Financial Accounting Project.docx-2

Thana Kittisathanon

“My Company” Case

EMBA-Winter 2015

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A. Overview

1) Precision Castparts Corporation (PCC) or (PCP) on the New York Stock Exchange is a leading

manufacturer in structural investment castings, forged components and airfoil castings for aircraft

engines and industrial gas turbine. The company is headquartered in Portland, Oregon and currently

has 159 facilities around the world.

2) PCC continues to be in a growth cycle mainly through business acquisitions, improving performance

on existing product lines and operational process improvements. The growth strategy focuses on 3

key initiatives, exploring opportunities on new products and non-core products in the Aerospace and

Power Industries, continues improvement through managing operating costs and lastly expanding its

market for both current and non-core products.

3)

a) PCC’s core businesses is manufacturing, selling and distributing complex metal components to 3

major market areas: General, Aerospace and the Power industries.

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b) The primary goal of PCC is growth through acquisitions of strategic operations and capital

equipment. The company has completed 8 acquisitions in 2014. PCC will continue to seek

acquisitions of complementary businesses, products, capital equipment and technologies to add

products and services for their core customer base and will also continue to expand each of their

businesses geographically. The success of each transaction depends on PCC’s ability to integrate

assets and personnel. Changes may be required to integrate the acquired businesses into their

operations methods and procedures.

c) Business and capital equipment acquisitions entails a number of other risks, including:

- Inaccurate assessment of liabilities

- Entry into markets in which PCC has limited or no experience

- Diversion of management's attention from existing businesses

- Difficulties in realizing projected efficiencies, synergies, installation schedules and cost savings

- Decrease in cash or increase in indebtedness

- Limitation in the company’s ability to access additional capital

- Risks associated with investments where PCC does not have full operational control

The inability to address these acquisition risks could cause PCC to incur increased expenses or to

fail to realize the benefits from the transactions or acquisition.

4) PCC is a worldwide manufacturer of complex metal components and products, provides high quality

investment castings, forgings, fasteners and systems for critical general, aerospace and power

generation applications. The company is a leading manufacturer and supplier of 3 main products:

Investment Cast Products, Aerospace Airfoil Castings, Forged Products and Airframes Products. Its

main customer is General Electric Company were approximately 13%, 15% and 15% of total sales

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from fiscal year 2014, 2013 and 2012 respectively. Other major customers include Boeing, Airbus,

Roll-Royce and United Technologies.

B. Trend Analysis of Sales and Earnings Growth

The Common Size Income Statement shows that even though sales and revenue continues to trend up

from 2010 to 2015, the overall Net Income has relatively remained flat at an average of 17%.

1) Revenue Growth:

The Company’s revenue continues to grow from 2010 to 2014. The graph on the next page

indicates a comparison of the annual percentage change in the PCC’s cumulative total

shareholder return on its common stock to the cumulative total return of the S&P 500 Index and

the S&P 500 Aerospace and Defense Index.

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The signs indicate that the growth rate is accelerating year over year and based on the sales trend

the company should continue it growth cycle. However, due to market conditions and

international competition the growth rate will trend up at a slower rate than in the past.

2) Operating Income:

Since PCC does not have any non-operating income the Operating Income for PCC is equivalent

to its EBIT. EBIT grew from $1.43B in 2010 to $2.68B in 2014. Compared to its Revenues

Growth of 16% from 2012-2013 and 15% from 2013-2014 the company’s Operating Income has

increase from 19% between 2012-2013 to 24% from 2013-2014. One factor is the increase in

SG&A expense of 20% in 2013. The biggest factor however affecting operational income is

acquisitions the company made from 2010-2015, the largest being TIMEX (largest mining

titanium company in the world) in 2013.

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3) Net Income:

Net income has shown an increase in the last 5 years and is growing at a higher percentage rate

than revenue growth. Net income performances are 9%, 21%, 16% and 23% from 2010 to 2011,

2011 to 2012, 2012 to 2013 and 2013-2014 respectively. Factors resulting in the Net Income

grow trend in 2013 to 2014 were selling off discontinued operations and assets resulting in a Net

Income growth of $33M from 2013 to 2014.

C. Analysis of Operating Efficiency, Liquidity and Solvency

1) Operating efficiency:

The Receivable Ratio measures the ability for a company to collect its loans. As of 2014, PCC’s

Receivable Ratio is 6.26. The industry average is about 7.0, which meet that PCC is slower on

collecting their customer’s payments then that of their competitors. However, considering PCC’s

sales and revenue are above their competitors, it could mean that PCC has a less stringent credit

policy which allows the company to gain more sales opportunity. Its Inventory Turnover Ratio is

1.86 versus an industry average of 3.86. Again, the ratio would suggest the company is selling

inventory at a slower rate than their competitors. But after reviewing the company’s COGS which

has increase from $3.7B in 2010 to $6.32B in 2015. One can conclude that even though PCC’s

inventory moves at a slower rate its sales rate is trending up. Lastly, Its Total Asset Turnover

Ratio is .53 for 2014 compare to an industry average of .94. This indicates that PCC does not use

it asset effectively to generate revenues compare to other companies in the same industry.

Overall, the Account Receivable, Inventory Turnover and Total Asset Turnover ratios are all

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below the industry average. The conclusion however, is that based on other data such as COGS

and Revenue trends over the past 5 years, PCC is operating efficiently.

2) Liquidity:

The Current Ratio for PCC is at 3.42, which means that the company is able to cover a little more

than 3 times as much in their short-term liabilities with their total current assets. The Quick Ratio

compares the cash, short-term marketable securities and accounts receivable to current liabilities.

The Quick Ratio for PCC is 1.29 means that the company can cover it current liabilities with its

assets. Lastly, the Cash Ratio of PCC is .22. This means that compared to its current liabilities,

the current cash and invested funds will only cover about 22% of the total liabilities. Based on the

3 ratios the company has the ability to cover its current liabilities with its current assets and short-

term investments but does not have the ability to cover liabilities with cash on hand.

3) PCC’s Total Debt to Equity is at 31%, this indicates that the company does not use a lot of debt to

finance its assets. It Times Interest Earned is calculated by taking EBIT, which for 2014 was

$2.68B, divided by its interest expense, which was $71M. The Times Interest Earned comes out

to a ratio of 37.7. This means that PCC does generate enough cash from EBIT to cover expenses.

Lastly, ROE is currently at 16.6%. This does indicate that the company is profitable. According

to PCC’s 2014 10K, there are Off-balance Sheet Debts to consider. Total Off-balance Sheet Debt

is $4.8B, the largest part coming from Long-term debt from its large acquisition in 2013 of

TIMEX totaling $3.5B.

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D. Analysis of Cash Flows

1. Over the past 3 years, PCC’s Net Income was $1.23B in 2012, $1.43B in 2013 and $1.78B in

2014. The two largest sources of cash came from Depreciation & Amortization (totaling $648M

from 2012-2014) and Common stock Issues (totaling $365M from 2012-2014). The largest use of

cash was Capital Expenditures ($867.6M from 2012-2014) and Net Assets from Acquisitions

($7.5B from 2012-2014).

2. PCC’s CFO (cash flow from operations) improved by $81M from 2013 to 2014. Pervious to

2014, the company did not have enough CFO to fund it growth plan. In 2013, the company

funded its shortage of CFO by issuing $3B of long-term debt and $600K in commercial papers.

By the end of 2014, PCC was able to grow its CFO mainly from its operational activities (totaling

$1.8B in 2014).

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3. Based on the review of the Statement of Cash Flow, PCC’s continues to grow mainly through

acquisitions and capital equipment. Both of these activities account for $1.4B in investment

activities in 2014.

4. It does appear that the CFO can fund the company’s growth. PCC’s Net Income continues to

improve and last year increased by $330M. In addition, the company’s strategy is to quickly

integrate newly acquired businesses to contribute to earnings within a few years. Acquiring and

integrating new businesses will only help to improve CFO over the next couple of years.

5. The company did repurchase stock in 2013 and 2014 with a total value of $580M. It also paid

cash dividends totaling $52M from 2012-2014. PCC repurchased it stock in order to reduce the

number of outstanding shares because the company believes the shares are undervalued. Because

a stock repurchase reduces the number of shares outstanding, earnings per share has the

possibility of increasing and thus drive up the market value of the remaining shares.

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E. Accounting Policies

3. PCC uses GAAP, the 3 most significant accounting polices affecting the company’s goals and

strategies are Revenue Recognition, Acquisition Accounting and Goodwill.

1: Revenue Recognition- This practice recognizes earnings when the transaction is completed.

Shipment to customer per contract, risk transferred to customer, collectability assured and pricing

is all fixed and determinable. Treatment is appropriate; contracts are adhered to per supplier and

customer agreements. Payment terms are stated and are part of the contract. All other exceptions

will fall back to the original sales agreement.

2: Acquisition Accounting- PCC uses Acquisition of Accounting. This requires various

assumptions based on several factors: fair value of assets, liabilities and contractual as well as

non-contractual contingencies at date of acquisition. Treatment is appropriate and the balance

sheet reflects all mentioned variables along with the depreciation and amortization expense

values.

3: Goodwill and Acquired Intangible Assets- Goodwill and Intangible Assets with indefinite

lives are tested for impairment each fiscal year. Asset determined to have indefinite lives are not

subject to amortization per GAAP. The testing compares carrying value of asset versus estimated

fair values. Treatment is appropriate given the process and the rules followed. Testing once a year

can affect the market balance sheet if market value is determined to irrelevant.

2. The accounting policies are significant to PCC’s core activities, goals and strategies. Each

business’s revenue must be recognized in order to ensure EBIT is reported accurately and

promptly. Acquisition Accounting is important during PCC’s multiple business acquisitions the

last 3 years. Acquisitions of assets and liabilities must be accurately accounted for in the

company’s financial statements. Goodwill and Acquired Intangible Assets accounts similarly to

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Acquisition Accounting. One critical strategy for PCC is that newly acquired companies must be

able to integrate as quickly as possible in order for PCC to profit from additional earnings.

3. PCC does do a satisfactory job of discussing its accounting policies. Based on its 2014 10K, all

items in the balance sheet are discussed in regards to the company’s financials. From the review

of the 10K, PCC seems to be transparent in discussing its accounting polices.

4. MD&A for PCC does do an adequate job in explaining operational, financial and cash flow

activities. The MD&A has a breakdown of all segment acquisition year by year. It also describes

any changes to it financials and what were the contributing factors. For example, the company

was transparent with explaining its low third quarter earnings due to a decline in regional

business/jet and military spares activity. Overall, PCC does a good job in being transparent on all

of its financial statements.

F. Own Question

1. a) Will the company’s long-term debt both on it balance sheet and on its off-balance sheet affect

its strategy to acquire more businesses?

b) The question is interesting because acquisitions has been extremely important and critical part

in PCC’s growth strategy over the last 3 years. Business like TIMEX, which PCC acquired in

2013, helped in overall stock market price and value.

c) To be able to answer this question, we will need to know what type of strategies and goals the

company’s leadership will pursue in the near future. We know the dollar value of both the debts

on the balance sheet and debts on its off-balance sheet. But how much more debt will PCC be

willing to incur to acquire additional business in the near future? As mention in the beginning, the

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company naturally assumes a great deal of risk if the acquired business does not yield expected

earnings as anticipated. The graph below shows the stock price for the last 5 years; in the end the

stock price and the value of the shareholders will drive the answer. Bottom line, if PCC believes

that incurring more debt to pursue additional ventures will help its stock value, it will assume the

necessary risks associated with any acquisitions and pursue them.

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