FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

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

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

CRAFTMADE INTERNATIONAL, INC.

Registrant’s telephone number, including area code (972) 393-3800

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 þ No o

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

4,995,615 shares of Common Stock were outstanding as of January 31, 2005.

CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES

Index to Quarterly Report on Form 10-Q

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PART I
FINANCIAL INFORMATION

Item 1. Financial Statements. (Unaudited)

CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES

SEE ACCOMPANYING NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS

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CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES

ASSETS

SEE ACCOMPANYING NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS

4

CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands except per share amounts)

LIABILITIES AND STOCKHOLDERS’ EQUITY

SEE ACCOMPANYING NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS

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CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES

SEE ACCOMPANYING NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
OF CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES
AS OF AND FOR THE SIX MONTHS ENDED
DECEMBER 31, 2004

Note 1 - BASIS OF PREPARATION AND PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and with the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting, and include all adjustments which are, in the opinion of management, necessary for a fair presentation. The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The Company believes that the disclosures are adequate to make the information presented not misleading; however, it is suggested that these financial statements be read in conjunction with the financial statements and the notes thereto, in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2004 filed with the SEC on September 28, 2004. The financial data for the interim periods may not necessarily be indicative of results to be expected for the year.

Note 2 - SUMMARY OF CERTAIN SIGNIFICANT ACCOUNTING POLICIES

Revenue Recognition

Revenue is recognized as product is shipped and related services are performed in accordance with all applicable revenue recognition criteria. For these transactions the Company applies the provisions of SEC Staff Accounting Bulletin No. 104 “Revenue Recognition.” The Company recognizes revenue when there is persuasive evidence of an arrangement, title and risk of loss have passed, delivery has occurred or the services have been rendered, the sales price is fixed or determinable and collection of the related receivable is reasonably assured. Title generally transfers upon shipment of goods from our warehouse. The Company does not have an obligation or policy of replacing, at no cost, customer products damaged or lost in transit. In some instances, the Company ships product directly from our suppliers to the customers. In these cases, the Company recognizes revenue when the product is accepted by the customer’s representative. The Company applies the provisions of Emerging Issues Task Force (EITF) Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent.” The Company’s application of EITF 99-19 includes evaluation of the terms of each major customer contract relative to a number of criteria that management considers in making its determination with respect to gross versus net reporting of revenue for transactions with its customers. Management’s criteria for making these judgments place particular emphasis on determining the primary obligor in a transaction and which party bears general inventory risk. The Company records all shipping and handling fees billed to customers as revenue, and related costs as cost of sales, when incurred, in accordance with EITF 00-10, “Accounting for Shipping and Handling Fees and Costs.”

As part of its revenue recognition policy, the Company records estimated incentives payable to its customers at a future date as a reduction of revenue at the time the revenues are recorded. The Company bases its estimates on contractual terms of the programs and estimated or actual sales to individual customers. Actual incentives in any future period are inherently uncertain and, thus, may differ from its estimates. If actual or expected incentives were significantly greater than the reserves the Company had established, the Company would record a reduction to net revenues in the period in which the Company made such determination.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
OF CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES
AS OF AND FOR THE SIX MONTHS ENDED
DECEMBER 31, 2004

In addition to various incentive programs, from time to time the Company has historically provided mark-down funds to certain of it mass retail customers to assist them in clearing slow-moving inventory.

These mark-down funds were recorded as a reduction of revenue in the period in which they were granted. In March 2004, the Company began to estimate and record reductions to revenue for these mark-down funds that it records when the revenue is recorded because based on its past practice these mark-down funds were estimable and considered likely to be granted.

FIN 46

In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46) and amended it by issuing FIN 46R in December 2003. Among other things, FIN 46R generally deferred the effective date of FIN 46 to the quarter ended March 31, 2004. Variable interest entities (VIEs) are primarily entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders lack adequate decision making ability. All VIEs with which the Company is involved must be evaluated to determine the primary beneficiary of the risks and rewards of the VIE. The primary beneficiary is required to consolidate the VIE for financial reporting purposes.

The Company has a 50% ownership interest in two limited liability companies, Design Trends and PHI. In connection with the adoption of FIN 46R, the Company concluded that Design Trends and PHI are VIEs and that the Company is the primary beneficiary of each of Design Trends and PHI. Pursuant to the provisions of FIN 46R, effective January 1, 2004, the Company began to consolidate Design Trends and PHI and retroactively applied to previously issued financial statements.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
OF CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES
AS OF AND FOR THE SIX MONTHS ENDED
DECEMBER 31, 2004

Note 3 - EARNINGS PER SHARE

The following is a reconciliation of the numerator and denominator used in the basic and diluted EPS calculations:

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
OF CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES
AS OF AND FOR THE SIX MONTHS ENDED
DECEMBER 31, 2004

Note 4 - STOCK-BASED COMPENSATION

The Company follows the disclosure only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” as amended by SFAS No. 148. However, the Company continues to measure compensation cost for those plans using the intrinsic value based method of accounting as prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”.

Had compensation cost for the Company’s stock option plans been determined based on the fair value of the stock options at grant date, in accordance with the provisions of FAS 123, “Accounting for Stock-Based Compensation”, the Company’s net income and diluted earnings per common share would have been adjusted to the pro forma amounts indicated:

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
OF CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES
AS OF AND FOR THE SIX MONTHS ENDED
DECEMBER 31, 2004

Note 5 - SEGMENT INFORMATION

The Company operates in two reportable segments, Craftmade and TSI. The accounting policies of the segments are the same as those described in Note 2 - Summary of Significant Accounting Policies to the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2004. The Company evaluates the performance of its segments and allocates resources to them based on their operating profit and loss and cash flows.

The Company is organized on a combination of product type and customer base. The Craftmade segment primarily derives its revenue from home furnishings including ceiling fans, light kits, bathstrip lighting, outdoor lighting, and lamps offered primarily through lighting showrooms and selected electrical distributors. The TSI segment derives its revenue from indoor lighting, including portable table lamps, floor lamps, ceiling mount lighting fixtures, bath-strip lighting, and outdoor lighting marketed solely to mass merchandisers.

The following table presents information about the reportable segments (in thousands):

Note 6 - SUBSEQUENT EVENTS

Subsequent to December 31, 2004, the Company entered into a non-binding letter of intent to purchase all of the issued and outstanding capital stock of Bill Teiber Co., Inc., a Texas corporation doing business as Teiber Lighting Products. Teiber was established in 1968 as an importer and distributor of decorative light bulbs. Today, Teiber distributes over 3,000 different light bulbs and complementary lighting products as well as an extensive line of door chimes and pushbuttons from its three distribution centers.

Craftmade is currently negotiating a definitive agreement for this acquisition and completion of this transaction is subject to a number of customary closing conditions. The purchase price will be a combination of the Company’s common stock and cash. Finalization of the terms of the acquisition is subject to adjustment based on the results of the due diligence, which has commenced, and approval by the Craftmade Board of Directors. While management of the Company expects to complete this acquisition during its third fiscal quarter of 2005, there can be no assurance that the parties will be able to negotiate a definitive acquisition agreement or that due diligence will satisfy all conditions to which closing is subject under such definitive agreement.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
OF CRAFTMADE INTERNATIONAL, INC. AND SUBSIDIARIES
AS OF AND FOR THE SIX MONTHS ENDED
DECEMBER 31, 2004

Note 7 - COMMITMENTS AND CONTINGENCIES

The Company is a party to a lawsuit alleging patent infringement related to a patent held by Lamps Plus, Inc. In November 2003, a jury verdict held that the Company willfully infringed on the patent. The jury awarded damages of $143,385, and Lamps Plus filed a motion to seek treble damages plus reasonable attorneys’ fees and court costs. On September 14, 2004, the Court entered a Judgment and Permanent Injunction and issued an Order Awarding Attorneys’ Fees. The Judgment awards Lamps Plus $143,385 in actual damages plus costs of court. The Order awards $600,000 in attorneys’ fees to Lamps Plus. The Company and other defendants in the lawsuit have appealed the Judgment and Order, and the outcome of the appeal is uncertain, accordingly no accrual for any amount has been made in the Company’s consolidated financial statements as of December 31, 2004.

Craftmade has an agreement with Dolan Northwest, LLC (the owner of the other 50% of Design Trends) pursuant to which Dolan Northwest is responsible for the judgment rendered in the lawsuit, plus all costs and expenses, including legal fees and court costs, associated with the judgment. Pat Dolan has unconditionally guaranteed the obligations of Dolan Northwest under this agreement.

If the defendants’ appeal is unsuccessful, according to the above mentioned agreement, any damages would be the responsibility of Dolan Northwest, LLC. In the event that both Dolan Northwest and Pat Dolan became insolvent or otherwise unable to meet any such obligation, it could become a liability of Design Trends or Craftmade.

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

Cautionary Statement

With the exception of historical information, the matters discussed in this document contain forward-looking statements. There are certain important factors which could cause actual results to differ materially from those anticipated by these forward-looking statements. Some of the important factors which would cause actual results to differ materially from those in the forward-looking statements include, among other things, the dependency of Trade Source International, Inc. (“TSI”), Design Trends, LLC (“Design Trends”) and Prime/Home Impression, LLC (“PHI”) on sales to select mass merchandiser customers and changes in those relationships, changes in anticipated levels of sales, whether due to future national or regional economic and competitive conditions, changes in relationships with Craftmade customers, customer acceptance of existing and new products, pricing pressures due to excess capacity, cost increases, changes in tax or interest rates, unfavorable economic and political developments in Asia (the location of the Company’s primary vendors) and changes in the foreign currency exchange rate between the U.S. and Taiwan dollar, declining conditions in the home construction industry, inability to realize deferred tax assets, labor strikes, lockouts, and other labor slow downs, the ability of the Company to import merchandise from foreign countries without significantly restrictive tariffs, duties or quotas and the ability of the Company to source, ship and deliver items from foreign countries to its U.S. distribution centers at reasonable prices and rates and in a timely fashion, as well as other uncertainties, all of which are difficult to predict and many of which are beyond the control of the Company. When used in this Quarterly Report, the words “believes,” “plans,” “estimates,” “expects,” “anticipates,” “intends,” “continue,” “may,” “will,” “should”, “projects”, “forecast”, “might”, “could” or the negative of such terms and similar expressions as they relate to Craftmade or its management are intended to identify forward-looking statements.

Critical Accounting Policies and Estimates

The Company’s management’s discussion and analysis of its financial condition and results of operations following 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 the financial statements requires the Company’s management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company’s estimates are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for the Company’s conclusions. The Company continually evaluates the information used to make these estimates as its business and the economic environment changes. As the financial statements contained herein are condensed, one should also read our Form 10-K for the year ended June 30, 2004 regarding expanded information about our critical accounting policies and estimates.

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Overview

Management reviews a number of key indicators to evaluate the Company’s financial performance, including net sales, gross profit and selling, general and administrative expenses by segment. A condensed overview of results for the three months ended December 31, 2004 and the corresponding prior year period can be summarized as follows (in thousands):

Results of Operations

Three Months Ended December 31, 2004 Compared to Three Months Ended December 31, 2003

Net Sales. Net sales for the Company declined $599,000 or 2.1% to $28,349,000 for the three month period ended December 31, 2004 compared to $28,948,000 for the same three month period last year. The Craftmade segment contributed to 46% of the decline while the TSI segment contributed to 54% of the decline.

Net sales from the Craftmade segment decreased $278,000 or 2.2% to $12,268,000 for the three months ended December 31, 2004 from $12,546,000 for the same three month period last year. The decrease in sales of the Craftmade segment was primarily related to a general decline across product lines.

Net sales of the TSI segment declined $321,000, or 2.0% to $16,081,000 for the three months ended December 31, 2004 from $16,402,000 for the same three month period last year. The change in net sales of the TSI segment between periods can be summarized as follows (in thousands):

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The $3,601,000 or 31.9% decline in Design Trends’ net sales was primarily due to changes in the buying pattern of its largest mass retail customer. Management believes the changes are related to the retailer’s sales forecasts, targeted levels of replenishment inventory, targeted inventory turns, and other factors that are within the realm of the retailer’s control. Craftmade’s management receives feedback from the retailer primarily at the time of the retailer’s annual line review in connection with the semi-annual reset of its lighting program. Based on the most recent annual line review, management believes that the retailer remains committed to the lighting program with Design Trends, a 50% owned subsidiary of the TSI segment. However, lower average unit prices went into effect in June 2004 in Design Trends’ portable lamp program with its largest customer. Based on sales results in the first half of the fiscal year, management anticipates that Design Trends’ sales will continue to decline for the remainder of the fiscal year compared to the same period in the previous year.

The largest mass retailer customer of Design Trends maintains a BATNA (“Better Alternative to Negotiated Agreement”) policy, which mitigates the risk associated with maintaining a sole supplier for a given product line. Pursuant to BATNA, the Design Trends’ mix and match lamp program has exited 118 of the mass retailer’s stores, located in the Midwestern region of the United States, and a competitor’s mix and match lamp program has replaced the Design Trends’ mix and match lamp program in such stores. The Company has estimated that exiting from 118 stores has reduced net sales by approximately $1,061,000 for the three months ended December 31, 2004 compared to the same period a year ago.

Design Trends has been notified by the mass retailer that Design Trends remains the primary vendor of its mix and match lamp program. As of August 2004, Design Trends’ mix and match lamp program supplied approximately 90% of the mass retailer’s stores and management of Design Trends anticipates Design Trends will obtain product placements in approximately 90% of the new stores the mass retailer opens. According to publicly available information, the mass retailer has indicated that it will open 150 stores in 2005. Management believes that the Company’s share of product placement in these new store openings will help the Company offset the loss of net sales from the 118 exited stores.

The change in net sales between periods was impacted by a charge that totaled $2,100,000. The charge decreased net sales in the quarter ended December 31, 2003 and was incurred in connection with the rollout of a new product to a customer of PHI.

The increase in net sales from the remaining divisions of the TSI segment resulted in part from higher sales of indoor lighting products.

Gross Profit. Gross profit of the Company as a percentage of sales increased to 31.1% for the three months ended December 31, 2004, compared to 26.4% for the same period of 2003. Gross profit benefited from a $304,000 reduction in cost of sales by an amount that had been accrued in prior periods related to import brokerage fees and duties (“Gross Profit Benefit”). The pre-tax earnings impact of the Gross Profit Benefit totaled $224,000 net of minority interest from the 50% owned subsidiaries. On an adjusted basis, gross profit as a percentage of sales was 30.0% for the second quarter.

The gross profit percentage of the Craftmade segment of 37.5% includes $133,000 from the Gross Profit Benefit described above. On an adjusted basis, gross profit as a percentage of sales was 36.5% for the second quarter, compared to 38.3% of net sales in the prior year period. The decline in the gross margin of the Craftmade segment was partially due to an increase in outbound freight as a percentage of net sales. Outbound freight increased to 8.3% of sales for the three months ended December 31, 2004, compared to 7.4% in the same period a year ago. The decline in the gross profit margin was also the result of increased product costs due to a weaker U.S. dollar compared to the Taiwan dollar. In addition, gross profit margins were impacted by a change in sales mix with a greater portion of sales being driven by Craftmade’s builders’ model ceiling fans, which carry a lower gross profit percentage than the overall product mix. The

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Company anticipates that margins for the remainder of fiscal 2005 for the Craftmade division will decrease slightly in the third quarter from higher product costs, but improve after a price increase takes effect on March 1, 2005.

The gross profit percentage of the TSI segment increased to 26.2% of sales for the three months ended December 31, 2004, compared to 17.3% of sales in the prior year period. The increase was due to the following:

	(i)	a $2,100,000 charge that reduced gross sales in the quarter ended December 31, 2003 that was incurred in connection with the rollout of a new product to a customer of PHI,
	(ii)	the implementation of a markdown accrual on sales to TSI’s largest mass retail customer of 2.9% of gross sales from 0.0% of gross sales in the prior year period,
	(iii)	a decrease in outbound freight cost to 0.5% of gross sales from 1.8% of gross sales in the prior year period that was related to the rollout of a new product to a customer of PHI, and
	(iv)	a $171,000 increase from the Gross Profit Benefit as described above.

The $2,100,000 charge was incurred in connection with the rollout of a new product to a customer of PHI and lowered gross margins by approximately 9.4% in the three months ended December 31, 2003.

For the remainder of fiscal 2005, gross profit as a percentage of sales of the TSI segment is expected to remain consistent with the first half of the fiscal year.

Selling, General and Administrative Expenses. Total selling, general and administrative (“SG&A”) expenses of the Company decreased $440,000 to $4,496,000 or 15.9% of net sales for the three months ended December 31, 2004 from $4,936,000 or 17.1% of net sales for the same three month period last year. The TSI segment contributed to substantially all of the decrease. This decrease was offset by a slight increase in the Craftmade segment.

Total SG&A expenses of the Craftmade segment increased $81,000 to $2,672,000 or 21.8% of sales compared to $2,591,000 or 20.7% of sales for the same period in the previous fiscal year. The increase was primarily related to an increase in salaries and benefits that resulted from the severance agreement with the Company’s former Chief Financial Officer. The cost of this agreement was approximately $174,000. This increase in SG&A was offset by nominal decreases in a broad category of expenses.

Total SG&A expenses of the TSI segment decreased $521,000 to $1,824,000 or 11.3% of sales compared to $2,345,000 or 14.3% of sales for the same period in the previous year. The decrease in SG&A expenses of the TSI segment between periods can be summarized as follows (in thousands):

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The change in overhead allocation was primarily the result of a smaller portion of the Company’s fixed and variable overhead being allocated to the TSI division due to the decline in sales of Design Trends. In addition, there were lower salary and wages as the result of reduced headcount from the closure of the TSI division’s California office and related severance costs incurred in the prior year quarter. Similarly, travel costs were higher in the prior year quarter from relocating employees from the California office to either Arkansas or the Company’s office in Texas.

The Company anticipates SG&A expenses to increase in the remaining half of the year primarily as a result of higher costs from compliance with Section 404 of the Sarbanes-Oxley Act of 2002.

Interest Expense. Net interest expense of the Company increased $94,000 to $240,000 for the three months ended December 31, 2004 from $146,000 for the three month period ended December 31, 2003. The average outstanding balance on the Company’s lines of credit was higher in the fiscal first quarter compared to the prior year period, and interest rates on its lines of credit in effect during the period were higher than in the prior year period. The balance on the Company’s revolving lines of credit increased partially as a result of PHI’s borrowings to finance the rollout of its lamp parts program in fiscal 2004. In addition, borrowings on the Company’s revolving lines of credit increased as a result of an increase in the Company’s accounts receivable due to a change in its accounts receivable payment terms with its largest mass retail customer to 60 days from a previous range of 30 to 45 days. The outstanding balance on the Company’s facility note was lower than in the prior year period, and the interest rate on the facility note remained unchanged compared to the prior year period.

Minority Interests. Minority interests increased $721,000 to $995,000 for the second quarter from $274,000 for the same period in the previous year. The increase primarily resulted from a charge that occurred in the three month period ended December 31, 2003, that did not occur in the same period of the current year. The charge totaled $2,100,000, or $1,050,000 net of the 50% minority interest, and was incurred in connection with the rollout of a new product to a customer of PHI.

Provision For Income Taxes. The provision for income tax was $1,068,000 or 36.3% of income for the three months ended December 31, 2004, compared to $772,000 or 36.1% for the same period of the prior year.

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Six Months Ended December 31, 2004 Compared to Six Months Ended December 31, 2003

A condensed overview of results for the six months ended December 31, 2004 and the corresponding prior year period can be summarized as follows (in thousands):

Net Sales.Net sales for the Company decreased $2,764,000 or 4.6%, to $57,374,000 for the six month period ended December 31, 2004 from $60,138,000 for the same six month period last year. The TSI segment contributed to virtually all of the decrease, offset by only a slight increase from the Craftmade segment.

Net sales of the Craftmade segment increased $10,000, or 0.0%, to $26,868,000 for the six months ended December 31, 2004 from $26,858,000 for the same six month period last year. Management believes net sales of the Craftmade segment will increase during the remaining half of the 2005 fiscal year due to the Company refocusing its efforts on sales to lighting showrooms and specialty retailers.

Net sales of the TSI segment declined $2,774,000, or 8.3% to $30,506,000 for the six months ended December 31, 2004 from $33,280,000 for the same six month period last year. The change in net sales between periods can be summarized as follows:

The $7,574,000 or 35.4% decline in Design Trends’ net sales was primarily due to changes in the buying pattern of TSI’s largest mass retail customer as described above.

The change in net sales between periods was also impacted by a charge that totaled $2,100,000.The charge decreased net sales in the quarter ended December 31, 2003 and was incurred in connection with the rollout of a new product to a customer of PHI.

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The increase in net sales from the remaining divisions of the TSI segment resulted in part from higher sales of indoor lighting products.

Gross Profit. Gross profit of the Company as a percentage of sales increased to 30.2% of net sales for the six months ended December 31, 2004 compared to 29.7% for the same period of 2003. Gross profit benefited from a $304,000 reduction in cost of sales from the Gross Profit Benefit as described above. The pre-tax earnings impact of the Gross Profit Benefit totaled $224,000 net of minority interest from the 50% owned subsidiaries. On an adjusted basis, gross profit as a percentage of sales was 29.7% for the six months ended December 31, 2004, compared to the same amount for the prior year period.

Gross profit as a percentage of sales of the Craftmade segment decreased to 38.1% for the six months ended December 31, 2004, compared to 39.6% for the same period of 2003. Gross profit benefited from a $133,000 reduction in cost of sales from the Gross Profit Benefit. On an adjusted basis, gross margin was 37.6% for the six months ended December 31, 2004. The decline in the gross margin of the Craftmade segment was partially due to an increase in outbound freight as a percentage of net sales, increased product costs due to a weaker U.S. dollar compared to the Taiwan dollar, and a change in sales mix with a greater portion of sales being driven by Craftmade’s builders’ model ceiling fans, which carry a lower gross profit percentage than the overall product mix. The Company anticipates that margins for the remainder of fiscal 2005 for the Craftmade division will decrease slightly in the third quarter from higher product costs, but improve after a price increase takes effect on March 1, 2005.

The gross profit of the TSI segment increased to 23.3% of sales for the six months ended December 31, 2004 compared to 21.7% of sales in the year ago period. The increase was due to (i) a $2,100,000 charge that reduced gross sales in the quarter ended December 31, 2003, (ii) the implementation of a markdown accrual on sales to TSI’s largest mass retail customer of 3.0% of gross sales from 0.0% of gross sales in the prior year period, and (iii) a $171,000 increase from the Gross Profit Benefit described above. The $2,100,000 charge was incurred in connection with the rollout of a new product to a customer of PHI in the quarter ended December 31, 2003 and lowered gross margins by approximately 4.7% in the six months ended December 31, 2003.

For the remainder of fiscal 2005, gross profit as a percentage of sales of the TSI segment is expected to remain consistent with the first half of the fiscal year.

Selling, General and Administrative Expenses. Total selling, general and administrative (“SG&A”) expenses of the Company increased $464,000 to $9,905,000 or 17.3% of net sales for the six months ended December 31, 2004 from $9,441,000 or 15.7% of net sales for the same six month period last year. The increase in SG&A came from the Craftmade segment. This increase was partially offset by a decrease in SG&A by the TSI segment.

Total SG&A expense of the Craftmade segment increased $908,000 to $6,459,000 or 24.0% of sales compared to $5,551,000 or 20.7% of sales for the same period in the previous year. The increase in SG&A of the Craftmade segment can be summarized as follows (in thousands):

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Higher accounting and legal fees were primarily due to an increase in costs incurred with respect to the Company’s independent auditors, outside legal counsel, management consultants and contract labor. These increased costs were incurred in order to address internal controls issues and the continuing evaluation by the Company’s management and independent auditors of the proper interpretation of FIN 46 with respect to the Company’s 50% owned subsidiaries.

The increase in salaries and benefits was impacted by the severance agreement with the Company’s former Chief Financial Officer that totaled $174,000.

Total SG&A expenses of the TSI segment decreased $444,000 to $3,446,000 or 11.3% of sales for the six month period ended December 31, 2004 from $3,890,000 or 11.7% of sales for the same period in the previous year. The decrease in SG&A expenses of the TSI segment between periods can be summarized as follows (in thousands):

The change in overhead allocation was primarily the result of a smaller portion of the Company’s fixed and variable overhead being allocated to the TSI division due to the decline in sales of Design Trends. In addition, there were lower salary and wages as the result of lower headcount from the closure of the California office in October 2003 and related severance paid in the prior year quarter.

The Company anticipates that its SG&A expenses to increase in the remaining half of the year primarily as a result of higher costs from compliance with Section 404 of the Sarbanes-Oxley Act of 2002.

Interest Expense. Net interest expense of the Company increased $131,000 to $470,000 for the six-months ended December 31, 2004 from $339,000 for the same six-month period last year. This increase was primarily the result of higher outstanding balances from the Company’s revolving line of credit, combined with higher interest rates in effect during the period.

Minority Interests. Minority interests generated by the Company’s 50% owned subsidiaries decreased $360,000 to $1,561,000 for the six months ended December 31, 2004 from $1,921,000 for the same period in the previous year. The decline was primarily related to the decline in sales and gross profit of Design Trends, as discussed above.

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Provision For Income Taxes. The provision for income tax was $1,838,000 or 36.0% of income for the six months ended December 31, 2004, compared to $2,125,000 or 36.3% for the same period of the prior year.

Liquidity and Capital Resources

The Company’s cash increased $1,499,000 from $5,838,000 at June 30, 2004 to $7,337,000 at December 31, 2004. The Company’s operating activities provided cash of $6,665,000, which was primarily attributable to income from operations before minority interest expense.

The $32,000 of cash used in investing activities related to additions to property and equipment, which consisted primarily of purchases of computer equipment and office furniture, and additions to other intangibles which consisted of the purchase of a patent.

Cash used in financing activities of $5,134,000 was primarily the result of (i) repurchases of the Company’s outstanding common stock of $2,925,000, (ii) principal payments on the Company’s notes payable of $1,583,000, (iii) cash dividends of $1,010,000, and (iv) distributions to minority interest members of $742,000. These amounts were partially offset by (i) net proceeds from the Company’s revolving lines of credit of $962,000 and (ii) proceeds from stock options exercised of $164,000.

The Company’s management believes that its current lines of credit, combined with cash flows from operations, are adequate to fund the Company’s current operating needs, debt service payments, repurchases of Company common stock, and any future dividend payments, as well as fund its projected growth over the next twelve months. Management believes that alternative bank financing on acceptable terms would be available should the Company not be able to renew its existing lines of credit. The Company remains committed to its business strategy of creating long-term earnings growth, maximizing stockholder value through internal improvements, making selective acquisitions and dispositions of assets, focusing on cash flow, and retaining quality personnel.

Management anticipates that future cash flows will be used primarily to retire existing debt and to repurchase Company common stock. As of December 31, 2004, the Company had repurchased 494,463 shares at an aggregate cost of $11,194,000 under this program. The average price paid per share repurchased was $22.63. See “Part II. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds” for further information.

At December 31, 2004, subject to continued compliance with certain covenants and restrictions, the Company had a $20,000,000 line of credit with The Frost National Bank at an interest rate of prime (5.25% at December 31, 2004) less 0.5%, of which $15,539,000 was outstanding. The line of credit is due on demand; however, if no demand is made, it is scheduled to mature on October 31, 2005. Under this line of credit, for each one-percentage point (1%) incremental increase in the prime rate, the Company’s annualized interest expense would increase by approximately $155,000. Consequently, an increase in the prime rate of five percentage points (5%) would result in an estimated annualized increase in interest expense for the Company of approximately $777,000.

At December 31, 2004, Design Trends had a $2,000,000 loan agreement with Frost, of which none had been utilized. Design Trends can borrow under this loan subject to continued compliance with certain covenants.

One of the Company’s 50%-owned subsidiaries, PHI, has a $2,000,000 line of credit (the “$2 Million Line of Credit”) with Wachovia Bank, N.A. (“Wachovia”), at an interest rate equal to the Monthly LIBOR index plus 2%, which expires October 15, 2005. There was an outstanding balance of $1,548,000 at December 31, 2004.

In addition, PHI has a $500,000 three-year note payable to Wachovia (the “$500,000 Note”) maturing on July 29, 2005, of which $111,000 was outstanding at December 31, 2004. The $500,000 Note bears interest at a rate equal to one-month LIBOR plus 2.5%.

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Furthermore, PHI entered into a loan agreement with Wachovia (the “$2.1 Million Note”) whereby Wachovia agreed to advance up to $2,100,000 to PHI, subject to PHI’s continued compliance with certain loan covenants specified by the agreement. The $2.1 Million Note bears interest at a rate equal to the one-month LIBOR plus 2.5%. At December 31, 2004, there was a $525,000 balance outstanding under the $2.1 Million Note, which is scheduled to mature on March 15, 2005. The PHI members agreed to be guarantors of the $2 Million Line of Credit, the $500,000 Note and the $2.1 Million Note for business purposes, in order to induce the lender to provide these loans to PHI.

Under the amounts outstanding of the PHI $2 Million Line of Credit, $500,000 Note and $2.1 Million Note, for each one-percentage point (1%) incremental increase in LIBOR, the Company’s annualized interest expense would increase by approximately $22,000. Consequently, an increase in LIBOR of five percentage points (5%) would result in an estimated annualized increase in interest expense for the Company of approximately $109,000.

At December 31, 2004, $3,391,000 remained outstanding under the note payable for the Company’s 378,000 square foot operating facility. The Company’s management believes that this facility will be sufficient for its purposes for the foreseeable future. The facility note payable matures on January 1, 2008.

Fanthing, Craftmade’s ceiling fan vendor, has provided Craftmade with a $1,000,000 credit limit, pursuant to which it will manufacture and ship ceiling fans prior to receipt of payment from Craftmade. Accordingly, payment can be deferred until delivery of such products. At present levels, such credit facility is equivalent to approximately three weeks’ supply of ceiling fans and represents a supplier commitment, which, in the opinion of the Company’s management, is unusual for the industry and favorable to the Company. This manufacturer is not required to provide this credit facility under its agreement with Craftmade, and it may discontinue this arrangement at any time.

Management does not anticipate that the covenants and restrictions of its lines of credit and loan agreements will limit the Company’s growth potential.

During fiscal year 2004, the Company extended its accounts receivable payment terms with its largest mass retail customer to 60 days from a previous range of 30 to 45 days. The Company does not anticipate that this will have a material impact on the availability of future cash collections to meet the Company’s expected future cash obligations.

TSI maintained inventory levels of $4,608,000 at December 31, 2004. TSI’s sales are highly concentrated with one mass retail customer. Should the revenues generated by TSI from its programs with this customer be at levels significantly lower than originally anticipated, the Company would be required to find other customers for this inventory. There can be no assurances that the Company would be able to obtain additional customers for this inventory or that any alternative sources would generate similar sales levels and profit margins as anticipated with the current mass merchandiser customer.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The information set forth below constitutes a “forward looking statement.” See Management’s Discussion and Analysis of Financial Condition and Results of Operations – Cautionary Statement.

The Company currently purchases a substantial amount of ceiling fans and other products of its Craftmade segment from Fanthing, a Taiwanese company. The Company’s verbal understanding with Fanthing provides that all transactions are to be denominated in U.S. dollars; however, the understanding further provides that, in the event that the value of the U.S. dollar appreciates or depreciates against the Taiwan dollar by one Taiwan dollar or more, Fanthing’s prices will be accordingly adjusted by 2.5%. The following table summarizes the exchange rate of the United States dollar (“USD”) to the Taiwan dollar (“TWD”):

A sharp appreciation of the Taiwan dollar relative to the U.S. dollar could materially adversely affect the financial condition and results of operations of the Company. The Company has not entered into any instruments to minimize this market risk of adverse changes in currency rates because the Company believes the cost associated with such instruments would outweigh the benefits that would be obtained from utilizing such instruments. All other purchases of the Company from foreign vendors are denominated in U.S. dollars and are not subject to adjustment provisions with respect to foreign currency fluctuations. As a result, the Company does not believe that it is subject to any material foreign currency exchange risk with respect to such purchases.

During the fiscal quarter ended December 31, 2004, the Company purchased approximately $3,443,000 of products from Fanthing. Under the Company’s understanding with Fanthing, each $1 incremental appreciation of the Taiwan dollar would result in an estimated annualized net increase in cost of goods sold of approximately $344,000, based on the Company’s purchases during the fiscal quarter ended December 31, 2004 on an annualized basis. A $5 incremental appreciation of the Taiwan dollar would result in an estimated annualized increase in cost of goods sold of approximately $1,722,000, based on the Company’s purchases during the fiscal quarter ended December 31, 2004 on an annualized basis. A $10 incremental appreciation of the Taiwan dollar would result in an increase of approximately $3,443,000 on an annualized basis, based on the Company’s purchases during the fiscal quarter ended December 31, 2004 on an annualized basis. These amounts are estimates of the financial impact of an appreciation of the Taiwan dollar relative to the U.S. dollar and are based on annualizations of the Company’s purchases from Fanthing for the fiscal quarter ended December 31, 2004. Consequently, these amounts are not necessarily indicative of the effect of such changes with respect to an entire year.

Other market risks at December 31, 2004 have not changed significantly from those discussed in Item 7A of our Form 10-K for the year ended June 30, 2004 filed with the Securities and Exchange Commission.

For a discussion of the effects of hypothetical changes in interest rates, see “Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Liquidity and Capital Resources.”

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Item 4. CONTROLS AND PROCEDURES.

The Company’s management, with the participation of the Company’s Chief Executive Officer and interim Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and interim Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of the end of the period covered by this report were not designed nor were functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. This conclusion is based on the identified material weakness in internal control over financial reporting previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2004.

Change in Internal Control over Financial Reporting

In connection with the audit of the Company’s consolidated financial statements for the fiscal year ended June 30, 2004, PricewaterhouseCoopers, LLP (“PwC”), the Company’s registered independent public accounting firm, informed the Company’s Audit Committee that it believed that the personnel and management of the Company who perform its accounting and financial reporting functions were not sufficiently expert in U.S. GAAP and the requirements of the SEC and the Public Company Accounting Oversight Board, and this lack of expertise represented a material weakness (as defined under standards established by the American Institute of Certified Public Accountants (“AICPA”)) in the operation of internal control over financial reporting.

In response to the foregoing material weakness, management of the Company, with the guidance of the Company’s Audit Committee, has been engaged in remediation efforts to ensure that the preparation of the Company’s consolidated financial statements, including the process to review and analyze elements of the Company’s financial statement close process, is in accordance with U.S. GAAP. The Chief Accounting Officer and senior Company finance and accounting staff responsible for the preparation of U.S. GAAP financial reports and SEC disclosures have increased their level of attendance at targeted U.S. GAAP and SEC reporting courses. The Company has subscribed during the second quarter of fiscal year 2005 to additional information networks that provide publications and updates of SEC and U.S. GAAP releases and rule changes and of information about the requirements of the Public Company Accounting Oversight Board.

As a result of the remediation efforts mentioned above and more fully described in the Company’s Form 10-Q for the fiscal quarter ended September 30, 2004 as filed with the SEC on November 9, 2004, management of the Company believes that its internal controls and procedures over financial reporting have been strengthened and functioned better during the period covered by this Quarterly Report, as compared to recent reporting periods.

Although Management of the Company believes there has been improvement in the operation of the Company’s internal controls during the period covered by this Quarterly Report, the material weakness will not be considered completely remediated until the procedures resulting from the remediation efforts are fully implemented, operate for a period of time, are tested and the Company concludes that such procedures are operating effectively. Moreover, the Company is continuing to implement additional internal controls remediation efforts prior to the 2005 audit, including adding additional controls and review processes to its monthly and quarterly close

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processes. To assist it with the documentation and testing of the Company’s internal controls to ensure they are operating effectively, the Company engaged outside internal control consultants in the second quarter of fiscal year 2005.

Until management of the Company is satisfied that it has addressed its need for sufficient expertise in preparing financial statements required in its filings under the securities laws, the Company will seek to mitigate this weakness by conferring with its outside accounting advisers with respect to the technical requirements applicable to the Company’s financial statements.

The implementation of the Company’s remediation plan is among the Company’s highest priorities. The Company’s Board of Directors, in coordination with the Company’s Audit Committee, will continually assess the progress and sufficiency of these efforts and make adjustments as and when necessary. As of the date of this report, management of the Company believes that the plan, when completely implemented prior to June 30, 2005, will eliminate the material weakness in internal accounting control as described above. However, a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues have been detected.

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PART II
OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS.

As more fully described in the Company’s Form 10-Q for the fiscal quarter ended September 30, 2004, on August 8, 2001, Lamps Plus, Inc. and Pacific Coast Lighting (collectively “Lamps Plus”) sued several defendants, including Patrick S. Dolan, Dolan Northwest, LLC, Design Trends, and Craftmade International, Inc. (collectively, the “Craftmade Parties”), for alleged patent infringement in the United States District Court for the Northern District of Texas. On September 14, 2004, the Court entered a Judgment and Permanent Injunction and issued an Order Awarding Attorneys’ Fees against the Craftmade Parties. Dolan, Design Trends, and Craftmade have appealed the Judgment and Order. However, the outcome of this appeal is uncertain.

With regard to the foregoing litigation (the “Lawsuit”), the Craftmade Parties entered into an agreement (the “Agreement”), that sets forth the responsibilities of the Craftmade Parties for payment of additional fees, costs and expenses of the Lawsuit. Pursuant to the Agreement, on April 16, 2003, Dolan Northwest became responsible for all legal fees and expenses incurred by the Craftmade Parties in connection with the Lawsuit from that date forward, and agreed to indemnify and hold harmless Craftmade and Design Trends from and against any and all claims, liabilities, or losses arising out of the legal fees and expenses incurred in the defense of the Lawsuit after February 21, 2003, including the appeal mentioned above.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

On December 9, 2003 the Company’s Board of Directors authorized the Company’s management to repurchase up to 500,000 shares of the Company’s outstanding common stock. As of December 31, 2004, the Company had repurchased 494,463 shares at an aggregate cost of $11,194,000 under this program. The average price paid per share repurchased was $22.63. The following table summarizes the repurchase activity during the six months ended December 31, 2004:

ISSUER PURCHASES OF EQUITY SECURITIES

Although no expiration date was specified for the repurchase program, it was substantially complete as of December 31, 2004. No shares were purchased by the Company other than through publicly announced plans or programs.

Item 3. DEFAULTS UPON SENIOR SECURITIES.

Not Applicable

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

The Company held its annual meeting of stockholders on November 30, 2004. With respect to the election of directors, the shares were voted as follows:

With respect to the ratification of PricewaterhouseCoopers, LLP as the Company’s auditors for 2005, the votes were as follows:

Item 5. OTHER INFORMATION.

Not Applicable

Item 6. EXHIBITS.

Exhibits

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*

Each document marked with an asterisk is filed herewith.

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SIGNATURES

     Pursuant to the requirements 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.

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Index to Exhibits

*

Each document marked with an asterisk is filed herewith.

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