Reading the Annual Report

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Reading the Annual Report

FINANCIAL REPORTING AND ANALYSIS
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Learning Objectives

After going through this chapter, you will gain a basic understanding of : Importance of Annual Reports Structure of Annual Reports Chairmans Statement Management Discussion and Analysis (MD&A), including:

- Utility of information in MD&A - Discussion of operational factors and developments in the marketplace for the companys products - Understanding opportunities and threats - Growth analysis - Basic overview and understanding of acquisitions - Operational developments - Opportunities and threats - Understanding growth rates - Financial strategies - Mergers and Acquisitions (M&A)


Learning Objectives

Financial Statements - The Income Statement - Balance Sheet - Cash Flow Statement

Notes to Consolidated Statements Report of Management's Responsibilities Risk Factors Legal Proceedings Report of Independent Auditors Directors and Officers


Significance

An annual report is a formal report on a companys performance in the preceding year. A public company produces an annual report for its stockholders, the people and institutions that own the company. Other interested parties, such as employees, customers and potential investors, read this report, too.

An annual report is one of the most important documents a company produces and is often the first document someone consults when researching a company. It reports how the company did financially and often explains the scope of its business mission and management philosophy.


Significance

Some points of paramount importance of annual reports are: Decision-making tool for investors Annual reports are the most effective tool to assist investors. They contain a wealth of data to aid the investor in evaluating financial situation, corporate value and risk. Annual reports provide valuable insight into management philosophy as well as a sense of what the company is about. Financial analysts often calculate representative ratios based on accounting data in the annual report and recommend clients to buy, hold or sell the shares in a company. Investors and financial analysts often keep annual reports for many years and the value of the company is determined by this document. The annual report is one of the most important sources of investor relations. It is one of the tools available to investors that help them build a better understanding of a company.


Significance

Corporate information source The annual report is the most important source of corporate information. It is the first source consulted by stakeholders when searching for information. It is usually the starting point for any company research. Annual reports provide detailed financial information about a company in a standardized format. The result is easy comparison of companies and effortless location of specific information. The standards to which annual report information must adhere are nationally defined and enforced by law. The annual report briefs shareholders on key financial news relating to the company. It further provides an abundance of valuable information that enables an investor to better understand the company investigated. It is the most believable source of investment information because it is governed by legal and regulatory rules requiring full disclosure to shareholders.


Significance

Companys communication tool An annual report provides a means for the enterprise to communicate effectively with the companys shareholders and other stakeholders such as investors and analysts. Besides financial information, companies also use annual reports to communicate the past actions of the company, the results of those past actions, intended future actions and issues of major strategic importance for corporate performance.


Significance

Company Marketing tool An annual report is part of the corporate communication strategy that pursues strategic objectives, such as strengthening the corporate image or brand. Annual reports can be useful in recruiting employees and introducing the company to new or potential customers. The annual reports educate investors and project a company in a positive context. Over the years the annual report has changed from a plain statement to an increasingly glossy product containing maps, charts and pictures in a multi-colored production designed to have mass appeal.


Structure of Annual Reports

Chairmans Statement / Letter to stockholders

Financial highlights

Management's Discussion and Analysis [MD&A]

Financial Statements

Notes to Consolidated Statements

Report of Management's Responsibilities

Risk Factors

Legal Proceedings

Report of Independent Auditors

Directors and Officers

Annual Report

The Income Statement Balance Sheet Cash Flow Statement

Annual reports generally include the following sections:



Company Annual Reports typically commence with the Chairmans Statement (CS), also called a letter to shareholders. This is followed by Management Discussion and Analysis (MD&A). These are followed by detailed financial statements.



Birds Eye View

Elaborates the above and

provides further information

Detailed Numerical

Snapshot of Performance

As is evident from the diagram below, the level of detail (with respect to the information provided)

increases as we progress from the CS to the financial sections / numbers.



While CS and MD&A sections do not focus primarily on numbers, you must nevertheless note that

the CS + MD&A and the financial statements together constitute an integral whole - in other words,

solely relying on either of the two will lead to erroneous conclusions in ones analysis.




Another aspect of the CS + MD&A is that they contain both facts and opinions (unlike financial

statements, which contain only facts). It is important to sift facts from opinions and then come to

independent conclusions about the opinions. Opinions typically concern companies expectations

with regards to growth prospects, their expectations with regards to the overall economy, etc.

Contain both facts

and opinions

Contain only facts

Chairmans

Statement

Management Discussion

& Analysis

Numbers



In this process, a company also provides insights into its key strengths and weaknesses, challenges,

success factors for its industry, etc. Also, going through these two sections will leave you with a

clear framework to tackle the financial statements (which always follow the CS and MD&A). This

chapter also tries to show you how the CS and MD&A link up with the financial statements.

At this stage, it is sufficient to have a clear grasp of the companys strategies. However, for the

analysis to be thorough, it is necessary to understand whether these strategies are appropriate for

the company, how they stack up vis--vis strategies adopted by competitors and the risks / rewards

associated with each strategy.



Note that one of the objectives of going through the CS+MD&A is to arrive at a set of questions which will provide you with a platform to take your analysis to the next level. These sections, while providing you an insight into company strategies and performance, will not provide you with 100% of the needed information / understanding.


Chairmans Statement (CS)

While there is no regulatory requirement for companies to provide CS, companies do so because

they use this to communicate with their shareholders. Although this section is also useful to

bondholders, employees, analysts, etc., this is primarily aimed at shareholders.

Bondholders,

Employees,

Analysts,

etc.

Chairmans

Statement Shareholders Primarily

Communicates with

Also useful to



This section sums up the past years performance in broad terms and lays out the thrust / strategy

for the companys future (This typically springs from the companys past performance). This in turn,

affects the companys future. A schematic representation is given below:



This section generally does not contain too many details and does not get into specifics such as

market share increase, etc. A reading of this section should clarify areas such as which sectors /

products the company proposes to focus on, whether growth will be organic or inorganic (i.e. by

acquisitions) going forward, as well as potential diversification strategies and entry into / exit from

businesses, etc.



An example

Dear Shareholder,

The Indian economy continued its trend of robust growth on the back of strong performance in

key industrial sectors. While inflationary concerns during the year have prompted a correction in

interest rates, which could lead to a slowdown in consumer demand, the fundamentals of the

economy continue to remain strong and the long-term outlook for the economy continues to be

positive.

Excerpts from Tata Motors Limited 62nd Annual Report 2006-07

Salient point: Continued good performance of the economy.



The Indian automotive industry, after experiencing a slow-down in growth rate last year, bounced

back impressively this year to post strong volumes in all segments. In particular, the commercial

vehicles segment, which saw a decline in growth rates over the last two years, grew by 33%,

buoyed by increased industrial activity and continued investment in road infrastructure. The

passenger vehicle segment was favorably impacted by a reduction in excise duty on small cars

and increased consumer spending.

An example




In this scenario, Tata Motors has had another outstanding year. The Company out-performed the

industry with record revenues and sales volumes. It significantly improved its market share in

commercial vehicles, driven by the enormous market acceptance of the Ace 0.75-tonne pickup

vehicle.

Salient point: Continued good performance of the company.

An example




The Company also achieved its highest-ever sales volumes of passenger cars and utility vehicles

during the year.

The Company has, over the past few years, followed a conscious strategy of expanding its

product range and its geographic spread in order to reduce its dependence on one single

economy and one single business cycle. This has led to the development of new products such

as the Ace in the case of commercial vehicles, and the proposed small car, apart from serious

expansion of exports and/or assembly activities in overseas markets.

Salient point: Medium-term focus on increasing product range largest roll-out in the history of the

company.

An example




As a result of this strategy, the Company has formed a joint venture in Thailand to assemble and

market pick-up trucks in the Thai market, which is the second largest pick-up market in the world.

The Company has also entered into a joint venture with the Brazil-based Marcopolo Company, to

manufacture and assemble fully built buses and coaches in India. The Company has achieved

great visibility in the passenger car markets in South Africa, Spain and Italy. It is now proposed

that the vast markets of Latin American countries be jointly addressed with the Fiat Group, as part

of the global alliance between the two companies.

Salient point: Focus on increasing geographic footprint.

Points to ponder: How large are the joint ventures that the Chairman is talking about are these

merely feel-good statements / hopes or are these financially significant? Is this true for exports

also?

An example




During the year, construction of the new manufacturing plant (jointly owned with Fiat) at Ranjangaon

has been progressing on schedule and will go on-stream in 2008. The Fiat relationship has further

been strengthened through the execution of a Memorandum of Understanding with Iveco (the Fiat

Groups commercial vehicle company), to explore opportunities for cooperation in engineering,

manufacturing, sourcing and distribution of products, aggregates and components of commercial

vehicles across markets. FIAT has also signed a licensing agreement with the Company to build a

pick-up vehicle for sale in the Latin American market.

An example




Tata Motors remains committed to launching its new small car in the first half of 2008.

Construction work has commenced at the plant site at Singur in West Bengal. There is

confidence that the Companys presence in Singur will result in the same positive impact on the

communities in the area and in the state that its plants have had on the communities in and

around Pune, Jamshedpur, Lucknow and Dharwad. In addition to the Companys own

investment in Singur, large investments will also be made within the plant perimeter by a large

number of automotive component suppliers and manufacturers who will serve the small car

project. One hopes that the Companys bona fides and high sense of social responsibility will

overcome the misplaced apprehensions and concerns which arose in the early days of the

project.

Salient point: Commitment to small car project.

Point to ponder: What are the financial implications of small car project? (i.e. - the likely capex, how

will it be funded, etc)

An example




There continue to be pressures on margins arising from rising prices of raw materials like steel, non-

ferrous metals, rubber and engineering plastics. These will be partially offset by the cost reduction

initiatives undertaken by the Company. However, the prices of most of these materials continue to

spiral upwards for the second consecutive year and this may impact the Companys profitability

going forward. The hardening of consumer finance interest rates and tight liquidity in the second half

of the fiscal year under review, have already started to have an adverse impact on the automotive

industry. If these trends were to continue, growth in the automotive sector could be adversely

impacted. Despite these bothersome trends, the years ahead for the industry and in particular for

Tata Motors, although challenging, are years of great opportunity. The growth of the Indian market,

the increased sophistication in components suppliers capabilities and global sectoral

competitiveness will result in the establishment of a world-scale automotive industry.

An example




The challenge for Tata Motors will be to develop and produce technically-advanced commercial

vehicles and passenger cars of world-class quality for the domestic and overseas markets. An

impressive range of new products is planned to be launched over the next two years. This will be the

most aggressive new product program in the Companys history. The focus has been on innovation

and market leadership. The new Ace goods carrier and its passenger-carrying variants are such

innovative products the first in the industry. Similarly, the small car proposed to be launched at a

price of around Rs. 1 lakh, will be a never-before-undertaken project which will hopefully create a

new paradigm in fulfillment of the aspirations of lower-income segment of the people of India, Asia

and Africa.

An example




With intense global competition, the challenges will be great but with the spirit, commitment

and dedication displayed by employees at all levels, these challenges will continue to be met

and overcome. Tata Motors will strive to retain its leadership position in India while being

increasingly recognized internationally as an emerging automobile company in the global

marketplace.

An example




An example: Tata Motors Limited 62nd Annual Report: 2006-07

Comment: Note that companies also like to keep some cards close to the chest. For example, Tata

Motors Chairmans statement (FY 2006-07) is silent on the potential for acquisitions it gives no

hint of the future bid for Fords European brands an extremely significant development.


Financial Highlights

(In millions, except per share data) Fiscal Year Ended June 30

2007 2006 2005 2004 2003

Revenue $51,122 $44,282 $39,788 $36,835 $32,187

Operating income 18,524 16,472 14,561 9,034 9,545

Net income 14,065 12,599 12,254 8,168 7,531

Diluted earnings per share $ 1.42 $ 1.20 $ 1.12 $ 0.75 $ 0.69


It consists of key financial statistics for a companys most recent 5 to 10 years period.

Excerpts from Microsoft Corporation 2007 Annual Report

An Example



(In millions, except per share data) Fiscal Year Ended June 30

2007 2006 2005 2004 2003

Cash dividend declared per share $ 0.40 $ 0.35 $ 3.40 $ 0.16 $ 0.08

Cash and short-term investments 23,411 34,161 37,751 60,592 49,048

Total assets 63,171 69,597 70,815 94,368 81,732

Long-term obligations 8,320 7,051 5,823 4,574 2,846

Stockholders equity 31,097 40,104 48,115 74,825 64,912


Excerpts from Microsoft Corporation 2007 Annual Report

An Example


Management Discussion and Analysis (MD & A)

The purpose of MD&A is to provide investors with information that the companys management

believes to be necessary to an understanding of its financial condition, changes in financial condition

and results of operations. It is intended to help investors to see the company through the eyes of

management. It is also intended to provide context for the financial statements and information about

the companys earnings and cash flows.


Management Discussion and Analysis

This section, while providing an overview of the companys performance and objectives, goes into

greater detail than the Chairmans Statement. Typical information contained in the MD&A includes

Information on the operating environment such as the state of the market, regulatory changes etc.

Division-wise / product-wise performance

Performance vis--vis the market (i.e. increase / decrease in market share)

The companys own SWOT assessment



Company specific factors This could include a host of factors such as labor issues, legal disputes,

etc.

Strategies Strategies which are briefly mentioned in the Chairmans Statement are typically

elaborated in the MD&A. For example, while the Chairmans statement will typically mention various

JVs, the MD&A will go into the operating and financial performance of individual JVs.

Financial information / strategies The level of dividend payouts, potential for share buybacks,

rights issues etc. are also generally covered in this section.

In summary, any factor which materially affects the companys performance is covered in the MD&A.



Utility of information in MD&A

It is necessary to clearly grasp all the facts presented in this section in order to understand the

companys performance. While doing so, it is also necessary to see whether there are any

inconsistencies between the CS & MD&A and between the MD&A & financials (for example, growth

rates mentioned in these sections should be in line with those calculated from financial statements).



It provides information on industry size and growth prospects.

The company is optimistic on future growth because penetration levels are low

(it doesnt give the figures a good analyst should independently verify if this is

true).

Industry Structure and Development

The Indian Fast moving consumer goods (FMCG) industry is characterized by a well established

distribution network, intense competition between the organized and unorganized sector and low

operation costs. The FMCG market is set to increase from US $ 11.6 billion in 2003 to US $ 33.4

billion in 2015. (Source: www.ibef.org). Penetration level as well as per capita consumption in

most product categories like skin care and shampoo in India is low indicating a large untapped

market potential.

Comments:

Utility of information: An Example

Excerpts from Marico Limited Annual Report 2006-07



Comments: Overall growth rate seems to have risen, even after taking into account acquisitions.

(A good analyst will, at this point, make a mental note to delve deeper into the factors behind this

accelerated growth).

MARICO Limited Growth Strategy - Sustained Growth

The financial year 2006-07 (FY07) was one of high growth at Marico, as compared to a

compounded growth rate of about 13% during the period from FY02 to FY06. Marico achieved

a turnover growth of 36% during the year, taking its revenue to Rs.1557 crore. While 14% of

this growth was contributed to by acquisitions made by the company, organic growth was 22%.

The company saw significant franchise expansion and thus 20% out of this 22% resulted from

volume led growth.

Utility of information: An Example

Excerpts from Marico Limited Annual Report 2006-07



Operational developments Companies also list out various operational developments that have

occurred during the past year. These portions of the MD&A are mostly factual. This typically covers

the performance of various products / divisions. It could also include a range of developments such

as reorganizations, sale of a division, etc. It is fairly detailed and gives various facts and figures,

including operating metrics. Other information provided could include listing new initiatives taken

during the year, etc.



Excerpts from Marks & Spencer Group plc Annual Report 2006-07

Operational developments

On average, we had 15.8 million visitors to our stores each week and we successfully

encouraged shoppers to buy more each time they visited.

Our TV, newspaper and billboard advertising campaigns are allowing us to project our brand,

one of our most valuable assets, with much greater impact. The key to good marketing is

great product. Now that we have better products, we are using advertising to drive sales with

greater confidence. This year, we extended our television advertising into childrens wear for

the first time.

Note that very few opinions are expressed in this example it mostly consists of facts.

Operational developments: An Example



2006/07 saw us invest heavily in modernising our stores. 35% of the portfolio was modernised

by Christmas 2006 from big stores such as Cribbs Causeway and Manchester to small high

street stores in Crewe and Clapham. We have a target to complete 70% of the portfolio by the

end of 2007.

This is a big programme. But it is being managed with minimal disruption to customers and our

overall performance. Feedback from customers is good and sales performance at the new

stores is encouraging.





We want to offer a convenient, exciting and modern shopping experience. However, our new

stores will only thrive if we keep getting our products and service right. As well as improving

the look and feel of our stores, we have invested in our people, increasing the number of

customer assistants and the amount of time they spend helping customers. Our work on

reward, training and career paths is helping us recruit and retain the best people.

The website, www.marksandspencer.com, performed well, reaching sales of over 100m for

the first time. We know that online is a big opportunity for us and, in March 2007, we launched

our new website the first step in building our multi-channel offer.





Our international business also performed well. We have built a strong franchise operation and

now have 219 stores in 34 territories. Turnover, including our eight wholly-owned stores in

Hong Kong and 13 in the Republic of Ireland, rose 16.8% to 610.6m (last year 522.7m)

while operating profits rose 33.2% to 87.5m (last year 65.7m).

M&S Money is benefiting from our partnership with HSBC, with our share of profits more than

doubling from 9.6m to 19.5m. Over three million people now use the &More credit card,

relaunched during the year, and we have over 100 Bureaux de Change at our stores serving

3.8 million customers. We expanded the range of financial products, which now includes home

and car insurance and a new ethical investment fund.





Opportunities and threats

Companies typically lay out a whole range of opportunities and threats facing them. The key things

to note while going through this area are to:

First list all the opportunities / threats, and then

Try and get a sense of, which are the most important opportunities and threats.



Opportunities Threats

Road development Global competition

Car penetration in India Fuel prices

International business Input costs

Increase in disposable income Inflation / hardening of interest rates

Large two-wheeler parc Government regulations

Growing consumer culture Growing consumer awareness

Growth of Mass Transport Systems

Opportunities and threats: An Example

Excerpts from Tata Motors Limited Annual Report 2006-07

Comments: The areas in italic are likely the most important opportunities/ threats.



Tata Motors Limited 2006-07 Annual Report Opportunities and threats:

An Example

Comments: Note that there is no one right answer these areas are somewhat open to debate. One

way of trying to figure out which factors are more important than the others is to examine how the

companys performance in past years has been impacted by each of the opportunities and threats

mentioned earlier. Another way would be to look for examples from overseas markets i.e. - to see

how changes in these factors have affected companies that operate in the same industry but in other

geographical locations. Another way would be to see how competitors have been affected by these

opportunities and threats factors.



Understanding growth rates

The MD&A contains / is preceded by a snapshot of the companys financial performance. This

enables you to calculate various growth rates. Note that it does not make sense to calculate growth

rates for ratios. Blindly calculating growth rates and viewing them in isolation does not help in

analysis. However, several inferences can be drawn from these growth rates when they are viewed

in relation to each other.



Key growth rates and the inferences that can be drawn from these are given below:

Full Year Ended March 31

Particulars Unit 2003 2004 2005 2006 2007 CAGR

Total customer base 000s 3,443 7,141 11,842 20,926 39,013 83%

Mobile Services 000s 3,071 6,504 10,984 19,579 37,141 86%

Broadband & Telephone Services 000s 372 637 857 1,347 1,871 50%

A quick look at the CAGRs tells us the following:

Growth rates are extremely high, in any context.

Rate of increase of customers in the mobile business has far exceeded that in the broadband /

telephone businesses.

Understanding growth rates: An Example

Excerpts from Bharti Airtel Annual Report 2006-07





Total customer base 000s 3,443 7,141 11,842 20,926 39,013 83%

Based on Statement of Operations

Revenue Rs. Mn 30,554 50,369 81,558 116,641 184,202 57%

EBITDA Rs. Mn 7,634 17,055 30,658 41,636 74,407 77%

Cash Profit from Operations

Rs. Mn 4,904 14,363 28,219 40,006 73,037 107%

Earnings Before Tax Rs. Mn (1,762) 5,527 15,832 23,455 46,784 NA

Profit After Tax Rs. Mn (2,051) 5,837 12,116 20,279 40,621 NA

Comments: EBITDA growth rates are close to that of customer growth rates, i.e., the company is

not achieving growth at the cost of profitability.







Based on Balance Sheet

Stockholders Equity Rs.Mn 48,262 49,146 53,200 73,624 114,884 24%

Net Debt Rs.Mn 32,395 42,292 41,171 41,738 42,867 7%

Capital Employed Rs.Mn 80,657 91,438 94,371 115,362 157,750 18%

Key Ratios

EBITDA Margin % 25.0% 33.9% 37.6% 35.7% 40.4%

Net Profit Margin % -6.7% 11.6% 14.9% 17.4% 22.1%

Comments: Growth in all balance sheet metrics shareholders equity, net debt and capital employed

is significantly lower than that in P&L items. This is a +ve, i.e., growth in income has not come about

simply by increasing the asset base / balance sheet.






Particulars Unit 2003 2004 2005 2006 2007

Key Ratios

Return on Stockholders Equity % -4.2% 12.0% 23.7% 32.0% 43.1%

Return on Capital Employed % 0.9% 9.9% 15.7% 21.5% 31.6%

Net Debt to EBITDA Times 4.24 2.48 1.34 1.00 0.58

Interest Coverage Ratio Times 2.44 5.24 9.65 17.45 26.47

Book Value per Equity Share Rs. 26.04 26.52 28.70 38.87 60.59

Net Debt to Stockholders Equity

Times 0.67 0.86 0.77 0.57 0.37

Earnings per Share (Basic) Rs. (1.11) 3.15 6.53 10.78 21.43





Financial strategies

This part of the MD&A ties in very closely with the financial statements. These sections typically

contains an overview of financial performance as well as elements such as:

Funding plans for capital expenditure (capex)

Companies generally talk about the capex incurred in the previous year as well as capex

requirements for the current year. It is important to understand whether this will involve raising debt /

equity or both. It is also necessary to try and gauge the market implications of a companys funding

plans i.e. the potential reaction from the stock & bond markets. One can also try and link the

amount mentioned in this part of the MD&A with those in the cash flow statement to try and gauge

what portion of the funding plans can be covered by ploughing back operational cash flows.




Share buybacks

Several companies have share buyback programmes in place. These prevent EPS (Earnings Per

Share) dilution due to stock issuance from stock option grants as well as help to maintain a targeted

capital structure. The CS/MD&A typically talk about the continuation / discontinuation of these

programmes as well as the resultant funding implications.




Dividends

This section gives an insight into a companys attitude towards dividends. Some companies pay a

large proportion of their net income as dividends. Others may choose to re-invest dividends in their

businesses (i.e. have a low dividend payout), in the belief that shareholders would not earn similar

results by receiving dividends and then re-investing them elsewhere.



Chairmans Message of Rio Tinto, a global mining company, expressly talks about its capex plans,

dividends and share buyback in relation to cash from operations in its 2006 Annual Report. In cases

where companies do not link up funding requirements with their operational cash flows, it will be

necessary for the analyst to do so.

The final dividend declared for 2006 of 64 US cents per share brings the total for 2006 to 104 US

cents, an increase of 30%. We have a long standing policy of progressive dividend delivery and

maintaining it remains a priority. In addition, our strong operational cash flows have enabled us to

return US$2.4 Billion to shareholders through the buyback of shares and the payment of US$1.5

Billion special dividend. We have recently announced, subject to market conditions, our intention

to return a further US$3 Billion to be completed by the end of 2007, while still retaining the

financial flexibility to take up growth opportunities as they arise.

Excerpts from Rio Tinto Global Mining Company Annual Report 2006-07

Financial strategies: An Example



Our main priority for the use of cash generated continues to be profitable investment in the

growth of the business with particular emphasis on our portfolio of economically robust projects.

Our capital investment grew from US$2.5 Billion in 2005 to US$3.9 Billion in 2006. Our pipeline

of project opportunities will see this grow to around US$5.0 Billion in 2007.

Financial strategies: An Example

Excerpts from Rio Tinto Global Mining Company Annual Report 2006-07



Mergers and Acquisitions (M&A)

The Chairman's statement and MD&A typically cover acquisitions (if any). The analyst will have to

thoroughly understand the following:

Investment in acquisition

Synergies

Logic and reasoning behind the acquisitions

Market and operational reach behind the acquisitions



The Year for Tata Steel

This has been a momentous year for Tata Steel. It has been a year of record performance and

growth with significant progress in the expansion programme to raise capacity from 5 to 6.8

million tonnes in Jamshedpur. But undoubtedly the most notable event during the year was the

companys public offer to acquire 100% of the shares of Corus Group plc, a 21 million tonne

capacity steel producer with plants in the United Kingdom and the Netherlands. Together, Tata

Steel and Corus will be a 30 million tonne steel enterprise, (after completion of the expansion

programme in Jamshedpur), and the sixth largest steel company in the world, with operations in

four continents.

Mergers and Acquisitions: An Example

Excerpts from Tata Steels Acquisition of Corus plc (UK). Annual Report 2006-07



The acquisition of Corus has transformed Tata Steel from a domestic steel producer to an

international steel company with global scale. It is a fitting tribute to the vision of our Founder,

Jamsetji N. Tata, that this very major transformation has taken place in the centenary year of the

Companys operations.

The synergies that will be derived from Tata Steel and Corus coming together will be of

tremendous strategic value to both organisations. The leveraging of low cost intermediate

products from India with further processing at Corus to produce high-end finished products,

along with several operation-related initiatives will improve the competitiveness of Corus in the

European markets while India will benefit from high-value, sophisticated finished products

developed in Corus R&D facilities.





Further, the combined entity will foster cross fertilisation of Research & Development

personnel, and domain expertise in the automotive, packaging and construction sectors, in

addition to the exchange of technology, best practices and expertise. An integration team is

in place, which will drive the operations as one single virtual enterprise. The enthusiasm,

support and acceptance of the acquisition by employees on both sides has been very

heartening.

Comments: The company expects cross-fertilisation of R&D activated as well as improved expertise

in areas sectors such as auto, packaging and construction.





Acquisition of Corus Group plc, UK

Tata Steels investment in Corus Group plc is consistent with the Companys stated

objective of growth and globalisation.

In keeping with its vision of becoming a truly global player and creating a 50 million tonne

steel capacity by 2015, through both organic and inorganic growth, the Company had been

examining various opportunities.





The process started with the acquisition of NatSteel Asia Pte. Ltd. (Singapore) in 2005 and

Tata Steel (Thailand) Public Co. Ltd. (erstwhile Millennium Steel) in 2006, the planned

brownfield expansion in Jamshedpur and the long-term green-field projects in Orissa,

Chhattisgarh and Jharkhand.

Comments: The Corus acquisition is not a one-off event. It has been preceded by others and is part

of the companys overall strategy to become a global player. Note that the companys final targeted

capacity of 50 million tonnes by 2015 is still much above the Tata Steel+Corus combine. Therefore,

further acquisitions cannot be ruled out.





Corus Financing

On 2nd April, 2007, Tata Steel completed its acquisition of Corus Group plc (Corus) at a

price of 608p per ordinary share in cash. The net funding requirement for the acquisition of

Corus was Rs. 56,150 crores (USD 12.90 billion). The acquisition was initially funded by a

cash contribution by Tata Steel of Rs. 11,750 crores (USD 2.7 billion) (funded by a mixture

of its own cash resources and syndicate loans) to Tata Steel Asia Holdings Pte. Ltd.

(TSAH). TSAH raised bridge loans of Rs. 10,900 crores (USD 2.5 billion) and Tulip UK

Holdings raised a mezzanine loan of Rs. 2,600 crores (USD 0.6 billion) which was invested

by way of equity in Tata Steel UK Ltd.

Comments: The total cost of the acquisition is USD12.9 billion. One point to note is the large size

of the acquisition in relation to the companys size (compare capacities pre and post Corus). A

larger question is: is this the right price for acquisition?





To finance the balance of the consideration due under the acquisition, Tata Steel UK Ltd.

(through its wholly owned subsidiary, Tulip Finance Netherlands BV) raised senior debts of

Rs. 17,400 crores (USD 4.0 billion) and Mezzanine bridge of Rs. 13,500 cores (USD 3.1

billion). These loans were raised without recourse to Tata Steel.

The combination of Tata Steel and Corus will enable Corus to move towards the next level

of strategic transformation through access to low cost steel production and high growth

markets in Asia.





The transaction creates the sixth largest steel producer in the world and Corus can now

grow and compete on a global scale, whilst still pursuing its existing plans for Western

Europe. Both companies also share a set of common, core values and the same approach

to business performance. A similar commitment to continuous improvement augurs well for

the future of the enlarged Group.





I. Strategic Rationale for acquisition of Corus

The Companys investment in Corus Group plc (which was completed in April 2007) is

consistent with the Companys stated objective of growth and globalisation. Post Corus

acquisition, Tata Steel is the sixth largest steel producing company in the world with a steel

making capacity (crude) of around 28 million tonnes.

Corus is Europes second largest and the ninth largest steel producer in the world and

produced 18.3 million tonnes of crude steel in 2006. Corus has crude steel production

capacity of 21.2 million tonnes in UK and Netherlands. Corus also has downstream

manufacturing facilities in Germany, France, Norway and Belgium.





In the UK, Corus has a 14.4 million tonne capacity - Port Talbot (4.7 million tonnes),

Scunthorpe (4.5 million tonnes), Teesside (3.9 million tonnes) and Rotherham (1.3 million

tonnes). The Ijmuiden plant in Netherlands has a crude steel capacity of 6.8 million tonnes

and is also one of the lowest cost producers of steel in the Western Europe.

Corus is one of the leading suppliers of steel to the automotive, construction, packaging,

engineering, rail, aerospace, metal goods, and oil and gas industries. Corus has a strong

Research and Development capability which focuses on continuous improvement in

manufacturing processes and development of high value added steel products.





Through the acquisition of Corus, Tata Steel would also have a presence in the developed

markets of Europe, have access to the strong product portfolio and research and

development facilities in Corus. The combined businesses of Tata Steel and Corus will be

driven by a common vision and strategy to cater to the requirements of the global

customers from its worldwide operations. The steel industry is also undergoing structural

changes and increased consolidation in the steel sector is likely to result in a re-rating of the

industry in the near future.

Geographical reach will increase (through Corus presence in European

markets) and product range will also increase.

A larger question is: is this the right strategy for Tata Steel?

Comments:





II. Valuation of Corus Group plc

The Enterprise Value (EV) of the Corus acquisition was around Rs. 59,850 crores (USD

13.75 billion), which includes its continuing debt of Rs. 3,700 crores (USD 0.85 billion). The

Enterprise Value/tonne of the Corus acquisition works out to around Rs. 32,700/tonne (USD

751/tonne) based on Corus actual crude steel production of 18.3 million tonnes in 2006 and

Rs. 28,250/ tonne (USD 649/tonne) based on its crude steel capacity.





III. Integration of overseas acquisitions

Integration of Corus and Tata Steel

The Integration philosophy of the Tata Steel Corus combine is premised on the strong

cultural fit and corporate governance practices of the two companies. To facilitate

integration and create a virtual organisation across the combined businesses, a Strategic

and Integration Committee (SIC) has been formed with Mr. Ratan Tata as the Chairman, Mr.

B. Muthuraman, Mr. Philippe Varin, Dr. T. Mukherjee, Mr. Rauke Henstra, Mr. Koushik

Chatterjee and Mr. David Lloyd as members.





The SIC will develop the common agenda for the combined Group that will focus on

continuous improvement, sharing of best practices, manufacturing excellence, cross

fertilization of research and development capabilities, rationalisation of costs across the

businesses and create the foundation to pursue growth in the future.

A structured approach has been undertaken and the entire integration is being co-ordinated

by a Program Office formed for the above purpose. Several teams having representations

from both companies have already been set up to handle the integration and strategic work

streams.





The following checklist of questions will serve to organize your thoughts when you go through a

companys CS & MD&A. Note that it is not exhaustive, as each company has analytical points that

will be specific to it. Even so, using the following checklist as a guide will help you in your analysis,

especially in the initial stages.

1.What has the company achieved in the previous year (in terms of operational performance)?

2.What are the goals for the current and future years?

3.What are the strategies that the company proposes to use in order to achieve these goals?

Checklist of Important Learnings



4. Which products / divisions have outperformed / underperformed? What are the reasons behind

this?

5. How have volumes and prices moved over the past year?

6. What are the prospects for the industry in which the company operates?

7. What are the overall economic prospects for the countries in which the company operates? How

are these likely to impact the companys performance?




8. What are the companys key success factors? Are they likely to persist in the medium term?

9. What have you learned after calculating CAGRs for key numbers such as sales, EBITDA, net

income, total assets and shareholders equity (this includes reserves)?

10. What are the key opportunities and threats facing the company and how does it propose to

address these?

11. What are the companys growth strategies?




12. What are its plans with respect to dividends?

13. Are there any share buyback plans? Is the company proposing to continue the same?

14. What are its capex plans and the resultant funding implications?

15. Are there any inconsistencies between the CS / MD&A and the financial statements?

16. Are there any key areas that are left unanswered by these two sections?




Financial statements (or financial reports) are formal records of a businesses' financial activities.

Financial statements provide an overview of a business' financial condition in both short and long

term. There are three basic financial statements:

Financial

Statements

Income

Statement

Balance Sheet Cash Flow

Statement



For large corporations, these statements are often

complex and include an extensive set of notes to the

financial statements and management discussion and

analysis. The notes typically describe items on the

balance sheet, income statement and cash flow

statement in further detail. Notes to financial

statements are considered an integral part of the

financial statements.



Notes provide supplementary information to consolidated financial statements and are considered

an integral part of any Annual Report. These must be read as thoroughly as the financial

statements. Notes can be divided into three major categories as shown below:

Notes to

Consolidated

Statements

Accounting

Policies

Explanatory

Notes

Supplementary

Information



Accounting Policies

These provide an overview of major accounting principles used by a company in the preparation of

its financial statements. A few examples are given below.

Excerpts from Microsoft Corporation Annual Report 2007

Note 1 Accounting Policies

Accounting Principles

The financial statements and accompanying notes are prepared in accordance with

accounting principles generally accepted in the United States of America.



Accounting Policies: Example

Principles Of Consolidation: The financial statements include the accounts of Microsoft

Corporation and its subsidiaries. Intercompany transactions and balances have been

eliminated. Equity investments in which we exercise significant influence but do not control

and are not the primary beneficiary are accounted for using the equity method. Investments

in which we are not able to exercise significant influence over the investee and which do not

have readily determinable fair values are accounted for under the cost method.




Accounting Policies: Example

Foreign Currencies: Assets and liabilities recorded in foreign currencies are translated at

the exchange rate on the balance sheet date. Revenue and expenses are translated at

average rates of exchange prevailing during the year. Translation adjustments resulting from

this process are charged or credited to Other Comprehensive Income (OCI).




Explanatory Notes

Fixed assets

Stock options

Financing and debt

Leases

These offer a detailed overview on a number of supplementary financial metrics, including:

Shareholders equity

Taxes

Employee benefit plans



Explanatory Notes: Example

Employee Stock Purchase Plan. We have an employee stock purchase plan for all

eligible employees. Compensation expense for the employee stock purchase plan is

recognized in accordance with SFAS No. 123(R). Shares of our common stock may be

purchased by employees at three-month intervals at 90% of the fair market value on the

last day of each three-month period. Employees may purchase shares having a value not

exceeding 15% of their gross compensation during an offering period. Employees

purchased the following shares:

Excerpts from Note 14 Employee Stock and Savings Plans - Microsoft Corporation Annual Report

2007



Explanatory Notes: Example

Excerpts from Note 14 Employee Stock and Savings Plans - Microsoft Corporation Annual Report

2007

(Shares in millions) 2007 2006 2005

Shares purchased 17 17 16

Average price per share $25.36 $23.02 $23.33

At June 30, 2007, 125 million shares were reserved for future issuance.



Supplementary Information

A listing of reserves

Unit sales by product line

Supplementary information notes provide additional details about a companys operations. For

example, for an oil & gas company, it may provide:


Report of Managements Responsibilities

Report of Management's Responsibilities

Responsibilities of

Management

Preparing

companys

financial

statements and

reports

Companys

internal financial

controls

Allowing company directors and

independent auditors to carry out

their respective roles in assuring the

accuracy of the companys financial

statements.

Major responsibilities of management include:



Report of Management on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over

financial reporting for the company. Internal control over financial reporting is a process to provide

reasonable assurance regarding the reliability of our financial reporting for external purposes in

accordance with accounting principles generally accepted in the United States of America. Internal

control over financial reporting includes maintaining records that in reasonable detail accurately and

fairly reflect our transactions; providing reasonable assurance that transactions are recorded as

necessary for preparation of our financial statements; providing reasonable assurance that receipts

and expenditures of company assets are made in accordance with management authorization; and

providing reasonable assurance that unauthorized acquisition, use or disposition of company assets

that could have a material effect on our financial statements would be prevented or detected on a

timely basis.

An example




Because of its inherent limitations, internal control over financial reporting is not intended to

provide absolute assurance that a misstatement of our financial statements would be prevented

or detected.

Management conducted an evaluation of the effectiveness of our internal control over financial

reporting based on the framework in Internal Control Integrated Framework issued by the

Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation,

management concluded that the companys internal control over financial reporting was effective

as of June 30, 2007. There were no changes in our internal control over financial reporting during

the quarter ended June 30, 2007 that have materially affected, or are reasonably likely to

materially affect, our internal control over financial reporting. Deloitte & Touche LLP has audited

this assessment of our internal control over financial reporting.

An example



Risk Factors

An example

Our operations and financial results are subject to various risks and uncertainties, including those

described below, that could adversely affect our business, financial condition, results of operations,

cash flows, and trading price of our common stock.

Challenges to our business model may reduce our revenues and operating margins.

We face intense competition.

We may not be able to adequately protect our intellectual property rights.

Third parties may claim we infringe their intellectual property rights.

Excerpts from Microsoft Corporation Form 10-K 2007


Risk Factors

We may not be able to protect our source code from copying if there is an unauthorized disclosure

of source code.

Security vulnerabilities in our products could lead to reduced revenues or to liability claims.

We are subject to government litigation and regulatory activity that affects how we design and

market our products.

Our business depends largely on our ability to attract and retain talented employees.

Delays in product development schedules may adversely affect our revenues.

An example



Risk Factors

We make significant investments in new products and services that may not be profitable.

Adverse economic conditions may harm our business.

We have claims and lawsuits against us that may result in adverse outcomes.

We may have additional tax liabilities.

Our consumer hardware products may experience quality or supply problems.

An example



Risk Factors

If our goodwill or amortizable intangible assets become impaired we may be required to record a

significant charge to earnings.

We operate a global business that exposes us to additional risks.

Catastrophic events or geo-political conditions may disrupt our business.

Acquisitions and joint ventures may have an adverse effect on our business.

Improper disclosure of personal data could result in liability and harm our reputation.

Other risks that may affect our business.

An example



Legal Proceedings

See Note 17 Contingencies of the Notes to Financial Statements (Part II, Item 8) for information

about legal proceedings in which we are involved.

An example

Government competition law matters.

Antitrust, unfair competition, and overcharge class actions.

Other antitrust litigation and claims.

Patent and intellectual property claims.

Other.



Auditors Report

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Microsoft Corporation:

We have audited the accompanying consolidated balance sheets of Microsoft Corporation and

subsidiaries (the Company) as of June 30, 2007 and 2006, and the related consolidated

statements of income, cash flows, and stockholders equity for each of the three years in the period

ended June 30, 2007. These financial statements are the responsibility of the Companys

management. Our responsibility is to express an opinion on these financial statements based on our

audits.

An example



Auditors Report

We conducted our audits in accordance with the standards of the Public Company Accounting

Oversight Board (United States). Those standards require that we plan and perform the audit to

obtain reasonable assurance about whether the financial statements are free of material

misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and

disclosures in the financial statements. An audit also includes assessing the accounting principles

used and significant estimates made by management, as well as evaluating the overall financial

statement presentation. We believe that our audits provide a reasonable basis for our opinion.

An example



Auditors Report

In our opinion, such consolidated financial statements present fairly, in all material respects, the

financial position of Microsoft Corporation and subsidiaries as of June 30, 2007 and 2006, and the

results of their operations and their cash flows for each of the three years in the period ended

June 30, 2007, in conformity with accounting principles generally accepted in the United States of

America.

An example



Auditor Report

We have also audited, in accordance with the standards of the Public Company Accounting

Oversight Board (United States), the effectiveness of the Companys internal control over

financial reporting as of June 30, 2007, based on the criteria established in Internal Control

Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway

Commission and our report dated August 3, 2007, expressed an unqualified opinion on

management's assessment of the effectiveness of the Companys internal control over financial

reporting and an unqualified opinion on the effectiveness of the Company's internal control over

financial reporting.

/s/ DELOITTE & TOUCHE LLP

Seattle, Washington

August 3, 2007

An example



Details of Directors and Officers

DIRECTORS

William H. Gates III0 Chairman of the Board, Microsoft Corporation

Raymond V. Gilmartin4,5 Former Chairman, President, CEO, Merck & Co., Inc.

Charles H. Noski1,3 Former Vice Chairman, AT&T Corporation

Steven A. Ballmer0 Chief Executive Officer, Microsoft Corporation

Reed Hastings3 Founder, Chairman and Chief Executive Officer, Netflix, Inc.

Dr. Helmut Panke2,5 Former Chairman of the Board of Management, BMW AG

This section lists the directors and executive officers of the company and their past and current professional affiliations. Example of Microsoft Corporation is given below.

An example




James I. Cash Jr., PhD.1,2,5 Former James E. Robison Professor, Harvard Business School

David F. Marquardt3,4 General Partner, August Capital

Jon A. Shirley3 Former President, Chief Operating Officer, Microsoft Corporation

Dina Dublon1,2,3 Former Chief Financial Officer, JPMorgan Chase

Board Committees

1. Audit Committee

2. Compensation Committee

3. Finance Committee

An example

4. Governance and Nominating Committee

5. Antitrust Compliance Committee




Executive Officers

William H. Gates III Chairman of the Board

Lisa E. Brummel Senior Vice President, Human Resources

Jeffrey S. Raikes President, Microsoft Business Division

Steven A. Ballmer Chief Executive Officer

Kevin R. Johnson President, Platforms & Services Division

Bradford L. Smith Senior Vice President, General Counsel and Secretary

Robert J. (Robbie) Bach President, Entertainment and Devices Division

Christopher P. Liddell Senior Vice President and Chief Financial Officer

B. Kevin Turner Chief Operating Officer

An example:



Thank You.

Reading the Annual Report

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