<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-Q
|x| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 31, 1997
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-10860
THE HE-RO GROUP, LTD.
(Exact name of registrant as specified in its charter)
Delaware 13-3615898
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
550 Seventh Avenue 10018
New York, NY
(Address of principal (Zip Code)
executive offices)
(212) 840-6047
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 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 subject to such filing
requirements for the past 90 days. YES |X| NO |_|
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Outstanding at
Class of Common Stock October 14, 1997
--------------------- ----------------
$.01 par value 6,717,333
<PAGE> 2
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
Index
PART I. FINANCIAL INFORMATION Page No.
Item 1. Financial Statements:
Consolidated Balance Sheets
August 31, 1997 and May 31, 1997.......................... 3
Consolidated Statements of Income
Three Months Ended August 31, 1997 and 1996............... 4
Consolidated Statements of Changes in Stockholders' Equity
(deficiency) Three Months Ended August 31, 1997 and 1996.. 5
Consolidated Statements of Cash Flows
Three Months Ended August 31, 1997 and 1996............... 6
Condensed Notes to Consolidated Financial Statements...... 7 - 13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 14 - 17
PART II. OTHER INFORMATION......................................... 18
<PAGE> 3
THE HE-RO GROUP,LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
August 31, May 31,
1997 1997
(unaudited)
----------- -------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash ................................................ $ 168 $ 354
------- -------
Accounts receivable:
Trade, net of allowances for doubtful
accounts of $400 .................................. 3,771 1,016
Suppliers and other ............................... 2,886 3,311
------- -------
6,657 4,327
Inventory ........................................... 11,543 10,751
Other current assets ................................ 396 828
------- -------
Total current assets ........................... 18,764 16,260
------- -------
FIXED ASSETS - at cost, net of accumulated
depreciation and amortization ....................... 443 515
OTHER ASSETS ........................................... 1,030 1,031
------- -------
$20,237 $17,806
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank loans .......................................... $10,710 $ 7,782
Accounts payable .................................... 8,404 7,604
Accrued expenses and other current
liabilities ....................................... 2,875 3,082
------- -------
Total current liabilities ...................... 21,989 18,468
------- -------
Subordinated Notes Payable --
stockholder, net of current maturities .............. 5,296 5,296
------- -------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; 1,000,000
authorized shares; no shares outstanding .......... -- --
Common stock, $.01 par value; 25,000,000
authorized shares; issued and outstanding
6,717,333 shares .................................. 67 67
Additional paid-in capital .......................... 40,166 40,166
Accumulated Deficit ................................. <47,281> <46,191>
------- -------
Total stockholders' deficit .................... <7,048> <5,958>
------- -------
$20,237 $17,806
======= =======
</TABLE>
The accompanying condensed notes are an integral part of these consolidated
statements.
3
<PAGE> 4
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
------------------------
August 31,
------------------------
1997 1996
---- ----
<S> <C> <C>
Net sales .................................. $ 9,893 $11,577
Cost of sales .............................. 6,374 6,935
--------- -------
Gross profit ............................ 3,519 4,642
Selling, general and administrative expenses 4,048 5,075
Operating loss ............................. <529> <433>
Interest expense ........................... 561 561
--------- -------
Loss before income taxes ................ <1,090> <994>
Provision for income taxes ................. -- --
--------- -------
Net loss ................................ $<1,090> $<994>
========= =======
Net loss per common share .................. $<0.16> $<0.15>
========= =======
Weighted average shares outstanding ........ 6,717 6,717
========= =======
</TABLE>
The accompanying condensed notes are an integral part of these consolidated
statements.
4
<PAGE> 5
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY)
(In thousands)
(UNAUDITED)
<TABLE>
<CAPTION>
Common Stock Additional
No. of Paid in Accumulated
Shares Amount Capital Deficit Total
<S> <C> <C> <C> <C> <C>
Balance, May 31, 1996 6,717 $67 $40,166 $<37,502> $ 2,731
Net loss <994> <994>
----- --- ------- -------- -------
Balance, August 31, 1996 6,717 $67 $40,166 $<38,496> $ 1,737
===== === ======= ======== =======
Balance, May 31, 1997 6,717 $67 $40,166 $<46,191> $<5,958>
Net loss <1,090> <1,090>
----- --- ------- -------- -------
Balance, August 31, 1997 6,717 $67 $40,166 $ <47,281> $<7,048>
===== === ======= ========= =======
</TABLE>
The accompanying condensed notes are an integral part of these consolidated
statements.
5
<PAGE> 6
THE HE-RO GROUP, LTD., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
------------------------
August 31,
------------------------
1997 1996
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ........................................ <1,090> $ <994>
------ --------
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Depreciation and amortization ................. 72 246
Amortization of deferred finance costs ........ 56 79
(Increase) decrease in assets:
Trade receivables ............................... <2,755> <2,916>
Other receivables ............................... 425 <68>
Inventories ..................................... <792> <252>
Other current assets ............................ 432 <64>
Increase (decrease) in liabilities:
Accounts payable ................................ 800 1,083
Accrued expenses and other current liabilities .. <207> 140
------- -------
Total adjustments ............................... <1,969> <1,752>
------- -------
Net cash used in operating activities ...... <3,059> <2,746>
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of fixed assets ..................... -- <27>
Increase in other assets ........................ 5 26
------- -------
Net cash used in (provided by) investing
activities ......................................... 5 <1>
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in bank loans ................ 2,928 2,994
Deferred finance costs ........................... <60> <39>
------- -------
Net cash provided by financing activities .. 2,868 2,955
------- -------
NET INCREASE <DECREASE> IN CASH .................... <186> 208
------- -------
CASH, beginning of period .......................... 354 405
------- -------
CASH, end of period ................................ $168 $613
======= =======
</TABLE>
The accompanying condensed notes are an integral part of these consolidated
statements.
6
<PAGE> 7
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
Condensed Notes To Consolidated Financial Statements
(UNAUDITED)
August 31, 1997
1. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of The
HE-RO Group, Ltd. and its subsidiaries (the "Company"). The consolidated
financial statements are presented in accordance with the requirements of
the quarterly report on Form 10-Q and consequently do not include all of
the disclosures normally made in an annual report on Form 10-K filing.
Accordingly, the consolidated financial statements included herein should
be reviewed in conjunction with the consolidated financial statements and
the notes included therein with the Company's Annual Report on Form 10-K.
The financial information as of and for the three months ended
August 31, 1997 and 1996 has been prepared in accordance with the
Company's customary accounting practices and has not been audited. In the
opinion of management, the information presented reflects all adjustments
necessary for a fair statement of interim results. All such adjustments
are of a normal and recurring nature. The foregoing interim results are
not necessarily indicative of the results of operations for the full year
ending May 31, 1998 ("Fiscal 1998").
2. RESTRUCTURING
In February 1997, at a Special Meeting of the Company's Board of
Directors, as part of its ongoing cost cutting efforts the Board adopted a
restructuring plan in connection with the subletting of the Company's
domestic warehouse and distribution center, administrative offices and
retail store, which were located in a single leased facility in Secaucus,
New Jersey; and in March, 1997 the Company entered into a sublease with
Harve Benard with respect to such facility. Because the Company has
downsized its operation to its core eveningwear business as a result of a
restructuring plan adopted by the Board in October 1993, the Company's
current operations no longer justify the use of the more expansive
facilities located in Secaucus, New Jersey. Accordingly, the Company
relocated its administrative offices and retail store to smaller leased
space in Secaucus, and is utilizing an independent third party for the
distribution and warehousing of inventory.
In May 1997, at a Special Meeting of the Company's Board of
Directors, the Board expanded upon the restructuring plan, adopted in
February 1997 to further cut costs and streamline operations. The Board
elected to further restructure the Company's Hong Kong operations by
further downsizing and consolidating the production office and moving the
sample making operations from Hong Kong to China. Additionally, as part of
this restructuring, the Company will close certain unprofitable retail
stores to aid the Company in focusing its resources on developing the
profitable store operations.
7
<PAGE> 8
Included on the accompanying consolidated balance sheets in accrued
expenses and other current liabilities related to the restructuring
charges is an accrual of $.7 million as of August 31, 1997.
3. INVENTORY
Inventory is stated at the lower of cost (first-in, first-out) or
market, and at August 31, 1997 was calculated using the gross profit
method.
<TABLE>
<CAPTION>
(In Thousands)
August 31, May 31,
1997 1997
--------- -----
(UNAUDITED)
<S> <C> <C>
Finished goods......................... $10,154 $ 9,012
Raw materials.......................... 1,389 1,739
------- -------
$11,543 $10,751
======= =======
</TABLE>
4. FIXED ASSETS
Fixed assets consist of the following:
<TABLE>
<CAPTION>
(In Thousands)
August 31, May 31,
1997 1997
------------ -----
(UNAUDITED)
<S> <C> <C>
Machinery and equipment................. $ 1,943 $1,943
Furniture and fixtures.................. 2,526 2,526
Leasehold improvements.................. 1,894 1,894
------- ------
6,363 6,363
Less - Accumulated depreciation and
amortization............................ 5,920 5,848
------- ------
$ 443 $ 515
======= ======
</TABLE>
5. RELATED PARTY TRANSACTIONS
The Company has an investment of $798,000 in Great Projects Limited
("GPL"), a Hong Kong corporation. Fifty percent of GPL is owned by a
subsidiary of the Company, and 25% is owned by each of two Hong Kong
companies that are unaffiliated with the Company or its officers or
directors. As of October 31, 1993, the partners agreed to discontinue the
operations of GPL. In January 1996, liquidation proceedings in Hong Kong
were commenced to wind up GPL. Included in accounts payable is $2,151,000
due to the foreign affiliate at August 31, 1997 and May 31, 1996. The
Company does not expect any material impact on its results of operations
due to the liquidation of GPL.
Notes and obligations payable to the beneficial principal
stockholder in the aggregate principal amount of $5,296,000 are
subordinated to bank borrowing and bear interest varying from 8% to 12%
per annum. These obligations are due upon demand but because these
obligations are subordinated to the bank borrowing, the liability relating
thereto has been classified as long-term.
8
<PAGE> 9
6. BANK LOANS AND LONG TERM DEBT
On May 12, 1995, the Company signed a credit agreement (the
"Foothill Credit Agreement") with Foothill Capital Corporation
("Foothill") for a two year term expiring June 2, 1997, to enable the
Company to borrow, assuming that borrowing base thresholds are met (for
direct loans and letters of credit), amounts not exceeding $15,000,000
during the term of the credit agreement. As a result of an amendment dated
August 27, 1997, the term of the Foothill Credit Agreement has been
extended through November 30, 1997. The indebtedness incurred under the
Foothill Credit Agreement is secured by a first lien on the Company's
domestic inventory and accounts receivable, among other collateral.
Interest on direct debt is payable at the prime rate (8.50% at
August 31, 1997) plus 2 1/2% per annum. At August 31, 1997, the direct
debt outstanding under the Foothill Credit Agreement was $7,960,000 and
the Company was contingently liable for outstanding letters of credit of
approximately $472,000.
The Company's credit line with Foothill refinanced a substantial
portion of the indebtedness previously outstanding from the Company to a
group of four banks (the "Bank Group"). At August 31, 1997, the
outstanding indebtedness of the Company to the Bank Group was $2,750,000
in the aggregate under the Company's fourth amended and restated credit
agreement with its Bank Group, evidenced by a term note to each bank with
interest at 2% above the prime rate. The Company's indebtedness to the
Bank Group is (i) subordinated to the Company's indebtedness to Foothill
(ii) secured by a second lien on the domestic inventory and accounts
receivable, among other collateral, and a first lien on the inventory
located in Hong Kong and China, and (iii) subject to a mandatory
prepayment of $100,000 for any month in which the Company's inventory in
Hong Kong and China decrease below certain minimum thresholds. This loan
is due and payable in monthly installments of principal ranging from
$50,000 to $150,000 beginning August 1995, plus monthly interest payments,
with the final payment due in June 1997. These payments are permitted
under the Foothill Credit Agreement if certain liquidity standards are
met. For the months ended December 1995 through September 1996, because
these liquidity standards were not met, the Company was not permitted to
pay the monthly installments of principal to the Bank Group, and
accordingly was not in compliance with its credit agreement with the Bank
Group. As a result of the foregoing and in connection with the current
transaction negotiations. as discussed in Note 9, the Company will be
seeking to revise its credit facilities.
The Bank Group holds warrants to purchase up to an aggregate of
250,000 shares of the Company's common stock at a price of $2.00 per
share, expiring on September 17, 1999.
9
<PAGE> 10
The Company's credit agreements with Foothill and the Bank Group
requires Della Rounick and the estate of Herbert Rounick, collectively, to
own or control at least 51% of the Company's outstanding common stock. In
addition, the more significant restrictive covenants as defined in the
Foothill Credit Agreement are as follows:
- The minimum current ratio must equal: 1.0 to 1
- The maximum liabilities to net worth must equal: 38.0 to 1
- The minimum net worth required: $400,000
- The minimum working capital required : $3,500,000
- Capital expenditures may not exceed $500,000 in one year.
- The Company is prohibited from paying dividends throughout the term of
the agreement.
- The net income on a cumulative basis and measured at the end of each
fiscal quarter may not fall below negative $4,500,000 from June 1, 1995.
As of August 31, 1997, the Company was not in compliance with
certain financial covenants under the Foothill Credit Agreement. The
Company has received a waiver from Foothill relating to the foregoing
non-compliance (see Note 9 for further discussion).
7. SUPPLEMENTAL CASH FLOW INFORMATION
Payments of income taxes were $9,000 and $37,000 for the three
months ended August 31, 1997 and 1996, respectively. Payments of interest
during the corresponding periods were $519,000 and $554,000 respectively.
8. CONTINGENCIES
Because a substantial amount of the Company's products are
manufactured in The People's Republic of China ("China"), the loss of
"most-favored-nation" ("MFN") trading status for China would have, and the
conditional granting of MFN trading status for China or the imposition of
retaliatory trade sanctions against China involving the Company's products
could have a material adverse affect on the Company, resulting from
significantly higher rates of duty and other trade sanctions imposed on
goods originating in China.
In May 1997, President Clinton issued a Presidential Determination
recommending the renewal of "most-favored-nation" trade status for China
for the twelve months ending July 2, 1998. Although resolutions
disapproving such renewal were introduced into both the U.S. Senate and
the House of Representatives, the House resolution was voted on and
10
<PAGE> 11
failed to pass. As has occurred in the last three years, in a break with
previous years, the Presidential Determination did not recommend
subjecting any future renewal of "most-favored-nation" trade status for
China to various conditions, such as China's compliance with the 1992
bilateral agreement with the United States concerning prison labor and
overall progress with respect to human rights, release and accounting of
Chinese citizens imprisoned or detained for their political and religious
beliefs, humane treatment of prisoners, protecting Tibet's religious and
cultural heritage and permitting international radio and television
broadcasts into China. However, bills have been introduced into Congress
which, if enacted, would ban all entries or importations of Chinese origin
articles which are the product, growth or manufacture of forced labor and
which would deny most-favored-rates of duty to goods produced by the
People's Liberation Army. "Most-favored-nation" trade status was renewed
in July 1997 for an additional year. There is no assurance that the
President will recommend the renewal of "most- favored-nation" trade
status for China for the year commencing July 3, 1998 or thereafter or
that Congress will not enact legislation denying or conditioning the grant
of "most-favored-nation" trade status to China in the future.
In February 1997, the United States and China entered into a four
year bilateral textile agreement, covering certain cotton, wool, man-made
fiber, silk blend and other vegetable fiber textiles and textile products,
expiring December 31, 2000. Among other things, the agreement reduces
China's export quotas with respect to fourteen (14) apparel and fabric
categories and permits the United States to impose significant penalties
for transshipment violations. Such penalties include the assessment of
"transshipment charges" against the restraint levels of affected
categories which could result in such levels filling more rapidly or
becoming fully utilized with little or no advance notice. In addition, a
separate agreement between the United States and China was reached which,
for the first time, subjects to quota limitations, China's exports of
apparel containing 70% or more by weight of silk. This agreement is
effective with respect to goods produced or manufactured in China and
exported to the United States during the period from January 1, 1997
through December 31,1997 and replaces a substantially similar agreement
which was in effect from April 1, 1994 through December 31, 1996.
On July 1, 1997, the British Crown Colony of Hong Kong reverted to
the People's Republic of China. The United States has announced its
agreement with China on the separate treatment of textile quotas for Hong
Kong after the reversion of such territory. Should the United States
determine that goods produced in Hong Kong would be subjected to Chinese
quota, such a determination would adversely affect any contingency plans
of the Company which are premised on the shifting of production or
assembly of the products from China to Hong Kong.
11
<PAGE> 12
In addition, over the past several years including 1996, the Office
of the United States Trade Representative has conducted, and may in the
future conduct, investigations relating to China's trade policies and
practices. While previous investigations were resolved without resort to
retaliatory trade sanctions against China by the United States, an
unfavorable resolution of any future investigation could result in the
imposition of retaliatory trade sanctions against China and on products
imported from China, including products manufactured by the Company in
China.
Legislation implementing the Uruguay Round of the General Agreement
on Tariffs and Trade was signed by President Clinton in late 1994. Among
other provisions, it contained a section which amended the rules of origin
applicable to textiles and textile products, effective with respect to
goods entered or withdrawn from warehouse for consumption on or after July
1, 1996. Regulations implementing these changes were promulgated. In
general, and with specified exceptions, the statute and regulations
provide that most textile apparel articles will be considered to originate
in the country in which they are wholly assembled. In many cases, this
represents a change from the manner in which country of origin has been
determined, which in many instances, was based on where the components
were cut. The Company cannot now predict to what extent the new rules
concerning country of origin will change import trade patterns or how it
will impact upon quota usage from exporting countries.
The Company is a party to various claims, legal actions, and
complaints arising in the ordinary course of business. In the opinion of
the Company's management, all such matters are without merit or involve
such amounts in which an unfavorable disposition would not have a material
effect on the consolidated financial statements of the Company.
9. GOING CONCERN CONSIDERATION
Because the Company has been incurring losses from operations, there
has been insufficient liquidity, as required by its credit agreement with
its senior lender, Foothill Capital Corporation ("Foothill"), to allow the
Company to pay required monthly installments of principal to its group of
four banks that rank junior to Foothill. In addition, the Company is
projecting losses from operations for the year ending May 31, 1998, which
will result in its non-compliance with the financial covenants under its
credit agreement with Foothill in fiscal 1998. In addition, the Company's
credit agreement with Foothill currently expires on November 30, 1997. The
combination of these factors raises substantial doubt about the Company's
ability to continue as a going concern. In the fourth quarter of fiscal
1996, the Company began to explore its options relative to alleviating its
financial instability including strategic alliances with other companies,
an infusion of capital into the Company, the sale or merger of the
Company, or any combination of the foregoing. On September 4, 1997, the
Company
12
<PAGE> 13
signed a letter of intent (the "Letter of Intent") with Nah Nah
Collections, Inc., a New York corporation ("Nah Nah"), pursuant to which
Mr. Han, the President, CEO and owner of Nah Nah would receive up to 49%
of the common stock of the Company in return for the sale to the Company
of all the issued and outstanding capital stock of Nah Nah. The
transaction is subject to due diligence to be conducted by each of Nah Nah
and He-Ro, execution of definitive agreements currently being negotiated,
obtaining financing, third party approvals, obtaining a fairness opinion
and other closing conditions. Nah Nah Collections, Inc., a privately held
company, produces and markets several lines of women's ready to wear and
special occasion wear consisting of suits and dresses under the labels
including Victor Costa by Nahdree, Constance Saunders by Nahdree Nah Nah
Collections and under private label through its NNP division.
In the absence of the consummation of any of the contemplated
transactions or similar events that would provide plans to restructure
debt, to reduce or delay expenditures, or to increase ownership equity,
there could be a substantial doubt as to the Company's success of future
operations. The result includes a possible discontinuance of operations in
which there is a commencement of dissolution or bankruptcy, or there could
be an externally forced revision of its present operating structure.
13
<PAGE> 14
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The following discussion provides information and analysis of the
Company's results of operations for the three month period ended August 31,
1997, and its liquidity and capital resources. The following discussion and
analysis should be read in conjunction with the Unaudited Consolidated Financial
Statements included elsewhere herein.
Because a substantial amount of the Company's products are manufactured in
The People's Republic of China ("China"), the loss of "most-favored- nation"
("MFN") trading status for China would have, and the conditional granting of MFN
trading status for China or the imposition of retaliatory trade sanctions
against China involving the Company's products could have a material adverse
affect on the Company, resulting from significantly higher rates of duty and
other trade sanctions imposed on goods originating in China.
In May 1997, President Clinton issued a Presidential Determination
recommending the renewal of "most-favored-nation" trade status for China for the
twelve months ending July 2, 1998. Although resolutions disapproving such
renewal were introduced into both the U.S. Senate and the House of
Representatives, the House resolution was voted on and failed to pass. As has
occurred in the last three years, in a break with previous years, the
Presidential Determination did not recommend subjecting any future renewal of
"most-favored-nation" trade status for China to various conditions, such as
China's compliance with the 1992 bilateral agreement with the United States
concerning prison labor and overall progress with respect to human rights,
release and accounting of Chinese citizens imprisoned or detained for their
political and religious beliefs, humane treatment of prisoners, protecting
Tibet's religious and cultural heritage and permitting international radio and
television broadcasts into China. However, bills have been introduced into
Congress which, if enacted, would ban all entries or importations of Chinese
origin articles which are the product, growth or manufacture of forced labor and
which would deny most-favored-rates of duty to goods produced by the People's
Liberation Army. "Most-favored-nation" trade status was renewed in July 1997 for
an additional year. There is no assurance that the President will recommend the
renewal of "most-favored-nation" trade status for China for the year commencing
July 3, 1998 or thereafter or that Congress will not enact legislation denying
or conditioning the grant of "most-favored-nation" trade status to China in the
future.
In February 1997, the United States and China entered into a four year
bilateral textile agreement, covering certain cotton, wool, man-made fiber, silk
blend and other vegetable fiber textiles and textile products, expiring December
31, 2000. Among other things, the agreement reduces China's export quotas with
respect to fourteen (14) apparel and fabric categories and permits the United
States to impose significant penalties for transshipment violations. Such
penalties include the assessment of "transshipment charges" against the
restraint levels of affected categories which could result in
14
<PAGE> 15
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
such levels filling more rapidly or becoming fully utilized with little or no
advance notice. In addition, a separate agreement between the United States and
China was reached which, for the first time, subjects to quota limitations,
China's exports of apparel containing 70% or more by weight of silk. This
agreement is effective with respect to goods produced or manufactured in China
and exported to the United States during the period from January 1, 1997 through
December 31,1997 and replaces a substantially similar agreement which was in
effect from April 1, 1994 through December 31, 1996.
On July 1, 1997, the British Crown Colony of Hong Kong reverted to the
People's Republic of China. The United States has announced its agreement with
China on the separate treatment of textile quotas for Hong Kong after the
reversion of such territory. Should the United States in the future determine
that goods produced in Hong Kong would be subjected to Chinese quota, such a
determination would adversely affect any contingency plans of the Company which
are premised on the shifting of production or assembly of the products from
China to Hong Kong.
In addition, over the past several years including 1996, the Office of the
United States Trade Representative has conducted, and may in the future conduct,
investigations relating to China's trade policies and practices. While previous
investigations were resolved without resort to retaliatory trade sanctions
against China by the United States, an unfavorable resolution of any future
investigation could result in the imposition of retaliatory trade sanctions
against China and on products imported from China, including products
manufactured by the Company in China.
Legislation implementing the Uruguay Round of the General Agreement on
Tariffs and Trade was signed by President Clinton in late 1994. Among other
provisions, it contained a section which amended the rules of origin applicable
to textiles and textile products, effective with respect to goods entered or
withdrawn from warehouse for consumption on or after July 1, 1996. Regulations
implementing these changes were promulgated. In general, and with specified
exceptions, the statute and regulations provide that most textile apparel
articles will be considered to originate in the country in which they are wholly
assembled. In many cases, this represents a change from the manner in which
country of origin has been determined, which in many instances, was based on
where the components were cut. The Company cannot now predict to what extent the
new rules concerning country of origin will change import trade patterns or how
it will impact upon quota usage from exporting countries.
15
<PAGE> 16
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company is a party to various claims, legal actions, and complaints
arising in the ordinary course of business. In the opinion of the Company's
management, all such matters are without merit or involve such amounts in which
an unfavorable disposition would not have a material effect on the consolidated
financial statements of the Company.
Results of Operations
First Quarter Fiscal 1998 Compared to First Quarter Fiscal 1997
Net sales of $9.9 million for the three months ended August 31, 1997
decreased by $1.7 million, or <14.7>% compared to net sales of $11.6 million for
the three months ended August 31, 1996. This decrease is primarily attributable
to reduced sales for evening wear products due to the soft economy in the
apparel industry. The decrease is primarily attributable to reduced sales for
the Niteline division due to increased competition and the disrupted
business including loss of personnel resulting from transaction negotiations for
the contemplated sale of the Company.
Cost of sales for the three months ended August 31, 1997 was $6.4 million,
or 64.4% of net sales compared to $6.9 million, or 59.9% of net sales for the
three months ended August 31, 1996. Gross profit for the three months ended
August 31, 1997 was $3.5 million, or 35.6% of net sales, compared to $4.6
million, or 40.0% of net sales for three months ended August 31, 1996. The
decrease in gross profit dollars and as a percent of sales is primarily
attributable to the decrease in sales described above.
Selling, general and administrative expenses were $4.0 million, or 40.9%
of net sales for the three months ended August 31, 1997, compared to $5.1
million, or 43.8% of net sales for the three months ended August 31, 1996. The
lower selling, general and administrative expenses for the quarter ending August
31, 1997 are primarily attributable to planned reductions in salary expenses,
rent and occupancy, professional fees and insurance.
Operating loss was $<.5> million or <5.4>% of net sales for the three
months ended August 31, 1997 compared to an operating loss of $<.4> million or
<3.7>% of net sales for the three months ended August 31, 1996. The increase in
operating loss was attributable to the reduced sales and gross profit dollars
described above.
Interest expense for the three months ended August 31, 1997 was $.6
million, or 5.7% of net sales compared to $.6 million, or 4.8% of net sales for
the three months ended August 31, 1996.
As a result of the factors described above, the Company's net loss
increased to $<1.1> million, or <11.0>% of net sales during the three months
ended August 31, 1997, compared to $<1.0> million, or <8.6>% of net sales for
the three months ended August 31, 1996.
16
<PAGE> 17
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
At August 31, 1997, the Company had a decrease in cash flows from
operating activities of $3.1 million. This decrease resulted primarily from a
net increase in accounts receivable of $2.3 million and a net loss of $1.1
million, offset by an increase in accounts payable of $.8 million. The Company's
level of cash flows from operating activities varies from quarter to quarter due
to the seasonality of its business.
In regard to cash flows from investing activities, during the first three
months of fiscal 1998 and 1997, capital improvements and replacement
expenditures were not significant. Capital improvements and replacements for the
full fiscal 1998 year are expected to approximate $.2 million.
Cash flows from financing activities increased by $2.9 million resulting
primarily from an increase in bank borrowings under the Company's revolving
credit facilities.
Because the Company has been incurring losses from operations, there has
been insufficient liquidity, as required by its credit agreement with its senior
lender, Foothill Capital Corporation ("Foothill"), to allow the Company to pay
required monthly installments of principal to its group of four banks that rank
junior to Foothill. In addition, the Company is projecting losses from
operations for the year ending May 31, 1998, which will result in its
non-compliance with the financial covenants under its credit agreement with
Foothill in fiscal 1998. In addition, the Company's credit agreement with
Foothill currently expires on November 30, 1997. The combination of these
factors raises substantial doubt about the Company's ability to continue as a
going concern. In the fourth quarter of fiscal 1996, the Company began to
explore its options relative to alleviating its financial instability including
strategic alliances with other companies, an infusion of capital into the
Company, the sale or merger of the Company, or any combination of the foregoing.
On September 4, 1997, the Company signed a letter of intent (the "Letter of
Intent") with Nah Nah Collections, Inc., a New York corporation ("Nah Nah"),
pursuant to which Mr. Han, the President, CEO and owner of Nah Nah would receive
up to 49% of the common stock of the Company in return for the sale to the
Company of all the issued and outstanding capital stock of Nah Nah. The
transaction is subject to due diligence to be conducted by each of Nah Nah and
He-Ro, execution of definitive agreements currently being negotiated, obtaining
financing, third party approvals, obtaining a fairness opinion and other closing
conditions. Nah Nah Collections, Inc., a privately held company, produces and
markets several lines of women's ready to wear and special occasion wear
consisting of suits and dresses under the labels including Victor Costa by
Nahdree, Constance Saunders by Nahdree Nah Nah Collections and under private
label through its NNP division.
17
<PAGE> 18
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
27. Financial Data Schedule
(b) Reports on Form 8-K:
The Company did not file any report on Form 8-K during the three
months ended August 31, 1997
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
The He-Ro Group, Ltd. has duly caused this Quarterly Report on Form 10-Q to be
signed on its behalf by the undersigned thereunto duly authorized.
Date: October 14, 1997 THE HE-RO GROUP, LTD.
(Registrant)
By:/s/ DELLA ROUNICK
---------------------------------
Della Rounick
Chairman of the Board
of Directors and Chief
Executive Officer
Date: October 14, 1997
/s/ SAM D. KAPLAN
---------------------------------
Sam D. Kaplan
Chief Financial Officer
and Secretary
(Principal Financial and
Accounting Officer)
18
<PAGE> 19
INDEX TO EXHIBITS
TO
THE QUARTERLY REPORT
FOR THE QUARTER ENDED AUGUST 31, 1997
OF
THE HE-RO GROUP, LTD.
3.1 Restated Certificate of Incorporation of Registrant. Incorporated by
reference to Exhibit 3.1 of Registrant's Annual Report on Form 10-K for
the year ended May 31, 1995 ("Registrant's 1995 10-K").
3.2 Bylaws of Registrant, as amended. Incorporated by reference to Exhibit 3.2
of Registrant's 1995 10-K.
3.3 Specimen Certificate for Common Stock of Registrant. Incorporated by
reference to Exhibit 3.3 of Registrant's 1995 10-K.
10.1 Lease dated December 20, 1990, between Hartz Mountain Industries, Inc. and
The He-Ro Group, Inc. relating to the premises located at 35 Enterprise
Avenue, Secaucus, New Jersey. Incorporated by reference to Exhibit 10.1 of
Registrant's 1995 10-K.
10.2 Sublease dated March 6, 1997 between The He-Ro Group, Inc. (as sublessor)
and Harve Benard (as sublessee) relating to the premises located at One
American Way, Secaucus, New Jersey. Incorporated by reference to Exhibit
10.2 of Registrant's Annual Report on Form 10-K for the year ended May 31,
1997
10.3 Lease dated September 21, 1994, between The Louis Adler Realty Company and
H.R.I., Inc. relating to the premises located at 550 Seventh Avenue, New
York, New York. Incorporated by reference to Exhibit 10.3 of Registrant's
1995 10-K.
10.4 Lease dated September 24, 1994, between The Louis Adler Realty Company and
H.R.I., Inc. relating to the premises located at 550 Seventh Avenue, New
York, New York. Incorporated by reference to Exhibit 10.4 of Registrant's
1995 10-K.
10.5 Lease dated September 21, 1994, between The Louis Adler Realty Company and
H.R.I., Inc.
19
<PAGE> 20
relating to the premises located at 550 Seventh Avenue, New York, New
York. Incorporated by reference to Exhibit 10.10 of Registrant's 1995
10-K.
10.6 Lease dated September 21, 1994, between The Louis Adler Realty Company and
The He-Ro Group, Inc. relating to the premises located at 530 Seventh
Avenue, New York, New York. Incorporated by reference to Exhibit 10.6 of
Registrant's 1995 10-K.
10.7 Tenancy Agreement dated December 20, 1994, between Grandford Development
and The He-Ro Group, Inc. relating to the premises located at Cosmos Sing
Shing Building, 81 Hung To Road, Kwun Tong, Kowloon, Hong Kong.
Incorporated by reference to Exhibit 10.7 of Registrant's 1995 10-K.
10.8 License Agreement dated June 1, 1990, between The He-Ro Group, Inc. and
Oleg Cassini, Inc. ("Cassini License"). Incorporated by reference to
Exhibit 10.8 of Registrant's 1995 10-K.
10.8.1 Letter Agreement dated December 15, 1995, from Oleg Cassini, Inc. to the
He-Ro Group, Inc., amending Cassini License. Incorporated by reference to
Exhibit 10.8.1 of Registrant's Annual Report on Form 10-K for the year
ended May 31, 1996 ("Registrant's 1996 10-K").
10.9 Fourth Amended and Restated Revolving Credit Agreement dated as of May 15,
1995, by and among The He-Ro Group, Inc., and Marine Midland Bank, N.A.,
as agent, The Chase Manhattan Bank, The Hongkong and Shanghai Banking
Corporation Limited and ABN AMRO Bank N.V. Incorporated by reference to
Exhibit 10.9 of Registrant's 1995 10-K.
10.10 Loan and Security Agreement dated as of May 12, 1995, by and between The
He-Ro Group, Ltd. and certain of its subsidiaries and Foothill Capital
Corporation, as amended. 10.11 Contribution Agreement dated as of May 20,
1991, between the Registrant and Herbert
20
<PAGE> 21
Rounick. Incorporated by reference to Exhibit 10.11 of Registrant's 1995
10-K.
10.12 1991 Stock Option Plan. Incorporated by reference to Exhibit 10.12 of
Registrant's 1995 10-K.
10.13 1992 Outside Director Stock Option Plan. Incorporated by reference to
Exhibit 10.13 of Registrant's 1995 10-K.
10.14 1993 Outside Director Stock Option Plan. Incorporated by reference to
Exhibit 10.14 of Registrant's 1995 10-K.
10.15 Amended and Restated 1994 Outside Director Stock Option Plan. Incorporated
by reference to Exhibit 10.15 of Registrant's 1996 10-K.
21.1 Subsidiaries of the Registrant. Incorporated by reference to Exhibit 21.1
of Registrant's 1995 10-K.
*27 Financial Data Schedule
- ---------------------------
*Filed herewith
21
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