SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES AND EXCHANGE ACT OF 1934
For the quarterly period ended August 31, 1996.
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
For the transition period from...................to......................
Commission file number 0-18926
INNOVO GROUP INC.
(Exact name of Registrant as specified in its charter)
Delaware 11-2928178
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
27 North Main Street
Springfield, Tennessee 37172
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (615) 384-0100
.................................................................
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or Section 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such
reports), and (2) has been the subject to such filing requirements for
the past 90 days.
Yes___X__ No_____
Indicate the number of shares outstanding of each issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding as of October 1, 1996
_____ _________________________________
Common stock, par
value of $.01 per share 18,818,167 shares
<PAGE>
INNOVO GROUP INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
Item 1. Financial Statements
Condensed consolidated balance sheets as of
August 31, 1996 and October 31, 1995 3
Condensed consolidated statements of operations
for the three and nine months ended August 31, 1996
and July 31, 1995 4
Condensed consolidated statements of cash flows for the
nine months ended August 31, 1996 and July 31, 1995 5
Notes to condensed consolidated financial statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 6. Exhibits and Reports on Form 8-K 19
Signature Page 20
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
INNOVO GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(000's except for share data)
(Unaudited)
<TABLE>
<CAPTION>
August 31, October 31,
1996 1995
________ ___________
ASSETS
CURRENT ASSETS
</CAPTION>
<S> <C> <C>
Cash and cash equivalents $ 1,466 $ 6
Accounts receivable 1,229 1,524
Inventories 1,571 1,229
Prepaid expenses 449 406
_______ ______
TOTAL CURRENT ASSETS 4,715 3,165
PROPERTY AND EQUIPMENT, net 5,078 2,126
OTHER ASSETS 1,394 376
_______ ______
$ 11,187 $ 5,667
_______ ______
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable $ 1,159 $ 993
Subordinated notes payable - 235
Current maturities of long-term debt 228 143
Accounts payable 1,231 1,942
Accrued expenses 1,355 735
_______ ______
TOTAL CURRENT LIABILITIES 3,973 4,048
LONG-TERM DEBT, less current
maturities 4,325 1,422
OTHER 111 153
_______ ______
TOTAL LIABILITIES 8,409 5,623
_______ ______
CLASS 3 TRUST - 274
_______ ______
STOCKHOLDERS' EQUITY
Common stock $.01 par; shares authorized
30,000,000; issued 18,757,783 shares in
1996 and 3,050,062 shares in 1995 187 30
Stock subscription - 350
Additional paid-in capital 24,056 19,137
Deficit (19,039) (17,358)
Treasury stock, 119,691 and 53,072 shares (2,426) (2,389)
_______ ______
TOTAL STOCKHOLDERS' EQUITY 2,778 (230)
_______ ______
$ 11,187 $ 5,667
_______ ______
</TABLE>
See accompanying notes to condensed consolidated financial statements.
INNOVO GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(000's except per share information)
<TABLE>
<CAPTION>
Three months ended Nine Months ended
___________________ ____________________
August 31, July 31, August 31, July 31,
1996 1995 1996 1995
_______ _______ ______ _________
</CAPTION>
<S> <C> <C> <C> <C>
NET SALES $ 2,304 $ 1,638 $ 5,704 $ 4,002
COST OF SALES 1,548 1,253 3,551 2,387
_______ ______ _______ ______
Gross profit 756 385 2,153 1,615
OPERATING EXPENSES
Selling, general and administrative 1,117 788 2,725 1,888
Depreciation and amortization 205 110 473 323
_______ ______ _______ ______
Income (loss) from operations (566) (513) (1,045) (596)
INTEREST EXPENSE (231) (67) (515) (349)
OTHER INCOME (EXPENSE) - Net (93) (21) 73 1,960
_______ ______ _______ ______
Income (loss) before income taxes (benefit) (890) (601) (1,487) 1,015
INCOME TAXES (BENEFIT): - - - -
_______ ______ _______ ______
INCOME (LOSS) FROM CONTINUING OPERATIONS (890) (601) (1,487) 1,015
DISCONTINUED OPERATIONS:
Results of discontinued NASCO
Products operations - (483) - (927)
Gain on sale of NASCO Products
operations - 263 - 263
_______ ______ _______ ______
- (220) - (664)
_______ ______ _______ ______
NET INCOME (LOSS) $ (890) $ (821) $(1,487) $ 351
_______ ______ _______ ______
EARNINGS (LOSS) PER SHARE:
Continuing operations $ (.05) $ (.22) $ (.13) $ .40
Discontinued operation - (.08) - (.26)
_______ ______ _______ ______
Net income (loss) $ (.05) $ (.30) $ (.13) $ .14
_______ ______ _______ ______
WEIGHTED AVERAGE SHARES OUTSTANDING 16,750 2,781 11,199 2,533
_______ ______ _______ ______
</TABLE>
See accompanying notes to condensed consolidated financial statements.
INNOVO GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(000's)
<TABLE>
<CAPTION>
Nine Months ended
________________________
August 31, July 31,
1996 1995
_________ _________
CASH PROVIDED BY (USED IN)
</CAPTION>
<S> <C> <C>
OPERATING ACTIVITIES $ (2,137) $ 994
_______ ______
CASH FLOWS PROVIDED BY
INVESTING ACTIVITIES:
Capital expenditures (213) -
Proceeds from sale of
discontinued operation 199 100
_______ ______
Net cash provided by (used in)
investing activities (14) 100
_______ ______
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 2,054 -
Additions to long-term debt 1,675 163
Debt issue costs (285) -
Repayments of long-term debt (85) (99)
Additions to notes payable 312 -
Repayments on notes payable (56) (1,156)
_______ ______
Net cash provided by (used in)
financing activities 3,615 (1,092)
_______ ______
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 1,464 2
CASH AND EQUIVALENTS, (beginning of period) 2 4
_______ ______
CASH AND EQUIVALENTS, (end of period) $ 1,466 $ 6
_______ ______
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE>
INNOVO GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1: BASIS OF PRESENTATION
The condensed consolidated financial statements include the
accounts of Innovo Group Inc. ("Innovo Group") and its wholly-owned
subsidiaries (collectively "the Company"). The condensed consolidated
financial statements included herein have been prepared by the Company,
without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations, although the Company believes
that the disclosures are adequate to make the information presented not
misleading. These condensed consolidated financial statements and the
notes thereto should be read in conjunction with the consolidated
financial statements included in the Company's Annual Report on Form 10-K
for the year ended October 31, 1995.
In the opinion of the management of the Company, the accompanying
unaudited condensed consolidated financial statements contain all
necessary adjustments to present fairly the financial position, the
results of operations and cash flows for the periods reported. All
adjustments are of a normal recurring nature.
The results of operations for the above periods are not
necessarily indicative of the results to be expected for the full year.
Effective November 1, 1995, the Company changed its fiscal year
to end on November 30. Previously the Company's fiscal year ended on
October 31. The results of operations and cash flows for the transition
period of November 1, 1995 to November 30, 1995 were separately presented
in the Company's Quarterly Report on Form 10-Q for the quarter ended
February 29, 1996.
NOTE 2: ACQUISITION
On April 12, 1996, the Company acquired 100% of the outstanding
common stock of Thimble Square, Inc. ("Thimble Square") for an aggregate
of $1.1 million, paid by the issuance of shares of the restricted common
stock of the Company. In a concurrent transaction, Thimble Square
acquired from its stockholders a plant it had previously leased from them
in exchange for (a) $300,000 paid by the issuance of shares of the
restricted common stock of Innovo Group, and (b) the issuance by Thimble
Square of $200,000 of unsecured notes payable due, without interest, on
August 31, 1996 (with certain prepayments required in the event of
certain refinancings or asset sales by Thimble Square). The Company also
issued 95,686 shares in payment of a finder's fee related to the
acquisition.
A total of 2,840,784 shares of the Company's common stock were
initially issued to effect the acquisition. However, in August, 1996,
upon completion of the audit of Thimble Square's financial statements and
INNOVO GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 2: ACQUISITION (continued)
the appraisal of its plants and equipment, the number of shares was,
pursuant to the terms of the merger agreement, reduced by 519,608 shares.
Additionally, at the time of the acquisition Thimble Square owned
1,080,000 shares of the Company's common stock as a result of the
January, 1996 manufacturing agreement between the companies (see Note 6).
As a result of the acquisition, Innovo Group reacquired, and retired,
those shares, and the net increase in the number of shares of Innovo
Group common stock outstanding was 1,241,176 shares.
The aggregate purchase price, as adjusted, of $1,584,000 (which
includes the finder's fee of $49,000 and acquisition costs of $200,000)
was allocated to Thimble Square's assets and liabilities, based on their
fair values, as follows:
(000's)
Current assets $ 220
Property and equipment 1,525
Investment in Innovo Group
common stock 551
Goodwill 842
Current liabilities (924)
Long-term debt (546)
Other liabilities (84)
______
$ 1,584
______
The acquisition was accounted for as a purchase, and Thimble
Square's operating results are included in the consolidated results of
operations from April 12, 1996. The following unaudited pro forma
information indicates what net sales, income from continuing operations,
and income from continuing operations per share, would have been had the
acquisition of Thimble Square been completed on December 1, 1995 and
November 1, 1994, respectively. This unaudited pro forma information has
been prepared for illustrative purposes only and is not necessarily
indicative of the Company's future financial position or results of
operations.
<TABLE>
<CAPTION>
Nine months ended
___________________
August 31, July 31,
1996 1995
_______ _________
(000's except per share amounts)
</CAPTION>
<S> <C> <C>
Sales $ 6,137 $ 6,885
Income (loss) from continuing
operations (1,699) 964
Income (loss) per share from
continuing operations (.16) .26
</TABLE>
INNOVO GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 2: ACQUISITION (concluded)
The goodwill arising from the acquisition of Thimble Square is
being amortized over a period of 10 years. The Company will periodically
assess the recoverability of the goodwill by comparison to the projected
undiscounted operating cash flows from the acquired operations over the
remaining amortization period. If such a comparison indicates
impairment, unamortized goodwill will be reduced to equal the present
value of such projected cash flows.
NOTE 3: DISCONTINUED OPERATIONS
On July 31, 1995 the Company executed an agreement with Accessory
Network Group ("ANG") under which ANG succeeded to all of the rights held
by NASCO Products to market and distribute in the United States the
National Football League, NBA, Major League Baseball and National Hockey
League logoed sports bags, backpacks and equipment bags NASCO Products
previously imported and distributed. The products marketed and sold
under those license rights represented a separate class of products and
previously issued 1995 financial statements have been restated to report
the results of those operations as a discontinued operation.
For each license ANG is paying NASCO Products $187,500 ($750,000
in the aggregate), of which $100,000 was paid on July 31, 1995. The
remaining $650,000 is payable, without interest, in monthly installments
equal to 5% of ANG's aggregate sales of the licensed products, with the
final payment due July 31, 1998. ANG assumed all of NASCO Products'
obligations under the licenses, including payment of royalties and
minimum royalties. NASCO Products also transferred to ANG its existing
inventory of these products, for which ANG paid approximately 67% of
NASCO Products' cost over a six month period. The payments to be
received from the sale of the NASCO Products' domestic operations were
recorded at their present value, discounted 10% per annum.
In addition, ANG will make an ongoing annual payment to NASCO
Products of 2% of sales under each of the National Football League, Major
League Baseball and National Hockey League licenses, and 1% of sales
under the NBA license, up to aggregate sales of $15 million, and 1.5% and
.5% of sales thereafter. The payments will continue for forty years
unless a license expires or is terminated and is not renewed or
reinstated within twelve months.
INNOVO GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 4: INVENTORIES
Inventory consisted of the following:
<TABLE>
<CAPTION>
August 31, October 31,
1996 1995
_________ ___________
(000's)
</CAPTION>
<S> <C> <C>
Finished goods $ 663 $ 601
Work-in-process 219 177
Raw materials 714 469
Inventory reserve (25) (18)
______ ______
Total $ 1,571 $ 1,229
______ ______
</TABLE>
NOTE 5: NOTES PAYABLE AND LONG-TERM DEBT
(a) Notes Payable
Notes payable consisted of the following:
<TABLE>
<CAPTION>
August 31, October 31,
1996 1995
_________ ___________
(000's)
Innovo factoring
</CAPTION>
<S> <C> <C>
facility $ 433 $ 356
Bank credit facility - 202
Working capital loan 239 407
NPI International loan 100 -
Thimble Square acquisition
(Note 2) 200 -
Other 187 28
______ ______
$ 1,159 $ 993
______ ______
</TABLE>
In December, 1995 the Company obtained a $300,000 short term loan
collateralized by the common stock of NPI International. The loan bears
interest at an annual rate of 12% and is due July 31, 1996. $200,000 of
such note was repaid in the second quarter fiscal 1996.
The $200,000 notes payable issued in connection with the
acquisition of Thimble Square were repaid in September, 1996.
(b) Long-Term Debt
In November, 1995 the Company acquired a facility which it is
developing as an indoor retail outlet featuring antique and flea market
shops. The $1.5 million purchase price was paid by the issuance to the
INNOVO GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 5: NOTES PAYABLE AND LONG-TERM DEBT (concluded)
seller of (i) options to purchase 1 million shares of the Company's
common stock, exercisable at $.01 per share through March, 1998, and (ii)
an $800,000 first lien non-recourse mortgage secured by the property.
The mortgage is payable $25,500 quarterly, beginning July 1, 1996; all
unpaid principal, and interest (which accrues at the rate of 9.5% per
annum) is due January, 2006. The stock option was exercised in March,
1996. The Company also issued a warrant, exercisable for the purchase of
100,000 shares at $.01 per share, as a finder's fee on the property
acquisition. The warrant was exercised in April, 1996.
During the third quarter of fiscal 1996 the Company completed the
private placement of $1,675,000 of 8% Convertible Debentures. The 8%
Convertible Debentures are convertible, beginning October 13, 1996, into
shares of the Company's common stock at a per share price ("the
Conversion Price") equal to the lesser of $.42 per share or 70% of the
closing bid price for the five days preceding any election of conversion.
The 8% Convertible Debentures also provide that the Company may call the
debentures, beginning November 12, 1996, by the payment of the value of
the shares of common stock obtainable upon conversion, and may pay the
debentures, together with the accrued interest, at their September 30,
1998 maturity by the issuance of shares of common stock on the basis of
the Conversion Price.
NOTE 6: STOCKHOLDERS' EQUITY
The changes in common stock, additional paid-in capital, and
treasury stock during the month of November, 1995 and during the first
quarter of fiscal 1996 were as follows:
<TABLE>
<CAPTION>
Additional
Common Stock Stock paid-in Treasury Stock
Shares Amount Subscription capital Shares Amount
______ ______ ____________ _________ ______ ______
(000's) (000's) (000's) (000's)
</CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Balance, October 31, 1995 3,050,062 $ 30 $ 350 $ 19,137 (53,072) $(2,389)
Issuances of common stock
Exercise of warrants 750,000 8 - 232 - -
Subscription agreement 60,793 1 (58) 57 - -
Spirco reorganization 18,000 - - 12 - -
Issuance of option (Note 5) - - - 700 - -
_________ ____ ______ _______ _______ _______
Balance, November 30, 1995 3,878,855 39 292 20,138 (53,072) (2,389)
Issuances of common stock
Cash 7,201,996 72 - 1,737 - -
Subscription agreement 311,356 3 (292) 289 - -
Spirco reorganization 282,994 3 - 280 - -
Manufacturing agreement 1,200,000 12 - 388 - -
Thimble Square acquisition
(Note 2) 1,241,176 12 - 622 - -
Extinguishment of debt 1,048,588 10 - 321 - -
Exercise of warrants and
options (below and Note 5) 3,372,730 34 - 412 - -
Loan fees 105,802 1 - 31 - -
Debt settlement - - - - (66,619) (37)
Issuance of warrants - - - 40 - -
Issuance costs 114,286 1 - (202) - -
_________ _____ _______ ________ _______ _______
Balance, May 31, 1996 18,757,783 $ 187 $ - $ 24,056 (119,691) $(2,426)
</TABLE>
<PAGE>
INNOVO GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 6: STOCKHOLDERS' EQUITY (concluded)
In October, 1995 the holder of unsecured notes aggregating
$319,000 tendered the notes, and accrued interest of $31,000, as a
subscription for shares of the Company's common stock. Under the
subscription agreement the Company issued between November 1, 1995 and
April 30, 1996 shares of common stock that had an aggregate value of
approximately $350,000, on the basis of 75 percent of the market prices
at the times the shares are issued, subject to a maximum of 375,000
shares.
In January, 1996, the Company entered into an agreement to obtain
contract manufacturing services, and issued to the contractor (Thimble
Square) 1,200,000 shares of its common stock as prepayment for $400,000
(approximately 57,000 hours) of manufacturing operations which the
Company may use on an as needed basis through July 31, 1997. Thimble
Square owned 1,080,000 of such shares at the time of its acquisition by
the Company (see Note 2), as the result of which the agreement was
canceled and the Company reacquired, and retired, such 1,080,000 shares.
During the first quarter of fiscal 1996 the Company settled an
outstanding obligation held by a creditor who had previously received
66,619 shares of common stock as a partial payment. As a part of the
settlement the creditor returned the shares to the Company. The returned
shares were recorded as treasury stock at their market value.
In connection with the private placement of shares of its common
stock for cash during the first quarter of fiscal 1996, the Company
issued warrants for the issuance of 2,272,730 shares of its common stock,
exercisable through January, 1998 at a per share price equal to 50% of
the exercise date market price of the Company's common stock (25% for any
exercises occurring at a time when the Company's common stock is not
trading on the NASDAQ). The warrants were exercised in April and May,
1996.
During the third quarter of fiscal 1996 the Company completed the
private placement of aggregate of 1,751,516 shares of its common stock
for net cash proceeds of $560,000. The placements included the issuance
of warrants for the purchase of 775,758 shares of the Company's common
stock exercisable for five years at an exercise price of $.52 per share.
In connection with the third quarter fiscal 1996 placements of
common stock and convertible debentures, the Company issued to the
placement agent warrants for the purchase of an aggregate of 4,715,909
shares of its common stock, subject to adjustment, exercisable for a
period of five years at an exercise price of $.44 per share, subject to
adjustment.
NOTE 7: CONTINGENCIES
In December 1991, a former employee filed suit against the
Company and others alleging breach of his employment agreement and
conversion of his interest in certain property rights of the Company.
INNOVO GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 7: CONTINGENCIES (continued)
The complaint, as amended, sought compensation damages of at least $13.5
million. In August, 1994 the trial court granted the Company's motion
for partial summary judgement and directed verdicts with respect to
certain of the former employee's claims, including those concerning his
ownership of an interest in the "E.A.R.T.H." trademark, or the existence
of a partnership with the Company to jointly own the trademark, and the
state court jury returned findings in favor of the Company on the
remainder of the plaintiff's claim concerning the trademark as well as
his claims for wrongful termination of employment. However, the jury
awarded to plaintiff approximately $700,000, of which $50,000 was
assessed against Innovo Group and $650,000 was assessed against Innovo,
including pre-judgement interest and attorney's fees, on the theory that
he was entitled to have received certain employment benefits, including
employee stock awards, during, and after, the term of his employment.
The Company appealed the jury's award, and in August, 1996 (as revised in
an amended October, 1996 opinion), the appeals court reversed
approximately $350,000 of the initial judgement as not supported by the
evidence or improper as a matter of law. As a result, the judgement,
including post-judgement interest through August, 1996, has been reduced
to $420,000. In addition, the appeals court ruled that the trial court
erred in not submitting to the jury the questions of the Company's
counterclaim of breach of fiduciary duty by Tedesco, ruling that the
trial record indicated that there was evidence of such breach and damages
therefrom. The appeals court remanded the case to the trial court for
trial on, and submission to a jury of, the Company's claim of breach of
fiduciary duty by Tedesco. The Company is filing motions with the trial
court for the scheduling of the ordered trial on its claims against
Tedesco and would be entitled to offset any damages it is awarded against
the Tedesco award. The Company also may, but has not yet, appeal to the
Texas Supreme Court the issue of the appeal courts' decision to uphold
$200,000 of the original judgement (which accounts for $340,000 of the
August, 1996 $420,000 amount). Tedesco has not indicted, as of this
time, whether he will further appeal to the Texas Supreme Court. In
connection with its appeals the Company has pledged as an appeal bond
200,000 shares of its unissued common stock. The Company continues to
believe that the ultimate resolution of the case is unlikely to result in
a material loss.
Under the plan of reorganization of Spirco, Inc. ("Spirco")
certain claims were contributed to a trust ("the Class 3 Trust") to which
Innovo Group issued shares of its common stock. The Class 3 Trust, which
is administered by an independent trustee, is selling the shares of
common stock and distributing the net proceeds therefrom to the Class 3
claimants. If the proceeds from the sale of the shares of common stock
issued to the Class 3 Trust are not sufficient to pay the allowed Class
3 claims, plus interest accruing at the rate of 7% per annum from
November 7, 1994, then Innovo Group will be required to pay the remaining
amount in installments with interest at 7% through November, 1999. On
the basis of the sales by the Class 3 Trust through September 30, 1996,
the market price of the Company's common stock on that date, and the
INNOVO GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (concluded)
(Unaudited)
NOTE 7: CONTINGENCIES (concluded)
estimated amount of disputed claims that will be allowed (including the
IRS assessment described below), the proceeds from the sale of shares by
the Class 3 Trust will be sufficient to satisfy all Class 3 claims.
During fiscal 1995 the Internal Revenue Service ("IRS") conducted
an examination of Spirco's 1991 income tax return. In March, 1996 the
IRS issued an audit report with respect to such returns which proposed to
reclassify certain capital losses, which would have had the effect of
increasing the taxes by $250,000. In June, 1996, after considering
additional information provided by the Company, the IRS revised its audit
report. The revised report reflected taxes due which were less than the
amount the Company had previously provided in its consolidated financial
statements. During the third quarter of fiscal 1996 the audit was
settled on the basis of the revised amount, and the taxes, which
represented a Class 3 claim under Spirco's plan of reorganization, were
paid from funds available in the Class 3 Trust.
In April, 1996, the Company received notice that a foreign
manufacturer that had supplied imported products to NASCO Products
asserts that it is owed approximately $300,000 in excess of the amount
recorded by NASCO Products. NASCO Products and the supplier had
previously reached an agreement on the balance owed (which is the balance
recorded), as well as an arrangement under which the schedule for the
Company's payments reducing that balance would be based on future
purchases from that supplier of products distributed internationally by
NPI International. The Company disputes the supplier's claim, and
believes that it has affirmative defenses, including the supplier's
subsequent refusal to accept and fill NPI International orders on terms
contained in the agreement. NASCO Products sold its operations in July,
1995 and that company currently has no operations or unencumbered assets
(see Note 2).
The Company is also a defendant in certain other legal actions
arising from normal business activities or the bankruptcy proceedings of
Spirco. Management believes that those actions are without merit or that
the ultimate liability, if any, resulting therefrom will not materially
effect the Company's consolidated financial position or results of
operations.<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Acquisition of Thimble Square, Inc.
As discussed in Note 2 of Notes to Condensed Consolidated
Financial Statements, on April 12, 1996 the Company acquired Thimble
Square, Inc. ("Thimble Square"). Thimble Square's operating results are
included in the consolidated results of operations from April 12, 1996.
Thimble Square manufactures and markets ladies' ready-to-wear at-
home, sleep and lounge wear from plants in Pembroke and Baxley, Georgia.
Its products are sold to retailers and through mail order distribution.
Thimble Square also provides sub-contract manufacturing for other
distributors of private-label sleep and lounge wear; in those instances,
the customer provides the raw materials, and Thimble Square manufactures
the products to the distributor's specifications. Thimble Square's sales
for its fiscal year ended December 31, 1995 were approximately $3
million. Thimble Square operated profitably for many years, but during
fiscal 1994 and 1995 (years ended December 31) incurred losses, due
principally to lower levels of sales. That lower level of sales has
continued through August 31, 1996, in part due to labor shortages and the
Company's use of Thimble Square's production capacity to produce Innovo
products. As discussed below, in October, 1996, the Company leased
additional production capacity for Innovo, and, as a result, Innovo Group
will now attempt to increase Thimble Square's sales by marketing its
products to major mass merchants and other retailers with whom Innovo
Group already has relationships, and to which Thimble Square has not had
material sales. The Company also plans to utilize Thimble Square's mail
order distribution to market Innovo's products. However, such steps will
take a period of time to implement, and until such time the inclusion of
Thimble Square's operating results could have an adverse effect on the
Company's consolidated results of operations.
Change in Fiscal Year
Effective November 1, 1995 the Company changed its fiscal year to
end on November 30. Previously, the Company's fiscal year ended on
October 31. As a result, the results of operations for the first quarter
of fiscal 1996 (December, 1995 through February, 1996) may, in some
respects, lack comparability to the results of operations for the first
quarter of fiscal 1995 (November, 1994 to January, 1995). The results of
operations and cash flows for the transition period of November 1, 1995
to November 30, 1995 were separately presented in the Company's Quarterly
Report on Form 10-Q for the quarter ended February 29, 1996.
Results of Continuing Operations
Sales for the first nine months of fiscal 1996 increased by
$1,702,000, or 42.5%, to $5,704,000, from $4,002,000 for the three
quarters of fiscal 1995. The inclusion of Thimble Square's operations
for April 12, 1996 through August 31, 1996, contributed $668,000 of the
increase. The remaining $1,034,000 increase was due to sales of the
Company's new craft products, the recapture of certain craft accounts
from import suppliers, and approximately $750,000 of sales of the
Company's U.S. Olympic Team products.
Sales for the third quarter of fiscal 1996 were $2,304,000,
representing a $666,000 or 40.7% increase over sales of $1,638,000 for
the three months ended July 31, 1995. Of such increase, $438,000 is
attributable to the inclusion of Thimble Square's operations for the
third quarter of fiscal 1996, while the remaining $228,000 increase is
due to the factors discussed above.
During the first three quarters of fiscal 1996 the Company
obtained four new licenses; a license for the domestic and foreign use of
the logos and taglines of the Anheuser-Busch Cos. on various bags and
totes, a license of the domestic and foreign use of the sports drawings
of sports artist Gary Patterson on various bags, and on t-shirts, and
a license for the use of the Warner Bros. studios Looney Tunes cartoon
characters on various bags and backpacks to be sold in Europe. Additionally,
the Company is currently completing negotiations for an additional major
European license. In general, a period of from four to six months is required,
once a license is obtained, to develop and obtain the approval for the art and
products for the new license, and produce samples and begin marketing. As a
result, sales for the first three quarters of fiscal 1996 do not reflect any
increases for sales of products under these licenses, and although some sales of
products under the Warner Bros., Anheuser-Busch and Gary Patterson licenses may
take place in the fourth quarter of fiscal 1996, material sales from these
licenses are currently projected to begin in the second quarter of fiscal
1997 as the result of the time needed to complete the development of
these products, and due to retail buying cycles. The Company expended
approximately $260,000 during the first nine months of fiscal 1996 on the
development and promotion of new products, and additional product development
costs are expected to reduce operating results for the fourth quarter of fiscal
1996.
Sales for the first three quarters of fiscal 1996 were adversely
effected by shortages of labor at the Company's Tennessee and Georgia
plants, and, during the first half of fiscal 1996, by the lack of working
capital for the purchase of raw materials. As a result, the Company was
unable to accept orders for an estimated $750,000 of products. The
Company raised additional working capital in the second and third
quarters of 1996 which was used, in part, to increase raw material levels
to more desirable levels. The Company's April, 1996 acquisition of
Thimble Square allowed Innovo, Inc. to, beginning in May, utilize a
portion of Thimble Square's production capacity to offset its labor
shortage; however, Thimble Square and Innovo, Inc., both continued to
experience labor shortages in the third quarter of fiscal 1996. In
October, 1996, the Company obtained a three year lease of a sewing
facility in Red Boiling Springs, Tennessee. This facility is expected to
approximately double the Company's Tennessee production capacity. The
annual rental cost will not materially effect operating costs. The
Company anticipates that operations at the facility will begin in
November, 1996. The Company is currently exploring additional steps
which it believes will, in the long term, reduce the likelihood of labor
shortages. However, because production at the new leased facility will
not begin until November, 1996, it is likely that the labor shortage will
also adversely affect sales in the fourth quarter of fiscal 1996.
Gross profit as a percentage of sales was 32.8% and 37.7%,
respectively, for the three and nine months ended August 31, 1996, as
compared to 23.5% and 40.4%, respectively, for the third quarter and
first nine months of fiscal 1995. The gross margin percentage for the
year to date period in 1996 is lower, and is higher for the third quarter
of 1996, as compared to those for the respective comparable periods in
fiscal 1995, in part due to a change in fiscal 1996 in the method used to
allocate fixed manufacturing costs to interim periods. Prior to fiscal
1996 the Company utilized all projected sales to project production in
each quarter and allocate fixed manufacturing costs between interim
periods. Beginning in fiscal 1996, the allocation of fixed manufacturing
costs between interim periods is being based on production projections
that reflect only confirmed or customer planned orders. The Company
anticipates that as a result quarterly gross profit percentages will vary
less than in fiscal 1995, when the gross profit percentages for the first
half of the year were significantly higher than those for the second half
of the year. The gross profit percentages in the third quarter and first
nine months of fiscal 1996 were also adversely affected by the Company's
lack of working capital for the purchase of raw materials, and the
shortages of labor at its manufacturing facilities. These factors caused
production inefficiencies and higher freight costs.
Selling, general and administrative ("SG&A") expenses increased
from $1,888,000 for the first nine months of fiscal 1995 to $2,725,000
for the nine months ended August 31, 1996. The $837,000 increase was
principally due to the inclusion of Thimble Square's operations since
April 12, 1996 ($245,000), an increase in commissions and royalties of
$244,000 as the result of higher sales, and $268,000 in costs related to
additional personnel. The personnel additions were principally for
functions related to the development of new products, and products for
the Company's newly obtained licenses. These factors were also the
principal reason for the $329,000 increase in SG&A expenses for the third
quarter, from $788,000 in fiscal 1995 to $1,117,000 for fiscal 1996. As
a percentage of sales SG&A expenses were 47.8% for the first nine months
of fiscal 1996 compared to 47.2% for the nine months ended July 31, 1995.
Depreciation and amortization expense increased in the fiscal 1996
periods principally due to the inclusion of the depreciation and
amortization of Thimble Square, including goodwill amortization of
$35,000.
In October, 1996, the Company implemented a restructuring of its
senior management. A new chief operating officer was added, who will be
directly responsible for production operations and cost controls. The
marketing and sales functions were restructured to be under the direct,
full-time supervision of the chief executive officer. Previously, both
functions had reported to the chief executive officer. The Company
believes that having each function directed on a full-time basis by
separate senior executives will improve the effectiveness of both areas.
In connection with the restructuring the Company implemented salary and
personnel reductions that will reduce expenses, net of salaries for new
positions, by $150,000 annually. The management and administrative
structure in place after this restructuring represents a level of costs
that the Company currently plans to continue in anticipation of, and to
generate, increased sales. The Company recognizes that absent such an
increase in sales it will not operate profitably without additional
significant expense reductions. If sales increases are not achieved, it
will attempt to further restructure to accomplish those cost reductions.
The loss from operations was $1,045,000 for the nine months ended
August 31, 1996, compared to $596,000 for the first three quarters of
fiscal 1995, a difference of $449,000. That difference is caused
principally by the lower year to date gross margin percentage, and
increase in SG&A expenses, discussed above.
Interest expense increased to $515,000 for the nine months ended
August 31, 1996 as compared to $349,000 for the first three quarters of
fiscal 1995. The majority of the $166,000 increase occurred in the third
quarter, as the result of interest on higher accounts receivable based
borrowings reflecting the increase in sales.
In March, 1995 the Company recognized other income of $1.9
million for the net proceeds it received upon the settlement of its
lawsuit against the former auditors of NASCO. The absence of such a gain
from fiscal 1996 is the principal cause in the decline in other income
between the current and prior year periods, and also for $2.5 million of
the change in the results of continuing operations.
Liquidity and Capital Resources
Operating cash flows were a negative $2.1 million for the first
nine months of fiscal 1996 principally as the result of the $1.5 million
net loss, a $862,000 increase in accounts receivable and inventories and
a $542,000 decrease in accounts payable and accrued expenses. The
increase in accounts receivable results from the increase in sales; at
August 31, 1996, accounts receivable equals approximately 48 days of
sales, as compared to 108 days at October 31, 1995.
The accounts receivable and inventory increases and accounts
payable and accrued expense decreases were financed with an aggregate of
$1.6 million obtained from the sale of shares of the Company's common
stock, or the exercise of outstanding common stock purchase warrants, and
new notes payable borrowings (net of repayments on those notes). That
capital was raised during the second quarter and used to reduce trade
debt, which improved the Company's trade credit with its suppliers and
allowed it to finance through new trade credit the increases in accounts
receivables and inventories required to support the increases in sales.
The private placements of shares of common stock, which the Company
undertook to obtain the working capital needed to support the increase in
sales, were undertaken in February, April and May, 1996, at times when
the Company's common stock was trading at prices of between $.25 and $.63
per share.
During the third quarter of fiscal 1996 the Company raised an
aggregate of $2.0 million, principally from the issuance of 8%
Convertible Debentures. The Company undertook these financings to fund
the development of the products, and the advance royalty deposits, for
the new Warner Bros. license and other licenses currently being negotiated, the
repayment of the notes issued in the acquisition of Thimble Square (repaid in
September, 1996), the completion of the development of the Florida retail
property, and to obtain a working capital reserve while funds were available to
the Company at acceptable terms. The Florida retail property is presently
undergoing the final stages of its renovation, and the Company currently
expects that tenants, including the Company, will begin to occupy the
retail property in December, 1996.
As a result of these financings, the Company had cash and cash
equivalents of $1.5 million at August 31, 1996, and the Company's current
ratio was 1.19 to 1, as compared to .92 to 1 at July 31, 1996.
The Company completed the repayment of the borrowings under its
NBD credit facility in the third quarter of fiscal 1996 with funds from
payments received from ANG (see Note 3 of Notes to Condensed Consolidated
Financial Statements). The remaining payments received from ANG were
used to reduce the outstanding borrowings on the Company's July, 1994
working capital loan to $239,000.
The Company believes that on an overall basis cash will be
sufficient to fund planned operations. However, a failure of the retail
environment to improve in the manner projected by the Company, or
continued labor shortages, would adversely effect sales and could force
the Company to further constrict operations.<PAGE>
PART II: OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Reference is hereby made to Part I, Item 3 of Company's Annual
Report on Form 10-K for the period ended October 31, 1995, and to
Note 7 of Notes to Condensed Consolidated Financial Statements in
Part I of this report, which are incorporated herein by
reference.
Item 3. DEFAULTS UPON SENIOR SECURITIES
None
Item 6. EXHIBITS AND REPORTS ON FROM 8-K
(a) Exhibits.
Exhibit 27. Financial Data Schedule (included only in the
electronically filed version of this report).
(b) Reports on Form 8-K.
No Current Reports on Form 8-K were filed during the fiscal
quarter covered by this report.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INNOVO GROUP INC.
Dated: October 21, 1996 By/s/Patricia Anderson-Lasko
Patricia Anderson-Lasko,
President, Chairman and
Chief Executive Officer
Dated: October 21, 1996 By/s/Terrance J. Bond
Terrance J. Bond,
Controller
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL
INFORMATION EXTRACTED FROM THE CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS CONTAINED IN
THE COMPANY'S QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED AUGUST 31, 1996 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> US Dollars
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> Nov-30-1996
<PERIOD-START> Dec-01-1995
<PERIOD-END> Aug-31-1996
<EXCHANGE-RATE> 1
<CASH> 1,466
<SECURITIES> 0
<RECEIVABLES> 1,349
<ALLOWANCES> 120
<INVENTORY> 1,571
<CURRENT-ASSETS> 4,715
<PP&E> 6,917
<DEPRECIATION> 1,839
<TOTAL-ASSETS> 11,187
<CURRENT-LIABILITIES> 3,973
<BONDS> 0
<COMMON> 187
0
0
<OTHER-SE> 2,591
<TOTAL-LIABILITY-AND-EQUITY> 11,187
<SALES> 5,704
<TOTAL-REVENUES> 5,704
<CGS> 3,551
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 515
<INCOME-PRETAX> (1,487)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,487)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,487)
<EPS-PRIMARY> (.13)
<EPS-DILUTED> 0
</TABLE>
