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
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