Turnarounds & Restructurings -Institute Management Consultants J Davidson

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Institute of Management Consultants Presentation on Turnarounds and Restructuring by Jim Davidson, CIRA, CTP, CPA/CFF, CFE

Institute of Management Consultants Presentation on Turnarounds and Restructuring by Jim Davidson, CIRA, CTP, CPA/CFF, CFE

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  • 1. Turnaround Opportunities to Grow Your Consulting Practice Jim Davidson CTP, CIRA, CPA/CFF, CFE, CM&AA
  • 2. Current Turnaround Environment • More than other consulting services • Less than previous recessions • Why? – Excess financial leverage coupled with decreased collateral values – Recent M&A valuations/financing - enterprise value not collateral value – Greater capital structure complexity – Covenant-light debt agreements
  • 3. Current Turnaround Environment – More “administratively insolvent” cases – Near credit market collapse – No liquidity, credit drought, fewer financing options – Forbearance agreements, i.e., “kick can down alley” – Out of court workouts – Zone of insolvency issues – Fewer options and legal minefield – Significant uncertainty and questionable visibility
  • 4. Current Turnaround Environment • Bankruptcy is questionable – More “administratively insolvent” – Under secured creditors – Few “Carve-outs” – Lack of DIP financing – Complexity and lack of visibility (feasibilty) – Only 85% successfully reorganized – Many unsuccessful – Several Chapter 22s
  • 5. Current Turnaround Environment • Bankruptcy Law Changes – New 20 –day supplier administrative claim, e.g., Circuit City – New utility deposit requirements – Expanded inventory reclamation rights – Tighter deadlines e.g., exclusivity, rejection of executory contracts (leases) – Single asset real estate rules (SARE) – Few filings in California (New York, Delaware)
  • 6. Current Turnaround Environment • Result? – Fewer traditional Chapter 11 reorganizations (less than 15%) – Fewer and quicker turnarounds – More straight Chapter 7 liquidations – Increased Chapter 11 liquidations or Chapter 7 conversions – More 363 sales and state sanctioned alternatives – Less turnaround consulting
  • 7. Current Turnaround Environment • Costs and timing are over riding – Fast “pre-packs”, e.g. 32 hours – More out of court sales/liquidations • Consensual “friendly” Article 9 foreclosures • ABCs • Receiverships
  • 8. Types of Insolvency Consulting • “Stressed,” e.g., trip of covenant – Best chance for course correction – Typically, creditor referral – Business assessment/financial analysis – Identification and correction of underlying problem – Likely out of court “workout” – Easiest on the restructuring/turnaround continuum
  • 9. Types of Insolvency Consulting • “Distressed,” i.e., Zone of Insolvency – Legal determination but financial parameters – Balance sheet and cash flow criteria – Expanded D&O duty of care in zone – Law in development and flux – Tension and competing goals between creditors and corporation/shareholders – Insufficient assets and/or cash flows may results in suits against “deep pockets”
  • 10. Types of Insolvency Consulting • Operational Stress – Loss of revenues (industry or macroeconomic) – Increased expenses – Fixed expenses (high operating leverage) – Any one or all of above reflected in operating losses – Resulting in negative cash flows – Turnaround/operational restructuring candidate
  • 11. Types of Insolvency Consulting • Financial Stress/Pressure – Poor financial structure, i.e., balance sheet – Excess debt/financial leverage – May be fundamentally strong/operationally solid – “Good-Company-Bad Balance Sheet” scenario – Inability to refinance, extend, or restructure – May be due to timing weak credit markets or dislocation – Short term liquidity or overall debt load – Candidate for financial restructuring or “workout” – May represent balance sheet make-over
  • 12. Types of Insolvency Consulting • Both Operational and Financial Distress – Represents “true” corporate turnaround situation – Extensive, pervasive revamping of operations and financial structure – Potentially performed out of court subject to: • Industry • Timing • Complexity of capital structure • Number and cooperation of constituents
  • 13. Types of Insolvency Consulting • Both Operational and Financial Distress – If one or more of these factors are overriding, then, – Rehabilitation via Chapter 11 reorganization – Retailers and restaurant chains represent prime examples • Reduced sales (consumer retrenchment) • High operating expenses, e.g., leases and franchise agreements • Low collateral values • High debt levels • Extensive legal obligations, i.e., executory contracts – Alternative may be Chapter 7 liquidation
  • 14. Turnarounds – Who? • Restore/obtain lender confidence and credibility – Experience and expertise – Former CEOs and CFOs – Professional certifications (e.g., general practitioner i.e., CMC versus specialization surgeon, i.e., CTP) • Attorneys, financial advisors (CIRA, CPA, CFE, CFF, etc.) • Certified Turnaround Professional (CTP)
  • 15. Types of Insolvency Consulting • Out of court workout/financial restructuring • Turnaround (strategic, operational, financial) – All encompassing and pervasive – May be out of court or in-court (bankruptcy) • Reorganization - Chapter 11 bankruptcy (strategic, operational, financial, rehabilitation via legal process)
  • 16. Requirements of a Turnaround • Financial expertise, e.g., financial statement restatements (e.g., fraud) – 13-week rolling cash flow forecast (90 days) – Liquidity most critical - Detailed cash analysis, preserving, maximization – Working capital - receivables, inventory, payables – Scour balance sheet for any sources, e.g., tax refunds, noncore asset sales, sale-leaseback – P&L analysis – Revenues, logistics, outsourcing, lean manufacturing, fixed cost reduction
  • 17. Requirements of a Turnaround • Management replacement • Orderly liquidation analysis/value estimation • “Going-concern” assessment • Viability analysis • Identification of and return to core operations
  • 18. Requirements of a Turnaround • Customer profitability analysis (large and small) • Inventory item/SKU analysis (turns, margins, non-core products analysis • Vendor analysis-critical versus non-critical • Four-wall analysis • Different dashboard metrics – KPIs and CSFs • Incessant, detailed cash flows scrutiny
  • 19. Required Skills and Consulting Specialties • Financial skills and acumen (e.g., CFO, Controller, CPA, CVA, CFE) • Executive experience in troubled situations (e.g., CEO, COO) • Turnaround expertise (CTP, CIRA) • Industry experience (retail and restaurant, healthcare, manufacturing, high technology/E-commerce, energy, real estate)
  • 20. Required Skills and Consulting Specialties • Functional experience – Strategy – Marketing/revenue enhancement – Lean manufacturing/Supply chain/logistics – International/import/export – Product development – Organizational/management – Human resources/incentives
  • 21. Turnaround Case Issues and Moving Parts • Turnaround strategies/options impacted by following factors: – Industry • Macroeconomic/ recession, i.e., cyclical trough • Macroeconomic concerns may dominate microeconomic • Highly competitive • Consumer retrenchment • Financing dependent
  • 22. Turnaround Case Issues and Moving Parts • Products and Markets – Quality and product - differentiation critical – Co-dependency with dealership network – R&D and intellectual property – Expanded into additional product lines – Increased capital expenditures (e.g., molds, facilities, fixed costs) – “Stuffed” sales channels – Cannibalized other product sales
  • 23. Turnaround Case Issues and Moving Parts • Litigation and successor liability issues – Product liability – Environmental liability – Employee litigation – Continuing management – Continuing products – Continuing name/brand
  • 24. Turnaround Case Issues and Moving Parts • Management and Corporate Governance – Misdirected board involvement/arrogance – Sales dominated versus orientated (unbalanced) – $85MM purchase/investment now $12MM value – Management assessment and participation – Management competence and industry experience – Related party affiliations – Loan guarantees
  • 25. Turnaround Case Issues and Moving Parts • Operations – Utilization of lean manufacturing and efficient supply chain concepts – Strong supplier relationships – Strong dealer relationships – Industry leader – Poor information technology utilization – High facility fixed costs
  • 26. Turnaround Case Issues and Moving Parts • Significant asset write-downs and operating losses – Loss on discontinued operations – Goodwill, intellectual property, and asset impairments and write-downs - $65MM – Floor financing lender repurchase requirements - $5 - $10MM – Industry and company sales declines exceeding 70%
  • 27. Turnaround Case Issues and Moving Parts • Capital Structure, Financing, and Liquidity – Negative equity, significant debt – One floor financing lender withdrew from the market – Primary floor lender curtailed lending to Company pending resolution situation – Primary bank group swept $3MM cash collateral – Cross-defaults and cascading effect – “Melting ice cube” and in Zone of Insolvency
  • 28. Turnaround Case Issues and Moving Parts • Turnaround Strategy – Variable expense reductions (RIF) – Marketing and promotion/dealer refocus – Discontinued operations and retrenchment to core – Redoubling of product development/innovation – Working capital reductions – Liquidation analysis – 13-week rolling cash flow and longer-term forecasts
  • 29. Turnaround Case Issues and Moving Parts • Sales Process and Alternatives Evaluation – “Naked” out-of-court asset sale – “Loan to own” and/or “Own to Own” – $12MM of specified assets ($80MM only 4 years ago) – Prepackaged bankruptcy – Section 363 sale (successor liability/clear title) – “Friendly” UCC Article 9 Foreclosure – ABC (Hand over the keys”)
  • 30. Fees –When and How • Retainers or guarantees – Risk of bankruptcy – Unsecured creditor • Carve-outs • Fee applications – Trustee reviewed – Parties-in-interest objections – Court approval
  • 31. Insolvency Terms and Concepts • ABC – Assignment for Benefit of Creditors – Less costly and timely state law alternative • Absolute priority rules – Bankruptcy code's ranking for payment of unsecured claims – Requires full satisfaction of senior claims before payments to junior creditors
  • 32. Insolvency Terms and Concepts • Administrative claims – Professional fees – Post-filing expenses – Priority after secured claims – Goods received within 20 days of filing • Administratively Insolvent – Inadequate cash from assets or operations to affect a Chapter 11 reorganization
  • 33. Insolvency Terms and Concepts • Article 9 Proceeding - Foreclosure under state laws less costly than bankruptcy • Carve-Out – Secured lender agrees to pay professional fees when administratively insolvent – If not court-approved
  • 34. Insolvency Terms and Concepts • Chapter 7 – Liquidation proceeding to effectively shutter doors – No “going- concern” value • Chapter 11 – Reorganization proceeding with confirmed plan – Sale of assets under Section 363 • Cram-down – Plan confirm over certain creditor classes objections
  • 35. Insolvency Terms and Concepts • Debtor in Possession – Debtor continuing to operate under court approval and U.S. Trustee administrative supervision – Essentially acting as own trustee – Acceptable as long as no fraud, negligence, mismanagement – Has “breathing spell” under automatic stay – Exclusive 120 day right to plan development
  • 36. Insolvency Terms and Concepts • Debtor in Possession Financing – Short-term financing for DIP to operate business – Primes secured lenders if “adequate protection” – Contentious – “Deepens zone of insolvency – Super-priority status –any new money to repay the DIP first
  • 37. Insolvency Terms and Concepts • Fraudulent Transfer – Transfer of assets (or a sale) within 12 months prior to bankruptcy filing, or within "zone of insolvency” – Classified fraudulent transfer if deemed inappropriate in hindsight – Receiver can be compelled to return assets to estate
  • 38. Insolvency Terms and Concepts • Prepackaged Bankruptcy (“Pre-pack”) – Agreement in advance of Chapter 11 filing – “Blessed by the Court to eliminate hold-outs and clear title – Simultaneously filing and request for Court approval of plan of reorganization detailing: • Sale of assets ,e.g., Section 363 • Repayment of debt (in whole or in part) • Provision for administrative claims.
  • 39. Insolvency Terms and Concepts • Preference Payments – Payment to creditor 90-days before bankruptcy filing (or one year if insider) – Gives creditor more than would have received in bankruptcy – “Claw-back” provisions or disgorgement may be overcome based on specified conditions
  • 40. Insolvency Terms and Concepts • Trustee – Representative of bankruptcy estate – Exercises statutory powers principally for benefit of unsecured creditors – Under general supervision of court and direct supervision of U.S. trustee – Chapter 7 liquidation – Rare Chapter 11 cases (fraud, mismanagement, etc.
  • 41. Insolvency Terms and Concepts • U.S. Trustee – Officer of Justice Department to supervise administration of bankruptcy cases, estates, and trustees – Monitors plans and disclosure statements – Monitors creditors' committees – Reviews fee applications
  • 42. Insolvency Terms and Concepts • Zone of Insolvency – Expanded fiduciary duty of board and executives beyond shareholder interests to include interests of creditors – Potential personal liability for “deepening insolvency” at expense of creditors – Focus on preserving enterprise value rather than creditors versus corporation/shareholders
  • 43. QUESTIONS?
  • 44. Avant Advisory Group Presentation by: Jim Davidson, CTP, CIRA, CFE, CPA, CM&AA Marty McDermut, CPA, CM&AA, CFS Managing Director Managing Director 714-928-7888 805-705-0042 • Operational Turnarounds, Financial Restructuring, Bankruptcy • Mergers, Acquisitions and Capital Transactions • Forensic Accounting, Fraud Investigations, and Dispute Consulting • CFO and C-Suite Interim Management Services Los Angeles Newport Beach San Francisco Santa Barbara