Case $36$

Garden State Container Corporation

Financial Analysis and Forecasting

Directed

Garden State Container Corporation manufactures boxes and other containers primarily for farm products. More than $85$ percent of the company's sales come from the northeastern part of the United States, especially Pennsylvania, New Jersey, New York, and Maryland, although the company's patented egg cartons are distributed throughout the United States. Jim Jackson, the founder and president, recently received a call from Martha Menendez, vice president of Atlantic First National Bank. Menendez told him that a negative report had been generated by the bank's computerized analysis system; the report showed that Garden State's financial position was bad and getting worse.

The bank requires quarterly financial statements from each of its major loan customers. Information from these statements is fed into the computer, which then calculates key ratios for each customer and charts trends in these ratios. The system also compares the statistics for each company with the average ratios of other firms in the same industry and against any protective covenants in the loan agreements. If any ratio is significantly worse than the industry average, reflects a marked adverse trend, or fails to meet contractual requirements, the computer highlights the deficiency.

The latest report on Garden State revealed a number of adverse trends and several potentially serious problems $($see Tables $1$ through $6$ for Garden State's historical financial statements$).$ Particularly disturbing were the $1992$ current, quick, and debt ratios, all of which failed to meet the contractual limits of $2\mathrm{.}0,1\mathrm{.}0,$ and $55$ percent, respectively. Technically, the bank had a legal right to call all the loans it had extended to Garden State for immediate repayment and, if the loans were not repaid within ten days, to force the company into bankruptcy.

Martha hoped to avoid calling the loans if at all possible, as she knew this would back Garden State into a corner from which it might not be able to emerge. Still, her own bank's examiners had recently become highly sensitive to the issue of problem loans, because the recent spate of bank failures had forced regulators to become more strict in their examination of bank loan portfolios and to demand earlier identification of potential repayment problems.

One measure of the quality of a loan is the Altman Z score, which for Garden State was $3\mathrm{.}04$ for $1992,$ slightly below the $3\mathrm{.}20$ minimum that Martha's bank uses to differentiate strong firms with little likelihood of bankruptcy in the next two years from those deemed likely to go into default. This will put the bank under increased pressure to reclassify Garden State's loans as "problem loans," to set up a reserve to cover potential losses, and to take whatever steps are necessary to reduce the bank's exposure. Setting up the loss reserve would have a negative effect on the bank's profits and reflect badly on Martha's performance.

To keep Garden State's loan from being reclassified as a "problem loan," the Senior Loan Committee will require strong and convincing evidence that the company's present difficulties are

Case $14$: Garden State Container Corporation: Directed

only temporary. Therefore, it must be shown that appropriate actions to overcome the problems have been taken and that the chances of reversing the adverse trends are realistically good. Martha now has the task of collecting the necessary information, evaluating its implications, and preparing a recommendation for action.

The recession that plagued the U$.$S$.$ economy in the early $1990$ s caused severe, though hope. temporary, problems fully temporary, problems for companies like Garden State. On top of this, disastrous droughts $f_{0r}$ sively reduced prices in $1991$ and $1992$ to allow it to realize greater economies of scale in production and to ride the learning, or exped, would curve down to a lower cost position. Garden State's management had full confidence that in expe, weather and national economic policies would revive the ailing economy and that the downtmal demand would be only a short$-$term problem. Consequently, production continued unabated in inventories increased sharply.

In a further effort to reduce inventory, Garden State relaxed its credit standards in early $1992$ and improved its already favorable credit terms. As a result, sales growth did remain high by indus. try standards through the third quarter of $1992,$ but not high enough to keep inventories from con. tinuing to rise. Further, the credit policy changes had caused accounts receivable to increase dramatically by late $1992.$

To finance its rising inventories and receivables, Garden State turned to the bank for a long. term loan in $1991$ and also increased its short$-$term credit lines in both $1991$ and $1992.$ However, this expanded credit was insufficient to cover the asset expansion, so the company