SALTON INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

(Mark One)

[X] Quarterly Report Pursuant To Section 13 Or 15(d) Of The Securities Exchange
Act Of 1934 For the Quarterly Period Ended April 2, 2005 or

[ ] Transition Report Pursuant To Section 13 Or 15(d) Of The Securities
Exchange Act Of 1934 For the Transition Period From _________ to ________.

Commission file number: 0-19557

Salton, Inc.
(Exact name of registrant as specified in its charter)

Delaware 36-3777824
--------- ----------
(State of other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification Number)

1955 Field Court 60045
Lake Forest, IL (Zip Code)
(Address of principal executive offices)

(847) 803-4600
(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 the check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).

Yes X No
---- ----

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: As of May 7, 2005, 11,376,297
shares of its $0.01 par value Common Stock.

PAGE NO.
--------

PART I FINANCIAL INFORMATION
Item 1: Consolidated Financial Statements (Unaudited)

Consolidated Balance Sheets - April 2, 2005 and July 3, 2004 3

Consolidated Statements of Operations - Thirteen weeks ended 4
April 2, 2005 and March 27, 2004 and Thirty-nine weeks ended
April 2, 2005 and March 27, 2004

Consolidated Statements of Cash Flows -Thirty-nine weeks ended 5
April 2, 2005 and March 27, 2004

Notes to Consolidated Financial Statements 6

Item 2: Management's Discussion and Analysis of Financial Condition and 20
Results of Operations

Item 3: Quantitative and Qualitative Disclosures About Market Risk 30

Item 4: Controls and Procedures 31

PART II OTHER INFORMATION

Item 1: Legal Proceedings 31

Item 5: Other Information 34

Signature 35

Item 6: Exhibits 36

2

SALTON, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

(IN THOUSANDS EXCEPT SHARE DATA) APRIL 2, 2005 JULY 3, 2004
------------- ------------

ASSETS
CURRENT ASSETS:
Cash $ 18,214 $ 43,217
Compensating balances on deposit 34,194 34,000
Accounts receivable, less allowances 179,378 180,391
Inventories 271,743 253,627
Prepaid expenses and other current assets 20,719 21,267
Deferred income taxes 20,139 25,742
--------- ---------
Total Current Assets 544,387 558,244
Property, Plant and Equipment, net 60,317 81,152
Tradenames 185,691 184,421
Non-Current Deferred Tax Asset 34,991 18,007
Other Assets 12,882 15,516
--------- ---------
TOTAL ASSETS $ 838,268 $ 857,340
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving line of credit and other current debt $ 73,200 $ 48,667
Senior subordinated notes due 2005 - current 125,000 -
Accounts payable 90,845 137,671
Accrued expenses 74,523 56,997
Income taxes payable 11,283 8,805
--------- ---------
Total Current Liabilities 374,851 252,140
Non-Current Deferred Income Taxes 5,802 6,418
Senior Subordinated Notes Due 2005 - 125,000
Senior Subordinated Notes due 2008, including an adjustment
of $7,702 and $9,581 to the carrying value related
to interest rate swap agreements, respectively 156,951 158,642
Term Loan and Other Notes Payable 101,957 100,761
Other Long Term Liabilities 18,540 17,288
--------- ---------
658,101 660,249
Minority Interest 24,662 23,515
STOCKHOLDERS' EQUITY:
Preferred Stock, $0.01 par value; authorized, 2,000,000
shares; 40,000 shares issued - -
Common Stock, $0.01 par value; authorized, 40,000,000
shares; issued and outstanding: 2005-11,376,297 shares;
2004-11,370,282 shares 148 148
Treasury Stock - at cost (65,793) (65,793)
Additional Paid-In Capital 95,757 96,147
Accumulated Other Comprehensive Income 17,947 12,668
Retained Earnings 107,446 130,406
--------- ---------
Total Stockholders' Equity 155,505 173,576
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 838,268 $ 857,340
========= =========

See Notes to Consolidated Financial Statements.

3

SALTON, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

(IN THOUSANDS EXCEPT SHARE DATA) 13 WEEKS ENDED 39 WEEKS ENDED
------------------------------- --------------------------------
April 2, 2005 March 27, 2004 April 2, 2005 March 27, 2004
-------------- -------------- ------------- --------------

NET SALES $ 203,365 $ 191,376 $ 854,476 $ 827,018
Cost of Goods Sold 146,959 135,971 597,899 546,601
Distribution Expenses 15,833 16,813 52,931 54,264
------------------------------------------------------------------
GROSS PROFIT 40,573 38,592 203,646 226,153
Selling, General and Administrative Expenses 57,333 68,300 187,882 210,607
Impairment Loss on Goodwill and Intangible Assets 243 34,324 243 34,324
Restructuring Costs 287 - 1,077 -
------------------------------------------------------------------
OPERATING (LOSS) INCOME (17,290) (64,032) 14,444 (18,778)
Interest Expense, net 13,400 9,783 40,245 29,794
------------------------------------------------------------------
(LOSS) BEFORE INCOME TAXES (30,690) (73,815) (25,801) (48,572)
Income Tax Benefit (8,908) (16,588) (7,222) (8,296)
Minority Interest 748 790 4,381 4,654
------------------------------------------------------------------
NET (LOSS) $ (22,530) $ (58,017) $ (22,960) $ (44,930)
==================================================================

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 11,376,297 11,276,572 11,373,127 11,217,907

WEIGHTED AVERAGE COMMON AND COMMON

EQUIVALENT SHARES OUTSTANDING 11,376,297 11,276,572 11,373,127 11,217,907

Net (Loss) per Common Share: Basic $ (1.98) $ (5.14) $ (2.02) $ (4.01)

Net (Loss) per Common Share: Diluted $ (1.98) $ (5.14) $ (2.02) $ (4.01)

See Notes to Consolidated Financial Statements.

4

APRIL 2, 2005 MARCH 27, 2004
------------- --------------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net (Loss) $(22,960) $(44,930)
Adjustments to Reconcile Net (Loss) to Net Cash from Operating Activities:
Imputed interest on notes payable and other non-cash items (1,362) (1,354)
Deferred income tax provision (14,488) 1,346
Depreciation and amortization 17,864 17,013
Bad debt (recovery) provision (1,321) 1,740
Loss on disposal of equipment 41 335
Inventory valuation adjustment (1,577) 1,278
Impairment loss on goodwill and intangible assets 243 34,324
Foreign currency gains and losses 23 665
Gain on sale of investment (109) -
Minority interest, net of tax 4,381 4,654
Changes in assets and liabilities:
Accounts receivable 3,301 13,032
Inventories (14,671) (52,097)
Prepaid expenses and other current assets 379 (6,864)
Other non-current assets 155 (198)
Accounts payable (46,830) 58,644
Income taxes payable 2,573 (2,477)
Accrued expenses 21,440 19,860
-------- --------
NET CASH FROM OPERATING ACTIVITIES (52,918) 44,971

CASH FLOWS FROM INVESTING ACTIVITIES:

Capital expenditures (8,137) (13,991)
Proceeds from sale of property and investments 15,486 951
Additional payment for tradenames (619) (21,750)
-------- --------
NET CASH FROM INVESTING ACTIVITIES 6,730 (34,790)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from revolving line of credit and other debt 25,369 12,689
Repayment of long term debt (738) (601)
Distributions to minority shareholders (2,296) -
Costs associated with refinancing (967) (1,130)
Common stock issued 27 223
Increase in compensating balances on deposit (194) (5,600)
-------- --------
NET CASH FROM FINANCING ACTIVITIES 21,201 5,581
-------- --------
Effect of Exchange Rate Changes on Cash (16) 1,613
-------- --------
Net Change in Cash (25,003) 17,375

Cash, Beginning of Period 43,217 32,602
-------- --------
Cash, End of Period $ 18,214 $ 49,977
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

Cash Paid (Received) During the Period for:

Interest $ 27,334 $ 20,807

Income taxes, net of (refunds) $ 5,424 $ (6,759)

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:

In the quarter ended April 2, 2005, the Company incurred a capital lease
obligation of $81.

In the quarter ended March 27, 2004, the Company issued 146,902 shares of common
stock out of treasury in lieu of cash for the final payment to one of the
venture participants under the Foreman obligation.

In the quarter ended December 27, 2003, the Company incurred a capital lease
obligation of $705.

See Notes to Consolidated Financial Statements.

5

SALTON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. CONSOLIDATED FINANCIAL STATEMENTS

In the opinion of management, the accompanying consolidated balance sheets
and related interim consolidated statements of income and cash flows
include all adjustments, consisting only of normal recurring items,
necessary for their fair presentation in conformity with principles,
generally accepted in the United States of America. Preparing financial
statements requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenue and expenses.
Actual results may differ from these estimates. Our business is highly
seasonal, with operating results varying from quarter to quarter. Interim
results are not necessarily indicative of results for a full year. The
information included in this Form 10-Q should be read in conjunction with
Management's Discussion and Analysis and consolidated financial statements
and notes thereto included in the Salton, Inc. 2004 Annual Report on Form
10-K. Certain reclassifications have been made for consistent presentation.

2. NEW ACCOUNTING PRONOUNCEMENTS

In March 2005, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 47, "Accounting for Conditional Asset Retirement
Obligations" to clarify certain provisions of FASB Statement No. 143,
"Accounting for Asset Retirement Obligations." Interpretation No. 47
specifies that the term "conditional asset retirement obligation" includes
an entity's legal obligation to perform an asset retirement activity for
which the timing and (or) method of settlement are conditional on a future
event that may or may not be in the control of the entity. This
interpretation provides that an entity is required to recognize a liability
for a conditional asset retirement obligation if the fair value of the
obligation can be reasonably estimated. Interpretation No. 47 is effective
no later than the end of fiscal years ending after December 15, 2005. The
company is currently evaluating the impact of this interpretation on its
financial statements.

In December 2004, the FASB issued Statement No. 123(R), "Share Based
Payment", which replaces Statement No. 123, "Accounting for Stock-Based
Compensation," and Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees." This statement requires
compensation expense to be measured based on fair value of the stock
options, and to be recognized as an expense on the financial statements.
This statement is effective for fiscal periods beginning after June 15,
2005. The Company will be adopting this statement for the first quarter of
fiscal 2006, beginning July 3, 2005, and is currently evaluating the impact
on its financial statements.

On October 22, 2004, the American Jobs Creation Act (the "AJCA") was signed
into law. The AJCA provides for a deduction of 85% of certain foreign
earnings that are repatriated, as defined in the AJCA. The Company has
completed its evaluation of the repatriation provision of the AJCA and does
not intend to apply this provision to qualifying foreign earnings
repatriations. The Company currently has options to employ lower tax
alternatives for potential future foreign earnings repatriations, including
accumulated foreign earnings that were previously taxed in the U.S., as
well as the use of the Company's U.S. net operating loss carryforward.

3. FINANCING ARRANGEMENTS

On September 28, 2004 Salton Europe, Limited ("Salton Europe"), the
Company's wholly owned subsidiary, amended its facility (the "Facility
Letter") agreement with Hong Kong Shanghai Bank. The amended Facility
Letter includes an overdraft facility of up to (pound)8 million ($15.0
million) and a money market borrowing facility of up to (pound)7 million
($13.2 million). In addition, Salton Europe has an invoice finance facility
of between (pound)15 and (pound)40 million ($28.2 million and $75.2
million) depending

6

on seasonality and accounts receivable levels. As of April 2, 2005, there
was $16.5 million outstanding under the facility, which is included in
other current debt.

The Company has $125.0 million of 10 3/4% senior subordinated notes
outstanding with a maturity date of December 15, 2005. As of January 1,
2005, the notes have been reclassified to current debt.

4. STOCK-BASED COMPENSATION

At April 2, 2005, the Company had various stock-based employee compensation
plans, which are described more fully in Note 10 of the Company's 2004
Annual Report on Form 10-K. The Company accounts for those plans in
accordance with APB Opinion No. 25, "Accounting for Stock Issued to
Employees" and related Interpretations. No stock-based employee
compensation cost is reflected in net income, as no options granted under
those plans had an exercise price less than the market value of the
underlying common stock on the date of grant. The following table
illustrates the effect on net income and earnings per share if the Company
had applied the fair value recognition provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation."

13 Weeks Ended 39 Weeks Ended
------------------------ --------------------------
April 2, March 27, April 2, March 27,
(In thousands except earnings per share) 2005 2004 2005 2004
---------- ---------- ---------- ----------

Net (loss) - as reported $ (22,530) $ (58,017) $ (22,960) $ (44,930)
Less: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related taxes 376 427 948 1,281
---------- ---------- ---------- ----------
Net (loss)- pro forma $ (22,906) $ (58,444) $ (23,908) $ (46,211)
========== ========== ========== ==========
(Loss) per share - basic
As reported $ (1.98) $ (5.14) $ (2.02) $ (4.01)
Pro forma (2.01) (5.18) (2.10) (4.12)
(Loss) per share - diluted
As reported $ (1.98) $ (5.14) $ (2.02) $ (4.01)
Pro forma (2.01) (5.18) (2.10) (4.12)

5. NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE

Basic net income per common share is computed based upon the weighted
average number of common shares outstanding. Diluted net income per common
share is computed based upon the weighted average number of common shares
outstanding, adjusted for dilutive common stock equivalents applying the
treasury stock method for options and warrants and the if-converted method
for convertible securities.

For the thirteen weeks ended April 2, 2005 and March 27, 2004, and for the
thirty-nine weeks ended April 2, 2005 and March 27, 2004, the dilutive
effect of the Company's outstanding common stock equivalents, options and
warrants were excluded from the computation of diluted earnings per share
because they had an anti-dilutive effect due to the Company's losses in
these periods.

6. DERIVATIVE FINANCIAL INSTRUMENTS

The Company uses derivative financial instruments to manage foreign
currency risk. The Company does not enter into derivative financial
instruments for trading purposes. The Company uses forward exchange
contracts to hedge foreign currency payables for periods consistent with
the expected cash flow of the underlying transactions. The contracts
generally mature within one year and are designed to limit exposure to
exchange rate fluctuations, primarily related to the Great Britain Pound
and the South Africa Rand to the U.S. Dollar.

7

All foreign exchange contracts have been recorded in the consolidated
balance sheets within accrued expenses at a fair value of $0.2 million and
$8.7 million at April 2, 2005 and July 3, 2004, respectively. The change in
the fair value of contracts in the third quarter was $(5.5) million. There
was $(0.6) million and $(6.0) million at April 2, 2005 and July 3, 2004,
respectively, recorded in accumulated other comprehensive income, net of
tax, related to these contracts. The Company anticipates that all gains and
losses deferred in accumulated other comprehensive income related to
foreign exchange contracts will be reclassified into earnings within the
next twelve months as the related inventories are sold. At April 2, 2005,
the Company had foreign exchange forward contracts for the purchase of 37.6
million U.S. dollars. Contracts for the purchase of 25.1 million U.S.
dollars were entered into during the third quarter of fiscal 2005.

7. COMPREHENSIVE INCOME AND ACCUMULATED OTHER COMPREHENSIVE INCOME

For the thirteen weeks ended April 2, 2005 and March 27, 2004, components
of other comprehensive income include foreign currency translation
adjustments of $(4.9) million and $1.6 million, respectively and derivative
liability adjustments of $1.6 million and $1.8 million, respectively. For
the thirty-nine weeks ended April 2, 2005 and March 27, 2004, components of
other comprehensive income include foreign currency translation adjustments
of $(0.1) million and $12.6 million, respectively and derivative liability
adjustments of $5.4 million and $(3.4) million, respectively.

13 Weeks Ended 39 Weeks Ended
------------------------------ ------------------------------
(In thousands) April 2, 2005 March 27, 2004 April 2, 2005 March 27, 2004
------------- -------------- ------------ --------------

Net (Loss) $(22,530) $(58,017) $(22,960) $(44,930)
Other Comprehensive Income, net of tax of
$517 and $(537), $1,674 and $1,032, respectively (3,272) 3,424 5,279 9,156
-------- -------- -------- --------
Comprehensive Income $(25,802) $(54,593) $(17,681) $(35,774)
======== ======== ======== ========

Accumulated other comprehensive income is comprised of the following:

As Of
-------------------------------
(In thousands) April 2, 2005 July 3, 2004
------------- ------------

Minimum Pension Liability, net of tax of $4,975 and $4,888, respectively $(10,375) $(10,172)
Unrealized Loss on Derivative, net of tax of $264 and $2,663, respectively (630) (6,030)
Foreign Currency Translation 28,952 28,870
-------- --------
$ 17,947 $ 12,668
======== ========

8. PENSION BENEFIT PLANS

The components of net periodic pension cost are as follows:

(In thousands) Domestic Salton Europe Total
13 Weeks Ended: 04/02/05 03/27/04 04/02/05 03/27/04 04/02/05 03/27/04
-------- -------- -------- -------- -------- --------

Service cost-benefits earned during the year $ 42 $ 42 $ 80 $ 73 $ 122 $ 115
Interest cost on projected benefit obligation 176 179 566 466 742 645
Actuarial return on plan assets (156) (166) (439) (346) (595) (512)
Net amortization and deferral 65 99 191 177 256 276
----- ----- ----- ----- ----- -----
Net pension cost $ 127 $ 154 $ 398 $ 370 $ 525 $ 524
===== ===== ===== ===== ===== =====

8

(In thousands) Domestic Salton Europe Total
39 Weeks Ended: 04/02/05 03/27/04 04/02/05 03/27/04 04/02/05 03/27/04
-------- -------- -------- -------- -------- --------

Service cost-benefits earned during the year $ 126 $ 126 $ 236 $ 220 $ 362 $ 346
Interest cost on projected benefit obligation 529 536 1,666 1,398 2,195 1,934
Actuarial return on plan assets (467) (497) (1,291) (1,039) (1,758) (1,536)
Net amortization and deferral 194 296 561 530 755 826
----- ----- ------- ------- ------- -------
Net pension cost $ 382 $ 461 $ 1,172 $ 1,109 $ 1,554 $ 1,570
===== ===== ======= ======= ======= =======

The Company previously disclosed in its financial statements for the year
ended July 3, 2004, that it expected to contribute $0.7 million to its
domestic pension plans and $0.3 million to the Salton Europe pension plan
in fiscal 2005. Due to a shortfall in the Europe plan, the Company is
legally obligated to bring the plan up to 90% minimum funding level within
3 years and 100% in 10 years. Therefore, the contributions under the Europe
plan have been increased to an expected $1.0 million in fiscal 2005. As of
April 2, 2005, $0.6 million and $0.6 million of contributions have been
made to the domestic and Europe plans, respectively.

9. OPERATING SEGMENTS AND MAJOR CUSTOMERS

Salton consists of a single operating segment which designs, sources,
markets and distributes a diversified product mix for use in the home. The
product mix consists of small kitchen and home appliances, electronics for
the home, tabletop products, time products, lighting products, picture
frames and personal care and wellness products. The Company believes this
segmentation is appropriate based upon Management's operating decisions and
performance assessment. Nearly all of the Company's products are consumer
goods within the housewares market, procured through independent
manufacturers, primarily in the Far East. Salton's products are distributed
through similar distribution channels and customer base using the marketing
efforts of its Global Marketing Team.

Major Customers - For the thirteen weeks ended April 2, 2005 and March 27,
2004, no one customer accounted for more than 10.0% of total net sales. For
the thirty-nine weeks ended April 2, 2005, one customer accounted for 12.2%
of total net sales. During the same period of fiscal 2004, no one customer
accounted for more than 10.0% of net sales.

10. LEASE COMMITMENTS

The Company leases certain facilities and equipment under long-term
operating leases. During the third quarter of fiscal 2005, the Company
entered into a sale agreement, whereby it sold a distribution warehouse in
Europe for $15.2 million, which approximated book value at the date of
sale. The Company subsequently entered into an operating lease agreement
for this distribution warehouse with an initial lease termination date of
2030. Terms of the lease include scheduled rent increases every five years.
Rental expense under this lease was approximately $0.3 million for the
thirteen weeks ended April 2, 2005. The future minimum lease payments for
this lease as of April 2, 2005 were as follows:

Fiscal Year Ended (In thousands)
---------------- -------------

2005 $ 276
2006 1,105
2007 1,105
2008 1,105
2009 1,105
Thereafter 31,005
--------
Total minimum lease payments $ 35,701
========

9

11. LEGAL PROCEEDINGS

SECURITIES CLASS ACTION LAWSUITS

In May 2004, two stockholder lawsuits, named Mariss Partners, LLP v.
Salton, Inc., Leonhard Dreimann and David M. Mulder, and Warren Beeler v.
Salton, Inc., Leonhard Dreimann and David Mulder, were filed in the United
States District Court for the Northern District of Illinois against the
Company and certain Salton executives. The complaints allege that the
defendants violated the federal securities laws, specifically Sections
10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 of
the Securities and Exchange Commission, by making certain alleged false and
misleading statements. The plaintiffs seek unspecified damages on behalf of
a purported class of purchasers of our securities during the period from
November 11, 2002 through May 11, 2004. The Company believes that these
lawsuits are without merit and that it has compelling defenses to the
allegations contained in the complaints. Salton intends to vigorously
defend the Company. The outcome of the class action lawsuits cannot be
predicted with certainty, however, Salton does not believe that this matter
will have a material adverse affect on its business, financial condition or
results of operations. Therefore, no amounts have been accrued for such
claims. The plaintiffs have voluntarily dismissed the Mariss Partners
lawsuit.

PHILIPS

In June 2003, the Company received a letter from Philips Domestic
Appliances and Personal Care B.V. (Philips) accusing Salton of interfering
in a contractual relationship between Philips and a manufacturing source
for Salton, Electrical and Electronics (E&E), misappropriating trade
secrets and infringing other unspecified intellectual property rights in
connection with its development and marketing of the One:One single serve
coffee maker. On August 14, 2003, Salton filed a complaint in the United
States District Court for the Northern District of Illinois seeking a
declaratory judgment that the Company had not infringed the alleged trade
secret rights of Philips and had not tortuously interfered with the
contractual relationship between Philips and E&E.

Philips response has been to file a series of lawsuits against Salton. On
October 23, 2003, Philips filed a counterclaim against Salton in the
Northern District of Illinois, Declaratory Judgment case, reiterating the
allegations of Philips' June letter and adding a claim for copyright
infringement. The counterclaim sought to enjoin the distribution of the
One:One in the United States and money damages. On January 5, 2004, the
Court dismissed the action for failure to join E&E and suggested that the
matter should be litigated in the courts of Hong Kong. Philips has appealed
the Court's decision to the United States Court of Appeals for the Seventh
Circuit. A decision on this appeal is not expected for a number of months.
In view of the District Court's ruling, the Company sought and obtained the
consent of E&E to join in the action previously filed by Philips in Hong
Kong in May 2003, against E&E, alone. That Hong Kong suit alleges that E&E
misappropriated trade secrets, infringed intellectual property and breached
its contract with Philips in the process of developing and manufacturing
the One:One coffee maker for Salton.

On January 6, 2004, Philips filed a new action in the United States
District Court for the Northern District of Illinois, against Salton
alleging violations of U.S. Copyright Law seeking to enjoin the Company
from selling the One:One coffee maker and any monetary damages that the
Court deems proper. Contemporaneously, Philips sought a preliminary
injunction. On January 30, 2004, the Court dismissed Philips' new action on
the grounds that it was barred by the Court's dismissal decision in the
prior action. Philips appealed this dismissal and the appeal was
consolidated with the appeal of the earlier case in the United States Court
of Appeals for the Seventh Circuit.

10

On November 24, 2003, Philips and Sara Lee NV also filed a patent
infringement suit against Salton asserting that the One:One infringed a
U.S. patent. Like the other actions, this case seeks damages and injunctive
relief. The case is pending as in the United States District Court for the
Northern District of Illinois.

Philips has also filed an action for copyright infringement in the United
Kingdom. This suit alleges that the software on the electronic controller
of the One:One infringes Philips copyright and seeks unspecified money
damages and injunctive relief. At issue were the 55,624 units initially
introduced into the United Kingdom; Salton has discontinued the sales of
these units. This case is currently pending in the United Kingdom. E&E has
intervened in this action, and E&E's motion to dismiss or in the
alternative stay this action in favor of the Hong Kong action described
above was denied. On October 14, 2004, Salton offered to submit to judgment
in this action, and in the event the parties cannot agree on a royalty for
the use of this software in the 55,624 units, a judicial determination will
have to be made of any monetary award.

PRODUCT LIABILITY

On or about October 27, 2004, a lawsuit entitled DiNatale vs. Salton was
filed in the New York State Supreme Court against the Company. The
plaintiffs, who seek unspecified damages, allege that they were injured by
water contaminated with lead taken from a tea kettle sold by the Company
under its Russell Hobbs brand. The plaintiffs' attorney is seeking to
convert the lawsuit into a class action suit. The manufacturer of the
product and its insurer are defending this lawsuit. The Company's attorneys
and its insurers are cooperating in the defense of the lawsuit.

Shortly after receiving notice of the lawsuit, the Company voluntarily
suspended selling the product. The Company believes that at substantially
the same time, the two retailers who had purchased the kettle from the
Company also suspended selling the product. Based on information received
from the two retailers, the Company believes that only a limited number of
the kettles were sold to consumers. The Company voluntarily contacted the
U.S. Food and Drug Administration and has shared its information and test
results concerning the product with the agency.

The Company is reviewing the status of any other similar products, which
the same manufacturer has sold to the Company in recent years.

The outcome of the foregoing legal matters cannot be predicted with
certainty, however Salton does not believe that these actions will have a
material adverse affect on its business, financial condition or results of
operations. Therefore, no amounts have been accrued for such claims.

HOMEPLACE OF AMERICA

Homeplace of America, a company in liquidation under the United States
Bankruptcy Code, brought a lawsuit for recovery of preferential payments
made to Salton and its subsidiary, Toastmaster, during the 90 day
"preference" period prior to filing for bankruptcy. Homeplace's total
claimed preferences are approximately $3.5 million. The trial started the
first week of November 2004 in the U.S. Bankruptcy Court for the District
of Delaware. Settlement discussions to date have not, in Salton's view,
been meaningful. Salton does not believe that this matter will have a
material adverse affect on its business, financial condition or results of
operations. Therefore, no material amounts have been accrued for such
claims.

11

ENVIRONMENTAL

The Company has accrued approximately $0.2 million for the anticipated
costs of environmental remediation at four of our sites. Although such
costs could exceed that amount, Salton believes any such excess will not
have a material adverse effect on the financial condition or annual results
of operations of the Company.

OTHER

The Company is a party to various other actions and proceedings incident to
our normal business operations. The Company believes that the outcome of
any litigation will not have a material adverse effect on our business,
financial condition or results of operations. The Company also has product
liability and general liability insurance policies in amounts believed to
be reasonable given its current level of business. Although historically
the Company has not had to pay any material product liability claims, it is
conceivable that we could incur claims for which we are not insured.

12. SUPPLEMENTAL CONSOLIDATING FINANCIAL INFORMATION

The payment obligations of the Company under the senior secured revolving
credit facility and the senior subordinated notes are guaranteed by certain
of the Company's wholly-owned domestic subsidiaries (Subsidiary
Guarantors). Such guarantees are full, unconditional and joint and several.
Separate financial statements of the Subsidiary Guarantors are not
presented because the Company's management has determined that they would
not be material to investors. The following supplemental financial
information sets forth, on a combined basis, balance sheets, statements of
income and statements of cash flows for Salton, Inc. (Parent), the
Guarantor Subsidiaries, and the Company's Non-Guarantor subsidiaries (Other
Subsidiaries).

12

CONSOLIDATING BALANCE SHEET AS OF APRIL 2, 2005
(IN THOUSANDS)

13

CONSOLIDATING BALANCE SHEET AS OF JULY 3, 2004
(IN THOUSANDS)

GUARANTOR OTHER CONSOLIDATED CONSOLIDATED
PARENT SUBSIDIARIES ELIMINATIONS TOTAL SUBSIDIARIES ELIMINATIONS TOTAL
----------------------------------------------------------------------------------------

ASSETS
Current Assets:
Cash $ 1 $ 903 $ - $ 904 $ 42,313 $ - $ 43,217
Compensating balances on deposit - - - - 34,000 - 34,000
Accounts receivable, net of allowances 311 96,905 - 97,216 83,175 - 180,391
Inventories 5,133 165,189 (28,341) 141,981 111,646 - 253,627
Prepaid expenses and other current
assets 5,054 2,597 - 7,651 13,616 - 21,267
Intercompany 131,818 (104,380) (756) 26,682 (26,682) - -
Deferred income taxes 913 16,577 - 17,490 8,252 - 25,742
--------------------------------------------------------------------------------------
Total current assets 143,230 177,791 (29,097) 291,924 266,320 - 558,244
Property, Plant and Equipment,
Net of Accumulated Depreciation 11,016 14,910 - 25,926 55,226 - 81,152
Investments in Subsidiaries 390,773 53,646 (444,419) - - - -
Tradenames 134,723 10,313 - 145,036 39,385 - 184,421
Non-current deferred tax asset 8,840 9,167 - 18,007 - - 18,007
Other Assets 12,442 274 - 12,716 2,800 - 15,516
--------------------------------------------------------------------------------------
Total Assets $701,024 $266,101 $(473,516) $493,609 $363,731 $ - $857,340
=======================================================================================

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Revolving line of credit and other
current debt $ - $ 33,189 $ - $ 33,189 $ 15,478 $ - $ 48,667
Accounts payable 2,922 2,039 (584) 4,377 133,294 - 137,671
Accrued expenses 9,491 13,478 - 22,969 34,028 - 56,997
Income taxes payable (2,336) (1,496) - (3,832) 12,637 - 8,805
--------------------------------------------------------------------------------------
Total current liabilities 10,077 47,210 (584) 56,703 195,437 - 252,140
Non-current Deferred Income Taxes - - - - 6,418 - 6,418
Senior subordinated notes due 2005 125,000 - - 125,000 - - 125,000
Senior subordinated notes due 2008,
including an adjustment of $9,581
to the carrying value related to
interest rate swap agreements 158,642 - - 158,642 - - 158,642
Long-term debt-revolving credit agreement - 100,000 - 100,000 - - 100,000
Other notes payable - 175 - 175 586 - 761
Other long term liabilities 418 3,932 - 4,350 12,938 - 17,288
--------------------------------------------------------------------------------------
Total liabilities 294,137 151,317 (584) 444,870 215,379 - 660,249
Minority Interest - - - - 23,515 - 23,515
Stockholders' Equity 406,887 114,784 (472,932) 48,739 124,837 - 173,576
--------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $701,024 $266,101 $(473,516) $493,609 $363,731 $ - $857,340
======================================================================================

14

CONSOLIDATING STATEMENT OF OPERATIONS FOR THE THIRTEEN WEEKS ENDED APRIL 2, 2005
(IN THOUSANDS)

GUARANTOR OTHER CONSOLIDATED CONSOLIDATED
PARENT SUBSIDIARIES ELIMINATIONS TOTAL SUBSIDIARIES ELIMINATIONS TOTALS
----------------------------------------------------------------------------------------------

Net Sales $ 55,700 $ 124,772 $ (87,092) $ 93,380 $ 160,150 $(50,165) $ 203,365
Cost of Goods Sold 44,646 110,428 (85,555) 69,519 126,998 (49,558) 146,959
Distribution Expenses - 8,601 - 8,601 7,232 - 15,833
----------------------------------------------------------------------------------------------
Gross Profit 11,054 5,743 (1,537) 15,260 25,920 (607) 40,573
Selling, General and Administrative
expenses 11,139 14,061 - 25,200 32,740 (607) 57,333
Intangible Impairment Loss - 243 - 243 - - 243
Impairment loss on Goodwill and
Intangible Assets 173 114 - 287 - - 287
---------------------------------------------------------------------------------------------
Operating(Loss) Income (258) (8,675) (1,537) (10,470) (6,820) - (17,290)
Interest Expense, Net 7,254 3,792 - 11,046 2,354 - 13,400
Equity in Earnings of Subsidiaries 19,066 (9) (19,057) - - - -
---------------------------------------------------------------------------------------------
(Loss) Income Before Income Taxes (26,578) (12,458) 17,520 (21,516) (9,174) - (30,690)
Income Tax (Benefit) Expense (5,594) - - (5,594) (3,314) - (8,908)
Minority interest - - - - 748 - 748
---------------------------------------------------------------------------------------------
Net (Loss) Income $ (20,984) $ (12,458) $ 17,520 $ (15,922) $ (6,608) $ - $ (22,530)
=============================================================================================

CONSOLIDATING STATEMENT OF OPERATIONS FOR THE THIRTEEN WEEKS
ENDED MARCH 27, 2004
(IN THOUSANDS)

GUARANTOR OTHER CONSOLIDATED CONSOLIDATED
PARENT SUBSIDIARIES ELIMINATIONS TOTAL SUBSIDIARIES ELIMINATIONS TOTALS
----------------------------------------------------------------------------------------------

Net Sales $ 47,801 $ 120,623 $ (71,041) $ 97,383 $ 154,242 $ (60,249) $ 191,376
Cost of Goods Sold 35,411 91,688 (67,676) 59,423 124,600 (48,052) 135,971
Distribution Expenses - 10,752 - 10,752 6,061 - 16,813
---------------------------------------------------------------------------------------------
Gross Profit 12,390 18,183 (3,365) 27,208 23,581 (12,197) 38,592
Selling, General and Administrative
expenses 19,264 25,694 - 44,958 36,238 (12,896) 68,300
Impairment loss on Goodwill and
Intangible Assets - 24,143 - 24,143 10,181 - 34,324
---------------------------------------------------------------------------------------------
Operating(Loss) Income (6,874) (31,654) (3,365) (41,893) (22,838) 699 (64,032)
Interest Expense, Net 6,886 1,274 - 8,160 1,623 - 9,783
Equity in Earnings of Subsidiaries 53,923 145 (54,068) - - - -
---------------------------------------------------------------------------------------------
(Loss) Income Before Income Taxes (67,683) (33,073) 50,703 (50,053) (24,461) 699 (73,815)
Income Tax (Benefit) Expense (9,259) (5,167) - (14,426) (2,162) - (16,588)
Minority interest - - - - 790 - 790
---------------------------------------------------------------------------------------------
Net (Loss) Income $ (58,424) $ (27,906) $ 50,703 $ (35,627) $ (23,089) $ 699 $ (58,017)
=============================================================================================

15

CONSOLIDATING STATEMENT OF OPERATIONS FOR THE THIRTY-NINE WEEKS
ENDED APRIL 2, 2005
(IN THOUSANDS)

GUARANTOR OTHER CONSOLIDATED CONSOLIDATED
PARENT SUBSIDIARIES ELIMINATIONS TOTAL SUBSIDIARIES ELIMINATIONS TOTALS
------------------------------------------------------------------------------------------

Net Sales $174,077 $466,239 $(279,066) $361,250 $703,320 $(210,094) $854,476
Cost of Goods Sold 141,134 396,695 (282,168) 255,661 542,058 (199,820) 597,899
Distribution Expenses - 27,364 - 27,364 25,567 - 52,931
----------------------------------------------------------------------------------------
Gross Profit 32,943 42,180 3,102 78,225 135,695 (10,274) 203,646
Selling, General and Administrative
expenses 42,123 36,726 - 78,849 119,307 (10,274) 187,882
Intangible Impairment Loss - 243 - 243 - - 243
Restructuring Costs 527 550 - 1,077 - - 1,077
----------------------------------------------------------------------------------------
Operating Income (9,707) 4,661 3,102 (1,944) 16,388 - 14,444
Interest Expense, net 21,589 11,312 - 32,901 7,344 - 40,245
Income (Loss) from Subsidiary 4,123 (36) (4,087) - - - -
----------------------------------------------------------------------------------------
(Loss) Income Before Income Taxes (35,419) (6,615) 7,189 (34,845) 9,044 - (25,801)
Income Tax (Benefit) Expense (9,394) - - (9,394) 2,172 - (7,222)

Minority Interest, net of tax - - - - 4,381 - 4,381
----------------------------------------------------------------------------------------
Net (Loss) Income $(26,025) $ (6,615) $ 7,189 $(25,451) $ 2,491 $ - $(22,960)
========================================================================================

CONSOLIDATING STATEMENT OF OPERATIONS FOR THE THIRTY-NINE WEEKS
ENDED MARCH 27, 2004
(IN THOUSANDS)

GUARANTOR OTHER CONSOLIDATED CONSOLIDATED
PARENT SUBSIDIARIES ELIMINATIONS TOTAL SUBSIDIARIES ELIMINATIONS TOTALS
------------------------------------------------------------------------------------------

Net Sales $ 214,758 $ 561,820 $(344,470) $ 432,108 $650,922 $(256,012) $ 827,018
Cost of Goods Sold 163,762 464,694 (340,022) 288,434 498,283 (240,116) 546,601
Distribution Expenses - 34,591 - 34,591 19,673 - 54,264
----------------------------------------------------------------------------------------
Gross Profit 50,996 62,535 (4,448) 109,083 132,966 (15,896) 226,153
Selling, General and Administrative
expenses 44,650 86,520 - 131,170 95,333 (15,896) 210,607
Impairment Loss on Goodwill and
Intangible Assets - 24,143 - 24,143 10,181 34,324
----------------------------------------------------------------------------------------
Operating (Loss) Income 6,346 (48,128) (4,448) (46,230) 27,452 - (18,778)
Interest Expense, Net 21,052 3,760 - 24,812 4,982 - 29,794
Equity in Earnings of Subsidiaries 37,832 754 (38,586) - - - -
----------------------------------------------------------------------------------------
(Loss) Income Before Income Taxes (52,538) (52,642) 34,138 (71,042) 22,470 - (48,572)
Income Tax (Benefit) Expense (8,376) (9,282) - (17,658) 9,362 - (8,296)
Minority interest - - - - 4,654 4,654
----------------------------------------------------------------------------------------
Net (Loss) Income $ (44,162) $ (43,360) $ 34,138 $ (53,384) $ 8,454 $ - $ (44,930)
========================================================================================

16

CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE THIRTY-NINE WEEKS
ENDED APRIL 2, 2005
(IN THOUSANDS)

GUARANTOR OTHER CONSOLIDATED CONSOLIDATED
PARENT SUBSIDIARIES ELIMINATIONS TOTAL SUBSIDIARIES ELIMINATIONS TOTALS
---------------------------------------------------------------------------------------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(26,025) $ (6,615) $ 7,189 $(25,451) $ 2,491 $ - $(22,960)
Adjustments to reconcile net income
(loss) to net cash used in operating
activities:
Imputed interest on notes payable
and other non-cash items (1,690) - - (1,690) 328 - (1,362)
Deferred income tax provision (21,215) 10,816 - (10,399) (4,089) - (14,488)
Depreciation and amortization 7,091 2,457 - 9,548 8,316 - 17,864
Bad debt (recovery) provision - (1,367) - (1,367) 46 - (1,321)
Loss on disposal of equipment - 100 - 100 (59) - 41
Inventory valuation adjustment - (662) - (662) (915) - (1,577)
Impairment loss on intangible asset - 243 - 243 - - 243
Foreign currency gains and losses - 23 - 23 - - 23
Gain on sale of investment - - - - (109) - (109)
Equity in net income of
unconsolidated affiliate/
consolidated subsidiaries 4,124 (36) (4,088) - - - -
Minority interest - - - - 4,381 - 4,381
Changes in assets and liabilities:
Accounts receivable 189 8,280 - 8,469 (5,168) - 3,301
Inventories (657) 4,099 (3,101) 341 (15,012) - (14,671)
Prepaid expenses and other current
assets 1,753 (1,002) - 751 (372) - 379
Other non-current assets - 52 - 52 103 - 155
Accounts payable 3 3,881 - 3,884 (50,714) - (46,830)
Taxes payable 6,324 1,497 - 7,821 (5,248) - 2,573
Accrued expenses 32,202 (39,750) - (7,548) 28,988 - 21,440
-------------------------------------------------------------------------------------
NET CASH FROM OPERATING ACTIVITIES 2,099 (17,984) - (15,885) (37,033) - (52,918)
-------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (599) (524) - (1,123) (7,014) - (8,137)
Proceeds from sale of property and
investments - 120 - 120 15,366 - 15,486
Additional payment for patents and
trademarks (376) (243) - (619) - - (619)
-------------------------------------------------------------------------------------
NET CASH FROM INVESTING ACTIVITIES (975) (647) - (1,622) 8,352 - 6,730
-------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from revolving line of
credit and other debt - 19,070 - 19,070 6,299 - 25,369
Repayment of long-term debt - (477) - (477) (261) - (738)
Distributions to minority shareholders - - - - (2,296) (2,296)
Costs associated with refinancing (967) - - (967) - - (967)
Common stock issued 27 - - 27 - - 27
Increase in compensating balances
on deposit - - - - (194) - (194)
-------------------------------------------------------------------------------------
NET CASH FROM FINANCING ACTIVITIES (940) 18,593 - 17,653 3,548 - 21,201
-------------------------------------------------------------------------------------
Effect of Exchange Rate Changes on Cash - - - - (16) - (16)
-------------------------------------------------------------------------------------
Net Change in Cash 184 (38) - 146 (25,149) - (25,003)
Cash, Beginning of Period 1 903 - 904 42,313 - 43,217
-------------------------------------------------------------------------------------
Cash, End of Period $ 185 $ 865 $ - $ 1,050 $ 17,164 $ - $ 18,214
=====================================================================================

17

CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE THIRTY-NINE WEEKS
ENDED MARCH 27, 2004
(IN THOUSANDS)

GUARANTOR OTHER CONSOLIDATED CONSOLIDATED
PARENT SUBSIDIARIES ELIMINATIONS TOTAL SUBSIDIARIES ELIMINATIONS TOTALS
----------------------------------------------------------------------------------------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(44,162) $(43,361) $ 34,137 $(53,386) $ 8,456 $ - $(44,930)
Adjustments to reconcile net income
(loss) to net cash used in operating
activities:
Imputed interest on notes payable (1,691) - - (1,691) 337 - (1,354)
Deferred income tax provision 1,794 (519) - 1,275 71 - 1,346
Depreciation and amortization 7,088 3,074 - 10,162 6,851 - 17,013
Bad debt provision - 1,740 - 1,740 - - 1,740
Loss on disposal of equipment - - - - 335 - 335
Equity in net income of
unconsolidated affiliate/
consolidated subsidiaries 37,832 753 (38,585) - - - -
Inventory valuation adjustment - 1,278 - 1,278 - - 1,278
Impairment loss on goodwill and
intangible assets - 24,143 - 24,143 10,181 - 34,324
Foreign currency gains and losses - 665 - 665 - - 665
Minority interest - - - - 4,654 - 4,654
Changes in assets and liabilities:
Accounts receivable (116) 16,836 - 16,720 (3,688) - 13,032
Inventories (7,019) (19,341) 4,448 (21,912) (30,185) - (52,097)
Prepaid expenses and other current
assets (1,098) 423 - (675) (6,189) - (6,864)
Other non-current assets - - - - (198) - (198)
Accounts payable 2,048 886 - 2,934 55,710 - 58,644
Taxes payable 15,848 (20,268) - (4,420) 1,943 - (2,477)
Accrued expenses 14,503 21,791 - 36,294 (16,434) - 19,860
--------------------------------------------------------------------------------------
NET CASH FROM OPERATING ACTIVITIES 25,027 (11,900) - 13,127 31,844 - 44,971
--------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (2,051) (2,828) - (4,879) (9,112) - (13,991)
Proceeds from sale of investment - - - - 951 - 951
Additional payment for tradenames (21,750) - - (21,750) - - (21,750)
--------------------------------------------------------------------------------------
NET CASH FROM INVESTING ACTIVITIES (23,801) (2,828) - (26,629) (8,161) - (34,790)
--------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from revolving line of
credit and other debt - 7,500 - 7,500 5,189 - 12,689
Repayment of long-term debt (317) (284) - (601) - - (601)
Costs associated with refinancing (1,130) - - (1,130) - - (1,130)
Common stock issued 223 - - 223 - - 223
Increase in compensating balances
on deposit - - - - (5,600) - (5,600)
-------------------------------------------------------------------------------------
NET CASH FROM FINANCING ACTIVITIES (1,224) 7,216 - 5,992 (411) - 5,581
-------------------------------------------------------------------------------------
Effect of Exchange Rate Changes on Cash - - - - 1,613 - 1,613
Net Change in Cash 2 (7,512) - (7,510) 24,885 - 17,375
Cash, Beginning of Period - 8,972 - 8,972 23,630 - 32,602
-------------------------------------------------------------------------------------
Cash, End of Period $ 2 $ 1,460 $ - $ 1,462 $ 48,515 $ - $ 49,977
=====================================================================================

13. SUBSEQUENT EVENT

On May 11, 2005, the Company entered into a Second Amendment to the Amended
and Restated Credit Agreement by and among Wells Fargo Foothill, Inc., as
administrative agent and collateral agent, Silver Point Finance, LLC, as
the co-agent, syndication agent, documentation agent, arranger and book
runner, the Company and each of the Company's domestic subsidiaries. The
Second Amendment amends and restates (a) the minimum Consolidated Fixed
Charge Coverage Ratio that the Company must maintain for the rolling
twelve-month periods ending each calendar month from March 31, 2005 through
December 31 2005, (b) the minimum EBITDA covenant and (c) the definition of
"Borrowing Base" to provide up to an additional $11 million of
availability. The Amendment subjects the Company's foreign subsidiaries
(other than Amalgamated Appliance Holdings Limited ("AMAP")) to the
covenants currently restricting the Company and its domestic subsidiaries
from engaging in certain actions without the consent of the senior lender,
including incurring debt, engaging in mergers or certain sales of assets,
making guaranties, incurring liens or engaging in sale and leaseback
transactions. The Second Amendment also increases the prepayment premium
and provides for certain mandatory prepayments upon issuance of debt or
equity, or sales of certain assets, by the Company's foreign subsidiaries.
The Amendment is subject to certain conditions, including that the Company
deliver to the senior lender within certain time periods stock pledges of
certain of the Company's foreign subsidiaries, including AMAP.

18

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

As used in this quarterly report on Form 10-Q, "we," "us," "our," "Salton"
and "the Company" refer to Salton, Inc. and our subsidiaries, unless the
context otherwise requires.

INTRODUCTION

Salton designs, sources, markets and distributes small appliances and
electronics for the home, home decor and personal care products under
recognized brand names in the International Housewares Industry. Our
product mix consists of kitchen and home appliances, electronics, tabletop
products, time products, lighting products, picture frames and personal
care and wellness products. In recent years, we have expanded our
international presence and strengthened our product offerings through
strategic acquisitions, alliances and internal international growth.

DISCUSSION OF CRITICAL ACCOUNTING POLICIES

Our financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America, which
require us to make estimates and judgments that significantly affect the
reported amounts of assets, liabilities, revenues and expenses and related
disclosure of contingent assets and liabilities. We regularly evaluate
these estimates, including those related to our allowance for doubtful
accounts, reserve for inventory valuation, reserve for returns and
allowances, valuation of intangible assets having indefinite lives,
cooperative advertising accruals, valuation reserves against deferred tax
assets, pension benefits and depreciation and amortization. We base these
estimates on historical experience and on assumptions that are believed by
management to be reasonable under the circumstances. Actual results may
differ from these estimates, which may impact the carrying value of assets
and liabilities.

The following critical accounting policies required the most significant
estimates used in the preparation of our consolidated financial statements

ALLOWANCE FOR DOUBTFUL ACCOUNTS - We calculate allowances for estimated
losses resulting from the inability of our customers to make required
payments. We utilize a number of tools to evaluate and mitigate our
customer credit risk. Management evaluates each new customer account using
a combination of some or all of the following sources of information:
credit bureau reports, industry credit group reports, customer financial
statement analysis, customer supplied credit references and bank
references. Appropriate credit limits are set in accordance with our credit
risk policy and monitored on an on-going basis. Existing customers are
monitored and credit limits are adjusted according to changes in their
financial condition. We calculate additional accounts receivable allowances
for anticipated future customer returns and claims. This additional accrual
covers defective product (warranty), sales returns and other customer
allowances. The amounts and trends are analyzed to develop appropriate
percentages that are applied against future sales. Based on the procedures
outlined herein, and the fact that only one customer accounted for 12.1% of
the gross accounts receivable at April 2, 2005 and no customer accounted
for 10.0% or more of the gross accounts receivable at July 3, 2004, we
believe there is no concentration of credit risk.

Our exposure to credit loss on our foreign currency forward contracts in
the event of non-performance by the counterparties is believed to be remote
due to the requirements that the counterparties consist only of major
financial institutions that have a long-term credit rating of single-A or
better from both Moody's and Standard & Poor's. Additionally, our foreign
currency forward contracts generally have terms of one year or less.

19

INVENTORY VALUATION - The Company's domestic inventories are generally
determined using the last-in, first-out (LIFO) method. These inventories
account for approximately 50.1% and 53.7% of the Company's inventories as
of April 2, 2005 and July 3, 2004, respectively. All remaining inventory
cost is determined on the first-in, first-out basis. The Company records
inventory at the lower of its cost or net realizable value. Management
regularly evaluates the composition of inventory to identify slow-moving
and obsolete inventories and for items that we are unable to sell at prices
above their original cost. When such items are identified, a charge to
operations results to reduce the book value to the net amount expected to
be realized upon the sale of such items. There is inherent subjectivity and
uncertainty in this estimation process.

COMMITMENTS AND CONTINGENCIES - We are subject to lawsuits and other claims
related to product and other matters that are being defended and handled in
the ordinary course of business. We maintain reserves and or accruals for
such costs that may be incurred, which are determined on a case-by-case
basis, taking into consideration the likelihood of adverse judgments or
outcomes, as well as the potential range of probable loss. The reserves and
accruals are monitored on an ongoing basis and are updated for new
developments or new information as appropriate.

INTANGIBLE ASSETS - We record intangible assets through transactions and
acquisitions. The cost of acquisitions are allocated to the assets and
liabilities acquired, including identifiable intangible assets, with the
remaining amount being classified as goodwill. Goodwill and other
intangible assets that have an indefinite life are assessed annually for
impairment during the fourth quarter. The allocation of the acquisition
cost to intangible assets and goodwill therefore has a significant impact
on our future operating results. The allocation process requires the
extensive use of estimates and assumptions, including estimates of future
cash flows expected to be generated by the acquired assets. Further, when
impairment indicators are identified with respect to previously recorded
intangible assets, the values of the assets are determined using a variety
of techniques including discounted future cash flows, which are based on
estimated future operating results. Significant management judgment is
required in the forecasting of future operating results, which are used in
the preparation of projected discounted cash flows.

INCOME TAXES - Significant management estimates and judgments are required
in determining income tax expense for financial statement purposes. These
estimates and judgments occur in the calculation of certain deferred tax
assets and liabilities, which arise from differences in the timing of
recognition of revenue and expense for tax and financial statement
purposes. We must assess the likelihood that we will be able to recover our
deferred tax assets. If recovery is not likely, we must increase our
provision for taxes by recording a valuation allowance against the deferred
tax assets that we estimate will not ultimately be recoverable. As changes
occur in our assessments regarding our ability to recover our deferred tax
assets, the valuation allowance and the tax provision are adjusted
accordingly.

REVENUE RECOGNITION - The Company recognizes revenue at FOB shipping point
which corresponds to when title and risks and rewards of ownership transfer
to its customers. Fees charged for shipping and handling are included in
net sales and the associated costs are included in distribution expenses.
Provision is made for estimated cost of returns, warranties and product
liability claims.

NEW ACCOUNTING PRONOUNCEMENTS

In March 2005, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 47, "Accounting for Conditional Asset Retirement
Obligations" to clarify certain provisions of FASB Statement No. 143,
"Accounting for Asset Retirement Obligations." Interpretation No. 47
specifies that the term "conditional asset retirement obligation" includes
an entity's legal obligation to perform

20

an asset retirement activity for which the timing and (or) method of
settlement are conditional on a future event that may or may not be in the
control of the entity. This interpretation provides that an entity is
required to recognize a liability for a conditional asset retirement
obligation if the fair value of the obligation can be reasonably estimated.
Interpretation No. 47 is effective no later than the end of fiscal years
ending after December 15, 2005. The company is currently evaluating the
impact of this interpretation on its financial statements.

In December 2004, the FASB issued Statement No. 123(R), "Share Based
Payment", which replaces Statement No. 123, "Accounting for Stock-Based
Compensation," and Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees." This statement requires
compensation expense to be measured based on fair value of the stock
options, and to be recognized as an expense on the financial statements.
This statement is effective for fiscal periods beginning after June 15,
2005. The Company will be adopting this statement for the first quarter of
fiscal 2006, beginning July 3, 2005, and is currently evaluating the impact
on its financial statements.

On October 22, 2004, the American Jobs Creation Act ("the AJCA") was signed
into law. The AJCA provides for a deduction of 85% of certain foreign
earnings that are repatriated, as defined in the AJCA. The Company has
completed its evaluation of the repatriation provision of the AJCA and does
not intend to apply this provision to qualifying foreign earnings
repatriations. The Company currently has options to employ lower tax
alternatives for potential future foreign earnings repatriations, including
accumulated foreign earnings that were previously taxed in the U.S., as
well as the use of the Company's U.S. net operating loss carryforward.

QUARTER IN REVIEW

For the third quarter of fiscal 2005 (thirteen weeks ended April 2, 2005),
Salton continued its focus on increasing international opportunities,
increasing domestic pricing to offset rising product costs, and reducing
domestic operating costs in an effort to align U.S. costs with current
sales levels and return the domestic business to profitability.

During the third quarter, Salton invested approximately $4.2 million of
selling, advertising, general and administrative costs to expand sales into
Spain, Italy and Germany, which resulted in new sales of $4.5 million for
the quarter.

Domestic price increases are underway within the industry to offset rising
product costs to the domestic market. Although the Company believes the
industry-wide cost drivers will ultimately result in the acceptance of the
price increases, existing industry inventories built under lower cost
structures could delay full acceptance of the price increases in the
immediate future.

We continued to implement the U.S. restructuring plan with additional
headcount reductions and facility closures in the domestic operations. Our
U.S. restructuring plan is on-target and, when fully implemented this
fiscal year, is expected to generate in excess of $40.0 million in annual
cost savings.

21

RESULTS OF OPERATIONS
The following table sets forth our results of operations as a percentage of
net sales for the periods indicated:

13 WEEKS ENDED
-------------------------------
APRIL 2, 2005 MARCH 27, 2004
------------- --------------

Net sales 100.0% 100.0%
Cost of goods sold 72.2 71.0
Distribution expenses 7.8 8.8
------ ------
Gross profit 20.0% 20.2%
Selling, general and administrative expense 28.2 35.7
Intangible Impairment Loss 0.1 17.9
Restructuring Costs 0.1 0.0
------ ------
Operating income -8.4% -33.4%
------ ------

THIRD QUARTER FISCAL 2005 COMPARED TO THIRD QUARTER FISCAL 2004

NET SALES AND GROSS PROFIT
Sales for the third quarter of 2005 were $203.4 million compared to $191.4
million the third quarter of 2004. The $12.0 million or 6.3% increase was
primarily a result of a $3.3 million domestic sales increase, led primarily
by an increase in the sale of George Foreman branded products and an $8.7
million foreign sales increase primarily driven by increases in AMAP.
Foreign sales increase includes $7.8 million of foreign currency
fluctuation gain.

International growth from AMAP, Brazil and Mexico and new growth from our
start-up operations in Spain, Italy and Germany, was partially offset by
softer sales in the United Kingdom as a result of a continued weak retail
environment.

Gross profit, as a percent of net sales, was 20.0% in third quarter of 2005
as compared to 20.2% in third quarter of 2004, a decrease of 0.2%. The
gross profit was impacted by lower gross margins domestically, principally
as a result of higher materials costs and inventory reduction efforts.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased to 28.2% of net
sales or $57.3 million in the third quarter of 2005 compared to 35.7% of
net sales or $68.3 million for the third quarter of 2004. The decrease was
a result of domestic cost reductions partially offset by approximately $4.2
million of additional expenses associated with our new subsidiaries in
Spain, Italy and Germany and $1.6 million of foreign currency fluctuations.

For the third quarter of 2005, as a percent of sales, expenditures for
television, royalty expense, certain other media and cooperative
advertising and promotional activities decreased to 9.8% from 14.5% of net
sales for second quarter of 2004. Most of the decrease was in cooperative
advertising and promotional activities in the domestic market, which were
reduced to more normalized levels in the current year.

NET INTEREST EXPENSE
Net interest expense was $13.4 million for the third quarter of 2005
compared to $9.8 million in the third quarter of 2004. Our annualized
weighted average rate of interest on average borrowings was 11.6% in the
third quarter of 2005 compared to 10.5% in the same period in 2004. The
average amount of all debt outstanding was $463.7 million for the third
quarter of 2005 compared to $373.3 million for the same period in 2004.

22

IMPAIRMENT LOSS ON GOODWILL AND INTANGIBLE ASSETS
Effective with the beginning of Fiscal Year 2003, the Company adopted SFAS
No. 142, "Goodwill and Other Intangible Assets". Upon adoption of SFAS No.
142, the Company discontinued the amortization of goodwill and indefinite
lived intangible assets and instead, performs an annual fair-value based
impairment test which is done more frequently if circumstances indicate a
potential impairment.

The annual test for impairment of goodwill and other intangible assets is
conducted during the fourth quarter of each fiscal year, with interim
reviews performed by Management quarterly. Management determined that the
balance of $0.2 million of goodwill was impaired and was therefore written
off. There was no other impairment of the Tradenames comprising the
remaining balances. During the third quarter of 2004, Management determined
that the combination of certain events including the shortfall in meeting
projected operating results along with the Company's inability to meet its
financial debt covenant requirement for its senior secured revolving credit
facility for two consecutive quarters and a downgrade in the debt rating
could have an adverse effect on the carrying value of the Goodwill and
Other Intangible Assets so an interim impairment test was conducted. As a
result, the Company determined that the implied fair value of goodwill and
the fair value of certain other indefinite lived intangible assets were
less than their carrying values and the Company recorded a non-cash
impairment charge totaling $34.3 million pre-tax or $29.9 million net of
tax, consisting of consolidated goodwill of $28.2 million and certain other
indefinite lived intangible assets of $6.1 million.

RESTRUCTURING EXPENSE
Restructuring expenses in the current quarter included closure costs for
certain distribution facilities and consulting fees.

INCOME TAXES
The Company's provision for income taxes is based upon estimated annual tax
rates for the year applied to federal, state, and foreign income. The
Company expects its effective tax rate benefit for the third quarter of
2005 of (29.0)% to differ from the prior year rate of (22.5)% due to a
shift in income mix from lower rate foreign jurisdictions to the U.S. in
2005 as well as non-deductible goodwill impairment charges and the
establishment of deferred tax valuation allowances recorded in 2004. The
effective tax rate benefit for the third quarter 2005 was also impacted by
$1.1 million of adjustments to certain deferred tax asset balances and an
increase in tax reserves based upon management's estimates of probable
losses. The adjustments of the deferred tax asset balances are not material
to the Company's estimated full year earnings per share, cash from
operations or shareholders' equity.

THIRTY-NINE WEEKS IN REVIEW

For the first thirty-nine weeks of fiscal 2005 (thirty-nine weeks ended
April 2, 2005), Salton continued its focus on increasing international
opportunities and reducing domestic operating costs in an effort to align
U.S. costs with current sales levels and return the domestic business to
profitability.

Salton continued its international expansion and opened operations in
Spain, Italy and Germany, generating $10.3 million in new international
business.

We continued to implement the U.S. restructuring plan with additional
headcount reductions and facility closures in the domestic operations. Our
U.S. restructuring plan is on-target and, when fully implemented this
fiscal year, is expected to generate at least $40.0 million in annual cost
savings.

23

In connection with the U.S. restructuring, we recorded pretax charges of
$1.1 million in the first thirty-nine weeks of fiscal 2005 for consulting
and legal fees, termination and severance costs associated with the
headcount reduction in the U.S. and costs involved in the closure of
certain distribution facilities Although the dollar amount is minimal,
these costs do impact the overall comparability of reported operating
income, net income and earnings per share for the first half of fiscal
2005.

RESULTS OF OPERATIONS

The following table sets forth our results of operations as a percentage of
net sales for the periods indicated:

39 WEEKS ENDED
-------------------------------
APRIL 2, 2005 MARCH 27, 2004
------------- --------------

Net sales 100.0% 100.0%
Cost of goods sold 70.0 66.1
Distribution expenses 6.2 6.6
------------- --------------
Gross profit 23.8% 27.3%
Selling, general and administrative expense 22.0 25.5
Intangible impairment loss 0.0 4.1
Restructuring costs 0.1 0.0
------------- --------------
Operating income 1.7% -2.3%
------------- --------------

FIRST THIRTY-NINE WEEKS OF 2005 COMPARED TO FIRST THIRTY-NINE WEEKS OF
FISCAL 2004

NET SALES AND GROSS PROFIT
Salton's net sales for the thirty-nine weeks ended April 2, 2005 were
$854.5 million. This represented an increase in revenues of 3.3% compared
to $827.0 million for the same period in 2004. This increase was primarily
the result of foreign sales increases of $73.5 million, which includes
$38.5 million of foreign currency fluctuation gain, substantially offset by
decreases in the domestic market from the first half of 2005.

Gross profit in first thirty-nine weeks of 2005 decreased to $203.6 million
compared to $226.1 million in the first thirty-nine weeks of 2004. As a
percent of net sales, gross profit decreased from 27.3% in the first
thirty-nine weeks of 2004 to 23.8% of net sales in the first thirty-nine
weeks of 2005. The percentage decline was primarily a result of a higher
volume of lower margin electronic sales from AMAP, higher industry-wide
product costs, promotional pricing to launch the Company's coffee pod
initiatives combined with a large volume of lower margin sales in the
domestic market in an effort to move discontinued product under our
inventory reduction plans and warehouse closures.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased to 22.0% of net
sales or $187.9 million in first thirty-nine weeks of 2005 compared to
25.5% of net sales or $210.6 million for first thirty-nine weeks of 2004.
Cost reductions achieved under the U.S. restructuring plan were partially
offset by foreign increases which included international expansion, and
$7.9 million related to foreign currency fluctuations.

24

For the first thirty-nine weeks of 2005, as a percent of sales,
expenditures for television, royalty expense, certain other media and
cooperative advertising and promotional activities decreased to 9.1% from
11.9% of sales for first thirty-nine weeks of 2004. While first quarter
product launches increased direct advertising expenditures, second quarter
promotional and direct advertising expenditures were reduced and third
quarter cooperative advertising and promotional activities returned to more
normalized levels. This returned the Company's overall rate of expenditures
to a more normalized level.

IMPAIRMENT LOSS ON GOODWILL AND INTANGIBLE ASSETS
Effective with the beginning of Fiscal Year 2003, the Company adopted SFAS
No. 142, "Goodwill and Other Intangible Assets". Upon adoption of SFAS No.
142, the Company discontinued the amortization of goodwill and indefinite
lived intangible assets and instead, performs an annual fair-value based
impairment test which is done more frequently if circumstances indicate a
potential impairment.

The annual test for impairment of goodwill and other intangible assets is
conducted during the fourth quarter of each fiscal year, with interim
reviews performed by Management quarterly. Management determined that the
balance of $0.2 million of goodwill was impaired and was therefore written
off. There was no other impairment of the Tradenames comprising the
remaining balances. During the third quarter of 2004, Management determined
that the combination of certain events including the shortfall in meeting
projected operating results along with the Company's inability to meet its
financial debt covenant requirement for its senior secured revolving credit
facility for two consecutive quarters and a downgrade in the debt rating
could have an adverse effect on the carrying value of the Goodwill and
Other Intangible Assets so an interim impairment test was conducted. As a
result, the Company determined that the implied fair value of goodwill and
the fair value of certain other indefinite lived intangible assets were
less than their carrying values and the Company recorded a non-cash
impairment charge totaling $34.3 million pre-tax or $29.9 million net of
tax, consisting of consolidated goodwill of $28.2 million and certain other
indefinite lived intangible assets of $6.1 million.

RESTRUCTURING COSTS
In connection with the U.S. restructuring, we recorded pretax charges of
$1.1 million in the first thirty-nine weeks of fiscal 2005 for consulting
and legal fees, termination and severance costs associated with the
headcount reduction in the U.S. and costs involved in the closure of
certain distribution facilities.

NET INTEREST EXPENSE
Net interest expense was $40.2 million for the first thirty-nine weeks of
fiscal 2005 compared to $29.8 million in the first thirty-nine weeks of
fiscal 2004. Our annualized weighted average rate of interest on average
borrowings was 11.2% in the first thirty-nine weeks of 2005 compared to
10.0% in the same period in 2004. The average amount of all debt
outstanding was $480.7 million for the first thirty-nine weeks of 2005
compared to $397.3 million for the same period in 2004.

25

INCOME TAXES
Our provision for income taxes is based upon estimated annual tax rates for
the year applied to federal, state, and foreign income. We expect our
effective tax rate benefit for the thirty-nine weeks ended April 2, 2005 of
(28.0)% to differ from the prior year rate of (17.1)% due to a shift in
income mix from lower rate foreign jurisdictions to the U.S. in 2005 as
well as non-deductible goodwill impairment charges and the establishment of
deferred tax valuation allowances recorded in 2004. The effective tax rate
benefit for the thirty-nine weeks ended April 2, 2005 was also impacted by
a $1.1 million of adjustments to certain deferred tax asset balances and an
increase in tax reserves based upon management's estimates of probable
losses. The adjustments of the deferred tax asset balances are not material
to our estimated full year earnings per share, cash from operations or
shareholders' equity.

LIQUIDITY AND CAPITAL RESOURCES

CASH FLOW FROM OPERATIONS
Our primary sources of liquidity are our cash flow from operations and
borrowings under our senior secured revolving credit facility. In the first
thirty-nine weeks of fiscal 2005, Salton's operations used $52.9 million in
cash flow, compared with cash inflow of $45.0 million in the first
thirty-nine weeks of fiscal 2004. The most significant impact was in
accounts payable, which was a source of cash rising $58.6 million in the
prior year but decreased to $46.8 million in the current year. Given the
seasonal nature of our business, borrowings and availability tend to be
highest in mid-Fall and early Winter.

Our cash flow from operations for the periods discussed have not been
materially affected by inflation or foreign currency fluctuation. We
generally negotiate our purchase orders with our foreign manufacturers in
United States dollars. Thus, our cost under any purchase order is not
subject to change after the time the order is placed due to exchange rate
fluctuations. However, the weakening of the United States dollar against
local currencies could result in certain manufacturers increasing the
United States dollar prices for future product purchases. In addition, we
have recently experienced an upward trend in raw material prices and expect
this trend could continue.

We also currently use foreign exchange contracts to hedge anticipated
foreign currency transactions, primarily U.S. dollar inventory purchases.
The contracts generally mature within one year and are designed to limit
exposure to exchange rate fluctuations, primarily the Great Britain Pound
and South Africa Rand against United States Dollars.

INVESTING ACTIVITIES
We incurred approximately $8.1 million for capital expenditures during the
first thirty-nine weeks of fiscal 2005, including approximately $2.7
million in construction-in-progress for a warehouse renovation in Europe.
We received proceeds of $15.5 million from the sale of property and
investments, primarily from the sale of the renovated warehouse in Europe.

FINANCING ACTIVITIES
We had net proceeds from worldwide credit facilities of $25.4 million. The
increase in facility usage represents an increase in working capital that
was financed through our credit facilities in the U.S. and the UK.

26

REVOLVING CREDIT FACILITY
On June 15, 2004, we entered into an amended and restated $275.0 million
senior secured revolving credit facility, which initially provides us with
the ability to borrow up to $207.0 million (including $10.0 million for
letters of credit). Advances under the senior secured revolving credit
facility are primarily based upon percentages of eligible accounts
receivable and inventories. The facility has a maturity date of June 15,
2007 and is subject to a prepayment premium based on the date of
prepayment.

As of April 2, 2005, we had borrowed $151.7 million under the senior
secured revolving credit facility, $100.0 million of which is included in
long-term liabilities. We had approximately $7.8 million available under
this facility for future borrowings.

Our senior indebtedness contains a number of significant covenants that,
among other things, restrict our ability to dispose of assets, incur
additional indebtedness, prepay other indebtedness, pay dividends,
repurchase or redeem capital stock, enter into certain investments, enter
into sale and lease-back transactions, make certain acquisitions, engage in
mergers and consolidations, create liens, or engage in certain transactions
with affiliates and otherwise restrict our corporate and business
activities. In addition, under our senior secured revolving credit
facility, we are required to comply with a minimum EBITDA, consolidated
fixed charge coverage ratio and foreign leverage ratio. We are also
required to deposit all proceeds from collection of accounts receivable and
sale of collateral with an account under the exclusive dominion and control
of the senior lenders.

Borrowings under our senior secured credit facility accrue interest, at our
option, at either: LIBOR, plus 5.0%, equaling 7.7% at April 2, 2005; or the
Base Rate (prime rate), plus 3.0%, equaling 8.75% at April 2, 2005. The
Company has the option to convert any base rate loan to LIBOR rate loan,
which includes an applicable margin of 5.0%. LIBOR rate loans are to be no
lower than a rate of 7.0%.

Events of default under our senior secured revolving credit facility
include, but are not limited to: (a) our failure to pay principal or
interest when due; (b) our material breach of any representation or
warranty; (c) covenant defaults; (d) our default with respect to any other
debt with an outstanding principal amount in excess of $1.0 million if the
effect thereof is to accelerate or permit the acceleration of such debt;
and (e) events of bankruptcy.

The senior secured revolving credit facility is secured by all of our
tangible and intangible assets and all of the tangible and intangible
assets of our domestic subsidiaries and a pledge of the capital stock of
our domestic subsidiaries and 65.0% of the capital stock of certain of our
foreign subsidiaries. The senior secured revolving credit facility is
unconditionally guaranteed by each of our direct and indirect domestic
subsidiaries.

We failed to comply with certain financial covenants contained in the
senior secured credit revolving facility for the fiscal month ended April
2, 2005.

On May 11, 2005, we entered into a Second Amendment to the Amended and
Restated Credit Agreement by and among Wells Fargo Foothill, Inc., as
administrative agent and collateral agent, Silver Point Finance, LLC, as
the co-agent, syndication agent, documentation agent, arranger and book
runner, the Company and each of the Company's domestic subsidiaries. The
Second Amendment amends and restates (a) the minimum Consolidated Fixed
Charge Coverage Ratio that we must maintain for the rolling twelve-month
periods ending each calendar month from March 31, 2005 through December 31
2005, (b) the minimum EBITDA covenant and (c) the definition of "Borrowing
Base" to provide up to an additional $11 million of availability. The
Amendment subjects the Company's foreign subsidiaries (other than
Amalgamated Appliance Holdings Limited ("AMAP")) to the covenants currently
restricting us and our domestic subsidiaries from engaging in certain
actions without the consent of the senior lender, including incurring debt,
engaging in mergers or certain sales of assets, making guaranties,
incurring liens or engaging in sale and leaseback transactions. The Second
Amendment also increases the prepayment premium and provides for certain
mandatory prepayments upon issuance of debt or equity, or sales of certain
assets, by our foreign subsidiaries. The Amendment is subject to certain
conditions, including that we deliver to the senior lender within certain
time periods stock pledges of certain of our foreign subsidiaries,
including AMAP.

27

SENIOR SUBORDINATED NOTES
In addition to borrowings under our senior secured revolving credit
facility, we have $125.0 million of 10 3/4% senior subordinated notes due
December 15, 2005 outstanding and $150.0 million of 12 1/4% senior
subordinated notes due April 15, 2008 outstanding (excluding $7.7 million
related to the fair value of interest rate swap agreements that have been
monetized).

Under the terms of our senior secured revolving credit facility, our senior
lenders in their discretion may establish a reserve against our
availability under such facility at any time during the 90-day period
before the maturity date of the 10-3/4% senior subordinated notes in an
amount equal to the lesser of $50.0 million or the amount due and payable
under such notes upon maturity.

The indenture governing our 12 1/4% senior subordinated notes due 2008 and
10 3/4% senior subordinated notes due 2005 contains, covenants that, among
other things, limit our ability and the ability of our restricted
subsidiaries to incur additional indebtedness and issue preferred stock,
pay dividends or make certain other restricted payments, create certain
liens, enter into certain transactions with affiliates, enter into sale and
lease-back transactions, sell assets or enter into certain mergers and
consolidations.

Interest is payable on the 10 3/4 % senior subordinated notes on June 15th
and December 15th of each year in an amount equal to approximately $6.7
million on each payment date. Interest is payable on the 12 1/4 % senior
subordinated notes on April 15th and October 15th of each year in an amount
equal to approximately $9.2 million on each payment date.

Our senior subordinated notes are general unsecured obligations and are
subordinated to all our current and future senior debt, including all
borrowings under our senior secured revolving credit facility. The
subordinated notes rank equally with all our other existing and future
senior subordinated indebtedness.

Events of default under our senior subordinated notes include, but are not
limited to: (a) our default for 30 days in the payment when due of
interest; (b) our default in payment when due of principal or premium; (c)
covenant defaults; (d) default under any indebtedness that (1) is caused by
a failure to pay principal or interest or (2) results in the acceleration
of such indebtedness and, in each of clause (1) and (2), the principal
amount of such indebtedness exceeds $2.5 million; and (e) events of
bankruptcy.

Our current and future domestic restricted subsidiaries jointly and
severally guarantee our payment obligations under the senior subordinated
notes on a senior subordinated basis. The guarantees rank junior to all
senior debt of the guarantors (including guarantees under our senior
secured revolving credit facility) and equally with all other senior
subordinated indebtedness of the guarantors.

OTHER CREDIT FACILITIES
We maintain credit facilities outside of the United States that locally
support our foreign subsidiaries operations and working capital
requirements. These facilities are at current market rates in those
localities and at certain peak periods of the year, are secured by various
assets.

On September 28, 2004 Salton Europe, Limited ("Salton Europe"), the
Company's wholly owned subsidiary, amended their facility agreement with
Hong Kong Shanghai Bank. As of April 2, 2005, there was $16.5 million
utilized under the facility included in other current debt.

28

FORWARD LOOKING
We anticipate capital expenditures on an ongoing basis to be at historical
levels in relation to net sales.

One or more of our overseas manufacturers, including some of our major
suppliers, have recently been experiencing financial difficulties due to
challenging business and economic conditions. If we are required to, or
decide to, transition some of our production to different suppliers, the
cost and availability of certain of our products during such a transition
could be adversely affected.

We are currently pursuing various strategic options to raise the funds
required to repay the $125.0 million of outstanding 10-3/4% senior
subordinated notes due December 15, 2005 and allow us to satisfy our
anticipated liquidity needs. These strategic options may include, among
other things, incurring additional debt, issuing debt or equity securities,
sales of assets or businesses, reducing expenditures for new product
development and/or cutting other costs, exchange offers and/or consent
solicitations of our outstanding securities. The availability and success
of any of these options will depend on a number of factors, some of which
relate to our financial condition and performance, and some of which are
beyond our control, such as prevailing interest rates and general economic
conditions. We will have to accomplish several of the foregoing options,
some of which require the consent of our senior lenders and/or the holders
of our senior subordinated notes, within the next six months in order to
enable us to repay the outstanding 10-3/4% subordinated notes and satisfy
our liquidity needs. We cannot assure you that any of such options could be
effected, or if so, on terms favorable to us, that such options would
enable us to repay the outstanding 10-3/4% subordinated notes or satisfy
our liquidity needs and/or that such options would be permitted under the
terms of our senior secured revolving credit facility or the indentures
governing our senior subordinated notes.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

We use derivative financial instruments to manage interest rate and foreign
currency risk. Our objectives in managing our exposure to interest rate
changes are to limit the impact of interest rate changes on earnings and
cash flows and to lower our overall borrowing costs through the use of
interest rate swaps. Our objectives in managing our exposure to foreign
currency fluctuations is to reduce the impact of changes in foreign
exchange rates on consolidated results of operations and future foreign
currency denominated cash flows. We do not enter into derivative financial
instruments for trading purposes. Our policy is to manage interest rate
risk through the use of a combination of fixed and variable rate debt and
hedge foreign currency commitments of future payments and receipts by
purchasing foreign currency forward contracts.

29

All foreign exchange contracts have been recorded in the consolidated
balance sheets within accrued expenses at a fair value of $0.2 million and
$8.7 million at April 2, 2005 and July 3, 2004, respectively. The change in
the fair value of contracts in the third quarter was $(5.5) million. There
was $(0.6) million and $(6.0) million at April 2, 2005 and July 3, 2004,
respectively, recorded in accumulated other comprehensive income, net of
tax, related to these contracts. The Company anticipates that all gains and
losses deferred in accumulated other comprehensive income related to
foreign exchange contracts will be reclassified into earnings within the
next twelve months as the related inventories are sold. At April 2, 2005,
the Company had foreign exchange forward contracts for the purchase of 37.6
million U.S. dollars. Contracts for the purchase of 25.1 million U.S.
dollars were entered into during the third quarter of fiscal 2005.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. Based on their evaluation
as of a date within 90 days of the filing date of this Quarterly Report on
Form 10-Q, the Company's principal executive officer and principal
financial officer have concluded that the Company's disclosure controls and
procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the
Securities Exchange Act of 1934 (the "Exchange Act")) are effective to
ensure that information required to be disclosed by the Company in reports
that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms.

(b) Changes in internal controls. There were no significant changes in the
Company's internal controls or in other factors that could significantly
affect these controls subsequent to the date of their evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

PART II: OTHER INFORMATION

ITEM 1: LEGAL PROCEEDINGS

SECURITIES CLASS ACTION LAWSUITS

In May 2004, two stockholder lawsuits, named Mariss Partners, LLP v.
Salton, Inc., Leonhard Dreimann and David M. Mulder and Warren Beeler v.
Salton, Inc., Leonhard Dreimann and David Mulder, were filed in the United
States District Court for the Northern District of Illinois against the
Company and certain Salton executives. The complaints allege that the
defendants violated the federal securities laws, specifically Sections
10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 of
the Securities and Exchange Commission, by making certain alleged false and
misleading statements. The plaintiffs seek unspecified damages on behalf of
a purported class of purchasers of our securities during the period from
November 11, 2002 through May 11, 2004. The Company believes that these
lawsuits are without merit and that it has compelling defenses to the
allegations contained in the complaints. Salton intends to vigorously
defend the Company. The outcome of the class action lawsuits cannot be
predicted with certainty, however, Salton does not believe that this matter
will have a material adverse affect on its business, financial condition or
results of operations. Therefore, no amounts have been accrued for such
claims. The plaintiffs have voluntarily dismissed the Mariss Partners
lawsuit.

30

PHILIPS

In June 2003, the Company received a letter from Philips Domestic
Appliances and Personal Care B.V. (Philips) accusing Salton of interfering
in a contractual relationship between Philips and a manufacturing source
for Salton, Electrical and Electronics (E&E), misappropriating trade
secrets and infringing other unspecified intellectual property rights in
connection with its development and marketing of the One:One single serve
coffee maker. On August 14, 2003, Salton filed a complaint in the United
States District Court for the Northern District of Illinois seeking a
declaratory judgment that the Company had not infringed the alleged trade
secret rights of Philips and had not tortuously interfered with the
contractual relationship between Philips and E&E.

Philips response has been to file a series of lawsuits against Salton. On
October 23, 2003, Philips filed a counterclaim against Salton in the
Northern District of Illinois, Declaratory Judgment case, reiterating the
allegations of Philips' June letter and adding a claim for copyright
infringement. The counterclaim sought to enjoin the distribution of the
One:One in the United States and money damages. On January 5, 2004, the
Court dismissed the action for failure to join E&E and suggested that the
matter should be litigated in the courts of Hong Kong. Philips has appealed
the Court's decision to the United States Court of Appeals for the Seventh
Circuit. A decision on this appeal is not expected for a number of months.
In view of the District Court's ruling, the Company sought and obtained the
consent of E&E to join in the action previously filed by Philips in Hong
Kong in May 2003, against E&E, alone. That Hong Kong suit alleges that E&E
misappropriated trade secrets, infringed intellectual property and breached
its contract with Philips in the process of developing and manufacturing
the One:One coffee maker for Salton.

On January 6, 2004, Philips filed a new action in the United States
District Court for the Northern District of Illinois, against Salton
alleging violations of U.S. Copyright Law seeking to enjoin the Company
from selling the One:One coffee maker and any monetary damages that the
Court deems proper. Contemporaneously, Philips sought a preliminary
injunction. On January 30, 2004, the Court dismissed Philips' new action on
the grounds that it was barred by the Court's dismissal decision in the
prior action. Philips appealed this dismissal and the appeal was
consolidated with the appeal of the earlier case in the United States Court
of Appeals for the Seventh Circuit.

On November 24, 2003, Philips and Sara Lee NV also filed a patent
infringement suit against Salton asserting that the One:One infringed a
U.S. patent. Like the other actions, this case seeks damages and injunctive
relief. The case is pending as in the United States District Court for the
Northern District of Illinois.

Philips has also filed an action for copyright infringement in the United
Kingdom. This suit alleges that the software on the electronic controller
of the One:One infringes Philips copyright and seeks unspecified money
damages and injunctive relief. At issue were the 55,624 units initially
introduced into the United Kingdom; Salton has discontinued the sales of
these units. This case is currently pending in the United Kingdom. E&E has
intervened in this action, and E&E's motion to dismiss or in the
alternative stay this action in favor of the Hong Kong action described
above was denied. On October 14, 2004, Salton offered to submit to judgment
in this action, and in the event the parties cannot agree on a royalty for
the use of this software in the 55,624 units, a judicial determination will
have to be made of any monetary award.

31

PRODUCT LIABILITY

On or about October 27, 2004, a lawsuit entitled DiNatale vs. Salton was
filed in the New York State Supreme Court against the Company. The
plaintiffs, who seek unspecified damages, allege that they were injured by
water contaminated with lead taken from a tea kettle sold by the Company
under its Russell Hobbs brand. The plaintiffs' attorney is seeking to
convert the lawsuit into a class action suit. The manufacturer of the
product and its insurer are defending this lawsuit. The Company's attorneys
and its insurers are cooperating in the defense of the lawsuit.

Shortly after receiving notice of the lawsuit, the Company voluntarily
suspended selling the product. The Company believes that at substantially
the same time, the two retailers who had purchased the kettle from the
Company also suspended selling the product. Based on information received
from the two retailers, the Company believes that only a limited number of
the kettles were sold to consumers. The Company voluntarily contacted the
U.S. Food and Drug Administration and has shared its information and test
results concerning the product with the agency.

The Company is reviewing the status of any other similar products, which
the same manufacturer has sold to the Company in recent years.

The outcome of the foregoing legal matters cannot be predicted with
certainty, however Salton does not believe that these actions will have a
material adverse affect on its business, financial condition or results of
operations. Therefore, no amounts have been accrued for such claims.

HOMEPLACE OF AMERICA

Homeplace of America, a company in liquidation under the United States
Bankruptcy Code, brought a lawsuit for recovery of preferential payments
made to Salton and its subsidiary, Toastmaster, during the 90 day
"preference" period prior to filing for bankruptcy. Homeplace's total
claimed preferences are approximately $3.5 million. The trial started the
first week of November 2004 in the U.S. Bankruptcy Court for the District
of Delaware. Settlement discussions to date have not, in Salton's view,
been meaningful. Salton does not believe that this matter will have a
material adverse affect on its business, financial condition or results of
operations. Therefore, no material amounts have been accrued for such
claims.

ENVIRONMENTAL

The Company has accrued approximately $0.2 million for the anticipated
costs of environmental remediation at four of our sites. Although such
costs could exceed that amount, Salton believes any such excess will not
have a material adverse effect on the financial condition or annual results
of operations of the Company.

OTHER

The Company is a party to various other actions and proceedings incident to
our normal business operations. The Company believes that the outcome of
any litigation will not have a material adverse effect on our business,
financial condition or results of operations. The Company also has product
liability and general liability insurance policies in amounts believed to
be reasonable given its current level of business. Although historically
the Company has not had to pay any material product liability claims, it is
conceivable that we could incur claims for which we are not insured.

32

ITEM 5. OTHER INFORMATION

On May 11, 2005, the Company entered into a Second Amendment to the Amended
and Restated Credit Agreement by and among Wells Fargo Foothill, Inc., as
administrative agent and collateral agent, Silver Point Finance, LLC, as
the co-agent, syndication agent, documentation agent, arranger and book
runner, the Company and each of the Company's domestic subsidiaries. The
Second Amendment amends and restates (a) the minimum Consolidated Fixed
Charge Coverage Ratio that the Company must maintain for the rolling
twelve-month periods ending each calendar month from March 31, 2005 through
December 31 2005, (b) the minimum EBITDA covenant and (c) the definition of
"Borrowing Base" to provide up to an additional $11 million of
availability. The Amendment subjects the Company's foreign subsidiaries
(other than Amalgamated Appliance Holdings Limited ("AMAP")) to the
covenants currently restricting the Company and its domestic subsidiaries
from engaging in certain actions without the consent of the senior lender,
including incurring debt, engaging in mergers or certain sales of assets,
making guaranties, incurring liens or engaging in sale and leaseback
transactions. The Second Amendment also increases the prepayment premium
and provides for certain mandatory prepayments upon issuance of debt or
equity, or sales of certain assets, by the Company's foreign subsidiaries.

The Amendment is subject to certain conditions, including that the Company
deliver to the senior lender within certain time periods stock pledges of
certain of the Company's foreign subsidiaries, including AMAP.

33

SIGNATURE

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.

Date: May 12, 2005
SALTON, INC.

/s/ DAVID M. MULDER
David M. Mulder
Executive Vice President, Chief Administrative
Officer and Senior Financial Officer
(Duly Authorized Officer of the Registrant)

34

EXHIBIT INDEX

EXHIBIT NUMBER DESCRIPTION OF DOCUMENT
- -------------- -----------------------

10.25 Second Amendment to Amended and Restated Credit Agreement
dated as of May 11, 2005 by and among the Lenders that are
signatories thereto, Wells Fargo Foothill, Inc., as
administrative agent and collateral agent for the Lenders,
Silver Point Finance, LLC, as the co-agent, syndication
agent, documentation agent, arranger and book runner,
Salton, Inc., a Delaware corporation, each of its
subsidiaries that are signatories thereto as the Borrowers
and each of its other subsidiaries that are signatories
thereto as Guarantors

12(A) Computation of Ratio of Earnings to Fixed Charges

31.1 Certification By The Chief Executive Officer Pursuant To
Section 302 Of The Sarbanes-Oxley Act Of 2002

31.2 Certification By The Senior Financial Officer Pursuant To
Section 302 Of The Sarbanes-Oxley Act Of 2002

32.1 Certification of The Chief Executive Officer Pursuant to 18
U.S.C. 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002

32.2 Certification of The Senior Financial Officer Pursuant to
18. U.S.C. 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002

35