Comment on Peytons recent financial performances Quantify the impact of the accounting policy, and estimate changes being proposed by McNeilly on FY 2015s earnings relative to the figures that would be reported under Peytons existing policies and estimates Is McNeilly correct in her assumption that conservative accounting during the current difficult period will be viewed positively by the market when they go into IPO? Any other issue that this situation throws up which needs to be addressed ?

Peyton Enterprises John Berry closed his office door, shuffled to his desk, and slumped in his chair. It was April 8, 2015, and the quarterly meeting with his company's financial planning team had just ended. The meeting was perhaps his worst since he assumed the position as CFO of Peyton Enterprises three years earlier. Most of his disappointment stemmed from the questions and comments received from Sarah McNeill, Peyton's new CEO. McNeilly had just been hired after a six-month search and came with an impressive record of executive leadership. I listorically, the financial planning meetings at Peyton were attended by only two division presidents, the controller, and the CFO Berry was pleased that the CEO had decided to attend, but for someone this new to the company, it was disheartening to hear the set of questions she had posed. And it was the required follow- up that had Berry most upset. It appeared to him that others in the meeting felt the same way. Peyton's performance over the last four quarters had been lackluster at hest. Sales growth had skewed considerably and the company was having difficulty controlling costs. As a consequence, a medest quarterly loss had just been reported for the first time in more than a decade. The actual financial results came as no surprise to anyone in the meeting. The coaversation, however, was dominated by a debate about the appropriate accounting policies to adopt going forward. Although Berry had been charged with setting the accounting methods and assumptions underlying Peyton's financial statements, McNeilly had posited that Berry was being too aggressive with these policies in light of the company's recent negative performance. She indicated that any boost to camnings from accounting decisions made under her watch just would not happen." She called a meeting for 8:00 am the next moming to review Peyton's most material accounting policies. Up for discussion would also be the proposed closing of two of the company's kwer-producing plants and the transfer of those operations to a newer facility The Company Peyton Enterprises was engaged in the design and manufacture of equipment and component products used in the chemicals industry. It was privately held and based in Pittsburgh, Pennsylvania. Since the company's founding in 1947, it had built a solid reputation as a supplier of reliable and affordable filtering products throughout the United States. Peyton's specialty products were filtration components, filtration equipment, and other systems that used peopeietary welded wedge wire screens of at least 20 microns. Its filter housing and strainers could be made from carbon steel, stainless stech, nickel, titanium, or bronze, depending on the types of chemicals produced by its customers. Peyton's main competitors ranged from the very larye manufacturers (e... General Electric and Pall Corporation to the many smaller specialty manufacturers. A wide array of chemical companies used Peyton as their sole supplier, some had contracted for periods as long 10 years These customers provided Peyton with a steady and predictable since of revenue and enabled the company to expand and innovate in other areas of filtration into which it might not otherwise have ventured. In the mac to late 1990s, the company began its move from a relatively small and nache supplier to one with national reach. Some of its largest customers were chemical companies that were involved in energy and life sciences. In the energy sector, Peyton's niche market related to coal mining and garnered a 30% share as the supplier of choice to those producing coal-cleaning agents. Danng 2014, there were spillover declines from the drop in use of coal-fired power plants in the United States. There was less coal being mind and bumed and thus less coxal needing to be cleaned. Peyton's sales and profits were feeling this pinch The life sciences sector was the fastest growing segment of the broader chemicals industry and was helping to offset the decline related to energy. Life sciences chemical substances were those used in such arcas as pharmaceuticals, vitamins, and pesticides. These chemical products were often produced with extreme precision and had been increasingly scrutinized by gewernment agencies t.e., the U.S. FDA). The green imowement had also created greater demand for the complete filtration of certain chemicals contained in "cmp protection chemicals," and Peyton's proprietary filtration screens were guaranteed as compliant to a 99.8% clean specimen full 0.5% greater than its nearest competitor McNeilly was hired to help com the company back to growing profitably. Her compensation consisted of a salary plus the promise of a cash bonus based upon Peyton's ROA, earnings growth, and a successful IPO. McNeilly was replacing the retiring CEO, who was a longtime friend of the company's founder, Robert Peyton 111. The retirement had been anticipated and planned for since 2012, and its timing was meant to coincide with a planned offering of Peytoa stock for public sale in 2014. The IPO would raise capital to fuel the expected future growth in the life sciences sector and would facilitate the implementation of share-based compensation schemes for senior management and lower level employees. Not surprisingly, however, the IPO that had been planned for 2014 was delayed as a result of the company's downturn. Peyton's results for its two most recent fiscal years, as well as for the first quarter of FY2015, are presented in Exhibit 1, while its financial position is depicted in the balance sheets contained in Exhibit 2 April 9, 2015 Berry arrived to the meeting 30 minutes early, where he met Sun Emmott, Peyton's controller. Emmott had been in this role for over a decade and was intimately familiar with all of the company's accounting policies. Berry had asked Emmott to have a close look at three critical balance sheet accounts receivables, inventory and fixed assets and to assess how the counting methods they had adopted stacked up against other companies "Well, what did you learn?" Berry asked directly Emmott was fast and sure with his summary I couldn't find any direct peer firms because most of the candidates for this, like us, are private. But I did have a look at a number of publicly traded companies. Some were our customers, including Dew, Lyondell, and RASE, but I also found one our filtration competitors-Pall Corp. Nothing jumped out at me from my review of their accounting policies and estimates Pall cared a pecvision for uncollectibles of between 2% and 1%, although they bounced it up almost a full percentage point this past year. They also use FIFO for inventory. We pay a price against earnings, as you know, for using LIFO, in order to enjoy the associated tax benefit. This is very prudent, and certainly not aggressive. All the companies that I looked at use straight-line depreciation for PPE, as far as I could tell, just like us. I'm not sure where Sarah is coming from on this Berry was satisfied. And be expected the meeting with McNeilly to be straightforward McNeilly amved right on time. Even though she had only been with the company for a few months, she had eamed a reputation as an executive who was almost all business. She expected everyone to be on time and engaged, and prepared, as she would be. This meeting was no exception. After a few pleasanties, she opened with a statement of her objective We've had a bad year. I can handle our current board of directors, but if and when we take Peyton public, the last thing I want to hear about is pxxtential new investors questioning the quality of our earnings. When I reviewed each of our major acounts and expense items, from an investor lens mind you I was struck by the feeling that we are doing some things that might be interpreted 24 propping up our earnings. I would like us to be as conservative as we can right now, while times are bad, in order to avoid any future criticism. We should anticipate that we will be subject to mach higher levels of scrutinyby analysts, institutional investors, and regulators once we become a public company The next hour was spent in a review of some of these accounting methods and assumptions Exhibit 3 summanzes the details behind the accounts receivable, inventory, and fixed asset balance sheet accounts. McNeilly had done het math. The allowance for doubtfal accounts for 2014 had dropped by about $4.5 million, while, at the same time, the total receivables balance had been increasing Sales had been skywing, so a Mig reserve made more sense to her. Emmott explained that he used an aging schedule to determine bad debt expense, but at the end of the year it was more his gut feel about Peyton's customers that determined how much would be accrued as uncollectible. There were a few very large accounts, but most were smaller and very volatile. The average uncollectable of accounts receivable was estimated at around 2.5%, and, historically for the company, it ranged between 2% and 5%, depending on the mix of customers and the pevailing economic conditions. McNeilly wanted to see this moved to about 4.5%, given the current state of affairs. Regarding inventory, McNeilly viewed a recent 2015 (2) company-wide initiative to slow inventory purchases as an attempt to tap some of Peyton's $75 million LIFO reserve. Accordingly, she proposed that this initiative be delayed. Beyond the accounting effects, a skywdown in purchases created inventory supply risks that she did not want to see materialize. An uptick in demand was expected arcund the beginning of FY2016. Berry lightly protested, given that there were real savings to be had by using the company to lower inventory levels. McNeilly agreed to revisit the policy toward the end of 2015. Fixed assets passed a different set of accounting issues. During 2015, the company expected to incur one- time additional capital expenditures of $100 million. This unusual expenditure related to the company's opening a new facility in eastern Pennsylvania. Aside from these unusual one-time expenditures, fixed asset purchases were expected to be incurred at their historical levels, which was just enough to sustain productive capacity, McNeilly flatly proposed to reduce Peyton's average useful life of the $100 million in additional assets purchased in 2015, switching the assumption from seven to just five years. Furthermore, an accelerated method (double declining balance) made much more sense to her because the productive use of almost all of the asset classes, and especially equipment, was higher in the early years of the assets' lives. Berry and Emmott could not disagree, and because this change would only be implemented for this one new set of assets, there would be no need to classify it as a "change in accounting method" on the 2015 financial statements. Finally, the team assessed the likely financial statement impacts of the planned restructuring. Their best estimates were that severance and other related one-time cut-of-pocket costs of abxxut $10 million would be incurred, that equipment impairments of $80 million might be necessary, and that inventory write-downs would be in the range of about $15 million. Some uncertainty remained, however, as to when these charges woul ultimately hit the books. Exhibit 1 Peyton Enterprises Summary Income Statements (in thousands) Net Sales Cost of Goods Sold Gross Profit SG&A Operating Income Net Financing Costs Other Expenses Income Before Income Taxes Income Tax Expense Net Income Projected Q1-2015 2014 2013 2012 $ 535,543 $ 2,462,171 $3,040,570 $2,677,547 398,480 1,779,209 2,134,007 1,887,692 137,063 682,962 906,563 789,855 135,642 506,563 579,292 521,699 1,421 176,399 327,271 268,156 354 1,417 1,570 532 1,182 3,431 3,578 3,793 (115) 171,551 322,123 263,831 (40) 60,043 112,743 92,341 (75) 111,508 209,380 171,490 Data source: All exhibits made by case writer using company data. Exhibit 2 Peyton Enterprises Summary Balance Sheets in thousands) 2014 2013 $ Assets Cash and equivalents A/R, net Inventories Other Total current assets 73,164 $ 329,880 281,417 52,819 737,280 78,442 302,043 218,506 41,155 640, 146 PP&E, net Intangibles, net Goodwill 268,630 91,267 106,849 $ 1,204,026 $ 254,103 84,840 106,849 1,085,938 $ Liabilities Accounts payable Other current Total current liabilities Pension obligations Other long-term debt Total liabilities Shareholders' Equity Common stock Retained earnings AOCI (loss) Total Shareholders' Equity 136,575 $ 45,426 182,001 10,919 26,272 219,192 125,890 46,130 172,020 19,750 24,133 215,903 163,893 824,362 (3,421) 984,834 1,204,026 163,893 712,854 (4,569) 872,178 1,088,081 Exhibit 3 Peyton Enterprises Summary Account DetailAccounts Receivable, Inventory and Fixed Assets (in thousands) Accounts Receivable Gross accounts receivable Allowance for doubtful accounts Accounts receivable, net 2014 $ 338,370 $ 8,490 $ 329,880 $ 2013 315,030 12,987 302,043 Property, Plant, and Equipment Land Buildings Equipment Total PP&E-cost Less: Accumulated depreciation PP&E, net 2014 $ 10,125 $ 85,463 385,161 480,749 (212,119) $ 268,630 $ 2013 10,125 84,477 364,283 458,885 (204,782) 254,103 Inventories Inventories at current cost Less: Excess of current cost over LIFO Carrying value of inventories 2014 $ 357,125 $ 75,708 $ 281,417 $ 2013 293,262 74.756 218,506 Peyton Enterprises John Berry closed his office door, shuffled to his desk, and slumped in his chair. It was April 8, 2015, and the quarterly meeting with his company's financial planning team had just ended. The meeting was perhaps his worst since he assumed the position as CFO of Peyton Enterprises three years earlier. Most of his disappointment stemmed from the questions and comments received from Sarah McNeill, Peyton's new CEO. McNeilly had just been hired after a six-month search and came with an impressive record of executive leadership. I listorically, the financial planning meetings at Peyton were attended by only two division presidents, the controller, and the CFO Berry was pleased that the CEO had decided to attend, but for someone this new to the company, it was disheartening to hear the set of questions she had posed. And it was the required follow- up that had Berry most upset. It appeared to him that others in the meeting felt the same way. Peyton's performance over the last four quarters had been lackluster at hest. Sales growth had skewed considerably and the company was having difficulty controlling costs. As a consequence, a medest quarterly loss had just been reported for the first time in more than a decade. The actual financial results came as no surprise to anyone in the meeting. The coaversation, however, was dominated by a debate about the appropriate accounting policies to adopt going forward. Although Berry had been charged with setting the accounting methods and assumptions underlying Peyton's financial statements, McNeilly had posited that Berry was being too aggressive with these policies in light of the company's recent negative performance. She indicated that any boost to camnings from accounting decisions made under her watch just would not happen." She called a meeting for 8:00 am the next moming to review Peyton's most material accounting policies. Up for discussion would also be the proposed closing of two of the company's kwer-producing plants and the transfer of those operations to a newer facility The Company Peyton Enterprises was engaged in the design and manufacture of equipment and component products used in the chemicals industry. It was privately held and based in Pittsburgh, Pennsylvania. Since the company's founding in 1947, it had built a solid reputation as a supplier of reliable and affordable filtering products throughout the United States. Peyton's specialty products were filtration components, filtration equipment, and other systems that used peopeietary welded wedge wire screens of at least 20 microns. Its filter housing and strainers could be made from carbon steel, stainless stech, nickel, titanium, or bronze, depending on the types of chemicals produced by its customers. Peyton's main competitors ranged from the very larye manufacturers (e... General Electric and Pall Corporation to the many smaller specialty manufacturers. A wide array of chemical companies used Peyton as their sole supplier, some had contracted for periods as long 10 years These customers provided Peyton with a steady and predictable since of revenue and enabled the company to expand and innovate in other areas of filtration into which it might not otherwise have ventured. In the mac to late 1990s, the company began its move from a relatively small and nache supplier to one with national reach. Some of its largest customers were chemical companies that were involved in energy and life sciences. In the energy sector, Peyton's niche market related to coal mining and garnered a 30% share as the supplier of choice to those producing coal-cleaning agents. Danng 2014, there were spillover declines from the drop in use of coal-fired power plants in the United States. There was less coal being mind and bumed and thus less coxal needing to be cleaned. Peyton's sales and profits were feeling this pinch The life sciences sector was the fastest growing segment of the broader chemicals industry and was helping to offset the decline related to energy. Life sciences chemical substances were those used in such arcas as pharmaceuticals, vitamins, and pesticides. These chemical products were often produced with extreme precision and had been increasingly scrutinized by gewernment agencies t.e., the U.S. FDA). The green imowement had also created greater demand for the complete filtration of certain chemicals contained in "cmp protection chemicals," and Peyton's proprietary filtration screens were guaranteed as compliant to a 99.8% clean specimen full 0.5% greater than its nearest competitor McNeilly was hired to help com the company back to growing profitably. Her compensation consisted of a salary plus the promise of a cash bonus based upon Peyton's ROA, earnings growth, and a successful IPO. McNeilly was replacing the retiring CEO, who was a longtime friend of the company's founder, Robert Peyton 111. The retirement had been anticipated and planned for since 2012, and its timing was meant to coincide with a planned offering of Peytoa stock for public sale in 2014. The IPO would raise capital to fuel the expected future growth in the life sciences sector and would facilitate the implementation of share-based compensation schemes for senior management and lower level employees. Not surprisingly, however, the IPO that had been planned for 2014 was delayed as a result of the company's downturn. Peyton's results for its two most recent fiscal years, as well as for the first quarter of FY2015, are presented in Exhibit 1, while its financial position is depicted in the balance sheets contained in Exhibit 2 April 9, 2015 Berry arrived to the meeting 30 minutes early, where he met Sun Emmott, Peyton's controller. Emmott had been in this role for over a decade and was intimately familiar with all of the company's accounting policies. Berry had asked Emmott to have a close look at three critical balance sheet accounts receivables, inventory and fixed assets and to assess how the counting methods they had adopted stacked up against other companies "Well, what did you learn?" Berry asked directly Emmott was fast and sure with his summary I couldn't find any direct peer firms because most of the candidates for this, like us, are private. But I did have a look at a number of publicly traded companies. Some were our customers, including Dew, Lyondell, and RASE, but I also found one our filtration competitors-Pall Corp. Nothing jumped out at me from my review of their accounting policies and estimates Pall cared a pecvision for uncollectibles of between 2% and 1%, although they bounced it up almost a full percentage point this past year. They also use FIFO for inventory. We pay a price against earnings, as you know, for using LIFO, in order to enjoy the associated tax benefit. This is very prudent, and certainly not aggressive. All the companies that I looked at use straight-line depreciation for PPE, as far as I could tell, just like us. I'm not sure where Sarah is coming from on this Berry was satisfied. And be expected the meeting with McNeilly to be straightforward McNeilly amved right on time. Even though she had only been with the company for a few months, she had eamed a reputation as an executive who was almost all business. She expected everyone to be on time and engaged, and prepared, as she would be. This meeting was no exception. After a few pleasanties, she opened with a statement of her objective We've had a bad year. I can handle our current board of directors, but if and when we take Peyton public, the last thing I want to hear about is pxxtential new investors questioning the quality of our earnings. When I reviewed each of our major acounts and expense items, from an investor lens mind you I was struck by the feeling that we are doing some things that might be interpreted 24 propping up our earnings. I would like us to be as conservative as we can right now, while times are bad, in order to avoid any future criticism. We should anticipate that we will be subject to mach higher levels of scrutinyby analysts, institutional investors, and regulators once we become a public company The next hour was spent in a review of some of these accounting methods and assumptions Exhibit 3 summanzes the details behind the accounts receivable, inventory, and fixed asset balance sheet accounts. McNeilly had done het math. The allowance for doubtfal accounts for 2014 had dropped by about $4.5 million, while, at the same time, the total receivables balance had been increasing Sales had been skywing, so a Mig reserve made more sense to her. Emmott explained that he used an aging schedule to determine bad debt expense, but at the end of the year it was more his gut feel about Peyton's customers that determined how much would be accrued as uncollectible. There were a few very large accounts, but most were smaller and very volatile. The average uncollectable of accounts receivable was estimated at around 2.5%, and, historically for the company, it ranged between 2% and 5%, depending on the mix of customers and the pevailing economic conditions. McNeilly wanted to see this moved to about 4.5%, given the current state of affairs. Regarding inventory, McNeilly viewed a recent 2015 (2) company-wide initiative to slow inventory purchases as an attempt to tap some of Peyton's $75 million LIFO reserve. Accordingly, she proposed that this initiative be delayed. Beyond the accounting effects, a skywdown in purchases created inventory supply risks that she did not want to see materialize. An uptick in demand was expected arcund the beginning of FY2016. Berry lightly protested, given that there were real savings to be had by using the company to lower inventory levels. McNeilly agreed to revisit the policy toward the end of 2015. Fixed assets passed a different set of accounting issues. During 2015, the company expected to incur one- time additional capital expenditures of $100 million. This unusual expenditure related to the company's opening a new facility in eastern Pennsylvania. Aside from these unusual one-time expenditures, fixed asset purchases were expected to be incurred at their historical levels, which was just enough to sustain productive capacity, McNeilly flatly proposed to reduce Peyton's average useful life of the $100 million in additional assets purchased in 2015, switching the assumption from seven to just five years. Furthermore, an accelerated method (double declining balance) made much more sense to her because the productive use of almost all of the asset classes, and especially equipment, was higher in the early years of the assets' lives. Berry and Emmott could not disagree, and because this change would only be implemented for this one new set of assets, there would be no need to classify it as a "change in accounting method" on the 2015 financial statements. Finally, the team assessed the likely financial statement impacts of the planned restructuring. Their best estimates were that severance and other related one-time cut-of-pocket costs of abxxut $10 million would be incurred, that equipment impairments of $80 million might be necessary, and that inventory write-downs would be in the range of about $15 million. Some uncertainty remained, however, as to when these charges woul ultimately hit the books. Exhibit 1 Peyton Enterprises Summary Income Statements (in thousands) Net Sales Cost of Goods Sold Gross Profit SG&A Operating Income Net Financing Costs Other Expenses Income Before Income Taxes Income Tax Expense Net Income Projected Q1-2015 2014 2013 2012 $ 535,543 $ 2,462,171 $3,040,570 $2,677,547 398,480 1,779,209 2,134,007 1,887,692 137,063 682,962 906,563 789,855 135,642 506,563 579,292 521,699 1,421 176,399 327,271 268,156 354 1,417 1,570 532 1,182 3,431 3,578 3,793 (115) 171,551 322,123 263,831 (40) 60,043 112,743 92,341 (75) 111,508 209,380 171,490 Data source: All exhibits made by case writer using company data. Exhibit 2 Peyton Enterprises Summary Balance Sheets in thousands) 2014 2013 $ Assets Cash and equivalents A/R, net Inventories Other Total current assets 73,164 $ 329,880 281,417 52,819 737,280 78,442 302,043 218,506 41,155 640, 146 PP&E, net Intangibles, net Goodwill 268,630 91,267 106,849 $ 1,204,026 $ 254,103 84,840 106,849 1,085,938 $ Liabilities Accounts payable Other current Total current liabilities Pension obligations Other long-term debt Total liabilities Shareholders' Equity Common stock Retained earnings AOCI (loss) Total Shareholders' Equity 136,575 $ 45,426 182,001 10,919 26,272 219,192 125,890 46,130 172,020 19,750 24,133 215,903 163,893 824,362 (3,421) 984,834 1,204,026 163,893 712,854 (4,569) 872,178 1,088,081 Exhibit 3 Peyton Enterprises Summary Account DetailAccounts Receivable, Inventory and Fixed Assets (in thousands) Accounts Receivable Gross accounts receivable Allowance for doubtful accounts Accounts receivable, net 2014 $ 338,370 $ 8,490 $ 329,880 $ 2013 315,030 12,987 302,043 Property, Plant, and Equipment Land Buildings Equipment Total PP&E-cost Less: Accumulated depreciation PP&E, net 2014 $ 10,125 $ 85,463 385,161 480,749 (212,119) $ 268,630 $ 2013 10,125 84,477 364,283 458,885 (204,782) 254,103 Inventories Inventories at current cost Less: Excess of current cost over LIFO Carrying value of inventories 2014 $ 357,125 $ 75,708 $ 281,417 $ 2013 293,262 74.756 218,506