**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**






**FORM
      10-K**


**(Mark
      One)**




x
            **ANNUAL
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**





**For
      the fiscal year ended December 31, 2006**





o
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE****SECURITIES
                EXCHANGE ACT OF 1934**





**For
      the transition period from ____________** **to
      _____________**





**Commission
      File Number: 0-24439**





**HINES
      HORTICULTURE, INC.**


**(Exact
      name of registrant as specified in its charter)**






**Delaware**
            
            **33-0803204**(State
                or other jurisdiction of
            
            (I.R.S.
                Employerincorporation
                or organization)
            
            Identification
                Number)





**12621
      Jeffrey Road, Irvine, California 92620**


**(Address
      of principal executive offices) (Zip Code)**





**(949)
      559-4444**


http://www.HinesHorticulture.com





**** Securities
      registered pursuant to Section 12(b) of the Act:





Title
                of each class
            Name
                of each exchange on which registeredCommon
                Stock, par value $0.01 per share
            NASDAQ
                Global Market





Securities
      registered pursuant to Section 12(g) of the Act: None





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act. Yes  No X .





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or 15(d) of the Act.     
Yes  No X .





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
      during the preceding 12 months (or for such shorter period that the
      registrant was required to file such reports), and (2) has been subject to
      such filing requirements for the past 90 days. Yes __ No X
      .





Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K (§229.405 of this chapter) is not contained herein, and will
      not be contained, to the best of registrant’s knowledge, in definitive proxy or
      information statements incorporated by reference in Part III of this
      Form 10-K or any amendment to this
      Form 10-K. (   )





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
      (Check One).


Large
      accelerated
      filer    Accelerated
      filer    Non-accelerated
      filer X .





Indicate
      by check mark whether the registrant is a shell company (as defined in
      Rule 12b-2 of the Act). Yes  No X .





As
      of
      June 30, 2006, the aggregate market value of the registrant’s voting common
      stock held by non-affiliates of the registrant was approximately $36.1
      million.





As
      of
      June 22, 2007, there were 22,072,549 shares of Common Stock
      outstanding.








HINES
      HORTICULTURE, INC.





TABLE
      OF
      CONTENTS







**Page****No.****PART
                I**ITEM
                1.
            BUSINESS
            6ITEM
                1A.
            RISK
                FACTORS
            11ITEM
                1B.
            UNRESOLVED
                STAFF COMMENTS
            19ITEM
                2.
            PROPERTIES
            19ITEM
                3.
            LEGAL
                PROCEEDINGS
            20ITEM
                4.
            SUBMISSION
                OF MATTERS TO A VOTE OF SECURITY HOLDERS
            20**PART
                II**ITEM
                5.
            MARKET
                FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDERMATTERS
                AND ISSUER PURCHASES OF EQUITY SECURITIES
            20ITEM
                6.
            SELECTED
                FINANCIAL DATA
            23ITEM
                7.
            MANAGEMENT’S
                DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
                OPERATIONS
            25ITEM
                7A.
            QUANTITATIVE
                AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
            38ITEM
                8.
            FINANCIAL
                STATEMENTS AND SUPPLEMENTARY DATA
            38ITEM
                9.
            CHANGES
                IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
                DISCLOSURE
            40ITEM
                9A.
            CONTROLS
                AND PROCEDURES
            40ITEM
                9B.
            OTHER
                INFORMATION
            41**PART
                III**ITEM
                10.
            DIRECTORS,
                EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
            43ITEM
                11.
            EXECUTIVE
                COMPENSATION
            46ITEM
                12
            SECURITY
                OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
                STOCKHOLDER MATTERS
            58ITEM
                13.
            CERTAIN
                RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
                INDEPENDENCE
            59ITEM
                14.
            PRINCIPAL
                ACCOUNTING FEES AND SERVICES
            60**PART
                IV**ITEM
                15.
            EXHIBITS,
                FINANCIAL STATEMENT SCHEDULES
            61SIGNATURES
            
            66







**HINES
      HORTICULTURE, INC.**





**CAUTIONARY
      STATEMENT FOR PURPOSES OF THE SAFE HARBOR PROVISIONS OF THE**


**PRIVATE
      SECURITIES LITIGATION REFORM ACT OF 1995**





This
      report contains forward-looking statements. Hines Horticulture, Inc. desires
      to
      take advantage of the safe harbor provisions of the Private Securities
      Litigation Reform Act of 1995 and is including this statement for the express
      purpose of availing itself of the protections of the safe harbor with respect
      to
      all forward-looking statements. Several important factors, in addition to the
      specific factors discussed in connection with such forward-looking statements
      individually, could affect the future results of Hines Horticulture, Inc. and
      could cause those results to differ materially from those expressed in the
      forward-looking statements contained herein.





Hines
      Horticulture, Inc.’s estimated or anticipated future results, products and
      service performance or other non-historical facts are forward-looking and
      reflect our management’s current perspective of existing trends and information.
      These statements involve risks and uncertainties that cannot be predicted or
      quantified and, consequently, actual results may differ materially from those
      expressed or implied by such forward-looking statements. Such risks and
      uncertainties include, among others, the continued ability of Hines
      Horticulture, Inc. to access water, the impact of growing conditions, risks
      associated with customer concentration, adverse weather conditions, seasonality,
      government regulations, loss of key employees, general economic conditions,
      general agricultural risks including risks associated with plant disease and
      pests and sudden oak death, increases in operating costs, the impact of
      competition, the ability to obtain future financing or to satisfy payment
      obligations under existing financing, limitations resulting from Hines
      Horticulture, Inc.’s substantial leverage and debt restrictions and other risks
      and uncertainties described below in the section entitled “Risk Factors” and in
      Hines Horticulture, Inc.’s other Securities and Exchange Commission (“SEC”)
      filings.





Therefore,
      Hines Horticulture, Inc. wishes to caution each reader of this report to
      consider carefully these factors as well as the specific factors discussed
      with
      each forward-looking statement in this report and disclosed in its filings
      with
      the Securities and Exchange Commission as such factors, in some cases, have

      affected, and in the future (together with other factors) could affect, the
      ability of Hines Horticulture, Inc. to implement its business strategy and
      may
      cause actual results to differ materially from those contemplated by the
      statements expressed herein.





We
      assume
      no obligation to update any of the forward-looking statements after the date
      of
      the Form 10-K.





We
      maintain an Internet website at http://www.hineshorticulture.com (this
      uniform resource locator, or URL, is an inactive textual reference only and
      is
      not intended to incorporate our website into this Form 10-K). We file our
      reports with the Securities and Exchange Commission and make available,
      free of charge, on or through this website, our annual reports on Form 10-K,
      quarterly reports on Form 10-Q, current reports on Form 8-K, proxy and
      information statements and amendments to these reports filed or furnished
      pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934,
      as
      amended, as soon as reasonably practicable after we electronically file such
      material with, or furnish it to, the SEC. Our reports filed with, or furnished
      to, the SEC are also available directly at the SEC’s website at http://www.sec.gov .





Any
      of
      the materials we file with the SEC may also be read and copied at the SEC's
      Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information
      on
      the operation of the SEC's Public Reference Room may be obtained by calling
      the
      SEC at 1-800-SEC-0330. The SEC maintains an Internet website that contains
      reports, proxy and information statements, and other information regarding
      issuers that file electronically with the SEC at http://www.sec.gov .


2


**EXPLANATORY
      NOTE**


**Restatement
      of Consolidated Financial Statements**





In
      connection with the preparation of our consolidated financial statements for
      the
      year ended December 31, 2006, we identified errors which affected the full
      year and each of the fiscal quarters of 2004 and 2005 and the first, second
      and third quarters of 2006, as discussed below.





We
      are
      restating herein the following consolidated financial
      statements:


·
            our
                consolidated balance sheet as of December 31, 2005;
                and


·
            our
                consolidated statements of operations, shareholders’ equity and cash flows
                for the years ended December 31, 2005 and
                2004.





For
      each
      of the errors presented below, the corrections to 2004 have only been reflected
      in our full year consolidated financial statements contained herein. The errors
      that affected the quarters in 2006 and 2005 have been corrected in our
      amended Quarterly Reports on Form 10-Q/A for each of the first three quarters
      of
      2006, which are being filed concurrently with this Form 10-K .


**Inventory
        Costs**
 We
          determined that certain materials and supplies were incorrectly capitalized
          as a
          component of nursery stock after the related inventory was sold, thereby
          misstating inventory and costs of goods sold for the full year and each of
          the quarters of 2004 and 2005 and the first, second and third quarters
          of 2006.
          These materials and supplies should have been relieved to cost of goods
          sold as
          the related inventory was sold. The correction to reduce inventory balances
          resulted in lower cost of goods sold in subsequent periods as the nursery
          stock
          was sold.
  The
          effect of the correction of this error in the consolidated balance sheet
          as of
          December 31, 2004 was a decrease in inventory of approximately $5.1 million.
          The
          effect of the correction of this error in the consolidated statement of
          operations for the year ended December 31, 2004 was an increase in cost
          of goods
          sold of approximately $5.1 million. In addition, in 2004, the Company corrected
          a misclassification of distribution costs resulting in an increase in
          distribution costs of $2.4 million and a corresponding decrease in cost
          of goods
          sold.
  The
          effect of the correction of this error in the consolidated balance sheet as
          of December 31, 2005 was a decrease in inventory of approximately $4.2
          million.
          The net effect of the correction of this error in the consolidated statement
          of
          operations for the year ended December 31, 2005 was a decrease in cost
          of goods
          sold of approximately $0.9 million, representing the net difference in
          the
          inventory error between 2004 and 2005.
  The
          net
          effect of the correction of this error for the first three quarterly periods
          in
          the year ended December 31, 2006 has been corrected in the amended Quarterly
          Reports on Form 10-Q/A for these three Quarterly Periods, which were filed
          on
          July 10, 2007.
  **Lower
          of Cost or Market Adjustment and Excessive Inventory Write
          Off**
 We
        determined that we should have recorded both a lower of cost or market
        adjustment for certain of our inventory and a write off of excess inventory
        in
        the third quarter of 2006 at our South Carolina facility. The lower of cost
        or
        market adjustment was caused by pricing pressures in the region as a result
        of
        increased competition and lost market share, which occurred in the third
        fiscal
        quarter of 2006. The lost market share also caused excess inventory at this
        facility. The effect of the correction of these two errors was an increase
        to
        cost of goods sold and a corresponding decrease in inventory of approximately
        $5.7 million for the third fiscal quarter of 2006. These errors have been
        corrected in our quarterly report on Form 10-Q/A for the third quarter of
        2006,
        which was filed on July 10, 2007.
 
 **Fixed
        Asset Impairment**
 Due
        to
        lost market share, as discussed above, in the market served by the our South
        Carolina facility, we determined that the expected undiscounted future cash
        flows at the South Carolina facility would not exceed the carrying value
        of its
        fixed assets. As a result, we determined that the fixed assets located at
        the
        South Carolina facility were impaired in the third quarter of 2006. The effect
        of the correction of this error was an increase in total operating expenses
        of
        $1.5 million and a corresponding decrease in fixed assets in the third quarter
        of 2006. This error has been corrected in our Quarterly Report on Form 10-Q/A
        for the third quarter of 2006, which was filed on July 10,
        2007.


3


**Sale
        of Properties in Miami and Vacaville**
 We
        sold
        certain properties located in our facilities in Miami, Florida and Vacaville,
        California in November 2005 and April 2006, respectively. We did not correctly
        record the transactions in accordance with Statement of Financial Accounting
        Standards (“SFAS”) No. 98, “Accounting for Leases,” as a financing transaction.
        The effect of the correction of this error in the June 30, 2006 and December
        31,
        2005 and in subsequent consolidated balance sheets was the recognition of a
        financing obligation of $63.7 million and $47.0 million, respectively,
        reinstatement of the carrying value of the properties sold of $7.6 million
        and
        $7.2 million, respectively, reclassification of deferred tax assets of $15.8
        million from non-current to current, and a decrease in deferred gain
        on land sale of $56.1 million and $39.9 million, respectively. The effect
        of the
        correction of this error in the consolidated statements of operations for
        the
        year ended December 31, 2006 is not material and there was no impact in
        2005. The effects of the correction of these errors in the June 30, 2006
        consolidated financial statements have been corrected in our Quarterly Report
        on
        Form 10-Q/A for the second quarter of 2006, which was filed on July 10,
        2007.
  **Workers’
        Compensation and Auto Insurance Accruals**


In
        connection with the preparation of our 2006
        consolidated financial statements, we discovered an error in the calculation
        of the workers’ compensation insurance and auto insurance accruals. This
        error affected the consolidated financial statements for the year ended December
        31, 2005 and the interim periods contained therein and also the first three
        quarters of 2006.




The
      effect of the correction of this error in the consolidated statement of
      operations for the year ended December 31, 2005 was a decrease in cost of
      goods sold of less than $0.1 million, a decrease in distribution
      expense of less than $0.1 million and a decrease in loss from
      discontinued operations of approximately $0.1 million. The effect of
      the correction of this error in the consolidated balance sheet as of December
      31, 2005 was a decrease to both inventory and liabilities of $0.1 million
      and $0.3 million, respectively. The effect of the correction of this error
      for the 2006 quarters is reflected in our amended Quarterly Reports on Form
      10-Q/A, which were filed on July 10, 2007.





**Asset
      Retirement Obligations Adjustment**


In
        connection with the preparation of our 2006
        consolidated financial statements, we discovered that we had not properly
        recorded asset retirement obligations or appropriately applied the transition
        rule of  SFAS No. 143, “Accounting for Asset Retirement
        Obligations,” for certain of the assets located at
        our Irvine, California facility.  The effect of the correction of this
        error was a cumulative-effect adjustment to retained earnings of $0.3
        million as of January 1, 2003. In applying the transition provisions of
        SFAS No. 143, there was no impact to the consolidated statements of operations
        or cash flows for the year ended December 31, 2003 or prior.




The
      effect of the correction of this error in each of the 2006 quarters has been
      corrected in our amended Quarterly Reports on Form 10-Q/A for the first three
      quarters of 2006, which were filed on July 10, 2007.





The
      effect of the correction of this error in the consolidated balance sheet as
      of December 31, 2005 was a decrease in net fixed assets of
      less than $0.1 million, an increase in liabilities of $0.4 million,
      and an increase in inventories of $0.1 million. The effect of the
      correction of this error in the consolidated statement of operations for
      the year ended December 31, 2005 was a decrease in cost of goods sold
      of less than $0.1 million.





The
      effect of the correction of this error in the consolidated balance sheet as
      of December 31, 2004 was an increase in net fixed assets of less
      than $0.1 million, an increase in liabilities of $0.3 million,
      and a decrease in inventory costs of $0.1 million. The effect of the
      correction of this error in the consolidated statement of operations for the
      year ended December 31, 2004 was an increase in cost of goods sold of less
      than $0.1 million.





A
      table
      set forth in Note 2 to the Consolidated Financial Statements summarizes the
      impact of the adjustments described above on the individual line items on our
      consolidated financial statements for the affected periods, as well as the
      discontinued operations discussed in Note 3 to the Consolidated Financial
      Statements on those line items.


4


Unless
      otherwise specified, all financial information contained in this report gives
      effect to the restatements of our consolidated financial statements for the
      errors described above in Note 2 to the Consolidated Financial Statements and
      the reclassifications for discontinued operations as described in Note 3 to
      the Consolidated Financial Statements. We have not amended, and we do not intend
      to amend, our previously filed Annual Reports on Form 10-K or Quarterly Report
      on Form 10-Q for each of the fiscal years and fiscal quarters of 2005 and 2004.
      Financial information included in our previously filed Annual Reports on Form
      10-K for the fiscal years ended December 31, 2005 and 2004, and Quarterly
      Reports on Form 10-Q for each of the quarters of 2005 and 2004, and for the
      first three quarters of 2006, should not be relied upon and are superseded
      by
      the information in this Annual Report on Form 10-K, and amended Quarterly
      Reports on Form 10-Q/A for the quarters ended March 31, June 30, and September
      30, 2006.





For
      the
      convenience of the reader, the following items in this Form 10-K contain
      disclosures related to the matters described in this explanatory
      note:





Part
      II -
      Item 6 - Selected Financial Data;


Part
      II -
      Item 7 - Management’s Discussion and Analysis of Financial Condition and Results
      of Operations;


Part
      II -
      Item 8 - Financial Statements and Supplementary Data; and


Part
      II -
      Item 9A - Controls and Procedures.


5


**PART
      I**





**ITEM
      1. BUSINESS**





**Introduction**





Hines
      Horticulture, Inc. (“Hines,” the “Company,” “we,” “our” or “us”), a Delaware
      corporation, produces and distributes horticultural products through its wholly
      owned subsidiary, Hines Nurseries, Inc. (“Hines Nurseries”). Unless otherwise
      specified, references to “Hines” or the “Company” refer to Hines Horticulture,
      Inc. and its subsidiary.





Hines
      is
      a leading national supplier of ornamental shrubs, color plants and
      container-grown plants with eight commercial nursery facilities located in
      Arizona, California, Oregon, South Carolina and Texas. Hines markets its
      products to retail and commercial customers throughout the United States. Hines
      produces approximately 5,900 varieties of ornamental shrubs and color plants.
      Hines sells to more than 1,180 retail and commercial customers, representing
      more than 6,670 outlets throughout the United States.




*Hines
        Fertilizer Sale*
 On
        July
        25, 2005, Hines Nurseries sold to a third party vendor substantially all of
        the assets of Hines Fertilizer, a wholly owned subsidiary of Hines Nurseries
        which was dissolved in November 2006, excluding cash, accounts receivables
        and
        intercompany receivables. The purchase price for the assets was approximately
        $0.6 million and was paid through the issuance of customer credits for past
        purchases. The gain on sale of assets was approximately $0.1 million. In
        accordance with the asset purchase agreement, the Company entered into a
        three
        year non-compete agreement, which restricts our ability to own and manage
        a
        competing fertilizer company. Upon a change in control of Hines Horticulture
        or
        Hines Nurseries, all non-compete restrictions shall cease and no longer be
        of
        any effect.


In
        August
        2006, the Company received approval from its Board of Directors to pursue
        the
        sale of its four nursery facilities located in the northeast and certain
        assets
        located in Miami, Florida in connection with the Company entering into the
        Third
        Amendment and Limited Waiver to Credit Agreement to its credit facility then
        in
        effect. As a result, the Company’s consolidated financial statements included in
        this Annual Report on Form 10-K and the disclosure contained herein reflect
        the
        financial position, results of operations and cash flows of the Company’s former
        operations of its Miami, Florida and four nursery facilities located in the
        Northeast as “discontinued operations.” In accordance with Statement of
        Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the
        Impairment or Disposal of Long-lived Assets,” the Company’s consolidated
        financial statements have been restated to reflect the financial position,
        results of operations and cash flows of the Miami, Florida and four Northeast
        facilities as “discontinued operations.” Asset sales relating to the Miami,
        Florida and the four Northeast facilities are described in more detail
        below.




*Miami Property
      Sale*


On
      November 7, 2005, the Company successfully completed the sale of 122 acres
      of
      unimproved property in Miami, Florida (“Miami Property Sale”) and received
      net proceeds of $47.0 million. In accordance with an amendment to our then
      existing senior credit facility (the “Old Senior Credit Facility”), the proceeds
      from the Miami Property Sale were used to payoff the entire outstanding
      balance of the term loan and the residual amount was used to pay down
      the revolving credit facility. As part of the Miami Property Sale, the Company
      entered into a two-year lease agreement with the buyer to lease the property
      while transitioning operations to other locations. The Company leased the entire
      property for a one-year period, with a thirty-day extension right, and then
      vacated approximately 33 acres. Pursuant to the first amendment to the lease,
      the Company will lease the remaining 89 acres until June 30, 2007. In addition,
      the buyer agreed to let us sublease the property for the remainder of the lease
      term. The Company pays the buyer rent of five hundred dollars per acre,
      annually, during the lease term plus fifty percent of the rent the Company
      receives from subleasing the property. In addition, the Company is entitled
      to
      additional amounts if the buyer is successful in obtaining zoning for a certain
      number of residential lots. The Company originally recognized the sale of the
      property and deferred the gain on the transaction; however, due to the Company’s
      continuing involvement in the property, in order to conform with the provisions
      of SFAS No. 98, the Company has reinstated the net book value of the
      assets, as well as recorded the proceeds received as a financing obligation
      in
      its consolidated balance sheet as of December 31, 2005. When the Company exits
      the lease on June 30, 2007, the Company will remove the net book value of the
      assets and expects to recognize a gain of approximately $39.9
      million.




6






In
        October 2006, the Company entered into asset purchase agreements and sold
        certain inventory, vehicles, equipment and other assets located at its Miami,
        Florida facility. Total proceeds from the sale of these assets were
        approximately $4.1 million, of which approximately $1.8 million was used
        to pay
        off outstanding lease obligations related to the assets which were sold.
        In
        connection with the sale, the Company ceased active operations at its Miami,
        Florida facilities.
  On
        October 30, 2006, the Company entered into a commercial contract to sell
        one of
        its two remaining real properties located in Miami, Florida. The sale of
        approximately 138 acres of land in Miami-Dade County, Florida and certain
        other
        assets of the Company which were identified during the buyer’s inspection and
        due diligence period closed on December 22, 2006. The sales price for the
        land
        and the other assets was approximately $12.2 million. The Company recorded
        a net
        gain of approximately $8.8 million from the sale of the 138 acres of land,
        which
        was recorded as a component of discontinued operations. On
        April
        18, 2007, the Company completed the sale of its last remaining parcel of
        land in
        Miami, Florida, which consisted of approximately 79 acres of land and certain
        improvements thereon, for approximately $7.2 million. The Company will record
        a
        net gain of approximately $2.5 million from the sale, which will be recorded
        as
        a component of discontinued operations in 2007.


Vacaville
      Property Sale


On
      March
      1, 2006, the Company received notice that Triad Communities, L.P. exercised
      its
      option to purchase, pursuant to the previously disclosed Option Agreement dated
      April 30, 2003 (“Option Agreement”), its 168-acre property in Vacaville,
      California. The total book value of assets related to the sale was
      approximately $0.5 million. The Option Agreement provided that the gross
      purchase price of the property be $15.1 million. On April 3, 2006, the
      Company sold the property for a net purchase price of $14.3
      million. Total proceeds from the Option Agreement and sale of the property
      were
      approximately $16.9 million, which included approximately $2.6 million in option
      payments previously received.




Under
        the
        terms of the Option Agreement, the Company is able to transition off
        the property in three phases from 2006 to 2008. The first phase of
        transition was completed on July 1, 2006 and consisted of 24 acres. The second
        phase of transition will be July 1, 2007 and the third phase of the transition
        will be July 1, 2008, and will consist of approximately 88 acres and 56 acres,
        respectively. The Company is continuing to develop replacement acreage and
        infrastructure at its 842-acre Winters South facility in Northern California.
        Because the Company is not paying rent, the Company is in a sale-leaseback
        with
        continuing involvement position with respect to this property. The Company
        originally recognized the sale of the property and deferred the gain on the
        Lagoon Valley property. However, in order to conform to SFAS No. 98, as of
        June
        30, 2006, the Company has reinstated the net book value of the assets and
        recorded the proceeds received as a financing obligation. When the Company
        completes the transition on July 1, 2008, the Company will remove the net
        book value of the assets and expects to recognize a gain of approximately
        $16.2
        million.




*Northeast
      Facilities*


On
      November 15, 2006, the Company entered into an asset purchase agreement and
      sold
      certain real property, inventory and other assets located at its nursery
      facility in Pipersville, Pennsylvania, including the right to purchase real
      property which was previously leased by the Company. The sales price was
      approximately $5.3 million, approximately $1.1 million of which was deferred
      as
      it is contingent upon certain entitlements for the construction of
      additional greenhouses on certain real property which was previously leased
      by
      the Company. The sale of these assets and real property resulted in a loss
      of
      approximately $1.2 million, which has been recorded as a component of
      discontinued operations.




On
      January 10, 2007, the Company completed the sale of certain real property,
      inventory and other assets located at the nursery facilities in Danville,
      Pennsylvania, Utica, New York and Newark, New York for approximately $6.7
      million. In connection with the sale, the Company terminated the leases for
      the
      real property comprising its Danville, Pennsylvania nursery facility.




**History**





*Ownership*





James
      W.
      Hines Sr. founded Hines in 1920 in San Gabriel, California. Hines was a family
      owned business until its acquisition by the Weyerhauser Company in 1976. Hines
      was sold in 1990 to a private investment group and certain members of our
      management. In August 1995, Hines was acquired by Madison Dearborn Capital
      Partners, L.P. (“MDCP”), a private equity investment firm and certain members of
      our management. On June 22, 1998, Hines completed an initial public offering
      of
      5.1 million shares of its Common Stock.


7


**Business
      Overview**





Hines
      is
      one of the largest commercial nursery operations in North America, producing
      one
      of the broadest assortments of container-grown plants in the industry. Hines
      sells its green goods primarily to the retail segment which includes the premium
      independent garden centers, as well as the leading home centers and mass
      merchandisers, such as The Home Depot, Lowe’s and Wal-Mart.





All
      information presented below relates to continuing operations, unless
      specifically identified.





Hines
      produces and markets approximately 5,900 varieties of ornamental,
      container-grown plants grown primarily for outdoor use, most of which are sold
      under its Hines NurseriesTM and IversonTM trade names. The Company grows most of
      its product categories at several of its nurseries. However, the Company
      emphasizes certain product categories at particular nurseries depending on
      the
      growing climate conducive to a particular product and on regional customer
      needs. Hines’ revenues falls into the following variety categories for the years
      ended December 31:





**Product
                Category**
            
            **Representative
                Products**
            
            **2006**
            
            **2005**
            
            **2004**Shrubs
            
            Azalea,
                boxwood, camellia, holly, conifers, hibiscus
            
            41%
            
            40%
            
            40%Flowering
                Color Plants
            
            Perennials,
                  annual bedding plants, tropical flowering plants, and
                  bulbs
            
            29
            
            33
            
            34Vines
            
            Gelsemium,
                clematis, campsis
            
            6
            
            5
            
            5Trees
            
            Pines,
                maples, magnolia
            
            5
            
            4
            
            5Topiary
            
            Plants
                pruned into special forms
            
            4
            
            5
            
            5Other
            
            Ornamental
                grass, hanging baskets, patio plants, holiday plants
            
            15
            
            13
            
            11100%
            
            100%
            
            100%





Since
      1993, Hines has added numerous plant varieties to its product line. Hines has
      also successfully developed patio-ready type products, which it markets under
      the names of Patio TropicsTM and Festival PotsTM. These products generally command
      premium prices and improved profit margins compared with other plants offered
      by
      the Company.





Plants
      (other than annual bedding plants) are produced by propagating young plants
      called “liners” using cuttings from mature plants. Using propagation techniques
      for each specific crop with respect to growing media, hormonal stimulation
      and
      growing conditions, these cuttings are cultivated into viable liners and are
      then transplanted into one gallon containers. These plants are placed in the
      nursery for six to 24 months until they reach certain specified sizes and levels
      of maturity, according to market demand, and are sold at different price points
      depending on their size and levels of maturity. During the field growing stages,
      plants are typically pruned by mechanized pruning machines that are designed
      for
      specific plant categories and watered and fertilized by integrated irrigation
      and fertilization systems, which are closely monitored and regulated to ensure
      consistency and quality.





The
      Company’s water and fertilizer recycling systems are designed to minimize the
      costs of these elements and maximize water conservation. Each of the Company’s
      facilities has infrastructure and procedures in place to protect its growing
      stock from most frost, snow and freezing conditions typically prevailing at
      these facilities.





To
      produce annual bedding plants, a nursery either buys and germinates seeds to
      produce small plants, called “plugs,” or purchases plugs from specialized plug
      producers. The plugs are then transplanted to bedding packs, gallon hanging
      baskets and containers of various sizes. The growth cycle of color plants is
      typically less than one year, with many color plants having a growing season
      as
      short as eight to 16 weeks, allowing certain of the Company’s nurseries to
      produce approximately three to four inventory turns per year. As with ornamental
      plants, the Company applies controlled watering and fertilizing in order to
      ensure high quality.


8


*Customers.* Our
      retail customers include home centers, mass merchandisers, independent garden
      centers and garden center chains. The following table sets forth the estimated
      percentage of Hines’ net sales by customer type for the period indicated:





**Years
                Ended December 31,****Customer
                Type**
            
            **2006**
            
            **2005**
            
            **2004**Home
                centers
            
            
            56%
            
            
            59%
            
            
            55%Mass
                merchandisers
            
            
            13
            
            
            11
            
            
            16Retail
                & independent garden centers
            
            
            19
            
            
            19
            
            
            19Grocery
                & hardware
            
            
            3
            
            
            3
            
            
            3Trade,
                government & others
            
            
            9
            
            
            8
            
            
            7Total
            
            
            100%
            
            
            100%
            
            
            100%





Our
      management believes the Company enjoys competitive advantages in selling into
      these channels due to its ability to provide a broad assortment of consistently
      high quality products in large volumes, its nationwide distribution and its
      value-added services such as custom labeling, bar-coding, full electronic data
      interchange and technical support. Our management expects to participate in
      the
      overall growth of these channels to a greater extent than its competitors that
      do not offer such services. Hines' top three customers accounted for
      approximately 68%, 69% and 66% of its net sales in 2006, 2005 and 2004,
      respectively. Hines’ largest customer, The Home Depot, accounted for
      approximately 42%, 44% and 39% of its net sales in 2006, 2005 and 2004,
      respectively. Hines’ next largest customer, Lowe’s Companies, Inc., accounted
      for approximately 14%, 15% and 16% of its net sales in 2006, 2005 and 2004,
      respectively. Hines’ third largest customer, Wal-Mart Stores, Inc., accounted
      for approximately 12%, 10% and 11% of its net sales in 2006, 2005 and 2004,
      respectively. No other customer accounted for more than 10% of net
      sales.





*Distribution* .
      Hines
      distributes its products directly from its nursery sites to its retail customers
      primarily through common carriers and through the Company’s fleet of
      approximately 70 trucks, seven of which are owned and the balance of which
      are
      leased. The Company believes that common carriers are available to accommodate
      seasonal delivery peaks. The Company uses a variety of product shipping
      techniques, such as specialized shelving, protective racks and special loading
      techniques. Nursery products are distributed nationwide, except color plants,
      which are typically distributed within a 300-mile radius of each
      nursery.





*Research
      and Development; Patents and Trademarks* .
      Hines’
product sourcing and development yield unique plant varieties, which are
      marketed under a trade name and patented whenever possible. The Company applies
      for patents on plant varieties that are significantly different from existing
      varieties. Differences among plant varieties may include coloration, size at
      maturity or hardiness in drought or cold conditions. These varieties command
      higher prices, provide higher unit margins and enhance the Company's reputation
      as a product innovator. The Company’s expenses associated with research and
      development are not material and are recorded in selling, general and
      administrative expenses.





The
      Company has registered numerous trademarks, service marks and logos used in
      its
      businesses in the United States and Canada. The Company currently holds 45
      registered trademarks, with six trademark applications pending. In addition,
      the
      Company has developed and continues to develop specialty plants for which it
      holds patents registered with the U.S. Patent and Trademark Office. The Company
      currently holds 71 patents, with six patent applications pending. The Company’s
      management does not believe that the loss of any particular patent would have
      a
      material adverse effect on the Company.





*Production.* Raw
      materials consist of starter materials, containers and soil mixtures. The
      Company’s management believes that there are alternate sources of supply readily
      available.





*Sales
      and Marketing* .
      Most of
      Hines’ facilities have separate sales forces, which include a sales manager,
      in-house customer service representatives, direct sales consultants and various
      support personnel. As of December 31, 2006, Hines employed approximately 270
      direct sales consultants, key account managers, market area managers and
      merchandisers. National accounts are serviced through "National Account Task
      Teams" comprised of a senior management member and direct sales personnel from
      each nursery supplying the account. Hines also markets its products through
      trade shows, print advertising in trade journals, direct mail promotion and
      catalogues.


9


*Competition* .
      Competition in the nursery products segment of the lawn and garden industry
      is
      based principally on the breadth of product offering, consistent product quality
      and availability, customer service and price. The nursery products segment
      is
      highly fragmented. According to the 2002 Census of Agriculture released in
      June
      2004 by the U.S. Department of Agriculture’s National Agricultural Statistics
      Service, the nursery business is comprised of approximately 60,000 primarily
      small and regionally based growers. Management believes Hines is one of only
      two
      growers able to serve every major regional market in North America, the
      Company’s only national competitor being Monrovia Nursery Company. In each of
      its markets, Hines competes with regional growers such as Color Spot in the
      West, Clinton Nurseries in the Northeast and many other smaller regional and
      local growers. Hines' believes that its key competitive advantages are its
      ability to provide consistent, high quality products in large volumes, its
      nationwide distribution and its value-added services.





**Seasonality**





Our
      business is highly seasonal in nature, with most of sales typically occurring
      in
      the first half of the year. In particular, our sales are strongest in the second
      quarter, which corresponds to the Spring gardening season. In 2006 approximately
      73% of net sales occurred in the first half of the year. Approximately 53%
      of
      net sales occurred in the second quarter of 2006. The table below sets forth
      the
      Company’s quarterly net sales, as a percentage of total year net sales, for the
      periods indicated:





**Percentage
                of Total Net Sales****2006**
            
            **2005**
            
            **2004**First
                Quarter
            
            
            20%
            
            
            20%
            
            
            18%Second
                Quarter
            
            
            53
            
            
            55
            
            
            57Third
                Quarter
            
            
            16
            
            
            15
            
            
            16Fourth
                Quarter
            
            
            11
            
            
            10
            
            
            9100%
            
            
            100%
            
            
            100%





**Government
      Regulation**





The
      Company is subject to certain United States federal, state and local provincial
      health, safety and environmental laws and regulations regarding the production,
      storage and transportation of certain products and the disposal of its wastes.
      The Environmental Protection Agency (“EPA”) and similar state and local agencies
      regulate the Company’s operations and activities, including, but not limited to,
      water runoff and the use of certain pesticides in its nursery operations. In
      the
      ordinary course of business, the Company uses substances that are regulated
      or
      may be classified as hazardous under environmental laws. The Company does not
      anticipate that future expenditures for compliance with such environmental
      laws
      and regulations will have a material adverse effect on the Company’s financial
      position, results of operations or competitive position. The Company cannot
      give
      any assurance, however, that compliance with such laws and regulations, or
      compliance with other environmental laws and regulations that may be enacted
      in
      the future, will not have an adverse effect on the Company’s financial position,
      results of operations or competitive position.





Hines
      obtains certain irrigation water supplied to local water districts from
      facilities owned and operated by the United States acting through the Department
      of Interior Bureau of Reclamation ("Reclamation Water"). Federal reclamation
      laws and regulations govern the use and price of Reclamation Water, including
      availability of subsidized water rates. Hines utilizes Reclamation Water as
      one
      of the water supplies for its Northern California and Oregon facilities. The
      Company’s management believes that the nursery operations are in compliance with
      applicable regulations and it maintains a compliance program; however, changes
      in law may reduce availability of, or increase the price of, Reclamation Water
      to the Company.





**Employees**





As
      of
      December 31, 2006, the Company employed approximately 2,100 persons. At the
      peak
      of our growing cycle, an additional 600 seasonal employees were employed during
      2006. All of the Company’s employees are non-union, and the Company’s management
      believes that its labor relations are good.


10


**ITEM
      1A. RISK FACTORS**





You
      should carefully consider and evaluate all of the information in this Form
      10-K,
      including the risk factors listed below. The risks described below are the
      ones
      we currently deem material, but they may not be the only risks facing our
      company. Additional risks not now known to us or that we currently deem
      immaterial may also impair our business operations.





The
      risks
      described below and the risks described elsewhere in this Form 10-K, including
      in the section entitled “Management’s Discussion and Analysis of Financial
      Condition and Results of Operations,” could materially adversely affect our
      business, prospects, financial condition, operating results or cash flow. If
      our
      business is harmed, the trading price of our common stock could
      decline.





This
      Form
      10-K also contains forward-looking statements that involve risks and
      uncertainties. Our actual results could differ materially from those discussed
      in these statements. Factors that could contribute to these differences include
      those discussed below and elsewhere in this Form 10-K. The cautionary statements
      made in this Form 10-K, including those in the risk factors below, should be
      read as being applicable to all forward-looking statements wherever they appear.
      Our operations are subject to a variety of risks and uncertainties and the
      following risk factors are not to be considered a definitive list of all risks
      associated with our operations and should be read in conjunction with the risks
      and uncertainties contained in our other filings with the Securities and
      Exchange Commission. The Private Securities Litigation Reform Act of 1995
      provides a "safe harbor" for forward-looking statements. The cautionary
      statements contained in the risk factors below are being made pursuant to the
      provisions of the Private Securities Litigation Reform Act and with the
      intention of obtaining the benefits of the "safe harbor" provisions of the
      Act.
      We caution investors that any forward-looking statements made by us are not
      guarantees of future performance and that a variety of factors, including those
      discussed below, could cause our actual results and experience to differ
      materially from the anticipated results or other expectations expressed in
      our
      forward-looking statements. The risks and uncertainties which may affect the
      operations, performance and results of our business are described in more detail
      below. We undertake no duty to update any of the forward-looking statements
      after the date of this Form 10-K.





**Risks
      Related to Our Capital Structure**




**We
      have a substantial amount of debt outstanding, which could hurt our future
      prospects and prevent us from fulfilling our debt
      obligations.**




We
      have a
      significant amount of debt outstanding, including 10.25% Senior Notes issued
      on
      September 30, 2003, which we refer to as the Senior Notes, and loans outstanding
      under a new senior credit facility that consists of a revolving facility with
      availability of up to $100 million (subject to borrowing base and other limits),
      which we refer to as the New Senior Credit Facility. As of December 31, 2006,
      we
      had total consolidated debt outstanding of $178.1 million. This debt may have
      several important consequences as it could:




·
            make
                it more difficult for us to satisfy our obligations, including making
                scheduled interest or principal payments under the Senior Notes and
                other
                debt obligations;




·
            limit
                our ability to obtain additional
                financing;




·
            increase
                our vulnerability to adverse general economic conditions, including
                changes in interest rates and adverse changes in the commercial nursery
                industry conditions;




·
            require
                us to dedicate a substantial portion of our cash flow from operations
                to
                payments on our debt, thereby reducing the availability of our cash
                flow
                for other purposes;




·
            limit
                our flexibility in planning for, or reacting to, opportunities or
                changes
                in our business and the commercial nursery industry;
                and




·
            place
                us at a competitive disadvantage compared to our competitors that
                have
                less debt.




11


**The
      terms of our debt may limit our ability to plan for, or respond to, changes
      in
      our business.**




The
      loan
      agreement that provides for the New Senior Credit Facility and the indenture
      governing the Senior Notes issued by Hines Nurseries contain covenants that
      restrict our ability to, among other things:




·
            incur
                additional debt or issue certain preferred
                stock;




·
            pay
                dividends or distributions on, or redeem or repurchase, capital
                stock;




·
            create
                liens or negative pledges with respect to our
                assets;




·
            make
                investments, loans or advances;




·
            make
                capital expenditures;




·
            issue,
                sell or allow distributions on capital stock of specified
                subsidiaries;




·
            enter
                into sale and leaseback
                transactions;




·
            prepay
                or defease specified debt;




·
            enter
                into transactions with affiliates;




·
            enter
                into specified hedging
                arrangements;




·
            merge,
                consolidate or sell our assets; or




·
            engage
                in any business other than the commercial nursery
                business.




These
      covenants may affect our ability to operate our business, may limit our ability
      to take advantage of business opportunities as they arise and may adversely
      affect the conduct of our current business. A breach of a covenant in our debt
      instruments could cause acceleration of a significant portion of our outstanding
      indebtedness.





**As
      a result of the delays in filing our periodic reports, we were required to
      obtain certain waivers in connection with the delivery of financial statements
      and related matters under our senior loan and security agreement. In the future,
      we may require additional waivers under our loan and security agreement and
      the
      indenture for our senior notes in the event we experience unexpected delays
      in
      filing our periodic reports or as a result of other matters, and the failure
      to
      obtain the necessary waivers could have a material adverse effect on our
      business, financial condition and results of
      operations.**


We
        have
        previously obtained waivers, and may in the future seek additional waivers,
        under our senior loan and security agreement. We obtained a waiver waiving
        certain potential breaches of representations and covenants under our loan
        and
        security agreement and extending to May 28, 2007 the deadlines for us to
        deliver
        our annual financial statements for the fiscal year ended December 31, 2006
        and
        quarterly financial statements for the fiscal quarter ended March 31, 2007.
        On
        May 29, 2007, we obtained an additional extension to June 28, 2007 for the
        deadline for delivering such financial statements. On June 21, 2007, we obtained
        an additional extension to July 20, 2007 for the deadline for delivering
        our
        quarterly financial statements for the fiscal quarter ended March 31, 2007.
        Finally, on July
        3 ,
        2007,
        we obtained a further waiver, effective as of June 25, 2007,  extending
        to July 13, 2007 the deadline for us to deliver our annual financial statements
        for the fiscal year ended December 31, 2006, and extending to July 31, 2007
        the
        deadline for us to deliver our quarterly financial statements for the fiscal
        quarter ended March 31, 2007. The delivery of this Annual Report on Form
        10-K to
        our bank satisfied our obligation to deliver our annual financial statements
        for
        the fiscal year ended December 31, 2006 within the specified timeframe. As
        of
        the date of this filing, we have not issued our quarterly financial statements
        for the first quarter of 2007 and there is a risk that we might not be able
        to
        complete these quarterly financial statements by July 31, 2007, although
        we
        anticipate being able to do so


Under
      our
      indenture for our senior notes, the trustee and the holders of at least 25%
      in
      principal amount of the outstanding notes under the indenture have the right
      to
      notify us if they believe we have breached a representation or covenant under
      the indenture and may declare an event of default. In addition, the lenders
      under our loan and security agreement may declare an event of default if we
      breach a representation or covenant under the loan and security agreement.
      If
      one or more events of default occur, we believe we will be given a period of
      time by our lenders in which to cure such events of default or obtain necessary
      waivers, except in limited circumstances. If we do not cure the events of
      default or obtain necessary waivers within the required time periods or certain
      extended time periods, the maturity of our public and bank debt could be
      accelerated and our ability to incur additional indebtedness could be
      restricted. Moreover, defaults under our indenture and bank loan and security
      agreement could trigger cross-default provisions under those and other
      arrangements. There can be no assurance that any additional waivers will be
      received in the future on a timely basis, if at all, or that any waivers
      obtained, including the waivers we have already obtained, will extend for a
      sufficient period of time to avoid an acceleration event, an event of default
      or
      other restrictions on our business operations. The failure to obtain such
      waivers could have a material adverse effect on our business, financial
      condition and results of operations.


12


**Our
      stock may be delisted from The Nasdaq Global Market, which could adversely
      affect the market liquidity of our common stock.**





Since
      we
      failed to timely file our Annual Report on Form 10-K for the year ended December
      31, 2006 and our Quarterly Report on Form 10-Q for the fiscal quarter ended
      March 31, 2007, NASDAQ notified us through letters dated April 18, 2007 and
      May
      17, 2007, respectively, that we were not in compliance with the filing
      requirements for continued listing set forth in Marketplace Rule 4310(c)(14),
      and that we were therefore subject to delisting from The Nasdaq Global Market.
      As a result, we requested and participated in a hearing before a NASDAQ Listing
      Qualifications Panel, which had the effect of staying the delisting of our
      securities pending a decision by the NASDAQ Panel. We are filing hereby our
      Annual Report on Form 10-K for the year ended December 31, 2006, and are working
      to file our Quarterly Report on Form 10-Q for the fiscal quarter ended March
      31,
      2007 as quickly as practicable. However, there can be no assurance that the
      NASDAQ Panel will grant our request for continued listing as a result of the
      hearing or the filing of our delinquent reports. In addition, our common stock
      has recently traded below $1.00 per share, which could also impact our ability
      to remain listed on The Nasdaq Global Market. In the event that our securities
      are delisted, the market liquidity of our common stock could be adversely
      affected and the market price of our common stock could decrease.




**Repayment
      of the principal of the Senior Notes and our other debt may require additional
      financing. We are not certain of the source or availability of any such
      financing at this time.**




Our
      anticipated operating cash flows will not be sufficient to repay the principal
      of the Senior Notes issued by Hines Nurseries and our other debt under our
      New
      Senior Credit Facility which come due in 2011 and 2012, respectively.
      Accordingly, in order to pay the principal of the Senior Notes and our other
      debt, we will be required to refinance our debt, sell our equity securities,
      sell our assets or take other actions. The foregoing actions may not enable
      us
      to pay the principal of the Senior Notes or such other debt or may not be
      permitted by the terms of our debt instruments then in effect.





**Risks
      Related to Our Business**





**Our
      production of plants may be adversely affected by a number of agricultural
      risks, including factors beyond our control. In addition, our nursery operations
      were adversely affected by the acute tropical weather season that plagued the
      Southern and South-eastern regions of the United States in 2005, and significant
      tropical storms in the future could adversely impact our
      operations.**




Our
      production of plants may be adversely affected by a number of agricultural
      risks, including disease, pests, freezing conditions, snow, drought or other
      inclement weather and improper use of pesticides or herbicides. These factors
      could cause production difficulties which could damage or reduce our inventory,
      resulting in sales, profit and operating cash flow declines, which could be
      material.




**Increases
      in water prices or insufficient availability of water could adversely affect
      our
      plant production, resulting in reduced sales and
      profitability.**




Plant
      production depends upon the availability of water. Our nurseries receive their
      water from a variety of sources, including on-site wells, creeks, reservoirs
      and
      holding ponds, municipal water districts and irrigation water supplied to local
      districts by facilities owned and operated by the United States acting through
      the Department of Interior Bureau of Reclamation. The loss or reduction of
      access to water at any of our nurseries could have a material adverse effect
      on
      our business, results of operations and operating cash flows. In addition,
      increases in our costs for water could adversely impact our profitability and
      operating cash flows.




Our
      nursery in Arizona receives its water from on-site wells. Under Arizona’s
      Groundwater Management Act, these wells have been issued “grandfathered
      non-irrigation water” permits, which limit the amount of groundwater we can use.
      The availability of water depends on the groundwater aquifer, which at this
      time, we believe is adequate to supply our needs for this nursery as it is
      currently operated.




Our
      Northern California and Oregon nurseries rely primarily on surface water
      supplies and, therefore, may experience fluctuations in available water supplies
      and serious reductions in their supplies of surface water in the event of
      prolonged droughts. If such reductions occur, those nurseries would have to
      rely
      on backup water supplies which are more costly than surface water
      supplies.


13


The
      use
      and price of water supplied by facilities owned and operated by the Department
      of Interior Bureau of Reclamation, including availability of subsidized water
      rates, is governed by federal reclamation laws and regulations. Such water
      is
      used at our Northern California nursery and is the source of a substantial
      majority of the water for our Oregon nursery. While we believe we are in
      material compliance with applicable regulations and maintain a compliance
      program, there can be no assurance that changes in law will not reduce
      availability or increase the price of reclamation water to us. Any such change
      could have a material adverse effect on our business, financial position,
      results of operations and operating cash flows.




The
      reclamation regulations govern who may hold an interest in irrigation lands.
      Under the reclamation regulations, persons having a direct or indirect
      beneficial economic interest in us will be treated as “indirect holders” of
      irrigation land owned by us in proportion to their beneficial interest in us.
      If
      any holder of our common stock (whether directly or indirectly through a
      broker-dealer or otherwise) is ineligible under applicable reclamation
      regulations to hold an indirect interest in our irrigation land, we may not
      be
      eligible to receive reclamation water on this land. Generally, the eligibility
      requirement of the reclamation regulations would be satisfied by a
      person:




·
            who
                is a citizen of the United States or an entity established under
                federal
                or state law or a person who is a citizen of or an entity established
                under the laws of certain foreign countries (including Canada and
                Mexico
                and members of the Organization for Economic Cooperation and Development);
                and




·
            whose
                ownership, direct and indirect, of other land which is qualified
                to
                receive water from a reclamation project, when added to such person’s
                attributed indirect ownership of irrigation land owned by us, does
                not
                exceed certain maximum acreage limitations (generally, 960 acres
                for
                individuals and 640 acres for
                entities).




While
      our
      restated certificate of incorporation contains provisions intended to prohibit
      ineligible holders of irrigation land from owning our common stock, such
      provisions may not be effective in protecting our right to continue to use
      reclamation water.




**We
      face risks associated with sudden oak death (“SOD”). Quarantines of our products
      or other actions by federal and state regulatory authorities in response to
      sudden oak death could have a material adverse effect on our business and
      results of operations.**




SOD
      is
      caused by a fungus-like pathogen recently identified by scientists in California
      as Phytophthora ramorum (“P. ramorum”). Since its appearance in 1995, P. ramorum
      has killed thousands of Coast Live Oak, Black Oak, Tan Oak and Shreve Oak in
      Northern California. P. ramorum can also infect the leaves and branches of
      other
      plants referred to as SOD host plants. Currently, approximately 90 plant species
      appear on the host list.





In
      February 2004, as part of the SOD National Nursery Survey, the United States
      Department of Agriculture (“USDA”) encouraged all states to conduct a survey of
      nurseries that ship SOD host plants interstate. Accordingly, the California
      Department of Food & Agriculture (“CDFA”) and the USDA conducted joint tests
      at nurseries located throughout California. On March 9, 2004, two nurseries
      in
      California, which we do not own or operate, tested positive for P. ramorum.
      As a
      result of these findings, certain states declared a quarantine on all plant
      material coming from California and several others imposed a quarantine on
      SOD
      host and associated host plants only.





On
      March
      19, 2004, we took the precautionary measure of voluntarily suspending the
      shipment of all SOD host plants grown in our California facilities pending
      the
      results of the joint CDFA and USDA testing of all interstate shippers, including
      our facilities. On March 26, 2004, we were notified by the CDFA that all of
      our
      California growing facilities had tested negative for P. ramorum. As a result
      of
      these findings, the CDFA and the USDA issued SOD Compliance Agreements with
      our
      Fallbrook and Irvine facilities, allowing us to ship host and associated host
      plants interstate if we meet, and continue to meet, certain inspection
      requirements. Our Vacaville and Winters facilities are located in a California
      quarantined county and have continued to operate under the terms of their
      Compliance Agreements with the CDFA and USDA since 2002. The Compliance
      Agreement requires that potential SOD host plants be inspected and tested
      monthly during the growing season for the presence of the pathogen.





Currently,
      our Forest Grove, Oregon facility and all of our California facilities that
      ship
      product interstate are SOD-free and are operating under USDA SOD Compliance
      Agreements. However, if in the future we do test positive for SOD, our products
      could be subject to quarantine by federal and state regulatory authorities.
      If
      this were to occur, we could experience a significant loss of sales and may
      be
      required to destroy inventory, which could have a material adverse effect on
      our
      business, results of operations and operating cash flows.


14


**Because
      our business is highly seasonal, our revenues, cash flows from operations and
      operating results may fluctuate on a seasonal and quarterly
      basis.**




Our
      business is highly seasonal. The seasonal nature of our operations results
      in a
      significant increase in our working capital during the growing and selling
      cycles. As a result, operating activities during the first and fourth quarters
      use significant amounts of cash, and in contrast, operating activities for
      the
      second and third quarters generate substantial cash as we ship inventory and
      collect accounts receivable. We have experienced, and expect to continue to
      experience, significant variability in net sales, operating cash flows and
      net
      income on a quarterly basis. One significant factor contributing to this
      variability is weather, particularly on weekends during the peak gardening
      season in the second quarter. Unfavorable weather conditions during the peak
      gardening season could have a material adverse effect on our net sales, cash
      flows from operations and operating income.




Other
      factors that may contribute to this variability include:




·
            shifts
                in demand for live plant products;




·
            changes
                in product mix, service levels and pricing by us and our
                competitors;




·
            period-to-period
                changes in holidays;




·
            the
                economic stability of our retail customers;
                and




·
            our
                relationship with each of our retail
                customers.




**Because
      we depend on a core group of significant customers, our sales, cash flows from
      operations and results of operations may be negatively affected if our key
      customers reduce the amount of products they purchase from
      us.**




Our
      top
      three customers together accounted for approximately 68% of our net sales in
      2006. Our largest customer, The Home Depot, accounted for approximately 42%
      of
      our 2006 net sales, our second largest customer, Lowe’s Companies, Inc.,
      accounted for approximately 14% of our 2006 net sales and our third largest
      customer, Wal-Mart Stores, Inc., accounted for approximately 12% of our 2006
      net
      sales. We expect that a small number of customers will continue to account
      for a
      substantial portion of our net sales for the foreseeable future. We do not
      have
      long-term contracts with any of our retail customers, and they may not continue
      to purchase our products.




The
      loss
      of, or a significant adverse change in, our relationship with The Home Depot,
      Lowe’s Companies, Inc., Wal-Mart Stores, Inc. or any other major customer could
      have a material adverse effect on our business, financial position, results
      of
      operations and operating cash flows. The loss of, or a reduction in orders
      from,
      any significant retail customers, losses arising from retail customers’ disputes
      regarding shipments, fees, merchandise condition or related matters, or our
      inability to collect accounts receivable from any major retail customer could
      have a material adverse effect on us. In addition, revenue from customers that
      have accounted for significant revenue in past periods, individually or as
      a
      group, may not continue, or if continued, may not reach or exceed historical
      levels in any period.




**We
      face intense competition, and our inability to compete effectively for any
      reason could adversely affect our business.**




Our
      competition varies by region, each of which is highly competitive. Although
      many
      of our largest customers are national retailers, buying decisions are generally
      made locally by our customers. We compete primarily on the basis of breadth
      of
      product mix, consistency of product quality, product availability, customer
      service and price. We generally face competition from several local companies
      and usually from one or two regional companies in each of our current markets.
      Competition in our existing markets may also increase considerably in the
      future. Some of our competitors may have greater market share in a particular
      region or market, less debt, greater pricing flexibility or superior marketing
      or financial resources. Increased competition could result in lower profit
      margins, substantial pricing pressure, reduced market share and lower operating
      cash flows. Price competition, together with other forms of competition, could
      have a material adverse effect on our business, financial position, results
      of
      operations and operating cash flows.


15


**Our
      nursery facility in Irvine, California is entirely on leased land and we do
      not
      expect the leases to be extended beyond their current
      terms.**




Our
      nursery facility and headquarters in Irvine, California are entirely on leased
      land. In 2003, we entered into an amended lease agreement for this facility
      in
      which 63 new acres were added and the lease expiration schedule was changed.
      Under the amended lease agreement, the lease on 114 acres expired on June 30,
      2006, the lease on 140 acres expired on December 31, 2006 and the lease on
      the
      remaining 288 acres expires on December 31, 2010. On January 1, 2007, we entered
      into another amendment of the 140 acre lease that expired on December 31, 2006,
      which amendment extended our lease on 50 of the 140 acres until June 30, 2007.
      We do not expect these leases to be extended beyond their current terms. For
      the
      204 acres that expired in 2006, we transitioned a majority of the production
      to
      our Winters, California facility and the remaining production to the parcel
      recently added to our facility in Irvine. For the 50 acres that will expire
      on
      June 30, 2007 we are completing the process of transitioning capacity off this
      portion of land similar to the 204 acres that expired in 2006. For the 288
      acres
      that will expire at the end of 2010, we will be required to establish new
      production facilities or transition production to existing facilities. We may
      incur substantial costs in connection with the establishment of these new
      production facilities or the transition of production to existing
      facilities.




We
      may
      not be successful in establishing suitable replacement production facilities
      or
      in transitioning production to existing facilities. If we are unsuccessful
      in
      these efforts, our net sales, cash flows and operating income could be
      materially adversely affected. In addition, when we vacate the facility in
      2010,
      we currently estimate that we will incur approximately $0.9 million in removal
      and remediation costs. We may incur significant expenses beyond what we have
      forecasted if additional remedial action is required. Significant costs in
      excess of our estimates could have a material adverse effect on our business,
      financial position, results of operations and operating cash flows.




**Our
      anticipated transition of our operations resulting from our Vacaville,
      California property sale may not be as successful as we anticipate and
      unexpected delays and difficulties or increased costs could adversely affect
      our
      business and prospects.**




In
      2006,
      we sold our approximately 168-acre property located in Vacaville, California
      (Vacaville Property). In connection with the sale of the Vacaville
      Property, the agreement provides that we are to transition off the property
      in three phases from 2006 to 2008. Interruptions or delays in the transitioning
      from the Vacaville Property could adversely impact our nursery operations
      and increase our costs. In addition, we could incur significant expenses beyond
      those which we have forecasted in connection with such relocations. Our failure
      to effectively manage the transition from these properties or the incurrence
      of
      additional related costs beyond those which we forecast could result in a
      decrease in revenue or other adverse effects in our business and results of
      operations.




**We
      are subject to various environmental laws and regulations that govern, and
      impose liability for, our activities and operations. If we do not comply with
      these laws and regulations, our business could be materially and adversely
      affected.**




We
      are
      subject to federal, state and local laws and regulations that govern, and impose
      liability for, our activities and operations which may have adverse
      environmental effects, such as discharges to air and water, as well as handling
      and disposal practices for hazardous substances and other wastes. Some of our
      nursery operations are conducted near residential developments, which could
      increase our exposure to liability for the environmental effects of our
      operations. Our operations have resulted, or may result, in noncompliance with
      or liability for cleanup under these laws. In addition, the presence of
      hazardous substances on our properties, or the failure to properly remediate
      any
      resulting contamination may adversely affect our ability to sell, lease or
      operate our properties or to borrow using them as collateral. In some cases,
      our
      liability may not be limited to the value of the property or its improvements.
      We cannot assure you that these matters, or any similar matters that may arise
      in the future, will not have a material adverse effect on us.




Certain
      of our operations and activities, such as water runoff from our production
      facilities and the use of certain pesticides, are subject to regulation by
      the
      United States Environmental Protection Agency and similar state and local
      agencies. These agencies may regulate or prohibit the use of such products,
      procedures or operations, thereby affecting our operations and profitability.
      In
      addition, we must comply with a broad range of environmental laws and
      regulations. Additional or more stringent environmental laws and regulations
      may
      be enacted in the future and such changes could have a material adverse effect
      on our business.


16


**We
      are subject to federal and state "fair trade" laws and weights and measures
      regulations that govern and impose liability for improperly marketing, labeling
      or advertising plant container size. If we do not comply with these laws and
      regulations, our business could be materially and adversely
      affected.**





We
      are
      subject to federal and state weights and measures regulations that govern and
      impose liability for improperly labeling or advertising our plant container
      sizes. It is common in our industry, at the wholesale and retail levels, to
      market, label, and advertise container grown nursery stock with varying types
      of
      measurements, such as imperial volume or diameter of container. These
      measurements, although consistent with industry practice, may not represent
      the
      exact size of the actual product. If the Federal Trade Commission or any state
      regulator determines that our current marketing, labeling, or advertising is
      in
      violation of "fair trade" laws or weights and measures regulations in their
      jurisdiction, we may incur significant costs to become compliant, be forced
      to
      terminate further shipments of inventory into certain jurisdictions, be fined,
      or otherwise suffer a material adverse affect on our business and results of
      operations.





**Changes
      in local zoning laws may adversely affect our business.**




We
      are
      subject to local zoning laws regulating the use of our owned and leased
      property. Some of our facilities are located in areas experiencing rapid
      development and growth, which typically are characterized by changes in existing
      zoning. Changes in local zoning laws could require us to establish new
      production facilities or transition production to other facilities, which could
      have a material adverse effect on our cash flows, financial position and results
      of operations.




**Compliance
      with, and changes to, labor laws, particularly those concerning seasonal
      workers, could significantly increase our costs.**




The
      production of our plants is labor intensive. We are subject to the Fair Labor
      Standards Act as well as various federal, state and local regulations that
      govern matters such as minimum wage requirements, overtime and working
      conditions, including, but not limited, to federal and state health and worker
      safety rules and regulations. A large number of our seasonal employees are
      paid
      at or slightly above the applicable minimum wage level and, accordingly, changes
      in minimum wage laws could materially increase our costs. Non-U.S. nationals
      comprise a large portion of our seasonal employee workforce and changes to
      U.S.
      immigration policies that restrict the ability of immigrant workers to obtain
      employment in the United States and which may contribute to shortages of
      available seasonal labor could increase our costs. Non-compliance with
      applicable regulations or modifications to existing regulations may increase
      costs of compliance, require a termination of certain activities, result in
      fines or loss of a portion of our labor force or otherwise have a material
      adverse impact on our business and results of operations.




**Our
      transportation costs are significant and we depend on independent contractors
      for trucking services to ship large quantities of our products and increases
      in
      transportation costs, changes in available trucking capacity and other changes
      affecting such carriers, as well as interruptions in service or work stoppages,
      could adversely impact our results of operations.**




We
      rely
      extensively on the services of agents and independent contractors to provide
      trucking services to us. Transportation costs accounted for approximately 25%
      of
      our net sales in 2006. Our ability to ship our products, particularly during
      our
      peak shipping seasons, could be adversely impacted by shortages in available
      trucking capacity, changes by carriers and transportation companies in policies
      and practices, such as scheduling, pricing, payment terms and frequency of
      service, or increases in the cost of fuel, taxes and labor, and other factors
      not within our control. We compete with other companies who ship perishable
      goods for available trucking capacity and, accordingly, reductions in capacity
      or shortages of the agents and independent contractors who provide trucking
      services to us could potentially adversely impact our sales, results of
      operations and cash flows. Higher diesel fuel costs and increased third party
      carrier charges adversely impacted our results of operations during 2005 and
      2006 and future significant increases in transportation costs could have a
      material adverse effect on our business, particularly if we are not able to
      pass
      on such price increases to our customers in the form of higher prices for our
      products. Material interruptions in service or stoppages in transportation,
      whether caused by strike or otherwise, could adversely impact our business,
      results of operations, financial position and operating cash flows.




**Our
      research and development efforts may not be successful.**




Our
      success is based, in part, upon our ability to discover and develop new products
      that customers will want. As a result, we continue to invest in research and
      development in order to enable us to identify and develop new products to meet
      consumer demands. Despite investments in this area, our research and development
      may not result in the discovery or successful development of new products which
      will be accepted by our customers.


17


**Our
      current principal stockholders have significant influence over our business
      and
      could delay, deter or prevent a change of control or other business
      combination.**




Investment
      partnerships controlled by Madison Dearborn Partners, L.P. beneficially own
      approximately 53% of the outstanding common stock of Hines Horticulture, Inc.
      and have sufficient voting power to control, or at the least significantly
      influence, the election of directors and the approval of other actions requiring
      the approval of our shareholders. In addition, Madison Dearborn Partners has
      two
      of its designees on Hines Horticulture, Inc.’s six member board of
      directors.




**Our
      business will suffer if certain senior executives discontinue employment with
      us
      or if we are unable to recruit and retain highly skilled
      staff.**




Our
      success is largely dependent on the skills, experience and efforts of our senior
      management, including Robert A. Ferguson (President and Chief Executive Officer)
      and Claudia M. Pieropan (Chief Financial Officer, Secretary and Treasurer).
      The
      loss of services of one or more members of our senior management could have
      a
      material adverse effect on us. We do not maintain key-man life insurance
      policies on any members of management. No members of senior management are
      bound
      by non-compete agreements, and if any such members were to depart and
      subsequently compete with us, such competition could have a material adverse
      effect on us. Our business also depends on our ability to continue to recruit,
      train and retain skilled employees, particularly skilled growers and sales
      personnel. The loss of the services of any key personnel, or our inability
      to
      hire new personnel with the requisite skills, could impair our ability to
      develop new products or enhance existing products, sell products to our
      customers or manage our business effectively.




**Price
      increases of certain raw materials could adversely affect our
      business.**




We
      are
      vulnerable to price increases for raw materials. For 2006, raw material costs
      accounted for approximately 19% of net sales. We do not have long-term contracts
      with the majority of our raw material suppliers. Increases in the cost of raw
      materials essential to our operations, including seed, plastic, chemicals and
      fertilizer, would increase our costs of production. Significant increases in
      the
      price of petrochemicals or a scarcity of raw materials essential to plant
      propagation could have a material adverse effect on our business. Recent
      increases in the cost of diesel fuel have increased our operating expenses,
      and
      if these price increases continue, our results of operations could be adversely
      affected. We may not be able to pass such price increases on to our customers
      in
      the form of higher prices for our products, which could materially adversely
      affect our results of operations and operating cash flows.




**If
      we are unable to protect our intellectual property rights, our business and
      prospects may be harmed.**




Our
      success depends in part on proprietary techniques and plant designs. Although
      we
      attempt to protect our proprietary property and processes through a combination
      of patents, trade secrets and non-disclosure agreements, these may be
      insufficient. Litigation may be necessary to protect our intellectual property
      and determine the validity and scope of the proprietary rights of competitors.
      Intellectual property litigation could result in substantial costs and diversion
      of our management and other resources. If we are unable to successfully protect
      our intellectual property rights, our competitors could be able to market
      products that compete with our proprietary products without obtaining a license
      from us.




**Changes
      in corporate governance requirements may continue to increase our compliance
      and
      financial reporting costs, and failure to achieve and maintain effective
      internal control over financial reporting in accordance with Section 404 of
      the
      Sarbanes-Oxley Act of 2002 could have a material adverse effect on our business
      and stock price.**





The
      Sarbanes-Oxley Act of 2002 has required us to change or supplement some of
      our
      corporate governance and securities disclosure and compliance practices. The
      Sarbanes-Oxley Act of 2002 and related rules and regulations promulgated by
      the
      SEC have increased, and may continue to increase, our legal compliance and
      financial reporting costs.





We
      currently anticipate being subject to Section 404 of the Sarbanes-Oxley Act
      of
      2002 (“Section 404”), which requires management to report on internal control
      over financial reporting, beginning with our annual report for the fiscal year
      ending December 31, 2007. Accordingly, we are in the process of documenting
      and
      testing our internal control procedures in order to satisfy the requirements
      of
      Section 404. We expect to incur additional expenses and diversion of
      management’s time as a result of performing the system and process evaluation,
      testing and remediation required in order to comply with Section 404. In
      addition, our management has concluded that as of December 31, 2006, the Company
      did not have effective disclosure controls and procedures as a result of certain
      material weaknesses in internal control over financial reporting, as described
      in more detail under Item 9A of Part II hereof. During the course of our
      testing, we may identify additional deficiencies, which we may not be able
      to
      remediate in time to meet the deadline for compliance with the requirements
      of
      Section 404.


18


**Significant
      decreases in our stock price could result in our having to record an impairment
      charge related to our goodwill.**




Applicable
      accounting standards require that goodwill be tested for impairment at least
      annually or whenever evidence of potential impairment exists. If, in any period,
      our stock price decreases to the point where the fair value of our Company,
      as
      determined by our market capitalization, is less than our book value, this
      could
      indicate a potential impairment and we may be required to record an impairment
      charge in that period.




**ITEM
      1B. UNRESOLVED STAFF COMMENTS**





Not
      applicable.





**ITEM
      2. PROPERTIES**





At
      December 31, 2006, the Company owned approximately 3,795 acres related to its
      continuing nursery facilities. In addition, the Company leases approximately
      765
      acres related to its continuing nursery facilities (including leases from
      Blooming Farm, Inc., an affiliated entity). Approximately 2,600 acres were
      usable for production, with approximately 2,250 acres currently in production.
      We believe that our owned and leased facilities are sufficient to meet our
      operating requirements for the foreseeable future.





The
      Company's current facilities of its continuing operations are identified in
      the
      table below:





**Location**
            **Description**
            **Status**Chino
                Valley, Arizona
            66
                acre nursery
            OwnedFallbrook,
                California
            261
                acre nursery
            Owned/leased
                (a)Forest
                Grove, Oregon
            1,013
                acre nursery
            Owned/leased
                (b)Fulshear,
                Texas
            435
                acre nursery
            OwnedIrvine,
                California
            338
                acre nursery and headquarters
            Leased
                (c)Northern
                California
            1,389
                acre nursery
            Owned
                (d)San
                Joaquin Valley, California
            57
                acre nursery
            Owned/leased
                (e)Trenton,
                South Carolina
            1,001
                acre nursery
            Owned/leased
                (f)





(a)
            We
                own 248 acres and lease 13 acres at this nursery.(b)
            We
                own 668 acres and lease 345 acres at this nursery.(c)
            This
                acreage does not reflect 114 acres that expired in June 2006 and
                90 acres
                that expired in December 2006 without being extended. This lease
                will
                expire with respect to 50 acres in June 2007, and will expire with
                respect
                to the remaining acreage in December 2010.(d)
            The
                Northern California nursery consists of sites in Allendale, Vacaville
                and
                Winters South, California.(e)
            The
                San Joaquin nursery consists of sites in Chowchilla and Madera,
                California. We own 48 acres and lease 9 acres at this
                nursery.(f)
            We
                own 941 acres and lease 60 acres at this
                nursery.




Our
        nursery facility and headquarters in Irvine, California are entirely on leased
        land. In 2003, we entered into an amended lease agreement for this facility
        in
        which 63 new acres were added and the lease expiration schedule was changed.
        Under the amended lease agreement, the lease on 114 acres expired on June
        30,
        2006, the lease on 140 acres expired on December 31, 2006 and the lease on
        the
        remaining 288 acres expires on December 31, 2010. On January 1, 2007, we
        entered
        into another amendment with respect to the 140 acre lease that expired on
        December 31, 2006, which extended our lease on 50 of the 140 acres until
        June
        30, 2007. We do not expect these leases to be extended beyond their current
        terms. For the 204 acres that expired in 2006, we transitioned a majority
        of the
        production to our Winters, California facility and the remaining production
        to
        the parcel recently added to our facility in Irvine. For the 50 acres that
        will
        expire on June 30, 2007, we are in the process transitioning capacity off
        this
        portion of land similar to the 204 acres that expired in 2006. For the 288
        acres
        that will expire at the end of 2010, we will be required to establish new
        production facilities or transition production to existing
        facilities.


19


**ITEM
      3. LEGAL PROCEEDINGS**





On
      July
      18, 2006, Mr. Jean-Paul filed an action against us and other defendants in
      the
      Eleventh Judicial Circuit, Dade County, Florida, alleging negligence in
      connection with an automobile accident involving one of our trailers and a
      third-party carrier.  On March 6, 2007, additional plaintiffs filed an
      action related to this incident in the same court, alleging negligence and
      vicarious liability for negligence against us and other defendants.  The
      first filed claim is scheduled for trial in August 2007.  We are defended
      in these actions by our insurance carrier, and are fully insured with respect
      to
      this matter, beyond a deductible.  We have accrued an amount we believe
      represents the probable estimated claim at December 31, 2006. We have also
      recorded an asset at December 31, 2006 for the probable full insurance
      recovery.





From
      time
      to time, we are involved in various disputes and litigation matters, which
      arise
      in the ordinary course of business. While it is not possible to predict or
      determine the outcome of the legal actions, investigations and proceedings
      brought against us, we believe that the resolution of all such matters currently
      pending will not have a material adverse effect on our financial position or
      liquidity, however the litigation process is inherently uncertain and it is
      possible that the resolution of these disputes and lawsuits may adversely affect
      our financial position and liquidity. Our management believes that we are not
      currently involved in any legal proceedings that would materially affect our
      results of operations and we know of no such proceedings contemplated by
      governmental authorities.





**ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**





No
      matters were submitted to a vote of security holders during the fourth quarter
      of 2006.








**PART
      II**





**ITEM
      5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER** **MATTERS
      AND ISSUER PURCHASES OF EQUITY SECURITIES**





**Market
      Information**





The
      Common Stock of Hines currently trades on The Nasdaq Global Market under the
      symbol “HORT.” As of June 22, 2007, there were 69 registered holders of record
      of the Company’s Common Stock. The following table sets forth the quarterly high
      and low sale prices of our Common Stock as reported on The Nasdaq Global Market
      for the periods indicated:





Fiscal
                year ended December 31, 2006High
            
            Low1stquarter
            
            $4.25
            
            $3.422ndquarter
            
            $4.04
            
            $3.063rdquarter
            
            $3.58
            
            $1.394thquarter
            
            $2.25
            
            $1.02Fiscal
                year ended December 31, 2005High
            
            Low1stquarter
            
            $4.65
            
            $3.302ndquarter
            
            $4.36
            
            $3.363rdquarter
            
            $4.06
            
            $3.184thquarter
            
            $3.84
            
            $3.10





**Dividends**





Hines
      has
      not paid dividends on its Common Stock in the past and does not presently plan
      to pay dividends on the Common Stock. The payment of dividends is restricted
      in
      terms of amounts that may be paid and the circumstances under which dividends
      may be paid, pursuant to the terms of the Company's new senior credit facility
      and senior subordinated note indenture. See “Management’s Discussion and
      Analysis of Financial Condition and Results of Operations - Liquidity and
      Capital Resources.”


20


**Securities
      Authorized for Issuance Under Equity Compensation Plans**





The
      Company currently maintains its 1998 Long-Term Equity Incentive Plan (the “1998
      Stock Plan”) under which shares of Common Stock are authorized for issuance to
      employees and directors pursuant to various equity awards. As of December 31,
      2006, the Company did not have outstanding any options, warrants or rights
      under
      any other equity compensation plan. The following table provides aggregate
      information regarding the shares of Common Stock that may be issued upon the
      exercise of options, warrants and rights under all of the Company’s equity
      compensation plans as of December 31, 2006.





Number
                of securities to be issued upon exercise of outstanding options,
                warrants
                and rights
            
            Weighted-average
                exercise price of outstanding options, warrants and rights
            
            Number
                of securities remaining available for future issuance under equity
                compensation plans (excluding securities reflected in column
                (a))Plan
                Category
            
            (a)
            
            (b)
            
            (c)**Equity
                compensation plans****approved
                by security holders:**1998
                Long-Term EquityIncentive
                Plan
            
            
            828,414
            
            $
            6.20
            
            
            2,760,796**Equity
                compensation plans not****approved
                by security holders:**
            
            
            -
            
            $
            -
            
            
            -Total
            
            
            828,414
            
            
            
            
            
            2,760,796








**Performance
      Graph**





The
      following Performance Graph and related information compares the cumulative
      five-year total return to shareholders on Hines Horticulture, Inc.'s Common
      Stock relative to the cumulative total returns of the NASDAQ Composite index
      and
      the Russell 2000 index. An investment of $100 (with reinvestment of all
      dividends) is assumed to have been made in our Common Stock and in each of
      the
      indexes on December 31, 2001 and its relative performance is tracked through
      December 31, 2006.





The
      comparisons shown in the graph below are based on historical data and we caution
      that the stock price performance shown in the graph below is not indicative
      of,
      and is not intended to forecast, the potential future performance of our Common
      Stock. Information used in the graph was obtained from Research Data Group,
      Inc., a source believed to be reliable, but the Company is not responsible
      for
      any errors or omissions in such information. The following graph and related
      information shall not be deemed “soliciting materials” or to be “filed” with the
      Securities and Exchange Commission, nor shall such information be incorporated
      by reference into any future filing under the Securities Act of 1933 or the
      Securities Exchange Act of 1934, except to the extent that we specifically
      incorporate it by reference into such filing.


21







**December
                31,****2001**
            **2002**
            **2003**
            **2004**
            **2005**
            **2006****Hines
                Horticulture, Inc.**
            
            **$100.00**
            **$78.38**
            **$118.92**
            **$92.97**
            **$97.30**
            **$45.68****NASDAQ
                Composite**
            
            **100.00**
            **71.97**
            **107.18**
            **117.07**
            **120.50**
            **137.02****Russell
                2000**
            
            **100.00**
            **79.52**
            **117.09**
            **138.55**
            **144.86**
            **171.47**


22


**ITEM
      6. SELECTED FINANCIAL DATA**





The
      following selected consolidated financial data should be read in conjunction
      with “Management’s Discussion and Analysis of Financial Condition and Results of
      Operations” and the consolidated financial statements and the notes thereto
      included elsewhere in this Form 10-K to fully understand factors that may affect
      the comparability of the information presented below. The information presented
      in the following tables has been adjusted to reflect the restatement of our
      consolidated financial results which is more fully described in the Explanatory
      Note immediately preceding Part I of this Form 10-K and in Note 2 to the
      consolidated financial statements, “Restatement of Consolidated Financial
      Statements.” We derived the selected consolidated financial data as of
      December 31, 2006 and 2005 and for the years ended December 31, 2006,
      2005 and 2004 from our audited consolidated financial statements, and
      accompanying notes, in this report on Form 10-K.





The
      selected financial data presented below is unaudited.





Certain
      reclassifications have been made in prior periods’ financial statements to
      conform to fiscal 2006 classifications. These reclassifications include
      discontinued operations, as discussed in Note 3 to the Consolidated Financial
      Statements, “Discontinued Operations.”


**Year
                Ended December 31,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002****(in
                thousands, except share data)****Statement
                of Operations Data:**
            
            
            
            As
                Restated (a)Sales,
                net
            
            $
            232,570
            
            $
            245,326
            
            $
            243,968
            
            $
            244,210
            
            $
            241,990Cost
                of goods sold
            
            
            135,731
            
            
            121,007
            
            
            121,823
            
            
            117,013
            
            
            116,577Gross
                profit
            
            
            96,839
            
            
            124,319
            
            
            122,145
            
            
            127,197
            
            
            125,413Operating
                expenses
            
            
            108,242
            
            
            101,564
            
            
            97,745
            
            
            95,793
            
            
            90,875Operating
                (loss) income
            
            
            (11,403
            )
            
            22,755
            
            
            24,400
            
            
            31,404
            
            
            34,538Other
                expense, primarily interest expense
            
            
            20,923
            
            
            24,793
            
            
            24,498
            
            
            35,213
            
            
            33,883Income
                tax (benefit) provision
            
            
            (12,619
            )
            
            (742
            )
            
            210
            
            
            (1,561
            )
            
            266(Loss)
                income from continuing operations
            
            
            (19,707
            )
            
            (1,296
            )
            
            (308
            )
            
            (2,248
            )
            
            389(Loss)
                income from discontinued operations, net of tax (b)
            
            
            (26,765
            )
            
            (527
            )
            
            5,433
            
            
            11,961
            
            
            2,056Cumulative
                effect of change in accounting principle, net of tax (c)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (55,148
            )Net
                (loss) income
            
            $
            (46,472
            )
            $
            (1,823
            )
            $
            5,125
            
            $
            9,713
            
            $
            (52,703
            )**(Loss)
                earnings per share:**(Loss)
                income from continuing operationsBasic
            
            $
            (0.89
            )
            $
            (0.06
            )
            $
            (0.01
            )
            $
            (0.10
            )
            $
            0.02Diluted
            
            $
            (0.89
            )
            $
            (0.06
            )
            $
            (0.01
            )
            $
            (0.10
            )
            $
            0.02Net
                (loss) incomeBasic
            
            $
            (2.11
            )
            $
            (0.08
            )
            $
            0.23
            
            $
            0.44
            
            $
            (2.39
            )Diluted
            
            $
            (2.11
            )
            $
            (0.08
            )
            $
            0.23
            
            $
            0.44
            
            $
            (2.39
            )Weighted
                average shares outstanding - Basic
            
            
            22,072,549
            
            
            22,072,549
            
            
            22,072,549
            
            
            22,072,549
            
            
            22,072,549Weighted
                average shares outstanding - Diluted
            
            
            22,072,549
            
            
            22,072,549
            
            
            22,121,182
            
            
            22,072,549
            
            
            22,078,012**Summary
                Cash Flow Data:**Net
                cash (used in) provided by operating activities
            
            $
            (12,966
            )
            $
            7,117
            
            $
            19,012
            
            $
            22,963
            
            $
            29,469Net
                cash provided by (used in) investing activities
            
            
            5,997
            
            
            (7,474
            )
            
            (6,541
            )
            
            2,464
            
            
            109,738Net
                cash provided by (used in) financing activities
            
            
            7,015
            
            
            (181
            )
            
            (12,574
            )
            
            (25,157
            )
            
            (139,450
            )**Supplemental
                Data:**Depreciation
            
            $
            8,811
            
            $
            7,884
            
            $
            7,133
            
            $
            6,417
            
            $
            5,945Capital
                expenditures
            
            
            12,034
            
            
            9,832
            
            
            5,588
            
            
            5,573
            
            
            5,594**Balance
                Sheet Data (at end of period):**Cash
            
            $
            108
            
            $
            62
            
            $
            600
            
            $
            703
            
            $
            433Working
                capital
            
            
            69,259
            
            
            146,354
            
            
            112,488
            
            
            62,219
            
            
            52,386Total
                assets
            
            
            340,368
            
            
            391,094
            
            
            393,026
            
            
            404,329
            
            
            406,245Short-term
                debt
            
            
            3,128
            
            
            10,080
            
            
            29,328
            
            
            36,107
            
            
            90,335Long-term
                debt
            
            
            175,000
            
            
            175,000
            
            
            203,571
            
            
            209,287
            
            
            164,829Shareholders’
                equity (d)
            
            
            9,242
            
            
            55,714
            
            
            57,537
            
            
            52,412
            
            
            41,802




23


**Notes
      to Selected Consolidated Yearly Financial Data**


**(Dollars
      in Thousands)**





(a)
            For
                the fiscal year 2005, financial data has been restated to reflect
                the
                correction of errors and to reflect discontinued operations relating
                to
                our Miami and Northeast operations as more fully discussed in Note
                3 to
                Consolidated Financial Statements, “Discontinued Operations”. See the
                Explanatory Note on page 1 of this Form 10-K, “Restatement of Consolidated
                Financial Statements,” and Note 2 to Consolidated Financial Statements,
                “Restatement of Consolidated Financial Statements” of the notes to
                consolidated financial statements. In addition, the fiscal years
                2004,
                2003 and 2002, financial data has been restated to reflect the correction
                of errors and discontinued
                operations.





(b)
            On
                March 27, 2002, we sold Sun Gro, our peat moss and soil mix business,
                for
                net proceeds of approximately $125,000, the majority of which we
                used to
                repay indebtedness. Our consolidated financial statements in this
                filing
                reflect the financial position, results of operations and cash flows
                of
                the Sun Gro business as “discontinued operations.” For the year ended
                December 31, 2003, we recognized a $4,148 gain, net of tax of $2,784,
                from
                the sale. For the year ended December 31, 2002, we recognized a $5,562
                loss, net of tax of $10,729, from the sale and $149 income, net of tax of
                $287, from the operations through the date of the sale.





In
      August
      2006, we decided to discontinue our nursery operations located in the Northeast
      and Miami, Florida. Our consolidated financial statements in this filing reflect
      the financial position, results of operations and cash flows of the Northeast
      and Miami, Florida nursery operations as “discontinued operations.” For the
      years ended December 31, 2006 and 2005, we recognized a loss from discontinued
      operations, net of tax, of $26,765 and $527, respectively. For the years ended
      December 31, 2004, 2003 and 2002, we recognized income from discontinued
      operations, net of tax, of $5,433, $7,813 and $7,469, respectively.





(c)
            The
                cumulative effect of change in accounting principle for the year
                ended
                December 31, 2002 of $55,148, net of tax of $23,609, represents the
                goodwill impairment charge resulting from the Company’s adoption of SFAS
                No. 142, “Goodwill and Other Intangible
                Assets.”





(d)
            The
                Company recorded a cumulative effect adjustment to retained earnings
                as of
                January 1, 2003 for the correction of an asset retirement obligation
                error
                which is discussed in Note 2, “Restatement of Consolidated Financial
                Statements” of the notes to consolidated financial statements.


24


**ITEM
      7.**  **MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS** **OF
      OPERATIONS**





*The
      following discussion and analysis of our financial condition and results of
      operations gives effect to the restatement as discussed in the Explanatory
      Note
      immediately proceeding Item 1 of this Form 10-K and Note 2 to the Consolidated
      Financial Statements and to the reclassifications arising out of discontinued
      operations as discussed in Note 3 to the Consolidated Financial Statements.
      This
      discussion and analysis should be read in conjunction with our consolidated
      financial statements and related notes included elsewhere in this Annual Report
      on Form 10-K. In addition to historical information, this discussion contains
      certain forward-looking statements that involve risks and uncertainties. Our
      actual results could differ materially from those anticipated by these forward
      looking statements due to factors, including but not limited to, those set
      forth
      under “Risk Factors” and elsewhere in this Form 10-K. We assume no obligation to
      update any of the forward-looking statements after the date of this Form 10-K.*





**Overview**





We
      are a
      leading national supplier of ornamental shrubs, color plants and container-grown
      plants with eight commercial nursery facilities located in Arizona, California,
      Oregon, South Carolina and Texas. We produce approximately 5,900 varieties
      of
      ornamental shrubs and color plants and we sell to more than 1,180 retail and
      commercial customers, representing more than 6,670 outlets throughout the United
      States and Canada. Hines Horticulture, Inc. produces and distributes
      horticultural products through its wholly owned subsidiary, Hines
      Nurseries.





**Certain
      Reclassifications**





The
      Company has made certain reclassifications to prior periods’ financial
      statements to conform to fiscal 2006 classifications. These reclassifications
      include the Company’s discontinued operations, as fully discussed in Note 3 to
      the Consolidated Financial Statements, “Discontinued Operations.”





**Restatements**





The
      Company has made restatements to prior period financial statements to correct
      errors as discussed in Note 2 to the Consolidated Financial Statements,
“Restatement of Consolidated Financial Statements.”





**Refinancing**





On
      September 30, 2003, we refinanced substantially all of our outstanding debt,
      which included the issuance of $175.0 million of 10.25% Senior Notes (“Notes”)
      due in 2011 and the amended and restated Old Senior Credit Facility, which
      under
      its original terms would have expired in 2008. Our Old Senior Credit Facility
      was replaced by the New Senior Credit Facility as described below. This
      refinancing enabled us to extend the maturity of our previous debt, which we
      believed provided us with greater financial and operating flexibility in the
      future.





On
      January 18, 2007, we entered into a new Loan and Security Agreement (the “Loan
      Agreement”) that expires in 2012. The Loan Agreement consists of a $100.0
      million credit facility (subject to limitations), which includes a $15.0 million
      letter of credit sub line. The New Senior Credit Facility was used to refinance
      the outstanding revolving loans under the Old Senior Credit Facility. For
      additional information concerning our Notes and New Senior Credit Facility,
      see
“Liquidity and Capital Resources.”





**Sale
      of 122 Acres in Miami, Florida**





On
      November 7, 2005, we successfully completed the sale of 122 acres of unimproved
      property in Miami, Florida (“Miami Property Sale”) and received net proceeds of
      $47.0 million. In accordance with an amendment to our Old Senior Credit
      Facility, the proceeds from the Miami Property Sale were used to payoff the
      entire outstanding balance of the term loan; the residual amount was used to
      pay
      down our revolving credit facility. As part of the Miami Property Sale, we
      entered into a two-year lease agreement with the buyer to lease the property
      while transitioning operations to other locations. We leased the entire property
      for a one-year period, with a thirty-day extension right, and then vacated
      approximately 33 acres. Pursuant to the first amendment to the lease, we will
      lease the remaining 89 acres until June 30, 2007. In addition, the buyer has
      agreed to let us sublease the property for the remainder of the lease term.
      We
      pay the buyer rent of five hundred dollars per acre, annually, during the lease
      term plus fifty percent of the rent we receive from subleasing the property.
      We
      are also entitled to additional amounts if the buyer is successful in obtaining
      zoning for a certain number of residential lots. We originally recognized the
      sale of the property and deferred the gain on the transaction; however, due
      to
      continuing involvement in the property, and in accordance with SFAS No.
      98, we have reinstated the net book value of the assets, as well as
      recorded the proceeds received as a financing obligation in our December 31,
      2005 consolidated financial statements. When we exit the lease on June 30,
      2007,
      we will remove the net book value of the assets and expect to recognize a
      gain of approximately $39.9 million.


25


**Sale
      of 168 Acres in Vacaville, California**


On
        March
        1, 2006, we received notice that Triad Communities, L.P. exercised its option
        to
        purchase, pursuant to the previously disclosed Option Agreement dated April
        30,
        2003 (“Option Agreement”), our 168-acre property in Vacaville, California. The
        total book value of assets related to the sale was approximately $0.5 million.
        The Option Agreement provided that the gross purchase price of the property
        be
        $15.1 million. On April 3, 2006, we sold the property for a net purchase
        price
        of approximately $14.3 million. Total proceeds from the Option Agreement
        and
        sale of the property were approximately $16.9 million, which included
        approximately $2.6 million in option payments previously received.
 
 Under
        the
        terms of the Option Agreement, we are able to transition off the property
        in
        three phases from 2006 to 2008. The first phase of transition was completed
        on
        July 1, 2006 and consisted of 24 acres. The second phase of transition will
        be
        July 1, 2007 and the third phase of the transition will be July 1, 2008,
        and
        will consist of approximately 88 acres and 56 acres, respectively. We are
        continuing to develop replacement acreage and infrastructure at our 842-acre
        Winters South facility in Northern California. Because we are not paying
        rent,
        we are in a sale-leaseback with continuing involvement position with respect
        to
        this property. We originally recognized the sale of the property and deferred
        the gain on the Lagoon Valley property. However, in order to conform to SFAS
        No.
        98, as of June 30, 2006, we reinstated the net book value of the assets and
        recorded the proceeds received as a financing obligation. When we complete
        the
        transition on July 1, 2008, we will remove the net book value of the assets
        and
        expect to recognize a gain of approximately $16.2 million.





**Discontinued
      Operations**





*Miami
      Asset Sales*


On
      October 2, 2006, we entered into asset purchase agreements to sell certain
      inventory, vehicles, equipment and other assets located at our Miami, Florida
      facility. Total proceeds from the sale of these assets were approximately $4.1
      million, of which approximately $1.8 million was used to payoff outstanding
      related lease obligations. In connection with entering into the asset purchase
      agreements, we ceased active operations at our Miami, Florida
      facility.




On
      November 8, 2006, we completed the evaluation of the fair value of our Miami,
      Florida assets. The evaluation was based on the sales price of the assets
      compared to book value of the assets. As a result of the evaluation, we recorded
      an impairment charge of approximately $5.3 million to reflect the fair value
      of
      these assets. This impairment charge was recorded in the statements of
      operations as a component of the loss from discontinued operations in the third
      quarter of 2006.




On
      October 30, 2006, we entered into a commercial contract to sell one of our
      two
      remaining real properties located in Miami, Florida. The sale of approximately
      138 acres of land in Miami-Dade County, Florida and certain other assets of
      the
      Company closed on December 22, 2006. The sales price for the land and the other
      assets was approximately $12.2 million. We recorded a net gain of approximately
      $8.8 million from the sale of the 138 acres of land, which was recorded as
      a
      component of discontinued operations.




On
      April
      18, 2007, we completed the sale of our last remaining parcel of land in Miami,
      Florida, which consisted of approximately 79 acres of land and certain
      improvements thereon, for approximately $7.2 million. We will record a net
      gain
      of approximately $2.5 million from the sale, which will be recorded as a
      component of discontinued operations in 2007.




As
      of
      December 31, 2006, all of our remaining assets related to the Miami, Florida
      operations have been reclassified on the balance sheet as “assets held for
      sale.”





*Northeast
      Facilities*


In
      August
      2006, we made a decision to pursue the sale of our four Northeast nursery
      operations as provided for in the third amendment to our Old Senior Credit
      Facility. These operations consisted of our facilities in Danville and
      Pipersville, Pennsylvania and Newark and Utica, New York.


26






On
      November 15, 2006, we entered into an asset purchase agreement and sold certain
      real property, inventory and other assets located at our nursery facility in
      Pipersville, Pennsylvania, including the right to purchase real property which
      was previously leased to us. The sales price was approximately $5.3 million,
      approximately $1.1 million of which was deferred and is contingent upon certain
      entitlements for the construction of additional greenhouses on certain real
      property which was previously leased by us. The sale of these assets and real
      property resulted in a loss of approximately $1.2 million, which has been
      recorded as a component of discontinued operations.





As
      of
      December 31, 2006, the fixed assets, inventories and related liabilities of
      the
      three remaining properties at Danville, Pennsylvania, Utica, New York and
      Newark, New York have been reclassified as “Assets held for sale,” and the
      operations related to such assets have been reclassified as “discontinued
      operations.”




On
      January 10, 2007, we completed the sale of certain real property, inventory
      and
      other assets located at the nursery facilities in Danville, Pennsylvania, Utica,
      New York and Newark, New York for approximately $6.7 million. In connection
      with
      the sale, we terminated the leases for the real property comprising our
      Danville, Pennsylvania nursery facility.




**Impairment
        Charges at Northeast Facilities**


In
          reviewing our long-lived assets for impairment in accordance with SFAS No.
          144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” we
          determined in the second quarter of 2006 that our four nursery facilities
          located in the Northeast were impaired because the carrying values of the
          long-lived assets exceeded the estimated undiscounted future cash flows
          of the
          assets. We used an independent third party appraisal in order to determine
          fair
          value, which resulted in an impairment charge of approximately $8.0
          million. The charge was recorded by the Company in its consolidated statements
          of operations in the second quarter of 2006 as a component of discontinued
          operations.
 
 In
          October 2006, two major customers withdrew substantial future sales
          commitments from three of the four Northeast facilities, which withdrawal
          occurred subsequent to the original announcement of the sale of the four
          Northeast facilities. The withdrawal represented a reduction of approximately
          75% of the 2007 annual sales commitments for the three facilities, greatly
          reducing the fair market value of these assets. As a result, it was determined
          that the long-lived assets associated with these facilities were impaired.
          The
          fair value used to determine the impairment was based on letters of
          intent we received in connection with the sale of our Northeast facilities.
          As a
          result, we recorded an additional impairment charge of approximately $11.1
          million in the third quarter of 2006 to reflect the revised estimate
          of the fair value of these assets. This impairment charge was recorded
          as a
          component of the loss from discontinued operations in the consolidated
          statements of operations in the third quarter of 2006.
 
 In
          the
          fourth quarter of 2006, actual offers received on the Company’s Northeast
          facilities were less than the carrying values of the long-lived assets.
          As a
          result, the Company determined that an additional impairment charge of
          approximately $0.3 million should be recorded to reflect the revised estimate
          of
          the fair value of these assets. This impairment charge was recorded as
          a
          component of the loss from discontinued operations in the consolidated
          statements of operations in the fourth quarter of 2006. In addition, in
          the
          fourth quarter of 2006, the Company also recorded approximately $2.3 million
          of
          exit and disposal activity costs in order to terminate certain leases.
          These
          lease termination costs were recorded as a component of the loss from
          discontinued operations in the consolidated statements of operations in
          the
          fourth quarter of 2006.


**United
      States Tax Matters**





As
      a
      result of our business activities, we qualify for a special exception under
      the
      U.S. federal tax code that allows us to use the cash method of accounting for
      federal and state income tax purposes. Under the cash method, sales are included
      in taxable income when payments are received and expenses are deducted as they
      are paid. We derive significant tax benefits by being able to deduct the cost
      of
      inventory as the cost is incurred. As a result of our ability to utilize the
      cash method of accounting, we have historically generated net operating losses
      for federal income tax purposes. At December 31, 2006, we had $54.0 million
      in
      net operating loss carryforwards for federal income tax purposes, which begin
      to
      expire in 2024. In addition, we had approximately $53.0 million in net operating
      loss carryforwards for state income tax reporting purposes. Our state net
      operating losses in certain states begin expiring in 2008.





Based
      on
      our current projections, we anticipate that we will not pay cash income taxes
      for federal or state income taxes through 2010.


27


The
      use
      of the cash method of accounting for federal income tax purposes results in
      a
      current deferred tax liability for accounting purposes. At December 31, 2006,
      we
      had a current deferred liability of $44.2 million related to the use of the
      cash
      method of accounting. The deferred tax liability is deemed current for
      accounting purposes because the majority of the items to which this liability
      relates are comprised of current assets and current liabilities in our balance
      sheet (such as inventory, accounts receivable and accounts payable). The
      classification of this liability as a current item, however, does not mean
      that
      it is required to be paid within the next twelve months.





We
      accrue
      a liability for tax exposure items relating to matters where we do not believe
      it is probable that the tax position will be sustained.  New laws and new
      interpretations of laws and rulings by tax authorities may affect the liability
      for potential tax assessments. Due to the subjectivity and complex nature of
      the
      underlying issues, actual payments or assessments may differ from estimates.
      To
      the extent our estimates differ from actual payments or assessments, income
      tax
      expense is adjusted.  Management believes that adequate amounts of tax and
      related interest, if any, have been provided for any adjustments that may result
      from these examinations. During 2006, $1.2 million of previously recorded
      liabilities for probable tax assessments was reversed due to the expiration
      of the applicable statute of limitations for such items.  This reversal
      included $0.2 million for continuing operations and $1.0 million for
      discontinued operations.





**Seasonality**





Our
      business is highly seasonal. The seasonal nature of our operations results
      in a
      significant increase in our working capital between the growing and selling
      cycles. As a result, operating activities in the first and fourth quarters
      use
      significant amounts of cash, and in contrast, operating activities in the second
      and third quarters generate substantial cash as we ship inventory and collect
      accounts receivable. We have experienced, and expect to continue to experience,
      significant variability in net sales, operating income and net income on a
      quarterly basis.





**Pay
      By Scan**





In
      January 2005, we entered into an agreement with our largest customer to sell
      a
      portion of our product under a pay by scan program. Under this program, our
      customer does not take ownership of the inventory at its stores until the
      product is scanned at the check out register. Revenue is recorded at the point
      the store sells our product to its customer. Sales under this program began
      in
      February 2005 on a limited basis. Annuals and perennials are the only products
      impacted by this agreement.





Despite
      the implementation of the new pay by scan program, we did not encounter any
      material variances with the quality and variability of our earnings and cash
      flows during 2005 and 2006.




**Results
      of Operations**





The
      discussion of results of operations reflect amounts restated for the correction
      of errors discussed and discontinued operations, which are discussed in detail
      in the Note 2 and Note 3, respectively, to the Consolidated Financial
      Statements. In addition, the discussions presented below also reflect the
      restatement of the consolidated financial results to correct certain errors
      in
      prior periods, as discussed in the Explanatory Note and in Note 2 to the
      Consolidated Financial Statements and this report, and in the amended quarterly
      reports and on Form 10-Q/A for each of the first, second, and third quarters
      of
      2006, which were filed on July 10, 2007.





***Fiscal
      Year Ended December 31, 2006 compared to Fiscal Year Ended December 31, 2005***





Net
      Sales. Net sales of $232.6 million for the fiscal year ended December 31, 2006
      decreased $12.8 million, or 5.2%, from net sales of $245.3 million in 2005.
      The
      decline in net sales was primarily due to the persistent rain in the Pacific
      Northwest, Northern California and Southwest which we experienced in the first
      and second quarters of 2006, which reduced consumer demand and also led to
      delayed product availability during that time period. Additionally, our facility
      in South Carolina reported less sales volume as a result of lost market share
      primarily in the mid-Atlantic markets.




Gross
      Profit. Gross profit of $96.8 million for the fiscal year ended December 31,
      2006 decreased $27.5 million, or 22.1%, from gross profit of $124.3 million
      in
      2005. As a percentage of net sales, gross profit for the year decreased to
      41.6%
      compared to 50.7% in 2005. The decline in gross profit and gross profit margin
      was primarily due to overall lower net sales, a lower of cost or market
      adjustment and a reserve for excess inventory of $5.7 million at our Trenton,
      South Carolina facility in the third quarter of 2006. The lower of cost or
      market adjustment was caused by pricing pressures in the region as a result
      of
      increased competition and lost market share. The lost market share also caused
      us to record the reserve for excess inventory at the South Carolina facility.
      In
      addition, higher cost inventory, which was produced during 2005, also
      contributed to the decline.


28


Distribution
      Expenses. Distribution expenses of $52.6 million for the fiscal year ended
      December 31, 2006 decreased $0.3 million, or 0.6%, from $53.0 million in 2005.
      The decrease was due primarily to lower sales. As a percentage of net sales,
      distribution expenses for the fiscal year ended December 31, 2006 increased
      to
      22.6% from 21.6% for the comparable period in 2005. The increase in distribution
      expense expressed as a percentage of net sales is primarily due to increased
      diesel fuel costs and third party carrier costs.




Selling,
      General and Administrative Expenses. Selling, general and administrative
      expenses of $51.7 million for the fiscal year ended December 31, 2006 increased
      $4.5 million, or 9.4%, from $47.3 million in 2005. The increase in selling
      expenses of $2.1 million is primarily due to an increase in third party product
      merchandising costs, which have been increasingly required by certain customers.
      The increase in general and administrative expense of $2.3 million is primarily
      due to an increase in staffing in IT of approximately $0.9 million relating
      to
      systems related upgrades and finance resources of approximately $1.2 million
      for
      Sarbanes-Oxley 404 compliance related work.




Other
      Operating Expenses. Other operating expenses of $2.4 million for the fiscal
      year
      ended December 31, 2006 increased $1.1 million, or 81.9%, from $1.3 million
      in
      2005. Other operating expense in 2006 consisted primarily of consulting fees
      related to our productivity initiatives.




Asset
      Impairment Charges. Asset impairment charges of $1.5 million for fiscal year
      ended December 31, 2006 were recorded in connection with our Trenton, South
      Carolina facility. Due to lost market share we determined that the expected
      future cash flows at the facility would not be sufficient to recover the net
      book value of its fixed assets. As a result, we reduced the carrying value
      of
      the assets to fair value in the third fiscal quarter of 2006 through an
      impairment charge of $1.5 million.




Operating
      (Loss) Income. Operating loss for fiscal year ended December 31, 2006 was $11.4
      million compared to operating income of $22.8 million for the comparable period
      in 2005. The change from operating income to operating loss resulted from a
      decline in gross profit for the 2006 fiscal year of $27.5 million, an increase
      in selling expense of $2.1 million, an increase of $2.3 million in general
      and
      administrative expenses, an increase of other operating expenses of $1.1 million
      and an asset impairment charge of $1.5 million.




Other
      Expenses. Other expenses of $20.9 million for the fiscal year ended December
      31,
      2006 decreased $3.9 million, or 15.6%, from $24.8 million in 2005. The decrease
      was primarily due to a reduction in interest expense of $3.1 million related
      to
      lower outstanding debt and partially offset by higher interest rates. The
      decrease in interest expense was further offset by the swap agreement income
      in
      2005 of $0.9 million. The swap agreement matured in February of
      2005.




Loss
      from
      Continuing Operations Before Income Taxes. Loss from continuing operations
      before income taxes of $32.3 million for the fiscal year ended December 31,
      2006
      increased $30.3 million from loss from continuing operations before income
      taxes
      of $2.0 million in 2005. The increase in loss from continuing operations before
      income taxes was primarily a result of having operating losses during the fiscal
      year ended December 31, 2006, partially offset by a decrease in other
      expenses.




Income
      Tax (Benefit) Provision. Our effective income tax rate was 39.0% and 36.4%
      for
      the fiscal years ended December 31, 2006 and 2005, respectively. Benefit from
      income taxes was $12.6 million for the fiscal year ended December 31, 2006,
      compared to benefit from income taxes of $0.7 million in the fiscal year ended
      December 31, 2005. The increase in the effective income tax rate is mainly
      due
      to the increase in loss before income taxes which decreased the percentage
      impact of various permanent differences between financial statement accounting
      and income tax accounting. Since these were loss years, the permanent
      differences decrease the income tax rate and corresponding tax benefit. A larger
      loss before income taxes decreases the percentage impact of these permanent
      differences and increases the tax rate. Additionally, during 2006 approximately
      $0.2 million of previously recorded liabilities for potential tax assessments
      was reversed due to the expiration of the applicable statute of limitations
      for
      such items.





Loss
      from
      Discontinued Operations Net of Income Taxes. Loss from discontinued operations,
      net of income taxes, for the fiscal year ended December 31, 2006 of $26.8
      million increased $26.2 million from loss from discontinued operations, net
      of
      tax of $0.5 million in 2005. The increase in loss from discontinued operations
      was primarily due to exit and disposal costs, asset and other impairment charges
      totaling $29.0 million recorded during the fiscal year ended December 31, 2006.
      Discontinued operations is discussed in more detail in Note 3 to the
      Consolidated Financial Statements.


29


Net
      Loss.
      Net loss of $46.5 million for the fiscal year ended December 31, 2006 increased
      $44.6 million from net loss of $1.8 million for the comparable period in 2005.
      The increase in net loss is primarily due to lower net sales volume, lower
      gross
      profit margin, the loss from discontinued operations and other factors discussed
      above.




***Fiscal
      Year Ended December 31, 2005 compared to Fiscal Year Ended December 31, 2004***





Net
      Sales. Net sales of $245.3 million for the fiscal year ended December 31, 2005
      increased $1.4 million, or 0.6%, from net sales of $244.0 million in 2004.
      The
      slight increase in net sales was primarily due to an increase in net sales
      and
      sales unit volume at our west coast facilities, partially offset by a decline
      in
      sales unit volume as a result of the impacts of hurricanes Katrina, Rita and
      Wilma in the South and the Southeastern regions.




Gross
      Profit. Gross profit of $124.3 million for the fiscal year ended December 31,
      2005 increased $2.2 million, or 1.8%, from gross profit of $122.1 million in
      2004. As a percentage of net sales, gross profit for the year increased to
      50.7%
      compared to 50.1% in 2004. The increase in gross profit and gross profit margin
      percentage was mainly attributable to the increase in sales which was offset
      by
      higher raw material and commodity costs. This was especially true for
      petroleum-based plastic containers and higher fuel costs.




Distribution
      Expenses. Distribution expenses of $53.0 million for the fiscal year ended
      December 31, 2005 increased $3.0 million, or 5.9%, from $50.0 million in 2004.
      The increase in distribution expenses was attributable to higher diesel fuel
      costs and increased third party carrier charges, which were primarily driven
      by
      more expensive diesel fuel.




Selling,
      General and Administrative Expenses. Selling, general and administrative
      expenses of $47.3 million for the fiscal year ended December 31, 2005 increased
      $0.1 million, or 0.1%, from $47.2 million in 2004. Selling expenses for the
      fiscal year ended December 31, 2005 decreased by $0.7 million from a year ago
      mainly as a result of the cost savings generated from the reorganization carried
      out in the second quarter of 2005 which included the realignment of certain
      aspects of management as well as a permanent reduction in headcount. Such cost
      savings were partially offset by an increase in advertising costs, as well
      as an
      increase in third-party merchandising costs. The decrease in selling expenses
      was offset by an increase in general and administrative expense which was
      primarily due to increased cost associated with the implementation of
      Sarbanes-Oxley.




Other
      Operating Expenses. Other operating expenses of $1.3 million for the fiscal
      year
      ended December 31, 2005 increased $0.8 million, or 149.1%, from $0.5 million
      in
      2004. Other operating expense in 2005 consisted primarily of $1.0 million of
      consulting fees relating to productivity improvements and severance costs of
      $0.5 million incurred during our strategic reorganization in the second quarter
      of 2005. These amounts were partially offset by approximately $0.2 million
      from
      gains on sales of assets.




Operating
      Income. Operating income of $22.8 million for the fiscal year ended December
      31,
      2005 decreased $1.6 million, or 6.7%, from $24.4 million in 2004. The decline
      in
      operating income was mainly due an increase in distribution expenses due to
      rising fuel costs and common carrier charges.




Other
      Expenses. Other expenses of $24.8 million for the fiscal year ended December
      31,
      2005 increased $0.3 million, or 1.2%, from $24.5 million in 2004. The small
      increase was due to lower interest rate swap agreement income and deferred
      financing fees written off in connection with the early termination of our
      Senior Credit term loan of $1.1 million. This was offset by a decline in
      interest expense due to lower overall debt.


(Loss)
        Income from Continuing Operations Before Income Taxes.  Loss from
        continuing operations before income taxes for the fiscal year ended December
        31,
        2005 of $2.0 million increased $2.1 million from the loss from continuing
        operations before income taxes of $0.1 million for the comparable period
        in
        2004.




Income
      Tax (Benefit) Provision. Our effective income tax rate was 36.4% and 214% for
      the fiscal years ended December 31, 2005 and 2004, respectively. Benefit from
      income taxes was $0.7 million for the fiscal year ended December 31, 2005,
      compared to provision for income taxes of $0.2 million in the fiscal year ended
      December 31, 2004. The decrease in the effective income tax rate was mainly
      due
      the impact of permanent differences between book and tax in the 2004
      year.




(Loss)
      Income from Discontinued Operations Net of Income Taxes. Loss from discontinued
      operations, net of income taxes, for the fiscal year ended December 31, 2005
      of
      $0.5 million was $6.0 million less than income from discontinued operations,
      net
      of tax, of $5.4 million for the comparable period in 2004.




Net
      (Loss) Income. The net loss of $1.8 million for the fiscal year ended December
      31, 2005 changed by $6.9 million, or 135.6%, from net income of $5.1 million
      for
      the comparable period in 2004 primarily as a result of the decline in operating
      income, as discussed above.


30


**Liquidity
      and Capital Resources**





Our
      primary sources of liquidity have historically been funds generated by
      operations and borrowings under our credit facilities. The seasonal nature
      of
      our operations results in significant fluctuation in certain components of
      working capital (primarily accounts receivable and inventory) during the growing
      and selling cycles. As a result, operating activities during the first and
      fourth quarters use significant amounts of cash, and in contrast, operating
      activities for the second and third quarters generate substantial cash as we
      ship inventory and collect accounts receivable.





Net
      cash
      used in operating activities of continuing operations was $8.1 million for
      the
      fiscal year ended December 31, 2006 compared to net cash provided by operating
      activities of continuing operations of $3.9 million for 2005. The increase
      in
      cash used by operating activities was mainly due to the decline in gross profit
      during the period, partially offset by reduced working capital levels. The
      decline in gross profit was primarily due to the decrease in net sales and
      an
      increase in cost of goods sold resulting from the sell-through of higher cost
      inventory that was produced in 2005. The reduced working capital balances were
      mainly due to reduced accounts receivable and inventory balances at year end.
      The decline in accounts receivable of $4.9 million resulted mainly from the
      reduction in net sales. The decline in inventory of $11.8 million resulted
      from
      fewer units in production as we sought to better align production with
      forecasted sales as well as the fact that we are now capturing units into
      inventory with lower production costs resulting from our internal labor
      productivity initiatives.





Net
      cash
      used in operating activities of discontinued operations was $4.9 million for
      the
      fiscal year ended December 31, 2006 compared to net cash provided by operating
      activities of discontinued operations of $3.2 million. The increase in cash
      used
      in operating activities of discontinued operations was primarily due to the
      decline in gross profit. The decline in gross profit was primarily due to the
      decrease in net sales and an increase in cost of goods sold resulting from
      the
      sell-through of higher cost inventory that was produced in 2005.





Net
      cash
      used by investing activities of continuing operations was $12.0 million for
      the
      fiscal year ended December 31, 2006 compared to net cash used in investing
      activities of continuing operations of $7.6 million for 2005. The increase
      in
      cash used by investing activities was mainly due to an increase in capital
      expenditures of $2.2 million. Capital expenditures during 2006 mainly consisted
      of general operating capital and expenditures related to our Irvine capacity
      relocation project.





Net
      cash
      provided by investing activities of discontinued operations was $18.0 million
      compared to net cash provided by investing activities of discontinued operations
      of $0.2 million. The increase in cash provided was mainly due to the receipt
      of
      $13.9 million related to the sale of our Miami operations and $4.2 million
      related to our Pipersville operations.





Net
      cash
      provided by financing activities of continuing operations was $7.0 million
      for
      the fiscal year ended December 31, 2006 compared to net cash used of $48.0
      million for 2005. Net cash provided by financing operations in 2006 primarily
      represents the receipt of $14.3 million of cash proceeds from the Lagoon Valley
      land sale. The decrease in cash used in financing activities in 2005 is mainly
      attributed to the pay-off of our entire $30.5 million outstanding balance of
      our
      term loan and approximately $16.5 million to pay down our revolver in
      2005.





There
      was
      no cash provided by or used in financing activities of discontinued operations
      for the fiscal year ended December 31, 2006 compared to net cash provided by
      financing activities of discontinued operations of $47.9 million for 2005.
      The
      entire 2005 amount represents the receipt of $47.9 million of cash proceeds
      from
      the first parcel of land sold at our Miami, Florida facility, which is reflected
      as a financing obligation in accordance with SFAS No. 98.





We
      typically draw down our revolving credit facilities in the first and fourth
      quarters to fund our seasonal inventory buildup and seasonal operating expenses.
      Approximately 75% of our sales occur in the first half of the year, generally
      allowing us to reduce borrowing under our revolving credit facilities in the
      second and third quarters. After applying the borrowing base limitations and
      letters of credits to our available borrowings under the Old Senior Credit
      Facility as of December 31, 2006, we were limited to a maximum borrowing
      availability of $10.8 million based on the utilization limits in place for
      the
      third quarter of 2006 and $23.3 million for the fourth quarter of 2006.
      Borrowing availability and amount outstanding as of December 31, 2006 were
      $20.2
      million and $3.1 million, respectively. In addition, borrowing availability
      under our New Senior Credit Facility, described below, as of June 15, 2007
      was
      approximately $77.0 million.





At
      December 31, 2006, we had total indebtedness outstanding of $178.1 million.
      We
      believe that cash generated by operating activities and funds available under
      our credit facilities will be sufficient to finance our operating activities
      for
      at least the next 12 months.


31


Since
      we
      failed to timely file our Annual Report on Form 10-K for the year ended December
      31, 2006 and our Quarterly Report on Form 10-Q for the fiscal quarter ended
      March 31, 2007, NASDAQ notified us through letters dated April 18, 2007 and
      May
      17, 2007, respectively, that we were not in compliance with the filing
      requirements for continued listing set forth in Marketplace Rule 4310(c)(14),
      and that we were therefore subject to delisting from The Nasdaq Global Market.
      As a result, we requested and participated in a hearing before a NASDAQ Listing
      Qualifications Panel, which had the effect of staying the delisting of our
      securities pending a decision by the NASDAQ Panel. We are filing hereby our
      Annual Report on Form 10-K for the year ended December 31, 2006, and are working
      to file our Quarterly Report on Form 10-Q for the fiscal quarter ended March
      31,
      2007 as quickly as practicable. However, there can be no assurance that the
      NASDAQ Panel will grant our request for continued listing as a result of the
      hearing or the filing of our delinquent reports. In addition, our common stock
      has recently traded below $1.00 per share, which could also impact our ability
      to remain listed on The Nasdaq Global Market. In the event that our securities
      our delisted, the market liquidity of our common stock could be adversely
      affected and the market price of our common stock could decrease.





***Off
      Balance Sheet Arrangements***





We
      do not
      have any off balance sheet financing or any other similar financial arrangements
      with related parties, other than operating leases. The following table discloses
      aggregate information about our contractual obligations and commercial
      commitments as of December 31, 2006.




Payments
                Due by PeriodContractual
              Cash Obligations
            
            
            Total
            
            
            Less
                than1
                year
            
            
            1-3years
            
            
            4-5
                years
            
            
            After
                5 years(In
                millions)Revolving
                facility
            
            $
            3.1
            
            $
            3.1
            
            $
            -
            
            $
            -
            
            $
            -Senior
                notes
            
            
            175.0
            
            
            -
            
            
            -
            
            
            175.0
            
            
            -Interest
            
            
            117.7
            
            
            19.6
            
            
            39.2
            
            
            39.2
            
            
            19.7Operating
                leases
            
            
            10.6
            
            
            3.6
            
            
            4.6
            
            
            2.0
            
            
            0.4Total
            
            $
            306.4
            
            $
            26.3
            
            $
            43.8
            
            $
            216.2
            
            $
            20.1





We
      believe that cash generated by operations and from borrowings expected to be
      available under our New Senior Credit Facility will be sufficient to meet our
      anticipated working capital, capital expenditures and debt service requirements
      for at least the next twelve months.





The
      following is a summary of certain material terms of our Old Senior Credit
      Facility as of December 31, 2006, our New Senior Credit Facility entered into
      on
      January 18, 2007 and Hines Nurseries’ 10.25% Senior Notes due 2011.





***Old
      Credit Facility***





We
      entered into the Old Senior Credit Facility on September 30, 2003. Hines
      Nurseries and its domestic operating subsidiaries were borrowers under the
      Old
      Senior Credit Facility. The credit facility originally consisted of a revolving
      facility with availability of up to $145.0 million (subject to borrowing base
      limits), which was eventually reduced through amendments to the Old Senior
      Credit Facility to $100.0 million (subject to borrowing base limits) from
      various amendments. The revolving facility also permitted us to obtain letters
      of credit up to a sub-limit.





The
      Old
      Senior Credit Facility required Hines Nurseries and its subsidiaries to meet
      specific covenants and financial ratios, including a minimum fixed charge
      coverage test, a maximum leverage test and a maximum capital expenditure test.
      The Old Senior Credit Facility contained customary representations and
      warranties and customary events of default and other covenants. As of December
      31, 2006, we were not in compliance with some of our covenants; however, as
      discussed below, the non-compliance was cured with the Fourth Amendment and
      Limited Waiver.





*Fourth
      Amendment and Limited Waiver To Old Senior Credit Facility.* In
      December 2006, Hines Nurseries negotiated and entered into the Fourth Amendment
      to the Old Senior Credit Facility to waive the minimum fixed charge coverage
      ratio covenant of the Old Senior Credit Facility for the fourth quarter of
      fiscal quarter 2006. The Fourth Amendment and Limited Waiver amended the date
      we
      were required to sell our four nursery facilities in the Northeast and certain
      assets in Miami, Florida to March 31, 2007. On January 18, 2007, the Old Senior
      Credit Facility was terminated and replaced with the New Senior Credit Facility
      as described below.


32


***New
      Senior Credit Facility***





On
      January 18, 2007, we entered into a Loan and Security Agreement (the "New Senior
      Credit Facility") that expires in 2012. The New Senior Credif
      Facility consists of a $100.0 million credit facility, which includes a
      $15.0 million letter of credit subline. The New Senior Credit Facility was
      used
      to refinance the outstanding revolving loans under the Old Senior Credit
      Facility.





*Guarantees;
      Collateral* .
      The
      obligations under the New Senior Credit Facility are guaranteed by us.
      Borrowings under the New Senior Credit Facility are collateralized by
      substantially all of our and Hines Nurseries’ assets.





*Restrictions;
      Covenants; Defaults* .
      The New
      Senior Credit Facility includes customary events of default and other customary
      covenants, including, but not limited to, a fixed charge coverage ratio test,
      restrictions on certain types of activities, transactions and payments,
      including distributions and dividends from Hines Nurseries to us, reporting
      covenants and others. The New Senior Credit Facility also includes standard
      provisions related to conditions of borrowing and customary representations
      and
      warranties. The lenders may terminate their obligation to make loans under
      the
      Loan Agreement, and may accelerate payment of the indebtedness under the Loan
      Agreement, upon the occurrence of an event of default, including the failure
      to
      comply with the covenants contained in the Loan Agreement. Upon the occurrence
      and during the continuance of an event of default, the interest rate will
      increase by 2.00%.





*Limited
      Waiver to Loan Agreement.* On
      April
      30, 2007, we obtained a waiver from the financial institutions pursuant to
      which
      the lenders waived certain defaults under the New Senior Credit Facility and
      extended the deadline for filing the financial statements for the fiscal year
      ended December 31, 2006 and for the fiscal quarter ended March 31, 2007 to
      May 28, 2007. On May 29, 2007, we obtained an additional waiver under
      the New Senior Credit Facility to, among other things, to extend the date of
      filing such financial statements from May 28, 2007 to June 28, 2007.
      On June 21, 2007, we obtained an additional waiver under the Loan Agreement
      to
      extend the date of delivering our quarterly financial statements for the fiscal
      quarter ended March 31, 2007 to July 20, 2007. OnJuly
      3,
      2007,
      we obtained a further waiver under the Loan Agreement, effective as of June
      28,
      2007, extending to July 13, 2007 the deadline for us to deliver our annual
      financial statements for the fiscal year ended December 31, 2006, and extending
      to July 31, 2007 the deadline for us to deliver our quarterly financial
      statements for the fiscal quarter ended March 31, 2007.





*Interest
      Rate; Fees* .
      The
      interest rate on the loans under the New Senior Credit Facility may be, at
      our
      option, base rate loans or London Interbank Offering Rate (“LIBOR”) loans. Base
      rate loans under the New Senior Credit Facility bear interest at our lenders
      prime rate plus an additional amount that ranges from 0.50% to 1.25%, depending
      on our average availability of borrowing under the New Senior Credit Facility.
      Currently, the applicable margin for base rate loans is 0.75%. LIBOR rate loans
      under the New Senior Credit Facility bear interest at the LIBOR rate plus an
      additional amount that ranges from 1.50% to 2.25%, depending on our average
      availability of borrowing under the New Senior Credit Facility. Currently,
      the
      applicable margin for LIBOR rate loans is 1.75%.





In
      addition to paying interest on outstanding principal, we are required to pay
      a
      commitment fee on the daily average unused portion of the New Senior Credit
      Facility which accrues based on the utilization of the New Senior Credit
      Facility. Additionally, we are required to pay a fee for each letter of credit
      outstanding under the Loan Agreement equal to the applicable margin for LIBOR
      rate loans to be shared by the lenders and a fronting fee of 0.125% to the
      individual issuer of a letter of credit.





*Availability;
      Borrowing Base.* Availability of borrowing under the New Senior Credit Facility is subject to
      a
      borrowing base consisting of the lesser of (i) the amount equal to the aggregate
      amount of the revolving loan commitment minus the aggregate amount of all
      letters of credit outstanding under the Loan Agreement and all fees or other
      amounts owing by us with respect thereto (less certain amounts) minus the amount
      of the availability block under the Loan Agreement, which is currently $15.0
      million but which shall be reduced to $0 at such time as we achieve a fixed
      charge coverage ratio of at least 1.1:1 for two consecutive fiscal quarters
      and
      (ii) the amount equal to 85% of eligible accounts receivable plus the lesser
      of
      (a) during the period commencing on December 31 of each calendar year and ending
      on April 30 each calendar year, the lesser of 65% of eligible inventory or
      85%
      of the appraised net orderly liquidation value of eligible inventory or (b)
      during the period commencing on May 1 of each calendar year and ending on
      December 30 each calendar year, the lesser of 55% of eligible inventory or
      85%
      of the appraised net orderly liquidation value of eligible inventory minus
      the
      sums of the reserves provided for in Loan Agreement.





We
      must
      deliver borrowing base certificates and reports at least monthly. The borrowing
      base also may be subject to certain other adjustments and reserves to be
      determined by the agent. Eligible accounts receivable of both The Home Depot,
      our largest customer, and Lowe’s Companies, Inc., our second biggest customer,
      may not exceed 30% of total eligible accounts receivable at any
      time.


33


*Maturity
      Date; Prepayments* .
      Amounts
      outstanding under the New Senior Credit Facility mature on January 18, 2012
      and
      we may prepay amounts outstanding under the Loan Agreement without fees or
      penalties, subject to the payment of costs associated with the prepayment of
      any
      LIBOR rate loans.





*Change
      of Control* .
      In the
      event of a change of control, the commitments of the lenders under the New
      Senior Credit Facility may be cancelled and we may be required to immediately
      repay the outstanding amount of the New Senior Credit Facility, together with
      accrued interest and all other amounts accrued under the New Senior Credit
      Facility.





***Our
      Senior Notes***





On
      September 30, 2003, Hines Nurseries issued $175.0 million of Senior Notes that
      mature on October 1, 2011. The Senior Notes bear interest at the rate of 10.25%
      per annum and will be payable semi-annually in arrears on each April 1 and
      October 1, which commenced on April 1, 2004.





*Guarantees.* Hines
      Horticulture and each of its domestic subsidiaries, subject to certain
      exceptions, has, jointly and severally, fully and unconditionally guaranteed,
      on
      a senior unsecured basis, the obligations of Hines Nurseries under the Senior
      Notes.





*Redemption.* Prior to
      October 1, 2006, up to 35% of the aggregate principal amount of the Senior
      Notes
      may be redeemed with the net cash proceeds from one or more public equity
      offerings, at our option, at a redemption price of 110.250% of the principal
      amount thereof plus accrued interest, if any, to the date of redemption. On
      or
      after October 1, 2007, we are entitled, at our option, to redeem all or a
      portion of the Senior Notes at redemption prices ranging from 100.000% to
      105.125%, depending on the redemption date, plus accrued and unpaid
      interest.





*Restrictions.* The
      indenture pursuant to which the Senior Notes were issued imposes a number of
      restrictions on Hines Nurseries and our other subsidiaries. Subject to certain
      exceptions, we may not incur additional indebtedness, make certain restricted
      payments, make certain asset dispositions, incur additional liens or enter
      into
      significant transactions. A breach of material term of the indenture or other
      material indebtedness that results in acceleration of the indebtedness under
      the
      Notes also constitutes an event of default under our New Senior Credit
      Facility.





*Repurchase
      on a Change in Control.* The
      Senior Notes contain a put option whereby the holders have the right to put
      the
      Senior Notes back to us at 101.000% of the principal amount thereof on the
      date
      of purchase, plus accrued and unpaid interest if a change of control
      occurs.





**Critical
      Accounting Policies and Estimates**





The
      preparation of financial statements in conformity with generally accepted
      accounting principles requires us to make estimates and assumptions that affect
      the reported amounts of assets and liabilities and disclosure of contingent
      assets and liabilities at the date of the financial statements and the reported
      amounts of revenues and expenses during the reporting period. Actual results
      could differ from those estimates. We believe that the following areas represent
      our most critical accounting policies related to actual results that may vary
      from those estimates.


34


**Revenue
      Recognition**





We
      record
      revenue, net of sales discounts and allowances, when all of the following have
      occurred: an agreement of sale exists, product delivery and acceptance has
      occurred, the sales price is fixed or determinable and collection is reasonably
      assured.





Sales
      with pay by scan arrangements are recognized when the products are sold by
      the
      retailers. Under this program, retailers do not take ownership of the inventory
      at their stores until the product is scanned at the check out register. Revenue
      is recorded at the point the retailer sells our product to their
      customer.





*Sales
      Returns and Allowances* :
      Amounts
      accrued for sales returns and allowance are maintained at a level believed
      adequate by management to absorb probable losses in the trade receivable due
      to
      sales returns and discounts and allowances. The provision rate is established
      by
      management using the following criteria: past sales returns experience, current
      economic conditions and other relevant factors, and are re-evaluated on a
      quarterly basis. The allowance is increased by provisions for sales returns
      and
      discounts and allowances and are netted against sales. We record revenue, net
      of
      sales discounts and allowances, when the risk of ownership is transferred to
      the
      customer. Allowances are provided at the time of revenue is recognized in
      accordance with SFAS No. 48, “Revenue Recognition When Right of Return
      Exists.”





*Accounts
      Receivable and Allowance for Doubtful Accounts:* Trade
      accounts receivable are recorded at the invoiced amount and do not bear
      interest. The allowance for doubtful accounts is our best estimate of the amount
      of probable credit losses in our existing accounts receivable. The allowance
      for
      doubtful accounts is maintained at a level believed adequate by management
      to
      reflect the probable losses in the trade receivable due to customer default,
      insolvency or bankruptcy. The provision is established by management using
      the
      following criteria: customer credit history, historical write-offs, customer
      current credit rating and other relevant factors, and is re-evaluated on a
      quarterly basis. Past due balances over 90 days and over a specified amount
      are
      reviewed individually for collectibility. The allowance is increased by
      provisions to bad debt expense and charged to general and administrative
      expenses.  All recoveries on trade receivables previously charged off are
      credited to bad debt expense, while direct charge-offs of trade receivables
      are
      deducted from the allowance.





**Goodwill**





In
      accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," goodwill
      is not amortized, but instead is subject to an annual impairment review. Each
      of
      our locations represents a component of a single reporting unit as they each
      have similar economic characteristics, as defined in SFAS No. 142. As our
      operations are comprised of one reporting unit, we review the recoverability
      of
      our goodwill by comparing the fair value to the book value of equity. If our
      book value of equity exceeds fair value, the goodwill is written down to its
      implied fair value. We evaluate the carrying value of goodwill in the fourth
      quarter of each year and when events and circumstances indicate that the assets
      may be impaired.





**Accrued
      Liabilities**





Accrued
      liabilities include amounts accrued for expected claims costs relating to our
      insurance programs for workers’ compensation and auto liabilities. We have large
      deductibles for these lines of insurance, which means we must pay the portion
      of
      each claim that falls below the deductible amount. Our expected claims costs
      are
      based on an actuarial analysis that considers our current payroll and automobile
      profile, recent claims history, insurance industry loss development factors
      and
      the deductible amounts. We accrue our expected claims costs for each year on
      a
      ratable monthly basis with a corresponding charge against income. Management
      reviews the adequacy of the accruals at the end of each quarter. The accruals
      for the expected costs relating to our insurance programs for workers’
compensation and auto liabilities are maintained at levels believed by our
      management to adequately reflect our probable claims obligations. In addition,
      we accrue for additional amounts for claims that are expected to settle for
      more
      than the deductible amounts. These additional amounts are recorded in other
      liabilities and are offset by an equal amount in other assets, in the
      accompanying consolidated balance sheets, as these potential additional losses
      are fully insured.


35




**Operating
      Leases**





We
      lease
      certain land, office, trucks and warehouse facilities under various renewable
      long-term operating leases, which expire through 2013. All of the leases we
      enter into are accounted for in accordance with SFAS No. 13, “Accounting for
      Leases.” Certain of these leases include escalation clauses based upon changes
      in the consumer price index and/or the fair rental value of leased land and
      are
      accounted for on a straight-line basis over the term of the lease. Contingent
      rentals are not considered minimum lease payments and are included in rent
      expense as they are incurred. Rent concessions or lessor provided incentives
      are
      included in the minimum lease payments or are offset to rent expense in the
      case
      of non-contingent rentals. For contingent rentals, such concessions or
      incentives are recorded as an offset to rent expense as incurred.





**Inventories**





We
      determine the cost of inventory of nursery stock by accumulating costs
      associated with getting the plants ready for sale.  These costs include
      direct labor, overhead, materials (soil, water, containers, stakes, chemicals)
      and normal scrap.   Abnormal scrap is charged to cost of goods sold
      when incurred. Scrap occurs at both our nursery facilities and, in some cases,
      at the retailer, if the scrap relates to unsold consigned inventory associated
      with the Pay by Scan program.  Abnormal scrap includes scrap incurred
      outside of historically determined statistical levels. Abnormal scrap in many
      cases is caused by natural causes such as hurricanes or extreme freezes. 
In addition, abnormal scrap also occurs when we determine we have excess or
      obsolete inventories, which can occur as a result of adverse changes in the
      market or incorrect forecasting of customer demand.  Costs are accumulated
      until the time of harvest, which for us means that they are ready for
      sale.  We allocate costs to individual plants in inventory using a
      methodology designed to estimate the relative value of the plants using factors
      such as plant size and growing cycle. We carry our inventory at the lower of
      cost or current replacement cost. We generally determine current replacement
      cost on a site by site basis. Nursery stock also includes plants that are not
      yet ready for sale.  Hines' ornamental nursery stock has an average growing
      period of approximately eighteen months. All nursery stock is classified as
      a
      current asset based on our normal operating cycle.  Materials and supplies
      not yet used in the production process are stated at the lower of cost
      (first-in, first-out) or market.





**Income
      Taxes**





Our
      operations are agricultural in nature and we derive significant benefits by
      qualifying to use the cash method of accounting for federal tax purposes. We
      record income taxes under the asset and liability method, whereby deferred
      tax
      assets and liabilities are recognized for the future tax consequences
      attributable to differences between the financial statement carrying amounts
      of
      existing assets and liabilities and their respective tax bases, and for
      operating loss and tax credit carryforwards. Deferred tax assets and liabilities
      are measured using enacted tax rates expected to apply in the years in which
      those temporary differences are expected to be recovered or settled. The effect
      on deferred tax assets and liabilities of a change in tax rates is recognized
      in
      income in the period that includes the enactment date. Management evaluates
      the
      need to establish a valuation allowance for deferred tax assets based upon
      the
      amount of existing temporary differences, the period in which they are expected
      to be recovered and expected levels of taxable income. A valuation allowance
      to
      reduce deferred tax assets is established when it is “more likely than not” that
      some or all of the deferred tax assets will not be realized.





The
      Company accrues a liability for tax exposure items relating to matters where
      the
      Company does not believe it is probable that the tax position will be
      sustained.  New laws and new interpretations of laws and rulings by tax
      authorities may affect the liability for potential tax assessments. Due to
      the
      subjectivity and complex nature of the underlying issues, actual payments or
      assessments may differ from estimates. To the extent the Company’s estimates
      differ from actual payments or assessments, income tax expense is adjusted.





**Impairment
      of Long-Lived Assets**





In
      accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
      Long-Lived Assets,” long-lived assets and intangible assets with determinate
      lives are reviewed for impairment whenever events or changes in circumstances
      indicate that the carrying amount of an asset may not be recoverable. We
      evaluate potential impairment by comparing the carrying amount of the asset
      with
      the estimated undiscounted future cash flows associated with the use of the
      asset and its eventual disposition. Should the review indicate that the asset
      is
      not recoverable; our carrying value of the asset would be reduced to its
      estimated fair value, which is generally measured by future discounted cash
      flows.


36


**Accounting
      Pronouncements Adopted**





In
      December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment,” which
      establishes standards for transactions in which an entity exchanges its equity
      instruments for goods or services. This standard requires a public entity to
      measure the cost of employee services received in exchange for an award of
      equity instruments based on the grant-date fair value of the award. This
      eliminates the exception to account for such awards using the intrinsic method
      previously allowable under Accounting Principles Board (“APB”) Opinion No. 25.
      In March 2005, the Securities and Exchange Commission (SEC) released Staff
      Accounting Bulletin (“SAB”) 107, “Share-Based Payment,” which expresses views of
      the SEC Staff about the application of SFAS No. 123(R). SFAS No. 123(R) was
      to
      be effective for interim or annual reporting periods beginning on or after
      June
      15, 2005, but in April 2005 the SEC issued a rule that SFAS No. 123(R) would
      be
      effective for annual reporting periods beginning on or after June 15, 2005.
      We
      adopted SFAS No. 123(R) on January 1, 2006 under the modified prospective
      transition method. The adoption of this standard did not have a material impact
      on our consolidated financial position, results of operations and cash
      flows.





In
      December 2004, the FASB issued SFAS No. 153, "Exchange of Non-Monetary Assets
      -
      An Amendment of ARB Opinion No. 29," which requires non-monetary asset exchanges
      to be accounted for at fair value. We are required to adopt the provisions
      of
      SFAS No. 153 for non-monetary exchanges occurring in fiscal periods beginning
      after June 15, 2005. The adoption of this standard did not have a material
      impact on our consolidated financial position, results of operations and cash
      flows.





In
      May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error
      Corrections.” FASB No. 154 replaces APB Opinion No. 20, “Accounting
      Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim
      Financial Statements,” and changes the requirements for the accounting for and
      reporting of a change in an accounting principle. This standard applies to
      all
      voluntary changes in an accounting principle. It also applies to changes
      required by an accounting pronouncement in the unusual instance that the
      pronouncement does not include specific transition provisions. When a
      pronouncement includes specific transition provisions, those provisions should
      be followed. APB Opinion No. 20 previously required that most voluntary changes
      in an accounting principle be recognized by including in net income of the
      period of the change the cumulative effect of changing to the new accounting
      principle. This standard requires retrospective application to prior periods’
financial statements of changes in an accounting principle. SFAS No. 154 is
      effective for accounting changes and corrections of errors made in fiscal years
      beginning after December 15, 2005. The adoption of this standard did not
      have a material impact on our consolidated financial position, results of
      operations and cash flows.





In
      September 2006, the Securities and Exchange Commission (the “SEC”) issued
      SAB 108, “Considering the Effects of Prior Year Misstatements when Quantifying
      Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108
      provides guidance on the consideration of the effects of prior year
      misstatements in quantifying current year misstatements for the purpose of
      determining whether the current year’s financial statements are materially
      misstated. SAB 108 is effective for fiscal years ending after November 15,
      2006. The adoption of SAB 108 did not have a material impact on our consolidated
      financial position, results of operations or cash flows.





**Recent
      Accounting Pronouncements**





In
      June 2006, the FASB ratified Emerging Issues Task Force Issue
      No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental
      Authorities Should Be Presented in the Income Statement (That Is, Gross versus
      Net Presentation)” (“EITF 06-3”). The scope of EITF 06-3 includes any tax
      assessed by a governmental authority that is directly imposed on a
      revenue-producing transaction between a seller and a customer. This issue
      provides that a company may adopt a policy of presenting taxes either gross
      within revenue or net. If taxes subject to this issue are significant, a company
      is required to disclose its accounting policy for presenting taxes and the
      amount of such taxes that are recognized on a gross basis. We do not believe
      the
      adoption of EITF 06-3 will have a material impact on our consolidated financial
      position, results of operations or cash flows.





In
      June
      2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes - An
      Interpretation of FASB Statement No. 109.” FIN 48 clarifies the accounting for
      uncertainty in income taxes recognized in an enterprise’s financial statements
      in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 is
      effective for all uncertainty in income taxes recognized in the financial
      statements in fiscal years beginning after December 15, 2006. We do not
      believe the adoption of FIN 48 will have an impact on our consolidated
      financial position, results of operations or cash flows.


37


In
      September 2006, the FASB issued SFAS No. 157, “Fair Value
      Measurements.” This standard defines fair value, establishes a framework for
      measuring fair value in accounting principles generally accepted in the United
      States of America, and expands disclosure about fair value measurements. This
      pronouncement applies to other accounting standards that require or permit
      fair
      value measurements. Accordingly, this statement does not require any new fair
      value measurement. This statement is effective for fiscal years beginning after
      November 15, 2007, and interim periods within those fiscal years. We are
      currently evaluating the requirements of SFAS No. 157 and the impact that the
      adoption of this standard may have on our consolidated financial
      statements.





**Effects
      of Inflation**





Management
      believes the Company's results of operations have not been materially impacted
      by inflation over the past three years.





**ITEM
      7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK**





As
      part
      of our ongoing business, we are exposed to certain market risks, including
      fluctuations in interest rates and commodity prices. We do not enter into
      transactions designed to mitigate market risks for trading or speculative
      purposes.




We
      have
      one fixed rate and one variable rate debt instrument. For the fixed-rate debt,
      interest rate changes affect the fair market value of such debt but do not
      impact earnings or cash flows. Conversely, for the variable-rate debt, interest
      rate changes generally do not affect the fair market value of such debt but
      do
      impact future earnings and cash flows, assuming other factors are held constant.
      At December 31, 2006 the carrying amount and estimated fair value of our debt
      was $178.1 million and $157.1 million, respectively. Given the current balance
      of our variable rate debt, we estimate a change in interest costs of
      approximately less than $0.1 million for every one-percentage point change
      in
      applicable interest rates.





**ITEM
      8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**





The
      consolidated financial statements commence at page F-1 of this report and an
      index thereto is included in Part IV, Item 15 of this report.


38


**SELECTED
      QUARTERLY FINANCIAL DATA (UNAUDITED)**





The
      following selected unaudited quarterly financial data should be read in
      conjunction with the consolidated financial statements and the related notes
      and
“Management’s Discussion and Analysis of Financial Condition and Results of
      Operations” included elsewhere in the Annual Report on Form 10-K. Amounts
      presented in the tables have been restated for discontinued operations as
      discussed in Note 3 to the Consolidated Financial Statements, as well as for
      the
      correction of errors, as discussed in Note 2 to the Consolidated Financial
      Statements of the report and in the Company’s 10 Q/As for the first, second and
      third quarters of 2006 filed on July 10, 2007.





**Fourth**
            
            **Third**
            
            **Second**
            
            **First****2006**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter**
            
            **Quarter****As
                Restated**
            
            **As
                Restated**
            
            **As
                Restated*****(In
                thousands, except share data)***Sales,
                net
            
            $
            24,304
            
            $
            37,478
            
            $
            124,354
            
            $
            46,434Gross
                profit
            
            
            9,525
            
            
            9,762
            
            
            57,518
            
            
            20,034Net
                loss
            
            
            (11,479
            )
            
            (30,252
            )
            
            (449
            )
            
            (4,292
            )Net
                loss per common share:Basic
                and Diluted
            
            $
            (0.52
            )
            $
            (1.37
            )
            $
            (0.02
            )
            $
            (0.19
            )**Fourth**
            
            
            **Third**
            
            
            **Second**
            
            
            **First****2005**
            
            
            **Quarter
                (a)**
            
            
            **Quarter**
            
            
            **Quarter**
            
            
            **Quarter*****(In
                thousands, except share data, as
                restated)***Sales,
                net
            
            $
            23,215
            
            $
            37,939
            
            $
            135,561
            
            $
            48,611Gross
                profit
            
            
            10,829
            
            
            18,447
            
            
            71,014
            
            
            24,029Net
                (loss) income
            
            
            (10,787
            )
            
            (5,331
            )
            
            15,916
            
            
            (1,621
            )Net
                (loss) income per common share:Basic
                and Diluted
            
            $
            (0.49
            )
            $
            (0.24
            )
            $
            0.72
            
            $
            (0.07
            )





(a)
      The
      information presented for the fourth quarter of 2005 has been corrected and
      restated for discontinued operations, as more fully described in Note 3 to
      the
      Consolidated Financial Statements, and the errors as discussed in more detail
      in
      Note 2 to the Consolidated Financial Statements. The fourth quarter adjustment
      of $0.2 million to gross profit was comprised of the correction for the
      inventory cost error of approximately $0.2 million and nominal amounts for
      the
      correction of the asset retirement obligations and workers’
compensation and auto insurance accruals errors. The change in net loss
      reflects the after tax effect of the corrections described above.





**2005
                - Fourth Quarter**
            
            *As
                Originally Reported*
            
            *As
                Restated for Correction of Errors*
            
            *As
                Restated for Correction of Errors and Discontinued
                Operations****(In
                thousands, except share data)***Sales,
                net
            
            $
            37,659
            
            $
            37,659
            
            $
            23,215Gross
                profit
            
            
            11,527
            
            
            11,721
            
            
            10,829Net
                loss
            
            
            (10,374
            )
            
            (10,787
            )
            
            (10,787
            )Net
                loss per common share:Basic
                and Diluted
            
            $
            (0.47
            )
            $
            (0.49
            )
            $
            (0.49
            )




39





**ITEM
      9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING** **AND**  **FINANCIAL
      DISCLOSURES**





On
      November 16, 2006, the Company dismissed PricewaterhouseCoopers LLP ("PwC")
      as
      its independent registered public accounting firm. The Company’s Audit Committee
      participated in and approved the decision to change the Company’s independent
      registered public accounting firm.





The
      reports of PwC on the financial statements of the Company for the fiscal years
      ended December 31, 2005 and 2004 contained no adverse opinion or disclaimer
      of
      opinion and were not qualified or modified as to uncertainty, audit scope or
      accounting principle.





During
      the fiscal years ended December 31, 2005 and 2004 and through November 16,
      2006,
      there have been no disagreements (as described in Regulation S-K Item
      304(a)(1)(iv)) with PwC on any matter of accounting principles or practices,
      financial statement disclosure or auditing scope or procedure, which
      disagreements, if not resolved to the satisfaction of PwC, would have caused
      PwC
      to make reference thereto in its report on the financial statements for such
      years.





During
      the fiscal years ended December 31, 2005 and 2004 and through November 16,
      2006,
      there have been no reportable events (as described in Regulation S-K Item 304
      (a)(1)).





**ITEM
      9A. CONTROLS AND PROCEDURES**




*Evaluation
      of Disclosure Controls and Procedures*




The
      Company carried out an evaluation, under the supervision and with the
      participation of the Chief Executive Officer and Chief Financial Officer, of
      the
      effectiveness of the design and operation of the Company’s disclosure controls
      and procedures, as defined in Securities Exchange Act of 1934 Rules 13a-15(e)
      and 15d-15(e), as of the end of the period covered by this Annual Report on
      Form 10-K. Based upon that evaluation, the Company’s Chief Executive
      Officer and Chief Financial Officer concluded that, solely as a result of the
      material weaknesses referenced below, the Company’s disclosure controls and
      procedures were not effective as of the end of the year ended December 31,
      2006.




In
      connection with the preparation of our financial statements for the fiscal
      year
      ended December 31, 2006, we became aware of errors which affected each of the
      quarters of 2004 and 2005 and the first, second and third quarters of 2006.
      On
      May 3, 2007, the Company’s executive officers informed the Audit Committee of
      the Board of Directors that the Company's previously issued consolidated
      financial statements for the fiscal years ended December 31, 2004 and 2005,
      the
      interim periods contained therein, and the first, second and third quarters
      of
      2006 should no longer be relied upon as a result of errors contained therein.
      The Audit Committee agreed with management's findings and concluded on such
      date
      that the consolidated financial statements for the years ended December 31,
      2004
      and 2005, the first, second, third and fourth quarters of 2005 and the first
      second and third quarters of 2006 should be restated. Please refer to Note
      2 to
      the Consolidated Financial Statements for a description of the nature and impact
      of these errors.




In
      connection with the foregoing and in the course of the performance of the
      external audit of the Company’s consolidated financial statements as of and for
      the year ended December 31, 2006, certain material weaknesses in our internal
      controls were identified. A material weakness in internal control over financial
      reporting is a control deficiency, or combination of control deficiencies,
      that
      results in more than a remote likelihood that a material misstatement of the
      annual or interim financial statements will not be prevented or detected by
      a
      company’s internal controls over financial reporting. We have determined that,
      as of December 31, 2006, the following represented material weaknesses in
      our internal control over financial reporting: **




·  We
      did
      not have adequate policies and procedures and adequate review and oversight
      relating to the recording of inventory. For example, there was no policy or
      mechanism in place to identify abnormal scrap using statistical metrics, and
      there was no appropriate process in place to analyze the net realizable value
      of
      inventory. This lead to adjustments recorded in the restatement of the
      consolidated financial statements for the quarter ended September 30, 2006.
      In
      addition, there was no process in place to appropriately review and approve
      significant changes to our inventory costing methodology, resulting in errors
      which began in fiscal 2004 and continued into 2005 and the first three quarters
      of 2006. These deficiencies represent a material weakness in internal control
      over financial reporting because they did or could lead to material
      misstatements in the Company’s financial statements.


40




·  We
      did
      not perform sufficient analysis and review of significant estimates and
      accounts, and certain journal entries were recorded without an appropriate
      level
      of documentation and support. For example, certain transactions were not
      appropriately analyzed, including the sale-leaseback transactions for the
      disposition of our Miami facility in 2005 and the disposition of our Vacaville
      property in 2006, nor did; we properly analyze the recoverability of our assets
      associated with our Trenton facility. These matters represent a material
      weakness in internal control over financial reporting because they could result
      in material misstatements to interim and annual consolidated financial
      statements that were not properly prevented or detected by the Company’s
      internal control. All identified errors related to this material weakness have
      been corrected in connection with the restatement of the consolidated financial
      statements for the applicable period.




·  We
      had
      information technology general control deficiencies that in the aggregate were
      deemed to represent a material weakness in the control environment and were
      the
      result of a lack of communication and enforcement of control consciousness.
      These deficiencies in the aggregate represented more than a remote likelihood
      that a material misstatement of our annual or interim financial statements
      would
      not have been prevented or detected. These deficiencies included deficiencies
      related to logical and physical access requests, configuration changes, updates
      of control documentation and data backup and storage.




We
      have
      taken, or are in the process of taking, a number of corrective actions with
      respect to the material weaknesses in our internal control over financial
      reporting identified above. These actions include improving the documentation
      and review of our inventory accounting policies and procedures and the
      communication of such policies and procedures within our organization. In this
      regard, we have implemented policies and procedures to analyze scrap by
      facility on a quarterly basis using statistical metrics, and determine the
      net
      realizable value of inventory by facility  on
      a
      quarterly basis. We have also implemented additional policies and procedures
      to
      analyze and approve all changes to our inventory costing
      methodology.




With
      regard to the analysis and review of significant estimates and accounts, we
      have
      established a formal process to identify key estimates and accounts and have
      assigned additional levels of analysis and review with respect to such key
      estimates and accounts. We have also established a formal process regarding
      the
      review and analysis of significant transactions. In addition, we are designing
      and implementing procedures for increased documentation and additional levels
      of
      review regarding journal entries.




In
      addition, a senior information technology manager has been assigned to lead
      the
      review of all information technology internal controls and a remediation plan
      has been put into place beginning in March 2007. It includes establishing
      controls related to logical and physical access requests, configuration changes,
      updates of control documentation and data backup and storage.




In
      addition to the remediation actions outlined above, we have taken steps to
      hire
      additional personnel with appropriate backgrounds in accounting to enhance
      our
      existing capabilities and we have taken steps to enhance the training and
      education provided to our finance and accounting personnel, including newly
      hired employees. We have also engaged outside consultants to advise us in
      connection with the design, implementation, documentation, and testing of our
      internal controls.




*Changes
      in Internal Control Over Financial Reporting*




There
      were no material changes in our internal controls over financial reporting
      during the fourth quarter of fiscal 2006 that materially affected, or are
      reasonably likely to materially affect, our internal control over financial
      reporting.







**ITEM
      9B. OTHER INFORMATION**





The
      following information required by the Items of Form 8-K set forth below is
      hereby disclosed:





Item
      1.01 Entry
      into a Material Definitive Agreement





*Waiver
      to Loan and Security Agreement*





On
      April
      30, 2007, Hines Nurseries, Inc. (“Hines Nurserires”), a wholly owned subsidiary
      of Hines Horticulture, Inc., entered into a Limited Waiver (the “Waiver”) to the
      Loan and Security Agreement, dated January 18, 2007, by and among Bank of
      America, N.A., PNC Bank, National Association, and GMAC Commercial Finance
      LLC
      (the “Loan and Security Agreement”). Pursuant to the Waiver, the required
      lenders under the Loan and Security Agreement waived certain defaults under
      the
      Loan and Security Agreement and extended to May 28, 2007 the deadline for filing
      of the financial statements for the fiscal year ended December 31, 2006 and
      the
      fiscal quarter ended March 31, 2007. This waiver was granted for the period
      commencing on the date of the Waiver through May 28, 2007.


41


Pursuant
      to a second waiver dated May 29, 2007, the required lenders waived certain
      defaults under the Loan and Security Agreement and extended to June 28, 2007
      the
      deadline for filing of the financial statements for the fiscal year ended
      December 31, 2006 and the fiscal quarter ended March 31, 2007. On June 28th,
      2007 Hines Nursuries received permission from its lender to file our 2006 Form
      10-K on June 29, 2007.





On
      June
      21, 2007, Hines Nurseries entered into a third waiver to the Loan and Security
      Agreement. Pursuant to the third waiver, the required lenders waived certain
      defaults under the Loan and Security Agreement and extended to July 20, 2007
      the
      deadline for filing of the financial statements for the fiscal quarter ended
      March 31, 2007. This waiver was granted for the period commencing on the date
      of
      the third waiver through July 20, 2007.


On July
        3, 2007,
        Hines Nurseries entered into a fourth waiver to the Loan and Security Agreement,
        effective as of June 28, 2007. Pursuant to this waiver, the required lenders
        waived certain defaults under the Loan and Security Agreement, extended to
        July
        13, 2007 the deadline for us to deliver our annual financial statements for
        the
        fiscal year ended December 31, 2006, and extended to July 31, 2007 the deadline
        for us to deliver our quarterly financial statements for the fiscal quarter
        ended March 31, 2007.
  The
        foregoing description of each waiver is only a summary and is qualified by
        reference to each waiver in its entirety, as filed as Exhibits 10.51, 10.52,
        10.53 and 10.54, respectively, hereto and incorporated herein by
        reference.
  *Amendment
        to Irvine, California Agreement*





On
      January 1, 2007, the Company entered into an amendment to the Amended and
      Restated Lease Agreement dated September 1, 1996. Previously, the Company had
      agreed to exit 254 acres at its Irvine, California headquarters. This amendment
      extended the lease with respect to 50 of the acres to be vacated until June
      30,
      2007.





The
      foregoing description of the Amendment to Amended and Restated Ground Lease
      dated January 1, 2007, is only a summary and is qualified by reference to the
      agreement in its entirety, which is filed as Exhibit 10.46 hereto and
      incorporated herein by reference.





Item
      2.01





Item
      2.01. Completion of Acquisition or Disposition of Assets





*Sale
      of Assets in Miami, Florida*





As
      disclosed in a Form 8-K/A filed on February 5, 2007, on October 2, 2006, Hines
      Nurseries completed the sale of the certain inventory, vehicles, farm equipment
      and other assets located at Hines Nurseries' Miami, Florida facility (the “Miami
      Assets”) to Costa Nursery Farms, LLC, a Florida, limited liability company
      (“Costa”) and Pure Beauty Farms, Inc., a Florida corporation (“Pure Beauty”),
      pursuant to the asset purchase agreement dated October 2, 2006 between Hines
      Nurseries and Costa and the asset purchase agreement dated October 2, 2006
      between Hines Nurseries and Pure Beauty (collectively, the “Miami Purchase
      Agreements”). Copies of the Miami Purchase Agreements are listed as Exhibits
      10.34 and 10.35 to this Form 10-K.





The
      purchase price for the Miami Assets was approximately $4.1 million. There are
      no
      material relationships, other than with respect to the Miami Purchase
      Agreements, between the Company, Hines Nurseries or their respective directors,
      officers (or any associate of any such director or officer) or affiliates on
      the
      one side and Costa and Pure Beauty or their respective officers, directors
      (or
      any associate of any such director or officer) or affiliates on the other
      side.





Item
      9.01. Financial Statements and Exhibits





(b)(1)
      Pro Forma Financial Information





Unaudited
      pro forma financial information, including income statements for the twelve
      month period ended December 31, 2005 and nine month period ended September
      30,
      2006 and balance sheet for the period ended September 30, 2006 was filed as
      Exhibit 99.1 to the Form 8-K/A filed on February 5, 2007.





Item
      5.02 Departure of Directors or Principal Officers; Election of Directors; Appointment
      of Principal Officers





(e) *Severance
      Agreement*





As
      previously disclosed, Lincoln Moehle, the former Vice President of Operations
      of
      the Company’s eastern region, left the Company effective January 26, 2007. In
      connection with Mr. Moehle’s departure, the Company entered into a Severance and
      Release Agreement with Mr. Moehle on December 29, 2006 (the “Severance
      Agreement”). Pursuant to the terms of the Severance Agreement and in
      consideration for the releases and agreements of Mr. Moehle contained therein,
      Mr. Moehle is entitled to receive a one time severance payment of $73,684,
      less
      applicable withholding, and continued health, dental and vision insurance
      through June 29, 2007.





The
      foregoing description of the Severance Agreement is only a summary and is
      qualified in its entirety by reference to the full terms and conditions of
      the
      Severance Agreement, which is filed as Exhibit 10.49 hereto and incorporated
      herein by reference.


42


**PART
      III**





**ITEM
      10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**





The
      following table sets forth the names, ages and positions of the Company’s
      executive officers and directors as of June 26, 2007. Their respective
      backgrounds are described below.





**EXECUTIVE
                OFFICERS AND DIRECTORS****NAME**
            
            **AGE**
            
            **POSITION**Robert
                A. Ferguson
            
            49
            
            Chief
                Executive Officer, President and a Director of HinesClaudia
                M. Pieropan
            
            51
            
            Chief
                Financial Officer, Secretary and Treasurer of Hines and Hines
                NurseriesStephen
                C. Avery
            
            55
            
            Vice
                President of Operational Excellence and Human ResourcesJeffrey
                Dunbar
            
            49
            
            Vice
                President of Supply ChainJames
                J. O'Donnell
            
            47
            
            Vice
                President of Marketing and SalesEdwin
                G. Summers, Jr.
            
            51
            
            Vice
                President of OperationsG.
                Ronald Morris (1)(2)(3)(4)
            
            70
            
            DirectorStan
                R. Fallis (1)(2)(3)
            
            66
            
            DirectorThomas
                R. Reusche (2)
            
            52
            
            DirectorJames
                R. Tenant (1)(2)(3)
            
            54
            
            DirectorPaul
                R. Wood (3)
            
            53
            
            Director(1)
                Member of the Audit Committee(2)
                Member of the Compensation Committee(3)
                Member of the Nomination and Corporate Governance
                Committee(4)
                Mr. Morris has announced his intention to resign as a director effective
                at the conclusion of the Company's 2007 annual
                meeting





**Directors**





*Robert
      A. Ferguson*





Mr.
      Ferguson has served as President and Chief Executive Officer and as a director
      of Hines since March 2004. Mr. Ferguson served as Acting Chief Executive Officer
      and President and Chief Operating Officer of Hines and Hines Nurseries, a
      wholly-owned subsidiary of Hines, from August 2003 until March 2004. He served
      as Chief Operating Officer and Acting President of Hines and Hines Nurseries,
      from February 2003 to August 2003. Mr. Ferguson served as President of the
      Nursery Division for Hines Nurseries from June 2000 to February 2003. He served
      as Vice President of the Hines Nurseries Southern Region from January 1999
      to
      June 2000. Prior to that, Mr. Ferguson served with us in various site,
      production and sales management positions since 1983.





*G.
      Ronald Morris*




Mr. Morris
      has served as a director of Hines since March 2001. Mr. Morris is
      currently serving as a director for NN, Inc., an independent, publicly held
      manufacturer and supplier of high quality bearing components to both domestic
      and international anti-friction bearing manufacturers and other industrial
      customers. Mr. Morris retired in 1999 after serving as President and Chief
      Executive Officer of PT Components, Inc. from 1982 through 1989 and Western
      Industries, Inc. from 1991 through 1999.


43


*Stan
      R. Fallis*





Mr. Fallis
      has served as a director of Hines since September 2001. Mr. Fallis is
      currently retired and previously served as the Chairman and Chief Executive
      Officer of EVEREN Clearing Corporation from 1994 to 1999, which provided all
      securities clearing and trade processing operations for its parent, EVEREN
      Securities, Inc. a major independently owned broker dealer firm. Mr. Fallis
      serves on the board of directors of Stancorp Financial Group, Inc.
      Mr. Fallis also served as Senior Executive Vice President and Chief
      Financial Officer of Kemper Securities Group from 1990 through 1994.





*Thomas
      R. Reusché*





Mr. Reusché
      has served as a director of Hines and Hines Nurseries since August 1995.
      Mr. Reusché has also served as Chairman of the Board from March 2004
      to April 2007. Mr. Reusché served as Secretary and Treasurer of Hines from
      August 1995 until June 1998 and as Assistant Secretary of Hines from
      June 1998 to June 2000. Mr. Reusché also served as a Vice
      President and Assistant Secretary of Hines Nurseries from August 1995 to
      June 2000. From its formation in January 1993 until his retirement in
      September 2003, Mr. Reusché served as a principal of Madison Dearborn
      Capital Partners, L.P. (“MDCP”), a private equity investment firm which is
      Hines’ largest stockholder, and as a Vice President or as a Managing Director of
      Madison Dearborn Partners, Inc., MDCP’s indirect general partner (“MDP”). Prior
      to that time, Mr. Reusché was a senior investment manager at First Chicago
      Venture Capital, which comprised the private equity investment activities of
      First Chicago Corporation, the holding company parent of First National Bank
      of
      Chicago. Mr. Reusché serves on the boards of directors of Stericycle Inc.
      and a number of private companies.





*James
      R. Tennant*





Mr. Tennant
      has served as a director of Hines since October 1998 and as Chairman of the
      Board since April 2007. Mr. Tennant served as Chairman and Chief Executive
      Officer of Home Products International, a manufacturer and full-service marketer
      of quality consumer houseware products, from April 1994 to
      December 2004.





*Paul
      R. Wood*





Mr. Wood
      has served as a director of Hines since August 1995. Mr. Wood was also
      Chairman of the Board and President of Hines from September 1995 until
      June 1998 and an Assistant Secretary of Hines from June 1998 to
      June 2000. Mr. Wood has served as a director of Hines Nurseries since
      August 1995 and as a Vice President and Assistant Secretary of Hines
      Nurseries from August 1995 to June 2000. Since its formation in 1993,
      Mr. Wood has served as a principal of MDCP and as a Vice President or as a
      Managing Director of MDP. Prior to that time, Mr. Wood served as Vice
      President of First Chicago Venture Capital. Mr. Wood serves on the board of
      directors of CapitalSource Inc. and a number of private companies.





**Executive
      Officers**





*Robert
      A. Ferguson*





Mr. Ferguson’s
      business biography is referenced above.





*Claudia
      M. Pieropan*





Ms.
      Pieropan has served as Chief Financial Officer of Hines and Hines Nurseries
      since January 1996 and as Secretary and Treasurer of Hines and Hines Nurseries
      since June 1998. Previously Ms. Pieropan served as the Vice President of Finance
      and Administration of Sun Gro Horticulture, Inc., a growing media company,
      from
      October 1991 until December 1995. Ms. Pieropan also serves as the Company’s
      principal accounting officer and principal financial officer. Prior to that
      time, Ms. Pieropan practiced with PricewaterhouseCoopers LLP in Montreal,
      Toronto and Vancouver, Canada from 1977 to 1991.


44


*Stephen
      C. Avery*




Mr.
      Avery
      joined Hines in May 2006 as Vice
      President Operational Excellence and Human Resources. Previously Mr. Avery
      served as Executive Vice President Operational Excellence and Human Resources
      at
      Valeant Pharmaceuticals from January 2005 to May 2006 and provided Executive
      Associate consulting services with Human Capital
      Associates from March 2001 to January 2005 for various companies including
      Lockheed Martin and Merck. Mr. Avery held positions of increasing responsibility
      in the operations and human resources functions at Gateway Computers, Engelhard
      Inc, and Phillips Petroleum between 1977 and 2000. Mr.
      Avery
      received his BS
      in
      Psychology and MA in Organization Behavior from Brigham Young
      University.





*Jeffrey
      Dunbar*




Mr.
      Dunbar joined Hines in May 2006 as Vice President Supply Chain. Previously
      Mr.
      Dunbar served as Vice President Operations at Tree of Life North America a
      provider of natural and specialty food products from 2005 to 2006 and as Senior
      Vice President Strategic Planning and Supply Chain for Wise Foods between 2003
      and 2005. Prior to this Mr. Dunbar held Director level distribution positions
      at
      various consumer goods companies including Kellogg Company, Keebler Company,
      and
      Revlon Incorporated. Mr. Dunbar received his BA from Kean University of New
      Jersey and his MBA from Georgia State University.





*James
      J. O’Donnell*





James
      O’Donnell has served as Vice President, Sales and Marketing since October 2006.
      Prior to joining Hines Horticulture, Inc., Mr. O’Donnell served separately
      as Vice President of Sales and as Vice president of Marketing at
      Ampad. He began his career at Duracell, which was eventually acquired by The
      Gillette Company, where he rose to Vice President, OEM Sales and Marketing,
      Global Business Management and Vice President New Products, Global Business
      Management. Mr. O’Donnell received his MBA in 1993 and his BS
      degree in 1981 from St. Joseph's University, Philadelphia, PA.





*Edwin
      G. Summers, Jr.*





Mr.
      Summers has served as Vice President of Operations since 2006. From 2005 to
      2006 Mr. Summer served as Vice President of Operations for the
      company’s Western Region and as Vice President and General Manager of the
      Company’s Irvine, California nursery from 2001 to 2005. He served as Vice
      President of the Nursery Division from 1996 to 2000 and as General Manager
      of
      the Company's Irvine, California nursery from 1988 to 1996. Mr. Summers served
      in numerous executive management positions since 1984. He has served as a
      statistical analyst to the USDA from 1981 to 1984 and as
      an instructor in the Department of Horticulture at the University of
      Maryland from 1979 to 1981. Mr. Summers received his BS from Salisbury State
      University in 1977, his MS in Horticulture from the University of Maryland
      in 1979, and  a  Ph.D. in Horticulture from the University of
      Maryland in 1983.





**Audit
      Committee**





The
      Company has a separately-designated standing Audit Committee established in
      accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934,
      as
      amended. The members of the Audit Committee are Stan R. Fallis, G. Ronald Morris
      and James R. Tenant. The Board has determined that each of these directors
      is
      independent for purposes of the rules of the NASDAQ Stock Market and the
      Securities and Exchange Commission (“SEC”) as they relate to audit committee
      members. The Board has also determined that Mr. Fallis is an “Audit Committee
      Financial Expert” as defined under the rules of the SEC.


45


**Section
      16(a) Beneficial Ownership Reporting Compliance**





The
      Company’s executive officers, directors and owners of more than 10 percent of
      the Company’s securities are required under Section 16(a) of the Exchange Act to
      file reports of ownership and changes in ownership with the SEC. Pursuant to
      regulations adopted under the Sarbanes-Oxley Act of 2002, most transactions
      are
      now reportable within two business days of the transaction and are required
      to
      be filed electronically with the SEC through its EDGAR system. To facilitate
      compliance, the Company assists with the preparation and filing of these reports
      on behalf of the Company’s executive officers and directors. Hines is required
      to disclose in this Form 10-K any late filings or failures to file.





Based
      solely upon a review of the filings made by the Company’s executive officers and
      directors furnished to the Company pursuant to the Exchange Act during 2006
      and
      written representations that no other reports were required during 2006, as
      well
      as the Company’s records, all required reports were timely filed, except that
      the initial statements of beneficial ownership on Form 3 for each of Mr. Stephen
      C. Avery and Michael J. Trebing were not timely filed.





**Code
      of Ethics**





The
      Company has adopted a code of conduct and ethics that applies to all directors,
      officers and employees. The code of conduct and ethics is posted on the
      Company’s website, the address of which is www.hineshorticulture.com and is
      available in print to any shareholder upon written request addressed to: Hines
      Horticulture, Inc., Attention: Investor Relations Department, 12621 Jeffrey
      Road, Irvine, CA 92620. The Company intends to include on its website any
      amendments to, or waivers from, a provision of its code of conduct and ethics
      that applies to the Company’s executive officers that relates to any element of
      the code of conduct and ethics definition enumerated in Item 406(b) of
      Regulation S-K.





**ITEM
      11. EXECUTIVE COMPENSATION**





**Compensation
      Discussion and Analysis**





The
      following Compensation Discussion and Analysis describes the duties,
      responsibilities and role of our Compensation Committee as well as the material
      elements of compensation for the Company’s executive officers identified in the
      Summary Compensation Table set forth below (the “Named Executive
      Officers”).




*Objectives
      of Our Compensation Program*





The
      primary objective of the Company’s compensation program, including our executive
      compensation program, is to maintain a compensation program that will fairly
      compensate our executives and employees, attract and retain qualified executives
      and employees who are able to contribute to our long-term success, encourage
      performance consistent with clearly defined corporate goals and align our
      executives’ long-term interests with those of our stockholders. To that end, the
      Company’s compensation practices are intended to:




·
            tie
                total compensation to Company performance and individual performance
                in
                achieving financial and non-financial objectives;
                and





·
            closely
                align senior management’s interests with stockholders’ interests through
                long-term equity incentive
                compensation.





*Role
      of the Compensation Committee*





The
      Compensation Committee determines the compensation of Hines’ Chief Executive
      Officer and its other executive officers. In addition, the Compensation
      Committee is responsible for adopting, reviewing and administering Hines’
compensation policies and programs, including the cash bonus incentive plan
      and
      equity incentive plan, which are discussed in more detail below. In reviewing
      Hines’ compensation programs, the Compensation Committee intends to adhere to a
      compensation philosophy that (i) seeks to attract and retain qualified
      executives who will add to the long-term success of Hines, (ii) promotes
      the achievement of operational and strategic objectives, and
      (iii) compensates individuals commensurate with each executive’s level of
      performance, level of responsibility and overall contribution to the success
      of
      Hines.


46


In
      determining the compensation of Hines’ Chief Executive Officer and other
      executive officers, the Compensation Committee considers the financial condition
      and operational performance of Hines during the prior year. In determining
      the
      executive compensation for executive officers other than Mr. Ferguson, our
      Chief
      Executive Officer, the Compensation Committee considers the recommendations
      of
      Mr. Ferguson. In making his recommendations, Mr. Ferguson receives information
      from our human resources department and this information is also made available
      to the Compensation Committee. The Committee also considers publicly available
      market and other data on executive compensation matters. ****




The
      Compensation Committee reviews the compensation practices of other companies,
      based in part on market survey data. The Compensation Committee does not
      benchmark the Company’s compensation program directly with other publicly-traded
      companies or other companies with which we directly compete for talent, since
      our competitors are predominantly privately held companies for which executive
      compensation information is not available. The Compensation Committee compares
      our executive compensation program as a whole with the programs of other
      companies for which survey data is available, and also compares the pay of
      individual executives if the jobs are sufficiently similar to make the
      comparison meaningful. The Committee uses peer group survey data primarily
      to
      ensure that our executive compensation program as a whole is competitive, when
      the Company achieves the targeted performance levels.




*Components
      of Executive Compensation for Fiscal 2006*





The
      elements of the Company’s compensation program are base salary, annual bonus and
      long-term equity incentives. Our compensation program is designed to balance
      our
      need to provide our executives with incentives to achieve our short- and
      long-term performance goals with the need to pay competitive base salaries.
      Each
      Named Executive Officer’s current and prior compensation is considered in
      setting future compensation.




In
      addition, the employment agreements with certain of our Named Executive Officers
      provide for other benefits, including retirement benefits and potential payments
      upon termination of employment for a variety of reasons. Each of the elements
      of
      our executive compensation program is discussed in the following
      paragraphs.




*Base
      Salaries*





Base
      salary is the guaranteed element of employees’ annual cash compensation. Base
      salaries generally vary based on a number of factors, including the executive’s
      experience level and scope of responsibility, performance level, future
      potential and overall contribution. The value of base salary also reflects
      the
      employee’s long-term performance, skill set and the market value of that skill
      set. Base salaries for our Named Executive Officers are reviewed on an annual
      basis and adjustments are made to reflect performance-based factors, as well
      as
      competitive conditions. The Company does not apply specific formulas to
      determine increases. In setting base salaries for 2006, the Compensation
      Committee considered the following factors:




·
            The
                Company’s overall financial
                condition;





·
            Individual
                performance;





·
            Level
                of responsibility; and





·
            Competitive
                market conditions.





The
      Company’s employment agreements with Mr. Ferguson, Mr. Summers and Ms. Pieropan
      also provide that their respective annual salaries shall be their current salary
      rates or such other greater amount as may be determined by the board of
      directors from time to time. None of the Named Executive Officers received
      an
      increase in base salary for fiscal 2006 compared to the prior fiscal
      year.




*Annual
      Cash Bonuses*





The
      Company believes that as an employee’s level of responsibility increases, a
      greater portion of the individual’s cash compensation should be variable and
      linked to both quantitative and qualitative expectations, including key
      operational and strategic metrics. To that end, the Company has established
      an
      annual cash bonus program in order to align executives’ goals with the Company’s
      strategic and tactical objectives.


47


Each
      of
      Hines’ executive officers participates in the Company’s Executive Incentive Plan
      (the “Hines Bonus Plan”), which enables them to be eligible to earn an annual
      cash bonus based upon meeting certain performance metrics.




Within
      the overall context of Hines’ pay philosophy and culture, the objectives of the
      Hines Bonus Plan are to:




·
            Provide
                competitive levels of total cash
                compensation;





·
            Align
                pay with organizational and individual
                performance;





·
            Focus
                executive attention on key business
                metrics;





·
            Provide
                a significant incentive for achieving and exceeding performance
                goals;





·
            Create
                a focus on shareholder value; and





·
            Be
                easily understood and easily
                administered.





For
      the
      Named Executive Officers, the performance metrics under the Hines Bonus Plan
      include corporate performance and individual-specific goals. Corporate
      performance may be measured with reference to, among other things, operating
      cash flows (defined as earnings before interest, taxes, depreciation and
      amortization and adjusted for maintenance capital expenditures and changes
      in
      inventory), net sales and return on sales. Individual performance goals are
      tied
      to the Company’s business plan, may be quantitative or qualitative in nature,
      and for 2006 included such measures as executing new sales models and improving
      productivity.




The
      mix
      of Company-wide and individual-specific performance goals to which annual cash
      bonuses are tied varies based on the role and seniority of the executive or
      manager. For 2006, with respect to each of the Named Executive Officers, 90%
      of
      the potential annual cash bonus was tied to Company-wide performance metrics
      and
      10% was tied to individual-specific performance goals. The total potential
      annual cash bonus available to Named Executive Officers for 2006 was targeted
      at
      levels between 50% and 70% of annual base salary.




Specific
      performance standards, both corporate and individual, are recommended by
      management and approved by the Compensation Committee on an annual basis. For
      2006, the corporate performance measures consisted of the attainment of budgeted
      levels of free cash flow and net sales, with a weight of 70% attached to the
      free cash flow metric and 30% to the net sales metric. For the free cash flow
      metric, achievement of less than a threshold of 90% of the budgeted level would
      result in no bonus payment under any element of the Hines Bonus Plan.
      Achievement of the threshold level of free cash flow performance would result
      in
      a minimum payout of 50% of the targeted bonus with respect to that metric,
      and
      higher levels of achievement would result in greater payouts up to a maximum
      payout of 150% of the targeted bonus for achievement of 120% of the budgeted
      level. For net sales, achievement of less than a threshold of 95% of the
      budgeted level would result in no bonus payment with regard to that metric.
      Achievement of the threshold level of net sales performance would result in
      a
      minimum payout of 90% of the targeted bonus with respect to that metric, and
      higher levels of achievement would result in greater payouts up to a maximum
      payout of 150% of the targeted bonus for achievement of 120% of the budgeted
      level.




The
      Compensation Committee reviewed the performance objectives and corresponding
      results for 2006 and determined that the threshold performance levels had not
      been met. As a result, no payments were made for 2006 under the Hines Bonus
      Plan.





*Long-Term
      Equity Incentives*





Long-term
      incentive awards are a key element of the Company’s total compensation package
      for individuals in significant positions of responsibility. Such awards may
      be
      made under the Hines Amended and Restated 1998 Long-Term Equity Incentive Plan
      (the “1998 Stock Plan”) to senior management and select employees who are key to
      the Company’s achievement of its long-term goals. The purpose of the 1998 Stock
      Plan is to promote the long term growth and profitability of Hines by
      (i) providing certain directors, officers and employees with incentives to
      maximize stockholder value, and (ii) enabling Hines to attract, retain and
      reward the best available persons for positions of responsibility. The 1998
      Stock Plan provides for a variety of long-term awards including incentive or
      non-qualified stock options, restricted stock, stock appreciation rights and
      performance awards.


48


Under
      the
      1998 Stock Plan, the Board and the Compensation Committee have broad authority
      to award equity-based compensation arrangements to any eligible employee,
      director, consultant, or advisor of Hines. An aggregate of approximately 3.6
      million shares of Common Stock are reserved for issuance upon the exercise
      of
      awards granted to eligible participants under the 1998 Stock Plan. Since the
      ultimate value of stock options bears a direct relationship to the market price
      of the Common Stock, the Committee believes that awards under the 1998 Stock
      Plan can be an effective incentive for Hines’ management to create value for
      Hines’ stockholders. Awards under the 1998 Stock Plan are made in the discretion
      of the Board of Directors, upon recommendation from the Compensation Committee.
      No awards were granted to any executive officer under the 1998 Stock Plan in
      2006, due to the Company’s performance during that period.




*Perquisites
      and Other Benefits*





The
      Company does not provide significant perquisites or personal benefits to
      executive officers, other than the health insurance premiums. Hines provides
      automobiles for the use of certain of the Named Executive Officers, including
      Mr. Ferguson, under the Hines automobile policy. The costs associated with
      these
      benefits for Named Executive Officers are included in the Other Compensation
      column of the Summary Compensation Table, to the extent earned in
      2006.




*Employment
      and Severance Agreements*





Each
      of
      Mr. Ferguson, Ms. Pieropan and Mr. Summers is party to an employment agreement
      with the Company (collectively, the “Employment Agreements”), each of which has
      materially similar terms. The principal purpose of the employment agreements
      is
      to protect the Company from certain business risks (e.g., threats from loss
      of
      confidentiality or trade secrets, disparagement, solicitation of customers
      and
      employees) and to define the Company’s right to terminate the employment
      relationship. In return, the executive officers are provided assurances with
      regard to salary, other compensation and benefits, as well as certain severance
      benefits.




The
      Employment Agreements provide that the executives shall devote full time
      attention, skill and ability to discharge the duties assigned to them, and
      to
      use their best efforts to promote and protect the interests of Hines. The
      Employment Agreements are terminable by each of the respective parties thereto
      at any time, for any reason and with or without cause, upon 30 days advance
      written notice. The Employment Agreements provide for an annual base salary
      (which may be increased by the Board of Directors), an annual cash bonus in
      an
      amount determined by the Board of Directors, participation in any senior
      management equity incentive plan which Hines adopts, participation in the
      Company’s employee’s life insurance program, certain short-term disability
      benefits, vacation in accordance to the Company’s standard vacation policy,
      automobile allowance and expense reimbursements.




Each
      of
      Mr. Ferguson, Ms. Pieropan and Mr. Summers is entitled to receive
      certain benefits upon termination of his or her employment without “Cause,” or
      upon his or her resignation for “Good Reason,” as more fully detailed below
      under “Termination and Change in Control Payments.”





The
      employment agreements are intended to preserve employee productivity and
      encourage retention. They are also intended to align executive and shareholder
      interests by enabling executives to consider corporate transactions that are
      in
      the best interests of the shareholders and other constituents of the Company
      without undue concern over whether the transactions may jeopardize the
      executives’ own employment.




Each
      of
      Messrs. Avery, Dunbar and O’Donnell is party to a severance agreement with
      the Company. The principal purpose of the severance agreements is to define
      the
      Company’s right to terminate the employment relationship and, in return, to
      provide the executive officers assurances with regard to severance benefits
      under various circumstances which may accompany termination of employment.
      A
      description of the terms of their severance agreements can be found below under
      the caption “Termination and Change in Control Payments.”




*Employee
      Benefits*





The
      Company offers employee benefits coverage to:





·
            provide
                our workforce with a reasonable level of financial support in the
                event of
                illness or injury, and





·
            enhance
                productivity and job satisfaction through programs that focus on
                work/life
                balance.




49


Benefits,
      which are available to all full time employees, include executive officers
      of
      the Company, and include medical and dental coverage, disability insurance,
      life
      insurance and the 401(k) Plan. The executive officers of the Company, including
      the Named Executive Officers, participate in these plans on the same basis
      as
      all other employees. The cost of employee benefits is partially borne by the
      participating employee, including each executive officer.




*The
      Impact of Favorable Accounting and Tax Treatment on Compensation Program
      Design*





Favorable
      accounting and tax treatment of the various elements of our compensation
      programs is an important consideration in their design; however, it is not
      the
      sole consideration.




Section
      162(m) of the Internal Revenue Code limits the deductibility of certain items
      of
      compensation paid to the Chief Executive Officer, Chief Financial Officer and
      to
      each of the Named Executive Officers (the “Covered Employees”) to $1.0 million
      annually. Although the Company’s bonus program has not been designed to provide
      for the deductibility of compensation to Covered Employees for the short-term
      compensation awards provided thereunder, the 1998 Stock Plan has been designed
      to provide for the deductibility of certain compensation to the Covered
      Employees for the long-term incentive awards under that Plan. Similar to the
      decisions made with respect to the bonus programs, the Compensation Committee
      reserves the right to provide for compensation to employees which may not be
      deductible.




In
      the
      first quarter of 2006, the Company adopted the provisions of SFAS 123(R), which
      requires the fair value of options to be recorded as compensation cost in the
      consolidated financial statements. Because all options granted are fully vested
      as of December 31, 2005, the adoption of SFAS 123(R) resulted in no additional
      compensation costs to be recognized. However, it may have such an effect in
      the
      future.





*Stock
      Ownership Requirements*





The
      board
      of directors has historically encouraged its members and members of senior
      management to acquire and maintain stock in the Company to link the interests
      of
      such persons to the stockholders. However, neither the board of directors nor
      the Compensation Committee has established stock ownership guidelines for
      members of the board of directors or the executive officers of the Company.




**Compensation
      Committee Report**





The
      Compensation Committee, comprised of independent directors, reviewed and
      discussed the above Compensation Discussion and Analysis (“CD&A”) with the
      Company’s management. Based on such review and discussions, the Compensation
      Committee recommended to the Company’s Board of Directors that the CD&A be
      included in this annual report on Form 10-K for the fiscal year ended December
      31, 2006 and proxy statement on Schedule 14A relating to the upcoming annual
      meeting.




G.
      Ronald
      Morris, Chairman


Stan
      R.
      Fallis


Thomas
      R.
      Reusché


James
      R.
      Tennant


50


**Summary
      Compensation Table**





**Change
                in****Pension****Value
                and****Nonqualified****Non-Equity**
            
            **Deferred****Stock**
            
            **Option**
            
            **Incentive
                Plan**
            
            **Compensation**
            
            **All
                Other****Salary
                (1)**
            
            **Bonus**
            
            **Awards**
            
            **Awards**
            
            **Compensation**
            
            **Earnings**
            
            **Compensation
                (2)**
            
            **Total
                (3)****Name
                and Principal Position**
            
            **Year**
            
            **($)**
            
            **($)**
            
            **($)**
            
            **($)**
            
            **($)**
            
            **($)**
            
            **($)**
            
            **($)***Executive
                officers as of**December
                31, 2006***Robert
                A. Ferguson**
            
            
            2006
            
            $
            325,000
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            19,776
            
            $
            344,776Chief
                Executvie OfficerPresident,
                Director**Claudia
                M. Pieropan**
            
            
            2006
            
            
            218,064
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            12,801
            
            
            230,865Chief
                Financial OfficerSecreatry
                and Treasurer**Stephen
                C. Avery**
            
            
            2006
            
            
            126,923
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            19,084
            
            
            146,007Vice
                PresidentOperational
                Excellence & Human Resources**Jeffrey
                Dunbar**
            
            
            2006
            
            
            107,308
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            3,186
            
            
            110,494Vice
                PresidentSupply
                Chain**Edwin
                G. Summers, Jr.**
            
            
            2006
            
            
            224,433
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            14,064
            
            
            238,497Vice
                PresidentOperations*Employees
                who have served as executive officers during fiscal year 2006, but
                were
                not executive officers as of December 31, 2006***Lincoln
                B. Moehle**
            
            
            2006
            
            $
            147,369
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            11,785
            
            $
            159,154**Michael
                J. Trebing**
            
            
            2006
            
            
            192,536
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            10,859
            
            
            203,395





(1)
            *Salary*.
                The amounts reported in this column represent base salaries paid
                to each
                of the Named Executive Officers for fiscal
                2006.





(2)
            *All
                Other Compensation*.
                The amounts reported in this column represent the aggregate dollar
                amount
                for each Named Executive Officer for perquisites and other personal
                benefits. Under rules of the SEC, the Company is required to identify
                by
                type all perquisites and other personal benefits for a Named Executive
                Officer if the total value for that individual equals or exceeds
                $10,000,
                and to report and quantify each perquisite or personal benefit that
                exceeds the greater of $25,000 or 10% of the total amount for that
                individual. The amounts disclosed in this column consist of health
                insurance premiums, contributions for a Company provided automobile
                and
                life insurance premiums. In addition, amounts in this column for
                Mr. Avery
                also include amounts received for housing
                allowance.





(3)
            *Total
                Compensation*.
                The amounts reported in this column are the sum of the prior columns
                for
                each of the Named Executive
                Officers.





**Fiscal
      2006 Grants of Plan Based Awards**




No
      incentive plan-based awards, equity or otherwise, were awarded in fiscal
      2006.


51


**Outstanding
      Equity Awards At Fiscal 2006 Year-End**





**Option
                Awards**
            
            **Stock
                Awards****Equity****Incentive****Equity**
            
            **Plan****Incentive**
            
            **Awards:****Equity**
            
            
            
            
            
            
            
            
            
            **Plan**
            
            **Market
                or****Incentive**
            
            
            
            
            
            
            
            
            
            **Awards:**
            
            **Payout****Plan**
            
            
            
            
            
            
            
            
            
            **Number
                of**
            
            **Value
                of****Awards:**
            
            
            
            
            
            
            
            **Market**
            
            **Unearned**
            
            **Unearned****Number
                of**
            
            **Number
                of**
            
            **Number
                of**
            
            
            
            
            
            **Number
                of**
            
            **Value
                of**
            
            **Shares,**
            
            **Shares,****Securities**
            
            **Securities**
            
            **Securities**
            
            
            
            
            
            **Shares
                or**
            
            **shares
                or**
            
            **Units
                or**
            
            **Units
                or****Underlying**
            
            **Underlying**
            
            **Underlying**
            
            
            
            
            
            **Units
                of**
            
            **Units
                of**
            
            **Other**
            
            **Other****Unexercised**
            
            **Unexercised**
            
            **Unexercised**
            
            **Option**
            
            
            
            **Stock
                That**
            
            **Stock That**
            
            **Rights
                That**
            
            **Rights
                That****Options**
            
            **Options**
            
            **Unearned**
            
            **Exercise**
            
            **Option**
            
            **Have
                Not**
            
            **Have
                Not**
            
            **Have
                Not**
            
            **Have
                Not****(#)**
            
            **(#)**
            
            **Options**
            
            **Price**
            
            **Expiration**
            
            **Vested**
            
            **Vested**
            
            **Vested**
            
            **Vested****Name**
            
            **Exercisable**
            
            **Unexercisable**
            
            **(#)**
            
            **($)**
            
            **Date**
            
            **(#)**
            
            **(#)**
            
            **(#)**
            
            **(#)***Executive
                officers as of December 31, 2006*Robert
                A. Ferguson
            
            
            100,000
            
            
            -
            
            
            -
            
            $
            5.50
            
            
            6/22/2008
            
            
            -
            
            
            -
            
            
            -
            
            
            -100,000
            
            
            -
            
            
            -
            
            $
            5.50
            
            
            2/18/2013
            
            
            -
            
            
            -
            
            
            -
            
            
            -Claudia
                M. Pieropan
            
            
            100,000
            
            
            -
            
            
            -
            
            $
            5.50
            
            
            2/18/2013
            
            
            -
            
            
            -
            
            
            -
            
            
            -Stephen
                C. Avery
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            
            
            
            -
            
            
            -
            
            
            -
            
            
            -Jeffrey
                Dunbar
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            
            
            
            -
            
            
            -
            
            
            -
            
            
            -Edwin
                G. Summers, Jr.
            
            
            30,001
            
            
            -
            
            
            -
            
            $
            5.50
            
            
            2/18/2013
            
            
            -
            
            
            -
            
            
            -
            
            
            -*Employees
                who have served as executive officers during fiscal year 2006, but
                were
                not executive officers as of December 31, 2006*Lincoln
                B. Moehle (1)
            
            
            10,000
            
            
            -
            
            
            -
            
            $
            5.50
            
            
            2/18/2013
            
            
            -
            
            
            -
            
            
            -
            
            
            -Michael
                J. Trebing (1)
            
            
            30,000
            
            
            -
            
            
            -
            
            $
            5.50
            
            
            2/18/2013
            
            
            -
            
            
            -
            
            
            -
            
            
            -





(1)
            Pursuant
                to the 1998 Stock Plan, options expire 90 days after an employee’s
                departure if such departure is due to any reason besides death,
                disability, retirement or for cause. Messrs. Moehle and Trebing departed
                from the Company on January 26, 2007 and March 30, 2007,
                respectively.





**Pension
      Benefits**





The
      Company does not accrue pension benefits to its senior executives, including
      the
      Named Executive Officers.





**Non-Qualified
      Deferred Compensation**





The
      Company does not have a non-qualified deferred compensation plan.





**Termination
      and Change in Control Payments**





Set
      forth
      below are the elements of compensation that would be paid to each Named
      Executive Officer under various post-employment and change-in-control scenarios
      under (i) the terms of existing employment agreements, (ii) the terms
      of existing severance agreements and (iii) the terms of the 1998 Stock
      Plan.




In
      addition to the below amounts, in connection with any termination of employment,
      each Named Executive Officer would be entitled to receive the following:
      (i) all vested amounts paid by the Company under its 401(k) plan or any
      similar plans, (ii) all amounts earned through the date of termination but
      not yet paid (bonuses, sick pay and benefits available under existing benefit
      plans to the extent applicable, etc.) and (iii) the value of all vested
      equity awards, whether in the form of share appreciation rights or stock
      options. We have not included these elements of compensation below nor have
      we
      valued these elements because they are not “triggered” by any termination of
      employment or change in control. Information regarding the equity-based
      incentive awards currently held by the Named Executive Officers can be found
      in
      the table above entitled “Outstanding Equity Awards at Fiscal
      2006 Year-End.”




Two
      of
      our Named Executive Officers for fiscal 2006, Messrs. Moehle and Trebing, ceased
      being executive officers of the Company as of October 2006 and March 2007,
      respectively. The post-employment compensation that was paid to Messrs. Moehle
      and Trebing is described below under the caption “Severance Payments to Former
      Executive Officers”.


52


***Employment
      Agreements***





Each
      of
      Mr. Ferguson, Ms. Pieropan and Mr. Summers is a party to an employment
      agreement with the Company, and each such agreement contains materially similar
      severance terms (the “Employment Agreements”). Each element of post-employment
      compensation contained in the Employment Agreements is described below.




Involuntary
      Termination Without Cause/Disability





If
      the
      executive’s employment is terminated for any reason, other than for Cause (as
      defined below), death or the executive’s voluntary “at-will” termination, the
      executive will receive the following severance benefits:





·
            cash
                severance equal to two times annual base salary, paid within thirty
                days;





·
            a
                pro rata share of the executive’s bonus for the fiscal year in which such
                termination occurs; and





·
            continued
                payment of health insurance benefits for a one-year period following
                such
                termination.





Involuntary
      Termination for Cause/Death





If
      the
      executive’s employment is terminated for Cause or if the executive dies, he or
      she is entitled to continued payment of health insurance benefits for a one-year
      period following such termination. Under certain circumstances, the executive
      is
      entitled to voluntarily terminate his or her employment for Cause.





Voluntary
      “At-Will” Termination





If
      the
      executive voluntarily terminates his or her employment he or she is not entitled
      to severance benefits unless he or she terminates such employment for
      Cause.





***Severance
      Agreements***





Each
      of
      Messrs. Avery, Dunbar and O’Donnell is party to a severance agreement with
      the Company, each of which contains materially similar terms (collectively,
      the
“Severance Agreements”). Each element of post-employment compensation contained
      in the Severance Agreements is described below.




Involuntary
      Termination Without Cause/Voluntary Resignation With “Good Reason”





If
      the
      executive’s employment is terminated without cause, as defined below, or
      voluntarily for good reason, as defined below, the executive is entitled to
      the
      following severance benefits:





·
            a
                lump sum payment equal to six months of his then-current monthly
                base
                salary less deductions or withholdings permitted or required by applicable
                law within 30 days of the date of his termination or resignation;





·
            any
                bonus amount which he earned as determined in accordance with applicable
                terms and conditions for the fiscal year ended prior to the date
                of his
                termination and which remains unpaid to him as of the date of his
                termination or resignation, which bonus shall be paid to him at the
                same
                time that other bonuses for such ended fiscal year are paid to other
                employees of the Company, consistent with past practices;
                and





·
            the
                pro rata portion of any bonus which he otherwise would have been
                entitled
                to receive had he otherwise been employed by the Company on the last
                day
                of the fiscal year during which his terminated was effective, which
                bonus
                shall be paid to him at the same time that other bonuses for such
                ended
                fiscal year are paid to other employees of the Company, consistent
                with
                past practices.





Involuntary
      Termination for Cause/Voluntary Resignation Without Good
      Reason/Disability/Death





If
      the
      executive’s employment is terminated with cause, or the executive voluntarily
      resigns without Good Reason (as defined below), the executive is entitled to
      no
      severance benefits.


53


***1998
      Long-Term Equity Incentive Plan*** ***(“1998 Stock Plan”)***





In
      addition, the post-employment benefits described below are available to all
      eligible participants in the 1998 Stock Plan, including the Named Executive
      Officers. No awards were granted under 1998 Stock Plan during fiscal
      2006.





Change
      in Control





·
            If
                there is a Change in Control (as defined below) of the Company and
                an
                executive is terminated within one year thereafter, all stock options
                and
                stock appreciation rights shall become fully vested and exercisable
                immediately prior to such termination and remain so for one year
                after the
                date of termination.





·
            All
                restrictions on restricted stock will
                lapse.





·
            The
                executive shall earn a proportionate portion of any performance award
                based upon the elapsed portion of the period over which performance
                is
                measured and the Company’s performance over that portion of such
                period.





Retirement
      with Approval of the Compensation Committee (“Retirement”)





·
            All
                stock options and stock appreciation rights that were exercisable
                on the
                date of a Retirement remain exercisable for a period of up to three
                years
                after the date of Retirement (provided that the executive does not
                compete
                with the Company during such three-year period), but in no event
                after the
                expiration date of the options or stock appreciation rights; and
                all
                options and stock appreciation rights unvested on the date of Retirement
                may become fully vested and exercisable in the discretion of the
                Compensation Committee.





·
            Restrictions
                on restricted stock may lapse in the discretion of the Compensation
                Committee.





·
            The
                executive shall earn a proportionate portion of any performance award
                based upon the elapsed portion of the period over which performance
                is
                measured and the Company’s performance over that portion of such
                period.





Death
      or Disability





·
            Stock
                options and stock appreciation rights shall become fully vested and
                exercisable and shall remain so for one year from the date of death
                or
                disability, but in no event after the expiration date of the options
                or
                stock appreciation rights.





·
            All
                restrictions on restricted stock will
                lapse.





·
            The
                executive shall earn a proportionate portion of any performance award
                based upon the elapsed portion of the period over which performance
                is
                measured and the Company’s performance over that portion of such
                period.








*Definitions
      of “Cause,” “Change of Control” and “Good Reason”*




For
      purposes of the Employment Agreements, “Cause” means:





·
            willful
                and habitual breach of the duties;





·
            habitual
                neglect of the duties or
                obligations;





·
            commission
                of fraud, embezzlement or misappropriation, or other willful acts
                of
                dishonesty or willful misconduct, or commission of a crime of moral
                turpitude involving the Company whether or not a criminal or civil
                charge
                is filed in connection therewith;
                or





·
            misuse
                of confidential information or trade secrets of the Company.




54


An
      executive shall have the option under the Employment Agreement to consider
      his
      or her employment terminated other than for Cause following events:





·
            he
                or she is required to accept a diminution in base salary or material
                diminution of benefits, or an assignment of employment duties which
                are
                not commensurate with his or her office described in the Employment
                Agreements; and





·
            he
                or she has notified Hines in writing of his or her intention to terminate
                his or her employment on account of such diminution or assignment
                and
                Hines has failed to cure the situation within 15 days of receipt
                of such
                notice.





For
      purposes of the Severance Agreements “Cause” means:





·
            a
                material breach of any provision of the Severance Agreement, the
                Company’s
                policies, procedures, code of conduct, any confidentiality agreement,
                or
                any other agreements made with the
                Company;





·
            a
                willful failure to perform, or the gross negligence in performance,
                of
                duties in connection with the employee’s employment with the Company;





·
            engagement
                in an act of dishonesty involving the
                Company;





·
            the
                employee’s indictment or conviction for a crime of theft, embezzlement,
                fraud, misappropriation of funds or other alleged act of dishonesty,
                or
                crime involving moral turpitude; or





·
            engagement
                in any violation of law relating to employment by, or violation of
                a duty
                of loyalty to, the Company.





For
      purposed of the Severance Agreement “Good Reason” shall occur when:





·
            the
                employee’s base salary is reduced without his
                consent;





·
            the
                employee is assigned to an office or facility which is different
                than the
                office or facility where he is located on the date of the Severance
                Agreement and which is not within a radius of 50 miles of his current
                office or facility and he reasonably objects to the transfer to the
                new
                place of assignment; or





·
            the
                Company takes any other action which results in a material adverse
                diminution in his position, authority, duties or responsibilities,
                and the
                Company fails to cure such reduction, re-assignment or material adverse
                diminution within 15 business days after the Company’s receipt of written
                notice from the employee specifying the particular acts objected
                to and
                the specific cure requested by such
                employee.





*Change
      of Control* *.* For
      purposes of the 1998
      Long-Term Equity Incentive Plan, a “Change
      of Control” occurs if:




·
            Any
                “person” or “group” is or becomes the “beneficial owner,” directly or
                indirectly, of securities of the Company representing fifty percent
                (50%)
                or more of the combined voting power of the Company’s then-outstanding
                securities;





·
            during
                any period of two consecutive years, individuals who at the beginning
                of
                such period constitute the Board of Directors and any new directors
                whose
                election was approved by at least two-thirds of the directors then
                still
                in office who either were directors at the beginning of the period
                or
                whose election was previously so approved, cease for any reason to
                constitute a majority
                thereof;




·
            the
                stockholders of the Company approve a merger or consolidation of
                the
                Company with any other corporation, other than a merger or consolidation
                (A) which would result in all or a portion of the voting securities
                of the
                Company outstanding immediately prior thereto continuing to represent
                more
                than 50% of the combined voting power of the voting securities of
                the
                Company or such surviving entity outstanding immediately after such
                merger
                or consolidation or (B) by which the corporate existence of the Company
                is
                not affected and following which the Company’s chief executive officer and
                directors retain their positions with the Company and constitute
                at least
                a majority of the Board; or


55





·
            the
                stockholders of the Company approve a plan of complete liquidation
                of the
                Company or an agreement for the sale or disposition by the Company
                of all
                or substantially all the Company’s assets, subject to certain
                exceptions;





The
      following table quantifies the amounts payable to each Named Executive Officer
      under the scenarios described above. For the purposes of determining the value
      of any equity-based compensation, we have assumed that the relevant triggering
      event took place on December 31, 2006, the last day of fiscal 2006. We have
      not
      included in the following table any benefits associated with the acceleration
      of
      outstanding equity awards pursuant to the 1998 Stock Plan, since as of December
      31, 2006, all such outstanding equity awards held by the Named Executive
      Officers were fully vested.





*Executive*
            
            *Benefit*
            
            *Involuntary
                Termination For Cause/ Resignation Without Good Reason
                ($)*
            
            *Involuntary
                Termination Without Cause/ Resignation for Good Cause
                ($)*
            
            *Disability
                ($)*Stephen
                C. Avery
            
            
            Severance
                Cash Payment
            
            $
            -
            
            $
            100,000
            
            $
            -Continued
                Healthcare Benefits
            
            
            -
            
            
            -
            
            
            -$
            -
            
            $
            100,000
            
            $
            -Jeffrey
                Dunbar
            
            
            Severance
                Cash Payment
            
            $
            -
            
            $
            90,000
            
            $
            -Continued
                Healthcare Benefits
            
            
            -
            
            
            -
            
            
            -$
            -
            
            $
            90,000
            
            $
            -Robert
                A. Ferguson
            
            
            Severance
                Cash Payment
            
            $
            -
            
            $
            650,000
            
            $
            650,000Continued
                Healthcare Benefits
            
            
            11,892
            
            
            11,892
            
            
            11,892$
            11,892
            
            $
            661,892
            
            $
            661,892Claudia
                M. Pieropan
            
            
            Severance
                Cash Payment
            
            $
            -
            
            $
            436,128
            
            $
            436,128Continued
                Healthcare Benefits
            
            
            10,845
            
            
            10,845
            
            
            10,845$
            10,845
            
            $
            446,973
            
            $
            446,973Edwin
                G. Summers, Jr.
            
            
            Severance
                Cash Payment
            
            $
            -
            
            $
            448,866
            
            $
            448,866Continued
                Healthcare Benefits
            
            
            10,845
            
            
            10,845
            
            
            10,845$
            10,845
            
            $
            459,711
            
            $
            459,711





*Severance
      Payments to Former Executive Officers*





In
      connection with his cessation from serving as an executive officer in October
      2006 and his departure in January 2007, Mr. Moehle received a one time severance
      payment of $73,684, less applicable withholding, and is entitled to receive
      continued health, dental and vision insurance through June 29,
      2007.





In
      connection with his departure from the Company in January 2007, Mr. Trebing
      received (i) a one time severance payment of $80,000, less applicable
      withholding, (ii) a one time payment of an amount equal to Mr. Trebing’s cost of
      continuing his health, dental and vision insurance under the Consolidated
      Omnibus Budget Reconciliation Act (COBRA) for a period of six months, and (iii)
      payment of all accrued and unused vacation through his departure
      date.


56


**Compensation
      of Directors**




Directors
      who are also employees of Hines receive no separate compensation for serving
      as
      directors or as members of Board committees. Directors who are not employees
      of
      Hines receive a $20,000 annual retainer paid in quarterly installments, $1,000
      for each Board meeting attended in person or $500 for each Board meeting
      attended telephonically. The Chairman of the Board receives an additional annual
      retainer of $37,500 paid in quarterly installments.






Excluding
      employee directors, the Chairperson of each committee receives an additional
      annual retainer of $3,500. All non-employee directors receive $500 for each
      committee meeting attended in person or telephonically. All directors are
      reimbursed for all travel-related expenses incurred in connection with their
      activities as directors. Directors are eligible to receive stock option grants
      under the Hines Amended and Restated 1998 Stock Plan. Under the 1998 Stock
      Plan,
      the amount of options, if any, granted to directors and the terms and provisions
      of any options granted to directors are at the discretion of the Compensation
      Committee. No options were granted to any non-employee director during
      2006.





**Change
                in****Pension****Fees**
            
            
            
            
            
            **Non-Equity**
            
            **Value
                and****Earned**
            
            
            
            
            
            **Incentive**
            
            **Nonqualified****or
                Paid**
            
            **Stock**
            
            **Option**
            
            **Plan**
            
            **Defered**
            
            **All
                Other****in
                Cash**
            
            **Awards**
            
            **Awards**
            
            **Compensation**
            
            **Compensation**
            
            **Compensation**
            
            **Total****Name**
            
            **($)**
            
            **($)**
            
            **($)**
            
            **($)**
            
            **Earnings**
            
            **($)**
            
            **($)**G.
                Ronald Morris
            
            $
            37,000
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            37,000Stan
                R. Fallis
            
            
            36,500
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            36,500Thomas
                R. Reusche
            
            
            36,000
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            36,000James
                R. Tennant
            
            
            37,000
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            37,000Paul
                R. Wood
            
            
            32,000
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            32,000





**Compensation
      Committee Interlocks and Insider Participation**





No
      member
      of the Compensation Committee is or was an officer or employee of the Company
      or
      any of its subsidiaries. During 2006, no member of the Compensation Committee
      had a current or prior relationship that must be described under the SEC rules
      relating to disclosure of related party transactions. None of our executive
      officers serves as a member of the board of directors or compensation committee
      of any entity that has one or more executive officers who serve on our board
      of
      directors or our Compensation Committee.


57


**ITEM
      12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
      AND** **RELATED
      STOCKHOLDER** **MATTERS.**





The
      shares of Common Stock are the Company's only outstanding class of voting
      securities. The following table furnishes, as of June 22, 2007, certain
      information as to the common shares beneficially owned by each of the current
      directors of the Company, by each of the individuals named in the Summary
      Compensation Table and by all current directors and executive officers of the
      Company as a group, as well as by the only persons known to the Company to
      beneficially own more than 5% of the outstanding common shares. Beneficial
      ownership of less than one percent is indicated by an asterisk (*). Unless
      otherwise indicated, the beneficial owner has sole voting and dispositive power
      as to all common shares reflected in the table. No effect has been given to
      shares reserved for issuance under outstanding stock options, except where
      otherwise indicated. All fractional common shares have been rounded to the
      nearest whole common share. The mailing address of each of the current executive
      officers and directors of the Company is 12621 Jeffery Road, Irvine, California,
      92620.





**Name
                and address of beneficial owner**
            
            **Number
                of Shares Beneficially Owned**
            
            **Common
                Shares Which Can Be Acquired upon Exercise of Options Exercisable
                Within
                60 Days**
            
            **Percent
                of Class Outstanding****(1)**
            
            **(2)**Madison
                Dearborn Capital Partners, L.P. (3)Three
                First National Plaza, Suite 3800
            
            
            11,785,628
            
            
            —
            
            
            53.4
            %Chicago,
                IL 60602California
                State Teachers’ Retirement System (4)7667
                Folsom Avenue, Suite 250
            
            
            2,520,598
            
            
            —
            
            
            11.4
            %Sacramento,
                California 95826Abbott
                Capital 1330 Investors I, LP (5)c/o
                Abbott Capital Management
            
            
            1,314,115
            
            
            —
            
            
            6.0
            %1211
                Avenue of the Americas, Suite 4300New
                York, New York 10036Boston
                Partners Asset Management, L.L.C. (6)
            
            
            
            
            
            —28
                State Street, 20thFloor
            
            
            1,294,710
            
            
            —
            
            
            5.9
            %Boston,
                MA 02109Stephen
                C. Avery
            
            
            —
            
            
            —
            
            
            —Jeffrey
                Dunbar
            
            
            —
            
            
            —
            
            
            —Stan
                R. Fallis
            
            
            15,000
            
            
            45,000
            
            
            *Robert
                A. Ferguson
            
            
            193,252
            
            
            200,000
            
            
            1.8
            %Lincoln
                B. Moehle (7)
            
            
            6,428
            
            
            10,000
            
            
            *G.
                Ronald Morris
            
            
            12,000
            
            
            36,000
            
            
            *James
                J. O'Donnell
            
            
            3,000
            
            
            —
            
            
            *Claudia
                M. Pieropan
            
            
            65,632
            
            
            100,000
            
            
            *Thomas
                R. Reusché
            
            
            —
            
            
            —
            
            
            —Edwin
                G. Summers, Jr.
            
            
            192,300
            
            
            30,001
            
            
            1.0
            %James
                R. Tennant
            
            
            7,000
            
            
            21,000
            
            
            *Michael
                J. Trebing (7)
            
            
            9,843
            
            
            30,000
            
            
            *Paul
                R. Wood (8)
            
            
            11,785,628
            
            
            —
            
            
            53.4
            %All
                Executive Officers and Directorsas
                a Group (13 persons)
            
            
            12,095,383
            
            
            472,001
            
            
            55.7
            %




58


(1)
            Represents
                the shares that can be acquired through the exercise of stock options
                granted pursuant the Incentive
                Plan.


(2)
            Based
                on 22,072,549 shares of Common Stock outstanding as of June 21, 2007.
                Shares subject to options exercisable within 60 days of June 22,
                2007 are
                considered for the purpose of determining the percent of the class
                held by
                the holder of such options, but not for the purpose of computing
                the
                percentage held by others.


(3)
            Based
                solely on a Schedule 13D/A filed with the Securities and Exchange
                Commission (“SEC”) on January 18, 2001. MDCP is the record holder of
                10,785,628 shares. Madison Dearborn Capital Partners II, L.P. (“MDCP II”)
                is the record holder of 1,000,000 shares. Because MDCP and MDCP II
                are
                under common control, MDCP may be deemed to be the beneficial owner
                of the
                shares held by MDCP II. The number of shares reported on the Schedule
                13D/A filed with the SEC on January 18, 2001 included warrants held
                by
                MDCP to acquire 440,000 shares which expired without being exercised
                on
                December 31, 2005.


(4)
            Based
                solely on a Schedule 13G filed with the SEC on February 12,
                2007.


(5)
            Based
                solely on a Schedule 13G/A filed with the SEC on February 14, 2007.
                Abbott
                Capital 1330 Investors I, LP (“Abbott”) is the record holder of 1,308,036
                shares. Abbott Co-Investment I, LLC (“LLC”) is the record holder of 6,079
                shares. Because Abbott and LLC are affiliated entities, Abbott may
                be
                deemed to be the beneficial owner of the shares held by
                LLC.


(6)
            Based
                solely on a Schedule 13G filed with the SEC on February 14,
                2007.


(7)
            Messrs.
                Moehle and Trebing ceased being executive officers of the Company
                in
                October 2006.


(8)
            All
                of such shares are held by MDCP or MDCP II. Mr. Wood is a Managing
                Director of MDP, the ultimate general partner of MDCP and MDCP II,
                and
                therefore may be deemed to share voting and investment power over
                the
                shares owned by MDCP and MDCP II, and therefore to beneficially own
                such
                shares. Mr. Wood disclaims beneficial ownership of the shares owned
                by MDCP and MDCP II. The address of Mr. Wood is the address of
                MDCP.





**ITEM
      13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE**





**Related
      Party Transactions**





Pursuant
      to our Audit Committee’s charter and as required by Nasdaq Rules, our Audit
      Committee or a comparable independent body of our Board of Directors is
      responsible for reviewing and approving related party transactions (as that
      term
      is defined in the SEC regulations).





In
      1995
      we sold 290 acres of its Forest Grove, Oregon nursery facility property to
      Blooming Farm, Inc., a corporation owned by Madison Dearborn Capital Partners
      and by Mr. Ferguson, our Chief Executive Officer and President, Ms. Pieropan,
      our Chief Financial Officer, Secretary and Treasurer, Stephen Thigpen, our
      former Chief Executive Officer, and other members of our current and former
      management. As payment in full for the 290 acres, Blooming Farm issued an
      interest-only promissory note to us in the amount of $826,865 secured by a
      deed
      of trust on the land. In 1996 we sold an additional 53 acres to Blooming Farm.
      As payment in full for the 53 acres, Blooming Farm issued an interest-only
      promissory note to us in the amount of $151,050 secured by a deed of trust
      on
      the 53 acres. The maturity date of each of these promissory notes is May 31,
      2008.




The
      land
      was sold to Blooming Farm to avoid exceeding a limit on the amount of land
      we
      are able to receive federal reclamation water for under applicable federal
      reclamation water law. Blooming Farm is obligated to make interest payments
      of
      $67,476 per year on the principal balances of the notes. We lease all such
      343
      acres from Blooming Farm pursuant to a lease which expires on May 31, 2008
      and
      under which we are is obligated to make annual lease payments of $68,600.
      Pursuant to such lease, we have an option to purchase the land and rights of
      first refusal.




We
      are a party to a registration rights agreement whereby MDCP has the right,
      subject to certain restrictions, to cause us to register shares of our Common
      Stock for sale under the Securities Act. Pursuant to the agreement, we are
      required to pay the registration expenses associated with such
      registrations.





Pursuant
      to a stockholders agreement, we have the option to repurchase shares of Common
      Stock owned by Mr. Ferguson and Ms. Pieropan in the event of termination for
      fraud and MDCP, Mr. Ferguson, Ms. Pieropan and certain of our former executive
      officers have the right to participate in certain registrations of securities
      by
      us.


59


**Director
      Independence**





Our
      board
      of directors has determined that Messrs. Stan R. Fallis, G. Ronald Morris,
      and
      James R. Tenant, together representing a majority of the board, are independent
      directors as defined under the rules of the NASDAQ Global Market.





Our
      board
      has three standing committees: the Audit Committee, the Compensation Committee
      and the Nominations and Corporate Governance Committee. Our board has determined
      that each member of the Audit Committee is independent for purposes of the
      rules
      of The NASDAQ Stock Market and the Securities and Exchange Commission as they
      relate to audit committee members.





Hines
      is
      a controlled company as defined in the rules of The NASDAQ Stock Market because
      more than 50% of its voting stock is held by MDCP. Please see Item 12 - Security
      Ownership of Certain Beneficial Owners and Management and Related Stockholder
      Matters above. Therefore, the Company is not subject to the rules of the NASDAQ
      Stock Market that would otherwise require it to have (i) a majority of
      independent directors on the Board; (ii) a compensation committee composed
      solely of independent directors; (iii) a nominating committee composed solely
      of
      independent directors; (iv) the compensation of the Company’s executive officers
      determined by a majority of the independent directors or a compensation
      committee composed solely of independent directors; and (v) director nominees
      selected, or recommended for the Board's selection, either by a majority of
      the
      independent directors or a nominating committee composed solely of independent
      directors.





**ITEM
      14. PRINCIPAL ACCOUNTING FEES AND SERVICES**





On
      November 16, 2006, the Company dismissed PricewaterhouseCoopers LLP ("PwC")
      and
      hired KPMG LLP (“KPMG”) as its independent registered public accounting firm.
      The description of accounting fees below sets forth separately the aggregate
      fees billed by PwC and KPMG for the fiscal years ended December 31, 2006 and
      2005.





AUDIT
      FEES. Aggregate fees billed for fiscal 2006 and 2005 for professional services
      for the annual audit of the Company's financial statements and the review of
      the
      Company's quarterly financial statements were $798,323 and $370,020,
      respectively. Fees billed for 2006 were comprised of $293,252 and $505,071
      for
      PwC and KPMG, respectively. All fees billed in 2005 were related to
      PwC.




AUDIT-RELATED
      FEES. The aggregate fees for audit related services for our 2006 and 2005 fiscal
      years were $142,019 and $22,300, respectively. Audit-related fees for fiscal
      2006 and 2005 include advisory work in connection with Section 404 of the
      Sarbanes-Oxley Act of 2002. All fees billed in 2006 and 2005 were related to
      PwC. In addition, audit-related fees of $80,030 billed by PwC were for
      consultations on accounting and financial reporting standards which were
      incurred for fiscal 2006.





TAX
      FEES.
      The aggregate fees billed for tax services for our 2006 and 2005 fiscal years
      were $765 and $4,350, respectively. The tax services rendered by the independent
      registered public accounting firm primarily consisted of tax compliance and
      advisory services. All tax fees billed in 2006 and 2005 were related to
      PwC.





ALL
      OTHER
      FEES. Fees billed of $1,500 in 2006 comprised of technical resources from
      PwC.





The
      Audit
      Committee pre-approved all services described above for fiscal 2006, including
      non-audit services, and has determined that these fees and services are
      compatible with maintaining the independence of the Accounting Firms. The
      Company's Audit Committee requires that each service provided by the Accounting
      Firms be pre-approved by the committee.


60


**PART
      IV**





**ITEM
      15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES**





(a)
      List
      of documents filed as part of this report:





(1)
            Financial
                Statements:





**Page**Reports
                of Independent Registered Public Accounting Firms
            F-1Consolidated
                Balance Sheets at December 31, 2006 and 2005 (as restated)
            F-3Consolidated
                Statements of Operations for the Years Ended December 31, 2006, 2005
                (as
                restated)
              and
                2004 (as restated)
            F-4Consolidated
                Statements of Shareholders’ Equity for the Years Ended December 31, 2006,
                2005
              (as
                restated) and 2004 (as restated)
            F-5Consolidated
                Statements of Cash Flows for the Years Ended December 31, 2006, 2005
                (as
                restated)
              and
                2004 (as restated)
            F-6Notes
                to Consolidated Financial Statements
            F-7


(2)
            Financial
                Statement Schedules:





All
      schedules are omitted since the required information is not present or is not
      present in amounts sufficient to require submission of the schedule, or because
      the information required is included in the Consolidated Financial Statements
      and Notes thereto.


61





(3)
            List
                of Exhibits


**INDEX
      TO EXHIBITS**





**Exhibit**
              **Number**
            **Description**3.1
            Restated
                Certificate of Incorporation of Hines Horticulture, Inc.
                (3)3.2
            Amended
                and Restated By-laws of Hines Horticulture, Inc. (3)4.1
            Indenture,
                dated as of September 30, 2003, between Hines Nurseries, Inc., Hines
                Horticulture, Inc., the Subsidiary Guarantors named therein and the
                Bank
                of New York, as Trustee, relating to Hines Nurseries, Inc.’s $175,000,000
                10.25% Senior Notes due 2011. (4)4.2
            Holdings
                Guaranty dated September 30, 2003, by Hines Horticulture, Inc., in
                favor
                of and for the benefit of, Deutsche Bank Trust Company Americas,
                as
                Guaranteed Party. (4)4.3
            Form
                of 144A Senior Note due 2011. (4)4.4
            Form
                of Senior Note due 2011. (4)4.5
            Form
                of Regulation S Senior Note due 2011. (4)4.6
            Registration
                Rights Agreement, dated as of September 30, 2003, between Hines Nurseries,
                Inc., Hines Horticulture, Inc., Hines SGUS Inc., Enviro-Safe Laboratories,
                Inc. and the Initial Purchasers named therein. (4)10.1
            Employment
                Agreement dated as of August 3, 1995 between Hines Horticulture and
                Robert
                A. Ferguson. (8)*10.2
            Employment
                Agreement dated as of August 4, 1995 between Hines Horticulture and
                Claudia M. Pieropan. (2)*10.3
            Amended
                and Restated 1998 Long-Term Equity Incentive Plan, as Amended.
                (25)*10.4
            Form
                of Incentive Stock Option Agreement. (3)*10.5
            Stock
                Purchase Agreement dated September 9, 1999 between Hines Nurseries,
                Inc.
                and those individuals whose names are set forth on the Signature Page to
                Stock Purchase Agreement. (8)10.6
            Purchase
                Agreement, dated as of March 3, 2000, by and among Hines Nurseries,
                Inc.,
                Lovell Farms, Inc., Botanical Farms, Inc., Warren W. Lovell III,
                Jeffrey
                S. Lovell, Jenifer E. Moreno, as Trustee of the Trace Lovell Family
                Investment Trust and Enrique A. Yanes. (5)10.7
            Amended
                and Restated Promissory Note by Blooming Farm, Inc. in favor of Hines
                Nurseries, Inc. dated September 22, 2003. (4)10.8
            Amended
                and Restated Secured Promissory Note by Blooming Farm, Inc. in favor
                of
                Hines Nurseries, Inc. dated September 22, 2003. (4)10.9
            Amended
                and Restated Ground Lease dated September 1, 1996 by and between
                The
                Irvine Company and Hines Horticulture, Inc. (4)**10.10
            Addendum
                No. 1 to Amended and Restated Ground Lease dated October 29, 1996
                by and
                between The Irvine Company and Hines Horticulture, Inc.
                (4)10.11
            Addendum
                No. 2 to Amended and Restated Ground Lease dated December 18, 1997
                by and
                between The Irvine Company and Hines Horticulture, Inc.
                (4)10.12
            Addendum
                No. 3 to Amended and Restated Ground Lease dated May 19, 2003 by
                and
                between The Irvine Company and Hines Nurseries, Inc.
                (4)**10.13
            Letter
                Agreement dated September 18, 2003 by and between The Irvine Company
                and
                Hines Nurseries, Inc. (4)**10.14
            Credit
                Agreement dated September 30, 2003 among Hines Nurseries, Inc.,
                Enviro-Safe Laboratories, Inc., and Hines SGUS Inc., as Borrowers,
                the
                lenders listed therein, Deutsche Bank Trust Company Americas, as
                Agent,
                Fleet Capital Corporation and Lasalle Business Credit, LLC, as
                Co-Syndication Agents, and Harris Trust and Savings Bank and Wells
                Fargo
                Bank, N.A., as Co-Documentation Agents. (4)10.15
            Security
                Agreement, dated September 30, 2003, among Hines Nurseries, Inc.,
                Enviro-Safe Laboratories, Inc. Hines SGUS Inc., and Hines Horticulture,
                Inc., as Grantors, and Deutsche Bank Trust Company Americas, as agent
                for
                and representative of the beneficiaries named therein.
                (4)10.16
            Registration
                Agreement dated as of June 11, 1998 by and between Hines Holdings,
                Inc.
                and MDCP. (3)10.17
            First
                Amendment to Credit Agreement, effective as of June 30, 2005.
                (9)10.18
            Waiver
                Regarding Financial Covenants dated October 13, 2005, among Hines
                Nurseries, Inc. and Hines SGUS Inc., as borrowers, the lenders listed
                therein, and Deutsche Bank Trust Company Americas, as agent.
                (9)10.19
            Second
                Amendment to Credit Agreement, effective as of February 3, 2006.
                (25)


62





10.20
            Real
                Property Purchase and Sale Agreement and Escrow Instructions, dated
                September 12, 2005, by and between Hines Nurseries, Inc. and Quantum
                Ventures, LLC. (10)10.21
            Summary
                of Oral Amendment to Real Property Purchase and Sale Agreement and
                Escrow
                Instructions, dated September 12, 2005, by and between Hines Nurseries,
                Inc. and Quantum Ventures, LLC. (10)10.22
            Lease
                Agreement dated November 7, 2005, by and between Hines Nurseries,
                Inc. and
                Quantum Ventures, LLC. (10)10.23
            Option
                Agreement, dated April 30, 2005, by and between Hines Nurseries,
                Inc. and
                Triad Communities, L.P. (25)10.24
            First
                Amendment to Option Agreement, dated February 28, 2005, by and between
                Hines Nurseries, Inc. and Triad Communities, L.P. (25)10.25
            Exercise
                of Option Agreement, dated March 1, 2006, by and between Hines Nurseries,
                Inc. and Triad Communities, L.P. (25)10.26
            Agricultural
                Lease dated as of June 26, 1998 between Blooming Farm, Inc. as lessor,
                and
                Oregon Garden Products, Inc. as lessee. (11)10.27
            Offer
                Letter and attached Corporate Resources Participant Summary, by and
                between Hines Horticultures, Inc. and Steven C. Avery.
                (12)*10.28
            Severance
                Agreement between Hines Horticulture, Inc. and Steven Avery dated
                August
                9, 2006. (13)*10.29
            Offer
                Letter and attached Corporate Resources Participant Summary, by and
                between Hines Horticulture, Inc. and Jeffrey Dunbar.
                (14)*10.30
            Severance
                Agreement between Hines Horticulture, Inc. and Jeffrey Dunbar dated
                August
                9, 2006. (13)*10.31
            Third
                Amendment to Credit Agreement dated as of August 8, 2006 by and among
                Hines Nurseries, Inc., a subsidiary of Hines Horticulture, Inc.,
                Hines
                SGUS Inc., the financial institutions party thereto, Deutsche Bank
                Trust
                Company Americas, as administrative agent for the Lenders.
                (13)10.32
            Asset
                Purchase Agreement by and between Hines Nurseries, Inc. and Costa
                Nursery
                Farms, LLC dated as of October 2, 2006. (15)10.33
            Asset
                Purchase Agreement by and between Hines Nurseries, Inc. and Pure
                Beauty
                Farms, Inc. dated as of October 2, 2006. (15)10.34
            Offer
                Letter and attached Corporate Resources Participant Summary, by and
                between Hines Horticulture, Inc. and James J. O'Donnell.
                (16)*10.35
            Severance
                Agreement between Hines Horticulture, Inc. and James O'Donnell dated
                November 9, 2006. (17)*10.36
            Commercial
                Contract between Hines Horticulture, Inc. and F & J Farms, LLC dated
                as of October 30, 2006. (18)10.37
            Asset
                Purchase Agreement by and between Hines Nurseries, Inc., Costa Penn
                Farms,
                LLC and Costa Penn Land Holdings, LLC Dated as of November 15, 2006.
                (19)10.38
            Fourth
                Amendment and Waiver to Credit Agreement, dated December 27, 2006,
                by and
                between Hines Nurseries, Inc., Hines Horticulture, Inc., the financial
                institutions party thereto and Deutsche Bank Trust Company Americas,
                as
                administrative agent. (20)10.39
            Asset
                Purchase Agreement by and among Hines Nurseries, Inc., KW Mohawk
                Valley
                LLC, 621 East Maple LLC, Danville PA LLC, KW Utica LLC, KW Newark
                LLC and
                KW Danville LLC dated January 9, 2007. (21)10.40
            Commercial
                Contract by and between Hines Nurseries, Inc. and F & J Farms, LLC
                dated January 10, 2007. (21)10.41
            Loan
                and Security Agreement, dated January 18, 2007, by and between Hines
                Nurseries, Inc., Bank of America, N.A., as agent and a lender, Banc
                of
                America Securities LLC, as lead arranger and book manager and the
                financial institutions party thereto from time to time.
                (22)10.42
            Commercial
                Contract by and between Hines Nurseries, Inc. and Garden Depot, Corp.
                effective March 1, 2007. (23)10.43
            Severance
                and Release Agreement between Michael Trebing and Hines Horticulture,
                Inc.
                dated March 19, 2007. (24)*10.44
            Hines
                Horticulture, Inc. Executive Incentive Plan 2004. (26)*10.45
            Employment
                Agreement, dated August 3, 1995, by and between Edwin G. Summers,
                Jr. and
                Hines Horticulture, Inc. (26)*10.46
            Amendment
                to Amended and Restated Ground Lease dated January 1, 2007 by and
                between
                The Irvine Company and Hines Horticulture, Inc.****(†)


63





10.47
            Severance
                and Release Agreement between Lincoln Moehle and Hines Horticulture,
                Inc.
                dated December 29, 2006. (†)*10.48
            Amendment
                No. 1 to Loan and Security Agreement dated as of February 28, 2007,
                by and
                among Hines Nurseries, Inc., the parties hereto as lenders and Bank
                of
                America, N.A., in its capacity as agent for Lenders.
                (†)10.49
            Amendment
                No. 2 to Loan and Security Agreement dated as of March 7, 2007, by
                and
                among Hines Nurseries, Inc., the parties hereto as lenders and Bank
                of
                America, N.A., in its capacity as agent for Lenders.
                (†)10.50
            First
                Amendment to Lease Agreement dated as of October 2, 2006, by and
                between
                Hines Nurseries, Inc. and Quantum Ventures, LLC. (†)10.51
            Limited
                Waiver to the Loan and Security Agreement, dated April 30, 2007,
                by Hines
                Nurseries, Inc., Bank of America, N.A., PNC Bank, National Association
                and
                GMAC Commercial Finance LLC. (†)10.52
            Limited
                Waiver to the Loan and Security Agreement, dated May 29, 2007, by
                and
                among Hines Nurseries, Inc., Bank of America, N.A., PNC Bank, National
                Association and GMAC Commercial Finance LLC. (†)10.53
            Limited
                Waiver to the Loan and Security Agreement, dated June 21, 2007, by
                and
                among Hines Nurseries, Inc., Bank of America, N.A., PNC Bank, National
                Association and GMAC Commercial Finance LLC. (†)10.54
            Limited
                Waiver to the Loan and Security Agreement, dated June 28, 2007, by
                and
                among Hines Nurseries, Inc., Bank of America, N.A., PNC Bank, National
                Association and GMAC Commercial Finance LLC. (†)21.1
            Subsidiaries
                of the Company. (†)23.1
            Consent
                of independent registered public accounting firm, KPMG LLP.
                (†)31.1
            Certification
                of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a),
                as
                adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
                (†)31.2
            Certification
                of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a),
                as
                adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
                (†)32.1
            Certification
                of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, As
                Adopted
                Pursuant To Section 906 Of The Sarbanes-Oxley Act of 2002.
                (†)(‡)32.2
            Certification
                of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, As
                Adopted
                Pursuant To Section 906 Of The Sarbanes-Oxley Act of 2002.
                (†)(‡)99.1
            Unaudited
                pro forma financial information, including income statements for
                the year
                ended December 31, 2005 and nine month period ended September 30,
                2006 and
                balance sheet as of September 30, 2006 (15).


________________


†
            Filed
                herewith.*
            Management
                contract or compensatory arrangement.**
            Confidential
                treatment requested as to certain portions of the exhibit which have
                been
                filed separately with the Securities and Exchange
                Commission‡
            This
                certification shall not be deemed “filed” for purposes of Section 18 of
                the Securities Exchange Act of 1934, or otherwise subject to the
                liability
                of that section, nor shall it be deemed to be incorporated by reference
                into any filing under the Securities Act of 1933 or the Securities
                Exchange Act of 1934.(1)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K filed on April 10,
                2002.(2)
            Incorporated
                by reference to Hines Holdings, Inc.’s Registration Statement on Form S-4,
                File No. 33-99452, filed on November 15, 1995 and amended on December
                22,
                1995 and January 6, 1996.(3)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Registration Statement on Form
                S-1, File No. 333-51943, filed on May 6, 1998 and amended on May
                26 1998
                and June 16, 1998.(4)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Quarterly Report on Form 10-Q
                for the quarter ended September 30, 2003(5)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K filed on March 17,
                2000.(6)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K filed on November 29,
                2000.(7)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Annual Report on Form 10-K for
                the year ended December 31, 2003.(8)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Annual Report on Form 10-K for
                the year ended December 31, 2004.(9)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Quarterly Report on Form 10-Q
                for the quarter ended June 30, 2005.(10)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K filed on November 9,
                2005.


64





(11)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Annual Report on Form 10-K for
                the year ended December 31, 1998.(12)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K filed on May 5,
                2006.(13)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Quarterly Report on Form 10-Q
                for the quarter ended June 30, 2006.(14)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K filed on May 18,
                2006.(15)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K/A filed on February 5,
                2007.(16)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K filed on October 17,
                2006.(17)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Quarterly Report on Form 10-Q
                for the quarter ended September 30, 2006.(18)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K filed on November 3,
                2006.(19)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K filed on November 21,
                2006.(20)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K filed on January 3,
                2007.(21)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K filed on January 17,
                2007.(22)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K filed on January 24,
                2007.(23)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K filed on March 7,
                2007.(24)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Form 8-K filed on March 23,
                2007.(25)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Annual Report on Form 10-Kfor
                the year ended December 31, 2005.(26)
            Incorporated
                by reference to Hines Horticulture, Inc.’s Annual Report on Form 10-K/A
                filed May 12, 2006.


65


**SIGNATURES**








Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, the registrant has duly caused this report to be signed on its behalf
      by
      the undersigned, thereunto duly authorized on July 10, 2007.





HINES
      HORTICULTURE, INC.





By:  /s/
      Claudia M.
      Pieropan


Claudia
      M. Pieropan


Chief
      Financial Officer





Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the registrant in the
      capacities indicated on July 10, 2007.








**Signature**
            
            **Capacity**/s/
                Robert A. Ferguson
            
            President,
                Chief Executive Officer and DirectorRobert
                A. Ferguson
            
            (Principal
                Executive Officer)/s/
                Claudia M. Pieropan
            
            Chief
                Financial Officer, Secretary and TreasurerClaudia
                M. Pieropan
            
            (Principal
                Financial and Accounting Officer)/s/
                James R. Tennant
            
            Director
                and Chairman of the BoardJames
                R. Tennant/s/
                Stan R. Fallis
            
            DirectorStan
                R. Fallis/s/
                Thomas R. Reusché
            
            DirectorThomas
                R. Reusché/s/
                G. Ronald Morris
            
            DirectorG.
                Ronald Morris/s/
                Paul R. Wood
            
            DirectorPaul
                R. Wood




66


**Report
      of Independent Registered Public Accounting Firm**








The
      Board
      of Directors and Shareholders


Hines
      Horticulture, Inc.:





We
      have
      audited the accompanying consolidated balance sheet of Hines Horticulture,
      Inc.
      and ** subsidiaries
      as of December 31, 2006, and the related consolidated statements of operations,
      shareholders’ equity, and cash flows for the year then ended. These consolidated
      financial statements are the responsibility of the Company’s management. Our
      responsibility is to express an opinion on these consolidated financial
      statements based on our audit.





We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audit provides a
      reasonable basis for our opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the financial position of Hines Horticulture, Inc.
      and ** subsidiaries
      as of December 31, 2006, and the results of their operations and their cash
      flows for the year then ended, in conformity with U.S. generally accepted
      accounting principles.





As
      discussed in Note 2 to the consolidated financial statements, the consolidated
      financial statements for 2005 and 2004 have been restated.





/s/
      KPMG
      LLP





Costa
      Mesa, California


June
      28,
      2007


F-1





**Report
      of Independent Registered Public Accounting Firm**











To
      the
      Board of Directors and


Shareholders
      of Hines Horticulture, Inc.





In
      our
      opinion, the consolidated balance sheet as of December 31, 2005 and the related
      consolidated statements of operations, shareholders' equity and cash flows
      for
      each of two years in the period ended December 31, 2005 present fairly, in
      all
      material respects, the financial position of Hines Horticulture, Inc. and its
      subsidiaries at December 31, 2005, and the results of their operations and
      their
      cash flows for each of the two years in the period ended December 31, 2005,
      in
      conformity with accounting principles generally accepted in the United States
      of
      America. These financial statements are the responsibility of the Company's
      management. Our responsibility is to express an opinion on these financial
      statements based on our audits. We conducted our audits of these statements
      in
      accordance with the standards of the Public Company Accounting Oversight Board
      (United States). Those standards require that we plan and perform the audit
      to
      obtain reasonable assurance about whether the financial statements are free
      of
      material misstatement. An audit includes examining, on a test basis, evidence
      supporting the amounts and disclosures in the financial statements, assessing
      the accounting principles used and significant estimates made by management,
      and
      evaluating the overall financial statement presentation. We believe that our
      audits provide a reasonable basis for our opinion.





As
      discussed in Note 2 to the consolidated financial statements, the Company has
      restated its 2005 and 2004 consolidated financial statements.








/s/
      PricewaterhouseCoopers LLP


Orange
      County, California


March
      24,
      2006, except for the restatement discussed in Note 2 and the discontinued
      operations as discussed in Note 3 to the consolidated financial statements,
      as
      to which the date is July 10, 2007


F-2


**HINES
      HORTICULTURE, INC.**


**CONSOLIDATED
      BALANCE SHEETS**


**(Dollars
      in thousands, except share data)**





**December
                31,****As
                Restated (Note 2)****2006**
            
            **2005****ASSETS**CURRENT
                ASSETS:Cash
            
            
            
            
            $
            108
            
            $
            62Accounts
                receivable, net of allowance fordoubtful
                accounts of $120 and $325
            
            
            
            
            
            11,594
            
            
            16,444Inventories
            
            
            
            
            
            146,775
            
            
            159,733Consigned
                inventories
            
            
            
            
            
            542
            
            
            138Prepaid
                expenses and other current assets
            
            
            
            
            
            1,662
            
            
            2,666Assets
                held for sale
            
            
            
            
            
            32,652
            
            
            72,391Total
                current assets
            
            
            
            
            
            193,333
            
            
            251,434FIXED
                ASSETS, net
            
            85,470
            
            
            82,851DEFERRED
                  FINANCING COSTS, net of accumulated amortization of $3,767 and
                  $3,207
            
            5,361
            
            
            6,207DEFERRED
                INCOME TAXES
            
            6,082
            
            
            6,676GOODWILL
            
            38,818
            
            
            43,926OTHER
                ASSETS
            
            11,304
            
            
            -$
            340,368
            
            $
            391,094**LIABILITIES
                AND SHAREHOLDERS' EQUITY**CURRENT
                LIABILITIES:Accounts
                payable
            
            
            
            
            $
            15,113
            
            $
            12,624Accrued
                liabilities
            
            
            
            
            
            5,216
            
            
            8,591Accrued
                payroll and benefits
            
            
            
            
            
            4,282
            
            
            4,453Accrued
                interest
            
            
            
            
            
            4,667
            
            
            4,711Borrowings
                on revolving credit facility
            
            
            
            
            
            3,128
            
            
            10,080Liabilities
                related to assets held for sale
            
            
            
            
            
            471
            
            
            8,079Deferred
                income taxes
            
            
            
            
            
            44,165
            
            
            56,542Financing
                obligations
            
            
            
            
            
            47,032
            
            
            -Total
                current liabilities
            
            
            
            
            
            124,074
            
            
            105,080LONG-TERM
                DEBT
            
            175,000
            
            
            175,000FINANCING
                OBLIGATIONS
            
            16,689
            
            
            47,040OTHER
                LIABILITIES
            
            15,363
            
            
            8,260COMMITMENTS
                AND CONTINGENCIES (Note 11)SUBSEQUENT
                EVENTS (Notes 3 and 9b)SHAREHOLDERS'
                EQUITYPreferred
                stockAuthorized
                - 2,000,000 shares, $0.01 par value; none
                outstandingCommon
                stockAuthorized
                - 60,000,000 shares, $0.01 par value;issued
                  and outstanding - 22,072,549 shares at December 31, 2006 and
                  2005
            
            
            
            
            
            221
            
            
            221Additional
                paid-in capital
            
            
            
            
            
            128,781
            
            
            128,781Accumulated
                deficit
            
            
            
            
            
            (119,760
            )
            
            (73,288
            )Total
                shareholders' equity
            
            
            
            
            
            9,242
            
            
            55,714$
            340,368
            
            $
            391,094




The
      accompanying notes are an integral part of these consolidated financial
      statements.


F-3





**HINES
      HORTICULTURE, INC.**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**(Dollars
      in thousands, except share and per share data)**





**Years
                Ended December 31,****As
                Restated**
            
            **As
                Restated****(Note
                2)**
            
            **(Note
                2)****2006**
            
            **2005**
            
            **2004**Sales,
                net
            
            $
            232,570
            
            $
            245,326
            
            $
            243,968Cost
                of goods sold
            
            
            135,731
            
            
            121,007
            
            
            121,823Gross
                profit
            
            
            96,839
            
            
            124,319
            
            
            122,145Distribution
                expenses
            
            
            52,639
            
            
            52,970
            
            
            50,001Selling,
                general and administrative expenses
            
            
            51,747
            
            
            47,286
            
            
            47,219Other
                operating expenses
            
            
            2,379
            
            
            1,308
            
            
            525Asset
                impairment charges
            
            
            1,477
            
            
            -
            
            
            -Total
                operating expenses
            
            
            108,242
            
            
            101,564
            
            
            97,745Operating
                (loss) income
            
            
            (11,403
            )
            
            22,755
            
            
            24,400Other
                expenses (income)Interest
                expense, net
            
            
            19,746
            
            
            22,797
            
            
            27,139Interest
                rate swap agreement income
            
            
            -
            
            
            (895
            )
            
            (4,425
            )Amortization
                of deferred financing costs
            
            
            1,177
            
            
            2,891
            
            
            1,78420,923
            
            
            24,793
            
            
            24,498Loss
                from continuing operationsbefore
                income taxes
            
            
            (32,326
            )
            
            (2,038
            )
            
            (98
            )Income
                tax (benefit) provision
            
            
            (12,619
            )
            
            (742
            )
            
            210Loss
                from continuing operations
            
            
            (19,707
            )
            
            (1,296
            )
            
            (308
            )(Loss)
                income from discontinued operations,net
                of income taxes
            
            
            (26,765
            )
            
            (527
            )
            
            5,433Net
                (loss) income
            
            $
            (46,472
            )
            $
            (1,823
            )
            $
            5,125Basic
                and diluted (loss) earnings per share:Loss
                per common share fromcontinuing
                operations
            
            $
            (0.89
            )
            $
            (0.06
            )
            $
            (0.01
            )(Loss)
                income per common share fromdiscontinued
                operations
            
            
            (1.22
            )
            
            (0.02
            )
            
            0.24Net
                (loss) income per common share
            
            $
            (2.11
            )
            $
            (0.08
            )
            $
            0.23Weighted
                average shares outstanding-Basic
            
            
            22,072,549
            
            
            22,072,549
            
            
            22,072,549Weighted
                average shares outstanding-Diluted
            
            
            22,072,549
            
            
            22,072,549
            
            
            22,121,182






The
      accompanying notes are an integral part of these consolidated financial
      statements.


F-4





**HINES
      HORTICULTURE, INC.**


**CONSOLIDATED
      STATEMENTS OF SHAREHOLDERS' EQUITY**


**(Dollars
      in thousands, except share data)**





**Common
                Stock**
            
            **Additional****Number
                of**
            
            
            
            **Paid
                -In**
            
            **Accumulated**
            
            **Shareholders'****Shares**
            
            **Amount**
            
            **Capital**
            
            **Deficit**
            
            **Equity**BALANCE,
                December 31, 2003, as originally reported
            
            
            22,072,549
            
            $
            221
            
            $
            128,781
            
            $
            (76,272
            )
            $
            52,730Cumulative
                effect adjustment (Note 2)
            
            
            -
            
            
            -
            
            
            -
            
            
            (318
            )
            
            (318
            )BALANCE,
                December 31, 2003, as restated
            
            
            22,072,549
            
            
            221
            
            
            128,781
            
            
            (76,590
            )
            
            52,412Net
                income, as restated (Note 2)
            
            
            -
            
            
            -
            
            
            -
            
            
            5,125
            
            
            5,125BALANCE,
                December 31, 2004, as restated
            
            
            22,072,549
            
            
            221
            
            
            128,781
            
            
            (71,465
            )
            
            57,537Net
                loss, as restated (Note 2)
            
            
            -
            
            
            -
            
            
            -
            
            
            (1,823
            )
            
            (1,823
            )BALANCE,
                December 31, 2005, as restated
            
            
            22,072,549
            
            
            221
            
            
            128,781
            
            
            (73,288
            )
            
            55,714Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            (46,472
            )
            
            (46,472
            )BALANCE,
                December 31, 2006
            
            
            22,072,549
            
            $
            221
            
            $
            128,781
            
            $
            (119,760
            )
            $
            9,242


The
      accompanying notes are an integral part of these consolidated financial
      statements.


F-5


**HINES
      HORTICULTURE, INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(Dollars
      in thousands)**





**Years
                Ended December 31,****As
                Restated**
            
            **As
                Restated****(Note
                2)**
            
            **(Note
                2)****2006**
            
            **2005**
            
            **2004**CASH
                FLOWS FROM OPERATING ACTIVITIESNet
                (loss) income
            
            $
            (46,472
            )
            $
            (1,823
            )
            $
            5,125Loss
                (income) from discontinued operations, net of income taxes
            
            
            26,765
            
            
            527
            
            
            (5,433
            )Adjustments
                to reconcile (loss) income from continuingoperations
                to net cash (used in) provided by operating activities:Depreciation
            
            
            8,811
            
            
            7,884
            
            
            7,133Accretion
                on asset retirement obligations
            
            
            63
            
            
            44
            
            
            52Amortization
                of deferred financing costs
            
            
            1,177
            
            
            2,891
            
            
            1,784Interest
                rate swap agreement income
            
            
            -
            
            
            (895
            )
            
            (4,425
            )(Gain)
                loss on sale of assets
            
            
            (24
            )
            
            (205
            )
            
            16Asset
                impairment charges
            
            
            1,477
            
            
            -
            
            
            -Deferred
                income taxes
            
            
            (12,619
            )
            
            (742
            )
            
            210Changes
                in working capital accounts:Accounts
                receivable
            
            
            4,850
            
            
            3,525
            
            
            3,755Inventories
            
            
            11,841
            
            
            (5,158
            )
            
            (3,866
            )Prepaid
                expenses and other current assets
            
            
            1,178
            
            
            115
            
            
            85Accounts
                payable and accrued liabilities
            
            
            (5,145
            )
            
            (2,287
            )
            
            1,317Net
                cash (used in) provided by continuing operations
            
            
            (8,098
            )
            
            3,876
            
            
            5,753Net
                cash (used in) provided by discontinued operations
            
            
            (4,868
            )
            
            3,241
            
            
            13,259Net
                cash (used in) provided by operating activities
            
            
            (12,966
            )
            
            7,117
            
            
            19,012CASH
                FLOWS FROM INVESTING ACTIVITIESPurchases
                of fixed assets
            
            
            (12,034
            )
            
            (9,832
            )
            
            (5,588
            )Proceeds
                from sale of fixed assets
            
            
            43
            
            
            208
            
            
            -Proceeds
                from land sale option
            
            
            -
            
            
            2,000
            
            
            275Payment
                of contingent consideration for acquisitions
            
            
            -
            
            
            -
            
            
            (947
            )Net
                cash used in continuing operations
            
            
            (11,991
            )
            
            (7,624
            )
            
            (6,260
            )Net
                cash provided by (used in) discontinued operations
            
            
            17,988
            
            
            150
            
            
            (281
            )Net
                cash provided by (used in) investing activities
            
            
            5,997
            
            
            (7,474
            )
            
            (6,541
            )CASH
                FLOWS FROM FINANCING ACTIVITIESBorrowings
                on revolving credit facility
            
            
            220,070
            
            
            303,242
            
            
            295,929Repayments
                on revolving credit facility
            
            
            (227,022
            )
            
            (316,771
            )
            
            (302,638
            )Repayments
                of long-term debt
            
            
            -
            
            
            (34,290
            )
            
            (5,786
            )Proceeds
                from financing obligations
            
            
            14,297
            
            
            -
            
            
            -Payments
                of deferred financing costs
            
            
            (330
            )
            
            (216
            )
            
            (79
            )Net
                cash provided by (used in) continuing operations
            
            
            7,015
            
            
            (48,035
            )
            
            (12,574
            )Net
                cash provided by discontinued operations
            
            
            -
            
            
            47,854
            
            
            -Net
                cash provided by (used in) financing activities
            
            
            7,015
            
            
            (181
            )
            
            (12,574
            )NET
                CHANGE IN CASH
            
            
            46
            
            
            (538
            )
            
            (103
            )CASH,
                beginning of period
            
            
            62
            
            
            600
            
            
            703CASH,
                end of period
            
            $
            108
            
            $
            62
            
            $
            600Supplemental
                disclosure of cash flow information:Cash
                paid during the period for interest, net of amounts
                capitalized
            
            $
            19,472
            
            $
            22,754
            
            $
            26,481Cash
                paid for income taxes
            
            $
            953
            
            $
            24
            
            $
            33


The
      accompanying notes are an integral part of these consolidated financial
      statements.


F-6


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





**1.**  **Description
      of Business and Summary of Significant Accounting
      Policies**





**Description
      of Business and Basis of Presentation**





Hines
      Horticulture, Inc. (“Hines” or the “Company”), a Delaware corporation, produces
      and distributes horticultural products through its wholly owned subsidiary,
      Hines Nurseries, Inc. (“Hines Nurseries”). Unless otherwise specified,
      references to “Hines” or the “Company” refer to Hines Horticulture, Inc. and its
      subsidiary.





Hines
      is
      a leading national supplier of ornamental shrubs, color plants and
      container-grown plants with commercial nursery facilities located in Arizona,
      California, Oregon, South Carolina and Texas. Hines markets its products to
      retail and commercial customers throughout the United States.





In
      addition, in August 2006, the Company decided to discontinue its nursery
      operations in the Northeast and Miami, Florida locations. The nursery facilities
      and/or assets in the Northeast and Miami, Florida have been sold or are in
      the
      process of being sold. Accordingly, the Company has reclassified its operations
      related to these facilities to “discontinued operations.”





**Significant
      Accounting Policies**





**Revenue
      Recognition**





Hines
      records revenue, net of sales discounts and allowances, when all of the
      following have occurred: an agreement of sale exists, product delivery and
      acceptance has occurred, the sales price is fixed or determinable, and
      collection is reasonably assured.





Sales
      with “pay by scan” arrangements are recognized when the products are sold by the
      retailers. Under this program, retailers do not take ownership of the inventory
      at their stores until the product is scanned at the check out register. Revenue
      is recognized at the point the retailer sells the Company’s product to its
      customer.





*Sales
      Returns and Allowances:* Amounts
      accrued for sales returns and allowance are maintained at a level believed
      adequate by management to absorb probable losses in the trade receivable due
      to
      sales returns and discounts and allowances. The provision rate is established
      by
      management using the following criteria: past sales returns experience, current
      economic conditions and other relevant factors, which are re-evaluated on a
      quarterly basis. The allowance is netted against sales. Allowances are provided
      at the time revenue is recognized in accordance with Statement of Financial
      Accounting Standards (“SFAS”) No. 48, “Revenue Recognition When Right of Return
      Exists.”




*Accounts
      Receivable and Allowance for Doubtful Accounts:* Trade
      accounts receivable are recorded at the invoiced amount and do not bear
      interest. The allowance for doubtful accounts is the Company’s best estimate of
      the amount of probable credit losses in the Company’s existing accounts
      receivable. The allowance for doubtful accounts is maintained at a level
      believed adequate by management to reflect the probable losses in the trade
      receivable due to customer default, insolvency or bankruptcy. The provision
      is
      established by management using the following criteria: customer credit history,
      historical write-offs, customer current credit rating and other relevant
      factors, and is re-evaluated on a quarterly basis. Past due balances over 90
      days and over a specified amount are reviewed individually for collectibility.
      The allowance is increased by provisions to bad debt expense and charged to
      general and administrative expenses.  All recoveries on trade receivables
      previously charged off are credited to bad debt expense, while direct
      charge-offs of trade receivables are deducted from the
      allowance.


F-7


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





Activity
      with respect to the Company's allowance for doubtful accounts is summarized
      as
      follows:





**Years
                Ended December 31,****2006**
            
            **2005**
            
            **2004**Beginning
                balance
            
            $
            325
            
            $
            456
            
            $
            601Adjustment
                to expense
            
            
            (130
            )
            
            112
            
            
            (88
            )Amounts
                written off
            
            
            (75
            )
            
            (243
            )
            
            (57
            )Ending
                balance
            
            $
            120
            
            $
            325
            
            $
            456


**Principles
        of Consolidation**
 
 The
        Consolidated Financial Statements include the accounts of Hines Horticulture,
        Inc. and its wholly owned subsidiary after elimination of intercompany
        accounts and transactions.


**Concentration
      of Credit Risk**





The
      Company is subject to credit risk primarily through its accounts receivable
      balances. The Company does not require collateral for its accounts receivable.
      The Company’s largest customer, The Home Depot, accounted for approximately 42%,
      44% and 39% of the Company’s consolidated net sales in 2006, 2005 and 2004,
      respectively. The Company’s second largest customer, Lowe’s Companies, Inc.,
      accounted for approximately 14%, 15% and 16% of its consolidated net sales
      in 2006, 2005 and 2004, respectively. The Company’s third largest customer,
      Wal-Mart Stores, Inc., accounted for approximately 12%, 10% and 11% of its
      consolidated net sales in 2006, 2005 and 2004, respectively. No other
      customer accounts for more than 10% of the Company's consolidated net sales.
      These three customers represented 39% and 51% of accounts receivable before
      the
      allowance for doubtful accounts at December 31, 2006 and 2005, respectively.
      No
      other customers represented more than 10% of the Company’s accounts
      receivable.





**Amortization
      of Deferred Financing Costs**





Deferred
      financing costs are being amortized using the effective interest method over
      the
      term of the associated financing agreements. As a result of the Company’s
      refinancing in 2003 of both the amended and restated Senior Credit Facility
      and
      Senior Notes, $11,110 was capitalized as deferred financing costs. In 2005,
      the Company wrote off $1,135 of deferred financing costs in connection with
      the
      pay-off of the Senior Credit Facility term loan and the reduction of the
      availability of the revolving facility from $145,000 to $120,000. In addition,
      the Company capitalized $215 of deferred financing costs in connection with
      the
      First Amendment to Credit Facility and Waiver Regarding Financial Covenants
      in
      2005. In 2006, the Company wrote off $613 of deferred financing expenses in
      connection with the reduction of the availability of the revolving facility
      from
      $120,000 to $100,000. In addition, the Company capitalized an additional $330
      of
      deferred financing expenses in connection with the Third Amendment and Limited
      Waiver to Credit Facility in 2006. Amortization expense was $1,177, $2,891
      and
      $1,784 for the years ended December 31, 2006, 2005 and 2004,
      respectively.





**Depreciation**





Fixed
      assets are stated at cost less accumulated depreciation. Interest is capitalized
      for qualifying constructed assets during the assets’ construction period. The
      Company capitalized $150, $120 and $36 of interest for the years ended December
      31, 2006, 2005 and 2004, respectively. Capitalized interest is recorded as
      a
      component of the asset to which it relates and is depreciated over the
      respective asset’s estimated useful life. Depreciation is provided for on the
      straight-line method over the following estimated economic useful lives:





Buildings
            10
                to 40 yearsLeasehold
                improvements
            Shorter
                of 20 years or term of leaseMachinery
                and equipment
            2
                to 10 yearsVehicles
                and trailers
            2
                to 10 yearsSoftware
            5
                to 10 yearsFurniture
                and fixtures
            3
                to 5 years




F-8


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





**Impairment
      of Long-Lived Assets**





In
      accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
      Long-Lived Assets,” long-lived assets and intangible assets with determinate
      lives are reviewed for impairment whenever events or changes in circumstances
      indicate that the carrying amount of an asset may not be recoverable. The
      Company evaluates potential impairment by comparing the carrying amount of
      the
      asset with the estimated undiscounted future cash flows associated with the
      use
      of the asset and its eventual disposition. Should the review indicate that
      the
      asset is not recoverable, the Company’s carrying value of the asset would be
      reduced to its estimated fair value, which is generally measured by future
      discounted cash flows. In 2006, the Company recorded total impairment charges
      of
      $26,098 in accordance with SFAS No. 144, of which $24,621 was related to
      discontinued operations. See Note 3 for additional details on these impairment
      charges. Due to lost market share at the Company’s Trenton, South Carolina
      facility, the Company determined that the expected undiscounted future cash
      flow at its South Carolina facility would not exceed the net book value of
      its
      fixed assets. As a result, the Company reduced the carrying value of the assets
      to fair value in the third quarter of 2006. The amount of the fixed asset
      impairment was $1,477.





**Accounting
      for Costs Associated with Exit or Disposal Activities**





In
      accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or
      Disposal Activities,” a liability for a cost associated with an exit or disposal
      activity is recognized and measured initially at its fair value in the period
      in
      which the liability is incurred. In conjunction with the divestiture of the
      Company’s Northeast facilities, the Company recorded a liability for lease
      termination costs of $2,300 in the fourth quarter of 2006 (the time the Company
      ceased use of the leased facility). This was recorded as a component of
      discontinued operations.





**Goodwill**





In
      accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill
      is not amortized, but instead is subject to an annual impairment review. Each
      of
      the Company’s locations represents a component of a single reporting unit as
      they each have similar economic characteristics, as defined in SFAS No. 142.
      As
      the Company's operations are comprised of one reporting unit, the Company
      reviews the recoverability of its goodwill by comparing the Company's fair
      value
      to the book value of its equity. If the book value of the Company's equity
      exceeds the Company's fair value, the goodwill is written down to its implied
      fair value. The Company evaluates the carrying value of goodwill in the fourth
      quarter of each year and when events and circumstances indicate that the assets
      may be impaired. In connection with the Company’s decision to sell the four
      Northeast facilities and the Miami, Florida assets, the Company allocated $5,108
      of goodwill to these facilities and assets. This allocation was based on the
      relative fair values of the four Northeast facilities and the Miami, Florida
      assets obtained from appraisals of the Company’s assets performed by independent
      third party appraisers.  Prior to
      the allocation, the Company reported total goodwill of $43,926, which was
      initially recorded based on purchase price allocations from various acquisitions
      made by the Company. Subsequent to the allocation of the goodwill to the
      operations to be disposed of, the Company concluded that the carrying value
      of
      the goodwill allocated to the four Northeast color facilities and the Miami,
      Florida assets was impaired. As a result, the Company recorded a goodwill
      impairment charge of $5,108. The goodwill impairment charge was recorded as
      a
      component of the loss from discontinued operations in the third quarter of
      2006.
      At December 31, 2006, the Company determined the remaining goodwill of $38,818
      was not impaired.




**Asset
      Retirement Obligations**





The
      Company’s asset retirement obligations (“AROs”) are equal to the present value
      of estimated future costs associated with reclamation costs and other legal
      obligations associated with exiting facilities. Included in this liability
      are
      the costs of reservoir and basin removal, soil remediation, fuel tank and
      irrigation pipe removal and removal of existing structures. The current
      portion of $145 and $159 was recorded in accrued liabilities as of
      December 31, 2006 and 2005, respectively. The long term portion of $644 and
      $360 has been recorded in other liabilities as of December 31, 2006 and 2005,
      respectively.  Any costs incurred prior to exiting a facility reduce the
      current portion of the ARO.


F-9


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





**Environmental
      Remediation Costs**





The
      Company recognizes environmental remediation liabilities on a site by site
      basis
      when a loss is probable and can be reasonably estimated. Expenditures that
      extend the life of the related property or mitigate or prevent future
      environmental contamination are capitalized. Environmental remediation
      liabilities are not discounted or reduced for possible recoveries from insurance
      carriers.





**Internal
      Use Software**





The
      Company capitalizes costs of materials, consultants, interest and payroll and
      payroll-related costs for employees incurred in developing internal-use computer
      software in accordance with Statement of Position 98-1, “Accounting for the
      Costs of Computer Software Developed or Obtained for Internal Use.” Computer
      software costs are being amortized using the straight-line method over an
      estimated useful life of 5 to 10 years.





**Inventories**





The
      Company determines the cost of inventory of nursery stock by accumulating costs
      associated with getting the plants ready for sale.  These costs include
      direct labor, overhead, materials (soil, water, containers, stakes, chemicals)
      and normal scrap.   Abnormal scrap is charged to cost of goods sold
      when incurred. Scrap occurs at both the Company’s nursery facilities and, in
      some cases, at the retailer, if the scrap relates to unsold consigned inventory
      associated with the Pay by Scan program.  Abnormal scrap includes scrap
      incurred outside of historically determined statistical levels. Abnormal scrap
      in many cases is caused by natural causes such as hurricanes or extreme
      freezes.  In addition, abnormal scrap also occurs when the Company
      determines it has excess or obsolete inventories, which can occur as a result
      of
      adverse changes in the market or incorrect forecasting of customer demand. 
Costs are accumulated until the time of harvest, which for the Company means
      that they are ready for sale.  The Company allocates costs to individual
      plants in inventory using a methodology designed to estimate the relative value
      of the plants using factors such as plant size and growing cycle. The Company
      carries its inventory at the lower of cost or current replacement cost. The
      Company generally determines current replacement cost on a site by site basis.
      Nursery stock also includes plants that are not yet ready for sale.  The
      Company's ornamental nursery stock has an average growing period of
      approximately eighteen months. All nursery stock is classified as a current
      asset based on the Company’s normal operating cycle.  Materials and
      supplies not yet used in the production process are stated at the lower of
      cost
      (first-in, first-out) or market.




**Income
      Taxes**





The
      Company’s operations are agricultural in nature and the Company derives
      significant benefits by qualifying to use the cash method of accounting for
      federal and state income tax purposes. The Company records income taxes under
      the asset and liability method, whereby deferred tax assets and liabilities
      are
      recognized for the future tax consequences attributable to differences between
      the financial statement carrying amounts of existing assets and liabilities
      and
      their respective tax bases, and for operating loss and tax credit carryforwards.
      Deferred tax assets and liabilities are measured using enacted tax rates
      expected to apply in the years in which those temporary differences are expected
      to be recovered or settled. The effect on deferred tax assets and liabilities
      of
      a change in tax rates is recognized in income in the period that includes the
      enactment date. Management evaluates the need to establish a valuation allowance
      for deferred tax assets based upon the amount of existing temporary differences,
      the period in which they are expected to be recovered and expected levels of
      taxable income. A valuation allowance to reduce deferred tax assets is
      established when it is “more likely than not” that some or all of the deferred
      tax assets will not be realized.





The
      Company accrues a liability for tax exposure items relating to matters where
      the
      Company does not believe it is probable that the tax position will be
      sustained.  New laws and new interpretations of laws and rulings by tax
      authorities may affect the liability for potential tax assessments. Due to
      the
      subjectivity and complex nature of the underlying issues, actual payments or
      assessments may differ from estimates. To the extent the Company’s estimates
      differ from actual payments or assessments, income tax expense is
      adjusted.


F-10


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





**Advertising**





The
      Company expenses advertising costs at the time the advertising first takes
      place. Advertising expense was $852, $1,125 and $758 in 2006, 2005 and
      2004, respectively.





**Accrued
      Liabilities**





Accrued
      liabilities include amounts accrued for expected claims costs relating to the
      Company’s insurance programs for workers’ compensation and auto liabilities. The
      Company has large deductibles for these lines of insurance, which means the
      Company must pay the portion of each claim that falls below the deductible
      amount. Expected claims costs are based on an actuarial analysis that considers
      the Company’s current payroll and automobile profile, recent claims history,
      insurance industry loss development factors and the deductible amounts. Expected
      claims costs for each year are accrued on a ratable monthly basis with a
      corresponding charge against income. The adequacy of the accruals is reviewed
      at
      the end of each quarter. The accruals for the expected costs relating to the
      insurance programs for workers’ compensation and auto liabilities are maintained
      at levels believed by the Company’s management to adequately reflect its claims
      obligations. In addition, the Company has accrued additional amounts for claims
      that are expected to settle for more than the deductible amounts. These
      additional amounts are recorded in other liabilities and are offset by an equal
      amount in other assets in the accompanying consolidated balance sheets, as
      these
      potential additional losses are fully insured.





**Operating
      Leases**





The
      Company leases certain land, office, trucks, warehouse facilities and
      machinery and equipment under various renewable long-term operating leases,
      which expire through 2013. All of the leases the Company enters into are
      accounted for in accordance with SFAS No. 13, “Accounting for Leases.” Certain
      of these leases include escalation clauses based upon changes in the consumer
      price index and/or the fair rental value of leased land and are accounted for
      on
      a straight-line basis over the term of the lease. Contingent rentals are not
      considered minimum lease payments and are included in rent expense as they
      are
      incurred. Rent concessions or lessor provided incentives are included in the
      minimum lease payments as an offset to rent expense. For contingent rentals,
      such concessions or incentives are recorded as an offset to rent expense as
      incurred.





**Comprehensive
      Income**





Comprehensive
      income encompasses all changes in equity other than those arising from
      transactions with shareholders, and consists of net income and prior to 2005,
      unrealized net gains and losses on cash flow hedges. There are no items in
      accumulated other comprehensive income at December 31, 2006 and
      2005.





**Use
      of Estimates**





The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      the financial statements and the reported amounts of revenues and expenses
      during the reporting period. Actual results could differ from those estimates.





**Earnings
      Per Share (“EPS”)**





Earnings
      per share are calculated in accordance with SFAS No. 128, “Earnings per Share,”
which requires the Company to report both basic earnings per share, based on
      the
      weighted-average number of common shares outstanding, and diluted earnings
      per
      share, based on the weighted-average number of common shares outstanding
      adjusted to include the potentially dilutive effect of outstanding stock options
      and warrants. For the year ended December 31, 2006, no warrants were outstanding
      that would have an effect on diluted earnings per share. On December 31, 2005,
      440,000 warrants outstanding had expired and therefore had no effect on the
      Company’s diluted earnings per share for the year ended December 31, 2005. For
      the year ended December 31, 2004, the incremental shares related to 440,000
      warrants outstanding increased fully diluted shares by 48,633. Additionally,
      for
      the years ended December 31, 2006, 2005 and 2004, shares related to employee
      stock options in the amount of 0.8 million, 0.9 million and 1.1 million,
      respectively, were excluded from the computation of diluted earnings per share
      because they would have been anti-dilutive.


F-11


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





**Shipping
      and Handling Fees and Costs**





Amounts
      billed to a customer in a sale transaction related to shipping and handling
      are
      classified as revenue. Shipping and handling fees included as revenue totaled
      $30,179, $31,927 and $28,888 for the years ended December 31, 2006, 2005 and
      2004, respectively. Total shipping and handling costs included in distribution
      expenses were $48,795, $49,034 and $46,414 for the years ended December 31,
      2006, 2005 and 2004, respectively.





**Derivatives**





Derivative
      instruments are accounted in accordance with SFAS No. 133, “Accounting for
      Derivative Instruments and Hedging Activities,” as amended. The Company’s only
      derivative instrument was an interest rate swap agreement that did not qualify
      for hedge accounting treatment under SFAS No. 133 and therefore was marked
      to
      market (see Note 8). The interest rate swap agreement matured in February
      2005.




**Accounting
      Pronouncements Adopted**





The
      Company has adopted SFAS No. 123(R), “Share-Based Payment,” which established
      standards for transactions in which an entity exchanges its equity instruments
      for goods or services. This standard requires a public entity to measure the
      cost of employee services received in exchange for an award of equity
      instruments based on the grant-date fair value of the award. This eliminates
      the
      exception to account for such awards using the intrinsic method previously
      allowable under Accounting Principles Board (APB) Opinion No. 25. In March
      2005,
      the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin
      (SAB) 107, “Share-Based Payment,” which expressed views of the SEC Staff about
      the application of SFAS No. 123(R). SFAS No. 123(R) was to be effective for
      interim or annual reporting periods beginning on or after June 15, 2005, but
      in
      April 2005 the SEC issued a rule that SFAS No. 123(R) will be effective for
      annual reporting periods beginning on or after June 15, 2005. The Company
      adopted SFAS No. 123(R) on January 1, 2006 under the modified prospective
      transition method. The adoption of this standard did not have an impact on
      the
      Company’s consolidated financial position, results of operations and cash flows
      because all of the Company’s outstanding options were fully vested as of
      December 31, 2005.





In
      December 2004, the FASB issued SFAS No. 153, “Exchanges of Non Monetary Assets -
      an amendment of APB Opinion No. 29,” which requires non monetary asset exchanges
      to be accounted for at fair value. The Company adopted the provisions of SFAS
      No. 153 for non monetary exchanges occurring in fiscal periods beginning after
      June 15, 2005. The adoption of this standard did not have an impact on the
      Company’s consolidated financial position, results of operations and cash
      flows.





In
      May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error
      Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3.”
SFAS No. 154 changes the requirements for the accounting for and reporting
      of a change in an accounting principle. This standard applies to all voluntary
      changes in an accounting principle. It also applies to changes required by
      an
      accounting pronouncement if that pronouncement does not include
      specific transition provisions. When a pronouncement includes specific
      transition provisions, those provisions should be followed. APB Opinion No.
      20
      previously required that most voluntary changes in an accounting principle
      be
      recognized by including in net income of the period of the change the cumulative
      effect of changing to the new accounting principle. SFAS No. 154 requires
      retrospective application to prior periods’ financial statements of changes in
      an accounting principle. SFAS No. 154 is effective for accounting changes
      and corrections of errors made in fiscal years beginning after December 15,
      2005. The adoption of this standard did not have an impact on the Company’s
      consolidated financial position, results of operations and cash
      flows.





In
      September 2006, the Securities and Exchange Commission (the “SEC”) issued
      Staff Accounting Bulletin (“SAB”) 108, “Considering the Effects of Prior Year
      Misstatements when Quantifying Misstatements in Current Year Financial
      Statements.” SAB 108 provides guidance on the consideration of the effects of
      prior year misstatements in quantifying current year misstatements for the
      purpose of determining whether the current year’s financial statements are
      materially misstated. SAB 108 is effective for fiscal years ending after
      November 15, 2006. The adoption of SAB 108 did not have a material impact
      on the Company’s consolidated financial position, results of operations or cash
      flows.


F-12


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





**Recent
      Accounting Pronouncements**





In
      June 2006, the FASB ratified Emerging Issues Task Force Issue
      No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental
      Authorities Should Be Presented in the Income Statement (That is, Gross versus
      Net Presentation).” The scope of EITF 06-3 includes any tax assessed by a
      governmental authority that is directly imposed on a revenue-producing
      transaction between a seller and a customer. This issue provides that a company
      may adopt a policy of presenting taxes either gross within revenue or net.
      If
      taxes subject to this issue are significant, a company is required to disclose
      its accounting policy for presenting taxes and the amount of such taxes that
      are
      recognized on a gross basis. The Company does not believe that the adoption
      of
      EITF 06-3 which will be effective for fiscal periods beginning after December
      15, 2006 will have a material impact on its consolidated financial position,
      results of operations or cash flows.





In
      June
      2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes - an
      interpretation of FASB Statement No. 109.” FIN 48 clarifies the accounting for
      uncertainty in income taxes recognized in an enterprise’s financial statements
      in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 is
      effective for all uncertainty in income taxes recognized in the financial
      statements in fiscal years beginning after December 15, 2006. The
      Company does not believe the adoption of FIN 48 will have a material impact
      on its consolidated financial position, results of operations or cash
      flows.




In
      September 2006, the FASB issued SFAS No. 157, “Fair Value
      Measurements.” This standard defines fair value, establishes a framework for
      measuring fair value in accounting principles generally accepted in the United
      States of America, and expands disclosure about fair value measurements. This
      pronouncement applies to other accounting standards that require or permit
      fair
      value measurements. Accordingly, this statement does not require any new fair
      value measurement. This statement is effective for fiscal years beginning after
      November 15, 2007, and interim periods within those fiscal years. The
      Company is currently evaluating the requirements of SFAS No. 157 and the impact
      that the adoption of this statement will have on its consolidated financial
      statements.





**Reclassifications**





Certain
      prior year and prior period amounts have been reclassified to conform to current
      year presentations. These reclassifications include discontinued operations
      associated with the Company’s Miami, Florida and four Northeast facilities as
      described in Note 3.





**2.**  **Restatement
      of Consolidated Financial Statements**





In
      connection with the preparation of the Company’s consolidated financial
      statements for the year ended December 31, 2006, the Company identified
      errors which affected the full year and each of the quarters of 2004 and
      2005 and the first, second and third quarters of 2006, as discussed
      below.





The
      Company is restating herein the following consolidated financial
      statements:


·
            the
                Company’s consolidated balance sheet as of December 31, 2005;
                and


·
            the
                Company’s consolidated statements of operations, shareholders’ equity and
                cash flows for the years ended December 31, 2004 and
                2005.







F-13


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





**Inventory
        Costs**
 The
          Company determined that certain materials and supplies were incorrectly
          capitalized as a component of nursery stock after the related inventory
          was
          sold, thereby misstating inventory and costs of goods sold for 2004 and
          2005.
          These materials and supplies should have been relieved to cost of goods
          sold as
          the related inventory was sold. The correction to reduce inventory balances
          resulted in lower cost of goods sold in subsequent periods as the nursery
          stock
          was sold.
  The
          effect in the consolidated balance sheet as of December 31, 2004 was a
          decrease
          in inventory of approximately $5,100. The effect of the correction of this
          error
          in the consolidated statement of operations for the year ended December
          31, 2004
          was an increase in cost of goods sold of approximately $5,100. In addition,
          in
          2004, the Company corrected a misclassification of distribution costs resulting
          in an increase in distribution costs of $2,400 and a corresponding decrease
          in
          cost of goods sold.
  The
          effect in the consolidated balance sheet as of December 31, 2005 was a
          decrease
          in inventory of approximately $4,200. The net effect of the correction
          of this
          error in the consolidated statement of operations for the year ended December
          31, 2005 was a decrease in cost of goods sold of approximately $900.
 **Sale
          of Property in Miami**
 The
          Company sold its property located at its Miami, Florida facility in November
          2005.  The Company did not correctly record this transaction in accordance
          with SFAS No. 98, “Accounting for Leases,” as a financing transaction.  The
          effect of the correction of this error in the December 31, 2005 consolidated
          balance sheet was the recognition of a financing obligation of $47,040,
          reinstatement of the carrying value of the property sold of $7,160,
          reclassification of deferred tax assets of $15,750 from non-current to
          current
          and a decrease in deferred gain on land sale of $39,880.  The effect of the
          correction of this error had no impact in the consolidated statement of
          operations for the years ended December 31, 2006 and 2005.




F-14


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





**Workers’
      Compensation and Auto Insurance Accruals**


In
      connection with the preparation of the Company’s 2006 consolidated financial
      statements, an error was discovered in the calculation of the workers’
compensation insurance and auto insurance liabilities. This error affected
      the
      consolidated financial statements for the year ended December 31, 2005 and
      the
      interim periods contained therein and also the first three quarters of 2006.




The
      effect of the correction of this error on the consolidated statement of
      operations for the year ended December 31, 2005 was a decrease in  cost of
      goods sold of $38 and a decrease in distribution expense of $48. Loss
      from discontinued operations for the year ended December 31, 2005 was reduced
      by
      $108. The effect of the correction of this error on the consolidated
      balance sheet as of December 31, 2005 was a decrease in inventory of $143 and
      a
      decrease in liabilities of $337.





**Asset
      Retirement Obligations Adjustment**


In
        connection with the preparation of the Company’s 2006 consolidated financial
        statements, it was discovered that the Company had not recorded an asset
        retirement obligation or appropriately applied the transition rule of
 SFAS No. 143, “Accounting for Asset Retirement
        Obligations,” for certain assets located at its Irvine,
        California facility. To correct this error in accordance with SFAS No. 143,
        the
        Company recorded a cumulative-effect adjustment to retained earnings in the
        amount of $318 as of January 1, 2003. In applying the transition provisions
        of SFAS No. 143, there was no impact to the consolidated statements of
        operations or cash flows for the year ended December 31, 2003 or
        prior.


The
      effect of the correction of this error on the consolidated balance sheet as
      of December 31, 2005 was an increase in net fixed assets of
      $60, an increase in liabilities of $359 and an increase in
      inventory of $4.  The effect of the correction of this error on
      the consolidated statement of operations for the year ended December 31, 2005
      was a decrease in cost of goods sold of $59.




The
        effect of the correction of this error on the consolidated statement of
        operations for the year ended December 31, 2004 was an increase in cost of
        goods sold of $36.





F-15


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





The
      tables set forth below summarizes the impact of the adjustments described above
      on the individual line items on the Company’s consolidated financial statements
      for the affected periods as well as the impact of the discontinued operations
      discussed in Note 3 on those line items.




**2005**
            
            **2004***As
                Originally Reported*
            
            *As
                Restated for Correction of Errors*
            
            *As
                Restated for Correction of Errors and Discontinued
                Operations*
            
            *As
                Originally Reported*
            
            *As
                Restated for Correction of Errors*
            
            *As
                Restated for Correction of Errors and Discontinued
                Operations***Statements
                of Operations:**Cost
                of goods sold
            
            $
            174,580
            
            $
            173,451
            
            $
            121,007
            
            $
            170,694
            
            $
            173,444
            
            $
            121,823Gross
                profit
            
            
            153,333
            
            
            154,462
            
            
            124,319
            
            
            164,474
            
            
            161,724
            
            
            122,145Distribution
                expenses (a)
            
            
            75,900
            
            
            75,844
            
            
            52,970
            
            
            69,702
            
            
            72,090
            
            
            50,001Total
                operating expenses
            
            
            132,599
            
            
            132,543
            
            
            101,564
            
            
            125,928
            
            
            128,316
            
            
            97,745Operating
                income
            
            
            20,734
            
            
            21,919
            
            
            22,755
            
            
            38,546
            
            
            33,408
            
            
            24,400(Loss)
                income from continuing operations before income taxes
            
            
            (4,081
            )
            
            (2,896
            )
            
            (2,038
            )
            
            14,036
            
            
            8,898
            
            
            (98
            )Income
                tax (benefit) provision
            
            
            (1,523
            )
            
            (1,073
            )
            
            (742
            )
            
            5,800
            
            
            3,773
            
            
            210(Loss)
                income from continuing operations
            
            
            (2,558
            )
            
            (1,823
            )
            
            (1,296
            )
            
            8,236
            
            
            5,125
            
            
            (308
            )Net
                (loss) income
            
            
            (2,558
            )
            
            (1,823
            )
            
            (1,823
            )
            
            8,236
            
            
            5,125
            
            
            5,125Basic
                and diluted (loss) earnings per share:(Loss)
                income from continuing operations
            
            $
            (0.12
            )
            $
            (0.08
            )
            $
            (0.06
            )
            $
            0.37
            
            $
            0.23
            
            $
            (0.01
            )Net
                (loss) income per common share
            
            
            (0.12
            )
            
            (0.08
            )
            
            (0.08
            )
            
            0.37
            
            
            0.23
            
            
            0.23**Statements
                of Cash Flows:**Net
                (loss) income
            
            $
            (2,558
            )
            $
            (1,823
            )
            $
            (1,823
            )
            $
            8,236
            
            $
            5,125
            
            $
            5,125Depreciation
                (b)
            
            
            11,333
            
            
            11,538
            
            
            7,884
            
            
            10,559
            
            
            10,582
            
            
            7,133Accretion
                on asset retirement obligations (b)
            
            
            51
            
            
            44
            
            
            44
            
            
            122
            
            
            52
            
            
            52Deferred
                income taxes
            
            
            (2,589
            )
            
            (1,073
            )
            
            (742
            )
            
            5,739
            
            
            3,773
            
            
            210Inventories
            
            
            (3,880
            )
            
            (5,007
            )
            
            (5,158
            )
            
            (8,318
            )
            
            (3,123
            )
            
            (3,866
            )Accounts
                payable and accrued liabilities
            
            
            (1,008
            )
            
            (2,287
            )
            
            (2,287
            )
            
            1,387
            
            
            1,317
            
            
            1,317Net
                cash provided by operating activities
            
            
            7,074
            
            
            7,117
            
            
            7,117
            
            
            19,012
            
            
            19,012
            
            
            19,012Purchase
                of fixed assets
            
            
            (10,258
            )
            
            (10,305
            )
            
            (9,832
            )
            
            (5,869
            )
            
            (5,869
            )
            
            (5,588
            )Proceeds
                from sale of land
            
            
            47,854
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Net
                cash provided by (used in) investing activities
            
            
            40,423
            
            
            (7,474
            )
            
            (7,474
            )
            
            (6,541
            )
            
            (6,541
            )
            
            (6,541
            )Proceeds
              from
              financing obligation
            
            
            -
            
            
            47,854
            
            
            -
            
            
            -
            
            
            -
            
            
            -Net
              cash provided by discontinued operations
            
            
            -
            
            
            -
            
            
            47,854
            
            
            -
            
            
            -
            
            
            -Net
                cash used in financing activities
            
            
            (48,035
            )
            
            (181
            )
            
            (181
            )
            
            (12,574
            )
            
            (12,574
            )
            
            (12,574
            )


(a)
        This
        line item originally reported combined with selling expenses
 (b)
          These
          line items originally reported combined under depreciation, depletion and
          amortization




F-16


**HINES
        HORTICULTURE, INC.**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **(Dollars
        in thousands, except share data)**


**2005***As
                Originally Reported*
            
            
            *As
                Restated for Correction of Errors*
            
            
            *As
                Restated for Correction of Errors and Discontinued
                Operations***Balance
                Sheets****:**Inventories
            
            $
            183,281
            
            $
            178,975
            
            $
            159,733Total
                current assets
            
            
            204,287
            
            
            199,981
            
            
            251,434Fixed
                assets, net
            
            
            122,234
            
            
            129,454
            
            
            82,851Deferred
                income taxes, non-current
            
            
            11,481
            
            
            -
            
            
            6,676Total
                assets
            
            
            388,135
            
            
            379,568
            
            
            391,094Accrued
                liabilities
            
            
            11,474
            
            
            8,591
            
            
            8,591Deferred
                income taxes, current
            
            
            66,127
            
            
            48,868
            
            
            56,542Total
                current liabilities
            
            
            109,469
            
            
            89,327
            
            
            105,080Deferred
                gain on land sale
            
            
            39,880
            
            
            -
            
            
            -Financing
                obligation
            
            
            -
            
            
            47,040
            
            
            47,040Deferred
              income
              taxes, non-current
            
            
            -
            
            
            4,227
            
            
            -Other
                liabilities
            
            
            5,378
            
            
            8,260
            
            
            8,260Accumulated
              deficit
            
            
            (70,594
            )
            
            (73,288
            )
            
            (73,288
            )Total
                shareholders' equity
            
            
            58,408
            
            
            55,714
            
            
            55,714Total
                liabilities and shareholders' equity
            
            
            388,135
            
            
            379,568
            
            
            391,094


F-17


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





**3.**  **** **Discontinued
      Operations**





**Hines
      Fertilizer Sale**





On
      July
      25, 2005, Hines Fertilizer and Hines Nurseries entered into an asset purchase
      agreement with a third party vendor to sell substantially all of the assets
      of Hines Fertilizer, excluding cash, accounts receivables and intercompany
      receivables. The purchase price for the assets was approximately $600 and was
      paid through the issuance of customer credits for past purchases. The gain
      on
      sale of assets was approximately $100. In accordance with the asset purchase
      agreement, the Company entered into a three year non-compete agreement, which
      restricts the Company’s ability to own and manage a competing fertilizer company
      and restricts the Company’s Miami production facility’s ability to co-brand and
      market with competing fertilizer companies, unless directly requested by the
      Company’s customers. Upon a change in control of Hines Horticulture or Hines
      Nurseries, all non-compete restrictions shall cease and no longer be of any
      effect.





**Miami
      Property Sales**





On
      November 7, 2005, the Company successfully completed the sale of 122 acres
      of
      unimproved property in Miami, Florida (“Miami Property Sale”) and received net
      proceeds of approximately $47,000. In accordance with an amendment to the
      existing senior credit facility, the proceeds from the Miami Property Sale
      were
      used to pay off the entire outstanding balance of the term loan, with the
      residual amount was used to pay down the revolving credit facility. As
      part of the Miami Property Sale, the Company entered into a two-year lease
      agreement with the buyer while transitioning operations to other locations.
      The
      Company leased the entire property for a one-year period, with a thirty-day
      extension right, and then vacated approximately 33 acres. The Company is
      leasing the remaining 89 acres until June 30, 2007, and is subleasing the
      property for the remainder of the lease term. The Company pays the buyer rent
      of
      five hundred dollars per acre annually during the lease term plus fifty percent
      of the rent the Company receives from subleasing the property. In addition,
      the
      Company is entitled to additional amounts if the buyer is successful in
      obtaining zoning for a certain number of residential lots. The Company
      originally recognized the sale of the property and deferred the gain on the
      transaction; however, as described in Note 2, due to continuing involvement
      in
      the property and in accordance with SFAS No. 98, the Company has reinstated
      the net book value of the assets, as well as recorded the proceeds received
      as a
      financing obligation as of December 31, 2005. The impact of this correction
      is discussed in Note 2. When the Company exits the lease on June 30, 2007,
      the
      Company will remove the net book value of the assets and expects to
      recognize a gain of $39,880.




In
      August
      2006, the Company made the decision to pursue the sale of the remainder of
      the
      Miami assets and cease operations at this facility as follows:




1)  
      On October 2, 2006, the Company entered into asset purchase agreements and
      sold
      certain inventory, vehicles, equipment and other assets located at its Miami,
      Florida facility. Total proceeds from the sale of these assets were
      approximately $4,100, of which approximately $1,800 was used by the Company
      to terminate outstanding related lease obligations. In connection with the
      sale, the Company ceased active operations at its Miami, Florida
      facilities.




2)  
      On October 30, 2006, the Company entered into a commercial contract to sell
      one
      of its two remaining real properties located in Miami, Florida. The sale of
      approximately 138 acres of land in Miami-Dade County, Florida and certain other
      assets closed on December 22, 2006. The sales price for the land and the other
      assets was approximately $12,200. The Company recorded a net gain of
      approximately $8,800 from the sale of the 138 acres of land, which was recorded
      as a component of discontinued operations.


F-18


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





3)  
      On April 18, 2007, the Company completed the sale of its last remaining parcel
      of land in Miami, Florida, which consisted of approximately 79 acres of land
      and
      certain improvements thereon, for approximately $7,200. The Company will record
      a net gain of approximately $2,500 from the sale, which will be recorded as
      a
      component of discontinued operations in 2007.




**Northeast
      Facilities**





In
      August
      2006, the Company made a decision to pursue the sale of its four Northeast
      nursery operations. These operations consist of the Company’s facilities in
      Danville and Pipersville, Pennsylvania and Newark and Utica, New York.




On
        November 15, 2006, the Company entered into an asset purchase agreement and
        sold
        certain real property, inventory and other assets located at its nursery
        facility in Pipersville, Pennsylvania, including the right to purchase real
        property which was previously leased by the Company. The sales price was
        approximately $5,300, approximately $1,100 of which was deferred as it is
        contingent upon certain entitlements for the construction of additional
        greenhouses on certain real property which was previously leased by the Company.
        The sale of these assets and real property resulted in a loss of approximately
        $1,200, which has been recorded as a component of discontinued
        operations.
 
 On
        January 10, 2007, the Company completed the sale of certain real property,
        inventory and other assets located at the nursery facilities in Danville,
        Pennsylvania, Utica, New York and Newark, New York for approximately $6,700.
        In
        connection with the sale, the Company terminated the leases for the real
        property comprising its Danville, Pennsylvania nursery facility.
  **Impairment
        Charges at Miami and Northeast
        Facilities**





In
      reviewing the Company's long-lived assets for impairment in accordance
      with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived
      Assets,” the Company determined in the second quarter of 2006 that its four
      nursery facilities located in the Northeast were impaired because the carrying
      values of the long-lived assets exceeded the estimated undiscounted future
      cash
      flows of the assets. The Company estimated fair value based on appropriate
      valuation methodologies, which resulted in an impairment charge of
      approximately $8,000. The charge was recorded by the Company in its consolidated
      statements of operations in the second quarter of 2006 as a component of
      discontinued operations.





In
      October 2006, two major customers withdrew substantial future sales
      commitments from three of the four Northeast facilities, which withdrawal
      occurred subsequent to the original announcement of the sale of the four
      Northeast facilities. The withdrawal represented a reduction of approximately
      75% of the 2007 annual sales commitments for the three facilities, greatly
      reducing the fair market value of these assets. As a result, it was determined
      that the long-lived assets associated with these facilities were impaired.
      The
      fair value used to determine the impairment was based on letters of
      intent the Company received in connection with the sale of the Company’s
      Northeast facilities. As a result, the Company recorded in the quarter
      ended September 30, 2006 an additional impairment charge of approximately
      $11,100 to reflect the revised estimate of the fair value of these assets.
      This
      impairment charge was recorded as a component of the loss from discontinued
      operations in the consolidated statements of operations in the third quarter
      of
      2006.




On
      November 8, 2006, the Company completed the
      evaluation of the fair value of its Miami, Florida assets, which were sold
      as
      described above. The evaluation was based on the expected sales price of the
      assets compared to the carrying value of the assets. As a result of the
      evaluation, the Company recorded an impairment charge of approximately $5,300
      to
      reflect the fair value of these assets, which was recorded in the consolidated
      statement of operations as a loss from discontinued operations in the third
      quarter of 2006.





In
      the
      fourth quarter of 2006, actual offers received on the Company’s Northeast
      facilities were less than the carrying values of the long-lived assets. As
      a
      result, the Company determined that an additional impairment charge of
      approximately $300 should be recorded to reflect the revised estimate of the
      fair value of these assets. This impairment charge was recorded as a component
      of the loss from discontinued operations in the consolidated statements of
      operations in the fourth quarter of 2006. In addition, in the fourth quarter
      of
      2006, the Company also recorded approximately $2,300 of exit and disposal
      activity costs in order to terminate certain leases. These lease termination
      costs were recorded as a component of the loss from discontinued operations
      in
      the consolidated statements of operations in the fourth quarter of
      2006.





F-19


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





The
      fixed
      assets, inventories and related liabilities of the remaining Northeast and
      Miami
      facilities are classified on the consolidated balance sheet as “assets, or
      liabilities related to assets, held for sale” as of December 31,
      2006.





Summarized
      financial information for discontinued operations is set forth
      below:





Years
                Ended December 31,2006
            
            2005
            
            2004Sales,
                net
            
            $
            53,625
            
            $
            82,587
            
            $
            91,200(Loss)
                income before income taxes
            
            
            (44,990
            )
            
            (858
            )
            
            8,996Income
                tax (benefit) provision
            
            
            (18,225
            )
            
            (331
            )
            
            3,563(Loss)
                income from discontinued operations
            
            $
            (26,765
            )
            $
            (527
            )
            $
            5,433





As
      of
      December 31, 2006 and 2005, the components of assets and liabilities of
      discontinued operations in the consolidated balance sheets under assets, or
      liabilities related for assets, held for sale were as follows:





December
                31,2006
            
            2005As
                RestatedInventories
            
            $
            1,193
            
            $
            20,454Fixed
                assets, net
            
            
            16,445
            
            
            46,603Deferred
                income taxes
            
            
            15,014
            
            
            4,850Assets
                held for sale
            
            $
            32,652
            
            $
            71,907Deferred
                income taxes
            
            $
            471
            
            $
            8,079Liabilities
                related to assets held for sale
            
            $
            471
            
            $
            8,079





The
        2005
        assets held for sale in the above table does not include $484 related to
        the
        Company's Vacaville, California facility because this facility is part of
        continuing operations as of December 31, 2005.


**4.**  **Dispositions
      and Impairments**





**Vacaville
      Property Sale**





On
        March
        1, 2006, the Company received notice that Triad Communities, L.P. exercised
        its
        option to purchase, pursuant to the previously disclosed Option Agreement
        dated
        April 30, 2003 (“Option Agreement”), its 168-acre property in Vacaville,
        California. The total book value of assets related to the sale was approximately
        $500. The Option Agreement provided that the gross purchase price of the
        property be $15,100. On April 3, 2006, the Company sold the property for
        a net
        purchase price of approximately $14,300. Total proceeds from the Option
        Agreement and sale of the property were approximately $16,900, which included
        approximately $2,600 in option payments previously received.
  Under
        the
        terms of the Option Agreement, the Company is able to transition off the
        property in three phases from 2006 to 2008. The first phase of transition
        was
        completed on July 1, 2006 and consisted of 24 acres. The second phase of
        transition will be July 1, 2007 and the third phase of the transition will
        be
        July 1, 2008, and will consist of approximately 88 acres and 56 acres,
        respectively. The Company is continuing to develop replacement acreage and
        infrastructure at its 842-acre Winters South facility in Northern California.
        Because the Company is not paying rent, the Company is in a sale-leaseback
        with
        continuing involvement position with respect to this property. The Company
        originally recognized the sale of the property and deferred the gain on the
        Lagoon Valley property. However, in order to conform to SFAS No. 98, as of
        June
        30, 2006, the Company has reinstated the net book value of the assets and
        recorded the proceeds received as a financing obligation. When the Company
        completes the transition on July 1, 2008, the Company will remove the net
        book
        value of the assets and expects to recognize a gain of approximately
        $16,200.


F-20


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





**Trenton
      South Carolina Facility**





As
      discussed in Note 2, due to lost market share at the Company’s Trenton, South
      Carolina facility, the Company determined that the expected
      undiscounted future cash flow at its South Carolina facility would not
      exceed the net book value of its fixed assets. As a result, the Company reduced
      the carrying value of the assets to fair value in the third fiscal quarter
      of
      2006. The amount of the fixed asset impairment was $1,477 and was recorded
      as a
      component of operating loss in the accompanying consolidated statement of
      operations.





**5.**  **Inventories**





Inventories
      consisted of the following:





December
                31,2006
            
            2005As
                RestatedNursery
                stock
            
            $
            138,376
            
            $
            151,992Material
                and supplies
            
            
            8,399
            
            
            7,741Inventories
            
            $
            146,775
            
            $
            159,733Consigned
                inventories
            
            $
            542
            
            $
            138








**6.**  **Fixed
      Assets**





Fixed
      assets consisted of the following:





December
                31,2006
            
            2005As
                RestatedLand
            
            $
            15,169
            
            $
            15,169Buildings
                and improvements
            
            
            74,428
            
            
            68,683Machinery
                and equipment
            
            
            28,967
            
            
            27,953Software
            
            
            21,049
            
            
            20,355Asset
                retirement obligations
            
            
            538
            
            
            247Construction
                in progress
            
            
            7,226
            
            
            3,512147,377
            
            
            135,919Less
                accumulated depreciation
            
            
            (61,907
            )
            
            (53,068
            )Fixed
                assets, net
            
            $
            85,470
            
            $
            82,851





Capitalized
      interest cost aggregated $150 in fiscal 2006 and $120 in fiscal
      2005.


F-21


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





**7.**  **Asset
      Retirement Obligations**





The
      changes in the carrying amount of the asset retirement obligations, as restated
      (see Note 2), during 2006 and 2005 were as follows:





2006
            
            2005As
                RestatedBeginning
                balance
            
            $
            519
            
            $
            523Accretion
                expense
            
            
            63
            
            
            44Cost
                of current year work performed
            
            
            (84
            )
            
            (48
            )Additions
                during the period
            
            
            291
            
            
            -Ending
                balance
            
            $
            789
            
            $
            519








**8.**  **Interest
      Rate Swap Agreement**





In
      May
      2000, the Company entered into an interest rate swap agreement to economically
      hedge $75,000 of debt. This interest rate swap agreement did not qualify for
      hedge accounting treatment under SFAS No. 133, “Accounting for Derivative
      Instruments and Hedging Activities,” as amended, and therefore was marked to
      market in earnings. The interest rate swap agreement effectively changed the
      Company's exposure on its variable-rate interest payments to fixed-rate interest
      payments (7.13%) based on the 3-month London Inter Bank Offering Rate (“LIBOR”)
      rate in effect at the beginning of each quarterly period. Despite the
      refinancing of long-term debt, the interest rate swap agreement remained
      outstanding and matured in February 2005.





Effective
      January 1, 2001, the Company adopted the provisions of SFAS No. 133, as amended.
      Adopting the provisions of SFAS No. 133 on January 1, 2001 resulted in a
      cumulative after-tax charge to accumulated other comprehensive income as of
      January 1, 2001 of $2,334, representing the fair value of the interest rate
      swap
      agreement, net of tax. This amount was being amortized as interest rate swap
      agreement expense over the term of the debt. For the years ended December 31,
      2005 and 2004, the Company recognized pre-tax income of $895 and $4,425,
      respectively, reported as interest rate swap agreement income in the
      accompanying consolidated statements of operations.





**9.**  **Credit
      Facility**





***(a)
      Old Credit Facility***





On
      September 30, 2003, the Company amended and restated its senior credit
      facility (“Old Senior Credit Facility”). Hines Nurseries and its domestic
      operating subsidiaries were borrowers under the Old Senior Credit Facility.
      The
      Old Senior Credit Facility originally consisted of a revolving facility with
      availability of up to $145,000 (subject to borrowing base limits), which was
      eventually reduced through amendments to the Old Senior Credit Facility to
      $100,000 (subject to borrowing base limits). The revolving facility also
      permitted the Company to obtain letters of credit up to a sub-limit.





The
      Old
      Senior Credit Facility required Hines Nurseries and its subsidiaries to meet
      specific covenants and financial ratios, including a minimum fixed charge
      coverage test, a maximum leverage test and a maximum capital expenditure test.
      The Old Senior Credit Facility contained customary representations and
      warranties and customary events of default and other covenants. As of December
      31, 2006, the Company was not in compliance with certain of its covenants;
      however, as discussed below, the non-compliance was cured with the Fourth
      Amendment and Limited Waiver.


F-22


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





In
      December 2006, Hines Nurseries negotiated and entered into the Fourth Amendment
      to the Old Senior Credit Facility to waive the minimum fixed charge coverage
      ratio covenant of the Old Senior Credit Facility for the fourth quarter of
      fiscal quarter 2006. The Fourth Amendment and Limited Waiver amended the date
      by
      which the Company was required to sell its four nursery facilities in the
      Northeast to January 31, 2007 and certain assets in Miami, Florida to March
      31,
      2007. On January 18, 2007, the Old Senior Credit Facility was terminated and
      replaced with a new credit facility as described below.





***(b)
      New Senior Credit Facility***





On
      January 18, 2007, Hines Nurseries entered into a Loan and Security Agreement
      (the “New Senior Credit Facility”) that expires in 2012. The New Senior Credit
      Facility consists of a $100,000 credit facility, which includes a $15,000 letter
      of credit subline. The New Senior Credit Facility was used to refinance the
      outstanding revolving loans under the Old Senior Credit Facility.





*Guarantees;
      Collateral* .
      The
      obligations under the New Senior Credit Facility are guaranteed by the Company.
      Borrowings under the New Senior Credit Facility are collateralized by
      substantially all of the Company’s and Hines Nurseries’ assets.





*Restrictions;
      Covenants; Defaults* .
      The New
      Senior Credit Facility includes customary events of default and other customary
      covenants, including, but not limited to, a fixed charge coverage ratio test,
      restrictions on certain types of activities, transactions and payments,
      including distributions and dividends from Hines Nurseries to Hines
      Horticulture, reporting covenants and others. The New Senior Credit Facility
      also includes standard provisions related to conditions of borrowing and
      customary representations and warranties. The lenders may terminate their
      obligation to make loans under the New Senior Credit Facility, and may
      accelerate payment of the indebtedness under the New Senior Credit Facility,
      upon the occurrence of an event of default, including the failure to comply
      with
      the covenants contained in the New Senior Credit Facility. Upon the occurrence
      and during the continuance of an event of default, the interest rate will
      increase by 2%.





*Limited
      Waiver to New Senior Credit Facility* .
      On
      April 30, 2007, Hines Nurseries obtained a waiver from the financial
      institutions pursuant to which the lenders waived certain defaults under the
      New
      Senior Credit Facility and extended the deadline for filing the financial
      statements for the fiscal year ended December 31, 2006 and for the fiscal
      quarter ended March 31, 2007 to May 28, 2007. On May 29, 2007,
      the Company obtained an additional waiver under the Loan Agreement to, among
      other things, extend the date of filing such financial statements from
      May 28, 2007 to June 28, 2007. On June 21, 2007, the Company obtained
      an additional waiver under the New Senior Credit Facility to extend the date
      of
      delivering its quarterly financial statements for the fiscal quarter ended
      March
      31, 2007 to July 20, 2007. OnJuly
      3,
      2007,
      we obtained a further waiver under the Loan Agreement, effective June 28, 2007,
      extending to July 13, 2007 the deadline for us to deliver our annual financial
      statements for the fiscal year ended December 31, 2006, and extending to July
      31, 2007 the deadline for us to deliver our quarterly financial statements
      for
      the fiscal quarter ended March 31, 2007.





*Interest
      Rate; Fees* .
      The
      interest rate on the loans under the New Senior Credit Facility may be, at
      the
      Company’s option, base rate loans or London Interbank Offering Rate (“LIBOR”)
      loans. Base rate loans under the New Senior Credit Facility bear interest at
      the
      lenders prime rate plus an additional amount that ranges from 0.50% to 1.25%,
      depending on the Company’s average availability of borrowing under the New
      Senior Credit Facility. Currently, the applicable margin for base rate loans
      is
      0.75%. LIBOR rate loans under the New Senior Credit Facility bear interest
      at
      the LIBOR rate plus an additional amount that ranges from 1.50% to 2.25%,
      depending on the Company’s average availability of borrowing under the New
      Senior Credit Facility. Currently, the applicable margin for LIBOR rate loans
      is
      1.75%.





In
      addition to paying interest on outstanding principal, the Company is required
      to
      pay a commitment fee on the daily average unused portion of the New Senior
      Credit Facility. Additionally, the Company is required to pay a fee for each
      letter of credit outstanding under the Loan Agreement equal to the applicable
      margin for LIBOR rate loans to be shared by the lenders and a fronting fee
      of
      0.125% to the individual issuer of a letter of credit.


F-23


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





*Availability;
      Borrowing Base.* Availability of borrowing under the New Senior Credit Facility is subject to
      a
      borrowing base consisting of the lesser of (i) the amount equal to the aggregate
      amount of the revolving loan commitment minus the aggregate amount of all
      letters of credit outstanding under the Loan Agreement and all fees or other
      amounts owing by the Company with respect thereto (less certain amounts) minus
      the amount of the availability block under the Loan Agreement, which is
      currently $15,000 but which shall be reduced to $0 at such time as the Company
      achieves a fixed charge coverage ratio of at least 1.1:1 for two consecutive
      fiscal quarters and (ii) the amount equal to 85% of eligible accounts receivable
      plus the lesser of (a) during the period commencing on December 31 of each
      calendar year and ending on April 30 each calendar year, the lesser of 65%
      of
      eligible inventory or 85% of the appraised net orderly liquidation value of
      eligible inventory or (b) during the period commencing on May 1 of each calendar
      year and ending on December 30 each calendar year, the lesser of 55% of eligible
      inventory or 85% of the appraised net orderly liquidation value of eligible
      inventory minus the sums of the reserves provided for in the Loan
      Agreement.





The
      Company must deliver borrowing base certificates and reports at least monthly.
      The borrowing base also may be subject to certain other adjustments and reserves
      to be determined by the agent. Eligible accounts receivable of both The Home
      Depot, the Company’s largest customer, and Lowe’s Companies, Inc., the Company’s
      second largest customer, may not exceed 30% of total eligible accounts
      receivable at any time.





*Maturity
      Date; Prepayments* .
      Amounts
      outstanding under the Loan Agreement mature on January 18, 2012 and the Company
      may prepay amounts outstanding under the Loan Agreement without fees or
      penalties, subject to the payment of costs associated with the prepayment of
      any
      LIBOR rate loans.





*Change
      of Control* .
      In the
      event of a change of control, the commitments of the lenders under the Loan
      Agreement may be cancelled and the Company may be required to immediately repay
      the outstanding amount of the Loan Agreement, together with accrued interest
      and
      all other amounts accrued under the Loan Agreement.





**10.**  **Long-term
      Debt**





December
                31,2006
            
            2005Senior
                Notes, interest at 10.25% payable semi-annually on April 1
              andOctober
                1, maturing on October 1, 2011.
            
            $
            175,000
            
            $
            175,000





***Senior
      Notes.*** On
      September 30, 2003, Hines Nurseries issued $175,000 of Senior Notes that mature
      on October 1, 2011. The Senior Notes bear interest at the rate of 10.25% per
      annum and are payable semi-annually in arrears on each April 1 and October
      1,
      which commenced on April 1, 2004.





*Guarantees.* Hines
      Horticulture and each of its domestic subsidiaries, subject to certain
      exceptions, has, jointly and severally, fully and unconditionally guaranteed,
      on
      a senior unsecured basis, the obligations of Hines Nurseries under the Senior
      Notes.





*Redemption.* Prior
      to
      October 1, 2006, up to 35% of the aggregate principal amount of the Senior
      Notes
      may be redeemed with the net cash proceeds from one or more public equity
      offerings, at the Company’s option, at a redemption price of 110.250% of the
      principal amount thereof plus accrued interest, if any, to the date of
      redemption. On or after October 1, 2007, the Company is entitled, at its option,
      to redeem all or a portion of the Senior Notes at redemption prices ranging
      from
      100.000% to 105.125%, depending on the redemption date plus accrued and unpaid
      interest.





*Restrictions.* The
      indenture pursuant to which the Senior Notes were issued imposes a number of
      restrictions on Hines Nurseries and its other subsidiaries. Subject to certain
      exceptions, the Company may not incur additional indebtedness, make certain
      restricted payments, make certain asset dispositions, incur additional liens
      or
      enter into significant transactions. A breach of a material term of the
      indenture or other material indebtedness that results in acceleration of the
      indebtedness under the Senior Notes also constitutes an event of default under
      its Senior Credit Facility.


F-24


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





*Repurchase
      on a change of control* .
      The
      Senior Notes contain a put option whereby the holders have the right to put
      the
      Senior Notes back to Hines at 101.000% of the principal amount thereof on the
      date of purchase plus accrued and unpaid interest upon a change of control
      of
      Hines. ****





**11.**  **Commitments
      and Contingencies**





*Operating
      Leases*





The
      Company leases certain land, office, trucks and warehouse facilities, and
      machinery and equipment under various renewable long-term operating leases,
      which expire through 2013. All of the leases the Company enters into are
      accounted for in accordance with SFAS No. 13, “Accounting for Leases.” Certain
      of these leases include escalation clauses based upon changes in the consumer
      price index and/or the fair rental value of leased land. The Irvine, California
      operating land lease requires the Company to pay rent equal to the greater
      of
      2.25 percent, increasing to 3 percent by the year 2010, of the sales derived
      from the related land, or a minimum per acre amount, as defined in the
      agreement. Total rent expense for these operating lease agreements for the
      years
      ended December 31, 2006, 2005 and 2004 was $6,409, $5,569 and $5,190,
      respectively.





The
      following are the Company's future minimum annual payments under its
      non-cancelable operating leases for each of the next five years ending December
      31 and thereafter:





ContinuingOperations2007
            
            $
            3,5652008
            
            
            2,6202009
            
            
            1,9972010
            
            
            1,7002011
            
            
            314Thereafter
            
            
            453$
            10,649





In
      May
      2003, the Company amended the lease for its Irvine, California nursery and
      headquarters. Under the amendment, the Company agreed to vacate 254 acres
      covered by the lease in 2006 in exchange for an extension of the term of the
      lease on 170 acres that was set to expire beginning in September 2003 to
      December 2010 and the lease of an additional 63 acres contiguous to its existing
      facility from July 2003 to December 2010. The landlord also agreed to assist
      with the costs of developing the new acreage and transition costs of up to
      $4,000, which included a cash payment of $2,000 which was included in the
      minimum lease payments, and rental credits of $2,000, which were used to offset
      contingent rent and were fully utilized in 2005. The rent credits were applied
      to the operating land lease as described above, which provides that the Company
      pay rent based on sales from the related land. On January 1, 2007, the Company
      negotiated and entered into another amendment of the lease to extend 50 acres
      of
      the 254 acres the Company was to vacate by 2006 to June 30, 2007.





*Legal
      Matters*





On
      July
      18, 2006, Mr. Jean-Paul filed an action against the Company and other defendants
      in the Eleventh Judicial Circuit, Dade County, Florida, alleging negligence
      in
      connection with an automobile accident involving one of the Company’s trailers
      and a third-party carrier.  On March 6, 2007, additional plaintiffs filed
      an action related to this incident in the same court, alleging negligence and
      vicarious liability for negligence against the Company and other
      defendants.  The first filed claim is scheduled for trial in August
      2007.  The Company is defended in these actions by its insurance carrier,
      and is fully insured with respect to this matter, beyond a deductible.  The
      Company has accrued an amount it believes represents the probable estimated
      claim at December 31, 2006. The Company has also recorded an asset at December
      31, 2006, for the probable full insurance recovery.


F-25


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





From
      time
      to time, the Company is involved in various disputes and litigation matters,
      which arise in the ordinary course of business. The litigation process is
      inherently uncertain and it is possible that the resolution of these disputes
      and lawsuits may adversely affect the Company. Management believes, however,
      that the ultimate resolution of such matters will not have a material adverse
      impact on the Company’s consolidated financial position, results of operations
      or cash flows.





**12.**  **Shareholders’
      Equity and Share-Based Payments**





On
      June
      22, 1998, the Board adopted the 1998 Long-Term Equity Incentive Plan (the "1998
      Stock Plan"). The 1998 Stock Plan provides for grants of stock options, stock
      appreciation rights, restricted stock, performance awards and any combination
      of
      the foregoing to certain directors, officers and employees of the Company and
      its subsidiary. The purpose of the 1998 Stock Plan is to provide such
      individuals with incentives to maximize shareholder value and otherwise
      contribute to the success of the Company and to enable the Company to attract,
      retain and reward the best available persons for positions of substantial
      responsibility.





On
      June
      1, 2000, the Board of Directors adopted and approved to increase the number
      of
      shares of common stock available for issuance under the 1998 Stock Plan by
      1.0
      million shares. At December 31, 2006, the Company had reserved 3.6 million
      shares of its common stock for issuance upon exercise of options granted or
      to
      be granted under this plan.





Effective
      the beginning of the first quarter of fiscal year 2006, the Company adopted
      the
      provisions of SFAS No. 123(R), “Share-Based Payment,” using the modified
      prospective transition method. Under this method, prior periods are not
      restated. The provisions of SFAS No. 123(R) apply to new stock options and
      stock
      options outstanding, but not yet vested, on the effective date. As of December
      31, 2005, all outstanding options were fully vested.





Prior
      to
      January 1, 2006, the Company measured stock compensation expense using the
      intrinsic value method of accounting in accordance with Accounting Principles
      Board (APB) Opinion No. 25, “Accounting for Stock Issued to
      Employees,” and related interpretations (APB No. 25). Thus, expense was
      generally not recognized for the Company’s employee stock option plans. Results
      for prior periods have not been restated.





The
      following table shows net income and EPS had the Company applied the fair value
      method of accounting for stock-based compensation in accordance with SFAS
      No. 123 during of the years ended 2005 and 2004.





Year
                Ended
            
            Year
                EndedDecember
                31, 2005
            
            December
                31, 2004Net
                (loss) income, as restated
            
            $
            (1,823
            )
            $
            5,125Stock-based
                compensation expense, net of tax
            
            
            (43
            )
            
            (252
            )Pro
                forma net (loss) income, as restated
            
            $
            (1,866
            )
            $
            4,873Net
                (loss) income per share:Basic
                and diluted - as restated
            
            $
            (0.08
            )
            $
            0.23Basic
                and diluted - pro forma, as restated
            
            $
            (0.08
            )
            $
            0.22





F-26


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





The
      weighted-average assumptions used in estimating the fair value of stock options
      granted in 2004, along with the weighted-average grant date fair values, were
      as
      follows:





2004Dividend
                yield
            0%Expected
                volatility
            83.86%Risk-free
                interest rate
            3.48%Expected
                term
            Four
                yearsForfeiture
                rate
            0%





Valuation
      Method - The Company estimates the fair value of stock options granted using
      the
      Black-Scholes option-pricing model and a single option award
      approach.





Expected
      Dividend - No dividends are expected to be paid.





Expected
      Volatility - The computation of expected volatility is based on the historical
      volatility.





Risk-Free
      Interest Rate - The risk-free interest rate used in the Black-Scholes valuation
      method is based on the implied yield currently available on U.S. Treasury
      securities with an equivalent remaining term.





Expected
      Term - The expected term represents the period the Company’s stock-based awards
      are expected to be outstanding and was determined based on historical experience
      with similar awards, giving consideration to the contractual terms of the
      stock-based awards, vesting schedules and expectations of future employee
      behavior as influenced by changes to the terms of its stock-based
      awards.





Forfeiture
      Rate - The forfeiture rate is an estimate of the percentage of granted stock
      options that will be cancelled prior to becoming vested.





There
      were no stock option grants during the years ended December 31, 2006 and
      2005.





A
      summary
      of the status of the Company’s stock option plan as of December 31, 2006, 2005
      and 2004 is provided in the table below:







2006
            
            2005
            
            2004Weighted
                Average
            
            
            
            Weighted
                Average
            
            
            
            Weighted
                AverageShares
            
            Exercise
                Price
            
            Shares
            
            Exercise
                Price
            
            Shares
            
            Exercise
                PriceOutstanding
                -- beginning of year
            
            
            869,110
            
            
            $   
                6.22
            
            
            1,067,923
            
            
            $   
                6.15
            
            
            989,723
            
            
            $   
                6.22Granted
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            100,000
            
            
            5.50Cancelled
            
            
            (40,696
            )
            
            6.72
            
            
            (198,813
            )
            
            5.82
            
            
            (21,800
            )
            
            6.00Outstanding
                - end of year
            
            
            828,414
            
            
            $   
                6.20
            
            
            869,110
            
            
            $   
                6.22
            
            
            1,067,923
            
            
            $   
                6.15Exercisable
            
            
            828,414
            
            
            $   
                6.20
            
            
            869,110
            
            
            $   
                6.22
            
            
            1,006,237
            
            
            $   
                6.20Weighted
                average fair valueof
                options granted during period
            
            
            
            
            
            -
            
            
            
            
            
            -
            
            
            
            
            
            $   
                5.18





The
      aggregate intrinsic value represents the difference between the exercise prices
      of the underlying awards and the quoted price of the Company’s common stock for
      those awards that have an exercise price below the quoted price on December
      31,
      2006. The Company had no options outstanding on December 31, 2006 with an
      exercise price below the quoted price of the Company’s common stock resulting in
      an aggregate intrinsic value of $0.


F-27


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





The
      weighted average remaining contractual life was five years at December 31,
      2006.
      As of December 31, 2006, expiration dates ranged from June 22, 2008 to February
      18, 2013.





2006
            
            2005**Outstanding
                and Exercisable**
            
            **Outstanding
                and Exercisable**Average
            
            Weighted
            
            
            
            Average
            
            WeightedNumber
                of
            
            Remaining
            
            Average
                of
            
            Number
                of
            
            Remaining
            
            Average
                ofRange
                of Exercise Price
            
            Options
            
            Contract
                Life
            
            Exercise
                Price
            
            Options
            
            Contract
                Life
            
            Exercise
                Price$3.32
                to $5.00
            
            81,000
            
            4.56
            
            $
                4.53
            
            81,000
            
            5.56
            
            $
                4.53$5.50
            
            602,314
            
            5.40
            
            5.50
            
            632,910
            
            6.40
            
            5.50$6.00
                to $8.00
            
            33,000
            
            2.82
            
            6.73
            
            34,200
            
            3.82
            
            6.71$11.00
            
            112,100
            
            1.58
            
            11.00
            
            121,000
            
            2.58
            
            11.00Total
            
            828,414
            
            
            
            $
                6.20
            
            869,110
            
            
            
            $
                6.222004**Outstanding**
            
            **Exercisable**Average
            
            Weighted
            
            
            
            WeightedNumber
                of
            
            Remaining
            
            Average
                of
            
            Number
                of
            
            Average
                ofRange
                of Exercise Price
            
            Options
            
            Contract
                Life
            
            Exercise
                Price
            
            Options
            
            Exercise
                Price$3.32
                to $5.00
            
            81,000
            
            6.56
            
            $
                4.53
            
            69,314
            
            $
                4.53$5.50
            
            814,023
            
            7.56
            
            5.50
            
            764,023
            
            5.50$6.00
                to $8.00
            
            43,800
            
            4.82
            
            6.87
            
            43,800
            
            6.87$11.00
            
            129,100
            
            3.58
            
            11.00
            
            129,100
            
            11.00Total
            
            1,067,923
            
            
            
            $
                6.15
            
            1,006,237
            
            $
                6.20




**13.**  **Income
      Taxes**





The
      components of the income tax (benefit) provision from continuing operations
      consisted of the following:




For
                the years ended December 31,2006
            
            2005
            
            2004Current
                income tax (benefit) provision:
            
            
            
            As
                Restated
            
            As
                RestatedFederal
            
            $
            -
            
            $
            -
            
            $
            -State
            
            
            -
            
            
            -
            
            
            --
            
            
            -
            
            
            -Deferred
                income tax (benefit) provision:Federal
            
            
            (11,182
            )
            
            (658
            )
            
            186State
            
            
            (1,437
            )
            
            (84
            )
            
            24Income
                tax (benefit) provision, continuing operations
            
            $
            (12,619
            )
            $
            (742
            )
            $
            210





F-28


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





The
      reported (benefit from) provision for income taxes from continuing operations
      differs from the amount computed by applying the statutory federal income tax
      rate of 35% to income/(loss) as follows:




For
                the Years Ended December 31,2006
            
            2005
            
            2004As
                Restated
            
            As
                RestatedBenefit
                computed at statutory rate
            
            $
            (11,314
            )
            $
            (713
            )
            $
            (34
            )Increase
                (decrease) resulting from:State
                tax, net of federal benefit
            
            
            (1,456
            )
            
            (92
            )
            
            (4
            )Meals
                and entertainment
            
            
            76
            
            
            75
            
            
            79Reversal
                of tax contingency accrual
            
            
            (150
            )
            
            -
            
            
            -Other
            
            
            225
            
            
            (12
            )
            
            169Income
                tax (benefit from) provision for continuing operations
            
            $
            (12,619
            )
            $
            (742
            )
            $
            210Components
                of total income tax (benefit) provisionIncome
                tax (benefit from) provision for continuing operations
            
            $
            (12,619
            )
            $
            (742
            )
            $
            210Income
                tax (benefit from) provision for discontinued operations
            
            
            (18,225
            )
            
            (331
            )
            
            3,563Total
                income tax (benefit) provision
            
            $
            (30,844
            )
            $
            (1,073
            )
            $
            3,773








Deferred
                tax assets (liabilities) are comprised of the following:December
                31,Deferred
                tax assets:
            
            2006
            
            2005As
                RestatedNet
                operating loss carryforwards
            
            $
            21,414
            
            $
            1,148Intangible
                assets
            
            
            -
            
            
            10,623Tax
                credits
            
            
            708
            
            
            768Other
            
            
            327
            
            
            423Total
                deferred tax assets
            
            
            22,449
            
            
            12,962Deferred
                tax liabilities:Accrual
                to cash adjustment
            
            
            (28,884
            )
            
            (48,868
            )Intangible
                assets
            
            
            (8,576
            )
            
            -Fixed
                assets
            
            
            (8,529
            )
            
            (17,189
            )Total
                deferred tax liabilities
            
            
            (45,989
            )
            
            (66,057
            )Net
                deferred tax liability
            
            $
            (23,540
            )
            $
            (53,095
            )Net
                deferred income tax liability, current
            
            
            (44,165
            )
            
            (56,542
            )Deferred
                income tax, assets held for sale
            
            
            15,014
            
            
            4,850Deferred
                income tax liability, related to assets held for sale
            
            
            (471
            )
            
            (8,079
            )Net
                deferred income tax asset, non-current
            
            
            6,082
            
            
            6,676$
            (23,540
            )
            $
            (53,095
            )




F-29


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





The
      Company derives significant benefits by qualifying to use the cash method of
      accounting for federal and state income tax purposes. Under the cash method,
      sales are included in taxable income when payments are received and expenses
      are
      deducted as they are paid. The primary benefit the Company receives is the
      ability to deduct the cost of inventory as it is incurred. The net benefit
      realized by the Company thus far is represented by the “Accrual to Cash
      Adjustment” item above. Because the items to which this “Accrual to Cash
      Adjustment” relate to are comprised of current assets and current liabilities in
      the consolidated balance sheets (such as inventory, accounts receivable,
      accounts payable, etc.), this deferred tax item is also characterized as
      current.





At
      December 31, 2006, the Company had approximately $53,963 in net operating loss
      carryforwards for federal income tax reporting purposes. The Company's federal
      net operating losses begin to expire in 2024. In addition, the Company had
      approximately $52,981 in net operating loss carryforwards for state income
      tax
      reporting purposes. The Company’s state net operating losses in certain states
      begin to expire in 2008.





The
      Company believes its net deferred tax assets are realizable due to the expected
      future reversal of existing taxable temporary differences, principally
      attributable to the cash method of accounting for tax return
      purposes .





The
      Company records a liability for potential tax assessments based on its estimate
      of the potential exposure. New laws and new interpretations of laws and rulings
      by tax authorities may affect the liability for potential tax assessments.
      Due
      to the subjectivity and complex nature of the underlying issues, actual payments
      or assessments may differ from estimates. To the extent the Company’s estimates
      differ from actual payments or assessments, income tax expense is adjusted.
       Management believes that adequate amounts of tax and related interest, if
      any, have been provided for any adjustments that may result from these
      examinations. During 2006, a reserve of $1,227 for probable tax assessments
      was
      reversed due to the expiration of the applicable statute of limitations for
      such
      items.  This reversal included $150 for continuing operations and $1,077
      for discontinued operations.





**14.**  **Employee
      Benefit Plans**





As
      of
      January 1, 2001, Hines Nurseries established a 401(k) Retirement Savings Plan
      (the “Plan”) for salaried and permanent hourly employees. As of January 1, 2003,
      pursuant to Internal Revenue Service (“IRS”) rules, participants make
      voluntary contributions to the plan up to a maximum of $12 not to exceed 20
      percent of their annual compensation (as defined). In addition, employees over
      age 50 may now contribute an additional $2. Hines’ matching contribution to the
      Plan was equal to 100 percent of the first three percent of a participant’s
      voluntary deferral of salary, and 50 percent of the next two percent of a
      participant’s voluntary deferral of salary per calendar year. As of May 16,
      2003, Hines discontinued its matching contributions. As of January 2006,
      pursuant to IRS rules, participants may make voluntary contributions to the
      plan
      up to a maximum of $15 not to exceed 50 percent of their annual compensation
      (as
      defined). In addition, employees over age 50 may now contribute an additional
      $5.





The
      total
      expense related to the Hines plan was $0 for the years ended December 31, 2006,
      2005 and 2004.





**15.**  **Fair
      Values of Financial Instruments**





The
      fair
      value of the Senior Notes is based on the closing price of the debt securities
      at December 31, 2006 and 2005. The carrying amount of short-term debt
      approximates fair value based on the short-term maturity of the
      instrument.


F-30


**HINES
      HORTICULTURE, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(Dollars
      in thousands, except share data)**





The
      carrying amounts and estimated fair values of the Company's financial
      instruments at December 31, 2006 and 2005 are as follows:





December
                31,2006
            
            2005Carrying
            
            Estimated
            
            Carrying
            
            EstimatedAmount
            
            Fair
                Value
            
            Amount
            
            Fair
                ValueRevolving
                line of credit
            
            $
            3,128
            
            $
            3,128
            
            $
            10,080
            
            $
            10,080Long-term
                debt
            
            $
            175,000
            
            $
            154,000
            
            $
            175,000
            
            $
            171,500


**16. 
        Related Party Transactions**


In
        1995 the Company sold 290 acres of its Forest Grove, Oregon nursery facility
        property to Blooming Farm, Inc., a corporation owned by Madison Dearborn
        Capital
        Partners and by Mr. Ferguson, the Company's Chief Executive Officer and
        President, Ms. Pieropan, the Company's Chief Financial Officer, Secretary
        and
        Treasurer, Stephen Thigpen, the Company's former Chief Executive Officer,
        and
        other members of the Company's current and former management. As payment
        in full
        for the 290 acres, Blooming Farm issued an interest-only promissory note
        to the
        Company in the amount of $827 secured by a deed of trust on the land. In
        1996
        the Company sold an additional 53 acres to Blooming Farm. As payment in full
        for
        the 53 acres, Blooming Farm issued an interest-only promissory note to the
        Company in the amount of $151 secured by a deed of trust on the 53 acres.
        The
        maturity date of each of these promissory notes is May 31, 2008.
 
 Blooming
        Farm is obligated to make interest payments of $67 per year on the principal
        balances of the notes. The Company leases all such 343 acres from Blooming
        Farm
        pursuant to a lease which expires on May 31, 2008 and under which the Company
        is
        obligated to make annual lease payments of $69. Pursuant to such lease, the
        Company has an option to purchase the land and rights of first
        refusal.
  **17.**  **Guarantor/Non-guarantor
          Disclosures**


The
      Senior Notes issued by Hines Nurseries (the “issuer”) have been guaranteed by
      the Company (the “parent guarantor”). The issuer is a 100% owned subsidiary of
      the parent guarantor. The parent guaranty is full and unconditional. The parent
      guarantor has no independent assets, liabilities or operations. In addition,
      under the Senior Notes, the parent guarantor is unable to obtain dividends
      or
      loans from the issuer. As a result of the foregoing, separate financial
      statements of Hines Nurseries are not presented.






F-31