** **

**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 March 31, 2008** |
| ** **                                             | ** ** | ** **                                                                                                   |
| **Or**                                                 |
| ** **                                             | ** ** | ** **                                                                                                   |
| o                                                      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**     |

**For thetransition period from                to                 **

 

**Commission file number: 1-8681**

 

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**RUSSBERRIE AND COMPANY, INC.**

(Exactname of registrant as specified in its charter)

 

| **New Jersey**                     | ** ** | **22-1815337**                          |
|------------------------------------|------------|-----------------------------------------|
| (State of or other jurisdiction of |       | (I.R.S. Employer Identification Number) |
| incorporation or organization)     | ** ** | ** **                              |

 

| **111 Bauer Drive, Oakland, New Jersey** | ** ** | **07436**  |
|------------------------------------------|------------|------------|
| (Address of principal executive offices) | ** ** | (Zip Code) |

 

| **(201) 337-9000**                                        |
|-----------------------------------------------------------|
| (Registrant’s Telephone Number, including area code) |

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x  No o

 

Indicate bycheck mark whether the registrant is a large accelerated filer, an acceleratedfiler, a non-accelerated filer, or a smaller reporting company. See definitionsof “large accelerated filer,” “accelerated filer,” and “smaller reportingcompany” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer o                      |   | Accelerated filer x         |
|------------------------------------------------|--------|-----------------------------|
|                                           |   |                        |
| Non-accelerated filer o                        |   | Smaller reporting company o |
| (Do not check if a smaller reporting  company) |   |                        |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o  No x

 

The number of sharesoutstanding of each of the registrant’s classes of common stock, as of May 5,2008 was as follows:

** **

| **CLASS**                        | ** ** | **OUTSTANDING   At May 5, 2008** |
|----------------------------------|------------|------------------------------------------------------|
| Common Stock, $0.10 stated value |       | 21,299,643                                           |

 

 

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**RUSS BERRIE AND COMPANY, INC.**

 

**INDEX**

 
| **PART I – FINANCIAL INFORMATION** |   |
|----------------------------------------------|--------|
|                                         |   |   |   |
| Item 1.                                      |   | Financial Statements (unaudited) |   |
|                                         |   |   |   |
| a)                                           |   | Consolidated Balance Sheets as of  March 31, 2008 and December 31, 2007 |   |
|                                         |   |   |   |
| b)                                           |   | Consolidated Statements of  Operations for the three months ended March 31, 2008 and 2007 |   |
|                                         |   |   |   |
| c)                                           |   | Consolidated Statements of  Cash Flows for the three months ended March 31, 2008 and 2007 |   |
|                                         |   |   |   |
| 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 6.                                      |   | Exhibits |   |
|                                         |   |   |   |
| Signatures                                   |   |
|                                         |   |
| Exhibit  Index                               |   |

 

2

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**PART 1 - FINANCIALINFORMATION**

 

**ITEM 1.  FINANCIAL STATEMENTS**

 

**RUSS BERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(In Thousands, except share and per share data)(UNAUDITED)**

 
| ** **                                                                                                                                   | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| **Assets**                                                                                                                                   |       |                         |       |                            |       |
| Current assets:                                                                                                                              |       |                         |       |                            |       |
| Cash and cash equivalents                                                                                                                    |       | $                            | 17,330     |                            | $          | 21,925 |   |
| Accounts receivable, trade, less allowances  of $2,243 in 2008 and $2,289 in 2007                                                            |       | 60,209                       |       | 64,544                          |       |
| Inventories, net                                                                                                                             |       | 54,028                       |       | 59,069                          |       |
| Prepaid expenses and other current assets                                                                                                    |       | 2,845                        |       | 3,137                           |       |
| Income tax receivable                                                                                                                        |       | 761                          |       | 663                             |       |
| Deferred income taxes                                                                                                                        |       | 1,611                        |       | 1,619                           |       |
| **Total current assets**                                                                                                                     |       | 136,784                      |       | 150,957                         |       |
| Property, plant and equipment, net                                                                                                           |       | 12,596                       |       | 13,093                          |       |
| Goodwill                                                                                                                                     |       | 120,773                      |       | 120,777                         |       |
| Intangible assets                                                                                                                            |       | 51,168                       |       | 51,172                          |       |
| Restricted cash                                                                                                                              |       | 944                          |       | 916                             |       |
| Deferred income taxes                                                                                                                        |       | 861                          |       | 897                             |       |
| Other assets                                                                                                                                 |       | 5,533                        |       | 4,163                           |       |
| **Total assets**                                                                                                                             |       | $                            | 328,659    |                            | $          | 341,975 |   |
| **Liabilities and Shareholders’ Equity**                                                                                                |       |                         |       |                            |       |
| Current liabilities:                                                                                                                         |       |                         |       |                            |       |
| Current portion of long-term debt                                                                                                            |       | $                            | 12,000     |                            | $          | 11,500 |   |
| Short-term debt                                                                                                                              |       | 26,813                       |       | 23,344                          |       |
| Accounts payable                                                                                                                             |       | 10,150                       |       | 19,822                          |       |
| Accrued expenses                                                                                                                             |       | 23,654                       |       | 31,289                          |       |
| Income taxes payable                                                                                                                         |       | 2,678                        |       | 1,869                           |       |
| **Total current liabilities**                                                                                                                |       | 75,295                       |       | 87,824                          |       |
| Income taxes payable long-term                                                                                                               |       | 9,406                        |       | 9,406                           |       |
| Deferred income taxes                                                                                                                        |       | 3,736                        |       | 3,736                           |       |
| Long-term debt, excluding current portion                                                                                                    |       | 29,000                       |       | 32,000                          |       |
| Other long-term liabilities                                                                                                                  |       | 4,049                        |       | 4,370                           |       |
| **Total liabilities**                                                                                                                        |       | 121,486                      |       | 137,336                         |       |
|                                                                                                                                         |       |                         |       |                            |       |
| Commitments and contingencies                                                                                                                |       |                         |       |                            |       |
| Shareholders’ equity:                                                                                                                   |       |                         |       |                            |       |
| Common stock: $0.10 stated value;  authorized 50,000,000 shares; issued 26,727,780 shares at March 31, 2008  and December 31, 2007 |       | 2,674                        |       | 2,674                           |       |
| Additional paid in capital                                                                                                                   |       | 91,289                       |       | 90,844                          |       |
| Retained earnings                                                                                                                            |       | 202,228                      |       | 200,228                         |       |
| Accumulated other comprehensive income                                                                                                       |       | 17,065                       |       | 16,976                          |       |
| Treasury stock, at cost, 5,428,137 shares  at March 31, 2008 and December 31, 2007                                                 |       | (106,083                     | )          | (106,083                        | )          |
| **Total shareholders’ equity**                                                                                                          |       | 207,173                      |       | 204,639                         |       |
| **Total liabilities and shareholders’ equity**                                                                                          |       | $                            | 328,659    |                            | $          | 341,975 |   |

 

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

 

3

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**RUSS BERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OFOPERATIONS**

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

**(UNAUDITED)**

 
| ** **                                                            | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                            | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Net sales                                                             |       | $                                                    | 75,924     |   | $ | 75,073 |   |
|                                                                  |       |                                                 |       |   |   |
| Cost of sales                                                         |       | 45,366                                               |       | 43,746 |   |
|                                                                  |       |                                                 |       |   |   |
| **Gross profit**                                                      |       | 30,558                                               |       | 31,327 |   |
|                                                                  |       |                                                 |       |   |   |
| Selling, general and administrative  expenses                         |       | 26,984                                               |       | 26,458 |   |
|                                                                  |       |                                                 |       |   |   |
| **Operating income**                                                  |       | 3,574                                                |       | 4,869 |   |
|                                                                  |       |                                                 |       |   |   |
| Other (expense) income:                                               |       |                                                 |       |   |   |
| Interest expense, including amortization of  deferred financing costs |       | (1,192                                               | )          | (1,236 | ) |
| Interest and investment income                                        |       | 165                                                  |       | 192 |   |
| Other, net                                                            |       | 428                                                  |       | (78 | ) |
|                                                                  |       | (599                                                 | )          | (1,122 | ) |
|                                                                  |       |                                                 |       |   |   |
| **Income before income tax provision**                                |       | 2,975                                                |       | 3,747 |   |
|                                                                  |       |                                                 |       |   |   |
| Income tax provision                                                  |       | 975                                                  |       | 1,201 |   |
|                                                                  |       |                                                 |       |   |   |
| **Net income**                                                        |       | $                                                    | 2,000      |   | $ | 2,546 |   |
|                                                                  |       |                                                 |       |   |   |
| **Net income per share:**                                             |       |                                                 |       |   |   |
| Basic                                                                 |       | $                                                    | 0. 09      |   | $ | 0.12 |   |
| Diluted                                                               |       | $                                                    | 0. 09      |   | $ | 0.12 |   |
|                                                                  |       |                                                 |       |   |   |
| **Weighted average shares:**                                          |       |                                                 |       |   |   |
| Basic                                                                 |       | 21,300,000                                           |       | 21,076,000 |   |
| Diluted                                                               |       | 21,325,000                                           |       | 21,141,000 |   |

 

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

 

4

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**RUSS BERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(In Thousands)(UNAUDITED)**

 
| ** **                                                                       | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| **Cash flows from operating activities:**                                        |       |                                                 |       |   |   |
| Net income                                                                       |       | $                                                    | 2,000      |   | $ | 2,546 |   |
| Adjustments to reconcile net income to net  cash (used in) operating activities: |       |                                                 |       |   |   |
| Depreciation and amortization                                                    |       | 1,053                                                |       | 1,163 |   |
| Amortization of deferred financing costs                                         |       | 163                                                  |       | 157 |   |
| Accounts receivable allowance                                                    |       | 268                                                  |       | 739 |   |
| Provision for inventory reserve                                                  |       | 1,361                                                |       | (770 | ) |
| Deferred income taxes                                                            |       | —                                               |       | 929 |   |
| Share-based compensation expense                                                 |       | 445                                                  |       | 75 |   |
| Other                                                                            |       | (203                                                 | )          | 295 |   |
| Change in assets and liabilities:                                                |       |                                                 |       |   |   |
| Restricted cash                                                                  |       | 15                                                   |       | 12 |   |
| Accounts receivable                                                              |       | 4,143                                                |       | (11,535 | ) |
| Income tax receivable                                                            |       | (367                                                 | )          | 1,079 |   |
| Inventories                                                                      |       | 3,542                                                |       | 763 |   |
| Prepaid expenses and other current assets                                        |       | 285                                                  |       | 6,055 |   |
| Other assets                                                                     |       | (1,532                                               | )          | (277 | ) |
| Accounts payable                                                                 |       | (10,072                                              | )          | (5,602 | ) |
| Accrued expenses                                                                 |       | (3,030                                               | )          | (1,419 | ) |
| Accrued income taxes                                                             |       | 571                                                  |       | 595 |   |
| Net cash used in operating activities                                            |       | (1,358                                               | )          | (5,195 | ) |
|                                                                             |       |                                                 |       |   |   |
| **Cash flows from investing activities:**                                        |       |                                                 |       |   |   |
| Capital expenditures                                                             |       | (537                                                 | )          | (656 | ) |
| Payment of Kids Line, LLC Earnout  Consideration                                 |       | (3,617                                               | )          | — |   |
| Net cash used in investing activities                                            |       | (4,154                                               | )          | (656 | ) |
|                                                                             |       |                                                 |       |   |   |
| **Cash flows from financing activities:**                                        |       |                                                 |       |   |   |
| Repayment of long-term debt                                                      |       | (2,500                                               | )          | (2,250 | ) |
| Net borrowing on revolving credit facility                                       |       | 3,469                                                |       | 7,558 |   |
| Payment of capital lease obligations                                             |       | (42                                                  | )          | — |   |
| Net cash provided by financing activities                                        |       | 927                                                  |       | 5,308 |   |
|                                                                             |       |                                                 |       |   |   |
| Effect of exchange rate changes on cash and  cash equivalents                    |       | (10                                                  | )          | 83 |   |
| Net decrease in cash and cash equivalents                                        |       | (4,595                                               | )          | (460 | ) |
| Cash and cash equivalents at beginning of  period                                |       | 21,925                                               |       | 11,526 |   |
| Cash and cash equivalents at end of period                                       |       | $                                                    | 17,330     |   | $ | 11,066 |   |
| **Cash paid during the period for:**                                             |       |                                                 |       |   |   |
| Interest expense                                                                 |       | $                                                    | 798        |   | $ | 918 |   |
| Income taxes                                                                     |       | $                                                    | 62         |   | $ | 46 |   |

 

*The accompanying notes are an integral part of theseunaudited consolidated financial statements*

 

5

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**NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 - INTERIM CONSOLIDATED FINANCIAL STATEMENTS**

 

The accompanying unaudited interim consolidatedfinancial statements have been prepared by Russ Berrie and Company, Inc. andits subsidiaries (the “Company”) in accordance with accounting principlesgenerally accepted in the United States of America for interim financialreporting and the instructions to the Quarterly Report on Form 10-Q and Rule 10-01of Regulation S-X. Accordingly, certain information and footnote disclosuresnormally included in financial statements prepared under generally acceptedaccounting principles have been condensed or omitted pursuant to suchprinciples and regulations.  The information furnished reflects alladjustments, which are, in the opinion of management, of a normal recurringnature and necessary for a fair presentation of the Company’s consolidatedfinancial position, results of operations and cash flows for the interimperiods presented.  Results for interim periods are not necessarily anindication of results to be expected for the year.

 

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

 

The Company’s infant and juvenile segment designs,manufactures through third parties and markets products in a number of babycategories including, among others, infant bedding and accessories, bath toysand accessories, developmental toys, feeding items and baby comfortingproducts. As of March 31, 2008, the infant and juvenile segment consistedof Sassy, Inc. (“Sassy”), and Kids Line LLC (“Kids Line”).  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.  See Note 13 –Subsequent Events, for a description of recent acquisitions in the infant andjuvenile segment.

 

The Company’s gift segment designs, manufacturesthrough third parties and markets a wide variety of gift products to retailstores throughout the United States and throughout the world via the Company’sinternational wholly-owned subsidiaries and independent distributors.

 

This Quarterly Report on Form 10-Q for thethree months ended March 31, 2008 should be read in conjunction with theconsolidated financial statements and notes thereto included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2007, asamended (the “2007 10-K”).

 

**NOTE 2 - SHAREHOLDERS’ EQUITY**

 

The costs resulting from share based paymenttransactions are recognized in the financial statements at their grant date fairvalue. The grant date fair value of options granted under stock option plans orotherwise is estimated on the date of grant using a Black-Scholes optionspricing model using the assumptions below. Expected volatilities are calculatedbased on the historical volatility of the Company’s stock; management’sestimate of implied volatility of the Company’s stock and other factors.  The expected term of options granted isderived from the vesting period of the award, as well as historical exercisebehavior, and represents the period of time that options are expected to beoutstanding. Management monitors stock option exercises and employeetermination patterns to estimate forfeiture rates within the valuation model.Separate groups of employees, directors and officers that have similarhistorical exercise behavior are considered separately for valuation purposes.The risk-free interest rate is based on the Treasury note interest rate ineffect on the date of grant for the expected term of the stock option.

 

***Stock Plans***

 

The Company currently maintains the 2004 StockOption, Restricted and Non-Restricted Stock Plan (the “2004 Option Plan”) andthe Amended and Restated 2004 Employee Stock Purchase Plan (the “2004 ESPP”).  As of March 31, 2008 there were anaggregate of 885,214 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 the1999 Predecessor Plans and after December 31, 1998 with respect to the1994 Predecessor Plans. No awards may be made after December 31, 2008under the 2004 Option Plan.  In addition,the Company may issue stock options outside of the plans discussed above. As ofMarch 31, 2008 there were 370,000 stock options outstanding that weregranted outside these plans.  Theexercise price for options issued under the 2004 Option Plan, the PredecessorPlans or otherwise is generally equal to the closing price of the Company’scommon stock as of the date the option is granted. Generally, stock optionsunder the 2004 Option Plan (or otherwise) and the Predecessor Plans vest over aperiod ranging from one to five years from the grant date unless otherwisestated by the specific grant. Options generally expire 10 years from thedate of grant.  See Notes 2 and 17 of theNotes to Consolidated Financial Statements of the 2007 10-K for further detailswith respect to equity plans.

 

6

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**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

 

***Stock Options***

 

The following table summarizes activity regardingoutstanding options as of March 31, 2008, and changes during the threemonths ended March 31, 2008:

 
| ** **                                     | ** ** | **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,  2007 |       | 1,775,417   |       | $                                                                             | 18.20      |                                      | $11.19 - $34.80 |                                                                                       | 7.2        |                                              | $          | 1,400 |   |
| Granted                                        |       | 100,000     |       | 14.83                                                                         |       | $14.83                                    |            | 5.0                                                                                        |       |                                              |       |
| Exercised                                      |       | —      |       | —                                                                        |       | —                                    |            |                                                                                       |       |                                              |       |
| Forfeited/cancelled                            |       | (24,653     | )          | $                                                                             | 20.87      |                                      | $16.77-$34.05   |                                                                                       |       |                                              |       |   |
| Options outstanding at March 31, 2008     |       | 1,850,764   |       | $                                                                             | 17.98      |                                      | $11.19-$34.05   |                                                                                       | 6.8        |                                              | $          | 456 |   |
| Vested and exercisable at March 31,  2008 |       | 1,147,164   |       | $                                                                             | 19.09      |                                      | $11.19-$34.05   |                                                                                       | 6.1        |                                              | $          | 471 |   |

 

Other than 100,000 options granted to our ChiefExecutive Officer pursuant to the terms of his employment agreement with theCompany, there were no stock options granted during the three months ended March 31,2008.  There were no grants of restrictedstock during the three months ended March 31, 2008.  No options or shares of restricted stock weregranted during the three months ended March 31, 2007.

 

Share-based compensation expense related to theCompany’s stock options recorded in selling, general and administrative expensefor the three months ended March 31, 2008 and 2007 was approximately$221,000 and $37,000, respectively. Share-based compensation expense related to the Company’s outstandingrestricted stock recorded in selling, general and adminstrative expense for thethree months ended March 31, 2008 and 2007 was approximately $179,000 and$0, respectively.  No compensation costrelated to equity grants was capitalized (in inventory or any other assets) asof March 31, 2008 and 2007. For the three months ended March 31, 2008and 2007, there were no excess tax benefits recognized as a result ofshare-based compensation cost.

 

The assumptions used to estimate the fair value ofthe stock options granted during three months ended March 31, 2008 isestimated on the date of grant using the Black-Scholes option-pricing modelwith the following assumptions:

 
| ** **              | ** ** | **Three Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **March 31,**               | ** ** |
| ** **              | ** ** | **2008**                         | ** ** |
| Dividend Yield          |       | —                           |       |
| Risk-free Interest Rate |       | 3.18                             | %          |
| Volatility              |       | 38.60                            | %          |
| Expected Life (years)   |       | 5                                |       |

 

***Non-vested Stock Options andRestricted Stock***

 

As of March 31, 2008,there was approximately $3.4 million of total unrecognized compensation cost related to 703,600 non-vestedstock options. This cost is expected to be recognized over a weighted-averageperiod of 4.0 years.

 

A summary of the Company’s non-vested stock optionsat March 31, 2008 andchanges during the three months ended March 31,2008 are presented below:

 

7

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**NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 
| ** **                             | ** ** | ** ** | ** ** | **Weighted Average**     | ** ** |
|----------------------------------------|------------|------------|------------|-------------------------------|------------|
| ** **                             | ** ** | ** ** | ** ** | **Grant Date Fair** | ** ** |
| **Non-vested stock options** | ** ** | **Shares** | ** ** | **Value**                     | ** ** |
| Non-vested at December 31, 2007   |       | 618,600    |       | $                             | 16.41      |   |
| Granted                                |       | 100,000    |       | $                             | 14.83      |   |
| Vested                                 |       | —     |       | —                        |       |
| Forfeited                              |       | (15,000    | )          | $                             | 16.77      |   |
| Non-vested at March 31, 2008      |       | 703,600    |       | $                             | 16.17      |   |

 

During the year ended December 31, 2007, there were 170,675 sharesof restricted stock issued under the 2004 Option Plan, all of which remainnon-vested. These restricted stock grants have vesting periods ranging fromthree to five years, with fair market values at date of grant ranging from$14.90 to $16.77 per share. Compensation expense is determined for the issuanceof restricted stock by amortizing over the requisite service period, or thevesting period, the aggregate fair value of the restricted stock awarded basedon the closing price of the Company’s Common Stock effective on the date theaward is made.   There were no grants ofrestricted stock made during the first quarter of 2008.

 

As of March 31, 2008, the total remaining unrecognizedcompensation cost related to outstanding shares of restricted stock wasapproximately $2.5 million, and is expected to be recognized over aweighted-average period of 3.6 years.

 

**Employee Stock Purchase Plan**

 

Underthe 2004 ESPP, eligible employees are provided the opportunity to purchase theCompany’s common stock at a discount. Pursuant to this plan, options are granted to participants as of thefirst trading day of each plan year, which is the calendar year, and may beexercised as of the last trading day of each plan year, to purchase from theCompany the number of shares of common stock that may be purchased at therelevant purchase price with the aggregate amount contributed by eachparticipant.  In each plan year, aneligible employee may elect to participate in the plan by filing a payrolldeduction authorization form for up to 10% (in whole percentages) of his or hercompensation.  No employee shall have theright to purchase the Company’s common stock under the 2004 ESPP which has a fairmarket value in excess of $25,000 in any plan year.  The purchase price is the lesser of 85% ofthe closing market price of the Company’s common stock on either the firsttrading day or the last trading day of the plan year.  If an employee does not elect to exercise hisor her option, the total amount credited to his or her account during that planyear is returned to such employee, and his or her option expires.  As of March 31, 2008, the 2004 ESPP hadapproximately 80,269 shares reserved for future issuance.

 

Totalshare-based compensation expense related to the 2004 ESPP was approximately$45,000 and $38,000 for the three months ended March 31, 2008 and 2007,respectively.

 

Thefair value of each option granted under the 2004 ESPP is estimated on the dateof grant using the Black-Scholes option-pricing model with the followingassumptions:

 
| ** **              | ** ** | **Three Months Ended   March 31,** | ** ** |
|-------------------------|------------|--------------------------------------------------------|------------|
| ** **              | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| Dividend yield          |       | —                                                 |       | — |   |
| Risk-free interest rate |       | 3.17                                                   | %          | 4.98 | % |
| Volatility              |       | 34.40                                                  | %          | 36.70 | % |
| Expected life (years)   |       | 1                                                      |       | 1 |   |

 

Expectedvolatilities are calculated based on the historical volatility of the Company’sstock; management’s estimate of implied volatility of the Company’s stock andother factors. The risk-free interest rate is based on the U.S. Treasury yieldwith a term that is consistent with the expected life of the options. Theexpected life of options under the 2004 ESPP is one year, or the equivalent ofthe annual plan year.

 

8

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**NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 3 - WEIGHTED AVERAGE COMMON SHARES**

 

The weighted average common shares outstandingincluded in the computation of basic and diluted net income per share is setforth below (in thousands):

 
| ** **                                                                | ** ** | **Three Months Ended   March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| Weighted average common shares outstanding                                |       | 21,300                                                 |       | 21,076 |   |
| Dilutive effect of common shares issuable  upon exercise of stock options |       | 25                                                     |       | 65 |   |
| Weighted average common shares outstanding  assuming dilution             |       | 21,325                                                 |       | 21,141 |   |

 

Stock options to purchase approximately 1.9 millionand 1.8 million shares were outstanding at March 31, 2008 and 2007,respectively.  For the three months endedMarch 31, 2008 and 2007, approximately 1.5 million and 0.9 million stockoptions, respectively, 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 period and were therefore anti-dilutive.

 

**NOTE 4 – DEBT**

 

Consolidated long-term debt at March 31, 2008 and December 31,2007 consisted of the following (in thousands):

 
| ** **                              | ** ** | **March 31,   2008** | ** ** | **December 31,   2007** | ** ** |
|-----------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|
| Term Loan (Infantline Credit Agreement) |       | $                              | 41,000     |                              | $          | 43,500 |   |
| Less current portion                    |       | 12,000                         |       | 11,500                            |       |
| Long-term debt                          |       | $                              | 29,000     |                              | $          | 32,000 |   |

 

9

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**NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

At March 31, 2008, there was approximately $18.3 millionborrowed under the Infantline Revolving Loan, approximately $8.5 millionborrowed under the Giftline Revolving Loan (each as defined below) and $0.9million outstanding under the letter of credit facility, all of which isclassified as short-term debt.  At December 31,2007, there was approximately $15.5 million borrowed under the InfantlineRevolving Loan and approximately $7.8 million borrowed under the GiftlineRevolving Loan, all of which is classified as short-term debt.  See Note 13— Subsequent Events, for adescription of additional debt incurred in connection with the recentacquisitions in the infant and juvenile segment.

 

*A. The Infantline Credit Agreement*

 

On March 14, 2006 (the “Closing Date”), as amended as of December 22,2006 (discussed below), Kids Line, LLC (“KL”) and Sassy, Inc. (“Sassy”),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, the Company as loanparty representative, Sovereign Bank as syndication agent, and Bank of America,N.A. as documentation agent (as amended, the “Infantline Credit Agreement”).Unless otherwise specified herein, capitalized terms used but undefined in thisNote 4, Section A shall have the meanings ascribed to them in theInfantline Credit Agreement.  Alldisclosures in this Note 4 with respect to the Infantline Credit Agreementspeak as of March 31, 2008.  TheInfantline Credit Agreement was amended and restated as of April 2, 2008.  See Note 13 — Subsequent Events, for adescription of such amendment and restatement and the material provisionsaffected thereby.

 

The commitments under the Infantline Credit Agreement as of March 31,2008 consisted of (a) a $35.0 million revolving credit facility (the “RevolvingLoan”), with a subfacility for letters of credit in an amount not to exceed$5.0 million, and (b) a term loan facility in the original amount of$60 million (the “Term Loan”). The Infantline Borrowers drew downapproximately $79.7 million on the Infantline Credit Agreement on the Closing Date,including the full amount of the Term Loan, which reflected the payoff of allamounts outstanding under a prior credit facility and certain fees and expensesassociated with the Infantline Credit Agreement. As of March 31, 2008, theoutstanding balance on the Revolving Loan was $41.0 million, theoutstanding balance on the Term Loan was $18.3 million and $0.9 million wasoutstanding under the letter of credit facility. As of March 31, 2008, theCompany had availability under this Revolving Loan of $13.9 million. MandatoryTerm Loan repayment obligations as of March 31, 2008 were as follows:$9.0 million in 2008, $14.5 million in 2009, $15.0 million in2010; and $2.5 million in 2011.

 

As of December 22, 2006, the Infantline Credit Agreement wasamended (the “First Amendment”) to permit the repayment and subsequentreborrowing of up to $20 million under the Term Loan, which was intendedto enable the Infantline Borrowers to continue to utilize cash flows expectedto be generated from operations to repay debt until the earnout considerationwith respect to the purchase of Kids Line (the “KL Earnout Consideration”)became due.  As a result of the LaSalleRefinancing, the obligation to pay such earnout became the joint and severalobligations of KL and Sassy.

 

Pursuant to the First Amendment, KL and Sassy borrowed $20 millionunder the Revolving Loan, the outstanding balance of which had previously beenreduced to zero, and utilized the proceeds of such draw to prepay$20 million of the Term Loan. The lenders agreed to provide an additionalTerm Loan reborrowing commitment (the “TR Commitment”) of an aggregate maximumprincipal amount of $20 million, which amounts could only be reborrowedduring specified periods and only to fund the payment of the KL Earnout Consideration.Pursuant to the First Amendment, KL and Sassy paid 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.

 

In December 2007, KL and Sassy paid $28.5 million of the KLEarnout Consideration, which amount was financed by drawing on the TRCommitment of $20 million and drawing an additional $8.5 million on theInfantline Revolving Loan. The remaining portion of the KL EarnoutConsideration ($3.6 million) was paid by KL and Sassy in January of 2008,also through a draw on the Infantline Revolving Loan.

 

As of March 31, 2008, the Infantline Loans bore interest at a rateper annum equal to the Base Rate (for Base Rate Loans) or the LIBOR Rate (forLIBOR Loans) at the option of the Infantline Borrowers, plus an applicablemargin, in accordance with a pricing grid based on the most recent quarter-endTotal Debt to EBITDA Ratio, which applicable margin ranged from 1.75% -2.50% for LIBOR Loans and from 0.25% - 1.00% for Base Rate Loans. Theapplicable interest rate margins as of March 31, 2008 were: 2.00% forLIBOR Loans and 0.50% for Base Rate Loans. The weighted average interest ratesfor the outstanding loans as of March 31, 2008 were as follows:

 

10

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**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

 
| ** **           | ** ** | **At March 31, 2008** | ** ** |
|----------------------|------------|--------------------------------------|------------|
| ** **           | ** ** | **LIBOR Loans**                 | ** ** | **Base Rate Loans** | ** ** |
| Infantline Revolver  |       | 4.64                                 | %          | 5.75 | % |
| Infantline Term Loan |       | 4.64                                 | %          | 5.75 | % |

 

Interest is due and payable (i) with respect to Base Rate Loans,monthly in arrears on the last day of each calendar month, upon a prepaymentand at maturity and (ii) with respect to LIBOR Loans, on the last day ofeach Interest Period, upon a prepayment (and if the Interest Period is inexcess of three months, on the three-month anniversary of the first day of suchInterest Period), and at maturity.

 

In connection with the execution of the Infantline Credit Agreement, KLand Sassy paid aggregate closing fees of $1.4 million and an aggregate agencyfee of $25,000. An aggregate agency fee of $25,000 will be payable on eachanniversary of the Closing Date. As of March 31, 2008, the Revolving Loanwas subject to an annual non-use fee (payable monthly, in arrears, and upontermination of the relevant obligations) of 0.50% for unused amounts under theRevolving Loan, an annual letter of credit fee (payable monthly, in arrears,and upon termination of the relevant obligations) for undrawn amounts withrespect to each letter of credit based on the most recent quarter-end TotalDebt to EBITDA Ratio ranging from 1.75% - 2.50% and other customary letterof credit administration fees.

 

As of March 31, 2008, the principal of the Term Loan was beingrepaid in installments as follows: (a) $0.75 million on the last dayof each calendar month for the period commencing March 2006 through andincluding February 2008, (b) $1.0 million on the last day ofeach calendar month for the period commencing March 2008 through andincluding February 2009 and (c) $1.25 million on the last day ofeach calendar month for the period commencing March 2009 through andincluding February 2011. As of March 31, 2008, a final installment inthe aggregate amount of the unpaid principal balance of the Term Loan (inaddition to all outstanding amounts under the Infantline Revolver) was due andpayable on March 14, 2011, in each case subject to customary earlytermination provisions (without any prepayment penalty) in accordance with theterms of the Infantline Credit Agreement.

 

KL and Sassy are required to make prepayments of the Term Loan upon theoccurrence of certain transactions, including most asset sales or debt orequity issuances. Additionally, annual mandatory prepayments of the Term Loanwould be required in an amount equal to 50% of Excess Cash Flow for each fiscalyear (starting with 2007) unless the Total Debt to EBITDA Ratio for such fiscalyear was equal to or less than 2.00:1.00. For fiscal year 2007, no Excess CashFlow payment was required.

 

The Infantline Credit Agreement contains customary affirmative andnegative covenants, as well as the following financial covenants (the “InfantlineFinancial Covenants”) as of March 31, 2008: (i) a minimum EBITDAtest, (ii) a minimum Fixed Charge Coverage Ratio, (iii) a maximumTotal Debt to EBITDA Ratio and (iv) an annual capital expenditurelimitation. In addition, upon the occurrence of an event of default under thecredit agreement, including a failure to maintain compliance with theInfantline Financial Covenants, the lenders could elect to declare all amountsoutstanding under the credit facility to be immediately due and payable.

 

As of March 31, 2008, KL and Sassy were in compliance with theInfantline Financial Covenants.

 

The Infantline Credit Agreement contains significant limitations on theability of KL and Sassy to distribute cash to Russ Berrie and Company, Inc.(“RB”), which became a corporate holding company when the Infantline CreditAgreement was put into place, for the purpose of paying dividends to theshareholders of RB or for the purpose of paying their allocable portion of RB’scorporate overhead expenses, including a cap (subject to certain exceptions) asof March 31, 2008 of $2.0 million per year on the amount that can beprovided to RB to pay corporate overhead expenses.

 

To secure the obligations of KL and Sassy to pay the KL EarnoutConsideration, KL and Sassy granted a subordinated lien on substantially all oftheir assets, on a joint and several basis, and RB granted a subordinated lienon the equity interests of each of KL and Sassy to the Earnout SellersAgent. All such security interests and lienswere subordinated to the senior indebtedness of KL and Sassy arising under theInfantline Credit Agreement. As a result of the payment in full of the KLEarnout Consideration, all such subordinated security interests and liens werereleased as of February 29, 2008.

 

Pursuant to the Infantline Pledge Agreement, RB has agreed that it willfunction solely as a holding company and will not, without the prior writtenconsent of the Agent, engage in any business or activity except for 

 

11

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**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

 

specifiedactivities, including those relating to its investments in its subsidiaries existingon the Closing Date, the maintenance of its existence and compliance with law,the performance of obligations under specified contracts and other specifiedordinary 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 7, 2007, Russ Berrie U.S. GiftInc. (“U.S. Gift”) and other specified wholly-owned domestic subsidiaries of RB(collectively, the “Giftline Borrowers”), entered into a credit agreement asborrowers, on a joint and several basis, with LaSalle Bank NationalAssociation, as issuing bank (the “Issuing Bank”), LaSalle BusinessCredit, LLC as administrative agent (the “Administrative Agent”), thelenders from time to time party thereto, and the Company, as loan partyrepresentative (as amended, the “Giftline Credit Agreement”. Unless otherwisespecified herein, capitalized terms used but undefined in this Note 4, Section Bshall have the meanings ascribed to them in the Giftline Credit Agreement.

 

Prior to the August 8, 2007 amendment to the Giftline CreditAgreement (the “Fourth Amendment”), the Giftline Credit Agreement consisted ofa maximum revolving credit loan commitment (the “Giftline Revolver”) in anamount equal to the lesser of (i) $15.0 million (with a maximumavailability of $13.5 million) and (ii) the then-current BorrowingBase, in each case minus amounts outstanding under the Canadian CreditAgreement (as defined below), with a sub-facility for letters of credit to beissued by the Issuing Bank in an amount 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 ineffect at such time and (y) the Borrowing Base at such time, minus (b) thesum of the aggregate principal amount of all “Loans”, “Specified HedgingObligations” and the “Stated Amount” of all “Letters of Credit” outstanding orrequested but not yet funded under the Canadian Loan Agreement. The BorrowingBase is primarily a function of a percentage of eligible accounts receivableand eligible inventory. As of March 31, 2008, the outstanding balance onthe Giftline Revolver was $8.5 million, there was no outstanding balanceon the Canadian Revolving Loan (see Section C below), and there was$1.2 million utilized under the Canadian sub-facility for letters ofcredit. At March 31, 2008, based on available collateral, the unusedamount available to be borrowed under the Giftline Revolver was$3.9 million.

 

All outstanding amounts under the Giftline Revolver are due and payableon March 14, 2011, subject to earlier termination in accordance with theterms of 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 Company’s option plus an applicable margin, which margin was originally2.75% for LIBOR Loans and 1.25% for Base Rate Loans. However, pursuant to the December 28,2006 amendment 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 range from 2.00% - 2.75% for LIBOR Loans and from0% - 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 March 31, 2008 were 2.25% for LIBOR Loans and 0.25% for BaseRate Loans. As of March 31, 2008, the interest rate was 5.50% for the oneoutstanding Base Rate loan ($3.5 million) and 4.85% for one outstandingLIBOR loan ($5.0 million).

 

In connection with the execution of the Giftline Credit Agreement, theInfantline Borrowers paid (on behalf of the Giftline Borrowers) aggregateclosing fees of $0.15 million and an aggregate agency fee of $20,000.Aggregate agency fees of $20,000 will be payable by the Giftline Borrowers oneach 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 fees are as described in the Giftline CreditAgreement.

 

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

 

12

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**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

 

followingfinancial covenants: (i) a minimum EBITDA test, (ii) a minimum ExcessRevolving Loan Availability requirement of $5.0 million, (iii) an annualcapital expenditure limitation and (iv) a minimum Fixed Charge CoverageRatio (for quarters commencing with the quarter ended March 31, 2008). On August 8,2006, the Giftline Credit Agreement was amended to lower the threshold on theMinimum EBITDA covenant by $1.0 million per quarter for each of fourconsecutive quarters commencing with the quarter ending September 30,2006. The Third Amendment (i) eliminated in their entirety both theminimum EBITDA 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 Amendmenteliminated the existing Excess Revolving Loan Availability requirement, andre-instituted a Fixed Charge Coverage Ratio covenant based on the last day ofany month for the applicable Computation Period (as defined in the FourthAmendment) 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. Thiscovenant is only applicable, however, if during the three month period thenending on such date of determination (the “Test Period”) Revolving LoanAvailability (defined above) was less than $3.5 million for any three (3) consecutivebusiness day period (the “Test Condition”). If compliance is required becausethe Test Condition was not met, the Giftline Borrowers will be required todeliver a specified compliance certificate to the Administrative Agent. Inaddition, the Giftline Borrowers must comply with the Fixed Charge CoverageRatio covenant for a period of three consecutive months after they fail tosatisfy the Test Condition. The Company’s availability was not less than $3.5million during the quarter ended March 31, 2008 and the Fixed ChargeCoverage Ratio was not applicable during the quarter. As of March 31,2008, the Company was in compliance with the applicable financial covenantscontained in the Giftline 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 the shareholders of the Company or for the purpose ofpaying RB’s corporate overhead expenses, including a cap (subject to certainexceptions) on the amount that can be provided to RB to reimburse for itsallocable portion of corporate overhead expenses equal to $4.5 million peryear for each of fiscal years 2006 and 2007, and $5.0 million for eachfiscal year thereafter. The Third Amendment permits the Giftline Borrowers topay dividends or make distributions to RB if no default or event of defaultexists or would result therefrom and immediately after giving effect to suchpayments, there is at least $1.5 million available to be drawn under theGiftline Revolver. The amount of any such payments to RB cannot exceed theamount of capital contributions made by RB to the Giftline Borrowers after December 28,2006, which are used by the Giftline Borrowers to pay down the GiftlineRevolver minus the total amount of dividends or other distributions made by theGiftline Borrowers to RB under this provision of the Giftline Credit Agreement.

 

In order to secure the obligations of the Giftline Borrowers, theGiftline Borrowers pledged and have granted security interests to the AdministrativeAgent in substantially all of their existing and future personal property, andeach Giftline Borrower guaranteed the performance of the other GiftlineBorrowers under the Giftline Credit Agreement. In addition, RB provided alimited recourse guaranty of the obligations of the Giftline Borrowers underthe Giftline Credit Agreement. This guarantee is secured by a lien on theassets intended to be assigned to U.S. Gift pursuant to the Assignment. RB alsopledged 100% of the equity interests of each of the Giftline Borrowers and 65%of its equity interests in certain of its First Tier Foreign Subsidiaries tothe Administrative Agent (the “Giftline Pledge Agreement”). The Giftline PledgeAgreement contains substantially similar limitations on the activities of RB asis set forth in the Infantline Pledge Agreement.

 

*C. Canadian Credit Agreement*

 

As contemplated by a previous credit facility with LaSalle BankNational Association, on June 28, 2005, the Company’s Canadian subsidiary,Amram’s Distributing 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, aCanadian branch of a Netherlands bank, as issuing bank and administrative agent(the “Canadian Credit Agreement”), and related loan documents with respect to amaximum U.S. $10.0 million revolving loan (the “Canadian Revolving Loan”).RB executed an unsecured Guarantee (the “Canadian Guarantee”) to guarantee theobligations of Amrams under the Canadian Credit Agreement. In connection withthe execution of the Giftline Credit Agreement, on March 14, 2006, theCanadian Credit Agreement was amended to (i) replace references to theprevious credit facility with the Giftline Credit Agreement (such that, amongother conforming changes, a default under the Giftline Credit Agreement will bea default under the Canadian Credit Agreement), (ii) release RB from theCanadian Guaranty and (iii) provide for a maximum U.S. $5.0 million 

 

13

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**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

 

revolvingloan. In connection with the release of the Company from the Canadian Guaranty,U.S. Gift executed an unsecured Guarantee to guarantee the obligations ofAmrams under the Canadian Credit Agreement. A default under the InfantlineCredit Agreement will not constitute a default under the Canadian CreditAgreement. There were no borrowings under the Canadian Revolving Loan as of March 31,2008 and December 31, 2007.

 

The Commitments under the Canadian Credit Agreement bear interest at arate per annum equal to the sum of the Base Rate (for Base Rate Loans) or theLIBOR Rate (for LIBOR Loans) plus an applicable margin. As of March 31,2008 and December 31, 2007, there were no Base Rate or Libor Loansoutstanding.

 

Russ Berrie (UK) Limited Business Overdraft Facility

 

On March 19, 2007, Russ Berrie UK Limited entered into a BusinessOverdraft Facility (the “Facility”) with National Westminster Bank PLC(the “Bank”) and The Royal Bank of Scotland plc (“RBS”), acting as agentfor the Bank. The Facility, as amended, consists of a maximum credit line of£1.5 million. Interest is charged on amounts outstanding under theFacility at an annual rate of 1.5% over the Bank’s Base Rate, which interestrate spread will be increased to 3.5% for any amounts outstanding in excess ofthe maximum limit. The Facility replaced the Framework Agreement with BarclaysBank Plc, which was terminated as of March 31, 2007. The Facility wasestablished to assist in meeting the working capital requirements of RussBerrie UK Limited. As of March 31, 2008 and December 31, 2007, therewere no borrowings outstanding under the facility.

 

**NOTE 5 – GOODWILL AND INTANGIBLE ASSETS**

 

As of March 31, 2008, the Company’s goodwilltotaling approximately $120.8 million is in the infant and juvenile segment andresults from the acquisitions of Kids Line, LLC in 2004, and Sassy in2002.  There were no significant changesto the carrying amount of goodwill for the three months ended March 31,2008.

 

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

 
| ** **                       | ** ** | **Weighted   Average   Amortization   Period** | ** ** | **March 31,   2008** | ** ** | **December 31,   2007** | ** ** |
|----------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|
| 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                                                     |       | 22                             |       | 26                                |       |
|                             |       |                                                          |       | $                              | 51,168     |                              | $          | 51,172 |   |

 

Other intangible assets as of March 31, 2008and December 31, 2007 include Kids Line non-compete agreements, which arebeing amortized over four years, and a patent. Amortization expense was approximately $4,000 and $7,000 for the firstthree months of 2008 and 2007, respectively.

 

**NOTE 6 – SEGMENTS OF THE COMPANY AND RELATEDINFORMATION**

 

The Company operates intwo segments: (i) the infant and juvenile segment, which as of March 31,2008 is comprised of Sassy, Inc. and Kids line, LLC., and (ii) theCompany’s gift segment.  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 giftsegment.  See Note 13 — Subsequent Eventsfor a description of the recent acquisitions of LaJobi and CoCaLo in the infantand juvenile segment.

 

14

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**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

 
| ** **                                        | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------------|------------|
| **(in thousands)**                           | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| ** **                                        | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| **Infant and juvenile:**                          |       |                                                 |       |   |   |
| Net sales                                         |       | $                                                    | 41,612     | ** ** | $ | 38,682 | ** ** |
| Selling, general and administrative  expenses     |       | 7,317                                                |       | 6,692 |   |
| Operating income                                  |       | 7,838                                                |       | 8,185 |   |
| Other expense                                     |       | (1,029                                               | )          | (1,202 | ) |
| Depreciation and amortization                     |       | 151                                                  |       | 173 |   |
| Income before income taxes                        |       | $                                                    | 6,809      |   | $ | 6,983 |   |
| **Gift:**                                         |       |                                                 |       |   |   |
| Net sales                                         |       | $                                                    | 34,312     |   | $ | 36,391 |   |
| Selling, general and administrative  expenses (a) |       | 19,667                                               |       | 19,766 |   |
| Operating (loss)                                  |       | (4,264                                               | )          | (3,316 | ) |
| Other income                                      |       | 430                                                  |       | 80 |   |
| Depreciation and amortization                     |       | 902                                                  |       | 990 |   |
| Loss before income taxes                          |       | $                                                    | (3,834     | ) | $ | (3,236 | ) |
| **Consolidated:**                                 |       |                                                 |       |   |   |
| Net sales                                         |       | $                                                    | 75,924     |   | $ | 75,073 |   |
| Selling, general and administrative  expenses     |       | 26,984                                               |       | 26,458 |   |
| Operating income                                  |       | 3,574                                                |       | 4,869 |   |
| Other expense                                     |       | (599                                                 | )          | (1,122 | ) |
| Depreciation and amortization                     |       | 1,053                                                |       | 1,163 |   |
| Income before income taxes                        |       | $                                                    | 2,975      |   | $ | 3,747 |   |

 

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(a)          The Gift segment selling, general andadministrative expense includes a charge of $0.4 million in the first quarterof 2007 related to the closure of a showroom.

 

Totalassets of each segment were as follows:

 
| **(Dollars in thousands)** | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|--------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| Infant and juvenile                  |       | $                            | 236,879    |                            | $          | 237,064 |   |
| Gift                                 |       | 91,780                       |       | 104,911                         |       |
| Total                                |       | $                            | 328,659    |                            | $          | 341,975 |   |

 

**Concentration of Risk**

** **

As disclosed in the notes to the consolidated financial statementsincluded in the 2007 10-K, approximately 82% of the Company’s purchases areattributable to manufacturers in the People’s Republic of China.  The supplier accounting for the greatestdollar volume of purchases in 2007 accounted for approximately 19% and the fivelargest suppliers accounted for approximately 44% in the aggregate.  TheCompany utilizes approximately 75 manufacturers in Eastern Asia and believesthat there are many alternative manufacturers for the Company’s products andsources of raw materials.  As a result, the Company does not believe thereis a concentration of risk associated with any significant manufacturingrelationship.

 

With respect to customers, Toys “R” Us, Inc. and Babies “R” Us, Inc.,in the aggregate, accounted for 24.2% and 23.8% of the Company’s consolidatednet sales during the three month periods ended March 31, 2008 and 2007,respectively.

 

15

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**NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 7 - FOREIGN CURRENCY FORWARD EXCHANGE CONTRACTS**

 

Certain of the Company’s subsidiaries periodically enter into foreigncurrency forward exchange contracts to hedge inventory purchases, bothanticipated and firm commitments, denominated in the United States dollar.These contracts reduce foreign currency risk caused by changes in exchangerates and are used to offset the currency impact of these inventory purchases,generally for periods up to 13 months. At March 31, 2008, the Company’sforward contracts had expiration dates which ranged from one to nine months.

 

The Company accounts for its forward exchange contracts as an economichedge, with subsequent changes in fair value recorded in the ConsolidatedStatements of Operations.  Unrealized gainsof $0.2 million relating to forward contracts are included in other currentassets on the balance sheet at March 31, 2008.  Unrealized gains of $0.1 million are includedin other current assets and $0.1 million in unrealized losses are included inother current liabilities at December 31, 2007.

 

The Company has forward contracts to exchange British pounds, Canadiandollars and Australian dollars for United States dollars with notional amountsof $8.0 million and $9.7 million as of March 31, 2008 and December 31,2007, respectively. The Company has forward contracts to exchange United Statesdollars to Euros with notional amounts of $0.6 million and $2.8 million as of March 31,2008 and December 31, 2007, respectively. The Company does not anticipateany material adverse impact on its results of operations or financial positionfrom these contracts.

 

**NOTE 8 – FINANCIAL INSTRUMENTS**

 

We adopted SFAS No. 157 on January 1, 2008, the first day ofour 2008 fiscal year.  SFAS No. 157 defines fair value as the pricethat would be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants at the measurement date (anexit price). The standard outlines a valuation framework and creates a fairvalue hierarchy in order to increase the consistency and comparability of fairvalue measurements and the related disclosures. Under generally accepted accountingprinciples, certain assets and liabilities must be measured at fair value, andSFAS No. 157 details the disclosures that are required for items measuredat fair value.

 

 Financial assets and liabilities are measured using inputs fromthe three levels of the SFAS No. 157 fair value hierarchy. The threelevels are as follows:

 

 Level 1—Inputs are unadjusted quoted prices in active markets foridentical assets or liabilities.

 

 Level 2—Inputs include quoted prices for similar assets andliabilities in active markets, quoted prices for identical or similar assets orliabilities in markets that are not active, inputs other than quoted pricesthat are observable for the asset or liability (i.e., interest rates, yieldcurves, etc.), and inputs that are derived principally from or corroborated byobservable market data by correlation or other means (market corroboratedinputs).

 

 Level 3—Unobservable inputs that reflect our assumptions aboutthe assumptions that market participants would use in pricing the asset orliability.

 

In accordance with the fair value hierarchy described above, thefollowing table shows the fair value of our foreign exchange contracts as of March 31,2008, (dollars in thousands):

 
| ** **                 | ** ** | ** **                   | ** ** | **Fair Value Measurements as of March 31, 2008** | ** ** |
|----------------------------|------------|------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| ** **                 | ** ** | **March 31, 2008** | ** ** | **Level 1**                                                                    | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Forward exchange contracts |       | $                            | 8,600      |                                                                                | $          | — |   | $ | 8,800 |   | $ | — |   |
|                            |            |                              |            |                                                                                     |            |  |  |  |  |  |  |  |  |

 

Cash and cash equivalents, trade accounts receivable, income taxreceivable, trade accounts payable and accrued expenses are reflected in theconsolidated balance sheets at carrying value, which approximates fair valuedue to the short-term nature of these instruments.

 

The carrying value of our term loan borrowings approximates fair valuebecause interest rates under the term loan borrowings are variable, based onprevailing market rates.

 

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**NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 9 - COMPREHENSIVE INCOME**

 

Comprehensive Income, representing all changes in Shareholders’ Equityduring the period other than changes resulting from the issuance or repurchaseof the Company’s common stock and payment of dividends, is reconciled to netincome for the three months ended March 31, 2008 and 2007 as follows (inthousands):

 
| ** **                               | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                               | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Net income                               |       | $                                                    | 2,000      |   | $ | 2,546 |   |
| Other comprehensive income:              |       |                                                 |       |   |   |
| Foreign currency translation adjustments |       | 212                                                  |       | 290 |   |
| Comprehensive income                     |       | $                                                    | 2,212      |   | $ | 2,836 |   |

 

**NOTE 10 – INCOME TAXES**

 

InJuly 2006, the Financial Accounting Standards Board (“FASB”) issued FASBInterpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN48”) and in May 2007 issued FASB Staff Position (“FSP”) FSP FIN 48-1.  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 ismore “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.  The Company adopted theprovisions of FIN 48 on January 1, 2007. The Company did not make any additional adjustments to its openingbalance sheet related to the implementation of FIN 48, other than to reclassifythe portion of its tax liabilities to non-current which the Company did notanticipate will settle, or for which the statute of limitations will not close,in the next twelve months, and the Company did not make any adjustments to itsopening retained earnings related to the implementation of FIN 48.

 

TheCompany operates in multiple tax jurisdictions, both within the United Statesand outside of the United States, and faces audits from various tax authoritiesregarding the inclusion of certain items in taxable income, the deductibilityof certain expenses, transfer pricing, the utilization and carryforward ofvarious tax credits, and the utilization of various carryforward items such ascharitable contributions and net operating loss carryforwards (“NOLS”).  At March 31, 2008, the amount ofliability for unrecognized tax benefits related to federal, state, and foreigntaxes was approximately $13.4 million, including approximately $0.7 million ofaccrued interest.  The Company hasvarious tax attributes such as NOL’s, charitable contribution carryovers, andforeign tax credit carryovers which could be utilized to offset these uncertaintax positions.

 
| ** **                                                   | ** ** | **(in thousands)** | ** ** |
|--------------------------------------------------------------|------------|-------------------------|------------|
| Balance at January 1, 2008                              |       | $                       | 13,394     |   |
| Increases related to prior year tax  positions               |       | 0                       |       |
| Decreases related to prior year tax  positions               |       | 0                       |       |
| Increases related to current year tax  positions/settlements |       | 0                       |       |
| Lapse of statue                                              |       | 0                       |       |
| Balance at March 31, 2008                               |       | $                       | 13,394     |   |

 

TheCompany is currently under examination in several tax jurisdictions and remainssubject to examination until the statute of limitations expires for therespective tax jurisdiction.  Based uponthe 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 $4.0 million within twelve months of March 31,2008.  If recognized, approximately $1.6million of the

 

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**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

 

decreasewould impact the Company’s effective tax rate. For the remaining amounts, the Company anticipates that the deferred taxassets associated with various tax attributes such as foreign tax creditcarryforwards and charitable contribution carryforwards would be increased.

 

TheCompany’s policy is to classify interest and penalties related to unrecognizedtax benefits as income tax expense.

 

**NOTE 11 – LITIGATION AND COMMITMENTS**

 

In the ordinary course of its business, the Company is party to variouscopyright, patent and trademark infringement, unfair competition, breach ofcontract, customs, employment and other legal actions incidental to itsbusiness, as plaintiff or defendant.  Inthe opinion of management, the amount of ultimate liability with respect tosuch actions that are currently pending will not materially adversely affectthe consolidated results of operations, financial condition or cash flows ofthe Company.

 

TheCompany enters into various license agreements relating to trademarks,copyrights, designs, and products which enable the Company to market itemscompatible with its product line.  Alllicense agreements other than the agreement with MAM Babyartikel GmbH (whichwas terminated March 26, 2008), are for three year terms with extensionsif agreed to by both parties.  Several ofthese license agreements require prepayments of certain minimum guaranteedroyalty amounts.  The amount of minimumguaranteed royalty payments with respect to all license agreements through theend of their current terms aggregates approximately $5.9 million, of whichapproximately $3.7 million remained unpaid at March 31, 2008,substantially all of which is due prior to December 31, 2009.  During the year ended December 31, 2007,the Company recorded charges to cost of sales of $0.3 million against theseroyalty prepayments for amounts that management believed will not be realized.Royalty Expense for the three months ended March 31, 2008 and 2007 was$1.4 million and $1.2 million, respectively.

 

**NOTE 12 – RECENTLY ISSUED ACCOUNTING STANDARDS**

 

In September 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements” (SFAS No. 157), which defines fair value, establishes aframework for measuring fair value and expands disclosures about fair valuemeasurements.  The provisions of SFAS No. 157 are effective as of thebeginning of our 2008 fiscal year, with the exception of certain provisionsdeferred until the beginning of our 2009 fiscal year.  In February 2008,the FASB issued FASB Staff Position SFAS No. 157-2, “Effective Date ofFASB Statement No. 157”, which delayed the effective date of SFAS No. 157for all non-financial assets and liabilities, except those that are recognizedor disclosed at fair value in the financial statements on a recurring basis,until January 1, 2009.  On January1, 2008, we adopted SFAS No. 157 for financial assets and liabilities.  As of March 31, 2008, we did not have anynon-financial assets and liabilities that are carried at fair value on arecurring basis in the financial statements.  The impact of the adoption of SFAS No. 157for financial assets and liabilities was not material to our consolidatedinterim financial statements.  The expanded disclosures about fair valuemeasurements for financial assets and liabilities on a recurring basis arepresented in Note 8.  We have not yet determined the impact that theadoption of SFAS No. 157 will have on our non-financial assets andliabilities which are not recognized on a recurring basis; however we do notanticipate it to materially impact our consolidated financial statements. 

 

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**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

 

In February 2007, the FASB issued SFAS No. 159, “The FairValue Option for Financial Assets and Financial Liabilities.” SFAS No. 159provides companies with an option to report selected financial assets andliabilities at fair value and establishes presentation and disclosurerequirements designed to facilitate comparisons between companies that choosedifferent measurement attributes for similar types of assets and liabilities.SFAS No. 159 is effective for fiscal years beginning after November 15,2007. The Company adopted SFAS No. 159 effective January 1, 2008 andthere was no impact on its consolidated statement of financial position.

 

In December 2007, SFAS No. 141R (revised 2007), “BusinessCombinations,” was issued.  Thisstatement requires an acquirer to recognize assets acquired, the liabilitiesassumed, and any noncontrolling interest in the acquiree at their fair valueson the acquisition date, with goodwill being the excess value over the netidentifiable assets acquired.  Thisstatement is effective for business combinations for which the acquisition dateis on or after the beginning of the first annual reporting period beginning onor after December 15, 2008.  TheCompany is evaluating the effect the adoption of this standard will have on itsconsolidated financial position, results of operations and cash flows.

 

In December 2007, SFAS No. 160, “Noncontrolling Interests inConsolidated Financial Statements,” was issued. This statement establishes accounting and reporting standards for thenoncontrolling interest in a subsidiary and for the deconsolidation of asubsidiary.  It clarifies that anoncontrolling interest in a subsidiary is an ownership interest in theconsolidated entity that should be reported as equity in the consolidatedfinancial statements.  This statement iseffective for fiscal years, and interim periods within those fiscal years,beginning on or after December 15, 2008. The Company is evaluating the effect the adoption of this standard willhave on its consolidated financial position, results of operations and cashflows.

 

In March 2008, SFAS No. 161, “Disclosures about DerivativeInstruments and Hedging Activities,” was issued.  This statement requires enhanced disclosuresabout an entity’s derivative and hedging activities.  This statement is effective for financialstatements issued for fiscal years and interim periods beginning after November 15,2008.  The Company is evaluating theeffect the adoption of this standard will have on its consolidated financialposition, results of operations and cash flows.

 

**NOTE 13 – SUBSEQUENT EVENTS**

 

On April 1, 2008, a newly-formed and indirectly wholly-ownedDelaware subsidiary of the Company, LaJobi, Inc. (“LJ”) entered into anAsset Purchase Agreement (the “Asset Agreement”) with LaJobi Industries, Inc.,a New Jersey corporation (“LaJobi”), and each of Lawrence Bivona and JosephBivona for the purchase of substantially all of the assets used in the businessof LaJobi and specified obligations. LaJobi designs, imports and sells infantand juvenile furniture and related products (including cribs, changing tables,dressers, hutches, armoires, bookcases and end tables) to specialty stores andboutiques, baby superstores and mass merchandisers. LaJobi also sells mattressesand changing pads. The acquisition of LaJobi is being accounted for as apurchase business combination. The transactions contemplated by the AssetAgreement were consummated as of April 2, 2008. Capitalized terms used inthis section but undefined herein have the meanings ascribed to them in the AssetAgreement, which was filed as Exhibit 2.3 to the 2007 10-K.

 

The aggregate purchase price payable for LaJobi was equal to: $47.0million, reduced by the amount of assumed indebtedness (including capitalizedlease obligations), as further increased or decreased by the amount that FinalWorking Capital is greater or less than $7.3 million, plus the earnout considerationdescribed below. At Closing, LJ paid $44.5 million in cash to LaJobi, plus$3.2 million (the estimated amount of the working capital adjustment). Anyadjustment between the estimated and final working capital adjustment will bemade after the Closing, as set forth in the Asset Agreement. The remaining$2.5 million of the purchase price was deposited in escrow at Closing inrespect of potential indemnification claims. As additional consideration, ifthe following conditions have been satisfied, LJ will pay the amounts describedbelow (the “Earnout Consideration”):

 

(a)                                                    Subject to paragraph (b) below, providedthat the EBITDA of LaJobi’s business (the “Business”) (determined as providedin Asset Agreement) has grown at a compound annual growth rate (“CAGR”) of notless than 4% during the period from January 1, 2008 through December 31,2010 (the “Measurement Date”), as compared to the specified EBITDA of theBusiness for the 2007 calendar year, LJ will pay to LaJobi a specifiedpercentage of the Agreed Enterprise Value of LJ as of the Measurement Date orEarly Measurement Date (as defined in paragraph (b) below), as the casemay be; provided that the minimum amount of such payment shall be $0.0 and themaximum amount of such payment shall be $15.0 million. Any EarnoutConsideration shall be paid on or prior to the 60th day after the MeasurementDate (the “Payment Date”). The “Agreed Enterprise Value” shall be the 

 

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**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

 

product of: (i) the Business’s EBITDA during the twelve (12)months ending on the Measurement Date or Early Measurement Date (or, in theevent an Early Measurement Date selected by LaJobi as permitted by the AssetAgreement is a date prior to January 1, 2009, the annualized EBITDA of theBusiness for such period), as the case may be, multiplied by (ii) theapplicable multiple (ranging from 5 to 9) based on specified levels of EBITDACAGR achieved, subject to the $15.0 million cap described above.

 

(b)                                                   In the event that LB relocates the principallocation of the Business beyond an agreed distance prior to the MeasurementDate, the calculation of the Earnout Consideration may be accelerated upon theelection of LaJobi. For purposes of determining the Earnout Consideration, theCAGR shall be based on the period from January 1, 2008 through the lastday of the month (the “Early Measurement Date”) immediately preceding the dateof such relocation. On or prior to the sixtieth (60th) day after the EarlyMeasurement Date (the “Early Payment Date”), LJ will pay to LaJobi any EarnoutConsideration, discounted, at the Agreed Rate, from the Payment Date to, andincluding, the Early Payment Date.

 

Underthe Asset Agreement, the LaJobi Buyer is entitled to indemnification fromLaJobi and the Stockholders for various matters, including, but not limited to,breaches of representations, warranties or covenants, and specified excludedobligations, subject, in the case of specified matters, to a minimum thresholdof $250,000 (with a separate threshold for individual claims of $15,000,whether or not aggregate damages have exceeded the $250,000 threshold) and amaximum aggregate indemnification limit of $10.0 million. The right toindemnification (other than with respect to certain specified exceptions)terminates 18 months after the Closing Date.

 

In connection with the Asset Agreement, the Companypaid a finder’s fee of $1.5 million at Closing to a financial institution,and has agreed to pay such institution 1% of the Agreed Enterprise Value of LJ,payable in the same manner and at the same time as the Earnout Consideration ispaid to LaJobi. 

 

The Company has not yet performed an assessment ofthe fair values of the assets acquired or liabilities assumed, or otherwisecompleted the initial accounting for the acquistion of Lajobi. Accordingly, theCompany is currently unable to disclose either the allocation of the purchaseprice or summary pro forma financial information with respect to the acquiredentity.

 

Also, on April 1, 2008, a newly-formed,wholly-owned Delaware subsidiary of the Company, I&J Holdco, Inc. (the“CoCaLo Buyer”) entered into a Stock Purchase Agreement (the “Stock Agreement”),with each of Renee Pepys Lowe and Stanley Lowe for the purchase of all of theissued and outstanding capital stock of CoCaLo, Inc., a Californiacorporation (“CoCaLo”). CoCaLo designs, outsources, markets and distributesinfant bedding (including crib bumpers, blankets, crib sheets and dust ruffles)and related accessories (including wall hangings, musical mobiles, blankets,diaper stackers, valances, wall paper borders, lamps, shades, nightlights,switch plates, decorative pillows and rugs). The acquisition of CoCaLo is being accounted for as a purchase businesscombination. The transactions contemplated by the Stock Agreement wereconsummated as of April 2, 2008.

 

In addition, as of April 2, 2008, the Infantline Credit Agreementhas been amended and restated in order to, among other things, increase thefacilities available thereunder and to permit the acquisitions of LaJobi andCoCaLo.  Specifically, as of April 2,2008, RB, KL, Sassy, the CoCaLo Buyer, LJ and CoCaLo (via a Joinder Agreement)entered into an Amended and Restated Credit Agreement (the “Amendment”) withthe financial institutions party to the Infantline Credit Agreement or theirassignees (the “Lenders”), LaSalle Bank National Association, as administrativeagent for the Lenders (in such capacity, the “Agent”) and as Fronting Bank,Sovereign Bank as Syndication Agent, Wachovia Bank, N.A. as Documentation Agentand Banc of America Securities LLC as Lead Arranger. KL, Sassy, the CoCaLoBuyer, LJ and CoCaLo are referred to in this Note 13 collectively as the “InfantlineBorrowers”, and I&J, LJ and CoCaLo are referred to in this Note 13 as the “NewBorrowers”. The Amendment amends and restates the Infantline Credit Agreement.The Pledge Agreement dated as of March 14, 2006 between RB and the Agent(as amended on December 22, 2006) was also amended and restated as of April 2,2008, to provide, among other things, for a pledge to the Agent of the capitalstock of the CoCaLo Buyer by RB. In connection with the Amendment, 100% of theequity of each Infantline Borrower, including each New Borrower, has beenpledged as collateral to the Agent. In addition, the Guaranty and CollateralAgreement, dated as of March 16, 2004, entered into among KL and Sassy infavor of LaSalle Bank National Association, as Administrative Agent (the “Guaranty”)was also amended and restated as of April 2, 2008, to add the NewBorrowers (CoCaLo via a Joinder Agreement) as parties and to includesubstantially all of the existing and future assets and properties of the NewBorrowers as security for the satisfaction of the obligations of all InfantlineBorrowers, including the New Borrowers, under the Amendment and the otherrelated loan documents. Capitalized terms used but undefined in this Note 13shall have the meanings assigned to such terms in the Amendment.

 

The following constitute the material changes to the Infantline CreditAgreement effected by the Amendment:

 

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**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

 

(i)  The New Borrowers are now parties to the Infantline CreditAgreement;

 

(ii) The commitments thereunder now consist of: (a) a $75.0million revolving credit facility (the “New Revolving Loan”), with asubfacility for letters of credit in an amount not to exceed $5.0 million, and (b) a$100.0 million term loan facility (the “New Term Loan”). Previously, themaximum revolving loan commitment was $35.0 million and the maximum term loancommitment was $60.0 million. The Infantline Borrowers drew down $31.0 millionunder the New Revolving Loan and the entire $100.0 million available under theNew Term Loan on the Closing Date, in order to finance the acquisitions ofLaJobi and CoCaLo, and pay related transaction expenses of such acquisitionsand the Amendment, and to reallocate the existing indebtedness among the banksyndicate;

 

(iii) The scheduled maturity date of the obligations under theInfantline Credit Agreement has been extended from March 14, 2011 to April 1,2013;

 

(iv) The definition of Borrowing Base was amended from 85% ofeligible receivables plus 55% of eligible inventory to 85% of eligiblereceivables plus the lesser of: (i) $25.0 million and (ii) 55% ofeligible inventory;

 

(v) The Termination Fee (previously 1% of the total commitment ifthe Termination Date occurs prior to the first anniversary of the Closing Date)was eliminated in its entirety;

 

(vi) The applicable interest rate margins (to be added to theapplicable interest rate) previously ranged from 1.75% — 2.50% for LIBOR Loansand from 0.25% — 1.00% for Base Rate Loans. Pursuant to the Amendment, themargins now range from 2.0% — 3.0% for LIBOR Loans and from 0.50% — 1.50% forBase Rate Loans, based on a pricing grid set forth in the Amendment (untildelivery of specified financial statements and compliance certificates withrespect to the quarter ending June 30, 2008, the applicable margins willbe 2.75% for LIBOR Loans and 1.25% for Base Rate Loans);

 

(vii) Previously, the principal of the term loan was to be repaid,on a monthly basis, as follows: $9.0 million for each of years 1-2; $12.0million for year 3; and $15.0 million for each of years 4-5. Pursuant to theAmendment, the principal on the New Term Loan will be repaid, on a quarterlybasis, at an annual rate of $14.4 million per year, commencing June 30,2008;

 

(viii) The Infantline Borrowers must make mandatory prepayments ofthe credit facility with 100% of the proceeds of most asset sales, debtissuances, equity issuances and pursuant to the Amendment, extraordinaryreceipts;

 

(ix) The requirement that mandatory prepayments be made fromExcess Cash Flow has been eliminated in its entirety;

 

(x) The minimum EBITDA test as a financial covenant has beendeleted in its entirety;

 

(xi) The Amendment specifies that conditions to lending are applicableto each Infantline Borrower, including each New Borrower, and include specifiedamended financial tests;

 

(xii) Prior to the effectiveness of the Amendment, KL and Sassy werenot permitted (except in specified situations) to distribute cash to RB to payRB’s overhead expenses unless: (i) before and after giving effect to suchdistribution, no Event of Default would exist and (ii) before and aftergiving effect to such distribution, Excess Revolving Loan Availability willequal or exceed $4.0 million; provided that the aggregate amount of suchdistributions could not exceed $2.0 million per year. Pursuant to theAmendment, the $4.0 million availability threshold was increased to $5.0million, and the aggregate maximum amount of such distributions was increasedto $3.5 million, and apply in each case to all Infantline Borrowers. Otherrestrictions on dividends and distributions to RB remain unchanged;

 

(xiii) Payment of amounts outstanding under the promissory note underthe Stock Agreement is prohibited if before and after giving effect to any suchrepayment, a default or event of default would exist;

 

(xiv) Payment of any earnout consideration under either the AssetAgreement or the Stock Agreement is prohibited if: before and after givingeffect to any such repayment, (a) a default or event of default wouldexist, (b) Excess Revolving Loan Availability will not equal or exceed$9.0 million, or (c) before and after giving effect to any such repayment,the financial covenants in the Amendment will not be satisfied (the “EarnoutConditions”);

 

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**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

 

(xv) Specified defaults with respect to the earnout consideration undereither the Asset Agreement or the Stock Agreement have been added as events ofdefault (including failure to deliver to the Agent specified certifications andcalculations within a specified time period, the reasonable determination bythe Agent that any Earnout Conditions will not be satisfied as of theapplicable payment date, if any material information provided to the Agent withrespect to the Earnout Conditions shall be incorrect in any material respectand remain unremedied prior to the relevant payment date, or any EarnoutConsideration is paid at any time that the Earnout Conditions are notsatisfied) ; and

 

(xvi) The Infantline Borrowers are required to maintain in effect HedgeAgreements that protect against potential fluctuations in interest rates withrespect to a minimum of 50% of the outstanding amount of the New Term Loan.

 

In connection with the Amendment, the Infantline Borrowers paid theAgent and Lenders a closing fee of approximately $1.5 million. The followingfees are now applicable to the Infantline Credit Agreement: an agency fee of$35,000 per annum, a non-use fee of 0.40% to 0.60% of the unused amounts underthe Revolving Loan, as well as other customary fees as are set forth in theAmendment.

 

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** **

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

 

The financial andbusiness analysis below provides information which the Company believes isrelevant to an assessment and understanding of the Company’s consolidatedfinancial condition, changes in financial condition and results of operations.This financial and business analysis should be read in conjunction with theCompany’s unaudited consolidated financial statements and accompanying Notes toUnaudited Consolidated Financial Statements set forth in Part I, FinancialInformation, Item 1, “Financial Statements” of this Quarterly Report on Form 10-Qand the Company’s Annual Report on Form 10-K for the year ended December 31,2007, as amended (the “2007 10-K”) including the consolidated financialstatements and notes thereto.

 

**OVERVIEW**

 

The Company is aleader in the infant and juvenile and gift industries. The Company’s infant andjuvenile businesses design, manufacture through third parties and marketproducts in a number of baby categories, including infant bedding andaccessories, bath toys and accessories, developmental toys, feeding items andbaby comforting products. These products are sold to consumers, throughout theUnited States and the world via national accounts and independent retailers,including toy, specialty, food, drug, and other retailers, and military postexchanges. The Company’s gift business designs, manufactures through thirdparties and markets a wide variety of gift products to retail stores throughoutthe world via the Company’s wholly-owned subsidiaries and independentdistributors.

 

The Company’srevenues are primarily derived from sales of its products.  For the three months ended March 31,2008, 54.8% of revenues were generated by the infant and juvenile segment and45.2% of revenues were generated by the gift segment, as compared to 51.5% and48.5%, respectively, for the same period in the prior year.

 

The principalelements of our global business strategy include:

 

·                  focusing on design-led and branded product development in each of oursegments, to enable us to continue to introduce compelling new products, withthe intention of increasing our market share;

 

·                  pursuing organic growth opportunities, including:

 

(i)                                   expanding our product offerings intorelated categories; and

 

(ii)                                expanding and diversifying of ourdistribution channels, with particular emphasis on further extending the infantand juvenile segment into international markets and further expanding our saleschannels to include business-to-business and web-based offerings;

 

·                  growing through licensing, distribution or other strategic alliances,including pursuing acquisition opportunities in businesses complementary toours;

 

·                  implementing strategies to further capture synergies within and betweenour segments, through cross-marketing opportunities and consolidation ofback-office activities; and

 

·                  continuing efforts to manage costs within each of our segments, withparticular focus on further streamlining our gift segment by concentrating onmore profitable product lines and creating additional operational efficiencies.

 

We believe that wehave made substantial progress in successfully implementing this strategyduring 2007 and the beginning of 2008. Specifically, revenues in the infant andjuvenile segment continued to grow throughout 2007, primarily as a result ofnew product development and increased distribution with respect to each of ourinfant and juvenile businesses. In particular, during 2007, Kids Linesuccessfully introduced its Carter’s® branded bedding and established an officein the United Kingdom to serve the European market. In addition, Sassy expandedits product line during 2007, including through a license agreement with LeapFrogTM and Sassy’s entry into the baby gear category with the introduction of adoorway jumper and a bouncer that incorporates Kids Line designed fabric. Weanticipate that Sassy will introduce additional baby gear products in 2008.

 

In addition,during the second half of 2007, we also renewed our focus on growth through theexploration of strategic acquisitions. As a result of these efforts, on April 1,2008, we entered into separate agreements to acquire each of: (i) LaJobiIndustries, Inc. (“LaJobi”), a privately-held company based in Cranbury,New Jersey that 

 

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designs, imports andsells infant and juvenile furniture and related products; and (ii) CoCaLo, Inc.(“CoCaLo”), a privately-held company based in Costa Mesa, California thatdesigns, markets and distributes infant bedding and related accessories.  Both acquisitions were consummated as of April 2,2008.  We anticipate that theseacquisitions will significantly expand our infant and juvenile segment, andwill enable us to offer a more complete range of products for the baby nursery.  In connection with such acquisitions, theCompany has amended and restated the Infantline Credit Agreement (definedbelow) to amend such agreement in order to, among other things, increase thefacilities available thereunder and to permit the acquisitions of LaJobi andCoCaLo. See “Liquidity and Capital Resources” below under the sectionscaptioned “*Recent Acquisitions*” and “*Financings*”.

 

With respect to our giftbusiness, during 2007, we continued our focus on product categories where webelieve we can command an authoritative position. As a result, we substantiallyrejuvenated our gift product line, with approximately 70% of the 2007 productline consisting of new products. New products for 2007 included the ShiningStars® product range, which was the gift segment’s most successful new productintroduction in several years. We intend to continue our focus on creatingcompelling new products, and our 2008 product offerings include two new productranges that will capitalize on the popularity of dimensional products thatinclude a virtual play component. As a result of the popularity of productsthat incorporate web-based interactivity and the large amount of inventorycurrently in the market from competitive products, as well as the initialretail shelf placement for the introductory year of Shining Stars, the Companydoes not anticipate that its Shining Stars product range will achieve in 2008the high level of sales that it achieved during its 2007. The Company continuesto expect significant sales for Shining Stars in 2008, albeit at levelsconsiderably below those achieved in 2007. The Company also anticipates that aportion of this shortfall, if any, will be mitigated by sales of its newweb-based product ranges, as well as other new product launches. In addition,potential expanded distribution for all of the Company’s web-interactiveproducts, including in international markets, as well as the viral marketingnature of such products, may create additional opportunities, although therecan be no assurance that this will be the case.

 

**SEGMENTS**

 

The Companycurrently operates in two segments:  (i) its infant and juvenilesegment and (ii) its gift segment.

 

**RESULTSOF OPERATIONS—THREE MONTHS ENDED MARCH 31, 2008 AND 2007**

 

The Company’sconsolidated net sales for the three months ended March 31, 2008 increased1.1% to $75.9 million compared to $75.1 million for the three months ended March 31,2007, as a result of an increase in the infant and juvenile segment net salesof $2.9 million, offset by a decrease in gift segment net sales of $2.1million.

 

Net sales for theinfant and juvenile segment for the three months ended March 31, 2008increased 7.5% to $41.6 million, compared to $38.7 million for the three monthsended March 31, 2007, primarily resulting from new product introductionsand growth in international sales.  TheCompany’s gift segment net sales for the three months ended March 31, 2008decreased 5.7% to $34.3 million compared to $36.4 million for the three monthsended March 31, 2007, primarily as a result of weakness in the gift marketas a result of the economic slowdown. Net sales in the Company’s gift segment were favorably impacted byapproximately $1.3 million for the three months ended March 31, 2008 as aresult of foreign exchange rates.

 

Consolidated grossprofit was 40.2% of consolidated net sales for the three months ended March 31,2008 as compared to 41.7% for the three months ended March 31,2007.   Gross profit for the Company’sinfant and juvenile segment decreased from 38.5% of net sales for the threemonths ended March 31, 2007 to 36.4% of net sales for the three monthsended March 31, 2008, primarily as a result of competitive pricingpressure, increased raw material costs and product mix. Gross profit for theCompany’s gift segment increased slightly to 45.2% for the three months ended March 31,2007 as compared to 44.9% for the three months ended March 31, 2008.

 

Consolidatedselling, general and administrative expense was $27.0 million, or 35.5% ofconsolidated net sales, for the three months ended March 31, 2008,compared to $26.5 million, or 35.2% of consolidated net sales, for the threemonths ended March 31, 2007.  Selling, general and administrativeexpense in the Company’s infant and juvenile segment increased from $6.7million, or 17.3% of net sales in the first quarter of 2007, to $7.3 million,or 17.6% of net sales, in the first quarter of 2008, primarily as a result ofincreased product development and advertising costs incurred to support growthin this segment. Selling, general and administrative expense in the Company’sgift segment was relatively unchanged at $19.7 million, or 57.3% of net sales,in the first quarter of 2008 as compared to $19.8 million, or 54.3% of netsales, in the prior year period.

 

Consolidated otherexpense was $0.6 million for the three months ended March 31, 2008compared to $1.1 million for the three months ended March 31, 2007, or adecrease of $0.5 million. Other expense in the Company’s infant and juvenilesegment decreased by $0.2 million to $1.0 million compared to $1.2 million inthe prior year period as a result of lower borrowing costs. Other income in theCompany’s gift segment for the three months ended March 31, 2008 increasedto $0.4 million from $0.1 million in the prior year period due to foreignexchange gains and lower borrowing costs.

 

The Company recorded consolidatedtax expense of approximately $1.0 million for the three months ended March 31,2008.   The difference between theeffective tax rate of 32.8% and the U.S. statutory rate of 35% primarily resultsfrom following: (i) a $0.1 million tax provision for state income taxes(4.4%); (ii) a $0.3 million benefit related to a reduction in thevaluation allowance (-10.4%); and (iii) foreign tax expense of $0.1million (3.8%).

 

The Company recorded adomestic income tax expense of approximately $1.0 million for the three monthsended March 31, 2007 primarily related to the deferred tax liabilityassociated with the tax amortization of intangible assets relating to the Kids Line,Sassy, and Applause acquisitions.  Thesedeferred tax liabilities are indefinite in nature for accounting purposes, andtherefore cannot be offset by the Company’s deferred tax assets.  The Company recorded full valuationallowances against those deferred tax assets as management believed it was morelikely than not that those deferred tax assets would not be realized.  The Company also recorded approximately 

 

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$0.2 million of foreigntax expense for the three months ended March 31, 2007 related toprofitable operations in Canada, Hong Kong, and Australia.

 

As a result of theforegoing, consolidated net income for the three months ended March 31,2008 was $2.0 million, or $0.09 per diluted share, compared to consolidated netincome of $2.5 million, or $0.12 per diluted share, for the three months ended March 31,2007, representing a decrease of $0.5 million, or $0.03 per diluted share.

 

**Liquidityand Capital Resources**

 

The Company’s principal sources of liquidity are cashand cash equivalents, funds from operations, and availability under its bankfacilities. The Company believes that cash flows from operations and futureborrowings will be sufficient to fund its operating needs and capitalrequirements for at least the next 12 months.

 

As of March 31, 2008, the Company had cash andcash equivalents of $17.3 million compared to $21.9 million at December 31,2007. The decrease in cash and cash equivalents primarily reflects the use ofexcess cash to maintain debt levels, which otherwise would have increased as aresult of losses incurred in the gift segment. As of March 31, 2008 and December 31, 2007, working capitalwas $61.5 million and $63.1 million, respectively.

 

Cash and cashequivalents decreased by $4.6 million during the three months ending March 31,2008 compared to a decrease of $0.4 million during the three months ending March 31,2007.  Net cash used by operatingactivities was approximately $1.4 million during the three months ended March 31,2008 compared to net cash used by operating activities of approximately $5.2million during the three months ended March 31, 2007. The cash used inoperating activities for the three months ended March 31, 2008 wasprimarily the result of a reduction of accounts payable and accrued expensespartially offset by a reduction in inventory and accounts receivable.  Net cash used in investing activities wasapproximately $4.2 million for the three months ended March 31, 2008compared to net cash used of approximately $0.7 million for the three monthsended March 31, 2007. The increased usage was primarily related to the$3.6 million payment of the Kids Line earnout consideration offset by decreasedcapital expenditures.  Net cash providedby financing activities was approximately $0.9 million for the three monthsended March 31, 2008 compared to net cash provided by financing activitiesof $5.3 million for the three months ended March 31, 2007.  The decrease of $4.4 million was dueprimarily to lower average borrowings incurred under the company’s creditfacilities.

 

***RecentAcquisitions***

 

I.                                         LaJobi

 

On April 1, 2008, anewly-formed and indirect, wholly-owned Delaware subsidiary of the Company,LaJobi, Inc. (“LJ”), entered into an Asset Purchase Agreement (the “AssetAgreement”) with LaJobi Industries, Inc., a New Jersey corporation (“LaJobi”),and each of Lawrence Bivona and Joseph Bivona (collectively, the “Stockholders”),for the purchase of substantially all of the assets used in the business ofLaJobi and specified obligations. LaJobi designs, imports and sells infant andjuvenile furniture and related products (including cribs, changing tables,dressers, hutches, armoires, bookcases and end tables, mattresses and changingpads) to specialty stores and boutiques, baby superstores and massmerchandisers. The transactions contemplated by the Asset Agreement wereconsummated as of April 2, 2008. All capitalized terms used in this Section I but undefined hereinshall have the meanings ascribed to them in the Asset Agreement, which is filedas Exhibit 2.3 to the 2007 10-K.

 

The aggregate purchaseprice payable for LaJobi was equal to: $47.0 million, reduced by theamount of assumed indebtedness (including capitalized lease obligations), asfurther increased or decreased by the amount that Final Working Capital isgreater or less than $7.3 million. At Closing, LJ paid $44.5 million incash to LaJobi, plus $3.2 million (the estimated amount of the working capitaladjustment).  The remaining$2.5 million of the purchase price was deposited in escrow at Closing inrespect of potential indemnification claims. As additional consideration, if the following conditions have beensatisfied, LJ will pay the amounts described below:

 

(a)     Subject to paragraph (b) below,provided that the EBITDA of LaJobi’s business (the “Business”) (determined asprovided in the Asset Agreement) has grown at a compound annual growth rate (“CAGR”)of not less than 4% during the period from January 1, 2008 through December 31,2010 (the “Measurement Date”), as compared to the specified EBITDA of theBusiness for calendar year 2007, LJ will pay to LaJobi a percentage of theAgreed Enterprise Value of LJ as of the Measurement Date or Early MeasurementDate (as defined in paragraph (b) below), as the case may be. Theamount of such payment will range from zero to a maximum amount of $15.0million (the “LaJobi Earnout Consideration”). The “Agreed Enterprise Value”will be the product of (i) the Business’s EBITDA during the twelve(12) months ending on the 

 

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Measurement Dateor Early Measurement Date (or, in the event an Early Measurement Date selectedby LaJobi as permitted by the Asset Agreement is a date prior to January 1,2009, the annualized EBITDA of the Business for such period), as the case maybe, multiplied by (ii) an applicable multiple (ranging from 5 to9) depending on the specified levels of CAGR achieved, subject to the$15.0 million cap described above.

 

(b)     In the event LJ, prior to the MeasurementDate, relocates the principal location of the Business beyond an agreeddistance, the calculation of the LaJobi Earnout Consideration may beaccelerated upon election of LaJobi. For purposes of determining the LaJobiEarnout Consideration, the CAGR shall be based on the period from January 1,2008 through the last day of the month (the “Early Measurement Date”)immediately preceding the date of the relocation. In such event, any LaJobiEarnout Consideration payable will be discounted, at the Agreed Rate, from thescheduled payment date to, and including, such early payment date.

 

The Asset Agreementcontains various representations, warranties and covenants. Under the AssetAgreement, LJ is entitled to indemnification from LaJobi and the Stockholders forvarious matters, including, but not limited to, breaches of representations,warranties or covenants, and specified excluded obligations, subject, in thecase of specified matters, to certain minimum thresholds and a maximumaggregate indemnification limit of $10.0 million. The right toindemnification (other than with respect to certain specified exceptions)terminates 18 months after the Closing Date.

 

In accordance with theAsset Agreement, LJ entered into (i) a transitional services agreementwith a Thailand affiliate of LaJobi, and (ii) a three year employmentagreement with Lawrence Bivona as President of LJ. Mr. Bivona was formerlythe President of LaJobi.

 

In connection with theAsset Agreement, the Company paid a finder’s fee to a financial institution inthe amount of $1.5 million at the closing of the transaction, and has agreed topay to such financial institution 1% of the Agreed Enterprise Value of LJ,payable in the same manner and at the same time as the LaJobi EarnoutConsideration is paid to LaJobi.

 

II.                                     CoCaLo

 

On April 1, 2008, anewly-formed, wholly-owned Delaware subsidiary of the Company, I&J Holdco, Inc.(the “CoCaLo Buyer”), entered into a Stock Purchase Agreement (the “StockAgreement”) with each of Renee Pepys Lowe and Stanley Lowe (collectively, the “Sellers”),for the purchase of all of the issued and outstanding capital stock of CoCaLo, Inc.,a California corporation (“CoCaLo”). CoCaLo designs, outsources, markets anddistributes infant bedding (including crib bumpers, blankets, crib sheets anddust ruffles) and related accessories (including wall hangings, musicalmobiles, blankets, diaper stackers, valances, wall paper borders, lamps,shades, nightlights, switch plates, decorative pillows and rugs). Thetransactions contemplated by the Stock Agreement were consummated as of April 2,2008.  All capitalized terms used in thisSection II but undefined herein shall have the meanings ascribed to themin the Stock Agreement, which is filed as Exhibit 2.4 to the 2007 10-K.

 

The aggregate basepurchase price payable for CoCaLo was equal to: (i) $16.0 million,minus (ii) the aggregate Debt of CoCaLo outstanding at Closing (includingaccrued interest), minus (iii) specified transaction expenses, and furtherincreased or decreased by the amount that Closing Date Net Working Capital isgreater or less than $5.8 million. An estimate of the aggregate basepurchase price (including an estimate of the working capital adjustment) wascalculated prior to Closing. Such estimate, less $1.6 million (the “ClosingAmount”), was paid in cash at Closing, in addition to amounts necessary todischarge the Debt to be repaid at Closing (to the extent included in thecalculation of the Closing Amount), for an aggregate of $11.6 million. If theactual aggregate base purchase price (determined after the Closing) less$1.6 million is greater than the Closing Amount (after giving effect toany difference between the estimated and actual working capital adjustment),the CoCaLo Buyer will pay the difference to the Sellers. If the Closing Amountis greater than the actual aggregate base purchase price (determined after theClosing) less $1.6 million (after giving effect to any difference betweenthe estimated and actual working capital adjustment), the Sellers will pay thedifference to the CoCaLo Buyer. The $1.6 million was evidenced by anon-interest bearing promissory note and will be paid as additionalconsideration in equal annual installments over a three year period from theClosing Date. The CoCaLo Buyer will also pay the Additional Earnout Payments,if payable as described below.

 

The Additional EarnoutPayments provide for a potential payment ranging from zero to a maximum of$4.0 million, payable with respect to performance on three metrics—sales,gross profit and combined Kids Line and CoCaLo EBITDA—as follows:

 

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(i)                                    $666,667 will be paid if CoCaLo’saggregate net sales for the three years ending December 31, 2010 (the “MeasurementPeriod”) exceeds a specified target, and up to an additional $666,667 will bepaid, on a straight line sliding scale basis, to the extent that CoCaLo’s netsales for the Measurement Period are between the initial performance target anda specified maximum target.

 

(ii)                                 $666,667 will be paid if CoCaLo’saggregate gross profit for the Measurement Period exceeds a specified target,and up to an additional $666,667 will be paid, on a straight-line sliding scalebasis, to the extent that CoCaLo’s aggregate gross profit for the Measurement Periodis between the initial performance target and a specified maximum target.

 

(iii)                              $666,666 will be paid if the aggregate EBITDA of KidsLine and CoCaLo for the Measurement Period exceeds a specified target, and upto an additional $666,666 will be paid, on a straight-line sliding scale basis,to the extent that the aggregate EBITDA of Kids Line and CoCaLo is between theinitial performance target and a specified maximum target.

 

Kids Line has guaranteedall of the obligations of the CoCaLo Buyer under the Stock Agreement.

 

The Stock Agreementcontains various representations, warranties and covenants. Under the StockAgreement, the CoCaLo Buyer is entitled to indemnification from the Sellers forvarious matters, including, but not limited to, breaches of representations,warranties or covenants, and liabilities with respect to specified proceedingsand obligations, subject, in the case of specified matters, to certain minimumthresholds and a maximum aggregate indemnification limit of $3.0 million.The right to indemnification (other than with respect to certain specifiedexceptions) terminates on the third anniversary of the Closing Date.

 

In accordance with theStock Agreement, CoCaLo entered into a three year employment agreement withRenee Pepys Lowe as President and Chief Executive Officer. Ms. Pepys Lowewas formerly the President and Chief Executive Officer of CoCaLo.

 

***Financings***

 

*Background*

 

In December 2004,Russ Berrie and Company, Inc. (“RB”) purchased all of the outstandingequity interests and warrants in Kids Line (the “Purchase”) in accordance withthe terms and provisions of a Membership Interest Purchase Agreement (the “PurchaseAgreement”). The aggregate purchase price under the Purchase Agreement includedthe payment of contingent consideration (the “KL Earnout Consideration”).  Kids Line LLC (“KL”) and Sassy Inc. (“Sassy”),who were responsible for such payment, paid an aggregate of $32.1 million inrespect of the KL Earnout Consideration, as discussed below.  To secure the obligations of KL and Sassy topay the KL Earnout Consideration, KL and Sassy had previously granted asubordinated lien on substantially all of their assets, on a joint and severalbasis, and RB granted a subordinated lien (to the senior indebtedness of KL andSassy) on the equity interests of each of them to the payees thereof.  As a result of the payment in full of the KLEarnout Consideration, all such subordinated security interests and liens werereleased as of February 29, 2008.

 

The Purchase wasoriginally financed with the proceeds of a term loan, which was subsequentlyreplaced by a $105.0 million credit facility with LaSalle Bank as agent (the “2005Credit Agreement”) and the 2005 Canadian Credit Agreement (defined below). Inorder to reduce overall interest expense and gain increased flexibility withrespect to the financial covenant structure of the Company’s senior financing,on March 14, 2006, the 2005 Credit Agreement was terminated and theobligations thereunder were refinanced (the “LaSalle Refinancing”) with theexecution of separate credit agreements for each of the Company’s infant andjuvenile segment and domestic gift segment. For a detailed description of suchcredit agreements, which are summarized below, see Note 4 of Notes to UnauditedConsolidated Financial Statements herein. In connection with the LaSalleRefinancing, all outstanding obligations under the 2005 Credit Agreement(approximately $76.3 million) were repaid using proceeds from the senior creditfacility of the infant and juvenile segment executed in connection with theLaSalle Refinancing.

 

As part of the LaSalleRefinancing, RB formed a wholly-owned Delaware subsidiary, Russ Berrie U.S.Gift Inc. (“U.S. Gift”) to which it assigned (the “Assignment”) substantiallyall of its assets and liabilities which pertain primarily to its domestic giftbusiness, such that separate loan facilities could be made directly availableto each of the Company’s infant and juvenile business and domestic giftbusiness. The Assignment transaction reinforced the operation of the Company astwo separate segments, and the credit facilities that have been extended toeach 

 

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segment are separate anddistinct. There are no cross-default provisions between the loan facilitiesextended to the infant and juvenile segment and gift segment, respectively.

 

Pursuant to theAssignment, RB, our parent company, is now organized as a holding company, withall of its operations being conducted through its subsidiaries.  RB, however, has continuing cash needs forcorporate overhead expenses, taxes and other purposes (collectively, the “Requirements”).Our current credit agreements contain significant limitations on the ability ofRB’s domestic subsidiaries, to distribute cash, including in the form ofdividends, loans or other advances, to RB to pay for its Requirements (suchlimitations are described in more detail below). Management believes that theamounts permitted to be distributed to RB by its domestic subsidiaries will be sufficientto fund the Requirements, although there can be no assurance that suchRequirements will not exceed current estimates. Although there are norestrictions in our current 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 our current credit agreements, this could have a material adverse impacton the Company’s liquidity.

 

In connection with thepurchases of LaJobi and CoCaLo (described above under the section captioned “RecentAcquisitions”), the credit agreement applicable to the Company’s infant andjuvenile segment was amended and restated to, among other things, increase thefacilities available thereunder and permit such acquisitions, all as describedbelow.

 

At March 31, 2008,there was approximately $18.3 million outstanding under the Original RevolvingLoan and approximately $8.5 million outstanding under the Giftline Revolver(each defined below) and $0.9 million outstanding under the letter of creditfacility, all of which is classified as short-term debt. At December 31,2007, there was approximately $15.5 million borrowed under the OriginalRevolving Loan and approximately $7.8 million borrowed under the GiftlineRevolving Loan, all of which is classified as short-term debt.

 

*The LaSalle Refinancing—EffectiveMarch 14, 2006, amended on December 22, 2006 and amended and restatedas of April 2, 2008*

 

A. The InfantlineCredit Agreement

 

On March 14, 2006(the “Closing Date”), KL and Sassy entered into a credit agreement asborrowers, on a joint and several basis, with LaSalle Bank National Associationas administrative agent and arranger (the “Agent”), the lenders from time totime party thereto, RB as loan party representative, Sovereign Bank assyndication agent, and Bank of America, N.A. as documentation agent (as amendedon December 22, 2006, the “Infantline Credit Agreement”). The originalcommitments under the Infantline Credit Agreement consisted of (a) a $35.0million revolving credit facility (the “Original Revolving Loan”), with asubfacility for letters of credit in an amount not to exceed $5.0 million, and (b) aterm loan facility in the original amount of $60 million (the “Original TermLoan”).

 

As of December 22,2006 the Infantline Credit Agreement was amended (the “First Amendment”) topermit the repayment and subsequent reborrowing of up to $20 million under theOriginal Term Loan, which was intended to enable KL and Sassy to continue toutilize cash flows expected to be generated from operations to repay debt untilthe KL Earnout Consideration became due. Pursuant to the First Amendment, KL and Sassy borrowed $20 million underthe Original Revolving Loan, the outstanding balance of which had previouslybeen reduced to zero, and utilized the proceeds of such draw to prepay $20million of the Original Term Loan. The lenders then provided an additional termloan reborrowing commitment (the “TR Commitment”) of an aggregate maximumprincipal amount of $20 million, which amounts could only be reborrowed duringspecified periods and only to fund the payment of the KL EarnoutConsideration.  Pursuant to the FirstAmendment, KL and Sassy paid a non-use fee in respect of undrawn amounts of theTR Commitment at a per annum rate of 0.375% of the daily average of the undrawnamounts.  In December 2007, KL andSassy paid $28.5 million of the KL Earnout Consideration, which amount wasfinanced by drawing the TR Commitment of $20 million and drawing an additional$8.5 million on the Original Revolving Loan. The remaining portion of the KLEarnout Consideration ($3.6 million) was paid by KL and Sassy in January of2008, also through a draw on the Original Revolving Loan.

 

As of April 2, 2008,RB, KL, Sassy, the CoCaLo Buyer, LJ and CoCaLo (via a Joinder Agreement)entered into an Amended and Restated Credit Agreement (the “Amendment”) withthe financial institutions party to the Infantline Credit Agreement or theirassignees (the “Lenders”), LaSalle Bank National Association, as Agent andFronting Bank, Sovereign Bank as Syndication Agent, Wachovia Bank, N.A. asDocumentation Agent and Banc of America Securities LLC as Lead Arranger.  KL, Sassy, the CoCaLo Buyer, LJ and CoCaLoare referred to herein 

 

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collectively as the “InfantlineBorrowers”, and the CoCaLo Buyer, LJ and CoCaLo are referred to herein as the “NewBorrowers”.  The Amendment amends andrestates the Infantline Credit Agreement, and adds the New Borrowers as partiesthereto.  The Pledge Agreement dated asof March 14, 2006 between RB and the Agent (as amended on December 22,2006) was also amended and restated as of April 2, 2008, to provide, amongother things, for a pledge of the capital stock of the CoCaLo Buyer by RB.  In connection with the Amendment, 100% of theequity of each Infantline Borrower, including each New Borrower, has beenpledged as collateral to the Agent.  In addition,the Guaranty and Collateral Agreement (as defined in the Amendment) was alsoamended and restated as of April 2, 2008, to add the New Borrowers (CoCaLovia a Joinder Agreement) as parties and to include substantially all of theexisting and future assets and properties of the New Borrowers as security forthe satisfaction of the obligations of all Infantline Borrowers, including theNew Borrowers, under the Amendment and the other related loan documents.  Unless otherwise specified herein,capitalized terms used but undefined in this Section A shall have themeanings ascribed to them in the Amendment.

 

The commitments under theAmendment consist of (a) a $75.0 million revolving credit facility (the “NewRevolving Loan”), with a subfacility for letters of credit in an amount not toexceed $5.0 million, and (b) a $100.0 million term loan facility (the “NewTerm Loan”). The Infantline Borrowers drew down $31.0 million under the NewRevolving Loan and the entire $100 million available under the New Term Loan onthe Closing Date, in order to finance the acquisitions of LaJobi and CoCaLo,and pay related transaction expenses of such acquisitions and the Amendment,and to reallocate the existing indebtedness among the bank syndicate.  The scheduled maturity date has been extendedfrom March 14, 2011 to April 1, 2013 (subject to customary earlytermination provisions).  The principalof the Original Term Loan was to be repaid on a monthly basis as follows: $9.0million for each of years 1-2; $12.0 million for year 3; and $15.0 million foreach of years 4-5.  Pursuant to theAmendment, the principal of the New Term Loan will be repaid, on a quarterlybasis, at an annual rate of $14.4 million per year, commencing June 30,2008.

 

The Infantline Loans bearinterest at a rate per annum equal to the Base Rate (for Base Rate Loans) orthe LIBOR Rate (for LIBOR Loans) at the option of the Infantline Borrowers,plus an applicable margin, in accordance with a pricing grid based on the mostrecent quarter-end Total Debt to EBITDA Ratio, which applicable margin prior tothe execution of the Amendment ranged from 1.75% - 2.50% for LIBOR Loans andfrom 0.25% - 1.00% for Base Rate Loans. Pursuant to the Amendment, the margins now range from 2.0% - 3.0% forLIBOR Loans and from 0.50% - 1.50% for Base Rate Loans (until delivery ofspecified financial statements and compliance certificates with respect to thequarter ending June 30, 2008, the applicable margins will be 2.75% forLIBOR Loans and 1.25% for Base Rate Loans).

 

The applicable interestrate margins as of March 31, 2008 were: 2.00% for LIBOR Loans and 0.50%for Base Rate Loans. The weighted average interest rates for the outstandingloans as of March 31, 2008 were as follows:

 
| ** **           | ** ** | **At March 31, 2008** | ** ** |
|----------------------|------------|--------------------------------------|------------|
| ** **           | ** ** | **LIBOR Loans**                 | ** ** | **Base Rate Loans** | ** ** |
| Infantline Revolver  |       | 4.64                                 | %          | 5.75 | % |
| Infantline Term Loan |       | 4.64                                 | %          | 5.75 | % |

 

In connection with theAmendment, the Infantline Borrowers paid the Agent and Lenders a closing fee ofapproximately $1.5 million.  In addition,pursuant to the Amendment, the following fees are now applicable:  an agency fee of $35,000 per annum, an annualnon-use fee (payable monthly, in arrears, and upon termination of the relevantobligations) of 0.40% to 0.60% of the unused amounts under the Revolving Loan,an annual letter of credit fee (payable monthly, in arrears, and upontermination of the relevant obligations) for undrawn amounts with respect toeach letter of credit based on the most recent quarter-end Total Debt to EBITDARatio ranging from 2.75% - 3.25% and other customary letter of creditadministration fees.

 

The Infantline Borrowersare required to make prepayments of the New Term Loan upon the occurrence ofcertain transactions, including most asset sales or debt or equity issuances,and pursuant to the Amendment, extraordinary receipts. Commencing in early 2008with respect to fiscal year 2007, annual mandatory prepayments of the OriginalTerm Loan would have been required in an amount equal to 50% of Excess CashFlow for each fiscal year unless the Total Debt to EBITDA Ratio for such fiscalyear was equal to or less than 2.00:1.00. For fiscal year ended 2007, no ExcessCash Flow payment was required, and pursuant to the Amendment, this requirementhas been eliminated in its entirety.

 

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The Amendment containscustomary affirmative and negative covenants. Prior to the Amendment, the Infantline Credit Agreement also containedthe following financial covenants: (i) a minimum EBITDA test, (ii) aminimum Fixed Charge Coverage Ratio, (iii) a maximum Total Debt to EBITDARatio and (iv) an annual capital expenditure limitation.  As of March 31, 2008, the Company was incompliance with all applicable financial covenants contained in the InfantlineCredit Agreement.  Pursuant to theAmendment, the minimum EBITDA test has been deleted in its entirety.  Upon the occurrence of an event of defaultunder the Amendment, including a failure to remain in compliance with allapplicable Infantline financial covenants, the lenders could elect to declareall amounts outstanding under the Amendment to be immediately due and payable.

 

The Amendment containssignificant limitations on the ability of the Infantline Borrowers todistribute cash to RB, which became a corporate holding company by virtue ofthe Assignment, for the purpose of paying dividends to the shareholders of theCompany or for the purpose of paying their allocable portion of RB’s corporateoverhead expenses.  Prior to theeffectiveness of the Amendment, KL and Sassy were not permitted (except inspecified situations) to distribute cash to RB to pay RB’s overhead expensesunless: (i) before and after giving effect to such distribution, no eventof default would exist and (ii) before and after giving effect to suchdistribution, Excess Revolving Loan Availability will equal or exceed $4.0million; provided that the aggregate amount of such distributions could notexceed $2.0 million per year.  Pursuantto the Amendment, the $4.0 million availability threshold was increased to $5.0million, and the aggregate maximum amount of such distributions was increasedto $3.5 million, and apply in each case to all Infantline Borrowers.  Other restrictions on dividends anddistributions to RB remain unchanged by the Amendment.

 

The Amendment alsoeffected the following additional changes, among others, to the InfantlineCredit Agreement:

 

(i)            The definition of Borrowing Base wasamended from 85% of eligible receivables plus 55% of eligible inventory to 85%of eligible receivables plus the lesser of (x) $25.0 million and (y) 55%of eligible inventory;

 

(ii)           Payment of the amounts outstandingunder the promissory note under the Stock Agreement is prohibited if before andafter giving effect to any such repayment, a default or event of default wouldexist;

 

(iii)          Payment of the LaJobi EarnoutConsideration or the Additional Earnout Payments is prohibited if before andafter giving effect to any such repayment, (b) a default or event ofdefault would exist, (b) Excess Revolving Loan Availability will not equalor exceed $9.0 million, or (c) before and after giving effect to any suchrepayment, the Infantline Financial Covenants will not be satisfied (the “EarnoutConditions”);

 

(iv)          Specified defaults with respect to theLaJobi Earnout Consideration and/or the Additional Earnout Payments have beenadded as events of default (including failure to deliver to the Agent specifiedcertifications and calculations within a specified time period, the reasonabledetermination by the Agent that any Earnout Conditions will not be satisfied asof the applicable payment date, if any material information provided to theAgent with respect to the Earnout Conditions shall be incorrect in any materialrespect and remain unremedied prior to the relevant payment date, or any LaJobiEarnout Consideration or Additional Earnout Payments are paid at any time thatthe Earnout Conditions are not satisfied); and

 

(v)           The Infantline Borrowers are requiredto maintain in effect Hedge Agreements that protect against potentialfluctuations in interest rates with respect to a minimum of 50% of the outstandingamount of the New Term Loan.

 

B.The Giftline Credit Agreement

 

On March 14, 2006,as amended on April 11, 2006, August 8, 2006, December 28, 2006and August 7, 2007, U.S. Gift and other specified wholly-owned domesticsubsidiaries of the Company (collectively, the “Giftline Borrowers”), enteredinto a credit agreement as borrowers, on a joint and several basis, withLaSalle Bank National Association, as issuing bank (the “Issuing Bank”),LaSalle Business Credit, LLC as administrative agent (the “AdministrativeAgent”), the lenders from time to time party thereto, and the Company, as loanparty representative (as amended, the “Giftline Credit Agreement”). Unlessotherwise specified herein, capitalized terms used but undefined in this, Section Bshall have the meanings ascribed to them in the Giftline Credit Agreement.

 

Prior to the August 8,2007 amendment to the Giftline Credit Agreement (the “Fourth Amendment”), theGiftline Credit Agreement consisted of a maximum revolving credit loancommitment (the “Giftline Revolver”) in an amount equal to the lesser of (i) $15.0 million(with a maximum availability of $13.5 million) and (ii) thethen-current Borrowing Base, in each case minus amounts outstanding under theCanadian Credit Agreement (as defined below), with a sub-facility for lettersof credit to be issued by the Issuing Bank in an amount not to exceed$8.0 million. The Fourth Amendment increased the aggregate totalCommitment under the Giftline Credit 

 

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Agreement from$15.0 million to $25.0 million, and amended the definition ofRevolving Loan Availability so that it now equals the difference between (a) thelesser of (x) the Maximum Revolving Commitment in effect at such time and (y) theBorrowing Base at such time, minus (b) the sum of the aggregate principalamount of all “Loans”, “Specified Hedging Obligations” and the “Stated Amount”of all “Letters of Credit” outstanding or requested but not yet funded underthe Canadian Loan Agreement. The Borrowing Base is primarily a function of apercentage of eligible accounts receivable and eligible inventory. As of March 31,2008, the outstanding balance on the Giftline Revolver was $8.5 million,there was no outstanding balance on the Canadian Revolving Loan (see Section Cbelow), and there was $1.2 million utilized under the Canadiansub-facility for letters of credit. At March 31, 2008, based on availablecollateral, the unused amount available to be borrowed under the GiftlineRevolver was $3.9 million.

 

All outstanding amountsunder the Giftline Revolver are due and payable on March 14, 2011, subjectto earlier termination in accordance with the terms of the Giftline CreditAgreement.

 

The Giftline Revolverbears interest at a rate per annum equal to the sum of the Base Rate (for BaseRate Loans) or the LIBOR Rate (for LIBOR Loans), at the Company’s option plusan applicable margin, which margin was originally 2.75% for LIBOR Loans and1.25% 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 Loansand from 0% - 0.50% for Base Rate Loans. Interest is due and payable inthe same manner as with respect to the Infantline Loans. The applicableinterest rate margins as of March 31, 2008 were 2.25% for LIBOR Loans and0.25% for Base Rate Loans. As of March 31, 2008, the interest rate was5.50% for the one outstanding Base Rate loan ($3.5 million) and 4.85% for oneoutstanding LIBOR loan ($5.0 million).

 

Aggregate agency fees of$20,000 are payable by the Giftline Borrowers on each anniversary of theClosing Date. Pursuant to the Third Amendment, the Giftline Revolver is subjectto an annual non-use fee (payable monthly, in arrears, and upon termination ofthe relevant obligations), ranging from 0.375% to 0.50% for unused amountsunder the Giftline Revolver, and an annual letter of credit fee ranging from2.00% to 2.75%. Other fees are as described in the Giftline Credit Agreement.

 

Receivable anddisbursement bank accounts of the Giftline Borrowers are required to be withthe Administrative Agent or its affiliates, and cash in such accounts is swepton a daily basis to pay down outstanding amounts under the Giftline Revolver.

 

The Giftline CreditAgreement contains customary affirmative and negative covenants substantiallysimilar to those applicable to the Amendment. The Giftline Credit Agreementoriginally contained the following financial covenants: (i) a minimumEBITDA test, (ii) a minimum Excess Revolving Loan Availability requirementof $5.0 million, (iii) an annual capital expenditure limitation and (iv) aminimum Fixed Charge Coverage Ratio (for quarters commencing with the quarterended 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) eliminatedin their entirety both the minimum EBITDA financial covenant and the FixedCharge Coverage Ratio financial covenant and (ii) reduced the minimumExcess Revolving Loan Availability requirement from $5.0 million to$3.5 million. The Fourth Amendment eliminated the existing ExcessRevolving Loan Availability requirement, and re-instituted a Fixed ChargeCoverage Ratio covenant based on the last day of any month for the applicableComputation Period (as defined in the Fourth Amendment) ending on such date.The Fixed Charge Coverage Ratio now specifies that the Fixed Charge CoverageRatio, as determined for the Computation Period ending on the last day of anymonth, may not be less than 1.1:1.0. This covenant is only applicable, however,if during the three month period then ending on such date of determination (the“Test Period”) Revolving Loan Availability (defined above) was less than$3.5 million for any three (3) consecutive business day period (the “TestCondition”). If compliance is required because the Test Condition was not met,the Giftline 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. The ExcessRevolving Loan Availability was not less than $3.5 million during the quarterended March 31, 2008 and the Fixed Charge Coverage Ratio was not applicableduring the quarter.  As of March 31,2008, the Company was in compliance with the remaining financial covenantscontained in the Giftline Credit Agreement.

 

In addition to thechanges discussed above, the Fourth Amendment permits, subject to specifiedconditions, the mergers of specified subsidiaries of RB with and into RB(including certain Giftline Borrowers), and increases 

 

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the amount of in-transitinventory which may be deemed “Eligible Inventory” under specifiedcircumstances from $3.0 million to $8.0 million.

 

The Giftline CreditAgreement contains significant limitations on the ability of the GiftlineBorrowers to distribute cash to RB for the purpose of paying dividends to theshareholders of the Company or for the purpose of paying their allocableportion of RB’s corporate overhead expenses, including a cap (subject tocertain exceptions) on the amount that can be provided to RB for corporateoverhead expenses equal to $4.5 million per year for each of fiscal years2006 and 2007, and $5.0 million for each fiscal year thereafter. The ThirdAmendment permits the Giftline Borrowers to pay dividends or make distributionsto RB if no default or event of default exists or would result therefrom andimmediately after giving effect to such payments, there is at least$1.5 million available to be drawn under 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 areused by the Giftline Borrowers to pay down the Giftline Revolver minus thetotal amount of dividends or other distributions made by the Giftline Borrowersto RB under this provision of the Giftline Credit Agreement.

 

C.Canadian Credit Agreement

 

As contemplated by the2005 Credit Agreement, on June 28, 2005, the Company’s Canadiansubsidiary, Amram’s Distributing Ltd. (“Amrams”), executed a separateCredit Agreement (acknowledged by the Company) with the financial institutionsparty thereto and LaSalle Business Credit, a division of ABN AMROBank, N.V., Canada Branch, a Canadian branch of a Netherlands bank, asissuing bank and administrative agent (as amended on August 4, 2005, December 7,2005 and March 14, 2006, the “Canadian Credit Agreement”), and relatedloan documents with respect to a maximum U.S. $10.0 million revolving loan(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, on March 14, 2006,the Canadian Credit Agreement was amended to (i) replace references to the2005 Credit Agreement with the Giftline Credit Agreement (such that, amongother conforming changes, a default under the Giftline Credit Agreement will bea default under the Canadian Credit Agreement), (ii) release RB from theCanadian Guaranty and (iii) provide for a maximum U.S. $5.0 millionrevolving loan. In connection with the release of the Company from the CanadianGuaranty, U.S. Gift executed an unsecured Guarantee to guarantee theobligations of Amrams under the Canadian Credit Agreement. A default under theAmendment will not constitute a default under the Canadian Credit Agreement.There were no borrowings under the Canadian Revolving Loan as of March 31,2008 and December 31, 2007.

 

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 March 31, 2008 and December 31, 2007, therewere no Base Rate or Libor Loans outstanding.

 

***RussBerrie (UK) Limited Business Overdraft Facility***

 

On March 19, 2007,Russ Berrie UK Limited entered into a Business Overdraft Facility (the “Facility”)with the National Westminster Bank PLC (the “Bank”) and the Royal Bank ofScotland plc (RBS), acting as agent for Bank. The Facility, as amendedconsists of a maximum credit line of £1.5 million. Interest will becharged on amounts outstanding under the Facility at an annual rate of 1.5%over the Bank’s Base Rate, which interest rate spread will be increased to 3.5%for any amount outstanding in excess of the maximum limit. The Facility issecured by a lien on substantially all of the assets of Russ Berrie UKLimited.  The Facility was established toassist in meeting the working capital requirements of Russ Berrie UK Limited.As of March 31, 2008 there were no borrowings outstanding under theFacility.

 

**OtherEvents and Circumstances Pertaining to Liquidity**

 

As previously disclosed, the Company believes it hassubstantially completed its gift segment restructuring.  In the event that additional initiativesrelated to the Profit Improvement Program (“PIP”) are implemented, however,certain significant restructuring charges may be recognized.  As the determination to implement any or allsuch initiatives has not yet been made, estimates of the range of anyadditional charges or other related expenditures cannot be determined at thistime.  See our Annual Report on Form 10-Kfor the year ended December 31, 2006 for a detailed description of the PIPand the restructuring activities undertaken in 2005 and 2006.

 

Sassy has operatedunder a distribution agreement with MAM Babyartikel GmbH of Vienna,Austria (the “MAM Agreement”) prior to and after the acquisition of Sassy bythe Company in 2002. Based on several factors, including the views of theCompany’s new chief executive officer (in consultation with senior management),the 

 

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inability to obtainconcessions from MAM during discussions in December 2007, the decreasingprofitability of the products sold under the MAM Agreement and specifiedrestrictions contained therein limiting the Company’s ability to enter intocompetitive product categories, the Company exercised its right to terminatethe MAM Agreement and recognized an impairment charge for $6.4 million ,effective as of March 26, 2008. The Company expects to continue todistribute MAM products throughout 2008 pursuant to contractual transitionprocedures, but anticipates that it will experience a sales decline ofapproximately $20-25 million (although, as noted above, the agreementgenerates only limited profitability), until such time as the Company cangenerate replacement or alternate product sales. Pursuant to the MAM Agreement,the Company will be restricted from selling products competitive with the MAMproducts for a period of one year following the termination of the MAMAgreement.

 

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 March 31, 2008, the Company had outstanding forward contractswith a notional amount totaling approximately $8.6 million.  See Note 7 to Notes to Unaudited ConsolidatedFinancial Statements.

 

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 businesses.  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 were placed on hold pending a decisionon 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 cashflows.

 

Consistent withits past practices and in the normal course of its business, the Companyregularly reviews acquisition opportunities of varying sizes.  See “Recent Acquisitions” above for adescription of our recent acquisitions of LaJobi and CoCaLo.  The Company may consider the use of debt orequity financing to fund potential acquisitions.  Our current creditagreements impose restrictions on the Company that could limit its ability torespond to market conditions or to take advantage of acquisitions or otherbusiness opportunities.  See “Financings”above.

 

The Company hasentered into certain transactions with certain parties who are consideredrelated parties, and these transactions are disclosed in Note 14 of Notesto Consolidated Financial Statements and Item 13, “Certain Relationshipsand Related Transactions and Director Independence” of the 2007 10-K.

 

**ContractualObligations**

 

The followingtable summaries the Company’s significant known contractual obligations as of March 31,2008 and the future periods in which such obligations are expected to besettled in cash (in thousands):

 
| ** **                                    | ** ** | **Total** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **Thereafter** | ** ** |
|-----------------------------------------------|------------|-----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|
| Operating Lease Obligations                   |       | $         | 42,830     |     | $          | 5,492    |       | $        | 6,650      |     | $          | 5,969    |       | $              | 5,258      |   | $ | 5,268 |   | $ | 14,193 |   |
| Capitalized Leases                            |       | $         | 773        |     | $          | 244      |       | $        | 325        |     | $          | 204      |       | $              | —     |   | $ | — |   | $ | — |   |
| Purchase Obligations(1)                       |       | $         | 38,805     |     | $          | 38,805   |       | $        | —     |     | $          | —   |       | $              | —     |   | $ | — |   | $ | — |   |
| Debt Repayment Obligations(2)(2A)             |       | $         | 41,000     |     | $          | 9,000    |       | $        | 14,500     |     | $          | 15,000   |       | $              | 2,500      |   | $ | — |   | $ | — |   |
| Interest on Debt Repayment Obligations(3)(3A) |       | $         | 5,100      |     | $          | 2,100    |       | $        | 2,000      |     | $          | 900      |       | $              | 100        |   | $ | — |   | $ | — |   |
| Royalty Obligations                           |       | $         | 3,710      |     | $          | 1,892    |       | $        | 1,763      |     | $          | 55       |       | $              | —     |   | $ | — |   | $ | — |   |
| Total Contractual Obligations                 |       | $         | 132,218    |     | $          | 57,533   |       | $        | 25,238     |     | $          | 22,128   |       | $              | 7,858      |   | $ | 5,268 |   | $ | 14,193 |   |

 

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

 

(2)           Reflects repayment obligations underthe Infantline Credit Agreement prior to the Amendment. See Note 4 ofNotes to Unaudited Consolidated Financial Statements for a description of theInfantline Credit Agreement prior to the Amendment, including provisions that create,increase and/or accelerate obligations thereunder.  See Note 13 of Notes to UnauditedConsolidated Financial Statements and “Financings” above for a description ofthe 

 

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amendment and restatementof the Infantline Credit Agreement, effective as of April 2, 2008.  Excludes revolving loan facilities which (asof March 31, 2008), expired on March 14, 2011. As of March 31,2008 there was approximately $18.3 million borrowed under the OriginalRevolving Loan and approximately $8.5 million borrowed under the GiftlineRevolver. The estimated interest payment for these Revolving Loans using a 6%interest rate for 2008 is $1.2 million.

 

(2A)        The $100 million New Term Loan repaymentobligations under the Amendment (effective April 2, 2008) are: $10.8million in 2008; $14.4 million in 2009; $14.4 million in 2010; $14.4 million in2011; $14.4 million in 2012; and $31.6 million in 2013.

 

(3)           This amount reflects estimatedinterest payments on the long-term debt repayment obligation as of March 31,2008 calculated using an interest rate range of 7.5%-8.5% and then- currentlevels of outstanding long-term debt. Such amounts are estimates only andactual interest payments could differ materially. See “Financings” aboveregarding a recent increase in long-term debt, and other material changes tothe Infantline Credit Agreement as of April 2, 2008.

 

(3A)        Estimated interest payments of $28.3million on the New Term Loan under the Amendment are: $5.8 million in 2008;$6.8 million in 2009; $5.7 million in 2010; $5.0 million in 2011; $4.3 millionin 2012; and $ 0.7 million in 2013.

 

Of thetotal income tax payable of $12.1 million, the Company has classified$2.7 million as current, as such amount is expected to be resolved withinone year. The remaining amount has been classified as a long-term liability.These amounts are not included in the above table as the timing of theirpotential settlement is not reasonably estimable.

 

**OffBalance Sheet Arrangements**

 

As of March 31,2008, there have been no material changes in the information provided under thecaption “Off Balance Sheet Arrangements” of Item 7 of the 2007 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 of assets,liabilities, revenue and expenses, and related disclosure of contingent assetsand liabilities. Estimates and assumptions are reviewed periodically, andrevisions made as determined to be necessary by management.  There have been no material changes to theCompany’s significant accounting estimates and assumptions or the judgmentsaffecting the application of such estimates and assumptions during the periodcovered by this report from those described in the Company’s 2007 10-K.

 

Also see Note 2 ofNotes to Consolidated Financial Statements of the 2007 10-K for a summary ofthe significant accounting policies used in the preparation of the Company’sconsolidated financial statements.  SeeNote 2 to Notes to Unaudited Consolidated Financial Statements herein for adiscussion of SFAS No. 123R, and the assumptions used in optionvaluations.

 

**RecentlyIssued Accounting Standards**

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS No. 157),which defines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements.  The provisions of SFASNo. 157 are effective as of the beginning of our 2008 fiscal year, withthe exception of certain provisions deferred until the beginning of our 2009fiscal year.  In February 2008, the FASB issued FASB Staff PositionSFAS No. 157-2, “Effective Date of FASB Statement No. 157”, whichdelayed the effective date of SFAS No. 157 for all non-financial assetsand liabilities, except those that are recognized or disclosed at fair value inthe financial statements on a recurring basis, until January 1,2009.  The impact of the adoption of SFAS No. 157 for financialassets and liabilities on a recurring basis was not material to ourconsolidated interim financial statements.  The expanded disclosures aboutfair value measurements for financial assets and liabilities are presented in Note8 to Notes to Unaudited Consolidated Financial Statements herein.  On January 1, 2008, we adopted SFAS 157 forfinancial assets and liabilities.  As ofMarch 31, 2008, we did not have any non-financial assets and liabilities thatare carried at fair value on a recurring basis in the financial statements.  We have not yet determined the impact that theadoption of SFAS No. 157 will have on our non-financial assets andliabilities which are not recognized on a recurring basis; however we do notanticipate it to materially impact our consolidated financial statements.

 

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In February 2007,the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assetsand Financial Liabilities.” SFAS No. 159 provides companies with an optionto 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 forfiscal years beginning after November 15, 2007. The Company adopted thisstandard on January 1, 2008 and there was no effect on its consolidatedfinancial position, results of operations or cashflows resulting therefrom.

 

In December 2007,SFAS No. 141R (revised 2007), “Business Combinations,” was issued.  This statement requires an acquirer torecognize assets acquired, the liabilities assumed, and any noncontrollinginterest in the acquiree at their fair values on the acquisition date, withgoodwill being the excess value over the net identifiable assets acquired.  This statement is effective for businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15,2008.  The Company is evaluating theeffect the adoption of this standard will have on its consolidated financialposition, results of operations and cash flows.

 

In December 2007,SFAS No. 160, “Noncontrolling Interests in Consolidated FinancialStatements,” was issued.  This statementestablishes accounting and reporting standards for the noncontrolling interestin a subsidiary and for the deconsolidation of a subsidiary.  It clarifies that a noncontrolling interestin a subsidiary is an ownership interest in the consolidated entity that shouldbe reported as equity in the consolidated financial statements.  This statement is effective for fiscal years,and interim periods within those fiscal years, beginning on or after December 15,2008.  The Company is evaluating theeffect the adoption of this standard will have on its consolidated financialposition, results of operations and cash flows.

 

In March 2008,SFAS No. 161, “Disclosures about Derivative Instruments and HedgingActivities,” was issued.  This statementrequires enhanced disclosures about an entity’s derivative and hedgingactivities.  This statement is effectivefor financial statements issued for fiscal years and interim periods beginningafter November 15, 2008.  TheCompany is evaluating the effect the adoption of this standard will have on itsconsolidated financial position, results of operations and cash flows.

 

**Forward-LookingStatements**

 

This Quarterly Report on Form 10-Q containscertain forward-looking statements.  Additional written and oralforward-looking statements may be made by the Company from time to time inSecurities and Exchange Commission (SEC) filings and otherwise.  ThePrivate Securities Litigation Reform Act of 1995 provides a safe-harbor forforward-looking statements.  These statements may be identified by the useof forward-looking words or phrases including, but not limited to, “anticipate”,“project”, “believe”, “expect”, “intend”, “may”, “planned”, “potential”, “should”,“will” or “would”.  The Company cautions readers that results predicted byforward-looking statements, including, without limitation, those relating tothe Company’s future business prospects, revenues, working capital, liquidity,capital needs, interest costs and income are subject to certain risks anduncertainties that could cause actual results to differ materially from thoseindicated in the forward-looking statements.   Specific risks and uncertainties include, but are notlimited to, those set forth under Item 1A, “Risk Factors”, of the 200710-K.  The Company undertakes noobligation to publicly update any forward-looking statement, whether as aresult of new information, future events or otherwise.

 

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES****ABOUTMARKET RISK**

 

As of March 31,2008, there have been no material changes in the Company’s market risks associatedwith marketable securities and foreign currency exchange rates, as described inItem 7A of the 2007 10-K.  The interestapplicable to the Company’s credit facilities as March 31, 2008 was based upon (i) theLIBOR Rate and (ii) the Base Rate (each as defined in the 2006 CreditAgreements), plus an applicable margin. At March 31, 2008, a sensitivity analysis to measure potentialchanges in applicable interest rates indicates that a one percentage pointincrease in interest rates would increase the Company’s interest expense byapproximately $0.7 million annually, based upon the level of debt at March 31,2008. A sensitivity analysis to measure potential changes in applicableinterest rates subsequent to the execution of the Amendment (effective April 2,2008) indicates that a one percentage point increase in interest rates wouldincrease the Company’s interest expense by approximately $1.4 million annually,See Note 4 and 13 of Notes to Unaudited Consolidated Financial Statements for adescription of the interest rates applicable to the loans under the Company’s creditfacilities prior and subsequent to the Amendment.

 

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**ITEM 4.  CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controls and Procedures***

 

We maintain disclosure controls and procedures as defined in Rules 13a-15(e) or15d-15(e) of the Exchange Act that are designed to ensure that informationrequired to be disclosed in our Exchange Act reports is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms and that such information isaccumulated and communicated to our management, including our principalexecutive officer and principal financial officer (together, the “CertifyingOfficers”), to allow for timely decisions regarding required disclosure.

 

In designing and evaluating disclosure controls and procedures,management recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable, not absolute assurance ofachieving the desired objectives.

 

Under the supervision and with the participation of management, includingthe Certifying Officers, we carried out an evaluation of the effectiveness ofthe design and operation of our disclosure controls and procedures pursuant toparagraph (b) of Exchange Act Rules 13a-15 or 15d-15 as of March 31,2008.  Based upon that evaluation, theCertifying Officers have concluded that our disclosure controls and proceduresare effective at the reasonable assurance level as of March 31, 2008.

 

***Changes in Internal Control over Financial Reporting***

 

There was no change in our internal control over financial reportingidentified in connection with the evaluation required by paragraph (d) ofExchange Act Rule 13a-15 or 15d-15 that occurred during the fiscal quarterended March 31, 2008 that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

 

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**PART II - OTHER INFORMATION**

 

**ITEM1A.  RISK FACTORS**

 

There have been nomaterial changes to the risk factors set forth in Part I, Item 1A, “RiskFactors”, of the Company’s 2007 10-K.

 

**ITEM 6.  EXHIBITS**

 
| Exhibits to this  Quarterly Report on Form 10-Q. |
|-------------------------------------------------------|
|                                                  |
| 4.21                                                  |   | Amended and Restated Credit Agreement, dated  as of April 2, 2008, among Russ Berrie and Company, Inc., Kids  Line, LLC, Sassy, Inc., I & J Holdco, Inc.,  LaJobi, Inc., CoCaLo, Inc. (via a Joinder Agreement), the financial  institutions party thereto or their assignees (the “Lenders”), LaSalle Bank  National Association, as Administrative Agent for the Lenders and as Fronting  Bank, Sovereign Bank as Syndication Agent, Wachovia Bank, N.A. as  Documentation Agent and Bank of America Securities LLC as Lead Arranger,  incorporated by reference to the Company’s Current Report on Form 8-K  filed on April 8, 2008. Schedules and other attachments are omitted, but  will be furnished supplementally to the Commission upon request. |
|                                                  |   |   |
| 4.22                                                  |   | Amended and Restated Guaranty and Collateral  Agreement, dated as of April 2, 2008, entered into among Kids Line, LLC,  Sassy, Inc., I&J Holdco, Inc., LaJobi Inc. and  CoCaLo, Inc. (via a Joinder Agreement) in favor of LaSalle Bank National  Association, as Administrative Agent, incorporated by reference to the  Company’s Current Report on Form 8-K filed on April 8, 2008.  Schedules and other attachments are omitted, but will be furnished  supplementally to the Commission upon request. |
|                                                  |   |   |
| 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/  Anthony Cappiello |
| Date:  | May 12, 2008 |                           |   | Anthony Cappiello |   |
|   |              |                           | Executive Vice  President and Chief   Administrative Officer (Principal Financial   Officer) |
|        |                   |                                |  |  |  |  |

 

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**EXHIBIT INDEX**

 
| 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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