CASE TWO Koala Fun ILLION-DOLLAR COMPUTER GAME companies such as Activision, Blizzard, and Zynga are unusual in the electronic arts Industry, which consists primarily of small developers. One such firm is Koala Fun (KF). located in Baltimore, MD. KP was started seven years ago by Owen Charles and Tessa Benjamin, who between them had over 15 years of experience with various computer systems design companies. The partnership initially blended very well. Owen, reserved and introspec- tive, is creative with a flair for designing games and spotting trends. Mainly as a result of his genlus, the KF brand is synonymous with intriguing electronics with high graphic appeal. Tessa, more outgoing with a strong marketing focus, has assumed the role of the firm's chief operating officer. . THE PARTNERS' FIRST SUCCESS The first successful product the two partners developed was a game called Koala Fun, which they used as the company name. The game uses a cute image of a 223 koala bear cub chasing treasure and villains around coastal Australia--the koala homeland-while helping "rescue heroes and animals. The game was so successful that various spinoff products were licensed, including stuffed toys and a movie. The Chinese even picked up on the idea and joint-ventured games with KF using a giant panda as the theme. Tessa was particularly good at marketing opportunities like the panda deal and working with resellers like the retailers GameStop and Target, the online merchandiser Amazon, and other large companies. She also sold to smaller resellers who provided national and some global distribution. However, the Great Recession and the resulting reduction in consumer discretionary spend Ing affected KF. In addition, competition from free or low-cost Internet games made it more difficult to sell the tens of thousands of games and other products required for an assured, constant revenue flow. A problem with this industry is that it experiences cyclicality, as players (usually children and teens) move on to other activities. The company enjoyed Initial success, showing profits by its second year. Owen and Tessa preferred to work on designing new games and the development of marketing strategies over the administrative aspects of the business. As the result, new games and products were in development and production costs escalated, but sales were somewhat slow to be realized. flow FINANCIAL CONCERNS Owen and Tessa loved their company but were inexperienced in business matters. Owen asked his mother, Amy, an accountant, for assistance. After studying the ledgers and other records, she reported that there was a signifi cant working capital problem with declining cash, unsold Inventory (mostly old Koala Pun games), and vendors who had not been paid. Tessa had been handling this side of the company, but that had mostly Involved writing checks to employees and for payables while waiting around airports. Plles were misplaced, documents were missing, and some money was unaccounted for. The problems appeared to be more related to failing to priori- tize financial matters rather than any deliberate mistakes. Owen's first reaction was to consider the sale of his half Interest In KP. Though he has enjoyed the creative side of the business, he was upset by his mother's report and by Tessa's apparent failure to take care of that responsibil lan d in Working Capital 225 to be loved mestresultate nding the company' s Though wou hire scatto admin , he decides is a good to date himself about K andals Anothers that we sterested in the firm' s so hea better competence. We wanting Owen thought Tessa da , but now he wonder whether he is capable of operating their choy, Owen rec o nd that is a competent manager be would not consider selling out t he way being an Owner of creative software developer, Bethetische instry wife toughers in the next few years, and wonder whether Tei lsted ough to successfully meet the challenges BORROWING ISSUES T 'perty composer to make vitnily allorOperating de Os concerned that firms they have had di g a stable bank relationship. Due to increasingly writtel e e lenders have come in ons and most reserung sew business loss very carefully Coty. T wo bank dibang s a potential problem should b e become and think that loon en capable of wasting her time Owen ' w what make of these arguments the conced that ongelhastantly reduced and be mes that all will have to be equity and a t over the past tve years there are been dividends because all earnings have been invested And three year ach of the paren t contribute 520,000 of pital In order to meet the company's needs Another of capital may be the m a tch position is low by historical standards. More important, however, we feels that the company is not editing from the vergeet of d a ng. and that this bar the polity of them to the town WORKING CAPITAL Owen suspects that saventory Heated. Capital artly tied up inventory is that are to provide speedy delivery to custom Shoplied. Our custom apet quick rice when a game is in demand and a large inventory help us to 226 Koala Fun provide it. Oweskeptical of this argumented wooden frenta mare eficient way of providing good service He also u s e d tandards and collection procedures, and believe that be quite sous t e xto cu Alp a y 45 percent of the company recebes were more than 90 dana . Purthermore, would come to and ship to the wait was clear that the y to pay was manga lotions that she doesn't want to see and that the difficulties p orty Owen wonder hout the wisdom ofangup trade discounts and frequently our reso /10set 30. That is a percent discount is paid in 10 day and all payment is expected within 30 days. T arely takes these discount because want to bold our cash og pow . She shoot that the discount interpe cally and 98 percent of the matte paid FINAL THOUGHTS Despite all of Owe n s, however, the lateship between the two partners has been relatively smooth the years. And that may beundly co mpetenterall" deshe was to be for what she does, and we ever los mony w ted which a r e cond. ally, foraminer Owen based with two sons the point of g o them . Since r idy traded the market value of the company stocks The a ter that worth between $35 510 pershan are that par t EXHIBIT C2.1 KF Income Statements: 2012-2013 2012 Sales $6,572,800 Cost of goods sold 4,896,700 Gross margin $ 1,676,100 Administrative 1,281,700 Depreciation 72,000 Earnings before interest and taxes $ 322,400 Interest 37,900 Earnings before taxes $ 284,500 Taxes (at 40%) 113,800 Net income $ 170,700 2013 $7,811,500 5,866,200 $1,945,300 1,492,200 86,000 $ 367,100 31,600 $ 335,500 134,200 $ 201,300 EXHIBIT C2.2 KF Balance Sheets: 2012-2013 2012 2013 Assets Cash Accounts receivable Inventory Other current Current assets Gross fixed assets Accumulated depreciation Net fixed assets Total assets Liabilities and Net Worth Accounts payable Notes payable Accruals Current liabilities Long-term debt Common stock (62,000 shares outstanding) Retained earnings Total liabilities and net worth $ 328,000 $1,004,200 $ 765,400 $ 39,200 $2,136,800 $ 372,200 ($ 147,900) $ 224,300 $ 2,361,100 $ 244,000 $1,106,600 $1,222,300 $ 46,800 $ 2,619,700 $493,600 ($ 233,800) $ 259,800 $2,879,500 $ 345,700 $ 63,200 $ 164,300 $ 573,200 $ 316,000 $948,000 $ 524,000 $2,361,200 su $ 544,800 $ 63,200 $ 156,100 $ 764,100 $ 252,800 $ 1,137,600 $ 725,000 $2,879,500 228 Koala Fun EXHIBIT C2.3 Financial Ratios for the Electronic Arts Industry Industry Averages* Current times) 2.6/1.71.3 Quick (times) 1.6/0.8/0.6 Debt % 41/57/71 Times interest earned (times) 7.4/3.9/1.3 Inventory turnover (times) 8.1/6,0/3.5 Total asset turnover (times) 3.5/2.8/2.0 Average collection period (days) 41/50/68 Return on equity % 27.3/19.5/7.8 Third quartile, median, and first quartile results D1. Using Koala's financial statements (Exhibits C 2.1 and C 2.2), calculate the firm's ratios using the same ratios as in the Electronic Arts Industry ratios (Exhibit C.3). Calculate the ratios for both years using the financial information provided in Exhibits C 2.1 and C 2.2 Compare Koala's ratios to the median industry ratios. Are the ratios close to the industry ? Above or below? What are the ramifications for the different ratios if either higher or lower than the industry