School Specialty, Inc (fka SCHSQ)

[DFYSW]

The matters scheduled to be heard tomorrow can be found in the most recent agenda which is filed here:

http://www.kccllc.net/documents/1310125/1310125130419000000000008.pdf

The main item will be the court's ruling (approval, rejection, or continuance) on the debtor's disclosure statement. The disclosure statement is the document by which the debtor provides information about the current financial status of the company. Creditors, stockholders, and other interested parties use the information in the disclosure statement as a basis for voting on whether to accept or reject the debtor's plan of reorganization (POR). The debtor's POR is basically the meat of the BK process; court confirmation of the POR dictates how everybody's interests in the BK estate are going to be handled (leases cancelled, debts forgiven, loans cut, equity eliminated), and how the company will be structured upon emergence from BK.

SCHSQ's most recent POR is filed here:

http://www.kccllc.net/documents/1310125/1310125130419000000000007.pdf

Usually the disclosure statement is contested as not factual, correct, and/or complete. Any properly-filed objection by a legitimate party to the proceeding gets to be heard before the court rules on the motion to accept the disclosure statement. Voting on the POR (the main event in BK) generally cannot occur without an approved disclosure statement.

In this particular case the debtors continue to "revise" (radically change, actually) the POR, and therefore the disclosure statement, even on the eve of the hearing. Consequently, the obvious objection has been filed that it is unreasonable (impossible really) to have a legal proceeding on the adequacy of a disclosure statement (and underlying POR) that remains in flux.

Since this seems like a no-brainer (even though there is no such thing when lawyers are involved) it may be likely that the motion to accept the disclosure statement is not granted at tomorrow's hearing. This would be the second time that the debtors (first Bayside now the Ad Hoc DIP Lenders) tried to quickly snatch the entire business before anyone else had time to realize or understand what was going on. Remember that the court only rules on motions and issues that are correctly introduced by parties with standing. If the timeframe is accelerated and/or information disclosure is lacking yet no-one notices or properly objects, the court will support all manner of sins.

Even if all the rules are followed the process still is subject to a level of officially tolerated manipulation that makes the best OTCBB and Pinksheet stock scams look like the penny-ante promotions that they are. BK is the big leagues and Delaware is center court where millions -- even billions -- of dollars in equity are legally, shamelessly, and with full transparency, stolen from the owners who earned it and awarded to lenders and lawyers who show up only after there is blood in the water. Remember that the U.S. bond market is about TWICE the size of the U.S. stock market.

So the hearing on the disclosure statement is still a bracket event; confirmation of the POR is the final contest for all the marbles. In SCHSQ, as in most BK, stockholders can't even vote on whether to accept or reject the plan that gives away the going concern. This is because any POR that cancels equity assumes stockholders will vote to reject, so the POR is structured to ensure that stockholders are outvoted by everyone else.

This is most easily accomplished by dramatically understating the equity in the BK estate so that current shares are cancelled and creditors accept in lieu of full payment new shares that are found to have surprising value only after the company emerges. Unless there is a large stockholder such as a pension fund that the debtor fails to cut in on the deal, current stockholders usually lack the knowledge, time, or money to successfully challenge the debtor's valuation of the estate, especially since the debtor holds all the cards (information on assets, financial position, upcoming events, etc) and is in control of company decisions.

However, if the debtor's valuation can be successfully challenged to show additional equity then the POR must be revised to indicate how that additional equity will be distributed. To the extent that enough additional equity is found that current stockholders might receive a distribution, current shares would have value and probably even survive to participate in any upside after the restructured company emerges. To the almost-unprecedented event that equity is found to exceed debt (throwing the entire BK filing into question), the board of director's fiduciary duties would revert back to equity.

Since everything is frozen at the time of a filing (permission usually is granted to conduct business as usual but not much else during the process), a BK company cannot issue additional shares or debt. As a consequence you would think that trading activity in a BK company's stocks/bonds/claims might represent knowledgeable jockeying for position in the line for payoff. This is not always the case, and it is almost never the case in Q stocks. It's true that BK provides an excuse for volatility, especially in low-floaters, that can be profitable to nimble and disciplined traders, but don't confuse the market action as having anything more than a passing connection to the courthouse drama. If you must look for reliable clues the market price of traded debt is the best indicator but in the case of SCHSQ none is available.