**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(MarkOne)**

 
| **ý**                                                                                                                                                                                                                  | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934**  |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                        |
| **For the quarterly period ended  September 30, 2003**                                                                                                                                                                 |
|                                                                                                                                                                                                                        |
| **OR**                                                                                                                                                                                                                      |
|                                                                                                                                                                                                                        |
| **o**                                                                                                                                                                                                                       | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|                                                                                                                                                                                                                        |
| **For the transition period  from                 to               ** |

 

**Commissionfile number  1-8681**

 

| **RUSS BERRIE AND COMPANY, INC.**                                                   |
|-------------------------------------------------------------------------------------|
| (Exact name of registrant as specified in its  charter)                             |
|                                                                                |
| **New Jersey**                                                                      |   | **22-1815337** |
| (State or other jurisdiction of incorporation or  organization)                     |   | (IRS Employer Identification No.) |
|                                                                                |   |   |
| **111 Bauer Drive, Oakland, New  Jersey**                                           |   | **07436** |
| (Address of principal executive offices)                                            |   | (Zip Code) |
|                                                                                |   |   |
| **(201) 337-9000**                                                                  |
| (Registrant’s telephone number, including area code)                           |
|                                                                                |   |   |
| (Former name, former address and former fiscal year,  if changed since last report) |

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15 (d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes  ý   No  o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act). Yes  ý   No  o

 

The number of sharesoutstanding of each of the registrant’s classes of common stock, as ofNovember 5, 2003 was as follows:

 
| **CLASS**                        | ** ** | **OUTSTANDING  AT  November 5, 2003** |
|----------------------------------|------------|--------------------------------------------|
| Common Stock, $0.10 stated value |       | 20,651,100                                 |

 

 

----

 

**RUSS BERRIE AND COMPANY, INC.**

 

**INDEX**

 
| **PART I – FINANCIAL  INFORMATION** |                                                                                                    |
|------------------------------------------|---------------------------------------------------------------------------------------------------------|
|                                     |                                                                                                    |   |
| Item 1.                                  | Financial Statements                                                                                    |   |
|                                     |                                                                                                    |   |
| a)                                       | Consolidated Balance Sheet  as of September 30, 2003 and December 31, 2002                    |   |
|                                     |                                                                                                    |   |
| b)                                       | Consolidated Statement  of Income for the three and nine months ended September 30, 2003 and  2002 |   |
|                                     |                                                                                                    |   |
| c)                                       | Consolidated  Statement of Cash Flows for the nine months ended September 30, 2003 and  2002       |   |
|                                     |                                                                                                    |   |
| d)                                       | Notes to  Consolidated Financial Statements                                                             |   |
|                                     |                                                                                                    |   |
| Item 2.                                  | Management’s  Discussion and Analysis of Results of Operations and Financial Condition             |   |
|                                     |                                                                                                    |   |
| Item  3.                                 | Quantitative  and Qualitative Disclosures About Market Risk                                             |   |
|                                     |                                                                                                    |   |
| Item 4.                                  | Controls and  Procedures                                                                                |   |
|                                     |                                                                                                    |   |
| **PART II – OTHER INFORMATION**     |                                                                                                    |
|                                     |                                                                                                    |   |
| Item 1.                                  |  Legal Proceedings                                                                                 |   |
|                                     |                                                                                                    |   |
| Item 6.                                  | Exhibits  and Reports on Form 8-K                                                                       |   |
|                                     |                                                                                                    |   |
| Signatures                               |                                                                                                    |
|                                     |                                                                                                    |   |
|                                          |                                                                                                         |  |  |

 

2

----

 

**PART 1 - FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIAL STATEMENTS**

 

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

 

**CONSOLIDATEDBALANCE SHEET**

 

**(Dollars in Thousands)**

**(UNAUDITED)**

 
|                                                                                                                               |   | **September 30,  2003** |       | **December 31,  2002** |       |
|------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|------------|-----------------------------|------------|
| ***ASSETS***                                                                                                                       |   |                         | ** ** |                        | ** ** |
| Current assets                                                                                                                     |   |                         |       |                        |       |
| Cash and cash  equivalents                                                                                                         |   | $                            | 68,240     |                        | $          | 93,513 |   |
| Marketable  securities                                                                                                             |   | 155,713                      |       | 109,350                     |       |
| Other  investments                                                                                                                 |   | —                       |       | 22,888                      |       |
| Accounts  receivable, trade, less allowances of $3,698 in 2003 and $3,395 in 2002                                                  |   | 84,778                       |       | 73,938                      |       |
| Inventories —  net                                                                                                            |   | 49,316                       |       | 44,749                      |       |
| Prepaid expenses  and other current assets                                                                                         |   | 4,742                        |       | 4,896                       |       |
| Deferred income  taxes                                                                                                             |   | 6,566                        |       | 6,548                       |       |
| **Total  current assets**                                                                                                          |   | 369,355                      |       | 355,882                     |       |
|                                                                                                                               |   |                         |       |                        |       |
| Property, plant and equipment — net                                                                                           |   | 44,385                       |       | 42,096                      |       |
| Goodwill                                                                                                                           |   | 10,388                       |       | 10,388                      |       |
| Other assets                                                                                                                       |   | 22,948                       |       | 22,086                      |       |
| **Total  assets**                                                                                                                  |   | $                            | 447,076    |                        | $          | 430,452 |   |
|                                                                                                                               |   |                         |       |                        |       |
| ***LIABILITIES AND  SHAREHOLDERS’ EQUITY***                                                                                   |   |                         |       |                        |       |
| Current liabilities                                                                                                                |   |                         |       |                        |       |
| Accounts payable                                                                                                                   |   | $                            | 9,870      |                        | $          | 10,752 |   |
| Accrued expenses                                                                                                                   |   | 25,078                       |       | 26,346                      |       |
| Accrued income  taxes                                                                                                              |   | 6,175                        |       | 4,463                       |       |
| **Total  current liabilities**                                                                                                     |   | 41,123                       |       | 41,561                      |       |
| Commitments and contingencies                                                                                                      |   |                         |       |                        |       |
| Shareholders’ equity                                                                                                          |   |                         |       |                        |       |
| Common stock:  $.10 stated value per share; authorized 50,000,000 shares; issued 2003,  26,276,096 shares; 2002, 26,163,986 shares |   | 2,628                        |       | 2,618                       |       |
| Additional paid  in capital                                                                                                        |   | 84,230                       |       | 81,403                      |       |
| Retained  earnings                                                                                                                 |   | 425,510                      |       | 417,047                     |       |
| Accumulated  other comprehensive income (loss)                                                                                     |   | 3,795                        |       | (1,967                      | )          |
| Treasury stock,  at cost (5,639,314 shares at September 30, 2003 and at December 31,  2002)                              |   | (110,210                     | )          | (110,210                    | )          |
|                                                                                                                               |   |                         |       |                        |       |
| **Total  shareholders’ equity**                                                                                               |   | 405,953                      |       | 388,891                     |       |
|                                                                                                                               |   |                         |       |                        |       |
| **Total  liabilities and shareholders’ equity**                                                                               |   | $                            | 447,076    |                        | $          | 430,452 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

3

----

 

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

 

**CONSOLIDATEDSTATEMENT OF INCOME**

 

**(Dollars in Thousands, Except PerShare Data)**

 

**(UNAUDITED)**

 
|                                          |   | **THREE MONTHS ENDED  SEPTEMBER 30,** |       | **NINE MONTHS ENDED  SEPTEMBER 30,** |       |
|-----------------------------------------------|--------|--------------------------------------------|------------|-------------------------------------------|------------|
|                                          |   | **2003**                                   |       | **2002**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| Net sales                                     |   | $                                          | 87,848     |                                      | $          | 95,740 |   | $ | 242,566 |   | $ | 239,384 |   |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| Cost of Sales                                 |   | 41,228                                     |       | 41,893                                    |       | 112,618 |   | 106,651 |   |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| **Gross  profit**                             |   | 46,620                                     | ** ** | 53,847                                    |       | 129,948 |   | 132,733 | ** ** |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| Selling, general and  administrative expense  |   | 32,217                                     |       | 30,931                                    |       | 98,032 |   | 90,525 |   |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| Investment and other  income-net              |   | 1,131                                      |       | 1,216                                     |       | 4,403 |   | 5,775 |   |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| **Income  before provision for income taxes** |   | 15,534                                     | ** ** | 24,132                                    |       | 36,319 |   | 47,983 | ** ** |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| Provision for income  taxes                   |   | 3,939                                      |       | 6,533                                     |       | 10,567 |   | 13,675 |   |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| **Net****income**                             |   | $                                          | 11,595     | ** **                                | $          | 17,599 |   | $ | 25,752 |   | $ | 34,308 | ** ** |
|                                          |   |                                       |       |                                      |       |   |   |   |   |
| **Net  income per share:**                    |   |                                       |       |                                      |       |   |   |   |   |
| Basic                                         |   | $                                          | 0.56       |                                      | $          | 0.86 |   | $ | 1.25 |   | $ | 1.68 |   |
| Diluted                                       |   | $                                          | 0.56       |                                      | $          | 0.86 |   | $ | 1.25 |   | $ | 1.67 |   |

 

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

 

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

 

**CONSOLIDATEDSTATEMENT OF CASH FLOWS**

 

**(Dollars in Thousands)**

**(UNAUDITED)**

 
|                                                                               |   | **NINE MONTHS ENDED  SEPTEMBER 30,** |    |
|------------------------------------------------------------------------------------|--------|-------------------------------------------|---------|
|                                                                               |   | **2003**                                  |    | **2002** | ** ** |
| **Cash  flows from operating activities:**                                         |   |                                      |    |   |   |
| Net income                                                                         |   | $                                         | 25,752  |   | $ | 34,308 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |   |                                      |    |   |   |
| Depreciation and amortization                                                      |   | 4,885                                     |    | 3,609 |   |
| Provision for accounts receivable reserves                                         |   | 1,448                                     |    | 3,672 |   |
| Realized loss (gain) on other investments                                          |   | 1,537                                     |    | (97 | ) |
| Other                                                                              |   | 1,147                                     |    | 1,001 |   |
| Changes in assets and liabilities:                                                 |   |                                      |    |   |   |
| Accounts receivable                                                                |   | (12,288                                   |  ) | (23,199 |  ) |
| Inventories — net                                                             |   | (4,567                                    | )       | 5,273 |   |
| Prepaid expenses and other current assets                                          |   | 154                                       |    | (255 | )  |
| Other assets                                                                       |   | (841                                      | )       | 85 |   |
| Accounts payable                                                                   |   | (882                                      | )  | 1,097 |   |
| Accrued expenses                                                                   |   | (1,268                                    | )       | 5,015 |   |
| Accrued income taxes                                                               |   | 1,712                                     |    | 693 |   |
| Total adjustments                                                                  |   | (8,963                                    | )       | (3,106) |   |
| Net cash provided by operating activities                                          |   | 16,789                                    |    | 31,202 |   |
|                                                                               |   |                                      |    |   |   |
| **Cash  flows from investing activities:**                                         |   |                                      |    |   |   |
| Purchase of marketable  securities                                                 |   | (354,196                                  | )       | (156,320 | ) |
| Proceeds from sale of  marketable securities                                       |   | 328,259                                   |    | 127,489 |   |
| Proceeds from sale of  property, plant and equipment                               |   | 17                                        |    | — |   |
| Capital expenditures                                                               |   | (6,437                                    | )       | (13,006 | ) |
| Payment for purchase of  Sassy, Inc.                                               |   | —                                    |    | (46,100 | ) |
| Net cash (used in)  investing activities                                           |   | (32,357                                   | )       | (87,937 | ) |
|                                                                               |   |                                      |    |   |   |
| **Cash  flows from financing activities:**                                         |   |                                      |    |   |   |
| Proceeds from issuance  of common stock                                            |   | 2,836                                     |    | 5,186 |   |
| Dividends paid to  shareholders                                                    |   | (17,289                                   | )       | (15,921 | ) |
| Purchase of treasury  stock                                                        |   | —                                    |    | (214 | ) |
| Net cash (used in) financing activities                                            |   | (14,453                                   | )       | (10,949 | ) |
|                                                                               |   |                                      |    |   |   |
| Effect of exchange rate  changes on cash and cash equivalents                      |   | 4,748                                     |    | 2,701 |   |
| Net increase (decrease)  in cash and cash equivalents                              |   | (25,273                                   |  ) | (64,983 | ) |
| Cash and cash  equivalents at beginning of period                                  |   | 93,513                                    |    | 148,872 |   |
| Cash and cash  equivalents at end of period                                        |   | $                                         | 68,240  |   | $ | 83,889 |   |
|                                                                               |   |                                      |    |   |   |
| **Cash  paid during the period for:**                                              |   |                                      |    |   |   |
| Interest                                                                           |   | $                                         | 17      |   | $ | 20 |   |
| Income taxes                                                                       |   | $                                         | 8,855   |   | $ | 12,982 |   |

 

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

 

4

----

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

(Unaudited)

 

**NOTE1 - INTERIM CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

The Company operates intwo segments which consist of the Company’s core gift business and theCompany’s non-core business, which includes the Company’s July 26, 2002acquisition of Sassy, Inc.  The Company’s core business designs,manufactures through third parties and markets a wide variety of gift and homedécor products to retail stores throughout the United States and throughout theworld via the Company’s international wholly-owned subsidiaries and distributors. The Company’s non-core businesses design and market functional consumerproducts

 

5

----

 

sold at comparable pricepoints with comparable gross margins to each other and consists of Sassy, Inc.since its acquisition on July 26, 2002 and the Company’s wholly-ownedsubsidiary Bright of America, Inc.  These products are sold to consumers,primarily in the United States, through mass marketers.

 

Certain prior yearamounts have been reclassified to conform to the 2003 presentation.  (SeeNote 8).

 

This Quarterly Report onForm 10-Q for the three and nine months ended September 30, 2003 should beread in conjunction with the Company’s Quarterly Reports on Form 10-Q for thethree months ended March 31, 2003 and June 30, 2003 and the Company’sAnnual Report on Form 10-K for the year ended December 31, 2002.

 

**NOTE2 – FINANCIAL INSTRUMENTS**

 

**MARKETABLESECURITIES AND OTHER INVESTMENTS**

 

Inaccordance with SFAS No. 115, “Accounting for Certain Investments in Debt andEquity Securities,” the Company’s marketable securities are consideredavailable-for-sale investments.  Accordingly, these investments arecarried in the accompanying consolidated balance sheet at fair value, with thedifference between cost and fair value (unrealized gain and losses) recorded asa component of shareholders’ equity, net of tax in Accumulated OtherComprehensive Income/Loss.  These investments consist of U.S. governmentobligations, municipal obligations, preferred stock and mutual funds.  TheCompany liquidated, in July 2003, its equity investment in a limitedpartnership which managed a portfolio of mortgage-backed securities to achievereturns through yield income and price appreciation.  This investment,included in Other Investments in the consolidated balance sheet until itsliquidation, was accounted for using the equity method and accordingly theCompany’s proportionate share of the limited partnership’s income or lossamounting to a non-cash loss of $49,000 and $599,000 for the three months ended September 30, 2003 andSeptember 30, 2002, respectively, and a non-cash loss of  $1,537,000and non-cash income of $97,000 for the nine months ended September 30,2003 and September 30, 2002, respectively, is included in investment andother income-net in the Consolidated Statement of Income. Additionally,realized losses on sales of available-for-sale marketable securities of$112,000 and realized gains of $945,000 for the three months endedSeptember 30, 2003 and 2002, respectively, and realized gains on sales ofavailable-for sale marketable securities of $2,368,000 and $1,136,000 for thenine months ended September 30, 2003 and 2002, respectively, as determinedon a specific identification basis, are included in investment and other income,net in the Consolidated Statement of Income.

 

Marketable securitiesconsist of the following:

 
|                         |   | **As of  September 30, 2003** |        |
|------------------------------|--------|------------------------------------|-------------|
|                         |   | **Cost**                           |        | **Gross  Unrealized  Gain** | ** ** | **Gross  Unrealized  (Loss)** |   | **Fair Value** | ** ** |
| U.S. Government  obligations |   | $                                  | 28,623,000  |   | $ | 44,000 |   | $ | (87,000 | ) | $ | 28,580,000 |   |
| Municipal obligations        |   | 101,499,000                        |        | 532,000 |   | (99,000 | ) | 101,932,000 |   |
| Preferred stock &  other |   | 7,817,000                          |        | 55,000 |   | (67,000 | ) | 7,805,000 |   |
| Equity securities            |   | 14,025,000                         |        | 143,000 |   | (270,000 | ) | 13,898,000 |   |
| Asset Backed Securities      |   | 3,486,000                          |        | 15,000 |   | (3,000 | ) | 3,498,000 |   |
|                         |   |                               |        |   |   |   |   |   |   |
| Total marketable  securities |   | $                                  | 155,450,000 |   | $ | 789,000 |   | $ | (526,000 | ) | $ | 155,713,000 |   |
|                         |   |                               |        |   |   |   |   |   |   |
|                         |   | **As of  December 31. 2002**  |        |
|                         |   |                               |        |   |   |   |   |   |   |
| U.S. Government  obligations |   | $                                  | 38,918,000  |   | $ | 155,000 |   | $ | (5,000 | ) | $ | 39,068,000 |   |
| Municipal obligations        |   | 52,200,000                         |        | 848,000 |   | (42,000 | ) | 53,006,000 |   |
| Preferred stock &  other |   | 12,950,000                         |        | 41,000 |   | (892,000 | ) | 12,099,000 |   |
| Equity securities            |   | 5,148,000                          |        | 100,000 |   | (71,000 | ) | 5,177,000 |   |
|                         |   |                               |        |   |   |   |   |   |   |
| Total marketable  securities |   | $                                  | 109,216,000 |   | $ | 1,144,000 |   | $ | (1,010,000 | ) | $ | 109,350,000 |   |

 

6

----

 

**NOTE3 - EARNINGS PER SHARE**

 

A reconciliation ofweighted average common shares outstanding to weighted average common sharesoutstanding assuming dilution is as follows:

 
|                                                                |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |       |
|---------------------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|------------|
|                                                                |   | **2003**                                   |   | **2002**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                |   |                                       |   |                                      |       |   |   |   |   |
| Weighted average common  shares outstanding                         |   | 20,628,000                                 |   | 20,452,000                                |       | 20,581,000 |   | 20,401,000 |   |
|                                                                |   |                                       |   |                                      |       |   |   |   |   |
| Dilutive effect of  common shares issuable under stock option plans |   | 104,000                                    |   | 103,000                                   |       | 100,000 |   | 124,000 |   |
| Weighted average common  shares outstanding assuming dilution       |   | 20,732,000                                 |   | 20,555,000                                |       | 20,681,000 |   | 20,525,000 |   |

 

There were no stockoptions outstanding at September 30, 2003 or September 30, 2002, which were notincluded in the computation of earnings per common share assuming dilutionbecause none of the options’ exercise prices were greater than the averagemarket price of the common shares.  

** **

**NOTE4 - DIVIDENDS**

 

Cash dividends of$5,777,000 ($0.28 per share) were paid on August 29, 2003 toshareholders of record of the Company’s Common Stock on August 15,2003.  Cash dividends of $17,289,000 ($0.28 per share per quarter) werepaid in the nine months ended September 30, 2003.

 

Cash dividends of$5,318,000 ($0.26 per share) were paid on August 30, 2002 to shareholdersof record of the Company’s Common Stock on August 16, 2002.  Cashdividends of $15,921,000 ($0.26 per share per quarter) were paid in the ninemonths ended September 30, 2002.

 

**NOTE5 - COMPREHENSIVE INCOME**

 

Comprehensive Income,representing all changes in Shareholders’ equity during the period other thanchanges resulting from the issuance or repurchase of the Company’s common stockand payment of dividends, is reconciled to net income for the three and ninemonths ended September 30, 2003 and 2002 as follows:

 
|                                                                                 |   | **Three Months Ended  September 30,** |       | **Nine Months Ended  September 30,** |       |
|--------------------------------------------------------------------------------------|--------|--------------------------------------------|------------|-------------------------------------------|------------|
|                                                                                 |   | **2003**                                   |       | **2002**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income                                                                           |   | $                                          | 11,595,000 |                                      | $          | 17,599,000 |   | $ | 25,752,000 |   | $ | 34,308,000 |   |
| Other comprehensive  income (loss), net of tax:                                      |   |                                       |       |                                      |       |   |   |   |   |
| Foreign currency  translation adjustments                                            |   | 669,000                                    |       | (688,000)                                 |       | 5,630,000 |   | 3,285,000 |   |
|                                                                                 |   |                                       |       |                                      |       |   |   |   |   |
| Net unrealized gain  (loss) on securities available-for-sale                         |   | 372,000                                    |       | (141,000)                                 |       | 94,000 |   | (61,000) |   |
| Net unrealized gain  (loss) on foreign currency forward exchange contracts and other |   | (22,000                                    | )          | (146,000)                                 |       | 38,000 |   | 550,000 |   |
| Other comprehensive  income                                                          |   | 1,019,000                                  |       | (975,000)                                 |       | 5,762,000 |   | 3,774,000 |   |
|                                                                                 |   |                                       |       |                                      |       |   |   |   |   |
| Comprehensive income                                                                 |   | $                                          | 12,614,000 |                                      | $          | 16,624,000 |   | $ | 31,514,000 |   | $ | 38,082,000 |   |

 

7

----

 

**NOTE6 – LITIGATION AND COMMITMENTS**

 

In the ordinary course ofits business, the Company is party to various copyright, patent and trademarkinfringement, unfair competition, breach of contract, customs, employment andother legal actions incidental to its business, as plaintiff ordefendant.  In the opinion of management, the amount of ultimate liabilitywith respect to these actions will not materially adversely affect theconsolidated results of operations, financial condition or cash flows of theCompany, except for the matter described below.

 

As previously reported inthe Company's Quarterly Reports on Form 10-Q for the periods ended March 31,2003 and June 30, 2003, an action was commenced against the Company onAugust 22, 2001, in the United States District Court, District of NewJersey, by Dam Things from Denmark (a/k/a Troll Company ApS.), alleging, amongother things, copyright infringement by the Company of the plaintiff’sreinstated United States copyrights for its troll designs, unfair competitionunder common law and violation of Danish and U.S. copyrights constitutingcopyright infringement under the laws of the Peoples Republic of China. The plaintiff is seeking, among other things, injunctive relief prohibiting theCompany from continuing to offer for sale its troll products, cancellation ofthe Company’s U.S. copyright registrations with respect to its various trollproducts, as well as unspecified damages and attorney’s fees andexpenses.  On December 3, 2001, a preliminary injunction was issuedby the District Court which, as subsequently modified, prohibited the Companyfrom manufacturing and importing its troll products into the United States andselling such products in the United States after a date specified by thecourt.  The issuance of the preliminary injunction was appealed by theCompany to the Third Circuit Court of Appeals.  On May 14, 2002, theappeals court vacated the preliminary injunction, and the matter was remandedto the District Court.  The plaintiff, on June 13, 2003, renewed its motionfor preliminary injunctive relief seeking to reinstate the relief which waspreviously vacated by the Third Circuit Court of Appeals.  The DistrictCourt had set September 8, 2003, for a hearing on this motion, but after aconference with the parties the Court requested new legal submissions from theparties and it adjourned the hearing without setting a new hearing date. TheCompany believes it has substantial defenses to the allegations.  In thequarter ended September 30, 2003, the sale of troll products representedless than one-half of one percent of the Company’s net sales.  As ofDecember 31, 2001 in response to the issuance of the preliminaryinjunction, the Company had segregated the amount of its troll productsinventory and recorded such inventory as a long-term asset in the Company’sConsolidated Balance Sheet.  As a result of the vacation of thepreliminary injunction, such inventory is no longer segregated or classified asa long-term asset.  The Company does not believe that the ultimateresolution of this action will have a material adverse impact on theconsolidated financial condition of the Company; however, the outcome of anylitigation is uncertain.  The plaintiff has advised the Company of itsintention to amend the claims under the litigation to include allegedinfringements of the plaintiff’s copyrights under the laws of unspecifiedforeign countries and to seek unspecified damages for sales of the Company’stroll products sold throughout the world.  Since the new assertions have not,to date, been included in the litigation, the Company cannot evaluate them ortheir potential impact on the Company. 

 

The Company has entered into letteragreements, dated July 2, 2003, with each of eleven employees of the Company,with respect to the payment of a special cash bonus to such employee in theevent that an unaffiliated purchaser acquires substantially all of theCompany's outstanding stock or assets through a negotiated transaction on orbefore December 31, 2003. Such bonus is payable only in the event that therelevant officer remains employed by the Company through the consummation ofsuch transaction. The aggregate potential amount of the bonuses that could bepayable by the Company under all such letter agreements equals $1,450,000.

 

**NOTE7 - ACQUISITION**

 

On July 26, 2002,pursuant to the terms of an asset purchase agreement, a wholly-owned subsidiaryof the Company acquired the business and substantially all of the assets ofSassy, Inc. (“Sassy”), a designer, manufacturer and distributor of babyand juvenile products based in Grand Rapids, Michigan, including, but notlimited to, real property, tangible personal property, inventory, most accountsreceivable, designated contracts, intellectual property rights, governmentalauthorizations and intangible rights. The assets acquired will continue to beused by the Company in Sassy’s business. In addition to the Sassy brand, theCompany also gained distribution rights to certain baby soothing and comfortingproducts from MAM Babyartikel GmbH, of Vienna, Austria.  The Companypurchased privately held Sassy, Inc. for approximately $46,204,000(including acquisition costs and a working capital adjustment) using theCompany’s own internal funds, based on Sassy’s current and projected earningsbefore interest, taxes, depreciation and amortization, and workingcapital.  Additional payments, not expected to exceed $3,800,000, maybecome payable based on future performance and other measurements and will beexpensed as incurred in the Company’s Consolidated Statement of Income. The results of operations of Sassy, Inc. are included in the Company’sConsolidated Statement of Income since July 26, 2002.

 

The Company believes thatthe identifiable intangible assets purchased in the acquisition valued basedupon a third party valuation have an indefinite life.  Goodwill of$10,388,000 was assigned to the Company’s non-core segment.  The aggregateamount of goodwill expected to be deductible for tax purposes is estimated tobe $10,176,000. There have been no changes in the carrying amount of goodwillduring the three and nine months ended September 30, 2003.

 

8

----

 

The following unauditedpro forma consolidated results of operations for the three months and nine monthsended September 30, 2002 assumes the acquisition of Sassy, Inc.occurred as of January 1, 2002.

 
|                   |   | **Three months ended  September 30, 2002** |       | **Nine months ended  September 30, 2002** |   |
|------------------------|--------|-------------------------------------------------|------------|------------------------------------------------|--------|
| Net sales              |   | $                                               | 98,597,000 |                                           | $      | 265,865,000 |   |
| Net income             |   | 17,900,000                                      |       | 36,420,000                                     |   |
| Net income  per share: |   |                                            |       |                                           |   |
| Basic                  |   | $                                               | 0.88       |                                           | $      | 1.79 |   |
| Diluted                |   | $                                               | 0.87       |                                           | $      | 1.77 |   |

 

The above amounts arebased upon certain assumptions and estimates, and do not reflect any benefitsfrom combined operations.  The pro forma results have not been audited anddo not necessarily represent results which would have occurred if theacquisition had taken place on the basis assumed above, and may not beindicative of the results of future combined operations.

 

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

 

The Company operates intwo segments which consist of the Company’s core gift business and theCompany’s non-core business, which includes the Company’s July 26, 2002acquisition of Sassy, Inc.  This segmentation of the Company’s operationsreflects how the Company’s Chief Executive Officer currently views the resultsof operations.  There are no intersegment revenues to eliminate. Prior to the acquisition of Sassy, Inc., the Company had only one reportablesegment, as such, the Company has reclassified the prior year’s single segmentinformation to be consistent with the current period’s presentation.

 

The Company’s corebusiness designs, manufactures through third parties and markets a wide varietyof gift and home décor products to retail stores throughout the United Statesand throughout the world via the Company’s international wholly-ownedsubsidiaries and distributors.  The Company’s non-core business designsand markets functional consumer products sold at comparable price points with comparablegross margins to each other and consists of the Company’s wholly-ownedsubsidiaries, Sassy, Inc. and Bright of America, Inc.  The products aresold to consumers, primarily in the United States, through mass marketers.

 

9

----

 
|                        |   | **Three Months Ended  September 30,** |       | **Nine Months Ended  September 30,** |       |
|-----------------------------|--------|--------------------------------------------|------------|-------------------------------------------|------------|
|                        |   | **2003**                                   |       | **2002**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Core:                       |   |                                       |       |                                      |       |   |   |   |   |
| Net sales                   |   | $                                          | 73,681,000 |                                      | $          | 83,761,000 |   | $ | 199,285,000 |   | $ | 223,077,000 |   |
| Income before income  taxes |   | 13,007,000                                 |       | 22,258,000                                |       | 30,244,000 |   | 45,465,000 |   |
|                        |   |                                       |       |                                      |       |   |   |   |   |
| Non-core:                   |   |                                       |       |                                      |       |   |   |   |   |
| Net Sales                   |   | 14,167,000                                 |       | 11,979,000                                |       | 43,281,000 |   | 16,307,000 |   |
| Income before income  taxes |   | 2,527,000                                  |       | 1,874,000                                 |       | 6,075,000 |   | 2,518,000 |   |
|                        |   |                                       |       |                                      |       |   |   |   |   |
| Consolidated:               |   |                                       |       |                                      |       |   |   |   |   |
| Net Sales                   |   | 87,848,000                                 |       | 95,740,000                                |       | 242,566,000 |   | 239,384,000 |   |
| Income before income  taxes |   | 15,534,000                                 |       | 24,132,000                                |       | 36,319,000 |   | 47,983,000 |   |
|                        |   |                                       |       |                                      |       |   |   |   |   |   |   |   |   |

 

Additionally,total assets of each segment were as follows:

 
|     |   | **September 30,  2003** |   | **December 31,  2002** |        |
|----------|--------|------------------------------|--------|-----------------------------|-------------|
|     |   |                         |   |                        |        |
| Core     | $      | 375,861,000                  |   | $                           | 363,820,000 |   |
| Non-core |   | 71,215,000                   |   | 66,632,000                  |        |
|     |   |                         |   |                        |        |
| Total    | $      | 447,076,000                  |   | $                           | 430,452,000 |   |

 

**NOTE 9—INVESTMENTAND OTHER INCOME – NET**

 

The significantcomponents of investment and other income—net consist of the following: 

 
|                                |   | **Three Months Ended  September 30,** |      | **Nine Months Ended  September 30,** |       |
|-------------------------------------|--------|--------------------------------------------|-----------|-------------------------------------------|------------|
|                                |   | **2003**                                   |      | **2002**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Investment income                   |   | $                                          | 926,000   |                                      | $          | 1,688,000 |   | $ | 4,201,000 |   | $ | 5,770,000 |   |
| Interest (expense)  income          |   | (4,000                                     | )         | 27,000                                    |       | (17,000 | ) | (20,000 | ) |
| Foreign currency  transactions, net |   | 69,000                                     |      | (530,000                                  | )          | 13,000 |   | (81,000 | ) |
| Other                               |   | 140,000                                    |      | 31,000                                    |       | 206,000 |   | 106,000 |   |
| Total                               |   | $                                          | 1,131,000 |                                      | $          | 1,216,000 |   | $ | 4,403,000 |   | $ | 5,775,000 |   |

 

**NOTE10 - ACCOUNTING FOR STOCK OPTIONS**

 

During the fourth quarterof 2002, the Company adopted the disclosure provisions of SFAS No. 148. The Company had previously adopted the disclosure-only provisions of SFASNo. 123, “Accounting for Stock-Based Compensation” and, therefore,accounts for its stock option plans in accordance with the provisions ofAccounting Principles Board (APB) Opinion No. 25, “Accounting for StockIssued to Employees”, and related interpretations using the intrinsic valuemethod of accounting.  Accordingly, no compensation cost has beenrecognized for the options granted under these Stock Plans except for theapplication of Financial Accounting Interpretation No. 44, “Accounting forCertain Transactions Involving Stock Compensation”, which resulted in non cashincome of $75,000 and $236,000 during the three months ended September 30,2003 and September 30, 2002, respectively, and non cash charges of $7,000and $49,000 during the nine months ended September 30, 2003 andSeptember 30, 2002, respectively, which is included in selling, generaland administrative expenses in the Consolidated Statement of Income. These charges relate only to the options granted during 2000 that were repricedas of February 29, 2000 upon approval of the Board of Directors andShareholders.  Had compensation cost for the Company’s Stock Plans beendetermined based on the fair value recognition provisions of SFAS No. 123at the grant date, in the three and nine months ended September 30, 2003 and2002, the Company’s net income and earnings per share would have been reducedto the pro forma amounts indicated below:

 

10

----

 
|                                                                                                     |   | **Three Months Ended  September 30,** |       | **Nine Months Ended  September 30,** |       |
|----------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|------------|-------------------------------------------|------------|
|                                                                                                     |   | **2003**                                   |       | **2002**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income-as reported                                                                                   |   | $                                          | 11,595,000 |                                      | $          | 17,599,000 |   | $ | 25,752,000 |   | $ | 34,308,000 |   |
| Deduction for  stock-based compensation expense determined under fair value method net of  tax-pro forma |   | 392,905                                    |       | 518,264                                   |       | 620,240 |   | 651,104 |   |
|                                                                                                     |   |                                       |       |                                      |       |   |   |   |   |
| Net income-pro forma                                                                                     |   | 11,202,095                                 |       | 17,080,736                                |       | 25,131,760 |   | 33,656,896 |   |
| Earnings per share  (basic) - as reported                                                                |   | .56                                        |       | .86                                       |       | 1.25 |   | 1.68 |   |
| Earnings per share  (basic) – pro forma                                                             |   | .54                                        |       | .84                                       |       | 1.22 |   | 1.65 |   |
| Earnings per share  (diluted) – as reported                                                         |   | .56                                        |       | .86                                       |       | 1.25 |   | 1.67 |   |
| Earnings per share  (diluted) – pro forma                                                           |   | .54                                        |       | .83                                       |       | 1.22 |   | 1.64 |   |
|                                                                                                     |   |                                       |       |                                      |       |   |   |   |   |   |   |   |   |

 

The fair value of eachoption granted under the Stock Option Plans is estimated on the date of grantusing the Black-Scholes option-pricing model with the following assumptions usedfor all grants:

 
|                                                            |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |       |
|-----------------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|------------|
|                                                            |   | **2003**                                   |   | **2002**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| Dividend yield                                                  |   | 3.22                                       | %      | 3.36                                      | %          | 3.22 | % | 3.36 | % |
| Risk-free interest rate                                         |   | 2.09                                       | %      | 3.69                                      | %          | 2.09 | % | 3.69 | % |
| Volatility                                                      |   | 32.64                                      | %      | 86.94                                     | %          | 18.72 | % | 34.6 | % |
| Expected life (years)                                           |   | 2.9                                        |   | 3.3                                       |       | 2.9 |   | 3.3 |   |
| Weighted average fair  value of options granted during the year |   | $                                          | 6.37   |                                      | $          | 15.85 |   | $ | 3.49 |   | $ | 6.94 |   |
|                                                            |   |                                       |   |                                      |       |   |   |   |   |   |   |   |   |

 

**NOTE11 - FOREIGN CURRENCY FORWARD EXCHANGE CONTRACTS**

 

Certain of the Company’sforeign subsidiaries periodically enter into foreign currency forward exchangecontracts (“Forward Contracts”) to hedge inventory purchases, both anticipatedand firm commitments, denominated in the United States dollar.  Thesecontracts reduce foreign currency risk caused by changes in exchange rates andare used to hedge these inventory purchases, generally for periods up to 13months.  At September 30, 2003, the Company’s Forward Contracts haveexpiration dates which range from one to eight months.

 

Since there is a directrelationship between the Forward Contracts and the currency denomination of theunderlying transaction, such Forward Contracts are highly effective in hedgingthe cash flows of certain of the Company’s foreign subsidiaries related totransactions denominated in the United States dollar.  These ForwardContracts meet the criteria for cash flow hedge accounting treatment andaccordingly, gains or losses are included in other comprehensive income (loss)and are recognized in cost of sales based on the turnover of inventory.

 

**NOTE12 - RECENTLY ISSUED ACCOUNTING STANDARDS**

 

In June 2001, FASBissued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143will require the Company to record the fair value of an asset retirementobligation as a liability in the period in which it incurs a legal obligationassociated with the retirement of tangible long-lived assets that result fromthe acquisition, construction, development, and/or normal use of the assets.The Company also will record a corresponding asset that is depreciated over thelife of the asset. Subsequent to the initial measurement of the assetretirement obligation, the obligation will be adjusted at the end of eachperiod to reflect the passage of time and changes in the estimated future cashflows underlying the obligation. The Company adopted SFAS No. 143 onJanuary 1, 2003 and such adoption did not have a material effect on theCompany’s consolidated financial statements.

 

 

11

----

 

In June 2002, theFASB issued SFAS No. 146, Accounting for Costs Associated with Exit or DisposalActivities. SFAS No. 146 addresses financial accounting and reporting for costsassociated with exit or disposal activities and nullifies Emerging Issues TaskForce (EITF) Issue 94-3, Liability Recognition for Certain Employee TerminationBenefits and Other Costs to Exit an Activity. The provisions of this Statementare effective for exit or disposal activities that are initiated after December 31,2002. The Company adopted SFAS No. 146 with respect to the aforementionedactivities occurring during the quarter ended September 30, 2003, and suchadoption did not have a material impact on the Company’s consolidated financialstatements.

 

In November 2002,the FASB issued Interpretation No. 45, Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness toOthers.  This Interpretation elaborates on the disclosures to be made by aguarantor in its interim and annual financial statements about its obligationsunder guarantees issued.  The Interpretation also clarifies that aguarantor is required to recognize, at inception of a guarantee, a liabilityfor the fair value of the obligation undertaken.  The initial recognitionand measurement provisions of the Interpretation are applicable to guaranteesissued or modified after December 31, 2002 and did not have a materialeffect on the Company’s consolidated financial statements.

 

In January 2003, theFASB issued Interpretation No. 46, Consolidation of Variable Interest Entities,an interpretation of ARB No. 51.  This Interpretation addresses theconsolidation by business enterprises of variable interest entities as definedin the Interpretation.  The Interpretation applies immediately to variableinterests in variable interest entities created after January 31, 2003,and to variable interests in variable interest entities obtained afterJanuary 31, 2003.  The application of this Interpretation did nothave a material effect on the Company’s consolidated financial statements.

 

In April 2003, theFASB issued No. 149, “Amendment of Statement 133 on Derivatives Instruments andHedging Activities”. SFAS No. 149 amends and clarifies financial accounting andreporting for derivative instruments, including certain derivative instrumentsembedded in other contracts (collectively referred to as derivatives) and forhedging activities under SFAS No. 133 “Accounting for Derivative Instrumentsand Hedging Activities.” The changes are for decisions made as part of thederivatives implementation group process that effectively required amendmentsto Statement 133, in connection with other board projects dealing withfinancial instruments, and in connection with implementation issues raised inrelation to the application of the definition of a derivative, in particular,the meaning of an initial net investment that is smaller than would be requiredfor other types of contracts that would be expected to have a similar response tochanges in market factors, the meaning of underlying, and the characteristicsof a derivative that contains financing components. SFAS No. 149 will beeffective for contracts entered into or modified after June 30, 2003except for implementation issues that have been effective for fiscal quartersthat began prior to June 15, 2003, should continue to be applied inaccordance with their respective dates, and for hedging relationshipsdesignated after June 30, 2003 and all provisions of this Statement shouldbe applied prospectively.  The adoption of this statement did not have amaterial impact on the Company’s consolidated financial statements.

 

In May 2003, theFASB issued Statement of Financial Accounting Standard No. 150, Accounting forCertain Financials Instruments with Characteristics of both Liabilities andEquity.  SFAS No. 150 establishes standards for how an issuer classifiesand measures certain financial instruments with characteristics of bothliabilities and equity and requires that an issuer classify a financialinstrument that is within its scope as a liability (or an asset in somecircumstances). Previously, many of these instruments were classified asequity.  SFAS No. 150 is effective for financial instruments entered intoor modified after May 31, 2003, and otherwise is effective at thebeginning of the first interim period beginning after June 15, 2003,except for mandatorily redeemable financial instruments of non publicentities.  It is to be implemented by reporting the cumulative effect of achange in an accounting principle for financial instruments created before theissuance date of the Statement and still existing at the beginning of theinterim period of adoption.  Restatement is not permitted.  TheCompany does not believe the adoption of this statement will have a materialimpact on its consolidated financial statements.

 

**ITEM2.  MANAGEMENT’S DISCUSSION****AND ANALYSIS OF RESULTS OF OPERATIONSAND FINANCIAL CONDITION**

 

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

 

12

----

 

and results ofoperations.  This financial and business analysis should be read inconjunction with the Notes to the Consolidated Financial Statements in Item 1of this Quarterly Report on Form 10-Q and the Company’s Annual Report on Form10-K for the year ended December 31, 2002.

 

**SEGMENTS**

 

The Company operates intwo segments which consist of the Company’s core gift business and theCompany’s non-core business, which includes the Company’s July 26, 2002acquisition of Sassy, Inc.  The Company’s core business designs,manufactures through third parties and markets a wide variety of gift and homedécor products to retail stores throughout the United States and throughout theworld via the Company’s international wholly-owned subsidiaries anddistributors.  The Company’s non-core businesses design and marketfunctional consumer products sold at comparable price points with comparablegross margins to each other and consists of Sassy, Inc. since its acquisitionon July 26, 2002 and the Company’s wholly-owned subsidiary Bright ofAmerica, Inc.  These products are sold to consumers, primarily in theUnited States, through mass marketers.

 

**RESULTS OF OPERATIONS—NINE MONTHS ENDED SEPTEMBER 30,2003 AND 2002**

 

The Company’sconsolidated net sales for the nine months ended September 30, 2003 increased1.3% to $242,566,000 compared to consolidated net sales of $239,384,000 for thenine months ended September 30, 2002.  The net sales increase wasprimarily attributable to the Company’s non-core segment, specifically, fromsales generated by Sassy, Inc., whose results of operations are included sinceits acquisition on July 26, 2002, offset in part by the decline in netsales in the Company’s core segment in its United States and certaininternational markets.

 

The Company’s coresegment’s net sales for the nine months ended September 30, 2003 decreased10.7% to $199,285,000 compared to core net sales of $223,077,000 for the ninemonths ended September 30, 2002 primarily as a result of the continuingdifficult retail environment in its United States and certain internationalmarkets.  Net sales in the Company’s core segment benefited from foreignexchange rates by approximately $7,400,000 for the nine months ended September30, 2003.  The Company’s non-core segment’s net sales for the nine monthsended September 30, 2003 increased to $43,281,000 compared to non-core netsales of $16,307,000 for the nine months ended September 30, 2002 as a resultof the acquisition of Sassy, Inc.

 

Consolidated cost ofsales were 46.4% of consolidated net sales for the nine months ended  September30, 2003 as compared to 44.6% of consolidated net sales for the nine monthsended September 30, 2002.    Cost of sales for the Company’s coresegment were 42.4% of net sales for such segment for the nine months endedSeptember 30, 2003 as compared to 43.2% of net sales for the nine months endedSeptember 30, 2002 due primarily to lower charitable donations of inventory inthe nine months ended September 30, 2003 as compared to the nine months endedSeptember 30, 2002.  Cost of sales for the Company’s non-core segment were65.1% of net sales for such segment for the nine months ended September 30,2003 as compared to 63.0% of net sales for the nine months ended September 30,2002 primarily due to the addition of Sassy, Inc.

 

Consolidated selling,general and administrative expense was $98,032,000 or 40.4% of consolidated netsales for the nine months ended September 30, 2003 compared to $90,525,000 or37.8% of consolidated net sales for the nine months ended September 30,2002.  This increase in consolidated selling, general and administrativeexpense is due primarily to the addition of Sassy, Inc. to its non-coresegment, a $1,300,000 restructuring charge for headcount reductions and closureof certain of the Company’s showrooms completed during the third quarter whichis expected to result in reduced overhead prospectively, and higher systemsrelated costs in its core segment.  See“Liquidity and Capital Resources” below.

 

Consolidated investmentand other income of $4,403,000 for the nine months ended September 30, 2003compares to $5,775,000 for the nine months ended September 30, 2002, a decreaseof $1,372,000, or 23.8%.  This decrease was primarily the result of lowerinvestment income, offset, in part, by foreign exchange gains for the nine monthsended September 30, 2003 as compared to foreign exchange losses for the ninemonths ended September 30, 2002 in the Company’s core segment (See Notes 2 and9 to the Notes to the Consolidated Financial Statements).

 

13

----

 

The consolidatedprovision for income taxes as a percent of income before taxes for the ninemonths ended September 30, 2003 was 29.1% compared to 28.5% for the nine monthsended September 30, 2002.  The increase in the effective income tax rateis due primarily to a lower amount of charitable donations resulting in areduced income tax benefit as compared to the nine months ended September 30,2002.

 

Consolidated net incomefor the nine months ended September 30, 2003 was $25,752,000 compared toconsolidated net income of $34,308,000 for the nine months ended September 30,2002, representing a decrease of $8,556,000 or 24.9% and a decrease of $0.42,or 25.1%, per diluted share (See Note 3 to the Notes to the ConsolidatedFinancial Statements).  The decrease in consolidated net income wasprimarily the result of decreased sales in the Company’s core segment,increased consolidated selling, general and administrative expense and lowerinvestment and other income, slightly offset by increased sales in theCompany’s non-core segment, as described above.

 

**RESULTS OF OPERATIONS—THREE MONTHS ENDED SEPTEMBER 30, 2003AND 2002**

 

The Company’sconsolidated net sales for the three months ended September 30, 2003 declined8.2% to $87,848,000 compared to consolidated net sales of $95,740,000 for thethree months ended September 30, 2002.  The net sales decrease wasprimarily attributable to the decline in net sales in the Company’s coresegment in its United States and certain international markets, offset, in part,by the increase in sales in the Company’s non-core segment, specifically, fromsales generated by Sassy, Inc., whose results of operations are included sinceits acquisition on July 26, 2002.

 

The Company’s coresegment’s net sales for the three months ended September 30, 2003 decreased12.0% to $73,681,000 compared to core net sales of $83,761,000 for the threemonths ended September 30, 2002 primarily as a result of the continuingdifficult retail environment in its United States and certain internationalmarkets.  Net sales in the Company’s core segment benefited from foreignexchange rates by approximately $2,700,000 in the three months ended September30, 2003.  The Company’s non-core segment’s net sales for the three monthsended September 30, 2003 increased to $14,167,000 compared to non-core netsales of $11,979,000 for the three months ended September 30, 2002 as a resultof the acquisition of Sassy, Inc.

 

Consolidated cost ofsales increased to 46.9% of consolidated net sales for the three months endedSeptember 30, 2003, as compared to 43.8% of consolidated net sales for thethree months ended September 30, 2002.  Cost of sales for the Company’score segment were 43.5% of net sales for such segment for the three monthsended September 30, 2003 as compared to 40.8% of net sales for the three monthsended September 30, 2002, due primarily to lower gross profit margins on salesof certain of the Company’s core product line concepts and higher inventoryreserve requirements. Cost of sales for the Company’s non-core segment were65.0% of net sales for such segment for the three months ended September 30,2003 as compared to 64.4% of net sales for the three months ended September 30,2002, due primarily to the addition of Sassy, Inc. in the comparable threemonths of the prior year.

 

Consolidated selling,general and administrative expense was $32,217,000 or 36.7% of consolidated netsales for the three months ended September 30, 2003 compared to $30,931,000 or32.3% of consolidated net sales for the three months ended September 30,2002.  This increase in consolidated selling, general and administrativeexpense is due primarily to a $1,300,000 restructuring charge resulting fromheadcount reductions and closure of certain of the Company’s showrooms completedin the third quarter which are expected to result in reduced overheadprospectively, higher systems related costs in its core segment and theaddition of Sassy, Inc. to its non-core segment, offset, in part, by lowercosts in the Company’s core business for the three months ended September 30,2003.

 

Consolidated investmentand other income of $1,131,000 for the three months ended September 30, 2003compares to $1,216,000 for the three months ended September 30, 2002, adecrease of $85,000, or 7.0%.  This decrease was primarily the result oflower investment income, offset, in part, by foreign exchange gains for the three months ended September 30, 2003 ascompared to foreign exchange losses in the three months ended September 30,2002 in the Company’s core segment (See Notes 2 and 9 to the Notes to theConsolidated Financial Statements).

 

14

----

 

The consolidatedprovision for income taxes as a percent of income before taxes for the threemonths ended September 30, 2003 was 25.4% compared to 27.1% for the threemonths ended September 30, 2002.  The decrease in the effective income taxrate is due primarily to the finalization of audits of U.S. tax returns through1999, true up of the Company’s tax provision to its recently filed U.S. taxreturn and lower effective tax rates of certain of its internationalsubsidiaries.

 

Consolidated net incomefor the three months ended September 30, 2003 was $11,595,000 compared toconsolidated net income of $17,599,000 for the three months ended September 30,2002, representing a decrease of $6,004,000 or 34.1% and a decrease of $0.30 or34.9% per diluted share (See Note 3 to the Notes to the Consolidated FinancialStatements).  The decrease in consolidated net income was primarily theresult of the sales decline in the core segment, increased consolidatedselling, general and administrative expense and lower investment and otherincome, offset, in part, by the lower effective income tax rate, as discussedabove.

 

The Company is dependentupon information technology systems in many aspects of its business. During 2002, the Company began a project to implement a new Enterprise ResourcePlanning (“ERP”) system for the Company’s core businesses and successfullycompleted the replacement of its warehouse management system in its SouthBrunswick, New Jersey and Petaluma, California, Canadian and Europeandistribution facilities in addition to the implementation of the purchasingmodule of its new ERP system worldwide.  The Company’s prior customsoftware that had been utilized to operate and manage its business and otherthird party software systems are being replaced using a strategic and phasedapproach.  The Company’s worldwide headquarters in the United Statescompleted the implementation of the finance module of the new ERP system in thefirst quarter of 2003 and transitioned to the order management and inventorymodules during the second quarter of 2003.  The Company’s internationalsubsidiaries have begun to phase-in certain aspects of the Company’s new ERPsystem and the transition to order management, inventory and finance modules isnow anticipated by the end of the fourth quarter of 2004.  This delay ismeant to continue to enable the Company to enhance its proficiency in utilizingthe new system and to help ensure the efficiency of the internationalimplementations.  The Company has experienced certain startup issues buthas not experienced any significant business disruptions related to thereplacement of these systems.

 

**Liquidityand Capital Resources**

 

As of September 30,2003, the Company had cash, cash equivalents, marketable securities and otherinvestments of $223,953,000 as compared to $225,751,000 at December 31,2002.

 

As of September 30,2003 and December 31, 2002, the Company had marketable securities andother investments of $155,713,000 and $132,238,000 respectively, included inthe amounts above.  This increase is primarily a result of the Company’sinvestment of additional cash and cash equivalents in marketablesecurities.  As of September 30, 2003 these investments consist ofU.S. government obligations, municipal obligations, preferred stock, mutualfunds and equity securities.  The objective of the investment portfolio isto maximize after-tax returns while minimizing risk.  The Company’smarketable securities are subject to market fluctuations based largely, but notexclusively, on the securities’ sensitivity to changes in interest rates. For more information regarding marketable securities and other investments, seeNote 2 of the Notes to Consolidated Financial Statements.

 

Working capitalrequirements during the quarter ended September 30, 2003 were met entirelythrough internally generated funds.  The Company anticipates capitalexpenditure requirements for 2003 to be approximately $8,000,000, primarily forsystems development costs.  Capital expenditures for the quarter endedSeptember 30, 2003 of $2,391,000 and $6,437,000 for the nine months endedSeptember 30, 2003 were primarily for systems development.  TheCompany remains in a highly liquid position and believes that the resourcesavailable from cash and cash equivalents, marketable securities, operations andbank lines of credit are sufficient to meet the foreseeable requirements of itsbusiness.

 

Certain buildings,including the newly constructed facility in the United Kingdom, are leased fromentities or parties owned or controlled by, or related to the late RussellBerrie, one of the Company’s former directors, who was also Chairman and ChiefExecutive Officer of the Company and a significant shareholder, until his deathon December 25, 2002.  Ms. Angelica Berrie, Chief Executive Officer,Director of the Company and the widow of Mr. Berrie, is the beneficial owner ofthe landlord of the UK facility as distributee under a trust established by thelate Mr. Berrie, subject to administration by the executors of the Estate ofRussell Berrie and by the trustees of said

 

15

----

 

trust.  The lease,which commenced in April 2002, is for a term of twenty years and includesa tenant’s option to terminate the lease at the end of the tenth year. The Company occupied the facility in June 2002.  Annual base rentalis approximately $1,600,000 with rent reviews at the end of every fifth year ofthe lease, adjusted to an open market rental value.  A discussion of otherrelated party information including debt guarantees is included in Item 13,“CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS”, of the Company’s Annual Reporton Form 10-K for the year ended December 31, 2002.

 

The Company enters intoforward exchange contracts, principally to manage the economic currency risksassociated with the purchase of inventory by its European, Canadian andAustralian subsidiaries.  Gains and losses related to such contracts werenot material to its results of operations or cash flows.  The Company doesnot anticipate any material adverse impact on its results of operations orfinancial position from these contracts.

 

As of September 30,2003, the Board of Directors had previously authorized the Company torepurchase 7,000,000 shares of common stock of which 5,643,200 shares have beenrepurchased since the beginning of the Company’s stock repurchase program inMarch 1990.  During the quarter ended September 30, 2003, noshares were repurchased by the Company.

 

Cash dividends of$5,777,000 ($0.28 per share) and $5,318,000 ($0.26 per share) were paid in thequarters ended September 30, 2003 and September 30, 2002,respectively.  Cash dividends of $17,289,000 ($0.28 per share per quarter)and $15,921,000 ($0.26 per share per quarter) were paid in the nine monthsended September 30, 2003 and September 30, 2002, respectively.

 

The Company is subject tolegal proceedings and claims arising in the ordinary course of its businessthat could possibly have a material adverse impact on the Company’s results ofoperations and cash flows.  See Note 6 of the Notes to ConsolidatedFinancial Statements for information regarding specific litigation.

 

In connection with theCompany’s continuing expansion of its operations in the People’s Republic ofChina (“PRC”), the Company completed a voluntary review of the activities ofits offices in the PRC to assess their compliance with applicable laws andregulations.  As a result of this review, management became aware of somepotential operational and tax compliance issues under applicable PRC laws andregulations and is taking appropriate corrective actions.  As a result,although the relevant PRC authorities have broad discretion with respect to theimposition of sanctions on noncompliant companies, the Company does not expectthe consequences, if any, of these matters to have a material impact on itsresults of operations, financial condition or cash flows.

 

Consistent with its pastpractices and in the normal course of its business, the Company regularlyreviews acquisition opportunities of varying sizes.  There can be noassurance, however, that any discussions arising in connection therewith willresult in definitive purchase agreements and, if they do, what the terms ortiming of any such agreements would be.

 

The Board of Directors is exploring various strategic alternatives thatmay be available to the Company and has engaged Bear Stearns to act as itsfinancial advisor in this connection. At this time, there can be no assurance as to when or if thesepreliminary efforts will lead to a transaction.  The Company’s financial advisor believes that it is unlikely thatany transaction in the foreseeable future would value the Company significantlyin excess of its current market capitalization.

 

**CRITICALACCOUNTING POLICIES**

 

Financial ReportingRelease No. 60, “Cautionary Advice Regarding Disclosure about CriticalAccounting Policies”, issued by the Securities and Exchange Commission (“SEC”),advises companies to include a discussion of critical accounting policies ormethods used in the preparation of financial statements. Note 2 of theNotes to Consolidated Financial Statements on the Company’s Annual Report onForm 10-K for the year ended December 31, 2002, includes a summary ofthe significant accounting policies and methods used in the preparation of theCompany’s Consolidated Financial Statements. The following is a briefdiscussion of those accounting policies and methods used by the Company whichrequire subjective judgments and are considered critical to the understandingof the Company’s consolidated financial condition, results of operations andcash flows.

 

**MarketableSecurities and Other Investments**

 

The Company has asignificant amount of marketable securities, all of which are considered asavailable-for-sale investments, in accordance with SFAS No. 115,“Accounting for Certain Investments in Debt and Equity Securities”.Accordingly, these investments, except for the investment in the limitedpartnership, which was

 

16

----

 

liquidated in July 2003,are carried in the accompanying consolidated balance sheet at fair value, withthe difference between cost and fair value recorded as a component ofshareholders’ equity, net of tax, in Accumulated Other ComprehensiveIncome/Loss. The investment in the limited partnership was accounted for usingthe equity method and accordingly the Company’s proportionate share of the limitedpartnership’s income or loss amounting to a non-cash loss of $49,000 for thequarter ended September 30, 2003, which is included in investment andother income-net in the Consolidated Statement of Income.  Realized gainsand losses on sales of investments, as determined on a specific identificationbasis, are included in the Consolidated Statement of Income.  As ofSeptember 30, 2003, marketable securities were comprised primarily of U.S.government obligations, municipal obligations, preferred stock, mutual fundsand other equity securities. The Company’s marketable securities are subject tomarket fluctuations based largely, but not exclusively, on the securities’sensitivity to changes in interest rates.

 

17

----

 

**AccountsReceivable, Trade and Revenue Recognition**

 

In the normal course ofbusiness, the Company extends credit to customers which satisfy establishedcredit criteria. The Company believes that it does not have a significantconcentration of credit risk due to the significant diversity of its customerbase. Accounts receivable, trade, as shown on the Consolidated Balance Sheet,is net of allowances, discounts and estimated bad debts. An allowance fordoubtful accounts is determined through analysis of the aging of accountsreceivable at the date of the financial statements, assessments ofcollectibility based on historical trends and an evaluation of the impact ofcurrent and projected economic conditions.

 

The Company recognizesrevenue in accordance with SEC Staff Accounting Bulletin No. 101, RevenueRecognition in Financial Statements (SAB 101), as amended.  SAB 101requires that four basic criteria must be met before revenue can be recognized:(1) persuasive evidence of a sales arrangement exists; (2) deliveryhas occurred or services rendered; (3) the amount of revenue is fixed anddeterminable; and (4) collectibility is reasonably assured.

 

Determination of criteria(3) and (4) are based on management’s judgments regarding the fixed nature of theamounts billed to the Company’s customers for products delivered and servicesrendered and the collectibility of those revenues.

 

**Inventory**

 

The Company valuesinventory at the lower of the actual cost or its current estimated marketvalue. The Company regularly reviews inventory quantities on hand, by item, andrecords a provision for excess inventory based primarily on the Company’shistorical experience and estimated forecast of product demand using historicaland recent ordering data relative to the quantity on hand for each item. Asignificant decrease in demand for the Company’s products could result in anincrease in the amount of excess inventory quantities on hand, however, theCompany manages inventory and monitors product purchasing to minimize thisrisk.

 

**Impairmentof Long-Lived Assets**

 

In accordance with SFASNo. 144, long-lived assets, such as property, plant, and equipment, andpurchased intangibles subject to amortization, are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Recoverability of assets to be held andused is measured by a comparison of the carrying amount of an asset toestimated undiscounted future cash flows expected to be generated by the asset.If the carrying amount of an asset exceeds its estimated future cash flows, animpairment charge is recognized by the amount by which the carrying amount ofthe asset exceeds the fair value of the asset, which is generally based ondiscounted cash flows.

 

Goodwill and intangibleassets not subject to amortization are tested annually for impairment, and aretested for impairment more frequently if events and circumstances indicate thatthe asset might be impaired. An impairment loss is recognized to the extentthat the carrying amount exceeds the asset’s fair value.

 

**AccruedLiabilities**

 

The preparation of theCompany’s consolidated financial statements in conformity with generallyaccepted accounting principles in the United States requires management to makecertain estimates and assumptions that affect the reported amounts ofliabilities and disclosure of contingent liabilities at the date of thefinancial statements. Such liabilities include, but are not limited to,accruals for various legal matters, tax accruals and valuation allowances,self-funded medical claims for its domestic business, product liability claims,sales commissions and bonuses and management incentive compensation plans. Thesettlement of the actual liabilities could differ from the estimates includedin the Company’s consolidated financial statements.

 

18

----

 

**RECENTLYISSUED ACCOUNTING STANDARDS**

 

The information set forthin Part I, Financial Information, Item 1, Notes to Consolidated FinancialStatements, Note 12 - “Recently Issued Accounting Standards”, of this QuarterlyReport on Form 10-Q is incorporated herein by reference thereto.

 

**FORWARD-LOOKINGSTATEMENTS**

 

This Quarterly Report onForm 10-Q contains certain forward-looking statements. Additional written andoral forward-looking statements may be made by the Company from time to time inSecurities and Exchange Commission (SEC) filings and otherwise. The PrivateSecurities Litigation Reform Act of 1995 provides a safe-harbor forforward-looking statements. These statements may be identified by the use offorward-looking words or phrases including, but not limited to, “anticipate”,“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 uncertaintiesinclude, but are not limited to, the Company’s ability to continue to manufactureits products in the Far East, the seasonality of revenues, the actions ofcompetitors, ability to increase production capacity, price competition, theeffects of government regulation, results of any enforcement action by thePeople Republic of China (“PRC”) authorities with respect to the Company’s PRCoperations, the resolution of various legal matters, possible delays in theintroduction of new products, customer acceptance of products, issues relatedto the Company’s new business ventures, changes in foreign currency exchangerates, issues related to the Company’s computer systems, the current and futureoutlook of the global retail market, and other factors.

 

**ITEM 3.  QUANTITATIVE ANDQUALITATIVE DISCLOSURES****ABOUTMARKET RISK**

 

As of September 30,2003, there have been no material changes in the Company’s market risks asdescribed in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2002.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

Basedon the evaluation required by paragraph (b) of Rule 13a-15 or 15d-15promulgated under the Securities Exchange Act of 1934, as amended (the“Exchange Act”), the Company’s Chief Executive Officer and Chief FinancialOfficer have concluded that, as of the end of the period covered by thisreport, the Company’s disclosure controls and procedures (as defined in Rules13a-15(e) or 15d-15(e) under the Exchange Act), are effective.

 

Therehas been no change in the Company’s internal control over financial reportingthat occurred during the fiscal quarter to which this report relates that hasmaterially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

**PART II - OTHER INFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS**

 

The information set forthin Part I, Financial Information, Item 1, “Notes to Consolidated FinancialStatements, Note 6 — Litigation,” of this Quarterly Report on Form 10-Q isincorporated herein by reference thereto.

 

**ITEM 6.  EXHIBITS AND REPORTS ONFORM 8-K**

 

a)                 Exhibits to this Quarterly Report on Form 10-Q.

 

19

----

 

10.72   Letter dated July 2, 2003 between the Companyand Arnold Bloom regarding retention bonus.

 

10.73   Letter dated July 2, 2003 between the Companyand Chris Robinson regarding retention bonus.

 

10.74   Letter dated July 2, 2003 between the Companyand Curts Cooke regarding retention bonus.

 

10.75   Letter dated July 2, 2003 between the Companyand Dan Schlotterbeck regarding retention bonus.

 

10.76   Letter dated July 2, 2003 between the Companyand Eva Goldenberg regarding retention bonus.

 

10.77   Letter dated July 2, 2003 between the Companyand Jack Toolan regarding retention bonus.

 

10.78   Letter dated July 2, 2003 between the Companyand Jeff Bialosky regarding retention bonus

 

10.79   Letter dated July 2, 2003 between the Companyand John Wille regarding retention bonus

 

10.80   Letter dated July 2, 2003 between the Companyand Michael Saunders regarding retention bonus

 

10.81   Letter dated July 2, 2003 between the Companyand Ricky Chan regarding retention bonus

 

10.82   Letter dated July 2, 2003 between the Companyand Tom Higgerson regarding retention bonus

 

10.83   Executive Employment Agreement datedSeptember 22, 2003 between Russ Berrie and Company, Inc. and John T. Toolan

 

10.84   Stock Option Agreement dated September 8,2003 between Russ Berrie and Company, Inc. and Geff Lee.

 

10.85   Stock Option Agreement dated September 5,2003 between Russ Berrie and Company, Inc. and Dennis Nesta.

 

31.1     Certification of CEO required by Section302 of the Sarbanes Oxley Act of 2002.

 

31.2     Certification of CFO required by Section302 of the Sarbanes Oxley Act of 2002.

 

32.1     Certification of CEO required by Section906 of the Sarbanes Oxley Act of 2002.

 

32.2     Certification of CFO required by Section906 of the Sarbanes Oxley Act of 2002.

 
| b) |   | During the quarter  ended September 30, 2003, the Company filed a current report on Form 8-K  on July 31, 2003 under Item 7.  Financial Statements, Pro Forma  Financial Information and Exhibits and Item 12. Results of Operations and  Financial Condition, with respect to the issuance of a press release covering  results of operations and financial condition for the second quarter of 2003. |
|----|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

 

**Items2, 3, 4 and 5 are not applicable and have been omitted.**

 

20

----

 

**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/ John D. Wille                           |   |
| Date:   November 14, 2003 |                          |                                        | John D. Wille |
|                                     |                          |                                        |   |
|                                     |                          | Vice President and  Chief Financial Officer |
|                                     |                          |                                        |   |   |   |
|                                          |                               |                                             |  |  |  |  |

 

21

----