Case Study - Corp Finance - Padgett Paper Products

Padgett Paper Products Company

Agida * Dantes * de Leon * Estanislao * Lope * Ronquillo

Current Situation

Padgett and Caslon have been long time banking partners

Recently, $ 3.7 Million loan was granted to Padgett when to acquire Tri-state Tablet.

The terms of the loan is abnormal Padgett's debt structure must be revised in a

mutually satisfactory manner.

Objective

To find a mutually acceptable debt structure that will minimize lender risk while increasing company value.

Methodology Review Company Background and Industry

Conditions Evaluate Padgett Paper Product’s Strategy and

Financial Performance. Provide advantages and disadvantages of the

proposed options using the financial ratios. Recommend the best solution or combination

of solutions that will benefit all concerned parties.

Company and Owners Padgett Paper Products is a 100 year old

closely-held company and only a few family members were active in the management of the company

Owners interest is mainly on dividend distribution

The main business of the company is into manufacturing stationary such as notebooks, loose leaf binders and filler paper.

It has over 5,000 wholesalers and retailers in US and Canada.

Industry Conditions During the 1970s, there has been a

consolidation in the market due to high inflation rates which made it difficult for small firms to finance their current assets. Financial difficulties and inventory problems due to the recession in the early 1980s further reduced the level of competition. Increasing paper prices created financial strains and forced small firms to sell. Price increases were not passed to customers due to strong competition from large integrated paper companies.

Company Strategies Management’s expertise is largely on

operations maintain level production to reduce unit cost minor acquisitions of companies that fit into its

product or marketing needs take advantage of seasonal sales peaks.

Management’s expertise is largely on operations and managers (Ruhl) are not finance savvy

Company Strategies Financial policy is primarily conservative.

The company also does not require high levels of debt.

Short-term borrowing used for seasonal cash needs during back-to-school sales and minor acquisitions.

Increased dependence on 90 day term notes even on large loans (including Tri-State Tablet Co. 3.6M)

The company has not taken advantage as well of its significant level of equity. D/E is not maximized and value from tax shield is lost.

Predicament Ruhl’s POV:

Forecasted lower interest due to upcoming elections

Libris proposal is too high Believes that firm should continue with the

current strategy Libris’ POV:

Pay out would take 8 years based on forecast No collateral – high risk’

Padgett Liabilities Position(1993 - 1996)

0 0

3,118

7,221

338 221 507 4550

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

1993 1994 1995 1996

Years

tho

usa

nd

of

US

D

Short term notes Long term Debt

Analysis of Current Financial Status

There is a drastic increase of 3M short term notes in 1995 and an additional of roughly 4M in 1996.

Incr ( Dcr ) Incr ( Dcr ) Incr ( Dcr )

1993-1994 1994-1995 1995-1996

Short term notes Difference 0.00 3,118.00 4,103.00

% Difference n/a n/a 131.59%

Long term Debt Difference -117.00 286.00 -52.00

% Difference -34.62% 129.41% -10.26%


There is a huge increase in short term notes, reaching 130% increase from 1995 to 1996. There are minimal fluctuations in long term debt as compared to short term debt.

Continued…

1993 1994 1995 1996

Gross Sales 10,603 10,632 14,293 16,014

Operating Expenses 5,814 6,965 9,742 10,968

Operating Profit 4,789 3,667 4,551 5,046

Interest Expense 0 32 220 379

Other expenses ( income ) 83 -42 -39 -71

Income taxes 2,702 1,893 2,216 2,132

Profit after taxes 2,004 1,784 2,154 2,606

Number of shares ( 000 ) 1,000 1,115 1,116 1,118

Earnings per share 2.00 1.60 1.93 2.33

Dividends per share 1.00 1.00 1.00 1.00

Figures from Padgett’s Income Statements for the Fiscal Years Ended April 30,1993-1996 ( thousand of dollars except per share figures )

Incr (Dcr)

1993-1994Incr (Dcr) 1994-1995

Incr (Dcr) 1995-1996

%Diff 1993-1994

%Diff 1994-1995

%Diff 1995-1996

Gross Sales 29 3,661 1,721 0.27% 34.43% 12.04%

Operating Expenses 1,151 2,777 1,226 19.80% 39.87% 12.58%

Operating Profit -1,122 884 495 -23.43% 24.11% 10.88%

Interest Expense 32 188 159 587.50% 72.27%

Other expenses ( income ) -125 3 -32 -150.60% -7.14% 82.05%

Income taxes -809 323 -84 -29.94% 17.06% -3.79%

Profit after taxes -220 370 452 -10.98% 20.74% 20.98%


There is a continued decrease in profit margin.

Profitability 1993 1994 1995 1996

Diff 1993-1994

Diff 1994-1995

Diff 1995-1996

Sales Growth n.a. 3.37% 35.56% 11.95% 32.18% -23.60%

Gross Profit Margin 40.27% 39.06% 38.74% 38.77% -1.21% -0.32% 0.03%

Operating expenses/sales 22.08% 25.59% 26.40% 26.55% 3.51% 0.81% 0.15%

Pre-tax margin 17.87% 13.51% 11.84% 11.47% -4.36% -1.67% -0.37%

After-tax margin 7.61% 6.55% 5.84% 6.31% -1.06% -0.72% 0.47%

ROE n.a. 11.36% 13.01% 14.63% 1.65% 1.61%

ROA 10.67% 9.23% 8.66% 8.41% -1.44% -0.56% -0.26%

EBIT/total assets 25.05% 19.18% 18.46% 16.51% -5.86% -0.72% -1.95%

Dividend Payout 49.90% 62.50% 51.81% 42.90% 12.60% -10.69% -8.91%

Self sustaining Growth rate n.a. 4.26% 6.27% 8.35%


OPEX steadily increases

Profitability 1993 1994 1995 1996

Diff 1993-1994

Diff 1994-1995

Diff 1995-1996

Sales Growth n.a. 3.37% 35.56% 11.95% 32.18% -23.60%



Pre-tax margin 17.87% 13.51% 11.84% 11.47% -4.36% -1.67% -0.37%

After-tax margin 7.61% 6.55% 5.84% 6.31% -1.06% -0.72% 0.47%

ROE n.a. 11.36% 13.01% 14.63% 1.65% 1.61%

ROA 10.67% 9.23% 8.66% 8.41% -1.44% -0.56% -0.26%


Dividend Payout 49.90% 62.50% 51.81% 42.90% 12.60% -10.69% -8.91%



Margins are becoming tight due to competition

Profitability 1993 1994 1995 1996

Diff 1993-1994

Diff 1994-1995

Diff 1995-1996

Sales Growth n.a. 3.37% 35.56% 11.95% 32.18% -23.60%



Pre-tax margin 17.87% 13.51% 11.84% 11.47% -4.36% -1.67% -0.37%

After-tax margin 7.61% 6.55% 5.84% 6.31% -1.06% -0.72% 0.47%

ROE n.a. 11.36% 13.01% 14.63% 1.65% 1.61%

ROA 10.67% 9.23% 8.66% 8.41% -1.44% -0.56% -0.26%


Dividend Payout 49.90% 62.50% 51.81% 42.90% 12.60% -10.69% -8.91%



There is a constant dividend payout over the years despite fluctuations in other indicators of profitability

Profitability 1993 1994 1995 1996

Diff 1993-1994

Diff 1994-1995

Diff 1995-1996

Sales Growth n.a. 3.37% 35.56% 11.95% 32.18% 23.60%

Gross Profit Margin 40.27% 39.06% 38.74% 38.77% 1.21% -0.32% 0.03%


Pre-tax margin 17.87% 13.51% 11.84% 11.47% -4.36% -1.67% -0.37%

After-tax margin 7.61% 6.55% 5.84% 6.31% -1.06% -0.72% 0.47%

ROE n.a. 11.36% 13.01% 14.63% 1.65% 1.61%

ROA 10.67% 9.23% 8.66% 8.41% -1.44% -0.56% -0.26%


Dividend Payout 49.90% 62.50% 51.81% 42.90% 12.60% 10.69% -8.91%



Plowback rate of less than 10% can be considered very low.

Profitability 1993 1994 1995 1996

Diff 1993-1994

Diff 1994-1995

Diff 1995-1996

Sales Growth n.a. 3.37% 35.56% 11.95% 32.18% 23.60%

Gross Profit Margin 40.27% 39.06% 38.74% 38.77% 1.21% -0.32% 0.03%


Pre-tax margin 17.87% 13.51% 11.84% 11.47% -4.36% -1.67% -0.37%

After-tax margin 7.61% 6.55% 5.84% 6.31% -1.06% -0.72% 0.47%

ROE n.a. 11.36% 13.01% 14.63% 1.65% 1.61%

ROA 10.67% 9.23% 8.66% 8.41% -1.44% -0.56% -0.26%


Dividend Payout 49.90% 62.50% 51.81% 42.90% 12.60% 10.69% -8.91%



Despite rise and fall in sales, OPEX, NI, and other figures in the its Income Statement, Padgett’s Div per Share remains constant.

Trend of Figures from Padgett's Income Statement(1993 - 1996)

10,603 10,632

14,29316,014

2,004 1,784 2,154 2,606

5,8146,965

9,74210,968

83 -42 -39 -711.00 1.00 1.00 1.00

-2,000

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

1993 1994 1995 1996

Years

tho

usa

nd

of

US

D

Gross Sales Profit after taxes

Operating Expenses Other expenses ( income )

Dividends per share

Analysis of Current Financial Status360/Turnover on Sales (1993-1996)

-

50

100

150

200

250

Receivables Inventory AccountsPayable

WorkingCapital

Fixed Asset Net worth

Metrics

Nu

mb

er o

f D

ays

1993 1994 1995 1996


receivables are collected every 2.25 months

inventory is consumed up every 4.17 months

payables/dues are settled within 0.57 months

working capital is turned over every 3.61 months

fixed asset value is turned over every 2.11 months

net worth is turned over every 5.39 months

360/Turnover on Sales 1993 1994 1995 1996

Receivables 64.7 73.3 62.0 67.6

Inventory 99.5 102.4 106.9 125.1

Accounts Payable 15.4 21.4 21.1 17.1

Working Capital 157.6 150.3 113.9 108.4

Fixed Asset 65.6 70.5 62.0 63.3

Net worth 210.1 212.1 166.6 161.8


There is a drastic increaser in Debt-Equity Ratio over tha last 2 years.

Padgett Leverage Position(1993 - 1996)

0.22 0.21

0.46

0.67

0.02 0.01 0.03 0.020.00

0.20

0.40

0.60

0.80

1993 1994 1995 1996

Years

Debt/equity Ratio Long term debt / Equity Ratio


acquisition of Tri-state additional 3.6m loan

has more short term notes than long term debt

high interest expense due to more short term notes

total long term debt 6.1x of short term notes in 1995 and 15.9x in 1996

current liabilities is already higher than current assets less inventory

higher current liabilities

Leverage 1993 1994 1995 1996

Debt/equity Ratio 22.3% 20.6% 45.6% 67.0%

Long term debt / Equity Ratio 2.2% 1.4% 3.0% 2.5%

Interest coverage (EBIT/interest ) n.a.

115.9

20.9

13.5

Short term notes/ Long term debt Ratio

-

-

6.1

15.9

Liquidity

Quick Ratio ((cash + securities +AR )/current liabilities)

2.7

2.4

1.1

0.8

Current ratio ( current assets / current liabilities )

5.8

5.8

2.8

2.1

Analysis of Current Financial Status Key Findings:

There is a huge amount of short-term notes vis-à-vis long–term debt: a very risky position

Owners continue to get constant dividends regardless of the firms financial status

Plowback rate is very lowCurrent liabilities could not anymore be

financed by current assetsDebt/Equity Ratio reveals that current

situation may lead to bankruptcy in the long run

General Recommendation

Shift to long-term financing to finance long-term assets First level of leverage

• Collateralized assets (c/o Rachelle)• Mortgage general purpose building (c/o Rachelle)• Continue using LIFO instead of FIFO (c/o Erle)

Second level of leverage• Debt through insurance company (c/o Mic)• Factor Receivables at 2% instead of 2/10 net 30 (c/o

Rachelle)

LIFO Instead of FIFO

LIFO stands for last-in, first-out, meaning that the most recently purchased items are recorded as sold first.

Most recent good bought is more expensive than the older ones.

LIFO reduces income taxes in times of inflation

LIFO Instead of FIFO

Gross Margin = Net Sales – Cost of Goods Sold

Operating Profit = Gross Margin – OPEX

Profit before taxes = Operating Profit – Interest and Other Expenses

Income Tax = Profit before taxes * %tax

• Assumption: %tax remains constant• Refer to Financial Model for Example

Microsoft Excel Worksheet

Documents

Case Study - Corp Finance - Padgett Paper Products