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Financial Analysis Chapter 12 Page 1 of 9
Financial Analysis: A User Approach
Chapter 12
Credit Analysis
Credit Analysis can be accomplished through the following six-
step process.
Step 1 – Loan Purpose
The lender needs to get an understanding of the reason or
purpose for the business borrowing funds. This purpose will
often determine the terms of the loan. Several examples are:
Working Capital Loan to fund seasonal growth in receivables
and inventory (that cannot be funded by payables). Often
secured by the inventory and receivables.
Lines of Credit to fund miss-matched cash inflow/outflow
timing. Often not secured.
Intermediate and Long-Term Loans to purchase equipment
and facilities. Often secured by the assets purchased.
Lease-based Financing.
Banks may require customers who have lending relationships to
carry compensating balances in their accounts.
Industry focus and experience can speed up this process.
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Step 2 – Corporate Overview
Larger corporations typically borrow (using commercial paper,
lines of credit, and various secured borrowing) from large
commercial banks. They also issue bonds that are actively
traded in the bond markets.
Smaller businesses often work with lenders that are more
regional and local in their nature. While a small business can
shop around for loans and rates, many choose to focus their
banking needs on one or a few banks.
Proper questions at this point would include the following:
What are the macro and micro economic forces that bear
on this business and its industry?
What is the company’s strategy and how does their
strategy position them vis-à-vis their competitors?
Step 3 – Quantitative Financial Analysis
This step is accomplished using the tools we have covered in
previous chapters. The focus is to examine the company to
determine its creditworthiness – Will the company be able to
pay back the loan under its original terms and/or if they default
what collateral can the lender rely on to recover any unpaid
amounts?
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Forecasts will typically start with a revenue forecast, followed
by an income statement forecast, followed by a balance sheet
forecast, followed by a statement of cash flows forecast. The
forecast period should reflect the possible term or terms of the
loan.
Step 5 – Comprehensive Analysis
In this step you are summarizing and integrating all of the work
done in the previous steps. In addition you are now ready to
propose potential loan parameters including term, interest
rate, collateral and compensating balances, and debt
covenants.
Step 6 – Loan Decision
For most commercial lenders there will be a process to follow
to have the loan approved. As the loan grows larger higher
levels of approval will be required.
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Liquidity and Capital Resources
The following is a discussion of our principal liquidity requirements and capital resources.
We had approximately $1.1 billion in cash, cash equivalents and short-term investments at June 27, 2008, which includes $990 million of cash and cash equivalents, which was flat from fiscal year 2007. During fiscal year 2008, cash provided by operating activities and cash provided by employee stock option exercises and employee stock purchases were offset by capital expenditures, the repurchase of our common shares, dividends paid to shareholders and the acquisition of MetaLINCS, Inc. (“MetaLINCS”).
The following table summarizes results of statement of cash flows for the periods indicated:
Fiscal Years Ended (Dollars in millions) June 27, 2008
June 29, 2007
June 30, Net cash flow provided by (used in): 2006 Operating Activities $ 2,538 $ 943 $ 1, Investing Activities $ (991) $ (402) $ (561) Financing Activities $ (1,545) $ (463) $ (732) Net increase in cash and cash equivalents $ 2 $ 78 $ 164
Cash Provided by Operating Activities
Cash provided by operating activities for fiscal year 2008 was approximately $2.5 billion and included the effects of:
- net income adjusted for non-cash items including depreciation, amortization, and stock-based compensation;
- an increase of $351 million in accounts payable, primarily as a result of outsourcing the manufacture of certain sub-assemblies to third parties;
- an increase of $238 million in vendor non-trade receivables, primarily as a result of outsourcing the manufacture of certain sub-assemblies to third parties (see Note 2 to the Notes to Consolidated Financial Statements);
- an increase of $151 million in inventories, principally raw materials and finished goods; and
- an increase of $154 million in accrued expenses, employee compensation and warranty.
Cash provided by operating activities for fiscal year 2007 was approximately $943 million and included the effects of:
- net income adjusted for non-cash items including depreciation, amortization, stock-based compensation and tax benefits related to a change in our valuation allowance for deferred tax assets;
- a decrease of $391 million in accounts payable;
- a decrease of $465 million in accrued expenses, employee compensation and warranty. A large part of this increase was due to variable performance-based compensation earned during fiscal year 2006 and paid in fiscal year 2007;
- the payment of accrued exit costs and retention bonuses related to the Maxtor acquisition; and
- a reduction of $106 million in inventories.
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Our $500 million revolving credit facility that matures in September 2011 is available for cash borrowings and for the issuance of letters of credit up to a sub-limit of $100 million. Although no borrowings have been drawn under this revolving credit facility to date, we had used $62 million for outstanding letters of credit and bankers’ guarantees as of June 27, 2008, leaving $438 million for additional borrowings, subject to compliance with financial covenants and other customary conditions to borrowing.
The credit agreement that governs our revolving credit facility contains covenants that we must satisfy in order to remain in compliance with the agreement. This credit agreement contains three financial covenants: (1) minimum cash, cash equivalents and marketable securities; (2) a fixed charge coverage ratio; and (3) a net leverage ratio. As of June 27, 2008, we are in compliance with all covenants.
Our principal liquidity requirements are primarily to meet our working capital, research and development, capital expenditure needs, and to service our debt. In addition, since the second half of fiscal year 2002 and through the June 2008 quarter, we have paid dividends to our shareholders.
On August 17, 2007, November 16, 2007, February 16, 2008 and May 16, 2008, we paid dividends aggregating approximately $216 million, or $0.42 per share, to our common shareholders of record as of August 3, 2007, November 2, 2007, February 1, 2008 and May 2, 2008. On July 15, 2008, we declared a quarterly dividend of $0.12 per share that will be paid on or before August 15, 2008 to our common shareholders of record as of August 1, 2008. In deciding whether or not to declare quarterly dividends, our directors will take into account such factors as general business conditions within the disc drive industry, our financial results, our capital requirements, contractual and legal restrictions on the payment of dividends by our subsidiaries to us or by us to our shareholders, the impact of paying dividends on our credit ratings and such other factors as our board of directors may deem relevant.
With respect to the closure of our Limavady and Milpitas facilities, we expect to pay cash restructuring charges aggregating approximately $25 million to $30 million in the next 12 months.
As a result of the acquisition of Maxtor, we assumed all of Maxtor’s outstanding debts, including, without limitation, its outstanding convertible senior notes. Maxtor’s 2.375% Convertible Senior Notes due August 2012 (the “2.375% Notes), of which $326 million were outstanding as of June 27, 2008, contain a cash conversion feature that will require Seagate to deliver the holders, upon any conversion of these notes, cash in an amount equal to the lesser of (a) the principal amount of the notes converted and (b) the as-converted value of the notes. We will also be required to deliver an additional amount equal to the difference between the as-converted value of the notes and the principal amount in either cash or stock at our election. To the extent holders of the Maxtor notes choose to convert their notes, Seagate may require additional amounts of cash to meet this obligation. The payment of dividends to holders of the Company’s common shares have in certain quarters resulted in upward adjustments to the conversion rate of the 2.375% Notes and may continue in the future. If the conversion rate continues to increase, we may be required to book an increased amount of interest expense.
In December 2007, we completed our acquisition of MetaLINCS, in an all cash transaction valued at approximately $74 million. MetaLINCS provides enterprise level E-Discovery software that helps companies respond to litigation and regulatory issues which requires them to search large volumes of electronic data for relevant information.
During fiscal year 2008, we repurchased approximately 65 million of our common shares through open market repurchases at an average price of $22.89 for a total of approximately $1.5 billion. We
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repurchased approximately $974 million under the $2.5 billion August 2006 stock repurchase plan and approximately $500 million under a new plan announced on February 4, 2008, to repurchase up to an additional $2.5 billion of our outstanding common shares over 24 months. As of June 27, 2008 we had no amounts remaining under the August 2006 stock repurchase plan and had approximately $2.0 billion remaining under the February 2008 stock repurchase plan.
As part of our strategy, we may selectively pursue strategic alliances, acquisitions and investments. Any material future acquisitions, alliances or investments will likely require additional capital. We may enter into more of these types of arrangements in the future, which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all. We will require substantial amounts of cash to fund scheduled payments of principal and interest on our indebtedness, future capital expenditures, any increased working capital requirements and share repurchases. If we are unable to meet our cash requirements out of existing cash or cash flow from operations, we cannot provide assurance that we will be able to obtain alternative financing on terms acceptable to us, if at all.
We believe that our sources of cash will be sufficient to fund our operations and meet our cash requirements for at least the next 12 months. Our ability to fund these requirements and comply with the financial covenants under our debt agreements will depend on our future operations, performance and cash flow and is subject to prevailing economic conditions and financial, business and other factors, some of which are beyond our control.
Contractual Obligations and Commitments
Our contractual cash obligations and commitments as of June 27, 2008, have been summarized in the table below (in millions):
Fiscal Year(s) Total 2009 2010 - 2011
2012 - 2013
Thereafter
Contractual Cash Obligations: Long term debt $ 2,037 $ 361 $ 446 $ 630 $ 600 Interest payments on long-term debt 560 113 190 114 143 Capital expenditures 289 243 46 — — Operating leases 281 42 77 54 108 Purchase obligations 3,783 3,257 517 — 9 Subtotal 6,950 4,016 1,276 798 860 Commitments: Letters of credit or bank guarantees 89 88 1 — — Total $ 7,039 $ 4,104 $ 1,277 $ 798 $ 860
Off-Balance Sheet Arrangements
As of June 27, 2008, we did not have any material off-balance sheet arrangements (as defined in Item 303(a)(4)(ii) of Regulation S-K).
