It is October24, 2020, and you have just been assigned to join Ruth Hillman on a new consulting engagement for Environmental Venture Capitalists Inc. (EVC). This group provides venture capital financing to companies dedicated to improving the environment, and it has asked your firm for assistance regarding one of its investments, Alberta Oil Recyclers Ltd. (AOR).

Ruth explains that the two of you will be working with Aaron Wardell, an experienced senior account manager with EVC. Ruth hands you some background information Aaron has supplied about AOR's history and some financial information excerpts (Exhibit I). Later in the day, you and Ruth head out to AOR to meet with Aaron.

Aaron: Thanks very much for coming. AOR's cash position has deteriorated significantly over the last year. It has missed some loan payments, and Cassidy Lincoln, the operations manager, has asked us to consider exercising our right to convert our loan to common shares and take over control of the company. She has a vested interest in the continuation of AOR since she inherited 20% of the common shares of the company just over a year ago when her father, Peter Lincoln, who founded AOR, died in a car accident. She will be joining us in a minute. We would really like to see AOR succeed, but we need to carefully assess this cash-flow issue.

Cassidy joins the meeting.

Cassidy: Hello! As Aaron may have already noted, we are running out of money, and this just doesn't make any sense to me because we are operating at full capacity and oil prices just keep climbing. Just last week our controller suddenly quit after having a very heated argument with Ryan Alexander, our transportation manager. I don't know exactly what it was about, but I got the impression that he was upset about the oil shipping procedures. I found these notes in his office after he left (Exhibit II).

Aaron: The board appointed Jake Sinclair as the president and general manager when Peter passed away. He is a chemical engineer and an old friend of Peter's who came out of retirement to help out at Cassidy's urging.

Cassidy: Yes, Jake is very cooperative, but I am not sure if he was the best choice, as he doesn't have any management experience at this level. He has given management free rein over the company. Since my father died, the company has struggled, and morale has been on the decline, especially since we reduced our employee bonuses this year, for obvious reasons.

You and Ruth return to your office.

Ruth: I think it would be useful to provide Aaron with some commentary about their concerns.

Background information for Alberta Oil Recyclers Ltd

Oil recycling industry

The Western Canada Used Oil Management Association (WCUOMA) was established 13 years ago by oil and oil filter industries at the direction of the western provincial governments. WCUOMA coordinates all collection and dispersion of used oil and by-product. Used oil is provided free of charge to licensed oil recyclers, but they have to bear the transportation costs to get the oil to their plants.

AOR submitted quarterly reports to WCUOMA prior to Peter's death; however, such reports have not been prepared since September 2019.

Alberta Oil Recyclers Ltd.

AOR was established by Peter Lincoln 19 years ago and initially focused on oil sand refining processes. The company was initially financed by a private placement including Peter and about two dozen other investors. Peter led his company to develop the Lincoln recovery process (LRP) through the decade.

Twelve years ago, Peter was able to adapt LRP for use in recycling oil. The next year, the company commenced construction of a new production plant just north of Calgary. Early in the following year, the plant was fully operational.

The LRP allows for recovery of used oil components as follows:

Retail grade oil, which sells on the market as equivalent to new motor oil 75%

Industrial grade oil, which is used in plant operations 15%

Solids, which are disposed of to asphalt producers via WCUOMA at no cost 10%

For example, by processing 100cubic metres of used oil, the company generates 75cubic metres of retail quality oil.

2020 operations summary and financial information

Due to industry fluctuations, the retail price of retail grade oil has increased 20% in 2020, but because AOR was locked into annual contracts, it experienced only a 10% price increase, from $408 to $449 per cubic metre.

100% of the industrial grade oil produced is used by AOR to operate the plant and is recorded against utilities.

AOR operated at full capacity for 365 days in both 2019 and 2020, and the recovery ratio was consistent with the target of 75%. Total volume of used oil processed in 2019 and 2020 was 15,600 cubic metres.

Oil transportation and utilities costs increased 10% in 2020, which is consistent with industry results.

Other direct costs include direct plant labour and equipment repairs, which both increased 5.5% in 2020; again, this is consistent with industry results.

2020 2019 (draft) (audited) Sales $4,903,080 $4,773,600 Cost of sales Transportation 1,291,440 1,174,035 Utilities 745,065 677,330 Other direct costs 543,960 514.865 2,580,465 2,366,230 Gross margin $2,322,615 $2,407,370