• performance of a straightforward differential analysis (inflows, outflows, investments, ROI, and payback) of the case study attached.

908N19 ADEPT CHEMICAL INC. Lindsay Brock 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 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com. Copyright 2008, Richard Ivey School of Business Foundation Version: 2014-04-25 In February 2008, Mike Brock, chief executive officer (CEO) of Adept Chemical, Inc. (Adept), a regional supplier of cleaning and hygiene products and services, was deciding if he should bid on $3 million in new business from Cargill Foods. Cargill was Adept's largest customer and had recently named Adept as a preferred supplier. The new business, i.e., supplying sanitation products for nine meat-processing plants, starting July 1, 2008, would be a huge opportunity to grow Adept's sales and profitability. Qualitatively and quantitatively, Brock wanted to make the bid as attractive as possible. Brock wondered how to structure the deal, and, if Adept was successful in winning the contract, whether he should bring on his youngest son, Adam, as a new sales and service employee. THE INDUSTRY Food and Beverage Manufacturing On average, the Canadian food and beverage manufacturing industry generated $82 billion in domestic retail and foodservice sales1 and was the third largest employer in Canada.2 It was subdivided into 17 sectors (see Exhibit 1), of which Adept participated significantly in three: meat-processing, poultryprocessing and brewing (see Exhibit 2 for Adept's customer list). Bakery products made up the majority of the food and beverage manufacturing industry in Toronto (see Exhibit 3). The industry experienced modest sales growth of three to four per cent from 2006 to 2007; however, it had one of Canada's lowest average pre-tax profit margins (4.3 per cent in 2006). Despite low profit margins, investments were still being aggressively undertaken in new plants, while current plants were under expansion. Modernization projects and upgrades were being put into place. George Weston Limited (Weston) founded in 1882, was one of the largest companies in the North American food processing and distribution industry. Weston operated Weston Foods and Loblaw Companies Limited (Loblaw). Weston Foods was involved primarily in the baked goods and dairy 1 2 www.agriculture.gov.sk.ca/Statistics-Processing, June 24, 2008. www.thecanadianencyclopedia.com/index.cfm?PgNm=TCE&Params=A1ARTA0002883, May 13, 2008. This document is authorized for use only by jahnavi mange (jmange20@student.scad.edu). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. Page 2 9B08N019 manufacturing industries, while Loblaw was Canada's largest food distributor and a leading provider of general merchandise, drugstore and financial products and services.3 Other significant industry players included McCain Foods Limited (the world's largest producer of frozen potato products), Olymel (Canada's largest pork and poultry processor), General Mills, Kraft and Coca-Cola. Regulations To protect the health and safety of Canadian consumers, the food and beverage manufacturing industry was heavily regulated by the Canadian Food Inspection Agency and by Health Canada. These government agencies regulated and enforced strict processing, handling, packaging and labeling laws. For example, food processing areas had to be sanitized every four hours of production time, and nutritional content had to be displayed on all packaging. In more recent years, due to increased public awareness about foodsafety issues, these laws and restrictions had become even more stringent, which had the effect of encumbering manufacturers. Food and beverage manufacturers were required to measure more areas more often, and were being held more accountable for results that did not meet the government's standards. Food and beverage manufacturers could be fined or closed down for repeated non-compliance. Environment Canada imposed similarly strict regulations on the treatment and disposal of manufacturing waste water and byproducts. Adherence In response to exacting regulation, all food and beverage manufacturers operated a food safety department responsible for reducing the threat of food-borne pathogens and protecting the food supply. Common food-borne pathogens included salmonella,4 E. coli5 and listeria.6 These food safety departments purchased equipment, chemicals, detergents and solutions from suppliers in the food and beverage hygiene industry to keep their company's food and beverages safe and to clean their factories. Food and Beverage Hygiene Food and beverage hygiene suppliers competed on product formulations, price and service. Product formulations that could extend shelf-life, reduce bacteria counts or improve yield7 would be considered superior products and attractive to manufacturing customers. Given the food and beverage manufacturing industry's low-profit margins, offering the lowest price was equally as attractive and was often enough to win contracts. Finally, on-time shipments and quick repair services were important to overall customer satisfaction. Consulting was considered a value-added service. Manufacturers rarely switched suppliers since it was risky, time consuming and expensive. 3 http://www.weston.ca/en/abt_corprof.html, June 24, 2008. Salmonella is a bacterium most commonly found in raw eggs. 5 E. coli bacteria are usually associated with eating unwashed vegetables and meat that becomes contaminated postslaughter. 6 Listeria bacteria outbreaks have been caused by hot dogs, deli meats, raw milk, cheeses, raw and cooked poultry, raw meats, ice cream, raw vegetables, and raw and smoked fish. 7 Yield refers to the amount of meat that, for example, can be packaged and sold from one chicken. 4 This document is authorized for use only by jahnavi mange (jmange20@student.scad.edu). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. Page 3 9B08N019 Competition The Canadian food and beverage hygiene industry was dominated by two large, multi-national corporations: EcoLab, Inc. (EcoLab) and JohnsonDiversey Holdings, Inc. (JDH). EcoLab, based in St. Paul, Minnesota, developed and marketed products and services for the hospitality, foodservice, health-care and industrial markets. The company provided cleaning and sanitizing products and programs, as well as pest elimination, maintenance and repair services, primarily to hotels and restaurants, health-care and education facilities, quick-service (fast food and other convenience store) units, grocery stores, commercial and institutional laundries, dairy plants and farms, food and beverage processors, and the vehicle wash industry.8 EcoLab considered itself the \"world leader in premium commercial cleaning and sanitizing.\"9 It was a publicly traded corporation with $5 billion in worldwide sales and 23,000 associates who performed sales and service functions. See Exhibit 4 for EcoLab's key financial ratios. JDH, headquartered in Racine, Wisconsin, operated four separate companies, one of which competed in the food and beverage hygiene industry. Like EcoLab, JDH offered cleaning and hygiene products and services in hundreds of countries across several industries (food and beverage, lodging, health care, etc). JDH was an unlisted (private) company, with sales of almost $3 billion in 2004.10 EcoLab and JDH competed in the same geographic area as did Adept, and many of Adept's current customers had previously been supplied by EcoLab or JDH. In the past, when Adept had bid for a contract currently supplied by EcoLab or JDH, the two competitor companies would respond by offering to pricematch Adept's bid in order to keep their accounts. If customers were currently satisfied with the products and services offered, EcoLab and JDH were successful in keeping their contracts. In addition, there were several smaller detergent-business competitors servicing different industries such as hospitals, schools and retail food distributors, that competed indirectly with Adept. ADEPT CHEMICAL, INC. Chief Executive Officer Mike Brock Brock started his career working at Silverwoods Dairy (an ice cream and milk products manufacturer) in London, Ontario, at the age of 18. Brock moved into the food and beverage hygiene industry in 1981 when he accepted a job with EcoLab. Brock worked as a salesperson and then as a sales manager for EcoLab until 1989 when he was hired as the senior vice-president of sales for JDH. In 1997, Brock became the CEO of Alex C. Fergusson, Inc. (AFCO), a $16 million private detergent and sanitation business located in Philadelphia, Pennsylvania. Brock relocated to Canada four years later to be closer to his family and to launch Adept. Brock's goals for the business were simple: to provide himself with a job (at a salary of $80,000) until retirement, to recoup his initial investment in Adept through dividends over the next 10 years, and to leave a legacy for his three children. 8 Dow Jones Factiva, 2008. www.ecolab.com, May 13, 2008. 10 www.johnsondiversey.com/cultures/en/default.htm, May 13, 2008. 9 This document is authorized for use only by jahnavi mange (jmange20@student.scad.edu). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. Page 4 9B08N019 History Adept Chemical, Inc. was incorporated on August 1, 2001, with an objective to be the best regional supplier of cleaning and hygiene products and services in the Montreal-to-Windsor corridor; however, Adept would accept business in Canada and the United States when customers required mainly products, not service. Adept's initial strategy was to bid on the food and beverage manufacturers' detergent business with the hopes of gaining the sanitization business (for the food itself) over time. Adept had four legally protected specialized sanitizers that had an outstanding record for reducing or eliminating food-borne pathogens. These sanitizers targeted specific bacterium, unlike Adept's competitors' products, which used one sanitizer to kill all bacteria (but did so less effectively). In 2004, Adept decided to focus new sales on the specialized sanitation business because it had significantly higher margins than other detergent products. This had proven to be an excellent decision because food and beverage manufacturers were having a difficult time meeting the new, stricter, food-related regulations. A long-term goal of the company was to build an export business for its four specialized exclusive sanitizer products. Corporate Structure Adept was owned by three stakeholders: Sodrox Chemicals (Sodrox) (50 per cent), Mike Brock (35 per cent) and Ken Pedder (15 per cent). Adept was essentially a marketing arm of Sodrox, a firm that operated several other marketing arms in non-competing industries. Sodrox blended chemicals according to Adept's formulas, shipped the product to customers, took orders, billed customers, collected payments and handled payroll. In exchange, Adept paid Sodrox for the cost of the finished goods plus 15 per cent on this cost. Adept had two full-time employees, Brock and Pedder. Pedder was Brock's brother-in-law, and he had worked for Brock at AFCO. Brock was the CEO, focusing mainly on sales, while Pedder focused on servicing existing customers. The Sales Process The first step in securing a sale was the sales call. In the beginning, Brock was permitted to make sales calls only because he knew many of the safety managers from his employment with EcoLab and JDH.11 After Adept had developed a reputation for high-quality, low-priced products with exceptional service, Brock began receiving unsolicited calls asking for his \"pitch.\" In fact, Brock had received so many salescall requests in the past year that he was turning them down on a regular basis due to lack of time. The next step was to perform a plant audit of the potential customers' facilities. A plant audit involved such steps as taking samples, measuring bacteria counts and identifying areas for improved safety or lower costs. A plant audit allowed Brock to showcase his skill and experience. After the audit, several meetings took place, both with and without an Adept representative to determine \"the fit\" between the company needs and Adept's offerings. The final step was to negotiate and prepare the contract (or bid), outlining prices, services provided, equipment rentals/purchases and guarantees. Contracts were generally three to five years in length and prevented competitors from gaining the same business within this time period. 11 Small hygiene suppliers would not normally be given the opportunity to bid on such large contracts. Also, many former employees of large companies are required to sign non-compete agreements stating that they will not compete with their former employer in a certain geographical area or during a certain time period. Brock's non-compete agreements had expired in Canada. This document is authorized for use only by jahnavi mange (jmange20@student.scad.edu). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. Page 5 9B08N019 Recent Financial Performance Adept had experienced strong growth each year since incorporation (see Exhibit 5 for financial statements from fiscal 2005 to 2007), but, like many small and growing companies, although profitable, it was plagued with cash-flow problems. THE CARGILL FOODS BID New Business Cargill Foods was an international provider of food and agricultural products and services.12 Privately held, Cargill employed 158,000 employees in 66 countries. Since Adept had recently been named as a preferred supplier, it was allowed to bid on any new business that Cargill tendered (resulting from the opening of new plants) or on expiring contracts with current suppliers. Cargill's contracts with current suppliers for sanitation products were set to expire on June 30, 2008, instigating Cargill's call for bids. The business on which Brock wanted to bid included seven additional meat-processing plants in Ontario and two meat-processing plants in Alberta for a contract length of three years. This proposed bid, if awarded to Adept, was expected to increase monthly sales by an additional $250,000. At that price, gross margins would average 63 per cent. The Deal If Adept's bid was accepted, Adept would need to invest in equipment at a cost of $30,000 per plant. The company depreciated equipment over 10 years (straight-line) with no expected residual value. Adept would also need the equivalent of one month's inventory (15 days' worth at the customer's plant(s) and 15 days' worth in Adept's warehouse) on-hand for this contract. Payment from Cargill was expected to be in line with Adept's fiscal 2007 days of accounts receivable. Although Sodrox preferred to be paid within 60 days, it had allowed Adept to pay late without consequence in the past. Additional annual costs for this contract would include salaries ($40,000), a car allowance ($10,200), and maintenance costs ($9,600), which would be spread evenly throughout the year and would be paid in the same month the work was performed. Brock also estimated that 20 per cent of his time would be spent managing the account; therefore, the proposal should also cover 20 per cent of his salary, which would remain unchanged in the next fiscal period. Brock was considering an alternative deal wherein Adept would lower the bid price by seven per cent, but Cargill would have to purchase its own equipment. This alternative would be financially attractive to Cargill, given the length of the contract. Brock wanted to compare the two proposals, both from a return on investment perspective and from a monthly cash flow perspective (for six months from July 2008 to December 2008). Financing The first hurdle Brock faced would be winning the contract; however, if awarded, financing would be another challenge. While Sodrox had the resources to finance the contract, it was hesitant to do so considering it had not yet received any dividends from its investment in Adept. Brock believed the bank 12 www.cargill.com, May 15, 2008. This document is authorized for use only by jahnavi mange (jmange20@student.scad.edu). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. Page 6 9B08N019 would also be hesitant to extend further loans since banks rarely deemed this kind of equipment as collateral (i.e. it was too specialized to have any significant resale value). A New Employee If Cargill accepted either one of Adept's bids, Brock would need to hire a new salesperson to take on some of Brock's sales responsibilities. Brock was currently the only employee making sales calls, but he believed that his youngest son, Adam, or another qualified person could be trained within three to six months to handle sales calls on his own. Adam graduated from secondary school in June 2002 at the age of 19. He had worked in the car industry for many years; first as an oil guard and oil change technician and then as a front counter salesperson at Midas13 and Canadian Tire. Although Adam was passionate about cars, the career prospects in that field were not very appealing. He was excited about the opportunity to work with and learn from his father in an altogether different industry. As outlined in the proposed deal, Adam (or another new employee) would be paid a salary of $40,000 annually and would receive a car allowance of $850 per month for a lease, insurance, maintenance and gas. After the three-to-six month training period, Adam would then be eligible to receive a 25 per cent commission on any new sales (Cargill's new business was not eligible for this commission). Brock wondered what sales level would need to be reached in order for the company to break even on the cost of Adam's employment, excluding his training period. Brock also wondered what qualities and characteristics a new sales person should possess, and whether hiring family members was a wise decision. CONCLUSION Brock was excited about the potential new business, but he had some serious concerns about cash flow and his time commitments to this new business along with his current responsibilities. He wanted to project financial statements for fiscal 2008 and expected similar growth in sales to that experienced between fiscal year 2006 and fiscal 2007, regardless of whether the new bid was accepted. If the new bid were accepted, only one month of the new business would be reflected in the fiscal 2008 statements; however, Brock did not feel the need to project further out. 13 Midas is an auto maintenance and repair services company with locations across the United States and Canada. This document is authorized for use only by jahnavi mange (jmange20@student.scad.edu). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. Page 7 9B08N019 Exhibit 1 CANADIAN FOOD AND BEVERAGE MANUFACTURING SECTORS Sector Meat-processing Poultry-processing Fish products Dairy Confectionery Sugar Vegetable Baking Biscuit Miscellaneous food Vegetable oil Feed Flour and breakfast cereal Soft-drink Distilling Brewing Wine Source: www.thecanadianencyclopedia.com, May 15, 2008. This document is authorized for use only by jahnavi mange (jmange20@student.scad.edu). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. Page 8 9B08N019 Exhibit 2 ADEPT CUSTOMER LIST (Segmented by industry and listed in order, from most to least sales dollars) MEAT & POULTRY (67% of Adept's sales) Cargill Foods (four plants) Maple Leaf Foods Cami Poultry MISCELLANEOUS (30% of Adept's sales) Hubbert's Industries R-Squared Products BoxSys Great North Chemicals Touche Bakery BREWERY (3% of Adept's sales) Cool Beer Wellington Brewery Lakes of Muskoka Brewery Cameron's Brewing Co. F&M Brewery Newstadt Spring Brewery Black Oak Brewery Stratford Brewery King Brewery Amber Brewery Durham Brewing Company Winemakers of Hanover Grand River Brewery Robert Simpson Brewery D. Sykes Brewery Slater Brewery Source: Company files. This document is authorized for use only by jahnavi mange (jmange20@student.scad.edu). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. Page 9 9B08N019 Exhibit 3 SHARE OF FOOD AND BEVERAGE MANUFACTURING IN TORONTO Source: http://www.toronto.ca/invest-in-toronto/food.htm, June 26, 2008 Exhibit 4 ECOLAB - KEY RATIOS Fiscal 2007 Current ratio Acid test Long-term debt to equity Interest coverage 1.13 0.83 31.0 13.1 times Net income before tax to sales Gross profit to sales Return on assets Return on equity 11.1% 50.4% 9.6% 24.1% Inventory turnover Age of accounts receivable 6.7 times 60.5 days Source: Company profiles, www.factiva.com, May 20, 2008. This document is authorized for use only by jahnavi mange (jmange20@student.scad.edu). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. Page 10 9B08N019 Exhibit 5 STATEMENT OF EARNINGS For the years ending July 31 2007 2006 Product sales Equipment sales Other sales Total Revenue $ 824,494 33,639 1,546 $ 859,679 $ 620,990 12,734 991 $ 634,715 $ 481,377 12,557 2,150 $ 496,084 Cost of Goods Sold Product purchases1 Equipment purchases Freight Packaging $ 402,833 27,784 44,924 13,601 $ 248,771 11,092 32,683 18,724 $ 189,677 8,375 25,890 23,324 Total Cost of Goods Sold Gross Profit 489,1422 $ 370,537 311,270 $ 323,445 247,266 $ 248,818 $ $ $ REVENUE 2005 OPERATING EXPENSES Accounting & legal Advertising and promotion Depreciation Bad debt Bank charges Benefits Insurance Interest Lab and test kits Meals, entertainment and travel Miscellaneous Office expenses Rentals Service work Shop expenses Telephone U.S. exchange Vehicle expense Wages Payroll taxes 2,616 4,001 10,990 -- 1,481 4,389 10,737 12,569 728 20,307 1,318 8,559 1,886 10,080 43,099 10,995 6,869 40,855 130,000 6,827 1,597 3,018 8,507 967 858 3,630 9,167 9,496 3,553 15,152 466 18,350 1,926 3,600 32,728 7,387 1,988 34,764 129,020 7,169 Total Operating Expenses $ 328,306 $ 293,343 Net Earnings (loss)3 $ $ 42,231 30,102 2,657 598 7,666 722 853 -- 5,269 6,775 1,114 10,137 265 9,438 873 -- 25,011 7,384 4,142 32,971 132,594 7,853 $ 256,322 $ (7,504) 1 Product purchases included cost of finished goods and 15 per cent paid to Sodrox. In 2007, Adept began selling a few commodity products that had significantly higher COGS than did its other products. 3 Sodrox pays corporate tax on Adept's earnings. 2 This document is authorized for use only by jahnavi mange (jmange20@student.scad.edu). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. Page 11 9B08N019 Exhibit 5 (continued) VERTICAL ANALYSIS 2007 2006 2005 95.9% 3.9% 0.2% 97.8% 2.0% 0.2% 97.0% 2.5% 0.4% 100.0% 100.0% 100.0% Cost of Goods Sold Product purchases Equipment purchases Freight Packaging 46.9% 3.2% 5.2% 1.6% 39.2% 1.7% 5.1% 2.9% 38.2% 1.7% 5.2% 4.7% Total Cost of Goods Sold 56.9% 49.0% 49.8% Gross Profit 43.1% 51.0% 50.2% 0.3% 0.5% 1.3% 0.0% 0.2% 0.5% 1.2% 1.5% 0.1% 2.4% 0.2% 1.0% 0.2% 1.2% 5.0% 1.3% 0.8% 4.8% 15.1% 0.8% 0.3% 0.5% 1.3% 0.2% 0.1% 0.6% 1.4% 1.5% 0.6% 2.4% 0.1% 2.9% 0.3% 0.6% 5.2% 1.2% 0.3% 5.5% 20.3% 1.1% 0.5% 0.1% 1.5% 0.1% 0.2% 0.0% 1.1% 1.3% 0.2% 2.0% 0.1% 1.9% 0.2% 0.0% 5.0% 1.5% 0.8% 6.6% 26.7% 1.6% 38.2% 46.2% 51.7% 4.9% 4.7% (1.5%) REVENUE Product sales Equipment sales Other sales Total Revenue OPERATING EXPENSES Accounting and legal Advertising and promotion Depreciation Bad debt Bank charges Benefits Insurance Interest Lab and test kits Meals, entertainment and travel Miscellaneous Office expenses Rentals Service work Shop expenses Telephone U.S. exchange Vehicle expense Wages Payroll taxes Total Operating Expenses Net Earnings (loss) This document is authorized for use only by jahnavi mange (jmange20@student.scad.edu). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies. Page 12 9B08N019 Exhibit 5 (continued) STATEMENTS OF FINANCIAL POSITION As at July 31 2007 2006 2005 ASSETS Current assets: Cash Accounts receivable4 Prepaids Inventory Total current assets $ Capital assets: Customer equipment (net)5 Control panels (net) Computers (net) Vehicles (net) Total capital assets Total Assets -- 132,613 4,388 19,908 156,909 $ -- 92,791 3,483 17,943 114,217 $ -- 77,794 2,075 20,281 100,150 77,952 1,953 1,680 11,363 92,948 56,842 2,442 1,003 -- 60,287 64,308 3,053 1,433 -- 68,794 $ 249,857 $ 174,504 $ 168,944 $ $ $ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Operating line of credit6 Accounts payable7 Accrued liabilities and other current payables Total current liabilities 34,327 113,250 5,575 153,152 43,078 65,944 6,248 115,270 63,565 70,227 6,020 139,812 Long-term liabilities: Sodrox term loan Shareholder loan Personal loan Total long-term liabilities 88,000 45,000 42,240 175,240 100,000 45,000 35,000 180,000 100,000 45,000 35,000 180,000 Total liabilities 328,392 295,270 319,812 120,000 (198,535) (78,535) 120,000 (240,766) (120,766) 120,000 (270,868) (150,868) Shareholders' equity Capital stock Retained earnings Total shareholders' equity Total Liabilities and Shareholders' Equity $ 249,857 $ 174,504 $ 168,944 4 Accounts receivable related only to product sales. Represents equipment owned by Adept but located at customer manufacturing plants. 6 The line of credit had a $50,000 limit and an average interest rate of eight per cent per annum. 7 Adept paid all cost of goods sold expenses on account. 5 This document is authorized for use only by jahnavi mange (jmange20@student.scad.edu). Copying or posting is an infringement of copyright. Please contact customerservice@harvardbusiness.org or 800-988-0886 for additional copies