From red to black: rebuilding wounded companies; When faced with declines or disasters, a struggling company can cease operations or it can choose to fight, and in the process, turn the business around. Two experts share lessons learned from turnaround situations.

Disaster struck Knowlton Specialty Papers Inc. in 2002 when an explosion at its main plant disrupted operations for more than five months. At the time, management could not know that this was only the first of many problems that would bring the company to its knees and threaten its very existence, the jobs of more than 100 employees and the economic health of a community that had experienced a declining manufacturing base for the last 50 years.

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Indeed, the series of events that unfolded could have been the end of the paper processing mill. Instead, what follows is an account of how the company survived the explosion, three additional events--each of which alone could have destroyed the company--a management team that wouldn't quit and an all-out effort to save the struggling company and an important community resource.

Knowlton is the oldest continuously operating paper processing mill in the U.S. Located in Watertown, N.Y., it is a leading producer of superior quality filtration materials, friction drive materials and specialty papers, and one of four remaining paper mills in an area where more than 20 were located a decade ago.

Knowlton manufactures products that are highly valued by its customers, and it wins awards for excellence in product innovation and performance. In addition, it has a long, valued track record of working with its customers to develop propriety paper products to the industry.

Following the explosion, the CEO and management team immediately began the needed repairs to bring operations back on line. To their shock, however, when the repairs were completed, the insurers--both Tier I companies--disputed the claims, leaving Knowlton woefully short and forcing payment delays to the contractors who helped it rebuild.

Compounding matters were cash flow shortfalls resulting from a slow economy, a depressed paper industry and three years of weak core business performance. Also, management's attention was distracted from the core business by poor labor relations and integration problems with acquisitions. In short, the storied company was in serious financial trouble.

Management's Response

Knowlton's managers--while highly experienced in paper manufacturing--were not savvy in the skills needed to cure the ailing company. Typical of many small companies of less than $50 million in annual sales, they were weak in management and leadership skills, and lacked the experience to manage the problems they faced. Management's immediate response to the events was to implement temporary cost cuts, believing the cash problems were only short-term.

Others saw a different picture. Knowlton's bankers--concerned about the future of the business and its sizeable, outstanding loans--recommended retaining a turnaround consultant. The verdict from two turnaround firms, several already-involved equity investment firms, the company's attorneys, the board of directors, CPAs and the insurance companies was "liquidate or sell at a heavy discount."

The turnaround firm Knowlton eventually hired performed its own assessment and determined that, beneath all the adversity, was a solid business model and that with focus, careful planning and rigorous execution, the issues could be fixed and the company could be returned to health.

The CEO and his management team were reinvigorated and determined to fight. Knowlton's management and the outside team members prepared to embark on the long, difficult process of fixing the business, achieving stability and returning the company to prosperity.

It's All About the Team

Successful turnarounds are not much different from successes in most businesses, sports or the military. The key factor almost always comes back to a well-coordinated team that is totally focused on a goal and working closely together. Superstars help, but a great team is almost always better. Knowlton was no exception. In addition to management and the turnaround consultants, the team included bankers, CPAs, attorneys and union representatives.

Many turnarounds focus solely on restructuring a company's capital structure. This buys important cash flow time but often leaves management alone to resolve any underlying problems that may have caused the downturn in the first place. The result can be more debt, large consulting and financing fees and a delayed but predictable ending.

The Knowlton team focused on finding and fixing the underlying problems that caused the company's troubles. The team focused on fixing the core business as the first step, stabilizing and improving the business to provide important cash flow and profitability; next, determining the future of the non-core businesses; and then, resolving lawsuits with insurance carriers and late payments to contractors.

* FIXING THE CORE BUSINESS. The business was broken in many areas. In October 2003, the team began to attack the following areas, focusing on the highest priorities first:

Getting control of the cash -- implementing aggressive cash flow forecasting and management to identify, defer and ultimately eliminate looming cash walls.

Fixing customer management -- improving communications, negotiating price increases and terms with important but low- and slow-paying customers, and shedding low-value customers.

Improving supplier management -- visiting all critical suppliers to discuss Knowlton's situation and recovery plans, and to obtain temporary payment relief wherever possible.

Fixing Knowlton's team -- reorganizing an outdated management structure and filling the seats with the right people. For example, the operations and sales and marketing vice presidents were removed; tactical headcount cuts were implemented to re-size to a profitable level; and open negotiations were conducted with the union to obtain a fair contract and reestablish credibility.

Improving manufacturing -- fixing operations to eliminate crippling manufacturing variances.

Improving R & D -- driving cost reductions and changing processes to bring important new products to market faster.

Communicating -- keeping employees, customers, suppliers and bankers fully informed and contributing to the turnaround.

Five months later, in March 2004, the core business was stable. All actions were implemented, and cash flows and profits were improving strongly. Management was ready to focus attention on the insurance losses and the non-core businesses.

But, then the bottom fell out. Unpaid contractors rejected Knowlton's proposed solution to the insurance disputes--an "informal bankruptcy"--and filed an involuntary Chapter 7. Citing "burnout," the CFO and COO resigned. Once again, Knowlton was facing an impending business closure, making all its hard recovery work meaningless.

Resolution was again found in teamwork and determination. The team anticipated the filing and was prepared. Within two weeks, the Chapter 7 was successfully converted to a Chapter 11, and management began to take the steps necessary to file a recovery plan for emergence. With the core business well on its way to recovery, Knowlton now possessed the resources to weather this latest storm.

New team members were added. The turnaround consultant provided a temporary CFO while conducting a search for a new CFO/COO who was hired in July. New experts were added: bankruptcy attorneys, an independent financial advisor and attorneys and financial advisors for the creditors' committee.

The team quickly developed a workable recovery plan. The plan, adopted in May 2005, provided for 100 percent payout to all creditors, including bankers and unsecured creditors.

* DETERMINING THE FUTURE OF NON-CORE BUSINESSES. When the core business was stable and the bankruptcy under control, the team turned its attention to Knowlton's sister operations and quickly determined that these businesses were non-strategic and should be liquidated or sold. M & A consulting and legal specialists were added to the team.

In March 2005, all non-strategic operations were successfully sold to an equity investment firm, which continues to own these businesses today.

* SETTLING THE INSURANCE CLAIMS. Knowlton could never successfully recover without resolving the disputed insurance claims; the cash losses would be too great. Management now turned its attention to the claims, filing suit against the insurance companies, which resulted in successful settlement for more than 90 percent of the original claims.

A Win-Win

By April 2005, the turnaround team had worked itself out of a job, fully transitioning all functional areas to self-sufficient Knowlton management. While Knowlton was struggling for its survival, its competitors weren't sleeping. However, the Knowlton of today is a much stronger adversary.

Product research, previously limited to development, is strongly focused on new product programs with customers. Continued focus on costs and margins, weekly cash flows and critical performance measures help ensure continued stability. Most importantly, management is currently seeking opportunities to grow the business to new levels.

The Watertown community has benefited significantly from Knowlton's recovery: 100 jobs were saved, with additional positions being continuously added. An important community asset was retained, in an area that has suffered extensive business losses.

Digging in and doing the hard work of a turnaround builds a stronger foundation for companies to grow once they emerge from distress. These companies rarely make the same mistakes that first got them in trouble, and the skills they learn help them to prosper in the future. As for the turnaround professionals: their successes are measured when their clients no longer need their services!

Ron Castor ([e-mail]) and Terry Newcomb ([e-mail]) are partners with JC Jones & Associates, LLC. The Rochester, N.Y.-based consultancy specializes in corporate renewal services (performance improvement and turnarounds), M & A and specialty compliance and control services. JC Jones is the recent recipient of the National Turnaround of the Year Award for Small Companies from the Turnaround Management Association for its work with Knowlton Specialty Papers.

RELATED ARTICLE: Why Are Turnarounds Important? Lessons Learned

Companies face turnarounds for many reasons--with economic downturns, competition, poor cash management and poor management decisions among the most prevalent. A common thread in most, however, is simply that the rules have changed. The management skill sets that help to drive companies up are not the same as those needed when the wolf is at the door. As profits fall and cash tightens, many management teams are unable to respond; and nowhere is this phenomenon more apparent than in privately owned middle-market companies.

Each business saved and returned to prosperity is an important gain, not only for the shareholders and the bankers who provide the financing, but also for the employees and the affected communities.

Turnaround professionals and the resources they provide are an important part of this process. Without them, many struggling companies would not recover. What follows are a few lessons learned from years of many turnarounds:

Troubled companies are much tougher than you might think. Recovery gets harder as the deterioration gets worse, but it takes a lot to stress a company to the brink. Don't stop pushing and never give up.

Fix the core business first. Without a core business, recapitalization does not stop the inevitable and may only deepen a hole from which a company can never escape.

Make bankruptcy a last resort, not the first. Too many companies enter bankruptcy at the first sign of serious trouble. The result is both costly and distracting when all efforts should be focused on fixing the core. Fix the business first. Use the bankruptcy tool for the right reasons.

Small company turnarounds are just as hard as big ones. While big companies face bigger and more complex problems, smaller companies are often alone--without the internal resources or knowledge to get help. And, to a small company owner, the end of the road looks just as tragic, even though the consequences to large-company shareholders and communities may be farther-reaching.

Use turnaround "guides." Because the skill sets required are different and the stress levels high, it's a rare management team that can go it alone. Gathering a highly experienced turnaround team is essential to help fix or avoid the potholes on the road to recovery.

Rifle-shot focus and complete dedication. Keep everyone focused on fixing the core business first before dealing with all other distractions. Never lose sight of the end goal. Keep the desire high. Analyze rigorously; then build a comprehensive recovery plan. Execute flawlessly. There are many tough decisions required, and rigorous discipline is a must.

Make it personal but keep perspective. Great turnaround teams really get involved. They get passionate about the business. At the same time, however, they must use subjective evaluation tools, and keep emotions in perspective. Balancing these seemingly opposite perspectives is critical to success.

Plan, plan, plan. Plan ahead, and then have a backup plan for everything and another backup plan for the backup plan. Problems are usually solvable. Problems accompanied by surprise and fire drills are much more difficult.

RELATED ARTICLE: takeaways

* A key factor in successful turnarounds is a well-coordinated team consisting of turnaround consultants, CPAs, bankers, attorneys, M & A specialists, union representatives, etc., all working closely together.

* Focusing on reforming the capital structure can buy cashflow time, but often leaves management to resolve underlying problems that caused the downturn.

* Common threads among companies facing turnarounds are: economic downturns, competition and poor cash management.

* Turnaround professionals are successful when their clients no longer need their services.