Elite Running

1. Elite Running Responses to Questions

2. The controller explains the $3 million reversal of the inventory write-down in the current year • We had trouble selling our top-of-the-line trail shoe, Switchback, in 2002. Marketing and sales research indicated a strong market for a trail shoe that combined all the bells and whistles of our top-of-the-line running shoe with the ruggedness of our top-of-the-line trail shoe. We began production of Switchback in the third quarter of 2001 and began selling it in the fourth quarter of 2001. The sales forecast and results looked promising halfway through the second quarter of 2002. But the market simply evaporated by the third quarter of 2002. So, we decided it would be best to take a $3 million write-down for the remaining inventory we had on hand for Switchback. This was the reserve that was recorded in 2002. • In 2003, marketing and sales took a second chance in pushing Switchback to our distributors. The market research still indicates that a high potential demand for Switchback. I’m sure it is just a matter of convincing retailers to put the product on their shelves again. Once we get retailers to believe our market studies, the distributors will fall right in line. Distributors can’t argue when the manufacturer has the product and retailers want it. At the end of the year, the director of sales indicated that two of the largest retailers were about ready to request the product from their distributors. So it looked like the Switchback line would be back in action.

3. The AR manager explains the $7 million decrease in accounts receivable in the current year compared with the prior year 2003 wasn’t the greatest for Elite. I had to hear the sales people moan and groan all year long about not making their numbers and not getting the big fat bonus they are accustomed to receiving. Life is tough when you can’t buy another expensive imported car for your collection. I guess that’s what happens when you take your eye off the ball. But anyway, sales were down from the current year compared with the prior year — 24 percent, I believe. As you know, our sales are relatively consistent throughout the year. Therefore, a drop in sales will usually result in a proportionate drop in accounts receivable. There’s nothing magical about the current-year variance in accounts receivable, just a decrease in sales.

4. The AR manager explains why the 24 percent drop in sales should have resulted in current-year receivables being $51 million rather than $60 million I see what you’re saying. With the drop in sales, the total receivable balance should have been even lower. I didn’t see that. Management just beats up on me to make sure that the balances are consistent. Here are the aging balances for last year and the current year:

5. The AR manager’s response continued • My goal is to keep the “less than 30 days outstanding” at 85 percent. Personally, I think that goal is a little steep. I got pretty close to it this year, but being close only counts in horseshoes. But, you can see that there was not a significant change in the aging when you look at the percentages. So, the fact that receivables are higher than your expectation isn’t because of the aging. I guess the difference is associated with these Andy Dufresne sales, classified in other receivables. There were three separate sales transactions (A, B, and C), each for about $3 million; these are included in the current aging bucket. We still haven’t collected the cash on those sales, but I was told by the boss not to worry about them. Don’t know much more that that.

6. The inventory manager explains the current-year increase in inventory We sure have a lot more inventory on hand at the end of the current year compared with the prior year. A lot of this was planned. You see, our suppliers sometimes get cute with their pricing and try to entice their customers to buy a lot of their products before year-end. I guess their business isn’t much different than ours. Everyone wants to get more sales out the door before the end of the year. Sometimes our suppliers will offer a deal that isn’t worth the hassle, and sometimes they offer a deal we just can’t pass up. At the end of 2003, one of our largest rubber manufacturers offered a great price on anything purchased, shipped, and received before the end of the year. This manufacturer also offered a cash discount if we paid the invoice within 10 days. We thought this would be a great deal, so we received the shipment just before we closed the doors for the year. I think this shipment was worth about $10 million or $11 million.

7. The inventory manager explains why inventory is still higher this year compared to last year, despite the inventory receipt just before year-end • I guess this is because of our poor sales this year. Our actual sales were much lower than forecasted. In other years in which we had poor sales, we usually cut down on production to make sure we didn’t fill our shelves up with too much stuff. But, upper management wanted to keep the production lines running at full steam. I guess they expected things to turn around pretty quickly. Well, it didn’t happen, and we now have about $5 million in extra inventory on the shelves because of it. • There was also a change in our inventory write-down. Management believed that the $3 million write-down wasn’t necessary anymore.

8. Sales and marketing explains the decline in sales and the change in gross profit • 2003 was very difficult and surprised all of us. Normally, we experience moderate increases in the demand for our products. So, upper management forecasted a 10% increase in sales compared with the prior year. But this forecast was prepared before we knew that a new competitor, Stampy, had entered the market with similar-quality products. In addition to the similar, if not better, quality of Stampy’s products, they are selling these products for lower prices. When we figured out what was happening, some customers had already switched to Stampy. This caused a big cut into our projected sales. We realized that if we didn’t change the way we did things around here, Stampy could end up with all of our customers and put us out of business. So we reacted fast. We started to cut prices on all of our products that Stampy was offering. This helped a lot in retaining our current customer base. The only downside was that our gross profits shrank. We have historically experienced a 25 percent gross margin. After the price competition in the current year, our gross margin was down to 14 percent. Now we have the uphill battle of trying to win some of our customers back.

9. Sales and Marketing explains the Andy Dufresne sales • The Andy Dufresne sales are a new sales and marketing tool we are using to win back some of our customer base. It is a relatively new concept, and we have only had three such transactions so far. The good news is that our customers really enjoy the transactions we have structured. All the new structures are designed to provide our customers with greater financing flexibility, while allowing us to record higher sales volume and win customers back. The first transaction was structured so that customers receive a bulk order but don’t have to pay the invoice until nine months after the shipment. The second transaction was structured so that the customer purchases the inventory today but we don’t deliver it for two or three months (whenever the customer tells us to deliver it). Also, payment isn’t due until the customer receives the product. The third transaction was structured so that we deliver the product at a predetermined date about a month after the sale. The best part of this transaction was that the customer agrees to pay the invoice within 30 days after entering the agreement.