Microline Corporation Memo

In reviewing the financials of the Microline Corporation, I recommend that we move forward with acquiring the corporation. On top of being a solvent company, they’ve shown increased sales, net income and returns on equity and assets over a two year period. They are a profitable company showing good potential for growth with an indicator of strong earning power potential. There are some several areas of risk however, but I believe the potential for reward outweighs the risks.

From a solvency position, Microline seems to be in pretty good shape. There is a debt covenant which holds the company to a current ratio greater than 1, which during 2011 the current ratio exceeded that amount (1.3). Because the debt covenant has a restriction on the current ratio, I don’t believe management’s reporting decisions are influenced, as they’ll always want their current assets to grow greater than the current liabilities so they will be covered. Also, the current ratio has increased year over year by .33. While the quick ratio shows room for improvement (.72), there was significant improvement year over year (up from .46). The interest coverage ratio is worrisome at .5, down YOY from 1.75; however that is probably driven be the increase on the interest expense associated with the debt covenant.

From a balance sheet perspective, Microline has an average return on assets at 7%, up YOY from 2%. The company acquired one company in 2010, Littleton, and paid $12,750, which was a 70% premium on the fair market value of $7,500. Microline is also invested 40% in Ellery Incorporated, an affiliate company. Ellery received no cash during 2011 but paid out 40% of its income in the form of a dividend. Ellery had a net income of $4,000 in 2011 which Microline recognized 40% of ($1,000). This affiliate is a profitable asset and is a positive for Microline to have on its books and as a equity owner. The current assets of the company are in good shape as well. Every account has...