UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004

COMMISSION FILE NUMBER 333-62021

HOME INTERIORS & GIFTS, INC.

(972) 695-1000
Registrant’s Telephone Number, Including Area Code

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

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

As of May 13, 2004, 15,240,218 shares of the Company’s common stock, par value $0.10 per share, were outstanding.

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

INDEX

2

ITEM 1. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS.

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
As of December 31, 2003 and March 31, 2004

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

3

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
For the three months ended March 31, 2003 and 2004
(In thousands)
(Unaudited)

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

4

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2003 and 2004
(In Thousands)
(Unaudited)

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

5

HOME INTERIORS & GIFTS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Background

     Home Interiors & Gifts, Inc. (the “Company”) is a fully integrated manufacturer and distributor of home decorative accessories. The Company believes it is the largest direct seller of home decorative accessories in the United States, as measured by sales. The Company’s products include, but are not limited to, framed artwork and mirrors, candles and candle accessories, plaques, figurines, planters, artificial floral arrangements, wall shelves, sconces, small furniture, and tableware (the “Products”). The Company primarily sells the Products through a direct selling channel of non-employee, independent contractor sales representatives (“Decorating Consultants”) who resell the Products primarily through one-on-one sales, brochure sales and through the “party-plan” method of conducting in-home presentations for potential customers. The Company has approximately 94,200 active Decorating Consultants located in the United States, Mexico, Canada and Puerto Rico.

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

     The Company purchases its Products from a select number of independent suppliers as well as from its wholly owned subsidiaries. During the first quarter of 2004, approximately 55.6% of the dollar volume of Products purchased for the direct selling channel of the Company was purchased from, and manufactured by, the Company’s subsidiaries. In addition to the Products sold to the Company for the direct selling channel, certain subsidiaries have a growing presence in the wholesale supply market.

2. Significant Accounting Policies

     These consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in the consolidation. The Company records sales and related expenses on a weekly basis ending on each Saturday. Each quarter consists of thirteen weeks. The last days of the quarters ended March 31, 2003 and 2004 in the accompanying unaudited consolidated financial information were March 29, 2003 and April 3, 2004, respectively.

     The consolidated financial information as of March 31, 2004 and for the three months ended March 31, 2003 and 2004 is unaudited. In the opinion of management, the accompanying unaudited consolidated financial information and related notes thereto contain all adjustments, consisting only of normal, recurring adjustments, necessary to present fairly the Company’s consolidated financial position as of March 31, 2004 and December 31, 2003, its operating results and comprehensive income for the three months ended March 31, 2003 and 2004, and its cash flows for the three months ended March 31, 2003 and 2004. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year.

     These unaudited interim consolidated financial statements and notes thereto should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2003 as filed with the SEC.

Reclassifications

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

Stock-based Compensations Plans

     The Company has adopted three stock option plans. For Decorating Consultants and independent contractors, the Company has adopted the “Independent Contractor Stock Option Plan” and accounts for options issued under the Independent Contractor Stock Option Plan in accordance with Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). For key employees, the Company has adopted the “1998 Key Employee Stock Option Plan” and the “2002 Key Employee Stock Option Plan”. The Company accounts for the options issued under the 1998 Key Employee Stock Option Plan and the 2002 Key Employee Stock Option Plan in accordance with the Accounting Principles Board Opinion No. 25, “Accounting for

6

Stock Issued to Employees” (“APB 25”), as allowed by FAS 123.

Compensation Charge

     SFAS No. 123 establishes a fair value basis of accounting for stock-based compensation plans. The effects of applying SFAS No. 123 as shown below are not indicative of future amounts. Had the compensation cost for the Company’s 1998 Key Employee Stock Option Plan and 2002 Key Employee Stock Option Plan been determined consistent with SFAS No. 123, the Company’s compensation cost and net income for the three months ended March 31, 2003 and 2004 would approximate (in thousands):

3. Inventories, Net

     Inventories, net, consisted of the following as of December 31, 2003 and March 31, 2004 (in thousands):

4. Other Current Liabilities

     Other current liabilities consisted of the following as of December 31, 2003 and March 31, 2004 (in thousands):

5. Adoption of New Accounting Standards

     In April 2004, the Financial Accounting Standards Board, (“FASB”), issued Staff Position Statement of Financial Accounting Standards No. 129-1, “Disclosure Requirements under FASB Statement No. 129, Disclosure of Information about Capital Structure, Relating to Contingently Convertible Securities” (“FSP FAS 129-1”). FSP FAS 129-1 provides interpretation guidance regarding the disclosure provisions of FASB Statement No. 129 as it applies to contingently convertible securities and the potential dilutive effects on earnings per share. FSP FAS 129-1 is effective as of April 9, 2004 and applies to all existing and newly created securities. The Company adopted FSP FAS 129-1 on April 9, 2004 and there was no financial accounting impact associated with its adoption.

7

6. Refinancing of Senior Credit Facility

     On March 31, 2004, the Company entered into a senior credit facility, “New Senior Credit Facility”, with Bear Stearns Corporate Lending Inc., as syndication agent, JPMorgan Chase Bank, as administrative agent, and the several lenders from time to time parties thereto, pursuant to which the Company, among other things, refinanced loans outstanding under the Company’s existing credit facility. The New Senior Credit Facility provides for a seven-year term loan facility of up to $320.0 million, “Term Loans”, and a $50.0 million five-year revolving credit facility, “Revolving Loans”.

     On March 31, 2004, $320.0 million in proceeds received from the Term Loans were used to complete the following transactions:

•		For an aggregate purchase price of $139.0 million, the Company repurchased all of the Company’s outstanding shares of its 12.5% Senior Convertible Preferred Stock, pursuant to a Stock Purchase Agreement, dated March 31, 2004, among the Company and certain affiliates of the Company’s controlling stockholders, “Preferred Stock Repurchase”.
•		$169.1 million of the proceeds were used to pay off the existing credit facility which included an outstanding debt balance, related partial year interest, commitment fees, and outstanding letter of credit fees.
•		$9.4 million of the proceeds were used to pay legal and advisory fees associated with the Preferred Stock Repurchase and the pay off of the existing credit facility, and New Senior Credit Facility debt issuance costs.

     There were no amounts drawn under the Revolving Loans and the remaining net Term Loans proceeds of approximately $2.5 million were used for general working capital purposes.

     As a result of the existing credit facility refinancing, the Company recognized a $1.1 million loss related to a $0.4 million write-off of unamortized debt issuance costs and $0.7 million of legal and advisory costs for the period ended March 31, 2004. The Company also incurred debt issuance costs related to the New Credit Facility of $8.4 million that were deferred. As a result of the Preferred Stock Repurchase, the Company recognized a $45.1 million reduction in additional paid-in-capital related to $29.5 million preferred stock dividends paid, $15.3 million premium paid in excess of the liquidation value of the preferred stock, and $0.3 million of legal and advisory fees.

     Borrowings under the New Senior Credit Facility require quarterly principal and interest payments. The term loan facility matures on March 31, 2011. The revolving loan facility matures on March 31, 2009. The Company may, at its option, prepay the Term Loans and Revolving Loans without premium or penalty. Additionally, the Company may reduce or eliminate its revolving loan commitment prior to maturity. The Company is subject to accelerated payments in the event that the Senior Subordinated Notes are not refinanced in whole through issuance of refinancing securities with a maturity no less than six months after March 31, 2011, incremental term loans, or an initial public offering by December 1, 2007. If the Senior Subordinated notes are not refinanced by December 1, 2007, all term loans outstanding will be due and payable on that date. Accordingly, the Company is amortizing its debt issue costs over the period from March 31, 2004 through December 1, 2007. The New Senior Credit Facility is guaranteed unconditionally on a senior basis by the Company’s wholly owned domestic subsidiaries and is collateralized by a lien on substantially all assets of the Company and its wholly owned subsidiaries. There are no material restrictions on the Company’s ability to obtain funds from its wholly owned subsidiaries by dividend or otherwise.

     The Term Loans under the New Senior Credit Facility bear interest, at the Company’s election, at either LIBOR plus an applicable margin or the Base Rate Basis plus an applicable margin. The Base Rate Basis is the higher of the prime rate of JPMorgan Chase Bank, the Base CD rate in effect plus 1%, or the federal funds effective rate plus 0.5%. For the revolving loans, the applicable LIBOR margin and Base Rate margin are subject to adjustments, upwards or downwards after December 31, 2004, based upon the leverage ratio as defined by the New Senior Credit Agreement. The interest rates on all borrowings outstanding under the New Senior Credit Facility were based on LIBOR as of March 31, 2004. The weighted-average interest rate on the Term borrowings outstanding at March 31, 2004 was 5.41%.

     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 March 31, 2004. Outstanding letters of credit totaled $4.2 million as of March 31, 2004.

     The terms of the Notes and New Senior Credit Facility include significant operating and financial restrictions, such as limits on the Company’s ability to incur indebtedness, create liens, sell assets, engage in mergers, acquisitions or consolidations, make investments and pay dividends. In addition, under the New Senior Credit Facility, the Company is required to comply with specified financial ratios and tests, including fixed charge coverage ratios, maximum leverage ratios, capital expenditure measurements, and Adjusted EBITDA measurements.

8

     A summary of long-term debt obligations under the New Credit Facility as of March 31, 2004 is as follows (in thousands):

     The following table represents a summary of the maturities of Term Loans under the New Senior Credit Facility as of March 31, 2004 (in thousands):

7. Segment Reporting

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

•		Direct Selling Domestic — direct seller of home decorative accessories in the United States;
•		Direct Selling International — direct seller of home decorative accessories in Mexico, Canada and Puerto Rico; and
•		Domistyle — wholesale supply operation that manufactures, imports, and distributes candles, framed artwork, mirrors, various types of molded plastic, metal, glass, and ceramic products for affiliates and other non-affiliated resellers.

     The Company evaluates the performance of its segments and allocates resources to them based on earnings before interest, taxes, the effects of SAB 101, depreciation and amortization, reorganization costs, non-cash expense for stock options, losses on debt restructure, Hicks Muse management fees, and losses on disposition of assets, (defined as “Adjusted EBITDA”). The Company also uses Adjusted EBITDA as a performance measure due to the Company’s required compliance thresholds for Adjusted EBITDA covenants under the New Senior Credit Facility. During March 2004, the Company modified its internal reporting to reflect the Adjusted EBITDA measure as defined by the New Credit Facility. Prior year’s Adjusted EBITDA has been recalculated for comparative purposes. The accounting principles of the segments are the same as those described in Note 2. Segment data includes intersegment sales and intercompany net receivable balances. Eliminations consist primarily of intersegment sales between the Domistyle segment and the direct selling segments, as well as the elimination of the investment in each subsidiary for consolidation purposes. The table below presents information about reportable segments used by the Company’s chief operating decision makers as of and for the three months ended March 31, 2003 and 2004 (in thousands):

9

     The following table represents a reconciliation of net income to consolidated Adjusted EBITDA for the three months ended March 31, 2003 and 2004 (in thousands):

8. Guarantor Financial Data

     Dallas Woodcraft Company, LP, DWC GP, Inc., GIA, Inc., Homco, Inc., Spring Valley Scents, Inc., Laredo Candle Company, L.P., Domistyle, Inc., EM Boehm, Inc., Home Interiors de Puerto Rico, Inc. and HIG Investments, Inc. (collectively, the “Guarantors”) unconditionally, on a joint and several basis, guarantee the Company’s (“Borrower”) payment and performance of its obligation under the New Senior Credit Facility agreement and the Debt Holder’s 10 1/8% Senior Subordinated Notes due 2008 in the amount of $149.1 million (the “Notes”). The Company’s other subsidiaries, Home Interiors de Mexico, S. de R.L. de C.V., Home Interiors Services de Mexico, S.A. de C.V., HI Ceramics, S.A. de C.V., HI Metals, S.A. de C.V., HI Glass, S.A. de C.V., HI Trading Mexicana, S.A. de C.V., and Home Interiors & Gifts of Canada, Inc. (collectively, the “Non-Guarantors”) have not guaranteed the New Senior Credit Facility or the Notes. Guarantor and Non-Guarantor financial statements on an individual basis are not significant and have been omitted. Accordingly, the following table presents financial information of the Guarantors and Non-Guarantors on a consolidating basis (in thousands):

10

Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Three Months Ended March 31, 2003

Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
For the Three Months Ended March 31, 2004

11

Condensed Consolidating Balance Sheet
As of December 31, 2003

12

Condensed Consolidating Balance Sheet
As of March 31, 2004

13

Condensed Consolidating Cash Flow Statement
For the Three Months Ended March 31, 2003

14

Condensed Consolidating Cash Flow Statement
For the Three Months Ended March 31, 2004

9. Commitments and Contingencies

     The Company is engaged in various legal proceedings incidental to its normal business activities. Management believes that the amounts, if any, which ultimately may be due in connection with such lawsuits and claims would not have a material effect upon the Company, because most of the claims are covered by insurance.

     The Company is also engaged in product recall campaigns related to its normal business activities. Management believes that the costs, if any, associated with the product recalls would not have a material effect upon the Company.

15

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

     The following discussion and analysis should be read in conjunction with the Company’s unaudited consolidated financial statements and accompanying notes thereto, which are included elsewhere herein. Unless otherwise mentioned, all references to the number of Decorating Consultants, number of orders shipped and average order size relate to domestic direct sales activity only.

Special Note Regarding Forward-Looking Statements

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

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

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

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

Company Background

     The Company believes it is the largest direct seller of home decorative accessories in the United States, as measured by sales. As of March 31, 2004, the Company has approximately 94,200 active Decorating Consultants located in the United States, Mexico, Canada and Puerto Rico. The Company’s direct sales are dependent upon the number of Decorating Consultants selling the Company’s products and their resulting productivity. Decorating Consultant productivity fluctuates from time to time based on seasonality and special marketing programs, which offer Decorating Consultants new incentives and discounts timed to generate additional sales. The Company also sells products to customers outside of its direct selling channel.

     To stimulate sales within the direct selling channel, the Company offers a variety of discounts and incentives to Decorating Consultants. The amount and timing of discounts and incentives vary from year to year. The cost of discounts is reflected in the Company’s net sales while the cost of incentives is reflected in selling expense.

Company Direct Selling Strategy

     The Company has evolved its strategy to put greater focus on what management believes to be the key drivers of the direct selling business - recruiting, retention and productivity of the Decorating Consultant base.

     The Company recognizes the need to continue to attract and retain new Decorating Consultants. As of March 31, 2004, the Company’s active Decorating Consultant base in the United States increased 13.9% to approximately 72,200 active Decorating Consultants from approximately 63,400 as of March 31, 2003. This increase was a result of the Company’s continued focus on key areas such as Decorating Consultant understanding and awareness of the Hostess program, improved training and business guides, and a more clearly defined and communicated career path as reflected in the new recruit program.

     The retention of experienced Decorating Consultants requires operational focus on several areas: product distribution fulfillment rates, product selection and sales training and motivation. Fulfillment rates for product distribution remained strong at approximately

16

99% as of March 31, 2004. The Company is continuing to introduce new products during 2004, which complement the current line of products, in an attempt to give the product line a fresh and more innovative look. The Company’s “Recertification” program educates Decorating Consultants on how to become more effective Directors and Trainers by helping them develop and enhance their leadership skills.

     Decorating Consultant training and motivation requires the introduction of sales promotion and development activities directed at helping Decorating Consultants increase their productivity. Sales tools such as “Power Paks” and the Company’s “HIG Creative Concepts” DVD/video series have helped the field leadership plan and present more effective sales meetings and training sessions for the Decorating Consultants.

Company Manufacturing and Wholesale Strategy

     The Company refers to its manufacturing or wholesale supply operations as “Domistyle”, a uniquely positioned home décor manufacturing and design operation that not only sells to the Company’s core direct selling business, but also sells to the Company’s wholesale supply channel.

     The Company continues to emphasize products from its wholesale supply operation in the direct selling channel, which the Company believes provides opportunities for gross margin improvements and leverages the fixed expense component of its cost structure. During the three months ended March 31, 2004, approximately 55.6% of the dollar volume of products purchased for the direct selling channel of the Company was purchased from, and manufactured by, the Company’s subsidiaries. The Company believes that this increased focus of the Company’s manufacturing strategy has supported Decorating Consultant productivity and retention through increased fulfillment rates and increased flexibility related to promotion strategies.

     The Company’s Domistyle operation increased sales to customers outside of the direct selling channel by $2.4 million or 39.3%. Wholesale supply sales by the Company were $8.5 million for the three months ended March 31, 2004, as compared to $6.1 million for the three months ended March 31, 2003. The Company is currently evaluating its manufacturing operations in Mexico.

Recent Developments

Refinancing of Senior Credit Facility

     On March 31, 2004, the Company entered into a senior credit facility, “New Senior Credit Facility”, with Bear Stearns Corporate Lending Inc., as syndication agent, JPMorgan Chase Bank, as administrative agent, and the several lenders from time to time parties thereto, pursuant to which the Company, among other things, refinanced loans outstanding under the Company’s existing credit facility. The New Senior Credit Facility provides for a seven-year term loan facility of up to $320.0 million, “Term Loans”, and a $50.0 million five-year revolving credit facility, “Revolving Loans”.

     On March 31, 2004, $320.0 million in proceeds received from the Term Loans were used to complete the following transactions: