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English Lecture with Chinese Subtitle arrow
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Chinese Lecture with English Subtitle:

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1. My name is James F. Fox, I am a Managing Director with the Financial and Business Advisory Firm of Executive Sounding Board Associates, Inc. in the United States. The purpose of this presentation is to provide information concerning supplier relationship with foreign customers. We are not providing legal, accounting or business advice. Every situation is different and should you need assistance, you should contact your own legal and financial advisors. I would first like to provide you with some basic information about myself and my firm. Our firm is engaged in providing Bankruptcy Advisory, Corporate Finance and other related services for various companies around the world including professionals.

2. As far as my own background, after receiving my MBA degree from Wharton Business School of the University of Pennsylvania, I undertook a number of positions in operating management, management consulting and investment banking. I currently serve as financial advisor to numerous creditor committees in Bankruptcy proceedings in various court venues around the United States. Many of my clients are Asian companies who have provided goods to American and other companies that then went bankrupt, leaving very large receivables in some cases in the hands of those Chinese creditors and that would like to get their money back.

3. The purpose of this presentation is to provide some thoughts on some of the considerations that you should have in your entire supply relationship with various customers. This presentation specifically will address several sequential stages of the relationship between the Chinese supplier which I will call creditor and the U.S. customer which I will call debtor. Our purpose is to give you a broad overview of these stages; later we will discuss and address how individual stages of interest can affect your interest in providing goods. The various stages include initiation and ongoing that we will call business as usual. The second is the stage of the company that you supply in which that company maybe exhibiting some potential weaknesses, operating or financial. In the third stage the company is openly acknowledging that it is experiencing distress. In the fourth stage, the company is pursuing a restructuring scenario outside of bankruptcy. Finally, in the fifth stage, the company is pursuing a restructuring scenario inside of bankruptcy.

4. Our objective is to let you know that as a supplier that are certain steps you can take to inform yourself to take action prior to the point at which a company is in bankruptcy and can't pay you because either he doesn't have the money or the court won't let him. Before getting into specifics I would like to underscore the question as to "why do you need to worry about these issues?"; you are just the supplier, you are neither an equity share holder nor a lender, often refer to as a secured creditor to your customers, so why do you need to worry about these things?

5. I would like to relate a case involving a value added marketer toys and gifts. As background, this company was a style oriented business in which the company continuously developed new product ideas and licensing relationships for popular television and other cultural figures. The company generated about $150 million in sales annually and sold its products to retail stores. These products were sourced from various manufacturers in China and elsewhere.

6. The business in the beginning was doing very well and for some time it did very well. It had 2 key employees, one of them was a creative person and he invented the new products and secured the licenses from the television networks that enabled him to produce these products. The other one managed the sourcing of the manufacturer goods from Chinese suppliers. The business was producing about $15 million of earnings before interest, taxes, depreciation and amortization which are also refer to in financial circles as EBITDA and it was then sold for $75 million, approximately five times its EBITDA level, which was the going rate for a manufacturing company.

7. The new owner of the business was a financial buyer, a private equity firm that did not know the industry. As part of the transaction, the two key employees received all their compensation in upfront cash, there were no incentive payments, and no portion of the purchase price was held back pending the satisfactory performance of the business following the transaction. The 2 key employees were retained with employment agreements and they stayed on and continued to work for the company. But they had very little incentive to produce at the same high level they had before they sold their company. As a result, they were not as creative in either developing new products or as resourceful in finding the best sources of supply in China, and elsewhere in Asia. As a result, the sales volume of the company dropped off, the business did not go well and it filed for bankruptcy leaving unsecured creditors owed a substantial amount of money; many of these companies were located in China.

8. The purpose of this discussion is to help you by providing you with some ideas as to ways that you may be able to protect yourself from the beginning from the negative impact of situations like the story that I just told. All supply relationships of course are initiated by identifying a customer and a supplier and having those 2 parties come together for general discussions about ways in which they can work together. Many successful suppliers to American companies and companies elsewhere go through a process of initially qualifying the customer. In the case of public companies, there are SEC filings (Security and Exchange Commission filings) that will provide a great deal of information on the financial solidity of the company, etc. For private companies, before supplying private companies, as a supplier, you may want to secure financial statements from these parties to ensure that they have the financial resources to pay your bills on time.

9. If you can find out what cash balances they have and banking relationships, that's all the better. If you are planning to be a very large supplier to a customer, you may want to determine what percent of their sales are accounted for by your products so that you will be able to determine how heavily dependent they are on you. Another thing you can do as part of the initial qualification process is to talk to other significant suppliers to see what their experience has been with this customer.

10. The second consideration to consider is the motivation of the company for ordering from you in the first place. Are they seeking to diversify their sources of supply, are they after better pricing, did other suppliers fall down on the job and were they not able to meet the quality standards of the customer, who are the other suppliers for these products, are there a lot of them, will you become a critical vendor if the company's business gets into trouble, because in some cases when the company gets into trouble, so called critical vendors can receive some preferential payments? Other questions you might consider asking are will your products will be used to serve a new product category for the company? The next question you should think about is who are the customers that ultimately use your products, the products that you are supplying to the customer and what are their tastes, will they change, will the market demand change rapidly?

11. The next consideration you should think of as you are initiating an ongoing business relationship are the terms of your relationship; will you be supplying these under a letter of credit, which can greatly reduce your financial risk of supply? Ultimately the customer may demand that you depart from a letter of credit arrangement and you should do so only after you have convinced yourself that this is a very, very reliable customer.
12. Another thing you should do as you are initiating a client relationship is to secure an agreement from the customer to inform you when the company secures incremental debt financing or any changes in ownership control because those two circumstances can affect the ability and the will of that company to continue as a customer of yours. On an ongoing basis, you should determine the levels and patterns with which the company that is going to purchase goods from you. As I said before, agree on payment terms and then receive regular reports from the customer on any important operating or financial indicators. You should also consider having regular meetings with management, perhaps under the guise of requirements planning and there are people who can do that for you, financial advisors or any other business representative here in the United States, who could undertake those meetings for you.

13. You should also be vigilant for press reports and any changes in the company's operating behavior or the relationship. All of your efforts should involve setting the stage for regular communication by senior management; this is simple good form for managing any important operating relationship. As I said before, all of the foregoing issues can be addressed with the assistance of an outside financial professional.

14. At the point that you extend credit, you have the right to information because you are effectively involved in a strategic relationship, particularly if the shipping volumes are high, and it's not unreasonable to ask for several years of projections, a balance sheet and a couple of years of historic financial statements. You should not be afraid to sign a confidentiality agreement again in concert with your legal counsel. If that information is not forthcoming, then it may be a red flag because other than confidentiality issues, there may be no reason for the company not to release the information to you as a perspective supplier.

15. The next period we will talk about in the relationship is that of possible stress, where the company has not yet come to you and said that they are having any financial or operating difficulties. But there may be some possible indicators in the market place for you to identify and consider. The first is a change in the payment pattern from agreed upon relationships. Typically, such changes will involve slower payment. If you ship goods every month and you expect payment in the next month and suddenly you get payment two months down the road, this is a departure from the standard payment agreements.
16. It is also possible that the company may be from a financial performance standpoint becoming increasingly close to its' debt covenants which are the levels at which it must perform before it's in violation of its loan agreements. Debt covenants may involve agreed upon levels of revenue, cash flow, or debt to equity ratio--recognizing that a higher debt to equity ratio indicates a higher level of risk at the company-- and interest coverage ratios.

17. Other indicators of possible stress include declines in order levels or changes in order level patterns. This should trigger on your part inquiries about how the debtor's business or market may be changing. Insights of some of this may be provided through news developments on the company's customers or news developments on the company's alternative suppliers, which are your competitors. They may be innovating or having problems themselves which are conditions that you as a supplier ought to be considering. Other indictors of possible stress before the company comes to you are changes in senior management. Very often the first member of the senior management team to leave the company is the chief financial officer because if there is a problem internally, sometimes the chief financial officer is the one who first gets officially blamed for those problems and leaves the company.

18. There are additional ways of getting insights into the company; in the case of public companies; you can follow reports from security analysts. In your supply relationship, you may also detect some defensiveness on the part of normally very open members of management. In addition, if there are departures of key employees of the company other than the CFO, that's another indication that the company's core business may not be doing that well.

19. Other changes that you should follow are changes in the nature of the company's product line or strategy which may indicate a greater or lesser demand for your products. Some of the SCC filings that you may consider following for very important customers are the following reports, 10K reports which are published every year and provide a summary of the company's operations for the prior year, 10Q reports providing the same information for the latest reported quarter and 8K reports which provide information on material events affecting the company. Examples of information that might be contained in those reports are increases in debt, decreases in net working capital and any vertical integration initiatives.

20. The final possible indication of a change in the status of the company as a customer for you might be if the company changes ownership, because that could affect the company's capitalization, its product line, prospects, plans and its general operating philosophies.

21. The third stage in a relationship between a company and its suppliers is that of acknowledged stress outside of bankruptcy, where the customer comes to you as the supplier and says we have a problem or we are having significant problems and we are not either going to continue ordering from you with regularity or we are not going to be able to pay you for past goods shipped in accordance with our normal payment schedules. Very often this happens when a company has too much debt on its books, which can happen for a number of reasons including making an unsuccessful acquisition or paying a dividend to shareholders or any number of other factors.

22. When a company gets into trouble, it will ultimately follow one of three directions and these avenues can be pursued inside our outside of bankruptcy. The first is that the company can be fixed, sometimes with the aid of additional or replacement financing. In this case the company may be assisted by a turnaround management firm or investment banker and my firm happens to play those roles so we understand the direction that these kinds of cases can take. In addition to a company being fixed, it can be either sold or merged into another company with the aid of an outside investment banker. Finally, if conditions are really bad and the company has some assets but it cannot continue in normal operations, the company may be liquidated, either inside of bankruptcy with a court appointed liquidating trustee or outside of bankruptcy.

23. Typically, the company can remain outside of bankruptcy if the company's operations can be fixed reasonably quickly, perhaps through revenue increases or cost cuts, if it has sufficient cash to meet its obligations as they come due. It is also possible that a company can generate enough cash outside of bankruptcy by selling off what we will call redundant assets or even an operation that for example may not be profitable but can obtain reasonable cash purchase price.

24. If conditions are particularly difficult, the business may, as I said before, choose to sell itself. In such an instance, as a supplier you will want to know who the buyer is and their intentions for the product line you are continuing to supply and you will want to know if they are going to continue that product line. While the company is determining it restructuring approach outside of bankruptcy you will want to stay close to the company to understand its cash situation. Often they will bring in a turnaround management consultant to prepare a rolling 13 week cash flow statement and to assess the situation. Many creditors secured and unsecured such as your self will hire a financial consultant to assess the situation for them. The roadmap for turning around a company is the 13 week cash flow statement; it demonstrates whether or not the company can make it on its own through a restructuring plan.

25. The next stage that some companies go through when they get particularly strained and they experience extreme stress is a bankruptcy filing. This happens when it is anticipated that cash is expected to run out in the foreseeable future. It can be in the company's best interest to file for bankruptcy at that point, because the bankruptcy process itself is expensive and the company will want to have in place as much cash reserves as it can to pay professionals and meet the other obligations that it incurs while in bankruptcy.

26. Typically a bankruptcy filing occurs when the 13 week cash flow statement doesn't work; that is, the company can't meet its financial obligations as they come due. Typically these financial obligations are to suppliers, lenders, landlords, employees, salaries, taxation authorities, etc. This is one of the definitions of insolvency. There are three tests of insolvency; the first is the balance sheet test, the capital adequacy and the cash flow test. As a company nears the point of filing for bankruptcy, typically it does not past one or more of these three tests. Sometimes the lender will agree to what is known as a debt for equity swap when one of the major problems encountered by the company is meeting its debt obligations in terms of servicing its debt for principal and interest. One way around that is to reduce the amount of outstanding debt.

 

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