<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
-----------
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2000
-----------
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
incorporation or organization) Identification No.)
4055 VALLEY VIEW LANE, SUITE 500
DALLAS, TEXAS 75244
(Address of principal executive offices) (Zip Code)
(972) 386-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirement for the past 90 days. Yes [X] No [ ]
As of May 8, 2000, the registrant had outstanding 15,240,218 shares of
its common stock, $0.10 par value per share.
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<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, 1999 and
March 31, 2000 ...................................................... 3
Consolidated Statements of Operations and Comprehensive Income
for the three months ended March 31, 1999 and 2000 .................. 4
Consolidated Statements of Cash Flows for the three months ended
March 31, 1999 and 2000 ............................................. 5
Notes to Unaudited Interim Consolidated Financial Statements ........... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk ....... 14
PART II - OTHER INFORMATION
Item 1. Legal proceedings ................................................ 15
Item 6. Exhibits and Reports on Form 8-K ................................. 15
</TABLE>
2
<PAGE> 3
ITEM 1. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1999 AND MARCH 31, 2000
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
<TABLE>
<CAPTION>
ASSETS
DECEMBER 31, MARCH 31,
1999 2000
------------ ------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents ................................................. $ 32,406 $ 27,324
Accounts receivable, net .................................................. 13,885 13,873
Inventories ............................................................... 42,716 41,772
Deferred income tax benefit ............................................... 3,922 3,609
Other current assets ...................................................... 4,736 1,755
------------ ------------
Total current assets ................................................... 97,665 88,333
Property, plant and equipment, net ........................................ 30,473 46,480
Restricted cash ........................................................... 14,590 --
Investments ............................................................... 1,668 1,668
Debt issuance costs, net .................................................. 15,881 15,105
Other assets .............................................................. 1,264 1,273
------------ ------------
Total assets ........................................................... $ 161,541 $ 152,859
============ ============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current Liabilities:
Accounts payable .......................................................... $ 20,986 $ 20,023
Accrued seminars and incentive awards ..................................... 14,146 10,283
Royalties payable ......................................................... 9,771 4,989
Hostess prepayments ....................................................... 8,687 3,223
Income taxes payable ...................................................... 2,858 3,701
Current maturities of long-term debt and capital lease obligations ........ 27,308 28,559
Other current liabilities ................................................. 11,318 19,684
------------ ------------
Total current liabilities ........................................... 95,074 90,462
Long-term debt and capital lease obligations, net of current maturities ...... 428,238 420,794
Other liabilities ............................................................ 6,443 6,503
------------ ------------
Total liabilities ................................................... 529,755 517,759
------------ ------------
Minority interest ............................................................ 2,972 3,161
Commitments and contingencies
Shareholders' deficit:
Preferred stock, 10,000 shares authorized ................................. -- --
Common stock, par value $0.10 per share, 75,000,000 shares
authorized, 15,240,218 shares issued and outstanding ................... 1,524 1,524
Additional paid-in capital ................................................ 179,975 180,103
Accumulated deficit ....................................................... (552,726) (549,721)
Other ..................................................................... 41 33
------------ ------------
Total shareholders' deficit ......................................... (371,186) (368,061)
------------ ------------
Total liabilities and shareholders' deficit ......................... $ 161,541 $ 152,859
============ ============
</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 ENDED MARCH 31, 1999 AND 2000
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
1999 2000
-------- --------
<S> <C> <C>
Net Sales............................................ $116,748 $121,121
Cost of goods sold................................... 56,712 60,644
-------- --------
Gross Profit......................................... 60,036 60,477
Selling, general and administrative:
Selling............................................. 21,719 20,688
Freight, warehouse and distribution................. 11,133 12,665
General and administrative.......................... 6,214 10,021
Gains on the sale of assets......................... -- (2)
Stock option expense................................ 481 128
Restructuring expense............................... -- 1,027
-------- --------
Total selling, general and administrative....... 39,547 44,527
-------- --------
Operating Income..................................... 20,489 15,950
Other income (expense):
Interest income..................................... 774 621
Interest expense.................................... (11,261) (11,131)
Other income (expense), net......................... 70 (593)
-------- --------
Other income (expense), net.................... 10,417 11,103
-------- --------
Income before income taxes........................... 10,072 4,847
Income taxes......................................... 4,130 1,842
-------- --------
Net income........................................... 5,942 3,005
Cumulative translation adjustment................... 272 32
-------- --------
Comprehensive income................................. $ 6,214 $ 3,037
======== ========
</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 THREE MONTHS ENDED MARCH 31, 1999 AND 2000
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
1999 2000
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income ............................................. $ 5,942 $ 3,005
-------- --------
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization ......................... 907 976
Amortization of debt issuance costs ................... 776 776
Provision for doubtful accounts ....................... 317 376
Provision for losses on inventories ................... -- 198
Gains on the sale of assets ........................... -- (2)
Stock option expense .................................. 481 128
Equity in earnings of an affiliate .................... (42) --
Deferred tax expense (benefit) ........................ (499) 313
Minority interest ..................................... -- 59
Changes in assets and liabilities:
Accounts receivable .................................. (3,849) (353)
Inventories .......................................... (7,472) 746
Other current assets ................................. (735) 2,981
Other assets ......................................... 16 (221)
Accounts payable ..................................... (1,619) (963)
Income taxes payable ................................. 3,771 843
Other accrued liabilities ............................ 7,834 (5,636)
-------- --------
Total adjustments .................................. (114) 221
-------- --------
Net cash provided by operating activities .......... 5,828 3,226
-------- --------
Cash flows from investing activities:
Purchases of property, plant, and equipment ........... (1,259) (16,980)
Purchases of property, plant, and equipment by the
minority owner of Laredo Candle ...................... (249) (36)
Payments received on notes receivable ................. 2,151 189
Decrease in restricted cash ........................... -- 14,590
-------- --------
Net cash (used in) provided by investing
activities ........................................ 643 (2,237)
-------- --------
Cash flows from financing activities:
Capital contribution from the minority owner of
Laredo Candle ........................................ 280 130
Payments under the Senior Credit Facility ............. (14,186) (6,193)
-------- --------
Net cash used in financing activities .............. (13,906) (6,063)
-------- --------
Effect of cumulative translation adjustment ............ 272 (8)
-------- --------
Net decrease in cash and cash equivalents .............. (7,163) (5,082)
Cash and cash equivalents at beginning of year ......... 41,024 32,406
-------- --------
Cash and cash equivalents at end of period ............. $ 33,861 $ 27,324
======== ========
</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 in-home shows provide 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 27% of its products and purchases
the remainder of its product line from a select group of independent suppliers,
many of whom sell their products exclusively to the Company. The Company
expanded its operations internationally in 1995.
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 artwork 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. On February
1, 2000, the Company announced that it would combine its two separate
injection molding facilities into a single facility at GIA in Grand
Island, Nebraska. (See Note 5.)
o Laredo Candle Company, L.L.P. ("Laredo Candle"), which is owned 60% by
the Company, recently was established and began manufacturing candles
in late 1999.
o Subsidiaries of the Company 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 March 31, 1999 and 2000 in the accompanying
unaudited consolidated financial information were April 3, 1999 and April 1,
2000, respectively.
The consolidated financial information as of March 31, 2000 and for the
three months ended March 31, 1999 and 2000 is unaudited. In the opinion of
management, the accompanying unaudited consolidated financial information and
related notes thereto contain all adjustments, consisting only of normal,
recurring adjustments, necessary to present fairly the Company's consolidated
financial position as of March 31, 2000, and its operating results,
comprehensive income and cash flows for the three months ended March 31, 1999
and 2000. 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.
6
<PAGE> 7
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
3. INVENTORIES
Inventories consisted of the following as of December 31, 1999 and
March 31, 2000 (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1999 MARCH 31, 2000
------------------ --------------
(UNAUDITED)
<S> <C> <C>
Raw materials .............................. $ 7,085 $ 8,102
Work in process ............................ 2,598 1,878
Finished goods ............................. 33,033 31,792
------------------ --------------
$ 42,716 $ 41,772
================== ==============
</TABLE>
As of December 31, 1999 and March 31, 2000, raw materials include an
allowance of $593,000 and $481,000 for obsolete materials, and finished goods
include a net realizable value provision of $749,000 at the end of each period
presented.
4. OTHER CURRENT LIABILITIES
Other current liabilities consisted of the following as of December
31, 1999 and March 31, 2000 (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1999 MARCH 31, 2000
------------------ --------------
(UNAUDITED)
<S> <C> <C>
Interest payable ........................... $ 2,289 $ 6,750
Accrued compensation ....................... 2,803 4,238
Employee benefit plan contributions ........ 1,190 1,356
Sales tax payable .......................... 2,644 3,622
Other current liabilities .................. 2,392 3,718
------------------ --------------
$ 11,318 $ 19,684
================== ==============
</TABLE>
5. CONSOLIDATION OF HOMCO INTO GIA
On February 1, 2000, the Company announced that it would combine its
Homco manufacturing operations with GIA's operations. On April 1, 2000, the
Company discontinued operations at the Homco manufacturing and warehouse
facility in McKinney, Texas and transferred operations to GIA in Grand Island,
Nebraska. The Company has estimated that it will incur approximately $1,027,000
of non-recurring costs related to the combination of Homco's operations into
GIA. This charge is reflected as restructing expense in the accompanying
statement of operations for the three months ended March 31, 2000.
7
<PAGE> 8
HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
6. SEGMENT REPORTING
The Company's reportable segments are based upon functional lines of
business as follows:
o Home Interiors ("HI") - direct seller of home decorative accessories
in the United States;
o Manufacturing - manufactures framed artwork and mirrors, as well as
various types of molded plastic products and candles, for Home
Interiors; and
o International - direct seller of home decorative accessories in Mexico
and Puerto Rico.
The Company evaluates the performance of its segments and allocates
resources to them based on earnings before interest, taxes, depreciation and
amortization, less gains on the sale of assets, plus stock option expense and
restructuring expense ("EBITDA"). The accounting principles of the segments are
the same as those described in Note 2. Segment data includes intersegment sales.
Eliminations consist primarily of intersegment sales between Manufacturing and
HI, as well as the elimination of the investment in each subsidiary for
consolidated purposes. The table below presents information used by the chief
operating decision-maker about reportable segments of the Company as of and for
the three months ended March 31 (in thousands):
<TABLE>
<CAPTION>
HI MANUFACTURING INTERNATIONAL ELIMINATIONS CONSOLIDATED
------------- ------------- ------------- ------------ ------------
1999
- ----
<S> <C> <C> <C> <C> <C>
Net sales $ 116,443 $ 25,085 $ 1,493 $ (26,273) $ 116,748
EBITDA 16,853 6,035 (86) (925) 21,877
Total assets 132,040 32,549 (482) (28,698) 135,409
Capital expenditures(1) 733 525 1 -- 1,259
2000
- ----
Net sales $ 120,093 $ 20,479 $ 2,837 $ (22,288) $ 121,121
EBITDA 13,946 3,756 66 311 18,079
Total assets 148,357 34,873 (237) (30,134) 152,859
Capital expenditures(1) 16,696 272 12 -- 16,980
</TABLE>
(1) Additional capital expenditures of $249,000 and $36,000 were paid by the
minority owner of Laredo Candle in the three months ended March 31, 1999 and
2000.
The following table represents a reconciliation of consolidated
EBITDA to income before income taxes for the three months ended March 31
(in thousands):
<TABLE>
<CAPTION>
1999 2000
------------ ------------
<S> <C> <C>
EBITDA ............................................... $ 21,877 $ 18,079
Depreciation and amortization ........................ (907) (976)
Gains on the sale of assets .......................... -- 2
Stock option expense ................................. (481) (128)
Restructing expense .................................. -- (1,027)
Interest income ...................................... 774 621
Interest expense ..................................... (11,261) (11,131)
Other income (expense), net .......................... 70 (593)
------------ ------------
Income before income taxes ........................... $ 10,072 $ 4,847
============ ============
</TABLE>
7. RECENTLY ISSUED STATEMENT OF FINANCIAL ACCOUNTING STANDARDS
In June 1999, the Financial Accounting Standards Board voted to delay
the effective date for implementation of Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities." The new standard is effective for fiscal years beginning after June
15, 2000. The Company will adopt this new standard in the first quarter of
fiscal 2001 and it has not yet determined the effect the new standard will have
on its financial statements.
8
<PAGE> 9
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, 1999, 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.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere in this report
constitute forward-looking statements. These statements involve known and
unknown risks, uncertainties and other factors that may cause the Company's
actual results to be materially different from any future results expressed or
implied by such forward-looking statements.
In some cases, forward-looking statements are identified by
terminology such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "potential" or "continue" or the negative
of such terms or other comparable terminology.
All of these forward-looking statements are based on estimates and
assumptions made by management of the Company which, although believed to be
reasonable, are inherently uncertain. Therefore, undue reliance should not be
placed upon such statements. No assurance can be given that any of such
estimates or statements will be realized and actual results may differ
materially from those contemplated by such forward-looking statements. Factors
that may cause such differences include: (i) 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) the success of the Company's new
program designed to better reward hostesses ("Hostesses") of home shows
conducted by Displayers; and (viii) unexpected delays or problems associated
with integration and implementation of the Company's automated order fulfillment
system. Many of these factors will be beyond the control of the Company.
Moreover, neither the Company nor any other person assumes
responsibility for the accuracy and completeness of such statements. The
Company is under no duty to update any of the forward-looking statements after
the date of this Form 10-Q to conform such statements to actual results.
COMPANY BACKGROUND
The Company believes it is the largest direct seller of home
decorative accessories in the United States, as measured by sales. The Company's
sales are dependent upon the number of Displayers selling the Company's
products and their resulting productivity. As of March 31, 2000, the Company
sold its products to approximately 64,700 active Displayers located in the
United States; the Company is also represented in Mexico and Puerto Rico.
Displayer productivity also fluctuates from time to time based on length of
service, training, seasonality and special marketing programs, which offer
Displayers new incentives and discounts timed to generate additional sales. The
Company offers a variety of discounts and incentives to Displayers. The amount
and timing of discounts and incentives vary from year to year. The cost of
discounts is reflected in the Company's net sales while the cost of incentives
is reflected in selling expense.
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 42% during the last three
years. The Company believes that new Displayers are generally among the least
productive Displayers and that the majority of Displayers whose status as
Displayers terminates 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.
Historically, the Company has benefited from relatively stable gross
profit and operating profit margins. 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.
During 1999, the Company initiated a plan to broaden its product line with new
product categories which are targeted to appeal to a broader market. The
Company also is reviewing its pricing policies and, in the future, may purchase
a larger percentage of products directly from overseas vendors, which the
Company believes will improve its gross profit margins. The Company experienced
significant manufacturing inefficiencies in the latter half of 1999 and in the
first quarter of
9
<PAGE> 10
2000. While the manufacturing inefficiencies have been identified and
corrective cost reduction actions have been taken, the Company believes that,
primarily as a result of continued volume declines, margin deterioration will
continue in 2000.
The Company delivers its products to Displayers via common carrier,
UPS 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 shipping charges 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, 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.
In March 2000, the Company implemented a new Hostess program. The new
Hostess program enables Hostesses to select merchandise from the entire product
line rather than from a limited number of exclusive Hostess products offered
under the previous Hostess program. Hostesses of shows that meet certain sales
thresholds receive products with a value equal to 20% of the sales generated at
the show. The Company's product line under the previous Hostess program included
an exclusive line of non-commissionable, low-margin Hostess products. Because
the Company altered the product mix covered by the new Hostess program to
include one complete line of higher-margin, commissionable merchandise, the
Company expects that the new Hostess program will result in higher gross profit
margins for the Company, as well as higher selling expenses. In addition, as of
March 2000, the Company no longer sells Hostess merits, which will result in an
increase in general and administrative expenses due to a reduction in income
from unredeemed Hostess merits. The Company believes that, in addition to
simplifying the sales process, the new Hostess program will also benefit
Displayers by increasing the product selection for Hostesses and customers.
While the Company believes that the new Hostess program benefits Displayers,
Hostesses and customers in numerous ways, the Company also realizes that
training its Displayers on how to market the new Hostess program is critical. As
a result, the Company plans to devote a substantial amount of resources during
the remainder of 2000 to effectively train its Displayers in the new Hostess
program.
RESULTS OF OPERATIONS
The Three Months Ended March 31, 2000 Compared to the Three Months
Ended March 31, 1999
Net sales. Net sales increased $4.4 million, or 3.7%, to $121.1
million in the three months ended March 31, 2000 from $116.7 million in the
comparable period in 1999. This growth primarily was attributable to an
increase in the number of orders shipped, up 7.6% to 217,137 orders in the
three months ended March 31, 2000 from 201,875 orders shipped in the comparable
period in 1999. This growth more than offset a 4.6% reduction in the average
order size of $545 in the three months ended March 31, 2000 from $571 in the
comparable period in 1999. The change in composition and growth of the Displayer
network is a major factor in the overall sales production; the average number of
Displayers increased 30.9% to 66,500 in the three months ended March 31, 2000
from 50,800 in the comparable period in 1999. Growth in the Displayer base
resulted in an increased percentage of less experienced and, therefore, less
productive sales representation. Additionally, the Company experienced an
unusual increase in sales immediately prior to the implementation of the new
Hostess program in March 2000 as Hostesses redeemed their outstanding merits for
low-margin, non-commissionable Hostess merchandise. The Company expects that
the trend of more orders shipped and lower order sizes, each as compared to
comparable historical periods, will continue throughout 2000 as a result of the
factors discussed above.
Gross profit. Gross profit remained flat at $60.5 million in the three
months ended March 31, 2000 and $60.0 million in the comparable period in 1999.
As a percentage of net sales, gross profit declined to 49.9% in the 2000 period
from 51.4% in the 1999 period. While the Company has benefited from the
introduction of new products with higher margins, manufacturing inefficiencies
experienced in the latter half of 1999 continued in the first quarter of 2000.
Most of the inefficiencies were related to product mix and low production
volumes. While the manufacturing inefficiencies have been identified and
corrective cost reduction actions have been taken, volume declines have
continued. In response to these issues, the Company consolidated its Homco
operations with its GIA operations to maximize operational efficiency and to
absorb underutilized capacity that existed in its molded plastic manufacturing
operations. The Company expects that the consolidation will generate new
efficiencies in the production of molded plastic products. The Company made
additional selective temporary and permanent work-force reductions in the first
quarter of 2000 at DWC, GIA and Laredo Candle. In spite of the measures already
taken to reduce costs, the Company expects that it may incur additional margin
deterioration in 2000 as a result of these manufacturing related issues,
primarily as a result of lower volumes.
10
<PAGE> 11
Selling expense. Selling expense decreased $1.0 million, or 4.7%, to
$20.7 million in the three months ended March 31, 2000 from $21.7 million in the
comparable period in 1999. As a percentage of net sales, selling expense
decreased to 17.1% in the 2000 period from 18.6% in the 1999 period. This
decrease was primarily attributable to lower reimbursed selling expenses,
reduced incentive costs and lower bonus accrual for directors. The Company
anticipates that the trend of lower incentive costs will continue throughout
2000 in line with the Company's intention to rely less on an incentive-driven
sales strategy. The reduced level of expenses more than offset an increase in
royalties paid, which began to increase in March 2000 in connection with the
new Hostess program when substantially all products were made commissionable.
Freight, warehouse and distribution expense. Freight, warehouse and
distribution expense increased $1.6 million, or 13.8%, to $12.7 million in the
three months ended March 31, 2000 from $11.1 million in the comparable period
in 1999. These costs were 10.5% of net sales in the 2000 period compared to
9.5% in the 1999 period. This increase was due primarily to higher warehouse
and distribution expense in the 2000 period due to non-recurring facility costs
and an increase in the number of orders shipped, which requires additional
labor to service the higher level of ordering activity. The Company expects
that the trend of higher operating costs will continue throughout 2000 until
all of its warehouse and distribution centers have been consolidated, the
automated order fulfillment system is fully operational and integration is
complete.
General and administrative expense. General and administrative expense
increased $3.8 million, or 61.3%, to $10.0 million in the three months ended
March 31, 2000 from $6.2 million in the comparable period in 1999. This
increase was primarily due to higher costs related to personnel and
professional fees, payment of credit card fees in connection with Home Online
orders and other credit card transactions, increased depreciation and
amortization expense, a reduction in income from unredeemed Hostess merits, and
rent for the Company's new corporate headquarters, which began in January 2000.
Sales force growth and modernization of the Company's computer systems required
the Company to hire additional employees with specialized skills, which
contributed to higher personnel costs.
Restructuring expenses. Restructuring expenses consist of
non-recurring costs related to the combination of Homco operations into GIA in
the three months ended March 31, 2000.
Other income (expense). Other income (expense) included an adjustment
to expense in the three months ended March 31, 2000 of approximately $406,000 to
adjust to market the knockout and option provisions of the Company's interest
rate swap agreements.
Income taxes. Income taxes decreased $2.3 million, or 55.4%, to $1.8
million in the three months ended March 31, 2000 from $4.1 million in the
comparable period in 1999. Income taxes, as a percentage of income before income
taxes, decreased to 38.0% in the 2000 period from 41.0% in the 1999 period. The
Company believes that the effective income tax rate in the 2000 period will be
consistent with its effective income tax rate for the year ended December 31,
2000.
SEGMENT PROFITABILITY
The Company's reportable segments include its domestic direct sales
business, its manufacturing operations and its international business. The
manufacturing operations sell substantially all of their products to the
Company. As a result, manufacturing sales generally follow the Company's
domestic sales trend. International operations include direct sales by
Displayers in Mexico and Puerto Rico. International sales are directly
attributable to the number of international Displayers the Company has selling
its products. The Company's chief operating decision-maker monitors each
segment's profitability primarily on the basis of EBITDA performance. See Note
6 to Unaudited Interim Consolidated Financial Statements.
Consolidated net sales increased $4.4 million, or 3.7%, to $121.1
million in the three months ended March 31, 2000 from $116.7 million in the
comparable period of 1999 due to the $3.6 million increase in the Company's
domestic direct sales. International sales increased $1.3 million, or 87.1%, to
$2.8 million in the three months ended March 31, 2000 from $1.5 million in the
comparable period of 1999 due to expansion of the international Displayer
network. Manufacturing related sales in the three months ended March 31, 2000
decreased $4.6 million, or 18.4%, to $20.5 million in the three months ended
March 31, 2000 from $25.1 million in the comparable period of 1999 primarily due
to volume declines in wood-framed prints and plastic products as a result of a
higher percentage of candle sales relative to overall sales in the 2000 period.
Consolidated EBITDA decreased $3.8 million, or 17.4%, to $18.1 million
in the three months ended March 31, 2000 from $21.9 million in the comparable
period of 1999 primarily due to higher general and administrative costs in the
Company's domestic direct sales business and manufacturing
11
<PAGE> 12
inefficiencies in the 2000 period. Manufacturing related EBITDA decreased $2.2
million, or 37.8%, to $3.8 million in 2000 from $6.0 million in 1999 primarily
due to lower production volumes and product mix. International EBITDA is not
significant.
SEASONALITY
The Company's business is influenced by the Christmas holiday season and by
promotional events. Historically, a higher portion of the Company's sales and
net income have been realized during the fourth quarter, and net sales and net
income have generally been slightly lower during the first quarter as compared
to the second and third quarters. Working capital requirements also fluctuate
during the year. They reach their highest levels during the third and fourth
quarters as the Company increases its inventory for the peak season. In addition
to the Company's peak season fluctuations, quarterly results of operations may
fluctuate depending on the timing of, and amount of sales from, discounts,
incentive promotions and/or the introduction of new products. As a result, the
Company's business activities and results of operations in any quarter are not
necessarily indicative of any future trends in the Company's business.
LIQUIDITY AND CAPITAL RESOURCES
The Company has satisfied its historical requirements for capital through
cash flow from operations. As a result of the 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 decreased $2.6 million to $3.2 million
in the three months ended March 31, 2000 from $5.8 million in the comparable
period in 1999.
The Company estimates that its capital expenditures for the year ended
December 31, 2000 will increase significantly compared to 1999. In February
2000, the Company purchased an undivided 69% interest in a new warehouse and
distribution facility for $14.7 million with the restricted cash proceeds
received from the sale of substantially all of its owned properties and
facilities in the Dallas area in December 1999. The Company's purchase of the
undivided 69% interest in the new warehouse and distribution facility
represented a signification portion of the $17.0 million of capital expenditures
in the three months ended March 31, 2000. The Company is scheduled to purchase
the remaining undivided 31% interest in the new warehouse and distribution
facility no later than May 26, 2000, for approximately $6.7 million.
Additionally, the Company expects to incur approximately $1.2 million in
improvements to construct office space in the warehouse and distribution
facility, which is expected to be completed by June 2000.
The Company will use an automated order fulfillment system in the new
warehouse and distribution facility, which is expected to cost approximately
$11.0 million. The Company incurred $1.2 million in costs associated with the
automated order fulfillment system in 1999, $900,000 in the three months ended
March 31, 2000, and entered into a capital lease obligation of $6.2 million
for certain automated equipment in April 2000. The Company expects to incur
the remaining $2.7 million during the three months ended June 30, 2000 when the
automated order fulfillment system becomes operational.
The Company spent approximately $740,000 on its computer system and
Internet capabilities in the first three months of 2000. The Company has
engaged Vectrix.com, an e-commerce consulting firm, to assist the Company in
enhancing its Internet capabilities, including improvements to the Home Online
order entry system for Displayers. The Company plans to complete the initial
phase of its e-commerce strategy with Vectrix, which consists primarily of
enhancements to the business-to-business application, by September 1, 2000, at
a cost of approximately $2.0 million. The Company currently expects to spend
approximately $10.0 million on its computer system and Internet related
strategy over the entire year.
Payments on the Notes and the Senior Credit Facility represent significant
cash requirements for the Company. Interest payments on the Notes commenced in
December 1998, and will continue semi-annually until the Notes mature in 2008.
Borrowings under the Senior Credit Facility require quarterly interest and
principal payments. In addition, the Senior Credit Facility includes $40.0
million of revolving loans (the "Revolving Loans"), which mature on June 30,
2004. The Revolving Loans remained undrawn as of March 31, 2000.
The Company paid a total of $12.0 million in debt service for the three
months ended March 31, 2000, consisting of principal payments under the Senior
Credit Facility of $6.2 million and interest under the Senior Credit Facility
of approximately $5.8 million. The Company anticipates that its debt service
requirements will total approximately $68.3 million in 2000, consisting of
principal payments due under the Senior Credit Facility of
12
<PAGE> 13
approximately $27.2 million, interest due under the Senior Credit Facility of
approximately $20.8 million and interest of approximately $20.3 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 will
be required to make certain mandatory prepayments of the term loans on an
annual basis. The Company prepaid $7.7 million on the term loans as of March
31, 1999. The Company was not required to make a mandatory prepayment on March
31, 2000. The Revolving Loans remained undrawn as of March 31, 2000. However,
as a result of the timing and the magnitude of working capital requirements and
capital expenditures, the Company may have to utilize the Revolving Loans at
varying times during 2000, primarily to meet working capital needs and to make
capital expenditures. The Company anticipates that use of the Revolving Loans,
if any, will be on a short-term basis.
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 uses derivative financial instruments. The
Company does not use derivative financial instruments for speculative or trading
purposes. The Company's international operations are not significant, and as a
result, changes in foreign currency exchange rates do not have a material effect
on the Company. There are no material quantitative changes in market risk
exposure as of March 31, 2000 when compared to December 31, 1999.
ENVIRONMENTAL ISSUES
In 1989, DWC was named as a potentially responsible party ("PRP") based on
alledgedly 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, 1998, 1999
or in the three months ended March 31, 2000. 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 Company believes that the probability that Homco will be
required to pay more than a de minimis amount is remote.
13
<PAGE> 14
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, that the total
cost of resolving such contingencies should not have a material adverse effect
on the Company's business, financial condition and results of operations.
RECENTLY ISSUED STATEMENT OF FINANCIAL ACCOUNTING STANDARDS
In June 1999, the Financial Accounting Standards Board voted to delay
the effective date for implementation of Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities." The new standard is effective for fiscal years beginning after June
15, 2000. The Company will adopt this new standard in the first quarter of
fiscal 2001 and it has not yet determined the effect the new standard will have
on its financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The Securities and Exchange Commission requires that registrants
include information about potential effects of changes in interest rates and
currency exchange in their financial statements. Refer to information appearing
under the subheading "Market-Sensitive Instruments and Risk Management" under
"Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations," which information is hereby incorporated by reference
into this Item 3. All statements other than historical information incorporated
into this Item 3 are forward-looking statements. The actual impact of future
market changes could differ materially due to, among other things, the factors
discussed in this report.
14
<PAGE> 15
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Environmental Issues" for information regarding legal
proceedings which is incorporated herein by reference.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit Number Description
(27) Financial Data Schedule
(b) Reports on Form 8-K
None.
15
<PAGE> 16
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: May 8, 2000
16
<PAGE> 17
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-2000
<CASH> 27,324
<SECURITIES> 0
<RECEIVABLES> 15,466
<ALLOWANCES> 1,593
<INVENTORY> 41,772
<CURRENT-ASSETS> 88,333
<PP&E> 82,243
<DEPRECIATION> 35,762
<TOTAL-ASSETS> 152,859
<CURRENT-LIABILITIES> 93,623
<BONDS> 0
0
0
<COMMON> 1,524
<OTHER-SE> (369,585)
<TOTAL-LIABILITY-AND-EQUITY> 152,859
<SALES> 121,121
<TOTAL-REVENUES> 121,121
<CGS> 60,644
<TOTAL-COSTS> 105,171
<OTHER-EXPENSES> 28
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 11,131
<INCOME-PRETAX> 4,847
<INCOME-TAX> 1,842
<INCOME-CONTINUING> 3,005
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,005
<EPS-BASIC> 0
<EPS-DILUTED> 0
</TABLE>
