Page 1 How to use the NZICA template Welcome to the 2012 NZICA template case study. This case study is to help with the assessment of 90504 „prepare a report that analyses and interprets a company‟s financial report for external users‟. For version 3 of 90504 the standard allows teachers to assess students against a case study or an annual report. The questions (and suggested answers) provided in this pumpkin patch limited resource form the basis of a case study, and can be used as one. Our NZQA moderator, who put together this case study for us, has suggested some techniques that you could use with students to help them engage with the wider aspects of the firm. They have also provided some suggested methods to help the students use the financial ratios effectively to make a decision about seeking employment with the firm or purchasing shares. You could: Brainstorm as a class using the headings (and the annual report) outlined in questions 1-7 of the non-financial section. Try and encourage students to ask: „what does this mean for our specified end- user (shareholder/employee)?‟ Teachers may choose to focus on the end user. Potential lenders may also be a topic of choice, if the focus is “expanding into a new market.” Conduct group or individual research to provide a story about the firm (based on questions 1-7 of the non-financial section), prior to reviewing the relevant data. Have students share their findings with the class. Groups could do a subsection each to create a depository of findings. Students should use the answers found to engage with the firm, and use specific trends and examples as the basis for their individual reports, as per the financial analysis (p.p.12-21). Please note: Teachers can provide students with relevant rations, as the standard does not require students to calculate these. The rations chosen by the author reflects the effects on the finances of decisions made by the firm given the NZ retail and global business environment (and the firm‟s past). Much of the latter commentaries regarding the financial analysis is carried on from earlier sections. Students should use the relevant notes to reinforce their opinion for the end- user‟s decision.
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Transcript
Page 1
How to use the NZICA template
Welcome to the 2012 NZICA template case study.
This case study is to help with the assessment of 90504 „prepare a report that analyses and interprets a company‟s financial report for external users‟. For version 3 of 90504 the standard allows teachers to assess students against a case study or an annual report.
The questions (and suggested answers) provided in this pumpkin patch limited resource form the basis of a case study, and can be used as one.
Our NZQA moderator, who put together this case study for us, has suggested some techniques that you could use with students to help them engage with the wider aspects of the firm. They have also provided some suggested methods to help the students use the financial ratios effectively to make a decision about seeking employment with the firm or purchasing shares.
You could:
Brainstorm as a class using the headings (and the annual report) outlined in questions 1-7 of the non-financial section. Try and encourage students to ask: „what does this mean for our specified end-user (shareholder/employee)?‟
Teachers may choose to focus on the end user. Potential lenders may also be a topic of choice, if the focus is “expanding into a new market.”
Conduct group or individual research to provide a story about the firm (based on questions 1-7 of the non-financial section), prior to reviewing the relevant data.
Have students share their findings with the class. Groups could do a subsection each to create a depository of findings. Students should use the answers found to engage with the firm, and use specific trends and examples as the basis for their individual reports, as per the financial analysis (p.p.12-21).
Please note:
Teachers can provide students with relevant rations, as the standard does not require students to calculate these. The rations chosen by the author reflects the effects on the finances of decisions made by the firm given the NZ retail and global business environment (and the firm‟s past).
Much of the latter commentaries regarding the financial analysis is carried on from earlier sections. Students should use the relevant notes to reinforce their opinion for the end-user‟s decision.
Page 2
Pumpkin Patch Ltd. Analysis and interpretation of the 2011 Annual Report
PLANNING TEMPLATE 1: NARRATIVE QUESTIONS
Q1 What are the core business area(s) and geographic locations that Pumpkin Patch Ltd operates in?
Pumpkin Patch Ltd is retail brand that was founded in 1990 and wholesales and retails children‘s
clothing through its own stores in NZ, Australia, and UK and US (until mid-way through 2011)
The clothing range it designs is known for high quality and encompasses clothes that are resilient to
children‘s activities.
It is known for having a good ―fashion‖ brand image, and competes with other children‘s designer
brands such as Witchery Kids, Levis Kids, flo, Motion, EllieB, fresh, Papoose, Le Bon, Elfwear, Osh
Kosh (which is sold through Farmers, Smith & Caugheys etc.).
In 2010 the launch of the brand, ―Charlie and Me‖, occurred and was seen as an opportunity for
Pumpkin Patch Limited (PPL) to use its brand image to enter the ―everyday‖ market (that includes,
in New Zealand, t&t, Cotton On for Kids, JK Kids gear, The Baby Factory, Kmart and the
Warehouse) that encompasses 75% of the global chi ldrenswear sales. (Chairman‘s letter p.8,
2010)
In the 2011 year, Charlie & Me had 11 stores open across Australasia and a dedicated onli ne
trading website was created for this brand.
Since balance day 2011, Pumpkin Patch has launched a new brand called Pumpkin Patch General,
which is a part of PPL that sells non-clothing items for babies, nurseries and school aged children
(and is signalled by the Chairperson‘s letter where she states “We are currently assessing a number
of initiatives to leverage our existing online and supply chain capabilities. We hope to launch some
of these in the coming year.”) (Chairman‘s letter p.9, 2011). Pumpkin Patch General is an online
shop, currently.
The target market for the brand has, historically, been middle-income parents and grandparents
earners, and the growth of PPL since being listed has been based on the consistent growth of the
economies in which it has operated throughout the 2000s. The company has historically performed
well in all the markets it operated in except for the USA and the UK where the brand has been a
consistent money loser for PPL shareholders.
Simply put, 2011 has been a main departure from these foci.
The past three years have been challenging as global market conditions, the capital intensive
structure and restructures have had their impacts.
There are 5 main revenue centres (p.11, 2011 Annual Report):
Retail markets:
Australia (51% - down 1% from 2010); New Zealand (15% - unchanged from 2010) UK (14% - unchanged from 2010) US (5% – to be closed in 2012 year) Wholesale/Direct(website) (14% - up 1% from 2010)
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Q2. What is Pumpkin Patch Ltd current strategy(s) and key point of difference in the target
market? What is the current and future market potential for Pumpkin Patch Ltd? What
influence has the global economic crisis appeared to have had on Pumpkin Patch Ltd in 2011?
What specific areas?
The organisation‘s strategy at the end of 2010, was to manage its assets and liabilities carefully,
through ―balance sheet management‖ (p.08, 2010) and grow its brand in its 22 markets, in the
midst of soft economic conditions. It aimed to do this in a number of phases. Throughout the 2011
year the firm faced a number of significant challenges that has led to it underperforming, and
requiring a reassessment. These challenges include:
volatile trading conditions in all markets
natural disasters
political unrest in the Middle East
a high NZD exchange rate
low inventory levels at the start of the which generated a poor 6 week trading period in August and September 2010
higher product costs driven mostly by cotton price increases
new store opening costs From the annual report (and moving forward):
1. PPL announced that it is closing the 20 retail stores in the United States and are reviewing
underperforming stores in the United Kingdom. The brand will continue to be sold in the United
States through Wholesale and the growing online operation. The danger is that any gains in sales
will be offset by the high NZD.
2. PPL reviewed its Head Office operation to ensure it better matched the new store network as it
felt it was more appropriate given the challenging nature of global markets. Consequently, PPL
recognised this $15.6m of non-recurring reorganisation costs (see note 4D, 2011 annual report, p.
63)
3. The growth of stores of 20 new stores in 2012 in Australia and NZ are near the 2010 target (22). Three quarters of these were Charlie & Me. The three Urban Angel stores (kids aged 8+) in NZ were re-branded as Charlie & Me.
4. PPL opened 3 new stores in 2012 in Ireland, and also, over that period, it analysed the underperforming stores in the United Kingdom. In the 2011 financial year recognised the losses regarding store assets and agreed that the number of leases of stores in the UK was onerous, especially as the austerity measures in the UK continue. With fourteen stores whose leases expire or have exit clauses falling in the 2012 financial year, stores were flagged for closure. Two outlet stores were closed between July 2011 and November 2011. In Jan 2012, the decision was made to close the UK.
5. In 2012 there is anticipated continued growth of the Pumpkin Patch and Charlie & Me online
businesses. The websites are amongst the most visited children‘s product related websites in Australasia. Subscribers to the online newsletter receive a number of newsletters per week to give subscriber specials.
6. To leverage off this and its existing online capability PPL has generated the General brand.
7. The brand has been broadened in the past twelve months to integrate a wider target market
– online, general, Charlie & Me (and consolidate the original brand).
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8. The brand itself in the Australasian markets remains very strong.
From its investor relations website it states: Pumpkin Patch intends to continue increasing its sales and earnings by using strategies similar to those that it has successfully used during the past ten years. Pumpkin Patch's strategy is based around selling leading edge kids' fashion through a range of channels including its own retail stores, selected department stores, wholesale distribution arrangements, the internet and via mail order catalogues. Through these avenues, Pumpkin Patch sees its key growth coming from the following:
Continued development of its markets particularly in Australia.
Continued expansion of overseas third party retailing through department stores in Australia, the United States, Europe, the Middle East, South Africa and Asia
Continued expansion of online revenues through its websites in New Zealand, Australia, The United Kingdom, Ireland and The United States.
In 2011, there had not been a significant change to the major shareholders. However the Board had some significant shifts in the post Balance Day dates. “Pumpkin Patch Ltd. has announced that Chrissy Conyngham [Group General Manager at the time of publishing of the annual report] has informed the Board of Directors that she has decided not to seek re-election at the Annual Shareholders Meeting on 22 November 2011 and that she wishes to focus solely on her executive role with the business. Chrissy Conyngham commented „We are currently working on a number of exciting new opportunities across our international markets and I believe it is best that I am 100% focused on my executive role helping the business make the most of those opportunities. While I have enjoyed contributing at Board level the commitment of being a director has been considerable. The time is right for me to focus my efforts towards the design and branding areas of the business which are key to our long term success. This decision will give me more time to work
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with Neil and the wider executive team developing and executing strategies that will take us into the future‟.” (Source: http://www.findata.co.nz/Markets/NZX/51855/Director_announcement.htm ) The most significant shift from 2010 to 2011 was the purchase of shares by NZPT Custodians (Grosvenor) Limited, which is a company that has a significant stake in a number of NZ firms, such as NZ Steel and Tube. PPL may have represented a ―bargain‖. However, in the latter part of 2011, the share price went from $1.15 to $0.58c.
The 2nd
most significant shift in the share portfolio was that Pumpkin Patch Nominees Limited
was issued 150,000 shares and has grown its stake by 65%. This is the company‘s employee share
scheme. Maurice Prendergast and Sally Synnott are Directors and shareholders of Pumpkin Patch
Nominees Limited which acts as Trustee for various employee share ownership plans. (p.35, 2011)
PUMPKIN PATCH LTD FINANCIAL ANALYSIS AND INTERPRETATION
Please note that these figures have been generated from a number of sources, and have been kindly reproduced here.
There may be other ratios not referred to that would also be an acceptable method to use in analysing the information. Therefore, be sure to state any assumptions.
PROFITABILITY (INCLUDING DISCONTINUED)
31/07/2011 31/07/2010 31/07/2009
Gross Margin GP/Sales 62.8% 61.4% 57.5%
Net Margin NPAT/Sales - 0.05% 6.68% 4.50%
Return on Assets EBIT/Total Assets -0.9% 14.3% 9.9%
Return on Equity NPAT/Equity -5.8% 31.5% 20.9%
Note that all discussions are based on Net (loss)/profit after tax and before other
Comprehensive Income.
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Profitability summary and conclusions
The results coming from Charlie & Me [were] pleasing and gave the board encouragement about that specific brand‘s potential (Chairperson‘s report p.11, 2011). From the segment report (page 65) of the report 1% growth in sales in the Wholesale/Direct segment translates to a change of revenue from $53.22 Million to $54.14 Million. This has provided $10 M of the profit to the firm.
Overall, the Group profits tell two stories, (including and excluding the proposed closure of the
US stores). Excluding the closures, the firm has had a positive Net profit after tax of more than
$15 Million. This is, however, STILL a decrease of $10 Million. The NPAT accounting for the
discontinued/ items resulted in a loss of $1.9 million.
Overall group revenues slid further in 2011, from $362 Million to $338 Million. This has resulted
in a two year decrease from $412 (2009) of $74 Million. In 2010, the result was attributed to the
‘softening of the general retail environment in the second half of the year ‘ (CEO comments,
2010). In 2011, the Chairperson stated that this year has been ―one of the most challenging
years the Company has ever encountered. Not only did we face difficult trading conditions in all
our markets and a continuation of the higher New Zealand dollar, we also had to deal with a
number of other challenges such as a series of natural disasters and civil unrest in key markets
around the world.” (p.8, 2011)
The strongest sales sector of the organisation, Australia, also had subdued results as the year
progressed. This, combined with the Queensland floods resulted in a $144.8 Million decrease;
down 8% on 2010. The majority of the decline occurred in the first half which was down 14% on
the same period last year following the poor August and September trading period. AUD sales in
the second half of the year were down 1% when compared to the same period last year.
Therefore, the 2009 losses attributed to discontinuing operations (when the US stores were
initially re-organised) had been turned around in 2010, but these have now been wiped away by
a finalised discontinuing the US operations. At the end of the financial year 2011, a number of
issues regarding profitability may need to be asked:
1. In the annual report, a number of key issues in 2009 (and 2011) were classified as ―non-
recurring‘ items. If these occur in two out of three years – is it still reasonable to class
them as ‗non-recurring‘? (If one looks at the UK announcement in Jan 2012 – flagged in
the Chairperson‘s report where she stated, “we continue to develop strategies for the
United Kingdom stores which are currently facing very challenging trading conditions as
Europe as a whole deals with some major economic issues” , it seems that there may be
some more ‗discontinued/non-recurring items‘ in the 2012 annual report). In January
2012, this was confirmed.
2. The high New Zealand dollar has been attributed to the significant effect on the results
from the wholesale/direct markets (p.8)
3. The Australian sector was the strongest in the 2010 year, but in 2011, consumers
‗tightened their belts‘.
4. The NZICA toolkit suggested in 2011 that moving forward:
“if the markets do not rebound and
if another re-organisation (say in UK, or full closure of the US were to occur) in
2010-11
This would have severe effects on PPL‟s income statements again. The company is not set up
in this manner.” This seems to have come to fruition. Is the firm now set up to keep growing?
Fixed Asset Turnover (times) Net Sales/Fixed Assets
(PPE) 3.94 5.21 5.75
Accounts Receivable Turnover
(times) Sales/Acc Rec 18.6 x 18.43 x 21.08 x
Accounts Receivable (days) 365/Acc Rec. Turnover 19.63 days 19.80 days 17.31 days
*Including discontinued stores
Note that Accounts Receivable Turnover (times) calculation ignores non-current Accounts
Receivable.
Efficiency summary and conclusions
Overall the inventory management has flowed alongside the decrease in sales revenue. There has
been a 20+% deterioration in inventory turnover. This may due to the need to re-stock after an
inventory shortage in the initial stages of the financial year and the decrease in sales revenue.
The new branding for Charlie & Me would also have contributed to the slow-down in inventory
management.
The more realistic option is that the overseas sales have translated poorly to the reports due to high
NZD.
The Accounts Receivable management is not significant in itself, given that there would be very little in
the form of AR (other than delays of payments from credit card companies to PPL).
The AR might being offered to customers of its wholesale division stores. This may be a sign of the
times, where customers of the wholesale division are offered extended credit terms. The new markets
may be afforded longer repayment plans to increase the overall sales output, and ensure that a
partnership ensues.
LIQUIDITY AND THE BALANCE SHEET
31/07/2011 31/07/2010 31/07
/2009
Current ratio CA/CL 1.28 1.42 1.99
Quick ratio (CA-Inv)/CL 0.25 0.35 0.51
Net working capital ratio (CA-CL)/Total Assets 0.12 0.17 0.31
% Change in cash +140% -44.7% N/A
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Liquidity summary and the Balance Sheet Summary
The 2010 decrease has continued to slide in 2011. This is a decreasing and worsening trend
for Pumpkin Patch Ltd.
In the Current Assets section, there has been a significant growth, on balance day, of inventory valued at an additional $13 M. The cash position has also grown, but this is, due in the main to a large loan to offset the forward exchange contracts (below) . Linking the cash position to the cash flow statement, one sees the $10M is as a result of cash borrowings of $38,000,00 in the 2011 year
The Current Liabilities is a mix of positive and negative, as the overdraft organised in 2010
has been reduced by $5M to $20 Million (from $25M).
The bulk of the $19.5 Million increase in CL (and consequent decrease in the ratios above)
is due to the value of the forward foreign exchange contracts due to expire in the upcoming
year.
Exporting companies like PPL cannot ignore the impact of currency, changes on cash flows,
profitability, and their asset and liability position. No company is immune—the cash received
from exporting is affected by the relationship between the currency used by the customer to
pay and the currency in which the cost of providing the product or service is denominated.
A forward contract allows PPL to arrange for delivery (or sale) of a specific amount of
currency on a specified future date, at the current market price.
The past two decades has seen a significant increase in the types and complexity of financial
instruments offered in the market place. Users of financial statements need detailed
information on financial assets, liabilities and equity instruments in order to better understand
the risk profile of the entity. Because the effects are as material (significant) as they are to
the PPL‘s balance sheet, they need to be reported.
Because Forward FOREX contracts fix the exchange rate over different periods to try and
reduce the volatility of exchange rate fluctuations, PPL has these liabilities over the current &
non-current period.
From the CEO report , post-balance-date there was ―significant exchange rate volatility which
led to an improvement in the after tax value of those derivatives and a corresponding
increase in total shareholders‘ funds of around $21m (based on exchange rates in early
October.)‖ Post Balance Date, measurements reduce the liability by $21M.
The reason for recognising the liability on Balance Day is that IAS requires that the contract
is priced at fair value on the date the contract is entered into and remeasured to fair value
(on Balance Date).
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CASH FLOW RATIOS
31/07/2011* 31/07/2010 31/07/2009**
Free Cash Flow
(FCF)
Net Cash from Operating—
Capital Expenditures -$15,846 $8,775 $48,551
Cash Debt
Coverage
Net Cash from Operating
Average Total Liabilities -0.03 0.21 0.61
Cash Return on
Sales
Net Cash from Operating Net Sales
-0.01 0.05 0.15
Net cash flow from operating activities -$4,574 $20,801 $60,577
Net cash flow from investing activities -$17,144 -$13,379 -$11,796
Net cash flow from financing activities $24,803** -$15,041 -$51,880
Net cash flow for period $3,085 -$7,619 $62,901
Net bank debt at period end -$60,970 -$26,055 -$18,436
Cashflow gearing
ratio
Total Bank Debt : EBITDA
4.54 times 0.81 times 0.75 times
* Including discontinued store provisions ** Excluding discontinued stores *** Includes Cash Borrowings of $38,000,00 in 2011 **** Note that the FCF calculations are based on PPE only
Page 18
Cashflow summary and conclusions
Free cash flow (FCF)
FCF represents the cash that a company is able to generate after laying out the money required
to maintain or expand its asset base. (Investopedia) Free cash flow is important because it
allows a company to pursue opportunities that enhance shareholder value. Without cash, it's
tough to develop new products, make acquisitions, pay dividends and reduce debt.
It was flagged in the 2011 iteration of this analysis “the 2010 decrease in FCF for PPL was
concerning as the strategy is focused on new stores, and growth, but there may be insufficient
free cash available for this, without going to the market for more equity or more debt.
The cash debt coverage is also concerning for PPL, as there are still liabilities in the balance
sheet (they are now simply current). The cash generated is only sufficient to cover 20% of the
average liabilities in the balance sheet.”
Cash flow analysis:
Overall cash in the bank balance increased $3 M, which resulted in a closing bank balance of
$10 M..
The main reason for the increase in the is the amount of the loan ($38,000,000) The growth of
the loan book, and the path of red cash flow figures in operations, investments is concerning,
but the debt has been locked in until December 2013, so there is 2.5 years of opportunity for
rebounding from this.
The loans have funded the new stores, and also the discontinued operations, but the Cash Debt
Coverage and Cash Return on Sales amounts, on balance day, may deter the bank to afford any
further credit. The CEO states that ―Based on current trading conditions and expected working
capital and capital expenditure requirements net bank debt is expected to be between $40m and
$50m at July 2012.‖
Cash from Financing:
The major inflow was the loan, but this is offset by $13M in dividends. The shareholders have
received some rewards for being loyal to the firm, especially in light of the erosion of the share
price. It was predicted in 2011 that ―Given the large decrease in bank balance and weak liquid
ratio, it might be unlikely that Pumpkin Patch can maintain this level of dividend pay -outs in the
future, although it does have a history of this”. This has been confirmed in the interim 2012 year,
as PPL is ‗tightening its belts‘.
With limited cash available for the dividends, and the fair value of the derivatives having an
impact on the balance sheet, it is suggested that PPL would have been unable to fulfil the tests