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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 MARCH 31, 2005 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 þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act
Rule 12b-2).
Yes o No þ As of May 13, 2005, 15,240,218 shares of the Companys common stock, par value $0.10 per share,
were outstanding.   1




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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, 2004 and March 31, 2005
    
    
    3Consolidated Statements of Operations and Comprehensive Income for the three months ended
March 31, 2004 and 2005
    
    
    4Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2005
    
    
    5Notes to Unaudited Interim Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    17Item 3. Quantitative and Qualitative Disclosure About Market Risk
    
    
    26Item 4. Controls and Procedures
    
    
    27PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    28Item 5. Other Information
    
    
    28Item 6. Exhibits and Reports on Form 8-K
    
    
    29Letter AgreementCertification 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, 2004 and March 31, 2005
 (Unaudited)December 31,
    
    
    March 31,2004
    
    

    2005(In thousands, exceptshare information)ASSETSCurrent assets:Cash
    
    $
    27,820
    
    
    $
    24,878Accounts receivable, net
    
    
    26,081
    
    
    
    31,754Inventories, net
    
    
    71,801
    
    
    
    83,345Deferred income tax asset
    
    
    6,111
    
    
    
    6,342Other current assets
    
    
    5,507
    
    
    
    7,893Total current assets
    
    
    137,320
    
    
    
    154,212Property, plant and equipment, net
    
    
    66,466
    
    
    
    65,362Debt issuance costs, net
    
    
    10,593
    
    
    
    9,719Goodwill
    
    
    13,703
    
    
    
    13,800Other assets, net
    
    
    1,186
    
    
    
    1,282Total assets
    
    $
    229,268
    
    
    $
    244,375LIABILITIES AND SHAREHOLDERS DEFICITCurrent liabilities:Book overdraft
    
    $
    4,838
    
    
    $
    7,788Accounts payable
    
    
    26,156
    
    
    
    33,032Accrued seminars and incentive awards
    
    
    9,732
    
    
    
    10,011Royalties payable to decorating consultants
    
    
    5,416
    
    
    
    6,253Accrued compensation
    
    
    2,448
    
    
    
    3,203Income taxes payable
    
    
    15,273
    
    
    
    11,357Current maturity of related party note payable
    
    
    687
    
    
    
    687Current maturities of long-term debt and capital lease obligations
    
    
    15,550
    
    
    
    16,827Other current liabilities
    
    
    20,092
    
    
    
    28,798Total current liabilities
    
    
    100,192
    
    
    
    117,956Long-term debt and capital lease obligations, net of current maturities
    
    
    450,325
    
    
    
    446,092Deferred income tax liability
    
    
    2,812
    
    
    
    2,917Other liabilities
    
    
    6,611
    
    
    
    5,328Total liabilities
    
    
    559,940
    
    
    
    572,293Commitments and contingencies (Note 10)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
    
    
    
    145,045Accumulated deficit
    
    
    (475,295
    )
    
    
    (473,522
    )Accumulated other comprehensive loss
    
    
    (962
    )
    
    
    (965
    )Total shareholders deficit
    
    
    (330,672
    )
    
    
    (327,918
    )Total liabilities and shareholders deficit
    
    $
    229,268
    
    
    $
    244,375
 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, 2004 and 2005
 (In thousands)
 (Unaudited)
 Three Months EndedMarch 31,2004
    
    
    2005Net sales
    
    $
    130,916
    
    
    $
    124,188Cost of goods sold
    
    
    58,569
    
    
    
    59,210Gross profit
    
    
    72,347
    
    
    
    64,978Selling, general and administrative:Selling
    
    
    26,841
    
    
    
    25,366Freight, warehouse and distribution
    
    
    17,021
    
    
    
    17,395General and administrative
    
    
    17,680
    
    
    
    16,258Loss on the disposition of assets
    
    
    
    
    
    
    10Stock option expense
    
    
    989
    
    
    
    984Loss on debt refinancing
    
    
    1,071
    
    
    
    Total selling, general and administrative
    
    
    63,602
    
    
    
    60,013Operating income
    
    
    8,745
    
    
    
    4,965Other income (expense):Interest income
    
    
    70
    
    
    
    120Interest expense
    
    
    (7,004
    )
    
    
    (10,637
    )Other income, net
    
    
    77
    
    
    
    1,568Other expense, net
    
    
    (6,857
    )
    
    
    (8,949
    )Income (loss) from continuing operations before income taxes
    
    
    1,888
    
    
    
    (3,984
    )Income tax provision (benefit)
    
    
    543
    
    
    
    (5,757
    )Income from continuing operations
    
    
    1,345
    
    
    
    1,773Discontinued operations (Note 6):Discontinued operations loss, net of tax
    
    
    447
    
    
    
    Net income
    
    
    898
    
    
    
    1,773Other comprehensive income (loss):Cumulative translation adjustment
    
    
    30
    
    
    
    (3
    )Comprehensive income
    
    $
    928
    
    
    $
    1,770
 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, 2004 and 2005
 (In Thousands)
 (Unaudited)
 Three Months EndedMarch 31,2004
    
    
    2005Cash flows from operating activities:Net income
    
    $
    898
    
    
    $
    1,773Adjustments to reconcile net income to net cash used in
operating activities:Depreciation and amortization
    
    
    3,899
    
    
    
    3,646Amortization of debt issuance costs
    
    
    277
    
    
    
    874Provision for doubtful accounts
    
    
    825
    
    
    
    814Provision for losses on inventories
    
    
    (501
    )
    
    
    (2,587
    )Loss on debt refinancing
    
    
    1,071
    
    
    
    Loss on disposition of assets
    
    
    
    
    
    
    10Unrealized gain on derivatives
    
    
    
    
    
    
    (1,341
    )Stock option expense
    
    
    989
    
    
    
    984Deferred tax expense (benefit)
    
    
    284
    
    
    
    (132
    )Changes in assets and liabilities:Accounts receivable
    
    
    (4,198
    )
    
    
    (6,487
    )Inventories
    
    
    (9,221
    )
    
    
    (8,957
    )Other current assets
    
    
    (3,583
    )
    
    
    (2,380
    )Other assets
    
    
    161
    
    
    
    Accounts payable
    
    
    (3,901
    )
    
    
    6,623Related party payable
    
    
    (576
    )
    
    
    (748
    )Income taxes payable
    
    
    (1,882
    )
    
    
    (3,916
    )Other current liabilities
    
    
    10,305
    
    
    
    11,190Total adjustments
    
    
    (6,051
    )
    
    
    (2,407
    )Net cash used in operating activities
    
    
    (5,153
    )
    
    
    (634
    )Cash flows from investing activities:Purchases of property, plant and equipment
    
    
    (1,308
    )
    
    
    (2,337
    )Proceeds from the sale of property, plant and equipment
    
    
    
    
    
    
    38Increase in restricted cash
    
    
    424
    
    
    
    Net cash used in investing activities
    
    
    (884
    )
    
    
    (2,299
    )Cash flows from financing activities:Book overdraft
    
    
    2,420
    
    
    
    2,950Payments of principal under capital lease obligations
    
    
    (388
    )
    
    
    (456
    )Proceeds from borrowings under senior credit facility
    
    
    320,000
    
    
    
    Payments of principal under senior credit facility
    
    
    (168,682
    )
    
    
    (2,500
    )Debt issuance costs
    
    
    (9,125
    )
    
    
    Preferred stock repurchase costs
    
    
    (299
    )
    
    
    Payment of preferred stock repurchase
    
    
    (109,459
    )
    
    
    Payment of preferred stock dividends
    
    
    (29,541
    )
    
    
    Net cash provided by (used in) financing activities
    
    
    4,926
    
    
    
    (6
    )Effect of cumulative translation adjustment
    
    
    30
    
    
    
    (3
    )Net decrease in cash
    
    
    (1,081
    )
    
    
    (2,942
    )Cash at beginning of year
    
    
    36,636
    
    
    
    27,820Cash at end of period
    
    $
    35,555
    
    
    $
    24,878
 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, importer, and
distributor of indoor and outdoor home decorative accessories. Types of home décor accessories
offered by the Company include, but are not limited to, framed artwork and mirrors, scented
candles, candle accessories, plaques, figurines, planters, artificial floral arrangements, wall
shelves, sconces, small furniture, tableware and table accessories (the Products). Many of the
Products are manufactured exclusively for the Company by wholly-owned subsidiaries of the Company,
resulting in lower costs, higher gross profit, and higher fulfillment rates. During the first
quarter of 2005, approximately 51% of the dollar volume of Products purchased for the Direct
Selling Channel, as defined below, were purchased from, and manufactured by the Companys
manufacturing subsidiaries. The Products not manufactured and supplied by the Companys
subsidiaries are purchased from numerous foreign and domestic suppliers. There are two channels by
which the Company distributes the Products. The first channel is the direct selling channel
whereby the Company sells the Products directly to independent contractor sales representatives
(Decorating Consultants) located in the United States, Mexico, Canada and Puerto Rico, who then
resell the Products to customers (Direct Selling Channel). As of March 31, 2005, the Company had
approximately 105,800 active Decorating Consultants within the Direct Selling Channel. The second
channel (the Domistyle Channel) is whereby the Company manufactures and distributes the Products
to the Direct Selling Channel and to non-affiliated national retailers. The Companys management
evaluates the operational performance of the Companys different channels of business based upon
three reporting segments. Direct selling domestic and direct selling international are the two
reporting segments used by management to evaluate the Direct Selling Channel, and Domistyle is the
third reporting segment used by management to evaluate the Domistyle Channel. The Company has been located in the Dallas, Texas area since the Companys inception in 1957.
Currently, a majority of the Companys outstanding common stock is owned by affiliates of Hicks,
Muse, Tate & Furst Incorporated, a Dallas-based private investment firm (Hicks Muse). 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 final day of the quarters
ended March 31, 2004 and 2005 included in the accompanying unaudited consolidated financial
information was April 3, 2004 and April 2, 2005, respectively. The consolidated financial information as of March 31, 2005 and for the three months ended
March 31, 2004 and 2005 are 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, 2005 and December 31, 2004, its operating results and
comprehensive income for the three months ended March 31, 2004 and 2005, and its cash flows for the
three months ended March 31, 2004 and 2005. 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, 2004 as filed with the SEC. Reclassifications Certain reclassifications have been made to prior period balances to conform with the current
year presentation. 6




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The Company reclassified the operating losses attributed to the discontinued operations of the
ceramics manufacturing plant to losses from discontinued operations in the statement of
consolidated operations and comprehensive income for the three months ended March 31, 2004, as a
result of the discontinued ceramics manufacturing operations in Mexico during the quarter ended
June 30, 2004. The effect of this reclassification increased operating income $0.4 million for the
three months ended March 31, 2004. This reclassification had no impact on net income for the three
months ended March 31, 2004. Stock-based Compensations Plans The Company adopted three stock option plans. For Decorating Consultants and independent
contractors, the Company 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 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 Stock Issued to Employees (APB No.
25), as allowed by SFAS No. 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 consistently with SFAS No. 123, the Companys compensation cost and net
income for the three months ended March 31, 2004 and 2005 would approximate (in thousands): Three Months EndedMarch 31,2004
    
    
    2005Net income, as reported
    
    $
    898
    
    
    $
    1,773Add: Stock-based employee compensation expense
included in reported net income, net of related
tax effects
    
    
    491
    
    
    
    475Deduct: Stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects
    
    
    (520
    )
    
    
    (544
    )Pro forma net income
    
    $
    869
    
    
    $
    1,704
 3. Inventories, Net Inventories, net, consisted of the following as of December 31, 2004 and March 31, 2005 (in
thousands): December 31,
    
    
    March 31,2004
    
    
    2005Raw materials
    
    $
    8,184
    
    
    $
    11,461Work in process
    
    
    2,231
    
    
    
    2,888Finished goods
    
    
    67,559
    
    
    
    72,78477,974
    
    
    
    87,133Inventory allowance
    
    
    (6,173
    )
    
    
    (3,788
    )$
    71,801
    
    
    $
    83,345
 7




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4. Other Current Liabilities Other current liabilities consisted of the following as of December 31, 2004 and March 31,
2005 (in thousands): December 31,
    
    
    March 31,2004
    
    
    2005Interest
    
    $
    1,258
    
    
    $
    5,126Accrued employee benefits
    
    
    2,997
    
    
    
    3,078Sales taxes
    
    
    3,872
    
    
    
    4,840Other taxes
    
    
    1,743
    
    
    
    1,193Deferred revenue
    
    
    4,482
    
    
    
    10,837Related parties
    
    
    748
    
    
    
    96Accrued product license royalties
    
    
    1,439
    
    
    
    1,264Other
    
    
    3,553
    
    
    
    2,364$
    20,092
    
    
    $
    28,798
 5. Adoption of New Accounting Standards In December 2004, the Financial Accounting Standards Board (FASB) issued Staff Position
Statement No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004 (FSP FAS 109-2). The American Jobs
Creation Act signed into law on October 22, 2004, provides for a special one-time tax deduction, or
dividend received deduction (DRD), of 85% of qualifying foreign earnings that are repatriated in
either a companys last tax year that began before the enactment date or the first tax year that
begins during the one-year period beginning on the enactment date. FSP FAS 109-2 provides entities
additional time to assess the effect of repatriating foreign earnings under the American Jobs
Creation Act for purposes of applying SFAS No. 109, which typically requires the effect of a new
tax law to be recorded in the period of enactment. The Company may elect, if applicable, to apply
the DRD to qualifying dividends of foreign earnings repatriated during 2005. The Company is
currently evaluating the impact of the repatriation. In December of 2004, the FASB issued Statement of Financial Accounting Standards No. 153,
Exchanges of Nonmonetary Assets an amendment of APB Opinion No. 29 (SFAS No. 153). SFAS No. 153
amends APB Opinion No. 29 Accounting for Nonmonetary Transactions to eliminate the exception for
nonmonetary exchanges of similar productive assets that do not have commercial substance. A
nonmonetary exchange has commercial substance if the future cash flows of the entity are expected
to change significantly as a result of the exchange. SFAS No. 153 is effective for nonmonetary
assets exchanges occurring in fiscal periods beginning after June 15, 2005. The Company is
currently evaluating the guidance provided under SFAS No. 153. In December of 2004, the FASB issued Statement of Financial Accounting Standards No. 123(R),
Share-Based Payment (SFAS No. 123(R)). SFAS No. 123(R) is a revision of FASB Statement No. 123,
Accounting for Stock Based Compensation and supersedes APB Opinion No. 25, Accounting for Stock
Issued to Employees and its related implementation guidance. SFAS No. 123(R) is effective for
public entities that do not file as small business issuers as of the beginning of the first
interim, or annual reporting period that begins after June 15, 2005. In April of 2005, the
Securities and Exchange Commission issued a ruling that SFAS No. 123(R) is now effective for public
companies for annual, rather than interim, periods that begin after June 15, 2005. The Company is
currently evaluating the guidance provided under SFAS No. 123(R). 6. Discontinued Operations In the first quarter of 2003, the Company acquired 100% of the assets of Ceramica y Vidrio de
Nuevo Leon, S.A. de C.V., Maquiladora Produr, S.A. de C.V., and Industrias Tromex Corporation, S.A.
de C.V. (collectively Produr). Produr manufactured glass, ceramics, and metal products and was
located in Monterrey, Mexico. In the second quarter of 2004, the Company decided to discontinue the
manufacturing operations of ceramics products and to close the glass manufacturing plant. The
metals manufacturing operations were shut down on March 8, 2005. The Company accounted for the shut
down of the manufacturing operations of ceramics products as discontinued operations in the
consolidated statement of operations and comprehensive income, as discussed below. The costs
incurred related to the shut down of the glass and metals manufacturing are reflected in continuing
operations in the 8




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consolidated statement of operations and comprehensive income, since the Company will continue
to source glass and metals products from non-affiliated vendors and distribute glass and metal
products to non-affiliated retailers. On April 28, 2004, the Company discontinued the manufacturing operations of ceramics products
in the Companys Mexico manufacturing facility. The Company will not have any involvement in the
manufacturing of these types of products in the future. The Company incurred approximately $0.6
million in severance costs, $0.1 million in contract termination costs, $2.0 million in impairment
of property, plant, and equipment, and $1.1 million in write-off of goodwill related to the shut
down and disposal activity. The remaining assets related to the ceramics product manufacturing
operations were sold as of December 31, 2004. The operations and cash flows of the ceramics manufacturing operation have been eliminated
from the Companys ongoing operations as a result of the shutdown, and the Company does not have
any continued involvement in the manufacturing of ceramics products. The results of operations of
ceramics manufacturing have been classified as discontinued operations, and information presented
for all periods reflects the new classification. The operations of ceramics manufacturing were
previously reported in the Companys Domistyle operating segment. Components of amounts reflected
as loss on discontinued operations in the Companys Consolidated Statements of Operations and
Comprehensive Income are presented in the following table (in thousands): Three Months EndedMarch 31,2004
    
    
    2005Net sales
    
    $
    436
    
    
    $
    Cost of goods sold
    
    
    700
    
    
    
    Gross profit
    
    
    (264
    )
    
    
    Selling, general and administrative:General and administrative
    
    
    178
    
    
    
    Total selling, general and administrative
    
    
    178
    
    
    
    Operating loss
    
    
    (442
    )
    
    
    Other expense:Interest expense
    
    
    (2
    )
    
    
    Other expense, net
    
    
    (3
    )
    
    
    Other expense, net
    
    
    (5
    )
    
    
    Loss before income taxes
    
    
    (447
    )
    
    
    Income tax benefit
    
    
    
    
    
    
    Loss on discontinued operations
    
    $
    (447
    )
    
    $
    
 7. Income Tax Benefit The income tax benefit for the three months ended March 31, 2005 includes a $4.6 million
benefit associated with a deduction the Company will take in its 2005 U.S. tax return for shut down
of manufacturing operations in Mexico. Due to the favorable benefit associated with ceasing
manufacturing operations in Mexico in 2005, income taxes as a percentage of income before income
taxes was 144.5% in the three months ended March 31, 2005 as compared to 37.6% in the three months
ended March 31, 2004. The Company believes that the effective income tax rate for the year ended
December 31, 2005 will be lower than the effective income tax rate for the three months ended March
31, 2005. 8. Segment Reporting The Companys reportable segments are based upon functional lines of business as follows:  
    Direct Selling Domestic  direct seller of indoor and outdoor home decorative
accessories in the United States;
    Direct Selling International  direct seller of indoor and outdoor home decorative
accessories in Mexico, Canada and Puerto Rico; and 9




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
    Domistyle  wholesale supply operation that manufactures, imports, and distributes
scented 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,
discontinued operations, reorganization costs, non-cash expense for stock options, losses on debt
restructure, realized gain on derivatives, unrealized gain on derivatives, and losses on
disposition of assets (defined as Modified EBITDA). The Company also uses Modified EBITDA as a
performance measure due to the Companys required compliance thresholds for Modified EBITDA
covenants under the senior credit facility. 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 Domistyle and the
direct selling segments, as well as the elimination of the investment in each subsidiary for
consolidation purposes. Modified EBITDA is not reported by product group or group of similar
products, as it is impractical to do so. The table below presents information about reportable
segments used by the Companys chief operating decision maker as of and for the three months ended
March 31, 2004 and 2005 (in thousands): Direct
    
    
    DirectSelling
    
    
    SellingDomestic
    
    
    International
    
    
    Domistyle
    
    
    Eliminations
    
    
    Consolidated2004Net sales to non-affiliates
    
    $
    108,529
    
    
    $
    14,260
    
    
    $
    8,127
    
    
    $
    
    
    
    $
    130,916Net sales to affiliates
    
    
    6,698
    
    
    
    
    
    
    
    35,187
    
    
    
    (41,885
    )
    
    
    Modified EBITDA
    
    
    9,735
    
    
    
    1,189
    
    
    
    9,325
    
    
    
    (1,035
    )
    
    
    19,214Total assets
    
    
    236,140
    
    
    
    13,822
    
    
    
    83,782
    
    
    
    (74,873
    )
    
    
    258,871Goodwill
    
    
    
    
    
    
    
    
    
    
    14,600
    
    
    
    
    
    
    
    14,600Capital expenditures
    
    
    473
    
    
    
    249
    
    
    
    586
    
    
    
    
    
    
    
    1,3082005Net sales to non-affiliates
    
    $
    99,978
    
    
    $
    15,397
    
    
    $
    8,813
    
    
    $
    
    
    
    $
    124,188Net sales to affiliates
    
    
    8,350
    
    
    
    
    
    
    
    29,808
    
    
    
    (38,158
    )
    
    
    Modified EBITDA
    
    
    4,012
    
    
    
    1,414
    
    
    
    8,001
    
    
    
    (7
    )
    
    
    13,420Total assets
    
    
    210,943
    
    
    
    21,085
    
    
    
    79,277
    
    
    
    (66,930
    )
    
    
    244,375Goodwill
    
    
    
    
    
    
    
    
    
    
    13,800
    
    
    
    
    
    
    
    13,800Capital expenditures
    
    
    1,680
    
    
    
    520
    
    
    
    137
    
    
    
    
    
    
    
    2,337
 The following table represents a reconciliation of net income to consolidated Modified EBITDA
for the three months ended March 31, 2004 and 2005 (in thousands): Three Months EndedMarch 31,2004
    
    
    2005Net income
    
    $
    898
    
    
    $
    1,773Discontinued Operations
    
    
    447
    
    
    
    Effect of SAB 101
    
    
    2,869
    
    
    
    3,005Depreciation and amortization
    
    
    3,855
    
    
    
    3,646Loss on debt restructure
    
    
    1,071
    
    
    
    Loss on disposition of assets
    
    
    
    
    
    
    10Stock option expense
    
    
    989
    
    
    
    984Reorganization costs
    
    
    1,608
    
    
    
    643Interest income
    
    
    (70
    )
    
    
    (120
    )Interest expense
    
    
    7,004
    
    
    
    10,637Realized gain on derivatives
    
    
    
    
    
    
    (60
    )Unrealized gain on derivatives
    
    
    
    
    
    
    (1,341
    )Income tax provision (benefit)
    
    
    543
    
    
    
    (5,757
    )Modified EBITDA
    
    $
    19,214
    
    
    $
    13,420
 10




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##### Table of Contents



9. 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 Home Interiors & Gifts, Inc.s (Borrower) credit agreement with its
principal lenders under the senior credit facility, (the Senior Credit Facility) and the
Borrower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 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): 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
    
    
    $
    15,828
    
    
    $
    (43,624
    )
    
    $
    130,916Cost of good sold
    
    
    61,894
    
    
    
    27,915
    
    
    
    11,437
    
    
    
    (42,677
    )
    
    
    58,569Gross profit
    
    
    55,322
    
    
    
    13,581
    
    
    
    4,391
    
    
    
    (947
    )
    
    
    72,347Total selling, general and administrative
    
    
    54,468
    
    
    
    3,599
    
    
    
    5,535
    
    
    
    
    
    
    
    63,602Operating income (loss)
    
    
    854
    
    
    
    9,982
    
    
    
    (1,144
    )
    
    
    (947
    )
    
    
    8,745Other income (expense), net
    
    
    (6,784
    )
    
    
    133
    
    
    
    (118
    )
    
    
    (88
    )
    
    
    (6,857
    )Income (loss) before income taxes
    
    
    (5,930
    )
    
    
    10,115
    
    
    
    (1,262
    )
    
    
    (1,035
    )
    
    
    1,888Income 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
    )
    
    
    Income (loss) from continuing operations
    
    
    1,716
    
    
    
    4,222
    
    
    
    (1,454
    )
    
    
    (3,139
    )
    
    
    1,345Discontinued operations loss, net of tax
    
    
    
    
    
    
    
    
    
    
    (447
    )
    
    
    
    
    
    
    (447
    )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 Statement of Operations and Comprehensive Income (Loss)
For the Three Months Ended March 31, 2005 Non-Borrower
    
    
    Guarantors
    
    
    Guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet sales
    
    $
    110,021
    
    
    $
    39,110
    
    
    $
    12,984
    
    
    $
    (37,927
    )
    
    $
    124,188Cost of good sold
    
    
    61,417
    
    
    
    28,571
    
    
    
    7,180
    
    
    
    (37,958
    )
    
    
    59,210Gross profit
    
    
    48,604
    
    
    
    10,539
    
    
    
    5,804
    
    
    
    31
    
    
    
    64,978Total selling, general and administrative
    
    
    51,408
    
    
    
    3,166
    
    
    
    5,439
    
    
    
    
    
    
    
    60,013Operating income (loss)
    
    
    (2,804
    )
    
    
    7,373
    
    
    
    365
    
    
    
    31
    
    
    
    4,965Other income (expense), net
    
    
    (9,016
    )
    
    
    96
    
    
    
    (17
    )
    
    
    (12
    )
    
    
    (8,949
    )Income (loss) before income taxes
    
    
    (11,820
    )
    
    
    7,469
    
    
    
    348
    
    
    
    19
    
    
    
    (3,984
    )Income tax benefit (provision)
    
    
    3,898
    
    
    
    1,962
    
    
    
    (177
    )
    
    
    74
    
    
    
    5,757Equity in income (loss) of affiliated
companies, net of tax
    
    
    9,629
    
    
    
    27
    
    
    
    
    
    
    
    (9,656
    )
    
    
    Income (loss) from continuing operations
    
    
    1,707
    
    
    
    9,458
    
    
    
    171
    
    
    
    (9,563
    )
    
    
    1,773Discontinued operations loss, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    
    1,707
    
    
    
    9,458
    
    
    
    171
    
    
    
    (9,563
    )
    
    
    1,773Other comprehensive income (loss)
    
    
    1
    
    
    
    
    
    
    
    (4
    )
    
    
    
    
    
    
    (3
    )Comprehensive income (loss)
    
    $
    1,708
    
    
    $
    9,458
    
    
    $
    167
    
    
    $
    (9,563
    )
    
    $
    1,770
 12




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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
    
    
    13,290
    
    
    
    7,860
    
    
    
    4,931
    
    
    
    26,081
    
    
    
    
    
    
    
    26,081Inventories, net
    
    
    53,313
    
    
    
    15,538
    
    
    
    7,567
    
    
    
    76,418
    
    
    
    (4,617
    )
    
    
    71,801Other current assets
    
    
    5,203
    
    
    
    1,810
    
    
    
    3,427
    
    
    
    10,440
    
    
    
    1,178
    
    
    
    11,618Due 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 10)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
 13




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##### Table of Contents



Condensed Consolidating Balance Sheet
As of March 31, 2005 Non-Borrower
    
    
    Guarantors
    
    
    Guarantors
    
    
    Consolidating
    
    
    Eliminations
    
    
    ConsolidatedASSETSCurrent assets:Cash
    
    $
    23,715
    
    
    $
    171
    
    
    $
    992
    
    
    $
    24,878
    
    
    $
    
    
    
    $
    24,878Accounts receivable, net
    
    
    19,104
    
    
    
    7,483
    
    
    
    5,167
    
    
    
    31,754
    
    
    
    
    
    
    
    31,754Inventories, net
    
    
    58,020
    
    
    
    19,413
    
    
    
    10,511
    
    
    
    87,944
    
    
    
    (4,599
    )
    
    
    83,345Other current assets
    
    
    5,864
    
    
    
    2,081
    
    
    
    5,037
    
    
    
    12,982
    
    
    
    1,253
    
    
    
    14,235Due from (due to) affiliated
companies
    
    
    (5,233
    )
    
    
    24,897
    
    
    
    (19,664
    )
    
    
    
    
    
    
    
    
    
    
    Total current assets
    
    
    101,470
    
    
    
    54,045
    
    
    
    2,043
    
    
    
    157,558
    
    
    
    (3,346
    )
    
    
    154,212Property, plant and equipment, net
    
    
    40,615
    
    
    
    18,635
    
    
    
    6,112
    
    
    
    65,362
    
    
    
    
    
    
    
    65,362Investment in affiliates
    
    
    73,173
    
    
    
    (7,422
    )
    
    
    
    
    
    
    65,751
    
    
    
    (65,751
    )
    
    
    Debt issuance costs and other
assets, net
    
    
    10,641
    
    
    
    13,977
    
    
    
    183
    
    
    
    24,801
    
    
    
    
    
    
    
    24,801Total assets
    
    $
    225,899
    
    
    $
    79,235
    
    
    $
    8,338
    
    
    $
    313,472
    
    
    $
    (69,097
    )
    
    $
    244,375LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    27,292
    
    
    $
    4,120
    
    
    $
    988
    
    
    $
    32,400
    
    
    $
    632
    
    
    $
    33,032Current maturity of related
party note payable
    
    
    687
    
    
    
    
    
    
    
    
    
    
    
    687
    
    
    
    
    
    
    
    687Current maturities of long-term
debt and capital lease
obligations
    
    
    16,395
    
    
    
    236
    
    
    
    196
    
    
    
    16,827
    
    
    
    
    
    
    
    16,827Other current liabilities
    
    
    54,250
    
    
    
    5,385
    
    
    
    7,775
    
    
    
    67,410
    
    
    
    
    
    
    
    67,410Total current liabilities
    
    
    98,624
    
    
    
    9,741
    
    
    
    8,959
    
    
    
    117,324
    
    
    
    632
    
    
    
    117,956Long-term debt and capital lease
obligations, net of current
maturities
    
    
    445,678
    
    
    
    187
    
    
    
    227
    
    
    
    446,092
    
    
    
    
    
    
    
    446,092Other liabilities
    
    
    4,540
    
    
    
    3,508
    
    
    
    197
    
    
    
    8,245
    
    
    
    
    
    
    
    8,245Total liabilities
    
    
    548,842
    
    
    
    13,436
    
    
    
    9,383
    
    
    
    571,661
    
    
    
    632
    
    
    
    572,293Commitments and contingencies
(Note 10)Shareholders equity
(deficit):Common stock
    
    
    1,524
    
    
    
    1,001
    
    
    
    29
    
    
    
    2,554
    
    
    
    (1,030
    )
    
    
    1,524Additional paid-in capital
    
    
    145,045
    
    
    
    58,830
    
    
    
    20,504
    
    
    
    224,379
    
    
    
    (79,334
    )
    
    
    145,045Retained earnings (accumulated
deficit)
    
    
    (469,517
    )
    
    
    5,968
    
    
    
    (20,608
    )
    
    
    (484,157
    )
    
    
    10,635
    
    
    
    (473,522
    )Accumulated other comprehensive
income (loss)
    
    
    5
    
    
    
    
    
    
    
    (970
    )
    
    
    (965
    )
    
    
    
    
    
    
    (965
    )Total shareholders equity
(deficit)
    
    
    (322,943
    )
    
    
    65,799
    
    
    
    (1,045
    )
    
    
    (258,189
    )
    
    
    (69,729
    )
    
    
    (327,918
    )Total liabilities and
shareholders equity (deficit)
    
    $
    225,899
    
    
    $
    79,235
    
    
    $
    8,338
    
    
    $
    313,472
    
    
    $
    (69,097
    )
    
    $
    244,375
 14




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##### Table of Contents



Condensed Consolidating Cash Flow Statement
For the Three Months Ended March 31, 2004 Non-Borrower
    
    
    Guarantors
    
    
    Guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet cash 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 senior
credit facility
    
    
    320,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    320,000Debt issuance costs
    
    
    (9,125
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,125
    )Payment of preferred stock repurchase
    
    
    (109,459
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (109,459
    )Payment 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
 Condensed Consolidating Cash Flow Statement
For the Three Months Ended March 31, 2005 Non-Borrower
    
    
    Guarantors
    
    
    Guarantors
    
    
    Eliminations
    
    
    ConsolidatedNet cash provided by (used in) operating
activities
    
    $
    (479
    )
    
    $
    (713
    )
    
    $
    558
    
    
    $
    
    
    
    $
    (634
    )Cash flows from investing activities:Purchases of property, plant and equipment
    
    
    (1,680
    )
    
    
    (504
    )
    
    
    (153
    )
    
    
    
    
    
    
    (2,337
    )Proceeds from the sale of property, plant
and equipment
    
    
    
    
    
    
    
    
    
    
    38
    
    
    
    
    
    
    
    38Net cash used in investing activities
    
    
    (1,680
    )
    
    
    (504
    )
    
    
    (115
    )
    
    
    
    
    
    
    (2,299
    )Cash flows from financing activities:Book overdraft
    
    
    1,536
    
    
    
    1,414
    
    
    
    
    
    
    
    
    
    
    
    2,950Payments of principal under capital lease
obligations
    
    
    (340
    )
    
    
    (56
    )
    
    
    (60
    )
    
    
    
    
    
    
    (456
    )Payment of principal under senior credit
facility
    
    
    (2,500
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,500
    )Net cash provided by (used in)
financing activities
    
    
    (1,304
    )
    
    
    1,358
    
    
    
    (60
    )
    
    
    
    
    
    
    (6
    )Effect of cumulative translation adjustment
    
    
    1
    
    
    
    
    
    
    
    (4
    )
    
    
    
    
    
    
    (3
    )Net increase (decrease) in cash
    
    
    (3,462
    )
    
    
    141
    
    
    
    379
    
    
    
    
    
    
    
    (2,942
    )Cash at beginning of year
    
    
    27,177
    
    
    
    46
    
    
    
    597
    
    
    
    
    
    
    
    27,820Cash at end of period
    
    $
    23,715
    
    
    $
    187
    
    
    $
    976
    
    
    $
    
    
    
    $
    24,878
 15




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##### Table of Contents



10. 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. 16




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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, average order size, and fulfillment rate 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) success of new product launches,
promotion programs, and incentive award programs; and (vii) general economic conditions. 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 Overview Home Interiors & Gifts, Inc. (the Company) is a fully integrated manufacturer, importer, and
distributor of indoor and outdoor home decorative accessories. Types of home décor accessories
offered by the Company include, but are not limited to, framed artwork and mirrors, scented
candles, candle accessories, plaques, figurines, planters, artificial floral arrangements, wall
shelves, sconces, small furniture, tableware and table accessories (the Products). Many of the
Products are manufactured exclusively for the Company by wholly-owned subsidiaries of the Company,
resulting in lower costs, higher gross profit, and higher fulfillment rates. During the first
quarter of 2005, approximately 51% of the dollar volume of Products purchased for the Direct
Selling Channel, as defined below, were purchased from, and manufactured by the Companys
manufacturing subsidiaries. The Products not manufactured and supplied by the Companys
subsidiaries are purchased from numerous foreign and domestic suppliers. There are two channels by
which the Company distributes the Products. The first channel is the direct selling channel
whereby the Company sells the Products directly to independent contractor sales representatives
(Decorating Consultants) located in the United States, Mexico, Canada and Puerto Rico, who then
resell the Products to customers (Direct Selling Channel). As of March 31, 2005, the Company had
approximately 105,800 active Decorating Consultants within the Direct Selling Channel. The second
channel (the Domistyle Channel) is whereby the Company manufactures and distributes the Products
to the Direct Selling Channel and to non-affiliated national retailers. The Companys management
evaluates the operational performance of the Companys different channels of business based upon
three reporting segments. Direct selling domestic and direct selling international are the two
reporting segments used by management to evaluate the Direct Selling Channel, and Domistyle is the
third reporting segment used by management to evaluate the Domistyle Channel. 17




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##### Table of Contents



The Company has been located in the Dallas, Texas area since the Companys inception in 1957.
Currently, a majority of the Companys outstanding common stock is owned by affiliates of Hicks,
Muse, Tate & Furst Incorporated, a Dallas-based private investment firm (Hicks Muse). Direct Selling Channel Overview & Strategy The Direct Selling Channel of the Companys business provides an opportunity for those
individuals who desire to own and operate a home-based business. The Companys management believes
the Company provides such an opportunity by offering the Decorating Consultants a large and varied
selection of Products in addition to a storehouse of educational materials. At any one time, the
Company offers approximately 1,200 home décor accessory items for sale, including a specific line
of products designed and marketed under the product collection name of Better Homes & Gardens
Collectionâ. Products are constantly being analyzed and updated to give the Decorating
Consultants access to not only traditional favorites, but also the latest trends in home décor. In
addition to the large number of Products offered, the Company created a field environment in which
Decorating Consultants have the opportunity to grow their own business through a direct financial
and vested interest in the career development and growth of other Decorating Consultants that enter
into the business. To support the Decorating Consultants career development, growth, and
profitability, the Company provides educational materials that address various selling and
recruiting techniques such as in-home decorating shows, personal decorating appointments,
fundraising, brochure sales, and gift services, along with motivation materials and events. The
educational materials have been developed over the Companys 48 year history in the direct selling
industry and represent the most successful and proven strategies of its Decorating Consultants. The Companys current strategic initiatives for the Direct Selling Channel include (i)
maintaining a competitive edge over other home décor and direct selling organizations by leveraging
the Companys relationships with key product brand partners, such as Thomas Kinkade and Better
Homes & Gardens, and (ii) focusing on what management believes to be the key drivers of growth
within the direct sales business  sales productivity, recruiting productivity, and retention of
the Decorating Consultant base. Management believes that actions being taken in these areas will
improve the profitability of the Direct Selling Channel. During the quarter ended March 31, 2005, in order to promote domestic recruiting, retention,
and productivity of the Decorating Consultant base, the Companys management introduced a new
Decorating Consultant career path and compensation program. The new Decorating Consultant career
path and compensation program focuses Decorating Consultants on sponsoring and mentoring other
individuals to become Decorating Consultants, building teams of Decorating Consultants, and
financially rewarding Decorating Consultants based upon their attainment of individual sales
production and sponsoring productivity levels, in addition to compensation based upon the sales
production and sponsoring productivity levels of those Decorating Consultants being sponsored and
mentored. Domistyle Channel Overview & Strategy The Domistyle Channel of the Companys business is comprised of the manufacturing and
distribution of framed artwork and mirrors, scented candles, plaques, and various types of molded
plastic products through the use of custom-designed equipment for the Companys Direct Selling
Channel and non-affiliated national retailers. In a continued effort to increase the profitability of the Domistyle Channel, during the
quarter ended March 31, 2005, the Company ceased all manufacturing operations within Mexico, and
the Companys management redirected the Companys focus in this area to its manufacturing
operations within the United States. Managements strategy is focused on leveraging the fixed
component of the Products cost structure and maintaining a competitive edge with regard to
quality, price, and fulfillment needs of national retailers. 18




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##### Table of Contents



Results of Operations The three months ended March 31, 2005 compared to the three months ended March 31, 2004 The following table summarizes the Companys operating results with corresponding percentages
of net sales, variance amounts, and the change in percentage of net sales: Three months ended March 31,
    
    
    
    
    
    
    % of(Dollars in thousands)
    
    
    Variance
    
    
    Sales2004
    
    
    %
    
    
    2005
    
    
    %
    
    
    Amount
    
    
    ChangeNet sales
    
    $
    130,916
    
    
    
    100.0
    %
    
    $
    124,188
    
    
    
    100.0
    %
    
    $
    (6,728
    )
    
    
    0.0
    %Cost of goods sold
    
    
    58,569
    
    
    
    44.7
    
    
    
    59,210
    
    
    
    47.7
    
    
    
    641
    
    
    
    3.0Gross Profit
    
    
    72,347
    
    
    
    55.3
    
    
    
    64,978
    
    
    
    52.3
    
    
    
    (7,369
    )
    
    
    (3.0
    )Operating expensesSelling
    
    
    26,841
    
    
    
    20.5
    
    
    
    25,366
    
    
    
    20.4
    
    
    
    (1,475
    )
    
    
    (0.1
    )Freight, warehouse and distribution
    
    
    17,021
    
    
    
    13.0
    
    
    
    17,395
    
    
    
    14.0
    
    
    
    374
    
    
    
    1.0General and administrative
    
    
    17,680
    
    
    
    13.5
    
    
    
    16,258
    
    
    
    13.1
    
    
    
    (1,422
    )
    
    
    (0.4
    )Other
    
    
    2,060
    
    
    
    1.6
    
    
    
    994
    
    
    
    0.8
    
    
    
    (1,066
    )
    
    
    (0.8
    )Operating income
    
    
    8,745
    
    
    
    6.7
    
    
    
    4,965
    
    
    
    4.0
    
    
    
    (3,780
    )
    
    
    (2.7
    )Other income (expense), net
    
    
    (6,857
    )
    
    
    (5.2
    )
    
    
    (8,949
    )
    
    
    (7.2
    )
    
    
    (2,092
    )
    
    
    (2.0
    )Income (loss) before income taxes
    
    
    1,888
    
    
    
    1.4
    
    
    
    (3,984
    )
    
    
    (3.2
    )
    
    
    (5,872
    )
    
    
    (4.6
    )Income tax provision (benefit)
    
    
    543
    
    
    
    0.4
    
    
    
    (5,757
    )
    
    
    (4.6
    )
    
    
    (6,300
    )
    
    
    (5.0
    )Income from continuing operations
    
    
    1,345
    
    
    
    1.0
    
    
    
    1,773
    
    
    
    1.4
    
    
    
    428
    
    
    
    0.4Discontinued operations loss, net
    
    
    447
    
    
    
    0.3
    
    
    
    
    
    
    
    0.0
    
    
    
    (447
    )
    
    
    (0.3
    )Net income
    
    $
    898
    
    
    
    0.7
    %
    
    $
    1,773
    
    
    
    1.4
    %
    
    $
    875
    
    
    
    0.7
    %
 The Companys operations are divided into three reporting segments: direct selling
domestic, direct selling international, and Domistyle. The Companys management evaluates the
performance of its segments and allocates resources to them based on performance. These reportable
segments are based on similarities in distribution channels and management oversight. The direct
selling domestic segment includes direct sales by Decorating Consultants located within the United
States, including Washington D.C. The direct selling international segment includes direct sales
by Decorating Consultants located in Mexico, Canada, and Puerto Rico. The direct selling domestic
and direct selling international operational segments are directly impacted by the number of
Decorating Consultants the Company has selling its Products. The Domistyle operational segment
manufactures and distributes framed artwork and mirrors, scented candles, plaques, and various
types of molded plastic products through the use of custom-designed equipment for the Companys
Direct Selling channel and for non-affiliate national retailers. The Domistyle operations are
directly impacted by raw material costs and the ability to promote and market products to national
retailers. The following table presents net sales to non-affiliates by segment along with other key
Decorating Consultant data for the quarter ended March 31, 2005 compared to the same period in
2004. Intercompany sales to affiliates are eliminated in consolidation. Variance
    
    
    PercentageFor the three months ended March 31,
    
    2004
    
    
    2005
    
    
    Amount
    
    
    VarianceNet Sales (dollars in thousands)Direct Selling Domestic net sales to non-affiliates
    
    $
    108,529
    
    
    $
    99,978
    
    
    $
    (8,551
    )
    
    
    (7.9
    )%Direct Selling International net sales to non-affiliates
    
    
    14,260
    
    
    
    15,397
    
    
    
    1,137
    
    
    
    8.0
    %Domistyle net sales to non-affiliates
    
    
    8,127
    
    
    
    8,813
    
    
    
    686
    
    
    
    8.4
    %Net sales
    
    $
    130,916
    
    
    $
    124,188
    
    
    $
    (6,728
    )
    
    
    (5.1
    )%Other Key Domestic DataAverage number of active Decorating Consultants
    
    
    71,522
    
    
    
    74,853
    
    
    
    3,331
    
    
    
    4.7
    %Number of orders shipped
    
    
    243,732
    
    
    
    235,120
    
    
    
    (8,612
    )
    
    
    (3.5
    )%Number of orders per Decorating Consultant
    
    
    3.41
    
    
    
    3.14
    
    
    
    (0.27
    )
    
    
    (7.9
    )%Average order size (actual dollars)
    
    $
    445
    
    
    $
    425
    
    
    $
    (20
    )
    
    
    (4.5
    )%Other Key International DataAverage number of active Decorating Consultants
    
    
    24,742
    
    
    
    27,831
    
    
    
    2,639
    
    
    
    10.7
    %Number of orders shipped
    
    
    52,564
    
    
    
    56,571
    
    
    
    4,007
    
    
    
    7.6
    %Number of orders per Decorating Consultant
    
    
    2.12
    
    
    
    2.03
    
    
    
    (0.09
    )
    
    
    (4.2
    )%Average order size (actual dollars)
    
    $
    271
    
    
    $
    272
    
    
    $
    1
    
    
    
    0.4
    %
 19




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##### Table of Contents



Net Sales Net sales decreased $6.7 million, or 5.1%, to $124.2 million in the three months ended March
31, 2005 compared with $130.9 million in the three months ended March 31, 2004. The decrease in net
sales was directly attributed to the 7.9% decrease in the net sales to non-affiliates within the
direct selling domestic segment of operations, partially offset by an 8.0% increase in the net
sales to non-affiliates within the direct selling international segment of operations, and an 8.4%
increase in the net sales to non-affiliates within the Domistyle segment of operations. Net Sales  Direct Selling Domestic Direct selling domestic net sales to non-affiliates decreased $8.5 million, or 7.9% to $100.0 million
in the three months ended March 31, 2005 from $108.5 million in the same period of 2004. The
primary drivers of the decrease in net sales to non-affiliates were a 10% decrease in domestic
direct Product sales volume of units sold (offset by a slight average price increase), a 4.5%
decline in the average order size per Decorating Consultant, and a 7.9% decrease in the number of
orders per Decorating Consultant. Even though the number of recruits and average number of active Decorating Consultants have
increased 69.8% and 4.7%, respectively, the number of orders per Decorating Consultants declined.
Management believes the decline in sales productivity of the Decorating Consultant base was
primarily due to macroeconomic conditions such as rising energy prices that had a compound negative
impact of reducing the disposable income of the Decorating Consultants customer base and the
Decorating Consultants and customers willingness to organize and attend parties. Additionally,
the home furnishing sector has been down, as customers have directed disposable income elsewhere.
Finally, new recruits are typically less productive than seasoned Decorating Consultants. In an
effort to regain top line momentum, management is focusing on increasing the number of Decorating
Consultants by continuing to promote the new career path and compensation program, focusing the
Decorating Consultant base on sales productivity, mentoring new recruits to become productive,
introducing new product lines and new selling and recruiting techniques, as well as providing
motivation materials and events to the Decorating Consultants. Net Sales  Direct Selling International Direct selling international net sales to non-affiliates increased $1.1 million, or 8.0%, to $15.4
million in the three months ended March 31, 2005 from $14.3 million in the three months ended March
31, 2004. Decorating Consultant selling and recruiting productivity remained strong in the direct
selling international segment. The number of orders shipped increased 7.6% and the average order
size in the first quarter of 2005 remained flat to the 2004 level. The average number of active
international Decorating Consultants increased 10.7% in the first quarter of 2005 as compared to
the same period in 2004 driven by a 12.1% increase in recruiting. As of March 31, 2005 the average
number of active Decorating Consultants was 24,642, 1,431, and 1,308 for Mexico, Canada, and Puerto
Rico, respectively. Net sales in Mexico and Puerto Rico have increased 5.7% and 55.3%, respectively, but were
offset by a decrease of 14.9% in sales within Canada. The increase in net sales in Puerto Rico
contributed approximately 57% of the total net sales growth of 11.7%. Recruiting growth in Puerto
Rico accounted for approximately 45% of the 12.1% increase in recruiting for this segment.
Managements focus on providing brochures that appeals specifically to the Hispanic market, and the
new Decorating Consultant career path and compensation program have led to growth in both selling
and recruiting productivity in the Puerto Rico market. Exchange rate fluctuations can also impact year-over-year comparisons. International direct
sales are transacted in the local currency in Mexico and Canada. The following table compares net
sales in the local currency in Mexico and Canada to the U.S. dollar equivalent net sales recorded
at the year-to-date weighted-average exchange rate for the three months ended March 31, 2004 and
2005. 20




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##### Table of Contents



Variance
    
    
    PercentageFor the three months ended March 31,
    
    2004
    
    
    2005
    
    
    Amount
    
    
    VarianceNet Sales (in thousands)Mexico direct net sales in Mexican pesos
    
    
    119,863
    
    
    
    127,604
    
    
    
    7,741
    
    
    
    6.5
    %Mexico direct net sales in U.S. dollars
    
    
    10,784
    
    
    
    11,395
    
    
    
    611
    
    
    
    5.7
    %Canada direct net sales in Canadian dollars
    
    
    2,560
    
    
    
    2,008
    
    
    
    (552
    )
    
    
    (21.6
    )%Canada direct net sales in U.S. dollars
    
    
    1,989
    
    
    
    1,693
    
    
    
    (296
    )
    
    
    (14.9
    )%
 Net Sales  Domistyle Net sales to non-affiliates for the three-month period increased $0.7 million, or 8.4%, to
$8.8 million in 2005 as compared to $8.1 million in the comparable period of 2004. Included in the
2004 net sales to non-affiliates was $0.4 million in net sales from the Companys manufacturing
operations in Mexico. In a continued effort to increase the profitability of the Domistyle
segment, the Company ceased all manufacturing operations in Mexico, and there were no comparable
net sales to non-affiliates from Mexico in 2005. Excluding prior year Mexico net sales, net sales
for the remaining operations increased $1.1 million, or 14.3% for the comparable periods. This
increase was a result of the Companys continued effort to gain product entry into the supply chain
market of non-affiliated national retailers. Management believes that in order to have continued
growth of this portion of the segment, Domistyle must maintain a competitive edge with regard to
quality, price, and fulfillment needs of national retailers. Additionally, management must leverage
the Companys manufacturing operations to expand the product lines offered to retailers. Cost of Goods Sold Cost of goods sold increased $0.6 million to $59.2 million in the three months ended March 31,
2005 from $58.6 million in the three months ended March 31, 2004. As a percentage of net sales,
cost of goods sold increased 3.0% to 47.7% in 2005 from 44.7% in 2004. 1.4% of the increase in
cost of goods sold as a percentage of net sales was due to an increase in the costs of those
Products purchased from and manufactured by the Companys manufacturing affiliates. The increase
in Product costs was a direct result of rising oil prices that are raising the prices of petroleum
based commodities, such as wax and styrene, both of which are raw materials used in the production
of the products that are manufactured by the Domistyle Channel and distributed to the Direct
Selling Channel. The Company also experienced similar Product costs increases from the Companys
non-affiliated overseas and domestic suppliers. In order to maintain a high fulfillment rate and meet the Product demands of the Decorating
Consultants, the Company incurred additional inland freight costs of $0.6 million to expedite the
Product from the overseas manufacturers to the distribution center located in the Dallas, Texas
area. As of March 31, 2005 the Companys Product fulfillment rate was approximately 97%. Inventory reserve provisions included in cost of sales decreased $2.1 million in the first
quarter of 2005 as compared to 2004 due to the release of reserves for the sell through of
discontinued seasonal product reserved for at December 31, 2004. Gross Profit Gross profit decreased $7.3 million, or 10.2%, to $65.0 million in the three months ended
March 31, 2005 from $72.3 million in the three months ended March 31, 2004. The primary reasons for
the decrease in gross profit were the $6.7 million sales decline and a shift in buying behavior of
Decorating Consultants towards the purchase of discontinued Products, which made up 8.7% of sales
as compared to 7.7% of sales in 2004. The discontinued Products sold during 2005 were also sold at
significantly lower margins than in 2004. Additionally there were $2.0 million in Product
promotional discounts on non-discontinued Products that were offered to the Decorating Consultants,
of which $1.2 million was directly related to a promotion targeted at getting newly recruited
Decorating Consultants in the business, and increased Product manufacturing costs as discussed in
the cost of goods sold section above. 21




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##### Table of Contents



Operating Expenses Selling Expense Selling expense decreased $1.4 million, or 5.5%, to $25.4 million in the three months ended
March 31, 2005 from $26.8 million in the comparable period of 2004. As a percentage of net sales,
selling expense decreased to 20.4% for the three-month period ended March 31, 2005 from 20.5% in
the comparable period of 2004. Selling expense was comprised primarily of Decorating Consultant
royalties and bonuses, sales promotions and sales event expenses, personnel costs, and product
licensing royalties. Decorating Consultant royalties and bonuses increased $0.5 million, or 2.8%
in 2005 as compared to 2004 due to the new Decorating Consultant career path and compensation
program. As a percentage of sales, Decorating Consultant royalties and bonuses increased 1.1%.
Sales promotions and sales event expenses decreased $2.0 million in the first quarter of 2005 as
compared to 2004 due to the timing of sales promotions and incentive trips, and a change in the
methodology for accounting for the Companys annual Seminar which will be accounted for as a period
cost in 2005. Personnel costs remained relatively flat in the comparable periods. Product
licensing royalties increased $0.3 million in the first quarter of 2005 as compared to 2004 due to
a new product licensing agreement with regard to candle technology and amendments to existing
product licensing agreements. Freight, Warehouse and Distribution Expense Freight, warehouse, and distribution expense increased $0.4 million, or 2.2%, to $17.4 million
in the three months ended March 31, 2005 from $17.0 million in the three months ended March 31,
2004. As a percentage of net sales, freight, warehouse and distribution expense increased 1.0%.
Freight, warehouse and distribution expense was comprised primarily of personnel costs, facilities
costs, and freight expense. Personnel and facilities costs remained relatively flat in the first
quarter of 2005 as compared to 2004. Freight expense increased $0.3 million, or 3.4% in the three
months ended March 31, 2005 compared to the same period in 2004. As a percentage of net sales,
freight expense increased 0.6% due to a decrease in the average order size and rising fuel costs. General and Administrative Expense General and administrative expense decreased $1.4 million, or 8.0%, to $16.3 million in the
three months ended March 31, 2005 from $17.7 million in the three months ended March 31, 2004.
General and administrative expense was comprised primarily of personnel costs, professional fees,
corporate facilities costs, depreciation expense, contract services, insurance, and other operating
expenses, and corporate organizational realignment costs. Depreciation expense decreased $0.2
million, corporate organizational realignment expenses decreased $0.7 million, and other operating
expenses decreased $0.6 million. Included in selling, and general and administrative expenses are certain non-recurring costs
related to corporate organizational realignment expenses and strategic planning consulting
expenses. These costs were approximately $0.6 million and $1.6 million for the three months ended
March 31, 2005 and 2004 respectively. Other operating expense Other operating expense decreased $1.1 million, or 51.7%, to $1.0 million in the three months
ended March 31, 2005 from $2.1 million in the three months ended March 31, 2004. Other operating
expense was comprised of a loss on asset sales, loss on debt restructuring, and stock option
expense. The decrease was due to the loss on debt restructuring of $1.1 million incurred in the
first quarter of 2004 related to the refinancing of the Companys senior credit facility. Stock
option expense remained flat at $1.0 million in 2005 and 2004. Other Income (Expense) Other income (expense) increased $2.0 million, or 30.5%, to $8.9 million in the three months
ended March 31, 2005 from $6.9 million in the three months ended March 31, 2004. Other income
(expense) was comprised primarily of interest income, interest expense, and an unrealized and
realized gain on derivatives. Interest income increased slightly in 2005 due to increased interest
rates. Interest expense increased $3.6 million, or 51.9%, to $10.6 million in the three months
ended March 31, 2005 from $7.0 million in the three months ended March 31, 2004. The 22




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increase was a result of higher debt balances related to the refinancing of the Companys
senior credit facility that occurred on March 31, 2004 and higher interest rates. In the first
quarter of 2005, the Company recorded a $1.3 million unrealized gain on derivatives related to the
interest rate swap agreements entered into in 2004 as required by the Companys senior credit
facility. Income Tax Provision The Company recognized a tax benefit of $5.8 million in the three months ended March 31, 2005
as compared to an expense of $0.5 million in the comparable period of 2004. Due to the favorable
benefit associated with ceasing manufacturing operations in Mexico in 2005, income tax benefit as a
percentage of income before income taxes was 144.5% in the three months ended March 31, 2005 as
compared to income tax expense as a percentage of income before income taxes of 37.6% in the three
months ended March 31, 2004. The Company believes that the effective income tax rate for the year
ended December 31, 2005 will be lower than the effective income tax rate for the three months ended
March 31, 2005. Discontinued Operations On April 28, 2004, the Company discontinued the ceramics products manufacturing operations in
the Companys Mexico manufacturing facility. The operations and cash flows of the ceramics
manufacturing operations have been eliminated from the Companys ongoing operations and have been
classified as discontinued operations. Discontinued operations loss was $0.4 million in the three
months ended March 31, 2004. The shutdown was completed in 2004 and there was no discontinued
operations loss recorded in 2005. Seasonality The Companys business is influenced by the Christmas holiday season and by promotional
events. Historically, the highest portions of the Companys net sales and operating income have
been realized during the fourth quarter. Working capital requirements also fluctuate during the
year. Working capital requirements are at the highest levels during the third and fourth quarters
as the Companys obligations for increases in inventory for the peak season become due. In addition
to the Companys peak season fluctuations, quarterly results of operations may fluctuate depending
on the timing of, and amount of sales from, discounts, incentive promotions and/or the introduction
of new Products. As a result, the Companys business activities and results of operations in any
quarter are not necessarily indicative of any future trends in the Companys business. Liquidity and Capital Resources The Company has historically funded its operations, capital expenditures, and working capital
requirements with cash flows from operating activities and revolving loans under the Companys
senior credit facility. The Company has significant cash requirements for debt service related to
the Companys senior credit facility and the senior subordinated notes. Additional cash
requirements consist primarily of working capital requirements and capital expenditures. The
Company will continue to fund operations, capital expenditures, and working capital requirements,
along with any unanticipated shortfalls, through cash flows from operating activities and revolving
loans, rather than incurring additional long-term debt. The Companys future operating performance
and ability to service or refinance 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. As of March 31, 2005, the Company held $24.9 million in cash. The Company principally uses
cash from operations to fund operating expenses, such as Decorating Consultant royalties, product
licensing royalties, inventory purchases, and warehouse, freight and distribution costs. For the three months ended March 31, 2005, the Companys cash decreased $2.9 million to $24.9
million from $27.8 million as of December 31, 2004. The decrease resulted from $0.6 million of net
cash used by operating activities and $2.3 million of net cash used by investing activities. Net cash of $0.6 million used by operating activities consisted of $5.4 million provided by
net income, as adjusted for non-cash items, and $6.0 million used by working capital. The net
decrease in cash was primarily due to lower than anticipated sales volume. This, in combination
with $1.9 million of cash outlay for the annual seminar 23




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held in April 2005, and $1.5 million of Decorating Consultant production and promotion
bonuses, which were earned during 2004 and subsequently paid in January 2005, resulted in the $0.6
million decrease. The Company expects to continue to fund operations and working capital
requirements through cash flows from operating activities and revolving loans under the Companys
senior credit facility. Net cash of $2.3 million used by investing activities during the three months ended, Marcy 31,
2005, consisted of capital expenditures for property, plant, and equipment related to upgrades for
information technology and equipment to improve efficiencies in order fulfillment. The Company has an unsecured senior credit facility which provides a seven-year term loan
facility of up to $320.0 million (the Term Loans), and a $50.0 million five-year revolving credit
facility (the Revolving Loans), of which $20.0 million may be used for letters of credit. As of
March 31, 2005, there were $310.0 million of Term Loans outstanding along with $4.0 million in
letters of credit. There were no outstanding Revolving Loans as of March 31, 2005. The term loan
facility matures on March 31, 2011 and the revolving loan facility matures on March 31, 2009
provided that, in the event that the senior subordinated notes are not refinanced in whole on or
prior to December 1, 2007 through the issuance of refinancing securities with a maturity no less
than six months after March 31, 2011, incremental term loans, or an initial public offering, then
all Term Loans outstanding will be due and payable, and the revolving credit facility will
terminate on that date. The senior credit facility may be used for general corporate purposes and
seasonal working capital needs. The senior credit facility, among other provisions, includes
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 senior credit facility, the Company is
required to comply with specified financial ratios and tests, including an interest coverage ratio,
maximum leverage ratio, and maximum capital expenditures as defined per the senior credit facility
agreement. The Term Loans under the senior credit facility bear interest, at the Companys election, at
either LIBOR plus an applicable margin or the Alternate Base Rate plus an applicable margin. The
Alternate Base Rate 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 Alternate Base Rate margin are subject to adjustments, upwards or
downwards after December 31, 2004, based upon the leverage ratio as defined by the senior credit
agreement. The interest rates on all borrowings outstanding under the senior credit facility were
based on LIBOR as of March 31, 2005. As of March 31, 2005, Term Loan borrowings outstanding totaled
$310.0 million. The weighted-average interest rate on the Term Loan borrowings outstanding at March
31, 2005 was 8.38%. In June 1998, the Company issued $200.0 million aggregate principal amount of 10 1/8% senior
subordinated notes. As of March 31, 2005, the Company had a total of $149.1 million in principal
outstanding. Such senior subordinated notes contain, among other provisions, restrictions on,
among other things, the ability of the Company to incur debt, make restricted payments, create
liens, sell assets, engage in mergers, acquisitions or consolidations, and enter into transactions
with affiliates. At March 31, 2005, the Company was in compliance with such provisions. Interest
payments commenced in December 1998 and continue semi-annually until the senior subordinated notes
mature in 2008. Payments on the senior subordinated notes and the senior credit facility represent significant
cash requirements for the Company. The Company has the option to redeem the senior subordinated
notes in whole or in part at any time. The Term Loans under the senior credit facility require
quarterly interest and principal payments. During the three months ended March 31, 2005, the
Company paid a total of $8.3 million in debt service, consisting of principal payments under the
senior credit facility of $2.5 million, interest and commitment fees under the senior credit
facility of approximately $5.8 million, and no interest on the senior subordinated notes. As of March 31, 2005, the Company was in compliance with all covenants and other requirements
set forth in the credit agreement under the senior credit facility and indenture with respect to
the senior subordinated notes. As a result of declining sales and increasing Product and freight
costs, there is the potential that as of June 30, 2005, the Company may not be able to comply with
certain of the specified financial ratios and tests set forth in the senior credit facility. A breach of these financial covenants in the senior credit facility could result in a default.
Upon the occurrence of an event of default under the senior credit facility, the lenders could
elect to declare all amounts outstanding 24




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under the credit facility to be immediately due and payable and terminate all commitments to
extend further credit under the Revolving Loans. Acceleration of the amounts outstanding under the
senior credit facility would result in an event of default under the indenture governing the
Companys senior subordinated notes, which could result in the principal amount outstanding under
the senior subordinated notes becoming due and payable immediately. In that event, the Company
would not have sufficient liquidity to make the payments required under the senior credit facility
and the senior subordinated notes and for working capital purposes. The Company is in discussions with its agent bank to obtain amendments to the senior credit
facility that would modify or waive the financial covenants that could be at issue. However, there
can be no assurance that the Companys lenders will agree to any modifications or waivers under the
senior credit facility. Off-Balance Sheet Arrangements At March 31, 2005, 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, market, or credit risk that could arise if the
Company had engaged in such relationships. 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 rate 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. The following table represents, by country, the low and high currency
exchange rates to the United States dollar, for the three months ended March 31, 2005: Country
    
    Currency
    
    
    Low
    
    
    HighCanada
    
    Dollar
    
    $
    0.7961
    
    
    $
    0.8336Mexico
    
    Peso
    
    $
    0.0879
    
    
    $
    0.0911
 As a result of the interest pricing mechanism associated with the 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. During the second quarter of 2004, the Company finalized a series
of interest rate swap agreements with a trade date of May 5, 2004 and a start date of September 30,
2004, to limit the effect of changes in interest rates on a portion of its long-term borrowings.
Under the trade agreement the Company pays on a quarterly basis a fixed interest rate per quarter
ranging from 1.91% to 5.18%. 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 LIBOR,
excluding the margin paid under the credit facility on a quarterly basis. The Company recognized an
unrealized gain of approximately $1.3 million in the consolidated statement of operations and
comprehensive income for the three months ended March 31, 2005, related to the interest rate swap
agreement. The swap expires on September 28, 2007. The Company does not use derivative instruments
for trading or speculative purposes. 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 25




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agreement mentioned above. The interest rates are estimated based on actual and implied forward
rates using a yield as of March 31, 2005. The Notes are at a fixed rate of 10.125% and will mature
in 2008. Expected Maturity Date2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    Total
    
    
    Fair Value(in thousands)Variable Rate Debt
    
    $
    11,250
    
    
    $
    15,000
    
    
    $
    283,750
    
    
    
    
    
    
    $
    310,000
    
    
    
    Average Interest Rate
    
    
    8.50
    %
    
    
    9.19
    %
    
    
    9.65
    %
    
    
    
    
    
    
    
    
    
    
    Fixed-Rate Debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    149,100
    
    
    $
    149,100
    
    
    $
    124,499Interest 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 three months
ended March 31, 2005. Recently Issued Statements and Adoption of Financial Accounting Standards In December 2004, the Financial Accounting Standards Board (FASB) issued Staff Position
Statement No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004 (FSP FAS 109-2). The American Jobs
Creation Act signed into law on October 22, 2004, provides for a special one-time tax deduction, or
dividend received deduction (DRD), of 85% of qualifying foreign earnings that are repatriated in
either a companys last tax year that began before the enactment date or the first tax year that
begins during the one-year period beginning on the enactment date. FSP FAS 109-2 provides entities
additional time to assess the effect of repatriating foreign earnings under the American Jobs
Creation Act for purposes of applying SFAS No. 109, which typically requires the effect of a new
tax law to be recorded in the period of enactment. The Company may elect, if applicable, to apply
the DRD to qualifying dividends of foreign earnings repatriated during 2005. The Company is
currently evaluating the impact of the repatriation. In December of 2004, the FASB issued Statement of Financial Accounting Standards No. 153,
Exchanges of Nonmonetary Assets an amendment of ABP Opinion No. 29 (SFAS No. 153). SFAS No. 153
amends APB Opinion No. 29 Accounting for Nonmonetary Transactions to eliminate the exception for
nonmonetary exchanges of similar productive assets that do no have commercial substance. A
nonmonetary exchange has commercial substance if the future cash flows of the entity are expected
to change significantly as a result of the exchange. SFAS No. 153 is effective for nonmonetary
assets exchanges occurring in fiscal periods beginning after June 15, 2005. The Company is
currently evaluating the guidance provided under SFAS No. 153. In December of 2004, the FASB issued Statement of Financial Accounting Standards No. 123(R),
Share-Based Payment (SFAS No. 123(R)). SFAS No. 123(R) is a revision of FASB Statement No. 123,
Accounting for Stock Based Compensation and supersedes APB Opinion No. 25, Accounting for Stock
Issued to Employees and its related implementation guidance. SFAS No. 123(R) is effective for
public entities that do not file as small business issuers as of the beginning of the first
interim, or annual reporting period that begins after June 15, 2005. In April of 2005, the
Securities and Exchange Commission issued a ruling that SFAS No. 123(R) is now effective for public
companies for annual, rather than interim, periods that begin after June 15, 2005. The Company is
currently evaluating the guidance provided under SFAS No. 123(R). 
 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. 26




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##### Table of Contents



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, 2005. 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, 2005, that has materially affected, or is reasonably likely to
materially affect, the Companys internal control over financial reporting. 27




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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 5. OTHER INFORMATION In August of 2004, the Company and Christi Carter Urschel entered into an agreement (the
Master Agreement) with Meredith Corporation (Meredith), whereby Meredith agreed, among other
things, to publish a book on behalf of the Company and Ms. Urschel (who is the author of the book).
Under the Master Agreement, the Company agreed to purchase a minimum number of copies of the book
from Meredith for an agreed price per book set forth in the Master Agreement, with the intention
that the Company would market and sell the book to its customers. The Master Agreement provided
that Ms. Urschel would be compensated by Meredith on a royalty basis for books sold by Meredith to
persons other than the Company, if any, and that any compensation payable to Ms. Urschel in respect
of books to be sold by the Company would be separately agreed by the Company and Ms. Urschel. On January 20, 2005, the Company and Ms. Urschel entered into a Letter Agreement whereby the
Company agreed to pay Ms. Urschel the difference between (i) all net receipts generated by the
Company from the sale of any books and (ii) the Companys cost of purchasing the books from
Meredith plus the Companys direct, out-of-pocket costs associated with marketing, distributing and
selling the purchased books. As of March 31, 2005, the Company had paid approximately $21,000 to
Ms. Urschel under the Letter Agreement. Ms. Urschel is a shareholder and officer of the Company
and is a member of the Companys board of directors. 28




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##### Table of Contents



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS EXHIBITNUMBER
    
    DESCRIPTION10.1*
    
    Letter Agreement executed January 20, 2005 to confirm certain
agreements between Home Interiors & Gifts, Inc. and Christi Carter
Urschel relating to the undertakings set forth in the Master Book
Agreement, among Meredith Corporation, Home Interiors & Gifts,
Inc. and Christi Carter Urschel, dated as of August 9, 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 6, 2005, the Company filed a current report on Form 8-K with respect to an
issued press release announcing that the Company had appointed Mary-Knight Tyler as Chief
Operating Officer, effective January 1, 2005. On January 14, 2005, the Company filed a current report on Form 8-K with respect to the
resignation of Thomas O. Hicks as a member of the Board of Directors of the Company in
conjunction with his retirement from Hicks, Muse, Tate & Furst Incorporated. On March 10, 2005, the Company filed a current report on Form 8-K with respect to entering
into a letter agreement with the Companys Chief Financial Officer, Kenneth J. Cichocki that
served to amend in part Mr. Cichockis existing employment agreement. 29




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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, 2005 30




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EXHIBIT INDEX EXHIBITNUMBER
    
    DESCRIPTION10.1*
    
    Letter Agreement executed January 20, 2005 to confirm certain
agreements between Home Interiors & Gifts, Inc. and Christi
Carter Urschel relating to the undertakings set forth in the
Master Book Agreement, among Meredith Corporation, Home
Interiors & Gifts, Inc. and Christi Carter Urschel, dated as
of August 9, 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. 31