##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
 QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 FOR
THE QUARTERLY PERIOD ENDED JUNE 30, 2005
 COMMISSION
FILE NUMBER 333-62021
 HOME INTERIORS & GIFTS, INC.
  TEXAS
    
    75-0981828(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)1649 FRANKFORD ROAD WEST, CARROLLTON, TEXAS
    
    75007-4605(Address of principal executive offices)
    
    (Zip Code)
 
 þ o
 o þ




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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
  
 INDEX
 PAGE NO.PART I  FINANCIAL INFORMATIONItem 1. Unaudited Interim Consolidated Financial Statements:Consolidated Balance Sheets as of December 31, 2004 and June 30, 2005
    
    
    3Consolidated Statements of Operations and Comprehensive Income for the three months and six
months ended June 30, 2004 and 2005
    
    
    4Consolidated Statements of Cash Flows for the three months and six months ended June 30,
2004 and 2005
    
    
    5Notes to Unaudited Interim Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    18Item 3. Quantitative and Qualitative Disclosure About Market Risk
    
    
    32Item 4. Controls and Procedures
    
    
    32PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    33Item 5. Other Information
    
    
    33Item 6. Exhibits and Reports on Form 8-K
    
    
    34Employment and Non-Competition AgreementCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
  2




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##### Table of Contents



ITEM 1. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
 HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED BALANCE SHEETS
As of December 31, 2004 and June 30, 2005
 (Unaudited)December 31,
    
    June 30,2004
    
    2005(In thousands, exceptshare information)ASSETSCurrent assets:Cash
    
    $
    27,820
    
    
    $
    18,352Accounts receivable, net
    
    
    19,534
    
    
    
    22,298Inventories, net
    
    
    71,801
    
    
    
    86,003Deferred income tax asset
    
    
    6,111
    
    
    
    7,991Other current assets
    
    
    12,054
    
    
    
    18,136Total current assets
    
    
    137,320
    
    
    
    152,780Property, plant and equipment, net
    
    
    66,466
    
    
    
    64,860Debt issuance costs, net
    
    
    10,593
    
    
    
    9,434Goodwill
    
    
    13,703
    
    
    
    13,879Other assets, net
    
    
    1,186
    
    
    
    1,155Total assets
    
    $
    229,268
    
    
    $
    242,108LIABILITIES AND SHAREHOLDERS DEFICITCurrent liabilities:Book overdraft
    
    $
    4,838
    
    
    $
    6,418Accounts payable
    
    
    26,156
    
    
    
    24,294Accrued seminars and incentive awards
    
    
    9,732
    
    
    
    9,255Royalties payable to decorating consultants
    
    
    5,416
    
    
    
    5,333Accrued compensation
    
    
    2,448
    
    
    
    2,681Income taxes payable
    
    
    15,273
    
    
    
    14,602Current maturity of related party note payable
    
    
    687
    
    
    
    687Current maturities of long-term debt and
capital lease obligations
    
    
    15,550
    
    
    
    333,110Other current liabilities
    
    
    20,092
    
    
    
    20,045Total current liabilities
    
    
    100,192
    
    
    
    416,425Long-term debt and capital lease obligations,
net of current maturities
    
    
    450,325
    
    
    
    150,625Deferred income tax liability
    
    
    2,812
    
    
    
    1,976Other liabilities
    
    
    6,611
    
    
    
    6,129Total liabilities
    
    
    559,940
    
    
    
    575,155Commitments and contingencies (Note 11)Shareholders deficit:Common stock, par value $0.10 per share,
75,000,000 shares authorized, 15,240,218
shares issued and outstanding
    
    
    1,524
    
    
    
    1,524Additional paid-in capital
    
    
    144,061
    
    
    
    146,051Accumulated deficit
    
    
    (475,295
    )
    
    
    (479,629
    )Accumulated other comprehensive loss
    
    
    (962
    )
    
    
    (993
    )Total shareholders deficit
    
    
    (330,672
    )
    
    
    (333,047
    )Total liabilities and shareholders deficit
    
    $
    229,268
    
    
    $
    242,108
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
For the three months and six months ended June 30, 2004 and 2005
(In thousands)
(Unaudited)
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2005
    
    2004
    
    2005Net sales
    
    $
    132,875
    
    
    $
    126,584
    
    
    $
    263,791
    
    
    $
    250,772Cost of goods sold
    
    
    61,235
    
    
    
    61,245
    
    
    
    119,804
    
    
    
    120,455Gross profit
    
    
    71,640
    
    
    
    65,339
    
    
    
    143,987
    
    
    
    130,317Selling, general and administrative:Selling
    
    
    27,023
    
    
    
    27,496
    
    
    
    53,864
    
    
    
    52,862Freight, warehouse and distribution
    
    
    17,387
    
    
    
    16,990
    
    
    
    34,408
    
    
    
    34,385General and administrative
    
    
    17,998
    
    
    
    17,700
    
    
    
    35,678
    
    
    
    33,958Loss (gain) on the disposition of assets
    
    
    1,517
    
    
    
    (9
    )
    
    
    1,517
    
    
    
    1Stock option expense
    
    
    943
    
    
    
    1,006
    
    
    
    1,932
    
    
    
    1,990Loss on debt refinancing
    
    
    
    
    
    
    
    
    
    
    1,071
    
    
    
    Total selling, general and administrative
    
    
    64,868
    
    
    
    63,183
    
    
    
    128,470
    
    
    
    123,196Operating income
    
    
    6,772
    
    
    
    2,156
    
    
    
    15,517
    
    
    
    7,121Other income (expense):Interest income
    
    
    89
    
    
    
    149
    
    
    
    159
    
    
    
    269Interest expense
    
    
    (9,183
    )
    
    
    (12,117
    )
    
    
    (16,187
    )
    
    
    (22,754
    )Other income (expense), net
    
    
    (457
    )
    
    
    116
    
    
    
    (380
    )
    
    
    1,684Other income (expense), net
    
    
    (9,551
    )
    
    
    (11,852
    )
    
    
    (16,408
    )
    
    
    (20,801
    )Loss from continuing operations before
income taxes
    
    
    (2,779
    )
    
    
    (9,696
    )
    
    
    (891
    )
    
    
    (13,680
    )Income tax benefit
    
    
    2,259
    
    
    
    3,589
    
    
    
    1,716
    
    
    
    9,346Income (loss) from continuing operations
    
    
    (520
    )
    
    
    (6,107
    )
    
    
    825
    
    
    
    (4,334
    )Discontinued operations (Note 6):Discontinued operations loss, net of tax
    
    
    (3,261
    )
    
    
    
    
    
    
    (3,708
    )
    
    
    Net loss
    
    
    (3,781
    )
    
    
    (6,107
    )
    
    
    (2,883
    )
    
    
    (4,334
    )Other comprehensive income (loss):Cumulative translation adjustment
    
    
    (27
    )
    
    
    (28
    )
    
    
    3
    
    
    
    (31
    )Other comprehensive income (loss)
    
    
    (27
    )
    
    
    (28
    )
    
    
    3
    
    
    
    (31
    )Comprehensive loss
    
    $
    (3,808
    )
    
    $
    (6,135
    )
    
    $
    (2,880
    )
    
    $
    (4,365
    )
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 2004 and 2005
(In Thousands)
(Unaudited)
 Six Months EndedJune 30,2004
    
    2005Cash flows from operating activities:Net loss
    
    $
    (2,883
    )
    
    $
    (4,334
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    7,421
    
    
    
    7,317Impairment of goodwill
    
    
    1,060
    
    
    
    Impairment of property, plant and equipment
    
    
    1,409
    
    
    
    Amortization of debt issuance costs
    
    
    1,051
    
    
    
    1,823Provision for doubtful accounts
    
    
    1,625
    
    
    
    1,533Provision for losses on inventories
    
    
    841
    
    
    
    1,208Loss on debt refinancing
    
    
    1,071
    
    
    
    Loss on disposition of assets
    
    
    1,517
    
    
    
    1Stock option expense
    
    
    1,932
    
    
    
    1,990Unrealized gain on derivatives
    
    
    
    
    
    
    357Deferred tax benefit
    
    
    (714
    )
    
    
    (2,591
    )Changes in assets and liabilities:Accounts receivable
    
    
    (6,651
    )
    
    
    (4,297
    )Inventories
    
    
    (11,110
    )
    
    
    (15,410
    )Other current assets
    
    
    (6,561
    )
    
    
    (6,082
    )Other assets
    
    
    150
    
    
    
    30Accounts payable
    
    
    (6,481
    )
    
    
    (2,054
    )Related party payable
    
    
    (661
    )
    
    
    (820
    )Income taxes payable
    
    
    (2,934
    )
    
    
    (796
    )Other current liabilities
    
    
    7,095
    
    
    
    (569
    )Total adjustments
    
    
    (9,940
    )
    
    
    (18,770
    )Net cash used in operating activities
    
    
    (12,823
    )
    
    
    (22,693
    )Cash flows from investing activities:Purchases of property, plant and equipment
    
    
    (3,036
    )
    
    
    (5,592
    )Proceeds from the sale of property, plant and equipment
    
    
    4
    
    
    
    72Net cash used in investing activities
    
    
    (3,032
    )
    
    
    (5,520
    )Cash flows from financing activities:Book overdraft
    
    
    40
    
    
    
    1,580Proceeds from borrowings under revolving loan facility
    
    
    
    
    
    
    40,000Payments under revolving loan facility
    
    
    
    
    
    
    (15,000
    )Payments of principal under capital lease obligations
    
    
    (799
    )
    
    
    (890
    )Proceeds from borrowings under senior credit facility
    
    
    320,000
    
    
    
    Payments of principal under senior credit facility
    
    
    (171,182
    )
    
    
    (6,250
    )Debt issuance and amendment costs
    
    
    (9,125
    )
    
    
    (664
    )Payment of preferred stock repurchase and preferred stock dividends
    
    
    (139,000
    )
    
    
    Preferred stock issuance costs
    
    
    (299
    )
    
    
    Net cash used in financing activities
    
    
    (365
    )
    
    
    18,776Effect of cumulative translation adjustment
    
    
    3
    
    
    
    (31
    )Net decrease in cash
    
    
    (16,217
    )
    
    
    (9,468
    )Cash at beginning of year
    
    
    36,636
    
    
    
    27,820Cash at end of period
    
    $
    20,419
    
    
    $

    18,352
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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
 
 NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
 1. Organization and Background
   2. Significant Accounting Policies
    Reclassifications
  6




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Stock-based Compensations Plans
  Compensation Charge
  Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2005
    
    2004
    
    2005Net loss, as reported
    
    $
    (3,781
    )
    
    $
    (6,107
    )
    
    $
    (2,883
    )
    
    $
    (4,334
    )Add: Stock-based employee
compensation expense
included in reported net
income, net of related
tax effects
    
    
    446
    
    
    
    485
    
    
    
    937
    
    
    
    960Deduct: Stock-based
employee compensation
expense determined under
fair value based method
for all awards, net of
related tax effects
    
    
    (507
    )
    
    
    (551
    )
    
    
    (1,027
    )
    
    
    (1,095
    )Pro forma net loss
    
    $
    (3,842
    )
    
    $
    (6,173
    )
    
    $
    (2,973
    )
    
    $
    (4,469
    )
 3. Inventories, Net
  December 31,
    
    June 30,2004
    
    2005Raw materials
    
    $
    8,184
    
    
    $
    10,520Work in process
    
    
    2,231
    
    
    
    2,621Finished goods
    
    
    67,559
    
    
    
    80,68077,974
    
    
    
    93,821Inventory allowance
    
    
    (6,173
    )
    
    
    (7,818
    )$
    71,801
    
    
    $
    86,003
 4. Other Current Liabilities
  December 31,
    
    June 30,2004
    
    2005Interest
    
    $
    1,258
    
    
    $
    1,430Accrued employee benefits
    
    
    2,997
    
    
    
    3,037Sales taxes
    
    
    3,872
    
    
    
    4,048Other taxes
    
    
    1,743
    
    
    
    1,180Deferred revenue
    
    
    4,482
    
    
    
    6,755Related parties
    
    
    748
    
    
    
    103Accrued product license royalties
    
    
    1,439
    
    
    
    1,172Other
    
    
    3,553
    
    
    
    2,320$
    20,092
    
    
    $
    20,045
 7




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##### Table of Contents



5. Adoption of New Accounting Standards
     6. Discontinued Operations
   8




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Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2005
    
    2004
    
    2005Net sales
    
    $
    392
    
    
    $
    
    
    
    $
    828
    
    
    $
    Cost of goods sold
    
    
    1,076
    
    
    
    
    
    
    
    1,776
    
    
    
    Gross profit
    
    
    (684
    )
    
    
    
    
    
    
    (948
    )
    
    
    Selling, general and administrative:General and administrative
    
    
    2,454
    
    
    
    
    
    
    
    2,632
    
    
    
    Total selling, general and administrative
    
    
    2,454
    
    
    
    
    
    
    
    2,632
    
    
    
    Operating loss
    
    
    (3,138
    )
    
    
    
    
    
    
    (3,580
    )
    
    
    Other income (expense):Interest expense
    
    
    
    
    
    
    
    
    
    
    (2
    )
    
    
    Other income (expense), net
    
    
    (123
    )
    
    
    
    
    
    
    (126
    )
    
    
    Other income (expense), net
    
    
    (123
    )
    
    
    
    
    
    
    (128
    )
    
    
    Loss before income taxes
    
    
    (3,261
    )
    
    
    
    
    
    
    (3,708
    )
    
    
    Income tax benefit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Loss on discontinued operations, net of tax
    
    $
    (3,261
    )
    
    $
    
    
    
    $
    (3,708
    )
    
    $
    
 (Unaudited)
    
    (Unaudited)June 30, 2004
    
    June 30, 2005Balance sheet data:Current assets held for sale
    
    $
    3
    
    
    
    Long term assets held for sale
    
    $
    206
    
    
    
    
 7. Income Tax Benefit
  8. Senior Credit Facility
  9




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##### Table of Contents



9. Segment Reporting
  
    
    Direct Selling Domestic  direct seller of home decorative accessories in the United
States;
    
    Direct Selling International  direct seller of home decorative accessories in Mexico,
Canada and Puerto Rico; and
    
    Domistyle  wholesale supply operation that manufactures, imports, and distributes
various Products.
  10




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##### Table of Contents



Direct
    
    DirectSelling
    
    SellingThree months ended June 30,
    
    Domestic
    
    International
    
    Domistyle
    
    Eliminations
    
    Consolidated2004Net sales to non-affiliates
    
    $
    110,751
    
    
    $
    16,122
    
    
    $
    6,002
    
    
    $
    
    
    
    $
    132,875Net sales to affiliates
    
    
    8,518
    
    
    
    
    
    
    
    33,272
    
    
    
    (41,790
    )
    
    
    Modified EBITDA
    
    
    6,863
    
    
    
    2,112
    
    
    
    10,566
    
    
    
    (514
    )
    
    
    19,0272005Net sales to non-affiliates
    
    $
    100,381
    
    
    $
    18,659
    
    
    $
    7,544
    
    
    $
    
    
    
    $
    126,584Net sales to affiliates
    
    
    9,461
    
    
    
    
    
    
    
    30,311
    
    
    
    (39,772
    )
    
    
    Modified EBITDA
    
    
    2,300
    
    
    
    2,336
    
    
    
    7,087
    
    
    
    (1,605
    )
    
    
    10,119
 Direct
    
    DirectSelling
    
    SellingSix months ended June 30,
    
    Domestic
    
    International
    
    Domistyle
    
    Eliminations
    
    Consolidated2004Net sales to non-affiliates
    
    $
    219,280
    
    
    $
    30,382
    
    
    $
    14,129
    
    
    $
    
    
    
    $
    263,791Net sales to affiliates
    
    
    15,216
    
    
    
    
    
    
    
    68,459
    
    
    
    (83,675
    )
    
    
    Modified EBITDA
    
    
    16,598
    
    
    
    3,301
    
    
    
    19,890
    
    
    
    (1,549
    )
    
    
    38,240Total assets
    
    
    219,077
    
    
    
    16,119
    
    
    
    82,588
    
    
    
    (74,155
    )
    
    
    243,629Goodwill
    
    
    
    
    
    
    
    
    
    
    13,570
    
    
    
    
    
    
    
    13,570Capital expenditures
    
    
    1,343
    
    
    
    537
    
    
    
    1,156
    
    
    
    
    
    
    
    3,0362005Net sales to non-affiliates
    
    $
    200,359
    
    
    $
    34,056
    
    
    $
    16,357
    
    
    $
    
    
    
    $
    250,772Net sales to affiliates
    
    
    17,811
    
    
    
    
    
    
    
    60,119
    
    
    
    (77,930
    )
    
    
    Modified EBITDA
    
    
    6,312
    
    
    
    3,750
    
    
    
    15,089
    
    
    
    (1,612
    )
    
    
    23,539Total assets
    
    
    204,841
    
    
    
    24,211
    
    
    
    81,048
    
    
    
    (67,992
    )
    
    
    242,108Goodwill
    
    
    
    
    
    
    
    
    
    
    13,879
    
    
    
    
    
    
    
    13,879Capital expenditures
    
    
    3,943
    
    
    
    1,405
    
    
    
    244
    
    
    
    
    
    
    
    5,592
  Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2005
    
    2004
    
    2005Net loss
    
    $
    (3,781
    )
    
    $
    (6,107
    )
    
    $
    (2,883
    )
    
    $
    (4,334
    )Effect of SAB 101
    
    
    (602
    )
    
    
    (967
    )
    
    
    2,267
    
    
    
    2,038Discontinued operations, net of tax
    
    
    3,261
    
    
    
    
    
    
    
    3,708
    
    
    
    Interest income
    
    
    (89
    )
    
    
    (149
    )
    
    
    (159
    )
    
    
    (269
    )Interest expense
    
    
    9,183
    
    
    
    12,117
    
    
    
    16,187
    
    
    
    22,754Realized gain on derivatives
    
    
    
    
    
    
    (79
    )
    
    
    
    
    
    
    (139
    )Unrealized (gain) loss on derivatives
    
    
    (89
    )
    
    
    985
    
    
    
    (89
    )
    
    
    (356
    )Income tax benefit
    
    
    (2,259
    )
    
    
    (3,589
    )
    
    
    (1,716
    )
    
    
    (9,346
    )Depreciation and amortization
    
    
    3,566
    
    
    
    3,671
    
    
    
    7,421
    
    
    
    7,317Stock option expense
    
    
    943
    
    
    
    1,006
    
    
    
    1,932
    
    
    

    1,990Loss on debt refinancing
    
    
    
    
    
    
    
    
    
    
    1,071
    
    
    
    Reorganization costs
    
    
    7,377
    
    
    
    3,240
    
    
    
    8,984
    
    
    
    3,883Loss (gain) on disposition of assets
    
    
    1,517
    
    
    
    (9
    )
    
    
    1,517
    
    
    
    1Modified EBITDA
    
    $
    19,027
    
    
    $
    10,119
    
    
    $
    38,240
    
    
    $
    23,539
 11




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##### Table of Contents



10. Guarantor Financial Data
  Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Three Months Ended June 30, 2004
 Borrower
    
    Guarantors
    
    Non-Guarantors
    
    Eliminations
    
    ConsolidatedNet sales
    
    $
    121,352
    
    
    $
    37,857
    
    
    $
    16,351
    
    
    $
    (42,685
    )
    
    $
    132,875Cost of good sold
    
    
    65,075
    
    
    
    25,897
    
    
    
    12,639
    
    
    
    (42,376
    )
    
    
    61,235Gross profit
    
    
    56,277
    
    
    
    11,960
    
    
    
    3,712
    
    
    
    (309
    )
    
    
    71,640Total selling, general and
administrative
    
    
    53,711
    
    
    
    3,072
    
    
    
    8,085
    
    
    
    
    
    
    
    64,868Operating income (loss)
    
    
    2,566
    
    
    
    8,888
    
    
    
    (4,373
    )
    
    
    (309
    )
    
    
    6,772Other income (expense), net
    
    
    (8,928
    )
    
    
    257
    
    
    
    (675
    )
    
    
    (205
    )
    
    
    (9,551
    )Income (loss) before income
taxes
    
    
    (6,362
    )
    
    
    9,145
    
    
    
    (5,048
    )
    
    
    (514
    )
    
    
    (2,779
    )Income tax benefit (provision)
    
    
    4,323
    
    
    
    (1,674
    )
    
    
    (394
    )
    
    
    4
    
    
    
    2,259Equity in loss of affiliated
companies, net of tax
    
    
    (1,229
    )
    
    
    (9,420
    )
    
    
    
    
    
    
    10,649
    
    
    
    Loss from continuing operations
    
    
    (3,268
    )
    
    
    (1,949
    )
    
    
    (5,442
    )
    
    
    10,139
    
    
    
    (520
    )Discontinued operations loss,
net of tax
    
    
    
    
    
    
    
    
    
    
    3,261
    
    
    
    
    
    
    
    3,261Net loss
    
    
    (3,268
    )
    
    
    (1,949
    )
    
    
    (8,703
    )
    
    
    10,139
    
    
    
    (3,781
    )Other comprehensive income
(loss)
    
    
    1
    
    
    
    
    
    
    
    (28
    )
    
    
    
    
    
    
    (27
    )Comprehensive loss
    
    $
    (3,267
    )
    
    $
    (1,949
    )
    
    $
    (8,731
    )
    
    $
    10,139
    
    
    $
    (3,808
    )
 Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Three Months Ended June 30, 2005
 Borrower
    
    Guarantors
    
    Non-Guarantors
    
    Eliminations
    
    ConsolidatedNet sales
    
    $
    111,779
    
    
    $
    40,058
    
    
    $
    13,785
    
    
    $
    (39,038
    )
    

    $
    126,584Cost of good sold
    
    
    61,604
    
    
    
    30,453
    
    
    
    6,636
    
    
    
    (37,448
    )
    
    
    61,245Gross profit
    
    
    50,175
    
    
    
    9,605
    
    
    
    7,149
    
    
    
    (1,590
    )
    
    
    65,339Total selling, general and
administrative
    
    
    52,520
    
    
    
    3,448
    
    
    
    7,215
    
    
    
    
    
    
    
    63,183Operating income (loss)
    
    
    (2,345
    )
    
    
    6,157
    
    
    
    (66
    )
    
    
    (1,590
    )
    
    
    2,156Other income (expense), net
    
    
    (12,817
    )
    
    
    168
    
    
    
    837
    
    
    
    (40
    )
    
    
    (11,852
    )Income (loss) before income
taxes
    
    
    (15,162
    )
    
    
    6,325
    
    
    
    771
    
    
    
    (1,630
    )
    
    
    (9,696
    )Income tax benefit (provision)
    
    
    5,631
    
    
    
    (2,258
    )
    
    
    (327
    )
    
    
    543
    
    
    
    3,589Equity in income (loss) of
affiliated companies, net of
tax
    
    
    4,486
    
    
    
    (163
    )
    
    
    
    
    
    
    (4,323
    )
    
    
    Net income (loss)
    
    
    (5,045
    )
    
    
    3,904
    
    
    
    444
    
    
    
    (5,410
    )
    
    
    (6,107
    )Other comprehensive income
(loss)
    
    
    1
    
    
    
    
    
    
    
    (29
    )
    
    
    
    
    
    
    (28
    )Comprehensive income (loss)
    
    $
    (5,044
    )
    
    $
    3,904
    
    
    $
    415
    
    
    $
    (5,410
    )
    
    $
    (6,135
    )
 12




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##### Table of Contents



Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Six Months Ended June 30, 2004
 Borrower
    
    Guarantors
    
    Non-Guarantors
    
    Eliminations
    
    ConsolidatedNet sales
    
    $
    238,568
    
    
    $
    79,353
    
    
    $
    32,179
    
    
    $
    (86,309
    )
    
    $
    263,791Cost of good sold
    
    
    126,969
    
    
    
    53,812
    
    
    
    24,076
    
    
    
    (85,053
    )
    
    
    119,804Gross profit
    
    
    111,599
    
    
    
    25,541
    
    
    
    8,103
    
    
    
    (1,256
    )
    
    
    143,987Total selling, general and
administrative
    
    
    108,179
    
    
    
    6,671
    
    
    
    13,620
    
    
    
    
    
    
    
    128,470Operating income (loss)
    
    
    3,420
    
    
    
    18,870
    
    
    
    (5,517
    )
    
    
    (1,256
    )
    
    
    15,517Other income (expense), net
    
    
    (15,712
    )
    
    
    390
    
    
    
    (793
    )
    
    
    (293
    )
    
    
    (16,408
    )Income (loss) before
income taxes
    
    
    (12,292
    )
    
    
    19,260
    
    
    
    (6,310
    )
    
    
    (1,549
    )
    
    
    (891
    )Income tax benefit
(provision)
    
    
    7,399
    
    
    
    (5,317
    )
    
    
    (586
    )
    
    
    220
    
    
    
    1,716Equity in income (loss) of
affiliated companies, net
of tax
    
    
    3,341
    
    
    
    (11,670
    )
    
    
    
    
    
    
    8,329
    
    
    
    Income (loss) from
continuing operations
    
    
    (1,552
    )
    
    
    2,273
    
    
    
    (6,896
    )
    
    
    7,000
    
    
    
    825Discontinued operations
loss, net of tax
    
    
    
    
    
    
    
    
    
    
    3,708
    
    
    
    
    
    
    
    3,708Net income (loss)
    
    
    (1,552
    )
    
    
    2,273
    
    
    
    (10,604
    )
    
    
    7,000
    
    
    
    (2,883
    )Other comprehensive income
(loss)
    
    
    7
    
    
    
    
    
    
    
    (4
    )
    
    
    
    
    
    
    3Comprehensive income
(loss)
    
    $
    (1,545
    )
    
    $
    2,273
    
    
    $
    (10,608
    )
    
    $
    7,000
    
    
    $
    (2,880
    )
 Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Six Months Ended June 30, 2005
 Borrower
    
    Guarantors
    
    Non-Guarantors
    
    Eliminations
    
    ConsolidatedNet sales
    
    $
    221,800
    
    
    $
    79,168
    
    
    $
    26,769
    
    
    $
    (76,965
    )
    
    $
    250,772Cost of good sold
    
    
    123,021
    
    
    
    59,024
    
    
    
    13,816
    
    
    
    (75,406
    )
    
    
    120,455Gross profit
    
    
    98,779
    
    
    
    20,144
    
    
    
    12,953
    
    
    
    (1,559
    )
    
    
    130,317Total selling, general and
administrative
    
    
    103,928
    
    
    
    6,614
    
    
    
    12,654
    
    
    
    
    
    
    
    123,196Operating income (loss)
    
    
    (5,149
    )
    
    
    13,530
    
    
    
    299
    
    
    
    (1,559
    )
    
    
    7,121Other income (expense), net
    
    
    (21,833
    )
    
    
    264
    
    
    
    820
    
    
    
    (52
    )
    
    
    (20,801
    )Income (loss) before
income taxes
    
    
    (26,982
    )
    
    
    13,794
    
    
    
    1,119
    
    
    
    (1,611
    )
    
    
    (13,680
    )Income tax benefit
(provision)
    
    
    9,529
    
    
    
    (296
    )
    
    
    (504
    )
    
    
    617
    
    
    
    9,346Equity in income (loss) of
affiliated companies, net
of tax
    
    
    14,115
    
    
    
    (136
    )
    
    
    
    
    
    
    (13,979
    )
    
    
    Net income (loss)
    
    
    (3,338
    )
    
    
    13,362
    
    
    
    615
    
    
    
    (14,973
    )
    
    
    (4,334
    )Other comprehensive income
(loss)
    
    
    2
    
    
    
    
    
    
    
    (33
    )
    
    
    
    
    
    
    (31
    )Comprehensive income
(loss)
    
    $
    (3,336
    )
    
    $
    13,362
    
    
    $
    582
    
    
    $
    (14,973
    )
    
    $
    (4,365
    )
 13




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##### Table of Contents



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




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##### Table of Contents



Condensed Consolidating Balance Sheet
As of June 30, 2005
 Borrower
    
    Guarantors
    
    Non-Guarantors
    
    Consolidating
    
    Eliminations
    
    ConsolidatedASSETSCurrent assets:Cash
    
    $
    17,481
    
    
    $
    54
    
    
    $
    817
    
    
    $
    18,352
    
    
    $
    
    
    
    $
    18,352Accounts receivable, net
    
    
    13,636
    
    
    
    5,472
    
    
    
    3,190
    
    
    
    22,298
    
    
    
    
    
    
    
    22,298Inventories, net
    
    
    60,615
    
    
    
    5,472
    
    
    
    13,316
    
    
    
    92,232
    
    
    
    (6,229
    )
    
    
    86,003Other current assets
    
    
    14,802
    
    
    
    2,807
    
    
    
    6,722
    
    
    
    24,331
    
    
    
    1,796
    
    
    
    26,127Due from (due to)
affiliated companies
    
    
    (9,465
    )
    
    
    30,406
    
    
    
    (20,941
    )
    
    
    
    
    
    
    
    
    
    
    Total current assets
    
    
    97,069
    
    
    
    57,040
    
    
    
    3,104
    
    
    
    157,213
    
    
    
    (4,433
    )
    
    
    152,780Property, plant and
equipment, net
    
    
    39,942
    
    
    
    18,629
    
    
    
    6,289
    
    
    
    64,860
    
    
    
    
    
    
    
    64,860Investment in subsidiaries
    
    
    77,658
    
    
    
    (7,584
    )
    
    
    
    
    
    
    70,074
    
    
    
    (70,074
    )
    
    
    Debt issuance costs and
other assets, net
    
    
    10,235
    
    
    
    14,042
    
    
    
    191
    
    
    
    24,468
    
    
    
    
    
    
    
    24,468Total assets
    
    $
    224,904
    
    
    $
    82,127
    
    
    $
    9,584
    
    
    $
    316,615
    
    
    $
    (74,507
    )
    
    $
    242,108LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    20,283
    
    
    $
    2,571
    
    
    $
    809
    
    
    $
    23,663
    
    
    $
    631
    
    
    $
    24,294Current maturity of
related party note payable
    
    
    687
    
    
    
    
    
    
    
    
    
    
    
    687
    
    
    
    
    
    
    
    687Current maturities of
long-term debt and capital
lease obligations
    
    
    332,662
    
    
    
    240
    
    
    
    208
    
    
    
    333,110
    
    
    
    
    
    
    
    333,110Other current liabilities
    
    
    43,403
    
    
    
    6,112
    
    
    
    8,819
    
    
    
    58,334
    
    
    
    
    
    
    
    58,334Total current liabilities
    
    
    397,035
    
    
    
    8,923
    
    
    
    9,836
    
    
    
    415,794
    
    
    
    631
    
    
    
    416,425Long-term debt and capital
lease obligations, net of
current maturities
    
    
    150,317
    
    
    
    125
    
    
    
    183
    
    
    
    150,625
    
    
    
    
    
    
    
    150,625Other liabilities
    
    
    4,534
    
    
    
    3,375
    
    
    
    196
    
    
    
    8,105
    
    
    
    
    
    
    
    8,105Total liabilities
    
    
    551,886
    
    
    
    12,423
    
    
    
    10,215
    
    
    
    574,524
    
    
    
    631
    
    
    
    575,155Commitments and
contingencies (Note 11)Shareholders equity
(deficit):Common stock
    
    
    1,524
    
    
    
    1,001
    
    
    
    29
    
    
    
    2,554
    
    
    
    (1,030
    )
    
    
    1,524Additional paid-in capital
    
    
    146,051
    
    
    
    58,831
    
    
    
    20,503
    
    
    
    225,385
    
    
    
    (79,334
    )
    
    
    146,051Retained earnings
(accumulated deficit)
    
    
    (474,564
    )
    
    
    9,872
    
    
    
    (20,163
    )
    
    
    (484,855
    )
    
    
    5,226
    
    
    
    (479,629
    )Accumulated comprehensive
income (loss)
    
    
    7
    
    
    
    
    
    
    
    (1,000
    )
    
    
    (993
    )
    
    
    
    
    
    
    (993
    )Total shareholders
equity (deficit)
    
    
    (326,982
    )
    
    
    69,704
    
    
    
    (631
    )
    
    
    (257,909
    )
    
    
    (75,138
    )
    
    
    (333,047
    )Total liabilities and
shareholders equity

(deficit)
    
    $
    224,904
    
    
    $
    82,127
    
    
    $
    9,584
    
    
    $
    316,615
    
    
    $
    (74,507
    )
    
    $
    242,108
 15




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##### Table of Contents



Condensed Consolidating Cash Flow Statement
 For the Six Months Ended June 30, 2004Borrower
    
    Guarantors
    
    Non-Guarantors
    
    Eliminations
    
    ConsolidatedNet cash provided by (used
in) operating activities
    
    $
    (15,789
    )
    
    $
    2,088
    
    
    $
    878
    
    
    $
    
    
    
    $
    (12,823
    )Cash flows from investing
activities:Purchases of property, plant
and equipment
    
    
    (1,343
    )
    
    
    (940
    )
    
    
    (753
    )
    
    
    
    
    
    
    (3,036
    )Proceeds from the sale of
property, plant and equipment,
and other
    
    
    
    
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    4Net cash used in investing
activities
    
    
    (1,343
    )
    
    
    (936
    )
    
    
    (753
    )
    
    
    
    
    
    
    (3,032
    )Cash flows from financing
activitiesCash overdraft
    
    
    966
    
    
    
    (926
    )
    
    
    
    
    
    
    
    
    
    
    40Payments of principal under
capital lease obligations
    
    
    (657
    )
    
    
    (115
    )
    
    
    (27
    )
    
    
    
    
    
    
    (799
    )Payments of principal under
senior credit facility
    
    
    (171,182
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (171,182
    )Proceeds from borrowings under
senior credit facility
    
    
    320,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    320,000Debt issuance costs
    
    
    (9,125
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,125
    )Payment of preferred stock
repurchase and preferred stock
dividends
    
    
    (139,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (139,000
    )Preferred stock repurchase costs
    
    
    (299
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (299
    )Net cash provided by (used
in) financing activities
    
    
    703
    
    
    
    (1,041
    )
    
    
    (27
    )
    
    
    
    
    
    
    (365
    )Effect of cumulative
translation adjustment
    
    
    7
    
    
    
    
    
    
    
    (4
    )
    
    
    
    
    
    
    3Net increase (decrease) in cash
    
    
    (16,422
    )
    
    
    111
    
    
    
    94
    
    
    
    
    
    
    
    (16,217
    )Cash at beginning of year
    
    
    34,222
    
    
    
    176
    
    
    
    2,238
    
    
    
    
    
    
    
    36,636Cash at end of period
    
    $
    17,800
    
    
    $
    287
    
    
    $
    2,332
    
    
    $
    
    
    
    $
    20,419
 16




---



##### Table of Contents



Condensed Consolidating Cash Flow Statement
 For the Six Months Ended June 30, 2005Borrower
    
    Guarantors
    
    Non-Guarantors
    
    Eliminations
    
    ConsolidatedNet cash provided by
(used in) operating activities
    
    $
    (25,066
    )
    
    $
    1,812
    
    
    $
    561
    
    
    $
    
    
    
    $
    (22,693
    )Cash flows from investing
activities:Purchases of property, plant
and equipment
    
    
    (3,943
    )
    
    
    (1,396
    )
    
    
    (253
    )
    
    
    
    
    
    
    (5,592
    )Proceeds from the sale of
property, plant and equipment
    
    
    1
    
    
    
    33
    
    
    
    38
    
    
    
    
    
    
    
    72Net cash used in investing
activities
    
    
    (3,942
    )
    
    
    (1,363
    )
    
    
    (215
    )
    
    
    
    
    
    
    (5,520
    )Cash flows from financing
activitiesCash overdraft
    
    
    1,907
    
    
    
    (327
    )
    
    
    
    
    
    
    
    
    
    
    1,580Proceeds from borrowings
under revolving loan facility
    
    
    40,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    40,000Payments of principal under
revolving loan facility
    
    
    (15,000
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15,000
    )Payments of principal under
capital lease obligations
    
    
    (683
    )
    
    
    (114
    )
    
    
    (93
    )
    
    
    
    
    
    
    (890
    )Payments of principal under
senior credit facility
    
    
    (6,250
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,250
    )Debt issuance costs
    
    
    (664
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (664
    )Net cash provided by (used
in) financing activities
    
    
    19,310
    
    
    
    (441
    )
    
    
    (93
    )
    
    
    
    
    
    
    18,776Effect of cumulative
translation adjustment
    
    
    2
    
    
    
    
    
    
    
    (33
    )
    
    
    
    
    
    
    (31
    )Net increase (decrease) in cash
    
    
    (9,696
    )
    
    
    8
    
    
    
    220
    
    
    
    
    
    
    
    (9,468
    )Cash at beginning of year
    
    
    27,177
    
    
    
    46
    
    
    
    597
    
    
    
    
    
    
    
    27,820Cash at end of year
    
    $
    17,481
    
    
    $
    54
    
    
    $
    817
    
    
    $
    
    
    
    $
    18,352
 11. Commitments and Contingencies
   17




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Special Note Regarding Forward-Looking Statements
     Company Overview
  18




---



##### Table of Contents



Direct Selling Channel Overview & Strategy
 â
   Domistyle Channel Overview & Strategy
   19




---



##### Table of Contents



Results of Operations
 The three months ended June 30, 2005 compared to the three months ended June 30, 2004
  Three months ended June 30,
    
    
    
    
    
    % of(Dollars in thousands)
    
    Variance
    
    Sales2004
    
    %
    
    2005
    
    %
    
    Amount
    
    ChangeNet sales
    
    $
    132,875
    
    
    
    100.0
    %
    
    $
    126,584
    
    
    
    100.0
    %
    
    $
    (6,291
    )
    
    
    0.0
    %Cost of goods sold
    
    
    61,235
    
    
    
    46.1
    
    
    
    61,245
    
    
    
    48.4
    
    
    
    10
    
    
    
    2.3Gross profit
    
    
    71,640
    
    
    
    53.9
    
    
    
    65,339
    
    
    
    51.6
    
    
    
    (6,301
    )
    
    
    (2.3
    )Operating expenses:Selling
    
    
    27,023
    
    
    
    20.3
    
    
    
    27,496
    
    
    
    21.7
    
    
    
    473
    
    
    
    1.4Freight, warehouse and
distribution
    
    
    17,387
    
    
    
    13.1
    
    
    
    16,990
    
    
    
    13.4
    
    
    
    (397
    )
    
    
    0.3General and administrative
    
    
    17,998
    
    
    
    13.5
    
    
    
    17,700
    
    
    
    14.0
    
    
    
    (298
    )
    
    
    0.5Other
    
    
    2,460
    
    
    
    1.9
    
    
    
    997
    
    
    
    0.8
    
    
    
    (1,463
    )
    
    
    (1.1
    )Operating income
    
    
    6,772
    
    
    
    5.1
    
    
    
    2,156
    
    
    
    1.7
    
    
    
    (4,616
    )
    
    
    (3.4
    )Other income (expense), net
    
    
    (9,551
    )
    
    
    (7.2
    )
    
    
    (11,852
    )
    
    
    (9.4
    )
    
    
    (2,301
    )
    
    
    (2.2
    )Loss before income taxes
    
    
    (2,779
    )
    
    
    (2.1
    )
    
    
    (9,696
    )
    
    
    (7.7
    )
    
    
    (6,917
    )
    
    
    (5.6
    )Income tax benefit
    
    
    2,259
    
    
    
    1.7
    
    
    
    3,589
    
    
    
    2.8
    
    
    
    1,330
    
    
    
    1.1Loss from continuing
operations
    
    
    (520
    )
    
    
    (0.4
    )
    
    
    (6,107
    )
    
    
    (4.8
    )
    
    
    (5,587
    )
    
    
    (4.4
    )Discontinued operations
loss, net
    
    
    3,261
    
    
    
    2.5
    
    
    
    
    
    
    
    0.0
    
    
    
    (3,261
    )
    
    
    (2.5
    )Net loss
    
    $
    (3,781
    )
    
    
    (2.8
    )%
    
    $
    (6,107
    )
    
    
    (4.8
    )%
    
    $
    (2,326
    )
    
    
    (2.0
    )%
  Variance
    
    PercentageFor the three months ended June 30,
    
    2004
    
    2005
    
    Amount
    
    VarianceNet Sales (dollars in thousands)Direct Selling Domestic net sales to non-affiliates
    
    $
    110,751
    
    
    $
    100,381
    
    
    $
    (10,370
    )
    
    
    (9.4
    )%Direct Selling International net sales to non-affiliates
    
    
    16,122
    
    
    
    18,659
    
    
    
    2,537
    
    
    
    15.7
    %Domistyle net sale to non-affiliates
    
    
    6,002
    
    
    
    7,544
    
    
    
    1,542
    
    
    
    25.7
    %Net sales
    
    $
    132,875
    
    
    $
    126,584
    
    
    $
    (6,291
    )
    
    
    (4.7
    )%Other Key Domestic DataAverage number of active Decorating Consultants
    
    
    71,697
    
    
    
    80,591
    
    
    
    8,894
    
    
    
    12.4
    %Number of orders shipped
    
    
    222,742
    
    
    
    238,809
    
    
    
    16,067
    
    
    
    7.2
    %Number of orders per Decorating Consultant
    
    
    3.11
    
    
    
    2.96
    
    
    
    (0.15
    )
    
    
    (4.8
    )%Average order size (actual dollars)
    
    $
    497
    
    
    $
    420
    
    
    $
    (77
    )
    
    
    (15.5
    )%
 20




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##### Table of Contents



Variance
    
    PercentageFor the three months ended June 30,
    
    2004
    
    2005
    
    Amount
    
    VarianceOther Key International DataAverage number of active Decorating Consultants
    
    
    23,222
    
    
    
    25,907
    
    
    
    2,685
    
    
    
    11.6
    %Number of orders shipped
    
    
    59,907
    
    
    
    64,442
    
    
    
    4,535
    
    
    
    7.6
    %Number of orders per Decorating Consultant
    
    
    2.58
    
    
    
    2.49
    
    
    
    (0.09
    )
    
    
    (3.5
    )%Average order size (actual dollars)
    
    $
    269
    
    
    $
    290
    
    
    $
    21
    
    
    
    7.8
    %
 Net Sales
  Net Sales  Direct Selling Domestic
   Net Sales  Direct Selling International
    21




---



##### Table of Contents



Variance
    
    PercentageFor the three months ended June 30,
    
    2004
    
    2005
    
    Amount
    
    VarianceNet Sales (in thousands)Mexico direct net sales in Mexican pesos
    
    
    142,661
    
    
    
    158,229
    
    
    
    15,568
    
    
    
    10.9
    %Mexico direct net sales in U.S. dollars
    
    $
    12,500
    
    
    $
    14,402
    
    
    $
    1,902
    
    
    
    15.2
    %Canada direct net sales in Canadian dollars
    
    
    2,717
    
    
    
    2,355
    
    
    
    (362
    )
    
    
    (13.3
    )%Canada direct net sales in U.S. dollars
    
    $
    2,083
    
    
    $
    1,937
    
    
    $
    (146
    )
    
    
    (7.0
    )%
 Net Sales  Domistyle
  Cost of Goods Sold
  Gross Profit
  Operating Expenses
 Selling Expense
  22




---



##### Table of Contents



Freight, Warehouse and Distribution Expense
  General and Administrative Expense
   Other operating expenses
  Other Income (Expense)
  23




---



##### Table of Contents



Income Tax Provision
  Discontinued Operations
  The six months ended June 30, 2005 compared to the six months ended June 30, 2004
  Six months ended June 30,
    
    
    
    
    
    % of(Dollars in thousands)
    
    Variance
    
    Sales2004
    
    %
    
    2005
    
    %
    
    Amount
    
    ChangeNet sales
    
    $
    263,791
    
    
    
    100.0
    %
    
    $
    250,772
    
    
    
    100.0
    %
    
    $
    (13,019
    )
    
    
    0.0
    %Cost of goods sold
    
    
    119,804
    
    
    
    45.4
    
    
    
    120,455
    
    
    
    48.0
    
    
    
    651
    
    
    
    2.6Gross profit
    
    
    143,987
    
    
    
    54.6
    
    
    
    130,317
    
    
    
    52.0
    
    
    
    (13,670
    )
    
    
    (2.6
    )Operating expenses:Selling
    
    
    53,864
    
    
    
    20.4
    
    
    
    52,862
    
    
    
    21.1
    
    
    
    (1,002
    )
    
    
    0.7Freight, warehouse and
distribution
    
    
    34,408
    
    
    
    13.0
    
    
    
    34,385
    
    
    
    13.7
    
    
    
    (23
    )
    
    
    0.7General and administrative
    
    
    35,678
    
    
    
    13.5
    
    
    
    33,958
    
    
    
    13.5
    
    
    
    (1,720
    )
    
    
    0.0Other
    
    
    4,520
    
    
    
    1.7
    
    
    
    1,991
    
    
    
    0.8
    
    
    
    (2,529
    )
    
    
    (0.9
    )Operating income
    
    
    15,517
    
    
    
    5.9
    
    
    
    7,121
    
    
    
    2.8
    
    
    
    (8,396
    )
    
    
    (3.1
    )Other income (expense), net
    
    
    (16,408
    )
    
    
    (6.2
    )
    
    
    (20,801
    )
    
    
    (8.3
    )
    
    
    (4,393
    )
    
    
    (2.1
    )Loss before income taxes
    
    
    (891
    )
    
    
    (0.3
    )
    
    
    (13,680
    )
    
    
    (5.5
    )
    
    
    (12,789
    )
    
    
    (5.2
    )Income tax benefit
    
    
    1,716
    
    
    
    0.7
    
    
    
    9,346
    
    
    
    3.7
    
    
    
    7,630
    
    
    
    3.0Income (loss) from
continuing operations
    
    
    825
    
    
    
    0.3
    
    
    
    (4,334
    )
    
    
    (1.7
    )
    
    
    (5,159
    )
    
    
    (2.0
    )Discontinued operations
loss, net
    
    
    3,708
    
    
    
    1.4
    
    
    
    
    
    
    
    0.0
    
    
    
    (3,708
    )
    
    
    (1.4
    )Net loss
    
    $
    (2,883
    )
    
    
    (1.1
    )%
    
    $
    (4,334
    )
    
    
    (1.7
    )%
    
    $
    (1,451
    )
    
    
    (0.6
    )%
  Variance
    
    PercentageFor the six months ended June 30,
    
    2004
    
    2005
    
    Amount
    
    VarianceNet Sales (dollars in thousands)Direct Selling Domestic net sales to non-affiliates
    
    $
    219,280
    
    
    $
    200,359
    
    
    $
    (18,921
    )
    
    
    (8.6
    )%Direct Selling International net sales to non-affiliates
    
    
    30,382
    
    
    
    34,056
    
    
    
    3,674
    
    
    
    12.1
    %Domistyle net sales to non-affiliates
    
    
    14,129
    
    
    
    16,357
    
    
    
    2,228
    
    
    
    15.8
    %Net sales
    
    $
    263,791
    
    
    $
    250,772
    
    
    $
    (13,019
    )
    
    
    (4.9
    )%Other Key Domestic DataAverage number of active Decorating Consultants
    
    
    71,411
    
    
    
    76,535
    
    
    
    5,124
    
    
    
    7.2
    %Number of orders shipped
    
    
    466,474
    
    
    
    473,929
    
    
    
    7,455
    
    
    
    1.6
    %
 24




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##### Table of Contents



Variance
    
    PercentageFor the six months ended June 30,
    
    2004
    
    2005
    
    Amount
    
    VarianceNumber of orders per Decorating Consultant
    
    
    6.53
    
    
    
    6.19
    
    
    
    (0.34
    )
    
    
    (5.2
    )%Average order size (actual dollars)
    
    $
    470
    
    
    $
    423
    
    
    $
    (47
    )
    
    
    (10.0
    )%Other Key International DataAverage number of active Decorating Consultants
    
    
    24,646
    
    
    
    27,364
    
    
    
    2,718
    
    
    
    11.0
    %Number of orders shipped
    
    
    112,471
    
    
    
    121,013
    
    
    
    8,542
    
    
    
    7.6
    %Number of orders per Decorating Consultant
    
    
    4.56
    
    
    
    4.42
    
    
    
    (0.14
    )
    
    
    (3.1
    )%Average order size (actual dollars)
    
    $
    270
    
    
    $
    281
    
    
    $
    11
    
    
    
    4.1
    %
 Net Sales
  Net Sales  Direct Selling Domestic
   Net Sales  Direct Selling International
    25




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##### Table of Contents



Variance
    
    PercentageFor the six months ended June 30,
    
    2004
    
    2005
    
    Amount
    
    VarianceNet Sales (in thousands)Mexico direct net sales in Mexican pesos
    
    
    262,524
    
    
    
    285,833
    
    
    
    23,309
    
    
    
    8.9
    %Mexico direct net sales in U.S. dollars
    
    $
    23,284
    
    
    $
    25,797
    
    
    $
    2,513
    
    
    
    10.8
    %Canada direct net sales in Canadian dollars
    
    
    5,277
    
    
    
    4,363
    
    
    
    (914
    )
    
    
    (17.3
    )%Canada direct net sales in U.S. dollars
    
    $
    4,072
    
    
    $
    3,630
    
    
    $
    (442
    )
    
    
    (10.9
    )%
 Net Sales  Domistyle
  Cost of Goods Sold
  Gross Profit
  Operating Expenses
 Selling Expense
  26




---



##### Table of Contents



Freight, Warehouse and Distribution Expense
  General and Administrative Expense
   Other operating expenses
  Other Income (Expense)
  27




---



##### Table of Contents



Income Tax Provision
  Discontinued Operations
  Seasonality
  Liquidity and Capital Resources
     28




---



##### Table of Contents



29




---



##### Table of Contents



Off-Balance Sheet Arrangements
  Market Sensitive Instruments and Risk Management
  Country
    
    Currency
    
    Low
    
    HighCanada
    
    Dollar
    
    $
    0.7851
    
    
    $
    0.8286Mexico
    
    Peso
    
    $
    0.0885
    
    
    $
    0.0931
  30




---



##### Table of Contents



Expected Maturity Date2005
    
    2006
    
    2007
    
    2008
    
    Total
    
    Fair Value(in thousands)LIBOR Variable Rate Debt
    
    $
    7,500
    
    
    $
    15,000
    
    
    $
    283,750
    
    
    
    
    
    
    $
    306,250
    
    
    $
    280,219Average Interest Rate
    
    
    8.62
    %
    
    
    9.25
    %
    
    
    9.46
    %
    
    
    
    
    
    
    
    
    
    
    ABR Variable Rate Debt
    
    $
    0
    
    
    $
    0
    
    

    $
    25,000
    
    
    
    
    
    
    $
    25,000
    
    
    $
    22,500Average Interest Rate
    
    
    9.60
    %
    
    
    10.06
    %
    
    
    10.13
    %
    
    
    
    
    
    
    
    
    
    
    Fixed-Rate Debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    149,100
    
    
    $
    149,100
    
    
    $
    96,915Interest Rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10.125
    %
    
    
    
    
    
    
    
 Inflation
  Recently Issued Statements and Adoption of Financial Accounting Standards
    31




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##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4. CONTROLS AND PROCEDURES
   32




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##### Table of Contents



PART II
 OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 ITEM 5. OTHER INFORMATION
        33




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##### Table of Contents



ITEM 6. EXHIBITS
 EXHIBITNUMBER
    
    DESCRIPTION10.1*
    
    Employment and Non-Competition Agreement, dated as of
August 10, 2005 between Home Interiors & Gifts, Inc., a
Texas corporation and Eugenia B. Price.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. 34




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##### Table of Contents



SIGNATURES
  HOME INTERIORS & GIFTS, INC.By:
    
    /s/ KEITH S. KRZEMINSKIKeith S. KrzeminskiSenior Vice President of Finance andChief Financial Officer(principal financial and accounting officer)
  35




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##### Table of Contents



EXHIBIT INDEX
 EXHIBITNUMBER
    
    DESCRIPTION10.1*
    
    Employment and Non-Competition Agreement, dated as of August 10,
2005 between Home Interiors & Gifts, Inc., a Texas corporation
and Eugenia B. Price.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. 36