Q) Applying Positive Accounting Theory (PAT) , what steps would PAT theorists suggest that the management of Colorado group might undertake to avoid breaching debt covenants? In your answer include results/findings from PAT research to support your answer;include 4 specific examples of debt covenants, and which accruals could be managed to ensure those debt covenants were not breached.

Retailer Colorado at risk of defaulting loans

The Australian,Blair Speedy,December 30, 2010 12:00AM

THE private equity owners of Colorado Group have been forced to reassure a syndicate of lenders about its financial position.

The lenders have also sought from the Hong Kong private equity group, Affinity Equity Partners,its commitment to theretailer, whichteeters perilously close to breaching key covenants attached to $387 million worth of loans.

Financial accounts for Colorado Group obtained by The Australian reveal that auditor PricewaterhouseCoopers harbours significant fears for the group as a "going concern".

The company operates 430 stores in Australia and New Zealand and owns adventurewear, apparel and footwear brands including Colorado, Jag, Williams, diana ferrari and Mathers.

Page 11 of the accounts for the year ended July 31 states: "The instability in the retail environment raises significant risk that the group may breach financial covenant thresholds under its financing agreements within the next 12 months."

It notes that the $387m in external syndicated loans would probably become immediately due and payable if the covenants were breached or Affinity, "decides to exit its investments in the group".

According to the notes of the financial statements, Affinity told Colorado's directors that it would only exit the investment after consultation with its lenders and agreement that a sale would not trigger a call for repayment of the loans.

PwC noted that if the debt was called as a result of Colorado breaching its financial covenants, "there is significant uncertainty whether the group will continue as a going concern".

But Colorado's directors say they believe the business should remain a going concern for the next 12 months for several reasons, including its historical ability to meet interest payments and its track record in renegotiating loan facility terms and loan covenants with its financiers.

Even if the loan facility agreements are breached, Colorado can invoke a mechanism that provides for a "workout" as a going concern without the appointment of receivers.

Brisbane-based Colorado posted a loss before income tax of $62.7m, dragged down by impairment charges against assets of $86.9m as a result of revised company forecasts because of the retailing downturn.

The group noted in its accounts: "The retail apparel industry in particular has experienced declining margins and market size."

Despite the tough outlook, Colorado managed to produce operating earnings of $37.9m and positive cashflows of $12.8m last financial year.

Excluding its financing difficulties, Colorado booked sales of $462.5m in 2009-10 and reported a solid rise in pre-tax profit to $24.3m, up from $7.6m a year earlier.

Affinity spent $595m to buy Colorado in 2007 in Australia's first public to private unsolicited takeover by a buyout fund.

Affinity's interest in Colorado is held through an entity called ARH Investments. The notes to its financial accounts reveal the private equity group provided direct funding of $134.7m, which it may struggle to recover because it ranks behind other lenders.

The notes to ARH Investments' accounts state that "the terms of the external syndicated loan facility ensure that the shareholder loans cannot be serviced prior to the repayment of a minimum of $60m of the external syndicated loans".

Affinity was expected to relist Colorado by 2012, in line with the standard private equity investment time horizon, but it is now more likely the group will either hold on to the company until the balance sheet can be patched up, or offload it to a trade buyer.

Affinity chairman Bob Dalziel, who also chairs Colorado, did not respond to requests for comment.