For the exclusive use of J. Cole, 2020. 9 -9 1 5 -5 2 3 FEBRUARY 5, 2015 W. CARL KESTER CRAIG STEPHENSON Classic Fixtures & Hardware Company ”What’s really happening at Classic Fixtures & Hardware Company?” It was August 6, 2008, and Gary Matocha, a senior lending officer at Southwest National Bank, kept rolling this question through his mind as he prepared for tomorrow’s meeting with Dan Watkins, the company’s Chief Financial Officer. The amounts borrowed under Classic’s seasonal loan facility had been significantly above forecast during the last few months, and Mr. Watkins had just informed Mr. Matocha that the company would likely be unable to pay off the balance of the loan in the fall of 2008, as both Classic and the bank had originally anticipated. This admission that the company would not be “out of the loan” was especially troublesome to Matocha, and he had immediately scheduled the meeting with Watkins at their headquarters in East Texas. The agenda for tomorrow was straightforward; discuss the company’s current financial situation, identify the reasons why Classic would be unable to liquidate the loan balance, and develop solutions to remedy Classic’s current financial problems. Classic Fixtures & Hardware Company was a successful manufacturer and distributor of a wide range of kitchen and bathroom fixtures and trim, as well as lock sets and hardware for doors and windows. These products, known for their quality, classic design, and timeliness, were sold to individuals and contractors in large home-improvement retailers, smaller hardware and lumber stores, and directly to large home builders through a small internal sales force. Home improvement expenditures and housing construction were both impacted by the weather in the northern tier of states, resulting in more sales for Classic in the spring and summer (approximately 60% of yearly sales), and fewer sales in autumn and winter (approximately 40%). The company’s plan for 2008, developed and approved by management in late 2007, anticipated moderate increases in housing starts and home improvement activity, and Classic ramped up its production and sales efforts to meet this expected increase in demand. The company’s forecasted monthly income statements and monthly balance sheets presented in Exhibit 1 and Exhibit 2, respectively, show detailed information about the year 2008 plan. All manufacturing took place in rural East Texas, and Classic produced inventory at a level rate through the year to meet forecast demand. Level production minimized the stress on the production facilities, and provided steady income for employees, making Classic an important employer in the county and region. Sales, however, were highly seasonal, and the mismatch between level production ________________________________________________________________________________________________________________ HBS Professor W. Carl Kester and Senior Instructor Craig Stephenson, Leeds School of Business at the University of Colorado, Boulder prepared this case solely as a basis for class discussion and not as an endorsement, a source of primary data, or an illustration of effective or ineffective management. Although based on real events and despite occasional references to actual companies, this case is fictitious and any resemblance to actual persons or entities is coincidental. Copyright © 2014 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. This document is authorized for use only by Jarett Cole in SPR20 Integrated Mgmt taught by Anne Fuller, Georgia Institute of Technology from Jan 2020 to Jul 2020. For the exclusive use of J. Cole, 2020. 915-523 | Classic Fixtures & Hardware Company and seasonal sales caused inventory levels and the supporting working capital financing to expand and contract with sales and collections of accounts receivable. As a family-owned firm, Classic had limited access to the capital markets and therefore depended on its loan facility with Southwest to finance its working capital needs. Southwest had been Classic’s lead bank for many years, and the company understood the bank believed that working capital financing was by definition short-term instead of permanent financing; Southwest strongly preferred short-term borrowings be fully paid off at least one month per year. Classic’s seasonal sales and collections pattern resulted in higher inventory and working capital loan balances in the first half of the year, and declining inventory and loan balances in the second half of the year. This pattern of building inventory levels in the winter and spring, heavy sales in the spring and summer, and large collections in the summer and fall had always allowed Classic to fully pay down its loan facility during the fourth quarter of the year. That is, until 2008. The first sign that Classic’s year 2008 performance wasn’t meeting the plan came in early April. Matocha noticed the company’s end of March loan balance was $4 million above forecast, leading to a phone call with the CFO to discuss the variance. Watkins attributed the increase to cost overruns in the company’s plant expansion and modernization program, which was launched in January, and was expected to be completed in early December, with total capital expenditures forecast at $30 million. Actual expenditures in the first quarter of 2008 had come in higher than expected, but Mr. Watkins explained that program costs in future months were expected to be at or below forecast. The CFO expressed confidence that loan balances would quickly return to forecast levels, and Matocha accepted this explanation, although he wondered if Classic was actually using short-term bank credit for longerterm capital projects, or if other problems were the true cause of the increased borrowings. In early June, Matocha had another conversation with Watkins about the continuing variance versus plan in amounts borrowed by the company under the loan facility. The CFO stated that sales during April and May had been well below forecast, with May’s results nearly 12% below expectations. Watkins also explained that sales were down in both the retail and direct-to-builder channels, and the decrease in sales and collections had forced the company to increase borrowings until the company could adjust operations to match current economic conditions. The maximum funding available to the company was $90 million, so Classic was well within the terms of the seasonal loan facility, but Matocha was increasingly concerned about the company’s product markets and management’s actions. The third, and most alarming phone conversation between the senior loan officer and CFO, occurred early on August 6th, when Watkins admitted that even though the loan balance had fallen by $8 million during July, he believed that Classic would likely be unable to pay off the balance of the loan this year, and before the seasonal upturn in funds requirements in 2009. Collections from customers would allow the company to reduce the amount borrowed, but sales had continually failed to meet forecast through the summer, so cash receipts would probably not be sufficient to pay off the entire amount borrowed. Matocha asked if Classic’s inability to repay the seasonal loan facility this year was due to a permanent change in the company’s funding needs, perhaps caused by the expansion and modernization program, or if the company’s financial problems were instead the result of significant changes in Classic’s product markets. Watkins was not able to answer this question with any certainty, and they both agreed to a meeting at Classic’s headquarters to discuss the situation. To prepare for the meeting, Matchoa began to analyze the company’s actual monthly income statements and monthly balance sheets provided by Mr. Watkins, as presented in Exhibit 3 and Exhibit 4, respectively. Beyond this information, Matocha also collected the data presented in Exhibit 5, so he could better understand conditions in the home improvement and housing construction industries. He expected his analysis of Classic’s financial performance would reveal why it would be unable to repay its loan balance this year, and hopefully identify actions to correct the company’s financial problems. 2 BRIEFCASES | HARVARD BUSINESS SCHOOL This document is authorized for use only by Jarett Cole in SPR20 Integrated Mgmt taught by Anne Fuller, Georgia Institute of Technology from Jan 2020 to Jul 2020. 26,911 47,428 16,000 31,428 Income taxes Net income Dividends Addition to retained earnings Cumulative addition to retained earnings 208,392 82,926 Selling, general & administrative expenses Operating income 8,587 74,339 881,424 590,106 291,318 Net sales Cost of goods sold Gross profit Interest expense Income before income taxes Actual 2007 ($ in thousands) 11 11 26 11 539 37 17,900 576 56,330 37,854 18,476 Jan 1,246 1,257 703 1,246 621 1,949 17,900 2,570 62,410 41,940 20,470 Feb Exhibit 1 Year 2008 Forecasted Monthly Income Statements 4,400 -954 303 1,914 3,446 736 5,360 17,900 6,096 73,160 49,164 23,996 Mar 6,776 7,079 3,776 6,776 786 10,552 17,900 11,338 89,140 59,902 29,238 Apr 7,430 14,509 4,144 7,430 784 11,574 17,900 12,358 92,250 61,992 30,258 May 4,400 4,273 18,782 4,847 8,673 760 13,520 17,900 14,280 98,110 65,930 32,180 Jun 9,021 27,803 5,062 9,021 679 14,083 17,900 14,762 99,580 66,918 32,662 2008 Jul 7,373 35,176 4,158 7,373 571 11,531 17,900 12,102 91,470 61,468 30,002 Aug 4,400 1,107 36,283 3,117 5,507 533 8,624 17,900 9,157 82,490 55,433 27,057 Sep 2,786 39,069 1,587 2,786 533 4,373 17,900 4,906 69,530 46,724 22,806 Oct -550 38,519 -289 -550 533 -839 17,900 -306 53,640 36,046 17,594 Nov 4,400 -5,103 33,416 -376 -703 528 -1,079 17,900 -551 52,890 35,541 17,349 Dec 17,600 33,416 28,669 51,016 7,603 79,685 214,800 87,288 921,000 618,912 302,088 Year 915-523 -3- For the exclusive use of J. Cole, 2020. This document is authorized for use only by Jarett Cole in SPR20 Integrated Mgmt taught by Anne Fuller, Georgia Institute of Technology from Jan 2020 to Jul 2020. 107,067 104,409 121,670 19,744 352,890 165,681 518,571 18,247 0 0 27,597 45,844 86,250 81,639 304,838 386,477 518,571 Cash Accounts receivable a Inventories Other current assets Current assets Net plant & equipment Total assets Accounts payable b Short-term bank debt c Income taxes payable d Other current liabilities Current liabilities Long-term debt e Common stock Retained earnings Owners' equity Total liabilities & owners' equity 518,583 81,639 304,849 386,488 86,250 18,100 36 26 27,683 45,845 167,335 518,583 88,202 107,830 135,442 19,774 351,248 Jan 540,295 81,639 306,095 387,734 86,250 18,100 19,665 729 27,817 66,311 170,104 540,295 86,520 118,740 145,128 19,803 370,191 Feb 561,942 81,639 305,141 386,780 86,250 18,100 47,313 -4,524 28,023 88,912 171,919 561,942 87,030 135,570 147,590 19,833 390,023 Mar 584,607 81,639 311,917 393,556 86,250 18,100 59,341 -748 28,108 104,801 175,264 584,607 87,540 162,300 139,639 19,864 409,343 Apr 595,826 81,639 319,347 400,986 86,250 18,100 58,835 3,396 28,259 108,590 176,893 595,826 88,050 181,390 129,598 19,895 418,933 May 592,633 81,639 323,620 405,259 85,350 18,100 54,450 1,076 28,398 102,024 178,157 592,633 88,570 190,360 115,619 19,927 414,476 Jun e The interest rate on long-term debt is 7.5% d Estimated taxes of $7,167,250 are paid in March, June, September, and December, based on forecasted year 2008 income taxes c The interest rate on short-term bank debt is 5% b Assumes a 1 month payment period on purchases a Assumes a 2 month collection period Actual 12-31-2007 ($ in thousands) Exhibit 2 Year 2008 Forecasted Monthly Balance Sheets Jul 587,181 81,639 332,641 414,280 85,350 18,100 34,834 6,138 28,479 87,551 179,472 587,181 89,080 197,690 100,982 19,957 407,709 2008 Aug 573,164 81,639 340,014 421,653 85,350 18,100 9,051 10,296 28,714 66,161 180,791 573,164 89,540 191,050 91,795 19,988 392,373 Sep 561,389 81,639 341,121 422,760 85,350 18,100 0 6,245 28,934 53,279 181,396 561,389 97,373 173,960 88,643 20,017 379,993 Oct 565,894 81,639 343,907 425,546 85,350 18,100 0 7,832 29,066 54,998 182,648 565,894 116,620 152,050 94,535 20,041 383,246 Nov 565,223 81,639 343,357 424,996 85,350 18,100 0 7,543 29,234 54,877 183,843 565,223 127,043 123,170 111,105 20,062 381,380 551,826 81,639 338,254 419,893 84,450 18,100 0 0 29,383 47,483 184,636 551,826 112,400 106,530 128,180 20,080 367,190 Dec 915-523 -4- For the exclusive use of J. Cole, 2020. This document is authorized for use only by Jarett Cole in SPR20 Integrated Mgmt taught by Anne Fuller, Georgia Institute of Technology from Jan 2020 to Jul 2020. 61,417 51,626 37,854 75,189 Finished goods Beginning balance + Additions from work in progress - Cost of goods sold Ending balance 135,442 36,103 18,100 11,861 21,665 51,626 36,103 Work in progress Beginning balance + Additions from raw materials + Direct labor + Manufacturing overhead - Transfers to finished goods Ending balance Total ending inventories 24,150 18,100 18,100 24,150 Jan Raw materials Beginning balance + Purchases - Transfers to work in progress Ending balance ($ in thousands) 145,128 75,189 51,626 41,940 84,875 36,103 18,100 11,861 21,665 51,626 36,103 24,150 18,100 18,100 24,150 Feb Exhibit 2 (Continued - Forecasted Monthly Inventories) 147,590 84,875 51,626 49,164 87,337 36,103 18,100 11,861 21,665 51,626 36,103 24,150 18,100 18,100 24,150 Mar 139,639 87,337 51,951 59,902 79,386 36,103 18,100 11,861 21,990 51,951 36,103 24,150 18,100 18,100 24,150 Apr 129,598 79,386 51,951 61,992 69,345 36,103 18,100 11,861 21,990 51,951 36,103 24,150 18,100 18,100 24,150 May 115,619 69,345 51,951 65,930 55,366 36,103 18,100 11,861 21,990 51,951 36,103 24,150 18,100 18,100 24,150 2008 Jun 100,982 55,366 52,281 66,918 40,729 36,103 18,100 11,861 22,320 52,281 36,103 24,150 18,100 18,100 24,150 Jul 91,795 40,729 52,281 61,468 31,542 36,103 18,100 11,861 22,320 52,281 36,103 24,150 18,100 18,100 24,150 Aug 88,643 31,542 52,281 55,433 28,390 36,103 18,100 11,861 22,320 52,281 36,103 24,150 18,100 18,100 24,150 Sep 94,535 28,390 52,616 46,724 34,282 36,103 18,100 11,861 22,655 52,616 36,103 24,150 18,100 18,100 24,150 Oct 111,105 34,282 52,616 36,046 50,852 36,103 18,100 11,861 22,655 52,616 36,103 24,150 18,100 18,100 24,150 Nov 128,180 50,852 52,616 35,541 67,927 36,103 18,100 11,861 22,655 52,616 36,103 24,150 18,100 18,100 24,150 Dec 915-523 -5- For the exclusive use of J. Cole, 2020. This document is authorized for use only by Jarett Cole in SPR20 Integrated Mgmt taught by Anne Fuller, Georgia Institute of Technology from Jan 2020 to Jul 2020. 8,587 74,339 26,911 47,428 16,000 31,428 Income taxes Net income Dividends Addition to retained earnings Cumulative addition to retained earnings 208,392 82,926 Selling, general & administrative expenses Operating income Interest expense Income before income taxes Actual 2007 881,424 590,106 291,318 ($ in thousands) Net sales Cost of goods sold Gross profit Exhibit 3 Year 2008 Actual Monthly Income Statements -153 -153 -67 -153 542 -220 17,914 322 Jan 55,496 37,260 18,236 834 681 470 834 624 1,304 17,897 1,928 Feb 60,204 40,379 19,825 4,400 -1,982 -1,301 1,332 2,418 751 3,750 17,922 4,501 Mar 68,320 45,897 22,423 4,913 3,612 2,721 4,913 818 7,634 17,906 8,452 2008 Apr 80,507 54,149 26,358 5,136 8,748 2,840 5,136 844 7,976 17,918 8,820 May 81,593 54,855 26,738 4,400 1,398 10,146 3,205 5,798 867 9,003 17,873 9,870 Jun 84,868 57,125 27,743 5,792 15,938 3,209 5,792 833 9,001 17,909 9,834 Jul 84,760 57,017 27,743 915-523 -6- For the exclusive use of J. Cole, 2020. This document is authorized for use only by Jarett Cole in SPR20 Integrated Mgmt taught by Anne Fuller, Georgia Institute of Technology from Jan 2020 to Jul 2020. 519,354 81,639 304,685 386,324 86,250 18,486 686 -67 27,675 46,780 167,974 519,354 Jan 88,246 107,096 136,236 19,802 351,380 540,474 81,639 305,519 387,158 86,250 18,411 20,446 403 27,806 67,066 171,015 540,474 Feb 86,436 115,763 147,447 19,813 369,459 563,879 81,639 303,537 385,176 86,250 18,866 50,947 -5,432 28,072 92,453 173,048 563,879 Mar 86,966 130,411 153,627 19,827 390,831 587,782 81,639 308,450 390,089 86,250 19,112 66,929 -2,711 28,113 111,443 176,898 587,782 2008 Apr 86,525 152,439 152,036 19,884 410,884 a Estimated taxes of $7,167,250 are paid in March, June, September, and December, based on forecasted year 2008 income taxes 518,571 Total liabilities & owners' equity 86,250 Long-term debt 81,639 304,838 386,477 18,247 0 0 27,597 45,844 Accounts payable Short-term bank debt Income taxes payablea Other current liabilities Current liabilities Common stock Retained earnings Owners' equity 165,681 518,571 Actual 12-31-2007 107,067 104,409 121,670 19,744 352,890 Net plant & equipment Total assets ($ in thousands) Cash Accounts receivable Inventories Other current assets Current assets Exhibit 4 Year 2008 Actual Monthly Balance Sheets 601,712 81,639 313,586 395,225 86,250 18,714 73,098 129 28,296 120,237 178,842 601,712 May 85,780 167,907 149,276 19,907 422,870 605,317 81,639 314,984 396,623 85,350 18,618 80,153 -3,834 28,407 123,344 180,618 605,317 Jun 81,382 179,342 144,051 19,924 424,699 605,997 81,639 320,776 402,415 85,350 18,410 71,986 -625 28,461 118,232 182,028 605,997 Jul 80,663 184,314 139,039 19,953 423,969 915-523 -7- For the exclusive use of J. Cole, 2020. This document is authorized for use only by Jarett Cole in SPR20 Integrated Mgmt taught by Anne Fuller, Georgia Institute of Technology from Jan 2020 to Jul 2020. For the exclusive use of J. Cole, 2020. 915-523 | Classic Fixtures & Hardware Company Exhibit 4 (Continued - Actual Monthly Inventories) 8 ($ in thousands) Raw materials Beginning balance + Purchases - Transfers to work in progress Ending balance Jan Feb Mar 2008 Apr May Jun Jul 24,150 18,267 18,209 24,208 24,208 18,112 18,074 24,246 24,246 18,436 18,482 24,200 24,200 18,579 18,371 24,408 24,408 18,135 18,027 24,516 24,516 17,966 17,961 24,521 24,521 17,683 17,860 24,344 Work in progress Beginning balance + Additions from raw materials + Direct labor + Manufacturing overhead - Transfers to finished goods Ending balance 36,103 18,209 11,849 21,710 51,760 36,111 36,111 18,074 11,827 21,651 51,623 36,040 36,040 18,482 11,902 21,739 52,109 36,054 36,054 18,371 11,893 22,086 52,335 36,069 36,069 18,027 11,931 22,029 51,976 36,080 36,080 17,961 11,830 22,104 51,847 36,128 36,128 17,860 11,895 22,427 52,137 36,173 Finished goods Beginning balance + Additions from work in progress - Cost of goods sold Ending balance 61,417 51,760 37,260 75,917 75,917 51,623 40,379 87,161 87,161 52,109 45,897 93,373 93,373 52,335 54,149 91,559 91,559 51,976 54,855 88,680 88,680 51,847 57,125 83,402 83,402 52,137 57,017 78,522 Total ending inventories 136,236 147,447 153,627 152,036 149,276 144,051 139,039 BRIEFCASES | HARVARD BUSINESS SCHOOL This document is authorized for use only by Jarett Cole in SPR20 Integrated Mgmt taught by Anne Fuller, Georgia Institute of Technology from Jan 2020 to Jul 2020. For the exclusive use of J. Cole, 2020. Classic Fixtures & Hardware Company | 915-523 Exhibit 5 Reported Information for the Home Improvement and New Construction Industries Net sales ($ in millions) Home Depot Lowe's 3 months ending April 30, 2008 3 months ending January 31, 2008 $17,907 $14,607 $12,009 $9,984 3 months ending October 31, 2007 3 months ending July 31, 2007 3 months ending April 30, 2007 3 months ending January 31, 2007 $18,961 $22,184 $18,545 $17,659 $11,565 $14,167 $12,172 $10,379 3 months ending October 31, 2006 3 months ending July 31, 2006 3 months ending April 30, 2006 3 months ending January 31, 2006 $23,085 $26,026 $21,461 $20,265 $11,211 $13,389 $11,921 $10,406 3 months ending October 31, 2006 3 months ending July 31, 2006 3 months ending April 30, 2006 3 months ending January 31, 2006 $20,744 $22,305 $18,973 $19,489 $10,592 $11,929 $9,913 $10,809 * Sources: Form 10-K filings with the U.S. Securities & Exchange Commission New privately owned housing units authorized by building permits (not seasonally adjusted) Calendar 2Q 2008 Calendar 1Q 2008 294.4 231.5 Calendar 4Q 2007 Calendar 3Q 2007 Calendar 2Q 2007 Calendar 1Q 2007 271.1 349.0 412.5 365.6 Calendar 4Q 2006 Calendar 3Q 2006 Calendar 2Q 2006 Calendar 1Q 2006 358.1 445.8 537.2 497.8 Calendar 4Q 2005 Calendar 3Q 2005 Calendar 2Q 2005 Calendar 1Q 2005 490.2 587.2 598.2 479.6 * Source: http://www.census.gov/construction/pdf/bpua.pdf HARVARD BUSINESS SCHOOL | BRIEFCASES 9 This document is authorized for use only by Jarett Cole in SPR20 Integrated Mgmt taught by Anne Fuller, Georgia Institute of Technology from Jan 2020 to Jul 2020.
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