Clearview Windows Limited (A)

Introduction

February 17,1982 began as a cloudy and overcast wintry day in Halifax. Adam Firth, president of Clearview Windows Limited, and John Marsh, Clearview's financial consultant and a potential investor, sat drinking coffee. They were anxiously pondering the reaction to the informal proposal that they had presented to the creditors of Clearview Windows Limited of Nova Scotia. Acceptance of this voluntary proposal, designed to rescue a floundering, but viable, Nova Scotian window manufacturer, would mean a chance to make up for past mistakes. Alternatively, rejection would mean the end of the company through either receivership or bankruptcy. Neither man was sure what had caused the company to reach its current precarious position, nor were they sure how the creditors would react to the reorganisation proposal. They believed that they had considered all options and that all parties could gain from their proposal's acceptance. Optimistically, they were already beginning to make plans for the resurrection of Clearview Windows Limited.


This case was prepared by Professor David Bateman of Saint Mary's University for the Atlantic Entrepreneurial Institute as a basis for class discussion, and is not meant to illustrate either effective or ineffective management. Some elements of this case have been disguised.

Copyright © 1993, the Atlantic Entrepreneurial Institute. Reproduction of this case is allowed without permission for educational purposes, but all such reproduction must acknowledge the copyright. This permission does not include publication.


Background

Clearview Windows Limited was a manufacturer and assembler of windows, steel entry doors, and patio doors. It was a relatively young company, incorporated in 1976 by James Roach as Maritime Home Improvements Limited. Its origins, however, were much older, as Roach had previously developed a reputation in the window industry with a small business called Precision Woodworks.

As Maritime Home Improvements Limited, the company had achieved good earnings for the four-year period 1976 to 1980 (see Exhibits 1 & 2 for the years 1978-81). Roach's marketing strategy during this time had been custom-sized products and lower prices (due to low overhead costs). As the company grew, Roach chose to sell his interest and take on a less demanding role. Adam Firth was aware that, like many one-person management operations, most of the strengths and weaknesses of the successor company, Clearview Windows Limited, could be linked to the management style of the company's former principal.

New Ownership

Adam Firth purchased the shares of Maritime Home Improvements Limited in August 1980 through his holding company, A&F Investments Limited. The purchase of the company was financed, in large part, by a $350,000 dividend paid by Maritime to the holding company after the purchase. This action left the new company, which Firth renamed Clearview Windows Limited, thinly capitalised and with a relatively weak current position (see Exhibit 1).

Firth, 45 years old, had been practising law for ten years in Nova Scotia when, in 1980, he decided to acquire Maritime Home Improvements Limited. Initially, it appeared that he had acquired the company at a reasonable price. However, he had convinced the bank to allow the purchase without an audit of the company, as the company had never been audited in the past. The initial audit, for the five months ending August 31, 1980, was performed immediately following the purchase in August 1980 and indicated no significant problems. This audit was qualified with respect to inventory, as the auditors could not attest to the authenticity of beginning inventory levels, since these figures preceded their appointment as auditors.

As the new owner/manager, Firth was eager to put his full energies into the business. As Firth jokingly admitted "he didn't know a window from a door," however, sales and marketing were areas in which he believed he was particularly skilled. Unfortunately, he soon realised that it was difficult to fill Roach's shoes. Roach had operated the business with the zest of "a one man gangbuster," performing the functions of management, delivery, sales, as well as the estimating and order-taking functions. Firth convinced Roach to stay on for Firth's first few months of ownership so that he could become familiar with the company's product line, suppliers, and customers.

When Roach left after three months, Firth was thrust into the unfamiliar and multi-faceted role of owner and general manager. As an initial strategy, Firth was content to maintain the status quo, with minor changes, of what had appeared to be a successful strategy for Maritime Home Improvements under Roach's guidance.

Markets and Competition

As a producer of windows and doors, both of which could be either for new construction or replacement units, Clearview's market was divided between retail and contractor sales. Retail sales consisted primarily of replacement windows and/or doors purchased by individual customers. Typically, these orders were for one or two custom-sized units. In contrast, sales to contractors generally were for a larger number of units and, depending on the nature of contractor's job (i.e. new building or replacement work), could be stock or custom-sized units. Sales to contractors were generally on account, whereas retail sales were usually for cash.

As a small producer (1981 sales of approximately $2.2 million and between 15 - 20 employees) Clearview focused primarily on the Nova Scotia housing market. Within this market, its sales effort was focused on the Halifax-Dartmouth metro area, the largest market in Nova Scotia. In addition, other sales were regularly made to the South Shore area and the Annapolis Valley as far as Annapolis Royal, which was a distance of 200 km from Halifax.

The Competition

In the Maritime region, windows and doors were usually sold in three ways: direct sales to customers (retail outlets), direct sales to contractors (usually via salespersons), and sales to dealers (usually building supply companies). Clearview's major competitors were Heritage Cedar Homes (distributors of DF Windows Ltd) in Quebec, Mason in Quebec, Schurmans in Prince Edward Island, Westmount Windows Limited in Halifax, Nova Scotia, and Lockwoods in New Brunswick. Clearview was much smaller in terms of sales and productive capacity than all of its competitors.

Only Schurmans, Westmount and Heritage had retail outlets, and this form of direct sales represented the greatest competition to Clearview. The other manufacturers all used dealers, and Schurmans; and Heritage used dealers for the area outside of Metro Halifax. Nova Scotia dealers tended to be building supply companies that often carried more than one brand of windows. Clearview once used dealers, but this practice was replaced by direct selling to both retail customers and contractors, with delivery from Halifax. Roach believed that the main deterrents to using a dealer distribution had been the lower margins and the company's inability to offer a complete line of Clearview windows. This meant that dealers would have to carry a second line of windows in order to fill in the gaps left by Clearview's product line.

Clearview's products were advertised through the yellow pages, where they were listed in all the province's phone books and through an occasional household and business flyer. Contractor sales were handled by Firth or the former owner, James Roach, who returned to the company in February 1981 as a salesperson. About 55% of the company's business was with contractors.

As with all industries relating to housing construction, Clearview's fate was linked to the general state of the housing market, and as conditions worsened here, so did Clearview's sales for new construction starts. However, Clearview enjoyed some degree of independence from the housing industry because many of its sales were derived from replacement products, demand for these products being much less cyclical.

Problems Encountered By New Management

After taking over Clearview Windows Limited, Firth was faced with many operational, financial, and management problems.

Operational Issues

The Products and the Production Process

At the start of the 1982 calendar year, Clearview's product line consisted of self-manufactured Kolaris Steel Entry Door Systems, horizontal sliding thermo and semi-sashless windows, pine casement windows, picture windows, and patio doors. All of these products could be customised to meet customer needs. As well, Clearview was a dealer for Mason Windows and Joseph LeBlanc & Fils; (1975) Ltd, which allowed the company to fill out its product line. As a small sideline, they also carried Sitton Vinyl house siding (see Exhibit 4 for product sales distribution). The most favourable attributes of Clearview's products were their low prices and fully customised fit (i.e. length, width and depth). Many competitors' products did not fit with respect to depth and required a supplemental window kit, which was an additional cost and inconvenience to the purchaser.

At the time of the ownership change, the company had a sales volume of approximately $2.0 million and a staff of fourteen. Plant facilities consisted of two buildings on the same property (see Exhibit 5 for layout design).

In total, the company had 10-20 key suppliers. The majority of supplies, e.g. glass, vinyl sliders, screens, steel doors, etc, came from suppliers in Quebec. Pine, the typical wood used, was purchased locally and was introduced into the production process in a green state because there were no facilities to either kiln dry the lumber or to store dry lumber.

The firm produced few windows for inventory because there were no suitable storage facilities. Finished units were often stored in stacks inside the production area and this resulted in a severely crowded work area. Production was sporadic in its attempts to meet incoming orders. This, combined with an ad hoc order-taking system (orders not always co-ordinated with production), led to many scheduling and delivery problems. At one point, about 60% of all incoming calls were enquiries about late shipments. In many cases, it was the customer who "hollered the loudest" whose order was given priority. This absence of a systematic production process and uneven production runs meant that some employees were busy while others were unoccupied.

Firth believed that the uncoordinated production runs, poor quality inputs (green lumber), and crowded storage facilities increased the probability of flaws in the final product and decreased the product's quality. Clearview had always had a reputation for a window that was strong, but a bit rough. As one contractor commented, "It was a good window but the next time you send one out to my job site, please cut off the limbs!".

Although pricing (or lack of cost controls) was viewed as a major cause of the decline in gross profits, other serious deficiencies in internal controls such as waste, breakage, and theft were detected in 1981. Management's estimates of wastage in the shop had been "guesstimated" at approximately 10%. Later analysis of the production process by financial consultant John Marsh indicated that, in some cases, wastage could have been as high as 30% of a product's total cost. The primary reasons for this level of wastage were employee's poor work habits and attitudes and the damage that raw materials and finished goods experienced in movement and storage.

At the time of the ownership change employee morale was low. Employees were not used to formalised control procedures, and many did not respond favourably to Firth's attempts to bring in additional controls. This resulted in more inefficiencies and decreased productivity. Many of the employees had performed the same jobs for many years, and the lack of training and poor attitudes made job rotation and scheduling difficult.

Raw materials were often exposed to the elements because of inadequate storage facilities. Breakage was a serious problem, but it was difficult to quantify because the company had no reporting mechanism to properly account for it. Much of the breakage was caused by the movement of materials and products between the two buildings and the lack of proper storage for finished units. In addition, employee attitudes with respect to quality control were not good, and often little care was exercised when handling finished units.

Theft was suspected and estimated at approximately $30,000 (in 1980-81). In 1981 the RCMP were called in to conduct an investigation. This resulted in the dismissal of, and charges being laid against, several employees.

Financial Issues

Poor economic conditions in 1981 resulted in a slump in the construction industry and a decline in sales for all businesses related to housing construction. Interest rates on Clearview's bank debts had been approximately 16% when Firth bought the business in August 1980. By late 1981, the company faced interest rates of 22%. This, combined with an increased debt load, resulted in a substantially increased debt servicing charge. As economic conditions worsened, the company's investment in accounts receivable grew because many customers, also affected by the economy, had difficulty paying their accounts on time and, in many cases, were unable to pay at all.

Clearview used an outside computer service to generate monthly customer statements, to maintain accounts receivable files, and to maintain a basic general ledger. Unfortunately, this service was inadequate because in most cases the information lagged by at least a month. Furthermore, the general ledger figures were only as good as the base data which was provided by Clearview's staff. Firth did not give the accounting and finance functions high priority, and consequently, many key decisions were made without the help of sound financial data. Only at the end of 1981, when a chartered accountant audited the full year's operations, did management receive a complete report card (with a failing grade) for the year's results.

Shortly after Firth acquired Clearview, it was audited by Revenue Canada for past income and federal sales tax violations. As a result of these audits, the company was reassessed additional taxes of $75,648. This worsened the company's financial position.

Management Issues

Clearview's new owner, Firth, had little expertise in the window and construction industry. Consequently, overhead costs increased as staff were hired to perform such functions as deliveries, estimates, measurements, and production coordination that Roach had performed when he owned the business. It became painfully clear to Firth that more formalised information systems were required to provide the information necessary to manage the business more effectively.

No formal process for product costing was present and the company was never sure what its costs were or what it should charge for a product. Because of this lack of proper costing records, the costing and pricing of products was inaccurate. It appeared that Roach had set prices based on his intimate knowledge of Clearview's operating characteristics and the industry in general. His gross margin had been relatively stable between the 15-18% range.

As mentioned earlier, the first time that Clearview Windows Limited had been audited and the inventory carefully counted and valued was in August 1980 after Firth bought the company. The financial statements prepared at this time indicated no major operating problems since the gross profit was approximately 18%. However, the auditors had qualified their report because they were unable to verify the opening inventory figures. As a result, the actual gross profit from operations was not evident until 1981. Subsequent detailed investigation (by Marsh) of many of their major products revealed that the company was selling some products, for example, doors, below its direct materials cost. Consequently, labour, selling costs and profits were not covered. This explained why Clearview's largest customers were buying a high volume of these products. Prices were increased in late September 1981 after the damage had been detected when the 1981 audited financial statements showed only a 10% gross profit for that year.

The Proposal

As a consequence of these many problems, Clearview found itself with a very severe cash flow problem. (see Exhibit 1 & 2). Suppliers had begun to place Clearview on COD, and by late 1981 it had become almost impossible to keep the business operating smoothly Clearview's attempts to arrange additional financing from the company's bank, the Federal Business Development Bank, the Small Business Development Corporation and other potential equity investors were unsuccessful. Of those approached for funds, only Scotia Sales Limited of which John Marsh was a principal, was willing to make an investment. Scotia Sales Limited, a successful local retail business, was willing to invest $75,000 through a joint venture capital company in return for a 49% equity position in Clearview as part of the informal proposal package (see Exhibit 6).

John Marsh was a successful local businessman/ accountant who had extensive experience in small business management obtained through his involvement with several joint venture capital projects. He had started to work for Clearview as a financial consultant in late 1981. He had attempted to improve the company's information flows and internal controls, but before changes could be implemented cash had run out. He had become attracted to investing in Clearview because he believed there was potential for a profitable business, if it could get its house in order. It was upon his advice that his associates at Scotia Sales were willing to invest in Clearview Windows.

Outlook For Future

Although the results for 1981 were discouraging, Clearview's prospects were not. Firth believed that many of the company's problems had begun to be addressed. Also Marsh was working towards improving the information flow to top management. It was hoped that the major problem, an inadequate gross to cover increased overhead, would be remedied by product price increases which had been introduced in the fall of 1981. This was to be followed by additional price increases in February 1982. Other efforts were being initiated early in 1982 to improve the company's marketing and production policies. However, before they could be implemented, the severe cash crunch forced the company to make its informal proposal to its creditors.

Firth and Marsh's proposal, if accepted, would see the company's major unsecured creditors agree to accept 25% of the monies owed them by Clearview. This would give the company the breathing room to try to deal with their problems and attempt to restructure the company into a viable, profitable business. As Mr. Marsh said, "This business has the potential to be a winner if we can get our house in order and the economy picks up a bit. In my opinion, I see a great likelihood for both in the near future".

Study Questions:

  1. What relationships in the 1981's financial statements should have been signals that serious problems were likely to happen?
  2. What should Firth have done differently before purchasing Clearview Windows Limited (then named Maritime Home Improvements Limited) in August 1980?
  3. Identify factors or symptoms of the problems which led to Clearview's 1982 financial situation. There are likely to be several symptoms for each major problem identified. Use the following format for your analysis.

    Symptom or factor Underlying problem
  4. Prioritise these problems and symptoms. Which ones do you think were the most pressing, why? Were they controllable by management? Why or Why not?
  5. Clearview took the route of an informal proposal to get a second chance. What were the advantages and disadvantages of this proposal and what other alternatives were available to management?
  6. Clearview 's largest creditor, Joseph LeBlanc & Fils, were owed $100,000 and were upset about the prospect of losing $75,000 under the proposal (100,000 - (100,000 * .25) = 75,000). Clearview was one of their largest customers with sales of approximately $40,000/month at an average gross profit of 25%. They were considering forcing formal bankruptcy proceedings against Clearview in an attempt to collect more of their money. Generate an argument to convince Joseph LeBlanc & Fils that it is in their best interest to accept the proposal.(Show calculations.)
  7. If the new proposal is accepted what recommendations for the future would you make to Marsh and Firth?

Exhibit 1

Clearview Windows Limited
Income Statements 1978-1981

Source: Company records.

Exhibit 2

Clearview Windows Limited
Balance Sheet
1978-1981

*Tax reassessments and penalties of $75,648 for prior years were applied against Retained Earnings. 1978-80ís financial statements have not been restated.

Source: Company Records.

Exhibit 3

Clearview Windows Limited
Ratio Analysis Summary
1978-1981

Source: Company records.

 

CLEARVIEW WINDOWS LIMITED

PRODUCT SALES MIX (SEPT 81 - JAN 82)

PRODUCT % SALES
STEEL DOORS 27%
VINYL SLIDERS 99%
PICTURE WINDOWS 11%
SIDING(incl installation) 11%
CASEMENT WINDOWS 10%
OTHER (misc sales and repairs) 19%
100%
Source: Company records.

 

Exhibit 5

Plant Layout

Source: Company records.

EXHIBIT 6

Clearview Windows Limited
Informal Proposal to Major Creditors of Clearview
Windows of Nova Scotia, February 17,1982

  1. Scotia Sales Limited to invest $75,000 in return for a 49% equity interest in Clearview Windows Limited. This would also include active management participation by the principals of Scotia Sales Limited.

  2. The Company's bank to convert current financing to a small business development bond.
  3. Claims of secured creditors shall be paid in accordance with existing contracts or as may be arranged with the said secured creditors.
  4. Preferred claims to be paid in full in priority to all claims of unsecured creditors.
  5. All purchases from trade creditors received after January 31, 1982, shall be paid in full within the usual credit terms.
  6. Dividend (amount to be paid to creditors) of $.25 on the $1.00 shall be paid in full and final satisfaction to the ordinary unsecured creditors on all trade balances outstanding as of January 31, 1982.

I greatly regret the necessity of having to put this proposal to my creditors, who in the past have been most cooperative and helpful. However, I and those who have been advising and assisting me feel that this is the only alternative left to the Company at this time.

The Company's bank has been supportive in the past; however, they have indicated that as the problems continue to worsen some arrangements must be made to cure the Company's problems if they are to continue to be supportive and work with the Company. I personally believe that with the acceptance of this proposal the problems of the Company can be solved and that the Company can continue to grow, make money and hopefully reestablish the excellent relationships we have had with our suppliers in the past.

Per. Adam Firth, President

Source: Company records

Note to students: As part of the joint Venture Capital program the Government of NS would advance an additional $75,000 as a 10 year interest free loan. This meant that $150,000 in cash would come into the business as a result of the proposal.