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Sally Holton examined Blue Wood's recent results and these are summarized in Appendix I. She could not find many comparable U.S. companies with published financial results. The only ones she could find that were vaguely comparable were The Hershey Company and Rocky Mountain Chocolate Factory, Inc., although these companies were of significantly different scale and scope of operations. Their results are summarized in Appendixes II and III, respectively.

The first things Sally noted were that almost all of Blue Wood's profitability measures were significantly worse than those of Hershey and Rocky Mountain. Sales growth had been sluggish compared with the others, and Blue Wood's gross margin was substantially lower. Moreover, Blue Wood's gross margin was quite volatile. Sally determined that the largest factor causing this volatility was gains, losses, and changes in the fair value of commodity derivatives. The one favorable comparison was selling, general, and administrative (SG&A) expenses.

Discussions with the sales department convinced Sally that the main problem was on the production side, although a drop in sales in the first half of 2013

U.S. Milk Prices, 1995-2013

Exhibit 18.3 U.S. Milk Prices, 1995-2013

Source: U.S. Department of Agriculture.

was worrying. She had been shown correspondence from customers complaining about unreliability of delivery schedules and returns of substandard product due to poor quality control. The sales and marketing department had also provided market research showing that Blue Wood's published selling prices were broadly in line with those of competitors, although she suspected that discounts might shine a slightly less favorable light on the situation.

Blue Wood's cash position had been deteriorating over the periods Sally examined. A healthy cash balance had disappeared and the company was now borrowing under the bank revolver line. Retained earnings had also been falling. Part of this was due to the high dividend payments, particularly in 2012.

Sally noted that Blue Wood's long-term debt, both the senior notes and the bank term loan, were to mature in two years' time. Scheduled reductions of the bank loan had started in 2012. No consideration had been given as to how these may be repaid or refinanced, nor did anyone seem particularly concerned. The CEO, John Ferguson Junior, was confident that the bank would support the company. It had always done so in the past, and he and the bank's chairman were members of the same golf club. He did refer to the bank's chairman in rather colorful language that was not particularly respectful of the latter's intelligence.

On the plus side, Blue Wood had built up a significant balance of investments amounting to around $56 million at the end of June 2013. Sally was informed that this was to enable future payments of dividends in case cash flow was insufficient. These investments were not available to be used in the business. The investments consisted of stocks, bonds, exchange-traded funds, and some investments in private companies. Sally could find little information on the last of these. There was no company policy regarding management monitoring of investments. Funds were managed and invested upon the recommendation of the chairman's personal broker. His recommendations had always been followed without exception.

Sally had also learned from speaking to internal counsel that Blue Wood faced a possible $10 million lawsuit from parents of a child who had suffered from severe poisoning after eating one of the company's products. The parents claimed that the child has had difficulty concentrating and learning and has also become incontinent since eating the chocolate. Counsel considered the lawsuit frivolous and recommended resisting it or, at most, offering a small settlement to make it go away without accepting liability and while insisting upon confidentiality. He did agree with Sally that, regardless of the merits of the case, there could be significant adverse publicity if it went to a jury trial, and the result could be a bit of a lottery. When Sally mentioned the potential lawsuit to the CEO, he said he had not heard of it, but was happy to concentrate on running the business while counsel took care of such legal things.

Sally also found that certain foreign exchange futures had been transacted by the previous CFO to hedge his estimate of 50 percent of exposure to Canadian dollars (CAD), euros (EUR), and pounds sterling (GBP) over a one-year horizon. His estimates were essentially back-of-the-envelope approximations and appeared to have little relation to reality. Moreover, some of the local offices had also entered forward contracts with local banks that duplicated what the previous CFO had done. Exhibit 18.4 shows historical exchange rates for CAD, EUR, GBP, and MXN (Mexican peso) against the U.S. dollar. Note: MXN is divided by 10 for scaling to fit the graph.

Exchange Rates

Exhibit 18.4 Exchange Rates


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