RECESSION ON THE HORIZON? WHAT IT MEANS TO THE CREDIT AND FINANCE TEAM Christa Hart Senior Managing Director Corporate Finance FTI Consulting Scott Blakeley, Esq. SEB@BlakeleyLLP.com www.BlakeleyLLP.com Orange County | Los Angeles | New York Steven C. Isberg, Ph.D. Senior Research Fellow Credit Research Foundation

Senior Research Fellow Credit Research Foundation Steven C. Isberg, Ph.D. Senior Research Fellow Credit Research Foundation

The Macro-Economy: Major Long Term Trends Consolidation and concentration Process reengineering Manufacturing Back office business processes Interest rates now increasing Rising nationalism leading to trade wars? What are the consequences?

Long term real economic growth has been slowing: the new normal seems to be low growth…

The yield curve is in a flattening cycle: prior flattening has preceded recessions

Wage and salary earnings have been slowing and barely keeping up with inflation

Low growth in wage and salary earnings is related to declining labor productivity…

Manufacturing is no longer as labor intensive as it once was…

The motor vehicle industry is a good example of the impact of technology and outsourcing

One benefit is in the form of lower durable goods price and profits: competition and consolidation have followed…

The benefits of economic growth have not been evenly distributed across classes...

Even so, higher taxes have taken a huge bite out of income, leaving less to spend…

Inflation rates for medical care, food and housing are higher than average…

Housing, health care and food price inflation since 2004…

Nominal and real consumer expenditures on apparel are down (using the clothing CPI)

Real expenditures on transportation are down, in spite of nominal increases

Real expenditures for housing are down…

Real expenditures on health care increase with income class…

Real expenditures on food are down…

Indebtedness is at Unsustainable Levels: Consumer: $4 MMMM; Federal $21.5MMMM

Slow Growth to Recession Likely… Low interest rates, consolidation, high turn to capital have driven stock market Manufacturing and business process reengineering have slowed labor productivity and dampened real wage growth Shifting income distribution and increasing oppressive tax burdens have cut into middle class consumer budgets Combined with heavy government and individual indebtedness, will place a drag on consumer spending and economic growth

Christa Hart Senior Managing Director Corporate Finance FTI Consulting

Impact of Amazon FTI estimates that Amazon North America has a 40% share of total online retail sales compared to 31% in 2016. By 2027, we expect U.S. online sales will approach $1.2 trillion and that Amazon’s share (1P+3P) will be 54% or $626 billion representing a 14.5% CAGR. FTI estimates that Amazon’s total Gross Merchandise Volume (1P + 3P) in North America was $180 billion in FY2017, with 3P sales accounting for nearly 60% of the total. In fact, Amazon’s 3P sales are growing at a considerably faster rate than its 1P sales— perhaps twice as fast. Source: SEC filings and FTI analysis. Seller services include revenue derived by Amazon from stocking, fulfillment and shipping fees and commissions of merchandise owned by third party sellers.

Consumer Prices for Goods Aren’t Moving Much Core consumer inflation is approaching the Fed’s targeted inflation level, mostly due to accelerating prices for consumer services. However, for several major categories of consumer goods, inflation remains tame—either negligible or negative. Source: Bureau of Labor Statistics.

Consumer Confidence Consumer confidence is near its highest levels in almost 20 years, which is important given its historically strong correlation with discretionary spending. However, history also tells us that consumer confidence has previously peaked near current levels prior to the onset of recession. Source: University of Michigan’s Survey of Consumers.

Forecast of Holiday and Online Sales Online sales (excluding auto, gas, food) has grown mid-teens since the end of the recession. Brick & Mortar discretionary sales (GAFO) are now growing at ~3.0% — a nice improvement. Total retail sales growth accelerated to 5.5% and we expect 2018 holiday sales to grow 5.8%. Source: U.S. Bureau of Census Reporting. Brick & Mortar discretionary spending (GAFO category includes General Merchandise, Apparel & Accessories, Furniture & Home, Consumer Electronics, Sporting Goods, and Miscellaneous). E-Commerce is reported separately.

Not Out of the Woods Yet, 22 Likely At Risk In reviewing the performance of 100 U.S. public retailers with sales over $100M, we find that 22 are underperforming. There’s likely a similar penetration in those owned by private equity. Source: S&P’s Capital IQ. Based on unweighted averages.

Scott Blakeley, Esq.

Revisiting A/R Portfolio and Credit Policies in Light of Recession Risk Examine traditional signs of customer defaults and adjust policy accordingly Is credit policy too liberal? Too loose must be formulated within the context of company goals and profit margins Credit, sales and management issues Adjusting policy to signs of customer defaults Using past insolvencies for predictive data points - data points are then run against current profile to further refine portfolio risk

Information Sources to Evaluate Customer Credit Risk

Restrictions on Suppliers Speech Antitrust Considerations Prohibited SP Member Statements Where Customer Placing POs or Supplier Holding POs Agreement not to sell to customer Agreement not to extend terms Agreement not to provide extended terms/workout Agreement to advise suppliers who are not SP members to refuse to sell

The Dynamics of Insiders, Lenders and Personal Guaranties Small- and Mid-sized Customer: lender conditions financing on principal guarantees Principal’s focus is on maximizing the company’s assets to ensure lender is paid in full and guaranty released May include principals ordering more inventory on terms from key suppliers The Debtor’s lender is undersecured

Protocol for Risk Flags Validating the credit risk flags Consider aggregating multiple data sources to confirm original source before taking action Responding to credit risk flags Holding orders and meeting with customers Attempt an in person meeting Converting credit sales to cash Demand written assurance of payment Refuse delivery and demand cash under Article 2 of UCC Stopping goods in transit Reclaiming goods Written demand for the return of the goods Customer divorce and filing suit If customer remains silent and account is not profitable Credit team should consider collectability of and judgment against customer or guarantors before filing suit

Credit Enhancement Decision Tree

Delinquent Account Decision Tree Credit Hold Report to Industry Group Late Penalty Payment Termination of Contract UCC Protections Setoff/ Recoupment Customer Divorce

Chapter 11 Checklist for the Supplier Dealing with Your Prepetition Claim Considering Post-petition Credit Sales Critical vendor Chapter 11 plan Dodging the Preference Preference waiver Trade credit Creditors’ committees

Our Listener’s and our Speaker’s Thank You… CRF would like to Thank Our Listener’s and our Speaker’s Questions?