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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
 QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
 COMMISSION FILE NUMBER 333-62021
 HOME INTERIORS & GIFTS, INC.
  TEXAS
    
    75-0981828(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)1649 FRANKFORD ROAD WEST, CARROLLTON, TEXAS
    
    75007-4605(Address of principal executive offices)
    
    (Zip Code)
 
 þ o
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
 INDEX
 PAGENO.PART I  FINANCIAL INFORMATIONItem 1. Unaudited Interim Consolidated Financial Statements:Consolidated Balance Sheets as of December 31, 2004 and September 30, 2005
    
    
    3Consolidated Statements of Operations and Comprehensive Income for the three months and nine months ended September 30, 2004 and 2005
    
    
    4Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2005
    
    
    5Notes to Unaudited Interim Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    20Item 3. Quantitative and Qualitative Disclosure About Market Risk
    
    
    36Item 4. Controls and Procedures
    
    
    36PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    37Item 6. Exhibits
    
    
    37Certification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
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ITEM 1. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
 HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED BALANCE SHEETS
 As of December 31, 2004 and September 30, 2005
 (Unaudited)December 31,
    
    
    September 30,2004
    
    
    2005(In thousands, exceptshare information)ASSETSCurrent assets:Cash
    
    $
    27,820
    
    
    $
    27,251Accounts receivable, net
    
    
    19,534
    
    
    
    25,634Inventories, net
    
    
    71,801
    
    
    
    83,698Deferred income tax asset
    
    
    6,111
    
    
    
    2,746Other current assets
    
    
    12,054
    
    
    
    12,673Total current assets
    
    
    137,320
    
    
    
    152,002Property, plant and equipment, net
    
    
    66,466
    
    
    
    62,823Debt issuance costs, net
    
    
    10,593
    
    
    
    8,701Goodwill
    
    
    13,703
    
    
    
    13,969Other assets, net
    
    
    1,186
    
    
    
    1,124Total assets
    
    $
    229,268
    
    
    $
    238,619LIABILITIES AND SHAREHOLDERS DEFICITCurrent liabilities:Book overdraft
    
    $
    4,838
    
    
    $
    4,699Accounts payable
    
    
    26,156
    
    
    
    30,346Accrued seminars and incentive awards
    
    
    9,732
    
    
    
    11,357Royalties payable to decorating consultants
    
    
    5,416
    
    
    
    5,890Accrued compensation
    
    
    2,448
    
    
    
    2,769Income taxes payable
    
    
    15,273
    
    
    
    646Current deferred tax liability
    
    
    
    
    
    
    709Current maturity of related party note payable.
    
    
    687
    
    
    
    687Current maturities of long-term debt and
capital lease obligations
    
    
    15,550
    
    
    
    329,388Other current liabilities
    
    
    20,092
    
    
    
    27,527Total current liabilities
    
    
    100,192
    
    
    
    414,018Long-term debt and capital lease obligations,
net of current maturities
    
    
    450,325
    
    
    
    150,158Deferred income tax liability
    
    
    2,812
    
    
    
    1,862Other liabilities
    
    
    6,611
    
    
    
    5,349Total liabilities
    
    
    559,940
    
    
    
    571,387Commitments and contingencies (Note 12)Shareholders deficit: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
    
    
    144,061
    
    
    
    146,170Accumulated deficit
    
    
    (475,295
    )
    
    
    (479,471
    )Accumulated other comprehensive loss
    
    
    (962
    )
    
    
    (991
    )Total shareholders deficit
    
    
    (330,672
    )
    
    
    (332,768
    )Total liabilities and shareholders deficit
    
    $
    229,268
    
    
    $
    238,619
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
 For the three months and nine months ended September 30, 2004 and 2005
 (In thousands)
 (Unaudited)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2004
    
    
    2005
    
    
    2004
    
    
    2005Net sales
    
    $
    123,675
    
    
    $
    118,410
    
    
    $
    387,466
    
    
    $
    369,182Cost of goods sold
    
    
    60,738
    
    
    
    61,545
    
    
    
    180,542
    
    
    
    182,000Gross profit
    
    
    62,937
    
    
    
    56,865
    
    
    
    206,924
    
    
    
    187,182Selling, general and administrative:Selling
    
    
    22,104
    
    
    
    22,632
    
    
    
    75,968
    
    
    
    75,494Freight, warehouse and distribution
    
    
    17,649
    
    
    
    16,016
    
    
    
    52,057
    
    
    
    50,401General and administrative
    
    
    13,805
    
    
    
    14,986
    
    
    
    49,483
    
    
    
    48,944Loss on the disposition of assets
    
    
    47
    
    
    
    248
    
    
    
    1,564
    
    
    
    249Stock option expense
    
    
    1,244
    
    
    
    119
    
    
    
    3,176
    
    
    
    2,109Loss on debt refinancing
    
    
    
    
    
    
    
    
    
    
    1,071
    
    
    
    Total selling, general and administrative
    
    
    54,849
    
    
    
    54,001
    
    
    
    183,319
    
    
    
    177,197Operating income
    
    
    8,088
    
    
    
    2,864
    
    
    
    23,605
    
    
    
    9,985Other income (expense):Interest income
    
    
    51
    
    
    
    203
    
    
    
    210
    
    
    
    472Interest expense
    
    
    (9,215
    )
    
    
    (12,143
    )
    
    
    (25,402
    )
    
    
    (34,897
    )Other income (expense), net
    
    
    (1,720
    )
    
    
    647
    
    
    
    (2,100
    )
    
    
    2,331Other income (expense), net
    
    
    (10,884
    )
    
    
    (11,293
    )
    
    
    (27,292
    )
    
    
    (32,094
    )Loss from continuing operations before income taxes
    
    
    (2,796
    )
    
    
    (8,429
    )
    
    
    (3,687
    )
    
    
    (22,109
    )Income tax benefit
    
    
    1,840
    
    
    
    8,587
    
    
    
    3,556
    
    
    
    17,933Income (loss) from continuing operations
    
    
    (956
    )
    
    
    158
    
    
    
    (131
    )
    
    
    (4,176
    )Discontinued operations (Note 7):Discontinued operations loss, net of tax
    
    
    190
    
    
    
    
    
    
    
    3,898
    
    
    
    Net income (loss)
    
    
    (1,146
    )
    
    
    158
    
    
    
    (4,029
    )
    
    
    (4,176
    )Other comprehensive income (loss):Cumulative translation adjustment
    
    
    (67
    )
    
    
    2
    
    
    
    (64
    )
    
    
    (29
    )Other comprehensive income (loss)
    
    
    (67
    )
    
    
    2
    
    
    
    (64
    )
    
    
    (29
    )Comprehensive income (loss)
    
    $
    (1,213
    )
    
    $
    160
    
    
    $
    (4,093
    )
    
    $
    (4,205
    )
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 For the Nine Months Ended September 30, 2004 and 2005
 (In Thousands)
 (Unaudited)
 Nine Months EndedSeptember 30,2004
    
    
    2005Cash flows from operating activities:Net loss
    
    $
    (4,029
    )
    
    $
    (4,176
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    11,775
    
    
    
    11,102Impairment of goodwill
    
    
    1,060
    
    
    
    Impairment of property, plant and equipment
    
    
    1,325
    
    
    
    Amortization of debt issuance costs
    
    
    1,824
    
    
    
    2,911Provision for doubtful accounts
    
    
    2,377
    
    
    
    2,258Provision for losses on inventories
    
    
    519
    
    
    
    6,005Loss on debt refinancing
    
    
    1,071
    
    
    
    Loss on disposition of assets
    
    
    1,564
    
    
    
    249Stock option expense
    
    
    3,176
    
    
    
    2,109Unrealized gain (loss) on derivatives
    
    
    (1,730
    )
    
    
    1,242Deferred tax expense
    
    
    422
    
    
    
    3,250Changes in assets and liabilities:Accounts receivable
    
    
    (10,882
    )
    
    
    (8,358
    )Inventories
    
    
    (22,395
    )
    
    
    (17,902
    )Other current assets
    
    
    (9,943
    )
    
    
    (619
    )Other assets
    
    
    221
    
    
    
    62Accounts payable
    
    
    12,492
    
    
    
    3,748Related party payable
    
    
    (709
    )
    
    
    (879
    )Income taxes payable
    
    
    (2,934
    )
    
    
    (14,753
    )Other current liabilities
    
    
    6,777
    
    
    
    7,964Total adjustments
    
    
    (3,990
    )
    
    
    (9,147
    )Net cash used in operating activities
    
    
    (8,019
    )
    
    
    (5,787
    )Cash flows from investing activities:Purchases of property, plant and equipment
    
    
    (6,539
    )
    
    
    (7,638
    )Proceeds from the sale of property, plant and equipment
    
    
    6
    
    
    
    372Net cash used in investing activities
    
    
    (6,533
    )
    
    
    (7,266
    )Cash flows from financing activities:Book overdraft
    
    
    (2,651
    )
    
    
    (139
    )Proceeds from borrowings under revolving loan facility
    
    
    
    
    
    
    40,000Payments under revolving loan facility
    
    
    
    
    
    
    (15,000
    )Payments of principal under capital lease obligations
    
    
    (1,216
    )
    
    
    (1,329
    )Proceeds from borrowings under senior credit facility
    
    
    320,000
    
    
    
    Payments of principal under senior credit facility
    
    
    (173,681
    )
    
    
    (10,000
    )Debt issuance and amendment costs
    
    
    (9,126
    )
    
    
    (1,019
    )Payment of preferred stock repurchase and preferred stock dividends
    
    
    (139,000
    )
    
    
    Preferred stock issuance costs
    
    
    (299
    )
    
    
    Net cash provided by (used in) financing activities
    
    
    (5,973
    )
    
    
    12,513Effect of cumulative translation adjustment
    
    
    (64
    )
    
    
    (29
    )Net decrease in cash
    
    
    (20,589
    )
    
    
    (569
    )Cash at beginning of year
    
    
    36,636
    
    
    
    27,820Cash at end of period
    
    $
    16,047
    
    
    $
    27,251
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
 
 NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
 1. Organization and Background
   2. Managements Plans, Liquidity and Capital Resources
  
    
    The Company has incurred losses from continuing operations before taxes and negative
operating cash flows in five of the last six quarterly periods. This performance is the
result of lower operating income from a decline in revenue and significant interest expense
on indebtedness.
    
    As a result of classifying $327.5 million of debt from our senior credit facility as a
current obligation (see Note 9), the Company had a working capital deficit of $254.5
million as of September 30, 2005.
    
    The Company was required to obtain waivers of compliance with financial covenants under
the senior credit facility as of June 30, 2005 and September 30, 2005 (see Note 9).
    
    The Company has significant cash debt service requirements related to its senior credit
facility and senior subordinated notes. In the event the Company is unable to obtain
further waivers or otherwise agree with its lenders on the terms of a restructuring of such
senior credit facility, the lenders under the senior credit facility could elect to
accelerate all amounts outstanding under the senior credit facility.
  6




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3. Significant Accounting Policies
    Reclassifications
  Stock-based Compensations Plans
  7




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Compensation Charge
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2004
    
    
    2005
    
    
    2004
    
    
    2005Net income (loss), as reported
    
    $
    (1,146
    )
    
    $
    158
    
    
    $
    (4,029
    )
    
    $
    (4,176
    )Add: Stock-based employee
compensation expense included
in reported net income
(loss), net of related tax
effects
    
    
    442
    
    
    
    42
    
    
    
    1,379
    
    
    
    1,002Deduct: Stock-based employee
compensation expense
determined under fair value
based method for all awards,
net of related tax effects
    
    
    (515
    )
    
    
    (98
    )
    
    
    (1,542
    )
    
    
    (1,193
    )Pro forma net income (loss)
    
    $
    (1,219
    )
    
    $
    102
    
    
    $
    (4,192
    )
    
    $
    (4,367
    )
 4. Inventories, Net
  December 31,
    
    
    September 30,2004
    
    
    2005Raw materials
    
    $
    8,184
    
    
    $
    10,204Work in process
    
    
    2,231
    
    
    
    2,298Finished goods
    
    
    67,559
    
    
    
    83,41377,974
    
    
    
    95,915Inventory allowance
    
    
    (6,173
    )
    
    
    (12,217
    )$
    71,801
    
    
    $
    83,698
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5. Other Current Liabilities
  December 31,
    
    
    September 30,2004
    
    
    2005Interest
    
    $
    1,258
    
    
    $
    5,133Accrued employee benefits
    
    
    2,997
    
    
    
    3,181Sales taxes
    
    
    3,872
    
    
    
    4,539Other taxes
    
    
    1,743
    
    
    
    1,613Deferred revenue
    
    
    4,482
    
    
    
    9,631Related parties
    
    
    748
    
    
    
    134Accrued product license royalties
    
    
    1,439
    
    
    
    1,099Other
    
    
    3,553
    
    
    
    2,197$
    20,092
    
    
    $
    27,527
 6. Adoption of Financial Accounting Standards
     9




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7. Discontinued Operations
    Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2004
    
    
    2005
    
    
    2004
    
    
    2005Net sales
    
    $
    (4
    )
    
    $
    
    
    
    $
    824
    
    
    $
    Cost of goods sold
    
    
    43
    
    
    
    
    
    
    
    1,819
    
    
    
    Gross profit
    
    
    (47
    )
    
    
    
    
    
    
    (995
    )
    
    
    Selling, general and administrative:General and administrative
    
    
    144
    
    
    
    
    
    
    
    2,776
    
    
    
    Total selling, general and administrative
    
    
    144
    
    
    
    
    
    
    
    2,776
    
    
    
    Operating loss
    
    
    (191
    )
    
    
    
    
    
    
    (3,771
    )
    
    
    Other income (expense):Interest expense
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    Other income (expense), net
    
    
    1
    
    
    
    
    
    
    
    (125
    )
    
    
    Other income (expense), net
    
    
    1
    
    
    
    
    
    
    
    (127
    )
    
    
    Loss before income taxes
    
    
    (190
    )
    
    
    
    
    
    
    (3,898
    )
    
    
    Income tax benefit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Loss on discontinued operations, net of tax
    
    $
    (190
    )
    
    $
    
    
    
    $
    (3,898
    )
    
    $
    
 September 30,
    
    
    September 30,2004
    
    
    2005Balance sheet data:Long term assets held for sale
    
    $
    164
    
    
    
    
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8. Income Tax Benefit
 Accounting for Income Taxes,
     9. Senior Credit Facility
   11




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10. Segment Reporting
  
    
    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 various Products.
  Direct
    
    
    DirectSelling
    
    
    SellingDomestic
    
    
    International
    
    
    Domistyle
    
    
    Eliminations
    
    
    ConsolidatedThree months ended September 30,2004Net sales to non-affiliates
    
    $
    98,957
    
    
    $
    18,064
    
    
    $
    6,654
    
    
    $
    
    
    
    $
    123,675Net sales to affiliates
    
    
    6,577
    
    
    
    
    
    
    
    30,090
    
    
    
    (36,667
    )
    
    
    Modified EBITDA
    
    
    5,708
    
    
    
    2,416
    
    
    
    7,714
    
    
    
    (172
    )
    
    
    15,6662005Net sales to non-affiliates
    
    $
    89,283
    
    
    $
    20,870
    
    
    $
    8,257
    
    
    $
    
    
    
    $
    118,410Net sales to affiliates
    
    
    5,922
    
    
    
    
    
    
    
    20,937
    
    
    
    (26,859
    )
    
    
    Modified EBITDA
    
    
    4,840
    
    
    
    3,262
    
    
    
    2,469
    
    
    
    520
    
    
    
    11,091
 12




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##### Table of Contents



Direct
    
    
    DirectSelling
    
    
    SellingDomestic
    
    
    International
    
    
    Domistyle
    
    
    Eliminations
    
    
    ConsolidatedNine months ended September 30,2004Net sales to non-affiliates
    
    $
    318,237
    
    
    $
    48,446
    
    
    $
    20,783
    
    
    $
    
    
    
    $
    387,466Net sales to affiliates
    
    
    21,793
    
    
    
    
    
    
    
    98,549
    
    
    
    (120,342
    )
    
    
    Modified EBITDA
    
    
    22,306
    
    
    
    5,717
    
    
    
    27,604
    
    
    
    (1,721
    )
    
    
    53,906Total assets
    
    
    224,707
    
    
    
    20,895
    
    
    
    86,735
    
    
    
    (78,626
    )
    
    
    253,711Goodwill
    
    
    
    
    
    
    
    
    
    
    13,645
    
    
    
    
    
    
    
    13,645Capital expenditures
    
    
    3,300
    
    
    
    817
    
    
    
    2,422
    
    
    
    
    
    
    
    6,5392005Net sales to non-affiliates
    
    $
    289,642
    
    
    $
    54,926
    
    
    $
    24,614
    
    
    $
    
    
    
    $
    369,182Net sales to affiliates
    
    
    23,733
    
    
    
    
    
    
    
    81,056
    
    
    
    (104,789
    )
    
    
    Modified EBITDA
    
    
    11,152
    
    
    
    7,012
    
    
    
    17,558
    
    
    
    (1,092
    )
    
    
    34,630Total assets
    
    
    207,585
    
    
    
    27,646
    
    
    
    78,580
    
    
    
    (75,192
    )
    
    
    238,619Goodwill
    
    
    
    
    
    
    
    
    
    
    13,969
    
    
    
    
    
    
    
    13,969Capital expenditures
    
    
    5,248
    
    
    
    1,952
    
    
    
    438
    
    
    
    
    
    
    
    7,638
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2004
    
    
    2005
    
    
    2004
    
    
    2005Net income (loss)
    
    $
    (1,146
    )
    
    $
    158
    
    
    $
    (4,029
    )
    
    $
    (4,176
    )Effect of SAB 101
    
    
    592
    
    
    
    1,007
    
    
    
    2,859
    
    
    
    3,045Discontinued operations, net of tax
    
    
    190
    
    
    
    
    
    
    
    3,898
    
    
    
    Interest income
    
    
    (51
    )
    
    
    (203
    )
    
    
    (210
    )
    
    
    (472
    )Interest expense
    
    
    9,215
    
    
    
    12,143
    
    
    
    25,402
    
    
    
    34,897Realized gain on derivatives
    
    
    
    
    
    
    (64
    )
    
    
    
    
    
    
    (203
    )Unrealized (gain) loss on derivatives
    
    
    1,819
    
    
    
    (886
    )
    
    
    1,730
    
    
    
    (1,242
    )Income tax benefit
    
    
    (1,840
    )
    
    
    (8,587
    )
    
    
    (3,556
    )
    
    
    (17,933
    )Depreciation and amortization
    
    
    4,354
    
    
    
    3,785
    
    
    
    11,775
    
    
    
    11,102Stock option expense
    
    
    1,244
    
    
    
    119
    
    
    
    3,176
    
    
    
    2,109Loss on debt refinancing
    
    
    
    
    
    
    
    
    
    
    1,071
    
    
    
    Reorganization costs
    
    
    1,242
    
    
    
    3,371
    
    
    
    10,226
    
    
    
    7,254Loss on disposition of assets
    
    
    47
    
    
    
    248
    
    
    
    1,564
    
    
    
    249Modified EBITDA
    
    $
    15,666
    
    
    $
    11,091
    
    
    $
    53,906
    
    
    $
    34,630
 11. Guarantor Financial Data
  13




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##### Table of Contents



Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Three Months Ended September 30, 2004
 Non-Borrower
    
    
    Guarantors
    
    
    Guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet sales
    
    $
    107,219
    
    
    $
    36,086
    
    
    $
    17,198
    
    
    $
    (36,828
    )
    
    $
    123,675Cost of good sold
    
    
    59,457
    
    
    
    26,630
    
    
    
    11,428
    
    
    
    (36,777
    )
    
    
    60,738Gross profit
    
    
    47,762
    
    
    
    9,456
    
    
    
    5,770
    
    
    
    (51
    )
    
    
    62,937Total selling, general and administrative
    
    
    46,633
    
    
    
    2,820
    
    
    
    5,396
    
    
    
    
    
    
    
    54,849Operating income
    
    
    1,129
    
    
    
    6,636
    
    
    
    374
    
    
    
    (51
    )
    
    
    8,088Other income (expense), net
    
    
    (11,152
    )
    
    
    187
    
    
    
    201
    
    
    
    (120
    )
    
    
    (10,884
    )Income (loss) before income taxes
    
    
    (10,023
    )
    
    
    6,823
    
    
    
    575
    
    
    
    (171
    )
    
    
    (2,796
    )Income tax benefit (provision)
    
    
    4,957
    
    
    
    (2,551
    )
    
    
    (462
    )
    
    
    (104
    )
    
    
    1,840Equity in income (loss) of affiliated
companies, net of tax
    
    
    4,193
    
    
    
    (1,266
    )
    
    
    
    
    
    
    (2,927
    )
    
    
    Income (loss) from continuing operations
    
    
    (873
    )
    
    
    3,006
    
    
    
    113
    
    
    
    (3,202
    )
    
    
    (956
    )Discontinued operations loss, net of tax
    
    
    
    
    
    
    
    
    
    
    190
    
    
    
    
    
    
    
    190Net income (loss)
    
    
    (873
    )
    
    
    3,006
    
    
    
    (77
    )
    
    
    (3,202
    )
    
    
    (1,146
    )Other comprehensive income (loss)
    
    
    6
    
    
    
    
    
    
    
    (73
    )
    
    
    
    
    
    
    (67
    )Comprehensive income (loss)
    
    $
    (867
    )
    
    $
    3,006
    
    
    $
    (150
    )
    
    $
    (3,202
    )
    
    $
    (1,213
    )
 Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Three Months Ended September 30, 2005
 Non-Borrower
    
    
    Guarantors
    
    
    Guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet sales
    
    $
    97,160
    
    
    $
    31,700
    
    
    $
    16,399
    
    
    $
    (26,849
    )
    
    $
    118,410Cost of good sold
    
    
    54,172
    
    
    
    26,828
    
    
    
    7,978
    
    
    
    (27,433
    )
    
    
    61,545Gross profit
    
    
    42,988
    
    
    
    4,872
    
    
    
    8,421
    
    
    
    584
    
    
    
    56,865Total selling, general and administrative
    
    
    44,820
    
    
    
    2,720
    
    
    
    6,461
    
    
    
    
    
    
    
    54,001Operating income (loss)
    
    
    (1,832
    )
    
    
    2,152
    
    
    
    1,960
    
    
    
    584
    
    
    
    2,864Other income (expense), net
    
    
    (11,284
    )
    
    
    148
    
    
    
    (92
    )
    
    
    (65
    )
    
    
    (11,293
    )Income (loss) before income taxes
    
    
    (13,116
    )
    
    
    2,300
    
    
    
    1,868
    
    
    
    519
    
    
    
    (8,429
    )Income tax benefit (provision)
    
    
    10,569
    
    
    
    (792
    )
    
    
    (983
    )
    
    
    (207
    )
    
    
    8,587Equity in income (loss) of affiliated
companies, net of tax
    
    
    2,393
    
    
    
    (337
    )
    
    
    
    
    
    
    (2,056
    )
    
    
    Net income (loss)
    
    
    (154
    )
    
    
    1,171
    
    
    
    885
    
    
    
    (1,744
    )
    
    
    158Other comprehensive income (loss)
    
    
    (5
    )
    
    
    
    
    
    
    7
    
    
    
    
    
    
    
    2Comprehensive income (loss)
    
    $
    (159
    )
    
    $
    1,171
    
    
    $
    892
    
    
    $
    (1,744
    )
    
    $
    160
 14




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##### Table of Contents



Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Nine Months Ended September 30, 2004
 Non-Borrower
    
    
    Guarantors
    
    
    Guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet sales
    
    $
    345,787
    
    
    $
    115,439
    
    
    $
    49,377
    
    
    $
    (123,137
    )
    
    $
    387,466Cost of good sold
    
    
    186,426
    
    
    
    80,442
    
    
    
    35,504
    
    
    
    (121,830
    )
    
    
    180,542Gross profit
    
    
    159,361
    
    
    
    34,997
    
    
    
    13,873
    
    
    
    (1,307
    )
    
    
    206,924Total selling, general and administrative
    
    
    154,812
    
    
    
    9,491
    
    
    
    19,016
    
    
    
    
    
    
    
    183,319Operating income (loss)
    
    
    4,549
    
    
    
    25,506
    
    
    
    (5,143
    )
    
    
    (1,307
    )
    
    
    23,605Other income (expense), net
    
    
    (26,864
    )
    
    
    577
    
    
    
    (592
    )
    
    
    (413
    )
    
    
    (27,292
    )Income (loss) before income taxes
    
    
    (22,315
    )
    
    
    26,083
    
    
    
    (5,735
    )
    
    
    (1,720
    )
    
    
    (3,687
    )Income tax benefit (provision)
    
    
    12,356
    
    
    
    (7,868
    )
    
    
    (1,048
    )
    
    
    116
    
    
    
    3,556Equity in income (loss) of affiliated
companies, net of tax
    
    
    7,534
    
    
    
    (12,936
    )
    
    
    
    
    
    
    5,402
    
    
    
    Income (loss) from continuing operations
    
    
    (2,425
    )
    
    
    5,279
    
    
    
    (6,783
    )
    
    
    3,798
    
    
    
    (131
    )Discontinued operations loss, net of tax.
    
    
    
    
    
    
    
    
    
    
    3,898
    
    
    
    
    
    
    
    3,898Net income (loss)
    
    
    (2,425
    )
    
    
    5,279
    
    
    
    (10,681
    )
    
    
    3,798
    
    
    
    (4,029
    )Other comprehensive income (loss)
    
    
    13
    
    
    
    
    
    
    
    (77
    )
    
    
    
    
    
    
    (64
    )Comprehensive income (loss)
    
    $
    (2,412
    )
    
    $
    5,279
    
    
    $
    (10,758
    )
    
    $
    3,798
    
    
    $
    (4,093
    )
 Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Nine Months Ended September 30, 2005
 Non-Borrower
    
    
    Guarantors
    
    
    Guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet sales
    
    $
    318,960
    
    
    $
    110,868
    
    
    $
    43,168
    
    
    $
    (103,814
    )
    
    $
    369,182Cost of good sold
    
    
    177,193
    
    
    
    85,852
    
    
    
    21,794
    
    
    
    (102,839
    )
    
    
    182,000Gross profit
    
    
    141,767
    
    
    
    25,016
    
    
    
    21,374
    
    
    
    (975
    )
    
    
    187,182Total selling, general and administrative
    
    
    148,748
    
    
    
    9,334
    
    
    
    19,115
    
    
    
    
    
    
    
    177,197Operating income (loss)
    
    
    (6,981
    )
    
    
    15,682
    
    
    
    2,259
    
    
    
    (975
    )
    
    
    9,985Other income (expense), net
    
    
    (33,117
    )
    
    
    412
    
    
    
    728
    
    
    
    (117
    )
    
    
    (32,094
    )Income (loss) before income taxes
    
    
    (40,098
    )
    
    
    16,094
    
    
    
    2,987
    
    
    
    (1,092
    )
    
    
    (22,109
    )Income tax benefit (provision)
    
    
    20,098
    
    
    
    (1,088
    )
    
    
    (1,486
    )
    
    
    409
    
    
    
    17,933Equity in income (loss) of affiliated
companies, net of tax
    
    
    16,508
    
    
    
    (473
    )
    
    
    
    
    
    
    (16,035
    )
    
    
    Net income (loss)
    
    
    (3,492
    )
    
    
    14,533
    
    
    
    1,501
    
    
    
    (16,718
    )
    
    
    (4,176
    )Other comprehensive loss
    
    
    (3
    )
    
    
    
    
    
    
    (26
    )
    
    
    
    
    
    
    (29
    )Comprehensive income (loss)
    
    $
    (3,495
    )
    
    $
    14,533
    
    
    $
    1,475
    
    
    $
    (16,718
    )
    
    $
    (4,205
    )
 15




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##### Table of Contents



Condensed Consolidating Balance Sheet
As of December 31, 2004
 Non-Borrower
    
    
    Guarantors
    
    
    Guarantors
    
    
    Consolidating
    
    
    Elimination
    
    
    ConsolidatedASSETSCurrent assets:Cash
    
    $
    27,177
    
    
    $
    46
    
    
    $
    597
    
    
    $
    27,820
    
    
    $
    
    
    
    $
    27,820Accounts receivable, net
    
    
    10,475
    
    
    
    7,483
    
    
    
    1,576
    
    
    
    19,534
    
    
    
    
    
    
    
    19,534Inventories, net
    
    
    53,313
    
    
    
    15,538
    
    
    
    7,567
    
    
    
    76,418
    
    
    
    (4,617
    )
    
    
    71,801Other current assets
    
    
    8,018
    
    
    
    2,187
    
    
    
    6,782
    
    
    
    16,987
    
    
    
    1,178
    
    
    
    18,165Due from (due to)
affiliated companies
    
    
    (8,358
    )
    
    
    22,358
    
    
    
    (14,000
    )
    
    
    
    
    
    
    
    
    
    
    Total current assets
    
    
    90,625
    
    
    
    47,612
    
    
    
    2,522
    
    
    
    140,759
    
    
    
    (3,439
    )
    
    
    137,320Property, plant and
equipment, net
    
    
    41,252
    
    
    
    19,037
    
    
    
    6,177
    
    
    
    66,466
    
    
    
    
    
    
    
    66,466Investment in subsidiaries
    
    
    66,248
    
    
    
    (7,449
    )
    
    
    
    
    
    
    58,799
    
    
    
    (58,799
    )
    
    
    Debt issuance costs and other
assets, net
    
    
    11,431
    
    
    
    13,868
    
    
    
    183
    
    
    
    25,482
    
    
    
    
    
    
    
    25,482Total assets
    
    $
    209,556
    
    
    $
    73,068
    
    
    $
    8,882
    
    
    $
    291,506
    
    
    $
    (62,238
    )
    
    $
    229,268LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    21,111
    
    
    $
    3,594
    
    
    $
    819
    
    
    $
    25,524
    
    
    $
    632
    
    
    $
    26,156Current maturity of related
party note payable
    
    
    687
    
    
    
    
    
    
    
    
    
    
    
    687
    
    
    
    
    
    
    
    687Current maturities of
long-term debt and
capital lease
obligations
    
    
    15,129
    
    
    
    232
    
    
    
    189
    
    
    
    15,550
    
    
    
    
    
    
    
    15,550Other current liabilities
    
    
    42,682
    
    
    
    6,519
    
    
    
    8,598
    
    
    
    57,799
    
    
    
    
    
    
    
    57,799Total current liabilities
    
    
    79,609
    
    
    
    10,345
    
    
    
    9,606
    
    
    
    99,560
    
    
    
    632
    
    
    
    100,192Long-term debt and capital
lease obligations, net of
current maturities
    
    
    449,784
    
    
    
    248
    
    
    
    293
    
    
    
    450,325
    
    
    
    
    
    
    
    450,325Other liabilities
    
    
    5,798
    
    
    
    3,430
    
    
    
    195
    
    
    
    9,423
    
    
    
    
    
    
    
    9,423Total liabilities
    
    
    535,191
    
    
    
    14,023
    
    
    
    10,094
    
    
    
    559,308
    
    
    
    632
    
    
    
    559,940Commitments and contingencies
(Note 12)Shareholders equity
(deficit):Common stock
    
    
    1,524
    
    
    
    1,001
    
    
    
    29
    
    
    
    2,554
    
    
    
    (1,030
    )
    
    
    1,524Additional paid-in capital
    
    
    144,061
    
    
    
    58,830
    
    
    
    20,504
    
    
    
    223,395
    
    
    
    (79,334
    )
    
    
    144,061Retained earnings
(accumulated deficit)
    
    
    (471,224
    )
    
    
    (786
    )
    
    
    (20,779
    )
    
    
    (492,789
    )
    
    
    17,494
    
    
    
    (475,295
    )Accumulated comprehensive
income (loss)
    
    
    4
    
    
    
    
    
    
    
    (966
    )
    
    
    (962
    )
    
    
    
    
    
    
    (962
    )Total shareholders equity
(deficit)
    
    
    (325,635
    )
    
    
    59,045
    
    
    
    (1,212
    )
    
    
    (267,802
    )
    
    
    (62,870
    )
    
    
    (330,672
    )Total liabilities and
shareholders equity
(deficit)
    
    $
    209,556
    
    
    $
    73,068
    
    
    $
    8,882
    
    
    $
    291,506
    
    
    $
    (62,238
    )
    
    $
    229,268
 16




---



##### Table of Contents



Condensed Consolidating Balance Sheet
As of September 30, 2005
 Non-Borrower
    
    
    Guarantors
    
    
    Guarantors
    
    
    Consolidating
    
    
    Eliminations
    
    
    ConsolidatedASSETSCurrent assets:Cash
    
    $
    26,417
    
    
    $
    36
    
    
    $
    798
    
    
    $
    27,251
    
    
    $
    
    
    
    $
    27,251Accounts receivable, net
    
    
    16,128
    
    
    
    6,063
    
    
    
    3,443
    
    
    
    25,634
    
    
    
    
    
    
    
    25,634Inventories, net
    
    
    64,560
    
    
    
    14,272
    
    
    
    10,576
    
    
    
    89,408
    
    
    
    (5,710
    )
    
    
    83,698Other current assets
    
    
    4,930
    
    
    
    3,365
    
    
    
    5,537
    
    
    
    13,832
    
    
    
    1,587
    
    
    
    15,419Due from (due to)
affiliated companies
    
    
    (17,666
    )
    
    
    32,458
    
    
    
    (14,792
    )
    
    
    
    
    
    
    
    
    
    
    Total current assets
    
    
    94,396
    
    
    
    56,194
    
    
    
    5,562
    
    
    
    156,125
    
    
    
    (4,123
    )
    
    
    152,002Property, plant and
equipment, net
    
    
    38,815
    
    
    
    18,261
    
    
    
    5,747
    
    
    
    62,823
    
    
    
    
    
    
    
    62,823Investment in subsidiaries
    
    
    71,051
    
    
    
    (7,921
    )
    
    
    
    
    
    
    63,130
    
    
    
    (63,130
    )
    
    
    Debt issuance costs and
other assets, net
    
    
    9,493
    
    
    
    14,110
    
    
    
    191
    
    
    
    23,794
    
    
    
    
    
    
    
    23,794Total assets
    
    $
    213,728
    
    
    $
    80,644
    
    
    $
    11,500
    
    
    $
    305,872
    
    
    $
    (67,253
    )
    
    $
    238,619LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    26,280
    
    
    $
    2,669
    
    
    $
    766
    
    
    $
    29,715
    
    
    $
    631
    
    
    $
    30,346Current maturity of
related party note
payable
    
    
    687
    
    
    
    
    
    
    
    
    
    
    
    687
    
    
    
    
    
    
    
    687Current maturities of
long-term debt and
capital lease
obligations
    
    
    328,933
    
    
    
    245
    
    
    
    210
    
    
    
    329,388
    
    
    
    
    
    
    
    329,388Other current liabilities
    
    
    30,955
    
    
    
    12,718
    
    
    
    9,924
    
    
    
    53,597
    
    
    
    
    
    
    
    53,597Total current
liabilities
    
    
    386,855
    
    
    
    15,632
    
    
    
    10,900
    
    
    
    413,387
    
    
    
    631
    
    
    
    414,018Long-term debt and capital
lease obligations, net of
current maturities
    
    
    149,950
    
    
    
    62
    
    
    
    146
    
    
    
    150,158
    
    
    
    
    
    
    
    150,158Other liabilities
    
    
    3,945
    
    
    
    3,075
    
    
    
    191
    
    
    
    7,211
    
    
    
    
    
    
    
    7,211Total liabilities
    
    
    540,750
    
    
    
    18,769
    
    
    
    11,237
    
    
    
    570,756
    
    
    
    631
    
    
    
    571,387Commitments and
contingencies (Note 12)Shareholders equity
(deficit):Common stock
    
    
    1,524
    
    
    
    1,001
    
    
    
    29
    
    
    
    2,554
    
    
    
    (1,030
    )
    
    
    1,524Additional paid-in
capital
    
    
    146,169
    
    
    
    58,831
    
    
    
    20,504
    
    
    
    225,504
    
    
    
    (79,334
    )
    
    
    146,170Retained earnings
(accumulated deficit)
    
    
    (474,716
    )
    
    
    2,043
    
    
    
    (19,278
    )
    
    
    (491,951
    )
    
    
    12,480
    
    
    
    (479,471
    )Accumulated
comprehensive income
(loss)
    
    
    1
    
    
    
    
    
    
    
    (992
    )
    
    
    (991
    )
    
    
    
    
    
    
    (991
    )Total shareholders
equity (deficit)
    
    
    (327,022
    )
    
    
    61,875
    
    
    
    263
    
    
    
    (264,884
    )
    
    
    (67,884
    )
    
    
    (332,768
    )Total liabilities and
shareholders equity
(deficit)
    
    $
    213,728
    
    
    $
    80,644
    
    
    $
    11,500
    
    
    $
    305,872
    
    
    $
    (67,253
    )
    
    $
    238,619
 17




---



##### Table of Contents



Condensed Consolidating Cash Flow Statement
For the Nine Months Ended September 30, 2004
 Non-Borrower
    
    
    Guarantors
    
    
    Guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet cash provided by (used in) operating
activities
    
    $
    (11,439
    )
    
    $
    3,297
    
    
    $
    123
    
    
    $
    
    
    
    $
    (8,019
    )Cash flows from investing activities:Purchases of property, plant and equipment
    
    
    (3,300
    )
    
    
    (1,746
    )
    
    
    (1,493
    )
    
    
    
    
    
    
    (6,539
    )Proceeds from the sale of property, plant
and equipment
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    6Net cash used in investing activities
    
    
    (3,300
    )
    
    
    (1,740
    )
    
    
    (1,493
    )
    
    
    
    
    
    
    (6,533
    )Cash flows from financing activities:Book overdraft
    
    
    (1,097
    )
    
    
    (1,554
    )
    
    
    
    
    
    
    
    
    
    
    (2,651
    )Payments of principal under capital lease
obligations
    
    
    (986
    )
    
    
    (169
    )
    
    
    (61
    )
    
    
    
    
    
    
    (1,216
    )Payments of principal under senior credit
facility
    
    
    (173,681
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (173,681
    )Proceeds from borrowings under senior
credit facility
    
    
    320,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    320,000Debt issuance costs
    
    
    (9,126
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,126
    )Payment of preferred stock repurchase and
preferred stock dividends
    
    
    (139,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (139,000
    )Preferred stock repurchase costs
    
    
    (299
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (299
    )Net cash used in financing activities
    
    
    (4,189
    )
    
    
    (1,723
    )
    
    
    (61
    )
    
    
    
    
    
    
    (5,973
    )Effect of cumulative translation adjustment
    
    
    13
    
    
    
    
    
    
    
    (77
    )
    
    
    
    
    
    
    (64
    )Net decrease in cash
    
    
    (18,915
    )
    
    
    (166
    )
    
    
    (1,508
    )
    
    
    
    
    
    
    (20,589
    )Cash at beginning of year
    
    
    34,222
    
    
    
    176
    
    
    
    2,238
    
    
    
    
    
    
    
    36,636Cash at end of period
    
    $
    15,307
    
    
    $
    10
    
    
    $
    730
    
    
    $
    
    
    
    $
    16,047
 18




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##### Table of Contents



Condensed Consolidating Cash Flow Statement
For the Nine Months Ended September 30, 2005
 Non-Borrower
    
    
    Guarantors
    
    
    Guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet cash provided by (used in) operating
activities
    
    $
    (8,372
    )
    
    $
    2,114
    
    
    $
    471
    
    
    $
    
    
    
    $
    (5,787
    )Cash flows from investing activities:Purchases of property, plant and
equipment
    
    
    (5,248
    )
    
    
    (1,943
    )
    
    
    (447
    )
    
    
    
    
    
    
    (7,638
    )Proceeds from the sale of property,
plant and equipment
    
    
    7
    
    
    
    34
    
    
    
    331
    
    
    
    
    
    
    
    372Net cash used in investing activities
    
    
    (5,241
    )
    
    
    (1,909
    )
    
    
    (116
    )
    
    
    
    
    
    
    (7,266
    )Cash flows from financing activities:Cash overdraft
    
    
    (97
    )
    
    
    (42
    )
    
    
    
    
    
    
    
    
    
    
    (139
    )Proceeds from borrowings under
revolving loan facility
    
    
    40,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    40,000Payments of principal under revolving
loan facility
    
    
    (15,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15,000
    )Payments of principal under capital
lease obligations
    
    
    (1,028
    )
    
    
    (173
    )
    
    
    (128
    )
    
    
    
    
    
    
    (1,329
    )Payments of principal under senior
credit facility
    
    
    (10,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,000
    )Debt issuance costs
    
    
    (1,019
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,019
    )Net cash provided by (used in)
financing activities
    
    
    12,856
    
    
    
    (215
    )
    
    
    (128
    )
    
    $
    
    
    
    
    12,513Effect of cumulative translation
adjustment
    
    
    (3
    )
    
    
    
    
    
    
    (26
    )
    
    
    
    
    
    
    (29
    )Net increase (decrease) in cash
    
    
    (760
    )
    
    
    (10
    )
    
    
    201
    
    
    
    
    
    
    
    (569
    )Cash at beginning of year
    
    
    27,177
    
    
    
    46
    
    
    
    597
    
    
    
    
    
    
    
    27,820Cash at end of period
    
    $
    26,417
    
    
    $
    36
    
    
    $
    798
    
    
    $
    
    
    
    $
    27,251
 12. Commitments and Contingencies
   19




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Special Note Regarding Forward-Looking Statements
     Company Overview
  20




---



##### Table of Contents



Direct Selling Channel Overview & Strategy
 â
   Domistyle Channel Overview & Strategy
   21




---



##### Table of Contents



Results of Operations
 The three months ended September 30, 2005 compared to the three months ended September 30, 2004
  Three months ended September 30,
    
    
    
    
    
    
    % of(Dollars in thousands)
    
    
    Variance
    
    
    Sales2004
    
    
    %
    
    
    2005
    
    
    %
    
    
    Amount
    
    
    ChangeNet sales
    
    $
    123,675
    
    
    
    100.0
    %
    
    $
    118,410
    
    
    
    100.0
    %
    
    $
    (5,265
    )
    
    
    0.0
    %Cost of goods sold
    
    
    60,738
    
    
    
    49.1
    
    
    
    61,545
    
    
    
    52.0
    
    
    
    807
    
    
    
    2.9Gross profit
    
    
    62,937
    
    
    
    50.9
    
    
    
    56,865
    
    
    
    48.0
    
    
    
    (6,072
    )
    
    
    (2.9
    )Operating expenses:Selling
    
    
    22,104
    
    
    
    17.9
    
    
    
    22,632
    
    
    
    19.1
    
    
    
    528
    
    
    
    1.2Freight,
warehouse and
distribution
    
    
    17,649
    
    
    
    14.3
    
    
    
    16,016
    
    
    
    13.5
    
    
    
    (1,633
    )
    
    
    (0.8
    )General and
administrative
    
    
    13,805
    
    
    
    11.2
    
    
    
    14,986
    
    
    
    12.7
    
    
    
    1,181
    
    
    
    1.5Other
    
    
    1,291
    
    
    
    1.0
    
    
    
    367
    
    
    
    0.3
    
    
    
    (924
    )
    
    
    (0.7
    )Operating income
    
    
    8,088
    
    
    
    6.5
    
    
    
    2,864
    
    
    
    2.4
    
    
    
    (5,224
    )
    
    
    (4.1
    )Other income
(expense), net
    
    
    (10,884
    )
    
    
    (8.8
    )
    
    
    (11,293
    )
    
    
    (9.5
    )
    
    
    (409
    )
    
    
    (0.7
    )Loss before income
taxes
    
    
    (2,796
    )
    
    
    (2.3
    )
    
    
    (8,429
    )
    
    
    (7.1
    )
    
    
    (5,633
    )
    
    
    (4.8
    )Income tax benefit
    
    
    1,840
    
    
    
    1.5
    
    
    
    8,587
    
    
    
    7.3
    
    
    
    6,747
    
    
    
    5.8Income (loss) from
continuing
operations
    
    
    (956
    )
    
    
    (0.8
    )
    
    
    158
    
    
    
    0.1
    
    
    
    1,114
    
    
    
    0.9Discontinued
operations loss,
net
    
    
    190
    
    
    
    0.2
    
    
    
    
    
    
    
    0.0
    
    
    
    190
    
    
    
    0.2Net income (loss)
    
    $
    (1,146
    )
    
    
    (0.9
    )%
    
    $
    158
    
    
    
    0.1
    %
    
    $
    1,304
    
    
    
    1.0
    %
  22




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##### Table of Contents



Variance
    
    
    PercentageFor the three months ended September 30,
    
    2004
    
    
    2005
    
    
    Amount
    
    
    VarianceNet Sales (dollars in thousands)Direct Selling Domestic net sales to non-affiliates
    
    $
    98,957
    
    
    $
    89,283
    
    
    $
    (9,674
    )
    
    
    (9.8
    )%Direct
Selling International net sales to non-affiliates
    
    
    18,064
    
    
    
    20,870
    
    
    
    2,806
    
    
    
    15.5
    %Domistyle net sale to non-affiliates
    
    
    6,654
    
    
    
    8,257
    
    
    
    1,603
    
    
    
    24.1
    %Net sales
    
    $
    123,675
    
    
    $
    118,410
    
    
    $
    (5,265
    )
    
    
    (4.3
    )%Other Key Domestic DataAverage number of active Decorating Consultants
    
    
    70,774
    
    
    
    78,170
    
    
    
    7,396
    
    
    
    10.5
    %Number of orders shipped
    
    
    235,841
    
    
    
    212,029
    
    
    
    (23,812
    )
    
    
    (10.1
    )%Number of orders per Decorating Consultant
    
    
    3.33
    
    
    
    2.71
    
    
    
    (0.62
    )
    
    
    (18.6
    )%Average order size (actual dollars)
    
    $
    420
    
    
    $
    421
    
    
    $
    1
    
    
    
    0.2
    %Other Key International DataAverage number of active Decorating Consultants
    
    
    26,477
    
    
    
    29,193
    
    
    
    2,716
    
    
    
    10.3
    %Number of orders shipped
    
    
    59,907
    
    
    
    64,442
    
    
    
    4,535
    
    
    
    7.6
    %Number of orders per Decorating Consultant
    
    
    2.26
    
    
    
    2.21
    
    
    
    (0.05
    )
    
    
    (2.2
    )%Average order size (actual dollars)
    
    $
    302
    
    
    $
    324
    
    
    $
    22
    
    
    
    7.3
    %
 Net Sales
  Net Sales  Direct Selling Domestic
   23




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##### Table of Contents



Net Sales  Direct Selling International
    Variance
    
    
    PercentageFor the three months ended September 30,
    
    2004
    
    
    2005
    
    
    Amount
    
    
    VarianceNet Sales (in thousands)Mexico direct net sales in Mexican pesos
    
    
    171,572
    
    
    
    177,945
    
    
    
    6,373
    
    
    
    3.7
    %Mexico direct net sales in U.S. dollars
    
    $
    15,043
    
    
    $
    16,544
    
    
    $
    1,501
    
    
    
    10.0
    %Canada direct net sales in Canadian dollars
    
    
    1,822
    
    
    
    2,005
    
    
    
    183
    
    
    
    10.0
    %Canada direct net sales in U.S. dollars
    
    $
    1,686
    
    
    $
    1,955
    
    
    $
    269
    
    
    
    16.0
    %
 Net Sales  Domistyle
  Cost of Goods Sold
  Gross Profit
  24




---



##### Table of Contents



Operating Expenses
 Selling Expense
  Freight, Warehouse and Distribution Expense
  General and Administrative Expense
   25




---



##### Table of Contents



Other operating expenses
  Other Income (Expense)
  Income Tax Provision
  Discontinued Operations
  26




---



##### Table of Contents



The nine months ended September 30, 2005 compared to the nine months ended September 30, 2004
  Nine months ended September 30,
    
    
    
    
    
    
    % of(Dollars in thousands)
    
    
    Variance
    
    
    Sales2004
    
    
    %
    
    
    2005
    
    
    %
    
    
    Amount
    
    
    ChangeNet sales
    
    $
    387,466
    
    
    
    100.0
    %
    
    $
    369,182
    
    
    
    100.0
    %
    
    $
    (18,284
    )
    
    
    0.0
    %Cost of goods sold
    
    
    180,542
    
    
    
    46.6
    
    
    
    182,000
    
    
    
    49.3
    
    
    
    1,458
    
    
    
    2.7Gross profit
    
    
    206,924
    
    
    
    53.4
    
    
    
    187,182
    
    
    
    50.7
    
    
    
    (19,742
    )
    
    
    (2.7
    )Operating expenses:Selling
    
    
    75,968
    
    
    
    19.6
    
    
    
    75,494
    
    
    
    20.4
    
    
    
    (474
    )
    
    
    0.8Freight,
warehouse and
distribution
    
    
    52,057
    
    
    
    13.4
    
    
    
    50,401
    
    
    
    13.7
    
    
    
    (1,656
    )
    
    
    0.3General and
administrative
    
    
    49,483
    
    
    
    12.8
    
    
    
    48,944
    
    
    
    13.3
    
    
    
    (539
    )
    
    
    0.5Other
    
    
    5,811
    
    
    
    1.5
    
    
    
    2,358
    
    
    
    0.7
    
    
    
    (3,453
    )
    
    
    (0.8
    )Operating income
    
    
    23,605
    
    
    
    6.1
    
    
    
    9,985
    
    
    
    2.7
    
    
    
    (13,620
    )
    
    
    (3.4
    )Other income
(expense), net
    
    
    (27,292
    )
    
    
    (7.0
    )
    
    
    (32,094
    )
    
    
    (8.7
    )
    
    
    (4,802
    )
    
    
    (1.7
    )Loss before income
taxes
    
    
    (3,687
    )
    
    
    (1.0
    )
    
    
    (22,109
    )
    
    
    (6.0
    )
    
    
    (18,422
    )
    
    
    (5.0
    )Income tax benefit
    
    
    3,556
    
    
    
    0.9
    
    
    
    17,933
    
    
    
    4.9
    
    
    
    14,377
    
    
    
    (4.0
    )Loss from
continuing
operations
    
    
    (131
    )
    
    
    (0.0
    )
    
    
    (4,176
    )
    
    
    (1.1
    )
    
    
    (4,045
    )
    
    
    (1.1
    )Discontinued
operations loss,
net
    
    
    3,898
    
    
    
    1.0
    
    
    
    
    
    
    
    0.0
    
    
    
    (3,898
    )
    
    
    (1.0
    )Net loss
    
    $
    (4,029
    )
    
    
    (1.0
    )%
    
    $
    (4,176
    )
    
    
    (1.1
    )%
    
    $
    (147
    )
    
    
    (0.1
    )%
  Variance
    
    
    PercentageFor the nine months ended September 30,
    
    2004
    
    
    2005
    
    
    Amount
    
    
    VarianceNet Sales (dollars in thousands)Direct Selling Domestic net sales to non-affiliates
    
    $
    318,237
    
    
    $
    289,642
    
    
    $
    (28,595
    )
    
    
    (9.0
    )%Direct Selling International net sales to non-affiliates
    
    
    48,446
    
    
    
    54,926
    
    
    
    6,480
    
    
    
    13.4
    %Domistyle net sales to non-affiliates
    
    
    20,783
    
    
    
    24,614
    
    
    
    3,831
    
    
    
    18.4
    %Net sales
    
    $
    387,466
    
    
    $
    369,182
    
    
    $
    (18,284
    )
    
    
    (4.7
    )%Other Key Domestic DataAverage number of active Decorating Consultants
    
    
    71,148
    
    
    
    76,512
    
    
    
    5,364
    
    
    
    7.5
    %Number of orders shipped
    
    
    702,315
    
    
    
    685,958
    
    
    
    (16,357
    )
    
    
    (2.3
    )%Number of orders per Decorating Consultant
    
    
    9.87
    
    
    
    8.97
    
    
    
    (0.90
    )
    
    
    (9.1
    )%Average order size (actual dollars)
    
    $
    453
    
    
    $
    422
    
    
    $
    (31
    )
    
    
    (6.8
    )%Other Key International DataAverage number of active Decorating Consultants
    
    
    25,609
    
    
    
    28,287
    
    
    
    2,678
    
    
    
    10.5
    %Number of orders shipped
    
    
    183,027
    
    
    
    185,778
    
    
    
    2,751
    
    
    
    1.5
    %Number of orders per Decorating Consultant
    
    
    7.15
    
    
    
    6.57
    
    
    
    (0.58
    )
    
    
    (8.1
    )%Average order size (actual dollars)
    
    $
    265
    
    
    $
    296
    
    
    $
    31
    
    
    
    11.7
    %
 27




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##### Table of Contents



Net Sales
  Net Sales  Direct Selling Domestic
   Net Sales  Direct Selling International
    Variance
    
    
    PercentageFor the nine months ended September 30,
    
    2004
    
    
    2005
    
    
    Amount
    
    
    VarianceNet Sales (in thousands)Mexico direct net sales in Mexican pesos
    
    
    434,096
    
    
    
    463,778
    
    
    
    29,682
    
    
    
    6.8
    %Mexico direct net sales in U.S. dollars
    
    $
    38,327
    
    
    $
    42,341
    
    
    $
    4,014
    
    
    
    10.5
    %Canada direct net sales in Canadian dollars
    
    
    7,099
    
    
    
    6,368
    
    
    
    (731
    )
    
    
    (10.3
    )%Canada direct net sales in U.S. dollars
    
    $
    5,757
    
    
    $
    5,584
    
    
    $
    (173
    )
    
    
    (3.0
    )%
 28




---



##### Table of Contents



Net Sales  Domistyle
  Cost of Goods Sold
  Gross Profit
  Operating Expenses
 Selling Expense
  29




---



##### Table of Contents



Freight, Warehouse and Distribution Expense
  General and Administrative Expense
   Other operating expenses
  Other Income (Expense)
  30




---



##### Table of Contents



Income Tax Provision
  Discontinued Operations
  Seasonality
  Liquidity and Capital Resources
   
    
    The Company has incurred losses from continuing operations before taxes and negative
operating cash flows in five of the last six quarterly periods. This performance is the
result of lower operating income from a decline in revenue and significant interest expense
on indebtedness.
 31




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##### Table of Contents




    
    As a result of classifying $327.5 million of debt from our senior credit facility as a
current obligation, the Company had a working capital deficit of $254.5 million as of
September 30, 2005.
    
    The Company was required to obtain waivers of compliance with financial covenants under
the senior credit facility as of June 30, 2005 and September 30, 2005.
    
    The Company has significant cash debt service requirements related to its senior credit
facility and senior subordinated notes. In the event the Company is unable to obtain
further waivers or otherwise agree with its lenders on the terms of a restructuring of such
senior credit facility, the lenders under the senior credit facility could elect to
accelerate all amounts outstanding under the senior credit facility.
         32




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##### Table of Contents



33




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##### Table of Contents



Off-Balance Sheet Arrangements
  Market Sensitive Instruments and Risk Management
  Country
    
    Currency
    
    
    Low
    
    
    HighCanada
    
    Dollar
    
    $
    0.8008
    
    
    $
    0.8601Mexico
    
    Peso
    
    $
    0.0912
    
    
    $
    0.0949
  34




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##### Table of Contents



Expected Maturity Date2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    Total
    
    
    Fair Value(in thousands)Term Loan LIBOR
Variable Rate Debt
    
    $
    3,750
    
    
    $
    15,000
    
    
    $
    283,750
    
    
    
    
    
    
    $
    302,500
    
    
    $
    276,788Average Interest Rate
    
    
    9.25
    %
    
    
    9.70
    %
    
    
    9.78
    %
    
    
    
    
    
    
    
    
    
    
    Revolving Loan LIBOR
Variable Rate Debt
    
    $
    
    
    
    $
    
    
    
    $
    25,000
    
    
    
    
    
    
    $
    25,000
    
    
    $
    22,875Average Interest Rate
    
    
    8.25
    %
    
    
    8.70
    %
    
    
    8.78
    %
    
    
    
    
    
    
    
    
    
    
    Fixed-Rate Debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    149,100
    
    
    $
    149,100
    
    
    $
    102,879Interest Rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10.125
    %
    
    
    
    
    
    
    
 Inflation
  Recently Issued Statements and Adoption of Financial Accounting Standards
    35




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##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4. CONTROLS AND PROCEDURES
   36




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##### Table of Contents



PART II
 OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 ITEM 6. EXHIBITS
 EXHIBITNUMBER
    
    DESCRIPTION31.1*
    
    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. 37




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##### Table of Contents



SIGNATURES
  HOME INTERIORS & GIFTS, INC.By:
    
    /s/ GEORGE FINFROCKGeorge FinfrockVice President, Controller(principal accounting officer)
  38




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##### Table of Contents



EXHIBIT INDEX
 EXHIBITNUMBER
    
    DESCRIPTION31.1*
    
    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. 39