Bellying Up to the Barr
By Christian Doering
Marketing Partner
Dynamic Market Systems

Mixed Reactions to Alesis Financial Woes
by Bruce Borgerson

Why did Alesis Go Chapter 11? (Talkback)
by Christian Doering

Say it ain't so, Joe

It can happen to the best and the biggest. It's not supposed to happen to the brightest, but it does. On April 27, Alesis joined Orange County, California, Pacific Gas & Electric and MXR (which Alesis owner Keith Barr co-founded, back in the day) by filing a Chapter 11 bankruptcy petition with the Honorable Sheri A. Bluebond, United States Bankruptcy Judge for the Los Angeles Division of the Central Court of California. Ch. 11 allows the petitioner to continue operating its business while negotiating to minimize the creditors' losses. Last Friday, May 11, Judge Bluebond approved the petition, allowing Alesis to go on the auction block May 23, 2001 in United States Bankruptcy Court, Courtroom 1475, 255 East Temple Street, Los Angeles, CA, 90012. If you think you might like to own the company that built the project studio market (along with Digidesing, Mackie, Steinberg, Soundcraft / Spirit, and others) by developing its main enabling technology, the ADAT, contact Alesis attorney Bennett Spiegel at Wynne, Spiegel, Itkin, 310-551-1015. And get ready to write a check for at least $12 million.

The auction is a formality of the Ch. 11 process, and the real price tag for Alesis appears to be somewhat less than $12 million. But even on the verge of ceasing operations, Alesis is still worth quite a lot to the right person (who happens in this case to be Jack O'Donnell, the largest investor in Numark). The ADAT's nine years old, but Alesis managed to sell $45 million worth of 48 products last year anyway. It had some of the hottest introductions of the AES/NAMM season, like Air FX. So how did Alesis go belly up? You can read the legal filing by paying Lexis or Dun & Bradstreet for a copy, and come to your own conclusions.

Tripods are supposed to be stable…

Having read what the lawyers put down on paper, I think Alesis was built to be quite profitable with sales of around $80 million a year (the company's best year was 1996, when the sales force posted $88 million to the top line and operating income reached $10 million before depreciation). Keith Barr invested heavily in vertical integration, setting up Alesis Semiconductor to fabricate the chips that are the heart of many Alesis Studio Electronics products, and moving ADAT production offshore to Shinco Technology Limited. Shinco, a Hong Kong limited company, has an association with a Chinese factory and is 99% owned by Alesis Holding Corporation (Barr personally owns the other 1%).

Although Alesis Studio Electronics, Alesis Semiconductor and Alesis Holding Corporation are legally separate, they make up one three-legged business operation. Alesis advances operating funds to both Holding and Semiconductor and is the largest customer for the products of both companies. All three entities have the same officers and directors, and all three pledged their assets as security for a $15 million line of credit granted by Bank of America Business Credit in June 2000, representing an advance of 15% on raw materials, 96% on finished goods, and 85% on accounts receivable. (Amazing how much inside info becomes available when a company gets into trouble, isn't it?)

Like the huge sheets of plastic covering the steep slopes next to some very expensive SoCal homes, the B of A credit line was meant to stop the ground underneath Alesis from melting away in the next storm. The three-company structure, built on expectations of $80 million a year in sales, was on very shaky footing: it's breakeven point might have been somewhere around $60 million in sales, but Alesis closed its last fiscal year on July 31, 2000 with only $45 million on the top line. As one contributor to gas-station.com's Alesis Andromeda thread stated, " I imagine most of the people that want a Midiverb IV or 3630 have bought one, the Masterlink is an interesting concept, but too easily duplicated with a low cost computer. I'm pretty sure ADAT sales had slowed to a trickly [sic], I mean you could by [sic] an LX for a grand, but then that's three grand for 24 tracks, you might as well shoot higher and get a MX-2424 or the Mackie HDR-24." To make matters worse, "inadequate controls over the Company's research and development kept overhead high, and Alesis terminated more engineering projects than it fully developed from 1997 to 2000." (That's from the bankruptcy report).

The erosion in sales was felt in the warehouse: Alesis had to write off more than $3.5 million of inventory. Like Cisco, they had built and warehoused more products than they were ever going to sell. Unlike Cisco, Alesis was not sitting on a huge pile of IPO cash, and had not staffed its finance department with some of the more creative accountants in the developed world. The B of A credit line, linked to finished goods, was chopped to $7.5 million. Every cent of that money has since been burned through, despite staff reductions from 260 employees to less than 70.
The Alesis tripod was now standing right on the edge of a revenue sand cliff, and the retailing rain was getting worse. In the unvarnished language of the Ch. 11 filing, "For the first six months in the next fiscal year, sales continued to decline as the Company continued to incur high engineering and manufacturing expenses while preparing new products for release. Because the Company failed to meet its sales projections, it offered its customers discounts, and its gross profit margin dropped. Meanwhile, its accounts payable grew, and its unpaid vendors refused to ship the Company more goods."

Hey kids, we could put on a show!

In an April 4 press release on Harmony Central, Alesis VP of Sales & Marketing Jim Mack put it more optimistically: "A very aggressive new product plan coupled with slower than expected sales of our current line have forced us to make targeted cutbacks in order to secure our position in the marketplace. These streamlining efforts, while unfortunate, guarantee the necessary resources for a strong product launch later this spring." That product plan was indeed aggressive. From the XT:c digital reverb to the ADAT, Alesis has been known for breaking price points that barred musicians from using the high tech tools of the "real pros" in the business. When the company finally realized that there was no more milk left in the ADAT cash cow, Alesis stormed back to the drawing board, announcing 14 new products at AES 2000 and NAMM 2001 (a couple of months after NAMM, when it became clear that they couldn't actually ship the HR Pro Drum Kit and the Vipre All-Tube Mic Pre, Alesis returned them to their developers, HART Dynamics and Groove Tubes).

The attempt to "engineer itself out of its financial hole," however, only brought the rain down harder. Lending a poignant twist to "Not Available Maybe March" (one possible expansion of NAMM), Alesis carried almost $4 million in back orders into April 2001. When vendors won't ship you any more parts, you can't ship the products you've sold. At the time of the filing, Alesis was "out of formula" by at least $1 million on its credit line (the formula, 15% of raw materials, 96% of finished goods and 85% of accounts receivable, totaled up to less than $6.5 million). B of A has refused to advance any more cash, and in fact sweeps receivables every day, after which it decides how much of an allowance Alesis has to live on until tomorrow.

Do you know Jack?

By that time, the Numark purchase deal was almost complete, even though Barr and his management team didn't begin looking for outside help until February 2001, which is when B of A told them to hire an investment banking firm. Alesis dutifully entertained proposals from two prominent investment banking firms. But when Bank of America declined to guarantee their fees, the investment bankers declined to find a new equity investor or a purchaser.

After wasting time on the investment banker search, Alesis executives had to begin discussing the impending failure of one of the industry's brightest stars with anyone who might be able to help. Over 50 companies and individuals heard some of the bad news, and anyone who expressed interest in putting up some cash got to see the books. After the requisite hanging out of underwear, eight "serious discussions" were held with prominent MI/pro audio companies and a venture capital firm.

While the stars of its current "Re-Evolution of Music" campaign are the Andromeda analog synth, the ADAT HD24 hard disk recorder and the ProLinear 820 Customizable DSP studio monitors, in the end it was probably Air FX that saved Alesis from tumbling over the cliff into Ch. 7 bankruptcy. Rockford, Digidesign, Phoenix Gold, and Samson declined to bid, while Blue Capital's proposed "equity infusion" was dependent on a lengthy due diligence process for which there was no longer time. Apparently Fender's offer was also too little and too late. The auction came down to a pair of DJ gear companies, Stanton Magnetics and Numark. Jack O'Donnell, the largest single investor in Numark, was the high bidder, possibly because Stanton already has a deal with KORG to incorporate its KAOS pad into Stanton mixers. The deal with Jack O'Donnell was signed on April 20 and a week later Alesis' attorneys were in bankruptcy court.

Why good companies go Chapter 11

The legal filing makes it clear that the sale of Alesis to Numark is contingent on the court's approving the bankruptcy petition in its current form. Apparently none of the purchasers were ready to assume all of Alesis' debts, which now total almost $16 million. If the court agrees to hold a hearing by May 25, and accepts the proposals in the petition, Alesis assets and liabilities will be transferred to a Delaware corporation called Alesis Distribution, Inc. The line of credit with Bank of America is $7.5 million, and since B of A supports the petition, we can assume that if the deal goes down Jack O'Donnell will pay off enough of that amount to satisfy B of A. How many cents on the dollar will B of A wind up with? That depends on what the negotiating parties thought that Alesis assets would bring at auction, and how badly Jack O'Donnell wants to put Air FX into Numark DJ Mixers.

There are other items in the purchase negotiations, too. Keith Barr has put up $1 million to keep Alesis running until the sale is complete, and he wants that money back as soon as the business is sold. Alesis Distribution will issue a promissory note of up to $2 million, which covers up to $250,000 in lawyer's fees and other cash expenses of the transaction, plus the acquisition of Shinco, the Hong Kong manufacturing company.

Meanwhile, Alesis's unsecured debts exceed $6 million. That's why attorneys Bennett L. Spiegel And Christopher W. Combs of Wynne Spiegel Itkin were down at the Edward R. Roybal Federal Building on April 30th, petitioning the honorable Sheri A. Bluebond for relief under Ch. 11 of the Federal Bankruptcy Code. More than 400 creditors can expect to receive "partial payments on account of their claims" after the sale under Ch. 11. Jack O'Donnell's Numark Corporation already does business with many Alesis suppliers, so Alesis Distribution, if and when it becomes the new owner, can offer those vendors a choice: Write off all or most of their Alesis Studio Electronics receivables and book future orders with Alesis Distribution and Numark, or watch a competitor who doesn't have to swallow any outstanding claims walk away with both Alesis and Numark orders. Here’s the rock, there's the hard place: what are you going to do?

Before you answer, remember that B of A would have padlocked the doors and placed auction ads in the LA Times on June 28 if the sale were not complete. A Chapter 7 forced liquidation (the official term for what B of A had promised to do) wouldn't have recovered the $7.5 million, leaving the unsecured creditors with neither their receivables nor any hope of ongoing business from Alesis.

$15 or $16 million is probably about the going rate for a solvent business with a strong brand and $40 million or so in sales (Mackie paid a little more than that for EAW last year, as you can find out from its SEC filing). Depending on how well the various creditors make out, the real price of this deal could end up under $10 million. That's a good bargain, and O'Donnell was willing to loan Alesis $500,000 to get it. That, along with Keith Barr's $1 million, should keep the doors open until the formality of the auction is complete.

It's a lock

Why is the auction a mere bag of shells, you ask? Well, along with a quick decision allowing the purchase deal to stand, Judge Bluebond was asked (and apparently approved) a "break-up fee" of roughly $720,000 payable to Jack O'Donnell if the sale does not go through as planned. Any last minute bidders would have to put up that amount, plus a $500,000 minimum overbid, plus $250,000 in expenses. Chances of that happening? Slim to none.

Alesis plans to continue normal operations at the company during this protection period, according to its release posted on Harmony Central last Friday. Jim Mack, V.P. of sales and marketing, said, “We have maintained the core integrity of the company including the majority of the engineering staff, our manufacturing and sourcing team and our key sales and marketing staff. This will allow us to support most normal operations during this period and to ramp back up to full speed quickly once we’re through this transition. We are working to continue the supply of Alesis products and services and we are poised to begin shipping the remainder of the new products introduced at AES and NAMM.”

“We’re very excited about the agreement with Mr. O’Donnell and what it means for the future of Alesis and our newly introduced product line. While we’ve had to make certain reductions in our operation, we’re confident that in a very short time we will be back to doing what we do best – supplying the market with innovative, high-quality audio products that improve the way people make and record music.”

Let's hope so: the future of the new Alesis remains cloudy at this point. But this time next year, Jack O'Donnell could be looking not only gutsy but also smart for taking that stroll up to the edge of the cliff with his new company.