CASE 1-2 LEMAY HOMETOWN LUMBER COMPANY LIMITED In March of 2016, Roseanne Chang, vice president of the Eastern Ontario Region of the Dominion Bank of Canada, was reviewing the file of Lemay Hometown Lumber Company, one of the regions largest borrowers. The following day, Larry Lemay and Linda Limeric, the president and controller, respectively, of Lemay Hometown Lumber Company, would meet with the banks loan committee, to present a request for a line of credit of up to $10 million dollars. The line of credit was in addition to the term loan they already had with the bank. The loan committee, consisted of Chang, the central credit manager, and the assistant central credit manager, would review the loan request and make a recommendation to the banks board of directors. Their recommendation would be the bases for the banks decision regarding the Lemay Hometown Lumbers request. PRE 2016 The Lemay lumber Company was founded by the Lemay family in 1870 to market the lumber produced from the trees on their land. After the original lumber stands were depleted near Palmerston Ontario, they continued to operate a wholesale lumber business and it was slowly expanded. In 1950 Lemay Lumber owned and operated four lumber yards in the Palmerston, Harriston and Arthur area. Although owned by Lemay Lumber each was a separate company operating independently. In 2000 Leroy K. Lemay became president and amalgamated the four lumber companies into Lemay Hometown Lumber Company Limited. The company then acquired seven additional lumber yards to the north and west of Palmerston Ontario, however further growth was limited by Leroy K. Lemays belief that further expansion should only be funded by internally generated funds. For over 100 years Lemay Lumber had been dealing with the Fergus branch of the First Capital Bank of Canada, and in 2015 had borrowed $1.5 million to meet the inventory requirements for their seasonal demand for building materials an meet their seasonal sales. From April until November 77 per cent of their sales were evenly spread over these months, while the remaining 23 per cent was distributed evenly between December and March. Lemay Lumbers sales between the years 2005 and 2015 were from $10 million to $15 million, with 90 per cent being wholesale sales to the residential construction trades. Exhibit 1 shows the before tax profits from 2005 to 2015. In 2011 L.K. Lemay, realized that due his poor health he would not be able to manage the company any longer. His son Larry Lemay, agreed to take over as president of the company. Larry Lemay had actually taken over the business in 2010 when his father actually became too sick to perform his duties as president. After his father returned Larry assumed the advertising and budgeting responsibilities for the company 2014 and 2015 Larry Lemay had a postgraduate degree in Business Administration and several years teaching experience. When he took over as president of the company Lemay Hometown Lumber Company was primarily a wholesale lumber business and was subject to the volatility of the residential housing market. Exhibit two outlines the selected ratios for the wholesale lumber industry. The new president was of the opinion that with a few changes in inventory and yard operations, the company would be able to take advantage of the growing retail market for building products and thereby stabilize their operations. Lemay approached the companys banker, the branch manager of the Fergus branch of the First Capital Bank of Canada, to finance the proposed changes in the company. However the Fergus branch manager would only support a seasonal loan to finance inventory, and refused to pass on the loan request to his superiors. Consequently, Larry Lemay took the loan application to the Dominion Bank of Canada, along with his plans and needs. In 2013, The Dominion Bank of Canada granted an initial line of credit for $3 million to be used as working capital. The Dominion Bank took the accounts receivable and inventory as collateral, and, as a condition of the loan, Lemay Hometown Lumber was required to provide the bank with quarterly financial statements and monthly reports of inventory, sales and receivables. Larry Lemay, also reorganized the companys 11 branch operations into 3 divisions or regions. The first Northern Region, which serviced an urban market, consisted of three lumber yards in the Owen Sound area. Four lumber yards in the Palmerston area formed the central region, and four lumber yards in and around Elmira formed the Western Region. The Eastern Region was primarily a rural market, while the Northern Region was partly a resort and a partially an urban market. In an attempt to minimize inventory one branch in each region was dedicated and operated as a depot. A fleet of trucks kept frequent and regular scheduled runs between the depots and the lumber yards to provide rapid deliveries to the customers. Each region was under an area manager whose responsibility it was to supervise the regions branches. The supervisors had years of experience working in the companys lumber yards. A management committee, consisting of the president, controller and area supervisors, met on a monthly basis, to discuss operational strategies. The committee also set the budgets for each branch every four months. Exhibits 3, 4, and 5 outline the companys financial statements ratios for the years 2013 to 2015. 2015 PROJECTIONS Exhibit 6 outlines the projected capital expenditures for 2015 and 2016. The projected 2015 projected capital expenditures of $1.8 million were primarily to upgrade and improve the companys showrooms and display areas. Depreciation and profits were expected to cover these capital expenses. A sales increase was projected for 2015 of $6.4 million. This projection was based on the opinions of, the building contractors, Lemays yard managers, and business publications reporting on the outlook for the economy and the projected housing market. Operating profits were anticipated to be $2.92 million, assuming a gross margin of 30 per cent and expenses of $6.08 million. To finance an increase of $2.52 million in receivables and inventory, a total operating line of credit of $3.6 million for working capital was requested and granted by The Dominion Bank. 2015 ACTUAL After studying the market for over six months, and researching the potential of the Owen Sound area, and discussing the revised capital budget with the bank, Lemay Hometown Lumber opened a discount home center in September of 2025. To finance this new operation, the bank granted a term loan of $4.2 million. The new discount home center was geared toward the retail home market. Exhibit 7 presents selected ratios for the retail building materials and hardware industry. The concept enabled customers to purchase, at one location, all types of building and hardware supplies, such as tiles, wallpaper, carpet, lumber, plumbing supplies including fixtures. Electrical supplies as well as lighting fixtures. Each item in the store was clearly marked with two separate and distinct prices so customers paid only for the services they desired. The regular price was for the customer could charge their purchases and have them delivered. The discount or cash and carry price was just as it states, the customer paid cash and left with their purchases. There was also a third price charged for those customers who wished to pay cash for their goods and then have them delivered. The new stores sales for the first two months of operation was $2.28 million. Sales in 2015 were $2,680,000 greater than projected and capital expenditures were $3,600,000 over budget. In addition to granting the term loan, the Dominion Bank also increased the companys line of credit to $5 million. 2016 PROJECTIONS For 2015 Larry Lemay projected a 65 per cent increase in sales to $54 million and an operating profit of 8 per cent of sales. To finance inventories and receivables of up to $24 million in June and July, an operating line of credit of $10.8 million was requested from the Dominion Bank. THE DOMINION BANK As she reviewed the file, Chang looked for any indicators that the bank should increase its protection of the loan. She particularly noted the companys profits since 2011 and her predecessors confidence in the Lemay management team. However Chang, closely examined Lemays projections for 2016. She questioned the accuracy of these projections, due to the fact that 65 per cent of Lemays sales were to contractors in the new housing market, meaning the company was still dependant on this housing market. Total housing starts in Canada were 138,000 in 2015 compared to 148,000 in 2014. New housing construction had slowed slightly in the first two months of 2016, attaining roughly 97 per cent of the starts reported in the first two months of 2015. Five year mortgage interest rates had risen slightly in February 2016, from 6.85 per cent to 6.9 per cent, although she noted an overall downward trend over the past decade. As Roseanne examined this information, she wondered if she should recommend the increase in their operating line of credit of Lemay Lumber and if so by how much and under what terms as to collateral and management growth plans. Exhibit 1 INCOME BEFORE TAX (000s) 2005 $ 40 2006 12 2007 (144) 2008 440 2009 512 2010 536 2011 644 2012 1,020 2013 508 2014 2,104 2015 2,860 Exhibit 2 Sears and Brewster Canadian Industry Norms and Key Business Ratios Industry: Wholesale Lumber 2013 2014 PROFITABILITY Vertical Analysis Gross Profit 7.4% 8.4% Net profit after tax 2.2% 2.5% Return on investment 29.1% 31.4% LIQUIDITY Current Ratio 1.4:1 1.5:1 Acid test 0.8:1 0.8:1 Working Capital $1,085,780 $1,154,636 EFFICIENCY Age of receivables 36.1 days 41.2 days Age of inventory 29.1 days 27.5 days Age of payables 21.2 days 23.5 days STABILITY Net worth: total assets 35.8% 37.0% GROWTH 2013 2014 Sales 5.6% Net profit 20.3% Equity 5.1% Assets 1.7% Exhibit 3 INCOME STATEMENTS For the years ending November 30 (000s) 2013 2014 2015 Net sales $19,436 $23,544 $32,624 Cost of sales 14,284 16,492 22,520 Gross profit 5,152 7,052 10,104 Operating Expenses Bad debt expense $ 264 $ 20 $ 108 General and admin expense 736 828 1,012 Interest expense 248 220 412 Salaries 2,776 3,280 4,420 Selling expense 752 888 1,320 Depreciation 264 264 416 Total operating expenses 5,040 5,500 7, 688 Operating income $ 112 $ 1,552 $ 2,416 Other income 396 552 444 Income before tax $ 508 $ 2,104 $ 2,860 Income taxes 248 972 1,312 Net earnings $ 260 $ 1,132 $ 1,548 ====== ===== ====== Exhibit 4 Balance Sheet As of November 30 (000s) 2013 2014 2015 ASSETS Current assets Cash $ 12 $ 40 $ 16 Accounts receivable 3,820 4,532 6,440 Inventories 4,720 5,048 9,460 Total current assets $8,552 $ 9,620 $15,916 Other investments 600 552 712 Net fixed assets 1,772 2,160 5,176 Other assets 368 336 940 TOTAL ASSETS $11,292 $12,668 $22,744 ====== ====== ====== LIABILITIES AND SHAREHOLDER EQUITY Liabilities Working capital loan $2,688 $1,512 $4,252 Accounts payable 912 1,752 3,856 Taxes payable 328 952 736 Other current liabilities 312 456 252 Total current liabilities $4,240 $4,672 $9,096 Term bank loan 4,200 Mortgages payable 752 564 468 Total liabilities $4,992 $5,236 $13,764 Shareholders equity Common stock $4,384 $4,384 $4,384 Retained earnings 1,916 3,048 4,596 Total shareholders equity $6,300 $7,432 $8,980 TOTAL LIABILITIES $11,292 $12,668 $22,744 AND SHAREHOLDERS ==== ==== ==== EQUITY EXHIBIT 5 RATIO ANALYSIS 2013 2014 2015 PROFITABILITY Sales 100% 100% 100% Cost of sales 73.5% 70.0% 69.0% Gross margin 26.5% 30.0% 31.0% Operating expenses Bad debt expense 1.4% 0.08% 0.03% General and admin expense 3.8% 3.5% 3.1% Interest expense 1.3% 0.9% 1.3% Salaries 14.3% 13.9% 13.5% Selling expense 3.9% 3.8% 4.0% Depreciation 1.4% 1.1% 1.3% Total operating expenses 25.9% 23.3% 23.6% Operating income 0.6% 6.6% 7.4% Other income 2.0% 2.3% 1.4% Income before taxes 2.6% 8.9% 8.8% Income taxes 1.3% 4.1% 4.0% Net earnings 1.3% 4.8% 4.8% ===== ===== ===== Return on average equity n/o 16.5% 18.9% STABILITY Net worth to total assets 55.8% 58.7% 39.5% Interest coverage (times) 3.0X 10.6X 7.9X LIQUIDITY Current ratio 2.02:1 2.06:1 1.75:1 Acid test ratio 0.90:1 0.98:1 0.71:1 Working capital $4,312,000 $4,948,000 $6,820,000 EFFICIENCY Age of receivables 71, 7 days 70.3 days 72.1 days Age of inventory 120.6 days 111.7 days 153.3 days Age of payables n/o 39.6 days 77.7 days Fixed assets/sales $ 0.09 $ 0.09 $ 0.16 GROWTH 2013-14 2014-15 Sales 21.1% 38.6% Net profit 335.4% 36.7% Assets 12.2% 79.5% Equity 18.0% 20.8% EXHIBIT 6 CAPITAL EXPENDITURES, 2015 AND 2016 (000s) 2015 2016 Projected Actual Projected Showroom renovations $ 140 $ 320 $ 160 Showroom expansion For two lumber yards 320 280 ---- New showrooms for Two lumber yards 1,040 1,700 400 Land for4 new yard In Northern Region 100 100 ---- Land for new yard In Western Region ---- ----- 60 New vehicles 200 1,400 480 New retail outlet In Owen Sound ----- 1,600 ----- TOTAL $1,600 $5,400 $ 1,100 ===== ===== ===== EXHIBIT 7 Sears and Brewster Canadian industry Norms and Key business Ratios Industry Retail --- Hardware, Home Improvement. 2013 2014 PROFITABILITY Vertical Analysis Gross profit 26.3% 25.3% Net profit after tax 2.2% 2.6% Return on investment 10.7% 12.5% LIQUIDITY Current ratio 1.6:1 1.6:1 Acid test 0.6:1 0.6:1 Working capital $554,686 $555,271 EFFICIENTCY Age of receivables 44.6 days 47.2 days Age of inventory 104.9 days 99.1 days Age of payables 46.3 days 51.9 days STABILITY Net worth : total assets 42.2% 40.7% GROWTH 2013 14 Sales 6.2% Net profit 25.9% Equity 1.7% Assets 6.0%

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