KIT Digital Files For Chapter 11 Bankruptcy, Plans to Re-Emerge as “Healthier, Focused Company” by IBC 2013

Posted by Joe Zaller
Apr 29 2013

One-time high flying online video delivery leader Kit Digital announced that it has filed a voluntary petition for reorganization under chapter 11 of the United States Bankruptcy Code.

The KIT story has been interesting to watch, and judging by what the company appears to be planning, things are going to a lot more interesting.

According to documents filed with the court, KIT has reached an agreement with three of its largest shareholders, Prescott Group Capital Management, JEC Capital Partners, and Ratio Capital Partners; who are collectively referred to as the “plan sponsor group.”

Under its reorganization plan, KIT will go into bankruptcy, be recapitalized by the “plan sponsor group,” and emerge as profitable, debt-free business with more than 800 employees focused on multi-screen video deployments.

The company plans to shed its loss-making businesses, while retaining four of its profitable subsidiaries, Ioko 365, Polymedia, KIT digital France and KIT digital – Americas. These four businesses will be consolidated into a new company to be Piksel.

According to court filings, these businesses generated aggregate revenues of approximately $134.5 million in 2012.

However, the company said it anticipates that another eight of its subsidiaries “will still need to be wound-down or divested through this chapter 11 case.”

KIT says that at the end of the reorganization process, it expects to emerge as “a healthier, focused company that is poised to take advantage of the burgeoning demand in its industry and to generate significant cash flows after obtaining a financial ‘fresh start.’”

The company also says that this plan will enable it to be in a position to pay all employees, vendors and suppliers for their valid pre-petition claims.

During the time of the reorganization, the company will continue to operate its business as a “debtor-in-possession” under the jurisdiction of the court.

KIT says it plans to be out of reorganization in about 90 days, just in time to launch Piksel at the IBC Show in September.

 

Court filings detail rise and fall

The documents KIT has filed with the court provide insight into what was happening at the company, and ultimately what led to the decision to file for Chapter 11.  It’s fascinating reading.

Selected excerpts follow from the Declaration of Fabrice Hamaide in Support of Debtor’s Chapter 11 Petition

 

The Debtor’s proposed restructuring is the result of an extensive marketing process that began over a year ago after the Debt or suffered a number of significant setbacks that impacted its operations. First, in early 2012, the Debtor accepted the resignation of its then-CEO amid an SEC investigation into certain of his trading practices with respect to the Debtor’s stock. Thereafter, the Debtor’s audit committee uncovered financial irregularities and the Debtor announced that it would need to restate historical financials from 2009 onward, sparking a flurry of securities lawsuits and derivative claims along with attendant litigation costs. Contemporaneously, the company was incurring extensive losses from unprofitable acquisitions made over the prior twenty-four (24) months. While the Debtor’s core businesses were (and remain) profitable and strong, mounting legal expenses and the costs of divesting and liquidating the unprofitable non-core businesses caused the Debtor to experience a near-term liquidity crunch. The crunch became more acute when the Debtor’s prepetition lender, without forewarning, swept the Debtor’s operating account and withdrew approximately $1.1 million.

Recognizing it had a short runway and no audited financials, the Debtor redirected the efforts of its investment banker, Deutsche Bank (“DB”), to assist the company with possible financing or sale alternatives. DB conducted an extensive marketing process over the past year canvassing a wide range of over fifty-six (56) financial and strategic players, as well as possible stand-alone financing options to accompany the Debtor in a chapter 11 process. In addition to DB, the Debtor also retained financing brokers to look into the availability of third-party financing. Although the Debtor engaged in extensive negotiations on non-binding terms with at least two parties, the negotiations ultimately failed to culminate in a binding term sheet either because of the need to provide audited financials or because of extensive requirements for due diligence that represented a substantial execution risk.

In March 2013, the Debtor was approached by a group of shareholders with the terms of a restructuring plan. The Debtor (through a special committee of its independent board of directors) negotiated with the shareholder group, which ultimately included the Debtor’s largest shareholders, Prescott Group Capital Management, JEC Capital Partners (an affiliate of the current CEO), and Ratio Capital Partners (collectively, the “ Plan Sponsor Group ”), on the terms of a restructuring to be backstopped by the Plan Sponsor Group. The special committee’s negotiations culminated in a plan support agreement (the “Plan Support Agreement”), which provides the Debtor with the resources necessary to fund this chapter 11 case and a reorganization plan that is expected to pay allowed unsecured claims in full while also providing a meaningful recovery to the Debtor’s equity holders in the form of the opportunity to participate in the reorganized company. A copy of the Plan Support Agreement is attached hereto as Exhibit A. 7. The Debtor believes the contemplated re organization pursuant to the Plan Support Agreement marks the best opportunity for the Debt or to preserve its global operations and the jobs of its over 800 employees world-wide. It is economically the best proposal the Debtor received through the prepetition marketing process, even including bids conditioned on due diligence. The Plan Support Agreement, however, requires the Debtor to emerge from chapter 11 within ninety-five (95) days of the filing date. Accordingly, to meet the required tight timeframe, contemporaneously herewith, the Debtor has filed a chapter 11 plan with the hope that confirmation of such plan can occur within 90 days of the date hereof

Under the management of its former CEO, the Debtor spent much of the last few years acquiring other companies in an effort to increase its market share in the video technology market. Since late 2008, the Company made 22 acquisitions, taking its revenue from less than $30 million to slightly over $200 million in 2011.  While certain of these acquired businesses have enhanced the Debtor’s operations, others have struggled or posed integration and  operational problems. In total, since May 2008 , the Debtor has paid,  in both cash and common  stock, more than $320 million in connection with acquisitions on its way to becoming an online  video technology powerhouse.  

The time and expense associated with the Debtor’s “buying binge” took a significant toll on the Debtor. Indeed, the acquired businesses that could not be successfully integrated became a significant cash drain on the entire KDI corporate group. Out of a total of $389 million paid-in-capital, $320 million was spent on acquisitions and approximately $60 million was spent operating and then liquidating or winding down unprofitable Subsidiaries. The Debtor anticipates 8 of its Subsidiaries will still need to be wound-down or divested through this chapter 11 case.

In the beginning of 2012, the Company experienced a protracted  period  of upheaval. In April 2012, Mr. Tuzman, the Debtor’s then-CEO, resigned as chairman and CEO after the Debtor’s receipt of subpoenas from the SEC related to certain 2010 transactions purportedly undertaken by Mr. Tuzman in the Debtor’s common stock. Several other Board members and officers of the Debtor, some of which were affiliated with Mr. Tuzman, had also resigned by this time. A securities class action lawsuit, two shareholder derivative lawsuits, as well as other similar litigations were initiated against the Debtor, diverting management time and expense at a critical time for the company.

To address the leadership void left after Mr. Tuzman’s exit, the Debtor made significant changes to the composition of its Board of Directors and its management team. On June 28, 2012, two independent directors, Bill Russell and Greg Petersen, were elected to the Board, and in July 2012, I was brought in as Chief Financial Officer. The following month two shareholder representatives were elected to the Board, Seth Hamot and K. Peter Heiland. Thereafter, K. Peter Heiland was also appointed as the Debtor’s interim Chief Executive Officer, a position he holds today.

The Debtor’s new management team took proactive steps to begin to focus the Debtor’s operations on its core strengths, while cutting costs. Ultimately, management was successful in reducing operating losses from an average consolidated monthly loss of -$7.0 million to -$1.0 million by October 2012. During the same time period, however, the audit committee (the “Audit Committee”) of the Debtor’s Board, after an extensive investigation, uncovered certain accounting errors and irregularities related to recognition of revenue  for certain perpetual software license agreements entered into by the prior management team in 2010 and 2011. The Audit Committee also determined that certain transactions the Debtor entered into under the prior management team during fiscal years ended December 31, 2008 through 2011 were related party transactions and additional disclosure with respect to those transactions should have been included in the footnotes to the relevant financial statements. As a result, the Audit Committee concluded on November 15, 2012, that the Debtor’s financial statements for the years ended December 31, 2009, 2010 and 2011 and each of the three quarters in 2009, 2010 and 2011 would need to be restated.  Because of the need to restate prior periods, the financial statements for the quarters ended March 31, 2012 and June 30, 2012 also had to be amended.

The public announcement of the need to restate the Debtor’s historical financials resulted in a significant decline in the trading price for the Debtor’s stock. Additional litigations were initiated against the Debtor, further diverting management time and expense. In addition, an event of default was triggered under the WTI Loans for breach of a financial representation therein, and on November 21, 2012, WTI, without advance notice to the Debtor, swept approximately $1.1 million from the Debtor’s cash collateral account.

Without reliable financials, the Debtor’s ability to “borrow” out of its near-term liquidity crisis by accessing the capital markets was foreclosed. In addition, the Subsidiaries, although profitable on a consolidated basis, could not continue to fund the Debtor’s mounting legal expenses and regulatory costs.

In February 2012, the Debtor engaged DB to assist the company in identifying sale alternatives. DB conducted an extensive search of financial and strategic players, aggressively canvassing the marketplace to locate potential financial or strategic partners to purchase the Debtor. Although DB contacted fifty-six (56) potential buyers (twenty-five (25) strategic and thirty-one (31) financial), no firm interest in the purchase of the Debtor resulted. Following the conclusion that its financials would have to be restated and the resulting short term liquidity constraints, the Debtor, to preserve its Business, redirected the efforts of DB to find stand-alone rescue financing or potential chapter 11 stalking horse bidders. In addition to DB’s efforts, the Debtor also reached out to specialized financing brokers who contacted over twenty-five (25) potential financing sources for stand-alone financing options. While several parties provided draft term sheets, the Debtor could not move forward with such proposals either because of the need to provide audited financials or because of extensive requirements for due diligence that represented a substantial execution risk. Moreover, despite advancing work fees to two interested parties, the Debtor still failed to obtain a binding commitment from either of those parties that could serve as a basis for a successful restructuring.

Thereafter, the Debtor was approached by a group of shareholders led by JEC, the private equity firm affiliate of KDI’s CEO, with the terms of a restructuring alternative. As a result, and to remove any conflicts of interest in the Debtor’s decision-making, the Board constituted a special committee of its independent directors to consider the shareholder proposal. Among other things, the special committee was charged with overseeing the sales and/or restructuring process from then forward, including the decision to file for chapter 11.

The special committee met numerous times to consider the Debtor’s alternatives. From the outset, the special committee, in an effort to achieve the highest and best result for the Debtor’s stakeholders, pursued restructuring on a dual-track, negotiating with the shareholder group and its then-proposed third-party DIP lender, on one hand, while having DB continue to canvas interested third-parties, on the other. All the while, the special committee was mindful of the Debtor’s dwindling cash position, which I advised them on regularly.

Discussions with the shareholder group stalled in early April 2013, when the group’s proposed DIP lender could not come to terms with the special committee on a path forward for the financing necessary to fund a chapter 11 process. Thereafter, the Debtor, unable to upstream sufficient funds from its Subsidiaries, failed to make a scheduled payment in respect of the WTI Loans on April 1, 2013, triggering an 8-K obligation to disclose the event of default. The special committee faced and prepared for the possibility of having to file chapter 11 without a restructuring plan in place, thereby risking the Debtor’s customer relationships and putting the Debtor’s chances of restructuring in peril. Indeed, if a filing would have happened at that time, the Debtor had sufficient cash in its corporate group to operate in chapter 11 for only several weeks. The Debtor was, put simply, at the end of its rope by early April 2013.

Ultimately, the shareholder group reconstituted itself into the Plan Sponsor Group and proposed terms for restructuring the Debtor, which included a debtor-in-possession financing from an affiliate of JEC sufficient to fund the chapter 11 case.

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Related Content:

Press Release: KIT digital, Inc. Files Previously Announced Plan of Reorganization

KIT Digital: Chapter 11 Plan of Reorganization

KIT Digital: Voluntary Petition for Chapter 11 & List of 30 Largest Unsecured Creditors

KIT Digital: Declaration of Fabrice Hamaide in Support of Debtor’s Chapter 11 Petition

KIT Digital Delisted by NASDAQ, Will Not Appeal

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