9B10N033 ENVY RIDES INCORPORATED Greg J.R. Smith wrote this case under the supervision of Elizabeth M. A. Grasby solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized, or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G ON1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveypublishing.ca. Our goal is to publish materials of the highest quality; submit any errata to publishcases@ivey.ca. Copyright @ 2010, Richard Ivey School of Business Foundation Version: 2021-11-22 In early January 2010, Scott Miller, newly appointed manager of commercial accounts at the Genesis Bank of Canada (GBC), was considering the latest loan request that was sitting on his desk. Jacob Hessels, dealer principal of Envy Rides Incorporated (Envy), had requested a $60,000 long-term loan for a partial renovation to his recreational motorsport dealership. Hessels had also requested an additional $450,000 working capital loan for the day-to-day operations of his business. Because of the current unstable economy, Hessels was becoming increasingly anxious about his loan request, and he wanted an immediate answer so he could approach other banks, if necessary. Without the requested loans, Hessels was uncertain whether he could continue operating Envy Rides. With the recent increase in loan requests from new and existing customers, Miller had four hours to make a decision before he was scheduled to meet with Hessels. JACOB HESSELS Jacob Hessels was a talented businessman, specializing in business start-ups. He prided himself on developing successful marketing campaigns and, at the age of 38, he was well known in many different industries. Hessels' career had started in the retail car sales industry, where he had worked as a car salesman. As an amiable and charismatic person, he was noticed in every role he filled. After excelling in car sales for over a decade, Hessels became the vice-president and director of marketing for Wegz Stadium Bar.' He stayed in this role for five years, and then moved on to accept the role of general manager for the start-up of a Hyundai dealership in a small Southwestern Ontario town. When the opportunity arose to purchase an existing motorsport dealership that sold recreational vehicles, Hessels could not pass it up. As a motorcycle enthusiast himself, Hessel viewed this chance as a dream come true. 1 Wegz Stadium Bar is a Sports Restaurant located in Toronto, Ontario, Canada.Page 2 9B10N033 ENVY RIDES INCORPORATED Hessels had always dreamed of owning and operating his own dealership. He had looked forward to the freedom of being his own boss and setting his own working hours. The banks were unwilling to loan Hessels money because he could provide only minimal start-up capital for his business venture, so instead, in order to purchase the dealership, Hessels personally borrowed funds from his network of private investors, who believed in his talent for his new business venture. In August 2007, Hessels bought Milton Motor Sports, an existing recreational motorsport dealership in the Milton area just outside Toronto, Ontario. Hessels immediately changed the business name to Envy Rides Incorporated, converting the business's identity and building to the Envy Rides brand. Hessels' business grew exponentially in its early months. Sales increased, and the staff complement expanded from six to more than 20 employees in less than a year. In February 2008, Envy's growth supported a move, so the business relocated to its current store in Mississauga, Ontario. ss from Sep 01, 2022 to Apr 30, 2023 The 14,000-square-foot leased facility focused on selling recreational vehicles, mainly in the motorsport category. Although the motorsport division consisted of a variety of vehicles, including ATVs, snowmobiles and mopeds, Envy focused primarily on motorcycles. The dealership carried many different brand names, with a large focus on Aprilia, Moto Guzzi, Suzuki and Yamaha, thereby increasing Envy's overall recreational market share by offering brands of interest to most consumers. Additionally, the dealership offered accessories and apparel (helmets, jackets, boots, etc.) that supplemented the recreational vehicle purchase. Envy provided recreational vehicle servicing by a knowledgeable and friendly parts-and- service team within the dealership (much like an automotive dealership). The dealership serviced all types of motorsport vehicles, with the exception of marine vehicles. To accommodate riders during the winter months, Envy offered storage for motorcycles and other motor sport vehicles. Envy also had a strong website presence on the Internet, with plenty of information ranging from events to the most recent news to inventory and dealer information; the site even allowed consumers to post testimonials about their buying experience. With Hessels and his marketing expertise at the helm of the company, Envy was the subject of brilliant marketing campaigns and initiatives. Hessels had big dreams and, with the 2008 expansion, he took advantage of the dealership's grand opening with the hope of further increasing sales. The grand opening featured activities and events, including a bike wash, races, prizes, a barbecue and massive inflatable ATVs covering the new facility's lot. Envy also had a large presence on the hit radio station z103.5, a station catering to Envy's prime demographic - consumers between 18 and 35 years of age. New to the market, Envy matched any other competitor's price (if quoted in writing), and the business relied on strong word-of-mouth advertising. As a motorcycle rider himself, Hessels possessed knowledge and expertise that played a key role in the buyer's purchasing experience. Envy strove to ensure customer satisfaction at the highest level and to represent its brands professionally at all times. Envy's mission statement sought to provide a new type of buying experience for consumers, wherein the dealership would also provide outstanding service after the sale was completed. Hessels believed Envy was the dealer that would be able to provide this kind of service. 2 Envy's first complete fiscal year end was 2008.Page 3 510N033 Hessels looked back on the expansion as necessary; however, with the current economy and the everyday woes of the recreational motor sport industry, he knew it was time to do more to improve his cash position and to improve Envy's profit margin. THE INDUSTRY Despite having strong marketing campaigns in place since Envy's inception, the company had two major competitors: Snow City Cycle and Kahuna Power Sports. Additionally, other Honda stores provided indirect competition in this market. However, in the spring of 2008, the severe downturn in the economy (which then developed into an economic recession) brought a significant change to the recreational motor sport industry, seriously affecting the sales of new and used motorcycles. In the past, many of Envy's previous customers had financed their purchases if they did not have the personal funds; however, following the economic downturn, banks and financial institutions had become reluctant to lend funds so it was difficult for consumers to get financing, even if they had strong credit. In the automotive industry, the economic recession led to reduced consumer spending on expensive luxury purchases such as cars, and this reduced spending filtered down to the recreational market as well. The Motor Cycle Industry Council reported that, among 12 of the leading brands, new motorcycle sales had declined by 30.5 per cent in the first quarter of 2009.' While many businesses in the motorcycle industry remained pessimistic, some analysts were hopeful that the industry could benefit from this crisis and position itself as a fuel-efficient transportation solution. This recreational market was further subjected to seasonal fluctuations. Inclement weather in Canada hindered motorcycling and other activities involving motorized sport, thereby deterring consumers from purchasing these goods. THE LOAN REQUEST Hessels believed it was time to expand once again and to restructure the financial side of the business. He viewed the current expansion as necessary for future sustainability. As well, Hessels remembered the advice of a student who had worked at his dealership during the summer months and who had taken Business 1220 at The University of Western Ontario. This student regularly stressed the importance of the working capital accounts and the risks of funding inventory through accounts payable. Because of this advice, Hessels was determined to reduce his reliance on Envy's suppliers, and he hoped to do so with a working capital loan. Renovation Loan Hessels was requesting a long-term loan for a small renovation within the current building. After operating in the industry for more than two years, Hessels noticed that many recreational riders, especially motorcyclists, were interested in tattoos. Hessels decided to offer tattooing services at Envy in order to maintain Envy's strong brand image in the motorsport market. He knew this service would be received favourably by his target market, but there would be barriers to entry in terms of licensing, health and safety. 3 Motorcycle Industry Council, Thursday, April 23, 2009.9610N033 A $60,000 long-term loan would cover the necessary renovation and equipment" to incorporate a tattoo parlor within the dealership. As Miller reviewed the file on Hessels, he came across a printed e-mail from Hessels with the following sentence highlighted: Preferably, financing would need to be secured by early January 2010. This is when the renovation would be scheduled to start; however, it is speculated that the project would not be completed until May 1, 2010, because of delays and the availability of the contractors. Working Capital Loan Hessels was also requesting a working capital loan for $450,000. In previous discussions, Hessels had told Miller that the loan would be used to offset outstanding debts and would be necessary to help sustain operations throughout the winter months. Due to slower sales, fluctuations in working capital requirements could vary by as much as $250,000 in winter months due to slower sales." FINANCIAL PROJECTIONS Hessels followed the industry very closely and, based on an optimistic view of the economic climate, he projected sales would increase to $6 million for fiscal 2010 and $7.5 million in fiscal 2011. While these sales estimates might be viewed as quite aggressive, given the past year's sales figures, Hessels strongly believed these estimates would reflect an increase in motor sport sales through the combination of stronger marketing initiatives and Envy's expansion into the tattoo business. Conversely, Hessels was less confident in his ability to forecast sales for a newly established tattoo parlor. Even though the tattoo parlor would provide guaranteed exposure and foot traffic from the motor sport marketing, Hessels conservatively estimated sales to be $50,000 in 2010 and $100,000 in 2011. Hessels projected Envy's cost of goods sold would remain at the same historical percentage of sales for the next two years, even with the addition of a tattoo parlor. Based on the previous financial information (see Exhibits 1 through 5), Hessels gave Miller reasonable assumptions regarding each projected statement for the next two years. Since Envy had just moved to a new building that met all its needs, relocation was not anticipated in the near future. Furthermore, Hessels had a locked-in lease agreement for the next three years, wherein rent would not increase under any circumstances. With the hiring of new employees to operate the tattoo parlor and new staff members to support the increase in motor sport sales, he projected salaries would increase to 12 per cent and 13 per cent of sales in 2010 and 2011, respectively. Hessels had strong relationships with his suppliers; however, funds from the working capital loan would reduce Envy's reliance on this trade debt. If Hessels received the working capital loan requested, Envy could immediately reduce its accounts payable to 175 days. Furthermore, Hessels wanted to improve Envy's management of inventory over time. He projected that fiscal 2010 would remain the same in terms of inventory days, but this term would decrease to 270 days in fiscal 2011. He expected the addition of a Equipment is expected to last 15 years, depending on usage. Slower sales were experienced in November, December, January and February.Page 5 9B10N033 tattoo parlor would have negligible impact on accounts receivable and predicted no change in the days of Envy's 2009 accounts receivable levels. Hessels admitted that advertising and promotion were large expenditures in a new business, but he expected advertising for fiscal 2010 and 2011 to remain at the same percentage of sales as 2009 levels. All other expenses associated with the cost of sales would remain at the same percentages of sales, and all other non- sales associated accounts would remain at the same dollar level as in 2009. In the past, banks had not been receptive to Envy's loan requests. If Envy were granted the loans, this would be the company's first experience at leveraging debt. Although the terms of the loan were not finalized, Miller felt a five-year repayment schedule with a nine per cent annual interest rate on the long- term loan would be favourable to both parties. Furthermore, Miller estimated Envy would incur $45,000 in annual interest charges on the working capital loan in both 2010 and 2011. Lastly, Envy was expected to pay back their shareholder advance by the same dollar amount as the most recent year in both 2010 and 2011. THE DECISION Hessels' excitement about the future and his commitment to his business were definite reasons for Miller to favour granting this loan request; nevertheless, Miller would need to crunch the numbers and consider the assumptions behind the numbers to ensure he had all the necessary financial pieces for this decision. He would need to give special consideration to Envy's statement of cash flows and ratio analysis. Miller also wanted to give a fair assessment of the entire file, including Hessels' leadership. Before he could make today's decision, Miller would need to draw up an analysis of the numbers and make a projection of Envy's financial statements for the next two years, along with an analysis of all other loan-related factors.Page 6 9B10N033 EXHIBIT 1 INCOME STATEMENT for the year ended December 31 2009 2008 2007 Sales $3,613,959 $4,885,958 Cost of Goods Sold 2,816,295 $434,463 3,823,864 Gross Margin 341,394 797,664 1,062,094 93,069 Expenses 22 to Apr 30, 2023 Rent and utilities 120,900 187,402 46,850 Salaries 284,121 404,994 46,040 Advertising and promotion 53,424 97,431 16,302 Automotive 26,129 43,704 11,243 Telephone 10,750 25,741 6,038 Insurance 7,258 13,034 4,481 Licence fees and dues 9,533 10,430 5,770 Office expense 10,270 20,645 5,334 Professional fees 2,092 3,000 5,300 Amortization 15,348 15,098 6,062 Total expenses 539,825 821,479 153,420 Net earnings from operations 257,839 240,615 (60,351) Income Tax 64,460 45, 154 Net Income $193,379 $195,461 $(60,351) Source: Company files. Exhibit 2 STATEMENT RETAINED EARNINGS for the year ended December 31 2009 2008 2007 Beginning retained earnings $135, 110 $(60,351) $- Add: Net income 193,379 195,461 (60,351) Less: Dividends Ending retained earnings $328,489 $135, 110 $(60,351) Source: Company files. 2007 and earlier losses were carried forward for tax purposes in 2008. For 2010 and beyond taxes were expected to be paid at a rate of 25 per cent on net earnings.Page 7 9B10N033 Exhibit 3 BALANCE SHEET as at December 31 2009 2008 2007 ASSETS Current Assets $138,640 Cash $175,661 119,964 $126,717 Accounts receivable 163,801 2,408,410 77,990 Inventory 1,957,362 5,231 886,840 Prepaid expense 7,393 17,250 2,013 Supplier deposit 17,400 15,750 Total Current Assets 2,689,495 2,321,617 1, 109,310 Fixed Assets Shop equipment 48,729 46,229 42,729 Computer equipment 7,087 7,087 7,087 Computer software 22,713 22,713 22,713 Furniture and fixtures 20, 148 20, 148 20, 148 Leasehold improvements 24,999 24,999 22,999 Total Fixed Assets 123,676 121, 176 115,676 Less: Accumulated amortization 36,508 21, 160 6,062 Net Fixed Assets 87, 168 100,016 109,614 TOTAL ASSETS $2,776,663 $2,421,633 $1,218,924 LIABILITIES Current Liabilities Accounts Payable $2, 107,815 $1,839,921 $743,027 Customer Deposits 3, 131 15,438 5,850 Total Liabilities 2, 110,946 1,855,359 748,877 SHAREHOLDERS' EQUITY Shareholder Advance 337, 128 431,064 530,298 Capital Stock 100 100 100 Retained Earnings (Deficit) 328,489 135, 110 (60,351) 665,717 566,274 470,047 Total Shareholder's Equity TOTAL LIABILITIES AND $1,218,924 SHAREHOLDERS' EQUITY $2,776,663 $2,421,633 Source: Company files.Page 8 9B10N033 EXHIBIT 4 STATEMENT OF CASH FLOW for the year ended December 31 2009 2008 OPERATIONS Net earnings $193,379 $ 195,461 Adjustment to Cash Basis Amortization 15,348 15,098 Accounts receivable 43,837 (85,811) Inventory (451,048) (1,070,522) Prepaid expense 2, 162 (5,380) Supplier deposits 150 (1,650) Accounts payable 267,894 1,096,894 Customer deposits (12,307) 9,588 Net Cash Flow From Operations 59,415 153,678 FINANCING Shareholder advancement (93,936) (99,234) Net Cash Flow from Financing Activities (93,936) (99,234) INVESTING Shop equipment (2,500) (3,500) Computer equipment Computer software 1 1 Furniture and fixtures Leasehold improvements (2,000) Net Cash Flow from Investing Activities (2,500) (5,500) Net Cash Flow (37,021) 48,944 Beginning Cash, January 1 175,661 126,717 Ending Cash, December 31 $138,640 $175,661 urce: Company files.Page 9 9B10N033 EXHIBIT 5 RATIO ANALYSIS VERTICAL ANALYSIS 2009 2008 Sales 100.00% 100.00% 2007 Cost of goods sold 77.9% 78.3% 100.00% Gross margin 22.1% 21.7% 78.6% 21.4% Expenses: Rent and utilities 3.3% 3.8% Salaries 7.9% 8.3% 10.8% Advertising and promotion 1.5% 2.0% 10.6% ss from Sep 01, 2022 to Apr 30, 2023. Automotive 0.7% 3.8% 0.9% 2.6% Telephone 0.3% 0.5% 1.4% Insurance 0.2% 0.3% 1.0% Licence fees and dues 0.3% 0.2% 1.3% Office expense 0.3% 0.4% 1.2% Professional fees 0.1% 0. 1% 1.2% Amortization 0.4% 0.3% 1.4% Total expenses 14.9% 16.8% 35.3% Income tax 1.8% 0.9% Net income (loss) 5.35% 4.00% (13.9%) Return on equity 29.05% 34.52% N/A Current ratio 1.27 1.25 1.48 Acid test 0.12 0.18 0.27 Working capital $578,549 $466,258 $360,433 EFFICIENCY Age of receivables 12.1 12.2 38.3 Age of inventory 312.1 186.8 558.3 Age of payables 235.5 137.2 184.9 STABILITY 38.56% Net worth/Total assets 23.98% 23.38% N/A Interest coverage N/A N/A GROWTH 2008-2009 2007-2008 Sales (26.03)% 557.37% Net income after taxes (1.07)% N/A Total assets 14.66% 98.67% Equity 17.56% 20.47% mpany files