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Harry & David faces hard choices soon

Harry & David Holdings is operating in a state of grace — for now.

Medford's gift and gourmet food retailer missed its March 1 bond interest payment, and its 30-day grace period runs out the middle of next week.

It has been two months since Harry & David announced that poor holiday sales left the company short on cash, behind in vendor payments and unable to borrow against its line of credit.

Since Jan. 18, when the company revealed it was in financial distress and had retained Rothschild Inc. as financial adviser and Jones Day as legal adviser, a cadre of lawyers and accountants has revamped the company's financial workings, positioning Harry & David for what it hopes will be a viable future.

The issues facing the company, its private equity owners at Wasserstein & Co., bondholders and creditors likely will converge in what is known as a prepackaged Chapter 11 bankruptcy filing once the grace period runs out.

Bondholders and others familiar with restructuring scenarios who were interviewed by the Mail Tribune say that a cash infusion before asking for court protection is an unlikely scenario, but remains a possibility.

What has occurred in recent weeks are negotiations with bondholders and creditors enabling Harry & David to get into and out of bankruptcy as quickly as possible.

"If their intent is to get a prepackaged plan through the bankruptcy court, they are approaching their (creditor) constituency and negotiating the plan," said Richard Feferman, senior managing director for Corporate Recovery Associates in San Diego, who has advised creditor committees in bankruptcy cases such as McGrath's Publick Fish House and Boston Market. "They want to get all their agreements in place before they file."

Although any one of the company's bondholders could force involuntary Chapter 7 bankruptcy, that is unlikely because it would prove both long and costly.

"There are so many variables at play right now," Feferman said. "Hopefully, they are working things out with creditors and lining up debtor-in-possession financing — the financing used by the company while it's going through the process."

Such financing, he said, comes at premium interest rates.

Attempts to reach Kay Hong, who was appointed interim chief executive officer and chief restructuring officer on Feb. 18, were referred to the New York public relations firm Sard Verbinnen & Co. and not immediately returned.

Debt, a key contributor to the present crisis, has to be dealt with, said bondholder John Wachter of Polymathes Capital in Princeton, N.J.

"This is a classic example of a company that is structurally insolvent because of private equity making a leveraged buyout," Wachter said. "You have a situation where a private equity sponsor put debt on the company (by selling bonds) and then when the economy went south and credit markets got tight, they were without the ability to roll over the debt."

Harry & David has $58.2 million worth of bonds that come due in 2012 and another $140 million due in 2013.

"In theory, the company could issue $200 million in new bonds to refinance the ones due in 2012 and 2013, pushing the debt into the future," Wachter said. "But for them the credit market is not getting better, and their EBITDA (how investors judge earnings before interest, taxes, depreciation and amortization) is not improving. The company needs to deleverage."

Harry & David's EBITDA fell from $21 million during calendar 2009 to a $17 million loss in calendar 2010. In the all-important Christmas quarter, for fiscal 2011, the company's EBITDA plunged to $30.2 million from $64.8 million a year earlier.

"You're looking at a company that in 2007 had EBITDA over $60 million and close to $50 million in 2008," Wachter said. "For a company without debt, that's pretty healthy. With close to $200 million debt coming due and $15 million in annual interest payments, it's harder to save for a rainy day. You will suffer an operating loss, especially if you keep discounting 'Fruit of the Month Club' under those circumstances because there is not enough consumer spending to go around.

"In a tough economy when you haven't gotten a raise, you are going to go for the Ford Escort, not a BMW. Harry & David is not a grocer, it's a specialty gourmet food company. People are going to spend less money on discretionary items."

A New York bondholder said a critical element in the restructuring process is determining who will lead the company on the other side.

Longtime Chief Executive Officer Bill Williams was ousted by the Wasserstein & Co. board in February 2010 and replaced by Steven J. Heyer, who remains chairman.

"You look at the management team and on average they have less than a year's experience at Harry & David," the bondholder said. "Are they the right guys to lead?"

Regardless of who leads, the company's focus likely will be selling tried-and-true core products, he said. "The company needs to downsize and get back to the basics. Pears are what they do best and Moose Munch, in particular, is profitable. Anyone can make cheesecake and throw a Harry & David label on it."

Reach reporter Greg Stiles at 541-776-4463 or e-mail business@mailtribune.com.

Harry & David workers inspect Royal Riviera pears in 2007. - Mail Tribune file photo