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Micheline Rousseau, sole owner and chief executive officer of Delisle Industries, received Delisles 2010 financial statements from the companys auditors and compared the results with previous years. While she was very happy with Delisles rapid growth, she had a number of serious concerns about its future. In particular, Rousseau was concerned about operating problems that had arisen as a result of rapid expansion as well as Delisles dependence on one vendor, Eagle Wholesale Club (Eagle), to distribute its product. She also had concerns about the establishment of a new production facility, wondered what could be done about the companys poor cash management and overreliance on debt financing, and was seeking opportunities to finance future growth. After discussing these issues with Delisles two vice-presidents, it was agreed that management consultant Jolly Jeffers, certified management accountant, should conduct a financial review of Delisle. Based on this report, Rousseau would implement operational improvements and decide whether or not to open a factory in Winnipeg and add plastic fencing to Delisles product line. COMPANY BACKGROUND Delisle Industries, a manufacturer of plastics products, was formed in Saskatoon, Saskatchewan in 2005 by Micheline Rousseau, a professional engineer who had worked for over 20 years at Rubbermaid, a U.S.-based plastics manufacturer. At Rubbermaid, Rousseau held senior positions in operations and was very familiar with the specialized injection moulding equipment that was used in the production of plastic products. Later in her career, she worked as a designer and earned an excellent reputation for her innovative products. After she applied for the position of vice-president of research and design and failed to be selected, Rousseau decided to return to her hometown of Saskatoon and start her own company. Rousseaus father had been a successful Saskatoon businessman and owned a manufacturing company that produced laminated oak staircase components such as railings, steps, and risers. Her father decided to close the business in 2003 after suffering a heart attack, but kept the building and equipment and hoped that his daughter would someday return to Saskatoon and take over the operation. When she eventually returned, Rousseau explained to her father that her expertise was in plastics and that working in the plastics industry held more potential than manufacturing wood products. With her savings, severance pay from Rubbermaid, and a gift of the facility by her father, Rousseau began operations. Page 2 9B15N014 Rousseaus first hire was Frank Dempsey as vice-president of marketing and sales. Together, the two thoroughly researched which products they would produce and decided on storage sheds, which many households in North America had in their backyards. These sheds were often used to house various items such as gardening supplies, tools, tires, and bicycles. Historically, these sheds were built on cement blocks and made of wood. They were expensive to buy or have custom built because construction was labour intensive and materials were expensive. There was also considerable maintenance associated with storage sheds because the buildings had to be painted regularly and were subject to rot in more humid climates. If the sheds were made of plastic panels, they could be produced more cost-effectively and would last longer with less maintenance. The sheds could also be produced easily in different colours to match existing home designs. Rousseau and Dempsey agreed to distribute sheds using two channels: a website and in-store placement at Eagle. The website showcased the companys products; customers could order sheds online, disassembled, to be shipped using a third-party carrier, reducing shipping costs. The sheds were easy to assemble, so customers only had to ensure that a proper cement pad was in place basic paving stones were all that were needed. In Eagle stores, a number of standard designs and colours were available in store for customers who wanted to take immediate possession, but Eagle also accepted orders for all versions of the shed and delivered them to their stores for pick-up. Eagle also offered the sheds through its website. COMPANY EXPANSION Delisles products proved to be very popular and sales expanded quickly. Merchandisers at Eagle immediately asked the company to work with them to develop additions to Delisles product line. By 2008, Delisle began to produce rain barrels, patio furniture, and plant holders in various designs and colours. Delisles rain barrels were a success as competitors products were made from metal, prone to rust, and not visually appealing. Patio furniture was also very popular because Delisle reproduced many of the traditional wooden designs that other plastic furniture makers did not. The plastic furniture could be produced at a fraction of the cost of wooden furniture, were much more durable, and did not need painting or refinishing. The plant holders were less of a success; there were already a large number of competing products on the market coming from low-cost, overseas producers. By late 2010, Delisles production facility in Saskatoon was reaching its limit due to increasing sales. The building had been expanded a number of times, but there was simply no more room on the lot and the company was not able to buy any adjoining property. At this time, Eagle made a request that Delisle produce plastic fencing, which made the space problem a larger issue. Research had indicated that consumers were frustrated with building expensive fences from wood, only to have them deteriorate rapidly due to weather. Even after using more expensive cedar or treated lumber, fences quickly began to lose their visual appeal. Frequent painting or staining was also needed, and this type of frequent manual labour was becoming a problem for Canadas aging, baby boomer population. Eagle could address this problem by creating an array of fencing designs in various colours, satisfying the needs of the baby boomers, do-it-yourselfers, and contractors. Expanding the product line to include fencing would require that Delisle construct a new factory. Output from the existing facility could also be transferred to this new factory to address space restrictions. Skilled labour was in short supply in Saskatoon due to rapid growth in the resource sector in Alberta and Saskatchewan. Delisle viewed Winnipeg as a good location for the new facility. The city was very affordable with low land and labour costs; had a ready supply of skilled production workers, especially in Page 3 9B15N014 plastics; and was a major North American producer of home windows, in which the primary material used was plastic (see Exhibits 1 to 6). OPERATIONS The key to Delisles success was its close relationship with Eagle, which accounted for approximately 95 per cent of Delisles sales. Eagle negotiated five-year, fixed price contracts in order to be the exclusive dealer for each of Delisles products, although it allowed Delisle to maintain its own online sales operation to better research customer needs, which aided in product design. All sales to Eagle were at terms net 60. Initially, Delisle had problems managing its factory. Coordinating production between different workstations was difficult because scheduling was done manually. Also, many of the operators were inexperienced in using injection moulding equipment and required considerable training. This inexperience resulted in higher cleaning and other maintenance costs. Production scheduling software was purchased in 2009, but the introduction of new products and the space limitations at the Saskatoon plant meant that Delisle continued to have difficulties. Raw materials were purchased from an Edmonton distributor who could supply most plastics on a just-in- time basis. This helped Delisle to lower its raw materials inventories, but it paid a 10 per cent premium compared to purchasing directly from the manufacturer. The dealer provided net 60 terms, and charged interest on overdue accounts at a rate of 8 per cent. Delisle had experienced significant raw material price increases in the last five years due to rapid growth in the developing world. Labour costs had also risen due to a shortage of skilled workers. For the seasonal items Delisle produced, manufacturers had to carry considerable finished goods inventory because production could not keep pace with sales during high demand periods. With so many new products, Delisle had also begun to rely more on batch production, resulting in higher inventories. Since its inception, Delisle had prided itself on remaining lean and mean. The company managed its operations with minimal staff in a suite of offices overlooking the factory floor. In 2009, the new production planning centre took over that space, and administration staff were relocated to a neighbouring industrial park. This location also contained a new research and development (R&D) facility where products were designed and tested. FINANCING Delisle had a three-year, $5,000,0001 revolving credit agreement with the Bank of Montreal, which was used to finance seasonal fluctuations in working capital. Delisle had remortgaged its production facility and negotiated a number of term loans to fund equipment purchases. The revolving credit agreement was committed, and was secured by Delisles inventories and accounts receivable department, a personal guarantee by Rousseau, and a $1,000,000 limited, third-party guarantee by Rousseaus father. The Bank of Montreal was to lend up to 75 per cent of accounts receivable, 30 per cent of raw materials, 40 per cent of work-in-process, and 50 per cent of finished goods inventory. The 1 All currencies are in Canadian dollars unless otherwise specified. Page 4 9B15N014 revolving credit had to be paid down to zero once a year to ensure it was not used to fund long-term assets. To comply with its loans, Delisle had to maintain a current ratio of 1.5, a cash flow coverage ratio of 1.5, and a long-term debt-to-total-capitalization ratio of no higher than 60 per cent. Audited quarterly and annual financial statements also had to be provided to the bank. Delisle had a very good working relationship with the Bank of Montreal. The bank was impressed with the companys rapid growth and recognized the security that the long-term sales contracts with Eagle provided. In order to finance Delisles rapid expansion, Rousseau was forced to sell 40 per cent of the company to Westco, a Regina-based venture capital firm specializing in Canadian manufacturing start-ups. A number of senior managers also made modest equity investments and agreed to receive a portion of their pay in shares. The senior managers currently owned 5 per cent of the company. The company did not pay dividends and instead reinvested all profits back into the business to finance its growth. After a five-year relationship, Westco indicated that it wanted to exit the investment either through an initial public offering or sale to another manufacturer. Rousseau wished to maintain control, but she and her father did not have sufficient personal funds, given the companys current size, and she knew the company was too leveraged to support a management buyout. ASSIGNMENT QUESTIONS 1. Assuming the role of Jolly Jeffers, certified management consultant, prepare a two-page memorandum that analyzes the financial condition of Delisle Industries and makes recommendations on the companys operational and financial problems and the proposed expansion. The memo should be divided into sections that describe liquidity, asset management, long-term debt-paying ability, profitability, and recommendations.

2. Prepare the following financial exhibits for 2006 through 2010: Ratio table Vertical analysis of income statements and balance sheets Horizontal analysis (index numbers) of income statements and balance sheets Cash flow statements (2007 through 2010) Five-part analysis of rate of return on equity (ROE) Note: Calculate all ratios using year-end totals only no averages.

EXHIBIT 1: DELISLE INDUSTRIES INCOME STATEMENTS ($) Sales Cost of goods sold Gross profit Operating costs Selling and distribution 2006 15,015,500 10,434,500 4,581,000 2007 26,130,560 18,595,530 7,535,030 2008 39,403,320 28,323,060 11,080,260 2009 58,532,340 42,565,660 15,966,680 2010 71,511,720 53,000,150 18,511,570 1,650,340 2,450,630 3,763,400 5,400,350 6,001,230 R&D Administration 145,340 550,340 453,640 1,050,750 765,340 1,950,600 1,580,340 3,400,000 1,900,450 4,080,520 Amortization Operating profit 574,944 1,660,036 908,884 2,671,126 1,880,284 2,720,636 2,999,199 2,586,791 3,838,790 2,690,580 Interest expense Earnings before taxes Taxes Net income 224,139 1,435,897 502,564 933,333 392,759 2,278,367 797,429 1,480,939 952,308 1,768,328 618,915 1,149,413 1,653,235 933,556 326,744 606,811 2,301,176 389,404 136,291 253,112 Source: Company data. 2010 765,340 11,550,420 3,240,340 2,489,390 6,751,713 EXHIBIT 2: DELISLE INDUSTRIES BALANCE SHEETS ($) 2006 2007 2008 2009 Cash 400,840 790,670 1,034,690 823,580 A/R 2,459,600 4,340,540 6,450,340 9,950,340 RM inventory 675,340 1,103,400 1,789,340 2,450,340 WIP inventory 874,230 1,440,530 1,950,340 2,340,680 Finished goods 802,160 1,674,293 2,614,583 4,413,753 inventory Total current assets 5,212,170 9,349,433 13,839,293 19,978,693 L, P & E, net 5,504,440 8,756,340 18,345,340 29,453,350 Intangibles 245,000 332,500 457,500 538,640 Total assets 10,961,610 18,438,273 32,642,133 49,970,683 A/P 1,760,340 4,009,870 6,498,227 9,922,996 Current portion of long- 399,534 649,188 1,518,833 2,636,739 term debt Total current 2,159,874 4,659,058 8,017,060 12,559,735 liabilities Long-term debt 3,995,340 6,491,880 15,188,326 26,367,389 Shareholders' equity 4,806,396 7,287,335 9,436,748 11,043,559 Total liabilities and 10,961,610 18,438,273 32,642,133 49,970,683 equities 24,797,203 37,689,560 698,340 63,185,103 12,885,442 3,545,726 16,431,168 35,457,263 11,296,671 63,185,103 Source: Company data. EXHIBIT 3: SALES ANALYSIS 2006 2007 2008 2009 2010 $590.00 $590.00 $410.00 $419.00 25,450 43,530 $590.00 $590.00 $590.00 $423.00 $430.00 $435.00 65,400 75,600 84,000 $0.00 $0.00 $98.00 $78.00 4,570 $98.00 $79.00 8,340 $98.00 $80.00 11,340 $98.00 $81.00 14,580 Sheds Price Cost Quantity Rain Barrels Price Cost Quantity Patio Furniture Price Cost Quantity Plant Holders Price Cost Quantity $0.00 $0.00 $0.00 $0.00 $0.00 $180.00 $180.00 $0.00 $120.00 $127.00 55,340 95,030 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $33.00 $33.00 $29.00 $31.00 86,540 103,560 Source: Company data. EXHIBIT 4: KEY FINANCIAL RATIOS - INDUSTRY AVERAGES (2010) 3.17 Current ratio Cash ratio RM turnover in days WIP turnover in days Finished goods turnover in days A/R turnover in days A/P turnover in days Cash conversion cycle Fixed assets turnover Total assets turnover Long-term debt to total capitalization Cash flow coverage Gross profit margin Operating profit margin Net profit margin Return on assets Return on equity 0.16 33.86 days 9.69 days 96.54 days 30.44 days 59.47 days 111.06 days 2.19 1.00 0.32 2.06 42.00% 15.55% 9.08% 5.90% 14.71% Source: Company data. EXHIBIT 5: VERTICAL ANALYSIS - INCOME STATEMENT (2010) (%) 100.00 58.00 42.00 Sales Cost of goods sold Gross profit Operating costs Selling and distribution R&D Administration Depreciation Operating profit Interest expense Earnings before taxes Taxes Net income 14.45 1.56 5.67 4.77 15.55 1.59 13.97 4.89 9.08 Source: Company data. EXHIBIT 6: VERTICAL ANALYSIS BALANCE SHEET, 2010 (%) Cash Accounts receivable RM inventory WIP inventory Finished goods inventory Total current assets Land, plant and equipment, net Other assets Total assets 16.45 8.34 5.38 1.54 15.34 47.05 45.65 7.30 100.00 Accounts payable Current portion of long-term debt Total current liabilities Long-term debt Shareholders' equity Total liabilities and equities 9.45 5.39 14.84 23.45 61.71 100.00 Source: Company data. EXHIBIT 1: DELISLE INDUSTRIES INCOME STATEMENTS ($) Sales Cost of goods sold Gross profit Operating costs Selling and distribution 2006 15,015,500 10,434,500 4,581,000 2007 26,130,560 18,595,530 7,535,030 2008 39,403,320 28,323,060 11,080,260 2009 58,532,340 42,565,660 15,966,680 2010 71,511,720 53,000,150 18,511,570 1,650,340 2,450,630 3,763,400 5,400,350 6,001,230 R&D Administration 145,340 550,340 453,640 1,050,750 765,340 1,950,600 1,580,340 3,400,000 1,900,450 4,080,520 Amortization Operating profit 574,944 1,660,036 908,884 2,671,126 1,880,284 2,720,636 2,999,199 2,586,791 3,838,790 2,690,580 Interest expense Earnings before taxes Taxes Net income 224,139 1,435,897 502,564 933,333 392,759 2,278,367 797,429 1,480,939 952,308 1,768,328 618,915 1,149,413 1,653,235 933,556 326,744 606,811 2,301,176 389,404 136,291 253,112 Source: Company data. 2010 765,340 11,550,420 3,240,340 2,489,390 6,751,713 EXHIBIT 2: DELISLE INDUSTRIES BALANCE SHEETS ($) 2006 2007 2008 2009 Cash 400,840 790,670 1,034,690 823,580 A/R 2,459,600 4,340,540 6,450,340 9,950,340 RM inventory 675,340 1,103,400 1,789,340 2,450,340 WIP inventory 874,230 1,440,530 1,950,340 2,340,680 Finished goods 802,160 1,674,293 2,614,583 4,413,753 inventory Total current assets 5,212,170 9,349,433 13,839,293 19,978,693 L, P & E, net 5,504,440 8,756,340 18,345,340 29,453,350 Intangibles 245,000 332,500 457,500 538,640 Total assets 10,961,610 18,438,273 32,642,133 49,970,683 A/P 1,760,340 4,009,870 6,498,227 9,922,996 Current portion of long- 399,534 649,188 1,518,833 2,636,739 term debt Total current 2,159,874 4,659,058 8,017,060 12,559,735 liabilities Long-term debt 3,995,340 6,491,880 15,188,326 26,367,389 Shareholders' equity 4,806,396 7,287,335 9,436,748 11,043,559 Total liabilities and 10,961,610 18,438,273 32,642,133 49,970,683 equities 24,797,203 37,689,560 698,340 63,185,103 12,885,442 3,545,726 16,431,168 35,457,263 11,296,671 63,185,103 Source: Company data. EXHIBIT 3: SALES ANALYSIS 2006 2007 2008 2009 2010 $590.00 $590.00 $410.00 $419.00 25,450 43,530 $590.00 $590.00 $590.00 $423.00 $430.00 $435.00 65,400 75,600 84,000 $0.00 $0.00 $98.00 $78.00 4,570 $98.00 $79.00 8,340 $98.00 $80.00 11,340 $98.00 $81.00 14,580 Sheds Price Cost Quantity Rain Barrels Price Cost Quantity Patio Furniture Price Cost Quantity Plant Holders Price Cost Quantity $0.00 $0.00 $0.00 $0.00 $0.00 $180.00 $180.00 $0.00 $120.00 $127.00 55,340 95,030 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $33.00 $33.00 $29.00 $31.00 86,540 103,560 Source: Company data. EXHIBIT 4: KEY FINANCIAL RATIOS - INDUSTRY AVERAGES (2010) 3.17 Current ratio Cash ratio RM turnover in days WIP turnover in days Finished goods turnover in days A/R turnover in days A/P turnover in days Cash conversion cycle Fixed assets turnover Total assets turnover Long-term debt to total capitalization Cash flow coverage Gross profit margin Operating profit margin Net profit margin Return on assets Return on equity 0.16 33.86 days 9.69 days 96.54 days 30.44 days 59.47 days 111.06 days 2.19 1.00 0.32 2.06 42.00% 15.55% 9.08% 5.90% 14.71% Source: Company data. EXHIBIT 5: VERTICAL ANALYSIS - INCOME STATEMENT (2010) (%) 100.00 58.00 42.00 Sales Cost of goods sold Gross profit Operating costs Selling and distribution R&D Administration Depreciation Operating profit Interest expense Earnings before taxes Taxes Net income 14.45 1.56 5.67 4.77 15.55 1.59 13.97 4.89 9.08 Source: Company data. EXHIBIT 6: VERTICAL ANALYSIS BALANCE SHEET, 2010 (%) Cash Accounts receivable RM inventory WIP inventory Finished goods inventory Total current assets Land, plant and equipment, net Other assets Total assets 16.45 8.34 5.38 1.54 15.34 47.05 45.65 7.30 100.00 Accounts payable Current portion of long-term debt Total current liabilities Long-term debt Shareholders' equity Total liabilities and equities 9.45 5.39 14.84 23.45 61.71 100.00 Source: Company data

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