C A SE

H O L LY F A S H I O N S

R AT I O A N A LY S I S

Billion-dollar apparel companies such as Calvin Klein and Liz Claiborne are
unusual in the garment industry, which consists primarily of much smaller
apparel makers. One such firm is Holly Fashions (HF), located in Cherry Hill,
New Jersey. HF was started 14 years ago by William Hamilton and John White,
who between them had over 25 years of experience with a major garment
manufacturer. And the partnership initially blended very well. Hamilton,
reserved and introspective, is extremely creative with a real flair for
merchandising and trend spotting. Mainly as a result of his genius, the HF
label is synonymous with quality and "in" fashions. White, outgoing and
forceful, has contributed important merchandising and marketing ideas, but
has mainly assumed the duties of the firm's chief operating officer.
Hamilton has had little interest in the financial aspects of the company, much
preferring to work on designing new fashions and the development of
marketing strategies. A few months ago, however, he decided that he had
better become more involved with the company's financials.
His motivation is twofold. First, he is considering the sale of his 50 percent
interest in HF. Though he enjoys the creative side of the business, he is tired of
the cash crunches that the firm has experienced in recent years. Periodically, the
retailers HF deals with have encountered financial problems and have strung
out their payments, which often caused a mad scramble for cash at HF. And if
Hamilton decides to sell, he knows that he is likely to be involved in some
stressful negotiations surrounding the company's value. Though he would hire
a consultant to aid him in any negotiations, he decides it is a good idea to
educate himself about HF's financials.
Another reason that Hamilton is interested in the firm's financials is so he
can better judge the managerial competence of White. When HF was small
Hamilton thought White did a fine job, but now he wonders whether White is
capable of running a firm as large as HF. Actually, if Hamilton were convinced
that White is a competent manager, he would not consider selling out since he

2
genuinely enjoys being an owner of an apparel firm. But he thinks the apparel
industry will face even tougher times in the next few years, and wonders if
White is talented enough to successfully meet these challenges.

BORROWING CONCERNS
White's personality is such that he makes virtually all major operating and
financial decisions. An important example of this was his decision three years
ago to retire all long-term debt, a move triggered by White's fear that HF's
business risk was increasing. He cited the difficulties of seemingly rock-solid
retailers like Bloomingdale's and Campeau to support his claim. White is
also concerned that firms the size of HF have had difficulty maintaining stable
bank relationships. Due to increasingly strict federal regulations, some banks
have called in loans at the slightest technicality, and most are scrutinizing new
business loans very carefully. Consequently White views bank debt
financing as "unreliable" and thinks that loan officers are capable of "chewing
up my time." Hamilton isn't sure what to make of these arguments, but he is
concerned that this debt avoidance has significantly reduced HF's financial
flexibility because it means that all projects will have to be equity financed. In
fact, over the past five years there have been no dividends because all earnings
have been reinvested. And two years ago each of the partners had to contribute
$15,000 of capital in order to meet the company's cash needs. Another infusion of
capital may be necessary since the firm's present cash position is low by historical
standards. (See Exhibit 2.) More importantly, however, Hamilton feels that the
company is not benefiting from the leverage effect of debt financing, and
that this hurts the profitability of the firm to the two owners.

WORKING CAPITAL CONCERNS

Hamilton suspects that HF's inventory is "excessive" and that "capital is
unnecessarily tied up in inventory." White's position is that a large inventory is
necessary to provide speedy delivery to customers. He argues that "our customers
expect quick service and a large inventory helps us to provide it."
Hamilton is skeptical of this argument and wonders if there isn't a more efficient
way of providing quicker service. He knows that a consultant recommended that HF
"very seriously" consider building a state-of-the-art distribution center. The
proposed facility would allow HF to reduce inventory and also handle big orders
from retailers such as Kmart and Wal-Mart. White rejected the suggestion
arguing that the estimated $5-million to $8-million cost is excessive.
Hamilton also questions White's credit standards and collection procedures.
Hamilton thinks that White has been quite generous in granting payment
extensions to customers, and at one point nearly 40 percent of the company's
receivables were more than 90 days overdue. Further, White would continue to

CASE 6 HOLLY FASHIONS

accept and ship orders to these retailers even when it was clear that their
ability to pay was marginal. White's position is that he doesn't want to lose
sales and that the rough times these retailers face are only temporary.
Hamilton also wonders about the wisdom of passing up trade discounts. HF
is frequently offered terms of 1/10, net 30. That is, the company receives
a 1-percent discount if a bill is paid in ten days and in any event f ull payment
is expected within 30 days. White rarely takes these discounts because he
"wants to hold onto our cash as long as possible." He also notes that "the dis
count isn't especially generous and 99 percent of the bill must still be paid."

FINAL THOUGHTS
Despite all of Hamilton's concerns, however, the relationship between the two
partners has been relatively smooth over the years. And Hamilton admits that
he may be unduly critical of White's management decisions. "After all, "he con
cedes, "the man seems to have reasons for what he does, and we have been in
the black every year since we started, which is an impressive record, really, for
a firm in our business."
Further, Hamilton has discussed with two consultants the possibility of
selling his half of the firm. Since HF is not publicly traded, the market value of
the company's stock must be estimated. These consultants believe that HF is
worth between $55 and $65 per share, figures that "seem quite good" to
Hamilton.

QUESTIONS
1. Calculate the firm's 2015 ratios listed in Exhibit 3.

2. Part of Hamilton's evaluation will consist of comparing the firm's ratios to

the industry numbers shown in Exhibit 3.
(a) Discuss the limitations of such a comparative financial analysis.
(b) In view of these limitations, why are such industry comparisons so
frequently made?
3. Hamilton thinks that the profitability of the firm to the owners has been hurt
by White's reluctance to use much interest-bearing debt. Is this a reasonable
position? Explain.
4. The case mentions that White rarely takes trade discounts, which are
typically 1/10, net 30. Does this seem like a wise financial move? Explain.
5. Calculate the company's market-to-book (MV/ BV) ratio. (There are 5,000
shares of common stock.)
6. Hamilton's position is that White has not competently managed the firm.
Defend this position using your previous answers and other information in
the case.

4
7. White's position is that he has effectively managed the firm. Defend this
position using your previous answers and other information in the case.
8. Play the role of an arbitrator. Is it possible based on an examination of the
firm's ratios and other information in the case to assess White's managerial
competence? Defend your position.
9. (a) Are the ratios you calculated based on market or book values? Explain.
(b) Would you prefer ratios based on market or book values? Explain.

EXHIBIT 1
Holly Fashions' Income Statements: 2012-2015 ( OOOs)

Sales
Cost of goods
Gross margin
Administrative
Depreciation
EBIT
Interest
EBT
Taxes
Net income

2012

2013

2014

2015

$985.0
748.6
236.4
169.4
10.8
56.1
7.0
49.1
19.7
$29.5

$l,040.0
774.8
265.2
202.8
11.4
51.0
6.0
45.0
18.0
$27.0

$1,236.0
928.2
307.8
236.1
13.6
58.1
5.0
53.1
21.2
$31.9

$1,305.0
978.8
326.3
249.3
14.4
62.6
4.0
58.6
23.5
$35.2

EXHIBIT 2
Balance Sheets of the Holly Fashions Company: 2012-2015 (OOOs)
2012

2013

2014

2015

$51.9
158.9
121.1
6.2
338.0
58.9
(23.4)
35.5
$373.5

$38.6
175.1
193.4
7.4
414.5
78.1
(37.0)
41.1
$455.5

$10.6
224.8
191.9
7.8
435.1
96.4
(51.4)
45.0
$480.1

ASSETS
Cash
Receivables

$40.4
153.2
Inventory
117.0
5.9
Other current
316.5
Current assets
Gross fixed
44.8
Accumulated depreciation (12.0)
32.8
Net fixed
Total assets
$349.3

(continued )

CASE 6 HOLLY FASHIONS

EXHIBIT 2
( Continued)
2012

2013

2014

2015

LIABILITIES & NET WORTH

Accounts payable
Debt due
Accruals
Current liabilities
Long-term debt
Common stock
Retained earnings
Total L&NW

$53.8
10.0
19.7
83.5
60.0
150.0
55.8
$349.3

$54.7
10.0
26.0
90.7
50.0
150.0
82.8
$373.5

$86.2
10.0
24.7
120.9
40.0
180.0
114.6
$455.5

$84.2
10.0
26.l
120.3
30.0
180.0
149.8
$480.1

EXHIBIT 3
Financial Ratios for the Holly Fashions Company: 2012-2015
Industry
( Present )

Average

2015

2012-2015

2012

2013

2014

Current

3.8

3.7

3.4

1.7
1.3
1.6

Quick

2.4

2.4

1.8

.8
.6

41.l

37.7

35.3

8.0

8.5

11.6

Liquidity Ratios
2.6

Leverage Ratios
41

Debt(%)
Times interest
earned

57
71
7.4
3.9

1.3
Activity Ratios
Inventory Turnover
(CGS)

6.4

6.4

4.8

8.1
6.0

3.5
Fixed Asset
Turnover

30.0

29.3

30.1

Total Asset
Turnover

2.8

2.8

2.7

40
25
12

3.5
2.8
2.0

(continued )

40

PART II FINANCIAL ANALYSIS

EXHIBIT 3
( Continued )
( Present)

2012

2013

2014

Average Collection
Period

56

55

51

Days Purchases
Outstanding**

25

22

31

24.0

25.5

24.9

Net Profit Margin ('%)

3.0

2.6

2.6

Return on Equity (%)

14.3

11.6

10.8

8.4

7.2

7.0

6.8

6.0

6.1

Profitability Ratios
Gross Margin (%)

Return on Total
Assets (%)

Operating Margin*** (%)

2015

Industry
average

2012-2015*
41

50
68
18
25
32
28
26
24
4.2
3.1
1.2
27.3
19.5
7.8
11.8
8.7
3.4
9.9
7.2
3.1

*The three numbers for each ratio are computed in the following way. Ratios for all firms in the industry are
arranged in what is considered a strongest-to-weakest order. The middle number represents the median ratio; that
is, half the firms in the industry had ratios better than the median ratio and half had ratios that were worse. The top
number represents the upper quartile figure, meaning 25 percent of the firms had ratios better than this. The
lower number represents the lowest quartile, that is, 25 percent of the firms had ratios worse than this.
**This shows the average length of time that trade debt is outstanding. Also called the average payment period.
Calculated as A/P / (CGS/360).
***Calculated as (EBIT/Dep)/Sales.