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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
---------------
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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 (I.R.S. Employer Identification No.)
incorporation or 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 November 8, 1999, the registrant had outstanding 15,240,218 shares of
its common stock, $0.10 par value per share.
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HOME INTERIORS & GIFTS, INC.
INDEX
PAGE NO.
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PART I - FINANCIAL INFORMATION
Item 1. Unaudited Interim Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1998 and
September 30, 1999 ........................................................ 3
Consolidated Statements of Operations and Comprehensive Income
For the three months and nine months ended September 30, 1998 and 1999 .... 4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 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 .......................................... 11
PART II - OTHER INFORMATION
Item 1. Legal proceedings ..................................................... 21
Item 5. Other Information ..................................................... 21
Item 6. Exhibits and Reports on Form 8-K ...................................... 21
2
3
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND SEPTEMBER 30, 1999
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
ASSETS
DECEMBER 31, SEPTEMBER 30,
1998 1999
------------ -------------
(UNAUDITED)
Current assets:
Cash and cash equivalents ............................................... $ 41,024 $ 24,124
Accounts receivable, net ................................................ 7,975 13,016
Inventories ............................................................. 31,010 42,651
Deferred income tax benefit ............................................. 2,164 2,389
Other current assets .................................................... 1,040 2,517
--------- ---------
Total current assets ............................................ 83,213 84,697
Property, plant and equipment, net ........................................ 21,774 29,539
Investments ............................................................... 1,667 1,805
Debt issuance costs, net .................................................. 19,132 16,705
Other assets .............................................................. 6,662 1,405
--------- ---------
Total assets .................................................... $ 132,448 $ 134,151
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable ........................................................ $ 13,119 $ 10,541
Accrued seminars and incentive awards ................................... 12,422 14,375
Royalties payable ....................................................... 6,922 6,514
Hostess prepayments ..................................................... 8,719 9,328
Income taxes payable .................................................... 4,101 1,055
Accrued compensation .................................................... 3,606 5,167
Current maturities and prepayment of long-term debt ..................... 33,723 25,929
Other current liabilities ............................................... 9,949 14,438
--------- ---------
Total current liabilities ....................................... 92,561 87,347
Long-term debt, net of current maturities ................................. 453,277 434,546
Deferred income tax liability and other ................................... 176 251
--------- ---------
Total liabilities ............................................... 546,014 522,144
--------- ---------
Minority interest ......................................................... 508 2,809
Commitments and contingencies
Shareholders' deficit:
Common stock, par value $0.10 per share, 75,000,000 shares
authorized, 15,234,422 and 15,240,218 shares issued and outstanding,
respectively ........................................................... 1,523 1,524
Additional paid-in capital .............................................. 178,944 179,913
Accumulated deficit ..................................................... (594,314) (572,306)
Cumulative translation adjustment ....................................... (227) 67
--------- ---------
Total shareholders' deficit ..................................... (414,074) (390,802)
--------- ---------
Total liabilities and shareholders' deficit ..................... $ 132,448 $ 134,151
========= =========
The accompanying notes are an integral part of these financial statements.
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME FOR THE THREE MONTHS AND NINE
MONTHS ENDED SEPTEMBER 30, 1998 AND 1999
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1998 1999 1998 1999
--------- --------- --------- ---------
Net sales .............................................. $ 111,132 $ 112,075 $ 347,205 $ 355,057
Cost of goods sold ..................................... 54,571 55,208 170,658 172,199
--------- --------- --------- ---------
Gross profit ........................................... 56,561 56,867 176,547 182,858
Selling, general and administrative:
Selling .............................................. 18,313 20,594 59,645 62,955
Freight, warehouse and distribution .................. 10,417 11,785 31,642 35,419
General and administrative ........................... 5,401 6,309 16,215 18,921
Gains on the sale of assets .......................... (1,170) (3) (6,349) (3)
Stock option expense ................................. 329 102 329 850
Recapitalization expenses ............................ -- -- 6,198 --
--------- --------- --------- ---------
Total selling, general and administrative ....... 33,290 38,787 107,680 118,142
--------- --------- --------- ---------
Operating income ....................................... 23,271 18,080 68,867 64,716
Other income (expense):
Interest income ...................................... 565 455 4,841 1,824
Interest expense ..................................... (12,422) (11,018) (15,913) (33,342)
Other, net ........................................... 649 419 1,027 313
--------- --------- --------- ---------
Other income (expense), net ..................... (11,208) (10,144) (10,045) (31,205)
--------- --------- --------- ---------
Income before income taxes ............................. 12,063 7,936 58,822 33,511
Income taxes ........................................... 4,776 888 23,346 11,503
--------- --------- --------- ---------
Net income ............................................. 7,287 7,048 35,476 22,008
Other comprehensive income (loss) before tax:
Cumulative translation adjustment .................... -- 76 (34) 294
Unrealized losses on investments ..................... -- -- (1,074) --
--------- --------- --------- ---------
Other comprehensive income (loss) before tax .... -- 76 (1,108) 294
Income tax benefit related to items of other
comprehensive income ................................. -- -- 376 --
--------- --------- --------- ---------
Other comprehensive income, net of tax ............... -- 76 (732) 294
--------- --------- --------- ---------
Comprehensive income ................................... $ 7,287 $ 7,124 $ 34,744 $ 22,302
========= ========= ========= =========
EBITDA ................................................. $ 23,301 $ 19,247 $ 71,413 $ 68,446
========= ========= ========= =========
The accompanying notes are an integral part of these financial statements.
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1999
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
1998 1999
--------- ---------
Cash flows from operating activities:
Net income ...................................................... $ 35,476 $ 22,008
--------- ---------
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ................................. 2,368 2,883
Amortization of debt issuance costs ........................... 1,124 2,427
Provision for doubtful accounts ............................... 589 635
Gains on the sale of assets ................................... (6,349) (3)
Stock option expense .......................................... 329 850
Realized gains on investments ................................. (203) --
Equity in earnings of an affiliate ............................ -- (138)
Deferred tax expense (benefit) ................................ 138 (150)
Changes in assets and liabilities:
Accounts receivable ........................................... (2,677) (6,946)
Inventories ................................................... (11,606) (11,641)
Other current assets .......................................... (63) (1,477)
Other assets .................................................. 11 359
Accounts payable .............................................. 7,038 (2,578)
Income taxes payable .......................................... 3,132 (3,046)
Prepaid sales orders .......................................... 6,477 --
Other current liabilities ..................................... 18,155 8,165
--------- ---------
Total adjustments ........................................ 18,463 (10,660)
--------- ---------
Net cash provided by operating activities ................ 53,939 11,348
--------- ---------
Cash flows from investing activities:
Purchases of investments ........................................ (87,581) --
Proceeds from the sale of investments ........................... 154,568 --
Purchases of property, plant and equipment ...................... (6,227) (8,644)
Purchases of property, plant and equipment by minority
owner of Laredo Candle ...................................... -- (1,925)
Payments received on notes receivable ........................... 1,619 6,131
Proceeds from the sale of property, plant and equipment ......... 7,700 --
--------- ---------
Net cash provided by (used in) investing activities ...... 70,079 (4,438)
--------- ---------
Cash flows from financing activities:
Dividends paid .................................................. (9,554) --
Proceeds from the issuance of Company common stock .............. 182,557 120
Purchase of treasury stock ...................................... (827,557) --
Proceeds from the issuance of the Notes ......................... 200,000 --
Proceeds from borrowings under the Senior Credit Facility ....... 300,000 --
Debt issuance costs ............................................. (21,118) --
Recapitalization fees and expenses .............................. (3,215) --
Capital contribution from Laredo Candle minority owner .......... -- 2,301
Payments under the Senior Credit Facility ....................... (6,500) (26,525)
--------- ---------
Net cash used in financing activities .................... (185,387) (24,104)
--------- ---------
Effect of cumulative translation adjustment ....................... (34) 294
--------- ---------
Net decrease in cash and cash equivalents ......................... (61,403) (16,900)
Cash and cash equivalents at beginning of year .................... 104,262 41,024
--------- ---------
Cash and cash equivalents at end of period ........................ $ 42,859 $ 24,124
========= =========
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. ("Homco") 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, began manufacturing candles in the third quarter of 1999 and
commenced shipments in October 1999
o Subsidiaries in Mexico and Puerto Rico provide sales support services to
the international Displayers
2. SIGNIFICANT ACCOUNTING POLICIES
The Company maintains its accounting records and prepares financial
statements on the accrual basis of accounting, which conforms with generally
accepted accounting principles. Following these principles, management makes
estimates and assumptions that affect the amounts reported in the financial
statements and notes. Actual results may differ from these estimates.
These consolidated financial statements include the accounts of the
Company. All significant intercompany accounts and transactions have been
eliminated. The Company records sales and related expenses on a weekly basis
ending on each Saturday and every quarter consists of thirteen weeks. The last
days of the quarter ended September 30, 1998 and 1999 in the accompanying
unaudited consolidated financial information were October 3, 1998 and October 2,
1999, respectively.
The consolidated financial information as of September 30, 1999 and for
the three months and nine months ended September 30, 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 Company's
consolidated financial position as of September 30, 1999, operating results and
comprehensive income for the three months and nine months ended September 30,
1998 and 1999, and cash flows for the nine months ended September 30, 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:
=> $11.2 million financial advisory fee paid to Hicks Muse for its
role in obtaining financing for the Recapitalization
=> $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
=> $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. NEW WAREHOUSE AND DISTRIBUTION FACILITY
The Company is currently operating in and from several separate
warehouse and distribution facilities. On July 19, 1999 the Company entered into
a contract with Argent Frankford L.P. ("Argent") to construct a new 660,000
square-foot warehouse and distribution facility in Carrollton, Texas for
approximately $19.4 million. The Company expects to incur an additional $3.1
million in customized improvements to prepare the facility for occupancy.
Construction is proceeding on schedule and the Company expects to occupy the
facility in the second quarter of 2000. In the event the sale transactions
described below are not consummated and the Company is unable to purchase the
facility, the Company is obligated to enter into a long-term lease agreement
with Argent upon completion of construction.
The new warehouse and distribution facility will allow the Company to
consolidate its current warehouse and distribution operation from several
smaller facilities into a single larger facility. Among other things, the
Company anticipates that it will benefit from reduced labor and inventory costs
and property tax savings. Additionally, the new facility will allow the Company
to utilize an automated order fulfillment system, which the Company expects will
result in additional labor savings. The Company is working with a consultant to
assist in the design layout of the facility and the implementation of an
automated order fulfillment system. The automated order
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
fulfillment system will include a new conveyor system, special racks and storage
bins, and a warehouse management software system. The Company has selected a
vendor to provide the warehouse management system, and is currently in the
process of negotiating an agreement with the vendor for the purchase,
installation and ongoing support of the system. The Company expects that its
automation related costs will be approximately $11.0 million. A small portion of
these costs will be incurred in late 1999 and the remainder will be incurred
throughout 2000 as the Company transitions from its current warehouse and
distribution facilities to its new facility. The Company expects to continue to
use its current distribution system until the automated system is fully
operational.
Concurrently with the transaction described above, the Company entered
into an exchange transaction with Parker Equities Inc. ("Parker") to sell to
Parker for $15.7 million, net of commissions and closing costs, substantially
all of the Company's owned properties and facilities in the Dallas area,
including all of its warehouse and distribution facilities and its corporate
headquarters. The Company is responsible for approximately $1.0 million of roof
replacement costs, which will reduce the net proceeds to the Company from the
sale. The Company plans to close the transaction on or before December 1, 1999
subject to certain customary terms and conditions. At closing, the Company
intends to enter into several separate lease agreements to lease back all of its
properties and facilities until the Company's new facilities are ready for
occupancy. The lease terms will vary in length based on a predetermined schedule
of facility closings between April 2000 and August 2000.
The Company expects that the process of selling its current facilities
and properties in exchange for purchasing a new facility and property will
qualify as a Section 1031 Tax-Free Exchange under the United States Internal
Revenue Code of 1986, as amended. The Company anticipates there will be a
pre-tax gain of approximately $10.0 million on the sale of its properties and
facilities for financial reporting purposes.
The transactions described above require the consent of the Company's
senior lenders, which the Company anticipates will be obtained in a timely
manner. The Company has requested an amendment to the Senior Credit Facility to
exclude these transactions from certain debt covenant requirements.
5. CORPORATE HEADQUARTERS FACILITY
The Company has negotiated a ten-year lease for a new corporate
headquarters location in Dallas. This facility consists of approximately 75,000
square feet of office space for annual rent of approximately $1.7 million.
Tenant improvements to customize the space are expected to be approximately $4.6
million, of which approximately $2.0 million will be borne by the landlord as
improvement allowances. The remaining $2.6 million will be borne by the Company.
The Company expects to move into its new headquarters facility in late 1999 or
early 2000.
6. INVENTORIES
Inventories consisted of the following as of December 31, 1998 and
September 30, 1999 (in thousands):
DECEMBER 31, SEPTEMBER 30,
1998 1999
------------ -------------
(UNAUDITED)
Raw materials .......................... $ 6,134 $ 6,569
Work in process ........................ 1,742 2,007
Finished goods ......................... 23,134 34,075
-------- --------
$ 31,010 $ 42,651
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
7. OTHER CURRENT LIABILITIES
Other current liabilities consisted of the following as of December 31,
1998 and September 30, 1999 (in thousands):
DECEMBER 31, SEPTEMBER 30,
1998 1999
------------ -------------
(UNAUDITED)
Interest payable ....................... $ 2,959 $ 7,911
Employee benefit plan contributions .... 2,264 1,251
Sales taxes payable .................... 1,871 1,839
Other current liabilities .............. 2,855 3,437
------- -------
$ 9,949 $14,438
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8. LONG TERM DEBT
Interest rates for the Senior Credit Facility are based on borrowings
entered into on varying dates. Long-term debt consisted of the following as of
September 30, 1999 (in thousands):
INTEREST APPLICABLE ADJUSTED
AMOUNT RATE MARGIN RATE
--------- -------- ---------- --------
Senior Credit Facility:
Tranche A Loan:
3 month borrowings ..... $ 85,000 5.50% 1.50% 7.00%
3 month borrowings ..... 79,254 5.51% 1.50% 7.01%
Tranche B Loan:
12 month borrowings .... 96,221 5.02% 2.00% 7.02%
---------
260,475
Notes ....................... 200,000 10.125% -- --
---------
460,475
Less current maturities ..... (25,929)
---------
$ 434,546
=========
Interest Rate Swap Agreements
The Company is exposed to financial market risks, including changes in
interest 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.
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. The Company recorded a $0.5 million loss in the
nine months ended September 30, 1999 as a result of the knockout provision
market adjustment.
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
In September 1999, the Company entered into three separate six month
interest rate swap agreements to limit the effect of changes in interest rates
on long-term borrowings. Under each swap agreement, the Company pays interest at
a fixed LIBOR rate on the notional amount and receives interest thereon at
three-month LIBOR on a quarterly basis. The lenders have the option at the end
of the term of each swap agreement to extend each agreement for an additional
six month period. The following table summarizes the terms of these new interest
rate swap agreements (in thousands):
Effective Date Maturity Date Notional Amount Fixed LIBOR Rate
-------------- ------------- --------------- ----------------
09/30/99 03/30/00 $ 70,000 5.80%
11/30/99 05/30/00 $ 50,000 5.80%
12/03/99 06/05/00 $ 15,000 5.90%
9. INCOME TAXES
The Company's effective income tax rate for the three months and nine
months ended September 30, 1999 was impacted by certain prior year income tax
provision adjustments. These adjustments primarily related to a prior year tax
refund applied in the 1999 period and costs associated with the
Recapitalization. The Company expects that its effective income tax rate for the
nine months ended September 30, 1999 will be consistent with its effective
income tax rate for the year ended December 31, 1999.
10. 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 quarters
and fiscal years beginning after June 15, 2000. 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, train
and retain a significant number of new Displayers each year.
The Company revised its recruiting and training criteria 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. The
Company recruited approximately 42,400 new Displayers during the nine months
ended September 30, 1999, which was more than the number recruited during the
entire year in 1998. Although the Displayer base grew from 52,800 as of December
31, 1998 to 92,800 as of September 30, 1999, many of the new Displayers were not
considered active because they had not placed their first order. To be
considered an active Displayer, the Displayer must have placed an order within
the 14 prior weeks. Active Displayers totaled 63,500 as of September 30, 1999,
up 26.7% from 50,100 as of December 31, 1998, and up 38.9% from 45,700 as of
September 30, 1998.
In connection with the recent growth in recruiting, the Company lowered
its minimum order requirement in June 1999, and as a result, experienced a
significant decline in average order sizes. The Company is continuing to
evaluate the impact the lower minimum order requirement is having on its
business; however, the Company expects that the higher operating costs
experienced during the second and third quarters will continue through the
remainder of the year. In an effort to offset a portion of its higher operating
costs and to encourage larger orders sizes, in September 1999, the Company added
a handling charge to the smaller orders.
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 during the remainder of 1999
until the new pricing structure is incorporated throughout its entire product
line. The Company experienced an unexpected decline in its gross margin in the
three months ended September 30, 1999, primarily due to significant
manufacturing inefficiencies. The Company expects that its operating profit
margins will decline slightly through the end of 1999 as compared to the related
1998 period primarily as a result of higher general and administrative costs and
the increased costs associated with processing and shipping more orders.
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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.
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:
=> $11.2 million financial advisory fee paid to Hicks Muse for its
role in obtaining financing for the Recapitalization
=> $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
=> $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 SEPTEMBER 30, 1999 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 1998
Net sales. Net sales increased $1.0 million, or 0.8%, to $112.1 million
in the three months ended September 30, 1999 from $111.1 million in the
comparable period in 1998. The number of orders shipped in the 1999 period
increased by 30.0%, which slightly offset a 22.8% decline in the average order
size. The decline in the average order size was primarily as a result of a lower
minimum order requirement implemented in June 1999 and growth in the Displayer
base that increased the percentage of less experienced, and therefore, less
productive Displayers. Growth in the Displayer base contributed to the increase
in the number of orders shipped in the 1999 period. The average number of active
Displayers increased to 62,500 in the three months ended September 30, 1999 from
45,400 in the comparable period in 1998. Orders shipped per active Displayer
decreased slightly. The Company expects that the trend of more orders shipped
and lower order sizes, each as compared to comparable historical periods, will
continue throughout 1999 as a result of the factors discussed above.
Additionally, the 1998 net sales were impacted negatively by an unusual
backlog of unfilled orders as of September 30, 1998. Sales are recognized when
products are shipped. The Company generally ships products to Displayers on the
same day orders are received. The Company received an unusually high volume of
orders during the final week of September 1998 in connection with a discount
program. The Company was unable to fill and ship all orders received during the
final week of September 1998, although all unfilled orders were shipped by the
following week. The backlog of unfilled orders totaled approximately $6.5
million and were reflected as sales when shipped the first week in October 1998.
If the Company had been able to fill and ship the backlog of unfilled orders
during the final week of September 1998, net sales of $112.1 million in the
three months ended September 30, 1999 would have decreased $5.5 million or $4.7%
from $117.6 million in the comparable period of 1998. The Company
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believes that backlog is unusual to its business, and as a result, does not
expect any significant backlog in the near future.
Gross profit. Gross profit increased $0.3 million, or 0.5%, to $56.9
million in the three months ended September 30, 1999 from $56.6 million in the
comparable period in 1998. As a percentage of net sales, gross profit decreased
to 50.7% in the 1999 period from 50.9% in the 1998 period. The Company continued
to benefit from the introduction of new products with higher margins; however,
the Company experienced significant manufacturing inefficiencies in the 1999
period that resulted in a reduction in gross profit of approximately $1.4
million compared to the 1998 period. Most of the inefficiencies are related to
product mix, low production volumes and unexpected high amounts of scrap
material. While most of the manufacturing inefficiencies have been identified,
the Company expects that it may incur additional inefficiencies during the
remainder of the year, although to a lesser degree than those experienced in the
three months ended September 30, 1999.
Selling expense. Selling expense increased $2.3 million, or 12.5%, to
$20.6 million in the three months ended September 30, 1999 from $18.3 million in
the comparable period in 1998. As a percentage of net sales, selling expense
increased to 18.4% in the 1999 period from 16.5% in the 1998 period. This
increase was primarily attributable to higher incentive costs, an increased
number of meetings with sales field leadership (the "Directors"), and higher
commission rates for certain Unit Directors in the 1999 period. The increases in
these expenses more than offset a reduced bonus accrual for all Directors in the
1999 period.
Freight, warehouse and distribution expense. Freight, warehouse and
distribution expense increased $1.4 million, or 13.1%, to $11.8 million in the
three months ended September 30, 1999 from $10.4 million in the comparable
period in 1998. As a percentage of net sales, freight, warehouse and
distribution expense increased to 10.5% in the 1999 period from 9.4% in the 1998
period. Freight expense is largely based on pounds shipped. An increase in the
percentage of candle sales to total sales contributed to more pounds shipped per
sales dollar in the 1999 period. As a result, freight expense increased as a
percentage of net sales in the 1999 period. The increase in freight expense was
offset to some extent by the addition of handling charges on small orders
beginning in September 1999 and an increased use of Local Distributors in the
1999 period. Warehouse and distribution expense increased in the 1999 period due
to an increase in the number of orders shipped, which required the Company to
hire more employees to fill the increased number of orders. The Company expects
the trend of more orders and higher labor costs will continue throughout the
remainder of 1999 and into 2000 until the Company's automated order fulfillment
system is fully operational.
General and administrative expense. General and administrative expense
increased $0.9 million, or 16.8%, to $6.3 million in the three months ended
September 30, 1999 from $5.4 million in the comparable period in 1998. The
increase was largely due to increased personnel costs and increased depreciation
expense. The higher personnel costs are primarily in response to the growth in
the sales force coupled with the modernization of the Company's computer systems
(which required the Company to hire employees with specialized skills).
Gains on the sale of assets. The Company recorded a gain of $1.2
million on the sale of a building in August 1998.
Income taxes. Income taxes decreased to $0.9 million in the three
months ended September 30, 1999 from $4.8 million in the comparable period in
1998. The Company's effective income tax rate decreased to 11.1% in the 1999
period from 39.6% in the 1998 period. This decrease was primarily due to certain
prior year income tax provision adjustments made in the 1999 period. These
adjustments primarily related to a prior year refund applied in the 1999 period
and costs associated with the Recapitalization. The Company expects that its
effective income tax rate for the nine months ended September 30, 1999 will be
consistent with its effective income tax rate for the year ended December 31,
1999.
THE NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1998
Net sales. Net sales increased $7.9 million, or 2.3%, to $355.1 million
in the nine months ended September 30, 1999 from $347.2 million in the
comparable period in 1998. This increase was primarily attributable to a 22.6%
increase in the number of orders shipped, which more than offset a 16.8%
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 56,600 in the nine months ended September 30, 1999 from 44,500 in the
comparable period in 1998. Orders shipped per active Displayer decreased
slightly. The decline in the average order size was primarily as a
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result of a lower minimum order requirement implemented in June 1999 and growth
in the Displayer base that increased the percentage of less experienced and,
therefore, less productive Displayers. Additionally, as previously discussed,
the 1998 net sales were impacted by an unusual backlog of unfilled orders as of
September 30, 1998.
Gross profit. Gross profit increased $6.4 million, or 3.6%, to $182.9
million in the nine months ended September 30, 1999 from $176.5 million in the
comparable period in 1998. As a percentage of net sales, gross profit increased
to 51.5% in 1999 from 50.8% in the 1998 period. The Company continued to benefit
from the introduction of new products with higher margins in the 1999 period,
which more than offset the significant manufacturing inefficiencies the Company
experienced in the three months ended September 30, 1999.
Selling expense. Selling expense increased $3.4 million, or 5.5%, to
$63.0 million in the nine months ended September 30, 1999 from $59.6 million in
the comparable period in 1998. As a percentage of net sales, selling expense of
17.7% in the 1999 period was slightly higher than 17.2% in the 1998 period
primarily as a result of higher commission rates for certain Unit Directors in
the 1999 period. These higher commission rates were implemented in April 1999.
Freight, warehouse and distribution expense. Freight, warehouse and
distribution expense increased $3.8 million, or 11.9%, to $35.4 million in the
nine months ended September 30, 1999 from $31.6 million in the comparable period
in 1998. As a percentage of net sales, freight, warehouse and distribution
expense increased to 10.0% in the 1999 period from 9.1% in the 1998 period. This
increase resulted from the increase in the number of orders shipped, and in
particular the compensation expense resulting from the hiring of additional
permanent and temporary employees in order to fill the higher number of orders.
The Company expects that the trend of more orders and higher labor costs will
continue throughout the remainder of 1999 and into 2000 until the Company's
automated order fulfillment system is fully operational.
General and administrative expense. General and administrative expense
increased $2.7 million, or 16.7%, to $18.9 million in the nine months ended
September 30, 1999 from $16.2 million in the comparable period in 1998. The
increase was largely due to increased personnel costs, the full period impact of
a monitoring and oversight fee payable to Hicks Muse, and increased depreciation
expense. The higher personnel costs were primarily in response to the growth in
the sales force coupled with the modernization of the Company's computer systems
(which required the Company to hire employees with specialized skills).
Gains on the sale of assets. The Company recorded gains of $6.3 million
primarily on the sale of two aircraft and a building in 1998.
Interest income. Interest income decreased to $1.8 million in the nine
months ended September 30, 1999 from $4.8 million in the comparable period in
1998 due to lower average investment balances as a result of the
Recapitalization.
Interest expense. Interest expense increased $17.4 million in the nine
months ended September 30, 1999 to $33.3 million from $15.9 million in the
comparable period in 1998. This increase resulted from the full period impact of
interest expense incurred in connection with the Senior Credit Facility and the
Notes.
Income taxes. Income taxes decreased to $11.5 million in the nine
months ended September 30, 1999 from $23.3 million in the comparable period in
1998. The Company's effective income tax rate decreased to 34.3% in the 1999
period from 39.7% in the 1998 period. This decrease was primarily due to certain
prior year income tax provision adjustments made in the 1999 period. These
adjustments related to a prior year refund applied in the 1999 period and costs
associated with the Recapitalization. The Company expects that its effective
income tax rate for the year ended December 31, 1999 will be consistent with its
effective income tax rate for the nine months ended September 30, 1999.
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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 has 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 nine months ended September 30,
1999 totaled $11.3 million, a $42.6 million decline from the $53.9 million in
cash provided by operations in the comparable period in 1998. The decrease was
largely attributable to reduced net income in the nine months ended September
30, 1999 primarily as a result of the full period impact of interest expense on
the Senior Credit Facility and the Notes, a larger increase in accounts
receivable during the 1999 period and decreases or smaller increases in accounts
payable and various other current liabilities during the 1999 period. Net cash
provided by operating activities was also higher in the 1998 period due to the
effect of $6.5 million in prepaid sales orders filled and shipped the first week
of October 1998.
Prior to June 4, 1998, the Company liquidated substantially all of its
investments held as of December 31, 1997 to meet the cash requirements of the
Recapitalization. As a result, proceeds from the sale of investments through
September 30, 1998 totaled $154.6 million. Purchases of investments totaled
$87.6 million through September 30, 1998. In addition to its other investing
activities, the Company sold two aircraft and a building in the nine months
ended September 30, 1998 for proceeds of approximately $7.7 million.
The Company used $4.4 million cash in investing activities during the
nine months ended September 30, 1999 and generated $70.1 million in the
comparable period in 1998. The Company's capital expenditures totaled $8.6
million during the nine months ended September 30, 1999 and $6.2 million in the
comparable period in 1998. Additionally, capital expenditures made by the
minority owner of Laredo Candle in the 1999 period totaled $1.9 million.
Payments received on notes receivable increased to $6.1 million during the nine
months ended September 30, 1999 from $1.6 million in the comparable period in
1998 primarily due to the early payoff of certain notes.
The Company is currently operating in and from several separate
warehouse and distribution facilities. On July 19, 1999 the Company entered into
a contract with Argent Frankford L.P. ("Argent") to construct a new 660,000
square-foot warehouse and distribution facility in Carrollton, Texas for
approximately $19.4 million. The Company expects to incur an additional $3.1
million in customized improvements to prepare the facility for occupancy.
Construction is proceeding on schedule and the Company expects to occupy the
facility in the second quarter of 2000. In the event the sale transactions
described below are not consummated and the Company is unable to purchase the
facility, the Company is obligated to enter into a long-term lease agreement
with Argent upon completion of construction.
The new warehouse and distribution facility will allow the Company to
consolidate its current warehouse and distribution operation from several
smaller facilities into a single larger facility. Among other things, the
Company anticipates that it will benefit from reduced labor and inventory costs
and property tax savings. Additionally, the new facility will allow the Company
to utilize an automated order fulfillment system, which the Company expects will
result in additional labor savings. The Company is working with a consultant to
assist in the design layout of the facility and the implementation of an
automated order fulfillment system. The automated order fulfillment system will
include a new conveyor system, special racks and storage bins, and a warehouse
management software system. The Company has selected a vendor to provide the
warehouse management system, and is currently in the process of negotiating an
agreement with the vendor for the purchase, installation and ongoing support of
the system. The Company expects that its automation related costs will be
approximately $11.0 million. A small portion of these costs will be incurred in
late 1999 and the remainder will be incurred throughout 2000 as
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the Company transitions from its current warehouse and distribution facilities
to its new facility. The Company expects to continue to use its current
distribution system until the automated system is fully operational.
Concurrently with the transaction described above, the Company entered
into an exchange transaction with Parker Equities Inc. to sell to Parker for
$15.7 million, net of commissions and closing costs, substantially all of the
Company's owned properties and facilities in the Dallas area, including all of
its warehouse and distribution facilities and its corporate headquarters. The
Company is responsible for approximately $1.0 million of roof replacement costs,
which will reduce the net proceeds to the Company from the sale. The Company
plans to close the transaction on or prior to December 1, 1999 subject to
certain customary terms and conditions. At closing, the Company intends to enter
into several separate lease agreements to lease back all of its properties and
facilities until the Company's new facilities are ready for occupancy. The lease
terms will vary in length based on a predetermined schedule of facility closings
between April 2000 and August 2000.
The Company expects that the process of selling its current facilities
and properties in exchange for purchasing a new facility and property will
qualify as a Section 1031 Tax-Free Exchange under the United States Internal
Revenue Code of 1986, as amended. The Company anticipates there will be a
pre-tax gain of approximately $10.0 million on the sale of its properties and
facilities for financial reporting purposes.
The transactions described above require the consent of the Company's
senior lenders, which the Company anticipates will be obtained in a timely
manner. The Company has requested an amendment to the Senior Credit Facility to
exclude these transactions from certain debt covenant requirements.
The Company has negotiated a ten year lease for a new corporate
headquarters location in Dallas. This facility consists of approximately 75,000
square feet of office space for annual rent of approximately $1.7 million.
Tenant improvements to customize the space are expected to be approximately $4.6
million, of which approximately $2.0 million will be borne by the landlords as
improvement allowances. The remaining $2.6 million will be borne by the Company.
The Company expects to move into its new headquarters facility in late 1999 or
early 2000.
The Company estimates that its capital expenditures for the year ended
December 31, 1999 will increase by $9.6 million to approximately $17.5 million
from $7.9 million in the comparable period of 1998. Additionally, the minority
owner of Laredo Candle spent $0.5 million in capital expenditures in the 1998
period and expects to spend approximately $2.3 million in the 1999 period for
its portion of the new candle manufacturing operation. The anticipated increase
in the Company's capital expenditures of approximately $9.6 million is
principally as a result of the following, which is expected to offset a decline
in other capital expenditures of approximately $1.4 million:
o leasehold improvements to the new corporate headquarters of
approximately $4.6 million (approximately $2.0 million will
be borne by the landlord)
o construction and purchase of machinery and equipment for the
Laredo Candle Company of approximately $2.3 million
o continued enhancements to the Company's new computer system,
including Internet capabilities, of approximately $2.8 million
o design development, and certain software costs associated with of
the new automated order fulfillmention system of approximately
$1.3
The Company's use of cash for financing activities decreased to $24.1
million during the nine months ended September 30, 1999 from $185.4 million in
the comparable period in 1998. The higher use of cash in the 1998 period was due
to the Recapitalization. The Company used proceeds of $182.6 million from the
contribution of equity by Hicks Muse, $200.0 million from the issuance of the
Notes and $300.0 million of borrowings under the Senior Credit Facility,
together with proceeds from the sale of investments as described above, to pay
$827.6 million for the redemption of common stock, and to pay $24.3 million of
fees and expenses associated with the Recapitalization. Prior to the
Recapitalization, the Company's primary financing activity was the payment of
dividends. Dividends paid during the 1998 period totaled $9.6 million. 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, and no dividends were paid during the 1999 period. The
Company's primary financing activity in the 1999 period consisted of principal
payments under the Senior Credit Facility of $26.5 million.
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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 $40.0
million of Revolving Loans, which mature on June 30, 2004. The Revolving Loans
remained undrawn as of September 30, 1999.
The Company paid a total of $51.9 million in debt service in the nine
months ended September 30, 1999. The debt service payments consisted of
scheduled principal payments under the Senior Credit Facility of $18.8 million,
a mandatory prepayment of $7.7 million under the Senior Credit Facility, and
interest under the Senior Credit Facility and the Notes of approximately $25.4
million.
The Company anticipates that its debt service requirements will total
$72.8 million in 1999. These debt service requirements are expected to consist
of scheduled principal payments due under the Senior Credit Facility of $25.0
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.
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 is
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 1998 activity. 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 September 30, 1999 primarily to meet working capital
needs and to fund capital expenditures, including costs associated with the
Company's new automated order fulfillment system and the transition to the
Company's new warehouse and distribution facility and corporate headquarters
facility.
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.
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 have historically not been
significant, and as a result, changes in foreign currency exchange rates have
not had 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. The Company recorded a $0.5 million loss in the
nine months ended September 30, 1999 as a result of the knockout provision
market adjustment.
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In September 1999, the Company entered into three separate six month
interest rate swap agreements to limit the effect of changes in interest rates
on long-term borrowings. Under each swap agreement, the Company pays interest at
a fixed LIBOR rate on the notional amount and receives interest thereon at
three-month LIBOR on a quarterly basis. The lenders have the option at the end
of the term of each swap agreement to extend each agreement for an additional
six month period. The following table summarizes the terms of these new interest
rate swap agreements (in thousands):
Effective Date Maturity Date Notional Amount Fixed LIBOR Rate
- -------------- ------------- --------------- ----------------
09/30/99 03/30/00 $ 70,000 5.80%
11/30/99 05/30/00 $ 50,000 5.80%
12/03/99 06/05/00 $ 15,000 5.90%
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 nine months ended September 30, 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 substances to the Materials Recovery Enterprises, Inc. facility near
Ovalo, Texas in Taylor County, Texas. In 1998, Homco paid an assessment of
approximately $1,000 for liability at the facility. By agreement, Kraft Foods,
Inc., a partial indemnitor to Homco, paid Homco 96.5% of this past assessment;
assumed the future administration of the matter, including payment of future
costs; and may, upon demand, request reimbursement from Homco for 3.5% of future
costs. Although Homco remains jointly and severally liable for the remediation
of the site, the probability that Homco will be required to pay more than a de
minimis amount is remote.
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 was issued in September regarding several
calculation errors in GIA's Form R Report. The EPA imposed a $21,000 fine which
the Company is seeking to recover from a third party.
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, results of operations or liquidity.
YEAR 2000 ISSUE
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 (the "Year 2000 Issue"). 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. Such
failures could materially and adversely affect the Company's results of
operations, liquidity and financial condition.
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The Company completed the assessment phase of the Year 2000 Issue in
early 1999, which consisted of taking an inventory of its information systems,
prioritizing items, determining critical items and establishing a timetable for
determining the modifications to existing software and new software required to
mitigate any Year 2000 Issue. The Company's evaluation included information
systems infrastructure and operating systems as well as the Company's
subsidiaries and its suppliers.
Because the Company implemented a 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, the Company believes its systems and related software are Year 2000
compliant. The Company upgraded the software for the Computer System through the
purchase of certain software products developed by Distribution Architects
International ("DAI"). DAI assisted with the implementation process and
continues to provide support for enhancement to the Computer System. Each
supplier (including DAI) of the hardware and software 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 Computer System has been thoroughly tested
and remediation has taken place where necessary. In addition, Year 2000 testing
and remediation of other aspects of the Company's infrastructure, including the
Company's subsidiaries, is complete. Costs associated with the Computer System
through September 30, 1999 totaled approximately $5.6 million. Additional costs
associated with remediating the Year 2000 Issue have been expensed as incurred
and are not material.
Although the Company expects its critical systems are compliant, and
testing supports this expectation, there is no assurance these results will be
achieved. However, the impact of a failure of any of the Company's information
systems would be mitigated to the extent that other alternate processes,
including manual processes, were able to meet processing requirements.
Presently, the Company expects alternate procedures would be able to meet the
Company's processing needs for a limited timeframe. The Company will have DAI
and other programmers on-site during the first week of January 2000 in order to
make required modifications to the Computer System should they be needed. The
Company expects that the required modifications, if any, will be insignificant
and remediation will be complete by the end of the first week in January 2000.
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. While the Company
believes that these scenarios, if they were to occur, would be temporary in
duration, there can be no assurance that the duration will be short-term. In the
event these conditions were to persist for a longer duration, they 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.
Although not anticipated, the most reasonably likely worst-case
scenario of failure by the Company or its key suppliers or service providers to
become Year 2000 compliant would be short-term slowdown or cessation of
manufacturing operations at one or more facilities and a short-term inability on
the part of the Company to process, fill and ship orders in a timely manner, and
to deliver product to Displayers.
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 quarters
and fiscal years beginning after June 15, 2000. The Company has not yet
determined the effect the new standard will have on its financial statements.
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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 completion of the Company's
new warehouse and distribution facility; (vii) unexpected delays or problems
associated with the sale of substantially all of the Company's existing
properties and facilities; (viii) unexpected delays or problems associated with
integration and implementation of the automated order fulfillment system; (ix)
unexpected delays or problems associated with the Year 2000 Issue; and (x) the
ability of third party suppliers and service providers to remediate any Year
2000 issues applicable to their respective businesses. 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.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Environmental Issues" for information regarding legal
proceedings which is incorporated herein by reference.
ITEM 5. Other Information
On November 1, 1999, the Company entered into an employment agreement
with Kenneth J. Cichocki to serve as its Vice President of Finance and Chief
Financial Officer. The initial term of the employment agreement is for one year
and may be extended for successive one year periods. Leonard A. Robertson, the
Company's Chief Financial Officer from July 1995 to October 1999, was appointed
to the newly-created position of Chief Administrative Officer.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit Number Description
-------------- -----------
10.1 Second Amendment to Real Estate Purchase
Contract dated August 18, 1999, between the
Company and Parker Equities, Inc.
10.2 Third Amendment to Real Estate Purchase
Contract dated September 15, 1999, between
the Company and Parker Equities, Inc.
10.3 Fourth Amendment to Real Estate Purchase
Contract dated October 15, 1999, between the
Company and Parker Equities, Inc.
10.4 Employment Agreement, dated November 1,
1999, between the Company and Kenneth J.
Cichocki
27 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/ KENNETH J. CICHOCKI
- ----------------------------
Kenneth J. Cichocki
Vice President of Finance and Chief Financial Officer
(principal financial and accounting officer)
Date: November 8, 1999
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INDEX TO EXHIBITS
Exhibit Number Description
-------------- -----------
10.1 Second Amendment to Real Estate Purchase
Contract dated August 18, 1999, between the
Company and Parker Equities, Inc.
10.2 Third Amendment to Real Estate Purchase
Contract dated September 15, 1999, between
the Company and Parker Equities, Inc.
10.3 Fourth Amendment to Real Estate Purchase
Contract dated October 15, 1999, between the
Company and Parker Equities, Inc.
10.4 Employment Agreement, dated November 1,
1999, between the Company and Kenneth J.
Cichocki
27 Financial Data Schedule