely unusual declines in the market which explains the high excess capacity.
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Exit Barriers Exit barriers in the industry are high because of significant funds spent on specialized assets. Due to the high exit barriers it will be harder for firms to leave the industry because of the substantial loss incurred in leaving the industry. Because of this issue it will create more rivalry among the firms which could possibly lead to a higher price competition. The factor that will distinguish firms is the quality of their products and to produce quality products R&D needs to be highly invested in to maintain up to date products. The bottom line is that the industry has a very high exit barrier, which keeps companies from leaving and continue to compete to gain market share which will create higher price competition throughout the industry.
Threat of New Entrants
Introduction New entrants are attracted to an industry when there is a favorable opportunity to earn profits. The threat of new entrants is the mixture of the barriers to the entry and the effect of the present competitors. The more barriers there are in the industry, the greater the chance of low profitability for the new entrants entering the market. Powerful rivalry is correlated to the presence of factors such as economies of scale, first mover advantage, channels of distribution and relationships, and legal barriers. Taking all these factors into consideration, the threat of new entrants to the analog IC semiconductor industry is reasonably low.
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Economies of Scale Economies of scale acts as a barrier requiring that the new entrant comes on a large scale alternatively they can also choose to come on a small scale with greater cost disadvantage. Although both options the new entrant has, will experience a cost disadvantage in competing with existing firms. Scale effects are probable because in the majority productions operations fixed and variable costs are involved, variable costs being related to the productions volume. To be successful in the analog IC semiconductor industry, there is a need for large capital; the following chart displays the analog IC semiconductors obvious large amount of assets. Total Assets 2004
2005
2006
2007
2008
ISIL
2,587,570
2,583,717
2,559,127
2,404,987
1,133,590
ADI
523,693
250,849
412,924
436,015
433,976
2,549,462
2,957,033
3,041,556
3,606,784
3,708,390
TXN
16,299,000
15,063,000
13,930,000
12,667,000
11,923,000
LLTC
2,087,703
2,286,234
2,390,895
1,218,857
1,583,889
21,959,725
20,854,599
19,943,607
19,114,786
17,198,956
MXIM
TOTAL
First Mover Advantage In the beginning of a new industry, the first companies to succeed can often take over an industry with what is called a first mover advantage. The firms that come in after the first firms have a lot to do to catch up to the firms. The beginning firms have a stronger foundation, a large customer base, more experience in the industry, and have been designing innovative products longer then the new entrant. New entrants need to consider that they will be facing the possibility of failure to develop successful brand 31 | P a g e
loyalty and recognition. Below is a graph that demonstrates the amount of money this industry spends on research and development. A new entrant needs to keep in mind the amount of capital they will need to enter this industry.
Research and Development 2004
2005
2006
2007
2008
ISIL
$107,430,000
$110,830,000
$126,460,000
$134,370,000
$143,500,000
ADI
$514,440,000
$497,100,000
$459,850,000
$509,550,000
$533,480,000
MXIM
$306,320,000
$328,160,000
$514,140,000
$659,540,000
$577,750,000
$1,978,000,000
$2,015,000,000
$2,195,000,000
$2,140,000,000
$1,940,000,000
$104,620,000
$131,430,000
$160,850,000
$183,560,000
$197,090,000
$3,010,810,000
$3,082,520,000
$3,456,300,000
$3,627,020,000
$3,391,820,000
TXN LLTC TOTAL
Research and Development Percentage of Sales 2003
2004
2005
2006
2007
2008
6 yr AVG
ISIL
18.0%
20.1%
18.5%
17.1%
17.8%
18.7%
18.3%
TXN
17.8%
15.7%
15.0%
15.4%
15.5%
15.5%
15.8%
ADI
22.1%
19.5%
20.8%
20.4%
20.7%
20.7%
20.7%
LLTC
15.1%
13.0%
12.5%
14.7%
16.9%
16.8%
14.8%
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MXIM
23.6%
21.3%
19.6%
27.7%
32.8%
28.1%
25.5%
Industry
19.3%
17.9%
17.3%
19.1%
20.7%
19.9%
19.0%
Texas Instruments spends the most amount of money of research and development within the industry, but when compared to their sales, they spend only 16% of their sales. The Analog IC industry spends about 20% of their revenues on research and development. When an industry has a significant first mover advantage, threat of new entrants is greatly condensed. If a new entrant wanted to enter this industry, they would need to have a substantial amount of capital to compete. However, recently new firms have been forming connections within this industry and entering easier than in the past. When an industry spends so much money on research and development, they need to protect their investment. Within the Analog IC industry, firms averagely have more than 1,000 patents. The Analog IC industry “seeks to establish and maintain our proprietary rights in our technology and products through the use of patents, copyrights, trademarks and trade secret laws”(ADI 10-K 2008). The Analog IC semiconductor industry threat of new entrants is moderately low.
Access to Channels of Distribution and Relationships Firms in the analog IC semiconductor industry need to be able to develop a relationship with the distributors, manufactures, suppliers and several others included in the supply chain. Access to distribution channels is significant if a firm wants to survive in this industry due to the industries heavy reliance on their distributors. Intersil “derives 28% of their revenues through distributors and value added resellers” (Intersil 10-k). “Linear technology corporations primary domestic distributor: Arrow Electronics, accounted for 12% of revenues during fiscal year 2008” (LLTC 10-K). Majority of the firms in this industry rely greatly on their distributors. New entrants entering this 33 | P a g e
industry often find it hard to develop relationships with the manufacturers, especially the overseas ones. Majority of the direct customers and distributors the Analog IC industry work with rather buy on an individual purchase than have long term agreements. In some cases, distributors agree to “allow for price protection on certain inventory if the firm lowers the price of their products” (MXIM 10-K 2008). Good relationships with everyone involved in the supply chain are very important to succeed in this industry.
Legal Barriers The amount of technology research the analog IC semiconductor industry requires prevents the new entrants from competing well within the industry. The analog IC industry has numerous barriers to entry including trademarks, patents, copyrights, trade secrets, government regulation, contracts, and several other legal barriers. Intersil has over 1,000 U.S. and foreign patents. Analog Devices hold over 1,400 patents as well. All the firms in the industry believe their patents have value, but the “company's future success will depend primarily upon the technical abilities and creative skills of its personnel, rather than on its patents.” (LLTC 10-K) Therefore, firms competing in the analog IC industry should generally be more concerned with larger existing competition than the threat of new entrants.
Conclusion The analog IC semiconductor industry is a complex industry to compete in as a coming new entrant into the industry. There is already a considerable amount of multibillion dollar, aged corporations in the industry. There are close to no advantages when it comes to first movers. The new entrant would be competing with large capital corporations. The lengthy relationships the firms build in the industry are very valuable 34 | P a g e
to the current firms, and to enter the industry and receive their same benefits and low costs would be nearly impossible to do. The legal barriers contribute significantly to the low threat. Overall, the analog IC semiconductor industry is not concerned by the new entrants due to the factors such as economies of scale, first mover advantage, distribution channels and relationships, and legal barriers. The threat of new entrants to the analog IC semiconductor industry is low.
Threat of Substitute Products
Introduction Industries face high competition amongst their products and the threat of substitute products will exist as long as the industries are competing against one another. Intersil is in the industry of analog integrated circuits. An industry of analog integrated circuits is a very specialized industry which requires a company to have highly skilled workers to create its products. Although Intersil is in a very specialized industry it produces a very wide range of products from Automobile IC’s to Communication IC’s. The industry here faces the risk of their product being eliminated or replaced by another product due to alternative product’s being produce with higher quality and better technology which will be a threat of substitute products.
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Relative Price and Performance In this industry price and performance plays a huge role in sustaining profitability. In the industry price and performance heavily rely on one another. Without the latest technology, price could not be controlled by the firm due to the growth of the industry. To gain leadership in the industry product differentiation will play a major factor. Being able to create products with better technology and unique innovative products will lead to more control over price. To be innovative is to set your product apart from the industry by providing a valuable product for the customer, which is a crucial way to gaining competitive advantage in the industry. The key in this industry is being on top of the technology in the industry so that patents could be created to eliminate the unnecessary competition. Significant amounts of money are spent in this industry on Research and Development. For example Intersil alone spends $143.6 million on R&D out of a total of $1,446.4 million on Total Operating Expense (Intersil Corp. 10-K). Intersil Corp. consists of over 600 employees in R&D and has a portfolio of 1,000 patents (Intersil 10-K). To have highly skilled workers and innovative minds is a key factor in continuously providing up to date technology.
Customer’s Willingness to switch
In an industry with such high competition and high pace demand for technology the threat of substitutes could be a challenge. Customers seek the latest technology with a price range that will fit their needs; however customers will not consider low quality products at average prices if there are high quality products with reasonable prices. The threat in this industry will be products of low switching cost that will benefit the customer’s needs. “The threat of new products will present significant business
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challenges” (Intersil 10-K) and the threat of substitutes of products is an uncertainty in which the industry presents.
Conclusion
In this industry firms need to provide customers with high quality products with reasonably low prices to the market in order to maintain loyal customers and prevent customers’ from switching between suppliers. By investing in R&D and creating patents for new technology is a strategy firms must undertake to survive in this industry in the long run. Without R&D firms will lose market share of their products and eventually be replaced by substitute products with better quality and price. The Analog IC industry is a moderately competitive market.
Bargaining Power of Customers The bargaining power of customers indicates if the customers can dictate price and terms or if the firms of the industry can dictate the price and terms. To determine who has the bargaining power, we must first establish who the industry’s customers are. The majority of the industry’s sales are from distributors and resellers and original equipment manufacturers or OEMs. An OEM uses the industry’s integrated circuits as part of their product, an example being Nokia using Texas Instruments’ integrated circuits for wireless internet on their phones. (Texas Instrument 10-K) Once the customer is established, there are a number of factors to determine who has the bargaining power of price these are, differentiation, switching cost, importance of
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product cost and quality, number of buyers and volume per buyer. Once each of the segments is analyzed we can then determine who has bargaining power in the industry.
Differentiation Differentiation is vital in bargaining power over customers, without it, firms can only compete on price rather than a superior product because customers can receive a similar product from another company. By offering unique features, a firm has more power to dictate price and terms to its customers rather than being interchangeable with its competition. In the Analog Integrated Circuits industry there are two main segments, highvolume analog chips, and standard linear circuits. For high-volume analog chips, customers write their own algorithms to be put onto the integrated circuits using the firm’s software development tools. (Analog Devices 10-K) This customizes each chip to the customers need, making it difficult to halt production and have a different firm begin replicating the integrated circuit. For instance, a chip that allows a home theater system to produce a better sound would not be that same chip used in a cell phone for wireless internet. However, standard linear and logic circuits are often interchangeable and can be applied for various applications among different customers, such as chips used in DC convertors. (Linear Technology’s 10-K) So based on the customer’s needs, the Analog ICs industry can be highly specialized or interchangeable.
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Importance of Product for Cost and Quality The importance of product for costs and quality helps indicate who has bargaining power in the customer firm relationship. If the product cuts corners and focuses more on lower cost than quality, then the customer has more power in driving the price. However, if a firm operates in order to produce a higher quality good, then the customer will be willing to pay a higher price for a greater good. As stated above, the firms in the Analog ICs industry custom ICs to customers specifications. This specific IC cost the industry more to produce, and because it has to meet a set quality and standards for an individual customer, the industry has pricing power. The market supplies the industry with a more high quality demand for the ICs. Due to greater technological advances and rising consumer demand for music, DVDs, pictures, digital camcorders and cameras, and home theater systems, high-quality ICs are in greater demand than similar linear ICs. The higher quality final products need higher quality ICs, giving the Analog ICs industry pricing power over customers. (Analog Devices 10-K) Also, product warranty replaces defective ICs and other parts from anywhere to between the government mandated 90 days up to 12 months. (Analog Devices 10-K) Warranty cost negatively impact the industry by about 1 to 2 billion dollars a year. Because such costs are incurred, the firms have to regain income by charging more for their product than other industries that do not have such exceeding warranty cost. (Intersil 10-K) Timing impacts price in this industry. If the firms do not deliver their ICs in on time to an OEM, the OEM’s product suffers timing delays and pricing. It is important that the IC be delivered on time in order to maintain customer satisfaction. Because
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firms in the Analog ICs industry are subject to time constraints placed on customer terms, customers have bargaining power on terms over firms in the industry based.
Number of Customers The number of customers impacts the bargaining power of the firm because if the firm only sells to a select few customers their bargaining power is limited. However, if the firm sells to a greater number of customers, the firm has more bargaining power since it does not have to rely on a select number of firms but can afford to lose a customer. The analog integrated circuits industry sales to many different customers, for instance Analog Devices has over 60,000 different customers in countries all over the world and Texas Instruments sells to almost 80,000. (Analog Devices 10-K and Texas Instruments 10-K). Because of the large number of buyers, the Analog ICs industry has more bargaining power over the customers to dictate prices.
Foreign Percent of Sales 90 80 70 Intersil
60
Analog Devices
50
Texas Instruments
40
Maxim Integrated Products
30
Linear Technology
20
Industry
10 0 2004
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2005
2006
2007
2008
As the chart above describes, the Analog ICs industry sales are mainly outside the United States. On average, about 77% of sales take place in foreign countries over the past five years, each firm selling to at least 20 different countries. The Analog ICs industry is becoming more global as foreign percent of sales are increasing over the last five years, displaying that the industry sells to a variety of countries as well as customers. This variety and large number of customers gives the Analog ICs industry more bargaining power over its customers.
Volume per Customer The greater the number a single customer buys from a firm, the more bargaining power it has over the firm. If a customer represents a large percentage of the firm’s sales, then they can dictate prices easier than a customer that makes up a small percent of sales because they can afford to lose that customers business. A firm cannot afford to lose a customer who makes up a large percentage of their revenue, so they try to keep that customers satisfaction, giving up bargaining power of price. In the Analog ICs industry, many firms have a single company that represents a large percentage of their total sales. Aeco represents 11% of Intersil’s revenue; Nokia represents 20% of Texas Instruments sales and for Analog Devices, their 20 largest customers make up 32% of their revenue. Because of the specific algorithms put into mass produced ICs, it would make sense that a customer would rely on a single firm for a specific chip, rather than dividing up their suppliers and receiving variations in their products. That is the reason many of these companies rely on a single firm in the Analog ICs industry for a majority of their IC production. Distributors and resellers make up on about 50% of the industries sales. Because of this they maintain some pricing power over the firms in the industry as wells as contractual incentives. One of these being that they can cancelled or terminate contract 41 | P a g e
with little notice and no penalty. (Intersil 10-K). The top reseller accounts for 11% of Intersil’s revenue, so resellers have bargaining power over the firms in this industry. However, on the more linear ICs, the parts are interchangeable and can be used for different functions, rather than a single set one. For instance, many circuits can be used to receive power, and can be interchanged through many compatible devices. (Maxim Integrated Products 10-K) Because of this, the non specialized segments of the industry have multiple buyers that account for smaller percentages of the firms revenue. For example, no single customer accounts for more than 10% of their total revenue. (Linear Technology 10-K) So in conclusion some select buyers have bargaining power over the firms, where as the rest do not.
Switching Cost Switching cost for customers refers to the cost incurred from switching from one company to another in the industry. This cost is generally lower with a commodity good or simple product and greater with specialty goods. Because of the fact that customized algorithms are embedded into mass produced ICs, it is difficult for customers to switch between firms in the industry. (Intersil 10-K) The interchangeable ICs can be produced by virtually every firm in the industry so the customer can easily switch between competitors. However, this does not comprise the majority of the industry so overall switching costs are high.
Conclusion After analyzing the differentiation, importance of quality cost and quality, number of buyers and switching cost, we have derived that firms in the Analog ICs industry have slight pricing and bargaining power over the firm. Because of the fact that the firms produce highly specialized, customized goods, often individualized for a single 42 | P a g e
customer, this gives them greater pricing power over the customers. Customers however often dictate terms on the time frame in which the ICs will be delivered by. So they have control over quality. When it comes to the number of buyers, there are thousands of customers globally, so the firm has bargaining power in this aspect, however, many of the customers that they sell to make up a majority of their sales. So even though there are many customers, the few customers that make up the majority sales have bargaining power over the firms. Taking all of this into consideration, the customers have some term bargaining power over the firm, however the firms in the Analog Industry produce such customized ICs that they can dictate price over the customers, so the bargaining power of customers is low.
Differentiation
High
Importance of Product Cost
Med
Importance of Product Quality
High
Number of Buyers
High
Volume per Customers
High
Switching Cost
High
Bargaining Power of Customer
Low
Bargaining Power of Suppliers First off, to determine if suppliers have bargaining power, we must first determine what is supplied. The Analog ICs industry receives raw wafers, chemicals, liquefied gases, poly-silicon, silicon wafers, pure metals, lead frames, molding compounds, as well as subcontracting work such as epitaxial growth, a portion of wafer fabrication, and ion implantation. (Maxim Integrated Products 10-K) These are supplied 43 | P a g e
by various specialty manufacturers as well as third party subcontractors. The bargaining power of suppliers is also based on many economic factors. These factors include but are not limited to the differentiation of the raw materials needed, the quality needed, the number of suppliers, and the volume per supplier. These factors are subject to the economic conditions which shape the markets. Greater demand for the products forces firms to find more suppliers, and shrinking the market share per firm on suppliers, so they are subject to suppliers’ prices and demands. The inverse is true, if the suppliers have fewer firms to sell to, each firm has more bargaining power with the price. If there is a scarcity of the suppliers materials, prices firms will pay are increased. If there is a surplus and suppliers have to pay more for overhead capacity, firms can receive their materials at cheaper cost, so the barging power of suppliers over price is subject to economic conditions.
Differentiation Differentiated or non-differentiated materials can indicate if suppliers have pricing power over firms. Suppliers that distribute non-differentiated goods are subject to firm pricing power due to the fact that suppliers have to compete on price rather than providing a specialty good. If the suppliers distribute differentiated goods, they have pricing power over firms because the firm will have limited, or potentially an exclusive, source(s) from which to obtain materials. This occurs when only a select few suppliers produce the raw materials needed for the firm. In order to determine if the raw materials are differentiated or not, we first have to figure out what the Analog ICs industry uses as raw materials. They receive raw wafers, chemicals, liquefied gases, poly-silicon, silicon wafers, pure metals, lead frames, molding compounds, as well as subcontracting work such as epitaxial growth, a portion of wafer fabrication, and ion implantation. (Maxim Integrated Products 10-K) Because most of these materials are not commonly found (such as liquefied gases and pure, 44 | P a g e
high-grade metals) and have to be processed through specific conditions, many materials used by the Analog IC industry are highly specialized and differentiated. This gives their suppliers pricing power over the firms in this industry. The subcontracting of epitaxial growth, wafer fabrication, and ion implantation often requires professional or highly skilled labor with higher degree educations, rather than inexpensive, unskilled labor. This higher degree of labor gives the subcontractors pricing power over firms operating in the Analog IC industry.
Importance of Product for Cost and Quality Quality and cost of supplies trickles down into the pricing of the firm’s product. If a firm has to pay more for quality materials required by the industry, then they will demand a higher price for their product in order to maintain profitability. However if the price of materials are cheaper, the firm does not have to raise their prices in order to maintain profitability. The Analog ICs industry require higher quality materials (as mentioned above) therefore these materials cost more. Firms are dependent on their suppliers’ ability to produces wafers, tests, and other materials that are up to their specifications and standards in a timely fashion. Suppliers’ inability to do so can result in a halt in production of certain products, making quality and timeliness of materials vital to success in the Analog ICs industry. (Texas Instruments 10-K) Because of this, if a supplier is able to meet the criteria needed in quality and timeliness, they are able to have bargaining power of price.
Number of Suppliers The greater the number of suppliers, the less bargaining power of price each supplier has over the firm. However, if a firm can only buy from a select few firms then 45 | P a g e
the suppliers have pricing power over the firms. Firms in the Analog ICs industry buy materials from different suppliers, since there are a wide variety of supplies needed to produce ICs. However, some supplies are bought primarily from sole suppliers. For instance, Analog Devices receives the majority of their external wafers and foundry services from Taiwan Semiconductor Manufacturing Company (TSMC). (Analog Devices 10-K) This grants TSMC pricing power over Analog Devices because of Analog Devices’ dependency for TSMC products. Having sole providers gives bargaining power of price to these suppliers. If the suppliers cannot provide the firms with the materials needed, firms may not be able to locate alternate sources for their required product inputs. (Maxim Integrated Products 10-K) Finding replacement or additional suppliers can result in additional expenses and production delays, causing unforeseen disruptions in projected income. (Analog Devices 10-K) Intersil purchases their products from a limited number of suppliers on a Just-inTime basis, increasing their risk exposure related unexpected cancellations or delays in supply shipments. (Intersil 10-K) Firms in the Analog ICs industry are subject to seasonal sales, with demand for electronics being greater in the second half of the year. This seasonality can largely be attributed to the higher demand observed in the high-end electronics market which includes mp3 players, computers, PDAs, and other high-tech devices. In general, an observable increase in the demand for high-tech consumer goods occurs during the third and fourth quarter, which is sometimes referred to as the “holiday” season. To keep up with demand, many firms hire more third party vendors and subcontractors to prepare of sales in the 4th quarter. Texas Instruments hires these venders earlier for mass production of back to school calculators in their 2nd and 3rd quarter. (Texas Instruments 10-K) This requires firms to sacrifice their barging power of supply in order to meet the demands of their electronics. However, because sales are generally weaker in the first quarters of the year, in fact “China's semiconductor manufacturing capacity went unused in the first quarter,” (Semiconductor Sales Fall 30% WSJ) Because of 46 | P a g e
these seasonal needs, firms in the Analog ICs industry do not have long term contracts with the seasonal venders. In conclusion, though the industry might have numerous materials and receive these materials on from various suppliers, the fact that they receive a number of materials from a single supplier gives the suppliers pricing advantage over the firms.
Volume per Suppliers Not only does the number of suppliers impact their pricing power, but the volume per suppliers affects the bargaining power of supplier. The greater amount of materials a firm purchases from a supplier, the more dependent they become on one suppliers satisfaction with the price. This gives suppliers who supply greater volume to firms to have bargaining power of price over the firm. On the other hand, if the supplier does not provide the firm with enough material for them to be dependent on their supply, then the firm has power to dictate prices over the supplier. As mentioned above, some firms in the Analog ICs industry receive their materials from a sole supplier. For example, Analog Devices outsourced 44% of their wafer production to TSMC in 2008. (Analog Devices 2008 10-K) This grants TSMC supplier bargaining power over Analog Devices due to the fact that TSMC fulfills a large portion of ADI’s input requirements. ADI would most likely be unable to fulfill its quotas for its customers if it were to lose TSMC as a supplier. Intersil, for instance, has three main suppliers of wafer ICs which are IBM Microelectronics, TSMC and United Microelectronics Corporation. Because of the fact Intersil receives the majority of its wafer ICs from three companies, these companies have bargaining power over the Intersil when it comes to prices. In conclusion, due to the sole providers of materials, firms in the Analog ICs industry do not have pricing power over their suppliers.
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Switching Cost Switching cost for suppliers is based on the suppliers’ abilities not only to sell to other firms in a set industry, but their capacity to sell their products to other firms outside of the industry. Suppliers in the Analog ICs industry often provide manufacturing and subcontracting services to other firms in the industry, not just one set firm. Because of this, firms have to compete with each other over price to maintain a subcontracting supplier. (Analog Devices 10-K) For example, both Intersil and Analog Devices receive wafer ICs from Taiwan Semiconductor Manufacturing Company (TSMC). (Intersil and Analog Devices 10-K) So suppliers can switch between firms in the industry. Also, due to the fact that many suppliers are the single distributor a specific raw materials, due to the fact that they are specialized materials, a company cannot easily give up their main supplier. With suppliers accounting for 44% of materials, firms have to maintain relations with these suppliers in order to maintain production. (Analog Devices 10-K) Because suppliers can switch between firms in the industry and firms cannot afford to lose their sole supplier, suppliers have pricing power. Suppliers have difficulty selling to other firms outside of the industry based on the fact that the silcon wafers and ultra pure metals are unique to the industry (Linear Technlogy 10-k). Suppliers can sell to other specialized technological manufacturers, however, the ability to change industries in limited by the suppliers, so they are limited to sell in the Analog ICs industry. Due to the limitations of selling materials such as silicon wafers to other industries and leaving the Analog ICs industry, firms in the industry have bargaining power of price and terms over suppliers.
Conclusion To summarize, due to high differentiation and specialization the suppliers in the industry have power to dictated prices, due to limitations of suppliers based on 48 | P a g e
technological needs. The importance of the product cost is greatly emphasized in the Analog ICs industry as much as quality; however firms do dictate that supplies need to be received in a timely manner in order to maintain productivity. Waiting for suppliers or finding replacements are cost that firms attempt to avoid. Quality is very important in the Analog ICs industry, and because the firms have the suppliers test ICs to meet standards and specifications, the extra effort for quality assurance allows suppliers to have a bargaining price to meet the terms and conditions set by the firms. The numbers of suppliers are high; however, firms receive a majority of their supplies from single suppliers and subcontractors. Due to their dependency on certain suppliers, suppliers have pricing and term bargaining power. Switching cost within the industry are low for suppliers, yet it is difficult for suppliers to such specialized materials outside of the industry. So being stuck in the industry but not to a single firm, suppliers have slight bargaining powers of price and terms. Overall, because of the specialized materials needed, the importance of quality, and the fact that firms receive a majority of their materials form a single supplier, suppliers have moderately high pricing advantage over the firms in the Analog ICs industry. Differentiation
High
Importance of Product Cost
Med
Importance of Product Quality
High
Number of Suppliers
High
Volume per Supplier
High
Switching Cost (Industry)
Low
Switching Cost (Outside Industry)
High
Bargaining Power of Suppliers
Moderately High
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Firm Competitive Advantage Analysis
The first step of firm analysis is to analyze the structure of the industry in which it operates. This allows us to understand the dynamics of unique business environments and more precisely demarcate the area of the industry in which the firm and its peer group compete. However, in addition to industry structure, there are many factors that determine a firm’s potential to generate profits. Therefore, we apply competitive strategy analysis to determine whether a firm is taking the necessary actions to achieve a competitive advantage. A successful business strategy aims to create a competitive advantage, allowing a firm to increase market-share and outperform the competition. There are many ways to classify a firm’s business strategy, however, the “two most generic competitive strategies are: (1) cost leadership and (2) differentiation.” (Palepu & Healy) A cost leadership strategy “enables a firm to supply the same product or service offered by its competitors at a lower cost” and a differentiated strategy “involves providing a product or service that is distinct in some important respect valued by the customer.” (Palepu & Healy 2-9) The dominant technique varies between industries, but in general, successful implementation of either strategy leads to increased firm profitability. Through application of Porter’s Five Forces model, we are able to determine who the competitors are in the industry, how they compete, and what drives prices in the market. After analyzing the strategies necessary to achieve a competitive advantage, we determine how firms in the industry compete based on primarily a cost leadership or differentiated business strategy. After identifying key value drivers in the industry, we can begin evaluate firms’ performance using our identified key success factors as a benchmark. 50 | P a g e
Cost Leadership Firms seeking to achieve a competitive advantage based on cost leadership must be able to supply the same product or service offered by their competitors at a lower cost. (Palepu & Healy) In theory, this is the simplest method to compete against competitors. A firm that is able to supply the same product or commodity at a lower cost than its competitors can earn higher than average profits selling its product at the same price as competitors or can charge less than its competitors forcing them to lower their price, hence profit margin, to maintain market share. Strategies that lend to cost leadership are organizational structures based on tight cost-control, efficient production, better sourcing, lower input costs, etc. In respect to Intersil, it must be taken into consideration that they sell both simpler “linear� ICs, as well as more complex High-Performances ICs.
Economies of Scale
Taking advantage of economies of scale is one of the most common activities seen in firms that compete on the basis of price. An economy of scale exists when a firm has a low variable to fixed cost ratio, resulting in decreased per unit cost and a higher gross margin as a firm is able to expand production and successfully sell their inventory. In the Analog IC industry, the variable costs related to producing an additional, identical integrated circuit is generally very low compared to the fixed costs related to research and development, legal fees to obtain patents, and the property, plant, and equipment, that are all required to manufacture the first unit. Naturally, Intersil, like nearly all technology related companies, must sell many units of each product before R&D and PP&E expenses are covered at which time the firm begins to generate profits. In the constantly evolving high-tech industry, in order to create an opportunity with a long enough lifespan to be able to effectively benefit from economies of 51 | P a g e
scale, a firm would most likely have to introduce a unique, innovative product. Hence, differentiation would generally be a prerequisite to maximizing the potential benefit of economies of scale for the Analog ICs industry. Intersil reinforces this concept, stating, “The semiconductor industry has, for several decades, experienced a phenomenon of continual decline in sales prices per unit.” (ISIL 2008 10-K)
Economies of Scope
Economies of Scope is a similar concept to that of economies of scale, however, instead of mass-producing the same unit to lower per-unit cost, the economies of scope theorizes that the average production cost decreases as a firm increases its product line. This theory can definitely be applied to areas of the analog IC industry, as certain products require significant investments in property, plant, and equipment (PP&E), or fixed assets. In the integrated circuit industry, more specifically the analog IC industry, industry leaders generally have very broad product offerings. TXN has over 20,000 products in its analogue catalogue (TXN 2008 10-K) and Intersil, through acquisitions and continuous research and product development, is aiming to expand its catalogue to over 50 product families. (ISIL 2008 10-K)
Manufacturing Efficiency
ISIL, since adopting its “pure-play HQA IC” strategy in 2003, has focused the majority of its resources on R&D and the acquisition of firms to increase its vertical alignment and reinforce its core-competencies as a HQA IC firm. “In April 2008, we announced a plan to consolidate our two Florida fabrication facilities to reduce cost and increase utilization rates. The project is expected to be completed during our second quarter of 2009.” (ISIL 2008 10-K) However, the majority of its resources are focused on research and development and strategic mergers and acquisitions to reinforce its competitive advantage as a highly differentiated HQA IC firm.
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Tight Cost Control
Monitoring and eliminating unnecessary costs is important to improve the overall operating profitability of any firm. However, in 2008, after many years of constant growth, the analog IC industry felt the impact of the current global economic crisis. Excess capacity increased as OEMs and independent distributors were unable to turn over inventory in a timely fashion. Between 2003 and 2007, the year to year change in average industry backlog displayed constant growth. However, in 2008, the average change in backlog for ISIL and its peer group equated to -22.1%. The chart below represents firm and industry average yearly change in backlog between 2004 and 2008.
% Change of Backlog from Previous Year 90.0% 70.0%
ISIL
50.0%
TXN
30.0%
ADI LLTC
10.0%
MXIM -10.0%
2004
2005
2006
2007
2008
Industry
-30.0% -50.0%
In response to this abrupt decrease in backlog, ISIL mentions “…although not always the case…backlog can be a leading indicator of near-term revenue performance.” (ISIL 2008 10-K) “This will reduce its overall annual operating costs by approximately $12 million to $14 million.” “Amid the IC downturn and economic crisis, Intersil Corp. plans to cut 9 percent of its global workforce.” (Article: EE Times. “Intersil to cut 9 percent of workforce." By: Mark 53 | P a g e
LaPedus - EE Times) “In April 2008, we announced a plan to consolidate our internal foundries and reduce the related workforce. In November 2008, in response to the deteriorating global economic environment, we announced further restructuring efforts, that when combined with the foundry consolidation, would reduce our world-wide workforce by approximately 9%.” (ISIL 2008 10-K) According to an article from the Wall Street Journal, “Amid falling demand and increased competition, chip makers have taken cost-cutting steps including production-line shutdowns, salary cuts and layoffs. Semiconductor analysts have expressed concern about inventory levels as the effects of a lackluster holiday season, which typically is the industry's strongest time of year, work their way up the supply chain.” (Article: “Global Chip Sales Fell 29% in January” – 3/2/2009 - WSJ) However, in Intersil’s annual report, they mentioned that despite the projected decrease in sales and the cost cutting measures they are taking, they are maintaining similar levels of R&D to previous years.
Differentiation
In order to achieve a differentiated competitive advantage, a firm must be able to supply a product or service that is unique and is highly valued to its customers. Key attributes of a differentiated firm include high product quality, high product variety, significant R&D investment, made-to-order manufacturing, delivery timeliness, and an organizational structure that attracts highly-specialized intellectual human-capital and provides an environment that promotes creativity and innovation.
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R&D as a Percentage of Revenues 35.0% 30.0% ISIL
25.0%
TXN
20.0%
ADI
15.0%
LLTC
10.0%
MXIM
5.0%
Industry
0.0% 2003
2004
2005
2006
2007
2008
Superior Product Quality
Superior product quality is a key factor in establishing a differentiated competitive advantage. By focusing time and resources on quality, rather than cutting cost, firms can have more unique, superior goods in or to stay competitive. Intersil, MXIM, LLTC and ADI all offer a one year warranty from the date their products are transferred to customers. (MXIM 2008 10-K; ADI 2008 10-K) Intersil’s warranty policy is as follows: “We warrant that our products will be free from defects in material workmanship and possess the electrical characteristics to which we have committed. The warranty period is for one year following shipment.” (Intersil 2008 10-K) Texas Instruments negotiates warranty terms with certain customers that generally include the following conditions: “…three years coverage; an obligation to repair, replace or refund; and a maximum payment obligation tied to the price paid for our products.” (TXN 2008 10-K) Linear Technology, Inc. states that their policy provides for the replacement of defective parts and “In certain large contracts, the Company has agreed to negotiate in good faith a product warranty in the event that an epidemic failure of its parts were to take place.” (LLTC 2007 10-K)
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However, in general, warranty related expenses incurred by ISIL and its competitors are negligible due to intensive product testing and high quality standards.
Superior Product Variety
In the analog IC industry, competitors generally have a broad product portfolio. Intersil and its competitors incur significant research and development expenses in order to develop technologically superior and unique products that are valued by its customers. Currently, Intersil possesses “over 1,000 U.S and foreign patents and has approximately 570 U.S. and foreign patents pending.” (ISIL 2008 10-K) Texas Instruments (TXN), Intersil’s direct competitors, has an Analog business segment and claims, “…our standard analog portfolio includes more than 20,000 products.” (TXN 2008 10-K) Firms competing in the Analog IC strive to differentiate themselves within the industry. Intersil has made many acquisitions of firms that it feels will create relationships of synergy within the firm. "Intersil remains committed to key strategic acquisitions to broaden our product portfolio," said Dave Bell, Intersil's CEO, in a statement. "Kenet has developed the world's highest performance analog-to-digital converters with power consumption at a fraction of those currently on the market. This gives Intersil important technology leadership and access to many previously un-served markets." (EE Times - “Intersil to acquire Kenet” – by Mark LaPedus)
More Flexible Delivery
The customers of ISIL and its competitors are generally electronic OEMs or independent distribution firms. ISIL’s customers usually place orders approximately six months in advance and can generally cancel custom orders within 30 days of delivery while less specialized orders have a longer duration in which customers can cancel the order. “Our standard terms and 56 | P a g e
conditions of sale provide that these orders become non-cancelable thirty days prior to scheduled delivery for standard and ninety days prior to scheduled delivery for semicustom and custom products. Backlog is influenced by several factors, including market demand, pricing and customer order patterns in reaction to product lead times.� (ISIL 2008 10-K) This exposes Intersil to a certain amount of risk that it may not realize the full value of accounts receivable related to these orders, however, in the specialized Analog IC market, terms such as these are the norm.
Investment in Research and Development
High investment in research and development is essential to compete in the Analog IC industry. We calculated research and development as a percentage of total revenue for Intersil and its peer group and computed a 6-year average of 19%. In addition to high R&D, a trend that can be observed among Intersil and its peer group is the tendency to position itself away from higher-competition, lower-margin sub-sectors of the analog IC industry so that the firms can focus available resources to establish core competencies within the product range encompassed within the analog IC industry. For example, in 2003 Intersil led the IC market for WirelessLAN applications. Year end results of 2002 indicated ISIL held a 52% share in the WLAN market making it the market leader. However, with industry giants such as Intel and Texas Instruments increasing pressure in WLAN market, rather than exhaust its resources in a ditch attempt to preserve market share while suffering margin loss, Intersil sold its WLAN segment in 2003 so that it could focus on its core competency as a pure High-Quality-Analog (HQA) IC firm. (Appendix C-5) Since 2003, Intersil has channeled many of its resources towards strategic acquisitions of firms with Analog IC related intellectual property that it feels will serve to further reinforce its “pure-play� strategy aimed at becoming a leader in HQA Integrated circuits.
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R&D as a Percentage of Revenues 35.0% 30.0% ISIL
25.0%
TXN
20.0%
ADI
15.0%
LLTC
10.0%
MXIM
5.0%
Industry
0.0% 2003
2004
2005
2006
2007
2008
Organization Promotes Creativity and Innovation
In general, firms competing in high-tech industries place great value in intellectual human capital. The ability of Analog IC firms to translate immense investment in R&D into innovative new technology is essential to the evolution of other high-tech sectors as integrated circuits are one of the basic, while technologically complex, building blocks modern electronic devices. Intersil states, “Our future success depends largely upon the continued service of our key management and technicalpersonnel, and on our continued ability to hire, integrate and retain qualified management and technicalpersonnel, particularly engineers. Competition for these employees in the analog semiconductor industry isintense and we may not be successful in attracting or retaining these personnel.” (ISIL 2008 10-K)
Conclusion These strategies were traditionally viewed as being mutually exclusive and firms “stuck in the middle” were expected to have low profitability. (Palepu & Healy) In the 58 | P a g e
increasingly technological and globalized marketplace, we believe it is becoming more viable, and potentially necessary, for firms to be “semi-mixed.” However, firms in the Analog ICs industry lean more on differentiation, focusing on product quality, variety, customer service, research and development, and creativity. The industry applies some aspects of cost leadership such are economies of scale and scope and some efforts towards efficient production, yet is heavily in the differentiation side of competitive advantages.
Key Success Factors It is vital to understand the key success factors of any industry to determine which areas of the business firms focus on in order to stay profitable. As analyst, it is our job to determine which activities lead to competitive advantages. Through cost leadership, differentiation, or a combination of the two, firms apply these strategies in order to stay competitive and gain market share. In the Analog ICs industry, firms focus on differentiation, however, they adopt some cost leadership strategies to balance out the highly differentiated industry.
Superior Product Quality Firms in the Analog ICs industry customize ICs to customer specifications by directly inputting individual algorithms in order to create ICs specific to a customer’s needs. (Linear Technology 10-K) Not only do firms maintain quality by customization, they ensure the quality of their work through their warranties. Though the government mandates a 30-day warranty on electronic goods, Intersil, MXIM, LLTC and ADI all offer a one year warranty from the date their products are transferred to customers. (MXIM 2008 10-K; ADI 2008 10-K) In order to stay competitive, firms in the Analog ICs industry not only have to design their ICs to customer specifications, but have to ensure 59 | P a g e
that their ICs will work. If the ICs do not work, firms will suffer heavy warranty cost and replacement cost, so quality is a key factor to success.
Superior Product Variety Though many firms customize their ICs to customer specifications, it is ideal for the Analog ICs industry to have a large number of products that can perform varying IC task. Firms in the Analog ICs industry have on average 20,000 different products in their portfolio. (TXN 10-K) This vast number of products spreads from ICs that hold and AC charge, to ICs that are placed in cell phones for wireless networking. The varying demand for ICs in technological devices includes consumer demand for music, DVDs, pictures, digital camcorders and cameras, home theater systems, as well as graphing calculators, phones, wireless networking, and amps (ADI 10-K) To match all these market needs and specifications, firms need to manufacture diverse ICs, each developed to a particular need. As a result, to stay successful in the Analog ICs marketplace, it is essential that a firm has a large product variety.
Focus on Creativity In order to develop the numerous ICs needed for electronic consumer demand, firms in this industry have to focus on creativity. With some firms consisting of over 1,000 patents, firms in the Analog ICs industry are constantly developing new ICs as well as new ways to produce and manufacture these ICs. (Intersil 10-K) This number is reflected by the large amount of research and development implemented. After calculating research and development as a percentage of total revenue for the industry is a 6-year average of 19%. The total research and development cost of 2008 was $3,391,820,000 for the industry. This is based on the fact that firms need to maintain creativity in order to stay competitive in this marketplace. 60 | P a g e
Economies of Scale and Scope While the industry relies heavily on differentiation as a competitive strategy for key success factories, it implements cost leadership in order to maintain market share. The firms operate on economies of scale, with total industry assets for 2008 being $17,198,956, averaging $3,439,791 per firm. One of the smallest competitors, (ADI) is just under half a million, so in order to compete, a firm must have a large number of assets. With a market cap of $1.58 billion, the Analog ICs industry requires large amounts of capital in order to stay competitive. Firms in this industry compete globally, at least selling their products to 20 countries worldwide. (TXN 10-K) With number of buyers in the tens of thousands, firms must operate on a large area of scope in order to maintain market share.
Conclusion Although being strongly based in the differentiated strategy for competitive advantage, firms adopt some cost leadership to balance the differentiation and maintain development of a specialty product that is still profitable to manufacture. With a differentiated business strategy, firms set themselves apart from competitors to provide a large variety of quality goods, focusing on creativity. IN the cost leadership segment, firms operate on economies of scale and scope to sell to thousands of customers and drive down production cost.
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Accounting Analysis The next step in the firm valuation process is the accounting analysis. Through accounting flexibility set through by GAAP, firms have the ability to distort accounting statements. It is important to realize why, how, and how to undo these accounting distortion in order to grasps a better picture of the firm. By first determining a firm’s key accounting policies, we can determine what the incentives would be to manipulate the financial statements. Next we determine the flexibility of these policies. If these policies are highly flexible, managers have more discretion on how to record information, thus we need to determine how flexible these policies are to determine how much financial discrepancy might be present. After determining the accounting flexibility, we determine the firms accounting strategy. Industry competition may force managers to manipulate revenues or expenses in order give the firm a better financial image. The next step is to evaluate the level of disclosure. This is done in comparison to their competitors in the industry. If a firm discloses less information than its competitors it puts into question their accounting practices. Once we determine the level of disclosure, we then record the red flags. Red flags include many items, such as unexplained numbers from year to year, or negative change ratios. The last step is to undo any accounting distortions to get a better picture if the company. By restating the balance sheets, it gives a different view of the company, undoing any major accounting manipulation.
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Identify Key Accounting Policies (KAP) The first step in the accounting analysis process is to determine the key accounting policies of the industry. After understanding the Analog ICs industries key success factors, we then determined how distorting accounting statements could benefit those success factors. Manager’s have discretionary power to alter financial statements for their own (or firms) benefit. These accounting distortions can make the company seem better or worse than it actual is. To begin to analyze these key accounting, we must first divide them into two types. Type 1 key accounting policies, are not as concerned with the balance sheets, but the key success factors of the industry. For instance, Intersil resides in a highly differentiated industry, so their key success factors of superior product quality, product variety, focus on creativity and economies of scale and scope. These key factors and the amount of disclosure per each factor are what we will be looking at in the type 1 key accounting policies. The other type of accounting polices we will be analyzing, type 2 accounting polices involve the quality of the balance sheets. Given the flexibility of GAAP, firms are able to manipulate the balance sheets to their advantage. By analyzing type 2 accounting policies we are able to answer questions like if the firm is debt loaded do they distort the balance sheets to look more credit worthy. Type 2 accounting policies include goodwill, pensions and benefits, operating leases and capital leases. We then look at these policies and determine if they are misrepresented in the balance sheets and need to be restated to maintain a clearer view of the firm.
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Type 1 Key Accounting Policies
Although Intersil competes in a differentiated market, by using accounting policies to limit cost and implement key success factors through their accounting methodology. Through disclosing more information that will help inventors informed investment decisions on the company. By not disclosing information, a firm can limit its liability on investor’s misjudgments and subsequent loss. The first key success factor that the Analog ICs industry partakes in is superior product quality. If a product fails, the government mandates a 30-day return policy, but some companies will extend this return policy to up to one year. (MXIM 2008 10-K; ADI 2008 10-K) Because of this companies disclose their warranty expense. If a firm’s warranty expense exceeds the industrial norm, it raises question to the overall quality of the firm’s products. On the other hand, if the firms warranty expenses are below the industrial norm, the firm could either be manufacturing a better quality product with less recalls or not reporting enough expenses. Along with product variety, the Analog ICs industry focuses on creativity. This is demonstrated through firm’s disclosure of research and development. By having more research and development on the books, it expresses that firms are applying more effort into the thought and creativity process. Also, by disclosing more research and development, it correlates to the fact that the industry focuses on product variety. Through more research and development, more products can be develop, so in an industry that focuses on creativity and product variety, disclosure of research and development cost and allocations are important. Intersil and its competitors disclose information regarding patent leases and renewals, which in a competitive industry focusing on creativity and product variety, patents are extremely important. In the Analog ICs industry, thrives on economies of scale. Throughout the industry’s 10-k, companies report information on foreign production, markets, variety of 64 | P a g e
customers and outsourcing. The financial statements include income not only from the United States, but from countries across the globe. Many companies, including Intersil, segment their foreign sales and inventories into major geographical regions such as Europe, Asia, and North and South America.
Research and Development
In the Analog ICs industry, companies are persistently seeking new ways to create new innovative products that will meet the demands of the consumers. So, to compete in this industry, an abundant amount of money needs to be allocated towards research and development. Firms in the Analog ICs industry have a product portfolio consisting of on average 20,000 different products as wells as some firms having over 1,000 patents. (Intersil 10-k) In order to maintain this competitive edge, firms apply this key success factor by implementing more research and development. The following table represents the percentage of research and development to revenue over the past six years for the Analog ICs industry.
R&D as a Percentage of Revenues 35.0% 30.0% ISIL
25.0%
TXN
20.0%
ADI
15.0%
LLTC
10.0%
MXIM
5.0%
Industry
0.0% 2003
2004
2005
2006
2007
2008
Aside from MXIM’s spikes over the last three years, firms in the Analog ICs industry typically range from 15-20%. This consistency among firms indicates that in 65 | P a g e
order to maintain competitiveness in a differentiated industry, firms must allocate 1520% of their revenues towards research and development. Firms have found this to be a sufficient amount to finance ongoing product development and patent development. MXIM’ spikes in research and development are caused by their development of re-drivers over the past few years. Essentially these are used for storage of high speed signals, improving performance, have low power operations, and will be used in desktops, workstations and servers. In order to develop a higher quality chip, a firm must allocate more money towards research and development.
Type 2 Key Accounting Policies
Introduction While type 1 accounting policies dealt with the disclosure of the key success factors of the firm, type 2 accounting policies pertain to items that will impact the firm during the restatement of financials. These accounting policies include research and development expense, product warranty, foreign currency, and goodwill. Each item will be but through a threshold test. If firms meet threshold test, then their financials need to be restated in order to ascertain a clearer view of the company.
Research and Development
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GAAP regulations state that R&D costs need to be expensed. Research and development result in many innovative products that create revenue. Because of the revenue that is created from research and development, there is good reason why R&D should be capitalized as an asset. If over the past five years, the average R&D expense exceeds 20% of operating income there is a need to capitalize the R&D and treat it as an asset. As you can tell from the table below, Intersil’s R&D expense greatly exceeds 20% of their operating income. The overall average throughout the past six years is 176%.
2003
2004
2005
2006
2007
2008
R&D Expense
91,267
107,430
110,834
126,458
134,374
143,583
Operating
73,841
16,191
100,140
151,832
151,923
-1,047,037
124%
664%
111%
83%
88%
-47%
Income R&D/OI %
*In millions Since Intersil doesn’t capitalize their R&D, their expenses are overstated, and assets, stock holders equity, and net income are understated as the table below demonstrates. Assets U
Liability N
Foreign Currency
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Equity U
Revenue N
Expenses O
Net Income U
The Analog IC industry relies heavily on international sales. Over half of this industry’s total revenue comes from international sales, resulting with a high currency risk exposure. Below is a pie chart that shows the distribution of Intersil’s revenues for year 2008 amongst the companies as well as a table indicating the percentage of sales received from foreign countries.
International Sales
2004
2005
2006
2007
2008
76%
78%
78%
83%
82%
The chart above indicates that Intersil is becoming a more global company, having a 6% international sales growth over the past 5 years. This indicates that Intersil does rely solely on American sales, but more on international sales.
Revenues by Country 2008
China United States South Korea Japan Other
Intersil believes that since they choose to use the U.S dollar that, “they do not have material risk to revenues due to currency fluctuations between billing and collection of funds for those amounts billed in other currencies.” (Intersil 10-k) Sales from foreign countries must convert their currency into dollars for Intersil. Although Intersil practices hedging, they predict that the dollar will remain the stronger currency 68 | P a g e
and do not practice a significant amount of hedging. In January 2009, Intersil will hedge only 10% of total operations. (Intersil 10-k)
Operating Leases Operating leases are leases that provide part time usage of assets/property. Operating leases can cause the financial statements to not be obvious as it makes liabilities appear lower than they in reality are. Firms within the Analog CI industry favor operating leases because it is debt that doesn’t have to be shown on the balance or income statement, and they can still use the assets. Operating leases help avoid ownership risks, and show no interest expense or depreciation on the income statement. Therefore expenses are understated, and net income and equity of the corporation are overstated. Operating leases can significantly affect the firm’s financial statements when the present value of operating leases exceeds 10% of the long term debt. The basic accounting equation showed below displays the assets understated and the stockholders equity as a result of Intersil using all operating leases. Assets
Liabilities
Equity
U
U
O
A big red flag is raised due to the fact that Intersil doesn’t post any long term debt on their balance sheet. Normally you would be able to analyze the importance of operating leases compared to long term debt, but in Intersil’s case the operating leases are the only long term debt listed within their 10-K. So as far as we know, operating leases consist 100% of long term debt. Intersil also has no capital leases, just operating leases. The only reason Intersil gives for using all operating leases is they “use standby letters of credit primarily for security for workers compensation, environmental items, and as security for our vendors” (Intersil 10-K 2008). Pension Plan In order to attract and maintain employees companies will offer pension plans. Pension plans are offered because people will end up retiring and in the end employees 69 | P a g e
will benefit from these pension plans. There are 2 different kinds of pensions plans which are defined benefit pension plan and a defined contribution plan. The main difference between the two pension plans is that the defined benefit plan guarantees a certain amount in the future using a discount rate and the defined contribution plan does not guarantee a specified future benefit because it heavily relies on investment earnings which are bound to fluctuate. The pension plan Intersil Corporation provides to all its employees is the defined contribution plan. In the defined contribution plan the amount of the employer's annual contribution is specified. “Individual accounts are set up for the employees and benefits are based on the amounts credited to these accounts plus any investment earnings on the money in the account” (Wikipedia). The risk of the defined contribution plan is that the future benefits are not guaranteed and only employer contributions to the account are guaranteed. Intersil provides “retirement benefits to substantially all employees primarily through a defined contribution plan to which both Intersil and its employees contribute (a 401(k) Plan under Internal Revenue Code Section 401(k))” (Intersil 10-K).
Intersil Pension Plans Expense $6,000,000 $5,000,000 $4,000,000 $3,000,000
Pension's Expense
$2,000,000 $1,000,000 $0 2006
2007
2008
Intersil pension plans expense from continuing operation was “$5.7 million, $4.9 million and $4.6 million for 2008, 2007 and 2006, respectively, which is primarily the matching contributions to employees’ 401(k) accounts (Intersil 10-K). Intersil will match dollar for 70 | P a g e
dollar on which the employees decided to invest up to a percentage. Intersil also provides “retirement benefits under statutorily required plans for employees in certain countries outside the U.S. Accrued liabilities relating to these unfunded plans were $3.6 million and $3.5 million as of January 2, 2009 and December 28, 2007, respectively” (Intersil 10-K).
Goodwill Goodwill is a type 2 accounting policy. Goodwill is the difference between the acquisition price and the fair market value when acquiring a new firm. Goodwill is an intangible asset located on the balance sheet. FASB issued the Statement of Financial Accounting Standards (SFAS) No. 142 title “Goodwill and other Intangible Assets”, in June 2001; goodwill is evaluated at the end of every year and if the fair value of goodwill is less than the carrying value of goodwill, than goodwill must be impaired. Companies must assess goodwill for impairment at least once annually. In the Intersil 10-K it states that “Goodwill is an indefinite-lived intangible asset that is not amortized, but instead is tested for impairment annually or more frequently if indicators of impairment exist” (Intersil 10-K). Top level managers have the ability to determine if Goodwill is impaired. If goodwill is impaired, its carrying amount is reduced and an impairment loss is recognized. However, the matter of impairing Goodwill has some controversies. Managers are expected to achieve certain target profits on which they are evaluated on. Managers have the ability to assess the goodwill and impair it if it is necessary. Assets = Liabilities + Equity O
N
O
Revenue - Expenses = Net Income N
U
O
Assets will be overstated if the Goodwill is impaired when it is not written down. This is a possibility if managers decide not to write down impaired Goodwill when they should. Managers may not impair Goodwill to protect their position; they may look for different accounting policies so they could raise profits and by impairing Goodwill it will 71 | P a g e
decrease profits which may make the manager look like he is not carrying out benefits for the company. By not impairing the goodwill when needed it will distort the financial statements and it will ultimately overstate assets and liquidity leading to and understatement in expenses and overstatement in Net income. Intersil Corporation has had a huge impairment in Goodwill of $1,154,676,000 in the year of 2008. Looking at Intersil Corp. for the past five years they have never had an impairment of Goodwill except for the year of 2008. This impacted the Net income significantly and resulted in a Net loss of $1,062,502. Goodwill in the year of 2007 represented 60% Total Assets. In 2008 Goodwill only represent 28% of total assets. Intersil announced “We recorded an impairment loss of $1,154.7 million against our goodwill in the fourth quarter of 2008, calculated as the excess of carrying amount of goodwill over the implied fair value of goodwill in our reporting units.” The reason impairment took place in the goodwill is the carry amount was stated to high compared to the fair value of the goodwill which is what it is worth in the market.
Degree of Potential Accounting Flexibility
Introduction GAAP allows accounting flexibility for firms to use their discretion on how to impair and record certain items, since each firm is unique in their business strategy and no two firms are directly identical. Because firms vary in size and accounting needs, the SEC allows GAAP to give managers the ability to choose their accounting strategy, rather than find a single set of rule that ever firm must apply. It would be impossible to find a set that satisfies every firm’s needs, so the SEC allows GAAP to have flexibility. Because of this, managers can use this flexibility to their advantage, representing situations that benefit their company’s outlook based on their firm’s key success
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factors. In this section, we will take a close look at the flexible accounting policies that impact Intersil’s key success factors.
Research and Development Many firms within the Analog CI industry see research and development as an asset, although GAAP sees R&D has an expense. It is required by GAAP that all R&D is written off as an expense. Unable to capitalize the expense, firms overstate expenses and understate net income, stockholders equity and assets. An investor or analyst is less informed from looking at the firm’s financial statements because the firm is forced to expense earned revenue. According to Intersil’s 10-K, R&D expenses include salaries (more than 600 employees engaged in R&D), direct costs occurred, and building costs.
Research and Development (In millions) 2003
2004
2005
2006
2007
2008
ISIL
91.27
107.43
110.83
126.46
134.37
143.58
TXN
1,748.00
1,978.00
2,015.00
2,195.00
2,140.00
1,940.00
ADI
452.86
514.44
497.10
459.85
509.55
533.48
LLTC
91.41
104.62
131.43
160.85
183.56
197.09
272.32
306.32
328.16
514.14
659.54
577.75
MXIM
The table above shows the large amount of money this industry has spent on R&D for the past 6 years. All the firms are fairly consistent due to their overall relative size. There is no room for flexibility in accounting policies for research and development.
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Foreign Currency Risk The accounting standards board is extremely specific on how managers can record their business actions. The SEC requires under FASB Statement No. 161 that companies enhance their disclosure of financial activities in order to provide more transparent financial statements. Implemented on November 15, 2008, the SEC requires that the company report on their hedging activities. Intersil’s hedging activities attempt to protect foreign currency risk. Although they have improved their hedging techniques, they still have hedging risk brought on by accuracy of sales estimates, volatility of currency markets and the cost of availability of hedging instruments. (Intersil 10-K) Intersil typically uses foreign hedging contract for up to six months. However, hedging only provides so much protection. On January 2, 2009, Intersil lost 10% do to hedging fees and miss-apprehended hedging techniques. (Intersil 10-k)
Operating Leases There are three options that all firms may choose to report their long term assets as, either operating leases, capital leases or both. Capital leases are treated as an asset, and the lease payments are treated as a liability. GAAP attempts to lessen the flexibility whether the firm chooses to do operational and/or capital leases. The accountings standards board sets rules clarifying the exceptions of being able to use operating leases. The rules make the flexibility moderately low, but the managers of the firms can usually find a way to get around it, and attain their preferred results on their financial statements. Firms often choose operating leases over capital leases, because capital leases recognize expenses earlier. 74 | P a g e
Goodwill Goodwill is an intangible asset that is the difference between the acquisition price and the fair market value when acquiring a new firm. Within the Integrated IC industry there is a lot of flexibility in regards to the impairment of goodwill. Statement No. 142 issued by FASB announces that “Goodwill and other intangible assets are accounted for subsequent to their initial recognition. Because goodwill and some intangible assets will no longer be amortized, the reported amounts of goodwill and intangible assets (as well as total assets) will not decrease at the same time and in the same manner as under previous standards� (www.fasb.org). This statement describes that FASB allows managers to delay the impairment of Goodwill even when Goodwill should be impaired. This allows for a company to maintain higher Net Income for the year. Intersil has impaired Goodwill in the past years. The impairment was detrimental to the net Income and assets of 2008. The impairment of goodwill resulted in a $1,154,676,000 loss. This could possibly mean that the manager in Intersil have pushed the impairment too far by not impairing on a regular basis. Intersil may have had this problem due to the high flexibility of impairing Goodwill. If Goodwill was impaired and recognized on a regular basis it may have reduced the huge impairment resulting in 2008. Managers having the flexibility of impairment of Goodwill questions the accuracy of the financial statements provided. By allowing more flexibility managers can control the and benefit the company as needed but if the flexibility of impairment of Goodwill is abused it could lead to detrimental problems in the long run.
Evaluation of Actual Accounting Strategy
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Introduction The next step in analyzing the firms accounting is to determine the firms accounting strategy. By analyzing the accounting flexibility, we are able to understand how the firm can use these flexibility discretions to their advantage. There are two classifications of accounting styles, aggressive and conservative. The aggressive approach tends to overstate assets, understate impairment and depreciation, have lower liabilities, have higher owner’s equity, and have a higher net income by increasing revenue recognized or decreasing expenses recognized. A conservative approach tends to have lower assets, overstate impairment and depreciation, have greater liabilities, and have higher owner’s equity and a lower net income by decreasing revenue recognized or increasing expenses recognized. The more flexible the accounting, the more discretion firm managers have to take a conservative or aggressive approach. By comparing the accounting strategies to the rest of the industry, we are able to determine if a firm is acting more aggressively, more conservatively, or right on average with the rest of the industries accounting practices and strategies.
Research and Development Intersil reports all their R&D costs, which include everything to do with designing, developing, and testing the products as an expense incurred. R&D is reported by Intersil to a minimum degree that will satisfy GAAP. Accruing the R&D as an expense, results in conservative accounting. Intersil uses internal R&D. They report R&D as an expense on financial statements which are required by GAAP. Later R&D will be changed to a purchased R&D which will allows R&D to be booked as an asset by capitalizing it. The capitalization of R&D is shown on the restatements.
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Intersil is responsible to show preliminary and final valuation estimates of R&D of all acquires. These estimates are included in the consolidated statements of operations, but shown separately in the 10-K. “The purchased R&D written off at the time of acquisition is shown in a separate line on the consolidated statements of operations� (Intersil 10-K)
R&D / Operating Income
7 6
ISIL
5
TXN
4
ADI
3
LLTC
2
MXIM
1 0 -1
2003
2004
2005
2006
2007
2008
The chart above shows a direct relationship to the amount of research and development being spent by the firms and the impact it has on operating income. Throughout the past six years, the industry is pretty consistent, with the exception of Intersil’s year 2004 spike.
Foreign Currency Risk The Analog IC industry has effectively utilized the foreign currency to hedge their risk globally and as a firm that provides services worldwide. Intersil and their competitors operate in many countries selling their products to different markets outside the United States. The exchange is especially essential as markets are declining and currency weakens in many countries. Intersil has conservatively hedged their
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position in the currency exchange business by operating future contracts for commitments up to six months. Intersil reported a total net gain on foreign exchange contacts of $1.1 million this past fiscal year, 2008. Intersil disclose their figures in the statements of operations, furthermore, indicated Intersil’s efforts in disclosing critical information and their position compared to their competitors in this aspect. This is a heavily influenced area since majority of Intersil’s total revenue is from international countries.
Operating Leases Operating leases are terms and conditions to use such equipment, space, and resources for a given amount of time. Firms who operate globally make use of this strategy to actually produce and manufacture their products without having to carry these long term assets on the balance sheet. Another advantage of creating operating leases is the opportunity to manipulate net income by leaving this account of the balance sheet. Long term assets such as PP&E are depreciated and expensed to reduce net income but excluding operating leases on the balance sheet reduces liability of that company. Capital leases represents ownership of that asset therefore the company depreciates and recognizes this account on the balance sheet as long term assets. Firms have the option to use the best approach for their business or whatever strategy is beneficial to their success. Investors should be aware when a company discloses their strategic method as operating leases. This practice could lead to overstating net income. Currently and in the past, Intersil doesn’t show long term debt on their financial statements. So, the operating lease is 100% of the long term debt. Intersil chooses not to disclose why they choose nothing as their long term debt in their financial statements. Intersil is different in this way compared to Intersil’s competitors who chose to post long term debt on their financial statements. Intersil would be considered 78 | P a g e
highly aggressive in their reporting. The use of all operating leases is a strong indication of aggressive accounting policies.
Goodwill To evaluate the impairments made in relation to Goodwill it will be important to understand the accounting policies and strategies concerning Goodwill. Before FASB issued the Statement of Financial Accounting Standards (SFAS) No. 142 title “Goodwill and other Intangible Assets,� the life of Goodwill had an indefinite life and was amortized over its useful life. Currently the accounting policy has changed due to FASB and Goodwill has an indefinite life which is tested for impairments annually to determine if the carrying value exceeds fair value. If the fair value is found less than the carrying value it is known that the Goodwill is impaired and the firm should impair the goodwill to the new fair vale ultimately decreasing total assets.
Goowill $1,600,000,000 $1,400,000,000 $1,200,000,000 $1,000,000,000 $800,000,000 Intersil
$600,000,000 $400,000,000 $200,000,000 $0 2004
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2005
2006
2007
2008
Goodwill / Total Assets 70.00% 60.00% 50.00% 40.00% 30.00%
Intersil
20.00% 10.00% 0.00% 2004
2005
2006
2007
2008
Interisl’s disclosure stated that “We recorded an impairment loss of $1,154.7 million against our goodwill in the fourth quarter of 2008, calculated as the excess of carrying amount of goodwill over the implied fair value of goodwill in our reporting units” (Intersil 10-K). No sign of impairments have been made from 2003 to 2007 from Intersil Corp. However, the 78% decrease in Goodwill in the year of 2008 raises questions if Intersil has been accurately using the impairment test for Goodwill. Intersil’s regarding Goodwill is aggressive because from 2004 to 2007 there has been no impairments and also very little information about the tests that have been performed regarding Goodwill. In conclusion, Intersil severely impacted Goodwill in 2008 hurting Net Income and by analyzing the information on Goodwill it seems that Intersil disclosed only the minimal requirements by GAAP. Compared to its competitors, Intersil’s accounting strategy related to goodwill is overly conservative. This has led to an overstated asset value, until the “Big Bath” in 2008, that was likely taken partially due to new management and also due to the overall negative outlook of the Analog IC industry during 2008 which was related to decreased revenues and backlogs that is generally attributed to the global recession. Due to the fact that we feel Intersil should have been impairing capitalized intangibles 80 | P a g e
such as goodwill in previous years to more accurately reflect its true total value of assets, we will later restate its impairment and total goodwill accounts.
Quality of Disclosure
Introduction Although a certain amount of disclosure is regulated by GAAP, firms still can choose whether or not to disclose certain facts. Some firm managers only publish what is required by the SEC, where as others go beyond the mandatory disclosures. With more law suits, firms are disclosing less and less for fear of “telling someone� information that would lead to a personal financial disaster. While lower levels of disclosure make it more difficult for an investor to grasp an accurate image of the company, a firm cannot not be liable on information it does not disclose, but can be on
information that it does. By disclosing less, firms are less liable. Also if a firm takes a more aggressive accounting approach as mentioned in the evaluation of the accounting strategy, they are less likely to disclose more information. If a firm adopts a more conservative accounting approach, they are more likely to disclose more information. If a firm discloses less information than the rest of the firms in the industry, it raises a red flag. The amount of disclosure a firm gives allows us to look for potential red flags.
Intersil 81 | P a g e
Currency
Research and
Operating
Exposure
Development
Leases
Moderate
Low
Low
Goodwill
Low
Research and Development To compete to the Analog IC industry, firms within the industry have to be constantly producing innovative products. For that to be possible, the firms spend a significant amount of money on R&D. Intersil does not release research and development quantitative numbers, the firm is very general about the costs that are included in R&D. Intersil’s “research and development costs consist of designing, developing and testing new or significantly enhanced products” (Intersil 10-K 2008). Disclosure of R&D is important to investors because they want to see that the firm is allocating a proper amount to have products that will catch the attention of the consumers. But in this industry, there is a relatively low level of disclosure in reporting R&D expense.
Foreign Currency Intersil fully discloses their foreign currency exchange risks and their hedging strategy so that the investor/analyst can understand. Intersil discusses their forward contracts and hedging in detail within the 10-K. There are also supplemental footnotes with detail relating to foreign currency so the reader can relate it to items on the financial statements. Intersil has a high quality of disclosure.
Operating Leases Intersil favors using operating leases, and doesn’t capitalize any of their leases. Recently Intersil chose to capitalize an abundant amount of leases in year 2008. This correlates with the fact that they capitalized a significant amount of goodwill and replaced their CEO. Because all these factors are present, Intersil took a big bath in 2008 to correct previous year’s impairments and set a new standard under a CEO. The economic conditions in 2008 gave a bleak outlook for the Analog IC industry, being that 82 | P a g e
they are a specialty good, so cutting back already diminished profits did not harm the firm’s image as much as it would in consequent years.
Goodwill The overall disclosure for the goodwill in Intersil is insufficient in information. Intersil lost $1,154.7 million due to impairment in the fourth quarter of 2008. This is a huge number for Intersil which account for 78% of their goodwill. Considering the magnitude of the impairment Intersil should have disclosed in detail why the impairment took place. Looking at Intersil’s financial statements from 2004, there has been no impairment from 2004 to 2007. However in 2008 they recorded the significant loss of Goodwill which resulted in a $1,047 million loss in operation income. To sufficiently disclose the Goodwill Intersil should have stated information on what affected the goodwill to drop so significantly and the step they have taken to impair it. In Intersil’s 10-K they state the obvious impairment rules but nothing on the direct affects of their impairment loss. Overall, Intersil have very little information over Goodwill which only questions the quality of their disclosure.
Quantitative Analysis Financial statements project the current value and status of the firm. Through accounting flexibility managers can alter the outlook of financial statements. By performing sales and expense manipulations diagnostic ratios, we are able to test if managers are misrepresenting their sales or expenses. Managers often overstate sales or understate expenses in a more aggressive accounting strategy in order to make the firm appear more financial sound. However, a conservative accounting approach will understate sales, and overstate expenses. Through analyzing these manipulation 83 | P a g e
diagnostic ratios, we are able to conclude if the firm is altering the financial statements to their advantage.
Sales Manipulation Diagnostics Firms can manipulate their sales to overstate or understate their revenue. This distorts the net income, either having too much or too little. In order to test the balance sheets for these distortions, we run sales diagnostic ratios. If these ratios drastically increase, the firm is recognizing too much revenue. If the ratios drastically decrease, the firm is not recognizing enough revenue. We then calculate change ratios, looking at the first derivative. If the first derivative is positive, the ratio is believable, because the increase or decrease in sales is related to cash from sales, accounts receivable, or inventory. Sales should be tied into cash from sales, accounts receivable and inventory. So, if the first derivative is negative, sales are not tied into these accounting items and it raises a red flag in the firms accounting practices.
Net Sales / Cash from Sales This ratio indicates the firm’s ability to tie together cash from sales to net sales. Ideally this ratio should be around 1, with higher ratio indicating that a firm is recognizing more revenue than cash. A ratio below means that a firm is receiving more cash than sales. If the firm’s ratio rises substantially, this would raise concern because it would indicate that they are receiving more sales without receiving more cash.
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Net Sales / Cash from Sales 1.60 1.40 1.20
ISIL
1.00
TXN
0.80
ADI
0.60
LLTC
0.40
MXIM
0.20
Industry
0.00 2004
2005
2006
2007
2008
As the chart above indicates, the industry remains constant and is slightly declining over the past 5 years. The industrial average moves from 1.27 steadily to 1.00 in 2008. This indicates that the industry was recognizing more net sales than it should have and that it is phasing out this sales manipulation to a more true recognition of net income.
Net Sales / Cash from Sales (Change) 10.00 8.00 6.00
ISIL
4.00
TXN
2.00
ADI
0.00
LLTC
-2.00 -4.00 -6.00 -8.00
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2004
2005
2006
2007
2008
MXIM Industry
Net Sales / Accounts Receivable This ratio demonstrates how closely related the accounts receivable are to net sales. Ideally, this ratio should be consistent if companies maintain constant contract terms with customers, and enforce them. If the ratio unexpectedly increases, there is a potential red flag, because the firm is recognizing too much revenue. However, if the industry’s ratio increases, then sales are not supported by accounts receivable.
Net Sales / Accounts Receivable (Raw) 16.00 14.00 12.00
ISIL
10.00
TXN
8.00
ADI
6.00
LLTC
4.00
MXIM
2.00
Industry
0.00 2003
2004
2005
2006
2007
2008
The chart above indicates stability throughout the industry from 2003 to 2007. In 2008, the ratio spikes to an industrial average of 9.66 (2007 industrial average of 7.68) . This spike is represented by economic pressures on the industry. In recent years, the Analog ICs industry could be more lenient on the time that it receives its accounts receivable because they were generating enough cash flow to cover late payments. When the 2008 market became tough for the industry, firms had to “tighten their belts� and enforce the timeliness of accounts receivable. By having sales decrease, firms needed the money from accounts receivable sooner to pay for current operations.
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The change ratio of net sales over accounts receivable represented in the graph and chart below, allows us to analyze the relation between the change in sales and accounts receivable. The sign change is important, not the magnitude of the ratio. If this ratio is negative it means that an increase in sales resulted in a decrease in accounts receivable or a decrease in sale resulted in an increase in accounts receivable. This discrepancy raises a red flag, showing that sales and accounts receivable are not tied together.
Net Sales / Accounts Receivable (Change) 150.0 100.0 ISIL
50.0
TXN
0.0 -50.0 -100.0 -150.0
2004
2005
2006
2007
2008
ADI LLTC MXIM Industry
-200.0 -250.0
As the chart above indicates, the ratio is negative for LLTC in 2004, Intersil, TXN, and ADI in 2006, ADI in 2007, Intersil, and ADI in 2008. These negative numbers show that in these years, net sales were not related to accounts receivable. ADI’s numbers raise concern because in only 2 out of the past 5 years net sales and accounts receivable were tied together, showing that they have an aggressive style of accounting. In 2006, only 3 firms, (Intersil, TXN, and ADI) had a negative ratio showing that in 2006, firms in the industry took an aggressive accounting approach and their accounts receivable were not tied into their net income. In 2008, two firms, (Intersil, and ADI) had negative ratios. Intersil’s was barely negative so that could be correlated to the shift in accounting showed in the entire industry in 2008. ADI’s numbers have 87 | P a g e
been mostly negative so this demonstrates a continued discontinuity between accounts receivable and net sales.
Net Sales / Inventory Net sales divided by inventory captures the linkage from sales and inventory. If inventory drops, so should net sales. If sales increase, the amount of inventory should increase as well. This ratio should remain constant because of this, and an inconsistency in this ratio would raise a red flag showing that net sales are not properly related to inventory.
Net Sales / Inventory (Raw) 35.0 30.0 ISIL
25.0
TXN
20.0
ADI
15.0
LLTC
10.0
MXIM
5.0
Industry
0.0 2003
2004
2005
2006
2007
2008
As the chart above shows, the industry’s ratios are consistent, with exception to LLTC. LLTC numbers are significantly larger than the rest of the industry, which could be due the fact that this is not a perfect mix of competitors and LLTC manages their inventory at lower levels than the rest of the industry. The change ratio of net sales over inventory is calculated by dividing net sale minus net sales of the previous year over inventory minus inventory from the previous 88 | P a g e
year. If the ratio is negative, it raises a red flag because a change in inventory is inversely related in net sales. Again the magnitude of the number is not significant, only the sign.
Net Sales / Inventory (Change) 300.0 200.0 ISIL
100.0
TXN
0.0 -100.0
2004
2005
-200.0 -300.0
2006
2007
2008
ADI LLTC MXIM Industry
-400.0 -500.0
The graph above displays that negative numbers occurred with LLTC and MXIM in 2004, Intersil in 2005, ADI in 2006, ADI and LLTC in 2007, and ADI in 2008. This brings ADI accounting practices into question because in 2006 though 2008 their change ratio was negative. This demonstrates that inventory was not directly tied into net income, raising a red flag for ADI’s sales and inventory relationship. Though in the raw ratio showed that LLTC’s ratio was inconsistent with the rest of the industry, in 2005, 2006, and in 2008 their change ratios were positive, showing that there is a direct correlation between sales and inventory. This would enforce the theory that LLTC manages their inventory differently than the rest of the firms because not all firms are perfect competitors.
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Conclusion
Intersil remains mostly consistent with their sales ratios, with few discrepancies. In a couple of the change ratios, Intersil had negative numbers, but not enough to completely discredit the correlation and raise a red flag. Their numbers did not typically differ from the industrial trend. With few variations in their numbers and no significant red flags, we have come to the conclusion that Intersil does not significantly manipulate their sales.
Expense Manipulation Diagnostics Expense manipulation tests a firm’s balance sheet for distortions. A firm can understate or overstate their expenses, which would manipulate their net income. If the expense manipulation ratio increases, then the firm is overstating their expenses and in turn, understating their net income. If the ratio decreases then a firm is understating their expenses to overstate their net income. The change ratios test for red flags. The change ratio should be positive, if the change ratio is negative, then a red flag occurs. The magnitudes of the numbers in the change ratio are not significant, only if the ratio is positive or negative.
Asset Turnover The asset turnover ratio is calculated by dividing sales by the previous year-end reported assets and is useful to determine if a firm is properly impairing their assets. If sales increase and assets are not impaired, the result will be an overstatement of asset values and a decreased asset turnover ratio. A sharp increase would indicate that the
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firm impaired more than it should have for the year, and a decrease would indicate that they did not impair enough.
Asset Turnover 1.20 1.00 ISIL 0.80
TXN
0.60
ADI
0.40
LLTC MXIM
0.20
Industry
0.00 2004
2005
2006
2007
2008
The chart above displays the Analog ICs industry’s asset turnover ratio. For the most part, each firm remains fairly consistent; although each firm operates at a different level. In 2008, LLTC’s asset turnover ratio spiked from .45 to .96 due to a large decrease in assets resulting from the issuance of $1.7 billion of convertible senior notes for an accelerated share repurchase initiative. This led to a large increase in liabilities while creating a deficit in shareholder’s equity that had the net effect of decreasing its total assets by approximately $1.17 billion in 2007. Also, in 2008, ADI’s asset turnover spiked from .61 to .87, stemming from approximately $40.5 million of asset impairments. The fact that Intersil’s value remains significantly lower than the industry average represents a red flag that Intersil has been understating its expenses related to the impairment of intangibles and overstating its assets between 2004 and 2007. However, in 2008, Intersil incurred an expense of approximately $1.155 billion related to the impairment of goodwill. We believe this action was a result of a decision by Intersil’s new CEO to take a “big bath” at a time when performance figures for 91 | P a g e
Analog ICs firms were already looking bullish due to the current state of the economy and the global recession. However, below, we can the rapid rate at which ISIL’s asset turnover ratio adjusts towards the industry average after restating total assets with 20% yearly impairment of ISIL’s goodwill between 2003 and 2008.
Asset Turnover (Change) 15.00 10.00 5.00 0.00 -5.00 -10.00 -15.00 -20.00 -25.00 -30.00 -35.00 -40.00
ISIL 2004
2005
2006
2007
2008
TXN ADI LLTC MXIM Industry
The change ratio measures the relationship between asset impairment and sales. If the ratio is negative, then the amount impaired and the amount of sales are inversely related. This means that on a year that sales increased, a firm impaired less or in a year a firm’s sales decreased, the firm impaired more. As the chart above describes, the industry remains positive for the most part. Intersil’s change numbers were negative 3 out of the last 5 years and ADI’s change ratio numbers were negative 4 out of the last 5 years. This raises the red flag that impairment and sales are not related for these two firms. Intersil’s negative numbers could be based on the fact that they took a “big bath” in 2008, and that they were covering up impairment in the previous years before the CEO was fired. ADI had $40.5 million in asset impairments in 2008, causing the ratio to spike in the raw form but also bringing into question, why did they need to impair so much so rapidly. This could be an affect of the previous years’ improper impairment causing the negative change ratios. This could have caught up to ADI causing them to 92 | P a g e
impair more than usual in 2008 in order to get back to where their impairment needs to be.
Asset Turnover Ratio
Asset Turnover (After 20% Yearly Goodwill Impairment 2003-2007) 0.80 0.70 0.60 0.50 0.40 0.30 0.20
2004
2005
2006
2007
2008
ISIL (Adj)
0.24
0.28
0.39
0.43
0.53
ISIL (Actual)
0.22
0.23
0.29
0.30
0.32
Industry
0.53
0.54
0.56
0.59
0.74
Asset Turnover (With and Without 20% Yearly Goodwill Impairment 2003-2007) 2004
2005
2006
2007
2008
ISIL (Adjusted)
0.24
0.28
0.39
0.43
0.53
ISIL (Actual)
0.22
0.23
0.29
0.3
0.32
Industry (Actual)
0.53
0.54
0.56
0.59
0.74
CFFO / Operating Income This ratio links together the income statement and the statement of cash flows. Because it connects these two statements, we are able to observe how firms handle their cash. The ratio should remain constant showing that the amount of cash received by from operations relates to operating income. If the ratio sharply decreases, income 93 | P a g e
is not supported by cash, so it raises a red flag. A sharp increase in the ratio indicates that the firm is understating its expenses, increasing its income.
CFFO / OI (Raw) 7.00 6.00 ISIL
5.00
TXN
4.00
ADI
3.00
LLTC
2.00
MXIM
1.00
Industry
0.00 -1.00
2003
2004
2005
2006
2007
2008
As the chart above describes, all other firms in the industry remain constant, except for intersil, showing that they are correctly stating their expenses and not distorting them. In 2004 Intersil ratio spiked from 1.37 to 6.07 raising a red flag that they are overstating their expenses, decreasing their net income and owner’s equity. In 2008, Intersil’s ratio declined from 1.53 to -.19 due to a severe understatement of expenses, overstating their net income and owner’s equity. These two discrepancies raise red flags that Intersil is distorting their expenses to manipulate their expenses. The change ratio of cash flows from operations of operating income should be positive because an increase in cash received from operations should correlate an increase in operating income. A decrease in cash from one should increase from cash in the other, if the accounting statements are accurate. If there is a negative ratio, it raises a red flag because that means an increase in cash in the income statement caused a decrease in cash in the statement of cash flows (or the other way around), which does not make sense. 94 | P a g e
CFFO / OI (Change) 50.0 40.0 30.0
ISIL
20.0
TXN
10.0
ADI
0.0 -10.0
2004
2005
-20.0 -30.0
2006
2007
2008
LLTC MXIM Industry
-40.0 -50.0
As the chart above describes, in 2005 and 2006 ADI and MXIM had negative ratios. In 2007 Intersil had a negative ratio and MXIM had a negative ratio in 2008. This raises a red flag for MXIM had negative ratios 3 out of the 5 years, proving that the cash received from operating income is not directly correlated with the cash flows from operations. This puts into question the integrity for MXIM to manipulate their expenses to misrepresent their net income.
CFFO / Net Operating Assets This ratio, much like asset turnover, allows us to analyze the firm’s depreciations consistency. Though there is not ideal ratio, an overstatement of depreciation will drastically increase the ratio and a understatement of depreciation with cause the ratio to decline. A firm will distort the amount of depreciation to overstate expenses to understate net income or understate depreciation understating net income.
95 | P a g e
CFFO / NOA (Raw) 2.5 2.0
ISIL TXN
1.5
ADI 1.0
LLTC MXIM
0.5
Industry 0.0 2003
2004
2005
2006
2007
2008
As the chart above demonstrates, each firm operates at different level and there are several discrepancies in the ratio. Intersil’s ratio rises in 2006 and stays consistently higher than its previous years. This could be due to Intersil adopting a more conservative approach to recognizing depreciation and impairment of assets. The same can be said about LLTC because in 2004, their numbers spiked from 2003’s 1.3 to 2.3 and stayed around 2.0, so LLTC is impairing more of their assets, increasing their expenses and using a more conservative approach. In 2006, TXN ratio dropped from 1.0 to .06 then rose up to 1.2, this is probably due to the fact that they did not impair enough in 2006 so they slightly overcorrected in 2007 and then brought the ratio back to normal. Also, MXMIM ratios have steadily been declining indicating that they are not recognizing as much impairment expense, overstating their income and moving to a more aggressive accounting style. The change ratio should be positive, signifying that more assets should generate more cash. Again, the magnitude of the change is not relevant, just if the number is positive or negative. A negative change ratio allows us to determine red flags in firm’s expenses.
96 | P a g e
CFFO / NOA (Change) 30.0 20.0 ISIL 10.0
TXN
0.0 -10.0
ADI 2004
2005
2006
2007
2008
-20.0
LLTC MXIM Industry
-30.0 -40.0
As the chart above displays, TXN has a huge red flag with all of their change ratios being negative 5 out of the past 6 years. They increase their plant property and equipment in from 2005 to 2007, even though their sales decreased. For the rest of the years, (aside from 2008) the plant property and equipment decreased while sales increased. This means that increasing cash and depreciation are inversely related, and that their impairment practices are inconsistent. Also in 2005, nearly every firm had a negative change ratio (all except LLTC). This explains that in 2005 the industry did not correlate their depreciation with their cash flow from operations.
Total Accruals / Sales Total accruals are calculated by subtracting CFFO from OI. If a firm’s accruals suddenly spike, then they are overstating their expenses. Although there is no ideal ratio number, if the ratio is less than one and a firm has more sales than accruals, and they are probably distorting their accruals.
97 | P a g e
Total Accruals / Sales (Raw) 40.0 30.0 ISIL 20.0
TXN
10.0
ADI
0.0
LLTC
-10.0
2003
2004
2005
2006
2007
2008
MXIM Industry
-20.0 -30.0
As the chart, shown previously, describes, firms generally display fairly consistent values, respectively, aside from ADI. ADI’s ratio spikes up in 2006, then sharply declines in 2007 and 2008. In 2006 we observe other spike, which indicates that they increased their expenses and understated their net income for that year. In 2007, ADI’s ratio dropped from 31.4 to 7.6 and continued to decline to -22.1 in 2008, indicating an understatement of expenses and an overstatement in net income and owner’s equity. In 2008, their total accruals were negative, raising a red flag. TXN raises a red flag because in the past 6 years, the ratio was less than one, showing that sales were greater than accruals, and because sales exceed accruals. Since sales were greater than accruals, TXN understated their expenses to overstate their net income and owner’s equity, raising a red flag. The change-form of total accruals to sales ratio signifies year to year relationship between changes in accruals and sales. If accruals increase, so should sales, and if accruals decrease, sales should decrease as well. This is represented in a positive change ratio, and the magnitude of the change ratio is not of significance. If the ratio is 98 | P a g e
negative, it represents an increase in accruals causes a decrease in sales or a decrease in accruals causes an increase in sales, raising a red flag.
Total Accruals / Sales (Change) 120.0 100.0 80.0 60.0 40.0 20.0 0.0 -20.0 -40.0 -60.0 -80.0 -100.0
ISIL TXN ADI LLTC 2004
2005
2006
2007
2008
MXIM Industry
As the chart above indicates, companies that displayed negative ratios include: in 2004, Intersil; in 2005, TXN, ADI, and LLTC; in 2006, MXIM; in 2007 all companies had a positive ratio; and in 2008, TXN, ADI, and MXIM displayed negative ratios. TXN, ADI, and MXIM all had negative numbers for 2 years, showing that changes in accruals were not directly correlated with sales. Although each firm had a negative ratio during at least one of the last five years, no companies’ values were consistently negative; therefore, no red flags are raised. Only some of the ratios showed discontinuity between accruals and sales, though for the most part they displayed direct correlation.
Conclusion Though Intersil stays fairly consistent with some of its ratios, there are some variations in their numbers that raise concern. First off, its change asset turnover is negative 3 out of the 5 years, raising a red flag that their impairment is not directly 99 | P a g e
related to their sales. Also, in their CFFO/OI raw ratio, their numbers spike in 2004, overstating their expenses, then declining in 2008 to a -.19, drastically understating their expenses. However their change ratio was only negative so even though the numbers were skewed in the raw form, and they CFFO and OI directly increased and decreased. The CFFO/NOA raw ratio represented a change in accounting practice for Intersil as their ratio rose in 2006 and only slowly declined from there. However, for 3 of the 5 years, Intersil displayed a negative change CFFO/NOA ratio meaning that increasing cash and depreciation are inversely related for these three years. As far as the Total Accruals to Sales ratios, Intersil showed little variations or negative change ratios. The overall expense diagnostics allows us to conclude that from time to time Intersil will overstated their expenses, however, for the most part they are do not distort their expenses.
Sales Conclusion Intersil remains mostly consistent with their sales ratios, with few discrepancies. In a couple of the change ratios, Intersil had negative numbers, but not enough to completely discredit the correlation and raise a red flag. Their numbers did not typically differ from the industrial trend. With few variations in their numbers and no significant red flags, we have come to the conclusion that Intersil does not significantly manipulate their sales.
100 | P a g e
Potential Red Flags
Introduction Red flags signify that there might be unexplained distortions that may discredit the financial statements of the firm. Red flags can be anything from unusual changes in accounting practices or unexplained changes in the sales and expense diagnostics. Some changes can be related to the industry, where firms in the industry adopt different practices in order stay competitive, but it is up to the analyst to determine the significance of these changes and the plausibility of an industrial explanation.
Operating Leases An area of questionable accounting that we encountered was the amount of capital spent of operating leases by Intersil. The past five years overall total present value came out to be $251,075,994 of the operating leases. In order to determine whether capitalizing operating leases would be material in restating Intersil’s financial statements for valuation purposes, we determined if the present value of operating leases exceeded long-term debt by 10%, restatement would be necessary. Assets
Liabilities
Equity
U
U
O
This accounting strategy used by Intersil raises a concern for a red flag because they choose to leave off a considerable amount of liabilities off their balance sheet. The income statement is affected as well, not properly accounting for the correct amount of depreciation and interest. We feel that Intersil is understating assets and liabilities, and 101 | P a g e
overstating equity as the table demonstrates below. Overall, Intersil’s leasing accounting raises a red flag.
Research and Development In the past, and currently, Intersil treats research and development as an expense due to GAAP requirements. Unfortunately, Intersil doesn’t have a choice on how to account for their research and development. The only way that firms can capitalize research and development is through purchase and the majority of Intersil’s research and development is done within the firm. Due to the large amount of capital allocated to research and development expenses, we feel that if ISIL were able to capitalize R&D expense as an asset, the underlying business structure would be better represented for valuation purposes. A key success factor in the analog IC industry is high investment in R&D to create new innovative products which leads to revenue. Therefore, Intersil research and development raises a red flag.
Goodwill After examining ISIL’s financial statements, we determined that their actual accounting policies related to goodwill exhibit abnormal patterns. Upon analysis of Intersil’s financial statements, the most immediately noticeable and drastic accounting event was a $1.15 billion expense related to impairment of goodwill in 2008. This caused ISIL to report over a net loss of over a billion in 2008 and resulted in a 52.9% decrease in assets between 2007 and 2008. We noticed that between 2003 and 2004, Intersil increased its goodwill by approximately $387.9 million and between 2004 and 2007 Intersil maintained an average of $1.44 until the massive impairment in 2008. This represents a red flag and it is our opinion that the restatement of these values will serve transform investors’ views of the firm. 102 | P a g e
Intersil: Goodwill Value $1,600,000 $1,400,000 $1,200,000 $1,000,000 $800,000 ISIL
$600,000 $400,000 $200,000 $2003
103 | P a g e
2004
2005
2006
2007
2008
Undoing Accounting Distortions
Introduction Now that we have identified red flags for potential instances of accounting flexibility and distortion, we must draw upon our knowledge of the firm and industry in order to make decisions upon how to restate the financial statements in order to better represent the value of the firm. From restating financial statements, we can mitigate the impact of accounting flexibility and distortion on the underlying business reality of the firm. The goal is to generate a new set of financial statements allow us to generate a clearer image of the firm which will allow us to more accurately value the firm. The most prominent red flags that we have identified to have the largest material effect on ISIL’s financial statements include the following: goodwill, operating leases, and research and development. After evaluating and restating these key line items, we feel the net effect is likely to transform our image and opinion of the firm.
Research and Development
For purposes improving valuation accuracy, we determined that if R&D expense exceeds 20% of reported operating income throughout the past five years, then there is a need to capitalize R&D. As high investment in R&D is a key success factor in the analog IC industry, Intersil invests large amounts of capital in research and development causing the R&D expense to exceed 20% of Intersil’s operating income. Therefore, we have determined that R&D should be recorded as an asset rather than an expense to improve the materiality of Intersil’s financial statements to firm valuation.
104 | P a g e
The graph on the next page shows all calculations we had to go through to arrive at a R&D impairment adjustment and capitalized R&D. We forecasted six years, dividing up 100% of the original R&D over six years. To start out every year, the original R&D was taken and multiplied by 10%. The next four years after that the same years original R&D was multiplied by 20%, and that left the last forecasted year multiplied by 10 % again. Then to arrive at the should impair cost, we summed up the new R&D for every year. Next, we calculated the impairment adjustment and capitalized R&D, which belong on the income statement, by subtracting should impair by the original impaired (original R&D).
105 | P a g e
Research and Development Captilized 2004 Original R&D Assume Mid Year Acquisitions New R&D
107430
2004 2004 2005 2006 2007 2008
Impair New R&D
total RD write down should impair Did impair impairment adjustment
IS
Capitalized RD
BS
106 | P a g e
10,743
2005 110834
2005
2006 126,458
2006
2007 134,374
2007
2008 143,583
2008
2009
2010
2011
2012
2013
21,486
21,486
21,486
21,486
10,743
11,083
22,167
22,167
22,167
22,167
11,083
12,646
25,292
25,292
25,292
25,292
13,437
26,875
26,875
26,875
14,358
28,717
28,717
12645.8 26874.8 13437.4 28716.6 28716.6 14358.3
113,793
91,966
68,237
42,154
10,743
32,569
56,299
82,382
110,178
14,358
107,430
110,834
126,458
134,374
143,583
12,427
12,427
12,427
(96,687)
(78,265)
(70,159)
(51,992)
(33,406)
101,365
79,539
55,810
12427.4 12427.4 29726.6 1930.9
(96,687)
(174,952)
(245,111)
(297,103)
(330,509)
(229,143)
(149,604)
(93,794)
(64,068)
(62,137)
Operating Leases The operating lease test, says if the present value of operating leases exceeds long term debt by 10%, then there is a need to capitalize operating leases and restate Intersil’s past financial statements. To arrive at the interest and depreciation expense we go back to year 2003 to find the expenses for years 2004 through 2008. Since Intersil doesn’t use capital leases, so we can’t calculate the discount rate or state their discount rate we chose to use a 20 year A corporate bond. We used 6.50% discount rate (20 year A corporate bond) to find the total present value for each year. To determine the payment we used the following equation: Beginning operating lease + Interest – Payment = Ending Balance. We arrived at the depreciation amount by dividing the operating leases by 6 years. We determined six years to be an approximate lifespan appropriate for lease amortization. Below is a table demonstrating the process we went through to arrive at the final numbers we used to change the financial statements.
107 | P a g e
0.065 year 2005 2006 2007 2008 2009 2010 0.065 year 2006 2007 2008 2009 2010 2011 0.065 year 2007 2008 2009 2010 2011 2012 0.065 year 2208 2009 2010 2011 2012 2013 0.065 year 2009 2010 2011 2012 2013 2014
Ol payment t 1 2 3 4 5 6 t 1 2 3 4 5 6 t 1 2 3 4 5 6 t 1 2 3 4 5 6 t 1 2 3 4 5 6
5000 3300 2600 2200 2200 3200 Ol payment 30700 3300 2800 2700 2400 1300 Ol payment 37100 5900 4800 4400 2400 700 Ol payment 35300 6600 5400 3400 1800 800 Ol payment 52200 31600 26000 24400 2500 500
108 | P a g e
Loan Amortization Table pv factor 0.938967 0.881659 0.827849 0.777323 0.729881 0.685334
pv payment 4,695 2,909 2,152 1,710 1,606 2,193
pv factor 0.938967 0.881659 0.827849 0.777323 0.729881 0.685334
pv payment 28,826 2,909 2,318 2,099 1,752 891
pv factor 0.938967 0.881659 0.827849 0.777323 0.729881 0.685334
pv payment 34,836 5,202 3,974 3,420 1,752 480
pv factor 0.938967 0.881659 0.827849 0.777323 0.729881 0.685334
pv payment 33,146 5,819 4,470 2,643 1,314 548
pv factor 0.938967 0.881659 0.827849 0.777323 0.729881 0.685334
pv payment 49,014 27,860 21,524 18,967 1,825 343
BB 2005 1 15,266 2006 2 11,258 2007 3 8,690 2008 4 6,654 2009 5 4,887 2010 6 3,005 Loan Amortization Table BB 2006 1 38,834 2007 2 10,658 2008 3 8,051 2009 4 5,774 2010 5 3,450 2011 6 1,274 Loan Amortization Table BB 2007 1 49,663 2008 2 15,791 2009 3 10,917 2010 4 6,827 2011 5 2,871 2012 6 657 Loan Amortization Table BB 2008 1 47,940 2009 2 15,756 2010 3 10,180 2011 4 5,442 2012 5 2,395 2013 6 751 Loan Amortization Table BB 2009 1 119,512 2010 2 75,080 2011 3 48,361 2012 4 25,504 2013 5 2,762 2014 6 441
interest 992 732 565 433 318 195
payment 5,000 3,300 2,600 2,200 2,200 3,200
EB CHANGE IN LOAN Depreciation 11,258 (4,008) 2,544 8,690 (2,568) 2,544 6,654 (2,035) 2,544 4,887 (1,767) 2,544 3,005 (1,882) 2,544 0 (3,005) 2,544
total CL exp 3,537 3,276 3,109 2,977 2,862 2,740
CL-OL (1,463) (24) 509 777 662 (460)
AT diff (1,024) (17) 356 544 463 (322)
interest 2,524 693 523 375 224 83
payment 30,700 3,300 2,800 2,700 2,400 1,300
EB CHANGE IN LOAN Depreciation 10,658 (28,176) 6,472 8,051 (2,607) 6,472 5,774 (2,277) 6,472 3,450 (2,325) 6,472 1,274 (2,176) 6,472 57 (1,217) 6,472
total CL exp 8,997 2,469 1,865 1,338 799 295
CL-OL (21,703) (831) (935) (1,362) (1,601) (1,005)
AT diff (15,192) (582) (654) (954) (1,121) (703)
interest 3,228 1,026 710 444 187 43
payment 37,100 5,900 4,800 4,400 2,400 700
EB CHANGE IN LOAN Depreciation 15,791 (33,872) 8,277 10,917 (4,874) 8,277 6,827 (4,090) 8,277 2,871 (3,956) 8,277 657 (2,213) 8,277 0 (657) 8,277
total CL exp 11,505 3,658 2,529 1,582 665 152
CL-OL (25,595) (2,242) (2,271) (2,818) (1,735) (548)
AT diff (17,916) (1,569) (1,590) (1,973) (1,214) (383)
interest 3,116 1,024 662 354 156 49
payment 35,300 6,600 5,400 3,400 1,800 800
EB CHANGE IN LOAN Depreciation 15,756 (32,184) 7,990 10,180 (5,576) 7,990 5,442 (4,738) 7,990 2,395 (3,046) 7,990 751 (1,644) 7,990 0 (751) 7,990
total CL exp 11,106 3,650 2,358 1,261 555 174
CL-OL (24,194) (2,950) (3,042) (2,139) (1,245) (626)
AT diff (16,936) (2,065) (2,129) (1,498) (872) (438)
interest 7,768 4,880 3,143 1,658 180 29
payment 52,200 31,600 26,000 24,400 2,500 500
EB CHANGE IN LOAN Depreciation 75,080 (44,432) 19,919 48,361 (26,720) 19,919 25,504 (22,857) 19,919 2,762 (22,742) 19,919 441 (2,320) 19,919 (30) (471) 19,919
total CL exp 27,687 24,799 23,062 21,576 20,098 19,947
CL-OL (24,513) (14,206) (14,796) (18,492) (1,860) (398)
AT diff (17,159) (9,944) (10,358) (12,944) (1,302) (278)
Goodwill Upon examination of Intersil’s financial statements, the most immediately noticeable and drastic accounting event was a $1.15 billion expense related to impairment of goodwill in 2008. This caused ISIL to report over a net loss of over a billion in 2008 and resulted in a 52.9% decrease in assets between 2007 and 2008. We noticed that between 2003 and 2004, Intersil increased its goodwill by approximately $387.9 million and between 2004 and 2007 Intersil maintained an average of $1.44 until the massive impairment in 2008. This event is indicative of a “big bath” that we believe might have been the result of Intersil appointing a new CEO during 2008 and the fact that the yearend financial results were already expecting to be poor due the negative effects of the world recession on the analog IC industry. However, we feel that had Intersil been steadily decreasing goodwill in past years, this event might not have been so drastic. After depreciating goodwill over a five year basis, we see that Intersil’s goodwill value rapidly adjusts towards levels that are more representative of its competitors. After allocating goodwill impairment over a 5 year basis, beginning in 2004, the net effect minimizes the drastic impact of an expense of approximately $1.55 billion for the impairment of goodwill during 2008. In order to impair goodwill, we assumed a 5 year life span during which goodwill can be “depreciated” on a straight-line basis. In addition, we assumed that new acquisitions of goodwill are recognized at year-end, hence are not included in the value used for restated adjustment during the fiscal year. The spreadsheet on the following page depicts the procedure we applied to calculate goodwill values.
109 | P a g e
INTERSIL - GOODWILL RESTATEMENT 2004 BB G.W.
1,059,121
Acquisition
375,373
Impair G.W. EB G.W.
2005
2006
1,429,836
1,423,630
2007
-
-
-4660
-6206
1,429,834
1,423,630
2008
1,419,781
1,445,778
29,594
22,781
-3,849
-3,597
-1,154,830
1,419,781
1,445,778
313,729
ASSUME YEAR END ACQUISITION 2004
NEW GOODWILL Original G.W. Impairment
END 2003:
2005
2006
2007 0
29,594
22,781
211,824
211,824
211,824
211,824
211,824
75,075
75,075
75,075
75,075
75,075
-
-
-
-
-
-
-
-
-
5,919
5,919
5,919
5,919
5,919
4,556
4,556
4,556
4,556
2006 2007 2008
SHOULD IMPAIR DID IMPAIR IMPAIRMENT ADJUSTMENT -->
Adjusted Balance G.W. (Prior Add)
ADJUSTED END BALANCE G.W.
110 | P a g e
2013
0
2005
2004
FORECASTING 2011 2012
2010
375,373 2004
2005
TOTAL NEW GW IMPAIR
2009
2008
2006
2007
2008
2009
2010
2014
-
2011
2012
2013
4,556 2014
75,075
75,075
75,075
80,993
85,550
10,475
10,475
10,475
4,556
-
211,824
286,899
286,899
286,899
292,818
85,550
10,475
10,475
10,475
4,556
-
(4,660)
(6,206)
(3,849)
(3,597)
(1,154,830)
-
-
-
-
-
-
207,164
280,693
283,050
283,302
292,818
85,550
10,475
10,475
10,475
4,556
-
847,297
935,771
648,872
361,973
98,750
35,981
25,506
15,031
4,556
(0)
(0)
1,222,670
935,771
648,872
391,567
121,531
35,981
25,506
15,031
4,556
(0)
(0)
FINACIAL STATEMENTS
Income Statement The income statement calculates net income or loss, making it a bridge between the balance sheet and statement of cash flows. Therefore, to construct a foundation for the restatement and forecasting of a firms’ financial statements, there is a need to first forecast and restate the income statement. An accurate forecast of the income is necessary to set the proper trends and assumptions. In order to provide a basis for our forecast, the first step was to analyze and compute the historical sales growth rate for Intersil over the past six years.
INTERSIL Corporation Income Statement
YEAR 2003
2004
2005
2006
2007
2008
Revenue
507,684 535,775 600,255
740,597
756,966
769,675
CGS
221,074 237,155 265,560
315734
325,372
370,274
Gross Profit
286,610 298,620 334,695
424863
431,594
399,401
R&D
91,267 107,430 110,834
126,458
134,374
143,583
SG&A
88,274
90,697
99,788
137,105
131,914
124,281
0
0
0
0
0
-1,154,676
Amort of Unearned Compensation
10,895
10,834
14,109
0
0
0
Impair.(gain) Long-Lived Assets
12,576
26,224
-618
0
0
0
6,298
7,397
9,597
9,468
10,723
12,176
0
31,205
0
0
2,660
3,037
4,887
6,104
2,845
0
0
8,685
-1,428
-901
0
0
0
0
0
3,439
-2,000
0
0
0
Impairment of Goodwill
Amort of Purchases Intangeables In-Process R&D Restructuring/Related Activities (Gain) on sale of certain operations Other losses (gains)
111 | P a g e
Operating Gain (Loss)
73,841
151,832
151,923
-1,047,037
Interest Income, Net
8,958
13,227
18,966
29,711
30,911
14,655
(Loss) gain on certain investments, net
-3,443
3,799
0
-1,367
870
-35,429
OP(L) b/f Tax
79,356
33,217 119,106
180,176
183,704
-1,067,811
Income Tax Expense (Benefit)
20,899
-7,136
32,284
28,828
40,965
-5,309
Income (Loss) from Cont. Ops.
58,457
40,353
86,822
151,348
142,739
-1,062,502
Loss(Inc) DO b/f Income Taxes
19,983
1,092
-1,071
851
-288
0
Income Tax Exp (Benefit) DcOps.
32,603
764
-126
322
1,975
-24,942
Inc (Loss) from DcOps
-12,620
328
-945
529
-2,263
24,942
NET INCOME (LOSS)
45,837
40,681
85,877 151,877 140,476
-1,037,560
112 | P a g e
16,191 100,140
BALANCE SHEET INTERSIL CORPORATION BALANCE SHEET (in Millions)
2003 Current Assets Cash and cash equivalents 190,457 Short-term investments 629,076 Trade receivables, net of allowances 76,713 Inventories 83,631 Prepaid expenses and other current assets 10,468 Deferred income taxes 39,843 Total Current Assets 1,030,188 Non-current Assets
2004 129,700 393,299 77,919 96,450 14,649 43,175 755,192
2005 137,697 417,531 99,791 86,604 11,893 32,849 786,365
Property, plant and equipment, net of accumulated 153,410depreciation101,354 96,610 Purchased intangibles, net of accumulated amortization 39,330 Goodwill 1,090,905 1,478,762 1,423,630 Long-term investments 156,730 179,651 157,139 Deferred income taxes 9,554 68,860 65,862 499 Related party notes Other 7,561 3,751 14,781 Non-Current Assets 1,418,659 1,832,378 1,797,352 TOTAL ASSETS 2,448,847 2,587,570 2,583,717 LIABILITIES AND SHAREHOLDERS’ EQUITY LIABILITIES Current Liabilities Trade payables 27,122 20804 18401 Accrued current and retirement compensation26,082 32,203 24,841 Deferred net revenue 10,961 12,105 11,347 Other accrued expenses 34,391 22,203 4142 Non-income taxes payable 2,976 3,481 49641 Income taxes payable 58,140 83,956 56,211 Total Current Liabilities 154,110 196,730 148,167 Non-current Liabilities Income taxes payable 0 0 0 Total L-T Liabilities 0 0 0 TOTAL LIABILITIES 196,730 148,167 154,110 SHAREHOLDERS' EQUITY 2003 2004 2005 Preferred Stock, $0.01 par value, 2 million shares authorized; no shares issued or outstanding 0 0 0 Class A Common Stock, $.01 par value, voting; 600 million shares authorized; 121,626,122 and 126,990,547 shares issued and outstanding as of Jan. 2, 2009 and Dec. 28, 2007, respectively 1,411 1,393 1,518 Additional paid-in capital 2,312,663 2,246,402 2,553,855 Accumulated deficit/Retained earnings 124,779 40,898 63,103 Unearned compensation -9,455 (8,956) (22,900) Treasury Shares purchases, at cost 0 (29,998) (157,667) Accumulated other comprehensive loss 209 2,378 1,494 Total Shareholders’ Equity 2,252,117 2,439,403 2,429,607 2,252,117 2,439,403 2,429,607 Total Liabilities and Shareholders’ Equity 2,448,847 2,587,570 2,583,717
113 | P a g e
2006
2007
2008
158,938 465,096 98,048 92,413 16,589 18,523 849,607
323,403 160,427 117,421 98,650 9,041 39,543 748,485
215,625 97,008 66,607 109,644 9,467 35,489 533,840
101,121
109,633
112,825
29,863 1,419,781 78,585 67,065 13,105 1,709,520 2,559,127
29,910 1,445,778 19,108 37,455 14,618 1,656,502 2,404,987
29,041 313,729 81,301 46,994 15,860 599,750 1,133,590
24,229 33,433 12,813 19,159 3,170 44,810 137,614
40,234 39,504 10,259 12,676 3,498 19,267 125,438
22,264 30,461 10,638 37,256 3,319 4,012 107,950
0 0
40,670 40670 166,108 2007
0 0
137,614 2006
107,950 2008
0
0
0
1,359 2,171,642 247,217 0 0 1,295 2,421,513 2,421,513 2,559,127
1,270 1,906,179 333,528
1,216 1,797,072 -764,262
0 -2,098 2,238,879 2,238,879 $2,404,987
0 -8,386 1,025,640 1,025,640 1,133,590
RESTATED FINANCIAL STATEMENTS
Trial Balance In order to restate our financial statements to reconcile capitalized research and development, impairment of goodwill, and capitalizing operating leases we first had to create amortization tables for each of these accounts. After forming the amortization tables, we had the necessary financial numbers to begin our restatement of Intersil’s financial statements beginning in 2004. In order to ensure that our restated numbers properly translated into the financial statements, we created a trial balance which depicted the year by year official financial statements, columns for the debits and credits to ensure that we were properly allocating debits and credits related to increasing and decreasing various line items. We then applied the appropriate debits and credits on year by year basis to generate yearly restated financial statements, and carried over values such as accrued goodwill amortization, capitalized research and development, accrued depreciation on capital lease assets, and accrued amortization of lease liabilities. After applying this method, as depicted below, we were able to generate restated income statements and balance sheets for goodwill between 2004 and 2008. We feel that our restated financial statements allow for a more clarified view of Intersil’s financial standpoint. After applying the restated financials to calculate a number of ratios representing firm activities these values significantly gravitated towards industry benchmarks.
114 | P a g e
Trial Balance
2004
INCOME STATEMENTS
Revenue CGS Gross Profit R&D SG&A Less Lease Payment Impairment of Goodwill Amort of Unearned Compensation Impair.(gain) Long-Lived Assets (Added Depr) Amort of Purchases Intangeables In-Process R&D Restructuring/Related Activities (Gain) on sale of certain operations Other losses (gains) Operating Income (Loss) Interest Expense
2005
2004
As Stated 535,775 237,155 298,620 107,430 90,697 10,834 26,224 7,397 31,205 6,104 (901) 3,439 16,191
Debits
Credits
96,687
207,164
Adjusted 535,775 237,155 298,620 10,743 90,697 207,164 10,834 26,224 7,397 31,205 6,104 (901) 3,439 (94,286)
(Gain)/Lossfrom Disc. Ops./Extraordinary/Other
24,490
24,490
NET INCOME (LOSS)
40,681
(69,796)
Trial Balance 429,594 Change in Retained Earnings 110,477
319,117 (110,477)
2006
2005
As Stated
Debits
Credits
600,255 265,560 334,695 118,255 106,476
Adjusted
Carryover
2006
As Stated
Credits
Carryover
(100,825) 32,284 (133,109) 18,966
(945)
(945)
529
529
85,877
(115,088)
151,877
(39,310)
-
5,000 -
280,693
(618) 9,597 2,845 (2,000) 100,140
2,544
100,140 32,284 67,856 18,966
Tr. Balance Change in Retained Earnings
716,778 200,965
612,500
740,597 315,734 424,863 126,458 137,105
Adjusted
(1,367) 150,465 28,828 121,637 29,711
78,265
600,255 265,560 334,695 39,990 106,476 (5,000) 280,693 1,926 9,597 2,845 (2,000) (99,832) 992
Debits
740,597 315,734 424,863 56,299 137,105 (30,700) 283,050 6,472 9,468 (36,831) 2,524 (1,367) (40,722) 28,828 (69,550) 29,711
992
-
115 | P a g e
Carryover
70,159 30,700
9,468 151,832
283,050 6,472
2,524
Tr. Balance Change in Retained Earnings
942,673 191,187
927,901
-
Trial Balance (Cont.) INCO ME STATEMENTS
Revenue CGS Gross Profit R&D SG&A Less Lease Payment Impairment of Goodwill Amort of Unearned Compensation Impair.(gain) Long-Lived Assets (Added Depr) Amort of Purchases Intangeables In-Process R&D Restructuring/Related Activities (Gain) on sale of certain operations Other losses (gains) Operating Income (Loss) Interest Expense
2007
2008
2007
As Stated 756,966 325,372 431,594 134,374 131,914
Debits
Credits
51,992 37,100
10,723 2,660 151,923
283,302 8,277
3,228
Adjusted 756,966 325,372 431,594 82,382 131,914 (37,100) 283,302 8,277 10,723 2,660 (50,564) 3,228
(2,263)
(2,263)
(Gain)/Lossfrom Disc. O ps./Extraordinary/O ther
(11,447)
(11,447)
NET INCOME (LOSS)
140,476
(65,239)
116 | P a g e
2008
As Stated
Debits
769,675 370,274 399,401 143,583 124,281 1,154,676 12,176 3,037 8,685 (1,047,037)
Credits
33,406 35,300 862,012 7,990
3,116
Adjusted 769,675 370,274 399,401 110,178 124,281 (35,300) 292,664 7,990 12,176 3,037 8,685 (124,309) 3,116
(53,792) 40,965 (94,757) -
40,965
Tr. Balance Change in Retained Earnings
Carryover
1,136,955 205,715
1,199,518
9,477
9,477
(1,037,560) Tr. Balance Change in Retained Earnings
(117,949) 1,766,564
3,032,040 919,611
Trial Balance Sheet (Cont.)
2006
2007 As Stated
Carryover
2008
2007 Debits
Credits
Adjusted
Carryover
2008
As Stated
Debits
Credits
Adjusted
Current Assets Cash and cash equivalents
323,403
323,403
215,625
215,625
Short-term investments
160,427
160,427
97,008
97,008
Trade receivables, net of allowances
117,421
117,421
66,607
66,607
98,650
98,650
109,644
109,644
Inventories Prepaid expenses and other current assets Deferred income taxes Total Current Assets
9,041
9,041
9,467
9,467
39,543
39,543
35,489
35,489
748,485
748,485
533,840
533,840
109,633
109,633
112,825
112,825
29,910
29,910
29,041
Non-current Assets Property, plant and equipment, net of accumulated depreciation Purchased intangibles, net of accumulated amortization Capitalized Lease Liabilities
47,940
Accrued Amortization of Lease Liabilites
(9,017)
Capitalized RD
8,277
245,111
Goodwill, , less acc. Amort
770,907
47,940
51,992 1,445,778
1,054,209
29,041 119,512
(17,294)
(17,294)
297,103
297,103
391,569
1,054,209
119,512 7,990
33,406 313,729
862,012
(25,284) 330,509
1,054,209
Long-term investments
19,108
19,108
81,301
81,301
Deferred income taxes Related party notes
37,455
37,455
46,994
46,994
-
-
-
-
Other
14,618
14,618
15,860
15,860
1,656,502
930,043
599,750.00
832,291
2,404,987
1,678,528
1,133,590
1,366,131
Trade payables
40,234
40,234
22,264
22,264
Accrued current and retirement compensation
39,504
39,504
30,461
30,461
Deferred net revenue
10,259
10,259
10,638
10,638
Other accrued expenses
12,676
12,676
37,256
37,256
3,498
3,498
3,319
3,319
19,267
19,267
4,012
4,012
125,438
125,438
107,950
107,950
Non-Current Assets TO TAL ASSETS
330,509
####### #####
NET CAP R&D Current Liabilities
Non-income taxes payable Income taxes payable Total Current Liabilities Non-current Liabilities Income taxes payable
40,670
40,670
Capitalized Lease Liabilities Amortized Lease Liability
47,940 (32,184)
Total L-T Liabilities TO TAL LIABILITIES Common Stock at Par Additional paid-in capital Accumulated deficit/Retained earnings Unearned compensation Treasury Shares purchases, at cost Accumulated other comprehensive loss Total Shareholders’ Equity
TO TAL LIABILITIES & EQ UITY
117 | P a g e
502,629
33,872
-
-
47,940 (66,055)
119,512 (66,055)
32,184
119,512
(98,239)
(32,184)
40,670
22,554
166,108
147,992
107,950
1,270
1,270
1,216
1,216
1,906,179
1,906,179
1,797,072
1,797,072
333,528 -
708,344
(374,816)
-
119,512
708,344
(764,262)
21,273 129,223
708,344
919,611
(552,994)
-
-
-
-
-
(2,098)
(2,098)
(8,386)
(8,386)
2,238,879
1,530,535
1,025,640
1,236,908
2,404,987
1,678,528
1,133,590
1,366,131
Intersil: Restated Income Statement 2004
2005
2006
2007
2008
Revenue 535,775 CGS 237,155 Gross Profit 298,620 R&D 10,743 SG&A 90,697 Less Lease Payment Impairment of Goodwill 207,164 Amort of Unearned Compensation 10,834 Impair.(gain) Long-Lived Assets (Added Depr)26,224 Amort of Purchases Intangeables 7,397 In-Process R&D 31,205 Restructuring/Related Activities 6,104 (Gain) on sale of certain operations (901) Other losses (gains) 3,439 Operating Income (Loss) (94,286) Interest Expense -
600,255 265,560 334,695 39,990 106,476 (5,000) 280,693 1,926 9,597 2,845 (2,000) (99,832) 992 (100,825) 32,284 (133,109) 18,966 (945)
740,597 315,734 424,863 56,299 137,105 (30,700) 283,050 6,472 9,468 (36,831) 2,524 (1,367) (40,722) 28,828 (69,550) 29,711 529
756,966 325,372 431,594 82,382 131,914 (37,100) 283,302 8,277 10,723 2,660 (50,564) 3,228 (53,792) 40,965 (94,757) (2,263)
769,675 370,274 399,401 110,178 124,281 (35,300) 292,664 7,990 12,176 3,037 8,685 (124,309) 3,116 -
(Gain)/Lossfrom Disc. Ops./Extraordinary/Other 24,490 NET INCOME (LOSS) (69,796)
(115,088)
(39,310)
(11,447) (65,239)
9,477 (117,949)
118 | P a g e
Intersil: Restated Balance Sheet 2004
Fiscal Year
2005
2006
2007
2008
Current Assets Cash and cash equivalents
129,700
137,697
158,938
Short-term investments
393,299
417,531
465,096
160,427
97,008
Trade receivables, net of allowances
77,919
99,791
98,048
117,421
66,607
Inventories
96,450
86,604
92,413
98,650
109,644
Prepaid expenses and other current assets
14,649
11,893
16,589
9,041
9,467
Deferred income taxes
43,175
32,849
18,523
39,543
35,489
Total Current Assets
755,192
786,365
849,607
323,403
748,485
215,625
533,840
Non-current Assets Property, plant and equipment, net of accumulated depreciation
101,354
96,610
101,121
109,633
39,330
29,863
29,910
29,041
15,266
38,834
49,663
47,940
119,512
(17,294)
(25,284)
96,687
174,952
245,111
297,103
330,509
1,271,598
935,773
648,874
391,569
121,532
Purchased intangibles, net of accumulated amortization Leased Asset Rights (Capitalized Lease Liability)(less accum depr) Accumulated Depreciation of Operating Lease Asset Rights Capitalized RD
Goodwill, , less acc. Amort
(2,544)
(9,017)
112,825
Long-term investments
179,651
157,139
78,585
19,108
81,301
Deferred income taxes Related party notes
68,860
65,862 -
67,065 -
37,455 -
46,994 -
Other
3,751
Non-Current Assets
14,781
13,105
14,618
15,860
1,737,166
1,520,736
1,224,370
930,043
832,291
2,492,358
2,307,101
2,073,977
1,678,528
1,366,131
Trade payables
18,401
27,122
24,229
40,234
22,264
Accrued current and retirement compensation
24,841
32,203
33,433
39,504
30,461
Deferred net revenue
11,347
10,961
12,813
10,259
10,638
Other accrued expenses
34,391
22,203
19,159
12,676
37,256
2,976
3,481
3,170
3,498
3,319
56,211
58,140
44,810
19,267
TOTAL ASSETS NET CAP R&D
Current Liabilities
Non-income taxes payable Income taxes payable
Total Current Liabilities
148,167
154,110
137,614
125,438
38,834
49,663
47,940
4,012
107,950
Non-current Liabilities Income taxes payable Capitalized Lease Liabilities Amortized Lease Liability
Total L-T Liabilities TOTAL LIABILITIES Common Stock at Par Additional paid-in capital
Accumulated deficit/Retained earnings Unearned compensation Treasury Shares purchases, at cost Accumulated other comprehensive loss
Total Shareholders’ Equity
TOTAL LIABILITIES & EQUITY
119 | P a g e
15,266 -
40,670 (4,008)
(32,184)
(66,055)
119,512 (98,239)
15,266
34,826
17,479
22,554
21,273
163,433
188,936
155,093
147,992
129,223
1,518
1,411
1,359
1,270
1,216
2,553,855
2,312,663
2,171,642
1,906,179
1,797,072
(47,374)
(186,663)
(255,412)
(374,816)
(552,994)
(22,900)
(9,455)
(157,667) 1,494
209
-
-
-
-
-
1,295
(2,098)
(8,386)
2,328,926
2,118,165
1,918,884
1,530,535
1,236,908
2,492,358
2,307,101
2,073,977
1,678,528
1,366,131
Statement of Cash Flows The last statement forecasted is the Statements of Cash Flows. The statement of cash flows is the hardest statement to forecast due to its volatility and unreliability to forecast from year to year. Within the statement of cash flows it consists of cash flows from operating activities (CFFO), investing activities (CFFI), and financing activities (CFFF). The statement of cash flows turns out to be very volatile which means it is not to reliable; although the statements of cash flows may not be reliable it is important to forecast the statement for investors.
The first step in forecasting the statements of cash flows is forecasting the cash flows from operating activities. There are actually a couple of ways this could be done. The first step is to compute these ratios: CFFO/Sales, CFFO/Operating Income (OI), or CFFO/Net Income (NI). After computing these ratios we found that the most consistent data came from CFFO/Sales. We averaged CFFO/Sales for 6 years starting from 2003 and then took the average for CFFO/Sales came out to be .26 or 26%. With this ratio of 26% we multiplied it to the forecasted sales for the next ten years to get our forecast for cash flows from operations.
The next step we took after forecasting the cash flows from operating activities was to forecast the cash flows from investing activities. To do this we decided to use our PP&E turnover ratio. This was because we found that PP&E had the least change throughout the years. The PP&E turnover ratio on average was .1755 or 17.55%. After finding the ratio we took the forecast sales for Intersil and multiplied it to .1755. The CFFI was very hard to predict to the volatility of the CFFI in the past years.
The last step to forecast in the cash flow statements is to forecast dividends under the cash flows from financing activities. To forecast the dividends we analyzed the past six years of dividends. Intersil Corp. has been increasing dividends very steadily throughout the 120 | P a g e
years. We stated the quarterly dividends to remain at $.12 per share for the next three years. As of right now the economy is in a recession and we believe it will take a while for the technology industry to advance which was the reason to leave the quarterly dividends at $.12 per share for 3 years. After that we forecasted that quarterly dividends to increase 2 cents per share every 2 years. The chart below shows the forecasting for the dividends over the next 10 years. Dividend Forecast
Dividends /share Yearly dividends/share Shares outstanding(in thousands) Dividends paid (in thousands)
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
0.12
0.12
0.12
0.14
0.14
0.16
0.16
0.18
0.18
0.2
0.48
0.48
0.48
0.56
0.56
0.64
0.64
0.72
0.72
0.8
121,679
121,679
121,679
121,679
121,679
121,679
121,679
121,679
121,679
121,679
58405.92
58405.92
58405.92
68140.24
68140.24
77874.56
77874.56
87608.88
87608.88
97343.2
121 | P a g e
INTERSIL CORPORATION: STATEMENT OF CASH FLOWS
Actual Financials 2003
Fiscal Year
Net income (loss) from continuing operations Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization Provisions for inventory obsolescence Impairment of goodwill Other loss Write-off of in-process research and development Restructuring and impairments Gain on sale of certain operations Gain on sale of certain investments Gain on sale of equipment Deferred income taxes Net income (loss) from discontinued operations Adjustments to reconcile net income (loss) to net cash provided by operating activities: Gain on sale of Wireless Networking Segment Other adjustments
2004
Forecast Financial Statements 2005
2006
2007
2008
45,837
40,681
85,877
151,877
140,476
46,471
36,332
34,437
31,880 -
31,172 -
34,761 1,154,676 2,115
1,870
11,538 7,607 3,005 3,439
15,181 12,156 3,295 -
48,056 33,140
44,296 2,660 20,728
30,787 3,037 6,274
31,205 32,328 (901) (3,799) (725) 2,622 328
2,227 15 12,400 (945)
(9,802) 5,165 7,732 529 1,892
(7,840) 5,944 3,380 (2,263) -
(931) 26,162 (3,087) 24,942 31,797
(493)
(2,091)
1,743 (10,500) (1,461) (3,235) (22,760) 2,758
(18,707) (9,620) 3,250 4,043 15,148 (451)
51,074 (35,846) (1,240) (3,370) (55,925) 1,087
53,816 10,653 (1,264) 3,920 18,326
12,208
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
102,533
113,104
124,765
137,628
151,818
167,470
184,736
203,782
224,792
247,968
101,835
114,055
124,320
135,508
147,704
160,997
175,487
191,281
208,496
227,261
compute PPE with a ppe TURNOVER RATIO then fc ppe multiple change in ppe by 7.5 to get CFFI (354,673) 58,982 49,545
(1,037,560)
87
Changes in operating assets and liabilities: Trade receivables Gain on sale of Wireless Networking product group Inventories Prepaid expenses and other current assets Trade payables and accrued liabilities Income taxes Other Net assets held for sale
(22,911) 6,225 3,702 2,391 2,699 5,319 (18,729)
3,815 (7,900) (9,831)
(21,872) 6,550
(5,912) (23,711) (26,935) 5,500
1,646 1,996 243 (1,116)
Net cash provided by operating activities
101,400
98,358
153,035
235,992
232,388
203,898
20% 137.322% 221.2187%
18% 607.486% 241.7787%
25% 152.821% 178.2025%
32% 155.430% 155.3836%
31% 152.964% 165.4290%
26% -19.474% -19.6517%
CFFO/Sales CFFO/Op Inc CFFO/Net Inc
2003 INVESTING ACTIVITIES: Proceeds from sale of short-term investments Purchases of short-term investments Purchases of held-to-maturity securities Held-to-maturity securities called by issuer
2004
5,560 -
Proceeds from sale of Wireless Networking product group, netProceeds from sale of available-for-sale equity investments Cash paid for acquired businesses Purchase of Xicor, net of cash received Purchase of Bitblitz Communications Purchase of cost method investments
Property, plant and equipment for discontinued operations Proceeds from sale of property, plant and equipment Purchase of property, plant and equipment
5,264 (24,026) -
2005
658,508 1,000,636 (411,319) (1,143,301)
2006
2007
657,810 (694,147) 10,000 156,567 (11,275) -
759,985 (535,250) 85,471 88,136 -
29,275 (2,500) 2,000 9,911 (80,000) -
(88,384) -
(36,171) (47,995) -
(47,955) -
-
-
-
5,904 (24,109)
123 (31,873)
56,175 (80,592) 237,513
211,563 (93,130) (23,953)
156,652 (147,979) (3,042) (240,568) -
49,745 (37,964) (235,980) 408 (2,602) (3,042)
(23,953) 6,422 (6,022)
(1,503) 5,626 (24,007)
(2,716) 1,419 (31,087)
(35,719)
(31,927)
(1,813)
2008
Net cash used in investing activities
(6,386) (46,606) - - - - - (66,194)
SALES/PPE
3.309327945 5.286175188 6.21317669 7.323869424 6.904545164 6.821847995
Change in NC Assets Change in PPE important stuff multiplier
2003 FINANCING ACTIVITIES: Proceeds from exercise of stock-based awards
Effect of exchange rates on cash and cash equivalents Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at the beginning of the period Cash and cash equivalents at the end of the period
2004
2005
87,832 (4,511) (31,087) 6.89 2006
53,018 (8,512) (72,104) 8.47 2007
AVG 5.97649 Forecasted PPE Change in PPE Multiply by 7.5
54,004
58,864
64,162
69,936
76,231
83,091
90,570
65,535 (47,290) (354,673)
73,400 7,864 58,982
80,006 6,606 49,545
87,206 7,200 54,004
95,055 7,849 58,864
103,609 8,555 64,162
112,934 9,325 69,936
123,098 10,164 76,231
134,177 11,079 83,091
146,253 12,076 90,570
(58406)
(58406)
(58406)
(68140)
(68140)
(77875)
(77875)
(87609)
(87609)
(97343)
1,056,752 (3,192) (79,828) 25.01
2008 CFFI FC
21,568
40,455
92,552
-
(18,476)
(24,202)
9,802 7,827 (29,439)
7,840 (53,440)
931 (59,823)
(18,565)
(127,670)
(127,750)
(294,995)
(434,990)
(154,998)
(9,187)
(124,578)
(111,497) 2005
(214,253) 2006
(364,891) 2007
(191,724)
(1,614) 7,997 129,700 137,697
1,315 21,241 137,697 158,938
997 164,465 158,938 323,403
1,067 (107,778) 323,403 215,625
Excess tax benefit received on exercise of stock-based awards Proceeds from exercise of warrants Dividends paid
Net cash used in financing activities
35,026 4,744 (24,007)
(121,019)
9,378
122 | P a g e
Repurchase of outstanding common shares
(413,719) 52,056 (9,064)
295,971
2003
2004
1,690 27,709 259,042 286,751
1,182 (60,757) 190,457 129,700
115,699
22,166
2008
Restated Statement of Cash Flows The restated statement of cash flows shows almost no change in values. The only restatement done is the Net Income because sales have not changed. The restated cash flows look very similar to the cash flows statement. The net income has been lowered which lowers the cash flow operations. To find the new cash flow operations we found the difference between the net incomes for each year. We then took that number and subtracted that number by the cash flow operations from the statement of cash flows. This gave us our restated cash flow operations. To forecast the CFFO we used the CFFO/Sales which was 26% to multiply this to the forecasted sales for 10 years.
123 | P a g e
INTERSIL CORPORATION: RESTATED STATEMENT OF CASH FLOWS
Actual Financials Fiscal Year
Net income (loss) from continuing operations Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization Provisions for inventory obsolescence Impairment of goodwill Other loss Write-off of in-process research and development Restructuring and impairments Gain on sale of certain operations Gain on sale of certain investments Gain on sale of equipment Deferred income taxes Net income (loss) from discontinued operations Adjustments to reconcile net income (loss) to net cash provided by operating activities: Gain on sale of Wireless Networking Segment Other adjustments
2004
Forecast Financial Statement 2005
2006
2007
2008
(69,796)
(115,088)
(39,310)
(65,239)
(117,949)
36,332
34,437
31,880 -
31,172 -
34,761 1,154,676 2,115
11,538 7,607 3,005 3,439
15,181 12,156 3,295 -
48,056 33,140
44,296 2,660 20,728
30,787 3,037 6,274
31,205 32,328 (901) (3,799) (725) 2,622 328
2,227 15 12,400 (945)
(9,802) 5,165 7,732 529 1,892
(7,840) 5,944 3,380 (2,263) -
(931) 26,162 (3,087) 24,942 31,797
(493)
(2,091)
3,815 (7,900) (9,831)
(21,872) 6,550
(5,912) (23,711) (26,935) 5,500
1,646 1,996 243 (1,116)
1,743 (10,500) (1,461) (3,235) (22,760) 2,758
(18,707) (9,620) 3,250 4,043 15,148 (451)
(12119.20)
(47929.74)
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
102,533
113,104
124,765
137,628
151,818
167,470
184,736
203,782
224,792
247,968
101,835
114,055
124,320
135,508
147,704
160,997
175,487
191,281
208,496
227,261
87
Changes in operating assets and liabilities: Trade receivables Gain on sale of Wireless Networking product group Inventories Prepaid expenses and other current assets Trade payables and accrued liabilities Income taxes Other Net assets held for sale Net cash provided by operating activities
2004 INVESTING ACTIVITIES: Proceeds from sale of short-term investments Purchases of short-term investments Purchases of held-to-maturity securities Held-to-maturity securities called by issuer Proceeds from sale of Wireless Networking product group, net
Proceeds from sale of available-for-sale equity investments Cash paid for acquired businesses Purchase of Xicor, net of cash received Purchase of Bitblitz Communications Purchase of cost method investments
Property, plant and equipment for discontinued operations Proceeds from sale of property, plant and equipment Purchase of property, plant and equipment Net cash used in investing activities SALES/PPE
Change in NC Assets Change in PPE important stuff multiplier
1,000,636 (1,143,301)
56,175 (80,592) 237,513
211,563 (93,130) (23,953)
156,652 (147,979) (3,042) (240,568) -
49,745 (37,964) (235,980) 408 (2,602) (3,042)
(23,953) 6,422 (6,022)
(1,503) 5,626 (24,007)
Excess tax benefit received on exercise of stock-based awards Proceeds from exercise of warrants Dividends paid
2006
26673.18
2007
1123509.44
2008
657,810 (694,147) 10,000 156,567 (11,275) -
759,985 (535,250) 85,471 88,136 -
29,275 (2,500) 2,000 9,911 (80,000) -
(88,384) -
(36,171) (47,995) -
(47,955) -
-
-
-
(2,716) 1,419 (31,087)
5,904 (24,109)
123 (31,873)
(413,719) 52,056 (9,064)
35,026 4,744 (24,007)
2005
87,832 (4,511) (31,087) 6.89 2006
53,018 (8,512) (72,104) 8.47 2007
49,545
54,004
58,864
64,162
69,936
76,231
83,091
90,570
65,535 (47,290) (354,673)
73,400 7,864 58,982
80,006 6,606 49,545
87,206 7,200 54,004
95,055 7,849 58,864
103,609 8,555 64,162
112,934 9,325 69,936
123,098 10,164 76,231
134,177 11,079 83,091
146,253 12,076 90,570
(58406)
(58406)
(58406)
(68140)
(68140)
(77875)
(77875)
(87609)
(87609)
(97343)
1,056,752 (3,192) (79,828) 25.01
2008 CFFI FC
21,568
40,455
92,552
115,699
22,166
124 | P a g e
(18,476)
(24,202)
9,802 7,827 (29,439)
7,840 (53,440)
931 (59,823)
Repurchase of outstanding common shares
(127,670)
(127,750)
(294,995)
(434,990)
(154,998)
Net cash used in financing activities
(124,578)
(111,497) 2005
(214,253) 2006
(364,891) 2007
(191,724)
(1,614) 7,997 129,700 137,697
1,315 21,241 137,697 158,938
997 164,465 158,938 323,403
1,067 (107,778) 323,403 215,625
2004 Effect of exchange rates on cash and cash equivalents Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at the beginning of the period Cash and cash equivalents at the end of the period
compute PPE with a ppe TURNOVER RATIO then fc ppe multiple change in ppe by 7.5 to get CFFI (354,673) 58,982
(35,719) (31,927) (1,813) 295,971 (121,019) AVG 3.492438563 5.922361229 7.66584205 5.298355436 5.475130663 5.976490401 Forecasted PPE Change in PPE Multiply by 7.5
2004 FINANCING ACTIVITIES: Proceeds from exercise of stock-based awards
2005
658,508 (411,319)
44805.07
51,074 (35,846) (1,240) (3,370) (55,925) 1,087
1,182 (60,757) 190,457 129,700
2008
Financial Ratio Analysis and Forecasting The financial analysis portion compares companies of a set industry in order to test their liquidity, profitability, capital structure, and risk of bankruptcy. By using ratios, we are able to compare firms in the same industry regardless of their size. Also, by analyzing liquidity, profitability, and capital structure ratio over a period of 5 years, creditors, investors, and financial analyst are able to observe industrial trends, as well as yearly discrepancies. As well as testing the liquidity, profitability, capital structure, and risk of bankruptcy of the firm, this section we will forecast the future outlook of the firm for the next 10 years in for both the as stated and restated financial statements.
Liquidity Ratios Liquidity ratios measure the cash resources that are available for a firm to sustain its current financial obligations. Liquidity ratios are indicators of how easily a firm can convert assets in to cash in order to finance short term debt. Firms should maintain the ability to pay off their current debt through having higher liquidity ratios. Lower liquidity ratios demonstrate that a firm in struggling to pay off its current portion of debt. However, a firm risks being too liquid and missing out on opportunities to make more money by having too much cash on hand instead of re-investing it into the firm.
Current Ratio The current ratio is calculated by dividing current assets over current liabilities in order to test the firm’s ability to pay off its short term debt, in particular its bills and debt required to keep running day to day operations using only its short term assets. Because current liabilities are paid off in one year, the best way to pay off the liabilities is by with current assets a firm has on hand by the end of the year. Current assets will be turned into cash, or cash equivalents, within one year, so the best it is the best 125 | P a g e
indicator of the firm’s ability to pay off its short term debt. The higher the current ratio, the more current assets it has to cover current liabilities and the more liquid the firm is. This makes it easier for them to pay off their short term debt. Different types of firms have different current ratios. For instance manufacturers would have a lower ratio than those firms that outsource. This is because they have higher plant property an equipment, as well as inventory, raw materials, and storage cost. Bankers like to see a current ratio of over 2, so they can prove the likely-hood that the companies that they loan to have enough money to pay it back.
Current Ratio 12.00 10.00 ISIL 8.00
TXN
6.00
ADI
4.00
LLTC MXIM
2.00
Industry
0.00 2004
2005
2006
2007
2008
As the chart above describes, the Analog ICs industry’s current ratio generally stays between 4 to 6. This means that for every dollar of short term debt, the firms have 4 to 6 dollars or resources on hand. The high ratio can be attributed to the fact that firms in the Analog ICs industry outsource most of their production, cutting back on people cost and short term liabilities. Also, firms have just-in-time inventory with some of the suppliers that they have a long term relationship with, so this cuts down on inventory cost, lowering their total current liabilities cost, raising the current ratio. (ADI 10-K)
126 | P a g e
LLTC’s current ratio is consistently higher than the rest of the industry. This can because the even though we classified the industry as Analog ICs, the industry is still segmented and not every company is a perfect competitor. LLTC sharp decline in 2007 was due to a 1.2 billion dollar cut in cash and short term investments from 2006. Meanwhile, they also cut back on other current liabilities but it was not by as substantial of amount as the cut from cash and short term investments were.
ISIL TXN ADI LLTC MXIM Industry
2004 5.10 5.27 6.07 9.04 4.95 6.09
Current Ratio 2005 2006 2007 5.10 6.17 5.97 3.92 3.78 3.42 4.56 6.13 3.61 9.66 8.77 4.79 5.66 4.15 4.55 5.78 5.80 4.47
2008 4.95 3.78 3.67 7.11 4.88 4.88
5 yr AVG 5.46 4.03 4.81 7.87 4.84 5.40
Quick Asset Ratio The quick asset, also called the acid-test ratio, test the liquidity of the firm much like the quick ratio. The difference is that inventories are subtracted from the current assets before they are divided by current liabilities. This takes the sales process out of the ratio, because it does not include inventory which may not be a for-sure sale, so inventory may not be completely liquid. Again a greater ratio indicates that the firm is more liquid and can pay off its short term debt easier with a higher ratio than a lower ratio.
127 | P a g e
Quick Asset Ratio 10.00 9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00
ISIL TXN ADI LLTC MXIM Industry 2004
2005
2006
2007
2008
As the chart above indicates, the industry is moving down from around a 4-5 ratio meaning for every dollar of debt they have 4-5 dollars to pay it off, down to between 2 to 4 ratio. This could be because inventory was inflating the industry’s current ratio. In the past year, there was a decline in sales, so inventory and storage increased, increasing the quick ratio not the current ratio. Because inventory management is a part of the cash to cash cycle, the drop in the ratio represents lack of operating efficiency, reducing the liquidity of the industry. Again as previously stated, LLTC ratios are substantially greater than the rest of the industry indicating that it remains more liquid than other firms of the Analog ICs industry. Because they consistently require more cash-on-hand, their business needs requires LLTC to stay more liquid, showing diversification and segmentation through the Analog ICs industry.
ISIL TXN ADI 128 | P a g e
2004 4.06 4.18 5.24
Quick Asset Ratio 2005 2006 2007 4.25 5.25 4.79 3.05 2.64 2.30 3.70 5.01 2.56
2008 3.51 2.25 2.86
5 yr AVG 4.37 2.89 3.87
LLTC MXIM Industry
8.57 4.06 5.22
9.23 4.72 4.99
8.33 3.32 4.91
4.25 3.39 3.46
6.44 3.56 3.72
7.36 3.81 4.46
Accounts Receivables Turnover Accounts receivable turnover measures how many turns in the business cycle it takes to collect accounts receivable after sales. This is an important factor in the cash to cash cycle because the quicker the receivables are paid, the faster the firm receives money and the faster they can invest that money back into financing operations. The larger the ratio, the more turns it takes to collect receivables, and the longer the cash to cash cycle.
Accounts Receivables Turnover 16.0 14.0 12.0
ISIL
10.0
TXN
8.0
ADI
6.0
LLTC
4.0
MXIM
2.0
Industry
0.0 2004
2005
2006
2007
2008
As shown above, the industry started with ratios ranging from 7 to 12, then condensed to in between 6 and 8, indicating that they firms in the industry took longer to collected their money. The chart above also displays an upturn in the accounts receivable turnover in 2008, due to the bad economy. When economic troubles hit,
129 | P a g e
firms needed cash, so they started collecting their accounts receivables at a faster rate. This makes the industry more liquid, because they are collecting money faster.
ISIL TXN ADI LLTC MXIM Industry
2004 0.9 1.5 0.9 0.5 1.1 1.0
Working Capital Turnover 2005 2006 2007 2008 0.9 1.0 1.2 1.8 2.0 2.5 2.8 2.9 0.8 0.9 1.7 1.7 0.6 0.6 1.6 1.1 1.0 1.2 1.2 1.3 1.1 1.2 1.7 1.8
5 yr AVG 1.2 2.3 1.2 0.9 1.2 1.4
Days Sales Outstanding Days in sales outstanding, calculated by dividing 365 by accounts receivable, represents the number of days money was tied up after the initial sale was made. The more days, the longer it takes for firms to collect their accounts receivable. The fewer days, the shorter amount of time it takes for firms to collect money. This ratio essentially takes the accounts receivable turnover ratio and converts it from business cycles to days.
130 | P a g e
Days Sales Outstanding 70.0 60.0 ISIL
50.0
TXN
40.0
ADI
30.0
LLTC
20.0
MXIM
10.0
Industry
0.0 2004
2005
2006
2007
2008
Similar to the accounts receivable ratio, the industry did not follow strict collection polices before 2007. The industry shifted down from 2007 to 2008, as the industry tightened their belt, enforcing collection policies to maintain cash flow. This coincides with the accounts receivables turnover results, showing a 2008 industrial shift due to economic conditions. The decline in sales outstanding represents the industry becoming more liquid.
ISIL TXN ADI LLTC MXIM Industry
2004 53.1 49.2 45.8 36.2 29.8 42.8
Days Sales Outstanding 2005 2006 2007 60.7 48.3 56.6 49.4 45.4 46.0 49.0 53.4 48.6 27.5 42.0 52.0 39.1 41.5 47.7 45.1 46.1 50.2
2008 31.6 26.7 44.6 40.5 48.4 38.4
5 yr AVG 50.1 43.3 48.3 39.7 41.3 44.5
Inventory Turnover Inventory turnover represents how many times a year a firms inventory has to be completely replaced. This ratio is derived through dividing a firm’s cost of goods sold by the firm’s inventory. The more times inventory has to be replaced, the more sales 131 | P a g e
are being made since sales create need for inventory, and so a higher inventory turnover represents greater efficiency. If sales are not increasing, a higher ratio would indicate that the firm is not properly managing its inventory and is over-ordering inventory. Lower inventory turnover represents that a firm is not making as many sales and having trouble turning over inventory. If sales decline while the firm has a substantial amount of inventory on hand, they become less liquid, having a more difficult time converting inventory into cash.
Inventory Turnover 7.0 6.0 ISIL
5.0
TXN
4.0
ADI
3.0
LLTC
2.0
MXIM
1.0
Industry
0.0 2004
2005
2006
2007
2008
The chart above describes the industry moving towards a ratio between 3 and 5. For some firms this represents less efficiency and for other this represents more. As shown in the five forces analysis the Analog ICs industry is a competitive market in an economy of scale. Because the Analog ICs industry has become a competitive market with economies of scale, other firms are stealing customers from other leading firms to rise up and these leading firms are losing sales bring down their inventory turnover. Because the number is decreasing across the industry, the Analog ICs industry is less liquid than it was in previous years.
132 | P a g e
ISIL TXN ADI LLTC MXIM Industry
2004 2.6 5.5 3.1 5.8 4.1 4.2
Inventory Turnover 2005 2006 2007 2.5 3.1 3.4 5.5 4.9 4.6 3.1 2.3 2.9 6.4 6.1 4.7 2.8 3.0 3.0 4.0 3.9 3.7
2008 3.3 4.5 3.2 4.8 3.0 3.8
5 yr AVG 3.0 5.0 2.9 5.6 3.2 3.9
Days Supply Inventory Days supply of inventory represents the number of days that a firm has on hand in inventory. Ideally lower days supplied in inventory represent that the firm is operating more efficiency. With lower days in inventory, the firm is not suffering from excess inventory cost, reducing the productivity of the firm. Also, with more days in inventory, the more days it takes the firm to complete the cash to cash cycle, so a lower days supply inventory is better than a higher days supply inventory. A significant change in this ratio would be one day or greater, anything less is inconsequential.
Days Supply Inventory 180.0 160.0 140.0
ISIL
120.0
TXN
100.0
ADI
80.0 60.0
LLTC
40.0
MXIM
20.0
Industry
0.0 2004
133 | P a g e
2005
2006
2007
2008
As the chart above shows, the firms in the industry had a wide range of days of inventory, (ADI having some jumps in 2006 due to backlog) as the economy increased the demand for electronic goods requiring ICs. However, in 2007 and 2008, the industry focused in on having between 80-120 days supply of inventory. In order to maintain profitability, firms had to limit the amount of inventory taking up overhead space. The more the firms have to store, the more money they have to pay. In order to cut production cost during the recession, firms found a competitive numbers of days of inventory, and maintained it for the past 2 years. Intersil generally kept more days supply of inventory than its competitors. However, in order to stay competitive, Intersil followed this industrial trend, cutting their amount of inventory on hand by nearly one month over the past 5 years.
ISIL TXN ADI LLTC MXIM Industry
2004 138.1 65.9 117.7 63.0 89.5 94.9
Days Supply Inventory 2005 2006 2007 148.4 119.0 106.8 66.1 75.0 80.0 118.1 161.4 123.8 57.2 59.8 77.2 130.9 120.5 121.0 104.1 107.1 101.8
2008 110.7 80.2 114.2 76.6 122.1 100.8
5 yr AVG 124.6 73.5 127.0 66.7 116.8 101.7
Cash to Cash Cycle (Days) Derived by adding up the days in sales and the days supplied in inventory, the cash to cash cycle represents the amount of days that it takes to convert a dollar inputted into the business back into revenue. Similar to the previous ratios, a smaller cash to cash cycle indicates that a firm is operating more efficiently than a firm that takes longer to make the dollar back. The cycle starts when a firm builds or buys new inventory, then sells them to the customers, some with cash and some with accounts receivable. After the accounts receivables are issued, the cycle ends when the cash is 134 | P a g e
collected from the accounts receivable. That money is then put back into the cycle by buying more materials/inventory. Firms can become more liquid by shortening the cycle, receiving money faster, and more times a year.
Collect Accounts Recievable
Money Enters The Cycle
Issue Accounts Receivable
Build/Buy Inventory
Sell to Customers
Cash to Cash Cycle 250.0 200.0
ISIL TXN
150.0
ADI 100.0
LLTC MXIM
50.0
Industry 0.0 2004
2005
2006
2007
2008
The chart above indicates that in recent years the industry has tightened up its cash to cash cycle to become more liquid. The cycle ranges from around 100 days to 135 | P a g e
170, meaning that it takes a firm 100 days since a dollar was input to receive their dollar of sales. This also means that firms in the Analog ICs industry complete this cycle 2-3 times a year. The more rotations in this cycle, the more a firm is producing and selling, and the more liquid the firm is. Again, Intersil followed industrial trends reducing its cash to cash cycle by nearly a month.
ISIL TXN ADI LLTC MXIM Industry
2004 191.2 115.1 163.5 99.2 119.4 137.7
Cash to Cash Cycle (Days) 2005 2006 2007 209.1 167.4 163.5 115.5 120.4 126.0 167.1 214.8 172.4 84.7 101.8 129.2 170.0 162.0 168.7 149.3 153.3 152.0
2008 142.3 106.9 158.7 117.1 170.5 139.1
5 yr AVG 174.7 116.8 175.3 106.4 158.1 146.3
Working Capital Turnover Computed by sales divided by working capital (working capital being current assets minus current liabilities, this ratio measures how efficiently a firm’s dollar is working for them (bang for their buck) Working capital represents a company’s investment in the cash to cash cycle, so a high ratio indicates that a company is using its working capital efficiently to generate revenue.
136 | P a g e
Working Capital Turnover 3.5 3.0 ISIL
2.5
TXN
2.0
ADI
1.5
LLTC
1.0
MXIM
0.5
Industry
0.0 2004
2005
2006
2007
2008
The chart above described the industries trend to achieve a more efficient working capital in generating revenue. TXN does this better than the rest of the industry, again showing the segmentation of the Analog ICs industry. TXN brand recognition among calculator, having nearly every student own one, make it easy to understand that TXN sales to working capital ratio could be greater than the rest of the competitors.
ISIL TXN ADI LLTC MXIM Industry
2004 0.9 1.5 0.9 0.5 1.1 1.0
Working Capital Turnover 2005 2006 2007 2008 0.9 1.0 1.2 1.8 2.0 2.5 2.8 2.9 0.8 0.9 1.7 1.7 0.6 0.6 1.6 1.1 1.0 1.2 1.2 1.3 1.1 1.2 1.7 1.8
5 yr AVG 1.2 2.3 1.2 0.9 1.2 1.4
Conclusion To summarize, Intersil typically stays about as liquid as the rest of the Analog IC’s industry or slightly below. They typically take longer in their cash to cash cycle, 137 | P a g e
however, over the past five years they have cut that cycle down by nearly a month. Though they are on the bottom end of the industrial average, they are generally improving their ratios, making Intersil more liquid throughout the years.
Profitability Ratios Profitability ratios link numbers from the firm’s balance sheet, income statement, and statement of cash flows in order to assess the profitability of the firm. Generally speaking, the greater the profitability ratio, the more profitable the firm is. While the liquidity ratios tested the firm’s ability to pay off its current debt and financial responsibilities. Profitability ratios test the relationship between a firm’s revenue and expenses, and determine how profitable the firm’s operations are. This section also test the firm’s potential growth rates as well as its danger of bankruptcy. The ratios that are included in the profitability analysis are gross profit margin, operating profit margin, net profit margin, asset turnover, return on assets, and return on equity, internal growth rate, sustainable growth rate and Altman’s z scores. By comparing these ratios to the firm’s competitors, we are able to grasp any industrial trends that may occur, explaining alterations in the ratios.
Gross Profit Margin Derived by dividing gross profit by sales, a higher gross profit margin indicates a more profitable firm. Gross profit minus selling, general and administrative cost gives the firms operating income, which after more deductions gives the firms net income. By having a greater gross profit to begin with, a firm has a greater possibility of deriving a larger net income. This ratio is also important because gross profit is sales minus cost of goods sold, so the higher the ratio, the more efficiently a firm can cover its fixed and variable cost, or overhead cost. It is important to determine how firms relate to their competitor’s gross profit margin, since each industry operates at different margins. It is 138 | P a g e
also valuable to look for discrepancies and determine if they can be explained through industrial trends or through economic conditions.
Gross Profit Margin 90.0% 80.0% 70.0%
ISIL
60.0%
TXN
50.0%
ADI
40.0% 30.0%
LLTC
20.0%
MXIM
10.0%
Industry
0.0% 2004
2005
2006
2007
2008
As shown above, the higher Analog ICs industry operates at a fairly consistent gross profit margin. With an industry average around 60%, firms generally operate between 45 and 70 percent. Intersil is on the lower end of the industrial average, having a 5 year average of 55.6%. Intersil has stayed fairly constant ranging only 6% from their high and low. In 2006 and 2007 they were operating more profitable at 57%, however suffered in the 2008 markets dropping 6% to 51%. The graph indicates that LLTC operates consistently around 80%, about 10% higher than the other firms in the Analog ICs industry. This is because there is segmentation in the industry, and not every firm is a perfect competitor to one another. Even though not every firm is a direct competitor, the industry still falls within a competitive profitability range.
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ISIL TXN ADI LLTC MXIM Industry
2004 55.7% 44.7% 59.0% 77.0% 66.7% 60.6%
Gross Profit Margin 2005 2006 2007 55.8% 57.4% 57.0% 47.5% 50.9% 53.3% 57.9% 61.9% 61.2% 79.1% 78.2% 77.7% 70.1% 65.6% 60.5% 62.1% 62.8% 61.9%
2008 51.9% 50.0% 61.1% 77.3% 60.3% 60.1%
5 yr AVG 55.6% 49.3% 60.2% 77.9% 64.7% 61.5%
Operating Profit Margin Operating profit margin takes a firms operating income (the firm’s gross profit less the selling and administrative expenses) and divides it by total sales. Much like the gross profit, a higher operating profit indicates the firm’s opportunity to have a higher net income, and be more profitable. The lower the percentages operating income represents the less profitable the firm is. With a lower ratio, too much money is being spent through selling and administrative cost. The higher the percentage the more operating income, and the less the company is spending on selling expenses, making them more profitable.
Operating Profit Margin 100.00% ISIL
50.00%
TXN ADI
0.00% 2004 -50.00% -100.00% -150.00%
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2005
2006
2007
2008
LLTC MXIM Industry ISIL Adj
As the chart above displays, the industry remains fairly consistent with exception to Intersil’ drastic drop in 2008. This is because Intersil reported a negative operating profit due to their $1,154 million impairment of goodwill in 2008. This shows that the impairment caused Intersil to not have a profit in 2008. With the restated numbers, Intersil’s operating profit margin is consistently much lower than the industrial average. However the restated numbers are much higher than those of the as-stated 2008. This is because instead of taking a “big-bath” in 2008, we gradually impaired goodwill overtime, diminishing profit over the years rather than a drastic fall in 2008.
Operating Profit Margin = OI/Sales
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
5 yr AVG
2004
2005
2006
2007
3.02% 17.54% 26.55% 54.10% 29.49% 26.14% 17.60%
16.68% 20.84% 21.60% 56.17% 40.00% 31.06% 16.63%
20.50% 23.62% 23.39% 51.60% 28.30% 29.48%
20.07% 25.28% 23.41% 48.41% 17.54% 26.94%
2008 136.04% 19.49% 24.20% 48.39% 20.75% -4.64%
-4.97%
-6.68%
-16.15% -12.41%
-15.15% 21.36% 23.83% 51.73% 27.22% 21.80%
Net Profit Margin Calculated though dividing net profit margin by a firms sales, this is one of the most important financial profitability ratios because it signifies what percentage of dollar sales return as profit. This is important to know because; firms re-allocate the net profit either as shareholder dividends or into company projects. A higher net profit margin means more money for the firm to use back, and that a firm is effectively managing its expenses. A lower net profit margin shows that the firm is not effectively
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managing its expenses, and that in order to grow and become more profitable, the firm needs to take a different approach in expense management.
Net Profit Margin 100.0% ISIL
50.0%
TXN ADI
0.0% 2004 -50.0%
2005
2006
2007
2008
LLTC MXIM Industry
-100.0%
ISIL Adj
-150.0%
Intersil 2008 negative net income resulted in a negative net profit margin, indicating that they were not profitable for the year end 2008. The net income was negative due to a $1,154 million goodwill impairment as part of a big bath. Also, although the industry typically operates around 27%, ADI operates at double the industry average. They reach net profit margins as high as 86.9%, further demonstrating that there is segmentation within the industry, having firms operate at different profit margins in the Analog ICs industry. Again, Intersil’s restated numbers are much lower than that of the rest of the industry. However, the restated numbers show that Intersil is not as profitable as they claim they are. Also, even though the numbers were constantly lower, the net profit was diminished over time instead of “nose diving” down in the big-bath Intersil took in 2008. Even though the restated numbers were lower for four of the years, the 2008 numbers were higher than the firm’s actual numbers. This shows that Intersil was making themselves look more profitable than they really were, and that in 2008, they had to overcorrect.
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ISIL TXN ADI LLTC MXIM Industry ISIL Adj
Net Profit Margin 2004 2005 2006 2007 9.0% 7.6% 14.3% 20.5% 14.8% 17.4% 30.5% 19.2% 64.4% 50.6% 49.1% 60.9% 21.7% 17.4% 24.4% 20.5% 21.2% 27.7% 20.9% 14.2% 26.2% 24.1% 27.8% 27.1% -13.0% -19.2% -5.3% -8.6%
2008 -134.8% 15.4% 86.9% 30.4% 15.5% 2.7% -15.3%
5 yr AVG -16.7% 19.4% 62.4% 22.9% 19.9% 21.6% -12.3%
Asset Turnover The asset turnover ratio links the income statement to it a firm’s balance sheet. Due to this linkage, it is an important ratio in forecasting. The greater the ratio, the more efficiently a firm generates revenue from selling its assets. A ratio of one signifies that for every dollar invested into assets generates a dollar of sales. Therefore firm with a ratio less than 1, (or 100%) signifies that the firm is not properly using their assets to increase sales.
Asset Turnover 120.0% 100.0%
ISIL
80.0%
TXN ADI
60.0%
LLTC 40.0%
MXIM Industry
20.0%
ISIL Adj
0.0% 2004
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2005
2006
2007
2008
As shown above, the industry varies from up 21% upwards to 98%, with the industrial average hovering around 50-60%. With the absence of a clear industrial pattern, the segmentation in the industry allows competitors to operate at different turnover ratios. Numbers spiked from 2007 to 2008, reporting and average from 59% increasing to 74%. Intersil also reported a growing asset turnover ratio, constantly increasing its ratio growing form 21% to 32% over the last 5 years. The restated numbers were not applicable in 2004 because it is a lag ratio and we did not restate 2003 numbers. However, in 2005, they received more sales per asset than if they restated their numbers. Their asset turnover grew substantially from 2005 to 2008, while Intersil’s as stated numbers were growing at a slower rate. This demonstrates that Intersil would receive more sales per asset if they appropriately stated their financials from the beginning.
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
2004 21.9% 81.1% 64.4% 39.2% 60.8% 53.5% N/A
Asset Turnover 2005 2006 2007 23.2% 28.7% 29.6% 82.2% 94.6% 99.3% 50.6% 49.1% 60.9% 50.3% 47.8% 45.3% 65.6% 60.7% 61.1% 54.4% 56.2% 59.3% 24.1% 32.1% 36.5%
2008 32.0% 98.7% 86.9% 96.4% 56.9% 74.2% 45.9%
5 yr AVG 27.1% 91.2% 62.4% 55.8% 61.0% 59.5% 34.6%
Return on Assets The more money an asset returns to the company, the more profitable the firm. To figure out how much the firm returns on its assets, we divided net income by the previous year’s total assets. This is a lagged ratio because the assets from the previous year generated this year’s income, and this year’s assets will generate next year’s income, so in order to match the right assets with the income received, we have to lag 144 | P a g e
the ratio. Because it is a lagged ratio, we could not calculate Intersil’s adjusted ratio for 2005 because we did not restate the 2004 financials.
Return on Assets 40.00% 30.00%
ISIL
20.00%
TXN
10.00%
ADI
0.00% -10.00% -20.00% -30.00% -40.00%
2004
2005
2006
2007
2008
LLTC MXIM Industry ISIL Adj
-50.00%
Excluding Intersil, the Analog ICs industry returns around 15%. Having a negative income, Intersil’s return on assets for 2008 was -43.14, exhibiting that Intersil was not profitable for the year end 2008, due to their big bath and extraordinary impairment of goodwill. Even though the previous ratio showed that Intersil was receiving more sales for their total assets, their net income was depleted during the restatement. This caused their restated return on assets to be consistently lower than the industry, yet again; the ratio was greater than the 2008 as stated ratio. This shows that firm would be more profitable if it would have impaired its goodwill overtime, rather than in one big bath. Because Intersil has less assets (goodwill) they are able to earn more per asset.
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2004 ISIL TXN ADI LLTC MXIM Industry ISIL Adj
1.66% 12.00% 13.94% 15.95% 12.91% 11.29% N/A
Return on Assets 2005 2006 2007 3.32% 14.26% 8.78% 20.79% 18.13% 13.06% -4.99%
5.88% 28.82% 11.99% 18.75% 12.67% 15.62% -1.90%
5.49% 19.07% 12.46% 17.22% 8.71% 12.59% -3.89%
2008 43.14% 15.16% 26.47% 31.80% 8.81% 7.82% -8.63%
5 yr AVG -5.36% 17.86% 14.73% 20.90% 12.25% 12.08% -4.85%
Return on Equity Return on equity is measured by taking a firm’s current year’s net income and dividing it by their previous year’s total equity. It is used to determine how efficiently the firm is using their shareholder’s equity to produce income for the firm. A higher ratio represents that each dollar of equity, more income is produced, and the firm is more profitable. A lower ratio represent that less income is produced for each dollar of equity so the firm is less profitable. It is important to determine the efficiency of the equity in order to determine the firm’s profitability.
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Return on Equity 60.00% 40.00%
ISIL TXN
20.00%
ADI
0.00%
LLTC 2004
-20.00% -40.00%
2005
2006
2007
2008
MXIM Industry ISIL (Adj.)
-60.00%
The chart above shows that aside from Intersil and LLTC, the industry generally operates around 15%. Intersil had a negative income for 2008, causing a discrepancy in the chart, as well as a negative return on equity. LLTC bought back its shares resulting in a negative owner’s equity in 2008. This shows that Intersil and LLTC were not profitable in 2008 according to their return on equity. Like the return on assets, Intersil’s restated return on equity was consistently less than the industrial average. However, like the return on assets, Intersil’s 2008 restated numbers, although negative, were substantially larger than the 2008 as stated numbers. This once again proves that the firm would be more profitable if they impaired their good will over time rather than in a 2008 big bath. Again, because it was a lagged ratio, we did not calculate Intersil’s 2004 numbers.
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Return on Equity 2005 2006 2007
2004 ISIL TXN ADI
2008 46.34% 19.25% 33.64% 54.75% 10.14% -7.61% -9.54%
1.81% 3.52% 6.25% 5.80% 15.69% 17.79% 36.37% 23.39% 17.36% 10.92% 14.89% 14.46%
LLTC 18.08% 23.97% 21.36% 19.56% MXIM 14.76% 21.88% 14.44% 10.31% Industry 13.54% 15.62% 18.66% 14.71% ISIL Adj N/A -5.43% -2.05% -4.26%
5 yr AVG -5.79% 22.50% 18.25% 5.64% 14.31% 10.98% -5.32%
Operating Expense The operating expense ratios is derived by dividing a firm’s selling and administrative cost over the firms sales. By doing so, it determines how much of sales are depleted through selling and administrative cost. The lower the ratio, the better, with a low ratio, it demonstrates that the firms cost are not eating up the sales, reducing the firms profitability.
Operating Expense 0.20 0.18 0.16 0.14 0.12 0.10 0.08 0.06 0.04 0.02 0.00
ISIL TXN ADI LLTC MXIM Industry 2004
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2005
2006
2007
2008
The graph above depicts the Analog ICs industry having a diverse reatio, which then consolidates in 2008. Again this is due to the economic pressures on the industry. When the economy was stronger, firms were less concerned about their selling cost. Now, due to expansionary cost, the industry operates a little higher than it did 4 years ago, but the industry is more consolidated, rather than each firm operating at a different level. This is related to the fact that in times of economic strain, pressures force the firms to operate at a competitive levels.
Internal Growth Rate The internal growth rate measures the rate at which a firm can sustain growth using only funding from the firm cash flows. This is derived by multiplying the firm’s return on assets by the plowback ratio. (NET INCOME/PREVIOUS YEAR’S TOTAL ASSETS)*(1-[DIVIDENDS/NET INCOME])
Internal Growth Rate 40.00% 30.00%
ISIL
20.00%
TXN
10.00%
ADI
0.00% -10.00% -20.00%
2004
2005
2006
2007
2008
LLTC MXIM
-30.00%
Industry
-40.00%
ISIL Adj
-50.00%
The industry can generally sustain an internal growth rate of around 8-12%. However, Intersil’s growth rate drops in 2008 to -45.63, meaning that the company cannot grow 149 | P a g e
but must reduce their operations. This is because Intersil reported a negative $1,062 million net income, due to a $1,154 million goodwill impairment, in the 2008 “big bath.” The restated numbers indicate not only that Intersil is not able to grow as rapidly as the rest of the industry, but that they should decrease their operations. Even though the restated suggest that the firm should shrink, the numbers are not as drastic as the as stated, thus proving that operations would have been better off the goodwill was amortized sooner than later.
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
Internal Growth Rate = ROA(1-(Div/NI)) 2004 2005 2006 2007 2008 0.91% 2.38% 4.74% 3.40% -45.63% 12.99% 15.32% 30.14% 22.12% 19.40% 12.11% 6.26% 7.59% 6.74% 18.98% 11.70% 15.47% 12.02% 9.17% 17.31% 8.49% 17.12% 7.67% 2.62% 2.14% 9.24% 11.31% 12.43% 8.81% 2.44% N/A -4.19% -0.73% -2.13% -4.72%
5 yr AVG -6.84% 19.99% 10.34% 13.13% 7.61% 8.85% -2.94%
Sustainable Growth Rate The sustainable measures the firm’s capable growth much like internal cash flows. However, the sustainable growth rate includes the firm’s capital structure, and test how much a firm can grow without increasing financial leverage by taking on more debt. The sustainable growth rate is calculated by multiplying the internal growth rate by 1 plus the debt to equity ratio, or total liabilities divided by total equity. (NET INCOME/PREVIOUS YEAR’S TOTAL ASSETS)*(1-[DIVIDENDS/NET INCOME])*(1+TOTAL LIABILITIES/SHAREHOLDERS EQUITY) Changes in a firm’s capital structuring can greatly impact the firm’s sustainable growth rate based on the fact that it the sustainable growth rate measures a firm’s ability to remain at its constant debt to equity ratio. 150 | P a g e
Sustainable Growth Rate 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% -10.00% -20.00% -30.00% -40.00% -50.00% -60.00%
ISIL TXN ADI 2004
2005
2006
2007
2008
LLTC MXIM Industry ISIL Adj
As previously mentioned, Intersil’s reported negative $1,062 million net income; due to a $1,154 million goodwill impairment in 2008 caused the sustainable growth rate to be negative. This indicated that the company should be reducing its size rather than expanding its operations. Also, LLTC reported a negative growth rate for 2008 due to negative retained earnings causing a negative debt to equity ratio. This is because LLTC started a share buy back in 2007 and 2008. This caused the 2007 ratio to decrease and in 2008 to become negative. These negative growth rates in 2008 demonstrate that both Intersil and LLTC cannot sustain their current operations, and need to reduce their company.
Sustainable Growth Rate = SGR(1+(Dt-1/Et-1))
2004 ISIL 0.99% TXN 16.98% ADI 15.08% LLTC 13.26% MXIM 9.89% Industry 11.24% ISIL Adj N/A 151 | P a g e
2005 2.53% 19.12% 7.78% 17.84% 16.86% 12.83% -0.06422
2006 2007 2008 5 yr AVG 5.04% 3.59% -49.01% -7.37% 38.03% 27.13% 24.63% 25.18% 9.43% 7.82% 24.12% 12.85% 13.69% 10.42% -29.80% 5.08% 12.67% 8.71% 8.81% 11.39% 15.77% 11.53% -4.25% 9.42% -3.56% -7.58% -14.08% -7.91%
Conclusion The profitability ratios show that Intersil’s restated numbers are usually slightly below the firms as stated numbers, yet remain constant and outperform the as stated numbers in 2008. This shows that it is better for Intersil to slowly amortize goodwill, rather than amortize most of it at once.
Capital Structure Ratios Capital structure ratios are used in order to determine the riskiness of firms. A firm can finance their assets two ways, either through debt (liabilities) or through equity. Through capital structure ratios we can determine how much of the firm finance through owner’s equity and through liabilities is. If a firm is financed more through debt then they must make payments to their creditors, where as they do not have to with owners equity. Because of a firm is obligated to make payments, firms have greater risk of going bankrupt if they have trouble making payments. Therefore a firm is riskier if they finance through liabilities rather than equity. Through such ratios as debt to equity, times interest earned, and debt service margin, we will be able to conclude Intersil’s financial structure.
Debt to Equity Debt to equity shows how much of the firm’s assets are finance through debt or through equity by dividing total liabilities by owner’s equity. The firm is financed primarily though debt if the ratio exceeds 1. This magnifies losses and returns if the ratio is less than one, then the firm finances their assets through equity. 152 | P a g e
Debt to Equity 1.00 0.00
ISIL 2004
2005
2006
2007
2008
-1.00
TXN ADI
-2.00
LLTC MXIM
-3.00
Industry ISIL Adj
-4.00 -5.00
The chart above shows that that industry operates with a ratio less than one. This means that the Analog ICs industry finances their assets through equity, rather than debt. In 2007, LLTC had share repurchasing, causing them to have negative owner’s equity for 2007 and 2008. Because of the fact both debt and equity were impaired in the restatement, the firms restated numbers did not differ much from the as stated numbers, showing that the capital structure did not change with impairments aside from 2008, where there more debt for Intersil impairing good will, than slowly impairing it in the restated. This showed that in 2008, the restated numbers were slightly less risky firm.
ISIL TXN ADI LLTC MXIM Industry 153 | P a g e
2004 0.06 0.25 0.24 0.15 0.21 0.18
Debt to Equity 2005 2006 2007 0.06 0.06 0.07 0.26 0.23 0.27 0.24 0.16 0.27 0.14 0.14 -2.72 0.14 0.18 0.15 0.17 0.15 -0.39
2008 0.11 0.28 0.28 -4.65 0.18 -0.76
5 yr AVG 0.07 0.26 0.24 -1.39 0.17 -0.13
ISIL Adj
0.06
0.07
0.07
0.08
0.09
0.08
Times Interest Earned Times interest earned test the firm’s ability to pay off its interest on its debt. It is calculated by dividing a firm’s operating income by its interest expense. It is important that a firm can maintain its payments on its debt through its operations. If not, a firms capital structure is too highly debt levered and the firm cannot handle the debt it already has.
Times Interest Earned 50.0 0.0 -50.0
2004
2005
2006
2007
2008
ISIL TXN
-100.0
ADI
-150.0
LLTC
-200.0
MXIM
-250.0
Industry
-300.0
ISIL Adj
-350.0
The Analog ICs industry maintains a fairly constant times interest earned. As mentioned above there is segmentation within the industry as each firm is leveraged differently, yet the trends of the industry mirror their competitors. Overall, the industry operates at a medium times interest earned, with the lower end at 15 times the amount of interest. This means that a firms is making only 15 times the amount of interest it earns. However, not every firm in the Analog ICs disclosed their interest expense, for instance TXN only disclosed their interest in 2004 and 2005, so 2006, 2007, and 2008 154 | P a g e
numbers are not applicable. Intersil’s restated number did not disclose interest expense in 2004, however, they were earning less than there interest expense because of incurring net income from 2005 to 2008.
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
2004 1.2 -105.1 -19.4 17.1 19.9 -17.3 N/A
Times Interest Earned 2005 2006 2007 5.3 5.1 4.9 -310.1 N/A N/A -7.2 -5.3 -7.4 19.4 10.3 9.1 22.2 11.3 5.8 -54.1 5.4 3.1 -100.6 -14.6 -15.7
2008 -71.4 N/A -15.2 18.9 7.5 -15.1 -39.9
5 yr AVG -11.0 -207.6 -10.9 15.0 13.3 -15.6 -42.7
Debt Service Margin The debt service margin ratio measures the ability of a firm to meet its current debt obligations. Current debt (or current liabilities) is debt that will be expensed within a fiscal year. This is calculated by dividing available cash flow by the current notes payable. The greater the ratio, the easier it is for a firm to pay off their current debt obligations. When the ratio drops below 1, it indicates a negative cash flow for the firm.
Debt Service Margin 400.0 350.0
ISIL
300.0
TXN
250.0
ADI
200.0
LLTC
150.0
MXIM
100.0
Industry
50.0
ISIL Adj
0.0 -50.0
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2004
2005
2006
2007
2008
Overall, the Analog ICs industry operates well above a 1 ratio, indicating that the firms have the ability to pay off their current portion of debt. TXN spikes in 2005 due to a decrease in current notes payable. Firms in this industry generally have little debt, so slight changes in current notes payable magnify the discrepancy do to the denominator effect. In conclusion, firms do not have a significant amount of current notes payable in relationship to cash coming in, so they should have no problem paying off their short term debt. Also, there was not any interest expense for TXN in 2008, so there is no applicable ratio for 2008. Because the ratio is lagged, there is not applicable restated ratio. Also, the firms number are substantially lower than the as-stated number, signifying that there is a negative cash flow for the restated number in 2005, 2006, and 2007. However, in 2008, Intersil rebounds with a 10.41 debt service margin.
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
Debt Service Margin : DSM = CFFO t / NPC t-1 2004 2005 2006 2007 2008 4.7 8.3 8.7 9.6 5.1 7.2 342.9 8.2 102.5 N/A 6.9 5.3 3.8 5.3 4.5 61.2 34.2 43.2 32.8 47.5 9.8 7.3 14.2 7.3 7.2 18.0 79.6 15.6 31.5 16.1 N/A -0.31 0.33 0.21 10.41
5 yr AVG 7.3 115.2 5.2 43.8 9.2 32.2 2.7
Altman’s Z-Score In the early 60’s, Edward Altman discovered a serious of ratios when combined in a weighted equation, predicted bankruptcy among existing firms. He found that firms with a score below 1.81 were in serious danger of bankruptcy. Firms with scores between 1.81 and 2.67 were in a grey area, and anything above 2.67 is considered healthy. The score is calculated as follows.
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1.2(NET WORKING CAPIALT/TOTAL ASSETS) +1.4(RETAINED EARNINGS/TOTAL ASSETS) +3.3(EARNINGS BEFORE INTERST AND TAXES/TOTAL ASSETS) +0.6(MARKET VALUE OF EQUITY/BOOK VALUE OF LIABILITIES) +1.0(SALES/TOTAL ASSETS)
Altman's Z-Scores 12.0 10.0
ISIL
8.0
TXN
6.0
ADI
4.0
LLTC
2.0
MXIM
0.0
Industry
-2.0
2004
2005
2006
2007
2008
ISIL Adj
-4.0
As the chart demonstrates above, Intersil is below the industrial average with low Z-scores under 1.81. This indicates that Intersil is in danger of going bankrupt. In 2008, when Intersil reported negative net earnings before interest and taxes, and retained earnings, Intersil had a negative Z-score. This is because of the “big bath” which they underwent in 2008 after a change in CEO, failing economy, and a need to impair goodwill (Intersil 10-K). The $1,154 million goodwill impairment diminished the gross profit, and this resulted in a trickle down of losses resulting in negative earnings before interest and taxes and a negative net income which translates to a negative retained earnings. Because Intersil took this big bath, their Z-score’s should improve over the next few years with positive retained earnings and earnings before interest and taxes, making the new CEO look like he drastically improved the company, due to a lower benchmark of standards through a big bath. However, when restated, Intersil is 157 | P a g e
nowhere near bankruptcy according to the Z-scores. With a restated five year average of 5.1, they are well above they “healthy” 2.67 with scores soaring in 2008 to 9.3. This
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
2004 0.6 10.2 2.9 2.7 3.8 4.1 3.6
Altman Z-Score 2005 2006 2007 0.7 1.0 1.0 3.5 4.3 5.0 2.9 3.2 3.3 3.0 2.8 0.7 4.5 4.2 3.7 2.5 2.8 2.5 4.0 4.4 4.4
2008 -3.2 4.9 3.6 1.6 8.1 1.8 9.3
5 yr AVG 0.0 5.6 3.2 2.2 4.9 2.7 5.1
Conclusion In conclusion, the profitability and capital structure analysis show Intersil as a much healthier, more profitable firm than as restated. They would fall slightly behind in profitability but would surpass the as-stated numbers in 2008. Also, their Z-score are substantially higher than, nearly 5 times as high in some years, where as their as-stated number indicated that Intersil is near bankruptcy. By restating the financial statements, Intersil is a healthier firm and would not require a big-bath.
Cost of Equity The cost of equity is the minimum return required by stockholders when investing in a firm’s stock. The cost of equity (Ke) is the rate of return demanded by investors in exchange for owning and bearing the risks of an asset. When there is a 158 | P a g e
higher cost of equity it means that there is a greater risk involved but potentially a larger return. The capital asset pricing model (CAPM) was used to derive Ke; the formula for the CAPM is: Ke= Rf + β (MRP) Rf is the risk free rate; RM is the market return; and β is known as the betta coefficient which measures the correlation between an assets expected return and the markets return. To find Beta o a firm we ran a linear regression analysis. After we found the beta we multiplied it by the market risk premium which is MRP. For Intersil, we used the year 1 yield; slice 24 with the adjusted r squared of .2925. This gave us a beta of 1.0991, with and upper and lower bounds beta of .3959 and 1.8022 respectively. We then used the risk free rate of 3.29% and the market risk premium of 6.8% . This gave us a cost of equity of 10.76 percent and a lower and upper bounds of 5.98% and 15.55%. Ke .1076= .0329 + 1.0991(.068) Lower .0598= .0329 + .3959(.068) Upper .1555= .0329 + 1.8022(.068)
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Size Adjusted CAPM Sometimes analysts argue that the CAPM is not the best method to find the cost of equity. This is because on average smaller firms yield higher returns than larger firms in the market. To consider size we use the CAPM model plus a size premium. By adding the size premium it will let us take into account the size of the firm when calculating the cost of equity. The size premium we used that fit our market cap was 1.7%. This gave us a size adjusted cost of equity of 12.46% with 7.68% and 17.25% lower and upper bound. Size Adjusted Ke Ke = Rf + β*(MRP) + Size Premium (Palepu Healy) Size Adjusted Ke .1246= .0329 + 1.0991(.068)+ .017 Lower Size Adjusted Ke .078= .0329 + .3959(.068)+ .017 Upper Sized Adjusted Ke .1725= .0329 + 1.8022(.068)+ .017
Alternative cost of equity Another way we found the cost of equity is by an alternative method or also called the back door method. The formula used in this method is:
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Backdoor Ke Market/Book = 1 + (ROE – Ke / Ke – g) On the left hand side is the market to book ratio. This equals the return of equity – Ke divided by Ke minus the growth rate “g”. All of this is then added by one. The “g” variable in our formula is the assumed historical sales growth rate which is 10%,. To simplify the formula in finding Ke we can use: Backdoor Ke .3818=(.52+1.49*.1-.1)/(1/49)
Cost of Debt
The Cost of Debt (Kd) is calculated by taking the weighted average of short and long term liabilities over the total liabilities multiplied by the interest rates for each specific liability. The cost of debt is usually lower than the cost of equity. The cost of debt is usually lower than the cost of equity because when a firm defaults the debt holders will get paid first then it will be the equity holders. Due to this issue equity holder bear more risk because of default. So this is why the cost of equity is higher than the cost of debt because investors require higher return rates compared to the extra risk they must consider.
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Actual Financials Fiscal Year Current Liabilities Trade payables Accrued current and retirement compensation Deferred net revenue Other accrued expenses Non-income taxes payable Income taxes payable Total Current Liabilities Non-current Liabilities Income taxes payable Total L-T Liabilities TOTAL LIABILITIES
2008
22,264 30,461 10,638 37,256 3,319 4,012 107,950
Interest Rate Weight Weighted Interest 6.5% 20.62% 1.34% 6.5% 28.22% 1.83% 6.5% 9.85% 0.64% 6.5% 34.51% 2.24% 6.5% 3.07% 0.20% 6.5% 3.72% 0.24%
107,950 Cost of Debt
6.50%
Restated Financials Fiscal Year 2008 Current Liabilities 22,264 Trade payables Accrued current and retirement compensation 30,461 10,638 Deferred net revenue 37,256 Other accrued expenses 3,319 Non-income taxes payable 4,012 Income taxes payable Total Current Liabilities 107,950 Non-current Liabilities Income taxes payable Capitalized Lease Liabilities Amortized Lease Liability Total L-T Liabilities TOTAL LIABILITIES
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119,512 (98,239) 21,273 129,223
6.5% 6.5% 6.5% 6.5% 6.5% 6.5%
17.23% 23.57% 8.23% 28.83% 2.57% 3.10%
1.12% 1.53% 0.54% 1.87% 0.17% 0.20%
6.5% 6.5%
92.49%
6.01%
-76.02%
-4.94%
100.00%
6.50%
Weighted Average Cost of Capital (WACC) Previously shown we can see that firms are financed by debt and equity. The Weighted Average Cost of Capital can either be found before and after taxes to assume the percent available for financing assets. The weighted average cost of capital is used to find the appropriate interest rate to finance the firm. In the first step to find WACC you will need to calculate the cost of debt and cost of equity. The next step is to take market value of liabilities divided by the market value of asset which is multiplied b the cost of debt. If you have taxes you would take the number calculated and multiply it by 1-T. The next step is to take the Market Value of Equity divided by the Market Value of Assets multiplied by Ke. When you find that you will add up the two calculations together and should give you WACC. We will then take the before tax and after tax WACC. The tax rate that we will use is 30%. WACCbt = (VL/Vf)(Kd) + (Ve/Vf)(Ke)
Before Tax Cost of Debt BACKDOOR 6.50% SIZE ADJUSTED 6.50% LOWER SIZE 6.50% UPPER SIZE 6.50%
MVL/MVA 9.52% 9.52% 9.52% 9.52%
Ke 38.18% 12.46% 0.0768 0.1725
MVE/MVA 90.48% 90.48% 90.48% 90.48%
WACC 35.16% 11.89% 7.57% 16.23%
WACCat = (VL/Vf)(Kd)(1-Tax Rate) + (Ve/Vf)(Ke) After Tax Cost of Debt BACKDOOR 6.50% SIZE ADJUSTED 6.50% LOWER SIZE 6.50% UPPER SIZE 6.50%
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MVL/MVA 9.52% 9.52% 9.52% 9.52%
Tax Rate 30% 30% 30% 30%
Ke 38.18% 12.46% 7.68% 17.25%
MVE/MVA 90.48% 90.48% 90.48% 90.48%
WACC 34.98% 11.71% 7.38% 16.04%
Financial Statement Forecast Firms typically reference their past data to measure future performance as well as predicting any trends with factors being alike. Historical numbers provide a benchmark that illustrates on average how the firm ranks within the industry and what strategically changes may be necessary. We were able to measure and forecast Intersil’s firm based on the past five years of data that we collected from their financial statements. The three most important financial statements any firm has are the Income Statement, the Balance Sheet and the Statement of Cash Flows. Income Statement
Trends and assumptions from the income statement are used for forecasting the other financial statements, so there is a need to forecast the income statement first. An accurate forecast of the income is necessary to set the proper trends and assumptions. To help forecast we created a common size income statement to size up all the accounts on the statement to sales revenue. The first step in the forecast was analyzing the historical sales growth rate for Intersil over the past five years. Dividing present net sales by previous year’s sales, minus one gave us the percentage of sales growth. The average sales growth rate over the past six years for Intersil is 9%. Due to what would appear to be indicative of a “big bath” that Intersil took in fiscal year 2008, we chose to grow at a -25% growth rate. After looking at the current state of the economy, we estimated that the sales growth will be stable year 2011 and on. Below is two tables demonstrating the past historical and forecasted sales growth rates for Intersil and the quarterly forecast of 2009 fiscal year.
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Intersil's Sales Growth Rate Historical
2004 5.53%
2005 12.03%
2006 23.38%
Forcasted
2007 2.21%
2008 1.68%
2009 -25.00%
2010 12.00%
2011 9.00%
2012 9.00%
2013 9.00%
2014 9.00%
2015 9.00%
2016 9.00%
2017 9.00%
Intersil Corporation Forecast
Actual Financials Fiscal Year Quarter
2005 Q1 2005
Growth Revenue $ 128,080.00
Q2 2005
2006 Q3 2005
$ 139,076.00 $ 157,469.00
Q4 2005
Q1 2006
2005 $ 175,630.00 $ 178,932.00
Q2 2006
2007 Q3 2006
$ 187,632.00 $ 192,937.00
Q4 2006
Q1 2007
2006 $ 181,096.00 $ 167,716.00
Q2 2007
2008 Q3 2007
$ 178,340.00 $ 198,285.00
Q4 2007
Q1 2008
2007 $ 212,625.00 $ 203,702.00
Q2 2008
2009 Q3 2008
$ 216,227.00 $ 218,663.00
Q4 2009
Q1 2009
$ 131,083.002008 $ 118,171.00
Q2 2009
Q4 2009
$ 125,261.26 $ 72,666.19 $ 75,572.84
Q2/Q1
108.5%
104.8%
106.3%
106.1%
Q3/Q1
122.9%
107.8%
118.2%
107.2%
Q4/Q1
137.1%
101.2%
126.7%
64.4%
Q1/Q2
132.3%
102.9%
111.2%
101.1%
Q4/Q3
115.3%
93.8%
107.2%
59.9%
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Q3 2009
2018 9.00%
To forecast the appropriate revenue for year 2009, we compared the past four years of quarterly financial data. We compared the percent change from quarter to quarter within a year, and the same quarter from year to year. We choose a percentage based on the consistency of the percentage change. We grew the quarters at: second quarter 106%, third quarter 58%, and the fourth quarter at 104%. The second step in the forecast of the income statement is forecasting the future COGS, gross profit, R&D, SG&A, operating income and net income. We use the common size statement percentages of the past five years to help us forecast these accounts. Typically we would forecast these accounts with the average percentage of the past five years. We also took into account the recession, and the big bath that Intersil took in 2008 when deciding on the declining growth rates.
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.
Intersil - Income Statement Actual Financials (In thousands) 2003
Fiscal Year
Annual Sales Growth
Revenue COGS
Gross Profit R&D SG&A Amort of Unearned Compensation Amort of Purchases Intangeables In-Process R&D Restructuring/Related Activities (Gain) on sale of certain operations Other losses (gains)
Operating Income Interest Income, Net (Loss) gain on certain investments, net
OP(L) b/f Tax Income Tax Expense (Benefit)
Income (Loss) from Cont. Ops. Loss(Inc) DO b/f Income Taxes Income Tax Exp (Benefit) DcOps. Inc (Loss) from DcOps
NET INCOME (LOSS)
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2004 6%
Forecasted Finicial Statements
2005 12%
2006 23%
2007 2%
2008 2%
507,684 221,074 286,610 91,267 88,274 10,895 6,298 4,887
535,775 237,155 298,620 107,430 90,697 10,834 7,397 31,205 6,104
600,255 265,560 334,695 110,834 99,788 14,109 9,597 2,845
740,597 315,734 424,863 126,458 137,105 9,468 -
756,966 325,372 431,594 134,374 131,914 10,723 2,660 -
769,675 370,274 399,401 143,583 124,281 12,176 3,037 8,685
(1,428) 86,417 8,958 (3,443) 79,356 20,899 58,457 19,983 32,603 (12,620) 45,837
(901) 3,439 16,191 13,227 3,799 33,217 (7,136) 40,353 1,092 764 328 40,681
(2,000) 100,140 18,966 119,106 32,284 86,822 (1,071) (126) (945) 85,877
151,832 29,711 (1,367) 180,176 28,828 151,348 851 322 529 151,877
151,923 30,911 870 183,704 40,965 142,739 (288) 1,975 (2,263) 140,476
(1,047,037) 14,655 (35,429) (1,067,811) (5,309) (1,062,502) (24,942) 24,942 (1,037,560)
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
391,671 106,930 284,741 169,902 145,620
438,672 194,332 244,340 32,618 35,172
478,152 211,821 266,331 34,575 39,068
521,186 230,885 290,301 36,650 39,335
568,093 251,665 316,428 38,849 40,988
619,221 274,315 344,906 41,180 170,623
674,951 299,003 375,948 43,651 41,211
735,697 325,914 409,783 46,270 45,776
801,909 355,246 446,663 49,046 46,089
874,081 387,218 486,863 51,989 48,026
116,517
137,432
162,101
191,199
225,519
265,999
313,746
370,064
436,490
514,840
102,533
113,104
124,765
137,628
151,818
167,470
184,736
203,782
224,792
247,968
Intersil - Income Statement Common Sized 2003
Fiscal Year
Percentage Sales Growth
SALES
Forecast Financial Statements
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
5.53%
12.03%
23.38%
2.21%
1.68%
-25.00%
12.00%
9.00%
9.00%
9.00%
9.00%
9.00%
9.00%
9.00%
9.00%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
CGS
43.5%
44.3%
44.2%
42.6%
43.0%
48.1%
Gross Profit
56.5%
55.7%
55.8%
57.4%
57.0%
51.9%
R&D SG&A Impairment of Goodwill Amort of Unearned Compensation Impair.(gain) Long-Lived Assets Amort of Purchases Intangeables In-Process R&D Restructuring/Related Activities (Gain) on sale of certain operations Other losses (gains)
18.0% 17.4% 0.0% 2.1% 2.5% 1.2% 0.0% 1.0% -0.3% 0.0%
20.1% 16.9% 0.0% 2.0% 4.9% 1.4% 5.8% 1.1% -0.2% 0.6%
18.5% 16.6% 0.0% 2.4% -0.1% 1.6% 0.0% 0.5% 0.0% -0.3%
17.1% 18.5% 0.0% 0.0% 0.0% 1.3% 0.0% 0.0% 0.0% 0.0%
17.8% 17.4% 0.0% 0.0% 0.0% 1.4% 0.4% 0.0% 0.0% 0.0%
18.7% 16.1% -150.0% 0.0% 0.0% 1.6% 0.4% 1.1% 0.0% 0.0%
43.00% 55.70% 18.33% 17.17%
43.00% 55.70% 18.33% 17.17%
43.00% 55.70% 18.33% 17.17%
43.00% 55.70% 18.33% 17.17%
43.00% 55.70% 18.33% 17.17%
43.00% 55.70% 18.33% 17.17%
43.00% 55.70% 18.33% 17.17%
43.00% 55.70% 18.33% 17.17%
43.00% 55.70% 18.33% 17.17%
43.00% 55.70% 18.33% 17.17%
Operating Income (Loss)
14.5%
3.0%
16.7%
20.5%
20.1%
-136.0%
17.95%
17.95%
17.95%
17.95%
17.95%
17.95%
17.95%
17.95%
17.95%
17.95%
Interest Income, Net (Loss) gain on certain investments, net
1.8% -0.7%
2.5% 0.7%
3.2% 0.0%
4.0% -0.2%
4.1% 0.1%
1.9% -4.6%
Operating Profit (Loss) before Tax
15.6%
6.2%
19.8%
24.3%
24.3%
-138.7%
4.1%
-1.3%
5.4%
3.9%
5.4%
-0.7%
Income (Loss) from Cont. Ops. Loss(Inc) DO b/f Income Taxes
11.5% 3.9%
7.5%
14.5%
20.4%
18.9%
-138.0%
Income Tax Exp (Benefit) DcOps. Inc (Loss) from DcOps
6.4% -2.5%
0.2% 0.1% 0.1%
-0.2% 0.0% -0.2%
0.1% 0.0% 0.1%
0.0% 0.3% -0.3%
0.0% -3.2% 3.2%
NET INCOME (LOSS)
9.0%
7.6%
14.3%
20.5%
18.6%
-134.8%
10.31%
10.31%
10.31%
10.31%
10.31%
10.31%
10.31%
10.31%
10.31%
10.31%
Income Tax Expense (Benefit)
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57.0%
Forecasted Restated Income Statement The restated income forecast is very similar to the actual income forecast except for some accounts added before operating income, and the net income changes. The sales revenue, COGS, and many other accounts were not affected by the restated numbers. We forecasted the net income by taking the net income change, which changed from 10.3% on the actual forecast to 15.2% growth rate average. The technique we used to forecast net income is very similar to how we forecasted operating income but with a 12.4% average growth rate. The research and development, lease payment, impairment of goodwill, operating lease depreciation were additional line items that were added to the restated forecasted income statement. The research and development was computed by taking the actual impairment of R&D and subtracting what we derived that they should impair. The goodwill impairment was forecasted out until the balance hit zero dollars. The operating lease depreciation was forecasted out using the average percentage depreciation is of the capitalized operating lease. The net income restated was negative to begin with, and continued to be negative although it increased throughout the years.
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Intersil - Restated Income Statement Actual Financials (In thousands) Fiscal Year
Annual Sales Growth
Revenue COGS
Gross Profit R&D SG&A Less Lease Payment Impairment of Goodwill Amort of Unearned Compensation Impair.(gain) Long-Lived Assets (Add Deprec) Amort of Purchases Intangeables In-Process R&D Restructuring/Related Activities (Gain) on sale of certain operations Other losses (gains)
Operating Income
2004 6%
2005 12%
740,597 315,734 424,863 56,299 137,105 (30,700) 283,050 6,472 9,468 -
756,966 325,372 431,594 82,382 131,914 (37,100) 283,302 8,277 10,723 2,660 -
769,675 370,274 399,401 110,178 124,281 (35,300) 292,664 7,990 12,176 3,037 8,685 -
3,439 (94,286)
(2,000) (99,832) 992
(50,564) 3,228
(124,309) 3,116
(100,825) 32,284 (133,109) 18,966
(36,831) 2,524 (1,367) (40,722) 28,828 (69,550) 29,711
(945)
529
(2,263)
(115,088)
(39,310)
(11,447) (65,239)
Income Tax Expense (Benefit)
Income (Loss) from Cont. Ops. Loss(Inc) DO b/f Income Taxes Inc(Loss) from DcOps
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2008 2%
600,255 265,560 334,695 39,990 106,476 (5,000) 280,693 1,926 9,597 2,845 -
OP(L) b/f Tax
NET INCOME (LOSS)
2007 2%
535,775 237,155 298,620 10,743 90,697 207,164 10,834 26,224 7,397 31,205 6,104 (901)
(Loss) gain on certain investments, net
Gain/Loss from Disc. Ops. /Extraordinary Others
Forecasted Finicial Statements
2006 23%
24,490 (69,796)
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
568,093 251,665 316,428 34,143.3
619,221 274,315 344,906 8,466.8
674,951 299,003 375,948 (5,772.9)
735,697 325,914 409,783 (6,119.3)
801,909 355,246 446,663 (6,486.5)
874,081 387,218 486,863 (6,875.7)
391,671 106,930 284,741
438,672 194,332 244,340
478,152 211,821 266,331
(177,810.8)
(50,008.6)
77,623.3
521,186 230,885 290,301 56,588.2
(52,200) 85,550
(31,600) 10,475
(26,000) 10,475
(24,400) 10,475
(2,500) 4,556
(125) -
(125) -
(125) -
(125) -
(125) -
(39,135)
(11,006)
24,694
20,521
16,065
10,927
8,337
8,837
9,367
9,929
(108,887)
(95,377)
(83,544)
(73,179)
(64,100)
(56,147)
(49,181)
(43,080)
(37,735)
(33,053)
(57,716)
(51,060)
(45,172)
(39,963)
(35,355)
(31,278)
(27,671)
(24,480)
(21,657)
(19,160)
(53,792) 40,965 (94,757) -
9,477 (117,949)
Intersil - Restated Income Statement- Common Size Common Sized Fiscal Year
Percentage Sales Growth
SALES CGS
Gross Profit R&D SG&A Less Lease Payment Impairment of Goodwill Amort of Unearned Compensation Impair.(gain) Long-Lived Assets (Add Deprec) Amort of Purchases Intangeables Restructuring/Related Activities (Gain) on sale of certain operations Other losses (gains)
Operating Income (Loss)
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
5.53%
12.03%
23.38%
2.21%
1.68%
-25.00%
12.00%
9.00%
9.00%
9.00%
9.00%
9.00%
9.00%
9.00%
9.00%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
44.3% 125.9%
44.2% 55.8%
42.6% 57.4%
43.0% 57.0%
48.1% 51.9%
27.30% 266.29%
44.30% 55.70%
44.30% 72.70%
44.30% 72.70%
44.30% 72.70%
44.30% 72.70%
44.30% 72.70%
44.30% 72.70%
44.30% 72.70%
44.30% 72.70%
33.39%
29.45%
23.47%
17.89%
12.85%
8.02%
5.61%
5.46%
5.31%
5.16%
-13.33% 21.84%
-7.20% 2.39%
-5.44% 2.19%
-4.68% 2.01%
-0.44% 0.80%
-0.02% 0.00%
-0.02% 0.00%
-0.02% 0.00%
-0.02% 0.00%
-0.01% 0.00%
7.35%
6.48%
5.16%
3.94%
2.83%
1.76%
1.24%
1.20%
1.17%
1.14%
-12.41%
-12.41%
-12.41%
-12.41%
-12.41%
-12.41%
-12.41%
-12.41%
-12.41%
-12.41%
-11.53%
-11.53%
-11.53%
-11.53%
-11.53%
-11.53%
-11.53%
-11.53%
-11.53%
-11.53%
3.6%
6.7%
7.6%
10.9%
14.3%
844.2% 0.0% 38.7% 5.2% 242.1% 28.2% 421.9% 19.6% -14.8% -17.6%
17.7% -0.8% 46.8% 0.0% 0.3% 1.6% 0.0% 0.5% 0.0% -16.6% -16.6% 0.2% 0.0% -16.8% 5.4%
18.5% -4.1% 38.2% 0.0% 0.9% 1.3% 0.0% 0.0% 0.0% -5.0% -5.0% 0.3% -0.2% -5.5% 3.9%
17.4% -4.9% 37.4% 0.0% 1.1% 1.4% 0.4% 0.0% 0.0% -6.7% -6.7% 0.4% 0.0% -7.1% 5.4%
16.1% -4.6% 38.0% 0.0% 1.0% 1.6% 0.4% 1.1% 0.0% -16.2% -16.2% 0.4% 0.0% 0.0% 0.0%
-22.2%
-9.4%
-12.5%
0.0%
4.6%
3.2% 0.0% -0.2% 0.0% 0.0%
4.0% 0.0% 0.1% 0.0% 0.0%
0.0% 0.0% -0.3% 0.0% 0.0%
0.0% 0.0% 0.0% 0.0% 0.0%
-13.0%
-19.2%
-5.3%
-8.6%
-15.3%
(Loss) gain on certain investments, net
OP(L) b/f Tax Income Tax Expense (Benefit)
Income (Loss) from Cont. Ops. Loss(Inc) DO b/f Income Taxes Inc (Loss) from DcOps
Gain/Loss from Disc. Ops. /Extraordinary Others
NET INCOME (LOSS)
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Forecast Financial Statements
The Balance Sheet The balance sheet is the second statement to be forecasted. The three main components of the balance sheet are assets, liabilities, and owner’s equity. The forecasted sales from the income statement guide many important line items on the balance sheet. The asset turnover ratio connects the income statement and balance sheet. The asset turnover ratio is calculated by dividing the previous year’s revenue by total assets of the current year. Normally, you would use the average asset turnover to forecast total assets, but not it Intersil’s case. Intersil decided to take a “big bath” in goodwill in the fourth quarter of 2008, which cleaned out there assets significantly. So, to accurately forecast their total assets, we compared their past quarters. Intersil’s assets stay pretty consistent throughout the year, and based on Intersil’s first quarter we forecasted a similar number of $1,114 million for fiscal year 2009. Years 2010 and on, we calculated a new asset turnover for each year. Below is the asset turnover we used to forecast each year. Year By Year Asset Turnover
2010
2011
2012
2013
2014
2015
2016
2017
2018
39.4% 42.5% 46.3% 50.5% 55.0% 60.0% 65.4% 70.9% 76.3% Our next step in forecasting the balance sheet is to forecast current and noncurrent assets. To arrive at a reasonable forecast for these line items, we used the current ratio. We took the current asset percentage of total assets, and the non current asset percentage of total assets. We allocated 35.5% of total assets to current assets, and 64.5% of total assets to noncurrent assets. Current Asset Percentage of Total Assets
2003 42.1%
2004 29.2%
2005 30.4%
2006 33.2%
2007 31.1%
2008 47.1%
Average 35.5%
Noncurrent Asset Percentage of Total Assets
2003 57.9% 172 | P a g e
2004 70.8%
2005 69.6%
2006 66.8%
2007 68.9%
2008 52.9%
Average 64.5%
We forecasted accounts receivable based on a accounts receivable turnover ratio of 7.6 times. Inventories and PP&E were forecasted similar to accounts receivable using an inventory ratio of 3 times, and a PP&E turnover ratio 6 times. Below is a table displaying the past years turnover ratios for all three accounts, and their averages. Turnover Ratios
2004
2005
2006
2007
2008
Average
Acct Rec
6.88
6.02
7.55
6.45
11.56
7.69
Inventory
2.60
2.50
3.10
3.40
3.00
3.00
PP&E
5.29
6.21
7.32
6.90
6.82
5.98
After finding the assets portion of the balance sheet we can start on the liability and shareholder’s equity section of the statement. We started off with forecasting the retained earnings. We forecasted retained earnings by taking the beginning retained earnings (the previous years), adding the forecasted net income and subtracting the forecasted dividends. We forecasted Intersil reaching a positive retained earnings balance in year 2013. After that, to make sure the book value of equity is correct, we took the previous year’s book equity, added it to the forecasted net income and subtracted the forecasted dividends paid then balanced it out. Next, we forecasted the total liabilities. We forecasted our total liabilities by subtracting total assets from total shareholders’ equity. To forecast current liabilities, generally you take the current ratio, but in Intersil’s case in the past years the trend is they account for no long term liabilities. So, current liabilities are 100% of total liabilities.
173 | P a g e
ntersil Corporation
I
BALANCE SHEET (in Thousands)
Balance Sheet (In Thousands)
Actual Financials 2003
Fiscal Year
2004
Forecasted Finacial Statements
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
ASSETS Current Assets 129,700 393,299 77,919 96,450 14,649 43,175
137,697 417,531 99,791 86,604 11,893 32,849
158,938 465,096 98,048 92,413 16,589 18,523
323,403 160,427 117,421 98,650 9,041 39,543
215,625 97,008 66,607 109,644 9,467 35,489
50,937 35,643
57,049 64,777
62,184 70,607
67,780 76,962
73,881 83,888
80,530 91,438
87,778 99,668
95,678 108,638
104,289 118,415
113,675 129,073
Deferred income taxes
190,457 629,076 76,713 83,631 10,468 39,843
Total Current Assets
1,030,188
755,192
786,365
849,607
748,485
533,840
395,822
399,497
399,591
399,807
399,546
399,873
399,540
401,998
406,880
425,273
153,410 1,090,905 156,730 9,554 499 7,561 1,418,659
101,354 1,478,762 179,651 68,860 3,751 1,832,378
96,610 39,330 1,423,630 157,139 65,862 14,781 1,797,352
101,121 29,863 1,419,781 78,585 67,065 13,105 1,709,520
109,633 29,910 1,445,778 19,108 37,455 14,618 1,656,502
112,825 29,041 313,729 81,301 46,994 15,860 599,750
65,535
73,400
80,006
87,206
95,055
103,609
112,934
123,098
134,177
146,253
718,628
725,302
725,473
725,865
725,390
725,984
725,379
729,843
738,705
772,099
2,448,847
2,587,570
2,583,717
2,559,127
2,404,987
1,133,590
1,114,450
1,124,800
1,125,064
1,125,672
1,124,936
1,125,857
1,124,918
1,131,841
1,145,585
1,197,371
24,229 33,433 12,813 19,159 3,170 44,810 137,614
40,234 39,504 10,259 12,676 3,498 19,267 125,438
22,264 30,461 10,638 37,256 3,319 4,012 107,950
44,683
335
(65,759)
(134,640)
(219,053)
(307,728)
(415,527)
(524,778)
(648,218)
(747,056)
44,683
335
(65,759)
(134,640)
(219,053)
(307,728)
(415,527)
(524,778)
(648,218)
(747,056)
(248,643)
(42,875)
177,083
422,428
685,038
976,430
1,288,831
1,634,142
Cash and cash equivalents Short-term investments Trade receivables, net of allowances Inventories Prepaid expenses and other current assets
Non-current Assets Property, plant and equipment, net of accumulated depreciation Purchased intangibles, net of accumulated amortization Goodwill Long-term investments Deferred income taxes Related party notes Other
Non-Current Assets
TOTAL ASSETS
LIABILITIES AND OWNER'S EQUITY LIABILITIES Current Liabilities Trade payables Accrued current and retirement compensation Deferred net revenue Other accrued expenses Non-income taxes payable Income taxes payable
Total Current Liabilities
20,804 26,082 12,105 4,142 49,641 83,956 196,730
18,401 24,841 11,347 34,391 2,976 56,211 148,167
27,122 32,203 10,961 22,203 3,481 58,140 154,110
Non-current Liabilities -
Income taxes payable
Total L-T Liabilities
TOTAL LIABILITIES SHAREHOLDERS' EQUITY
196,730
-
-
-
40,670 40,670
-
148,167
154,110
137,614
166,108
107,950
1,518 2,553,855 63,103 (22,900) (157,667) 1,494
1,411 2,312,663 124,779 (9,455) 209
1,359 2,171,642 247,217 1,295
1,270 1,906,179 333,528
1,216 1,797,072 (764,262)
(2,098)
(8,386)
Preferred Stock, $0.01 par value, 2 million shares authorized; no shares issued or outstanding Class A Common Stock, $.01 par value, voting; 600 million shares authorized; 121,626,122 and 126,990,547 shares issued and outstanding as of Jan. 2, 2009 and Dec. 28, 2007, respectively Additional paid-in capital Accumulated deficit/Retained earnings Unearned compensation Treasury Shares purchases, at cost Accumulated other comprehensive loss
Total Shareholders’ Equity
TOTAL LIABILITIES & EQUITY
174 | P a g e
1,393 2,246,402 40,898 (8,956) (29,998) 2,378
(603,323) 160,939
(431,814)
1,069,767
1,124,465
1,190,824
1,260,311
1,343,989
1,433,584
1,540,446
1,656,619
2,252,117
2,439,403
2,429,607
2,421,513
2,238,879
1,025,640
1,069,767
1,124,465
1,190,824
1,260,311
1,343,989
1,433,584
1,540,446
1,656,619
1,793,803
1,944,428
2,448,847
2,587,570
2,583,717
2,559,127
2,404,987
1,133,590
1,114,450
1,124,800
1,125,064
1,125,672
1,124,936
1,125,857
1,124,918
1,131,841
1,145,585
1,197,371
INTERSIL CORPORATION BALANCE SHEET (in Thousands)
BALANCE SHEET (in Thousands)
Actual Financials
Forecasted Financial Statements 2003
Fiscal Year
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
ASSETS Current Assets Cash and cash equivalents Short-term investments Trade receivables, net of allowances Inventories Prepaid expenses and other current assets Deferred income taxes
Total Current Assets
Non-current Assets Property, plant and equipment, net of accumulated depreciation Purchased intangibles, net of accumulated amortization Goodwill Long-term investments Deferred income taxes Related party notes Other
Non-Current Assets
TOTAL ASSETS
8% 26% 3% 3% 0% 2% 42%
5% 16% 3% 4% 1% 2% 31%
6% 17% 4% 4% 0% 1% 32%
6% 19% 4% 4% 1% 1% 35%
13% 7% 5% 4% 0% 2% 31%
9% 4% 3% 4% 0% 1% 22%
0% 6% 0% 45% 6% 0% 0% 0% 58%
4% 0% 60% 7% 3% 0% 75%
4% 2% 58% 6% 3% 1% 73%
4% 1% 58% 3% 3% 1% 70%
4% 1% 59% 1% 2% 1% 68%
5% 1% 13% 3% 2% 1% 24%
29%
30%
30%
30%
30%
30%
30%
30%
30%
32%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
4%
0%
-6%
-12%
-20%
-28%
-37%
-47%
-58%
-62%
4%
0%
-6%
-12%
-20%
-28%
-37%
-47%
-58%
-62%
-54%
-38%
-22%
-4%
16%
38%
61%
86%
113%
136%
2%
2%
3%
3%
3%
3%
4%
4%
4%
5%
16%
16%
16%
16%
16%
16%
16%
16%
17%
17%
0%
0%
0%
0%
0%
0%
0%
0%
0%
0%
ASSET TURNOVER RATIO
+ LIABILITIES Current Liabilities Trade payables Accrued current and retirement compensation Deferred net revenue Other accrued expenses Non-income taxes payable Income taxes payable
Total Current Liabilities
1% 1% 0% 0% 2% 3% 8%
1% 1% 0% 1% 0% 2% 6%
1% 1% 0% 1% 0% 2% 6%
1% 1% 1% 1% 0% 2% 5%
2% 2% 0% 1% 0% 1% 5%
2% 3% 1% 3% 0% 0% 10%
Non-current Liabilities
0%
0%
0%
0%
0%
0%
Income taxes payable
2% 2%
Total L-T Liabilities
TOTAL LIABILITIES SHAREHOLDERS' EQUITY
8%
6%
6%
5%
7%
10%
0
0
0
0
0
0% 99% 2% -1% -6% 0%
0% 90% 5% 0% 0% 0%
0% 85% 10% 0% 0% 0%
0% 79% 14% 0% 0% 0%
0% 159% -67% 0% 0% -1%
92%
94%
94%
95%
93%
90%
96%
100%
106%
112%
119%
127%
137%
146%
157%
162%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
Preferred Stock, $0.01 par value, 2 million shares authorized; no shares issued or outstanding 0 Class A Common Stock, $.01 par value, voting; 600 million shares authorized; 121,626,122 and 126,990,547 shares issued and outstanding as of Jan. 2, 2009 and Dec. 28, 2007, respectively 0% Additional paid-in capital 92% Accumulated deficit/Retained earnings 2% Unearned compensation 0% Treasury Shares purchases, at cost -1% Accumulated other comprehensive loss 0%
Total Shareholders’ Equity
TOTAL LIABILITIES & EQUITY
175 | P a g e
Restated Balance Sheet
Due to the red flags we found from analyzing the accounting portion of the firm we needed to restate the actual forecast. These red flags were goodwill impairment, capitalization of research and development and capitalizing operating leases. To beging with, since total assets were affected, we had to calculate a new asset turnover ratio which over the past five years averaged to be 56%. Several accounts were added to the balance sheet. We forecasted lease asset rights and capitalized lease liabilities from the last year’s payment operating lease plan (2008). We averaged the growth rate of the accumulated depreciation compared to lease asset rights at an average of 135%. The research and development was capitalized all ten years using the model, by adding the previous year capitalized amount that Intersil should impair, and then subtracting the original research and development. Finally, we forecasted out the goodwill until it was completely reduced to zero. By restating our financials, we can assume what would happen with all the goodwill impairment, capitalization of research and development, and capitalizing operating leases.
176 | P a g e
ntersil Corporation
I
BALANCE SHEET (in Thousands)
Balance Sheet (In Thousands)
Restated 2004
Fiscal Year
2005
Forecasted Finacial Statements
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
ASSETS Current Assets 137,697 417,531 99,791 86,604 11,893 32,849
158,938 465,096 98,048 92,413 16,589 18,523
323,403 160,427 117,421 98,650 9,041 39,543
215,625 97,008 66,607 109,644 9,467 35,489
50,937 35,643
57,049 64,777
62,184 70,607
67,780 76,962
73,881 83,888
80,530 91,438
87,778 99,668
95,678 108,638
104,289 118,415
113,675 129,073
Deferred income taxes
129,700 393,299 77,919 96,450 14,649 43,175
Total Current Assets
755,192
786,365
849,607
748,485
533,840
69,104
278,221
303,261
330,555
360,305
392,732
428,078
466,605
508,600
554,374
101,354 15,266
96,610 39,330 38,834 (2,544) 174,952 935,773 157,139 65,862 14,781 1,520,736
101,121 29,863 49,663 (9,017) 245,111 648,874 78,585 67,065 13,105 1,224,370
109,633 29,910 47,940 (17,294) 297,103 391,569 19,108 37,455 14,618 930,043
112,825 29,041 119,512 (25,284) 330,509 121,532 81,301 46,994 15,860 832,291
65,535
73,400
80,006
87,206
95,055
103,609
112,934
123,098
134,177
146,253
75,080 (34,133) 369,627 35,981
48,361 (46,080) 273,037 25,506
50,779 (62,207) 195,414 15,031
53,318 (83,980) 138,826 4,556
55,984 (113,373) 104,682 (0)
58,783 (153,054) 96,216 (0)
61,722 (206,622) 101,989 -
64,808 (278,940) 108,108 -
68,048 (376,569) 114,594 -
71,451 (508,368) 121,470 -
Cash and cash equivalents Short-term investments Trade receivables, net of allowances Inventories Prepaid expenses and other current assets
Non-current Assets Property, plant and equipment, net of accumulated depreciation Purchased intangibles, net of accumulated amortization Lease Asset Rights (Capitalized Lease Liability)(Less Accum Depr) Accumulated Depreciation of Operating Lease Asset - Rights Capitalized R&D Goodwill, less acct. Amort Long-term investments Deferred income taxes Related party notes Other
Non-Current Assets
TOTAL ASSETS
96,687 1,271,598 179,651 68,860 3,751 1,737,166
2,492,358
2,307,101
2,073,977
1,678,528
1,366,131
125,461
505,121
550,582
600,134
654,147
713,020
777,192
847,139
923,381
1,006,486
194,565
783,343
853,843
930,689
1,014,451
1,105,752
1,205,270
1,313,744
1,431,981
1,560,859
LIABILITIES AND OWNER'S EQUITY LIABILITIES Current Liabilities Trade payables Accrued current and retirement compensation Deferred net revenue Other accrued expenses Non-income taxes payable Income taxes payable
Total Current Liabilities
18,401 24,841 11,347 34,391 2,976 56,211 148,167
27,122 32,203 10,961 22,203 3,481 58,140 154,110
24,229 33,433 12,813 19,159 3,170 44,810 137,614
40,234 39,504 10,259 12,676 3,498 19,267 125,438
22,264 30,461 10,638 37,256 3,319 4,012 107,950
(836,476)
(2,253)
334,601
757,890
1,288,396
1,980,585
2,890,642
4,125,835
5,821,195
8,201,855
15,266 15,266
38,834 (4,008) 34,826
49,663 (32,184) 17,479
40,670 47,940 (66,055) 22,554
119,512 (98,239) 21,273
75,080 (147,359) (72,279)
48,361 (221,039) (172,678)
50,779 (331,558) (280,779)
53,318 (497,337) (444,019)
55,984 (746,005) (690,022)
58,783 (1,119,008) (1,060,225)
61,722 (1,678,511) (1,616,790)
64,808 (2,517,767) (2,452,959)
68,048 (3,776,651) (3,708,602)
71,451 (5,664,976) (5,593,525)
(908,755)
(174,931)
(569,770) (16,776)
(598,005)
Non-current Liabilities Income taxes payable Capitalized Lease Liabilites Amortized Lease Liability
Total L-T Liabilities
TOTAL LIABILITIES SHAREHOLDERS' EQUITY
163,433
154,110
137,614
166,108
107,950
1,411 2,312,663 (186,663) (9,455) 209
1,359 2,171,642 (255,412) 1,295
1,270 1,906,179 (374,816) (2,098)
1,216 1,797,072 (552,994)
53,822
313,871
598,374
920,360
1,273,852
1,672,876
2,112,593
2,608,330
Preferred Stock, $0.01 par value, 2 million shares authorized; no shares issued or outstanding Class A Common Stock, $.01 par value, voting; 600 million shares authorized; 121,626,122 and 126,990,547 shares issued and outstanding as of Jan. 2, 2009 and Dec. 28, 2007, respectively Additional paid-in capital Accumulated deficit/Retained earnings Unearned compensation Treasury Shares purchases, at cost Accumulated other comprehensive loss
Total Shareholders’ Equity
TOTAL LIABILITIES & EQUITY
177 | P a g e
1,518 2,553,855 (47,374) (22,900) (157,667) 1,494
(8,386)
(639,445)
(686,368)
(750,828)
(825,764)
(923,990)
(1,039,322)
1,281,035
1,335,732
1,402,091
1,471,579
1,555,256
1,644,852
1,751,713
1,867,887
2,328,926
2,118,165
1,918,884
1,530,535
1,236,908
1,103,320
958,273
800,022
616,818
416,077
185,392
(68,583)
(359,132)
2,492,358
2,307,101
2,073,977
1,678,528
1,366,131
194,565
783,343
853,843
930,689
1,014,451
1,105,752
1,205,270
1,313,744
(1,185,584)
(1,357,756)
(680,612)
(1,047,471)
1,431,981
1,560,859
INTERSIL CORPORATION BALANCE SHEET (in Thousands)
BALANCE SHEET (in Thousands)
Restated
Forecasted Financial Statements 2004
Fiscal Year
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
ASSETS Current Assets Cash and cash equivalents Short-term investments Trade receivables, net of allowances Inventories Prepaid expenses and other current assets Deferred income taxes
5% 16% 3% 4% 1% 2% 30%
6% 18% 4% 4% 1% 1% 34%
8% 22% 5% 4% 1% 1% 41%
19% 10% 7% 6% 1% 2% 45%
16% 7% 5% 8% 1% 3% 39%
Property, plant and equipment, net of accumulated depreciation Purchased intangibles, net of accumulated amortization
0% 4% 0%
0% 4% 2%
0% 5% 1%
0% 7% 2%
0% 8% 2%
Lease Asset Rights (Capitalized Lease Liability)(Less Accum Depr)
1%
2%
Total Current Assets
Non-current Assets
Accumulated Depreciation of Operating Lease Asset Rights
2%
3%
9%
26%
7%
7%
7%
7%
7%
7%
7%
7%
7%
36%
36%
36%
36%
36%
36%
36%
36%
36%
36%
0 (0) 2 0
0 (0) 0
0 (0) 0
0 (0) 0
0 (0) 0
0 (0) 0
0 (0) 0
0 (0) 0
0 (0) 0
0 (0) 0
0%
0%
-1%
-2%
4%
8%
12%
18%
24%
51% 3% 0% 0% 70% 100%
41% 3% 0% 1% 66% 100%
31% 3% 0% 1% 59% 100%
23% 2% 0% 1% 55% 100%
9% 3% 0% 1% 61% 100%
64%
64%
64%
64%
64%
64%
64%
64%
64%
64%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
1% 1% 0% 1% 0% 2% 6%
18% 21% 7% 14% 2% 38% 100%
18% 24% 9% 14% 2% 33% 100%
24% 24% 6% 8% 2% 12% 76%
21% 28% 10% 35% 3% 4% 100%
-430%
-1%
172%
390%
662%
1018%
1486%
2121%
2992%
525%
0% 0%
0%
0%
0%
0%
Income taxes payable Capitalized Lease Liabilites
1%
0% 25%
0% 36%
24% 29%
0% 111%
Amortized Lease Liability
0%
-3%
-23%
-40%
-91%
Total L-T Liabilities
1%
23%
13%
14%
20%
7%
7%
7%
10%
8%
-467%
-90%
28%
161%
308%
473%
655%
860%
1086%
167%
0
0
0
0
0% 100% -8% 0% 0% 0%
0% 105% -12% 0% 0% 0%
0% 114% -22% 0% 0% 0%
0% 132% -40% 0% 0% -1%
-293%
-76%
-75%
-74%
-74%
-75%
-77%
-79%
-83%
-87%
93%
92%
93%
91%
91%
567%
122%
94%
66%
41%
17%
-6%
-27%
-48%
-67%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
Capitalized R&D Goodwill, less acct. Amort Long-term investments Deferred income taxes Related party notes Other
Non-Current Assets
TOTAL ASSETS ASSET TURNOVER RATIO
LIABILITIES Current Liabilities Trade payables Accrued current and retirement compensation Deferred net revenue Other accrued expenses Non-income taxes payable Income taxes payable
Total Current Liabilities
Non-current Liabilities
TOTAL LIABILITIES SHAREHOLDERS' EQUITY
Preferred Stock, $0.01 par value, 2 million shares authorized; no shares issued or outstanding 0 Class A Common Stock, $.01 par value, voting; 600 million shares authorized; 121,626,122 and 126,990,547 shares issued and outstanding as of Jan. 2, 2009 and Dec. 28, 2007, respectively 0% Additional paid-in capital 102% Accumulated deficit/Retained earnings -2% Unearned compensation -1% Treasury Shares purchases, at cost -6% Accumulated other comprehensive loss 0%
Total Shareholders’ Equity
TOTAL LIABILITIES & EQUITY
178 | P a g e
Statement of Cash Flows The last statement forecasted is the Statements of Cash Flows. The statement of cash flows is the hardest statement to forecast due to its volatility and unreliability to forecast from year to year. Within the statement of cash flows it consists of cash flows from operating activities (CFFO), investing activities (CFFI), and financing activities (CFFF). The statement of cash flows turns out to be very volatile, which means it is not very reliable. Although the statements of cash flows may not be reliable it is important to forecast the statement for investors. The first step in forecasting the statements of cash flows is forecasting the cash flows from operating activities. There are actually a couple of ways this could be done. The first step is to compute these ratios: CFFO/Sales, CFFO/Operating Income (OI), or CFFO/Net Income (NI). After computing these ratios we found that the most consistent data came from CFFO/Sales. So we averaged all six years starting from 2003 and the average for CFFO/Sales came out to be .26 or 26%. With this ratio of 26% we multiplied it to the forecasted sales for the next ten years to get our forecast for cash flows from operations. The next step we took after forecasting the cash flows from operating activities was to forecast the cash flows from investing activities. To do this we decided to use our PP&E turnover ratio. This was because we found that PP&E had the least change throughout the years. The PP&E turnover ratio on average was .1755 or 17.55%. After finding the ratio we took the forecast sales for Intersil and multiplied it to .1755. The CFFI was very hard to predict to the volatility of the CFFI in the past years. The last step to forecast in the cash flow statements is to forecast dividends under the cash flows from financing activities. To forecast the dividends we analyzed the past six years of dividends. Intersil Corp. has been increasing dividends very steadily throughout the years. We stated the quarterly dividends to remain at $.12 per share for the next three years. As of right now the economy is in a recession and we believe it will take a while for the technology industry to advance which was the reason to leave the quarterly dividends at $.12 per share for 3 years. After that we forecasted 179 | P a g e
that quarterly dividends to increase 2 cents per share every 2 years. The chart below shows the forecasting for the dividends over the next 10 years.
Dividend Forecast
Dividends /share Yearly dividends/shar e Shares outstanding(in thousands) Dividends paid (in thousands)
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
0.12
0.12
0.12
0.14
0.14
0.16
0.16
0.18
0.18
0.2
0.48
0.48
0.48
0.56
0.56
0.64
0.64
0.72
0.72
0.8
121,679
121,679
121,679
121,679
121,679
121,679
121,679
121,679
121,679
121,679
58405.92
58405.92
58405.92
68140.24
68140.24
77874.56
77874.56
87608.88
87608.88
97343.2
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INTERSIL CORPORATION: STATEMENT OF CASH FLOWS
Actual Financials 2003
Fiscal Year
Net income (loss) from continuing operations Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization Provisions for inventory obsolescence Impairment of goodwill Other loss Write-off of in-process research and development Restructuring and impairments Gain on sale of certain operations Gain on sale of certain investments Gain on sale of equipment Deferred income taxes Net income (loss) from discontinued operations Adjustments to reconcile net income (loss) to net cash provided by operating activities: Gain on sale of Wireless Networking Segment Other adjustments
2004
Forecast Financial Statements 2005
2006
2007
2008
45,837
40,681
85,877
151,877
140,476
46,471
36,332
34,437
31,880 -
31,172 -
34,761 1,154,676 2,115
1,870
11,538 7,607 3,005 3,439
15,181 12,156 3,295 -
48,056 33,140
44,296 2,660 20,728
30,787 3,037 6,274
31,205 32,328 (901) (3,799) (725) 2,622 328
2,227 15 12,400 (945)
(9,802) 5,165 7,732 529 1,892
(7,840) 5,944 3,380 (2,263) -
(931) 26,162 (3,087) 24,942 31,797
(493)
(2,091)
1,743 (10,500) (1,461) (3,235) (22,760) 2,758
(18,707) (9,620) 3,250 4,043 15,148 (451)
51,074 (35,846) (1,240) (3,370) (55,925) 1,087
53,816 10,653 (1,264) 3,920 18,326
12,208
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
102,533
113,104
124,765
137,628
151,818
167,470
184,736
203,782
224,792
247,968
101,835
114,055
124,320
135,508
147,704
160,997
175,487
191,281
208,496
227,261
compute PPE with a ppe TURNOVER RATIO then fc ppe multiple change in ppe by 7.5 to get CFFI (354,673) 58,982 49,545
(1,037,560)
87
Changes in operating assets and liabilities: Trade receivables Gain on sale of Wireless Networking product group Inventories Prepaid expenses and other current assets Trade payables and accrued liabilities Income taxes Other Net assets held for sale
(22,911) 6,225 3,702 2,391 2,699 5,319 (18,729)
3,815 (7,900) (9,831)
(21,872) 6,550
(5,912) (23,711) (26,935) 5,500
1,646 1,996 243 (1,116)
Net cash provided by operating activities
101,400
98,358
153,035
235,992
232,388
203,898
20% 137.322% 221.2187%
18% 607.486% 241.7787%
25% 152.821% 178.2025%
32% 155.430% 155.3836%
31% 152.964% 165.4290%
26% -19.474% -19.6517%
CFFO/Sales CFFO/Op Inc CFFO/Net Inc
2003 INVESTING ACTIVITIES: Proceeds from sale of short-term investments Purchases of short-term investments Purchases of held-to-maturity securities Held-to-maturity securities called by issuer
2004
5,560 -
Proceeds from sale of Wireless Networking product group, netProceeds from sale of available-for-sale equity investments Cash paid for acquired businesses Purchase of Xicor, net of cash received Purchase of Bitblitz Communications Purchase of cost method investments
Property, plant and equipment for discontinued operations Proceeds from sale of property, plant and equipment Purchase of property, plant and equipment
5,264 (24,026) -
2005
658,508 1,000,636 (411,319) (1,143,301)
2006
2007
657,810 (694,147) 10,000 156,567 (11,275) -
759,985 (535,250) 85,471 88,136 -
29,275 (2,500) 2,000 9,911 (80,000) -
(88,384) -
(36,171) (47,995) -
(47,955) -
-
-
-
5,904 (24,109)
123 (31,873)
56,175 (80,592) 237,513
211,563 (93,130) (23,953)
156,652 (147,979) (3,042) (240,568) -
49,745 (37,964) (235,980) 408 (2,602) (3,042)
(23,953) 6,422 (6,022)
(1,503) 5,626 (24,007)
(2,716) 1,419 (31,087)
(35,719)
(31,927)
(1,813)
2008
Net cash used in investing activities
(6,386) (46,606) - - - - - (66,194)
SALES/PPE
3.309327945 5.286175188 6.21317669 7.323869424 6.904545164 6.821847995
Change in NC Assets Change in PPE important stuff multiplier
181 | P a g e
2003
FINANCING ACTIVITIES: Proceeds from exercise of stock-based awards
Net cash used in financing activities
35,026 4,744 (24,007)
2004
2005
87,832 (4,511) (31,087) 6.89 2006
53,018 (8,512) (72,104) 8.47 2007
(121,019)
AVG 5.97649 Forecasted PPE Change in PPE Multiply by 7.5
54,004
58,864
64,162
69,936
76,231
83,091
90,570
65,535 (47,290) (354,673)
73,400 7,864 58,982
80,006 6,606 49,545
87,206 7,200 54,004
95,055 7,849 58,864
103,609 8,555 64,162
112,934 9,325 69,936
123,098 10,164 76,231
134,177 11,079 83,091
146,253 12,076 90,570
(58406)
(58406)
(58406)
(68140)
(68140)
(77875)
(77875)
(87609)
(87609)
(97343)
1,056,752 (3,192) (79,828) 25.01
2008 CFFI FC
9,378
21,568
40,455
92,552
-
(18,476)
(24,202)
9,802 7,827 (29,439)
7,840 (53,440)
931 (59,823)
(18,565)
(127,670)
(127,750)
(294,995)
(434,990)
(154,998)
(9,187)
(124,578)
(111,497) 2005
(214,253) 2006
(364,891) 2007
(191,724)
Excess tax benefit received on exercise of stock-based awards Proceeds from exercise of warrants Dividends paid Repurchase of outstanding common shares
(413,719) 52,056 (9,064)
295,971
2003
2004
115,699
22,166
2008
Restated Statement of Cash Flows The restated statement of cash flows shows almost no change in values. The only Net Income was restated because sales did not change. The restated cash flows look very similar to the cash flows statement. The net income has been lowered which lowers the cash flow operations. To find the new cash flow operations we found the difference between the net incomes for each year. We then took that number and subtracted that number by the cash flow operations from the statement of cash flows. This gave us our restated cash flow operations. To forecast the CFFO we used the CFFO/Sales which was 26% to multiply this to the forecasted sales for 10 years.
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INTERSIL CORPORATION: RESTATED STATEMENT OF CASH FLOWS
Actual Financials Fiscal Year
Net income (loss) from continuing operations Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization Provisions for inventory obsolescence Impairment of goodwill Other loss Write-off of in-process research and development Restructuring and impairments Gain on sale of certain operations Gain on sale of certain investments Gain on sale of equipment Deferred income taxes Net income (loss) from discontinued operations Adjustments to reconcile net income (loss) to net cash provided by operating activities: Gain on sale of Wireless Networking Segment Other adjustments
2004
Forecast Fin 2005
2006
2007
2008
(69,796)
(115,088)
(39,310)
(65,239)
(117,949)
36,332
34,437
31,880 -
31,172 -
34,761 1,154,676 2,115
11,538 7,607 3,005 3,439
15,181 12,156 3,295 -
48,056 33,140
44,296 2,660 20,728
30,787 3,037 6,274
31,205 32,328 (901) (3,799) (725) 2,622 328
2,227 15 12,400 (945)
(9,802) 5,165 7,732 529 1,892
(7,840) 5,944 3,380 (2,263) -
(931) 26,162 (3,087) 24,942 31,797
(493)
(2,091)
3,815 (7,900) (9,831)
(21,872) 6,550
(5,912) (23,711) (26,935) 5,500
1,646 1,996 243 (1,116)
1,743 (10,500) (1,461) (3,235) (22,760) 2,758
(18,707) (9,620) 3,250 4,043 15,148 (451)
(12119.20)
(47929.74)
2009
2010
2011
2012
2013
102,533
113,104
124,765
137,628
151,81
101,835
114,055
124,320
135,508
147,70
87
Changes in operating assets and liabilities: Trade receivables Gain on sale of Wireless Networking product group Inventories Prepaid expenses and other current assets Trade payables and accrued liabilities Income taxes Other Net assets held for sale Net cash provided by operating activities
2005
2004 INVESTING ACTIVITIES: Proceeds from sale of short-term investments Purchases of short-term investments Purchases of held-to-maturity securities Held-to-maturity securities called by issuer Proceeds from sale of Wireless Networking product group, net
Proceeds from sale of available-for-sale equity investments Cash paid for acquired businesses Purchase of Xicor, net of cash received Purchase of Bitblitz Communications Purchase of cost method investments
Property, plant and equipment for discontinued operations Proceeds from sale of property, plant and equipment Purchase of property, plant and equipment Net cash used in investing activities
658,508 (411,319)
1,000,636 (1,143,301)
56,175 (80,592) 237,513
211,563 (93,130) (23,953)
156,652 (147,979) (3,042) (240,568) -
49,745 (37,964) (235,980) 408 (2,602) (3,042)
(23,953) 6,422 (6,022)
(1,503) 5,626 (24,007)
44805.07
2006
26673.18
2007
51,074 (35,846) (1,240) (3,370) (55,925) 1,087
1123509.44
2008
657,810 (694,147) 10,000 156,567 (11,275) -
759,985 (535,250) 85,471 88,136 -
29,275 (2,500) 2,000 9,911 (80,000) -
(88,384) -
(36,171) (47,995) -
(47,955) -
-
-
-
(2,716) 1,419 (31,087)
5,904 (24,109)
123 (31,873)
compute PPE with a ppe TURNOVER RATIO then fc ppe multiple change in ppe by 7.5 to get CFFI (354,673) 58,982
(35,719) (31,927) (1,813) 295,971 (121,019) AVG 3.492438563 5.922361229 7.66584205 5.298355436 5.475130663 5.976490401 Forecasted PPE Change in PPE Multiply by 7.5
SALES/PPE
Change in NC Assets Change in PPE important stuff multiplier
(413,719) 52,056 (9,064)
2004 FINANCING ACTIVITIES: Proceeds from exercise of stock-based awards
35,026 4,744 (24,007)
2005
87,832 (4,511) (31,087) 6.89 2006
53,018 (8,512) (72,104) 8.47 2007
49,545
54,004
58,86
65,535 (47,290) (354,673)
73,400 7,864 58,982
80,006 6,606 49,545
87,206 7,200 54,004
95,05 7,84 58,86
(58406)
(58406)
(58406)
(68140)
(6814
2009
2010
2011
2012
1,056,752 (3,192) (79,828) 25.01
2008 CFFI FC
21,568
40,455
92,552
115,699
22,166
(18,476)
(24,202)
9,802 7,827 (29,439)
7,840 (53,440)
931 (59,823)
Repurchase of outstanding common shares
(127,670)
(127,750)
(294,995)
(434,990)
(154,998)
Net cash used in financing activities
(124,578)
(111,497) 2005
(214,253) 2006
(364,891) 2007
(191,724)
(1,614) 7,997 129,700 137,697
1,315 21,241 137,697 158,938
997 164,465 158,938 323,403
1,067 (107,778) 323,403 215,625
Excess tax benefit received on exercise of stock-based awards Proceeds from exercise of warrants Dividends paid
2004 Effect of exchange rates on cash and cash equivalents Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at the beginning of the period Cash and cash equivalents at the end of the period
1,182 (60,757) 190,457 129,700
2008
INTERSIL CORPORATION: RESTATED STATEMENT OF CASH FLOWS
Actual Financials Fiscal Year
Net income (loss) from continuing operations
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Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization Provisions for inventory obsolescence Impairment of goodwill Other loss Write-off of in-process research and development Restructuring and impairments Gain on sale of certain operations Gain on sale of certain investments
2004
Forecast Fin 2005
2006
2007
2008
100%
100%
100%
100%
100%
-299.79% 0.00% 0.00% -95.20% -62.77% -24.80% -28.38% 0.00% -257.48%
-71.85% 0.00% 0.00% -31.67% -25.36% -6.87% 0.00% 0.00% 0.00%
71.15% 0.00% 0.00% 0.00% 107.26% 0.00% 73.96% 0.00% -21.88%
116.87% 0.00% 0.00% 0.00% 166.07% 9.97% 77.71% 0.00% -29.39%
3.09% 102.77% 0.19% 0.00% 2.74% 0.27% 0.56% 0.00% -0.08%
100%
100%
100%
100%
2013
100
Firm Valuation The final step of this analysis aims to determine whether the ISIL’s share price represents its underlying economic value. In order to come to a conclusion concerning whether Intersil is fairly valued, undervalued, or overvalued, we will apply two different methods of valuation. The first method is a quick and simple method that uses ratios that can be calculated using publicly available financial date that are used to determine the share price of a firm. This is called the method of comparables. However, the method of comparables can generate misleading results and had little theory supporting its findings. The other method we will apply is “intrinsic valuation.” Based on financial theory, the approach to finding a firm’s “intrinsic “ value involves utilizing a variety of models which take into account a broad range of factors effecting firm profitability.
Method of Comparables A common approach to the valuation of a firm is using method of comparables ratios. In order to apply this method, we have collected publicly available data concerning Intersil and its peer group, which we have collected from http://finance.yahoo.com. The method of comparables approach to valuation seeks to compute ratios using financial data of a firm’s competitors, and then take an average from which the target firm is excluded, which can then be applied to the firm being valued in order to calculate the price per share. Once applying each method of comparable ratio to calculate ISIL’s share price based, we will concluded whether ISIL is over, correctly, or undervalued based on whether the computed value exceeds a 10% standard deviation from ISIL’s actual share price of $13 per share on June 1st, 2009. At a 10% margin of safety, the “safety zone” falls between $11.70 and $14.3 per share. Accordingly, if the computed share price is less than $11.7, the method will assume ISIL is overvalued, and contrastingly, if the method of comparable is applied to compute ISIL’s share price as being 184 | P a g e
over $14.3 per share, then it concludes that ISIL is undervalued. It should be noted that although the method of comparables approach can provide an analyst a quick and relatively simple method of valuation, we will present it as a supplement to “intrinsic valuation” which involves theoretical models that take into account a broader range of factors to reflect underlying business reality. It should also be noted that one weakness of this method is that a number of these ratios cannot be applied in the event that a firm experienced a recent loss per share, or is forecasting to have losses in the future.
Price to Earnings Ratio (Trailing)
The price to earnings (P/E) trailing ratio is computed by dividing a firm’s share price by its earnings per share. The trailing method uses historical data; therefore, it is seen as a more reliable method of comparable. However, due to the fact that ISIL reported a loss on its 2008 10-K, we were unable to compute an “As Stated” P/E ratio for ISIL due to the fact that it would result in a negative share value.
Price to Earnings Ratio (Forward)
Similarly to the price to earnings ratio, the turbulence in recent economic activity has led to a loss in share value due to our forecasted losses. So we could not compute Intersil’s price to earnings ratio. Unfortunately, the same holds true for the Price Earns Growth (P.E.G.) ratio. Due to the fact that we have negative earnings forecasts, to apply these methods would yield irrelevant results due to the fact that share value would compute as negative.
Price / Book
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The price to book ratio measures is one of the most popular methods of comparables ratios which is computed by dividing the price per share or market value of equity of a firm by the total book value of equity or book value of equity per share of a firm. We were able to take the average of the price to book ratios of TXN, ADI, and MXIM which was computed to be 2.57. LLTC had to be excluded to its equity deficit related to an accelerated share repurchase arrangement. After calculating this ratio, we were able to apply it to ISIL’s BPS which resulted in a valuation of $21.41 per share. Thus, according to this method of comparable, ISIL is overvalued.
Price to Book Ratio FIRM ISIL ISIL Adj. TXN ADI LLTC MXIM
PPS
Comparables
BPS
$
13.00
$ $ $ $
21.27 24.39 22.23 15.76
$ $ $ $ $ $
P/B Ratio 8.34 8.39 7.23 8.31 (1.30) 8.64
$ $ $ $
1.56 $ 1.55 $ 2.94 2.94
Ind. Avg.
ISIL PPS
2.57 $ 2.57 $
21.41 20.14
N/A $
1.83
Dividends / Price The dividends to price ratio can be very useful when it comes to the methods of comparable. All four of the competitors had dividends which made this valuation very useful. To find Intersil’s price we took Intersil’s dividends per share and divided it by the industry average dividends over price to get the price of Intersil. The price of Intersil came out to be $16.17. By calculating it this method it leads to say that Intersil is undervalued.
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Dividends / Price FIRM ISIL
13.00 21.27
$
0.480
D/P 0.037
TXN
$ $
$
0.410
0.019
ADI
$
24.39
$
0.780
0.032
LLTC
$ $
22.23 15.76
$
0.840
0.038
$
0.966
0.061
MXIM
PPS
Comparables
DPS
$
Ind. Avg. 0.0297
$
ISIL PPS 16.17
Price / EBITDA The Price to EBITDA ratio is calculated by the market cap divided by the earnings before interest, tax, depreciation, and amortization (EBITDA). There is one weakness to this model ratio which is because it ignores a company’s ability to manage debt and taxes. The lower the Price / EBITDA it could mean more profitability because EBITDA represents an operating cash flow. A low ratio could also tell us that there is a strong correlation between the value generated by the firm and the markets valuation of firm assets. According to this ratio it shows that ISIL is overvalued compared to the industry.
Price / EBITDA FIRM
Mkt. Cap (Mil)
ISIL ISIL Adj. TXN ADI LLTC
$ $ $ $
1,589 $ $ 27,580 $ 7,120 $ 4,940 $
MXIM
$
4,870 $
187 | P a g e
Comparables
EBITDA (Mil)
P/EBITDA
111 $ 189 3,050 $ 609 $ 527 $ 409
$
Ind. Avg. 14.33 $ $ 9.04 11.70 9.37 11.89
10.50 $ 10.50 $
ISIL PPS 9.53 16.20
Price / Free Cash Flows The price to free cash flows gives us an overview by comparing value of operating cash flows relative to the market price. The price to free cash flows ratio is calculated by dividing the firm’s market capitalization rate by their free cash flows. If a firm has a P / FCP that is negative or significantly different from the rest of the firms it should be taken out, however we do not see such a case. ISIL price was found to be $19.13 which states that it is undervalued. The equation for a firm’s price to free cash flow is: P/FCF = (Price per share x shares outstanding) / (Cash flows from operations +/Cash flows from investing)
Price / Free Cash Flows FIRM ISIL ISIL Adj. TXN ADI LLTC MXIM
Mkt. Cap (Mil.) 1,589 $ $ $ $
Comparables
FCF (Mil.)
P/FCF
$
83
$
165.42
27,580 $ 7,120 $ 4,940 $ 4,870 $
2,149 205 279 151
$ $ $ $ $
19.17 $ $ 12.83 34.74 17.73 32.16
Ind. Avg. 28.21 28.21
$ $
ISIL PPS 19.13 38.18
Enterprise Value/EBITDA The enterprise value to EBITDA ratio can be found by dividing the firm’s earnings before interest, tax, depreciation and amortization into the firm’s enterprise value. To find the enterprise value add the firm’s market value of equity with its book value of 188 | P a g e
liabilities and then subtract its cash and investments from that. The enterprise value to EBITDA carries the same weakness as price/EBITDA ratio because taxes and debt management are not taken into account.
Enterprise Value / EBITDA FIRM
EV (Mil.)
ISIL
$
EBITDA (Mil.)
$ $ $ $
EV/EBITDA
Ind. Avg.
ISIL PPS
1,200 $
111
$
9.46
$
11.72
$
189
$
9.46
$
19.92
ISIL Adj. TXN ADI LLTC MXIM
Comparables
24,740 $ 5,820 $ 5,520 $ 3,910 $
3,050 $ 609 $ 527 $ 409 $
8.11 9.56 10.47 9.71
Using this ratio ISIL shows a price of $11.72 and and industry average of $9.46. It shows us that Intersil is fairly value however when Intersil is restated the price is undervalued.
Enterprise Value / Free Cash Flows To find this ratio you would take the enterprise value and divide it by free cash flows. We see here that no firm is really a major outlier so we took each firm to find the industry average. The industry average showed a price $24.67 and ISIL a price of $15.12. Again this shows us that Intersil is fairly valued compared to the industry.
Enterprise Value / Free Cash Flows Firm ISIL TXN
$ $
ADI LLTC MXIM
$ $ $
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EV (Mil.) 1,200.00 24,740.00
FCF (Mil.)
Comparables
$ $
74.89 2,149.00
$ $
EV / FCF 16.02 11.51
5,820.00 $ 5,520.00 $ 3,910.00 $
204.97 278.67 151.45
$ $ $
28.39 19.81 25.82
$
Ind. Avg. 24.67 $
ISIL PPS 15.12
Conclusion By analyzing the method of comparable ratios we see a wide range of values which makes it difficult to rely on these ratios for accuracy. These ratios do not include analyst insights and are just number computed to one another which make it difficult to predict. The valuation ratios’ present a wide range of speculative value and overall present conflicting results. The overall valuation shows us that Intersil is fairly valued there were a couple ratios that told us the firm as undervalued and a couple that told us they were overvalued. Two of the ratios told us that they are fairly valued which means the firm on average is fairly valued.
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Intrinsic Valuation Models The Intrinsic Valuation Models are created to asses or estimate a company’s market value price per share. The different valuation models analyze a detailed view of the valuation of a firm. The intrinsic valuation models will include Discounted Dividends Model, Residual Income Model, Free Cash Flow Model, Abnormal Earnings Growth (AEG), and Long Run Residual Income Model. To find an accurate estimation of current stock price performance each valuation model must use forecast to create assumptions. A sensitivity analysis is achieved for each model by using growth rates and the cost of equity in order to find the value of a firm. The forecasting line items used included are from the income statement, balance sheet, and statement of cash flows. There are three ways we can value a firm which can be describe as; over-valued, fairly valued, or under-valued. By analyzing the valuation models it will show a better representation of the value of Intersil Corp.
Discounted Dividends Model The Discounted Dividends Model is the simplest model for valuing equity; it presents that the value of the stock is the present value of all expected dividends. This model is the simplest equity valuation model but at the same time it is also the most unreliable model. The two basic inputs for the discounted dividends model are the expected dividends and the cost of equity. The expected dividends are determined by assumptions made about future earnings growth rates and payout ratios. The Discounted Dividends Model are supported by many financial theories but is seen as the most unreliable in estimating equity value and the model also holds limitations. The models sensitivity to growth rate inputs is considered the most significant limitation. In this model growth rate inputs are estimated and are kept at a 191 | P a g e
constant rate throughout the model. This method is somewhat impractical because it will be unlikely for a firm to grow the dividends at a constant rate or even pay a dividend each year. Another problem with the model is that it holds the rate of return constant; however, a firm’s required rate of return is going to change throughout time. The as stated results indicated that Intersil is overstated, as shown below.
Cost of Equity
Backdoor
0.0768 0.0927 0.1087 0.1246 0.1405 0.1565 0.1725 0.3818
0 $9.63 $7.86 $6.61 $5.68 $4.98 $4.41 $3.96 $1.65
0.033 $13.79 $10.79 $23.44 $6.53 $5.54 $4.81 $4.24 $1.66
Growth Rates 0.067 0.1 0.133 $47.37 N/A N/A $18.37 N/A N/A $11.15 $7.24 $5.29 $8.41 $15.21 N/A $6.66 $9.53 $37.65 $5.51 $7.01 $12.72 $4.71 $5.29 $7.94 $1.68 $1.70 $1.72
<$11.70 $ 11.70
0.167 N/A N/A $4.11 N/A N/A N/A $39.89 $1.48
0.2 $0.67 $0.34 $3.36 N/A N/A N/A N/A $1.79
$ 14.30 $14.30<
According to the as stated discounted dividends, about $5.00 out of the $13.00 share is explained through dividends. The model shows that the firm is overvalued because it relies heavily on dividends, not on capital gains. In some instances there was a negative share value, which is not applicable so the chart above read N/A because you cannot have a negative share price. The N/A share price was caused by growth exceeding the cost of equity, which cost of equity should always be greater than the growth rate.
Residual Income Model The Residual Income valuation model is considered to have the highest explanatory power, which makes this model the most reliable. The reason why this model has the highest explanatory power is because it is the least responsive to changes in the growth rate. This model is based on a firmâ&#x20AC;&#x2122;s book value of equity and present value of the value added by the company instead of terminal value. When the 192 | P a g e
terminal value is used in models there is a higher risk in calculating errors in the long run. The residual income model avoids the method of using terminal value which makes it the most accurate out of the models we look at. The annual residual income is the value added back into the company. To find the annual residual income you subtract the companyâ&#x20AC;&#x2122;s net income for that year by the normal income. You can find the normal income by multiplying the book value of equity from the previous year to the cost of equity. If the annual residual income is positive it means that the company created value to that year. When the annual residual value is negative it means that the company lost value. The as stated residual income model denotes that Intersil is overrated. Since the residual income model is grounded in theory and can explain nearly 90% of a firms valuation, it is more reliable than the other valuation model and more consideration should be given towards it.
-10%
Cost of Equity
Backdoor
0.0768 0.0927 0.1087 0.1246 0.1405 0.1565 0.1725 0.3818
N/A N/A N/A N/A N/A N/A N/A
N/A N/A N/A N/A N/A N/A $1.06
N/A<0
<$11.70
Growth Rates -20% -30% N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A $0.03 $0.12 $0.30 $1.06 $1.06 $
11.70
$
-40%
-50% N/A N/A N/A N/A
$0.17 $0.38 $1.06 14.70 $14.30<
Above is the restated residual income model. It resembles the as stated but it relies heavily on income, and since income is negative, it causes a majority of negative share values. Although the restated show Intersil in a better light when it comes to profitability and capital structure ratios, the residual income model finds that Intersil is very over-valued. 193 | P a g e
$0.01 $0.26 $0.46 $1.06
Discounted Free Cash Flows Model The discounted free cash flows model is a valuation model that determines the value of a company by adding the present value of a firm’s forecasted year by year free cash flow and the present value of the free cash flow perpetuity. The model depends on the cash flows from operating (CFFO) and cash flows from investing (CFFI). These line items are both found on the statements of cash flows. The first step in this model is to find the year by year cash flows by taking the CFFO and subtracting CFFI. After that you take the year by year cash flows and multiply it to the year’s present value factor to find the present value for each year. After that the present value of the year by year free cash flows are summed up and added to the present value of the free cash flows perpetuity which equals the total market value of assets. After you find the total market value of assets you then divide it by the number of total shares outstanding to calculate the price per share. To compare figures the time consistent price is used as a benchmark like the discounted dividends model.
Cost of Equity
Backdoor
0.0768 0.0927 0.1087 0.1246 0.1405 0.1565 0.1725 0.3818
0 $9.63 $7.86 $6.61 $5.68 $4.98 $4.41 $3.96 $1.65
0.033 $13.79 $10.79 $23.44 $6.53 $5.54 $4.81 $4.24 $1.66 N/A<0
Growth Rates 0.067 0.1 0.133 $47.37 N/A N/A $18.37 N/A N/A $11.15 $7.24 $5.29 $8.41 $15.21 N/A $6.66 $9.53 $37.65 $5.51 $7.01 $12.72 $4.71 $5.29 $7.94 $1.68 $1.70 $1.72 <$11.70 $ 11.70
0.167 N/A N/A $4.11 N/A N/A N/A $39.89 $1.48
0.2 $0.67 $0.34 $3.36 N/A N/A N/A N/A $1.79
$ 14.70 $14.30<
The as stated free cash flows model indicates that Intersil is overvalued. This is because it bases its evaluation on “wishful thinking” and what is projected for the firm. It does not take into account time zero, which for Intersil, 2008 was not a 194 | P a g e
good overall fiscal year due to their â&#x20AC;&#x153;big-bath,â&#x20AC;? even though Intersil reported positive cash flow. Because we forecasted positive cash flows for future years, Intersilâ&#x20AC;&#x2122;s outlook looks better than its current fiscal standing. However, though these numbers are our most educated forecast, they are not 100% accurate. Also, there were still N/As representing a negative price for the firm, which is impossible. This is due to the growth rate exceeding WACCbt. WACC is always greater than the growth rate so these growth rates were not plausible for WACCbt, causing not-applicable price. 0.0757 0.0901 0.1045 WACCbt 0.1189 0.1334 0.1478 0.1623 Backdoor 0.35163
0 $27.42 $21.76 $18.17 $15.36 $13.00 $11.21 $9.67 $2.36
0.023 $35.43 $26.33 $21.16 $16.47 $14.39 $12.21 $10.39 $2.40 N/A<0
0.047 $57.49 $36.21 $26.84 $19.76 $16.62 $13.73 $11.43 $2.45 <$11.70 $
0.07 0.09 0.12 $252.93 N/A N/A $66.86 $1,239.60 N/A $39.68 $83.98 N/A $27.19 $41.20 N/A $20.35 $26.80 $72.59 $16.06 $19.61 $34.38 $12.94 $15.02 $21.76 $2.50 $2.55 $2.65 11.70
$
0.14 N/A N/A N/A N/A N/A $107.94 $35.94 $2.73
14.70 $14.30<
Above is the restated free cash flows model, which is not as heavily based on net income as the residual income and AEG model. Because cash is still flowing into the firm, just being taking out later on in the financial statements, and because the free cash flow model does not take into consideration time zero, (which is negative for Intersil) the free cash flows model show that Intersil is undervalued. However, the residual income model is not as sensitive to growth rates and is based in theory, so it is more reliable.
Abnormal Earnings Growth The abnormal earnings growth model is based on the forecasted numbers from net income and total dividends. This model here uses information directly from the financial statements. The abnormal earnings growth rate has a higher explanatory power than the the discounted dividend and discounted free cash flow model.
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To derive the abnormal earnings growth the first step needed to be taken is find dividend reinvestment or DRIP. To find DRIP you would multiply previous year’s total dividend payment by the cost of equity for the 10 years forecasted. DRIP is used to understand the dividends reinvested back in to a company’s stock based on the return from the cost of equity. After finding DRIP the next step would be to calculate the sum of the current year’s net income and dividend amount. The next step is to calculate normal or benchmark earnings. To calculate this we multiplied a year lagged net income by one plus our cost of equity. After we find our normal earnings we need to subtract cumulative dividend earnings by our normal earnings. After we calculated that we must convert this number to abnormal earnings growth in current 2009 dollars. In order to find our abnormal earnings growth in present value we multiplied our abnormal earnings growth by each year’s present value factor. The present value factor is found by using this 1/(1+Ke)^ t. The next step we took was to find the terminal value of perpetuity. To find our perpetuity we took our forecasted AEG from 2018 and divided it by the cost of equity minus our growth rate. Then we took that number and multiplied it to our PV factor from 2019 which gives us our perpetuity. After that we summed up the total core net income which is net income from 2006, we take this number and add it to the total present value of AEG plus our perpetuity. We then take that number and divided it by the number of share outstanding which is 122220. We then take that number and divide by our cost of equity to find the intrinsic value per share. We now have the model price at the end of 2008 for Intersil.
196 | P a g e
Cost of Equity
Backdoor
-10% $21.19 $15.51 $11.86 $9.40 $7.66 $6.39 $5.43 $1.66
0.0768 0.0927 0.1087 0.1246 0.1405 0.1565 0.1725 0.3818
N/A<0
-20% $19.85 $14.83 $11.51 $9.23 $7.59 $6.36 $5.43 $1.67
Growth Rates -30% $19.22 $14.49 $11.33 $9.14 $7.55 $6.35 $5.43 $1.67
<$11.70
$
11.70
-40% $18.86 $14.29 $11.22 $9.08 $7.52 $6.34 $5.54 $1.68 $
-50% $18.62 $14.15 $11.14 $9.04 $7.50 $6.34 $5.44 $1.68
14.70 $14.30<
The as stated AEG shows that Intersil is overvalued. This correlates to the as stated residual income, which is good validation that these models are displaying an accurate valuation of Intersil since the AEG is closely related to the residual income model.
-10%
Cost of Equity
Backdoor
0.0768 0.0927 0.1087 0.1246 0.1405 0.1565 0.1725 0.3818
N/A N/A N/A N/A N/A
N/A<0
-20%
N/A N/A N/A N/A N/A $0.08 N/A $1.15
Growth Rates -30% N/A N/A N/A N/A N/A N/A
$1.18
<$11.70
-40% N/A N/A N/A N/A N/A N/A
$1.18 $
11.70
-50% N/A N/A N/A N/A N/A N/A
$1.16 $
$1.15
14.70 $14.30<
The AEG valuation above is the restated version. Much like the restated residual income. The AEG model puts more weight on projected earnings and due to the negative net income in 2008, as well as increased expenses, net income remained negative throughout the forecast. The AEG confirms that the restated valuations are over-valued.
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Long Run Residual Income The Long Run Residual Income uses similar methods from the residual income model but there are a few differences between the two. In the residual income model we used dividends to forecast the market value of equity. In the long run dividends are harder to forecast. So in the long run residual income model we use: Mve = Be(t0) * [1+(Roe-Ke)/(Ke-g)] to calculate the market value of equity.
YEAR ROE
2009 9.6%
2010 10.1%
KL Ke Ku
Back Door
2011 10.5%
2012 10.9% g1 1.5% $15.91 $12.70 $10.57 $9.07 $7.95 $7.07 $6.13 $2.85
0.0768 0.0927 0.1087 0.1246 0.1405 0.1565 0.1725 0.3818
<$11.70
2013 11.3% g2 3.5% $19.43 $14.13 $11.10 $9.16 $7.81 $6.80 $5.80 $2.49 $ 11.70
RL KL
Ke
Ku Back Door
0.0768 0.0927 0.1087 0.1246 0.1405 0.1565 0.1725 0.3818
g3 5.5% $29.41 $17.07 $12.03 $9.31 $7.61 $6.43 $5.57 $2.09
2015 12.0%
0.1195 25.29 14.68 10.34 8.01 6.54 5.53 4.79 1.8 $ 11.70
2016 12.3%
2017 12.5%
g4 g5 7.3% 9.0% $128.23 N/A $24.82 $127.11 $13.75 $18.42 $9.55 $9.99 $7.32 $6.87 $5.94 $5.23 $5.00 $4.23 $1.68 $1.25
$ 14.30 $14.30<
R* 0.1000 17.65 10.24 7.22 5.59 4.56 3.86 3.34 1.25
<$11.70
198 | P a g e
2014 11.7%
Ru 0.1390 32.94 19.12 13.47 10.43 8.52 7.2 6.24 2.34
0.1585 40.59 23.55 16.6 12.85 10.5 8.87 7.69 2.88
$ 14.30 $14.30<
0.1780 48.23 27.99 19.72 15.27 12.48 10.55 9.14 3.42
2018 12.8%
RL
0.1100 0.1350 0.1600 0.1900 0.2200
R* Ru
g1 1.5% 7.49 9.46 11.43 13.80 16.16 <$11.70
g2 3.5% 7.23 9.64 12.06 14.95 17.84 $ 11.70
g3 5.5% 6.83 9.93 13.04 16.76 20.49
g4 7.3% 6.2 10.38 14.57 19.59 24.62
g5 9.0% 5 11.24 17.48 24.98 32.47
$ 14.30 $14.30<
As shown above, the as stated sensitivity analysis shows that Intersil is overstated. The last sensitivity analysis showed that Intersil is fairly stated; however it shows high growth rates with high return on equity, so it is natural that Intersil would have a greater value through this sensitivity test.
KL R 24%
Ke Ku
Back Door
0.0768 0.0927 0.1087 0.1246 0.1405 0.1565 0.1725 0.3818
g1 -23.3% $13.05 $12.46 $11.92 $11.43 $10.98 $10.57 $10.19 $7.00 N/A<0
KL G 2.3% Ke
Ku Back Door
0.0768 0.0927 0.1087 0.1246 0.1405 0.1565 0.1725 0.3818
RL -0.2430 N/A N/A N/A N/A N/A N/A N/A N/A N/A<0
199 | P a g e
g2 -10.5% $16.22 $14.65 $13.90 $12.99 $12.19 $11.48 $10.86 $6.45 <$11.70
g3 2.3% $34.48 $23.71 $21.80 $18.46 $16.02 $14.15 $12.68 $5.50 $ 11.70
g4 15.1% N/A N/A N/A N/A N/A $140.82 $36.15 $3.51
g5 27.9% $1.65 $1.80 $1.97 $2.18 $2.44 $2.77 $3.20 N/A
$ 14.70 $14.30<
R* 0.0000 N/A N/A N/A N/A N/A N/A N/A N/A <$11.70
Ru 0.2430 0.4860 0.7290 $34.96 $68.80 $112.18 $27.08 $56.99 $86.91 $22.11 $46.52 $3.37 $18.71 N/A $60.05 $16.24 $197.11 $52.11 $14.34 $98.59 $46.02 $12.85 $65.88 $41.24 $5.58 $12.78 $17.90
$ 11.70
$ 14.70 $14.30<
RL K 12.46%
R* Ru
-0.2430 0.0000 0.2430 0.4860 0.7290
g1 -23.3% N/A $5.63 $11.50 $17.38 $23.12 N/A<0
g2 -10.5% N/A $3.95 $13.10 $22.24 $31.39
g3 2.3% N/A N/A N/A $18.65 $60.05
<$11.70
$ 11.70
g4 15.1% $128.97 $49.43 N/A N/A N/A
g5 27.9% $29.22 $15.62 $2.01 N/A N/A
$ 14.70 $14.30<
Above is the restated long run residual income. This shows that prices are no so much subject to cost of equity, but the growth rate and return on equity. Due to the irregularity of the forecasted growth and ROE, it was difficult to find a median into which most years applied. By calculating larger spread, we were able to see that growth rates and ROE played a more significant factor in price.
Conclusion The models such as discounted dividends and free cash flow models find that it is fairly to undervalued. The restated numbers also agreed with the stated numbers, indicating a much stronger undervalued. However the residual income and AEG models indicate that the firm is strongly overvalued. The residual income model is generally more accepted than the free cash flow, since free cash flow does not take into account time zero and is based on wishful thinking. So according to models, Intersil is overvalued.
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Appendix A.
Wallstreet Journal Articles: 1. Semiconductor Sales Fall 30% http://online.wsj.com/article/SB124117330343176947.html 2. What Does Steve Jobs Want With All Those Chip Guys? http://blogs.wsj.com/digits/2009/04/29/what-does-steve-jobs-wantwith-all-those-chip-guys/ 3. In Major Shift, Apple Builds Its Own Team to Design Chips http://online.wsj.com/article/SB124104666426570729.html 4. China's Chip-Making Capacity Use Slumps http://online.wsj.com/article/SB124030929365338685.html
5. Semiconductor Sales Fall 30% http://online.wsj.com/article/SB124117330343176947.html 6. Chip Makers to Benefit From 'Smart Meters' http://online.wsj.com/article/SB123855858310477279.html B.
Firm SEC filings 1. Intersil 10-K 2004-2008 http://www.intersil.com
2. Texas Instruments 10-K 2004-2008 http://www.ti.com
3. Analog Devices 10-K 2004-2008 http://www.analog.com
4. Linear Technology, Inc. 10-K 2004-2008 http://www.linear.com
5. Maxim Integrated Products 10-K 2004-2008 http://www.maxim-ic.com
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C.
Additional Articles:
1. EE Times. “Intersil to cut 9 percent of workforce." By: Mark LaPedus. http://www.eetimes.com/showArticle.jhtml;jsessionid=KECCEHGDPIMY WQSNDLOSKHSCJUNN2JVN?articleID=212000650 2. EE Times - “Intersil to acquire Kenet” – by Mark LaPedus. (09/30/2008 10:08 AM EDT) http://www.eetimes.com/showArticle.jhtml;jsessionid=24PC10PRQB3MCQSNDL OSKHSCJUNN2JVN?articleID=210604697 3. EE Times – “Freescale to focus on core units, exit mobile IC business” - By Bolaji Ojo. http://www.eetimes.com/showArticle.jhtml;jsessionid=BAZNHO0IWL2B2QSNDL OSKHSCJUNN2JVN?articleID=210605416 4. EE Times – “Intersil buys power management firm” – By Mark LaPedus. (12/18/2008 10:12 AM EST) http://www.eetimes.com/showArticle.jhtml;jsessionid=BAZNHO0IWL2B2QSNDL OSKHSCJUNN2JVN?articleID=212501155 5. TheStreet.com – “Intersil Sells Off Its WLAN Business” – By K.C. Swanson. - (07/16/03) http://www.thestreet.com/story/10100866/1/intersil-sells-off-its-wlanbusiness.html 6. EE Times – “IC vendors come (back) to analog” – By Bill Schweber (12/15/2008) http://www.eetimes.com/showArticle.jhtml;jsessionid=GBUNE2OZX5MQSQSND LOSKHSCJUNN2JVN?articleID=212300483 7. EE Times - "High-voltage hype charges up foundries" - By Mark LePedus (11/17/2008) http://www.eetimes.com/showArticle.jhtml;jsessionid=FBITHGIVQ5UHQQSNDL OSKHSCJUNN2JVN?articleID=211800567&pgno=2
202 | P a g e
D.
Excel Spreadsheet Quantitative Data
FIRM BACKLOG FIRM
2003
2004
2005
2006
2007
2008
ISIL
83.6
78.8
132.8
117.7
176.4
86.9
TXN
1708
1576
1880
1640
1500
860
ADI
387
329
356
390
396
333
LLTC
57.2
151.2
90.1
93.7
112.2
122.5
MXIM
227
529
313
429
412
370
492.56
532.8
554.38
534.08
519.32
354.48
Industry
% Change of Backlog from Previous Year FIRM
2004
2005
2006
2007
2008
ISIL
-5.7%
68.5%
-11.4%
49.9%
-50.7%
TXN
-7.7%
19.3%
-12.8%
-8.5%
-42.7%
ADI
-15.0%
8.2%
9.6%
1.5%
-15.9%
LLTC
164.3%
-40.4%
4.0%
19.7%
9.2%
MXIM
133.0%
-40.8%
37.1%
-4.0%
-10.2%
Industry
53.8%
3.0%
5.3%
11.7%
-22.1%
R&D as a Percentage of Total Revenue 2003
2004
2005
2006
2007
2008
6 yr AVG
ISIL
18.0%
20.1%
18.5%
17.1%
17.8%
18.7%
18.3%
TXN
17.8%
15.7%
15.0%
15.4%
15.5%
15.5%
15.8%
ADI
22.1%
19.5%
20.8%
20.4%
20.7%
20.7%
20.7%
LLTC
15.1%
13.0%
12.5%
14.7%
16.9%
16.8%
14.8%
MXIM
23.6%
21.3%
19.6%
27.7%
32.8%
28.1%
25.5%
Industry
19.3%
17.9%
17.3%
19.1%
20.7%
19.9%
19.0%
FIRM
\
203 | P a g e
Percentage Change of Revenue from Previous Year FIRM
2004
2005
2006
2007
2008 5yr AVG
ISIL
17.71%
3.17%
14.10%
6.26%
6.85%
9.62%
TXN
13.16%
1.87%
8.93%
-2.51%
-9.35%
2.42%
ADI
13.60%
-3.37%
-7.49%
10.81%
4.70%
3.65%
LLTC
14.45%
25.63%
22.38%
14.12%
7.37%
16.79%
MXIM
12.48%
7.13%
56.67%
28.28%
-12.40%
18.43%
Industry
14.28%
6.88%
18.92%
11.39%
-0.57%
10.18%
Percentage Change in Revenue from Previous Year FIRM
2004
2005
2006
2007
2008
5yr AVG
ISIL
17.7%
3.2%
14.1%
6.3%
6.9%
9.6%
TXN
13.2%
1.9%
8.9%
-2.5%
-9.3%
2.4%
ADI
13.6%
-3.4%
-7.5%
10.8%
4.7%
3.6%
LLTC
14.5%
25.6%
22.4%
14.1%
7.4%
16.8%
MXIM
12.5%
7.1%
56.7%
28.3%
-12.4%
18.4%
Industry
14.3%
6.9%
18.9%
11.4%
-0.6%
10.2%
Percentage Change in R&D from Previous Year FIRM
2004
2005
2006
2007
2008
5yr AVG
ISIL
17.7%
3.2%
14.1%
6.3%
6.9%
9.6%
TXN
13.2%
1.9%
8.9%
-2.5%
-9.3%
2.4%
ADI
13.6%
-3.4%
-7.5%
10.8%
4.7%
3.6%
LLTC
14.5%
25.6%
22.4%
14.1%
7.4%
16.8%
MXIM
12.5%
7.1%
56.7%
28.3%
-12.4%
18.4%
Industry
14.3%
6.9%
18.9%
11.4%
-0.6%
10.2%
204 | P a g e
CGS / Property, Plant, & Equipment FIRM
2003
2004
2006
2005
2007
2008
ISIL
1.44
2.34
2.75
3.12
2.97
3.28
TXN
1.42
1.77
1.80
1.77
1.79
1.89
ADI
1.38
1.62
1.68
1.52
1.72
1.77
LLTC
0.69
0.92
0.99
0.96
0.91
1.02
MXIM
0.45
0.51
0.50
0.55
0.55
0.55
Total Assets by Firm (in Millions) 2003
2004
2006
2005
2007
2008
ISIL
$
2,448.8
$
2,587.6
$
2,583.7
$
2,559.1
$
2,405.0
$
1,133.6
TXN
$
15,510.0
$
16,299.0
$
15,063.0
$
13,930.0
$
12,667.0
$
11,923.0
ADI
$
4,092.9
$
4,723.3
$
4,583.2
$
3,986.9
$
2,970.9
$
3,091.0
LLTC
$
2,056.9
$
2,087.7
$
2,286.2
$
2,390.9
$
1,218.9
$
1,583.9
MXIM
$
2,368.0
$
2,549.5
$
3,059.9
$
3,286.5
$
3,606.8
$
3,708.4
Industry
$
5,295.3
$
5,649.4
$
5,515.2
$
5,230.7
$
4,573.7
$
4,288.0
Percentage Change in Inventory from Previous Year 2004
2005
2006
2007
2008
ISIL
15.3%
-10.2%
6.7%
6.7%
11.1%
TXN
-13.4%
1.4%
12.9%
-1.3%
-3.0%
ADI
18.2%
-6.5%
16.3%
-14.3%
-3.0%
LLTC
-1.9%
7.0%
13.7%
30.9%
9.7%
MXIM
-2.8%
52.1%
17.7%
24.6%
3.7%
3.1%
8.7%
13.5%
9.3%
3.7%
FIRM
Industry
205 | P a g e
E.
SALES MANIPULATION DIAGNOSTIC RATIOS Net Sales / Cash from Sales (Raw) 2004
2005
2006
2007
2008
5 yr AVG
ISIL
1.06
1.17
1.23
1.05
0.95
1.09
TXN
1.31
1.07
1.06
0.97
0.85
1.05
ADI
1.32
0.90
0.96
1.07
1.04
1.06
LLTC
1.33
1.38
1.07
0.97
1.12
1.17
MXIM
1.33
1.16
1.18
1.05
1.04
1.15
Industry
1.27
1.14
1.10
1.02
1.00
1.11
FIRM
Net Sales / Cash from Sales (Change) 2004
2005
2006
2007
2008
5 yr AVG
ISIL
0.40
8.68
1.59
0.14
0.15
2.19
TXN
1.91
0.28
0.89
-0.49
-3.54
-0.19
ADI
1.01
-0.37
0.43
-6.84
0.69
-1.01
LLTC
2.14
1.58
0.17
-0.10
-1.43
0.47
MXIM
5.26
0.65
1.36
0.45
0.60
1.66
Industry
2.14
2.17
0.89
-1.37
-0.70
0.63
Net Sales / Accounts Receivable (Raw) 2003
2004
2005
2006
2007
2008
6 yr AVG
ISIL
6.62
6.88
6.02
7.55
6.45
11.56
7.51
TXN
6.78
7.42
7.39
8.04
7.94
13.69
8.54
ADI
6.95
7.56
7.34
5.94
7.49
8.21
7.25
LLTC
7.57
10.20
8.34
7.08
8.30
7.28
8.13
MXIM
9.10
7.31
8.38
6.25
8.20
7.55
7.80
Industry
7.40
7.87
7.49
6.97
7.68
9.66
7.84
FIRM
Net Sales / Accounts Receivable (Change) 2004
2005
2006
2007
2008
ISIL
23.3
2.9
-80.5
0.8
-0.3
TXN
11.2
7.0
-22.7
13.1
1.6
ADI
10.9
10.7
-2.6
-3.3
-15.7
LLTC
-210.8
5.2
1.5
0.4
3.0
MXIM
4.1
95.0
1.9
-2.9
1.6
-32.3
24.2
-20.5
1.6
-2.0
FIRM
Industry
206 | P a g e
Net Sales / Inventory (Raw) 2003
2004
2005
2006
2007
2008
6 yr AVG
ISIL
6.1
5.6
6.9
8.0
7.7
7.0
6.9
TXN
10.0
10.0
10.5
9.9
9.8
9.1
9.9
ADI
6.9
7.6
7.3
5.9
7.5
8.2
7.2
LLTC
18.5
25.2
30.6
28.0
21.2
21.0
24.1
MXIM
9.5
12.2
9.3
8.8
7.6
7.5
9.2
Industry
10.2
12.1
12.9
12.1
10.8
10.6
11.5
FIRM
Net Sales / Inventory (Change) 2004
2005
2006
2007
2008
ISIL
2.2
-6.5
24.2
2.6
1.2
TXN
10.1
47.8
5.3
22.1
31.0
ADI
10.9
10.7
-2.6
-3.3
-15.7
LLTC
-329.0
108.5
9.2
-0.8
18.6
MXIM
-422.8
27.2
58.5
38.8
211.5
Industry
-145.7
37.5
18.9
11.9
49.3
FIRM
207 | P a g e
F.
EXPENSE MANIPULATION DIAGNOSTIC RATIOS
Asset Turnover (Raw) 2004
2005
2006
2007
2008
5 yr AVG
ISIL
0.22
0.23
0.29
0.30
0.32
0.27
TXN
0.81
0.82
0.95
0.99
0.99
0.91
ADI
0.64
0.51
0.49
0.61
0.87
0.62
LLTC
0.39
0.50
0.48
0.45
0.96
0.56
MXIM
0.61
0.66
0.61
0.61
0.57
0.61
Industry
0.53
0.54
0.56
0.59
0.74
0.59
FIRM
Asset Turnover (Change) 2004
2005
2006
2007
2008
5 yr AVG
ISIL
0.35
0.46
-36.42
-0.67
-0.08
-7.27
TXN
3.30
1.03
-0.70
0.37
1.06
1.01
ADI
-0.66
-0.39
0.99
-0.30
-0.15
-0.10
LLTC
2.93
7.86
0.22
-0.09
-0.08
2.17
MXIM
0.80
1.27
0.36
0.67
0.14
0.65
Industry
1.35
2.05
-7.11
0.00
0.18
-0.71
CFFO/OI (Raw) 2003
2004
2005
2006
2007
2008
6 yr AVG
ISIL
1.37
6.07
1.53
1.55
1.53
-0.19
1.98
TXN
2.23
1.43
1.35
0.73
1.26
1.37
1.39
ADI
1.16
1.11
1.30
1.18
1.44
1.07
1.21
LLTC
0.97
1.05
0.84
0.90
0.91
0.93
0.93
MXIM
1.56
1.64
0.87
1.18
1.75
1.22
1.37
Industry
1.46
2.26
1.18
1.11
1.38
0.88
1.38
FIRM
CFFO/OI (Change) 2004
2005
2006
2007
2008
ISIL
0.1
0.7
1.6
-39.6
0.0
TXN
0.8
1.1
-2.3
15.0
1.0
ADI
2.1
-2.8
43.9
16.5
9.1
LLTC
1.2
0.2
-0.7
0.8
1.2
MXIM
0.2
-0.5
-0.3
0.0
-1.3
Industry
0.9
-0.3
8.5
-1.5
2.0
FIRM
208 | P a g e
CFFO/NOA (Raw) 2003
2004
2005
2006
2007
2008
6 yr AVG
ISIL
0.7
1.0
1.6
2.3
2.1
1.8
1.6
TXN
0.5
0.8
1.0
0.6
1.2
1.0
0.9
ADI
0.6
1.2
1.1
1.1
1.5
1.2
1.1
LLTC
1.3
2.3
2.2
2.1
1.8
2.0
1.9
MXIM
0.9
0.7
0.6
0.5
0.4
0.3
0.6
Industry
0.8
1.2
1.3
1.3
1.4
1.3
1.2
FIRM
CFFO/NOA (Change) 2004
2005
2006
2007
2008
ISIL
0.1
-11.5
18.4
-0.4
-8.9
TXN
-4.6
-32.9
-25.8
-5.7
3.5
ADI
9.3
-0.9
-0.6
11.1
-1.8
LLTC
-7.8
1.7
0.6
-1.7
-9.5
MXIM
0.0
-1.7
0.2
0.0
-1.8
Industry
-0.6
-9.1
-1.4
0.6
-3.7
FIRM
Total Accruals / Sales (Raw) 2003
2004
2005
2006
2007
2008
6 yr AVG
ISIL
4.1
9.2
9.1
8.7
8.4
0.6
6.7
TXN
0.2
0.1
0.2
0.2
0.2
0.1
0.2
ADI
15.2
12.7
9.3
31.4
7.6
-22.1
9.0
LLTC
12.7
6.2
17.9
13.4
16.3
8.2
12.5
MXIM
7.3
5.2
6.1
8.0
6.1
10.2
7.2
Industry
7.9
6.7
8.5
12.4
7.7
-0.6
7.1
FIRM
Total Accruals / Sales (Change) 2004
2005
2006
2007
2008
5 yr AVG
ISIL
-2.4
0.1
0.1
0.3
92.6
18.2
TXN
29.9
-87.3
26.2
35.8
-57.3
-10.6
ADI
0.1
-0.2
1.3
1.2
-3.7
-0.3
LLTC
0.4
-0.3
0.5
1.5
0.8
0.6
MXIM
0.4
0.0
-0.2
0.7
-2.9
-0.4
Industry
5.7
-17.5
5.6
7.9
5.9
1.5
FIRM
209 | P a g e
INTERSIL - GOODWILL RESTATEMENT 2004 BB G.W. Acquisition
1,429,836
375,373
2007
1,423,630
2008
1,419,781 29,594
1,445,778
-
-
-4660
-6206
-3,849
-3,597
-1,154,830
1,429,834
1,423,630
1,419,781
1,445,778
313,729
Impair G.W. EB G.W.
2006
2005
1,059,121
22,781
ASSUME YEAR END ACQUISITION 2004
NEW GOODWILL Original G.W. Impairment
2005
375,373 END 2003:
211,824
2004
2006
2007
0
0 211,824
211,824
211,824
75,075
75,075
75,075
75,075
75,075
-
-
-
-
-
-
-
-
-
5,919
5,919
5,919
5,919
4,556
4,556
4,556
2006 2007 2008 2005
TOTAL NEW GW IMPAIR SHOULD IMPAIR DID IMPAIR IMPAIRMENT ADJUSTMENT -->
Adjusted Balance G.W. (Prior Add)
ADJUSTED END BALANCE G.W.
210 | P a g e
211,824 (4,660)
2006
2007
75,075
75,075
75,075
286,899
286,899
286,899
(6,206)
FORECASTING 2011 2012
2010
(3,849)
(3,597)
2008
2013
2014
22,781
211,824
2005
2004
2009
2008
29,594
2009
2010
-
2011
2012
5,919 4,556 2013
4,556 2014
80,993
85,550
10,475
10,475
10,475
4,556
-
292,818
85,550
10,475
10,475
10,475
4,556
-
-
-
-
-
-
-
4,556
(1,154,830)
207,164
280,693
283,050
283,302
292,818
85,550
10,475
10,475
10,475
847,297
935,771
648,872
361,973
98,750
35,981
25,506
15,031
4,556
(0)
(0)
1,222,670
935,771
648,872
391,567
121,531
35,981
25,506
15,031
4,556
(0)
(0)
-
PROFITABILITY RATIOS ISIL TXN ADI LLTC MXIM Industry
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
ISIL TXN ADI LLTC MXIM Industry
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
Gross Profit Margin 2005 2006 2007 2008 55.8% 57.4% 57.0% 51.9% 47.5% 50.9% 53.3% 50.0% 57.9% 61.9% 61.2% 61.1% 79.1% 78.2% 77.7% 77.3% 70.1% 65.6% 60.5% 60.3% 62.1% 62.8% 61.9% 60.1% Net Profit Margin 2004 2005 2006 2007 2008 9.0% 7.6% 14.3% 20.5% -134.8% 14.8% 17.4% 30.5% 19.2% 15.4% 64.4% 50.6% 49.1% 60.9% 86.9% 21.7% 17.4% 24.4% 20.5% 30.4% 21.2% 27.7% 20.9% 14.2% 15.5% 26.2% 24.1% 27.8% 27.1% 2.7% -13.0% -19.2% -5.3% -8.6% -15.3% Asset Turnover 2004 2005 2006 2007 2008 21.9% 23.2% 28.7% 29.6% 32.0% 81.1% 82.2% 94.6% 99.3% 98.7% 64.4% 50.6% 49.1% 60.9% 86.9% 39.2% 50.3% 47.8% 45.3% 96.4% 60.8% 65.6% 60.7% 61.1% 56.9% 53.5% 54.4% 56.2% 59.3% 74.2% N/A 24.1% 32.1% 36.5% 45.9% Operating Profit Margin = OI/Sales 2004 2005 2006 2007 2008 3.02% 16.68% 20.50% 20.07% -136.04% 17.54% 20.84% 23.62% 25.28% 19.49% 26.55% 21.60% 23.39% 23.41% 24.20% 54.10% 56.17% 51.60% 48.41% 48.39% 29.49% 40.00% 28.30% 17.54% 20.75% 26.14% 31.06% 29.48% 26.94% -4.64% -17.60% -16.63% -4.97% -6.68% -16.15% Operating Expense Ratio = SG&A / Sales 2004 2005 2006 2007 2008 0.17 0.17 0.19 0.17 0.16 0.11 0.12 0.12 0.12 0.13 0.13 0.14 0.17 0.16 0.16 0.10 0.10 0.12 0.12 0.12 0.09 0.07 0.10 0.10 0.11 0.12 0.12 0.14 0.14 0.14 Return on Assets 2004 2005 2006 2007 2008 1.66% 3.32% 5.88% 5.49% -43.14% 12.00% 14.26% 28.82% 19.07% 15.16% 13.94% 8.78% 11.99% 12.46% 26.47% 15.95% 20.79% 18.75% 17.22% 31.80% 12.91% 18.13% 12.67% 8.71% 8.81% 11.29% 13.06% 15.62% 12.59% 7.82% N/A -4.99% -1.90% -3.89% -8.63% Return on Equity 2004 2005 2006 2007 2008 1.81% 3.52% 6.25% 5.80% -46.34% 15.69% 17.79% 36.37% 23.39% 19.25% 17.36% 10.92% 14.89% 14.46% 33.64% 18.08% 23.97% 21.36% 19.56% -54.75% 14.76% 21.88% 14.44% 10.31% 10.14% 13.54% 15.62% 18.66% 14.71% -7.61% N/A -5.43% -2.05% -4.26% -9.54% 2004 55.7% 44.7% 59.0% 77.0% 66.7% 60.6%
211 | P a g e
5 yr AVG 55.6% 49.3% 60.2% 77.9% 64.7% 61.5% 5 yr AVG -16.7% 19.4% 62.4% 22.9% 19.9% 21.6% -12.3% 5 yr AVG 27.1% 91.2% 62.4% 55.8% 61.0% 59.5% 34.6% 5 yr AVG -15.15% 21.36% 23.83% 51.73% 27.22% 21.80% -12.41% 5 yr AVG 0.17 0.12 0.15 0.11 0.10 0.13 5 yr AVG -5.36% 17.86% 14.73% 20.90% 12.25% 12.08% -4.85% 5 yr AVG -5.79% 22.50% 18.25% 5.64% 14.31% 10.98% -5.32%
ISIL TXN ADI LLTC MXIM Industry
2004 5.10 5.27 6.07 9.04 4.95 6.09
ISIL TXN ADI LLTC MXIM
2004 4.06 4.18 5.24 8.57 4.06
ISIL TXN ADI LLTC MXIM Industry
2004 0.9 1.5 0.9 0.5 1.1 1.0
ISIL TXN ADI LLTC MXIM Industry
2004 2.6 5.5 3.1 5.8 4.1 4.2
ISIL TXN ADI LLTC MXIM Industry
2004 138.1 65.9 117.7 63.0 89.5 94.9
ISIL TXN ADI LLTC MXIM Industry
2004 6.9 7.4 8.0 10.1 12.2 8.9
TXN ADI LLTC MXIM Industry
2004 53.1 49.2 45.8 36.2 29.8 40.3
ISIL TXN ADI LLTC MXIM Industry
2004 191.2 115.1 163.5 99.2 119.4 137.7
212 | P a g e
LIQUIDITY RATIOS Current Ratio 2005 2006 2007 5.10 6.17 5.97 3.92 3.78 3.42 4.56 6.13 3.61 9.66 8.77 4.79 5.66 4.15 4.55 5.78 5.80 4.47 Quick Asset Ratio 2005 2006 2007 4.25 5.25 4.79 3.05 2.64 2.30 3.70 5.01 2.56 9.23 8.33 4.25 4.72 3.32 3.39 Working Capital Turnover 2005 2006 2007 0.9 1.0 1.2 2.0 2.5 2.8 0.8 0.9 1.7 0.6 0.6 1.6 1.0 1.2 1.2 1.1 1.2 1.7 2005 2006 2007 2.5 3.1 3.4 5.5 4.9 4.6 3.1 2.3 2.9 6.4 6.1 4.7 2.8 3.0 3.0 4.0 3.9 3.7 Days Supply of Inventory 2005 2006 2007 148.4 119.0 106.8 66.1 75.0 80.0 118.1 161.4 123.8 57.2 59.8 77.2 130.9 120.5 121.0 104.1 107.1 101.8 Accounts Receivables Turnover 2005 2006 2007 6.0 7.6 6.4 7.4 8.0 7.9 7.5 6.8 7.5 13.3 8.7 7.0 9.3 8.8 7.6 8.7 8.0 7.3 Days Sales Outstanding 2005 2006 2007 60.7 48.3 56.6 49.4 45.4 46.0 49.0 53.4 48.6 27.5 42.0 52.0 39.1 41.5 47.7 41.2 45.6 48.6 Cash to Cash Cycle (Days) 2005 2006 2007 209.1 167.4 163.5 115.5 120.4 126.0 167.1 214.8 172.4 84.7 101.8 129.2 170.0 162.0 168.7 149.3 153.3 152.0
2008 4.95 3.78 3.67 7.11 4.88 4.88
5 yr AVG 5.46 4.03 4.81 7.87 4.84 5.40
2008 3.51 2.25 2.86 6.44 3.56
5 yr AVG 4.37 2.89 3.87 7.36 3.81
2008 1.8 2.9 1.7 1.1 1.3 1.8
5 yr AVG 1.2 2.3 1.2 0.9 1.2 1.4
2008 3.3 4.5 3.2 4.8 3.0 3.8
5 yr AVG 3.0 5.0 2.9 5.6 3.2 3.9
2008 110.7 80.2 114.2 76.6 122.1 100.8
5 yr AVG 124.6 73.5 127.0 66.7 116.8 101.7
2008 11.6 13.7 8.2 9.0 7.5 10.0
5 yr AVG 7.7 8.9 7.6 9.6 9.1 8.6
2008 31.6 26.7 44.6 40.5 48.4 40.0
5 yr AVG 50.1 43.3 48.3 39.7 41.3 43.1
2008 142.3 106.9 158.7 117.1 170.5 139.1
5 yr AVG 174.7 116.8 175.3 106.4 158.1 146.3
Capital Structure Analysis
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
Times Interest Earned 2004 2005 2006 2007 2008 1.2 5.3 5.1 4.9 -71.4 N/A N/A N/A N/A N/A -19.4 -7.2 -5.3 -7.4 -15.2 17.1 19.4 10.3 9.1 18.9 19.9 22.2 11.3 5.8 7.5 4.7 9.9 5.4 3.1 -15.1 N/A -100.6 -14.6 -15.7 -39.9 Debt Service Margin : DSM = CFFO t / NPC t-1 2004 2005 2006 2007 2008 4.7 8.3 8.7 9.6 5.1 7.2 342.9 8.2 102.5 6.9 5.3 3.8 5.3 4.5 61.2 34.2 43.2 32.8 47.5 9.8 7.3 14.2 7.3 7.2 18.0 79.6 15.6 31.5 16.1 N/A -0.31 0.33 0.21 10.41 Debt to Equity 2004 2005 2006 2007 2008 0.06 0.06 0.06 0.07 0.11 0.25 0.26 0.23 0.27 0.28 0.24 0.24 0.16 0.27 0.28 0.15 0.14 0.14 -2.72 -4.65 0.21 0.14 0.18 0.15 0.18 0.18 0.17 0.15 -0.39 -0.76 0.06 0.07 0.07 0.08 0.09 Altman Z-Score 2004 2005 2006 2007 2008 0.6 0.7 1.0 1.0 -3.2 10.2 3.5 4.3 5.0 4.9 2.9 2.9 3.2 3.3 3.6 2.7 3.0 2.8 0.7 1.6 3.8 4.5 4.2 3.7 8.1 4.1 2.5 2.8 2.5 1.8 3.6 4.0 4.4 4.4 9.3 Internal Growth Rate = ROA(1-(Div/NI)) 2004 2005 2006 2007 2008 0.91% 2.38% 4.74% 3.40% -45.63% 12.99% 15.32% 30.14% 22.12% 19.40% 12.11% 6.26% 7.59% 6.74% 18.98% 11.70% 15.47% 12.02% 9.17% 17.31% 8.49% 17.12% 7.67% 2.62% 2.14% 9.24% 11.31% 12.43% 8.81% 2.44% N/A -4.19% -0.73% -2.13% -4.72%
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
2004 0.99% 16.98% 15.08% 13.26% 9.89% 11.24% N/A
ISIL TXN ADI LLTC MXIM ISIL Adj Industry
2004 54.58% 108.28% 86.86% 73.33% 65.78% N/A 77.77%
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
ISIL TXN ADI LLTC MXIM Industry ISIL Adj
5 yr AVG -11.0 N/A -10.9 15.0 13.3 1.6 -42.7 5 yr AVG 7.3 115.2 5.2 43.8 9.2 32.2 2.7 5 yr AVG 0.07 0.26 0.24 -1.39 0.17 -0.13 0.08 5 yr AVG 0.0 5.6 3.2 2.2 4.9 2.7 5.1 5 yr AVG -6.84% 19.99% 10.34% 13.13% 7.61% 8.85% -2.94%
Sustainable Growth Rate = SGR(1+(Dt-1 /Et-1 ))
2005 2.53% 19.12% 7.78% 17.84% 16.86% 12.83% -0.06421538
2006 5.04% 38.03% 9.43% 13.69% 12.67% 15.77% -3.56%
2007 3.59% 27.13% 7.82% 10.42% 8.71% 11.53% -7.58%
2008 -49.01% 24.63% 24.12% -29.80% 8.81% -4.25% -14.08%
5 yr AVG -7.37% 25.18% 12.85% 5.08% 11.39% 9.42% -7.91%
2008 105.77% 127.97% 71.70% 54.43% 24.33% 54.69% 76.84%
5 yr AVG 74.95% 112.85% 69.45% 63.91% 55.03% 57.99% 75.24%
Earnings Retention Rate = IGR/ROA
213 | P a g e
2005 71.82% 107.44% 71.31% 74.43% 94.40% 83.95% 83.89%
2006 80.62% 104.58% 63.34% 64.11% 60.54% 38.43% 74.64%
2007 61.96% 116.00% 54.06% 53.26% 30.08% 54.88% 63.07%
G.
Regression Analysis
3 Month slice B est Adj R^2 LB B UB B MRP 72 1.190577 0.2497 0.712 1.669 60 1.18855 0.27939 0.701648 1.675461 48 1.156865 0.279394 0.701648 1.675461 36 1.156865 0.296939 0.628556 1.685174 24 1.097866 0.291193 0.393503 1.802229 1 Year slice B est Adj R^2 LB B UB B MRP 72 1.191585 0.250646 0.713865 1.669305 60 1.189574 0.280564 0.703604 1.675545 48 1.157361 0.282712 0.630131 1.68459 36 1.079862 0.268106 0.489562 1.670162 24 1.099087 0.292491 0.39594 1.802233 2 Year slice B est Adj R^2 LB B UB B MRP 72 1.192777 0.251009 0.715023 1.670531 60 1.189619 0.280678 0.703761 1.675476 48 1.156515 0.282503 0.629413 1.683616 36 1.07909 0.267966 0.489017 1.669162 24 1.098786 0.292121 0.395263 1.802308 5 Year slice B est Adj R^2 LB B UB B MRP 72 1.195745 0.252716 0.718879 1.67261 60 1.189729 0.281884 0.705214 1.674244 48 1.155083 0.283134 0.629411 1.680755 36 1.077421 0.268281 0.488699 1.666143 24 1.098511 0.292323 0.395475 1.680755 10 Year slice B est Adj R^2 LB B UB B MRP 72 1.197156 0.253896 0.721155 1.673156 60 1.189512 0.282825 0.706162 1.672861 48 1.153795 0.283693 0.629394 1.678196 36 1.075844 0.268476 0.488254 1.663433 24 1.098318 0.292457 0.395612 1.801024
214 | P a g e
Rf
Est Ke LB Ke UB Ke 3.29 11.39 8.13 14.64 3.29 11.37 8.06 14.68 3.29 11.16 8.06 14.68 3.29 11.16 7.56 14.75 3.29 10.76 5.97 15.55
Rf
Est Ke LB Ke UB Ke 3.29 11.39 8.14 14.64 3.29 11.38 8.07 14.68 3.29 11.16 7.57 14.75 3.29 10.63 6.62 14.65 3.29 10.76 5.98 15.55
6.8 6.8 6.8 6.8 6.8
6.8 6.8 6.8 6.8 6.8 Rf 6.8 6.8 6.8 6.8 6.8
3.29 3.29 3.29 3.29 3.29
Est Ke LB Ke UB Ke 11.40 8.15 14.65 11.38 8.08 14.68 11.15 7.57 14.74 10.63 6.62 14.64 10.76 5.98 15.55
3.29 3.29 3.29 3.29 3.29
Est Ke LB Ke UB Ke 11.42 8.18 14.66 11.38 8.09 14.67 11.14 7.57 14.72 10.62 6.61 14.62 10.76 5.98 14.72
Rf 6.8 6.8 6.8 6.8 6.8 Rf 6.8 6.8 6.8 6.8 6.8
Est Ke LB Ke UB Ke 3.29 11.43 8.19 14.67 3.29 11.38 8.09 14.67 3.29 11.14 7.57 14.70 3.29 10.61 6.61 14.60 3.29 10.76 5.98 15.54
AEG VALUATION
WACC(AT)=11.71%
2008 (117,948.56) 59,823.00
Net Income (Millions) Total Dividends (Millions) Dividends Reinvested at 17% (Drip) Cum-Dividend Earnings Normal Earnings Abnormal Earning Growth (AEG) PV Factor PV of AEG Residual Income Check Figure % Change in AEG
Kd=.065
0 2009 (75,182.00) 58,405.92
1 2010 (86,640.64) 58,405.92 22299.38 (64,341) (103,886) 39,545 0.7237 28618.63 39,545.23
0
Ke=.1246
2 3 4 5 6 7 8 9 2011 2012 2013 2014 2015 2016 2017 2018 (99,845.72) (115,063.42) (132,600.47) (152,810.38) (176,100.52) (202,940.36) (233,870.92) (269,515.67) 58,405.92 68,140.24 68,140.24 77,874.56 77,874.56 87,608.88 87,608.88 97,343.20 22299.38 22299.38 26015.94 26015.94 29732.51 29732.51 33449.07 33449.07 (77,546) (92,764) (106,585) (126,794) (146,368) (173,208) (200,422) (236,067) (119,720) (137,967) (158,995) (183,227) (211,153) (243,336) (280,423) (323,163) 42,174 45,203 52,410 56,433 64,785 70,128 80,001 87,096 0.5237 0.3790 0.2743 0.1985 0.1437 0.1040 0.0752 0.0544 22087.74 17132.85 14375.87 11202.28 9306.92 7290.78 6019.14 4742.34 42,173.70 45,202.79 52,410.10 56,432.89 64,785.37 70,127.84 80,001.14 87,096.24 7% 7% 16% 8% 15% 8% 14% 9%
10
0.0394
% Value Core Net Income Total PV of AEG PV of Terminal Value Total Average Net Income Perp (t+1) Numbe of Shares Divide by shares to Get Average EPS Perp Capitalization Rate (perpetuity)
(75,182.00) 120776.56 3,892.04 49,486.60 122,220.00 0.40 0.3818
-152% 244% 8% 100%
-10% Intrinsic Value Per Share (12/31/1987) time consistent implied price 4/1/2009 June 1, 2009 observed price Ke g
$ $ $
1.06 1.15 13.00 0.3818 -0.5
0.0768 0.0927 0.1087 0.1246 0.1405 0.1565 0.1725 0.3818
Cost of Equity
Backdoor
N/A N/A N/A N/A N/A
N/A N/A N/A N/A N/A $0.08 N/A $1.15
N/A<0
$
5% 12.35 $
13.65 $
10% 11.70 $
14.30 $
-20%
Growth Rates -30% N/A N/A N/A N/A N/A N/A
$1.18
<$11.70 15% 11.05 $
-40% N/A N/A N/A N/A N/A N/A
$1.18
-50% N/A N/A N/A N/A N/A N/A
$1.16
$1.15
$
11.70 $
14.70 $14.30<
14.95 $
20% 10.40 $
15.60
RESIDUAL INCOME MODEL All Items in Millions of Dollars
1,103,320 0 1 2008 2009 Net Income (Thousands) (117,948.56) (75,182.00) Total Dividends (Thousands) 59,823.00 58,405.92 Book Value Equity (Thousands)1,236,907.75 1,103,319.83 ROE -9.5% -6.8% Percent Change ROE -28.5% Percent Change Be -10.8% Ann. N. I. (Benhmrk) 472,251 Annual Residual Income (547,433) pv factor 0.7237 YBY PV RI -396174 Annual Change in Residual Income
Book Value Equity (Millions) Total PV of YBY RI Terminal Value Perpetuity MVE 12/31/2008 divide by shares Model Price on 12/31/2008 time consistent Price
958,273 2 2010 (86,640.64) 58,405.92 958,273.26 -9.0% 32.7% -13.1% 421,248 (507,888) 0.5237 -265998
800,022 3 2011 (99,845.72) 58,405.92 800,021.62 -12.5% 38.0% -16.5% 365,869 (465,714) 0.3790 -176516
39,545
1,236,908 (1,116,491) (462) 119,955 122,220.00 0.98 1.06
42,174
616,818 4 2012 (115,063.42) 68,140.24 616,817.96 -18.7% 49.5% -22.9% 305,448 (420,512) 0.2743 -115345
416,077 5 2013 (132,600.47) 68,140.24 416,077.25 -31.9% 70.8% -32.5% 235,501 (368,102) 0.1985 -73070
45,203
185,392 6 2014 (152,810.38) 77,874.56 185,392.32 -82.4% 158.6% -55.4% 158,858 (311,669) 0.1437 -44774
52,410
56,433
64,785
$13.00 0.3818 -0.5
Backdoor
0.0768 0.0927 0.1087 0.1246 0.1405 0.1565 0.1725 0.3818
N/A N/A N/A N/A N/A N/A N/A
Growth Rates -30% N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A $0.03 $0.12 $0.30 $1.06 $1.06
$
13.65 $
10% 11.70 $
-20%
N/A N/A N/A N/A N/A N/A $1.06
N/A<0 5% 12.35 $
(680,612) (1,047,471) 9 10 11 2017 2018 (233,870.92) (269,515.67) 87,608.88 97,343.20 (680,611.81) (1,047,470.68) AVERAGE 34.4% 25.7% 24.3% -39.2% -25.1% -23.3% 89.5% 53.9% 27.9% (137,117) (259,858) (96,754) (9,658) -10334 0.0544 0.0394 -5268 -381
70,128
80,001
perp
Cost of Equity
215 | P a g e
(359,132) 8 2016 (202,940.36) 87,608.88 (359,132.01) 56.5% -78.0% 423.6% (26,185) (176,755) 0.0752 -13299
% Value 1031.1% -930.8% -0.4% 100.0%
-10% Obsd Shr Pr (04/1/2009) Initial Cost of Equity Perp Growth Rate (g)
(68,583) 7 2015 (176,100.52) 77,874.56 (68,582.76) 256.8% -411.5% -137.0% 70,783 (246,883) 0.1040 -25667
14.30 $
<$11.70 15% 11.05 $
-40%
(11,719)
-50% N/A N/A N/A N/A
$0.17 $0.38 $1.06
$
11.70 $
14.70 $14.30<
14.95 $
20% 10.40 $
15.60
87,096
$0.01 $0.26 $0.46 $1.06
Discounted Free Cash Flow WACC(BT)=.11892
Kd=.065
Ke=.1246
0 2008 Cash Flow From Operations (Thousands)1,123,509 Cash Flow From Investing Activities (121,019) Change FCF Firm's Assets 1,002,490 PV Factor PV YBY Free Cash Flows Total PV YBY FCF FCF Perp Market Value of Assets (6/1/09) Book Value Debt & Preferred Stock Market Value of Equity PPS at 12/31/08 Time consistent Price (12/31/08) Observed Share Price (6/1/09) WACC(BT) Perp Growth Rate
1 2 3 4 5 6 7 8 9 10 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 101,835 114,055 124,320 135,508 147,704 160,997 175,487 191,281 208,496 227,261 (354,673) 58,982 49,545 54,004 58,864 64,162 69,936 76,231 83,091 90,570 -125.22% -168.44% 0.48% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% (252,838) 173,036 173,864 189,512 206,568 225,159 245,424 267,512 291,588 317,831 0.7398 0.5474 0.4050 0.2996 0.2217 0.1640 0.1213 0.0898 0.0664 0.0491 (187,062) 94,716 70,410 56,781 45,790 36,927 29,779 24,015 19,366 15,618 Percent 206,341 67.4% 99,747 32.6% 306,088 100.0% 11,917 294,171 2.41 Perp 1,501,823 $2.73 Growth Rates $13.00 0 0.023 0.047 0.07 0.09 0.12 0.14 0.0757 $27.42 $35.43 $57.49 $252.93 N/A N/A N/A 0.3516 0.0901 $21.76 $26.33 $36.21 $66.86 $1,239.60 N/A N/A 0.14 0.1045 $18.17 $21.16 $26.84 $39.68 $83.98 N/A N/A WACCbt 0.1189 $15.36 $16.47 $19.76 $27.19 $41.20 N/A N/A 0.1334 $13.00 $14.39 $16.62 $20.35 $26.80 $72.59 N/A 0.1478 $11.21 $12.21 $13.73 $16.06 $19.61 $34.38 $107.94 0.1623 $9.67 $10.39 $11.43 $12.94 $15.02 $21.76 $35.94 Backdoor 0.35163 $2.36 $2.40 $2.45 $2.50 $2.55 $2.65 $2.73
Shares Otsd as of Dec. 31, 2008 122,220.00
N/A<0
$
Discounted Dividends Approach
<$11.70 $
11.70 $
14.70 $14.30<
5% 10% 15% 12.35 $ 13.65 $ 11.70 $ 14.30 $ 11.05 $ 14.95 $
20% 10.40 $
15.60
WACC(AT)=
Kd=6.5
Ke=0.1246
Relevant Valuation Item
0 2008
1 2009
2 2010
3 2011
4 2012
5 2013
6 2014
7 2015
8 2016
9 2017
10 2018
11 2019
DPS (Dividends Per Share) PV Dividends YBY
0.48 0.48
0.48 0.35
0.48 0.25
0.48 0.18
0.56 0.15
0.56 0.11
0.64 0.09
0.64 0.07
0.72 0.05
0.72 0.04
0.80 0.03
0.80
Total PV YBY Dividends
1.33
PV Factor Ke
PVTVperp Model Price Time Consistant Price Observed Share Price Initial Cost of Equity (Ke) Perpetuity Growth Rate (g)
1.0000
0.11 1.44 1.65 $13.00 0.3818 0
Perp 2.10 0.7237
0.5237
0.3790
Cost of Equity
Shares Otsd as of Dec. 31, 2008 Backdoor
0.2743
0.1985
0.1437
0.1040
0.0544
0.0394
0.0768 0.0927 0.1087 0.1246 0.1405 0.1565 0.1725 0.3818
0 $9.63 $7.86 $6.61 $5.68 $4.98 $4.41 $3.96 $1.65
0.033 $13.79 $10.79 $23.44 $6.53 $5.54 $4.81 $4.24 $1.66
Growth Rates 0.067 0.1 0.133 $47.37 N/A N/A $18.37 N/A N/A $11.15 $7.24 $5.29 $8.41 $15.21 N/A $6.66 $9.53 $37.65 $5.51 $7.01 $12.72 $4.71 $5.29 $7.94 $1.68 $1.70 $1.72
0.167 N/A N/A $4.11 N/A N/A N/A $39.89 $1.48
N/A<0 5% $ 12.35 $ 13.65 $
216 | P a g e
0.0752
<$11.70 $ 11.70 $ 14.70 $14.30<
10% 15% 20% 11.70 $ 14.30 $ 11.05 $ 14.95 $ 10.40 $ 15.60
0.2 $0.67 $0.34 $3.36 N/A N/A N/A N/A $1.79
Research and Development Captilized 2004 Original R&D Assume Mid Year Acquisitions New R&D
107430
2004 2004 2005 2006 2007 2008
Impair New R&D
total RD write down should impair Did impair impairment adjustment Capitalized RD
217 | P a g e
10,743
2005 110834
2005
2006 126,458
2006
2007 134,374
2007
2008 143,583
2008
2009
2010
2011
2012
2013
21,486
21,486
21,486
21,486
10,743
11,083
22,167
22,167
22,167
22,167
11,083
12,646
25,292
25,292
25,292
25,292
13,437
26,875
26,875
26,875
14,358
28,717
28,717
12645.8 26874.8 13437.4 28716.6 28716.6 14358.3
10,743
32,569
56,299
82,382
110,178
113,793
91,966
68,237
42,154
107,430
110,834
126,458
134,374
143,583
12,427
12,427
12,427
IS
(96,687)
(78,265)
(70,159)
(51,992)
(33,406)
101,365
79,539
55,810
12427.4 12427.4 29726.6 1930.9
14,358
BS
(96,687)
(174,952)
(245,111)
(297,103)
(330,509)
(229,143)
(149,604)
(93,794)
(64,068)
(62,137)