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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION    FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004 COMMISSION FILE NUMBER 333-62021 HOME INTERIORS & GIFTS, INC.  TEXAS
    
    75-0981828(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)1649 FRANKFORD ROAD WEST, CARROLLTON, TEXAS
    
    75007-4605(Address of principal executive offices)
    
    (Zip Code)
 (972) 695-1000
Registrants Telephone Number, Including Area Code Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes o No x As of November 15, 2004, 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, 2003 and September 30, 2004
    
    
    3Consolidated Statements of Operations and Comprehensive Income for the three months and nine
months ended September 30, 2003 and 2004
    
    
    4Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and 2004
    
    
    5Notes to Unaudited Interim Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    20Item 3. Quantitative and Qualitative Disclosure About Market Risk
    
    
    30Item 4. Controls and Procedures
    
    
    30PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    30Item 5. Other Information
    
    
    30Item 6. Exhibits and Reports on Form 8-K
    
    
    30Form of Amendment to Tier 1 and Tier 2 Option AgreementsCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
  2




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ITEM 1. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS. HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS As of December 31, 2003 and September 30, 2004
 (Unaudited)December 31,
    
    September 30,2003
    
    2004(In thousands, exceptshare information)ASSETSCurrent assets:Cash
    
    $
    36,636
    
    
    $
    16,047Accounts receivable, net
    
    
    22,027
    
    
    
    33,181Inventories, net
    
    
    73,135
    
    
    
    94,788Deferred income tax asset
    
    
    6,006
    
    
    
    9,092Assets held for sale
    
    
    
    
    
    
    26Other current assets
    
    
    3,444
    
    
    
    7,456Total current assets
    
    
    141,248
    
    
    
    160,590Property, plant and equipment, net
    
    
    75,191
    
    
    
    68,217Debt issuance costs, net
    
    
    3,956
    
    
    
    10,187Goodwill
    
    
    14,519
    
    
    
    13,645Assets held for sale
    
    
    
    
    
    
    253Other assets, net
    
    
    1,009
    
    
    
    819Total assets
    
    $
    235,923
    
    
    $
    253,711LIABILITIES AND SHAREHOLDERS DEFICITCurrent liabilities:Book overdraft
    
    $
    4,913
    
    
    $
    2,262Accounts payable
    
    
    30,757
    
    
    
    43,070Accrued seminars and incentive awards
    
    
    15,592
    
    
    
    9,730Royalties payable to decorating consultants
    
    
    8,109
    
    
    
    5,364Accrued compensation
    
    
    4,796
    
    
    
    2,826Current maturity of related party note payable
    
    
    675
    
    
    
    675Current maturities of long-term debt and capital lease obligations
    
    
    10,099
    
    
    
    14,274Other current liabilities
    
    
    18,234
    
    
    
    28,688Total current liabilities
    
    
    93,175
    
    
    
    106,889Long-term related party note payable, net of current maturity
    
    
    687
    
    
    
    687Long-term debt and capital lease obligations, net of current maturities
    
    
    311,777
    
    
    
    454,528Deferred income tax liability
    
    
    2,586
    
    
    
    2,426Other liabilities
    
    
    19,080
    
    
    
    20,779Total liabilities
    
    
    427,305
    
    
    
    585,309Commitments and contingencies (Note 12)Shareholders deficit:Preferred stock, par value $0.01 per share 10,000,000 shares
authorized 96,058.98 shares designated as cumulative 12.5% Senior
Convertible Preferred Stock at a liquidation value of $1,000 per
share, 96,058.98 shares issued and repurchased
    
    
    94,196
    
    
    
    Common stock, par value $0.10 per share, 75,000,000 shares
authorized, 15,240,218 shares issued and outstanding
    
    
    1,524
    
    
    
    1,524Additional paid-in capital
    
    
    185,036
    
    
    
    143,109Accumulated deficit
    
    
    (471,370
    )
    
    
    (475,399
    )Accumulated other comprehensive loss
    
    
    (768
    )
    
    
    (832
    )Total shareholders deficit
    
    
    (191,382
    )
    
    
    (331,598
    )Total liabilities and shareholders deficit
    
    $
    235,923
    
    
    $
    253,711
 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 and nine months ended September 30, 2003 and 2004
(In thousands)
(Unaudited)
 THREE MONTHS ENDED
    
    NINE MONTHS ENDEDSEPTEMBER 30,
    
    SEPTEMBER 30,2003
    
    2004
    
    2003
    
    2004Net sales
    
    $
    146,629
    
    
    $
    123,675
    
    
    $
    423,413
    
    
    $
    387,466Cost of goods sold
    
    
    75,924
    
    
    
    60,738
    
    
    
    196,191
    
    
    
    180,542Gross profit
    
    
    70,705
    
    
    
    62,937
    
    
    
    227,222
    
    
    
    206,924Selling, general and administrative:Selling
    
    
    25,968
    
    
    
    22,104
    
    
    
    72,739
    
    
    
    75,968Freight, warehouse and distribution
    
    
    20,483
    
    
    
    17,649
    
    
    
    54,374
    
    
    
    52,057General and administrative
    
    
    17,720
    
    
    
    13,805
    
    
    
    49,302
    
    
    
    49,483Loss/(gain) on the disposition of assets
    
    
    (439
    )
    
    
    47
    
    
    
    (146
    )
    
    
    1,564Stock option expense
    
    
    1,001
    
    
    
    1,244
    
    
    
    3,216
    
    
    
    3,176Loss on debt refinancing
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,071Total selling, general and administrative
    
    
    64,733
    
    
    
    54,849
    
    
    
    179,485
    
    
    
    183,319Operating income
    
    
    5,972
    
    
    
    8,088
    
    
    
    47,737
    
    
    
    23,605Other income (expense):Interest income
    
    
    37
    
    
    
    51
    
    
    
    262
    
    
    
    210Interest expense
    
    
    (6,748
    )
    
    
    (9,215
    )
    
    
    (20,610
    )
    
    
    (25,402
    )Other expense, net
    
    
    (506
    )
    
    
    (1,720
    )
    
    
    (203
    )
    
    
    (2,100
    )Other income (expense), net
    
    
    (7,217
    )
    
    
    (10,884
    )
    
    
    (20,551
    )
    
    
    (27,292
    )Income (loss) from continuing operations
before income taxes
    
    
    (1,245
    )
    
    
    (2,796
    )
    
    
    27,186
    
    
    
    (3,687
    )Income tax provision (benefit)
    
    
    (3,631
    )
    
    
    (1,840
    )
    
    
    6,820
    
    
    
    (3,556
    )Income (loss) from continuing operations
    
    
    2,386
    
    
    
    (956
    )
    
    
    20,366
    
    
    
    (131
    )Discontinued operations (Note 6):Loss from operations of discontinued
ceramics
manufacturing
    
    
    536
    
    
    
    190
    
    
    
    1,616
    
    
    
    3,898Income tax benefit
    
    
    (276
    )
    
    
    
    
    
    
    (462
    )
    
    
    Discontinued operations loss, net of tax
    
    
    260
    
    
    
    190
    
    
    
    1,154
    
    
    
    3,898Net income (loss)
    
    
    2,126
    
    
    
    (1,146
    )
    
    
    19,212
    
    
    
    (4,029
    )Other comprehensive loss:Cumulative translation adjustment
    
    
    362
    
    
    
    67
    
    
    
    19
    
    
    
    64Other comprehensive loss
    
    
    362
    
    
    
    67
    
    
    
    19
    
    
    
    64Comprehensive income (loss)
    
    $
    1,764
    
    
    $
    (1,213
    )
    
    $
    19,193
    
    
    $
    (4,093
    )
 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 Nine Months Ended September 30, 2003 and 2004
(In Thousands)
(Unaudited)
 Nine Months EndedSeptember 30,2003
    
    2004Cash flows from operating activities:Net income (loss)
    
    $
    19,212
    
    
    $
    (4,029
    )Adjustments to reconcile net income (loss) to net cash used in operating activities:Depreciation and amortization
    
    
    11,767
    
    
    
    11,775Impairment of goodwill
    
    
    
    
    
    
    1,060Impairment of property, plant and equipment
    
    
    
    
    
    
    1,325Amortization of debt issuance costs
    
    
    833
    
    
    
    1,824Provision for doubtful accounts
    
    
    2,271
    
    
    
    2,377Provision for losses on inventories
    
    
    (1,177
    )
    
    
    519Loss on debt refinancing
    
    
    
    
    
    
    1,071Loss (gain) on disposition of assets
    
    
    (146
    )
    
    
    1,564Stock option expense
    
    
    3,216
    
    
    
    3,176Deferred tax expense (benefit)
    
    
    (2,304
    )
    
    
    422Changes in assets and liabilities:Accounts receivable
    
    
    (15,927
    )
    
    
    (13,531
    )Inventories
    
    
    (27,794
    )
    
    
    (22,395
    )Other current assets
    
    
    (364
    )
    
    
    (7,294
    )Other assets
    
    
    (70
    )
    
    
    221Accounts payable
    
    
    2,861
    
    
    
    12,492Related party payable
    
    
    
    
    
    
    (709
    )Income taxes payable
    
    
    3,204
    
    
    
    (2,934
    )Other current liabilities
    
    
    (3,798
    )
    
    
    5,047Total adjustments
    
    
    (27,428
    )
    
    
    (3,990
    )Net cash used in operating activities
    
    
    (8,216
    )
    
    
    (8,019
    )Cash flows from investing activities:Purchases of property, plant and equipment
    
    
    (10,865
    )
    
    
    (6,539
    )Business acquisitions, net of cash acquired
    
    
    (13,474
    )
    
    
    Proceeds from the sale of property, plant and equipment
    
    
    630
    
    
    
    6Net cash used in investing activities
    
    
    (23,709
    )
    
    
    (6,533
    )Cash flows from financing activities:Book overdraft
    
    
    265
    
    
    
    (2,651
    )Payments of principal under capital lease obligations
    
    
    (1,443
    )
    
    
    (1,216
    )Proceeds from borrowings under New Senior Credit Facility
    
    
    
    
    
    
    320,000Payments of principal under Senior Credit Facility
    
    
    (15,477
    )
    
    
    (168,681
    )Payments of principal under New Senior Credit Facility
    
    
    
    
    
    
    (5,000
    )Debt issuance costs
    
    
    
    
    
    
    (9,126
    )Payment of principal of other bank debt
    
    
    (750
    )
    
    
    Preferred stock repurchase costs
    
    
    
    
    
    
    (299
    )Payment of preferred stock repurchase
    
    
    
    
    
    
    (109,459
    )Payment of preferred stock dividends
    
    
    
    
    
    
    (29,541
    )Net cash used in financing activities
    
    
    (17,405
    )
    
    
    (5,973
    )Effect of cumulative translation adjustment
    
    
    (19
    )
    
    
    (64
    )Net decrease in cash
    
    
    (49,349
    )
    
    
    (20,589
    )Cash at beginning of year
    
    
    68,111
    
    
    
    36,636Cash at end of period
    
    $
    18,762
    
    
    $
    16,047
 The accompanying notes are an integral part of these consolidated financial statements. 5




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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES 
 NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Background Home Interiors & Gifts, Inc. (the Company) is a fully integrated
manufacturer and distributor of home decorative accessories. The Company
believes it is the largest direct seller of home decorative accessories in the
United States, as measured by sales. The Companys products include, but are
not limited to, framed artwork and mirrors, candles and candle accessories,
plaques, figurines, planters, artificial floral arrangements, wall shelves,
sconces, small furniture, and tableware (the Products). The Company primarily
sells the Products through a direct selling channel of non-employee,
independent contractor sales representatives (Decorating Consultants) who
resell the Products primarily through one-on-one sales, brochure sales and
through the party-plan method of conducting in-home presentations for
potential customers. The Company has approximately 98,900 active Decorating
Consultants located in the United States, Mexico, Canada, and Puerto Rico. The Company has been located in Dallas, Texas since its inception in 1957.
Currently the majority of the Companys outstanding common stock of record is
owned by affiliates of Hicks, Muse, Tate & Furst Incorporated, a Dallas-based
private investment firm (Hicks Muse). The Company purchases its Products from a select number of independent
suppliers as well as from its wholly owned subsidiaries. During the first nine
months of 2004, approximately 49% of the dollar volume of Products purchased
for the direct selling channel of the Company was purchased from, and
manufactured by, the Companys subsidiaries. In addition to the Products sold
to the Company for the direct selling channel, certain subsidiaries have a
growing presence in the wholesale supply market. 2. Significant Accounting Policies These consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in the consolidation. The
Company records sales and related expenses on a weekly basis ending on each
Saturday. Each quarter consists of thirteen weeks. The final day of the
quarters ended September 30, 2003 and 2004 included in the accompanying
unaudited consolidated financial information was September 27, 2003 and October
2, 2004, respectively. The consolidated financial information as of September 30, 2004 and for
the three months and nine months ended September 30, 2003 and 2004 is
unaudited. In the opinion of management, the accompanying unaudited
consolidated financial information and related notes thereto contain all
adjustments, consisting only of normal, recurring adjustments, necessary to
present fairly the Companys consolidated financial position as of September
30, 2004 and December 31, 2003, its operating results and comprehensive income
for the three months and nine months ended September 30, 2003 and 2004, and its
cash flows for the nine months ended September 30, 2003 and 2004. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission (the SEC). The results of operations for the periods presented are
not necessarily indicative of the results to be expected for the full year. These unaudited interim consolidated financial statements and notes
thereto should be read in conjunction with the Companys audited consolidated
financial statements and notes thereto included in the Companys Form 10-K for
the year ended December 31, 2003 as filed with the SEC. Reclassifications Certain reclassifications have been made to prior period balances to
conform with the current year presentation. The Company has 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 and nine months ended September 30, 2003 and
2004. The effect of this 6




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reclassification increased operating income $0.5 million and $1.6 million
for the three months and nine months ended September 30, 2003. This
reclassification had no impact on net income for the three months and nine
months ended September 30, 2004. Stock-based Compensations Plans The Company has adopted three stock option plans. For Decorating
Consultants and independent contractors, the Company has adopted the
Independent Contractor Stock Option Plan and accounts for options issued
under the Independent Contractor Stock Option Plan in accordance with Statement
of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS No. 123). For key employees, the Company has adopted the
1998 Key Employee Stock Option Plan and the 2002 Key Employee Stock Option
Plan. The Company accounts for the options issued under the 1998 Key Employee
Stock Option Plan and the 2002 Key Employee Stock Option Plan in accordance
with the Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB No. 25), as allowed by FAS 123. Compensation Charge SFAS No. 123 establishes a fair value basis of accounting for stock-based
compensation plans. The effects of applying SFAS No. 123 as shown below are not
indicative of future amounts. Had the compensation cost for the Companys 1998
Key Employee Stock Option Plan and 2002 Key Employee Stock Option Plan been
determined consistent with SFAS No. 123, the Companys compensation cost and
net income for the three months and nine months ended September 30, 2003 and
2004 would approximate (in thousands): Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2004
    
    2003
    
    2004Net income (loss), as reported
    
    $
    2,126
    
    
    $
    (1,146
    )
    
    $
    19,212
    
    
    $
    (4,029
    )Add: Stock-based employee
compensation expense included
in reported net income
(loss), net of related tax
effects
    
    
    449
    
    
    
    442
    
    
    
    1,440
    
    
    
    1,379Deduct: Stock-based employee
compensation expense
determined under fair value
based method for all awards,
net of related tax effects
    
    
    (497
    )
    
    
    (515
    )
    
    
    (1,760
    )
    
    
    (1,542
    )Pro forma net income (loss)
    
    $
    2,078
    
    
    $
    (1,219
    )
    
    $
    18,892
    
    
    $
    (4,192
    )
 3. Inventories, Net Inventories, net, consisted of the following as of December 31, 2003 and
September 30, 2004 (in thousands): December 31,
    
    September 30,2003
    
    2004Raw materials
    
    $
    9,364
    
    
    $
    9,259Work in process
    
    
    2,458
    
    
    
    3,182Finished goods
    
    
    66,212
    
    
    
    87,34778,034
    
    
    
    99,788Inventory allowance
    
    
    (4,899
    )
    
    
    (5,000
    )$
    73,135
    
    
    $
    94,788
 7




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4. Other Current Liabilities Other current liabilities consisted of the following as of December 31,
2003 and September 30, 2004 (in thousands): December 31,
    
    September 30,2003
    
    2004Interest
    
    $
    1,258
    
    
    $
    5,220Accrued employee benefits
    
    
    4,443
    
    
    
    4,261Income taxes payable
    
    
    2,934
    
    
    
    Sales taxes
    
    
    3,498
    
    
    
    4,688Other taxes
    
    
    1,535
    
    
    
    1,497Deferred revenue
    
    
    2,033
    
    
    
    9,880Related parties
    
    
    600
    
    
    
    108Other
    
    
    1,933
    
    
    
    3,034$
    18,234
    
    
    $
    28,688
 5. Adoption of New Accounting Standards In April 2004, the Financial Accounting Standards Board (FASB), issued
Staff Position Statement of Financial Accounting Standards No. 129-1,
Disclosure Requirements under FASB Statement No. 129, Disclosure of
Information about Capital Structure, Relating to Contingently Convertible
Securities (FSP FAS 129-1). FSP FAS 129-1 provides interpretation guidance
regarding the disclosure provisions of FASB Statement No. 129 as it applies to
contingently convertible securities and the potential dilutive effects on
earnings per share. FSP FAS 129-1 is effective as of April 9, 2004 and applies
to all existing and newly created securities. The Company adopted FSP FAS 129-1
on April 9, 2004 and there was no financial accounting impact associated with
its adoption. 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 is located in
Monterrey, Mexico. In the second quarter of 2004 the Company made the decision
to discontinue the manufacture of ceramics products and, also, to close the
glass manufacturing plant. The Company has accounted for the shutdown of the
manufacturing efforts of ceramics products as discontinued operations in the
consolidated statement of operations and comprehensive income for the period
ended September 30, 2004, as discussed below. The costs incurred related to the
shutdown of the glass manufacturing facility are reflected in continuing
operations in the consolidated statement of operations and comprehensive income
for the period ended September 30, 2004, since the Company will continue to
source glass products from non-affiliated vendors and distribute glass products
to non-affiliated retailers. On April 28, 2004, the Company discontinued the manufacturing of ceramics
products that were produced in its Mexico manufacturing facility. The Company
will not have any involvement in the manufacturing of these types of products
in the future. The Company has incurred approximately $0.6 million in
severance costs, $0.1 million in contract termination costs, $1.3 million in
impairment of property, plant, and equipment, and $1.1 million in impairment of
goodwill related to the shut-down and disposal activity. The remaining assets
related to the ceramics product manufacturing have been classified as assets
held for sale and the Company anticipates disposing of all assets within one
year. The operations and cash flows of the ceramics manufacturing operation have
been eliminated from the Companys ongoing operations as a result of the
shut-down, 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 and Statement of Financial Position are presented in the
following table (in thousands): 8




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THREE MONTHS ENDED
    
    NINE MONTHS ENDEDSEPTEMBER 30,
    
    SEPTEMBER 30,2003
    
    2004
    
    2003
    
    2004Net sales
    
    $
    686
    
    
    $
    (4
    )
    
    $
    1,286
    
    
    $
    824Cost of goods sold
    
    
    908
    
    
    
    43
    
    
    
    2,159
    
    
    
    1,819Gross profit
    
    
    (222
    )
    
    
    (47
    )
    
    
    (873
    )
    
    
    (995
    )Selling, general and administrative:General and administrative
    
    
    229
    
    
    
    144
    
    
    
    688
    
    
    
    2,776Total selling, general and administrative
    
    
    229
    
    
    
    144
    
    
    
    688
    
    
    
    2,776Operating loss
    
    
    (451
    )
    
    
    (191
    )
    
    
    (1,561
    )
    
    
    (3,771
    )Other income (expense):Interest income
    
    
    1
    
    
    
    
    
    
    
    1
    
    
    
    Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2
    )Other income (expense), net
    
    
    (86
    )
    
    
    1
    
    
    
    (56
    )
    
    
    (125
    )Other income (expense), net
    
    
    (85
    )
    
    
    1
    
    
    
    (55
    )
    
    
    (127
    )Loss before income taxes
    
    
    (536
    )
    
    
    (190
    )
    
    
    (1,616
    )
    
    
    (3,898
    )Income tax benefit
    
    
    276
    
    
    
    
    
    
    
    462
    
    
    
    Loss on discontinued operations
    
    $
    (260
    )
    
    $
    (190
    )
    
    $
    (1,154
    )
    
    $
    (3,898
    )
 Balance sheet data: September 30,2004Long term assets held for sale
    
    $
    164
 7. Assets Held for Sale Assets classified as held for sale include the remaining assets related to
the discontinuation of manufacture of ceramics products (Note 6 Discontinued
Operations) and the remaining assets related to the manufacture of glass
products. In May 2004, the Company made the decision to cease the manufacture of
glass products, and in June 2004 the glass manufacturing plant was shut down.
The Company has incurred approximately $0.9 million in impairment of property,
plant, and equipment related to the glass plant closure. The remaining assets
of the glass manufacturing plant have been classified as long-term assets held
for sale in the consolidated statement of financial position. The total of
assets held for sale related the glass plant closure at September 30, 2004 was
$0.1 million. The Company anticipates disposing of all assets within one year. 8. Refinancing of Senior Credit Facility On March 31, 2004, the Company entered into a senior credit facility, New
Senior Credit Facility, with Bear Stearns Corporate Lending Inc., as
syndication agent, JPMorgan Chase Bank, as administrative agent, and the
several lenders from time to time parties thereto, pursuant to which the
Company, among other things, refinanced loans outstanding under the Companys
existing credit facility. The New Senior Credit Facility provides a seven-year
term loan facility of up to $320.0 million, Term Loans, and a $50.0 million
five-year revolving credit facility, Revolving Loans. On March 31, 2004, $320.0 million in proceeds received from the Term Loans
were used to complete the following transactions: 9




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##### Table of Contents




    
    For an aggregate purchase price of $139.0 million, the Company
repurchased all of the Companys outstanding shares of its 12.5% Senior
Convertible Preferred Stock, pursuant to a Stock Purchase Agreement,
dated March 31, 2004, among the Company and certain affiliates of the
Companys controlling stockholders the Preferred Stock Repurchase.
    
    $169.1 million of the proceeds were used to pay off the existing
credit facility, which included an outstanding debt balance, related
partial year interest, commitment fees, and outstanding letter of credit
fees.
    
    $9.4 million of the proceeds were used to pay legal and advisory fees
associated with the Preferred Stock Repurchase and to pay off of the
existing credit facility, and New Senior Credit Facility debt issuance
costs. There were no amounts drawn under the Revolving Loans and the remaining
Term Loan proceeds of approximately $2.5 million were used for general working
capital purposes. As a result of the existing credit facility refinancing, the Company
recognized a $1.1 million loss related to a $0.4 million write-off of
unamortized debt issuance costs and $0.7 million of legal and advisory costs
for the nine month period ended September 30, 2004. The Company also incurred
debt issuance costs related to the New Senior Credit Facility of $8.4 million
that were deferred. As a result of the Preferred Stock Repurchase, the Company
recognized a $45.1 million reduction in additional paid-in-capital related to
$29.5 million preferred stock dividends paid, $15.3 million premium paid in
excess of the liquidation value of the preferred stock, and $0.3 million of
legal and advisory fees. Borrowings under the New Senior Credit Facility require quarterly
principal and interest payments. The term loan facility matures on March 31,
2011 and the revolving loan facility matures on March 31, 2009 provided that in
the event that the senior subordinated notes (the 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. Accordingly, the Company is amortizing its debt
issuance costs over the period from March 31, 2004 through December 1, 2007.
The Company may, at its option, prepay the Term Loans and Revolving Loans
without premium or penalty provided that in certain circumstances prepayment of
the Term Loans on or prior to the first anniversary of the closing date of the
New Senior Credit Facility must be accompanied by a 1% prepayment premium.
Additionally, the Company may reduce or eliminate its revolving loan commitment
prior to maturity. The New Senior Credit Facility is guaranteed unconditionally
on a senior basis by the Companys wholly owned domestic subsidiaries and is
collateralized by a lien on substantially all assets of the Company and its
wholly owned domestic subsidiaries. There are no material restrictions on the
Companys ability to obtain funds from its wholly owned subsidiaries by
dividend or otherwise. The Term Loans under the New Senior Credit Facility bear interest, at the
Companys election, at either LIBOR plus an applicable margin or the 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 New Senior Credit Agreement. The interest
rates on all borrowings outstanding under the New Senior Credit Facility were
based on LIBOR as of September 30, 2004. As of September 30, 2004, term
borrowings outstanding totaled $315.0 million. The weighted-average interest
rate on the Term Loan borrowings outstanding at September 30, 2004 was 6.42%. The Revolving Loans are subject to a commitment fee based on the undrawn
portion of the Revolving Loans. The commitment fee is eligible for certain
performance pricing step-downs and was 0.5% per annum as of September 30, 2004.
Outstanding letters of credit totaled $4.2 million as of September 30, 2004. The terms of the Notes and New Senior Credit Facility include significant
operating and financial restrictions, such as limits on the Companys ability
to incur indebtedness, create liens, sell assets, engage in mergers,
acquisitions or consolidations, make investments and pay dividends. In
addition, under the New Senior Credit Facility, the Company is required to
comply with specified financial ratios and tests, an interest coverage ratio,
maximum leverage ratio, and maximum capital expenditures as defined per the New
Senior Credit Facility agreement. As of September 30, 2004, the Company was in
compliance with all covenants and other requirements set forth in the credit
agreement under the New Senior Credit Facility and indenture with respect to
the Notes. 10




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##### Table of Contents



A summary of long-term debt obligations under the New Senior Credit
Facility as of September 30, 2004 is as follows (in thousands): Term Loans, interest at LIBOR plus an applicable margin (6.42%)
    
    $
    312,500Term Loans, interest at LIBOR plus an applicable margin (6.23%)
    
    
    2,500Less current maturities
    
    
    (12,500
    )$
    302,500
 The following table represents a summary of the maturities of Term Loans
under the New Senior Credit Facility as of September 30, 2004 (in thousands): 2004
    
    $
    2,5002005
    
    
    13,7502006
    
    
    15,0002007
    
    
    283,750$
    315,000
 9. Income Tax Benefit The income tax benefit for the nine month period ended September 30, 2004
includes a $1.6 million benefit associated with a deduction the Company will
take in its 2004 U.S. tax return for the closure of a subsidiary in Mexico. 10. Segment Reporting The Companys reportable segments are based upon functional lines of
business as follows:  
    
    Direct Selling Domestic  direct seller of home decorative
accessories in the United States;
    
    Direct Selling International  direct seller of home decorative
accessories in Mexico, Canada, and Puerto Rico; and
    
    Domistyle  wholesale supply operation that manufactures, imports,
and distributes candles, framed artwork, mirrors, various types of
molded plastic, and metal 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 income and expense,
unrealized loss on derivatives, taxes, the effects of SAB 101, discontinued
operations, depreciation and amortization, reorganization costs, non-cash
expense for stock options, losses on debt refinancing, impairment of goodwill,
and gains and losses on disposition of assets, (defined as Modified EBITDA).
Prior years Modified EBITDA has been recalculated for comparative purposes.
The accounting principles of the segments are the same as those described in
Note 2. Segment data includes intersegment sales and intercompany net
receivable balances. Eliminations consist primarily of intersegment sales
between the Domistyle segment and the direct selling segments, as well as the
elimination of the investment in each subsidiary for consolidation purposes.
The table below presents information about reportable segments used by the
Companys chief operating decision makers as of and for the three months and
nine months ended September 30, 2003 and 2004 (in thousands): 11




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##### Table of Contents



Direct
    
    DirectSelling
    
    SellingThree months ended September 30,
    
    Domestic
    
    International
    
    Domistyle
    
    Eliminations
    
    Consolidated2003Net sales to non-affiliates
    
    $
    121,680
    
    
    $
    17,149
    
    
    $
    7,800
    
    
    $
    
    
    
    $
    146,629Net sales to affiliates
    
    
    6,030
    
    
    
    
    
    
    
    34,770
    
    
    
    (40,800
    )
    
    
    Modified EBITDA
    
    
    2,629
    
    
    
    473
    
    
    
    10,834
    
    
    
    (1,120
    )
    
    
    12,8162004Net sales to non-affiliates
    
    $
    98,957
    
    
    $
    18,064
    
    
    $
    6,654
    
    
    $
    
    
    
    $
    123,675Net sales to affiliates
    
    
    6,577
    
    
    
    
    
    
    
    30,090
    
    
    
    (36,667
    )
    
    
    Modified EBITDA
    
    
    5,708
    
    
    
    2,416
    
    
    
    7,714
    
    
    
    (172
    )
    
    
    15,666
 Direct
    
    DirectSelling
    
    SellingNine months ended September 30,
    
    Domestic
    
    International
    
    Domistyle
    
    Eliminations
    
    Consolidated2003Net sales to non-affiliates
    
    $
    363,133
    
    
    $
    41,593
    
    
    $
    18,687
    
    
    $
    
    
    
    $
    423,413Net sales to affiliates
    
    
    24,252
    
    
    
    
    
    
    
    104,928
    
    
    
    (129,180
    )
    
    
    Modified EBITDA
    
    
    35,266
    
    
    
    3,158
    
    
    
    33,939
    
    
    
    (3,350
    )
    
    
    69,013Total assets
    
    
    215,074
    
    
    
    9,815
    
    
    
    97,889
    
    
    
    (82,724
    )
    
    
    240,054Goodwill
    
    
    
    
    
    
    
    
    
    
    14,475
    
    
    
    
    
    
    
    14,475Capital expenditures
    
    
    5,232
    
    
    
    356
    
    
    
    5,277
    
    
    
    
    
    
    
    10,8652004Net sales to non-affiliates
    
    $
    318,237
    
    
    $
    48,446
    
    
    $
    20,783
    
    
    $
    
    
    
    $
    387,466Net sales to affiliates
    
    
    21,793
    
    
    
    
    
    
    
    98,549
    
    
    
    (120,342
    )
    
    
    Modified EBITDA
    
    
    22,306
    
    
    
    5,717
    
    
    
    27,604
    
    
    
    (1,721
    )
    
    
    53,906Total assets
    
    
    224,707
    
    
    
    20,895
    
    
    
    86,735
    
    
    
    (78,626
    )
    
    
    253,711Goodwill
    
    
    
    
    
    
    
    
    
    
    13,645
    
    
    
    
    
    
    
    13,645Capital expenditures
    
    
    3,300
    
    
    
    817
    
    
    
    2,422
    
    
    
    
    
    
    
    6,539
 12




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##### Table of Contents



The following table represents a reconciliation of net income (loss) to
consolidated Modified EBITDA for the three months and nine months ended
September 30, 2003 and 2004 (in thousands): Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2004
    
    2003
    
    2004Net income (loss)
    
    $
    2,126
    
    
    $
    (1,146
    )
    
    $
    19,212
    
    
    $
    (4,029
    )Effect of SAB 101
    
    
    (72
    )
    
    
    592
    
    
    
    2,790
    
    
    
    2,859Discontinued operations
    
    
    260
    
    
    
    190
    
    
    
    1,154
    
    
    
    3,898Interest income
    
    
    (37
    )
    
    
    (51
    )
    
    
    (262
    )
    
    
    (210
    )Interest expense
    
    
    6,748
    
    
    
    9,215
    
    
    
    20,610
    
    
    
    25,402Unrealized loss on derivatives
    
    
    
    
    
    
    1,819
    
    
    
    
    
    
    
    1,730Income tax provision (benefit)
    
    
    (3,631
    )
    
    
    (1,840
    )
    
    
    6,820
    
    
    
    (3,556
    )Depreciation and amortization
    
    
    4,062
    
    
    
    4,354
    
    
    
    11,664
    
    
    
    11,775Stock option expense
    
    
    1,001
    
    
    
    1,244
    
    
    
    3,216
    
    
    
    3,176Loss on debt refinancing
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,071Reorganization costs
    
    
    2,798
    
    
    
    1,242
    
    
    
    3,955
    
    
    
    10,226Loss (gain) on disposition of assets
    
    
    (439
    )
    
    
    47
    
    
    
    (146
    )
    
    
    1,564Modified EBITDA
    
    $
    12,816
    
    
    $
    15,666
    
    
    $
    69,013
    
    
    $
    53,906
 11. Guarantor Financial Data Dallas Woodcraft Company, LP, DWC GP, Inc., GIA, Inc., Homco, Inc., Spring
Valley Scents, Inc., Laredo Candle Company, L.P., Domistyle, Inc., EM Boehm,
Inc., Home Interiors de Puerto Rico, Inc. and HIG Investments, Inc.
(collectively, the Guarantors) unconditionally, on a joint and several basis,
guarantee the Companys (Borrower) payment and performance of its obligation
under the New Senior Credit Facility agreement and the Debt Holders 10 1/8%
Senior Subordinated Notes due 2008 in the amount of $149.1 million (the
Notes). The Companys other subsidiaries, Home Interiors de Mexico, S. de
R.L. de C.V., Home Interiors Services de Mexico, S.A. de C.V., HI Ceramics,
S.A. de C.V., HI Metals, S.A. de C.V., HI Glass, S.A. de C.V., HI Trading
Mexicana, S.A. de C.V., and Home Interiors & Gifts of Canada, Inc.
(collectively, the Non-Guarantors) have not guaranteed the New Senior Credit
Facility or the Notes. Guarantor and Non-Guarantor financial statements on an
individual basis are not significant and have been omitted. Accordingly, the
following table presents financial information of the Guarantors and
Non-Guarantors on a consolidating basis (in thousands): Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Three Months Ended September 30, 2003 Non-Borrower
    
    Guarantor
    
    Guarantors
    
    Eliminations
    
    ConsolidatedNet sales
    
    $
    129,177
    
    
    $
    40,881
    
    
    $
    19,075
    
    
    $
    (42,504
    )
    
    $
    146,629Cost of good sold
    
    
    76,973
    
    
    
    27,391
    
    
    
    12,972
    
    
    
    (41,412
    )
    
    
    75,924Gross profit
    
    
    52,204
    
    
    
    13,490
    
    
    
    6,103
    
    
    
    (1,092
    )
    
    
    70,705Total selling, general and administrative
    
    
    55,032
    
    
    
    2,822
    
    
    
    6,879
    
    
    
    
    
    
    
    64,733Operating income (loss)
    
    
    (2,828
    )
    
    
    10,668
    
    
    
    (776
    )
    
    
    (1,092
    )
    
    
    5,972Other income (expense), net
    
    
    (6,578
    )
    
    
    108
    
    
    
    (718
    )
    
    
    (29
    )
    
    
    (7,217
    )Income (loss) before income taxes
    
    
    (9,406
    )
    
    
    10,776
    
    
    
    (1,494
    )
    
    
    (1,121
    )
    
    
    (1,245
    )Income tax benefit (provision)
    
    
    6,922
    
    
    
    (3,815
    )
    
    
    524
    
    
    
    
    
    
    
    3,631Equity in income (loss) of affiliated
companies, net of tax
    
    
    5,729
    
    
    
    (1,477
    )
    
    
    
    
    
    
    (4,252
    )
    
    
    Net income (loss) from continuing
operations
    
    
    3,245
    
    
    
    5,484
    
    
    
    (970
    )
    
    
    (5,373
    )
    
    
    2,386Discontinued operations loss, net of tax
    
    
    
    
    
    
    
    
    
    
    260
    
    
    
    
    
    
    
    260Net income (loss)
    
    
    3,245
    
    
    
    5,484
    
    
    
    (1,230
    )
    
    
    (5,373
    )
    
    
    2,126Other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    362
    
    
    
    
    
    
    
    362Comprehensive income (loss)
    
    $
    3,245
    
    
    $
    5,484
    
    
    $
    (1,592
    )
    
    $
    (5,373
    )
    
    $
    1,764
 13




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##### Table of Contents



Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Nine Months Ended September 30, 2003 Non-Borrower
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedNet sales
    
    $
    392,147
    
    
    $
    119,849
    
    
    $
    43,405
    
    
    $
    (131,988
    )
    
    $
    423,413Cost of good sold
    
    
    216,339
    
    
    
    78,875
    
    
    
    29,653
    
    
    
    (128,676
    )
    
    
    196,191Gross profit
    
    
    175,808
    
    
    
    40,974
    
    
    
    13,752
    
    
    
    (3,312
    )
    
    
    227,222Total selling, general and administrative
    
    
    157,042
    
    
    
    8,016
    
    
    
    14,427
    
    
    
    
    
    
    
    179,485Operating income (loss)
    
    
    18,766
    
    
    
    32,958
    
    
    
    (675
    )
    
    
    (3,312
    )
    
    
    47,737Other income (expense), net
    
    
    (19,892
    )
    
    
    299
    
    
    
    (950
    )
    
    
    (8
    )
    
    
    (20,551
    )Income (loss) before income taxes
    
    
    (1,126
    )
    
    
    33,257
    
    
    
    (1,625
    )
    
    
    (3,320
    )
    
    
    27,186Income tax benefit (provision)
    
    
    4,302
    
    
    
    (11,821
    )
    
    
    699
    
    
    
    
    
    
    
    (6,820
    )Equity in income (loss) of affiliated
companies, net of tax
    
    
    19,385
    
    
    
    (3,231
    )
    
    
    
    
    
    
    (16,154
    )
    
    
    Net income (loss) from continuing
operations
    
    
    22,561
    
    
    
    18,205
    
    
    
    (926
    )
    
    
    (19,474
    )
    
    
    20,366Discontinued operations loss, net of tax
    
    
    
    
    
    
    
    
    
    
    1,154
    
    
    
    
    
    
    
    1,154Net income (loss)
    
    
    22,561
    
    
    
    18,205
    
    
    
    (2,080
    )
    
    
    (19,474
    )
    
    
    19,212Other comprehensive loss
    
    
    10
    
    
    
    
    
    
    
    9
    
    
    
    
    
    
    
    19Comprehensive income (loss)
    
    $
    22,551
    
    
    $
    18,205
    
    
    $
    (2,089
    )
    
    $
    (19,474
    )
    
    $
    19,193
 Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Three Months Ended September 30, 2004 Non-Borrower
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedNet sales
    
    $
    107,219
    
    
    $
    36,086
    
    
    $
    17,198
    
    
    $
    (36,828
    )
    
    $
    123,675Cost of good sold
    
    
    59,457
    
    
    
    26,630
    
    
    
    11,428
    
    
    
    (36,777
    )
    
    
    60,738Gross profit
    
    
    47,762
    
    
    
    9,456
    
    
    
    5,770
    
    
    
    (51
    )
    
    
    62,937Total selling, general and administrative
    
    
    46,633
    
    
    
    2,820
    
    
    
    5,396
    
    
    
    
    
    
    
    54,849Operating income (loss)
    
    
    1,129
    
    
    
    6,636
    
    
    
    374
    
    
    
    (51
    )
    
    
    8,088Other income (expense), net
    
    
    (11,152
    )
    
    
    187
    
    
    
    201
    
    
    
    (120
    )
    
    
    (10,884
    )Income (loss) before income taxes
    
    
    (10,023
    )
    
    
    6,823
    
    
    
    575
    
    
    
    (171
    )
    
    
    (2,796
    )Income tax benefit (provision)
    
    
    4,957
    
    
    
    (2,551
    )
    
    
    (462
    )
    
    
    (104
    )
    
    
    1,840Equity in income (loss) of affiliated
companies, net of tax
    
    
    4,193
    
    
    
    (1,266
    )
    
    
    
    
    
    
    (2,927
    )
    
    
    Income (loss) from continuing operations
    
    
    (873
    )
    
    
    3,006
    
    
    
    113
    
    
    
    (3,202
    )
    
    
    (956
    )Discontinued operations loss, net of tax
    
    
    
    
    
    
    
    
    
    
    190
    
    
    
    
    
    
    
    190Net income (loss)
    
    
    (873
    )
    
    
    3,006
    
    
    
    (77
    )
    
    
    (3,202
    )
    
    
    (1,146
    )Other comprehensive income (loss)
    
    
    6
    
    
    
    
    
    
    
    (73
    )
    
    
    
    
    
    
    (67
    )Comprehensive income (loss)
    
    $
    (867
    )
    
    $
    3,006
    
    
    $
    (150
    )
    
    $
    (3,202
    )
    
    $
    (1,213
    )
 14




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##### Table of Contents



Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Nine Months Ended September 30, 2004 Non-Borrower
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedNet sales
    
    $
    345,787
    
    
    $
    115,439
    
    
    $
    49,377
    
    
    $
    (123,137
    )
    
    $
    387,466Cost of good sold
    
    
    186,426
    
    
    
    80,442
    
    
    
    35,504
    
    
    
    (121,830
    )
    
    
    180,542Gross profit
    
    
    159,361
    
    
    
    34,997
    
    
    
    13,873
    
    
    
    (1,307
    )
    
    
    206,924Total selling, general and administrative
    
    
    154,812
    
    
    
    9,491
    
    
    
    19,016
    
    
    
    
    
    
    
    183,319Operating income (loss)
    
    
    4,549
    
    
    
    25,506
    
    
    
    (5,143
    )
    
    
    (1,307
    )
    
    
    23,605Other income (expense), net
    
    
    (26,864
    )
    
    
    577
    
    
    
    (592
    )
    
    
    (413
    )
    
    
    (27,292
    )Income (loss) before income taxes
    
    
    (22,315
    )
    
    
    26,083
    
    
    
    (5,735
    )
    
    
    (1,720
    )
    
    
    (3,687
    )Income tax benefit (provision)
    
    
    12,356
    
    
    
    (7,868
    )
    
    
    (1,048
    )
    
    
    116
    
    
    
    3,556Equity in income (loss) of affiliated
companies, net of tax
    
    
    7,534
    
    
    
    (12,936
    )
    
    
    
    
    
    
    5,402
    
    
    
    Income (loss) from continuing operations
    
    
    (2,425
    )
    
    
    5,279
    
    
    
    (6,783
    )
    
    
    3,798
    
    
    
    (131
    )Discontinued operations loss, net of tax
    
    
    
    
    
    
    
    
    
    
    3,898
    
    
    
    
    
    
    
    3,898Net income (loss)
    
    
    (2,425
    )
    
    
    5,279
    
    
    
    (10,681
    )
    
    
    3,798
    
    
    
    (4,029
    )Other comprehensive income (loss)
    
    
    13
    
    
    
    
    
    
    
    (77
    )
    
    
    
    
    
    
    (64
    )Comprehensive income (loss)
    
    $
    (2,412
    )
    
    $
    5,279
    
    
    $
    (10,758
    )
    
    $
    3,798
    
    
    $
    (4,093
    )
 15




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##### Table of Contents



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




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##### Table of Contents



Condensed Consolidating Balance Sheet
As of September 30, 2004 Non-Borrower
    
    Guarantors
    
    Guarantors
    
    Consolidating
    
    Eliminations
    
    ConsolidatedASSETSCurrent assets:Cash
    
    $
    15,307
    
    
    $
    10
    
    
    $
    730
    
    
    $
    16,047
    
    
    $
    
    
    
    $
    16,047Accounts receivable, net
    
    
    19,343
    
    
    
    5,340
    
    
    
    8,498
    
    
    
    33,181
    
    
    
    
    
    
    
    33,181Inventories, net
    
    
    72,091
    
    
    
    18,060
    
    
    
    11,150
    
    
    
    101,301
    
    
    
    (6,513
    )
    
    
    94,788Other current assets
    
    
    8,963
    
    
    
    2,037
    
    
    
    4,012
    
    
    
    15,012
    
    
    
    1,562
    
    
    
    16,574Due from (due to) affiliated
companies
    
    
    (10,946
    )
    
    
    37,694
    
    
    
    (26,748
    )
    
    
    
    
    
    
    
    
    
    
    Total current assets
    
    
    104,758
    
    
    
    63,141
    
    
    
    (2,358
    )
    
    
    165,541
    
    
    
    (4,951
    )
    
    
    160,590Property, plant and equipment, net
    
    
    39,991
    
    
    
    19,226
    
    
    
    9,000
    
    
    
    68,217
    
    
    
    
    
    
    
    68,217Investment in affiliates
    
    
    73,662
    
    
    
    (8,728
    )
    
    
    
    
    
    
    64,934
    
    
    
    (64,934
    )
    
    
    Debt issuance costs and other
assets, net
    
    
    10,131
    
    
    
    13,513
    
    
    
    1,260
    
    
    
    24,904
    
    
    
    
    
    
    
    24,904Total assets
    
    $
    228,542
    
    
    $
    87,152
    
    
    $
    7,902
    
    
    $
    323,596
    
    
    $
    (69,885
    )
    
    $
    253,711LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    36,945
    
    
    $
    4,170
    
    
    $
    1,324
    
    
    $
    42,439
    
    
    $
    631
    
    
    $
    43,070Current maturity of related
party note payable
    
    
    675
    
    
    
    
    
    
    
    
    
    
    
    675
    
    
    
    
    
    
    
    675Current maturities of long-term
debt and capital lease
obligations
    
    
    13,863
    
    
    
    229
    
    
    
    182
    
    
    
    14,274
    
    
    
    
    
    
    
    14,274Other current liabilities
    
    
    27,849
    
    
    
    12,378
    
    
    
    8,643
    
    
    
    48,870
    
    
    
    
    
    
    
    48,870Total current liabilities
    
    
    79,332
    
    
    
    16,777
    
    
    
    10,149
    
    
    
    106,258
    
    
    
    631
    
    
    
    106,889Long-term related party note
payable, net of current maturity
    
    
    687
    
    
    
    
    
    
    
    
    
    
    
    687
    
    
    
    
    
    
    
    687Long-term debt and capital lease
obligations, net of current
maturities
    
    
    453,884
    
    
    
    307
    
    
    
    337
    
    
    
    454,528
    
    
    
    
    
    
    
    454,528Other liabilities
    
    
    19,813
    
    
    
    3,256
    
    
    
    136
    
    
    
    23,205
    
    
    
    
    
    
    
    23,205Total liabilities
    
    
    553,716
    
    
    
    20,340
    
    
    
    10,622
    
    
    
    584,678
    
    
    
    631
    
    
    
    585,309Commitments and contingencies
(Note 12)Shareholders equity (deficit):Common stock
    
    
    1,524
    
    
    
    1,001
    
    
    
    29
    
    
    
    2,554
    
    
    
    (1,030
    )
    
    
    1,524Additional paid-in capital
    
    
    143,109
    
    
    
    3,031
    
    
    
    12,331
    
    
    
    158,471
    
    
    
    (15,362
    )
    
    
    143,109Retained earnings (accumulated
deficit)
    
    
    (469,816
    )
    
    
    62,780
    
    
    
    (14,239
    )
    
    
    (421,275
    )
    
    
    (54,124
    )
    
    
    (475,399
    )Accumulated other comprehensive
income (loss)
    
    
    9
    
    
    
    
    
    
    
    (841
    )
    
    
    (832
    )
    
    
    
    
    
    
    (832
    )Total shareholders equity
(deficit)
    
    
    (325,174
    )
    
    
    66,812
    
    
    
    (2,720
    )
    
    
    (261,082
    )
    
    
    (70,516
    )
    
    
    (331,598
    )Total liabilities and
shareholders equity
(deficit)
    
    $
    228,542
    
    
    $
    87,152
    
    
    $
    7,902
    
    
    $
    323,596
    
    
    $
    (69,885
    )
    
    $
    253,711
 17




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##### Table of Contents



Condensed Consolidating Cash Flow Statement
For the Nine Months Ended September 30, 2003 Non-Borrower
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedNet cash provided by (used in) operating activities
    
    $
    (27,034
    )
    
    $
    14,174
    
    
    $
    4,644
    
    
    $
    
    
    
    $
    (8,216
    )Cash flows from investing activities:Purchases of property, plant and equipment
    
    
    (5,232
    )
    
    
    (2,848
    )
    
    
    (2,785
    )
    
    
    
    
    
    
    (10,865
    )Payment for acquisition, net of cash acquired
    
    
    (1,798
    )
    
    
    (11,676
    )
    
    
    
    
    
    
    
    
    
    
    (13,474
    )Proceeds from the sale of property, plant and
equipment
    
    
    601
    
    
    
    29
    
    
    
    
    
    
    
    
    
    
    
    630Net cash used in investing activities
    
    
    (6,429
    )
    
    
    (14,495
    )
    
    
    (2,785
    )
    
    
    
    
    
    
    (23,709
    )Cash flows from financing activities:Book overdraft
    
    
    (686
    )
    
    
    951
    
    
    
    
    
    
    
    
    
    
    
    265Payments under Senior Credit Facility
    
    
    (15,477
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15,477
    )Payments of principal under capital lease
obligations
    
    
    (889
    )
    
    
    
    
    
    
    (554
    )
    
    
    
    
    
    
    (1,443
    )Payment of principal of other bank debt
    
    
    
    
    
    
    (750
    )
    
    
    
    
    
    
    
    
    
    
    (750
    )Net cash provided by (used in) financing
activities
    
    
    (17,052
    )
    
    
    201
    
    
    
    (554
    )
    
    
    
    
    
    
    (17,405
    )Effect of cumulative translation adjustment
    
    
    (10
    )
    
    
    
    
    
    
    (9
    )
    
    
    
    
    
    
    (19
    )Net increase (decrease) in cash
    
    
    (50,525
    )
    
    
    (120
    )
    
    
    1,296
    
    
    
    
    
    
    
    (49,349
    )Cash at beginning of year
    
    
    66,775
    
    
    
    317
    
    
    
    1,019
    
    
    
    
    
    
    
    68,111Cash at end of period
    
    $
    16,250
    
    
    $
    197
    
    
    $
    2,315
    
    
    $
    
    
    
    $
    18,762
 Condensed Consolidating Cash Flow Statement
For the Nine Months Ended September 30, 2004 Non-Borrower
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedNet cast provided by (used in) operating activities
    
    $
    (11,439
    )
    
    $
    3,297
    
    
    $
    123
    
    
    $
    
    
    
    $
    (8,019
    )Cash flows from investing activities:Purchases of property, plant and equipment
    
    
    (3,300
    )
    
    
    (1,746
    )
    
    
    (1,493
    )
    
    
    
    
    
    
    (6,539
    )Proceeds from the sale of property, plant and
equipment
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    6Net cash used in investing activities
    
    
    (3,300
    )
    
    
    (1,740
    )
    
    
    (1,493
    )
    
    
    
    
    
    
    (6,533
    )Cash flows from financing activities:Book overdraft
    
    
    (1,097
    )
    
    
    (1,554
    )
    
    
    
    
    
    
    
    
    
    
    (2,651
    )Payments of principal under capital lease
obligations
    
    
    (986
    )
    
    
    (169
    )
    
    
    (61
    )
    
    
    
    
    
    
    (1,216
    )Payments of principal under Senior Credit Facility
    
    
    (168,681
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (168,681
    )Proceeds from borrowings under New Senior Credit
Facility
    
    
    320,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    320,000Payment of principal under New Senior Credit
Facility
    
    
    (5,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,000
    )Debt issuance costs
    
    
    (9,126
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,126
    )Payment of preferred stock repurchase
    
    
    (109,459
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (109,459
    )Payments of preferred stock dividends
    
    
    (29,541
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (29,541
    )Preferred stock repurchase costs
    
    
    (299
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (299
    )Net cash used in financing activities
    
    
    (4,189
    )
    
    
    (1,723
    )
    
    
    (61
    )
    
    
    
    
    
    
    (5,973
    )Effect of cumulative translation adjustment
    
    
    13
    
    
    
    
    
    
    
    (77
    )
    
    
    
    
    
    
    (64
    )Net decrease in cash
    
    
    (18,915
    )
    
    
    (166
    )
    
    
    (1,508
    )
    
    
    
    
    
    
    (20,589
    )Cash at beginning of year
    
    
    34,222
    
    
    
    176
    
    
    
    2,238
    
    
    
    
    
    
    
    36,636Cash at end of period
    
    $
    15,307
    
    
    $
    10
    
    
    $
    730
    
    
    $
    
    
    
    $
    16,047
 18




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##### Table of Contents



12. 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. 19




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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) the success of new
products and promotion programs; (vii) general economic conditions, and (viii)
the success of integrating acquired businesses. Many of these factors will be
beyond the control of the Company. Moreover, neither the Company nor any other person assumes responsibility
for the accuracy and completeness of such statements. The Company is under no
duty to update any of the forward-looking statements after the date of this
Form 10-Q to conform such statements to actual results. Company Background The Company believes it is the largest direct seller of home decorative
accessories in the United States, as measured by sales. As of September 30,
2004, the Company has approximately 98,900 active Decorating Consultants
located in the United States, Mexico, Canada, and Puerto Rico. The Companys
direct sales are dependent upon the number of Decorating Consultants selling
the Companys products and their resulting productivity. Decorating Consultant
productivity fluctuates from time to time based on seasonality and promotion
programs, which offer Decorating Consultants new incentives and discounts timed
to generate additional sales. The amount and timing of discounts and
incentives vary from year to year. The cost of discounts is reflected in the
Companys net sales while the cost of incentives is reflected in selling
expense. The Company also sells products to customers outside of its direct
selling channel. Company Direct Selling Strategy The Company has evolved its strategy to put greater focus on what
management believes to be the key drivers of the direct selling business -
recruiting, retention, and productivity of the Decorating Consultant base. The Company recognizes the need to continue to attract and retain new
Decorating Consultants. As of September 30, 2004, the Companys active
Decorating Consultant base in the United States increased 6.2% to approximately
70,400 active Decorating Consultants from approximately 66,300 as of September
30, 2003. This increase was a result of the Companys continued focus on key
areas such as Decorating Consultant understanding and awareness of the Hostess
program, improved training and business guides, and a more clearly defined and
communicated career path as reflected in the new recruit program. 20




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The retention of experienced Decorating Consultants requires operational
focus on several areas: product distribution fulfillment rates, product
selection, and sales training and motivation. Fulfillment rates for product
distribution remained strong at approximately 99% as of September 30, 2004. The
Company is continuing to introduce new products during 2004, which complement
the current line of products, in an attempt to give the product line a fresh
and more innovative look. The Companys Recertification program educates
Decorating Consultants on how to become more effective directors and trainers
by helping them develop and enhance their leadership skills. Decorating
Consultant training and motivation requires the introduction of sales promotion
and development activities directed at helping Decorating Consultants increase
their productivity. Sales tools such as Power Paks and the Companys HIG
Creative Concepts DVD/video series have helped the field leadership plan and
present more effective sales meetings and training sessions for the Decorating
Consultants. Company Manufacturing and Wholesale Strategy The Company refers to its manufacturing and wholesale supply operations as
Domistyle, a uniquely positioned home décor manufacturing and design
operation that not only sells to the Companys core direct selling business,
but also sells to non-affiliated retailers. The Company continues to emphasize products from its wholesale supply
operation in the direct selling channel, which the Company believes provides
opportunities for gross margin improvements and leverages the fixed expense
component of the Companys cost structure. During the nine months ended
September 30, 2004, approximately 49.1% of the dollar volume of products
purchased for the direct selling channel of the Company was purchased from, and
manufactured by, the Companys subsidiaries. The Company believes that this
increased focus of the Companys manufacturing strategy has supported
Decorating Consultant productivity and retention through increased fulfillment
rates and increased flexibility related to promotion strategies. The Companys Domistyle operation increased net sales to non-affiliated
retailers by $2.1 million or 11.2% for the nine months ended September 30,
2004. Wholesale supply net sales by the Company were $20.8 million for the nine
months ended September 30, 2004, as compared to $18.7 million for the nine
months ended September 30, 2003. Results of Operations The three months ended September 30, 2004 compared to the three months ended
September 30, 2003 Amount
    
    Percentage2003
    
    2004
    
    Variance
    
    VarianceNet SalesDomestic direct net sales to non-affiliates
    
    $
    121,680
    
    
    $
    98,957
    
    
    $
    (22,723
    )
    
    
    (18.7
    )%International direct net sales to non-affiliates
    
    
    17,149
    
    
    
    18,064
    
    
    
    915
    
    
    
    5.3
    %Domistyle net sales to non-affiliates
    
    
    7,800
    
    
    
    6,654
    
    
    
    (1,146
    )
    
    
    (14.7
    )%Net sales
    
    $
    146,629
    
    
    $
    123,675
    
    
    $
    (22,954
    )
    
    
    (15.7
    )%Other Key Domestic DataNumber of average active Decorating Consultants
    
    
    67,200
    
    
    
    70,800
    
    
    
    3,600
    
    
    
    5.4
    %Number of average active international
Decorating Consultants
    
    
    21,700
    
    
    
    26,500
    
    
    
    4,800
    
    
    
    22.1
    %Number of orders shipped
    
    
    239,260
    
    
    
    235,841
    
    
    
    (3,419
    )
    
    
    (1.4
    )%Number of orders per Decorating Consultant
    
    
    3.56
    
    
    
    3.33
    
    
    
    (0.23
    )
    
    
    (6.5
    )%Average order size (actual dollars)
    
    $
    509
    
    
    $
    420
    
    
    $
    (89
    )
    
    
    (17.5
    )%
 Net sales decreased $22.9 million, or 15.7%, to $123.7 million in the
three months ended September 30, 2004 from $146.6 million in the comparable
period in 2003. Domestic direct net sales to non-affiliates decreased $22.7
million, or 18.7%, in the three months ended September 30, 2004 as compared to
the three months ended September 30, 2003. The Company believes the decline in
sales is the result of a number of factors, including macroeconomic conditions,
such as rising gasoline prices, which have had a compounded negative impact of
reducing both disposable income amongst its principal customer base, and the
Decorating Consultants and customers willingness to organize and attend sales
parties. Additionally, weather-related issues due to hurricanes in the
southeastern United States have negatively impacted sales. Other factors that
impact results are the number of Decorating Consultants, the number of orders
shipped, the number of orders per Decorating Consultant, and average order
size. 21




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The average order size decreased 17.5% to $420 in the three months ended
September 30, 2004 as compared to $509 for the comparable period in 2003. The
Company believes the decrease in average order size was due to the increase of
new Decorating Consultants, who are historically less productive, and cautious
consumer spending resulting from economic concerns. Given the decline in domestic direct sales, management believes there are certain adjustments that need to be made to components of the domestic direct sales program and is currently undertaking several key initiatives to regain sales momentum. International direct net sales to non-affiliates increased $0.9 million,
or 5.3%, in the three months ended September 30, 2004 as compared to the three
months ended September 30, 2003. This increase in net sales was primarily
related to the increase in the number of Decorating Consultants in Mexico,
Canada, and Puerto Rico. The average number of international active Decorating
Consultants increased 22.1% to 26,500 in the three month period ending
September 30, 2004 from 21,700 in the comparable period in 2003. Domistyle net
sales to non-affiliates decreased 14.7%, or $1.1 million, over the comparable
periods. The decrease was mainly attributable to timing of wholesale supply
orders shipped in 2004 as the Company continues to expand the wholesale supply
channel as year to date results reflect. Gross profit decreased $7.8 million, or 11.0%, to $62.9 million in the
three months ended September 30, 2004 from $70.7 million in the three months
ended September 30, 2003. The decrease in domestic direct selling gross profit
is directly attributable to the decline in net sales. This impact was softened
by an increase in domestic direct selling gross profit percentage as a result
of managements actions taken during 2004. As a percentage of net sales, gross
profit increased to 50.9% in 2004 from 48.2% in 2003. In addition,
international manufacturing was operating at a negative gross margin due to
operating inefficiencies, inventory write offs, and redundant facilities as the
Company continued the consolidation of international manufacturing operations
into one Company-owned facility. The impact to gross profit was a $1.1 million
decrease for the three months ended September 30, 2004, compared to a $0.7
million decrease for the same period in 2003. Selling expense decreased $3.9 million, or 14.9%, to $22.1 million in the
three months ended September 30, 2004 from $26.0 million in the comparable
period of 2003. As a percentage of net sales, selling expense increased to
17.9% for the three-month period ended September 30, 2004 from 17.7% in the
comparable period of 2003. The increase as a percentage of net sales is
primarily due to new royalty agreements on product sales in 2004, and the cost
and timing of accruals for sales events and incentive trips. Royalty expense on
product net sales related to the new royalty agreements was $0.9 million in the
three-month period ended September 30, 2004. Freight, warehouse, and distribution expense decreased $2.8 million, or
13.8%, to $17.7 million in the three months ended September 30, 2004 from $20.5
million in the three months ended September 30, 2003. These costs were 14.3% of
net sales in the 2004 period, as compared to 14.0% in the comparable 2003
period. General and administrative expense decreased $3.9 million, or 22.1%, to
$13.8 million in the three months ended September 30, 2004, from $17.7 million
in the three months ended September 30, 2003. The decrease was related to cost
savings initiatives implemented by the Company in the third quarter of 2004. Stock option expense related to the options issued under the 1998 and 2002
Key Employee Stock Option Plans and the 1998 Independent Contractor Stock
Option Plan of approximately $1.2 million was recorded in the three months
ended September 30, 2004, as compared to $1.0 million in the comparable 2003
period. Interest expense increased $2.5 million, or 36.6%, to $9.2 million in the
three months ended September 30, 2004 from $6.7 million in the three months
ended September 30, 2003. The increase is a result of higher debt balances
related to the refinancing of the Companys Senior Credit Facility that
occurred on March 31, 2004. The Company recognized a tax benefit of $1.8 million in the three months
ended September 30, 2004 as compared to a tax benefit of $3.6 million in the
comparable period of 2003. The difference relates to the favorable state income
tax audit determination the company received in 2003 offset by the valuation
allowance recognized in 2004 as a result of tax losses in its foreign
operations that the Company believes may expire unused. The Company believes
that the effective income tax rate for year ended December 31, 2004 will be
lower than the effective income tax rate for the three-month period ended
September 30, 2004. 22




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##### Table of Contents



The nine months ended September 30, 2004 compared to the nine months ended
September 30, 2003 Amount
    
    Percentage2003
    
    2004
    
    Variance
    
    VarianceNet SalesDomestic direct net sales to non-affiliates
    
    $
    363,133
    
    
    $
    318,237
    
    
    $
    (44,896
    )
    
    
    (12.4
    )%International direct net sales to non-affiliates
    
    
    41,593
    
    
    
    48,446
    
    
    
    6,853
    
    
    
    16.5
    %Domistyle net sales to non-affiliates
    
    
    18,687
    
    
    
    20,783
    
    
    
    2,096
    
    
    
    11.2
    %Net sales
    
    $
    423,413
    
    
    $
    387,466
    
    
    $
    (35,947
    )
    
    
    (8.5
    )%Other Key Domestic DataNumber of average active Decorating Consultants
    
    
    65,500
    
    
    
    71,100
    
    
    
    5,600
    
    
    
    8.5
    %Number of average active international
Decorating Consultants
    
    
    19,400
    
    
    
    25,600
    
    
    
    6,200
    
    
    
    32.0
    %Number of orders shipped
    
    
    702,003
    
    
    
    702,315
    
    
    
    312
    
    
    
    Number of orders per Decorating Consultant
    
    
    10.72
    
    
    
    9.87
    
    
    
    (0.85
    )
    
    
    (7.9
    )%Average order size (actual dollars)
    
    $
    517
    
    
    $
    453
    
    
    $
    (64
    )
    
    
    (12.4
    )%
 Net sales decreased $35.9 million, or 8.5%, to $387.5 million in the nine
months ended September 30, 2004 from $423.4 million in the comparable period in
2003. Domestic direct net sales to non-affiliates decreased $44.9 million, or
12.4%, in the nine months ended September 30, 2004 as compared to the nine
months ended September 30, 2003. The Company believes the decline in sales is
the result of a number of factors, including macroeconomic conditions, such as
rising gasoline prices, which have had a compounded negative impact of reducing
both disposable income among its principal customer base, and the Decorating
Consultants and customers willingness to organize and attend sales parties
Additionally, weather-related issues due to hurricanes in the southeastern
United States have negatively impacted sales. Other factors that impact
results are the number of Decorating Consultants, the number of orders shipped,
the number of orders per Decorating Consultant, and average order size. The
average order size decreased 12.4% to $453 in the nine months ended September
30, 2004 as compared to $517 for the comparable period in 2003. The Company
believes the decrease in average order size is due to the increase of new
Decorating Consultants, who are historically less productive, and cautious
consumer spending resulting from economic concerns. Given the decline
in domestic direct sales, management believes there are certain
adjustments that need to be made to components of the domestic direct
sales program and is
currently undertaking several key initiatives to regain sales momentum. International direct net sales to non-affiliates increased $6.9 million,
or 16.5%, in the comparable nine-month periods primarily related to the
increase in the number of Decorating Consultants in Mexico, Canada, and Puerto
Rico. The average number of international active Decorating Consultants
increased 32.0% to 25,600 for the nine-month period ending September 30, 2004
from 19,400 in the comparable period in 2003. Domistyle net sales to
non-affiliates increased 11.2% or $2.1 million over the comparable periods as
the Company continues to expand the wholesale supply channel. Gross profit decreased $20.3 million, or 8.9%, to $206.9 million in the
nine months ended September 30, 2004 from $227.2 million in the nine months
ended September 30, 2003. The decrease in gross profit is directly
attributable to the decline in net sales. As a percentage of net sales, gross
profit decreased to 53.4% in 2004 from 53.7% in 2003. The gross profit
percentage was impacted by several factors. In comparison to 2003, domestic
direct selling gross profit percentage in 2004 was higher as a result of
managements actions taken during 2004. As the international direct net sales
and Domistyle net sales increased, gross profit as a percentage of total net
sales declined slightly, since the international direct net sales and Domistyle
net sales generally have a lower margin than domestic Decorating Consultant net
sales. In addition, metals and glass manufacturing was operating at negative
gross margins due to operating inefficiencies, inventory write offs, and
redundant facilities. The impact to gross profit was a $4.8 million decrease
for the nine months ended September 30, 2004 compared to a $1.8 million
decrease for the same period in 2003. Selling expense increased $3.2 million, or 4.4%, to $76.0 million in the
nine months ended September 30, 2004 from $72.7 million in the comparable
period of 2003. As a percentage of net sales, selling expense increased to
19.6% for the nine-month period ended September 30, 2004 from 17.2% in the
comparable period of 2003. The increase as a percentage of net sales is
primarily due to new royalty agreements on product sales in 2004, and the cost
and timing of accruals for sales events, sales promotions, and incentive trips
offset by a decrease in Decorating Consultant sales compensation due to lower
sales volumes. Royalty expense on product net sales related to the new 23




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royalty agreements was $2.6 million in 2004. Accruals for sales events,
sales promotions, and incentive trips increased $4.4 million to $13.6 million
during the nine months ended September 30, 2004 from $9.2 million for the
comparable period in 2003. This was offset by a decrease in Decorating
Consultant sales compensation of $5.0 million to $42.9 million in 2004 from
$47.9 million in 2003. Freight, warehouse, and distribution expense decreased $2.3 million, or
4.3%, to $52.1 million in the nine months ended September 30, 2004 from $54.4
million in the nine months ended September 30, 2003. These costs were 13.4% of
net sales in the 2004 period, as compared to 12.8% in the comparable 2003
period. This increase in freight, warehouse and distribution expense as a
percentage of sales was primarily due to a $0.8 million increase in additional
facilities costs, and additional freight, labor and packaging supplies costs as
a result of the 12.4% decrease in average order size in 2004 over the
comparable period of 2003. General and administrative expense increased $0.2 million, or 0.4%, to
$49.5 million in the nine months ended September 30, 2004, from $49.3 million
in the nine months ended September 30, 2003. The increase consists primarily of
$2.1 million in fees incurred for strategic consulting services provided to the
Company during 2004 offset by cost savings initiatives implemented by the
Company in the third quarter of 2004. Included in cost of goods sold and general and administrative expenses are
certain additional non-recurring costs related to excess facilities, corporate
organizational realignment expenses, and strategic planning consulting
expenses. Corporate organizational realignment and strategic planning expenses
were approximately $4.5 million and $2.6 million for the nine months ended
September 30, 2004 and 2003, respectively. Non-recurring costs related to
operating inefficiencies and the shutdown and consolidation of redundant
facilities in the Companys Mexico manufacturing operations were approximately
$5.7 million in the nine months ended September 30, 2004 as compared to $1.4
million in the same period of 2003. Loss on debt refinancing of $1.1 million in the nine months ended
September 30, 2004 was a result of the write-off of $0.4 million of unamortized
debt issuance costs and $0.7 million of legal and advisory fees related to the
debt restructure in March, 2004. Stock option expense related to the options issued under the 1998 and 2002
Key Employee Stock Option Plans and the 1998 Independent Contractor Stock
Option Plan of approximately $3.2 million was recorded in both the nine month
periods ended September 30, 2004 and 2003. Interest expense increased $4.8 million, or 23.3%, to $25.4 million in the
nine months ended September 30, 2004 from $20.6 million in the nine months
ended September 30, 2003. The increase is a result of higher debt balances
related to the refinancing of the Companys Senior Credit Facility that
occurred on March 31, 2004. The Company recognized a tax benefit of $3.6 million in the nine months
ended September 30, 2004 as compared to an expense of $6.8 million in the
comparable period of 2003. Due to a favorable state income tax audit
determination in 2003 and the favorable benefit associated with the closure of
a subsidiary in Mexico in 2004, income taxes as a percentage of income before
income taxes was 96.4% in the nine months ended September 30, 2004, as compared
to 25.1% in the nine months ended September 30, 2003. The Company believes that
the effective income tax rate for the year ended December 31, 2004 will be
lower than the effective income tax rate for the nine-month period ended
September 30, 2004. On April 28, 2004, the Company discontinued the manufacture of ceramics
products produced in its Mexico manufacturing facility. The operations and cash
flows of the ceramics manufacturing operation have been eliminated from the
Companys ongoing operations and have been classified as discontinued
operations. The loss on discontinued operations was $3.9 million for the nine
months ended September 30, 2004 as compared to $1.2 million for the nine months
ended September 30, 2003. 24




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##### Table of Contents



Segment Analysis The Companys operations are divided into three reporting segments: direct
sales domestic, direct sales international, and Domistyle. The direct sales
domestic segment includes direct sales by Decorating Consultants located within
the fifty states of the United States. The direct sales international segment
includes direct sales by Decorating Consultants located in Mexico, Canada and
Puerto Rico. The direct sales domestic and direct sales international
operations are directly attributed to the number of Decorating Consultants the
Company has selling its products. The Domistyle segment of operations includes
the Companys manufacturing operations, from which the majority of manufactured
products are purchased by the companys direct selling domestic segment. As a
result, Domistyle sales generally follow the Companys domestic direct selling
trends. The three months ended September 30, 2004 compared to the three months ended
September 30, 2003 Consolidated net sales decreased $22.9 million, or 15.7%, to $123.7
million in the three months ended September 30, 2004, from $146.6 million in
the three months ended September 30, 2003 period. See discussion in Results of
Operations. Direct Selling Domestic Domestic direct net sales decreased $22.2 million, or 17.4% to $105.5
million in the three months ended September 30, 2004 from $127.7 million in the
same period of 2003. Domestic direct net sales to non-affiliates decreased
$22.7 million, or 18.7%, to $99.0 million for the third quarter of 2004 from
$121.7 million for the third quarter of 2003. The primary sales drivers for
non-affiliate sales are average order size, Decorating Consultant productivity,
and number of active Decorating Consultants. Average order size decreased 17.5%
to $420 in the third quarter of 2004 from $509 in the third quarter of 2003.
Number of orders shipped decreased 1.4% to 235,841 in the three months ended
September 30, 2004 compared to 239,260 in the same period in 2003. Net sales to
affiliates increased $0.6 million, or 9.1%, to $6.6 million in the three months
ended September 30, 2004 from $6.0 million in the three months ended September
30, 2003. Direct Selling International International direct net sales increased $1.0 million, or 5.3%, to $18.1
million in the three months ended September 30, 2004 from $17.1 million in the
three months ended September 30, 2003. This increase is primarily due to the
increase in the Decorating Consultant base in Mexico, Canada, and Puerto Rico.
For the three months ended September 30, 2004, the average active Decorating
Consultant base was approximately 24,200, 1,300 and 1,000 in Mexico, Canada,
and Puerto Rico, respectively, as compared to 20,000, 1,000 and 600 for the
three months ended September 30, 2003. Domistyle The Company is in the process of expanding its wholesale supply sales to
non-affiliate resellers through its Domistyle segment. Net sales to
non-affiliate resellers for the three-month period decreased $1.1 million, or
14.7%, to $6.7 million in 2004 as compared to $7.8 million in the comparable
period of 2003. The decrease is due to timing of wholesale supply orders
shipped in 2004 as year to date results reflect an 11.2% increase over prior
year. Net sales to non-affiliate resellers accounted for 18.1% of Domistyle
net sales in the three months ended September 30, 2004 as compared to 18.3% in
the three months ended September 30, 2003. Net sales to affiliates decreased
$4.7 million, or 13.5%, to $30.1 million in the three-month period ended
September 30, 2004 from $34.8 million in the same period of 2003. The decrease
was a result of the decline in product demand from the Companys direct selling
domestic segment. The nine months ended September 30, 2004 compared to the nine months ended
September 30, 2003 Consolidated net sales decreased $35.9 million, or 8.5%, to $387.5 million
in the nine months ended September 30, 2004, from $423.4 million in the nine
months ended September 30, 2003. See discussion in Results of Operations. 25




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##### Table of Contents



Direct Selling Domestic Domestic direct net sales decreased $47.4 million, or 12.2%, to $340.0
million in the nine months ended September 30, 2004 from $387.4 million in the
same period of 2003. Domestic direct net sales to non-affiliates decreased
$44.9 million, or 12.4%, to $318.2 million in 2004 from $363.1 million in 2003.
The primary sales drivers for non-affiliate sales are average order size,
Decorating Consultant productivity, and number of active Decorating
Consultants. Average order size decreased 12.4% to $453 in the nine months
ended September 30, 2004 from $517 in the same period of 2003. The number of
orders shipped was 702,315 in 2004 compared to 702,003 in 2003. The average
number of active Decorating Consultants increased to 71,100 in 2004 from 65,500
in 2003. Net sales to affiliates decreased $2.5 million, or 10.1% to $21.8
million in the nine months ended September 30, 2004 from $24.3 million in the
nine months ended September 30, 2003. Direct Selling International International direct net sales increased $6.8 million, or 16.5%, to $48.4
million in the nine months ended September 30, 2004 from $41.6 million in the
nine months ended September 30, 2003. This increase was primarily due to the
increase in the Decorating Consultant base in Mexico, Canada, and Puerto Rico.
For the nine months ended September 30, 2004, the average active Decorating
Consultant base was approximately 23,400, 1,300, and 900 in Mexico, Canada, and
Puerto Rico, respectively, as compared to 17,900, 900, and 600 for the nine
months ended September 30, 2003. Domistyle The Company is in the process of expanding its wholesale supply sales to
non-affiliate resellers through its Domistyle segment. Net sales to
non-affiliate resellers for the nine month period increased $2.1 million, or
11.2%, to $20.8 million in 2004 as compared to $18.7 million in the comparable
period of 2003. The increase in net sales to non-affiliate resellers accounted
for 17.4% of Domistyle net sales in the nine months ended September 30, 2004 as
compared to 15.1% in the nine months ended September 30, 2003. Net sales to
affiliates decreased $6.4 million, or 6.1%, to $98.5 million in the nine months
ended September 30, 2004 from $104.9 million in the same period of 2003. The
decrease is a result of the decline in product demand from the Companys direct
selling domestic segment. Seasonality The Companys business is influenced by the Christmas holiday season and
by promotional events. Historically, a higher portion of the Companys net
sales and net income have been realized during the fourth quarter. Net sales
have generally been slightly lower during the first quarter as compared to the
second and third quarters, and net income has generally been the lowest during
the third 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 increases inventory for the peak season. In
addition to the Companys peak season fluctuations, quarterly results of
operations may fluctuate depending on the timing of, and amount of sales from,
discounts, incentive promotions and/or the introduction of new products. As a
result, the Companys business activities and results of operations in any
quarter are not necessarily indicative of any future trends in the Companys
business. Liquidity and Capital Resources At September 30, 2004, the Company had $16.0 million in cash and $45.8
million, net of outstanding letters of credit, available under the $50.0
million Revolving Loans. The Company has historically funded its operations, capital expenditures,
and working capital requirements with cash flows from operations and Revolving
Loans under its New Senior Credit Facility. The Company has significant cash
requirements for debt service related to its New Senior Credit Facility and the
Notes. Additional cash requirements consist primarily of working capital
requirements and capital expenditures. The Companys future operating
performance and ability to service or refinance its current indebtedness will
be subject to future economic conditions and to financial, business and other
factors, many of which are beyond the Companys control. 26




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##### Table of Contents



The Companys cash decreased $20.6 million from $36.6 million as of
December 31, 2003, to $16.0 million at September 30, 2004. The decrease
resulted primarily from $8.0 million, $6.5 million, and $6.0 million of net
cash used by operating, investing, and financing activities, respectively. Net cash of $8.0 million used by operating activities consisted primarily
of $21.1 million provided by net income, as adjusted for non-cash items, and
$29.1 million used by working capital. Working capital usage consisted
primarily of a $22.4 million increase in inventory balances, a $13.5 million
increase in accounts receivable, a $3.7 million increase in prepaid expenses, a
$3.1 million increase in the deferred income tax benefit, a $5.9 million
decrease in accrued seminar and incentive award expenses, a $2.9 million
decrease in income tax payable and an increase of $12.5 million in accounts
payable, which was offset by a $7.8 million increase in deferred revenue. Net cash of $6.5 million used in investing activities was a result of
approximately $6.5 million of cash used for the purchase of property, plant,
and equipment. Net cash of $6.0 million used in financing activities consisted primarily
of $2.9 million provided by the refinance of the Companys existing credit
facility, which was offset by $5.0 million of new senior credit facility
principal payments, $1.2 million in capital lease payments, and an increase in
book overdraft of $2.7 million. On March 31, 2004, the Company entered into a senior credit facility, New
Senior Credit Facility, with Bear Stearns Corporate Lending Inc., as
syndication agent, JPMorgan Chase Bank, as administrative agent, and the
several lenders from time to time parties thereto, pursuant to which the
Company, among other things, refinanced loans outstanding under the Companys
existing credit facility. The New Senior Credit Facility provides a seven-year
term loan facility of up to $320.0 million, Term Loans, and a $50.0 million
five-year revolving credit facility, Revolving Loans. On March 31, 2004, $320.0 million in proceeds received from the Term Loans
were used to complete the following transactions:  
    
    For an aggregate purchase price of $139.0 million, the Company
repurchased all of the Companys outstanding shares of its 12.5% Senior
Convertible Preferred Stock, pursuant to a Stock Purchase Agreement,
dated March 31, 2004, among the Company and certain affiliates of the
Companys controlling stockholders the Preferred Stock Repurchase.
    
    $169.1 million of the proceeds were used to pay off the existing
credit facility which included an outstanding debt balance, related
partial year interest, commitment fees, and outstanding letter of credit
fees.
    
    $9.4 million of the proceeds were used to pay legal and advisory fees
associated with the Preferred Stock Repurchase and to pay off of the
existing credit facility, and New Senior Credit Facility debt issuance
costs. There were no amounts drawn under the Revolving Loans and the remaining
Term Loans proceeds of approximately $2.5 million were used for general working
capital purposes. Borrowings under the New Senior Credit Facility require quarterly
principal and interest payments. 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 (the 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. Accordingly, the Company is amortizing its debt
issuance costs over the period from March 31, 2004 through December 1, 2007.
The Company may, at its option, prepay the Term Loans and Revolving Loans
without premium or penalty provided that in certain circumstances prepayment of
the Term Loans on or prior to the first anniversary of the closing date of the
New Senior Credit Facility must be accompanied by a 1% prepayment premium.
Additionally, the Company may reduce or eliminate its revolving loan commitment
prior to maturity. The New Senior Credit Facility is guaranteed unconditionally
on a senior basis by the Companys wholly owned domestic subsidiaries and is
collateralized by a lien on substantially all assets of the Company and its
wholly owned domestic subsidiaries. There are no material restrictions on the
Companys ability to obtain funds from its wholly owned subsidiaries by
dividend or otherwise. 27




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The Term Loans under the New Senior Credit Facility bear interest, at the
Companys election, at either LIBOR plus an applicable margin or the 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 New Senior Credit Agreement. The interest
rates on all borrowings outstanding under the New Senior Credit Facility were
based on LIBOR as of September 30, 2004. As of September 30, 2004, term
borrowings outstanding totaled $315.0 million. The weighted-average interest
rate on the Term Loan borrowings outstanding at September 30, 2004 was 6.42%. The Revolving Loans are subject to a commitment fee based on the undrawn
portion of the Revolving Loans. The commitment fee is eligible for certain
performance pricing step-downs and was 0.5% per annum as of September 30, 2004.
Outstanding letters of credit totaled $4.2 million as of September 30, 2004. Payments on the Notes and the New Senior Credit Facility represent
significant cash requirements for the Company. Interest payments on the Notes
commenced in December 1998 and continue semi-annually until the Notes mature in
2008. The Company has the option to redeem the Notes in whole or in part at any
time. The Term Loans under the New Senior Credit Facility require quarterly
interest and principal payments. In addition, the New Senior Credit Facility
includes a $50.0 million five-year revolving credit facility, which matures on
March 31, 2009. As of September 30, 2004, there were no outstanding Revolving
Loans. During the nine months ended September 30, 2004, the Company paid a total
of $24.1 million in debt service, consisting of principal payments under the
New Senior Credit Facility of $5.0 million, interest and commitment fees under
the New Senior Credit Facility of approximately $11.6 million, and interest on
the Notes of approximately $7.5 million. The terms of the Notes and New Senior Credit Facility include significant
operating and financial restrictions, such as limits on the Companys ability
to incur indebtedness, create liens, sell assets, engage in mergers,
acquisitions or consolidations, make investments and pay dividends. In
addition, under the New Senior Credit Facility, the Company is required to
comply with specified financial ratios and tests, an interest coverage ratio,
maximum leverage ratio, and maximum capital expenditures as defined per the New
Senior Credit Facility agreement. As of September 30, 2004, the Company was in compliance with all covenants
and other requirements set forth in the credit agreement under the New Senior
Credit Facility and indenture with respect to the Notes. As a result of
declining sales, there is the potential that as of December 31, 2004, the
Company may not be able to comply with certain of the specified financial
ratios and tests set forth in the New Senior Credit Facility. Management
believes the decline in sales is the result of a number of factors, including
macroeconomic conditions related to rising gasoline prices and weather related
issues due to hurricanes in the southeastern United States. In addition,
management believes there are certain adjustments that need to be
made to components of the domestic direct sales program and is
currently undertaking several key initiatives to regain sales
momentum. A breach of these financial covenants in the New Senior Credit Facility
could result in a default. Upon the occurrence of an event of default under the
New Senior Credit Facility, the lenders could elect to declare all amounts
outstanding 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 New Senior Credit Facility
would result in an event of default under the indenture governing the Companys
Notes, which could result in the principal amount outstanding under the Notes
becoming due and payable immediately. In that event, the Company would not
have sufficient liquidity to make the payments required under the Companys New
Senior Credit Facility and the Notes and for working capital purposes. The Company is in discussions with its agent bank to obtain amendments to
its New 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 New Senior Credit Facility. 28




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Market Sensitive Instruments and Risk Management The Companys Products are sold in Mexico and Canada thereby subjecting
the Company to financial market risk due to fluctuating foreign currency
exchange rates. Historically, due to a stable foreign exchange and due to the
fact that these operations have not been significant, the risk has been minor.
However, as the Companys international operations become significant to the
Company as a whole, changes in foreign currency exchange rates could have a
material effect on the Company in the future. The Company has not entered into
any hedging instruments related to foreign currency risk. As a result of the interest pricing mechanism associated with the New
Senior Credit Facility, the Company is exposed to financial market risk due to
fluctuating interest rates. The Company monitors this risk and makes decisions
to participate in interest hedging devices based on interest rate expectations,
the Companys desire to maintain total yield within predetermined levels and
the ratio of fixed to variable debt. 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 London Inter-Bank Offer Rate
(LIBOR), excluding the margin paid under the credit facility on a quarterly
basis. The Company recognized an unrealized loss of approximately $1.8 million
and $1.7 million in the consolidated statement of operations and comprehensive
income for the three months and nine months ended September 30, 2004, 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 agreement
mentioned above. The interest rates are estimated based on actual and implied
forward rates using a yield as of October 22, 2004. The Notes are at a fixed
rate of 10.125% and will mature in 2008. Expected Maturity Date2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Total
    
    Fair ValueVariable Rate Debt
    
    $
    2,500
    
    
    $
    13,750
    
    
    $
    15,000
    
    
    $
    283,750
    
    
    $
    
    
    
    $
    315,000
    
    
    $
    Average Interest Rate
    
    
    6.42
    %
    
    
    6.59
    %
    
    
    7.38
    %
    
    
    7.96
    %
    
    
    
    
    
    
    
    
    
    
    Fixed-Rate Debt
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    149,100
    
    
    $
    149,100
    
    
    $
    128,972Interest 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 and nine months ended September 30, 2004. Adoption of Accounting Standards In April 2004, the Financial Accounting Standards Board (FASB), issued
Staff Position Statement of Financial Accounting Standards No. 129-1,
Disclosure Requirements under FASB Statement No. 129, Disclosure of
Information about Capital Structure, Relating to Contingently Convertible
Securities (FSP FAS 129-1). FSP FAS 129-1 provides interpretation guidance
regarding the disclosure provisions of FASB Statement No. 129 as it applies to
contingently convertible securities and the potential dilutive effects on
earnings per share. FSP FAS 129-1 is effective as of April 9, 2004 and applies
to all existing and newly created securities. The Company has adopted FSP FAS
129-1 on April 9, 2004 and there was not a financial accounting nor disclosure
impact associated with its adoption. 29




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Securities and Exchange Commission requires that registrants include
information about potential effects of changes in interest rates and currency
exchange on their financial statements. Refer to the information appearing
under the subheading Market-Sensitive Instruments and Risk Management under
Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operation, which information is hereby incorporated by reference
into this Item 3. All statements other than historical information incorporated
into this Item 3 are forward-looking statements. The actual impact of future
market changes could differ materially due to, among other things, the factors
discussed in this report. 
 ITEM 4. CONTROLS AND PROCEDURES Based on their evaluation of the Companys disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the Exchange Act)), the Companys principal
executive and principal financial officers concluded that the Companys
disclosure controls and procedures were effective as of September 30, 2004. There has been no change in the Companys internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)
that occurred during the Companys fiscal quarter ended September 30, 2004,
that has materially affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting. 
 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 Effective November 11, 2004, the Company amended the Equity Value Targets
for each outstanding Stock Option granted under the Companys 2002 Stock Option
Plan. The Equity Value Targets (which are used for purposes of determining
whether the Stock Options vest) were amended to reflect the alterations in the
Companys capital structure due to its refinancing transaction that occurred
March 31, 2004. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS EXHIBITNUMBER
    
    DESCRIPTION10.1*
    
    Form of Amendment, dated November 11, 2004, to Tier 1 and Tier 2
Option Agreements under the Home Interiors & Gifts 2002 Stock
Option Plan.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.
 30




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##### Table of Contents



EXHIBITNUMBER
    
    DESCRIPTION32.2*
    
    Certification of Chief Financial Officer of the Company pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
   *Filed herewith. 31




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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. CichockiSr. Vice President of Finance andChief Financial Officer(principal financial and accounting officer)
 Date: November 15, 2004 32




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##### Table of Contents



EXHIBIT INDEX EXHIBITNUMBER
    
    DESCRIPTION10.1*
    
    Form of Amendment, dated November 11, 2004, to Tier 1 and Tier 2 Option Agreements under the Home Interiors & Gifts 2002 Stock Option Plan.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. 33