Financial Statement Analysis Report

The following is an actual analysis report for a customer of Moorhead Management

Services. Although the report is actual, I have changed the company name to a
fictitous name to protect the identity of the client and their customer. Five Star
Furniture is a fictional name.

Five Star Furniture and Subsidiaries

Bangor, Wisconsin

BACKGROUND

A decline in sales, coupled with increased cost of sales and selling, general and
administrative expenses have resulted in an operating loss of $5.26 million and a net
loss of $4.55 million for the year ended March 31, 1998. Performance covenants have
not been met nor have they been waived on the Industrial Revenue Bonds, thus
forcing long term financing of $621,000 into the current liability section of the
balance sheet. The mortgage holder (which accounts for the majority of the long term
debt) has waived certain debt compliance requirements. Despite the losses,
stockholder's equity is still adequate at $13.6 million and there is an acceptable total
debt to equity ratio of 2.73:1.

The C.F.O. , Mr. Hoppen, states in a August 20, 1998 letter that the Company has
decided to divest itself of the Jewlery Group, sell the corporate headquarter building
(moving corporate into the warehouse) and dispose of two other properties. I would
ask for a review of the financial statements of the separate divisions to review the
profitability and margins of each.

At March 31, 1998 and 1997, the Company operated 36 and 40 furniture stores and 35
and 39 jewlery stores, respectively.

PROFITABILITY REVIEW

Net sales (before finance and servicing fee income) were down $2.9 million or 2.8%
from 1997. Although down from last year, net sales are up from 1995 (by $11 million)
and up from 1996 (by $21.3 million).
In the past, finance and servicing fee income has been between 3.2% and 3.9% of net
sales. This year it was only 2.2% of net sales. Finance and servicing fee income
includes installment finance charges, credit insurance commissions, and income from
servicing sold receivables, less interest costs directly associated with carrying in-
house receivables. I would question why this was reduced (as a percentage of sales)
for 1998. A possible explanation could be a change in product mix such as they sold
more jewlery than furniture in the past which had a higher percentage of sales
financed or possibly they reduced finance charges (i.e. lowered interest rates to their
customers or gave 90 days same as cash terms which resulted in collecting less
finance charges.)

Historically, cost of sales and occupancy costs have been between 63% and 64% of
net sales. This year, cost of sales and occupancy costs were 66% of net sales. The
C.F.O. indicated this was due to increasing the reserve for obsolete inventory by $1.5
million to cover a write-off of obsolete inventory of approximately $5.5 million. (I
assume he was saying they had a huge write-off and the reserve was inadequate to
cover.) This write-up of the reserve increased expense by 1.5%. I would ask the
C.F.O. why there was a need to write off such a large amount of obsolete inventory
(did they mis-manage inventory, change brands, etc.?)

Selling, general and administrative expenses have also increased both in terms of real
dollars and as a percentage of sales. S,G and A expenses historically have been
between 38.2% and 38.7% of net sales. This year, S, G and A expenses were 41.2% of
sales.

Mr. Hoppen, in his letter, states that the entire organization has been restructured and
a layer of management has been eliminated. You may want to ask when the
restructuring took place (early in the year or later in the year) and what the impact the
restructuring had to the March 31, 1998 financial statement. Was there a large amount
of severance payments, etc. that impacted expense on this financial statement? I
would question how the company can eliminate a layer of management and also
become more responsive to customer service (less people doing more work). This
question may be at least partially answered by increasing the standards and
accountability regarding sales training and sales productivity which he notes in his
letter.

S, G and A expenses increased $1.4 million (3.4%) from 1997 and $7 million from
1995. The footnote states that $1 million of this increase from 1997 to 1998 was due
to increased advertising expense.

Footnote 9 on commitments and contingencies indicates that rent expense has

increased by $321,000 from 1996 to 1997 ($5.7 million to $6 million.) I would
question why the number of stores have decreased, yet rent expense has increased
(probably the newer stores have much higher rent expense than the stores which were
closed or sold.)

BALANCE SHEET REVIEW

The liquidity of Five Star Furniture has declined from last year and is below industry
averages. The Current Ratio which measures a company's ability to meet its current
obligations has decreased from 1.45 in 1997 to 1.19 in 1998. The industry comparison
(for like asset size retail furniture stores) is 1.8. The Quick Ratio (a more liquid
measurement which compares only cash plus receivables to current liabilities) has
also declined to .31 compared to 1997 of .37 and the industry average of .80.

Receivable turns (net sales divided by receivables) has been reduced from 13.4 to
12.5. This is a faster turn than the industry average of 9.5 probably due to the
financing arrangement whereby the company sells their receivables to an outside
company. The change from 1997 to 1998 may have something to do with changing to
a different factoring company. Days Receivables Outstanding has increased from 27
days in 1997 to 29 days in 1998. This is considerably less than 57 and 60 days in 1993
and 1994 respectively and probably also reduced due to the selling of receivables to
an outside party (receivables are not actually held on the books until collected.)

Inventory turnover has increased from 2.9 in 1997 to 3.1 in 1998 and is slightly below
the industry average of 3.5. The write-off of obsolete inventory may have favorably
impacted the inventory turns. The inventory footnote states that $2.984 million of the
inventory is collateral for accounts payable of approximately $4.176 million. This
indicates that the Company does allow vendors to take a security interest in the
inventory.

Fixed assets and other long term assets remained relatively unchanged from 1997.

Total current liabilities increased from $23.9 million in 1997 to $30 million in 1998.
Notes Payable increased almost $5 million (from $7.3 million to $12.3 million.) This
would indicate an increased use of the $20 million available credit line. However, we
do not know whether this is a timing issue due to the timing of payables or the general
need for increased cash. The borrowing rate on the line of credit is 1% over prime.
Days payable outstanding has increased from 50.8 in 1997 to 55.8 in 1998. This
would indicate a trending of slower payments to vendors.

Long term liabilities have declined slightly between years from $7.9 to $7 million.
This would be partially due to the movement of the industrial revenue bonds into the
current maturities.

Stockholder's equity decline of $4.6 million (from $18.2 million to $13.6 million) was
due to the net loss on the income statement and the repurchase of treasury stock.
$59,000 of treasury stock was repurchased in 1998. The purchase appears to be in
relation to the repurchase of stock from former participants in the Company's ESOP
plan (employee stock ownership plan.)

OPERATING EFFICIENCY REVIEW

Total asset turnover (net sales/total assets) is fairly consistent at 2.0 versus 2.1 in
1997. This is in line with the industry average of 2.0. The working capital turnover
has increased dramatically from 9.7 to 18.3. This is directly driven by the reduction of
working capital from $10.8 million to $5.6 million (1997 to 1998). The reduction was
primarily the result of the increase in notes payable (which I believe is the credit line)
and is not an indication of a more efficient use of corporate assets. The equity
turnover (net sales/stockholder's equity) has increased from 5.8 to 7.5 which is the
result of reduced equity (due to the income loss). The fixed asset turnover (net
sales/fixed assets) remains stable at 8.3. This shows the stability on the asset side and
indicates that the reduction of stockholder's equity from net income loss was funded
by increased liabilities (not reduced assets).

FINANCIAL RISK REVIEW

The long term debt to equity ratio has increased slightly from .43 to .50 primarily due
to the reduction in equity (due to the income loss.) Long term debt to total capital has
improved slightly from .16 to .13. Two factors impacted this - the increased short term
borrowing and the reduced stockholder's equity. Total debt to total capital has
increased from .64 to .73 which is also a factor of the increased borrowing and a
reduction in stockholder's equity. Total liabilities to net worth (or stockholder's equity)
has increased from 1.75 to 2.73. This is an important indication of the increased
leverage of the company. The industry average for this ratio is 1.6.

SUMMARY

Five Star Furniture has experienced a substantial loss for the year ended March 31,
1998. The loss was funded through additional short-term debt and higher payables,
thus making the company more leveraged. The Company is also in the process of
changing the company's make-up by selling the jewlery division. All of these factors
lead to concern over the long term health of the company. However, at this point, the
equity position of the company, although deteriorating, is still substantial at $13.6
million. Although the leverage of the company is becoming higher, I would not
consider it at the insolvent point, but the account should be put on monthly or
quarterly review.

The company was not able to receive a waiver on the performance covenants for the
Industrial Revenue Bonds at March 31, 1998. I would monitor this closely (and also
the bank covenants) if there are quarterly compliance issues. If there are quarterly
compliance issues with the bank, are they in compliance or have they been waived?
This will indicate whether the bank and the Industrial Revenue Bond holders are
working with Five Star Furniture.

Credit references should be conducted on a monthly basis with other vendors. Watch
to see if there is a change in the way other suppliers are being paid. In addition,
security in your inventory should be requested, if possible.

I would highly recommend quarterly financial statements in order to monitor the

stability. The company is in the state of change (with the sale of the window division
and current losses) and needs to be closely watched. If one assumes that the asset side
is being managed efficiently, the losses will probably continue to be funded by an
increased debt load (or slowing of payments to vendors.) In Mr. Hoppen's letter, he
states that there has been significant progress. However, it is interesting to note that he
does not say that they have operating income or net income for the current six month
period. This is a red flag to me to take a look at what is currently happening within
this company. Although he states they are making progress, have they actually
succeeded in stopping the losses?

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