Microsoft Word - New England Lumber2.docx
New England Lumber Corporation
On April 20, 2018, Lynn Thomas started to prepare her files for a meeting with the Hall
family. She has been employed to advise them about the financials of the firm and to
give them advice moving forward. As credit assistant to Ha
y Sarson of the Maritime
Bank in New York, Lynn had been asked to review the file of New England Lumber
Corporation. Her job was to decide if Gail Hall's explanation of what had gone
wrong was plausible, then to predict risks to the bank under various projections of
the company's future. Finally, Lynn was to make recommendations for action by the
ank. In preparing her report she has questions at the end of the study that should
e answered in Word. Please use complete sentences and spell check your answers.
New England Lumber Corporation was established in 2013 in Battleboro, Vermont to
wholesale lumber in the New England region. Major shareholders were
other and sister
Edward and Gail Hall, members of a wealthy and respected family with a long
entrepreneurial history in Vermont.
After four years of profitable operations, the company showed an operating loss of
$219,666 and a net loss of $174,216 on sales of approximately $17 million for the year
ending December 31, 2018. This loss was an urgent concern to the Halls and to the
Maritime Bank which had extended the company a $1.3 million revolving line of credit
(at prime plus 1%).
When the third quarter results were in, Gail Hall felt she needed to personally take charge
of the company. In October of 2018 she therefore put aside her lucrative law practice (she
had netted $140,000 in 2018) to devote her full attention to the company. She first had to
identify its main problems, then take co
ective action.
Company History
New England Lumber Corporation has sales te
itories in the New England, Vermont,
Massachusetts, Connecticut and Rhode Island and, secondarily, in Canada.
Approximately 80% of sales were generated in the New England, 19% in New York and
I % in Canada. Edward and Gail own shares of the firm, and also by David Lawson, who
had managed the company until October 2008. At that time he was released and Edward
and Gail had purchased his shares for one dollar. Lawson was blamed for the company's
poor performance in late 2007 and 2008. The Halls, however, admitted they should have
een more involved.
With the exception of 2018, the operation had enjoyed significant sales increases from $3
million for the first year of operation (2014), to $19 million for fiscal 2017 (Exhibit 2).
Net income had reached a high of $128,000 (after a $48,000 loss from a rental operation).
The rental operation consisted of two sixteen-unit apartment buildings acquired by the
company in 2017. The rental operation loss was intended to offset income from the
lumber operation. During 2018, due in part to the poor performance of New England
Lumber Corporation, the rental property was sold (at book value) to another company
operated by the Halls. According to Gail, the rental operation now
oke even because
she stepped in, did some refu
ishing, changed property managers and thus increased
occupancy.
The lumber operation was straightforward. At the end of 2018, New England Lumber
Corporation had a sales team of four - three full-time traders and a general manager who
did some selling - to wholesale lumber to a customer base of XXXXXXXXXXlarge retailers. The
sales staff were paid a commission of 1.8% and the mark-up ranged between 4.5% and
5.5%. No inventory for the bulk of sales was required, as orders were placed with the
mills as received and wood was transported from the mill directly to the purchaser. New
England Lumber Corporation had a small administrative staff of two to three people to
handle accounting. Terms with most mills were net ten days, with an average collection
period on receivables of 22 days in XXXXXXXXXXdays for the Industry, see Exhibit 3). The
company thus needed to finance about 40 days' sales on average, which required a large
capital base. A small inventory of uncommon lengths was maintained for special orders;
approximate inventory value was $200,000.
According to Gail Hall, these practices ended when she took over the day-to-day
operation of the company. Her efforts produced a small profit of $16,000 for the first
quarter of 2019. According to her, this showed that the company had turned around
ecause the first quarter of the year was traditionally the company's worst.
The Principals in the Company
Although New England Lumber Corporation was founded in 2003; the Hall family had
een involved in the wood/lumber industry for more than half a century. The Halls felt
they knew the lumber industry, and that they had the developed relationships in the
industry to generate substantial sales. Edward Hall had never taken an active role in the
usiness and Gail agreed she neglected it. Gail appeared knowledgeable and was
prepared to assist in a sales effort if necessary.
Because the Halls were very influential in the Battleboro marketplace, Lynn knew that
her boss, Ha
y Sarson, wished to maintain their goodwill. However he also wanted to
ensure the safety of the bank's investment.
The Banker's Risk Assessment of the Company in April 2019
Lynn Thomas identified four areas where the company significantly risked the bank's
capital: (1) operating losses sustained to date; (2) debt to equity at 17:1 for year-end
2018, down to 4:1 when subordinated loans1 and liquid security were included for the
first quarter of 2019; (3) competition; and (4) inability to sustain any further losses.
1 Subordinate to the bank debt. Also called a postponement of shareholders’ claims. In this case the Halls had injected
$200,000 (a subordinated shareholders’ loan) into the company since year-end 2018.
According to Lynn, there were mitigating circumstances for each risk factor. The
improvement in performance since year-end 2018 seemed to indicate that problem areas
had been identified and co
ected. Gail Hall monitored all In-house financial statements
closely for the period. Lynn did not consider the Canada-US Free Trade Agreement a
significant risk; Given the 1% of sales to Canada even if there were new trade tariffs it
would not be a major concern.
Personal guarantees in the amount of $316,000 from the Halls partly offset the debt to
equity position.
New England Lumber Corporation had an established client base.; the Hall name had
een synonymous with lumber for over fifty years. Lynn felt that reluctance to tarnish the
Hall family name would prompt Gail to cooperate with the bank. Gail had indicated that
to forestall losses, she would close down operations if there was any sign of a downturn.
Economic Forecast
As part of her background analysis of the business, Lynn had reviewed the economic
forecast prepared by the bank's Economics Department in early 2019. The forecast
surveyed leading economic indicators, and showed that the economy would begin to slow
down during the second quarter. The bank's economists believed that interest rates would
emain high as long as Jerome Powell, Chairman of the Federal Reserve tried to reduce
inflation.
Industry Scan
Lumber traders' customers were usually independent supply stores, general contractors
working on large projects (cutting out the middleman), or large end users such as mobile
home manufacturers.
Lumber traders needed experience. It was also important to know the reputation for
quality and reliability of each mill. The trader also had to a
ange for transportation from
the mill to the destination. Given that the lumber was heavy it often required equipment
to get it on and off the trucks. In addition, if a purchaser did not want a full load, as was
often the case, the cost of transporting a partial load could make the order uneconomical.
Low cost was a critical factor in the lumber business because it operated on low margins.
There were risks inherent in the lumber trading business; the most significant was bad
debts. The trader was responsible for paying the mill regardless of whether the customer
paid on time, late or not at all. If the customer did not pay, the resulting loss could
ankrupt the trader. The trader also had the responsibility to deliver the stated quantity
and quality of product on time. Buying off-grade lumber or having late deliveries could
hurt customer relations and affect receivables collection. This is commonly known as a
cash flow problem.
Because of the cost of transportation and the fact that many orders were not full loads,
New England constituted the major market of New England Lumber Corporation; this
market consumed approximately 1.2 billion board feet of lumber per year. The company's
market share was about 5% in a fiercely competitive industry where they competed with
other well established families.
Environmental factors could negatively affect the supply of lumber. Termite damage
could impact the lumber sales as customers did not want to
ing home the pests. To
eradicate the termites there were forest-spraying programs but environmental groups
were concerned about the pollution and hazards associated with those chemicals. In
addition, there were costs associated with the forest-spraying. Those costs would
initially be bore by the lumber and timber farms and ultimately borne to the end
consumer. Customers would realize that the New England Lumber costs have increased
from period to period but not know or understand this was to reduce the threat of the
termite. This put additional pressure on lumber traders' margins.
One other factor was the Teammates Union, which operated many of the trucks in transit.
The Union folks often threatened a strike when the were not “fairly compensated” and
sometimes lead to salary increases beyond what New England Lumber wanted to pay
which may be a contributing factor in the Salary Expense increase. A threat or actual
strike could cause delays in transportation. One time in the past the Halls attempted to
use a non-Union transportation company. That did not go very successfully.
Final Preparations