Case Study: Pacific Aerospace & Electronics Inc.
Pacific Aerospace & Electronics Inc.,
Wenatchee, WA
Situation:
$95 million in sales Pacific has six aerospace product manufacturing businesses. Three are its basic core and tightly related. Three are completely unrelated to core:
Core Businesses:
Hermetic connectors and enclosures.
Electromagnetic, ceramic filters.
Metallurgical bonding and fusing.
Non-Core Businesses:
Aircraft parts machining.
Aerospace design engineering service.
Non-light reflective LCD glass display converter.
Pacific ran into serious cash flow problems. Its majority subordinated bondholder was GSC Partners. Retained by GSC to evaluate Pacific, determine operational improvements and pro form the financial statements.
Positives:
» Competent division management at first and second tier. Largely highly knowledgeable, well educated, motivated and relatively long-tenure employees. Controller is very capable and should be considered as Chief Financial Officer.
» Interconnect and Filter businesses are solid with potential for profitable sales growth.
Negatives:
» Chief Executive Officer. Not capable or not interested in working as an operating CEO of a manufacturing company. An undisciplined dreamer who does not have the ability to hold disciplined strategic and operating focus. Within a short period of time after the change of control, will lead Pacific into trouble again.
» Chief Operating Officer. A $95 million in sales company does not need a COO. Was appointed in 1999 to improve Pacific’s operating results. Has not succeeded.
» High Corporate and Division Overhead. Corporate overhead is set for a company with sales above $200 million. Examples:
- General Counsel
- Legal Assistant,
- Assistant to the CEO,
- Environmental Coordinator,
- CEO’s annual salary excessive at $416,000,
- Headquarters building costing $168,000 per year when office space is readily available in the nearby manufacturing buildings.
- An overhead concern: there are two Division General Managers of similar product line divisions with sales of approximately $20 million. Each general manager earns about $140,000 annually.
» No strategic focus. Pacific’s business plan is not a strategic plan. It’s largely a description of Pacific. The company is going in too many directions at the same time. Knee jerk, opportunistic decision making has resulted in putting Pacific in unrelated, non-core, money losing and cash draining businesses.
» Poor organization. There are no cost accountants and no manufacturing engineers in the company. These positions are essential for pricing and application of capital spending. There are too many small manufacturing operations without the economies of scale to absorb the overhead and produce acceptable profitability.
» Excess inventory. Interconnect’s net inventory totals $5.1 million and 28% of sales. Machining’s net inventory totals $5.1 million and 33% of sales. These inventories are in excess by approximately $5.4 million. Inventory turns are a poor 3.
» Machining Division. Negatives:
- Low equipment utilization estimated at 50%. There is apparently a duplication of equipment with the Interconnect Division. The capital expenditure requirements for Machining include equipment that is in-place in the Interconnect plant.
- 87% of sales are to one customer, Boeing. It is a commodity machining operation. Nothing is proprietary. There are thousands of machine shops exactly like this one in the USA.
- The burden rate is 300% and needs to be one-half of this to have competitive and profitable prices.
» Two businesses are not viable. The Enhanced Display and Engineering Services Divisions are not viable and are not in Pacific’s core. These are cash users and a drain. It is doubtful either division can be made profitable.
» Changing the well-recognized brand names. Prior to Pacific’s ownership the following were the companies brand names: Interconnect was Pacific Coast Technologies (PCT), Filters was Ceramic Devices, Machining was Cashmere.
- These names were reportedly well regarded. Changing these names to Pacific was a mistake. It takes years for a company to be recognized in its field. The brand becomes a franchise and should not be changed if the company had a successful reputation.
Conclusions and Recommendations:
» Close or sell the Enhanced Displays and Engineering Services Divisions. These are not viable businesses and are a cash drain. First Quarter FY2002 EBITDA Loss for Enhanced Displays was $698,000. Engineering Services’ loss was estimated at $255,000.
- Engineering should reinstate its trade name: Novatech, which is well known to potential customers.
» Europe. It is important to effect the sale of the European operation. There is no one capable of managing it at Pacific.
» Sell the Headquarters building. The mortgage is $1.1 million. Apparently it can be sold for approximately $3 million. If it cannot be sold because of the recession, it should be leased. Move accounting, information technology and other functions into the manufacturing buildings. The annual cost of the building is $168,000.
» Bonded Metals. Complete the move of the Bonded Metals operation into one of Pacific’s manufacturing buildings in Wenatchee, WA.
» Trade Names. Reinstate the product brand names for customer and supplier contact.
» Consolidation. Consolidate the Machining Division into the Interconnect Division.
» Salaried headcount. Reduction of six officers and managers would yield total savings of $1.1 million annually.
» Filters pricing. As overhead is reduced, consider pricing filters at the lower gross profit margin of 28% to increase sales to approximately $10 million from the current level of $3 million.
» Chief Executive Officer. Terminate the CEO on the first day of GSC’s active control. Appoint the filter and hermetic division general manager the chief executive officer. He is quite capable of running the company.
» Pro forma Operating Profit & Sales:
The schedule outlined below records the low and high Operating Profit on a Most Likely basis for FY2002. This forecast is based on conversations with Pacific’s officers and managers.
By FY2004, sales are expected to grow for the Interconnect and Filters businesses and to be relatively flat for the Machining and Bonded Metals businesses.
Income Statement Most Likely – FY2002 Forecast
(000 $) Low High FY2004
Net Sales $92,605 $97,905
Divest: 3 businesses 59,305 59,305
Adjusted Net Sales $33,305 $38,605 $48,200
Operating Profit $2,176 $4,176 $6,748
% to Sales 6.5% 10.8% 14.0%
EBITDA $4,192 $6,192 $8,764
% to Sales 12.6% 16.0% 18.1%
At same time, Robert Amter operated as Chief Executive Officer of Springfield Precision Instruments Inc. and Burke Industries Inc.
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