Turnarounds & Restructurings -Institute Management Consultants J Davidson

Turnaround Opportunities to Grow Your Consulting

Practice

Jim Davidson CTP, CIRA, CPA/CFF, CFE, CM&AA

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

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

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

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)

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

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

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

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”


• 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

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

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

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

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)


• 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)

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

Requirements of a Turnaround• Management replacement• Orderly liquidation analysis/value

estimation• “Going-concern” assessment• Viability analysis• Identification of and return to core

operations

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

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)

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

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


• 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


• Litigation and successor liability issues– Product liability– Environmental liability– Employee litigation– Continuing management– Continuing products– Continuing name/brand


• 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


• 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


• 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%


• 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


• 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


• 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”)

Fees –When and How• Retainers or guarantees

– Risk of bankruptcy– Unsecured creditor

• Carve-outs• Fee applications

– Trustee reviewed – Parties-in-interest objections– Court approval

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

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

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

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

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

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


• 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

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.

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

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.


• 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


• 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

QUESTIONS?

Avant Advisory Group Presentation by:

Marty McDermut, CPA, CM&AA, CFSManaging Director805-705-0042

Jim Davidson, CTP, CIRA, CFE, CPA, CM&AA

Managing Director714-928-7888

Los Angeles Newport Beach San Francisco Santa Barbara

• Operational Turnarounds, Financial Restructuring, Bankruptcy• Mergers, Acquisitions and Capital Transactions• Forensic Accounting, Fraud Investigations, and Dispute Consulting• CFO and C-Suite Interim Management Services

Turnarounds & Restructurings -Institute Management Consultants J Davidson

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