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Clarkson Lumber

Hardwoods, Hard Times

BBUS 505a
Cavelero, Engstrom, Tobey & Zadah
Overview
• Case Summary

• Problem Identification

• Findings

• Methodology

• Metrics

• Insights
Case Summary
• Clarkson Lumber Company [‘CLC’], is a small PNW lumber concern
experiencing rapid, questionably financed growth.

• Keith Clarkson [‘Clarkson’], sole owner of CLC, has maxed out ($399K of
$400K) his line of credit [‘LOC’] at Suburban National.

• CLC relies heavily on trade credit and short term debt.

• Clarkson wants to move to Northrup National Bank – a larger bank – with a


a $750K short-term LOC.

• George Dodge, Northrup officer, is cautiously receptive. He’s asked a team


of intelligent, attractive analysts to investigate the current state of CLC.
Problem Identification
“Clarkson wants to move to Northrup National Bank – a larger bank offering
a $750K LOC.”

• CLC overuses expensive short-term debt to finance growth and


buyout his former partner.

• It is our opinion that receiving a larger LOC from our bank will result
in negative future growth and exacerbate current cash flow problems.

• There are other problems with cash-flow, including inventory


purchasing, A/R and a 2% A/P discount (opportunity).

• PPE depreciation is an unkown; for our analysis, we factored it out.


Findings
• CLC can be a profitable investment for Northrup, but not with the stated
credit terms. Debt restructuring is needed to maximize CLC’s profitability.

• According to our research, CLC is in danger of growing at a


“unsustainable” pace:
a. Most metrics are highly positive
b. DuPont shows consistent gains
c. However, CLC’s sustainable growth rate is 20.7%; his
current projected growth is 21.7%

• Greatest challenge is cash flow


a. Poor financing, capital structure
b. Growth overly reliant on expensive short- term debt
c. Increasing inventory
Findings
1. Short-term LOC of $750k will put CLC in bankruptcy by the end of 1998

2. CLC’s projected growth creates a forecasted EFN of ~$975K.

3. By maintaining the projected growth rate, Northrup can facilitate CLC’s


maximum profitability by offering “balanced” financing of 35% short-term
(~$340k) and 65% long-term (~$635 k).
Findings
Operating Income

$180

$160 $20

$140 $14
$8
$120

$100 Balanced

$80 Short Term

$60

$40

$20

$0
1996 1997 1998
Methodology
1. Financial Statements Analysis
• Common-Size Income Statement (% Sales)
• Common-Size Balance Sheet (%Assets)
2. Ratio Analysis
• Short-Term Solvency (Liquidity)
• Long-Term Solvency (Financial Leverage)
• Assets Management (Turnover)
• Profitability
3. The Du Pont Identity (Current, Forecasted)
4. Financial Planning
• Estimated sales growth
• Forecasted growth using ‘% of sales’ approach 1996: Q1
• Estimated amount, type of EFN
• Estimated sustainable growth
Clarkson vs. Industry
Low-Profit Outlets High-Profit Outlets CLC 3YR 1995
Percent of Total
Sales:
Cost of goods 76.90% 75.10% 75.60% 75.80%

Operating expense 22.00% 20.60% 20.90% 20.80%


Cash 1.30% 1.10% 1.40% 1.20%

Accounts receivable 13.70% 12.40% 11.90% 13.40%


Inventory 12.00% 11.60% 12.30% 13.00%

Fixed assets, net 12.10% 9.20% 8.00% 8.60%


Total Assets 39.10% 34.30% 33.70% 36.20%
Percent of Total
Assets:

Current liabilities 52.70% 29.20% 48.41% 66.50%

Long-term liabilities 34.80% 16.00% 13.45% 6.10%


Equity 12.50% 54.80% 38.14 27.40%
Total Assets 100.00% 100.00% 100.00% 100.00%
Metrics: Short Term Solvency
QUICK RATIO CURRENT RATIO
2.49

2.5 2.5

2.0 2.0 1.58

1.27
1.5 1.5 1.15

0.82
1.0 1.0
0.61

0.5 0.5

0.0 0.0
1993 1994 1995 1993 1994 1995
Metrics: Leverage 4.06 0.73
0.68
4.50 0.80
4.00
2.59 0.70
3.50 0.45
1993 0.60
3.00 1993
2.50 0.50
1994
0.40 1994
2.00
0.86 1995
1.50 0.30 1995
1.00 0.20
0.50 0.10
0.00
0.00
DEBT-EQUITY RATIO
TOTAL DEBT RATIO

66.46% 66.46%

70.00% 70.00% 52.70%


48.83%
60.00% 60.00%
50.00% 29.92% 50.00%
29.20%
40.00%
40.00%
30.00%
20.00% 30.00%

10.00% 20.00%
0.00% 10.00%
Current liabilities
0.00%
Current Liab. - Industry Comparison
CLC 1993 CLC 1994 CLC 1995 Low-Profit High-Profit CLC 1995
Metrics: Asset Utilization
48.95

50.00 43.14
64.00 62.57
45.00 38.24

62.00 40.00
59.86

35.00
60.00 1993
1993
30.00
1994 1994
58.00 25.00 1995
55.86 1995

20.00
56.00
15.00

10.00
54.00
5.00

52.00 0.00
DAYS PER INVENTORY TURNOVER DAYS ACCOUNTS IN A/R COLLECTION
Metrics: Inventory
% of Sales

12.32%
12.40%

12.20%
12.00%

12.00%

Inventory
11.80%
11.60%

11.60%

11.40%

11.20%
Low-Profit Outlets High-Profit Outlets Clarkson 3YR
Metrics: Inventory
vs. Current Assets

54.00% 53.00%
50.87% 51.73%
53.00%
52.00%
51.00%
% of Current

50.00% 49.13%
49.00%
48.00% 48.27%
47.00%
46.00%
45.00% 47.00%
Non-inventory
44.00%
43.00%

1993
Inventory
1994

1995

Years
Metrics: DuPont Analysis
0.20
0.18 0.17
0.03 2.1% 2.0%
1.7%
0.12 0.02
0.15
0.02
0.10
0.01
0.05 0.01

0.00 0.00
1993 1994 1995 1993 1994 1995

ROE PROFIT MARGIN

3.18 3.65
3.20 3.01 4.00 3.11
3.10 3.50
3.00 3.00
2.76 1.82
2.90 2.50
2.80 2.00
2.70 1.50
2.60 1.00
2.50 0.50
1993 1994 1995 0.00
1993 1994 1995
TOTAL ASSET TURNOVER
EQUITY MULTIPLIER
Metrics: Forecasted DuPont
0.21 0.20

0.19
0.025
2.2%
2.3%
2.4%

0.20

0.020
0.15

0.10 0.015
1996 1997 1998 1996 1997 1998

ROE PROFIT MARGIN

2.99 2.99 2.99


3.24
3.00 4.00 2.85
2.56
2.75 3.00

2.50 2.00

2.25 1.00

2.00 0.00
1996 1997 1998 1996 1997 1998

TOTAL ASSET TURNOVER EQUITY MULTIPLIER


Income Statement
Operating Expenses
1993 1994 1995 Percent of Sales
Net sales $2,921 $3,477 $4,519
Cost of Goods Sold:
Beginning inventory 330 337 432 10.1%
Purchases 2,209 2,729 3,579 78.0%
Total Inventory $2,539 $3,066 $4,011
Ending inventory 337 432 587 12.4%
Total Cost of Goods Sold $2,202 $2,634 $3,424 75.7%

Gross profit $719 $843 $1,095


622 717 940 20.9%
Operating expensesb
EBIT $97 $126 $155
2% AP Discount
Interest expense 23 42 56
EBT $74 $84 $99
14 16 22
Provision for income taxesc
Net income $60 $68 $77
Balance Sheet
Balance
1993 1994 1995 Percent of Sales
Net sales $2,921 $3,477 $4,519
Cash $43 $52 $56 1.4%
Accounts receivable, net $306 $411 $606 12.4%
Inventory $337 $432 $587 11.6%
Current $686 $895 $1,249
Property, net $233 $262 $388 8.1%
Total Assets $919 $1,157 $1,637

Notes payable, banka -- $60 $390


Note payable to -- $100 $100
Notes payable, trade -- -- $127
Accounts payable $213 $340 $376 8.1%
Accrued expenses $42 $45 $75 1.5%
Term loan, current portionc $20 $20 $20
Current liabilities $275 $565 $1,088

Term loan $140 $120 $100


Note payable, Mr. Holtzb -- $100 $0
Total Liabilities $415 $785 $1,188
Net worth $504 $372 $449
Total Liabilities and Net Worth $919 $1,157 $1,637
Insights: Long-Term Debt
• Exchange a portion of short-term liabilities for long-term debt
• Will reduce interest payments
• Long-term debt has smaller payments, lower rates
• Savings passed to his cash flow; used to manage A/P
Insights: Reduce Inventory

• Reduce existing inventory


• Increase sales?
• Slow inventory growth; more capital in cash flow
• Drain inventory by growing with current excess
Insights: Increase A/R Turnover

• Increasing A/R turnover primes cash flow


• More cash in hand
• Can incentivize quicker collections with cash discount
• Savings in financing charges greater than 1% rebate
Key Concerns
• Key Concerns
• Will bank accept such a loan?
• Can CLC collateralize long-term debt?
• Micromanaging sales within bank’s core capabilities?
• High inventory a hedge against price fluctuations?
• Can CLC profit margin afford 1% hit?