TMA / UCLA Team Case Presentation

In today’s uncertain business climate, the threat of insolvency or bankruptcy may seem close. The Turnaround Management Association (TMA) strives to provide education to fill these gaps.  On October 26, 2010, a TMA team gave a case presentation at the UCLA Anderson School of Management involving a real company.

I was honored to participate with the team doing this presentation, which was both informative, thought provoking and fun.  About 40 students and local business professionals attended.

The case used a real-world Chapter 11 bankruptcy filing and successful exit, the Accuride Corporation.  At the time of the filing it was doing about $600 million/yr in volume.  The company is a supplier to the automotive and heavy truck industry, which is very cyclical, a major factor in its difficulties.

You can download the presentation we used by clicking on this link.

The team used a “role playing” style of presentation with each person speaking from the viewpoint of a real or assumed key person in this process, and bringing their specific professional skills to light in his “lines.”  These included:

• CEO – Rob Holland, of Creo Capital Partners.
• Investment Banker/Financial Advisor – Jeff Reithel, of Houlihan Lokey.  Jeff actually worked on the Accuride case, a real bonus.
• Attorney for the Secured Lender – Chris Manderson, of Manderson Shafer & McKinlay.
• Attorney for the Company (Accuride) – John Schafer, of Manderson Schafer & McKinlay.
• Turnaround Consultant – Paul Deis (that would be me).

We used the format of a 3 act play:

Act I – Making Trouble

Act II – Dealing with Trouble

Act III – The Turnaround – an Alternate Ending

Presentation Highlights:

• The CEO was very experienced – a long-time company senior leader, who believed in the company, and in the effectiveness of the cost cutting and other changes to enable the company to survive.
• The company was highly leveraged – which ballooned from $488 MM in 2004 to nearly $700 MM in 2009 – as revenues went from $6000 MM in 2004, peaked at $1.4 Billion in 2006, then plunged $600 million in 2009.
• Gross margins were small – even in the “good” year of 2006, Cost of Good Sold was 86% of sales.
• Uncertain value of the company – while there was not a formal valuation fight, it WAS a challenge, because no one knew, with confidence, if the company would remain solvent once it emerged from the bankruptcy protection and thus what its value would be then.
• Multiple layers of debt – The legal challenges in negotiating a restructured debt and equity arrangement were made more complex by multiple creditors with different rights and priority.
• Equity traded – The resolution involved exchanging of some of the debt for equity in the company – betting, in effect that it would return to solvency and be able to both pay on the remaining debt, and generate equity value.  Shareholders were essentially wiped out, receiving only 2% of the company.
• Operational complexity factors – the company has 23 separate plants, each making different products, but that involve similar processes. While some consolidation was done, it was not major.
• Union issues – some plants are unionized, with debatable (or less) help during the crisis.  Other plants were non-unionized, a much easier situation during a solvency crisis.
• Time urgent & critical – while these factors were being calculated, negotiated and resolved, all under court supervision, the business faced daily pressure, as always, to DELIVER its products, on time, in the right quantity, and of high quality, or face being replaced by another vendor in the intensely competitive automotive supply world.  Nothing could wait.

Highlights and Key Discussion Points

As the scenario unfolded, explained by our “cast “ of professionals, the following key points, factors, observations and conclusions were drawn:

• Sales, not profit focus – management had, for years, focused on sale volume, almost to the total exclusion of cost management, or ensuring the company’s survival.
• Cash is king – drives and determines everything in this and all businesses; profitability is secondary, as one can be profitable and insolvent.
• Low margins drove lack of cash – even in good years the company didn’t make much gross margin (15%), yet knowing it was a very cyclical business, nothing was done to reduce fixed costs to enable the company to survive a large downturn.
• Too heavy reliance on debt – the company was, even in good years, carrying far too much debt.
• Fatal combination – the presence of low margins + high debt + unproactive management results in serious survival challenges.
• Lack of cash = bankruptcy – no cash drives Chapter 11 filing.
• Others gain control in a bankruptcy – owners & senior leaders essentially lose control of the company once the company is in a Chapter 11 proceeding.  Their agendas are not in alignment with top management or owners.
• Outside expertise crucial – certainly once the company is in a Chapter 11 proceeding, but in reality well before it, the company becomes heavily dependent on outside expertise in order to even survive.  These are situations for which no one is trained or experienced, not an occasion to see who has the most testosterone.
• Value of assets difficult – the value placed on the company may be determined by others – often with antagonistic agendas.  These parties are NOT friends of the shareholders.
• Cost reduction not equal to a turnaround – the company did make some effort to cut costs and at least minor consolidation.  However, it did nothing to substantially alter the fixed cost structure of the company and its 23 separate manufacturing facilities.

Alternate Ending – a real operational turnaround

A real, substantial operational turnaround that would essentially re-position the company for long-term survival first, then success, would require focusing on actually correcting the primary problems, including:

• Very low margins – on 14 to 15% in a good year, negative in bad years.  Most of this is due to the fixed costs of having 23 separate plants, each with a high breakeven volume.
• Unionization – uncooperative attitudes make low margins worse and harder to improve.
• No product rationalization – need to drop or sell losers, focus cost improvements and/or price negotiations on others.
• Redundant processes – many of the 23 plants, of 200-300 people each, have similar equipment & processes, many of which are well underutilized.
• Mexican plants do not appear to be helping – at a minimum, further analysis, including transportation costs and other factors, should be done.

Initial Turnaround Plan – Actions To Take

• Replace leadership – a new leadership team with a fresh vision that goes beyond survival for the company is needed.
• Integrate marketing process and sales forces – may include re-branding some products, having a sales person sell multiple brands, and other fixed and indirect cost reductions.
• Develop, implement cash-focused reporting – supplement with P&L / GAAP oriented reports, but run daily operations on a cash basis, including capital expenditures.
• Consolidate plants, capabilities, brands – the 23 plants can and should be reduced to a much smaller number in the 4 to 6 plant range.  Multiple brands can be produced at one plant.  This is not a quick-fix, of course, but is essential to insure long-term survival.
• Product rationalization – analyze, drop money-losing products, negotiate prices where there is market strength.
• Cut per-plant fixed cost structure – now buried in Cost Of Goods Sold (COGS).
• Inventory – the carrying costs are hidden in the 23 plants fixed and indirect cost structure; as the consolidation process goes forward, it will also reduce inventory costs – handling, transportation, storage, deliveries of similar materials to multiple plants.
• Get blunt with unions – require that unions become productivity and quality improvement focused collaborators, or close plants by moving the production to other plants.  It is the adversarial, “make work” stance, not union membership per se, that does the damage.  This includes shifting to a much smaller number of work classifications to implement multi-purpose workers who can move around continually as the varying work load requires, rather than being idled.  It is the survival of the company that is at stake; responsible leadership simply cannot allow an adversarial union to destroy the company, and the jobs of people at those plants in the process.
• Transportation management – develop a corporation wide transportation management capability to optimize these costs, such as “milk run” shipments – pick up products at multiple plants on a single truck, deliver to multiple customers via a system optimized route, or routes that combine incoming material with deliveries.
• Continuous improvements – The new leadership must shift the culture and daily processes to drive hard towards a new collaborative culture of work teams and continuous improvements.  These are requirements of simply staying in business in this era.

Observations & Conclusions

Since a more radical operational restructuring was not actually performed, it is likely that Accuride will return to the Chapter 11 process – a “Chapter 22” – before too long.  The company is essentially betting that much higher, and more sustained volumes of vehicle production by their customers will lift volumes above the break-even points at multiple plants.

If this volume doesn’t materialize, the company simply cannot be profitable at these lower volumes.  The “cost reduction” efforts made are too small, and do not target the real, fundamental causes of the lack of profitability – high fixed and indirect costs.

We believe a more aggressive action plan is to expect a long-term of much lower sales volumes, to re-engineer the company to be profitable at smaller volumes.

By re-tooling the company – itself a capital investment of sorts – for a lower fixed costs structure, and a much lower breakeven point, it is positioning itself to first survive, no matter what the industry and economy does, and second, to prosper in this highly cyclical industry, by making money even at the lower levels of volume.

If this expectation of lower business volumes turns out to be wrong – with strong, sustained sales growth – there are many, many actions that can be taken to enlarge capacity at a smaller number of larger volume plants.