Corporate finance

By late 2010, Delisle’s production facility in Saskatoon was reaching its limit. The building had been expanded several times, but there was simply no more room on the lot and the company was not able to buy any adjoining property. Making this problem worse was a request by Costco to begin producing plastic fencing. Research indicated 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, which was becoming a problem for Canada’s aging “baby boomer” population. By creating an array of fencing designs in various colours, Costco felt an important need for “do-it-yourselfers” and contractors would be met.

Expanding the product line to include fencing would require the construction of a new factory. Output from the existing facility might also be transferred to this new plant to address space restrictions. Skilled labour was in short supply in Saskatoon due to rapid growth in the resource sector in Alberta and Saskatchewan. Winnipeg was viewed as a good location for the new facility. The city was very affordable with low land and labour costs and had a ready supply of skilled production workers. The city was a major North American producer of home windows where the primary material was plastics.

Financial Data

Financial Benchmarks

The following industry average information was available from RMA:

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Operations

The key to Delisle’s success is its close relationship with Costco, which accounts for approximately 95% of its sales. Costco negotiates 5-year, fixed-price contracts to be the exclusive dealer for each of Delisle’s products, although it does allow Delisle to maintain its own on-line sales operation to better research customer needs, which aids in product design. All sales to Costco are at terms net 60.

Initially, Delisle had problems managing its factory. Coordinating production between different workstations was difficult as scheduling was done manually. Also, many of the operators were inexperienced using injection molding equipment and required considerable training. This inexperience resulted in higher cleaning and other maintenance costs. Production scheduling software was purchased in 2009, but with the introduction of new products and the space limitations at the Saskatoon plant, Delisle continued to have difficulties.

Raw materials are purchased from an Edmonton distributor who can supply most plastics on a just-in-time basis. This helps Delisle to lower its raw materials inventories, but it pays a 10% premium compared to purchasing directly from the manufacturer. The dealer provides net 60 terms and charges interest on overdue accounts at a rate of 8%. Delisle has experienced significant raw material price increases in the last five years due to rapid growth in the developing world. Labour costs have also risen due to a shortage of skilled workers.

For the seasonal items Delisle produces, manufacturers must normally carry considerable finished goods inventory. Since many of Costco’s stores are in the southern U.S. and Mexico, sales of these items are more balanced throughout the year. With so many new products, Delisle has also begun to rely more on batch production.

Since its inception, Delisle has prided itself on remaining “lean and mean.” The company managed its operations with minimal staff from a suite of offices overlooking the factory floor. In 2009, the new production planning centre took over that space, and administration was relocated to a neighbouring industrial park. This location also contains a new R&D facility where products are designed and evaluated.

Financing

Delisle has a 3-year, CAD 5,000,000 revolving credit agreement with the Bank of Montreal, which is used to finance seasonal fluctuations in working capital. It has re-mortgaged its production facility and negotiated a number of term loans to fund equipment purchases.

The revolving credit agreement is committed and secured by Delisle’s inventories and accounts receivable as well as a personal guarantee by Rosseau and a CAD 1,000,000 limited, third-party guarantee by her father. The Bank of Montreal will lend up to 75% of accounts receivable, 30% of raw materials, 40% of work-in-process, and 50% of finished goods inventory. The revolving credit agreement must be paid down to zero once a year to ensure it is not used to fund long-term assets.

Delisle must maintain a Current Ratio of 1.5, a Fixed-Charge Coverage ratio of 1.5, and a Long-term Debt to Total Capitalization ratio of no higher than 60% to comply with its loans. Audited quarterly and annual financial statements must also be provided to the bank. Delisle has a very good working relationship with the Bank of Montreal. The bank is impressed with their rapid growth and recognizes the security that the long-term sales contracts with Costco provide.

In order to finance Delisle’s rapid expansion, Rosseau was forced to sell 40% 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 – they currently own 5% of the company. The company does not pay dividends and instead reinvests all profits back in the business to finance its growth.

After a 5-year relationship, Westco indicated it wants to exit the investment through either an IPO or sale to another manufacturer. Rousseau wishes to maintain control, but she and her father do not have sufficient personal funds given the company’s current size and knows it is too leveraged to support a management buyout.