Causes of Distress Speaker: David Johnson

January 28, 2013

1

Note on Client Confidentiality

No actual client data appears in this presentation. The values in all exhibits have been altered to protect client confidentiality.

2

ACM Partners Overview

• ACM Partners is a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services.

• Launched in January 2010, the company focuses on small and mid-size organizations.

• ACM Partners provides the assistance needed for management teams, as well as all stakeholders, to adjust to a changed environment while minimizing disruption to a company’s core operations.

3

Speaker Biography • David Johnson is a founding partner of ACM Partners. His

advisory experience spans North America and ranges from pre-revenue startups to Fortune 500 companies.

• An active member of the Chicago business community, David currently serves on the board of directors (audit committee) of Gateway Foundation, a $70 million nonprofit organization focused on providing substance abuse treatment. Additionally, he is an active member of several professional associations.

• David’s writing has appeared in several industry publications, and he has lectured at the University of Chicago, Northwestern University, the University of Wisconsin-Madison, the University of Illinois-Chicago and Loyola University Chicago.

• David earned his MBA from the University of Chicago. His undergraduate studies were completed at Fairleigh Dickinson University.

4

Understanding Distress

• Distress and under-performance, though often afforded little study or consideration, happens.

• For the sake of this presentation, distress will be considered a crisis state in which an organization is at risk of failure absent extreme measures (i.e. in or out of court restructuring). Under-performance will be considered a state in which an organization is operating below its peer group in profitability and cash flow measures.

• As organizational complexity increases, market dynamics continue to shift rapidly and financially savvy investors seek out ever-smaller niches, the underlying skills of turnaround and restructuring will become increasingly important regardless of company size or industry.

5

Causes of Distress

• Organizations find themselves in distress for a number of reasons, but over the past 15 years I have seen five causes in particular that seem to be recurring:

1. Undisciplined Growth

2. Shifting Business

3. Wrong Capital Structure

4. Ill-Fated Expansion Initiatives

5. External Catalysts

6

Undisciplined Growth

7

• Growth, especially rapid growth, places severe stress on an organization.

• When senior management fails to pay careful attention to factors such as profitability, cost structure, availability of cash/financing and reporting capability, growth companies become susceptible to distress.

38,752

54,556 60,392

-

10,000

20,000

30,000

40,000

50,000

60,000

70,000

Year 1 Year 2 Year 3

Sale

s (0

00s)

Restaurant Company

8,960

14,863

21,487

-

5,000

10,000

15,000

20,000

25,000

Year 1 Year 2 Year 3

Sale

s (0

00s)

Home Remodeling Company

Shifting Business

8

• As the pace of change increases across industries, many small and mid-size companies find that they have shifted the core of their business away from its historical roots.

• Such shifts are not inherently a problem, the danger arises when management fails to take into account how a business has changed, and adjust strategy and tactics accordingly.

1,174 1,082 1,014

9,503 9,699 8,713

-

2,000

4,000

6,000

8,000

10,000

12,000

Year 1 Year 2 Year 3

Tota

l Sal

es ($

000s

)

Craft / Stationery Company

Mfg Sales Dist Sales

Wrong Capital Structure

9

• To paraphrase John Mauldin, a suboptimal capital structure is “a bug in search of a windshield.”

• Organizations need to align their capital structure with their financial performance and their strategy in order to maximize the possibilities for success.

Home Goods Company ($000s)

Revolver 13,586 CRE Loan 45,500 Total Debt 59,086 Equity 10,244 Adj EBITDA 3,078

Debt / Equity 5.8x Leverage Ratio 19.2x

Ill-Fated Expansion Initiatives

10

• Organizations pursuing expansion initiatives, whether through new products/services, launch of a new division, acquisitions, or joint-ventures, take on considerable execution risk.

• Too often, the assumptions underlying expansion efforts were flawed, and as a result those efforts need to be unwound in order to position an organization for optimal performance.

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

-

50,000

100,000

150,000

200,000

250,000

Baseline Scenario #2 Scenario #3

EBIT

DA

(000

s)

Sale

s (0

00s)

Building Products Company

External Catalysts

• Relatively few high-performing organizations find themselves pushed into distress by external forces. However, organizations with pre-existing performance issues often are. Some of the more common external catalysts are:

– Legal Judgments

– Debt Maturities

– Commodity Price Swings

– Accidents (Fire, Flood, Etc.)

11

Lessons Learned

• Many organizations will, at some point, struggle with under-performance or distress. While it is the goal of all stakeholders to avoid this, the reality is that many professionals will, at some point in their career, find themselves involved with an under-performing or distressed company.

• While causes of distress vary, internal causes are most common. External causes rarely push high-performing companies into distress, but often force marginal performers to acknowledge underlying issues.

12

About ACM Partners

• ACM Partners is a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services.

• David Johnson can be contacted at: – Email: david@acm-partners.com – Ph: 312-505-7238

• For more information visit: www.acm-partners.com.

13