================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
COMMISSION FILE NUMBER 333-62021
---------------
HOME INTERIORS & GIFTS, INC.
(Exact name of registrant as specified in its charter)
TEXAS 75-0981828
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1649 FRANKFORD ROAD, W CARROLLTON, TEXAS 75007-4605
(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 requirements for the past 90 days. Yes [X] No [ ]
As of November 12, 2002, 15,240,218 shares of the Company's common stock, par
value $0.10 per share, were outstanding.
================================================================================
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
INDEX
PAGE NO.
--------
PART I - FINANCIAL INFORMATION
Item 1. Unaudited Interim Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2001 and
September 30, 2002............................................... 3
Consolidated Statements of Operations and Comprehensive
Income for the three months and nine months ended
September 30, 2001 and 2002...................................... 4
Consolidated Statements of Cash Flows for the nine months
Ended September 30, 2001 and 2002................................ 5
Notes to Unaudited Interim Consolidated Financial
Statements....................................................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................. 16
Item 3. Quantitative and Qualitative Disclosures About
Market Risk...................................................... 24
PART II - OTHER INFORMATION
Item 1. Legal proceedings........................................... 25
Item 6. Exhibits and Reports on Form 8-K............................ 26
2
ITEM 1. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2001 AND SEPTEMBER 30, 2002
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
DECEMBER 31, SEPTEMBER 30,
2001 2002
------------ -------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents.................................................. $ 13,712 $ 33,936
Accounts receivable, net................................................... 11,703 21,468
Inventories, net........................................................... 40,452 77,457
Deferred income tax........................................................ 6,540 9,331
Other current assets....................................................... 1,096 3,079
--------- ---------
Total current assets................................................. 73,503 145,271
Property, plant and equipment, net............................................ 65,164 66,055
Debt issuance costs, net...................................................... 10,048 5,345
Other assets, net............................................................. 5,833 5,906
--------- ---------
Total assets......................................................... $ 154,548 $ 222,577
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable........................................................... $ 25,672 $ 28,529
Accrued seminars and incentive awards...................................... 19,126 18,754
Royalties payable.......................................................... 7,790 11,928
Accrued compensation....................................................... 6,598 5,709
Income taxes payable....................................................... 2,770 --
Current maturities of long-term debt and capital lease obligations......... 15,031 8,718
Other current liabilities.................................................. 15,292 30,011
--------- ---------
Total current liabilities............................................ 92,279 103,649
Long-term debt and capital lease obligations, net of current maturities....... 302,811 337,575
Other liabilities............................................................. 22,471 22,737
--------- ---------
Total liabilities.................................................... 417,561 463,961
--------- ---------
Commitments and contingencies
Shareholders' deficit:
Preferred stock, par value $0.01 per share 10,000,000 shares
authorized, 96,058.98 shares designated as cumulative 12.5% Senior
Convertible Preferred Stock at a liquidation value of $1,000 per
share, 96,058.98 shares issued and outstanding.......................... 95,637 95,637
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................................................. 179,562 179,669
Accumulated deficit........................................................ (539,379) (517,667)
Other...................................................................... (357) (547)
--------- ---------
Total shareholders' deficit.......................................... (263,013) (241,384)
--------- ---------
Total liabilities and shareholders' deficit.......................... $ 154,548 $ 222,577
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
3
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2002
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
2001 2002 2001 2002
------------ ------------ ------------ ------------
Net sales.................................................. $ 100,117 $ 125,673 $ 300,649 $ 390,397
Cost of goods sold......................................... 43,913 56,000 131,623 170,113
--------- --------- --------- ---------
Gross profit............................................... 56,204 69,673 169,026 220,284
Selling, general and administrative:
Selling................................................. 19,060 23,337 57,821 72,393
Freight, warehouse and distribution..................... 11,222 14,980 32,497 43,160
General and administrative.............................. 14,014 14,046 41,333 41,709
Loss (gain) on the disposition of assets................ 131 -- 495 (361)
Stock option expense.................................... 212 14 246 107
Redundant warehouse and distribution.................... 29 -- 1,175 --
--------- --------- --------- ---------
Total selling, general and administrative......... 44,668 52,377 133,567 157,008
--------- --------- --------- ---------
Operating income........................................... 11,536 17,296 35,459 63,276
Other income (expense):
Interest income......................................... 74 121 986 245
Interest expense........................................ (8,107) (7,009) (31,195) (20,274)
Other income (expense), net............................. (25) 421 241 (1,597)
--------- --------- --------- ---------
Other income (expense), net....................... (8,058) (6,467) (29,968) (21,626)
--------- --------- --------- ---------
Income before income taxes and extraordinary loss.......... 3,478 10,829 5,491 41,650
Income taxes............................................... 1,318 3,920 2,057 15,410
--------- --------- --------- ---------
Income before extraordinary loss........................... 2,160 6,909 3,434 26,240
Extraordinary loss......................................... 15,200 4,528 15,200 4,528
--------- --------- --------- ---------
Net income (loss).......................................... (13,040) 2,381 (11,766) 21,712
Other comprehensive income (loss):
Cumulative translation adjustment and other............. (10) (32) (57) (190)
Unrealized gains on derivative swaps at adoption of
SFAS No. 133......................................... -- -- 456 --
Amortization to earnings of unrealized gain on
derivative swap...................................... (114) -- (342) --
--------- --------- --------- ---------
Other comprehensive income (loss)................. (124) (32) 57 (190)
--------- --------- --------- ---------
Comprehensive income (loss)................................ $ (13,164) $ 2,349 $ (11,709) $ 21,522
========= ========= ========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
4
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2002
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
2001 2002
----------- -----------
Cash flows from operating activities:
Net income (loss).......................................................... $ (11,766) $ 21,712
Adjustments to reconcile net income to net cash provided by operating
activities:
Extraordinary loss...................................................... 15,200 4,528
Depreciation and amortization........................................... 6,862 8,757
Amortization of debt issuance costs and other........................... 1,934 1,616
Provision for doubtful accounts......................................... 1,398 1,546
Provision for losses on inventories..................................... 1,759 2,532
Loss (gain) on the disposition of assets................................ 495 (361)
Stock option expense.................................................... 246 107
Deferred tax expense (benefit).......................................... (502) 188
Changes in assets and liabilities:
Accounts receivable.................................................. (9,854) (11,311)
Inventories.......................................................... (24,412) (39,537)
Other current assets................................................. 406 (1,983)
Other assets......................................................... (205) (64)
Accounts payable..................................................... 2,352 2,180
Income taxes payable................................................. 707 (2,770)
Other accrued liabilities............................................ 22,000 17,544
--------- ---------
Net cash provided by operating activities......................... 6,620 4,684
--------- ---------
Cash flows from investing activities:
Purchases of property, plant, and equipment............................. (8,221) (9,184)
Purchase of intangible assets........................................... -- (10)
Proceeds from the sale of property, plant, and equipment................ 250 574
--------- ---------
Net cash used in investing activities............................. (7,971) (8,620)
--------- ---------
Cash flows from financing activities:
Increase in book overdrafts payable..................................... 424 --
Payments under capital lease obligations................................ (985) (1,049)
Payments under the Senior Credit Facility............................... (17,589) (5,500)
Proceeds from borrowings under the Senior Credit Facility............... -- 35,000
Proceeds from borrowings under the revolving loan....................... 14,000 --
Payments under the revolving loan....................................... (34,000) --
Debt issuance costs..................................................... (1,574) (4,101)
Proceeds from issuance of preferred stock............................... 231 --
Preferred stock issuance cost........................................... (422) --
--------- ---------
Net cash provided by (used in) financing activities............... (39,915) 24,350
--------- ---------
Effect of cumulative translation adjustment................................ (57) (190)
--------- ---------
Net increase (decrease) in cash and cash equivalents....................... (41,323) 20,224
Cash and cash equivalents at beginning of year............................. 41,720 13,712
--------- ---------
Cash and cash equivalents at end of period................................. $ 397 $ 33,936
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
5
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BACKGROUND
Home Interiors & Gifts, Inc, ("HI"), is a fully integrated manufacturer and
distributor of home decorative accessories. HI, together with its subsidiaries
(the "Company"), primarily uses the "party plan" method of distribution, 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 in
the typical retail setting.
The Company has been located in Dallas, Texas since its inception in 1957.
Currently, a majority of the Company's outstanding capital stock is owned by
affiliates of Hicks, Muse, Tate & Furst Incorporated, a Dallas based private
investment firm ("Hicks Muse"). Approximately 47% of the dollar volume of
products purchased by the Company in the first nine months of 2002 were
purchased from, and manufactured by, the Company's subsidiaries. The Company's
subsidiaries sell substantially all of their products to the Company.
The following is a brief description of the Company's operating
subsidiaries, each of which is wholly owned:
- Dallas Woodcraft Company, LP (formerly Dallas Woodcraft, Inc.) ("DWC")
manufactures framed artwork and mirrors using custom-designed
equipment.
- GIA, Inc. ("GIA") manufactures various types of molded plastic products
using custom-designed equipment.
- Laredo Candle Company, L.P. ("Laredo Candle") manufactures candles
using custom-designed equipment. Spring Valley Scents, Inc. ("SVS") is
the general partner of Laredo Candle.
- Subsidiaries of the Company in Mexico and Puerto Rico provide sales
support services to international Displayers.
- Business operations were initiated in Canada during September 2001 and
consisted primarily of start-up activities. The Company has not yet
formed a separate legal entity to conduct its Canadian operations.
2. SIGNIFICANT ACCOUNTING POLICIES
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. Each quarter consists of thirteen weeks. The last days of the quarters
ended September 30, 2001 and 2002 in the accompanying unaudited consolidated
financial information were September 29, 2001 and September 28, 2002,
respectively.
The consolidated financial information as of September 30, 2002 and for the
three months and nine months ended September 30, 2001 and 2002 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, 2002, its operating results
and comprehensive income for the three months and nine months ended September
30, 2001 and 2002, and its cash flows for the nine months ended September 30,
2001 and 2002. 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/A for the year
ended December 31, 2001 as filed with the SEC.
Certain reclassifications have been made to prior period's balances to
conform with current year presentation.
6
3. INVENTORIES
Inventories, net consisted of the following as of December 31, 2001 and
September 30, 2002 (in thousands):
DECEMBER 31, SEPTEMBER 30,
2001 2002
------------ -------------
Raw materials.......... $ 4,406 $ 5,617
Work in process........ 2,169 1,218
Finished goods......... 38,399 75,390
-------- ---------
44,974 82,225
Inventory Allowance.... (4,522) (4,768)
-------- ---------
$ 40,452 $ 77,457
======== =========
At December 31, 2001 and September 30, 2002, the Company had approximately $4.0
million and $10.6 million of finished goods inventory was in-transit from
overseas vendors.
4. OTHER CURRENT LIABILITIES
Other current liabilities consisted of the following as of December 31, 2001
and September 30, 2002 (in thousands):
DECEMBER 31, SEPTEMBER 30,
2001 2002
------------ -------------
Interest payable....................... $ 1,294 $ 7,041
Employee benefit plan contributions.... 1,665 1,242
Sales taxes payable.................... 3,408 4,550
Other taxes payable.................... 1,335 1,193
Deferred revenue....................... 3,794 11,550
Other current liabilities.............. 3,796 4,435
-------- ---------
$ 15,292 $ 30,011
======== =========
5. RECENTLY ISSUED AND ADOPTED STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS
In October of 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 147, "Acquisitions of Certain
Financial Institutions - an Amendment of FASB Statements No. 72 and No. 144 and
FASB Interpretation of No. 9" ("SFAS No. 147"). The Company has adopted these
provisions effective October 1, 2002, and there was not a financial accounting
impact associated with its adoption.
In July of 2002 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146 requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS No. 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. The Company will adopt SFAS No. 146 with
fiscal year beginning January 1, 2003 and does not anticipate any financial
accounting impact associated with its adoption.
In April of 2002 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4,
44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections" ("SFAS
No. 145"). SFAS No. 145 rescinds FASB Statement No. 4, "Reporting Gains and
Losses from the Extinguishment of Debt," and an amendment of that Statement,
FASB Statement No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements." SFAS No. 145 also rescinds FASB No. 44 "Accounting for Leases,"
to eliminate an inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications that
are similar to sale-leaseback transactions. SFAS No. 145 also amends other
existing authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under changed conditions. The
provision of SFAS No. 145 related to the rescission of Statement No. 4 is
effective in fiscal years beginning after May 15, 2002. The Company will adopt
this provision of SFAS No. 145 with fiscal year beginning on January 1, 2003 and
does not anticipate any material financial accounting impact associated with its
adoption. All other provisions of SFAS No. 145 are effective for transactions
occurring and financial statements issued after May 15, 2002. The Company
adopted these provisions effective May 15, 2002, and there was not a financial
accounting impact associated with their adoption.
7
SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142") was
issued on July 20, 2001. SFAS No. 142 addresses financial accounting and
reporting for acquired goodwill and other intangible assets. The statement
eliminates amortization of goodwill and intangible assets with indefinite lives
and requires a transitional impairment test of these assets within six months of
the date of adoption and an annual impairment test thereafter in certain
circumstances. The Company adopted the provisions of this statement on January
1, 2002, and there was no material financial accounting impact associated with
its adoption.
SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets,"
("SFAS No. 144") was issued in October 2001. SFAS No. 144 provides new guidance
on the recognition of impairment losses on long-lived assets to be held and used
or to be disposed of and also broadens the definition of what constitutes a
discontinued operation and how the results of a discontinued operation are to be
measured and presented. The Company adopted the provisions of this statement on
January 1, 2002, and there was no financial accounting impact associated with
its adoption.
In September 2001, the EITF issued EITF 01-09, "Accounting for Consideration
Given by a Vendor to a Customer or Reseller of the Vendor's Products," which
applies to the income statement characterization of stock option awards,
royalties, and other cash consideration the Company pays its District Directors,
Branch Directors, Group Directors, Unit Directors, and Trainers. The Company
adopted the provisions on January 1, 2002, and there was no financial accounting
impact associated with its adoption.
6. DEBT RESTRUCTURE AND RELATED PARTY TRANSACTIONS
In January 2001, a limited partnership that includes an affiliate of Hicks,
Muse, Tate, & Furst Incorporated ("Hicks Muse"), certain members of the Donald
J. Carter Jr. family (the "Carter Family"), and their respective affiliates (the
"Note Limited Partnership") acquired, in the open market, $50.9 million
aggregate principal amount of the Company's 10 1/8% Series B Senior Subordinated
Notes due 2008 ("Notes") for approximately $23.0 million plus accrued interest.
In March 2001, another limited partnership that includes an affiliate of Hicks
Muse, certain members of the Carter Family, and their respective affiliates (the
"Debt Limited Partnership") purchased $44.9 million of the Company's senior bank
debt for approximately $35.6 million.
On July 16, 2001 the Company completed its debt restructuring (the "Debt
Restructure") through the following transactions:
- Transfer of $50.9 million aggregate principal amount of Notes from the
Note Limited Partnership to the Company in exchange for 50,900.00
shares of 12.5% Senior Convertible Preferred Stock, par value $.01 per
share, issued by the Company ("Senior Preferred Stock").
- Transfer of $44.9 million of the Company's senior bank debt from the
Debt Limited Partnership to the Company in exchange for 44,927.98
shares of Senior Preferred Stock.
- The Debt Limited Partnership purchased an additional 231 shares of
Senior Preferred Stock for $231,000 cash.
- The Company converted $44.9 million of the Term A Loans of the
Company's Senior Credit Facility into Term B Loans of the Company's
Senior Credit Facility.
- The Company's Senior Credit Facility was amended and restated to
provide for, among other things, an increase of $10 million in the
revolving credit line and the extension of the maturity dates of the
Term A and Term B Loans for an additional six month period.
As a result of the foregoing transactions, for financial reporting purposes,
the Company wrote off $2.4 million in unamortized debt issuance costs (with a
related income tax benefit of $902,000) and recorded $13.7 million of income
taxes. These transactions are reflected in the Statement of Operations as an
extraordinary loss for the nine-month period ending September 30, 2001.
Additionally, in connection with the Debt Restructure and Senior Preferred
Stock issuances, the Company incurred additional debt issuance costs of $1.3
million which have been deferred and $422,000 in costs related to the Senior
Preferred Stock issuance which have been recorded as a reduction to Senior
Preferred Stock during the third quarter of 2001.
Included in general and administrative expenses in the three months and nine
months ended September 30, 2001 are approximately $1.4 million and $3.4 million,
respectively, in costs related to legal and consulting fees associated with the
Company's amendment to its Senior Credit Facility.
8
In conjunction with the Debt Restructure, the Company designated 96,058.98
shares of Senior Preferred Stock. The shares of Senior Preferred Stock shares
have a par value of $0.01 per share and a liquidation preference of $1,000 per
share, together with all declared or accrued and unpaid dividends thereon. In
the event of any liquidation of the Company, holders of shares of Senior
Preferred Stock shall be paid the liquidation preference plus all accrued
dividends to the date of liquidation before any payments are made to the holders
of Common Stock. Dividends, as and if declared by the Company's Board of
Directors, are cumulative and payable quarterly beginning October 1, 2001 at the
rate of 12.5% of the liquidation preference per annum. Each share of Senior
Preferred Stock is convertible at any time at the option of the holder for
51.49330587 shares of the Company's Common Stock.
Holders of Senior Preferred Stock are entitled to the number of votes equal
to the number of shares of the Company's Common Stock into which such shares of
Senior Preferred Stock are convertible on the record date for such vote. Each
holder has a preemptive right to purchase a pro rata share of future securities
issuances, excluding public securities issued under applicable securities laws,
securities issued to employees and Displayers for incentive compensation and
securities issued in exchange for assets in the normal course of business.
On July 29, 2002, the Company completed a refinancing agreement through the
following transactions:
- The Company converted $31.0 million of a $50.0 million Term A Loans
into Term B Loans of the Company's Senior Credit Facility.
- The Company received from the Company's lenders under the Senior Credit
Facility a $35.0 million cash infusion in exchange for additional Term
B Loans.
- The Company's Senior Credit Facility was amended and restated to
provide for, among other items, increased interest rates for consenting
lenders 150 basis points over the interest rates currently paid to the
non-consenting lenders, modified quarterly principal payments, and
modification to the Company's required compliance thresholds for each
of the minimum EBITDA covenant, maximum leverage ratio covenant
(including senior leverage) and minimum fixed charge ratio covenant.
The maturity dates of the loans were not extended.
As a result of the foregoing refinancing transaction, the Company has
reported in the Statement of Operations as of September 30, 2002 an
extraordinary loss of $4.5 million. The extraordinary loss is comprised of $3.3
million in unamortized debt issuance costs, $3.9 million of fees paid to
creditors, less the related income tax benefit of $2.7 million.
7. SEGMENT REPORTING
The Company's reportable segments are based upon functional lines of
business as follows:
- Home Interiors "HI" -- direct seller of home decorative accessories in
the United States;
- Manufacturing -- manufactures framed artwork and mirrors, as well as
various types of molded plastic products and candles; and
- International -- direct seller of home decorative accessories in
Mexico, Puerto Rico, and Canada.
The Company evaluates the performance of its segments and allocates
resources to them based on earnings before interest, taxes, the effects of SAB
101, depreciation and amortization, reorganization costs, redundant warehouse
and distribution expenses, non-cash (expense) credit for stock options, gains
(losses) on disposition of assets, Senior Credit Facility restructuring and
amendment fees, and other income (expense) ("EBITDA"). The accounting principles
of the segments are the same as those described in Note 2. Segment data includes
intersegment sales and intercompany net receivable balances. 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 about reportable segments used by the
Company's executive management team as of and for the three months and nine
months ended September 30, 2001 and 2002 (in thousands):
9
THREE MONTHS ENDED
SEPTEMBER 30: HI MANUFACTURING INTERNATIONAL ELIMINATIONS CONSOLIDATED
- ------------------ --------- ------------- ------------- ------------ ------------
2001
Net sales $ 98,113 $ 29,059 $ 5,137 $(32,192) $ 100,117
EBITDA 10,782 8,163 777 (764) 18,958
2002
Net sales $ 119,160 $ 31,927 $ 8,558 $(33,972) $ 125,673
EBITDA 10,921 10,009 757 (254) 21,433
NINE MONTHS ENDED
SEPTEMBER 30: HI MANUFACTURING INTERNATIONAL ELIMINATIONS CONSOLIDATED
- ----------------- -------- ------------- ------------- ------------ ------------
2001
Net sales $293,464 $ 82,651 $ 14,154 $ (89,620) $ 300,649
EBITDA 29,984 24,590 1,443 (1,615) 54,402
Total assets 137,745 65,799 2,130 (52,537) 153,137
Capital expenditures 6,279 1,900 42 -- 8,221
2002
Net sales $371,207 $106,810 $ 24,446 $(112,066) $ 390,397
EBITDA 40,001 35,477 2,783 (1,709) 76,552
Total assets 205,372 90,813 5,781 (79,389) 222,577
Capital expenditures 7,615 1,551 18 -- 9,184
The following table represents a reconciliation of consolidated EBITDA to
income before income taxes for the three months and nine months ended September
30, 2001 and 2002 (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- --------------------------
2001 2002 2001 2002
------------ ----------- ------------ ------------
EBITDA........................................... $ 18,958 $ 21,433 $ 54,402 $ 76,552
Effects of SAB 101............................... (1,794) (535) (4,063) (2,730)
Depreciation and amortization.................... (2,460) (2,884) (6,862) (8,757)
Gain (loss) on the disposition of assets......... (131) -- (495) 361
Stock option (expense) credit.................... (212) (14) (246) (107)
Reorganization costs............................. (1,405) (704) (2,736) (2,043)
Redundant warehouse & distribution............... (29) -- (1,175) --
Senior Credit Facility amendment fees............ (1,391) -- (3,366) --
Interest income.................................. 74 121 986 245
Interest expense................................. (8,107) (7,009) (31,195) (20,274)
Other income (expense), net...................... (25) 421 241 (1,597)
--------- -------- --------- ---------
Income before income taxes and
extraordinary loss............................ $ 3,478 $ 10,829 $ 5,491 $ 41,650
========= ======== ========= =========
8. GUARANTOR FINANCIAL DATA
DWC, GIA, Homco, SVS, Laredo Candle and Homco Puerto Rico (collectively, the
"Guarantors") unconditionally, on a joint and several basis, guarantee the
Company's credit agreement with its principal lenders (the "Senior Credit
Facility"), and the Company's 10-1/8% Senior Subordinated Notes due 2008 in the
amount of $149.1 million (the "Notes"). The Company's other subsidiaries, Home
Interiors de Mexico and Home Interiors de Mexico Services (the "Non-Guarantors")
have not guaranteed the Senior Credit Facility nor the Notes. Guarantor and
Non-Guarantor financial statements on an individual basis are not significant
and have been omitted. Accordingly, the following table presents financial
information of the Guarantors and Non-Guarantors on a consolidating basis (in
thousands):
10
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001
THREE MONTHS ENDED
SEPTEMBER 30: HI GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
- ------------------------------ ---------- -------------- ------------------ ---------------- ----------------
Net sales................... $ 98,113 $ 29,411 $ 4,785 $ (32,192) $ 100,117
Cost of goods sold.......... 52,491 20,455 2,395 (31,428) 43,913
------ ------ ----- ------- -------
Gross profit.............. 45,622 8,956 2,390 (764) 56,204
Total selling, general and
administrative............ 41,502 1,448 1,718 -- 44,668
------ ------ ----- ------- -------
Operating income.......... 4,120 7,508 672 (764) 11,536
Other income (expense), net. (8,130) 209 (137) -- (8,058)
------ ------ ----- ------- -------
Income (loss) before income
taxes and extraordinary
loss..................... (4,010) 7,717 535 (764) 3,478
Benefit (provision) for income
taxes..................... 1,187 (2,184) (321) -- (1,318)
Equity in earnings of
affiliated companies,
net of tax............... 5,746 2 -- (5,748) --
------ ------ ----- ------- -------
companies, net of tax......
Income before extraordinary
loss...................... 2,923 5,535 214 (6,512) 2,160
Extraordinary loss.......... 15,200 -- -- -- 15,200
------ ------ ----- ------- -------
Net income (loss)......... (12,277) 5,535 214 (6,512) (13,040)
Other comprehensive loss.... (114) -- (10) -- (124)
------ ------ ----- ------- -------
Comprehensive income (loss) $ (12,391) $ 5,535 $ 204 $ (6,512) $ (13,164)
====== ====== ===== ======= =======
NINE MONTHS ENDED
SEPTEMBER 30: HI GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
- ----------------------------- ---------- -------------- ------------------ ---------------- ----------------
Net sales................... $ 293,464 $ 83,583 $ 13,222 $ (89,620) $ 300,649
Cost of goods sold.......... 156,037 56,685 6,906 (88,005) 131,623
------- ------ ------ ------ -------
Gross profit.............. 137,427 26,898 6,316 (1,615) 169,026
Total selling, general and
Administrative............ 124,114 4,378 5,075 -- 133,567
------- ------ ------ ------ -------
Operating income.......... 13,313 22,520 1,241 (1,615) 35,459
Other income (expense), net. (30,888) 1,003 (83) -- (29,968)
------- ------ ------ ------ -------
Income (loss) before income
taxes and extraordinary
loss..................... (17,575) 23,523 1,158 (1,615) 5,491
Benefit (provision) for income
taxes..................... 6,344 (8,249) (152) -- (2,057)
Equity in earnings of
affiliated companies,
net of tax...... 16,278 10 -- (16,288) --
------- ------ ------ ------ -------
Income before extraordinary
loss...................... 5,047 15,284 1,006 (17,903) 3,434
Extraordinary loss.......... 15,200 -- -- -- 15,200
------- ------ ------ ------ -------
Net income (loss)......... (10,153) 15,284 1,006 (17,903) (11,766)
Other comprehensive income
(loss).................... 114 -- (57) -- 57
------- ------ ------ ------ -------
Comprehensive income (loss) $ (10,039) $ 15,284 $ 949 $ (17,903) $ (11,709)
======= ====== ====== ====== =======
11
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002
THREE MONTHS ENDED
SEPTEMBER 30: HI GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
- ----------------------------- ---------- -------------- ------------------ ---------------- ----------------
Net sales................... $ 119,865 $ 32,556 $ 7,224 $(33,972) $ 125,673
Cost of goods sold.......... 64,124 21,522 4,072 (33,718) 56,000
------- ------ ------ ------ -------
Gross profit.............. 55,741 11,034 3,152 (254) 69,673
Total selling, general and
administrative............ 48,295 1,518 2,564 -- 52,377
------- ------ ------ ------ -------
Operating income.......... 7,446 9,516 588 (254) 17,296
Other income (expense), net. (6,851) 128 (88) 344 (6,467)
------- ------ ------ ------ -------
Income before income taxes.. 595 9,644 500 90 10,829
Provision for income taxes
and extraordinary loss..... (869) (2,853) (198) -- (3,920)
Equity in earnings of
affiliated companies,
net of tax...... 7,092 3 -- (7,095) --
------- ------ ------ ------ -------
Income before extraordinary
loss...................... 6,818 6,794 302 (7,005) 6,909
Extraordinary loss.......... 4,528 -- -- -- 4,528
------- ------ ------ ------ -------
Net income................ 2,290 6,794 302 (7,005) 2,381
Other comprehensive income
(loss).................... 5 -- (37) -- (32)
------- ------ ------ ------ -------
Comprehensive income...... $ 2,295 $ 6,794 $ 265 $ (7,005) $ 2,349
======= ====== ====== ====== =======
NINE MONTHS ENDED
SEPTEMBER 30: HI GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
- ----------------------------- ---------- -------------- ------------------ ---------------- ----------------
Net sales................... $ 372,982 $108,671 $20,810 $(112,066) $ 390,397
Cost of goods sold.......... 199,670 69,982 10,818 (110,357) 170,113
------- ------ ------ ------ -------
Gross profit.............. 173,312 38,689 9,992 (1,709) 220,284
Total selling, general and
administrative............ 144,673 4,872 7,463 -- 157,008
------- ------ ------ ------ -------
Operating income.......... 28,639 33,817 2,529 (1,709) 63,276
Other income (expense), net. (21,183) 339 (438) (344) (21,626)
------- ------ ------ ------ -------
Income before income taxes 7,456 34,156 2,091 (2,053) 41,650
Provision for income taxes
and extraordinary loss.. (3,107) (11,742) (561) (15,410)
Equity in earnings of
affiliated companies,
net of tax............... 23,942 15 -- (23,957) --
------- ------ ------ ------ -------
Income before extraordinary
loss...................... 28,291 22,429 1,530 (26,010) 26,240
Extraordinary loss.......... 4,528 -- -- -- 4,528
------- ------ ------ ------ -------
Net income................ 23,763 22,429 1,530 (26,010) 21,712
Other comprehensive income
(loss).................... 9 -- (199) -- (190)
------- ------ ------ ------ -------
Comprehensive income...... $ 23,772 $ 22,429 $ 1,331 $(26,010) $ 21,522
======= ====== ====== ====== =======
12
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 2001
HI GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
----------- ------------ ---------------- -------------- --------------
ASSETS
Current assets:
Cash and cash equivalents................... $ 13,757 $ (542) $ 497 $ -- $ 13,712
Accounts receivable, net.................... 9,879 1,022 802 -- 11,703
Inventories, net............................ 36,238 5,141 1,944 (2,871) 40,452
Other current assets........................ 5,743 1,707 186 -- 7,636
Due to (due from) affiliated companies...... (42,484) 43,503 (1,019) -- --
-------- ------ ------ ------- --------
Total current assets.................. 23,133 50,831 2,410 (2,871) 73,503
Property, plant and equipment, net............ 47,213 17,591 360 -- 65,164
Investment in subsidiaries.................... 56,442 17 -- (56,459) --
Debt issuance costs and other assets, net..... 10,736 5,554 (409) -- 15,881
-------- ------ ------ ------- --------
Total assets.......................... $ 137,524 $ 73,993 $ 2,361 $(59,330) $ 154,548
======== ====== ====== ======= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
(DEFICIT)
Current liabilities:
Accounts payable............................ $ 22,697 $ 2,210 $ 133 $ 632 $ 25,672
Current maturities of long-term debt
and capital lease obligations............ 15,031 -- -- -- 15,031
Other current liabilities................... 35,167 15,522 887 -- 51,576
-------- ------ ------ ------- --------
Total current liabilities............. 72,895 17,732 1,020 632 92,279
Long-term debt and capital lease obligations,
net of current maturities................ 302,811 -- -- -- 302,811
Other liabilities............................. 20,973 1,498 -- -- 22,471
-------- ------ ------ ------- --------
Total liabilities..................... 396,679 19,230 1,020 632 417,561
-------- ------ ------ ------- --------
Commitments and contingencies
Shareholders' equity (deficit):
Preferred stock............................. 95,637 -- -- -- 95,637
Common stock................................ 1,524 1,000 14 (1,014) 1,524
Additional paid-in capital.................. 179,562 26,642 1,014 (27,656) 179,562
Retained earnings (accumulated deficit)..... (535,878) 27,121 670 (31,292) (539,379)
Other....................................... -- -- (357) -- (357)
-------- ------ ------ ------- --------
Total shareholders' equity
(deficit)........................... (259,155) 54,763 1,341 (59,962) (263,013)
-------- ------ ------ ------- --------
Total liabilities and shareholders'
equity (deficit).................... $ 137,524 $ 73,993 $ 2,361 $(59,330) $ 154,548
======== ====== ====== ======= ========
13
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF SEPTEMBER 30, 2002
HI GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
------------ ------------ ---------------- --------------- --------------
ASSETS
Current assets:
Cash and cash equivalents..................... $ 35,102 $ (1,711) $ 545 $ -- $ 33,936
Accounts receivable, net...................... 17,735 1,366 2,367 -- 21,468
Inventories, net.............................. 68,945 8,437 5,000 (4,925) 77,457
Other current assets.......................... 10,441 1,346 623 -- 12,410
Due to (due from) affiliated companies........ (55,391) 59,150 (3,759) -- --
-------- ------ ------ ------- --------
Total current assets.................... 76,832 68,588 4,776 (4,925) 145,271
Property, plant and equipment, net.............. 48,403 17,327 325 -- 66,055
Investment in subsidiaries...................... 74,432 32 -- (74,464) --
Debt issuance costs and other assets, net....... 5,705 5,546 -- -- 11,251
-------- ------ ------ ------- --------
Total assets............................ $ 205,372 $ 91,493 $ 5,101 $(79,389) $ 222,577
======== ====== ====== ======= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
(DEFICIT)
Current liabilities:
Accounts payable.............................. $ 25,030 $ 2,629 $ 238 $ 632 $ 28,529
Current maturities of long-term debt
and capital lease obligations.............. 8,718 -- -- -- 8,718
Other current liabilities..................... 49,038 16,023 1,341 -- 66,402
-------- ------ ------ ------- --------
Total current liabilities.................. 82,786 18,652 1,579 632 103,649
Long-term debt and capital lease obligations,
net of current maturities.................. 337,575 -- -- -- 337,575
Other liabilities............................... 20,280 1,605 852 -- 22,737
-------- ------ ------ ------- --------
Total liabilities....................... 440,641 20,257 2,431 632 463,961
-------- ------ ------ ------- --------
Commitments and contingencies
Shareholders' equity (deficit):
Preferred stock............................... 95,637 -- -- -- 95,637
Common stock.................................. 1,524 1,000 14 (1,014) 1,524
Additional paid-in capital.................... 179,669 29,920 1,014 (30,934) 179,669
Retained earnings (accumulated deficit)....... (512,109) 40,316 2,199 (48,073) (517,667)
Other......................................... 10 -- (557) -- (547)
-------- ------ ------ ------- --------
Total shareholders' equity
(deficit)............................. (235,269) 71,236 2,670 (80,021) (241,384)
-------- ------ ------ ------- --------
Total liabilities and shareholders'
equity (deficit)...................... $ 205,372 $ 91,493 $ 5,101 $(79,389) $ 222,577
======== ====== ====== ======= ========
14
CONDENSED CONSOLIDATING CASH FLOW INFORMATION
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001
---------------------------------------------------------------------------------
HI GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
-------- --------------- ------------------- ----------------- --------------
Net cash provided by (used in)
operating activities.............. $ 5,966 $ 845 $(191) $ -- $ 6,620
Cash flows from investing activities:
Purchase of property, plant
and equipment.................... (6,278) (1,900) (43) -- (8,221)
Proceeds from the sale of property,
plant and equipment.............. 33 217 -- -- 250
------- ------ ---- ------ -------
Net cash used in investing
activities....................... (6,245) (1,683) (43) -- (7,971)
------- ------ ---- ------ -------
Cash flows from financing activities:
Increase in book overdraft payable.. (98) 522 -- -- 424
Payments under capital lease
obligations...................... (985) -- -- -- (985)
Payment under the Senior Credit
Facility......................... (17,589) -- -- -- (17,589)
Proceeds from borrowings under
revolving loan.. ................ 14,000 -- -- -- 14,000
Payments for borrowings under
revolving loan.... .............. (34,000) -- -- -- (34,000)
Debt issuance costs................. (1,574) -- -- -- (1,574)
Proceeds from issuance of preferred
stock........................... 231 -- -- -- 231
Preferred stock issuance cost....... (422) -- -- -- (422)
------- ------ ---- ------ -------
Net cash provided by (used in)
financing activities............. (40,437) 522 -- -- (39,915)
------- ------ ---- ------ -------
Effect of cumulative translation
adjustment....................... -- -- (57) -- (57)
------- ------ ---- ------ -------
Net decrease in cash and cash
equivalents....................... (40,716) (316) (291) -- (41,323)
Cash and cash equivalents at the
beginning of year................. 40,823 432 465 -- 41,720
------- ------ ---- ------ -------
Cash and cash equivalents at the end
of the period...................... $ 107 $ 116 $ 174 $ -- $ 397
======= ====== ==== ====== =======
FOR THE NINE ENDED SEPTEMBER 30, 2002
----------------------------------------------------------------------------------
HI GUARANTORS NON-GUARANTORS ELIMINATIONS CONSOLIDATED
-------- --------------- ------------------ ---------------- ----------------
Net cash provided by operating
activities......................... $ 4,036 $ 382 $ 266 $ -- $ 4,684
Cash flows from investing activities:
Purchase of property, plant
and equipment.................... (7,615) (1,551) (18) -- (9,184)
Purchase of intangible assets...... (10) -- -- -- (10)
Proceeds from the sale of property,
plant and equipment.............. 574 -- -- -- 574
------- ------ ----- ------ -------
Net cash used in investing
activities....................... (7,051) (1,551) (18) -- (8,620)
------- ------ ----- ------ -------
Cash flows from financing activities:
Payments under capital lease
obligations...................... (1,049) -- -- -- (1,049)
Payment under the Senior Credit
Facility......................... (5,500) -- -- -- (5,500)
Proceeds from borrowings under the
Senior Credit Facility.......... 35,000 -- -- -- 35,000
Debt issuance costs................ (4,101) -- -- -- (4,101)
------- ------ ----- ------ --------
Net cash provided by financing
activities....................... 24,350 -- -- -- 24,350
------- ------ ----- ------ -------
Effect of cumulative translation
adjustment......................... 10 -- (200) -- (190)
------- ------ ----- ------ -------
Net increase (decrease) in cash and
cash 21,345 (1,169) 48 -- 20,224
equivalents......................
Cash and cash equivalents at the
beginning of year.................. 13,757 (542) 497 -- 13,712
------- ------ ----- ------ -------
Cash and cash equivalents at the end
of the period...................... $ 35,102 $(1,711) $ 545 $ -- $ 33,936
======= ====== ===== ====== =======
15
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, 2001, included in its Form 10-K and Form 10-K/A.
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) Displayer recruiting and activity
levels; (ii) loss or retirement of key members of management; (iii) imposition
of federal or state taxes; (iv) change in status of independent contractors; (v)
increased competition; (vi) the success of new products and promotion programs;
(vii) unexpected problems associated with the new enterprise resource planning
system ("ERP") and (viii) general economic conditions. 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. As of September 30,
2002, the Company sold its products to approximately 63,600 active Displayers
located in the United States. The Company is also represented in Mexico, Puerto
Rico and Canada. The Company's sales are dependent upon the number of Displayers
selling the Company's products and their resulting productivity. Displayer
productivity fluctuates from time to time based on seasonality and special
marketing programs, which offer Displayers new incentives and discounts timed to
generate additional sales.
To stimulate sales, the Company offers a variety of discounts and incentives
to Displayers. The amount and timing of discounts and incentives vary from year
to year. The cost of discounts is reflected in the Company's net sales while the
cost of incentives is reflected in selling expense.
COMPANY STRATEGY
The Company has evolved its strategy to put greater focus on what management
believes to be the key drivers of the business which are recruiting, retention
and productivity of the Displayer base and leveraging of the assets of the
manufacturing subsidiaries.
The number of new Displayers who have been recruited during the nine months
ended September 30, 2002 and approved through the Company's application process
increased 22.5% as compared to the nine months ended September 30, 2001
resulting from the successful implementation of the Company's career strategies
and promotions directed at recruiting. The increase in the number of new
recruits emphasizes the Company's focus on training and retention in order to
help the new Displayers become productive and successful in their business.
The Company also experienced a 2% increase in retention of Displayers with
greater than two years of service for the nine months ended September 30, 2002.
The retention of experienced Displayers was a result of significant improvements
in areas such as product
16
distribution fulfillment rates, product selection and Displayer training and
motivation. Fulfillment rates for product distribution remained strong at 99% as
of September 30, 2002. The Company is continuing to introduce new products in
2002 in an attempt to give the product line a fresh and more innovative look.
New products are carefully selected and tested with Displayers prior to their
introduction and placement in the product line. In the first nine months of
2002, the Company launched a new children's line and a new line of prints from
the award-winning artist Thomas Kinkade, also known as the "Painter of
Light(TM)." The initial responses to these new product lines have been positive.
In addition, the Company has added 35 new products to its Christmas line.
The Company introduced sales promotion and development activities directed
at helping Displayers increase their individual sales. In 2002, Displayer
productivity increased 19.0% as measured by average sales per Displayer in the
nine-month period ended September 30, 2002 as compared to the same period in
2001. Sales tools such as the "Show Flip Chart" introduced in 2001, have helped
the Displayers conduct successful Show presentations. The increase in
productivity for the nine months ended September 30, 2002 was also partially
attributable to the success of the "Pocketful of Hope" charity initiative,
raising approximately $1.1 million for various charities such as the American
Heart Association, National Fallen Firefighters Foundations, and breast cancer
research and awareness initiatives.
In addition to recruiting, retention and productivity, the Company initiated
improvements in other operational areas. The Company continues to emphasize
products of its manufacturing subsidiaries, which provide opportunities for
gross margin improvement, and leverage of the fixed expense component of its
cost structure. The manufacturing subsidiaries have also initiated additional
sales to customers external to the Company. Outside sales for the nine months
ended September 30, 2002 were $6.9 million. In comparison, outside sales for the
nine months ended September 30, 2001 were $782,000. In addition, the Company
initiated business operations in Canada during 2001 as a way of developing and
promoting growth of the core business. Through the first nine months of 2002,
the financial impact of Canada operations has been minimal.
REORGANIZATION ACTIVITIES
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. In December 2000, the Company relocated its corporate headquarters
to the new warehouse and distribution facility. Through September 30, 2002, the
Company has sublet approximately 44,000 square feet of its 75,000 square feet of
vacated corporate headquarters to a subtenant.
Included in general and administrative expenses in the three months and nine
months ended September 30, 2002 and 2001 Consolidated Statements of Operations
and Comprehensive Income are costs related to excess facilities, fees related to
obtaining a debt covenant waiver in 2001, consulting costs associated with the
Company's reorganization plan, and uncapitalizable fees related to ERP. These
costs totaled $704,000 and $2.0 million in the three and nine months ended
September 30, 2002 as compared to $2.7 million and $5.9 million in the three and
nine months ended September 30, 2001, respectively. Included in selling expense
for the three and nine months ended September 30, 2001 were labor related costs
of approximately $97,000 and $227,000, respectively, related to redundant costs.
There were no redundant selling costs in the comparable 2002 periods.
RESULTS OF OPERATIONS
The Three Months Ended September 30, 2002 Compared to the Three Months Ended
September 30, 2001
Net sales increased $25.6 million, or 25.5%, to $125.7 million in the three
months ended September 30, 2002, from $100.1 million in the comparable period in
2001. The principal variables that impact net sales include the number of
Displayers, the number of orders shipped, the number of orders per Displayer and
average order size. Each of these variables increased in the three months ended
September 30, 2002 as compared to the comparable period of 2001. The average
number of active Displayers increased to approximately 63,900 in the three
months ended September 30, 2002, from 58,000 in the same period of 2001. The
number of orders shipped increased 13.3% to 217,486 in the third quarter of 2002
from 191,911 in the 2001 period. In addition, the number of orders per Displayer
increased 3.0% to 3.41 from 3.31 for the three months ended September 30, 2002
and 2001, respectively. Finally, the average order size increased 7.0% to $522
in the three months ended September 30, 2002, as compared to $488 in the
comparable period in 2001. These variables, combined with increased outside
sales by the Company's manufacturing subsidiaries of $2.1 million, comprised the
majority of the increase in net sales.
Gross profit increased $13.5 million, or 24.0%, to $69.7 million in the
three months ended September 30, 2002 from $56.2 million in the three months
ended September 30, 2001. As a percentage of net sales, gross profit decreased
to 55.4% in the third quarter of 2002 from 56.1% in the third quarter of 2001.
The decrease in the gross profit percentage was due to additional sales
promotion discounts in the quarter ended September 30, 2002 as compared to the
quarter ended September 30, 2001 and the increase in outside sales which have
slightly lower gross margins.
17
Selling expense increased 22.4% to $23.3 million in the three months ended
September 30, 2002 from $19.1 million in the comparable period of 2001. As a
percentage of net sales, selling expense decreased to 18.6% as of the quarter
ended September 30, 2002 from 19.0% in the comparable period of 2001. The
decrease in percentage is primarily due to the timing of promotional related
expenses including lower costs of incentive trips as a percentage of net sales
and decreases in field related expenses such as reimbursed selling expense.
These reductions were partially offset by higher Director related bonuses as a
result of increased commissionable sales over the comparable periods. Redundant
labor costs of approximately $97,000 are included in selling expense for the
quarter ended September 30, 2001. There were no related redundant selling costs
in the three months ended September 30, 2002.
Freight, warehouse and distribution expense increased $3.8 million, or
33.5%, to $15.0 million in the three months ended September 30, 2002 from $11.2
million in the three months ended September 30, 2001. These costs were 11.9% of
net sales in the 2002 period, as compared to 11.2% in the comparable 2001
period. The primary reason for the increase in percentage as compared to net
sales is the costs associated with additional warehousing space required for the
growth in inventory.
General and administrative expense remained flat at $14.0 million in the
three months ended September 30, 2002 compared to the same period in 2001.
Credit card fees increased $1.5 million and hostess merit income decreased $0.3
million for the three months ended September 30, 2002 compared to the same
period in 2001. Certain additional non-recurring costs related to excess
facilities, fees related to obtaining a debt covenant waiver in 2001, consulting
costs associated with the Company's reorganization plan and uncapitalizable fees
related to ERP are included in general and administrative expenses. These costs
were approximately $704,000 and $2.7 million for the quarter ended September 30,
2002 and 2001, respectively.
Redundant warehouse and distribution expenses of approximately $29,000 were
recorded in the three months ended September 30, 2001, and consisted primarily
of costs associated with operating certain manual distribution centers longer
than anticipated and consolidation of the manual distribution centers into the
new distribution facility. There were no redundant warehouse and distribution
expenses in the three months ended September 30, 2002.
Interest expense decreased $1.1 million to $7.0 million in the three months
ended September 30, 2002, from $8.1 million in the three months ended September
30, 2001. Despite the $35 million of additional debt incurred in the third
quarter of 2002, the decrease in interest expense is primarily related to the
lower debt balance as a result of the conversion of $95.8 million in debt to
12.5% Senior Convertible Preferred Stock, par value $0.01 per share, issued by
the Company (the "Senior Preferred Stock") as part of the debt restructuring
that occurred in July 2001.
Income taxes increased $2.6 million to $3.9 million in the three months
ended September 30, 2002 from $1.3 million in the comparable period of 2001.
Income taxes, as a percentage of income before income taxes was 36.2% in the
three months ended September 30, 2002, as compared to 37.9% in the three months
ended September 30, 2001. The decrease in percentage for the three month period
ended September 30, 2002 is due to the corporate restructuring of certain
subsidiaries, thereby lowering the overall state income tax percentage.
The Nine Months Ended September 30, 2002 Compared to the Nine Months Ended
September 30, 2001
Net sales increased $89.8 million, or 29.9%, to $390.4 million in the nine
months ended September 30, 2002, from $300.6 million in the comparable period in
2001. The principal variables that impact net sales include the number of
Displayers, the number of orders shipped, the number of orders per Displayer and
average order size. Each of these variables increased in the nine months ended
September 30, 2002 as compared to the comparable period of 2001. The average
number of active Displayers increased to approximately 61,400 in the nine months
ended September 30, 2002, from 58,100 in the same period of 2001. The number of
orders shipped increased 16.9% to 648,435 in the first nine months of 2002 from
554,889 in the 2001 period. In addition, the number of orders per Displayer
increased 10.7% to 10.56 from 9.54 for the nine months ended September 30, 2002
and 2001, respectively. Finally, the average order size increased 7.6% to $552
in the nine months ended September 30, 2002, as compared to $513 in the
comparable period in 2001. These variables, combined with increased outside
sales by the Company's manufacturing subsidiaries of $6.1 million, comprised the
majority of the increase in net sales.
Gross profit increased $51.3 million, or 30.3%, to $220.3 million in the
nine months ended September 30, 2002 from $169.0 million in the nine months
ended September 30, 2001. As a percentage of net sales, gross profit increased
to 56.4% in the first nine
18
months of 2002 from 56.2% in the comparable period of 2001. The increase in the
gross profit percentage was due to the continued introduction of new products
with higher gross margins, an increased focus on emphasizing the products of the
Company's manufacturing subsidiaries and improved margins on the Company's
imported products.
Selling expense increased 25.2% to $72.4 million in the nine months ended
September 30, 2002 from $57.8 million in the comparable period of 2001. As a
percentage of net sales, selling expense decreased to 18.5% as of the nine
months ended September 30, 2002 from 19.2% in the comparable period of 2001. The
decrease in percentage is primarily due to cost and timing of promotional
related expenses including lower costs of incentive trips as a percentage of net
sales and decreases in field related expenses such as reimbursed selling
expense. These decreases were partially offset by an increase in Director
bonuses as a result of increased commissionable sales over the comparable
periods. Redundant labor costs of approximately $227,000 are included in selling
expense for the nine months ended September 30, 2001. There were no related
redundant selling costs in the nine months ended September 30, 2002.
Freight, warehouse and distribution expense increased $10.7 million, or
32.8%, to $43.2 million in the nine months ended September 30, 2002 from $32.5
million in the nine months ended September 30, 2001. As a percentage of net
sales, these costs were 11.1% in the nine months ended September 30, 2002 as
compared to 10.8% in the comparable 2001 period. The primary reason for the
increase in percentage as compared to net sales is the costs associated with
additional warehousing space required for the growth in inventory.
General and administrative expense increased $0.4 million, or 0.9%, to $41.7
million in the nine months ended September 30, 2002, from $41.3 million in the
nine months ended September 30, 2001. The increase is primarily related to an
increase of $1.6 million related to credit card fees, $1.6 million related to
increased depreciation on additional equipment, $0.7 million increase in
insurance expense, $0.7 million increase in charitable contributions, and $0.5
million increase related to professional fees. These increases were offset by a
$0.9 million decrease related to repairs and maintenance as well as a decrease
in certain additional non-recurring costs related to excess facilities, fees
related to obtaining a debt covenant waiver in 2001, consulting costs associated
with the Company's reorganization plan and uncapitalizable fees related to ERP.
These costs were approximately $2.0 million and $5.9 million for the nine months
ended September 30, 2002 and 2001, respectively.
Redundant warehouse and distribution expenses of approximately $1.2 million
were recorded in the nine months ended September 30, 2001, and consisted
primarily of costs associated with operating certain manual distribution centers
longer than anticipated and consolidation of the manual distribution centers
into the new distribution facility. There were no redundant warehouse and
distribution expenses in the nine months ended September 30, 2002.
Interest expense decreased $10.9 million to $20.3 million in the nine months
ended September 30, 2002, from $31.2 million in the nine months ended September
30, 2001. Despite the $35 million of additional debt incurred in the third
quarter of 2002, the decrease in interest expense is primarily related to the
lower debt balance as a result of the conversion of $95.8 million in debt to
Senior Preferred Stock as part of the debt restructuring that occurred in July
2001.
Income taxes increased $13.3 million to $15.4 million in the nine months
ended September 30, 2002 from $2.1 million in the comparable period of 2001.
Income taxes, as a percentage of income before income taxes was 37.0% in the
nine months ended September 30, 2002, as compared to 37.5% in the nine months
ended September 30, 2001. The Company believes that the effective income tax
rate for the year ended December 31, 2002 will be consistent with its effective
income tax rate for the nine-month period ended September 30, 2002.
SEGMENT PROFITABILITY
The Company's reportable segments include its domestic direct sales
business, its manufacturing operations and its international direct sales
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, Puerto Rico and Canada. 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 7
to the Consolidated Financial Statements.
The Three Months Ended September 30, 2002 compared to the Three Months Ended
September 30, 2001
19
Consolidated net sales increased $25.6 million, or 25.5%, to $125.7 million
in the three months ended September 30, 2002, from $100.1 million in the
comparable 2001 period. This increase is primarily due to the $21.0 million or
21.5% increase in the Company's domestic direct sales. See discussion in
"Results of Operations." International sales increased $3.5 million, or 66.6%,
to $8.6 million in the three months ended September 30, 2002, from $5.1 million
in the three months ended September 30, 2001. This increase is primarily due to
a 78.3% increase in the three-month average active Displayer count in Mexico to
12,516 as of September 30, 2002 from 7,018 as of September 30, 2001.
Manufacturing related sales increased $2.8 million, or 9.9%, to $31.9 million in
the third quarter of 2002, from $29.1 million in the third quarter of 2001.
Outside sales for Laredo Candle were $1.3 million for the three months ended
September 30, 2002. There were no outside sales for Laredo Candle in the same
period of 2001. DWC contributed $1.1 million in outside sales in the quarter
ended September 30, 2002 as compared to $268,000 comparable quarter in 2001. The
Company is continuing to develop relationships with its current and new outside
sales customers.
Consolidated EBITDA increased $2.4 million, or 13.1%, to $21.4 million in
the three months ended September 30, 2002, from $19.0 million in the comparable
period of 2001. International related EBITDA decreased approximately $20,000 to
$757,000 in the three months ended September 30, 2002 from $777,000 in the
comparable period in 2001 primarily due to unfavorable movement in the exchange
rate for the peso in the third quarter of 2002 as compared to the same period
last year. Manufacturing related EBITDA increased $1.8 million, or 22.6% to
$10.0 million in the three months ended September 30, 2002, from $8.2 million in
the comparable period of 2001. This increase is primarily due to the overall
increase in sales of the manufacturing subsidiaries, including increased outside
sales, and improved manufacturing efficiencies.
The Nine Months Ended September 30, 2002 compared to the Nine Months Ended
September 30, 2001
Consolidated net sales increased $89.8 million, or 29.9%, to $390.4 million
in the nine months ended September 30, 2002, from $300.6 million in the
comparable 2001 period. This increase is primarily due to the $77.7 million or
26.5% increase in the Company's domestic direct sales. See discussion in
"Results of Operations." International sales increased $10.2 million, or 72.7%,
to $24.4 million in the nine months ended September 30, 2002, from $14.2 million
in the nine months ended September 30, 2001. This increase is primarily due to a
78.2% increase in the nine-month average active Displayer count in Mexico to
11,060 as of September 30, 2002 from 6,208 as of September 30, 2001.
Manufacturing related sales increased $24.1 million, or 29.2%, to $106.8 million
in the first nine months of 2002, from $82.7 million in the first nine months of
2001.
Outside sales for Laredo Candle were $5.0 million for the nine months ended
September 30, 2002. There were no outside sales for Laredo Candle in the same
period of 2001. DWC contributed $1.9 million in outside sales for the same
period of 2002 as compared to $782,000 in the nine months ended September 30,
2001.
Consolidated EBITDA increased $22.2 million, or 40.7%, to $76.6 million in
the nine months ended September 30, 2002, from $54.4 million in the comparable
period of 2001. International related EBITDA increased approximately $1.4
million to $2.8 million in the nine months ended September 30, 2002 from $1.4
million in the comparable period in 2001. This increase is primarily due to the
increase in Displayers in Mexico. Manufacturing related EBITDA increased $10.9
million, or 44.3% to $35.5 million in the nine months ended September 30, 2002,
from $24.6 million in the comparable period of 2001. This increase is primarily
due to the overall increase in sales of the manufacturing subsidiaries,
including outside sales, and improved manufacturing efficiencies.
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,
incentive promotions 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.
20
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents increased to $33.9 million as of
September 30, 2002, from $13.7 million at December 31, 2001. This increase was a
result of net cash provided by operating activities of $4.6 million and net cash
provided by financing activities of $24.4 million and offset by net cash used in
investing activities of $8.6 million as well as a decrease of $0.2 million
related primarily to cumulative translations adjustments for our Mexico and
Canada operations.
Net cash provided by operating activities decreased $1.9 million during the
nine months ended September 30, 2002, as compared to the nine months ended
September 30, 2001. Net income increased $33.5 million and was offset by
decreases in non-cash related items of $8.5 million which consisted primarily of
a $10.7 million decrease in extraordinary loss related to the debt restructuring
that occurred in July 2001 and $1.9 million increase in depreciation and
amortization. In addition, working capital decreased by $26.9 million which
consists of a $15.1 million increase in inventories, $1.5 million increase in
accounts receivable, $2.4 million increase in other current assets, $3.5 million
decrease in income taxes payable, and $4.5 million decrease in other accrued
liabilities. The primary reason for the change in the working capital components
relates to the increase in sales over the prior year. In addition, inventory
increased in September 2002 due to early purchases in preparation for the
Longshoreman strike that occurred in the third quarter of 2002 as well as a
change in the timing of inventory ownership whereby the title to overseas
products passes to the Company when it leaves the overseas port as compared to
when it is received at our Dallas distribution center.
The Company has been closely monitoring the Longshoreman labor dispute and
has taken steps to mitigate the risk to the business. The Company has worked
with import suppliers to obtain inventory earlier in 2002 as compared to 2001.
As a direct result, the Company had approximately $10.6 million of inventory on
the water at the end of September 2002 as compared to $4.0 million as of
December 31, 2001, and total inventory, net of the reserve, was $77.5 million as
compared to $40.5 million as of December 31, 2001. Subsequently, inventory on
the water has decreased to $3.6 million as of November 12, 2002. By accelerating
the Company's inventory purchases, the Company experienced very few lost sales
due to inventory shortages and had no inventory reserve issues related to
seasonal items that were delayed. In October 2002, President Bush invoked the
Taft-Hartley Act to provide strike relief. The Company will continue to monitor
the Longshoreman labor dispute, but the Company could experience a delay in new
import product introductions if the Longshoreman labor dispute is not resolved.
Net cash used in investing activities increased $0.6 million in the nine
months ended September 30, 2002 as compared to the nine months ended September
30, 2001. Purchases of property, plant and equipment in the nine months ended
September 30, 2002 totaled $9.2 million, as compared to $8.2 million in the nine
months ended September 30, 2001.
In November 2001, the Company initiated a project to install a new ERP
system in the Dallas corporate office and selected the J. D. Edwards, OneWorld
XE Solutions, software package. The Company elected to undertake this project to
mitigate the risks associated with the stability and productivity of the current
information systems. The Company expects that the new ERP system will increase
scalability, enhance functionality and provide a strong technical foundation to
support anticipated growth. The implementation of the new ERP system is expected
to be completed before December 31, 2002. The Company could experience business
interruption and an increase to current cost estimates of the project if the
estimated project plan were to encounter unexpected delays. Since the inception
of the project in 2001 and excluding internal costs and capitalized interest,
the cash outlay for the ERP system was approximately $9.0 million.
Net cash provided by financing activities was $24.4 million in the nine
months ended September 30, 2002, as compared to a use of $39.9 million in the
nine months ended September 30, 2001. Financing activities in the nine months
ended September 30, 2002 consisted of principal payments on debt and capital
leases of $6.5 million, $4.1 million of debt issuance costs related to the
refinancing in July 2002, and proceeds of $35.0 million of additional debt that
was issued in July 2002. The comparable period of 2001 consisted primarily of
$18.6 million of principle payments on debt and capital leases, $1.6 million of
debt issuance costs related to the restructuring of debt that occurred in July
2001, and $20.0 million net paydown of borrowings against the Revolver.
Payments on the Company's Notes and the Senior Credit Facility represent
significant cash requirements for the Company. Interest payments on the Notes
commenced in December 1998 and will continue semi-annually until the Notes
mature in 2008. Borrowings under the Senior Credit Facility require monthly
interest payments and quarterly principal payments. In addition, the Senior
Credit Facility includes $30.0 million of revolving loans ("Revolving Loans"),
that mature on June 30, 2004.
As a result of the timing and the magnitude of working capital requirements
and purchases of property, plant and equipment, the Company utilized the
Revolving Loans during the nine months ended September 30, 2001. As of September
30, 2001, there was no outstanding balance on the Revolving Loans. The Revolving
Loans were not utilized during the first nine months of 2002 and as of September
30, 2002, there was not an outstanding balance on the Revolving Loans.
The Company paid a total of $17.8 million in debt service for the nine
months ended September 30, 2002, consisting of principal payments under the
Senior Credit Facility of $5.5 million, interest under the Senior Credit
Facility of approximately $4.6 million, interest of $0.2 million on commitment
fees and $7.5 million of interest on the Notes. Principal payments of $1.8
million on the Senior Credit Facility were paid after the end of the third
quarter of 2002 on September 30, 2002 as a result of the timing of the due dates
for the quarterly principal payments. See Note 2 to the Consolidated Financial
Statements.
21
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 fixed charge coverage ratios, and
maximum leverage ratios, capital expenditure measurements and EBITDA
measurements. The Company may be required to make mandatory prepayments of the
term loans on an annual basis if certain predetermined thresholds of specific
financial ratios and tests are met.
On July 16, 2001, the Note Limited Partnership transferred $50.9 million
aggregate principal amount of Notes that the Note Limited Partnership had
acquired in the open market in January 2001 for approximately $23.0 million plus
accrued interest to the Company in exchange for 50,900 shares of Senior
Preferred Stock. Concurrently, the Debt Limited Partnership; (I) transferred its
interest in approximately $44.9 million of the Company's senior bank debt which
it had purchased in March 2001 for approximately $35.6 million to the Company in
exchange for 44,927.98 shares of Senior Preferred Stock and (ii) purchased an
additional 231 shares of Senior Preferred Stock for $231,000 cash.
In conjunction with the Debt Restructure, the Company designated 96,058.98
shares of Senior Preferred Stock. The shares of Senior Preferred Stock have a
par value of $0.01 per share and a liquidation preference of $1,000 per share,
together with all declared or accrued and unpaid dividends thereon. In the event
of any liquidation of the Company, holders of shares of Senior Preferred Stock
shall be paid the liquidation preference plus all accrued dividends to the date
of liquidation before any payments are made to the Common Stock holders.
Dividends, as and if declared by the Company's Board of Directors, are
cumulative and payable quarterly as of October 1, 2001 at the rate of 12.5% of
the liquidation preference per annum. Each share of Senior Preferred Stock is
convertible at any time at the option of the holder for 51.49330587 shares of
the Company's Common Stock.
Concurrently with the exchanges described above, the Company's Senior Credit
Facility was amended and restated. Changes resulting from such amendment and
restatement included, among other things, the extension of the maturity dates of
the Term A and Term B Loans for an additional six-month period.
Effective July 29, 2002, the Company, Bank of America, N.A. and certain of
the Company's senior secured lenders entered into an amendment to the Company's
senior secured credit agreement pursuant to which, among other things, certain
of the holders of the Company's Tranche A term loans have agreed to convert
their loans into Tranche B term loans. The Tranche B loans have nominal
amortization requirements until December 31, 2004 (the stated Tranche A term
loan maturity date) and have a stated maturity date of December 31, 2006. In
connection with such conversion, Bank of America and certain of the Company's
other existing senior secured and new lenders have agreed to advance an
additional $35.0 million in Tranche B term loans to the Company, the proceeds of
which will be used by the Company to fund its general corporate and working
capital needs (including potential acquisitions).
To induce the holders of the Tranche A term loans to convert their loans,
the Company has agreed to pay each such lender a conversion fee of 50 basis
points on the amount of such lender's Tranche A term loans so converted. To
induce each of the other senior secured lenders to consent to the amendment, the
Company has agreed to (1) pay such lenders a 25 basis point consent fee and (2)
increase the interest rates payable to such consenting lenders by 150 basis
points over the interest rates currently payable to the non-consenting lenders.
In addition to the conversion of the Tranche A term loans and the incurrence
of the additional new-money Tranche B term loans, the Company and its lenders
agreed to increase the size of the Company's permitted acquisition basket,
increase the Company's capital expenditure (including capital lease) basket and
modify the Company's required compliance thresholds for each of the minimum
EBITDA covenant, maximum leverage (including senior leverage) ratio covenant and
minimum fixed charge ratio covenant.
As of November 12, 2002, the Company is in compliance with all covenants or
other requirements set forth in its credit agreements and indentures. Further,
the Company does not have any rating downgrade triggers that would accelerate
maturity dates of its debt.
The Company's near and long-term operating strategies focus on broadening
the Displayer base through recruiting efforts and increasing retention and
productivity of the existing Displayer base and leveraging of the assets of the
manufacturing subsidiaries. The Company believes that cash on hand, net cash
flow from operations and borrowings under the Revolving Loans will be sufficient
to fund its cash requirements through the year ended December 31, 2002. Cash
requirements will consist primarily of payments of
22
principal and interest on outstanding indebtedness, working capital requirements
and capital expenditures. The Company's future operating performance and
ability to service or refinance its current indebtedness will be subject to
future economic conditions and to financial, business and other factors, many of
which are beyond the Company's control.
MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
The Company is exposed to financial market risks, including changes in
interest rates and foreign currency exchange rates. The Company does not use
derivative financial instruments for speculative or trading purposes. The
Company's international operations are becoming more significant, and as a
result, changes in foreign currency exchange rates may have a material effect on
the Company in the future.
ADOPTION OF ACCOUNTING STANDARDS
In October of 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 147, "Acquisitions of Certain
Financial Institutions - an Amendment of FASB Statements No. 72 and No. 144 and
FASB Interpretation of No. 9" ("SFAS No. 147"). The Company has adopted these
provisions effective October 1, 2002, and there was not a financial accounting
impact associated with its adoption.
In July of 2002 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146 requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS No. 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. The Company will adopt SFAS No. 146 with
fiscal year beginning January 1, 2003 and does not anticipate any financial
accounting impact associated with its adoption.
In April of 2002 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4,
44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections" ("SFAS
No. 145"). SFAS No. 145 rescinds FASB Statement No. 4, "Reporting Gains and
Losses from the Extinguishment of Debt," and an amendment of that Statement,
FASB Statement No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements." SFAS No. 145 also rescinds FASB No. 44 "Accounting for Leases,"
to eliminate an inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications that
are similar to sale-leaseback transactions. SFAS No. 145 also amends other
existing authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under changed conditions. The
provision of SFAS No. 145 related to the rescission of Statement No. 4 is
effective in fiscal years beginning after May 15, 2002. The Company will adopt
this provision of SFAS No. 145 with fiscal year beginning on January 1, 2003 and
does not anticipate any material financial accounting impact associated with its
adoption. All other provisions of SFAS No. 145 are effective for transactions
occurring and financial statements issued after May 15, 2002. The Company
adopted these provisions effective May 15, 2002, and there was not a financial
accounting impact associated with their adoption.
SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142") was
issued on July 20, 2001. SFAS No. 142 addresses financial accounting and
reporting for acquired goodwill and other intangible assets. The statement
eliminates amortization of goodwill and intangible assets with indefinite lives
and requires a transitional impairment test of these assets within six months of
the date of adoption and an annual impairment test thereafter in certain
circumstances. The Company adopted the provisions of this statement on January
1, 2002, and there was no material financial accounting impact associated with
its adoption.
SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets,"
("SFAS No. 144") was issued in October 2001. SFAS No. 144 provides new guidance
on the recognition of impairment losses on long-lived assets to be held and used
or to be disposed of and also broadens the definition of what constitutes a
discontinued operation and how the results of a discontinued operation are to be
measured and presented. The Company adopted the provisions of this statement on
January 1, 2002, and there was no financial accounting impact associated with
its adoption.
In September 2001, the EITF issued EITF 01-09, "Accounting for Consideration
Given by a Vendor to a Customer or Reseller of the Vendor's Products," which
applies to the income statement characterization of stock option awards,
royalties, and other cash consideration the Company pays its District Directors,
Branch Directors, Group Directors, Unit Directors, and Trainers. The Company
adopted the provisions on January 1, 2002, and there was no financial accounting
impact associated with its adoption.
23
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 on their financial statements. Refer to the 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
Operation," 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.
ITEM 4. CONTROLS AND PROCEDURES.
(a) The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the Company's
filings under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the periods specified in the rules and forms of
the Securities and Exchange Commission. Such information is accumulated and
communicated to the Company's management, including its principal executive
officer and principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure. The Company's management, including the
principal executive officer and principal accounting officer, recognizes that
any set of controls and procedures, no matter how well designed and operated,
can provide only reasonable assurance of achieving the desired control
objectives.
Within 90 days prior to the filing date of this quarterly report on
Form 10-Q, the Company has carried out an evaluation, under the supervision and
with the participation of the Company's management, including the Company's
principal executive officer and the Company's principal financial officer, of
the effectiveness of the design and operation of the Company's disclosure
controls and procedures. Based on such evaluation, the Company's principal
executive officer and principal financial officer concluded that the Company's
disclosure controls and procedures are effective.
(b) There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect the internal
controls subsequent to the date of their evaluation in connection with the
preparation of this quarterly report on Form 10-Q.
24
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company previously purchased certain assets of House of Lloyd entities
in bankruptcy. Such assets included that certain letter agreement, dated October
23, 2001, among Richmont Corporation and its affiliates and representatives, and
House of Lloyd Management, LLC (the "Letter Agreement").
On April 25, 2002, the Company, in the name of several House of Lloyd
entities, filed a petition against Richmont Corporation, Richmont International,
Inc. d/b/a Richmont House and John P. Rochon ("Defendants") asserting various
claims arising from, inter alia, the Letter Agreement. Defendants answered the
lawsuit and, on September 12, 2002, filed an Original Counterclaim and Third
Party Petition against the House of Lloyd entities, as counter-defendants, and
the Company and Mr. Donald J. Carter Jr., as third-party defendants, pursuant to
which defendants asserted claims for tortious interference with prospective
business relations, tortious interference with existing business relations,
business disparagement, conspiracy and malicious prosecution, and are seeking
actual damages and punitive damages in the amount of $100 million. The House
of Lloyd entities, the Company and Mr. Carter answered the Original Counterclaim
and Third Party Petition and, on October 15, 2002, removed certain of
Defendants' claims to the United States Bankruptcy Court for the Northern
District of Texas, Dallas Division, and have since moved the federal court to
transfer the removed claims to the United States Bankruptcy Court for the
Western District of Missouri, which previously approved the sale of certain of
the House of Lloyd assets. On October 31, 2002, Defendants filed a notice of
removal purporting to remove the balance of the lawsuit to the United States
Bankruptcy Court for the Northern District of Texas, Dallas Division. Presently,
the case is in the discovery stages. The Company, Mr. Carter and the House of
Lloyd entities believe that the claims in the Original Counterclaim and Third
Party Petition are without merit and intend to vigorously defend their position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On or about September 26, 2002, the Company submitted to a vote of its
shareholders the 2002 Stock Option Plan for Key Employees (the "2002 Plan"), a
copy of which is included in this quarterly report as Exhibit 10.1. 12,901,786
votes were cast "for" the 2002 Plan, 11,943 votes were cast "against" the 2002
Plan and there were 2,286 abstentions or broker non-votes.
25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
- --------- -------------------------------------------------------------
10.1 Home Interiors & Gifts, Inc. 2002 Stock Option Plan for Key
Employees dated August 14, 2002.*
10.2 Home Interiors & Gifts, Inc. 2002 Form of Tier 1 Option
Agreement.*
10.3 Home Interiors & Gifts, Inc. 2002 Form of Tier 2 Option
Agreement.*
10.4 Industrial real estate lease dated September 13, 2002
between Argent Frankford, L.P. and the Company.*
10.5 Commercial lease dated August 15, 2002 between H.T. Ardinger
& Son, Co. and the Company (for building and facilities
located in Carrollton, Texas.)*
99.1 Certification of Chief Executive Officer of the
Company.*
99.2 Certification of Chief Financial Officer of the
Company.*
(b) Reports on Form 8-K
On August 1, 2002 the Company filed a current report on Form 8-K with
respect to an amendment to the Company's Credit Agreement dated as of July 29,
2002.
- ----------
*Filed herewith.
26
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
Sr. Vice President of Finance and Chief Financial Officer
(principal financial and accounting officer)
Date: November 12, 2002
27
CERTIFICATIONS*
I, Donald J. Carter, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Home Interiors &
Gifts, Inc.(the "Registrant");
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and
we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the Registrant's auditors and the
audit committee of Registrant's board of directors (or persons
performing the equivalent function);
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
Registrant's ability to record, process, summarize and report
financial data and have identified for the Registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
Registrant's internal controls; and
6. The Registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 12, 2002
/s/ Donald J. Carter, Jr.
--------------------------
Donald J. Carter, Jr.
Chairman and Chief Executive Officer
28
CERTIFICATIONS*
I, Kenneth J. Cichocki, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Home Interiors &
Gifts, Inc.(the "Registrant");
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and
we have:
d) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
e) evaluated the effectiveness of the Registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
f) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the Registrant's auditors and the
audit committee of Registrant's board of directors (or persons
performing the equivalent function);
c) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
Registrant's ability to record, process, summarize and report
financial data and have identified for the Registrant's
auditors any material weaknesses in internal controls; and
d) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
Registrant's internal controls; and
6. The Registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 12, 2002
/s/ KENNETH J. CICHOCKI
----------------------------
Kenneth J. Cichocki
Chief Financial Officer
29
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- --------- --------------------------------------------------------------
10.1 Home Interiors & Gifts, Inc. 2002 Stock Option Plan for Key
Employees dated August 14, 2002.*
10.2 Home Interiors & Gifts, Inc. 2002 Form of Tier 1 Option
Agreement.*
10.3 Home Interiors & Gifts, Inc. 2002 Form of Tier 2 Option
Agreement.*
10.4 Industrial real estate lease dated September 13, 2002
between Argent Frankford, L.P. and the Company.*
10.5 Commercial lease dated August 15, 2002 between H.T. Ardinger
& Son, Co. and the Company (for building and facilities
located in Carrollton, Texas.)*
99.1 Certification of Chief Executive Officer of the
Company.*
99.2 Certification of Chief Financial Officer of the
Company.*
- ----------
*Filed herewith.