Pre-Session Assignment PROBLEM LOAN IDENTIFICATION … · Pre-Session Assignment . PROBLEM LOAN...

Pre-Session Assignment

PROBLEM LOAN IDENTIFICATION AND RESOLUTION

Michael Davis President

Heritage Management Services, Inc. Naples, FL

[email protected] 239-354-2939

August 8 – 10, 2016

Graduate School of Banking – Problem Loan Identification and Resolution PC01 Binder Cover Page

Problem Loan Identification

and Resolution

Michael Davis, Section Leader

Graduate School of Banking – Problem Loan Identification and Resolution PC02 Cover Memo To Participants Prior to Binder Tab 1

GRADUATE SCHOOL OF BANKING WELCOME TO THE SEMINAR ON PROBLEM LOAN IDENTIFICATION AND

RESOLUTION Seminar Pre-Course Work and Participant Assignment I am looking forward to working with you in our upcoming Problem Loan Identification and Resolution program. Attached is the seminar pre-reading material for the program; please be sure to bring it with you to the seminar, along with a calculator. It is essential that the assignments described below be completed prior to the class sessions. Our schedule for this class is very concentrated; therefore your valuable time will be maximized if the pre-reading of the cases and the work on the exercises occurs prior to class. In reviewing the binder and pre-work, please focus on the following sections: Session One: Introduction, Overview and Timetable. Please review prior to class. Exercise I: Early Warning Signs in Lending. Please review the five categories for

Early Warning Signs and circle your answers to the questions in Exercise I prior to our session. While assessing the risk of each Warning Sign, be prepared to select at least one early warning sign from each of the five categories and relate the particular warning sign to a banking situation you have faced.

Exercise II: Identifying Warning Signs in Financial Statements. Please review

each of the 4 Vignettes and answer the questions for each Vignette. Be prepared to discuss your answers in class. While answering the questions of each Vignette, be prepared to select additional questions concerning the situation that would be appropriate to determine if the situation is truly a warning sign for a problem loan.

Session Two: Read the Luck Dairies Case and complete the assignments. Session Three: Read the Christy Candies Case and answer the questions. Please do not hesitate to contact me at 614-325-4550 or at [email protected] if you have any questions regarding the pre-course assignment.

_____________________________________________________________________________________ Graduate School of Banking – Problem Loan Identification and Resolution PC03 Introduction, Objective Setting and Timetable

Graduate School of Banking

Problem Loan Identification and Resolution

Introduction, Overview and Timetable

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Introduction In good times and bad, problem loans are a normal part of lending. How well this process is managed will determine the extent of the impact problem loans have on the bank’s bottom line. In this elective, the students will learn the proper management techniques and tactics used to mitigate the impact of problem loans. The content of this elective relates to commercial loans to all business sizes and industries, however many of the techniques are highly applicable to consumer loans. Purpose The purpose of this elective is to look at the management of a side of lending that potentially has the greatest impact on the bank’s bottom line. Banks devote tremendous amounts of resources and management to the lending function that generates loans that meet profit expectations and risk tolerance. This “pipeline” is the life blood of the bank’s viability, however, if the underwriting process fails to assess the risk factors or if the risk escalates due to changing circumstances, the value of the pipeline could quickly diminish. The purpose of this elective is to review the management process for identifying and mitigating the effects of problem loans. Participant Objectives After completion of this elective, student will understand the:

• costs of problem loans • common underwriting mistakes and how to avoid them • need to develop a sound monitoring method for a loan portfolio • early warning signs to developing problem loan • actions to take when a problem loan is identified • steps involved in determining an appropriate “workout” plan” • types of workouts and when to use them • alternatives to a workout • avoid lender liability issues

Schedule Day One Introduction and Objective Setting

The Cost of Problem Loans Monitoring Methods Early Warning Signs – Exercise I & II

Day Two Investigating Warning Signs

Establishing an Action Plan Steps in Setting a Workout Plan Luck Dairies Case

Day Three Types of Workout Actions and When to Use Them

Alternatives to a Workout Plan Christy Candies Case Avoiding Lender Liability Luck Dairies Summary

___________________________________________________________________________________ Graduate School of Banking - Problem Loan Identification and Resolution PC04. Exercise I - Early Warning Signs in Lending

Early Warning Signs in Lending

Exercise I

Graduate School of Banking - Problem Loan Identification and Resolution PC04. Exercise I - Early Warning Signs in Lending

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Assignment - For each listed early warning sign, circle your best guess regarding the gravity of the risk involved with the item. Be prepared to discuss the “Why” for your “highest rated” items. Which three are the most important in each category?

I. Earnings Related Warning Signs Possible Early Warning Sign: High Risk ------------ Low Risk 1. Decreasing Gross Profit in businesses with high fixed

costs 5 4 3 2 1

2. Rising portion of EBITDA derived from non-recurring income items

5 4 3 2 1

3. Reliance on non-operating sources of income as a component of net income

5 4 3 2 1

4. Sale of assets with gains making up a larger percentage of earnings

5 4 3 2 1

5. Increased fixed assets in anticipation of increased revenue

5 4 3 2 1

6. Underestimating the amount of bad debt allowance as receivables days increase

5 4 3 2 1

7. Contractors – a build-up in costs over billings, signaling a loss on a contract

5 4 3 2 1

8. Contractors – uncollected and unreserved receivables from customers disputing job performance

5 4 3 2 1

9. Business expanding faster than expertise and infrastructure

5 4 3 2 1

10. Overvalued assets, particularly inventory

5 4 3 2 1

11. Increase in raw materials costs and inability to pass through the higher cost

5 4 3 2 1

12. Declining gross margin but inability to reduce operating expenses in tandem

5 4 3 2 1

13. Shifting stale trade accounts receivable to notes receivable

5 4 3 2 1


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II. Liquidity Related Early Warning Signs

Possible Early Warning Sign: High Risk ------------ Low Risk 1. Overdrafts

5 4 3 2 1

2. Buildup in inventory

5 4 3 2 1

3. No cleanup of credit line as required

5 4 3 2 1

4. Quick buildup in accounts receivable

5 4 3 2 1

5. Significant increases in day’s receivables or inventory

with level or declining sales

5 4 3 2 1

6. Stagnant line usage at or near maximum

5 4 3 2 1

7. Lengthening of trade payables days

5 4 3 2 1

8. Frequent calls from other creditors regarding payment

status of the bank borrower

5 4 3 2 1

9. Past due payroll taxes

5 4 3 2 1

10. Request for funding to cover payroll

5 4 3 2 1

11. Fewer deposits made with the bank

5 4 3 2 1

12. Overdraft on YE balance sheet

5 4 3 2 1

13. Inability to liquefy certain current assets due to

capital or credit market conditions

5 4 3 2 1

14. Requests for renewal and increase in permanent

working capital facilities when sales are declining

5 4 3 2 1


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III. Management related early warning signs Possible Early Warning Sign: High Risk ------------ Low Risk

1. New management or ownership

5 4 3 2 1

2. Unexpected management turnover

5 4 3 2 1

3. Aging management and no succession plan

5 4 3 2 1

4. Failure to meet bank provided projections

5 4 3 2 1

5. Owner indulges in lavish lifestyle while

business prospects languish

5 4 3 2 1

6. Absentee management

5 4 3 2 1

7. Owner defers to treasurer in all dealings with

bankers

5 4 3 2 1

8. Change in attitude or behavior to bank

inquiries

5 4 3 2 1

9. Admitted tax fraud or tax evasion

5 4 3 2 1

10. Requesting release from personal guarantee

5 4 3 2 1

11. Requesting use of revolving working capital

loans to purchase fixed assets

5 4 3 2 1

12. Management and ownership succession plan

includes only unproven and inexperienced family members

5 4 3 2 1


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IV. Borrower Communications related early warning signs Possible Early Warning Sign: High Risk ------------ Low Risk 1. Information flow slows noticeably

5 4 3 2 1

2. Customer does not return phone calls, texts or e-

mails

5 4 3 2 1

3. Vague answers are given for specific questions

regarding business performance

5 4 3 2 1

4. Borrower constantly talks about overcoming

problems that never seem to get resolved

5 4 3 2 1

5. Borrower feels the company has only positive

characteristics when results suggest otherwise

5 4 3 2 1

6. The administrative assistant handles all bank calls

5 4 3 2 1

7. Customer states business is good when the economy

and the industry is in a downturn

5 4 3 2 1

8. Delay in delivery of financial statements

5 4 3 2 1

9. Change in CPA’s with no valid explanation

5 4 3 2 1

10. Change in fiscal year end to avoid covenant default

5 4 3 2 1

11. Moving from audited to reviewed, or reviewed to

compiled financial statements

5 4 3 2 1

12. Reluctance to provide tax returns, K-1’s or other tax

related information

5 4 3 2 1

13. Unusual accounting practices, not GAAP

5 4 3 2 1


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V. Strategy and Tactics related early warning signs Possible Early Warning Sign: High Risk ------------ Low Risk

1. New product lines, new locations

5 4 3 2 1

2. Major changes in business plan

5 4 3 2 1

3. Frequent changes in target market

5 4 3 2 1

4. Expansion into unrelated business due to

apparent success in existing business

5 4 3 2 1

5. Change in direction for the business in an attempt

to meet stated earning goals

5 4 3 2 1

6. Hiring of telephone marketers to increase sales

5 4 3 2 1

7. Building a new building to commemorate

business success

5 4 3 2 1

8. Acquiring new fixed asset infrastructure in

anticipation of higher sales

5 4 3 2 1

_____________________________________________________________________________________ Graduate School of Banking - Problem Loan Identification and Resolution PC05. Exercise II Identifying Warning Signs in Financial Statements

Identifying Warning Signs in Financial Statements

Exercise II


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Introduction In this next exercise, we will identify warning signs in three important areas of financial statement analysis: the balance sheet, the income statement, and the statement of cash flow. All of the examples are drawn from actual credit files. Be aware that the warning signs embedded in the exercise may only reflect the symptom, not the cause of a financial problem. Vignette 1 - Drypers Diapers Drypers Diapers is a regional manufacturer of diapers, competing with Proctor and Gamble and Kimberly Clark. The company has had a relationship with Wal-Mart for over 10 years, with approximately 50% of sales to Wal-Mart. Drypers Diapers 2013 2014 2015 Sales 41,322 46,310 55,020 Cost of Goods Sold 33,152 36,315 42,554 GROSS PROFIT 8,170 9,995 12,466 Selling, General and Administrative 3,179 3,608 3,498 OPERATING PROFIT 4,991 6,387 8,968 Interest Expense 947 988 1,031 Profit Before Taxes 4,044 5,399 7,937 Taxes 1,375 1,835 2,777 Net Profit After Taxes 2,669 3,563 5,160 2013 2014 2015 Cash 206 366 206 Accts Receivable – Wal-Mart 1,800 2,796 3,243 Accounts Receivable - Other 704 797 957 Inventory 7,406 7,017 12,082 Other Current Assets 424 523 406 Total Current Assets 10,540 11,499 16,894


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Questions 1. What credit underwriting risks are evident in the abbreviated Drypers

financial statements?

2. What questions would you ask of management?

3. What is the risk to the bank?


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Vignette 2 – Chamberlain Furniture The credit analysis accompanying the renewal of the credit line to Chamberlain Furniture asserted the following: “The Company continues to exhibit an increasing ability to service and repay debt, as evidenced by the increasing Net Cash after Operations figure and rising CADA in each of the last 3 years.” 2013 2014 2015 Sales 2,304 2,147 1,697 Change in Accounts Receivable 3 15 124 CASH FROM SALES 2,307 2,162 1,821 Cost of Goods Sold (1,463) (1,256) (989) Change in Inventory 16 12 130 Change in Accounts Payable 11 (59) 6 CASH PRODUCTION COST (1,436) (1,303) (853) GROSS CASH PROFITS 871 859 968 SG&A Expense (721) (717) (642) Change in Prepaid Expenses 3 7 (1) CASH OPERATING EXPENSES (718) (710) (643) CASH AFTER OPERATIONS 153 149 325 Miscellaneous Cash Income 89 99 76 NET CASH AFTER OPERATIONS 242 248 401 Interest Expense (107) (101) (81) NET CASH INCOME 135 147 320 CMLTD (23) (23) (27) CASH AFTER DEBT AMORTIZATION 112 124 293 Capital Expenditures (5) (5) (5) FINANCING SURPLUS/(REQ) 107 119 288 Change in STD 1 (32) (169) Change in LTD 0 (1) 0 Change in Equity (122) (87) (106) TOTAL EXTERNAL FINANCING (121) (120) (275) Cash After Financing (14) (1) 13


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Chamberlain Furniture Company – Additional Data

INDUSTRY: Retail Furniture Sales 2013 2014 2015 Sales Growth -15.94 -6.81 -20.96 Gross Margin 36.5 41.5 41.7 SG&A / Sales 31.3 33.4 37.8 Accounts Receivable Days 79 82 78 Inventory Days 174 199 205 Accounts Payable Days 21 7 11

Questions

1. Based upon the information above -- what is the quality and sustainability of cash flows available to repay debt?

2. What questions would you ask of company management?

3. What do you think happened to this company?


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Vignette 3: Southwestern Products Southwestern Products is a Sub-Chapter S, a fast-growing, aggressive company in the lumber distributing and light manufacturing/finishing business. The following abbreviated cash flow statement was derived from the compiled statements.

SOUTHWESTERN PRODUCTS 2015 Net Income 259 Plus: Interest Expense 195 Plus: Tax Expense 220 Plus: Depreciation/Amortization 935 EBITDA Cash Flow 1,609 Less: Interest (195) Less: CMLTD (135) Less: Taxes (220) Less: Dividends (113) Cash Avail for CAPEX & WC Growth 946 Capital Expenditures (230) Other 0 (Increase)/Decrease Intangibles 7 Total CAPEX & Intangibles (223)

(Increase)/Decrease Receivables (1,883) (Increase)/Decrease Inventory (864) Increase/(Decrease) Payables 109 (Increase)/Decrease Other Curr. Assets (74) Increase/(Decrease) Other Curr. Lblts. 715 Total (Used for)/Provided by WC (1,997)


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Questions

1. Name at least three warning signs evident in the Southwestern cash flow statement.

2. What questions would you have for management?

3. What additional information about the business would you require?


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Vignette 4: Greiner Contracting Greiner Contracting is a Phoenix local building contractor participating in the residential building business in Arizona. The company specializes in site preparation for the construction of residential subdivisions.

Greiner Contracting 2013 2014 2015 Cash 123 449 56 Accounts Receivable 3,136 3,426 5,154 Retentions Receivable 977 1,006 550 Total Accounts Receivable 4,113 4,432 5,704 Supplies 199 173 201 Costs in Excess of Billings 413 1,213 1,600 TOTAL CURRENT ASSETS 4,848 6,267 7,561 Machinery and Equipment 760 923 1,056 Leasehold Improvements 64 71 71

Questions

1. What questions would you ask about the asset mix above?

2. Are there additional clues as to the fortunes of Greiner’s contracting business?

Graduate School of Banking – Problem Loan Identification and Resolution PC06. Luck Dairies Case

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CASE STUDY - LUCK DAIRIES

PART 1

Mike Davis, Section Leader


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LUCK DAIRIES

It’s Monday morning and you are returning from a good weekend at the lake (particularly the food) which was your reward for sitting through several loan related meetings last week including a breakout session on “Problem Loans and Workouts”. You notice that you have several phone calls from a variety of people, but the one that catches your eye is from Tom Luck, who is owner/President of Luck Dairies, a third generation family business and one of your larger loans. Luck has been a “slow pay” on its loans during most of 2015, but not more than 20 days. Tom blamed the problem on the former CFO who left in early 2015 and has yet to be replaced. The message indicates that Tom will need to borrow money early this week to make payroll. No problem you think, but when you look at the availability of their credit line, it appears that it is almost fully drawn. You wonder why Tom didn’t see this coming sooner and mutter to yourself “just what I need on a Monday!”

So you start thinking about what you remember about Luck Dairies and

start considering the possibility that there may be a problem. Luck Dairies has been a good customer of the bank for more than 40 years. They are a wholesale supplier of consumer dairy products to the grocery and convenience store market. Tom took over as President a year ago after his Dad had major heart problems. Tom has worked in the company for more than 10 years, mostly in delivery operations.

Tom’s dad had started a plan two years ago to modernize the company’s

delivery fleet to help offset the pressure on the product profit margins that has reduced profitability at Luck for several years. The idea was the new fleet would help fuel costs, repair costs and labor efficiencies. Fiscal 2015 did reflect a smaller decline in the margin than the previous four years. No interim financials yet for 2016.

Having just attended the breakout session, you start to consider some salient types of weaknesses that may create problem loans and determine if they apply to Luck.

ASSIGNMENT ONE: What are some of the early warning signs to be concerned about?

1. ___________________________________________________________________

2. ___________________________________________________________________

3. ___________________________________________________________________

4. ___________________________________________________________________

5. ____________________________________________________________________

6. ____________________________________________________________________

7. ____________________________________________________________________

8. ____________________________________________________________________

9. ____________________________________________________________________

10. ___________________________________________________________________

Having an idea of what to consider, you decide that you need to develop an action plan of what to do about Luck. Certainly before you can give Tom an answer, you want to make sure there isn’t a problem loan developing. So based on that, you begin to form an action plan.


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ASSIGNMENT TWO : List some of the actions you may take and why.

1) Action ______________________________________________________

Why? ______________________________________________________

______________________________________________________

2) Action ______________________________________________________

Why? ______________________________________________________

______________________________________________________

3) Action ______________________________________________________

Why? ______________________________________________________

______________________________________________________

4) Action ______________________________________________________

Why? ______________________________________________________

______________________________________________________

5) Action ______________________________________________________

Why? ______________________________________________________

______________________________________________________

Graduate School of Banking – Problem Loan Identification and Resolution PC07. Christy Candies Case Study

Christy Candies, Inc.

A Case Study in Workout Plans

Graduate School of Banking – Problem Loan Identification and Mediation PC07. Christy Candies Case Study

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Assignment Read the Christy Candies case study prior to class, including reviewing the financial statements at the end of the case study. Please address the following issues:

1. What are potential early warning signs within the company itself? 2. What are the potential structural warning signs imbedded in the loan request?

Seek to identify potential credit issues with the company as it exists today, and include in your analysis at least 3 potential financial warning signs in each of the two categories mentioned above. Introduction It is March, 2016. John Bremer, a relationship manager, is pleased with the progress of his important client, Christy Candies. The company has grown more than 50% in the past seven years, from sales of $16.8 million in 2013 to $22.3 million in fiscal 2015. Moreover, the company is projecting an average 10% annual growth in sales over the next four years, taking it to a projected $30 million by fiscal 2020. Loan Request To support continued growth, Christy Candies (CC) has been discussing a request to increase its credit facilities from $2.5 million to $4.5 million, including the following:

• A new $1,500,000 term loan to CC’s affiliate, Christy Enterprises, LLC (CE), a new single purpose entity, to finance the expansion of a Distribution Center which CE will own and rent to CC;

• A new $500,000 line of credit to CC to purchase equipment and to fund other

capital expenditures during the upcoming building expansion phase The Bank has enjoyed a relationship with Christy for 23 years and handles all of the Company’s borrowing needs as well as all of the principals’ personal banking business. The $1.5 million Distribution Center loan is designed to house the Packaging Division, one of three divisions operated by the company. As a result of estimated labor and occupancy expense savings from this consolidation, management believes that it will save $206,000 per year by combining two divisions in one facility. This should also increase manufacturing efficiency by allowing that division to expand into the vacated packaging building. The revolving credit facilities have been growing steadily, accommodating seasonal needs in the Easter, Halloween, and Christmas holiday periods. John has been pleased with the way that, notwithstanding the increased limits, the line has always been cleaned


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down to some degree, reducing to a low point of $1,100,000 out of $2,000,000 available during the last 12 months. History and Background Christy Candies (CC) is a third generation Tukwila, Washington company. Currently, the Company operates through three divisions: Manufacturing, Packaging and Wholesale Distribution. These Divisions serve their customers with manufactured chocolates, packaged candies and the distribution of national brand candy. Manufacturing Division Christy Candies has been manufacturing candies for 92 years under the “Christy Chocolates” brand name. While this division represented 12% of the company’s revenues in 2015, it is the most profitable area of the business and is also the division with the greatest potential for growth. The company specializes in manufacturing chocolates, which are primarily sold during the Christmas and Easter holiday seasons. Traditionally, Christy Chocolates were marketed in the state of Washington with tremendous brand loyalty. Over time, Christy Chocolates came to serve the Oregon and northern California areas. Further, Christy Chocolates are now sold on a national level, primarily through the company’s packaging customers. National accounts include Target, Starbucks, Safeway, Osco Drug, Drug Mart, Drug Emporium and The Price Club. Packaging Division Christy Candies started packaging its own bag candy in 1967 under the brand name “Emma’s Delights”. Named after the daughter of the company founder and Tom Christy’s grandmother, Emma Christy, the company has enjoyed great success in selling this line of candy to independent grocers over the years in conjunction with the Wholesale Distribution Division. The Emma’s Delights line of candy totals over 150 different items including chocolate items, jelly candy, hard candy, sugarless candy, nuts, mints, gummy candy and licorice. Over time, this division has expanded to 29 states with much of the growth resulting from private label lines in which Christy packages candy it has produced or purchased from other manufacturers under its customers’ labels. Current private label customers include Drug Mart, Walgreens, Pace, Drug Emporium and The Price Club. Wholesale Distribution Division In 2008, Christy Candies began distributing national brands of candy, in addition to Emma’s Delights, in order to meet all of the independent grocers’ confectionary needs, including servicing the front end racks and holiday displays. Christy Candies distributes for companies such as M & M/Mars, Nestle, Wrigley, Lifesavers, Tootsie Roll, E. J. Brach, and many more, carrying over 2,500 inventory items.


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For the past 40+ years, Christy Candies has been successful by selling to independent grocers and regionally located chain accounts (Fry’s, Smitty’s, Smith’s, etc.). Due to the competition and slim gross margins in distributing candy products, however, sales growth is limited in this area. The Wholesale Distribution Division’s percentage of contribution to total revenues is projected to fall as the market becomes increasingly competitive. The company is an approved vendor for Wal-Mart and the likes of Starbucks and can call on any of their stores across the country. In addition, Christy Candies’ distribution network, sales force, and retail connections provide excellent cross-selling opportunities. Management Tom Christy, CEO/President – Tom Christy, 70 years old, started with the company in 1975 and currently oversees all operations. In 1996, Tom became president of the company. Since then, sales have increased approximately tenfold under his direction. Nancy Christy Thomson, Secretary/CFO – Tom’s elder daughter started in 1994 as an assistant to the bookkeeper and now oversees all accounting functions. Steven S. Christy, General Manager, Packaging and Manufacturing – Tom’s eldest son started with the company in 2006, working in the warehouse. He has worked in the field assisting salespeople, and is currently in charge of the Packaging Division. In addition, the company endured and survived financial difficulties in the early 2000’s as a result of the recessionary environment coupled with the difficulty in making the shift in distribution channels from grocery stores to drug stores and mass merchants. These past hardships are deeply embedded in the Christy’s minds, and as such, management is considered very conservative. Because of the changing structure of the market for confectionery products, Christy Candies has looked to other markets for growth in sales, and as such, has realigned its target customer base. It now concentrates its sales efforts on larger accounts such as chain groceries, mass merchandisers, discount drug chains, distributors, and club stores. Christy also has plans to expand beyond the 29 states they now service, and they’re currently investigating methods of selling to Canada and Mexico. Expansion will be achieved by integrating the three divisions in their selling efforts. Operating Performance Revenues have grown nearly 50% over the last 4 years to $22.3 million in fiscal 2015. Notwithstanding a 5.6% decline in 2015 in the Wholesale Distribution Division, primarily driven by continued price competition and consolidation of the industry’s customer base, both the Packaging and Manufacturing Divisions realized substantial increases as Christy continued to develop their market niches in these areas.


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Growth in sales to Drug Mart, Smitty’s, Fry’s and Target and the active pursuit of new customers contributed to the $1,710,000 increase in the Packaging Division, while the Manufacturing Division achieved a $610,000 increase in 2015 capitalizing on Christy Candies’ existing distribution channels. A breakdown of revenue by division is presented below. Revenue Breakdown: 2014 2015 Packaging Division 9,492 46% 11,202 50% Wholesale Distribution Division 8,956 44% 8,454 38% Manufacturing Division 2,045 10% 2,655 12% Total 20,493 100% 22,311 100%

Gross Margin has continued to improve, driven primarily by cost economies of scale in purchasing inventory as well as efficiency of labor. These efficiencies are also related to the change in composition of the company’s total revenues as Christy Candies moved away from low margin wholesaling of candy to higher margin packaging and manufacturing of candy. Currently, Drug Mart sales comprise approximately 18% of the company’s total revenues. Two other customers, Smitty’s and Fry’s, account for approximately 7% and 8%, respectively, of Christy’s revenues. Although there is a receivable concentration with respect to these customers and Drug Mart in particular, Christy is able to collect its receivables on a timely basis; Drug Mart continues to pay Christy within 28 days. Drug Mart, a publicly traded investment grade company, continued to show dramatic growth in each of the last 3 years and remained a good customer of Christy. Christy Candies’ inventory is comprised of candy purchased from other manufacturers to be packaged and distributed by Christy, raw chocolate, and individually manufactured chocolate candies. A secondary market for raw chocolate and candy purchased from suppliers exists as these items are commodity-type in nature. Although not as substantial, there is a secondary market for the chocolates manufactured by Christy as these candies are edible for approximately one year if stored as a specific temperature and humidity. Throughout most of the year, the candies purchased for packaging constitute approximately 90% of total inventory. During the 4th fiscal quarter, however, Christy’s inventory of manufactured chocolates typically increases to about 40% of total inventory.


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EXHIBIT I - Financial Statements: Christy Candies, Inc.

Statement Date 12/30/2013 12/30/2014 12/30/2015 Months Covered 12 12 12 Audit Mthd Unqualif'd Unqualif'd Co.Prep'd Accountant Ingram Ingram Ingram Analyst Saban Saban Saban Stmt Type Annual Annual Annual

CURRENT ASSETS Cash 76 1.7 40 0.7 34 0.6 Accts/Notes Rec-Trade 909 19.8 1,112 20.2 1,040 18.8 Inventory 1,985 43.3 2,629 47.7 2,774 50.1 Prepaids/Deferreds - CP 21 0.5 12 0.2 - -

¯ ¯ ¯ ¯ ¯ ¯ ¯

TOTAL CURRENT ASSETS 2,991 65.2 3,793 68.8 3,848 69.5 ¯ ¯ ¯ ¯ ¯ ¯ ¯

NON-CURRENT ASSETS Land 83 1.8 83 1.5 83 1.5 Buildings & Improvements 372 8.1 433 7.9 437 7.9 Machinery & Equipment 1,312 28.6 1,533 27.8 1,629 29.4 Furniture & Fixtures 338 7.4 350 6.3 404 7.3 Leasehold Improvements 141 3.1 162 2.9 162 2.9 Transportation Equipment 287 6.3 267 4.8 257 4.6

¯ ¯ ¯ ¯ ¯ ¯ ¯

Gross Fixed Assets 2,533 55.2 2,828 51.3 2,972 53.7 Accumulated Deprec (-) 1,094 23.9 1,258 22.8 1,443 26.1

¯ ¯ ¯ ¯ ¯ ¯ ¯

Total Fixed Assets - Net 1,439 31.4 1,570 28.5 1,529 27.6 Accts/Notes Rec-Offcr/Stkh 28 0.6 56 1.0 38 0.7 Cash Value Life Insurance 48 1.0 76 1.4 105 1.9 Other Investments 63 1.4 - - - - Operating Non-Cur Assets 18 0.4 18 0.3 18 0.3

¯ ¯ ¯ ¯ ¯ ¯ ¯

TOTAL NON-CURRENT ASSETS 1,596 34.8 1,720 31.2 1,690 30.5 TOTAL ASSETS 4,587 100.0 5,513 100.0 5,538 100.0

¯ ¯ ¯ ¯ ¯ ¯ ¯

CURRENT LIABILITIES Overdrafts (Book) - - 281 5.1 218 3.9 ST Loans Payable-Bank 1,017 22.2 1,122 20.4 1,251 22.6 CPLTD-Bank 149 3.2 192 3.5 152 2.7 CPLTD-Other Secured 94 2.0 21 0.4 - - Accounts Payable-Trade 394 8.6 381 6.9 276 5.0 Accounts Pay-Other 42 0.9 111 2.0 - - Wages/Salaries Payable 29 0.6 35 0.6 35 0.6 Bonuses Payable 22 0.5 33 0.6 49 0.9 Other Accruals - - 64 1.2 137 2.5 Other Taxes Payable 134 2.9 158 2.9 125 2.3

¯ ¯ ¯ ¯ ¯ ¯ ¯

Total Accrued Liabilities 185 4.0 290 5.3 346 6.2 Income Taxes Payable - - - - 74 1.3 Operating Current Liabs - - 66 1.2 106 1.9

¯ ¯ ¯ ¯ ¯ ¯ ¯

TOTAL CURRENT LIABILITIES 1,881 41.0 2,464 44.7 2,423 43.8 ¯ ¯ ¯ ¯ ¯ ¯ ¯

NON-CURRENT LIABILITIES Long Term Debt-Bank 144 3.1 225 4.1 12 0.2 Long Term Debt-Other Sec 92 2.0 - - - - Long Term Debt-Other Unsec 160 3.5 160 2.9 - - Deferred Fed Inc Tax - LTP 161 3.5 168 3.0 155 2.8

¯ ¯ ¯ ¯ ¯ ¯ ¯

TOTAL NON-CURRENT LIABILITIES 557 12.1 553 10.0 167 3.0 TOTAL LIABILITIES 2,438 53.2 3,017 54.7 2,590 46.8

¯ ¯ ¯ ¯ ¯ ¯ ¯

NET WORTH Common Stock 13 0.3 13 0.2 13 0.2 Retained Earnings 2,647 57.7 2,994 54.3 3,446 62.2 Treasury Stock (-) 511 11.1 511 9.3 511 9.2

¯ ¯ ¯ ¯ ¯ ¯ ¯

TOTAL NET WORTH 2,149 46.8 2,496 45.3 2,948 53.2 TOTAL LIABILITIES & NET WORTH 4,587 100.0 5,513 100.0 5,538 100.0

Working Capital 1,110 24.2 1,329 24.1 1,425 25.7 Tang Net Worth-Actual 2,149 46.8 2,496 45.3 2,948 53.2


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Statement Date 12/30/2013 12/30/2014 12/30/2015 Months Covered 12 12 12 Audit Mthd Unqualif'd Unqualif'd Co.Prep'd Accountant Ingram Ingram Ingram Analyst Saban Saban Saban Stmt Type Annual Annual Annual

Sales/Revenues 16,882 100.0 20,493 100.0 22,311 100.0

Cost of Sales/Revenues 14,582 86.4 17,394 84.9 18,739 84.0 Cost of Sales - Depreciation 364 2.2 495 2.4 485 2.2

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TOTAL COST OF SALES/REV 14,946 88.5 17,889 87.3 19,224 86.2 ¯ ¯ ¯ ¯ ¯ ¯ ¯

GROSS PROFIT 1,936 11.5 2,604 12.7 3,087 13.8

Selling Expense 1,273 7.5 1,807 8.8 2,127 9.5 Bad Debt Expense 131 0.8 48 0.2 87 0.4

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TOTAL OPERATING EXPENSE 1,404 8.3 1,855 9.1 2,214 9.9 ¯ ¯ ¯ ¯ ¯ ¯ ¯

NET OPERATING PROFIT 532 3.2 749 3.7 873 3.9

Interest Expense (-) 195 1.2 221 1.1 189 0.8 Interest Income 28 0.2 19 0.1 18 0.1

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Total Interest Inc(Exp) (167) (1.0) (202) (1.0) (171) (0.8)

Other Income 8 - 2 - - - Other Expense (-) 8 - 7 - 6 - Gain(Loss) on Asset Sale - - (8) - (6) -

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TOTAL OTHER INCOME(EXP) (167) (1.0) (215) (1.0) (183) (0.8) ¯ ¯ ¯ ¯ ¯ ¯ ¯

PROFIT BEFORE TAXES 365 2.2 534 2.6 690 3.1

Current Income Tax 99 0.6 179 0.9 252 1.1 Deferred Income Tax 28 0.2 8 - (14) (0.1)

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TOTAL INCOME TAX EXPENSE 127 0.8 187 0.9 238 1.1 ¯ ¯ ¯ ¯ ¯ ¯ ¯

NET PROFIT 238 1.4 347 1.7 452 2.0

EBIT 560 3.3 755 3.7 879 3.9 EBITDA 924 5.5 1,250 6.1 1,364 6.1 EBIDA 797 4.7 1,063 5.2 1,126 5.0

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Statement Date 12/30/2013 12/30/2014 12/30/2015 Months Covered 12 12 12 Analyst Saban Saban Saban Stmt Type Annual Annual Annual

Sales/Revenues 20,493 22,311 Chg in Accts/Notes Rec-Trade (203) 72 Bad Debt Expense (48) (87)

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Cash Collected From Sales 20,242 22,296 Cost of Sales/Revenues (17,394) (18,739) Chg in Inventory (644) (145) Chg in Accounts Payable-Trade (13) (105)

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Cash Paid To Suppliers (18,051) (18,989) ¯ ¯ ¯

CASH FROM TRADING ACTIVITIES 2,191 3,307 Selling Expense (1,807) (2,127) Chg in Prepaids/Deferreds - CP 9 12 Chg in Overdrafts (Book) 281 (63) Chg in Accounts Pay-Other 69 (111) Chg in Wages/Salaries Payable 6 - Chg in Bonuses Payable 11 16 Chg in Other Accruals 64 73 Chg in Other Taxes Payable 24 (33)

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Cash Paid for Operating Costs (1,343) (2,233) ¯ ¯ ¯

CASH AFTER OPERATIONS 848 1,074 Other Income 2 - Interest Income 19 18 Other Expense (-) (7) (6) Chg in Operating Current Liabs 66 40 Current Income Tax (179) (252) Deferred Income Tax (8) 14 Chg in Income Taxes Payable - 74 Chg in Deferred Fed Inc Tax - LTP 7 (13)

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Other Income(Exp) & Taxes Paid (100) (125) ¯ ¯ ¯

NET CASH AFTER OPERATIONS 748 949 ¯ ¯ ¯ ¯

Interest Expense (-) (221) (189) ¯ ¯ ¯

Cash Paid for Dividends & Interest (221) (189) ¯ ¯ ¯

NET CASH INCOME 527 760 CPLTD-Bank (149) (192) CPLTD-Other Secured (94) (21)

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Current Portion Long Term Debt (243) (213) ¯ ¯ ¯

CASH AFTER DEBT AMORT. 284 547 Chg in Buildings & Improvements (61) (4) Chg in Machinery & Equipment (221) (96) Chg in Furniture & Fixtures (12) (54) Chg in Leasehold Improvements (21) - Chg in Transportation Equipment 20 10 Chg in Accumulated Deprec (-) 164 185 Cost of Sales - Depreciation (495) (485) Gain(Loss) on Asset Sale (8) (6)

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Chg in Net Fixed Assets (634) (450) Chg in Accts/Notes Rec-Offcr/Stkh (28) 18 Chg in Cash Value Life Insurance (28) (29) Chg in Other Investments 63 -

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Chg in Investments 7 (11) ¯ ¯ ¯

Cash Paid for Plant and Investments (627) (461) FINANCING SURPLUS (REQMNTS) (343) 86

Chg in ST Loans Payable-Bank 105 129 Chg in Long Term Debt 202 (221)

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Total External Financing 307 (92) ¯ ¯ ¯

CASH AFTER FINANCING (36) (6) Add: Cash 76 40

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ENDING CASH & EQUIVALENTS 40 34


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Statement Date 12/30/2013 12/30/2014 12/30/2015 Months Covered 12 12 12 Analyst Saban Saban Saban Stmt Type Annual Annual Annual

LIQUIDITY Working Capital 1,110 1,329 1,425 Quick Ratio 0.52 0.47 0.44 Current Ratio 1.59 1.54 1.59 Net Sales/Working Capital 15.21 15.42 15.66

LEVERAGE Net Worth-Actual 2,149 2,496 2,948 Tang Net Worth-Actual 2,149 2,496 2,948 Eff Tang Net Worth-Actual 2,149 2,496 2,948 Debt/Worth 1.13 1.21 0.88 Debt/Tang Worth 1.13 1.21 0.88 Debt Less Sub Debt-Liability/Eff Tg Wth 1.13 1.21 0.88 Borrowed Funds/Eff Tg Worth 0.77 0.69 0.48 LT Debt/Net Fixed Assets 0.44 0.38 0.11 Total Liabilities/Total Assets 0.53 0.55 0.47

COVERAGE Interest Coverage 2.87 3.42 4.65 Net Income+Depr+Amort-Divs/CPLTD 2.48 3.95 6.16 Net Income+Depr+Amort-Divs/CPLTD pp 3.47 4.40 UCA Cash Flow Coverage 1.72 2.78 UCA Cash Flow/CPLTD pp 1.61 2.36 EBITDA/Interest Exp+CPLTD 2.11 2.88 4.00 EBITDA/Interest Exp+CPLTD pp 2.69 3.39 EBITDA 924 1,250 1,364 EBIDA 797 1,063 1,126 Fixed Charge Coverage 2.11 2.88 4.00

PROFITABILITY (%) Return on Assets 5.19 6.29 8.16 Return on Equity 11.07 13.90 15.33 Gross Margin 11.47 12.71 13.84 Gross Margin (plus Depr) % 13.62 15.12 16.01 Operating Expense % 8.32 9.05 9.92 Operating Expense (excl Depr) % 8.32 9.05 9.92 Operating Profit Margin 3.15 3.65 3.91 Operating Profit Margin (plus Depr) % 5.31 6.07 6.09 Net Margin 1.41 1.69 2.03 Dividend Payout Rate - - - Effective Tax Rate 34.79 35.02 34.49

ACTIVITY Net Accounts Receivable Days 19.65 19.81 17.01 Inventory Days on Hand 48.48 53.64 52.67 Inventory Days on Hand (excl Depr) 49.69 55.17 54.03 Accounts Payable Days 9.62 7.77 5.24 Accounts Payable Days (excl Depr) 9.86 7.99 5.38 Net Sales/Total Assets 3.68 3.72 4.03 Net Sales/Net Worth 7.86 8.21 7.57 Net Sales/Net Fixed Assets 11.73 13.05 14.59 Profit Before Taxes/Total Assets (%) 7.96 9.69 12.46

GROWTH (%) Total Assets Growth 20.19 0.45 Total Liabilities Growth 23.75 (14.15) Net Worth Growth 16.15 18.11 Net Sales Growth 21.39 8.87 Operating Profit Growth 40.79 16.56 Net Profit Growth 45.80 30.26 Sustainable Growth 12.45 16.15 18.11

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