Please discuss the Atlantic Lumber Traders case study, focusingthe following elements of the case:
· Identify the problem in financial terms
· Diagnose the cause(s) by identifying specific businesspractices or situations that created or caused the problem
· Prescribe possible alternatives
· Recommend a plan of action (decision/implementation) alongwith proposed financial metrics (ratios/measures) which woulddefine improvement success
· State the importance and relevance of the case to the study ofbusiness.
On April 20, 1989, Lynne Thomas put down the phone and looked atthe notes before her. Gad Hall, one of the owners of AtlanticLumber Traders, had just given Lynne the final details she needed.As credit assistant to Harry Sarson of the Maritime Bank in SaintJohn, New Brunswick, Lynne had been asked to review the file ofAtlantic Lumber Traders. Her job was to decide if Gail Hall’sexplanation of what had gone wrong was plausible, then to predictrisks to the bank under various projections of the company’sfuture. Finally, Lynne was to make recommendations for action bythe bank In the worst instance, if a turnaround was not possible,it was Lynne Thomas’s job to recommend the best course for theorderly wind-up of Atlantic Lumber Traders. The file indicated thatAtlantic Lumber Traders had been established in 1983 in Saint Johnto wholesale lumber in the Atlantic provinces. Major shareholderswere brother and sister Edward and Gail Hall, members of a wealthyand respected family with a long entrepreneurial history in NewBrunswick. After four years of profitable operations, the companyshowed an operating loss of $219,666 and a not loss of $174,216 onsales of $17 million for the year ending December 31, 1988. Thisloss was an urgent concern to the Halls and to the Maritime Bankwhich had extended the company a $1.3 million revolving line ofcredit (at prime plus 1%). When the third quarter results were in,Gaff Han felt she needed to personally take charge of the company.In October of 1988 she therefore put aside her lucrative lawpractice (she had netted $140,000 in 1988) to devote her fullattention to the company. She first had to identify its mainproblems, then take corrective action. Company History Edward andGaff Hall, both lawyers in their mid-thirties, had set up AtlanticLumber Traders in 1983 to wholesale lumber. Atlantic Lumber Tradershad sales territories in the four Atlantic Provinces, Quebec andOntario and, secondarily, in the United States. Approximately 80%of sales were generated in the Atlantic Provinces, 19% in Quebecand Ontario and I % in the United States. Shares had been owned byEdward and Gail, and also by David Lawson, who had managed thecompany until October 1988. At that time he was released and Edwardand Gail had purchased his shares for one dollar. Lawson was blamedfor the company’s poor performance in late 1987 and 1988. TheHalls, however, admitted they should have been more involved. Withthe exception of 1988, the operation had enjoyed significant salesincreases from $3 million for the first year of operation (1984),to $19 million for fiscal 1987 (Exhibit 2). Net income had reacheda high of $128,000 (after a $48,000 loss from a rental operation).The rental operation consisted of two sixteen-unit apartmentbuildings acquired by the company in 1987. The rental operationloss was intended to offset income from the lumber operation.During 1988, due in part to the poor performance of Atlantic Lumbertraders, the rental property was sold (at book value) to anothercompany operated by the Halls. According to Gail, the rentaloperation now broke even because she stepped in, did somerefurbishing, changed property managers and thus increasedoccupancy. The lumber operation was straightforward. At the end of1988, Atlantic Lumber Traders had a sales team of four – threefull-time traders and a general manager who did some selling – towholesale lumber to a customer base of 50- 100 large retailers. Thesales staff were paid a commission of 1.8% and the mark-up rangedbetween 4.5% and 5.5%. No inventory for the bulk of sales wasrequired, as orders were placed with the mills as received and woodwas transported from the mill directly to the purchaser. AtlanticLumber Traders had a small administrative staff of two to threepeople to handle accounting. Terms with most mills were net tendays, with an average collection period on receivables of 22 daysin 1987 (37 days for the Industry, see Exhibit 3). The company thusneeded to finance about 40 days’ sales on average, which required alarge capital base. A small inventory of uncommon lengths wasmaintained for special orders; approximate inventory value was$200,000. During 1988, David Lawson had speculated on purchasesboth for resale and inventory, which at one point, exceeded$600,000. In making these purchases, for which there was no firmorder, Lawson had attempted to take advantage of swings in marketprices. During 1987 and 1988 the number of employees had reached ahigh of eleven, with the office staff of six exceeding the salesforce of five. To satisfy customers, Lawson had sold lumber inirregular lots, rather than follow the industry practice ofrequiring customers to buy full lots. As a result, the company wasleft with a considerable stock of less popular lengths, whichrequired a write-down in inventory once this practice wasdiscovered. According to Gail Hall, these practices ended when shetook over the day-to-day operation of the company. Her effortsproduced a small profit of $16,000 for the first quarter of 1989.According to her, this showed that the company had turned aroundbecause the first quarter of the year was traditionally thecompany’s worst. The Principals in the Company Although AtlanticLumber Traders was founded in 1983, the Hall family had beeninvolved in the wood/lumber industry for more than half a century.Hall Investments Ltd. a holding company set up in 1984 by Edwardand Gail, had two wholly owned subsidiaries, one in transportationand the other in a lumber related business. The companies dealtwith all the major banks. The Halls felt they knew the lumberindustry, and that they had the required contacts to generatesubstantial sales. Edward Hall had Because the Halls were veryinfluential in the Now Brunswick marketplace, Lynne knew that herboss, Harry Sarson, wished to maintain their goodwill. However healso wanted to ensure the safety of the bank’s investment. TheBanker’s Risk Assessment of the Company in April 1989 Lynne Thomasidentified four areas where the company significantly risked thebank’s capital: (1) operating losses sustained to date; (2) debt toequity at 17:1 for year-end 1988, down to 4:1 when subordinatedloans1 and liquid security were included for the first quarter of1989; (3) competition; and (4) inability to sustain any furtherlosses. 1 Subordinate to the bank debt. Also called a postponementof shareholders’ claims. In this case the Halls had injected$200,000 (a subordinated shareholders’ loan) into the company sinceyear-end 1988. According to Lynne, there were mitigatingcircumstances for each risk factor. The improvement in performancesince year-end 1988 seemed to indicate that problem areas had beenidentified and corrected. In-house financial statements weremonitored closely by Gaff Hall. Lynne did not consider theCanada-US Free Trade Agreement a significant risk; Gail assured herit would have little impact on the 1% of company sales to the US.Personal guarantees in the amount of $316,000 from the Halls partlyoffset the debt to equity position. Atlantic Lumber Traders had anestablished client base.; the Hall name had been synonymous withlumber for over fifty years. Lynne felt that reluctance to tarnishthe Hall family name would prompt Gail to cooperate with the bank.Gaff had indicated that to forestall losses, she would close downoperations if there was any sign of a downturn. Economic ForecastAs part of her background analysis of the business, Lynne hadreviewed the economic forecast prepared by the bank’s EconomicsDepartment in early 1989. The forecast surveyed leading economicindicators, and showed that the economy would begin to slow downduring the second quarter. Ile bank’s economists believed thatinterest rates would remain high as long as John Crow, Governor ofthe Bank of Canada, tried to reduce inflation. The economic reportargued that the Canadian dollar was overvalued relative to the USdollar as a result of high interest rates, and the unusually widespread in interest rates between the two currencies. The Canadiandollar was expected to fall to around 81 cents US by the end of1989. An economic slowdown was also forecast for the Atlanticregion. This would have a negative effect on Atlantic LumberTraders’ sales. The Goods and Services Tax (GST) was to come intoeffect in January 1991, and because of additional record keepingcosts, was expected to have a significant impact on this low marginindustry. Industry Scan Lumber traders’ customers were usuallyindependent supply stores, general contractors working on largeprojects (cutting out the middleman), or large end users such asmobile home manufacturers. Without the service that a lumber traderprovided, the customer (wholesaler or retailer) would have to gothrough a time consuming process to purchase lumber. Wholesalersand retailers avoided the time necessary to purchase directly fromthe sawmill or to purchase partial loads by giving up a percentageof gross margin (usually 5% to 6%) to have the purchasing done bylumber traders. Lumber traders needed experience. to buy at lowcost and to know which sawmills were producing given species,dimensions and grades of lumber at any given time. It was alsoimportant to know the reputation for quality and reliability ofeach mill. The trader also had to arrange for transportation oflumber from the mill to its destination. If a purchaser did notwant a full load, as was often the case, the cost of transporting apartial load could make the order uneconomical. Low cost was acritical factor in the lumber business because it operated on lowmargins. There were risks inherent in the lumber trading business;the most significant was bad debts. The trader was responsible forpaying the mill regardless of whether the customer paid on time,late or not at all. If the customer did not pay, the resulting losscould bankrupt the trader. The trader also had the responsibilityto deliver the stated quantity and quality of product on time.Buying off-grade lumber or having late deliveries could hurtcustomer relations and affect receivables collection. Ile Atlanticprovinces constituted the major market of Atlantic Lumber Traders;this market consumed approximately 1.2 billion board feet of lumberper year. The company’s market share was about 5% in a fiercelycompetitive industry where they competed with other wellestablished families and interests such as the Irvings, anotherinfluential New Brunswick family. Atlantic Lumber Traders had torecover quickly if they were to maintain their competitiveposition. Environmental factors could negatively affect the supplyof lumber. Spruce budworm damage and the controversial forestspraying program had hurt the public image of the forestry industryand the profits of individual companies. Also, sawmills recognizedthe need to control pollution and the costs of doing so would bepassed on to customers. This would put additional pressure onlumber traders’ margins, and might cause some customers to dealdirectly with mills to reduce costs. The Situation in April 1989Since year-end 1988 the Halls had injected an additional $200,000into Atlantic Lumber Traders and the bank had reduced the availableline of credit from $1.3 to $1 million. The availability of fundsunder the operating line of credit was subject to a maximum of: 75%of the bank’s valuation of assigned accounts receivable afterdeducting receivables 60 days or more past due; plus 50% of thebank’s valuation of free and clear assigned inventory to a maximumvalue of $125,000. ‘Me bank asked for, and received, a Section 178lien over inventory in March 1989. The lein effectively meant thatif the company failed, the goods covered by the loin could beliquidated only against the debt owed by the company to the bank,and not to other creditors. The bank also had an assignment of bookdebts (accounts receivable). Action taken by Gail Hall includedreducing staff from eleven to six. The inefficient inhouseaccounting system was replaced by a simple, effective computerprogram. Sales personnel were put on commission only and lost theircommission on accounts unpaid after 60 days. Inventory levels werecut from the $500,000-$850,000 range to below $ 150,000. Accordingto Gail, these changes went a long way toward reestablishingprofitability. With its reduced staff, the company expected to sellabout $10 million of lumber in 1989, compared to $16.9 million in1988. A gross margin of 5% was expected for 1989. Based on pastperformance, on the company’s budget for 1989 and on industrybenchmarks, Lynne projected variable costs for a wholesale lumbercompany at about 3% of sales. She also estimated that fixed costsfor the company were between $14,000 and $15,000 per month. Sheused her estimates to calculate breakeven sales levels and thenprepared a spreadsheet to determine the combined effect (onbreakeven sales and net income) of changing each of her estimatesin turn – recalculating with gross margin, variable costs, andfixed costs above and below the expected values. The Alternativesfor Management and the Bank At their last meeting, Gail had givenLynne a proposal. Based on the improvements since year end, Gailhoped to negotiate an increase in the line of credit from $1 to$1.4 million. This would allow for increased sales to about $14.5million rather than the $10 million expected. Based on historicalsales and the improvements in the first quarter, Gail felt thisfigure more clearly reflected the ability of the company. Accordingto Gail there was space available in the office for another trader,and the administrative capacity to support the added business. Shepointed out that past history had shown the market could supportthe higher sales. Therefore, if the main constraint of workingcapital was overcome, Gail felt that Atlantic Lumber Traders was aviable operation. A more conservative plan, already in the back ofLynne’s mind, consisted of two parts: (1) increase the interestrate by I % (cost to the company $10,000 per year) to coveradditional monitoring costs, and (2) eliminate the margin availableon inventory (50% up to $ 125,000). Besides covering the additionalcosts incurred in monitoring the account, this plan would reducethe bank’s exposure. The lost margin on inventory would have adirect effect on the sales potential for Atlantic Lumber Traders.Lynne knew that at worst, she could recommend that the Halls closedown their operations in an orderly fashion, one sales territory ata time, so that they and the bank would recover their investments.Final Preparations Lynne took a mouthful of coffee and turned toher computer to prepare the report Harry needed before tomorrowmorning’s meeting with Gail Hall. She knew that since Gail Hall’sefforts had resulted in some improvement in company performance inthe first quarter of 1989, and Gail had cooperated with the bank inits review, calling the loan was not an option at this point
Exhibit 1 Atlantic Lumber Traders Balance Sheet(S000s) – December 31 1985 1986 1987 1988 Assets Current Cash Trade Receivables (Net) Other Receivables (Net) 938 39 184 688 101 262 645 1.174 570 0 1.836 Prepaid Expenses Due from Shareholders Income Tax Refund 746 Total Current Assets Flxed Assets 1.194 Land & Buildings Equipment &Machinery Leasehold Improvements Accumulated Depreciation(4 1,150 58 10 (69 1,149 13 Total Flxed Assets Other Assets Intangible Assets Investments in/Due from Deferred Gtee Charges Notes Receivable 180 Total Other Assets Total Assets Liabilitles& Shareholder Equity 328 Current Liabilites S 668 425 Bank Trade Payables Income Tax Payable Current Portion LTD $ 471 985 933 886 467 Total Current Liabilitles Long Term Liabilities 704 1,116 1,962 1,353 501 225 200 Bank LTD Other LTD to related Co.1 Other LTD to related Co. 2 0 Due to Shareholders 17 29 Total LT Liabilities Total Liabilities Shareholder Equity 733 1.133 2,918 1,383 Common Shares Retained Earnings 257 83 84 130 Total Shareholder Equity 42 258 Total Liabilities& Shareholder Equity Unaudited. 2 Audited. Deferred. Source: Company records and bank files
Atlantic Lumber Traders case study
Atlantic lumber traders was established in 1983 by Gaff Hall and Edward in a bid to wholesale lumber. The primary sales territories were in the Atlantic Provi . . .