D’Leon Inc.

, Part I

Donna Jamison, a 2007 graduate of the University of Florida with 4 years of banking experience, was recently brought in as
assistant to the chairperson of the board of D’Leon Inc., a small food producer that operates in north Florida and whose
specialty is high-quality pecan and other nut products sold in the snack foods market. D’Leon’s president, Al Watkins,
decided in 2011 to undertake a major expansion and to “go national” in competition with Frito-Lay, Eagle, and other major
snack foods companies. Watkins believed that D’Leon’s products were of higher quality than the competition’s; that this
quality differential would enable it to charge a premium price; and that the end result would be greatly increased sales,
profits, and stock price.
The company doubled its plant capacity, opened new sales offices outside its home territory, and launched an
expensive advertising campaign. D’Leon’s results were not satisfactory, to put it mildly. Its board of directors, which
consisted of its president, vice president, and major stockholders (who were all local businesspeople), was most upset
when directors learned how the expansion was going. Unhappy suppliers were being paid late; and the bank was
complaining about the deteriorating situation, threatening to cut off credit. As a result, Watkins was informed that
changes would have to be made—and quickly; otherwise, he would be fired. Also, at the board’s insistence, Donna
Jamison was brought in and given the job of assistant to Fred Campo, a retired banker who was D’Leon’s chairperson and
largest stockholder. Campo agreed to give up a few of his golfing days and help nurse the company back to health, with
Jamison’s help.
Jamison began by gathering the financial statements and other data given in Tables IC 3.1, IC 3.2, IC 3.3, and IC 3.4.
Assume that you are Jamison’s assistant. You must help her answer the following questions for Campo :

Table IC 3.1. Balance Sheets

2012 2011
Assets
Cash $ 7,282 $ 57,600
Accounts receivable 632,160 351,200
Inventories _____1,287,360 715,200
Total current assets $ 1,926,802 $ 1,124,000
Gross fixed assets 1,202,950 491,000
Less accumulated depreciation 263,160 146,200
Net fixed assets $ 939,790 $ 344,800
Total assets $ 2,866,592 $ 1,468,800
Liabilities and Equity
Accounts payable $ 524,160 $ 145,600
Notes payable 636,808 200,000
Accruals 489,600 136,000
Total current liabilities $ 1,650,568 $ 481,600
Long-term debt 723,432 323,432
Common stock (100,000 shares) 460,000 460,000
Retained earnings 32,592 203,768
Total equity $ 492,592 $ 663,768
Total liabilities and equity $ 2,866,592 $ 1,468,800

Table IC 3.2. Income Statements

2012 2011
Sales $ 6,034,000 $ 3,432,000
Cost of goods sold 5,528,000 2,864,000
Other expenses 519,988 358,672
Total operating costs excluding
depreciation and amortization $ 6,047,988 $ 3,222,672
Depreciation and amortization 116,960 18,900
EBIT ($ 130,948) $ 190,428
Interest expense 136,012 43,828
EBT ($ 266,960) $ 146,600
Taxes (40%) (106,784)a 58,640
Net income ($ 160,176) $ 87,960

EPS ($ 1.602) $ 0.880

DPS $ 0.110 $ 0.220
Book value per share $ 4.926 $ 6.638
Stock price $ 2.25 $ 8.50
Shares outstanding 100,000 100,000
Tax rate 40.00% 40.00%
Lease payments $ 40,000 $ 40,000
Sinking fund payments 0 0

TABLE IC 3.3. Statement of Stockholders’ Equity, 2012

Total
Common Stock Retained Stockholders’
Shares Amount Earnings Equity
Balances, 12/31/11 100,000 $460,000 $203,768 $663,768
2012 Net Income (160,176)
Cash Dividends (11,000)
Addition (Subtraction)
to Retained Earnings (171,176)
Balances, 12/31/12 100,000 $460,000 $ 32,592 $492,592
Table IC 3.4. Statement of Cash Flows, 2012

Operating Activities
Net income ($160,176)
Depreciation and amortization 116,960
Increase in accounts payable 378,560
Increase in accruals 353,600
Increase in accounts receivable (280,960)
Increase in inventories (572,160)
Net cash provided by operating activities ($164,176)

Long-Term Investing Activities

Additions to property, plant, and equipment ($711,950)
Net cash used in investing activities ($711,950)

Financing Activities
Increase in notes payable $436,808
Increase in long-term debt 400,000
Payment of cash dividends (11,000)
Net cash provided by financing activities $825,808

Summary
Net decrease in cash ($ 50,318)
Cash at beginning of year 57,600
Cash at end of year $ 7,282

A. What effect did the expansion have on sales, after-tax operating income, net operating income.

b. D’Leon purchases materials on 30-day terms, meaning that it is supposed to pay for purchases within 30
days of receipt. Judging from its 2012 balance sheet, do you think that D’Leon pays suppliers on time?
Explain, including what problems might occur if suppliers are not paid in a timely manner.

c. D’Leon spends money for labor, materials, and fixed assets (depreciation) to make products—and spends
still more money to sell those products. Then the firm makes sales that result in receivables, which
eventually result in cash inflows. Does it appear that D’Leon’s sales price exceeds its costs per unit sold?
How does this affect the cash balance?

d. Suppose D’Leon’s sales manager told the sales staff to start offering 60-day credit terms rather than the
30-day terms now being offered. D’Leon’s competitors react by offering similar terms, so sales remain
constant. What effect would this have on the cash account? How would the cash account be affected if
sales doubled as a result of the credit policy change?

e. Can you imagine a situation in which the sales price exceeds the cost of producing and selling a unit of
output, yet a dramatic increase in sales volume causes the cash balance to decline? Explain.
f. Did D’Leon finance its expansion program with internally generated funds (additions to retained earnings
plus depreciation) or with external capital? How does the choice of financing affect the company’s
financial strength?

g. If D’Leon starts depreciating fixed assets over 7 years rather than

10 years, would that affect (1) the physical stock of assets, (2) the balance sheet account for fixed assets,
(3) the company’s reported net income, and (4) the company’s cash position? Assume that the same
depreciation method is used for stockholder reporting and for tax calculations and that the accounting
change has no effect on assets’ physical lives.

h. Explain how earnings per share, dividends per share, and book value per share are calculated and what
they mean. Why does the market price per share not equal the book value per share?

D’Leon Inc., Part II : Analysis of Financial statements

Part I of this case, discussed the situation of D’Leon Inc., a regional snack foods producer, after an expansion program.
D’Leon had increased plant capacity and undertaken a major marketing campaign in an attempt to “go national.” Thus
far, sales have not been up to the forecasted level, costs have been higher than were projected, and a large loss
occurred in 2012 rather than the expected profit. As a result, its managers, directors, and investors are concerned about
the firm’s survival.
Donna Jamison was brought in as assistant to Fred Campo, D’Leon’s chairman, who had the task of getting the
company back into a sound financial position. D’Leon’s 2011 and 2012 balance sheets and income statements, together
with projections for 2013, are given in Tables IC 4.1 and IC 4.2. In addition, Table IC 4.3 gives the company’s 2011 and
2012 financial ratios, together with industry average data. The 2013 projected financial statement data represent
Jamison’s and Campo’s best guess for 2013 results, assuming that some new financing is arranged to get the company
“over the hump.”
Jamison examined monthly data for 2012 (not given in the case), and she detected an improving pattern during
the year. Monthly sales were rising, costs were falling, and large losses in the early months had turned to a small profit
by December. Thus, the annual data look somewhat worse than final monthly data. Also, it appears to be taking longer
for the advertising program to get the message out, for the new sales offices to generate sales, and for the new
manufacturing facilities to operate efficiently. In other words, the lags between spending money and deriving benefits
were longer than D’Leon’s managers had anticipated. For these reasons, Jamison and Campo see hope for the company
—provided it can survive in the short run.
 Jamison must prepare an analysis of where the company is now, what it must do to regain its financial health, and
what actions should be taken. Your assignment is to help her answer the following questions. Provide clear
explanations, not yes or no answers.

Table IC 4.1. Balance Sheets

2013E 2012 2011

Assets
Cash $ 85,632 $ 7,282 $ 57,600
Accounts receivable 878,000 632,160 351,200
Inventories 1,716,480 1,287,360 715,200
Total current assets $ 2,680,112 $ 1,926,802 $ 1,124,000
Gross fixed assets 1,197,160 1,202,950 491,000
Less accumulated depreciation 380,120 263,160 146,200
Net fixed assets $ 817,040 $ 939,790 $ 344,800
Total assets $ 3,497,152 $ 2,866,592 $ 1,468,800

Liabilities and Equity

Accounts payable $ 436,800 $ 524,160 $ 145,600
Notes payable 300,000 636,808 200,000
Accruals 408,000 489,600 136,000
Total current liabilities $ 1,144,800 $ 1,650,568 $ 481,600
Long-term debt 400,000 723,432 323,432
Common stock 1,721,176 460,000 460,000
Retained earnings 231,176 32,592 203,768
Total equity $ 1,952,352 $ 492,592 $ 663,768
Total liabilities and equity $ 3,497,152 $ 2,866,592 $ 1,468,800

Note: “E” indicates estimated. The 2013 data are forecasts.

 Table IC 4.2. Income Statements

2013E 2012 2011

Sales $ 7,035,600 $ 6,034,000 $ 3,432,000
Cost of goods sold 5,875,992 5,528,000 2,864,000
Other expenses 550,000 519,988 358,672
Total operating costs
excluding deprec. & amort. $ 6,425,992 $ 6,047,988 $ 3,222,672
EBITDA $ 609,608 ($ 13,988) $ 209,328
Deprec. & amort. 116,960 116,960 18,900
EBIT $ 492,648 ($ 130,948) $ 190,428
Interest expense 70,008 136,012 43,828
EBT $ 422,640 ($ 266,960) $ 146,600
Taxes (40%) 169,056 (106,784)a 58,640
Net income $ 253,584 ($ 160,176) $ 87,960

EPS $ 1.014 ($ 1.602) $ 0.880

DPS $ 0.220 $ 0.110 $ 0.220
Book value per share $ 7.809 $ 4.926 $ 6.638
Stock price $ 12.17 $ 2.25 $ 8.50
Shares outstanding 250,000 100,000 100,000
Tax rate 40.00% 40.00% 40.00%
Lease payments 40,000 40,000 40,000

Note: “E” indicates estimated. The 2013 data are forecasts.

a
The firm had sufficient taxable income in 2010 and 2011 to obtain its full tax refund in 2012.
 Table IC 4.3. Ratio Analysis

Industry
2013E 2012 2011 Average
Current 1.2 2.3 2.7
Quick 0.4 0.8 1.0
Inventory turnover 4.7 4.8 6.1
Days sales outstanding (DSO)a 38.2 37.4 32.0
Fixed assets turnover 6.4 10.0 7.0
Total assets turnover 2.1 2.3 2.6
Debt-to-assets ratio 82.8% 54.8% 50.0%
TIE (Interest Coverage ) -1.0 4.3 6.2
Operating margin -2.2% 5.6% 7.3%
Profit margin -2.7% 2.6% 3.5%

Basic earning power -4.6% 13.0% 19.1%

ROA -5.6% 6.0% 9.1%
ROE -32.5% 13.3% 18.2%
Price/earnings -1.4 9.7 14.2
Market/book 0.5 1.3 2.4
Book value per share $4.93 $6.64 n.a.

Note: “E” indicates estimated. The 2013 data are forecasts.

a
Calculation is based on a 365-day year.

(i) Calculate all the ratios as indicated in IC 4.3 for the year 2013(E) and comment on the same in comparison with
2011,2012 and industry average ratios with respect to liquidity,Profitability,Turnover,solvency and capital market
ratios. What are the firm’s major strengths and weaknesses?

j. Does it appear that inventories could be adjusted? If so, how should that adjustment affect D’Leon’s profitability and
stock price?