Cash is KingBy Jeffrey Rothfeder | Posted 03-01-2003
Case Study: Leiner Health Products and Restructuring
January 2001 was make-or-break time for Leiner Health Products, the largest manufacturer of private-label vitamins and supplements in the U.S. In 2000, Leiner had revenue of $662 million, with 60 percent of its sales driven by discounters like Wal-Mart Stores Inc., Sam's Club and Costco Wholesale Corp. On the face of it, this would seem to be a reliable and desirable customer base. But depending on these high-volume, low-margin, just-in-time inventory customers meant Leiner had to make sure its inventory management, supply chain, customer service and cash flow systems were operating in near-perfect sync. To be profitable, products had to be manufactured and shipped by specific dates to fulfill the requirements of in-store promotions. And Leiner had to bill and collect timely payments from these favored retailers while keeping track of a confusing series of discounts and special arrangements agreed to by the company's salespeople.
Two years ago, all of this was beyond Leiner's abilities. The company had no idea who its best customers were from one week to the next, let alone a plan for consistently delivering products to them on schedule. What's more, Leiner had just been hit by a bombshell: In May 1999, an international cartel of 27 vitamin supply companies was found guilty of price-fixing. That sent vitamin prices tumbling and Leiner was left holding about $150 million in overpriced inventory, which it had to mark down by as much as 50 percent. As a result, in 2000, Leiner lost $2 million before interest, taxes and depreciation. And with only about $8 million in cash on hand at the end of that year, Leiner was facing default on interest from $280 million in bank debt and $85 million in bonds.
A significant portion of future revenue was in jeopardy as well: Wal-Mart, its largest customer, threatened to pull its business because Leiner was repeatedly late in restocking Wal-Mart's shelves. So it was no surprisebut no less disconcerting to stakeholdersthat company president Gale Bensussen said at an early 2001 meeting: "We're in triage here. We're bleeding and we don't know from where and why."
Simply put, Leiner was in an information rut. The Carson, Calif.-based companywhich manufactures everything from vitamins A, C and E to Saint John's wort and sells it to retailers who label it with their own store brandshad enjoyed six heady years of solid growth and expansion, supported by cash flow and borrowed money. But during that time, Leiner executives had let the company's computer systems and databanks deteriorate. What was once a simple, easy-to-manage company serving relatively few large accounts with a limited number of products had become a hodgepodge of operations long on redundancy and complexity and short on usable data about such vital issues as which products are most profitable, which customers are most valuable, which accounts receivables are lagging and why, and which items must be manufactured and delivered on a tight schedule. Manufacturing and supply-chain information had become unreliable. Salespeople signed up orders without knowing whether they could be completed and shipped by a set date and the accounting department was managing cash flow from sheets of paper handed in by sales staff.
Many of the problems lay in the fact that Leiner had no CIO who could coordinate technology implementation and data distribution. The person most closely resembling a CIO was too busy overseeing Leiner's manufacturing resource planning (MRP) system to worry about Leiner's mushrooming IT woes. "This sort of do-nothing scenario is an option to only go backwards," says David Coles, a managing director at Alvarez & Marsal Inc., a New York City-based turnaround firm hired by Leiner in January 2001.
By that time, Leiner was spread thin, supporting 150 customers with 4,000 separate vitamin lines manufactured at five plants. Customer service performancemeasured by on-time and complete ordersdipped under 70 percent. Open chargebackspayments held back by retailers pending investigation into whether Leiner had billed them properlywere shaving $17 million from annual revenue. And inventory turns were an anemic 2.5 times a year, nearly half of what private-label pharmaceutical companies generate in profitable years.
The Road Back
The Road Back
Leiner is a cautionary talebut not an unusual oneof a cash-rich company in the midst of a go-go run that allowed itself to become information poor, and eventually suffered for it. It's a dangerous chain: As operations expand quickly, the habit of closely tracking fundamentalsprofitability measurements, capital expenditures, customer service performance, inventory levels and manufacturing capacitydiminishes, and the fear that something will arise to slow the business is foolishly cast aside. Companies undisciplined about data are too often instigating their own slowdownwithout detailed information, supply chain and accounting operations suffer, customer service slips and margins wiltand then find themselves in a losing battle to access the internal data required to get back on track.
"When Leiner's business tumbled, the executive team didn't have enough information to make important decisions about how to salvage the company," says Coles, who was appointed Leiner's interim chief financial officer in October 2001, a position he held until February 2002. "In the average high-growth organization, 20 percent of operational data reports are actually read and 80 percent are ignored. That's bad enough. But Leiner ignored even more reports than that, because so little of its data was valuable. That had to be fixed. At any company, if the right things get measured, the right things get done."
A&M, the lead player in the turnaround, and Leiner's management brought in supply-chain consultants and a cash flow software provider to help in the effort. Their mandate: pinpoint data that was germane to the company's current operations, toss out irrelevant, legacy information, and modernize systems so they provide a minute-by-minute picture of what management needs to know to run operations.
Manufacturing and inventory were among the first problems to be tackled. A&M's team ran a channel profitability analysis to assess earnings margins by account. That generated a long list of products that were being produced for customers who were costing Leiner more money to service than they were contributing to revenue. So the company decided that if these loss-leader customers weren't willing to pay more, Leiner would simply exit those businesses and drop the accounts. This exercise pruned Leiner's customer base by about 50 percent and the number of products it made by 60 percent. "Those sound like quite dramatic reductions, but the impact on sales was only something like 15 percent," says Coles. Which means, Coles adds, that 60 percent of what he calls Leiner's operational complexityproducts that were not making money and taking up significant manufacturing time and expensewas responsible for only 15 percent of revenue. Having eliminated these unprofitable customer relationships, Leiner shuttered three of its five factories, chalking up $40 million a year in savings.
Leiner's turnaround experts then focused their attention on the two remaining plants. The primary problem at these factories, it turned out, was excess inventory, again the result of an information shortfall. When an order was placed, Leiner's MRP system would issue a materials requirements plan blindly, without knowing whether the factories had enough capacity to handle the job and without accurate forecasts about future demand or current customer needs. Leiner's procurement team would then purchase raw materials to fulfill the MRP request, but the amount of raw materials bought almost always exceeded production capacity at some point. The result was excess inventories, which inevitably led to a cash crunch. So to save money, the procurement group would arbitrarily decide which raw materials to buy and which to put off. Ultimately, that meant some products couldn't be manufactured and some customersit could be any one of Leiner's customerswould not get their deliveries on time.
"It was a vicious cycle of overcapacity in the plants leading to too much inventory and then a panicky decision to cut inventory randomly, which led to a drop in production; at any part of the cycle Leiner was losing money," says Bob Murray, president of REM Associates, supply-chain consultants hired by Leiner. "During Leiner's high-growth phase in the 1990s, when vitamin sales took off, the company let its manufacturing database and infrastructure fall apart, instead of shoring them up in a way that would enable Leiner to make as much product as the market demanded, but always make it efficiently and profitably."
Over six months, REM collected production information from historical sales trends, point-of-sale systems at key customers and current manufacturing output, producing more than 17,000 new data elements to update the MRP software. In addition, the data entry component of the MRP system was refined to make sure that it received up-to-the-minute data about customer orders and delivery timelines. With more accurate forecasts about plant capacity, customer replenishment requirements and future demand for specific products, the MRP software could be programmed to limit its requests for materials to orders that were actually going to be filled. Primarily because of this MRP upgrade, Leiner cut its inventories of raw materials and finished goods by $50 million.
During the MRP upgrade, REM learned that corrupted data were poisoning Leiner's product pricing strategies. The company was setting wholesale rates based on the production pace of its fastest machines. But since very few of its products were actually manufactured that quickly, Leiner was underpricing itself and severely crimping its own margins. REM re-created product costing models based on the actual machines used to manufacture them and the models provided data to negotiate new and more profitable terms with customers when sales contracts expired.
"Sometimes companies just stick values into formulas without realizing how critically important data is," say Howard Weisz, an REM consultant. "It's not uncommon to have a team of people making decisions that aren't the best because their data is wrong."
Cash is King
Cash is King
Cash flow was another Leiner blind spot. Dependent on discounters for most of its business, Leiner's accounts receivables system had to navigate a maze of in-store promotions and special pricing arrangements offered by different retailers at different times. To bill properly, the system had to keep track of each customer's sales efforts, even as they changed, sometimes from week to week. Leiner's antiquated paper-based approach to accounting simply wasn't equipped to service complex customers.
A salesperson would make a deal with a retailer and hand the contract to marketing or bookkeeping with little follow-up to make sure the data was entered correctly and the account billed appropriately.
That's why Leiner was awash in chargebacks. Customers routinely questioned the accuracy of bills, tossing the problem in Leiner's lap and asking it to provide a detailed breakdown of charges. But Leiner was unable to resolve claims quicklyif at alland many bills remained unpaid pending further investigation for up to 90 days. Significant portions of Leiner's revenue were tied up in disputes, instead of paying for ongoing business activities. "Cash flow is all about improving accounts receivables and cleaning your balance sheet for the first 13 weeks of a turnaround," says Coles. "Accurate and fast collections is an absolute priority."
Leiner hired Emagia Corp., a Santa Clara, Calif. company that makes cash flow software, to install a database management system that would monitor and store customer contracts from initial invoice to payment. To fill an order, charges and billing information had to be entered by sales, marketing or accounting staff and double-checked for accuracy before it was processed; paper orders were eliminated. In addition, no change in the size or price of a shipment request could be made without first inputting it into the cash flow system. When a retailer asked Leiner to verify a bill, Emagia's software would instantly determine where the order originated from and automatically send an e-mail to the sales or marketing staffer requesting a detailed explanation of the charges attached to the order. When it was received, it was sent back to the customer for payment.
Emagia's program produced almost immediate resultsa critical outcome for Leiner, which needed nearly instant cash to fund day-to-day operations and keep creditors at bay during the turnaround effort. Within six weeks, the software slashed Leiner's payments backlog by about 75 percent. What's more, the system now delivers daily reports to Leiner management of how many chargebacks are claimed, how much cash flow is stuck and why. Just as important, it details the bottlenecks in the billing resolution process so executives can fix the organizational weaknesses before a new round of chargebacks can occur.
By October 2001, 10 months after Leiner began its turnaround effort, the company was heading in the right direction, but it wasn't immediately obvious. Sales in the six months ended Sept. 30 had slipped by $4 million compared to the year before, thanks mostly to discontinued products and fewer customers, while Leiner's net losses increased by about $15 million, fueled by the high costs of restructuring. And although improved inventory and accounts receivables systems had helped cash and equivalents balloon to $20 million compared with less than $8 million the year before, "bondholders were betting that we would not turn around," says Coles.
That was actually good news for Leiner; its survival depended on getting out from under its onerous interest obligations, which by 2001 were running at about $40 million a year. Consequently, Leiner's management was able to work out a prepackaged bankruptcy in which bondholders accepted $15 million in cash and newly created preferred stock for their $85 million in notes. Leiner's bank covenants were extended and the company received an additional $20 million in revolving credit.
"What was impressive about this turnaround was a management team that had done business a particular way for many years, but they still understood what their problems were and what they lacked," says Peter Shabecoff, managing director at North Castle Partners, a venture capital firm that funds health and nutrition companies and the largest shareholder in Leiner. They weren't in denial; they were willing to bring in outside help and there were no ego clashes. North Castle first invested in Leiner in 1997 and as the company was going into Chapter 11, North Castle backed Leiner with an additional $20 million.
Seeing the Light
Seeing the Light
In April 2002, Leiner emerged from bankruptcy. Many of the benefits from the new systems had taken hold and management was able to see the gains generated by the vastly improved access to essential data. Some of these gains are anecdotal: Chief Executive Officer Robert Kaminski now has a computer display on his desk that provides a minute-to-minute view of the company's financial performance measured by working capital, accounts receivable, accounts payable, cash flow and inventory. Kaminski, who calls his digital dashboard the Jumbotron, has said, "It tells you what you can't do without to run a company."
But there have also been vital statistical improvements at Leiner. Employee output is up more than 63 percent without additional investment in capital equipment; the company's key accounts are all still under contract and enjoy upwards of 95 percent accuracy in on-time deliveries and complete orders; total supply chain costs are down 15 percent; accounts receivable are being paid at a pace faster than industry averages; and inventory turns have improved 60 percent, to about 4 a year. All of this translates into impressive profits as well: After two years of negative numbers, Leiner recorded a positive EBIDTA of $40 million in fiscal 2002 and the company says EBIDTA will increase to $70 million in fiscal 2003, about 12 percent of sales. In addition, Leiner's bank debt-to-EBIDTA ratio, which was 9.5 in January 2002, fell to 2.4 in February 2003.
With the turnaround on course, Leiner is determined to learn from its near-death experience. For one thing, Leiner is continuing to improve its supply-chain and manufacturing systems as well as its forecasting capabilities, because "you have to keep ahead of the technology," says company president Bensussen. "Our retailers demand it, especially in difficult economic times." At the same time, Leiner is adding new products again, recently launching private-label versions of Advil Liqui-gels painkiller and the allergy pill Claritin. Over-the-counter drugs have typically represented about 25 percent of Leiner's sales in past years, but the company hopes to increase this to 30 percent or higher within the next five years or so. And even sooner, Leiner expects a bump in sales of multivitamins as aging Baby Boomers expand the market for daily pills. All of this, says Bensussen, is part of a diligently plotted business plan for short- and long-term growth: "It's very well programmed. Now that we've streamlined our supply chain and accounting systems, updated the data we have available for forecasting and analysis, and our service levels have reached historical highs, we're not going to let it slip."
Finding out how much it didn't know about itself was a tough lesson for Leiner. And after its dip into Chapter 11, it's not yet clear that the new growth strategy will succeed in a sluggish economy. But if Leiner struggles again, at least it will know where the bleeding is coming from.
Jeffrey Rothfeder writes frequently about business, security, environmental and technology issues. Please send comments and questions on this story to email@example.com.
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