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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
COMMISSION FILE NUMBER 333-62021
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HOME INTERIORS & GIFTS, INC.
(Exact name of registrant as specified in its charter)
TEXAS 75-0981828
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
1649 FRANKFORD ROAD, W CARROLLTON, TEXAS 75007-4605
(Address of principal executive offices) (Zip Code)
(972) 695-1000
Registrant's Telephone Number, Including Area Code
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
As of May 12, 2003, 15,240,218 shares of the Company's common stock, par value
$0.10 per share, were outstanding.
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
INDEX
PAGE NO.
--------
PART I - FINANCIAL INFORMATION
Item 1. Unaudited Interim Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2002 and
March 31, 2003.................................................... 3
Consolidated Statements of Operations and Comprehensive
Income for the three months ended March 31, 2002 and
2003.............................................................. 4
Consolidated Statements of Cash Flows for the three months
ended March 31, 2002 and 2003..................................... 5
Notes to Unaudited Interim Consolidated Financial
Statements........................................................ 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................... 15
Item 3. Quantitative and Qualitative Disclosure About
Market Risk....................................................... 20
Item 4. Controls and Procedures.................................... 21
PART II - OTHER INFORMATION
Item 1. Legal proceedings.......................................... 22
Item 6. Exhibits and Reports on Form 8-K........................... 22
2
ITEM 1. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2002 AND MARCH 31, 2003
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
DECEMBER 31, MARCH 31,
2002 2003
---- ----
(IN THOUSANDS, EXCEPT
SHARE INFORMATION)
ASSETS
Current assets:
Cash .......................................................... $ 64,116 $ 36,630
Accounts receivable, net ...................................... 13,581 24,489
Inventories, net .............................................. 55,209 65,757
Deferred income tax ........................................... 8,399 9,173
Other current assets .......................................... 2,997 3,258
--------- ---------
Total current assets .................................. 144,302 139,307
Property, plant and equipment, net .............................. 69,482 79,233
Debt issuance costs, net ........................................ 5,067 4,790
Goodwill ........................................................ 11,126 12,445
Other assets, net ............................................... 621 598
--------- ---------
Total assets .......................................... $ 230,598 $ 236,373
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable .............................................. $ 32,844 $ 29,411
Accrued seminars and incentive awards ......................... 22,435 17,818
Royalties payable ............................................. 13,327 5,635
Current portion of related party note payable ................. 663 663
Current maturities of long-term debt and capital lease
obligations ................................................ 21,017 20,215
Other current liabilities ..................................... 21,699 36,812
--------- ---------
Total current liabilities ............................. 111,985 110,554
Long-term related party note payable, net of current maturities . 1,362 1,362
Long-term debt and capital lease obligations, net of current
maturities .................................................... 321,874 321,688
Non-current deferred income tax liability ....................... 3,354 2,552
Other liabilities ............................................... 19,724 19,763
--------- ---------
Total liabilities ..................................... 458,299 455,919
--------- ---------
Commitments and contingencies (see Note 9)
Shareholders' deficit:
Preferred stock, par value $0.01 per share 10,000,000 shares
authorized 96,058.98 shares designated as cumulative 12.5%
Senior Convertible Preferred Stock at a liquidation value of
$1,000 per share, 96,058.98
shares issued and outstanding .............................. 94,196 94,196
Common stock, par value $0.10 per share, 75,000,000 shares
authorized, 15,240,218 shares issued and outstanding ....... 1,524 1,524
Additional paid-in capital .................................... 180,829 181,753
Accumulated deficit ........................................... (503,731) (496,498)
Other ......................................................... (519) (521)
--------- ---------
Total shareholders' deficit ........................... (227,701) (219,546)
--------- ---------
Total liabilities and shareholders' deficit ........... $ 230,598 $ 236,373
========= =========
The accompanying notes are an integral part of these financial statements.
3
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND 2003
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
2002 2003
---- ----
Net sales ......................................... $ 118,020 $ 126,121
Cost of goods sold ................................ 51,472 54,877
--------- ---------
Gross profit ...................................... 66,548 71,244
Selling, general and administrative:
Selling ......................................... 21,361 20,501
Freight, warehouse and distribution ............. 12,917 15,622
General and administrative ...................... 12,602 15,640
Loss on the disposition of assets ............... -- 4
Stock option expense ............................ 114 924
--------- ---------
Total selling, general and administrative 46,994 52,691
--------- ---------
Operating income .................................. 19,554 18,553
Other income (expense):
Interest income ................................. 48 156
Interest expense ................................ (6,498) (7,062)
Other income (expense), net ..................... (119) (69)
--------- ---------
Other income (expense), net ............. (6,569) (6,975)
--------- ---------
Income before income taxes ........................ 12,985 11,578
Provision for income taxes ........................ 4,796 4,345
--------- ---------
Net income ........................................ 8,189 7,233
Other comprehensive income (loss):
Cumulative translation adjustment ............... 23 (2)
--------- ---------
Other comprehensive income (loss) ....... 23 (2)
--------- ---------
Comprehensive income .............................. $ 8,212 $ 7,231
========= =========
The accompanying notes are an integral part of these financial statements.
4
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND 2003
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
2002 2003
---- ----
Cash flows from operating activities:
Net income ................................................ $ 8,189 $ 7,233
-------- --------
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization ........................... 2,953 3,656
Amortization of debt issuance costs and other ........... 552 277
Provision for doubtful accounts ......................... 531 786
Provision for losses on inventories ..................... 1,079 (2,728)
Loss on the disposition of assets ....................... -- 4
Stock option expense .................................... 114 924
Deferred tax benefit .................................... (2,797) (1,559)
Changes in assets and liabilities:
Accounts receivable ................................... (7,468) (12,085)
Inventories ........................................... (7,773) (5,868)
Other current assets .................................. (516) (281)
Other assets .......................................... 7 (32)
Accounts payable ...................................... 436 (1,893)
Income taxes payable .................................. 5,364 4,455
Other accrued liabilities ............................. 6,764 (1,832)
-------- --------
Total adjustments ................................. (754) (16,176)
-------- --------
Net cash provided by (used in) operating activities 7,435 (8,943)
-------- --------
Cash flows from investing activities:
Business acquisitions, net of cash acquired ............. -- (12,430)
Purchases of property, plant and equipment .............. (2,039) (4,592)
Proceeds from the sale of property, plant and equipment . -- 22
Increase in restricted cash ............................. (450) --
-------- --------
Net cash used in investing activities ............. (2,489) (17,000)
-------- --------
Cash flows from financing activities:
Payments under capital lease obligations ................ (344) (791)
Payments of other bank debt ............................. -- (750)
-------- --------
Net cash used in financing activities ............. (344) (1,541)
-------- --------
Effect of cumulative translation adjustment ............... 23 (2)
-------- --------
Net increase (decrease) in cash and cash equivalents ...... 4,625 (27,486)
Cash and cash equivalents at beginning of year ............ 13,712 64,116
-------- --------
Cash and cash equivalents at end of period ................ $ 18,337 $ 36,630
======== ========
The accompanying notes are an integral part of these financial statements.
5
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BACKGROUND
Home Interiors & Gifts, Inc. (the "Company") is a fully-integrated
manufacturer and distributor of home decorative accessories. The Company
believes it is the largest direct seller of home decorative accessories in the
United States, as measured by sales. The Company's products include, but are not
limited to, framed artwork and mirrors, candles and candle accessories, plaques,
figurines, planters, artificial floral arrangements, wall shelves, sconces, and
tableware (the "Products"). The Company primarily sells the Products through a
direct selling channel of non-employee, independent contractor sales
representatives ("Displayers") who resell the Products primarily through the
"party-plan" method of conducting in-home presentations ("Shows") for potential
customers. The Company has approximately 79,300 active Displayers located in the
United States, Mexico, Canada and Puerto Rico.
The Company has been located in Dallas, Texas since its inception in 1957.
Currently the majority of the Company's outstanding common stock of record is
owned by affiliates of Hicks, Muse, Tate & Furst Incorporated, a Dallas-based
private investment firm ("Hicks Muse").
The Company purchases its Products from a select number of independent
suppliers as well as from its wholly owned subsidiaries. During the first
quarter of 2003, approximately 37% of the dollar volume of Products purchased
for the direct selling channel of the Company was purchased from, and
manufactured by, the Company's subsidiaries. In addition to the products sold to
the Company for the direct selling channel, the subsidiaries have a growing
presence in the wholesale supply market.
2. SIGNIFICANT ACCOUNTING POLICIES
These consolidated financial statements include the accounts of the
Company. All significant intercompany accounts and transactions have been
eliminated. The Company records sales and related expenses on a weekly basis
ending on each Saturday. Each quarter consists of thirteen weeks. The last days
of the quarters ended March 31, 2002 and 2003 in the accompanying unaudited
consolidated financial information were March 30, 2002 and March 29, 2003,
respectively.
The consolidated financial information as of March 31, 2003 and for the
three months ended March 31, 2002 and 2003 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 March 31, 2003, its operating results and comprehensive
income for the three months ended March 31, 2002 and 2003, and its cash flows
for the three months ended March 31, 2002 and 2003. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been omitted
pursuant to the rules and regulations of the Securities and Exchange Commission
(the "SEC"). The results of operations for the periods presented are not
necessarily indicative of the results to be expected for the full year.
These unaudited interim consolidated financial statements and notes thereto
should be read in conjunction with the Company's audited consolidated financial
statements and notes thereto included in the Company's Form 10-K for the year
ended December 31, 2002 as filed with the SEC.
RECLASSIFICATIONS
Certain reclassifications have been made to prior period balances to
conform with current year presentation.
STOCK-BASED COMPENSATION PLANS
The Company has adopted several stock option plans. For Displayers and
independent contractors the Company has adopted the "Independent Contractor
Stock Option Plan" and accounts for options issued under the Independent
Contractor Stock Option Plan in accordance with Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
No. 123"). For key employees, the Company has adopted the "1998 Key Employee
Stock Option Plan" and the "2002 Key Employee Stock Option Plan". The Company
accounts for the options issued under the 1998 Key Employee Stock Option Plan
and the 2002 Key Employee Stock Option Plan in accordance with the Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25").
6
COMPENSATION CHARGE
SFAS No. 123 establishes a fair value basis of accounting for stock-based
compensation plans. The effects of applying SFAS No. 123 as shown below are not
indicative of future amounts. Had the compensation cost for the Company's 1998
Key Employee Stock Option Plan and 2002 Key Employee Stock Option Plan been
determined consistent with SFAS No. 123, the Company's compensation cost and net
income for the quarters ended March 31 would approximate (in thousands):
3-MONTHS ENDED
--------------
2002 2003
---- ----
Net income, as reported .................................. $ 8,189 $ 7,233
Add: Stock-based employee compensation expense included in
reported net income, net of related tax effects ........ -- 495
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects ............................. (153) (581)
------- -------
Pro forma net income ..................................... $ 8,036 $ 7,147
======= =======
3. ACQUISITIONS
On January 29, 2003, the Company acquired 100% of the assets of Tempus
Corporation, S.A. de C.V., a manufacturer of metal products located in
Monterrey, Mexico, for approximately $4.7 million, plus deferred payments of
$2.6 million, based upon the future profitability of the acquired business above
certain thresholds. Existing cash resources were used to fund the acquisition.
At closing, the Company paid $2.0 million in cash. In February and March of
2003, the Company paid an additional $2.3 million in cash. The acquisition of
Tempus Corporation, S.A. de C.V. was accounted for as a business acquisition in
accordance with SFAS No. 141. The aggregate purchase price was allocated to the
underlying assets purchased, primarily machinery and equipment assets of $4.0
million, based upon their respective fair market values at the date of
acquisition, and the excess of purchase price over the fair value of the net
assets acquired was recorded as goodwill. As a result of this acquisition,
goodwill recognized was approximately $162,000.
On February 7, 2003, the Company acquired 100% of the assets of Ceramica y
Vidrio de Nuevo Leon, S.A. de C.V., Maquiladora Produr, S.A. de C.V., and
Industrias Tromex Corporation, S.A. de C.V. (collectively, "Produr") for
approximately $6.7 million, plus a deferred payment of $125,000, based upon the
profitability of the acquired business in the year 2003. Produr manufactures
glass, ceramics, and metal products and is located in Monterrey and Guadalajara,
Mexico. Existing cash resources were used to fund the acquisition. Prior to
closing, the Company had advanced approximately $5.3 million under the terms of
a promissory note that was paid at closing. In connection with the closing, the
Company paid liabilities of the selling entities totaling $5.3 million. The
acquisition of Produr was accounted for as a business acquisition in accordance
with SFAS No. 141. The aggregate purchase price was allocated to the underlying
assets and liabilities, primarily property and equipment of $6.0 million,
inventory of $573,000 and capital lease obligations of $662,000, based upon
their respective fair market values at the date of acquisition. The excess of
the purchase price over the fair value of the net assets acquired was recorded
as goodwill. As a result of this acquisition goodwill recognized was
approximately $702,000.
On March 14, 2003, the Company acquired 100% of the assets of Edward
Marshall Boehm, Inc., a manufacturer of porcelain products located in Trenton,
New Jersey, for approximately $1.8 million. Existing cash resources were used to
fund the acquisition. The acquisition of Edward Marshall Boehm, Inc. was
accounted for as a business acquisition in accordance with SFAS No. 141. The
aggregate purchase price was allocated to the underlying assets purchased,
primarily machinery and equipment assets of $461,000 and inventory of $949,000,
based upon their respective fair market values at the date of acquisition. The
excess of the purchase price over the fair value of the net assets acquired was
recorded as goodwill. As a result of this acquisition, goodwill recognized was
approximately $400,000.
7
4. INVENTORIES, NET
Inventories, net consisted of the following as of December 31, 2002 and
March 31, 2003 (in thousands):
DECEMBER 31, MARCH 31,
2002 2003
---- ----
Raw materials ..... $ 4,974 $ 8,317
Work in process ... 1,175 1,984
Finished goods .... 57,076 60,338
------- -------
63,225 70,639
Inventory allowance (8,016) (4,882)
------- -------
$55,209 $65,757
======= =======
5. OTHER CURRENT LIABILITIES
Other current liabilities consisted of the following as of December 31,
2002 and March 31, 2003 (in thousands):
DECEMBER 31, MARCH 31,
2002 2003
---- ----
Interest ................ $ 1,241 $ 7,795
Accrued compensation .... 6,440 3,813
Income tax payable ...... -- 4,455
Sales taxes ............. 3,980 3,413
Deferred revenue ........ 1,274 10,986
Workers' compensation ... 3,142 3,369
Related party ........... 1,441 --
Other current liabilities 4,181 2,981
------- -------
$21,699 $36,812
======= =======
6. ADOPTION OF NEW ACCOUNTING STANDARDS
In April of 2003, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS No. 149"). SFAS No. 149
clarifies the definition of a derivative and amends the implementation guidance
and of Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003, except for
hedging relationships designated after June 30, 2003. The provisions of SFAS No.
149, which amend implementation guidance of SFAS No. 133, are effective for
fiscal quarters that began prior to June 15, 2003. The Company adopted certain
provisions of SFAS No. 149 and determined that there is not a financial impact
on the quarter ended, March 31, 2003. The Company will evaluate the remaining
provisions of SFAS No. 149 that are not effective until June 30, 2003.
In December of 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS No. 148"). SFAS No. 148 amends
FASB Statement No. 123 "Accounting for Stock-Based Compensation" to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation and amends the
disclosure requirements of Statement 123 to require prominent disclosure about
the effects on reported net income of an entity's accounting policy decisions
with respect to stock-based employee compensation. SFAS No. 148 also amends APB
Opinion No. 28 "Interim Financial Report", to require disclosure about those
effects in interim financial information. SFAS No. 148 is effective for fiscal
year ending December 31, 2002. The Company has elected to continue accounting
for the employee stock options plans under APB 25, however, the Company has
adopted the new disclosure requirements of SFAS No. 148.
In July of 2002 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146 requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS No. 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. The Company adopted SFAS No. 146 January 1,
2003 and there was not a financial accounting impact associated with its
adoption.
8
7. SEGMENT REPORTING
The Company's reportable segments are based upon functional lines of
business as follows:
- Direct Selling Domestic -- direct seller of home decorative
accessories in the United States;
- Direct Selling International -- direct seller of home decorative
accessories in Mexico, Puerto Rico, and Canada; and
- Wholesale Supply -- manufactures and distributes candles, framed
artwork, mirrors, various types of molded plastic, metal, glass, and
ceramic products for affiliates and other non-affiliate resellers.
The Company evaluates the performance of its segments and allocates
resources to them based on earnings before interest, taxes, the effects of SAB
101, depreciation and amortization, reorganization costs, non-cash expense for
stock options, losses on disposition of assets, and other income expense
("EBITDA"). The Company uses EBITDA as a performance measure due to the
Company's required compliance thresholds for EBITDA covenants per the Senior
Credit Agreement. The accounting principles of the segments are the same as
those described in Note 2. Segment data includes intersegment sales and
intercompany net receivable balances. Eliminations consist primarily of
intersegment sales between the wholesale supply and the direct selling markets,
as well as the elimination of the investment in each subsidiary for consolidated
purposes. The table below presents information about reportable segments used by
the Company's executive management team as of and for the quarters ended March
31 (in thousands):
DIRECT DIRECT
SELLING SELLING WHOLESALE
DOMESTIC INTERNATIONAL SUPPLY ELIMINATIONS CONSOLIDATED
-------- ------------- --------- ------------ ------------
2002
Net sales to non-affiliates ....................... $109,094 $ 7,289 $ 1,637 $ -- $118,020
Net sales to affiliates ........................... 3,634 -- 32,139 (35,773) --
EBITDA ............................................ 15,997 871 10,960 (558) 27,270
Total assets ...................................... 166,183 4,094 72,143 (67,148) 175,272
Capital expenditures .............................. 1,785 4 250 -- 2,039
2003
Net sales to non-affiliates ....................... $109,918 $10,093 $ 6,110 $ -- $126,121
Net sales to affiliates ........................... 4,641 -- 33,240 (37,881) --
EBITDA ............................................ 15,697 649 11,549 (383) 27,512
Total assets ...................................... 223,683 6,026 105,535 (98,871) 236,373
Capital expenditures .............................. 3,017 28 1,547 -- 4,592
The following table represents a reconciliation of consolidated EBITDA to
income before income taxes for the quarters ended March 31 (in thousands):
2002 2003
---- ----
EBITDA ...................... $ 27,270 $ 27,512
Effects of SAB 101 .......... (3,891) (3,570)
Depreciation and amortization (2,953) (3,656)
Loss on disposition of assets -- (4)
Stock option expense ........ (114) (924)
Reorganization costs ........ (758) (805)
Interest income ............. 48 156
Interest expense ............ (6,498) (7,062)
Other expense, net .......... (119) (69)
-------- --------
Income before income taxes .. $ 12,985 $ 11,578
======== ========
9
8. GUARANTOR FINANCIAL DATA
Dallas Woodcraft Company, LP, DWC GP, Inc., GIA, Inc., Homco, Inc., Spring
Valley Scents, Inc., Laredo Candle Company, L.P., Brenda Buell and Associates,
Inc., EM Boehm, Inc., Homco Puerto Rico, Inc. and HIG Investments, Inc.
(collectively, the "Guarantors") unconditionally, on a joint and several basis,
guarantee the Company's credit agreement with its principal lenders (the "Senior
Credit Agreement"), and the Company's 10 1/8% Senior Subordinated Notes due 2008
in the amount of $149.1 million (the "Notes"). The Company's other subsidiaries,
Home Interiors de Mexico, S. de R.L. de C.V. and Home Interiors Services de
Mexico, S.A. de C.V., HI Ceramics, S.A. de C.V., HI Metals, S.A. de C.V., HI
Glass, S.A. de C.V., and HI Trading Mexicana, S.A. de C.V. (collectively, the
"Non- Guarantors") have not guaranteed the Senior Credit Facility or the Notes.
Guarantor and Non-Guarantor financial statements on an individual basis are not
significant and have been omitted. Accordingly, the following table presents
financial information of the Guarantors and Non-Guarantors on a consolidating
basis (in thousands):
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2002
COMPANY GUARANTORS NON GUARANTORS ELIMINATIONS CONSOLIDATED
------- ---------- -------------- ------------ ------------
Net sales .......................... $ 113,040 $ 34,323 $ 6,430 $(35,773) $ 118,020
Cost of good sold .................. 61,022 22,373 3,292 (35,215) 51,472
--------- -------- ------- -------- ---------
Gross profit ..................... 52,018 11,950 3,138 (558) 66,548
Total selling, general and
administrative ................... 43,092 1,526 2,376 -- 46,994
--------- -------- ------- -------- ---------
Operating income (loss) .......... 8,926 10,424 762 (558) 19,554
Other income (expense), net ........ (6,628) 95 (36) -- (6,569)
--------- -------- ------- -------- ---------
Income (loss) before income
taxes ......................... 2,298 10,519 726 (558) 12,985
Provision for income taxes ......... (807) (3,678) (311) -- (4,796)
Equity in income (loss) of
subsidiaries, net of tax ......... 7,255 4 -- (7,259) --
--------- -------- ------- -------- ---------
Net income (loss) ................ 8,746 6,845 415 (7,817) 8,189
Other comprehensive income ......... 2 -- 21 -- 23
--------- -------- ------- -------- ---------
Comprehensive income (loss)....... $ 8,748 $ 6,845 $ 436 $ (7,817) $ 8,212
========= ======== ======= ======== =========
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2003
COMPANY GUARANTORS NON GUARANTORS ELIMINATIONS CONSOLIDATED
------- ---------- -------------- ------------ ------------
Net sales .......................... $ 115,774 $ 38,574 $ 9,912 $(38,139) $ 126,121
Cost of good sold .................. 60,684 25,001 6,948 (37,756) 54,877
--------- -------- ------- -------- ---------
Gross profit ..................... 55,090 13,573 2,964 (383) 71,244
Total selling, general and
administrative ................... 47,121 2,197 3,373 -- 52,691
--------- -------- ------- -------- ---------
Operating income (loss) .......... 7,969 11,376 (409) (383) 18,553
Other income (expense), net ........ (6,955) 86 (116) 10 (6,975)
--------- -------- ------- -------- ---------
Income (loss) before income
taxes ......................... 1,014 11,462 (525) (373) 11,578
Benefit (provision) for income taxes (565) (3,963) 183 -- (4,345)
Equity in income (loss) of
subsidiaries, net of tax ......... 7,156 (409) -- (6,747) --
--------- -------- ------- -------- ---------
Net income (loss) ................ 7,605 7,090 (342) (7,120) 7,233
Other comprehensive income (loss) .. (3) -- 1 -- (2)
--------- -------- ------- -------- ---------
Comprehensive income (loss) ...... $ 7,602 $ 7,090 $ (341) $ (7,120) $ 7,231
========= ======== ======= ======== =========
10
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 2002
COMPANY GUARANTORS NON GUARANTORS CONSOLIDATING ELIMINATIONS CONSOLIDATED
------- ---------- -------------- ------------- ------------ ------------
ASSETS
Current assets:
Cash ........................................... $ 64,053 $ (955) $ 1,018 $ 64,116 $ -- $ 64,116
Accounts receivable, net ....................... 9,682 2,226 1,673 13,581 -- 13,581
Inventories, net ............................... 47,186 7,473 3,875 58,534 (3,325) 55,209
Other current assets ........................... 10,274 952 170 11,396 -- 11,396
Due to (due from) subsidiaries ................. (56,142) 58,569 (2,427) -- -- --
--------- -------- ------- --------- -------- ---------
Total current assets ....................... 75,053 68,265 4,309 147,627 (3,325) 144,302
Property, plant and equipment, net ............... 51,044 18,079 359 69,482 -- 69,482
Investment in subsidiaries ....................... 74,805 29 -- 74,834 (74,834) --
Debt issuance costs and other assets ............. 5,663 11,151 -- 16,814 -- 16,814
--------- -------- ------- --------- -------- ---------
Total assets ............................... $ 206,565 $ 97,524 $ 4,668 $ 308,757 $(78,159) $ 230,598
========= ======== ======= ========= ======== =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ............................... $ 28,597 $ 3,159 $ 457 $ 32,213 $ 631 $ 32,844
Related party note payable ..................... 663 -- -- 663 -- 663
Current maturities of long-term debt and capital
lease obligations ............................. 20,266 751 -- 21,017 -- 21,017
Other current liabilities ...................... 35,973 20,030 1,458 57,461 -- 57,461
--------- -------- ------- --------- -------- ---------
Total current liabilities .................. 85,499 23,940 1,915 111,354 631 111,985
Long term related party note payable ............. 1,362 -- -- 1,362 -- 1,362
Long-term debt and capital lease obligations, net
of current maturities .......................... 321,874 -- -- 321,874 -- 321,874
Other liabilities ................................ 21,043 1,612 423 23,078 -- 23,078
--------- -------- ------- --------- -------- ---------
Total liabilities .......................... 429,778 25,552 2,338 457,668 631 458,299
--------- -------- ------- --------- -------- ---------
Commitments and contingencies
(see Note 9)
Shareholders' equity (deficit):
Preferred stock ................................ 94,196 -- -- 94,196 -- 94,196
Common stock ................................... 1,524 1,001 14 2,539 (1,015) 1,524
Additional paid-in capital ..................... 180,829 35,436 1,014 217,279 (36,450) 180,829
Retained earnings (accumulated deficit) ........ (499,773) 35,535 1,832 (462,406) (41,325) (503,731)
Other .......................................... 11 -- (530) (519) -- (519)
--------- -------- ------- --------- -------- ---------
Total shareholders' equity (deficit) ....... (223,213) 71,972 2,330 (148,911) (78,790) (227,701)
--------- -------- ------- --------- -------- ---------
Total liabilities and shareholders' equity
(deficit) ................................ $ 206,565 $ 97,524 $ 4,668 $ 308,757 $(78,159) $ 230,598
========= ======== ======= ========= ======== =========
11
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF MARCH 31, 2003
COMPANY GUARANTORS NON GUARANTORS CONSOLIDATING ELIMINATIONS CONSOLIDATED
------- ---------- -------------- ------------- ------------ ------------
ASSETS
Current assets:
Cash ......................................... $ 35,354 $ (1,738) $ 3,014 $ 36,630 $ -- $ 36,630
Accounts receivable, net ..................... 16,886 2,779 4,824 24,489 -- 24,489
Inventories, net ............................. 53,054 11,158 5,244 69,456 (3,699) 65,757
Other current assets ......................... 10,734 1,278 419 12,431 -- 12,431
Due to (due from) subsidiaries ............... (41,371) 49,480 (8,109) -- -- --
--------- --------- -------- --------- --------- ---------
Total current assets ..................... 74,657 62,957 5,392 143,006 (3,699) 139,307
Property, plant and equipment, net ............. 49,444 18,940 10,849 79,233 -- 79,233
Investment in subsidiaries ..................... 95,167 10,926 -- 106,093 (106,093) --
Debt issuance costs and other assets ........... 5,333 11,628 872 17,833 -- 17,833
--------- --------- -------- --------- --------- ---------
Total assets ............................. $ 224,601 $ 104,451 $ 17,113 $ 346,165 $(109,792) $ 236,373
========= ========= ======== ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ............................. $ 24,386 $ 2,868 $ 1,526 $ 28,780 $ 631 $ 29,411
Related party note payable ................... 663 -- -- 663 -- 663
Current maturities of long-term debt
and capital lease obligations ............... 20,215 -- -- 20,215 -- 20,215
Other current liabilities .................... 50,659 7,630 1,976 60,265 -- 60,265
--------- --------- -------- --------- --------- ---------
Total current liabilities ................ 95,923 10,498 3,502 109,923 631 110,554
Long term related party note payable ........... 1,362 -- -- 1,362 -- 1,362
Long-term debt and capital lease obligations,
net of current maturities .................... 321,688 -- -- 321,688 -- 321,688
Other liabilities .............................. 20,315 1,710 290 22,315 -- 22,315
--------- --------- -------- --------- --------- ---------
Total liabilities ........................ 439,288 12,208 3,792 455,288 631 455,919
--------- --------- -------- --------- --------- ---------
Commitments and contingencies
(see Note 9)
Shareholders' equity (deficit):
Preferred stock .............................. 94,196 -- -- 94,196 -- 94,196
Common stock ................................. 1,524 1,001 28 2,553 (1,029) 1,524
Additional paid-in capital ................... 181,753 48,640 12,331 242,724 (60,971) 181,753
Retained earnings (accumulated deficit) ...... (492,168) 42,602 1,491 (448,075) (48,423) (496,498)
Other ........................................ 8 -- (529) (521) -- (521)
--------- --------- -------- --------- --------- ---------
Total shareholders' equity (deficit) ..... (214,687) 92,243 13,321 (109,123) (110,423) (219,546)
--------- --------- -------- --------- --------- ---------
Total liabilities and shareholders'
equity (deficit) ....................... $ 224,601 $ 104,451 $ 17,113 $ 346,165 $(109,792) $ 236,373
========= ========= ======== ========= ========= =========
12
CONDENSED CONSOLIDATING CASH FLOW INFORMATION
FOR THE THREE MONTHS ENDED MARCH 31, 2002
-----------------------------------------
COMPANY GUARANTORS NON GUARANTORS ELIMINATIONS CONSOLIDATED
------- ---------- -------------- ------------ ------------
Net cash provided by (used in)
operations ..................... $ 7,639 $ (20) $ (184) $ -- $ 7,435
-------- -------- ------- ---- --------
Cash flows from investing
activities:
Purchase of property, plant
and equipment .................... (1,785) (250) (4) -- (2,039)
Increase in restricted cash ...... (450) -- -- -- (450)
-------- -------- ------- ---- --------
Net cash used in investing
activities ..................... (2,235) (250) (4) -- (2,489)
-------- -------- ------- ---- --------
Cash flows from financing
activities:
Payments under capital lease
obligations ...................... (344) -- -- -- (344)
-------- -------- ------- ---- --------
Net cash used in financing
activities ..................... (344) -- -- -- (344)
-------- -------- ------- ---- --------
Effect of cumulative
translation adjustment .......... 2 -- 21 -- 23
-------- -------- ------- ---- --------
Net increase (decrease) in cash
and cash equivalents ............... 5,062 (270) (167) -- 4,625
-------- -------- ------- ---- --------
Cash and cash equivalents at the
beginning of year .................. 13,757 (542) 497 -- 13,712
-------- -------- ------- ---- --------
Cash and cash equivalents at the
end of period ...................... $ 18,819 $ (812) $ 330 $ -- $ 18,337
======== ======== ======= ==== ========
FOR THE THREE MONTHS ENDED MARCH 31, 2003
-----------------------------------------
COMPANY GUARANTORS NON GUARANTORS ELIMINATIONS CONSOLIDATED
------- ---------- -------------- ------------ ------------
Net cash provided by (used in)
operations ......................... $(23,666) $ 11,484 $ 3,239 $ -- $ (8,943)
-------- -------- ------- ---- --------
Cash flows from investing
activities:
Purchase of property, plant
and equipment .................... (3,017) (885) (690) -- (4,592)
Business acquisitions, net of cash
acquired ......................... (1,799) (10,631) -- -- (12,430)
Other ............................ 23 (1) -- -- 22
-------- -------- ------- ---- --------
Net cash used in investing
activities ..................... (4,793) (11,517) (690) -- (17,000)
-------- -------- ------- ---- --------
Cash flows from financing
activities:
Payments under capital lease
obligations ...................... (237) -- (554) -- (791)
Payments other bank debt ......... -- (750) -- -- (750)
-------- -------- ------- ---- --------
Net cash used in financing
activities ..................... (237) (750) (554) -- (1,541)
-------- -------- ------- ---- --------
Effect of cumulative
translation adjustment .......... (3) -- 1 -- (2)
-------- -------- ------- ---- --------
Net increase (decrease) in cash
and cash equivalents ............... (28,699) (783) 1,996 -- (27,486)
-------- -------- ------- ---- --------
Cash and cash equivalents at the
beginning of year .................. 64,053 (955) 1,018 -- 64,116
-------- -------- ------- ---- --------
Cash and cash equivalents at the
end of period ...................... $ 35,354 $ (1,738) $ 3,014 $ -- $ 36,630
======== ======== ======= ==== ========
9. COMMITMENTS AND CONTINGENCIES
The Company is engaged in various legal proceedings incidental to its
normal business activities. Management believes that the amounts, if any, which
ultimately may be due in connection with such lawsuits and claims would not have
a material effect upon the Company, because most of the claims are covered by
insurance.
The Company previously purchased certain assets of House of Lloyd entities
in bankruptcy. Such assets included that certain letter agreement dated October
23, 2001, among Richmont Corporation and its affiliates and representatives, and
House of Lloyd Management, LLC (the "Letter Agreement").
13
On April 25, 2002, the Company in the name of several House of Lloyd
entities, filed a petition against Richmont Corporation, Richmont International,
Inc. d/b/a Richmont House and John P. Rochon ("Defendants") asserting various
claims arising from, inter alia, the Letter Agreement. Defendants answered the
lawsuit and, on September 12, 2002, filed an Original, Counterclaim and Third
Party Petition against the House of Lloyd entities, as counter-defendants, and
the Company and Mr. Donald J. Carter Jr., as a third-party defendants, pursuant
to which defendants asserted claims for tortious interference with prospective
business relations, tortious interference with existing business relations, a
business disparagement, conspiracy and malicious prosecution, and were seeking
actual damages and punitive damages in the amount of $100 million. The House of
Lloyd entities, the Company and Mr. Carter answered the Original Counterclaim
and third party petition, and filed an additional action against the Defendants
in the United States Bankruptcy Court for the Western District of Missouri,
Kansas City Division (the "Bankruptcy Court").
On March 10, 2003, the Defendants entered into a Settlement Agreement and
General Release (the "Settlement Agreement") in favor of the Company and Donald
J. Carter, Jr. which disposes of and fully resolves the pending claims without
the payment of any material amounts by any of the parties. All orders of
dismissals have been submitted and entered and all settlement documents have
been signed.
14
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, 2002, 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 direct sales activity
only.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere in this report
constitute forward-looking statements. These statements involve known and
unknown risks, uncertainties and other factors that may cause the Company's
actual results to be materially different from any future results expressed or
implied by such forward-looking statements.
In some cases, forward-looking statements are identified by terminology
such as "may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of such terms
or other comparable terminology.
All of these forward-looking statements are based on estimates and
assumptions made by management of the Company, which, although believed to be
reasonable, are inherently uncertain. Therefore, undue reliance should not be
placed upon such statements. No assurance can be given that any of such
estimates or statements will be realized and actual results may differ
materially from those contemplated by such forward-looking statements. Factors
that may cause such differences include: (i) Displayer recruiting and activity
levels; (ii) loss or retirement of key members of management; (iii) imposition
of foreign, federal or state taxes; (iv) change in status of independent
contractors; (v) increased competition; (vi) the success of new products and
promotion programs; (vii) general economic conditions and (viii) the success of
integrating the recently acquired 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.
COMPANY BACKGROUND
The Company believes it is the largest direct seller of home decorative
accessories in the United States, as measured by sales. As of March 31, 2003,
the Company has approximately 79,300 active Displayers located in the United
States, Mexico, Canada and Puerto Rico. The Company's direct sales are dependent
upon the number of Displayers selling the Company's products and their resulting
productivity. Displayer productivity fluctuates from time to time based on
seasonality and special marketing programs, which offer Displayers new
incentives and discounts timed to generate additional sales. The Company also
sells products to customers outside of its direct selling channel, however, to
date such sales have not been significant.
To stimulate sales within the direct selling channel, the Company offers a
variety of discounts and incentives to Displayers. The amount and timing of
discounts and incentives vary from year to year. The cost of discounts is
reflected in the Company's net sales while the cost of incentives is reflected
in selling expense.
COMPANY DIRECT SELLING STRATEGY
The Company has evolved its strategy to put greater focus on what
management believes to be the key drivers of the direct selling business, which
are recruiting, retention and productivity of the Displayer base.
The Company recognizes the need to continue to attract and retain new
Displayers. As of March 31, 2003, the Company's active Displayer base in the
United States increased 7.5% to approximately 63,400 active Displayers from
approximately 59,000 as of March 31, 2002. This increase was a result of the
Company's continued focus on key areas such as Displayer understanding and
awareness of the Hostess program, improved training and business guides and a
more clearly defined and communicated career strategy as reflected in the new
recruit program.
15
The retention of experienced Displayers requires operational focus on
several areas: product distribution fulfillment rates, product selection and
Displayer training and motivation. Fulfillment rates for product distribution
remained strong at approximately 99% at March 31, 2003 and 2002. The Company is
continuing to introduce new products in 2003, which compliment the current line
of products, in an attempt to give the product line a fresh and more innovative
look. New products are carefully selected and tested with Displayers prior to
their introduction and placement in the product line. Lastly, the Company's new
"Recertification" program retrains Displayers on how to become more effective
Displayers, Recruiters, and Trainers by helping them develop and enhance their
leadership skills. In order to enhance this program, the Company has partnered
with John Maxwell, a New York Times best-selling author on leadership. Mr.
Maxwell will be communicating with the field leadership through various media
including newsletters, audio, and regularly scheduled conference calls to help
them develop and enhance their leadership skills and grow their business.
Displayer training and motivation requires the introduction of sales
promotion and development activities directed at helping Displayers increase
their productivity. Sales tools such as "Power Paks" have helped the field
leadership plan and present more effective sales meetings and training sessions
for the Displayer. The continuation of the "Pocketful of Hope" charity
initiative has also helped to increase productivity by raising approximately
$200,000 in the three months ended March 31, 2003 for various charities through
sales of special products that were developed specifically for each charity.
COMPANY MANUFACTURING STRATEGY
The Company continues to emphasize products of its manufacturing
subsidiaries in the direct selling channel, which provides opportunities for
gross margin improvements and leverage of the fixed expense component of its
cost structure. This increased focus of the manufacturing strategy has supported
Displayer productivity and retention through increased fulfillment rates and
increased flexibility related to promotion strategies.
The Company has also increased its presence in its wholesale supply
channel with sales to non-affiliate resellers. Sales to non-affiliate resellers
for the three months ended March 31, 2003 were $6.1 million as compared to $1.6
million in the comparable period of 2002. The domestic manufacturing
subsidiaries doubled sales to non-affiliate resellers to $3.2 million in the
first quarter of 2003 as compared to $1.6 million in the comparable period of
the prior year. Newly acquired manufacturing companies (described below)
contributed an additional $2.9 million of wholesale supply channel sales in the
three months ended March 31, 2003.
In an effort to further increase the Company's manufacturing capabilities,
as well as its sales outside of the direct selling channel, the Company acquired
Brenda Buell & Associates, Inc. ("BBA"), a wholesaler that designs and develops
iron and glass accessories, on December 31, 2002. Additionally, during the first
quarter of 2003, the Company acquired certain assets of Tempus Corporation, S.A.
de C.V. ("HI Metals"), a metals manufacturing company in Mexico on January 29,
2003 and Ceramica y Vidiro de Nuevo Leon, S.A. de C.V., Maquiladora Produr, S.A.
de C.V. ("HI Ceramics") and Industrias Tromex Corporation, S.A. de C.V., ("HI
Glass") a metals, glass and ceramic manufacturing facility in Mexico on February
7, 2003 and Edward Marshall Boehm, Inc. ("Boehm") a porcelain manufacturing
company in New Jersey on March 14, 2003.
RESULTS OF OPERATIONS
The Three Months Ended March 31, 2003 Compared to the Three Months Ended March
31, 2002
Net sales increased $8.1 million, or 6.9%, to $126.1 million in the three
months ended March 31, 2003, from $118.0 million in the comparable period in
2002. The primary variables that impact domestic direct sales include the number
of Displayers, the number of orders shipped, the number of orders per Displayer
and average order size. The average number of active domestic Displayers
increased to approximately 63,700 in the three months ended March 31, 2003, from
58,700 in the same period of 2002. The number of orders shipped increased 12.2%
to 214,266 in the first quarter of 2003 from 190,945 in the 2002 period. In
addition, the number of orders per Displayer increased 3.4% to 3.36 from 3.25
for the three months ended March 31, 2003 and 2002, respectively. Finally, the
average order size decreased 10.2% to $513 in the three months ended March 31,
2003, as compared to $571 in the comparable period in 2002 primarily due to the
increase of newer Displayers who are historically less productive and the timing
of incentive promotions. In addition, international direct sales increased $2.8
million in the comparable quarters primarily related to the increase in the
Mexico displayer base. These variables, combined with increased wholesale supply
sales by the Company's manufacturing subsidiaries of $4.5 million, comprised the
majority of the increase in net sales.
Gross profit increased $4.7 million, or 7.1%, to $71.2 million in the three
months ended March 31, 2003 from $66.5 million in the three months ended March
31, 2002. As a percentage of net sales, gross profit increased slightly to 56.5%
in the first quarter of 2003 from 56.4% in the first quarter of 2002. In
addition, approximately $303,000 of non-recurring costs related to redundant
labor and
16
inventory valuation adjustments for the new international
manufacturing entities is included in gross margin for the three months ended
March 31, 2003.
Selling expense decreased 4.0% to $20.5 million in the three months ended
March 31, 2003 from $21.4 million in the comparable period of 2002. As a
percentage of net sales, selling expense decreased to 16.3% as of the quarter
ended March 31, 2003 from 18.1% in the comparable period of 2002. The decrease
in percentage is primarily due to the timing of sales promotion, primarily
incentive trips and recognition of income on expired unredeemed incentive
certificates.
Freight, warehouse and distribution expense increased $2.7 million, or
20.9%, to $15.6 million in the three months ended March 31, 2003 from $12.9
million in the three months ended March 31, 2002. These costs were 12.4% of net
sales in the 2003 period, as compared to 10.9% in the comparable 2002 period.
This increase in freight, warehouse and distribution expense as a percentage of
sales was primarily due to increased freight and labor related to the increase
in the number of orders and decrease in average order sizes.
General and administrative expense increased $3.0 million, or 24.1%, to
$15.6 million in the three months ended March 31, 2003, from $12.6 million in
the three months ended March 31, 2002. The increase consists primarily of a $0.6
million increase in facility related expenses, a $0.6 million increase in
depreciation and amortization expense, an increase in account maintenance and
bad debt fees related to field personnel of $0.5 million, $0.4 million increase
in employee benefit related expenses such as insurance and wages, and an
increase in professional fees of $0.2 million. Included in general and
administrative expense are certain additional non-recurring costs related to
excess facilities and uncapitalizable fees related to the implementation of the
new JD Edwards computer system. These costs were approximately $502,000 and
$758,000 for the quarters ended March 31, 2003 and 2002, respectively.
Stock option expense of approximately $0.9 million was recorded in the
three months ended March 31, 2003, as compared to $0.1 million in the comparable
2002 period due primarily to compensation expense on performance-based options
issued under the 2002 Key Employee Stock Option Plan.
Interest expense increased $0.6 million to $7.1 million in the three months
ended March 31, 2003, from $6.5 million in the three months ended March 31,
2002. The increase in interest expense is primarily related to the higher debt
balance as a result of the debt refinancing in July 2002.
Income taxes decreased $0.5 million to $4.3 million in the three months
ended March 31, 2003 from $4.8 million in the comparable period of 2002. Income
taxes, as a percentage of income before income taxes was 37.5% in the three
months ended March 31, 2003, as compared to 36.9% in the three months ended
March 31, 2002. The Company believes that the effective income tax rate for the
year ended December 31, 2003 will be consistent with its effective income tax
rate for the three-month period ended March 31, 2003.
SEGMENT PROFITABILITY
The Company's reportable segments include its domestic and international
direct sales operations and its wholesale supply operations. The manufacturing
operations are part of the wholesale supply segment and sell substantially all
of their products to the Company. As a result, wholesale supply operation sales
generally follow the Company's domestic sales trend. International operations
include direct sales by Displayers in Mexico, Puerto Rico and Canada.
International direct sales are directly attributable to the number of
international Displayers the Company has selling its products. The Company's
chief operating decision-maker monitors each segment's profitability primarily
on the basis of EBITDA performance The Company uses EBITDA as a performance
measure due to the Company's required compliance thresholds for EBITDA covenants
per the Senior Credit Agreement. See Note 7 to the Consolidated Financial
Statements.
The Three Months Ended March 31, 2003 compared to the Three Months Ended March
31, 2002
Consolidated net sales increased $8.1 million, or 6.9%, to $126.1 million in
the three months ended March 31, 2003, from $118.0 million in the comparable
2002 period. Consolidated EBITDA increased $0.2 million, or 0.9%, to $27.5
million in the quarter ended March 31, 2003 as compared to $27.3 million in the
three months ended March 31, 2002. See discussion in "Results of Operations."
17
Direct Selling
Domestic
Domestic net sales to non-affiliates and affiliates increased $1.9 million,
or 1.6% to $114.6 million from $112.7 million in the previous year. Of this
increase, sales to affiliates increased by $1.0 million. The primary sales
drivers for non-affiliate sales are average order size, Displayer productivity
and number of active Displayers. Domestic EBITDA decreased $0.3 million or 1.9%
in the quarter ended March 31, 2003 as compared to the comparable 2002 period.
The primary reasons for the decrease are discussed in the "Results of
Operations."
International
International direct sales include sales in Mexico, Canada and Puerto Rico.
These sales increased $2.8 million, or 38.5%, to $10.1 million in the three
months ended March 31, 2003, from $7.3 million in the three months ended March
31, 2002. This increase is primarily due to the increase in the Displayer base
in Mexico and Canada. As of March 31, 2003, the Displayer base was approximated
14,600, 800 and 500 in Mexico, Canada and Puerto Rico, respectively as compared
to 9,600, 200 and 400 in the comparable period of 2002. EBITDA related to
International direct sales decreased $0.3 million, or 25.5%, to $0.6 million in
the quarter ended March 31, 2003 as compared to $0.9 million in the quarter
ended March 31, 2002. Unfavorable movement in the exchange rate negatively
impacted International EBITDA in the comparable quarters of 2003 and 2002.
Wholesale Supply
The Company is in the process of growing its wholesale supply operations
through its domestic and international manufacturing facilities. External sales
for the three-month period totaled $6.1 million as compared to $1.6 million in
the comparable period of 2002. Of these sales, 47.2% or $2.9 million were
generated by the previously-described newly acquired companies and their
existing customer base - BBA, Boehm, HI Metals, HI Ceramics and HI Glass. EBITDA
generated through wholesale supply operations totaled $11.5 million in the three
months ended March 31, 2003 as compared to $11.0 million in the comparable
period of 2002.
Domestic
Domestic manufacturing operations consist of Dallas Woodcraft Company, LP
("DWC"), Laredo Candle Company, L.P. "(Laredo Candle") and GIA, Inc. ("GIA") as
well as two recently acquired operations, BBA and Boehm. Net sales generated by
the domestic manufacturing entities grew 11.7%, or $3.9 million, to $37.7
million in the three months ended March 31, 2003 from $33.8 million in the
comparable period of 2002. The newly acquired entities generated $1.4 million of
the increase while the established entities accounted for the remaining $2.5
million. Of total domestic manufacturing sales, $33.1 million was sold to the
Company for distribution to the Displayer base. The remaining $4.6 million of
sales was distributed through wholesale supply operations. Domestic
manufacturing EBITDA increased $0.8 million, or 8.0%, to $11.8 million in the
quarter ended March 31, 2003 from $11.0 million in the comparable period of
2002. The EBITDA contribution of the new acquisitions was not material in the
quarter ended March 31, 2003.
International
The international manufacturing operations; HI Metals, HI Ceramics and HI
Glass, were acquired in February 2003. Sales related to these entities were $2.0
million for the three months ended March 31, 2003, of which, $1.5 million was
distributed through wholesale supply to external customers. EBITDA for
these new acquisitions was $(287,000). Approximately $303,000 of cost of goods
sold of the international manufacturing operations was recorded as non-recurring
reorganization expense related to redundant labor and inventory valuation
adjustments and considered an add-back for EBITDA.
SEASONALITY
The Company's business is influenced by the Christmas holiday season and by
promotional events. Historically, a higher portion of the Company's sales and
net income have been realized during the fourth quarter, and net sales and net
income have generally been slightly lower during the first quarter as compared
to the second and third quarters. Working capital requirements also fluctuate
during the year. They reach their highest levels during the third and fourth
quarters as the Company increases its inventory for the peak season. In addition
to the Company's peak season fluctuations, quarterly results of operations may
fluctuate depending on the timing
18
of, and amount of sales from, discounts, incentive promotions and/or the
introduction of new products. As a result, the Company's business activities and
results of operations in any quarter are not necessarily indicative of any
future trends in the Company's business.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents decreased $27.5 million to $36.6
million as of March 31, 2003, from $64.1 million at December 31, 2002. The
decrease resulted from a use of cash of $9.0 million, $17.0 million and $1.5
million for operating, investing and financing activities, respectively.
Net cash used in operating activities increased $16.4 million during the
three months ended March 31, 2003, as compared to the three months ended March
31, 2002. The majority of the increase in funds used is attributable to a
decrease of $2.3 million related to accounts payable, a $7.6 million decrease in
royalties payable due to lower commissionable sales, a $1.2 million decrease in
seminar and incentive payable due to timing of incentives, and a $4.6 million
increase in accounts receivable.
Net cash used in investing activities increased $14.5 million in the three
months ended March 31, 2003 as compared to the three months ended March 31,
2002. Purchases of property, plant and equipment in the three months ended March
31, 2003 totaled $4.6 million, as compared to $2.0 million in the three months
ended March 31, 2002. In addition, approximately $12.4 million was used to
purchase certain assets of the new manufacturing entities in Mexico and New
Jersey. In the three months ended March 31, 2002, restricted cash of $450,000
was placed in escrow to fund an asset purchase in the second quarter of 2002.
Net cash used in financing activities was $1.5 million in the three months
ended March 31, 2003, as compared to $0.3 million in the three months ended
March 31, 2002. This change was primarily as a result of timing of principal
payments due under the capital leases and other debt.
Payments on the Company's Notes and the Senior Credit Facility represent
significant cash requirements for the Company. Interest payments on the Notes
commenced in December 1998 and will continue semi-annually until the Notes
mature in 2008. Borrowings under the Senior Credit Facility require quarterly
interest and principal payments. In addition, the Senior Credit Facility
includes $30.0 million of revolving loans ("Revolving Loans"), which mature on
June 30, 2004. The Revolving Loans were not utilized during the first quarter of
2003 or 2002 and as of May 12, 2003, there was no outstanding balance on the
Revolving Loans.
No payments were made in regards to debt service for the three months ended
March 31, 2003. Principal and interest payments of $14.2 million were paid after
the end of the first quarter of 2003 as a result of the timing of the due dates
for the payments and the Company's quarter end on March 29, 2003.
The terms of the Notes and Senior Credit Facility include significant
operating and financial restrictions, such as limits on the Company's ability to
incur indebtedness, create liens, sell assets, engage in mergers or
consolidations, make investments and pay dividends. In addition, under the
Senior Credit Facility, the Company is required to comply with specified
financial ratios and tests, including minimum fixed charge coverage ratios, and
maximum leverage ratios, capital expenditure measurements and EBITDA
measurements. 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 beginning in March 2003. The Company made a $12.4 million prepayment of
interest and principal on March 31, 2003, after the Company's quarter end on
March 29, 2003.
As of May 12, 2003, the Company is in compliance with all covenants or
other requirements set forth in its credit agreements and indentures. Further,
the Company does not have any rating downgrade triggers that would accelerate
maturity dates of its debt.
The Company's near and long-term operating strategies focus on broadening
the Displayer base through recruiting efforts and increasing retention and
productivity of the existing Displayer base and leveraging of the assets of the
manufacturing subsidiaries. The Company believes that cash on hand, net cash
flow from operations and borrowings under the Revolving Loans will be sufficient
to fund its cash requirements through the year ended December 31, 2003. Cash
requirements will consist primarily of payments 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.
19
MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
The Company's Products are sold in Mexico and Canada thereby subjecting the
Company to financial market risk due to fluctuating foreign currency exchange
rates. Historically, due to a stable foreign exchange and due to the fact that
these operations have not been significant, the foreign currency exposure has
been minimal. However, as the Company's international operations become
significant to the Company as a whole, changes in foreign currency exchange
rates could have a material effect on the Company in the future. The Company has
not entered into any hedging instruments related to foreign currency risk.
As a result of the interest pricing mechanism associated with the Senior
Credit Facility, the Company is exposed to financial market risk due to
fluctuating interest rates. The Company monitors this risk and makes decisions
to participate in interest hedging devices based on interest rate expectations,
the Company's desire to maintain total yield within predetermined levels and the
ratio of fixed to variable debt. The Company is not party to any hedging
instruments. In addition, the Company does not use derivative instruments for
trading or speculative purposes.
ADOPTION OF ACCOUNTING STANDARDS
In April of 2003, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS No. 149"). SFAS No. 149
clarifies the definition of a derivative and amends the implementation guidance
and of Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003, except for
hedging relationships designated after June 30, 2003. The provisions of SFAS No.
149, which amend implementation guidance of SFAS No. 133, are effective for
fiscal quarters that began prior to June 15, 2003. The Company adopted certain
provisions of SFAS No. 149 and determined that there is not a financial impact
on the quarter ended, March 31, 2003. The Company will evaluate the remaining
provisions of SFAS No. 149 that are not effective until June 30, 2003.
In December of 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS No. 148"). SFAS No. 148 amends
FASB Statement No. 123 "Accounting for Stock-Based Compensation" to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation and amends the
disclosure requirements of Statement 123 to require prominent disclosure about
the effects on reported net income of an entity's accounting policy decisions
with respect to stock-based employee compensation. SFAS No. 148 also amends APB
Opinion No. 28 "Interim Financial Report", to require disclosure about those
effects in interim financial information. SFAS No. 148 is effective for fiscal
year ending December 31, 2002. The Company has elected to continue accounting
for the employee stock option plans under APB 25, however, the Company has
adopted the new disclosure requirements of SFAS No. 148.
In July of 2002 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146 requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS No. 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. The Company adopted SFAS No. 146 January 1,
2003 and there was not a financial accounting impact associated with its
adoption.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Securities and Exchange Commission requires that registrants include
information about potential effects of changes in interest rates and currency
exchange on their financial statements. Refer to the information appearing under
the subheading "Market-Sensitive Instruments and Risk Management" under "Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operation," which information is hereby incorporated by reference into this Item
3. All statements other than historical information incorporated into this Item
3 are forward-looking statements. The actual impact of future market changes
could differ materially due to, among other things, the factors discussed in
this report.
20
ITEM 4. CONTROLS AND PROCEDURES
(a) The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the Company's
filings under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the periods specified in the rules and forms of
the Securities and Exchange Commission. Such information is accumulated and
communicated to the Company's management, including its principal executive
officer and principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure. The Company's management, including the
principal executive officer and principal accounting officer, recognizes that
any set of controls and procedures, no matter how well designed and operated,
can provide only reasonable assurance of achieving the desired control
objectives.
Within 90 days prior to the filing date of this quarterly report on Form
10-Q, the Company has carried out an evaluation, under the supervision and with
the participation of the Company's management, including the Company's principal
executive officer and the Company's principal financial officer, of the
effectiveness of the design and operation of the company's disclosure controls
and procedures. Based on such evaluation, the Company's principal executive
officer and principal financial officer concluded that the Company's disclosure
controls and procedures are effective.
(b) There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect the internal
controls subsequent to the date of their evaluation in connection with the
preparation of this quarterly report on Form 10-Q.
21
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company previously purchased certain assets of House of Lloyd entities
in bankruptcy. Such assets included that certain letter agreement dated October
23, 2001, among Richmont Corporation and its affiliates and representatives, and
House of Lloyd Management, LLC (the "Letter Agreement").
On April 25, 2002, the Company in the name of several House of Lloyd
entities, filed a petition against Richmont Corporation, Richmont International,
Inc., d/b/a Richmont House and John P. Rochon ("Defendants") asserting various
claims arising from, inter alia, the Letter Agreement. Defendants answered the
lawsuit and, on September 12, 2002, filed an Original, Counterclaim and Third
Party Petition against the House of Lloyd entities, as counter-defendants, and
the Company and Mr. Donald J. Carter Jr., as third-party defendants, pursuant to
which defendants asserted claims for tortious interference with prospective
business relations, tortious interference with existing business relations,
business disparagement, conspiracy and malicious prosecution, and were seeking
actual damages and punitive damages in the amount of $100 million. The House of
Lloyd entities, the Company and Mr. Carter answered the Original Counterclaim
and third party petition, and filed an additional action against the Defendants
in the United States Bankruptcy Court for the Western District of Missouri,
Kansas City Division (the "Bankruptcy Court").
On March 10, 2003, the Defendants entered into a Settlement Agreement and
General Release (the "Settlement Agreement") in favor of the Company and Donald
J. Carter, Jr., which disposes of and fully resolves the pending claims without
the payment of any material amounts by any of the parties. All orders of
dismissals have been submitted and entered and all settlement documents have
been signed.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.1* Asset Purchase Agreement dated March 5, 2003 among Edward
Marshall Boehm, Inc., Douglas Lorie, Inc., Helen F. Boehm and
EM Boehm, Inc.
10.2* Third Supplemental Indenture dated as of March 14, 2003 among
Home Interiors & Gifts, Inc., EM Boehm, Inc., and The Bank of
New York, as successor in interest to the corporate trust
business of United States Trust Company of New York, as
Successor Trustee.
99.1* Certification of Chief Executive Officer of the Company.
99.2* Certification of Chief Financial Officer of the Company.
(b) Reports on Form 8-K
None
- -----------
*Filed herewith.
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
HOME INTERIORS & GIFTS, INC.
By: /s/ KENNETH J. CICHOCKI
-----------------------
Kenneth J. Cichocki
Sr. Vice President of Finance and Chief Financial Officer
(principal financial and accounting officer)
Date: May 12, 2003
23
CERTIFICATIONS*
I, Donald J. Carter, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Home Interiors &
Gifts, Inc.(the "Registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors (or persons performing the
equivalent function);
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 12, 2003
/s/ Donald J. Carter, Jr.
-------------------------------------
Donald J. Carter, Jr.
Chairman and Chief Executive Officer
24
CERTIFICATIONS*
I, Kenneth J. Cichocki, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Home Interiors &
Gifts, Inc.(the "Registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors (or persons performing the
equivalent function);
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 12, 2003
/s/ KENNETH J. CICHOCKI
-------------------------------
Kenneth J. Cichocki
Chief Financial Officer
25
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.1* Asset Purchase Agreement dated March 5, 2003 among Edward
Marshall Boehm, Inc., Douglas Lorie, Inc., Helen F. Boehm and
EM Boehm, Inc.
10.2* Third Supplemental Indenture dated as of March 14, 2003 among
Home Interiors & Gifts, Inc., EM Boehm, Inc., and The Bank of
New York, as successor in interest to the corporate trust
business of United States Trust Company of New York, as
Successor Trustee.
99.1* Certification of Chief Executive Officer of the Company.
99.2* Certification of Chief Financial Officer of the Company.
- -----------
*Filed herewith.
26