Home Interiors & Gifts 10Q 2005 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005

COMMISSION FILE NUMBER 333-62021

HOME INTERIORS & GIFTS, INC.

(Exact name of registrant as specified in its charter)


TEXAS		75-0981828
(State or other jurisdiction of		(I.R.S. Employer
incorporation 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.
Yesþ Noo

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
Yeso Noþ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yeso Noþ

As of November 14, 2005, 15,240,218 shares of the Company’s common stock, par value $0.10 per share, were outstanding.

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

INDEX


	PAGE
	NO.
PART I — FINANCIAL INFORMATION
Item 1. Unaudited Interim Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2004 and September 30, 2005		3
Consolidated Statements of Operations and Comprehensive Income for the three months and nine months ended September 30, 2004 and 2005		4
Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2005		5
Notes to Unaudited Interim Consolidated Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		20
Item 3. Quantitative and Qualitative Disclosure About Market Risk		36
Item 4. Controls and Procedures		36

PART II — OTHER INFORMATION
Item 1. Legal Proceedings		37
Item 6. Exhibits		37
Certification of CEO Pursuant to Section 302
Certification of CFO Pursuant to Section 302
Certification of CEO Pursuant to Section 906
Certification of CFO Pursuant to Section 906

ITEM 1. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS.

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

As of December 31, 2004 and September 30, 2005


				(Unaudited)
	December 31,			September 30,
	2004			2005
	(In thousands, except
	share information)
ASSETS
Current assets:
Cash	$	27,820		$	27,251
Accounts receivable, net		19,534			25,634
Inventories, net		71,801			83,698
Deferred income tax asset		6,111			2,746
Other current assets		12,054			12,673

Total current assets		137,320			152,002
Property, plant and equipment, net		66,466			62,823
Debt issuance costs, net		10,593			8,701
Goodwill		13,703			13,969
Other assets, net		1,186			1,124

Total assets	$	229,268		$	238,619


LIABILITIES AND SHAREHOLDERS’ DEFICIT
Current liabilities:
Book overdraft	$	4,838		$	4,699
Accounts payable		26,156			30,346
Accrued seminars and incentive awards		9,732			11,357
Royalties payable to decorating consultants		5,416			5,890
Accrued compensation		2,448			2,769
Income taxes payable		15,273			646
Current deferred tax liability		—			709
Current maturity of related party note payable.		687			687
Current maturities of long-term debt and capital lease obligations		15,550			329,388
Other current liabilities		20,092			27,527

Total current liabilities		100,192			414,018
Long-term debt and capital lease obligations, net of current maturities		450,325			150,158
Deferred income tax liability		2,812			1,862
Other liabilities		6,611			5,349

Total liabilities		559,940			571,387

Commitments and contingencies (Note 12)
Shareholders’ deficit:
Common stock, par value $0.10 per share, 75,000,000 shares authorized, 15,240,218 shares issued and outstanding		1,524			1,524
Additional paid-in capital		144,061			146,170
Accumulated deficit		(475,295	)		(479,471	)
Accumulated other comprehensive loss		(962	)		(991	)

Total shareholders’ deficit		(330,672	)		(332,768	)

Total liabilities and shareholders’ deficit	$	229,268		$	238,619

The accompanying notes are an integral part of these consolidated financial statements.

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

For the three months and nine months ended September 30, 2004 and 2005

(In thousands)

(Unaudited)


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2004			2005			2004			2005
Net sales	$	123,675		$	118,410		$	387,466		$	369,182
Cost of goods sold		60,738			61,545			180,542			182,000

Gross profit		62,937			56,865			206,924			187,182

Selling, general and administrative:
Selling		22,104			22,632			75,968			75,494
Freight, warehouse and distribution		17,649			16,016			52,057			50,401
General and administrative		13,805			14,986			49,483			48,944
Loss on the disposition of assets		47			248			1,564			249
Stock option expense		1,244			119			3,176			2,109
Loss on debt refinancing		—			—			1,071			—

Total selling, general and administrative		54,849			54,001			183,319			177,197

Operating income		8,088			2,864			23,605			9,985
Other income (expense):
Interest income		51			203			210			472
Interest expense		(9,215	)		(12,143	)		(25,402	)		(34,897	)
Other income (expense), net		(1,720	)		647			(2,100	)		2,331

Other income (expense), net		(10,884	)		(11,293	)		(27,292	)		(32,094	)

Loss from continuing operations before income taxes		(2,796	)		(8,429	)		(3,687	)		(22,109	)
Income tax benefit		1,840			8,587			3,556			17,933

Income (loss) from continuing operations		(956	)		158			(131	)		(4,176	)

Discontinued operations (Note 7):
Discontinued operations loss, net of tax		190			—			3,898			—

Net income (loss)		(1,146	)		158			(4,029	)		(4,176	)
Other comprehensive income (loss):
Cumulative translation adjustment		(67	)		2			(64	)		(29	)

Other comprehensive income (loss)		(67	)		2			(64	)		(29	)

Comprehensive income (loss)	$	(1,213	)	$	160		$	(4,093	)	$	(4,205	)
			��

The accompanying notes are an integral part of these consolidated financial statements.

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2004 and 2005

(In Thousands)

(Unaudited)


	Nine Months Ended
	September 30,
	2004			2005
Cash flows from operating activities:
Net loss	$	(4,029	)	$	(4,176	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		11,775			11,102
Impairment of goodwill		1,060			—
Impairment of property, plant and equipment		1,325			—
Amortization of debt issuance costs		1,824			2,911
Provision for doubtful accounts		2,377			2,258
Provision for losses on inventories		519			6,005
Loss on debt refinancing		1,071			—
Loss on disposition of assets		1,564			249
Stock option expense		3,176			2,109
Unrealized gain (loss) on derivatives		(1,730	)		1,242
Deferred tax expense		422			3,250
Changes in assets and liabilities:
Accounts receivable		(10,882	)		(8,358	)
Inventories		(22,395	)		(17,902	)
Other current assets		(9,943	)		(619	)
Other assets		221			62
Accounts payable		12,492			3,748
Related party payable		(709	)		(879	)
Income taxes payable		(2,934	)		(14,753	)
Other current liabilities		6,777			7,964

Total adjustments		(3,990	)		(9,147	)

Net cash used in operating activities		(8,019	)		(5,787	)

Cash flows from investing activities:
Purchases of property, plant and equipment		(6,539	)		(7,638	)
Proceeds from the sale of property, plant and equipment		6			372

Net cash used in investing activities		(6,533	)		(7,266	)

Cash flows from financing activities:
Book overdraft		(2,651	)		(139	)
Proceeds from borrowings under revolving loan facility		—			40,000
Payments under revolving loan facility		—			(15,000	)
Payments of principal under capital lease obligations		(1,216	)		(1,329	)
Proceeds from borrowings under senior credit facility		320,000			—
Payments of principal under senior credit facility		(173,681	)		(10,000	)
Debt issuance and amendment costs		(9,126	)		(1,019	)
Payment of preferred stock repurchase and preferred stock dividends		(139,000	)		—
Preferred stock issuance costs		(299	)		—

Net cash provided by (used in) financing activities		(5,973	)		12,513

Effect of cumulative translation adjustment		(64	)		(29	)

Net decrease in cash		(20,589	)		(569	)
Cash at beginning of year		36,636			27,820

Cash at end of period	$	16,047		$	27,251

The accompanying notes are an integral part of these consolidated financial statements.

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Background

Home Interiors & Gifts, Inc. (the “Company”) is a fully integrated manufacturer, importer, and distributor of indoor and outdoor home decorative accessories. Types of home décor accessories offered by the Company include, but are not limited to, framed artwork and mirrors, scented candles, candle accessories, plaques, figurines, planters, artificial floral arrangements, wall shelves, sconces, small furniture, tableware and table accessories (the “Products”). Many of the Products are manufactured exclusively for the Company by wholly-owned subsidiaries of the Company. During the first nine months of 2005, approximately 43% of the dollar volume of Products purchased for the Direct Selling Channel, as defined below, were purchased from, and manufactured by the Company’s manufacturing subsidiaries. The Products not manufactured and supplied by the Company’s subsidiaries are purchased from numerous foreign and domestic suppliers. The Company distributes the Products through two channels. In the “direct selling” channel, the Company sells the Products directly to independent contractor sales representatives (“Decorating Consultants”) located in the United States, Mexico, Canada and Puerto Rico, who then resell the Products to customers (“Direct Selling Channel”). As of September 30, 2005, the Company had approximately 107,500 active Decorating Consultants within the Direct Selling Channel. In the second channel (the “Domistyle Channel”), the Company manufactures and/or distributes the Products to the Direct Selling Channel and to non-affiliated national retailers. The Company’s management evaluates the operational performance of the Company’s different channels of business based upon three reporting segments. Direct selling domestic and direct selling international are the two reporting segments used by management to evaluate the Direct Selling Channel, and management evaluates the Domistyle Channel separately.

The Company has been located in the Dallas, Texas area since the Company’s inception in 1957. Currently, a majority of the Company’s outstanding common stock is owned by affiliates of Hicks, Muse, Tate & Furst Incorporated, a Dallas-based private investment firm (“Hicks Muse”).

2. Management’s Plans, Liquidity and Capital Resources

The operating environment confronting the Company raises uncertainty about the Company’s ability to meet its debt obligations. As discussed below and in Note 9, management is currently discussing refinancing alternatives. Management believes, if successful, such refinancing would improve the Company’s cash flows and allow it to meet its debt obligations in the normal course of business. If unsuccessful, the Company’s ability to continue as a going concern will be uncertain. The principal conditions giving rise to this uncertainty are as follows:

	•		The Company has incurred losses from continuing operations before taxes and negative operating cash flows in five of the last six quarterly periods. This performance is the result of lower operating income from a decline in revenue and significant interest expense on indebtedness.

	•		As a result of classifying $327.5 million of debt from our senior credit facility as a current obligation (see Note 9), the Company had a working capital deficit of $254.5 million as of September 30, 2005.

	•		The Company was required to obtain waivers of compliance with financial covenants under the senior credit facility as of June 30, 2005 and September 30, 2005 (see Note 9).

	•		The Company has significant cash debt service requirements related to its senior credit facility and senior subordinated notes. In the event the Company is unable to obtain further waivers or otherwise agree with its lenders on the terms of a restructuring of such senior credit facility, the lenders under the senior credit facility could elect to accelerate all amounts outstanding under the senior credit facility.

business, improve financial reporting and controls at certain operations, and develop a more effective sales and marketing strategy.

Management believes the successful implementation of its strategic initiatives and a debt restructuring should enable the Company to improve operating results and cash flows in the future. Management also believes the long-term benefits of its plan will stabilize the Company and improve its financial ratios.

Achievement of projected cash flows from operations will be dependent upon the Company’s attainment of forecasted revenues, improved operating costs and trade support levels, which are consistent with its financial plans. Such operating performance will be subject to financial, economic and other factors affecting the industry and operations of the Company, including factors beyond the Company’s control, and there can be no assurance the Company’s plans will be achieved. In addition, as described in Note 9, the Company is in discussions with its lenders to obtain amendments to its senior credit facility that would modify or waive financial covenants and restructure existing obligations. In the event the Company is unable to obtain such modifications or waivers, or is unable to agree on the terms to restructure its obligations under the senior credit facility, the lenders under the senior credit facility could elect to accelerate all amounts under the facility, which would also constitute an event of default under the indenture governing the Company’s senior subordinated notes due 2008. In the event such debt is accelerated, the Company would be unable to pay such accelerated principal and interest obligations, including the notes, absent additional sources of equity or debt financing, which the Company may not be able to obtain on acceptable terms to it, or at all.

3. 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, 2004 and 2005 included in the accompanying unaudited consolidated financial information were October 2, 2004 and October 1, 2005, respectively.

The consolidated financial information as of September 30, 2005 and for the three and nine months ended September 30, 2004 and 2005 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, 2005 and December 31, 2004, its operating results and comprehensive income for the three and nine months ended September 30, 2004 and 2005, and its cash flows for the nine months ended September 30, 2004 and 2005. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year.

These unaudited interim consolidated financial statements and notes thereto should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2004 as filed with the SEC.

Reclassifications

Certain reclassifications have been made to prior period balances to conform with the current year presentation.

Stock-based Compensations Plans

The Company has adopted three stock option plans. For Decorating Consultants and other independent contractors, the Company adopted the “Independent Contractor Stock Option Plan” and accounts for options issued under the Independent Contractor Stock Option Plan in accordance with Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). For key employees, the Company adopted the “1998 Key Employee Stock Option Plan” and the “2002 Key Employee Stock Option Plan”. The Company accounts for the options issued under the 1998 Key Employee Stock Option Plan and the 2002 Key

Employee Stock Option Plan in accordance with the Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), as allowed by SFAS No. 123.

Compensation Charge

SFAS No. 123 establishes a fair value basis of accounting for stock-based compensation plans. The effects of applying SFAS No. 123 as shown below are not indicative of future amounts. Had the compensation cost for the Company’s 1998 Key Employee Stock Option Plan and 2002 Key Employee Stock Option Plan been determined consistently with SFAS No. 123, the Company’s compensation cost and net loss for the three months and nine months ended September 30, 2004 and 2005 would approximate (in thousands):


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2004			2005			2004			2005
Net income (loss), as reported	$	(1,146	)	$	158		$	(4,029	)	$	(4,176	)
Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects		442			42			1,379			1,002
Deduct: Stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(515	)		(98	)		(1,542	)		(1,193	)

Pro forma net income (loss)	$	(1,219	)	$	102		$	(4,192	)	$	(4,367	)

4. Inventories, Net

Inventories, net, consisted of the following as of December 31, 2004 and September 30, 2005 (in thousands):


	December 31,			September 30,
	2004			2005
Raw materials	$	8,184		$	10,204
Work in process		2,231			2,298
Finished goods		67,559			83,413

		77,974			95,915
Inventory allowance		(6,173	)		(12,217	)

	$	71,801		$	83,698

5. Other Current Liabilities

Other current liabilities consisted of the following as of December 31, 2004 and September 30, 2005 (in thousands):


	December 31,		September 30,
	2004		2005
Interest	$	1,258	$	5,133
Accrued employee benefits		2,997		3,181
Sales taxes		3,872		4,539
Other taxes		1,743		1,613
Deferred revenue		4,482		9,631
Related parties		748		134
Accrued product license royalties		1,439		1,099
Other		3,553		2,197

	$	20,092	$	27,527

6. Adoption of Financial Accounting Standards

In May 2005, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS No. 154”). SFAS No. 154 replaces ABP Opinion No. 20, “Accounting Changes” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements” and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 applies to all voluntary changes in accounting principle and to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company is currently evaluating the guidance provided under SFAS No. 154.

In December 2004, FASB issued Staff Position Statement No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (“FSP FAS No. 109-2”). The American Jobs Creation Act signed into law on October 22, 2004, provides for a special one-time tax deduction, or dividend received deduction (“DRD”), of 85% of qualifying foreign earnings that are repatriated in either a company’s last tax year that began before the enactment date or the first tax year that begins during the one-year period beginning on the enactment date. FSP FAS No. 109-2 provides entities additional time to assess the effect of repatriating foreign earnings under the American Jobs Creation Act for purposes of applying SFAS No. 109, which typically requires the effect of a new tax law to be recorded in the period of enactment. The Company may elect, if applicable, to apply the DRD to qualifying dividends of foreign earnings repatriated during 2005. The Company adopted FSP FAS No. 109-2 and there was not a financial accounting impact associated with its adoption.

In December of 2004, the FASB issued Statement of Financial Accounting Standards No. 153, “Exchanges of Nonmonetary Assets an amendment of ABP Opinion No. 29” (“SFAS No. 153”). SFAS No. 153 amends APB Opinion No. 29 “Accounting for Nonmonetary Transactions” to eliminate the exception for nonmonetary exchanges of similar productive assets that do no have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for nonmonetary assets exchanges occurring in fiscal periods beginning after June 15, 2005. The Company adopted SFAS No. 153 and there was not a financial accounting impact associated with its adoption.

In December of 2004, the FASB issued Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”). SFAS No. 123(R) is a revision of FASB Statement No. 123, “Accounting for Stock Based Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and its related implementation guidance. SFAS No. 123(R) is effective for public entities that do not file as small business issuers as of the beginning of the first interim, or annual reporting period that begins after June 15, 2005. In April of 2005, the Securities and Exchange Commission issued a ruling that SFAS No. 123(R) is now effective for registrants that are not a small business issuer will be required for annual, rather than interim, periods that begin

after June 15, 2005, and the effective date for public entities that file as small business issuers is as of the beginning of the first interim or annual reporting period that begins after December 15, 2005. The Company is currently evaluating the guidance provided under SFAS No. 123(R).

7. Discontinued Operations

In the first quarter of 2003, the Company acquired 100% of the assets of Ceramica y Vidrio de Nuevo Leon, S.A. de C.V., Maquiladora Produr, S.A. de C.V., and Industrias Tromex Corporation, S.A. de C.V. (collectively “Produr”). Produr manufactured glass, ceramics, and metal products and was located in Monterrey, Mexico. In the second quarter of 2004, the Company decided to discontinue the manufacture of ceramics products and, also, to close the glass manufacturing plant. The metals manufacturing operation was shut down on March 8, 2005. The Company has accounted for the shutdown of the manufacturing operations of ceramics products as discontinued operations in the consolidated statement of operations and comprehensive income, as discussed below. The costs incurred related to the shutdown of the glass and metals manufacturing are reflected in continuing operations in the consolidated statement of operations and comprehensive income, since the Company will continue to source glass and metals products from non-affiliated vendors and distribute glass and metal products to non-affiliated retailers.

On April 28, 2004, the Company discontinued the manufacturing 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, $2.0 million in impairment of property, plant, and equipment, and $1.1 million in write-off of goodwill related to the shut-down and disposal activity. The remaining assets related to the ceramics product manufacturing were sold as of December 31, 2004.

The operations and cash flows of the ceramics manufacturing operation have been eliminated from the Company’s ongoing operations as a result of the shutdown, and the Company does not have any continued involvement in the manufacturing of ceramics products. The results of operations of ceramics manufacturing have been classified as discontinued operations, and information presented for all periods reflects the new classification. The operations of ceramics manufacturing were previously reported in the Company’s Domistyle operating segment. Components of amounts reflected as loss on discontinued operations in the Company’s Consolidated Statements of Operations and Comprehensive Income and Statement of Financial Position are presented in the following table (in thousands):


	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2004			2005		2004			2005
Net sales	$	(4	)	$	—	$	824		$	—
Cost of goods sold		43			—		1,819			—

Gross profit		(47	)		—		(995	)		—

Selling, general and administrative:
General and administrative		144			—		2,776			—

Total selling, general and administrative		144			—		2,776			—

Operating loss		(191	)		—		(3,771	)		—
Other income (expense):
Interest expense		—			—		(2	)		—
Other income (expense), net		1			—		(125	)		—

Other income (expense), net		1			—		(127	)		—

Loss before income taxes		(190	)		—		(3,898	)		—
Income tax benefit		—			—		—			—

Loss on discontinued operations, net of tax	$	(190	)	$	—	$	(3,898	)	$	—


	September 30,		September 30,
	2004		2005
Balance sheet data:
Long term assets held for sale	$	164		—

8. Income Tax Benefit

SFAS 109,Accounting for Income Taxes,requires the Company to periodically assess whether it is more likely than not that it will generate sufficient taxable income to realize its deferred income tax assets. In making this determination, the Company considers all available positive and negative evidence and makes certain assumptions. The Company considers, among other things, its deferred tax liabilities, the overall business environment, its historical earnings and losses, current industry trends and its outlook for future years.

In the third quarter of 2005, the Company determined that it was unclear as to the timing of when it will generate sufficient taxable income to realize its deferred tax assets. This was primarily due to the negative industry trends, which caused the Company’s actual and anticipated financial performance to be worse than it originally projected. Accordingly, during the third quarter of 2005, the Company recorded a valuation allowance of $7.5 million against its deferred tax assets in the United States, which resulted in a net tax benefit for income taxes of $8.6 million and $17.9 million for the three and nine months ended September 30, 2005, respectively.

The income tax benefit for the three months ended September 30, 2005 includes a $12.7 million benefit associated with the release of the $12.7 million tax reserve in the third quarter of 2005, due to the passage of time, which the Company accrued in 2001 as a result of the purchase of company debt by affiliates of Hicks Muse and the associated issuance of preferred stock by the Company, and the benefit of $3.1 million associated with a $8.4 million pre-tax loss which is eligible to be carried back to previous tax years to offset prior year taxable income and generate a cash tax refund. These benefits are partially offset by the valuation allowance, described above, of $7.5 million against the Company’s deferred tax assets in the United States.

During the nine-month period ended September 30 2005, tax benefits, in addition to the $12.7 million benefit described above, were recognized by the Company that include a $4.6 million benefit associated with the closing of manufacturing operations in Mexico and a $8.2 million benefit associated with a $22.1 million pre-tax loss which is eligible to be carried back to previous tax years to offset prior year taxable income and generate a cash tax refund. These benefits are partially offset by the valuation allowance, as described above, of $7.5 million against the Company’s deferred tax assets in the United States.

Until the Company determines that it is more likely than not that it will generate sufficient taxable income to realize its deferred income tax assets in these markets, income tax benefits associated with current period losses will be fully reserved unless such losses are eligible for carryback refunds.

9. Senior Credit Facility

On September 28, 2005, the Company entered into an amendment and waiver (the “Third Amendment”), to the Company’s senior credit facility. The Third Amendment waives compliance by the Company with the consolidated leverage ratio and consolidated interest coverage ratio from June 30, 2005 to (but not including) November 28, 2005. The Third Amendment also, among other things, (i) limits the availability of revolving extensions of credit under the senior credit facility to $35.0 million at any time outstanding, (ii) imposes an additional condition precedent to each extension of credit under the revolving portion of the senior credit facility pertaining to the amount of available cash on hand and the use of the proceeds of such extension of credit, (iii) requires the Company to prepay the revolving loans under certain circumstances with proceeds of cash on hand, (iv) restricts the ability of the Company to incur certain types of debt and create certain types of liens in excess of a specified dollar amount, (v) restricts certain transactions among the Company and the subsidiaries of the Company which are guarantors, on the one hand, and the Company’s non-guarantor subsidiaries, on the other hand, and (vi) suspends payment of fees in cash under the Company’s financial advisory and monitoring and oversight agreements with Hicks Muse during the waiver period discussed above and under periods of default under the senior credit facility.

As a result of obtaining the Third Amendment, the Company recognized approximately $0.2 million loss related to a write off of unamortized debt issuance costs and $0.1 million of legal fees incurred for the three-month period ending, September 30, 2005. The Company also incurred debt issuance costs of $0.4 million that have been deferred.

As of September 30, 2005, the Company was in compliance with the requirements set forth in the credit agreement under the senior credit facility, as amended, and the indenture with respect to the senior subordinated notes.

Upon the occurrence of an event of default under the senior credit facility, the lenders could elect to block principal and interest payment under the Company’s senior subordinated notes for up to 179 days and/or declare all amounts outstanding under the senior credit facility to be immediately due and payable and terminate all commitments to extend further credit under the revolving loans. Acceleration of the amounts outstanding under the senior credit facility would result in an event of default under the indenture governing the Company’s senior subordinated notes, which could result in the principal amount outstanding under the senior subordinated notes becoming due and payable immediately. In that event, the Company would not have sufficient liquidity to make the payments required under the senior credit facility and the senior subordinated notes and for working capital purposes.

The Company is in discussions with its lenders to obtain amendments to the senior credit facility that would modify or waive the financial covenants that could be at issue on November 28, 2005 or otherwise restructure such obligations. However, there can be no assurance that the Company’s lenders will agree to any modifications or waivers under the senior credit facility or that the Company and its lenders will agree on the terms of a restructuring of such senior credit facility. As a result, the term loans outstanding of $302.5 million and the $25.0 million in revolving loans outstanding have been classified as a current liability on the September 30, 2005 consolidated balance sheet, in accordance with EITF Abstract issue No. 86-30 “Classification of Obligation When a Violation Is Waived by a Creditor”.

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 various Products.

The Company evaluates the performance of its segments and allocates resources to them based on earnings before interest, taxes, the effects of SAB 101, depreciation and amortization, discontinued operations, reorganization costs, non-cash expense for stock options, losses on debt refinancing, realized gain and unrealized (gain) loss on derivatives, goodwill impairment and (gains) losses on disposition of assets (defined as “Modified EBITDA”). The Company also uses Modified EBITDA as a performance measure due to the Company’s required compliance thresholds for Modified EBITDA covenants under the senior credit facility. The accounting principles of the segments are the same as those described in Note 2. Segment data includes intersegment sales and intercompany net receivable balances. Eliminations consist primarily of intersegment sales between Domistyle and the direct selling segments, as well as the elimination of the investment in each subsidiary for consolidation purposes. The table below presents information about reportable segments used by the Company’s chief operating decision maker as of and for the three months and nine months ended September 30, 2004 and 2005 (in thousands):


	Direct		Direct
	Selling		Selling
	Domestic		International		Domistyle		Eliminations			Consolidated
Three months ended September 30,
2004
Net sales to non-affiliates	$	98,957	$	18,064	$	6,654	$	—		$	123,675
Net sales to affiliates		6,577		—		30,090		(36,667	)		—
Modified EBITDA		5,708		2,416		7,714		(172	)		15,666
2005
Net sales to non-affiliates	$	89,283	$	20,870	$	8,257	$	—		$	118,410
Net sales to affiliates		5,922		—		20,937		(26,859	)		—
Modified EBITDA		4,840		3,262		2,469		520			11,091


	Direct		Direct
	Selling		Selling
	Domestic		International		Domistyle		Eliminations			Consolidated
Nine months ended September 30,
2004
Net sales to non-affiliates	$	318,237	$	48,446	$	20,783	$	—		$	387,466
Net sales to affiliates		21,793		—		98,549		(120,342	)		—
Modified EBITDA		22,306		5,717		27,604		(1,721	)		53,906
Total assets		224,707		20,895		86,735		(78,626	)		253,711
Goodwill		—		—		13,645		—			13,645
Capital expenditures		3,300		817		2,422		—			6,539
2005
Net sales to non-affiliates	$	289,642	$	54,926	$	24,614	$	—		$	369,182
Net sales to affiliates		23,733		—		81,056		(104,789	)		—
Modified EBITDA		11,152		7,012		17,558		(1,092	)		34,630
Total assets		207,585		27,646		78,580		(75,192	)		238,619
Goodwill		—		—		13,969		—			13,969
Capital expenditures		5,248		1,952		438		—			7,638

The following table represents a reconciliation of net income (loss) to consolidated Modified EBITDA for the three months and nine months ended September 30, 2004 and 2005 (in thousands):


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2004			2005			2004			2005
Net income (loss)	$	(1,146	)	$	158		$	(4,029	)	$	(4,176	)
Effect of SAB 101		592			1,007			2,859			3,045
Discontinued operations, net of tax		190			—			3,898			—
Interest income		(51	)		(203	)		(210	)		(472	)
Interest expense		9,215			12,143			25,402			34,897
Realized gain on derivatives		—			(64	)		—			(203	)
Unrealized (gain) loss on derivatives		1,819			(886	)		1,730			(1,242	)
Income tax benefit		(1,840	)		(8,587	)		(3,556	)		(17,933	)
Depreciation and amortization		4,354			3,785			11,775			11,102
Stock option expense		1,244			119			3,176			2,109
Loss on debt refinancing		—			—			1,071			—
Reorganization costs		1,242			3,371			10,226			7,254
Loss on disposition of assets		47			248			1,564			249

Modified EBITDA	$	15,666		$	11,091		$	53,906		$	34,630

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 Home Interiors & Gifts, Inc.’s (“Borrower”) credit agreement with its principal lenders under the senior credit facility, and the Borrower’s 10-1/8% senior subordinated notes due 2008 in the aggregate principal amount of $149.1 million (the “Notes”). The Company’s other subsidiaries, Home Interiors de Mexico, S. de R.L. de C.V., Home Interiors Services de Mexico, S.A. de C.V., HI Ceramics, S.A. de C.V., HI Metals, S.A. de C.V., HI Glass, S.A. de C.V., HI Trading Mexicana, S.A. de C.V., and Home Interiors & Gifts of Canada, Inc. (collectively, the “Non-Guarantors”) have not guaranteed the senior credit facility or the Notes. Guarantor and Non-Guarantor financial statements on an individual basis are not significant and have been omitted. Accordingly, the following table presents financial information of the Guarantors and Non-Guarantors on a consolidating basis (in thousands):

Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Three Months Ended September 30, 2004


							Non-
	Borrower			Guarantors			Guarantors			Eliminations			Consolidated
Net sales	$	107,219		$	36,086		$	17,198		$	(36,828	)	$	123,675
Cost of good sold		59,457			26,630			11,428			(36,777	)		60,738

Gross profit		47,762			9,456			5,770			(51	)		62,937
Total selling, general and administrative		46,633			2,820			5,396			—			54,849

Operating income		1,129			6,636			374			(51	)		8,088
Other 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	)		1,840
Equity 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			—			190

Net income (loss)		(873	)		3,006			(77	)		(3,202	)		(1,146	)
Other comprehensive income (loss)		6			—			(73	)		—			(67	)

Comprehensive income (loss)	$	(867	)	$	3,006		$	(150	)	$	(3,202	)	$	(1,213	)

Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Three Months Ended September 30, 2005


							Non-
	Borrower			Guarantors			Guarantors			Eliminations			Consolidated
Net sales	$	97,160		$	31,700		$	16,399		$	(26,849	)	$	118,410
Cost of good sold		54,172			26,828			7,978			(27,433	)		61,545

Gross profit		42,988			4,872			8,421			584			56,865
Total selling, general and administrative		44,820			2,720			6,461			—			54,001

Operating income (loss)		(1,832	)		2,152			1,960			584			2,864
Other income (expense), net		(11,284	)		148			(92	)		(65	)		(11,293	)

Income (loss) before income taxes		(13,116	)		2,300			1,868			519			(8,429	)
Income tax benefit (provision)		10,569			(792	)		(983	)		(207	)		8,587
Equity in income (loss) of affiliated companies, net of tax		2,393			(337	)		—			(2,056	)		—

Net income (loss)		(154	)		1,171			885			(1,744	)		158
Other comprehensive income (loss)		(5	)		—			7			—			2

Comprehensive income (loss)	$	(159	)	$	1,171		$	892		$	(1,744	)	$	160

Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Nine Months Ended September 30, 2004


							Non-
	Borrower			Guarantors			Guarantors			Eliminations			Consolidated
Net sales	$	345,787		$	115,439		$	49,377		$	(123,137	)	$	387,466
Cost of good sold		186,426			80,442			35,504			(121,830	)		180,542

Gross profit		159,361			34,997			13,873			(1,307	)		206,924
Total selling, general and administrative		154,812			9,491			19,016			—			183,319

Operating income (loss)		4,549			25,506			(5,143	)		(1,307	)		23,605
Other 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			3,556
Equity 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			—			3,898

Net income (loss)		(2,425	)		5,279			(10,681	)		3,798			(4,029	)
Other comprehensive income (loss)		13			—			(77	)		—			(64	)

Comprehensive income (loss)	$	(2,412	)	$	5,279		$	(10,758	)	$	3,798		$	(4,093	)

Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Nine Months Ended September 30, 2005


							Non-
	Borrower			Guarantors			Guarantors			Eliminations			Consolidated
Net sales	$	318,960		$	110,868		$	43,168		$	(103,814	)	$	369,182
Cost of good sold		177,193			85,852			21,794			(102,839	)		182,000

Gross profit		141,767			25,016			21,374			(975	)		187,182
Total selling, general and administrative		148,748			9,334			19,115			—			177,197

Operating income (loss)		(6,981	)		15,682			2,259			(975	)		9,985
Other income (expense), net		(33,117	)		412			728			(117	)		(32,094	)

Income (loss) before income taxes		(40,098	)		16,094			2,987			(1,092	)		(22,109	)
Income tax benefit (provision)		20,098			(1,088	)		(1,486	)		409			17,933
Equity in income (loss) of affiliated companies, net of tax		16,508			(473	)		—			(16,035	)		—

Net income (loss)		(3,492	)		14,533			1,501			(16,718	)		(4,176	)
Other comprehensive loss		(3	)		—			(26	)		—			(29	)

Comprehensive income (loss)	$	(3,495	)	$	14,533		$	1,475		$	(16,718	)	$	(4,205	)

Condensed Consolidating Balance Sheet
As of December 31, 2004


							Non-
	Borrower			Guarantors			Guarantors			Consolidating			Elimination			Consolidated
ASSETS
Current assets:
Cash	$	27,177		$	46		$	597		$	27,820		$	—		$	27,820
Accounts receivable, net		10,475			7,483			1,576			19,534			—			19,534
Inventories, net		53,313			15,538			7,567			76,418			(4,617	)		71,801
Other current assets		8,018			2,187			6,782			16,987			1,178			18,165
Due from (due to) affiliated companies		(8,358	)		22,358			(14,000	)		—			—			—

Total current assets		90,625			47,612			2,522			140,759			(3,439	)		137,320
Property, plant and equipment, net		41,252			19,037			6,177			66,466			—			66,466
Investment in subsidiaries		66,248			(7,449	)		—			58,799			(58,799	)		—
Debt issuance costs and other assets, net		11,431			13,868			183			25,482			—			25,482

Total assets	$	209,556		$	73,068		$	8,882		$	291,506		$	(62,238	)	$	229,268


LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable	$	21,111		$	3,594		$	819		$	25,524		$	632		$	26,156
Current maturity of related party note payable		687			—			—			687			—			687
Current maturities of long-term debt and capital lease obligations		15,129			232			189			15,550			—			15,550
Other current liabilities		42,682			6,519			8,598			57,799			—			57,799

Total current liabilities		79,609			10,345			9,606			99,560			632			100,192
Long-term debt and capital lease obligations, net of current maturities		449,784			248			293			450,325			—			450,325
Other liabilities		5,798			3,430			195			9,423			—			9,423

Total liabilities		535,191			14,023			10,094			559,308			632			559,940

Commitments and contingencies (Note 12)
Shareholders’ equity (deficit):
Common stock		1,524			1,001			29			2,554			(1,030	)		1,524
Additional paid-in capital		144,061			58,830			20,504			223,395			(79,334	)		144,061
Retained 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

Condensed Consolidating Balance Sheet
As of September 30, 2005


							Non-
	Borrower			Guarantors			Guarantors			Consolidating			Eliminations			Consolidated
ASSETS
Current assets:
Cash	$	26,417		$	36		$	798		$	27,251		$	—		$	27,251
Accounts receivable, net		16,128			6,063			3,443			25,634			—			25,634
Inventories, net		64,560			14,272			10,576			89,408			(5,710	)		83,698
Other current assets		4,930			3,365			5,537			13,832			1,587			15,419
Due from (due to) affiliated companies		(17,666	)		32,458			(14,792	)		—			—			—

Total current assets		94,396			56,194			5,562			156,125			(4,123	)		152,002
Property, plant and equipment, net		38,815			18,261			5,747			62,823			—			62,823
Investment in subsidiaries		71,051			(7,921	)		—			63,130			(63,130	)		—
Debt issuance costs and other assets, net		9,493			14,110			191			23,794			—			23,794

Total assets	$	213,728		$	80,644		$	11,500		$	305,872		$	(67,253	)	$	238,619


LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable	$	26,280		$	2,669		$	766		$	29,715		$	631		$	30,346
Current maturity of related party note payable		687			—			—			687			—			687
Current maturities of long-term debt and capital lease obligations		328,933			245			210			329,388			—			329,388
Other current liabilities		30,955			12,718			9,924			53,597			—			53,597

Total current liabilities		386,855			15,632			10,900			413,387			631			414,018
Long-term debt and capital lease obligations, net of current maturities		149,950			62			146			150,158			—			150,158
Other liabilities		3,945			3,075			191			7,211			—			7,211

Total liabilities		540,750			18,769			11,237			570,756			631			571,387

Commitments and contingencies (Note 12)
Shareholders’ equity (deficit):
Common stock		1,524			1,001			29			2,554			(1,030	)		1,524
Additional paid-in capital		146,169			58,831			20,504			225,504			(79,334	)		146,170
Retained earnings (accumulated deficit)		(474,716	)		2,043			(19,278	)		(491,951	)		12,480			(479,471	)
Accumulated comprehensive income (loss)		1			—			(992	)		(991	)		—			(991	)

Total shareholders’ equity (deficit)		(327,022	)		61,875			263			(264,884	)		(67,884	)		(332,768	)

Total liabilities and shareholders’ equity (deficit)	$	213,728		$	80,644		$	11,500		$	305,872		$	(67,253	)	$	238,619

Condensed Consolidating Cash Flow Statement
For the Nine Months Ended September 30, 2004


							Non-
	Borrower			Guarantors			Guarantors			Eliminations		Consolidated
Net cash provided by (used in) operating activities	$	(11,439	)	$	3,297		$	123		$	—	$	(8,019	)
Cash flows from investing activities:
Purchases of property, plant and equipment		(3,300	)		(1,746	)		(1,493	)		—		(6,539	)
Proceeds from the sale of property, plant and equipment		—			6						—		6

Net cash used in investing activities		(3,300	)		(1,740	)		(1,493	)		—		(6,533	)

Cash flows from financing activities:
Book overdraft		(1,097	)		(1,554	)		—			—		(2,651	)
Payments of principal under capital lease obligations		(986	)		(169	)		(61	)		—		(1,216	)
Payments of principal under senior credit facility		(173,681	)		—			—			—		(173,681	)
Proceeds from borrowings under senior credit facility		320,000			—			—			—		320,000
Debt issuance costs		(9,126	)		—			—			—		(9,126	)
Payment of preferred stock repurchase and preferred stock dividends		(139,000	)		—			—			—		(139,000	)
Preferred stock repurchase costs		(299	)		—			—			—		(299	)

Net cash used in financing activities		(4,189	)		(1,723	)		(61	)		—		(5,973	)

Effect of cumulative translation adjustment		13			—			(77	)		—		(64	)

Net decrease in cash		(18,915	)		(166	)		(1,508	)		—		(20,589	)
Cash at beginning of year		34,222			176			2,238			—		36,636

Cash at end of period	$	15,307		$	10		$	730		$	—	$	16,047

Condensed Consolidating Cash Flow Statement
For the Nine Months Ended September 30, 2005


							Non-
	Borrower			Guarantors			Guarantors			Eliminations		Consolidated
Net cash provided by (used in) operating activities	$	(8,372	)	$	2,114		$	471		$	—	$	(5,787	)
Cash flows from investing activities:
Purchases of property, plant and equipment		(5,248	)		(1,943	)		(447	)		—		(7,638	)
Proceeds from the sale of property, plant and equipment		7			34			331			—		372

Net cash used in investing activities		(5,241	)		(1,909	)		(116	)		—		(7,266	)

Cash flows from financing activities:
Cash overdraft		(97	)		(42	)		—			—		(139	)
Proceeds from borrowings under revolving loan facility		40,000			—			—			—		40,000
Payments of principal under revolving loan facility		(15,000	)		—			—			—		(15,000	)
Payments of principal under capital lease obligations		(1,028	)		(173	)		(128	)		—		(1,329	)
Payments of principal under senior credit facility		(10,000	)		—			—			—		(10,000	)
Debt issuance costs		(1,019	)		—			—			—		(1,019	)

Net cash provided by (used in) financing activities		12,856			(215	)		(128	)	$	—		12,513

Effect of cumulative translation adjustment		(3	)		—			(26	)				(29	)

Net increase (decrease) in cash		(760	)		(10	)		201			—		(569	)
Cash at beginning of year		27,177			46			597			—		27,820

Cash at end of period	$	26,417		$	36		$	798		$	—	$	27,251

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.

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. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance, and projections. 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,” “could,” “might,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negative of such terms or other comparable terminology.

All of these forward-looking statements are based on estimates and assumptions made by management of the Company, which, although believed to be reasonable, are inherently uncertain. Therefore, undue reliance should not be placed upon such statements. No assurance can be given that any of such estimates or statements will be realized and actual results may differ materially from those contemplated by such forward-looking statements. Factors that may cause such differences include: (i) Decorating Consultant recruiting and activity levels; (ii) loss or retirement of key members of management; (iii) imposition of foreign, federal or state taxes; (iv) change in status of independent contractors; (v) increased competition; (vi) success of new product launches, promotion programs, and incentive award programs; (vii) risks of shortages of, or increased costs of, raw materials; and (viii) general economic conditions, including, but not limited to, international economic or political instability, currency exchange rates, and consumer discretionary spending. Many of these factors will be beyond the control of the Company.

Moreover, neither the Company nor any other person assumes responsibility for the accuracy and completeness of such statements. The Company is under no duty to update any of the forward-looking statements after the date of this Form 10-Q to conform such statements to actual results.

Company Overview

Home Interiors & Gifts, Inc. (the “Company”) is a fully integrated manufacturer, importer, and distributor of indoor and outdoor home decorative accessories. Types of home décor accessories offered by the Company include, but are not limited to, framed artwork and mirrors, scented candles, candle accessories, plaques, figurines, planters, artificial floral arrangements, wall shelves, sconces, small furniture, tableware and table accessories (the “Products”). Many of the Products are manufactured exclusively for the Company by wholly owned subsidiaries of the Company. During the first nine months of 2005, approximately 43% of the dollar volume of Products purchased for the Direct Selling Channel, as defined below, were purchased from, and manufactured by the Company’s manufacturing subsidiaries. The Products not manufactured and supplied by the Company’s subsidiaries are purchased from numerous foreign and domestic suppliers. The Company distributes the Products through two channels. In the “direct selling” channel, the Company sells the Products directly to independent contractor sales representatives (“Decorating Consultants”) located in the United States, Mexico, Canada and Puerto Rico, who then resell the Products to customers (“Direct Selling Channel”). As of September 30, 2005, the Company had approximately 107,500 active Decorating Consultants within the Direct Selling Channel. In the second channel (the “Domistyle Channel”), the Company manufactures and/or distributes the Products to the Direct Selling Channel and to non-affiliated national retailers. The Company’s management evaluates the operational performance of the Company’s different channels of business based upon three reporting segments. Direct selling domestic and direct selling international are the two reporting segments used by management to evaluate the Direct Selling Channel, and management evaluates the Domistyle Channel separately.

Direct Selling Channel Overview & Strategy

The Direct Selling Channel of the Company’s business provides an opportunity for those individuals who desire to own, operate and build a home-based business selling home décor products. The Company’s management believes the Company provides such an opportunity by offering its Decorating Consultants a large and varied selection of Products in addition to a storehouse of educational materials. At any one time, the Company offers approximately 1,200 home décor accessory items for sale, including a specific line of Products designed and marketed under the product collection name of “Better Homes & Gardens Collectionâ”. Products are continually being analyzed and updated to give the Decorating Consultants access to not only traditional favorites, but also the latest styles in home décor. In addition to the large number of Products offered, the Company has created a field environment in which Decorating Consultants have the opportunity to grow their own business through a direct financial and vested interest in the career development and growth of other Decorating Consultants that enter into the business. To support the Decorating Consultants’ career development, growth, and profitability, the Company provides educational materials that address various selling and recruiting techniques such as in-home decorating parties, personal decorating appointments, fundraising, brochure sales, and gift services, along with motivational materials and events. The educational materials have been developed over the Company’s 48-year history in the direct selling industry and represent the most successful and proven strategies of its Decorating Consultants.

The Company’s current strategic initiatives for the Direct Selling Channel include (i) building a competitive edge over other home décor and direct selling organizations by leveraging the Company’s relationships with key product brand partners, such as Thomas Kinkade and Better Homes & Gardens among others, and (ii) focusing on what management believes to be the key drivers of growth within the direct sales business — sales productivity, recruiting productivity, and retention of the Decorating Consultant base.

The Company is currently pursuing a number of initiatives to improve productivity, recruiting, and retention of its Decorating Consultants. The new Decorating Consultant career path and compensation program, introduced during the first quarter of 2005, has shown positive results with growth in the area of new recruits, the numbers of orders placed by new recruits, and field leadership promotions when compared to the results for the nine months ended September 30, 2004.

Domistyle Channel Overview & Strategy

The Domistyle Channel of the Company’s business is comprised of the manufacturing and distribution of framed artwork and mirrors, scented candles, plaques, and various types of molded plastic Products through the use of custom-designed equipment for the Company’s Direct Selling Channel and non-affiliated national retailers.

In a continued effort to increase the profitability of the Domistyle Channel, management’s strategy is focused on leveraging the fixed component of the Products’ cost structure and maintaining a competitive edge with regard to quality, price, and fulfillment needs of national retailers.

Results of Operations

The three months ended September 30, 2005 compared to the three months ended September 30, 2004

The following table summarizes the Company’s operating results with corresponding percentages of net sales, variance amounts, and the change in percentage of net sales:


	Three months ended September 30,															% of
	(Dollars in thousands)												Variance			Sales
	2004			%			2005			%			Amount			Change
Net sales	$	123,675			100.0	%	$	118,410			100.0	%	$	(5,265	)		0.0	%
Cost of goods sold		60,738			49.1			61,545			52.0			807			2.9

Gross profit		62,937			50.9			56,865			48.0			(6,072	)		(2.9	)
Operating expenses:
Selling		22,104			17.9			22,632			19.1			528			1.2
Freight, warehouse and distribution		17,649			14.3			16,016			13.5			(1,633	)		(0.8	)
General and administrative		13,805			11.2			14,986			12.7			1,181			1.5
Other		1,291			1.0			367			0.3			(924	)		(0.7	)

Operating income		8,088			6.5			2,864			2.4			(5,224	)		(4.1	)
Other income (expense), net		(10,884	)		(8.8	)		(11,293	)		(9.5	)		(409	)		(0.7	)

Loss before income taxes		(2,796	)		(2.3	)		(8,429	)		(7.1	)		(5,633	)		(4.8	)
Income tax benefit		1,840			1.5			8,587			7.3			6,747			5.8

Income (loss) from continuing operations		(956	)		(0.8	)		158			0.1			1,114			0.9
Discontinued operations loss, net		190			0.2			—			0.0			190			0.2

Net income (loss)	$	(1,146	)		(0.9	)%	$	158			0.1	%	$	1,304			1.0	%

The Company’s operations are divided into three reporting segments: direct selling domestic, direct selling international, and Domistyle. The Company’s management evaluates the performance of its segments and allocates resources to them based on performance. These reportable segments are based on similarities in distribution channels and management oversight. The direct selling domestic segment includes direct sales by Decorating Consultants located within the United States, including Washington D.C. The direct selling international segment includes direct sales by Decorating Consultants located in Mexico, Canada, and Puerto Rico. The direct selling domestic and direct selling international operational segments are directly impacted by the number of Decorating Consultants the Company has selling its Products as well as the number of Product orders each Decorating Consultant places with the Company. The Domistyle operational segment manufactures and distributes framed artwork and mirrors, scented candles, plaques, and various types of molded plastic Products through the use of custom-designed equipment for the Company’s Direct Selling Channel and for non-affiliated national retailers. The Domistyle operations are directly impacted by raw material costs and the ability to promote and market Products to national retailers. The following table presents net sales to non-affiliates by segment along with other key Decorating Consultant data for the quarter ended September 30, 2005 compared to the same period in 2004. Intercompany sales to affiliates are eliminated in consolidation.


					Variance			Percentage
For the three months ended September 30,	2004		2005		Amount			Variance
Net Sales (dollars in thousands)
Direct Selling Domestic net sales to non-affiliates	$	98,957	$	89,283	$	(9,674	)		(9.8	)%
Direct Selling International net sales to non-affiliates		18,064		20,870		2,806			15.5	%
Domistyle net sale to non-affiliates		6,654		8,257		1,603			24.1	%

Net sales	$	123,675	$	118,410	$	(5,265	)		(4.3	)%


Other Key Domestic Data
Average number of active Decorating Consultants		70,774		78,170		7,396			10.5	%
Number of orders shipped		235,841		212,029		(23,812	)		(10.1	)%
Number of orders per Decorating Consultant		3.33		2.71		(0.62	)		(18.6	)%
Average order size (actual dollars)	$	420	$	421	$	1			0.2	%

Other Key International Data
Average number of active Decorating Consultants		26,477		29,193		2,716			10.3	%
Number of orders shipped		59,907		64,442		4,535			7.6	%
Number of orders per Decorating Consultant		2.26		2.21		(0.05	)		(2.2	)%
Average order size (actual dollars)	$	302	$	324	$	22			7.3	%

Net Sales

Net sales decreased $5.3 million, or 4.3%, to $118.4 million in the three months ended September 30, 2005 compared with $123.7 million in the three months ended September 30, 2004. The decrease in net sales was directly attributed to the 9.8% decrease in net sales to non-affiliates within the direct selling domestic segment of operations, partially offset by a 15.5% increase in the net sales to non-affiliates within the direct selling international segment of operations, and a 24.1% increase in the net sales to non-affiliates within the Domistyle segment of operations.

Net Sales — Direct Selling Domestic

Direct selling domestic net sales to non-affiliates decreased $9.7 million, or 9.8% to $89.3 million in the three months ended September 30, 2005 from $99.0 million in the same period of 2004. The primary drivers of the decrease were a 18.6% decline in number of orders per Decorating Consultant, offset by a 0.2% increase in the average order size per Decorating Consultant during the three month period ended September 30, 2005 when compared to the same period last year.

Even though the number of recruits and average number of active Decorating Consultants increased 62.9% and 10.5%, respectively, during the three months ended September 30, 2005 compared to the same period in 2004, the average productivity per Decorating Consultant declined. Management believes the decline in sales productivity of the Decorating Consultant base was due to a variety of factors, including macroeconomic conditions such as rising energy prices that had a compound negative impact of reducing the disposable income of the Decorating Consultants’ customer base and the Decorating Consultants’ and customers’ decreasing willingness to organize and attend parties, respectively. Additionally, the home furnishing sector has been down, as customers have directed disposable income elsewhere. Finally, new recruits are typically less productive than seasoned Decorating Consultants. In an effort to regain top line momentum, management is focusing on increasing the number and productivity of Decorating Consultants by continuing to promote the new career path and compensation program, focusing the Decorating Consultant base on sales productivity, mentoring new recruits to become productive, introducing new product lines and new selling and recruiting techniques, and providing motivational materials and events to the Decorating Consultants.

Net Sales — Direct Selling International

Direct selling international net sales to non-affiliates increased $2.8 million, or 15.5%, to $20.9 million in the three months ended September 30, 2005 from $18.1 million in the three months ended September 30, 2004. Decorating Consultant selling and recruiting productivity remained strong in the direct selling international segment. The number of orders shipped increased 7.6% and the average order size increased 7.3% in the third quarter of 2005 compared to the same period in 2004. In addition, the average number of active international Decorating Consultants was 10.3% higher than in the third quarter of 2004. As of September 30, 2005 the average number of active Decorating Consultants was 25,890, 1,441 and 1,862 for Mexico, Canada, and Puerto Rico, respectively.

Net sales in Mexico, Puerto Rico and Canada increased 10.0%, 77.7% and 16.0%, respectively. Management’s focus on providing brochures that appeal specifically to the Hispanic market, and the new Decorating Consultant career path and compensation program have led to growth in both selling and recruiting productivity in the Puerto Rico market.

Exchange rate fluctuations can also impact year-over-year comparisons. International direct sales are transacted in the local currency in Mexico and Canada. The following table compares net sales in the local currency in Mexico and Canada to the U.S. dollar equivalent net sales recorded at the year-to-date weighted-average exchange rate for the three months ended September 30, 2004 and 2005.


					Variance		Percentage
For the three months ended September 30,	2004		2005		Amount		Variance
Net Sales (in thousands)
Mexico direct net sales in Mexican pesos		171,572		177,945		6,373		3.7	%
Mexico direct net sales in U.S. dollars	$	15,043	$	16,544	$	1,501		10.0	%

Canada direct net sales in Canadian dollars		1,822		2,005		183		10.0	%
Canada direct net sales in U.S. dollars	$	1,686	$	1,955	$	269		16.0	%

Net Sales — Domistyle

Net sales to non-affiliates for the three-month period ended September 30, 2005 increased $1.6 million, or 24.1%, to $8.3 million in 2005 as compared to $6.7 million in the comparable period of 2004. This increase was a result of the Company’s continued effort to gain product entry into the supply chain market of non-affiliated national retailers. In order to increase the profitability of the Domistyle segment, the Company ceased the last of the Company’s manufacturing operations in Mexico during the first quarter 2005. Management believes that in order to have continued growth of this portion of the segment, Domistyle must maintain a competitive edge with regard to quality, price, and fulfillment needs of national retailers.

Cost of Goods Sold

Cost of goods sold was $61.5 million for the three months ended September 30, 2005 and $60.7 million for the same period in 2004, and as a percentage of net sales cost of goods sold increased 2.9% to 52.0% from 49.1%. The primary cause of the 2.9% increase was a $5.1 million increase in the inventory reserve provision during the three months ended September 30, 2005 as compared to the same period in 2004, related to reserve provisions for discontinued Product in the Direct Selling and Domistyle channels, and an increase in the costs of Products purchased from and manufactured by the Company’s manufacturing affiliates. The increase in Product cost was a direct result of rising oil prices that are raising the prices of petroleum based commodities, such as wax and styrene, both of which are raw materials used in the production of the Products that are manufactured by the Domistyle Channel and distributed to the Direct Selling Channel. The Company also experienced similar Product costs increases from the Company’s non-affiliated overseas and domestic suppliers.

Gross Profit

Gross profit decreased $6.1 million, or 9.6%, to $56.8 million in the three months ended September 30, 2005 from $62.9 million in the three months ended September 30, 2004. The primary reasons for the decrease in gross profit were the $5.3 million net sales decline primarily resulting from the 9.8% decline in the direct selling domestic

segment, the $5.1 million increase in the inventory reserve provision as discussed in the cost of goods sold section above, and a shift in buying behavior of Decorating Consultants towards the purchase of discontinued Products which comprised approximately 8.2% of net sales in the U.S, Canada, and Puerto Rico in the third quarter of 2005 as compared to approximately 6.5% in the third quarter of 2004. Product margins on discontinued Products improved approximately 21 percentage points in the third quarter of 2005 compared to the third quarter of 2004 as the Company changed its merchandising strategy for discontinued Product during the second quarter of 2005.

Operating Expenses

Selling Expense

Selling expense increased $0.5 million, or 2.4%, to $22.6 million in the three months ended September 30, 2005 from $22.1 million in the comparable period of 2004. As a percentage of net sales, selling expense increased to 19.1% for the three-month period ended September 30, 2005 from 17.9% in the comparable period of 2004. Selling expense was comprised primarily of Decorating Consultant royalties and bonuses, sales promotions and sales event expenses, personnel costs, and product licensing royalties. Decorating Consultant royalties and bonuses decreased $0.5 million, or 3.6% in 2005 as compared to 2004 due to the decline in net sales in the direct selling domestic segment. Sales promotions decreased $0.3 million and sales event expenses increased $0.7 million in the third quarter of 2005 as compared to 2004 due to the timing of sales promotions and incentive trips, and sales rallies held in the third quarter of 2005. Rallies were not held in 2004. Product licensing royalties increased $0.1 million and the Company incurred $0.2 million in non-recurring costs related to training the sales force leadership in new initiatives to be implemented in the fourth quarter of 2005. Personnel costs remained relatively flat in the comparable periods.

Freight, Warehouse and Distribution Expense

Freight, warehouse, and distribution expense decreased $1.6 million, or 9.3% to $16.0 million in the three months ended September 30, 2005 from $17.6 million in the three months ended September 30, 2004. As a percentage of net sales, freight, warehouse and distribution expense decreased 0.8%. Freight, warehouse and distribution expense was comprised primarily of personnel costs, facilities costs, and freight expense. Personnel and facilities costs decreased $0.4 million in the third quarter of 2005 as compared to 2004 as a result of lower sales volume and cost savings initiatives. Freight expense decreased $1.3 million, or 13.3% in the three months ended September 30, 2005 compared to the same period in 2004 due to the decline in net sales. As a percentage of net sales, freight expense decreased 0.8%. The decrease as a percentage of net sales is primarily driven by a decrease in the level of product discounting in the third quarter of 2005 versus the comparable period in 2004 and improved rates with third party logistics carriers in 2005.

General and Administrative Expense

General and administrative expense increased $1.2 million, or 8.6% to $15.0 million in the three months ended September 30, 2005 from $13.8 million in the three months ended September 30, 2004. General and administrative expense was comprised primarily of personnel costs, professional fees, corporate facilities costs, depreciation expense, contract services, insurance, other operating expenses, and corporate organizational realignment costs. Personnel costs remained relatively flat in third quarter 2005 versus third quarter 2004; however, third quarter 2004 included a $0.8 million reversal of year-to-date accrued bonus. Excluding the prior-year reversal, personnel costs for 2005 decreased $0.8 million due to cost savings initiatives implemented by the Company during the second quarter of 2005. Charitable contributions increased $0.4 million in the third quarter of 2005 versus the same period in 2004 due to the Company’s hurricane relief promotion. Non-recurring costs increased $1.1 million during the third quarter of 2005 primarily related to securing and complying with amendments and waivers to the Company’s senior credit facility. Excluding the impact of non-recurring costs and the prior year accrual reversal, general and administrative expense decreased $0.7 million in the third quarter of 2005 versus prior year.

the amendments to the Company’s senior credit facility. These costs were approximately $3.4 million and $1.2 million for the three months ended September 30, 2005 and 2004, respectively.

Other operating expenses

Other operating expenses, which include loss (gain) on disposition of assets and stock option expense, decreased $0.9 million, or 71.6%, to $0.4 million in the three months ended September 30, 2005 from $1.3 million in the three months ended September 30, 2004. The decrease was a result of a decrease in stock option expense of $1.1 million related to 2005 third quarter forfeitures by former employees, offset by an increase of $0.2 million in loss on disposition of assets related to the sale of certain assets of the Company’s shut down Mexico manufacturing facilities.

Other Income (Expense)

Other income (expense) increased $0.4 million, or 3.7%, to $11.3 million net other expense in the three months ended September 30, 2005 from $10.9 million net other expense in the three months ended September 30, 2004. Other income (expense) was comprised primarily of interest income, interest expense, unrealized gain or loss on derivatives, and exchange rate gain or loss. Interest income increased slightly in 2005 due to increased interest rates. Interest expense increased $2.9 million, or 31.8% to $12.1 million in the three months ended September 30, 2005 from $9.2 million in the three months ended September 30, 2004. The increase was a result of higher debt balances related to revolver borrowings of $25 million outstanding during the third quarter of 2005 and higher interest rates. In the third quarter of 2005, the Company recorded a $0.9 million unrealized gain on derivatives related to the interest rate swap agreements entered into in 2004 as required by the Company’s senior credit facility as compared to a $1.8 million unrealized loss in 2004. The Company recognized a $0.1 million transactional foreign exchange rate loss in the third quarter of 2005 compared to a $0.2 million transactional foreign exchange rate gain in the third quarter of 2004 due to favorable exchange rates in Mexico.

Income Tax Provision

The Company recognized a tax benefit of $8.6 million in the three months ended September 30, 2005 as compared to a tax benefit of $1.8 million in the comparable period of 2004. The benefit is primarily a result of a $3.1 million benefit associated with the pre-tax loss of $8.4 million for the three months ended September 30, 2005 which is eligible to be carried back to previous tax years to offset prior year taxable income and generate a cash tax refund and a favorable tax benefit recognized in the third quarter of 2005 associated with the release of the $12.7 million tax reserve, due to the passage of time, which the Company accrued in 2001 as a result of the purchase of Company debt by affiliates of Hicks Muse and the associated issuance of preferred stock by the Company. These benefits are partially offset by a valuation allowance of $7.5 million against the Company’s deferred tax assets in the United States. Income tax benefit as a percentage of income before income taxes was 101.9% for the three months ended September 30, 2005 as compared to income tax benefit as a percentage of income before income taxes of 65.3% for the three months ended September 30, 2004. See Note 8 to the consolidated financial statements for further discussion of income taxes.

Discontinued Operations

On April 28, 2004, the Company discontinued the ceramics products manufacturing operations in the Company’s Mexico manufacturing facility. The operations and cash flows of the ceramics manufacturing operations have been eliminated from the Company’s ongoing operations and have been classified as discontinued operations. Discontinued operations net loss was $0.2 million for the three months ended September 30, 2004. The shutdown was completed in 2004 and there were no discontinued operation losses recorded in 2005.

The nine months ended September 30, 2005 compared to the nine months ended September 30, 2004

The following table summarizes the Company’s operating results with corresponding percentages of net sales, variance amounts, and the change in percentage of net sales:


	Nine months ended September 30,															% of
	(Dollars in thousands)												Variance			Sales
	2004			%			2005			%			Amount			Change
Net sales	$	387,466			100.0	%	$	369,182			100.0	%	$	(18,284	)		0.0	%
Cost of goods sold		180,542			46.6			182,000			49.3			1,458			2.7

Gross profit		206,924			53.4			187,182			50.7			(19,742	)		(2.7	)
Operating expenses:
Selling		75,968			19.6			75,494			20.4			(474	)		0.8
Freight, warehouse and distribution		52,057			13.4			50,401			13.7			(1,656	)		0.3
General and administrative		49,483			12.8			48,944			13.3			(539	)		0.5
Other		5,811			1.5			2,358			0.7			(3,453	)		(0.8	)

Operating income		23,605			6.1			9,985			2.7			(13,620	)		(3.4	)
Other income (expense), net		(27,292	)		(7.0	)		(32,094	)		(8.7	)		(4,802	)		(1.7	)

Loss before income taxes		(3,687	)		(1.0	)		(22,109	)		(6.0	)		(18,422	)		(5.0	)
Income tax benefit		3,556			0.9			17,933			4.9			14,377			(4.0	)

Loss from continuing operations		(131	)		(0.0	)		(4,176	)		(1.1	)		(4,045	)		(1.1	)
Discontinued operations loss, net		3,898			1.0			—			0.0			(3,898	)		(1.0	)

Net loss	$	(4,029	)		(1.0	)%	$	(4,176	)		(1.1	)%	$	(147	)		(0.1	)%

The following table presents net sales to non-affiliates by segment along with other key Decorating Consultant data for the nine months ended September 30, 2005 compared to the same period in 2004. Intercompany sales to affiliates are eliminated in consolidation.


					Variance			Percentage
For the nine months ended September 30,	2004		2005		Amount			Variance
Net Sales (dollars in thousands)
Direct Selling Domestic net sales to non-affiliates	$	318,237	$	289,642	$	(28,595	)		(9.0	)%
Direct Selling International net sales to non-affiliates		48,446		54,926		6,480			13.4	%
Domistyle net sales to non-affiliates		20,783		24,614		3,831			18.4	%

Net sales	$	387,466	$	369,182	$	(18,284	)		(4.7	)%


Other Key Domestic Data
Average number of active Decorating Consultants		71,148		76,512		5,364			7.5	%
Number of orders shipped		702,315		685,958		(16,357	)		(2.3	)%
Number of orders per Decorating Consultant		9.87		8.97		(0.90	)		(9.1	)%
Average order size (actual dollars)	$	453	$	422	$	(31	)		(6.8	)%

Other Key International Data
Average number of active Decorating Consultants		25,609		28,287		2,678			10.5	%
Number of orders shipped		183,027		185,778		2,751			1.5	%
Number of orders per Decorating Consultant		7.15		6.57		(0.58	)		(8.1	)%
Average order size (actual dollars)	$	265	$	296	$	31			11.7	%

Net Sales

Net sales decreased $18.3 million, or 4.7%, to $369.2 million in the nine months ended September 30, 2005 compared with $387.5 million in the nine months ended September 30, 2004. The decrease in net sales was directly attributed to the 9.0% decrease in the net sales to non-affiliates within the direct selling domestic segment of operations, partially offset by a 13.4% increase in the net sales to non-affiliates within the direct selling international segment of operations, and a 18.4% increase in the net sales to non-affiliates within the Domistyle segment of operations.

Net Sales — Direct Selling Domestic

Direct selling domestic net sales to non-affiliates decreased $28.6 million, or 9.0% to $289.6 million in the nine months ended September 30, 2005 from $318.2 million in the same period of 2004. The primary drivers of the decrease were a 9.1% decline in number of orders per Decorating Consultant, and a 6.8% decline in the average order size per Decorating Consultant.

Even though the number of recruits and average number of active Decorating Consultants increased 66.7% and 7.5%, respectively, during the nine months ended September 30, 2005 as compared to the same period in 2004, the average productivity per Decorating Consultant declined. Management believes the decline in sales productivity of the Decorating Consultant base was primarily due to macroeconomic conditions such as rising energy prices that had a compound negative impact of reducing the disposable income of the Decorating Consultants’ customer base and the Decorating Consultants’ and customers’ decreasing willingness to organize and attend parties, respectively. Additionally, the home furnishing sector has been down, as customers have directed disposable income elsewhere. Finally, new recruits are typically less productive than seasoned Decorating Consultants. In an effort to regain top line momentum, management is focusing on increasing the number and productivity of Decorating Consultants by continuing to promote the new career path and compensation program, focusing the Decorating Consultant base on sales productivity, mentoring new recruits to become productive, introducing new product lines and new selling and recruiting techniques, and providing motivational materials and events to the Decorating Consultants.

Net Sales — Direct Selling International

Direct selling international net sales to non-affiliates increased $6.5 million, or 13.4%, to $54.9 million in the nine months ended September 30, 2005 from $48.4 million in the nine months ended September 30, 2004. Decorating Consultant selling and recruiting productivity remained strong in the direct selling international segment. The number of orders shipped increased 1.5% and the average order size increased 11.7% in 2005 compared to the same period in 2004. The average number of active international Decorating Consultants was 10.5% higher than in 2004. As of September 30, 2005 the average number of active Decorating Consultants was 25,266, 1,436, and 1,585 for Mexico, Canada, and Puerto Rico, respectively.

Net sales in Mexico and Puerto Rico increased 10.5% and 60.5%, respectively, but were offset by a decrease of 3.0% in net sales in Canada. Management’s focus on providing brochures that appeal specifically to the Hispanic market, and the new Decorating Consultant career path and compensation program, have led to growth in both selling and recruiting productivity in the Puerto Rico market.

Exchange rate fluctuations can also impact year-over-year comparisons. International direct sales are transacted in the local currency in Mexico and Canada. The following table compares net sales in the local currency in Mexico and Canada to the U.S. dollar-equivalent net sales recorded at the year-to-date weighted-average exchange rate for the nine months ended September 30, 2004 and 2005.


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

Net Sales — Domistyle

Net sales to non-affiliates for the nine-month period ended September 30, 2005 increased $3.8 million, or 18.4%, to $24.6 million in 2005 as compared to $20.8 million in the comparable period of 2004. Included in the 2004 net sales to non-affiliates was $0.8 million in net sales from the Company’s manufacturing operations in Mexico. There were no comparable sales in 2005. In a continued effort to increase the profitability of the Domistyle segment, the Company completed the shutdown of the Company’s manufacturing operations in Mexico during the first quarter 2005. Excluding prior year Mexico net sales, net sales for the remaining operations increased $4.6 million, or 23.3% for the comparable periods. This increase was a result of the Company’s continued effort to gain product entry into the supply chain market of non-affiliated national retailers. Management believes that in order to have continued growth of this portion of the segment, Domistyle must maintain a competitive edge with regard to quality, price, and fulfillment needs of national retailers.

Cost of Goods Sold

Cost of goods sold increased $1.5 million or 0.8% to $182.0 million for the nine months ended September 30, 2005 from $180.5 million for the nine months ended September 30, 2004, but as a percentage of net sales cost of goods sold increased 2.7% to 49.3% from 46.6%. The primary cause of the 2.7% increase was an increase in the cost of Products purchased from and manufactured by the Company’s manufacturing affiliates and a $5.5 million increase in the inventory reserve provision in 2005 as compared to 2004. The increase in Product cost was a direct result of rising oil prices that are raising the prices of petroleum based commodities, such as wax and styrene, both of which are raw materials used in the production of the Products that are manufactured by the Domistyle Channel and distributed to the Direct Selling Channel. The Company also experienced similar Product costs increases from the Company’s non-affiliated overseas and domestic suppliers. The increase in the inventory reserve provision is related to discontinued Product in the Direct Selling Channel due to new Product introductions, and significant obsolete inventory at the Company’s candle manufacturing facility, which is part of the Domistyle channel, due to discontinued Product in both the outside sales and Company Product lines.

Gross Profit

Gross profit decreased $19.7 million, or 9.5%, to $187.2 million in the nine months ended September 30, 2005 from $206.9 million in the nine months ended September 30, 2004. The primary reasons for the decrease in gross profit were the $18.3 million net sales decline primarily resulting from the 9.0% decline in the direct selling domestic segment, the $5.5 million increase in the inventory reserve provision as discussed in the cost of goods sold section above, and a shift in buying behavior of Decorating Consultants towards the purchase of discontinued Products. The purchase of discontinued Products made up 9.9% of net sales in the U.S, Canada, and Puerto Rico in 2005 as compared to 6.7% of sales in 2004. Product margins on discontinued Products improved approximately 3 percentage points in the nine months ended September 30, 2005 when compared to the same period in 2004 as the Company changed its merchandising strategy for discontinued Product during the second quarter of 2005.

Operating Expenses

Selling Expense

Selling expense decreased $0.5 million, or 0.6%, to $75.5 million in the nine months ended September 30, 2005 from $76.0 million in the comparable period of 2004. As a percentage of net sales, selling expense increased to 20.4% for the nine-month period ended September 30, 2005 from 19.6% in the comparable period of 2004. Selling expense was comprised primarily of Decorating Consultant royalties and bonuses, sales promotions and sales event expenses, personnel costs, and product licensing royalties. Decorating Consultant royalties and bonuses decreased $0.8 million, or 1.8% in 2005 as compared to 2004 due to the decline in net sales in the direct selling domestic segment. As a percentage of net sales, Decorating Consultant royalties and bonuses increased 0.4% due to the new Decorating Consultant career path and compensation program. Sales promotions decreased $3.2 million in 2005 as compared to 2004 due to the timing of sales promotions and the number of incentive trips. Sales event expenses increased $2.5 million in 2005 due to a change in the methodology for accounting for the Company’s annual

Seminar, which was accounted for as a period cost in the second quarter 2005. Personnel costs increased $0.2 million in the comparable periods. Product licensing royalties increased $0.5 million in 2005 as compared to 2004 due to a new product licensing agreement with regard to candle technology, and amendments to existing product licensing agreements.

Freight, Warehouse and Distribution Expense

Freight, warehouse, and distribution expense decreased $1.7 million to $50.4 million for the nine months ended September 30, 2005 from $52.1 million when compared to the same period in 2004. As a percentage of net sales, freight, warehouse and distribution expense decreased 0.3%. Freight, warehouse and distribution expense was comprised primarily of personnel costs, facilities costs, and freight expense. Personnel and facilities costs decreased $0.3 million for the nine-month period ended in 2005 as compared to 2004 primarily due to a decrease in packaging supplies due to lower sales volume. Freight expense declined $1.4 million in 2005 as compared to 2004 primarily due to the decline in net sales and decrease in average order size. Freight expense as a percentage of sales remained flat in the comparable periods.

General and Administrative Expense

General and administrative expense decreased $0.5 million, or 1.1%, to $48.9 million for the nine months ended September 30, 2005 from $49.4 million for the nine months ended September 30, 2004. General and administrative expense was comprised primarily of personnel costs, professional fees, corporate facilities costs, depreciation expense, contract services, insurance, and other operating expenses, and corporate organizational realignment costs. Personnel costs decreased $2.1 million in 2005 as compared to 2004 primarily due to severance costs related to both the shut down and consolidation of the Company’s glass and metals Mexico manufacturing operations that occurred in the second quarter of 2004, and to cost savings initiatives implemented by the Company in the second quarter of 2005. This was partially offset by increased expenses related to new strategic initiatives implemented by the Company in 2005, an increase in charitable contributions due to the Company’s hurricane relief promotion, an increase in depreciation expense, and an increase in facilities costs as compared to 2004.

Included in cost of goods sold and selling, general and administrative expenses are certain non-recurring costs related to corporate organizational realignment expenses, shut down costs related to the Company’s Mexico manufacturing facilities, product recall costs, strategic planning consulting expenses, and consulting fees related to the amendments to the Company’s senior credit facility. These costs were approximately $7.3 million and $10.2 million for the nine months ended September 30, 2005 and 2004 respectively.

Other operating expenses

Other operating expenses, which include loss (gain) on disposition of assets, stock option expense, and loss on debt refinancing decreased $3.4 million, or 59.4%, to $2.4 million in the nine months ended September 30, 2005 from $5.8 million in the nine months ended September 30, 2004. The decrease in other operating expenses of $3.4 million was due to the impairment of fixed assets and loss on asset sales of $1.6 million incurred in the first nine months of 2004 related to the shut down and consolidation of the Company’s glass and metals manufacturing operations in Mexico, and the loss on debt restructuring of $1.1 million incurred in the first quarter of 2004 related to the refinancing of the Company’s senior credit facility. Stock option expense decreased $1.1 million in 2005 to $2.1 million from $3.2 million in 2004; this is primarily due to the stock options that were forfeited by former employees during the third quarter 2005.

Other Income (Expense)

Other income (expense) increased $4.8 million, or 17.6%, to $32.1 million net other expense in the nine months ended September 30, 2005 from $27.3 million net other expense in the nine months ended September 30, 2004. Other income (expense) was comprised primarily of interest income, interest expense, unrealized gain (loss) on derivatives, and exchange rate gain or loss. Interest income increased slightly in 2005 due to increased interest rates. Interest expense increased $9.5 million, or 37.4%, to $34.9 million in the nine months ended September 30, 2005 from $25.4 million in the nine months ended September 30, 2004. The increase was a result of higher debt balances related to revolver borrowings during the first nine months of 2005 and higher interest rates. In 2005, the Company

recorded a $1.2 million unrealized gain on derivatives related to the interest rate swap agreements entered into in 2004 as required by the Company’s senior credit facility as compared to a $1.7 million unrealized loss in 2004. The Company recognized a $0.8 million foreign transaction exchange rate gain in the 2005 compared to a $0.4 million foreign transaction exchange rate loss in the comparable period of 2004 due to favorable exchange rates in Mexico.

Income Tax Provision

The Company recognized a tax benefit of $17.9 million in the nine months ended September 30, 2005 as compared to a tax benefit of $3.6 million in the comparable period of 2004. This benefit is primarily a result of an $8.2 million benefit associated with the pre-tax loss of $22.1 million for the nine months ended September 30, 2005 and a $4.6 million benefit associated with the closing of manufacturing operations in Mexico which are eligible to be carried back to previous tax years to offset prior year taxable income and generate a cash tax refund, and a $12.7 million benefit related to the release of a reserve, due to the passage of time, which the Company accrued in 2001 as a result of the purchase of Company debt by affiliates of Hicks Muse and the associated issuance of preferred stock by the Company. These benefits are partially offset by a valuation allowance of $7.5 million against the Company’s deferred tax assets in the United States Income tax benefit as a percentage of income before income taxes was 81.1% for the nine months ended September 30, 2005 as compared to income tax benefit as a percentage of income before income taxes of 96.4% for the nine months ended September 30, 2004. See Note 8 to the consolidated financial statements for further discussion of income taxes.

Discontinued Operations

On April 28, 2004, the Company discontinued the ceramics products manufacturing operations in the Company’s Mexico manufacturing facility. The operations and cash flows of the ceramics manufacturing operations have been eliminated from the Company’s ongoing operations and have been classified as discontinued operations. Discontinued operations loss was $3.9 million for the nine months ended September 30, 2004. The shutdown was completed in 2004 and there were no discontinued operations losses recorded in 2005.

Seasonality

The Company’s business is influenced by the Christmas holiday season and by promotional events. Historically, the highest portions of the Company’s net sales and operating income have been realized during the fourth quarter. Working capital requirements also fluctuate during the year. Working capital requirements are at the highest levels during the third and fourth quarters as the Company’s obligations for increases in inventory for the peak season become due. In addition to the Company’s peak season fluctuations, quarterly results of operations may fluctuate depending on the timing of, and amount of sales from, discounts, incentive promotions and/or the introduction of new Products. As a result, the Company’s business activities and results of operations in any quarter are not necessarily indicative of any future trends in the Company’s business.

Liquidity and Capital Resources

Until 2005, the Company historically funded its operations, capital expenditures, and working capital requirements with cash flows from operating activities. During 2005, the Company funded its operations and capital expenditures primarily through revolving loans under the Company’s senior credit facility.

The operating environment confronting the Company raises uncertainty about the Company’s ability to meet its debt obligations. As discussed below management is currently discussing refinancing alternatives. Management believes, if successful, such refinancing would improve the Company’s cash flows and allow it to meet its debt obligations in the normal course of business. If unsuccessful, the Company’s ability to continue as a going concern will be uncertain. The principal conditions giving rise to this uncertainty are as follows:

•

The Company has incurred losses from continuing operations before taxes and negative operating cash flows in five of the last six quarterly periods. This performance is the result of lower operating income from a decline in revenue and significant interest expense on indebtedness.

	•		As a result of classifying $327.5 million of debt from our senior credit facility as a current obligation, the Company had a working capital deficit of $254.5 million as of September 30, 2005.

	•		The Company was required to obtain waivers of compliance with financial covenants under the senior credit facility as of June 30, 2005 and September 30, 2005.

	•		The Company has significant cash debt service requirements related to its senior credit facility and senior subordinated notes. In the event the Company is unable to obtain further waivers or otherwise agree with its lenders on the terms of a restructuring of such senior credit facility, the lenders under the senior credit facility could elect to accelerate all amounts outstanding under the senior credit facility.

During 2005, the Company began to implement initiatives to improve productivity, improve efficiency, and reduce costs. The Company also made changes to its organizational structure to focus on key components of the business, improve financial reporting and controls at certain operations, and develop a more effective sales and marketing strategy.

Achievement of projected cash flows from operations will be dependent upon the Company’s attainment of forecasted revenues, improved operating costs and trade support levels which are consistent with its financial plans. Such operating performance will be subject to financial, economic and other factors affecting the industry and operations of the Company, including factors beyond the Company’s control, and there can be no assurance the Company’s plans will be achieved. In addition, as discussed below, the Company is in discussions with its lenders to obtain amendments to its senior credit facility that would modify or waive financial covenants and restructure existing obligations. In the event the Company is unable to obtain such modifications or waivers, or is unable to agree on the terms to restructure its obligations under the senior credit facility, the lenders under the senior credit facility could elect to accelerate all amounts under the facility, which would also constitute an event of default under the indenture governing the Company’s senior subordinated notes due 2008. In the event such debt is accelerated, the Company would be unable to pay such accelerated principal and interest obligations, including the notes, absent additional sources of equity or debt financing, which the Company may not be able to obtain on acceptable terms to it, or at all.

As of September 30, 2005, the Company held $27.3 million in cash. The Company principally uses cash from operations to fund operating expenses, such as Decorating Consultant royalties, product licensing royalties, inventory purchases, and warehouse, freight and distribution costs.

For the nine months ended September 30, 2005, the Company’s cash decreased $0.5 million to $27.3 million from $27.8 million as of December 31, 2004. The decrease resulted from $5.8 million of net cash used by operating activities and $7.3 million of net cash used by investing activities, offset by net cash provided by financing activities of $12.5 million.

Net cash of $5.8 million used by operating activities consisted of $24.9 million provided by net income, as adjusted for non-cash items, and $30.7 million used by working capital. The net decrease in cash was primarily due to lower than anticipated sales volume. The Company expects to continue to fund operations and working capital requirements through cash flows from operating activities and, to the extent they remain available, revolving loans under the Company’s senior credit facility.

Net cash of $7.3 million used by investing activities during the nine months ended September 30, 2005, consisted of capital expenditures for property, plant, and equipment related to upgrades for information technology and equipment to improve efficiencies in order fulfillment and manufacturing operations.

In March 2004, the Company secured a senior credit facility, which provided a seven-year term loan facility of up to $320.0 million (the “Term Loans”), and a $50.0 million five-year revolving credit facility (the “Revolving Loans”), of which $20.0 million may be used for letters of credit. As of September 30, 2005, there were $302.5

million of Term Loans outstanding along with $2.6 million in letters of credit and $25.0 million in outstanding Revolving Loans. The term loan facility matures on March 31, 2011 and the revolving loan facility matures on March 31, 2009 provided that, in the event that the senior subordinated notes are not refinanced in whole on or prior to December 1, 2007 through the issuance of refinancing securities with a maturity no less than six months after March 31, 2011, incremental term loans, or an initial public offering, then all Term Loans outstanding will be due and payable, and the revolving credit facility will terminate on that date. The senior credit facility may be used for general corporate purposes and seasonal working capital needs. The senior credit facility, among other provisions, includes significant operating and financial restrictions, such as limits on the Company’s ability to incur indebtedness, create liens, sell assets, engage in mergers, acquisitions or consolidations, make investments and pay dividends. In addition, under the senior credit facility, the Company is required to comply with specified financial ratios and tests, including an interest coverage ratio, maximum leverage ratio, and maximum capital expenditures as defined per the senior credit facility agreement.

The Term Loans under the senior credit facility bear interest, at the Company’s election, at either LIBOR plus an applicable margin or the Alternate Base Rate plus an applicable margin. The Alternate Base Rate is the higher of the prime rate of JPMorgan Chase Bank, the Base CD rate in effect plus 1%, or the federal funds effective rate plus 0.5%. The interest rates on Term Loan borrowings outstanding under the senior credit facility were based on LIBOR as of September 30, 2005. As of September 30, 2005, Term Loan borrowings outstanding totaled $302.5 million with an interest rate of 8.85%. For the Revolving Loans, the applicable LIBOR margin and Alternate Base Rate margin are subject to adjustments, upwards or downwards after December 31, 2004, based upon the leverage ratio as defined by the senior credit agreement. As of September 30, 2005, Revolving Loan borrowings outstanding totaled $25.0 million at a LIBOR rate of 7.85%.

In June 1998, the Company issued $200.0 million aggregate principal amount of 10 1/8% senior subordinated notes. As of September 30, 2005, the Company had a total of $149.1 million in principal outstanding. Such senior subordinated notes contain, among other provisions, restrictions on, among other things, the ability of the Company to incur debt, make restricted payments, create liens, sell assets, engage in mergers, acquisitions or consolidations, and enter into transactions with affiliates. At September 30, 2005, the Company was in compliance with such provisions. Interest payments commenced in December 1998 and continue semi-annually until the senior subordinated notes mature in 2008.

Payments on the senior subordinated notes and the senior credit facility represent significant cash requirements for the Company. The Company has the option to redeem the senior subordinated notes in whole or in part at any time. The Term Loans under the amended senior credit facility require quarterly principal payments and monthly interest payments. During the nine months ended September 30, 2005, the Company paid a total of $37.3 million in debt service, consisting of principal payments under the senior credit facility of approximately $10.0 million, interest and commitment fees under the senior credit facility of approximately $19.1 million, interest on the senior subordinated notes of $7.5 million, and $0.7 million in interest on the Revolving Loans.

On September 28, 2005, the Company entered into an amendment and waiver (the “Third Amendment”), to the Company’s senior credit facility. The Third Amendment waives compliance by the Company with the consolidated leverage ratio and consolidated interest coverage ratio from June 30, 2005 to (but not including) November 28, 2005. The Third Amendment also, among other things, (i) limits the availability of revolving extensions of credit under the senior credit facility to $35 million at any time outstanding, (ii) imposes an additional condition precedent to each extension of credit under the revolving portion of the senior credit facility pertaining to the amount of available cash on hand and the use of the proceeds of such extension of credit, (iii) requires the Company to prepay the revolving loans under certain circumstances with proceeds of cash on hand, (iv) restricts the ability of the Company to incur certain types of debt and create certain types of liens in excess of a specified dollar amount, (v) restricts certain transactions among the Company and the subsidiaries of the Company which are guarantors, on the one hand, and the Company’s non-guarantor subsidiaries, on the other hand, and (vi) suspends payment of fees in cash under the Company’s financial advisory and monitoring and oversight agreements with Hicks Muse during the waiver period discussed above and under periods of default under the senior credit facility.

ending, September 30, 2005. The Company also incurred debt issuance costs of $0.4 million that have been deferred.

Upon the occurrence of an event of default under the senior credit facility, the lenders could elect to block principal and interest payment under the Company’s senior subordinated notes for up to 179 days and/or declare all amounts outstanding under the senior credit facility to be immediately due and payable and terminate all commitments to extend further credit under the Revolving Loans. Acceleration of the amounts outstanding under the senior credit facility would result in an event of default under the indenture governing the Company’s senior subordinated notes, which could result in the principal amount outstanding under the senior subordinated notes becoming due and payable immediately. In that event, the Company would not have sufficient liquidity to make the payments required under the senior credit facility and the senior subordinated notes and for working capital purposes.

The Company is in discussions with its lenders to obtain amendments to the senior credit facility that would modify or waive the financial covenants that could be at issue on November 28, 2005 or otherwise restructure such obligations. However, there can be no assurance that the Company’s lenders will agree to any modifications or waivers under the senior credit facility or that the Company and its lenders will agree on the terms of a restructuring of such senior credit facility. As a result, the Term Loans outstanding of $302.5 million and the $25.0 million in Revolving Loans outstanding have been classified as a current liability on the September 30, 2005 consolidated balance sheet.

Off-Balance Sheet Arrangements

At September 30, 2005, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, the Company is not materially exposed to any financing, liquidity, market, or credit risk that could arise if the Company had engaged in such relationships.

Market Sensitive Instruments and Risk Management

The Company’s Products are sold in Mexico and Canada thereby subjecting the Company to financial market risk due to fluctuating foreign currency exchange rates. Historically, due to a stable foreign exchange rate and due to the fact that these operations have not been significant, the risk has been minor. However, as the Company’s international operations become significant to the Company as a whole, changes in foreign currency exchange rates could have a material effect on the Company in the future. The Company has not entered into any hedging instruments related to foreign currency risk. The following table represents, by country, the low and high currency exchange rates to the United States dollar, for the three months ended September 30, 2005:


Country	Currency	Low		High
Canada	Dollar	$	0.8008	$	0.8601
Mexico	Peso	$	0.0912	$	0.0949

As a result of the interest pricing mechanism associated with the senior credit facility, the Company is exposed to financial market risk due to fluctuating interest rates. The Company monitors this risk and makes decisions to participate in interest hedging devices based on interest rate expectations, the Company’s desire to maintain total yield within predetermined levels and the ratio of fixed to variable debt. During the second quarter of 2004, the Company finalized a series of interest rate swap agreements with a trade date of May 5, 2004 and a start date of September 30, 2004, to limit the effect of changes in interest rates on a portion of its long-term borrowings. Under the trade agreement the Company pays on a quarterly basis a fixed interest rate per quarter ranging from 1.91% to 5.18%. The agreement has a $100.0 million notional amount of indebtedness. The Company receives a variable rate

of interest under the swaps based on the three-month LIBOR, excluding the margin paid under the credit facility on a quarterly basis. The Company recognized an unrealized gain of approximately $1.2 million in the consolidated statement of operations and comprehensive income for the nine months ended September 30, 2005, related to the interest rate swap agreement. The last interest rate swap in the series of interest rate swap agreements 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, nor the impact of the current liability classification on the September 30, 2005 consolidates balance sheet for the outstanding Term Loans and Revolving Loans. The interest rates are estimated based on actual and implied forward rates using a yield as of September 30, 2005. The Notes are at a fixed rate of 10.125% and will mature in 2008.


	Expected Maturity Date
	2005			2006			2007			2008			Total		Fair Value
	(in thousands)
Term Loan LIBOR Variable Rate Debt	$	3,750		$	15,000		$	283,750			—		$	302,500	$	276,788
Average Interest Rate		9.25	%		9.70	%		9.78	%		—			—		—
Revolving Loan LIBOR Variable Rate Debt	$	—		$	—		$	25,000			—		$	25,000	$	22,875
Average Interest Rate		8.25	%		8.70	%		8.78	%		—			—		—
Fixed-Rate Debt		—			—			—		$	149,100		$	149,100	$	102,879
Interest 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 nine months ended September 30, 2005.

Recently Issued Statements and Adoption of Financial Accounting Standards

of similar productive assets that do no have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for nonmonetary assets exchanges occurring in fiscal periods beginning after June 15, 2005. The Company adopted SFAS No. 153 and there was not a financial accounting impact associated with its adoption.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Securities and Exchange Commission requires that registrants include information about potential effects of changes in interest rates and currency exchange on their financial statements. Refer to the information appearing under the subheading “Market-Sensitive Instruments and Risk Management” under “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation,” which information is hereby incorporated by reference into this Item 3. All statements other than historical information incorporated into this Item 3 are forward-looking statements. The actual impact of future market changes could differ materially due to, among other things, the factors discussed in this report.

ITEM 4. CONTROLS AND PROCEDURES

Based on their evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), the Company’s principal executive and principal financial officers concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2005.

There has been no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company’s fiscal quarter ended September 30, 2005 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 6. EXHIBITS


EXHIBIT
NUMBER		DESCRIPTION
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.

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/ GEORGE FINFROCK

				George Finfrock
				Vice President, Controller
				(principal accounting officer)

Date: November 14, 2005

EXHIBIT INDEX


EXHIBIT
NUMBER		DESCRIPTION
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.

Positive
Negative
Uncertain
Constraining
Legalese
Litigious
Readability	H.S. sophomore Avg

Home Interiors & Gifts Inactive 10-Q2005 Q3 Quarterly report

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