Financial Assessment of the North American

Technology Hardware and Equipment Industry

Capital Expenditure Investments Impacting Cash Flows for Electronic
Equipment Manufacturers

NFCE-F1
February 2016

Contents

Section

Slide Number

Executive Summary

Research Objectives and Scope

Research Methodology

Key Terms and Abbreviations

10

Market Trends

13

Financial AnalysisCommunication Equipment

17

Financial AnalysisElectronic Equipment

24

Conclusions

30

The Frost & Sullivan Story

33

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Executive Summary

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Key Findings
Impacted by constant change in the telecom industry, communication equipment vendors
are experiencing declining profitability.
Communication equipment manufacturers are focusing on cutting costs to maintain
profitability. Despite telecom firms investing in high-speed networks and shutting down
2G and legacy networks, capital investments for equipment manufacturers have shrunk
between FY 2011 and FY 2015.
Unlike for communication equipment manufacturers, profit margins of electronic
equipment manufacturers have been more stable, though this has not translated into
increased returns to shareholders. Firms in this industry have been investing in capital
expenditures, which has impacted these ratios.
The cash conversion cycle has marginally increased for firms in the electronic equipment
industry.
Firms in both equipment segments have increased their leverage to take advantage of
the prevailing low interest rate environment.
Source: Frost & Sullivan

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Research Objectives and Scope

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Research Objectives and Scope

Research Objectives
To analyze the financials of public companies in the North American technology hardware and
equipment industry.
To rank companies based on their financial and risk management.
To identify key trends and challenges that can impact the performance of industry participants over the
next 12 months.
Geographic Scope: North America

Industry Scope
Communication equipment
Electronic equipment

Broad Group of Ratios Analyzed

Profitability

Activity (turnover)
Liquidity
Solvency
Source: Frost & Sullivan

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Research Objectives and Scope (continued)

Study Period

Companies Analyzed

FY 2010FY 2015

395 companies operating in North America

Who Will Benefit?

Sources

Communications companies
Private equity firms
Venture capital investors
Fund managers
Retail investors
Sovereign wealth funds
Hedge funds
Insurance funds other members of the investing
community

Frost & Sullivan in-house research expertise

Established business and financial databases,
such as Capital IQ
Company annual reports
Published news
Press releases

Source: Frost & Sullivan

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Research Methodology

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Research Methodology
Research Methodology
Financial journals
Annual reports
Market research reports
Industry Web sites
Industry-related databases

1. Analyze
secondary
data

Define objective and scope

Thought leader briefings

Secondary
Research
Primary
Research
CEOs/CFOs

Research process

3. Analyze and
collate
different
perspectives

Assess financial ratios

Compute industry benchmarks

2. Interview
participants

General partners
Limited partners
Board members
Research heads
Strategic decision makers
Financial advisors

Stakeholder
insights,
perspectives, and
strategies

Outcome: Identification and evaluation of

the factors driving the key industry
financials and relevant ratios

Other investors

Research Methodology

Research Process
Source: Frost & Sullivan

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Key Terms and Abbreviations

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10

Key Terms and Abbreviations

Communication Equipment: Equipment and products including LANs, WANs, routers, telephones,
switchboards, and exchanges.
Electronic Equipment: Equipment and instruments including analytical, electronic test, and measurement
instruments, scanner/barcode products, lasers, display screens, point-of-sales machines, and security
system equipment.
CAGR: Compound Annual Growth Rate
CAPEX: Capital Expenditure
CFI: Cash Flow from Investing Activities
CFF: Cash Flow from Financing Activities
CFO: Cash Flow from Operations
COGS: Cost of Goods Sold
EBIT: Earnings Before Interest and Taxes
EBITA: Earnings Before Interest, Taxes, and Amortisation
EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortisation
FCFF: Free Cash Flow to Firm
PAT: Profit After Tax
ROA: Return on Total Assets
ROE: Return on Equity
SG&A: Selling, General, and Administrative Expenses
Source: Frost & Sullivan

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11

Ratios Used for Analysis

Profitability Ratios

ROA
Return on Capital Employed
ROE
Return on Invested Capital
Gross Margin
SG&A Margin
EBITDA Margin
EBITA Margin
EBIT Margin
Pre-tax Margin
Earnings from Continuing Operations Margin
Net Income Margin
Cash ROE
Cash ROA

Activity (Turnover) Ratios

Total Asset Turnover

Fixed Asset Turnover
Accounts Receivable Turnover
Inventory Turnover

Liquidity Ratios

Cash as Percentage of Total Assets

Current Ratio
Quick Ratio
Cash Ratio
Average Cash Conversion Cycle
Cash from Operations to Current Liabilities
Net Working Capital to Sales
Cash Flow to Revenue

Solvency Ratios

Total Debt to Equity

Total Debt to Capital
Total Liabilities to Total Assets
EBIT to Interest Expenses
EBITDA to Interest Expense
(EBITDA-CAPEX) to Interest Expense
Leverage Ratio
CFO to Total Debt
FCFF to Total Debt
EBITDA to Total Debt
Cash to Total Debt
Source: Frost & Sullivan

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12

Market Trends

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13

Key TrendsCommunication Equipment

2G Network Shutdown
Telecom operators in North America and other parts of the world, including China, Japan, Singapore and
Australia, have initiated the process of shutting down their 2G networks. In the United States, T-Mobile US,
Verizon Wireless, and AT&T have begun closing down their 2G networks because the spectrum has
become a critical resource. To utilize it more effectively, telecom firms are re-farming their existing
spectrum and deploying higher-speed networks such as long-term evolution (LTE). This trend is impacting
communication equipment manufacturers.
5G Networks
In addition to making old networks and related equipment obsolete, the shutdown of 2G networks is forcing
manufacturers to provide equipment that can handle data running into exabytes. To leverage older
equipment, firms are focusing on international sales, especially in regions where 2G networks remain
active. At the same time, equipment vendors are striving to differentiate themselves by providing a choice
of operating systems and equipment features.
Rise of Virtualization
Network virtualization has been steadily increasing over the past decade. The efficient use of networks and
increased software control has impacted many networking and communication products that were seen as
cash cows by firms and investors. The disruption has impacted cash flows and forced firms to come up
with new products.
Source: Frost & Sullivan

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Key TrendsElectronic Equipment

Demand for RF Testing
Telecom operators are increasingly adopting wireless technologies for mission-critical voice, video, data,
and cloud-based applications, and are demanding dynamic test equipment to monitor and manage their
networks. Faster access and the link to cloud networks and devicesmobile phones, tablets, and
notebookscreate more complex devices under test (DUT), increasing the need for radio frequency test
equipment.

Penetration of Modular Instrumentation

Reducing test cost by increasing throughput, reducing power consumption, increasing scalability, and
saving space drives the demand for modular instrumentation. National Instruments' leadership in this
space, along with Keysight Technologies' focus on expansion, is expected to further increase the share of
modular instrumentation in the overall general purpose electronic test equipment market. Although modular
instrumentation will replace traditional instrumentation, it is expected to boost the growth of the overall
market.
Economic Uncertainty that Affects End-user Confidence
Since the third quarter of 2008, ongoing uncertainty in the global economy has led customers to rethink
their test strategies. This is expected to continue to hinder market growth, as it affects end-user spending
and challenges vendors to grow or maintain their position in this market.
Source: Frost & Sullivan

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Key TrendsElectronic Equipment (continued)

Improved Research and Development Efficiency and Reduced Time to Market
Increasing globalization has provided end users with a higher potential for growth and profitability. With
greater market access, they must cater to global demands and fiercely compete with local and international
participants. End users need to structure and streamline their research and development, engineering,
manufacturing, and quality inspection to meet production demand and ensure product quality; they are
likely to adopt X-ray instruments to improve research and development and inspection efficiency and
reduce time to market. This trend is expected to be a key driver for this market.
Precision intrinsic applications such as semiconductor manufacturing have increased the need for
advanced motion technology with integrated wireless communication and networking capabilities.
Advancements in multiple axes have made motion controllers 30 time more powerful compared with those
of 5 years ago.

Source: Frost & Sullivan

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Financial AnalysisCommunication Equipment

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17

Ratio AnalysisCommunication Equipment

Profitability Ratios
There has been a marginal decline in gross margin, from 55.2% in FY 2011 to 53.2% in FY 2015.

Activity Ratios
Activity ratios have declined for the industry, with fixed asset turnover declining marginally from 1.28 in
FY 2011 to 1.22 in FY 2015. Total asset turnover has remained flat between 0.54 and 0.56 for the same period.

Liquidity Ratios
The liquidity position has improved marginally in this industry. The current ratio has improved from 2.72 to 3.06,
and the quick ratio from 2.29 to 2.67, from FY 2011 to FY 2015.

Solvency Ratios
Firms in this industry have been steadily increasing their leverage. The industrys debt equity ratio increased
from 0.26 in FY 2011 to 0.36 in FY 2015, due to the fact that total debt increased at a CAGR of 13.8%
between FY 2010 and FY 2015 while equity has grown at a CAGR of only 6.2%.
Source: Frost & Sullivan

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Profitability AnalysisCommunication Equipment

Overall
Trends

Margin
Analysis

Despite the decline in gross margin, the net margin marginally increased from 12.2% in
FY 2011 to 14.2% in FY 2015, suggesting that profitability in this industry is due to cost
reduction rather than increased sales. This is supported by the fact that revenue grew at
a CAGR of 8.3% between FY 2010 and FY 2015 while net income grew at a CAGR of
15.5%.

Between FY 2011 and FY 2015, firms in the communication equipment industry

witnessed stabl e profit margins. The EBITDA margin hovered between 22.0% and
24.0%, while the EBIT margin was range bound between 19.0% and 21.0%. The
sharpest change was in the SG&A margin, which declined from 23.3% to 20.2%.

The ROA was range bound between 6.0% and 8.0% between FY 2011 and FY 2015.
Returns on The other ratiosROE, return on invested capital, and return on capital employed
Assets and marginally increased.

Equity

Source: Frost & Sullivan

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Activity RatiosCommunication Equipment

Overall Position: Firms are focusing on cutting costs and improving profitability. CFI shrunk by 7.2%
between FY 2010 and FY 2015. while asset turnover remained stable. This suggests that firms are
investing only in replacement CAPEX and striving to increase utilization of existing assets.
Asset Utilization: CAPEX of firms in this industry has shrunk by 8.9% between FY 2010 and FY 2015.
This is also reflected in the cash flow in investing activities, which declined from $21.63 billion in FY 2010 to
$14.85 billion in FY 2015. Despite such cost-cutting measures, fixed asset turnover declined from
1.28 in FY2011 to 1.22 in FY 2015. The reduced utilization of fixed assets and the lack of investment in new
assets indicates that firms do not foresee growth in demand in the near future. Equipment suppliers to firms
in this market would need to focus on asset turnover ratios. Any increase in equipment demand from these
firms will be preceded by a growth in asset turnover ratios.
Accounts Receivable and Inventory: The inventory position has been fairly stable for firms in this
industry. The average days inventory outstanding ratio has been range bound between 45 and 47 days
between FY 2011 and FY 2015; however, cash flow problems existed in FY2015. The FCFF to revenue,
which increased from 0.21 times in FY 2011 to 0.27 times in FY 2014, dropped drastically to 0.14 times in
FY 2015.

Source: Frost & Sullivan

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Liquidity RatiosCommunication Equipment

Overall
Position

Liquidity
Ratios

Cash
Conversion
Cycle

Firms in this industry are maintaining higher cash reserves. The cash ratio of the
industry increased from 0.59 times in FY 2011 to 0.68 times in FY 2015. This could
be due to the drop in FCFF as detailed on the previous slide.

The net working capital requirement is extremely high in this industry. The net
working capital to sales ratio was range bound between 63.0% to 70.0% between
FY 2011 and FY 2015, implying that roughly two-thirds of sales are used for
maintaining working capital requirements.
The high level of working capital requirements influences the cash position of firms
and liquidity ratios. The industry liquidity ratio increased from 2.72 times in FY 2011
to 3.06 in FY 2015.

The average cash conversion cycle for the industry is slightly above 4 months. It
increased from 130.7 days in FY 2011 to 134.7 days in FY 2013 before dropping to
129.5 days by FY2015.

Source: Frost & Sullivan

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Solvency RatiosCommunication Equipment

Overall Position: The overall solvency position of the industry was stable between FY 2011 and FY 2014,
but FY 2015 saw a rapid decline mainly due to the sudden decline in cash flows.
Solvency Ratios: Firms in this industry are increasingly relying on debt. The debt/equity ratio increased
from 0.26 in FY 2011 to 0.36 in FY 2015. The total debt in this industry grew at a CAGR of 13.8% between
FY 2011 and FY 2015, while total equity grew by only 6.2% for the same period. This is also reflected in a
significant decline in the cash to total debt ratio, which declined from 2.67 in FY 2011 to 1.97 in FY 2015.
Significance of Solvency Ratios: The increase in leverage can be attributed to the low (or zero) interest
rate environment in many regions of the world. The increase in leverage is normal given the relatively low
leverage levels of this industry in comparison with other capital-intensive industries, such as telecom
service providers. The increase in leverage can be viewed as another form of increasing returns to
shareholders given the relatively low growth rate in topline profits. This is proven by the marginal increase
in ROE, from 11.1% in FY 2011 to 13.8% in FY 2015.

Source: Frost & Sullivan

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Financial BenchmarkingCommunication Equipment Top

Performers
Communication Equipment Industry: Top 10 Firms in Managing Financial Profitability and Business
Risk, North America, FY 2015
Company Name

Exchange:
Ticker

Profitability Activity
Rank
Rank

Liquidity
Rank

Solvency
Rank

Overall
Rank

32

10

26

14

NasdaqGM:CLFD

18

24

60

10

Plantronics, Inc.

NYSE:PLT

13

68

27

CoAdna Holdings, Inc.

TSEC:4984

27

26

59

17

35

25

70

NasdaqGS:UBNT

74

21

28

22

82

13

TSX:SVC

16

79

64

51

57

34

NasdaqGS:FFIV

53

98

10

Riverbed Technology, Inc.

Clearfield, Inc.

Winnebago Cooperative Telecom

Association
Ubiquiti Networks, Inc.
BreakingPoint Systems, Inc.
Sandvine Corporation
Scott County Telephone Co-Operative Inc.
F5 Networks, Inc.

Source: Frost & Sullivan

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23

Financial AssessmentElectronic Equipment

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Profitability AnalysisElectronic Equipment

Overall
Trends

Margin
Analysis

Return on
Assets and
Equity

The overall profitability margins were stable between FY 2011 and FY 2015. However,
returns to investors have been declining due to increased capital raised by firms in the
form of debt and equity.

Between FY 2011 and FY 2015, gross margin was stable for this industry, hovering
between 4.0% and 5.0%. Though SG&A margins marginally increased, this did not
impact overall net margins, which were range bound between 3.0% and 4.5%.

ROA marginally declined from 6.8% in FY 2011 to 5.4% in FY 2015. Return on invested
capital also declined from 9.5% to 7.8% during the same period, indicating the lower
returns to investors in this industry. This is expected to have a direct impact on new
CAPEX investments that take a longer time to provide returns, which might not be
acceptable with short-term investors.

Source: Frost & Sullivan

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25

Activity RatiosElectronic Equipment

Overall Position: As indicated earlier, firms in this industry raised capital, especially between FY 2011
and FY 2014. These funds, combined with existing cash reserves, have been used to invest in newer
CAPEX. This increase in assets has impacted the activity ratios. Cash as percentage of total assets
declined from 17.5% in FY 2011 to 15.1% in FY 2015.
Asset Utilization: CAPEX of firms in this industry grew at a CAGR of 11.0% between FY 2011 and
FY 2015. Cash flow in investing activities amounted to about $4.52 billion in FY 2010. This grew to
$11.31 billion in FY 2013 before declining marginally to $10.36 billion in FY 2015. This increase in assets
reduced the fixed asset turnover from 4.42 in FY 2011 to 3.93 in FY 2015. Given the expected growth in
demand from Mega Trends such as the Internet of Things, new investments can be expected to provide
returns to long-term investors.
Accounts Receivable and Inventory: The industrys supply chain management activities also seem to
have declined, evident by inventory turnover ratios. The average days inventory outstanding ratio has
marginally increased from 43.8 days in FY 2011 to 48.5 days in FY 2015. The accounts receivable
turnover also marginally declined from 8.3 in FY 2011 to 7.5 in FY 2015.

Source: Frost & Sullivan

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Liquidity RatiosElectronic Equipment

Overall
Position

While the overall liquidity position of this industry has remained fairly stable,
underlying changes in supply chain management and changes in supply-customer
agreements have impacted the cash conversion cycle.

Liquidity
Ratios

There has been a marginal shift in the liquidity position of this industry. While the
current and quick ratios were fairly stable between FY 2011 and FY 2015, the
underlying components of these ratios have changed. Average inventory levels
marginally increased, which was offset by an equally minor decline in liquid cash
levels.

Cash
Conversion
Cycle

Changes in cash levels have been accompanied by changes in the supply chain.
Average days payable outstanding increased from 53.2 days in FY 2011 to 57.9 days
in FY 2015. For the same period, the average days sales outstanding increased from
56.9 to 65.5 days, which resulted in the cash conversion cycle increasing from
47.6 to 56.1 days.
Source: Frost & Sullivan

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Solvency RatiosElectronic Equipment

Overall Position: Firms in this industry relied increasingly on debt between FY 2011 and FY 2015 to
leverage on the low/zero interest rate environment. Despite this, interest coverage ratios remained fairly
stable during this period.
Solvency Ratios: Firms in this industry are increasingly relying on debt. The debt/equity ratio increased
from 0.32 in FY 2011 to 0.39 in FY 2015. This is also reflected in a marginal decline in the cash to total debt
ratio, which declined from 1.12 in FY 2011 to 0.82 in FY 2015.
Significance of Solvency Ratios: The increase in leverage is normal given the relatively low leverage
levels of this industry compared with other capital-intensive industries, such as telecom service providers.
However, unlike the communication equipment industry, the increased leverage has not translated into
higher returns to shareholders. Instead, ROE declined from 13.9% in FY 2011 to 11.4% in FY 2015. The
higher debt is used to fund newer capital investments.

Source: Frost & Sullivan

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Financial BenchmarkingElectronic Equipment Top

Performers
Electronic Equipment Industry: Top 10 Firms in Managing Financial Profitability and Business Risk,
North America, FY 2015
Exchange:
Ticker

Profitability
Rank

Activity
Rank

Liquidity
Rank

Solvency
Rank

Overall
Rank

George Kelk Corporation

34

71

82

Caddo Connections Inc.

51

48

38

74

Kycon, Inc.

70

55

47

34

A-Tech Corporation

54

82

51

23

Vernier Software & Technology LLC

68

52

32

69

NasdaqCM:CPSH

95

81

33

Antennas Direct, Inc.

46

46

110

53

Metropolitan Sales Distributors, Inc.

121

22

70

37

Enovation Controls, Inc.

64

46

180

NasdaqGS:DAKT

87

110

29

10

Company Name

CPS Technologies Corp.

Daktronics Inc.

Source: Frost & Sullivan

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Conclusions

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30

Conclusions
As interest rates increase, firms reliance on debt is expected to decrease. This will
positively impact the leverage ratios of both communication and electronic equipment
manufacturers.
In the communication equipment manufacturing industry, firms are focusing on cost-cutting
measures to sustain profit margins. However, outperforming firms are also focusing more
on value-added services, such as bundling hardware with necessary system software and
providing distinct features, for differentiation.
Electronic equipment manufacturers are focusing on increased CAPEX at the cost of
return to shareholders. Long-term investors can expect to gain from such investments
given the rise of machine-to-machine communication and Internet of Things.
In both industries, supply chain issues have impacted the cash conversion cycle. While
this does not affect profit margins directly, focusing on these issues can positively impact
returns to shareholders in the long term, helping publicly traded firms to increase their
share prices.
Source: Frost & Sullivan

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