HOME INTERIORS & GIFTS INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

COMMISSION FILE NUMBER 333-62021

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HOME INTERIORS & GIFTS, INC.
(Exact name of registrant as specified in its charter)

TEXAS 75-0981828
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

1649 FRANKFORD ROAD, W CARROLLTON, TEXAS 75007-4605
(Address of principal executive offices) (Zip Code)

(972) 386-1000
Registrant's Telephone Number, Including Area Code

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

As of August 13, 2002, 15,240,218 shares of the Company's common stock, par
value $0.10 per share, were outstanding.

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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

INDEX

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ITEM 1. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS.

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2001 AND JUNE 30, 2002
(IN THOUSANDS, EXCEPT SHARE INFORMATION)

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

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HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2001 AND 2002
(IN THOUSANDS)
(UNAUDITED)

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

4

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2001 AND 2002
(IN THOUSANDS)
(UNAUDITED)

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

5

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND BACKGROUND

Home Interiors & Gifts, Inc, ("HI"), is a fully integrated manufacturer and
distributor of home decorative accessories. HI, together with its subsidiaries
(the "Company"), primarily uses the "party plan" method of distribution, whereby
its non-employee, independent sales representatives ("Displayers") conduct shows
in the homes of potential customers. The Company believes that in-home shows
provide a comfortable environment where the unique benefits and attributes of
the Company's products can be demonstrated in a more effective manner than in
the typical retail setting.

The Company has been located in Dallas, Texas since its inception in 1957.
Currently, a majority of the Company's outstanding capital stock is owned by
affiliates of Hicks, Muse, Tate & Furst Incorporated, a Dallas based private
investment firm ("Hicks Muse"). Approximately 49.7% of the dollar volume of
products purchased by the Company in the first six months of 2002 were purchased
from, and manufactured by, the Company's subsidiaries. The Company's
subsidiaries sell substantially all of their products to the Company.

The following is a brief description of the Company's operating
subsidiaries, each of which is wholly owned:

- Dallas Woodcraft Company, LP (formerly Dallas Woodcraft, Inc.) ("DWC")
manufactures framed artwork and mirrors using custom-designed equipment.

- GIA, Inc. ("GIA") manufactures various types of molded plastic products
using custom-designed equipment. In April 2000, the Company consolidated
its Homco, Inc. ("Homco") operations into its GIA facilities in Grand
Island, Nebraska and sold the Homco facility in McKinney, Texas. Prior
to April 2000, Homco manufactured molded plastic products similar to
those manufactured by GIA.

- Laredo Candle Company, L.P. ("Laredo Candle") manufactures candles using
custom-designed equipment. Spring Valley Scents, Inc. ("SVS") is the
general partner of Laredo Candle.

- Subsidiaries of the Company in Mexico and Puerto Rico provide sales
support services to international Displayers.

- Business operations were initiated in Canada during September 2001 and
consisted primarily of start-up activities. The Company has not yet
formed a separate legal entity to conduct its Canadian operations.

2. SIGNIFICANT ACCOUNTING POLICIES

These consolidated financial statements include the accounts of the Company.
All significant intercompany accounts and transactions have been eliminated. The
Company records sales and related expenses on a weekly basis ending on each
Saturday. Each quarter consists of thirteen weeks. The last days of the quarters
ended June 30, 2001 and 2002 in the accompanying unaudited consolidated
financial information were June 30, 2001 and June 29, 2002, respectively.

The consolidated financial information as of June 30, 2002 and for the three
months and six months ended June 30, 2001 and 2002 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 June 30, 2002, its operating results and comprehensive
income for the three months and six months ended June 30, 2001 and 2002, and its
cash flows for the six months ended June 30, 2001 and 2002. 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.

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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/A for the year
ended December 31, 2001 as filed with the SEC.

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

3. INVENTORIES

Inventories, net consisted of the following as of December 31, 2001 and June
30, 2002 (in thousands):

4. OTHER CURRENT LIABILITIES

Other current liabilities consisted of the following as of December 31, 2001
and June 30, 2002 (in thousands):

5. RECENTLY ISSUED AND ADOPTED STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS

In July of 2002 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146 requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS No. 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. The Company will adopt SFAS No. 146 with
fiscal year beginning January 1, 2003 and does not anticipate any financial
accounting impact associated with its adoption.

In April of 2002 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4,
44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections" ("SFAS
No. 145"). SFAS No. 145 rescinds FASB Statement No. 4, "Reporting Gains and
Losses from the Extinguishment of Debt," and an amendment of that Statement,
FASB Statement No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements." SFAS No. 145 also rescinds FASB No. 44 "Accounting for Leases,"
to eliminate an inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications that
are similar to sale-leaseback transactions. SFAS No. 145 also amends other
existing authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under changed conditions. The
provision of SFAS No. 145 related to the rescission of Statement No. 4 is
effective in fiscal years beginning after May 15, 2002. The Company will adopt
this provision of SFAS No. 145 with fiscal year beginning on January 1, 2003 and
does not anticipate any material financial accounting impact associated with its

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adoption. All other provisions of SFAS No. 145 are effective for transactions
occurring and financial statements issued after May 15, 2002. The Company
adopted these provisions effective May 15, 2002, and there was not a financial
accounting impact associated with their adoption.

SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142") was
issued on July 20, 2001. SFAS No. 142 addresses financial accounting and
reporting for acquired goodwill and other intangible assets. The statement
eliminates amortization of goodwill and intangible assets with indefinite lives
and requires a transitional impairment test of these assets within six months of
the date of adoption and an annual impairment test thereafter in certain
circumstances. The Company adopted the provisions of this statement on January
1, 2002, and there was no material financial accounting impact associated with
its adoption.

SFAS No. 144, "Accounting for Impairment of Disposal of Long-Lived Assets,"
("SFAS No. 144") was issued in October 2001. SFAS No. 144 provides new guidance
on the recognition of impairment losses on long-lived assets to be held and used
or to be disposed of and also broadens the definition of what constitutes a
discontinued operation and how the results of a discontinued operation are to be
measured and presented. The Company adopted the provisions of this statement on
January 1, 2002, and there was no financial accounting impact associated with
its adoption.

In September 2001, the EITF issued EITF 01-09, "Accounting for Consideration
Given by a Vendor to a Customer or Reseller of the Vendor's Products," which
applies to the income statement characterization of stock option awards,
royalties, and other cash consideration the Company pays its District Directors,
Branch Directors, Group Directors, Unit Directors, and Trainers. The Company
adopted the provisions on January 1, 2002, and there was no financial accounting
impact associated with its adoption.

6. SEGMENT REPORTING

The Company's reportable segments are based upon functional lines of
business as follows:

- Home Interiors "HI" -- direct seller of home decorative accessories in
the United States;

- Manufacturing -- manufactures framed artwork and mirrors, as well as
various types of molded plastic products and candles; and

- International -- direct seller of home decorative accessories in Mexico,
Puerto Rico, and Canada.

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, reorganization costs, redundant warehouse
and distribution expenses, non-cash (expense) credit for stock options, gains
(losses) on disposition of assets, Senior Credit Facility restructuring and
amendment fees, and other income (expense) ("EBITDA"). 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 Manufacturing and HI, as well as
the elimination of the investment in each subsidiary for consolidated purposes.
The table below presents information about reportable segments used by the
Company's executive management team as of and for the three months and six
months ended June 30, 2001 and 2002 (in thousands):

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The following table represents a reconciliation of consolidated EBITDA to
income before income taxes for the three months and six months ended June 30,
2001 and 2002 (in thousands):

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7. GUARANTOR FINANCIAL DATA

DWC, GIA, Homco, SVS, Laredo Candle and Homco Puerto Rico (collectively, the
"Guarantors") unconditionally, on a joint and several basis, guarantee the
Company's credit agreement with its principal lenders (the "Senior Credit
Facility"), and the Company's 10-1/8% Senior Subordinated Notes due 2008 in the
amount of $149.1 million (the "Notes"). The Company's other subsidiaries, Home
Interiors de Mexico and Home Interiors de Mexico Services (the "Non-Guarantors")
have not guaranteed the Senior Credit Facility nor 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 STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2001

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CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002

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CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 2001

12

CONDENSED CONSOLIDATING BALANCE SHEET
AS OF JUNE 30, 2002

13

CONDENSED CONSOLIDATING CASH FLOW INFORMATION

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8. SUBSEQUENT EVENTS

Effective July 29, 2002, the Company completed a refinancing that provided
among other things: (i) a conversion of approximately $31.0 million of a $50.0
million term loan (the "Tranche A Loan") to a $106.4 million term loan (the
"Tranche B Loan"); (ii) an advance of an additional $35.0 million of Tranche B
Loan; (iii) increased interest rates for consenting lenders 150 basis points
over the interest rates currently paid to the non-consenting lenders; (iv)
modified quarterly principal payments; and (v) modification to the Company's
required compliance thresholds for each of the minimum EBITDA covenant, maximum
leverage ratio covenant (including senior leverage) and minimum fixed charge
ratio covenant. The maturity dates of the loans were not extended. Approximately
$4.0 million of bank and legal fees were paid at closing as a result of the debt
restructuring.

The following table sets forth Senior Credit Facility debt of the Company on
an actual basis and as adjusted after giving the effect to the conversion of
debt and additional advance as if such transaction occurred on June 30, 2002.

"As Adjusted" includes the impact of $2.5 million of Tranche A Loan principal
payment and $250,000 of Tranche B Loan principal payment made on July 1, 2002.

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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 consolidated financial statements and accompanying notes as of and for
the year ended December 31, 2001, included in its Form 10-K and Form 10-K/A.
Unless otherwise mentioned, all references to the number of Displayers, number
of orders shipped and average order size relate to domestic sales activity only.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Some of the statements under "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere in this report
constitute forward-looking statements. These statements involve known and
unknown risks, uncertainties and other factors that may cause the Company's
actual results to be materially different from any future results expressed or
implied by such forward-looking statements.

In some cases, forward-looking statements are identified by terminology such
as "may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of such terms
or other comparable terminology.

All of these forward-looking statements are based on estimates and
assumptions made by management of the Company which, although believed to be
reasonable, are inherently uncertain. Therefore, undue reliance should not be
placed upon such statements. No assurance can be given that any of such
estimates or statements will be realized and actual results may differ
materially from those contemplated by such forward-looking statements. Factors
that may cause such differences include: (i) Displayer recruiting and activity
levels; (ii) loss or retirement of key members of management; (iii) imposition
of federal or state taxes; (iv) change in status of independent contractors; (v)
increased competition; (vi) the success of new products and promotion programs;
(vii) unexpected problems associated with the new enterprise resource planning
system ("ERP") and (viii) general economic conditions. Many of these factors
will be beyond the control of the Company.

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

COMPANY BACKGROUND

The Company believes it is the largest direct seller of home decorative
accessories in the United States, as measured by sales. As of June 30, 2002, the
Company sold its products to approximately 64,100 active Displayers located in
the United States. The Company is also represented in Mexico, Puerto Rico and
Canada. The Company's sales are dependent upon the number of Displayers selling
the Company's products and their resulting productivity. Displayer productivity
fluctuates from time to time based on seasonality and special marketing
programs, which offer Displayers new incentives and discounts timed to generate
additional sales.

To stimulate sales, the Company offers a variety of discounts and incentives
to Displayers. The amount and timing of discounts and incentives vary from year
to year. The cost of discounts is reflected in the Company's net sales while the
cost of incentives is reflected in selling expense.

COMPANY STRATEGY

The Company has evolved its strategy to put greater focus on what management
believes to be the key drivers of the business which are recruiting, retention
and productivity of the Displayer base and leveraging of the assets of the
manufacturing subsidiaries.

The number of new Displayers who have been recruited during the six months
ended June 30, 2002 and approved through the Company's application process
increased 27.6% as compared to the six months ended June 30, 2001 resulting from
the successful implementation of the Company's career strategies and promotions
directed at

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recruiting. The increase in the number of new recruits emphasizes the Company's
focus on training and retention in order to help the new Displayers become
productive and successful in their business.

The Company also experienced a 4% increase in retention of Displayers with
greater than two years of service for the six months ended June 30, 2002. The
retention of experienced Displayers was a result of significant improvements in
areas such as product distribution fulfillment rates, product selection and
Displayer training and motivation. Fulfillment rates for product distribution
remained strong at 99% as of June 30, 2002. The Company is continuing to
introduce new products in 2002 in an attempt to give the product line a fresh
and more innovative look. New products are carefully selected and tested with
Displayers prior to their introduction and placement in the product line. In the
first six months of 2002, the Company launched a new children's line and a new
line of prints from the award-winning artist Thomas Kinkade, also known as the
"Painter of Light(TM)." The initial responses to these new product lines have
been positive.

The Company introduced sales promotion and development activities directed
at helping Displayers increase their individual sales. In 2002, Displayer
productivity increased 22.8% as measured by average sales per Displayer in the
six month period ended June 30, 2002 as compared to the same period in 2001.
Sales tools such as the "Show Flip Chart" introduced in 2001, have helped the
Displayers conduct successful Show presentations. The increase in productivity
for the six months ended June 30, 2002 was also partially attributable to the
success of the "Pocketful of Hope" charity initiative, raising approximately
$230,000 for the American Heart Association through sales of a special candle
that was developed specifically for the charity.

In addition to recruiting, retention and productivity, the Company initiated
improvements in other operational areas. The Company continues to emphasize
products of its manufacturing subsidiaries, which provide opportunities for
gross margin improvement, and leverage of the fixed expense component of its
cost structure. The manufacturing subsidiaries have also initiated additional
sales to customers external to the Company. Outside sales for the six months
ended June 30, 2002 were $4.5 million. In comparison, outside sales for the six
months ended June 30, 2001 were $514,000. In addition, a review of the Company's
import purchasing strategy prompted changes in the Company's methods of
inventory management which have created gross margin improvements related to
imported products. Finally, the Company initiated business operations in Canada
during 2001 as a way of developing and promoting growth of the core business.
Through the first six months of 2002, the financial impact of Canada operations
has been minimal.

REORGANIZATION ACTIVITIES

During 2000, the Company implemented a corporate reorganization plan that
included, among other things, staff reductions and the elimination of excess
facility costs. As part of the reorganization, the Company has downsized various
departments. In December 2000, the Company relocated its corporate headquarters
to the new warehouse and distribution facility. Through June 30, 2002, the
Company has sublet approximately 44,000 square feet of its 75,000 square feet of
vacated corporate headquarters to a subtenant.

Included in general and administrative expenses in the three months and six
months ended June 30, 2002 and 2001 Consolidated Statements of Operations and
Comprehensive Income are costs related to excess facilities, fees related to
obtaining a debt covenant waiver in 2001, consulting costs associated with the
Company's reorganization plan, and uncapitalizable fees related to ERP. These
costs totaled $581,000 and $1.3 million in the three and six months ended June
30, 2002 as compared to $1.1 million and $1.2 million in the three and six
months ended June 30, 2001, respectively. Included in selling expense for the
three and six months ended June 30, 2001 is approximately $130,000 related to
redundant costs. There were no redundant selling costs in the comparable 2002
periods.

RESULTS OF OPERATIONS

The Three Months Ended June 30, 2002 Compared to the Three Months Ended June 30,
2001

Net sales increased $40.6 million, or 38.3%, to $146.7 million in the three
months ended June 30, 2002, from $106.1 million in the comparable period in
2001. The principal variables that impact net sales include the number of
Displayers, the number of orders shipped, the number of orders per Displayer and
average order size. Each of these

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variables increased in the three months ended June 30, 2002 as compared to the
comparable period of 2001. The average number of active Displayers increased to
approximately 61,500 in the three months ended June 30, 2002, from 57,700 in the
same period of 2001. The number of orders shipped increased 24.1% to 240,004 in
the second quarter of 2002 from 193,452 in the 2001 period. In addition, the
number of orders per Displayer increased 16.4% to 3.90 from 3.35 for the three
months ended June 30, 2002 and 2001, respectively. Finally, the average order
size increased 7.9% to $563 in the three months ended June 30, 2002, as compared
to $522 in the comparable period in 2001. These variables, combined with
increased outside sales by the Company's manufacturing subsidiaries of $2.6
million, comprised the majority of the increase in net sales.

Gross profit increased $24.0 million, or 39.9%, to $84.1 million in the
three months ended June 30, 2002 from $60.1 million in the three months ended
June 30, 2001. As a percentage of net sales, gross profit increased to 57.3% in
the second quarter of 2002 from 56.7% in the second quarter of 2001. The
increase in the gross profit percentage was due to the continued introduction of
new products with higher gross margins, an increased focus on emphasizing the
products of the Company's manufacturing subsidiaries and improved margins on the
Company's imported products.

Selling expense increased 49.7% to $27.8 million in the three months ended
June 30, 2002 from $18.5 million in the comparable period of 2001. As a
percentage of net sales, selling expense increased to 18.9% as of the quarter
ended June 30, 2002 from 17.5% in the comparable period of 2001. The increase in
percentage is primarily due to higher Director related bonuses as a result of
increased commissionable sales over the comparable periods. These expenses were
partially offset by the cost and timing of promotional related expenses
including lower costs of incentive trips as a percentage of net sales.

Freight, warehouse and distribution expense increased $5.5 million, or
51.9%, to $16.0 million in the three months ended June 30, 2002 from $10.5
million in the three months ended June 30, 2001. These costs were 10.9% of net
sales in the 2002 period, as compared to 9.9% in the comparable 2001 period.
This increase in freight as a percentage of sales was primarily due to certain
charges that occurred in the second quarter of 2002 related to rallies and
additional shipments via air freight.

General and administrative expense increased $1.7 million, or 13.0%, to
$14.3 million in the three months ended June 30, 2002, from $12.6 million in the
three months ended June 30, 2001. The increase is related to an increase in
insurance costs of $0.6 million, increased professional fees of $0.8 million as
a result of second quarter reclasses in 2001, $0.5 million related to
depreciation on additional equipment, and $0.3 million due to timing of
charitable contributions. In addition, certain additional non-recurring costs
related to excess facilities, fees related to obtaining a debt covenant waiver
in 2001, consulting costs associated with the Company's reorganization plan and
uncapitalizable fees related to ERP are included in general and administrative
expenses. These costs were approximately $581,000 and $1.4 million for the
quarter ended June 30, 2002 and 2001, respectively.

Redundant warehouse and distribution expenses of approximately $839,000 were
recorded in the three months ended June 30, 2001, and consisted primarily of
costs associated with operating certain manual distribution centers longer than
anticipated and consolidation of the manual distribution centers into the new
distribution facility. There were no redundant warehouse and distribution
expenses in the three months ended June 30, 2002.

Interest expense decreased $4.6 million to $6.8 million in the three months
ended June 30, 2002, from $11.4 million in the three months ended June 30, 2001.
The decrease in interest expense is primarily related to the lower debt balance
as a result of the conversion of $95.8 million in debt to 12.5% Senior
Convertible Preferred Stock, par value $0.01 per share, issued by the Company
(the "Senior Preferred Stock") as part of the debt restructuring that occurred
in July 2001.

Income taxes increased $4.5 million to $6.7 million in the three months
ended June 30, 2002 from $2.2 million in the comparable period of 2001. Income
taxes, as a percentage of income before income taxes was 37.6% in the three
months ended June 30, 2002, as compared to 36.3% in the three months ended June
30, 2001. The increase in percentage for the three-month period ended June 30,
2002 is due to accruals related to potential additional tax liabilities.

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The Six Months Ended June 30, 2002 Compared to the Six Months Ended June 30,
2001

Net sales increased $64.2 million, or 32.0%, to $264.7 million in the six
months ended June 30, 2002, from $200.5 million in the comparable period in
2001. The principal variables that impact net sales include the number of
Displayers, the number of orders shipped, the number of orders per Displayer and
average order size. Each of these variables increased in the six months ended
June 30, 2002 as compared to the comparable period of 2001. The average number
of active Displayers increased to approximately 60,700 in the six months ended
June 30, 2002, from 58,300 in the same period of 2001. The number of orders
shipped increased 18.7% to 430,949 in the first six months of 2002 from 362,978
in the 2001 period. In addition, the number of orders per Displayer increased
14.0% to 7.10 from 6.23 for the six months ended June 30, 2002 and 2001,
respectively. Finally, the average order size increased 7.8% to $567 in the six
months ended June 30, 2002, as compared to $526 in the comparable period in
2001. These variables, combined with the introduction of the new children's
product line and the line of Thomas Kinkade prints, and increased outside sales
by the Company's manufacturing subsidiaries of $4.0 million, comprised the
majority of the increase in net sales.

Gross profit increased $37.8 million, or 33.5%, to $150.6 million in the six
months ended June 30, 2002 from $112.8 million in the six months ended June 30,
2001. As a percentage of net sales, gross profit increased to 56.9% in the first
six months of 2002 from 56.3% in the comparable period of 2001. The increase in
the gross profit percentage was due to the continued introduction of new
products with higher gross margins, an increased focus on emphasizing the
products of the Company's manufacturing subsidiaries and improved margins on the
Company's imported products.

Selling expense increased 26.6% to $49.1 million in the six months ended
June 30, 2002 from $38.8 million in the comparable period of 2001. As a
percentage of net sales, selling expense decreased to 18.5% as of the quarter
ended June 30, 2002 from 19.3% in the comparable period of 2001. The decrease in
percentage is primarily due to cost and timing of promotional related expenses
including lower costs of incentive trips as a percentage of net sales and
decreases in field related expenses such as reimbursed selling expense. These
decreases were partially offset by an increase in Director bonuses as a result
of increased commissionable sales over the comparable periods.

Freight, warehouse and distribution expense increased $6.9 million, or
32.5%, to $28.2 million in the six months ended June 30, 2002 from $21.3 million
in the six months ended June 30, 2001. As a percentage of net sales, these costs
remained constant at 10.6% in the comparable periods of 2002 and 2001.

General and administrative expense increased $0.4 million, or 1.3%, to $27.7
million in the six months ended June 30, 2002, from $27.3 million in the six
months ended June 30, 2001. The increase is primarily related to an increase of
$1.3 million related to increased depreciation on additional equipment, $0.6
million increase in insurance expense, and $0.5 million increase in charitable
contributions. These increases were offset by a decrease in certain additional
non-recurring costs related to excess facilities, fees related to obtaining a
debt covenant waiver in 2001, consulting costs associated with the Company's
reorganization plan and uncapitalizable fees related to ERP. These costs were
approximately $1.3 million and $3.2 million for the six months ended June 30,
2002 and 2001, respectively.

Redundant warehouse and distribution expenses of approximately $1.1 million
were recorded in the six months ended June 30, 2001, and consisted primarily of
costs associated with operating certain manual distribution centers longer than
anticipated and consolidation of the manual distribution centers into the new
distribution facility. There were no redundant warehouse and distribution
expenses in the six months ended June 30, 2002.

Interest expense decreased $9.8 million to $13.3 million in the six months
ended June 30, 2002, from $23.1 million in the six months ended June 30, 2001.
The decrease in interest expense is primarily related to the lower debt balance
as a result of the conversion of $95.8 million in debt to Senior Preferred Stock
as part of the debt restructuring that occurred in July 2001.

Income taxes increased $10.8 million to $11.5 million in the six months
ended June 30, 2002 from $0.7 million in the comparable period of 2001. Income
taxes, as a percentage of income before income taxes was 37.3% in the six months
ended June 30, 2002, as compared to 36.7% in the six months ended June 30, 2001.
The Company believes that the effective income tax rate for the year ended
December 31, 2002 will be consistent with its effective

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income tax rate for the six-month period ended June 30, 2002.

SEGMENT PROFITABILITY

The Company's reportable segments include its domestic direct sales
business, its manufacturing operations and its international direct sales
business. The manufacturing operations sell substantially all of their products
to the Company. As a result, manufacturing sales generally follow the Company's
domestic sales trend. International operations include direct sales by
Displayers in Mexico, Puerto Rico and Canada. International sales are directly
attributable to the number of international Displayers the Company has selling
its products. The Company's chief operating decision-maker monitors each
segment's profitability primarily on the basis of EBITDA performance. See Note 6
to the Consolidated Financial Statements.

The Three Months Ended June 30, 2002 compared to the Three Months Ended June 30,
2001

Consolidated net sales increased $40.6 million, or 38.3%, to $146.7 million
in the three months ended June 30, 2002, from $106.1 million in the comparable
2001 period. This increase is primarily due to the $36.1 million or 35.0%
increase in the Company's domestic direct sales. See discussion in "Results of
Operations." International sales increased $3.7 million, or 77.2%, to $8.6
million in the three months ended June 30, 2002, from $4.9 million in the three
months ended June 30, 2001. This increase is primarily due to a 74.0% increase
in the three month average active Displayer count in Mexico over the comparable
period of 2001. Manufacturing related sales increased $12.9 million, or 45.8%,
to $41.1 million in the second quarter of 2002, from $28.2 million in the second
quarter of 2001. Excluding outside sales, which is discussed below, sales
increases of $4.0 million, $3.3 million and $3.0 million were provided by DWC,
Laredo Candle and GIA, respectively.

Outside sales for Laredo Candle were $2.3 million for the three months ended
June 30, 2002. There were no outside sales for Laredo Candle in the same period
of 2001. DWC contributed $635,000 in outside sales for the same period of 2002
as compared to $254,000 in the three months ended June 30, 2001. The Company is
continuing to develop relationships with its current and new outside sales
customers.

Consolidated EBITDA increased $6.5 million, or 30.7%, to $27.8 million in
the three months ended June 30, 2002, from $21.3 million in the comparable
period of 2001. International related EBITDA increased approximately $0.7
million to $1.2 million in the three months ended June 30, 2002 from $454,000 in
the comparable period in 2001. This increase is primarily due to the increase in
Displayers in Mexico. Manufacturing related EBITDA increased $5.4 million, or
59.8% to $14.5 million in the three months ended June 30, 2002, from $9.1
million in the comparable period of 2001. This increase is primarily due to the
overall increase in sales of the manufacturing subsidiaries, including increased
outside sales, and improved manufacturing efficiencies.

The Six Months Ended June 30, 2002 compared to the Six Months Ended June 30,
2001

Consolidated net sales increased $64.2 million, or 32.0%, to $264.7 million
in the six months ended June 30, 2002, from $200.5 million in the comparable
2001 period. This increase is primarily due to the $56.6 million or 29.0%
increase in the Company's domestic direct sales. See discussion in "Results of
Operations." International sales increased $6.9 million, or 76.2%, to $15.9
million in the six months ended June 30, 2002, from $9.0 million in the six
months ended June 30, 2001. This increase is primarily due to a 76.8% increase
in the six month average active Displayer count in Mexico over the comparable
period of 2001. Manufacturing related sales increased $21.3 million, or 39.7%,
to $74.9 million in the first six months of 2002, from $53.6 million in the
first six months of 2001. Excluding outside sales, which is discussed below,
sales increases of $7.6 million, $5.6 million and $4.1 million were provided by
DWC, Laredo Candle and GIA, respectively.

Outside sales for Laredo Candle were $3.7 million for the six months ended
June 30, 2002. There were no outside sales for Laredo Candle in the same period
of 2001. The Company is continuing to explore expansion possibilities with
Laredo Candle to support the expected increase in outside sales opportunities as
well as support its core business to Home Interiors. DWC contributed $837,000 in
outside sales for the same period of 2002 as compared to $514,000 in the six
months ended June 30, 2001.

Consolidated EBITDA increased $19.7 million, or 55.5%, to $55.1 million in
the six months ended June 30,

20

2002, from $35.4 million in the comparable period of 2001. International related
EBITDA increased approximately $1.3 million to $2.0 million in the six months
ended June 30, 2002 from $666,000 million in the comparable period in 2001. This
increase is primarily due to the increase in Displayers in Mexico. Manufacturing
related EBITDA increased $9.1 million, or 55.0% to $25.5 million in the six
months ended June 30, 2002, from $16.4 million in the comparable period of 2001.
This increase is primarily due to the overall increase in sales of the
manufacturing subsidiaries, including outside sales, and improved manufacturing
efficiencies.

SEASONALITY

The Company's business is influenced by the Christmas holiday season and by
promotional events. Historically, a higher portion of the Company's sales and
net income have been realized during the fourth quarter, and net sales and net
income have generally been slightly lower during the first quarter as compared
to the second and third quarters. Working capital requirements also fluctuate
during the year. They reach their highest levels during the third and fourth
quarters as the Company increases its inventory for the peak season. In addition
to the Company's peak season fluctuations, quarterly results of operations may
fluctuate depending on the timing of, and amount of sales from, discounts,
incentive promotions and/or the introduction of new products. As a result, the
Company's business activities and results of operations in any quarter are not
necessarily indicative of any future trends in the Company's business.

LIQUIDITY AND CAPITAL RESOURCES

The Company's cash and cash equivalents decreased to $5.9 million as of June
30, 2002, from $13.7 million at December 31, 2001. A $0.2 million increase
provided by operating activities was offset by $4.4 million and $3.4 million
used in investing and financing activities, respectively as well as $0.2 million
related primarily to cumulative translations adjustments for our Mexico and
Canada operations.

Net cash provided by operating activities decreased $4.7 million during the
six months ended June 30, 2002, as compared to the six months ended June 30,
2001. Net income increased $18.0 million and was offset by decreases in non-cash
related items of $1.5 million which consisted of a $3.9 million decrease in
deferred income taxes and offset by an increase of $1.5 million in depreciation
and amortization as well as an increase of $1.1 million related to provisions
for obsolete inventory. In addition, working capital increased by $21.3 million
which consists of a $15.1 million increase in inventories, $6.0 million increase
in accounts receivable, $5.6 million decrease in other accrued liabilities, and
offset by increases in accounts payable of $3.3 million and income taxes payable
of $2.8 million. The primary reason for the change in the working capital
components relates to the increase in sales over the prior year. In addition,
inventory grew in June 2002 due to the anticipation of a Longshoreman strike in
July 2002 as well as a change in the timing of inventory ownership whereby the
title to overseas products passes to the Company when it leaves the overseas
port as compared to when it is received at our Dallas distribution center.

Net cash used in investing activities decreased $2.1 million in the six
months ended June 30, 2002 as compared to the six months ended June 30, 2001.
Purchases of property, plant and equipment in the six months ended June 30, 2002
totaled $4.9 million, as compared to $6.7 million in the six months ended June
30, 2001.

In November 2001, the Company initiated a project to install a new ERP
system in the Dallas corporate office and selected the J. D. Edwards, OneWorld
XE Solutions, software package. The Company elected to undertake this project to
mitigate the risks associated with the stability and productivity of the current
information systems. The Company expects that the new ERP system will increase
scalability, enhance functionality and provide a strong technical foundation to
support anticipated growth. The implementation of the new ERP system is expected
to be completed before December 31, 2002. The Company could experience business
interruption and an increase to current cost estimates of the project if the
estimated project plan were to encounter unexpected delays. Since the inception
of the project in 2001, the cash outlay for the ERP system was approximately
$6.1 million.

Net cash used in financing activities was $3.4 million in the six months
ended June 30, 2002, as compared to $34.8 million in the six months ended June
30, 2001. Activities in the six months ended June 30, 2002 consisted exclusively
of principal payments on debt and capital leases. The comparable period of 2001
consisted of $15.6 million of principle payments on debt and capital leases
prior to the restructuring of debt that took place in July 2001.

21

Payments on the Company's Notes and the Senior Credit Facility represent
significant cash requirements for the Company. Interest payments on the Notes
commenced in December 1998 and will continue semi-annually until the Notes
mature in 2008. Borrowings under the Senior Credit Facility require monthly
interest payments and quarterly principal payments. In addition, the Senior
Credit Facility includes $30.0 million of revolving loans ("Revolving Loans"),
that mature on June 30, 2004.

As a result of the timing and the magnitude of working capital requirements
and purchases of property, plant and equipment, the Company utilized the
Revolving Loans during the six months ended June 30, 2001. As of June 30, 2001,
$11.0 million was outstanding on the Revolving Loans. The Revolving Loans were
not utilized during the first six months of 2002 and as of June 30, 2002, there
was not an outstanding balance on the Revolving Loans.

The Company paid a total of $14.3 million in debt service for the six months
ended June 30, 2002, consisting of principal payments under the Senior Credit
Facility of $2.8 million, interest under the Senior Credit Facility of
approximately $3.9 million, interest of $0.1 million on commitment fees and $7.5
million of interest on the Notes. Principal payments of $2.8 million on the
Senior Credit Facility were paid after the end of the second quarter of 2002 on
July 1, 2002 as a result of the timing of the due dates for the quarterly
principal payments.

The terms of the Notes and Senior Credit Facility include significant
operating and financial restrictions, such as limits on the Company's ability to
incur indebtedness, create liens, sell assets, engage in mergers 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 minimum fixed charge coverage ratios, and
maximum leverage ratios, capital expenditure measurements and EBITDA
measurements. The Company may be required to make mandatory prepayments of the
term loans on an annual basis if certain predetermined thresholds of specific
financial ratios and tests are met.

Effective July 29, 2002, the Company, Bank of America, N.A. and certain of
the Company's senior secured lenders entered into an amendment to the Company's
senior secured credit agreement pursuant to which, among other things, certain
of the holders of the Company's Tranche A term loans have agreed to convert
their loans into Tranche B term loans. The Tranche B loans have nominal
amortization requirements until December 31, 2004 (the stated Tranche A term
loan maturity date) and have a stated maturity date of December 31, 2006. In
connection with such conversion, Bank of America and certain of the Company's
other existing senior secured and new lenders have agreed to advance an
additional $35.0 million in Tranche B term loans to the Company, the proceeds of
which will be used by the Company to fund its general corporate and working
capital needs (including potential acquisitions).

To induce the holders of the Tranche A term loans to convert their loans,
the Company has agreed to pay each such lender a conversion fee of 50 basis
points on the amount of such lender's Tranche A term loans so converted. To
induce each of the other senior secured lenders to consent to the amendment, the
Company has agreed to (1) pay such lenders a 25 basis point consent fee and (2)
increase the interest rates payable to such consenting lenders by 150 basis
points over the interest rates currently payable to the non-consenting lenders.

In addition to the conversion of the Tranche A term loans and the incurrence
of the additional new-money Tranche B term loans, the Company and its lenders
agreed to increase the size of the Company's permitted acquisition basket,
increase the Company's capital expenditure (including capital lease) basket and
modify the Company's required compliance thresholds for each of the minimum
EBITDA covenant, maximum leverage (including senior leverage) ratio covenant and
minimum fixed charge ratio covenant.

As of August 13, 2002, the Company is in compliance with all covenants or
other requirements set forth in its credit agreements and indentures. Further,
the Company does not have any rating downgrade triggers that would accelerate
maturity dates of its debt.

The Company's near and long-term operating strategies focus on broadening
the Displayer base through recruiting efforts and increasing retention and
productivity of the existing Displayer base and leveraging of the assets of the
manufacturing subsidiaries. The Company believes that cash on hand, net cash
flow from operations and borrowings under the Revolving Loans will be sufficient
to fund its cash requirements through the year ended

22

December 31, 2002. Cash requirements will consist primarily of payments of
principal and interest on outstanding indebtedness, working capital requirements
and capital expenditures. The Company's future operating performance and ability
to service or refinance its current indebtedness will be subject to future
economic conditions and to financial, business and other factors, many of which
are beyond the Company's control.

MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT

The Company is exposed to financial market risks, including changes in
interest rates and foreign currency exchange rates. The Company does not use
derivative financial instruments for speculative or trading purposes. The
Company's international operations are becoming more significant, and as a
result, changes in foreign currency exchange rates may have a material effect on
the Company in the future.

ADOPTION OF ACCOUNTING STANDARDS

In July of 2002 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146 requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
SFAS No. 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. The Company will adopt SFAS No. 146 with
fiscal year beginning January 1, 2003 and does not anticipate any financial
accounting impact associated with its adoption.

In April of 2002 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4,
44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections" ("SFAS
No. 145"). SFAS No. 145 rescinds FASB Statement No. 4, "Reporting Gains and
Losses from the Extinguishment of Debt," and an amendment of that Statement,
FASB Statement No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements." SFAS No. 145 also rescinds FASB No. 44 "Accounting for Leases,"
to eliminate an inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications that
are similar to sale-leaseback transactions. SFAS No. 145 also amends other
existing authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under changed conditions. The
provision of SFAS No. 145 related to the rescission of Statement No. 4 is
effective in fiscal years beginning after May 15, 2002. The Company will adopt
this provision of SFAS No. 145 with fiscal year beginning on January 1, 2003 and
does not anticipate any material financial accounting impact associated with its
adoption. All other provisions of SFAS No. 145 are effective for transactions
occurring and financial statements issued after May 15, 2002. The Company
adopted these provisions effective May 15, 2002, and there was not a financial
accounting impact associated with their adoption.

SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142") was
issued on July 20, 2001. SFAS No. 142 addresses financial accounting and
reporting for acquired goodwill and other intangible assets. The statement
eliminates amortization of goodwill and intangible assets with indefinite lives
and requires a transitional impairment test of these assets within six months of
the date of adoption and an annual impairment test thereafter in certain
circumstances. The Company adopted the provisions of this statement on January
1, 2002, and there was no material financial accounting impact associated with
its adoption.

SFAS No. 144, "Accounting for Impairment of Disposal of Long-Lived Assets,"
("SFAS No. 144") was issued in October 2001. SFAS No. 144 provides new guidance
on the recognition of impairment losses on long-lived assets to be held and used
or to be disposed of and also broadens the definition of what constitutes a
discontinued operation and how the results of a discontinued operation are to be
measured and presented. The Company adopted the provisions of this statement on
January 1, 2002, and there was no financial accounting impact associated with
its adoption.

In September 2001, the EITF issued EITF 01-09, "Accounting for Consideration
Given by a Vendor to a Customer or Reseller of the Vendor's Products," which
applies to the income statement characterization of stock option awards,
royalties, and other cash consideration the Company pays its District Directors,
Branch Directors, Group Directors, Unit Directors, and Trainers. The Company
adopted the provisions on January 1, 2002, and there was no financial accounting
impact associated with its adoption.

23

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.

24

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 AND REPORTS ON FORM 8-K

(a) Exhibits

Exhibit
Number Description

10.1 Commercial lease dated May 21, 2002, between H.T.
Ardinger & Son, Co. and the Company (for building and
facilities located in Carrollton, Texas).*

10.2 Lease Agreement dated April 10, 2002, between GSG,
S.A. de S.V. and Home Interiors de Mexico S. de R.L.
de C.V. (for building and facilities located in San
Nicolas de Los Garza, Mexico).*

10.3 Consulting Agreement dated July 15, 2002, between PWC
Consulting and the Company.*

10.4 Multi-Tenant Industrial Net Lease dated July 29,
2002, between CalWest Industrial Holdings Texas, L.P.
and the Company.*

99.1 Certification of Chief Executive Officer of the
Company.*

99.2 Certification of Chief Financial Officer of the
Company.*

(b) Reports on Form 8-K

Report on Form 8-K (Item 5) filed on July 31, 2002, regarding amendment to
Credit Agreement dated June 30, 2001.

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*Filed herewith.

25

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.

HOME INTERIORS & GIFTS, INC.

By: /s/ KENNETH J. CICHOCKI
-----------------------
Kenneth J. Cichocki
Sr. Vice President of Finance and Chief Financial Officer
(principal financial and accounting officer)

Date: August 13, 2002

26

EXHIBIT INDEX

- ----------

*Filed herewith.

27