Wilson Lumber Company Case Study

January 10, 2020

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Preface

• Wilson Lumber Company (“Company” or “Wilson”) was founded in 1975 by Messrs.. Wilson
and Stark
– Products include plywood, moldings, and sash and door products
– In 1982, Mr. Wilson bought out Mr. Stark’s interest for $75,000
▪ This was a note to be paid off in 1983
– Funds were raised by using Mr. Wilson’s land and buildings as collateral for $50,000
▪ Interest rate of 14% with 10% annual amortization
• Wilson Lumber Company (“Company” or “Wilson”) experienced increase in sales in spring of
1985
– Borrowed $173,000 from Suburban National Bank (“Suburban”) to finance growth
– Suburban’s credit limit is $175,000
– Wilson is currently looking for another lender because of revolver capacity
• Wilson wants to work with Northrup National Bank (“Northrup”) for a higher revolver
– New revolver to be $325,000

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Operational Information

• Sales volume had been built based on price competition

– Possible through volume purchases of materials at discounts and control of operating
expenses
• Moldings, sash, and door products were used for repair work
• Employs no sales reps, so very little opex – majority of sales done through phone
• Employees:
– 1 assistant
– 5 worked in yard and drove trucks
– 5 in office work and sales
• Sales expected to reach $2.5MM in 1985
– Possibility of housing decline and tightening credit markets as well, which will slow sales
• Rapid increase in Wilson’s AP in spring of 1985
– Terms of suppliers provide 2% discount to payments made within 10 days of invoice

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Northrup National Bank Loan Terms

• Unsecured 90-Day Revolver

– Nominal value of $325,000
– Standard leverage and fixed charge covenants
– Restrictions on additional borrowing
– Net working capital at normal levels
– Growth capex must be approved by the bank
– Interest of 3% + lowest rate charged by the bank
▪ Would be approximately 14% at the date of issuance
– Severance of existing revolver with Suburban National

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Describe briefly the lumber business and what you think are the key factors to be successful in
it

• Plywood is a widely used, versatile sheet wood that can be used to construct fine furniture,
shelving, cabinets, and boats and has many applications in the construction industry
– Used as a raw material for many construction materials and furniture
• To be successful in the business:
✓ Strong Distribution Network – reliable distribution network that can reach majority of
potential market
✓ Reliable suppliers –has reliable suppliers of raw material to allow company to maximize
margins and overcome and production bottlenecks
✓ Good Returns on Capital Expenditure – be successful at execution of new projects that
generate good returns on capex
✓ High level of customer satisfaction – high level of customer satisfaction and good brand
reputation amongst its potential customers
✓ High levels of operating expertise – specific industry knowledge to run business operations
successfully and execute on new business opportunities

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How well is the Wilson Lumber Company doing from an operational standpoint ?

• From an operational standpoint, due diligence from Northrup reveals the following:
– Not wasted money in disproportionate plant investment
– Running on very minimal operating expenses
– Personal control over every feature of his business – including operations, capex, and
financials
– Excellent turnover rates on employees
– Managing working capital extremely as well trying to get AP discounts
• Based on customer due-diligence, the business is currently being run extremely well

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Describe briefly Wilson’s financial policy over the past few years

• Mr. Wilson’s financial policy over the last few years has been to obtain the most favorable
terms for raw materials
• In addition, he has also reduced operating expenses as much as possible to improve
profitability
– Employs no sales reps, so very little opex – majority of sales done through phone
• Finances growth and working capital using bank borrowing and debt
• He takes the 3G capital approach
– Obtain most favorable terms for procurement
– Reduce opex to drive up margins
– Any capex is financed using debt
– Only difference is Mr. Wilson doesn’t seem to have a dividend policy; whereas 3G seeks to
return as much capital to shareholders as possible

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Why does Mr. Wilson have to borrow money to support his business?

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Why does Mr. Wilson have to borrow money to support his business?

• Mr. Wilson borrows money to support the business for the following reasons:
– Margins are not high enough where he is able to generate enough cash for the business
– Uses the revolver fund working capital due to the growth of the business
▪ Needs to build up inventory for prospective customer orders
▪ Some investments in growth capex since PPE is going up over time
▪ Over time, Mr. Wilson seems to be delaying payments to vendors due to lack of cash

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Do you agree with Mr. Wilson’s conclusion that a $325,000 line of
credit would more than meet his foreseeable funding needs?

• To see whether or not a $325,000 line of credit would meet Mr. Wilson’s funding needs, we
need to see how much working capital the business requires
– Under the scenario that sales grows 25% YoY, while COGS and Opex remain same % of
revenue historically, and AP of 55 days, a $325K revolver would be able to meet his
funding needs
– However, under the cases that he reduces AP to only 10 days, then he’s going to run into
funding issues – the cash outflow from working capital needs are simply too great. Under
the case that he grows 25% a year and AP is 10 days, he will need over $620K to fund his
working capital needs
– If he grows 14% a year with 10 AP days, he will still need $377K revolver capacity to fund
his business so that he does not run out of csah

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Scenario 5A

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Scenario 5B

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Scenario 5C

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As Mr. Wilson’s financial advisor, would you urge him to go ahead with his plans for further
expansion and more debt financing — or reconsider both?

• Currently, Mr. Wilson’s business structure and industry really forces him to grow his top-line
• The lumber business is a high operating leverage business where there tends to be
substantial fixed costs
– Company is currently operating at 3% EBIT margins
– To increase profitability, the only thing Mr. Wilson can do is to “grow” his way up
– Cutting operating expenses is not really an option because he is already running a bare
bones minimum operation
• Because of the working capital needs of growth, especially in terms of inventory, Mr. Wilson is
forced to borrow on a revolver because the company isn’t generating enough cash
– Another alternative is to get some sort of equity funding, but unlikely given the stage of the
business
– Mr. Wilson can also fund the business himself, but he has limited capital
• If I were his financial advisor, I would ask him to negotiate with vendors and suppliers as
much as possible to get the best working capital terms
• Afterwards, he should grow the business such that it generates more cash flow

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As his banker, would you be willing to lend to Mr. Wilson? If so, what conditions would you attach
to the loan? If not, explain why, and what Wilson might do to make you change your mind.

• As a banker, I would lend to Mr. Wilson. However, the answer is how much…
– As of Q1 1985, Mr. Wilson’s has $24K of cash, $241K of AR, $389K of inventory, and $113K of PPE on
its balance sheet
– At the same time, it had $517K of total liabilities
– In the case that the Company is unable to pay back the loan, we could liquidate the company for a
portion of its assets and pay down the liabilities
– Assuming we could get $0.75 on the dollar for its assets (except for the cash), the total liquidation value
would be $558K on the AR, inventory, and PPE and $24K for the cash
– If we pay down the liabilities with the above amount, we have a net liquidation value of $65K, which
means that as a banker, I would be willing to lend Mr. Wilson’s business at least $65K more
• However, a standard revolver also looks at a few other ratios when making a loan
– Leverage ratios: Total debt / EBITDA
– Coverage ratios: EBITDA / interest expense
– Fixed charge coverage ratios: (EBITDA – capex – taxes) / (debt repayment + interest expense)

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As his banker, would you be willing to lend to Mr. Wilson? If so, what conditions would you attach
to the loan? If not, explain why, and what Wilson might do to make you change your mind.

• Leverage ratio = Total debt / EBIT

– $325K / $75K = 4.3x
• Coverage ratios: EBIT / interest expense
– $75K / ($325K * 14%) = 1.6x
• Fixed charge coverage ratios: (EBIT – capex – taxes) / (debt repayment + interest expense)
– ($75K - $3K - $13K) / ($325K * 14%) = 1.3x

The bank is cutting it extremely close in regards to these financial ratios if it does choose to lend
Mr. Wilson $325K. Generally, banks want to be below 4.0x leverage ratio, above 2.0x coverage
ratio, and above 1.5x for your FCCR

If I were a bank, I would extend a smaller loan to Mr. Wilson’s business

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