livoria sandwiches case cma

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MODULE 1, ASSIGNMENT 3

September 12, 2013 Livoria Sandwiches Inc. It was 2:00 a.m. and Paul Livoria sat in the corner stall of his restaurant staring out the window into the parking lot. His brother Sam was in the kitchen cleaning up after a very long day. Paul felt very restless, partially because of the seven cups of coffee he had had, but mostly because he was feeling very overwhelmed. He thought to himself, Running these two restaurants shouldnt be so complicated. At age 46, maybe it was time for a change. The Birth of Livoria Sandwiches Inc. Brothers Paul and Sam Livoria founded Livoria Sandwiches Inc. as a Canadian Controlled Private Corporation (CCPC) in December 2001, but began operations in January 2002. Both brothers had worked for Link Motor Company in the City of Dawkins (a major city of 275 sq. km) in one of its manufacturing plants. Paul was a truck production supervisor and Sam was an automobile line worker. Unfortunately, in 2001, both brothers were laid off as there was a huge decline in the automotive sector. With the severance packages they received, Paul and Sam opened up their first store. Both of them have no formal business training and many decisions have been made through trial and error. After five years of positive growth, Paul and Sam decided to open up a second location in a high-traffic area in Zone 1 (five kilometres away from each other) in Dawkins. Below is a map of the city:

Livoria Sandwiches Inc.

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R1 Restaurant Location 1 R2 Restaurant Location 2 The brothers hired a management consultant two years ago to help them develop the following vision and mission statements: Vision Statement Livoria will be the first choice of Dawkins residents who are seeking a variety of high-quality fresh sandwiches at reasonable prices. Mission Statement We are the highest-quality sandwich shop in Dawkins because of our legendary sandwich-making processes and our commitment to using the highest-quality ingredients. A History of Tradition Paul and Sam are first generation Canadian-Italians, and learned to make quality sandwiches from their mother and grandparents. The Livoria brand is well known for its traditional custom-made sandwiches. All ingredients are sourced locally from the Food Terminal (located only three kilometres from each location) and the stores keep minimal (if any) inventory on hand. As a result, there is no waste and demand is very strong. The menu boasts the highest-quality cuts of meats and produce. As a result, the company has developed a loyal customer base. Livoria is best known for its veal and chicken sandwiches, but also offers other sandwich choices. See Appendix A for more detailed information on the sandwiches. The employees of Livoria are fully trained to use all the machines, and there has never been a workplace accident to date.

Food Terminal

Airport


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The locations maintain a very simple concept and floor layout. Both locations are approximately 1,600 square feet, or approximately 150 square meters. Customers enter the store through one door, order at the counter, pick up their order at the other end of the counter and then sit down in the seating area. The dcor is very modern, yet traditionally Italian with green, white and red accents (the colours of the Italian flag) throughout the restaurants. Pictures from the brothers parents hometowns in Italy adorn the walls. Customers have commented that they appreciate the layout of the restaurant because many other fast food restaurants in the area are either very cluttered (when lining up) or the lineups sometimes extend out the door. As with other fast food restaurants, there are no receivables or payables as customers pay by cash or debit at point of sale, and suppliers are paid daily when deliveries occur. The stores have very committed employees and turnover is very low. The culture is very family-oriented. Information on the employees is located below: Direct Labour Detail Hrs Weeks 2013 Hrs Weeks 2014 Hrs Weeks 2015 PT Employee 1 25.0 52 1,300 30.0 52 1,560 30.0 52 1,560PT Employee 2 25.0 52 1,300 30.0 52 1,560 30.0 52 1,560PT Employee 3 20.0 52 1,040 20.0 52 1,040 20.0 52 1,040PT Employee 4 20.5 52 1,066 20.5 52 1,066 20.5 52 1,066PT Employee 5 5.0 50 250 5.0 52 260 10.0 52 520PT Employee 6 - 50 - - 50 - 5.0 50 250 4,956 5,486 5,996 While staff are scheduled to work (and are paid for) the hours outlined above, only 90% of worked hours are productive hours. The other 10% of hours are for cleanup, preparation, paid breaks, etc. No further staff can be added at this time due to space constraints in the stores. The shops are open 354 days a year (every day except 11 statutory holidays) between 10 a.m. and 12 a.m. The stores do not offer a breakfast menu and the brothers will not consider this as an option. The Fast Food Restaurant Industry Between 2011 and 2012, the fast food restaurant industry in Dawkins reported a growth of 1.2 per cent, and analysts suggest that growth could possibly hit 2 per cent for 2013. In 2006, the City introduced mandatory quarterly health audits for all restaurant locations, and many restaurant owners have complained that 2012 was the strictest year ever. Many locations were forced to close down because of minor violations. Appendix B outlines the fast food restaurants in Dawkins. Sources of Inputs The brothers have sourced all food inputs (poultry, meats, dairy products, bread and vegetables) from the local Food Terminal. This is common practice for most restaurants


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in Dawkins, as the Food Terminal has the best quality and is very reliable for on-time deliveries and product availability. However, in November 2012, a large fire damaged the buildings that serviced all wheat-based products (breads) and vegetables. The damage is estimated to be well over $2 million and arson is suspected. Consequently, this area of the Food Terminal is expected to be out of commission for an indefinite period of time (possibly 18 months or longer). As a result, all restaurants and food service companies must source their breads and vegetables from alternate suppliers. Paul and Sam were very concerned about where they were going to buy their bread and vegetables. There was always the option of buying from local supermarkets, but the cost of these inputs was significantly higher (nearly 6 per cent more) than what they were currently paying. After numerous frantic phone calls, Sam was able to source bread and vegetables from an alternate supplier (Canadiana Food Products) for only 0.5 per cent more than what Livoria was previously paying. The reason for this discount was twofold: volumes were significant and Sam and John (from Canadiana) are childhood friends. See Appendix A for cost information of the sandwiches. Other Information Concerning Dawkins Dawkins is an economically prosperous Canadian city, with a population of over 600,000. The municipal office keeps very accurate records on census household income information. Appendix C shows average household incomes from 2011 and 2012. Over the last three years, four large residential subdivisions, eight new office buildings and two luxury hotels have been constructed in Zone 1. No other zones have experienced such explosive growth. In addition, the office buildings are close to the airport and are home to many head offices of prominent Canadian corporations. Customers in the area have also indicated that they would like to see enhancements to Livorias menu. See Appendix D for potential menu options and pricing. Finally, in a recent study published in the Canadian Journal of Well-Being (CJWB), Dawkins was ranked as having the fastest-growing number of vegetarians in the country. Dr. Rupert Felder stated, There is mounting evidence that a vegetarian lifestyle acts as a preventive measure for numerous diseases including heart disease, diabetes and cancer. A vegetarian diet is said to increase energy and improve mental health while lowering bad cholesterol levels. The CJWB is read by over three million Canadians monthly and about 25% of the Dawkins residents. A Crisis for the Livoria Brothers In January 2012, a customer in Location 2 slipped on the floor and fell down the stairs on his way to the bathroom. He hit his head extremely hard and sustained serious injuries. He was subsequently hospitalized for three months, and during this time doctors determined that his short-term memory had been permanently impaired by the accident. By the end of 2012, the family of the injured young man brought legal action against Livoria Sandwiches Inc. and won a decision in court. The decision was that


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Livoria was to pay $750,000 in damages, of which only $250,000 would be covered by the general liability insurance policy. The contingent liability was booked in 2012, but the judge ordered that full compensation be paid by May 2015. Even though sales were not adversely affected, the brothers took this very seriously and took corrective action immediately by hiring a safety contractor who coated the floor with a thin, non-skid floor treatment which would greatly reduce the likelihood of this happening again. The brothers had to take a pay cut just to keep cash flow moving, as their preference is not to borrow from the open line of credit they have access to at the bank. Finally, in 2012, Livoria Sandwiches Inc. was audited and found to still owe $22,500 in back taxes. This amount is due in the first quarter of 2013. The next day, Paul and Sam had a heated discussion about the business: Paul: Sam, we need to do something to shake things up around here. Sam: Why? Were profitable. We had the lawsuit, and while well be paying that out in instalments over the next three years, it hasnt affected our reputation. Customers keep coming back and they like our custom-made sandwiches. I think we have a good thing going here and any changes should be minimal. Paul: Sam, the area is building up and soon there will be much in the way of competition. We need to be realistic and realize we may lose some of our market share. We need to consider growth. After all, we need to start thinking about our retirement. Sam: Our retirement? Thats still 16 years away for me. Im not ready to sell yet! Paul: Im not suggesting selling the business. Instead, have you ever considered franchising? This way we can have someone else prepare the sandwiches and well get a percentage of the sales. I looked into this, and I feel that we could franchise out the name for $50,000 up front, charge 4.5 per cent on gross sales, and pay about 2.5 per cent for advertising. I estimate that we could do three stores for each of the next three years, with $500,000 in sales per storewed make a fortune! Sam: I worry about losing control over our brand if someone else besides ourselves manages the business. Customers will see us as a mass producer of sandwiches without the attention to detail that were famous for. How do we know our franchisees will actually uphold the same level of quality were famous for? Or for that matter, not report all their earnings in an effort to avoid paying us the royalty? We should focus on expanding our menu. Youve heard our clients tell us that we need to enhance our vegetarian line. More and more people are concerned about cholesterol and bad fats. A menu diversification has less risk and theres no additional capital investment. Paul: Sam, I think we should think more in terms of growth. Besides, we expect to see major growth in the eggplant sandwich sales as recent studies show that the eggplant is an age-defying brain food.


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Financial Information The 2012 income statement is provided in Appendix E. Livoria generated 53% contribution margins, but profitability was depressed because of the $500,000 contingent liability booked in 2012. Refer to Appendix F for the brothers forecast of the operating expenses for the next three years. REQUIRED: To help the brothers decide on a course of action, they have retained the services of Dev Das, CMA. They have asked Das to review their options and come up with a recommendation on which option they should go with. Dass recommendation should also consist of at least three years of annual income statements (in contribution margin format) and cash flows for 2013, 2014 and 2015. The brothers have indicated that they would like to achieve $1.1 million in net income by 2015. Das is aware of the impending legal payment that must be met by May 2015.


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Appendix A Menu Choices and Sales Forecasts for 2013-2015

Current Menu Options (for 2013)

Sandwich Selling Price

per Unit DM Cost per Unit

DL Cost per Unit

Veal Cutlet $9.00 4.351 0.275 Chicken Cutlet $9.00 4.151 0.264 Sirloin Steak $9.00 4.551 0.242 Meatball $8.00 3.975 0.286 Eggplant $8.00 1.831 0.198 1. For 2014 and 2015, there will be a $0.15 price increase for all sandwiches and a

$0.05 increase for drinks. 2. For 2014, direct material (drinks included) and direct labour costs will increase by

1.5% (over 2013 figures). 3. For 2015, direct material (drinks included) and direct labour costs will increase by

2.5% (over 2014 figures). Estimated Demand (Units) for 2013-2015

Sandwich 2013

Demand 2014

Demand 2015

Demand Veal Cutlet 86,333 87,283 88,069 Chicken Cutlet 98,962 101,140 102,607 Sirloin Steak 32,031 32,128 32,161 Meatball 28,775 28,919 28,919 Eggplant 25,131 32,621 112,416 Sandwich Time Required Veal Sandwich 1.25 min Chicken Sandwich 1.20 min Sirloin Sandwich 1.10 min Meatball Sandwich 1.30 min Eggplant Sandwich 0.90 min Other Important Facts 1. Canned soft drink sales are expected to be 55% of total sandwich sales. 2. Bottled water sales are expected to be 30% of total sandwich sales. 3. Bottled juice sales are expected to be 5% of total sandwich sales. 4. Milk sales are expected to be 3% of total sandwich sales. For 2013, each beverage

carries a unit sale price of $1.50 and a unit cost of $0.40.


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Appendix B Fast Food Restaurants in Dawkins*

Establishment Chucks Burgers

Livoria Sandwiches Roccos Pizza The Sub Place Mama Janes Pablos Grill

Public/Private Private Private Private Private Private Private Number of Locations 12 2 2 8 4 6 2012 Revenue $17,158,452 $2,100,689 $1,462,134 $5,268,976 $3,407,876 $4,775,388 CM % 40.80% 52.93% 45.20% 46.10% 43.50% 39.20% Operating Income % 15.68% 0.29% 21.90% 20.55% 17.73% 16.42% Sales Growth % -0.6% 5.4% 3.2% 2.0% -0.4% -1.4% Franchised? Yes No No Yes No Yes Format Beef burgers,

fries, soft drinks Custom-made

Italian sandwiches

Sit-down style pizzeria, basic choices, pasta,

salads

Subs, pre-packaged sandwiches

and pitas

Sit-down style BBQ ribs, chicken

Beef burgers, fries, soft drinks,

alcoholic beverages

Zone(s) 2, 4, 6, 9 1 2 3, 5, 7 5, 8 2, 6, 8

Establishment Wok in China Souvlaki Odyssey Caravan Della

Dawkins Industry

Public/Private Private Private Private Private Both Number of Locations 14 8 26 9 125 2012 Revenue $10,636,388 $5,306,000 $18,027,126 $7,426,791 $92,969,500 CM % 44.90% 45.40% 49.80% 38.10% 44.70% Operating Income % 19.88% 19.26% 20.44% 18.10% 18.02% Sales Growth % 1.6% 1.8% 2.9% -1.4% 1.2% Franchised? Yes Yes Yes Yes Format Chinese buffet

format (over 50 menu items)

Greek, souvlaki dinners,

sit-down and takeout

Upscale Chinese cuisine, menu ordering only, sit-down

style

Beef burgers, fries, soft drinks

Zone(s) All 1, 2, 7 All 5, 6, 7, 8, 9 *Industry information from 2012


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Appendix C Census Family Income Distribution City of Dawkins

2011 2012


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Appendix D Prospective Menu Options (for 2013)

Sandwich Selling Price

per Unit DM Cost per Unit

DL Cost per Unit

Avocado $ 9.00 2.7400 0.1870 Grilled Tofu $10.50 2.9450 0.2068 Hummus $10.00 3.0123 0.1892 Grilled Veggies $ 9.00 2.4820 0.1980 1. For 2014 and 2015, there will be a $0.05 price increase for all sandwiches. 2. For 2014, direct material and direct labour costs will increase by 1.5% (over 2013

figures). 3. For 2015, direct material and direct labour costs will increase by 2.5% (over 2014

figures). Estimated Demand (Units) for 2013-2015

Sandwich 2013

Demand 2014

Demand 2015

Demand Avocado 2,478 3,282 13,844 Grilled Tofu 1,269 1,627 8,567 Hummus 1,844 2,608 21,421 Grilled Veggies 2,608 5,807 53,709 Sandwich Time Required Avocado 0.85 min Grilled Tofu 0.94 min Hummus 0.86 min Grilled Veggies 0.90 min


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Appendix E (Unaudited) Income Statement for 2012

2012 Revenue

Sandwich sales $1,819,003 Drink sales 281,686

Total Revenue $2,100,689 Variable Cost of Sales

Material costs sandwiches $852,404 Material costs drinks 80,482 Direct labour costs 55,907

Total Variable Costs $988,793 Contribution Margin $1,111,896 Fixed Manufacturing Costs

Rent $ 66,000 Property taxes 20,000 Business insurance 25,000 Utilities 55,000 Security monitoring 4,500 Waste management and maintenance 26,750 Amortization 25,000

Total Fixed Manufacturing Costs $222,250 Operating Expenses

Office expenses $ 13,650 Legal 145,000 Accounting 15,000 Management salaries 180,000 Sales and marketing costs 30,000 Litigation 500,000

Total Fixed Operating Expenses $883,650 Total Fixed Costs $1,105,900 Operating Income $5,996 Income Tax Expense 1,199

Net Income $4,797


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Appendix F 2013 Operating Expenses

Total Fixed Manufacturing Overhead Costs

Rent 78,000 Property taxes 25,000 Business insurance 30,000 Utilities 65,000 Security monitoring 5,000 Waste management and maintenance 30,000 Amortization 25,000

Fixed Operating Expenses

Office expenses 15,000 Legal 25,000 Accounting 20,000 Management salaries 350,000 Sales and marketing costs 40,000

For 2014 and 2015, all fixed costs (except amortization) are expected to increase by 2% over the previous year. Other Information 1. Direct labour costs include food preparers and staff who serve customers directly. 2. No capital purchases are expected for the next three years (2013-2015). 3. Income tax expense is 20%, and any amount owing arising from one fiscal year

(year-end is December 31) is due on March 31 of the following year. 4. Livoria has an open line of credit with its bank. The closing cash balance at

December 31, 2012, was $274,125. Interest charged on the line of credit is six per cent per annum. The bank requires a minimum cash balance of $20,000 on hand at any given time. The company pays back any amounts outstanding if it has excess cash at the end of the quarter.

5. Dividends of $100,000 will be declared and paid in each quarter of each year.

livoria sandwiches case cma

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