Company Background

Pear Computer Horizons (PCH) started out as the brain child of several engineers in the eighties, with the founding team working out of a garage in Winnipeg, Manitoba. The company originally focused on creating easy-to-assemble hardware (e.g., desktop computers) that the average Canadian could afford. Over time, as computers became the part of everyday life, PCH branched out into several different models and tiers.

In the mid 2000's, the company went on a large acquisition spree, acquiring several software companies and mobile manufacturing start-ups, allowing the once hardware-only company to diversify into phones, software, and gaming (both video game consoles, as well as game development). The business was reorganized into three segments in 2010. The first segment, computers, focuses on manufacturing computer chips, laptops, desktop computers, and computer accessories. The second segment, phones, was once the smallest business division, but has rapidly grown into the number one segment by total sales in 2017. The third major segment, software and gaming, includes games for computers and video game consoles, as well as anti-virus, word-processing, and analytics software.

PCH products are sold across Canada in various retail stores, as well as through their high-traffic e-commerce site. PCH manages shop-in-shops in electronic stores like Best Buy; specialized areas in big department or electronic stores that only sell PCH products. Products have also expanded in recent years into the US, but market share is low. There are future plans to expand into Latin America and India, two developing economies that do not have as much technology penetration as other more mature markets.

The last five years have been a wild ride," exclaimed Ms. Morrison, who has risen through the ranks to the top position after 15 years in the company. "We have almost tripled our revenue in the last five years, in large part to some big product launches in gaming and phones that were more successful than we ever imagined. We also benefited from the booming tech industry that continues to see large technological advances in a short period of time."

Ms. Morrison has asked for your help in developing a financial forecast for 2018, using the 2017 income statement as a reference point.

2018 is expected to see a reduction in the rapid growth rate that PCH experienced over the last five years, as total sales are only expected to increase by 10% in 2018. Customers have started hanging on to their older versions of phones, as there has been some customer dissatisfaction with newer mobile models, because they were not offering a unique enough position to warrant an upgrade. For example, the slim smartphone the Pearcer, which was 2016's best-selling smartphone, had lower-than expected sales for the third version, the Pearcer 3.0. The phone segment is expected to be 50% of total 2018 sales, down from 51.7% in 2017.

Computers will maintain a similar share as a percentage of sales as in 2017, while the gaming & software segment is expected to increase to 17% of sales, due to the launch of the newest version of InPEARmeable antivirus software and the sequel to the best-selling video game "Eternity." Ms. Morrison wants your forecast to include the dollar amount of sales that each segment should generate in 2018.

"Our company is dependent on big product launches for success," lamented Ms. Morrison. "These gambles often payoff, but they require thousands of man hours and millions of dollars. We have not had any major setbacks, like some of our competitors, but the risk is always there. Our last three major product releases had countless delays that frustrated some of our core customers. It did build up anticipation for our products in the end, but we will not always come out on top from poor planning. I want us to mitigate some of the risk with smaller projects that have the potential to give a high return. Similar to how movie production studios counter their big budget box office movies with lower-budget dramas and horror films that may offer a higher return on investment."

Historically, PCH had some of the highest gross margins in the industry, due, in large part, to the cutting edge technology incorporated in most of the products. PCH has focused mostly on the consumer segment, thanks to the larger margins, but is considering long-term partnerships with governments and universities, despite their lower margins, in order to stabilize a long-term revenue source.

However, several macro and micro factors are expected to influence gross margins for 2018. Material costs for aluminum, a key component in PCH computers, are expected to rise significantly in 2018, negatively impacting gross margin by 2%. The depreciating Canadian dollar relative to other currencies is also expected to negatively impact gross margin by -1%. PCH is switching to a more ethical supplier for some of its component parts, due to bad press in 2017 over this supplier's reported environmental violations. This change will lead to a 1% increase in the cost of goods sold. Finally, there is major uncertainty surrounding NAFTA and trade tariffs at the US border. Ms. Morrison suggests, as a conservative estimate, to include a 1% reduction in gross margin to incorporate this uncertainty. Taking all the aforementioned factors into account will help forecast what the expected 2018 gross margin is for PCH.

Advertising and marketing and also general and administrative (G&A) costs are expected to remain at the same percentage of sales as in the past. PCH lacks a strong advertising and marketing strategy, despite its large advertising budget, because the head of marketing left at the beginning of 2017 for medical reasons. G&A costs will be impacted by minimum wage increases, but those are not expected to take effect into 2019. PCH has managed to keep employee turnover low, despite minimum wages, due to its employee profit-sharing and stock ownership plan.

Research and development (R&D) costs have traditionally been budgeted as 20% of computer sales, because the company's superior R&D capability has been a competitive advantage. This advantage has helped attract some of the top talent in the country. Unfortunately, PCH's purchase of a virtual reality company a few years back was not as fruitful as anticipated. The virtual reality company was absorbed as a sub-division of the company, but it is now being divested to cut down on costs, leading to an expected $100M loss in 2018 from a write down of goodwill. Equipment and licenses from that division are also being sold, with a $20M gain from the license sale mitigated by a $10M loss from the equipment sale.

The tax rate, depreciation, and interest rate for PCH are expected to be consistent with prior years. PCH's long-term debt consists of ten-year bonds that do not mature into 2023. PCH also has a credit facility with $300M borrowing capacity that had no outstanding borrowings at the end of the fiscal year.

The company's mission statement, extracted from their 2017 annual report, is included below

Pear Computer Horizons strives to be the technological choice for people, businesses, and governments for their innovation, entertainment and security needs."

explain in detail if Pear Computer Horizons currently delivering on its mission statement.