Pinnacle Laboratories, Inc.

UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF NEW MEXICO
In re:
PINNACLE LABORATORIES, INC.
Debtor. 	No. 11-08-10239 SA
FINDINGS OF FACT AND CONCLUSIONS OF LAW
ON UNSECURED CREDITORS’ COMMITTEE’S MOTION
TO CONVERT CASE TO CHAPTER 7
This matter came before the Court for trial of the Unsecured
Creditors’ Committee’s (“UCC”) Motion to Convert Case to Chapter
7 (doc 69). 	The UCC appeared through its attorney George Moore.
Debtor appeared through its attorney William Davis. 	This is a
core proceeding. 	28 U.S.C. § 157(b)(2)(A). 	The Court has
considered the oral and written evidence presented at the trial
and at the earlier trial on the motion to use cash collateral and
has taken judicial notice of the file. 	The Court finds that the
UCC’s Motion to Convert is well taken and should be granted.
FINDINGS OF FACT
1. 	Debtor filed this Chapter 11 proceeding on January 30, 2008
and remains a debtor in possession.
2. 	Debtor filed its initial report on February 14, 2008 (doc
16). 	It includes, among other things, copies of calendar year
2005 and 2006 federal tax returns and a balance sheet as of
January 29, 2008. 	The balance sheet shows cash on hand of $9,670
and accounts receivable of $231,268. 	The 2006 tax return shows
$1.585 million in sales, cost of goods sold of $999,000 (63%) and
gross profit of $586,000 (37%). 	Debtor had an operating loss of
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$172,000 in 2006. 	The 2005 tax return shows $1.755 million in
sales, cost of goods sold of $1,224,000 (69%) and gross profit of
$530,000 (31%). 	Debtor had an operating loss of $128,000 in
2005.
3. 	The United States Trustee appointed the UCC on April 7,
2008. 	Debtor is therefore not a “small business debtor” under §
101(51D).
4. 	Debtor filed its first Monthly Operating Report (“MOR”), for
the month of February, 2008, on March 31, 2008 (doc 52). 	It
contains a balance sheet as of February 29, 2008 as well as two
profit and loss statements for the month of February, one
prepared on the cash basis (showing a loss of $5,144.48) and one
prepared on the accrual basis (showing a loss of $72,182.21).
The balance sheet shows a cash balance of $23,646 and accounts
receivable of $192,368. 	Post-petition accounts payable were
$35,154.63.
5. 	The UCC filed its Motion to Convert to Chapter 7 on April
22, 2008 (doc 69), alleging mismanagement and a continuing loss
to the estate without any likelihood of rehabilitation.
6. 	On April 22, 2008, Debtor filed an Amended MOR for February
(doc 71) which had substantially the same balance sheet and cash
basis profit and loss statement, but which omitted the accrual
basis profit and loss statement.
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7. 	On April 24, 2008, Debtor filed a Second Amended MOR for
February (doc 76) which had a different balance sheet from the
Amended MOR (particularly in the equity section of the balance
sheet), and a revised accrual basis profit and loss statement
(showing a loss of $70,038.27). 	This balance sheet shows a cash
balance of $29,145.96 and accounts receivables of $191,364.29.
8. 	On April 30, 2008, Debtor filed its March 2008 MOR (doc 86).
The profit and loss statement (accrual basis) shows a March loss
of an additional $20,544.73. 	The balance sheet shows cash of
$28,215.72 and account receivables of $175,513.43. 	Post-petition
accounts payable were $46,128.90.
9. 	On May 23, 2008, Debtor filed its April 2008 MOR (doc 99).
The profit and loss statement (accrual basis) shows an April loss
of an additional $62,246.82. 	The balance sheet shows cash of
$1,206.75 and account receivables of $185,728.90. 	Post-petition
accounts payable were $93,607.50.
10. 	Debtor’s estate has had a substantial and continuing loss
since the filing of the petition. 	By the end of April, 2008,
Debtor was substantially out of cash, its receivables had
declined by at least $45,000 from the filing date, and unpaid
post-petition expenses had climbed to $93,607.50. 	See also UCC
Trial Exhibit E (using same documents to arrive at $152,845.47
loss for Debtor while in bankruptcy.)
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11. 	In the three months since filing the bankruptcy, Debtor’s
average monthly receipts have been $97,115. 	See Exhibit 19, form
MOR-2. 	In the same time, average actual disbursements have been
$99,048. 	Id. 	And, monthly expenses for which disbursements have
not been made average $31,203. 	(Doc 99.) 	So, actual accrual
based expenses are approximately $130,000 per month.
12. 	Debtor Trial Exhibits 14 and 15 are drafts of Debtor’s
proposed Disclosure Statement and Plan of Reorganization.
13. 	On May 28, 2008, Debtor filed a Plan of Reorganization (doc
104)(“Plan”) and Disclosure Statement (doc 105) which appear to
be completed versions of trial exhibits 14 and 15.
14. 	Exhibit 17 is Debtor’s 5 year cash flow projection. 	It is
based upon the following assumptions: 1) monthly revenues of
$120,000 for the months of September through November, 2008, then
$125,000 for the next 57 months; and 2) monthly expenses starting
at around $55,000 and increasing gradually to $62,455 over the
next 60 months. 	These projections result in monthly income/cash
flows of between $7,000 and $8,000. 	The Plan, ¶ 5.1, calls for
the reorganized Debtor to fund the Plan by paying $6,500 per
month in cash for sixty months. 	Debtor has not yet met its
projections for either revenue or expense in the bankruptcy case.
The Court finds that the projections are simply speculations
fabricated by the Debtor’s management (albeit in good faith) to
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present something to the Court that appears plausible, but in
reality is not.
15. 	In addition to the unbelievable numbers for expenses in the
cash flow projections, even if the revenue figures were
attainable (as they appear to have been in 2005 and 2006), Debtor
was not profitable at those levels but suffered operating losses.
Furthermore, the Disclosure Statement does not show any
fundamental change in business plan or climate that would justify
reducing expenses by half, even taking into account the expense
reductions already effected by the Debtor. 	This is particularly
true in light of Debtor’s historical cost of goods sold, which
alone is about 60%. 	In sum, the Court finds that Debtor is
unable to fund a plan.
16. 	Because the UCC has filed this Motion to Convert, the Court
assumes that the unsecured creditors will not support Debtor’s
Plan.
17. 	The UCC established that Debtor’s manager has not reduced
his salary during the Chapter 11 and continues to use Debtor
funds to pay for the vehicle he uses. 	The Court does not find
these to be mismanagement, and there was no evidence of any gross
mismanagement presented.
CONCLUSIONS OF LAW
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1. 	The UCC argues that this Chapter 11 case should be converted
to Chapter 7 because “cause” exists under § 1112(b) of the
Bankruptcy Code. 	Section 1112(b)(1) provides:
(b)(1) Except as provided in paragraph (2) of this
subsection, subsection (c) of this section, and section
1104(a)(3), on request of a party in interest, and
after notice and hearing, absent unusual circumstances
specifically identified by the court that establish
that the requested conversion or dismissal is not in
the best interests of creditors and the estate, the
court shall convert a case under this chapter to a case
under chapter 7 or dismiss a case under this chapter,
whichever is in the best interests of creditors and the
estate, if the movant establishes cause.
2. 	Section 1112(b)(4) provides a list of non-exclusive factors
that constitute “cause” and includes the following factors which
the UCC asserts are relevant here: substantial and continuing
loss to the estate in conjunction with the absence of a
reasonable likelihood for rehabilitation, see § 1112(b)(4)(A),
and gross mismanagement of the estate, see § 1112(b)(4)(B).
3. 	Based on the above findings, the Court finds that there is
an absence of a reasonable likelihood of rehabilitation of the
Debtor in Chapter 11. 	Debtor cannot fund a plan, and is unable
to repay its creditors out of current or future income.
4. 	With regard to the other prong of § 1112(b)(4)(A),
whether the Debtor has suffered continuing losses
or diminution of the estate, the Court looks to
both the financial prospects of the Debtor and the
financial records filed with the Court. 	The track
record of the Debtor suggests a pattern of
declining assets and substantial continuing
losses. 	Negative cash flow and an inability to
pay current expenses as they come due can satisfy
the continuing loss or diminution of the estate
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1 This decision is being issued after the fifteen-day
deadline required by section 1112(b)(3) (added by the Bankruptcy
Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No.
109-08, 119 Stat. 23). 	The delay occurred due to an
administrative mistake by the Court (not its staff). 	The Court
does not read section 1112(b)(3) to impose a specific consequence
on either party for this failure. 	Compare subsections 362(e)(1)
and (2) (stay is modified if certain hearings are not conducted
or decisions rendered within certain periods of time). 	The Court
apologizes to the parties for missing this deadline.
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standard for purposes of § 1112(b). 	In re AdBrite
Corp., 290 B.R. 209, 215 (Bankr. S.D. N.Y. 2003);
In re Motel Properties, Inc., 314 B.R. 889, 894
(Bankr. S.D. Ga. 2004); In re Route 202 Corp. t/a
Lionti's Villa, 37 B.R. 367, 374 (Bankr. E.D. Pa.
1984); and In re Galvin, 49 B.R. 665, 669 (Bankr.
D. N.D. 1985) (Post-petition negative cash flow is
considered by courts to be evidence of continuing
losses.).
In re Gateway Access Solutions, Inc., 374 B.R. 556, 564 (Bankr.
M.D. Pa. 2007). 	Pinnacle Laboratories has a negative cash flow,
is depleting its current assets, and is demonstrating through its
growing accounts payable figure that it cannot meet current
demands. 	The estate is suffering continuing losses.
5. 	Cause exists under § 1112(b)(4)(A) to convert this case.
6. 	No cause exists under § 1112(b)(4)(B) to convert the case.
7. 	This case should be converted to Chapter 7 to enable a
Chapter 7 trustee to salvage what remains of the accounts
receivables and screen for potential recoverable transfers. 	A
separate Order will enter converting the case. 1
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Honorable James S. Starzynski
United States Bankruptcy Judge
Date Entered on Docket: 	June 19, 2008
copies to:
William F. Davis
6709 Academy NE, Suite A
Albuquerque, NM 87109
Leonard K Martinez-Metzgar
PO Box 608
Albuquerque, NM 87103-0608
George M Moore
Moore, Berkson & Gandarilla
PO Box 216
Albuquerque, NM 87103-0216
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