TURNAROUND CASE STUDY - A Pharma Industry Outsider’s Perspective - Turning Around the “ABCDMO” Company

INTRODUCTION

I’d previously worked for the private equity (PE) firm that owned it on another business experiencing challenges. Prior to working on companies owned by this particular private equity group, I’d worked on more than 50 such assignments, ranging in size from smaller, lower middle market companies owned by founders or families, up to public companies, in a mix of indus­tries.

In the fall of 2018, it would turn out that this PE firm had an­other business that was failing fast, a pharmaceutical contract development and manufacturing organization (CDMO) that grew rapidly from one production location to eight in just 4 years; but it was a few weeks away from running out of cash when I was asked to join as CEO.

I’ve never cared about titles. This one came with a significant amount of responsibility, risk, and opportunity. It was in a highly regulated industry that focuses on patients relying on their med­icines. I’ll call the company ABCDMO.

ABCDMO was simply, a roll-up of several unrelated legacy assets that were divested from big pharma. Unless I was missing something, I saw no apparent synergy in this $350-million global CDMO roll-up business. All I saw was a business struggling under the weight of a variety of challenges, not the least of which was poorly structured asset acquisition deals and teetering on in­solvency.

Other challenges included rigid employment and workforce contracts and assurances, financial and operational disconnects in the sites that were acquired, wild spending – including high IT spend, enormous looming cash requirements to fund high pay­rolls, and balloon and installment payments for acquiring the sites through creatively financed seller notes.

Like an unfortunate healthcare patient, it was bleeding. ABCDMO needed first responders. Those first responders would be our turnaround team and a cadre of key legacy employees who embraced the challenge and the change and who came alive and came to action. Did I have prior experience fixing and turning around companies? Yes. Did I have prior experience in healthcare and other related industries? Yes. Was I willing to out­work everyone to be successful and transform this business? Yes. Did I have prior experience in pharma? Zero!

But it didn’t matter. We (ABCDMO) had people. We had fearful people. Not many of them, but those that were, ran away, terrified. We also had fearless, brilliant, resilient people. Great employees. They just needed to be led toward clearly articulated goals to fix

So, we began the transformation. I had the good fortune to work with a team of strong advisors. While the personalities and egos often clashed, in the end, the re­sults were stellar, and it was only through building on the basics of Plan, Organize, Motivate, and Control (POMC) that sound management practice, tireless work, and the ability to humbly admit all I/we didn’t know and focus people much smarter than I on all we needed to fix, were some of the ingredients to our success. In this article I’ll point out a few letters. A little bit of alpha­bet soup. This was, after all, the pharma industry, which loves acronyms.

In addition to the POMC – there was one more C – Communicate. I figured out that if I didn’t reach out, get out there and communicate and earn the trust and con­fidence of the customers, the regulators, the employees, the bank, the other stake­holders, I, we, and the turnaround itself, were doomed.

One thing resonated with me above everything else – the P – the Patients. We were all ultimately accountable to them. That was the foundation of our program of change – that we shared with our stake­holders – especially the big pharma companies  whose names and brands were on the bottles, boxes, packages, vials, am­pules, and pills we produced – that we were unified in the drive for the big S – Sus­tainability. Here’s a little glimpse into the transformation of ABCDMO.

A TWO-SIDED LADDER

When you do turnaround work, in­terim CEO work, and/or any kind of orga­nizational change, you inevitably find yourself in the midst of a two-sided Ladder of Inference problem. The Ladder of Infer­ence was first put forward by organiza­tional psychologist Chris Argyris and used by Peter Senge in The Fifth Discipline: The Art and Practice of the Learning Organi­zation. The Ladder of Inference describes the thinking process that we go through, usually without realizing it, to get from a fact to a decision or action.¹

On the one hand, you can easily jump to conclusions and have precon­ceived notions, as the change agent; on the other side, the industry veterans can quickly dismiss your lack of industry knowl­edge as a major risk or failure factor, or it just may be a response to their own fears.

Why two sides? Well, you as the change agent view the steps and the se­quence of the rungs in the ladder one way, and the other folks see it differently. But that’s ok. From either side, success can only come from being rooted in reality. Re­ality and facts (and factual evidence) are at the base of the ladder. From this point of “safety,” where we’re closest to the ground, we begin to ascend. As we go up, we must look at facts, isolate our beliefs and prior experience, and draw conclu­sions based on hard data, and be pre­pared to take objective actions. That’s hard for people to do. Change is difficult. It’s human nature to page ahead in the test, to skip scenes while watching Netflix, to wanting to know what happens at the end of a book.

A challenge in the company in ques­tion is across sites and geography, “sets” of employees would undoubtedly have preconceived ideas. That is further compli­cated by what a prior management team (most of whom aren’t there anymore) told them, and whether they identified, or dis­agreed with, those perspectives. Did they know what a plan was? Did they agree with it? It doesn’t matter because now they were in the midst of another change – a new CEO and perhaps other new execu­tives, site heads, functional heads, etc.

All of the stakeholders of the CDMO – the bank, lenders, vendors, employees, shareholders, customers, former legacy owners (some of whom are creditors with seller notes) – have wildly varied beliefs, experiences, judgment, and degrees of openness of mind.

The point of The Ladder of Inference is to force objectivity and get consensus to move a team of people forward in unison, to respond to and manage challenges. Some of the employees thought I was in­sane. Some thought our entire team was insane. Some didn’t understand what we were doing. Some didn’t care. Some just left. Some checked out. But most dug in, buckled up, let go, and hung on. And when they first witnessed positive impacts, they realized they didn’t have to be fearful.

ABCDMO: LIKE OTHER CDMOS, A VICTIM OF FLAWED ASSUMPTIONS

ABCDMO was one of many compa­nies with business models that worked bet­ter in theory than in practice. Why? Flawed assumptions. When big pharma began selling off their large plants, the premise was that some entrepreneurial companies called CDMOs would own the plants, and the former cost centers would magically become vendors overnight.

The reality was that the legacy cul­tures had high inertia. How do you magi­cally turn a 20- or 25-year employee of some huge global pharma company into an overnight entrepreneur? It’s like taking a person who has played hockey for 25 years and asked them to be a pilot or For­mula One driver the next day. You might have a new business card that says you work for an airline or a race team, but you’re still probably thinking about playing hockey.

The transition to get former legacy-owned plants to independence and prof­itability has been a challenging one, and, like most industries that have been through deregulation, or whose largest players have spun off or spun out assets, the devil is in the details, normally embod­ied in the fine print of the contracts the di­vestiture was “papered” with, such as an asset purchase agreement (or asset sale agreement), master services agreement, or transitional services agreement.

Legacy plants are overbuilt, inefficient assets that were run as cost centers of big pharma. After acquisition by a CDMO, they are magically supposed to be effi­cient, low-cost production centers. This poses challenges from a number of per­spectives, the capital itself (buildings, facil­ities, equipment, machinery) and the workforce.

Transitioning the workforce culture from a bureaucratic pharmaceutical in­dustry to an entrepreneurial “low-cost but high-quality” nimble CDMO model poses many challenges. Pharma employees are highly compensated, and benefits are ex­tremely generous, compared to most sub­contracting businesses in other industries. With such high direct, indirect, and SG&A labor cost input into the model, it becomes very difficult to be profitable as a true low-cost provider.

Pharma organizational structures and staffing models are robust – with high span of control duplication, further bol­stered by regulatory requirements and the pharma mindset, which was to overbuild, overstaff, and throw resources and people at problems and inefficiencies. The most profitable CDMOs have embraced a cul­ture shift, injecting the mindset with new methodologies, operational excellence, more laser-focused KPIs, and flatter or­ganizations, to cut cost, improve margins, and ultimately lower the cost of drugs for their customers, the pharma companies, and the ultimate customers – the P – Pa­tients.

Workforce culture can be a major stumbling block for companies looking to make the transition from former big pharma cost center, or a purpose-built production facility dedicated to a single blockbuster drug, to a nimble, flexible low-cost provider. These two realities exist in conflict. Getting a long-term employee who’s never felt career risk or who has never been asked to double or triple their productivity over a period of time to em­brace change remains a challenge.

In order for this turnaround to be suc­cessful, we had to accelerate the rate of change and the adoption of new mindsets within the company as a whole, but in more granular fashion, at the sites. The sites are where the culture is most embed­ded.

The large legacy pharma companies divesting the plants, and many of the  CDMO startups that have acquired them, have found out that the typical 2- or 3- year transitional services agreement – a window of time that the acquirer presumes it can drive new business to the plant – is simply not enough time to transition the business.

Professionals on both sides of the arrangement – the supply chain and pro­curement people at pharma companies, and the people now working for the CDMO that was once a pharma cost cen­ter – agree that the time it takes to stabilize the spun off plant with enough diversified commercial business to produce net in­come and EBITDA – the main profitability KPI for CDMOs – is more like 6, 7, or 8 years.

A jointly crafted, fair, flexible, longer term site acquisition/supply agree­ment/asset purchase agreement, which places patient needs, sustainability of sup­ply, and product quality above a hastily conceived divestiture/acquisition to get a plant off the books (or on the books in the case of the acquiring CDMO), would be most important to ensure future success. We had to point in that direction – prag­matic sustainability – as “true north.”

THE TURNAROUND OF ABCDMO

Our turnaround team immediately went to work on all aspects of operations in the US, Canada, and Europe, which in­cluded a deep review of the purchase agreements and supply contracts under which these former legacy sites had been acquired from the elite top list of “big pharma” companies. While the CDMO’s revenues grew rapidly in just a few years, the facilities had not yet been integrated to save costs and leverage capabilities. Most of the sites were unprofitable, and the company had severely missed its internal forecasts on revenues, gross and net prof­its, EBITDA, and new customer sales.

The turnaround took a multi-pronged, site-specific approach to reme­dying the business model challenges along with the accompanying reputational issues. At the exact same time, mold was detected in a European operation, neces­sitating an immediate shut down and ex­pensive eradication program, for an additional combined loss of 2 million Euros/month. The company’s prime lender, a bank, was soon fatigued, which brought new pressures to the situation. While vendors started holding shipments, the company was locked into rigid supply agreements, labor contracts, and other constraints that made it difficult to operate and nearly impossible to generate profits. EBITDA was negative. The media and the European unions were beating us up. In some cases, so were the executives from the legacy owners, but we pushed through it.

The plan to restore ABCDMO took dramatic measures to optimize revenue and margins while cutting costs. A discrete diagnosis and turnaround plan were cre­ated for each subsidiary of ABCDMO. I and other new management personally met with each key customer, legacy com­pany management contacts, and key sup­ply chain vendors in order to build credi­bility and establish trust and retain vital lifelines to new commercial opportunities. As the turnaround took hold, ABCDMO restructured corporate and site-based staff to make sure every key management func­tion was efficiently and effectively covered.

ABCDMO’s eight global sites varied by location, legacy company, production focus, company culture, and most impor­tantly, the relative sustainability of the con­tracts associated with the acquisition of each unit. It would prove the best strategy to turn the company around would be to focus on each site’s unique pluses and mi­nuses, and determine which sites would be retained and fixed, and which ones di­vested.

The newly energized and focused team went to work on revenue improve­ment and cost reduction opportunities, while ensuring compliance with intensely regulated quality and delivery guidelines, with the main metric being “on time and in full, or OTIF,” THE contract pharma benchmark KPI.

PROBLEMS TO SOLVE

There were numerous issues plaguing the acquisitions which included the following:

• Rigid asset purchase agreements that restricted commercial opportunities, prohibited headcount reductions, and titular changes
• Sites that were grossly underutilized, with large excess capacity, producing late lifecycle products approaching or past the dreaded pharma “patent cliff” • Contract pricing and volume design that frontloaded obligations from for­mer legacy owners for sustainable vol­umes for a very short term
• An unrealistic forecast for commercial opportunities coupled with a grossly un­dersized sales team
• Sizeable capex obligations due to de­ferred maintenance, poorly executed contracts for new business requiring ABCDMO to expend large sums to “buy business” from other pharma compa­nies willing to transfer their commercial production (manufacturing and pack­aging) in exchange for low pricing, and large commitments to buy machinery and equipment
• Large deferred obligations, such as bal­loon payments, substantial seller note obligations, and other acquisition fi­nancing arrangements that severely im­paired near-term and long-term cash flow
• Excessive spending on IT (opex and capex)
• Excessive spending on HQ staff
• Ineffective sales and marketing – the company was focused on brand lead­ership above its size and scope when what it really needed was sales
• In addition, ABCDMO was in covenant violation with its bank, and the relation­ship was strained

THE FIRST 10 DAYS

1. Reduce headquarters line and staff offi­cers’ headcount – Complete
2. Recruit global restructuring team – Com­plete
3. Cease all non-critical spending – Complete
4. Contact Customers/Seller Note holders – Complete
5. Cease payments and begin negotiation of seller notes – Complete
6. Freeze all past due payables – Complete
7. Model Proforma forecast 2019 – Complete
8. CEO to visit every facility – Complete
9. Cease IT projects and reduce IT spend – Complete
10. Replace law and accounting firms at lower rates – Complete
11. Replace overpriced IT through insourcing – Complete
12. Move HQ; sublease corporate office – Complete
13. Establish supply chain credit programs with vendors – Complete
14. 14.Stop losses in factory No. 8 within 30 days – Complete
15. Stop losses in factory No. 7 within 30 days – Complete
16. Gain customer financial support for Fac­tory No. 6 – Complete
17. CEO to visit every customer – Complete
18. Accelerate A/R Collections – Complete
19. Limited headcount reductions/consolida­tion/attrition – Complete
20. Wage and benefit alignment – Complete
21. Consolidate certain senior management positions – Complete

Of those action steps:

• HQ headcount reductions produced an annual EBITDA improvement (Salary, Bonus, and Perquisites)
• Lease termination generated a savings, boosting annual EBITDA
• Cancellation of certain corporate events and trade shows produced an annual EBITDA improvement
• Divestiture/administration of certain Eu­ropean sites created tens of millions of annual EBITDA improvement
• Reduction of marketing expense
• Renegotiation of supply agreements at four US sites improved EBITDA by mil­lions annually
• Renegotiation of the maturities of seller notes and certain accounts payable
• Restructuring and insourcing of the ex­pensive IT program
• Negotiated stretch-out of the high ac­counts payable related to prior IT ex­pense with legacy IT vendors
• In-depth, on-site review of each opera­tion to explore opportunities to reduce costs and drive production and revenue
• Freeze on all hires
• Review of all insurances and health care policies with a new Broker of Record to eliminate excess costs and improve cov­erages and increase employee partici­pation in premiums
• Consolidation of executive roles and elimination of duplicate roles
• Reduction of millions in IT capex spend
• Reduction in IT contractor fees
• Reduction in audit and legal fees
• Streamlining and consolidation of com­mon vendor contracts
• Drawdown sale and shipment of excess inventory to customers to reduce on- hand materials and improve cash flow and cash on-hand

And the digging in, and the savings and EBITDA restoration, would continue to bear fruit.

RESULTS: ABCDMO SAVED & RESTORED: SUSTAINABILITY FOR PATIENTS

In less than 1 year, ABCDMO was successfully transformed, improving its re­lationship with its lender and vendors, maintaining critical mass with employees, retaining and improving (through contract renegotiation) all supply contracts with its customers, and regaining the confidence of its current as well as pending and new commercial customers. By strategically downsizing to four sites from eight, ABCDMO shed loss-making entities and improved EBITDA from FY 2018 to FY 2019 by increasing it from negative $45,000 to positive $30 million. The ma­jority of the 1,900 jobs were preserved as employees left through attrition or returned to prior legacy company payrolls for those sites divested or returned.

ABCDMO was efficiently and promptly restructured without resorting to a bankruptcy court filing for the entire group and without a change of control transaction. Administration court filings were made only for certain European sub­sidiaries, but an out-of-court restructuring for the ABCDMO Group was possible due to frequent communications and negotia­tions with ABCDMO’s bank and other key creditors.

Our major risk was from an IT vendor that threatened to shut down computer systems, wiping out supply in over 40 countries. After sensible, calm negotiation, this too was resolved peacefully. The com­munity and industry in general were posi­tively impacted by this turnaround. Industry supply was secured. Communities were protected even through the process, one of the European facilities was restored to health with mold eradication, Canadian and European facilities were sold, which protected those communities and the ac­companying union jobs.

As a consequence, customers were happy, jobs were protected and secured, employees had been stabilized, and the bank was pleased. Most importantly, pa­tients can depend on a stable supply of their medicines from a quality-driven, compliant, sustainable business operated by skilled, motivated, passionate employ­ees. That’s the win!

SUMMARY: ALPHABET SOUP

The X factor in this transformation of ABCDMO was the openness of employ­ees. It was their willingness to embrace the agents of change and to listen and learn. I wasn’t the solution. The rest of the turn­around team wasn’t the solution. The em­ployees were the solution and deserve the lion’s share of the credit. They accepted the challenge. They accepted the change. They accepted me. They accepted us.

It was my pleasure to serve as the CEO of ABCDMO, and I back and take pride in what we were able to do and look forward to my next challenges. And mean­while, the CDMO industry will likely con­tinue to consolidate, creating both competitive intensity and opportunity, and hopefully greater focus on sustainability as patients rely on the industry for life-saving and life-enhancing medicines.

POMC works in the CDMO. POMC delivers OTIF. Nobody in the industry can ever forget the big P – the Patients, and the big S – the Sustainability of CDMOs.

At this writing, the turnaround of the CDMO has been submitted to the TMA – Turnaround Management Association – for the 2019 International Turnaround of the Year, a tremendous honor. I hope the case wins. Not for anyone’s resume or ego, or for my peers, but for the employees, espe­cially the ones who looked beyond the team’s lack of pharma experience and embraced new ways of thinking, and new approaches to an industry and legacy or­ganizational structures that they’d grown up in.

 REFERENCE

1. Argyris, C. Overcoming Organizational Defenses: Facilitating Organi­zational Learning, 1st Edition,^© Printed electronically and repro­duced by permission of Pearson Education, Inc., Upper Saddle River, New Jersey. and Sons, Inc.

Paul Fioravanti, MBA, MPA, CAGS, is the Founder and Managing Partner of Qadent Management Services, LLC, a US-based turnaround, restructuring, business optimization and interim management firm. He is a proven turnaround CEO with experience in a variety of industries and situational challenges. He earned his MBA and MPA from the University of Rhode Island, and completed advanced post-masters research in finance and marketing at Bryant University. Mr. Fioravanti can be reached at paul@qadentmanagement.com.