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IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE In Re: NELLSON NUTRACEUTICAL, INC., et al., Debtors. ) ) ) ) ) ) ORDER For the reasons set forth in the Court's Findings of Fact and Conclusions of Law of this date, the Court concludes that, as of December 31, 2006, the Debtors' enterprise value is $320 million. Chapter 11 Case No. 06-10072 (CSS) (Jointly Administered) Related Docket No. 333
Christopher S. Sontchi United States Bankruptcy Judge Dated: January 18, 2007
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IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE
In Re: NELLSON NUTRACEUTICAL, INC., et al., Debtors.
) ) ) ) ) )
Chapter 11 Case No. 06-10072 (CSS) (Jointly Administered) Related Docket No. 333
FINDINGS OF FACT AND CONCLUSIONS OF LAW Laura Davis Jones, Esquire Curtis A. Hehn, Esquire Rachel Lowy Werkheiser, Esquire Pachulski, Stang, Ziehl, Young, Jones & Weintraub 919 N. Market Street, 16th Floor Wilmington, DE 19801 Brad R. Godshall, Esquire Alan J. Kornfeld, Esquire Pachulski, Stang, Ziehl, Young, Jones & Weintraub 10100 Santa Monica Boulevard, Suite 1100 Los Angeles, CA 90067 Counsel for Debtors and Debtors in Possession Robert S. Brady, Esquire M. Blake Cleary, Esquire Margaret B. Whiteman, Esquire Young Conaway Stargatt & Taylor, LLP P.O. Box 391 Wilmington, DE 19899-0391 Kurt F. Gwynne, Esquire Thomas Francella, Jr., Esquire Reed Smith, LLP 201 Market Street, 15th Floor Wilmington, DE 19801 Claudia Springer,Esquire Reed Smith, LLP 2500 One Liberty Place 650 Market Street Philadelphia, PA 19103 Counsel for the Official Committee Of Unsecured Creditors Richard W. Riley, Esquire Duane Morris, LLP 1100 North Market Street Suite 1200 Wilmington, DE 19801-1246 James J. Holman, Esquire Duane Morris, LLP 30 South 17th Street Philadelphia, PA 19103-4196
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Fred S. Hodara, Esquire Abid Qureshi, Esquire Akin, Gump, Strauss, Hauer & Feld 590 Madison Avenue New York, New York 10022
Linda Dakin-Grim, Esquire Gregory A. Bray, Esquire Thomas R. Kreller, Esquire Jason B. Baim, Esquire Milbank, Tweed, Hadley & McCoy 601 South Figueroa Street, Los Angeles, CA 90017 Counsel for UBS AG Stamford Branch
Scott L. Alberino, Esquire Akin, Gump, Strauss, Hauer & Feld 1333 New Hampshire Avenue, N.W. Washington, D.C. 20036 Counsel for the Informal Committee of First Lien Lenders Date: January 18, 2007
ii
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Table of Contents Preliminary Statement ................................... Jurisdiction & Venue .................................... Factual and Procedural Background ....................... I. Introduction .................................. A. B. C. D. General Background ....................... Nellson's Business ....................... Capital Structure ........................ Debtors' Management and Board of Directors ............................. 1 4 4 4 4 6 7 9 12 12 13 20 21 23 25 30 43 46 47 49 49 50 51 51 52
II.
Evolution of Nellson's May 2006 Long Range Plan A. B. C. D. E. F. G. H. I. The February 2005 LRP .................... The November 2005 LRP .................... The December 2005 LRP .................... Fremont Decides Not to Infuse Additional Capital ....................... Fremont's "Alternative Plan Parameters" .. The March 2006 Board Meeting ............. The May 2006 LRP ......................... Seneca Financial's Initial and Revised DCF Valuations ........................... Recent Performance Demonstrates the May 2006 LRP is Unrealistic ..............
III. The Valuation Opinions ........................ IV. The Valuation Methodologies ................... A. The DCF Methodology ...................... (i) Unlevered Projected Free Cash Flow .. (ii) The Terminal Value .................. Comparable Companies Analysis ............ Comparable Transactions Analysis .........
B. C. V.
Application of the Valuation Methodologies by the Three Experts ..........................
53
iii
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Determination of the Debtors' Enterprise Value ........... I. II. Introduction ................................... The Expert Opinions ............................ A. Chanin .................................... B. FTI ....................................... C. Houlihan ..................................
54 54 57 57 58 59 61 62 63 64 67 70 72
III. Adjustments to the Expert Opinions ............. A. Chanin .................................... (i) DCF Analysis ......................... (a) Chanin's Separate Consideration of the Riskier "Growth Ideas" ... (b) Chanin's Application of an Emergence Risk Premium .......... (c) Chanin's Selection of Multiple for Its Terminal Value .......... (ii) Comparable Companies Analysis ........ (a) Chanin's Use of Revenues in Its Comparable Companies Analysis ........................ (b) Chanin's Selection of EBITDA Multiple in Its Comparable Companies Analysis .............. (iii)Comparable Transactions Analysis ..... (iv) The Debtors' Non-Operating Assets .... (v) Conclusion ........................... B. FTI ....................................... (i) DCF Analysis ......................... (a) FTI's Application of a Company Specific Risk Premium ... (b) FTI's Exclusion of Any Value to the Debtors'Non-Operating Assets in Its DCF Analysis ...... (ii) Comparable Companies Analysis ........ (a) FTI's Use of Revenues and EBIT in Its Comparable Companies Analysis ........................ (b) FTI's Selection of EBITDA Multiple in Its Comparable Companies Analysis .............. (iii)Comparable Transactions Analysis ..... (iv) The Debtors' Non-Operating Assets .... (v) Conclusion ........................... iv
72
74 76 80 83 84 85 85
87 88
88
90 91 91 92
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C.
D. IV.
Houlihan .................................. (i) DCF Analysis ......................... (a) Houlihan's Calculation of a Size Risk Premium ............... (b) Houlihan's Selection of a Multiple for Its Terminal Value . (ii) Comparable Companies Analysis ........ (a) Houlihan's Use of Revenues in Its Comparable Companies Analysis ........................ (b) Houlihan's Selection of Multiples in Its Comparable Companies Analysis .............. (iii)Comparable Transactions Analysis ..... (iv) The Debtors' Non-Operating Assets .... (v) Conclusion ........................... Conclusion ................................
93 93 94 95 96
97
97 98 100 101 101 102 103 104 105 106
Weighing the Expert Opinions ................... A. Chanin .................................... B. FTI ....................................... C. Houlihan .................................. D. Conclusion ................................
V.
Compensating For the May 2006 LRP and the Debtors' Performance Since June 2006 ............ 107
Conclusion ................................................ 109
v
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SONTCHI, J. From September through December 2006, the Court devoted 23 trial days to determine the enterprise value of the above-captioned debtors and debtors in possession (collectively, the "Debtors" or "Nellson"). In addition to the Debtors, the principal parties
involved in the litigation were: (a) UBS AG, Stamford Branch, as administrative agent for various lenders ("UBS"); (b) the Ad Hoc Committee of First Lien Lenders (the "Informal Committee"); and © the Official Committee UBS, the of Unsecured Creditors and (the the "Official Official
Committee").
Informal
Committee
Committee are collectively referred to herein as the "Creditor Parties." The Court has been presented with an extensive
evidentiary record.
The Court has considered the evidence made a
part of the record in this contested matter and hereby makes its findings of fact and conclusions of law. The findings and conclusions set forth herein constitute the Court's findings of fact and conclusions of law pursuant to
Bankruptcy Rule 7052, made applicable pursuant to Bankruptcy Rule 9014. PRELIMINARY STATEMENT 1. The task before the Court is to determine the Debtors' enterprise value. Generally speaking, in order to accomplish that
1
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task
the
Court
would
consider
the
opinions
of
the
competent
experts. resolved.
There would be few, if any, factual disputes to be That is not the case here.
2. Each of the three experts in this case relied on the Debtors' May 2006 long range business plan ("May 2006 LRP") in reaching a conclusion as to the Debtors' enterprise value. The
evidence at trial, however, overwhelmingly established that the May 2006 LRP was not management's best and most honest thinking about the Debtors' financial future but rather was manipulated at the direction of and in cooperation with the Debtors' controlling shareholder to bolster the perceived value of the Debtors' business solely for purposes of this litigation. Moreover, the evidence
established that the Debtors' business has not stabilized but is continuing the deterioration that began in 2004. 3. As a direct result of the fact that the experts'
conclusions as to enterprise value are based upon the unrealistic May 2006 LRP, all of the experts have necessarily arrived at concluded enterprise values for the Debtors that are themselves somewhat unrealistic. This effect was succinctly described by one
of the experts: "garbage in . . . garbage out." 4. This creates a conundrum for the Court. How does the Court
rely on the expert testimony of the Creditor Parties that has been partially compromised by the actions of Debtors' management and its 2
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controlling shareholder?
Does the Court exclude those portions of
the expert reports based upon the May 2006 LRP, most notably the discounted cash flow analyses? Does the Court continue the already lengthy and expensive trial to allow for the submission of revised reports by the experts? 5. While there are adjustments that must be made to each of the expert reports to correct errors, each of the experts applied usual and customary valuation methodologies to reach their
conclusions as to the enterprise value of the Debtors. The primary source of error is not the experts themselves but the deliberately inaccurate information provided by the Debtors upon which the experts justly relied. Thus, to determine the Debtors' enterprise
value the Court will rely on the expert opinions as submitted by the Creditor Parties with an ex post adjustment to their conclusion to compensate for the evidence presented at trial showing the May 2006 LRP to have been manipulated and the Company's continuing poor performance. persons who Any other approach would serve to reward the very have created the conundrum (management and the
controlling shareholder) at the expense of the creditors. 6. Specifically, the Court will determine the Debtors'
enterprise value by (i) accepting the opinions of the three experts as to the Debtors' enterprise value; (ii) making adjustments to those opinions to correct for certain errors or inconsistences; 3
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(iii) weighing the three expert opinions (as adjusted) based upon the credibility of each expert's opinion and testimony; and (iv) adjusting the weighted average of the experts' opinions to
compensate for the May 2006 LRP and the Debtors' continuing poor performance since June 2006. After applying that approach, as set
forth in detail below, the Court concludes that, as of December 31, 2006, the enterprise value of the Debtors is $320 million. JURISDICTION AND VENUE 7. This Court has jurisdiction over this matter pursuant to
28 U.S.C. § 1334. 8. Venue of this proceeding is proper in this district This is a core proceeding
pursuant to 28 U.S.C. §§ 1408 and 1409. pursuant to 28 U.S.C. § 157(b)(2). 9.
The statutory predicate for the relief sought is section
506(a) of the Bankruptcy Code. FACTUAL AND PROCEDURAL BACKGROUND I. A. Introduction General Background 10. On January 28, 2006 (the "Petition Date"), the Debtors
commenced these bankruptcy cases by filing voluntary petitions for relief under chapter 11 of the Bankruptcy Code. 11. The Debtors continue to operate their business and manage their affairs as debtors-in-possession, 4 pursuant to sections
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1107(a) and 1108 of the Bankruptcy Code.
No trustee has been
appointed in any of the Debtors' chapter 11 cases. 12. On February 9, 2006, the Office of the United States
Trustee appointed the Official Committee to represent the interests of unsecured creditors in these cases. 13. On April 28, 2006, the Debtors commenced this contested
matter by filing the Motion of Debtors to Determine: (1) Enterprise Value of Debtors, and (2) Secured Claims of Prepetition Secured Lenders Pursuant to Section 506(a) of the Bankruptcy Code; Notice of Status Conference and Request that Court Enter Proposed
Scheduling and Procedures Order in Respect Thereon (Docket No. 333). This motion is the mechanism through which the Debtors seek
the Court to determine the Debtors' enterprise value. 14. On May 26, 2006, the Court entered its Revised Order Establishing Dates Regarding Valuation Hearing Related to the Debtors' Enterprise Value Pursuant to Bankruptcy Code Section 506(a)(Docket No. 383) (the "Valuation Protocol"). Pursuant to the Valuation Protocol, the parties have conducted extensive discovery, including the depositions of numerous fact and expert witnesses. The Valuation Protocol established that the sole issue for
consideration at the evidentiary hearing is the enterprise value of the Debtors. 15. On September 6, 2006, the Court conducted a pre-trial 5
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conference.
On September 11, 2006, the Court entered the Order
Regarding Valuation Trial, Exhibits, Confidentiality of Documents and Testimony [Docket No. 621].1 The evidentiary hearing on the
enterprise value of the Debtors took 23 trial days, beginning on September 13, 2006 and concluding on December 14, 2006. B. Nellson's Business 16. The Debtors formulate and manufacture functional
nutritional bars and powders for weight loss, sports training and wellness and medical categories. Trial Transcript ("Trial Tr.") 9/13/06 (Dias) at 179:18-180:3; UBS Ex. 209 at p. 1. 17. Nellson operates three manufacturing facilities, which
are located in Irwindale, California, Salt Lake City, Utah, and Montreal, Canada. Nellson's headquarters and primary production
facility is located in Irwindale. Trial Tr. 9/15/06 (Schouten) at 585:12-14. 18. Nellson has its own Research and Development department
that is fully dedicated, as part of its everyday ongoing business, to developing new products. Trial Tr. 9/14/06 (Dias) at 293:25295:10, 385:8-20; Trial Tr. 9/20/06 (Cudahy) at 1182:8-1184:23. 19. As the products which Nellson develops enjoy relatively
1
The Court subsequently entered the Order Regarding Valuation Trial: Confidentiality of Documents and Testimony [Docket No. 661] and the Supplemental Order Regarding Valuation Trial, Exhibits, Confidentiality of Documents and Testimony [Docket No. 795], both of which supplemented the previous procedural orders.
6
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short product lives (with the market regularly demanding new and improved products) R&D is a crucial element of the maintenance of Nellson's base business. Trial Tr. 9/13/06 (Dias) at 385:8-20. 20. branded Nellson does not manufacture products under its own label, but produces products that are sold by food
marketers. Trial Tr. 9/14/06 (Dias) at 313:3-314:8; 361:7-9; 362:719; Trial Tr. 9/27/06 (Harris) at 1581:13-18. 21. As a result of Nellson not manufacturing products under
its own branded label, Nellson does not enjoy any consumer brand loyalty the consumers who eat the products made by Nellson never know the Nellson name. Trial Tr. 9/14/06 (Dias) at 313:3-314:8; 361:7-9; 362:7-19; Trial Tr. 9/27/06 (Harris) at 1581:13-18; Trial Tr. 9/29/06 (Harris) at 1888:17-1889:1. 22. Nellson is not an exclusive manufacturer for the
marketers for which it produces product. Trial Tr. 9/14/06 (Dias) at 282:7-16; Trial Tr. 9/18/06 (Schouten) at 888:3-20. C. Capital Structure 23. Nellson is a privately held company. Since 2002, its
principal equity holder has been Fremont Investors VII, LLC. Trial Tr. 9/15/06 (Dias) at 457:13-15; Trial Tr. 9/28/06 (Harris) at 1780:2-4. 24. The Debtors (with the exception of Nellson Holdings and
Nellson Intermediate) have three tranches of principal indebtedness 7
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and trade credit consisting of: (a) First priority secured obligations to various
lenders under the First Lien Credit Agreement; (b) Second priority secured obligations to various
lenders under the Second Lien Credit Agreement; and (c) Unsecured obligations to trade vendors,
lessors, Fremont and others. UBS is agent for all lenders participating in the First Lien and Second Lien Credit Agreements (collectively, the "Lenders"). UBS Ex. 133, 207. 25. Nellson is the borrower and the other Debtors are
guarantors under both Credit Agreements.
The Debtors' obligations
under the Credit Agreements are secured by first and second liens, respectively, on substantially all of the Debtors' assets. Nellson Intermediate Holdings also has pledged the stock of Nellson to further secure the obligations under the Credit Agreements. Trial Tr. 9/21/06 (Donnelly) at 1367:19-1368:1; UBS Ex. 133, 207, 507, 508, 509. 26. As of the Petition Date, the Debtors' outstanding
principal obligations under the First Lien Credit Agreement and the Second Lien Credit Agreement totaled approximately $255 million and $75 million, respectively. As of December 31, 2006, the Lenders
will be owed, approximately $355.06 million in the aggregate, 8
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inclusive of estimated fees, charges, and interest (including default interest). Trial Tr. 9/21/06 (Donnelly) at 1367:22-1368:1; Trial Tr. 10/05/06 (Donnelly) at 2203:21-24; UBS Ex. 507, 508, 509. 27. Unsecured debt is estimated by the Debtors to total approximately $5.8 million. Joint Pretrial Memorandum at ¶9. D. Debtors' Management and Board of Directors 28. Fremont acquired Nellson in late 2002. The First Lien
Credit Agreement facilitated this acquisition. Trial Tr. 10/06/06 (Lenihan) 2672:9-12. 29. In February 2004, Nellson borrowed an additional $100 million and paid a dividend to Fremont in excess of $55 million. Trial Tr. 9/21/06 (Donnelly) at 1378:24-1379:4; 10/06/06 (Lenihan) at 2569:20-2572:25; Trial Tr. 10/10/06 (Jaunich) at 2707:22-2708:8; UBS Ex. 139, 207. 30. Subsequently, Nellson's performance deteriorated. Tr. 10/05/06 (Lenihan) at 2294:10-2299:1; Trial Tr. Trial at 2567:11-2568:9; Trial Tr. 10/10/06 (Jaunich) at
10/10/06
(Jaunich) at 2685:6-2686:17; UBS Ex. 135, 170. 31. As a result of the deterioration in Nellson's business,
Nellson breached the financial covenants in its loan agreements concerning its debt level and has been unable to correct its breach. Trial Tr. 10/05/06 (Lenihan) at 2297:4-20; Trial Tr. 10/10/06 (Jaunich) at 2684:21-2685:1, 2709.19-24; UBS Ex. 507, 508, 9
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509. 32. to turn During 2005, the Debtors brought in new management to try the company around. Trial Tr. 10/06/06 (Lenihan) at
2577:20-2578:10; UBS Ex. 135. 33. Nellson retained Jeffrey B. Dias as interim President in He accepted the position on a permanent basis in
January 2005.
April 2005. Trial Tr. 9/13/06 (Dias) at 140:1-5; Trial Tr. 10/06/06 (Lenihan) at 2579:9-2580:12. 34. Ted Schouten was hired as a Vice President and Chief
Financial Officer in May 2005. Trial Tr. 9/15/06 (Schouten) at 572:2-9. 35. Tom Jagiela was hired as Executive Vice President of Manufacturing and Operations in January 2005. Trial Tr. 9/13/06 (Dias) at 195:12-196:18; Trial Tr. 9/19/06 (Jagiela) at 971:22972:17. 36. Scott Sturgill, who was hired as a manager in 1998, is
now the Vice President of Research and Development for Nellson. Trial Tr. 9/18/06 (Schouten) at 750:10-13. 37. Jim Cudahy, who started in April 2004, is Vice President
and General Manager of Nellson's Powder Division in Nellson's Salt Lake City facility. Trial Tr. 9/14/06 (Dias) at 406:10-15; Trial Tr. 9/20/06 (Cudahy) at 1179:18-1180:1. 38. Nellson's Board of Directors consists of Chairman Robert 10
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Jaunich and directors William Lenihan, Tom Debrowski, Doyle Waggle, Ben Muhlenkamp and Mr. Dias. UBS Ex. 5, 20, 22, 26, 149. forth below, Mr. Waggle is the sole independent As set in
director
connection with Fremont. 39. Fremont. Mr. Jaunich is one of the three founding partners of He obtained his directorship and the Chairman's role on
Nellson's Board as a result of Fremont's equity investment in Nellson in 2002. Trial Tr. 10/05/06 (Lenihan) at 2267:23-24; Trial Tr. 10/10/06 (Jaunich) at 2670:17-2671:1. 40. Mr. Lenihan, a managing director of Fremont, also obtained his Board seat as a result of Fremont's investment in Nellson in 2002. Trial Tr. 10/05/06(Lenihan) at 2266:8-10; 2268:18-2269:2. 41. Mr. Lenihan has been deeply involved in the day-to-day management of Nellson, and in its long range planning, since Fremont acquired its equity position. Trial Tr. 10/05/06 (Lenihan) at 2268:20-22; Trial Tr. 9/14/06 (Dias) at 242:3-20; Trial Tr. 10/05/06 (Donnelly) at 2242:3-6. 42. Mr. Debrowski, a Mattel executive, was recruited by Mr.
Jaunich in 2003 to sit on Nellson's Board as an independent director. Trial Tr. 10/05/06 (Lenihan) at 2315:22-2316:2;
Deposition of Tom Debrowski taken August 16, 2006, and played into evidence by video at trial on October 11, 2006 ("Debrowski
Designated Tr.") at 14:5-24. 11
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43.
Mr. Debrowski is not, however, independent in connection In 2005, Fremont made Mr.
with the matters concerning Fremont.
Debrowski a compensated member of one of Fremont's "Advisory Boards." Trial Tr. 10/05/06 (Lenihan) at 2316:3-2324:16; Debrowski Designated Tr. at 20.13-25. 44. Mr. Waggle is an independent director, even though he was recruited by Mr. Jaunich. Deposition of Doyle Waggle taken August 16, 2006 and played into evidence by video at trial on October 10, 2006 ("Waggle Designated Tr."), at 10:24-13:3. 45. Ben Muhlenkamp preceded Mr. Dias as the President and CEO
of the Company. Trial Tr. 9/19/06 (Jagiela) at 1036:9-12; Trial Tr. 10/06/06 (Lenihan) at 2578:24-2579:8; UBS Ex 135. II. A. Evolution Of Nellson's May 2006 Long Range Plan The February 2005 LRP 46. Nellson's first long range plan (each, a "LRP")following
the covenant defaults in 2004 was created by Mr. Dias and presented to the Nellson Board shortly after Mr. Dias' arrival at Nellson in early 2005. Trial Tr. 10/5/06 (Dias) at 252:14-253:2; Trial Tr. 10/10/06 (Jaunich) at 2694:11-2702:15; UBS Ex 2.
12
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47. The February 2005 LRP adopted the following financial goals. UBS Ex 2. FEB. 2005 LRP NET SALES BASE STRETCH EBITDA BASE STRETCH B. 45m 57m 58m 63m 65m 70m 72m 80m 80m 90m 300m 320m 340m 360m 350m 375m 380m 410m 425m 460m `05 `06 `07 `08 `09
The November 2005 LRP 48. By April 2005, only two months after the February 2005 LRP
was finalized, Nellson was continuing to perform poorly with both its powder business and its more substantial bar business. By this time, it was clear that Nellson would never achieve any of the "base case" goals set out in the February 2005 plan, let alone its "stretch" aspirations. UBS Ex. 137. 49. In April 2005, Fremont was considering purchasing
Nellson's debt. In pursuit of this option, Mr. Lenihan's conducted his own internal analysis of Nellson's value. Based on 6 x EBITDA,
Mr. Lenihan calculated Nellson's total enterprise value at $257.8 million as of June 2005 and $280.9 as of December 2005. Trial Tr. 10/5/06 (Lenihan) at 2415:5-2416:5; Trial Tr. 10/10/06 (Jaunich) at 2702:16-2710:6; UBS Ex. 138 & 139. 50. In the summer of 2005, Messrs. Dias and Schouten set out 13
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to create a comprehensive "bottoms up" LRP that would be thoroughly researched and vetted. In exchange for a temporary waiver of the
loan covenant breaches, Mr. Dias repeatedly committed to present such a comprehensive LRP to the Lenders by September 30, 2005, and Fremont separately committed to provide a restructuring plan to the Lenders by October 2005. Trial Tr. 10/04/06 (Donnelly) at 2109:222118:4; UBS Ex. 161, 164, 507. 51. In preparing team worked the plan, for Dias and Schouten and their
management
hard
months
(from
August
through
November 2005) to build what ultimately evolved into the November 2005 LRP. In preparing this "bottom's up" plan, management
conducted exhaustive customer research (Mr. Dias spoke with most customers), closely examined Nellson's capabilities, conducted a series of off-site planning sessions and sought and received substantial input from the management team as well as Fremont's Mr. Lenihan and Mr. Hallow. Trial Tr. 9/14/06 (Dias) at 255:16-256:7; Trial Tr. 9/18/06 (Schouten) at 723.12-725:21; Trial Tr. 9/19/06 (Jagiela) at 1035:5-1040:2, 1045:4-1068:23; Trial Tr. 9/20/06
(Cudahy) at 1200:7-1232:24; Trial Tr. 9/21/06 (Cudahy) at 1261:1423,1263:8-13; UBS Ex. 3, 32, 33, 34, 36, 38, 41, 43, 44, 45, 48, 78, 79, 116, 117, 120, 125, 254, 257, 262, 308, 310, 311. 52. There is no evidence to suggest that any similar
diligence was pursued in arriving at the May 2006 LRP. Trial Tr. 14
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9/20/06 (Cudahy) at 1225:21-1226:22; Trial Tr. 9/21/06 (Cudahy) at 1263:8-1265:1; Trial Tr. 9/19/06 (Jagiela) at 1068:24-1070:3. 53. In mid-September 2005, Mr. Dias presented to Mr. Lenihan a September 2005 LRP that included the following targets, which were more modest than those contained in the February 2005 LRP. Trial Tr. 9/18/06 (Schouten) at 738:23-739:23. UBS Ex. 36. SEPT. 2005 LRP NET SALES GROUND ZERO BASE STRETCH EBITDA GROUND ZERO BASE STRETCH 47m 47m 51m 42m 48m 50m 46m 52m 58m 47m 54m 65m 47m 58m 74m 46m 59m 84m 304m 312m 320m 329m 331m 341m 344m 347m 372m 357m 361m 401m 367m 374m 439m 375m 383m 483m `05 `06 `07 `08 `09 `10
54. In presenting the September 2005 LRP to Mr. Lenihan, Mr. Dias stated that "ground zero" meant "a bare-bones effort that holds the status quo. Nellson loses ground but holds the EBITDA. Mr.
It's a low-business-risk scenario from an operating view."
Dias further explained that "Base Plan" meant "put emphasis on margin building. growth or require We exclude aspects that involve breakthrough restructuring to boost operating margin." This is
Finally, Mr. Dias stated "Stretch is where our heart is.
a forceful effort which would require investment for restructuring. 15
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There is a major push for growth, to get a new business thrust in international business. The Long Range Strategy/Plan is aimed at
getting the Stretch Plan." UBS Ex. 36. 55. Mr. Lenihan was displeased with management's approach to
its September 2005 LRP and, consequently, directed Mr. Dias and Mr. Schouten to abandon their September 2005 LRP and start fresh using Fremont's business model. Trial Tr. 9/18/06 (Schouten) at 743:1745:6 & 753:8-11; Trial Tr. 10/05/06 (Lenihan) at 2350:20-2355:1; UBS Ex. 260, 39. 56. In discussions with UBS, Mr. Lenihan repeatedly had assured UBS that the plan to be provided would provide for EBITDA in excess of $60 million per year, and the September 2005 LRP fell far short of those assurances. Trial Tr. 10/4/06 (Donnelly) at 2101:1-14, 2116:1-6, 2118:16-2120:2 & 2094:20-2095:7; Trial Tr. 10/05/06 (Lenihan) at 2350:20-2355:1; UBS Ex. 260. 57. Accordingly, Mr. Lenihan had Mr. Dias stall, by informing
the Lenders in writing that Nellson would not meet its commitment to provide a long range plan by September 30, 2005. Mr. Dias
blamed the failure to meet his commitment on the need for more thorough analysis. UBS Ex. 162, 165, 508, 509. 58. Fremont failed to provide its promised restructuring proposal to the Lenders in October 2005. Trial Tr. 10/04/06
(Donnelly) at 2117:23-2118:4; UBS Ex. 507, 508, 509. 16
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59.
From this point forward, Fremont (i.e., Messrs. Halow and
Lenihan) provided substantial input into the November 2005 LRP. First, Mr. Halow and Mr. Lenihan came to Nellson and met for several hours in person with Mr. Dias and Mr. Schouten. Following
the meeting of several hours, the rest of the management team was asked to provide follow-up analyses in response to a number of items raised in the Fremont meeting. Meanwhile, Mr. Halow of
Fremont took control of the business model and began populating it with assumptions based on follow-up responses from the Nellson management team and his own analyses (offering to "walk" Mr. Dias and Mr. Schouten through the assumptions he had added). Trial Tr. 9/15/06 (Dias) at 447:19-23; Trial Tr. 9/18/06 (Schouten) at 864:1867:14l; UBS Ex. 37-46, 48, 50-52. 60. Nellson presented what has come to be known as the "Lender version" of the November 2005 LRP (hereafter, the "November 2005 LRP") in a meeting with the Lenders on November 2, 2005. Trial Tr. 9/14/06 (Dias) at 255:16-256:10; Trial Tr. 9/15/06 (Dias) at 445:2445:10; Trial Tr. 9/18/06 (Schouten) at 768:22-769:3; Trial Tr. 10/10 (Jaunich) at 2720:7-11; Trial Tr. 10/05/06 (Lenihan) at 2381:13-2384:4, 2396:19-2397:1; UBS Ex. 3. 61. Both Mr. Schouten and Mr. Dias acknowledged that the lender version of the November 2005 LRP was their most realistic plan for Nellson. During the meeting at which it was presented, 17
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Mr. Dias told the Lenders. "rather than put out here a bunch of optimism, which is less substantial and which we don't have the facts obviously for, we've built our base plan around what's a very realistic, conservative base plan that we can honestly look people in the eye and promise." Trial Tr. 10/04/06 (Donnelly) at 2125:13-22; Trial Tr. 9/18/06 (Schouten) at 768:24-769:17; UBS Ex 303. 62. Unbeknownst to the Lenders, this version of the November
LRP had been "significantly filtered" by Fremont, and Mr. Dias and Mr. Schouten had been schooled by Fremont on how to "preempt" controversial topics in discussions with the Lenders such as Nellson's valuation or an appropriate level of debt for Nellson. UBS Ex. 50, 51; Trial Tr. 10/05/06 (Lenihan) at 2370:15-2377:5. 63. The November 2005 LRP presented to the Lenders was devoid
of the "ground zero" or "stretch" concepts that appeared in the September version. Instead, it included a single set of goals for
Net Sales and EBITDA that in some cases were higher than the September 2005 base case and in some cases lower. In every case,
the numbers were materially lower than the February 2005 base version of the LRP (and drastically lower than the stretch):
18
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NOV. 2005 LRP NET SALES
FEB. 2005(BASE)
VARIANCE FROM 2/05
`05 300.4m 300m (.4) 39.1m 45m (5.9)
`06 317.1m 340m (22.9) 45.9m 58m (12.1)
`07 334.1m 350m (15.9) 52.2m 65m (12.8)
`08 345.4m 380m (34.6) 53.8m 72m (18.2)
`09 365.1m 425m (59.9) 57.0m 80m (23)
`10 381.3m
EBITDA FEB.2006 (BASE)
VARIANCE FROM 2/05
Trial Tr. 10/05/06 (Lenihan) at 2406:6-18; UBS Ex. 3. 64. Although not disclosed to the Lenders, there actually existed two other "unfiltered" versions of the November 2005 LRP one presented to Fremont's Board of Directors and one presented to Nellson's Board. Trial Tr. 9/14/06 (Dias) at 392:20-394:1; Trial Tr. 9/18/06 (Schouten) at 773:11-774:19, 781:5-21; Trial Tr.
9/19/06 (Jagiela) at 1067:15-19; Trial Tr. 10/05/06(Lenihan) at 2399:9-17, 2400:20-2401:10; UBS Ex. 53, 55 & 4. 65. Mr. Dias and Mr. Schouten put together this alternative
version of the November 2005 LRP for presentation to the Fremont Board of Directors at the specific request of Mr. Lenihan for the purpose of soliciting a cash infusion into Nellson from Fremont. Trial Tr. 9/14/06 (Dias) 256:18-257:9; Trial Tr. 9/18/06 (Schouten) at 773:11-774:19. 66. The version of the November 2005 LRP presented to Fremont
included a "stretch plan," the achievement of which, according to
19
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Mr. Schouten, would require "breakthrough growth."
And it also
included the fact that Nellson had already learned it would lose a major customer. The loss of this customer was not disclosed to the
lenders until December 2005. Trial Tr. 10/05/06 (Lenihan) at 2390:4-2392:3, 2406:6-18; Trial Tr. 10/04/06 (Donnelly) at 2127:1117; Trial Tr. 9/18/06 Schouten) at 738:23-744:22; UBS Ex. 3, 4, 53, 57,267.2 C. The December 2005 LRP 67. In mid-December 2005, Nellson informed the Lenders of the At that time, Nellson provided the
loss of a major customer.
Lenders with a further material downward revision to is November 2005 LRP the December 2005 LRP which reflected the impending loss of a customer and the acknowledged effects of further severe price compression on Nellson and the industry as a whole. December 2005 LRP, Nellson projected the following: In the
2
Pursuant to the Order Regarding Confidentiality of Exhibits and Valuation Trial Testimony (Docket No. 879) (the "Confidentiality Order"), the identity of this customer is not set forth herein.
20
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DEC. 2005 LRP NET SALES NOV. 2005 LRP
VARIANCE FROM 11/0 5
`05 300.4 300.4 N/A
`06 316.8 317.1 (.3)
`07 320.7 334.1 (13.4)
`08 319.9 345.4 (25.5)
`09 338.0 365.1 (27.1)
`10
381.3 (28.7)
EBITDA
39.1
45.6
46.9
44.5
47.2
49.8
NOV. 2005 LRP
39.1
45.9
52.2
53.8
57.0
60.0
VARIANCE FROM 11/0 5
N/A
(.3)
(5.3)
(9.3)
(9.8)
(10.2)
Trial
Tr.
9/15/06
(Dias)
at
463:7-465:1;
Trial
Tr.
9/15/06
(Schouten) at 629:2-11; Trial Tr. 9/18/06 (Schouten) at 784:17785:12, 901:17-902:2; Trial Tr. 4/10/06 (Donnelly) at 2131:72132:11; UBS Ex. 8, 57, 167. D. Fremont Decides Not To Infuse Additional Capital 68. Immediately after Fremont's Board saw the version of LRP presented to it on November 11, 2005 and so learned of the expected loss of a major customer's business, Fremont advised Nellson that it would not make any capital infusion into Nellson,
notwithstanding Nellson's pitch that its "stretch plan" growth initiatives would be successful in the future. Trial Tr. 9/15/06 (Dias) at 451:2-14, 456:14-24; Trial Tr. 10/05/06 (Lenihan) at 2432:20-2433:3; Trial Tr. 9/21/06 (Donnelly) at 1429:14-1430:9;
21
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Trial Tr. 4/10/06 (Donnelly) at 2127:11-22, 2134:5-14; UBS Ex. 4, 7. 69. The Lenders were advised of Fremont's decision not to make a capital infusion in Nellson in mid-December 2005, when Mr. Dias wrote to the Lenders: "However, due to this development (more capacity in the industry, greater customer concentration among continuing customers, changing risk profile) Fremont is now of the view that it will be unable to meet the lender required outcome of a de-leveraging event through a significant equity infusion. The most likely outcome will be a transfer of a controlling equity position to the lenders in conjunction with a conversion of debt to equity." UBS Ex. 167. 70. After hearing of the loss of the customer and considering
Fremont's options, Mr. Lenihan placed a telephone call to Mr. Donnelly, the senior banker at UBS responsible for the work-out of the loans, at his home, on Friday, December 9, 2005, to advise that Fremont recognized it had lost its equity in the Company and had decided to "arrange an orderly transfer" of Nellson to the banks. The following day, Mr. Lenihan called Mr. Donnelly again, this time with Fremont's counsel on the line with him, and retracted his concession and offer of the previous day. Trial Tr. 4/10/06
(Donnelly) at 2132:19-2137:24; Contrast with Trial Tr. 10/05/06 (Lenihan) at 2435:14-2438:7; UBS Ex. 167. 22
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71.
UBS, acting at the instruction of requisite lenders under
both the First Lien Credit Agreement and the Second Lien Credit Agreement, accelerated the loans on December 21, 2006. Trial Tr. 9/21/06 (Donnelly) at 1352:12-17; UBS Ex. 6, 507. E. Fremont's "Alternative Plan Parameters" 72. Despite the fact that the December 2005 LRP was fresh and
had been exhaustively researched and recently updated, Fremont sent "alternative Plan parameters" to Nellson management at some time prior a January 3, 2006. UBS Ex. 9; Trial Tr. 9/15/06 (Dias) at 470:18-473:17; Trial Tr. 10/05/06 (Lenihan) at 2440:9-2443:9. 73. Mr. Dias initially rejected this further input from Fremont in the form of the alternative plan parameters, reasserting in to January 3, 2006 letter that, in his view, the "appropriate plan" for Nellson was the recently updated December 2005 LRP or, as Mr. Dias described it, the November 2005 LRP presented to the Lenders as adjusted for the loss of a major customer. In direct
response to receiving these "alternative Plan parameters," growth initiatives "bridge," and "valuation model" from Fremont, Mr. Dias advised Mr. Lenihan that his plan of layering growth initiatives onto a base plan to reach his valuation goals would lead to "unrealistic" expectations for Nellson, stating that "it is not wise, from an operating point of view, to layer initiatives in a way that engenders expectations of an unrealistic future." Trial 23
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Tr. 9/15/06 (Dias) at 470:18-473:17; UBS Ex. 9. 74. During early 2006, Mr. Dias wrote internal emails and memoranda to Mr. Lenihan and the Board stating that market
pressures that continued during 2006 necessitated further downward revisions to the LRP (from the December 2005 LRP). UBS Ex. 9, 59, 60, 61, 64, 83 & 84; Trial Tr. 9/18/06 (Schouten) at 797:21-801:23; Trial Tr. 10/05/06 (Lenihan) at 2454:10-2463:6; Trial Tr. 10/10/06 (Jaunich) at 2756:21-2758:18. 75. In response to one of these communications, a senior executive at XRoads (Nellson's financial advisors), counseled Mr. Dias, advising him to keep views such as those expressed in his January 3 letter (UBS Ex. 9) to himself in order that the interests of equity holders could be protected by the professionals. discouraged significance Mr. from Dias a from expressing views or that from may XRoads have
valuation
perspective,
ascribing
ultimate probabilities of success to any plan. Dias took the position that he would not
As a result, Mr. abandon Fremont's Mr.
alternative plan parameters but neither would he endorse it.
Dias determined that "he would stay out of their discussion about their own plans. I wasn't going to have an opinion or
recommendation about it." UBS Ex. 192; Trial Tr. 9/15/06 (Dias) at 474:10-480:24; Trial Tr. 10/05/06 (Lenihan) at 2452:5-2454:9.
24
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F.
The March 2006 Board Meeting 76. In late February 2006, Mr. Dias sent the Nellson Board
what he and Mr. Schouten variously referred to as management's "Proposed Plan 2:23.06," "Revised Plan 2:23.06" and "LRP." revised plan incorporated new and further material The
downward
revisions to the already-reduced December 2005 LRP, to reflect worsening market conditions that Mr. Dias laid out for the Board in letter of February 23, 2006 and February 27, 2006. In those
letters, Mr. Dias advised the Board that he intended to submit the full "Proposed 2:23.06 Plan" (see UBS Ex. 86) for approval at the upcoming March 16, 2006 Board meeting, but he provided the Board with the following summary in his letter as a preview:
25
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FEB.23RD 2006 Plan
`05 ACTUAL
`06
`07
`08
`09
`10
NET SALES DEC. 2005 LRP 300.4 316.8 320.7 319.9 338.0 352.6
FEB. 23 2006 LRP
298.8
310.8
313.2
308.6
322.3
332.4
VARIANCE FROM 12/05
(1.6)
(6.0)
(7.5)
(11.3)
(15.7)
(20.3)
EBITDA DEC. 2005 LRP 39.1 45.6 46.9 44.5 47.2 49.8
FEB.23 2006 LRP
40.8
42.5
43.3
41.4
43.7
46.2
VARIANCE FROM 12/05
1.7
(3.1)
(3.5)
(3.2)
(3.4)
(3.6)
UBS Ex. 11; 12, 86, 525; Trial Tr. 9/15/06 (Dias) at 481:1-488:14. 77. The proposed February 23, 2006 LRP (which was the last
honest and realistic LRP prepared by management) was not wellreceived by the two Fremont board members on Nellson's Board, Messrs. Lenihan and Jaunich. After their review of this proposed
LRP, Mr. Jaunich and Mr. Lenihan (and no other Board members), caused several events to occur in early March 2006, which resulted in this freshly updated February 2006 LRP being abandoned by management in favor of creating a new business plan that would "transform" the Company's outlook by layering "transformation" or 26
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"growth" ideas on top of a base business plan. UBS Ex. 11, 13, 14, 67, 86. 78. First, in early March, Mr. Jaunich called and wrote to
Mr. Dias, telling him not to include the Feb. 23, 2006 LRP in the materials for the March 16th Board meeting. Mr. Jaunich told Mr.
Dias that, instead, he should put off discussion of the LRP and focus instead on ideas that could "transform Nellson." UBS Ex. 13, 14, 67; Trial Tr. 9/15/06 (Dias) at 484:15-493:14; Trial Tr. 10/10/06 (Jaunich) at 2770:4-2771:10; 10/05/06 (Lenihan) at
2486:19-2487:11. 79. At the same time, Mr. Lenihan discussed with Mr. Dias the
possibility of an increased compensation package for Mr. Dias and the management team. UBS Ex. 11, 14. 80. During this time period in late 2005 and early 2006, Mr.
Lenihan also posed veiled threats to Mr. Dias by perpetually reminding Mr. Dias in their conversations that Mr. Dias served at the pleasure of the board, which in turn served at the pleasure of the shareholders. Mr. Dias told Mr. Donnelly of UBS and Mr. Eric
Carlson of UBS' financial advisor, Imperial Capital, on several occasions that he felt his job was in jeopardy if he did not comply with Fremont's wishes. Trial Tr. 9/14/06 (Dias) at 247:12-248:5; Trial Tr. 9/21/06 (Donnelly) at 1355:3-8, 1356:3-16, 1410:5-1413:2; Trial Tr. 10/05/06 (Donnelly) at 2252:10-2253:5; Trial Tr. 9/18/06 27
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(Schouten)
at
680:13-681:23;
Trial
Tr.
9/19/06
(Schouten)
at
944:18-945:3. 81. At this same time in early March 2006, Fremont and Fremont's counsel spearheaded the screening of potential valuation experts. Both Fremont and Debtors' counsel contacted Seneca
Financial about serving as a valuation expert (Seneca Financial was ultimately retained by the Debtors). Mr. Harris of Seneca
Financial was sent a detailed list of questions for his interview with Mr. Lenihan, Mr. Dias, other directors, and Debtors' counsel, with the goal of pre-determining, before even being hired, what valuation methodologies Mr. Harris would use and whether he would apply any specific risk premiums. 82. UBS Ex. 292.
On March 2, 2006, in advance of this interview, Fremont's
James Halow caused Debtors' counsel to send Mr. Harris a package containing the December 2005 LRP and certain values attributable to growth initiatives to be layered onto the LRP. It is clear that
Mr. Halow caused this to be sent to Mr. Harris (via Debtors' counsel) because he sent the same attachment with the growth initiatives on the same day to Mr. Dias and Mr. Harris, with the note that these initiatives were for the purpose of being layered onto the December 2005 LRP. 83. UBS Ex. 293, 272.
Fremont's outside counsel also participated in the email
exchanges by which Mr. Harris was provided with the framework for 28
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the new LRP.
UBS Ex. 292, 293.
84. On the same day that Mr. Jaunich directed Mr. Dias to discard his February 23, 2006 LRP and focus on "transforming" the new business plan, Mr. Harris advised Fremont's outside counsel by email that, after having "mulled over" the issues they had
privately discussed in the preceding days, Mr. Harris had figured out a way to "assist" Fremont (not Nellson) in the valuation process. UBS Ex. 274, 276, 13, 67.
85. Soon after, and following Mr. Jaunich's instruction, Mr. Dias capitulated to Fremont and sent the Board a re-worked agenda for the March 16 Board meeting that, according to Mr. Dias' email, "cut out 99% of the `Long-Range' financial tweaking," and instead focused the presentation on "transformation/new ideas" for the Company. UBS Ex. 67; Trial Tr. 9/15/06 (Dias) at 488:19-493:14; Trial Tr. 10/10/06 (Jaunich) at 2770:13-2771:10. crucial moment for the Debtors. 86. Rather than present his new downwardly revised February This was a
23 LRP, Mr. Dias instead prepared and circulated a Board pack that asked "How might Nellson be transformed?," and listed various "transformation options" with the lead-in that, "We have known that `transformation' might be essential for Nellson." UBS Ex. 14. 87. A resolution concerning a compensation increase for the senior management team at Nellson, including Mr. Dias and Mr. 29
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Schouten, was also tabled and approved at this Board meeting. UBS Ex. 14; Trial Tr. 10/05/06 (Lenihan) 2490:18-2495:14. G. The May 2006 LRP 88. Having capitulated to Fremont's demands, Mr. Dias and Mr. Schouten continued to work with Mr. Lenihan and Mr. Halow over the next two months to develop a new long-range plan which, as desired by Fremont's Mr. Lenihan, Mr. Halow and Mr. Jaunich, would layer "transformation" concepts onto a base business plan. UBS Ex. 13, 14, 67, 89, 100 at p. D010366, 272, 503; 9/18/06 (Schouten) at 864:1-867:14; Trial Tr. 9/18/06 (Schouten) at 729:2-11, 731:20732:2; Trial Tr. 9/15 (Dias) at 447:19-23. 89. Despite Mr. Dias' previous warnings as to the dangers of
"layer(ing) on initiatives in a way that engenders expectations of an unrealistic future", the May 2006 LRP was prepared in precisely this fashion. And unlike earlier "bottoms up" LRPs which had been
comprehensively researched and vetted with exhaustive customer research and planning sessions, the May 2006 LRP was hurriedly prepared without the same level of customer or operational analysis as occurred for earlier plans. In fact, Mr. Schouten admittedly
did not even begin work on the May 2006 LRP until mid-April 2006. And, as of mid-April, mere weeks before the May 2006 LRP was finalized, Mr. Schouten and Mr. Dias still had not decided which "growth ideas" to layer onto the base business plan. 30 As Mr.
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Schouten explained in an email, having identified a base plan model, the "next step is to create a simple layering in of growth initiatives (this is easy except we have to decide which ones, how much and when)." Trial Tr. 9/18/06 (Schouten) at 841:22-842:19; Trial Tr. 9/15/06 (Schouten) at 615:12-619:21; Trial Tr. 9/21/06 (Cudahy) at 1263:8-1265:1; UBS Ex. 90. 90. Fremont (particularly Mr. Lenihan and Mr. Halow) was
actively and heavily involved in the preparation of the May 2006 LRP in that Fremont dictated the overall framework of the new plan (i.e., a base plan with growth initiatives layered on), and had extensive meetings and conversations with Mr. Dias and Mr. Schouten in regard to the May 2006 LRP. See UBS Ex. 22, 66, 100, 154, 172, 173, 244, 245, 272, 293; Trial Tr. 9/18/06 (Schouten) at 859:7860:18; 863:21-867:8; Trial Tr. 10/05/06 (Lenihan) at 2532:222533:20; 2536:13-2537:13; 2538:15-2540:21. 91. Ultimately, when the May 2006 LRP was provided to the experts in this case, it contained significantly higher revenue and EBITDA projections than either the December 2005 or February 2006 LRPs. The forecasts contained in the May 2006 LRP as contrasted
with those from the December 2005 LRP, are as follows:
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MAY 2006 LRP
`06
`07
`08
`09
`10
`11
NET SALES
MAY 2006 LRP
314
333.2
340.5
374.4
412.9
432.7
DEC. 2005 LRP
316.8
320.7
319.9
338.0
332.4
N/A
VARIANCE
(2.8)
12.5
20.6
36.4
80.5
N/A
EBITDA
MAY 2006 LRP
43.2
45.6
45.8
51
58.7
62.1
DEC. 2005 LRP`
45.6
46.9
44.5
47.2
49.8
N/A
VARIANCE
(2.4)
(1.3)
1.3
3.8
8.9
N/A
UBS Ex. 503, 8 & 9. 92. There is no evidence to support the sudden optimism of Despite claims by Mr. Schouten and Mr. Dias that needed a "total rewrite" because of the
the May 2006 LRP. the long-range
plan
purported "turnaround" at the Company and because the assumptions being used in previous LRP iterations were "quickly becoming old," this was not true. In reality, the business was struggling at the
time Mr. Dias and Mr. Schouten were discarding the February 23,
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2006 LRP in favor of Fremont's new "stretch" plan scenario.
Mr.
Dias' own internal emails and letters reveal that, in the interim between the February 23, 2006 LRP and the May 2006 LRP, the market continued to show weakness, price compression risks continued to rise, Nellson continued to face the ever-present risk of losing customers to competitors (from their highly concentrated customer base), and even as late as May 3, 2006 (days before the May 2006 LRP was finalized) sales lagged behind what was needed for a successful year. Mr. Dias also acknowledged that the May 2006 LRP
was built using the same basic categories of assumptions from prior iterations. UBS Ex. 17, 88, 89, 111; Trial Tr. 9/14 (Dias) at 240:6-13; Trial Tr. 9/15/06 (Dias) at 445:11-448:9, 507:10-509:18; Trial Tr. 9/18/06 (Schouten) at 802:4-13. 93. Mr. Dias' February 23, 2006 letter to the Board showed that management did not need a fresh look at the business or "a total rewrite" of the Plan. On the contrary, his letter shows that
the February 23, 2006 LRP was exhaustively researched and up-todate (a rigorous "bottom's up" analysis like the September,
November and December 2005 LRPs before it), and that management had the utmost confidence in this plan based on a thorough
understanding of the business. Board that:
In this regard, Mr. Dias told the
33
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"Since then we have closed the year, generated intense contact with customers and suppliers, negotiated pricing and contracts with several mid-sized customers, gotten the initial experience with BK, and have insight into the business through February . . . . [¶] Obviously, the EBITDA line is not where we [Mr. Dias and Mr. Schouten] want it to be, but it does reflect specific changes and forces we understand quite well." UBS Ex. 11. 94. Meanwhile, as they adhered to Fremont's orders to create
a new puffed-up plan that layered growth ideas on top of the base business, their own concerns about continued poor performance led Messrs. Dias and Schouten to recommend yet another downward
revision to the budget and projections in April 2006 (just a month before the May 2006 LRP was issued). Specifically, Mr. Dias wrote
to the Board on April 3, 2006, recommending that the Board lower the 2006 budget goals that had been discussed at the March 16th Board meeting as a result of new customer intelligence, a "slower market," and the "dominant risk" of price compression which "keeps our management up at night." He wrote that approval of his higher
"stretch plan" budget, as the Board indicated at the March 16, 2006 meeting, would leave a $23 million revenue gap in the budget. Mr.
Dias proposed a base revenue goal of $305 million and EBITDA of $41.05, with the previous goals suggested at the March 16 Board Meeting of revenue $314 and EBITDA $43.02 being relegated to
34
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"stretch" goals. UBS Ex. 17, 18; Trial Tr. 10/05/06 (Lenihan) at 2511:8-2521:23. 95. Mr. Dias' recommendations were overruled by the Fremont
Board representatives Messrs. Lenihan, Jaunich and Debrowski, who, through their control of the Nellson Board, imposed a higher budget of revenue $314 million and EBITDA $43.2 million on the Company over Mr. Dias' objection. Mr. Dias was furious at the imposition
of what he regarded as an unachievable budget for 2006 and, in his last act of defiance, he abstained from the vote "indicating that there is a gap of about $23 million in revenue versus what customers have currently planned." UBS Ex. 149; Trial Tr. 9/14/06 (Dias) at 499:6-500:20; Debrowski Designated Tr. at 139:6-140:14; Trial Tr. 10/05/06 (Lenihan) at 2521:2-23, 2521:24-2522:4. 96. At Mr. Lenihan's request, Mr. Schouten's draft minutes of
the meeting which recorded the reason for Mr. Dias' abstention were later amended so as to eliminate any record of Mr. Dias' views as to the unreasonableness of the budget. UBS Ex 109, 19, 149; Trial Tr. 10/05/06 (Lenihan) at 2524:23-2526:17. 97. None of the remaining experts in this case (all of whom
used the 2006 budget numbers in their valuation analyses) were ever told that the 2006 budget was not management's best recommendation but instead had been imposed on them by the Board. Trial Tr.
10/12/06 (Belinsky) at 2974:23-2975:2; Trial Tr. 11/09/06 (Braun 35
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Testimony)
at
3410:23-3411:21,
3420:17-23;
Trial
Tr.
11/17/06
(Hardie) at 3859:19-3860:15.3 98. The significant increase in the projections for Nellson's
earning potential contained within the May 2006 LRP as compared with management's previous plans, is largely based on the
"transformational ideas" resurrected at Mr. Jaunich's direction for the March 16th Board meeting and layered onto the base business. Mr. Schouten conceded that this structure of the May 2006 LRP was precisely the same framework as the "stretch" plans he had
presented to Fremont in September 2005 and November 2005. UBS Ex. 8, 9, 14 & 503; Trial Tr. 9/18/06 (Schouten) 726:23-729:1; 775:8779:11. 99. business The May 2006 LRP drives revenue above and beyond the base revenue by relying on two "growth ideas" that are
generally described as being (a) a new line of breakfast items, with the lead option being a powder product, and (b) qualifying a private-label in Canada. UBS Ex. 503; UBS Ex. 15 at D-000362-369.4 100. Neither idea has progressed beyond a conceptual stage and there are no orders for any products falling within either growth idea. Trial Tr. 9/18/06 (Schouten) 694:20-695:7; Trial Tr. 9/19/06
3 The valuation report and testimony of the Debtors' expert was previously excluded by the Court as unreliable under Fed. R. Evid. 702. See Order of the Court dated November 29, 2006 (Docket No. 854).
Certain details of the "growth ideas" are not set forth herein pursuant to the Confidentiality Order.
4
36
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(Jagiela)
at
1074:11-14,
1080:16-20,
1095:8-1098:3;
Trial
Tr.
9/20/06 (Jagiela) at 1165:22-1166:10; Trial Tr. 9/20/06 (Cudahy) at 1187:14-16, 1235:14-17, 1236:18-20, 1238:8-1240:8, 1248:10-24;
Trial Tr. 9/21/06 (Cudahy) at 1317:19-24; Trial Tr. 10/06/06 (Lenihan) at 2500:8-14; Trial Tr. 10/13/06 (Belinsky) at 3230:143232:17. 101. No market research or customer surveys were prepared in connection with the inclusion of the "growth ideas" in the May 2006 LRP and no effort was made to determine whether any appetite for these "transformational ideas" existed in the market. Trial Tr. 9/15/06 (Dias) at 548:2-13; Trial Tr. 9/20/06 (Cudahy) at 1233:120, 1238:8-1240:8, 1242:8-21; Trial Tr. 9/21/06 (Cudahy) at 1252:81258:17. 102. As for the new powder "initiative" (growth idea #1) of which the powder product was the lead option neither Mr. Jagiela (head of all operations) nor Mr. Cudahy (head of the powder division and the facility where the product would be produced) were consulted on the operational aspects of this idea before its inclusion in the May 2006 LRP. In fact, neither Mr. Cudahy nor Mr.
Jagiela were even aware of the idea until being surprised at the March 16 Board meeting when a prototype was brought in by the R&D department. Trial Tr. 9/19/06 (Jagiela) at 1048:11-15; Trial Tr. 9/20/06 (Cudahy) at 1233:1-6. 37
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103. Nellson's CEO Mr. Dias told the experts that the "growth ideas" upon which substantial revenue in the new business plan are based are "more risky" than Nellson's base business. The added
risk is attributable to the fact that the growth ideas are still new and untried in the market, without any established sales or customers to speak of, and consumers have shown no inclination that they embrace the new ideas. Trial Tr. 9/28/06 (Harris) at 1760:1419; Trial Tr. 10/11/06 (Belinsky) at 2915:9-20. 104. Mr. Dias and Mr. Schouten claimed that they had
discounted the revenues and margins assigned to the growth ideas in the May 2006 LRP. Neither Mr. Dias nor Mr. Schouten could point to
a single document demonstrating a so-called discount being factored into the assigned revenues. Rather, they assigned revenue and
margin numbers for the growth ideas in their own minds, out of thin air, and then discounted them in their own minds, without input from the R&D department, head of powder division, sales department, or head of operations. Trial Tr. 9/18/06 (Schouten) at 685:3-688:6; 695:8-12; and Trial Tr. 9/14/06 (Dias) at 317:3-323:19; 381:5385:7). 105. In addition to these risks specifically facing the growth ideas, price compression and customer concentration remain material risks to all Nellson's future forecasts. Trial Tr. 9/15/06 (Dias) at 446:4-7, 474:5-9; 496:9-498:2; UBS Ex. 9, 17, 59, 60, 61, 64, 38
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83, 84, 167. 106. Nellson's recently successful "soup in a bucket" product is not a "growth idea." The product does not even fit Mr. Dias' According to Mr. Dias, the base
own definition of a "growth idea."
business items in the May 2006 LRP are items that require little change to the business model, and includes bars and powders with existing customers and growth from those existing customers based on conversations and input from those customers. Dias defined a "growth idea" as a product By contrast, Mr. that applies the
Company's existing skills, strengths, and capabilities but which also: (a) leads to "a change in the business model"; and (b) "requires moving beyond what the company has traditionally done in its base business." Trial Tr. 9/14/06 (Dias) at 264:23-266:13; 296:10-297:19. 107. To Mr. Schouten, a growth initiative meant to him a new product that required a new and different delivery system for example, they have bar and powder right now, and maybe the company gets into a liquid format or something like that. Trial Tr. 9/18/06 (Schouten) 783:21-784:6. 108. Mr. Jagiela, head of Nellson's operations, admitted that the "soup in a bucket" product has caused no change to the business model, as required by Mr. Dias' definition, and that Nellson has been producing a powdered soup product for a long time as part of 39
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its regular base business, with the only difference being that they are now taking the individual packets of soup and hand-packing them into "buckets" for a particular customer. Mr. Jagiela said that
"soup in a bucket" is not transformational for Nellson, but is just an extension of Nellson's existing business. And Mr. Schouten
admitted that the product resulted from the sales force receiving a specific request from an existing customer. Tr. 9/19/06 (Jagiela) at 1095:14-1098:3; Trial Tr. 9/18/06 (Schouten) at 771:21-771:24. 109. The May 2006 LRP also includes for the first time a new revenue category called "unallocated revenue." UBS Exs. 218, 503. 110. The Board's rejection of Mr. Dias' budget recommendation at the April 7th meeting created a $23 million gap in revenue in the May 2006 LRP. Yet, rather than reduce the revenue numbers
throughout in the May 2006 LRP, Mr. Dias admittedly "invented" a new revenue category called unallocated revenue. Mr. Schouten
admitted this is revenue that is "not underpinned by any specific action plans for any specific customer." The evidence shows that
this category was created solely to preserve the higher numbers in the Plan. In an April 17, 2006 email to Mr. Schouten, Mr. Dias
explicitly states that the purpose was "to preserve the [$314 million] net sales number" in the 2006 budget. Mr. Dias conceded
that both his use of unallocated revenue and his spreading of powder sales proportionally by customer to reach the $52 million 40
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projection for powder were "top-down" approaches. UBS Ex. 92, 111, 149; Trial Tr. 9/18/06 (Schouten) at 845:13-17; Trial Tr. 9/14/06 (Dias) at 268:21-270:3; Trial Tr. 9/15/06 (Dias) 528:22-530:13; 535:9-18, 539:16-543:18. 111. During the week that the May 2006 LRP was produced, Messrs. Dias and Schouten suddenly eliminated millions in projected capital expenditures in only the terminal years of the LRP without any input from Mr. Jagiela. The capital expenditure in the
terminal year was vitally important to Mr. Harris' modifications to the Discounted Cash Flow analysis. This is despite the fact that,
as Mr. Jagiela admitted, he is the only person at Nellson with the expertise to construct such a detailed capital plan. Not a single
witness at Nellson could offer a credible explanation as to why the capital expenditures were suddenly reduced. The head of
manufacturing and operations, Mr. Jagiela, who had prepared capital plans for more than 20 years, first sent his capital plan for Nellson to Mr. Schouten on October 5, 2005 for inclusion in the Nov. LRP. He stood by the same Cap Ex numbers for seven months and
re-sent the same basic plan to Schouten on April 12, 2006 for inclusion in the May 2006 LRP. The last minute reduction in
terminal year Cap Ex which was initiated by Mr. Schouten and Mr. Dias greatly assisted Mr. Harris in his valuation number that the Court has now excluded. Trial Tr. 9/19/06 (Jagiela) at 1105:141
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1118:14; Trial Tr. 9/18/06 (Schouten) at 860:20-864:12; UBS Ex. 24, 25, 72, 98, 100, 129, 503. 112. The $6 million figure for Cap Ex projected in the terminal year of the May, 2006 LRP is a highly speculative and questionable number the lowest Cap Ex figure in the Company's recent history. Trial Tr. 9/28/06 (Harris) at 1848:6-1851:21; Trial Tr. 9/29/06 (Harris) at 1933:19-1934:7; Trial Tr. 9/18/06
(Schouten) at 867:15-870:12; Trial Tr. 9/19/06 (Jagiela) at 1054:11055:1, 1143:1-1145:23. 113. In the event that sales of any of Nellson's
"transformational ideas" are made, there is insufficient CapEx in the May 2006 LRP to support them. UBS Ex. 283; Trial Tr. 9/28/06 (Harris) at 1799:9-12; Trial Tr. 9/18/06 (Schouten) at 870:3-880:3; Trial Tr. 10/13/06 (Belinsky) at 3241:8-3244:11. 114. This reduction in Cap Ex was instigated by Mr. Lenihan of Fremont. Mr. Schouten and Mr. Dias met with Mr. Lenihan and Mr. Mr.
Halow for hours on April 26, 2006 to discuss the new LRP.
Schouten memorialized Fremont's input from this meeting on the first page of his May 1, 2006 draft LRP. Among Mr. Schouten's
notes, which reflect the thoughts and input from Mr. Lenihan and Mr. Halow, is an item entitled "capital," which says that Nellson should "think about shoving around the mix required of base
business maybe less than $8m." 42
The very next draft of the LRP
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that was circulated by Mr. Schouten on May 9th (three days before the final LRP was issued) reduced the Cap Ex in years 2010 and 2011 from the $8 million levels in Mr. Jagiela's capital plan to $6 million. See UBS Ex. 100; 25; Trial Tr. 9/18/06 (Schouten) at 860:20-865:24. 115. Another manipulation occurred within days