A: Yes, distribution rights are included in “Other Assets.” Footnote 5 on page seven of the Sacramento Distributors financial statements shows the composition of other assets. As you see if you turn to the footnote, other assets are comprised of Due from Related Parties, Security Deposit, Distribution Rights, and Franchise fees. That Due from Related Parties is due from the owner, Melvin Ho. That is money that Ho has taken out of the company in the form of a loan for taxes and compensation, and so that is information that we need to compute Business Profit and Business Cash Income. In this case, the asset went down by $2,250, which means that $2,250 of the loan to the owner was reclassified as distributions in 2004.
You are correct that the distribution rights did not decrease. In fact, distribution rights increased by about $60,000 on a gross basis and about $54,000 on a net basis.
Q: Even though a guarantor may not have a great deal of liquid personal assets, their guarantee is still important for other reasons – like keeping that individual tied to the company and as interested in the success of the company as we are. Would you agree?
A. That is absolutely correct. Let me just emphasize that point. In the case of Larry Crevin, we see someone who has substantial liquid resources, but even if he did not, taking the personal guarantee would keep him tied to the business, and that is certainly something we want to happen, because if that business is going to succeed, it is going to succeed with present management. And so if we are going to bank that business and provide the financing, we want to be certain that we have, in this case, Larry Crevin’s full and undivided attention. In many cases, too, with somebody like Larry Crevin, he will conclude, as he has concluded, that the path to his own personal wealth is through Total Coverage, Inc. It is the company that is generating the cash flow that is allowing him to make good investments, and so, yes, a guarantee has more than just a financial dimension. It certainly has an ongoing viability dimension, in that it ties that owner completely to the fortunes of the company.
Q. “Why would there be such a flip-flop between Sacramento Distributors’ short-term debt and long-term debt?
Short term assets would be the receivables from the bars and restaurants, which may or may not be collectible; it gets back to the issue of the bad debt expense, whether it should exist, or, secondly, about the ability to liquidate the inventory- in this case the beer and mineral waters. What would the liquidation values of those short-term assets be in bankruptcy proceedings versus the liquidation value of equipment the company owns?
And so the lender may have had some role in the debt restructure. Obviously the lender did have some role, since it had to approve the reduction in the short-term debt and expansion of the long-term debt, but this flip-flop might have been at the lender’s request.
Q: Couldn't the increase in long-term debt be attributed to the assumption of the warehouse debt?
A: Assumption of the warehouse debt would be a logical reason for long term debt to increase, had that assumption taken place in 2004; however the warehouse debt was assumed in 2002 (per footnote #6 on page 7 of the Sacramento Distributors, Inc. financial statements). The only plausible explanation that I can think of for long term debt to increase from 2003 to 2004, while fixed assets decreased, is that the lender may have required that a portion of short term debt be converted to long term debt.
Perhaps the lender feels more comfortable with the amount and the type of collateral underlying either a term loan facility versus a short term facility. Short term assets would be the receivables from the bars and restaurants, which may or may not be collectible. Perhaps the line of credit was not revolving and the lender required that a portion of it be termed out. But these are only hypotheses.