Sarah Macphail is a food and beverage analyst at Carter-Brown Associates. In early 2011, she began to review several recent reports and the financial statements of Luhvul Cooperage Inc., listed as LUVC on the NASDAQ. The company’s financial statements are prepared under U.S. GAAP.

Luhvul Cooperage Inc. is located just outside of Louisville, Kentucky, U.S.A., in close proximity to the major bourbon distillers. By a 1964 U.S. law, Kentucky bourbon must be aged in brand new, charred oak barrels with the aging process taking anywhere from 6 to 12 years. Since the flavors and the char remain long after their initial use, the barrels can be reused for a variety of spirits including various whiskies, tequila, and rum. Luhvul Cooperage purchases selected barrels from the local distillers, reconditions them as needed, and resells them primarily to rum and whiskey producers worldwide. About 60% of sales are to the Unites Kingdom and about 25% to Chile, with all sales denominated in $US.

After reviewing the financial statements, the Notes to the Financial Statements and Management’s Discussion and Analysis (MD&A), Macphail became concerned that the company might be in violation of one or more of its debt covenants. The company’s recent abbreviated financial statements are shown in Exhibits 1 and 2, and selected excerpts from the notes and MD&A are provided in Exhibit 3.Exhibit 1Luhvul Cooperage Inc.Balance SheetsAll figures in $-thousandsAs of 31 December20102009 Cash506442 Accounts receivable6,3413,967 Inventories8,10312,791 Other current assets8061,498 Total current assets15,75618,698 Net property, plant and equipment16,34517,532 Total Assets32,10136,230 Total current liabilities5,9849,778 Long-term debt5,6157,128 Shareholder's equity20,50219,324 Total liabilities & equity32,10136,230




Exhibit 2Luhvul Cooperage Inc.Income StatementsAll figures in $-thousandsFor Periods Ending 31 December201020092008 Net sales 62,684 51,250 66,200 Non-operating revenue 1,618 602 586 Total revenues 64,302 51,852 66,786 Cost of good sold 57,035 45,525 55,568 Selling & admin expense 5,025 4,137 5,604 Interest 704 910 569 Total costs & Expenses 62,764 50,572 61,741 Earnings before tax 1,538 1,280 5,045 Taxes 513 217 1,684 Net Income 1,025 1,063 3,361 Exhibit 3Luhvul Cooperage Inc.Selected Excerpts of from Notes to the Financial Statements And Management’s Discussion and Analysis All figures in $-thousands, 31 December 2010

Excerpts 1.Debt Covenants

As determined under FIFO accounting, throughout the tern of the loan, the current ratio must equal or exceed 3.0 and the interest coverage ratio must equal or exceed 5.0 times.

Excerpts 2 Inventories

Inventories are reported on a LIFO basis. The LIFO reserve was $4,994 and $3,152 at the end 2010 and 2009, respectively. During 2010 the company liquidated certain LIFO inventories that had been carried at lower costs in prior years; the effect of the liquidation was to increase before tax earnings by $1,517.

Excerpts 3 Operations

During 2010, activity at the local distillers was interrupted due to a four-month strike and reduced the company’s access to used barrels.

Excerpts 4 Executive Compensation- stock Options

On 1 January 2010, the company granted 50,000 options on its common shares to its top managers. The options have following features:

The exercise price for all company stock options is the stock price on the date of the grant.

Options cannot be exercised for four years and expire in ten years from the grant date.

Based on prior experience, it is estimated that options are exercised, on average, in five years.

The related compensation expense is reported in selling & administrative expenses.

Exhibit 4 contains stock information and estimated option pieces during 2010; option prices are estimated using the Black-Scholes model using assumptions contained in the Notes to the Financial Statements.

Excerpts 5 Executive Compensation – Stock AwardsIn fiscal year 2011, the company will begin granting employees stock awards (SAs) rather than stock options as part of its executive compensation plans. SAs are grants that entitle the holder to shares of company stick as the award vest (normally a four-year period) with the award being based on accounting performance metrics as determined by the Compensation Committee of the Board of Directors. Exhibit 4Luhvul Cooperage Inc.Stock price and Estimated Option Prices throughout 2010

DateStock PriceOption Price 1-Jan$18.00 $4.38 1-Jul$21.00 $6.40 31-Dec$23.00 $7.78 Average for year$20.67 $6.13 In reviewing the change in the company’s executive compensation, Macphail made the following three observations:

1.Management will have the same downside risk exposure from the stock award plan as they currently face with stock options plan.

2.Because both the stock awards and stock options have the same vesting period, they will also have the same total effect on net income.

3.The issuance of new shares under the new stock awards plan should improve the company’s debt/equity ratio.

While demand for reconditioned American oak barrels from traditional sources has been strong, there has also been an increased interest in the use of new American oak barrels by both domestic and foreign wine makers since their cost is about half of the traditionally preferred French oak barrels.In a Bloomberg report earlier in the day, Macphail read that Luhvul Cooperage had just entered into a joint venture with a wine maker, three other cooperage firms and McFadden BioGroup, Ltd. To develop biological and biochemical processes that would accelerate the natural seasoning of wood to less than 15months from its current 2 to 3 years. In the joint venture named Oakwood Bio Treatment Inc., each company is to provide equal funding of $4 million. The joint venture is to have a debt/equity ratio of 50% with an equal share of the debt being guaranteed by each partner. The joint venture arrangement is to be terminated in 3 years unless extended by the partners.