Comfort essay

Conley had collected the summary financial information shown in Exhibits 1, 2, 3, and 4. As he was looking through some of the recent financial statements, the accounts payable clerk dropped a stack of overdue invoices on his desk. A note attached stated that cash was not available to pay the suppliers. Company Organization and History Comfort Zone was organized as a Florida corporation in 1961 with its headquarters in Jacksonville.

Since that time, the company has become a major Southeastern distributor of heating, air conditioning and refrigeration equipment, parts, and supplies with 45 outlets in Florida, Georgia, Alabama,North Carolina, South Carolina and Mississippi. Through the addition of sales outlets to expand its market area and broadening of its product line, Comfort Zone increased sales from $23 million in 1 985 to $108 million in its fiscal year ended January 31, 1991. Each sales outlet or “store” operated by Comfort Zone serves as a sales and distribution point for the full line of approximately 20,000 climate control and refrigeration products carried by the company.

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Each store is run by a manager who is responsible for the hiring and supervision of personnel and for sales, credit, purchasing, inventory, and cost control at the store level.Management feels that this delegation of authority and responsibility is a major contributor to the company’s success and managers are paid on the basis of the net profit generated by their stores. Decisions affecting company policy, selection of senior management, capital expenditures, and the addition of product lines are reviewed by corporate management.

Suppliers Products sold by the company are purchased on a regular basis from approximately 250 manufacturers and suppliers. Special order items are purchased occasionally from an additional 400 vendors.The largest single applier of new air conditioning equipment and parts to the company provides approximately 15% of total purchases each year. The company has nonexclusive wholesale distributorship agreements with many of its suppliers. These agreements are generally informal and are subject to termination by either party on short notice. Most purchases are made on open account with terms Of 2/1 0, net 30.

Customers Sales are made to approximately 8,000 customers consisting of mechanical, heating, air conditioning and refrigeration contractors, institutions, governmental units and a variety of commercial users such as supermarket chains.Substantially all sales to customers are on open account and no single customer accounts for as much as 1 112% of total sales during any one This case was originally written by Charles W. Young and revised by Peter C. Gamesman. It is intended as a basis for class discussion rather than to indicate either effective or ineffective handling of business situations.

Year. Terms typically are 2/1 0, net 30 but extended terms are sometimes offered to gain a competitive advantage. The company solicits sales from customers in both the new construction and the replacement and repair markets.

New equipment sales provide relatively rower gross margins than sales of replacement parts. It is difficult for the company to monitor sales by market category; however, estimates of total sales contributed by products sold in the two markets during each of the past four fiscal years are as follows: 1988 1989 1990 1991 91% 15% 80% New construction Replacement and repair Financial History In 1 981 the Toxic Waste International Company acquired a 57% interest in Comfort Zone through purchase of common stock. Toxin’s ownership was increased to 80. 7% in 1 984 when the company purchased a substantial block of common stock from another shareholder.On June 10, 1 988, in an underwritten public offering, Toxic sold a large portion of its stock holdings and the company sold some new shares. The public sale plus a private sale to Comfort Zone’s management personnel liquidated Toxin’s holdings in the company.

In mid-1 991, the company had 3,328, 722 shares of common stock issued and outstanding distributed among 588 holders of record. Selected high and low common stock prices are shown in Exhibit 5. Long-term debt outstanding on January 31, 1991 was as follows: Bank loan – 7 3/4% Insurance Co. Loan -8 1/2% Mortgage notes – 5 3/4% to 8% Other notes – 8% $2,430,000 305,1 57 330,000 57 611 ,355 Less: Current maturities Remainder The insurance company loan was closed on July 13, 1990 with part of the proceeds of $6 million applied to reduce the long-term bank loan from its previous high of $5. 1 million. Principal payments on the insurance company loan are deferred until December 1, 1995 at which time payments of $300,000 will be due on each of the June 1 and December 1 interest payment dates until the note is paid in full on June 1, 2005.

Covenants in the loan agreement require Comfort Zone to maintain consolidated net working capital of not less than $21 million and a consolidated current ratio of at least to 1 . Further, the company is precluded from incurring any funded or current debt except that short-term bank borrowing, not to exceed $3 million, is permitted providing that the company is out of the bank for sixty consecutive days in each fiscal year. A number of other negative covenants are also imposed by the loan agreement but none of them appear to materially constrain the company’s ability to operate as it has in the past.However, violation of any of the negative covenants, in addition to failure to make payments of principal and interest when due, gives the insurance many the option to declare the loan immediately due and payable.

2 Current Situation While looking through the stack of reports and statements he had gathered on his desk, Mr.. Conley notes that during the three years of public ownership the management of Comfort Zone has devoted most of its attention to promoting growth in both sales and earnings per share.

In fact, growth was the major topic discussed by the president in his letter to shareholders in the fiscal year 1990 annual report. In this letter, the 33% increase in sales and 23% growth in earnings per share were highlighted and continued growth was predicted for 1 991. Emphasis on growth was also apparent in the 1991 annual report.

For example, the president’s letter predicted: “The Southeast, as a whole and Radio in particular, continues to be the nation’s premier growth area.Management believes that exploitation of the market coverage we have achieved and continued efforts to control costs should result in another excellent year for the company. ” This letter also mentioned economic problems that had hit the country in late 1990, some product shortages, rising costs, and declining home construction as problems plaguing the industry in early 1991. The impact of these factors Was predicted to be less severe in Florida because of the strength of the state’s residential construction industry and because many expected construction to rise during the second half of 1991. Data on building permits, as available in September 1991, are shown in Exhibit 7. ) As Mr.. Conley dug deeper into the financial information he had collected, he was surprised to find that the outstanding short-term loan was 52,1 00,000 over the limit imposed by the term loan debt covenant.

Although a quick check provided information that the insurance company had agreed to the additional bank debt, their agreement had been obtained with the understanding that the loan would be reduced to $3 million by January 31, 1992.However, the insurance company had waived the requirement that Comfort Zone be out Of the bank for sixty days during fiscal year 1992. Analysis of the July 31 , 1991 accounts receivable balance provided the aging schedule shown in Exhibit 6. When questioned about the overdue amounts, the accounts receivable clerk reported that most accounts overdue in excess of 1 80 days represented sales of new equipment to construction contractors.

Investigation of the inventory balance disclosed that the company had adopted a policy in 1991 to build inventory as a hedge against future shortages. About $4. 8 million was added to inventory during fiscal year 1991 for this purpose and the build-up had continued into 1992. Further, it was found that there had been no significant inventory revaluations during the last several years to reflect obsolescence, deterioration or reductions of cost to market.

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