Power Green Industries In early January, 2022, 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, PGIs board of director thought it prudent to retain an independent consultant to review the companys performance. Despite its rapid sales growth, the board was worried about PGIs 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 companys 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 2008 by Dr. Maggie 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 bio gas segments of the alternative energy industry were not cost effective in the long term. McGruders 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 a number of equipment producers with her most recent position being with Stanley Tools. Each contributed $200,000 for a 25 percent 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 a number of 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 percent. In 2014, 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 2008 to 2010 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 2011, the products and manufacturing facilities were in place. Despite initial hesitancy, a number of key distributors were recruited. In Canada, both Canadian Tire and Home Hardware agreed to carry PGIs 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 Page 1 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 a number of regional farmer cooperatives also signed distribution agreements. Sales of PGIs products increased dramatically from 2012 to 2019. Farmers welcomed them as a way 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 users 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. Covid As was the case for the entire economy, covid significantly changed the profitability and financial growth for PGI. Sales plummeted in 2020, and although there was significant growth in 2021, the company has still a way to go before returning to pre-covid sales and profitability. 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 Sales Cost of Goods Sold Gross Profit Operating Costs Selling and Distribution Research & Development Administration Depreciation & Amortization Operating Profit Interest Earnings Before Taxes Taxes Net Income 2017 $ 697,587,120 426,250,000 271,337,120 73,084,587 67,526,433 23,887,576 48,556,244 58,282,279 9,693,523 48,588,757 17,006,065 31,582,692 2018 $ 828,700,200 513,890,600 314,809,600 84,915,252 81,378,360 31,690,334 51,147,315 65,678,339 9,438,430 56,239,909 19,683,968 36,555,941 2019 $ 1,272,696,252 793,110,100 479,586,152 127,517,801 118,742,560 45,307,987 71,973,162 116,044,642 15,418,238 100,626,404 35,219,241 $ 65,407,163 2020 $ 482,438,964 303,346,500 179,092,464 76,611,307 87,562,672 37,630,239 78,620,508 (101,332,263) 18,177,135 (119,509,397) (41,828,289) ($ 77,681,108) 2021 $ 640,826,380 408,030,700 232,795,680 79,270,223 85,934,818 30,118,840 81,577,854 (44,106,055) 27,944,766 (72,050,820) (25,217,787) ($ 46,833,033) $ $ Page 2 2017 $ 75,340,000 31,650,000 96,670,000 46,789,180 145,300,530 395,749,710 445,230,840 50,340,030 495,570,870 891,320,580 Exhibit 2 Balance Sheets 2018 2019 $ 95,630,000 65,340,000 245,320,600 86,650,675 271,530,200 764,471,475 712,401,600 87,300,200 799,701,800 1,564,173,275 2020 2021 Cash Accounts receivable Parts Inventory WIP Inventory Finished Goods Inventory Total Current Assets Land, plant, and equipment, net Intangibles Total Non-Current Assets Total Assets Accounts payable Line of credit Current portion of LT debt Total current liabilities Long-term debt Total Liabilities Shareholders' equity Total Liabilities and Equity Wind turbines Unit price Unit cost Quantity Water turbines Unit price Unit cost Quantity Solar panels Unit price Unit cost Quantity Financial Benchmarks $ $ $ $ 76,800,300 45,320,000 150,320,000 65,354,460 210,360,300 548,155,060 489,300,500 79,003,000 568,303,500 1,116,458,560 $ 95,620,000 $ 506,000 23,403,000 $ 119,529,000 393,306,139 512,835,139 603,623,421 1,116,458,560 Exhibit 3 Sales Analysis $ 55,320,100 17,800,300 490,350,200 93,050,700 264,930,000 921,451,300 786,261,000 87,300,200 873,561,200 1,795,012,500 $ 85,259,400 $ 613,000 68,775,500 $ 154,647,900 1,049,015,125 1,203,663,025 591,349,475 1,795,012,500 2021 $10,010 $6,210 8,220 $5,320 $4,500 1,850 $8,610 $5,350 65,170 $ 15,430,300 19,300,000 275,931,600 74,500,300 158,409,800 543,572,000 819,120,400 87,300,200 906,420,600 1,449,992,600 $ 98,361,100 $ 674,000 104,901,500 $ 203,936,600 701,539,558 905,476,158 544,516,442 1,449,992,600 $ $ $ $ $ $ $ $ $ $ $ 68,700,400 460,000 21,062,700 $ 90,223,100 234,030,000 324,253,100 567,067,480 $ 891,320,580 2017 $9,100 $5,750 15,800 $5,320 $3,900 2,500 $8,490 $5,010 65,000 $ $ $ $ 167,500,300 $ 557,000 39,330,600 207,387,900 687,754,792 895,142,692 669,030,583 1,564,173,275 $ $ $ $ 2018 2019 $9,100 $10,010 $5,880 $5,990 21,170 19,480 $5,320 $5,320 $4,100 $4,250 3,100 4,560 $8,520 $8,550 $5,070 $5,230 74,300 125,630 2020 $10,010 $6,100 6,230 $5,320 $4,350 1,410 $8,580 $5,290 49,000 Exhibit 4 contains industry average information secured from Statistics Canada. Exhibit 4 Industry Averages Financial Ratios Current Ratio Quick Ratio Cash Ratio Parts inventory days (avg) Industry Averages 2021 3.31x 1.90x 0.75x 30.85 days Page 3 WIP inventory days (avg) FG inventory days (avg) Accounts receivable days (avg) Accounts payable days (avg) Cash conversion cycle Fixed assets turnover Total assets turnover Debt ratio Long-term debt total capitalization Times interest earned Cash flow coverage Gross profit margin Operating profit margin Net profit margin Return on assets Return on equity 14.57 days 33.13 days 37.87 days 23.96 days 92.46 days 2.35x 1.33x 43.9% 36.2% 6.69x 3.35x 40.66% 9.90% 5.94% 7.90% 14.07% Vertical Analysis (%) Industry Avg. Income Statement 2021 Sales Cost of sales Gross profit Operating costs Selling and distribution Research and development Administration Depreciation Operating profit Interest Earnings before taxes Taxes Net income 100.00% 59.34% 40.66% 12.46% 8.02% 4.83% 5.45% 9.90% 1.48% 8.42% 2.48% 5.94% Vertical Analysis Industry Avg. Balance Sheet 2021 Cash Accounts receivable Parts inventory WIP inventory Finished goods inventory Total current assets Land, plant , and equipment, net Other assets Total assets Accounts payable Current portion of long-term debt Total current liabilities Long-term debt Shareholders' equity Total liabilities and equities 8.96% 13.80% 6.67% 3.15% 7.16% 39.74% 53.70% 6.56% 100.00% 5.18% 6.81% 11.99% 31.89% 56.12% 100.00% Page 4 Operations In order to expand sales, PGI has kept its prices constant over the last five years for water turbines. Wind turbine prices were only increased in 2017, and only solar turbines had annual price increases. However, competitors have increased prices annually. It also offers its distributors terms of 2/10, net 30, which vary from the industry standard of net 30. Most distributors took advantage of these terms over the past five years. 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 percent 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 common place 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 2019. A number of existing buildings were considered, but a new facility in an expensive area of Toronto was constructed to increase the profile of the company. PGI has not paid any dividends to date. Debt had already increased significantly due to growth and the new facilities, and was then compounded due to the collapse of revenues. 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 is considering going to the market to raise more equity through a secondary offering. To avoid losing control, the three founding shareholders have 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 $1,500,000 line of credit with Western Canadian Bank to finance seasonal variations in net working capital. The loan must be 200 percent secured by inventory and accounts receivable. Also, to comply with the different loan agreements, the following ratios must be maintained: The current ratio must be kept above 2.5; the long-term debt to total capitalization, measured as long-term debt / (long-term debt + equity), must remain below 50 percent; and the cash flow coverage ratio, measured as EBITDA / above 2.0