FINC Case Study

Case Study

Samson Medical Supplies and Devices, Corp.

Dr. Albert Samson was sitting at his desk in his office, reflecting on the past number of years of his “grand experiment” – to launch a company which would become a leader in the medical supplies field – as he was getting ready to prepare for a meeting with his strategy team (as he called them). Samson, the CEO, along with his team had developed a number of products that were unique and innovative and ultimately were well received in the medical community. He felt that he had assembled a very effective and unique team, consisting of his CFO, Jeff Pocketchange, Catherine Newdows, the Chief Medical Product Development Officer, and a number of other key individuals in marketing, sales and manufacturing. The company, Samson Medical Supplies and Devices, Corp., referred to as SMS and D, was founded in 2009 as a partnership by Samson and Pocketchange, later incorporated (in late 2010). It is a company that has done very well in the development and distribution of unique medical devices and supplies – some of which are proprietary – and has been more innovative during the past 3 to 4 years, including the year that just ended in 2016 (a huge growth year). He thinks the team is one of the best in the industry, although they don't always agree on issues. However, they do find ways to resolve differences and move forward effectively.

As Samson reflects, he begins to think about the future of the industry and the introduction of his new product line, which has been in development for the last 11 months. It is being created to forge a competitive advantage in the industry, hopefully for several years to come (SMS and D ranks high in a number of important financial ratios and other performance factors). He is getting ready to develop a capital budget for serious expansion, and his CFO has recommended that they talk to the banker first before looking for capital elsewhere to fund the expansion. The new product line consists of a number of products that are very innovative and simple to use. They are being developed for use in surgeries that require very fine motor skills – they will assist doctors in speeding up the surgical process without compromising safety and efficacy. Samson and Newdows have been dreaming of these products for many years, and now is the time for them to become realities and have a dramatic impact on the way surgeries are done. He knows he will have to go through an FDA approval process, but has the utmost confidence that this will be successful. In fact, he has some early feedback that the approval process might be quicker than normal because his products are so simple and straightforward to use. He also believes that he has most of the right people, and training will ensure that they are capable, although he may have to add some new people with specialized skills in the near future.

This is the largest single investment that the company has made in many years. A number of team members are privately expressing concern about the risks associated with a project this size, the commitment it would require of key staff, and have quietly suggested (among themselves) that they should consider other alternatives. In addition, he and his team have had several discussions about competition in the marketplace, especially with other firms with FDA approved products similar to his. One such company is Bundermed, a German firm which manufactures and currently sells its products both in Europe and the US; second is Brazmed Production SA out of Brazil, a successful company which manufactures and distributes its products throughout South and North America and is a major competitor. This company has been conducting a marketing war with SMS and D, and recently has been undercutting prices in anticipation of the launch of SMS and D’s new products. The matter has just come to a head recently, when Samson instituted a $5 million suit against Brazmed charging unfair trade practices. He was reasonably confident that he would prevail in this, since Brazmed has indicated that they might be willing to settle out of court for $500,000. He didn’t want this to become a problem with potential investors in the financial community, so he was pushing for a settlement to avoid the drama and publicity of a major court case. He still wasn’t completely convinced that the company needed outside financing, let alone how much. In the past they just asked for money from a small group of independent investors and were able to obtain it. This time might be different.

Several team members wonder if they have all of the information that will be needed, as they pull together the information that will be required to make the important decisions they are facing. Several members suggest that they discuss the issues with their banker, Warren Holden, since he has helped them in the past when they needed funds for expansion. Samson set up the meeting and met with the banker, who informed him that there were several restrictive covenants that the company would have to meet if it wished to obtain financing from the bank. Holden provided this information to Samson, and he and his team were taking a few days to consider it.

Today, Samson referred to the document that the banker had given him, and reviewed the three covenants that were highlighted with his team:

· dividends cannot be paid unless earnings are positive

· the current ratio must be maintained above 2.2 to 1

· the debt-to-assets ratio must be less than .4 to 1

Samson did not anticipate having any problems with the three covenants, but he wasn’t sure. Then he remembered that he had a meeting with one of his primary suppliers, and couldn’t take the time right now to explore the financials to see how the numbers would look – he wanted to analyze the numbers in more detail before the next board of directors meeting, and certainly before they approached any investors. (The financial information is presented in figures 1, 2, and 3.)

Figure 1

SMS and D, Corp. Income Statements (in 000s)

Current Pro-Forma

Year Statements

	2014	2015	2016		2017	2018	2019
Net sales (all credit)	$853	$2,936	$3,703		$4,998	$7,367	$9,953
Cost of goods sold	278	1001	1127		1582	2389	3868
Gross profit	575	1935	2576		3416	4978	6085
Selling and admin expenses	602	693	839		1387	2120	2597
Other income (expenses)*	0	0	0		500	0	0
Operating profit	(27)	1242	1737		2529	2858	3488
Interest expense	13	45	56		98	155	195
Income before taxes	-40	1197	1681		2431	2703	3293
Income taxes	0	479	555		802	892	1087
(40% in 2014; 33% thereafter)
Net income	($40)	$718	$1,126		$1,629	$1,811	$2,206
Dividends paid	0	0	0		0	0	0
Increase in retained earnings	($40)	$718	$1,126		$1,629	$1,811	$2,206
Average number of shares**	2326	2326	2347		2347	2347	2347
Earnings per share	($0.02)	$0.31	$0.48		$0.69	$0.77	$0.94
*Other income (expenses) refers to extraordinary gains and losses. In 2016 $500,000 is expected in
settlement of their suit - no final agreement yet.
**Shares are not publicly traded.

Figure 2

SMS and D, Corp. Balance Sheets (in 000s)

Pro-Forma B. S.

As of Dec. 31 As of Dec. 31,

years ended years ended

Assets	2014	2015	2016		2017	2018	2019
Cash and equivalents	$132	$145	$183		$211	$395	$475
Accounts receivable	127	397	567		933	1481	1843
Inventories	144	286	876		1078	1502	1106
Other current	16	41	103		38	46	73
Total current assets	$419	$869	$1,729		$2,260	$3,424	$3,497
Property, plant, and equipment	1943	2245	2959		4329	5103	7845
Less: accumulated depreciation	68	89	306		413	420	498
Property, plant, and equipment net	1878	2156	2653		3916	4683	7347
Other fixed assets	0	180	168		184	395	467
Total assets	$2,297	$3,205	$4,550		$6,360	$8,502	$11,311
Liabilities
Accounts Payable	217	398	572		783	1087	1585
Short-term debt	41	46	89		56	78	179
Total current liabilities	258	444	661		839	1165	1764
Long-term debt	17	21	23		26	31	34
Total liabilities	275	465	684		865	1196	1798
Equity
Common stock	2062	2062	2062		2062	2062	2062
Retained earnings	-40	678	1804		3433	5244	7451
Total equity	2022	2740	3866		5495	7306	9513
Total liabilities and equity	$2,297	$3,205	$4,550		$6,360	$8,502	$11,311

To prepare for the meeting, Samson asked the CFO to have his analyst review the financials and provide some preliminary feedback, especially about the Pro Forma statements. As the analyst, you are requested to focus on a number of issues that will be important during the more formal review process with the board, and ultimately with the bank and its small group of investors. The issues include but are not limited to the following:

· SMS and D’s record of profitability

· The prognosis for the future

· Various risk levels, and

· How it compares with others in the industry

Figure 3

Industry Statistics for Medical Products Category

Median Company in SIC 2831

	2014	2015	2016
Current ratio	2.5	2.3	2.4
Quick ratio	1.2	1.1	1.3
Inventory turnover	5.5	5.6	5.7
Total asset turnover	1.15	1.16	1.18
Return on sales	4.00%	4.00%	5.00%
Return on assets	4.60%	4.64%	5.90%
Return on equity	7.64%	8.44%	12.29%
Total debt-to-assets	0.40	0.45	0.52
Selected Statistics Brazmed Production SA
	2014	2015	2016
Current ratio	2.8	2.7	2.8
Quick ratio	1.5	1.3	1.6
Inventory turnover	5.6	5.7	5.8
Total asset turnover	1.9	2.0	1.9
Return on sales	6.00%	6.50%	7.00%
Return on assets	11.40%	13.00%	13.30%
Return on equity	19.04%	27.66%	29.56%
Total debt-to-assets	0.45	0.53	0.55
Price-earnings ratio	13.7	14.0	15.0
Average stock price	$21.78	$24.92	$31.50
· Source: Dons industry ratios (data have been adjusted for this case)

You, the analyst, have been developing a list of questions that the board members and the potential investors might be interested in, and you will need to answer them first.

Questions (please answer these questions):

1. Growth will be an important topic of discussion, and everyone will want to know about sales and profitability forecasts. What were the company’s rate of sales growth and the rate of net income growth in 2016? What are the rates of both sales and net income growth forecasted to be in each of the pro-forma years (2017, 2018, and 2019)?

2. Is projected net income growing faster or more slowly than projected sales? Discuss any differences. You should carefully review the 2017 income statement data to see if you want to recommend or make any adjustments.

3. a. The bankers will be interested in the current ratios. Calculate the current ratio for 2016 and compare it to Brazmed’s? How does it compare to the industry average? Compute SMS and D’s current ratio for 2019; is there any problem with it?

b. As part of current asset management, the average accounts receivable collection period is important. Calculate the average collection period (in days) for 2016, 2017, 2018, and 2019? Is the time frame getting longer or shorter? What are the consequences of this change in average collection periods?

4. Another ratio of interest to bankers is the debt level. Calculate the total debt-to-assets ratio for 2016, 2017, 2018, and 2019? Is any trend evident in the four-year period? Does SMS and D in 2016 have more or less debt than the average company in the industry? What are the implications of SMS and D’s debt levels?

5. How does SMS and D’s return-on-equity ratio (ROE) compare to Brazmed’s and the industry for 2016? Using the Du Pont method, compare the positions of SMS and D and Brazmed. Compare ROE for each company using the expanded formula (in the textbook on p. 123).

Discuss the results to highlight the sources of ROE for each company.

Rev. Oct 2017 Ver F