Power Green Industries

In early January 2017, William Wyler, CPA, a senior manager at Myers Norris Penny LLP in Regina, Saskatchewan, was assigned the task of reviewing the financial performance of Power Green Industries (PGI) Ltd., a Canadian-based manufacturer of alternative electrical generating equipment.Before proceeding with the introduction of a revolutionary new product, PGI's board of director thought it prudent to retain an independent consultant to review the company's performance.Despite its rapid sales growth, the board was worried about PGI's financial ability to execute this expansion.

Having taken two years of engineering before changing to accounting at university, Wyler feels he has the technical knowledge to understand the company's products, which will aid him in analyzing its financial performance.If this review goes smoothly, Wyler believes he will finally make partner after 10 years at the firm.

Company Formation

PGI was formed in 2005 by Dr. Maggi McGruder, P.Eng. who had taken a buyout from Natural Resources Canada, a department of the federal government of Canada, after becoming frustrated with the slow rate of implementation of her many ideas.McGruder completed her PhD in electrical engineering in 1997 at the University of Manitoba where her dissertation dealt with home and farm-based energy alternatives such as wind turbines, water turbines, solar panels, geothermal, and biogas.In the new start-up, she decided to focus on wind and water turbines and solar panels because of her background in electrical engineering.Also, in her opinion, the geothermal and biogas segments of the alternative energy industry were not cost effective in the long term.

McGruder's knowledge of manufacturing and marketing was limited so she recruited two partners, Matthew Wiggins, P.Eng. and Nancy Cranston, CSP.Wiggins had over 30 years of experience supervising manufacturing facilities for companies such as Caterpillar, General Electric, and Nortel while Cranston had been a vice-president of marketing and sales for several equipment producers with her most recent position being with Stanley Tools.Each contributed CAD200,000 for a 25.0% share of the company and the remainder of the seed capital was provided by Wilson McIvor, a retired Fortune 500 CEO, who had been an "angel" to several other tech start-ups in Canada.After three rounds of funding from CanDo Venture Capital, each of the three founders' holdings had been reduced to 15.0%.In 2007, the angel and venture capitalists took PGI public in an initial public offering in order to exit the investment.The partners bought enough of the shares to maintain control.

Company Expansion

The period from 2005 to 2007 was a troublesome one for PGI.Products took much longer than planned to develop and production processes where difficult to master.Venture capital financing was also difficult to acquire, and the owners had to relinquish a much larger portion of the business than hoped to secure the needed funding.By 2008, the products and manufacturing facilities were in place.Despite initial hesitancy, several key distributors were recruited.In Canada, both Canadian Tire and Home Hardware agreed to carry PGI's products.Canadian Tire also featured them in one of their advertising campaigns where they stressed their new focus on environmentally friendly products.The Co-op, a farmer cooperative organization and major agricultural supply chain, agreed to sell the products and allowed PGI to promote them at all their membership meetings.In the U.S., Eagle Hardware and several regional farmer cooperatives also signed distribution agreements.

Sales of PGI's products increased dramatically from 2008 to 2016.Farmers welcomed them to reduce costs in a competitive industry and to avoid frequent power outages that can be problematic especially for dairy and poultry producers.People living in remote areas found them to be a cheaper alternative to burning fossil fuels, while environmentally conscious consumers felt they greatly reduced their ecological footprint.

New Product Introduction

To expand its product line further, PGI is currently developing an advanced power management system.This includes high-capacity batteries that store electricity to balance differences in generation and consumption as well as a monitoring system that automatically resells power to the local grid when user's needs are met, and prices offered by the local public utility are at their highest.The monitoring system also detects faulty storage batteries so they can be quickly replaced.PGI will produce its own batteries using technology licensed from a well-known research firm, but the remainder of this new system is being developed in-house and is considered "leading-edge" by the industry.

Financial Data

PGI provided Wyler with financial statements for the last five years, which are contained in Exhibit 1 and 2.A detailed breakdown of unit prices and costs and sales quantities for the last five years was also provided in Exhibit 3.

Exhibit 1

Income Statements (CAD)

2012

2013

2014

2015

2016

Sales

711,100,000

850,762,000

1,625,324,200

2,211,360,600

2,651,882,800

Cost of sales

421,650,000

516,212,000

1,021,419,200

1,468,340,150

1,791,102,960

Gross profit

289,450,000

334,550,000

603,905,000

743,020,450

860,779,840

Operating costs

Selling and distribution

74,500,300

85,984,000

200,450,300

231,530,000

267,300,200

Research and development

45,890,340

55,689,500

101,230,000

185,640,000

239,560,000

Administration

24,350,300

32,534,000

95,608,890

124,890,000

137,450,300

Amortization

49,557,087

56,830,350

141,468,842

142,920,000

152,885,800

Operating profit

95,151,973

103,512,150

65,146,968

58,040,450

63,583,540

Interest

14,189,065

17,386,710

46,684,825

51,226,136

56,015,189

Earnings before taxes

80,962,908

86,125,440

18,462,143

6,814,314

7,568,351

Taxes

28,337,018

30,143,904

6,461,750

2,385,010

2,648,923

Net income

52,625,890

55,981,536

12,000,393

4,429,304

4,919,428

Exhibit 2

Balance Sheets (CAD)

2012

2013

2014

2015

2016

Cash

75,340,000

76,800,300

95,630,000

55,320,100

15,430,300

Accounts receivable

31,650,000

45,320,000

65,340,000

75,800,300

95,300,000

Parts inventory

96,670,000

150,320,000

245,320,600

339,760,200

423,340,000

WIP inventory

46,789,180

65,354,460

86,650,675

124,532,030

145,673,800

Finished goods inventory

145,300,530

210,360,300

271,530,200

314,580,400

389,640,200

Total current assets

395,749,710

548,155,060

764,471,475

909,993,030

1,069,384,300

Land, plant, and equipment, net

445,230,840

489,300,500

1,317,388,220

1,318,350,000

1,402,870,000

Intangibles

50,340,030

79,003,000

97,300,200

110,850,000

125,988,000

Total assets

891,320,580

1,116,458,560

2,179,159,895

2,339,193,030

2,598,242,300

Accounts payable

68,700,400

95,620,000

167,500,300

240,650,430

320,640,430

Current portion of long-term debt

23,453,000

26,790,000

69,575,000

73,453,020

79,567,030

Total current liabilities

92,153,400

122,410,000

237,075,300

314,103,450

400,207,460

Long-term debt

234,530,000

267,900,000

695,750,000

734,530,200

795,670,300

Shareholders' equity

564,637,180

726,148,560

1,246,334,595

1,290,559,380

1,402,364,540

Total liabilities and equities

891,320,580

1,116,458,560

2,179,159,895

2,339,193,030

2,598,242,300

Exhibit 3

Sales Analysis (CAD)

2012

2013

2014

2015

2016

Wind turbines

Unit price

9,500

9,500

9,500

9,500

9,500

Unit cost

5,750

5,932

6,010

6,230

6,500

Quantity

15,000

21,000

55,560

62,500

85,600

Water turbines

Unit price

5,400

5,400

5,400

5,400

5,400

Unit cost

3,900

4,100

4,200

4,350

4,450

Quantity

2,500

3,100

4,560

6,509

7,848

Solar panels

Unit price

8,540

8,540

8,540

8,540

8,540

Unit cost

5,010

5,100

5,320

5,670

5,704

Quantity

65,000

74,300

125,630

185,300

210,340

Financial Benchmarks

Exhibit 4 contains industry average information secured from Statistics Canada.

Exhibit 4

Industry Averages

Financial Ratios

Industry Averages 2016

Current ratio

4.90x

Cash ratio

.11x

Parts inventory turnover in days

33.71 days

WIP inventory turnover in days

15.93 days

FG inventory turnover in days

51.98 days

Accounts receivable turnover in days

30.44 days

Accounts payable turnover in days

19.13 days

Cash conversion cycle

112.93 days

Fixed assets turnover

2.42x

Total assets turnover

1.22x

Debt ratio

32%

Long-term debt total capitalization

29%

Times interest earned

9.47x

Cash flow coverage

2.66x

Gross profit margin

40.66%

Operating profit margin

14.04%

Net profit margin

8.16%

Return on assets

6.46%

Return on equity

14.51%

Vertical Analysis (%)

Income Statement 2016

Sales

100.00

Cost of sales

59.34

Gross profit

40.66

Operating costs

Selling and distribution

9.32

Research and development

7.02

Administration

4.83

Depreciation

5.45

Operating profit

14.04

Interest

1.48

Earnings before taxes

12.56

Taxes

4.40

Net income

8.16

Vertical Analysis (%)

Balance Sheet 2016

Cash

10.95

Accounts receivable

10.15

Parts inventory

6.67

WIP inventory

3.15

Finished goods inventory

10.28

Total current assets

41.21

Land, plant , and equipment, net

50.31

Other assets

8.48

Total assets

100.00

Accounts payable

3.78

Current portion of long-term debt

4.62

Total current liabilities

8.41

Long-term debt

23.12

Shareholders' equity

68.47

Total liabilities and equities

100.00

Operations

In order to expand sales, PGI has kept its prices constant over the last five years despite increases by competitors.It also offers its distributors terms of 2/15, net 30, which vary from the industry standard of net 30.

PGI designs and assembles its products in Canada but sources its components globally.As a precautionary measure, to guard against supply interruptions caused by strikes, material shortages, and transportation delays, it stockpiles many of its key parts.Its accounts payable relate primarily to inventory purchases.Industry standard credit terms are 3/15, net 60 and most suppliers charge interest of 10.0% per annum on any overdue accounts.

In order to remain competitive with low-wage countries, PGI invested heavily in factory automation, but has had difficulties with many of the complex systems.Breakdowns and software "bugs" are commonplace as most of the equipment was bought from a low-cost supplier, which has since gone bankrupt.Low educational standards also made training difficult and lowered production efficiency.It was thought automation would allow the company to reduce finished goods inventory though just-in-time production, but the frequent breakdowns made it necessary to carry more stock.

To accommodate company growth, PGI built a new corporate headquarters, R&D facility and distribution centre in 20014.Several existing buildings were considered, but a new facility in an expensive area of Toronto was constructed to increase the profile of the company.

Retained earnings were insufficient to fund PGI' rapid growth, so large amounts of capital had to be raised externally - the company has yet to pay a dividend.Terms loans and mortgages were negotiated with five different banks to diversify its funding sources.PGI is listed on the Toronto and New York Stock Exchanges and has gone to the market in each of the past five years to sell equity.To avoid losing control, the three founding shareholders agreed to issue only non-voting common shares but is appears the market has lost its appetite for this type of security.PGI maintains a CAD 1,500,000 line of credit with Western Canadian Bank to finance seasonal variations in net working capital.The loan must be 200.0% secured by inventory and accounts receivable.Also, to comply with the different loan agreements, the current ratio must be kept above 2.5, the long-term debt to total capitalization below 30.0%, and the cash flow coverage ratio above 2.0.

1.Prepare a following financial exhibits for 2013 through 2016:

Ratio table

Vertical analysis of income statements and balance sheets

Horizontal analysis (index numbers) of income statements and balance sheets

Cash flow statements

5-way analysis of ROE

2.Assuming the role of William Wyler, CPA, prepare a 2-page memorandum that analyzes the financial condition of PGI and makes recommendations relating to the company's financial performance and proposed new product introduction.The memo should be divided into sections describing liquidity, asset management, long-term debt paying ability, profitability, and recommendations.The memo should be single spaced and use the 12-point Calibri font with 0.7-inchfi margins.

Ratio Tables

2013

2014

2015

2016

Industry Average

Liquidity

Current ratio

Cash ratio

Asset Management

Parts inventory turnover in days

Work-in-progress turnover in days

Finished goods turnover in days

Accounts receivable turnover in days

Accounts payable turnover in days

Cash conversion cycle

Fixed assets turnover

Total asset turnover

Long-term Debt Paying Ability

Debt ratio

Long-term debt to total capitalization

Times interest earned

Cash flow coverage

Profitability

Gross margin

Operating profit margin

Net profit margin

ROA

ROE

Analysis of ROE - 5-Part

EBIT/Sales

EBT/EBIT

NI/EBT

Total Asset Turnover

Debt Ratio

ROE

2013

2014

2015

2016

Evaluation Form

Total:_________ / 100

Letter Grade:_________

Accuracy of Financial Data:25%

Ratio table

/10

Vertical/horizontal analysis

/5

Cash flow statements

/5

5-part analysis of ROE

/5

Thoroughness of Analysis:50%

Liquidity

/8

Asset management

/14

Long-term debt paying ability

/6

Profitability

/12

Recommendation

/10

Layout and Writing Quality:25%

Memo layout

/5

Grammatical and spelling errors

/10

Writing style

/10

Comments

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