Case Mark X Company (a)

Case MARK X COMPANY (A)

Financial Analysis and Forecasting

Mark X Company manufactures farm and specialty trailers of all types. More than 85 percent of the company's sales come from the western part of the United States, particularly California ,although a growing market for custom horse transport vans designed and produced by Mark X is developing nationally and even internationally. Also, several major boat companies in California and Washington have had Mark X design and manufacture trailers for their new models, and theseboat-trailer "packages" are sold through the boat companies' nationwide dealer networks.

Steve Wing, the president of Mark X, recently received a call from Karen Dennison, senior vice president of Wells Fargo Bank. Karen told Steve that a deficiency report, generated by the bank's computerized analysis system, had been filed because of Mark X's deteriorating financial position. The bank requires quarterly financial statements from each of its major loan customers.

Information from such statements is fed into the computer, which then calculates key ratios for each customer and charts trends in these ratios. The system also compares the statistics for each company with the average ratios of other firms in the same industry, and against any protective covenants in the loan agreements. If any ratio is significantly worse than the industry average, reflects a marked adverse trend, or fails to meet contractual requirements, the computer highlights the deficiency.

The latest deficiency report on Mark X revealed a number of significant adverse trends and several potentially serious problems (see Tables 1 through 6 for Mark X's historical financial statements). Particularly disturbing were the 2008 current, quick, and debt ratios, all of which failed to meet the contractual limits of 2, 1, and 55 percent, respectively. Technically, the bank had a legal right to call all the loans it had extended to Mark X for immediate repayment and, if the loans were not repaid within ten days, to force the company into bankruptcy.

Karen hoped to avoid calling the loans if at all possible, as she knew this would back Mark X into a corner from which it might not be able to emerge. Still, her own bank's examiners had recently become highly sensitive to the issue of problem loans, because the recent spate of bank failures had forced regulators to become more strict in their examination of bank loan portfolios and to demand earlier identification of potential repayment problems.

One measure of the quality of a loan is the Altman Z score, which for Mark X was 2.97 for 2008, just below the 2.99 minimum that is used to differentiate strong firms, with little likelihood of bankruptcy in the next two years, from those deemed likely to go into default. This will put the bank under increased pressure to reclassify Mark X's loans as "problem loans," to set up a reserve to cover potential losses, and to take whatever steps are necessary to reduce the bank's exposure.

Setting up the loss reserve would have a negative effect on the bank's profits and reflect badly on Karen's performance.

To keep Mark X's loan from being reclassified as a "problem loan," the Senior Loan Committee will require strong and convincing evidence that the company's present difficulties are only temporary. Therefore, it must be shown that appropriate actions to overcome the problems have been taken, and that the chances of reversing the adverse trends are realistically good. Karen now has the task of collecting the necessary information, evaluating its implications, and preparing a recommendation for action.

The recession that plagued the U.S. economy in the early 2006's had caused severe, though hopefully temporary, problems for companies like Mark X. Farm commodity prices have remained low, thus farmers have held their investments in new equipment to the bare minimum. On top of this, the luxury tax imposed in 2007 has had a disastrous effect on top-of-the-line boat/trailer sales. Finally, the Tax Reform Act of 2011 reduced many of the tax benefits associated with horse breeding, leading to a drastic curtailment of demand for new horse transport vans. In light of the softening demand, Mark X had aggressively reduced prices in 2007 and 2008 to stimulate sales. This, the company believed, would allow it to realize greater economies of scale in production and to ride the learning, or experience, curve down to a lower cost position. Mark X's management had full confidence that national economic policies would revive the ailing economy and that the downturn in demand would be only a short-term problem.