HOME INTERIORS & GIFTS INC - 10-K Annual Report

Back to GetFilings.com

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

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

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

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, W 75007
CARROLLTON, TEXAS (Zip Code)
(Address of principal executive offices)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(972) 695-1000

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE

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 [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

Indicate by check mark whether the registrant: is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]

The common stock of the registrant is not publicly registered or traded
and, therefore, no market value, whether held by affiliates or non-affiliates,
can readily be ascertained.

As of March 14, 2003, 15,240,218 shares of the Company's common stock, par
value $0.10 per share, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
NONE
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

PART I

ITEM 1. BUSINESS

GENERAL

Home Interiors & Gifts, Inc. (the "Company") is a Dallas-based Texas
corporation and a fully-integrated manufacturer and distribution company. The
Company believes it is the largest direct seller of home decorative accessories
in the United States, as measured by sales. The Company's products include
framed artwork and mirrors, candles and candle accessories, plaques, figurines,
planters, artificial floral displays, wall shelves and sconces (the "Products").
The Company primarily sells the Products through a direct selling channel of
non-employee, independent contractor sales representatives ("Displayers") who
resell the Products primarily through the "party-plan" method to conduct in-home
presentations ("Shows") for potential customers. The Company has approximately
82,000 active Displayers located in the United States, Mexico, Canada and Puerto
Rico. The Company also sells Products to customers outside of its direct selling
channel.

Since its inception in 1957, the Company has sold a coordinated line of
Products to Displayers, a group of individuals (a majority of which are women)
who operate their own businesses by purchasing the Products from the Company and
reselling them to customers. The Company continues to stress the importance and
dignity of women, a philosophy adopted by its founder, Mary Crowley. This
philosophy remains deeply imbedded in the Company's training, recruiting,
motivating and selling strategies. The Company believes that this philosophy has
contributed to its ability to attract and retain loyal Displayers and to
distinguish its Products in the marketplace. The Company also believes that by
providing its Displayers with the appropriate support and encouragement, they
can achieve personally satisfying and financially rewarding careers by enhancing
the home environments of their customers.

A majority of the Company's outstanding common stock of record is owned by
affiliates of Hicks, Muse, Tate & Furst Incorporated, a Dallas-based private
investment firm ("Hicks Muse").

The Company purchases its Products from a select number of independent
suppliers as well as from its wholly owned subsidiaries. Approximately 48% of
the dollar volume of Products purchased by the Company in 2002 was purchased
from, and manufactured by, the Company's subsidiaries and sold through the
direct selling channel. In addition to the products sold to the Company for the
direct selling channel, the subsidiaries have a growing presence in the outside
sales market. In 2002, outside sales comprised $9.1 million or 6.3% of total
manufacturing sales compared to $1.6 million or 1.4% of total manufacturing
sales in 2001.

North America is the Company's primary market. Sales in the United States
accounted for approximately 93% of net sales in 2002. Subsidiaries and divisions
of the Company in Mexico, Canada and Puerto Rico accounted for the remaining 7%
of net sales in 2002.

COMPANY DIRECT SELLING STRATEGY

Recruit and Retain Active Displayers. The Company recognizes the need to
continue to attract and retain new Displayers. As of December 31, 2002, the
Company's active Displayer base in the United States and Puerto Rico increased
9.3% to approximately 64,500 active Displayers from approximately 59,000 as of
December 31, 2001. This increase was a result of the Company's continued focus
on key areas such as Displayer understanding and awareness of the Hostess
program, improved training and business guides and a more clearly defined and
communicated career strategy.

Empower Displayers to Be Productive. Sales per average active domestic
Displayer increased approximately 13% in 2002 to $8,522 from $7,522 in 2001. The
Company believes that this increase is primarily due to the introduction of
sales promotions directed at helping Displayers increase their individual sales
and a continued focus on sales training. The Company introduces new products
throughout the year, and in 2002, the Company introduced several new product
lines including a children's line called "Home Interiors Kids(TM)," a new line
of prints from the award-winning artist Thomas Kinkade, also known as the
"Painter of Light(TM)" and a superior-quality tableware line starting with the
Apple Orchard Collection(TM).
1

COMPANY MANUFACTURING STRATEGY

Pursue Manufacturing Strategy and Outside Sales. The Company continues to
emphasize the Products of its manufacturing subsidiaries in the direct selling
channel which provides opportunities for gross margin improvements and leverage
of the fixed expense component of its cost structure. This increased focus of
the manufacturing strategy has supported Displayer productivity and retention
through increased fulfillment rates and increased flexibility related to
promotion strategies.

During 2002, the manufacturing subsidiaries also increased sales to
customers outside of the direct selling channel by nearly 470%. Outside sales by
the Company were $9.1 million for the year ended December 31, 2002, as compared
to $1.6 million for the year ended December 31, 2001. In an effort to further
increase the Company's manufacturing capabilities, as well as its sales outside
of the direct selling channel, the Company acquired Brenda Buell & Associates,
Inc. ("BBA"), a wholesaler that designs and develops iron and glass accessories,
on December 31, 2002. Additionally, during the first two months of 2003, the
Company acquired Bulco S.A. de C.V. and its affiliate Tempus Corporation, S.A.
de C.V. ("HI Metals"), a metals manufacturing company in Mexico on January 29,
2003 and Produr, S.A. de C.V. ("HI Ceramics") and its affiliates Tromex
Corporation, S.A. de C.V. and Tromex Corporation II, S.A. de C.V., ("HI Glass")
a metals, glass and ceramics manufacturing facility in Mexico on February 7,
2003.

The Company may pursue additional strategic acquisition opportunities in
the future.

PRODUCTS

Product Line. The Company's product line consists of approximately 1,000
items. The best selling Products include framed artwork and mirrors, candles and
candleholders. Most of the Products are designed for display and sale in
coordinated decorative groupings, which encourages customers to purchase several
accessories to achieve a "complete" look. In general, the Products fit within
design categories favored by Displayers and their customers, such as Casual
Comfort, Romantic Living, Timeless Elegance, Today's Lifestyle, Contemporary and
Ethnic. In February 2002, the Company added a line of children's products, "Home
Interiors Kids(TM)," and in December 2002, the Company launched a line of
tableware products. The Company also offers a selection of seasonal Products for
holiday decorating.

Prices. Products are targeted to individuals who are interested in
decorating their homes and appreciate the value of decorating services, but have
a limited budget. The Products' suggested retail price is generally below $100
per item, with most Products ranging in price from $7 to $30 per item. Although
Displayers may sell the Products at any price, the Company believes that most
Displayers charge the Company's suggested retail prices. The Company believes
that the suggested retail prices for the Products are lower than the prices of
products of similar quality and design available from other sources, thereby
offering the Displayers' customers excellent value. In addition, unlike many
other direct sales organizations, which the Company believes charge their field
representatives and/or customers shipping costs, the Company delivers the
majority of its Products to the Displayers in the 48 contiguous states and
Mexico free of shipping charges if minimum order sizes are met. A shipping
charge is applied in Alaska, Hawaii, Puerto Rico and Canada.

Product Design and Introduction Process. In order to meet the changing
needs of customers, the Company regularly introduces new merchandise. The
Product Development team coordinates the design, development and introduction of
new products. Team members attend color marketing seminars, as well as
furniture, home furnishing, gift & accessory and art trade shows to stay abreast
of trends in the gift, accessory and home furnishing categories. The performance
of existing products is constantly under review. The Product Development team
tests proposed or prototype products with a select group of Displayers in order
to receive feedback on product appeal and product value. Based on that review,
new products are introduced into the Product line. The Company has historically
replaced approximately one third of its Products annually with new items.

2

DIRECT SALES METHOD AND ORGANIZATION

Displayers. The Company's direct sales strategy is focused on motivating
Displayers to market the Company's Products. Because the Company generally does
not use mail-order catalogs, retail outlets or other methods of distribution, it
is entirely dependent on Displayers to market the Products. As independent
contractor sales representatives, each Displayer is responsible for operating
such Displayer's own business. Displayers work on a full or part-time basis.

Displayers can profit from the difference between the purchase price of the
Products paid by them to the Company and the sales price charged by them to
their customers, which, for Displayers who are not Directors, is their principal
source of income from doing business with the Company. Displayers are also able
to earn money and other incentives based on the number of Displayers they
recruit, as well as the dollar amount of Products they purchase from the
Company. In addition, Displayers benefit from periodic discounts offered by the
Company.

Generally, Displayers pay for Products ordered from the Company at the time
an order is placed, although the Company provides Displayers with an unsecured
line of credit of up to $4,000. The Company periodically modifies each
Displayer's credit limit based on sales volume and credit history. The Company
uses Home Online(SM), an internet order entry system ("Home Online") to simplify
the ordering process for its Displayers. Approximately 95% of the orders
received by the Company were received through Home Online at the end of 2002.
Displayers may have their own website linked to Home Online allowing them the
opportunity to better communicate with and service their customers. As of March
14, 2003, approximately 13% of the Company's Displayers have their own website.

Displayers are contractually prohibited from marketing any other goods at
Shows at which the Company's Products will be sold. In addition, Displayers who
become qualified trainers ("Trainers") or Directors are prohibited from
representing, or selling the products of, any other direct selling company whose
products or services directly compete with the Company's.

Shows. The principal sales method used by Displayers is the "party plan,"
in which Displayers conduct Shows in the homes of individuals who serve as
hostesses for the Shows ("Hostesses"). Each Show is attended by guests who have
been invited by the Hostess for that Show. At a Show, which typically lasts two
to three hours, a Displayer will display representative groups of Products and
color brochures depicting the Company's new Products or entire Product line.
Initially, the Displayer demonstrates the Products, but most of the Show time is
devoted to discussing each guest's decorating interests or needs and taking
orders for Products. Typically, Products are paid for at the time they are
ordered and are delivered to the Hostess by the Displayer within two weeks of
the Show. The Company believes that Shows create group enthusiasm for the
Products, enable Displayers to increase sales, offer the opportunity for
Displayers to develop new customers and provide Displayers the opportunity to
recruit new Hostesses and Displayers.

Hostesses. Hostesses are critical to a Displayer's success. A Hostess is
responsible for inviting guests, or prospective customers, to a Show and later
for distributing the purchased Products to each customer. To reward the Hostess
for their efforts, Hostesses who meet certain sales thresholds receive Products
in an amount equal to 20% of the sales generated at the Show. Hostesses also
qualify for 55% discount bonus buys and can receive additional gifts for
bookings. Several times per year, the Company will provide discounts which allow
the Displayer to increase the Hostess Program benefit to 30% or even 40% of the
sales generated at the Show.

Product Brochures. In addition to sales generated at Shows, Displayers
also receive orders generated from Product brochures. Displayers generally mail
Product brochures to Hostesses or distribute the brochures at Shows and other
events. The Company produces both quarterly brochures containing the Company's
complete Product line and supplemental monthly brochures containing the newest
and most popular Products. All brochures have a place for the Displayer to
insert personal contact information since Products cannot be purchased by
customers directly from the Company. The Company also has a preferred mailing
program whereby Displayers provide a list of customers to the Company through
Home Online. The Company then sends a personalized brochure directly to each
individual on the Displayer's mailing list for a small fee. This

3

service is designed to reduce the administrative burden on the Displayers and
allow them more time to make personal contact with their customers and expand
their business. As of March 14, 2003, nearly 3,900 Displayers have subscribed to
the preferred mailing program and over 129,000 customer names have been
submitted.

TRAINING AND SALES SUPPORT

Field Organization. The Company's training and sales support for
Displayers is designed to give Displayers a stable foundation upon which to
build their businesses. Displayers are recruited into "Units" for training and
motivational purposes. In the United States, the number of Displayers in a Unit
ranges from 11 to 209, with an average of approximately 59 Displayers per Unit.
Approximately 1,100 Units are headed by either a "Branch Director" or a "Unit
Director" and each Unit is grouped with other Units to constitute a "Branch."
The number of Units in a Branch ranges from 4 to 22, with an average of
approximately 10 Units per Branch. There are approximately 100 Branches in the
United States, the majority of which are headed by a Branch Director. In
addition, Branches are grouped into "Districts." Twelve District Directors
travel throughout the United States, Mexico, Puerto Rico and Canada motivating,
training and inspiring Branch and Unit Directors. All Displayers and Directors
are independent contractors and not employees of the Company. The Company's
sales development team, led by the Chief Executive Officer and Senior Vice
President of Sales, work closely with and provide support and direction to
Directors.

Recruiting and Training of New Displayers. It is vital to the Company's
success to consistently recruit new Displayers. Accordingly, the Company
provides Displayers with financial rewards and the possibility of promotions to
different Director levels based upon their ability to recruit and train
productive Displayers. As part of their marketing and sales activities,
Displayers seek to identify and to recruit new Displayers, typically women who
previously have attended Shows. Once a candidate is identified, a trainer or
Director interviews the candidate to explain the opportunities, time commitment,
start-up costs, training and other activities a Displayer can expect to
experience.

Though any Displayer can recruit an individual to become a Displayer, only
Displayers who are Trainers may train a recruit and earn commissions on the
Product sales of recruits that they have trained. To become a Trainer, a
Displayer must have demonstrated previous recruiting success, have been
recommended by the Displayer's Branch Director and have attended training
classes. In 2002, most of the training classes were held in the locale of the
Branch Director sponsoring the classes. Previous to 2002, these classes were
held in Dallas, TX. This change in training location helped increase the
interest and growth of the Certified Trainer program. The Company has certified
approximately 2,900 of its Displayers as Trainers. In 2002, Trainers earned
commissions totaling $3.9 million. When the recruiting and sales volume of a
Trainer and the Trainer's recruits reach certain levels, the Trainer may be
permitted to form a new Unit and become a Unit Director.

The Company believes that training is a critical component of a Displayer's
success. The Company emphasizes sales of its Products and typically requires all
recruits to participate in an intensive sales-training program. The Company
encourages Displayers to recruit new Displayers who will sell Products to
customers rather than purchase items for personal consumption. The training
program includes personal instruction by a Trainer and the observation of
several Shows conducted by experienced Displayers. In addition to the one-on-
one training sessions and group training sessions that are conducted by a
Certified Trainer, the Displayers receive a business guide that was created as a
reference manual for use in their business along with the "Show Flip Chart," a
tool to help the Displayer conduct successful Show presentations. New Displayers
also receive information from their Trainer about the Products, and are taught
the fundamental elements of home decorating as well as different methods of
conducting successful Shows.

On-Going Training and Motivation. The Company believes that
Company-sponsored training and motivation of Displayers is critical to Displayer
morale and, therefore, to the Company's sales. The Company hosts a three-day
annual seminar for all Displayers. At the seminar, the Company provides
motivational speakers, Product displays, entertainment and meals, conducts
recognition ceremonies to highlight Displayer achievements, and introduces new
Product lines as well as new Products in existing lines. The Company also
sponsors one-day or two-day "rallys" throughout the United States each August
and September, to introduce

4

the Company's fall and Christmas Product lines. Additionally, the Company's
Chief Executive Officer and Senior Vice President of Sales, plus other senior
executives and National Trainers routinely visit and assist Branch Directors.

Twice a month, the Company mails each Displayer a newsletter that announces
new incentive programs or discounts, discusses selling techniques, motivational
strategies and Product status, and recognizes successful Displayers. Unit
Directors typically hold weekly sales meetings for the Displayers in their Unit,
and Branch Directors hold quarterly meetings for their Unit Directors and
Displayers to discuss selling techniques, motivational strategies, Product
introductions and sales recognition.

Incentive Programs. In addition to the gross profit Displayers can earn
through the purchase and resale of the Products, the Company provides incentives
to Displayers by rewarding top-performing Displayers with vacation trips, gifts
and other prizes. The incentive rewards, which vary annually, are based on the
volume of Products purchased from the Company by a Displayer. The Company also
provides a variety of discount programs in connection with Product purchases and
rewards Displayers who recruit other productive Displayers.

Remuneration. Directors earn commissions on the Product purchases of the
Displayers they service and are eligible for performance bonuses. District,
Branch, Group and Unit Directors earned commissions, including performance
bonuses, amounting to $62.6 million in 2002. In general, District Directors also
receive a monthly amount for each Branch they service plus an annual payment
based on the percentage of their District's annual increase in Product
purchases. In addition, District Directors, Branch Directors, Group Directors
and certain Unit Directors are reimbursed for certain travel and other expenses.
Reimbursed expenses totaled $3.0 million in 2002.

PRODUCT SUPPLY AND MANUFACTURING

Approximately 48% of the dollar volume of Products purchased by the Company
in 2002 was purchased from, and manufactured by, the Company's subsidiaries and
sold through the direct selling channel. The Company manufactures framed artwork
and mirrors, candles, plaques, and various types of molded plastic products
through the use of custom-designed equipment. To date, the Company has been able
to secure an adequate supply of raw materials for its manufacturing operations
from numerous sources, and the Company does not expect any material
interruptions in the supply of raw materials it uses to manufacture Products.

Products not manufactured by the Company are purchased from numerous
foreign and domestic suppliers. The Company is either the largest or the only
customer of many of its suppliers, and most of its Products are manufactured
exclusively for the Company. Many of the Company's supplier relationships have
existed for more than 20 years, and the Company has experienced minimal supplier
turnover in recent years. However, because the Company does not enter into
supply agreements with its suppliers, these relationships generally may be
terminated at any time by either party. The Company believes that its
relationships with its suppliers are good. The Company has not had any material
interruptions in the supply of Products it purchases from suppliers. No
third-party supplier furnished the Company with more than 10% of its purchased
Products during 2002.

PRODUCT DISTRIBUTION

Displayers typically submit orders, via the internet or mail, to the
Company's headquarters weekly on one assigned order processing day. Upon
receipt, orders are recorded and the Displayer's recent sales activity, credit
and accounts receivable status are verified. Each order is filled and shipped,
generally within 24-36 hours from when it is received. The Company uses an
automated order fulfillment system and has two distribution centers.

To minimize shipping costs, the Company uses a two-step process in which
approximately 65 common carriers and truckload carriers ship full truck loads or
partial loads of Products to approximately 200 regional delivery sites where
locally-based freight distributors ("Local Distributors") sort the loads and
deliver the Products to each Displayer. Approximately 77% of the Products
shipped by the Company are delivered in this

5

manner. In cases where Local Distributors are not used, the Products are shipped
by common carrier, couriers via pod distribution or UPS directly to Displayers.

When the Displayer receives a bulk packaged order, she repackages the
Products for individual customers and typically delivers them to the Hostesses,
who in turn delivers the Products to the final customer. Displayers typically
contact customers to confirm their satisfaction with their Products. Multiple
contacts with Hostesses and customers provide Displayers several opportunities
to provide information regarding the Company and its Products, which assists in
the Displayers' sales and recruiting efforts.

INTERNATIONAL OPERATIONS

The Company's international operations are conducted primarily through both
the Dallas office and through Mexico. Operations were initiated in Canada in
September 2001, and as of December 31, 2002, active Displayers have grown to
over 575 with net sales of $3.7 million. Sales orders received from Canada and
Puerto Rico are processed by the Company's Dallas office where as all Mexico
sales are handled by the Company's Mexico subsidiary.

As of December 31, 2002, the Company had over 16,900 Displayers in Mexico
as compared to approximately 9,700 active Displayers as of December 31, 2001.
Net sales increased 51.1% to $30.2 million for the year ended December 31, 2002.

The Company's international operations are subject to certain customary
risks inherent in carrying on business abroad, including the risk of adverse
currency fluctuations as well as unfavorable economic and political conditions.

FINANCIAL INFORMATION ABOUT SEGMENTS

Refer to the information under Note 16 to Consolidated Financial
Statements, which is hereby incorporated by reference.

COMPETITION

The Company operates in a highly competitive environment. Products sold by
the Company compete with products sold elsewhere, including department and
specialty stores, mail order catalogs, internet and other direct-sales
companies. The Company competes in the sale of Products on the basis of quality,
price and service. Because of the limited number of Products it manufactures and
its relatively small number of suppliers of finished Products, the Company is
able to exercise some control over the quality and price of the Products. As a
result, the prices charged by Displayers are within a range believed to be
acceptable to their customers.

The Company also competes with other direct-selling organizations, even
those whose products may not compete with the Company's Products, in recruiting
and retaining sales representatives. The Company's success requires the
recruitment, retention and integration into the Company's business of highly
qualified management, sales, marketing and product development personnel in
order to support the needs of the Displayers.

EMPLOYEES

As of March 14, 2003, the Company employed approximately 2,400 persons
located principally in Texas and Monterrey, Mexico. The employees located in the
United States are not represented by a labor union or covered by a collective
bargaining agreement. The majority of the employees located in Mexico are
represented by various labor unions which have had favorable relationships with
the Company. The Company believes its relationship with its employees and
related labor unions to be good.

6

ITEM 2. PROPERTIES

As of December 31, 2002, the Company owned the following properties in the
United States, each of which is used for the respective purpose set forth below:

- ---------------

(1) All cities are located in Texas, except as noted.

(2) The Company has entered into an agreement to sell the vacant land in
Coppell, which is expected to close in June 2003.

In August 2000, the Company entered into a 60-month Industrial Lease with
Parker Metropolitan, L.P. ("Parker") for land, building and related facilities
located at 815 South Coppell, Coppell, Texas which is currently being used for
overflow warehousing activities.

In February 2001, the Company subleased approximately 41,000 square feet of
the Company's 75,000 square foot former headquarters at Granite Tower, Dallas,
Texas to a subtenant and subleased an additional 2,567 square feet to the same
subtenant on June 1, 2001. The Company has hired consultants to assist in
subleasing the remaining unused space to its current subtenant, another
subtenant or to complete a buyout of the remaining lease obligation.

In July 2002, the Company entered into a 12-month Industrial Lease with
Calwest Industrial Holdings, L.P. for building and related facilities located at
2828 Trade Center Drive, Carrollton, Texas which is currently being used for
overflow warehousing activities.

In September 2002, the Company entered into a 41-month Industrial Lease
with Argent Frankford, L.P. for building and related facilities located at 2901
Trade Center Drive, Carrollton, Texas which is also being used for overflow
warehousing activities.

ITEM 3. LEGAL PROCEEDINGS

The Company previously purchased certain assets of House of Lloyd entities
in bankruptcy. Such assets included that certain letter agreement dated October
23, 2001, among Richmont Corporation and its affiliates and representatives, and
House of Lloyd Management, LLC (the "Letter Agreement").

On April 25, 2002, the Company in the name of several House of Lloyd
entities, filed a petition against Richmont Corporation, Richmont International,
Inc. d/b/a Richmont House and John P. Rochon ("Defendants") asserting various
claims arising from, inter alia, the Letter Agreement. Defendants answered the
lawsuit and, on September 12, 2002, filed an Original, Counterclaim and Third
Party Petition against the House of Lloyd entities, as counter-defendants, and
the Company and Mr. Donald J. Carter Jr., as a third-party defendants, pursuant
to which defendants asserted claims for tortious interference with prospective
business relations, tortious interference with existing business relations, a
business disparagement, conspiracy and malicious prosecution, and are seeking
actual damages and punitive damages in the amount of $100 million. The House of
Lloyd entities, the Company and Mr. Carter answered the Original Counterclaim

7

and third party petition, and filed an additional action against the Defendants
in the United States Bankruptcy Court for the Western District of Missouri,
Kansas City Division (the "Bankruptcy Court").

On March 10, 2003, the Defendants entered into a Settlement Agreement and
General Release (the "Settlement Agreement") in favor of the Company and Donald
J. Carter, Jr. which, upon effectiveness, will dispose of and fully resolve the
pending claims without the payment of any material amounts by any of the
parties. If the Settlement Agreement is not approved by the Bankruptcy Court and
executed by the Company and Donald J. Carter, Jr. prior to April 24, 2003, it
will become null and void, although in such event the parties have nevertheless
agreed in the Settlement Agreement to continue to negotiate in good faith
towards achieving a settlement of these disputes.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth
quarter of 2002.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

There is no established public trading market for the Company's common
stock, $0.10 par value per share. As of March 14, 2003, the Company had
outstanding 15,240,218 shares of common stock held by 192 shareholders.

Holders of common stock are entitled to share ratably in dividends, if and
when declared by the Company's Board of Directors (the "Board") out of funds
legally available therefor. The Company is restricted in the amount of dividends
that may be paid to holders of common stock pursuant to the credit agreement
with its principal lenders (the "Senior Credit Facility") and the Indenture
dated as of June 4, 1998 (the "Indenture"), among the Company, certain of its
subsidiaries, as guarantors, and United States Trust Company of New York, as
trustee, pursuant to which the Company issued its 10 1/8% Senior Subordinated
Notes Due 2008 (the "Notes"). The certificate of designation governing the
Company's outstanding Preferred Stock (the "Preferred Stock Designation") also
provides that dividends cannot be paid on any junior securities, including
common stock, unless all accrued and unpaid dividends on the Preferred Stock
have been paid in full. Because the terms of the Notes, the Company's Senior
Credit Facility and the Preferred Stock Designation all restrict the Company's
ability to pay dividends, the Company does not anticipate the payment of
dividends on its common stock in the foreseeable future.

Securities Authorized for Issuance Under Equity Compensation Plans

EQUITY COMPENSATION PLAN INFORMATION

8

The Company did not sell any equity securities during the period covered by
this Form 10-K that were not registered under the Securities Act.

ITEM 6. SELECTED FINANCIAL DATA

The following summary is intended to highlight certain information
contained elsewhere in this report. Refer to "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations" and "Consolidated
Financial Statements" elsewhere in this report for greater detail.

- ---------------

(1) Certain non-recurring costs of $8.2 million, $6.6 million and $2.9 million
in 2000, 2001 and 2002 respectively, associated with non-capitalizable legal
fees related to obtaining the waiver to the Senior Credit Facility, staff
reductions, excess facilities, fees related to the Debt Restructuring (as
defined in "Liquidity and Capital Resources," below), consulting costs
associated with the Company's reorganization plan, accelerated amortization
of leasehold improvements and the non-capitalizable costs of a new
enterprise resource planning ("ERP") system, are also included in selling,
general and administrative expense.

(2) Recapitalization expenses consist of amounts paid to the Company's financial
and legal advisors in connection with the recapitalization of the Company in
June 1998 (the "Recapitalization").

(3) EBITDA represents operating income plus depreciation and amortization,
Recapitalization expenses, Homco restructuring expenses, redundant warehouse
and distribution expenses, debt restructuring and waiver fees, effects of
SAB 101 and non-cash expenses (credits) for stock options, and excludes
certain non-recurring costs associated with the corporate reorganization
included in selling and general and administrative expense and any gains or
losses on the sale of assets. EBITDA generally is considered to provide
information regarding a company's ability to incur and service debt, and it
is included herein to provide additional information with respect to the
ability of the Company to meet its future debt service, capital expenditure
and working capital requirements. EBITDA should not be considered in
isolation, as a substitute for net income, cash flows from operations or
other consolidated income or cash flow data prepared in accordance with
generally accepted accounting principles, or as a measure of a company's
profitability or liquidity. See Note 16 to the Consolidated Financial
Statements.

(4) Defined as EBITDA as a percentage of net sales.

(5) The Company does not anticipate the payment of dividends in the foreseeable
future because the terms of the Notes, the Senior Credit Facility and the
Preferred Stock Designation restrict the Company's ability to pay dividends.

10

(6) Average order size is calculated based on net sales less outside sales and
international sales divided by number of orders. For purposes of this
calculation, outside sales of $1.6 million and $9.1 million for 2001 and
2002 have been excluded from net sales, respectively. There were no outside
sales in 2000 or prior years. In addition, international sales of
approximately $6.4 million, $9.1 million, $15.1 million, $21.4 million and
$36.7 million for 1998, 1999, 2000, 2001 and 2002 have been excluded from
net sales, respectively.

(7) An active Displayer is a Displayer who has placed an order with the Company
within the prior 14 weeks.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

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) general economic conditions; and (viii) the success of integrating the
recently acquired businesses. Many of these factors will be beyond the control
of the Company.

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

COMPANY DIRECT SELLING STRATEGY

Recruit and Retain Active Displayers. The Company recognizes the need to
continue to attract and retain new Displayers. As of December 31, 2002, the
Company's active Displayer base in the United States and Puerto Rico increased
9.3% to approximately 64,500 active Displayers from approximately 59,000 as of
December 31, 2001. This increase was a result of the Company's continued focus
on key areas such as Displayer understanding and awareness of the Hostess
program, improved training and business guides and a more clearly defined and
communicated career strategy.

Empower Displayers to Be Productive. Sales per average active domestic
Displayer increased approximately 13% in 2002 to $8,522 from $7,522 in 2001. The
Company believes that this increase is primarily due to the introduction of
sales promotions directed at helping Displayers increase their individual sales
and a continued focus on sales training. The Company introduces new products
throughout the year, and in 2002, the Company introduced several new product
lines including a children's line called Home Interiors Kids(TM), a new line of
prints from the award-winning artist Thomas Kinkade, also known as the "Painter
of Light(TM)" and a superior-quality tableware line starting with the Apple
Orchard Collection(TM).

COMPANY MANUFACTURING STRATEGY

Pursue Manufacturing Strategy and Outside Sales. The Company continues to
emphasize the Products of its manufacturing subsidiaries in the direct selling
channel which provides opportunities for gross margin

11

improvements and leverage of the fixed expense component of its cost structure.
This increased focus of the manufacturing strategy has supported Displayer
productivity and retention through increased fulfillment rates and increased
flexibility related to promotion strategies.

During 2002, the manufacturing subsidiaries also increased sales to
customers outside of the direct selling channel by nearly 470%. Outside sales by
the Company were $9.1 million for the year ended December 31, 2002, as compared
to $1.6 million for the year ended December 31, 2001. In an effort to further
increase the Company's manufacturing capabilities, as well as its sales outside
of the direct selling channel, the Company acquired Brenda Buell & Associates
("BBA"), a company that designs and develops iron and glass accessories, on
December 31, 2002. Additionally, during the first two months of 2003, the
Company acquired Bulco S.A. de C.V. and its affiliate Tempus Corporation, S.A.
de C.V. ("HI Metals"), a metals manufacturing company in Mexico on January 29,
2003 and Produr, S.A. de C.V. ("HI Ceramics") and its affiliates Tromex
Corporation, S.A. de C.V. and Tromex Corporation II, S.A. de C.V., ("HI Glass")
a metals, glass and ceramics manufacturing facility in Mexico on February 7,
2003.

The Company may pursue additional strategic acquisition opportunities in
the future.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management's Discussion and Analysis of its financial condition and results
of operations are based upon the Company's consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements
requires management to make estimates and judgements that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, management evaluates
its estimates, including those related to allowances for bad debts, inventory
reserves, actuarially determined insurance reserves and tax reserves. Management
bases its estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.

Management believes the following critical accounting policies affect its
more significant judgments and estimates used in the preparation of its
consolidated financial statements.

REVENUE RECOGNITION

The Company recognizes revenue in accordance with SEC Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial Statements, as amended.
Accordingly, revenue from product sales is recognized upon an estimation of
expected delivery date to the Displayer at which point title to the product and
risk of ownership passes. Provisions for discounts and rebates to Displayers,
and returns and other adjustments are provided for in the same period the
related sales are recorded. Shipping and handling expenses are recorded as
operating expenses. Deferred revenue is recorded to the extent that shipments
have not been received by Displayers by period end.

ALLOWANCES FOR BAD DEBTS

The Company maintains allowances for bad debts for estimated losses
resulting from uncollectible amounts due from Displayers. The primary factors
considered by the Company in determining its allowance for bad debts is the age
of outstanding receivables, payment trends and estimated recovery dates. If the
financial condition of the Company's Displayers were to deteriorate, resulting
in an impairment of their ability to make payments, additional allowances may be
required.

INVENTORY RESERVES

The Company provides reserves for estimated obsolescence or unmarketable
inventory equal to the difference between the cost of inventory and the
estimated net realizable value using assumptions about future

12

demand for its Products and market conditions. If actual future demand or market
conditions are less favorable than those projected by management, additional
inventory reserves may be required.

INSURANCE RESERVES

The Company is self-insured for workers compensation and provides reserves
for workers' compensation claims which were incurred but not reported by year
end. The Company takes into consideration the status of current and historical
claims and actuarial estimates of losses from such claims to determine the
reserve amounts. If current or future claims are higher than estimated,
additional reserves may be required.

TAX RESERVES

The Company provides a reserve for the future payment of state and federal
income taxes arising out of completed transactions. The current reserve includes
the estimated tax due as a result of the debt purchase transaction and the
issuance of preferred stock by the Company as well as the estimated income tax
due to various states arising out of the Company's obligation to file income
taxes in all states for the years beginning in 1999. At this time, the Company
does not foresee any additional tax obligations beyond what is reserved.
However, if future tax obligations are higher than estimated, additional
reserves may be required.

GOODWILL

The Company follows SFAS No. 142, "Goodwill and Other Intangible Assets"
which states that there will be no amortization of goodwill or intangible assets
with indefinite lives. Impairment of these assets is assessed at least annually
to determine if the estimated fair value of the reporting unit exceeds the net
carrying value of the reporting unit, including the applicable goodwill. The
estimates of fair market value is based upon management's estimates of the
present value of future cash flows. Management makes assumptions regarding the
estimated cash flows and if these estimates or their related assumptions change,
an impairment charge may be incurred.

STOCK COMPENSATION PLANS

The Company accounts for grants under the Independent Contractor Stock
Option Plan (the "1998 Independent Contractor Plan") in accordance with
Statement of Accounting Financial Standards No. 123. The Company estimates
quarterly compensation expense using the Black-Scholes option-pricing model,
using certain key assumptions such as the estimated fair value of the Company's
common stock, term, dividend yield, volatility and risk-free interest rate.
These key assumptions are subjective in nature and future compensation expense
could vary significantly from prior periods.

The Company accounts for grants under the 1998 Key Employee Stock Option
Plan (the "1998 Plan") and the 2002 Key Employee Stock Option Plan (the "2002
Plan") in accordance with the Accounting Principles Board Opinion No. 25. The
1998 Plan is accounted for under fixed accounting, thus, the Company does not
record compensation expense related to these options. The 2002 Plan options are
accounted for under variable accounting due to their vesting being linked to
certain Company financial performance goals. The Company estimates quarterly
compensation expense for the 2002 Plan using the Minimum Value option-pricing
model, using certain key assumptions such as the estimated fair value of the
Company's common stock, term, dividend yield, and risk-free interest rate. These
key assumptions are subjective in nature and future compensation expense could
vary significantly from prior periods.

RESULTS OF OPERATIONS

2002 COMPARED TO 2001

Net sales increased $112.8 million, or 24.4%, to $574.5 million in 2002
from $461.7 million in 2001. The increase was primarily due to a larger and more
productive domestic Displayer base and an increase in outside sales of $7.5
million. The average domestic order size increased 1.8% to $570 in 2002 as
compared to $560 in 2001. The number of active domestic Displayers increased to
approximately 64,500 as of December 31, 2002

13

as compared to approximately 59,000 at December 31, 2001. The number of orders
shipped increased 18.4% to 926,934 orders in 2002 from 782,670 orders in 2001.

Gross profit increased $62.0 million, or 23.8%, to $322.8 million in 2002
from $260.8 million in 2001. As a percentage of net sales, gross profit
decreased slightly to 56.2% in 2002 from 56.5% in 2001. The decrease in the
gross profit percentage was primarily due to increased inventory reserves as
compared to the prior year as a result of an increase in year-end inventory
levels primarily related to additional product lines and an expanded Christmas
line.

Selling expense increased $18.2 million, or 21.1%, to $104.7 million in
2002 from $86.5 million in 2001. As a percentage of net sales, selling expense
decreased to 18.2% in 2002 from 18.7% in 2001. The decrease in selling expense
was a result of fewer promotional related expenses such as incentive trips and
recruiting incentives as compared to 2001. The decrease was partially offset by
increased Director bonuses of $9.2 million related to increased commissionable
sales over the prior year.

Freight, warehouse and distribution expense increased $14.9 million, or
30.2%, to $64.5 million in 2002 from $49.6 million in 2001. These costs were
11.2% of net sales in 2002 compared to 10.7% in 2001. This increase was
primarily due to costs associated with additional warehousing space required for
the growth in inventory in 2002.

General and administrative expense increased $3.5 million, or 6.1%, to
$60.7 million in 2002, from $57.2 million in 2001. This increase was primarily
due to increases in credit card processing fees of $2.2 million, depreciation
expense of $1.9 million, outside services of $1.2 million primarily related to
temporary labor, insurance expense of $0.8 million and professional fees of $0.9
million. These increases were offset by certain non-recurring costs of $2.9
million in 2002 as compared to $6.3 million in 2001 associated with
non-capitalizable legal fees related to obtaining a debt covenant waiver in
2001, excess facilities, consulting costs associated with the Company's
reorganization plan and the non-capitalizable costs of a new ERP system.

Gain on the disposition of assets of approximately $0.4 million and a loss
of approximately $0.5 million was recorded in 2002 and 2001, respectively. The
gain in 2002 was related to the sale of the Company's interest in an aircraft.
The loss in 2001 was related to an impairment loss on machinery at Laredo Candle
as well as a loss on the sale of land at DWC.

Stock option expense of approximately $1.3 million and a credit of $62,000
were recorded in 2002 and 2001, respectively. The increase in 2002 is due to the
issuance of options under the 2002 Stock Option Plan for Key Employees and an
increase in the fair value of the stock.

Redundant warehouse and distribution expense of $1.2 million was recorded
in 2001 and consisted primarily of costs associated with operating certain
manual distribution centers longer than anticipated and the consolidation of the
manual distribution centers into the new distribution facility. The Company did
not incur redundant warehouse costs in 2002 and does not anticipate additional
costs of this nature in 2003.

Interest income decreased $0.5 million, or 53.6%, to $0.5 million in 2002
from $1.0 million in 2001 primarily due to lower average interest rates.

Interest expense decreased $10.5 million, or 27.6%, to $27.5 million in
2002 from $38.0 million in 2001. The interest expense in 2002 declined as
compared to 2001 primarily due to a reduced debt balance as a result of the
conversion of $95.8 million in debt to Senior Preferred Stock as part of the
Debt Restructuring in July 2001.

Other income (expense) in 2002 includes expense of approximately $1.4
million related to an inventory purchase in the second quarter of 2002 that was
liquidated and not sold through the normal course of business.

Income taxes increased $12.6 million to $23.3 million in 2002 from $10.7
million in 2001. Income taxes, as a percentage of income before income taxes,
was 36.7% in 2002 compared to 36.3% in 2001.

Extraordinary loss of $4.5 million in 2002 was a result of the write-off of
previously capitalized debt issuance fees related to debt restructuring in July
2002. The loss in the year ended December 31, 2001 was a
14

result of completion of the Debt Restructuring in July 2001. As a result of the
July 2001 Debt Restructuring, for financial reporting purposes, the Company
wrote off $2.4 million in unamortized debt issuance costs, net of $0.9 million
in taxes, and recorded $13.7 million of income taxes.

2001 COMPARED TO 2000

Net sales increased $1.3 million, or 0.3%, to $461.7 million in 2001 from
$460.4 million in 2000. The increase was primarily a result of a more productive
domestic Displayer base with an increase in average domestic order size of 3.3%
to $560 in 2001 as compared to $542 in 2000. The number of active Displayers
remained stable at approximately 59,000 as of December 31, 2001 as compared to
approximately 59,300 at December 31, 2000. The number of orders shipped
decreased 4.8% to 782,670 orders in 2001 from 821,716 orders in 2000.

Gross profit increased $23.9 million, or 10.1%, to $260.8 million in 2001
from $236.9 million in 2000. As a percentage of net sales, gross profit
increased to 56.5% in 2001 from 51.5% in 2000. The increase in the gross profit
percentage was primarily due to the continued introduction of new Products with
higher gross margins and an increased focus on emphasizing the Products of our
manufacturing subsidiaries. In addition, the gross profit in 2000 included
charges to cost of goods sold recorded in the fourth quarter of 2000 related to
an inventory write-off of $1.1 million. Charges for obsolete inventory decreased
$2.5 million to $2.8 million as of December 31, 2001 from $5.3 million as of
December 31, 2000. The decrease in the inventory reserve is related to the
implementation of a more effective product discontinuation process which retires
less profitable Products more efficiently.

Selling expense increased $4.2 million, or 5.1%, to $86.5 million in 2001
from $82.3 million in 2000. As a percentage of net sales, selling expense
increased to 18.7% in 2001 from 17.9% in 2000. Selling expense increased as a
result of an increase in the cost associated with the Company's annual seminar
and rallies of $2.0 million over the prior year. In addition, Director bonuses
increased $3.4 million and royalties increased $1.3 million, both of which are
due to increased commissionable sales over the prior year. These increases were
partially offset by decreases in employee compensation of $1.1 million and
promotional related expenses of $0.6 million.

Freight, warehouse and distribution expense increased $4.7 million, or
10.4%, to $49.6 million in 2001 from $44.9 million in 2000. These costs were
10.7% of net sales in 2001 compared to 9.8% in 2000. This increase was due to a
combination of increased freight related expenses as a result of increased
distributor compensation and a larger percentage of candle orders which
increases freight costs due to the smaller and heavier packages. Redundant
warehouse and distribution costs of $1.2 million in 2001 and $6.1 million in
2000, primarily relating to duplicate facility costs and redundant temporary
labor, have been reclassified to a separate operating expense line item in the
accompanying Consolidated Statements of Operations and Comprehensive Income.

General and administrative expense increased $8.3 million, or 17.0%, to
$57.2 million in 2001, from $48.9 million in 2000. This increase was primarily
due to a $5.4 million increase in employee related expenses such as wages,
bonuses and 401(k) contributions, $1.0 million of increased depreciation related
to additional depreciable assets being placed into service and an increase in
utilities of $0.6 million over the prior year. Additional items such as
charitable contributions increased $0.6 million and repairs and maintenance
increased $0.7 million. Certain non-recurring costs of $6.3 million and $8.2
million in 2001 and 2000 respectively, associated with non-capitalizable legal
fees related to obtaining the waiver to the Senior Credit Facility, staff
reductions, excess facilities, fees related to the Debt Restructuring (as
defined below), consulting costs associated with the Company's reorganization
plan, accelerated amortization of leasehold improvements and the
non-capitalizable costs of a new ERP system, are also included in general and
administrative expense. See "Liquidity and Capital Resources."

Loss (gain) on the disposition of assets of approximately $0.5 million was
recorded in 2001 related to an impairment loss on machinery at Laredo Candle as
well as a loss on the sale of land at DWC. A gain of $2.7 million was recorded
in 2000 related to the sales of distribution facilities and associated land and
investments held for sale.
15

Stock option credits of approximately $62,000 and $351,000 were recorded in
2001 and 2000 respectively.

Homco restructuring expense of approximately $1.0 million was recorded in
2000 as a result of non-recurring costs related to the consolidation of Homco's
operations into GIA.

Redundant warehouse and distribution expenses of $1.2 million and $6.1
million were recorded in 2001 and 2000, respectively, and consist 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.

Interest income decreased $1.2 million, or 53.9%, to $1.0 million in 2001
from $2.2 million in 2000 due to lower average investment balances.

Interest expense decreased $7.5 million, or 16.5%, to $38.0 million in 2001
from $45.5 million in 2000. The interest expense in 2001 declined as compared to
2000 due to a decline in LIBOR rates in 2001 as it relates to the Senior Credit
Facility. In addition, the completion of the Debt Restructuring in July 2001
contributed to the decrease in interest expense.

Other income (expense) in 2000 includes income of approximately $1.2
million to adjust to fair market value the option provision of the Company's
interest rate swap agreement.

Income taxes increased $4.8 million to $10.7 million in 2001 from $5.9
million in 2000. Income taxes, as a percentage of income before income taxes,
was 36.3% in 2001 compared to 37.6% in 2000. The difference relates to corporate
restructuring of subsidiaries, thereby lowering the overall state income tax
percentage.

Extraordinary loss was recorded in the year ended December 31, 2001 as a
result of completion of the Debt Restructuring in July 2001. As a result of the
foregoing Debt Restructuring, for financial reporting purposes, the Company
wrote off $2.4 million in unamortized debt issuance costs, net of $0.9 million
in taxes, and recorded $13.7 million of income taxes.

SEGMENT PROFITABILITY

The Company's reportable segments include its domestic direct sales
business, its manufacturing operations and its international 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 because the
Company's Senior Credit Facility outlines certain covenants to be based upon
EBITDA measurements.

2002 COMPARED TO 2001

Consolidated net sales increased $112.8 million, or 24.4%, to $574.5
million in 2002 from $461.7 million in 2001. The Company's increase in domestic
direct sales was $97.1 million. See discussion in "Results of Operations." An
increase in International sales of $15.3 million, or 71.2%, to $36.7 million in
2002 from $21.4 million in 2001 was due to expansion of the international direct
selling channel in Mexico and $3.7 million in net sales related to our newly
initiated operations in Canada. Manufacturing related sales increased $26.8
million, or 22.6%, to $145.3 million in 2002 from $118.5 million in 2001.

The Company is in the process of growing their outside sales operations
through their manufacturing facilities. DWC and Laredo Candle generated $9.1
million of outside sales in 2002 compared to $1.6 million in 2001. As discussed
previously in "Company Strategy", the Company has acquired several additional
manufacturing companies in early 2003. The newly acquired manufacturing
companies will manufacture products for both the Company and outside sales
customers.

Consolidated EBITDA increased $21.6 million, or 25.3%, to $106.5 million in
2002 from $84.9 million in 2001 primarily due to increased manufacturing
profitability and increases in outside sales. Domestic direct

16

sales EBITDA increased $7.7 million due to efficiencies in operating expenses as
discussed previously in "Results of Operations." Manufacturing related EBITDA
increased $12.9 million or, 38.3%, to $46.8 million in 2002 from $33.9 million
in 2001 primarily due to improved manufacturing efficiencies at DWC and Laredo
Candle. International EBITDA increased $0.5 million or 19.3%, to $3.0 million in
2002 from $2.5 million in 2001.

2001 COMPARED TO 2000

Consolidated net sales increased $1.3 million, or 0.3%, to $461.7 million
in 2001 from $460.4 million in 2000. A decrease in the Company's domestic direct
sales of $4.0 million was offset by an increase in International sales of $6.3
million, or 41.6%, to $21.4 million in 2001 from $15.1 million in 2000 due to
expansion of the international direct selling channel primarily in Mexico.
Manufacturing related sales increased $30.9 million, or 35.3% to $118.5 million
in 2001 from $87.6 million in 2000 primarily due to increased sales at Laredo
Candle of $24.3 million over prior year.

Consolidated EBITDA increased $9.6 million, or 12.9%, to $84.9 million in
2001 from $75.3 million in 2000 primarily due to increased manufacturing
profitability in 2001. Domestic EBITDA decreased $7.2 million primarily due to
increased operating expenses as discussed previously in "Results of Operations."
As an offset, manufacturing related EBITDA increased $16.2 million, or 91.6%, to
$33.9 million in 2001 from $17.7 million in 2000 due to increased EBITDA at
Laredo Candle of $10.1 million over prior year. International EBITDA increased
$1.8 million to $2.5 million in 2001 from $0.7 million in 2000.

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 increased $50.4 million to $64.1 million as of December
31, 2002, from $13.7 million at December 31, 2001. The increase resulted
primarily from $44.2 million and $20.1 million provided by operating and
financing activities, respectively, offset in part by $13.8 million used in
investing activities.

Net cash of $44.2 million provided by operating activities consisted
primarily of $65.5 million from net income, as adjusted for non-cash items, and
$21.2 million used by working capital and other activities. Non-cash activities
consisted primarily of $11.7 million in depreciation, $6.7 million in inventory
reserves, and $4.5 million of extraordinary loss related to the write-off of
previously capitalized debt issuance fees associated with debt, which was
restructured in July 2002. Working capital consisted primarily of a $21.4
million increase in inventory balances related to increased demand for the
product line and new product line introductions and $5.4 million of accrued
Director commissions.

Net cash of $13.8 million used in investing activities primarily resulted
from $14.2 million in capital expenditures for the purchase of computer hardware
and software related to the Company's implementation of a new ERP system and
investments in the consolidated warehouse and distribution facility and
manufacturing facilities. These expenditures were partially offset by the
proceeds received from the sale of property, plant and equipment.

17

With the recent acquisition of several manufacturing facilities discussed
earlier, the Company expects to incur additional working capital requirements
such as higher inventory levels and increased accounts receivables. Non-cash
activities such as depreciation and amortization expense and inventory reserves
are expected to increase as well due to increased business requirements and
activities. The Company believes that the additional revenues and manufacturing
efficiencies that will be provided by the new facilities will offset the
additional costs and as a result, will not require us to draw on the Revolver or
incur more indebtedness.

In November 2001, the Company initiated a project to install a new ERP
system 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 old system. 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 was completed on December 29, 2002. The Company has
experienced no significant interruptions in business operations as a result of
the new systems implementation.

Cash provided by financing activities of $20.1 million consists primarily
of $35.0 million of additional debt incurred as a result of the July 2002 debt
restructure. As of December 31, 2002 there was no outstanding balance on the
Revolving Loans. Financing activities also include payments under the Senior
Credit Facility of $9.2 million and $20.3 million in 2002 and 2001, respectively
and the new debt issuance fees of $4.2 million and $1.6 million related to the
debt restructures in 2002 and 2001, respectively.

In 2001, net cash of $40.3 million provided by operating activities
consisted primarily of $35.9 million from net income, as adjusted for non-cash
items, and $4.4 million provided by working capital and other activities. Net
cash provided by working capital and other activities resulted from increases in
accounts payable and other accrued liabilities, partially offset by an increase
in inventories. The increase in inventories and accounts payable was primarily a
result of purchases in preparation for a greater number of new Products that the
Company introduced with the launch of the Company's children's line in February
2002. In addition, the Company instituted a change in import purchasing
procedures. The Company now assumes ownership of its Products at an earlier
stage in the procurement process than it did in 2000.

Net cash of $14.8 million used in investing activities in 2001 primarily
resulted from $15.1 million in capital expenditures for the purchase of computer
hardware and software and investments in the consolidated warehouse and
distribution facility and manufacturing facilities. These expenditures were
partially offset by the proceeds received for the sale of property, plant and
equipment.

Cash used in 2001 for financing activities of $53.4 million consisted
primarily of net payments of $30.0 million under the Revolving Loans. As a
result of the timing and the magnitude of working capital requirements and
capital expenditures, the Company utilized the Revolving Loans at varying times
during 2001. As of December 31, 2001 there was no outstanding balance on the
Revolving Loans as compared to $30.0 million outstanding on December 31, 2000.
Financing activities also included payments under the Senior Credit Facility of
$20.3 million and $27.2 million in 2001 and 2000, respectively.

Payments on the 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.
The Company has the option to redeem the Notes in whole or in part at any time
on or after June 1, 2003. Borrowings under the Senior Credit Facility require
quarterly interest and principal payments. In addition, the Senior Credit
Facility includes $30.0 million of Revolving Loans, which mature on June 30,
2004. The Revolving Loans were reduced from $40.0 million to $30.0 million as a
result of the amendment to the Senior Credit Facility in March 2001.

The Company paid a total of $33.9 million in debt service for 2002,
consisting of principal payments under the Senior Credit Facility of $9.2
million, interest under the Senior Credit Facility of approximately $9.6 million
and interest of $15.1 on the Notes. The Company anticipates that its debt
service requirements will total $48.2 million in 2003, consisting of principal
payments due under the Senior Credit Facility of $6.7 million, mandatory
prepayment of debt of $12.4 million, interest due under the Senior Credit
Facility of $14.0 million, interest of $15.1 million due on the Notes.

18

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. Subject to the financial ratios and tests, the Company will be
required to make certain mandatory prepayments of the term loans on an annual
basis beginning in March 2003. The Company will be making a $12.4 million
prepayment on debt on March 31, 2003. As of December 31, 2002, cumulative
preferred stock dividends in arrears were $17.5 million.

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 converted 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 advanced 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 paid 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 (1) paid
such lenders a 25 basis point consent fee and (2) increased 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 Tranche B term loans, the Company and its lenders
increased the size of the Company's permitted acquisition basket, increased the
Company's capital expenditure (including capital lease) basket and modified 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.

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 following table summarizes the contractual obligations at December 31,
2002, and the effects such obligations are expected to have on its liquidity and
cash flow in future periods (in thousands).

Long-term debt consists of borrowings under the Senior Credit Facility,
Notes and a note related to the acquisition of BBA. The Senior Credit Facility
borrowings require quarterly principal payments and the Notes require semiannual
interest payments. The Company may, at its option, prepay the term loans without
premium or penalty. The note related to BBA consists of annual payments.

19

The Company entered into capital lease obligations for equipment associated
with the automated order fulfillment system being used in the warehouse and
distribution facility. The lessor funded the equipment purchase when
construction of the automated order fulfillment system was completed in April
2000. The initial term of each of the leases is seven years. Interest is imputed
at approximately 6.1% per annum. The Company also leases office furniture and
equipment.

The Company has several outstanding operating leases related to the Granite
facilities and additional warehousing space. The majority of the Granite
facility has been subleased. See "Item 2. Properties."

During the year ended December 31, 2002, the Company had several letters of
credit outstanding related to insurance policies and an inventory supplier.

At December 31, 2002 and 2001, 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 or market or credit risk that
could arise if the Company had engaged in such relationships.

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 December 31, 2003. 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.

Corporate Headquarters Facility. On January 3, 2000, the Company entered
into a ten year lease with Granite for a new corporate headquarters location in
Dallas, Texas. The Company's offices occupied approximately 75,000 square feet
of office space at an annual rent of approximately $1.6 million. Tenant
improvements to customize the space totaled approximately $2.9 million, of which
approximately $2.0 million was borne by the landlord as improvement allowances.
Additionally, on December 30, 1999, the Company entered into a $1.2 million
capital lease obligation for certain furniture and fixtures to be used in the
new corporate headquarters. In December 2000, the Company moved the corporate
headquarters from these facilities to the new warehouse and distribution
facility. The Company has subleased approximately 44,000 square feet of the
Company's former leased headquarters to a subtenant. The Company has hired
consultants to assist in subleasing the remaining unused space or to complete a
buyout of the remaining lease obligation. See Note 8 to the Consolidated
Financial Statements.

MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT

The Company's Products are sold in Mexico and Canada thereby subjecting the
Company to financial market risk due to fluctuating foreign currency exchange
rates. Historically, due to a stable foreign exchange and due to the fact that
these operations have not been significant, the risk has been minor. However, as
the Company's international operations become significant to the Company as a
whole, changes in foreign currency exchange rates could have a material effect
on the Company in the future. The Company has not entered into any hedging
instruments related to foreign currency risk.

As a result of the interest pricing mechanism associated with the bank
debt, 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 2002, the Company did not enter into any
hedging instruments. In addition, the Company does not use derivative
instruments for trading or speculative purposes.

20

The following table presents principal cash flows of variable rate debt by
maturity date and the related average interest rates based upon existing terms.
The interest rates are weighted between the Tranche A Loan and the Tranche B
Loan based on debt outstanding and are estimated based on implied forward rates
using a yield curve as of December 31, 2002. The Notes are at a fixed rate of
10.125% and will mature in 2008.

The following table presents comparable data for the prior year ended
December 31, 2001.

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 in 2000, 2001 or 2002.

RECENTLY ISSUED STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS

In December of 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure" ("SFAS No. 148"). SFAS No. 148 amends
FASB Statement No. 123 "Accounting for Stock-Based Compensation" to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation and amends the
disclosure requirements of Statement 123 to require prominent disclosure about
the effects on reported net income of an entity's accounting policy decisions
with respect to stock-based employee compensation. SFAS No. 148 also amends APB
Opinion No. 28 "Interim Financial Reporting", to require disclosure about those
effects in interim financial information. SFAS No. 148 is effective for fiscal
year ending December 31, 2002. The Company is currently evaluating the change to
the fair value based method of accounting for stock-based employee compensation.
Effective December 31, 2002 the Company has adopted the new disclosure
requirements.

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,

21

"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 anticipates it will reclassify the Company's
previously recorded extraordinary loss into continuing operations. 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.

ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Securities and Exchange Commission requires that registrants include
information about the 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 7. Management's Discussion and Analysis of Financial
Condition and Results of Operation," which information is hereby incorporated by
reference into this Item 7A. All statements other than historical information
incorporated into this Item 7A 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. Based on our debt balance as of December 31,
2002, a one point increase or decrease in the variable interest rate for the
Tranche A Loan and the Tranche B Loan would result in an increase or decrease in
pretax earnings of approximately $1.9 million.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements and financial statement schedule of
the Company and its subsidiaries required by this Item 8 are listed in Part IV,
Item 14(a) of this report. Such consolidated financial statements are included
herein beginning on page F-1.

22

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not Applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

DIRECTORS AND EXECUTIVE OFFICERS

Set forth below is certain information as of March 2003 with respect to
those individuals who are serving as members of the Board or as executive
officers of the Company.

Set forth below is a description of the backgrounds of those persons who
are serving as members of the Board and as executive officers of the Company.
All of the Company's officers are appointed by the Board and serve at its
discretion.

Donald J. Carter, Jr. has served as Chief Executive Officer of the Company
since October 1997 and in June 1998 became Chairman of the Board. Since he
joined the Company in 1984, Mr. Carter has also served the Company in various
executive capacities, including as Executive Vice President of Sales from 1994
to 1997. Mr. Carter is Chairman of the Direct Selling Association ("DSA") and
also serves on the Board of Directors of the Direct Selling Educational
Foundation. Mr. Carter is the brother of Christina L. Carter Urschel, and the
grandson of the Company's founder, Mary Crowley.

Barbara J. Hammond has served as Vice Chairman of the Company since
February 2000 and as of January 1, 2002, is a consultant to the Company and has
been a director of the Company since 1970. Ms. Hammond served as President of
the Company from 1995 to January 2000. Ms. Hammond has served the Company in
various executive capacities from 1986 to 1995, including as National Sales
Manager and Executive Vice President of Sales. Ms. Hammond originally joined the
Company as a Displayer in 1960, when she was personally trained by Mary Crowley,
and rose to become one of the Company's top Displayers and Directors.

Christina L. Carter Urschel has served the Company as Vice Chairman and
National Spokesperson since November 1, 2001, President from February 2000 to
November 1, 2001, and has been a Director of the Company since May 1995. Ms.
Urschel served as Executive Vice President of the Company from 1997 to January
2000, and as Vice President from 1994 to 1997. Ms. Urschel joined the Company in
1987 and, since

23

that time, has undertaken various sales and marketing responsibilities. As of
November 1, 2001, Ms. Urschel serves as the President of the Pocketful of Hope
charitable foundation. Ms. Urschel is the sister of Donald J. Carter, Jr., and
the granddaughter of the Company's founder, Mary Crowley.

Michael D. Lohner has served the Company as President and Chief Operating
Officer since November 1, 2001, as Executive Vice President and Chief Operating
Officer from January 10, 2001 to November 1, 2001, and as Sr. Vice President and
Chief Operating Officer from May 24, 2000 to January 10, 2001. Mr. Lohner held
various positions, including President and CEO, at Evergreen Alliance Golf
Limited from 1991 through 1999. A graduate of Stanford Business School, Mr.
Lohner has also worked as a Management Consultant to Bain & Company and has
participated in the "Executive in Residence" program of Hicks, Muse, Tate &
Furst, Incorporated. Mr. Lohner also serves on the Board of Directors of the DSA
and is Chairman of the Industry Research Committee.

Kenneth J. Cichocki has served the Company as Sr. Vice President of Finance
and Chief Financial Officer since November 1, 2001 and as Vice President of
Finance and Chief Financial Officer from November 1, 1999 to November 1, 2001.
From 1993 to 1999, Mr. Cichocki served as a consultant for the RMP Group, a
corporate consulting firm that provided financial and management consulting
services. From 1980 to 1992, Mr. Cichocki served Guinness PLC in various
capacities, including Chief Financial Officer of one of its divisions. Prior to
joining Guinness, Mr. Cichocki served Price Waterhouse LLP from 1975 to 1980 as
a Senior Accountant. Mr. Cichocki is a Certified Public Accountant.

Nora I. Serrano has served the Company as Sr. Vice President of Sales since
November 1, 2002. Sr. Vice President of Sales Training and Development since
November 1, 2001, as Vice President of Sales Training and Development from
November 1, 2000 to November 1, 2001, and as Director of Sales Training and
Development from April 25, 2000 to November 1, 2000. Prior to joining the
company, Ms. Serrano held various positions in the Direct Selling Industry from
1993 through 2000 as a Sales and Marketing executive.

Eugenia B. Price has served the Company as Senior Vice President
International since May 21, 2002, as Vice President International and New Market
Development from October 2000 to April 2002, as Vice President Marketing and
International May 1999 to September 2000 and as Vice President International and
Strategic Planning January 1999 to April 1999. Prior to joining the Company, Ms.
Price held various management positions at Mary Kay Inc. in the International
Development and Marketing areas from 1991 through 1998.

Thomas O. Hicks has been a Director of the Company since June 1998. Mr.
Hicks is Chairman of the Board of Hicks, Muse, Tate & Furst Incorporated. From
1984 to May 1989, Mr. Hicks was Co-Chairman of the Board and Co-Chief Executive
Officer of Hicks & Haas Incorporated, a Dallas-based private investment firm.
Mr. Hicks serves as a Director of Clear Channel Communications, Inc., and is
Chairman of Viasystems Group, Inc. Mr. Hicks also serves as a Director of
Cooperative Computing Inc., Corpgroup Limited, Digital Latin America, Fox Pan
American Sports LLC, MVS Corporation, Pinnacle Foods, Swift & Co., and Yell,
Inc. He also serves on the Board of Directors of Crow Family Holdings, as well
as the JP Morgan Chase National Advisory Board.

Jack D. Furst has been a Director of the Company since June 1998. Mr. Furst
is a Partner of Hicks, Muse, Tate & Furst Incorporated. Prior to joining Hicks
Muse, Mr. Furst was a Vice President and subsequently a Partner of Hicks & Haas
Incorporated, a Dallas-based private investment firm from 1987 to May 1989. From
1984 to 1986, Mr. Furst was a merger and acquisition/corporate finance
specialist for The First Boston Corporation in New York. Before joining First
Boston, Mr. Furst was a financial consultant at Price Waterhouse, LLP. Mr. Furst
serves on the Board of Directors of Viasystems Group, Inc., International Wire
Holding Company and Cooperative Computing, Inc.

Joseph Colonnetta has been a Director of the Company since August 1999. Mr.
Colonnetta is a Partner of Hicks, Muse, Tate & Furst Incorporated. Prior to
joining Hicks Muse, Mr. Colonnetta served as a Managing Principal of a
management affiliate of Hicks Muse from 1995 to 1998. Mr. Colonnetta has served
in various Executive Positions of consumer and industrial companies owned by
Bass Investment Partners and

24

Oppenheimer & Company. Mr. Colonnetta is also a Director of Swift & Company,
Viasystems Group, Inc., Cooperative Computing, Inc., Grupo Minsa, Safeguard
Systems, Zilog and Veltri Automotive, Inc.

Sheldon I. Stein became a Director in July 1998. Mr. Stein is a Senior
Managing Director and oversees the Southwest Region Investment Banking for Bear
Stearns. Prior to joining Bear Stearns in 1986, Mr. Stein was a partner in the
Dallas law firm of Hughes & Luce, where he specialized in corporate finance and
mergers and acquisitions. Mr. Stein serves on the Boards of Directors of several
companies including The Men's Wearhouse, Inc. and Fitz and Floyd. He was a
Trustee of Brandeis University and currently serves on the Board of Overseers of
the Brandeis Graduate School of Economics and Finance.

Robert H. Dedman, Jr. became a Director of the Company in May 1999. Mr.
Dedman is Chairman of the Board and Chief Executive Officer of ClubCorp, Inc.
and Chairman of ClubCorp USA, Inc.. Mr. Dedman was Director of Corporate
Planning for ClubCorp from 1980 to 1984 and then served as an associate at
Salomon Brothers Inc specializing in mergers and acquisitions from 1984 to 1987.
In 1987 he returned to ClubCorp as CFO, was named President and Chief Operating
Officer in January 1989 and Chairman of the Board in August 2002. Mr. Dedman
serves on the Board of Directors of ClubCorp, National Golf Foundation, Southern
Methodist University's Dedman School of Law, JPMorgan Chase Dallas Region and
the University of Texas at Austin Development Board. He is also an Executive
Board Member of Golf 20/20, a National Trustee in the Southwest Region of the
Boys and Girls Clubs of America, Trustee of Southwestern Medical Foundation,
Dallas Museum of Art and past Chairman of the Texas Business Hall of Fame. Mr.
Dedman also Chairs the Southern Methodist University's 21st Century Council.

Gretchen M. Williams became a Director of the Company in December 1998. Ms.
Williams is Co-Chairman of the Board and Co-Chief Executive Officer of Minyard
Food Stores, Inc., its divisions Sack 'N Save and Carnival Food Stores and its
subsidiary, Minyard Properties. She has been employed by Minyard Food Stores,
Inc. since 1978. Ms. Williams also serves as a Director of JP Morgan/Chase Bank
of Texas N.A. and Baylor University Medical Center.

The Hicks Muse Shareholders (as defined below in "Item 12. Security
Ownership of Certain Beneficial Owners and Management") and Adkins Family
Partnership, Ltd., M. Douglas Adkins, Estate of Fern Ardinger, Ardinger Family
Partnership, Ltd., Donald J. Carter, Linda J. Carter, Donald J. Carter, Jr.,
Christina L. Carter Urschel, Ronald L. Carter, Carter 1997 Charitable Remainder
Unitrust and Hammond Family Trust (collectively, the "Carter Shareholders")
entered into a Shareholders Agreement (the "Shareholder Agreement") upon
consummation of the Recapitalization. The Shareholders Agreement generally
provides that Hicks Muse may designate six directors. Donald J. Carter, Jr.,
Barbara J. Hammond and Christina L. Carter Urschel, as designees (the "Carter
Designees") of the Carter Shareholders may designate three directors and Hicks
Muse and the Carter Designees mutually may designate two independent directors.
Thomas O. Hicks, Jack D. Furst, Joseph Colonnetta and Sheldon I. Stein are
designated as directors by Hicks Muse. Donald J. Carter, Jr., Barbara J. Hammond
and Christina L. Carter Urschel are designated as directors by the Carter
Designees. Hicks Muse and the Carter Designees mutually designated Robert H.
Dedman, Jr. and Gretchen M. Williams as independent Directors of the Company.
Hicks Muse has not designated the additional directors.

COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

The Company does not have any class of equity securities registered under
Section 12 of the Securities Exchange Act of 1934, as amended. Therefore, the
shareholders of the Company are not required to file reports pursuant to Section
16(a) thereof.

ITEM 11. EXECUTIVE COMPENSATION

The following table sets forth the compensation earned during each of the
three years, or as applicable, in the period ended December 31, 2002, to the
Chief Executive Officer and the other four most highly

25

compensated executive officers who were serving as executive officers at
December 31, 2002 (the "Named Executive Officers").

SUMMARY OF OPTION GRANTS

The following table provides certain summary information concerning grants
of options to the Named Executive Officers of the Company during the 2002 fiscal
year:

- ---------------

(1) The grant date present value was determined using the Minimum Value method
of option pricing with the following assumptions: dividend yield of zero,
risk-free interest rate of 3.12% and expected term of six years.

COMPENSATION OF DIRECTORS

Persons serving as independent directors on the Board are paid $2,500 per
Board meeting, and $750 per Committee Meeting ($250 for telephone
participation). The independent directors serving on the Board in 2002 were
Sheldon I. Stein, Gretchen M. Williams, Robert H. Dedman, Jr. and Barbara J.
Hammond. Mr. Stein and Ms. Williams also serve on the Audit Committee.

During 2002, Board and Board Committee fees were paid to certain outside
Directors in the amount of $33,500 as follows: Mr. Stein received $10,000, Ms.
Williams received $10,500, Mr. Dedman received $5,250 and Ms. Hammond received
$7,750.

In addition, the initial independent directors of the Company were given
the right to purchase up to $100,000 of common stock and were granted stock
options to purchase up to $100,000 of common stock based on the amount of their
common-stock investment. On November 15, 2002, Mr. Stein, Ms. Williams, and Mr.
Dedman each were granted additional options for 11,375 shares of common stock at
an exercise price

26

equal to $19.42 under the 1998 Plan. All such options vest in 20% increments in
five equal, consecutive annual installments on each anniversary of the grant.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The Company's Compensation Committee is comprised of Donald J. Carter Jr.,
Thomas O. Hicks, and Jack D. Furst. All decisions regarding compensation of
executive officers are made by the Compensation Committee. During fiscal 2002,
Mr. Carter also served as an executive officer of the Company. Messrs. Hicks and
Furst are also principals of Hicks Muse Partners (as defined below) an entity
which receives substantial fees in connection with certain advisory and
oversight services to the Company. See "Item 13. Certain Relationships and
Related Transactions."

EXECUTIVE EMPLOYMENT AND CONSULTING AGREEMENTS

On June 4, 1998, following the Recapitalization, the Company entered into
an Executive Employment Agreement with Donald J. Carter, Jr. The Company is
currently in negotiations with Donald J. Carter Jr. for renewal of his Executive
Employment Agreement. Pursuant to the terms of his Executive Employment
Agreement, Donald J. Carter, Jr. will be employed as Chairman of the Board and
Chief Executive Officer of the Company for five years with a base salary of
$500,000 and with total annual compensation (including bonuses) ranging from
$500,000 to $1,125,000. The Executive Employment Agreement with Donald J.
Carter, Jr., provides for a lump sum severance payment in the event such
individual is terminated by the Company without Cause (as defined in such
Executive Employment Agreement) or such individual terminates their employment
for Good Reason (as defined in such Executive Employment Agreement). Subject to
certain exceptions, the amount of such lump sum severance payment equals (i)
five times the applicable executive's base salary if such executive is
terminated within one year after the Recapitalization or (ii) the greater of (a)
the aggregate base salary payable to the executive from the date of termination
through the expiration of the remainder of the term of the Executive Employment
Agreement and (b) three times the total base salary and annual bonus, if any,
received by the executive in the fiscal year preceding the fiscal year in which
such executive was terminated. In addition, the executive has agreed pursuant to
his Executive Employment Agreement not to compete with the Company during his
employment and for a period of three years after termination of such executive's
employment for any reason.

On May 24, 2000, the Company entered into an Employment Agreement with
Michael D. Lohner. Mr. Lohner was employed as Senior Vice President and Chief
Operating Officer for the Company for one year with a base salary of $295,000
and with total annual compensation (including bonuses) that ranged from $295,000
to $405,625. Effective December 31, 2000, Mr. Lohner's Employment Agreement was
amended and restated as President and Chief Operating Officer allowing for a
$450,000 base salary and with total compensation (including bonuses) that ranges
from $450,000 to $1,868,750. Effective July 30, 2001, the Company entered into a
second amended and restated Employee Agreement with Mr. Lohner allowing for an
extended employment through December 2004 with the same compensation.

On November 1, 1999, the Company entered into an Employment Agreement with
Kenneth J. Cichocki. Mr. Cichocki was employed as Vice President of Finance and
Chief Financial Officer of the Company for one year with a base salary of
$250,000 and with total annual compensation (including bonuses) that ranges from
$250,000 to $350,000. Effective November 1, 2000, Mr. Cichocki's Employment
Agreement was amended and restated allowing for a $275,000 base salary and with
total compensation (including bonuses) that ranges from $275,000 to $378,125. As
of November 1, 2001, Mr. Cichocki is employed as Senior Vice President of
Finance and Chief Financial Officer. Effective November 1, 2002, Mr. Cichocki's
Employment Agreement was amended allowing for a $300,000 base salary and with
total compensation (including bonuses) that ranges from $300,000 to $412,500.
Mr. Cichocki's Employment Agreement may be extended for successive one year
periods.

On November 21, 2001, the Company entered into an Employment Agreement with
Nora I. Serrano. Ms. Serrano was employed as Senior Vice President of Sales
Training and Development for the Company for one year with a base salary of
$250,000 and with total annual compensation (including bonuses) that ranged

27

from $250,000 to $343,750. Effective November 21, 2002, Ms. Serrano's is
employed as Senior Vice President of Sales of the Company and her Employment
Agreement was amended allowing for a base salary of $275,000 and with total
annual compensation (including bonuses) that ranges from $275,000 to $378,125.
Ms. Serrano's Employment Agreement may be extended for successive one-year
periods.

On January 1, 2003, the Company entered into an Employment Agreement with
Eugenia B. Price. Ms. Price is employed as Senior Vice President International
for one year with a base salary of $214,000 and with total annual compensation
(including bonuses) that ranges from $214,000 to $294,250. Ms. Price's
Employment Agreement may be extended for successive one-year periods.

1998 STOCK OPTION PLAN FOR KEY EMPLOYEES

The employees eligible for options under the 1998 Stock Option Plan for Key
Employees (the "1998 Plan") are those employees whose performance and
responsibilities are determined by the Board (or a committee thereof) (in either
case, the "Committee") to be essential to the success of the Company and its
subsidiaries. A total of 1,353,924 shares of common stock are available for
grant under the 1998 Plan. Generally, the option period (i.e., the term under
which an option is exercisable) may not be more than ten years from the date the
option is granted. The Committee will determine, in its discretion, the key
employees and eligible non-employees who will receive grants, the number of
shares subject to each option granted, the exercise price and the option period
and will administer and interpret the 1998 Plan.

As of December 31, 2002, options for 1,106,823 of common stock at an
exercise price of $18.05451, options for 42,192 shares of common stock at an
exercise price of $21.33 and options for 34,125 shares of common stock at an
exercise price of $19.42 were issued under the 1998 Plan. In 2002, options for
10,540 shares of common stock were forfeited and no options for shares of common
stock were exercised at an exercise price of $18.05451. As of December 31, 2002,
options for 350,252 shares of common stock were available for grant under the
1998 Plan. As of December 31, 2002, Donald J. Carter, Jr., Mike Lohner, Ken
Cichocki, Nora Serrano and Eugenia Price held options to purchase 338,481,
50,000, 24,916, 10,000 and 9,376 shares of common stock, respectively. Theses
options were granted on substantially similar terms, and vest over a five year
period, subject to accelerated vesting in full upon a Change of Control (as
defined in "Purchase Option," below) or, in respect of any such holder, upon
such holder's termination of employment without cause.

Although the Committee has full discretion to determine the terms of any
option, it is expected that options will generally vest or become exercisable in
equal annual installments over a five-year period. All installments that become
exercisable will be cumulative and may be exercised at any time after they
become exercisable until the expiration of the option period. Both incentive
stock options and nonqualified stock options may be granted under the 1998 Plan.
Incentive stock options and, unless otherwise specified in the applicable stock
option agreements, nonqualified stock options may not be transferred other than
by will or by the laws of descent and distribution. The Committee shall have the
right, but not the obligation, to accelerate the vesting of any option upon the
occurrence of, or the entering into an agreement providing for, a Change of
Control.

Unless terminated sooner in accordance with its terms, the 1998 Plan will
terminate on April 11, 2008, and no options may be granted under the 1998 Plan
thereafter. The Committee may amend, modify, suspend or terminate the 1998 Plan
without the shareholders' approval, except that, without shareholder approval,
the Committee will not have the power or authority to increase the number of
shares of common stock that may be issued pursuant to the exercise of options
under the 1998 Plan, decrease the minimum exercise price of any incentive stock
options or modify the requirements relating to eligibility with respect to
incentive options. The Committee may, however, make appropriate adjustments in
the number and/or kind of shares and/or interests subject to an option and the
per share price or value thereof to reflect any merger, consolidation,
combination, liquidation, reorganization, recapitalization, stock dividend,
stock split, split-up, split-off, spin-off, combination of shares, exchange of
shares or other like change in capital structure of the Company.

28

2002 STOCK OPTION PLAN FOR KEY EMPLOYEES

The employees eligible for options under the 2002 Stock Option Plan for Key
Employees (the "2002 Plan") are those employees who are identified by the
Committee as having a direct and significant effect on the performance of the
Company or any related entity. A total of 6,000,000 shares of common stock are
available for grant under the 2002 Plan with a limitation of no more than
2,000,000 shares allowed to be issued to a single person. Generally, the option
period (i.e., the term under which an option is exercisable) may not be more
than ten years from the date the option is granted. The Committee will
determine, in its discretion, the key employees who will receive grants, the
number of shares subject to each option granted, the exercise price and the
option period and will administer and interpret the 2002 Plan.

As of December 31, 2002, options for 3,500,000 of common stock at an
exercise price of $19.42 had been granted under the 2002 Plan. As of December
31, 2002, options for 2,500,000 shares of common stock were available for grant
under the 2002 Plan. As of December 31, 2002, Mike Lohner, Ken Cichocki, Nora
Serrano and Eugenia Price held options to purchase 1,000,000, 600,000, 500,000
and 500,000 shares of common stock, respectively. These options were granted on
substantially similar terms, and vest over a five-year period, if certain equity
value targets are met or upon a Change of Control if certain Change of Control
equity values are met (as defined in "Purchase Option," below).

Although the Committee has full discretion to determine the terms of any
option, it is expected that options will generally vest or become exercisable in
equal annual installments over a five-year period, subject to the equity value
targets being met for such annual periods. All installments that become
exercisable will be cumulative and may be exercised at any time after they
become exercisable until the expiration of the option period. Both incentive
stock options and nonqualified stock options may be granted under the 2002 Plan.
Incentive stock options and, unless otherwise specified in the applicable stock
option agreements, nonqualified stock options may not be transferred other than
by will or by the laws of descent and distribution. The Committee shall have the
right, but not the obligation, to accelerate the vesting of any option upon the
occurrence of, or the entering into an agreement providing for, a Change of
Control.

Unless terminated sooner in accordance with its terms, the 2002 Plan will
terminate on August 14, 2012, and no options may be granted under the 2002 Plan
thereafter. The Committee may amend, modify, suspend or terminate the 2002 Plan
without the shareholders' approval, except that, without shareholder approval,
the Committee will not have the power or authority to increase the number of
shares of common stock that may be issued pursuant to the exercise of options
under the 2002 Plan, decrease the minimum exercise price of any incentive stock
options or modify the requirements relating to eligibility with respect to
incentive options or increase the term of the 2002 Plan. The Committee may,
however, make appropriate adjustments in the number and/or kind of shares and/or
interests subject to an option and the per share price or value thereof to
reflect any merger, consolidation, combination, liquidation, reorganization,
recapitalization, stock dividend, stock split, split-up, split-off, spin-off,
combination of shares, exchange of shares or other like change in capital
structure of the Company.

PURCHASE OPTION

Except in the case of options held by Donald J. Carter, Jr., until such
time as the Company has consummated an underwritten public offering with the
result that the ownership of the then outstanding shares of common stock held by
the Hicks Muse Shareholders (as defined below) is less than 10% of the fully-
diluted common stock of the Company, the Company shall have the right, but not
the obligation, to purchase an optionee's options under the 1998 Plan and the
2002 Plan or any shares of common stock acquired pursuant to the exercise of his
or her options in the event of an optionee's termination of employment or the
occurrence of a Change of Control. "Change of Control" shall mean, generally,
(a) any sale, lease, exchange or other transfer of all or substantially all of
the assets of the Company to an unaffiliated person or entity, (b) a majority of
the Board shall consist of individuals other than those nominated by the
majority of the Directors then serving on the Board or affiliates of the Hicks
Muse Shareholders or (c) the acquisition by any person other than one or more of
the Hicks Muse Shareholders of the power to vote or direct the voting of more
than 50% of the ordinary voting power for the election of directors of the
Company. If the Company exercises its

29

right to purchase any optionee's options or shares of common stock, the purchase
price shall be equal to the fair market value (as defined in the 1998 Plan and
the 2002 Plan).

STOCK OPTION TRUST

Effective on June 4, 1998, the Company adopted the Home Interiors & Gifts,
Inc. 1998 Stock Option Plan for Unit Directors, Branch Directors, and certain
other independent contractors (the "1998 Independent Contractor Plan"). This
Plan was put in place in order to afford certain Unit Directors, Branch
Directors and other independent contractors an opportunity to acquire a
proprietary interest in the Company. Options for a total of 338,481 shares of
common stock were available for grant under the 1998 Independent Contractor
Plan. As of December 31, 2002, options for 275,338 shares of common stock at an
exercise price of $18.05451, and options for 61,074 shares of common stock at an
exercise price of $21.33 had been granted to a trustee (the "Trust Options"), to
be held in trust (the "Stock Option Trust") for the benefit of such Unit
Directors, Branch Directors and other independent contractors. As of December
31, 2002, options for 2,069 shares of common stock were available for grant
under the Stock Option Trust. Under the terms of the Stock Option Trust, the
Trust Options vest in five equal annual installments from the date of grant or,
if earlier, upon the consummation of an underwritten initial public offering of
common stock satisfying certain requirements. The Trust Options expire on the
tenth anniversary of the date of grant. The Trust Options are not exercisable
until the first to occur of the 90th day following the consummation of an
underwritten initial public offering of common stock satisfying certain
requirements and the eighth anniversary of the consummation of the
Recapitalization. At such time as the Trust Options become exercisable, the
trust created under the Stock Option Trust will be liquidated and the Trust
Options will be distributed to the respective beneficiaries. Under certain
circumstances, the Company shall have the right to purchase the Trust Options,
or the shares of common stock issuable upon exercise thereof, for the difference
between the fair market value of the common stock underlying such Trust Options
and the option exercise price thereof.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

For information regarding securities authorized for issuance under equity
compensation plans, see Item 5 of this Form 10-K.

The following table sets forth as of March 14, 2003, certain information
regarding the beneficial ownership of the common stock by (i) each person who
owns beneficially more than 5% of the issued and outstanding shares of common
stock, (ii) each Director of the Company, (iii) each Named Executive Officer and
(iv) all Directors and Named Executive Officers of the Company as a group. The
Company believes that each such holder has sole voting and dispositive power
over the shares of common stock held, except as otherwise indicated.

- ---------------

* less than 1%.

(1) Includes 33,996 shares held by Linda J. Carter, Donald J. Carter's wife.
Donald J. Carter disclaims beneficial ownership of all shares held by Linda
J. Carter.

(2) Consists of (i) 9,779,081 shares of common stock owned of record by HI
Equity Partners, L.P. ("HIEP"), a limited partnership whose sole general
partner is TOH Home Interiors LLC ("Home Interiors LLC"), (ii) 55,388
shares of common stock owned of record by HM/SS Investment Partners, L.P.,
("HMIP"), a limited partnership whose sole general partner is Home
Interiors LLC and (iii) 276,967 shares of common stock owned of record by
HM/BST Investment Partners, L.P. ("HM BST"), a limited partnership whose
sole general partner is Home Interiors LLC. In addition, the amounts shown
also include an aggregate of 5,849,278 shares of common stock issuable upon
conversion of (a) 50,900 shares of Senior Preferred Stock (including shares
of common stock issuable in respect of accrued and unpaid dividends through
December 31, 2002 on such shares of Senior Preferred Stock) beneficially
owned by HI Cayman, L.P. ("Cayman LP"), a Cayman Islands exempted limited
partnership whose sole general partner is HI Cayman GP, Ltd. ("Cayman GP"),
and (b) 45,158.98 shares of Senior Preferred Stock (including shares of
common stock issuable in respect of accrued and unpaid dividends through
December 31, 2002 on such shares of Senior Preferred Stock) beneficially
owned by HI Senior Debt Partners, L.P. ("Debt LP"), a Texas limited
partnership whose sole general partner is HI Senior Debt Partners GP, LLC
("Debt GP"). Each share of Senior Preferred Stock is convertible into
51.49330587 shares of common stock (subject to adjustment, the "Conversion
Price"), and all accrued and unpaid dividends on the Senior Preferred Stock
as of the date of conversion are convertible into a number of shares of
common stock equal to the amount of such accrued and unpaid dividends
divided by the Conversion Price, in each case at any time at the holder's
election, subject to the satisfaction or waiver of any applicable waiting
period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976.
Thomas O. Hicks is the sole member or sole stockholder, as applicable, and
director of Home Interiors LLC, Cayman GP and Debt GP and, accordingly, may
be deemed to be the beneficial owner of common stock held by HIEP, HMIP, HM
BST, Cayman LP and Debt LP, (collectively, the "Hicks Muse Shareholders").
In addition, Mr. Hicks is an indirect minority limited partner in HIEP. Mr.
Hicks disclaims beneficial ownership of common stock owned of record by the
Hicks Muse Shareholders.

31

(3) Includes 235 shares held by Penni W. Carter, Donald J. Carter, Jr.'s wife,
and a total of 422 shares held by Donald J. Carter, Jr. as custodian for
his three children. Donald J. Carter, Jr. disclaims beneficial ownership of
all shares held by Penni W. Carter. Also includes, 183,620 shares held in
the name of DMC Non-Exempt Partnership, LTD and 38,088 shares held in the
name of DMC Exempt Partnership, LTD. Donald J. Carter, Jr. is one of four
Directors of David and Mary Crowley Corporation, a Texas corporation that
is the sole general partner of the DMC Non-Exempt Partnership, LTD and the
DMC Exempt Partnership, LTD. Therefore Mr. Carter may be deemed to share
voting and dispositive power with the other Directors. Donald J. Carter,
Jr. disclaims beneficial ownership of all shares held in the name of the
DMC Non-Exempt Partnership, LTD and the DMC Exempt Partnership, LTD. Also
includes 270,785 shares of common stock subject to presently exercisable
options.

(4) Consists of 258,570 shares held in the name of Barbara J. Hammond and
Howard L. Hammond, Trustees of the Hammond Family Trust.

(5) Includes 174 shares held by Harold Clifton Urschel, III, Christina L.
Carter Urschel's husband, and 124 shares held by Christina L. Carter
Urschel as custodian for her child. Christina L. Carter Urschel disclaims
beneficial ownership of all shares held by Harold Clifton Urschel, III.
Also includes 270,785 shares of common stock subject to presently
exercisable options.

(6) Includes 220,000 shares of common stock subject to presently exercisable
options.

(7) Includes 131,842 shares of common stock subject to presently exercisable
options.

(8) Includes 105,626 shares of common stock subject to presently exercisable
options.

(9) Includes 103,000 shares of common stock subject to presently exercisable
options.

(10) Mr. Furst holds indirect minority limited partnership interests in HIEP.
Mr. Furst disclaims beneficial ownership of common stock owned of record by
HIEP.

(11) Includes 3,153 shares of common stock subject to presently exercisable
options.

(12) Includes 2,216 shares of common stock subject to presently exercisable
options.

(13) Consists of 4,432 shares of common stock subject to presently exercisable
options. Mr. Stein also holds a limited partnership interest in HMIP. Mr.
Stein disclaims beneficial ownership of common stock owned of record by
HMIP.

THE SHAREHOLDERS' AGREEMENT

The Shareholders Agreement provides that the Board will consist of eleven
members, including six directors designated by Hicks Muse, three directors
designated by the Carter Designees and two independent directors mutually
designated by the Carter Designees and Hicks Muse. As of the date hereof, the
Board consists of nine members. The number of directors to be designated by
Hicks Muse and the Carter Designees is subject to adjustment based upon the
ownership of common stock by the Hicks Muse Shareholders and the Carter
Shareholders. See "Item 10. Directors and Executive Officers of the Registrant."

The Shareholders Agreement also includes the Company's grant of certain
registration rights to the Hicks Muse Shareholders and the Carter Shareholders,
pursuant to which they may require, subject to certain restrictions, in the
event the Company effects an underwritten initial public offering of common
stock for gross proceeds of in excess of $25.0 million under the Securities Act,
subject to certain restrictions, the Company to register under the Securities
Act the shares of common stock owned by them. In addition, if the Company
proposes to register any of its securities under the Securities Act, the Hicks
Muse Shareholders and the Carter Shareholders shall have the right, subject to
certain restrictions, to include in such registration their shares of common
stock.

If any Hicks Muse Shareholders desire to transfer shares of common stock
representing more than 20% of the shares of common stock then held by the Hicks
Muse Shareholders, the Hicks Muse Shareholders must, subject to certain
restrictions, offer the Carter Shareholders the opportunity to include in the
proposed sale their proportionate share of the Carter Shareholders' common
stock. In addition, if through multiple sales of less than 20% of the shares of
common stock then held by the Hicks Muse Shareholders, the Hicks Muse
32

Shareholders desire to sell shares that, when aggregated with such prior sales,
would result in the Hicks Muse Shareholders holding less than 50% of the shares
of common stock held by them immediately after consummation of the
Recapitalization, the Carter Shareholders will have the right to sell shares of
their common stock in an amount equal to the same percentage of the shares they
owned immediately after consummation of the Recapitalization as the percentage,
in the aggregate, previously sold by the Hicks Muse Shareholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Set forth below is a description of transactions entered into between the
Company and certain of its shareholders or affiliates during 2002.

EXECUTIVE EMPLOYMENT AGREEMENT WITH DONALD J. CARTER

In connection with the Recapitalization, the Company entered into an
Executive Employment Agreement with Donald J. Carter, a shareholder who
beneficially owns 6.2% of the outstanding common stock of the Company. Under the
terms of his Executive Employment Agreement, Donald J. Carter will remain with
the Company as Chairman Emeritus but will not work full-time. Donald J. Carter's
Executive Employment Agreement provides for an employment term of five years and
annual compensation of $200,000, plus reimbursement for certain business-related
aviation expenses, and the use of a Company-owned vehicle. Donald J. Carter's
Executive Employment Agreement generally requires the Company to pay Mr.
Carter's salary throughout the five-year term unless Mr. Carter voluntarily
terminates his employment during such term. Donald J. Carter has agreed,
pursuant to his Executive Employment Agreement, not to compete with the Company
during his employment and for three years thereafter (or, if earlier, until such
time as one of Mr. Carter's direct lineal descendants is no longer the Chief
Executive Officer of the Company). In 2002, the Company paid Mr. Carter
approximately $263,000 pursuant to the terms and conditions of his Executive
Employment Agreement. Mr. Carter is the father of Donald J. Carter Jr. and
Christi Carter Urschel.

POCKETFUL OF HOPE CHARITIES

Donald J. Carter, Jr., Mike Lohner, Christi Carter Urschel and Leonard
Robertson, the Chief Administrative Officer are officers of Pocketful of Hope
Charities, a not-for-profit charity organization. The Company contributed
approximately $1.5 million to the organization in 2002.

CERTAIN OTHER TRANSACTIONS

In connection with the Recapitalization, the Company entered into an
agreement (the "Monitoring and Oversight Agreement") with Hicks, Muse & Co.
Partners, L.P. ("Hicks Muse Partners"), an affiliate of Hicks Muse. The
Monitoring and Oversight Agreement makes available to the Company and its
management on an ongoing basis the resources of Hicks Muse Partners concerning a
wide variety of financial and operational matters. The Company does not believe
that the services that have been and will continue to be provided to the Company
by Hicks Muse Partners could otherwise be obtained by the Company without the
addition of personnel or the engagement of outside professional advisors.
Pursuant to the Monitoring and Oversight Agreement, the Company will pay Hicks
Muse Partners a fee, payable quarterly, for monitoring and oversight services to
be provided to the Company. The fee will be adjusted, but not below $1.0 million
on January 1 of each calendar year to an amount equal to 1.0% of the
consolidated annual budgeted earnings of the Company before interest, taxes,
depreciation and amortization, but in no event shall such fee exceed $1.5
million annually. The Company paid Hicks Muse Partners approximately $1.0
million for monitoring and oversight services and reimbursement of general
expenses in 2002.

If the Board requests financial advisory services from Hicks Muse Partners
from time to time after the Recapitalization, Hicks Muse Partners also will be
entitled to receive a fee equal to 1.5% of the "transaction value" (as defined
in the Financial Advisory Agreement) for each "subsequent transaction" (as
defined in the Financial Advisory Agreement) in which the Company is involved.
Each of the Monitoring and Oversight Agreement and the Financial Advisory
Agreement terminates upon the earlier to occur of (a) the tenth

33

anniversary of its execution, (b) at any time prior to an underwritten initial
public offering of common stock pursuant to the Securities Act that meets
certain requirements, if Hicks Muse and its affiliates do not beneficially own
at least 25% of the then outstanding shares of common stock and Hicks Muse has
not designated at least one member of the Board or (c) at any time after such an
underwritten initial public offering of common stock, if Hicks Muse and its
affiliates do not beneficially own at least 10% of the then outstanding shares
of common stock and Hicks Muse has not designated at least one member of the
Board. Pursuant to the Financial Advisory Agreement, as of March 14, 2003, the
Company paid approximately $1.4 million to Hicks Muse for financial advisory
services rendered by Hicks Muse in connection with the Senior Preferred Stock
issuance.

PART IV

ITEM 14. CONTROLS AND PROCEDURES

(a) The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the Company's
filings under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the periods specified in the rules and forms of
the Securities and Exchange Commission. Such information is accumulated and
communicated to the Company's management, including its principal executive
officer and principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure. The Company's management, including the
principal executive officer and principal accounting officer, recognizes that
any set of controls and procedures, no matter how well designed and operated,
can provide only reasonable assurance of achieving the desired control
objectives.

Within 90 days prior to the filing date of this annual report on Form 10-K,
the Company has carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's principal
executive officer and the Company's principal financial officer, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures. Based on such evaluation, the Company's principal executive
officer and principal financial officer concluded that the Company's disclosure
controls and procedures are effective.

(b) There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect the internal
controls subsequent to the date of their evaluation in connection with the
preparation of this annual report on Form 10-K.

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) Financial Statements

(1) and (2) Financial Statements and Schedules

See "Index to Consolidated Financial Statements and Schedules" on page
F-1.

(3) Exhibits

- ---------------

* Filed herewith.

(b) Reports on Form 8-K:

On August 1, 2002 the Company filed a current report on Form 8-K with
respect to an amendment to the Company's Credit Agreement dated as of July
29, 2002.

38

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, 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/ DONALD J. CARTER, JR.
------------------------------------
Donald J. Carter, Jr.
Chairman of the Board and
Chief Executive Officer

Date: March 14, 2003

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

39

CERTIFICATIONS

I, Donald J. Carter, Jr., certify that:

1. I have reviewed this annual report on Form 10-K of Home Interiors &
Gifts, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function);

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

/s/ DONALD J. CARTER, JR.
--------------------------------------
Donald J. Carter, Jr.
Chairman and Chief Executive Officer

Date: March 14, 2003

40

CERTIFICATIONS

I, Kenneth J. Cichocki, certify that:

7. I have reviewed this annual report on Form 10-K of Home Interiors &
Gifts, Inc.;

8. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

9. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

10. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

d) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

e) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

f) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

11. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function);

c) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

d) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

12. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

/s/ KENNETH J. CICHOCKI
--------------------------------------
Kenneth J. Cichocki
Chief Financial Officer

Date: March 14, 2003

41

SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION
15(d) OF THE EXCHANGE ACT BY REGISTRANTS, WHICH HAVE NOT REGISTERED SECURITIES
PURSUANT TO SECTION 12 OF THE EXCHANGE ACT.

No annual report or proxy material has been or will be sent to security
holders of the Registrant.

42

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Report of Independent Accountants........................... F-2
Consolidated Balance Sheets as of December 31, 2001 and
2002...................................................... F-3
Consolidated Statements of Operations and Comprehensive
Income for the years ended December 31, 2000, 2001 and
2002...................................................... F-4
Consolidated Statements of Shareholders' Deficit for the
years ended December 31, 2000, 2001 and 2002.............. F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 2001 and 2002.......................... F-6
Notes to Consolidated Financial Statements.................. F-7
Schedule II Valuation and Qualifying Accounts............... F-36

F-1

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders
of Home Interiors & Gifts, Inc.

In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations and comprehensive income,
shareholders' deficit and cash flows present fairly, in all material respects,
the financial position of Home Interiors & Gifts, Inc. and Subsidiaries at
December 31, 2001 and 2002, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2002 in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule listed in
the accompanying index presents fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

/s/ PRICEWATERHOUSECOOPERS LLP

Dallas, Texas
March 13, 2003

F-2

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2001 AND 2002

The accompanying notes are an integral part of these consolidated financial
statements.
F-3

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2000, 2001 AND 2002

The accompanying notes are an integral part of these consolidated financial
statements.
F-4

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 2000, 2001 AND 2002

The accompanying notes are an integral part of these consolidated financial
statements.
F-5

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2000, 2001 AND 2002

The accompanying notes are an integral part of these consolidated financial
statements.
F-6

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND BACKGROUND

Home Interiors & Gifts, Inc. (the "Company") is a Dallas-based Texas
corporation and a fully-integrated manufacturer and distribution company. The
Company believes it is the largest direct seller of home decorative accessories
in the United States, as measured by sales. The Company's products include
framed artwork and mirrors, candles and candle accessories, plaques, figurines,
planters, artificial floral displays, wall shelves and sconces (the "Products").
The Company primarily sells the Products through a direct selling channel of
non-employee, independent contractor sales representatives ("Displayers") who
resell the Products primarily through the "party-plan" method to conduct in-home
presentations ("Shows") for potential customers. The Company has approximately
82,000 active Displayers located in the United States, Mexico, Canada and Puerto
Rico. The Company also sells Products to customers outside of its direct selling
channel.

Since its inception in 1957, the Company has sold a coordinated line of
Products to Displayers, a group of individuals (a majority of which are women)
who operate their own businesses by purchasing the Products from the Company and
reselling them to customers. The Company continues to stress the importance and
dignity of women, a philosophy adopted by its founder, Mary Crowley. This
philosophy remains deeply imbedded in the Company's training, recruiting,
motivating and selling strategies. The Company believes that this philosophy has
contributed to its ability to attract and retain loyal Displayers and to
distinguish its Products in the marketplace. The Company also believes that by
providing its Displayers with the appropriate support and encouragement, they
can achieve personally satisfying and financially rewarding careers by enhancing
the home environments of their customers.

A majority of the Company's outstanding common stock of record is owned by
affiliates of Hicks, Muse, Tate & Furst Incorporated, a Dallas-based private
investment firm ("Hicks Muse").

The Company purchases its Products from a select number of independent
suppliers as well as from its wholly owned subsidiaries. Approximately 48% of
the dollar volume of Products purchased by the Company in 2002 was purchased
from, and manufactured by, the Company's subsidiaries and sold through the
direct selling channel. In addition to the products sold to the Company for the
direct selling channel, the subsidiaries have a growing presence in the outside
sales market. In 2002, outside sales comprised $9.1 million or 6.3% of total
manufacturing sales compared to $1.6 million or 1.4% of total manufacturing
sales in 2001.

North America is the Company's primary market. Sales in the United States
accounted for approximately 93% of net sales in 2002. Subsidiaries and divisions
of the Company in Mexico, Canada and Puerto Rico accounted for the remaining 7%
of net sales in 2002.

2. SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION AND USE OF ESTIMATES

The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant inter-company balances and
transactions have been eliminated in the consolidation.

The financial statements, having been prepared in conformity with generally
accepted accounting principles, require management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities and the reported amounts of
revenue and expenses during reporting periods. Actual results could differ from
those estimates.

FINANCIAL INSTRUMENTS

The Company considers all liquid interest-bearing instruments with a
maturity of three months or less when purchased to be cash equivalents. The
Company maintains cash and cash equivalents at financial
F-7

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

institutions in excess of federally insured limits. There were no cash
equivalents at December 31, 2001 and 2002.

The Company has historically used interest rate swap agreements to limit
the effect of changes in interest rates on its variable rate long-term
borrowings. Periodic amounts paid or received under the swap agreements are
recorded as part of interest expense. The swaps have historically contained
option provisions, which are separately valued and adjusted to market quarterly.
Any resulting gain or loss is included in other income (expense). There were no
outstanding interest rate swaps at December 31, 2001 and 2002.

As a result of adopting SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," ("SFAS No. 133"), effective January 1,
2001, the Company transferred a liability balance of approximately $456,000
related to the deferred gain on the terminated swap portion of an interest rate
swap to other comprehensive income. This balance was fully amortized into
earnings as an adjustment to interest expense during 2001.

INVENTORIES

Inventories are stated at the lower of cost or current market price. Cost
is determined using the first-in, first-out method.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are stated at cost less accumulated
depreciation. Depreciation is computed using the declining balance and
straight-line methods over estimated useful lives. Major expenditures for
property, plant, equipment, and those which substantially increase useful lives
are capitalized. Direct costs of developing software for internal use, including
programming and enhancements, are capitalized and amortized over the estimated
useful lives once the software is placed in service. Software training costs,
data conversion costs, maintenance and repairs are expensed as incurred. When
assets are sold or otherwise disposed of, costs and related accumulated
depreciation are removed from the financial statements and any resulting gains
or losses are included in operating income.

GOODWILL

Effective January 1, 2002, the Company ceased amortizing goodwill as a
result of adopting SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS
No. 142"). An annual goodwill impairment test is performed during the fourth
quarter of each year to determine if the estimated fair value of the reporting
unit exceeds the net carrying value of the reporting unit, including the
applicable goodwill. The fair market value of each reporting unit is based upon
management's estimates of the present value of future cash flows. Any losses
resulting from an impairment test are reflected in operating income in the
Statement of Operations. As of December 31, 2002, goodwill is not impaired.

SELF INSURANCE

The Company is primarily self-insured for workers' compensation.
Self-insurance liabilities are based on claims filed and estimates for claims
incurred but not reported. These liabilities are not discounted.

INCOME TAXES

The Company files its federal income tax return on a consolidated basis.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and income tax purposes, based upon enacted tax rates in effect for the
periods the tax differences are expected to be settled or realized.

F-8

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

REVENUE RECOGNITION

As a result of adopting Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements" ("SAB 101"), effective January 1, 2000,
revenue from product sales is recognized upon receipt of shipment by the
Displayers. Revenue from the sale of manufactured products to the outside sales
market is recognized when the products are picked up by the customer's common
carrier at the manufacturing plants. Prior to the adoption of SAB 101, revenue
was recognized when products were shipped. Provisions for discounts, returns,
and other adjustments are provided for in the same period the related sales are
recorded. Deferred revenue is recorded to the extent that shipments have not
been received by Displayers by period end.

There was no cumulative effect adjustment upon adoption of SAB 101 as the
Company had historically ceased shipping product to Displayers during the latter
part of December. The quarters for 2000 have been restated for the effects of
SAB 101 (Note 18).

SHIPPING AND HANDLING

The Company absorbs the majority of the costs associated with shipping and
handling; however, the Company does charge for shipping and handling when orders
do not meet the certain pre-set minimum order sizes. This revenue is immaterial
and has been offset by the shipping and handling costs. The net costs associated
with shipping and handling are reflected in freight, warehouse, and distribution
in the consolidated statements of operations and comprehensive income and were
$26.0 million, $30.4 million, and $36.8 million for 2000, 2001, and 2002,
respectively.

FOREIGN CURRENCY TRANSLATION

The balance sheet accounts of the Company's foreign operations are
translated into U.S. dollars at the year-end exchange rate. Revenues and
expenses are translated at the weighted average exchange rate for each period.
Translation gains and losses are included in shareholders' deficit. The total
amount of translation gains (losses) included in Other Income (Expense) totaled
$115,000 and ($340,000) for 2001 and 2002, respectively. There were no
translation gains or losses in 2000.

RECLASSIFICATIONS

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

MARKETABLE SECURITIES

In November 2000, the Company sold marketable securities classified as
available for sale. At that time, these securities had a book value of $1.7
million. Cash in the amount of $2.0 million was received in exchange for the
stock resulting in a realized gain of $0.3 million.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts of cash and cash equivalents, accounts receivable,
accounts payable and other current liabilities approximate fair market value due
to their short maturities. The carrying amounts of variable rate long-term debt
also approximate fair market value as their interest rates are based on current
interest rates. The Notes had a carrying value of $149.1 million as of December
31, 2001 and 2002. The Notes had a fair value of approximately $113.3 million as
of December 31, 2001 and $138.7 million as of December 31, 2002 based upon
quoted market prices.

F-9

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

BENEFIT PLANS

EMPLOYEE BENEFIT PLANS

The Company's 401(k) plan covers all full-time employees who have at least
six months of service and are age 18 or older. Beginning in 1999, the 401(k)
plan generally allows employees to contribute up to 16% of their base salary in
various investment alternatives and provides for Company matching contributions
of up to 4%. The Company's matching contributions totaled $752,000, $803,000,
and $1.0 million in 2000, 2001, and 2002, respectively. Additionally, the Board
may make discretionary contributions to the 401(k) plan at any time. The Board
approved discretionary contributions of $1.0 million for 2000 and $1.5 million
for 2001 and 2002.

STOCK-BASED COMPENSATION PLANS

The Company has adopted several stock option plans. For Displayers and
independent contractors the Company has adopted the "Independent Contractor
Stock Option Plan". For key employees, the Company has adopted the "1998 Key
Employee Stock Option Plan" and the "2002 Key Employee Stock Option Plan". Key
information regarding the Company's stock-based compensation plans is summarized
below.

INDEPENDENT CONTRACTOR STOCK OPTION PLAN

In connection with the Independent Contractor Stock Option Plan, the
Company sponsors a trust (the "Stock Option Trust") for the purpose of holding
and distributing stock options granted. Under the Stock Option Trust, the
Company is authorized to issue shares of common stock granted in the form of
non-qualified stock options. These options may be granted to certain Displayers
and other independent contractors (the "Non-Employees"). Options granted vest
ratably over five years, have a ten year term and vesting is accelerated if an
initial public offering were to occur. There are 338,481 shares of common stock
available for grant under this plan. The Company accounts for options issued
under the Independent Contractor Stock Option Plan and Stock Option Trust in
accordance with Statement of Accounting Financial Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS No. 123"). The fair value of options
granted is estimated on the date of grant using the Black-Scholes option-pricing
method with valuation assumptions for expected term, expected dividend yield,
and risk-free interest rate. An expected volatility factor is also used in the
Black-Scholes option-pricing model. The weighted-average fair value of these
stock options granted in 1999, 2000, and 2001 were $9.92, $9.27, and $5.43,
respectively. The Company granted no stock options to Non-Employees during 2002.
Compensation expense (credit) recognized totaled ($351,000), ($62,000), and
$483,000 for 2000, 2001, and 2002, respectively.

1998 KEY EMPLOYEE STOCK OPTION PLAN

The 1998 Key Employee Stock Option Plan authorizes the Company to issue
shares of common stock grants in the form of incentive non-qualified stock
options. According to the plan, these options may be granted to key executives
and employees of the Company, including the officers of the Company and the
Company's subsidiaries. Options granted vest ratably over five years and have a
ten year term. Additionally, vesting may accelerate on the outstanding options
upon a change in control, as defined by the agreement. There are 1,353,924
shares of common stock available for grant under this plan. The Company accounts
for options issued under the 1998 Key Employee Stock Option Plan in accordance
with the Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB 25"). Compensation expense for disclosure purposes
only in accordance with SFAS No. 123, is calculated based upon the Minimum Value
option-pricing method, including assumptions for expected term, expected
dividend yield, and risk-free interest rate. The weighted-average fair value of
these options granted in 2000, 2001, and 2002 were $4.66, $2.62, and $4.59,
respectively.

F-10

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2002 KEY EMPLOYEE STOCK OPTION PLAN

On August 14, 2002, the Company executed the 2002 Key Employee Stock Option
Plan which allows for the issuance of incentive and non-incentive qualified
options to key executives and employees of the Company, including officers and
directors of the Company and the Company's subsidiaries. There are 6,000,000
shares of common stock available for grant under the plan with a limitation of
no more than 2,000,000 options allowed to be issued to a single person. There
are two stock option grant types available under the plan. The first represents
grants to key employees with vesting over a five year period. The second
represents performance-based options that vest 20% annually upon achievement of
certain performance-based goals. The Company accounts for options issued under
the plan in accordance with APB 25 using the Minimum Value option-pricing method
including assumptions for expected term, expected dividend yield and risk-free
interest rate. The Company issued only performance-based options under this plan
during 2002 and recognized compensation expense of $784,000 as the performance
goal had been met. Additionally, vesting may be accelerated on the outstanding
options upon a change of control, as defined by the agreement. The
weighted-average fair value of the options granted in 2002 was $4.39.

Key information related to the Company's stock-based compensation plans is
summarized below:

F-11

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

COMPENSATION CHARGE

SFAS No. 123 establishes a fair value basis of accounting for stock-based
compensation plans. The effects of applying SFAS No. 123 as shown below are not
indicative of future amounts. Had the compensation cost for the Company's 1998
Key Employee Stock Option Plan and 2002 Key Employee Stock Option Plan been
determined consistent with SFAS No. 123, the Company's compensation cost and net
income for 2000, 2001 and 2002 would approximate (in thousands):

3. ACQUISITIONS

The Company recently completed the following strategic acquisitions:

ACQUISITION ON AND PRIOR TO DECEMBER 31, 2002

Prior to July 2000, the Company owned a 60% majority interest in Laredo
Candle. In July 2000, the Company purchased the remaining 40% minority interest
in Laredo Candle for cash of $8.7 million. Of the total purchase price, $900,000
was held in escrow and was subject to offset if certain performance standards
were not satisfied by Laredo Candle during the twelve months ended June 30,
2001. In July 2001, the entire $900,000 held in escrow was released and paid to
the seller. The Company accounted for the acquisition using the purchase method
of accounting and recognized goodwill of $4.2 million, representing the excess
of cost over the fair value of net assets acquired. Amortization expense totaled
$309,000 and $188,000 for 2001 and 2000, respectively. In accordance with SFAS
No. 142, there was no amortization expense for 2002.

On December 31, 2002, the Company acquired 100% of the stock of Brenda
Buell & Associates, Inc., a wholesaler and designer of home decor products, for
approximately $5.5 million plus future earn-out payments of $1.5 million,
conditional upon future profitability above certain thresholds. Existing cash
resources were used to fund the acquisition. At closing, the Company paid
$200,000 in cash and signed a three year $2.0 million note payable. During
January of 2003, the Company paid an additional $3.3 million in cash. The
acquisition of Brenda Buell & Associates, Inc. was accounted for as a business
acquisition in accordance with Statement of Financial Accounting Standard No.
141 "Business Combinations" ("SFAS No. 141"). The aggregate purchase price was
allocated to the underlying assets and liabilities, primarily accounts
receivable of $958,000 and accounts payable of $691,000 based upon their
respective fair market values at the date of acquisition, and the excess of
purchase price over the fair value of the net assets acquired was recorded as
goodwill. As a result of this acquisition, goodwill recognized totaled
approximately $5.6 million. There was no activity from the acquisition included
in the statement of operations due to it occurring at the close of the Company's
fiscal year. The assets acquired and liabilities assumed have been included in
the balance sheet at December 31, 2002.

F-12

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

ACQUISITIONS AFTER DECEMBER 31, 2002

On January 29, 2003, the Company acquired 100% of the assets of Tempus
Corporation, S.A. de C.V., a manufacturer of metal products located in
Monterrey, Mexico, for approximately $4.3 million, plus deferred payments of
$2.6 million, based upon the future profitability of the acquired business above
certain thresholds. Existing cash resources were used to fund the acquisition.
At closing, the Company paid $2.0 million in cash. In February and March of
2003, the Company paid an additional $2.3 million in cash. The acquisition was
accounted for as a business acquisition in accordance with SFAS No. 141. The
aggregate purchase price was allocated to the underlying assets, primarily
property and equipment of $4.0 million and inventories of $400,000, based upon
their fair market values at the date of acquisition. The aggregate fair market
value of the assets acquired exceeded the amount of the initial payment by
$200,000 excluding deferred payments which are not guaranteed, and this excess
value was applied as a reduction to the amount recorded for the property and
equipment acquired. The purchase price allocation is preliminary in nature and
subject to change.

On February 7, 2003, the Company acquired 100% of the assets of Ceramica y
Vidrio de Nuevo Loan, S.A. de C.V., Maquiladora Produr, S.A. de C.V., and
Industrias Tromex Corporation, S.A. de C.V. (collectively, "Produr") for
approximately $5.6 million, plus a deferred payment of $125,000, based upon the
profitability of the acquired business in the year 2003 exceeding an agreed-upon
threshold. Produr manufacturers glass, ceramic, and metal products and is
located in Monterrey and Guadalajara, Mexico. Existing cash resources were used
to fund the acquisition. Prior to closing, the Company had advanced
approximately $5.3 million under the terms of a promissory note that was paid at
closing. As of December 31, 2002, funds advanced to Produr totaled $610,000 and
is reflected in accounts receivable, net on the Consolidated Balance Sheet. In
connection with closing, the Company paid liabilities of the selling entities
totaling $5.3 million. The acquisition was accounted for as a business
acquisition in accordance with SFAS No. 141. The aggregate purchase price was
allocated to the underlying assets, primarily property and equipment of $5.9
million and inventories of $600,000, based upon their fair market values at the
date of acquisition. The aggregate fair market value of the assets acquired
exceeded the amount of the initial purchase price by $350,000 excluding the
deferred payment which is not guaranteed, and this excess value was applied as a
reduction to the amount recorded for the property and equipment acquired. The
purchase price allocation is preliminary in nature and subject to change.

4. ACCOUNTS RECEIVABLE, NET

Accounts receivable, net consisted of the following as of December 31 (in
thousands):

F-13

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5. INVENTORIES, NET

Inventories, net consisted of the following as of December 31 (in
thousands):

6. PROPERTY, PLANT AND EQUIPMENT, NET

Property, plant and equipment, net consisted of the following as of
December 31 (in thousands):

Depreciation expense was $7.9 million, $9.4 million, and $11.7 million for
the years ended 2000, 2001, and 2002, respectively. Equipment, furniture and
fixtures include assets held under capital lease obligations, with a cost of
$8.8 million and accumulated amortization of $2.3 million and $3.9 million as of
December 31, 2001 and 2002, respectively. The Company capitalized interest,
primarily related to the new computer system of $387,000 in 2002. There was no
significant interest capitalized in 2000 and 2001.

7. INCOME TAXES

The components of earnings before income tax expense and extraordinary loss
for the years ended December 31 are as follows:

F-14

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The components of income tax expense for the years ended December 31 are as
follows (in thousands):

A reconciliation of income tax expense computed at the federal statutory
rate applied to income before income taxes and extraordinary loss to income tax
expense at the Company's effective tax rate for the years ended December 31 is
as follows (in thousands):

The components of the net deferred tax balances as of December 31 are as
follows (in thousands):

A valuation allowance is required against deferred tax assets if, based on
the weight of available evidence, it is more likely than not that some or all of
the deferred tax assets will not be realized. As of December 31, 2001 and 2002,
no valuation reserve was required.

F-15

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. FORMER CORPORATE HEADQUARTERS FACILITY

On January 3, 2000, the Company entered into a ten-year lease for a new
corporate headquarters location in Dallas, Texas. The Company's offices occupied
approximately 75,000 square feet of office space at an annual rent of
approximately $1.6 million. Tenant improvements to customize the space totaled
approximately $2.9 million, of which approximately $2.0 million was borne by the
landlord as improvement allowances. In December 2000, the Company moved the
corporate headquarters from these facilities into the new warehouse and
distribution facility.

In 2001, the Company signed an agreement to sublease approximately 44,000
square feet of the corporate headquarters commencing on February 2001 through
January 2010. The sublease rental charge begins at $67,000 per month and
increases to $80,000 per month over the life of the lease. The Company also
agreed to provide the subtenant with an allowance for tenant improvements of
$150,000. The Company has not been successful in subleasing any additional
space.

Included in general and administrative expenses for 2000 is $6.4 million
primarily related to an accrual for the net present value of estimated future
abandoned lease commitments, as adjusted for estimated future sublease rental
income and deferred lease incentives of $3.8 million, and accelerated
amortization on related leasehold improvements of $2.6 million.

Included in other long-term liabilities is the net present value of the
abandoned lease commitments, net of sublease, of approximately $4.0 million and
$3.6 million as of December 31, 2001 and 2002, respectively.

9. OTHER CURRENT LIABILITIES

Other current liabilities consisted of the following as of December 31 (in
thousands):

10. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS

LONG-TERM DEBT

In June of 1998 the Company issued $200.0 million of senior subordinated
notes (the "Notes") and entered into a $340.0 million senior credit facility
(the "Senior Credit Facility"). The Senior Credit Facility provides for a $200.0
million term loan (the "Tranche A Loan"), a $100.0 million term loan (the
"Tranche B Loan"), and $40.0 million of revolving loans (the "Revolving Loans").
The Company may use the Revolving Loans for letters of credit of up to $15.0
million.

F-16

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

DEBT RESTRUCTURE 2001

In January 2001, a limited partnership that includes an affiliate of Hicks
Muse, certain members of the Donald J. Carter Jr. family (the "Carter Family"),
and their respective affiliates (the "Note Limited Partnership") acquired, in
the open market, $50.9 million aggregate principal amount of the Company's Notes
for approximately $23.0 million plus accrued interest. In March 2001, another
limited partnership that includes an affiliate of Hicks Muse, certain members of
the Carter Family, and their respective affiliates (the "Debt Limited
Partnership") purchased $44.9 million of the Company's senior bank debt for
approximately $35.6 million. This transaction is discussed further below and in
Note 14.

Effective March 30, 2001, the Company entered into an amendment to the
Senior Credit Facility which, among other things: (i) reduced the Revolving
Loans available to the Company from $40.0 million to $30.0 million; (ii)
increased pricing by 75 basis points above previous levels; (iii) provided for
an amendment fee of 25 basis points immediately payable to the Lenders who
executed the amendment prior to March 31, 2001; (iv) provided for a fee of $3.0
million payable to the Lenders, with the payment of such fee deferred until
September 30, 2001, and which such fee was forgiven in the event that certain
existing equity holders or their affiliates contribute $40.0 million in equity
to the Borrower prior to September 30, 2001; (v) reset the leverage and interest
coverage ratios applicable through the fiscal quarter ended December 31, 2001;
and (vi) added additional financial covenants with respect to minimum liquidity
and EBITDA. Further limitations related to capital lease obligations, liens,
acquisitions, payment of management fees to affiliates, letters of credit, loans
and advances to suppliers, and asset sales were also added to the Senior Credit
Facility. Payment terms of interest changed from quarterly payments to monthly
payments. Additionally, the amendment to the Senior Credit Facility waived
compliance with the minimum interest coverage and maximum leverage ratios of the
Senior Credit Facility for the quarter ended December 31, 2000.

In connection with the amendment to the Senior Credit Facility, the Company
incurred debt issuance costs of $200,000 that were deferred, and the Company
incurred $1.5 million in legal and consulting fees, which are included in
general and administrative expense as of December 31, 2001.

On July 16, 2001, the Company completed the 2001 debt restructure through
the following transactions:

- Transfer of $50.9 million aggregate principal amount of Notes from the
Note Limited Partnership to the Company in exchange for 50,900.00 shares
of 12.5% Senior Convertible Preferred Stock, par value $.01 per share,
issued by the Company ("Senior Preferred Stock").

- Transfer of $44.9 million of the Company's senior bank debt from the Debt
Limited Partnership to the Company in exchange for 44,927.98 shares of
Senior Preferred Stock.

- The Debt Limited Partnership purchased an additional 231 shares of Senior
Preferred Stock for $231,000 cash.

- The Company converted $44.9 million of the Tranche A Loan of the Senior
Credit Facility into the Tranche B Loan of the Senior Credit Facility.

- The Company's Senior Credit Facility was amended and restated to provide
for, among other things, an increase of $10 million in the revolving
credit line and the extension of the maturity dates of the Tranche A Loan
and the Tranche B Loan for an additional six month period.

As a result of the debt restructure, the Company recognized a $15.2 million
extraordinary loss as of December 31, 2001. The extraordinary loss was comprised
of $2.4 million in unamortized debt issuance costs, less $902,000 related income
tax benefit and $13.7 million of income taxes. Included in general and
administrative expenses are approximately $1.9 million in costs related to legal
and consulting fees. The Company also incurred additional debt issuance costs of
$1.3 million, which were deferred, and $422,000 in

F-17

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

costs related to the Senior Preferred Stock issuance, which were recorded as a
reduction to Senior Preferred Stock.

The Company will not report significant net taxable income in respect of
the debt restructuring transactions and the issuance of the Senior Preferred
Stock. However, if tax is found to be due and payable by the Company with
respect to such transactions prior to the termination of the Senior Credit
Facility, the Note Limited Partnership and the Debt Limited Partnership are
required, at their option: (i) to make a cash contribution to the capital of the
Company; (ii) to purchase shares of common stock of the Company at the
then-current market value; or (iii) to purchase additional shares of Preferred
Stock, in each case in an aggregate amount equal to the net amount of tax paid
by the Company.

DEBT RESTRUCTURE 2002

On July 29, 2002, the Company completed the 2002 debt restructure through
the following transactions:

- The Company converted $31.0 million of $50.0 million Tranche A Loans into
Tranche B Loans of the Company's Senior Credit Facility.

- The Company received a $35.0 million cash infusion from the Company's
lenders under the Senior Credit Facility in exchange for additional
Tranche B Loans.

- The Company's Senior Credit Facility was amended and restated to provide
for, among other items, increased interest rates for consenting of
lenders, 150 basis points over the interest rates then paid to the
non-consenting lenders, modified quarterly principal and interest
payments, and 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.

As a result of the 2002 debt restructure, the Company reported an
extraordinary loss of $4.5 million. The extraordinary loss was comprised of $3.3
million in unamortized debt issuance costs, $3.9 million of fees paid to
creditors, less the related income tax benefit of $2.7 million.

Borrowings under the Senior Credit Facility require quarterly principal and
interest payments. The Tranche A Loan and Revolving Loans mature on December 31,
2004. The Tranche B Loan matures on December 31, 2006. The Company may, at its
option, prepay the term loans without premium or penalty. Additionally, the
Company may reduce or eliminate its revolving loan commitment prior to maturity.
The Senior Credit Facility is guaranteed unconditionally on a senior basis by
the Company's wholly owned domestic subsidiaries and is collateralized by a lien
on substantially all assets of the Company and its wholly-owned subsidiaries.
There are no material restrictions on the Company's ability to obtain funds from
its wholly owned subsidiaries by dividend or otherwise.

The loans under the Senior Credit Facility bear interest, at the Company's
election, at either the LIBOR rate plus an applicable margin, the Base Rate
Basis plus an applicable margin or at a Swing Line Rate that is equal to the
Base Rate less a 0.5% commitment fee. The Base Rate Basis is the higher of the
prime rate of Bank of America or the federal funds effective rate plus 0.5%. The
applicable LIBOR margin and Base Rate margin are subject to adjustments, upwards
or downwards, based upon the leverage ratio as defined by the Amended and
Restated Credit Agreement. The interest rates on all borrowings outstanding
under the Senior Credit Facility as of December 31, 2001 and 2002 were based on
LIBOR. The weighted-average interest rate on the Tranche A and Tranche B
borrowings outstanding at December 31, 2001 and 2002 was 4.99% and 5.81%
respectively.

The Revolving Loans are subject to a commitment fee based on the undrawn
portion of the Revolving Loans. The commitment fee is eligible for certain
performance pricing step-downs and was 0.5% per annum as of December 31, 2001
and 2002. Commitment fees of approximately $173,000, 107,600 and $141,000 are
F-18

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

included in interest expense in 2000, 2001 and 2002, respectively. Outstanding
letters of credit totaled $1.5 million and $3.5 million as of December 31, 2001
and 2002, respectively.

The Notes bear interest at 10.125% per year, payable semi-annually in
arrears on June 1 and December 1 of each year. The Notes mature on June 1, 2008
and are guaranteed, unconditionally, jointly and severally, on an unsecured
senior subordinated basis by all of the Company's wholly owned domestic
subsidiaries. Except as set forth below, the Notes are not redeemable by the
Company prior to June 1, 2003. Thereafter, the Notes are subject to redemption
by the Company, in whole or in part, at specified redemption prices.

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 fixed charge coverage ratios, maximum
leverage ratios, capital expenditure measurements, and EBITDA measurements.
Subject to the financial ratios and tests, the Company will be required to make
certain mandatory prepayments of the term loans on an annual basis beginning in
March 2003. As of December 31, 2002 management estimates a $12.4 million
mandatory prepayment to be paid in March 2003.

CAPITAL LEASES

In December 1999, the Company entered into capital leases for certain
equipment associated with the automated order fulfillment system being used in
the new warehouse and distribution facility. The lessor funded the equipment
purchase when construction of the automated order fulfillment system was
completed in April 2000. The initial term of each of the leases is seven years.
Interest is imputed at approximately 6.1% per annum. Total cost of the equipment
funded under this lease was approximately $6.2 million. The Company also leases
certain office furniture and equipment under capital lease obligations. Future
minimum lease payments for the Company's assets held under capital lease
obligations as of December 31, 2002 are as follows (in thousands):

YEARS ENDING DECEMBER 31:

2003........................................................ $ 1,556
2004........................................................ 1,366
2005........................................................ 1,355
2006........................................................ 1,344
2007........................................................ 479
Thereafter.................................................. --
-------
Total minimum lease obligations............................. 6,100
Less: amounts representing interest......................... (749)
-------
Present value of minimum lease obligations.................. 5,351
Less: current maturities.................................... (1,261)
-------
Long-term capital lease obligations......................... $ 4,090
=======

F-19

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A summary of long-term debt and capital lease obligations as of December
31, including the impact of the mandatory repayment of $12.4 million in March
2003, is as follows (in thousands):

The following table represents a summary of the maturities of debt,
including the impact of the mandatory repayment of $12.4 million in March 2003,
and capital leases as of December 31 (in thousands):

2003........................................................ $ 21,017
2004........................................................ 10,096
2005........................................................ 71,848
2006........................................................ 90,358
2007........................................................ 472
Thereafter.................................................. 149,100
--------
$342,891
========

11. 12.5% SENIOR CONVERTIBLE PREFERRED STOCK

In connection with the Debt Restructuring, the Company designated 96,058.98
shares of Senior Preferred Stock. The shares of Senior Preferred stock shares
have a par value of $0.01 per share and a liquidation preference of $1,000 per
share, together with all declared or accrued and unpaid dividends thereon. In
the event of any liquidation of the Company, holders of shares of Senior
Preferred Stock shares shall be paid the liquidation preference plus all accrued
dividends to the date of liquidation before any payments are made to the Common
Stock holders. Dividends, as and if declared by the Company's Board of
Directors, are cumulative and payable quarterly beginning October 1, 2001 at the
rate of 12.5% of the liquidation preference per annum. Each share of Senior
Preferred Stock is convertible at any time at the option of the holder for
51.49330587 shares of the Company's Common Stock. In 2002, the Company recorded
a $1.4 million payable to a related party for financial advisory fees associated
with services rendered in connection with the 2001 Senior Preferred Stock
issuance.

Holders of Senior Preferred Stock are entitled to the number of votes equal
to the number of shares of the Company's Common Stock into which such shares of
Senior Preferred Stock are convertible on the record date for such vote. Each
holder has a preemptive right to purchase a pro rata share of future securities
issuances, excluding public securities issued under applicable securities laws,
securities issued to employees and Displayers for incentive compensation and
securities issued in exchange for assets in the normal course of business.

F-20

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The table below presents the net income (loss) applicable to common
shareholders for the years ended December 31 (in thousands):

The cumulative preferred stock dividends in arrears total $17.5 million as
of December 31, 2002. No dividends have been paid or declared as of December 31,
2001 and 2002.

12. OPERATING LEASES

The Company has entered into operating lease agreements for office and
manufacturing space with unrelated third parties. Total rent expense for 2000,
2001, and 2002 was $2.0 million, $634,000, and $1.4 million, respectively.
Future minimum rents due under noncancelable operating leases with initial terms
greater than twelve months are as follows (in thousands):

13. RESTRUCTURING, REDUNDANCY AND REORGANIZATION

HOMCO RESTRUCTURING

On April 1, 2000, the Company discontinued operations at the Company's
manufacturing and warehouse facility in McKinney, Texas and transferred
operations to the Company's facility in Grand Island, Nebraska. The Company
incurred approximately $1.0 million of non-recurring costs related to the
combination of operations and recorded a non-recurring charge amount in the
statement of operations for the year ended December 31, 2000.

On May 15, 2000, the Company sold the manufacturing and warehouse facility
located in McKinney, Texas, to Donald J. Carter, Jr., the Company's Chairman of
the Board and Chief Executive Officer, for approximately $3.7 million. The
Company used the proceeds from the sale, together with approximately $1.7
million in proceeds from the sale of another property, to purchase an undivided
interest in the Company's new warehouse and distribution facility. This exchange
qualified as a Section 1031 like-kind exchange under the Internal Revenue Code.

REDUNDANT WAREHOUSE AND DISTRIBUTION COST

The Company's previously announced plan to consolidate its several
distribution centers into a single facility was contingent upon timely
integration and implementation of its automated order fulfillment system. This
plan anticipated a significant warehouse and distribution headcount reduction in
connection with the consolidation process. The Company encountered delays and
problems associated with the design and
F-21

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

implementation of the automated order fulfillment system and the overall
productivity of the consolidated distribution facility. These delays forced the
Company to hire additional temporary laborers and retain existing warehouse
employees longer than originally anticipated.

In addition, the Company continued to operate two of its older manual order
fulfillment distribution facilities longer then was anticipated. In October
2000, one of the two manual operations was moved into the consolidated
distribution facility. The Company has extended the lease term on the other
manual distribution facility for a period of five years.

Redundant warehouse and distribution costs resulting from the issues
discussed above were approximately $6.1 million and $1.2 million for the year
ended December 31, 2000 and 2001, respectively. These costs consist primarily of
incremental labor associated with productivity issues at the new consolidated
distribution facility, costs of 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 costs incurred during 2002.

REORGANIZATION COST

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 downsized various
departments. In December 2000, the Company relocated its corporate headquarters
to a new warehouse and distribution facility. The Company sublet approximately
44,000 square feet of the former corporate headquarters and accelerated
amortization of the related leasehold improvements.

During 2001, in addition to redundant headquarter facility costs associated
with the Company's reorganization plan, the Company incurred non-capitalizable
legal fees related to obtaining a waiver for the Senior Credit Facility and Debt
Restructuring.

During 2002, in addition to expenses incurred related to the Company's
reorganization plan, the Company incurred non-capitalized expenses, such as
training, data conversion, and consulting fees, related to an implementation of
a new computer system.

Included in selling and general and administrative expenses in the
consolidated statements of operations and comprehensive income are the following
amounts associated with the Company's reorganization plan as of December 31:

14. RELATED PARTY TRANSACTIONS

During 2002, in connection with the Company's purchase of 100% of the stock
of Brenda Buell & Associates, Inc., the Company paid a related party $200,000
and signed a three year $2.0 million note payable. Simultaneously with the
transaction, the former stock owner of Brenda Buell & Associates, Inc. became an
officer of the Company. As of December 31, 2002 $5.3 million, including the $2.0
million in note payable, was due to the related party.

F-22

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

During 2002, the Company loaned $77,600 to one of the Company's
subsidiaries' officers. The amount due to the Company from the officer was
$34,000 as of December 31, 2002.

Another shareholder and former Director of the Company owns a company that
supplies inventory items to the Company and whose primary customer is the
Company. The Company paid the supplier approximately $28.4 million, $16.4
million, and $12.2 million during 2000, 2001, and 2002 for inventory purchases.
During 2002 the Company also paid approximately $224,000 for warehouse space
that was leased from this supplier. Amounts due to this supplier totaled
approximately $225,000 and $508,000 as of December 31, 2001 and 2002,
respectively.

Another shareholder of the Company owns a company that supplies inventory
items to the Company. The Company paid the supplier approximately $2.9 million,
$2.5 million, and $2.3 million during 2000, 2001, and 2002. Amount payable to
the supplier as of December 31, 2002 was $109,000. There were no amounts due to
the supplier at December 31, 2001.

In conjunction with the June 1998 Recapitalization, the Company entered
into an agreement requiring payment of a quarterly management fee to Hicks Muse
and reimbursement of general expenses. The management fee will be adjusted
annually, but in no event will the annual fee be less than $1.0 million or
exceed $1.5 million. Management fees and reimbursements of general expenses
totaled $1.1 million, $1.0 million and $1.0 million during 2000, 2001, and 2002,
respectively. In addition, if the Board requests Hicks Muse to perform
additional financial advisory services in the future, Hicks Muse will receive a
financial advisory fee. The management agreement with Hicks Muse terminates on
June 4, 2008 or earlier under certain circumstances. Amounts due to Hicks Muse
were approximately $1.4 million at December 31, 2002. There were no amounts due
to Hicks Muse at December 31, 2001.

On June 4, 1998, the Company entered into a five-year executive employment
agreement with its former chief executive officer with annual compensation of
$200,000, plus reimbursement for certain expenses. The agreement generally
requires the Company to pay the former chief executive officer's salary
throughout the five-year term unless he voluntarily terminates his employment
during such term. The agreement, which contains a covenant not to compete with
the Company during the employment term and for three years thereafter, can be
voluntarily terminated only by the employee. In 2000, 2001, and 2002 the Company
paid the former chief executive officer approximately $200,000, $266,000 and
$263,000 pursuant to the terms and conditions of his executive employment
agreement.

During 2000, 2001 and 2002, Board fees were paid to certain outside
Directors that totaled $33,000, $24,000 and $33,500, respectively. There were no
amounts due to certain outside Directors at December 31, 2001 and 2002.

During 2002, an outside Director was paid $22,000 for reimbursement of
general expenses and assignment fees. As of December 31, 2002, there were no
amounts outstanding to this Director.

During 2001 and 2002, the Company contributed approximately $784,000 and
$1.5 million, respectively, to a not-for-profit charity organization that was
established in September 2001. The Company and the charity share some of the
same officers. Amounts due to this charitable organization totaled approximately
$120,000 and $56,000 as of December 31, 2001 and 2002.

During 2001 and 2002, the Company paid a related party for marketing
related expenses, approximately $10,000 and $65,000, respectively.

During 2000 and 2001, a shareholder and former Director of the Company was
a partner of a law firm that renders various legal services for the Company. The
Company paid the law firm approximately $236,000, $67,000, and $58,000 for legal
services during 2000, 2001, and 2002. There were no amounts due to this law firm
at December 31, 2001. There was $8,000 due at December 31, 2002.

F-23

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In 2000 and 2001, the Company engaged the services of a freight company
controlled by former Directors of the Company to handle a small portion of its
freight. The Company paid this freight company $110,000 and $25,000 during 2000
and 2001 for its services. There were no amounts due this supplier as of
December 31, 2001.

In January 2001, Hicks Muse acquired in the open market, $50.9 million
aggregate principal amount of the Company's 10 1/8% Series B Senior Subordinated
Notes due 2008 ("Notes") for approximately $23.0 million plus accrued interest.
In March 2001, the Debt Limited Partnership purchased $44.9 million of the
Company's senior bank debt for approximately $35.6 million.

In 2000, the Company purchased inventory from a supplier who was also the
minority owner of Laredo Candle through July of 2000. The Company paid the
supplier $12.7 million during 2000. As of December 31, 2000 there were no
amounts due to the minority owner.

In 2000, the Company owned 21% of the common stock of Charles W. Weaver
Manufacturing Company, a supplier whose primary customer is the Company. The
investment was sold on November 30, 2000 for $2.0 million resulting in a gain of
$300,000. The Company paid the supplier $12.4 million during 2000.

15. 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 previously purchased certain assets of House of Lloyd entities
in bankruptcy. Such assets included that certain letter agreement dated October
23, 2001, among Richmont Corporation and its affiliates and representatives, and
House of Lloyd Management, LLC (the "Letter Agreement").

On April 25, 2002, the Company in the name of several House of Lloyd
entities, filed a petition against Richmont Corporation, Richmont International,
Inc. d/b/a Richmont House and John P. Rochon ("Defendants") asserting various
claims arising from, inter alia, the Letter Agreement. Defendants answered the
lawsuit and, on September 12, 2002, filed an Original, Counterclaim and Third
Party Petition against the House of Lloyd entities, as counter-defendants, and
the Company and Mr. Donald J. Carter Jr., as a third-party defendants, pursuant
to which defendants asserted claims for tortious interference with prospective
business relations, tortious interference with existing business relations, a
business disparagement, conspiracy and malicious prosecution, and are seeking
actual damages and punitive damages in the amount of $100 million. The House of
Lloyd entities, the Company and Mr. Carter answered the Original Counterclaim
and third party petition, and filed an additional action against the Defendants
in the United States Bankruptcy Court for the Western District of Missouri,
Kansas City Division (the "Bankruptcy Court").

On March 10, 2003, the Defendants entered into a Settlement Agreement and
General Release (the "Settlement Agreement") in favor of the Company and Donald
J. Carter, Jr. which, upon effectiveness, will dispose of and fully resolve the
pending claims without the payment of any material amounts by any of the
parties. If the Settlement Agreement is not approved by the Bankruptcy Court and
executed by the Company and Donald J. Carter, Jr. prior to April 24, 2003, it
will become null and void, although in such event the parties have nevertheless
agreed in the Settlement Agreement to continue to negotiate in good faith
towards achieving a settlement of these disputes.

F-24

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

16. 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 primarily for Home
Interiors; 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, extraordinary loss,
the effects of SAB 101, depreciation and amortization, reorganization costs,
redundant warehouse and distribution expenses, non-cash (expense) credit for
stock options, Homco restructuring, gains (losses) on disposition of assets,
debt restructuring and waiver fees, and other income (expense) ("EBITDA"). The
Company uses EBITDA as a performance measure due to Company's required
compliance thresholds for EBITDA covenants per the Senior Credit Agreement. 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 years ended December 31 (in thousands):

F-25

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table represents a reconciliation of consolidated EBITDA to
income before income taxes and extraordinary loss for the years ended December
31 (in thousands):

17. GUARANTOR FINANCIAL DATA

Dallas Woodcraft Company LP, DWC GP Inc., GIA Inc., Homco Inc., Spring
Valley Scents Inc., Laredo Candle Company LP, Brenda Buell and Associates, Inc.,
Homco Puerto Rico Inc. and HIG Investments Inc. (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 or the Notes. Guarantor and Non-Guarantor
financial statements on an individual basis are not significant and have been
omitted. Accordingly, the

F-26

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

following table presents financial information of the Guarantors and
Non-Guarantors on a consolidating basis (in thousands):

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2000

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2001

F-27

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2002

F-28

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 2001

F-29

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 2002

F-30

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED CONSOLIDATING CASH FLOW INFORMATION

F-31

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED CONSOLIDATING CASH FLOW STATEMENT

F-32

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONDENSED CONSOLIDATING CASH FLOW STATEMENT

18. QUARTERLY RESULTS (UNAUDITED)

The following table summarizes (in thousands) the effect of SAB 101 on the
quarters ended for the year 2000:

F-33

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table presents quarterly results (in thousands) during 2001.

The following table presents quarterly results (in thousands) during 2002.

19. RECENTLY ISSUED ACCOUNTING STANDARDS

In December of 2002, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure" ("SFAS No. 148"). SFAS No. 148 amends
FASB Statement No. 123 "Accounting for Stock-Based Compensation" to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation and amends the
disclosure requirements of Statement 123 to require prominent disclosure about
the effects on reported net income of an entity's accounting policy decisions
with respect to stock-based employee compensation. SFAS No. 148 also amends APB
Opinion No. 28 "Interim Financial Reporting", to require disclosure about those
effects in interim financial information. SFAS No. 148 is effective for fiscal
year ending December 31, 2002. The Company is currently evaluating the change to
the fair value based method of accounting for stock-based employee compensation.
Effective December 31, 2002 the Company has adopted the new disclosure
requirements.

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

F-34

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 anticipates it will
reclassify the Company's previously recorded extraordinary loss into continuing
operations. 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.

F-35

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS

- ---------------

(1) Represents provision for losses on accounts receivable.

(2) Represents collection of accounts previously written off.

(3) Represents write-off of uncollectable accounts receivable.

- ---------------

(A) Provisions for losses.

(B) Write-offs or reserve utilization as a result of inventory sales.

F-36

INDEX TO EXHIBITS

- ---------------

* Filed herewith.