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 bank's 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 bank's board of directors. Their recommendation would be the bases forthe bank's decision regarding the Lemay Hometown Lumber's 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. Lemay's 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 Lumber's 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 andwas 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 company's 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 company's 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 company's 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 company's 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 company's 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, Lemay's 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 store's 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 company's 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 company's profits since 2011 and her predecessor's confidence in the Lemay management team. However Chang, closely examined Lemay's projections for 2016. She questioned the accuracy of these projections, due to the fact that 65 per cent of Lemay's 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

200612

2007(144)

2008440

2009512

2010536

2011644

20121,020

2013508

20142,104

20152,860

Exhibit 2

Sears and Brewster Canadian Industry Norms and Key Business

Ratios Industry: Wholesale - Lumber

20132014

PROFITABILITY

Vertical Analysis

Gross Profit7.4%8.4%

Net profit after tax2.2%2.5%

Return on investment29.1%31.4%

LIQUIDITY

Current Ratio1.4:11.5:1

Acid test0.8:10.8:1

Working Capital$1,085,780$1,154,636

EFFICIENCY

Age of receivables36.1 days41.2 days

Age of inventory29.1 days27.5 days

Age of payables21.2 days23.5 days

STABILITY

Net worth: total assets35.8%37.0%

GROWTH2013 - 2014

Sales5.6%

Net profit20.3%

Equity5.1%

Assets1.7%

Exhibit 3

INCOME STATEMENTS

For the years ending November 30

(000s)

201320142015

Net sales$19,436$23,544$32,624

Cost of sales14,28416,49222,520

Gross profit5,1527,05210,104

Operating Expenses

Bad debt expense$264$20$108

General and admin expense7368281,012

Interest expense248220412

Salaries2,7763,2804,420

Selling expense7528881,320

Depreciation264264416

Total operating expenses5,0405,5007, 688

Operating income$112$ 1,552$2,416

Other income396552444

Income before tax$508$ 2,104$2,860

Income taxes2489721,312

Net earnings$260$ 1,132$1,548

=================

Exhibit 4

Balance Sheet

As of November 30

(000s)

201320142015

ASSETS

Current assets

Cash$12$40$16

Accounts receivable3,8204,5326,440

Inventories4,7205,0489,460

Total current assets$8,552$ 9,620$15,916

Other investments600552712

Net fixed assets1,7722,1605,176

Other assets368336940

TOTAL ASSETS$11,292$12,668$22,744

==================

LIABILITIES AND SHAREHOLDER EQUITY

Liabilities

Working capital loan$2,688$1,512$4,252

Accounts payable9121,7523,856

Taxes payable328952736

Other current liabilities312456252

Total current liabilities$4,240$4,672$9,096

Term bank loan4,200

Mortgages payable752564468

Total liabilities$4,992$5,236$13,764

Shareholder's equity

Common stock$4,384$4,384$4,384

Retained earnings1,9163,0484,596

Total shareholders equity$6,300$7,432$8,980

TOTAL LIABILITIES$11,292$12,668$22,744

AND SHAREHOLDERS============

EQUITY

EXHIBIT 5

RATIO ANALYSIS

201320142015

PROFITABILITY

Sales100%100%100%

Cost of sales73.5%70.0%69.0%

Gross margin26.5%30.0%31.0%

Operating expenses

Bad debt expense1.4%0.08%0.03%

General and admin expense3.8%3.5%3.1%

Interest expense1.3%0.9%1.3%

Salaries14.3%13.9%13.5%

Selling expense3.9%3.8%4.0%

Depreciation1.4%1.1%1.3%

Total operating expenses25.9%23.3%23.6%

Operating income0.6%6.6%7.4%

Other income2.0%2.3%1.4%

Income before taxes2.6%8.9%8.8%

Income taxes1.3%4.1%4.0%

Net earnings1.3%4.8%4.8%

===============

Return on average equityn/o16.5%18.9%

STABILITY

Net worth to total assets55.8%58.7%39.5%

Interest coverage (times)3.0X10.6X7.9X

LIQUIDITY

Current ratio2.02:12.06:11.75:1

Acid test ratio0.90:10.98:10.71:1

Working capital$4,312,000$4,948,000$6,820,000

EFFICIENCY

Age of receivables71, 7 days70.3 days72.1 days

Age of inventory120.6 days111.7 days153.3 days

Age of payablesn/o39.6 days77.7 days

Fixed assets/sales$0.09$0.09$0.16

GROWTH2013-142014-15

Sales21.1%38.6%

Net profit335.4%36.7%

Assets12.2%79.5%

Equity18.0%20.8%

EXHIBIT 6

CAPITAL EXPENDITURES, 2015 AND 2016

(000s)

20152016

ProjectedActualProjected

Showroom renovations$140$320$160

Showroom expansion

For two lumber yards320280----

New showrooms for

Two lumber yards1,0401,700400

Land for4 new yard

In Northern Region100100----

Land for new yard

In Western Region---------60

New vehicles2001,400480

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.

20132014

PROFITABILITY

Vertical Analysis

Gross profit26.3%25.3%

Net profit after tax2.2%2.6%

Return on investment10.7%12.5%

LIQUIDITY

Current ratio1.6:11.6:1

Acid test0.6:10.6:1

Working capital$554,686$555,271

EFFICIENTCY

Age of receivables44.6 days47.2 days

Age of inventory104.9 days99.1 days

Age of payables46.3 days51.9 days

STABILITY

Net worth : total assets42.2%40.7%

GROWTH2013 - 14

Sales6.2%

Net profit25.9%

Equity1.7%

Assets6.0%

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