Assignment
Payne Equipment LLC is a regional manufacturer of various commercial tree trimming equipment. Products include Chain saws, prune saws, pole saws, pole pruners & loppers, and stump grinders. Thomas Payne formed the business 7 years ago. He has a background in a related business as the Vice President of Marketing for a national manufacturer of lawn maintenance equipment. Tom is 43 years old, married, and has two children. He owns 75% of the company. The marketing of Payne's products is his primary responsibility. His cousin Paul Trout owns the other 25% of the company. Paul is 50 years old and has prior management experience in the industry in production and finance. As such, Paul handles the company's accounting and production requirements. The industry is mature with a handful of large national companies (Grainger, Jameson, Klein, Corona, and Silky) who have the lion's share of the market.
There are several small manufacturers, like Payne, selling in their geographic markets. The number of manufacturers in this business has consolidated, with the pressure by the major hardware retailers offering more competitive products at lower prices. Payne's niche is with service contractors who seek more reliable, long lasting, and higher capacity equipment that has helped Payne retains its market share. About 500 small service businesses in the Southeastern United States represent the base of Payne's clients. Payne also has modest sales with one the big three national hardware chains. Although there are no major concentrations, the top 4 customers account for 20% of total sales. The terms of sale call for full payment within 20 days of delivery.
The service companies typically pay on time, but the national hardware chain pays about 15 days beyond the stated terms. The attached spreads of Payne's historical financial statements reflect a consistently profitable business with good margins on a growing sales base leading to improving balance sheet proportions. However, the company remains leveraged with tight liquidity. Payne Equipment conducts its business out of an office/warehouse type facility in a local industrial park. It leases 75% of the building from a local commercial real estate company. The rent is $480,000 per year on a triple net basis (taxes, insurance, and maintenance are tenants' responsibility). Although the lease is about to expire, Payne has an option to either renew the lease for 3 more years with an 8% increase in the rent or purchase the building at its fair market value (estimated at $2,600,000). The building's other tenant has notified the property owner that they will not be renewing their lease. Thomas and his company, Payne Equipment, have been clients of your bank for the last 7 years.
The current term loan of $200,000 represents the balance of an $800,000 7.5-year 80% SBA guaranteed credit. The fixed assets of Payne Equipment secure this loan. In addition, the bank provides Payne with a $1,400,000 revolving credit which is secured by Payne's current assets with advances limited to the lesser of: $1,400,000 or the sum of 80% of eligible accounts receivable plus 33% of net inventory (inventory less accounts payable). The advances are controlled and monitored through use of a borrowing base certificate and a lockbox for all collections. All loans have been handled as agreed and in compliance with the loan agreement. Thomas and Margret Payne guarantee them. The Payne's have an outside net worth of over $1,300,000 consisting of: cash ($120,000), primary residence ($600,000 value less $300,000 mortgage), retirement accounts ($450,000), a beach house ($240,000 value), and personal assets. Their credit scores exceed 710. Based upon the continued success of the business, Tom and Paul would like to take advantage of the option to buy the building that they currently lease. The anticipated mortgage payments would be about half of the current rent. Plus, Payne would have nearly one third more space.
In addition, they would like to expand their operations to manufacture lawn maintenance equipment. The space vacated by the other tenant creates this opportunity. It is further supported by the interest expressed by existing customers for Payne to supply these products. Tom feels that this is necessary to solidify Payne's client relationships and ward off competition. Internal projections NS (not provided) indicated 15% sales growth in FY 2015 with a net profit of $542,000 after expected start-up costs. Paul has some good contacts in the finance industry and has a letter commitment from SouthEastern Life Insurance Co. for a $2,000,000 first mortgage (20-year term) at 5.5% fixed subject to adequate financial commitments (equipment, permanent and seasonal working capital) for the balance of Payne's identified needs. The two owners would guarantee the proposed mortgage. It does not require escrow of taxes, insurance, or maintenance, but is subject to an agreement that requires these items to be maintained current along with mortgage payments. SouthEastern has completed its due diligence on the company's financials as well as the appraisal, environmental, and property condition evaluations. All of these were favorable. The owners plan to invest $400,000 from their personal resources into the company to facilitate the purchase of the building and the equipment. Paul has the $100,000 that he will be investing on deposit at the bank.
Tom has $100,00 in cash and a contract to sell his beach property for $240,000 net of expenses. However, the company will need this $300,000 equity before Tom closes on the sale of the beach house. The contract is subject to the normal conditions including an appraisal of at least $240,000, a property condition inspection with no material issues, and a standard title policy. The buyers have been preapproved for the extension of credit necessary to consummate the sale. The buyer's lender has indicated that the process will take 1 to 2 months. Payne Equipment's purchase option on the building expires in 3 weeks. As such, Tom would like the bank to make him a bridge loan for $200,000 for the remaining part of his equity investment.
This loan would be repaid upon the closing of the sale on the beach house. The company also needs to borrow another $200,000 to buy the building plus $600,000 for the new equipment that has a class life of asset under the IRS code of 8 years (ADR) and a continuation of the $1,400,000 revolving credit and the existing $200,000 term loan. The insurance company requires a commitment from a bank to provide the $800,000 fixed asset financing plus working capital, as a condition for the mortgage loan. The lease agreement purchase option expiration means that time is of the essence for all parties. As the account officer for this credit, you are expected to meet the company's needs within the bank's policy parameters of safety and soundness
Review the NP-Bk line (Notes Payable - Bank) and circle the lowest and highest amount of notes payable in use during the fiscal year. Review the Adj WC line (Adjusted Working Capital) and circle the lowest and highest amount during the fiscal year.
Task
I. What is the dollar difference between the low point and high point of Payne's adjusted working capital (AWC)?
II. What causes the increase in AWC to the high point and the subsequent reduction by fiscal year-end?
III. What is the dollar difference between the low point and high point of Notes Payable-Bank?
IV. What is the revolving credit being used to support as it increases through the year?
V. How was Payne able to reduce the Notes Payable-Bank after borrowings reached their high point?
VI. Was the revolving credit fully repaid during the year?
VII. What was the revolving credit supporting at the low point of usage? Is the revolving credit an appropriate facility to meet this need?
VIII. What sources might be available and appropriate to support permanent working capital?