Clarkson

Clarkson LumberHardwoods, Hard Times

BBUS 505aCavelero, Engstrom, Tobey & Zadah

Overview

• Case Summary

• Problem Identification

• Findings

• Methodology

• Metrics

• Insights

Case Summary• Clarkson Lumber Company [‘CLC’], is a small PNW lumber concern

experiencing rapid, questionably financed growth.

• Keith Clarkson [‘Clarkson’], sole owner of CLC, has maxed out ($399K of • Keith Clarkson [‘Clarkson’], sole owner of CLC, has maxed out ($399K of

$400K) his line of credit [‘LOC’] at Suburban National.

• CLC relies heavily on trade credit and short term debt.

• Clarkson wants to move to Northrup National Bank – a larger bank – with a

a $750K short-term LOC.

• George Dodge, Northrup officer, is cautiously receptive. He’s asked a team

of intelligent, attractive analysts to investigate the current state of CLC.

Problem Identification“Clarkson wants to move to Northrup National Bank – a larger bank offering

a $750K LOC.”

• CLC overuses expensive short-term debt to finance growth and • CLC overuses expensive short-term debt to finance growth and

buyout his former partner.

• It is our opinion that receiving a larger LOC from our bank will result

in negative future growth and exacerbate current cash flow problems.

• There are other problems with cash-flow, including inventory

purchasing, A/R and a 2% A/P discount (opportunity).

• PPE depreciation is an unkown; for our analysis, we factored it out.

Findings• CLC can be a profitable investment for Northrup, but not with the stated

credit terms. Debt restructuring is needed to maximize CLC’s profitability.

• According to our research, CLC is in danger of growing at a

“unsustainable” pace:“unsustainable” pace:

a. Most metrics are highly positive

b. DuPont shows consistent gains

c. However, CLC’s sustainable growth rate is 20.7%; his

current projected growth is 21.7%

• Greatest challenge is cash flow

a. Poor financing, capital structure

b. Growth overly reliant on expensive short- term debt

c. Increasing inventory

Findings1. Short-term LOC of $750k will put CLC in bankruptcy by the end of 1998

2. CLC’s projected growth creates a forecasted EFN of ~$975K.

3. By maintaining the projected growth rate, Northrup can facilitate CLC’s 3. By maintaining the projected growth rate, Northrup can facilitate CLC’s

maximum profitability by offering “balanced” financing of 35% short-term

(~$340k) and 65% long-term (~$635 k).

$160

$180

$20

Operating Income

Findings

$0

$20

$40

$60

$80

$100

$120

$140

$160

1996 1997 1998

$8

$14

$20

Balanced

Short Term

Methodology1. Financial Statements Analysis

• Common-Size Income Statement (% Sales)

• Common-Size Balance Sheet (%Assets)

2. Ratio Analysis2. Ratio Analysis

• Short-Term Solvency (Liquidity)

• Long-Term Solvency (Financial Leverage)

• Assets Management (Turnover)

• Profitability

3. The Du Pont Identity (Current, Forecasted)

4. Financial Planning

• Estimated sales growth

• Forecasted growth using ‘% of sales’ approach

• Estimated amount, type of EFN

• Estimated sustainable growth

1996: Q1

Clarkson vs. IndustryLow-Profit Outlets High-Profit Outlets CLC 3YR 1995

Percent of Total

Sales:

Cost of goods 76.90% 75.10% 75.60% 75.80%

Operating expense 22.00% 20.60% 20.90% 20.80%

Cash 1.30% 1.10% 1.40% 1.20%

Accounts receivable 13.70% 12.40% 11.90% 13.40%

Inventory 12.00% 11.60% 12.30% 13.00%

Fixed assets, net 12.10% 9.20% 8.00% 8.60%

Total Assets 39.10% 34.30% 33.70% 36.20%

Percent of Total

Assets:

Current liabilities 52.70% 29.20% 48.41% 66.50%

Long-term liabilities 34.80% 16.00% 13.45% 6.10%

Equity 12.50% 54.80% 38.14 27.40%

Total Assets 100.00% 100.00% 100.00% 100.00%

2.5

2.49

CURRENT RATIO

Metrics: Short Term Solvency

2.5

QUICK RATIO

0.0

0.5

1.0

1.5

2.0

1993 1994 1995

1.58

1.15

0.0

0.5

1.0

1.5

2.0

1993 1994 1995

1.27

0.82

0.61

Metrics: Leverage

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.45

0.680.73

1993

1994

1995

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

0.86

2.59

4.06

1993

1994

1995

0.00

0.10

TOTAL DEBT RATIO

0.00

0.50

DEBT-EQUITY RATIO

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

Current liabilities

29.92%

48.83%

66.46%

CLC 1993 CLC 1994 CLC 1995

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00% 52.70%

29.20%

66.46%

Low-Profit High-Profit CLC 1995

Current Liab. - Industry Comparison

Metrics: Asset Utilization

45.00

50.00

38.24

43.14

48.95

64.00 62.57

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

40.00

45.00 38.24

1993

1994

1995

52.00

54.00

56.00

58.00

60.00

62.00

55.86

59.86

1993

1994

1995

DAYS PER INVENTORY TURNOVER DAYS ACCOUNTS IN A/R COLLECTION

12.40%12.32%

% of Sales

Metrics: Inventory

11.20%

11.40%

11.60%

11.80%

12.00%

12.20%

Low-Profit Outlets High-Profit Outlets Clarkson 3YR

12.00%

11.60%

Inventory

54.00% 50.87% 51.73%53.00%

vs. Current Assets

Metrics: Inventory

Inventory

Non-inventory

43.00%

44.00%

45.00%

46.00%

47.00%

48.00%

49.00%

50.00%

51.00%

52.00%

53.00%

1993

1994

1995

49.13%

48.27%

47.00%

50.87% 51.73%

% o

f C

urr

en

t

Years

0.00

0.05

0.10

0.15

0.20

0.12

0.18 0.17Metrics: DuPont Analysis

0.00

0.01

0.01

0.02

0.02

0.032.1% 2.0%

1.7%

0.00

1993 1994 1995

ROE

0.00

1993 1994 1995

PROFIT MARGIN

2.50

2.60

2.70

2.80

2.90

3.00

3.10

3.20

1993 1994 1995

3.18

3.01

2.76

TOTAL ASSET TURNOVER

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

1993 1994 1995

1.82

3.11

3.65

EQUITY MULTIPLIER

0.10

0.15

0.20

0.21 0.20

0.19

Metrics: Forecasted DuPont

0.015

0.020

0.0252.2%

2.3%2.4%

1996 1997 1998

ROE

1996 1997 1998

PROFIT MARGIN

2.00

2.25

2.50

2.75

3.00

1996 1997 1998

2.99 2.99 2.99

TOTAL ASSET TURNOVER

0.00

1.00

2.00

3.00

4.00

1996 1997 1998

3.24

2.85

2.56

EQUITY MULTIPLIER

Income StatementOperating Expenses

1993 1994 1995 Percent of Sales

Net sales $2,921 $3,477 $4,519

Cost of Goods Sold:

Beginning inventory 330 337 432 10.1%Beginning inventory 330 337 432 10.1%

Purchases 2,209 2,729 3,579 78.0%

Total Inventory $2,539 $3,066 $4,011

Ending inventory 337 432 587 12.4%

Total Cost of Goods Sold $2,202 $2,634 $3,424 75.7%

Gross profit $719 $843 $1,095

Operating expensesb 622 717 940 20.9%

EBIT $97 $126 $155

2% AP Discount

Interest expense 23 42 56

EBT $74 $84 $99

Provision for income taxesc 14 16 22

Net income $60 $68 $77

Balance SheetBalance

1993 1994 1995 Percent of Sales

Net sales $2,921 $3,477 $4,519

Cash $43 $52 $56 1.4%

Accounts receivable, net $306 $411 $606 12.4%

Inventory $337 $432 $587 11.6%Inventory $337 $432 $587 11.6%

Current $686 $895 $1,249

Property, net $233 $262 $388 8.1%

Total Assets $919 $1,157 $1,637

Notes payable, banka -- $60 $390

Note payable to -- $100 $100

Notes payable, trade -- -- $127

Accounts payable $213 $340 $376 8.1%

Accrued expenses $42 $45 $75 1.5%

Term loan, current portionc $20 $20 $20

Current liabilities $275 $565 $1,088

Term loan $140 $120 $100

Note payable, Mr. Holtzb -- $100 $0

Total Liabilities $415 $785 $1,188

Net worth $504 $372 $449

Total Liabilities and Net Worth $919 $1,157 $1,637

Insights: Long-Term Debt

• Exchange a portion of short-term liabilities for long-term debt

• Will reduce interest payments• Will reduce interest payments

• Long-term debt has smaller payments, lower rates

• Savings passed to his cash flow; used to manage A/P

Insights: Reduce Inventory

• Reduce existing inventory

• Increase sales?

• Slow inventory growth; more capital in cash flow

• Drain inventory by growing with current excess

Insights: Increase A/R Turnover

• Increasing A/R turnover primes cash flow

• More cash in hand

• Can incentivize quicker collections with cash discount

• Savings in financing charges greater than 1% rebate

• Key Concerns

• Will bank accept such a loan?

• Can CLC collateralize long-term debt?

Key Concerns

• Can CLC collateralize long-term debt?

• Micromanaging sales within bank’s core capabilities?

• High inventory a hedge against price fluctuations?

• Can CLC profit margin afford 1% hit?