The latter was a manufacturer of disk-drives for personal computers, and was rumored to be experiencing cash flow and inventory problems.
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The objective of Pula’s analysis is to help her manager decide if Inscribe Corporation should remain in Alexander and Ferris’ ‘ Buy recommendation list or not. The case Nas therefore analyses from Paula Perry’s viewpoint as a research analyst who must make a recommendation. Rhea group made a background check of Inscribe and the disk-drive industry, and took note of all the important events and developments which have led to the company’s current financial condition.
Next, the group prepared the Income Statement, Balance Sheet and Statement of Cash Flows. The group then proceeded to calculate financial ratios and cash flow availability to extract more quantitative information.
From the assessment of the Inscriber’s liquidity, solvency, profitability, stability and efficiency ratios, the group has come up with a strong basis for a recommendation. Eased on the available information, the group recommends that Inscribe be removed trot Alexander and Ferris’ ‘ Buy recommendation list because to the firm’s liquidity, stability and profitability issues.
Inscribe included in the Fortune 500 by year-end 1988. The company had Just issued its initial public offering in November 1983 at $1 1. 50 per share when two months after, IBMdecided to manufacture their own disk drives.
Inscribe was understandably perturbed because IBM accounted for 61% of the formers 1983 revenues. Around the same period, the growth of the microcomputer industry slowed down significantly. Inscribe was challenged by a severe liquidity crisis due to reduced sales and heavy spending on research and development.
In particular, they had Just made a massive capital expenditure infusion in their own Singapore manufacturing facility. Come 1985, Hamburger ; Quits, an investment firm headed by Q. T.
Wiles, invested a sum of $20 million as capital into Inscribe. In conjunction with this investment, Q. T. Wiles also became concurrent chairman of the board and CEO of Inscribe. The appointment also realigned the company’s senior management and organization structure.
Rhea Management: Mr.. Wiles was an autocratic leader who advocated his own management style. He Nas popularly known in high-tech companies as Dry.
Fix It, and was credited for rescuing over 12 high-tech companies.
He reorganized Inscribe into 5 major divisions and required managers to keep a weekly market profit report, thus necessitating closing the books weekly to monitor divisional performance. With these Changes, managers would know in seven days how their area was performing and rolled therefore respond to and resolve problems bettor they cause severe damage. Under Q. T. Wiles’ leadership, Inscribe also introduced new products such as the 380-MBA high performance drive, which was quickly accepted by the market and Increased the company’s sales.
The company was profitable once again by the third ratter of 1985.
To maintain market share, the company invested heavily in research and development in 1987 and was ranked by a leading trade Journal, Electronic Business, as second in R&D spending, based on a 131 . 7% increase from 1986 to 1987. The company’s share price bounced back from a low $1 in 1985 to $13 in July 1988. With all these developments, it seemed that the company had indeed made a comeback and was on its way to becoming a billion-dollar company. Rhea Industry: Seagate Technology dominated the disk-drive industry in 1988 with sales of over $1.
Other competitors like Computer Memories, Necropolis, Maxtor, Quantum and Prima were minor industry players with combined sales of less than $1 billion. There Mere other new competitors who entered the industry in 1987 and 1988. The Industry was frequently embroiled in heated price wars because competition for sales was intense. This resulted in over supply, and the average cost of a megabyte of memory dropped roughly 25% during the first 10 months of 1988. Research firm Data Quest estimated the over capacity at over 17 million disk drives.
Out of this lot, only an estimated 14 million would be purchased in 1988.
Because of this, it was expected that write-off of inventories would be high. The market’s preference was Changing from 5 IL-inch to 3 h-inch disk drives. Although Inscribe controlled the growing 3 h-inch market, the rapid technological change put too much pressure on the company to turn their inventory into sales as quickly as possible. Other possible threats to the established firms and industry leaders were the new entrants who designed disk-drives with less parts and thus lower cost.
Finally, the industry faced the challenge of a forecasted decline in the US PC market to 29%, 17% and 9% for 1987, 1988 and 1989, respectively.
This forced Inscribe to actively look for niche customers who could produce demand for smaller disk drives. The disk drives could potentially be installed in fax machines, laser printers and photocopiers. Due to Inscribe Corporation’s record of consecutive quarterly increases in revenue and profits, it became one of Wall Street’s favorite stocks, and was recommended by many investment analysts and firms in Wall Street, including the prestigious brokerage firm of Alexander & Ferris. However, in light of intense competition, overcapacity issues, the forecasted decline in the US PC market, and rumors that
Inscribe was experiencing cash flow and inventory problems, Alexander & Ferris deemed it necessary to re-evaluate Inscriber’s financial position and performance. Research analyst Paula Perry of said brokerage firm was requested by her manager to analyses Inscriber’s latest financial results and recommend whether to retain Inscribe Corporation on its ‘ Buy recommendation list or not.
Rhea group studied Inscriber’s history from its inception in July 1980 up to early October 1988, the time the protagonist, Paula Perry, must make a recommendation to remove or retain Inscribe in Alexander and Ferris’ ‘ Buy recommendation list.
The group started by summarizing the firm’s story using the DuPont formula. From the three components of the DuPont formula, the group identified potential areas for concern, and subsequently coaxed more data out of those aspects for further analysis. The group took note of important milestones in Inscriber’s history that had the most profound effects on its current performance, considering the firm’s financial history, changes in top management, operational changes and strategic direction.
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The group also reviewed the disk-drive industry status from 1987 to 1988 along with analysts’ forecasts of the industry growth in 1989.
Both the qualitative and quantitative data provided by the two background studies above are instrumental in providing support information for the financial statements analysis and, ultimately, in looking at Inscriber’s future growth (which should be Pula’s basis for her recommendation). The group then constructed a Statement of Cash Flows using the unedited interim Consolidated Income Statement and Consolidated alliance Sheet.
The three financial statements are then examined using vertical and horizontal analyses, to discover key areas that have the most significant effect on Inscriber’s financial condition. The ‘ red flags’ gleaned from this exercise served to focus the group’s further investigation. The group then calculated financial ratios on the liquidity, solvency, profitability, stability and efficiency of the firm, and compared them with the industry averages.
Finally, after summarizing the results of the analyses and putting the results in the context of Inscriber’s historical background, current condition and the trends in the industries where it operates, the group synthesized its findings to come up with the basis for making its decision.
Given the firm’s data over the last three quarters, we started with a DuPont analysis o identify potential areas of concern. The DuPont formula elements were computed by quarter. Net margin increased significantly from IQ to SQ but dropped in SQ. Similarly, Asset runner increased in SQ but dropped in the third quarter.
Financial Leverage was flat on the first two quarters, but increased significantly on the third quarter. The decrease in Asset Turnover from SQ to SQ was caused by a huge increase in assets that didn’t translate to sales; also, the huge rise in financial leverage was caused by the rise in assets financed by debt: Rhea graphs made it clear that the resulting increase in ROE from IQ to SQ were due o boot increases in PM and AT; the decrease in ROE trot % were due to slight decrease in PM and the huge decrease in AT, which were slightly offset by the increase in FL.
The DuPont analysis suggested that we take a close look into the increasing assets financed by debt, especially because these assets do not help increase sales. Income Statement Next, the Income Statement is processed using vertical analysis. Profitability Ratio Using Vertical Analysis Based on the vertical analysis of the Income Statement, there seems to be no problem if we look at each line item in the Income Statement as a percentage (%) of Sales. Comparing each line item from period to period, no deviation is noticeable.
Looking at the horizontal analysis illustrated below, a 4% increase in Sales and an 8% increase in Gross Profit is seen from the quarter ending September; however, this Nas almost offset by the 9% increase in SO; A.
By the third quarter of 1988, heavy spending on research and development was undertaken by Inscribe, causing a 22% increase (amounting to $940 thousand) in research and development expenses. As we can recall, the company has been investing a great deal in research Ninth a 131 . 7% increase in 1987 and this is continuing to 1988. Net Income increase is at par with Sales increase.