Forum on Private Companies March 25 – 26, 2004 “Credit Sources in a Distressed Environment”

1. Forum on Private Companies March 25 – 26, 2004 “Credit Sources in a Distressed Environment” By: John S. Sumner, Jr. Michael Epstein

2. Overview of Today’s Discussion • Trends in middle market distress • Chief causes of bankruptcies • Affect of distress on a company's finance options • Expanding creditor universe on corporate finance • Alternative financing sources

3. TRG Perspective Our clients: • Corporate executives and directors • Private equity investors and other investment vehicles • Senior bank syndicates • Lenders to distressed middle-market companies • Investors in distressed debt Our role: • Evaluate distressed borrowers • Identify critical and fundamental business issues • Develop and implement meaningful operating and financial change • Manage financial restructurings and turnaround strategies • Manage creditor relationships

4. Changes in Capital Access Affects Decision Making • Sources of capital: More diverse group with varying interests now stretching down into middle market (technology, disintermediation, money in search of yield, etc) • Single lender facilities vs syndicated loans • Accessibility of public markets more prevalent (High yield, PIPES) • Alternative lenders (insurance cos, mutual funds, non-banks, CLO’s, CDO’s) • Into 2003, appetite for distressed debt increased • Distressed debt investors: • Money in the market vs deal flow (time horizon for investment of money) • Buy for yield vs “loan to own” • New players (distressed debt buyers) and more money vs 10 years ago

5. Public Co. Bankruptcy Filings vs. Total Business Filings Total Business Filings Total Business Filings Number of Public Filings Public Co. Filings Annualized Source: BankruptcyData.com

6. Middle Market Distress • Record increases in financially-troubled companies and corporate bankruptcies • Many failed acquisition vehicles unable to service overwhelming leverage Commercial Net Loan Charge-Offs (%)1990 – 2Q 2003

7. Top Ten Sectors - Defaults by Volume First 9 Months of 2003 (in billions) 2004 will likely result in increased defaults of restructurings (as amortization and interest rates step up) Source: Moody’s

8. Size of Defaulted and Distressed Debt Market in Billions Source: E. Altman, NYU Salomon Center Distressed Debt is defined as the portion of performing high yield debt trading at least 1000 basis points above 10-year Treasury bonds.

9. Maturing High Yield Debt Maturing high yield debt will increase 25% in 04; 32% in 05 Growing debt overhang will encourage distressed debt investing, restructuring $66.2 $50.1 $40.2 $36.4 $28.3 $ in billions $19.0 $29.8 $21.2 $21.8 Source: Moody’s, Deloitte

10. High Yield Bond Debt Maturing 2003-2005 by Industry Source: Moody’s

11. High Yield Bank Debt Maturing 2003-2005 by Industry Source: Moody’s

12. Changes in the Creditor Market • Implications for the Financial Executive : • Pro’s: • More sources of credit • Impact on bank group paralysis: Can foster a change in thinking • Con’s: • More creditor relationships for the financial executive to manage • More pressure from unfamiliar sources • Lack of fundamental “workout” mindset

13. Creditor Considerations in a Distressed Environment • Business viability • Restructuring plans • Sale/liquidation options • Expected recovery values under each scenario • All tempered by creditor mandate (again arbitrage player looks for leverage) • All can play out regardless of company or operations “It’s about yield not jobs.”

14. Strategic/Tactical Options from Creditor’s Point of View • Operational streamlining/downsizing and subsequent restructuring • Company sale, asset sales, other alternatives • Debt for equity swap with current lender • Recapitalization through a private placement • Informal reorganization (Workout) • Prepackaged bankruptcy • Chapter 7 • Chapter 11

15. Impact of Distressed Debt Ownership on Borrower • Old/cold debt vs newly acquired debt • Ability/willingness to inject new funds • Outlook for management • Impact on other constituents • Implications for the financial executive • What happens when an investor buys a portion of your bank debt? • How will price increases and disappointing yields affect new investors?

16. High Yield Debt vs. Yield Spread HY Spread (In Basis Points) ($ in Billions) HY Debt (Face) Source: Lehman Brothers

17. Defaulted Debt Indexes Market-to-Face Value Ratio Source: E. Altman, NYU Salomon Center

18. How Creditors Assess Internal Distress • Management • Where is management on the “D” Scale? • Can this be salvaged? Can you affect change? • Financial Indicators • Accounts receivable • Inventory • Fixed assets • Other hidden liabilities • Operating Structure and Results • Income statement • Operating unit / Product Lines • Quality of earnings “I’d like to introduce you to your new relationship manager from our Special Assets Group”

19. Recapitalization Improved Performance Distressed Enterprise Turnaround Not Sustainable Recapitalization Lower Break Even Generate Cash Sustainable Turnaround Phases of The Turnaround Process Recapitalization before meaningful change will not result in a sustainable turnaround.

20. The Slippery Slope BUSINESS STATUS CREDIT WORTHINESS PERFORMANCE IMPROVEMENT GOOD ACCEPTABLE TURNAROUND MARGINAL CRISIS LIQUIDATION UNACCEPTABLE VIABLE UNDER-PERFORMING INSOLVENT NON-VIABLE THECOMPANY TROUBLED Management’s response to pressure and lenders’ credit concerns will determine a company’s success or failure: The earlier turnaround assistance is obtained, the greater a company’s chances for survival.

21. Early Warning Signs Standard due diligence can identify the most obvious signs of distress: • Depressed markets • Declining sales / Unanticipated losses • Shrinking margins (especially at higher sales) • Operating losses • Vanishing cash availability • Vanishing covenant coverage • Aging accounts receivable • Aging accounts payable • Increasing ineligibles • Collateral audit issues

22. Early Warning Signs: The Less Obvious Other critical knowledge points in evaluating a distressed business: • Revenue increase without increase in profits • Profits without cash or availability • Increasing inventory with flat or declining sales • Increasing receivables with flat or declining sales • Deteriorating backlog or order slowdown • Declining unit selling price • Reduced sales per employee • Inadequate cost accounting • Significant variances from standard costs • Acquisition growth without reduced operating expenses • Focus on gross profit and not on contribution margin • Excessive number of SKU’s • Non contributing operating units • “Absorption Management” • The “They” syndrome • “Fly by” management • Middle management turnover • Failure to meet “THE” plan • Hesitant or indecisive management

23. Create Significant Change Reinforce, Improve and Rationalize Reinforce Management Team Improve Cash Flow Dynamics Rationalize Operating Economics Successful Turnaround Without significant change, the business will, at best, move sideways and most likely downward.

24. Operating Leverage Operating economics must be rationalized • Lower breakeven, increase operating leverage and reduce top line risk • Improve contribution margins • Rationalize product and customer mix • Outsource non-core competencies • Improve labor productivity • Establish strong purchasing ethic and control • Reduce fixed costs • Streamline organizational structure • Rationalize manufacturing expenses • Consolidate redundant S,G&A expenses • Eliminate non-productive development and engineering expenses • Close under-utilized and non-performing operating units • Outsource non-critical functions and eliminate non-performing cost centers • Reduce headcount at all levels Successful Turnaround The business must produce cash profit at current or lower sales.

25. Turnaround Principles Turnaround Principles • A financial crisis is rarely sudden; It takes time to develop. • Projections don’t fix businesses; Deliberate action and managing variances do. • Vendors need to be shown how they are part of the solution. • Employees are a big part of the solution; Tie incentive to the turnaround. • Managing a turnaround is a full-time job. • Money does not fix problems. • Turnarounds are like most competitive encounters, if you control the momentum you will win the game.

26. Appendix

27. Public Co. Bankruptcy Filings by Asset Size Asset Size ($ in billions) Source: BankruptcyData.com Annualized * Bankruptcies by industry are based on Chapter 11 filings with assets over one billion dollars. The “Other” category may also include bankruptcies in the above categories.

28. High Yield Debt Default Rates (in Billions) Par Value Outstanding High Yield Default Rate Source: NYU Salomon Center and Salomon Smith Barney Estimate

29. Distressed and Defaulted Debt Total High Yield Debt Market Source: Salomon Smith Barney and NYU Salomon Center Distressed Debt is defined as the portion of performing high yield debt trading at least 1000 basis points above 10-year Treasury bonds.

30. High Yield Downgrade to Upgrade Ratio Source: Moody’s, Fitch, Standard & Poor’s In the first three quarters of 2003, compared with the same period in 2002, downgrades have decreased, in both number and par value by 20% and 30% respectively; while at the same time the number of upgrades jumped by 62%.

31. High Yield Default % by Industry Source: Fitch Percentages are defaulted portions of high yield debt within each particular sector, not percentages of all defaults.

32. Top Ten Sectors – Number of Defaults First 9 Months of 2003 Source: Moody’s, Fitch, Standard & Poor’s

33. High Yield Downgrades Top 15 Industries - 2003 (10/15/03 YTD) Source: Moody’s, Fitch, Standard & Poor’s

34. Most Troubled Industries – 2003 Source: Turnaround Management Association Trend Watch survey