”What’s really happening at Classic Fixtures & Hardware Company?” It was August 6, 2008, and Gary Matocha, a senior lending officer at Southwest National Bank, kept rolling this question through his mind as he prepared for tomorrow’s meeting with Dan Watkins, the company’s Chief Financial Officer. The amounts borrowed under Classic’s seasonal loan facility had been significantly above forecast during the last few months, and Mr. Watkins had just informed Mr. Matocha that the company would likely be unable to pay off the balance of the loan in the fall of 2008, as both Classic and the bank had originally anticipated. This admission that the company would not be “out of the loan” was especially troublesome to Matocha, and he had immediately scheduled the meeting with Watkins at their headquarters in East Texas. The agenda for tomorrow was straightforward; discuss the company’s current financial situation, identify the reasons why Classic would be unable to liquidate the loan balance, and develop solutions to remedy Classic’s current financial problems. Classic Fixtures & Hardware Company was a successful manufacturer and distributor of a wide range of kitchen and bathroom fixtures and trim, as well as lock sets and hardware for doors and windows. These products, known for their quality, classic design, and timeliness, were sold to individuals and contractors in large home-improvement retailers, smaller hardware and lumber stores, and directly to large home builders through a small internal sales force. Home improvement expenditures and housing construction were both impacted by the weather in the northern tier of states, resulting in more sales for Classic in the spring and summer (approximately 60% of yearly sales), and fewer sales in autumn and winter (approximately 40%). The company’s plan for 2008, developed and approved by management in late 2007, anticipated moderate increases in housing starts and home improvement activity, and Classic ramped up its production and sales efforts to meet this expected increase in demand. The company’s forecasted monthly income statements and monthly balance sheets presented in Exhibit 1 and Exhibit 2, respectively, show detailed information about the year 2008 plan. All manufacturing took place in rural East Texas, and Classic produced inventory at a level rate through the year to meet forecast demand. Level production minimized the stress on the production facilities, and provided steady income for employees, making Classic an important employer in the county and region. Sales, however, were highly seasonal, and the mismatch between level production and seasonal sales caused inventory levels and the supporting working capital financing to expand and contract with sales and collections of accounts receivable. As a family-owned firm, Classic had limited access to the capital markets and therefore depended on its loan facility with Southwest to finance its working capital needs. Southwest had been Classic’s lead bank for many years, and the company understood the bank believed that working capital financing was by definition short-term instead of permanent financing; Southwest strongly preferred short-term borrowings be fully paid off at least one month per year. Classic’s seasonal sales and collections pattern resulted in higher inventory and working capital loan balances in the first half of the year, and declining inventory and loan balances in the second half of the year. This pattern of building inventory levels in the winter and spring, heavy sales in the spring and summer, and large collections in the summer and fall had always allowed Classic to fully pay down its loan facility during the fourth quarter of the year. That is, until 2008. The first sign that Classic’s year 2008 performance wasn’t meeting the plan came in early April. Matocha noticed the company’s end of March loan balance was $4 million above forecast, leading to a phone call with the CFO to discuss the variance. Watkins attributed the increase to cost overruns in the company’s plant expansion and modernization program, which was launched in January, and was expected to be completed in early December, with total capital expenditures forecast at $30 million. Actual expenditures in the first quarter of 2008 had come in higher than expected, but Mr. Watkins explained that program costs in future months were expected to be at or below forecast. The CFO expressed confidence that loan balances would quickly return to forecast levels, and Matocha accepted this explanation, although he wondered if Classic was actually using short-term bank credit for longer-term capital projects, or if other problems were the true cause of the increased borrowings. In early June, Matocha had another conversation with Watkins about the continuing variance versus plan in amounts borrowed by the company under the loan facility. The CFO stated that sales during April and May had been well below forecast, with May’s results nearly 12% below expectations. Watkins also explained that sales were down in both the retail and direct-to-builder channels, and the decrease in sales and collections had forced the company to increase borrowings until the company could adjust operations to match current economic conditions. The maximum funding available to the company was $90 million, so Classic was well within the terms of the seasonal loan facility, but Matocha was increasingly concerned about the company’s product markets and management’s actions. The third, and most alarming phone conversation between the senior loan officer and CFO, occurred early on August 6th, when Watkins admitted that even though the loan balance had fallen by $8 million during July, he believed that Classic would likely be unable to pay off the balance of the loan this year, and before the seasonal upturn in funds requirements in 2009. Collections from customers would allow the company to reduce the amount borrowed, but sales had continually failed to meet forecast through the summer, so cash receipts would probably not be sufficient to pay off the entire amount borrowed. Matocha asked if Classic’s inability to repay the seasonal loan facility this year was due to a permanent change in the company’s funding needs, perhaps caused by the expansion and modernization program, or if the company’s financial problems were instead the result of significant changes in Classic’s product markets. Watkins was not able to answer this question with any certainty, and they both agreed to a meeting at Classic’s headquarters to discuss the situation. To prepare for the meeting, Matchoa began to analyze the company’s actual monthly income statements and monthly balance sheets provided by Mr. Watkins, as presented in Exhibit 3 and Exhibit 4, respectively. Beyond this information, Matocha also collected the data presented in Exhibit 5, so he could better understand conditions in the home improvement and housing construction industries. He expected his analysis of Classic’s financial performance would reveal why it would be unable to repay its loan balance this year, and hopefully identify actions to correct the company’s financial problems.

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In Classic Fixtures and hardware company The company was a successful manufacturer and distributor of a wide range of kitchen bathroom fixtures and trims it was also engaged in manufacturing locksets ... View the full answer