ACC 305 Spring 2020 Case #4 Intangibles/Goodwill

Spartan Automotive, Inc. (SA) is a Tier 1 automotive supplier headquartered in Auburn Hills Michigan that produces high quality component parts for their Original Equipment Manufacturer (OEM) customers like General Motors, Ford, FCA, Honda, etc.

SA has 4 US manufacturing plants located in Fort Wayne Indiana, Fort Worth Texas, Mobile Alabama, and Flat Rock Michigan where they produce high precision parts used in OEM drivetrains.

The company also has one manufacturing plant located 20 miles outside Shanghai China where they produce wiring harnesses that require a significant amount of manual labor. These wiring harnesses are completed in China and then shipped to the United States for inclusion on the vehicle that is assembled by the OEMs. This facility was purchased by Spartan Automotive 10 years ago at a cost of $1.4 billion when the labor cost advantage of manufacturing in that location justified the investment.

Spartan Automotive also has a controlling interest in joint venture called Breslin Electronics, Inc. that is developing drivetrain technology solely for the electrified car. The company anticipates licensing this intellectual property out to the OEMs for usage in the up-and-coming electrified battery driven auto that industry experts anticipate being produced on a large scale someday.

Spartan Automotives balance sheet as of February 29, 2020 is summarized as follows:

Cash $ 195,500,000 Accounts Payable $ 575,777,000

Accounts receivable 188,800,000 Bonds payable 4,500,000,000

Inventory (FIFO) 1,345,890,000 Long-term debt 888,876,000

Intangibles 250,567,000 Total liabilities 5,964,653,000

Property, Plant & Equipment 15,666,890,000

Goodwill 100,000,000 Shareholders Equity 11,792,994,000

Total assets $17,747,647,000 Total liabilities & equity $17,757,647,000

Explanatory notes as respects the year-end balance sheet include the following:

1. Accounts receivable are considered fully collectible at the balances stated in the financial statements.
2. Inventories of approximately $1.3 billion are comprised primarily of work in process at the 4 US-based manufacturing plants and will no doubt be sold at standard prices once the auto industry is back in operation.
3. Intangibles totaling approximately $250 million were capitalized when Spartan Automotive purchased Breslin Electronics. Specifically, this is the value assigned to the patents that Breslin Electronics had developed internally and was purchased by Spartan Automotive when SA purchased their controlling interest in Breslin from the company founders four years ago.
4. Property plant and equipment primarily represents the book value of the buildings and other productive capacity at the 4 US manufacturing plants except as follows. Spartan Automotive still has $1.0 billion of book value on its books pertaining to the Shanghai China location.
   1. Goodwill of $100 million is fully attributable to the cost Spartan Automotive paid for their Shanghai China manufacturing plant over and above the fair market value of the identified physical assets at the time of purchase 10 years ago.
5. Bonds payable require a debt to equity ratio of no more than 1:1 or else they become due and payable immediately.

From an income perspective, Spartan Automotive has been averaging approximately $250/million net income per quarter over the last several years during a time when the US auto industry was selling approximately 17 million automobiles per year.

Spartan Automotive is run by a lady named Mary Dawn Withers.

In addition to being the CEO of Spartan Automotive, Mary Dawn is also a member of the very exclusive Bohemian Club that is comprised of Fortune 100 CEOs and other influential leaders from around the country. At a recent Bohemian Club meeting in Southern California, club members heard top-level experts predict and discuss what effects the recent coronavirus crisis is anticipated to have going forward on the world economy, world politics, modern culture, etc.

Specifically, Mary Dawn learned of the following:

1. De-globalization - and how the world's economic segments will soon commence a process of diminished interdependence and a significant lessening of economic trade between countries.
2. Cheap oil - driven by a projected prolonged worldwide economic downturn, tensions between oil-producing countries that have excess oil reserves they need to sell into the marketplace, and technological advancements allowing oil to be extracted from the earth at a significantly lower cost (i.e. fracking, shale oil, enhanced offshore drilling, etc.).
3. Significant focus on supply chain integrity - driven by the need to no longer be vulnerable to lean manufacturing or just-in-time supply chains that can break down because of political issues between countries and/or logistical issues associated with importing products from countries located around the world - the new focus will be on supply chain integrity and dependability not low-cost manufacturing and low-cost sourcing as in the past.

Once again, your friend and boss Shaun Coulson has asked you to help a friend.

In brief, Shaun was one of the CEOs that participated in the Bohemian Club grove meeting out in California along with his friend Mary Dawn Withers, Bill Boyce, etc.

Again, Shaun told his friend Mary Dawn about how you've helped his company recognized megatrends in the marketplace and then using GAAP, quantify the economic reality of those things in the company's financial statements for use by management in making strategic decisions.

Bill Boyce heard this conversation between Shaun and Mary Dawn and similarly, passed along his praises of you to Mary Dawn.

As a favor to Mary Dawn, Shaun has asked that you meet with Mary Dawn in Auburn Hills and help her quantify the effects of certain decisions she's already made concerning Spartan Automotive.

Specifically, Mary Dawn has decided to do the following:

1. Completely close down Breslin Electronics. In Mary Dawn's opinion, the company is consuming too much cash and given the ongoing availability of cheap oil and the fact that the US government is now relaxing corporate annual fuel economy standards, the electrified auto is an investment opportunity that will probably not pay off in any reasonable time frame and therefore is not worthy of the heavy ongoing investment that it requires.
2. Completely close down the Shanghai facility given that the labor advantage is no longer what it initially was. Moreover, Mary Dawn thinks that the vulnerability of having a manufacturing facility making critical parts that far away from their OEM customers is something their OEM customers will no longer accept.

Specifically, Mary Dawn has asked for your opinion on the following:

What financial statement adjustments will Spartan Automotive need to make to their March 31 balance sheet and income statement if the Spartan Automotive Board of Directors gives her the go-ahead to make and announce these changes right away (please identify and quantify these items and explain the GAAP conceptual guidance that requires these adjustments )?

Mary Dawn has asked that you prepare a one-page business memo for her addressing these items in preparation for her Board of Directors meeting of Spartan Automotive on April 20.