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The Charter Company The Charter Company Overview The Charter Company was organized in 1959 as a consolidation of several existing corporations. The company's primary line of business was petroleum production and marketing, although it also maintained a significant equity investment in the Charter Security Life Insurance Company. In 1983, the Charter Company was listed by Fortune magazine among the 100 largest U.S. industrial companies. For the year ended December 31, 1983, revenues totaled $5.7 billion, and income from continuing operations was $50.4 million. For 1982, revenues were $4 billion, and earnings from continuing operations were $29.8 million. In spite of the continuing worldwide glut in crude oil and petroleum products, Charter had maintained its quarterly dividend of $.25 per share from the second quarter of 1980 through the first quarter of 1984. During 1983 and early 1984, Charter's common stock traded in a range of $8.00 to $13.75. In the latter half of 1983, however, a number of adverse articles began appearing in the financial press, questioning the quality of Charter's reported earnings. Nonetheless, the company's 1983 financial statements, released in early 1984, indicated no particular financial concerns. Moreover, the firm's \"Big Eight\" auditing firm, Peat, Marwick, Mitchell & Co., had issued a \"clean\" opinion subject only to a consistency qualification (to which they concurred). During the first week of April 1984, however, Charter reported a substantial first quarter loss and announced plans to cut oil production and lay off employees. The company's common stock dropped in price from $9.50 per share on April 3 to $6.625 on April 5. The price then steadily decreased to $3.25 by the end of April. On April 20, 1984, the Charter Company and 43 of its subsidiaries filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Act. Copyright 1988: C. Norgaad and R. Kochanek Page 1 of 9 The Charter Company Discussion Questions Answer these questions using the overview (p. 1) and 5 Exhibits (pp. 3 - 9). Write your responses in a new thread on the board. 1. Calculate the following ratios for each year during the period 1980-1983. Comment on the trend indicated by each ratio with respect to the financial performance and condition of the Charter Company. a. Profitability: Return on average total assets (assume a 46% income tax rate) b. Turnover: i. Accounts receivable (based on average gross trade receivables). ii. Inventory (based on average total inventory). iii. Total assets (based on average total assets). c. Liquidity: i. Current ratio ii. Quick ratio d. Solvency i. Total liabilities to total equities ii. Total long-term debt to total long-term debt plus owner's equity 2. The Charter Company had a number of nonrecurring and/or noncash components of income from continuing operations in 1983. Beginning with the 1983 earnings from continuing operations, adjust this figure for nonrecurring and/or noncash items (information for these adjustments are included in Exhibit 1 (p. 3), Exhibit 3 (p. 6), and Exhibit 4 (pp. 7 - 8)). 3. Based on the information presented in the case, discuss the extent to which the stock market, in the aggregate, anticipated Charter's problems and priced its common stock accordingly (see Exhibit 5 (p. 9)). Page 2 of 9 The Charter Company The Charter Company Consolidated Statement of Earnings Years Ended December 31 (In thousands) Exhibit 1 1983 $5,656,770 1982 $4,017,161 1981 $4,966,171 1980 $4,563,011 1979 $4,296,370 117,958 43,402 14,080 661 2,357 $5,774,728 $4,060,563 $4,980,251 $4,563,672 $4,298,727 $5,364,820 99,987 80,886 $3,744,462 101,968 69,879 $4,512,215 190,656 89,196 $4,193,275 112,694 77,133 $3,624,619 154,608 44,000 37,939 36,074 32,511 35,085 28,851 49,428 7,772 - - - - $5,640,832 $3,952,383 $4,824,578 $4,418,187 $3,852,078 Earnings before income taxes, etc. Income taxes Earnings from continuing operations Discontinued operations, net Extraordinary charge $133,896 83514 $50,382 (1,950) - $108,180 78350 $29,830 5,430 - $155,673 99727 $55,946 (48,229) - $145,485 95248 $50,237 - $446,649 78923 $367,726 (2,388) Earnings before cumulative effect Cumulative effect on prior years of a change in accounting principle $48,432 $35,260 $7,717 $50,237 $365,338 5,463 - - - - Net earnings $53,895 $35,260 $7,717 $50,237 $365,338 Revenues Equity in net earnings of Charter Security Life and other affiliates Expenses: Cost of sales and operating Selling, general and administrative Interest Depreciation, depletion and amortization Write-off of certain units at Bahamas refinery Write-down of tanker Total Expenses Page 3 of 9 The Charter Company The Charter Company Consolidated Balance Sheets 31-Dec (In thousands) Exhibit 2 Assets Current assets: Cash & Cash Equivalents........................ Receivables: Trade accounts........................................ Other....................................................... Affiliates.................................................. Short-term notes and current installments of long-term receivables............................ 1983 1982 1981 1980 1979 $64,031 $59,939 $69,283 $94,112 $95,632 294,715 22,756 31,030 262,646 18,736 30,106 343,862 25,967 11,479 322,237 32,142 16,312 296,344 41,488 499 2,868 351,369 24,744 336,232 8,815 390,123 3,133 373,824 8,745 347,076 Less: Allowance for doubtful receivables............................................ 10,951 8,622 14,464 6,062 14,005 Net receivables........................................ 340,418 327,610 375,659 367,762 333,071 Inventories Petroleum................................................ Other....................................................... 352,162 17,554 228,462 11,287 111,313 25,374 270,094 25,477 319,001 29,179 Total Inventories...................................... 369,716 239,749 136,687 295,571 348,180 Assets held for sale................................. Prepaid expenses.................................... 15,260 12,302 14,578 27,316 16,217 16,971 Total current assets................................. 801,727 641,876 608,945 773,662 793,854 311,151 374,913 389,060 407,402 408,635 261,115 4,237 125,955 41,515 76,751 41,160 83,190 39,990 55,060 44,342 Total Investments.................................... 576,503 542,383 506,971 530,582 508,037 Property, plant & equipment..................... Less: Accumulated depreciation and depletion..................... 426,415 407,814 403,187 468,851 395,188 Investments Bahamas refinery affiliates....................... Charter Security Life & other affiliates................................................. Other....................................................... 152,343 140,977 124,409 122,225 92,889 Net property, plant & equipment............................................. 274,072 266,837 278,778 346,626 302,299 Net assets of discontinued operations............................................. Intangibles from acquisitions (net)........... Other assets............................................ 61,877 99,020 26,282 59,110 91,558 2,717 74,115 69,800 44,293 51,097 73,023 51,481 Total assets............................................. $1,813,199 $1,628,046 $1,541,326 $1,746,260 $1,728,694 Page 4 of 9 The Charter Company Exhibit 2 (cont.) Liabilities and Stockholders' Equity Current Liabilities: Notes payable.......................................... Current installment of long-term debt....... Accounts payable.................................... Payable to affiliates................................................... Accrued expenses.................................... Income taxes........................................... Total current liabilities.............................. Long-term debt excluding current installments............................... Long-term debt payable to unconsolidatd, wholly owned subsidiaries............ Subordinated debt, net of discount, excluding current installments................ Net liabilities of discontinued operations............................................. Deferred income taxes............................. Deferred credits and other........................ Stockholders' equity (a) Preferred stock ................................... (b) Common stock ................................... Additional paid-in-capital on common stock...................................................... Retained earnings.................................... Net unrealized gain on investment securities of unconsolidated subsidiaries, net of taxes............................. Total liabilities & stockholders' equity....... $144,000 28,317 419,967 39,143 $3,250 29,342 416,924 21,257 $50,500 17,192 309,275 - $76,563 21,402 348,312 - $858 23,363 374,387 - 54,579 14,749 700,755 48,261 21,625 540,659 54,939 27,217 459,123 71,747 17,433 535,457 74,499 28,208 501,315 111,134 133,086 251,425 404,631 416,087 94,000 91,000 - - - 189,261 154,200 81,673 81,316 84,412 20,554 32,504 50,864 16,068 52,242 43,820 50,704 27,377 19,793 41,728 36,828 129,312 16,587 114,787 21,570 117,608 21,592 117,917 21,592 125,372 20,166 35,635 429,298 53,721 448,924 67,233 447,555 67,202 470,476 57,268 449,629 3,295 1,789 593 499 (4,111) 614,127 640,791 654,581 677,686 648,324 1,813,199 1,628,046 1,541,326 1,746,260 1,728,694 Page 5 of 9 The Charter Company Exhibit 3 Working capital provided by operations Earnings from continuing operations.... Charges (credits) to earnings affecting working capital: Depreciation, depletion, and amortization.......................................... Gain on exchange of investment in St. Joe Paper Company.............................. Deferred income taxes and other............. Equity in net earnings of Charter Life and other affiliates................................ Equity in net losses of Bahamas refinery affiliates included in cost of sales........... Write-off of certain units in Bahamas refinery.................................................. Write-down of tanker............................... Total working capital provided by operations............................................. The Charter Company Schedules of Working Capital Provided by Operations Years Ended December 31 (In thousands) $50,382 $29,830 $55,946 $50,237 $367,726 37,939 36,074 32,511 35,085 28,851 (17,125) 7,850 (7,631) 4,254 1,928 4,843 (117,958) (43,402) (14,080) (661) (2,357) 12,511 18,542 27,548 16,775 10,376 49,428 7,772 - - - - $30,799 $33,413 $106,179 $103,364 $409,439 Page 6 of 9 The Charter Company Exhibit 4 THE CHARTER COMPANY Selected Notes of 1983 Financial Statements 1. Significant Accounting Policies and Other A. Basis of Financial Presentation. The accompanying consolidated financial statements include the accounts of The Charter Company and its majority-owned subsidiaries ("Charter") other than Charter Security Life Insurance Company (Louisiana) and subsidiaries ("Charter Security LIFE"), COFI Credit Corporation ("COFI") and First Charter Savings Bank ("First Charter") which are accounted for by the equity method. Charter's Bahamas refinery affiliates and other affiliated companies, all 31% to 50% owned, are also accounted for by the equity method. All significant intercompany accounts and transactions for Charter have been eliminated in consolidation. B. Inventories. Inventories are stated at the lower of cost or market. Certain petroleum inventories aggregating $115,242,000 at December 31, 1983 and $83,664,000 at December 31, 1982 were determined under the last-in, first-out method ("LIFO"). Such petroleum inventories, if stated at current costs, would have been $41,554,000 and $48,051,000 higher, respectively. If the first-in, first-out method ("FIFO") of inventory valuation had been used for such inventories, reported net earnings would have been lower by $6,497,000 ($a.28 primary and fully diluted earnings per share) for 1983., $6,015,000 ($.21 primary and fully diluted earnings per share) for 1982 and $12,750,000 ($.45 primary and fully diluted earnings per share) for 1981. The cost of the remaining petroleum and other inventories is determined under the FIFO method. Crude oil and product exchange balances are reflected in petroleum inventories. Certain petroleum inventories at December 31, 1983 were less than inventory levels at December 31, 1982 or the date of acquisition resulting in a liquidation of LIFO layers which were carried at lower costs. If such inventories had replaced at current costs, net earnings for 1983 would have been lower by approximately $12,803,000 ($.56 primary and fully diluted earnings per share). Certain petroleum inventories at December 31, 1981 were less than prior year levels resulting in a liquidation of prior years' LIFO layers which were carried at lower costs. If such inventories had been replaced at current costs, net earnings for 1981 would have been lower by approximately $15,686,000 ($.56 primary and fully diluted earnings per share). F. Change in Accounting Principle. Effective January 1, 1983, Charter changed its accounting method of expensing the cost of spare parts at the Houston refinery to inventorying the spare parts and changing the cost to operations as utilized. This change was made to improve the matching of costs of spare parts to the benefits derived from their usage and establish financial control over these items. Net earnings for the first quarter of 1983 have been restated by $5,463,000 to reflect the cumulative effect of the change on prior years. The effect of this change was not material to 1983 earnings from continuing operations. The pro forma and cumulative effects on net earnings of prior years is not determinable because the necessary data is unavailable. G. Miscellaneous Policies. Refining, marketing and other facilities are depreciated principally by the straight-line method over their estimated useful lives. During 1983, Charter revised the Page 7 of 9 The Charter Company estimated useful lives of certain property, plant and equipment. The effect of this change in accounting estimate was an increase in net earnings of $3,003,000 ($.13 primary and fully diluted earnings per share). During the fourth quarter of 1983, Charter renegotiated a contract and recorded a gain of $33,600,000. 5. Investment in Bahamas Refinery Affiliates Charter's investment in the Bahamas refinery affiliated includes three 50% owned joint ventures: Bahamas Oil Refining Company ("BORCO"), BORCO Desulfurization Company ("BODCO") and BORCO Marine Company ("MARCO"). These joint ventures receive fees from the partners for use of the refinery and related facilities. The operations of these joint ventures do not reflect the partners' purchases of crude oil, sales of refined products and processing or storage agreements with third parties. Charter's share of the net operating losses of these ventures was $12,511,000, $18,542,000 and $27,548,000, for 1983, 1982 and 1981, respectively, including depreciation and amortization related to the excess of the appraised value over the historical cost of the assets allocated to property, plant and equipment at the time of the acquisition. charter's share of the losses of these ventures is recorded as cost of sales and operating expenses in its consolidated statements of earnings because these joint ventures are part of Charter's crude oil refining system. In addition, BARCO and BODCO wrote-off certain units during 1983 since use of such units is not anticipated in the foreseeable future. Charter's share of the write-off plus the write-off of the related excess of the appraised value over the historical cost of these asses was $49,428,000. Page 8 of 9 The Charter Company Exhibit 5 The Charter Company Quarterly Earnings per Share, Cash Dividends, and Common Stock Price For the Fiscal Year 1983 and the First Two Quarters of 1984 First Quarter Fully diluted earnings per share: From continuing operations..................... Net earnings............................................ Common dividend per share.................... Market price: High Low 1983 Second Third Quarter Quarter Fourth Quarter 1984 First Second Quarter Quarter $(0.31) (0.05) 0.25 $0.51 0.43 0.25 $1.34 1.34 0.25 $0.23 0.23 0.25 $(1.49) (2.38) 0.25 $(2.84) (35.14) - 13.375 11.125 13.750 10.750 12.500 10.250 12.250 8.000 12.875 8.500 9.750 2.000 Page 9 of 9