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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
----------
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
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COMMISSION FILE NO. 333-62021
HOME INTERIORS & GIFTS, INC.
(Exact name of registrant as specified in its charter)
TEXAS 75-0981828
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification No.)
organization)
4055 VALLEY VIEW LANE, SUITE 500
DALLAS, TEXAS 75244
(Address of principal executive offices) (Zip Code)
(972) 386-1000
(Registrant's telephone number, including area code)
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 requirement for the past 90 days. Yes [X] No [ ]
As of August 14, 2000, the registrant had outstanding 15,240,218 shares of
its common stock, $0.10 par value per share.
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HOME INTERIORS & GIFTS, INC.
INDEX
PAGE NO.
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PART I - FINANCIAL INFORMATION
Item 1. Unaudited Interim Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1999 and
June 30, 2000.................................................................... 3
Consolidated Statements of Operations and Comprehensive Income
for the three months and six months ended June 30, 1999 and 2000................. 4
Consolidated Statements of Cash Flows for the six months ended
June 30, 1999 and 2000........................................................... 5
Notes to Unaudited Interim Consolidated Financial Statements........................ 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................................. 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk................... 18
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................................ 19
Item 5. Other Information............................................................ 19
Item 6. Exhibits and Reports on Form 8-K............................................. 19
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ITEM 1. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND JUNE 30, 2000
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
ASSETS
DECEMBER 31, JUNE 30,
1999 2000
------------ ------------
(UNAUDITED)
Current assets:
Cash and cash equivalents ................................................. $ 32,406 $ 14,300
Accounts receivable, net .................................................. 13,885 14,510
Inventories ............................................................... 42,716 38,247
Deferred income tax benefit ............................................... 3,922 4,202
Other current assets ...................................................... 4,736 3,836
------------ ------------
Total current assets .............................................. 97,665 75,095
Property, plant and equipment, net .......................................... 30,473 58,630
Restricted cash ............................................................. 14,590 --
Investments ................................................................. 1,668 1,690
Debt issuance costs, net .................................................... 15,881 14,328
Other assets ................................................................ 1,264 1,039
------------ ------------
Total assets ...................................................... $ 161,541 $ 150,782
============ ============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable .......................................................... $ 20,986 $ 20,653
Accrued seminars and incentive awards ..................................... 14,146 10,548
Royalties payable ......................................................... 9,771 4,271
Hostess prepayments ....................................................... 8,687 2,500
Income taxes payable ...................................................... 2,858 --
Current maturities of long-term debt and capital lease obligations ........ 27,308 30,897
Other current liabilities ................................................. 11,318 13,968
------------ ------------
Total current liabilities ......................................... 95,074 82,837
Long-term debt and capital lease obligations, net of current maturities ..... 428,238 419,439
Other liabilities ........................................................... 6,443 6,465
------------ ------------
Total liabilities ................................................. 529,755 508,741
------------ ------------
Minority interest ........................................................... 2,972 3,706
Commitments and contingencies (See Note 10)
Shareholders' deficit:
Preferred stock, 10,000 shares authorized ................................ -- --
Common stock, par value $0.10 per share, 75,000,000 shares
authorized, 15,240,218 shares issued and outstanding ................... 1,524 1,524
Additional paid-in capital ............................................... 179,975 180,299
Accumulated deficit ...................................................... (552,726) (543,396)
Other .................................................................... 41 (92)
------------ ------------
Total shareholders' deficit ....................................... (371,186) (361,665)
------------ ------------
Total liabilities and shareholders' deficit ....................... $ 161,541 $ 150,782
============ ============
The accompanying notes are an integral part of these financial statements.
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 1999 AND 2000
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- --------------------------
1999 2000 1999 2000
---------- ---------- ---------- ----------
Net sales .............................................. $ 126,234 $ 104,932 $ 242,982 $ 226,053
Cost of goods sold ..................................... 60,279 48,996 116,991 109,640
---------- ---------- ---------- ----------
Gross profit ........................................... 65,955 55,936 125,991 116,413
Selling, general and administrative:
Selling .............................................. 20,642 18,017 42,361 38,705
Freight, warehouse and distribution .................. 12,501 12,802 23,634 25,467
General and administrative ........................... 6,398 8,273 12,612 18,294
Gains on the sale of assets .......................... -- (2,711) -- (2,713)
Stock option expense ................................. 267 196 748 324
Restructuring expense ................................ -- -- -- 1,027
---------- ---------- ---------- ----------
Total selling, general and administrative .... 39,808 36,577 79,355 81,104
---------- ---------- ---------- ----------
Operating income ....................................... 26,147 19,359 46,636 35,309
Other income (expense):
Interest income ...................................... 595 494 1,369 1,115
Interest expense ..................................... (11,063) (11,268) (22,324) (22,399)
Other income (expense), net .......................... (176) 1,074 (106) 480
---------- ---------- ---------- ----------
Other income (expense), net .................. (10,644) (9,700) (21,061) (20,804)
---------- ---------- ---------- ----------
Income before income taxes ............................. 15,503 9,659 25,575 14,505
Income taxes ........................................... 6,485 3,333 10,615 5,175
---------- ---------- ---------- ----------
Net income ............................................. 9,018 6,326 14,960 9,330
Cumulative translation adjustment ................... (54) (165) 218 (133)
---------- ---------- ---------- ----------
Comprehensive income ................................... $ 8,964 $ 6,161 $ 15,178 $ 9,197
========== ========== ========== ==========
The accompanying notes are an integral part of these financial statements.
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
--------
1999 2000
---------- ----------
Cash flows from operating activities:
Net income ............................................................................ $ 14,960 $ 9,330
---------- ----------
Adjustments to reconcile net income to net cash (used in) provided
by operating activities:
Depreciation and amortization ....................................................... 1,815 2,285
Amortization of debt issuance costs ................................................. 1,596 1,553
Provision for doubtful accounts ..................................................... 278 894
Provision for losses on inventories ................................................. -- 1,268
Gains on the sale of assets ......................................................... -- (2,713)
Stock option expense ................................................................ 748 324
Equity in earnings of an affiliate .................................................. (62) (22)
Deferred tax expense (benefit) ...................................................... 176 (280)
Minority interest ................................................................... -- 92
Changes in assets and liabilities:
Accounts receivable ............................................................... (4,572) (1,508)
Inventories ....................................................................... (10,318) 3,201
Other current assets .............................................................. (1,245) 900
Other assets ...................................................................... 53 --
Accounts payable .................................................................. (4,328) (333)
Income taxes payable .............................................................. (1,277) (2,858)
Other accrued liabilities ......................................................... 780 (11,671)
---------- ----------
Total adjustments ............................................................. (16,356) (8,868)
---------- ----------
Net cash (used in) provided by operating activities ........................... (1,396) 462
---------- ----------
Cash flows from investing activities:
Purchases of property, plant, and equipment ......................................... (5,009) (26,619)
Payments received on notes receivable ............................................... 3,089 189
Purchase of property, plant, and equipment by the minority owner of Laredo Candle ... (1,229) (19)
Proceeds from the sale of property, plant, and equipment ............................ -- 5,407
Decrease in restricted cash ......................................................... -- 14,590
---------- ----------
Net cash used in investing activities ......................................... (3,149) (6,452)
---------- ----------
Cash flows from financing activities:
Proceeds from issuance of Company common stock ...................................... 100 --
Capital contribution from the minority owner of Laredo Candle ...................... 1,298 642
Payments under the Senior Credit Facility ........................................... (20,355) (12,625)
---------- ----------
Net cash used in financing activities ....................................... (18,957) (11,983)
---------- ----------
Effect of cumulative translation adjustment ........................................... 218 (133)
---------- ----------
Net decrease in cash and cash equivalents ............................................. (23,284) (18,106)
Cash and cash equivalents at beginning of year ........................................ 41,024 32,406
---------- ----------
Cash and cash equivalents at end of period ........................................... $ 17,740 $ 14,300
========== ==========
The accompanying notes are an integral part of these financial statements.
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BACKGROUND
Home Interiors & Gifts, Inc., together with its subsidiaries (the
"Company"), is a direct seller of home decorative accessories using the "party
plan" method whereby its non-employee, independent sales representatives
("Displayers") conduct shows in the homes of potential customers. The Company
believes that in-home shows provide a comfortable environment where the unique
benefits and attributes of the Company's products can be demonstrated in a more
effective manner than the typical retail setting.
The Company has been located in Dallas, Texas since its inception in
1957. The Company manufactures approximately 30% of its products and purchases
the remainder of its product line from a select group of independent suppliers,
many of whom sell their products exclusively to the Company. The Company
expanded its operations internationally in 1995.
The following is a brief description of the Company's principal
subsidiaries, each of which is wholly owned:
o Dallas Woodcraft, Inc. ("DWC") manufactures framed artwork and mirrors
using custom-designed equipment.
o GIA, Inc. ("GIA") and Homco, Inc. ("Homco") manufacture various types
of molded plastic products using custom-designed equipment. On April 3,
2000, the Company combined its two separate injection molding
facilities into a single facility at GIA in Grand Island, Nebraska.
(See Note 8.)
o Laredo Candle Company, L.L.P. ("Laredo Candle") began manufacturing
candles in late 1999. (See Note 6).
o Subsidiaries of the Company in Mexico and Puerto Rico provide sales
support services to the international Displayers.
2. SIGNIFICANT ACCOUNTING POLICIES
The Company maintains its accounting records and prepares financial
statements on the accrual basis of accounting, which conforms with generally
accepted accounting principles. Following these principles, management makes
estimates and assumptions that affect the amounts reported in the financial
statements and notes. Actual results may differ from these estimates.
These consolidated financial statements include the accounts of the
Company. All significant intercompany accounts and transactions have been
eliminated. The Company records sales and related expenses on a weekly basis
ending on each Saturday and every quarter consists of thirteen weeks. The last
days of the quarter ended June 30, 1999 and 2000 in the accompanying unaudited
consolidated financial information were July 3, 1999 and July 1, 2000.
The consolidated financial information as of June 30, 2000 and for the
three months and six months ended June 30, 1999 and 2000 is unaudited. In the
opinion of management, the accompanying unaudited consolidated financial
information and related notes thereto contain all adjustments, consisting only
of normal, recurring adjustments, necessary to present fairly the Company's
consolidated financial position as of June 30, 2000, its operating results and
comprehensive income for the three months and six months ended June 30, 1999 and
2000, and its cash flows for the six months ended June 30, 1999 and 2000.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted pursuant to the rules and regulations of the Securities and
Exchange Commission (the "SEC"). The results of operations for the periods
presented are not necessarily indicative of the results to be expected for the
full year.
These unaudited interim consolidated financial statements and notes
thereto should be read in conjunction with the Company's audited consolidated
financial statements and notes thereto included in the Company's Form 10-K for
the year ended December 31, 1999 as filed with the SEC.
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3. INVENTORIES
Inventories consisted of the following as of December 31, 1999 and June
30, 2000 (in thousands):
DECEMBER 31, JUNE 30, 2000
1999 -------------
----------- (UNAUDITED)
Raw materials .......................... $ 7,085 $ 6,638
Work in process ........................ 2,598 2,105
Finished goods ......................... 33,033 29,504
----------- -----------
$ 42,716 $ 38,247
=========== ===========
As of December 31, 1999 and June 30, 2000, raw materials include an
allowance of $593,000 and $225,000 for obsolete materials, and finished goods
include a net realizable value provision of $749,000 and $1,131,000.
4. CAPITAL LEASE OBLIGATIONS
In December 1999, the Company entered into capital leases with Bank One
Leasing for certain equipment associated with the automated order fulfillment
system located at the new warehouse and distribution facility. The lessor funded
the equipment purchase when construction of the automated order fulfillment
system was completed in April 2000. The initial term of each of the leases is
seven years. Interest is imputed at approximately 7.06% per annum. Total
estimated cost of the equipment is approximately $6.2 million. The Company also
leases certain office furniture and equipment under capital lease obligations.
Future minimum lease payments for the Company's assets held under capital lease
obligations as of June 30, 2000 are as follows (in thousands):
Years ending December 31:
------------------------
2000........................................................ $ 854
2001........................................................ 1,708
2002........................................................ 1,708
2003 ....................................................... 1,500
2004 ....................................................... 1,350
Thereafter.................................................. 3,159
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Total minimum lease obligations............................. $10,279
Less: amounts representing interest......................... (1,909)
-------
Present value of minimum lease obligations.................. $ 8,370
Less current maturities..................................... (1,218)
-------
Long-term capital lease obligations at June 30, 2000 ....... $ 7,152
=======
5. OTHER CURRENT LIABILITIES
Other current liabilities consisted of the following as of December 31,
1999 and June 30, 2000 (in thousands):
DECEMBER 31, JUNE 30, 2000
1999 -------------
----------- (UNAUDITED)
Interest payable ......................... $ 2,289 $ 2,464
Accrued compensation ..................... 2,803 3,453
Employee benefit plan contributions ...... 1,190 1,675
Sales tax payable ........................ 2,644 2,248
Other current liabilities ................ 2,392 4,128
----------- -----------
$ 11,318 $ 13,968
=========== ===========
6. LAREDO CANDLE COMPANY
On July 3, 2000, Spring Valley Scents, Inc. ("SVS"), a wholly owned
subsidiary of the Company, purchased the remaining 40% ownership interest of
Laredo Candle not owned by the Company from the minority owner for $8.7
million in cash. Of the total purchase price, $900,000 is
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held in escrow and is subject to offset if certain EBITDA performance standards
are not satisfied by Laredo Candle during the twelve months ending June 30,
2001.
7. AMENDMENT TO THE SENIOR CREDIT FACILITY
Effective July 3, 2000, the Company amended the terms of its Senior
Credit Facility primarily to authorize the purchase by SVS of the minority
owner's interest in Laredo Candle and to provide for a future increase in the
Company's Revolving Loans from $40.0 million to up to $70.0 million (with any
such increase to be effective only at the request of the Company and subject to,
among other conditions, the agreement of the requisite lenders to participate in
such increase).
8. CONSOLIDATION OF HOMCO INTO GIA
On April 1, 2000, the Company discontinued operations at Homco's
manufacturing and warehouse facility in McKinney, Texas and transferred
operations to GIA's facility in Grand Island, Nebraska. The Company estimated
that it would incur approximately $1,027,000 of non-recurring costs related to
the combination of Homco's operations into GIA and recorded a charge to
restructuring expense of this amount in its Consolidated Statement of Operations
and Comprehensive Income for the three months ended March 31, 2000. There were
no significant changes to this estimate during the three months ended June 30,
2000.
On May 15, 2000, the Company sold Homco's manufacturing and warehouse
facility to Donald J. Carter, Jr., the Company's Chairman of the Board and Chief
Executive Officer, for approximately $3.7 million. The Company used the proceeds
from the sale, together with approximately $1.7 million in proceeds from the
sale of another property, to purchase a portion of an undivided interest in the
Company's new warehouse and distribution facility. The Company expects that the
sale of these properties, in exchange for the purchase of an undivided interest
in the Company's new warehouse and distribution facility, will qualify as a
Section 1031 like-kind exchange under the Internal Revenue Code. The Company
recorded a pre-tax gain of approximately $5.4 million in the three months ended
June 30, 2000, on the sale of these properties for financial reporting purposes.
9. INTEREST RATE SWAP AGREEMENTS
In May 2000, the Company terminated the swap portion of a $75.0 million
interest rate swap and received approximately $1.0 million, which resulted in a
deferred gain of approximately $722,000 on the transaction. The gain has been
recorded as a long-term liability and will be amortized over the remaining term
of the swap as an adjustment to interest expense. The option portion of this
instrument is still outstanding and had a fair market value of $720,000 at June
30, 2000 and is included in long-term liabilities.
In addition, during the first six months of 2000, three other interest
rate swap agreements expired and the bank that was a party to such agreements
did not exercise its option to renew the agreements. There were no significant
gains or losses recorded on the expiration of these three agreements.
10. REORGANIZATION ACTIVITIES
On August 1, 2000, the Company announced its plans to relocate
approximately one-half of its headquarters employees to office space in its
consolidated distribution facility. The Company considers a portion of its
approximately $3.2 million build-out costs and its approximate $1.6 million in
annual rental costs attributable to its headquarters to be redundant as a result
of this reorganization. The Company intends to sub-lease its unoccupied office
space as soon as possible. Future charges, if any, for impairment of the
build-out costs and for rental costs in excess of rental income will be based on
the terms of sub-lease agreements.
The Company's previously announced plan to consolidate its several
distribution centers into a single facility was contingent upon timely
integration and implementation of its automated order fulfillment system. The
Company has encountered delays and problems associated with the design and
implementation of the automated order fulfillment system and the overall
productivity of the consolidated distribution facility. The Company has hired
consultants to identify and correct any system design problems and to improve
the overall productivity of the consolidated distribution facility. The Company
anticipates that it will incur additional capital expenditures to improve the
operational effectiveness of the automated order fulfillment system. The Company
continues to operate two of its older manual order fulfillment distribution
facilities. One distribution facility will remain operational until October 2000
when its manual operation will be moved into the consolidated distribution
facility. The Company has extended the lease term on the other manual
distribution facility for a period of five years, which was the minimum term
permitted by the landlord. Annual rentals on this facility are approximately
$250,000. The Company intends to sub-lease that facility once the automated
order fulfillment system and consolidated distribution facility are fully
operational. The inability to sub-lease the manual distribution facility for an
amount equal to or in excess of the remaining rents may result in a
non-recurring charge.
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As a result of these issues, the Company anticipates that it will incur
significant costs to maintain and operate duplicate distribution facilities. The
Company intends to reduce the number of SKUs it currently offers in a further
effort to improve the operational effectiveness of the consolidated distribution
facility. The Company estimates that its related costs will be between $8
million and $15 million in 2000 in connection with its reorganization and
distribution-related activities relating to staff reductions, the accelerated
liquidation of excess SKUs, the operation of multiple facilities and costs
associated with improving the operational effectiveness of the automated order
fulfillment system.
11. SEGMENT REPORTING
The Company's reportable segments are based upon functional lines of
business as follows:
o Home Interiors ("HI") - direct seller of home decorative accessories in
the United States;
o Manufacturing - manufactures framed artwork and mirrors, as well as
various types of molded plastic products and candles, for Home
Interiors; and
o International - direct seller of home decorative accessories in Mexico
and Puerto Rico.
The Company evaluates the performance of its segments and allocates
resources to them based on earnings before interest, taxes, depreciation
and amortization, less gains on the sale of assets, plus stock option
expense and restructuring expense ("EBITDA"). The accounting principles of
the segments are the same as those described in Note 2. Segment data
includes intersegment sales. Eliminations consist primarily of intersegment
sales between Manufacturing and HI, as well as the elimination of the
investment in each subsidiary for consolidated purposes. The table below
presents information used by the chief operating decision-maker about
reportable segments of the Company as of and for the three months and six
months ended June 30 1999 and 2000 (in thousands):
THREE MONTHS ENDED
JUNE 30: HI MANUFACTURING INTERNATIONAL ELIMINATIONS CONSOLIDATED
-------- --------- ------------- ------------- ------------ ------------
1999
- ----
Net sales $ 125,381 $ 22,232 $ 2,040 $ (23,419) $ 126,234
EBITDA 21,605 5,635 91 (9) 27,322
2000
- ----
Net sales $ 103,241 $ 18,997 $ 3,385 $ (20,691) $ 104,932
EBITDA 13,465 4,464 235 (11) 18,153
SIX MONTHS ENDED
JUNE 30: HI MANUFACTURING INTERNATIONAL ELIMINATIONS CONSOLIDATED
-------- --------- ------------- ------------- ------------ ------------
1999
- ----
Net sales $ 241,824 $ 47,317 $ 3,533 $ (49,692) $ 242,982
EBITDA 38,458 11,670 5 (934) 49,199
Total assets 112,342 38,146 588 (26,428) 124,648
Capital expenditures (1) 2,408 2,591 10 -- 5,009
2000
- ----
Net sales $ 223,335 $ 39,474 $ 6,223 $ (42,979) $ 226,053
EBITDA 27,411 8,219 301 301 36,232
Total assets 143,275 54,933 206 (47,632) 150,782
Capital expenditures (1) 22,244 4,362 13 -- 26,619
(1) Additional capital expenditures of $1.2 million and $19,000 were paid by
the minority owner of Laredo Candle in the six months ended June 1999 and
2000.
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The following table represents a reconciliation of consolidated EBITDA
to income before income taxes for the three months and six months ended June 30,
1999 and 2000 (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------- --------
1999 2000 1999 2000
---------- ---------- ---------- ----------
EBITDA ................................. $ 27,322 $ 18,153 $ 49,199 $ 36,232
Depreciation and amortization .......... (908) (1,309) (1,815) (2,285)
Gains on the sale of assets ............ -- 2,711 -- 2,713
Stock option expense ................... (267) (196) (748) (324)
Restructuring expense .................. -- -- -- (1,027)
Interest income ........................ 595 494 1,369 1,115
Interest expense ....................... (11,063) (11,268) (22,324) (22,399)
Other income (expense), net ............ (176) 1,074 (106) 480
---------- ---------- ---------- ----------
Income before income taxes ............. $ 15,503 $ 9,659 $ 25,575 $ 14,505
========== ========== ========== ==========
12. RECENTLY ISSUED STATEMENT OF FINANCIAL ACCOUNTING STANDARDS
In June 1999, the Financial Accounting Standards Board voted to delay
the effective date for implementation of Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities." The new standard is effective for fiscal years beginning after June
15, 2000. The Company will adopt this new standard in the first quarter of
fiscal 2001 and it has not yet determined the effect the new standard will have
on its financial statements.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the Company's consolidated financial statements and accompanying notes as
of and for the year ended December 31, 1999, included in its Form 10-K. Unless
otherwise mentioned, all references to the number of Displayers, number of
orders shipped, and average order size, relate to domestic sales activity only.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere in this report
constitute forward-looking statements. These statements involve known and
unknown risks, uncertainties and other factors that may cause the Company's
actual results to be materially different from any future results expressed or
implied by such forward-looking statements.
In some cases, forward-looking statements are identified by terminology
such as "may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of such terms
or other comparable terminology.
All of these forward-looking statements are based on estimates and
assumptions made by management of the Company which, although believed to be
reasonable, are inherently uncertain. Therefore, undue reliance should not be
placed upon such statements. No assurance can be given that any of such
estimates or statements will be realized and actual results may differ
materially from those contemplated by such forward-looking statements. Factors
that may cause such differences include: (i) loss of Displayers; (ii) loss or
retirement of key members of management; (iii) imposition of state taxes; (iv)
change in status of independent contractors; (v) increased competition; (vi) the
success of the Company's new program designed to better reward hostesses
("Hostesses") of home shows conducted by Displayers; and (vii) unexpected or
increased delays or problems associated with integration and implementation of
the Company's automated order fulfillment system and operational effectiveness
of the Company's consolidated distribution facility. Many of these factors will
be beyond the control of the Company.
Moreover, neither the Company nor any other person assumes
responsibility for the accuracy and completeness of such statements. The Company
is under no duty to update any of the forward-looking statements after the date
of this Form 10-Q to conform such statements to actual results.
COMPANY BACKGROUND
The Company believes it is the largest direct seller of home decorative
accessories in the United States, as measured by sales. The Company's sales are
dependent upon the number of Displayers selling the Company's products and their
resulting productivity. As of June 30, 2000, the Company sold its products to
approximately 60,900 active Displayers located in the United States. The Company
is also represented in Mexico and Puerto Rico. Displayer productivity fluctuates
from time to time based on length of service, training, seasonality and special
marketing programs, which offer Displayers incentives and discounts timed to
generate additional sales. The Company traditionally has offered a variety of
discounts, promotions and incentives to Displayers. The amount and timing of
discounts, promotions and incentives vary from year to year. The cost of
discounts is reflected in the Company's net sales while the cost of promotions
and incentives is reflected in selling expense.
In March 2000, the Company implemented a new Hostess program. The new
Hostess program enables Hostesses to select merchandise from the entire product
line rather than from a limited number of exclusive Hostess products offered
under the previous Hostess program. Hostesses of shows that meet certain sales
thresholds receive products with a value equal to 20% of the sales generated at
the show. The Company's product line under the previous Hostess program included
an exclusive line of non-commissionable, low-margin Hostess products. Because
the Company altered the product mix covered by the new Hostess program to
include one complete line of higher-margin, commissionable merchandise, the
Company experienced higher gross profit margins and higher selling expenses in
the three months ended June 30, 2000 as compared to the comparable period of
1999. In addition, as of March 2000, under the new Hostess program the Company
no longer sells or utilizes Hostess merits, which resulted in an increase in
general and administrative expenses due to the reduction in income from
unredeemed Hostess merits. The Company believes that, in addition to simplifying
the sales process, the new Hostess program will also benefit Displayers by
increasing the product selection for Hostesses and customers. While the Company
believes that the new Hostess program benefits Displayers, Hostesses and
customers in numerous ways, the Company also recognizes that training its
Displayers on how to most effectively market the new Hostess program is
critical. As a result, the Company devoted a substantial amount of time during
the second
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quarter of 2000 to effectively train its Displayers in the new Hostess program
and to develop improved training materials for the program.
The Company's ability to maintain its sales volume and to achieve
growth depends upon its ability to attract, train and retain a significant
number of new Displayers each year. The Company's average annual Displayer
turnover of approximately 42% during the last three fiscal years increased
significantly to approximately 90% for the twelve months ended June 30, 2000.
While this recent level of sales representative turnover is relatively common in
the direct sales industry, it is unusual for the Company. Although numerous
other general and economic factors might affect Displayer turnover, the Company
believes that new Displayers are generally among the least productive Displayers
and that the majority of Displayers who become inactive in any particular year
are Displayers recruited in that year or in the immediately preceding year. The
Company believes that the recent increase in Displayer turnover is due to the
adoption of revised recruiting and training criteria in early 1999, and, to a
lesser extent, a change in the policy in 2000 that requires a Displayer to place
an order at least once in each quarter to be considered "active." Among other
things, the Company increased its efforts to recruit new Displayers in early
1999 by reducing initial purchase requirements and time commitments and by
lowering certain other barriers to becoming a Displayer. These changes resulted
in a significant increase in the number of new Displayers, and the active
Displayer base grew from 50,100, as of December 31, 1998, to 68,300, as of
December 31, 1999. This growth resulted in a greater percentage of newer, less
experienced, and, therefore, less productive sales representation. Additionally,
in June 1999, the Company lowered its minimum order requirements, and
experienced a further decline in Displayer productivity, reflected primarily in
lower average order sizes. The Company believes that many of the new Displayers
recruited in 1999 were former Hostesses who became Displayers in order to
purchase merchandise at a discount. A majority of these personal purchases
occurred during the seasonal period in the fourth quarter of 1999. As of June
30, 2000, the active Displayer base was 60,900, which was less than the 61,400
active Displayers as of June 30, 1999.
In connection with training its Displayers on the new Hostess program,
the Company is in the process of re-establishing productivity standards and
higher expectations for its new Displayers through a more targeted training
program. While the Company intends to improve its training focus, it realizes
that training is an intensive process that may take time away from potential
sales activity. The Company believes that this factor, combined with fewer and
less productive Displayers than the prior year, will result in lower sales
during the remainder of 2000 as compared to the comparable period in 1999.
REORGANIZATION ACTIVITIES
On August 1, 2000, the Company announced its plans to relocate
approximately one-half of its headquarters employees to office space in its
consolidated distribution facility. The Company considers a portion of its
approximately $3.2 million build-out costs and its approximate $1.6 million in
annual rental costs attributable to its headquarters to be redundant as a result
of this reorganization. The Company intends to sub-lease its unoccupied office
space as soon as possible. Future charges, if any, for impairment of the
build-out costs and for rental costs in excess of rental income will be based on
the terms of sub-lease agreements.
The Company's previously announced plan to consolidate its several
distribution centers into a single facility was contingent upon timely
integration and implementation of its automated order fulfillment system. The
Company has encountered delays and problems associated with the design and
implementation of the automated order fulfillment system and the overall
productivity of the consolidated distribution facility. The Company has hired
consultants to identify and correct any system design problems and to improve
the overall productivity of the consolidated distribution facility. The Company
anticipates that it will incur additional capital expenditures to improve the
operational effectiveness of the automated order fulfillment system. The Company
continues to operate two of its older manual order fulfillment distribution
facilities. One distribution facility will remain operational until October 2000
when its manual operation will be moved into the consolidated distribution
facility. The Company has extended the lease term on the other manual
distribution facility for a period of five years, which was the minimum term
permitted by the landlord. Annual rentals on this facility are approximately
$250,000. The Company intends to sub-lease that facility once the automated
order fulfillment system and consolidated distribution facility are fully
operational. The inability to sub-lease the manual distribution facility for an
amount equal to or in excess of the remaining rents may result in a
non-recurring charge.
As a result of these issues, the Company anticipates that it will incur
significant costs to maintain and operate duplicate distribution facilities. The
Company intends to reduce the number of skills it currently offers in a further
effort to improve the operational effectiveness of the consolidated distribution
facility. The Company estimates that its related costs will be between $8
million and $15 million in 2000 in connection with its reorganization and
distribution-related activities relating to staff reductions, the accelerated
liquidation of excess SKUs, the operation of multiple facilities and costs
associated with improving the operational effectiveness of the automated order
fulfillment system.
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RESULTS OF OPERATIONS
The Three Months Ended June 30, 2000 Compared to the Three Months Ended
June 30, 1999
Net sales. Net sales decreased $21.3 million, or 16.9%, to $104.9
million in the three months ended June 30, 2000 from $126.2 million in the
comparable period in 1999. Although the average number of active Displayers
increased 11.2% to 62,800 in the three months ended June 30, 2000 from 56,500 in
the comparable period in 1999, the number of active Displayers declined 5.9%
from 64,700 at March 31, 2000 to 60,900 at June 30, 2000. Orders per Displayer
dropped 25.0% from 4.4 in the 1999 period to 3.3 in the 2000 period, which
resulted in a decrease in the number of orders shipped, down 15.8% to 206,919
orders in the three months ended June 30, 2000 from 245,877 orders shipped in
the comparable period in 1999. Additionally, the average order size declined
2.8% to $491 in the three months ended June 30, 2000 from $505 in the comparable
period in 1999.
The Company believes that Displayer productivity in the three months
ended June 30, 2000 was impacted by a change in the Company's incentive-driven
sales strategy. Although the Company believes that its Displayers depend upon a
certain level of discounts, promotions and incentives, the Company provided no
significant discounts, promotions or incentives during the three months ended
June 30, 2000, primarily in an effort to emphasize the new Hostess program. The
Company devoted a substantial amount of time during the second quarter of 2000
to effectively train its Displayers in the new Hostess program and to develop
improved training materials for the program. Focused training will continue
through the remainder of 2000. Additionally, the Company intends to return to
more of an incentive-driven sales strategy in order to improve Displayer
productivity.
Displayer productivity was also impacted by a significant decline in
the historical merchandise fulfillment rate during the three months ended June
30, 2000. The Company believes many factors have contributed to the increase in
the percentage of items within each order that are not shipped to the Displayer.
These factors include, but are not limited to, an increase in the number of
product SKUs to a level that exceeds the capacity of the Company's distribution
facilities; an increased reliance on products manufactured overseas that require
longer lead times than products manufactured by domestic suppliers; the use of
less efficient temporary laborers in the distribution centers due to the
problems experienced in the consolidated distribution facility; and the
inability of certain domestic suppliers to deliver sufficient products in a
timely manner primarily as a result of their working capital constraints.
Gross profit. Gross profit decreased $10.1 million to $55.9 million in
the three months ended June 30, 2000 from $66.0 million in the comparable period
in 1999. As a percentage of net sales, gross profit increased to 53.3% in the
2000 period from 52.2% in the 1999 period. The increase in gross profit
percentage was primarily due to the change to the new Hostess program that
altered the product mix to more high-margin products and significantly fewer
discounts in the 2000 period as a result of less reliance on an incentive-driven
sales strategy during that period, partially offset by an increase in the
provision for obsolete inventory of $1.1 million.
Selling expense. Selling expense decreased $2.6 million, or 12.7%, to
$18.0 million in the three months ended June 30, 2000 from $20.6 million in the
comparable period in 1999. As a percentage of net sales, selling expense
increased to 17.2% in the 2000 period from 16.4% in the 1999 period. This
increase was primarily attributable to the higher effective commission rates,
which began to increase in March 2000 in connection with the implementation of
the new Hostess program when substantially all products were made
commissionable.
Freight, warehouse and distribution expense. Freight, warehouse and
distribution expense increased $0.3 million, or 2.4%, to $12.8 million in the
three months ended June 30, 2000 from $12.5 million in the comparable period in
1999. These costs were 12.2% of net sales in the 2000 period compared to 9.9% in
the 1999 period. This increase was primarily due to duplicate facility costs,
the use of less efficient temporary labor to operate duplicate facilities, and
an increase in the percentage of heavier items shipped in the 2000 period. In
addition, certain of the Company's freight expenses are fixed, and do not
decrease as a result of reduced shipments. The Company expects that the trend of
higher operating costs as a percentage of net sales will continue throughout
2000.
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General and administrative expense. General and administrative expense
increased $1.9 million, or 29.3%, to $8.3 million in the three months ended June
30, 2000 from $6.4 million in the comparable period in 1999. This increase was
due primarily to credit card fees in connection with the Company's
internet-based order entry system, Home Online, increased depreciation and
amortization expense as a result of a higher level of capital expenditures, a
reduction in income from unredeemed Hostess merits, rent for the Company's new
corporate headquarters which began in January 2000, and an increase in the
allowance for doubtful accounts.
Other income (expense). Other income (expense) included an adjustment
to income in the three months ended June 30, 2000 of approximately $945,000 to
adjust to fair market value the option provisions of the Company's interest rate
swap agreements.
Income taxes. Income taxes decreased $3.2 million, or 48.6%, to $3.3
million in the three months ended June 30, 2000 from $6.5 million in the
comparable period in 1999. Income taxes, as a percentage of income before income
taxes, decreased to 34.5% in the 2000 period from 41.8% in the 1999 period. The
effective income tax rate for the 2000 period was impacted by the sale of
certain assets and the disposition of obsolete inventory.
The Six Months Ended June 30, 2000 Compared to the Six Months Ended
June 30, 1999
Net sales. Net sales decreased $16.9 million, or 7.0%, to $226.1
million in the six months ended June 30, 2000 from $243.0 million in the
comparable period in 1999. Although the average number of active Displayers
increased 18.9% to 64,700 in the six months ended June 30, 2000 from 54,400 in
the comparable period in 1999, this growth has resulted in an increased
percentage of less experienced and, therefore, less productive Displayers.
Orders per Displayer dropped 19.5% from 8.2 in the 1999 period to 6.6 in the
2000 period, which resulted in a decrease in the number of orders shipped, down
5.3% to 424,056 orders in the six months ended June 30, 2000 from 447,752 orders
shipped in the comparable period in 1999. This decline was coupled with a 3.2%
reduction in the average order size to $518 in the six months ended June 30,
2000 from $535 in the comparable period in 1999. As previously discussed,
Displayer productivity was impacted by fewer discounts, promotions and
incentives and the decline in the merchandise fulfillment rate in the second
quarter of 2000.
Gross profit. Gross profit decreased $9.6 million to $116.4 million in
the six months ended June 30, 2000 from $126.0 million in the comparable period
in 1999. As a percentage of net sales, gross profit decreased to 51.5% in the
2000 period from 51.9% in the 1999 period. While the Company's gross profit
margins have improved as a result of the introduction of new products with
higher margins in conjunction with the new Hostess program in March 2000 and
fewer discounts, primarily in the second quarter of 2000, manufacturing
inefficiencies experienced in the latter half of 1999 continued through the
first quarter of 2000. Although the Company consolidated its Homco operations
with its GIA operations to increase operational efficiency and to absorb
underutilized capacity that existed in its molded plastic manufacturing
operations, the Company believes that manufacturing-related margin deterioration
will continue so long as the Company experiences volume declines. Additionally,
gross profit was also negatively impacted in the 2000 period by an increase in
the provision for obsolete inventory of $1.3 million.
Selling expense. Selling expense decreased $3.7 million, or 8.6%, to
$38.7 million in the six months ended June 30, 2000 from $42.4 million in the
comparable period in 1999. As a percentage of net sales, selling expense
decreased slightly to 17.1% in the 2000 period from 17.4% in the 1999 period.
This decrease was a combination of lower reimbursed selling expenses, reduced
incentive costs and lower bonus accrual for sales directors as a result of the
new Hostess program, offset by higher effective commission rates, which began to
increase in March 2000 in connection with the new Hostess program when
substantially all products were made commissionable.
Freight, warehouse and distribution expense. Freight, warehouse and
distribution expense increased $1.9 million, or 7.8%, to $25.5 million in the
six months ended June 30, 2000 from $23.6 million in the comparable period in
1999. These costs were 11.3% of net sales in the 2000 period compared to 9.7% in
the 1999 period. This increase was primarily due to duplicate facility costs,
the use of less efficient temporary labor to operate duplicate facilities, and
an increase in the percentage of heavier products shipped in the 2000 period as
previously discussed.
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General and administrative expense. General and administrative expense
increased $5.7 million, or 45.1%, to $18.3 million in the six months ended June
30, 2000 from $12.6 million in the comparable period in 1999. This increase was
primarily due to increased personnel and consulting fees, payment of credit card
fees in connection with Home Online orders, increased depreciation and
amortization expense, a reduction in income from unredeemed Hostess merits, an
increase in the provision for doubtful accounts, and rent for the Company's new
corporate headquarters, which began in January 2000. Expanded utilization of the
Company's computer systems required the Company to hire additional employees
with specialized skills, which contributed to higher personnel costs and higher
consulting fees.
Restructuring expenses. Restructuring expenses consisted of
non-recurring costs related to the combination of Homco operations into GIA in
the six months ended June 30, 2000.
Other income (expense). Other income (expense) included an adjustment
to income in the six months ended June 30, 2000 of approximately $520,000 to
adjust to fair market value the option provisions of the Company's interest rate
swap agreements.
Income taxes. Income taxes decreased $5.4 million, or 51.2%, to $5.2
million in the six months ended June 30, 2000 from $10.6 million in the
comparable period in 1999. Income taxes, as a percentage of income before income
taxes, decreased to 35.7% in the 2000 period from 41.5% in the 1999 period. The
effective income tax rate for the 2000 period was impacted by the sale of
certain assets and the disposition of obsolete inventory. The Company believes
that the effective income tax rate in the 2000 period will be consistent with
its effective income tax rate for the year ended December 31, 2000.
SEGMENT PROFITABILITY
The Company's reportable segments include its domestic direct sales
business, its manufacturing operations and its international business. The
manufacturing operations sell substantially all of their products to the
Company. As a result, manufacturing sales generally follow the Company's
domestic sales trend. International operations include direct sales by
Displayers in Mexico and Puerto Rico. International sales are directly
attributable to the number of international Displayers the Company has selling
its products. The Company's chief operating decision-maker monitors each
segment's profitability primarily on the basis of EBITDA performance. See Note
11 to Unaudited Interim Consolidated Financial Statements.
The Three Months Ended June 30, 2000 Compared to the Three Months Ended
June 30, 1999
Consolidated net sales decreased $21.3 million, or 16.9%, to $104.9
million in the three months ended June 30, 2000 from $126.2 million in the
comparable period of 1999 due to the $22.2 million decrease in the Company's
domestic direct sales as previously discussed. International sales increased
$1.4 million, or 65.9%, to $3.4 million in the three months ended June 30, 2000
from $2.0 million in the comparable period of 1999 primarily due to expansion of
the international Displayer network. Manufacturing related sales in the three
months ended June 30, 2000 decreased $3.2 million, or 14.6%, to $19.0 million in
the three months ended June 30, 2000 from $22.2 million in the comparable period
of 1999 primarily due to overall volume declines in wood-framed prints and
plastic products in the Company's domestic direct sales business.
Consolidated EBITDA decreased $9.1 million, or 33.6%, to $18.2 million
in the three months ended June 30, 2000 from $27.3 million in the comparable
period of 1999 primarily due to lower sales volumes in the Company's domestic
direct sales business coupled with higher general and administrative and
freight, warehouse and distribution costs. Manufacturing related EBITDA
decreased $1.1 million, or 20.8%, to $4.5 million in 2000 from $5.6 million in
1999 primarily due to lower production volumes. International EBITDA improved,
but was not significant to consolidated EBITDA.
The Six Months Ended June 30, 2000 Compared to the Six Months Ended
June 30, 1999
Consolidated net sales decreased $16.9 million, or 7.0%, to $226.1
million in the six months ended June 30, 2000 from $243.0 million in the
comparable period of 1999 due to the $18.5 million decrease in the Company's
domestic direct sales as previously discussed. International sales increased
$2.7 million, or 76.1%, to $6.2 million in the six months ended June 30, 2000
from $3.5 million in the comparable period of 1999 primarily due to expansion of
the international Displayer network. Manufacturing related sales in the six
months ended June 30, 2000 decreased $7.8 million, or 16.6%, to $39.5 million in
the six months ended June 30, 2000 from $47.3 million in the comparable period
of 1999 primarily due to volume declines in wood-framed prints and plastic
products in the Company's domestic direct sales business.
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Consolidated EBITDA decreased $13.0 million, or 26.4%, to $36.2 million
in the six months ended June 30, 2000 from $49.2 million in the comparable
period of 1999 primarily due to business sales volumes in the Company's domestic
direct sales business, manufacturing inefficiencies in the 2000 period and
higher general and administrative and freight, warehouse and distribution costs
in the 2000 period. Manufacturing related EBITDA decreased $3.5 million, or
29.6%, to $8.2 million in 2000 from $11.7 million in 1999 primarily due to lower
production volumes. International EBITDA improved, but was not significant to
consolidated EBITDA.
SEASONALITY
The Company's business is influenced by the Christmas holiday season
and by promotional events. Historically, a higher portion of the Company's sales
and net income have been realized during the fourth quarter, and net sales and
net income have generally been slightly lower during the first quarter as
compared to the second and third quarters. Working capital requirements also
fluctuate during the year. They reach their highest levels during the third and
fourth quarters as the Company increases its inventory for the peak season. In
addition to the Company's peak season fluctuations, quarterly results of
operations may fluctuate depending on the timing of, and amount of sales from,
discounts, promotions and incentives and/or the introduction of new products. As
a result, the Company's business activities and results of operations in any
quarter are not necessarily indicative of any future trends in the Company's
business.
LIQUIDITY AND CAPITAL RESOURCES
The Company has satisfied its historical requirements for capital
through cash flow from operations. As a result of the borrowings under the
Senior Credit Facility and the issuance of the Notes, the Company is subject to
cash requirements, which are significantly greater than its historical
requirements. Net cash provided by operating activities increased $1.9 million
to $0.5 million in the six months ended June 30, 2000, from a $1.4 million use
of cash in the comparable period in 1999. A decrease in inventory in the 2000
period contributed to an increase in cash of $3.2 million as compared to a $10.3
million use of cash in the 1999 period. In connection with the implementation of
the new Hostess program in March 2000, the Company announced that it would no
longer sell Hostess merits. As a result, the Company experienced significant
redemptions of Hostess merit certificates and other incentive coupons in the
2000 period. The increased redemption rate of Hostess merit certificates for
merchandise resulted in a $6.2 million decrease in cash in the 2000 period.
Additionally, a higher redemption rate of incentive coupons for cash immediately
prior to the implementation of the new Hostess program contributed to the net
decrease in cash of $2.1 million in the 2000 period as compared to a net
increase in cash of $3.5 million in the 1999 period related to such incentive
coupons.
Investing activities during the six months ended June 30, 2000 resulted
in a net cash outflow of $6.5 million. Capital expenditures increased
significantly from $5.0 million in the 1999 period to $26.6 million in the 2000
period. The Company purchased the consolidated distribution facility for
approximately $21.4 million and incurred approximately $1.2 million in
improvements to construct office space in the facility. Proceeds of $14.6
million from the sale of properties and facilities in December 1999 and proceeds
of $5.4 million from the sale of the Homco facility and another facility were
used to pay for substantially all of the costs associated with the consolidated
distribution facility. The remaining $4.0 million in capital expenditures in the
2000 period primarily related to costs associated with the automated order
fulfillment system in the consolidated distribution facility and upgrades for
the Company's new computer system and internet capabilities.
The Company has contracted with Vectrix.com, an e-commerce consulting
firm, to assist the Company in enhancing its Internet capabilities, including
improvements to the Home Online order entry system for Displayers. The Company
plans to complete the initial phase of its e-commerce strategy with Vectrix.com
during the fourth quarter of 2000, which consists primarily of upgrades and
enhancements to its current business-to-business application at an additional
cost of approximately $3.0 million.
In December 1999, the Company entered into capital leases with Bank One
for certain equipment associated with the automated order fulfillment system
located at the new warehouse and distribution facility. The lessor funded the
equipment purchase when construction of the automated order fulfillment system
was completed in April 2000. The total estimated cost of the equipment under
capital lease obligations is approximately $6.2 million. The Company originally
anticipated the automated order fulfillment system would cost approximately
$11.0 million. Approximately $1.2 million in costs were incurred in 1999 and the
remaining $9.8 million were incurred in the six months ended June 30, 2000,
consisting of capital expenditures and the foregoing capital leases. The Company
has hired consultants to help improve the operational effectiveness of the
system. The Company anticipates that it will incur additional capital
expenditures to improve the operational effectiveness of the automated order
fulfillment system.
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On July 3, 2000, SVS purchased the remaining 40% ownership interest in
Laredo Candle not owned by the Company from the minority owner for $8.7 million.
Of the total purchase price, $900,000 is held in escrow and is subject to offset
if certain EBITDA performance standards are not satisfied by Laredo Candle
during the twelve months ending June 30, 2001.
Payments on the Notes and the Senior Credit Facility represent
significant cash requirements for the Company. Interest payments on the Notes
commenced in December 1998, and are due semi-annually until the Notes mature in
2008. Borrowings under the Senior Credit Facility require quarterly interest and
principal payments. In addition, the Senior Credit Facility currently includes
$40.0 million of Revolving Loans (and, as amended, provides for a future
increase up to $70.0 million subject to certain conditions), which mature on
June 30, 2004.
The Company paid a total of $33.1 million in debt service for the six
months ended June 30, 2000, consisting of principal payments under the Senior
Credit Facility of $12.4 million, interest of approximately $10.6 million under
the Senior Credit Facility and interest of approximately $10.1 million under the
Notes.
The terms of the Notes and Senior Credit Facility include significant
operating and financial restrictions, such as limits on the Company's ability to
incur indebtedness, create liens, sell assets, engage in mergers or
consolidations, make investments and pay dividends. In addition, under the
Senior Credit Facility, the Company is required to comply with specified
financial ratios and tests, including minimum interest coverage and maximum
leverage ratios. Subject to the financial ratios and tests, the Company will be
required to make certain mandatory prepayments of the term loans on an annual
basis. The Company was not required to make a mandatory prepayment on March 31,
2000. The Revolving Loans remained undrawn as of June 30, 2000. However, as a
result of the timing and the magnitude of working capital requirements and
capital expenditures, the Company may have to utilize the Revolving Loans at
varying times during 2000, primarily to meet working capital needs and to make
capital expenditures.
AMENDMENT TO THE SENIOR CREDIT FACILITY
Effective July 3, 2000, the Company amended the terms of its Senior
Credit Facility primarily to authorize SVS' purchase of the minority owner's
interest in Laredo Candle and to provide for a future increase in the Company's
Revolving Loans from $40.0 million to up to $70.0 million (with any such
increase to be effective only at the request of the Company and subject to,
among other conditions, the agreement of the requisite lenders to participate in
such increase).
MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
The Company is exposed to financial market risks, including changes in
interest rates and foreign currency exchange rates. To mitigate risks on changes
in interest rates, the Company uses derivative financial instruments. The
Company does not use derivative financial instruments for speculative or trading
purposes. The Company's international operations are not significant, and as a
result, changes in foreign currency exchange rates do not have a material effect
on the Company.
In May 2000, the Company terminated the swap portion of the $75.0
million interest rate swap and received approximately $1.0 million, which
resulted in a deferred gain of approximately $722,000 on the transaction. The
gain has been recorded as a long-term liability and will be amortized over the
remaining term of the swap as an adjustment to interest expense. The option
portion of this instrument is still outstanding and had a fair market value of
$720,000 at June 30, 2000 and is included in long-term liabilities.
In addition, during the first six months of 2000, three other interest
rate swap agreements expired and the bank that was a party to such agreements
did not exercise its option to renew the agreements. There were no significant
gains or losses recorded on these expiration of these three agreements.
ENVIRONMENTAL ISSUES
In 1989, DWC was named as a potentially responsible party ("PRP") based
on allegedly having sent 2,640 gallons of waste to the Chemical Recycling, Inc.
facility in Wylie, Texas. The Company believes that DWC's share of the total
cleanup costs based on a volumetric allocation would be less than one percent.
In the future, DWC and the other PRPs, who are jointly and severally liable, may
incur additional costs related to the cleanup of hazardous substances at the
facility. DWC has not incurred any significant cleanup related costs. Because
the site has been
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dormant for several years, the Company does not believe it is probable that any
additional costs will be incurred and, accordingly, has not established any
accruals for future cleanup costs at the site.
In 1997, Homco was named as a PRP based on allegedly having transported
hazardous substances to the Materials Recovery Enterprises, Inc. facility near
Ovalo, Texas in Taylor County, Texas. In 1998, Homco paid an insignificant
assessment for liability at the facility. By agreement, Kraft Foods, Inc., a
partial indemnitor to Homco, paid Homco 96.5% of this past assessment; assumed
the future administration of the matter, including payment of future costs; and
may, upon demand, request reimbursement from Homco for 3.5% of future costs.
Although Homco remains jointly and severally liable for the remediation of the
site, the Company believes that the probability that Homco will be required to
pay more than a de minimis amount is remote.
The ultimate outcome and aggregate cost of resolving all of the above
contingencies will be based on a number of factors and will be determined over a
number of years. Accordingly, the total cost to the Company cannot currently be
determined with certainty. It is management's opinion, however, that the total
cost of resolving such contingencies should not have a material adverse effect
on the Company's business, financial condition and results of operations.
RECENTLY ISSUED STATEMENT OF FINANCIAL ACCOUNTING STANDARDS
In June 1999, the Financial Accounting Standards Board voted to delay
the effective date for implementation of Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities." The new standard is effective for fiscal years beginning after June
15, 2000. The Company will adopt this new standard in the first quarter of
fiscal 2001 and it has not yet determined the effect the new standard will have
on its financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Securities and Exchange Commission requires that registrants
include information about potential effects of changes in interest rates and
currency exchange in their financial statements. Refer to information appearing
under the subheading "Market-Sensitive Instruments and Risk Management" under
"Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations," which information is hereby incorporated by reference into this
Item 3. All statements other than historical information incorporated into this
Item 3 are forward-looking statements. The actual impact of future market
changes could differ materially due to, among other things, the factors
discussed in this report.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Environmental Issues" for information regarding legal
proceedings which is incorporated herein by reference.
ITEM 5. OTHER INFORMATION
On May 24, 2000, the Company entered into an employment agreement with
Michael D. Lohner to serve as its Senior Vice President and Chief Operating
Officer. The initial term of the employment agreement is for one year and may be
extended for successive one year periods.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit Number Description
10.1 Fourth Amendment to Credit Agreement
dated as of July 26, 2000, but
effective as of July 3, 2000, among
Home Interiors & Gifts, Inc., the
various Lenders that are parties
thereto, The Chase Manhattan Bank, as
syndication agent, National Westminster
Bank, PLC, as documentation agent, The
Prudential Insurance Company of
America, Societe Generale, and Citicorp
USA, Inc., as co-agents, and Bank of
America, N.A., as administrative agent
10.2 Purchase and Sale Agreement for 1400
Lavon Street, McKinney, Texas, entered
into as of May 15, 2000 between Homco,
Inc. and Donald J. Carter, Jr.
10.3 Assignment and Assumption of Purchase
and Sale Agreement dated as of May 12,
2000 between Donald J. Carter Jr. and
1400 Lavon, L.P.
10.4 Partnership Interests Purchase
Agreement dated as of July 3, 2000 by
and between Miracle Candle Company and
Spring Valley Scents, Inc.
10.5 Employment Agreement with Michael D.
Lohner, dated May 24, 2000
10.6 First Supplemental Indenture dated as
of July 3, 2000 among Home Interiors &
Gifts, Inc., Laredo Candle Company,
L.P. and United States Trust Company
of New York
10.7 Vectrix Customer Agreement dated July
21, 2000 executed by Vectrix
Corporation and Home Interiors & Gifts,
Inc.
10.8 Industrial Lease dated August 10, 2000
between Parker Metropolitan, L.P. and
Home Interiors & Gifts, Inc. (for
building and facilities located in
Coppell, Texas)
10.9 Master Lease Agreement dated as of
December 30, 1999 between Banc One
Leasing Corporation and Home Interiors
& Gifts, Inc.
(b) Reports on Form 8-K
None.
19
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
HOME INTERIORS & GIFTS, INC.
By: /s/ KENNETH J. CICHOCKI
- ----------------------------
Kenneth J. Cichocki
Vice President of Finance and Chief Financial Officer
(principal financial and accounting officer)
Date: August 14, 2000
21
INDEX TO EXHIBITS
Exhibit
Number Description
------- -----------
10.1 Fourth Amendment to Credit Agreement dated as of July
26, 2000, but effective as of July 3, 2000, among
Home Interiors & Gifts, Inc., the various Lenders
that are parties thereto, The Chase Manhattan Bank,
as syndication agent, National Westminster Bank, PLC,
as documentation agent, The Prudential Insurance
Company of America, Societe Generale, and Citicorp
USA, Inc., as co-agents, and Bank of America, N.A.,
as administrative agent
10.2 Purchase and Sale Agreement for 1400 Lavon Street,
McKinney, Texas, entered into as of May 15, 2000
between Homco, Inc. and Donald J. Carter, Jr.
10.3 Assignment and Assumption of Purchase and Sale
Agreement dated as of May 12, 2000 between Donald J.
Carter Jr. and 1400 Lavon, L.P.
10.4 Partnership Interests Purchase Agreement dated as of
July 3, 2000 by and between Miracle Candle Company
and Spring Valley Scents, Inc.
10.5 Employment Agreement with Michael D. Lohner, dated
May 24, 2000
10.6 First Supplemental Indenture dated as of July 3, 2000
among Home Interiors & Gifts, Inc., Laredo Candle
Company, L.P. and United States Trust Company of
New York
10.7 Vectrix Customer Agreement dated July 21, 2000
executed by Vectrix Corporation and Home Interiors &
Gifts, Inc.
10.8 Industrial Lease dated August 10, 2000 between Parker
Metropolitan, L.P. and Home Interiors & Gifts, Inc.
(for building and facilities located in Coppell,
Texas)
10.9 Master Lease Agreement dated as of December 30, 1999
between Banc One Leasing Corporation and Home
Interiors & Gifts, Inc.