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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
COMMISSION FILE NUMBER 333-62021
---------------
HOME INTERIORS & GIFTS, INC.
(Exact name of registrant as specified in its charter)
TEXAS 75-0981828
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1649 FRANKFORD ROAD WEST, 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 November 6, 2003, 15,240,218 shares of the Company's common stock, par
value $0.10 per share, were outstanding.
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1
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
September 30, 2003.................................................................... 3
Consolidated Statements of Operations and Comprehensive Income for
the three months and nine months ended September 30, 2002 and 2003.................... 4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 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............................................................. 16
Item 3. Quantitative and Qualitative Disclosure About Market Risk....................... 24
Item 4. Controls and Procedures......................................................... 24
PART II - OTHER INFORMATION
Item 1. Legal proceedings............................................................... 25
Item 6. Exhibits and Reports on Form 8-K................................................ 25
2
ITEM 1. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2002 AND SEPTEMBER 30, 2003
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
(UNAUDITED)
DECEMBER 31, SEPTEMBER 30,
2002 2003
------------ -------------
ASSETS
Current assets:
Cash .............................................................. $ 64,116 $ 14,502
Accounts receivable, net .......................................... 13,581 26,846
Inventories, net .................................................. 55,209 86,444
Deferred income tax ............................................... 8,399 9,107
Other current assets .............................................. 2,997 3,356
--------- ---------
Total current assets ........................................ 144,302 140,255
Property, plant and equipment, net ................................. 69,482 76,200
Debt issuance costs, net ........................................... 5,067 4,234
Goodwill ........................................................... 11,126 14,475
Other assets, net .................................................. 621 630
--------- ---------
Total assets ................................................ $ 230,598 $ 235,794
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable .................................................. $ 32,844 $ 33,871
Accrued seminars and incentive awards ............................. 22,435 14,387
Royalties payable ................................................. 13,327 6,154
Current portion of related party note payable ..................... 663 663
Current maturities of long-term debt and capital lease
obligations ...................................................... 21,017 8,183
Other current liabilities ......................................... 21,699 37,791
--------- ---------
Total current liabilities ................................... 111,985 101,049
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 ........................................................ 321,874 317,590
Non-current deferred income tax liability .......................... 3,354 1,757
Other liabilities .................................................. 19,724 19,327
--------- ---------
Total liabilities ........................................... 458,299 441,085
--------- ---------
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 ........................................ 180,829 184,046
Accumulated deficit ............................................... (503,731) (484,519)
Accumulated other comprehensive loss .............................. (519) (538)
--------- ---------
Total shareholders' deficit ................................. (227,701) (205,291)
--------- ---------
Total liabilities and shareholders' deficit ................. $ 230,598 $ 235,794
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
3
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2003
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2002 2003 2002 2003
--------- --------- --------- ---------
Net sales ........................................... $ 125,673 $ 147,301 $ 390,397 $ 424,571
Cost of goods sold .................................. 56,000 76,818 170,113 198,222
--------- --------- --------- ---------
Gross profit ........................................ 69,673 70,483 220,284 226,349
Selling, general and administrative:
Selling ............................................ 23,422 25,968 72,626 72,739
Freight, warehouse and distribution ................ 15,401 20,483 44,378 54,374
General and administrative ......................... 13,539 17,949 40,257 49,990
Loss on debt restructure ........................... 7,188 -- 7,188 --
Gain on the disposition of assets .................. -- (439) (361) (146)
Stock option expense ............................... 14 1,001 107 3,216
--------- --------- --------- ---------
Total selling, general and administrative..... 59,564 64,962 164,195 180,173
--------- --------- --------- ---------
Operating income .................................... 10,109 5,521 56,089 46,176
Other income (expense):
Interest income .................................... 122 38 246 263
Interest expense ................................... (7,013) (6,748) (20,278) (20,610)
Other income (expense), net ........................ 423 (592) (1,595) (259)
--------- --------- --------- ---------
Other income (expense), net .................. (6,468) (7,302) (21,627) (20,606)
--------- --------- --------- ---------
Income before income taxes .......................... 3,641 (1,781) 34,462 25,570
Income tax provision (benefit) ...................... 1,260 (3,907) 12,750 6,358
--------- --------- --------- ---------
Net income .......................................... 2,381 2,126 21,712 19,212
Other comprehensive loss:
Cumulative translation adjustment .................. (32) (362) (190) (19)
--------- --------- --------- ---------
Other comprehensive loss ..................... (32) (362) (190) (19)
--------- --------- --------- ---------
Comprehensive income ................................ $ 2,349 $ 1,764 $ 21,522 $ 19,193
========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
4
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2003
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
----------------------
SEPTEMBER 30,
----------------------
2002 2003
-------- --------
Cash flows from operating activities:
Net income ................................................ $ 21,712 $ 19,212
-------- --------
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization ............................ 8,757 11,767
Amortization of debt issuance costs and other ............ 1,616 833
Provision for doubtful accounts .......................... 1,546 2,271
Loss on debt restructure ................................. 7,188 --
Provision for losses on inventories ...................... 2,532 (1,177)
Gain on the disposition of assets ........................ (361) (146)
Stock option expense ..................................... 107 3,216
Deferred tax benefit ..................................... (2,472) (2,304)
Changes in assets and liabilities:
Accounts receivable ..................................... (11,311) (15,927)
Inventories ............................................. (39,537) (27,794)
Other current assets .................................... (3,364) (364)
Other assets ............................................ (64) (70)
Accounts payable ........................................ 3,561 2,861
Income taxes payable .................................... (2,770) 3,204
Other accrued liabilities ............................... 17,544 (3,798)
-------- --------
Total adjustments .................................... (17,028) (27,428)
-------- --------
Net cash provided by (used in) operating activities .. 4,684 (8,216)
-------- --------
Cash flows from investing activities:
Business acquisitions, net of cash acquired .............. -- (13,474)
Purchases of property, plant and equipment ............... (9,184) (10,865)
Proceeds from the sale of property, plant and equipment .. 574 630
Purchase of intangible assets ............................ (10) --
-------- --------
Net cash used in investing activities ................ (8,620) (23,709)
-------- --------
Cash flows from financing activities:
Payments of principal under capital lease obligations .... (1,049) (1,443)
Payments of principal under the Senior Credit Facility ... (5,500) (15,477)
Proceeds from borrowings under the Senior Credit
Facility ................................................ 35,000 --
Debt issuance costs ...................................... (4,101) --
Payments of principal of other bank debt ................. -- (750)
-------- --------
Net cash provided by (used in) financing activities .. 24,350 (17,670)
-------- --------
Effect of cumulative translation adjustment ............... (190) (19)
-------- --------
Net increase (decrease) in cash and cash equivalents ...... 20,224 (49,614)
Cash and cash equivalents at beginning of year ............ 13,712 64,116
-------- --------
Cash and cash equivalents at end of period ................ $ 33,936 $ 14,502
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
5
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BACKGROUND
Home Interiors & Gifts, Inc. (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,
small furniture, 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 90,400 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 third
quarter of 2003, approximately 41.8% 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 September 30, 2002 and 2003 in the accompanying unaudited consolidated
financial information were September 28, 2002 and September 27, 2003,
respectively.
The consolidated financial information as of September 30, 2003 and for the
three months and nine months ended September 30, 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 September 30, 2003 and December 31, 2002,
its operating results and comprehensive income for the three months and nine
months ended September 30, 2002 and 2003, and its cash flows for the nine months
ended September 30, 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.
In 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 145. "Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections"
("SFAS No. 145"). Previously the Company recognized a loss on a debt restructure
as an extraordinary loss, net of related tax effect. On January 1, 2003, the
Company adopted SFAS No. 145 and in accordance with SFAS No. 145, the Company
reclassified the extraordinary loss, net of related tax effect, to income from
operations and income tax expense. The effect of adopting SFAS No. 145 decreased
operating income from previously amounts reported by $7.2 million and decreased
income taxes by $2.7 million for the quarter and year ended September 30, 2002.
6
STOCK-BASED COMPENSATION PLANS
The Company has adopted several stock option plans. For Displayers 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").
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 three months and nine months ended September 30, 2002 and 2003
would approximate (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------- -------------------------
2002 2003 2002 2003
------------ ----------- ------------ -----------
Net income, as reported.......................................... $ 2,381 $ 2,126 $ 21,712 $ 19,212
Add: Stock-based employee compensation expense
included in reported net income, net of related tax effects.... -- 449 -- 1,440
Deduct: Stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects......................... (141) (497) (452) (1,760)
---------- -------- ---------- ----------
Pro forma net income............................................. $ 2,240 $ 2,078 $ 21,260 $ 18,892
========== ======== ========== ==========
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 $218,000. In July of 2003, the $2.6
million deferred payment obligation to the seller was terminated.
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 $6.5 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 $5.6 million,
inventory of $423,000 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 $1.1 million.
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
7
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 $411,000.
4. INVENTORIES, NET
Inventories, net consisted of the following as of December 31, 2002 and
September 30, 2003 (in thousands):
DECEMBER 31, SEPTEMBER 30,
2002 2003
-------------- ---------------
Raw materials................ $ 4,974 $ 9,944
Work in process.............. 1,175 2,588
Finished goods............... 57,076 78,862
---------- --------
63,225 91,394
Inventory allowance.......... (8,016) (4,950)
---------- --------
$ 55,209 $ 86,444
========== ========
5. OTHER CURRENT LIABILITIES
Other current liabilities consisted of the following as of December 31, 2002
and September 30, 2003 (in thousands):
DECEMBER 31, SEPTEMBER 30,
2002 2003
-------------- ---------------
Interest..................... $ 1,241 $ 7,489
Accrued compensation......... 6,440 5,488
Income tax payable........... -- 3,204
Sales taxes.................. 3,980 3,823
Deferred revenue............. 1,274 8,845
Workers' compensation........ 3,142 3,105
Related party................ 1,441 --
Other current liabilities.... 4,181 5,837
---------- --------
$ 21,699 $ 37,791
========== ========
6. ADOPTION OF NEW ACCOUNTING STANDARDS
In May of 2003, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS No.
150"). SFAS No. 150 establishes standards for classification and measurement of
financial instruments issued by entities that have the characteristics of both
liabilities and equity. SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003. The Company adopted SFAS No. 150 on
May 31, 2003 and there was not a financial accounting impact associated with its
adoption.
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 adopted the remaining
provisions of SFAS No. 149 on June 30, 2003 and there was not a financial impact
associated with its adoption.
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 Reporting", to require disclosure about those
effects in interim financial information. SFAS No. 148 is effective for fiscal
year ended December 31, 2002.
8
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. The Company is currently evaluating the change to
the fair value based method of accounting for stock-based employee compensation.
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 on January
1, 2003 and there was not a financial accounting impact associated with its
adoption.
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, Canada and Puerto Rico; and
- Domistyle - wholesale supply operation that manufactures, imports, 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 debt restructure, gains on disposition of assets, and
other income expense (defined as "EBITDA"). The Company also uses EBITDA, as
defined, as a performance measure due to the Company's required compliance
thresholds for EBITDA, as defined, 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 consolidation purposes. The table below
presents information about reportable segments used by the Company's executive
management team as of and for the three months and nine months ended September
30, 2002 and 2003 (in thousands):
DIRECT DIRECT
THREE MONTHS ENDED SELLING SELLING
SEPTEMBER 30, DOMESTIC INTERNATIONAL DOMISTYLE ELIMINATIONS CONSOLIDATED
------------- -------- ------------- --------- ------------ ------------
2002
Net sales to non-affiliates.... $ 114,718 $ 8,556 $ 2,399 $ -- $ 125,673
Net sales to affiliates........ 4,443 -- 29,529 (33,972) --
EBITDA, as defined............. 10,921 757 10,010 (255) 21,433
2003
Net sales to non-affiliates.... $ 121,680 $ 17,149 $ 8,472 $ -- $ 147,301
Net sales to affiliates........ 6,030 -- 34,785 (40,815) --
EBITDA, as defined............. 2,472 1,085 11,021 (1,090) 13,488
DIRECT DIRECT
NINE MONTHS ENDED SELLING SELLING
SEPTEMBER 30, DOMESTIC INTERNATIONAL DOMISTYLE ELIMINATIONS CONSOLIDATED
------------- -------- ------------- --------- ------------ ------------
2002
Net sales to
non-affiliates............. $ 359,010 $ 24,445 $ 6,942 $ -- $ 390,397
Net sales to affiliates.... 12,196 -- 99,870 (112,066) --
EBITDA, as defined......... 40,000 2,783 35,478 (1,709) 76,552
Total assets............... 205,372 5,781 90,813 (79,389) 222,577
Capital expenditures....... 7,615 18 1,551 -- 9,184
2003
Net sales to
non-affiliates............. $ 363,133 $ 41,593 $ 19,845 $ -- $ 424,571
Net sales to affiliates.... 24,252 -- 105,026 (129,278) --
EBITDA, as defined......... 34,657 4,172 33,472 (3,341) 68,960
Total assets............... 213,036 9,815 95,667 (82,724) 235,794
Capital expenditures....... 5,232 356 5,277 -- 10,865
9
The following table represents a reconciliation of net income to consolidated
EBITDA, as defined, for the three months and nine months ended September 30,
2002 and 2003 (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
2002 2003 2002 2003
------------ ------------ ------------ ------------
Net income (loss)..................... $ 2,381 $ 2,126 $ 21,712 $ 19,212
Effects of SAB 101.................... 337 (45) 1,720 1,745
Depreciation and amortization......... 2,883 4,105 8,757 11,767
Loss on debt restructure.............. 7,188 -- 7,188 --
Gain on disposition of assets......... -- (439) (361) (146)
Stock option expense.................. 14 1,001 107 3,216
Reorganization costs.................. 704 3,372 2,042 5,156
Interest income....................... (122) (38) (246) (263)
Interest expense...................... 7,013 6,748 20,278 20,610
Other income (expense), net........... (423) 592 1,595 259
Income tax provision (benefit)........ 1,458 (3,934) 13,760 7,404
---------- ---------- ---------- ----------
EBITDA, as defined.................... $ 21,433 $ 13,488 $ 76,552 $ 68,960
========== ========== ========== ==========
8. GUARANTOR FINANCIAL DATA
Dallas Woodcraft Company, LP, DWC GP, Inc., GIA, Inc., Homco, Inc., Spring
Valley Scents, Inc., Laredo Candle Company, L.P., Domistyle, Inc., EM Boehm,
Inc., Home Interiors de Puerto Rico, Inc. and HIG Investments, Inc.
(collectively, the "Guarantors") unconditionally, on a joint and several basis,
guarantee Home Interiors & Gifts, Inc.'s ("Borrower") credit agreement with its
principal lenders (the "Senior Credit Agreement"), and the Debt Holder'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., 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., HI Trading
Mexicana, S.A. de C.V., and Home Interiors & Gifts of Canada, Inc.
(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 AND NINE MONTHS ENDED SEPTEMBER 30, 2002
THREE MONTHS ENDED
SEPTEMBER 30, 2002 BORROWER GUARANTORS NON GUARANTORS ELIMINATIONS CONSOLIDATED
- --------------------------------------------- ------------ ----------- -------------- ------------ ------------
Net sales.................................... $ 119,865 $ 32,556 $ 7,224 $ (33,972) $ 125,673
Cost of good sold............................ 64,124 21,522 4,072 (33,718) 56,000
------------ -------- ------- --------- ---------
Gross profit............................... 55,741 11,034 3,152 (254) 69,673
Total selling, general and administrative.... 55,482 1,518 2,564 -- 59,564
------------ -------- ------- --------- ---------
Operating income (loss).................... 259 9,516 588 (254) 10,109
Other income (expense), net.................. (6,852) 128 (88) 344 (6,468)
------------ -------- ------- --------- ---------
Income (loss) before income taxes.......... (6,593) 9,644 500 90 3,641
Provision for income taxes................... 1,791 (2,853) (198) -- (1,260)
Equity in income (loss) of subsidiaries,
net of tax................................. 7,092 3 -- (7,095) --
------------ -------- ------- --------- ---------
Net income (loss).......................... 2,290 6,794 302 (7,005) 2,381
Other comprehensive income (loss)............ 5 -- (37) -- (32)
------------ -------- ------- --------- ---------
Comprehensive income (loss)................ $ 2,295 $ 6,794 $ 265 $ (7,005) $ 2,349
============ ======== ======= ========= =========
NINE MONTHS ENDED
SEPTEMBER 30, 2002 BORROWER GUARANTORS NON GUARANTORS ELIMINATIONS CONSOLIDATED
- ------------------------------------------- ------------ ----------- -------------- ------------ ------------
Net sales.................................. $ 372,982 $108,671 $ 20,810 $(112,066) $ 390,397
Cost of good sold.......................... 199,670 69,982 10,818 (110,357) 170,113
------------ -------- -------- --------- ---------
Gross profit............................. 173,312 38,689 9,992 (1,709) 220,284
Total selling, general and administrative.. 151,860 4,872 7,463 -- 164,195
------------ -------- -------- --------- ---------
Operating income (loss).................. 21,452 33,817 2,529 (1,709) 56,089
Other income (expense), net................ (21,184) 339 (438) (344) (21,627)
------------ -------- -------- --------- ---------
Income (loss) before income taxes........ 268 34,156 2,091 (2,053) 34,462
Provision for income taxes................. (447) (11,742) (561) -- (12,750)
Equity in income (loss) of subsidiaries,
net of tax............................... 23,942 15 -- (23,957) --
------------ -------- -------- --------- ---------
Net income (loss)........................ 23,763 22,429 1,530 (26,010) 21,712
Other comprehensive income................. 9 -- (199) -- (190)
------------ -------- -------- --------- ---------
Comprehensive income (loss).............. $ 23,772 $ 22,429 $ 1,331 $ (26,010) $ 21,522
============ ======== ======== ========= =========
10
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003
THREE MONTHS ENDED
SEPTEMBER 30, 2003 BORROWER GUARANTORS NON GUARANTORS ELIMINATIONS CONSOLIDATED
- --------------------------------------- ------------- ---------- -------------- ------------ ------------
Net sales.............................. $ 129,177 $ 40,881 $ 19,747 $ (42,504) $ 147,301
Cost of good sold...................... 76,973 27,391 13,866 (41,412) 76,818
------------ -------- -------- --------- ---------
Gross profit......................... 52,204 13,490 5,881 (1,092) 70,483
Total selling, general and
administrative....................... 55,032 2,822 7,108 -- 64,962
------------ -------- -------- --------- ---------
Operating income (loss).............. (2,828) 10,668 (1,227) (1,092) 5,521
Other income (expense), net............ (6,578) 108 (803) (29) (7,302)
------------ -------- -------- --------- ---------
Income (loss) before income taxes.... (9,406) 10,776 (2,030) (1,121) (1,781)
Benefit (provision) for income taxes... 6,922 (3,815) 800 -- 3,907
Equity in income (loss) of
subsidiaries, net of tax............. 5,729 (1,477) -- (4,252) --
------------ -------- -------- --------- ---------
Net income (loss).................... 3,245 5,484 (1,230) (5,373) 2,126
Other comprehensive loss............... -- -- (362) -- (362)
------------ -------- -------- --------- ---------
Comprehensive income (loss).......... $ 3,245 $ 5,484 $ (1,592) $ (5,373) $ 1,764
============ ======== ======== ========= =========
NINE MONTHS ENDED
SEPTEMBER 30, 2003 BORROWER GUARANTORS NON GUARANTORS ELIMINATIONS CONSOLIDATED
- --------------------------------------- ------------ ---------- -------------- ------------ ------------
Net sales.............................. $ 392,147 $119,849 $ 44,593 $(132,018) $ 424,571
Cost of good sold...................... 216,339 78,875 31,684 (128,676) 198,222
------------ -------- -------- --------- ---------
Gross profit......................... 175,808 40,974 12,909 (3,342) 226,349
Total selling, general and
administrative....................... 157,042 8,016 15,115 -- 180,173
------------ -------- -------- --------- ---------
Operating income (loss).............. 18,766 32,958 (2,206) (3,342) 46,176
Other income (expense), net............ (19,892) 299 (1,005) (8) (20,606)
------------ -------- -------- --------- ---------
Income (loss) before income taxes.... (1,126) 33,257 (3,211) (3,350) 25,570
Benefit (provision) for income taxes... 4,302 (11,821) 1,161 -- (6,358)
Equity in income (loss) of
subsidiaries, net of tax............. 19,385 (3,231) -- (16,154) --
------------ -------- -------- --------- ---------
Net income (loss).................... 22,561 18,205 (2,050) (19,504) 19,212
Other comprehensive loss............... (10) -- (9) -- (19)
------------ -------- -------- --------- ---------
Comprehensive income (loss).......... $ 22,551 $ 18,205 $ (2,059) $ (19,504) $ 19,193
============ ======== ======== ========= =========
11
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 2002
BORROWER 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)
Accumulated other comprehensive
income (loss) .............................. 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
========= ======== ======= ========= ======== =========
12
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF SEPTEMBER 30, 2003
BORROWER GUARANTORS NON GUARANTORS CONSOLIDATING ELIMINATIONS CONSOLIDATED
---------- ---------- -------------- ------------- ------------ ------------
ASSETS
Current assets:
Cash ........................................... $ 14,214 $ (2,026) $ 2,314 $ 14,502 $ -- $ 14,502
Accounts receivable, net ....................... 15,036 3,965 7,845 26,846 -- 26,846
Inventories, net ............................... 65,617 14,937 12,565 93,119 (6,675) 86,444
Other current assets ........................... 8,991 1,442 2,030 12,463 -- 12,463
Due to (due from) subsidiaries ................. (37,049) 56,675 (19,626) -- -- --
--------- --------- -------- --------- --------- ---------
Total current assets ....................... 66,809 74,993 5,128 146,930 (6,675) 140,255
Property, plant and equipment, net ............... 45,255 19,190 11,755 76,200 -- 76,200
Investment in subsidiaries ....................... 97,929 8,106 -- 106,035 (106,035) --
Debt issuance costs and other assets ............. 4,816 13,179 1,344 19,339 -- 19,339
--------- --------- -------- --------- --------- ---------
Total assets ............................... $ 214,809 $ 115,468 $ 18,227 $ 348,504 $(112,710) $ 235,794
========= ========= ======== ========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ............................... $ 27,949 $ 3,449 $ 1,841 $ 33,239 $ 632 $ 33,871
Related party note payable ..................... 663 -- -- 663 -- 663
Current maturities of long-term debt
and capital lease obligations ................. 8,178 5 -- 8,183 -- 8,183
Other current liabilities ...................... 38,529 15,933 3,870 58,332 -- 58,332
--------- --------- -------- --------- --------- ---------
Total current liabilities .................. 75,319 19,387 5,711 100,417 632 101,049
Long term related party note payable ............. 1,362 -- -- 1,362 -- 1,362
Long-term debt and capital lease
obligations, net of current maturities ......... 317,590 -- -- 317,590 -- 317,590
Other liabilities ................................ 17,983 2,188 913 21,084 -- 21,084
--------- --------- -------- --------- --------- ---------
Total liabilities .......................... 412,254 21,575 6,624 440,453 632 441,085
--------- --------- -------- --------- --------- ---------
Commitments and contingencies (see Note 9)
Shareholders' equity (deficit):
Preferred stock ................................ 94,196 -- -- 94,196 -- 94,196
Common stock ................................... 1,524 1,001 27 2,552 (1,028) 1,524
Additional paid-in capital ..................... 184,046 50,174 12,331 246,551 (62,505) 184,046
Retained earnings (accumulated deficit) ........ (477,212) 42,718 (216) (434,710) (49,809) (484,519)
Accumulated other comprehensive
income (loss) ................................ 1 -- (539) (538) -- (538)
--------- --------- -------- --------- --------- ---------
Total shareholders' equity (deficit) ....... (197,445) 93,893 11,603 (91,949) (113,342) (205,291)
--------- --------- -------- --------- --------- ---------
Total liabilities and shareholders' equity
(deficit) ................................ $ 214,809 $ 115,468 $ 18,227 $ 348,504 $(112,710) $ 235,794
========= ========= ======== ========= ========= =========
13
CONDENSED CONSOLIDATING CASH FLOW INFORMATION
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002
--------------------------------------------
BORROWER GUARANTORS NON GUARANTORS ELIMINATIONS CONSOLIDATED
-------- ---------- -------------- ------------ ------------
Net cash provided by operating activities .......... $ 4,036 $ 382 $ 266 $ -- $ 4,684
Cash flows from investing activities:
Purchase of property, plant and equipment ........ (7,615) (1,551) (18) -- (9,184)
Purchase of intangible assets .................... (10) -- -- (10)
Proceeds from the sale of property, plant and
equipment ..................................... 574 -- -- 574
-------- ------- ----- ----- --------
Net cash used in investing activities ............ (7,051) (1,551) (18) -- (8,620)
-------- ------- ----- ----- --------
Cash flows from financing activities:
Payments under capital lease obligations ......... (1,049) -- -- -- (1,049)
Payment under the Senior Credit facility ......... (5,500) -- -- -- (5,500)
Proceeds from borrowings under the
Senior Credit Facility ........................ 35,000 -- -- -- 35,000
Debt issuance costs ............................. (4,101) -- -- -- (4,101)
-------- ------- ----- ----- --------
Net cash provided by financing activities ....... 24,350 -- -- -- 24,350
-------- ------- ----- ----- --------
Effect of cumulative translation adjustment ...... 10 -- (200) -- (190)
-------- ------- ----- ----- --------
Net increase (decrease) in cash and
cash equivalents ................................. 21,345 (1,169) 48 -- (20,224)
Cash and cash equivalents at the beginning
of year .......................................... 13,757 (542) 497 -- 13,712
-------- ------- ----- ----- --------
Cash and cash equivalents at the end of period ..... $ 35,102 $(1,711) $ 545 $ -- $ 33,936
======== ======= ===== ===== ========
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003
--------------------------------------------
BORROWER GUARANTORS NON GUARANTORS ELIMINATIONS CONSOLIDATED
--------- ---------- -------------- ------------ ------------
Net cash provided by (used in)
operating activities ................................ $(27,034) $ 14,174 $ 4,644 $ -- $ (8,216)
Cash flows from investing activities:
Purchase of property, plant and equipment ........... (5,232) (2,848) (2,785) -- (10,865)
Business acquisitions, net of cash acquired ......... (1,798) (11,676) -- -- (13,474)
Other ............................................... 601 29 -- -- 630
-------- -------- ------- ----- --------
Net cash used in investing activities ............. (6,429) (14,495) (2,785) -- (23,709)
-------- -------- ------- ----- --------
Cash flows from financing activities:
Payments under Senior Credit Facility ............... (15,477) -- -- -- (15,477)
Payments under capital lease obligations ............ (889) -- (554) -- (1,443)
Payments other bank debt ............................ -- (750) -- -- (750)
-------- -------- ------- ----- --------
Net cash used in financing activities ............. (16,366) (750) (554) -- (17,670)
-------- -------- ------- ----- --------
Effect of cumulative translation adjustment ........ (10) -- (9) -- (19)
-------- -------- ------- ----- --------
Net increase (decrease) in cash and cash
equivalents ......................................... (49,839) (1,071) 1,296 -- (49,614)
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 ........ $ 14,214 $ (2,026) $ 2,314 $ -- $ 14,502
======== ======== ======= ===== ========
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 is also engaged in product recall campaigns related to its
normal business activities. Management believes that the costs, if any,
associated with the product recalls would not have a material effect upon the
Company.
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 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
14
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.
On June 6, 2003, the Company entered into a twelve-year license agreement
(the "License Agreement") with Meredith Corporation. The License Agreement
governs the development, manufacture, marketing and distribution of products to
be sold by the Company under the trademark "Better Homes and Gardens". The
agreement provides for earned royalty payments to Meredith Corporation
determined by a percentage of net sales and guaranteed annual minimum royalty
payments that escalate through the term of the License Agreement.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read in conjunction with the
Company's unaudited consolidated financial statements and accompanying notes
thereto, which are included elsewhere herein. 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 September 30,
2003, the Company has approximately 90,400 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.
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 September 30, 2003, the Company's active Displayer base in the
United States increased 4.9% to approximately 66,300 active Displayers from
approximately 63,200 as of September 30, 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 path as reflected in the new
recruit program.
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% as of
16
September 30, 2003 and 2002. The Company is continuing to introduce new products
during 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. The Company's "Recertification" program retrains
Displayers on how to become more effective Directors 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 is 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.
COMPANY MANUFACTURING STRATEGY
In connection with the Company's overall manufacturing and wholesale supply
strategy, the Company acquired Brenda Buell & Associates, Inc. ("BBA", now known
as Domistyle, Inc.), 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 Vidrio 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.
The combination of these newly acquired companies, along with the existing
manufacturing operations of Dallas Woodcraft Company, LP ("DWC"), Laredo Candle
Company, L.P. ("Laredo Candle") and GIA, Inc. ("GIA"), form what the Company
refers to as "Domistyle", a uniquely positioned home decor manufacturing and
design operation that not only sells to the Company's core direct selling
business, but also sells to the Company's wholesale supply channel. Manufactured
products include framed art and mirrors, candles, candle accessories, glass,
metal products, ceramics, porcelain and injection molded products. Domistyle
provides diversification to the Company's customer base and provides additional
insight to market and style trends.
The Company continues to emphasize Domistyle products in the direct selling
channel, which provides opportunities for gross margin improvements and
leverages 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 the wholesale supply channel
with sales to non-affiliate resellers. Sales to non-affiliate resellers for the
nine months ended September 30, 2003 were $19.8 million as compared to $6.9
million in the comparable period of 2002. The net sales of DWC, Laredo Candle
and GIA increased 35% to non-affiliate resellers to $9.3 million in the first
nine months of 2003 as compared to $6.9 million in the comparable period of the
prior year. Newly acquired manufacturing companies (described above) contributed
an additional $10.5 million of wholesale supply channel sales in the nine months
ended September 30, 2003.
17
RESULTS OF OPERATIONS
THE THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2002
2002 2003 % VARIANCE
---------- ---------- ----------
NET SALES
Domestic direct net sales to non-affiliates.................... $ 114,718 $ 121,680 6.1%
International direct net sales to non-affiliates............... 8,556 17,149 100.4%
Domistyle sales to non-affiliates.............................. 2,399 8,472 253.1%
---------- ---------- --------
Net sales...................................................... $ 125,673 $ 147,301 17.2%
========== ========== ========
OTHER KEY DOMESTIC DATA
Number of average active Displayers............................ 63,400 67,200 6.0%
Number of orders shipped....................................... 217,486 239,260 10.0%
Number of orders per Displayer................................. 3.4 3.6 5.9%
Average order size............................................. $ 522 $ 509 -2.5%
Net sales increased $21.6 million, or 17.2%, to $147.3 million in the three
months ended September 30, 2003, from $125.7 million in the comparable period in
2002. Domestic direct net sales to non-affiliates increased $7.0 million or 6.1%
in the three-month period ended September 30, 2003 as compared to the three
months ended September 30, 2002. The primary variables that impact domestic
direct net sales include the number of Displayers, the number of orders shipped,
the number of orders per Displayer and average order size. The Company believes
the decrease in average order size is due to the increase of newer Displayers
who are historically less productive in addition to the timing of incentive
promotions. International direct sales increased $8.5 million in the comparable
three-month periods primarily related to the increase in the Mexico and Canada
Displayer bases. Domistyle sales to non-affiliates increased $6.1 million over
the comparable quarters primarily due to sales from the newly acquired companies
described in Note 3.
Gross profit increased $0.8 million, or 1.2%, to $70.5 million in the three
months ended September 30, 2003 from $69.7 million in the three months ended
September 30, 2002. As a percentage of net sales, gross profit decreased to
47.8% in the third quarter of 2003 from 55.4% in the third quarter of 2002. The
decrease as a percentage of net sales is primarily due to significantly
discounted product sales resulting from a special, one-time inventory reduction
promotion that occurred in the third quarter of 2003. In addition, approximately
$1.3 million of non-recurring costs related to redundant labor and inventory
write-offs for the new international manufacturing entities is included in cost
of goods sold for the three months ended September 30, 2003.
Selling expense increased $2.6 million or 10.9% to $26.0 million in the
three months ended September 30, 2003 from $23.4 million in the comparable
period of 2002. As a percentage of net sales, selling expense decreased to 17.6%
as of the quarter ended September 30, 2003 from 18.6% in the comparable period
of 2002. The decrease as a percentage of sales is primarily due to the cost and
timing of accruals for sales events such as the Company's annual Seminar and a
decrease in estimated Director bonuses as a result of lower commissionable sales
over the comparable period.
Freight, warehouse and distribution expense increased $5.1 million, or
33.0%, to $20.5 million in the three months ended September 30, 2003 from $15.4
million in the three months ended September 30, 2002. These costs were 13.9% of
net sales in the 2003 period, as compared to 12.3% in the comparable 2002
period. This increase in freight, warehouse and distribution expense as a
percentage of sales was primarily due to the increase in freight, labor and
warehouse supplies as a result of the 10.0% increase in the number of orders
shipped over the comparable period of 2002.
General and administrative expense increased $4.4 million, or 32.6%, to
$17.9 million in the three months ended September 30, 2003, from $13.5 million
in the three months ended September 30, 2002. The increase consists primarily of
a $0.8 million increase in depreciation and amortization expense, $0.5 million
increase related to professional fees, $0.5 million increase in employee related
expenses such as salaries, wages and insurance and $1.3 million related to
additional subsidiary expenses primarily as a result of the newly acquired
companies. Included in general and administrative expense are certain additional
non-recurring costs related to excess facilities, uncapitalizable fees related
to the implementation of the new JD Edwards computer system and corporate
organizational realignment expenses. These costs were approximately $2.1 million
and $0.7 million for the quarters ended September 30, 2003 and 2002,
respectively.
18
Loss on debt restructure of $7.2 million in the third quarter of 2002 was a
result of the write-off of $3.3 million of unamortized debt issuance costs and
$3.9 million of fees paid to creditors related to the debt restructure in July
2002.
Stock option expense of approximately $1.0 million was recorded in the three
months ended September 30, 2003, as compared to $14,000 in the comparable 2002
period related to compensation expense on performance-based options issued under
the 2002 Key Employee Stock Option Plan.
Interest expense decreased $0.3 million to $6.7 million in the three months
ended September 30, 2003 from $7.0 million in 2002 primarily due to lower
interest rates and a reduction in outstanding debt.
Income taxes decreased $5.2 million recognizing a benefit of $3.9 million in
the three months ended September 30, 2003 from an expense of $1.3 million in the
comparable period of 2002 due to a favorable state income tax audit
determination of $5.8 million in the third quarter of 2003. As a result of the
receipt of the state income tax refund, the Company believes that the effective
income tax rate for the three months ended September 30, 2003 does not
accurately represent the anticipated income tax rate for the year ended December
31, 2003.
THE NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2002
2002 2003 % VARIANCE
---------- ---------- ----------
NET SALES
Domestic direct net sales to non-affiliates.................... $ 359,010 $ 363,133 1.1%
International direct net sales to non-affiliates............... 24,445 41,593 70.1%
Domistyle sales to non-affiliates.............................. 6,942 19,845 185.9%
---------- ----------- --------
Net sales...................................................... $ 390,397 $ 424,571 8.8%
========== ========== ========
OTHER KEY DOMESTIC DATA
Number of average active Displayers............................ 61,000 65,500 7.4%
Number of orders shipped....................................... 648,435 702,003 8.3%
Number of orders per Displayer................................. 10.6 10.7 1.0%
Average order size............................................. $ 552 $ 517 -6.3%
Net sales increased $34.2 million, or 8.8%, to $424.6 million in the nine
months ended September 30, 2003, from $390.4 million in the comparable period in
2002. Domestic direct net sales to non-affiliates increased $4.1 million or 1.1%
in the nine-month period ended September 30, 2003 as compared to the nine months
ended September 30, 2002. The primary variables that impact domestic direct net
sales include the number of Displayers, the number of orders shipped, the number
of orders per Displayer and average order size. The Company believes the
decrease in average order size is due to the increase of newer Displayers who
are historically less productive in addition to the timing of incentive
promotions. International direct sales increased $17.2 million in the comparable
nine-month periods primarily related to the increase in the Mexico and Canada
Displayer bases. Domistyle sales to non-affiliates increased $12.9 million over
the comparable nine-month periods due to sales from newly acquired companies
described in Note 3.
Gross profit increased $6.0 million, or 2.8%, to $226.3 million in the nine
months ended September 30, 2003 from $220.3 million in the nine months ended
September 30, 2002. As a percentage of net sales, gross profit decreased to
53.3% in the first nine months of 2003 from 56.4% in the comparable period of
2002. The decrease as a percentage of net sales is primarily due to
significantly discounted product sales resulting from a special, one-time
inventory reduction promotion that occurred in the third quarter of 2003.
Approximately $2.5 million of non-recurring costs related to redundant labor and
inventory write-offs for the new international manufacturing entities is
included in cost of goods sold for the nine months ended September 30, 2003.
Selling expense increased slightly to $72.7 million in the nine months ended
September 30, 2003 from $72.6 million in the comparable period of 2002. As a
percentage of net sales, selling expense decreased to 17.1% as of the nine
months ended September 30, 2003 from 18.6% in the comparable period of 2002. The
decrease as a percentage of sales is primarily due to the cost and timing of
accruals for sales events such as the Company's annual Seminar and decrease in
estimated Director bonuses and royalty expense as a result of lower
commissionable sales over the comparable period as a percentage of total net
sales. These decreases were partially offset by increased expenses related to
the newly acquired subsidiaries during the comparable nine-month periods.
19
Freight, warehouse and distribution expense increased $10.0 million, or
22.5%, to $54.4 million in the nine months ended September 30, 2003 from $44.4
million in the nine months ended September 30, 2002. These costs were 12.8% of
net sales in the 2003 period, as compared to 11.4% in the comparable 2002
period. This increase in freight, warehouse and distribution expense as a
percentage of sales was primarily due to the increase in facility related
expenses and freight, labor and warehouse supplies as a result of the 8.3%
increase in the number of orders shipped over the comparable period of 2002.
General and administrative expense increased $9.7 million, or 24.2%, to
$50.0 million in the nine months ended September 30, 2003, from $40.3 million in
the nine months ended September 30, 2002. The increase consists primarily of a
$2.1 million increase in depreciation and amortization expense, $1.5 million
related to additional facility related expenses, $1.1 million increase in
professional fees, $0.6 million increase in employee related expenses, $0.6
million related to bad debt expense and $3.1 million related to additional
subsidiary operating expenses primarily as a result of the newly acquired
companies. Included in general and administrative expense are certain additional
non-recurring costs related to excess facilities, uncapitalizable fees related
to the implementation of the new JD Edwards computer system and corporate
organizational realignment expenses. These costs were approximately $2.7 million
and $2.0 million for the nine months ended September 30, 2003 and 2002,
respectively.
Loss on debt restructure of $7.2 million in the nine months ended September
2002 was a result of the write-off of $3.3 million of unamortized debt issuance
costs and $3.9 million of fees paid to creditors related to the debt restructure
in July 2002.
Stock option expense of approximately $3.2 million was recorded in the nine
months ended September 30, 2003, as compared to $107,000 in the comparable 2002
period related to compensation expense on performance-based options issued under
the 2002 Key Employee Stock Option Plan.
Interest expense increased $0.3 million to $20.6 million in the nine months
ended September 30, 2003, from $20.3 million in the nine months ended September
30, 2002. The increase in interest expense is primarily related to the
accelerated interest payments made in regards to the mandatory prepayment of
debt in April 2003.
Income taxes decreased $6.4 million to $6.4 million in the nine months ended
September 30, 2003 from $12.8 million in the comparable period of 2002. Due to a
favorable state income tax audit determination of $5.8 million in the third
quarter of 2003, income taxes, as a percentage of income before income taxes,
was 24.9% in the nine months ended September 30, 2003, as compared to 37.0% in
the nine months ended September 30, 2002. The Company believes that the
effective income tax rate for the year ended December 31, 2003 will be slightly
higher than the effective income tax rate for the nine-month period ended
September 30, 2003.
SEGMENT PROFITABILITY
The Company's reportable segments include its domestic and international
direct sales operations and Domistyle. The manufacturing operations are part of
the Domistyle segment, which sells the majority of its products to the Company.
As a result, Domistyle sales generally follow the Company's domestic sales
trend. International operations include direct sales by Displayers in Mexico,
Canada and Puerto Rico. International direct sales are directly attributable to
the number of international Displayers the Company has selling its products. The
Company evaluates the performance of its segments and allocates resources to
them based on net income before interest, taxes, the effects of Staff Accounting
Bulletin No. 101, depreciation and amortization, reorganization costs, non-cash
expense for stock options, losses on debt restructure, losses on disposition of
assets and other income and expense ("EBITDA"). The Company also uses EBITDA, as
defined, as a performance measure due to the Company's required compliance
thresholds for covenants contained in the Company's Senior Credit Facility. See
Note 7 to the Company's Consolidated Financial Statements included herein for a
reconciliation of net income to EBITDA, as defined.
THE THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2002
Consolidated net sales increased $21.6 million, or 17.2%, to $147.3 million
in the three months ended September 30, 2003, from $125.7 million in the
comparable 2002 period. Consolidated EBITDA, as defined, decreased $7.9 million,
or 37.1%, to $13.5 million in the quarter ended September 30, 2003 from $21.4
million in the three months ended September 30, 2002. See discussion in "Results
of Operations."
20
DIRECT SELLING
Domestic
Domestic net sales to non-affiliates and affiliates increased $8.5 million,
or 7.2% to $127.7 million from $119.2 million in the previous year. Of this
increase, sales to affiliates increased by $1.6 million or 35.7% to $6.0 million
in the three months ended September 30, 2003 from $4.4 million in the comparable
2002 period. The primary sales drivers for non-affiliate sales are average order
size, Displayer productivity and number of active Displayers. Domestic EBITDA,
as defined, decreased $8.4 million or 77.4% to $2.5 million in the quarter ended
September 30, 2003 as compared to $10.9 million in 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 $8.5 million, or 100.4%, to $17.1 million in the three
months ended September 30, 2003, from $8.6 million in the three months ended
September 30, 2002. This increase is primarily due to the increase in the
Displayer base in Mexico and Canada. As of September 30, 2003, the Displayer
base was approximately 22,400, 1,000 and 600 in Mexico, Canada and Puerto Rico,
respectively as compared to 13,600, 600 and 400 in the comparable period of
2002. EBITDA, as defined, related to International direct sales increased $0.3
million, or 43.3%, to $1.1 million in the quarter ended September 30, 2003 as
compared to $0.8 million in the quarter ended September 30, 2002.
DOMISTYLE
The Company is in the process of growing its wholesale supply sales to
non-affiliate resellers through Domistyle. Sales to non-affiliate resellers for
the three-month period increased $6.1 million or 253.1% to $8.5 million as
compared to $2.4 million in the comparable period of 2002. Of these sales, 52.9%
or $4.5 million were generated by the previously-described newly acquired
companies and their existing customer base. EBITDA, as defined, generated
through Domistyle increased $1.0 million or 10.1% to $11.0 million in the three
months ended September 30, 2003 from $10.0 million in the comparable period of
2002.
THE NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2002
Consolidated net sales increased $34.2 million, or 8.8%, to $424.6 million
in the nine months ended September 30, 2003, from $390.4 million in the
comparable 2002 period. Consolidated EBITDA, as defined, decreased $7.6 million,
or 9.9%, to $69.0 million in the nine months ended September 30, 2003 from $76.6
million in the nine months ended September 30, 2002. See discussion in "Results
of Operations."
DIRECT SELLING
Domestic
Domestic net sales to non-affiliates and affiliates increased $16.2 million,
or 4.4% to $387.4 million from $371.2 million in the previous year. Of this
increase, sales to affiliates increased by $12.1 million or 98.9% to $24.3
million in 2003 from $12.2 million in the comparable 2002 period. The primary
sales drivers for non-affiliate sales are average order size, Displayer
productivity and number of active Displayers. Domestic EBITDA, as defined,
decreased $5.3 million or 13.4% to $34.7 million in the nine months ended
September 30, 2003 from $40.0 million in 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 $17.2 million, or 70.1%, to $41.6 million in the nine
months ended September 30, 2003, from $24.4 million in the nine months ended
September 30, 2002. This increase is primarily due to the increase in the
Displayer base in Mexico and Canada. EBITDA, as defined, related to
International direct sales increased $1.4 million, or 49.9%, to $4.2 million in
the nine months ended September 30, 2003 as compared to $2.8 million in the nine
months ended September 30, 2002.
21
DOMISTYLE
The Company is in the process of growing its wholesale supply sales to
non-affiliate resellers through Domistyle. Sales to non-affiliate resellers for
the nine-month period increased $12.9 million or 185.9% to $19.8 million as
compared to $6.9 million in the comparable period of 2002. Of these sales, 53.0%
or $10.5 million were generated by the previously-described newly acquired
companies and their existing customer base. EBITDA, as defined, generated
through Domistyle decreased $2.0 million or 5.7% to $33.5 million in the nine
months ended September 30, 2003 from $35.5 million in the comparable period of
2002 primarily due to product and pricing inefficiencies incurred during the
integration period.
SEASONALITY
The Company's business is influenced by the Christmas holiday season and by
promotional events. Historically, a higher portion of the Company's sales and
net income have been realized during the fourth quarter, and net sales and net
income have generally been slightly lower during the first quarter as compared
to the second and third quarters. Working capital requirements also fluctuate
during the year. They reach their highest levels during the third and fourth
quarters as the Company increases its inventory for the peak season. In addition
to the Company's peak season fluctuations, quarterly results of operations may
fluctuate depending on the timing of, and amount of sales from, discounts,
incentive promotions and/or the introduction of new products. As a result, the
Company's business activities and results of operations in any quarter are not
necessarily indicative of any future trends in the Company's business.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents decreased $49.6 million to $14.5
million as of September 30, 2003, from $64.1 million at December 31, 2002. The
decrease resulted from a use of cash of $8.2 million, $23.7 million and $17.7
million for operating, investing and financing activities, respectively.
Net cash used in operating activities increased $12.9 million during the
nine months ended September 30, 2003, as compared to the nine months ended
September 30, 2002. The majority of the increase in funds used is attributable
to a $6.8 million decrease in royalties payable due to lower commissionable
sales, an $8.1 million decrease in the Seminar accrual and incentive payable due
to timing of incentive promotions, a $4.6 million increase in accounts
receivable, a $7.2 million decrease in cash related to a loss on debt
restructure and a $3.7 million decrease in the reserve for obsolete inventory.
These uses of cash were offset in part by a decrease in inventory of $11.7
million and an increase in income taxes payable of $6.0 million.
In the last nine months, the reserve for obsolete inventory was reduced due
to the depletion of certain obsolete inventory, which was accrued for in
December 2002. In addition, inventory balances have grown during the nine-month
period ended September 30, 2003 due to the continued introduction of new
products as well as the inventory balances related to the new acquisitions
during 2003.
Net cash used in investing activities increased $15.1 million in the nine
months ended September 30, 2003 as compared to the nine months ended September
30, 2002. Purchases of property, plant and equipment in the nine months ended
September 30, 2003 totaled $10.9 million, as compared to $9.2 million in the
nine months ended September 30, 2002. In addition, approximately $13.5 million
was a result of the acquisitions of the new manufacturing entities in Mexico and
New Jersey.
Net cash used in financing activities increased $42.1 million in the nine
months ended September 30, 2003, as compared to the nine months ended September
30, 2002. This change was primarily as a result of proceeds of $35.0 million of
additional debt issued in July 2002, $4.1 million of debt issuance costs related
to that issuance, timing of principal payments due under the Senior Credit
Facility, capital leases and other debt and a mandatory prepayment of $12.4
million made on March 31, 2003.
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
December 31, 2004. The Revolving Loans were not utilized during the first nine
months of 2003 or 2002. As of November 6, 2003, there was not an outstanding
balance on the Revolving Loans.
The Company paid a total of $28.3 million in debt service for the nine
months ended September 30, 2003, consisting of principal payments under the
Senior Credit Facility of $15.5 million, interest under the Senior Credit
Facility of approximately $5.2 million, interest of $0.1 million on commitment
fees and $7.5 million of interest on the Notes. Principal and interest payments
of $4.3 million
22
on the Senior Credit Facility were paid after the end of the third quarter of
2003 on September 30, 2003, after the Company's quarter end on September 27,
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,
maximum leverage ratios, capital expenditure measurements and minimum thresholds
based on EBITDA, as defined in the Senior Credit Facility. 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 made a $12.4
million prepayment of interest and principal on March 31, 2003.
As of November 6, 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 failure to comply with any such
covenants could cause a default under the Company's Senior Credit Facility. A
default, if not waived, could result in an acceleration of the indebtedness
under the Company's Senior Credit Facility. There can be no assurance that the
Company could refinance its indebtedness on commercially reasonable terms, if at
all. Any failure to do so could impair liquidity and cause a material adverse
effect on the Company's business and results of operations.
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.
MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
The Company is selling its Products in both Mexico and Canada. In addition,
certain products are beginning to be manufactured in Mexico for sale in the U.S.
Mexico, Canada and Puerto Rico. This subjects 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. During the last
nine-month period, there has been a decline in the Mexican Peso and an increase
in the Canadian Dollar. This natural hedge has created an offset such that
Company operations have not been significantly affected. However, as sales to
and in Mexico increase, a continued decrease in the Peso could lead to depressed
sales and operational profitability. The Company is closely monitoring the
situation and expects to use financial instruments, when appropriate, to
mitigate the risk. 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. As of November 6, 2003, 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 May of 2003, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity' ("SFAS No.
150"). SFAS No. 150 establishes standards for classification and measurement of
financial instruments issued by entities that have the characteristics of both
liabilities and equity. SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003. The Company adopted SFAS No. 150 on
May 31, 2003 and there was not a financial accounting impact associated with its
adoption.
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.
23
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 adopted the remaining
provisions of SFAS No. 149 on June 30, 2003 and there was not a financial impact
associated with its adoption.
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. The Company is
currently evaluating the change to the fair value based method of accounting for
stock-based employee compensation.
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 on 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.
ITEM 4. CONTROLS AND PROCEDURES
Based on their evaluation of the Company's disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the "Exchange Act")), the Company's principal
executive and principal financial officers concluded that the Company's
disclosure controls and procedures were effective as of September 30, 2003.
There has been no change in the Company's internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)
that occurred during the Company's fiscal quarter ended September 30, 2003, that
has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
24
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the ordinary course of its business, the Company is from time to time
threatened with or named as a defendant in various lawsuits, including product
liability claims. The Company is also subject to certain environmental
proceedings. The Company is not currently a party to any material litigation or
proceeding, and is not aware of any litigation or proceeding threatened against
it that could have a material adverse effect on the Company's business,
financial condition or results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
10.1* Separation Agreement and Release between the Company and Nora I.
Serrano, entered into and effective as of August 15, 2003.
31.1* Certification of Chief Executive Officer of the Company pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2* Certification of Chief Financial Officer of the Company pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1* Certification of Chief Executive Officer of the Company pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2* Certification of Chief Financial Officer of the Company pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) REPORTS ON FORM 8-K
None.
- ----------
*Filed herewith.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
HOME INTERIORS & GIFTS, INC.
By: /s/ KENNETH J. CICHOCKI
-----------------------
Kenneth J. Cichocki
Sr. Vice President of Finance and Chief
Financial Officer (principal financial and
accounting officer)
Date: November 6, 2003
26
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
10.1* Separation Agreement and Release between the Company and Nora I.
Serrano, entered into and effective as of August 15, 2003.
31.1* Certification of Chief Executive Officer of the Company pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2* Certification of Chief Financial Officer of the Company pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1* Certification of Chief Executive Officer of the Company pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2* Certification of Chief Financial Officer of the Company pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
- ----------
*Filed herewith.
27