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 February 28, 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
New York, NY 10018
------------ -----
(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 April 11,1997
--------------------- --------------
$.01 par value 6,717,333
<PAGE>
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
Index
PART I.FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets
February 28, 1997 and May 31, 1996......................... 3
Consolidated Statements of Income
Three and Nine Months Ended February 28, 1997 and
February 29, 1996.......................................... 4
Consolidated Statements of Changes in Stockholders' Equity
Nine Months Ended February 28, 1997 and
February 29, 1996.......................................... 5
Consolidated Statements of Cash Flows
Nine Months Ended February 28, 1997 and
February 29, 1996.......................................... 6
Condensed Notes to Consolidated Financial Statements....... 7-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................ 13-18
PART II. OTHER INFORMATION.......................................... 19
2
<PAGE>
THE HE-RO GROUP,LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
February 28, May 31,
1997 1996
------------ -------
(unaudited)
ASSETS
CURRENT ASSETS:
Cash......................................... $ 457 $ 405
Accounts receivable:
Trade, net of allowances for doubtful
accounts of $350 (February), $300 (May)... 4,097 1,648
Suppliers and other.......................... 3,445 2,991
------- -------
7,542 4,639
Inventory.................................... 13,946 15,029
Other current assets......................... 970 493
------- -------
Total current assets.................. 22,915 20,566
------- -------
FIXED ASSETS - at cost, net of accumulated
depreciation and amortization................ 1,135 2,424
OTHER ASSETS................................... 1,394 1,633
------- -------
$25,444 $24,623
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank loans................................... $ 7,854 $ 5,977
Current maturities of long-term debt......... $ 2,750 2,600
Accounts payable............................. 8,172 5,981
Accrued expenses and other current
liabilities............................... 2,728 1,888
------- -------
Total current liabilities............. 21,504 16,446
------- -------
Subordinated Notes and Obligations Payable -
stockholder.................................. 5,296 5,296
------- -------
Long-term debt, net of current maturities...... - 150
------- -------
STOCKHOLDERS' EQUITY (DEFICIENCY):
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
Retained earnings (deficiency)............... (1,589) (37,502)
------- ------
Total stockholders' equity (deficiency (1,356) 2,731
------- ------
$25,444 $24,623
======= =======
The accompanying condensed notes are an integral part of these consolidated
statements.
3
<PAGE>
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------ -----------------
February 28 February 29 February 28 February 29
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales............................ $9,648 $12,278 $35,129 $40,827
Cost of sales........................ 6,033 7,635 21,632 24,955
------ ----- ------ ------
Gross profit...................... 3,615 4,643 13,497 15,872
Operating Expenses...................
Selling, general and administrative
expenses.......................... 4,725 5,003 14,564 15,666
Restructuring charges............. 1,300 - 1,300 -
------ ------ ------ ------
6,025 5,003 15,864 15,666
------ ------ ------ ------
Operating income (loss)............. (2,410) (360) (2,367) 206
Interest expense.................... 554 607 1,720 1,903
----- ------ ----- -----
Loss before income taxes.......... (2,964) (967) (4,087) (1,697)
Provision for income taxes.......... - - - -
----- ----- ----- -----
Net loss......................... $(2,964) $ (967) $(4,087) $(1,697)
======= ======= -------- --------
Net loss per common share.......... $(0.44) $ (0.14) $ (0.61) $ (0.25)
======= -------- ======== --------
Weighted average shares outstanding. 6,717 6,717 6,717 6,717
======= ======== ======== ========
</TABLE>
The accompanying condensed notes are an integral part of these consolidated
statements.
4
<PAGE>
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands)
(UNAUDITED)
<TABLE>
<CAPTION>
Total
Common Stock Additional Retained Stockholders'
No. of Paid-in Earnings Equity
Shares Amount Capital (Deficiency) (Deficiency)
------ ------ ------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Balance, May 31, 1995 6,717 $67 $40,166 $(33,574) $ 6,659
Net loss (1,697) (1,697)
Balance, February 29, 1996 6,717 $67 $40,166 $(35,271) $4,962
===== === ======= ======== ======
Balance, May 31, 1996 6,717 $67 $40,166 $(37,502) $ 2,731
Net loss (4,087) (4,087)
Balance, February 28, 1997 6,717 $67 $40,166 $(41,589) $(1,356)
===== === ======= ======== =======
</TABLE>
The accompanying condensed notes are an integral part of these consolidated
statements.
5
<PAGE>
THE HE-RO GROUP, LTD., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(UNAUDITED)
<TABLE>
<CAPTION>
Nine months Ended
-----------------
February 28 February 29
1997 1996
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss........................................ $(4,087) $ (1,697)
------- --------
Adjustments to reconcile pro forma net
loss to net cash provided by (used in)
operating activities:
Depreciation and amortization................ 653 810
Loss on disposition of fixed assets.......... 724 50
Amortization of deferred finance costs....... 239 204
(Increase) decrease in assets:
Trade receivables.............................. (2,449) (2,910)
Other receivables.............................. (454) (107)
Inventories.................................... 1,083 1,137
Other current assets........................... (477) 34
Increase (decrease) in liabilities:
Accounts payable............................... 2,191 (195)
Accrued expenses and other current liabilities. 840 (496)
---- -------
Total adjustments.............................. 2,350 (1,473)
------ -------
Net cash used in operating
activities.................................. (1,737) (3,170)
------ -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of fixed assets.................... (88) (57)
(Increase)Decrease in other assets............. 40 37
------ -------
Net cash used in investing activities....... (48) (20)
------ -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in bank loans.............. 1,877 3,216
Deferred finance costs......................... (40) (115)
------ -------
Net cash provided by financing
activities.............................. 1,837 3,101
------ -------
NET INCREASE (DECREASE) IN CASH..................... 52 (89)
CASH, beginning of period........................... 405 809
------ -------
CASH, end of period................................. $ 457 $ 720
===== =======
</TABLE>
The accompanying condensed notes are an integral part of these consolidated
statements.
6
<PAGE>
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
Condensed Notes To Consolidated Financial Statements
(UNAUDITED)
February 28, 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
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 nine months ended
February 28, 1997 and February 29, 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, 1997.
2. RESTRUCTURING CHARGES
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 are currently 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 plans to relocate its
administrative offices and retail store to smaller leased space in
Secaucus, and utilize an independent third party for the distribution
and warehousing of inventory. As a result of the foregoing, the
restructuring charge for the nine months ended February 28, 1997 is
$1.3 million, of which $0.8 million reflects losses due to the
abandonment of certain fixed assets and leasehold improvements and $0.5
million of costs related to the loss incurred by the Company due to the
lower rent payable by the sublessee and other expenses related to the
sublet. The Company's sublet of its Secaucus facilities and move to new
space will be effected during June, 1997.
7
<PAGE>
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
Condensed Notes To Consolidated Financial Statements - (continued)
(UNAUDITED)
3. INVENTORY
Inventory is stated at the lower of cost (first-in, first-out) or
market, and at February 28, 1997 was calculated using the gross profit
method.
(In Thousands)
February 28, May 31,
1997 1996
----------- ------
(UNAUDITED)
Finished goods....................... $10,146 $10,647
Raw materials........................ 3,800 4,382
------- ------
$13,946 $15,029
------- =======
4. FIXED ASSETS
Fixed assets consist of the following:
(In Thousands)
February 28, May 31,
1997 1996
---------- ------
(UNAUDITED)
Machinery and equipment............... $ 1,943 $ 3,115
Furniture and fixtures................ 2,536 2,979
Leasehold improvements................ 2,696 3,647
------- -------
7,175 9,741
Less - Accumulated depreciation and
amortization.......................... 6,040 7,317
------- -------
$ 1,135 $ 2,424
------- =======
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 February 28, 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. (See Note 9 for further discussion.)
8
<PAGE>
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. 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 (8.25% at
February 28, 1997) plus 2 1/2% per annum. At February 28, 1997, the
direct debt outstanding under the Foothill Credit Agreement was
$7,854,000 and the Company was contingently liable for outstanding
letters of credit of approximately $350,000.
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 February 28, 1997, the
outstanding indebtedness of the Company to the Bank Group was $2,750,000
in the aggregate, 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 March 1997, 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 contemplated
transaction with a potential purchaser of the Company as discussed in
Note 9, the Company will be seeking to refinance or revise its credit
facilities with Foothill. Additionally, the Company has reached an
agreement in principle with the Bank Group to settle their outstanding
balance upon the closing of the transaction.
As partial consideration for entering into the restated and amended
credit agreement, 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,
previously granted to the Bank Group were extended for a one year term
to September 17, 1999.
9
<PAGE>
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 1.0
- The maximum liabilities to net worth must equal: 38.0 to 1.0
- 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 February 28, 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.
7. SUPPLEMENTAL CASH FLOW INFORMATION
Payments of income taxes were $41,000 and $10,000 for the nine months
ended February 28, 1997 and February 29, 1996, respectively. Payments of
interest during the corresponding periods were $1,354,000 and $1,732,000
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 effect on the Company,
resulting from significantly higher rates of duty and other trade
sanctions imposed on goods originating in China.
In May 1996, President Clinton issued a Presidential Determination
recommending the renewal of "most-favored-nation" trade status for China
for the twelve months ending July 2, 1997. As has occurred in the last
two 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
10
<PAGE>
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.
Legislative attempts to defeat the Presidential Determination were
unsuccessful during the 104th Congress. "Most-favored-nation" trade
status was renewed effective July 1996 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, 1997 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 or otherwise restricting the importation of goods
from China. A bill was introduced into the House of Representatives in
January of 1997 which would ban all entries or importations of Chinese
origin articles unless the Secretary of the Treasury determines that the
merchandise is not the product, growth or manufacture of forced labor.
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 quota
levels of affected categories which could result in such levels filling
more rapidly or becoming fully utilized with little or no advance
notice. Pursuant to the previous bilateral textile agreement with China,
such transshipment charges have, on occasion, been applied by the United
States. In addition, a separate agreement between the United States and
China was reached which subjected to quota limitations China's exports
of apparel containing 70% or more by weight of silk. This agreement was
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. This agreement replaced a substantially
similar agreement which was in effect for goods so produced and exported
to the United States from April 1, 1994 through December 31, 1996.
On July 1, 1997, the British Crown Colony of Hong Kong reverts 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 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 to lessen the impact of punitive
measures taken by the U.S. with respect to Chinese quota, to the extent
that such contingency plans are premised on the shifting of production
or assembly of the products from China to Hong Kong.
11
<PAGE>
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 punitive duties, fees or restrictions on
certain Chinese products, 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 textile 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 have been
finalized. 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. SUBSEQUENT EVENT
Because the Company had incurred losses from operations and has been
incurring net losses, 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, as of February 28, 1997, the Company was not in
compliance with certain financial covenants under the Foothill Credit
Agreement for which the Company has received a waiver from Foothill (see
Note 6 for discussion). The Company is projecting losses from continued
operations for the remainder of fiscal 1997, which would result in its
non-compliance with the financial covenants under its credit agreement
with Foothill. The combination of these factors raises substantial doubt
about the Company's ability to continue as a going concern. The
Company's independent public accountants had issued a going concern
opinion for the year ended May 31, 1996. As described above, the
conditions leading to that opinion continue to exist.
12
<PAGE>
On March 12, 1997, the Company announced that it had signed a
purchase agreement with Oleg Cassini, Oleg Cassini, Inc. ("OCI") and
Stonehill Investment Corporation ("Stonehill"), pursuant to which Mr.
Cassini and Stonehill will invest $7,000,000 in the Company (of which
$5,000,000 will be invested at the closing of the transactions
contemplated in the purchase agreement, and an additional $1,000,000
will be invested at each of the first and second anniversaries of the
closing), and OCI will contribute certain licensing income to the
Company in connection with a licensing management agreement, for which
they will receive 80% of the Company's common stock. In addition,
Stonehill has negotiated to purchase the principal shareholder's
subordinated note (see Note 6).
In connection with the close of this transaction, the Company plans
to establish revised financing arrangements.
The transaction is subject to certain third party and regulatory
approvals and certain other closing conditions. Consequently, there can
be no assurance that the Company will consummate this transaction.
In the absence of the preceding transaction 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>
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 nine month period ended February 28,
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
effect on the Company, resulting from significantly higher rates of duty and
other trade sanctions imposed on goods originating in China.
In May 1996, President Clinton issued a Presidential Determination
recommending the renewal of "most-favored-nation" trade status for China for the
twelve months ending July 2, 1997. As has occurred in the last two 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. Legislative attempts
to defeat the Presidential Determination were unsuccessful during the 104th
Congress. "Most-favored-nation" trade status was renewed effective July 1996 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, 1997 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 or otherwise restricting the importation of goods from China. A bill was
introduced into the House of Representatives in January of 1997 which would ban
all entries or importations of Chinese origin articles unless the Secretary of
the Treasury determines that the merchandise is not the product, growth or
manufacture of forced labor.
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 quota
14
<PAGE>
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
levels of affected categories which could result in such levels filling more
rapidly or becoming fully utilized with little or no advance notice. Pursuant to
the previous bilateral textile agreement with China, such transshipment charges
have, on occasion, been applied by the United States. In addition, a separate
agreement between the United States and China was reached which 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. This agreement replaced a
substantially similar agreement which was in effect for goods so produced and
exported to the United States from April 1, 1994 through December 31, 1996.
On July 1, 1997, the British Crown Colony of Hong Kong reverts 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 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 to lessen the impact
of punitive measures taken by the U.S. with respect to Chinese quota, to the
extent that such contingency plans 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 punitive
duties, fees or restrictions on certain Chinese products, 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 textile 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 have been finalized. 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>
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
Third Quarter Fiscal 1996 Compared to Third Quarter Fiscal 1995
Net sales of $9.6 million for the three months ended February 28, 1997
decreased by $2.7 million (21.4%) compared to net sales of $12.3 million for the
three months ended February 29, 1996. This decrease is primarily attributable to
the downsizing of the Company's operations, in addition to reduced sales for
evening wear products due to the soft economy in the apparel industry.
Cost of sales for the three months ended February 28, 1997 was $6.0
million, or 62.5% of net sales compared to $7.6 million, or 62.2% of net sales
for the three months ended February 29, 1996. Gross profit for the three months
ended February 28, 1997 was $3.6 million, or 37.5% of net sales, compared to
$4.7 million, or 37.8% of net sales for three months ended February 29, 1996.
The decrease in gross profit dollars was primarily due to the decrease in sales
volume described above.
Selling, general and administrative expenses ("SGA") were $4.7 million,
or 49.0% of net sales for the three months ended February 28, 1997, compared to
$5.0 million, or 40.8% of net sales for the three months ended February 29,
1996. The lower selling, general and administrative expenses for the three
months ended February 28, 1997 are primarily attributable to decreases in salary
expenses, rent and occupancy, insurance and professional fees resulting from the
Company's planned cost cutting measures.
Restructuring charges were $1.3 million, or 13.5% of net sales, for the
three months ended February 28, 1997. (See Note 2 of Condensed Notes to
Consolidated Financial Statements.)
Operating loss was $2.4 million or 25.0% of net sales for the three
months ended February 28, 1997 compared to $.4 million or 2.9% of net sales for
the three months ended February 29, 1996. This increase in operating loss was
primarily attributable to a reduction in net sales and related gross profit and
restructuring charges described above.
Interest expense for the three months ended February 28, 1997 was $0.6
million, or 5.7% of net sales compared to $.6 million, or 4.9% of net sales for
the three months ended February 29, 1996.
As a result of the factors described above, the Company had a net loss
of $3.0 million ($.44 per share) for the three months ended February 28, 1997
compared to a net loss of $1.0 million (or $.14 per share) for the three months
ended February 29, 1996.
16
<PAGE>
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
Nine months Ended February 28, 1997 Compared to Nine months Ended
February 29, 1996
Net sales of $35.1 million for the nine months ended February 28, 1997
decreased by $5.7 million (14.0%) below net sales of $40.8 million for the nine
months ended February 29, 1996. This decrease is primarily attributable to the
downsizing of the Company's operations, in addition to reduced sales for evening
wear products due to the soft economy in the apparel industry.
Cost of sales for the nine months ended February 28, 1997 was $21.6
million, or 61.6% of net sales compared to $24.9 million, or 61.1% of net sales
for the nine months ended February 29, 1996. Gross profit for the nine months
ended February 28, 1997 was $13.5 million, or 38.4% of net sales, compared to
$15.9 million or 38.9% of net sales for the nine months ended February 29, 1996.
The decrease in gross profit dollars was primarily due to the decrease in sales
volume described above.
Selling, general and administrative expenses of $14.6 million or 41.5%
of net sales for the nine months ended February 28, 1997 compared to $15.7
million, or 38.4% for the nine months ended February 29, 1996. The lower
selling, general and administrative expenses for the nine months ended February
28, 1997 are primarily attributable to decreases in salary expenses, rent and
occupancy, professional fees and insurance.
Restructuring charges were $1.3 million, or 3.7% of net sales, for the
nine months ended February 28, 1997. (See Note 2 of Condensed Notes to
Consolidated Financial Statements.)
Operating loss of $2.4 million or 6.7% of net sales for the nine months
ended February 28, 1997 compared to an operating income of $.2 million or .5% of
net sales for the nine months ended February 29, 1996. This decrease in
operating income was primarily attributable to reduced net sales and related
gross profit and restructuring charges described above.
Interest expense of $1.7 million or 4.9% of net sales for the nine
months ended February 28, 1997 compared to $ 1.9 million, or 4.7% of net sales
for the nine months ended February 29, 1996.
As a result of the factors described above, the Company's net loss was
$4.1 million (or $.61 per share) for the nine months ended February 28, 1997
compared to a net loss of $1.7 million (or $.25 per share) for the nine months
ended February 29, 1996.
Liquidity and Capital Resources
At February 28, 1997, the Company had a decrease in cash flows from
operating activities of $1.7 million. This decrease resulted primarily from a
17
<PAGE>
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
net loss of $4.1 million for the nine months then ended and an increase in
receivables of $2.9 million, and offset partially by a net decrease in inventory
of $1.1 million, and an increase in accounts payable and accrued expenses of
$3.0 million for the nine months then ended. 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 nine
months of fiscal 1997 and 1996, the Company spent approximately $.1 million on
capital improvements and replacement expenditures in each period. Capital
improvements and replacements for the full fiscal 1997 year are expected to
approximate $.2 million.
Cash flows from financing activities increased by $1.8 million resulting
primarily from increased borrowings under the Company's revolving credit
facilities.
Because the Company had incurred losses from operations and has been
incurring net losses, 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 and,
accordingly, was not in compliance with it credit agreement with its bank group.
In addition, as of February 28, 1997, the Company was not in compliance with
certain financial covenants under the Foothill Credit agreement for which the
Company has received a waiver from Foothill (see Note 6 for discussion). The
Company is projecting losses from operations for the remainder of fiscal 1997,
which would result in its non-compliance with the financial covenants under its
credit agreement with Foothill. The combination of these factors raises
substantial doubt about its ability to generate sufficient cash to support its
operations. The Company's independent public accountants had issued a going
concern opinion for the year ended May 31, 1996. As described above, the
conditions leading to that opinion continue to exist. The Company's ability to
continue as a going concern is dependent upon plans to restructure debt, to
reduce or delay expenditures, or to increase ownership equity as discussed in
Note 9 of Condensed Notes to Consolidated Financial Statements. The Company
believes that the contemplated transaction with a potential purchaser of the
Company as discussed in Note 9, as well as funds generated by operations, in
addition to management's ability to reduce expenses, the availability of credit
under the revised credit facility coupled with reduced inventory levels will
contribute to meeting the Company's working capital, letter of credit and
capital expenditure requirements for the foreseeable future. There can be no
assurance that the Company will consummate a transaction with the potential
purchaser as discussed in Note 9 or with any other investor or purchaser.
18
<PAGE>
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:
None
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: April 10, 1997 THE HE-RO GROUP, LTD.
(Registrant)
By: /s/ DELLA ROUNICK
-------------------------
Della Rounick
Co-Chairman of the Board
of Directors and Chief
Executive Officer
Date: April 10, 1997
/s/ SAM D. KAPLAN
-------------------------
Sam D. Kaplan
Chief Financial Officer
and Secretary
(Principal Financial and
Accounting Officer)
19
<PAGE>
INDEX TO EXHIBITS
TO
THE QUARTERLY REPORT
ON FORM 10-Q
FOR THE QUARTER ENDED FEBRUARY 28, 1997
OF
THE HE-RO GROUP, LTD.
Exhibit Sequentially
No. Description Numbered Page
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 May 24, 1994 between The He-Ro
Group, Inc. (as sublessor) and USA Cargo
Distribution Center (as sublessee) relating to
the premises located at One American Way,
Secaucus, New Jersey. Incorporated by
reference to Exhibit 10.2 of the Registrant's
1995 10-K.
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.
<PAGE>
Exhibit Sequentially
No. Description Numbered Page
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.
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.
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 the 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.
<PAGE>
Exhibit Sequentially
No. Description Numbered Page
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. Incorporated by
reference to Exhibit 10.10 of
Registrant's 1995 10-K.
10.11 Contribution Agreement dated as of
May 20, 1991, between the Registrant
and Herbert 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.
10.16 Employment Agreement dated May 14,
1993 by and between Allan R. Bogner
and The He-Ro Group, Ltd. (the
"Bogner Employment Agreement").
Incorporated by reference to Exhibit
10.16 of Registrant's 1995 10-K.
10.17 Letter dated June 1, 1994 from the
He-Ro Group, Ltd. to Allan R. Bogner
relating to Bogner Employment
Agreement. Incorporated by
reference to Exhibit 10.17 of
Registrant's 1995 10-K.
<PAGE>
Exhibit Sequentially
No. Description Numbered Page
10.18 Settlement Agreement dated November
30, 1995, between Allan R. Bogner
and the Registrant. Incorporated by
reference to Exhibit 10.18 of
Registrant's Quarterly Report on
Form 10-Q for the quarter ended
February 29, 1996.
10.19 Note and Common Stock Purchase
Agreement dated as of September 25,
1996, by and among Registrant, The
He-Ro Group, Inc., Vasiliki Della
Pasvantidou Rounick, individually
and as the Executrix of the Estate
of Herbert Rounick, and Sun
Investment Partnership I, Ltd.
Incorporated by reference to Exhibit
10.19 of Registrant's Quarterly
Report on Form 10-Q for the quarter
ended August 31, 1996.
10.20 Amendment to Note and Common Stock
Purchase Agreement, dated November
18, 1996, by and among Registrant,
The He-Ro Group, Inc., Vasiliki
Della Pasvantidou Rounick,
individually and as the Executrix of
the Estate of Herbert Rounick, and
Sun Investment Partnership I, Ltd.
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.
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