Padgett Paper

Case Solution Outline

-Summary

-Company

-Market

-Product

-Projections

-Options

-Current Capital Structure

-Proposed Capital Structure

-Review

Summary

Objective: To find a mutually acceptable debt structure that will

minimize lender risk while increasing company value.

Constraints: 1) realistic cash flow projections, 2) Bank safety levels

Situation for each Business Group

Bank: Over extended and is in a bad situation. Lending exceeds reasonable levels and is not collateralized or subject to convenants.

A $8 million loan is abnormal for the bank. The companies management does not appear to understand the unrealistic debt

situation, the impact on firm value and impact on the upcoming audit report.

Management: Has unrealistic expectations and a lack of understanding of impact of current structure of firm value.

Company: The company has considerable levels of equity and is not maximizing its financial structure. It is capable of taking on

considerably more debt, however, the debt needs to be more appropriately structured.

Ownership: Closely-held company with owner having little interest in management. Owned for dividend distribution.

The Company Background

1. Closely held public company (OTC)

2. MFG stationery including notebooks, loose leaf binders, filler paper

3. 100 years old

4. Management is professional but not finance savvy

5. Customers: 5,000 wholersalers and retailers in US & Canada (not subject to concentrations)

6. Seasonal cash needs - back to school push

7. Minor acquisitions, until recent purchase of Tri-Star

The Market

-Consolidations

-Larger companies begin to dominate

-Thinning margins

-Price of paper increases

-Increased international competitors

Key Operating Ratios

1993 1994 1995 1996

Operating Expenses 22.1 25.6 26.4 26.5

Gross Profit % 40.3 39.1 38.7 38.8

Pre-Tax Margin 17.9 13.5 11.8 11.5

After Tax Margin 7.6 6.6 5.8 6.3

-Operating margins have declined due to competition and rising paper prices.

Product

-Stationery including notebooks, loose leaf binders, filler paper

-Low margins business

-Seasonal business (Back to School dominates)

Current Capital Structure

-Too much short-term debt

-90 day terms

-Significant level of equity - D/E is not maxmimized and value from tax shield is lost

Options

-Portion of debt through insurance company

-Continue at 90 day terms

-Factor receivables

-Collateralize assets

-Mortgage general purpose building

-Independent Canadian Financing

-Flat dividends

-Payment Terms - accelerate receipt

-LIFO / FIFO

Pros and Cons of Options

Debt through insurance company

Pros: longer maturity schedule, reduce risk to bank and company

Cons: Management is against this option due to restrictive convenants and interest rate uncertainty

Recommendation: This could be used as a second tier of leverage, to increase debt levels as needed. But not necessarily needed

now.

Continue at 90 day terms

Pros: Management likes

Cons: Subject to short term rate increases, going concern issues with upcoming audit, Callable in 90 days, no collateral or covenants,

bank management is negative on situation, significant distress costs reduce stock value.

Recommendation: Not an acceptable option

Factor Receivables

Pros: Increase cash flow, payroll savings in collections and credit departments, reduces risk to bank and bank's required

due-dillegence in regards to collateralized receivables.

Cons: Additional costs associated with factoring

Recommendations: Not advised as a first tier method, but we recommend the company pursue a relationship with a factoring firm to

allow