by Just two days before Election Day, on Sunday, and fairly late in the day, the Franchise Group filed for Chapter 11 bankruptcy protection with a rather tidy document that makes the Conn’s Chapter 11 filing look like War and Peace.
I didn’t even know you could file on a Sunday. Who’s even at the courthouse? Do they have an ATM?
Well, since then, we have learned quite a bit more about FRG’s difficulties, which include just a hair under $2 billion in reported debt, and about their restructuring plan. More than 100 additional documents have been added to the docket in the four days following the initial filing, most of them pedestrian and none of them rejecting the key aspects of the restructuring agreement. The court has approved, among other things, the continuing operation and administration of customer loyalty programs, payments to vendors, pre-petition obligations, FRG’s cash management system and inter-company transactions.
This train is going forward.
To understand the restructuring agreement, it was important for me to appreciate that FRG is not your traditional parent company. A collection of consumer brands, FRG comprises quite a number of company-owned stores as well as franchised locations numbering in the hundreds. Just what is going down and what might survive long enough to live on under new owners is, of course, a big question in filings like this.
Specifically, the FRG portfolio includes Buddy’s Home Furnishings and American Freight, both furniture retailers, as well as Pet Supplies Plus and The Vitamin Shoppe. Combined, these holdings represent 2,200 retail locations and nearly 12,000 employees, according to the filings.
As we reported Sunday night just a couple of hours after the filing, under the restructuring agreement, all of FRG’s brands will continue except for American Freight, a 357-store chain in 40 states that almost immediately, on Election Day, began its GOB sales. A likely reason American Freight faced such an abrupt and comprehensive fate is the big disparity in who owns the stores. FRG operates 344 of those 357 locations, with only 13 run by franchisees. FRG had control, in other words. And rumors of an American Freight bankruptcy had been circulating since FRG’s sale of Badcock to Conn’s in December. The shutdown affects about 3,000 employees.
“The debtors concluded that American Freight’s limited amount of profitable store locations could not support the rightsizing of its business through a plan of reorganization,” according to an affidavit from David Orlofsky, FRG’s appointed chief restructuring officer.
Back of the baseball card
As part of the restructuring agreement submitted by FRG, its lenders now are in charge, and one of their first moves was to bring on AlixPartners, an affiliate of AP Services and a restructuring and turnaround firm. Orlofsky is managing director of AlixPartners, and industry watchers will remember him from his tenure as COO and CFO at Malden Mills.
Orlofsky has been hired to restructure, forecast cash management and liquidity, revise and otherwise develop FRG’s business plans, and engage with creditors and stakeholders.
We’re all watching RTO specialist Buddy’s Home Furnishings, which is sort of the opposite of American Freight in its ownership ratio: 34 company-operated stores and 300 franchised locations.
FRG’s Vitamin Shoppe combines 680 company-operated stores and just 20 franchisee-operated locations. Pet Supplies Plus and Wag N’ Wash represent 240 locations each.
The rationale
Orlofsky’s affidavit provides a rationale for the bankruptcy, one that pairs what has become a litany of “headwinds” faced by most of retail (post-pandemic dips in demand, consumers holding on tighter to their discretionary income, inflation and rising interest rates) with a few insights and what we might even call candor.
In the affidavit, Orlofsky acknowledges that these macro trends “together with the allegations against [erstwhile FRG CEO Brian] Kahn, adversely impacted Franchise Group’s ability to sell or otherwise monetize any of its other businesses, which in turn meant that Franchise Group could not deleverage its balance sheet and reduce the related liquidity and cash flow burdens associated with its high debt level.”
Just as FRG was moving to divest Badcock and address its debt and liquidity problems, FRG was “suddenly rocked by the allegations that its then-chief executive officer, Brian Kahn, was involved in the demise of Prophecy Asset Management,” Orlofsky’s affidavit states.
On Nov. 23, 2023, the SEC filed a complaint against John Hughes, president and chief compliance officer of Prophey. At that same time, FRG “learned that Mr. Kahn was one of two unindicted co-conspirators referred to in both the [SEC’s] complaint and the indictment,” the affidavit states.
This is one of the clearest statements yet of just when and how FRG learned of the SEC’s interest in Kahn, who stepped down as CEO of FRG just two months later, or just after a law firm hired by FRG concluded that “no one at Franchise Group (including its current or former board members), had any involvement with, or knowledge of, Mr. Kahn’s alleged misconduct,” according to Orlofsky’s affidavit. The two-month investigation conducted by Petrillo Klein Boxer reviewed approximately 18,000 documents and included nine interviews with executives.
Badcock hangover
Orlofsky also expresses concern that because FRG is the guarantor for Badcock’s leases following the sale of the Badcock chain to Conn’s, further litigation could become a factor in FRG’s own Chapter 11. (Conn’s-Badcock filed for bankruptcy in July.)
“The rejection of one or more of the Badcock lease agreements in Conn’s Chapter 11 cases could potentially result in the landlords under such agreements asserting claims against Franchise Group pursuant to the lease guaranty agreements,” Orlofsky states in the 61-page affidavit.
Now 63 years old, the RTO specialist Buddy’s Home Furnishings chain should weather this latest storm, if published reports of its sales and growth trends are accurate. The RTO sector in general appears to be healthy, with annual growth of about 7% projected out as far as 2030, according to Grand View Research.
Buddy’s focuses on offering flexible payment plans; name-brand furniture, appliances, and electronics; and national retail name brand recognition. About nine of every 10 Buddy’s franchisees are multi-unit owners, according to its website, with the average portfolio numbering 10 stores.
There are at least two creditors that oppose the restructuring agreement: Pacific Investment Management and Irradiant Partners. Combined, the two are owed more than $600 million and, as second-lien loaners, each claims that the agreement offers no provision for repayment of these loans.
The Left Coast
So, that’s the news from Delaware. Checking in on Los Angeles, we find that B. Riley CEO Bryant Riley sent an email to employees expressing dismay at the FRG filing, according to a report from Bloomberg, citing a regulatory filing.
Riley was instrumental in arranging the $2.6 billion buyout of FRG by its management team, including and especially Kahn, a deal that gave B. Riley a 31% share in FRG and, therefore, made it also a victim of the collateral damage of FRG’s inability to pay down its sizable debt. That nearly one-third share made B. Riley FRG’s largest shareholder.
I’d feel personally sick, as well, if I woke up Monday morning to a $120 million impairment just as I am trying to salvage my company by selling off divisions and subsidiaries and just a few months after suspending my dividend to shareholders because I expected FRG-related write-downs of as much as $475 million.
“This is not the outcome we ever envisioned,” Riley wrote in his email. “I feel personally sick about this result.”
Riley’s email points to some of the same problems faced by FRG that Orlofsky highlights.
“The [B. Riley] investment [in FRG] was devastated by the precipitous decline in consumer spending in the markets served by the FRG brands,” Riley wrote, as well as by “the fallout and uncertainty from the Prophecy scandal and the related federal investigation into Brian Kahn.”
More investigations?
Echoing in some ways the claims made by ex-shareholders in their lawsuits, FRG’s law firm Petrillo Klein Boxer, one with expertise in white collar criminal investigations, internal investigations and regulatory enforcement, also is conducting an investigation into what Kahn and Riley knew and what they shared with shareholders in both their companies relating to the take-private buyout, the purchase of Badcock and the sale of Badcock two years later. This second, separate investigation initiated by FRG began last month in anticipation of the Chapter 11 filing, according to the affidavit.
Specifically, the investigation is looking at “potential claims and causes of actions that the debtors’ estates may have against Mr. Kahn, any of their other current or former directors and officers, or any other third parties arising from, or related to, among other things: (i) Franchise Group’s sale of Badcock to Conn’s in December 2023; (ii) the Take-Private Transaction; (iii) the FRII acquisition and any other transactions involving [B. Riley] and its affiliates; and (iv) the debtors’ historical transactions and relationship with Mr. Kahn,” according to the affidavit.
As part of this investigation and the bankruptcy proceeding, depositions have already been motioned, as the docket shows. It’s now a de facto race to see which investigation or judicial proceeding first gets to the truth, if the truth is, in fact, accessible. The race’s entrants: SEC, DOJ, Office of the Attorney General of New Jersey, at least two class action lawsuits, and now Petrillo Klein Boxer and the U.S. Bankruptcy Court for the District of Delaware.
Bonuses paid to the principals
Finally, it’s worth noting that, according to the filings, FRG paid company “insiders” nearly $6 million in bonuses to retain them in bankruptcy, though no names are listed. By doling out these bonuses before the filing, they aren’t subject to approval by creditors or the bankruptcy court. Another $2 million-plus went to key employees, also in bonuses, to incent their retention, as well.
