Please prepare a 2-3 page paper answering the case study questions. Note: Papers should NOT exceed 3 pages. Please use Times New Roman, 12-point font with 1” margins on each side (double-spaced). I recommend the following format for the paper: Introduction, Headings for each question, Conclusion/Summary. In addition, please cite references.
You should answer the case study questions by clearly stating your position(s) and supporting your points of view. In addition, I encourage you to incorporate insights discussed throughout the course and provide additional information beyond what was discussed in class (e.g. include current events and external references).
Recharge Due Diligence Instructions: Please prepare a 2-3 page paper answering the case study questions. Note: Papers should NOT exceed 3 pages. Please use Times New Roman, 12-point font with 1” margins on each side (double-spaced). I recommend the following format for the paper: Introduction, Headings for each question, Conclusion/Summary. In addition, please cite references. You should answer the case study questions by clearly stating your position(s) and supporting your points of view. In addition, I encourage you to incorporate insights discussed throughout the course and provide additional information beyond what was discussed in class (e.g. include current events and external references). Background: Your client is Illini Partners, a private equity firm interested in purchasing Recharge Products, Inc (the “Target”). The Target is a California-based technology company (headquartered in Silicon Valley, California) that manufactures and distributes battery charging cases for smartphones and other devices. The Target is an industry leader in the highly competitive protective case category. Since inception in 2009, Recharge has experienced substantial growth in sales and profits due to overall category expansion and the Target creating new and trendy products. The Target’s top customer is Apple, who represents 33% of their annual sales. The Target signed an exclusive supply contract with Apple in 2012. The 10-year contract is up for renewal in fiscal 2022. The fast-growing battery charging case market has attracted increased competition and Apple is rumored to be exploring entry into the space by introducing their own battery charging cases. Battery charging cases are a fast-growing category. Form factors frequently change due to new cell phone introductions (on an annual basis) that have different size and charging compatibility requirements. Assignment: Illini Partners has hired you to perform due diligence for their potential acquisition of Recharge. Read the documents provided and address the following questions: 1. What are the business/operational risks related to the Recharge acquisition? When appropriate, use ratio analysis to support your points 2. Do you believe management’s Non-GAAP adjustments are appropriate? Why or why not? 3. Which valuation model (P/E, P/B, P/S, EV/EBITDA) should be used to calculate Recharge’s estimated market value? Why? Do you believe Recharge’s valuation should be equal to, less than or greater than the peer average multiple? Why? Consolidated BS CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2019 AND 2018 ($ in 000's) ASSETS20192018 CURRENT ASSETS: Cash $158$354 A/R $3,336$1,590 Inventory $4,892$2,231 Prepaid expenses $60$34 Deferred tax asset $7$0 Total Current assets $8,453$4,209 LONG TERM ASSETS: Property and Equipment$513$3,160 Other$318$24 Total Long Term assets $831$3,184 TOTAL ASSETS$9,284$7,393 LIABILITIES AND STOCKHOLDERS’ EQUITY 20192018 CURRENT LIABILITIES: Current debt and line of credit$1,545$1,246 Accounts payable $1,634$1,951 Accrued expenses $1,065$716 Total current liabilities $4,244$3,913 LONG-TERM LIABILITIES: Long-term debt$626$474 Notes payable$2,062$1,600 Other $125$125 Total long-term liabilities $2,813$2,200 Total Liabilities $7,057$6,113 STOCKERHOLDERS' EQUITY: Common stock$1$1 Retained earnings $2,225$1,279 Total stockholders' equity $2,226$1,280 TOTAL LIABILITIES AND EQUITY$9,284$7,393 Income and RE CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018 ($ in 000's)2019% of Sales2018% of Sales SALES$21,666$14,995 COST OF SALES $14,145$9,898 GROSS PROFIT$7,52134.7%$5,09734.0% GENERAL AND ADMINISTRATIVE EXPENSES $6,15528.4%$3,79725.3% INCOME FROM OPERATIONS $1,3666.3%$1,3008.7% OTHER INCOME (EXPENSE): Interest expense—net of interest income($183)($96) Other-net$67$0 Total other income (expense) ($116)($96) INCOME BEFORE INCOME TAXES $1,251$1,205 Income Tax Expense$536$375 NET INCOME$714$830 Cash Flows CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018 ($ in 000's) 20192018 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $714$830 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization $228$154 Loss on equipment$163$0 Other($72)$151 (Increase) decrease in assets: A/R ($1,746)($2,021) Inventory ($2,661)($932) Other($29)($522) Increase (decrease) in liabilities: Accounts payable ($317)$1,787 Income taxes payable $923($805) Accrued expenses ($574)$172 Total adjustments ($4,086)($2,017) Net cash used in operating activities ($3,372)($1,188) CASH FLOWS FROM INVESTING ACTIVITES: Proceeds from the sale of equipment $1,988$0 Purchases of property and equipment ($464)($2,109) Other($8)$0 Net cash provided by (used in) investing activities $1,516($2,109) CASH FLOWS FROM FINANCING ACTIVITIES: Increase (decrease) in line of credit ($731)$1,246 Proceeds from long-term debt $4,823$2,440 Payments on long-term debt ($2,432)($177) Net cash provided by financing activities $1,660$3,510 NET INCREASE IN CASH ($196)$213 CASH BALANCE- Beginning of year $354$142 CASH BALANCE- End of year $158$354 Notes to Consolidated FS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Revenue Recognition—Sales are recognized on an accrual basis upon shipment of merchandise to customers. Title transfers to the customer upon shipment destination. Allowance for sales returns are recorded in the period the allowances are earned. Warranty expense is recognized when a customer submits a warranty claim. Accounts Receivable—The Company extends unsecured credit to customers under normal trade agreements, which predominantly requires payment within 30 days. Management has determined that an allowance for doubtful accounts is not necessary as of December 31, 2019 and 2018. This determination is based upon management’s review of delinquent accounts and an assessment of the Company’s historical evidence of collections. Specific accounts are charged directly to expense when management obtains evidence of a customer’s insolvency or otherwise determines the account is uncollectible. Bad debt expense, net of bad debt recovery, was $20,463 for the year ended December 31, 2019. Bad debt expense, net of bad debt recovery, was $38,102 for the year ended December 31, 2018. Inventories—Inventories are stated at the lower cost or market based on first-in, first-out method valuation. Market is determined by net estimated realizable values. Property and Equipment—Property and equipment are stated at cost and consist of real property, furniture and fixtures, machinery and equipment, tooling, and leasehold improvements. Depreciation is calculated utilizing both straight-line and accelerated methods over the estimated useful lives of such assets ranging from 3 to 40 years. Expenditures of maintenance and repairs are charged to expense as incurred. Product Warranties – The Company generally warrants its product eighteen months from shipment. Warranty expense is recognized when a claim is paid by a customer. Concentrations—The Company’s largest vendor accounts for approximately 49% and 45% of total inventory purchases for the years ended December 31, 2019 and 2018, respectively. The Company’s largest customer accounts for approximately 28% of sales for 2019. The Company’s largest customer accounts for approximately 25% of sales for 2018. Use of Estimates—The preparation of financial statements in conformity with United States GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ from those estimates. 2. INVENTORIES Inventories at December 31, 2019 and 2018, consist of the following: 20192018 Finished goods $ 4,198,915$ 2,568,242 Reserve release $ 400,000$ - 0 Raw materials$ 250,366$ 97,477 Reserve for inventory obsolecence $ (100,000)$ (500,000) $ 4,749,281$ 2,165,719 The inventory reserve was reevaluated in 2019. Due to the strong demand for the Company’s current inventory, the Company released a reserve of $400,000 to reflect the current and anticipated sales projections. The reserve release was recorded as a reduction of Cost of Sales. 3. LINE OF CREDIT The Company has a $5,000,000, revolving line of credit from a bank that bears interest at LIBOR plus 1.5% or Prime less 1.25% (at the discretion of the Company). Interest is paid monthly. The one-month LIBOR rate at December 31, 2019 and 2018 was 4.39% and 2.40%, respectively. The prime rate at December 31, 2019 and 2018 was 7.25% and 5.25%, respectively. At December 31, 2019 and 2018, the Company had outstanding balances on the line of credit of $500,000 and $1,210,000, respectively. The line of credit is collateralized by significantly all assets of the Company. The entire principal balance, together with all accrued and unpaid interest outstanding hereunder, shall be due and payable in full on the earlier of August 31, 2020, or upon acceleration of the note, if not otherwise extended or renewed. Certain loan covenants are required to satisfy the conditions of the agreement including the maintenance of minimum financial standards as defined in the loan agreement. The Company was in compliance with such covenants at December 31, 2019. 4. LONG-TERM DEBT Long term debt at December 31, 2019 and 2018 consists of the following: 20192018 Bank note payable bearing interest at LIBOR plus 1.5% or Prime less 1.25% at management discretion; monthly payments of $83,333 plus interest, due August 31, 2020. Secured by significantly all assets of the Company. $ 1,608,204$ - 0 Bank note payable bearing interest at the prime rate; monthly payments of interest only, due April 15, 2019. Secured by a mortgage on certain real property. Guaranteed by a certain shareholder. $ - 0$ 460,540 Current portion $ 1,000,000$ - 0 Long-term portion$ 608,204$ 460,540 5. CONTINGENCIES During 2015, the Company entered into a verbal agreement with a certain vendor whereby the Company provided technical assistance to the vendor to enable them to produce certain inventory items to be sold exclusively to the Company. In 2019, the vendor violated this agreement by selling such inventory items to independent third parties. In accordance with the terms of the agreement, the Company has the right to extinguish any amounts due to the vendor in response to this violation. Accordingly, the Company has written-off accounts payable to the vendor of approximately $223,000 during 2019. This write-off is included in other income, net on the accompanying consolidated statement of income and retained earnings. Management believes the write-off is within their rights in accordance with the terms of the agreement. The aforementioned vendor was also in possession of certain company-owned equipment with a net book value of approximately $131,000. The Company was unable to recover such equipment from the vendor. Therefore, the net book value of the equipment has been written-off and is included in other income, net on the accompanying consolidated statement of income and retained earnings. The Company is subject to claims and lawsuits in the ordinary course of business. In 2018, the Company was found in violation of Environment, Health, & Safety regulations after an investigation surrounding an injury of an employee. The resulting damages and fines totaled $250,000, which was paid and recorded as an expense in 2019. The case is