October/November 2004

Oh My, the New Client Owns a Plant in Mexico? What Do We Do Now? (Part 1) By: Miles Stover

You just were awarded an engagement, great. The bank that put you in is optimistic that you can turn things around, return the company to profitability and stop the cash drain. But why didn’t they tell you about the manufacturing operation in Mexico?

There are several reasons why they did not tell you. Maybe the bank that first approved the revolving line of credit five years ago is in New York, the client is in Los Angeles and the bank never asked. Maybe the client, I mean, the company you are now running, accounts for the product that comes across the border as a purchase and from a review of the financials, it was not obvious. Maybe they “rent their labor,” using what is referred to as a ‘shelter company,” and they just did not know. Maybe there were no “strange general ledger accounts” that indicated a foreign operation. The bottom line is that you better find out what you have because as you will learn, you can’t just shut down a Mexican operation without being liable for significant costs and there might be liabilities that are not obvious or even known about yet.

Providing a list of all of the things you need to concern yourself with in evaluating a Mexican operation is beyond the scope of this article, but we can discuss what you need to know first and how you can gain some controls quickly. This article will focus on the most important issues a turnaround professional must know when faced with this challenge, e.g., labor laws, regulations, forming and dissolving a company, cultural issues, and strategic alliances.

Trade between Mexico and the U.S.A. has been expanding ever since the passage of the North American Free Trade Agreement in the 1990’s. It was in 1965 that Mexico and the U.S. signed the Border Industrialization Program began development of a program to make industrialization more feasible between the two countries. Some industries over the years have really blossomed in Mexico, e.g. injection molding operations, while others haven’t and have gone East, usually to China. Today more than 21% of Mexico’s $600 billion GDP comes from manufacturing. 1.5 million of Mexico’s 100 million population work in the Maquila industry.

Many businessmen from the United States of America do not realize that what we generally refer to as Mexico is correctly named the United States of Mexico. In dealing with our friends from the South, we should respect that we are not the only United States nor are we the only Americans in the world.

So you now are responsible for a plant in Mexico. What do you need to know? Let’s start with some very basis information.

FORMING A COMPANY
As a turnaround professional, you don’t need to know exactly how the company was formed on Day One. You do need to find out under what rules the company was formed. Look for the following letters on invoices and other documents. S.A., S.A. de C.V., SNC, SCS, AP or S. de R.L. S.A. and S.A. de C.V. being the most common. Later we will discuss what this means.

MAQUILADORA AND PITEX
If the company you didn’t know you owned, but now do, has been around for many years, it was probably formed under what is called the Maquiladora program. A Maquiladora is nothing more than a factory or assembly plant operated in Mexico under preferential tariff programs established by the U.S. and Mexican governments to encourage the development of industry in Mexico. Today there are more than 3,000 U.S. owned maquilas.

If the company is less than ten years old, it was probably formed under the PITEX program rules. The PITEX program is generally a revised set of rules that were developed to make it easier to perform many of the once cumbersome exportations and importations under the Maquiladora program. It is important to realize that to move equipment or products into or out of Mexico, you will have to be in compliance with one of these program’s rules.

Many times, the Purchasing Manger is responsible, along with the Accounting Manager, for complying with the program requirements. Always interview both persons.

You do need to find out very quickly whether your import and export department is in total and full compliance with the specific program rules. Don’t be surprised if they aren’t. Get the records current as fast as possible! (I was involved with a potential large merger that was terminated, because one entity couldn’t get current in a reasonable time period.)

LABOR LAWS
Nothing you have learned about the WARN Act, state employment laws, U.S. labor laws, overtime rules has anything to do with Mexican labor laws. The laws in Mexico are very specific as to the liability of the employer, which will probably not be shown, nor is required to be shown, on the balance sheet. (The last turn-around I was involved with, the owner “found out” from our due diligence that he had a $3 million non-recognized liability.)

Some of the basic liability categories, which might not be accrued for, under the labor laws include:

PROFIT SHARING
All employers must distribute among their employees an amount equal to 10 percent of the employer’s pre-tax profit within 60 days after the employer is required to file its year-end income tax return. Fifty percent of this amount is to be distributed in prop-ortion to the number of days worked by each employee during the year, and the remainder according to the wages of each employee.

Note: While this is something that has to be paid, the reality is that there are legal ways to transfer costs and overhead, resulting in the Mexico operation having very little pre-tax profit.

CHRISTMAS BONUS
All employees must be paid a year-end bonus equal to at least 15 days wages, pay-able before the 20th of December. (Pay it or you won’t have employees December 21st.) Be aware that this liability is neither accrued for, nor are funds segregated to meet the liability much in advance, especially if you are having cash flow problems. These bonuses can be a large amount as you also have your normal payroll needs to meet at the same time.

Depending upon the product being made, a large percentage of plants close down from December 21st until the first week in January, allowing for the employees to celebrate the holidays and provide time for significant preventative maintenance operations to be conducted by the main-tenance staff. Also, Mexico’s workforce contains a very high percentage of practicing Catholics, and their religious requirements need to be respected. This period can be used to reduce the cash requirements at year-end.

PAID DAYS
The law provides that seven legal holidays must be observed, even though many companies offer eleven. Most of these are holidays not celebrated in the U.S. An employee required to work on any of these holidays must be paid overtime equal to three times the normal wage. After one year of uninterrupted activity, workers will enjoy an annual paid vacation, which can be no less than six working days, and will grow by two working days each year, until it reaches 12 days. During this period, workers will receive a 25 percent minimum vacation bonus above their normal wage. Again, this payable is not usually accrued for on the local balance sheet.

EMPLOYER HOUSING CONTRIBUTION
The law requires employers to pay an amount equal to 5 percent of each employee’s wages to the Federal Workers Housing Fund. (This is paid monthly so you should see an income statement entry.)

PAID MATERNITY LEAVE
All employers must provide their female employees with a fully paid maternity leave of six weeks prior to the approximate delivery date and six weeks thereafter. After the delivery they are guaranteed their previous job back with the increased seniority. (Did you know that 95% of all companies give the prospective female employees pregnancy tests before they hire them?)

OTHER
There are pension costs of 2 percent of total wages due. Overtime is paid at 100% plus a possible shift premium.

BAD NEWS – SEVERANCE PAY
You will find that total labor costs with benefits compare very favorably to those in the U.S. Today, for budgeting purposes, I usually use $4 - $5 per hour for direct labor inclusive of all wages and benefits. These labor costs are not for indirect labor, as that is industry specific. That is the good news. As for the bad news...

Mexican employers may not freely dismiss employees without cause. Workers become permanent employees after 90 days of employ-ment and are then entitled to severance benefits. Therefore, if an employer dismisses an employee without cause, the following severance costs will apply:

• Three months salary.
• Twenty days of salary for each year of service rendered.
• A seniority premium equal to 12 days salary per year, subject to a maximum.
• Back salary from the date of dismissal through the date of payment.
  (Again, the last engagement I was involved with the U.S. owner had a $3 million undisclosed liability on the balance sheet. There are legal ways to reduce this liability, but the subject of another paper.)

SUMMARY OF LABOR ISSUES
As the newly anointed turnaround pro-fessional, who just found out he or she has a Mexican operation, or even if you knew you had an operation before you took the engagement, you have to quickly grasp the situation and the exposure.

Cash is king in every country. “Cash es El Rey” (Cash is God) in Mexico, too, and especially in December, when many of the benefits are paid. You cannot expect negotiations to be successful or even entertained, when it comes to payment of the Christmas bonus.

99% of Mexican companies are unionized. There are “blue collar unions” and “white collar unions,” each with a different approach to working with management. Neither type of union will side with ownership over the employees at this time of the year.

The Government is very selfish and totally non-flexible, when it comes to payment of certain obligations, especially if they believe the ownership is considering leaving. Moving equipment across the border with obligations outstanding to the Govern-ment is not a situation you want to experience. Labor issues are very important and should be in a country that is generally considered socialistic. You need to know exactly where you stand on labor issues and the climate between the employees and ownership as many of the operational issues you will tackle are going to be tied to meeting your labor related obligations.

CONTRACT AND SHELTER MANUFACTURING
If you are still reading and haven’t been scared off by the last section, there is a way to eliminate the unknown liability and concern.

It has been very popular for U.S. based companies to set up an operation in Mexico by initially utilizing the services of a shelter or contract company. Under these relationships the U.S. company “rents” employees and, many times, the facility in which they work. By making one monthly payment to the shelter company, the U.S. company transfers all liability for wages and benefit payments, and reporting requirements to the shelter operator. (Most shelter operators accrue for the December payments throughout the year so they don’t get caught short and you don’t either.) The premium for their services could be $2-3 per hour, but is usually a good investment during the initial years, since you can then identify the workers you want to keep, establish your management team, get the plant properly organized and set up for the significant human resource reporting requirements. You can even test to see if the operation makes financial sense.

Note: When a company has less than 300-400 employees, it is cost effective to operate as a shelter company. With over 400 employees, the numbers usually change in favor of “going it” without outside assistance. As a turnaround professional now charged with operations in which you might be uncomfortable or totally unknow-ledgeable of the culture and conditions, it is possible to convert/sell all of your employees to a shelter operation and then “lease/rent” them back.

SUMMARY
When most turnaround professionals enter an engagement and become familiar with the conditions and circumstances, they have “check off lists” and go from Item 1 to Item 213. This practice isn’t that easy or even possible in Mexico, if you don’t have a due diligence list or know what questions to ask.

There are firms that can and will perform this initial due diligence for you. Someone who knows what they are doing can get you a report in two to three weeks, identifying strengths, weakness, exposures, unrecognized liabilities and a local management review. You will then have the ability to focus on the domestic operations and get answers your “domestic” team might not be able to obtain.

All of the Big 5 accounting firms have a presence in Mexico and do prepare financials on a basis very close to GAAP in the U.S. Because of the reports the Mexican Government requires to have prepared by a CPA firm, a call to the local CPA partner-in-charge of your account should be made quickly. Do not expect that they will have done many things operationally, e.g., inventories, cost reviews, but they will generally be very current on the reporting requirements to the Government.

Each of the thirty states in Mexico that allow Maquila program operations has a chamber of commerce and usually a Maquiladora Association, which will be helpful. They can tell you what average local labor rates are and generally know about the business climate.

Because the country is “very family oriented,” be aware that if you call the Maquiladora Association and ask about what it would take to close a plant down, you can expect the plant manager of your company to be calling you within an hour to tell you it is impossible. Communications need to be “selective.”

There are several quality publications one can access to learn, on a superficial level, how to conduct business in Mexico and about the general requirements of doing business in Mexico. The most popular seems to be Twin Plant News. It is published out of El Paso, Texas. (www.twinplantnews.com)

Most turnaround professionals are asked to perform an analysis to determine if a Mexican operation makes sense and the cost to establish one. If you are fortunate enough to walk into a situation where you have an operation in Mexico, you have to get a handle on not only the operational aspects of the plant, but also the different requirements and conditions of having a plant in Mexico.

If you know what you are doing, doing business in Mexico can be very straight-forward, and very profitable. Doing business in Mexico and not knowing “the rules” can be disastrous. When the company is going through cash availability challenges, it is even more important to understand the situation.

The person assigned to manage cash should be aware that Mexican operations have “Peso” accounts and “Dollar” accounts. They need to learn the rules for bringing cash into the country and getting cash out. The rules are not necessarily intuitive. Also, inflation has not been a problem in the last few years, but should be recognized as a risk, when it comes to conversion of cash to Pesos and back to Dollars.

The goal of the article was not to paint a dark picture for doing business in Mexico. You need to know and understand the rules and the culture, just as you would in any country in which you do business. In a turnaround situation, the learning process is unfortunately compressed and, the use of outside expertise is at these times warranted and necessary at the very initial data gathering stage and “game plan” development.

Remember that the Mexican Government and their Agencies want you to be successful. Success means employment and taxes. They will help as much as possible within the rules. Knowledge of the rules makes everything possible.

In Part 2 of this article, we will discuss some of the problems to avoid, how to establish strategic alliances and how to get products shipped in and out of Mexico, as well as how to sell in Mexico.

Benviendo y Mexico! (Welcome to Mexico!)

AIRA News is published six times a year by the Association of Insolvency and Restructuring Advisors, 221 Stewart Avenue, Suite 207, Medford, OR 97501. Copyright 2004 by the Association of Insolvency and Restructuring Advisors. All rights reserved. No part of this newsletter may be reproduced in any form, by xerography or otherwise, or incorporated into any information retrieval systems, without written permission of the copyright owner.