How Applause rode out the perfect storm.

After nearly 20 successful years in the business of manufacturing stuffed animals, San Fernando Valley-based Applause (www.applause.com) found itself late last year in a place where no company ever wants to end up. In a sort of "perfect storm," a slowing economy, combined with the lack of blockbuster movies to prompt sales of related stuffed animals (a la Toy Story, etc.), had put the company on the verge of bankruptcy.

"When we were called in to help, there was a major cash crunch due to excessive inventory and a huge debt service of more than $100 million," says Adam Michelin, a partner in the Los Angeles-based turnaround consulting firm Kibel Green Issa, Inc. (www.kginc.com) "By the time we arrived, the company was on life support."

After nearly a year of intense resuscitation efforts by Michelin and new owner Bob Solomon, Applause is now restored to sound financial health. The company offers a case study in how competent turnaround experts can breathe life into a nearly hopeless situation.

Being in the 'sentimental' business

To understand how an established company like Applause got into such dire straits, it's important to understand more about the nature of its business. "I don't position Applause as a toy or an entertainment company--we're a gift company, and we're really in the 'sentimental' business," says Solomon, one of the original founders of Applause who bought the company back from foreclosure about six months ago. He explains how the company was founded on this premise, but during the mid-'90s, it rode a wave of blockbuster movie deals--including Star Wars, Toy Story and The Lion King--to skyrocketing revenue.

Michelin explains that this was the beginning of the company's troubles: "They had become dependent on these blockbuster movie deals for huge chunks of revenue--Star Wars alone brought the company $50 million. They forecast that revenues would continue to go straight up and built an infrastructure and overhead and purchased inventory for $160 million in sales, with 25 percent of that coming from movie deals alone. When sales came in at closer to $110 million, they were in trouble."

"The debt was just crushing the company," says Solomon. "Applause got caught up in a vicious cycle. They purchased way too much inventory in anticipation of big movie deals. Meanwhile, they were forced to chase higher and higher revenues to support the huge debt burden. It was like a big Pyramid scheme, and by the end of last year, it all came crashing down."

The equity holders in the company bowed out and the banks froze the company's loans and credit lines. Soon after that, the banks foreclosed on the company's assets and sold them to Solomon and another equity partner.

Designing a downsizing plan

During this time, Michelin assumed the COO role at Applause and was busy designing a downsizing plan to refocus on the company's core strengths and products. "We focused on two main things: trimming the fat without cutting the muscle, and reducing inventory by reducing the number of items (or SKUs--stock keeping units) in stock," he says. "Of course, we were doing everything we could to conserve cash and keep the company afloat."

The key to the new structure created by Michelin and Solomon is that it enables Applause to live on its core business and expand or contract to meet variations in sales. "This is done primarily by outsourcing peak business," explains Michelin. "It costs a little more, but it gives the company the flexibility to handle sales fluctuations without destroying the base organization that runs the machine."

"Applause is in a drastically different financial position now than it was just six months ago," says Solomon, noting that Kibel Green Issa helped line up a $25 million line of credit that was "absolutely critical" in the restructuring plans. "We have a fraction of the debt, only 20 percent of the SKUs, 75 percent less inventory, a 30 percent larger sales force, and new licensing agreements with several major studios. Most importantly, we have a leaner, more efficient management team and infrastructure."

At the same time, major challenges await. "There's a lot of uncertainty," says Solomon. "Tourism, of course, is way down, and tourists buy gifts. But Applause is as well-positioned financially as it has ever been to take advantage of whatever opportunities may lie ahead."

Don Sadler is a business-to-business freelance writer for Trade Press Services, an editorial resource company based in Thousand Oaks.