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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION    FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004 COMMISSION FILE NUMBER 333-62021    HOME INTERIORS & GIFTS, INC.  TEXAS
(State or other jurisdiction of
incorporation or organization)
1649 FRANKFORD ROAD WEST, CARROLLTON, TEXAS
(Address of principal executive offices)
    
    75-0981828
(I.R.S. Employer
Identification No.)
75007-4605
(Zip Code)
 (972) 695-1000
Registrants Telephone Number, Including Area Code Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No
[  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [  ] No [X] As of May 13, 2004, 15,240,218 shares of the Companys common stock, par value
$0.10 per share, were outstanding.




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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES INDEX  
 PAGE NO.PART I  FINANCIAL INFORMATIONItem 1. Unaudited Interim Consolidated Financial Statements:Consolidated Balance Sheets as of December 31, 2003 and
March 31, 2004
    
    
    3Consolidated Statements of Operations and Comprehensive Income for
the three months ended March 31, 2003 and 2004
    
    
    4Consolidated Statements of Cash Flows for the three months ended
March 31, 2003 and 2004
    
    
    5Notes to Unaudited Interim Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    16Item 3. Quantitative and Qualitative Disclosure About Market Risk
    
    
    23Item 4. Controls and Procedures
    
    
    23PART II  OTHER INFORMATIONItem 1. Legal proceedings
    
    
    24Item 6. Exhibits and Reports on Form 8-K
    
    
    24Certification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
  2




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ITEM 1. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS. HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
As of December 31, 2003 and March 31, 2004 (Unaudited)December 31,
    
    March 31,2003
    
    2004(In thousands, exceptshare information)ASSETSCurrent assets:Cash
    
    $
    36,636
    
    
    $
    35,131Restricted cash
    
    
    
    
    
    
    424Accounts receivable, net
    
    
    22,027
    
    
    
    25,400Inventories, net
    
    
    73,135
    
    
    
    82,812Deferred income tax asset
    
    
    6,006
    
    
    
    6,981Other current assets
    
    
    3,444
    
    
    
    7,041Total current assets
    
    
    141,248
    
    
    
    157,789Property, plant and equipment, net
    
    
    75,191
    
    
    
    73,902Debt issuance costs, net
    
    
    3,956
    
    
    
    11,733Goodwill
    
    
    14,519
    
    
    
    14,600Other assets, net
    
    
    1,009
    
    
    
    847Total assets
    
    $
    235,923
    
    
    $
    258,871LIABILITIES AND SHAREHOLDERS DEFICITCurrent liabilities:Book overdraft
    
    $
    4,913
    
    
    $
    7,333Accounts payable
    
    
    30,757
    
    
    
    27,076Accrued seminars and incentive awards
    
    
    15,592
    
    
    
    15,847Royalties payable to decorating consultants
    
    
    8,109
    
    
    
    5,705Accrued compensation
    
    
    4,796
    
    
    
    3,501Current maturity of related party note payable
    
    
    675
    
    
    
    675Current maturities of long-term debt and capital lease obligations
    
    
    10,099
    
    
    
    11,624Other current liabilities
    
    
    18,234
    
    
    
    29,623Total current liabilities
    
    
    93,175
    
    
    
    101,384Long-term related party note payable, net of current maturity
    
    
    687
    
    
    
    687Long-term debt and capital lease obligations, net of current maturities
    
    
    311,777
    
    
    
    462,701Deferred income tax liability
    
    
    2,586
    
    
    
    3,846Other liabilities
    
    
    19,080
    
    
    
    19,017Total liabilities
    
    
    427,305
    
    
    
    587,635Commitments and contingencies (Note 9)Shareholders deficit:Preferred stock, par value $0.01 per share 10,000,000 shares
authorized 96,058.98 shares designated as cumulative 12.5% Senior
Convertible Preferred Stock at a liquidation value of $1,000 per
share, 96,058.98 shares issued and repurchased
    
    
    94,196
    
    
    
    Common stock, par value $0.10 per share, 75,000,000 shares
authorized, 15,240,218 shares issued and outstanding
    
    
    1,524
    
    
    
    1,524Additional paid-in capital
    
    
    185,036
    
    
    
    140,922Accumulated deficit
    
    
    (471,370
    )
    
    
    (470,472
    )Accumulated other comprehensive loss
    
    
    (768
    )
    
    
    (738
    )Total shareholders deficit
    
    
    (191,382
    )
    
    
    (328,764
    )Total liabilities and shareholders deficit
    
    $
    235,923
    
    
    $
    258,871
 The accompanying notes are an integral part of these consolidated financial statements. 3




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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
For the three months ended March 31, 2003 and 2004
(In thousands)
(Unaudited) THREE MONTHS ENDEDMARCH 31,2003
    
    2004Net sales
    
    $
    126,121
    
    
    $
    131,291Cost of goods sold
    
    
    54,877
    
    
    
    59,208Gross profit
    
    
    71,244
    
    
    
    72,083Selling, general and administrative:Selling
    
    
    20,501
    
    
    
    26,841Freight, warehouse and distribution
    
    
    15,622
    
    
    
    17,021General and administrative
    
    
    15,640
    
    
    
    17,858Loss on the disposition of assets
    
    
    4
    
    
    
    Stock option expense
    
    
    924
    
    
    
    989Loss on debt refinancing
    
    
    
    
    
    
    1,071Total selling, general and administrative
    
    
    52,691
    
    
    
    63,780Operating income
    
    
    18,553
    
    
    
    8,303Other income (expense):Interest income
    
    
    156
    
    
    
    70Interest expense
    
    
    (7,062
    )
    
    
    (7,006
    )Other income (expense), net
    
    
    (69
    )
    
    
    74Other income (expense), net
    
    
    (6,975
    )
    
    
    (6,862
    )Income before income taxes
    
    
    11,578
    
    
    
    1,441Income tax provision
    
    
    4,345
    
    
    
    543Net income
    
    
    7,233
    
    
    
    898Other comprehensive income (loss):Cumulative translation adjustment
    
    
    (2
    )
    
    
    30Other comprehensive income(loss)
    
    
    (2
    )
    
    
    30Comprehensive income
    
    $
    7,231
    
    
    $
    928
 The accompanying notes are an integral part of these consolidated financial statements. 4




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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2003 and 2004
(In Thousands)
(Unaudited) Three Months EndedMonths Ended2003
    
    2004Cash flows from operating activities:Net income
    
    $
    7,233
    
    
    $
    898Adjustments to reconcile net income to net cash used in
operating activities:Depreciation and amortization
    
    
    3,656
    
    
    
    3,899Amortization of debt issuance costs
    
    
    277
    
    
    
    277Provision for doubtful accounts
    
    
    786
    
    
    
    825Provision for losses on inventories
    
    
    (2,728
    )
    
    
    (501
    )Loss on debt refinancing
    
    
    
    
    
    
    1,071Loss on disposition of assets
    
    
    4
    
    
    
    Stock option expense
    
    
    924
    
    
    
    989Deferred tax expense (benefit)
    
    
    (1,559
    )
    
    
    284Changes in assets and liabilities:Accounts receivable
    
    
    (12,085
    )
    
    
    (4,198
    )Inventories
    
    
    (5,868
    )
    
    
    (9,221
    )Other current assets
    
    
    (281
    )
    
    
    (3,583
    )Other assets
    
    
    (32
    )
    
    
    161Accounts payable
    
    
    (1,893
    )
    
    
    (4,477
    )Income taxes payable
    
    
    4,455
    
    
    
    (1,882
    )Other current liabilities
    
    
    (1,832
    )
    
    
    10,305Total adjustments
    
    
    (16,176
    )
    
    
    (6,051
    )Net cash used in operating activities
    
    
    (8,943
    )
    
    
    (5,153
    )Cash flows from investing activities:Purchases of property, plant and equipment
    
    
    (4,592
    )
    
    
    (1,308
    )Business acquisitions, net of cash acquired
    
    
    (12,430
    )
    
    
    Proceeds from the sale of property, plant and equipment
    
    
    22
    
    
    
    Increase in restricted cash
    
    
    
    
    
    
    424Net cash used in investing activities
    
    
    (17,000
    )
    
    
    (884
    )Cash flows from financing activities:Book overdraft
    
    
    3,147
    
    
    
    2,420Payments of principal under capital lease obligations
    
    
    (791
    )
    
    
    (388
    )Proceeds from borrowings under New Senior Credit Facility
    
    
    
    
    
    
    320,000Payments of principal under Senior Credit Facility
    
    
    
    
    
    
    (168,682
    )Debt issuance costs
    
    
    
    
    
    
    (9,125
    )Payment of principal of other bank debt
    
    
    (750
    )
    
    
    Preferred stock repurchase costs
    
    
    
    
    
    
    (299
    )Payment of preferred stock repurchase
    
    
    
    
    
    
    (109,459
    )Payment of preferred stock dividends
    
    
    
    
    
    
    (29,541
    )Net cash provided by financing activities
    
    
    1,606
    
    
    
    4,926Effect of cumulative translation adjustment
    
    
    (2
    )
    
    
    30Net decrease in cash
    
    
    (24,339
    )
    
    
    (1,081
    )Cash at beginning of year
    
    
    68,111
    
    
    
    36,636Cash at end of period
    
    $
    43,772
    
    
    $
    35,555
 The accompanying notes are an integral part of these consolidated financial statements. 5




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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES 
 NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Background Home Interiors & Gifts, Inc. (the Company) is a fully integrated
manufacturer and distributor of home decorative accessories. The Company
believes it is the largest direct seller of home decorative accessories in the
United States, as measured by sales. The Companys products include, but are
not limited to, framed artwork and mirrors, candles and candle accessories,
plaques, figurines, planters, artificial floral arrangements, wall shelves,
sconces, small furniture, and tableware (the Products). The Company primarily
sells the Products through a direct selling channel of non-employee,
independent contractor sales representatives (Decorating Consultants) who
resell the Products primarily through one-on-one sales, brochure sales and
through the party-plan method of conducting in-home presentations for
potential customers. The Company has approximately 94,200 active Decorating
Consultants located in the United States, Mexico, Canada and Puerto Rico. The Company has been located in Dallas, Texas since its inception in 1957.
Currently the majority of the Companys outstanding common stock of record is
owned by affiliates of Hicks, Muse, Tate & Furst Incorporated, a Dallas-based
private investment firm (Hicks Muse). The Company purchases its Products from a select number of independent
suppliers as well as from its wholly owned subsidiaries. During the first
quarter of 2004, approximately 55.6% of the dollar volume of Products purchased
for the direct selling channel of the Company was purchased from, and
manufactured by, the Companys subsidiaries. In addition to the Products sold
to the Company for the direct selling channel, certain subsidiaries have a
growing presence in the wholesale supply market. 2. Significant Accounting Policies These consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in the consolidation. The
Company records sales and related expenses on a weekly basis ending on each
Saturday. Each quarter consists of thirteen weeks. The last days of the
quarters ended March 31, 2003 and 2004 in the accompanying unaudited
consolidated financial information were March 29, 2003 and April 3, 2004,
respectively. The consolidated financial information as of March 31, 2004 and for the
three months ended March 31, 2003 and 2004 is unaudited. In the opinion of
management, the accompanying unaudited consolidated financial information and
related notes thereto contain all adjustments, consisting only of normal,
recurring adjustments, necessary to present fairly the Companys consolidated
financial position as of March 31, 2004 and December 31, 2003, its operating
results and comprehensive income for the three months ended March 31, 2003 and
2004, and its cash flows for the three months ended March 31, 2003 and 2004.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted pursuant to the rules and regulations of the Securities and
Exchange Commission (the SEC). The results of operations for the periods
presented are not necessarily indicative of the results to be expected for the
full year. These unaudited interim consolidated financial statements and notes
thereto should be read in conjunction with the Companys audited consolidated
financial statements and notes thereto included in the Companys Form 10-K for
the year ended December 31, 2003 as filed with the SEC. Reclassifications Certain reclassifications have been made to prior period balances to
conform with current year presentation. Stock-based Compensations Plans The Company has adopted three stock option plans. For Decorating
Consultants and independent contractors, the Company has adopted the
Independent Contractor Stock Option Plan and accounts for options issued
under the Independent Contractor Stock Option Plan in accordance with Statement
of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS No. 123). For key employees, the Company has adopted the
1998 Key Employee Stock Option Plan and the 2002 Key Employee Stock Option
Plan. The Company accounts for the options issued under the 1998 Key Employee
Stock Option Plan and the 2002 Key Employee Stock Option Plan in accordance
with the Accounting Principles Board Opinion No. 25, Accounting for 6




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Stock Issued to Employees (APB 25), as allowed by FAS 123. Compensation Charge SFAS No. 123 establishes a fair value basis of accounting for stock-based
compensation plans. The effects of applying SFAS No. 123 as shown below are not
indicative of future amounts. Had the compensation cost for the Companys 1998
Key Employee Stock Option Plan and 2002 Key Employee Stock Option Plan been
determined consistent with SFAS No. 123, the Companys compensation cost and
net income for the three months ended March 31, 2003 and 2004 would approximate
(in thousands): Three Months EndedMarch 312003
    
    2004Net income, as reported
    
    $
    7,233
    
    
    $
    898Add: Stock-based employee compensation expense
included in reported net income, net of related tax effects
    
    
    495
    
    
    
    491Deduct: Stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects
    
    
    (581
    )
    
    
    (520
    )Pro forma net income
    
    $
    7,147
    
    
    $
    869
 3. Inventories, Net Inventories, net, consisted of the following as of December 31, 2003 and
March 31, 2004 (in thousands): December 31,
    
    March 31,2003
    
    2004Raw materials
    
    $
    9,364
    
    
    $
    12,638Work in process
    
    
    2,458
    
    
    
    2,892Finished goods
    
    
    66,212
    
    
    
    71,40378,034
    
    
    
    86,933Inventory allowance
    
    
    (4,899
    )
    
    
    (4,121
    )$
    73,135
    
    
    $
    82,812
 4. Other Current Liabilities Other current liabilities consisted of the following as of December 31,
2003 and March 31, 2004 (in thousands): December 31,
    
    March 31,2003
    
    2004Interest
    
    $
    1,258
    
    
    $
    5,285Accrued employee benefits
    
    
    4,443
    
    
    
    3,410Income taxes payable
    
    
    2,934
    
    
    
    1,052Sales taxes
    
    
    3,498
    
    
    
    6,130Other taxes
    
    
    1,535
    
    
    
    1,226Deferred revenue
    
    
    2,033
    
    
    
    9,854Related parties
    
    
    600
    
    
    
    103Other
    
    
    1,933
    
    
    
    2,563$
    18,234
    
    
    $
    29,623
 5. Adoption of New Accounting Standards In April 2004, the Financial Accounting Standards Board, (FASB), issued
Staff Position Statement of Financial Accounting Standards No. 129-1,
Disclosure Requirements under FASB Statement No. 129, Disclosure of
Information about Capital Structure, Relating to Contingently Convertible
Securities (FSP FAS 129-1). FSP FAS 129-1 provides interpretation guidance
regarding the disclosure provisions of FASB Statement No. 129 as it applies to
contingently convertible securities and the potential dilutive effects on
earnings per share. FSP FAS 129-1 is effective as of April 9, 2004 and applies
to all existing and newly created securities. The Company adopted FSP FAS 129-1
on April 9, 2004 and there was no financial accounting impact associated with
its adoption. 7




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6. Refinancing of Senior Credit Facility On March 31, 2004, the Company entered into a senior credit facility,
New Senior Credit Facility, with Bear Stearns Corporate Lending Inc., as
syndication agent, JPMorgan Chase Bank, as administrative agent, and the
several lenders from time to time parties thereto, pursuant to which the
Company, among other things, refinanced loans outstanding under the Companys
existing credit facility. The New Senior Credit Facility provides for a
seven-year term loan facility of up to $320.0 million, Term Loans, and a
$50.0 million five-year revolving credit facility, Revolving Loans. On March 31, 2004, $320.0 million in proceeds received from the Term
Loans were used to complete the following transactions:  
    
    For an aggregate purchase price of $139.0 million, the Company
repurchased all of the Companys outstanding shares of its 12.5%
Senior Convertible Preferred Stock, pursuant to a Stock Purchase
Agreement, dated March 31, 2004, among the Company and certain
affiliates of the Companys controlling stockholders, Preferred Stock
Repurchase.
    
    $169.1 million of the proceeds were used to pay off the existing
credit facility which included an outstanding debt balance, related
partial year interest, commitment fees, and outstanding letter of
credit fees.
    
    $9.4 million of the proceeds were used to pay legal and advisory
fees associated with the Preferred Stock Repurchase and the pay off of
the existing credit facility, and New Senior Credit Facility debt
issuance costs. There were no amounts drawn under the Revolving Loans and the remaining
net Term Loans proceeds of approximately $2.5 million were used for general
working capital purposes. As a result of the existing credit facility refinancing, the Company
recognized a $1.1 million loss related to a $0.4 million write-off of
unamortized debt issuance costs and $0.7 million of legal and advisory costs
for the period ended March 31, 2004. The Company also incurred debt issuance
costs related to the New Credit Facility of $8.4 million that were deferred.
As a result of the Preferred Stock Repurchase, the Company recognized a $45.1
million reduction in additional paid-in-capital related to $29.5 million
preferred stock dividends paid, $15.3 million premium paid in excess of the
liquidation value of the preferred stock, and $0.3 million of legal and
advisory fees. Borrowings under the New Senior Credit Facility require quarterly
principal and interest payments. The term loan facility matures on March 31,
2011. The revolving loan facility matures on March 31, 2009. The Company may,
at its option, prepay the Term Loans and Revolving Loans without premium or
penalty. Additionally, the Company may reduce or eliminate its revolving loan
commitment prior to maturity. The Company is subject to accelerated payments
in the event that the Senior Subordinated Notes are not refinanced in whole
through issuance of refinancing securities with a maturity no less than six
months after March 31, 2011, incremental term loans, or an initial public
offering by December 1, 2007. If the Senior Subordinated notes are not
refinanced by December 1, 2007, all term loans outstanding will be due and
payable on that date. Accordingly, the Company is amortizing its debt issue
costs over the period from March 31, 2004 through December 1, 2007. The New
Senior Credit Facility is guaranteed unconditionally on a senior basis by the
Companys wholly owned domestic subsidiaries and is collateralized by a lien
on substantially all assets of the Company and its wholly owned subsidiaries.
There are no material restrictions on the Companys ability to obtain funds
from its wholly owned subsidiaries by dividend or otherwise. The Term Loans under the New Senior Credit Facility bear interest, at
the Companys election, at either LIBOR plus an applicable margin or the Base
Rate Basis plus an applicable margin. The Base Rate Basis is the higher of
the prime rate of JPMorgan Chase Bank, the Base CD rate in effect plus 1%, or
the federal funds effective rate plus 0.5%. For the revolving loans, the
applicable LIBOR margin and Base Rate margin are subject to adjustments,
upwards or downwards after December 31, 2004, based upon the leverage ratio
as defined by the New Senior Credit Agreement. The interest rates on all
borrowings outstanding under the New Senior Credit Facility were based on
LIBOR as of March 31, 2004. The weighted-average interest rate on the Term
borrowings outstanding at March 31, 2004 was 5.41%. The Revolving Loans are subject to a commitment fee based on the undrawn
portion of the Revolving Loans. The commitment fee is eligible for certain
performance pricing step-downs and was 0.5% per annum as of March 31, 2004.
Outstanding letters of credit totaled $4.2 million as of March 31, 2004. The terms of the Notes and New Senior Credit Facility include
significant operating and financial restrictions, such as limits on the
Companys ability to incur indebtedness, create liens, sell assets, engage in
mergers, acquisitions or consolidations, make investments and pay dividends.
In addition, under the New Senior Credit Facility, the Company is required to
comply with specified financial ratios and tests, including fixed charge
coverage ratios, maximum leverage ratios, capital expenditure measurements,
and Adjusted EBITDA measurements. 8




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A summary of long-term debt obligations under the New Credit Facility as
of March 31, 2004 is as follows (in thousands): Term Loans, interest at LIBOR plus an applicable margin (5.36%)
    
    $
    2,500Term Loans, interest at LIBOR plus an applicable margin (5.41%)
    
    
    317,500320,000Less current maturities
    
    
    (10,000
    )$
    310,000
 The following table represents a summary of the maturities of Term Loans
under the New Senior Credit Facility as of March 31, 2004 (in thousands): 2004
    
    $
    7,5002005
    
    
    13,7502006
    
    
    15,0002007
    
    
    283,750$
    320,000
 7. Segment Reporting The Companys reportable segments are based upon functional lines of
business as follows:  
    
    Direct Selling Domestic  direct seller of home decorative accessories in the United States;
    
    Direct Selling International  direct seller of home decorative accessories in Mexico, Canada and Puerto Rico; and
    
    Domistyle  wholesale supply operation that manufactures,
imports, and distributes candles, framed artwork, mirrors, various
types of molded plastic, metal, glass, and ceramic products for
affiliates and other non-affiliated resellers. The Company evaluates the performance of its segments and allocates
resources to them based on earnings before interest, taxes, the effects of
SAB 101, depreciation and amortization, reorganization costs, non-cash
expense for stock options, losses on debt restructure, Hicks Muse management
fees, and losses on disposition of assets, (defined as Adjusted EBITDA).
The Company also uses Adjusted EBITDA as a performance measure due to the
Companys required compliance thresholds for Adjusted EBITDA covenants under
the New Senior Credit Facility. During March 2004, the Company modified its
internal reporting to reflect the Adjusted EBITDA measure as defined by the
New Credit Facility. Prior years Adjusted EBITDA has been recalculated for
comparative purposes. The accounting principles of the segments are the same
as those described in Note 2. Segment data includes intersegment sales and
intercompany net receivable balances. Eliminations consist primarily of
intersegment sales between the Domistyle segment and the direct selling
segments, as well as the elimination of the investment in each subsidiary for
consolidation purposes. The table below presents information about reportable
segments used by the Companys chief operating decision makers as of and for
the three months ended March 31, 2003 and 2004 (in thousands): 9




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Direct
    
    DirectSelling
    
    SellingDomestic
    
    International
    
    Domistyle
    
    Eliminations
    
    Consolidated2003Net sales to non-affiliates
    
    $
    109,918
    
    
    $
    10,093
    
    
    $
    6,110
    
    
    $
    
    
    
    $
    126,121Net sales to affiliates
    
    
    4,641
    
    
    
    
    
    
    
    33,240
    
    
    
    (37,881
    )
    
    
    Adjusted EBITDA
    
    
    15,937
    
    
    
    463
    
    
    
    11,711
    
    
    
    (373
    )
    
    
    27,738Total assets
    
    
    228,859
    
    
    
    6,026
    
    
    
    107,501
    
    
    
    (98,871
    )
    
    
    243,515Goodwill
    
    
    
    
    
    
    
    
    
    
    12,445
    
    
    
    
    
    
    
    12,445Capital expenditures
    
    
    3,017
    
    
    
    28
    
    
    
    1,547
    
    
    
    
    
    
    
    4,5922004Net sales to non-affiliates
    
    $
    108,529
    
    
    $
    14,260
    
    
    $
    8,502
    
    
    $
    
    
    
    $
    131,291Net sales to affiliates
    
    
    6,698
    
    
    
    
    
    
    
    35,222
    
    
    
    (41,920
    )
    
    
    Adjusted EBITDA
    
    
    10,011
    
    
    
    1,189
    
    
    
    8,996
    
    
    
    (1,035
    )
    
    
    19,161Total assets
    
    
    236,140
    
    
    
    13,822
    
    
    
    83,782
    
    
    
    (74,873
    )
    
    
    258,871Goodwill
    
    
    
    
    
    
    
    
    
    
    14,600
    
    
    
    
    
    
    
    14,600Capital expenditures
    
    
    473
    
    
    
    249
    
    
    
    586
    
    
    
    
    
    
    
    1,308
 The following table represents a reconciliation of net income to
consolidated Adjusted EBITDA for the three months ended March 31, 2003 and
2004 (in thousands): Three Months EndedMarch 31,2003
    
    2004Net income
    
    $
    7,233
    
    
    $
    898Effect of SAB 101
    
    
    3,570
    
    
    
    2,869Interest income
    
    
    (156
    )
    
    
    (70
    )Interest expense
    
    
    7,062
    
    
    
    7,006Income tax provision
    
    
    4,345
    
    
    
    543Depreciation and amortization
    
    
    3,656
    
    
    
    3,899Stock option expense
    
    
    924
    
    
    
    989Loss on debt refinancing
    
    
    
    
    
    
    1,071Reorganization costs
    
    
    805
    
    
    
    1,680Hicks Muse management fees
    
    
    295
    
    
    
    276Loss on disposition of assets
    
    
    4
    
    
    
    Adjusted EBITDA
    
    $
    27,738
    
    
    $
    19,161
 8. Guarantor Financial Data Dallas Woodcraft Company, LP, DWC GP, Inc., GIA, Inc., Homco, Inc., Spring
Valley Scents, Inc., Laredo Candle Company, L.P., Domistyle, Inc., EM Boehm,
Inc., Home Interiors de Puerto Rico, Inc. and HIG Investments, Inc.
(collectively, the Guarantors) unconditionally, on a joint and several basis,
guarantee the Companys (Borrower) payment and performance of its obligation
under the New Senior Credit Facility agreement and the Debt Holders 10 1/8%
Senior Subordinated Notes due 2008 in the amount of $149.1 million (the
Notes). The Companys other subsidiaries, Home Interiors de Mexico, S. de
R.L. de C.V., Home Interiors Services de Mexico, S.A. de C.V., HI Ceramics,
S.A. de C.V., HI Metals, S.A. de C.V., HI Glass, S.A. de C.V., HI Trading
Mexicana, S.A. de C.V., and Home Interiors & Gifts of Canada, Inc.
(collectively, the Non-Guarantors) have not guaranteed the New Senior Credit
Facility or the Notes. Guarantor and Non-Guarantor financial statements on an
individual basis are not significant and have been omitted. Accordingly, the
following table presents financial information of the Guarantors and
Non-Guarantors on a consolidating basis (in thousands): 10




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##### Table of Contents



Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Three Months Ended March 31, 2003 Non-Borrower
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedNet sales
    
    $
    115,774
    
    
    $
    38,574
    
    
    $
    9,912
    
    
    $
    (38,139
    )
    
    $
    126,121Cost of good sold
    
    
    60,684
    
    
    
    25,001
    
    
    
    6,948
    
    
    
    (37,756
    )
    
    
    54,877Gross profit
    
    
    55,090
    
    
    
    13,573
    
    
    
    2,964
    
    
    
    (383
    )
    
    
    71,244Total selling, general and
administrative
    
    
    47,121
    
    
    
    2,197
    
    
    
    3,373
    
    
    
    
    
    
    
    52,691Operating income (loss)
    
    
    7,969
    
    
    
    11,376
    
    
    
    (409
    )
    
    
    (383
    )
    
    
    18,553Other income (expense), net
    
    
    (6,955
    )
    
    
    86
    
    
    
    (116
    )
    
    
    10
    
    
    
    (6,975
    )Income (loss) before income
taxes
    
    
    1,014
    
    
    
    11,462
    
    
    
    (525
    )
    
    
    (373
    )
    
    
    11,578Income tax benefit (provision)
    
    
    (565
    )
    
    
    (3,963
    )
    
    
    183
    
    
    
    
    
    
    
    (4,345
    )Equity in income (loss) of
affiliated companies, net of tax
    
    
    7,156
    
    
    
    (409
    )
    
    
    
    
    
    
    (6,747
    )
    
    
    Net income (loss)
    
    
    7,605
    
    
    
    7,090
    
    
    
    (342
    )
    
    
    (7,120
    )
    
    
    7,233Other comprehensive income (loss)
    
    
    (3
    )
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    (2
    )Comprehensive income (loss)
    
    $
    7,602
    
    
    $
    7,090
    
    
    $
    (341
    )
    
    $
    (7,120
    )
    
    $
    7,231
 Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Three Months Ended March 31, 2004 Non-Borrower
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedNet sales
    
    $
    117,216
    
    
    $
    41,496
    
    
    $
    16,230
    
    
    $
    (43,651
    )
    
    $
    131,291Cost of good sold
    
    
    61,894
    
    
    
    27,915
    
    
    
    12,103
    
    
    
    (42,704
    )
    
    
    59,208Gross profit
    
    
    55,322
    
    
    
    13,581
    
    
    
    4,127
    
    
    
    (947
    )
    
    
    72,083Total selling, general and
administrative
    
    
    54,468
    
    
    
    3,599
    
    
    
    5,713
    
    
    
    
    
    
    
    63,780Operating income (loss)
    
    
    854
    
    
    
    9,982
    
    
    
    (1,586
    )
    
    
    (947
    )
    
    
    8,303Other income (expense), net
    
    
    (6,784
    )
    
    
    133
    
    
    
    (123
    )
    
    
    (88
    )
    
    
    (6,862
    )Income (loss) before income
taxes
    
    
    (5,930
    )
    
    
    10,115
    
    
    
    (1,709
    )
    
    
    (1,035
    )
    
    
    1,441Income tax benefit (provision)
    
    
    3,076
    
    
    
    (3,643
    )
    
    
    (192
    )
    
    
    216
    
    
    
    (543
    )Equity in income (loss) of
affiliated companies, net of
tax
    
    
    4,570
    
    
    
    (2,250
    )
    
    
    
    
    
    
    (2,320
    )
    
    
    Net income (loss)
    
    
    1,716
    
    
    
    4,222
    
    
    
    (1,901
    )
    
    
    (3,139
    )
    
    
    898Other comprehensive income
    
    
    6
    
    
    
    
    
    
    
    24
    
    
    
    
    
    
    
    30Comprehensive income (loss)
    
    $
    1,722
    
    
    $
    4,222
    
    
    $
    (1,877
    )
    
    $
    (3,139
    )
    
    $
    928
 11




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##### Table of Contents



Condensed Consolidating Balance Sheet
As of December 31, 2003 Non-Borrower
    
    Guarantors
    
    Guarantors
    
    Consolidating
    
    Eliminations
    
    ConsolidatedASSETSCurrent assets:Cash
    
    $
    34,222
    
    
    $
    176
    
    
    $
    2,238
    
    
    $
    36,636
    
    
    $
    
    
    
    $
    36,636Accounts receivable, net
    
    
    10,487
    
    
    
    5,116
    
    
    
    6,424
    
    
    
    22,027
    
    
    
    
    
    
    
    22,027Inventories
    
    
    55,935
    
    
    
    13,174
    
    
    
    8,818
    
    
    
    77,927
    
    
    
    (4,792
    )
    
    
    73,135Other current assets
    
    
    5,844
    
    
    
    1,447
    
    
    
    713
    
    
    
    8,004
    
    
    
    1,446
    
    
    
    9,450Due from (due to)
affiliated companies
    
    
    508
    
    
    
    15,782
    
    
    
    (16,290
    )
    
    
    
    
    
    
    
    
    
    
    Total current assets
    
    
    106,996
    
    
    
    35,695
    
    
    
    1,903
    
    
    
    144,594
    
    
    
    (3,346
    )
    
    
    141,248Property, plant and
equipment, net
    
    
    43,774
    
    
    
    19,791
    
    
    
    11,626
    
    
    
    75,191
    
    
    
    
    
    
    
    75,191Investment in subsidiaries
    
    
    66,128
    
    
    
    4,208
    
    
    
    
    
    
    
    70,336
    
    
    
    (70,336
    )
    
    
    Debt issuance costs and
other assets, net
    
    
    4,544
    
    
    
    13,475
    
    
    
    1,465
    
    
    
    19,484
    
    
    
    
    
    
    
    19,484Total assets
    
    $
    221,442
    
    
    $
    73,169
    
    
    $
    14,994
    
    
    $
    309,605
    
    
    $
    (73,682
    )
    
    $
    235,923LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    26,135
    
    
    $
    2,258
    
    
    $
    1,732
    
    
    $
    30,125
    
    
    $
    632
    
    
    $
    30,757Current maturity of
related party note payable
    
    
    675
    
    
    
    
    
    
    
    
    
    
    
    675
    
    
    
    
    
    
    
    675Current maturities of
long-term debt and capital
lease obligations
    
    
    10,096
    
    
    
    3
    
    
    
    
    
    
    
    10,099
    
    
    
    
    
    
    
    10,099Other current liabilities
    
    
    40,485
    
    
    
    6,826
    
    
    
    4,333
    
    
    
    51,644
    
    
    
    
    
    
    
    51,644Total current liabilities
    
    
    77,391
    
    
    
    9,087
    
    
    
    6,065
    
    
    
    92,543
    
    
    
    632
    
    
    
    93,175Long-term related party
note payable, net of
current maturity
    
    
    687
    
    
    
    
    
    
    
    
    
    
    
    687
    
    
    
    
    
    
    
    687Long-term debt and capital
lease obligations, net of
current maturities
    
    
    311,777
    
    
    
    
    
    
    
    
    
    
    
    311,777
    
    
    
    
    
    
    
    311,777Other liabilities
    
    
    18,225
    
    
    
    2,549
    
    
    
    892
    
    
    
    21,666
    
    
    
    
    
    
    
    21,666Total liabilities
    
    
    408,080
    
    
    
    11,636
    
    
    
    6,957
    
    
    
    426,673
    
    
    
    632
    
    
    
    427,305Commitments and
contingencies
(Note 9)Shareholders equity
(deficit):Preferred stock
    
    
    94,196
    
    
    
    
    
    
    
    
    
    
    
    94,196
    
    
    
    
    
    
    
    94,196Common stock
    
    
    1,524
    
    
    
    1,001
    
    
    
    29
    
    
    
    2,554
    
    
    
    (1,030
    )
    
    
    1,524Additional paid-in capital
    
    
    185,036
    
    
    
    3,031
    
    
    
    12,331
    
    
    
    200,398
    
    
    
    (15,362
    )
    
    
    185,036Retained earnings
(accumulated deficit)
    
    
    (467,391
    )
    
    
    57,501
    
    
    
    (3,558
    )
    
    
    (413,448
    )
    
    
    (57,922
    )
    
    
    (471,370
    )Accumulated comprehensive
loss
    
    
    (3
    )
    
    
    
    
    
    
    (765
    )
    
    
    (768
    )
    
    
    
    
    
    
    (768
    )Total shareholders
equity (deficit)
    
    
    (186,638
    )
    
    
    61,533
    
    
    
    8,037
    
    
    
    (117,068
    )
    
    
    (74,314
    )
    
    
    (191,382
    )Total liabilities and
shareholders equity
(deficit)
    
    $
    221,442
    
    
    $
    73,169
    
    
    $
    14,994
    
    
    $
    309,605
    
    
    $
    (73,682
    )
    
    $
    235,923
 12




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##### Table of Contents



Condensed Consolidating Balance Sheet
As of March 31, 2004 Non-Borrower
    
    Guarantors
    
    Guarantors
    
    Consolidating
    
    Eliminations
    
    ConsolidatedASSETSCurrent assets:Cash
    
    $
    33,696
    
    
    $
    321
    
    
    $
    1,114
    
    
    $
    35,131
    
    
    $
    
    
    
    $
    35,131Restricted cash
    
    
    
    
    
    
    
    
    
    
    424
    
    
    
    424
    
    
    
    
    
    
    
    424Accounts receivable, net
    
    
    15,006
    
    
    
    3,902
    
    
    
    6,492
    
    
    
    25,400
    
    
    
    
    
    
    
    25,400Inventories, net
    
    
    58,967
    
    
    
    19,099
    
    
    
    10,574
    
    
    
    88,640
    
    
    
    (5,828
    )
    
    
    82,812Other current assets
    
    
    6,962
    
    
    
    1,584
    
    
    
    3,814
    
    
    
    12,360
    
    
    
    1,662
    
    
    
    14,022Due from (due to) affiliated
companies
    
    
    (595
    )
    
    
    21,022
    
    
    
    (20,427
    )
    
    
    
    
    
    
    
    
    
    
    Total current assets
    
    
    114,036
    
    
    
    45,928
    
    
    
    1,991
    
    
    
    161,955
    
    
    
    (4,166
    )
    
    
    157,789Property, plant and equipment,
net
    
    
    42,212
    
    
    
    20,061
    
    
    
    11,629
    
    
    
    73,902
    
    
    
    
    
    
    
    73,902Investment in affiliates
    
    
    70,698
    
    
    
    1,958
    
    
    
    
    
    
    
    72,656
    
    
    
    (72,656
    )
    
    
    Debt issuance costs and other
assets, net
    
    
    12,288
    
    
    
    13,415
    
    
    
    1,477
    
    
    
    27,180
    
    
    
    
    
    
    
    27,180Total assets
    
    $
    239,234
    
    
    $
    81,362
    
    
    $
    15,097
    
    
    $
    335,693
    
    
    $
    (76,822
    )
    
    $
    258,871LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    21,463
    
    
    $
    2,862
    
    
    $
    2,120
    
    
    $
    26,445
    
    
    $
    631
    
    
    $
    27,076Current maturity of related
party note payable
    
    
    675
    
    
    
    
    
    
    
    
    
    
    
    675
    
    
    
    
    
    
    
    675Current maturities of
long-term debt and capital
lease obligations
    
    
    11,331
    
    
    
    171
    
    
    
    122
    
    
    
    11,624
    
    
    
    
    
    
    
    11,624Other current liabilities
    
    
    47,062
    
    
    
    9,625
    
    
    
    5,322
    
    
    
    62,009
    
    
    
    
    
    
    
    62,009Total current liabilities
    
    
    80,531
    
    
    
    12,658
    
    
    
    7,564
    
    
    
    100,753
    
    
    
    631
    
    
    
    101,384Long-term related party note
payable, net of current
maturity
    
    
    687
    
    
    
    
    
    
    
    
    
    
    
    687
    
    
    
    
    
    
    
    687Long-term debt and capital
lease obligations, net of
current maturities
    
    
    462,073
    
    
    
    311
    
    
    
    317
    
    
    
    462,701
    
    
    
    
    
    
    
    462,701Other liabilities
    
    
    19,169
    
    
    
    2,638
    
    
    
    1,056
    
    
    
    22,863
    
    
    
    
    
    
    
    22,863Total liabilities
    
    
    562,460
    
    
    
    15,607
    
    
    
    8,937
    
    
    
    587,004
    
    
    
    631
    
    
    
    587,635Commitments and contingencies
(Note 9)Shareholders equity (deficit):Common stock
    
    
    1,524
    
    
    
    1,001
    
    
    
    29
    
    
    
    2,554
    
    
    
    (1,030
    )
    
    
    1,524Additional paid-in capital
    
    
    140,922
    
    
    
    3,031
    
    
    
    12,331
    
    
    
    156,284
    
    
    
    (15,362
    )
    
    
    140,922Retained earnings
(accumulated deficit)
    
    
    (465,675
    )
    
    
    61,723
    
    
    
    (5,459
    )
    
    
    (409,411
    )
    
    
    (61,061
    )
    
    
    (470,472
    )Accumulated other
comprehensive income (loss)
    
    
    3
    
    
    
    
    
    
    
    (741
    )
    
    
    (738
    )
    
    
    
    
    
    
    (738
    )Total shareholders equity
(deficit)
    
    
    (323,226
    )
    
    
    65,755
    
    
    
    6,160
    
    
    
    (251,311
    )
    
    
    (77,453
    )
    
    
    (328,764
    )Total liabilities and
shareholders equity
(deficit)
    
    $
    239,234
    
    
    $
    81,362
    
    
    $
    15,097
    
    
    $
    335,693
    
    
    $
    (76,822
    )
    
    $
    258,871
 13




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##### Table of Contents



Condensed Consolidating Cash Flow Statement
For the Three Months Ended March 31, 2003 Non-Borrower
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedNet cash provided by (used in)
operating activities
    
    $
    (23,666
    )
    
    $
    11,484
    
    
    $
    3,239
    
    
    $
    
    
    
    $
    (8,943
    )Cash flows from investing
activities:Purchases of property,
plant and equipment
    
    
    (3,017
    )
    
    
    (885
    )
    
    
    (690
    )
    
    
    
    
    
    
    (4,592
    )Payment for acquisition,
net of cash acquired
    
    
    (1,799
    )
    
    
    (10,631
    )
    
    
    
    
    
    
    
    
    
    
    (12,430
    )Proceeds from the sale of
property, plant and
equipment
    
    
    23
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    22Net cash used in
investing activities
    
    
    (4,793
    )
    
    
    (11,517
    )
    
    
    (690
    )
    
    
    
    
    
    
    (17,000
    )Cash flows from financing
activities:Book overdraft
    
    
    2,453
    
    
    
    694
    
    
    
    
    
    
    
    
    
    
    
    3,147Payments of principal under
capital lease obligations
    
    
    (237
    )
    
    
    
    
    
    
    (554
    )
    
    
    
    
    
    
    (791
    )Payment of principal of
other bank debt
    
    
    
    
    
    
    (750
    )
    
    
    
    
    
    
    
    
    
    
    (750
    )Net cash provided by
(used in) financing
activities
    
    
    2,216
    
    
    
    (56
    )
    
    
    (554
    )
    
    
    
    
    
    
    1,606Effect of cumulative
translation adjustment
    
    
    (3
    )
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    (2
    )Net increase (decrease) in cash
    
    
    (26,246
    )
    
    
    (89
    )
    
    
    1,996
    
    
    
    
    
    
    
    (24,339
    )Cash at beginning of year
    
    
    66,775
    
    
    
    317
    
    
    
    1,019
    
    
    
    
    
    
    
    68,111Cash at end of period
    
    $
    40,529
    
    
    $
    228
    
    
    $
    3,015
    
    
    $
    
    
    
    $
    43,772
 14




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##### Table of Contents



Condensed Consolidating Cash Flow Statement
For the Three Months Ended March 31, 2004 Borrower
    
    Guarantors
    
    Non-Guarantors
    
    Eliminations
    
    ConsolidatedNet cast provided by (used in)
operating activities
    
    $
    (5,455
    )
    
    $
    1,081
    
    
    $
    (779
    )
    
    $
    
    
    
    $
    (5,153
    )Cash flows from investing
activities:Purchases of property, plant
and equipment
    
    
    (473
    )
    
    
    (466
    )
    
    
    (369
    )
    
    
    
    
    
    
    (1,308
    )Increase in restricted cash
    
    
    
    
    
    
    
    
    
    
    424
    
    
    
    
    
    
    
    424Net cash provided by (used
in) investing activities
    
    
    (473
    )
    
    
    (466
    )
    
    
    55
    
    
    
    
    
    
    
    (884
    )Cash flows
from financing activities:Book overdraft
    
    
    2,831
    
    
    
    (411
    )
    
    
    
    
    
    
    
    
    
    
    2,420Payments of principal
under capital lease
obligations
    
    
    (329
    )
    
    
    (59
    )
    
    
    
    
    
    
    
    
    
    
    (388
    )Payments of principal
under Senior Credit
Facility
    
    
    (168,682
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (168,682
    )Proceeds from borrowings
under New Senior Credit
Facility
    
    
    320,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    320,000Debt issuance costs
    
    
    (9,125
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,125
    )Payment of preferred stock
repurchase
    
    
    (109,459
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (109,459
    )Payments of preferred
stock dividends
    
    
    (29,541
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (29,541
    )Preferred stock repurchase
costs
    
    
    (299
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (299
    )Net cash provided by
(used in) financing
activities
    
    
    5,396
    
    
    
    (470
    )
    
    
    
    
    
    
    
    
    
    
    4,926Effect of cumulative
translation adjustment
    
    
    6
    
    
    
    
    
    
    
    24
    
    
    
    
    
    
    
    30Net increase (decrease) in cash
    
    
    (526
    )
    
    
    145
    
    
    
    (700
    )
    
    
    
    
    
    
    (1,081
    )Cash at beginning of year
    
    
    34,222
    
    
    
    176
    
    
    
    2,238
    
    
    
    
    
    
    
    36,636Cash at end of period
    
    $
    33,696
    
    
    $
    321
    
    
    $
    1,538
    
    
    $
    
    
    
    $
    35,555
 9. Commitments and Contingencies The Company is engaged in various legal proceedings incidental to its
normal business activities. Management believes that the amounts, if any, which
ultimately may be due in connection with such lawsuits and claims would not
have a material effect upon the Company, because most of the claims are covered
by insurance. The Company is also engaged in product recall campaigns related to its
normal business activities. Management believes that the costs, if any,
associated with the product recalls would not have a material effect upon the
Company. 15




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis should be read in conjunction with
the Companys unaudited consolidated financial statements and accompanying
notes thereto, which are included elsewhere herein. Unless otherwise mentioned,
all references to the number of Decorating Consultants, number of orders
shipped and average order size relate to domestic direct sales activity only. Special Note Regarding Forward-Looking Statements Some of the statements under Managements Discussion and Analysis of
Financial Condition and Results of Operations and elsewhere in this report
constitute forward-looking statements. These statements involve known and
unknown risks, uncertainties and other factors that may cause the Companys
actual results to be materially different from any future results expressed or
implied by such forward-looking statements. In some cases, forward-looking statements are identified by terminology
such as may, will, should, expects, plans, anticipates, believes,
estimates, predicts, potential or continue or the negative of such
terms or other comparable terminology. All of these forward-looking statements are based on estimates and
assumptions made by management of the Company, which, although believed to be
reasonable, are inherently uncertain. Therefore, undue reliance should not be
placed upon such statements. No assurance can be given that any of such
estimates or statements will be realized and actual results may differ
materially from those contemplated by such forward-looking statements. Factors
that may cause such differences include: (i) Decorating Consultant recruiting
and activity levels; (ii) loss or retirement of key members of management;
(iii) imposition of foreign, federal or state taxes; (iv) change in status of
independent contractors; (v) increased competition; (vi) the success of new
products and promotion programs; (vii) general economic conditions and (viii)
the success of integrating acquired businesses. Many of these factors will be
beyond the control of the Company. Moreover, neither the Company nor any other person assumes responsibility
for the accuracy and completeness of such statements. The Company is under no
duty to update any of the forward-looking statements after the date of this
Form 10-Q to conform such statements to actual results. Company Background The Company believes it is the largest direct seller of home decorative
accessories in the United States, as measured by sales. As of March 31, 2004,
the Company has approximately 94,200 active Decorating Consultants located in
the United States, Mexico, Canada and Puerto Rico. The Companys direct sales
are dependent upon the number of Decorating Consultants selling the Companys
products and their resulting productivity. Decorating Consultant productivity
fluctuates from time to time based on seasonality and special marketing
programs, which offer Decorating Consultants new incentives and discounts timed
to generate additional sales. The Company also sells products to customers
outside of its direct selling channel. To stimulate sales within the direct selling channel, the Company offers a
variety of discounts and incentives to Decorating Consultants. The amount and
timing of discounts and incentives vary from year to year. The cost of
discounts is reflected in the Companys net sales while the cost of incentives
is reflected in selling expense. Company Direct Selling Strategy The Company has evolved its strategy to put greater focus on what
management believes to be the key drivers of the direct selling business -
recruiting, retention and productivity of the Decorating Consultant base. The Company recognizes the need to continue to attract and retain new
Decorating Consultants. As of March 31, 2004, the Companys active Decorating
Consultant base in the United States increased 13.9% to approximately 72,200
active Decorating Consultants from approximately 63,400 as of March 31, 2003.
This increase was a result of the Companys continued focus on key areas such
as Decorating Consultant understanding and awareness of the Hostess program,
improved training and business guides, and a more clearly defined and
communicated career path as reflected in the new recruit program. The retention of experienced Decorating Consultants requires operational
focus on several areas: product distribution fulfillment rates, product
selection and sales training and motivation. Fulfillment rates for product
distribution remained strong at approximately 16




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##### Table of Contents



99% as of March 31, 2004. The Company is continuing to introduce new
products during 2004, which complement the current line of products, in an
attempt to give the product line a fresh and more innovative look. The
Companys Recertification program educates Decorating Consultants on how to
become more effective Directors and Trainers by helping them develop and
enhance their leadership skills. Decorating Consultant training and motivation requires the introduction of
sales promotion and development activities directed at helping Decorating
Consultants increase their productivity. Sales tools such as Power Paks and
the Companys HIG Creative Concepts DVD/video series have helped the field
leadership plan and present more effective sales meetings and training sessions
for the Decorating Consultants. Company Manufacturing and Wholesale Strategy The Company refers to its manufacturing or wholesale supply operations as
Domistyle, a uniquely positioned home décor manufacturing and design
operation that not only sells to the Companys core direct selling business,
but also sells to the Companys wholesale supply channel. The Company continues to emphasize products from its wholesale supply
operation in the direct selling channel, which the Company believes provides
opportunities for gross margin improvements and leverages the fixed expense
component of its cost structure. During the three months ended March 31, 2004,
approximately 55.6% of the dollar volume of products purchased for the direct
selling channel of the Company was purchased from, and manufactured by, the
Companys subsidiaries. The Company believes that this increased focus of the
Companys manufacturing strategy has supported Decorating Consultant
productivity and retention through increased fulfillment rates and increased
flexibility related to promotion strategies. The Companys Domistyle operation increased sales to customers outside of
the direct selling channel by $2.4 million or 39.3%. Wholesale supply sales by
the Company were $8.5 million for the three months ended March 31, 2004, as
compared to $6.1 million for the three months ended March 31, 2003. The
Company is currently evaluating its manufacturing operations in Mexico. Recent Developments Refinancing of Senior Credit Facility On March 31, 2004, the Company entered into a senior credit facility, New
Senior Credit Facility, with Bear Stearns Corporate Lending Inc., as
syndication agent, JPMorgan Chase Bank, as administrative agent, and the
several lenders from time to time parties thereto, pursuant to which the
Company, among other things, refinanced loans outstanding under the Companys
existing credit facility. The New Senior Credit Facility provides for a
seven-year term loan facility of up to $320.0 million, Term Loans, and a
$50.0 million five-year revolving credit facility, Revolving Loans. On March 31, 2004, $320.0 million in proceeds received from the Term Loans
were used to complete the following transactions:  
    
    For an aggregate purchase price of $139.0 million, the Company
repurchased all of the Companys outstanding shares of its 12.5% Senior
Convertible Preferred Stock, pursuant to a Stock Purchase Agreement,
dated March 31, 2004, among the Company and certain affiliates of the
Companys controlling stockholders.
    
    $169.1 million of the proceeds were used to pay off the existing
credit facility which included an outstanding debt balance, related
partial year interest, commitment fees, and outstanding letter of credit
fees.
    
    $9.4 million of the proceeds were used to pay legal and advisory fees
associated with the Preferred Stock Repurchase and pay off of the
existing credit facility, and New Senior Credit Facility debt issuance
costs. There were no amounts drawn under the Revolving Loans and the remaining
net Term Loan proceeds of approximately $2.5 million were used for general
working capital purposes. 17




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##### Table of Contents



Borrowings under the New Senior Credit Facility require quarterly
principal and interest payments. The term loan facility matures on March 31,
2011. The revolving loan facility matures on March 31, 2009. The Company may,
at its option, prepay the Term Loans and Revolving Loans without premium or
penalty. Additionally, the Company may reduce or eliminate its revolving loan
commitment prior to maturity. The Company is subject to accelerated payments
in the event that the Senior Subordinated Notes are not refinanced in whole
through issuance of refinancing securities with a maturity no less than six
months after March 31, 2011, incremental term loans, or an initial public
offering by December 1, 2007. If the Senior Subordinated notes are not
refinanced by December 1, 2007, all term loans outstanding will be due and
payable on that date. Accordingly, the Company is amortizing its debt issue
costs over the period from March 31, 2004 through December 1, 2007. The New
Senior Credit Facility is guaranteed unconditionally on a senior basis by the
Companys wholly owned domestic subsidiaries and is collateralized by a lien on
substantially all assets of the Company and its wholly owned subsidiaries.
There are no material restrictions on the Companys ability to obtain funds
from its wholly owned subsidiaries by dividend or otherwise. The Term Loans under the New Senior Credit Facility bear interest, at the
Companys election, at either LIBOR plus an applicable margin or the Base Rate
Basis plus an applicable margin. The Base Rate Basis is the higher of the
prime rate of JPMorgan Chase Bank, the Base CD rate in effect plus 1%, or the
federal funds effective rate plus 0.5%. For the revolving loans the applicable
LIBOR margin and Base Rate margin are subject to adjustments, upwards or
downwards after December 31, 2004, based upon the leverage ratio as defined by
the New Senior Credit Agreement. The interest rates on all borrowings
outstanding under the New Senior Credit Facility were based on LIBOR as of
March 31, 2004. The weighted-average interest rate on the Term borrowings
outstanding at March 31, 2004 was 5.41%. The Revolving Loans are subject to a commitment fee based on the undrawn
portion of the Revolving Loans. The commitment fee is eligible for certain
performance pricing step-downs and was 0.5% per annum as of March 31, 2004.
Outstanding letters of credit totaled $4.2 million as of March 31, 2004. The terms of the Notes and New Senior Credit Facility include significant
operating and financial restrictions, such as limits on the Companys ability
to incur indebtedness, create liens, sell assets, engage in mergers,
acquisitions or consolidations, make investments and pay dividends. In
addition, under the New Senior Credit Facility, the Company is required to
comply with specified financial ratios and tests, including fixed charge
coverage ratios, maximum leverage ratios, capital expenditure measurements, and
Adjusted EBITDA measurements. Results of Operations The three months ended March 31, 2004 compared to the three months ended March 31, 2003 Amount
    
    Percentage2003
    
    2004
    
    Variance
    
    VarianceNet SalesDomestic direct net sales to non-affiliates
    
    $
    109,918
    
    
    $
    108,529
    
    
    $
    (1,389
    )
    
    
    (1.3
    )%International direct net sales to non-affiliates
    
    
    10,093
    
    
    
    14,260
    
    
    
    4,167
    
    
    
    41.3
    %Domistyle net sales to non-affiliates
    
    
    6,110
    
    
    
    8,502
    
    
    
    2,392
    
    
    
    39.1
    %Net sales
    
    $
    126,121
    
    
    $
    131,291
    
    
    $
    5,170
    
    
    
    4.1
    %Other Key Domestic DataNumber of average active Decorating Consultants
    
    
    63,700
    
    
    
    71,500
    
    
    
    7,800
    
    
    
    12.2
    %Number of average active international
Decorating Consultants
    
    
    17,000
    
    
    
    24,700
    
    
    
    7,700
    
    
    
    45.3
    %Number of orders shipped
    
    
    214,266
    
    
    
    243,732
    
    
    
    29,466
    
    
    
    13.8
    %Number of orders per Decorating Consultant
    
    
    3.4
    
    
    
    3.4
    
    
    
    0
    
    
    
    0.0
    %Average order size
    
    $
    513
    
    
    $
    445
    
    
    $
    (68
    )
    
    
    (13.3
    )%
 Net sales increased $5.2 million, or 4.1%, to $131.3 million in the three
months ended March 31, 2004 from $126.1 million in the comparable period in
2003. Domestic direct net sales to non-affiliates decreased $1.4 million or
1.3% in the three-month period ended March 31, 2004 as compared to the three
months ended March 31, 2003. The primary variables that impact domestic direct
net sales include the number of Decorating Consultants, the number of orders
shipped, the number of orders per Decorating Consultant and average order size.
The average order size decreased 13.3% to $445 in the three months ended March
31, 2004 as compared to $513 for the comparable period in 2003. The Company
believes the decrease in average order size is due to the increase of new
Decorating Consultants, who are historically less productive, an increase in
individual customer brochure product sales, and the timing of incentive
promotions. International direct sales to non-affiliates increased $4.2 million
or 41.3% in the comparable three-month 18




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##### Table of Contents



periods primarily related to the increase in Decorating Consultant to
non-affiliates in Mexico, Canada and Puerto Rico. The average number of
international active Decorating Consultant increased 45.3 % to 24,700 for the
three month period ending March 31, 2004 from 17,000 in 2003. Domistyle sales
to non-affiliates increased 39.1% or $2.4 million over the comparable quarters
as the Company continues to expand the wholesale supply channel. Gross profit increased $0.9 million, or 1.3%, to $72.1 million in the
three months ended March 31, 2004 from $71.2 million in the three months ended
March 31, 2003. As a percentage of net sales, gross profit decreased to 54.9%
in the first quarter of 2004 from 56.5% in the first quarter of 2003. The
decrease in gross profit as a percentage of net sales is primarily due to an
inventory reserve adjustment in the first quarter of 2003 that increased gross
margin by $0.8 million related to recalled product. In addition, as the
International Decorating Consultant and Domistyle sales increase, gross profit
as a percentage of total sales declines slightly, since the International sales
generally have a lower margin than domestic Decorating Consultant sales. Selling expense increased $6.3 million or 30.7% to $26.8 million in the
three months ended March 31, 2004 from $20.5 million in the comparable period
of 2003. As a percentage of net sales, selling expense increased to 20.4% as of
the quarter ended March 31, 2004 from 16.3% in the comparable period of 2003.
The increase as a percentage of sales is primarily due to new royalty
agreements on product sales in 2004 with Better Homes and Gardens and The
Thomas Kinkade Company, and the cost and timing of accruals for sales events
and incentive trips. Royalties paid on product sales related to the new
royalty agreements was $0.8 million in 2004. There was a sales event,
Celebrate, held in the first quarter of 2004 which
replaced the Rally sales event that was held during the
third quarter of previous years and a new incentive trip accrued
in the first quarter of 2004 with costs of $1.3 million and $1.1, million
respectively. In addition, in 2003 there was a one-time benefit related to expired sales
incentive certificates of $1.4 million. Freight, warehouse and distribution expense increased $1.4 million, or
9.0%, to $17.0 million in the three months ended March 31, 2004 from $15.6
million in the three months ended March 31, 2003. These costs were 13.0% of net
sales in the 2004 period, as compared to 12.4% in the comparable 2003 period.
This increase in freight, warehouse and distribution expense as a percentage of
sales was primarily due to the increase in freight, labor and packaging
supplies costs as a result of the 13.8% increase in the number of domestic
orders shipped in 2004 over the comparable period of 2003 and the 13.3%
decrease in the average order size. General and administrative expense increased $2.3 million, or 14.7%, to
$17.9 million in the three months ended March 31, 2004, from $15.6 million in
the three months ended March 31, 2003. The increase consists primarily of a
$0.7 million increase in corporate reorganization costs, a $1.7 million
increase in additional subsidiary expenses primarily as a result of the timing
of acquisitions occurring during the first quarter of 2003, and increased
overhead costs due to higher sales in 2004 in the international direct sales
and Domistyle channels. Included in general and administrative expense are
certain additional non-recurring costs related to excess facilities, corporate
organizational realignment expenses, and strategic planning consulting
expenses. These costs were approximately $1.5 million and $0.8 million for the
quarters ended March 31, 2004 and 2003, respectively. Loss on debt refinancing of $1.1 million in the first quarter of 2004 was
a result of the write-off of $0.4 million of unamortized debt issuance costs
and $0.7 million of legal and advisory fees related to the debt restructure in
March, 2004. Stock option expense of approximately $1.0 million was recorded in the
three months ended March 31, 2004, as compared to $0.9 million in the
comparable 2003 period related to compensation expense on options issued under
the 1998 and 2002 Key Employee Stock Option Plans. Income taxes decreased $3.8 million to $0.5 million in the three months
ended March 31, 2004 from $4.3 million in the comparable period of 2003 as a
result of a decrease in income before taxes for the comparable periods. The
effective tax rate is 37.7% as of the first quarter of 2004 versus 37.5% as of
the first quarter of 2003. Segment Profitability The Companys reportable segments include its domestic and international
direct sales operations and Domistyle. The Companys manufacturing operations
are part of the Domistyle segment, which sells the majority of its products to
the Company. As a result, Domistyle sales generally follow the Companys
domestic sales trend. International operations include direct sales by
Decorating Consultants in Mexico, Canada and Puerto Rico. International direct
sales are directly attributable to the number of international Decorating
Consultants the Company has selling its products. The Company evaluates the
performance of its segments and allocates resources to them based on earnings
before interest, taxes, the effects of SAB 101, depreciation and amortization,
reorganization costs, non-cash expense for stock options, loss on debt
restructure, Hicks Muse management fees, and loss on disposition of assets,
(defined as Adjusted EBITDA). The Company also uses Adjusted EBITDA as a
performance measure due to the Companys required compliance thresholds for
Adjusted EBITDA covenants under the New Senior Credit Facility. See Note 7 to
the Companys 19




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##### Table of Contents



Unaudited Consolidated Financial Statements included herein for a
reconciliation of net income to Adjusted EBITDA. The three months ended March 31, 2004 compared to the three months ended March
31, 2003 Consolidated net sales increased $5.2 million, or 4.1%, to $131.3 million
in the three months ended March 31, 2004, from $126.1 million in the comparable
2003 period. Consolidated Adjusted EBITDA decreased $8.5 million, or 30.7%, to
$19.2 million in the quarter ended March 31, 2004 from $27.7 million in the
quarter ended March 31, 2003. See discussion in Results of Operations. Direct Selling Domestic Domestic net sales to non-affiliates and affiliates increased $0.6
million, or 0.5% to $115.2 million in the three months ended March 31, 2004
from $114.6 million in the same period of 2003. Of this increase, domestic net
sales to affiliates increased by $2.1 million or 45.7% to $6.7 million in 2004
from $4.6 million in 2003. The increase in net sales to affiliates is directly
attributable to the net sales increase in the international direct selling
segment. Domestic net sales to non-affiliates decreased $1.4 million or 1.3%
to $108.5 million for the first quarter 2004 from $109.9 million for the first
quarter 2003. The primary sales drivers for non-affiliate sales are average
order size, Decorating Consultant productivity, and number of active Decorating
Consultants. Average order size decreased 13.3% to $445 in the first quarter of
2004 from $513 in the first quarter of 2003. Domestic Adjusted EBITDA
decreased $5.9 million or 37.1% to $10.0 million in the quarter ended March 31,
2004 as compared to $15.9 million in the comparable 2003 period. The primary
reasons for the decrease are discussed in the Results of Operations. International International direct sales include sales in Mexico, Canada and Puerto
Rico. These sales increased $4.2 million, or 41.6%, to $14.3 million in the
three months ended March 31, 2004, from $10.1 million in the three months ended
March 31, 2003. This increase is primarily due to the increase in the
Decorating Consultant base in Mexico, Canada, and Puerto Rico. As of March 31,
2004, the Decorating Consultant base was approximately 19,700, 1,300 and 900 in
Mexico, Canada and Puerto Rico, respectively, as compared to 14,600, 800 and
600 in the comparable period of 2003. Adjusted EBITDA increased $0.7 million,
or 140.0%, to $1.2 million in the quarter ended March 31, 2004 as compared to
$0.5 million in the quarter ended March 31, 2003. Domistyle The Company is in the process of trying to expand its wholesale supply
sales to non-affiliate resellers through its Domistyle segment. Sales to
non-affiliate resellers for the three-month period increased $2.4 million or
39.3% to $8.5 million in 2004 as compared to $6.1 million in the comparable
period of 2003. The increased sales to non-affiliate resellers accounted for
19.5% of Domistyle net sales in the three months ended March 31, 2004 as
compared to 15.5% in the three months ended March 31, 2003. Adjusted EBITDA
generated through Domistyle decreased $2.7 million or 23.1% to $9.0 million in
the quarter ended March 31, 2004 from $11.7 million in the comparable period of
2003. The decrease is mainly attributable to lower margins in the Companys
manufacturing subsidiaries in Mexico. Seasonality The Companys business is influenced by the Christmas holiday season and
by promotional events. Historically, a higher portion of the Companys sales
and net income have been realized during the fourth quarter, and net sales and
net income have generally been slightly lower during the first quarter as
compared to the second and third quarters. Working capital requirements also
fluctuate during the year. They reach their highest levels during the third and
fourth quarters as the Company increases its inventory for the peak season. In
addition to the Companys peak season fluctuations, quarterly results of
operations may fluctuate depending on the timing of, and amount of sales from,
discounts, incentive promotions and/or the introduction of new products. As a
result, the Companys business activities and results of operations in any
quarter are not necessarily indicative of any future trends in the Companys
business. Liquidity and Capital Resources The Companys cash decreased $1.0 million from $36.6 million as of
December 31, 2003, to $35.6 million at March 31, 2004. The decrease resulted
primarily from $5.2 million and $0.9 million of net cash used by operating and
investing activities, respectively, which was offset in part by $4.9 million of
net cash provided by financing activities. 20




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##### Table of Contents



Net cash of $5.2 million used by operating activities consisted primarily
of $7.7 million provided by net income, as adjusted for non-cash items, and
$12.9 million used by working capital. Working capital usage consisted
primarily of a $9.2 million increase in inventory balances, a $4.2 million
increase in accounts receivable, a $3.3 million increase in prepaid expenses
and a decrease of $3.9 in accounts payable, which was offset by a $7.8 million
increase in deferred revenue. Net cash of $0.9 million used in investing activities was a result of
approximately $1.3 million of cash used for purchases of property, plant and
equipment, which was offset by a $0.4 million increase in restricted cash. Net cash of $4.9 million provided by financing activities was primarily a
result of the Companys refinancing of its existing credit facility plus a $2.4
million increase in the book overdraft. The New Senior Credit Facility
provided $320.0 million in cash. From those proceeds the Company paid $168.7
million to pay off the existing credit facility, $109.5 million to redeem the
Companys preferred stock, plus $29.5 million of accumulated preferred stock
dividends, and paid approximately $9.4 million for debt issuance costs and
preferred stock repurchase costs. There were no amounts drawn or paid under the
revolving credit facilities during the first quarter of 2004. Payments on the Notes and the New Senior Credit Facility represent
significant cash requirements for the Company. Interest payments on the Notes
commenced in December 1998 and continue semi-annually until the Notes mature in
2008. The Company has the option to redeem the Notes in whole or in part at any
time. The Term Loans under New Senior Credit Facility which have a maturity
date of March 31, 2011, require quarterly interest and principal payments
starting on June 30, 2004. In addition, the New Senior Credit Facility
includes a $50.0 million five-year revolving credit facility which matures on
March 31, 2009. As of March 31, 2004, there were no outstanding Revolving
Loans. During the first quarter of 2004, the Company paid a total of $171.2
million in debt service, consisting of principal payments under the existing
credit facility of $168.7 million, interest and commitment fees under the
existing credit facility of approximately $2.5 million, and zero interest on
the Notes. The terms of the Notes and New Senior Credit Facility include significant
operating and financial restrictions, such as limits on the Companys ability
to incur indebtedness, create liens, sell assets, engage in mergers or
consolidations, make investments, and pay dividends. In addition, under the New
Senior Credit Facility, the Company is required to comply with specified
financial ratios and tests, including consolidated Adjusted EBITDA
measurements, as defined per the New Senior Credit Facility agreement, minimum
fixed charge coverage ratios, consolidated leverage ratios, capital expenditure
measurements, and consolidated interest coverage ratios. As of March 31, 2004, the Company was in compliance with all covenants or
other requirements set forth in the credit agreement under the New Credit
Facility and indenture with respect to the Notes. Further, the Company does not
have any rating downgrade triggers that would accelerate maturity dates of its
debt. Contractual Obligations The following table summarizes the Companys contractual obligations at
March 31, 2004 and the effects such obligations are expected to have on its
liquidity and cash flow in future periods (in thousands). Payments Due by PeriodLess than
    
    
    
    
    
    
    
    
    
    After 5Total
    
    1 Year
    
    1-3 Years
    
    4-5 Years
    
    YearsCONTRACTUAL OBLIGATIONS:Long-term debt
    
    $
    469,100
    
    
    $
    10,000
    
    
    $
    310,000
    
    
    $
    149,100
    
    
    $
    Capital lease obligations
    
    
    5,225
    
    
    
    1,636
    
    
    
    3,589
    
    
    
    
    
    
    
    Related party note payable
    
    
    1,362
    
    
    
    675
    
    
    
    687
    
    
    
    
    
    
    
    Guaranteed minimum royalty obligation
    
    
    6,575
    
    
    
    3,050
    
    
    
    3,525
    
    
    
    
    
    
    
    Non-cancelable operating lease
obligations (net of subleases)
    
    
    13,140
    
    
    
    2,849
    
    
    
    7,364
    
    
    
    2,927
    
    
    
    Letters of credit
    
    
    4,241
    
    
    
    4,241
    
    
    
    
    
    
    
    
    
    
    
    Total contractual obligations
    
    $
    499,643
    
    
    $
    22,451
    
    
    $
    325,165
    
    
    $
    152,027
    
    
    $
    
 21




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##### Table of Contents



Long-term debt consists of borrowings under the New Senior Credit Facility
and Notes. The New Senior Credit Facility borrowings require quarterly
principal payments and the Notes require semi-annual interest payments. The
Company may, at its option, prepay the term loans without premium or penalty. The Company has entered into several capital leases for warehouse
equipment, manufacturing equipment and office furniture and fixtures. The
initial term of the leases range from three years to seven years. Interest is
imputed at a weighted average rate of 6.35% per annum. In June of 2003, the Company entered into a twelve-year license agreement
(the License Agreement) with Meredith Corporation, of which, the first two
years are non-cancelable by either party. The agreement provides for earned
royalty payments to Meredith Corporation determined by a percentage of net
sales and guaranteed annual minimum royalty payments that escalate through the
term of the license agreement. In addition to this License Agreement, in
February 2004, the Company entered into a two-year license agreement with The
Thomas Kinkade Company (the Licensor) that provides for earned royalty
payments to the Licensor determined by a percentage of net sales and guaranteed
minimum royalty payments. The Company has several outstanding operating leases related to the
Granite facility and additional warehousing space. The majority of the Granite
facility has been subleased. As of March 31, 2004, the Company had $4.2 million letters of credit
outstanding related to insurance policies. At March 31 2004 the Company did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. As such, the Company is not
materially exposed to any financing, liquidity or market or credit risk that
could arise if the Company had engaged in such relationships. The Companys near and long-term operating strategies focus on broadening
the Displayer base through recruiting efforts and increasing retention and
productivity of the existing Displayer base and leveraging the assets of the
Companys manufacturing subsidiaries. The Company believes that cash on hand,
net cash flow from operations and borrowings under the Revolving Loans will be
sufficient to fund its cash requirements through the year ended December 31,
2004. Cash requirements will consist primarily of payments of principal and
interest on outstanding indebtedness, working capital requirements and capital
expenditures. The Companys future operating performance and ability to service
or refinance its current indebtedness will be subject to future economic
conditions and to financial, business and other factors, many of which are
beyond the Companys control. Market-Sensitive Instruments and Risk Management The Companys Products are sold in Mexico and Canada thereby subjecting
the Company to financial market risk due to fluctuating foreign currency
exchange rates. Historically, due to a stable foreign exchange and due to the
fact that these operations have not been significant, the risk has been minor.
However, as the Companys international operations become significant to the
Company as a whole, changes in foreign currency exchange rates could have a
material effect on the Company in the future. The Company has not entered into
any hedging instruments related to foreign currency risk. As a result of the interest pricing mechanism associated with the New
Senior Credit Facility, the Company is exposed to financial market risk due to
fluctuating interest rates. The Company monitors this risk and makes decisions
to participate in interest hedging devices based on interest rate expectations,
the Companys desire to maintain total yield within predetermined levels and
the ratio of fixed to variable debt. The Company is in the process of
finalizing an interest rate swap agreement with a start date of September 28,
2004, to limit the effect of changes in interest rates on a portion of its
long-term borrowings. Under the agreement, the Company pays, on a quarterly
basis, interest at a fixed rate of 3.82%. The agreement has a $100.0 million
notional amount of indebtedness. The Company receives a variable rate of
interest under the swaps based on the three-month London Inter-Bank Offer Rate
(LIBOR) excluding the margin paid under the credit facility on a quarterly
basis. The swap expires on September 28, 2007. In addition, the Company does
not use derivative instruments for trading or speculative purposes. 22




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##### Table of Contents



The following table presents principal cash flows of variable rate debt by
maturity date and the related average interest rates based upon existing terms
and does not take into account the impact of the interest rate swap agreement
mentioned above. The interest rates are estimated based on actual and implied
forward rates using a yield as of April 28, 2004. The Notes are at a fixed rate
of 10.125% and will mature in 2008. Expected Maturity Date2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Total
    
    Fair ValueVariable rate debt
    
    $
    7,500
    
    
    $
    13,750
    
    
    $
    15,000
    
    
    $
    283,750
    
    
    
    
    
    
    $
    320,000
    
    
    $
    Average interest rate
    
    
    4.23
    %
    
    
    7.14
    %
    
    
    8.39
    %
    
    
    9.06
    %
    
    
    
    
    
    
    
    
    
    
    Fixed-rate debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    149,100
    
    
    $
    149,100
    
    
    $
    150,964Interest rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10.125
    %
    
    
    
    
    
    
    
 Inflation Although the Companys operations are affected by general economic trends,
inflation and changing prices did not have a material impact on the Companys
operations during the first quarter of 2003 and 2004. Adoption of Accounting Standards In April of 2004, the Financial Accounting Standards Board, (FASB),
issued Staff Position Statement of Financial Accounting Standards No. 129-1,
Disclosure Requirements under FASB Statement No. 129, Disclosure of
Information about Capital Structure, Relating to Contingently Convertible
Securities (FSP FAS 129-1). FSP FAS 129-1 provides interpretation guidance
regarding the disclosure provisions of FASB Statement No. 129 as it applies to
contingently convertible securities and the potential dilutive effects on
earnings per share. FSP FAS 129-1 is effective as of April 9, 2004 and applies
to all existing and newly created securities. The Company has adopted FSP FAS
129-1 on April 9, 2004 and there was not a financial accounting nor disclosure
impact associated with its adoption. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Securities and Exchange Commission requires that registrants include
information about potential effects of changes in interest rates and currency
exchange on their financial statements. Refer to the information appearing
under the subheading Market-Sensitive Instruments and Risk Management under
Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operation, which information is hereby incorporated by reference
into this Item 3. All statements other than historical information incorporated
into this Item 3 are forward-looking statements. The actual impact of future
market changes could differ materially due to, among other things, the factors
discussed in this report. 
 ITEM 4. CONTROLS AND PROCEDURES Based on their evaluation of the Companys disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the Exchange Act)), the Companys principal
executive and principal financial officers concluded that the Companys
disclosure controls and procedures were effective as of March 31, 2004. There has been no change in the Companys internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)
that occurred during the Companys fiscal quarter ended March 31, 2004, that
has materially affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting. 23




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##### Table of Contents



PART II OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS In the ordinary course of its business, the Company is from time to time
threatened with or named as a defendant in various lawsuits, including product
liability claims. The Company is also subject to certain environmental
proceedings. The Company is not currently a party to any material litigation or
proceeding, and is not aware of any litigation or proceeding threatened against
it that could have a material adverse effect on the Companys business,
financial condition or results of operations. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K  (a)
    
    EXHIBITS EXHIBITNUMBER
    
    DESCRIPTION10.1
    
    Credit Agreement, dated March 31, 2004, among Home Interiors &
Gifts, Inc., the several banks and other financial institutions or
entities parties thereto, Bear Sterns Corporate Lending Inc. and
JPMorgan Chase Bank (incorporated by reference to Exhibit 99.1 of
the Companys Current Report on Form 8-K, No. 333-62021, filed on
April 2, 2004).10.2
    
    Stock Purchase Agreement, dated March 31, 2004, among Home
Interiors & Gifts, Inc., HI Cayman, L.P. and HI Senior Debt
Partners L.P. (incorporated by reference to Exhibit 99.2 of the
Companys Current Report on Form 8-K, No. 333-62021, filed on
April 2, 2004).10.3
    
    Termination and Mutual Release, dated as of March 31, 2004, by and
between Home Interiors & Gifts, Inc., a Texas corporation, on the
one hand, and HI Cayman, L.P., a Cayman Islands exempted limited
partnership, and HI Senior Debt Partners, L.P., a Texas limited
partnership (incorporated by reference to Exhibit 99.3 of the
Companys Current Report on Form 8-K, No. 333-62021, filed on
April 2, 2004).31.1*
    
    Certification of Chief Executive Officer of the Company pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
    
    Certification of Chief Financial Officer of the Company pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.32.1*
    
    Certification of Chief Executive Officer of the Company pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.32.2*
    
    Certification of Chief Financial Officer of the Company pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
   *Filed herewith.  (b)
    
    REPORTS ON FORM 8-K On January 12, 2004, the Company filed a current report on Form 8-K
with respect to an issued press release announcing that the Company had
appointed Mike Lohner as CEO, effective January 1, 2004. On February 27, 2004 the Company filed a current report on Form 8-K
with respect to entering into a commitment letter with two financial
institutions pursuant to which the Company intends to refinance loans
outstanding under its existing senior credit facility. On April 2, 2004 the Company filed a current report on Form 8-K with
respect to entering into the following agreements:  
    
    Credit Agreement, dated March 31, 2004, among Home
Interiors & Gifts, Inc., the several banks and other financial
institutions or entities parties thereto, Bear Sterns Corporate
Lending Inc. and JPMorgan Chase Bank.
    
    Stock Purchase Agreement, dated March 31, 2004, among
Home Interiors & Gifts, Inc., HI Cayman, L.P. and HI Senior Debt
Partners, L.P.
    
    Termination and Mutual Release, dated as of March 31,
2004, by and between Home Interiors & Gifts, Inc., a Texas
corporation, on the one hand, and HI Cayman, L.P., a Cayman
Islands exempted limited partnership, and
HI Senior Debt Partners, L.P., a Texas limited partnership. 24




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##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized. HOME INTERIORS & GIFTS, INC.By:
    
    /s/ KENNETH J. CICHOCKIKenneth J. Cichocki Sr.Vice President of Finance and Chief Financial Officer(principal financial and accounting officer)Date: May 13, 2004
 25




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##### Table of Contents



EXHIBIT INDEX EXHIBITNUMBER
    
    DESCRIPTION10.1
    
    Credit Agreement, dated March 31, 2004, among Home Interiors &
Gifts, Inc., the several banks and other financial institutions or
entities parties thereto, Bear Sterns Corporate Lending Inc. and
JPMorgan Chase Bank (incorporated by reference to Exhibit 99.1 of
the Companys Current Report on Form 8-K, No. 333-62021, filed on
April 2, 2004).10.2
    
    Stock Purchase Agreement, dated March 31, 2004, among Home
Interiors & Gifts, Inc., HI Cayman, L.P. and HI Senior Debt
Partners L.P. (incorporated by reference to Exhibit 99.2 of the
Companys Current Report on Form 8-K, No. 333-62021, filed on
April 2, 2004).10.3
    
    Termination and Mutual Release, dated as of March 31, 2004, by and
between Home Interiors & Gifts, Inc., a Texas corporation, on the
one hand, and HI Cayman, L.P., a Cayman Islands exempted limited
partnership, and HI Senior Debt Partners, L.P., a Texas limited
partnership (incorporated by reference to Exhibit 99.3 of the
Companys Current Report on Form 8-K, No. 333-62021, filed on
April 2, 2004).31.1*
    
    Certification of Chief Executive Officer of the Company pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
    
    Certification of Chief Financial Officer of the Company pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.32.1*
    
    Certification of Chief Executive Officer of the Company pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.32.2*
    
    Certification of Chief Financial Officer of the Company pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
   *Filed herewith. 26