“Classic Fixtures and Hardware Company

“Classic Fixtures and Hardware Company”
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1) The Case “Classic Fixtures and Hardware Company” !
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________________________________________________________________________________________________________________
HBS Professor W. Carl Kester and Senior Instructor Craig Stephenson, Leeds School of Business at the University of Colorado, Boulder prepared
this case solely as a basis for class discussion and not as an endorsement, a source of primary data, or an illustration of effective or ineffective
management. Although based on real events and despite occasional references to actual companies, this case is fictitious and any resemblance to
actual persons or entities is coincidental.
Copyright © 2014 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. This publication may not be digitized,
photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.
W. CARL KESTER
CRAIG STEPHENSON
Classic Fixtures & Hardware Company
”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
9-915-523
FEBRUARY 5 , 2 0 1 5
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915-523 | Classic Fixtures & Hardware Company
2 BRIEFCASES | HARVARD BUSINESS SCHOOL
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 longerterm
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
$8 million during July, he believed that Classic would likely be unable to pay off the balance of the loan
this year, and before the seasonal upturn in funds requirements in 2009. Collections from customers
would allow the company to reduce the amount borrowed, but sales had continually failed to meet
forecast through the summer, so cash receipts would probably not be sufficient to pay off the entire
amount borrowed. Matocha asked if Classic’s inability to repay the seasonal loan facility this year was
due to a permanent change in the company’s funding needs, perhaps caused by the expansion and
modernization program, or if the company’s financial problems were instead the result of significant
changes in Classic’s product markets. Watkins was not able to answer this question with any certainty,
and they both agreed to a meeting at Classic’s headquarters to discuss the situation.
To prepare for the meeting, Matchoa began to analyze the company’s actual monthly income
statements and monthly balance sheets provided by Mr. Watkins, as presented in Exhibit 3 and Exhibit
4, respectively. Beyond this information, Matocha also collected the data presented in Exhibit 5, so he
could better understand conditions in the home improvement and housing construction industries. He
expected his analysis of Classic’s financial performance would reveal why it would be unable to repay
its loan balance this year, and hopefully identify actions to correct the company’s financial problems.
For the exclusive use of S. Alfalasi, 2015.
This document is authorized for use only by Saif Alfalasi in Case in Finance taught by Manu Gupta, Virginia Commonwealth University from August 2015 to December 2015.
915-523 -3-
Exhibit 1 Year 2008 Forecasted Monthly Income Statements
Actual 2008
($ in thousands) 2007 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Year
Net sales 881,424 56,330 62,410 73,160 89,140 92,250 98,110 99,580 91,470 82,490 69,530 53,640 52,890 921,000
Cost of goods sold 590,106 37,854 41,940 49,164 59,902 61,992 65,930 66,918 61,468 55,433 46,724 36,046 35,541 618,912
Gross profit 291,318 18,476 20,470 23,996 29,238 30,258 32,180 32,662 30,002 27,057 22,806 17,594 17,349 302,088
Selling, general & administrative expenses 208,392 17,900 17,900 17,900 17,900 17,900 17,900 17,900 17,900 17,900 17,900 17,900 17,900 214,800
Operating income 82,926 576 2,570 6,096 11,338 12,358 14,280 14,762 12,102 9,157 4,906 -306 -551 87,288
Interest expense 8,587 539 621 736 786 784 760 679 571 533 533 533 528 7,603
Income before income taxes 74,339 37 1,949 5,360 10,552 11,574 13,520 14,083 11,531 8,624 4,373 -839 -1,079 79,685
Income taxes 26,911 26 703 1,914 3,776 4,144 4,847 5,062 4,158 3,117 1,587 -289 -376 28,669
Net income 47,428 11 1,246 3,446 6,776 7,430 8,673 9,021 7,373 5,507 2,786 -550 -703 51,016
Dividends 16,000 4,400 4,400 4,400 4,400 17,600
Addition to retained earnings 31,428 11 1,246 -954 6,776 7,430 4,273 9,021 7,373 1,107 2,786 -550 -5,103 33,416
Cumulative addition to retained earnings 11 1,257 303 7,079 14,509 18,782 27,803 35,176 36,283 39,069 38,519 33,416
For the exclusive use of S. Alfalasi, 2015.
This document is authorized for use only by Saif Alfalasi in Case in Finance taught by Manu Gupta, Virginia Commonwealth University from August 2015 to December 2015.
915-523 -4-
Exhibit 2 Year 2008 Forecasted Monthly Balance Sheets
Actual 2008
($ in thousands) 12-31-2007 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Cash 107,067 88,202 86,520 87,030 87,540 88,050 88,570 89,080 89,540 97,373 116,620 127,043 112,400
Accounts receivable a 104,409 107,830 118,740 135,570 162,300 181,390 190,360 197,690 191,050 173,960 152,050 123,170 106,530
Inventories 121,670 135,442 145,128 147,590 139,639 129,598 115,619 100,982 91,795 88,643 94,535 111,105 128,180
Other current assets 19,744 19,774 19,803 19,833 19,864 19,895 19,927 19,957 19,988 20,017 20,041 20,062 20,080
Current assets 352,890 351,248 370,191 390,023 409,343 418,933 414,476 407,709 392,373 379,993 383,246 381,380 367,190
Net plant & equipment 165,681 167,335 170,104 171,919 175,264 176,893 178,157 179,472 180,791 181,396 182,648 183,843 184,636
Total assets 518,571 518,583 540,295 561,942 584,607 595,826 592,633 587,181 573,164 561,389 565,894 565,223 551,826
Accounts payable b 18,247 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100
Short-term bank debt c 0 36 19,665 47,313 59,341 58,835 54,450 34,834 9,051 0 0 0 0
Income taxes payable d 0 26 729 -4,524 -748 3,396 1,076 6,138 10,296 6,245 7,832 7,543 0
Other current liabilities 27,597 27,683 27,817 28,023 28,108 28,259 28,398 28,479 28,714 28,934 29,066 29,234 29,383
Current liabilities 45,844 45,845 66,311 88,912 104,801 108,590 102,024 87,551 66,161 53,279 54,998 54,877 47,483
Long-term debt e 86,250 86,250 86,250 86,250 86,250 86,250 85,350 85,350 85,350 85,350 85,350 85,350 84,450
Common stock 81,639 81,639 81,639 81,639 81,639 81,639 81,639 81,639 81,639 81,639 81,639 81,639 81,639
Retained earnings 304,838 304,849 306,095 305,141 311,917 319,347 323,620 332,641 340,014 341,121 343,907 343,357 338,254
Owners’ equity 386,477 386,488 387,734 386,780 393,556 400,986 405,259 414,280 421,653 422,760 425,546 424,996 419,893
Total liabilities & owners’ equity 518,571 518,583 540,295 561,942 584,607 595,826 592,633 587,181 573,164 561,389 565,894 565,223 551,826
a Assumes a 2 month collection period
b Assumes a 1 month payment period on purchases
c The interest rate on short-term bank debt is 5%
d Estimated taxes of $7,167,250 are paid in March, June, September, and December, based on forecasted year 2008 income taxes
e The interest rate on long-term debt is 7.5%
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This document is authorized for use only by Saif Alfalasi in Case in Finance taught by Manu Gupta, Virginia Commonwealth University from August 2015 to December 2015.
915-523 -5-
Exhibit 2 (Continued – Forecasted Monthly Inventories)
2008
($ in thousands) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Raw materials
Beginning balance 24,150 24,150 24,150 24,150 24,150 24,150 24,150 24,150 24,150 24,150 24,150 24,150
+ Purchases 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100
– Transfers to work in progress 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100
Ending balance 24,150 24,150 24,150 24,150 24,150 24,150 24,150 24,150 24,150 24,150 24,150 24,150
Work in progress
Beginning balance 36,103 36,103 36,103 36,103 36,103 36,103 36,103 36,103 36,103 36,103 36,103 36,103
+ Additions from raw materials 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100 18,100
+ Direct labor 11,861 11,861 11,861 11,861 11,861 11,861 11,861 11,861 11,861 11,861 11,861 11,861
+ Manufacturing overhead 21,665 21,665 21,665 21,990 21,990 21,990 22,320 22,320 22,320 22,655 22,655 22,655
– Transfers to finished goods 51,626 51,626 51,626 51,951 51,951 51,951 52,281 52,281 52,281 52,616 52,616 52,616
Ending balance 36,103 36,103 36,103 36,103 36,103 36,103 36,103 36,103 36,103 36,103 36,103 36,103
Finished goods
Beginning balance 61,417 75,189 84,875 87,337 79,386 69,345 55,366 40,729 31,542 28,390 34,282 50,852
+ Additions from work in progress 51,626 51,626 51,626 51,951 51,951 51,951 52,281 52,281 52,281 52,616 52,616 52,616
– Cost of goods sold 37,854 41,940 49,164 59,902 61,992 65,930 66,918 61,468 55,433 46,724 36,046 35,541
Ending balance 75,189 84,875 87,337 79,386 69,345 55,366 40,729 31,542 28,390 34,282 50,852 67,927
Total ending inventories 135,442 145,128 147,590 139,639 129,598 115,619 100,982 91,795 88,643 94,535 111,105 128,180
For the exclusive use of S. Alfalasi, 2015.
This document is authorized for use only by Saif Alfalasi in Case in Finance taught by Manu Gupta, Virginia Commonwealth University from August 2015 to December 2015.
915-523 -6-
Exhibit 3 Year 2008 Actual Monthly Income Statements
Actual 2008
($ in thousands) 2007 Jan Feb Mar Apr May Jun Jul
Net sales 881,424 55,496 60,204 68,320 80,507 81,593 84,868 84,760
Cost of goods sold 590,106 37,260 40,379 45,897 54,149 54,855 57,125 57,017
Gross profit 291,318 18,236 19,825 22,423 26,358 26,738 27,743 27,743
Selling, general & administrative expenses 208,392 17,914 17,897 17,922 17,906 17,918 17,873 17,909
Operating income 82,926 322 1,928 4,501 8,452 8,820 9,870 9,834
Interest expense 8,587 542 624 751 818 844 867 833
Income before income taxes 74,339 -220 1,304 3,750 7,634 7,976 9,003 9,001
Income taxes 26,911 -67 470 1,332 2,721 2,840 3,205 3,209
Net income 47,428 -153 834 2,418 4,913 5,136 5,798 5,792
Dividends 16,000 4,400 4,400
Addition to retained earnings 31,428 -153 834 -1,982 4,913 5,136 1,398 5,792
Cumulative addition to retained earnings -153 681 -1,301 3,612 8,748 10,146 15,938
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This document is authorized for use only by Saif Alfalasi in Case in Finance taught by Manu Gupta, Virginia Commonwealth University from August 2015 to December 2015.
915-523 -7-
Exhibit 4 Year 2008 Actual Monthly Balance Sheets
Actual 2008
($ in thousands) 12-31-2007 Jan Feb Mar Apr May Jun Jul
Cash 107,067 88,246 86,436 86,966 86,525 85,780 81,382 80,663
Accounts receivable 104,409 107,096 115,763 130,411 152,439 167,907 179,342 184,314
Inventories 121,670 136,236 147,447 153,627 152,036 149,276 144,051 139,039
Other current assets 19,744 19,802 19,813 19,827 19,884 19,907 19,924 19,953
Current assets 352,890 351,380 369,459 390,831 410,884 422,870 424,699 423,969
Net plant & equipment 165,681 167,974 171,015 173,048 176,898 178,842 180,618 182,028
Total assets 518,571 519,354 540,474 563,879 587,782 601,712 605,317 605,997
Accounts payable 18,247 18,486 18,411 18,866 19,112 18,714 18,618 18,410
Short-term bank debt 0 686 20,446 50,947 66,929 73,098 80,153 71,986
Income taxes payablea 0 -67 403 -5,432 -2,711 129 -3,834 -625
Other current liabilities 27,597 27,675 27,806 28,072 28,113 28,296 28,407 28,461
Current liabilities 45,844 46,780 67,066 92,453 111,443 120,237 123,344 118,232
Long-term debt 86,250 86,250 86,250 86,250 86,250 86,250 85,350 85,350
Common stock 81,639 81,639 81,639 81,639 81,639 81,639 81,639 81,639
Retained earnings 304,838 304,685 305,519 303,537 308,450 313,586 314,984 320,776
Owners’ equity 386,477 386,324 387,158 385,176 390,089 395,225 396,623 402,415
Total liabilities & owners’ equity 518,571 519,354 540,474 563,879 587,782 601,712 605,317 605,997
a Estimated taxes of $7,167,250 are paid in March, June, September, and December, based on forecasted year 2008 income taxes
For the exclusive use of S. Alfalasi, 2015.
This document is authorized for use only by Saif Alfalasi in Case in Finance taught by Manu Gupta, Virginia Commonwealth University from August 2015 to December 2015.
915-523 | Classic Fixtures & Hardware Company
8 BRIEFCASES | HARVARD BUSINESS SCHOOL
Exhibit 4 (Continued – Actual Monthly Inventories)
2008
($ in thousands) Jan Feb Mar Apr May Jun Jul
Raw materials
Beginning balance 24,150 24,208 24,246 24,200 24,408 24,516 24,521
+ Purchases 18,267 18,112 18,436 18,579 18,135 17,966 17,683
– Transfers to work in progress 18,209 18,074 18,482 18,371 18,027 17,961 17,860
Ending balance 24,208 24,246 24,200 24,408 24,516 24,521 24,344
Work in progress
Beginning balance 36,103 36,111 36,040 36,054 36,069 36,080 36,128
+ Additions from raw materials 18,209 18,074 18,482 18,371 18,027 17,961 17,860
+ Direct labor 11,849 11,827 11,902 11,893 11,931 11,830 11,895
+ Manufacturing overhead 21,710 21,651 21,739 22,086 22,029 22,104 22,427
– Transfers to finished goods 51,760 51,623 52,109 52,335 51,976 51,847 52,137
Ending balance 36,111 36,040 36,054 36,069 36,080 36,128 36,173
Finished goods
Beginning balance 61,417 75,917 87,161 93,373 91,559 88,680 83,402
+ Additions from work in progress 51,760 51,623 52,109 52,335 51,976 51,847 52,137
– Cost of goods sold 37,260 40,379 45,897 54,149 54,855 57,125 57,017
Ending balance 75,917 87,161 93,373 91,559 88,680 83,402 78,522
Total ending inventories 136,236 147,447 153,627 152,036 149,276 144,051 139,039
For the exclusive use of S. Alfalasi, 2015.
This document is authorized for use only by Saif Alfalasi in Case in Finance taught by Manu Gupta, Virginia Commonwealth University from August 2015 to December 2015.
Classic Fixtures & Hardware Company | 915-523
HARVARD BUSINESS SCHOOL | BRIEFCASES 9
Exhibit 5 Reported Information for the Home Improvement and New Construction Industries
Net sales ($ in millions) Home Depot Lowe’s
3 months ending April 30, 2008 $17,907 $12,009
3 months ending January 31, 2008 $14,607 $9,984
3 months ending October 31, 2007 $18,961 $11,565
3 months ending July 31, 2007 $22,184 $14,167
3 months ending April 30, 2007 $18,545 $12,172
3 months ending January 31, 2007 $17,659 $10,379
3 months ending October 31, 2006 $23,085 $11,211
3 months ending July 31, 2006 $26,026 $13,389
3 months ending April 30, 2006 $21,461 $11,921
3 months ending January 31, 2006 $20,265 $10,406
3 months ending October 31, 2006 $20,744 $10,592
3 months ending July 31, 2006 $22,305 $11,929
3 months ending April 30, 2006 $18,973 $9,913
3 months ending January 31, 2006 $19,489 $10,809
* Sources: Form 10-K filings with the U.S. Securities & Exchange Commission
New privately owned housing units authorized by building permits (not seasonally adjusted)
Calendar 2Q 2008 294.4
Calendar 1Q 2008 231.5
Calendar 4Q 2007 271.1
Calendar 3Q 2007 349.0
Calendar 2Q 2007 412.5
Calendar 1Q 2007 365.6
Calendar 4Q 2006 358.1
Calendar 3Q 2006 445.8
Calendar 2Q 2006 537.2
Calendar 1Q 2006 497.8
Calendar 4Q 2005 490.2
Calendar 3Q 2005 587.2
Calendar 2Q 2005 598.2
Calendar 1Q 2005 479.6
* Source: http://www.census.gov/construction/pdf/bpua.pdf
For the exclusive use of S. Alfalasi, 2015.
This document is authorized for use only by Saif Alfalasi in Case in Finance taught by Manu Gupta, Virginia Commonwealth University from August 2015 to December 2015.