Harry & David Files Chapter 11

Two months after it said it could not finance continuing operations without securing new capital and restructuring its obligations, Harry & David Holdings today filed for Chapter 11 protection in the U.S. Bankruptcy Court for the District of Delaware.

Harry & David Holdings is the parent company of food and gifts merchants Harry & David, Cushman’s and Wolferman’s.

As a part of a prepackaged restructuring, Harry & David entered into agreements with certain holders of the company’s senior notes, according to the filing. Supporting noteholders agreed to backstop a $55 million rights offering that will provide it with the necessary equity financing to emerge from Chapter 11, the company said in a filing with the Securities and Exchange Commission.

Harry & David said it had reached an agreement with holders of about 81% of its senior notes on the terms of reorganization. The move will eliminate substantial indebtedness and provide equity financing to restructure the balance sheet.

Neil Stern, a retail analyst and senior partner for consultancy McMillan Doolittle, views the Chapter 11 filing as another example of a “heavily leveraged private equity buyout that ran into trouble during the economic downturn.”

Chapter 11 allows a company to clean up its balance sheet and make strategic decisions that otherwise couldn’t be accomplished, Stern adds. Besides restructuring the debt, he would expect Harry & David “to use this opportunity to close a number of underperforming stores and refocus and streamline their operations.”

Harry & David operated 122 stores as of Dec. 25, the end of its fiscal second quarter. Since then, it shuttered 52 locations and is trying to shed those leases, according to the SEC filing.

But Portland, OR-based turnaround specialist Renee C. Fellman has been following the merchant and says “it will take more than converting debt to equity to solve Harry & David’s problems.”

The company had operating losses – before interest payments – in fiscal 2009 and fiscal 2010, she explains.

“And the company’s second quarter 10-Q shows the outlook is for even greater operating losses in fiscal 2011,” Fellman says. “The company’s turnaround leader must be strong, not only financially, but also operationally for the company to return to profitability.”

According to the Chapter 11 filing, Harry & David owes Wells Fargo Bank more than $198 million. It owes the back $140.2 million in senior fixed rate loans and $58.2 million in floating rate loans.

Harry & David also lists customer relations management firm Convergys CMG as one of its top creditors, and listed a claim of $2.22 million. But Convergys had filed a lawsuit last week claiming Harry & David owes it $3.83 million. Convergys is suing the merchant for that amount plus $5.96 million for “improper and unlawful termination of the agreement” as part of a breach of contract lawsuit.

Harry & David brought in Kay Hong last month as its CEO and chief restructuring officer.

But that’s not Harry & David’s only lawsuit. The merchant is being sued by a second top executive who claims his contract was breached when he was terminated.

Joseph P. Foley, who was senior vice president-general manager of stores, said he was fired on Aug. 2. Under the terms of his contract, Foley claims he is entitled to continuation of salary, payment of health insurance premiums, applicable bonuses and outplacement assistance because it was a “qualified termination.”

According to court documents, filed March 25 in the U.S. District Court in Medford, OR, Foley submitted a claim for benefits on Sept. 10, and was denied on Dec. 6 with no substantial basis.

Foley wrote the defendants on Dec. 14 requesting all documents and records relevant to the claim for benefits, including those that considered it, generated, or relied upon in making the benefit determination, and did not receive a response, the lawsuit says.

The lawsuit does not specify how much money Foley is seeking.

Former executive vice president/chief customer officer Drew Reifenberger filed a similar lawsuit against Harry & David this month in the U.S. District Court of Atlanta because he said his contract when he was terminated by the company “without cause” on Jan. 12.

The merchant says Reifenberger was fired with cause, though it did not provide the court with a reason.

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