Instructions:Click on the link to access the case study.Please read the case thoroughly several times and respond in depth to each question in the four numbered sections listed at the end of the...

1. 
   
   
   Reading financial statements
   
   
   




2. 
   
   
   Working capital management
   
   
   




3. 
   
   
   Financial statement analysis
   
   
   




4. 
   
   
   Company growth
   
   
   

THE FORGE GROUP LTD SUMMARY In 2012-2013, Forge Group Limited had more than 2,000 employees working across eight countries on four continents. The pride in the growth story is evident, as Forge Group’s 2012 Annual Report (released in September 2013) lists accomplishments in what is described as a groundbreaking year. The main milestones give a snapshot of the types of projects the company was involved in (see Figure 1). At the time of listing (June 26, 2007), Forge Group Ltd (FGL) shares traded for $0.56. (All monetary amounts discussed herein are in Australian dollars. To convert to another currency, visit www.x-rates.com.) The shares peaked at $6.98 on March 6, 2013, valuing the company at $600 million. In less than a year, FGL was placed in a trading halt (February 11, 2014). Voluntary administrators and receivers were appointed. THE ENGINEERING AND CONSTRUCTION INDUSTRY The engineering and construction sector provides significant economic activity in many countries. Large-scale engineering and construction projects—including highways, bridges, railways, airports, harbors, production facilities, and office and apartment buildings—provide employment opportunities and attract large capital investment. The quantum of resources employed in this industry and the profound affect they have on society means that there are strict compliance, regulatory, environmental, and tax requirements on those operating in the sector. The governments of many countries publicly funded a number of large scale infrastructure projects in the aftermath of the Global Financial Crisis (GFC) to stimulate the economy. Joint ventures and public/private partnerships are common in the industry to reduce the risk of large-scale projects and to ensure adequate capital and expertise. Major contracts generally involve a number of different companies with primary contractor and sub-contractor status, all tendering and quoting on various stages of work in a project. This makes the industry highly competitive, and therefore it is vital to have appropriate costing and project management expertise. Mining companies also took advantage of the cheaper finance post GFC and the upswing in demand for minerals and resources. Large-scale mining projects have been the driving force for some economies, especially in Australia. But with the construction of a number of the large projects nearing completion (and moving into production phase), there is a drop in engineering and construction spending. In Australia in 2013-2014, engineering and construction spending was $128 billion, dropping $1 billion from the previous year. This increased competition in the sector and, therefore, demand for lower-priced contracts and shorter completion times. The market value of engineering and construction companies are based partly on their future secured order book. “Order book” is a term used in the engineering and IMA EDUCATIONAL CASE JOURNAL VOL. 8 , NO. 1 , ART. 2 , MARCH 20151 ISSN 1940-204X Forge Group Ltd Case Study (A) The Revealing Nature of Numbers Suzanne Maloney University of Southern Queensland Toowoomba, Australia, 4350. [email protected] ©2015 IMA construction sector to capture the company’s future work and the dollar value of the work. The future work is contracted through the normal selling of services and through “tendering” for large-scale works needed by governments and large private companies. If a project is very large, it may be divided into segments with a separate tender process for each segment. Companies have to carefully consider the risk attached to each segment of the larger project and the interrelationship of each of the segments. A company can be held liable to another company if their segment completion is delayed and the other company cannot complete its work on time, as per their contract, because of the delay. For example, when building a tunnel, the riskier segment may be blasting the rock and strengthening the actual tunnel. Excavating the ground and surfacing the road may not carry the same risk but could be held up if the blasting and strengthening is not completed on time. In comparison to a retail or manufacturing concern, the products being sold are large capital works that tend not to be completed within a neat 12-month period. This means that there needs to be payment points built into the contracts. These are called “milestones.” Once a project milestone is reached, it triggers a point when the engineering and construction company can invoice the purchaser and recognize the revenue in its accounts. The product cost (Cost-of-Goods-Sold) expensed against this revenue will contain material, labor, equipment costs, and sub-contractor costs. These costs are all capitalized into inventory at the time they are incurred but not expensed until they reach a milestone. A lot of dollars, long-term time horizons, subjective milestones, and the application of large capital equipment costs contribute to the overall business risk in the sector. Many companies have suffered as a result of stalled projects, unforeseen circumstances or problems, poor costing of the work, and mismanaged cash flow. Within the industry, there is usually significant take-over activity. This is driven in part by companies not performing well and/or insolvency and also by normal merger and acquisition activity. Smaller companies find it difficult to compete with larger companies for the larger projects IMA EDUCATIONAL CASE JOURNAL VOL. 8 , NO. 1 , ART. 2 , MARCH 20152 Figure 1: The Year in Review Source: Forge Group Ltd 2013 Annual Report, www.openbriefing.com/AsxDownload.aspx?pdfUrl=Report%2FComNews%2F20130829%2F01438557.pdf, pp. 4-5. and generally need to combine or merge in some way or stay small. This adds further risk and places the financial statements and the order book under increased scrutiny as business valuations rely on this information. THE FORGE GROUP LTD (FGL) The company was a success story. It listed on the Australian stock exchange on June 26, 2007, from a private construction company called AiConstruction. It was a well-run company that needed access to more capital if it was to continue to grow. Within a year, it made its first acquisition by taking over Abesque Engineering. The company survived the Global Financial Crisis and leveraged to the subsequent mining and construction boom led by China’s appetite for minerals and resources. Over the next few years, the company grew organically and in April 2010 another construction company called Clough bought 13% (10.5 million shares) of FGL ordinary shares, thus becoming the largest shareholder. Clough continued to purchase shares in FGL until it divested its total holding of 35% in March 2013. Clough management explained its divestment by indicating that expectations of joint ventures between the two companies did not eventuate, and, therefore, the equity holding was cashed in to allow the pursuit of other objectives. In January 2012, FGL undertook a major acquisition by purchasing CTEC Pty Ltd. In essence, the acquisition meant taking over two major projects. The Diamantina Power Station (DPS) Project in Queensland, Australia, and the West Angelas Power Station (WAPS) Project in the Pilbara region of Western Australia. It was expected that these major projects would add $7.5 million and $10.8 million to earnings before interest, tax, depreciation, and amortization (EBITDA) in 2012 and 2013, respectively. The purchase price was $16 million up-front with further payments due on the meeting of specified performance targets (total paid was $32.26 million). This increased FGL’s order book significantly, and FGL’s share price rose in response. In June 2013, FGL acquired Taggart Global for $43 million. This purchase meant that FGL was now diversifying into asset management and into other economies. SHARE MARKET INFORMATION The historical share price chart since listing is shown in Figure 2. Figure 2: FGL Share Price $8 $7 $6 $5 $4 $3 $2 $1 $0 6/2 7/2 00 7 6/2 7/2 00 8 6/2 7/2 00 9 6/2 7/2 01 0 6/2 7/2 01 1 6/2 7/2 01 2 6/2 7/2 01 3 Closing Price The market closing prices, major announcements, and significant shareholding changes are listed in chronological order in Table 1. CTEC PURCHASE In the wash up of the demise of FGL is the attention being paid to two main contracts: The Diamantina Power Station (DPS) Project in Queensland, Australia, and the West Angelas Power Station (WAPS) Project in the Pilbara region of Western Australia. Both projects were acquired after FGL took over CTEC Pty Ltd on January 13, 2012. The purchase of CTEC was to change the business model by bringing sub-contracting work in-house with the intended consequence of taking out the “middle man” and thereby increasing earnings (by negating sub-contractor margins). The CTEC purchase payment terms required an up- front payment of $16 million with subsequent payments conditional on meeting performance criteria (possible further payment of $40 million in total). CTEC’s prior year (June 30, 2011) EBIT was $2 million, with expected EBITDA at year end 2012 and 2013 to be $18.4 million and $24.8 million, respectively. The DPS and WAPS projects were to increase this expected EBITDA by $7.5 million in 2012 and $10.8 million in 2013. IMA EDUCATIONAL CASE JOURNAL VOL. 8 , NO. 1 , ART. 2 , MARCH 20153 IMA EDUCATIONAL CASE JOURNAL VOL. 8 , NO. 1 , ART. 2 , MARCH 20154 Table 1. Timeline of Forge Group Ltd (FGL) Date Closing Market Major Announcement/Change June 27, 2007 $0.56 FGL listed on Australian Stock Exchange June 30, 2008 $0.78 June 30, 2009 $0.43 Global Financial Crisis impact April 6, 2010 $2.96 Clough purchases 10.5 million shares for 13% ownership June 30, 2010 $2.66 June 30, 2012 $5.46 June 30, 2012 $4.37 January 13, 2012 $5.25 FGL purchases 100% of CTEC Pty Ltd for $32.26 million March 6, 2013 $6.98 Peak share price March 26, 2013 $6.05 Clough sells FGL shares at $6.05 ($187 million, 35% of FGL) May 17, 2013 FGL awarded major contract (Dugald Rover) June 3, 2013 FGL acquires Taggart Global (U.S. company) at $43 million July 2, 2013 FGL awarded major contract (TAN Burrup plant) June 30, 2013 $4.09 August 29, 2013 Annual Report released NPAT at $63 million, equity at $213.5 million, dividend at $0.14 per share September 2, 2013 $1.47 billion joint venture with Duro Felguera announced (value to Forge is $830 million – order book now at $2.1 billion) September 12, 2013 FGL awarded major contract (Yandicooogina for Rio Tinto – $100 million contract) September 19, 2013 FGL major contract terminated (Dugald River) October 7, 2013 FGL declares $50 million in major contracts in U.S. and Australia since June 1, 2013 November 4, 2013 $4.18 Trading halt November 5, 2013 ANZ Bank (major financier) appoints KordaMentha to review books November 28, 2013 FGL Market Announcement: –ANZ Bank supports and negotiates new finance facilities –Considering equity capital raising –Identifies underperforming assets (i.e., CTEC projects) –Negotiates agreements with customers and sub-contractors –Normal operations for other parts of business November 28, 2013 $0.69 FGL Market Announcement: -$127 profit write down on two large contracts (Diamantina Power Station and West Angelas Power Station; $45 million to complete both projects) –Challenging liquidity period (net cash flow Nov. and Dec.) –ANZ Bank continued support with some adjustment to finance facilities –Business as usual November 28, 2013 $0.69 Trading halt lifted December 4, 2013 FGL Market Announcement: – In response to ASX query, indicated became aware of problems with Diamantina Power Station and West Angelas Power Station projects in late Sept. with margin erosions due to cost overruns and delays causing the profit down- grade. Costing analysis during Oct. and Nov. led to requested trading halt and profit downgrade in Nov. December 17, 2013 FGL awarded major $40 million contract in North American coal sector January 10, 2014 $1.25 Trading halt until January 14, 2014 January 14, 2014 $1.02 Trading halt until January 28, 2014 January 24, 2014 January 28, 2014 $0.90 February 10, 2014 $0.92 Trading ceases February 11, 2014 Board appoints administrators, and secured creditors appoint receivers. Instead cost overruns and poor budgeting meant that the projects’ revised 2013 estimates showed a $61 million project margin loss for the DPS project and a $41.7 million project margin loss on the WAPS project. The cost overruns on these two projects