FTI Consulting, Inc. (FCN) Earnings Call Transcript & Summary

Anyway, I'd like to -- we're now going on to a panel that I've really been looking forward to, the panel on retail. It's being moderated by Josh Sussberg, who, over the last year or 2, has become really one of my new heroes in the bankruptcy practice. He's been involved with just about everything, and in particular, he's been in the middle of just about every major retail case, including, I guess, we have to congratulate Josh for getting JCPenney up to a confirmation last week, and as a number of your panelists have done. He's been involved with everything from tailored brands, stage stores, Pier 1, Forever 21, Barneys, Toys "R" Us, et cetera. So he and his panel has seen it all. So let me turn it over to Josh to conduct and introduce the panel.

All right. Thank you, Harold. Much appreciated. And it's good to have this opportunity today. When we were putting up the panel together, I think the goal was to get a wide, diverse group of folks from all perspectives in the restructuring arena. And so we wanted to cover both legal, financial, the investing and the operational. And I am pleased that we're able to have a great panel of folks here today. I'm just going to go in order, Christa Hart, who's an MD FTI and a specialist in the retail landscape and has a ton of experience on the operational side of things and with restructurings, more specifically. Michael Neruda, who is a partner at TSSP and is involved on the investments in many different retail companies, most notably and most recently, JCPenney and Neiman Marcus, plus many, many others over the last several years. So he'll have a very interesting perspective into how you actually make money in retail these days, notwithstanding everything that we're dealing with. And then Julia Frost-Davies, who's a partner at Morgan, Lewis and is on the lending side of the practice and is frequently representing ABL, term loan lenders, DIP lenders, you name it, in many of the retail cases that have been out there and in the headlines today. So I welcome all of our panelists, and appreciate you guys taking the time. Getting right into it, and we've got a couple of different sets of questions with some themes that will play upon each of our experts expertise, but I'm going to start with Julia and just at a high level, Julia, can you explain, from your perspective, being on the side of the financing world, how are companies going about obtaining financing in this ever-changing retail market? And what are the types of financings we're seeing and how are people getting creative to ensure that there's adequate liquidity for these situations to give them a chance to restructure?

Yes, Josh, thank you. And good afternoon, everyone. So I think you start by thinking about what assets does your typical retailer have available to secure liquidity. So you'll have your working capital assets, your inventory, your AR. Sometimes, but not generally owned real estate, you may have some that is a distribution center, headquarters. There are some retailers, although not that many that actually have a significant amount of owned real estate in their portfolio. Leasehold interest, intellectual property, which is increasingly surveyed as a basis for liquidity, and your FF&E, not generally your primary source. When you think about what kind of investors are going to look to each of these assets. So revolving credit facility, for example, might be reported by the working capital asset. So you'll see inventory and the AR sitting in that facility. That's typically going to be your large national banks, you may have other participants from around the country. And the benefit of having based in that position is that you can have letters of credit that can sit within the facility, cash management services are often provided by one or more of the lenders. And they'll be agented by a primary lender, but often in order to raise the liquidity for retailers of the size that Josh and others represent, it does take a lot. So you'll have a large group, so there's enough to go around. I don't know if everyone -- I'm sorry to interrupt -- needs to mute, we're getting a bit of an echo. But the intellectual property may serve as primary collateral for term loan lenders, for -- you're seeing this in high-yield financings now as an additional source of liquidity. You often see -- Josh, are you on mute?

I am. Maybe not.

Okay. Great. Thank you so much. Sorry for that. I want to hear everything you have to say, but I just don't want to hear the echo. So thank you for that. So the intellectual property, the FF&E, the real estate may serve as primary collateral, typically for your high-yield investors, for secured senior notes, term loans. And then you'll often see intercreditor arrangements that have crisscross lien. So you'll have priority collateral being the working capital assets primarily for the asset-based revolver lenders and then the others for the high yield with junior liens on each other's collateral. So if you think about how you're going to determine the advance rates under your working capital facility, I which really is going to be the cornerstone of the liquidity for any retailer, how they actually manage their cash on a daily basis, that's done by having a third-party appraisal of the Net Orderly Liquidation Value of the inventory, so the NOLV. And what you're thinking about from an investment thesis is that every plug got pulled tomorrow, and you had to liquidate the collateral, if you're thinking about it from an ABL perspective, how are we in the box and how will we come out whole? So the thought is you take the time within which it will take to liquidate the collateral in place, in the stores because no one's really backing up trucks to take t-shirts to sell on the corners these days or any day. And what is that value going to be? And then the lender and borrower able to calculate the advance rates that are going to be available to drive that liquidity. So Josh, you would ask how had some of this changed post pandemic? And I think a few things. So one is, there are a lot of creative guys out there. Mr. Sussberg is one of them. And I think in Q1 and early Q2, there were a lot of offensive draws on revolvers in large amounts. So there were companies, including many whom he represents, entering bankruptcy with more liquidity and cash on hand than one would typically see in a failed retail situation or distressed retail situation. So one result of that has been a market correction as there often is through the amends and extend and forbearance period that we saw in Q2, Q3 of anti-cash hoarding provisions and things that might put some reserves and other abilities and guardrails around some of that borrowing. I'm not sure that's necessarily going to hold in the new deals going forward, but at least in some of the forbearance and amend and extend periods, we did see that. You also did see the [indiscernible] serving as a basis for generating additional liquidity. I don't know if the increase in IP value is driven solely by the reliance on e-com and the fact that a lot of the marketing, as we all, and we'll talk about, and the activity is happening on the online platform, or it is also just a little bit of a shift in relative value, where IP might or narrowly have been seen as boot collateral and now is seen as something that is much more valuable. Another trend we're sometimes seeing is to -- it's new, I think. Take the IP and segregate it out into an IpCo and not lien it out. And then have your assets sitting at your OpCos with -- of course, you'll need agreements for right to use because you can't sell your inventory without being able to brand it and go through that intellectual property. So Josh, that's some of what we're seeing out there now. I think that as we're seeing exit, they're trending in a similar way. And right now, the high yield markets, I think, are much more active than they will be coming up towards the end of the year. So we're definitely seeing activity there.

That's helpful. I think it's a pretty good segue to Michael. So Michael, you guys are active in various different ways from an investment standpoint. Obviously, there's distressed debt in companies that have multiple tranches, but I know you guys have also been active in the first out market, right, where you put in some capital behind the ABL and maybe take a first lien on everything that's uncovered, including the IP. So how do you go about thinking and assessing the value proposition and where it is that you want to play in a capital structure?

Yes. Thanks, Josh. So we're a bit different than most investment firms. We can originate financings. We can do secondary purchases, buy assets, start new companies. What we're really just looking for is good companies, assets and management teams. So as you mentioned, we have an industry-leading retail ABL practice, and we financed many retail businesses on the direct lending side. And we also have a business that invests in the public markets, which is what I focus on. So what we're looking for across any of these opportunities is industries that are undergoing change. And to us, that's what creates the opportunity. And obviously, retail is undergoing a lot of change. In retail, what we're looking for specifically are companies or assets that can withstand that change. And so we met -- Julia already mentioned, looking at brand and IP value, we look for value of real estate collateral and how that value is being utilized or not utilized on the company's balance sheet. We're looking at the value of inventory and other assets. And then finally, we're looking for good management teams with a smart, thoughtful, forward operating business plan. So ultimately, this has allowed us to invest in companies like Neiman and JCPenney and the fact that they have assets -- a strong set of assets, whether that's real estate, intellectual property or inventory, that has allowed these companies to reorganize because it provides them options and it allows third-party buyers and other capital providers to come in and execute on their business plans.

That's great. Thank you, Michael. And I actually think, right, so we're talking about how to finance these companies. But Christa, and you're seeing this, and you're on the front lines. There's just been so much change over the last 5 years in retail. And obviously, there's the Amazon effect, and we're sitting here and it's Cyber Monday, and hopefully, everybody is buying lots of stuff online. But it was like one of the worst Black Friday from a traffic perspective for obvious reasons in the face of a pandemic, but consumer habits really do drive a lot of these situations. And the change in behaviors is something that's making it hard to get a handle around financing opportunities and restructuring. So could you spend just a couple of minutes telling us what we're seeing on the consumer side of things and how that impacts everything that we do day-to-day?

Thanks, everybody. We did some -- we've been doing some research during the pandemic. We just fielded two studies about holiday gift giving. So we've been very curious about what's happening with consumers. I would say the one thing to keep in mind is that the results of the pandemic are not different from things that had been happening over the last 3 to 5 years. So it's an acceleration of change, but it's not really a difference with one exception. And so let's just talk about the things that have come about with the pandemic. Customers are definitely more value conscious. 64% of them say that they're going to wait till it's at least 25% off before they buy holiday gifts. And about 35% of the people are planning to wait till 40% off. Supporting that or kind of related to that, they are planning to spend less at department stores and upscale mall specialty stores and you're going to see that mass merchants and value department stores are going to claim share. And I think it's the appeal there to the COVID consumer who's nervous about safety, wanting to have one-stop shopping. So I do think you're going to see some big gains in Walmart -- the Walmarts and Targets of the world. Like most of us, they plan to spend most on apparel. Both in general and for gifts over the holiday and jewelry and accessories. They also are planning to spend less on. So I think that this whole, looking at everybody with the exception of Josh, who's wearing a suit jacket, most of -- the rest at us have changed the way that we address, and that's true of consumers, and they are not necessarily expecting that to change. They're planning to buy more online, and that's obvious after what we saw for Black Friday. But 79% of customers said they're going to buy a lot more online and 34% equal, and this is across nearly every age group is planning to spend at least 80% of their holiday shopping online. And so that's a very big number, and that's true across all of the different generations. It varies slightly, but in a very small way. And so I think we can expect to see those big trends continue at least through most of 2021.

That's super helpful. Thank you, Christa. So Michael, I'm going to come back to you on a relatively hot topic. And I don't know if this is necessarily specific to retail, but it's certainly something that's become more prolific over the last couple of years. And that is special type of financing arrangements led by a majority of lenders that don't necessarily include everybody in a single tranche. And this is different than 10 years ago when we had a first lien and a second lien and intercreditor arrangements that govern people's behaviors and actions. This is within an existing credit facility and amongst the lenders. How do you think about those dynamics and making sure that you're positioned to be in the group, so to speak? And when you're in that group, how do you think about it from the sense of moving a case forward and trying to get something done when at the same time looking at economics and wanting to make a recovery?

Yes. So Josh, as you said, I think this is one of the hottest topics in credit right now, whether it's outside of bankruptcy as a way to extend the company's runway or inside a bankruptcy as a way to move the case along. But from our perspective, this is really nothing new, it's just another tool in the issuer and the company advisers toolkit here. A few years ago, everybody was talking about the J.Crew trap door. Then it was the Chewy transaction, unrestricted subsidiary distributions and now it's open market repurchases and subordination. And I was just reading there was a covenant review article that said 94% of loans that they reviewed, majority lenders can subordinate minority lenders. So I think this is something that will continue. But this is a continuation of a trend that's been going on for a while now, and that's making loans at new issue look a lot more like the bond market. And a lot of these issues and deficiencies already exist in the bond market. So understanding how the dynamics work among different stakeholders not just lenders, but the company and advisers or sponsors. This is obviously very important. And I don't think it's specific to retail. I think you see it in any industry right now. And for us, from an investment perspective, it's always fact-dependent, and it's hard to kind of generalize here, but because it is so fact-dependent, we need to be very careful to read all of the documents, analyze with people those on the phone here and counsel to really understand the different permutations and what can happen to your investment. And throughout it all, we try to just do our work and stay even keeled about it, and there's a lot of noise around these types of situations, but it also creates interesting investment opportunities.

And Julia, a question for you. You're more typically representing the ABL and the big bank lender that are part of the ABL. But how do you think about these intra lender dynamics from an agent position? And how does the agent take a position vis-à-vis the group, the minority, the majority, whatever it may be?

Yes. So Josh, it's a great question. And one of the interesting things about retail lending, particularly is that a very specialized and nuanced area. So you're going to see we're key players. So if you're the agent on one deal, you may be in the group on another deal. So I do think that agents are always cognizant about the fact that what sauce for the goose may come back around, right? So there's sometimes talk within groups about if you have holdouts, let's say, you have a pre petition, asset-based lending facility, the agent and majority of the lenders want to provide better in possession financing and there's holdouts. Then you have to have the conversation about how you deal with that. And of course, first place you look is in your documents. But the next place you look is in relationships and thinking about the precedent that you're going to be setting for the next deals down the road. And they are almost always actually resolved in a way that is constructive. It's a little easier when you're moving from a debtor-in-possession facility to an exit because that's really a new credit. And so people can participate or not as they like. But I mean, I'm not going to tell you there aren't differences of opinion among a bank group, but strong agents and all of the players out there right now are on the national banking side are very strong agents, know how to work within that to do what's best them. They all do have a common lending thesis when you're looking at the asset-based lending side as opposed to what Michael is talking about when people may be buying open market and something that looks more like a term loan or senior secured note. And you're not -- par players, non-par, open market, people who want to loan to own, people who want to backstop into an exit or a diff and others who don't. So I think you're not going to see on the revolver ABL side as much of a difference in your ultimate goals, although you may have some negotiating and some differences of opinion and how to get there.

Got it. So Christa, a question for you. There's a balance sheet size to all of these retail restructurings. But I think everybody, ultimately, forgets that there's a huge operational side of this, too. And many of these businesses have been hampered for the last several years for a whole number of reasons. And the bankruptcy code affords some pretty significant tools for retail companies, in particular, when it comes to leases and contracts and all of the other operational tools that are available. So in these what have become short-lived cases, where costs are extremely high, and there's obviously a balance between administrative burn and all the benefits you can get from the operational side of things, how are you instructing retail companies to be proactive and think about affecting the necessary operational changes to ensure that ultimately, when the balance sheet is taken care of, the company can actually perform and thrive go forward.

I think we're -- I think everyone knows that we have a limited time frame with rejecting leases. And that probably is the #1 most important thing that retailers need to consider. And the -- I've never heard a company come back and say, wow, I wish we hadn't rejected so many leases. Generally speaking, people err on the side of keeping too many stores open. And in particular, that's problematic now because we've had several years of declining sales levels. And for many retailers instead of having really good stores and really bad stores, we have sort of a homogeneous group of really not great stores. And so I think taking a really hard look at those is very, very important. And I've heard a lot when I review business plans, people say to me, well, if we can just get back to 2018 or 2017 or 2019, I think we have to be very leary about that when we think about business plans going forward. I mean the consumer has really spoken very strongly about her preferences during this pandemic. And I think we have to assume that the future is in some ways, going to be more of the same. And so I think that realistic view about the sales line is probably the most important thing retailers can do. And being very clear about what stores to keep open and taking a portfolio view of a market because one of the positive things that I've seen recently is on sales transfer. I think originally, people had relatively simplistic view about what was going to happen when they closed the store, and they thought that most of those sales would just go away or transfer online or to a competitor. But instead, they've been seeing that their customers that do like to shop stores are very loyal, and we have much higher sales transfer rates than we thought. And so being thoughtful about the portfolio of stores in a location, I think, is really, really critical because I think you can keep more of the sales than you think if you're thoughtful in the way that you view those markets.

Yes. And your point on the leases is an important one. And Julia, I know this is a topic near and dear to your heart, right? It used to be that a retail company would hang out a bankruptcy. See two holiday seasons, want to determine whether or not things were turning around, make decisions and reorganize. Then our landlord community went and lobbied very hard to ensure that they have a go or no-go decision on each applicable unexpired lease within 210 days. So from a financing perspective and a lending perspective, that usually tends to lead the direction of the case, and we see that in milestones and the like because, Julia, to your point, the ABL lenders want to ensure that if God for bid, they need to get in there and protect themselves by liquidating the collateral, they still have leases. So how do the lenders think about that? And how does that drive all the underlying credit analysis and liquidity profile for all these retail companies?

Yes, Josh, it's really the #1 consideration, right? I mean, as both you and Christa said, and just to sort of level set for a moment, the bankruptcy code does normally provide for a longer time period, which is up to the time of confirmation for a debtor to make a decision, whether to assume or carry on with or to reject to get rid of a particular lease. It is different with respect to nonresidential real estate, which is the majority of your leasehold interest in the retail context. So that starts out with 120 days. With the ability to get an extra 90, which is where Josh is talking about the 210. So one thing that's important, ABL lender start from the outset, as I said, the opening of this program by thinking about, if I have to pull the plug, how long will it take, and what's going to be the net order liquidation value. So if I need to recover, what's my downside. So you start with that. So I've seen it run the gamut, it depends on the retailer, it can be 7 weeks, it can be 11 weeks, it can be 13 weeks that you need to recover. You take that 210 days as the day by which Josh's clients have to be out of the stores if things go badly or they have to make that decision. And then you got to back out of that, your liquidation profile. And say, it's going to take me 11 weeks. So I met, t 210 minus my liquidation period. And that's when you're thinking, I got to make a decision. As Josh says, by go and no go. Is this really a rework? And then if you start to bleed into that time period, you're really impairing your underlining investment thesis. And you can couple this with the fact that some of the inventory hasn't held value -- not alone increased in value during COVID. It's aging in place, sometimes companies can't even get into their stores. So even if they are open and you have reduced foot traffic, it's just not necessarily holding the value. So it's certainly top of mind and thinking about, we don't want to go the other way, but if I have to, what kind of time line will that take? That's why retail cases are so accelerated. And I know a lot of matters that Joshua and I have worked on together comes in with an exit strategy. It's like, okay, there's a lot of work done more now than maybe there used to be about knowing where you're going to go before you get there. You don't see the free falls, unless it's a complete crisis. You come in with maybe a term sheet, or restructuring support agreement and a time line to try to get there because you know you're going to be under the gun with respect to getting in and out of these leases. Now it's truly though because a lot of the landlords don't want you to reject their leases, right? That's their entire investment thesis is they've got a tenant, they've got an ongoing source of revenue stream. And so as you worry about some of the rejections, you're also seeing landlords form joint ventures to actually come and rescue a retailer because they don't want all these boxes to go dark. And then once they control part of the go-forward entity, they have leverage with respect to deciding which stores are going to close. And those who are outside of your own portfolio may have reduced negotiating leverage.

So Michael, just on this point and leases and operations more generally. You mentioned that you guys are looking to invest and you're looking at real estate, you're looking at IP, you're looking at management teams. How often is it the case that you're looking at a big business and you're noticing that from an operational perspective, there can be significant improvements and some capital would be necessary to help turn things around. Does that go into the investment thesis at all? Or is that something that kind of comes after the fact once you've made an initial investment and kind of dug a little bit deeper into the circumstances?

Yes. So we think there are always opportunities to support thoughtful management teams and business turnarounds. And you really don't know the full extent of that until you get in and do your diligence. But that's why we like to have an open dialogue with the management team and look for opportunities where management and investors are aligned, and you can properly incentivize management to get there. So when we go in and do diligence on a situation, whether that's in our direct lending business or on the secondary side, there's always some good things and some bad things. And when you have the change -- the type of change that you do in retail, in particular, you really need to dig through that opportunity and understand what assets are available and what the opportunity set is. So when we look at these situations, and look at the constraints that we're under and that the business is under, we're trying to figure out how to optimize that opportunity, how to focus on the investments that have the most interesting return on capital and set up a dynamic with the management team so that everybody is aligned and everybody is rowing in the same direction and that they're successful when the investors are successful. So I think it starts with kind of a silver assessment of the situation and making sure that you're aligned with the management in that turnaround, as you said.

That's insightful. So turning to a different topic. And just kind of taking a step back and kind of understanding the landscape since we found ourselves in this pandemic in March. Back at the beginning of the pandemic, there were a bunch of retail companies that were trying to effectuate liability management transactions. And as a result of the marketplace changing, all of those companies were unable to consummate amend and extends or otherwise extend runways to avoid a restructuring. And they were all pushed into Chapter 11 cases. You can think of JCPenney and Neiman and J.Crew as a few examples. But then there were a whole bunch of other companies that were already in bankruptcy. And these companies were teetering on whether or not there was going to be a reorganization, a sale or a liquidation. And think of Pier 1 and Modell's, all of whom were in bankruptcy and then literally had the mothball because of the environment in which we found ourselves. And ultimately, they needed to liquidate. So Chris says, as we think about liquidation sales, where sometimes it's unfortunate reality of various cases, how have things changed? And how our people and advisers analyzing recoveries in liquidation sales in a very uncertain marketplace in a very uncertain time when people, to your point, are doing much more shopping online, which makes it very difficult to liquidate inventory in stores.

I think first off, it obviously has been problematic with the pandemic. And I think what I will say is I've been almost surprised by how well the liquidation companies have done in forecasting. They have been astonishingly accurate in understanding what the consumer is thinking of different kinds of products and they've done really a great job in their forecasting this year. And I think we're -- it's been a clear signal that they missed is a couple of things is: we definitely can see changes in the store traffic patterns as COVID cases increase. There is a direct correlation. And we saw this -- very more difficult to see now because it's more of a blanket acceleration in cases. But back when we started to see some accelerated cases in California and some other specific markets, we could actually track the change in trend on store traffic. And so I think that, that's going to continue to be an issue at the end of this winter and into early spring. And then the other thing, I think they've been facing is this whole issue on apparel. And I think that, that's going to continue to be problematic. There's very few people looking for a tie, high heel sandals, or a sparkly dress this year. And I think that estimating how much the consumer is going to be willing to pay for those products is going to like very much continue to be an issue for them, even in partial or full liquidations.