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’
 Analysis of Current Financial Status
Padgett Liabilities Position
(1993 - 1996)

8,000
7,000 7,221
thousand of USD

6,000
5,000
4,000
3,000 3,118
2,000
1,000
338 221 507 455
0 0 0
1993 1994 1995 1996
Years

Short term notes Long term Debt

 There is a drastic increase of 3M short term notes in 1995

and an additional of roughly 4M in 1996.
 Analysis of Current Financial Status

  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…
 Figures from Padgett’s Income Statements for the Fiscal Years Ended April
30,1993-1996 ( thousand of dollars except per share figures )
  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
Incr (Dcr) Incr (Dcr) Incr (Dcr) %Diff %Diff %Diff
  1993-1994 1994-1995 1995-1996 1993-1994 1994-1995 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%
 Analysis of Current Financial Status
Diff Diff Diff
1993- 1994- 1995-
Profitability 1993 1994 1995 1996 1994 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%  

 There is a continued decrease in profit margin.

 Analysis of Current Financial Status
Diff Diff Diff
1993- 1994- 1995-
Profitability 1993 1994 1995 1996 1994 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

 Analysis of Current Financial Status
Diff Diff Diff
1993- 1994- 1995-
Profitability 1993 1994 1995 1996 1994 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%  

 Margins are becoming tight due to competition

 Analysis of Current Financial Status
Diff Diff Diff
1993- 1994- 1995-
Profitability 1993 1994 1995 1996 1994 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%  

 There is a constant dividend payout over the years despite

fluctuations in other indicators of profitability
 Analysis of Current Financial Status
Diff Diff Diff
1993- 1994- 1995-
Profitability 1993 1994 1995 1996 1994 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%  

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

Analysis of Current Financial Status
Trend of Figures from Padgett's Income Statement
(1993 - 1996)

18,000
16,000 16,014
14,000 14,293
thousand of USD

12,000
10,603 10,632 10,968
10,000 9,742
8,000
6,965
6,000 5,814
4,000
2,000 2,004 2,154 2,606
1,784
0 83
1.00 1.00
-42 1.00
-39 1.00
-71
-2,000
1993 1994 1995 1996
Years
Gross Sales Profit after taxes
Operating Expenses Other expenses ( income )
Dividends per share

 Despite rise and fall in sales, OPEX, NI, and other figures in the its
Income Statement, Padgett’s Div per Share remains constant.
Analysis of Current Financial Status
360/Turnover on Sales (1993-1996)

250

200
Number of Days

150

100

50

-
Receivab les Invento ry Acco unt s Wo rking Fixed As s et Net wo rth
Payab le Cap it al

Metrics

1993 1994 1995 1996

Analysis of Current Financial Status

360/Turnover on Sales 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

Receivables 64.7 73.3 62.0 67.6

 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

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

 Analysis of Current Financial Status
Padgett Leverage Position
(1993 - 1996)

0.80
0.67
0.60
0.46
0.40
0.20 0.22 0.21
0.00 0.02 0.01 0.03 0.02
1993 1994 1995 1996
Years

Debt/equity Ratio Long term debt / Equity Ratio

 There is a drastic increaser in Debt-Equity Ratio over tha

last 2 years.
 Analysis of Current Financial Status
Leverage 1993 1994 1995 1996
Debt/equity Ratio 22.3% 20.6% 45.6% 67.0%
Long term debt /  acquisition

 has

 high
of Tri-state additional 3.6m loan

more short term notes than long term debt

interest expense due to more short term notes

Equity Ratio 2.2% 1.4% 3.0% 2.5% 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

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 low
 Current liabilities could not anymore be
financed by current assets
 Debt/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