S w 9B06B024 HIGH PERFORMANCE TIRE Dan Thompson prepared this case solely to provide material for class discussion. The author does not intend to illustrate either effective or ineffective handling of a managerial situation. The author may have disguised certain names and other identifying information to protect confidentiality. Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. This material is not covered under authorization from CanCopy or any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail cases@ivey.uwo.ca. Copyright 2006, Ivey Management Services Version: (A) 2006-07-25 High Performance Tire (HPT) Ltd. is a retail tire chain with a network of company-owned stores in the B.C. Interior. It was formed by Harry and Edna Wallace in 1952 and was passed on to their daughter Jane Wallace in the late 1960s. Jane Wallace maintained control of this family-owned business until 2001, at which time she transferred the responsibility for day-to-day management to her son William. By early 2004, HPT was having difficulties and Jane Wallace decided to become actively involved again in the company to turn things around. Her first action was to hire Jenny Chen, CA, CFA, CMC from the accounting firm of Dexter, Mathews & Jones to review current operations and make recommendations. WILLIAMS TENURE William Wallace had led a privileged and carefree life, and his mother did not feel that he would be able to operate the business successfully, but she had little choice if she wanted to keep the business under family control. Despite his MBA with double concentrations in marketing and finance from a major university, Jane Wallace did not feel that her son had the patience and general business acumen to operate such a sizeable business at this time. She was also fearful that he would recklessly try to expand the business and lose interest once things did not go exactly as planned. Upon taking over operations in late 2001, William Wallace immediately began to put a major expansion plan into effect that he had worked on as the graduating project in his MBA. This plan had two major focal points. One was to expand the number of retail tire outlets in smaller communities and the other was to diversify the products provided at each of the outlets to include higher margin automotive maintenance services including fluid changes, tune-ups, alignments, batteries and brakes. A number of tire chains in Canada had followed a similar strategy of diversification and were successful. In 2001, all the outlets were expanded to include bays for maintenance work as well as tire installation. Sales of these new services were poor over the next two years. To have their fluids changed, customers had to leave the vehicle and wait for a considerable period of time in the customer reception area. An Authorized for use only in the course FINA55142 at Sheridan College taught by Umar Minhas from 10/17/2022 to 12/16/2022. Use outside these parameters is a copyright violation. Page 2 9B06B024 appointment was also required. This was not as convenient as other lube stores where patrons did not need either an appointment or to get out of their vehicles and generally could have the work done in less than 20 minutes. For more complicated maintenance work, like tune-ups and alignments, HPTs mechanics had a reputation in the community of not being highly qualified. There had been a number of cases that received extensive coverage in the local press, where HPT mechanics had made mistakes that caused major damage to the vehicles they were working on. Instead of admitting they were at fault and keeping public relations damage to a minimum, HPT was taken to court a number of times and forced to pay the repair costs. In addition to its sales outlets in Kamloops, Kelowna, Penticton, Prince George and Vernon, in 2002/2003 additional stores were added in Revelstoke, Golden, Chase, Williams Lake and Salmon Arm. By early 2004, all outlets were underutilized. Canadian Tire, as well as local service stations with strong ties to the community, lowered their prices and improved their customer service and proved to be formidable competitors. Prior to 2001, HPT Ltd.s workforce was composed of a number of experienced tire professionals who had been with the company for years. When William Wallace took over operations, he decided to try to increase profitability by cutting wages and benefits. The result was that most of these professionals left and were replaced by younger, less experienced staff with much poorer customer service skills. The tire sales staff was taken off salary and put on straight commission as a means of increasing sales. The sales staff did become hungrier, but the more aggressive practices alienated many customers. In order to increase gross profits, HPT began buying more no-name tires from overseas suppliers. These sales generated a higher gross profit margin for the retailer initially and the customer did receive a lower price, but quality concerns due to shorter tread life and blowouts soon caused sales and margins to fall. A new accounting system was purchased in 2002 in order to better automate the general accounting, billing, inventory and payroll functions of the company. The low-cost vendor was selected to save cash to help fund the expansion. This vendor provided very poor software installation and training and then went bankrupt. HPTs clerical staff struggled with the new system and matters were made worse by high employee turnover due to low wages and William Wallaces disorganized management style and short fuse. A lot of overtime had been used to clear the backlog of clerical work, while customers, staff and suppliers were becoming alienated over delays and errors. In the first quarter of 2003, Jane Wallace suspended all dividend payments. William Wallace had been drawing too much from the company to fund the construction of a new home and to purchase a new luxury car. Authorized for use only in the course FINA55142 at Sheridan College taught by Umar Minhas from 10/17/2022 to 12/16/2022. Use outside these parameters is a copyright violation. Page 3 9B06B024 FINANCIAL STATEMENTS Income Statement1 For Year Ending December 31 2003 2002 2001 Sales 6,500,000 5,550,000 4,050,000 Cost of Goods Sold 3,965,000 3,385,500 2,430,000 Gross Profit 2,535,000 2,164,500 1,620,000 Depreciation 485,600 287,200 158,500 Other Operating Expenses 1,690,000 1,387,500 1,012,500 Earnings Before Interest and Taxes 359,400 489,800 449,000 Interest 331,956 160,125 50,645 Earnings Before Taxes 27,444 329,675 398,355 Income Taxes 10,978 131,870 159,342 Net Income 16,467 197,805 239,013 Balance Sheet For Year Ending December 31 2003 2002 2001 Cash 57,000 110,000 155,000 Accounts Receivable 95,000 59,000 45,000 Inventories 1,050,000 723,000 540,000 Prepaid Expenses 42,000 36,000 25,000 Total Current Assets 1,244,000 928,000 765,000 Property, Plant and Equipment 7,288,800 4,819,200 3,245,000 Less: Accumulative Depreciation 2,432,800 1,947,200 1,660,000 Net Property, Plant and Equipment 4,856,000 2,872,000 1,585,000 Total Assets 6,100,000 3,800,000 2,350,000 Accounts Payable 440,556 165,000 99,000 Line of Credit 570,638 353,000 267,435 Current Portion of Long-term Debt 325,346 162,000 41,461 Total Current Liabilities 1,336,540 680,000 407,895 Long-term Debt 3,253,460 1,620,000 414,605 Equity 1,510,000 1,500,000 1,527,500 Total Liabilities and Equity 6,100,000 3,800,000 2,350,000 FINANCIAL SITUATION HPT has a $600,000 line-of-credit with the Toronto Dominion Bank. The limit could be extended, but only if the bank has sufficient loanable funds and the company is in good financial condition. The company must maintain a current ratio of 1.5, a times interest earned ratio of 5.0, and can only borrow up to 50 per cent of the value of its accounts receivable and inventory. The company negotiates separate term 1 All funds in Cdn$ unless otherwise noted. Authorized for use only in the course FINA55142 at Sheridan College taught by Umar Minhas from 10/17/2022 to 12/16/2022. Use outside these parameters is a copyright violation. Page 4 9B06B024 loans and mortgages to finance its capital purchases. Under Jane Wallaces leadership, HPT had an excellent relationship with its bank, but Williams poor management and interpersonal skills had put this relationship in jeopardy. Retail sales were paid for in cash or by credit card so there were no accounts receivable. Sales to businesses made up about 40 per cent of sales and were on terms 2/10, net 30 with negligible bad debts. HPT bought its tires from the various manufacturers on terms 2/15, net 30, which was the norm in the industry. Interest was charged on overdue accounts at 12 per cent per annum and many retailers who got too far in arrears were put on a cash-and-carry basis. A slowdown was forecasted in the local economy in 2004 due to the forest fires that took place in the summer of 2003 and the collapse of the Canadian beef industry caused by the discovery of mad cow disease in neighbouring Alberta. The following industry average ratios (based on year-end figures) were available for companies that sold both tires and automotive maintenance services: Current Ratio 1.90 Cash Ratio .51 Inventory Turnover in Days 60 days Accounts Receivable Turnover in Days 30 days Accounts Payable Turnover in Days 15 days Fixed Assets Turnover 3.19 Total Assets Turnover 2.00 Debt Ratio 30.00% Times Interest Earned 14.63 Cost of Borrowing 6.50% Gross Profit Margin 42.00% Operating Profit Margin 12.00% Net Profit Margin 6.71% Return on Assets 13.42% Return on Equity 19.17% HPTs marginal tax rate was 40 per cent. TURNAROUND Jenny Chen had just returned to her downtown office at Dexter, Mathews & Jones from a meeting with Jane Wallace in February, 2004 Chen was feeling quite sad. Jane Wallace had worked very hard the last 35 years managing the family business as a legacy to her beloved parents who had passed away in a car accident prior to her taking control in the late 1960s. At 64, she was in need of a rest after a long career building HPT, but her son seemed to have mismanaged the business terribly during his short tenure and she now had to take back control before things got even worse. Jane Wallace asked Chen to prepare a comprehensive review of HPTs operations with a focus on why things had deteriorated so much and what she might do to improve operations. Knowing, quite reasonably, that she could not continue running HPT indefinitely, Jane Wallace also asked Chen to make further recommendations on the future management of the company. Authorized for use only in the course FINA55142 at Sheridan College taught by Umar Minhas from 10/17/2022 to 12/16/2022. Use outside these parameters is a copyright violation. calculate: Profitability Use financial ratios & trend analysis in describing the profitability of HPT across time. Indicate whether HPT is doing better or worse since William Wallace took over. Liquidity Use financial ratios & trend analysis the liquidity of HPT. Try and compare with the industry average. Indicate whether HPT is doing better or worse than the industry. You can also compare HPT across time (Horizontal or trend analysis) Asset Management Use ratio analysis in describing how the business assets are managed. Try and compare with the industry average. Indicate whether HPT is doing better or worse than the industry Long Term Debt Use ratio analysis & trends in describing HPTs debt situation. Compare with the industry average. Indicate whether HPT is doing better or worse than the industry