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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 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 700
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 November 6, 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
September 30, 2000............................................................... 3
Consolidated Statements of Operations and Comprehensive Income
for the three months and nine months ended September 30, 1999 and 2000........... 4
Consolidated Statements of Cash Flows for the nine months ended
September 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.................................................. 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk................... 20
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................................ 21
Item 6. Exhibits and Reports on Form 8-K............................................. 21
2
3
ITEM 1. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND SEPTEMBER 30, 2000
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
ASSETS
DECEMBER 31, SEPTEMBER 30,
1999 2000
------------ -------------
(UNAUDITED)
Current assets:
Cash and cash equivalents ....................................................... $ 32,406 $ 7,499
Accounts receivable, net ........................................................ 13,885 13,619
Inventories ..................................................................... 42,716 40,158
Deferred income tax benefit ..................................................... 3,922 3,695
Other current assets ............................................................ 4,736 2,726
------------ -------------
Total current assets .................................................... 97,665 67,697
Property, plant and equipment, net ................................................ 30,473 58,790
Restricted cash ................................................................... 14,590 900
Investments ....................................................................... 1,668 1,703
Debt issuance costs, net .......................................................... 15,881 13,859
Other assets ...................................................................... 1,264 5,111
------------ -------------
Total assets ............................................................ $ 161,541 $ 148,060
============ =============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable ................................................................ $ 20,986 $ 21,203
Accrued seminars and incentive awards ........................................... 14,146 11,790
Royalties payable ............................................................... 9,771 4,553
Hostess prepayments ............................................................. 8,687 1,284
Income taxes payable ............................................................ 2,858 1,434
Current maturities of long-term debt and capital lease obligations .............. 27,308 32,201
Other current liabilities ....................................................... 11,318 18,054
------------ -------------
Total current liabilities ............................................... 95,074 90,519
Long-term debt and capital lease obligations, net of current maturities ........... 428,238 410,870
Other liabilities ................................................................. 6,443 6,247
------------ -------------
Total liabilities ....................................................... 529,755 507,636
------------ -------------
Minority interest ................................................................. 2,972 --
Commitments and contingencies
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 ..................................................... 179,975 179,713
Accumulated deficit ............................................................ (552,726) (540,805)
Other .......................................................................... 41 (8)
------------ -------------
Total shareholders' deficit ............................................. (371,186) (359,576)
------------ -------------
Total liabilities and shareholders' deficit ............................. $ 161,541 $ 148,060
============ =============
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 NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 2000
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
1999 2000 1999 2000
---------- ---------- ---------- ----------
Net sales ................................................ $ 112,075 $ 96,970 $ 355,057 $ 323,023
Cost of goods sold ....................................... 55,208 43,672 172,199 153,312
---------- ---------- ---------- ----------
Gross profit ............................................. 56,867 53,298 182,858 169,711
Selling, general and administrative:
Selling ................................................ 20,594 17,151 62,955 55,856
Freight, warehouse and distribution .................... 11,785 10,226 35,419 35,123
General and administrative ............................. 6,309 8,182 18,921 26,476
Gains on the sale of assets ............................ (3) (22) (3) (2,735)
Stock option expense (credit) .......................... 102 (587) 850 (263)
Homco restructuring .................................... -- -- -- 1,027
Redundant warehouse and distribution ................... -- 2,033 -- 2,603
---------- ---------- ---------- ----------
Total selling, general and administrative ...... 38,787 36,983 118,142 118,087
---------- ---------- ---------- ----------
Operating income ......................................... 18,080 16,315 64,716 51,624
Other income (expense):
Interest income ........................................ 455 286 1,824 1,401
Interest expense ....................................... (11,018) (11,816) (33,342) (34,215)
Other income, net ...................................... 419 83 313 563
---------- ---------- ---------- ----------
Other income (expense), net .................... (10,144) (11,447) (31,205) (32,251)
---------- ---------- ---------- ----------
Income before income taxes ............................... 7,936 4,868 33,511 19,373
Income taxes ............................................. 888 2,277 11,503 7,452
---------- ---------- ---------- ----------
Net income ............................................... 7,048 2,591 22,008 11,921
Cumulative translation adjustment ..................... 76 85 294 (48)
---------- ---------- ---------- ----------
Comprehensive income ..................................... $ 7,124 $ 2,676 $ 22,302 $ 11,873
========== ========== ========== ==========
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 NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 2000
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
1999 2000
---------- ----------
Cash flows from operating activities:
Net income ............................................................................ $ 22,008 $ 11,921
Adjustments to reconcile net income to net cash provided by (used in) operating
activities:
Depreciation and amortization ....................................................... 2,883 5,498
Amortization of debt issuance costs ................................................. 2,427 2,342
Provision for doubtful accounts ..................................................... 635 942
Provision for losses on inventories ................................................. -- 1,091
Gains on the sale of assets ......................................................... (3) (2,735)
Stock option expense (credit) ....................................................... 850 (263)
Equity in earnings of an affiliate .................................................. (138) (35)
Deferred tax expense (benefit) ...................................................... (150) 227
Minority interest ................................................................... -- 92
Changes in assets and liabilities:
Accounts receivable ............................................................... (6,946) (487)
Inventories ....................................................................... (11,641) 1,467
Other current assets .............................................................. (1,477) 1,950
Other assets ...................................................................... 359 --
Accounts payable .................................................................. (2,578) 217
Income taxes payable .............................................................. (3,046) (1,424)
Other accrued liabilities ......................................................... 8,165 (7,734)
---------- ----------
Total adjustments ............................................................. (10,660) 1,148
---------- ----------
Net cash provided by operating activities ..................................... 11,348 13,069
---------- ----------
Cash flows from investing activities:
Purchases of property, plant, and equipment ......................................... (10,569) (29,503)
Payments received on notes receivable ............................................... 6,131 11
Purchase of minority ownership of Laredo Candle ..................................... -- (7,800)
Proceeds from the sale of property, plant, and equipment ............................ -- 5,407
Decrease in restricted cash ......................................................... -- 13,690
---------- ----------
Net cash used in investing activities ......................................... (4,438) (18,195)
---------- ----------
Cash flows from financing activities:
Proceeds from issuance of Company common stock ...................................... 120 --
Capital contribution from the minority owner of Laredo Candle ....................... 2,301 642
Proceeds from borrowings under Revolving Loan ....................................... -- 20,000
Payments under Revolving Loan ....................................................... -- (20,000)
Payments under capital lease obligations ............................................ -- (295)
Payments under the Senior Credit Facility ........................................... (26,525) (19,760)
Debt issuance costs ................................................................. -- (320)
---------- ----------
Net cash used in financing activities .......................................... (24,104) (19,733)
---------- ----------
Effect of cumulative translation adjustment ........................................... 294 (48)
---------- ----------
Net decrease in cash and cash equivalents ............................................. (16,900) (24,907)
Cash and cash equivalents at beginning of year ........................................ 41,024 32,406
---------- ----------
Cash and cash equivalents at end of period ........................................... $ 24,124 $ 7,499
========== ==========
Supplemental schedule of non-cash investing activities:
Capital lease obligations incurred for the purchase of new equipment ................ $ -- $ 7,579
========== ==========
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 6.)
o Laredo Candle Company, L.L.P. ("Laredo Candle") began manufacturing
candles in late 1999. (See Note 5).
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 September 30, 1999 and 2000 in the accompanying
unaudited consolidated financial information were October 2, 1999 and September
30, 2000, respectively.
The consolidated financial information as of September 30, 2000 and for
the three months and nine months ended September 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 September 30, 2000, its operating results
and comprehensive income for the three months and nine months ended September
30, 1999 and 2000, and its cash flows for the nine months ended September 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.
6
7
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.
Certain reclassifications have been made to prior period's balances to
conform with current year presentation.
3. INVENTORIES
Inventories consisted of the following as of December 31, 1999 and
September 30, 2000 (in thousands):
DECEMBER 31, SEPTEMBER 30,
1999 2000
-------- --------
(UNAUDITED)
Raw materials ................. $ 7,085 $ 7,593
Work in process ............... 2,598 1,845
Finished goods ................ 33,033 30,720
-------- --------
$ 42,716 $ 40,158
======== ========
As of December 31, 1999 and September 30, 2000 raw materials includes
an allowance of $593,000 and $212,000, respectively, for obsolete materials, and
finished goods includes a net realizable value provision of $749,000 and
$949,000, respectively.
4. OTHER CURRENT LIABILITIES
Other current liabilities consisted of the following as of December 31,
1999 and September 30, 2000 (in thousands):
DECEMBER 31, SEPTEMBER 30,
1999 2000
-------- --------
(UNAUDITED)
Interest payable ...................... $ 2,289 $ 7,634
Accrued compensation................... 2,803 3,161
Employee benefit plan contributions.... 1,190 197
Sales tax payable...................... 2,644 3,157
Other current liabilities.............. 2,392 3,905
-------- --------
$ 11,318 $ 18,054
======== ========
5. 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 held in escrow, and has been
recorded as restricted cash, and is subject to offset if certain performance
standards are not satisfied by Laredo Candle during the twelve months ending
June 30, 2001. The Company accounted for the acquisition by the purchase method
of accounting. Goodwill of $4.2 million, representing the excess of cost over
the fair value of individual net assets acquired, will be amortized over 15
years.
6. HOMCO RESTRUCTURING
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 incurred
approximately $1,027,000 of non-recurring costs related to the combination of
Homco's operations into GIA and recorded a non-recurring charge amount in its
Consolidated Statement of Operations and Comprehensive Income for the three
months ended March 31, 2000.
7
8
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 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
proceeds of approximately $5.4 million on the sale of these properties for
financial reporting purposes.
7. REDUNDANT WAREHOUSE AND DISTRIBUTION COST
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. This
plan anticipated a significant warehouse and distribution headcount reduction in
connection with the consolidation process. 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. These delays have forced the Company to hire additional
temporary laborers and retain existing warehouse employees longer than
originally anticipated.
In addition, the Company continued to operate two of its older manual
order fulfillment distribution facilities through September 30, 2000. In October
2000 one of the manual operations was 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 sublease that facility once the automated order
fulfillment system and consolidated distribution facility are fully operational.
The inability to sublease the manual distribution facility for an amount equal
to or in excess of the remaining rents may result in a non-recurring charge.
Redundant warehouse and distribution costs resulting from the issues
discussed above were approximately $2.0 million and $2.6 million for the three
and nine months ended September 30, 2000, respectively. These costs consist
primarily of incremental labor associated with productivity issues at the new
consolidated distribution facility, costs of operating certain manual
distribution centers longer than anticipated and consolidation of the manual
distribution centers into the new distribution facility.
8. REORGANIZATION COST
During 2000, the Company implemented a corporate reorganization plan
that included among other things, staff reductions and the elimination of excess
facility costs. As part of the reorganization, the Company has downsized various
departments. Additionally, the Company announced its plan to relocate its
headquarters employees to office space in its consolidated distribution
facility. The Company intends to sublease its unoccupied office space as soon as
possible. Future charges, if any, for leasing fees, buildouts of the office
space, or rental costs in excess of sublease rental income will be based on the
terms of sublease agreements. Additionally, as a result of the plan to vacate
the headquarters office by December 31, 2000, the Company has accelerated
amortization of related leasehold improvements.
Included in general and administrative expenses in the Consolidated
Statements of Operations and Comprehensive Income are the following amounts
associated with the Company's reorganization plan:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 2000
------------------ -----------------
(UNAUDITED) (UNAUDITED)
Staff reductions, excess facilities
cost and other........................ $ 850 $ 1,424
Accelerated amortization of
leasehold improvements ............... 1,330 1,330
------------ -----------
$ 2,180 $ 2,754
============ ===========
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9. 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 nine months ended September 30, 1999 and 2000 (in
thousands):
THREE MONTHS ENDED
SEPTEMBER 30: HI MANUFACTURING INTERNATIONAL ELIMINATIONS CONSOLIDATED
------------- --------- ------------- ------------- ------------ ------------
(UNAUDITED)
1999
Net sales $ 111,186 $ 19,362 $ 2,089 (20,562) $ 112,075
EBITDA 16,781 2,761 (94) (201) 19,247
2000
Net sales $ 95,154 $ 19,880 $ 3,367 $ (21,431) $ 96,970
EBITDA 15,995 5,412 75 321 21,803
NINE MONTHS ENDED
SEPTEMBER 30: HI MANUFACTURING INTERNATIONAL ELIMINATIONS CONSOLIDATED
----------------- --------- ------------- ------------- ------------ ------------
(UNAUDITED)
1999
Net sales $353,010 $66,678 $ 5,623 $ (70,254) $ 355,057
EBITDA 55,239 14,431 (89) (1,135) 68,446
Total assets 120,398 40,476 455 (27,178) 134,151
Capital expenditures 4,227 4,248 169 --- 8,644
2000
Net sales $318,488 $59,356 $ 9,590 $ (64,411) $ 323,023
EBITDA 44,550 13,630 376 622 59,178
Total assets 144,345 58,094 431 (54,810) 148,060
Capital expenditures 32,050 4,989 43 --- 37,082
The following table represents a reconciliation of consolidated EBITDA
to income before income taxes for the three months and nine months ended
September 30, 1999 and 2000 (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30: SEPTEMBER 30:
(UNAUDITED)
1999 2000 1999 2000
-------- -------- -------- --------
EBITDA ............................................... $ 19,247 $ 21,803 $ 68,446 $ 59,178
Depreciation and amortization ........................ (1,068) (3,214) (2,883) (5,498)
Gains on the sale of assets .......................... 3 22 3 2,735
Stock option credit (expense)......................... (102) 587 (850) 263
Homco restructuring .................................. -- -- -- (1,027)
Reorganization cost .................................. -- (850) -- (1,424)
Redundant warehouse and distribution expense ......... -- (2,033) -- (2,603)
Interest income ...................................... 455 286 1,824 1,401
Interest expense ..................................... (11,018) (11,816) (33,342) (34,215)
Other income (expense), net .......................... 419 83 313 563
-------- -------- -------- --------
Income before income taxes ........................... $ 7,936 $ 4,868 $ 33,511 $ 19,373
======== ======== ======== ========
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10. 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 does not believe the new standard will have a significant impact
on its financial statements.
11. GUARANTOR FINANCIAL DATA
DWC, GIA, Homco, SVS, Laredo Candle and Homco PR (collectively, the
"Guarantors") unconditionally, on a joint and several basis, guarantee the
Company's outstanding $ 200 million 10 1/8% Senior Subordinated Notes due 2008
(the Notes). The Company's other subsidiary, Home Interiors de Mexico, (the
"Non-Guarantor") has not guaranteed the Notes. Guarantor and Non-Guarantor
financial statements on an individual basis are not significant and have been
omitted. Accordingly, the following presents financial information of the
Guarantors and Non-Guarantors on a consolidating basis (in thousands):
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000
(UNAUDITED)
HI GUARANTORS NON-GUARANTOR ELIMINATIONS CONSOLIDATED
-------- ---------- ------------- ------------ ------------
Net sales ............................ $ 95,154 $ 20,112 $ 3,135 $ (21,431) $ 96,970
Cost of good sold .................... 48,754 14,405 1,770 (21,257) 43,672
-------- ---------- ------------- ------------ ------------
Gross profit ....................... 46,400 5,707 1,365 (174) 53,298
Total selling, general and
administrative ..................... 35,196 939 1,343 (495) 36,983
-------- ---------- ------------- ------------ ------------
Operating income ................... 11,204 4,768 22 321 16,315
Other income (expense), net .......... (11,173) 243 (22) (495) (11,447)
-------- ---------- ------------- ------------ ------------
Income before income taxes ......... 31 5,011 -- (174) 4,868
Income taxes ......................... 659 1,618 -- -- 2,277
-------- ---------- ------------- ------------ ------------
Net income ......................... $ (628) $ 3,393 $ -- $ (174) $ 2,591
======== ========== ============= ============ ============
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
(UNAUDITED)
HI GUARANTORS NON-GUARANTOR ELIMINATIONS CONSOLIDATED
-------- ---------- ------------- ------------ ------------
Net sales ............................ $ 318,488 $ 60,224 $ 8,722 $ (64,411) $ 323,023
Cost of good sold .................... 167,993 44,655 4,863 (64,199) 153,312
--------- ---------- ------------- ------------ ------------
Gross profit ....................... 150,495 15,569 3,859 (212) 169,711
Total selling, general and
administrative ..................... 114,280 1,025 3,699 (917) 118,087
--------- ---------- ------------- ------------ ------------
Operating income ................... 36,215 14,544 160 705 51,624
Other income (expense), net .......... (32,136) 669 (44) (740) (32,251)
--------- ---------- ------------- ------------ ------------
Income before income taxes ......... 4,079 15,213 116 (35) 19,373
Income taxes ......................... 2,366 5,086 -- -- 7,452
--------- ---------- ------------- ------------ ------------
Net income ......................... $ 1,713 $ 10,127 $ 116 $ (35) $ 11,921
========= ========== ============= ============ ============
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CONSOLIDATING BALANCE SHEET
AS OF SEPTEMBER 30, 2000
(UNAUDITED)
HI GUARANTORS NON-GUARANTOR ELIMINATIONS CONSOLIDATED
--------- ---------- ------------- ------------ ------------
ASSETS
Current assets:
Cash and cash equivalents ........................ $ 6,544 $ 565 $ 390 $ -- $ 7,499
Accounts receivable, net ......................... 12,706 311 602 -- 13,619
Inventories, net ................................. 32,033 9,501 1,048 (2,424) 40,158
Other current assets ............................. 5,330 808 177 106 6,421
Intercompany ..................................... (6,498) 20,624 (2,378) (11,748) --
--------- ---------- ------------- ------------ ------------
Total current assets .......................... 50,115 31,809 (161) (14,066) 67,697
Property, plant and equipment, net ................. 41,688 16,892 302 (92) 58,790
Restricted cash .................................... -- 900 -- -- 900
Investment in subsidiaries ......................... 31,987 3,706 -- (35,693) --
Debt issuance costs and other assets ............... 20,555 5,077 -- (4,959) 20,673
--------- ---------- ------------- ------------ ------------
Total assets .................................. $ 144,345 $ 58,384 $ 141 $ (54,810) $ 148,060
========= ========== ============= ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ................................. $ 30,050 $ 2,862 $ 70 $ (11,779) $ 21,203
Current maturities of long-term
debt and capital lease obligations ............ 32,201 -- -- -- 32,201
Other current liabilities ........................ 29,170 7,557 282 106 37,115
--------- ---------- ------------- ------------ ------------
Total current liabilities ..................... 91,421 10,419 352 (11,673) 90,519
Long-term debt and capital lease
obligations, net of current
maturities ....................................... 410,870 -- -- -- 410,870
Other liabilities .................................. 10,408 798 -- (4,959) 6,247
--------- ---------- ------------- ------------ ------------
Total liabilities ............................. 512,699 11,217 352 (16,632) 507,636
Shareholders' equity (deficit):
Common stock ..................................... 1,524 1,010 9 (1,019) 1,524
Additional paid-in capital ....................... 179,713 14,940 1,015 (15,955) 179,713
Retained earnings (accumulated
deficit) ...................................... (549,591) 31,217 (1,227) (21,204) (540,805)
Other ............................................ -- -- (8) -- (8)
--------- ---------- ------------- ------------ ------------
Total shareholders' equity
(deficit) ................................... (368,354) 47,167 (211) (38,178) (359,576)
--------- ---------- ------------- ------------ ------------
Total liabilities and
shareholders' equity
(deficit) ................................... $ 144,345 $ 58,384 $ 141 $ (54,810) $ 148,060
========= ========== ============= ============ ============
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CONSOLIDATING CASH FLOW INFORMATION
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000 (UNAUDITED)
-----------------------------------------------------------------------
HI GUARANTORS NON-GUARANTOR ELIMINATIONS CONSOLIDATED
--------- ---------- ------------- ------------ ------------
Net cash provided by (used in)
operating activities ...................... $ 12,453 $ 2,077 $ (136) $ (1,325) $ 13,069
Net cash provided by (used in)
investing activities ...................... (17,221) (2,001) (43) 1,070 (18,195)
Net cash provided by (used in)
financing activities ...................... (20,375) 805 -- (163) (19,733)
12. SUBSEQUENT EVENT
On October 23, 2000 the Company signed a letter of intent to sell their
ownership interest in Charles W. Weaver Manufacturing, one of their suppliers,
for approximately $2.0 million. This will result in a gain of approximately
$345,000 that will be recorded in the fourth quarter.
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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 the 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; (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; and (viii) the failure to
comply with all terms of the Company's Senior Credit Facility and Notes. 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 September 30, 2000, the Company sold its products
to approximately 56,400 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 has experienced higher gross profit margins since the implementation. In
addition, as of March 2000 under the new Hostess program the Company no longer
sells or uses Hostess merits. This has resulted in a net increase in general and
administrative expenses due to the reduction in income from unredeemed Hostess
merits which is reflected in general and administrative cost. The Company
believes that the new Hostess program simplifies the sales process and benefits
Displayers by increasing the product selection for Hostesses and customers. In
addition , the Company recognizes that training its Displayers on how to most
effectively market the new Hostess program is critical. As a result, the Company
is devoting a substantial amount of time and effort in training its Displayers
in the new Hostess program and is developing improved training materials for
the program.
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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. A measurement of this ability is the
Company's average annual displayer turnover, which has been approximately 42%
for the last three fiscal years. During the previous twelve months ended
September 30, 2000 this percentage increased significantly to over 100%. While
this recent level of sales representative turnover is relatively common in the
direct sales industry, it is unusual for the Company. The Company believes that
the recent increase in displayer turnover is due to the adoption of revised
recruiting and training criteria in early 1999 coupled with the change in the
policy that requires a displayer to place an order more frequently in order to
be considered "active." In early 1999, the Company reduced initial purchase
requirements and time obligations thereby lowering the 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.
The Company believes that the best recruit for a displayer is that
displayer's former hostess. Because of this, the Company believes that many of
the new displayers recruited in 1999 were former hostesses who became a
displayer in order to purchase merchandise at a discount. This led to a much
greater percentage of displayers who were newer, less experienced and therefore
less productive. It has been the company's experience that although there are
numerous general and economic factors affecting displayer turnover, the majority
of displayers who become inactive in any particular year are displayers
recruited in that year or in the preceding year. This general rule along with
the fact that the Company increased the requirements needed in order to remain
active caused an increase in displayer turnover during the first three quarters
of 2000. As of September 30, 2000 the active displayer base was 56,400, which
was 7,100 less than the 63,500 active displayers at September 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 continue 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
Displayers than the prior year, may result in lower sales during the remainder
of 2000 as compared to the comparable period in 1999.
REORGANIZATION ACTIVITIES
Homco Restructuring
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 incurred
approximately $1,027,000 of non-recurring costs related to the combination of
Homco's operations into GIA and recorded a non-recurring charge amount in its
Consolidated Statement of Operations and Comprehensive Income for the three
months ended March 31, 2000.
Redundant Warehouse and Distribution Cost
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. This
plan anticipated a significant warehouse and distribution headcount reduction in
connection with the consolidation process. 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. These delays have forced the Company to hire additional
temporary laborers and retain existing warehouse employees longer than
originally anticipated.
In addition, the Company continued to operate two of its older manual
order fulfillment distribution facilities through September 30, 2000. In October
2000 one of the manual operations was 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 sublease that facility once the automated order
fulfillment system and consolidated distribution facility are fully operational.
The inability to sublease 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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15
Redundant warehouse and distribution costs resulting from the issues
discussed above were approximately $2.0 million and $2.6 million for the three
and nine months ended September 30, 2000, respectively. These costs consist
primarily of incremental labor associated with productivity issues at the new
consolidated distribution facility, costs of operating certain manual
distribution centers longer than anticipated and consolidation of the manual
distribution centers into the new distribution facility.
Reorganization Cost
During 2000, the Company implemented a corporate reorganization plan
that included among other things, staff reductions and the elimination of excess
facility costs. As part of the reorganization, the Company has downsized various
departments. Additionally, the Company announced its plan to relocate its
headquarters employees to office space in its consolidated distribution
facility. The Company intends to sublease its unoccupied office space as soon as
possible. Future charges, if any, for leasing fees, buildouts of the office
space, or rental costs in excess of sublease rental income will be based on the
terms of sublease agreements. As a result of the reorganization plan to vacate
the headquarters office by December 31, 2000, the Company has accelerated
amortization of related leasehold improvements. Included in general and
administrative expenses in the Consolidated Statement of Operations and
Comprehensive Income are the following amounts associated with the Company's
reorganization plan:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 2000
------------------ -----------------
(UNAUDITED) (UNAUDITED)
Staff reductions, excess facilities
cost and other........................ $ 850 $ 1,424
Accelerated amortization of
leasehold improvements ............... 1,330 1,330
------------ -----------
$ 2,180 $ 2,754
============ ===========
RESULTS OF OPERATIONS
The Three Months Ended September 30, 2000 Compared to the Three Months
Ended September 30, 1999
Net sales. Net sales decreased $15.1 million, or 13.5%, to $97.0
million in the three months ended September 30, 2000 from $112.1 million in the
comparable period in 1999. The decline in sales was due to a decrease in the
average number of displayers and the number of orders per displayer. The average
number of active displayers decreased 6.2% to 58,600 in the three months ended
September 30, 2000 from 62,500 in the comparable period in 1999. In addition,
orders per displayer dropped 16.2% from 3.7 in the 1999 period to 3.1 in the
2000 period. The decrease in the average number of displayers and the number of
orders per displayer resulted in a decrease in the number of orders shipped,
from 229,401 orders in the 1999 period to 182,899 orders in the three months
ended September 30, 2000. A 6.9% increase in the average order size from $479 in
the third quarter of 1999 to $512 for the third quarter of 2000 partially offset
the impact on net sales of the decrease in the number of orders shipped.
Displayer productivity continues to be impacted by the change in the
Hostess program, fewer sales incentive programs, product availability and
distribution operations. During the third quarter of 2000 the Company devoted a
substantial amount of time developing improved training materials for the new
hostess program and training its Displayers. The Company also increased the
number of incentive programs in the third quarter and has plans to continue such
in the fourth quarter. Consultants have been engaged to enhance the design and
operation of the automated order fulfillment system and overall operations of
the consolidated distribution facility. When enhancements are complete, the
Company anticipates an increase in displayer satisfaction regarding product
availability and shipments.
Gross profit. Gross profit decreased $3.6 million to $53.3 million in
the three months ended September 30, 2000 from $56.9 million in the comparable
period in 1999. As a percentage of net sales, gross profit increased to 55.0% in
the 2000 period from 50.7% 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 as well as improved
manufacturing efficiencies. Prior year gross margin was impacted by the product
mix, low production volumes and unexpected high amounts of scrap material at the
manufacturing subsidiaries, the majority of which was identified and corrected
in fiscal 2000.
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Selling expense. Selling expense decreased $3.4 million, or 16.7%, to
$17.2 million in the three months ended September 30, 2000 from $20.6 million in
the comparable period in 1999. As a percentage of net sales, selling expense
decreased to 17.7% in the 2000 period from 18.4% in the 1999 period. This
decrease was primarily attributable to lower promotion related expenses and
fewer reimbursed selling expenses to the field directors due to the change in
the reimbursement policy of the new Hostess program.
Freight, warehouse and distribution expense. Freight, warehouse and
distribution expense decreased $1.6 million, or 13.2%, to $10.2 million in the
three months ended September 30, 2000 from $11.8 million in the comparable
period in 1999. These costs remained flat at 10.5% of net sales in the 2000
period compared to 10.5% in the 1999 period. Redundant warehouse and
distribution costs of $2.0 million, primarily relating to duplicate facility
costs and redundant temporary labor, have been reclassified to a separate
operating expense line item in the accompanying Consolidated Statements of
Operations and Comprehensive Income.
General and administrative expense. General and administrative expense
increased $1.9 million, or 29.7%, to $8.2 million in the three months ended
September 30, 2000 from $6.3 million in the comparable period in 1999. This
increase was due primarily to corporate headquarters rental expense and
increased credit card fees in connection with the Company's internet-based order
entry system (Home Online). Certain non-recurring costs of $2.2 million
associated with staff reductions, excess facilities and accelerated amortization
on leasehold improvements at the headquarters facility are also included in
general and administrative expense for the three months ended September 30,
2000.
Redundant warehouse and distribution cost. Redundant warehouse and
distribution costs of $2.0 million, consist primarily of incremental labor
associated with productivity issues at the new consolidated distribution
facility, costs of operating certain manual distribution centers longer than
anticipated and consolidation of the manual distribution centers into the new
distribution facility.
Other income (expense). Other income (expense) included an adjustment
to income in the three months ended September 30, 2000 of approximately $463,000
to adjust to fair market value the option provisions of the Company's interest
rate swap agreements.
Income taxes. Income taxes increased $1.4 million to $2.3 million in
the three months ended September 30, 2000 from $0.9 million in the comparable
period in 1999. Income taxes, as a percentage of income before income taxes,
increased to 46.8% in the 2000 period from 11.2% in the 1999 period. Income
taxes for the three months ended September 30, 2000 reflects the impact of a
change in the estimated effective income tax rate for the full year to 38.5%.
Income taxes for the three months ended September 30, 1999 reflects the impact
of 1998 income tax adjustments related to a prior year refund and the
Recapitalization.
The Nine Months Ended September 30, 2000 Compared to the Nine Months Ended
September 30, 1999
Net sales. Net sales decreased $32.1 million, or 9.0%, to $323.0
million in the nine months ended September 30, 2000 from $355.1 million in the
comparable period in 1999. The average number of active Displayers increased
10.6% to 62,600 in the nine months ended September 30, 2000 from 56,600 in the
comparable period in 1999. This growth resulted in an increased percentage of
less experienced and less productive Displayers which is reflected in a 23.3%
decrease in the number of orders per displayer from 12.0 in 1999 to 9.2 in 2000.
The total number of orders shipped decreased 10.4% from 677,153 in the 1999
period to 606,955 in the nine months ended September 30, 2000. The average order
size of $516 in the nine months ended September 30, 2000 was consistent with
$516 for the comparable 1999 period.
Gross profit. Gross profit decreased $13.2 million to $169.7 million in
the nine months ended September 30, 2000 from $182.9 million in the comparable
period in 1999. As a percentage of net sales, gross profit increased to 52.5% in
the 2000 period from 51.5% in the 1999 period. Gross profit percentages
increased as a result of the new higher margin products, fewer discounts and
increased manufacturing efficiencies.
Selling expense. Selling expense decreased $7.1 million, or 11.3%, to
$55.9 million in the nine months ended September 30, 2000 from $63.0 million in
the comparable period in 1999. As a percentage of net sales, selling expense
decreased slightly to 17.3% in the 2000 period from 17.7% in the 1999 period.
This decrease was due to lower reimbursed selling expenses, reduced incentive
costs and lower bonus accruals for sales directors offset by higher effective
commissions. Commissions have increased in connection with the new Hostess
program since substantially all products were made commissionable.
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Freight, warehouse and distribution expense. Freight, warehouse and
distribution expense decreased $0.3 million, or 0.8%, to $35.1 million in the
nine months ended September 30, 2000 from $35.4 million in the comparable period
in 1999. These costs were 10.9% of net sales in the 2000 period compared to
10.0% in the 1999 period. This increase in percentage was primarily due to an
increase in the percentage of heavier products shipped in the 2000 period.
Redundant warehouse and distribution costs of $2.6 million, primarily relating
to duplicate facility costs and redundant temporary labor, have been
reclassified to a separate operating expense line item in the accompanying
Consolidated Statements of Operations and Comprehensive Income.
General and administrative expense. General and administrative expense
increased $7.6 million, or 39.9%, to $ 26.5 million in the nine months ended
September 30, 2000 from $18.9 million in the comparable period in 1999. This
increase was primarily due to corporate headquarters rental expense increased
credit card fees in connection with the Company's internet-based order entry
system (Home Online). Certain non-recurring costs of $2.8 million associated
with staff reductions, excess facilities and accelerated amortization on
leasehold improvements at the headquarters facility are also included in general
and administrative expense for the nine months ended September 30, 2000.
Homco restructuring. The Company incurred approximately $1.0 million of
non-recurring cost related to the combination of Homco's operations into GIA,
which is reflected in Homco restructuring.
Redundant warehouse and distribution. Redundant warehouse and
distribution costs of $2.6 million, consist primarily of incremental labor
associated with productivity issues at the new consolidated distribution
facility, costs of operating certain manual distribution centers longer than
anticipated and consolidation of the manual distribution centers into the new
distribution facility.
Other income (expense). Other income (expense) included an adjustment
to income in the nine months ended September 30, 2000 of approximately $983,000
to adjust to fair market value the option provision of the Company's interest
rate swap agreement.
Income taxes. Income taxes decreased $4.0 million to $7.5 million in
the nine months ended September 30, 2000 from $11.5 million in the comparable
period in 1999. Income taxes, as a percentage of income before income taxes,
increased to 38.5% in the 2000 period from 34.3% in the 1999 period. The Company
believes that the effective income tax rate for the entire 2000 period will be
consistent with the effective income tax rate for the nine months ended
September 30, 2000. Income taxes for the three months ended September 30, 1999
reflects the impact of 1998 income tax return adjustments related to a prior
year refund and the Recapitalization.
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 9
to Unaudited Interim Consolidated Financial Statements.
The Three Months Ended September 30, 2000 Compared to the Three Months
Ended September 30, 1999
Consolidated net sales decreased $15.1 million, or 13.5%, to $97.0
million in the three months ended September 30, 2000 from $112.1 million in the
comparable period of 1999 due to the $16.0 million decrease in the Company's
domestic direct sales as previously discussed. International net sales increased
$1.3 million, or 61.2%, to $3.4 million in the three months ended September 30,
2000 from $2.1 million in the comparable period of 1999 primarily due to
expansion of the international Displayer network. Manufacturing related sales in
the three months ended September 30, 2000 increased $0.5 million, or 2.7%, to
$19.9 million from $19.4 million in the comparable period of 1999 primarily due
to building inventory levels for certain promotions and sales incentives in the
third quarter of 2000.
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Consolidated EBITDA increased $2.6 million, or 13.3%, to $21.8 million
in the three months ended September 30, 2000 from $19.2 million in the
comparable period of 1999 primarily due to increased gross profit as a
percentage of sales that is the result of the shift to higher margin products.
Manufacturing related EBITDA increased $2.6 million, or 96.0%, to $5.4 million
in 2000 from $2.8 million in 1999 primarily due to increased efficiencies at the
manufacturing facilities. International EBITDA improved, but was not significant
to consolidated EBITDA.
The Nine Months Ended September 30, 2000 Compared to the Nine Months
Ended September 30, 1999
Consolidated net sales decreased $32.1 million, or 9.0%, to $323.0
million in the nine months ended September 30, 2000 from $355.1 million in the
comparable period of 1999 due to the $34.5 million decrease in the Company's
domestic direct sales as previously discussed. International sales increased
$4.0 million, or 70.5%, to $9.6 million in the nine months ended September 30,
2000 from $5.6 million in the comparable period of 1999 primarily due to
expansion of the international Displayer network. Manufacturing related sales in
the nine months ended September 30, 2000 decreased $7.3 million, or 11.0%, to
$59.4 million from $66.7 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.
Consolidated EBITDA decreased $9.2 million, or 13.5%, to $59.2 million
in the nine months ended September 30, 2000 from $68.4 million in the comparable
period of 1999 primarily due to decreases in business sales volumes in the
Company's domestic direct sales business, higher general and administrative and
freight, warehouse and distribution costs in the 2000 period. Manufacturing
related EBITDA decreased $0.8 million, or 5.6%, to $13.6 million in 2000 from
$14.4 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
Net cash provided by operating activities was $11.3 and $13.1 million
in the nine months ended September 30, 1999 and 2000, respectively. Net cash
provided by operating activities during the nine months ended September 30, 2000
was favorably impacted by a decrease in inventory and other current assets. This
favorable impact was primarily offset by decreases in income taxes payable and
accrued liabilities. Inventory decreased during 2000 due to the consolidation of
manufacturing facilities and distribution facilities, which eliminated the need
to maintain duplicate inventory sites. The decrease in other current assets is
primarily as a result of lower deposits on capital assets. Income taxes payable
decreased due to lower tax estimates based on net income. Accrued liabilities
decreased primarily as a result of the Company announcing that it will no longer
sell Hostess Merits. As a result of this announcement, the Company experienced
significant redemptions of outstanding Hostess Merit certificates during the
2000 period. Hostess Merits are coupons issued to displayers, which are
reflected on the Company's financial statements as a liability until the coupon
is redeemed.
Investing activities during the nine months ended September 30, 2000
resulted in a net cash outflow of $18.2 million. Capital expenditures increased
significantly from $10.6 million in the 1999 period to $29.5 million, not
including $7.6 million in capital leases, 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, in 2000, were used to pay for substantially
all of the costs associated with the consolidated distribution facility. The
remaining $6.9 million in capital expenditures in the 2000 period primarily
relate 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.
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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. This phase consists primarily of upgrades and
enhancements to the Company's current business-to-business application at an
additional cost of approximately $2.0 million.
In December 1999, the Company entered into capital leases with Bank One
for furniture and fixtures associated with its office facilities of $1.2
million. Through September 30, 2000, the Company entered into additional capital
lease of $7.6 million primarily related to the automated fulfillment system
located at the new warehouse and distribution facility.
On July 3, 2000 the Company 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 performance standards are not satisfied by Laredo
Candle during the twelve months ending June 30, 2001. The Company accounted for
the acquisition by the purchase method of accounting. Goodwill of $4.2 million,
representing the excess of cost over the fair value of individual net assets
acquired, will be amortized over 15 years.
Net cash used in financing activities was $24.1 and $19.7 million
during the nine months ended September 30, 1999 and 2000, respectively. Cash
used to make payments under the Senior Credit Facility decreased by $6.7 million
during the 2000 period primarily due to mandatory prepayments made in 1999 but
not required in 2000.
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
$70.0 million line of credit that matures on June 30, 2004. This line of credit,
which does not have a fixed payment schedule, is referred to as the Revolving
Loan.
The Company paid a total of $45.8 million in debt service for the nine
months ended September 30, 2000 consisting of principal payments under the
Senior Credit Facility of $19.8 million, interest of approximately $15.9 million
under the Senior Credit Facility and interest of approximately $10.1 million
under the Notes.
The Notes and Senior Credit Facility contain a number of affirmative
and negative covenants, including restrictions on indebtedness, liens,
investment sales or transfer of assets, mergers or consolidations, and dividend
payments. 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 is required to make certain mandatory prepayments of the term loans
on an annual basis. As mentioned above, a mandatory prepayment was made in 1999
of $7.7 million whereas no prepayment was required in 2000. The Notes and
Facility are guaranteed by all the Company's significant subsidiaries and are
collateralized by substantially all of the assets of the Company and its
significant subsidiaries.
Revolving Loans of $20 million were drawn during the third quarter of
2000 and were repaid in full by September 30, 2000. The Company estimates that
it will require additional capital during the fourth quarter of 2000, and has
drawn $20 million on the Revolving Loans as of November 1, 2000, to meet working
capital and capital expenditure needs. In addition, the Company may make up to
$20 million in additional borrowings under the Revolving Loans prior to the end
of fiscal 2000. Based on the Company's internal forecasts through December 31,
2000, the Company believes that, absent an amendment or waiver under its Senior
Credit Facility, it may not be in compliance with the financial covenants
(specifically, the leverage ratio and interest coverage ratio) contained in the
Company's Senior Credit Facility as of the quarter ending December 31, 2000. As
a result, the Company intends to seek the consent of its senior lenders to
certain amendments to its Senior Credit Facility, including amendments to the
financial covenants contained therein, prior to December 31, 2000 to insure such
compliance. The Company has retained a financial advisor to assist it with,
among other things, such efforts. While the Company believes that it will be
able to obtain the requisite consent of its senior lenders to such amendments
and, as a result, cause the Company to be in compliance as of December 31, 2000
with the financial covenants contained therein, there can be no assurance that
it will be able to do so on terms that are satisfactory to the Company.
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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
$258,000 at September 30, 2000 and is included in long-term liabilities.
In addition, during the first nine 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 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 does not believe the new standard will have a significant impact
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 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit Number Description
-------------- -----------
*27.1 Financial Data Schedule
*Filed herewith
(b) Reports on Form 8-K
None.
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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: November 10, 2000
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INDEX TO EXHIBIT
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
*27.1 Financial Data Schedule
- ----------
*Filed herewith.