UNITED STATES
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 May 27, 2006

OR

o            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
            EXCHANGE ACT OF 1934

For the transition period from              to                

Commission File Number:  0-18926

INNOVO GROUP INC.
(Exact name of registrant as specified in its charter)

 

 

(323) 725-5516
(Registrant’s telephone number, including area code)

N/A
(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.
x Yes    o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
(Check One):
Large accelerated filer o                                    Accelerated filer x                                             Non-accelerated filer  o

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).
Yes o    No x

The number of shares of the registrant’s common stock outstanding as of July 5, 2006 was 34,343,454.

 

 

INNOVO GROUP INC.

QUARTERLY REPORT ON FORM 10-Q

PART I.		FINANCIAL INFORMATION		Page
Item 1.		Financial Statements		1
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		24
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		43
Item 4.		Controls and Procedures		44
PART II.		OTHER INFORMATION
Item 1.		Legal Proceedings		45
Item 1A.		Risk Factors		45
Item 2.		Changes in Securities and Use of Proceeds		45
Item 3.		Defaults Upon Senior Securities		45
Item 4.		Submission of Matters to a Vote of Security Holders		45
Item 5.		Other Information		45
Item 6.		Exhibits		46
		Signatures		47

 

 

PART I — FINANCIAL INFORMATION

Item 1.    Financial Statements.

INNOVO GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

 

		05/27/06			11/26/05
		(unaudited)
ASSETS
Current assets
Cash and cash equivalents		$	520		$	560
Accounts receivable, net of allowance for customer credits and returns of $723 (2006) and $412 (2005)		620			60
Inventories, net		4,738			12,083
Due from related parties, net		—			2,781
Prepaid expenses and other current assets		546			96
Assets of discontinued operations		947			11,233
Total current assets		7,371			26,813
Property and equipment, net		477			428
Goodwill		20			20
Intangible assets, net		224			248
Other assets		135			87
Total assets		$	8,227		$	27,596
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable and accrued expenses		$	3,308		$	3,859
Due to factor		225			2,855
Due to related parties, net		714			54
Liabilities of discontinued operations		71			9,271
Total current liabilities		4,318			16,039
Commitments and Contingencies
Stockholders’ equity
Preferred stock, $0.10 par value: 5,000 shares authorized, no shares issued or outstanding		—			—
Common stock, $0.10 par value: 80,000 shares authorized 34,455 shares issued and 34,343 outstanding (2006) and 33,414 shares issued and 33,302 outstanding (2005)		3,447			3,343
Additional paid-in capital		79,741			78,823
Accumulated deficit		(76,503		)	(67,833		)
Treasury stock, 112 shares		(2,776		)	(2,776		)
Total stockholders’ equity		3,909			11,557
Total liabilities and stockholders’ equity		$	8,227		$	27,596

 

The accompanying notes are an integral part of these financial statements

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INNOVO GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except  per share data)

 

		Three months ended						Six months ended
		05/27/06			05/28/05			05/27/06			05/28/05
		(unaudited)						(unaudited)
Net sales		$	9,787		$	9,715		$	20,214		$	15,824
Cost of goods sold		6,556			5,457			15,163			9,071
Gross profit		3,231			4,258			5,051			6,753
Operating expenses
Selling, general and administrative		5,494			4,890			11,228			8,490
Depreciation and amortization		63			38			122			72
		5,557			4,928			11,350			8,562
Loss from continuing operations		(2,326		)	(670		)	(6,299		)	(1,809		)
Interest expense		(116		)	(271		)	(245		)	(494		)
Other income (expense)		(68		)	—			(68		)	7
Loss from continuing operations, before taxes		(2,510		)	(941		)	(6,612		)	(2,296		)
Income taxes		7			9			15			18
Loss from continuing operations		(2,517		)	(950		)	(6,627		)	(2,314		)
Income (loss) from discontinued operations, net of tax		(2,461		)	1,655			(2,043		)	2,201
Net income (loss)		$	(4,978	)	$	705		$	(8,670	)	$	(113	)
Earnings (loss) per common share - Basic
Earnings (loss) from continuing operations		$	(0.08	)	$	(0.03	)	$	(0.20	)	$	(0.08	)
Earnings (loss) from discontinued operations		(0.07		)	0.05			(0.06		)	0.07
Earnings (loss) per common share - Basic		$	(0.15	)	$	0.02		$	(0.26	)	$	(0.01	)
Earnings (loss) per common share - Diluted
Earnings (loss) from continuing operations		$	(0.08	)	$	(0.03	)	$	(0.20	)	$	(0.08	)
Earnings (loss) from discontinued operations		(0.07		)	0.05			(0.06		)	0.07
Earnings (loss) per common share - Diluted		$	(0.15	)	$	0.02		$	(0.26	)	$	(0.01	)
Weighted average shares outstanding
Basic		33,428			31,763			33,365			30,590
Diluted		33,428			31,763			33,365			30,590

 

The accompanying notes are an integral part of these financial statements

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INNOVO GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

 

		Six months ended
		05/27/06			05/28/05
		(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Cash provided by (used in) continuing activities		$	2,767		$	(3,701	)
Cash provided by discontinued operations		601			389
Net cash provided by (used in) operating activities		3,368			(3,312		)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment		(148		)	(200		)
Net cash used in continuing activities		(148		)	(200		)
Cash provided by (used in) discontinued operations		612			(26		)
Net cash used in investing activities		464			(226		)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from (payments on) factor borrowing, net		(2,630		)	527
Payments on note payable officer		—			(333		)
Proceeds from promissory note - former officer		—			703
Exercise of stock options		—			566
Exercise of warrants		—			2,175
Payment of stock issuance expense		—			(2		)
Net cash (used in) provided by continuing activities		(2,630		)	3,636
Cash (used in) provided by discontinued operations		(1,242		)	254
Net cash (used in) provided by financing activities		(3,872		)	3,890
NET CHANGE IN CASH AND CASH EQUIVALENTS		(40		)	352
CASH AND CASH EQUIVALENTS, at beginning of period		560			312
CASH AND CASH EQUIVALENTS, at end of period		$	520		$	664

 

The accompanying notes are an integral part of these financial statements

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INNOVO GROUP INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)

 

												Additional						Promissory						Total
		Preferred Stock					Common Stock					Paid-In			Accumulated			Note - former			Treasury			Stockholders’
		Shares		Par Value			Shares		Par Value			Capital			Deficit			Officer			Stock			Equity
Balance, November 27, 2004		194		$	—		29,266		$	2,927		$	72,043		$	(51,400	)	$	(703	)	$	(2,588	)	$	20,279
Net loss		—		—			—		—			—			(113		)	—			—			(113		)
Payment of promissory note - former officer		—		—			—		—			—			—			703			—			703
Redemption of preferred stock		(194	)	—			—		—			—			—			—			—			—
Conversion of Convertible notes to common stock		—		—			2,459		246			3,909			—			—			—			4,155
Common stock registration related expense		—		—			—		—			(2		)	—			—			—			(2		)
Exercise of stock options		—		—			623		62			470			—			—			(188		)	344
Exercise of warrants		—		—			917		92			2,083			—			—			—			2,175
Balance, May 28, 2005 (unaudited)		—		$	—		33,265		$	3,327		$	78,503		$	(51,513	)	$	—		$	(2,776	)	$	27,541
Balance, November 26, 2005		—		$	—		33,414		$	3,343		$	78,823		$	(67,833	)	$	—		$	(2,776	)	$	11,557
Net loss		—		—			—		—			—			(8,670		)	—			—			(8,670		)
Common stock issued to related party		—		—			1,041		104			(104		)	—			—			—			—
Stock-based compensation		—		—			—		—			1,022			—			—			—			1,022
Balance, May 27, 2006 (unaudited)		—		$	—		34,455		$	3,447		$	79,741		$	(76,503	)	$	—		$	(2,776	)	$	3,909

 

The accompanying notes are an integral part of these financial statements

4

 

INNOVO GROUP INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - BASIS OF PRESENTATION

The unaudited condensed consolidated financial statements of Innovo Group, Inc., or Innovo Group, which include the accounts of its wholly-owned subsidiaries, for the three and six months ended May 27, 2006 and May 28, 2005 and the related footnote information have been prepared on a basis consistent with Innovo Group’s audited consolidated financial statements as of November 26, 2005 contained in Innovo Group’s Annual Report on Form 10-K for the year ended November 26, 2005, or the Annual Report. Innovo Group’s operating subsidiaries include the following entities: Joe’s Jeans Inc., or Joe’s, and Innovo Azteca Apparel, Inc., or IAA. All significant inter-company transactions have been eliminated. Currently, Innovo Group has only one segment of operations - apparel. Historically, Innovo Group operated in two segments - apparel and accessories.

As a result of the sale of assets related to certain areas of its operations, Innovo Group has reclassified and reported the following operating divisions of its various subsidiaries as “Discontinued Operations”:  (1) its craft and accessories division operated under its Innovo Inc. subsidiary, or Innovo, sold in May 2005; (2) its former headquarters in Springfield, Tennessee that was used as a commercial rental property operated under its Leaseall Management Inc. subsidiary, or Leaseall, sold in February 2006; and (3) its private label apparel division operated by its IAA subsidiary and sold in May 2006. Continuing operations include the results of Innovo Group’s branded apparel business.

These unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the related notes thereto contained in Innovo Group’s Annual Report. In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of normal recurring adjustments), which management considers necessary to present fairly Innovo Group’s financial position, results of operations and cash flows for the interim periods presented. The results for the three and six months ended May 27, 2006 are not necessarily indicative of the results anticipated for the entire year ending November 25, 2006.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results may differ from those estimates.

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NOTE 2 — INVENTORIES

Inventories are stated at the lower of cost, as determined by the first-in, first-out method, or market. Inventories consisted of the following (in thousands):

 

NOTE 3 — SALE OF CERTAIN ASSETS OF PRIVATE LABEL APPAREL DIVISION

On March 31, 2006, Innovo Group and its IAA subsidiary entered into an Asset Purchase Agreement, or Cygne APA, with Cygne Designs, Inc., or Cygne. Pursuant to the Cygne APA, Innovo Group agreed to sell to Cygne certain assets related to its private label apparel division. These assets include the private label division’s customer list, the assumption of certain existing purchase orders and inventory related to the private label division, and the assumption of the benefit of a non-compete clause in favor of Azteca Production International, Inc., or Azteca, entered into under the original asset purchase agreement between IAA and Azteca. In exchange for the purchased assets, Cygne agreed to assume certain liabilities associated with the private label division, including, the remaining obligation under the original promissory note executed in favor of Azteca under the original asset purchase agreement (and as more fully described in “Note 4 — Related Party Transactions”), certain other liabilities owed in connection with the private label division to Azteca in excess of $1,500,000, certain liabilities associated with outstanding purchase orders and inventory schedules listed in the Cygne APA, the obligation to continue to pay the earn-out under the original asset purchase agreement and the assumption of the liabilities related to the workforce of the private label division. The aggregate value of the assumed liabilities, which represented the purchase price for the transaction at the time of execution of the Cygne APA, was estimated to be $10,437,000, subject to certain permitted adjustments as of the closing date. On May 12, 2006, Innovo Group conducted its annual meeting of stockholders and its stockholders approved the sale of its private label apparel division pursuant to the Cygne APA. Immediately thereafter, Innovo Group and Cygne closed the transaction. No cash was transferred except each party was responsible for its respective transaction costs. The following table sets forth a summary of the assumption of the liabilities less the net book value of the assets and Innovo Group’s resulting loss on the sale of these assets (in thousands):

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NOTE 4 —RELATED PARTY TRANSACTIONS

As of May 27, 2006 and November 26, 2005, Innovo Group’s related party balance consisted of amounts due (to) or due from certain related parties, as further described below, as follows: 

 

Commerce Investment Group and affiliates

Innovo Group has a strategic relationship with certain of its stockholders, Hubert Guez, Paul Guez and their affiliated companies, including Azteca and Commerce Investment Group LLC, or Commerce. By virtue of this relationship, Innovo Group has entered into the following agreements, at various times, with Hubert Guez, Paul Guez and their affiliated companies, Azteca and/or Commerce, entities in which Hubert Guez and Paul Guez have controlling interests.

The following table represents charges from the affiliated companies pursuant to Innovo Group’s relationship with them, including its discontinued operations, as follows:

		Three months ended						Six months ended
		(in thousands)						(in thousands)
		5/27/06			5/28/05			5/27/06			5/28/05
Continuing operations
Purchase order arrangements		$	1,534		$	803		$	1,950		$	1,124
Verbal facilities agreement		90			79			227			133
Discontinued operations
Supply agreement / Purchase order arrangements		7,163			16,572			16,642			30,810
Earn-out due to Sweet Sportswear		106			409			244			684
Verbal facilities agreement		121			181			302			362
Principal & interest on note payable		548			140			1,087			245
Supply and Distribution agreement		—			329			—			639

 

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Supply agreement/Purchase order arrangement

In July 2003, under an asset purchase agreement, or Blue Concept APA, with Azteca, Hubert Guez and Paul Guez, Innovo Group’s IAA subsidiary acquired the Blue Concept Division of Azteca, a division which sells denim apparel primarily to American Eagle Outfitters, Inc., or AEO. Simultaneous with the Blue Concept APA, IAA entered into a non-exclusive Supply Agreement with AZT International SA de CV, a Mexican corporation and wholly owned subsidiary of Azteca, or AZT, for the purchase of denim products to be sold to AEO, which expired on July 17, 2005. Under the terms of the Supply Agreement, AZT agreed that the purchase price on the products supplied would provide for a margin per unit of 15%. Since the expiration of the supply agreement, Innovo Group continued to utilize AZT as a supplier on a purchase order basis for its AEO products under similar terms. Upon completion of the sale of IAA’s private label division to Cygne, as discussed in Note 3 above, Cygne assumed a portion of the amounts owed to AZT under this purchase order supply arrangement.

Due to this preexisting relationship with AZT as a supplier of finished goods, Innovo Group presently utilizes AZT as a supplier on a purchase order basis for its branded denim goods. Under this arrangement, Innovo Group advances the funds to purchase raw materials anticipated for production of its products, which primarily includes fabric. Innovo Group pays AZT for the production cost less credit for the advances on raw materials. Innovo Group purchases products in various stages of production from partial to completed finished goods. These purchases are included as “Purchase order arrangement” transactions under the “Continuing operations” heading.

Earn-out due to Sweet Sportswear LLC

The Blue Concept APA also provided for the calculation and payment, on a quarterly basis, to Sweet Sportswear LLC, an entity owned by Hubert and Paul Guez, of an amount equal to 2.5% of the gross sales solely attributable to AEO. Under the terms of the Cygne APA, Cygne assumed the future liability associated with this payment and accordingly, as of May 12, 2006, Innovo Group no longer had any obligation with respect to this continuing payment. As of November 26, 2005, Innovo Group had a balance due to Sweet Sportswear LLC of $3,079,000 under this obligation.

Verbal facilities agreement

Innovo Group also utilizes space under a verbal month-to-month arrangement with Azteca for its headquarters and principal executive offices. Under this arrangement, Innovo Group pays to Azteca a monthly fee for allocated expenses associated with its use of office and warehouse space, including a fee charged on a per unit basis for inventory, and expenses in connection with maintaining such office and warehouse space. These allocated expenses include, but are not limited to, rent, security, office supplies, machine leases and utilities. By mid-July 2006, Innovo Group expects to move its headquarters and principal executive offices to nearby office and warehouse space at 5901 Eastern Avenue, Commerce, California and accordingly, will no longer have any obligation to pay Azteca under the verbal facilities arrangement.

Principal and interest on note payable

Innovo Group had originally incurred long-term debt in connection with the purchase of the Blue Concept Division from Azteca. IAA originally issued a seven-year unsecured, convertible promissory note in the original principal amount of $21.8 million, or the Blue Concept Note. The Blue Concept Note bore interest at a rate of 6% and required payment of interest only during the first 24 months and then was fully amortized over the remaining five-year period. On March 5, 2004, after stockholder approval, a portion of the Blue Concept Note was converted into 3,125,000 shares of common stock at a value per

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share of $4.00. Under the terms of the Cygne APA, Cygne assumed the remaining principal balance of the Blue Concept Note and on May 12, 2006, pursuant to the closing of the transaction, Azteca released Innovo Group from any and all remaining obligations under the Blue Concept Note and has been reclassified as a discontinued operation liability. Under the terms of the original asset purchase agreement, Innovo Group issued on May 17, 2006 an additional 1,041,667 shares of its common stock as a result of its average stock price trading at less than $3.00 per share for the period between February 10, 2006 and March 12, 2006, which has been recognized in the Statement of Stockholders’ Equity.

Discontinued craft & accessories business segment

In August 2000, Innovo Group entered into a supply agreement and distribution agreement for its craft products with Commerce. In connection with the sale of the craft inventory and certain other assets of its Innovo subsidiary in May 2005, the supply agreement and the distribution agreement were terminated.

Aggregate balances by entities

As of May 27, 2006 and November 26, 2005, respectively, the balances due (to) or due from these related parties and certain of their affiliates are as follows:

 

The AZT balances represent the balances due from Innovo Group’s current production efforts in Mexico related to our branded label apparel production. Upon completion of the sale of IAA’s private label division to Cygne, as discussed in Note 3 above, Cygne assumed the aggregate liability in the amount of $2,500,000 owed to Commerce and its affiliates. The balance due to Commerce and Cygne represents the adjusted balance remaining that Innovo Group continues to be obligated for after the completion of the transaction with Cygne.

Joe’s Jeans License

On February 7, 2001, Innovo Group acquired the license rights to the Joe’s Jeans label from JD Design, LLC, or JD Design, along with the right to market the previously designed product line and existing sales orders, in exchange for 500,000 shares of Innovo Group’s common stock and a warrant contingent on certain sales and gross margins which were not met and therefore, not eligible for exercise.

Additionally, Joe Dahan, the designer of the Joe’s Jeans line and managing member of JD Design, joined Innovo Group as President of its newly formed and wholly owned subsidiary, Joe’s Jeans, Inc. Under his employment agreement, Mr. Dahan received an option, with a four-year term, to purchase

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250,008 shares of Innovo Group’s common stock at $1.00 per share, vesting over 24 months. This option was exercised in full as of January 26, 2005. Under the terms of the license, Innovo Group is required to pay a royalty of 3% on net sales to JD Design. In October 2005, Innovo Group granted JD Design the right to develop the children’s branded apparel line under an amendment to its master license agreement in exchange for a 5% royalty on net sales of those products. In addition, Innovo Group had a verbal arrangement to pay JD Design a design fee of 3% of net sales for assistance related to designs for its indie™ products, the line of business that Innovo Group exited in 2006.

For the three and six months ended May 27, 2006 and May 28, 2005, the following table sets forth royalties, fees and income related to JD Design.

 

		Three months ended						Six months ended
		(in thousands)						(in thousands)
		5/27/06			5/28/05			5/27/06			5/28/05
Expense (income):
Joe’s Jeans® royalty expense		$	261		$	268		$	563		$	424
indie Design Fee		23			11			38			18
Children’s license, royalty income		(11		)	—			(26		)	—

 

NOTE 5 — LOSS FROM DISCONTINUED OPERATIONS

During fiscal 2004, Innovo Group made the decision to market for sale its commercial rental property consisting of four separate buildings that served as its former headquarters located in Springfield, Tennessee and to offer for sale the assets of its craft and accessory segment of operations conducted through its Innovo subsidiary. On May 17, 2005, Innovo Group completed the sale of the assets of its craft and accessory segment of operations. In February 2006, Innovo Group completed the sale of each of the four separate buildings that served as its former headquarters for an aggregate sales price of $741,000 before net selling costs of approximately $126,000. Innovo Group also paid off the remaining note payable balance of $287,000 collateralized by a first deed of trust on these buildings with the proceeds from the sale. In connection with the sale of one of the buildings, Innovo Group received a promissory note issued by the purchaser in the original principal amount of $50,000, which represented a portion of the purchase price. $2,000 of the promissory note has been included on Innovo Group’s balance sheet under “Other current assets” and $48,000 of the promissory note has been included under non-current “Other assets” of continuing operations. The note bears interest at a rate of 8%, has a term of five years and is collateralized by a deed of trust on the building.

On May 12, 2006, Innovo Group completed the sale of certain assets of its private label apparel division operated by its IAA subsidiary as discussed further in “Note 3 — Sale of Private Label Apparel Division.”  The following table sets forth a summary of the assumption of the liabilities less the net book value of the assets and Innovo Group’s resulting loss on the sale of these assets (in thousands):

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In accordance with the provisions of SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets,” the accompanying unaudited condensed consolidated financial statements reflect the results of operations and financial position of Innovo Group’s commercial rental property, its craft and accessory business segment and its private label apparel division separately as discontinued operations.

The assets and liabilities of the discontinued operations are presented in the unaudited condensed consolidated balance sheet under the captions “Assets of Discontinued Operations” and “Liabilities of Discontinued Operations.”  The underlying assets and liabilities of the discontinued operations are as follows:

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		(in thousands)
		Innovo, Inc.			Leaseall Management			Private Label Business			Total
May 27, 2006
Cash and cash equivalents		—			—			$	44		$	44
Accounts receivable and due from factor, net of allowance for customer credits and allowances of $53 (2006)		—			—			678			678
Inventories		—			—			180			180
Prepaid expenses and other current assets		—			—			7			7
Property, Plant and Equipment, net		—			—			38			38
Assets of discontinued operations		—			—			$	947		$	947
Accounts payable and accrued expenses		—			—			$	71		$	71
Liabilities of discontinued operations		—			—			$	71		$	71
November 26, 2005
Cash and cash equivalents		$	5		—			$	68		$	73
Accounts receivable and due from factor, net of allowance for customer credits and allowances of $23 (2005)		—			16			8			24
Inventories		—			—			366			366
Prepaid expenses and other current assets		—			18			20			38
Property, Plant and Equipment, net		—			599			59			658
Intangible assets, net		—			—			10,074			10,074
Assets of discontinued operations		$	5		$	633		$	10,595		$	11,233
Accounts payable and accrued expenses		—			$	5		$	87		$	92
Due to factor		—			—			$	130		130
Note payable		—			$	287		—			287
Note payable - related party		—			—			8,762			8,762
Liabilities of discontinued operations		—			$	292		$	8,979		$	9,271

 

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The following table sets forth the loss from the discontinued operations of each period.

		(in thousands)
		Innovo, Inc.			Leaseall Management			Private Label Business			Total
Three months ended May 27, 2006
Net sales		$	—		$	—		$	8,499		$	8,499
Pre-tax income (loss) from operations		(4		)	16			60			72
Loss on sale of assets		—			—			(2,533		)	(2,533		)
Income tax		—			—			—			—
Discontinued operations, net of tax		$	(4	)	$	16		$	(2,473	)	$	(2,461	)
Three months ended May 28, 2005
Net sales		$	888		$	—		$	19,683		$	20,571
Pre-tax income (loss) from operations		(78		)	(16		)	1,373			1,279
Gain on sale of assets		377			—			—			377
Income tax		—			1			—			1
Discontinued operations, net of tax		$	299		$	(17	)	$	1,373		$	1,655
Six months ended May 27, 2006
Net sales		$	—		$	—		$	20,001		$	20,001
Pre-tax income (loss) from operations		(4		)	(34		)	512			474
Gain (loss) on sale of assets		—			16			(2,533		)	(2,517		)
Income tax		—			—			—			—
Discontinued operations, net of tax		$	(4	)	$	(18	)	$	(2,021	)	$	(2,043	)
Six months ended May 28, 2005
Net sales		$	2,490		$	—		$	36,672		$	39,162
Pre-tax income (loss) from operations		(218		)	(80		)	2,121			1,823
Gain on sale of assets		377			—			—			377
Income tax (benefit)		—			(1		)	—			(1		)
Discontinued operations, net of tax		$	159		$	(79	)	$	2,121		$	2,201

 

Pre-tax loss from discontinued operations does not include an allocation of corporate overhead costs.

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NOTE 6 — ACCOUNTS RECEIVABLE, FACTOR FINANCING AND DUE (TO) FACTOR

Accounts receivable and due to factor consist of the following (in thousands):

 

		Continuing operations						Discontinued operations
		05/27/06			11/26/05			05/27/06			11/26/05
Non-recourse receivables assigned to factor		$	3,442		$	3,435		$	2,435		$	3,654
Recourse receivables assigned to factor		2,069			1,989			7			70
Total receivables assigned to factor		5,511			5,424			2,442			3,724
Allowance for customer credits and doubtful accounts		(821		)	(796		)	(53		)	(67		)
Net loan balance from factor		(4,915		)	(7,483		)	(1,730		)	(3,787		)
Due to factor		$	(225	)	$	(2,855	)	$	659		$	(130	)
Non-factored accounts receivable		1,344			472			111			47
Allowance for customer credits and doubtful accounts		(724		)	(412		)	(92		)	(23		)
Accounts receivable, net of allowance		$	620		$	60		$	678		$	24

 

Innovo Group bears the collection risk in the event of non-payment by the customers for the client recourse receivables assigned to factor for both continuing and discontinued operations. Innovo Group records its accounts receivable on the balance sheet net of receivables factored with CIT. Further, in the event its loan balance with CIT exceeds the face value of the receivables factored, net of allowances, with CIT, Innovo Group records the difference as a liability on its balance sheet as “Due to Factor.”

CIT Commercial Services

On June 1, 2001, Innovo Group’s Innovo and Joe’s subsidiaries, and on September 10, 2001, its IAA subsidiary, entered into accounts receivable factoring agreements with CIT. Subsequent to these agreements, the subsidiaries also entered into inventory security agreements, collectively with the factoring agreements referred to as the Factoring Facilities. These Factoring Facilities give Innovo Group, through its operating subsidiaries, the ability to obtain advances against factored receivables for up to 85% of the face amount of the factored receivables, on either a recourse or non-recourse basis depending on the creditworthiness of the customer, and also allow Innovo Group to borrow up to 50% of the value of certain eligible inventory. CIT has the ability, in its discretion at any time or from time to time, to adjust or revise any limits on the amount of loans or advances made to us pursuant to the Factoring Facilities. As further assurance to enter into the Factoring Facilities, cross guarantees were executed by and among Innovo Group, Innovo, Joe’s and IAA, to guarantee each subsidiaries’ obligations and in November 2004, upon request by CIT, Innovo Group’s Chairman, Sam Furrow, executed a personal guarantee for up to $1,000,000. During fiscal 2006, this personal guarantee by Mr. Furrow allowed Innovo Group to obtain advances under the existing Factoring Facilities.

Presently, Innovo Group obtains advances under the Factoring Facilities at 85% of factored invoices up to the $1,000,000 maximum availability under the inventory security agreement. As of May 31, 2006 based upon CIT’s month-end statement closest to the end of Innovo Group’s second fiscal quarter, Innovo Group’s availability with CIT was approximately $326,000 under the Factoring Facilities. This amount fluctuates on a daily basis based upon Innovo Group’s invoicing and collection related activity. In connection with the agreements with CIT, certain assets are pledged to CIT, including all of

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the inventory, merchandise, and/or goods, including raw materials through finished goods and receivables.

These Factoring Facilities may be terminated by CIT upon 60 days prior written notice or immediately upon the occurrence of an event of default, as defined in the agreement. The agreements may be terminated by Innovo Group or its subsidiaries, upon 60 days advanced written notice prior to June 30, 2007 or earlier provided that the minimum factoring fees have been paid for the respective period.

The factoring rate that Innovo Group pays to CIT to factor accounts, on which CIT bears some or all of the credit risk, is at 0.4% and the interest rate associated with borrowings under the inventory lines and factoring facility is at the Chase prime rate. As of May 27, 2006, the Chase prime rate was 7.75%.

In addition, in the event Innovo Group needs additional financing, Innovo Group has also established a letter of credit facility with CIT to allow it to open letters of credit for a fee of 0.25% of the letter of credit face value with international and domestic suppliers, subject to availability on the inventory line of credit.

As of May 27, 2006, Innovo Group had $7,079,000 of factored accounts receivable, net of allowances, with CIT and a loan balance of $6,645,000, including a discontinued operations balance. Innovo Group had two open letters of credit outstanding in the aggregate amount of $20,000 as of May 27, 2006.

 

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