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Wilson Lumber Company

This case has been adapted by Marc Bertonèche, Visiting Professor at the Harvard Business School,from the original Wilson Lumber Company case (HBS-9-286-122). It was prepared as the basis forclass discussion rather than to illustrate either effective or ineffective liandling of an administrativesituation.

After a rapid growth in its business during recent years, the Wilson Lumber Company in thespring of 2002 anticipated a further substantial increase in sales. Despite good profits, thecompany had experienced a shortage of cash and had found it necessary to increase itsborrowing trom the SuburbanNational Bank:to $1,630,000 at the end of2001. The maximumloan that Suburban Nationalwould make to any one borrower was $1,650,000 and Wilsonhadbeen able to stay within this limit only by relying very heavily on trade credit. Mr. RogerWilson, owner and president of the Wilson Lumber Company, was therefore actively lookingelsewhere for a new bankingrelationshipwhere he would be able to negotiate a larger loan.

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Mr. Wilson had recentlybeen introduced by a personal mend to Mr. George Dodge, an officerof a much larger bank:,the Northrop National Bank. The two men had tentatively discussedthepossibility that the Northrop bank:might extend a line of credit to Wilson Lumber up to amaximum amount of $3,250,000. Mr. Wilson thought that a loan ofthis size would more thanmeet his foreseeable needs, but he was eager for the flexibilitythat a line of credit of this sizewould provide. Subsequent to this discussion Mr. Dodge had arranged for the creditdepartment of the Northrop NationalBank:to investigateMr. Wilson and his company. '"

The Wilson Lumber Companyhad been founded in 1990 as a partnership by Mr. Wilson andhis brother-in-law, Mr. Henry Stark. ln 1997 Mr. Wilson bought out Mf. Stark's interest for$750,000 and incorporated the business.

The business was located in a growing suburb of a large city. The company owned land withaccess to a railroad siding, and two large storage buildingshad been erected on this land. Thecompany' s operations were limitedto the wholesaledistributionof lumber products in the localarea. Typical products inc1udedplywood, moldings, and sash and door products. Quantitydiscounts and credit terms of net 30 days on open account were usually offered to customers.

Sales volume had been built up largely on the basis of successful price competition madepossible by careful control of operating expenses and by quantity purchases of materials atsubstantial discounts. Much of the moldings and sash and door products, which constitutedsignificant items of sales, were used for repair work. About 55% of total sales were made inthe six months trom March through August. No sales representatives were employed, ordersbeing taken exclusivelyover the telephone. Annual sales of$II,870,000 in 1999, $14,080,000in 2000, and $18,840,000 in 2001 yielded after-tax profits of $210,000 in 1999, $240,000 in2000, $310,000 in 2001. Profit and loss statements for the years 1999 through 2001 are givenin Exhibit 1.

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Mr. Wilson was an energetic man, 39 years of age, who worked long hours on the job. He washelped by an assistantwho, in the words of the investigatorof the NorthrupNationalBank, .

"has been doing and can do about everything that Mr. Wilson does in the organisation." Otheremployees numbered 80 in early2002.

As part of its customary investigationof prospecti,,:eborrowers, the Northrop National Banksent inquiries concerningMf. Wilsonto a number of firms that had business dealingswith him.The manager of one of his large suppliers, the Barker Company,wrote in answer:

"The conservative operation of his business appeals to us. He has not wasted hismoney in disproportionate plant investment Ris operating expenses are as low asthey could possiblybe. He has personal control over every feature of his business, ~

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and he possesses sound judgement and a willingnessto work harder than anyone 1have ever known. This, with a good personality, gives him an excellent turnover;and ITommy personal experience in watching him work, 1 know that he keepsclose check on his own credits."

AlIthe other trade letters received by the bank bore out the statement quoted above.

The bank gave particular attention to the debt position and current ratio of the business. Itnoted the ready market for the company's products at all times and the fact that sales prospectswere favorable.The bank's investigatorreported:"... Salesare expectedto reach$25 millionin 2002 and may exceed this level if prices of lumber should rise substantially in the nearfuture." Wilson Lumber's sales were protected to some degree ITom fluctuations in newhousing construction because of the relatively high proportion of its repair business.Projections beyond 2002 were difficult to make, but the prospects appeared good for acontinued growth in the volume of WilsonLumber's business over the foreseeablefuture.

The bank also noted the rapid increase in WilsonLumber's accounts payable in the recent past.The usual terms of purchase in the trade provided for a discount of 2% for payments madewithin 10 days of the invoice date. Accounts were due in 30 days at the invoice price butsuppliers ordinarily did not object if payments lagged somewhat behind the due date. Duringthe last two years Mr. Wilson had taken very few purchase discounts because of the shortageof funds arising from the additional investments in working capital associated with thecompany's increasing sales volume. Trade credit was seriously extended as Mr. Wilson stroveto hold his bank borrowing within the $1,650,000 ceiling imposed by the Suburban NationalBank.

Balance sheets as of December 31,1999-2001 are presented in Exhibit 2.

The tentative discussionsbetween Mr. Dodge and Mr. Wilson had been in terms of a revolvingshort-term loan not to exceed $3,250,000 in amount. The specifie details of the loan had notbeen worked out, but Mr. Dodge had explainedthat the agreement would involve the standardcovenants applying to such a loan. He cited as illustrative provisions the requirement thatrestrictions on additional borrowing would be imposed, that net working capital would have tobe maintainedat an agreed level, that additionalinvestments in fixed assets could be made onlywith the prior approval of the bank, and that limitations would be placed on withdrawals offunds ITomthe business by Mr. Wilson. Interest would be set on a floating rate basis at 3percentage points above the lowest rate charged by the bank on short-term loans. Mf. Dodgeindicated that the initial rate to be paid would be approximately9%. Both men also understoodtnat NIT.Wilson would sever ms relationsmp with the Suburban National Bank if he enteredinto a loan agreement with the Northrop NationalBank.

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~Exhibit 1

Profit and Loss Statements for the Years ending Dece~ 1999 through 2001

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(1) Details of cost of sales

(2) OperaÜng expenses include a salary for Mr. Wilson of $145,000 in 1999, $150,000 in 2000, and $155,000in 2001. ~

1999 2000 2001

Net sales Il,870 14,080 18,840

Cost of sales(l) 8,550 10,050 13,640

Gross rnargin 3,320 4,030 5,200

Operating expenses(2) 2,970 3,600 4,600

Operating profit (EBIT) 350 430 600

Interest expense 90 140 230

Profit before taxes 260 290 370/"\

Incorne taxes 50 50 60

Net profit 210 240 310

1999 2000 2001

Beginning inventory 1,280 1,670 2,280

Purchases 8,940 10,660 14,280

Ending inventory (1,670) (2,280) (2,920)

Cost of sales 8,550 10,050 13,640

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Î' Exhibit 2

Balance Sheets as ofDecember 31, 1999-2001($ 'OOOs)

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Assets 1999 2000 2001

Cash 410 340 290

Accounts receivable, net 1,100, 1,550 2,220

Inventory 1,670 2,280 2,920

Total CUITentassets 3,280 4,170 5,430

Net fixed assets 900 980 1,100

Total assets 4,180 5,150 6,530

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Equity and liabilities

Short-tenn bank bOITowings 750 1,020 1,630

Accounts payable 870 1,340 1,790

Accrued expenses 170 210 270

Long-tenn debt - CUITent 50 50 50

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Total CUITentliabilities 1,840 2,620 3,740

Long-tenn debt 450 400 350--

Totalliabilities 2,290 3,020 4,090

Shareholders' equity 1,890 2,130 2,440

Totalliabilities and equity 4,180 5,150 6,530

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