The detailed information behind Marvel's first quarter report (see 'Marvel First Quarter Results') paints a picture of a company in considerable cash flow distress despite its $14 million in cash reserves and improving operating picture. Marvel (producer of Toy Biz toys and Marvel Comics) cannot borrow any money on its operating line with Citibank or finance any additional letters of credit with its suppliers, and in fact must deposit cash balances to offset the outstanding $17 million in letters of credit currently provided by Citibank. A letter of credit is a commitment by the bank to pay a debt of Marvel either outright or on a standby (only if Marvel doesn't pay it directly) basis.
Reading between the lines, Marvel apparently first got into trouble with its Citibank line of credit last August, when the financing agreement was amended to provide that the covenants (typically financial requirements regarding key ratios, profitability, balance sheet composition, or other criteria that must be met in order to maintain the credit line) would not be tested as long as Marvel kept its borrowing at least $20 million below its 'borrowing base.' We didn't go back to the original agreement to see how the borrowing base is calculated, but typically it's a discounted percentage of receivables, inventory, or both. With $17.5 million in letters of credit on the books at the end of the first quarter, Marvel was unable to meet the requirement for waiving (or not testing) the covenants, and since it was not in compliance with its borrowing covenants the Citibank credit could have been pulled absent a new agreement.
It was in this context that Marvel signed a new agreement with Citibank on May 14th providing that no additional money will be lent or letters of credit issued, and that Marvel has to start depositing money in a collateral account and have the whole $17 million in letters of credit (plus the 4.75%! fee) covered by the end of November, 2001. Furthermore, Marvel was required to collateralize the letters of credit with its full intellectual property assets.
Marvel also announced that it has begun requiring its Toy Biz customers to finance their purchases with letters of credit to Marvel. Presumably Marvel will then assign or otherwise direct these letters of credit to its toy suppliers, eliminating the need for bank financing of toy purchases. It is not an unknown practice for mass merchants to finance purchases in this way, but it's likely that Marvel will be paying a substantial premium for this financing versus what a financially stronger company would pay a bank.
With no additional bank financing available, and signs that Marvel's suppliers may be requiring letters of credit to a greater degree than in the past, Marvel is going to have a hard time generating enough cash to cover its nut. Marvel burned around $8 million of cash in the first quarter of 2001, and with $14 million in the bank and trouble getting more credit, it must turn its operations cash positive fast or be in serious trouble once again. Amending its financing agreement twice in nine months is also a sign that Marvel may have been surprised by the size of its Toy Biz losses, indicating that management may lack 'visibility' (to use the word du jour in the financial press for the inability to predict future performance). Marvel management continues to assert that it has enough cash for the future; pop culture stores that rely on Marvel for comics and toys hope they're right.