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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
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COMMISSION FILE NO. 333-62021
HOME INTERIORS & GIFTS, INC.
(Exact name of registrant as specified in its charter)
TEXAS 75-0981828
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification No.)
organization)
4550 SPRING VALLEY ROAD
DALLAS, TEXAS 75244
(Address of principal executive offices) (Zip Code)
(972) 386-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirement for the past 90 days. Yes [X] No [ ]
As of May 10, 1999, the registrant had outstanding 15,234,422 shares of its
common stock, $0.10 par value per share.
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HOME INTERIORS & GIFTS, INC.
INDEX
PAGE NO.
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PART I - FINANCIAL INFORMATION
Item 1. Unaudited Interim Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1998 and
March 31, 1999................................................... 3
Consolidated Statements of Operations and Comprehensive Income
for the three months ended March 31, 1998 and 1999............... 4
Consolidated Statements of Cash Flows for the three months
ended March 31, 1998 and 1999.................................... 5
Notes to Unaudited Interim Consolidated Financial Statements........ 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................. 9
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................ 16
Item 6. Exhibits and Reports on Form 8-K............................. 16
2
3
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND MARCH 31, 1999
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
DECEMBER 31, MARCH 31,
1998 1999
------------ ---------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents .......................................... $ 41,024 $ 33,861
Accounts receivable, net ........................................... 7,975 10,724
Inventories ........................................................ 31,010 38,482
Deferred income tax benefit ........................................ 2,164 2,845
Other current assets ............................................... 1,040 1,775
--------- ---------
Total current assets ....................................... 83,213 87,687
Property, plant and equipment, net ................................... 21,774 22,392
Investments .......................................................... 1,667 1,709
Debt issuance costs, net ............................................. 19,132 18,356
Other assets ......................................................... 6,662 5,265
--------- ---------
Total assets ............................................... $ 132,448 $ 135,409
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable ................................................... $ 13,119 $ 11,500
Accrued seminars and incentive awards .............................. 12,422 14,281
Royalties payable .................................................. 6,922 5,967
Hostess prepayments ................................................ 8,719 9,286
Income taxes payable ............................................... 4,101 7,872
Current portion of long-term debt .................................. 33,723 26,000
Other current liabilities .......................................... 13,555 19,922
--------- ---------
Total current liabilities .................................. 92,561 94,828
Long-term debt, net of current portion ............................... 453,277 446,814
Deferred income tax liability ........................................ 176 358
--------- ---------
Total liabilities .......................................... 546,014 542,000
--------- ---------
Minority interest .................................................... 508 788
Commitments and contingencies
Shareholders' deficit:
Common stock, par value $0.10 per share, 75,000,000 shares
authorized, 15,234,422 shares issued and outstanding ............ 1,523 1,523
Additional paid-in capital ......................................... 178,944 179,425
Accumulated deficit ................................................ (594,314) (588,372)
Cumulative translation adjustment .................................. (227) 45
--------- ---------
Total shareholders' deficit ................................ (414,074) (407,379)
--------- ---------
Total liabilities and shareholders' deficit ................ $ 132,448 $ 135,409
========= =========
The accompanying notes are an integral part of these financial statements.
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1999
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
------------------------
1998 1999
--------- ---------
Net sales ................................................... $ 108,321 $ 116,748
Cost of goods sold .......................................... 54,324 56,712
--------- ---------
Gross profit ................................................ 53,997 60,036
Selling, general and administrative:
Selling ................................................... 19,043 21,719
Freight, warehouse and distribution ....................... 9,674 11,133
General and administrative ................................ 4,917 6,214
Gains on the sale of assets ............................... (4,072) --
Stock option expense ...................................... -- 481
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Total selling, general and administrative ............ 29,562 39,547
--------- ---------
Operating income ............................................ 24,435 20,489
Other income (expense):
Interest income ........................................... 2,278 774
Interest expense .......................................... (10) (11,261)
Other income, net ......................................... 196 70
--------- ---------
Other income (expense), net .......................... 2,464 (10,417)
--------- ---------
Income before income taxes .................................. 26,899 10,072
Income taxes ................................................ 10,889 4,130
--------- ---------
Net income .................................................. 16,010 5,942
Other comprehensive income (loss) before tax:
Cumulative translation adjustment ......................... 39 272
Unrealized losses on investments .......................... (43) --
--------- ---------
Other comprehensive income (loss) before tax ......... (4) 272
Income tax benefit related to items of other
comprehensive income ...................................... 15 --
--------- ---------
Other comprehensive income, net of tax ............... 11 272
--------- ---------
Comprehensive income ........................................ $ 16,021 $ 6,214
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The accompanying notes are an integral part of these financial statements.
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1999
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
------------------------
1998 1999
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Cash flows from operating activities:
Net income .................................................... $ 16,010 $ 5,942
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Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ............................... 703 907
Amortization of debt issuance costs ......................... -- 776
Provision for doubtful accounts ............................. 219 317
Gains on the sale of assets ................................. (4,072) --
Stock option expense ........................................ -- 481
Equity in earnings of an affiliate .......................... -- (42)
Deferred tax expense (benefit) .............................. 612 (499)
Changes in assets and liabilities:
Accounts receivable ......................................... (534) (3,849)
Inventories ................................................. (6,614) (7,472)
Other current assets ........................................ (299) (735)
Other assets ................................................ (451) 16
Accounts payable ............................................ 6,436 (1,619)
Income taxes payable ........................................ 9,851 3,771
Other accrued liabilities ................................... (1,440) 7,834
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Total adjustments ...................................... 4,411 (114)
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Net cash provided by operating activities .............. 20,421 5,828
--------- ---------
Cash flows from investing activities:
Purchases of investments ...................................... (905) --
Proceeds from the sale of investments ......................... 500 --
Purchases of property, plant and equipment .................... (1,955) (1,259)
Purchases of property, plant and equipment by minority
owner of Laredo Candle ...................................... -- (249)
Payments received on notes receivable ......................... 323 2,151
Proceeds from the sale of property, plant and equipment ....... 4,072 --
--------- ---------
Net cash provided by investing activities .............. 2,035 643
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Cash flows from financing activities:
Dividends paid ................................................ (5,733) --
Capital contribution from Laredo Candle minority owner ........ -- 280
Payments under the Senior Credit Facility ..................... -- (14,186)
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Net cash used in financing activities .................. (5,733) (13,906)
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Effect of cumulative translation adjustment ..................... 39 272
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Net increase (decrease) in cash and cash equivalents ............ 16,762 (7,163)
Cash and cash equivalents at beginning of year .................. 104,262 41,024
--------- ---------
Cash and cash equivalents at end of period ...................... $ 121,024 $ 33,861
========= =========
The accompanying notes are an integral part of these financial statements.
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BACKGROUND
Home Interiors & Gifts, Inc., together with its subsidiaries (the
"Company"), is a direct seller of home decorative accessories using the "party
plan" method whereby its non-employee, independent sales representatives
("Displayers") conduct shows in the homes of potential customers. The Company
believes that the party plan method provides a comfortable environment where the
unique benefits and attributes of the Company's products can be demonstrated in
a more effective manner than the typical retail setting.
The Company has been located in Dallas, Texas since its inception in
1957. The Company manufactures approximately one-third of its products and
purchases the remainder of its product line from a select number of independent
suppliers, most of whom sell their products exclusively to the Company. The
Company expanded its operations internationally in 1995. Revenue from
international operations is not significant.
The following is a brief description of the Company's subsidiaries, each of
which is wholly-owned except as indicated:
o Dallas Woodcraft, Inc. ("DWC") manufactures framed art work and mirrors
using custom-designed equipment
o GIA, Inc. ("GIA") and Homco, Inc. manufacture various types of molded
plastic products using custom-designed equipment
o Laredo Candle Company, L.L.P. ("Laredo Candle"), which is owned 60% by the
Company, was recently established and is anticipated to begin manufacturing
candles in late 1999
o Homco de Mexico, S.A. de C.V. and Homco Puerto Rico, Inc. provide sales
support services to the international Displayers
2. SIGNIFICANT ACCOUNTING POLICIES
The Company maintains its accounting records and prepares financial
statements on the accrual basis of accounting, which conforms with generally
accepted accounting principles. Following these principles, management makes
estimates and assumptions that affect the amounts reported in the financial
statements and notes. Actual results may differ from these estimates.
These consolidated financial statements include the accounts of the
Company. All significant intercompany accounts and transactions have been
eliminated. The Company records sales and related expenses on a weekly basis
ending on each Saturday and every quarter consists of thirteen weeks. The last
days of the quarter ended March 31, 1998 and 1999 in the accompanying unaudited
consolidated financial information were April 4, 1998 and April 3, 1999,
respectively.
The consolidated financial information as of March 31, 1999 and for the
three months ended March 31, 1998 and 1999 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 consolidated financial
position as of March 31, 1999 and the operating results, comprehensive income
and cash flows for the three months ended March 31, 1998 and 1999. 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 results of operations for the periods presented are not
necessarily indicative of the results to be expected for the full year.
Certain reclassifications have been made to prior years' balances to
conform with current year presentation.
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
3. THE RECAPITALIZATION
The Company completed a recapitalization (the "Recapitalization") on
June 4, 1998 through the following simultaneous transactions:
o contribution of $182.6 million by Hicks, Muse, Tate & Furst Incorporated
("Hicks Muse") in exchange for 10,111,436 shares of the common stock, or
approximately 66% of all outstanding shares upon completion of the
Recapitalization
o issuance of $200.0 million of senior subordinated notes (the "Notes")
o borrowing of $300.0 million under a $340.0 million senior credit facility
(the "Senior Credit Facility")
o use of the above proceeds, together with available cash of $169.3 million,
to:
o redeem 45,836,584 shares of common stock for $827.6 million
o pay fees and expenses of $24.3 million associated with the
Recapitalization consisting of:
o $11.2 million financial advisory fee paid to Hicks Muse for its
role in obtaining financing for the Recapitalization
o $11.6 million of debt issuance costs paid primarily to the bank
syndicate group for the Senior Credit Facility and the initial
purchasers of the Notes
o $1.5 million of legal and accounting fees
The Company allocated the Hicks Muse financial advisory fee and the
legal and accounting fees on a proportionate basis to the debt and equity
financing for the Recapitalization. Accordingly, the Company allocated $9.5
million to debt issuance costs and $3.2 million to additional paid-in capital.
The total debt issuance costs of $21.1 million are being amortized using the
effective interest method over the term of the related indebtedness.
In addition to the $24.3 million of fees and expenses related to the
Recapitalization, the Company paid additional financial advisory and legal fees
of approximately $6.2 million in connection with the Recapitalization. The
Company paid its financial advisor approximately $5.7 million to assist with the
development of strategic alternatives, identify potential buyers, evaluate
proposals and assist in the negotiation of the Hicks Muse offer. These financial
advisory and legal fees were expensed as incurred in the three months ended June
30, 1998.
As a result of the Recapitalization, the issued and outstanding shares of
common stock decreased to 15,231,652 shares as of June 4, 1998, all treasury
stock was retired and Hicks Muse acquired a controlling interest in the Company.
4. INVENTORIES
Inventories consisted of the following as of December 31, 1998 and
March 31, 1999 (in thousands):
DECEMBER 31, MARCH 31,
1998 1999
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(UNAUDITED)
Raw materials ................................................................. $ 6,134 $ 6,169
Work in process ............................................................... 1,742 1,711
Finished goods ................................................................ 23,134 30,602
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$31,010 $38,482
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
5. OTHER CURRENT LIABILITES
Other current liabilities consisted of the following as of December
31, 1998 and March 31, 1999 (in thousands):
DECEMBER 31, MARCH 31,
1998 1999
----------- ---------
(UNAUDITED)
Interest payable ................................................................................ $ 2,959 $ 8,079
Accrued compensation ............................................................................ 3,606 3,860
Employee benefit plan contributions ............................................................. 2,264 363
Sales taxes payable ............................................................................. 1,871 4,564
Other current liabilities ....................................................................... 2,855 3,056
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$13,555 $19,922
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6. NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The new standard is effective for fiscal
years beginning after December 15, 1999. The Company has not yet determined the
effect the new standard will have on its financial statements.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the Company's consolidated financial statements and accompanying notes as
of and for the year ended December 31, 1998, included in its Form 10-K. Unless
otherwise mentioned, all references to the number of Displayers, number of
orders shipped, and average order size relate to domestic sales activity only.
COMPANY BACKGROUND
The Company believes it is the largest direct seller of home
decorative accessories in the United States, as measured by sales. The Company's
sales are dependent upon the number of Displayers selling the Company's products
and Displayer productivity. Displayer productivity is measured in terms of
orders shipped and average order size, both of which fluctuate from time to time
based on the implementation and timing of discounts and new incentive programs,
seasonality and recruiting activity.
To stimulate sales, the Company offers a variety of discounts and
incentives to Displayers. The amount and type of discounts and incentives vary
from year to year and throughout each year, but are generally consistent over
any given quarterly period. The cost of discounts is reflected in the Company's
net sales while the cost of incentives is reflected in selling expense.
Primarily because of the nature of the direct selling industry, and as
a result of numerous general and economic factors, the Company experienced
average annual Displayer turnover of approximately 40% during the last three
years. The Company believes that new Displayers are generally among the least
productive Displayers and that the majority of Displayers who terminate their
status as Displayers in any particular year are Displayers recruited in that
year or in the immediately preceding year. The Company's ability to maintain its
sales volume and to achieve growth depends upon its ability to attract and
retain a significant number of new Displayers each year.
The Company revised its recruiting and training criteria effective in
early 1999. Among other things, the Company increased opportunities for new
Displayers by reducing start-up costs and lowering certain other barriers to
entry. These changes resulted in a significant increase in the number of new
Displayers. Approximately 13,200 new Displayers were recruited during the three
months ended March 31, 1999, which was more than twice the number recruited
during the comparable period of 1998. Although the Displayer base grew to
approximately 66,000 as of March 31, 1999, many of the new Displayers were not
considered active because they had not yet placed their first order. To be an
active Displayer, the Displayer must have placed an order within the 14 prior
weeks. Active Displayers totaled 51,600 as of March 31, 1999, up 3.0% from
50,100 as of December 31, 1998, and up 16.2% from 44,400 as of March 31, 1998.
Historically, the Company has benefited from relatively stable gross
profit and operating profit margins. Once a product is introduced into the
Company's product line, the price at which the Company purchases the product
from its suppliers and the price at which the Company sells the product to
Displayers seldom changes. The Company has steadily improved its gross profit
margin since mid-1997, when the markup on all new products was increased. Prior
to that time, the Company seldom changed product markups. The Company believes
that further improvement in gross margin will occur throughout 1999 until the
new pricing structure is incorporated throughout its entire product line.
The Company delivers its products to Displayers via common carrier and
a regional network of locally-based freight distributors ("Local Distributors").
Unlike many other direct sales companies that the Company believes charge their
customers shipping costs, the Company delivers its products to Displayers free
of charge if minimum order sizes are met. The Company realizes substantial cost
savings from volume discounts it receives from its common carriers and its use
of Local Distributors. The use of Local Distributors enables the Company to
avoid the premiums charged by common carriers for delivery to private
residences, which is where most Displayers receive their deliveries. In
addition, the Company believes that, as a result of its good relationships with
its common carriers and the Local Distributors, it is able to quickly deliver
its products with minimal shipping errors or product damage.
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THE RECAPITALIZATION
The Company completed the Recapitalization on June 4, 1998 through the
following simultaneous transactions:
o contribution of $182.6 million by Hicks Muse,in exchange for 10,111,436
shares of the common stock, or approximately 66% of all outstanding shares
upon completion of the Recapitalization
o issuance of $200.0 million of the Notes
o borrowing of $300.0 million under the Senior Credit Facility
o use of the above proceeds, together with available cash of $169.3 million,
to:
o redeem 45,836,584 shares of common stock for $827.6 million
o pay fees and expenses of $24.3 million associated with the
Recapitalization consisting of:
o $11.2 million financial advisory fee paid to Hicks Muse for its
role in obtaining financing for the Recapitalization
o $11.6 million of debt issuance costs paid primarily to the bank
syndicate group for the Senior Credit Facility and the initial
purchasers of the Notes
o $1.5 million of legal and accounting fees
In addition to the $24.3 million of fees and expenses related to the
Recapitalization, the Company paid additional financial advisory and legal fees
of approximately $6.2 million in connection with the Recapitalization. The
Company paid its financial advisor approximately $5.7 million to assist with the
development of strategic alternatives, identify potential buyers, evaluate
proposals and assist in the negotiation of the Hicks Muse offer. These financial
advisory and legal fees were expensed as incurred during the three months ended
June 30, 1998.
RESULTS OF OPERATIONS
THE THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THE THREE MONTHS ENDED MARCH
31, 1998
Net Sales. Net sales increased $8.4 million, or 7.8%, to $116.7
million in the three months ended March 31, 1999 from $108.3 million in the
comparable period in 1998. This increase was primarily attributable to a 15.6%
increase in the number of orders shipped, which more than offset a 7.0% decrease
in the average order size. The increase in orders shipped was due to growth in
the Displayer base. The average number of active Displayers increased to 50,800
in the three months ended March 31, 1999 from 43,600 in the comparable period in
1998. Orders shipped per active Displayer remained flat. The decline in the
average order size was expected primarily as a result of growth in the Displayer
base that increased the percentage of less experienced and, therefore, less
productive Displayers.
Gross Profit. Gross profit increased $6.0 million, or 11.2%, to $60.0
million in the three months ended March 31, 1999 from $54.0 million in the
comparable period in 1998. As a percentage of net sales, gross profit increased
to 51.4% in 1999 from 49.8% in the 1998 period. This increase was primarily
attributable to the introduction of new products with higher profit margins, and
to a lesser extent, manufacturing efficiencies.
Selling expense. Selling expense increased $2.7 million, or 14.1%, to
$21.7 million in the three months ended March 31, 1999 from $19.0 million in the
comparable period in 1998. As a percentage of net sales, selling expense
increased to 18.6% in 1999 from 17.6% in the 1998 period. This increase was
primarily attributable to higher promotion bonuses for Displayers during the
1999 period.
Freight, warehouse and distribution expense. Freight, warehouse and
distribution expense increased $1.4 million, or 15.1%, to $11.1 million in the
three months ended March 31, 1999 from $9.7 million in the comparable period in
1998. As a percentage of net sales, freight, warehouse and distribution expense
increased to 9.5% in the 1999 period from 8.9% in the 1998 period. This increase
resulted from the increase in the number of orders shipped, and in particular,
the use of additional labor necessary to fill orders.
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General and administrative expense. General and administrative expense
increased $1.3 million, or 26.4%, to $6.2 million in the three months ended
March 31, 1999 from $4.9 million in the comparable period in 1998. The increase
was largely due to increased personnel costs, commencement of a monitoring and
oversight fee payable to Hicks Muse, and increased depreciation expense as a
result of a higher level of capital expenditures throughout 1998. The higher
personnel costs were primarily related to increased staffing necessary to
support the growth in the Displayer base and increased information and
technology demands.
Gains on the sale of assets. The Company recorded a gain of $4.1
million on the sale of an aircraft in March of 1998. No gains have been reported
in the three months ended March 31, 1999.
Interest Income. Interest income decreased to $0.8 million in the three
months ended March 31, 1999 from $2.3 million in the comparable period in 1998
due to lower average investment balances as a result of the Recapitalization.
Interest Expense. Interest expense increased to $11.3 million in the
three months ended March 31, 1999 due to interest expense incurred in connection
with the Senior Credit Facility and the Notes.
Income Taxes. Income taxes decreased to $4.1 million in the three
months ended March 31, 1999 from $10.9 million in the comparable period in 1998.
Income taxes as a percentage of income before income taxes increased slightly to
41.0% in the 1999 period from 40.5% in the 1998 period.
SEASONALITY
The Company's business is influenced by the Christmas holiday season
and promotional events. Historically, a higher portion of the Company's sales
and net income has 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 and 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 activity and results of operations in any quarter
are not necessarily indicative of any future trends in the Company's business.
LIQUIDITY AND CAPITAL RESOURCES
The Company satisfied its historical requirements for capital through
cash flow from operations. As a result of borrowings under the Senior Credit
Facility and the issuance of the Notes, the Company is subject to cash
requirements which are significantly greater than its historical requirements.
Net cash provided by operating activities in the three months ended March 31,
1999 decreased $14.6 million to $5.8 million from $20.4 million in the
comparable period in 1998. The decrease was primarily attributable to reduced
net income in the 1999 period as a result of interest expense on the Senior
Credit Facility and the Notes and a nonrecurring gain on the sale of an aircraft
in the 1998 period.
The Company generated $0.6 million cash flow from investing activities
during the three months ended March 31, 1999 and $2.0 million in the comparable
period in 1998. The Company's capital expenditures totaled $1.5 million during
the three months ended March 31, 1999 and $2.0 million in the comparable period
in 1998. Capital expenditures in the 1999 period included $0.2 million
attributable to the minority owner of Laredo Candle. Payments received on notes
receivable increased to $2.2 million during the three months ended March 31,
1999 from $0.3 million in the comparable period in 1999 primarily due to final
payment of a note prior to maturity. In addition to its other investing
activities, the Company sold an aircraft in March 1998 for proceeds of $4.1
million.
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The Company estimates that its capital expenditures will increase to
approximately $12.0 million during the year ended December 31, 1999 from $8.4
million in the comparable period of 1998. The anticipated increase is
principally as a result of continued enhancements to the Company's new computer
system, including Internet capabilities, and construction of the building and
purchase of equipment for Laredo Candle. The Company's capital expenditures
include expenditures attributable to the minority owner of Laredo Candle. The
minority owner of Laredo Candle spent $0.5 million in capital expenditures in
the 1998 period and expects to spend approximately $2.0 million in the 1999
period for its portion of the new candle manufacturing operation.
The Company is currently in the process of evaluating its facility
requirements, including the possibility of automating order fulfillment and
consolidating distribution facilities. If the Company makes some or all of the
contemplated changes, the Company's capital expenditures would increase by
approximately $5.0 million to $10.0 million over the next twelve months.
The Company's use of cash for financing activities increased to $13.9
million during the three months ended March 31, 1999 from $5.7 million in the
comparable period in 1998. This increased use of cash was due to principal
payments on the Senior Credit Facility totaling $14.2 million. Prior to the
Recapitalization, the Company's primary financing activity was the payment of
dividends. Dividends were not paid during the three months ended March 31, 1999
as compared to the $5.7 million paid in the comparable period in 1998. Since the
terms of the Notes and the Senior Credit Facility restrict the Company's ability
to pay dividends, the Company does not anticipate the payment of dividends in
the foreseeable future.
Payments on the Notes and 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 quarterly interest and
principal payments. In addition, the Senior Credit Facility includes a standby
revolving credit facility of $40.0 million (the "Revolving Loans"), which mature
on June 30, 2004. The Revolving Loans remained undrawn as of March 31, 1999.
The Company paid a total of $19.4 million in debt service in the three
months ended March 31, 1999. The debt service payments consisted of principal
payments under the Senior Credit Facility of $6.5 million, a mandatory
prepayment of $7.7 million under the Senior Credit Facility and interest under
the Senior Credit Facility of approximately $5.2 million.
The terms of the Notes and Senior Credit Facility include significant
operating and financial restrictions, such as limits on the Company's ability to
incur indebtedness, create liens, sell assets, engage in mergers or
consolidations, make investments and pay dividends. In addition, under the
Senior Credit Facility, the Company is required to comply with specified
financial ratios and tests, including minimum interest coverage and maximum
leverage ratios. Subject to the financial ratios and tests, the Company will be
required to make certain mandatory prepayments of the term loans on an annual
basis. The Company prepaid $7.7 million on the term loans on March 31, 1999. As
a result of the timing and magnitude of the prepayment amount, the Company may
have to utilize the Revolving Loans at varying times subsequent to March 31,
1999 primarily to meet working capital needs and to fund capital expenditures.
The Company anticipates that its debt service requirements will total
$73.8 million in 1999. These debt service requirements are expected to consist
of principal payments due under the Senior Credit Facility of $26.0 million, the
mandatory prepayment of $7.7 million under the Senior Credit Facility, interest
due under the Senior Credit Facility of $19.9 million and interest of $20.2
million due on the Notes. A one percentage point change in interest rates would
not have a significant impact on interest expense since the Company entered into
six-month and twelve-month borrowings on December 9, 1998 for a majority of its
variable-rate debt.
The Company believes that net cash flow from operations and borrowings
under the Revolving Loans, if any, will be sufficient to fund its cash
requirements over the next twelve months, which will consist primarily of
payment of 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.
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MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
The Company is exposed to financial market risks, including changes in
interest rates and foreign currency exchange rates. To mitigate risks on changes
in interest rates, the Company utilizes derivative financial instruments. The
Company does not use derivative financial instruments for speculative or trading
purposes. The Company's international operations are not significant, and as a
result, changes in foreign currency exchange rates do not have a material effect
on the Company.
In July 1998, the Company entered into an interest rate swap agreement
to limit the effect of changes in interest rates on long-term borrowings. Under
the swap, the Company pays interest at 5.50% on a notional amount of $75.0
million and receives interest thereon at three-month LIBOR on a quarterly basis.
Beginning June 9, 1999, if LIBOR is greater than 6.44% at the commencement of
any quarterly reset period, a knockout provision provides for no payment under
the swap during such period. The knockout provision is separately adjusted to
market on a quarterly basis. No material adjustments were made in the three
months ended March 31, 1999.
There are no material quantitative changes in market risk exposures at
March 31, 1999 when compared to December 31, 1998.
ENVIRONMENTAL ISSUES
In 1989, DWC was named as a potentially responsible party ("PRP") based
on allegedly having sent 2,640 gallons of waste to the Chemical Recycling, Inc.
facility in Wylie, Texas. The Company believes that DWC's share of the total
cleanup costs based on a volumetric allocation would be less than one percent.
In the future, DWC and the other PRPs, who are jointly and severally liable, may
incur additional costs related to the cleanup of hazardous substances at the
facility. DWC did not incur any cleanup related costs in 1996, 1997 and 1998 or
in the three months ended March 31, 1999. Because the site has been dormant for
several years, the Company does not believe it is probable that any additional
costs will be incurred and, accordingly, has not established any accruals for
future cleanup costs at the site.
In 1997, Homco was named as a PRP based on allegedly having transported
hazardous waste to the Materials Recovery Enterprises, Inc. facility in Ovalo,
Texas. In the future, Homco and the other PRPs, who are jointly and severally
liable, will incur costs related to the cleanup of hazardous substances at the
facility. The cleanup of the site is in the early stages. The PRP group has
hired an environmental consultant to conduct a remedial investigation and
feasibility study, which is expected to be completed in 1999. The Company
believes that Homco's share of the total cleanup costs based on a volumetric
allocation would be less than one percent. The Company did not incur any cleanup
related costs during 1997, 1998, or during the three months ended March 31, 1999
and has not established any accrual for such costs as no determination of the
cleanup costs for the site has been made.
In 1996, the United States Environmental Protection Agency issued a
Notice of Violation claiming that GIA had violated the Clean Air Act and
Nebraska Air Regulations by failing to obtain one or more Construction Permits
for plant expansions that occurred in the 1970s and 1980s. In January 1997, GIA
responded to the Notice of Violation and in January 1998, a combined
construction and operating permit was proposed for the facility. This permit has
been issued and GIA did not incur penalties for the activities covered by the
Notice of Violation.
On February 9, 1999, the EPA conducted an inspection at GIA to
determine compliance with the toxic chemical release reporting requirements for
1997 pursuant to the Emergency Planning and Community Right To Know Act of 1986,
Section 313. A final determination has not been issued, but several possible
calculation errors in GIA's Form R Report were noted during the inspection. The
EPA will make its final determination upon receipt and verification of GIA's
revised 1997 Form R calculation. It is possible that the EPA could seek
administrative penalties for these errors.
The ultimate outcome and aggregate cost of resolving all of the above
contingencies will be based on a number of factors and will be determined over a
number of years. Accordingly, the total cost to the Company cannot currently be
determined with certainty. It is management's opinion, however, the total cost
of resolving such contingencies should not have a material adverse effect on the
Company's business, financial condition or results of operations.
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YEAR 2000 ISSUES; MANAGEMENT INFORMATION SYSTEM
As a result of certain computer programs being written using two digits
rather than four digits to define the applicable year, any of the Company's
computer programs that have date sensitive software may recognize a date using
"00" as the Year 1900 rather than the Year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including among
other things, a temporary inability to process transactions, send invoices or
engage in normal business activities.
The Company has established a Year 2000 compliance team to address the
issue of computer programs and systems that are unable to distinguish between
the year 1900 and the year 2000 (the "Project"). The Project is divided into
three categories: infrastructure, subsidiaries and third party suppliers and
service providers. The Company has substantially completed the assessment phase
which consisted of identifying and inventorying items, prioritizing, determining
critical items and establishing a not yet defined timetable for Year 2000
compliance and is engaged in the remediation and testing phases of the Project.
The computer system is a critical aspect of the Project.
The Company implemented its new and significantly more sophisticated
computer system (the "Computer System") in January 1999, which replaced
substantially all of the hardware and software previously in use at the Company.
A limited amount of peripheral equipment was retained and testing for Year 2000
compliance will continue throughout the second quarter of 1999. The Computer
System includes a mainframe computer, certain business applications and upgraded
or replacement peripheral equipment associated with the Company's core business
systems. The Company upgraded the software for the Computer System through the
purchase of certain software products developed by Distribution Architects
International ("DAI"). DAI has been engaged to assist with the implementation
and enhancement process. Each supplier (including DAI) of the hardware and
software incorporated or to be incorporated into the Computer System has
provided to the Company a compliance statement or other documentation certifying
that its products will function properly in all material respects beyond 1999.
The DAI software was installed in January 1999, and the Computer System
is presently operational. In addition, Year 2000 remediation of other aspects of
the Company's infrastructure is substantially complete. Remediation of the
Company's subsidiaries was substantially completed in the first quarter of 1999
and testing will continue throughout the second quarter. As a result, the
Company believes that Year 2000 remediation of its infrastructure and its
subsidiaries will be complete in all material respects by the end of the second
quarter of 1999.
The Company is currently enhancing the effectiveness of the DAI
software and the Computer System in general. The Company's core business
functions, including inventory, purchasing and accounting are dependent on a
properly functioning management information system. Because the Computer System
replaced a significant portion of such system, the failure of the DAI software
to function as anticipated would require the Company to reassess its Year 2000
compliance and its Computer System in general. On-site systems testing will
continue throughout the second quarter of 1999. Specific testing of the DAI
software for Year 2000 compliance will take place in the second quarter of 1999.
If testing identifies a business function at risk, the Company will aggressively
seek to locate alternative sources of software as a contingency plan. There can
be no assurance that such software could be obtained and installed in a timely
fashion or that such software would be year 2000 compliant. Non-compliance could
potentially result in a disruption of operations, including, among other things,
a temporary inability to process transactions, ship products or engage in normal
business activities, which could have a material adverse effect on the Company's
business, financial condition, results of operations and liquidity of a
magnitude which the Company is presently unable to predict. However, if some or
all of the Company's remediated or replaced internal computer systems fail to
correctly distinguish between years before and after Year 2000, or if any
software applications critical to the Company's operations are overlooked in the
Company's assessment of its Year 2000 compliance, there could be a material
adverse effect on the Company's business, financial condition, results of
operations and liquidity of a magnitude which the Company presently is not able
to predict.
In addition to the foregoing, the Company has identified and surveyed
its critical third party suppliers and service providers, and continues to
monitor and assess their progress toward Year 2000 compliance to determine the
extent to which the Company is vulnerable to the failure of such suppliers and
service providers to remediate their own Year 2000 issues. The failure of such
third parties to adequately address their respective Year 2000 issues, could
have a material adverse effect on the Company's business, financial condition,
results of operations and liquidity of a magnitude which the Company is
presently not able to predict.
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The Company spent approximately $5.3 million on the Computer System as
of March 31, 1999, which represented substantially all of the costs to implement
the first phase of the rollout of the Computer System. Now that the installation
process is complete, the Company is responding to increased information demands
and overall growth by enhancing the operational performance and capabilities of
the Computer System. The Company expects that the additional costs associated
with remediating its remaining infrastructure will be less than $1.0 million.
NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The new standard is effective for fiscal
years beginning after December 15, 1999. The Company has not yet determined the
effect the new standard will have on its financial statements.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
SOME OF THE STATEMENTS UNDER "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS" CONSTITUTE FORWARD-LOOKING
STATEMENTS. THESE STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND
OTHER FACTORS THAT MAY CAUSE THE COMPANY'S ACTUAL RESULTS TO BE MATERIALLY
DIFFERENT FROM ANY FUTURE RESULTS EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING
STATEMENTS.
IN SOME CASES, FORWARD-LOOKING STATEMENTS ARE IDENTIFIED BY TERMINOLOGY
SUCH AS "MAY," "WILL," "SHOULD," "EXPECTS," "PLANS," "ANTICIPATES," "BELIEVES,"
"ESTIMATES," "PREDICTS," "POTENTIAL" OR "CONTINUE" OR THE NEGATIVE OF SUCH TERMS
OR OTHER COMPARABLE TERMINOLOGY.
ALL OF THESE FORWARD-LOOKING STATEMENTS ARE BASED ON ESTIMATES AND
ASSUMPTIONS MADE BY MANAGEMENT OF THE COMPANY WHICH, ALTHOUGH BELIEVED TO BE
REASONABLE, ARE INHERENTLY UNCERTAIN. THEREFORE, UNDUE RELIANCE SHOULD NOT BE
PLACED UPON SUCH STATEMENTS. NO ASSURANCE CAN BE GIVEN THAT ANY OF SUCH
ESTIMATES OR STATEMENTS WILL BE REALIZED AND ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THOSE CONTEMPLATED BY SUCH FORWARD-LOOKING STATEMENTS. FACTORS
THAT MAY CAUSE SUCH DIFFERENCES INCLUDE: (i) LOSS OF DISPLAYERS; (ii) LOSS OR
RETIREMENT OF KEY MEMBERS OF MANAGEMENT; (iii) IMPOSITION OF STATE TAXES; (iv)
CHANGE IN STATUS OF INDEPENDENT CONTRACTORS; (v) INCREASED COMPETITION; (vi)
UNEXPECTED DELAYS OR PROBLEMS ASSOCIATED WITH THE INTEGRATION AND IMPLEMENTATION
OF THE COMPUTER SYSTEM; (vii) UNEXPECTED DELAYS OR PROBLEMS ASSOCIATED WITH THE
COMPANY'S YEAR 2000 PROJECT; AND (ix) THE ABILITY OF THIRD PARTY SUPPLIERS AND
SERVICE PROVIDERS TO REMEDIATE ANY YEAR 2000 ISSUES APPLICABLE TO THEIR
RESPECTIVE BUSINESSES. MANY OF SUCH 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.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Environmental Issues" for information regarding legal
proceedings which is incorporated herein by reference.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit
EXHIBIT
NO.
-------
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
HOME INTERIORS & GIFTS, INC.
By: /s/ LEONARD A. ROBERTSON
- ------------------------------
Leonard A. Robertson
Chief Financial Officer
(principal financial and accounting officer)
Date: May 10, 1999
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INDEX TO EXHIBITS
Exhibit No. Description
- ----------- -----------
27.1 Financial Data Schedule