I spent my professional accounting career in the realms of strategy, governance, information technology, public sector and peripheral fields such as risk or project management. Although I have not done financial analysis in awhile, it is still fun to dust off the old neurons and see if they still work.

In this context, below is my analysis on four fiscal years for MEC (formerly the Mountain Equipment Cooperative). In a previous blog, MEC Debt Matters, I provided some thoughts for creditors as the future of this Canadian retailer works its way through the judicial process. This blog is my own thought exercise of how MEC wound up before the bankruptcy courts and what do the numbers look like anyway. MEC changed its financial year from December to February five years ago. Because inter-year comparisons would require a proration, I used four rather than say five fiscal years.

A Caveat Before Discussion

This analysis is entirely for information (or perhaps entertainment) purposes only. It is not meant to be professional advice to anyone. MEC members are welcome to build on this start but if they reference any of the following, this caveat must be included. The existing MEC members, board, creditors and others should not rely on this blog.

Information Sources and Structure

All of the information presented here is publicly available primarily from MEC.ca [1].  For one or two numbers I had to estimate an amount (e.g. employee count as of February, 2020). You can also request my working paper if you want to play with the values (via email or the comments section below).  The analysis is broken into the following sections: 

• MEC-Debt, How Bad Is It?
• Operations, Is MEC Making Money?
• Other Measures and Potential Questions.

MEC-Debt, How Bad Is It?

Obviously bad enough that MEC sought bankruptcy protection and the board is proposing the organization’s sale.  The first measure is the current ratio which is essentially how capable is the organization in meeting its short-term obligations (liabilities) from its easy to liquidate assets (e.g. cash, inventory, receivables, etc.) [2].  The question of what is a good current ratio is a function of industry.  A basic Google search suggests that most retail businesses have a ratio of about 1.2 to 1.5; about where MEC was two years ago [3]. 

The Gross Margin to Debt Service Ratio is my own creation.  It is essentially how much money is being generated to cover outstanding debt including that to suppliers.  In 2017 and 2018, the earnings before interest and taxes could cover about a tenth of the debt.  In subsequent years, there was not sufficient income to cover it and debt would accumulate.  

Select Key Indicators	2020	2019	2018	2017
Current Ratio	59.5%	67.8%	132.2%	126.2%
Gross Margin/Debt Service Ratio	-3.9%	-5.1%	9.3%	9.7%

Operations, Is MEC Making Money?

Is MEC making money, the answer is ‘no’ and ‘sort of’. Over the past four years, MEC has had an overall Deficit.  2018 is the exception because of the sale of the Toronto Retail store for $49.4 million along with a leaseback arrangement [1, February 25, 2018 financial statement, Note 6].

A better measure of the core business of the organization is Gross Margin which is Sales less the cost of the sales (e.g. what the MEC coat sold for less what it cost to buy it).  As a ratio, this is Gross Margin/Sales [4]. As a percentage, the gross margin has been relatively consistent and in the ball park for retail organizations [5]. 

Operating costs as a percentage of Gross Margin is another way of expressing profitability.  In 2020’s case, the operating costs exceeded the gross margin by 17.6%.  In other words, there were not enough net-sales to cover the overhead.  Core Operating Costs includes things such as salaries or rent but excludes amortization and interest payments.  In 2017 and 2018 MEC was barely generating sufficient sales and not enough to service its debt or to replace its capital.  

Is MEC making money, not really and it hasn’t been for a while.  

Select Key Indicators	2020	2019	2018	2017
Surplus/Deficit	($33,632)	($10,964)	$8,540	($3,205)
Gross Margin %	32.3%	33.9%	31.5%	31.4%
Operating Costs /Gross Margin	117.6%	115.2%	110.0%	106.4%
Core Operating Costs/Gross Margin	103.6%	103.0%	95.8%	94.2%

Other Measures

The following measures are a bit of an assortment: 

• Gross Margin/Employee: This is a measure of the effective use of staff.  The fewer the staff, with Gross Margin held constant, the higher the number.  There has been a year over year increase over the past 4 years suggesting management was doing a good job of trying to hold down staffing costs.  
• Gross Margin/Store: Similar to the above measure, how profitable is each store – on average.  I suspect that this number would vary widely across the stores.  A better measure would be something like Gross Margin/Square Metre of space.  
• Gross Margin/Member: With an increasing membership, how much profitability does each additional member add.  Not much it seems.  Increased membership has not translated into increased sales or profitability for MEC. 

Select Key Indicators	2020	2019	2018	2017
Gross Margin/Employee	$61.95	$60.61	$53.69	$59.75
Gross Margin/Store	$6,803	$7,116	$6,506	$6,970
Gross Margin/Member	$26.13	$28.73	$27.71	$30.04

Potential Questions

Well, it has been fun remembering, researching and calculating the above.  Assuming there are no significant or material errors in my calculations and methods.  As well, I have to assume that the current and past boards were made up of people acting in good faith and on the best available information.  Nevertheless, as a MEC Member, I do have some questions these numbers infer: 

1. Given the declining profitability of MEC since 2017, what measures did management and board take to return the organization to the black and how was this communicated to the membership?
2. MEC took on significant debt to cover the above losses during this period.  It appears that the organization was ill position to service this debt.  What advice did the board receive that lead to it approving taking on this debt?  
3. How profitable was the online business as compared to the physical-store model and assuming it was more profitable (think Amazon), should MEC have divested or reduced the size of its stores during this period?
4. A number of stores were added in the above period [6].  What analysis was performed on the profitability of these additional stores?  What assumptions failed to materialize or what risks did materialize that changed the above decision?  Did the board attempt to slow down or otherwise mitigate the expansion on the basis of this new information and changing circumstances?
5. Given the long-standing financial challenges, why did MEC not engage membership sooner in the challenges of the organization?

Notes and References

1. Annual Reports and Scorecards are available from: MEC’s TRANSPARENCY AND REPORTING.  
2. Investopedia:: Current Ratio.
3. Ready Ratios, Current Ratio – breakdown by industry.
4. Investopedia:: Gross Margin Definition.
5. Ready Ratios, Gross margin – breakdown by industry.
6. Wikipedia, Mountain Equipment Coop; 2015-19.