Like many things in life, turnarounds come in all shapes and sizes. Small businesses often face the same challenges in a turnaround as medium and large enterprises, but the margin for error is much smaller. For a team of professionals tasked with the turnaround of a fledgling food processor — which produced the delicacies of canned pork brains and tripe — focusing on five key steps applicable to any turnaround resulted in a large success.
Bost Distributing Company (BDC) had a risky concentration of sales to a limited number of customers. Headquartered just outside of Raleigh, NC, BDC operated from three manufacturing locations. BDC owned the personal and intellectual property associated with its business and leased one of its three manufacturing facilities. Its sole shareholder owned the two other manufacturing locations. For working capital, BDC relied heavily on a local lender that provided a series of secured loans — the majority extended to BDC and a few to its owner.
By its second decade in operation, two elements threatened BDC’s survival. The first was an increasing frequency of critical cash constraints. Given BDC’s high leverage ratio and stagnant growth, infusions of debt or equity capital were not available solutions. Instead, its management “solved” each crisis by further limiting purchases of raw materials and more aggressively prosecuting a delayed vendor payment strategy. Eventually, vendors that didn’t cut ties with BDC altogether exerted further pressure on its coffers by demanding cash on delivery or prepayment.
The second element derived from the first, but its consequences for profitability were even more acute. BDC’s wholesale customers, fed up with production delays, discontinued carrying BDC products. By the end of 2014, the combination of the two problems created a dire picture. Revenue had declined by more than 40% during the previous four years. The accounts payable balance was more than $600,000 (for a business with $6.5 million in annual gross revenues) and BDC suffered an annual EBITDA loss in excess of $200,000.
With a steep decline in revenues and cash at a premium, BDC had no choice but to default on its loans. Ultimately, BDC and its secured lender consensually agreed to a state court’s order that placed BDC in receivership and appointed Trigild as receiver. Trigild’s mandate was to stabilize BDC’s operations and sell it as a going concern. Trigild’s Kelley McLaren and Josh Hall assumed the interim roles of CEO and CFO, respectively, and led a team of turnaround professionals in this engagement.1
Transition Management Functions
In a small business, changes in leadership can be difficult because the owners are often managing the company. In this entangled scenario, existing management has more than just a financial stake in the turnaround — pride is involved. When faced with losing leadership of their company, many owners make emotional decisions with the hope of preserving control. Transitioning management functions during a turnaround’s infancy is a delicate, but crucial task that will set the tone for the entire engagement.
BDC’s owner had built the company from the ground up and served as its sole manager. He was unwilling to consider that his management contributed to deficiencies in business operations. Transitioning this owner from “active” management in a manner that did not disrupt day-to-day operations was riddled with potential pitfalls. If the team pushed too aggressively by using the court’s receivership order to prohibit the owner’s physical presence, then the risk of retaliatory action increased — perhaps a bankruptcy filing or key personnel becoming subversive. If the team was too lenient, allowing the owner to maintain a prominent leadership role, then the team might risk losing credibility if BDC’s health did not quickly improve.
Ultimately, the team took a unique and effective step. The owner was provided with a stipend in exchange for ceasing active management functions, cooperating on discrete issues and limiting physical presence. This enabled an effective transition of management functions. The team recognized the benefits of creating a more collaborative, success-driven environment among BDC’s workforce. Even with a court mandate over management functions, a receivership team might decide that expending precious cash resources on incumbent management is the best path to a smooth transition.
Is Survival Feasible?
Cash is king in a distressed scenario. The creation of a 13-week cash flow model provides a clearer sense of working capital needs and helps identify particular stress points anticipated during the business cycle. Coupled with a daily cash report, a turnaround professional will have the tools to implement long-term strategic decisions and rapidly react to immediate, critical needs. Each turnaround professional approaches the 13-week cash flow model in a different manner, and it is always customized for the company’s particular needs.
At BDC, the cash management model was to “read and react” to delinquency notices on the most pressing critical vendor invoices. To create a more effective process, the team built a cash flow model using BDC’s existing profit and loss statement as a template and added revenue and expense information in three categories:
- Production expenses (through an analysis of cost of goods sold per product, CoGS)
- Operating expenses
- Cash receipts
Initially, the team focused on understanding BDC’s typical production schedule to identify its business cycle over a 13-week period. From there, it identified how much demand could be satisfied with existing inventory, what could be produced with existing raw materials and what would need to be ordered from vendors. Next, the team cross-referenced vendors’ payment terms to create a schedule of when payments could be made, which generated a prospective accounts payable report used to identify the additional CoGS expenses that would be incurred to maintain critical vendor relationships. For operating expenses, the team principally focused on payroll, taxes, utilities and insurance. Finally, the team built a cash receipts model using known customer payment terms, discounting projections conservatively for the possibility of delayed or non-payment.
The initial 13-week cash flow model projected that BDC could survive for the immediate future — a threshold determination in any turnaround. However, BDC ultimately needed increased cash flow to thrive, which is achieved by either generating more receipts and/or lowering expenses. With that goal in mind, the team set out to improve back office functions and operations.
Revitalize Back Office Functions
In many companies, the back office acts as an air traffic control center for the entire organization. When it is not working properly, it can wreak havoc across the business. In a smaller company, these functions often overlap with traditional production roles, such as purchasing and CoGS models, further increasing the need for accuracy.
In BDC’s case, a lack of customary accounting controls resulted in inaccurate financial information. The team discovered accounting periods that were not closed, years of incomplete bank reconciliations, inaccurate depreciation schedules and annual expenses that were never recorded or reconciled. Addressing each of these issues created a clearer financial picture of the business.
Resolving the back office issues helped the team understand BDC’s health on a macro level. Next, it examined the micro level — the profitability of each product — by developing an accurate CoGS model. BDC’s existing product-level CoGS model was not managed actively and was often only reviewed annually with little to no adjustment despite changes in commodity pricing. Pricing decisions were made without regard to necessary gross margins for profitability. When the turnaround began, prices had not changed in more than two years, and BDC was running a 24% general and administrative expense burden. The gross margin on some products did not exceed 10%, and in some cases were zero or negative. At best, prices barely covered the cost of production.
Building a CoGS analysis from scratch with correct information enabled the team to properly analyze production operations and identify products that needed either a price increase or discontinuation.
BDC’s fresh salad products were drastically underpriced and would need to be terminated if a price increase was not implemented quickly. The team approached one of BDC’s largest fresh salad customers, responsible for 20% of its gross sales, to discuss pricing. Thanks to significantly improved models, the team obtained a 9% price increase within the first 60 days.
Providing the customer with information about the precise cost of the product coupled with the fact that the existing price resulted in a loss for BDC was essential to the negotiation. The customer understood the need to generate profit. The willingness to share accurate price information with key customers improved revenue through price increases while retaining the customer relationship.
Diagnose Inefficiencies, Implement Remedies
As in any turnaround, BDC was littered with operational inefficiencies — one worth highlighting. Prior to the management takeover, BDC used an ad hoc production schedule. Historically, production was split into two days of six batches, or the maximum produced in a full day was limited to 12 batches to avoid the marginal payroll cost of one overtime hour. By running a full day of production, increasing production to 18 batches and paying for the extra hour of overtime, BDC could eliminate the costs associated with approximately five hours of prep and the cleanup crew for the second shift of production. The resulting 2% increase in payroll costs in switching to a one-day, 18-batch production run was more than offset by a 45% increase in daily net profit. By taking the time to analyze production holistically instead of focusing solely on a few data points, daily net profit increased, indirect costs decreased and the manufacturing facility became available for an additional production day.
The coordinated implementation of changes to BDC’s production schedules, along with further refinement of the 13-week cash flow model, significantly improved cash flow, allowing the team to focus on longer-term goals.
Follow Through on the Exit Strategy
Every turnaround begins with an exit strategy. Indeed, the very use of the word “turnaround” instills a transitory feeling of an upcoming conclusion. BDC was no different. Within six months of the receivership imposition, the team made a litany of improvements, including better cash flow, accurate and timely financial reporting, an expanded customer base and a significantly reduced accounts payable balance. With BDC stabilized, the team focused on the court’s mandated exit strategy of selling the company as a going concern to pay creditors. The team’s intended exit strategy was successfully implemented, albeit through an unexpected process — bankruptcy.
The owner consensually agreed to the receivership of BDC and witnessed the demonstrable improvement in operations, in which he had a significant financial interest. Regardless, in an effort to thwart a sale through the receivership and shock the team into relinquishing operational control, the owner filed for Chapter 11 bankruptcy protection in September 2014. Fortunately, the owner was not successful as Trigild remained receiver in control of BDC’s operations during the entirety of the bankruptcy process. Nonetheless, the bankruptcy filing presented an opportunity to implement the desired exit strategy through the simultaneous consummation of a 363 sale and consensual structured dismissal. A few observations can be distilled from the experience:
- React thoughtfully. According to Section 543 of the Bankruptcy Code, a receiver with knowledge of a bankruptcy filing may not take any action with respect to the debtor’s property other than what is necessary to preserve it. A receiver who acts imprudently is subject to court-imposed surcharges. When a debtor in this situation files for bankruptcy, the receiver should take a fresh, thorough look at operating expenses to ensure only expenses critical to the preservation of the business and going concern value are paid.
- Do not act hastily. Though Section 543 of the Bankruptcy Code compels a receiver to return any property in its control to the debtor, property need not be returned if a motion for excusal of turnover is pending before the court. (The secured lender who sought the imposition of the receiver would most likely file this motion promptly after the bankruptcy filing.) Crucially, if a receiver does voluntarily turn over property to the debtor, then the court cannot re-vest the receiver’s control of the property even if the court determines that is a better approach. The receivership is effectively terminated.
- Bankruptcy is a path to sale. Bankruptcy may be the best available avenue to sell the business as a going concern. Efforts to sell BDC in receivership were unsuccessful because, in many respects, prospective purchasers viewed a court receivership sale as less desirable than the more familiar 363 sale process. Though a third-party bidder did not ultimately purchase the assets in this situation, BDC’s secured lender felt comfortable enough with the tried-and-true structure of a 363 sale coupled with a unique structured dismissal to simultaneously purchase BDC’s assets and force the conclusion of the bankruptcy proceedings. The lender also assumed a significant amount of BDC’s account payables to salvage relationships with critical vendors, seamlessly building on the operational and financial improvements already made to the underlying business.
Even with the headwinds that come with a receivership and bankruptcy process, BDC’s turnaround was a great success. During approximately 12 months in control of BDC, the team increased revenue by 21% by growing existing customer volume and reopening old customer relationships. Overall, expenses were reduced by 11% through operational efficiencies and financial prudence. Ultimately, EBITDA increased by 271% to $329,000 (after the cost of turnaround professionals), and approximately 50 hard-working employees kept their jobs and continue to thrive with BDC’s successor. The Turnaround Management Association honored the team for its accomplishments with the Turnaround of the Year: Small Company Award for 2015.
Today, under new owners, the company has rebranded itself as Boone Brands. It continues to distribute its traditional products, including Texas Tailgate Chili Sauce and Mrs. Patterson’s Hot Dog Chili, at outlets throughout the Southeastern U.S.