The Rocky Path Towards Recapitalisation - December 1995 to 23 February 1996
235 On 11 December, Fogarty telephoned O'Brien at the CBA and thanked him for the CBA's support in relation to the recapitalisation of Exicom. He told O'Brien that he would like to review ERG's relationship with the CBA and while he would give Western Australian business to the principal banker, the National Australia Bank, he would like to talk about the CBA funding both ERG and Simmonds for about $15 million (X462, T950). SPC Warburg wrote to ERG on the same day indicating its continuing interest in underwriting a proposed rights issue for the company (X89).
236 That day also saw the production within ERG of two papers entitled "Exicom Recapitalisation" (X90) and "Exicom Strategy Paper for Exicom Recapitalisation" (X91). Either or both Fogarty and Harley may have had a hand in their preparation (T846/847). The Executive Summary in the Exicom Recapitalisation Report referred to the due diligence exercise undertaken on Exicom by ERG. It summarised the position with respect to Telstra and Nortel and identified other potential areas of revenue growth. There were financial projections attached to both documents. The projections related to earnings before interest, tax depreciation and amortisation (EBITDA). The projection called "Base Case" was identified by Fogarty as "…the one you are assuming you can deliver on" (T849). This, he said, reflected what ERG believed would be the final position if the information it had been provided was accurate. Due diligence was still continuing at the time. The ERG Strategy Paper referred to the price paid for the company as effectively valuing it at $15 million. The company could report an excellent upside opportunity for ERG if profitability could be improved. The forecast numbers indicated the ability to achieve profitability of $10 million per annum which would value the business in the region of $70 million to $100 million. This projection was, of course, based on information to hand at the time. Much more was to emerge with the passage of time.
237 A meeting of ERG directors held on 12 December discussed the recapitalisation proposal and the Exicom Recapitalisation document of 11 December. The minutes noted that "the offer was still a very conditional one with several issues still to be resolved" (X92). Fogarty observed that ERG had up until March 1996, when it had to provide funds to Exicom, to withdraw on the basis of any material adverse change in the business, financial position, profitability or prospects for Exicom from 30 September 1995. The renegotiation of the Villawood lease remained in place as well as other conditions precedent. He reported that the Telstra negotiations were proceeding well and the contract was almost in its final form.
238 On 13 December, the CBA wrote to Exicom advising that it was not prepared to waive its requirement for a principal debt reduction on 20 December. It was, however, prepared to reduce the amount from $250,000 to $150,000 and defer the date of payment to 3 January 1996 (X93). Current facilities would be extended to 31 January 1996. In the meantime preparations for the ERG rights issue continued. No major announcements would be necessary if the issue were completed prior to Exicom's shareholders' meeting. Due diligence inquiries were ongoing as appears from a Draft Due Diligence Questionnaire prepared on 13 December (X95). Fogarty had agreed with Lynton McRostie that McRostie should prepare the questionnaire and draft answers and make it his "number one priority". They had also agreed that the questionnaire should be submitted to Exicom prior to Christmas. In the event, it was submitted to Exicom in mid-December (X438 par 105).
239 Fogarty was due to travel to North America on 17 December and was to be away until 19 January. On 14 December, he sent a memorandum to McRostie about the need to develop a "comprehensive plan for turning Exicom around". He requested a strategy paper (X96). Fogarty described fourteen issues in his request as "critical to our success in turning Exicom around in the first six months". He said:
"I expect you to drive the total project and also liaise with David Gordon and Steve Newman to ensure that the shareholder meeting is as early as possible."
The Board would need a complete document at the end of January. Management would require it before then.
240 Before leaving for the United States, Fogarty had meetings with Harley and McRostie to work out ERG's responsibilities in advancing the Exicom recapitalisation. This would involve ERG personnel visiting Exicom's premises, reviewing its manufacturing processes and being given access to due diligence information (X438 par 104). He made notes at this time of the allocation of responsibilities for various tasks in the implementation of recapitalisation. These were:
(a) An independent expert's report to be organised by Peter Patterson and Corrs Chambers Westgarth.
(b) A consultancy agreement between ERG and Exicom to be prepared by McRostie in conjunction with Leigh Warnick of the firm Mallesons Stephen Jaques.
(c) A loan agreement between ERG, Simmonds and Exicom to be prepared by Bill Napier of Freehill Hollingdale & Page.
(d) A subscription agreement to be managed by Gordon with Koeck of Corrs.
(e) A notice of extraordinary general meeting to be prepared by Patterson in conjunction with Koeck.
(f) Negotiations with the landlord at the Villawood premises to be carried out by Stephen Newman in conjunction with McRostie.
(g) The Telstra agreements to be negotiated by Gordon with Stephen Newman, one of Gordon's assistants and McRostie, due to be completed by 6 January 1996.
(h) The Foreign Investment Review Board application to be completed by 15 December 1995 by Gordon together with personnel from Simmonds.
(i) Various other agreements to be concluded in a similar timeframe.
(X438 par 105)
241 Fogarty also prepared, on 15 December, a "Statement of Relationships between ERG & SCL in Respect to the Investment in Exicom" (X97). That document sought to summarise the roles that ERG and Simmonds would play in relation to the recapitalisation. In connection with the CBA debt he observed:
"It was agreed that the bank debt with the CBA be satisfied by contributions of 50% from ERG and SCL and that the discount on the debt be shared in the same proportion. ERG intends funding its proportion of the $15.7 million by bank borrowing and we will either work together with SCL or separately arrange our own funding and then provide it to Exicom via a $21 million loan agreement which will be several in the sense that the obligations of SCL and ERG are separated."
He planned to meet, and did meet, with O'Kell in Toronto early in January to resolve issues arising from his memorandum. On 15 December, he spoke with Stephen Wilson of Grant Samuel who was to prepare the Independent Expert Report and discussed ERG's approach to Exicom with him.
242 On 20 December, Gordon sent a letter to Stephen Newman confirming extension of the time limited by the agreement of 29 November for renegotiation of the terms of the Villawood lease, a condition precedent of the recapitalisation. That time was extended from 31 December 1995 to 31 January 1996 (X99). A draft Information Memorandum to Shareholders was prepared by Corrs and sent to Exicom on 22 December (X101). Telstra wrote to Exicom on the same day forwarding reports on a review of the TF400 telephone production process at Villawood which had been carried out by Telstra and Telstra Technologies. Approval for continued delivery of the TF200 and production for TF400 was confirmed, subject to changes related to integration of quality management into the production process. Davis from Nortel, wrote to Capp on 22 December stating his full support for the involvement of ERG and Simmonds in the recapitalisation. He confirmed that Nortel would continue to honour its obligation under the P-phone Technology and Manufacturing Deed entered into between their two companies. He assured Capp that Nortel had no intention of acting on the breach notified in his letter of 4 January 1995 (X103).
243 On 29 December, an Information Memorandum was provided to the CBA on a confidential basis for use "… in connection with the proposal and pricing of Credit Facilities for Exicom Limited" (X104). It incorporated the "ERG Strategy Paper for Exicom Recapitalisation" of 11 December 1995. ERG also sent an Information Memorandum to Westpac on 4 January (X106). Exicom's financial results for the month of December were below what had been budgeted (X490). A deficit of $14 million had accumulated for the six months to 31 December.
244 Early in January a problem arose again over the TF400 telephone. Don Wellings of Telstra sent a memo to Lindsay Lockwood, General Manager, Corporate Operations of Exicom advising of "memory loss from the one touch memory keys". The failure was said to be "a major concern to Telstra" (X105).
245 On 5 January, Stephen Belben of Ernst & Young sent to ERG a review of KPMG's due diligence report on Exicom which had been prepared for Simmonds and Zilkha in October 1995 (X42). The KPMG document produced in evidence was a draft. Fogarty was unable to recall whether ERG had received a final version of the KPMG report (T928). He agreed however that Harley may well have received it as he was heading up the ERG financial team which was involved in assessing the value of the Exicom/ERG combination, the synergies it could bring, the opportunities to which it could give rise and how these things could add value to both companies (T929). Fogarty said of this process:
"Basically I was being kept up to date with very much what we would describe as a moving feast. It was very hard to pin down and get firm numbers. That's what we were trying to do. It was a relatively short period of due diligence given that we'd come in fairly late to do a complete reconstruction of a company that was in financial difficulties, so we were being very, very careful." (T929)
The Ernst and Young review identified the limits of the engagement of KPMG and the limits of their report which would not necessarily disclose all significant matters or business risks about Exicom's operations.
246 While in the United States, Fogarty had further discussions with Mead about the terms of agreement with Telstra and the settlement of its dispute with Exicom (X417). Mead told him Telstra's position with respect to a long term supply agreement and the settlement of the dispute could change as a new Retail Product Group Manager was to be appointed to replace the incumbent, Parker. He suggested to Fogarty that a release could provide that damages at large would not be payable to Telstra, but that they could be capped at 15% of contract price for goods delivered in the first eighteen months of the contract. Subject to rights to terminate any agreement, Telstra could commit to ordering sufficient amounts of product to claw back its damages (X438 par 110). Following this discussion Fogarty rang Harley who sent a fax to Andrew Pike at Freehills indicating that agreement with Telstra had been reached on outstanding issues including a liability cap of 15% which was to apply for an eighteen month period from the start of the contract. Thereafter if there were a major failure the recapitalised Exicom would have to be on the same terms with Telstra as Exicom's competitor, Alcatel (X474, T929-930).
247 At this time, ERG was providing some input into the preparation of the Grant Samuel report for submission to the shareholders' meeting. ERG was in receipt of drafts of the report as Grant Samuel was trying to do it as quickly as possible. Fogarty said that all concerned were conscious that Exicom was deteriorating and that there was a need to get the report completed so court approval for the recapitalisation could be obtained (T931).
248 There was an ongoing exchange between Freehills and Mallesons, the latter acting on behalf of Telstra, in relation to the terms of the proposed Exicom Product Supply Agreement (X470). However on 12 January 1996, Exicom received a telephone call from Mead to report a major failure of the TF400 during field trials. Rectification would be crucial to the existence of the Product Supply Agreement. Mead asked that somebody at ERG or Simmonds speak to Walton at Telstra urgently (X107). Fogarty telephoned Mead who said that the problems had to be sorted out before any settlement and long term sales agreement could be reached (X438 par 111).
249 FIRB approval for the Simmonds' acquisition, with ERG, of up to 100% of Exicom shares, was given on 18 January (X475). A status report from Freehills on the progress to satisfaction of the conditions precedent indicated that most remained to be satisfied. A Revised Product Supply Agreement and Release Agreement with Telstra was expected from Mallesons by 19 January. Confirmation of arrangements with Nortel had been received. There had been no developments relevant to the no material adverse change condition at that time (X475). There was no progress on the Villawood lease renegotiation. McRostie was pressing the Villawood landlord to renegotiate the lease. Following a meeting on 17 January he wrote a letter on 18 January pointing out that if Exicom were not the beneficiary of an immediate and substantial capital injection it would be the subject of a receivership by its secured creditor or liquidation by its unsecured creditors (X109).
250 On Sunday, 21 January, Fogarty arrived back in Perth. On 22 January, his board met to review the due diligence process. He reported that the documentation to go with notice of the Exicom extraordinary general meeting was being finalised. However the timetable for completion of formalities was extended by three weeks because of processes required by s 205 of the Corporations Law. This brought it close to the maximum time available under the Futuris settlement. Due diligence responses had not at that time been signed off by the Exicom Board. Harley told the Board that money was tight at Exicom and the longer the process took, the greater the risk of Exicom not surviving (X111). Harley sent a memorandum to Stephen Newman on the same day referring to developments of concern in relation to research and development costs of the Exicom P-phone product and the purchase of $5 million of components for which payment was due in March. He also sought a reforecasting of the Exicom results to 30 June 1996 based on the actual results for the December half (X112). McRostie delivered to Fogarty a further draft of the Strategy Plan for restructuring of Exicom on 23 January. This document became known as the "Exicom Restructure Strategy Paper" and was dated 31 January 1996.
251 On 24 January, Steven Arthurs, Group Financial Controller for Exicom wrote to O'Brien at the CBA requesting waiver of the principal reduction requirement for January 1996. He mentioned two developments adversely affecting cashflow. The first was the delay in the supply of TF400 telephones resulting from a design issue. It was said to have a "cashflow effect" of approximately $2 million. The second was the reversion by Telstra Technologies to thirty-day payment terms with a cashflow effect of about $1 million (X491).
252 Gordon sent further drafts of the Independent Expert Report to ERG and Simmonds on 25 January. Printing of the report was anticipated the following day. The date proposed for the extraordinary general meeting was 23 February (X113). On 29 January 1996, an Information Memorandum was prepared for issue to shareholders of Exicom incorporating notice of the extraordinary general meeting (X114). It attached, as an enclosure, the Independent Expert's Report from Grant Samuel (X115). That report was received in evidence, but not as evidence of the truth of its contents. ERG and Simmonds were trying to resolve details of the Subscription Agreement with Exicom. Gordon was handling this issue. The Exicom Board was declining to give any warranty as to the accuracy of the information it had supplied. The company had also not signed off on the due diligence questionnaire and draft answers which had been delivered in mid-December.
253 On 30 January, the CBA wrote to Exicom rejecting its request for waiver of the principal reduction of $200,000 due on 31 January. It was, however, prepared to defer $75,000 of its required reduction until 14 February (X116). Mallesons sent to Freehills on that day drafts of the Product Supply Agreement and Deed of Release between Exicom and Telstra. They noted that Telstra had not had an opportunity to review the documents and they reserved the right to make such amendments as their client thought necessary. In particular, Mr Lindsay Yelland had recently been appointed Group Managing Director of the Retail Products Group. He had not been briefed on the arrangements at that time. On 31 January, a further extension of the condition precedent relating to the Villawood lease renegotiation was agreed between Exicom, ERG and Simmonds. The extension was to 29 February 1996 (X117). Fogarty had a conference call with Capp, Gordon and Koeck. The object of the discussion was to finalise the Subscription Agreement and, in particular, the warranty issue and the liability of Exicom's directors. Fogarty told Koeck that because of the poor information Exicom was providing and its changing nature, ERG and Simmonds had to insist on warranties. He also said that the lack of focus by Exicom's Board and management on the finalisation of the recapitalisation process was putting the deal at risk. He expressed concern that Stephen Newman, Patterson and Arthurs had been spending time in India instead of attending to the due diligence questionnaire and the Subscription Agreement. He also pointed out that management should be trying to get the Telstra issue resolved so that deliveries could commence. He warned that unless the Telstra issue was resolved within a week ERG and Simmonds would consider not proceeding (X438 par 120).
254 On the afternoon of 31 January, Fogarty flew to Sydney. On 1 February he met with Phillips Australia to explore how Phillips might work with Exicom. Phillips supplied chip components to Exicom and Fogarty was keen to continue the relationship. In company with McRostie, he also met on that day with Richard Sheppard, the Managing Director of Macquarie Bank Management Division, which was managing the Villawood premises for the landlord. Fogarty told Sheppard that ERG and Simmonds were not prepared to waive the condition precedent for the recapitalisation requiring renegotiation of the Villawood lease. He also said that if the landlord refused to negotiate ERG and Simmonds would not continue with the recapitalisation and Exicom would "go broke". They discussed proposals relating to insurance costs and rental levels. The rental at that time was $A3,300,000 per annum. ERG and Simmonds were willing to consider $A2,500,000 even though the condition precedent specified $A2,400,000. Sheppard said he would get back to Fogarty. Fogarty arranged with Freehills to have a copy of the Independent Expert's Report delivered to Sheppard (X420).
255 Fogarty and McRostie also met with a potential operations manager for Exicom, Neville Pan, who was familiar with the Exicom business (X421). On the same day, they met with Stephen Newman to discuss the status of the operations of Exicom, staff reviews and Newman's own role. They discussed Exicom's forecasts. Fogarty expressed scepticism about their reliability. They discussed directors' remuneration. Newman told Fogarty that the directors had a retirement plan under which they would get one year's pay for every three years of service. This had not previously been disclosed. Fogarty told Stephen Newman that his employment contract would be honoured if he performed. He expressed concern about some of Newman's managerial decisions and what he regarded as the rather cavalier manner in which the recapitalisation exercise had been treated by Exicom's management. He said that ERG and Simmonds would look at preparing a new employment agreement to replicate the existing agreement but spelling out more clearly the obligations of the Chief Executive. Stephen Newman then disclosed to Fogarty his new employment agreement with Exicom, made on 8 November 1995, which provided twelve months notice or salary in lieu if his services were to be terminated. Fogarty asked why ERG and Simmonds had not been told of this but received no answer. He said that ERG and Simmonds were fed up with the delay in Exicom signing off on the due diligence questionnaire. If new issues or surprises kept arising, ERG and Simmonds would be better off not proceeding (X422, X423).
256 The "Exicom Restructure Strategy Paper" dated 31 January outlined all the information that ERG had been able to gather to that stage (X253). It mentioned the problems with the TF400 telephone and their consequences for Exicom's cashflow. The revenue effect was said to be $1 million per week. There were delays in the P-phone production and temporary revenue consequences flowing from those delays (T396). A two-month postponement had been requested by Optus on the rollout of a product which Exicom was supplying to it. This would delay two months of revenue totalling $1.2 million. There was a risk to Exicom Communication Systems ("ECS") revenue because of the adverse market perception of the financial stability and integrity of the Group. The customer base had contracted due to customer concerns over the solvency of the company and its ability to complete orders. This risk, however, could be allayed once recapitalisation was completed.
257 Fogarty agreed, in evidence, that apart from having to deal with the quality problem in relation to Telstra, the other major contract issues concerning the P-phone, Optus and ECS were such that if recapitalisation proceeded Exicom could be restored to the forecast position (T937). In relation to the Villawood lease, it was still the case that ERG would insist on the performance of the renegotiation condition. The one qualification to that stance was if it were the only condition outstanding, ERG and Simmonds would probably waive it. Fogarty said he had advised both Futuris and Exicom accordingly, but had never said that ERG and Simmonds would waive it regardless (T938). In cross-examination on the Strategy Paper, he explained that it was his opinion that Exicom was underpinned by Telstra and if it couldn't get an acceptable long-term arrangement with Telstra, the company didn't have a life. It would live or die by the Telstra agreement (T939).
258 Fogarty met with Gordon on 2 February 1996 and they had a conference call with O'Kell with a view to finalising the Subscription Agreement and the proposed agreements with Telstra (X424). Before starting that review they discussed O'Kell's planned visit to Australia which was to tie in with the extraordinary general meeting of Exicom on 23 February 1996. They agreed with O'Kell that they would review the Strategy Plan developed by ERG on 21 and 22 February in Melbourne. They also agreed that Morton and McRostie would complete fresh assessments of the numbers and also review ECS and the New Zealand operations in the weeks leading up to that meeting. They sent a copy of the Strategy Plan to O'Kell. In the course of that discussion O'Kell mentioned an agreement between Exicom and Simmonds under which Simmonds could manufacture the P-phone in North America. Nothing had happened because Exicom was a year behind schedule. Either Gordon or O'Kell said that under that agreement there was some $580,000 owing by Exicom to Simmonds which was not disclosed in the Exicom accounts. Fogarty, O'Kell and Gordon also discussed the Telstra situation and agreed that it was critical to finalise with Telstra in view of its change in management. They agreed upon a schedule for review of the Exicom strategy plan over the period from 5 February 1996 up to 26 February 1996 when they anticipated meeting Yelland at Telstra and representatives of Nortel and the CBA. On 2 February, ERG sought warranties in respect of the management accounts and due diligence responses from the directors of Exicom (X118).
259 On 5 February, Gordon sent a fax to Fogarty advising of a telephone conversation with Mead and his replacement, Chris Hanson. The new Telstra Retail Products Group Managing Director, Yelland, wanted to explore the possibility of Exicom meeting its obligation to provide phones to Telstra in another way. Gordon reported that Mead had told him Telstra would not be prepared to commit to purchase minimum volumes of TF200 or TF400 (or any other phones) from Exicom. This was a reversal of the position agreed between Fogarty and Mead some weeks previously. Telstra also wanted a $4.95 million claw back to apply to a broader range of products which Exicom could provide to Telstra. This could mean that the claw back did not apply to TF400 or any other phones. This was described by Gordon as a reversal of the position agreed with Yelland's predecessor, Parker, some months before and reaffirmed by various people at Telstra over recent times. While he acknowledged that the draft document provided by Mead and Mallesons was provided subject to Yelland's comments, fundamental changes of the kind proposed had not been anticipated. He also pointed out that the Information Memorandum sent to Exicom shareholders and to the ASX was based on the previous discussions and agreement with Telstra. The changes mentioned by Mead were inconsistent with Exicom's disclosure in that memorandum. There was no opportunity to resend documents to shareholders within the required timetables. Gordon said he told Mead these were fundamental changes.
260 On 6 February, the CBA advised ERG that it would not provide debt financing to the recapitalised Exicom group. On 7 February, Westpac sent a similar response to Del Borrello at ERG. It was not prepared to enter into banking arrangements with Exicom in an industry it considered to be high risk until such time as Exicom's performance improvement became apparent (X121). Fogarty contacted Mike Leonard of the CBA and arranged to meet him in Sydney on 14 February 1996.
261 Exicom executives, Stephen Newman and Arthurs, met with officers of the CBA on 8 February to provide them with an update on the recapitalisation process and Exicom's trading performance generally. They were informed at that meeting that O'Brien was being transferred and Mr Ross Griffiths was going to be involved with their matters thereafter (X123).
262 On 9 February, Fogarty sent a memorandum to McRostie referring to "surprise omissions" from the due diligence package and the need to "….start a list of the questionable matters that have been brought to our attention" (X125). He asked McRostie to manage and co-ordinate this. Items to which he referred were the following:
1. A $2 million sum owing to Nortel under a stock repurchase arrangement which represented a material change in information provided to ERG in the accounts and should be reflected in some way or another in the accounts to 31 December. This arrangement was disclosed to Fogarty by Harley or McRostie. It had involved Nortel repurchasing components previously supplied to Exicom on the basis that Exicom would repurchase the components from Nortel by 31 March 1996. Exicom was said to have set off the amount paid by Nortel against Exicom's debt to Nortel thus making the Exicom credit position look better.
2. The retirement remuneration that the Exicom directors were seeking to pay themselves. He had alerted Gordon to this.
3. A variation to the forecast Exicom finances showing a reduction from profit of $10 million to $4 million and possibly as low as $2 million.
4. Delays in production of the TF400 and the Nortel products.
5. The agreement with Simmonds whereby Simmonds were entitled to claim from Exicom the balance of certain moneys - $580,000.
In respect of Exicom's creditors, he believed it would be very difficult to deal with them after recapitalisation, It was necessary to do something over the course of the following fortnight. He suggested to McRostie that they be approached on the basis that all of the major creditors had agreed to "take a hair cut".
263 It was put to Fogarty in cross-examination that the memorandum of 9 February marked the beginning of a process of collecting a list of matters that could be raised in support of an argument that there had been a material adverse change and that would justify ERG not proceeding with the recapitalisation. Fogarty maintained that the ERG Strategy Paper which had been prepared for the Board still had holes in it because they hadn't been able to get the information they required from Exicom. He said he was becoming frustrated because ERG people undertaking the financial research were coming back to him saying that they were still not getting the information. In relation to the reference to surprise omissions from the due diligence package he said:
"So what was happening is we're doing due diligence over an extended process and virtually daily or weekly we're getting some new surprise comes out of the woodwork (sic). It's the old skeleton in the closet that you hate to inherit when you look at acquiring another business. Unfortunately the rate of them falling out of the cupboard was increasing dramatically and we were becoming extremely concerned about it. That is the purpose of this memo, and so what we said is, "We need to now build a list to go back to Exicom with and say, 'Please explain all these issues. We're very concerned about them'."" (T942)
Again, it was put to him that he was building a list so that he could say there was a material change in the company's position he didn't know about. In response, Fogarty said they were getting to the point where that was becoming an issue because they were concerned about increased funding required for the company if it were to survive (T943). Fogarty no doubt used the possibility of not proceeding as a negotiating tool, especially in dealing with the Villawood landlord and the Exicom management. It is also no doubt the case that he left open the possibility that ERG would not proceed with the recapitalisation if it could not do so under conditions which were acceptable to it and which were embodied in the conditions precedent of the agreement with Exicom. In my opinion, however, the scale, intensity and cost of the preparatory activities in which ERG's Board, management and advisors were engaged at this time is inconsistent with any suggestion that Fogarty and the company were not genuinely committed to trying to implement the recapitalisation.
264 It was also put to Fogarty that the approach to creditors was something of an after thought. In response he said that before 9 February ERG was proceeding on the assumption that the recapitalisation would occur and that there was no specific need to go back to creditors:
"It was only once we started to understand that this company had 10 to 20 million dollars more liabilities than we'd been led to believe. (sic) It wasn't anything to do with…having forgotten about creditors. We understand creditors when we are looking at buying a company. We were well aware of the position of the creditors, but it turned out they were a lot worse than had been provided to us." (T945)
He was unable to say, however, that any approach to creditors had been made as a result of his instructions to McRostie. And in any event "…the whole thing unravelled before we had that opportunity" (T946). Fogarty's responses are consistent with the view that there was a commitment to make the recapitalisation work which, as will be seen, was abandoned when it was perceived as unworkable some weeks later. That was not a sudden process but a growing realisation in the light of events which occurred.
265 On 9 February, Gordon sent a fax to Koeck at Corrs referring to Exicom's advice to ERG that it had revised its profit forecast for the year ended 30 June 1996 to project a materially reduced profit compared with the figures stated in the Independent Expert's Report. Gordon indicated to Koeck that in light of the disclosure in the Independent Expert's Report and the fact that a shareholders' meeting was to be held in two weeks, it was his view that Exicom was legally required to make an announcement of that material adverse change. He requested the opportunity to review a draft announcement before disclosure to the market (X126).
266 On 13 February, Fogarty heard from Sheppard at Macquarie Bank. Sheppard said the Villawood landlord was not willing to reduce rent at that time but that ERG and Simmonds should put a formal proposal to it in writing. He wanted them to set out the status of the recapitalisation and particularly the conditions precedent. He said that if it didn't look like other conditions would be satisfied then he didn't believe the Villawood landlord would negotiate. If rent were the only outstanding issue, he probably would. He suggested that ERG and Simmonds might put a proposal involving a rent reduction subject to an increase if Exicom performed well. Fogarty told him they had to know the Villawood landlord's position by 23 February (X426). He followed up on this discussion with a letter dated 16 February 1996 to Sheppard. He set out the relevant conditions precedent. He reasserted the importance of a reduction in the annual rental if the recapitalisation was to proceed. He reiterated his proposal for a $2.5 million per annum rental and pointed to compromises by other major creditors. ERG and Simmonds would be willing to consider the issue of options over shares in the company to the landlord to provide some compensation for the rent reduction. Alternatively, an escalation formula would be considered. He pointed out that it would be necessary to have the position clear prior to the extraordinary general meeting on Friday, 23 February (X135). James Hodgkinson, the General Manager of Industrial Property Management Limited, the Villawood landlord, responded to Fogarty on the same day. Fogarty's letter had been referred to him by Sheppard who was overseas. Hodgkinson said he would raise Fogarty's letter with his directors and would contact Fogarty by 21 February (X136).
267 Macquarie Bank was in correspondence with ERG on 13 February 1996 in another capacity, that of provider of financial services. It sent a letter to Del Borrello confirming its interest in assisting ERG with the recapitalisation (X129). Its proposal was that it be exclusively appointed by ERG to provide financial advice in respect of the recapitalisation as and when required. No question of a conflict of interest in the bank's role as manager for the Villawood landlord and as a proponent of services to ERG and Simmonds in connection with the recapitalisation was raised in the proceedings.
268 On 14 February, Fogarty met with representatives of the CBA for about 3 Ľ hours. He was asked to provide further information and was told the CBA would take three days to make a new decision. While he had thought, in November 1995, that the funding required would be $5 million cash plus $5 million non-cash facilities, he had now formed the view that this was insufficient and asked the CBA to provide $10 million by way of cash and $10 million non-cash facilities (X427). Also on that day, the CBA sent a letter to Stephen Newman at Exicom confirming the extension of Exicom's facilities and limits detailed in an attachment to the letter until 31 March 1996. The CBA was not prepared to waive the requirements for future monthly principal reductions pending finalisation of the recapitalisation process. $200,000 was required in respect of February and March, but the CBA was prepared to defer payment of those instalments and the $75,000 outstanding for January 1996 until settlement took place with ERG and Simmonds. A copy of the letter was sent to Freehills (X131). Back in Perth on 15 February 1996, Fogarty gave Del Borrello a list of requirements from the CBA. He also instructed Del Borrello to begin negotiations with the Macquarie Bank for it to provide the necessary facilities. Although Del Borrello sent the requisite information to the CBA, it still refused to provide any facilities for Exicom post recapitalisation.
269 Fogarty provided an update on progress for O'Kell on 15 February 1996. On Telstra he said:
"At this stage, I have told Telstra the deal falls over or alternatively we don't pay $7.5 million if they don't commit."
He asked O'Kell to confirm that the $580,000 owed by Exicom to Simmonds would not be claimed by Simmonds. He said that both ERG and Simmonds would need to confirm their ability to settle before the shareholders' meeting. He enclosed the underwriting letter from SPC Warburg and expressed the hope that the rights issue would be finalised on 26 February. He asked O'Kell to advise the status of Simmonds' fund raising (X132).
270 On 16 February, Fogarty was again in contact with Telstra. He spoke to Chris Wilkinson and made a file note of the conversation (X428). Wilkinson told him that Telstra was reviewing its requirements. The TF400 phone was to be used for first phone installation. Telstra however was required to provide a first phone free to its customers. It was lobbying in Canberra to have this requirement changed as its competitor, Optus, did not have to do so. Telstra would not purchase 2,200,000 TF400 phones. If it had to continue supplying a free first phone, it would want a cheaper $19 product referred to by Wilkinson as a "cardboard phone". Further, Telstra wanted its claim against Exicom paid in full. Fogarty told Wilkinson that an agreement "in principle" had been reached with Telstra but given the change in management ERG, Simmonds and Exicom would be willing to review Telstra's requirements. Wilkinson said Telstra needed time to consider the position. Fogarty pointed out that the Exicom extraordinary general meeting was to be held the following week. Wilkinson said he would get back to him.
271 Fogarty, Morton and McRostie met on the same day and discussed the position of ECS. Morton's report was that ECS was suffering and that it would not achieve its full year forecast. The dispute with Futuris had adversely affected market perceptions. Morton and McRostie agreed to work on a new financial analysis of Exicom based on their review of ECS. They did not feel they could rely upon figures provided by Exicom's senior management (X438 par 157).
272 David Jessop, Management Accountant with Exicom, sent a fax to Harley on 16 February advising that Exicom was working on a Base Case Balance Sheet for 30 June 1996 which would be available after review by Arthurs. Other items of financial information were provided with the fax, including summary pages containing projections for the New Zealand operation over the next six months and explanations for not meeting budget in the first half. A corporate profit and loss account showing "First Half Actuals and Second Half Forecast" was also attached (X493). A second fax from Jessop provided additional risk exposure relating to the Base Case cash flow (X494). Fogarty wrote to Jeff Shaw, Senior Manager, Risk Management with the CBA on 16 February by way of follow-up to the meeting of 14 February (X137). He enclosed with his letter information requested by the CBA which he had asked Del Borrello to assemble. This embodied a Base Case Scenario for Exicom prepared by ERG showing revenue and costs by division (X137A). A copy of the Strategy Plan for Restructuring was also attached.
273 The Base Case Scenario showed a forecast for total Exicom sales for 1995/96 of $165,887,000 which contrasted with a budgeted figure from Exicom of $220,464,000. The Base Case was described by Fogarty as "…our view of what the real position was for Exicom as opposed to the ultimate which could be a lot worse which is called the down side" (T953-954). The projected operating result, being net profit before tax, was $487,000 (T914).
274 Fogarty's evidence was, that in the days following, ERG and Simmonds received drafts of Exicom's half year results and a draft announcement of those results. He felt that Exicom's management did not have a clear idea of how critical its position was. Its half year profits were approximately $711,000. Harley wrote to Stephen Newman and Arthurs on 19 February drawing attention to a number of issues in relation to those results. He indicated, in effect, that the results were inflated because debtors were not properly accounted for, an abnormal bounty receipt was not treated as abnormal and $1.2 million of costs in relation to the P-phone project had been deferred (X139).
275 On 19 February, Paganin of Bennett & Co sent a fax to Corrs notifying that the proper party for payment of the sums of $480,000 and $800,000 under the agreements between Futuris and Exicom was FIL (X375). A similar letter was sent to Freehills directing payment of the $800,000 due from ERG and Simmonds under the ERG Agreement to FIPL. These payments were, of course, conditional under those agreements upon the reconstruction proceeding. The letter also said:
"In addition, please confirm the "Bank Option" (as defined in Clause 1 of the ERG Agreement) has been extended so as not to trigger Clause 3.1 of the ERG Agreement." (X376)
276 An Updated Due Diligence Report was prepared by ERG and Simmonds on 19 February (X141). Fogarty did not recall being involved in its preparation or review (T956). The Executive Summary, however, referred to Morton and McRostie's recent activity at ECS in Melbourne and at Exicom's Villawood premises with a view to interrogating the Exicom reforecast budget which had been presented to ERG and Simmonds in the previous week. Fogarty thought the document might have been prepared by ERG's finance people as part of due diligence for the rights issue. He agreed with the statements in the Executive Summary that Morton and McRostie's report of their investigations revealed a rapid deterioration in the Exicom Group's operations which were forecast for 1995/96. This was reflected in turnover, profit, inventory levels, creditors and cash and gross margins. The working capital position was said to be critical. Production was being affected due to suppliers refusing to provide further credit and no longer supplying components. The adverse market perception of the stability of Exicom was said in the Report to be more evident in the ECS forecast results due to their large customer base. Exicom's sales forecasts, according to the Report, had been revised from $220.5 million for 1995/96 to $185.9 million as against the ERG and Simmonds Base Case forecast of $165.9 million. Exicom profit had been reforecast from a high of $6.9 million to $4.4 million, while ERG and Simmonds' Base Case forecast was $0.5 million. Forecast working capital requirements for ERG and Simmonds had increased from $28.9 million to $36.2 million. The conclusion in the Report said:
"Due to the rapid deterioration in the business, ERG/SCL need to urgently reconsider the structure and method of our proposal investment in Exicom Ltd." (sic)
277 Major issues and omissions subsequent to the initial due diligence were set out at Appendix 14 to the document. They were:
- The reforecast by Exicom of its budget for 1995/96.
2. Production delays, being delays in production of the TF400 and delays in the Nortel deliverables, together with delays in budgeted sales of export phones because of component shortages.
3. The Nortel inventory repurchase which gave rise to an obligation to Exicom to repurchase $2.5 million of Nortel stock on 31 March 1996.
4. The provision of directors' retirement benefits, the estimated benefit payable as at March 1996 being $210,000.
5. A possible liability of between $1 million to $2 million for royalty payments due under a Sale Contract involving Austmode Power Systems Pty Ltd.
6. A potential liability for decontamination by Exicom of a property at Ashfield sold by it.
7. Increase in working capital requirements.
278 On 20 February, Arthurs sent Harley copies of Exicom's 31 December Half Yearly Report to the ASX and Half Yearly Consolidated Accounts. The Consolidated Accounts for the half year ended 31 December 1995 showed accumulated losses of $98,308,000 (X142).
279 Fogarty had a conference call with Stephen Newman, Gordon and Hanson, Wilkinson and Mead from Telstra on 20 February. Yelland was unable to join the conference. The discussion focussed on resolving the long term supply agreement and terms of settlement between Telstra and Exicom. At the outset Wilkinson said that he understood that an agreement "in principle" had been reached but that the new management could not accept it and that because nothing was signed, Telstra was not bound by it. Fogarty said he was extremely disappointed at that attitude but accepted that there was no point forcing Telstra into an agreement which it would try to get out of later. Wilkinson said Telstra wanted to retain local supply of phones but would not do so if the cost was prohibitive. Exicom was behind schedule on deliveries and Telstra had been inconvenienced. Telstra could not possibly commit to buying 2,200,000 phones, the most it could commit to was one year's supply or 700,000 units. Fogarty said that ERG and Simmonds could not possibly agree to that. The forecast in numbers they had relied upon assumed Exicom would supply Telstra with 2,200,000 phones. But he also said that ERG and Simmonds could be flexible as to whether or not all phones supplied to Telstra were TF400 provided Exicom was given a reasonable minimum order for each type. Wilkinson said Telstra would still want no minimum commitment as it did not know its requirements and could not make a long term commitment (X429). Mead confirmed the substance of the conversation as recounted by Fogarty in his evidence. He said it represented a significant change in dealings between Telstra and Exicom:
"Effectively, the result of this conference call was that Telstra had taken away a major plank of the settlement between Telstra and Exicom. I recall this conference call as being a significant point in the negotiations between Exicom and Telstra." (X471 par 62)
Fogarty discussed the status of deliveries to Telstra with Stephen Newman following the conference call. Stephen Newman told him that all was well and that the first deliveries of the TF400 phones would start that week or the following week. Fogarty told him he was concerned at the impact of further delays. Newman responded however, that he was one hundred per cent certain that Exicom could deliver.
280 Fogarty was cross-examined on the latter statement on the basis that it went to issues of credibility related to ERG's performance of its obligations under the agreement with Futuris on 13, 14 and 15 March (T1006). He was asked whether ERG was considering, as indicated in the minutes, alternative and cheaper methods of acquiring Exicom or its business. In reply he said that from about the middle of February ERG was looking at alternative ways to complete the recapitalisation and was becoming increasingly concerned with the diminishing value of Exicom. He described the company as "self destructing". It was in this context that they had had internal discussions about approaches to the creditors. He was exploring ways of keeping the recapitalisation proposal that had been put to the market place because if there were a substantial change it would mean going back to the shareholders. As time went on it was becoming more and more critical not to have a further extension of time because the company would go into liquidation. Although at that point the meeting had not yet been held, it would not be possible to call a fresh meeting on two days' notice. If there were to be any change to the structure of the recapitalisation it had to be within the broad parameters of the recapitalisation proposal sent to shareholders and assessed by Grant Samuel (T1007). I accept Fogarty's evidence in this respect. It is consistent with the commercial realities with which he then had to deal in relation to the recapitalisation proposal. I do not consider the implied suggestion that Fogarty had some hidden agenda of allowing the recapitalisation to fail with a view to picking up the pieces of Exicom at fire sale prices as credible given the time and effort that was still being put into advancing towards recapitalisation in what were, from ERG's perspective, very difficult circumstances. The contrary hypothesis would suggest that all of this activity was just an elaborate and expensive sham.
281 On 21 February, Andrew Pike of Freehills sent to Harley a draft of an announcement that Exicom proposed to make at the time of the release of its half yearly figures. Patterson had advised that he proposed making the announcement at lunchtime, Sydney time, on 22 February. The draft announcement described the result for the half year ending 31 December 1995 as "…particularly pleasing given the difficult circumstances the Company had faced during the half year with the recapitalisation negotiations and the litigation with Futuris Corporation Limited." Capp was quoted as saying that the company had now turned the corner and was set for a profitable future. The proposed announcement also stated:
"Commenting on the performance of the Divisions, Mr Capp noted that the Telecommunications Division continued to perform well and is now manufacturing the new Touchfone 400 for Telstra which is replacing the standard rental Touchfone 200. Additionally, Exicom has now signed a long term product supply agreement with Telstra and settled the dispute concerning the supply of the Touchphone 200 phones as part of the recapitalisation process. This will ensure that the Telecommunications Division continues to be a significant contributor to the bottom line."
As to ECS, the draft announcement said:
"Exicom Communications Systems continues to perform well, however it experienced some loss of sales during the half year as a result of the publicity surrounding the litigation with Futuris Corporation Limited. Now that this litigation has been settled the Division expects to continue its strong growth within the Australian PABX and key system telephone markets."
The announcement also asserted that the results for the half year were extremely encouraging and that the Board believed that the full year would also be profitable. However, it downgraded the forecast figure for the full year EBIT of $11.2 million which had been noted in the Grant Samuel Report sent to shareholders. The last paragraph read, in part:
"Finally, Mr Capp advised that should shareholders approve the recapitalisation proposals then the outgoing Board will be able to hand over a company to the new Board with a clean balance sheet and one that is now generating profit. …" (X144)
282 This was considerably at variance with what Fogarty regarded as the reality that must have been apparent to the Board and management of Exicom. Fogarty said he was "aghast at what it said. We couldn't believe it. It was a nonsense." (T1010) Counsel for Futuris asked whether his concern was that it was "too positive in essence". He said:
"No, not too positive in the way you're putting it. It was totally - well, not totally, but it had very significant statements in it that were false."
Fogarty raised his concerns with McRostie, Morton, O'Kell and Gordon who agreed with him. He decided to talk to Stephen Newman about the draft announcement. In the meantime there had been correspondence between ERG and Exicom about their draft half year results. McRostie sent Arthurs the forecasts on 21 February 1996 (X145). Harley sent a commentary to Arthurs on the same day on various aspects including the abnormal bounty, revenue from the P-phone contact, stock provisioning and the New Zealand operation (X430).
283 At this time Gordon at Freehills prepared a list of options in the event that the recapitalisation did not proceed. These were "informal" compromises with major creditors, the appointment of an administrator, a scheme of arrangement under s 411 of the Corporations Law, receivership and winding up. Fogarty said that they had asked Gordon to advise them of what could happen if ERG were not able to recapitalise and finish up in a shareholding position. He said:
"We asked for that advice because we needed to be informed because, as we said, the company was basically collapsing around us." (T1014)
Harley sent a fax to Stephen Newman on 22 February essentially reproducing the comments on the half yearly reports that he had made in his earlier fax to Arthurs. He suggested that the issues raised be properly addressed with the Board and the auditors before the release to the ASX was finalised (X148).
284 Fogarty rang Stephen Newman on 22 February to discuss the half year results and the draft announcement. Newman said he was keeping out of it and leaving it to Arthurs and Patterson to sort out. Fogarty told Newman he had better get involved. After that discussion he spoke to Capp and suggested that they meet before the Exicom extraordinary general meeting. Capp agreed. They set a time for midday on Friday, 23 February 1996. In the meantime, a redraft of the half year announcement dated 22 February 1996 was sent. The redraft deleted reference to the signing of a long term product supply agreement with Telstra. Nevertheless it still presented a picture of Exicom which seems to have been misleadingly optimistic (X149). Fogarty saw it and his handwriting appears on it, including the words "Change Conditions Precedent" but he was unable to recollect why he wrote those words (T1014). Exicom released the amended draft public announcement on that day.
285 Fogarty, O'Kell, Morton, McRostie and Gordon reviewed Exicom's financial position as they saw it on 22 February. Fogarty's major concerns were that creditors were substantially higher than he had expected, debtors were lower and recoverable debts lower still. The required cash injection would therefore be much higher than had been anticipated when ERG first agreed to the deal with Exicom. The Nortel position was far worse than he had expected. McRostie and Harley reported that Exicom owed Nortel about $10 million. In addition, McRostie had reported liabilities in mid-February 1996 previously not known to ERG and Simmonds, in particular a debt of $2 million owed by Exicom for payroll tax and sales tax. Morton believed that the forecast deliveries to Telstra were unlikely to occur. Fogarty proposed they redirect their focus as follows:
(a) Exicom had to verify its true and final financial position and ERG and Simmonds to see the January and February 1996 accounts as soon as possible.
(b) If the numbers were as predicted by Morton and McRostie, ERG and Simmonds needed to find an alternative way forward while keeping the recapitalisation plan on track. Fogarty said he believed that this could be done if the CBA, Telstra and Nortel agreed to accept a reduction in the amount to be paid to them. The Villawood rent also would become more critical.
(c) Updated cash flows and forecasts were to be obtained from Exicom as a matter of urgency and McRostie had requested this. Fogarty believed that his estimate of $21 million working capital to be injected into Exicom by ERG and Simmonds might now not be adequate.
286 O'Kell and Fogarty agreed to put their concerns in writing to Exicom's Board before the extraordinary general meeting. Fogarty's evidence was that he felt it imperative Exicom's board did not mislead the shareholders and that it make it clear to the shareholders how difficult the recapitalisation was becoming. He and O'Kell agreed to write the letter together after the morning meeting with Newman which they had planned for the following day, Friday, 23 February. Fogarty said he wanted to proceed with the recapitalisation but the funding requirements had to be reassessed once the revised numbers were available from Exicom. O'Kell and McRostie agreed.
287 At this stage, having regard to the history of dealings with the CBA, with Telstra and with the Villawood landlord, the prospects of any movement in those directions must have seemed small. The only negotiating position apparently available to Fogarty was that the alternative was liquidation or receivership promising a worse outcome than a negotiated outcome.
288 About this time, Fogarty again spoke to Hodgkinson concerning the Villawood landlord's position. This remained unchanged. Hodgkinson told him that the landlord was not willing to negotiate lower rental. He told Hodgkinson that ERG and Simmonds were running out of time and that he would contact him again only if all other conditions had been met. The condition precedent relating to the Villawood lease remained unsatisfied.
289 On 23 February 1996, Fogarty met with Stephen Newman briefly at 8.30am. He expressed his extreme concern at the worsening position of Exicom. Stephen Newman disagreed with Fogarty's assessment and said that Telstra had received its first deliveries of TF400s. Two pallets had been shipped. Fogarty was surprised as he did not believe the testing had been signed off but Newman told him it had. They went through the figures. Fogarty pointed out the outstanding tax debt which, he said, should be an issue of serious concern to directors as they could be personally liable. He told Stephen Newman that his latest calculation was that Exicom needed a cash injection of at least $40 million. He told him the deal would have to be reorganised in order to keep the recapitalisation afloat and that the keys to this were the CBA, Telstra and Nortel. With the support of these three, ERG and Simmonds might be able to rearrange the deal and go forward with it as a sort of informal administration. Newman told him he could discuss this idea with Nortel, Telstra and the Bank. They agreed to meet again at midday.