** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

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|       | x          | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d)   OF THE SECURITIES EXCHANGE ACT OF 1934**                            |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | **For  the quarterly period ended September 30, 2007**                                                                                   |
| **Or**     |
|       | o          | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d)   OF THE SECURITIES EXCHANGE ACT OF 1934**                                |
|       |       | **For the transition period from                    to** |

 

**Commissionfile number: 1-8681**

 

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**RUSSBERRIE AND COMPANY, INC.**

(Exact name of registrant as specified in its charter)

 

| **New Jersey**(State of or other jurisdiction of  incorporation or organization)

  | ** ** | **22-1815337**(I.R.S. Employer Identification Number) |
|------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|
| **111 Bauer Drive, Oakland, New Jersey**(Address of principal executive offices)         | ** ** | **07436**(Zip Code)                                   |

 

| ** (201)  337-9000**                                 |
|-----------------------------------------------------------|
| (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 (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past90 days. Yes x              No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer o             Acceleratedfiler x            Non-accelerated filer   o

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). Yes o             No x

Thenumber of shares outstanding of each of the registrant’s classes of commonstock, as of October 26, 2007 was as follows:

** **

|                             | ** ** | **OUTSTANDING**          |
|----------------------------------|------------|--------------------------|
| **CLASS**                        | ** ** | **At  October 26, 2007** |
| Common Stock, $0.10 stated value |       | 21,161,314               |

 

 

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**RUSSBERRIE AND COMPANY, INC.**

 

**INDEX**

 
| **PART I — FINANCIAL  INFORMATION** |                                                                                        |                                                                                                   |   |
|------------------------------------------|---------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------|--------|
|                                     |                                                                                        |                                                                                                   |   |
| Item 1.                                  | Financial Statements (unaudited)                                                            |                                                                                                   |   |
|                                     |                                                                                        |                                                                                                   |   |
| a)

                                |                                                                                        | Consolidated Balance  Sheets as of September 30, 2007 and December 31, 2006                       |   |   |
| b)                                       |                                                                                        | Consolidated Statements  of Operations for the three and nine months ended September 30, 2007 and 2006 |   |   |
| c)                                       |                                                                                        | Consolidated Statements of Cash Flows  for the nine months ended September 30, 2007 and 2006           |   |   |
| d)                                       |                                                                                        | Notes to Unaudited  Consolidated Financial Statements                                                  |   |   |
|                                     |                                                                                        |                                                                                                   |   |   |
| Item 2.                                  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |                                                                                                   |   |
|                                     |                                                                                        |                                                                                                   |   |
| Item 3.                                  | Quantitative and Qualitative Disclosures  About Market Risk                                 |                                                                                                   |   |
|                                     |                                                                                        |                                                                                                   |   |
| Item 4.                                  | Controls and Procedures                                                                     |                                                                                                   |   |
|                                     |                                                                                        |                                                                                                   |   |
| **PART II — OTHER INFORMATION**     |                                                                                        |                                                                                                   |   |
|                                     |                                                                                        |                                                                                                   |   |
| Item 1A.                                 | Risk Factors                                                                                |                                                                                                   |   |
|                                     |                                                                                        |                                                                                                   |   |
| Item 5.                                  | Other Information                                                                           |                                                                                                   |   |
|                                     |                                                                                        |                                                                                                   |   |
| Item 6.                                  | Exhibits                                                                                    |                                                                                                   |   |
|                                     |                                                                                        |                                                                                                   |   |
| Signatures                               |                                                                                        |                                                                                                   |   |
|                                     |                                                                                        |                                                                                                   |   |
| Exhibit Index                            |                                                                                        |                                                                                                   |   |
|                                          |                                                                                             |                                                                                                        |        |  |  |

 

 

 

2

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**PART 1 - FINANCIAL INFORMATION**

 

**ITEM1.  FINANCIAL STATEMENTS**

 

**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

 **CONSOLIDATEDBALANCE SHEETS**

 **(Dollars in Thousands, except share and per sharedata)(UNAUDITED)**

 
| ** **                                                                                                                                                          | ** ** | **September 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **Assets**                                                                                                                                                          | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                     |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                           |       | $                      | 16,929     |                  | $          | 11,526 |   |
| Accounts receivable, trade, less allowances of $1,980 in 2007 and  $1,402 in 2006                                                                                   |       | 84,386                 |       | 55,976                |       |
| Inventories, net                                                                                                                                                    |       | 53,729                 |       | 48,026                |       |
| Prepaid expenses and other current assets                                                                                                                           |       | 4,493                  |       | 12,025                |       |
| Income tax receivable                                                                                                                                               |       | 371                    |       | 2,200                 |       |
| Deferred income taxes                                                                                                                                               |       | 2,499                  |       | 2,331                 |       |
| **Total current assets**                                                                                                                                            |       | 162,407                |       | 132,084               |       |
| Property, plant and equipment, net                                                                                                                                  |       | 12,112                 |       | 13,993                |       |
| Goodwill                                                                                                                                                            |       | 120,242                |       | 89,242                |       |
| Intangible assets                                                                                                                                                   |       | 57,776                 |       | 61,600                |       |
| Restricted cash                                                                                                                                                     |       | 913                    |       | 824                   |       |
| Deferred income taxes                                                                                                                                               |       | 1,038                  |       | 957                   |       |
| Other assets                                                                                                                                                        |       | 5,230                  |       | 5,067                 |       |
| **Total assets**                                                                                                                                                    |       | $                      | 359,718    |                  | $          | 303,767 |   |
| ** **                                                                                                                                                          |       |                   |       |                  |       |
| **Liabilities and Shareholders’ Equity**                                                                                                                       | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                                                |       |                   |       |                  |       |
| Current portion of long-term debt                                                                                                                                   |       | $                      | 10,750     |                  | $          | 9,000 |   |
| Short-term debt                                                                                                                                                     |       | 30,320                 |       | 21,832                |       |
| Earnout consideration — short-term                                                                                                                             |       | 11,000                 |       | —                |       |
| Accounts payable                                                                                                                                                    |       | 13,729                 |       | 16,286                |       |
| Accrued expenses                                                                                                                                                    |       | 29,365                 |       | 24,056                |       |
| Income taxes payable                                                                                                                                                |       | 6,053                  |       | 15,038                |       |
| **Total current liabilities**                                                                                                                                       |       | 101,217                |       | 86,212                |       |
| Income taxes payable long-term                                                                                                                                      |       | 5,167                  |       | —                |       |
| Deferred income taxes                                                                                                                                               |       | 3,156                  |       | 160                   |       |
| Long-term debt, excluding current portion                                                                                                                           |       | 15,000                 |       | 23,500                |       |
| Earnout consideration — long-term                                                                                                                              |       | 20,000                 |       | —                |       |
| Other long-term liabilities                                                                                                                                         |       | 3,486                  |       | 3,231                 |       |
| **Total liabilities**                                                                                                                                               |       | 148,026                |       | 113,103               |       |
|                                                                                                                                                                |       |                   |       |                  |       |
| Commitments and contingencies                                                                                                                                       |       |                   |       |                  |       |
| Shareholders’ equity:                                                                                                                                          |       |                   |       |                  |       |
| Common stock: $0.10 stated value; authorized 50,000,000 shares;  issued 26,727,780 and 26,712,780 shares at September 30, 2007 and December  31, 2006, respectively |       | 2,674                  |       | 2,673                 |       |
| Additional paid in capital                                                                                                                                          |       | 91,721                 |       | 91,836                |       |
| Retained earnings                                                                                                                                                   |       | 208,538                |       | 191,320               |       |
| Accumulated other comprehensive income                                                                                                                              |       | 17,545                 |       | 14,985                |       |
| Treasury stock, at cost, 5,566,466 shares at September 30, 2007 and  5,636,284 at December 31, 2006                                                                 |       | (108,786               | )          | (110,150              | )          |
| **Total shareholders’ equity**                                                                                                                                 |       | 211,692                |       | 190,664               |       |
| **Total liabilities and shareholders’ equity**                                                                                                                 |       | $                      | 359,718    |                  | $          | 303,767 |   |

*The accompanying notes are anintegral part of the unaudited consolidated financial statements.*

 

3

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* *

**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Dollarsin Thousands, Except Share and Per Share Data)**

**(UNAUDITED)**

 

 
| ** **                                                                          | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                          | ** ** | **2007**                             | ** ** | **2006**                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales                                                                           |       | $                                    | 100,928    |                                | $          | 78,081 |   | $ | 246,715 |   | $ | 220,880 |   |
|                                                                                |       |                                 |       |                                |       |   |   |   |   |
| Cost of sales                                                                       |       | 56,769                               |       | 48,090                              |       | 142,861 |   | 132,261 |   |
| ** **                                                                          | ** ** | ** **                           | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Gross profit**                                                                    |       | 44,159                               |       | 29,991                              |       | 103,854 |   | 88,619 |   |
|                                                                                |       |                                 |       |                                |       |   |   |   |   |
| Selling, general and administrative expenses                                        |       | 30,932                               |       | 26,658                              |       | 83,070 |   | 86,707 |   |
|                                                                                |       |                                 |       |                                |       |   |   |   |   |
| **Operating income**                                                                |       | 13,227                               |       | 3,333                               |       | 20,784 |   | 1,912 |   |
|                                                                                |       |                                 |       |                                |       |   |   |   |   |
| Other (expense) income:                                                             |       |                                 |       |                                |       |   |   |   |   |
| Interest expense, including amortization and write-off of deferred  financing costs |       | (1,228                               | )          | (1,332                              | )          | (3,740 | ) | (8,497 | ) |
| Interest and investment income                                                      |       | 135                                  |       | 24                                  |       | 446 |   | 49 |   |
| Other, net                                                                          |       | 377                                  |       | (192                                | )          | 287 |   | 145 |   |
|                                                                                |       | (716                                 | )          | (1,500                              | )          | (3,007 | ) | (8,303 | ) |
|                                                                                |       |                                 |       |                                |       |   |   |   |   |
| **Income (loss) before income tax provision**                                       |       | 12,511                               |       | 1,833                               |       | 17,777 |   | (6,391 | ) |
|                                                                                |       |                                 |       |                                |       |   |   |   |   |
| Income tax (benefit) provision                                                      |       | (1,796                               | )          | 1,577                               |       | 559 |   | 4,319 |   |
|                                                                                |       |                                 |       |                                |       |   |   |   |   |
| **Net income (loss)**                                                               |       | $                                    | 14,307     |                                | $          | 256 |   | $ | 17,218 |   | $ | (10,710 | ) |
|                                                                                |       |                                 |       |                                |       |   |   |   |   |
| **Net income (loss) per share:**                                                    | ** ** | ** **                           | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                                               |       | $                                    | 0.68       |                                | $          | 0.01 |   | $ | 0.82 |   | $ | (0.51 | ) |
| Diluted                                                                             |       | $                                    | 0.67       |                                | $          | 0.01 |   | $ | 0.81 |   | $ | (0.51 | ) |
|                                                                                |       |                                 |       |                                |       |   |   |   |   |
| **Weighted average shares:**                                                        | ** ** | ** **                           | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                                               |       | 21,157,000                           |       | 20,864,000                          |       | 21,105,000 |   | 20,847,000 |   |
| Diluted                                                                             |       | 21,318,000                           |       | 20,882,000                          |       | 21,257,000 |   | 20,847,000 |   |

 

 

*Theaccompanying notes are an integral part of the unaudited consolidated financialstatements.*

 

 

 

 

4

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**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Dollarsin Thousands)(UNAUDITED)**

 
| ** **                                                                                          | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                          | ** ** | **2007**                            | ** ** | **2006** | ** ** |
| **Cash flows from operating activities:**                                                           | ** ** | ** **                          | ** ** | ** ** | ** ** |
| Net income (loss)                                                                                   |       | $                                   | 17,218     |   | $ | (10,710 | ) |
| Adjustments to reconcile net income (loss) to net cash provided by  (used in) operating activities: |       |                                |       |   |   |
| Depreciation and amortization                                                                       |       | 3,650                               |       | 4,060 |   |
| Amortization and write-off of deferred financing costs                                              |       | 474                                 |       | 3,009 |   |
| Provision for accounts receivable allowance                                                         |       | 1,631                               |       | 894 |   |
| Provision for inventory reserve                                                                     |       | 198                                 |       | 2,728 |   |
| Deferred income taxes                                                                               |       | 2,986                               |       | 3,016 |   |
| Share-based compensation expense                                                                    |       | 141                                 |       | — |   |
| Write-off on disposal of fixed assets                                                               |       | 361                                 |       | 2,988 |   |
| Impairment of intangible asset                                                                      |       | 3,600                               |       | — |   |
| Other                                                                                               |       | (92                                 | )          | (274 | ) |
| Change in assets and liabilities:                                                                   |       |                                |       |   |   |
| Restricted cash                                                                                     |       | 12                                  |       | (18 | ) |
| Accounts receivable                                                                                 |       | (28,597                             | )          | (4,507 | ) |
| Income tax receivable                                                                               |       | 2,233                               |       | 889 |   |
| Inventories                                                                                         |       | (4,650                              | )          | 8,003 |   |
| Prepaid expenses and other current assets                                                           |       | 7,722                               |       | (3,017 | ) |
| Other assets                                                                                        |       | (1,544                              | )          | 43 |   |
| Accounts payable                                                                                    |       | (2,371                              | )          | (4,540 | ) |
| Accrued expenses                                                                                    |       | 3,899                               |       | (844 | ) |
| Accrued income taxes                                                                                |       | (3,291                              | )          | (1,783 | ) |
| Total adjustments                                                                                   |       | (13,638                             | )          | 10,647 |   |
| Net cash provided by (used in) operating activities                                                 |       | 3,580                               |       | (63 | ) |
|                                                                                                |       |                                |       |   |   |
| **Cash flows from investing activities:**                                                           | ** ** | ** **                          | ** ** | ** ** | ** ** |
| Proceeds from sale of property, plant and equipment                                                 |       | —                              |       | 90 |   |
| Capital expenditures                                                                                |       | (1,584                              | )          | (2,840 | ) |
| Net cash used in investing activities                                                               |       | (1,584                              | )          | (2,750 | ) |
|                                                                                                |       |                                |       |   |   |
| **Cash flows from financing activities:**                                                           | ** ** | ** **                          | ** ** | ** ** | ** ** |
| Proceeds from issuance of common stock                                                              |       | 1,111                               |       | 1,057 |   |
| Issuance of long-term debt                                                                          |       | 45                                  |       | 59,250 |   |
| Repayment of long-term debt                                                                         |       | (8,500                              | )          | (81,017 | ) |
| Net borrowing on revolving credit facility                                                          |       | 10,237                              |       | 6,506 |   |
| Payment of deferred financing costs                                                                 |       | —                              |       | (2,508 | ) |
| Net cash provided by (used in) financing activities                                                 |       | 2,893                               |       | (16,712 | ) |
|                                                                                                |       |                                |       |   |   |
| Effect of exchange rate changes on cash and cash equivalents                                        |       | 514                                 |       | 2,040 |   |
| Net increase (decrease) in cash and cash equivalents                                                |       | 5,403                               |       | (17,485 | ) |
| Cash and cash equivalents at beginning of period                                                    |       | 11,526                              |       | 28,667 |   |
| Cash and cash equivalents at end of period                                                          |       | $                                   | 16,929     |   | $ | 11,182 |   |
| **Cash paid during the period for:**                                                                | ** ** | ** **                          | ** ** | ** ** | ** ** |
| Interest expense                                                                                    |       | $                                   | 3,062      |   | $ | 4,270 |   |
| Income taxes                                                                                        |       | $                                   | 1,075      |   | $ | 2,557 |   |

 

**Non-cash items from investing andfinancing activities are as follows:**
| Increase in Goodwill from Earnout Consideration         |   | $ | 31,000 |   | $ | — |   |
|---------------------------------------------------------|--------|---|--------|--------|---|--------|--------|
| Increase in short-term liability- Earnout Consideration |   | $ | 11,000 |   | $ | — |   |
| Increase in long-term liability- Earnout Consideration  |   | $ | 20,000 |   | $ | — |   |

 

 

 

*Theaccompanying notes are an integral part of the unaudited consolidated financialstatements.*

* *

 

5

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**NOTES TO UNAUDITED CONSOLIDATEDFINANCIAL STATEMENTS**

**(unaudited)**

 

**NOTE1 - INTERIM CONSOLIDATED FINANCIAL STATEMENTS**

The accompanyingunaudited interim consolidated financial statements have been prepared by RussBerrie and Company, Inc. and its subsidiaries (the “Company”) in accordancewith accounting principles generally accepted in the United States of Americafor interim financial reporting and the instructions to the Quarterly Report onForm 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, certaininformation and footnote disclosures normally included in financial statementsprepared under generally accepted accounting principles have been condensed oromitted pursuant to such principles and regulations.  The informationfurnished reflects all adjustments, which are, in the opinion of management, ofa normal recurring nature and necessary for a fair presentation of the Company’sconsolidated financial position, results of operations and cash flows for theinterim periods presented.  Results for interim periods are notnecessarily an indication of results to be expected for the year.

The Companycurrently operates in two segments: (i) its gift segment and (ii) its infantand juvenile segment.  This segmentationof the Company’s operations reflects how the chief operating decision makerscurrently view the results of operations.

The Company’s giftsegment designs, manufactures through third parties and markets a wide varietyof gift products to retail stores throughout the United States and throughoutthe world via the Company’s domestic and international wholly-ownedsubsidiaries and independent distributors.

The Company’sinfant and juvenile segment, which consists of Sassy, Inc. (“Sassy”) and KidsLine LLC (“Kids Line”), designs, manufactures through third parties and marketsproducts in a number of baby categories including, among others, infant beddingand accessories, bath toys and accessories, developmental toys, feeding itemsand baby comforting products. These products are sold to consumers, primarilyin the United States, through mass merchandisers, toy, specialty, food, drugand independent retailers, apparel stores, military post exchanges and othervenues.

Certain prior yearamounts have been reclassified to conform to the 2007 presentation.

ThisQuarterly Report on Form 10-Q should be read in conjunction with the Company’sAnnual Report on Form 10-K for the year ended December 31, 2006 (the “200610-K”), and the Company’s Quarterly Reports on Form 10-Q for the quarters endedMarch 31, 2007 and June 30, 2007.

**NOTE2 - SHAREHOLDERS’ EQUITY**

On January 1, 2006, the Company adopted theprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(revised 2004), “Share-Based Payment” (“SFAS 123R”), which requires the costsresulting from all share-based payment transactions to be recognized in thefinancial statements at their fair values. The Company adopted SFAS 123R usingthe modified prospective application method under which the provisions of SFAS123R apply to new awards and to awards modified, repurchased, or cancelledafter the adoption date.

 

The fair value of options granted isestimated on the date of grant using a Black-Scholes options pricing model.Expected volatilities are calculated based on the historical volatility of theCompany’s stock. Management monitors stock option exercise and employeetermination patterns to estimate forfeitures rates within the valuation model.The Company has established separate groups for employees and directors forvaluation purposes. The expected holding period of stock options represents theperiod of time that stock options are expected to be outstanding. The risk-freeinterest rate is based on the Treasury note interest rate in effect on the dateof grant for the expected term of the stock option.

 

***Stock Plans***

 

The Company currently maintains the 2004Stock Option, Restricted and Non-Restricted Stock Plan (the “2004 Option Plan”)and the Amended and Restated 2004 Employee Stock Purchase Plan (the “2004 ESPP”).  As of January 1, 2007, there were anaggregate of 1,513,720 shares of common stock reserved for issuance under the2004 Option Plan and the 2004 ESPP.   The Company also continues to have options outstanding under the 1999and 1994 Stock Option and Restricted Stock Plans, the 1999 and 1994 StockOption Plans and the 1999 and 1994 Stock Option Plans for Outside Directors,(collectively, the “Predecessor Plans”). No awards could be made after December 31, 2003 with respect to the 1999Predecessor Plans and after December 31, 1998 with respect to the

 

 

6

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**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(unaudited)**

 

1994 Predecessor Plans.  See Notes 2 and 18 of the Notes toConsolidated Financial Statements of the 2006 10-K for further details withrespect to option plans.

 

The exercise price for options issued underthe 2004 Option Plan and the Predecessor Plans is generally equal to theclosing price of the Company’s common stock as of the date the option isgranted. Generally, stock options under the 2004 Option Plan and thePredecessor Plans vest over a period ranging from one to five years from thegrant date unless otherwise stated by the specific grant. Options generallyexpire 10 years from the date of grant.

 

***Stock Options***

 

The following table summarizes activityregarding outstanding options as of September 30, 2007, and changes during thenine months ended September 30, 2007:

 
| ** **                                    | ** ** | **Options** | ** ** | **Weighted Average Exercise Price per Option** | ** ** | **Option Price per Share** | ** ** | **Weighted Average Remaining Contractual Term   (years)**          | ** ** | **Aggregate Intrinsic Value $(000)** | ** ** |
|-----------------------------------------------|------------|-------------|------------|------------------------------------------------|------------|----------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------|------------|
| Options outstanding at December 31, 2006      |       | 1,516,740   |       | $                                              | 17.99      |                       | $          | 11.19  - $34.80                                                    |       | 7.5                                  |       | $ | 1,620 |   |
| Granted                                       |       | 17,500      |       | $                                              | 14.90      |                       | $          | 14.90          — |       |                                 |       |   |   |
| Exercised                                     |       | (84,818     | )          | $                                              | 13.10      |                       | $          | 13.05  - $13.74                                                    |       |                                 |       |   |   |
| Forfeited/cancelled                           |       | (107,305    | )          | $                                              | 14.85      |                       | $          | 13.06  - $18.50                                                    |       |                                 |       |   |   |
| Options outstanding at  September 30, 2007    |       | 1,342,117   |       | $                                              | 18.51      |                       | $          | 11.19  - $34.80                                                    |       | 6.7                                  |       | $ | 2,140 |   |
| Vested and exercisable at September  30, 2007 |       | 1,264,617   |       | $                                              | 18.72      |                       |       |                                                               | 6.6        |                                 | $          | 2,002 |   |

 

 

During the three months ended September 30,2007 there were 17,500 stock options and 4,475 shares of restricted stockgranted under the 2004 Option Plan Plan. No options or shares of restrictedstock were granted in either the March 2007 or June 2007 quarters.

 

Share-based compensation expense related tothe Company’s equity compensation grants recorded in the consolidatedstatements of operations for the three and nine months ended September 30, 2007was approximately $17,000 and $28,000, respectively. No compensation costrelated to stock options was capitalized in inventory or any other assets forthe three and nine months ended September 30, 2007 and 2006. For the three andnine months ended September 30, 2007 and 2006, there were no excess taxbenefits recognized as a result of share-based compensation cost.

 

 

***Non-vested Stock Options***

 

As of September 30, 2007, there was approximately$305,000 of totalunrecognized compensation cost related to 77,500 non-vested stock optionsgranted under the 2004 Option Plan on November 1, 2006. This cost is expectedto be recognized over a weighted-average period of 4.3 years.

A summary of theCompany’s non-vested stock options at September30, 2007 and changes during the nine months ended September 30, 2007 is presented below:

 

 

7

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**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(unaudited)**

 

| **Non-vested stock options** | ** ** | **Shares** | ** ** | **Weighted Average  Grant Date Fair  Value** | ** ** |
|----------------------------------------|------------|------------|------------|------------------------------------------------------------------|------------|
| Non-vested at December 31, 2006   |       | 150,000    |       | $                                                                | 15.05      |   |
| Granted                                |       | 17,500     |       | $                                                                | 14.90      |   |
| Forfeited                              |       | (90,000    | )          | $                                                                | 15.05      |   |
| Non-vested at September 30, 2007       |       | 77,500     |       | $                                                                | 15.02      |   |

 

 

**Employee Stock Purchase Plan**

Under the 2004 ESPP,eligible employees are provided the opportunity to purchase the Company’scommon stock at a discount.  Pursuant tothis plan, options are granted to participants as of the first trading day ofeach plan year, which is the calendar year, and may be exercised as of the lasttrading day of each plan year, to purchase from the Company the number ofshares of common stock that may be purchased at the relevant purchase pricewith the aggregate amount contributed by each participant.  In each plan year, an eligible employee mayelect to participate in the plan by filing a payroll deduction authorizationform for up to 10% (in whole percentages) of his or her compensation.  No employee shall have the right to purchaseCompany common stock under the 2004 ESPP which has a fair market value inexcess of $25,000 in any plan year.  Thepurchase price is the lesser of 85% of the closing market price of the Company’scommon stock on either the first trading day or the last trading day of theplan year.  If an employee does not electto exercise his or her option, the total amount credited to his or her accountduring that plan year is returned to such employee, and his or her optionexpires.  As of September 30, 2007, the 2004 ESPP had approximately 106,000 sharesreserved for future issuance.

 

Total share-basedcompensation expense related to the 2004 ESPP was approximately $38,000 and$113,000 for the three and nine months ended September 30, 2007, respectively, and was approximately $67,000for the three and nine months ended September 30, 2006, respectively.

 

The fair value of eachoption granted under the 2004 ESPP is estimated on the date of grant using theBlack-Scholes option-pricing model with the following assumptions:

 

| ** **                                     | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                     | ** ** | **2007**                             | ** ** | **2006** | ** ** |
| Dividend yield                                 |       | —                               |       | — |   |
| Risk-free interest rate                        |       | 4.98                                 | %          | 4.38 | % |
| Volatility                                     |       | 36.70                                | %          | 50.40 | % |
| Expected life (years)                          |       | 1                                    |       | 1 |   |
| Weighted-average fair value of options granted |       | $4.49                                |       | $4.09 |   |

 

 

**NOTE3 - WEIGHTED AVERAGE COMMON SHARES**

The weightedaverage common shares outstanding included in the computation of basic anddiluted net income (loss) per share is set forth below (in thousands):

 
| ** **                                                                 | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                 | ** ** | **2007**                             | ** ** | **2006**                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Weighted average common shares outstanding                                 |       | 21,157                               |       | 20,864                              |       | 21,105 |   | 20,847 |   |
| Dilutive effect of common shares issuable under outstanding stock  options |       | 161                                  |       | 18                                  |       | 152 |   | — |   |
| Weighted average common shares outstanding assuming dilution               |       | 21,318                               |       | 20,882                              |       | 21,257 |   | 20,847 |   |

 

 

 

8

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**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(unaudited)**

 

Stockoptions to purchase an aggregate of approximately 1.3 million and 1.5 millionshares were outstanding at September 30, 2007 and 2006, respectively.  For the three and nine months ended September30, 2007, approximately 0.8 million stock options were excluded from thecomputation of diluted earnings per share because the exercise prices weregreater than the average market price of the common stock during such period.For the three and nine months ended September 30, 2006, approximately 1.3million stock options were excluded from the computation of diluted earningsper share because the exercise prices were greater than the average marketprice of the common stock during such periods.  The average number of diluted shares outstanding for the nine monthsended September 30, 2006 excludes shares issuable upon exercise of outstandingstock options, as the effect of their inclusion would have been anti-dilutiveto loss per share.

**N****OTE 4 — EARNOUTCONSIDERATION**

In December 2004,the Company purchased all of the outstanding equity interests and warrants inKids Line, LLC (the “Purchase”), in accordance with the terms and provisions ofa Membership Interest Purchase Agreement (the “Purchase Agreement”).  The Company paid approximately $130.6million, which represented the portion of the purchase price due at closingplus various transaction costs.  Theaggregate purchase price under the Purchase Agreement includes the payment ofcontingent consideration (the “Earnout Consideration”).  The Earnout Consideration shall equal 11.724%of the Agreed Enterprise Value (described below) of Kids Line as of the lastday of the Measurement Period (the three year period ending November 30,2007).  The Agreed Enterprise Value shallbe the product of (i) Kids Line’s EBITDA during the twelve (12) months endingNovember 30, 2007 and (ii) the applicable multiple (ranging from zero to eight)as set forth in the Purchase Agreement. Pursuant to the Purchase Agreement, 90% of the estimated EarnoutConsideration is due in December 2007 (which amount is not subject to refund orreturn), and any remaining portion earned, following the determination of thefinal Agreed Upon Enterprise Value, is due in January 2008.  The Company cannot currently determine theprecise amount of the Earnout Consideration that will be required to be paidpursuant to the Purchase Agreement. However, based on actual results to date and current estimates ofresults for the remaining portion of the Measurement Period, the Companybelieves that it can estimate with a high degree of probability the approximateamount of such consideration. Accordingly, the Company has recorded a liabilityfor the Earnout Consideration of $31.0 million as of September 30, 2007. Theamount could be more or less depending on the actual performance of Kids Linefor the remaining portion of the Measurement Period.  The estimated amount of the EarnoutConsideration was charged to goodwill as of September 30, 2007, and anyadjustment to the $31.0 million estimate based on actual results will berecorded in a subsequent period.  Of theaggregate estimated amount of the Earnout Consideration, $20.0 million isclassified as a long-term liability, as the Company intends to finance thisportion by drawing down upon the Term Loan reborrowing commitment (see Note 5below) which, pursuant to the Infantline Credit Agreement, is available to paythe Earnout Consideration and which will be classified as long-term debt. The Companyintends to finance the remaining portion of the Earnout Consideration(currently estimated at $11.0 million) pursuant to the terms of the InfantlineRevolver and, accordingly, such liability has been classified as short-term.The Company currently expects that anticipated availability under theInfantline Credit Agreement (described in Note 5 below) will be sufficient tofund the payment. As described in Note 5 (Section 1.A and 1.D) below, theInfantline Borrowers (defined below) have agreed, on a joint and several basis,to assume sole responsibility to pay the Earnout Consideration in place of RussBerrie and Company, Inc. (“RB”).  

**NOTE5 — DEBT**

In connection with thePurchase of Kids Line in December 2004, the Company and certain of itssubsidiaries entered into a financing agreement (the “Financing Agreement”).The Financing Agreement consisted of a term loan in the original principalamount of $125.0 million which was scheduled to mature on November 14,2007 (the “2004 Term Loan”).  The Company used the proceeds of the 2004Term Loan to substantially finance the Purchase and pay fees and expensesrelated thereto.  The 2004 Term Loan was repaid in full and the FinancingAgreement was terminated in connection with the execution of the 2005 CreditAgreement, defined in Note 8 of the Notes to Consolidated Financial Statementsin the 2006 10-K, as of June 28, 2005.  There were no fees paid as aresult of the early termination of the Financing Agreement.  However,during 2005, in connection with the termination of the 2004 Term Loan, theCompany wrote-off the remaining unamortized balance of approximately $4.8million in deferred financing costs.

In order to reduceoverall interest expense and gain increased flexibility with respect to thefinancial covenant structure of the Company’s senior financing, on March 14,2006, the 2005 Credit Agreement was terminated and the obligations thereunderwere refinanced (the “LaSalle Refinancing”). In connection with the LaSalle Refinancing, all outstanding obligations under the 2005 Credit Agreement(approximately $76.5 million) were repaid using proceeds from the InfantlineCredit Agreement defined below, which is part of the LaSalle Refinancing.  The Company paid a fee of approximately $1.3million in connection with the early termination of the 2005 CreditAgreement.  In addition, in 2006, theCompany wrote-off approximately $2.5 million in deferred financing costs inconnection with the LaSalle Refinancing.

 

 

9

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**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(unaudited)**

 

 

As part of the LaSalle Refinancing, the Company formeda wholly-owned Delaware subsidiary, Russ Berrie U.S. Gift, Inc. (“U.S. Gift”),to which it assigned (the “Assignment”) substantially all of its assets andliabilities which pertain primarily to its domestic gift business, such thatseparate loan facilities could be made directly available to each of theCompany’s domestic gift business and its infant and juvenile business.  The Assignment transaction reinforces theoperation of the Company as two separate segments, and the credit facilitiesthat have been extended to each segment are separate and distinct.  There are no cross-default provisions betweenthe Infantline Credit Agreement and Giftline Credit Agreement (which aredescribed below).

 

Long-termdebt at September 30, 2007 and December 31, 2006 consists of the following (inthousands):
| ** **                              | ** ** | **September 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|-----------------------------------------|------------|------------------------|------------|-----------------------|------------|
| Term Loan (Infantline Credit Agreement) |       | $                      | 25,750     |                  | $          | 32,500 |   |
| Less current portion                    |       | 10,750                 |       | 9,000                 |       |
| Long-term debt                          |       | $                      | 15,000     |                  | $          | 23,500 |   |

 

AtSeptember 30, 2007, there wasapproximately $15.6 million borrowed under the Infantline Revolver;approximately $14.7 million borrowed under the Giftline Revolver and noborrowings under the Russ Berrie (UK) Limited Business Overdraft Facility (eachdefined below), all of which is classified as short-term debt.

1.             The LaSalle Refinancing —Effective March 14, 2006

*A.  The Infantline Credit Agreement*

OnMarch 14, 2006 (the “Closing Date”), as amended as of December 22, 2006(discussed below), Kids Line, LLC (“KL”), and Sassy, Inc. (“Sassy”, andtogether with KL, the “Infantline Borrowers”), entered into a credit agreementas borrowers, on a joint and several basis, with LaSalle Bank NationalAssociation as administrative agent and arranger (the “Agent”), the lendersfrom time to time party thereto, RB as loan party representative, SovereignBank as syndication agent, and Bank of America, N.A. as documentation agent (asamended, the “Infantline Credit Agreement”). Unless otherwise specified herein, capitalized terms used but undefinedin this Note 5, Section 1.A  shall havethe meanings ascribed to them in the Infantline Credit Agreement.

Thecommitments under the Infantline Credit Agreement consist of (a) a $35.0million revolving credit facility (the “Infantline Revolver”), with asub-facility for letters of credit in an amount not to exceed $5.0 million, and(b) a $60.0 million term loan facility (the “Term Loan”).  The Infantline Borrowers drew downapproximately $79.7 million on the Infantline Credit Agreement on the ClosingDate, including the full amount of the Term Loan, which reflects the payoff ofall amounts outstanding under the 2005 Credit Agreement and certain fees andexpenses associated with the LaSalle Refinancing.  As of September 30, 2007, the outstandingbalance on the Infantline Revolver was $15.6 million, the outstanding balanceon the Term Loan was $25.8 million and there was $880,000 utilized under theletter of credit sub-facility.  AtSeptember 30, 2007, availability under the Infantline Revolver wasapproximately $16.5 million.

As of December 22, 2006, the Infantline Credit Agreement was amended (the “FirstAmendment”) to permit the repayment and subsequent reborrowing of up to $20.0million under the Term Loan, which has enabled the Infantline Borrowers tocontinue to utilize cash flows from operations to repay debt until the EarnoutConsideration becomes due.  The Companyintends to finance the payment of the Earnout Consideration by (i) reborrowing$20.0 million under the Term Loan pursuant to the TR Commitment (decribedbelow) and (ii) drawing on the Infantline Revolver for the remaining portion ofthe Earnout Consideration (currently estimated at $11.0 million).

 

Pursuant to the FirstAmendment, the Infantline Borrowers borrowed $20.0 million under the InfantlineRevolver, the outstanding balance of which had previously been reduced to zero,and utilized the proceeds of such draw to prepay $20.0 million of the TermLoan.  The lenders agreed to provide anadditional Term Loan reborrowing commitment (the “TR Commitment”) of anaggregate maximum principal amount of $20.0 million, which amounts may only bereborrowed during specified periods and only to fund the payment of the EarnoutConsideration.  Pursuant to the FirstAmendment, the Infantline Borrowers will pay a non-use fee in respect ofundrawn amounts of the TR Commitment at a per annum rate of 0.375% of the dailyaverage of the undrawn amounts.

TheInfantline Loans bear interest at a rate per annum equal to the Base Rate (forBase Rate Loans) or the LIBOR Rate (for LIBOR Loans) at the option of theInfantline Borrowers, plus an applicable margin, in accordance with a pricinggrid based on the most recent quarter-end Total Debt to EBITDA Ratio, whichapplicable margin shall range from 1.75% - 2.50% for LIBOR Loans and from 0.25%- 1.00% for Base Rate Loans.  The applicable interest rate 

 

10

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**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(unaudited)**

 

 

margins as of September 30,2007 were: 1.75% forLIBOR Loans and 0.25% for Base Rate Loans. The weighted average interest rates for the outstanding loans as of September 30,2007 were asfollows:  

| ** **           | ** ** | **At September 30, 2007** | ** ** |
|----------------------|------------|---------------------------|------------|
| ** **           | ** ** | **LIBOR Loans**           | ** ** | **Base Rate Loans** | ** ** |
| Infantline Revolver  |       | 7.48                      | %          | 6.92 | % |
| Infantline Term Loan |       | 7.48                      | %          | 6.92 | % |

 

Interestis due and payable (i) with respect to Base Rate Loans, monthly in arrears onthe last day of each calendar month, upon a prepayment and at maturity and (ii)with respect to LIBOR Loans, on the last day of each Interest Period, upon aprepayment (and if the Interest Period is in excess of three months, on thethree-month anniversary of the first day of such Interest Period), and atmaturity.

Inconnection with the execution of the Infantline Credit Agreement, theInfantline Borrowers paid aggregate closing fees of $1.4 million and anaggregate agency fee of $25,000.  Anaggregate agency fee of $25,000 will be payable on each anniversary of theClosing Date.  The Infantline Revolver issubject to an annual non-use fee (payable monthly, in arrears, and upontermination of the relevant obligations) of 0.50% for unused amounts under theInfantline Revolver, an annual letter of credit fee (payable monthly, inarrears, and upon termination of the relevant obligations) for undrawn amountswith respect to each letter of credit based on the most recent quarter-endTotal Debt to EBITDA Ratio ranging from 1.75% - 2.50% and other customaryletter of credit administration fees.

The principal ofthe Term Loan will be repaid in installments as follows: (a) $0.75 million onthe last day of each calendar month for the period commencing March, 2006through and including February, 2008, ($9.0 million in 2007), (b) $1.0 millionon the last day of each calendar month for the period commencing March 2008through and including February 2009 and (c) $1.25 million on the last day ofeach calendar month for the period commencing March, 2009 through and includingFebruary 2011. A final installment in the aggregate amount of the unpaidprincipal balance of the Term Loan (in addition to all outstanding amountsunder the Infantline Revolver) is due and payable on March 14, 2011, in eachcase subject to customary early termination provisions (without any prepaymentpenalty) in accordance with the terms of the Infantline Credit Agreement.

 

TheInfantline Borrowers are also required to make prepayments of the Term Loanupon the occurrence of certain transactions, including most asset sales or debtor equity issuances.   Additionally,commencing in early 2008 with respect to the most recently completed fiscalyear (beginning with fiscal 2007), in the event that the Total Debt to EBITDAratio for such fiscal year exceeds 2.00:1.00, annual mandatory prepayments ofthe Term Loan shall be required in an amount equal to 50% of Excess Cash Flow.

The Infantline CreditAgreement contains customary affirmative and negative covenants, as well as thefollowing financial covenants (the “Infantline Financial Covenants”):  (i) a minimum EBITDA test, (ii) a minimumFixed Charge Coverage Ratio, (iii) a maximum Total Debt to EBITDA Ratio and(iv) an annual capital expenditure limitation. In addition, upon the occurrence of an event of default under theInfantline Credit Agreement, the lenders could elect to declare all amountsoutstanding thereunder to be immediately due and payable.  As of September 30, 2007, the Company was incompliance with the Infantline Financial Covenants.

The Infantline CreditAgreement contains significant limitations on the ability of the InfantlineBorrowers to distribute cash to RB, which became a corporate holding company byvirtue of the Assignment, for the purpose of paying dividends to theshareholders of RB orfor the purpose of paying their allocable portion of RB’s corporateoverhead expenses, including a cap (subject to certain exceptions) of $2.0million per year on the amount that can be provided to RB to pay such corporateoverhead expenses.

As a result of the LaSalleRefinancing, the obligation to pay the Earnout Consideration pursuant to theKids Line acquisition (see Note 4) is no longer the obligation of RB, but thejoint and several obligation of the Infantline Borrowers.  With respect to the Earnout Consideration,the Infantline Borrowerswill be permitted to pay all or a portion of the Earnout Consideration to theextent that, before and after giving effect to such payment, (i) ExcessRevolving Loan Availability will equal or exceed $3.0 million and (ii) noviolation of the Infantline Financial Covenants would then exist, or would, ona pro forma basis, result therefrom.

Inorder to secure the obligations of the Infantline Borrowers, (i) the InfantlineBorrowers have pledged and have granted security interests to the Agent insubstantially all of their existing and future personal property, (ii) eachInfantline Borrower has guaranteed the performance of the other InfantlineBorrower, (iii) Sassy granted a mortgage for the benefit of the Agent and thelenders on its real property located at 2305 Breton Industrial Park Drive,S.E., 

 

11

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**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(unaudited)**

 

 

Kentwood,Michigan and (iv) the Company pledged 100% of the equity interests of each ofthe Infantline Borrowers to the Agent (the “Infantline Pledge Agreement”).  Pursuant to the Infantline Pledge Agreement,RB has agreed that it will function solely as a holding company and will not,without the prior written consent of the Agent, engage in any business oractivity except for specified activities, including those relating to itsinvestments in its subsidiaries existing on the Closing Date, the maintenanceof its existence and compliance with law, the performance of obligations underspecified contracts and other specified ordinary course activities.

*B.  The Giftline Credit Agreement*

On March 14, 2006 as amended on April 11, 2006, August 8, 2006,December 28, 2006, and August 8, 2007, U.S. Gift and other specifiedwholly-owned domestic subsidiaries of RB (collectively, the “Giftline Borrowers”),entered into a credit agreement as borrowers, on a joint and several basis,with LaSalle Bank National Association, as issuing bank (the “Issuing Bank”),LaSalle Business Credit, LLC as administrative agent (the “Administrative Agent”),the lenders from time to time party thereto, and RB, as loan partyrepresentative (as amended, the “Giftline Credit Agreement” and, together withthe Infantline Credit Agreement, the “2006 Credit Agreements”).  Unless otherwise specified herein,capitalized terms used but undefined in this Note 5 shall have the meaningsascribed to them in the Giftline Credit Agreement.

 

Prior to the August 8, 2007 amendment to the Giftline Credit Agreement(the “Fourth Amendment”), the Giftline Credit Agreement consisted of a maximumrevolving credit loan commitment (the “Giftline Revolver”) in an amount equalto the lesser of (i) $15.0 million (with a maximum availability of $13.5million) and (ii) the then-current Borrowing Base, in each case minus amountsoutstanding under the Canadian Credit Agreement (as defined below), with asub-facility for letters of credit to be issued by the Issuing Bank in anamount not to exceed $8.0 million. The Fourth Amendment increased the aggregate total Commitment under the Giftline CreditAgreement from $15.0 million to $25.0 million, and amended thedefinition of Revolving Loan Availability so that it now equals the differencebetween (a) the lesser of (x) the Maximum Revolving Commitment in effect atsuch time and (y) the Borrowing Base at such time, minus (b) the sum of theaggregate principal amount of all “Loans”, “Specified Hedging Obligations” andthe “Stated Amount” of all “Letters of Credit” outstanding or requested but notyet funded under the Canadian Loan Agreement. The Borrowing Base is primarily a function of a percentage of eligibleaccounts receivable and eligible inventory. As of September 30, 2007, the outstanding balance on the GiftlineRevolver was $14.7 million, there was no outstanding balance on the CanadianRevolving Loan (see Section 1.C below), and there was $1.2 million utilizedunder the Canadian sub-facility for letters of credit.  At September 30, 2007, based on availablecollateral, the unused amount available to be borrowed under the GiftlineRevolver was $8.2 million.

 

All outstanding amounts under the Giftline Revolver are due and payableon March 14, 2011, subject to earlier termination in accordance with the termsof the Giftline Credit Agreement.

 

The Giftline Revolver bears interest at a rate per annum equal to thesum of the Base Rate (for Base Rate Loans) or the LIBOR Rate (for LIBOR Loans),at the option of the Giftline Borrowers, plus an applicable margin, whichmargin was originally 2.75% for LIBOR Loans and 1.25% for Base Rate Loans.  However, pursuant to the December 28, 2006amendment to the Giftline Credit Agreement (the “Third Amendment”), theinterest rates applicable to the Giftline Revolver were reduced such that theapplicable margin is now determined in accordance with a pricing grid based onthe most recent quarter-end daily Average Excess Revolving Loan Availability,which applicable margins shall range from 2.00% - 2.75% for LIBOR Loans andfrom 0% - 0.50% for Base Rate Loans.  Interest is due and payable in the same manner as with respect to theInfantline Loans.  The applicableinterest rate margins as of September 30, 2007 were 2.00% for LIBOR Loans and0.00% for Base Rate Loans.  As ofSeptember 30, 2007, the interest rate was 7.75% for the one outstanding BaseRate loan ($8.8 million) and 7.74% for the one outstanding LIBOR loan ($6.0million).

 

In connection with the execution of the Giftline Credit Agreement, theInfantline Borrowers paid (on behalf of the Giftline Borrowers) aggregateclosing fees of $150,000 and an aggregate agency fee of $20,000.  Aggregate agency fees of $20,000 will bepayable by the Giftline Borrowers on each anniversary of the Closing Date.  Pursuant to the Third Amendment, the GiftlineRevolver is subject to an annual non-use fee (payable monthly, in arrears, andupon termination of the relevant obligations), ranging from 0.375% to 0.50% forunused amounts under the Giftline Revolver, and an annual letter of credit feeranging from 2.00% to 2.75%.  Other feesare as described in the Giftline Credit Agreement.

 

 

12

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** **

**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(unaudited)**

 

 

 

Receivable and disbursement bank accounts of the Giftline Borrowers arerequired to be with the Administrative Agent or its affiliates, and cash insuch accounts will be swept on a daily basis to pay down outstanding amountsunder the Giftline Revolver.

 

The Giftline Credit Agreement contains customary affirmative andnegative covenants substantially similar to those applicable to the InfantlineCredit Agreement.  The Giftline CreditAgreement originally contained the following financial covenants:  (i) a minimum EBITDA test, (ii) a minimumExcess Revolving Loan Availability requirement of $5.0 million, (iii) an annualcapital expenditure limitation and (iv) a minimum Fixed Charge Coverage Ratio(for quarters commencing with the quarter ended March 31, 2008).  On August 8, 2006, the Giftline CreditAgreement was amended to lower the threshold on the Minimum EBITDA covenant by$1.0 million per quarter for each of four consecutive quarters commencing withthe quarter ending September 30, 2006. The Third Amendment (i) eliminated in their entirety both the minimumEBITDA financial covenant and the Fixed Charge Coverage Ratio financialcovenant and (ii) reduced the minimum Excess Revolving Loan Availabilityrequirement from $5.0 million to $3.5 million. The Fourth Amendment eliminated the existing Excess Revolving LoanAvailability requirement, and re-instituted a Fixed Charge Coverage Ratiocovenant based on the last day of any month for the applicable ComputationPeriod (as defined in the Fourth Amendment) ending on such date.  The Fixed Charge Coverage Ratio now specifiesthat the Fixed Charge Coverage Ratio, as determined for the Computation Periodending on the last day of any month, may not be less than 1.1:1.0.  This covenant is only applicable, however, ifduring the three month period then ending on such date of determination (the “TestPeriod”) Revolving Loan Availability (defined above) was less than $3.5 millionfor any three (3) consecutive business day period (the “Test Condition”).  If, compliance is required because the TestCondition was not met, the Giftline Borrowers will be required to deliver aspecified compliance certificate to the Administrative Agent. In addition, theGiftline Borrowers must comply with the Fixed Charge Coverage Ratio covenantfor a period of three consecutive months after they fail to satisfy the TestCondition.  As of September 30, 2007, theCompany was in compliance with the financial covenants contained in theGiftline Credit Agreement.

 

In addition to the changes discussed above, the Fourth Amendmentpermits, subject to specified conditions, the mergers of specified inactivesubsidiaries of RB with and into RB (including certain Giftline Borrowers), andincreases the amount of in-transit inventory which may be deemed “EligibleInventory” under specified circumstances from $3.0 million to $8.0 million.

 

The Giftline Credit Agreement contains significant limitations on theability of the Giftline Borrowers to distribute cash to RB for the purpose ofpaying dividends to RB’s shareholders or for the purpose of paying RB’scorporate overhead expenses, including a cap (subject to certain exceptions) onthe amount that can be provided to RB to reimburse for its allocable portion ofcorporate overhead expenses equal to $4.5 million per year for each of fiscalyears 2006 and 2007, and $5.0 million for each year thereafter, of whichapproximately $3.9 million was paid in 2006 and approximately $1.9 million waspaid during the nine months ended September 30, 2007.  The Third Amendment permits the GiftlineBorrowers to pay dividends or make distributions to RB if no default or eventof default exists or would result there from, and immediately after givingeffect to such payments, there is at least $1.5 million available to be drawnunder the Giftline Revolver.  The amountof any such payments to RB cannot exceed the amount of capital contributionsmade by RB to the Giftline Borrowers after December 28, 2006, which are used bythe Giftline Borrowers to pay down the Giftline Revolver minus the total amountof dividends or other distributions made by the Giftline Borrowers to RB underthis provision of the Giftline Credit Agreement.  As of September 30, 2007, the amount ofcapital contributions made after December 28, 2006 by RB under this provisionof the Third Amendment to the Giftline Borrowers was $3.0 million.

 

In order to secure theobligations of the Giftline Borrowers, the Giftline Borrowers pledged and havegranted security interests to the Administrative Agent in substantially all oftheir existing and future personal property, and each Giftline Borrowerguaranteed the performance of the other Giftline Borrowers under the GiftlineCredit Agreement.  In addition, RBprovided a limited recourse guaranty of the obligations of the GiftlineBorrowers under the Giftline Credit Agreement. This guarantee is secured by a lien on the assets intended to beassigned to U.S. Gift pursuant to the Assignment.  RB also pledged 100% of the equity interestsof each of the Giftline Borrowers and 65% of its equity interests in certain ofits First Tier Foreign Subsidiaries to the Administrative Agent (the “GiftlinePledge Agreement”).  The Giftline PledgeAgreement contains substantially similar limitations on the activities of RB asis set forth in the Infantline Pledge Agreement.

 

13

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**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(unaudited)**

 

 

*C.Canadian Credit Agreement*

Ascontemplated by the 2005 Credit Agreement, on June 28, 2005, as amended on August4, 2005, December 7, 2005 and March 14, 2006, RB’s Canadian subsidiary, Amram’sDistributing Ltd. (“Amrams”), executed a separate Credit Agreement(acknowledged by RB) with the financial institutions party thereto and LaSalleBusiness Credit, a division of ABN AMRO Bank, N.V., Canada Branch, a Canadianbranch of a Netherlands bank, as issuing bank and administrative agent (asamended, the “Canadian Credit Agreement”), and related loan documents withrespect to an original maximum U.S. $10.0 million revolving loan (the “CanadianRevolving Loan”).  RB executed anunsecured Guarantee (the “Canadian Guarantee”) to guarantee the obligations ofAmrams under the Canadian Credit Agreement. In connection with the LaSalle Refinancing, on March 14, 2006, the CanadianCredit Agreement was amended to (i) replace references to the LaSalle CreditAgreement with the Giftline Credit Agreement (such that, among other conformingchanges, a default under the Giftline Credit Agreement will be a default underthe Canadian Credit Agreement), (ii) release RB from the Canadian Guaranty and(iii) provide for a maximum U.S. $5.0million revolving loan.  In connectionwith the release of RB from the Canadian Guaranty, U.S. Gift executed anunsecured Guarantee to guarantee the obligations of Amrams under the CanadianCredit Agreement.  A default under theInfantline Credit Agreement will not constitute a default under the CanadianCredit Agreement**. **Asof****September 30, 2007, there were no borrowingsunder the Canadian Revolving Loan.

The Commitments under theCanadian Credit Agreement bear interest at a rate per annum equal to the sum ofthe Base Rate (for Base Rate Loans) or the LIBOR Rate (for LIBOR Loans) plus anapplicable margin.  As of September 30, 2007, there were no Base Rate or Libor Loansoutstanding.

*D.Earnout Security Documents*

Allcapitalized terms used but undefined in this Note 5, Section 1.D, shall havethe meanings ascribed to them in the Giftline Credit Agreement.

As has been previously reported, RB was obligated topay the Earnout Consideration under the Kids Line Purchase Agreement.  Pursuant to the Letter Agreement dated March14, 2006 between the Infantline Borrowers and California KL Holdings, Inc., andthe other parties thereto (the “Letter Agreement”), the Infantline Borrowershave agreed, on a joint and several basis, to assume sole responsibility to paythe Earnout Consideration in the place of RB. In connection therewith, the Earnout Security Documents have been amendedto effect the partial release of RB as obligor and the full release of thesecurity interests granted thereunder by any Giftline Borrowers.  To secure the obligations of the InfantlineBorrowers to pay the Earnout Consideration, the Infantline Borrowers havegranted a subordinated lien on substantially all of their assets, on a jointand several basis, and RB has granted a subordinated lien on the equityinterests of each of the Infantline Borrowers to the Earnout SellersAgent.  All such security interests andliens are subordinated to the senior indebtedness of the Infantline Borrowersarising under the Infantline Credit Agreement. The Earnout Consideration is not secured by the Giftline Borrowers ortheir assets or equity interests.  TheCompany cannot currently determine the precise amount of the EarnoutConsideration that will be required to be paid pursuant to the PurchaseAgreement.  However, based on actual results to date and currentestimates of results for the remaining portion of the Measurement Period, theCompany believes that it can estimate with a high degree of probability theapproximate amount of such consideration. Accordingly, the Company has recordeda liability for the Earnout Consideration of $31.0 million as of September 30,2007. The amount could be more or less depending on the actual performance ofKids Line for the remaining portion of the Measurement Period.  The estimated amount of the EarnoutConsideration was charged to goodwill as of September 30, 2007, and anyadjustment to the $31.0 million estimate based on actual results will berecorded in a subsequent period.  Of theaggregate estimated amount of the Earnout Consideration, $20.0 million isclassified as a long-term liability, as the Company intends to finance this portionby drawing down upon the Term Loan reborrowing commitment (see Note 5 below)which, pursuant to the Infantline Credit Agreement, is available to pay theEarnout Consideration and which will be classified as long-term debt. TheCompany intends to finance the remaining portion of the Earnout Consideration(currently estimated at $11.0 million) pursuant to the terms of the InfantlineRevolver and, accordingly, such liability has been classified as short-term.The Company currently expects that anticipated availability under the Revolver (describedin Note 5 below) will be sufficient to fund the approximately $11.0 millionportion of the Earnout Consideration payment. 

2.             Russ Berrie (UK) LimitedBusiness Overdraft Facility

OnMarch 19, 2007, Russ Berrie UK Limited entered into a Business OverdraftFacility (the “Facility”) with National Westminster Bank PLC (the “Bank”) andThe Royal Bank of Scotland plc (“RBS”), acting as agent for the Bank.  The Facility, as amended, consists of amaximum credit line of £1.5 million. Interest will be charged on amounts outstanding under the Facility at anannual rate of 1.5% over the Bank’s Base Rate, which interest rate spread willbe increased to 3.5% for any amounts outstanding in excess of the maximumlimit.  The Facility is secured by a lienon substantially all of the assets of Russ Berrie UK Limited.  The Facility replaces the Framework Agreementwith Barclays Bank Plc described in Item 7 of the 2006 10-K, which wasterminated as of March 31, 2007.  TheFacility, like the Framework Agreement facility, was established to assist inmeeting the working capital requirements of Russ Berrie UK Limited.   As of September 30, 2007, there were noborrowings outstanding under this facility.

 

14

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**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(unaudited)**

 

 

**NOTE 6 — GOODWILL AND INTANGIBLE ASSETS**

The significant components of intangible assetsconsist of the following (in thousands):

 
| ** **                                  | ** ** | **Weighted   Average   Amortization   Period** | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------------------|------------|------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| MAM distribution agreement and relationship |       | 8.5  years                                     |       | $                       | 6,600      |                   | $          | 10,400 |   |
| Sassy trade name                            |       | Indefinite  life                               |       | 7,100                   |       | 7,100                  |       |
| Applause trade name                         |       | Indefinite  life                               |       | 7,646                   |       | 7,646                  |       |
| Kids Line customer relationships            |       | Indefinite  life                               |       | 31,100                  |       | 31,100                 |       |
| Kids Line trade name                        |       | Indefinite  life                               |       | 5,300                   |       | 5,300                  |       |
| Other intangible assets                     |       | 4.4  years                                     |       | 30                      |       | 54                     |       |
|                                        |       |                                           |       | $                       | 57,776     |                   | $          | 61,600 |   |

 

Other intangibleassets as of September 30, 2007 and December 31, 2006 include Kids Line and Sassynon-compete agreements, which are being amortized over four and five years,respectively, and a patent.  Amortizationexpense was approximately $224,000 and $19,000 for the nine months endedSeptember 30, 2007 and 2006, respectively.

All ofthe Company’s goodwill is in the infant and juvenile segment and results fromthe acquisition of Kids Line, LLC in 2004, and Sassy in 2002.  As discussed in Note 4 above, during thequarter ended September 30, 2007, goodwill was increased by $31.0 million inconnection with the anticipated payment of the Earnout Consideration commencingin December 2007.

Under SFAS No. 142, Goodwill and Other Intangible Assets, goodwill andother indefinite-lived intangible assets are no longer amortized but arereviewed for impairment at least annually, and more frequently in the event ofa triggering event indicating that an impairment may exist..  The Company’s annual impairment testing isperformed in the fourth quarter.  Duringthe third quarter of fiscal 2007, due to the adverse impact of foreign exchangerates on the MAM Babyartikel GmbH distribution agreement, the Company performedan analysis of the value of certain of its intangible assets.  In connection with this analysis and thepreparation of the Company’s financial statements for the three and nine monthsended September 30, 2007, the Company concluded that an impairment charge wasrequired under generally accepted accounting principles relating to the valueof a distribution agreement between Sassy and MAM Babyartikel GmbH. Based upon  the fair values derived using a discountedcash flows analysis, an impairment charge of $3.6 million has been reflected inthe Company’s consolidated statements of operations for the three and ninemonths ended September 30, 2007, which was recorded in selling, general andadministrative expenses in the Company’s infant and juvenile segment.  Based upon a valuation analysis preparedduring the third quarter 2007, the Company has determined that the MAMAgreement is a finite-lived asset and, as such, will be amortized over an 8.5year life. In connection with such determination, the Company recorded $200,000as amortization expense in the three months ended September 30, 2007.

 

**NOTE7 — RESTRUCTURING AND RELATED COST**

During 2006, the Companyengaged in certain restructuring efforts with respect to its domestic giftbusiness to reduce expenses, right-size the infrastructure consistent withcurrent business levels, and re-align domestic gift operations to better meetthe needs of different distribution channels. During the nine months ended September 30, 2006, the Company recorded a$4.1 million restructuring charge related to: (i) severance cost of employeesat its Petaluma, California distribution center, which was closed; (ii) reducedsales staff in its U.S. gift segment; and (iii) a charge of $2.2 millionrelated to down-sizing of its operations in Europe.  During the year ended December 31, 2006, theCompany recorded aggregate restructuring charges of $4.2 million.  The Company also incurred a one-time chargeof $1.3 million during 2006, which is included in selling, general andadministrative expenses, in connection with the relocation of its distributionfacility in the United Kingdom, primarily related to the write-off of fixedassets and moving costs.  During 2007,the Company recorded $193,000 for severance costs for its gift employees.  In addition, during the quarter endingSeptember 30, 2007, the Company recorded a one-time charge of $0.8 million (notclassified as a restructuring charge and therefore not reflected in the tablebelow) for additional inventory reserves and personnel costs, which areincluded in cost of sales and selling, general and administrative expenses, inconnection with its foreign gift operations. During the nine months ended September 30, 2007, the Company recordedone-time charges of approximately $1.1 million in connection with the closureof one of its showrooms for the gift segment, additional inventory reserves andpersonnel costs, which are included in cost of sales and selling, general andadministrative expenses, in connection with its foreign gift operations.

The Company reassessesthe reserve requirements under the restructuring efforts at the end of eachreporting period.  A rollforward of therestructuring accrual is set forth below (in thousands):

 

 

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**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(unaudited)**

 

 
| ** **                    | ** ** | **Employee  Separation** | ** ** | **Facility  Exit Costs** | ** ** | **Total** | ** ** |
|-------------------------------|------------|--------------------------|------------|--------------------------|------------|-----------|------------|
| Balance @ December 31, 2006   |       | $                        | 1,041      |                     | $          | 65        |       | $ | 1,106 |   |
| 2007 Provision                |       | 193                      |       | —                   |       | 193       |       |
| Less Payments                 |       | 1,106                    |       | 65                       |       | 1,171     |       |
| Balance @ September 30,  2007 |       | $                        | 128        |                     | $          | 0         |       | $ | 128 |   |

 

 

**NOTE8 — SEGMENTS OF THE COMPANY AND RELATED INFORMATION**

The Company operates in two segments: (i) the gift segment; and (ii) theinfant and juvenile segment, which includes Sassy, Inc. and Kids Line, LLC.  This segmentation of the Company’s operationsreflects how the Company’s chief operating decision makers currently view theresults of operations.  There are nointer-segment revenues to eliminate. Corporate assets and overhead expenses are included in the gift segment.

 
| ** **                                          | ** ** | **Three Months Ended   September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------|------------|-------------------------------------------|------------|
| **(Dollars in thousands)**                          | ** ** | **2007**                               | ** ** | **2006**                                  | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Gift:**                                           | ** ** | ** **                             | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                           |       | $                                      | 55,757     |                                      | $          | 43,413 |   | $ | 125,991 |   | $ | 112,603 |   |
| Selling, general and administrative expenses (a)(b) |       | 20,469                                 |       | 19,271                                    |       | 59,128 |   | 68,700 |   |
| Operating income (loss) (c)(d)                      |       | 6,148                                  |       | (3,920                                    | )          | (1,757 | ) | (26,377 | ) |
| Other income (expense)                              |       | (1                                     | )          | (9                                        | )          | 34 |   | 166 |   |
| Depreciation and amortization                       |       | 880                                    |       | 1,114                                     |       | 2,861 |   | 3,435 |   |
| Income (loss) before income taxes                   |       | $                                      | 6,147      |                                      | $          | (3,929 | ) | $ | (1,723 | ) | $ | (26,210 | ) |
|                                                |       |                                   |       |                                      |       |   |   |   |   |   |   |   |   |
| **Infant and juvenile:**                            | ** ** | ** **                             | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                           |       | $                                      | 45,171     | ** **                                | **$**      | 34,668 |   | $ | 120,724 | ** ** | **$** | 108**,**227 | ** ** |
| Selling, general and administrative expenses (b)(e) |       | 10,463                                 |       | 7,387                                     |       | 23,942 |   | 18,007 |   |
| Operating income                                    |       | 7,079                                  |       | 7,253                                     |       | 22,541 |   | 28,289 |   |
| Other (expense)                                     |       | (715                                   | )          | (1,491                                    | )          | (3,041 | ) | (8,469 | ) |
| Depreciation and amortization                       |       | 426                                    |       | 200                                       |       | 789 |   | 624 |   |
| Income before income taxes                          |       | $                                      | 6,364      |                                      | $          | 5,762 |   | $ | 19,500 |   | $ | 19,819 |   |
|                                                |       |                                   |       |                                      |       |   |   |   |   |   |   |   |   |
| **Consolidated:**                                   | ** ** | ** **                             | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                           |       | $                                      | 100,928    |                                      | $          | 78,081 |   | $ | 246,715 |   | $ | 220,880 |   |
| Selling, general and administrative expenses        |       | 30,932                                 |       | 26,658                                    |       | 83,070 |   | 86,707 |   |
| Operating income                                    |       | 13,227                                 |       | 3,333                                     |       | 20,784 |   | 1,912 |   |
| Other expense                                       |       | (716                                   | )          | (1,500                                    | )          | (3,007 | ) | (8,303 | ) |
| Depreciation and amortization                       |       | 1,306                                  |       | 1,314                                     |       | 3,650 |   | 4,059 |   |
| Income (loss) before income taxes                   |       | $                                      | 12,511     |                                      | $          | 1,833 |   | $ | 17,777 |   | $ | (6,391 | ) |

----

(a)          Selling, general and administrative expenses for thegift segment includes: (i) for the three months ended September 30, 2007 and2006, $0.0 million and $0.5 million, respectively, of restructuring cost; (ii)for the nine months ended September 30, 2007 and 2006, $0.0 million and $4.1million, respectively, of restructuring cost; and (iii) for the three and ninemonths ended September 30, 2006, $1.3 million and $3.8 million, respectively ofother special charges incurred in connection with the development of the 2006PIP.

(b)         Selling, general and administrative expenses for thenine months ended September 30, 2007 and 2006 for the gift segment were reducedby a $1.5 million infant and juvenile segment 

 

 

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** **

**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(unaudited)**

 

 

 

reimbursement forcorporate overhead cost, which is included in the gift segment for reportingpurposes. This offset to the gift segment expenses is eliminated inconsolidation with the corresponding $1.5 million charge to selling, generaland administrative expenses of the infant and juvenile segment.

(c)          Operating income (loss) for the gift segment isimpacted by special charges recorded in cost of sales, including: (i) for thethree months ended September 30, 2006, $2.4 million; and (ii) for the ninemonths ended September 30, 2006, $3.0 million.

(d)         For the three and nine months ended September 30,2007, operating income (loss) for the gift segment is impacted by one-timecharges of $0.8 million for additional inventory reserves and personnel costsassociated with its foreign operations.

(e)          For the three and nine months ended September 30,2007, selling, general and administrative expenses for the infant and juvenilesegment include an impairment charge of $3.6 million related to the MAMdistribution agreement (See Note 6).

 

Total assets ofeach segment were as follows:
| **(Dollars in thousands)** | ** ** | **September 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|----------------------------|------------|------------------------|------------|----------------------------|------------|
| Gift                       |       | $                      | 116,508    |                       | $          | 98,360 |   |
| Infant and juvenile        |       | 243,210                |       | 205,407                    |       |
| Total                      |       | $                      | 359,718    |                       | $          | 303,767 |   |

 

 

**Concentrationof Risk**

Asdisclosed in the 2006 10-K, approximately 87.3% of the Company’s purchases areattributable to manufacturers in the People’s Republic of China.  The supplier accounting for the greatestdollar volume of purchases accounted for approximately 20% and the five largestsuppliers accounted for approximately 48% in the aggregate.  The Companyutilizes approximately 62 manufacturers in Eastern Asia and believes that thereare many alternative manufacturers for the Company’s products and sources ofraw materials.  As a result, the Company does not believe there is aconcentration of risk associated with any significant manufacturingrelationship. See Item 1A, “Risk Factors”, of the 2006 10-K under the caption“We rely on foreign suppliers, primarily in the PRC, to manufacture most of ourproducts, which subjects us to numerous international business risks that couldincrease our costs or disrupt the supply of our products.”

Withrespect to customers, Toys “R” Us, Inc. and Babies “R” Us, Inc., in theaggregate, accounted for 26.4% and 25.3% of the Company’s consolidated netsales for the three and nine month periods ended September 30, 2007,respectively, and 19.3% and 23.1% for the three and nine month periods endedSeptember 30, 2006, respectively.  SeeItem 1A, “Risk Factors,” of the 2006 10-K under the caption “Our infant andjuvenile business is dependent on several large customers.”

**NOTE9 - FOREIGN CURRENCY FORWARD EXCHANGE CONTRACTS**

Certain of theCompany’s subsidiaries periodically enter into foreign currency forwardexchange contracts to hedge inventory purchases, both anticipated and firmcommitments, denominated in the United States dollar. These contracts reduceforeign currency risk caused by changes in exchange rates and are used tooffset the currency impact of these inventory purchases, generally for periodsup to thirteen months. At September 30, 2007, the Company’s forwardcontracts had expiration dates that ranged from one to ­­­­twelve months.

The Company accounts for its forward exchange contracts as an economichedge, with subsequent changes in fair value recorded in the ConsolidatedStatements of Operations.  Unrealizedlosses of $205,000 and $14,000 relating to forward contracts are included inaccrued expenses as of September 30, 2007 and December 31, 2006, respectively.

TheCompany has forward contracts to exchange British pounds, Canadian dollars andAustralian dollars for United States dollars with notional amounts of $10.5million and $5.9 million as of September 30, 2007 and December 31, 2006,respectively. The Company has forward contracts to exchange United Statesdollars to Euros with notional amounts of $2.1 million and $2.3 million as ofSeptember 30, 2007 and December 31, 2006, respectively. The Company doesnot anticipate any material adverse impact on its results of operations orfinancial position from these contracts.

 

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**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(unaudited)**

 

 

**NOTE10 - COMPREHENSIVE INCOME (LOSS)**

Comprehensive Income (loss), representing all changesin Shareholders’ Equity during the period other than changes resulting from theissuance or repurchase of the Company’s common stock and payment of dividends,is reconciled to net income (loss) for the three and nine months endedSeptember 30, 2007 and 2006 as follows (in thousands):

 

 
| ** **                               | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| **(Dollars in thousands)**               | ** ** | **2007**                             | ** ** | **2006**                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net income (loss)                        |       | $                                    | 14,307     |                                | $          | 256 |   | $ | 17,218 |   | $ | (10,710 | ) |
| Other comprehensive income:              |       |                                 |       |                                |       |   |   |   |   |
| Foreign currency translation adjustments |       | 1,046                                |       | 808                                 |       | 2,560 |   | 2,040 |   |
| Comprehensive income (loss)              |       | $                                    | 15,353     |                                | $          | 1,064 |   | $ | 19,778 |   | $ | (8,670 | ) |

 

**NOTE 11 — INCOME TAXES**

In July 2006 the Financial Accounting Standards Board (“FASB”) issuedFASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN48”) and FASB Staff Position (“FSP”) FSP FIN 48-1 (issued May 2007).  FIN 48 prescribes a comprehensive model forhow a company should recognize, measure, present and disclose in its financialstatements uncertain tax positions that the Company has taken or expects totake on a tax return.  FIN 48 states thata tax benefit from an uncertain tax position may be recognized only if it is“more likely than not” that the position is sustainable, based on its technicalmerits.  The tax benefit of a qualifyingposition is the largest amount of tax benefit that is greater than 50% likelyof being realized upon settlement with a taxing authority having full knowledgeof all relevant information.  A taxbenefit from an uncertain position was previously recognized if it was probableof being sustained.  Under FIN 48, theliability for unrecognized tax benefits is classified as noncurrent unless theliability is expected to be settled in cash within twelve months of thereporting date.  FIN 48 is effective asof the beginning of the first fiscal year beginning after December 15, 2006.  The Company adopted the provisions of FIN 48on January 1, 2007.  The Company believesthat the balance sheet as of December 31, 2006 is consistent with theimplementation of FIN 48.  The Companyhas not made any additional adjustments to its opening balance sheet related tothe implementation of FIN 48, other than to reclassify the portion of its taxliabilities to non-current which the Company does not anticipate will settle,or for which the statute of limitations will not close, in the next twelve months,and the Company has not made any adjustments to its opening retained earningsrelated to the implementation of FIN 48.

 

The Company operates in multiple tax jurisdictions, both within theUnited States and outside of the United States, and faces audits from varioustax authorities regarding the inclusion of certain items in taxable income, thedeductibility of certain expenses, transfer pricing, the utilization andcarryforward of various tax credits, and the utilization of variouscarryforward items such as charitable contributions and net operating losscarryforwards.  At January 1, 2007, theamount of liability for unrecognized tax benefits related to federal, state,and foreign taxes was approximately $15.1 million, including approximately $0.6million of accrued interest.  During thequarter ended September 30, 2007, the Company adjusted its liability foruncertain tax positions under FIN 48 by approximately $5.0 million inconnection with the expiration of the statute of limitations on the Company’s2003 Federal income tax return. Approximately $1.1 million of the adjustmentimpacted the Company’s effective tax rate for the period and the balance of theapproximately $5.0 million adjustment was offset by adjusting valuationallowances on net operating loss carryforwards, charitable contributioncarryforwards and foreign tax credit carryforwards. As of September 30, 2007,the amount of liability for unrecognized tax benefits related to federal,state, and foreign taxes was approximately $10.1 million, includingapproximately $0.4 million of accrued interest. The Company has various tax attributes such as NOL’s, charitablecontribution carryovers, and foreign tax credit carryovers that could beutilized to offset these uncertain tax positions.  As of September 30, 2007, the tax years thatremain subject to examination in the major tax jurisdictions are:

 

                United States —Federal                     2004 andforward

                United States —States                       1999 andforward

 

The Company is currently under examination in several tax jurisdictionsand remains subject to examination until the statute of limitations expires forthe respective tax jurisdiction.  Basedupon the expiration of statutes of limitations and/or the conclusion of taxexaminations in several jurisdictions, the Company believes it is reasonablypossible that the total amount of previously unrecognized tax benefitsdiscussed above may decrease by up to $4.9 million within twelve months ofSeptember 30, 2007.  If recognized,approximately $1.4 million of the decrease would impact the Company’s effectivetax rate.  For the remaining amounts, theCompany anticipates that the valuation allowances related to the deferred taxassets associated with various tax attributes such as NOL and foreign taxcredit carryovers would be increased based on management’s belief that it ismore likely than not that the full value of these tax attributes would not berealized.

 

 

 

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** **

**NOTESTO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(unaudited)**

 

 

 

The Company’s policy is to classify interest and penalties related tounrecognized tax benefits as income tax expense.

 

**NOTE 12 — LITIGATION AND COMMITMENTS**

In the ordinarycourse of its business, the Company is party to various copyright, patent andtrademark infringement, unfair competition, breach of contract, customs,employment and other legal actions incidental to its business, as plaintiff ordefendant.  In the opinion of management,the amount of ultimate liability with respect to such actions that arecurrently pending will not materially adversely affect the consolidated resultsof operations, financial condition or cash flows of the Company.

The Company entersinto various license agreements relating to trademarks, copyrights, designs,and products which enable the Company to market items compatible with itsproduct line.  The Company’s licenseagreements, other than the agreement with MAM Babyartikel GmbH (which currentlyhas a remaining term of approximately three years, with the ability to extend),are typically for three year terms with extensions if agreed to by bothparties.  Several of these licenseagreements require prepayments of certain minimum guaranteed royalty amounts.  The amount of minimum guaranteed royaltypayments with respect to all license agreements through the end of theiroriginal terms aggregates approximately $11.5 million, of which approximately$3.8 million remained unpaid at September 30, 2007.  Royalty Expense for the three and nine monthsended September 30, 2007 was approximately $3.1 million and $6.3 million,respectively, as compared to $0.9 million and $2.6 million for the three andnine months ended September 30, 2006, respectively.

 

**NOTE13 — RECENTLY ISSUED ACCOUNTING STANDARDS**

In September 2006, the FASB issued SFAS no. 157, *Fair ValueMeasurement* (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuringfair value and expands disclosure about fair value measurements.  SFAS No. 157 is effective for the Company’syear beginning January 1, 2009.  TheCompany is currently evaluating the impact of adopting SFAS No. 157 on itsconsolidated financial position and results of operations.

 

In February 2007, the FASB issued SFAS No. 159, “TheFair Value Option for Financial Assets and Financial Liabilities.”  SFAS No. 159 provides companies with anoption to report selected financial assets and liabilities at fair value andestablishes presentation and disclosure requirements designed to facilitatecomparisons between companies that choose different measurement attributes forsimilar types of assets and liabilities. SFAS No. 159 is effective for fiscal years beginning after November 15,2007.  The Company is currentlyevaluating the impact, if any, on its consolidated financial statements of SFASNo. 159.

 

 

 

19

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

Thefinancial and business analysis below provides information which the Companybelieves is relevant to an assessment and understanding of the Company’sconsolidated financial condition, changes in financial condition and results ofoperations. This financial and business analysis should be read in conjunctionwith the Company’s consolidated financial statements and accompanying Notes toUnaudited Consolidated Financial Statements set forth in Part I, FinancialInformation, Item 1, “Financial Statements” of this Quarterly Report onForm 10-Q, the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2006 (the “2006 10-K”) and the Company’s Quarterly Reports onForm 10-Q for the quarters ended March 31, 2007 (the “1st Quarter10-Q”) and June 30, 2007 (the “2nd Quarter 10-Q”).

**OVERVIEW**

The Company is aleader in the gift and infant and juvenile industries. The Company’s giftbusiness designs, manufactures through third parties and markets a wide varietyof gift products to retail stores throughout the United States and the worldvia its domestic and international wholly-owned subsidiaries and independentdistributors.  The Company’s infant andjuvenile businesses design, manufacture through third parties and marketproducts in a number of baby categories, including, among others, infantbedding and accessories, bath toys and accessories, developmental toys, feedingitems and baby comforting products. These products are sold to consumers,primarily in the United States, through mass merchandisers, toy, specialty,food, drug and independent retailers, apparel stores, military post exchangesand other venues.

The Company’srevenues are primarily derived from sales of its products.  For the nine months ended September 30, 2007,51.1% of revenues were generated by the gift segment and 48.9% of revenues weregenerated by the infant and juvenile segment, as compared to 51.0% and 49.0%,respectively, for the same period in the prior year.

The Company’sglobal business strategy for 2006 focused on: (i) capitalizing on growthopportunities with respect to its infant and juvenile segment, particularly ininternational markets; and (ii) continuing efforts to streamline its giftbusiness, concentrating on more profitable product lines and creatingoperational efficiencies.  The Companybelieves that it made substantial progress in successfully implementing thisstrategy during 2006.  Specifically,revenues in the infant and juvenile segment continued to grow throughout theyear, primarily as a result of new product development and increaseddistribution, particularly in international markets.  With respect to its gift business, the Companyrenewed its focus on product categories where it believes it can command anauthoritative position, and made substantial progress in rejuvenating itsproduct line.  The Company has reducedthe number of SKUs offered by its gift segment from approximately 13,000 in2005 to approximately 5,700 at the end of 2006, and approximately 70% of the2007 product line consists of new product introductions.

In addition, theCompany believes it has substantially completed its gift segment restructuringactivities. During 2006, the Company developed and substantially implementedits Profit Improvement Program (“PIP”), which is described in more detail inthe Company’s 2006 10-K.  As a result ofthe successful implementation of the PIP, the Company believes that its giftsegment infrastructure is now appropriately sized in light of the current giftretail environment. Since mid-2004, the Company has reduced its global giftsegment operating expenses by approximately $40.0 million, with approximately$25.0 million of those reductions having been achieved from November 2005through December 2006. See Item 7 of the 2006 10-K for a detaileddiscussion of the Company’s restructuring activities in recent periods.Although implementation of the PIP has been largely completed, there arecertain additional initiatives that have been identified by management butwhich have not commenced pending a final determination by management of whethertheir implementation would be appropriate or desirable. As a result, theestimated completion date of the PIP’s implementation and estimates of therange of additional charges to be incurred or other expenditures required inconnection therewith cannot be determined at this time. The Company may also berequired to make certain investments to generate the efficiencies and focus on profitableoperations that the PIP is designed to achieve, which amounts cannot bequantified at this time.

 

The Companybelieves that its 2007 gift product line has been favorably received byretailers and consumers.  In particular,in the Spring of 2007, the Company introduced a product range called ShiningStars® that has been very well received to date.  The Company believes it has sufficientcapacity to meet the anticipated demand for Shining Stars and to address thecurrent backlog, which was substantially reduced during the third quarter of2007. There can be no assurance that demand for Shining Stars product willcontinue at current levels, that the Company will be able to secure adequatesupplies of product, that such products will continue to be well received orthat existing or future competition for similar products will not have anadverse effect on the Company’s expectations for the success of the ShiningStars product range.

 

 

20

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As a result of thefavorable reception to new product introductions in the gift segment, includingShining Stars, the Company’s backlog in the gift segment as of September 30,2007 increased by 41% to approximately $35.7 million, as compared to $25.3million at September 30, 2006.

 

**SEGMENTS**

TheCompany currently operates in two segments:  (i) its gift segment;and (ii) its infant and juvenile segment.

**RESULTSOF OPERATIONS—THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006**

The Company’sconsolidated net sales for the three months ended September 30, 2007 increased29.3% to $100.9 million compared to $78.1 million for the three months endedSeptember 30, 2006, as a result of an increase in gift segment sales of $12.3million and an increase of $10.5 million in infant and juvenile segment sales.

The Company’s giftsegment net sales for the three months ended September 30, 2007 increased 28.4%to $55.8 million compared to $43.4 million for the three months ended September30, 2006, primarily as a result of the continued rollout of its Shining Starsproduct line, improved content and product availability as well as strongconsumer demand for the Company’s YomikoTM brand of premium plush products.  Net sales in the Company’s gift segment werefavorably impacted by approximately $1.7 million for the three months endedSeptember 30, 2007 as a result of foreign exchange rates.  Net sales forthe infant and juvenile segment for the three months ended September 30, 2007increased 30.3 % to $45.2 million, compared to $34.7 million for the threemonths ended September 30, 2006, primarily as a result of sales growth at both KidsLine and Sassy.

Consolidated grossprofit increased to 43.8% of consolidated net sales for the three months endedSeptember 30, 2007 from 38.4% for the three months ended September 30,2006.   Gross profit for the Company’sgift segment increased 1,230 basis points to 47.7% of net sales for the threemonths ended September 30, 2007 from 35.4% of net sales for the three monthsended September 30, 2006, primarily as a result of the introduction in 2007 ofnew, higher margin products throughout the gift segment product line. Gross profit for the Company’s infant and juvenile segment decreased from 42.2%of net sales for the three months ended September 30, 2006 to 38.8% of netsales for the three months ended September 30, 2007, primarily as a result ofpricing pressure, increased raw material costs, product mix and currencyexchange expense associated with Sassy’s MAM Babyartikel GmbH contract.

Consolidatedselling, general and administrative expense was $30.9 million, or 30.6% ofconsolidated net sales, for the three months ended September 30, 2007, comparedto $26.7 million, or 34.1% of consolidated net sales, for the three monthsended September 30, 2006.  Selling, general and administrative expense inthe Company’s gift segment increased on an absolute basis by 6.2%, or $1.2million, to $20.5 million in the third quarter of 2007 from $19.3 million inthe prior year period.  This increase ismainly the result of increased selling expense related to higher sales volumeand advertising expense incurred in the rollout of Shining Star product.  As a percentage of sales, selling, generaland administrative expense in the gift segment decreased to 36.7% during thethird quarter of 2007 as compared to 44.4% of sales in the prior year period,primarily as a result of expense reductions generated in connection with thePIP.  Selling, general and administrativeexpense in the Company’s infant and juvenile segment increased from $7.4million, or 21.3% of net sales, in the third quarter of 2006 to $10.5 million,or 23.2% of net sales, in the third quarter of 2007, due to an impairmentcharge of $3.6 million related to the MAM distribution agreement which wasrecorded in the third quarter of 2007.

Consolidated otherexpense was $0.7 million for the three months ended September 30, 2007 comparedto $1.5 million for the three months ended September 30, 2006, a decrease of$0.8 million.  Other expense in the Company’sgift segment for the three months ended September 30, 2007 and 2006 wasimmaterial in each period.  Other expensein the Company’s infant and juvenile segment decreased by $0.8 million to $0.7million compared to $1.5 million in the prior year period.  The decrease was primarily due to lowerborrowing costs.

The Company recorded an income tax benefit of approximately $1.8million for the three months ended September 30, 2007, primarily related to thereduction of the deferred tax liability associated with the impairment of the MAMdistribution agreement which generated a benefit of approximately $1.4 million,a reduction in the valuation allowance related to the Company’s foreign taxcredit carryforward which the Company estimates it will be able to utilize in2007 resulting in a benefit  ofapproximately $1.0 million, and an adjustment of the Company’s liability foruncertain tax positions under FIN 48 related to the statute of limitationsexpiring on the Company’s 2003 federal income tax return for a benefit ofapproximately $1.1 million.  Thesebenefit were offset by the deferred tax liability associated with the taxamortization of intangible assets relating to the Kids Line, Sassy and Applauseacquisitions of approximately $1.0 million. The deferred tax liabilities are indefinite in nature for accountingpurposes, and therefore cannot be offset by the Company’s deferred taxassets.  The Company has recorded fullvaluation allowances against these deferred tax assets as management believesit is more likely than not that those deferred tax assets will not be realized.The Company generated net operating loss carryforwards in prior years for whichthe 

 

 

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Company previously recorded full valuation allowances. The Companyanticipates it will be able to utilize these net operating loss carryforwardsin the current year and, accordingly, has reversed a portion of those valuation allowances in the current quarter.The Company recorded approximately $0.7 million of foreign tax expense relatedto profitable operations in Canada, Hong Kong and Australia.  Income tax expense for the three months endedSeptember 30, 2006 was $1.6 million primarily related to the deferred taxliability associated with the tax amortization of intangible assets relating tothe Kids Line, Sassy and Applause acquisitions of approximately $1.0 million,and foreign tax expense of approximately $0.6 million related to profitableoperation in Canada, Hong Kong and Australia.

 

As a result of theforegoing, consolidated net income for the three months ended September 30,2007 was $14.3 million, or $0.67 per diluted share, compared to consolidatednet income of $256,000, or $0.01 per diluted share, for the three months endedSeptember 30, 2006, representing an improvement of $14.0 million, or $0.66 perdiluted share.

 

**RESULTSOF OPERATIONS— NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006**

The Company’sconsolidated net sales for the nine months ended September 30, 2007 increased11.7% to $246.7 million compared to $220.9 million for the nine months endedSeptember 30, 2006 as a result of sales growth in both its infant and juvenileand gift business segments.

The Company’s giftsegment net sales increased 11.9% for the nine months ended September 30, 2007to $126.0 million, compared to $112.6 million for the nine months endedSeptember 30, 2006, primarily as a result of the rollout of the Shining Starsproduct line, improved content and product availability as well as strongconsumer demand for the Company’s YomikoTM brand of premium plush products.  Net sales in the Company’s gift segment werefavorably impacted by foreign exchange rates by approximately $3.6 million forthe nine months ended September 30, 2007.  The Company’s infant andjuvenile segment net sales for the nine months ended September 30, 2007increased 11.5% to $120.7 million compared to $108.3 million for the ninemonths ended September 30, 2006, primarily as a result of sales growth in theCompany’s Kids Line subsidiary.

Consolidated grossprofit was 42.1% of consolidated net sales for the nine months ended September30, 2007, as compared to 40.1% of consolidated net sales for the nine monthsended September 30, 2006.  The approximately 200 basis point increase inthe consolidated gross profit percentage is primarily due to increased marginsin the gift segment, primarily as a result of new, higher margin productintroductions throughout the gift segment product line in 2007, partiallyoffset by decreases in the infant and juvenile segment as a result of pricingpressure, increased raw material cost, product mix and currency exchangeexpenses associated with Sassy’s MAM Babyartikel GmbH contract.  Gross profit for the Company’s gift segmentwas 45.5% of net sales for such segment for the nine months ended September 30,2007 as compared to 37.6% of net sales for the nine months ended September 30,2006.  Gross profit for the Company’s infant and juvenile segment was38.5% of net sales for such segment for the nine months ended September 30,2007 as compared to 42.8% of net sales for the nine months ended September 30,2006.

Consolidatedselling, general and administrative expense was $83.1 million, or 33.6% ofconsolidated net sales, for the nine months ended September 30, 2007, comparedto $86.7 million, or 39.3% of consolidated net sales, for the nine months endedSeptember 30, 2006.  Selling, general and administrative expense in theCompany’s gift segment decreased by $9.6 million to $59.1 million for the ninemonths of 2007 from $68.7 million in the prior year period.  This decrease is a result of continuedexpense reductions from implementation of the PIP and similar cost reductioninitiatives that were implemented in prior years, partially offset by $1.1million of costs related to the exploration of strategic alternatives and otherspecial charges, as well as higher selling expenses resulting from increasedsales volume and advertising costs of approximately $1.6 million in connectionwith the introduction of the Shining Star product line in the gift segment.  Selling, general and administrative expense inthe Company’s infant and juvenile segment increased by $5.9 million from $18.0million for the nine months ended September 30, 2006 to $23.9 million for thesame period in 2007, primarily as a result of an impairment charge of $3.6million on the MAM distribution agreement and increased costs associated withgrowth at Kids Line.

Consolidated otherexpense was $3.0 million for the nine months ended September 30, 2007 comparedto $8.3 million for the nine months ended September 30, 2006, a decrease of$5.3 million.  This decrease is a resultof refinancing costs incurred in the first nine months of 2006, and lowerborrowing costs in 2007.

The Company recorded an income tax expense of approximately $0.6million for the nine months ended September 30, 2007, primarily related to thedeferred tax liability associated with the tax amortization of intangibleassets relating to the Kids Line, Sassy and Applause acquisitions ofapproximately $3.0 million.  The deferredtax liabilities are indefinite in nature for accounting purposes, and thereforecannot be offset by the Company’s deferred tax assets.  The Company has recorded full valuationallowances against these deferred tax assets as management 

 

 

 

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believes it is more likely than not that those deferred tax assets willnot be realized.  This expense was offsetby a reduction of the deferred tax liability associated with the impairment ofthe MAM distribution agreement which generated a benefit of approximately $1.4million, a reduction in the valuation allowance related to the Company’sforeign tax credit carryforward which the Company estimates it will be able toutilize in 2007 of approximately $1.0 million, and an adjustment of the Company’sliability for uncertain tax positions under FIN 48 related to the statute oflimitations expiring on the Company’s 2003 federal income tax return ofapproximately $1.1 million. The Company generated net operating losscarryforwards in prior years for which the Company previously recorded fullvaluation allowances. The Company anticipates it will be able to utilize thesenet operating loss carryforwards in the current year and, accordingly has reverseda portion of these valuation allowances in the current period.  The Company recorded approximately $1.1million of foreign tax expense related to profitable operations in Canada, HongKong and Australia.  Income tax expensefor the nine months ended September 30, 2006 was $4.3 million primarily relatedto the deferred tax liability associated with the tax amortization ofintangible assets relating to the Kids Line, Sassy and Applause acquisitions ofapproximately $3.2 million, and foreign tax expense of approximately $1.1million related to profitable operation in Canada, Hong Kong and Australia.

 

As a result of theforegoing, consolidated net income for the nine months ended September 30, 2007was $17.2 million, or $0.81 per diluted share, compared to a consolidated netloss of $10.7 million, or ($0.51) per diluted share, for the nine months endedSeptember 30, 2006, representing an improvement of $27.9 million, or $1.32 pershare.

 

**Liquidityand Capital Resources**

The Company’s principal sources of liquidity are cashand cash equivalents, cash flows from operations, and availability under itscredit facilities. The Company believes that cash flow from operations andfuture borrowings will be sufficient to fund its operating needs and capitalrequirements, including the payment of the Earnout Consideration, for at leastthe next 12 months.  See discussion ofthe Earnout Consideration below.

As of September30, 2007, the Company had cash and cash equivalents of $16.9 million comparedto $11.5 million at December 31, 2006. This increase of $5.4 million is primarily related to the net incomegenerated during the first nine months of 2007 and reduced prepaid expenses andother current assets, offset primarily by a $4.7 million increase in inventoryand a $28.6 million increase in accounts receivable primarily as a result ofincreased sales volume.  As of September30, 2007 and December 31, 2006, working capital was $61.2 and $45.9million, respectively.  This increase of$15.3 million was primarily the result of the increase in accounts receivableand inventory as a result of increased sales volume offset by a decrease inprepaid expenses and other current assets and an increase in short termborrowings.

Cash and cashequivalents increased by $5.4 million during the nine months ending September 30,2007, compared to a decrease of $17.5 million during the nine months endingSeptember 30, 2006. The increase during the nine months ended September 30,2007 was primarily a result of the factors described in the precedingparagraph.  The decrease during the ninemonths ended September 30, 2006 was primarily due to a net loss, increasedaccounts receivable, the payment of debt and reduced accounts payable,partially offset by reductions in inventory. Net cash provided by operating activities was approximately $3.6 millionduring the nine months ended September 30, 2007 compared to net cash used inoperating activities of approximately $63,000 during the nine months endedSeptember 30, 2006. The increase of $3.2 million was due primarily to netincome of $17.2 million in the first nine months of 2007 as compared to a netloss of $10.7 million in the first nine months of 2006 and other factors notedabove.  Net cash used in investingactivities was approximately $1.6 million for the nine months ended September30, 2007 compared to net cash used of approximately $2.8 million for the ninemonths ended September 30, 2006. The decrease was primarily related todecreased capital expenditures.  Net cashprovided by financing activities was approximately $2.9 million for the ninemonths ended September 30, 2007 compared to net cash used of $16.7 million forthe nine months ended September 30, 2006. The increase of $19.6 million was due primarily to the repayment of debtunder the Infantline Credit Agreement in 2006.

During the nine months ended September 30, 2007, the Company paidapproximately $1.1 million for income taxes. The Company currently expects thatits cash flows will exceed any income tax payments during 2007.

 

Kids Line and Related Financing

 

*Background.* In December 2004, the Company purchased all of the outstanding equityinterests and warrants in Kids Line, LLC (the “Purchase”), in accordance withthe terms and provisions of a Membership Interest Purchase Agreement (the“Purchase Agreement”).  

 

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The Company paid approximately $130.6 million, which represented theportion of the purchase price due at closing plus various transactioncosts.  The aggregate purchase priceunder the Purchase Agreement includes the payment of contingent consideration(the “Earnout Consideration”).  TheEarnout Consideration shall equal 11.724% of the Agreed Enterprise Value(described below) of Kids Line as of the last day of the Measurement Period(the three year period ending November 30, 2007).  The Agreed Enterprise Value shall be theproduct of (i) Kids Line’s EBITDA during the twelve (12) months ending November30, 2007 and (ii) the applicable multiple (ranging from zero to eight) as setforth in the Purchase Agreement. Pursuant to the Purchase Agreement, 90% of the estimated EarnoutConsideration is due in December 2007 (which amount is not subject to refund orreturn), and any remaining portion earned, following the determination of thefinal Agreed Upon Enterprise Value, is due in January 2008.  The Company cannot currently determine theprecise amount of the Earnout Consideration that will be required to be paidpursuant to the Purchase Agreement. However, based on actual results to date and current estimates of resultsfor the remaining portion of the Measurement Period, the Company believes thatit can estimate with a high degree of probability the approximate amount ofsuch consideration. Accordingly, the Company has recorded a liability for theEarnout Consideration of $31.0 million as of September 30, 2007. The amountcould be more or less depending on the actual performance of Kids Line for theremaining portion of the Measurement Period. The estimated amount of the Earnout Consideration was charged togoodwill as of September 30, 2007, and any adjustment to the $31.0 millionestimate based on actual results will be recorded in a subsequent period.  Of the aggregate estimated amount of theEarnout Consideration, $20.0 million is classified as a long-term liability, asthe Company intends to finance this portion by drawing down upon the Term Loanreborrowing commitment (see Note 5 below) which, pursuant to the InfantlineCredit Agreement, is available to pay the Earnout Consideration and which willbe classified as long-term debt. The Company intends to finance the remainingportion of the Earnout Consideration (currently estimated at $11.0 million)pursuant to the terms of the Infantline Revolver and, accordingly, suchliability has been classified as short-term. The Company currently expects thatanticipated availability under the Revolver (described in Note 5 below) will besufficient to fund the approximately $11.0 million portion of the EarnoutConsideration payment. As described in Note 5 (Section 1.A and 1.D) below, theInfantline Borrowers (defined below) have agreed, on a joint and several basis,to assume sole responsibility to pay the Earnout Consideration in place of RussBerrie and Company, Inc. (“RB”).

 

The Kids Line acquisition was financed with the proceeds of a termloan, which was subsequently replaced by a $105.0 million credit facility withLaSalle Bank as agent (the “2005 Credit Agreement”) and the 2005 CanadianCredit Agreement (defined below), which are described in the Current Report onForm 8-K filed by the Company with the SEC on July 5, 2005.

 

In order to reduce overall interest expense and gain increasedflexibility with respect to the financial covenant structure of the Company’ssenior bank financing, on March 14, 2006, the 2005 Credit Agreement wasterminated and the obligations thereunder were refinanced (the “LaSalleRefinancing”).  For a detaileddescription of the 2006 Credit Agreements, which are defined and summarizedbelow, see Note 5 of the Notes to Unaudited Consolidated Financial Statementsherein.  In connection with the LaSalleRefinancing, all outstanding obligations under the 2005 Credit Agreement(approximately $76.5 million) were repaid using proceeds from the InfantlineCredit Agreement.  The Company paid a feeof approximately $1.3 million in connection with the early termination of the2005 Credit Agreement. In 2006, the Company wrote-off approximately $2.5million in deferred financing costs in connection with the LaSalle Refinancing.

 

As part of the LaSalle Refinancing, the Company formed a wholly-ownedDelaware subsidiary, Russ Berrie U.S. Gift, Inc. (“U.S. Gift”), to which itassigned (the “Assignment”) substantially all of its assets and liabilitieswhich pertain primarily to its domestic gift business, such that separate loanfacilities could be made directly available to each of the Company’s domesticgift business and infant and juvenile business, respectively.  Pursuant to the Assignment, the Company’sparent company, Russ Berrie and Company, Inc. (“RB”), is now organized as aholding company, with all of its operations being conducted through its directand indirect subsidiaries. RB, however, has continuing cash needs for corporateoverhead expenses, taxes and other purposes (collectively, the “Requirements”).The 2006 Credit Agreements (defined below) contain significant limitations onthe ability of RB’s domestic subsidiaries to distribute cash, including in theform of dividends, loans or other advances, to RB to pay for its Requirements(such limitations are described in more detail below). Management believes thatthe amounts permitted to be distributed to RB by its domestic subsidiaries willbe sufficient to fund the requirements, although there can be no assurance thatsuch requirements will not exceed current estimates. Although there are norestrictions in the 2006 Credit Agreements on the ability of RB’s foreignsubsidiaries to distribute cash to RB, available cash therefrom may beinsufficient to cover the Requirements without additional distributions from RB’sdomestic subsidiaries. Because RB is dependent upon cash distributions from itsdomestic subsidiaries, if such domestic subsidiaries are unable to distributesufficient cash to RB to meet its requirements without triggering a defaultunder the 2006 Credit Agreements, this could have a material adverse impact onthe Company’s liquidity.

 

As a result of the LaSalle Refinancing, the obligation to pay theEarnout Consideration is no longer the obligation of RB, but the joint andseveral obligation of the Infantline Borrowers (defined below).  The Infantline Borrowers will be permitted topay all or a portion of the Earnout Consideration to the extent that, beforeand after giving effect to such payment, (i) Excess Revolving Loan Availabilityunder the Infantline Credit Agreement will equal or exceed $3.0 million and(ii) no violation of the financial covenants in the Infantline Credit Agreementwould then exist, or would, on a pro forma basis, result therefrom.

 

 

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*Infantline Credit Agreement.*  On March 14, 2006, as amended as of December 22, 2006 (discussed below),Kids Line, LLC and Sassy, Inc. (collectively, the “Infantline Borrowers”),entered into a credit agreement as borrowers, on a joint and several basis,with LaSalle Bank National Association as administrative agent and arranger(the “Agent”), the lenders from time to time party thereto, RB as loan partyrepresentative, Sovereign Bank as syndication agent, and Bank of America, N.A.as documentation agent (as amended, the “Infantline Credit Agreement”). Unlessotherwise specified herein, capitalized terms used but undefined in thissection shall have the meanings ascribed to them in the Infantline CreditAgreement.

 

The commitments under the Infantline Credit Agreement consist of (a) a$35.0 million revolving credit facility (the “Revolving Loan”), with a subfacility for letters of credit in an amount not to exceed $5.0 million, and (b)a $60.0 million term loan facility (the “Term Loan”).  As of September 30, 2007, the outstandingbalance on the Revolving Loan was $15.6 million and the outstanding balance onthe Term Loan was $25.8 million, and there was $880,000 utilized on the letterof credit sub-facility. At September 30, 2007, the availability under theRevolving Loan was approximately $16.5 million.

 

The principal of the Term Loan will be repaid in installments asdescribed in Note 5 to the Notes to Unaudited Consolidated FinancialStatements, with a final installment in the aggregate amount of the unpaidprincipal balance of the Term Loan (in addition to all outstanding amountsunder the Revolving Loan) due and payable on March 14, 2011, in each casesubject to customary early termination provisions (without any prepaymentpenalty) in accordance with the terms of the Infantline Credit Agreement.

 

As of December 22, 2006, the Infantline Credit Agreement was amended(the “First Amendment”) to permit the temporary repayment and subsequentreborrowing of certain amounts under the Term Loan, which has enabled theInfantline Borrowers to continue to utilize cash flows from operations to repaydebt until the Earnout Consideration becomes due.

 

Pursuant to the First Amendment, the Infantline Borrowers borrowed$20.0 million under the Revolving Loan, the outstanding balance of which hadpreviously been reduced to zero, and utilized the proceeds of such draw toprepay $20.0 million under the Term Loan. The lenders agreed to provide anadditional Term Loan reborrowing commitment (the “TR Commitment”) of an aggregatemaximum principal amount of $20.0 million, which amounts may only be reborrowedduring specified periods and only in connection with the payment of the EarnoutConsideration. Pursuant to the First Amendment, the Infantline Borrowers willpay a non-use fee in respect of undrawn amounts of the TR Commitment at a perannum rate of 0.375% of the daily average of the undrawn amounts.

 

The Infantline Loans bear interest at a rate per annumequal to the Base Rate (for Base Rate Loans) or the LIBOR Rate (for LIBORLoans) at the option of the Infantline Borrowers, plus an applicable margin, inaccordance with a pricing grid based on the most recent quarter-end Total Debtto EBITDA Ratio, which applicable margin shall range from 1.75% - 2.50% forLIBOR Loans and from 0.25% - 1.00% for Base Rate Loans. The applicable interestrate margins as of September 30, 2007 were: 1.75% for LIBOR Loans and 0.25% forBase Rate Loans.  The weighted averageinterest rates for the outstanding loans as of September 30, 2007 were asfollows:  
| ** **     | ** ** | **At September 30, 2007** | ** ** |
|----------------|------------|---------------------------|------------|
| ** **     | ** ** | **LIBOR Loans**           | ** ** | **Base Rate Loans** | ** ** |
| Revolving Loan |       | 7.48                      | %          | 6.92 | % |
| Term Loan      |       | 7.48                      | %          | 6.92 | % |

 

The Infantline Borrowers are required to make prepayments of the TermLoan as described in Note 5 to the Notes to Unaudited Consolidated FinancialStatements.

 

The principal ofthe Term Loan will be repaid in installments as follows: (a) $0.75 million onthe last day of each calendar month for the period commencing March, 2006through and including February, 2008, ($9.0 million in 2007), (b) $1.0 millionon the last day of each calendar month for the period commencing March 2008through and including February 2009 and (c) $1.25 million on the last day ofeach calendar month for the period commencing March, 2009 through and includingFebruary 2011. A final installment in the aggregate amount of the unpaidprincipal balance of the Term Loan (in addition to all outstanding amountsunder the Revolving Loan) is due and payable on March 14, 2011, in each casesubject to customary early termination provisions (without any prepaymentpenalty) in accordance with the terms of the Infantline Credit Agreement.

 

 

 

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The Infantline Credit Agreement contains customary affirmative andnegative covenants, as well as the following financial covenants: (i) a minimumEBITDA test, (ii) a minimum Fixed Charge Coverage Ratio, (iii) a maximum totalDebt to EBITDA Ratio and (iv) an annual capital expenditure limitation. As ofSeptember 30, 2007, the Infantline Borrowers were in compliance with thefinancial covenants contained in the Infantline Credit Agreement.

 

*Giftline Credit Agreement*.  Also on March 14, 2006, as amended on April 11, 2006, August 8, 2006,December 28, 2006, and August 8, 2007, U.S. Gift and other specifiedwholly-owned domestic subsidiaries of RB (collectively, the “Giftline Borrowers”),entered into a credit agreement as borrowers, on a joint and several basis,with LaSalle Bank National Association, as issuing bank (the “Issuing Bank”), LaSalleBusiness Credit, LLC as administrative agent (the “Administrative Agent”), thelenders from time to time party thereto, and RB, as loan party representative(as amended, the “Giftline Credit Agreement” and, together with the InfantlineCredit Agreement, the “2006 Credit Agreements”). Unless otherwise specifiedherein, capitalized terms used but undefined in this section shall have themeanings ascribed to them in the Giftline Credit Agreement.

 

Prior to the August 8, 2007 amendment to the Giftline Credit Agreement(the “Fourth Amendment”), the Giftline Credit Agreement consisted of a maximumrevolving credit loan commitment (the “Giftline Revolver”) in an amount equalto the lesser of (i) $15.0 million (with a maximum availability of $13.5million) and (ii) the then-current Borrowing Base, in each case minus amountsoutstanding under the Canadian Credit Agreement (as defined below), with asub-facility for letters of credit to be issued by the Issuing Bank in anamount not to exceed $8.0 million.  TheFourth Amendment increased the aggregate total Commitment under the GiftlineCredit Agreement from $15.0 million to $25.0 million, and amended thedefinition of Revolving Loan Availability so that it now equals the differencebetween (a) the lesser of (x) the Maximum Revolving Commitment in effect atsuch time and (y) the Borrowing Base at such time, minus (b) the sum of theaggregate principal amount of all “Loans”, “Specified Hedging Obligations” andthe “Stated Amount” of all “Letters of Credit” outstanding or requested but notyet funded under the Canadian Loan Agreement. The Borrowing Base is primarily a function of a percentage of eligibleaccounts receivable and eligible inventory. As of September 30, 2007, the outstanding balance on the Giftline Revolverwas $14.7 million, there was no outstanding balance on the Canadian RevolvingLoan (defined below), and there was $1.2 million utilized under the Canadiansub-facility for letters of credit.  AtSeptember 30, 2007, based on available collateral, the unused amount availableto be borrowed under the Giftline Revolver was $8.2 million.

 

All outstanding amounts under the Giftline Revolver are due and payableon March 14, 2011, subject to earlier termination in accordance with the termsof the Giftline Credit Agreement.

 

On December 28,2006, pursuant to the third amendment to the Giftline Credit Agreement (the “ThirdAmendment”), the interest rates applicable to the Giftline Revolver werereduced such that the applicable margin is now determined in accordance with apricing grid based on the most recent quarter-end daily average ExcessRevolving Loan Availability, which applicable margins shall range from 2.00% -2.75% for LIBOR Loans and from 0% - 0.50% for Base Rate Loans.  Interest is due and payable in the samemanner as with respect to the Infantline Loans. The applicable interest ratemargins as of September 30, 2007 were 2.00 % for LIBOR Loans and 0.00 % forBase Rate Loans. As of September 30, 2007, the interest rate was 7.75% for theone outstanding Base Rate loan ($8.8 million), and   7.74% for the one outstanding LIBOR loan($6.0 million)

 

Receivable and disbursement bank accounts of the Giftline Borrowers arerequired to be with the Administrative Agent or its affiliates, and cash insuch accounts will be swept on a daily basis to pay down outstanding amountsunder the Giftline Revolver.

 

The Giftline Credit Agreement contains customary affirmative andnegative covenants substantially similar to those applicable to the InfantlineCredit Agreement. The Giftline Credit Agreement originally contained thefollowing financial covenants:  (i) aminimum EBITDA test, (ii) a minimum Excess Revolving Loan Availabilityrequirement of $5.0 million, (iii) an annual capital expenditure limitation and(iv) a minimum Fixed Charge Coverage Ratio (for quarters commencing with thequarter ended March 31, 2008). On August 8, 2006, the Giftline Credit Agreementwas amended to lower the threshold on the Minimum EBITDA covenant by $1.0million per quarter for each of four consecutive quarters commencing with thequarter ending December 31, 2006. On December 28, 2006, the Third Amendment (i)eliminated in their entirety both the minimum EBITDA financial covenant and theFixed Charge Coverage Ratio financial covenant and (ii) reduced the minimumExcess Revolving Loan Availability requirement from $5.0 million to $3.5million. The Fourth Amendment eliminated the existing Excess Revolving LoanAvailability requirement, and re-instituted a Fixed Charge Coverage Ratiocovenant based on the last day of any month for the applicable ComputationPeriod (as defined in the Fourth Amendment) ending on such date.  The Fixed Charge Coverage Ratio now specifiesthat the Fixed Charge Coverage Ratio, as determined for the Computation 

 

 

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Period ending on the last day of any month, may not be less than1.1:1.0.  This covenant is onlyapplicable, however, if during the three month period then ending on such dateof determination (the “Test Period”) Revolving Loan Availability (definedabove) was less than $3,500,000 for any three (3) consecutive business dayperiod (the “Test Condition”).  If,however, compliance is required because the Test Condition was not met, theGiftline Borrowers will be required to deliver a specified compliancecertificate to the Administrative Agent. In addition, the Giftline Borrowersmust comply with the Fixed Charge Coverage Ratio covenant for a period of threeconsecutive months after they fail to satisfy the Test Condition.  As of September 30, 2007, the Company was incompliance with the remaining financial covenants contained in the GiftlineCredit Agreement.

 

In addition to the changes discussed above, the Fourth Amendmentpermits, subject to specified conditions, the mergers of specified inactivesubsidiaries of RB with and into RB (including certain Giftline Borrowers), andincreases the amount of In-Transit Inventory which may be deemed “EligibleInventory” under specified circumstances from $3.0 million to $8.0 million.

 

As contemplated by the 2005 Credit Agreement, on June 28, 2005, asamended as of August 4, 2005, December 7, 2005 and March 14, 2006, RB’sCanadian subsidiary, Amram’s Distributing Ltd. (“Amrams”), executed a separateCredit Agreement (acknowledged by RB) with the financial institutions partythereto and LaSalle Business Credit, a division of ABN AMRO Bank, N.V., CanadaBranch, a Canadian branch of a Netherlands bank, as issuing bank andadministrative agent (as amended, the “Canadian Credit Agreement”), and relatedloan documents with respect to an original maximum U.S. $10.0 million revolvingloan (the “Canadian Revolving Loan”). RB executed an unsecured Guarantee (the “CanadianGuarantee”) to guarantee the obligations of Amrams under the Canadian CreditAgreement. In connection with the LaSalle Refinancing, the March 14, 2006amendment to the Canadian Credit Agreement: (i) replaced references to the 2005Credit Agreement with the Giftline Credit Agreement (such that, among otherconforming changes, a default under the Giftline Credit Agreement will be adefault under the Canadian Credit Agreement), (ii) released RB from theCanadian Guaranty and (iii) provided for a maximum U.S. $5.0 million revolvingloan. In connection with the release of RB from the Canadian Guaranty, U.S.Gift executed an unsecured Guarantee to guarantee the obligations of Amramsunder the Canadian Credit Agreement. A default under the Infantline CreditAgreement will not constitute a default under the Canadian Credit Agreement. Asof September 30, 2007, there were no borrowings under this facility.

 

The Company believes that the lower interest rates that were extendedto the Company’s subsidiaries in connection with the LaSalle Refinancing willenable the Company to reduce its aggregate interest expense, on a comparablebasis, by approximately $2.0 million per year. However, because the financing available under the 2006 CreditAgreements is extended directly to RB’s domestic subsidiaries, RB is dependentupon its operating subsidiaries to provide the cash necessary to enable it tofund its corporate overhead and other expenses.

 

The 2006 Credit Agreements restrict the ability of RB’s domesticsubsidiaries to distribute cash to RB for the purpose of paying dividends to RB’sshareholders or for the purpose of satisfying RB’s corporate overheadexpenses.  Among other limitations, theInfantline Credit Agreement contains a cap (subject to certain exceptions) of$2.0 million per year on the amount that can be provided to RB to pay corporateoverhead expenses, and the Giftline Credit Agreement contains a similar cap(subject to certain exceptions) equal to $4.5 million per year for each offiscal years 2006 and 2007, and $5.0 million for each fiscal year thereafter,of which approximately $3.9 million was paid in 2006 and approximately $1.9million was paid during the nine months ended September 30, 2007.  The Third Amendment permits the GiftlineBorrowers to pay dividends or make distributions to RB if no default or eventof default exists or would result there from, and immediately after givingeffect to such payments, there is at least $1.5 million available to be drawnunder the Giftline Revolver.  The amountof any such payments to RB cannot exceed the amount of capital contributionsmade by RB to the Giftline Borrowers after December 28, 2006, which are used bythe Giftline Borrowers to pay down the Giftline Revolver minus the total amountof dividends or other distributions made by the Giftline Borrowers to RB underthis provision of the Giftline Credit Agreement.  As of September 30, 2007, the amount ofcapital contributions made after December 28, 2006 by RB under this provisionof the Third Amendment to the Giftline Borrowers was $3.0 million.  RB believes that the amounts permitted to bedistributed to it by its subsidiaries will be sufficient to fund its corporateoverhead expenses, although there can be no assurance that such expenses willnot exceed current estimates.

 

 

*RussBerrie (UK) Limited Business Overdraft Facility* - On March 19, 2007, Russ Berrie UK Limited enteredinto a Business Overdraft Facility (the “Facility”) with National WestminsterBank PLC (the “Bank”) and The Royal Bank of Scotland plc (“RBS”), acting asagent for the Bank.  The Facility, asamended, consists of a maximum credit line of £1.5 million.  Interest will be charged on amountsoutstanding under the Facility at an annual rate of 1.5% over the Bank’s BaseRate, which interest rate spread will be increased to 3.5% for any amountsoutstanding in excess 

 

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of themaximum limit.  The Facility is securedby a lien on substantially all of the assets of Russ Berrie UK Limited.  The Facility replaces the Framework Agreementwith Barclays Bank Plc described in Item 7 of the 2006 10-K, which wasterminated as of March 31, 2007.  TheFacility, like the Framework Agreement facility, was established to assist inmeeting the working capital requirements of Russ Berrie UK Limited.  As of September 30, 2007 there were noborrowings under this facility.

**OtherEvents and Circumstances Pertaining to Liquidity**

As previously disclosed, the Company believes it hassubstantially completed its gift segment restructuring activities.  In the event that additional initiatives relatedto the PIP are implemented, certain significant restructuring charges may berecognized.  As the determination toimplement any or all such initiatives has not yet been made, estimates of therange of any additional charges or other related expenditures cannot bedetermined at this time.  See “Overview”from the 2006 10-K for a description of the PIP and the restructuringactivities undertaken in 2005 and 2006.

The Company entersinto foreign currency forward exchange contracts, principally to manage theeconomic currency risks associated with the purchase of inventory by itsEuropean, Canadian and Australian subsidiaries in the gift segment and by SassyInc. in the infant and juvenile segment. As of September 30, 2007, the Company had outstanding forward contractswith a notional amount totaling approximately $12.6 million.

The Company isdependent upon information technology systems in many aspects of its business.In 2002, the Company commenced a global implementation of an EnterpriseResource Planning (“ERP”) system for its gift business.  During 2003 and continuing into 2004, certainof the Company’s international gift subsidiaries began to phase in aspects ofthe new ERP system.  In late 2005, theCompany began to explore alternative global information technology systems forits gift business that could provide greater efficiencies, lower costs andgreater reporting capabilities than those provided by the current ERPsystem.  As a result of this review, allremaining international implementations of the ERP system were placed on holdpending a decision on whether or not to replace the current ERP system.  The Company has not yet made a decision onwhether to replace its current ERP system and will continue to explore whethersuch replacement is advisable.

The Company issubject to legal proceedings and claims arising in the ordinary course of itsbusiness that the Company believes will not have a material adverse impact onthe Company’s consolidated financial condition, results of operations or cash flows.

Consistentwith its past practices and in the normal course of its business, the Companyregularly reviews acquisition opportunities of varying sizes. The Company mayconsider the use of debt or equity financing to fund potentialacquisitions.  The 2006 Credit Agreements impose restrictions on theCompany that could limit its ability to respond to market conditions or to takeadvantage of acquisitions or other business opportunities.

As has beenpreviously reported, the Company has begun to explore the possible sale of itsgift business. During this process, the performance of the gift business hascontinued to improve. The Company has hired Sagent Advisors to explore allstrategic alternatives, including: selling a business/segment, selling the Companyin its entirety or identifying candidates for potential acquisitions. TheCompany is unable to determine at this time whether any transaction will occur.

 

**ContractualObligations**

The followingtable summaries the Company’s significant known contractual obligations as ofSeptember 30, 2007 and the future periods in which such obligations areexpected to be settled in cash (in thousands):
| ** **                       | ** ** | **Total** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** |
|----------------------------------|------------|-----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|
| Operating Lease Obligations      |       | $         | 46,873     |     | $          | 1,863    |       | $        | 7,326      |     | $          | 6,668    |       | $              | 6,002      |   | $ | 5,308 |   | $ | 19,706 |   |
| Purchase Obligations(1)          |       | $         | 50,418     |     | $          | 47,584   |       | $        | 2,834      |     | $          | —   |       | $              | —     |   | $ | — |   | $ | — |   |
| Debt Repayment Obligations(2)(3) |       | $         | 25,700     |     | $          | 2,200    |       | $        | 11,500     |     | $          | 12,000   |       | $              | —     |   | $ | — |   | $ | — |   |
| Earnout Consideration            |       | $         | 31,000     |     | $          | 27,900   |       | $        | 3,100      |     | $          | —   |       | $              | —     |   | $ | — |   | $ | — |   |
| Royalty Obligations              |       | $         | 3,767      |     | $          | 411      |       | $        | 1,598      |     | $          | 1,758    |       | $              | —     |   | $ | — |   | $ | — |   |
| Total Contractual Obligations    |       | $         | 157,758    |     | $          | 79,958   |       | $        | 26,358     |     | $          | 20,426   |       | $              | 6,002      |   | $ | 5,308 |   | $ | 19,706 |   |

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(1)             The Company’s purchase obligationsconsist of purchase orders for inventory.

 

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(2)             Reflects repayment obligations under theInfantline Credit Agreement.  Mandatoryrepayment obligations under the Infantline Credit Agreements are as follows (inthousands) $2,200 in 2007; $11,500 in 2008; and $12,000 in 2009.  See Note 5 of Notes to Unaudited ConsolidatedFinancial Statements for a description of the Infantline Credit Agreement,including provisions that create, increase and/or accelerate obligationsthereunder.

(3)             The Company has revolving loan facilitiesthat expire on March 14, 2011.  AtSeptember 30, 2007, there was approximately $14.7 million borrowed under theGiftline Revolver and approximately $15.6 million borrowed under the InfantlineRevolving Loan, which have not been included in the table above.

(4)             Of the total income tax payable of $11.2million, the Company has classified $6.1 million as current, as such amount isexpected to be resolved within one year. The remaining amount has been classified as a long term liability.  These amounts are not included in the abovetable as the timing of their potential settlement is not reasonably estimable.

**Off Balance Sheet Arrangements**

As ofSeptember 30, 2007, there have been no material changes in the informationprovided under the caption “Off Balance Sheet Arrangements” of Item 7 of the2006 10-K.

**CRITICALACCOUNTING POLICIES**

The SEC has issueddisclosure advice regarding “critical accounting policies”, defined asaccounting policies that management believes are both most important to theportrayal of the Company’s financial condition and results and requireapplication of management’s most difficult, subjective or complex judgments,often as a result of the need to make estimates about the effects of mattersthat are inherently uncertain.

Management isrequired to make certain estimates and assumptions during the preparation ofits consolidated financial statements that affect the reported amounts ofassets, liabilities, revenue and expenses, and related disclosure of contingentassets and liabilities. Estimates and assumptions are reviewed periodically,and revisions made as determined to be necessary by management. Except asdescribed to Note 6 of Notes to Unaudited Consolidated Financial Statementswith respect to the MAM Agreement have been no material changes to the Company’ssignificant accounting estimates and assumptions or the judgments affecting theapplication of such estimates and assumptions during the period covered by thisreport from those described in the Company’s 2006 10-K.

Alsosee Note 2 of Notes to Consolidated Financial Statements of the 2006 10-K for asummary of the significant accounting policies used in the preparation of theCompany’s consolidated financial statements. See Note 2 to Notes to Unaudited Consolidated Financial Statementsherein for a discussion of SFAS No. 123R, and the assumptions used in optionvaluations.

TheCompany adopted “Accounting for Uncertainty in Income Taxes” (“FIN 48”) as ofJanuary 1, 2007.  The impact of theadoption of FIN 48 was not material to the Company’s consolidated financialposition or results of operations.  SeeNote 11 to Notes to Unaudited Consolidated Financial Statements herein for adiscussion of FIN 48.

**RecentlyIssued Accounting Standards**

In September 2006, the FASB issued SFAS No. 157, *Fair ValueMeasurement* (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuringfair value and expands disclosures about fair value measurements.  SFAS No. 157 is effective for the Company’sfiscal year beginning January 1, 2009. The Company is currently evaluating the impact of adopting SFAS No. 157on its consolidated financial position and results of operations.

 

In February 2007, FASB issued SFAS No. 159, “The FairValue Option for Financial Assets and Financial Liabilities.”  SFAS No. 159 provides companies with anoption to report selected financial assets and liabilities at fair value andestablishes presentation and disclosure requirements designed to facilitatecomparisons between companies that choose different measurement attributes forsimilar types of assets and liabilities. SFAS No. 159 is effective for fiscal years beginning after November 15,2007.  The Company is currentlyevaluating the impact, if any, on its consolidated financial statements of SFASNo. 159.

 

**Forward-Looking Statements**

This QuarterlyReport on Form 10-Q contains certain forward-looking statements. Additional written and oral forward-looking statements may be made by theCompany from time to time in Securities and Exchange

 

 

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Commission (SEC)filings and otherwise.  The Private Securities Litigation Reform Act of1995 provides a safe-harbor for forward-looking statements.  Thesestatements may be identified by the use of forward-looking words or phrasesincluding, but not limited to, “anticipate”, “project”, “believe”, “expect”, “intend”,“may”, “planned”, “potential”, “should”, “will” or “would”.  The Companycautions readers that results predicted by forward-looking statements,including, without limitation, those relating to the Company’s future businessprospects, backlog, revenues, working capital, liquidity, capital needs,interest costs and income are subject to certain risks and uncertainties thatcould cause actual results to differ materially from those indicated in theforward-looking statements.   Specific risks and uncertainties include, but are notlimited to, those set forth under Item 1A, “Risk Factors”, of the 2006 10-K,the 1st Quarter 10-Q and the 2nd Quarter 10-Q and this report.  The Company undertakes no obligation topublicly update any forward-looking statement, whether as a result of newinformation, future events or otherwise.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES****ABOUT MARKET RISK**

As ofSeptember 30, 2007, there have been no material changes in the Company’s marketrisks associated with marketable securities and foreign currency exchangerates, as described in Item 7A of the 2006 10-K.  The interest applicable to the 2006 CreditAgreements is based upon (i) the LIBOR Rate and (ii) the Base Rate (each asdefined in the 2006 Credit Agreements), plus an applicable margin.  At September 30, 2007, a sensitivity analysisto measure potential changes in applicable interest rates indicates that a onepercentage point increase in interest rates would increase the Company’sinterest expense by approximately $568,000 annually, based upon the level ofdebt at September 30, 2007.  See Note 5of Notes to Unaudited Consolidated Financial Statements for a description ofthe interest rates applicable to the loans under the 2006 Credit Agreements.

**ITEM 4. CONTROLS AND PROCEDURES**

***Evaluation of Disclosure Controls andProcedures***

We maintain disclosure controls and procedures asdefined in Rules 13a-15(e) or 15d-15(e) of the Exchange Act thatare designed to ensure that information required to be disclosed in ourExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’srules and forms and that such information is accumulated and communicatedto our management, including our Chief Executive Officer and Chief FinancialOfficer (together, the “Certifying Officers”), to allow for timely decisionsregarding required disclosure.

In designing and evaluating disclosure controls andprocedures, management recognizes that any controls and procedures, no matterhow well designed and operated, can provide only reasonable, not absolute,assurance of achieving the desired objectives.

Under the supervision and with the participation ofmanagement, including the Certifying Officers, we carried out an evaluation ofthe effectiveness of the design and operation of our disclosure controls andprocedures pursuant to paragraph (b) of Exchange Act Rules 13a-15 or 15d-15 asof September 30, 2007. Based upon that evaluation, the Certifying Officers have concluded thatour disclosure controls and procedures are effective at the reasonable assurancelevel as of September 30, 2007.

***Changes in Internal Control over FinancialReporting***

There was no change in our internal control overfinancial reporting identified in connection with the evaluation required byparagraph (d) of Exchange Act Rule 13a-15 or 15d-15 that occurred during thefiscal quarter ended September30, 2007 that has materially affected,or is reasonably likely to materially affect, our internal control overfinancial reporting.

 

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**PART II -OTHER INFORMATION**

**ITEM 1A.  RISK FACTORS**

Other than the addition of the following, there havebeen no material changes to the risk factors set forth in Part I, Item 1A, “RiskFactors”, of the Company’s 2006 10-K.

 

***Amounts included in our backlog may not result in actualrevenue or translate into profits.***

 

As of September30, 2007, the gift segment had a backlog of unfilled orders of approximately$35.7 million, as a result of high demand for the gift segment’s 2007 productline, including Shining Stars. This backlog amount is based primarily onpurchase orders and may not result in actual receipt of revenue in theoriginally anticipated period or at all. In addition, purchase orders includedin our backlog may not be profitable. We may experience variances in therealization of our backlog because of delays or cancellations resulting fromexternal market factors and economic factors beyond our control. If our backlogfails to materialize, we could experience a reduction in revenue, profitabilityand liquidity.

 

 **ITEM 6.  EXHIBITS** 
|   | Exhibits to this  Quarterly Report on Form 10-Q. |
|--------|--------------------------------------------------|
|   |                                             |   |
|   | 31.1                                             | Certification of CEO  required by Section 302 of the Sarbanes Oxley Act of 2002. |
|   | 31.2                                             | Certification of CFO  required by Section 302 of the Sarbanes Oxley Act of 2002. |
|   |                                             |   |
|   | 32.1                                             | Certification of CEO  required by Section 906 of the Sarbanes Oxley Act of 2002. |
|   |                                             |   |
|   | 32.2                                             | Certification of CFO  required by Section 906 of the Sarbanes Oxley Act of 2002. |
|        |                                                  |  |  |

** **

** **

** **

**Items 1,2, 3, 4 and 5 are not applicable and have been omitted.**

** **

 

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized. 
|   |             | RUSS BERRIE AND  COMPANY, INC. |                                        |   |   |   |
|--------|------------------|--------------------------------|---------------------------------------------|--------|--------|--------|
|   |             | (Registrant)                   |                                        |   |   |   |
|   |             |                           |                                        |   |   |   |
|   |             | By                             | /s/ James J. O’Reardon,  Jr.           |   |   |   |   |
| Date:  | November 9, 2007 |                           | James J. O’Reardon, Jr.                |   |   |   |   |
|   |             |                           | Vice President and  Chief Financial Officer |   |   |   |
|   |             |                           |                                        |   |   |   |
|   |             |                           |                                        |   |   |   |
|        |                  |                                |                                             |        |        |        |  |  |  |

** **

 

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** **

**EXHIBITINDEX**

 
|   |
|--------|
| 31.1   | Certification of CEO  required by Section 302 of the Sarbanes Oxley Act of 2002. |
|   |
| 31.2   | Certification of CFO  required by Section 302 of the Sarbanes Oxley Act of 2002. |
|   |
| 32.1   | Certification of CEO  required by Section 906 of the Sarbanes Oxley Act of 2002. |
|   |
| 32.2   | Certification of CFO  required by Section 906 of the Sarbanes Oxley Act of 2002. |
|   |

 

 

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