Peyton Enterprises Case Study

Peyton Enterprises Case

        Peyton Enterprises is in the business of design and manufacturing of filtration equipment and filtration component products used in the chemical industry. Peyton Enterprises’ “bread and butter” was there niche market related to coal mining. They also specialized in filtration components and equipment for chemicals involved in energy and life sciences. In 2014 however, there were significant declines in the use of coal-fueled plants. This effect caused less coal being mined and burned and thus less that needed to be cleaned and Peyton Enterprises felt this loss of production. Although the market for coal fell, the life sciences division of Peyton Enterprises offset the loss. After this has all taken place, Peyton Enterprises hired a new CEO to guide their business back to the top. Her name was Sarah McNeilly. Right before McNeilly’s arrival, Peyton Enterprises, was attempting to go public with their business. They predicted that the IPO, initial public offering, would boost capital to fuel the expected future growth of the life sciences sector and would implement the use of stock/share based compensation for management and lower level employees. The decline, however, delayed this activity until PE can reverse the downturn of the company. In her contract, McNeilly has a clause in it promising a cash bonus based upon Peyton’s ROA, earnings growth, and a successful IPO whenever it is offered. After review of financial statements, McNeilly brought in the CFO and the Controller of the company to a meeting and came to this conclusion. PE was being too aggressive with their accounting work while PE was in a slump. She wanted them to try be as conservative as possible until they could “stop the bleeding” of the company down turn.

        Some year to year trends seem to really outline the company’s past performance and where it is headed now. During 2012 and 2013, gross profits were increasing by 3% and in 2014 it decreased by 2.08%. Net sales decreased by 19.02% from 2013 to 2014. This decrease is due to coal cleaning not being as profitable as it has been in the past. The ratio of Selling, General, and Administrative expense to Sales goes down .004 percent and it increased to .21 in 2014. The increase in 2014 is due to the drop in sales and the expenses staying consistent. Also from 2013 to 2014, Peyton Enterprises’s ROA declines from 24.10% to 11.3%. From these numbers, I can assume that the weight of the coal industry declining really had a huge burden on this company. They have not fully integrated into the life sciences sector of the company and until they do they will continue to see the decline. With pharmaceuticals and other energies hitting their stride in the economy, it is only a matter of time before Peyton starts leaning on them more but until then, they have to ride the decline out.  Some strengths I see with Peyton is that they offer the highest quality of products to their customers. They produce a 99.8% filtration rate which is almost a clean specimen. They have had to have excellent sales numbers to keep them in business for so long. This also means they offer high quality products for such loyal customers. I believe a weakness that lead to this decline, was there dependence on coal. As technology has been advancing, scientists are trying to find alternatives to coal and I think the life science sector of Peyton Enterprises should have been already been making more money because of the huge market and how advanced those two sectors are becoming for it. I believe that the opportunities for the life sciences are there for Peyton. With technologies advancing, it is limitless of what they can accomplish and earn. With these opportunities comes threats and I believe they will have the same threats for these 2 sectors. Other companies are seeing the rapid development of these two markets and they want in the action. So with this, Peyton will see a lot of new entrants and thus will drive the average market price down.  

        During McNeilly’s meeting with the company CFO and controller; she laid out some things she would like see changed to the company’s accounting methods and assumptions. She first wanted the allowance for doubtful accounts to rise to 4.5%. The current percentage was 2.5% and that was roughly average for the company. McNeilly felt that a bigger reserve made more since to her since sales had been slowing up. Another item she wanted to address is the use of inventory. She read about a company-wide initiative to slow new inventory purchases and use the $75 million LIFO reserve. She wanted a halt on this process because she did not want to run into inventory supply risks. The CFO protested saying that they could save a lot of money, inventory expense wise, if this initiative was put into action. McNeilly also believed that fixed assets posed a different problem to the company. Due to the company opening a new facility, they were expected to incur a one-time cost of $100 million. Fixed asset purchases were to be incurred at historical levels. This is a minimal level to sustain PE’s productivity. This would not affect current equipment, only new purchases. Lastly, they discussed what the impact of the restructuring would have on the books. They estimated severance and other one-time costs to be about $10 million and some equipment impairments that are necessary would be $80 million. Also inventory write downs would be about $15 million.

        With these changes taking place, it gives the senior management some options going forward. As far as increasing bad debt expense, I believe this can be a good move for the short term. As bad debt expense increases, so does a loss in net revenue. This can make board members somewhat sympathetic to the decline in revenue. I believe that if they did put this part of her plan into action, it would reduce the pre-tax income for the company. I believe this is a smart move because the company is already losing money and having a bigger reserve of bad debt expenses can be helpful for financial statement purposes. Also since bad debt expense had dropped in 2014, the total balance for receivables had also been increasing. If they don’t expand the bad debt expense revenue, they will still be showing a decline and revenue while the receivables will still be growing. In response to the inventory change, I believe that using the LIFO inventory reserve of $75 million is a smart move. Using the reserve, can curb inventory expense for the short run and can cut costs which would increase revenues. Although if Peyton is going to raise the bad debt expense, reducing inventory expense would counteract the route in which McNeilly is trying to go with the company. McNeilly was worried about having a shortage of inventory risk if they started using the reserve. If they were going to start that initiative, they could specifically have one person being on top of the inventory so when Peyton gets close to the end of the reserve they can put a halt on it and start taking in more inventories again. The problem with Peyton right now is they are incurring too much cost and it isn’t matching up with the decrease in sales they are having. I think that cutting the inventory cost can be very helpful. When discussing fixed assets, they are expecting to have a $100 million purchase of a new facility in eastern Pennsylvania in 2015. I think this can be pushed back because this probably isn’t the most important thing to do as of now because of the decline in the company’s performance. Although it might be necessary or needed, I just believe that incurring this huge cost could really put the company’s position much worse and in a much more volatile state if things don’t turn around. Also they are taking the additional asset purchases of $100 million dollars and shortening their life from seven to five years and they will be using the double declining balance method for these. To get the equipment and the depreciation off the books as fast as possible, I think this is a wise opportunity. With that comes a big hit to revenue over the next 1-3 years since double declining balance happens when the majority of the depreciation comes out in the first few years of operation.

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