<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
---------------
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
---------------
COMMISSION FILE NO. 333-62021
HOME INTERIORS & GIFTS, INC.
(Exact name of registrant as specified in its charter)
TEXAS 75-0981828
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4550 SPRING VALLEY ROAD
DALLAS, TEXAS 75244
(Address of principal executive offices) (Zip Code)
(972) 386-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirement for the past 90 days. Yes [X] No [ ]
As of November 8, 1999, the registrant had outstanding 15,240,218 shares of
its common stock, $0.10 par value per share.
===============================================================================
<PAGE> 2
HOME INTERIORS & GIFTS, INC.
INDEX
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Unaudited Interim Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1998 and
September 30, 1999 ........................................................ 3
Consolidated Statements of Operations and Comprehensive Income
For the three months and nine months ended September 30, 1998 and 1999 .... 4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 1998 and 1999 ............................................... 5
Notes to Unaudited Interim Consolidated Financial Statements ................. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .......................................... 11
PART II - OTHER INFORMATION
Item 1. Legal proceedings ..................................................... 21
Item 5. Other Information ..................................................... 21
Item 6. Exhibits and Reports on Form 8-K ...................................... 21
</TABLE>
2
<PAGE> 3
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND SEPTEMBER 30, 1999
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
<TABLE>
<CAPTION>
ASSETS
DECEMBER 31, SEPTEMBER 30,
1998 1999
------------ -------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents ............................................... $ 41,024 $ 24,124
Accounts receivable, net ................................................ 7,975 13,016
Inventories ............................................................. 31,010 42,651
Deferred income tax benefit ............................................. 2,164 2,389
Other current assets .................................................... 1,040 2,517
--------- ---------
Total current assets ............................................ 83,213 84,697
Property, plant and equipment, net ........................................ 21,774 29,539
Investments ............................................................... 1,667 1,805
Debt issuance costs, net .................................................. 19,132 16,705
Other assets .............................................................. 6,662 1,405
--------- ---------
Total assets .................................................... $ 132,448 $ 134,151
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable ........................................................ $ 13,119 $ 10,541
Accrued seminars and incentive awards ................................... 12,422 14,375
Royalties payable ....................................................... 6,922 6,514
Hostess prepayments ..................................................... 8,719 9,328
Income taxes payable .................................................... 4,101 1,055
Accrued compensation .................................................... 3,606 5,167
Current maturities and prepayment of long-term debt ..................... 33,723 25,929
Other current liabilities ............................................... 9,949 14,438
--------- ---------
Total current liabilities ....................................... 92,561 87,347
Long-term debt, net of current maturities ................................. 453,277 434,546
Deferred income tax liability and other ................................... 176 251
--------- ---------
Total liabilities ............................................... 546,014 522,144
--------- ---------
Minority interest ......................................................... 508 2,809
Commitments and contingencies
Shareholders' deficit:
Common stock, par value $0.10 per share, 75,000,000 shares
authorized, 15,234,422 and 15,240,218 shares issued and outstanding,
respectively ........................................................... 1,523 1,524
Additional paid-in capital .............................................. 178,944 179,913
Accumulated deficit ..................................................... (594,314) (572,306)
Cumulative translation adjustment ....................................... (227) 67
--------- ---------
Total shareholders' deficit ..................................... (414,074) (390,802)
--------- ---------
Total liabilities and shareholders' deficit ..................... $ 132,448 $ 134,151
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 4
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME FOR THE THREE MONTHS AND NINE
MONTHS ENDED SEPTEMBER 30, 1998 AND 1999
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1998 1999 1998 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net sales .............................................. $ 111,132 $ 112,075 $ 347,205 $ 355,057
Cost of goods sold ..................................... 54,571 55,208 170,658 172,199
--------- --------- --------- ---------
Gross profit ........................................... 56,561 56,867 176,547 182,858
Selling, general and administrative:
Selling .............................................. 18,313 20,594 59,645 62,955
Freight, warehouse and distribution .................. 10,417 11,785 31,642 35,419
General and administrative ........................... 5,401 6,309 16,215 18,921
Gains on the sale of assets .......................... (1,170) (3) (6,349) (3)
Stock option expense ................................. 329 102 329 850
Recapitalization expenses ............................ -- -- 6,198 --
--------- --------- --------- ---------
Total selling, general and administrative ....... 33,290 38,787 107,680 118,142
--------- --------- --------- ---------
Operating income ....................................... 23,271 18,080 68,867 64,716
Other income (expense):
Interest income ...................................... 565 455 4,841 1,824
Interest expense ..................................... (12,422) (11,018) (15,913) (33,342)
Other, net ........................................... 649 419 1,027 313
--------- --------- --------- ---------
Other income (expense), net ..................... (11,208) (10,144) (10,045) (31,205)
--------- --------- --------- ---------
Income before income taxes ............................. 12,063 7,936 58,822 33,511
Income taxes ........................................... 4,776 888 23,346 11,503
--------- --------- --------- ---------
Net income ............................................. 7,287 7,048 35,476 22,008
Other comprehensive income (loss) before tax:
Cumulative translation adjustment .................... -- 76 (34) 294
Unrealized losses on investments ..................... -- -- (1,074) --
--------- --------- --------- ---------
Other comprehensive income (loss) before tax .... -- 76 (1,108) 294
Income tax benefit related to items of other
comprehensive income ................................. -- -- 376 --
--------- --------- --------- ---------
Other comprehensive income, net of tax ............... -- 76 (732) 294
--------- --------- --------- ---------
Comprehensive income ................................... $ 7,287 $ 7,124 $ 34,744 $ 22,302
========= ========= ========= =========
EBITDA ................................................. $ 23,301 $ 19,247 $ 71,413 $ 68,446
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 5
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1999
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
1998 1999
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income ...................................................... $ 35,476 $ 22,008
--------- ---------
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ................................. 2,368 2,883
Amortization of debt issuance costs ........................... 1,124 2,427
Provision for doubtful accounts ............................... 589 635
Gains on the sale of assets ................................... (6,349) (3)
Stock option expense .......................................... 329 850
Realized gains on investments ................................. (203) --
Equity in earnings of an affiliate ............................ -- (138)
Deferred tax expense (benefit) ................................ 138 (150)
Changes in assets and liabilities:
Accounts receivable ........................................... (2,677) (6,946)
Inventories ................................................... (11,606) (11,641)
Other current assets .......................................... (63) (1,477)
Other assets .................................................. 11 359
Accounts payable .............................................. 7,038 (2,578)
Income taxes payable .......................................... 3,132 (3,046)
Prepaid sales orders .......................................... 6,477 --
Other current liabilities ..................................... 18,155 8,165
--------- ---------
Total adjustments ........................................ 18,463 (10,660)
--------- ---------
Net cash provided by operating activities ................ 53,939 11,348
--------- ---------
Cash flows from investing activities:
Purchases of investments ........................................ (87,581) --
Proceeds from the sale of investments ........................... 154,568 --
Purchases of property, plant and equipment ...................... (6,227) (8,644)
Purchases of property, plant and equipment by minority
owner of Laredo Candle ...................................... -- (1,925)
Payments received on notes receivable ........................... 1,619 6,131
Proceeds from the sale of property, plant and equipment ......... 7,700 --
--------- ---------
Net cash provided by (used in) investing activities ...... 70,079 (4,438)
--------- ---------
Cash flows from financing activities:
Dividends paid .................................................. (9,554) --
Proceeds from the issuance of Company common stock .............. 182,557 120
Purchase of treasury stock ...................................... (827,557) --
Proceeds from the issuance of the Notes ......................... 200,000 --
Proceeds from borrowings under the Senior Credit Facility ....... 300,000 --
Debt issuance costs ............................................. (21,118) --
Recapitalization fees and expenses .............................. (3,215) --
Capital contribution from Laredo Candle minority owner .......... -- 2,301
Payments under the Senior Credit Facility ....................... (6,500) (26,525)
--------- ---------
Net cash used in financing activities .................... (185,387) (24,104)
--------- ---------
Effect of cumulative translation adjustment ....................... (34) 294
--------- ---------
Net decrease in cash and cash equivalents ......................... (61,403) (16,900)
Cash and cash equivalents at beginning of year .................... 104,262 41,024
--------- ---------
Cash and cash equivalents at end of period ........................ $ 42,859 $ 24,124
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE> 6
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BACKGROUND
Home Interiors & Gifts, Inc., together with its subsidiaries (the
"Company"), is a direct seller of home decorative accessories using the "party
plan" method whereby its non-employee, independent sales representatives
("Displayers") conduct shows in the homes of potential customers. The Company
believes that the party plan method provides a comfortable environment where the
unique benefits and attributes of the Company's products can be demonstrated in
a more effective manner than the typical retail setting.
The Company has been located in Dallas, Texas since its inception in
1957. The Company manufactures approximately one-third of its products and
purchases the remainder of its product line from a select number of independent
suppliers, most of whom sell their products exclusively to the Company. The
Company expanded its operations internationally in 1995. Revenue from
international operations is not significant.
The following is a brief description of the Company's subsidiaries,
each of which is wholly-owned except as indicated:
o Dallas Woodcraft, Inc. ("DWC") manufactures framed art work and mirrors
using custom-designed equipment
o GIA, Inc. ("GIA") and Homco, Inc. ("Homco") manufacture various types of
molded plastic products using custom-designed equipment
o Laredo Candle Company, L.L.P. ("Laredo Candle"), which is owned 60% by the
Company, began manufacturing candles in the third quarter of 1999 and
commenced shipments in October 1999
o Subsidiaries in Mexico and Puerto Rico provide sales support services to
the international Displayers
2. SIGNIFICANT ACCOUNTING POLICIES
The Company maintains its accounting records and prepares financial
statements on the accrual basis of accounting, which conforms with generally
accepted accounting principles. Following these principles, management makes
estimates and assumptions that affect the amounts reported in the financial
statements and notes. Actual results may differ from these estimates.
These consolidated financial statements include the accounts of the
Company. All significant intercompany accounts and transactions have been
eliminated. The Company records sales and related expenses on a weekly basis
ending on each Saturday and every quarter consists of thirteen weeks. The last
days of the quarter ended September 30, 1998 and 1999 in the accompanying
unaudited consolidated financial information were October 3, 1998 and October 2,
1999, respectively.
The consolidated financial information as of September 30, 1999 and for
the three months and nine months ended September 30, 1998 and 1999 is unaudited.
In the opinion of management, the accompanying unaudited consolidated financial
information and related notes thereto contain all adjustments consisting only of
normal, recurring adjustments, necessary to present fairly the Company's
consolidated financial position as of September 30, 1999, operating results and
comprehensive income for the three months and nine months ended September 30,
1998 and 1999, and cash flows for the nine months ended September 30, 1998 and
1999. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been omitted pursuant to the rules and regulations of the
Securities and Exchange Commission. The results of operations for the periods
presented are not necessarily indicative of the results to be expected for the
full year.
Certain reclassifications have been made to prior years' balances to
conform with current year presentation.
6
<PAGE> 7
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
3. THE RECAPITALIZATION
The Company completed a recapitalization (the "Recapitalization") on
June 4, 1998 through the following simultaneous transactions:
o contribution of $182.6 million by Hicks, Muse, Tate & Furst Incorporated
("Hicks Muse") in exchange for 10,111,436 shares of the common stock, or
approximately 66% of all outstanding shares upon completion of the
Recapitalization
o issuance of $200.0 million of senior subordinated notes (the "Notes")
o borrowing of $300.0 million under a $340.0 million senior credit facility
(the "Senior Credit Facility")
o use of the above proceeds, together with available cash of $169.3 million,
to:
o redeem 45,836,584 shares of common stock for $827.6 million
o pay fees and expenses of $24.3 million associated with the
Recapitalization consisting of:
=> $11.2 million financial advisory fee paid to Hicks Muse for its
role in obtaining financing for the Recapitalization
=> $11.6 million of debt issuance costs paid primarily to the bank
syndicate group for the Senior Credit Facility and the initial
purchasers of the Notes
=> $1.5 million of legal and accounting fees
The Company allocated the Hicks Muse financial advisory fee and the
legal and accounting fees on a proportionate basis to the debt and equity
financing for the Recapitalization. Accordingly, the Company allocated $9.5
million to debt issuance costs and $3.2 million to additional paid-in capital.
The total debt issuance costs of $21.1 million are being amortized using the
effective interest method over the term of the related indebtedness.
In addition to the $24.3 million of fees and expenses related to the
Recapitalization, the Company paid additional financial advisory and legal fees
of approximately $6.2 million in connection with the Recapitalization. The
Company paid its financial advisor approximately $5.7 million to assist with the
development of strategic alternatives, identify potential buyers, evaluate
proposals and assist in the negotiation of the Hicks Muse offer. These financial
advisory and legal fees were expensed as incurred in the three months ended June
30, 1998.
As a result of the Recapitalization, the issued and outstanding shares
of common stock decreased to 15,231,652 shares as of June 4, 1998, all treasury
stock was retired and Hicks Muse acquired a controlling interest in the Company.
4. NEW WAREHOUSE AND DISTRIBUTION FACILITY
The Company is currently operating in and from several separate
warehouse and distribution facilities. On July 19, 1999 the Company entered into
a contract with Argent Frankford L.P. ("Argent") to construct a new 660,000
square-foot warehouse and distribution facility in Carrollton, Texas for
approximately $19.4 million. The Company expects to incur an additional $3.1
million in customized improvements to prepare the facility for occupancy.
Construction is proceeding on schedule and the Company expects to occupy the
facility in the second quarter of 2000. In the event the sale transactions
described below are not consummated and the Company is unable to purchase the
facility, the Company is obligated to enter into a long-term lease agreement
with Argent upon completion of construction.
The new warehouse and distribution facility will allow the Company to
consolidate its current warehouse and distribution operation from several
smaller facilities into a single larger facility. Among other things, the
Company anticipates that it will benefit from reduced labor and inventory costs
and property tax savings. Additionally, the new facility will allow the Company
to utilize an automated order fulfillment system, which the Company expects will
result in additional labor savings. The Company is working with a consultant to
assist in the design layout of the facility and the implementation of an
automated order fulfillment system. The automated order
7
<PAGE> 8
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
fulfillment system will include a new conveyor system, special racks and storage
bins, and a warehouse management software system. The Company has selected a
vendor to provide the warehouse management system, and is currently in the
process of negotiating an agreement with the vendor for the purchase,
installation and ongoing support of the system. The Company expects that its
automation related costs will be approximately $11.0 million. A small portion of
these costs will be incurred in late 1999 and the remainder will be incurred
throughout 2000 as the Company transitions from its current warehouse and
distribution facilities to its new facility. The Company expects to continue to
use its current distribution system until the automated system is fully
operational.
Concurrently with the transaction described above, the Company entered
into an exchange transaction with Parker Equities Inc. ("Parker") to sell to
Parker for $15.7 million, net of commissions and closing costs, substantially
all of the Company's owned properties and facilities in the Dallas area,
including all of its warehouse and distribution facilities and its corporate
headquarters. The Company is responsible for approximately $1.0 million of roof
replacement costs, which will reduce the net proceeds to the Company from the
sale. The Company plans to close the transaction on or before December 1, 1999
subject to certain customary terms and conditions. At closing, the Company
intends to enter into several separate lease agreements to lease back all of its
properties and facilities until the Company's new facilities are ready for
occupancy. The lease terms will vary in length based on a predetermined schedule
of facility closings between April 2000 and August 2000.
The Company expects that the process of selling its current facilities
and properties in exchange for purchasing a new facility and property will
qualify as a Section 1031 Tax-Free Exchange under the United States Internal
Revenue Code of 1986, as amended. The Company anticipates there will be a
pre-tax gain of approximately $10.0 million on the sale of its properties and
facilities for financial reporting purposes.
The transactions described above require the consent of the Company's
senior lenders, which the Company anticipates will be obtained in a timely
manner. The Company has requested an amendment to the Senior Credit Facility to
exclude these transactions from certain debt covenant requirements.
5. CORPORATE HEADQUARTERS FACILITY
The Company has negotiated a ten-year lease for a new corporate
headquarters location in Dallas. This facility consists of approximately 75,000
square feet of office space for annual rent of approximately $1.7 million.
Tenant improvements to customize the space are expected to be approximately $4.6
million, of which approximately $2.0 million will be borne by the landlord as
improvement allowances. The remaining $2.6 million will be borne by the Company.
The Company expects to move into its new headquarters facility in late 1999 or
early 2000.
6. INVENTORIES
Inventories consisted of the following as of December 31, 1998 and
September 30, 1999 (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1998 1999
------------ -------------
(UNAUDITED)
<S> <C> <C>
Raw materials .......................... $ 6,134 $ 6,569
Work in process ........................ 1,742 2,007
Finished goods ......................... 23,134 34,075
-------- --------
$ 31,010 $ 42,651
======== ========
</TABLE>
8
<PAGE> 9
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
7. OTHER CURRENT LIABILITIES
Other current liabilities consisted of the following as of December 31,
1998 and September 30, 1999 (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1998 1999
------------ -------------
(UNAUDITED)
<S> <C> <C>
Interest payable ....................... $ 2,959 $ 7,911
Employee benefit plan contributions .... 2,264 1,251
Sales taxes payable .................... 1,871 1,839
Other current liabilities .............. 2,855 3,437
------- -------
$ 9,949 $14,438
======= =======
</TABLE>
8. LONG TERM DEBT
Interest rates for the Senior Credit Facility are based on borrowings
entered into on varying dates. Long-term debt consisted of the following as of
September 30, 1999 (in thousands):
<TABLE>
<CAPTION>
INTEREST APPLICABLE ADJUSTED
AMOUNT RATE MARGIN RATE
--------- -------- ---------- --------
<S> <C> <C> <C> <C>
Senior Credit Facility:
Tranche A Loan:
3 month borrowings ..... $ 85,000 5.50% 1.50% 7.00%
3 month borrowings ..... 79,254 5.51% 1.50% 7.01%
Tranche B Loan:
12 month borrowings .... 96,221 5.02% 2.00% 7.02%
---------
260,475
Notes ....................... 200,000 10.125% -- --
---------
460,475
Less current maturities ..... (25,929)
---------
$ 434,546
=========
</TABLE>
Interest Rate Swap Agreements
The Company is exposed to financial market risks, including changes in
interest rates. To mitigate risks on changes in interest rates, the Company
utilizes derivative financial instruments. The Company does not use derivative
financial instruments for speculative or trading purposes.
In July 1998, the Company entered into an interest rate swap agreement
to limit the effect of changes in interest rates on long-term borrowings. Under
the swap, the Company pays interest at 5.50% on a notional amount of $75.0
million and receives interest thereon at three-month LIBOR on a quarterly basis.
Beginning June 9, 1999, if LIBOR is greater than 6.44% at the commencement of
any quarterly reset period, a knockout provision provides for no payment under
the swap during such period. The knockout provision is separately adjusted to
market on a quarterly basis. The Company recorded a $0.5 million loss in the
nine months ended September 30, 1999 as a result of the knockout provision
market adjustment.
9
<PAGE> 10
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
In September 1999, the Company entered into three separate six month
interest rate swap agreements to limit the effect of changes in interest rates
on long-term borrowings. Under each swap agreement, the Company pays interest at
a fixed LIBOR rate on the notional amount and receives interest thereon at
three-month LIBOR on a quarterly basis. The lenders have the option at the end
of the term of each swap agreement to extend each agreement for an additional
six month period. The following table summarizes the terms of these new interest
rate swap agreements (in thousands):
<TABLE>
<CAPTION>
Effective Date Maturity Date Notional Amount Fixed LIBOR Rate
-------------- ------------- --------------- ----------------
<S> <C> <C> <C>
09/30/99 03/30/00 $ 70,000 5.80%
11/30/99 05/30/00 $ 50,000 5.80%
12/03/99 06/05/00 $ 15,000 5.90%
</TABLE>
9. INCOME TAXES
The Company's effective income tax rate for the three months and nine
months ended September 30, 1999 was impacted by certain prior year income tax
provision adjustments. These adjustments primarily related to a prior year tax
refund applied in the 1999 period and costs associated with the
Recapitalization. The Company expects that its effective income tax rate for the
nine months ended September 30, 1999 will be consistent with its effective
income tax rate for the year ended December 31, 1999.
10. NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The new standard is effective for quarters
and fiscal years beginning after June 15, 2000. The Company has not yet
determined the effect the new standard will have on its financial statements.
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the Company's consolidated financial statements and accompanying notes as
of and for the year ended December 31, 1998, included in its Form 10-K. Unless
otherwise mentioned, all references to the number of Displayers, number of
orders shipped, and average order size relate to domestic sales activity only.
COMPANY BACKGROUND
The Company believes it is the largest direct seller of home decorative
accessories in the United States, as measured by sales. The Company's sales are
dependent upon the number of Displayers selling the Company's products and
Displayer productivity. Displayer productivity is measured in terms of orders
shipped and average order size, both of which fluctuate from time to time based
on the implementation and timing of discounts and new incentive programs,
seasonality and recruiting activity.
To stimulate sales, the Company offers a variety of discounts and
incentives to Displayers. The amount and type of discounts and incentives vary
from year to year and throughout each year, but are generally consistent over
any given quarterly period. The cost of discounts is reflected in the Company's
net sales while the cost of incentives is reflected in selling expense.
Primarily because of the nature of the direct selling industry, and as
a result of numerous general and economic factors, the Company experienced
average annual Displayer turnover of approximately 40% during the last three
years. The Company believes that new Displayers are generally among the least
productive Displayers and that the majority of Displayers who terminate their
status as Displayers in any particular year are Displayers recruited in that
year or in the immediately preceding year. The Company's ability to maintain its
sales volume and to achieve growth depends upon its ability to attract, train
and retain a significant number of new Displayers each year.
The Company revised its recruiting and training criteria in early 1999.
Among other things, the Company increased opportunities for new Displayers by
reducing start-up costs and lowering certain other barriers to entry. These
changes resulted in a significant increase in the number of new Displayers. The
Company recruited approximately 42,400 new Displayers during the nine months
ended September 30, 1999, which was more than the number recruited during the
entire year in 1998. Although the Displayer base grew from 52,800 as of December
31, 1998 to 92,800 as of September 30, 1999, many of the new Displayers were not
considered active because they had not placed their first order. To be
considered an active Displayer, the Displayer must have placed an order within
the 14 prior weeks. Active Displayers totaled 63,500 as of September 30, 1999,
up 26.7% from 50,100 as of December 31, 1998, and up 38.9% from 45,700 as of
September 30, 1998.
In connection with the recent growth in recruiting, the Company lowered
its minimum order requirement in June 1999, and as a result, experienced a
significant decline in average order sizes. The Company is continuing to
evaluate the impact the lower minimum order requirement is having on its
business; however, the Company expects that the higher operating costs
experienced during the second and third quarters will continue through the
remainder of the year. In an effort to offset a portion of its higher operating
costs and to encourage larger orders sizes, in September 1999, the Company added
a handling charge to the smaller orders.
Historically, the Company has benefited from relatively stable gross
profit and operating profit margins. Once a product is introduced into the
Company's product line, the price at which the Company purchases the product
from its suppliers and the price at which the Company sells the product to
Displayers seldom changes. The Company has steadily improved its gross profit
margin since mid-1997, when the markup on all new products was increased. Prior
to that time, the Company seldom changed product markups. The Company believes
that further improvement in gross margin will occur during the remainder of 1999
until the new pricing structure is incorporated throughout its entire product
line. The Company experienced an unexpected decline in its gross margin in the
three months ended September 30, 1999, primarily due to significant
manufacturing inefficiencies. The Company expects that its operating profit
margins will decline slightly through the end of 1999 as compared to the related
1998 period primarily as a result of higher general and administrative costs and
the increased costs associated with processing and shipping more orders.
11
<PAGE> 12
The Company delivers its products to Displayers via common carrier and
a regional network of locally-based freight distributors ("Local Distributors").
Unlike many other direct sales companies that the Company believes charge their
customers shipping costs, the Company delivers its products to Displayers free
of charge if minimum order sizes are met. The Company realizes substantial cost
savings from volume discounts it receives from its common carriers and its use
of Local Distributors. The use of Local Distributors enables the Company to
avoid the premiums charged by common carriers for delivery to private
residences, which is where most Displayers receive their deliveries. In
addition, the Company believes that, as a result of its good relationships with
its common carriers and the Local Distributors, it is able to quickly deliver
its products with minimal shipping errors or product damage.
THE RECAPITALIZATION
The Company completed the Recapitalization on June 4, 1998 through the
following simultaneous transactions:
o contribution of $182.6 million by Hicks Muse in exchange for 10,111,436
shares of the common stock, or approximately 66% of all outstanding shares
upon completion of the Recapitalization
o issuance of $200.0 million of the Notes
o borrowing of $300.0 million under the Senior Credit Facility
o use of the above proceeds, together with available cash of $169.3 million,
to:
o redeem 45,836,584 shares of common stock for $827.6 million
o pay fees and expenses of $24.3 million associated with the
Recapitalization consisting of:
=> $11.2 million financial advisory fee paid to Hicks Muse for its
role in obtaining financing for the Recapitalization
=> $11.6 million of debt issuance costs paid primarily to the bank
syndicate group for the Senior Credit Facility and the initial
purchasers of the Notes
=> $1.5 million of legal and accounting fees
In addition to the $24.3 million of fees and expenses related to the
Recapitalization, the Company paid additional financial advisory and legal fees
of approximately $6.2 million in connection with the Recapitalization. The
Company paid its financial advisor approximately $5.7 million to assist with the
development of strategic alternatives, identify potential buyers, evaluate
proposals and assist in the negotiation of the Hicks Muse offer. These financial
advisory and legal fees were expensed as incurred during the three months ended
June 30, 1998.
RESULTS OF OPERATIONS
THE THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 1998
Net sales. Net sales increased $1.0 million, or 0.8%, to $112.1 million
in the three months ended September 30, 1999 from $111.1 million in the
comparable period in 1998. The number of orders shipped in the 1999 period
increased by 30.0%, which slightly offset a 22.8% decline in the average order
size. The decline in the average order size was primarily as a result of a lower
minimum order requirement implemented in June 1999 and growth in the Displayer
base that increased the percentage of less experienced, and therefore, less
productive Displayers. Growth in the Displayer base contributed to the increase
in the number of orders shipped in the 1999 period. The average number of active
Displayers increased to 62,500 in the three months ended September 30, 1999 from
45,400 in the comparable period in 1998. Orders shipped per active Displayer
decreased slightly. The Company expects that the trend of more orders shipped
and lower order sizes, each as compared to comparable historical periods, will
continue throughout 1999 as a result of the factors discussed above.
Additionally, the 1998 net sales were impacted negatively by an unusual
backlog of unfilled orders as of September 30, 1998. Sales are recognized when
products are shipped. The Company generally ships products to Displayers on the
same day orders are received. The Company received an unusually high volume of
orders during the final week of September 1998 in connection with a discount
program. The Company was unable to fill and ship all orders received during the
final week of September 1998, although all unfilled orders were shipped by the
following week. The backlog of unfilled orders totaled approximately $6.5
million and were reflected as sales when shipped the first week in October 1998.
If the Company had been able to fill and ship the backlog of unfilled orders
during the final week of September 1998, net sales of $112.1 million in the
three months ended September 30, 1999 would have decreased $5.5 million or $4.7%
from $117.6 million in the comparable period of 1998. The Company
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<PAGE> 13
believes that backlog is unusual to its business, and as a result, does not
expect any significant backlog in the near future.
Gross profit. Gross profit increased $0.3 million, or 0.5%, to $56.9
million in the three months ended September 30, 1999 from $56.6 million in the
comparable period in 1998. As a percentage of net sales, gross profit decreased
to 50.7% in the 1999 period from 50.9% in the 1998 period. The Company continued
to benefit from the introduction of new products with higher margins; however,
the Company experienced significant manufacturing inefficiencies in the 1999
period that resulted in a reduction in gross profit of approximately $1.4
million compared to the 1998 period. Most of the inefficiencies are related to
product mix, low production volumes and unexpected high amounts of scrap
material. While most of the manufacturing inefficiencies have been identified,
the Company expects that it may incur additional inefficiencies during the
remainder of the year, although to a lesser degree than those experienced in the
three months ended September 30, 1999.
Selling expense. Selling expense increased $2.3 million, or 12.5%, to
$20.6 million in the three months ended September 30, 1999 from $18.3 million in
the comparable period in 1998. As a percentage of net sales, selling expense
increased to 18.4% in the 1999 period from 16.5% in the 1998 period. This
increase was primarily attributable to higher incentive costs, an increased
number of meetings with sales field leadership (the "Directors"), and higher
commission rates for certain Unit Directors in the 1999 period. The increases in
these expenses more than offset a reduced bonus accrual for all Directors in the
1999 period.
Freight, warehouse and distribution expense. Freight, warehouse and
distribution expense increased $1.4 million, or 13.1%, to $11.8 million in the
three months ended September 30, 1999 from $10.4 million in the comparable
period in 1998. As a percentage of net sales, freight, warehouse and
distribution expense increased to 10.5% in the 1999 period from 9.4% in the 1998
period. Freight expense is largely based on pounds shipped. An increase in the
percentage of candle sales to total sales contributed to more pounds shipped per
sales dollar in the 1999 period. As a result, freight expense increased as a
percentage of net sales in the 1999 period. The increase in freight expense was
offset to some extent by the addition of handling charges on small orders
beginning in September 1999 and an increased use of Local Distributors in the
1999 period. Warehouse and distribution expense increased in the 1999 period due
to an increase in the number of orders shipped, which required the Company to
hire more employees to fill the increased number of orders. The Company expects
the trend of more orders and higher labor costs will continue throughout the
remainder of 1999 and into 2000 until the Company's automated order fulfillment
system is fully operational.
General and administrative expense. General and administrative expense
increased $0.9 million, or 16.8%, to $6.3 million in the three months ended
September 30, 1999 from $5.4 million in the comparable period in 1998. The
increase was largely due to increased personnel costs and increased depreciation
expense. The higher personnel costs are primarily in response to the growth in
the sales force coupled with the modernization of the Company's computer systems
(which required the Company to hire employees with specialized skills).
Gains on the sale of assets. The Company recorded a gain of $1.2
million on the sale of a building in August 1998.
Income taxes. Income taxes decreased to $0.9 million in the three
months ended September 30, 1999 from $4.8 million in the comparable period in
1998. The Company's effective income tax rate decreased to 11.1% in the 1999
period from 39.6% in the 1998 period. This decrease was primarily due to certain
prior year income tax provision adjustments made in the 1999 period. These
adjustments primarily related to a prior year refund applied in the 1999 period
and costs associated with the Recapitalization. The Company expects that its
effective income tax rate for the nine months ended September 30, 1999 will be
consistent with its effective income tax rate for the year ended December 31,
1999.
THE NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1998
Net sales. Net sales increased $7.9 million, or 2.3%, to $355.1 million
in the nine months ended September 30, 1999 from $347.2 million in the
comparable period in 1998. This increase was primarily attributable to a 22.6%
increase in the number of orders shipped, which more than offset a 16.8%
decrease in the average order size. The increase in orders shipped was due to
growth in the Displayer base. The average number of active Displayers increased
to 56,600 in the nine months ended September 30, 1999 from 44,500 in the
comparable period in 1998. Orders shipped per active Displayer decreased
slightly. The decline in the average order size was primarily as a
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<PAGE> 14
result of a lower minimum order requirement implemented in June 1999 and growth
in the Displayer base that increased the percentage of less experienced and,
therefore, less productive Displayers. Additionally, as previously discussed,
the 1998 net sales were impacted by an unusual backlog of unfilled orders as of
September 30, 1998.
Gross profit. Gross profit increased $6.4 million, or 3.6%, to $182.9
million in the nine months ended September 30, 1999 from $176.5 million in the
comparable period in 1998. As a percentage of net sales, gross profit increased
to 51.5% in 1999 from 50.8% in the 1998 period. The Company continued to benefit
from the introduction of new products with higher margins in the 1999 period,
which more than offset the significant manufacturing inefficiencies the Company
experienced in the three months ended September 30, 1999.
Selling expense. Selling expense increased $3.4 million, or 5.5%, to
$63.0 million in the nine months ended September 30, 1999 from $59.6 million in
the comparable period in 1998. As a percentage of net sales, selling expense of
17.7% in the 1999 period was slightly higher than 17.2% in the 1998 period
primarily as a result of higher commission rates for certain Unit Directors in
the 1999 period. These higher commission rates were implemented in April 1999.
Freight, warehouse and distribution expense. Freight, warehouse and
distribution expense increased $3.8 million, or 11.9%, to $35.4 million in the
nine months ended September 30, 1999 from $31.6 million in the comparable period
in 1998. As a percentage of net sales, freight, warehouse and distribution
expense increased to 10.0% in the 1999 period from 9.1% in the 1998 period. This
increase resulted from the increase in the number of orders shipped, and in
particular the compensation expense resulting from the hiring of additional
permanent and temporary employees in order to fill the higher number of orders.
The Company expects that the trend of more orders and higher labor costs will
continue throughout the remainder of 1999 and into 2000 until the Company's
automated order fulfillment system is fully operational.
General and administrative expense. General and administrative expense
increased $2.7 million, or 16.7%, to $18.9 million in the nine months ended
September 30, 1999 from $16.2 million in the comparable period in 1998. The
increase was largely due to increased personnel costs, the full period impact of
a monitoring and oversight fee payable to Hicks Muse, and increased depreciation
expense. The higher personnel costs were primarily in response to the growth in
the sales force coupled with the modernization of the Company's computer systems
(which required the Company to hire employees with specialized skills).
Gains on the sale of assets. The Company recorded gains of $6.3 million
primarily on the sale of two aircraft and a building in 1998.
Interest income. Interest income decreased to $1.8 million in the nine
months ended September 30, 1999 from $4.8 million in the comparable period in
1998 due to lower average investment balances as a result of the
Recapitalization.
Interest expense. Interest expense increased $17.4 million in the nine
months ended September 30, 1999 to $33.3 million from $15.9 million in the
comparable period in 1998. This increase resulted from the full period impact of
interest expense incurred in connection with the Senior Credit Facility and the
Notes.
Income taxes. Income taxes decreased to $11.5 million in the nine
months ended September 30, 1999 from $23.3 million in the comparable period in
1998. The Company's effective income tax rate decreased to 34.3% in the 1999
period from 39.7% in the 1998 period. This decrease was primarily due to certain
prior year income tax provision adjustments made in the 1999 period. These
adjustments related to a prior year refund applied in the 1999 period and costs
associated with the Recapitalization. The Company expects that its effective
income tax rate for the year ended December 31, 1999 will be consistent with its
effective income tax rate for the nine months ended September 30, 1999.
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<PAGE> 15
SEASONALITY
The Company's business is influenced by the Christmas holiday season
and promotional events. Historically, a higher portion of the Company's sales
and net income has been realized during the fourth quarter, and net sales and
net income have generally been slightly lower during the first quarter as
compared to the second and third quarters. Working capital requirements also
fluctuate during the year and reach their highest levels during the third and
fourth quarters as the Company increases its inventory for the peak season. In
addition to the Company's peak season fluctuations, quarterly results of
operations may fluctuate depending on the timing of, and amount of sales from
discounts, incentive promotions and/or the introduction of new products. As a
result, the Company's business activity and results of operations in any quarter
are not necessarily indicative of any future trends in the Company's business.
LIQUIDITY AND CAPITAL RESOURCES
The Company has satisfied its historical requirements for capital
through cash flow from operations. As a result of borrowings under the Senior
Credit Facility and the issuance of the Notes, the Company is subject to cash
requirements which are significantly greater than its historical requirements.
Net cash provided by operating activities in the nine months ended September 30,
1999 totaled $11.3 million, a $42.6 million decline from the $53.9 million in
cash provided by operations in the comparable period in 1998. The decrease was
largely attributable to reduced net income in the nine months ended September
30, 1999 primarily as a result of the full period impact of interest expense on
the Senior Credit Facility and the Notes, a larger increase in accounts
receivable during the 1999 period and decreases or smaller increases in accounts
payable and various other current liabilities during the 1999 period. Net cash
provided by operating activities was also higher in the 1998 period due to the
effect of $6.5 million in prepaid sales orders filled and shipped the first week
of October 1998.
Prior to June 4, 1998, the Company liquidated substantially all of its
investments held as of December 31, 1997 to meet the cash requirements of the
Recapitalization. As a result, proceeds from the sale of investments through
September 30, 1998 totaled $154.6 million. Purchases of investments totaled
$87.6 million through September 30, 1998. In addition to its other investing
activities, the Company sold two aircraft and a building in the nine months
ended September 30, 1998 for proceeds of approximately $7.7 million.
The Company used $4.4 million cash in investing activities during the
nine months ended September 30, 1999 and generated $70.1 million in the
comparable period in 1998. The Company's capital expenditures totaled $8.6
million during the nine months ended September 30, 1999 and $6.2 million in the
comparable period in 1998. Additionally, capital expenditures made by the
minority owner of Laredo Candle in the 1999 period totaled $1.9 million.
Payments received on notes receivable increased to $6.1 million during the nine
months ended September 30, 1999 from $1.6 million in the comparable period in
1998 primarily due to the early payoff of certain notes.
The Company is currently operating in and from several separate
warehouse and distribution facilities. On July 19, 1999 the Company entered into
a contract with Argent Frankford L.P. ("Argent") to construct a new 660,000
square-foot warehouse and distribution facility in Carrollton, Texas for
approximately $19.4 million. The Company expects to incur an additional $3.1
million in customized improvements to prepare the facility for occupancy.
Construction is proceeding on schedule and the Company expects to occupy the
facility in the second quarter of 2000. In the event the sale transactions
described below are not consummated and the Company is unable to purchase the
facility, the Company is obligated to enter into a long-term lease agreement
with Argent upon completion of construction.
The new warehouse and distribution facility will allow the Company to
consolidate its current warehouse and distribution operation from several
smaller facilities into a single larger facility. Among other things, the
Company anticipates that it will benefit from reduced labor and inventory costs
and property tax savings. Additionally, the new facility will allow the Company
to utilize an automated order fulfillment system, which the Company expects will
result in additional labor savings. The Company is working with a consultant to
assist in the design layout of the facility and the implementation of an
automated order fulfillment system. The automated order fulfillment system will
include a new conveyor system, special racks and storage bins, and a warehouse
management software system. The Company has selected a vendor to provide the
warehouse management system, and is currently in the process of negotiating an
agreement with the vendor for the purchase, installation and ongoing support of
the system. The Company expects that its automation related costs will be
approximately $11.0 million. A small portion of these costs will be incurred in
late 1999 and the remainder will be incurred throughout 2000 as
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<PAGE> 16
the Company transitions from its current warehouse and distribution facilities
to its new facility. The Company expects to continue to use its current
distribution system until the automated system is fully operational.
Concurrently with the transaction described above, the Company entered
into an exchange transaction with Parker Equities Inc. to sell to Parker for
$15.7 million, net of commissions and closing costs, substantially all of the
Company's owned properties and facilities in the Dallas area, including all of
its warehouse and distribution facilities and its corporate headquarters. The
Company is responsible for approximately $1.0 million of roof replacement costs,
which will reduce the net proceeds to the Company from the sale. The Company
plans to close the transaction on or prior to December 1, 1999 subject to
certain customary terms and conditions. At closing, the Company intends to enter
into several separate lease agreements to lease back all of its properties and
facilities until the Company's new facilities are ready for occupancy. The lease
terms will vary in length based on a predetermined schedule of facility closings
between April 2000 and August 2000.
The Company expects that the process of selling its current facilities
and properties in exchange for purchasing a new facility and property will
qualify as a Section 1031 Tax-Free Exchange under the United States Internal
Revenue Code of 1986, as amended. The Company anticipates there will be a
pre-tax gain of approximately $10.0 million on the sale of its properties and
facilities for financial reporting purposes.
The transactions described above require the consent of the Company's
senior lenders, which the Company anticipates will be obtained in a timely
manner. The Company has requested an amendment to the Senior Credit Facility to
exclude these transactions from certain debt covenant requirements.
The Company has negotiated a ten year lease for a new corporate
headquarters location in Dallas. This facility consists of approximately 75,000
square feet of office space for annual rent of approximately $1.7 million.
Tenant improvements to customize the space are expected to be approximately $4.6
million, of which approximately $2.0 million will be borne by the landlords as
improvement allowances. The remaining $2.6 million will be borne by the Company.
The Company expects to move into its new headquarters facility in late 1999 or
early 2000.
The Company estimates that its capital expenditures for the year ended
December 31, 1999 will increase by $9.6 million to approximately $17.5 million
from $7.9 million in the comparable period of 1998. Additionally, the minority
owner of Laredo Candle spent $0.5 million in capital expenditures in the 1998
period and expects to spend approximately $2.3 million in the 1999 period for
its portion of the new candle manufacturing operation. The anticipated increase
in the Company's capital expenditures of approximately $9.6 million is
principally as a result of the following, which is expected to offset a decline
in other capital expenditures of approximately $1.4 million:
o leasehold improvements to the new corporate headquarters of
approximately $4.6 million (approximately $2.0 million will
be borne by the landlord)
o construction and purchase of machinery and equipment for the
Laredo Candle Company of approximately $2.3 million
o continued enhancements to the Company's new computer system,
including Internet capabilities, of approximately $2.8 million
o design development, and certain software costs associated with of
the new automated order fulfillmention system of approximately
$1.3
The Company's use of cash for financing activities decreased to $24.1
million during the nine months ended September 30, 1999 from $185.4 million in
the comparable period in 1998. The higher use of cash in the 1998 period was due
to the Recapitalization. The Company used proceeds of $182.6 million from the
contribution of equity by Hicks Muse, $200.0 million from the issuance of the
Notes and $300.0 million of borrowings under the Senior Credit Facility,
together with proceeds from the sale of investments as described above, to pay
$827.6 million for the redemption of common stock, and to pay $24.3 million of
fees and expenses associated with the Recapitalization. Prior to the
Recapitalization, the Company's primary financing activity was the payment of
dividends. Dividends paid during the 1998 period totaled $9.6 million. Since the
terms of the Notes and the Senior Credit Facility restrict the Company's ability
to pay dividends, the Company does not anticipate the payment of dividends in
the foreseeable future, and no dividends were paid during the 1999 period. The
Company's primary financing activity in the 1999 period consisted of principal
payments under the Senior Credit Facility of $26.5 million.
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Payments on the Notes and Senior Credit Facility represent significant
cash requirements for the Company. Interest payments on the Notes commenced in
December 1998 and will continue semi-annually until the Notes mature in 2008.
Borrowings under the Senior Credit Facility require quarterly interest and
principal payments. In addition, the Senior Credit Facility includes $40.0
million of Revolving Loans, which mature on June 30, 2004. The Revolving Loans
remained undrawn as of September 30, 1999.
The Company paid a total of $51.9 million in debt service in the nine
months ended September 30, 1999. The debt service payments consisted of
scheduled principal payments under the Senior Credit Facility of $18.8 million,
a mandatory prepayment of $7.7 million under the Senior Credit Facility, and
interest under the Senior Credit Facility and the Notes of approximately $25.4
million.
The Company anticipates that its debt service requirements will total
$72.8 million in 1999. These debt service requirements are expected to consist
of scheduled principal payments due under the Senior Credit Facility of $25.0
million, the mandatory prepayment of $7.7 million under the Senior Credit
Facility, interest due under the Senior Credit Facility of $19.9 million and
interest of $20.2 million due on the Notes.
The terms of the Notes and Senior Credit Facility include significant
operating and financial restrictions, such as limits on the Company's ability to
incur indebtedness, create liens, sell assets, engage in mergers or
consolidations, make investments and pay dividends. In addition, under the
Senior Credit Facility, the Company is required to comply with specified
financial ratios and tests, including minimum interest coverage and maximum
leverage ratios. Subject to the financial ratios and tests, the Company is
required to make certain mandatory prepayments of the term loans on an annual
basis. The Company prepaid $7.7 million on the term loans on March 31, 1999 as a
result of 1998 activity. As a result of the timing and magnitude of the
prepayment amount, the Company may have to utilize the Revolving Loans at
varying times subsequent to September 30, 1999 primarily to meet working capital
needs and to fund capital expenditures, including costs associated with the
Company's new automated order fulfillment system and the transition to the
Company's new warehouse and distribution facility and corporate headquarters
facility.
The Company believes that net cash flow from operations and borrowings
under the Revolving Loans, if any, will be sufficient to fund its cash
requirements over the next twelve months, which will consist primarily of
payment of principal and interest on outstanding indebtedness, working capital
requirements and capital expenditures. The Company's future operating
performance and ability to service or refinance its current indebtedness will be
subject to future economic conditions and to financial, business and other
factors, many of which are beyond the Company's control.
MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
The Company is exposed to financial market risks, including changes in
interest rates and foreign currency exchange rates. To mitigate risks on changes
in interest rates, the Company utilizes derivative financial instruments. The
Company does not use derivative financial instruments for speculative or trading
purposes. The Company's international operations have historically not been
significant, and as a result, changes in foreign currency exchange rates have
not had a material effect on the Company.
In July 1998, the Company entered into an interest rate swap agreement
to limit the effect of changes in interest rates on long-term borrowings. Under
the swap, the Company pays interest at 5.50% on a notional amount of $75.0
million and receives interest thereon at three-month LIBOR on a quarterly basis.
Beginning June 9, 1999, if LIBOR is greater than 6.44% at the commencement of
any quarterly reset period, a knockout provision provides for no payment under
the swap during such period. The knockout provision is separately adjusted to
market on a quarterly basis. The Company recorded a $0.5 million loss in the
nine months ended September 30, 1999 as a result of the knockout provision
market adjustment.
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In September 1999, the Company entered into three separate six month
interest rate swap agreements to limit the effect of changes in interest rates
on long-term borrowings. Under each swap agreement, the Company pays interest at
a fixed LIBOR rate on the notional amount and receives interest thereon at
three-month LIBOR on a quarterly basis. The lenders have the option at the end
of the term of each swap agreement to extend each agreement for an additional
six month period. The following table summarizes the terms of these new interest
rate swap agreements (in thousands):
<TABLE>
<CAPTION>
Effective Date Maturity Date Notional Amount Fixed LIBOR Rate
- -------------- ------------- --------------- ----------------
<S> <C> <C> <C>
09/30/99 03/30/00 $ 70,000 5.80%
11/30/99 05/30/00 $ 50,000 5.80%
12/03/99 06/05/00 $ 15,000 5.90%
</TABLE>
ENVIRONMENTAL ISSUES
In 1989, DWC was named as a potentially responsible party ("PRP") based
on allegedly having sent 2,640 gallons of waste to the Chemical Recycling, Inc.
facility in Wylie, Texas. The Company believes that DWC's share of the total
cleanup costs based on a volumetric allocation would be less than one percent.
In the future, DWC and the other PRPs, who are jointly and severally liable, may
incur additional costs related to the cleanup of hazardous substances at the
facility. DWC did not incur any cleanup related costs in 1996, 1997 and 1998 or
in the nine months ended September 30, 1999. Because the site has been dormant
for several years, the Company does not believe it is probable that any
additional costs will be incurred and, accordingly, has not established any
accruals for future cleanup costs at the site.
In 1997, Homco was named as a PRP based on allegedly having transported
hazardous substances to the Materials Recovery Enterprises, Inc. facility near
Ovalo, Texas in Taylor County, Texas. In 1998, Homco paid an assessment of
approximately $1,000 for liability at the facility. By agreement, Kraft Foods,
Inc., a partial indemnitor to Homco, paid Homco 96.5% of this past assessment;
assumed the future administration of the matter, including payment of future
costs; and may, upon demand, request reimbursement from Homco for 3.5% of future
costs. Although Homco remains jointly and severally liable for the remediation
of the site, the probability that Homco will be required to pay more than a de
minimis amount is remote.
In 1996, the United States Environmental Protection Agency issued a
Notice of Violation claiming that GIA had violated the Clean Air Act and
Nebraska Air Regulations by failing to obtain one or more Construction Permits
for plant expansions that occurred in the 1970s and 1980s. In January 1997, GIA
responded to the Notice of Violation and in January 1998, a combined
construction and operating permit was proposed for the facility. This permit has
been issued and GIA did not incur penalties for the activities covered by the
Notice of Violation.
On February 9, 1999, the EPA conducted an inspection at GIA to
determine compliance with the toxic chemical release reporting requirements for
1997 pursuant to the Emergency Planning and Community Right To Know Act of 1986,
Section 313. A final determination was issued in September regarding several
calculation errors in GIA's Form R Report. The EPA imposed a $21,000 fine which
the Company is seeking to recover from a third party.
The ultimate outcome and aggregate cost of resolving all of the above
contingencies will be based on a number of factors and will be determined over a
number of years. Accordingly, the total cost to the Company cannot currently be
determined with certainty. It is management's opinion, however, the total cost
of resolving such contingencies should not have a material adverse effect on the
Company's business, financial condition, results of operations or liquidity.
YEAR 2000 ISSUE
As a result of certain computer programs being written using two digits
rather than four digits to define the applicable year, any of the Company's
computer programs that have date sensitive software may recognize a date using
"00" as the Year 1900 rather than the Year 2000 (the "Year 2000 Issue"). This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices or engage in normal business activities. Such
failures could materially and adversely affect the Company's results of
operations, liquidity and financial condition.
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The Company completed the assessment phase of the Year 2000 Issue in
early 1999, which consisted of taking an inventory of its information systems,
prioritizing items, determining critical items and establishing a timetable for
determining the modifications to existing software and new software required to
mitigate any Year 2000 Issue. The Company's evaluation included information
systems infrastructure and operating systems as well as the Company's
subsidiaries and its suppliers.
Because the Company implemented a new and significantly more
sophisticated computer system (the "Computer System") in January 1999, which
replaced substantially all of the hardware and software previously in use at the
Company, the Company believes its systems and related software are Year 2000
compliant. The Company upgraded the software for the Computer System through the
purchase of certain software products developed by Distribution Architects
International ("DAI"). DAI assisted with the implementation process and
continues to provide support for enhancement to the Computer System. Each
supplier (including DAI) of the hardware and software incorporated into the
Computer System has provided to the Company a compliance statement or other
documentation certifying that its products will function properly in all
material respects beyond 1999. The Computer System has been thoroughly tested
and remediation has taken place where necessary. In addition, Year 2000 testing
and remediation of other aspects of the Company's infrastructure, including the
Company's subsidiaries, is complete. Costs associated with the Computer System
through September 30, 1999 totaled approximately $5.6 million. Additional costs
associated with remediating the Year 2000 Issue have been expensed as incurred
and are not material.
Although the Company expects its critical systems are compliant, and
testing supports this expectation, there is no assurance these results will be
achieved. However, the impact of a failure of any of the Company's information
systems would be mitigated to the extent that other alternate processes,
including manual processes, were able to meet processing requirements.
Presently, the Company expects alternate procedures would be able to meet the
Company's processing needs for a limited timeframe. The Company will have DAI
and other programmers on-site during the first week of January 2000 in order to
make required modifications to the Computer System should they be needed. The
Company expects that the required modifications, if any, will be insignificant
and remediation will be complete by the end of the first week in January 2000.
In addition to the foregoing, the Company has identified and surveyed
its critical third party suppliers and service providers, and continues to
monitor and assess their progress toward Year 2000 compliance to determine the
extent to which the Company is vulnerable to the failure of such suppliers and
service providers to remediate their own Year 2000 issues. While the Company
believes that these scenarios, if they were to occur, would be temporary in
duration, there can be no assurance that the duration will be short-term. In the
event these conditions were to persist for a longer duration, they could have a
material adverse effect on the Company's business, financial condition, results
of operations and liquidity of a magnitude which the Company is presently not
able to predict.
Although not anticipated, the most reasonably likely worst-case
scenario of failure by the Company or its key suppliers or service providers to
become Year 2000 compliant would be short-term slowdown or cessation of
manufacturing operations at one or more facilities and a short-term inability on
the part of the Company to process, fill and ship orders in a timely manner, and
to deliver product to Displayers.
NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The new standard is effective for quarters
and fiscal years beginning after June 15, 2000. The Company has not yet
determined the effect the new standard will have on its financial statements.
19
<PAGE> 20
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Management's Discussion and Analysis of
Financial Condition and Results of Operations" constitute forward-looking
statements. These statements involve known and unknown risks, uncertainties and
other factors that may cause the Company's actual results to be materially
different from any future results expressed or implied by such forward-looking
statements.
In some cases, forward-looking statements are identified by terminology
such as "may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of such terms
or other comparable terminology.
All of these forward-looking statements are based on estimates and
assumptions made by management of the Company which, although believed to be
reasonable, are inherently uncertain. Therefore, undue reliance should not be
placed upon such statements. No assurance can be given that any of such
estimates or statements will be realized and actual results may differ
materially from those contemplated by such forward-looking statements. Factors
that may cause such differences include: (i) loss of Displayers; (ii) loss or
retirement of key members of management; (iii) imposition of state taxes; (iv)
change in status of independent contractors; (v) increased competition; (vi)
unexpected delays or problems associated with the completion of the Company's
new warehouse and distribution facility; (vii) unexpected delays or problems
associated with the sale of substantially all of the Company's existing
properties and facilities; (viii) unexpected delays or problems associated with
integration and implementation of the automated order fulfillment system; (ix)
unexpected delays or problems associated with the Year 2000 Issue; and (x) the
ability of third party suppliers and service providers to remediate any Year
2000 issues applicable to their respective businesses. Many of these factors
will be beyond the control of the Company.
Moreover, neither the Company nor any other person assumes
responsibility for the accuracy and completeness of such statements. The Company
is under no duty to update any of the forward-looking statements after the date
of this Form 10-Q to conform such statements to actual results.
20
<PAGE> 21
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Environmental Issues" for information regarding legal
proceedings which is incorporated herein by reference.
ITEM 5. Other Information
On November 1, 1999, the Company entered into an employment agreement
with Kenneth J. Cichocki to serve as its Vice President of Finance and Chief
Financial Officer. The initial term of the employment agreement is for one year
and may be extended for successive one year periods. Leonard A. Robertson, the
Company's Chief Financial Officer from July 1995 to October 1999, was appointed
to the newly-created position of Chief Administrative Officer.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit Number Description
-------------- -----------
<S> <C>
10.1 Second Amendment to Real Estate Purchase
Contract dated August 18, 1999, between the
Company and Parker Equities, Inc.
10.2 Third Amendment to Real Estate Purchase
Contract dated September 15, 1999, between
the Company and Parker Equities, Inc.
10.3 Fourth Amendment to Real Estate Purchase
Contract dated October 15, 1999, between the
Company and Parker Equities, Inc.
10.4 Employment Agreement, dated November 1,
1999, between the Company and Kenneth J.
Cichocki
27 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
None.
21
<PAGE> 22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
HOME INTERIORS & GIFTS, INC.
By: /s/ KENNETH J. CICHOCKI
- ----------------------------
Kenneth J. Cichocki
Vice President of Finance and Chief Financial Officer
(principal financial and accounting officer)
Date: November 8, 1999
22
<PAGE> 23
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Number Description
-------------- -----------
<S> <C>
10.1 Second Amendment to Real Estate Purchase
Contract dated August 18, 1999, between the
Company and Parker Equities, Inc.
10.2 Third Amendment to Real Estate Purchase
Contract dated September 15, 1999, between
the Company and Parker Equities, Inc.
10.3 Fourth Amendment to Real Estate Purchase
Contract dated October 15, 1999, between the
Company and Parker Equities, Inc.
10.4 Employment Agreement, dated November 1,
1999, between the Company and Kenneth J.
Cichocki
27 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 10.1
SECOND AMENDMENT TO
REAL ESTATE PURCHASE CONTRACT
THIS SECOND AMENDMENT TO REAL ESTATE PURCHASE CONTRACT (this
"Amendment"), is made this 18th day of August, 1999 (the "Effective Date"), by
and between Home Interiors & Gifts, Inc. ("Seller") and Parker Equities, Inc.
("Purchaser").
RECITALS:
WHEREAS, on July 19, 1999, Purchaser and Seller entered into that
certain Real Estate Purchase Contract (the "Contract") relating to the purchase
and sale of seven office/warehouse buildings, as more particularly described
therein and amended by First Amendment to Real Estate Contract dated August 9,
1999; and
WHEREAS, Purchaser and Seller now desire to enter into this Second
Amendment to amend the Contract.
NOW, THEREFORE, for and in consideration of the mutual covenants and
agreements herein contained and other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, Seller and Purchaser
hereby agree as follows:
1. Title/Survey Objection Date. Notwithstanding the provisions of
Sections 3.2 and 3.3 of the Contract, Purchaser's right to object to title and
survey matters is hereby extended until August 24, 1999.
2. Modifications. Except as expressly herein modified, the Contract
shall remain in full force and effect in accordance with its terms. Except as
otherwise expressly provided herein, all capitalized terms used but not defined
herein shall have the same meaning as that attributed to such terms in the
Contract.
3. Effectiveness/Counterparts. This Amendment does not become effective
as an amendment to the Contract or otherwise until executed and delivered by
both Purchaser and Seller. This Amendment may be executed in counterparts, and
facsimile signatures shall be deemed originals for all intents and purposes.
PARKER EQUITIES, INC. ("PURCHASER")
By: /s/ Jeff P. Howle
------------------------------------
JEFF P. HOWLE, PRESIDENT
HOME INTERIORS & GIFTS, INC. ("SELLER")
By: /s/Bettina Simon
------------------------------------
ITS: VP
-----------------------------------
<PAGE> 1
EXHIBIT 10.2
THIRD AMENDMENT TO REAL ESTATE PURCHASE CONTRACT
THIS THIRD AMENDMENT TO REAL ESTATE PURCHASE CONTRACT (this
"Amendment"), is made this 15th day of September, 1999 (the "Effective Date"),
by and between Home Interiors & Gifts, Inc., ("Seller"), and Parker Equities,
Inc. ("Purchaser").
RECITALS
WHEREAS, on July 19, 1999, Purchaser and Seller entered into that
certain Real Estate Purchase Contract relating to the purchase and sale of seven
office/warehouse buildings, as more particularly described therein; as amended
by that certain First Amendment to Real Estate Purchase Contract dated August 9,
1999 and that certain Second Amendment to Real Estate Purchase Contract dated
August 18,1999 (collectively, the "Contract"); and
WHEREAS, Purchaser and Seller now desire to enter into this Amendment
to amend the Contract.
NOW, THEREFORE, for and in consideration of the mutual covenants and
agreements herein contained and other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, Seller and Purchaser
hereby agree as follows:
1. Inspection Expiration Date. The Inspection Expiration Date is hereby
extended until October 15, 1999.
2. Earnest Money. Notwithstanding anything in the Contract to the
contrary, effective as of the Effective Date, the $50,000 of Earnest Money which
Purchaser has previously delivered to the Title Company shall be non-refundable;
provided, however, until the Inspection Expiration Date, such Earnest Money
shall be refundable until Seller has delivered the Surveys in a form which is
reasonably acceptable to Purchaser's lender.
3. Closing Escrow. In consideration of Purchaser accepting the
Buildings in their current condition on an "AS IS, WHERE IS" basis as more
specifically set forth in Article IV of the Contract, at Closing, $924,491 (the
"Escrowed Funds") of the closing funds shall be placed in escrow with the
Purchaser's lender. Such escrow shall be governed by an Escrow Agreement which
shall be in a form reasonably satisfactory to Purchaser, Seller and Purchaser's
lender.
4. Leases. Notwithstanding the provisions of Article XI(j) and the
schedule attached to Exhibit A, (i) the Lease relating to the Building located
at 815 S. Coppell Road, Coppell, Texas shall contain six (6) one month renewal
options which are each independently exercisable by Seller by giving Purchaser
written notice at least 90 days prior to the expiration of the term of such
Lease (as extended pursuant to the previous
<PAGE> 2
exercise of any such options) and (ii) the Lease relating to the Building
located at 10351 Home Road, Frisco, Texas shall contain four (4) one month
renewal options which are each independently exercisable by Seller by giving
Purchaser written notice at least 90 days prior to the expiration of the term of
such Lease (as extended pursuant to the previous exercise of any such options).
5. Platting. As mentioned in the letter from Peggy Jones to Jeff Howle
dated September 3, 1999, the surveyor is working with the City of Farmers Branch
and the City of Coppell with regards to the replatting of the properties located
at 4545 Spring Valley Road and 815 Coppell Road. Seller shall allow Purchaser to
reasonable participate in the platting process and to review and reasonably
approve any proposed plats prior to filing same in the real estate records.
6. Modifications. Except as expressly herein modified, the Contract
shall remain in full force and effect in accordance with its terms. Except as
otherwise expressly provided herein, all capitalized terms used but not defined
herein shall have the same meaning as that attributed to such terms in the
Contract.
7. Effectiveness/Counterparts. This Amendment does not become effective
as an amendment to the Contract or otherwise until executed and delivered by
both Purchaser and Seller. This Amendment may be executed in counterparts, and
facsimile signatures shall be deemed originals for all intents and purposes.
IN WITNESS WHEREOF, the parties hereto have executed this Amendment as
of the date first above written.
PURCHASER:
PARKER EQUITIES, INC.
By: /s/ Jeff P. Howle
------------------------------
Name: Jeff P. Howle
----------------------------
Title: President
---------------------------
SELLER:
HOME INTERIORS & GIFTS, INC.
By: /s/James W. Livingston
------------------------------
Name: James W. Livingston
----------------------------
Title: V.P. Operations
---------------------------
2
<PAGE> 1
EXHIBIT 10.3
FOURTH AMENDMENT TO REAL ESTATE PURCHASE CONTRACT
THIS FOURTH AMENDMENT TO REAL ESTATE PURCHASE CONTRACT (this
"Amendment"), is made effective this 15th day of October, 1999 (the "Effective
Date"), by and between Home Interiors & Gifts, Inc. ("Seller"), and Parker
Equities, Inc. ("Purchaser").
RECITALS
WHEREAS, on July 19, 1999, Purchaser and Seller entered into that
certain Real Estate Purchase Contract relating to the purchase and sale of seven
office/warehouse buildings, as more particularly described therein; as amended
by that certain First Amendment to Real Estate Purchase Contract dated August 9,
1999, that certain Second Amendment to Real Estate Purchase Contract dated
August 18,1999 and that certain Third Amendment to Real Estate Purchase Contract
dated September 15, 1999 (collectively, the "Contract"); and
WHEREAS, Purchaser and Seller now desire to enter into this Amendment
to amend the Contract.
NOW, THEREFORE, for and in consideration of the mutual covenants and
agreements herein contained and other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged, Seller and Purchaser
hereby agree as follows:
1. Earnest Money. Notwithstanding anything in the Contract to the
contrary, by no later than October 20, 1999, Purchaser shall deliver an
additional earnest money deposit of $200,000 to the Title Company, after which,
the total Earnest Money deposited as of such date shall equal $250,000.
Effective upon the deposit of such additional Earnest Money, all Earnest Money
shall be non-refundable unless Seller fails to file the replats of the
properties located at 4545 Spring Valley and 815 Coppell Road as specified in
Section 3 hereof by the Closing Date. If such replats are filed of record prior
to the Closing Date, within one (1) business day thereafter, Purchaser shall
deposit an additional earnest money deposit of $250,000 to the Title Company, at
which time all Earnest Money shall be non-refundable with no exceptions. If
Purchaser fails to deposit any portion of the Earnest Money when such portion of
the Earnest Money is due, the Contract shall automatically terminate and any
Earnest Money already deposited shall be released to Seller as liquidated
damages.
2. Closing Escrow. The amount of the Escrowed Funds to be held pursuant
to Section 3 of the Third Amendment to Real Estate Purchase Contract shall be
reduced by $10,000, reflecting roof repairs to the property located at 582 E.
Highway 121 which have been paid for directly by Seller to Windriver Roofing.
<PAGE> 2
3. Platting. As mentioned in the letter from Peggy Jones to Jeff Howle
dated September 3, 1999, the surveyor is working with the City of Farmers Branch
and the City of Coppell with regards to the replatting of the properties located
at 4545 Spring Valley Road and 815 Coppell Road. Seller shall allow Purchaser to
reasonably participate in the platting process and to review and reasonably
approve any proposed plats prior to filing same in the real estate records.
4. Modifications. Except as expressly herein modified, the Contract
shall remain in full force and effect in accordance with its terms. Except as
otherwise expressly provided herein, all capitalized terms used but not defined
herein shall have the same meaning as that attributed to such terms in the
Contract.
5. Effectiveness/Counterparts. This Amendment does not become effective
as an amendment to the Contract or otherwise until executed and delivered by
both Purchaser and Seller. This Amendment may be executed in counterparts, and
facsimile signatures shall be deemed originals for all intents and purposes.
IN WITNESS WHEREOF, the parties hereto have executed this Amendment as
of the date first above written.
PURCHASER:
PARKER EQUITIES, INC.
By: /s/ Jeff P. Howle
-------------------------
Name: Jeff P. Howle
-----------------------
Title: President
----------------------
SELLER:
HOME INTERIORS & GIFTS, INC.
By: /s/Bettina Simon
-------------------------
Name: Bettina Simon
-----------------------
Title: VP, Gen. Counsel
----------------------
2
<PAGE> 1
EXHIBIT 10.4
KENNETH J. CICHOCKI
EMPLOYMENT AGREEMENT
THIS EMPLOYMENT AGREEMENT (the "Agreement") is made and
entered into as of November 1, 1999 by and between Home Interiors & Gifts, Inc.,
a Texas corporation (together with its successors and assigns permitted
hereunder, the "Company"), and Kenneth J. Cichocki (the "Executive").
WHEREAS, the Company desires to employ the Executive in an
executive capacity with the Company, and the Executive desires to be employed by
the Company in said capacity; and
WHEREAS, the parties hereto deem it desirable and in the best
interest of the Company and its stockholders for the Company to employ the
Executive on the terms and conditions set forth herein.
NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS:
1. EMPLOYMENT PERIOD. Subject to Section 3 hereof, the Company hereby
agrees to employ the Executive, and the Executive hereby agrees to be employed
by the Company, in accordance with the terms and provisions of this Agreement,
for the period commencing as of the date of this Agreement and continuing until
November 1, 2000; provided, however, that such Employment Period shall be
extended for successive terms of one (1) year each unless either party advises
the other, at least ninety (90) days prior to the end of the initial term or
annual extension, as the case may be, that it will not agree to extend this
Agreement (the "Employment Period").
2. TERMS OF EMPLOYMENT.
(a) Position and Duties.
(i) During the Employment Period, the Executive shall perform
the functions of Vice President of Finance and Chief Financial Officer of the
Company and, in so doing, shall report to the Chief Executive Officer of the
Company. The Executive shall have such powers and duties as may from time to
time be prescribed by the appropriate officers, so long as such powers and
duties are reasonable and customary for the Vice President of Finance and Chief
Financial Officer of an enterprise comparable to the Company.
(ii) During the Employment Period and excluding any periods of
vacation and sick leave to which the Executive is entitled, the Executive agrees
to devote such time as the Chief Executive Officer shall deem necessary, up to
and including substantially all of his business time, to the business and
affairs of the Company and, to the extent necessary to discharge the
responsibilities assigned to the Executive hereunder, to use the Executive's
reasonable best efforts to perform faithfully, effectively and efficiently such
responsibilities. During the term of Executive's employment it shall not be a
violation of this Agreement for the Executive to (1) serve on corporate, civic
or charitable boards or committees, (2) deliver lectures or fulfill speaking
engagements, and (3) manage personal investments, so long as such activities
<PAGE> 2
do not significantly interfere with the performance of the Executive's
responsibilities as an employee of the Company in accordance with this
Agreement.
(b) Compensation.
(i) Base Salary. During the Employment Period, the Executive
shall receive, at such intervals and in accordance with such Company policies as
may be in effect from time to time, an annual salary (pro rata for any partial
year) equal to $250,000, payable in equal installments no less often than
monthly (the "Annual Base Salary"), which Annual Base Salary shall be subject to
appropriate increase, as determined by the sole discretion of the Board of
Directors of the Company.
(ii) Annual Bonus. The Executive shall be eligible to
participate in the Company's Key Employee Bonus Plan applicable to executives of
the Company (the "Annual Bonus") for each fiscal year of the Company commencing
with the fiscal year ending December 31, 2000 as approved by the Board of
Directors of the Company in good faith, and such other criteria as may be
recommended by management and established by the Board of Directors of the
Company from time to time. Each Annual Bonus (or portion thereof) shall be paid
in cash promptly following delivery to the Board of Directors of the Company of
audited financial statements of the Company for the fiscal year for which the
Annual Bonus (or pro rated portion) is earned or awarded, unless electively
deferred by the Executive pursuant to any deferral programs or arrangements that
the Company may make available to the Executive but on the same basis as for
other members of the Senior Executive Management Team;
(iii) Stock Options. The Company shall grant to the Executive
options to purchase that number of shares of Common Stock of the Company having
an aggregate value of $200,000. In addition, on the first anniversary of
Executive's employment with the Company, to the extent the initial term has been
extended for one additional year, as provided in Section 1 hereof, the Company
shall grant to the Executive options to purchase that number of additional
shares of Common Stock having an aggregate value of $100,000. The options will
be evidenced by a separate Option Agreement and will be granted pursuant to, and
subject to the terms and conditions of the Company's 1998 Stock Option Plan for
Key Employees. The options will vest and become exercisable in the manner and at
the times provided in the Option Agreement.
(iv) Incentive, Savings and Retirement Plans. During the term of
the Executive's employment, the Executive shall be entitled to participate in
all incentive, savings, and retirement plans, practices, policies and programs
applicable generally to other employees of the Company ("Investment Plans") as
determined by and at the discretion of the Board of Directors of the Company.
(v) Sign-on Bonus. Executive shall be paid a one time sign-on
bonus of $20,000. Such bonus is intended to offset any bonuses sacrificed by
Executive during the calendar year 1999.
<PAGE> 3
(vi) Welfare Benefit Plans. During the term of the Executive's
employment, the Executive and/or the Executive's family, as the case may be,
shall be eligible for participation in and shall receive all benefits under
welfare benefit plans, practices, policies and programs ("Welfare Plans")
provided by the Company (including, without limitation, medical, prescription,
dental, disability, salary continuance, employee life, group life, accidental
death and travel accident insurance plans and programs) to the extent applicable
generally to other executives of the Company.
(vii) Expenses. During the term of the Executive's employment,
the Executive shall be entitled to receive prompt reimbursement for all
reasonable employment expenses incurred by the Executive in accordance with the
policies, practices and procedures of the Company.
(viii) Vacation and Holidays. During the term of the Executive's
employment, the Executive shall be entitled to paid vacation of three weeks per
year and paid holidays in accordance with the plans, policies, programs and
practices of the Company for its employees.
(ix) Other Benefits. During the term of Executive's employment,
the Executive shall be entitled to other perquisites and benefits applicable to
other members of the Senior Executive Management Team in effect from time to
time and in accordance with the policies, practices and procedures of the
Company.
3. TERMINATION OF EMPLOYMENT.
(a) Death or Disability. The Executive's employment shall terminate
automatically upon the Executive's death during the Employment Period. If the
Disability of the Executive has occurred during the Employment Period (pursuant
to the definition of Disability set forth below), the Company shall give to the
Executive no less than thirty (30) days written notice in accordance with
Section 11(b) hereof of its intention to terminate the Executive's employment
based upon Disability, and in the event Executive shall within such 30 day
period become able to perform his duties and obligations under this Agreement,
then Executive's employment shall not be terminated. In such event, the
Executive's employment with the Company shall terminate effective on the receipt
of such notice by the Executive (the "Disability Effective Date"). For purposes
of this Agreement, "Disability" shall mean the Executive's inability to perform
his duties and obligations hereunder for a period of 120 consecutive days or any
120 days in any twelve month period due to mental or physical incapacity as
determined by a physician selected by the Company or its insurers and acceptable
to the Executive or the Executive's legal representative (such agreement as to
acceptability not to be withheld unreasonably).
(b) Termination by the Company. The Company may terminate the
Executive's employment during the Employment Period either with or without
Cause. For purposes of this Agreement, "Cause" shall mean (i) a breach by the
Executive of the Executive's obligations under Section 2(a) (other than as a
result of physical or mental incapacity) which constitutes a continued material
nonperformance by the Executive of his obligations and duties thereunder, as
reasonably determined by the Board of Directors of the Company, (ii) commission
<PAGE> 4
by the Executive of an act of fraud upon, or willful misconduct toward, the
Company, as reasonably determined by a majority of the disinterested members of
the Board of Directors of the Company (neither the Executive nor members of his
family being deemed disinterested for this purpose), (iii) a material breach by
the Executive of Section 6 or Section 9 hereof, (iv) the conviction of the
Executive of any felony (or deferred adjudication or a plea of nolo contendere
thereto), or (v) the failure of the Executive to carry out, or comply with, in
any material respect any directive of the Chief Executive Officer consistent
with the terms of this Agreement, which is not remedied within 30 days after
receipt of written notice from the Company specifying such failure.
(c) Termination by Executive. The Executive's employment may be
terminated during the Employment Period by the Executive for any reason or no
reason.
(d) Notice of Termination. Any termination by the Company (for Cause
or otherwise), or by the Executive, shall be communicated by Notice of
Termination to the other party hereto given in accordance with Section 11(b)
hereof.
(e) Date of Termination. "Date of Termination" means (i) the date of
receipt of the Notice of Termination or any later date specified therein
pursuant to Section 3(d) hereof, as the case may be, and (ii) if the Executive's
employment is terminated by reason of death or Disability, the date of death of
the Executive or the Disability Effective Date, as the case may be.
4. OBLIGATIONS OF THE COMPANY UPON TERMINATION.
(a) Termination by the Company. If the Company terminates Executive
other than for Cause, or in connection with death or disability as covered by
Section 4(b) below, or fails to renew this Agreement beyond the initial term
ending November 1, 2000, the Company shall pay to the Executive (i) in a lump
sum in cash within ten days after the Date of Termination (1) the sum of the
Executive's applicable Annual Base Salary through the Date of Termination to the
extent not theretofore paid ("Accrued Obligations") and (2) any amount arising
from Executive's participation in, or benefits under, any Investment Plans
("Accrued Investments"), which amounts shall be payable in accordance with the
terms and conditions of such Investment Plans, (ii) severance pay equal to the
Executive's Annual Base Salary, payable in accordance with the Company's regular
pay schedule, for twelve (12) months from the date of termination of employment
and (iii) any earned but unpaid Annual Bonus in respect of any full fiscal year
ended prior to the date the Executive's employment is terminated, payable in a
lump sum in cash at such time as such Annual Bonus otherwise would be payable
pursuant to the last sentence of Section 2(b)(ii) ("Accrued Bonus").
Notwithstanding the foregoing, an election by the Company not to extend any
annual extension thereof (not including the initial term) pursuant to Section 2
hereof shall not be considered a termination without Cause for purposes of this
Section 4(a).
(b) Death or Disability. If the Executive's employment is terminated
by reason of the Executive's death or Disability during the Employment Period,
the Company shall pay to his legal representatives (i) in a lump sum in cash
within ten days after the Date of Termination the aggregate the Accrued
Obligations; (ii) the Accrued Investments, which shall be payable in accordance
with the terms and conditions of the Investment Plans; and (iii) any Accrued
Bonus, which shall be payable at such time as such Annual Bonus otherwise would
be
<PAGE> 5
payable pursuant to the last sentence of Section 2(b)(ii). The Company shall
have no further payment obligations to the Executive or his legal
representatives under this Agreement.
(c) Cause. If the Executive's employment shall be terminated by the
Company for Cause, or by the Executive, during the Employment Period, the
Company shall have no further payment obligations to the Executive other than
for payment of Accrued Obligations, Accrued Investments (which shall be payable
in accordance with the terms and conditions of the Investment Plans), and
Accrued Bonus (which shall be payable at such time as such Annual Bonus
otherwise would be payable pursuant to the last sentence of Section 2(b)(ii)).
5. FULL SETTLEMENT, MITIGATION. In no event shall the Executive be
obligated to seek other employment or take any other action by way of mitigation
of the amounts payable to the Executive under any of the provisions of this
Agreement and such amounts shall not be reduced whether or not the Executive
obtains other employment. Neither the Executive nor the Company shall be liable
to the other party for any damages in addition to the amounts payable under
Section 4 hereof arising out of the termination of the Executive's employment
prior to the end of the Employment Period; provided, however, that the Company
shall be entitled to seek damages for any breach of Sections 6, 7, or 9 hereof
or criminal misconduct., and further provided Executive shall be entitled to
seek damages for any violation by Company of applicable statutory employment law
or for slander or libel.
6. CONFIDENTIAL INFORMATION.
(a) The Executive acknowledges that the Company and its affiliates
have trade, business, and financial secrets and other confidential and
proprietary information including but not limited to sales and marketing and
product information and strategy, identity of suppliers, displayers
(collectively, the "Confidential Information"). As defined herein, Confidential
Information shall not include (i) information that is generally known to other
persons or entities who can obtain economic value from its disclosure or use and
(ii) information required to be disclosed by the Executive pursuant to a
subpoena or court order, or pursuant to a requirement of a governmental agency
or law of the United States of America or a state thereof or any governmental or
political subdivision thereof; provided, however, that the Executive shall take
all reasonable steps to prohibit disclosure pursuant to subsection (ii) above at
the sole cost and expense of Company.
(b) The Executive agrees (i) to hold such Confidential Information
in confidence and (ii) not to release such information to any person (other than
Company employees and other persons to whom the Company has authorized the
Executive to disclose such information and then only to the extent that such
Company employees and other persons authorized by the Company have a need for
such knowledge).
(c) The Executive further agrees not to use any Confidential
Information for the benefit of any person or entity other than the Company.
<PAGE> 6
7. SURRENDER OF MATERIALS UPON TERMINATION. Upon any termination of the
Executive's employment, the Executive shall immediately return to the Company
all copies, in whatever form, of any and all Confidential Information and other
properties of the Company and its affiliates which are in the Executive's
possession, custody or control.
8. SUCCESSORS.
(a) This Agreement is personal to the Executive and without the
prior written consent of the Company shall not be assignable by the Executive
otherwise than by will or the laws of descent and distribution. This Agreement
shall inure to the benefit of and be enforceable by the Executive's legal
representatives.
(b) This Agreement shall inure to the benefit of and be binding upon
the Company and its successors and assigns.
(c) The Company will require any successor (whether direct or
indirect, by purchase, merger, consolidation or otherwise) to all or
substantially all of the business and/or assets of the Company to assume
expressly and agree to perform this Agreement in the same manner and to the same
extent that the Company would be required to perform it if no such succession
had taken place. The failure of any successor of Company to expressly assume to
perform this Agreement in writing shall, at the election of Executive, be deemed
to be termination of this Agreement without cause, entitling Executive to
payment of one year's severance. As used in this Agreement, "Company" shall mean
the Company as hereinbefore defined and any successor to its business and/or
assets as aforesaid which assumes and agrees to perform this Agreement by
operation of law, or otherwise.
9. NON-COMPETITION AND NON-SOLICITATION.
(a) The term of Non-Competition and Non-Solicitation (herein so
called) shall be for a term beginning on the date hereof and continuing until
the first anniversary of the Date of Termination of this Agreement, by either
the Company or the Executive for any reason.
(b) During the term of Non-Competition and Non-Solicitation, the
Executive will not (other than for the benefit of the Company pursuant to this
Agreement) directly or indirectly, individually or as an officer, director,
employee, shareholder, consultant, contractor, partner, joint venturer, agent,
equity owner or in my capacity whatsoever, (i) engage in any business that
competes with the Company, either by selling similar products in the continental
United States and Mexico or by utilizing a direct sales or multi-level marketing
sales format to sell consumer products in the continental United States (a
"Competing Business"), (ii) hire, attempt to hire, or contact or solicit with
respect to hiring any employee or Independent Contractor Displayers of the
Company, or (iii) divert or take away any customers, including Independent
Contractors, or suppliers of the Company in the continental United States.
Notwithstanding the foregoing, the Company agrees that the Executive may own
less than five percent of the outstanding voting securities of any publicly
traded company that is a Competing Business so long as the Executive does not
otherwise participate in such competing business in any way prohibited by the
preceding clause. As used in this Section 9(b) (and in Section 6 hereof),
"Company" shall include the Company and any of its subsidiaries.
<PAGE> 7
(c) During the term of Non-Competition and Non-Solicitation, the
Executive will not use the Executive's access to, knowledge of, or application
of Confidential Information to perform any duty for any Competing Business; it
being understood and agreed to that this Section 9(c) shall be in addition to
and not be construed as a limitation upon the covenants in Section 9(b) hereof.
(d) The Executive acknowledges that the geographic boundaries, scope
of prohibited activities, and time duration of the preceding paragraphs are
reasonable in nature and are no broader than are necessary to maintain the
confidentiality and the goodwill of the Company's proprietary information, plans
and services and to protect the other legitimate business interests of the
Company.
10. EFFECT OF AGREEMENT ON OTHER BENEFITS. The existence of this
Agreement shall not prohibit or restrict the Executive's entitlement to full
participation in the employee benefit and other plans or programs in which
employees of the Company are eligible to participate.
11. MISCELLANEOUS.
(a) This Agreement shall be governed by and construed in accordance
with the laws of the State of Texas without reference to principles of conflict
of laws. The captions of this Agreement are not part of the provisions hereof
and shall have no force or effect. Whenever the terms "hereof", "hereby",
"herein", or words of similar import are used in this Agreement they shall be
construed as referring to this Agreement in its entirety rather than to a
particular section or provision, unless the context specifically indicates to
the contrary. Any reference to a particular "Section" or "paragraph" shall be
construed as referring to the indicated section or paragraph of this Agreement
unless the context indicates to the contrary. The use of the term "including"
herein shall be construed as meaning "including without limitation." This
Agreement may not be amended or modified otherwise than by a written agreement
executed by the parties hereto or their respective successors and legal
representatives.
(b) All notices and other communications hereunder shall be in
writing and shall be given by hand delivery to the other party or by registered
or certified mail, return receipt requested, postage prepaid, addressed as
follows:
If to the Executive: Kenneth J. Cichocki
5612 Templin Way
Plano, Texas 75093
If to the Company: Donald J. Carter, Jr., CEO
Home Interiors & Gifts, Inc.
4550 Spring Valley Road
Dallas, Texas 75244
With a copy to the Company's General Counsel
<PAGE> 8
or to such other address as either party shall have furnished to the other in
writing in accordance herewith. Notice and communications shall be effective
when actually received by the addressee.
(c) If any provision of this Agreement is held to be illegal,
invalid or unenforceable under present or future laws effective during the term
of this Agreement, such provision shall be fully severable; this Agreement shall
be construed and enforced as if such illegal, invalid or unenforceable provision
had never comprised a portion of this Agreement; and the remaining provisions of
this Agreement shall remain in full force and effect and shall not be affected
by the illegal, invalid or unenforceable provision or by its severance from this
Agreement. Furthermore, in lieu of such illegal, invalid or unenforceable
provision there shall be added automatically as part of this Agreement a
provision as similar in terms to such illegal, invalid or unenforceable
provision as may be possible and be legal, valid and enforceable.
(d) The Company may withhold from any amounts payable under this
Agreement such Federal, state or local taxes as shall be required to be withheld
pursuant to any applicable law or regulation. The Company may not withhold any
sums under any circumstances from any amounts payable under this Agreement as
Accrued Obligations, Accrued Investments or Accrued Bonuses to Executive beyond
the date due.
(e) Executive's or the Company's failure to insist upon strict
compliance with any provision of this Agreement or the failure to assert any
right the Executive or the Company may have hereunder shall not be deemed to be
a waiver of such provision or right or any other provision or right of this
Agreement.
(f) The Executive acknowledges that money damages would be both
incalculable and an insufficient remedy for a breach of Section 6 or 9 by the
Executive and that any such breach would cause the Company irreparable harm.
Accordingly, the Company, in addition to any other remedies at law or in equity
it may have, shall be entitled, without the requirement of posting of bond or
other security, to equitable relief, including injunctive relief and specific
performance, in connection with a breach of Section 6 or 9 by the Executive.
(g) The provisions of this Agreement constitute the complete
understanding and agreement between the parties with respect to the subject
matter hereof.
(h) This Agreement may be executed in two or more counterparts.
(i) Sections 6 and 9 of this Agreement shall survive the
termination of this Agreement.
<PAGE> 9
IN WITNESS WHEREOF, the Executive has hereunto set the
Executive's hand and, pursuant to the authorization from the Board of Directors
of the Company, the Company has caused this Agreement to be executed in its name
on its behalf, all as of the day and year first above written.
KENNETH J. CICHOCKI
/s/ KENNETH J. CICHOCKI
--------------------------------------
HOME INTERIORS & GIFTS, INC.
By: /s/ DONALD J. CARTER, JR.
----------------------------------
Name: Donald J. Carter, Jr.
Title: Chief Executive Officer
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