<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 November 30, 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.)
530 Seventh Avenue 10018
New York, NY
(Address of principal (Zip Code)
executive offices)
(212) 398-6161
(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 January 13, 1998
$.01 par value 11,995,238
<PAGE> 2
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
Index
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page No.
<S> <C> <C>
Item 1. Financial Statements:
Consolidated Balance Sheets
November 30, 1997 and May 31, 1997........................ 3
Consolidated Statements of Income
Three and Six months Ended November 30, 1997 and 1996..... 4
Consolidated Statements of Changes in Stockholders' Equity
(deficiency) Six months Ended November 30, 1997 and 1996.. 5
Consolidated Statements of Cash Flows
Six months Ended November 30, 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 - 19
PART II. OTHER INFORMATION......................................... 20
</TABLE>
<PAGE> 3
THE HE-RO GROUP,LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
November 30, May 31,
1997 1997
----------- -------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash ........................................ $ 575 $ 354
-------- --------
Accounts receivable:
Trade, net of allowances for doubtful
accounts of $300 (November),$400(May) ... 2,591 1,016
Suppliers and other ....................... 2,672 3,311
-------- --------
5,263 4,327
Inventory ................................... 9,671 10,751
Other current assets ........................ 564 828
-------- --------
Total current assets ................. 16,073 16,260
-------- --------
FIXED ASSETS - at cost, net of accumulated
depreciation and amortization ............... 387 515
OTHER ASSETS .................................... 964 1,031
-------- --------
$ 17,424 $ 17,806
======== ========
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Bank loans .................................. $ 8,135 $ 7,782
Accounts payable ............................ 8,529 7,604
Accrued expenses and other current
liabilities ............................. 3,040 3,082
-------- --------
Total current liabilities ............ 19,704 18,468
-------- --------
Subordinated Notes and Obligations Payable -
stockholder ................................. 5,296 5,296
-------- --------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIT:
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 ......................... (47,809) (46,191)
-------- --------
Total stockholders' deficit ................. (7,576) (5,958)
-------- --------
$ 17,424 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 Six months Ended
November 30, November 30,
----------------- ---------------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net Sales.................. $10,927 $13,904 $20,820 $25,481
Cost of sales ............. 7,063 8,664 13,437 15,599
----- ----- ------- ------
Gross profit .............. 3,864 5,240 7,383 9,882
Selling, general and
administrative expenses... 3,778 4,764 7,826 9,839
------ ----- ------- ------
Operating Income (Loss).... 86 476 (443) 43
Interest Expense .......... 614 605 1,175 1,166
----- ----- ------- ------
Loss before income taxes (528) (129) (1,618) (1,123)
Provision for income
taxes .................... - - - -
Net Loss ................. $ (528) $ (129) $(1,618) $(1,123)
======= ======= ======== ========
Net Loss per common share $(0.08) $(0.02) $(0.24) $(0.17)
======= ======= ======== ========
Weighted average share
outstanding. 6,717 6,717 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 (1,123) (1,123)
----- --- ------- -------- -------
Balance, November 30, 1996 6,717 $67 $40,166 $(38,625) $ 1,608
===== === ======= ======== =======
Balance, May 31, 1997 6,717 $67 $40,166 $(46,191) $(5,958)
Net loss (1,618) (1,618)
----- --- ------- -------- -------
Balance, November 30, 1997 6,717 $67 $40,166 $ (47,809) $(7,576)
===== === ======= ========= =======
</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>
Six Months Ended
November 30,
------------------------
1997 1996
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ......................................... ($1,618) $(1,123)
------- -------
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Depreciation and amortization ................ 139 473
Amortization of deferred finance costs ....... 113 159
(Increase) decrease in assets:
Trade receivables ................................ (1,575) (1,230)
Other receivables ................................ 639 (545)
Inventories ...................................... 1,080 2,316
Other current assets ............................. 264 (360)
Increase (decrease) in liabilities:
Accounts payable ................................. 925 554
Accrued expenses and other current liabilities ... (42) (96)
------- -------
Total adjustments ................................ 1543 1,271
------- -------
Net cash provided by (used in)
operating activities ............................... (75) 148
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of fixed assets ...................... (11) (82)
Decrease in other assets ......................... 67 39
------- -------
Net cash provided by (used in) investing
activities ........................................... 56 (43)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in bank loans ............................. 353 257
Deferred finance costs ............................. (113) (40)
------- -------
Net cash provided by financing activities . 240 217
------- -------
NET INCREASE IN CASH ................................. 221 322
------- -------
CASH, beginning of period ............................ 354 405
------- -------
CASH, end of period .................................. $ 575 $ 727
======= =======
</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)
November 30, 1997
1. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of The
HE-RO Group, Ltd. and its subsidiaries (hereinafter collectively
referred to as the "Company" unless the context clearly otherwise
requires). 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 six months ended
November 30, 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 November 30, 1997.
3. INVENTORY
Inventory is stated at the lower of cost (first-in, first-out) or
market.
<TABLE>
<CAPTION>
(In Thousands)
November 30, May 31,
1997 1997
----------- ------
(UNAUDITED)
<S> <C> <C>
Finished goods......................... $ 7,946 $ 9,012
Raw materials.......................... 1,725 1,739
------- -------
$ 9,671 $10,751
======= =======
</TABLE>
4. FIXED ASSETS
Fixed assets consist of the following:
<TABLE>
<CAPTION>
(In Thousands)
November 30, May 31,
1997 1997
----------- ------
(UNAUDITED)
<S> <C> <C>
Machinery and equipment ........... $1,946 $1,943
Furniture and fixtures ............ 2,527 2,526
Leasehold improvements ............ 1,901 1,894
------ ------
6,374 6,363
Less - Accumulated depreciation and
amortization ...................... 5,987 5,848
------ ------
$ 387 $ 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 November 30, 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") as amended, expiring December 31, 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. At November 30, 1997, the direct debt outstanding under the
Foothill Credit Agreement was $5,385,000 and the Company was
contingently liable for outstanding letters of credit of approximately
$220,000.
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 November 30, 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 (the "Bank Group Credit Agreement").
Because certain liquidity standards were not met under the Foothill
Credit Agreement, the Company was not permitted to pay the monthly
installments of principal due to the Bank Group, and accordingly has not
been in compliance with the Bank Group Credit Agreement.
As of November 30, 1997, the Company was not in compliance with
certain financial covenants under the Foothill Credit Agreement, but
received a waiver from Foothill relating to such non-compliance. In
December 1997, the obligations to Foothill were paid in full in
connection with a new lending facility. (see Note 9 for further
discussion).
7. SUPPLEMENTAL CASH FLOW INFORMATION
Payments of income taxes were $9,000 and $37,000 for the six months
ended November 30, 1997 and 1996, respectively. Payments of interest
during the corresponding periods were $918,000 and $914,000
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.
9
<PAGE> 10
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 or of certain entities affiliated with the People's
Liberation Army 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 effective 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 or otherwise restricting the importation of goods
from China.
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 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.
10
<PAGE> 11
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. SUBSEQUENT EVENT
On December 24, 1997 (the "Closing Date"), the Company acquired all
of the outstanding capital stock of Nah Nah Collection, Inc. ("Nah Nah")
from Hong J. Han, president of Nah Nah, in exchange for the issuance by
the Company to Mr. Han of 5,277,905 shares of Common Stock (equivalent
to 44% of the Company's issued and outstanding capital stock), pursuant
to a Stock Purchase Agreement dated October 16, 1997 (the "Stock
Purchase Agreement"), among the Company, Nah Nah, Mr. Han and Della
Rounick. In addition, Ms. Rounick granted to Mr. Han, or his designee,
an irrevocable proxy to vote the 4,430,748 shares of Common Stock owned
by her, giving Mr. Han voting control over a total of approximately 81%
of the Company's issued and outstanding stock. Nah Nah produces and
markets several lines of women's ready to wear and special occasion wear
consisting of suits and dresses under labels including Victor Costa by
Nahdree, Constance Saunders by Nahdree, Nah Nah Collections and under
private label through its NNP division. For financial reporting
purposes, this transaction will be accounted for as a reverse
acquisition.
Historically, the Company incurred losses from operations and
there was insufficient liquidity, as required by its former senior
lender, Foothill, to pay the Company's obligations to the Bank Group. As
a result, the Company's financial statements have reflected doubt about
the
11
<PAGE> 12
Company's ability to continue as a going concern. On the Closing Date,
the Company and all of its active subsidiaries entered into a new
factoring and revolving inventory loan and security agreement (the
"Factoring Agreement") with Heller Financial, Inc. ("Heller"), replacing
Foothill as the senior lender. All of the outstanding obligations of the
Company to Foothill were paid in full and Foothill released its liens on
the assets of the Company and its subsidiaries. The factoring advances,
inventory and letter of credit facility under the Factoring Agreement
may not exceed an aggregate of $20,000,000 outstanding at any time and
includes (a) collection factoring with advances not to exceed 85% of the
purchase price of net eligible accounts; (b) advances not to exceed 60%
of eligible finished goods inventory located in the United States; (c)
documentary letters of credit; and (d) an over advance formula facility.
The significant restrictive covenants as defined in the Factoring
Agreement are as follows:
- Minimum tangible net worth for each fiscal year: $4,250,000
for 1998; $7,000,000 for 1999; $10,500,000 for 2000; and
$15,500,000 for each fiscal year thereafter.
- Minimum working capital: $2,200,000.
- Minimum current ratio: 1.30 to 1.10.
- Capital expenditures may not exceed $300,000 in one fiscal
year.
The Company's principal subsidiaries granted to Heller
continuing security interests in substantially all of their assets,
including receivables, inventory (other than raw materials and
work-in-progress), intangibles, equipment, and any proceeds from any of
the above. The obligations to Heller are further secured by a guaranty
by the Company and its other subsidiaries, and the obligations of such
guarantors are secured by liens on substantially all of the assets of
the guarantors.
In addition, Mr. Han acquired all of the Company's outstanding
obligations ($2,750,000 in principal amount) to the Bank Group, and all
of the collateral therefor, under the Bank Group Credit Agreement. The
obligations are evidenced by term notes with interest at 2% above prime
rate. The Company had been in default under the Bank Group Credit
Agreement and has acknowledged such defaults and that there are no
obligations to make any loans under the Bank Group Credit Agreement. The
Company's indebtedness to Mr. Han, as successor to the Bank Group, is
(i) subordinated to the Company's indebtedness to Heller, its new senior
lender, and (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. The Bank Group also
surrendered to the Company for cancellation warrants to purchase 250,000
shares of common stock of the Company.
Pursuant to certain conditions set forth in the Stock Purchase
Agreement, on the Closing Date, Mr. Han also purchased from Ms. Rounick
subordinated indebtedness of The He-Ro Group, Inc. ("HGI") to the
Estate of Herbert Rounick (of which Ms. Rounick is executrix) in the
amount of $4,296,000, plus accrued interest. Ms. Rounick retained
$1,000,000, plus accrued interest, of subordinated indebtedness. The
aggregate indebtedness (in the principal amount of $6,660,801, which
includes the accrued interest) is evidenced by subordinated notes of
the Company in favor of each of Mr. Han and Ms. Rounick bearing
interest at 9.278% per annum. The principal is due and payable on
demand and the interest is
12
<PAGE> 13
due on the first of each month commencing January 1, 1998, or otherwise
on demand. The Company and all its subsidiaries (except HGI) have
guaranteed payment and performance of the notes. The payments on, and
any conversion of, the notes, as well as other provisions on the notes,
will be on a pari passu basis, subject to certain restrictions, and Ms.
Rounick may not take any action to collect, enforce, convert or
otherwise deal with her note unless Mr. Han has taken such action (in
which event Ms. Rounick may take such action but only to the same
extent and on the same terms as Mr. Han) or unless she has received Mr.
Han's prior written consent.
Under the terms of subordination and intercreditor agreements with
Heller, all interest payments to Ms. Rounick and Mr. Han are subject to
certain conditions.
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 six month period ended
November 30, 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 or of certain entities
affiliated with the People's Liberation Army 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 effective 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 or
otherwise restricting the importation of goods from China.
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
14
<PAGE> 15
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 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.
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
15
<PAGE> 16
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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
SECOND QUARTER FISCAL 1998 COMPARED TO SECOND QUARTER FISCAL 1997
Net sales of $10.9 million for the three months ended November
30, 1997 decreased by $3.0 million, or (21.4)% compared to net sales of
$13.9 million for the three months ended November 30, 1996. 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 November 30,1997 was
$7.1 million, or 64.6% of net sales compared to $8.7 million, or 62.3%
of net sales for the three months ended November 30, 1996. Gross profit
for the three months ended November 30, 1997 was $3.9 million, or 35.4%
of net sales, compared to $5.4 million, or 37.7% of net sales for three
months ended November 30, 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 $3.8 million,
or 34.5% of net sales for the three months ended November 30, 1997,
compared to $4.8 million, or 34.2% of net sales for the three months
ended November 30, 1996. The lower selling, general and administrative
expenses for the quarter ending November 30, 1997 are primarily
attributable to planned reductions in salary expenses, rent and
occupancy, professional fees and insurance.
Operating income was $.1 million or .8% of net sales for the
three months ended November 30, 1997 compared to an operating income of
$.5 million or 3.4% of net sales for the three months ended November
30, 1996. The decrease in operating income was attributable to the
reduced sales and gross profit dollars described above.
Interest expense for the three months ended November 30, 1997 was
$.6 million, or 5.6% of net sales compared to $.6 million, or 4.4% of
net sales for the three months ended November 30, 1996.
As a result of the factors described above, the Company's net
loss increased to $(0.5) million, or (4.8)% of net sales during the
three months ended November 30, 1997, compared to $(0.1) million, or
(0.9)% of net sales for the three months ended November 30, 1996.
16
<PAGE> 17
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
SIX MONTHS ENDED NOVEMBER 30, 1997 COMPARED TO SIX MONTHS
ENDED NOVEMBER 30, 1996
Net Sales of 20.8 million for the six months ended months
November 30, 1997 decreased by 4.7 million (18.3%) below the net sales
of 25.5 million for the six months ended November 30, 1996. This
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 six months ended November 30, 1997 was
$13.4 million, or 64.5% of net sales compared to $15.6 million, or
61.2% of net sales for the six months ended November 30, 1996. Gross
profit for the six months ended November 30, 1997 was $7.4 million, or
35.4% of net sales, compared to $9.9 million or 38.7% of net sales for
the six months November 30, 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 of $7.8 million
or 37.5% of net sales for the six months ended November 30, 1997
compared to $ 9.8 million, or 38.6% for the six months ended November
30, 1996. The lower selling, general and administrative expenses for
the quarter ending November 30, 1997 are primarily attributable to
planned reductions in salary expenses, rent and occupancy, professional
fees and insurance.
Operating loss of $(0.4) million or .2% of net sales for the
six months ended November 30, 1997 compared to $0.1 million or 2.0% of
net sales for the six months ended November 30, 1996. This increase in
operating loss was primarily attributable to the reduced sales and
gross profit dollars and described above.
Interest expense of $1.2 million or 5.6% of net sales for the
six months ended November 30, 1997, compared to $1.2 million, or 4.5%
of net sales for the six months ended November 30, 1996.
As a result of the factors described above, the company's net
loss was $(1.6) million (or $(0.24) per share)for the six months ended
November 30, 1997 compared to a net loss of $(1.1) million (or $0.17
per share) for the six months ended November 30, 1996.
17
<PAGE> 18
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
At November 30, 1997, the Company had a decrease in cash flows from
operating activities of $.1 million. This decrease resulted primarily
from a net increase in accounts receivable of $.9 million and a net
loss of $1.6 million, offset by an increase in accounts payable of $.9
million and a decrease in inventories of 1.1 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
six 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 million
resulting primarily from an increase in bank borrowings under the
Company's revolving credit facilities.
On December 24, 1997 (the "Closing Date"), the Company acquired all
of the outstanding capital stock of Nah Nah Collection, Inc. ("Nah Nah")
from Hong J. Han, president of Nah Nah, in exchange for the issuance by
the Company to Mr. Han of 5,277,905 shares of Common Stock (equivalent
to 44% of the Company's issued and outstanding capital stock), pursuant
to a Stock Purchase Agreement dated October 16, 1997 (the "Stock
Purchase Agreement"), among the Company, Nah Nah, Mr. Han and Della
Rounick. In addition, Ms. Rounick granted to Mr. Han, or his designee,
an irrevocable proxy to vote the 4,430,748 shares of Common Stock owned
by her, giving Mr. Han voting control over a total of approximately 81%
of the Company's issued and outstanding stock. Nah Nah produces and
markets several lines of women's ready to wear and special occasion wear
consisting of suits and dresses under labels including Victor Costa by
Nahdree, Constance Saunders by Nahdree, Nah Nah Collections and under
private label through its NNP division. For financial reporting
purposes, this transaction will be accounted for as a reverse
acquisition.
Historically, the Company incurred losses from operations and there
was insufficient liquidity, as required by its former senior lender,
Foothill Capital Corporation ("Foothill") to pay the Company's
obligations to its bank group which ranked junior to Foothill (the
"Bank Group"). As a result, the Company's financial statements have
reflected doubt about the Company's ability to continue as a going
concern. On the Closing Date, the Company and all of its active
subsidiaries entered into a new factoring and revolving inventory loan
and security agreement (the "Factoring Agreement") with Heller
Financial, Inc. ("Heller"), replacing Foothill as the senior lender.
All of the outstanding obligations of the Company to Foothill were paid
in full and Foothill released its liens on substantially all of the
assets of the Company and its subsidiaries. Mr. Han also acquired all
of the obligations due and owing by the Company to the Bank Group, and
all of the collateral therefor, under the fourth amended and restated
revolving credit agreement dated May 15, 1995 between the Company and
the Bank Group (the "Bank Group Credit Agreement"), in the aggregate
principal amount of $2,750,000. The obligations are evidenced by term
notes with interest at 2% above the prime rate. The Company had been in
default under the Bank Group Credit Agreement and has acknowledged such
defaults and that there are no obligations to make any loans under the
Bank Group Credit Agreement. The Company's indebtedness to Mr. Han, as
successor to the Bank Group is (i) subordinated to the Company's
indebtedness to Heller, its new senior lender, and (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. The Bank Group also surrendered to the Company for
cancellation warrants to purchase 250,000 shares of common stock
of the Company.
18
<PAGE> 19
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Factoring Agreement provides for Heller to purchase eligible
receivables and advance to the Company's principal operating
subsidiaries up to 85% of the purchase price (as such term is defined
in the Factoring Agreement) of net eligible accounts. In addition,
Heller has agreed to make revolving loans (including letters of credit)
to each of such parties upon request and in Heller's discretion, in
amounts up to approximately 60% of each such party's eligible finished
goods inventory located in the United States, plus certain supplemental
amounts. The factoring advances, inventory and letter of credit
facility under the Factoring Agreement may not exceed an aggregate of
$20,000,000 outstanding at any time.
19
<PAGE> 20
THE HE-RO GROUP, LTD. AND SUBSIDIARIES
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
3.1 Restated Certificate of Incorporation of Registrant.
3.2 Bylaws of Registrant, as amended.
10.1 Stock Purchase Agreement dated October 16, 1997 among
The He-Ro Group, Ltd., Nah Nah Collection, Inc., Hong
J. Han and Della Rounick.
27.1 Financial Data Schedule
99.1 Factoring Agreement dated December 24, 1997 among
Heller Financial, Inc., The He-Ro Group, Inc., HRNL
Inc., Nah Nah Collection, Inc., The He-Ro Group, Ltd.
and certain other subsidiaries.
(b) Reports on Form 8-K:
The Company did not file any report on Form 8-K
during the three months ended November 30, 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: January 13, 1998 THE HE-RO GROUP, LTD.
(Registrant)
By: /s/ Hong J. Han
--------------------------
Hong J. Han
Chairman of the Board
of Directors and Chief
Executive Officer
Date: January 13, 1998
/s/ Sam D. Kaplan
--------------------------
Sam D. Kaplan
Chief Financial Officer
(Principal Financial and
Accounting Officer)
20
<PAGE> 21
INDEX TO EXHIBITS
TO
THE QUARTERLY REPORT
FOR THE QUARTER ENDED November 30, 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.
10.1 Stock Purchase Agreement dated October 16, 1997 among
The He-Ro Group, Ltd., Nah Nah Collection, Inc., Hong
J. Han and Della Rounick. Incorporated by reference
to Exhibit 2.1 to the Registrant's Current Report on
Form 8-K dated December 31, 1997.
*27.1 Financial Data Schedule
99.1 Factoring Agreement dated December 24, 1997 among
Heller Financial, Inc., The He-Ro Group, Inc., HRNL
Inc., Nah Nah Collection, Inc., The He-Ro Group Ltd.
and certain other subsidiaries. Incorporated by
reference to Exhibit 99.1 to the Registrant's Current
Report on Form 8-K dated December 31, 1997.
- --------------------------
* filed herewith
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S UNAUDITED CONSOLIDATED BALANCE SHEET AS OF NOVEMBER 30, 1997 AND
CONSOLIDATED STATEMENT OF INCOME FOR THE THREE AND SIX MONTH PERIODS ENDING
NOVEMBER 30, 1996 AND 1997, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAY-31-1998
<PERIOD-START> JUN-01-1997
<PERIOD-END> NOV-30-1997
<CASH> 575,000
<SECURITIES> 0
<RECEIVABLES> 5,563,000
<ALLOWANCES> 300,000
<INVENTORY> 9,671,000
<CURRENT-ASSETS> 16,073,000
<PP&E> 6,374,000
<DEPRECIATION> 5,987,000
<TOTAL-ASSETS> 17,424,000
<CURRENT-LIABILITIES> 19,704,000
<BONDS> 0
0
0
<COMMON> 6,717,000
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 17,424,000
<SALES> 20,820,000
<TOTAL-REVENUES> 20,820,000
<CGS> 13,437,000
<TOTAL-COSTS> 13,437,000
<OTHER-EXPENSES> 7,826,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,175,000
<INCOME-PRETAX> (1,618,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,618,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,618,000)
<EPS-PRIMARY> (0.24)
<EPS-DILUTED> (0.24)
</TABLE>
