**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 
| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION  13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|-----------------------------------------------------------------------------------------------|

 

**For the quarterly period ended March 31, 2005**

 

**OR**

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

 

**For the transition periodfrom             to              **

 

**Commissionfile number  1-8681**

 

**RUSSBERRIE AND COMPANY, INC.**

(Exactname 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 mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15 (d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes  ý  No  o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the ExchangeAct). Yes  ý  No  o

 

The number of shares outstanding of each ofthe registrant’s classes of common stock, as of April 30, 2005 was asfollows:

 
| **CLASS**                         | ** ** | **OUTSTANDING  At April 30, 2005** |
|-----------------------------------|------------|------------------------------------|
| Common  Stock, $0.10 stated value |       | 20,824,475                         |

 

 

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**RUSS BERRIE AND COMPANY, INC.**

 

**INDEX**

 
| **PART I – FINANCIAL INFORMATION** |   |
|-----------------------------------------|--------|
|                                    |   |
| Item 1.                                 |   | Financial Statements |   |
|                                    |   |   |   |
| a)                                      |   | Consolidated Balance Sheet  as of March 31, 2005 and December 31, 2004 |   |
|                                    |   |   |   |
| b)                                      |   | Consolidated  Statement of Income for the three months ended March 31, 2005 and 2004 |   |
|                                    |   |   |   |
| c)                                      |   | Consolidated  Statement of Cash Flows for the three months ended March 31, 2005 and  2004 |   |
|                                    |   |   |   |
| d)                                      |   | Notes  to Consolidated Financial Statements |   |
|                                    |   |   |   |
| Item  2.                                |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|                                    |   |   |   |
| Item  3.                                |   | Quantitative  and Qualitative Disclosures About Market Risk |   |
|                                    |   |   |   |
| Item 4.                                 |   | Controls and  Procedures |   |
|                                    |   |
| **PART II – OTHER INFORMATION**    |   |
|                                    |   |
| Item 6.                                 |   | Exhibits |   |
|                                    |   |   |   |
| Signatures                              |   |

 

2

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**PART 1- FINANCIAL INFORMATION**

 

**ITEM1.  FINANCIAL STATEMENTS**

 

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

**CONSOLIDATED BALANCE SHEET****S**

**(Dollars in Thousands)(UNAUDITED)**

 
| ** **                                                                                                                               | ** ** | **March 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ***ASSETS***                                                                                                                             |       |                    |       |                       |       |
| Current assets                                                                                                                           |       |                    |       |                       |       |
| Cash and cash equivalents                                                                                                                |       | $                       | 41,646     |                       | $          | 48,099 |   |
| Restricted cash                                                                                                                          |       | 3⁄4                  |       | 4,604                      |       |
| Accounts receivable, trade, less allowances  of $3,299 in 2005 and $2,950 in 2004                                                        |       | 64,198                  |       | 75,722                     |       |
| Inventories — net                                                                                                                   |       | 41,326                  |       | 47,391                     |       |
| Prepaid expenses and other current assets                                                                                                |       | 6,229                   |       | 6,090                      |       |
| Income tax receivable                                                                                                                    |       | 12,577                  |       | 11,359                     |       |
| Deferred income taxes                                                                                                                    |       | 2,830                   |       | 2,860                      |       |
| **Total current assets**                                                                                                                 |       | 168,806                 |       | 196,125                    |       |
|                                                                                                                                     |       |                    |       |                       |       |
| Property, plant and equipment — net                                                                                                 |       | 27,080                  |       | 28,690                     |       |
| Goodwill                                                                                                                                 |       | 89,213                  |       | 89,213                     |       |
| Intangible assets                                                                                                                        |       | 61,683                  |       | 61,927                     |       |
| Restricted cash                                                                                                                          |       | 11,082                  |       | 11,026                     |       |
| Deferred income taxes                                                                                                                    |       | 4,518                   |       | 4,518                      |       |
| Other assets                                                                                                                             |       | 11,353                  |       | 10,852                     |       |
| Assets held for sale                                                                                                                     |       | 3⁄4                  |       | 8,747                      |       |
| **Total assets**                                                                                                                         |       | $                       | 373,735    |                       | $          | 411,098 |   |
|                                                                                                                                     |       |                    |       |                       |       |
| ***LIABILITIES AND SHAREHOLDERS’ EQUITY***                                                                                          |       |                    |       |                       |       |
| Current liabilities                                                                                                                      |       |                    |       |                       |       |
| Current portion of long term debt                                                                                                        |       | $                       | 7,000      |                       | $          | 25,250 |   |
| Accounts payable                                                                                                                         |       | 6,622                   |       | 12,137                     |       |
| Accrued expenses                                                                                                                         |       | 26,331                  |       | 35,204                     |       |
| Accrued income taxes                                                                                                                     |       | 4,365                   |       | 4,241                      |       |
| **Total current liabilities**                                                                                                            |       | 44,318                  |       | 76,832                     |       |
| Long term debt, excluding current portion                                                                                                |       | 98,000                  |       | 99,750                     |       |
| **Total liabilities**                                                                                                                    |       | $                       | 142,318    |                       | $          | 176,582 |   |
| Commitments and contingencies                                                                                                            |       |                    |       |                       |       |
| Shareholders’ equity                                                                                                                |       |                    |       |                       |       |
| Common stock: $.10 stated value per share;  authorized 50,000,000 shares; issued 2005, 26,460,759 shares; 2004 –  26,460,759 shares |       | 2,648                   |       | 2,648                      |       |
| Additional paid in capital                                                                                                               |       | 88,685                  |       | 88,693                     |       |
| Retained earnings                                                                                                                        |       | 236,215                 |       | 237,937                    |       |
| Accumulated other comprehensive income                                                                                                   |       | 14,019                  |       | 15,388                     |       |
| Treasury stock, at cost (5,636,284 shares  at March 31, 2005 and at December 31, 2004)                                         |       | (110,150                | )          | (110,150                   | )          |
|                                                                                                                                     |       |                    |       |                       |       |
| **Total shareholders’ equity**                                                                                                      |       | 231,417                 |       | 234,516                    |       |
| **Total liabilities and shareholders’ equity**                                                                                      |       | $                       | 373,735    |                       | $          | 411,098 |   |

 

*The accompanying notes arean integral part of the consolidated financial statements.*

 

3

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

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 

**(Dollars in Thousands, Except Per Share Data)**

 

**(UNAUDITED)**

 
| ** **                                                     | ** ** | **THREE MONTHS ENDED  MARCH 31,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                     | ** ** | **2005**                               | ** ** | **2004** | ** ** |
|                                                           |       |                                   |       |   |   |
| Net sales                                                      |       | $                                      | 70,740     |   | $ | 65,713 |   |
|                                                           |       |                                   |       |   |   |
| Cost of Sales                                                  |       | 39,344                                 |       | 32,610 |   |
|                                                           |       |                                   |       |   |   |
| **Gross profit**                                               |       | 31,396                                 |       | 33,103 |   |
|                                                           |       |                                   |       |   |   |
| Selling, general and administrative expenses                   |       | 30,685                                 |       | 34,441 |   |
|                                                           |       |                                   |       |   |   |
| Investment and other (expense) income-net                      |       | (3,451                                 | )          | 1,963 |   |
|                                                           |       |                                   |       |   |   |
| **(Loss) income before (benefit) provision  for income taxes** |       | (2,740                                 | )          | 625 |   |
|                                                           |       |                                   |       |   |   |
| (Benefit) provision for income taxes                           |       | (1,018                                 | )          | 189 |   |
|                                                           |       |                                   |       |   |   |
| **Net (loss) income**                                          |       | $                                      | (1,722     | ) | $ | 436 |   |
|                                                           |       |                                   |       |   |   |
| **Net (loss) income per share:**                               |       |                                   |       |   |   |
| Basic                                                          |       | $                                      | (0.08      | ) | $ | 0.02 |   |
| Diluted                                                        |       | $                                      | (0.08      | ) | $ | 0.02 |   |
|                                                           |       |                                   |       |   |   |
| **Weighted average shares:**                                   |       |                                   |       |   |   |
| Basic                                                          |       | 20,824,000                             |       | 20,684,000 |   |
| Diluted                                                        |       | 20,824,000                             |       | 20,762,000 |   |

 

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

 

4

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

 

**CONSOLIDATED STATEMENT OF CASH FLOWS**

 

**(Dollars in Thousands)(UNAUDITED)**

 
| ** **                                                                               | ** ** | **THREE MONTHS ENDED  MARCH 31,** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                               | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| **Cash flows from operating activities:**                                                |       |                                   |       |   |   |
| Net income                                                                               |       | $                                      | (1,722     | ) | $ | 436 |   |
| Adjustments to reconcile net(loss) income  to net cash provided by operating activities: |       |                                   |       |   |   |
| Depreciation and amortization                                                            |       | 1,898                                  |       | 1,673 |   |
| Amortization of Deferred financing cost                                                  |       | 416                                    |       | 3⁄4 |   |
| Provision for accounts receivable reserves                                               |       | 96                                     |       | 620 |   |
| Other                                                                                    |       | 90                                     |       | 751 |   |
| Changes in assets and liabilities :                                                      |       |                                   |       |   |   |
| Restricted cash                                                                          |       | 4,548                                  |       | 3⁄4 |   |
| Accounts receivable                                                                      |       | 11,428                                 |       | 18,699 |   |
| Inventories—net                                                                     |       | 6,065                                  |       | 3,844 |   |
| Prepaid expenses and other current assets                                                |       | (139                                   | )          | (346 | ) |
| Other assets                                                                             |       | (129                                   | )          | 2,113 |   |
| Accounts payable                                                                         |       | (5,515                                 | )          | (3,165 | ) |
| Accrued expenses                                                                         |       | (8,873                                 | )          | (10,163 | ) |
| Income taxes                                                                             |       | (1,064                                 | )          | (2,259 | ) |
| Total adjustments                                                                        |       | 8,821                                  |       | 11,767 |   |
| Net cash provided by operating activities                                                |       | 7,099                                  |       | 12,203 |   |
| **Cash flows from investing activities:**                                                |       |                                   |       |   |   |
| Purchase of marketable securities and other  investments                                 |       | 3⁄4                                 |       | (138,334 | ) |
| Proceeds from sale of marketable securities  and other investments                       |       | 3⁄4                                 |       | 234,263 |   |
| Proceeds from sale of property, plant and  equipment                                     |       | 8,761                                  |       | 45 |   |
| Capital expenditures                                                                     |       | (320                                   | )          | (723 | ) |
| Other                                                                                    |       | (31                                    | )          | 3⁄4 |   |
| Net cash provided by investing activities                                                |       | 8,410                                  |       | 95,251 |   |
| **Cash flows from financing activities:**                                                |       |                                   |       |   |   |
| Proceeds from issuance of common stock                                                   |       | —                                 |       | 1,647 |   |
| Dividends paid to shareholders                                                           |       | 3⁄4                                 |       | (6,215 | ) |
| Payment of Deferred Financing cost                                                       |       | (788                                   | )          | 3⁄4 |   |
| Payment of Long Term Debt                                                                |       | (20,000                                | )          | 3⁄4 |   |
| Net cash (used in) financing activities                                                  |       | (20,788                                | )          | (4,568 | ) |
| Effect of exchange rate changes on cash and  cash equivalents                            |       | (1,174                                 | )          | 1,137 |   |
| Net (decrease) increase in cash and cash  equivalents                                    |       | (6,453                                 | )          | 104,023 |   |
| Cash and cash equivalents at beginning of  period                                        |       | 48,099                                 |       | 81,535 |   |
| Cash and cash equivalents at end of period                                               |       | $                                      | 41,646     |   | $ | 185,558 |   |
| **Cash paid during the year for:**                                                       |       |                                   |       |   |   |
| Interest expense                                                                         |       | $                                      | 3,077      |   | $ | 15 |   |
| Income taxes                                                                             |       | $                                      | 405        |   | $ | 2,237 |   |

 

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

 

5

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**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

(Unaudited)

 

**NOTE 1 - INTERIM CONSOLIDATEDFINANCIAL STATEMENTS**

 

The accompanying unaudited interim consolidatedfinancial statements have been prepared by Russ Berrie and Company, Inc.and its subsidiaries (the “Company”) in accordance with accounting principlesgenerally accepted in the United States of America for interim financialreporting and the instructions to the Quarterly Report on Form 10-Q and Rule 10-01of Regulation S-X.  Accordingly, 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 information furnished reflects alladjustments, which are, in the opinion of management, of a normal recurringnature and necessary for a fair presentation of the Company’s consolidatedfinancial position, results of operations and cash flows for the interimperiods presented.  Results for interimperiods are not necessarily an indication of results to be expected for theyear.

 

Priorto the acquisition of Kids Line, LLC, the Company had two reportable segments:the core segment, which consisted of the Company’s gift business, and thenon-core segment, which consisted of the businesses of Sassy, Inc. andBright of America, Inc.  After theacquisition of Kids Line as of December 15, 2004, the Company reclassifiedits operations into three reportable segments: (i) the Company’s giftbusiness, (ii) the Company’s infant and juvenile business, which consistsof the businesses of Sassy, Inc. and Kids Line, LLC, and (iii) itsnon-core business, which consisted of Bright of America, Inc., until itssale effective August 2, 2004.  TheCompany has redefined its 2004 segment disclosures to conform to the newsegment classifications.  Note, however,that as a result of the sale of Bright of America, the Company currentlyoperates in two segments:  (i) itsgift business and (ii) its infant and juvenile business.  The segmentation of the Company’s operationsreflects how the Company’s chief executive officer currently views results ofoperations.  There are no intersegmentrevenues.

 

The Company’s gift business designs, manufacturesthrough third parties and markets a wide variety of gift products to retailstores throughout the United States and throughout the world via the Company’sinternational wholly-owned subsidiaries and distributors.  The Company’s infant and juvenile businessesdesign and market products in a number of baby categories including, amongothers, infant bedding and accessories, bath toys and accessories,developmental toys, feeding items and baby comforting products, and consists ofSassy, Inc. and Kids Line LLC. These products are sold to consumers, primarily in the United States,through mass merchandisers, toy, specialty, food, drug and independentretailers, apparel stores and military post exchanges.  The Company’s non-core business consisted ofBright of America, Inc. until its sale by the company effective August 2,2004.  Non-core products includededucational products, placemats, candles and home fragrance products, whichwere sold to customers primarily in the United States through mass marketers.

 

Certain prior year amounts have been reclassified toconform to the 2005 presentation.

 

This Quarterly Report on Form 10-Q for thethree months ended March 31, 2005 should be read in conjunction with theCompany’s Annual Report on Form 10-K for the year ended December 31,2004.

 

**NOTE 2 - ACCOUNTING FOR STOCKOPTIONS**

 

The Company follows the disclosure only provisionsof SFAS No. 123, “Accounting for Stock-Based Compensation—Transition andDisclosure, an amendment of FASB Statement No. 123” and, accounts for itsstock option grants in accordance with the provisions of Accounting PrinciplesBoard (APB) Opinion No. 25, “Accounting for Stock Issued to Employees”,and related interpretations using the intrinsic value method ofaccounting.  Accordingly, no compensation cost has been recognized for theoptions granted by the Company with an initial exercise price equal to the fairvalue of the common stock except for the application of Financial AccountingInterpretation No. 44, “Accounting for Certain Transactions InvolvingStock Compensation”, which resulted in non-cash income of $8,600 and non-cashexpense of $30,000 during the three months ended March 31, 2005 and March 31,2004, respectively, due to options granted during 2000 that were repriced as ofFebruary 29, 2000 upon approval of the Board of Directors andShareholders.  Had compensation cost for the Company’s stock grants beendetermined based on the fair recognition provisions of SFAS No. 123 at thegrant date, in the three months ended March 31, 2005 and 2004, the Company’snet income and earnings per share would have been reduced to the pro formaamounts indicated below:

 

6

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| ** **                                                                                              | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                              | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Net (loss) income-as reported                                                                           |       | $                                      | (1,722,000 | ) | $ | 436,000 |   |
| Deduction for stock-based compensation  expense determined under fair value method net of tax-pro forma |       | 118,000                                |       | 187,000 |   |
|                                                                                                    |       |                                   |       |   |   |
| Net (loss) income-pro forma                                                                             |       | (1,840,000                             | )          | 249,000 |   |
|                                                                                                    |       |                                   |       |   |   |
| (Loss) earnings per share (basic) - as  reported                                                        |       | (0.08                                  | )          | 0.02 |   |
| (Loss) earnings per share (basic) – pro  forma                                                     |       | (0.09                                  | )          | 0.01 |   |
| (Loss) earnings per share (diluted) – as  reported                                                 |       | (0.08                                  | )          | 0.02 |   |
| (Loss) earnings per share (diluted) – pro  forma                                                   |       | (0.09                                  | )          | 0.01 |   |
|                                                                                                         |            |                                        |            |  |  |  |  |

 

The fair value of each option granted by Company isestimated on the date of grant using the Black-Scholes option-pricing modelwith the following assumptions used for all grants:

 
| ** **                                                      | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Dividend yield                                                  |       | 5.04                                   | %          | 3.52 | % |
| Risk-free interest rate                                         |       | 4.12                                   | %          | 2.40 | % |
| Volatility                                                      |       | 29.43                                  | %          | 23.56 | % |
| Expected life (years)                                           |       | 4.2                                    |       | 3.9 |   |
| Weighted average fair value of options  granted during the year |       | $                                      | 3.93       |   | $ | 5.06 |   |
|                                                                 |            |                                        |            |  |  |  |  |

 

**NOTE 3 - EARNINGS PER SHARE**

 

A reconciliation of weighted average common sharesoutstanding to weighted average common shares outstanding assuming dilution isas follows:

 

| ** **                                                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                          | ** ** | **2004** | ** ** |
|                                                                       |       |                              |       |   |   |
| Weighted average common shares outstanding                                 |       | 20,824,000                        |       | 20,684,000 |   |
|                                                                       |       |                              |       |   |   |
| Dilutive effect of common shares issuable  under outstanding stock options |       | 3⁄4                            |       | 78,000 |   |
| Weighted average common shares outstanding  assuming dilution              |       | 20,824,000                        |       | 20,762,000 |   |

 

Stock options outstanding at March 31, 2005 andMarch 31, 2004 to purchase 613,000 and 186,000 of common stock,respectively, were not included in the computation of earnings per common shareassuming dilution for such period because the options’ exercise prices weregreater than the average market price of the common shares.

 

**NOTE 4 – ACQUISITIONS**

 

As previously disclosed in the Company’s 2004 AnnualReport on Form 10-K, in December 2004, the Company purchased all ofthe outstanding equity interests and warrants in Kids Line, LLC (the “Purchase”),in accordance with the terms and provisions of a Membership Interest PurchaseAgreement (the “Purchase Agreement”) executed on December 16, 2004, as of December 15,2004.  Kids Line is a designer anddistributor of infant bedding products, and its assets consist primarily ofaccounts receivable and inventory and intangible assets.  At closing, the Company paid approximately$130,532,000, which represented the portion of the purchase price due atclosing plus various transaction costs. The aggregate purchase price under the Purchase Agreement, however,includes the 

 

7

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potential payment of contingent consideration (the “EarnoutConsideration”).  The EarnoutConsideration shall equal 11.724% of the Agreed Enterprise Value (describedbelow) of Kids Line as of the last day of the Measurement Period (the threeyear period ended November 30, 2007), and shall be paid at the timesdescribed in the Purchase Agreement (approximately the third anniversary of theclosing date).  The “Agreed EnterpriseValue” shall be the product of (i) Kids Line’s EBITDA during the twelve(12) months ending on the last day of the Measurement Period and (ii) theapplicable multiple (ranging from zero to eight) as set forth in the PurchaseAgreement. The amount of the Earnout Consideration will be charged to goodwillwhen and if it is earned.

 

In connection with the Purchase, the Company andcertain of its subsidiaries entered into a Financing Agreement dated as of December 15,2004, as amended on March 18 and March 31, 2005 (the “FinancingAgreement”) with the lenders named therein and Ableco Finance LLC, as collateralagent and as administrative agent (the “Agent”). The Financing Agreementconsists of a term loan in the original principal amount of $125 million whichmatures on November 14, 2007 (the “Term Loan”).  The Company used the proceeds of the TermLoan to substantially finance the Purchase and pay fees and expenses relatedthereto.  The Financing Agreement isdescribed in Note 5 to the Unaudited Consolidated Financial Statements.

 

**Pro Forma Information**

 

The following unaudited pro forma consolidatedresults of operations for the three months ended March 31, 2004 assumesthe acquisition of KidsLine LLC occurred as of January 1, 2004.

 
| ** **            | ** ** | **Three  Months Ended  March 31, 2004** | ** ** |
|-----------------------|------------|-----------------------------------------|------------|
| Net sales             |       | $                                       | 79,030,000 |   |
| Net income            |       | 1,408,000                               |       |
| Net income per share: |       |                                    |       |
| Basic                 |       | $                                       | 0.07       |   |
| Diluted               |       | $                                       | 0.07       |   |
|                       |            |                                         |            |  |  |

 

The above amounts are based upon certain assumptionsand estimates, and do not reflect any benefits from combined operations. Thepro forma results have not been audited and do not necessarily representresults which would have occurred if the acquisition had taken place on thebasis assumed above, and may not be indicative of the results of futurecombined operations.

 

**NOTE 5 – DEBT**

 

In connection with the Purchase of Kids Line, LLC,the Company and certain of its subsidiaries entered into a Financing Agreementdated as of December 15, 2004, amended on March 18, 2005 and March 31,2005, as described below (the “Financing Agreement”) with the lenders namedtherein and Ableco Finance LLC, as collateral agent and as administrative agent(the “Agent”).  The Financing Agreementconsists of a term loan in the original principal amount of $125 million whichmatures on November 14, 2007 (the “Term Loan”).  The Company used the proceeds of the TermLoan to substantially finance the Purchase and pay fees and expenses relatedthereto.

 

The Financing Agreement, as originally executed,provided the Company with two interest rate options for the borrowing under theTerm Loan, to which a margin spread is added: (1) the LIBOR Rate (which issubject to a minimum rate of 1.75% per annum) plus a spread of 7.00% per annumand (2) JPMorgan Chase Bank’s base or prime rate (the “Reference Rate”)(which is subject to a minimum rate of 4.75% per annum) plus a spread of 4.25%per annum. Pursuant to the terms of the March 31, 2005 amendment, (the “Amendment”)the Term Loan shall bear interest as follows: (i) if the relevant portionof the Term Loan is a LIBOR Rate Loan (as described in the FinancingAgreement), at a rate per annum equal to the LIBOR Rate plus 8.00 percentagepoints, and (ii) otherwise, at a rate per annum equal to the ReferenceRate plus 5.25 percentage points; provided that if the Company’s ConsolidationEBITDA equals or exceeds the applicable amount set forth opposite the fiscalquarter end appearing below, the Term Loan shall bear interest during theimmediately following fiscal quarter, as follows: (i) if the relevantportion of the Term Loan is a LIBOR Rate Loan, at a rate per annum equal to theLIBOR Rate plus 7.00 percentage points, and (ii) otherwise, at a rate perannum equal to the Reference Rate plus 4.25% percentage points:

 

8

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| **Fiscal Quarter End**       | ** ** | **Consolidated  EBITDA** | ** ** |
|----------------------------------------|------------|--------------------------|------------|
| March 31, 2005                    |       | $                        | 29,000,000 |   |
| June 30, 2005                     |       | $                        | 34,000,000 |   |
| September 30, 2005                |       | $                        | 39,000,000 |   |
| December 31, 2005                 |       | $                        | 44,000,000 |   |
| March 31, 2006                    |       | $                        | 46,000,000 |   |
| June 30, 2006                     |       | $                        | 50,000,000 |   |
| September 30, 2006                |       | $                        | 52,000,000 |   |
| December 31, 2006                 |       | $                        | 52,000,000 |   |
| March 31, 2007                    |       | $                        | 55,000,000 |   |
| June 30, 2007                     |       | $                        | 55,000,000 |   |
| September 30, 2007 and thereafter |       | $                        | 55,000,000 |   |

 

Under the Financing Agreement, as amended, theCompany is required to make prepayments of the Term Loan in an amount equal to$1,750,000 per quarter with the balance due at maturity. The first suchprepayment was made on March 31, 2005; subsequent prepayments will bepayable on the last day of the relevant quarter. In connection with theAmendment, as further described below, the Company made a $18,250,000prepayment on March 31, 2005. In addition, beginning with the fiscal yearending December 31, 2005, the Company will be required to make annualmandatory prepayments of the Term Loan, with specified percentages of excesscash flow (as defined in the Financing Agreement) and the proceeds of certain assetsales, debt issuances, equity issuances, tax refunds other than the Federal taxrefund that the Company expects to receive as a result of net operating losscarrybacks for 2004, insurance and other extraordinary receipts.

 

AblecoFinance LLC, as agent, has a lien on substantially all of the assets of theCompany, pursuant to the terms of the Security Agreement dated as of December 15,2004 among the Company, its domestic subsidiaries party thereto andAbleco.  Such lien includes a mortgage onthe real property located at 2305 Breton Industrial Park Drive, S.E., Kentwood,MI (the “Facility Encumbrance”). California KL Holdings, Inc., as agent, has a subordinated lienwith respect to the Facility Encumbrance, among other things, pursuant to theterms of the Subordinated Security Agreement dated as of December 15, 2004among the agent, the Company and its domestic subsidiaries party thereto.

 

On March 18, 2005, the Agent waived, withrespect to the year ending December 31, 2004, the Company’s non-compliancewith a covenant in the Financing Agreement as originally executed, that limitedthe amount of its aggregate operating lease expense, and amended such covenantto increase the amount of the annual expense limitation for the term of theFinancing Agreement. In addition, the Financing Agreement, as originallyexecuted, contains, among other things, various financial covenants to whichthe Company and its subsidiaries must adhere on a monthly and quarterly basis(a Funded Debt Ratio, a Fixed Charge Coverage Ratio, a Consolidated EBITDAcovenant, an Infant Line EBITDA covenant and a Minimum Qualified Cash covenant,all as defined in the Financing Agreement). The Company was in compliance withsuch financial covenants as of December 31, 2004. However, because managementbelieved that the Company would not be in compliance as of March 31, 2005,with the Consolidated EBITDA Covenant and the Funded Debt Ratio set forth inthe Financing Agreement as originally executed, and had substantial concernsover whether the Company would be in compliance with such covenants for theremainder of 2005, on March 31, 2005, the Agent, the Required Lendersunder the Financing Agreement, the Company and its subsidiaries party theretoexecuted the Amendment, which amended the Consolidated EBITDA covenant for thequarters ending March 31, June 30, September 30 and December 31,2005 (in light of the additional $18,250,000 prepayment of principal discussedabove, no amendment of the Funded Debt Ratio or any other financial covenantwas required).

 

The amended covenants are set forth below:

 
| ** **              | ** ** | **Original Required Consolidated EBITDA** | ** ** | **Amended Required Consolidated EBITDA** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
|                    |       |                                      |       |                                     |       |
| March 31, 2005     |       | $                                         | 29,000,000 |                                     | $          | 27,500,000 |   |
| June 30, 2005      |       | $                                         | 34,000,000 |                                     | $          | 31,000,000 |   |
| September 30, 2005 |       | $                                         | 39,000,000 |                                     | $          | 33,000,000 |   |
| December 31, 2005  |       | $                                         | 44,000,000 |                                     | $          | 36,000,000 |   |

 

Management believes that the Company will be incompliance with such amended covenants and all of the covenants of theFinancing Agreement through March 31, 2006. In connection with theAmendment, in addition to the dividend restrictions set forth below, theCompany agreed to (i) simultaneously with the execution of the Amendment,prepay a portion of the principal of the Term Loan in the amount of $18,250,000(in lieu of payment to the Agent of a portion of the Federal tax refund thatthe Company expects to receive as a result of net operating loss carrybacks for2004, as required in the original Financing Agreement but in addition to therequired quarterly

 

9

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principal payment), (ii) amend the interestrate provisions applicable to the term loan as discussed above, (iii) increasethe Minimum Qualified Cash level (as defined) required by the FinancingAgreement from $40,000,000 to $45,000,000, (iv) maintain the Term Loan LC(as defined below) throughout the term of the Financing Agreement (such TermLoan LC would otherwise have been released when the Funded Debt Ratio is lessthan 3.0:1.0), and (v) pay a fee of $787,500 in connection with theexecution of the Amendment.

 

 

In accordance with the Amendment, as long as all orany portion of the Term Loan is outstanding, the Company is not permitted todeclare and/or pay dividends unless, except in all cases with respect to thedividend declared by the Company on March 31, 2005 and paid during themonth of April, 2005 (the “First Quarter 2005 Dividend”), (i) no Defaultor Event of Default (as defined in the Financing Agreement) shall have occurredand be continuing either before or after giving effect to such declaration andpayment; (ii) at the time of declaration of such dividends, the chieffinancial officer of the Company shall have certified in writing to the Agentthat as of such date and after due investigation and inquiry, such chieffinancial officer has no reason to believe that, after giving effect to thepayment of such dividends, the Company will not be in compliance with any ofthe financial covenants in the Financing Agreement generally as of the end ofthe fiscal quarter in which such dividends are to be paid; and (iii) theCompany satisfies a minimum Consolidated EBITDA test for the fiscal quarterimmediately preceding the fiscal quarter in which such dividend is to be paid(in any event, no such dividend shall exceed $6,250,000 per quarter); providedfurther, notwithstanding the foregoing or any other provision of the FinancingAgreement, (a) the Company may declare and pay only the December 2004Dividend in the fiscal quarter ending December 31, 2004; (b) theamount of the First Quarter 2005 Dividend shall be no greater than either (i) tencents ($0.10) per share or (ii) $2,100,000; and  (c) the Companymay declare and pay a dividend not greater than either $0.05 per share (subjectto corresponding adjustment for stock splits, stock dividends andrecapitalizations) or $1,050,000 for each of the second, third and fourthquarters of 2005, *provided* thatthe Company has the Dollar Equivalent Amount of Qualified Cash (as defined inthe Financing Agreement) of at least $55,000,000, after giving effect to anysuch dividend, and the Company is in compliance with clauses (i), (ii) and(iii) above. In light of the foregoing, the Company cannot assure theability to pay dividends in the future.

 

The Financing Agreement contains certain events ofdefault, including, among others, non-payment of principal, interest, fees orother amounts, breach of representations and warranties, violation ofcovenants, cross defaults, bankruptcy events, judgments, ERISA violations,environmental costs that could reasonably be expected to result in a materialadverse effect, the occurrence of a change of control of the Company, theoccurrence of an event or development which results in a material adverseeffect and/or the failure of the Company’s current chief executive officer toremain as the chief executive officer of the Company under specifiedcircumstances (unless the termination of his employment has been approved by75% of the Board of Directors of the Company, excluding the vote of the currentchief executive officer and rounded down to the nearest whole number).  If an event of default occurs: (i) theAgent (on behalf of the lenders) is entitled to, among other things, to theextent permitted in the Financing Agreement, accelerate the Term Loan (providedthat upon events of bankruptcy, the Term Loan will be immediately due andpayable), and (ii) a default interest rate will become applicable to theTerm Loan at a rate per annum equal to the rate of interest otherwise in effectfrom time to time under the Financing Agreement plus 2.0 percentage points, or,if a rate of interest is not otherwise in effect, interest at the highest ratespecified therein for the Term Loan prior to the Event of Default plus 2.0percentage points.

 

TheCompany has pledged the equity interests of certain of its subsidiaries to theAgent in order to secure its obligations under the Financing Agreement pursuantto the terms of a Security Agreement made on December 15, 2004 among theCompany, its subsidiaries party thereto and the Agent (the “Security Agreement”).The Company has also provided an evergreen irrevocable letter of credit anamount of $10,000,000 which the Agent may draw upon if there is an Event ofDefault (as defined in the Financing Agreement) or other events specified underthe Financing Agreement occur (the “Term Loan LC”).  In addition, pursuant to the FinancingAgreement, the Company’s domestic subsidiaries have provided guarantees, andpursuant to the Security Agreement, have granted security interests, to theAgent in substantially all of their personal property in order to secure theCompany’s obligations to the lenders and such subsidiaries’ guarantees underthe Financing Agreement.

 

Inconnection with the original execution and amendments to the Financing Agreement,the Company incurred an aggregate of approximately $5,800,000 in specifiedfees.  These costs are included in “otherassets” on the Consolidated Balance Sheet for the applicable periods and are beingamortized over the three year term of the loan.

 

The domestic lines of credit in place prior to December 15, 2004totaling $50,000,000 have been canceled effective December 15, 2004.  The maximum amounts available to theCompany’s foreign operations at March 31, 2005, under local lines of credit areapproximately $20,684,000.

 

In connection with the purchase of imported merchandise, the Company atMarch 31, 2005, had letters of credit outstanding of $2,716,000, all related toforeign operations, were collateralized under their existing lines of credit.

 

10

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**NOTE 6 – GOODWILL AND INTANGIBLEASSETS**

 

The significant components of intangible assetsconsist of the following:

 
| ** **                                  | ** ** | **Weighted Average  Amortization Period** | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------|------------|-------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                                        |       |                                      |       |                     |       |                        |       |
| MAM distribution agreement and relationship |       | Indefinite life                           |       | $                        | 10,400,000 |                        | $          | 10,400,000 |   |
| Sassy trade name                            |       | Indefinite life                           |       | 7,100,000                |       | 7,100,000                   |       |
| Applause trade name                         |       | Indefinite life                           |       | 7,711,000                |       | 7,679,000                   |       |
| Kids Line customer relationships            |       | Indefinite life                           |       | 31,100,000               |       | 31,100,000                  |       |
| Kids Line trade name                        |       | Indefinite life                           |       | 5,300,000                |       | 5,300,000                   |       |
| Other intangible assets                     |       | 0.3 years                                 |       | 72,000                   |       | 348,000                     |       |
|                                        |       |                                      |       |                     |       |                        |       |
| Total intangible assets                     |       |                                      |       | $                        | 61,683,000 |                        | $          | 61,927,000 |   |

 

Other intangible assets as of March 31, 2005includes Kidsline and Sassy non-compete agreements which are being amortizedover four and five years, respectively. Other intangible assets as of December 31, 2004 includes Kids Linebacklog which was amortized over two months and Kids Line and Sassy non-competeagreements.  Amortization expense was$275,000 and $5,000 for the first three months of 2005 and 2004, respectively.

 

All of the Company’s goodwill is in the infant andjuvenile segment.  There were no changesto the carrying amount of goodwill for the three months ended March 31,2005:

 
| Balance as  of December 31, 2004 |   | $ | 89,213,000 | ** ** |
|---------------------------------------|--------|---|------------|------------|
| Adjustments to goodwill               |   | 0 |       |
| Balance as of March 31, 2005     |   | $ | 89,213,000 |       |

 

**NOTE 7 - DIVIDENDS**

 

No cash dividends were paid during the three monthsending March 31, 2005.  Cashdividends of $6,215,000 ($0.30 per share) were paid on March 26, 2004 toshareholders of record of the Company’s Common Stock on March 12,2004.  See Note 14 – Subsequent Eventsfor a description of dividends declared on March 31, 2005, paid on April 21,2005.

 

As is discussed in Note 5, in accordance with theterms of the Amendment, as long as all or any portion of the Term Loan isoutstanding, the Company is not permitted to declare and/or pay dividendsunless, except in all cases with respect to the First Quarter 2005 Dividend, (i) noDefault or Event of Default (as defined in the Financing Agreement) shall haveoccurred and be continuing either before or after giving effect to suchdeclaration and payment; (ii) at the time of declaration of suchdividends, the chief financial officer of the Company shall have certified inwriting to the Agent that as of such date and after due investigation andinquiry, such chief financial officer has no reason to believe that, aftergiving effect to the payment of such dividends, the Company will not be incompliance with any of the financial covenants in the Financing Agreementgenerally as of the end of the fiscal quarter in which such dividends are to bepaid; and (iii) the Company satisfies a minimum Consolidated EBITDA testfor the fiscal quarter immediately preceding the fiscal quarter in which suchdividend is to be paid (in any event, no such dividend shall exceed $6,250,000per quarter); provided further, notwithstanding the foregoing or any otherprovision of the Financing Agreement, (a) the Company may declare and payonly the December 2004 Dividend in the fiscal quarter ending December 31,2004; (b) the amount of the First Quarter 2005 Dividend shall be nogreater than either (i) ten cents ($0.10) per share or (ii) $2,100,000;and (c) the Company may declare and pay a dividend not greater than either$0.05 per share (subject to corresponding adjustment for stock splits, stockdividends and recapitalizations) or $1,050,000 for each of the second, thirdand fourth quarters of 2005, *provided* thatthe Company has the Dollar Equivalent Amount of Qualified Cash (as defined inthe Financing Agreement) of at least $55,000,000, after giving effect to anysuch dividend, and the Company is in compliance with clauses (i), (ii), and (iii) above.  In light of the foregoing, the Company cannotassure the ability to pay dividends in the future. 

 

**NOTE 8 – COST ASSOCIATED WITHDISPOSAL ACTIVITY**

 

OnSeptember 28, 2004, Russ Berrie and Company, Inc. announced acorporate restructuring designed to align the Company’s management and salesorganization with its strategic plans and to right-size its expensestructure.  The

 

11

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restructuringincluded the immediate elimination of approximately 75 domestic positions, andresulted in a pretax charge of $4.1 million in the third quarter of 2004,primarily related to severance costs.  Although these employees are nolonger employees of the Company, payments will continue through the thirdquarter of 2005.  These costs are shown in selling general andadministrative expenses in the Consolidated Statement of Operations and are allrelated to the Company’s gift segment.

 

Infurtherance of its efforts to right-size its infrastructure, during the fourthquarter of 2004, Russ Berrie reduced headcount by 38 positions in the Company’sFar East operations and recorded a restructuring charge of $.6 million inconnection therewith. Also during the fourth quarter of 2004, with respect toits domestic operations, the Company reduced headcount by 9 positions andrecorded a restructuring charge of $1.6 million in connection therewith.  Although these employees are no longeremployees of the Company, payments will continue through the fourth quarter of2005. All costs associated with these restructurings have been recorded inselling, general and administrative expenses in the Consolidated Statement ofOperations and are all related to the Company’s gift segment.

 

TheCompany reassesses the reserve requirement under the restructuring plan at theend of each reporting period.  Below is the rollforward of therestructuring accrual:

 
| ** **          | ** ** | **Balance  12/31/04** | ** ** | **2005  Provision** | ** ** | **Payments/  Write-offs** | ** ** | **Additional Cost  Incurred** | ** ** | **Balance at  3/31/05** | ** ** |
|---------------------|------------|-----------------------|------------|---------------------|------------|---------------------------|------------|-------------------------------|------------|-------------------------|------------|
| Employee separation |       | $                     | 3,935,000  |                | $          | —                    |       | $                             | 1,452,000  |                    | $          | — |   | $ | 2,483,000 |   |
| Facility exit cost  |       | 20,000                |       | —              |       | 20,000                    |       | —                        |       | —                  |       |
| Total               |       | $                     | 3,955,000  |                | $          | —                    |       | $                             | 1,472,000  |                    | $          | — |   | $ | 2,483,000 |   |

 

See“Overview” of Item 2.  Management’s Discussion and Analysis of FinancialCondition and Results of Operations for a discussion of the facts andcircumstances leading up to the restructuring charges discussed herein.

 

TheCompany may incur further restructuring costs as it continues to investigateother areas for cost reduction and efficiency improvements in its efforts toright-size its infrastructure, although the Company has no current intention toincur any material restructuring charges in the immediate future.

 

**NOTE 9 – SEGMENTS OF THE COMPANYAND RELATED INFORMATION**

 

Prior to the acquisition of Kids Line, LLC, theCompany had two reportable segments: the core segment, which consisted of theCompany’s gift business, and the non-core segment, which consisted of thebusinesses of Sassy, Inc. and Bright of America, Inc.  After the acquisition of Kids Line as of December 15,2004, the Company reclassified its operations into three reportable segments: (i) theCompany’s gift business, (ii) the Company’s infant and juvenile business,which consists of the businesses of Sassy, Inc. and Kids Line, LLC, and (iii) itsnon-core business, which consisted of Bright of America, Inc., until itssale effective August 2, 2004.  TheCompany has redefined its 2004 segment disclosures to conform to the newsegment classifications.  Note, however,that as a result of the sale of Bright of America, the Company currentlyoperates in two segments:  (i) itsgift business and (ii) its infant and juvenile business.  The segmentation of the Company’s operationsreflects how the Company’s chief executive officer currently views results ofoperations.  There are no intersegmentrevenues.

 

The Company’s gift business designs, manufacturesthrough third parties and markets a wide variety of gift products to retailstores throughout the United States and throughout the world via the Company’sinternational wholly-owned subsidiaries and distributors.  The Company’s gift products are designed toappeal to the emotions of consumers to reflect their feelings of happiness,friendship, fun, love and affection.

 

The Company’s infant and juvenile businesses designand market products in a number of baby categories including, among others,infant bedding and accessories, bath toys and accessories, developmental toys,feeding items and baby comforting products, and consists of Sassy, Inc.and Kids Line LLC.  These products aresold to consumers, primarily in the United States, through mass merchandisers,toy, specialty, food, drug and independent retailers, apparel stores andmilitary post exchanges.

 

The Company’s non-core business consisted of Brightof America, Inc. until its sale by the Company effective August 2,2004.  Non-core products includededucational products, placemats, candles and home fragrance products, whichwere sold to customers primarily in the United States through mass marketers.

 

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| ** **                        | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------|------------|----------------------------------------|------------|
| ** **                        | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Gift:                             |       |                                   |       |   |   |
| Net sales                         |       | $                                      | 37,905,000 |   | $ | 51,356,000 |   |
| (Loss) before income taxes        |       | (7,649,000                             | )          | (961,000 | ) |
|                              |       |                                   |       |   |   |
| Infant and juvenile:              |       |                                   |       |   |   |
| Net sales                         |       | 32,835,000                             |       | 12,270,000 |   |
| Income before income taxes        |       | 4,909,000                              |       | 1,354,000 |   |
|                              |       |                                   |       |   |   |
| Non-core:                         |       |                                   |       |   |   |
| Net Sales                         |       | 3⁄4                                 |       | 2,087,000 |   |
| Income before income taxes        |       | 3⁄4                                 |       | 232,000 |   |
|                              |       |                                   |       |   |   |
| Consolidated:                     |       |                                   |       |   |   |
| Net Sales                         |       | 70,740,000                             |       | 65,713,000 |   |
| (Loss) income before income taxes |       | (2,740,000                             | )          | 625,000 |   |
|                                   |            |                                        |            |  |  |  |  |

 

Additionally, total assets of each segment were asfollows:

 
| ** **          | ** ** | **March 31,  2005** | ** **  | **December 31,  2004** | ** ** |
|---------------------|------------|--------------------------|-------------|-----------------------------|------------|
|                |       |                     |        |                        |       |
| Gift                |       | $                        | 169,548,000 |                        | $          | 201,096,000 |   |
| Infant and juvenile |       | 204,187,000              |        | 210,002,000                 |       |
| Non-core            |       | 3⁄4                   |        | 3⁄4                      |       |
| Total               |       | $                        | 373,735,000 |                        | $          | 411,098,000 |   |

 

**Concentration of Risk**

 

As disclosed in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004, while 88% of purchases areattributable to manufacturers in the People’s Republic of China, the supplieraccounting for the greatest dollar volume of purchases accounted forapproximately 13% and the five largest suppliers accounted for approximately41% in the aggregate.  The Company utilizes approximately 100manufacturers in the Far East.  The Company believes that there are manyalternative manufacturers for the Company’s products and sources of rawmaterials.  As a result, the Company does not believe there is aconcentration of risk associated with any significant relationship.

 

**NOTE 10 - FOREIGN CURRENCY FORWARDEXCHANGE CONTRACTS**

 

Certainof the Company’s foreign subsidiaries periodically enter into foreign currencyforward exchange contracts (“Forward Contracts”) to hedge inventory purchases,both anticipated and firm commitments, denominated in the United Statesdollar. One of the Company’s domestic subsidiaries periodically entersinto Forward Contracts to hedge inventory purchases, both anticipated and firmcommitments, denominated in the Euro. These contracts reduce foreign currencyrisk caused by changes in exchange rates and are used to hedge these inventorypurchases, generally for periods up to 13 months.  At March 31, 2005,the Company’s Forward Contracts have expiration dates which range from one tonine months.

 

Sincethere is a direct relationship between the Forward Contracts and the currencydenomination of the underlying transaction, such Forward Contracts are highlyeffective in hedging the cash flows of certain of the Company’s foreignsubsidiaries related to transactions denominated in the United States dollarand certain of the Company’s domestic subsidiaries related to transactiondenominated in the Euro.  These Forward Contracts meet the criteria forcash flow hedge accounting treatment and accordingly, gains or losses areincluded in other comprehensive income (loss) and are recognized in cost ofsales based on the turnover of inventory.

 

**NOTE 11 - COMPREHENSIVE INCOME**

 

Comprehensive Income, representing all changes in Shareholders’Equity during the period other than changes resulting from the issuance orrepurchase of the Company’s common stock and payment of dividends, isreconciled to net income for the three months ended March  31, 2005and 2004 as follows:

 

13

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| ** **                                                                    | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                    | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Net (loss) income                                                             |       | $                                      | (1,722,000 | ) | $ | 436,000 |   |
| Other comprehensive (loss) income, net of  tax:                               |       |                                   |       |   |   |
| Foreign currency translation adjustments                                      |       | (1,448,000                             | )          | 1,541,000 |   |
|                                                                          |       |                                   |       |   |   |
| Net unrealized (loss) on securities  available-for-sale                       |       | 3⁄4                                 |       | (255,000 | ) |
| Net unrealized gain on foreign currency  forward exchange contracts and other |       | 79,000                                 |       | 109,000 |   |
| Other comprehensive income                                                    |       | (1,369,000                             | )          | 1,395,000 |   |
|                                                                          |       |                                   |       |   |   |
| Comprehensive (loss) income                                                   |       | $                                      | (3,091,000 | ) | $ | 1,831,000 |   |

 

**NOTE 12—INVESTMENT AND OTHER INCOME– NET**

 

The significant components of investment andother income—net consist of the following:

 
| ** **                              | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                              | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| Investment income                       |       | $                                      | 302,000    |   | $ | 2,299,000 |   |
| Interest expense                        |       | (3,076,000                             | )          | (15,000 | ) |
| Amortization of Deferred Financial cost |       | (416,000                               | )          | 3⁄4 |   |
| Foreign currency transactions, net      |       | (105,000                               | )          | (415,000 | ) |
| Other                                   |       | (156,000                               | )          | 94,000 |   |
| Total                                   |       | $                                      | (3,451,000 | ) | $ | 1,963,000 |   |
|                                         |            |                                        |            |  |  |  |  |  |

 

**NOTE 13 – LITIGATION ANDCOMMITMENTS**

 

In the ordinary course of its business, the Companyis party to various copyright, patent and trademark infringement, unfaircompetition, breach of contract, customs, employment and other legal actionsincidental to its business, as plaintiff or defendant. In the opinion ofmanagement, the amount of ultimate liability with respect to these actions willnot materially adversely affect the consolidated results of operations,financial condition or cash flows of the Company.

 

In connection with the Company’s purchase of KidsLine LLC, the aggregate purchase price includes a potential payment of EarnoutConsideration as more fully described in Note 4.  The amount of Earnout Consideration, if any,is not currently determinable.

 

The Company enters into various license agreementsrelating to trademarks, copyrights, designs, and products which enable theCompany to market items compatible with its product line.  All license agreements other than the agreementwith MAM Babyartikel GmbH (which has a remaining term of six years), are forthree year terms with extensions agreed to by both parties.  Some of these license agreements includeprepayments and minimum guarantee royalty payments.  The amount of guaranteed royalty paymentswith respect to all license agreements over the next three years aggregates$5.8 million.  The Company’s royaltyexpense for the first three months of 2005 and 2004 were $437,000 and $190,000,respectively.

 

14

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An action was commenced againstthe Company on August 22, 2001, in the United Stated District Court, Districtof New Jersey, by Dam Things from Denmark (a.k.a. Troll Company ApS.),alleging, among other things, copyright infringement by the Company of theplaintiff’s reinstated United States copyrights for its troll designs, unfaircompetition under common law and violation of Danish and U.S. copyrightsconstituting copyright infringement under the laws of the People’s Republic ofChina.  The plaintiff was seeking, amongother things, injunctive relief prohibiting the Company from continuing tooffer for sale its troll products, cancellation of the Company’s U.S. copyrightregistrations with respect to its various troll products, as well asunspecified damages and attorney’s fees and expenses.  On February 28, 2004, the parties to thislitigation executed a worldwide settlement agreement, pursuant to which amongother things (i) the parties have executed and filed with the appropriate courta stipulation and order of dismissal of the lawsuit with prejudice, (ii) theCompany paid $3,000,000 to the plaintiff, which amount was accrued as ofDecember 31, 2003, (iii) the Company assigned to plaintiff any rights it has intrademark “Good Luck Troll”, as well as any other trademarks relating to theCompany’s troll products (executive of trademarks or designations in the word“Russ”) as well as relevant copyright registrations owned by the Company to itstroll products, (iv) transferred its remaining inventory of troll products tothe plaintiff, and (v) the Company agreed to refrain from making, using, orselling any work that is substantially similar to the Company’s troll products.

 

In connection with theCompany’s continuing expansion of its operations in the People’s Republic ofChina (“PRC”), the Company completed a voluntary review in 2003 of theactivities of its offices in the PRC to assess their compliance with applicablelaws and regulations.  As a result ofthis review, management became aware of some potential operational and taxcompliance issues under applicable PRC laws and regulations and has takenappropriate corrective actions, including the establishment of a new subsidiaryin the PRC which became effective January, 2004, and settlement of prior yearindividual income tax underpayments and associated penalties, totalingapproximately $464,000, which was expensed in 2004.

 

OnMarch 31, 2005, the Company declared a cash dividend of $0.10 per commonshare, payable on April 21, 2005 to shareholders of record on April 11,2005.

 

**NOTE 14 – SUBSEQUENT EVENTS**

 

Cashdividends of $2,082,000 ($0.10) per share were paid on April 21, 2005 toshareholders of record of the Company’s Common Stock on April 11, 2005.

 

**NOTE 15 – RECENTLY ISSUEDACCOUNTING STANDARDS**

 

In December 2004, the FASB issued SFAS No. 123(R),*Share-Based Payments,*which establishesstandards for transactions in which an entity exchanges its equity instrumentsfor goods or services.  This statement isa revision to SFAS 123, Stock-Based Compensation and supersedes APB opinion No. 25,accounting for stock issued to employees. SFAS 123 R requires Companies to recognize an expense for compensationcost related to share-based payment arrangements including stock options andemployee stock purchase plans, based on the grant-date fair value of theaward.  Due to the extention of thecompliance deadline, SFAS No. 123(R) will be effective beginning with thefirst interim or annual reporting period of the first fiscal year beginning onor after June 15, 2005 (for the Company, the first quarter of 2006).  The Company is currently evaluating thestandard to determine its effect on the Consolidated Financial Statements.

 

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

 

The financial and business analysis below providesinformation which the Company believes is relevant to an assessment andunderstanding of the Company’s consolidated financial condition, changes infinancial condition and results of operations. This financial and businessanalysis should be read in conjunction with the Company’s consolidatedfinancial statements and accompanying notes to the consolidated financialstatements set forth in Part I, Financial Information, Item 1, “FinancialStatements” of this Quarterly Report on Form 10-Q and the Company’sAnnual Report on Form 10-K for the year ended December 31, 2004 (the “200410-K”).

 

**OVERVIEW**

 

TheCompany’s revenues are primarily derived from sales of its products, asignificant portion of which is attributable to sales of products in its giftsegment.  Sales and operating profits in the Company’s gift segment beganto decline during 2003 as a result of several factors, including (i) retailerconsolidation and a declining number of independent retail outlets, which inturn had a negative impact on sales from such outlets, (ii) increasedcompetition from other entities, both wholesellers and retailers, which offeredlower pricing and achieved greater customer acceptance of their products and (iii) changingbuying habits of consumers, marked by a shift from independent retailers tomass market retailers.  During the firsthalf of 2003, management realized that the factors discussed above wereunlikely to abate, and as a result, began an evaluation of how best to respond.  The result was a multi-pronged approach begunin the third quarter of 2003, which consisted of (i) focusing oncategorizing and rationalizing its product range, (ii) segmenting itsselling efforts to address management’s perception of new customer requirementsand shifting channels of distribution, (iii) focusing on growing itsinternational business and infant and juvenile segment and (iv) restructuringits operations in order to reduce overhead expenses through headcountreductions and the closure of certain domestic showrooms (includingrestructuring charges of $1.3 million and $1.0 million in the third and fourthquarters of 2003, respectively).  See the2004 10-K for a discussion of the impact of such 2003 restructurings.

 

Duringthe first half of 2004, the Company continued to be negatively impacted by thefactors discussed above.  As a result,its gift segment’s sales continued to decline. In response to this continued decline, in addition to the initiativesdescribed above, the Company discontinued pursuit of previously announcedstrategic alternatives and hired Andrew Gatto as its President and ChiefExecutive Officer (“CEO”), effective June 1, 2004.  In June

 

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2004,the new CEO implemented a comprehensive strategic review of Russ Berrie’sworldwide inventory, with a view towards his perception of the Company’s futuredirection in light of the current factors affecting its gift segment.  Asa result of this review, an additional inventory write-down of $13 million (pretax) was recorded in cost of sales in the second quarter of 2004 to reflectinventory in the gift segment at the lower of its cost or market value. The Company is selling substantially all of this inventory through other thanits normal sales channels. Therefore, no future impact on results of operationsor liquidity is anticipated related to this inventory.  Although the Company does not anticipatefurther material inventory write-downs at this time, a significant change indemand for the Company’s products could result in a change in the amount ofexcess inventories on hand.  The Companymanages inventory and monitors product purchasing to minimize this risk.

 

Concurrentlywith the inventory review discussed above, the Company continued to evaluate “rightsizing” its infrastructure in response to the changing businessenvironment.  As a result of suchevaluation, and as disclosed in the Company’s 8-K filed on September 28,2004, Russ Berrie reduced headcount by approximately 75 positions and recordeda restructuring charge of $4.1 million in the third quarter of 2004.  Management believes that future operatingexpenses, predominantly through reduced employee cost, will be reduced byapproximately $7.5 million as a result of these reductions.  The effects of these reduced costs began inthe fourth quarter of 2004.  Althoughthese employees are no longer employees of the Company, and the charges wererecorded in the third quarter of 2004, payments will continue through the thirdquarter of 2005. All costs associated with this restructuring have beenrecorded in selling, general and administrative expenses.

 

Asdiscussed in the 2004 10-K, in its continuing efforts to address the negativefactors affecting its gift segment and to create more efficient worldwideoperations, during the fourth quarter of 2004, the Company continued its “right-sizing”efforts and further reduced headcount by 38 positions in the Company’s Far Eastoperations and recorded a restructuring charge of $.6 million in connectiontherewith.  Management believes thatfuture operating expenses, predominantly through reduced employee cost, will bereduced by approximately $1.3 million. Also during the fourth quarter of 2004,with respect to its domestic operations, the Company reduced headcount by 9positions and recorded a restructuring charge of $1.6 million in connectiontherewith. Management believes that future operating expenses, predominantlythrough reduced employee cost, will be reduced by approximately $1.7 million.  The effects of these reduced costs began inthe fourth quarter of 2004.  Althoughthese employees are no longer employees of the Company, payments will continuethrough the fourth quarter of 2005.  Allcosts associated with these restructurings have been recorded in selling,general and administrative expenses.

 

TheCompany may incur further restructuring costs as it continues to investigateother areas for cost reduction and efficiency improvements in its efforts toright-size its infrastructure, although the Company has no current intention toincur any material restructuring charges in the immediate future.

 

In addition to the “right-sizing” efforts discussedabove, the Company is continuing to respond to these developments affecting itsgift business by (i) continuing to focus on realigning its product lineand distribution channels to better meet the changing demands of its customersand improve its competitive position in the industry, (ii) segmenting itsselling efforts with an increased focus on national accounts, in order to buildand strengthen the Company's presence in the mass market (the Company intendsto use the APPLAUSE® Trademark as the brand platform upon which the Company'sgrowth in the mass market will be positioned), (iii) continuing to focuson realigning growth opportunities in its international markets and its infantand juvenile business segment, as demonstrated by the acquisition of Kids Line,LLC as of December 15, 2004, (iv) selectively increasing its use oflicensing to differentiate its products from its competitors, including during2004 the license of certain intellectual property from Marvel Enterprises, Inc.relating to Spider-Man® and X-MenTM classic characters and certain othercharacters;  Andrew McMeel Universal(licensing representative for Ziggy® and Friends, Inc.) to create a “Ziggy”®product line, Sanrio, Inc. to develop and market certain products inconnection with the  “KEROPPI”property;  DreamWorks Animation L.L.C. todesign and market certain products related to an anticipated 2005 animatedmovie (MadagascarTM); Warner Brothers Consumer Products Inc. relating toScooby-DooTM and certain other characters; Hasbro International, Inc. andSimm R Schuster, Inc. relating to the Raggedy Ann and AndyTM property; andduring the first quarter of 2005, the license of certain intellectual propertyfrom Universal Studios relating to Curious GeorgeTM; and the Beanstock Grouprelating to Zelda WisdomTM, (v) pursuing strategic acquisitionopportunities; and (vi) implementing a three tiered “good”, “better”, “best”branding strategy within its gift segment to differentiate products sold intothe mass market, Russ Berrie’s traditional specialty retail market and upscaledepartment store market. As full implementation of the initiatives discussedabove is an on going process, the Company does not anticipate immediatematerial results from the foregoing program of changes.  Management does believe, however, that suchchanges are appropriate to address the various developments affecting its giftbusiness, and will yield positive results in the future.

 

See “Kids Line and Related Financing” under “Liquidityand Capital Resources” below for a discussion on amendments to the FinancingAgreement.

 

**SEGMENTS**

 

Priorto the acquisition of Kids Line, LLC, the Company had two reportable segments:the core segment, which consisted of the Company’s gift business, and thenon-core segment, which consisted of the businesses of Sassy, Inc.

 

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andBright of America, Inc.  After theacquisition of Kids Line as of December 15, 2004, the Company reclassifiedits operations into three reportable segments: (i) the Company’s giftbusiness, (ii) the Company’s infant and juvenile business, which consistsof the businesses of Sassy, Inc. and Kids Line, LLC, and (iii) itsnon-core business, which consisted of Bright of America, Inc., until itssale effective August 2, 2004. Note, however, that as a result of the sale of Bright of America, theCompany currently operates in two segments: (i) its gift business and (ii) its infant and juvenilebusiness.  See Note 9 of the Notes to theConsolidated Financial Statements for a discussion on reclassification of theCompany’s segments.  The Company’s giftbusiness designs, manufactures through third parties and markets a wide varietyof gift products to retail stores throughout the United States and throughoutthe world via the Company’s international wholly-owned subsidiaries anddistributors. The Company’s infant and juvenile businesses design and marketproducts in a number of baby categories including, among others, infant beddingand accessories, bath toys and accessories, developmental toys, feeding itemsand baby comforting products.  Theseproducts are sold to consumers, primarily in the United States, through massmerchandisers, toy, specialty, food, drug and independent retailers, apparelstores and military post exchanges. Until the Company’s sale of Bright ofAmerica, Inc. effective August 2, 2004, the Company’s non-core productsincluded educational products, placemats, candles and home fragrance products,which were sold primarily to customers in the United States through massmarketers.

 

**RESULTS OF OPERATIONS—THREE MONTHSENDED MARCH 31, 2005 AND 2004**

 

The Company’s consolidated net sales for the threemonths ended March 31, 2005 increased 7.6% to $70,740,000 compared to$65,713,000 for the three months ended March 31, 2004.  The net salesincrease was attributable to the Company’s infant and juvenile segment, whichhas included sales of KidsLine LLC since its acquisition in the fourth quarterof 2004.

 

The Company’s gift segment’s net sales for the threemonths ended March 31, 2005 decreased 26.2% to $37,905,000 compared to$51,356,000 for the three months ended March 31, 2004, primarily as aresult of the factors discussed in the “Overview” above.  Net sales in the Company’s gift segmentbenefited from foreign exchange rates by approximately $746,000 for the threemonths ended March 31, 2005.  The Company’s infant and juvenilesegment’s net sales for the three months ended March 31, 2005 increased167.6% to $32,835,000 compared to $12,270,000 for the three months ended March 31,2004. This increase is comprised of $18,873,000 million of sales attributableto Kids Line and sales growth of 13.8% ($1.7 million) in Sassy Inc.  There were no non-core sales for the threemonths ended March 31, 2005 compared to $2,087,000 for the three monthsended March 31, 2004, as a result of the sale of Bright of America, Inc.effective August 2004.

 

Consolidated gross profit was 44.4% of consolidatednet sales for the three months ended March 31, 2005 as compared to 50.4%of consolidated net sales for the three months ended March 31, 2004. The decline in the consolidated gross profit percentage is primarily due tocompetitive pricing pressure in the gift segment, and the increase in infantand juvenile sales as a percent of consolidated sales, which have lower grossprofit margins compared to gift segment margins. Gross profit for the Company’sgift segment was 48.1% of net sales for such segment for the three months endedMarch 31, 2005 as compared to 55.3% of net sales for the three monthsended March 31, 2004.  Gross Profit for the Company’s infant andjuvenile segment was 40.1% of net sales for such segment for the three monthsended March 31, 2005 as compared to 31.8% of net sales for the threemonths ended March 31, 2004 resulting from the acquisition of KidsLine.

 

Consolidated selling, general and administrativeexpense was $30,685,000 or 43.4% of consolidated net sales for the three monthsended March 31, 2005 compared to $34,441,000 or 52.4% of consolidated netsales for the three months ended March 31, 2004.  This decrease inconsolidated selling, general and administrative expense is due primarily tolower selling, product development, administration and advertising cost,predominately as a result of our restructuring efforts in 2004.  These reductions were partially offset byselling, general and administrative expense as a result of the acquisition ofKids Line.

 

Consolidated investment and other income/(expense)was an expense of $3,451,000 for the three months ended March 31, 2005compared to income of $1,963,000 for the three months ended March 31,2004, a decrease of $5,414,000.  This decrease was primarily the result ofinterest expense incurred in connection with the Term Loan under the FinancingAgreement (each as defined in “Kids Line and Related Financing” below) andlower interest income as all marketable security balances where liquidated in2004.

 

The income tax (benefit) in the three months ended March 31,2005 was $(1,018,000) as compared to an income tax provision of $189,000 in thefirst three months of 2004.  This changereflects that the Company incurred a pre-tax loss in the three months ended March 31,2005 of $(2,740,000) as compared to generating pre-tax income of $625,000 inthe three months ended March 31, 2004. The consolidated (benefit)/provision for income taxes as a percent ofincome before taxes for the three months ended March 31, 2005 was a(37.2%) benefit compared to a 30.2% provision for the three

 

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months ended March 31, 2004.  The increasein the effective rate relates to a decrease in tax-advantaged investmentincome, and an increase in state taxes associated with a reduction in theCompany’s deferred state tax asset, and an increase in the effective state raterelated to franchise/capital stock taxes constituting a larger percentagerelative to the reduced pre-tax profit.

 

As a result of the foregoing, consolidated net lossfor the three months ended March 31, 2005 was $1,722,000 or ($0.08) perdiluted share compared to consolidated net income of $436,000 or $0.02 perdiluted share for the three months ended March 31, 2004, representing adecrease of $2,158,000 and a decrease of $.10 per diluted share.

 

**Liquidity and Capital Resources**

 

The Company’s principal sources of liquidity arecash and cash equivalents and funds from operations. The Company believes thatit will able to fund its capital expenditure requirements for 2005 from suchsources. In addition, subject to the discussion below under “Kids Line andRelated Financing” with respect to the Earnout Consideration, the Companybelieves that after payment of the expenditures set forth in this “Liquidityand Capital Resources” section, the Company remains in a liquid position, andthat such sources will be sufficient to meet the currently anticipatedrequirements of its business.

 

As of March 31, 2005, the Company had cash andcash equivalents of $41,646,000 compared to $48,099,000 at December 31,2004.  This reduction of $6,453,000 wasprimarily related to the repayment of debt, offset somewhat by proceeds fromthe sale of assets in the UK and Hong Kong, and collections of accountsreceivable.  As of March 31, 2005and December 31, 2004, working capital was $124,488,000 and$119,293,000, respectively.  Thisincrease of $5,195,000 was primarily the result of proceeds from the sale ofassets in the UK and Hong Kong.

 

Cash and cash equivalents decreased by $6,453,000during the three months ending March 31, 2005 compared to an increase of$104,023,000 during the three months ending March 31, 2004. The increasein the first quarter of 2004 was primarily the result of the Company’s sale ofa significant portion of its available-for-sale marketable securities duringthe three months ended March 31, 2004. Net cash provided by operating activities was approximately $6,691,000during the three months ending March 31, 2005 as compared to approximately$12,203,000 during the three months ending March 31, 2004. This decreaseof $5,512,000 was due primarily to the net loss in the first quarter of 2005compared to net income in the first quarter of 2004. Net cash provided byinvesting activities was approximately $8,410,000 for the three months ending March 31,2005 as compared to approximately $95,251,000 for the three months ending March 31,2004. This decrease of approximately $86,841,000 was due primarily to proceedsfrom the sale of marketable securities in the first three months of 2004.  Net cash used in financing activities of$20,380,000 and $4,568,000 for the three months ending March 31, 2005 and2004, respectively, consisted primarily of payment of long-term debtobligations during the first three months of 2005 (as described in “Kids Lineand Related Financing” below) and payment of dividends in during the firstthree months of 2004.

 

During the three months ending March 31, 2005,the Company paid approximately $405,000 for income taxes. The Company currentlyexpects that its cash flows will exceed any income tax payments during 2005 andexpects to receive a United States federal tax refund of approximately$9,452,000 generated as a result of net operating loss carry-backs for thecalendar year ended December 31, 2004 (the “Tax Refund”).

 

Working capital requirements during the three monthsending March 31, 2005 were met entirely through internally generatedfunds. The Company’s capital expenditures during the three months ending March 31,2005 were approximately $320,000 primarily for continued system implementationand development costs. In the 2004 10K, the Company anticipates capitalexpenditure requirements for 2005 to be approximately $3,800,000 for distributioncenter improvements and continued system and development costs.  Due to revised estimates based on actualcosts related to such items in first quarter of 2005, capital expenditures for2005 are now estimated to be approximately $2,000,000 in the aggregate.

 

***Kids Line andRelated Financing***

 

The Company purchased all of the outstanding equityinterests and warrants in Kids Line, LLC (the “Purchase”), in accordance withthe terms and provisions of a Membership Interest Purchase Agreement (the “PurchaseAgreement”) executed on December 16, 2004, as of December 15, 2004.At closing, the Company paid approximately $130,532,000, which represented theportion of the purchase price due at closing plus various transaction costs.The aggregate purchase price under the Purchase Agreement, however, includesthe potential payment of the Earnout Consideration, which is defined as 11.724%of the Agreed Enterprise Value of Kids Line, LLC as of the last day of thethree year period ending November 30, 2007 (the “Measurement Period”). TheEarnout Consideration shall be paid at the times described in the PurchaseAgreement (approximately the third anniversary of the Closing Date.) The “AgreedEnterprise Value” shall be the product of (i) Kids Line’s EBITDA duringthe twelve (12) months ending on the last day of the Measurement Period and (ii) theapplicable multiple (ranging from zero to eight) as set forth in the PurchaseAgreement. The amount of the Earnout Consideration will be charged to goodwillif and when it is earned. Because the amount payable with respect to theEarnout Consideration, if any, and the Company’s financial condition at thetime any such payment is due, are not currently determinable, the 

 

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Company cannot assure that payment of the EarnoutConsideration will not have a material impact on the Company’s liquidity.

 

In connection with the Purchase, the Company andcertain of its subsidiaries entered into a Financing Agreement dated as of December 15,2004 amended on March 18, 2005 and March 31, 2005, as describedbelow, (the “Financing Agreement”), with the lenders named therein and AblecoFinance LLC, as collateral agent and as administrative agent (the “Agent”). TheFinancing Agreement consists of a term loan in the original principal amount of$125 million which matures on November 14, 2007 (the “Term Loan”). TheCompany used the proceeds of the Term Loan to substantially finance thePurchase and pay fees and expenses related thereto. The terms of the FinancialAgreement are further described below and in Note 5 to the Notes toConsolidated Financial Statements.

 

The Financing Agreement, as originally executed,provided the Company with two interest rate options for the borrowing under theTerm Loan, to which a margin spread is added: (1) the LIBOR Rate (which issubject to a minimum rate of 1.75% per annum) plus a spread of 7.00% per annumand (2) JPMorgan Chase Bank’s base or prime rate (the “Reference Rate”)(which is subject to a minimum rate of 4.75% per annum) plus a spread of 4.25%per annum. Pursuant to the terms of the March 31, 2005 amendment, (the “Amendment”)the Term Loan shall bear interest as follows: (i) if the relevant portionof the Term Loan is a LIBOR Rate Loan (as described in the FinancingAgreement), at a rate per annum equal to the LIBOR Rate plus 8.00 percentagepoints, and (ii) otherwise, at a rate per annum equal to the ReferenceRate plus 5.25 percentage points; provided that if the Company’s ConsolidationEBITDA equals or exceeds the applicable amount set forth opposite the fiscalquarter end appearing below, the Term Loan shall bear interest during theimmediately following fiscal quarter, as follows: (i) if the relevantportion of the Term Loan is a LIBOR Rate Loan, at a rate per annum equal to theLIBOR Rate plus 7.00 percentage points, and (ii) otherwise, at a rate perannum equal to the Reference Rate plus 4.25% percentage points:

 
| **Fiscal Quarter End**       | ** ** | **Consolidated  EBITDA** | ** ** |
|----------------------------------------|------------|--------------------------|------------|
| March 31, 2005                    |       | $                        | 29,000,000 |   |
| June 30, 2005                     |       | $                        | 34,000,000 |   |
| September 30, 2005                |       | $                        | 39,000,000 |   |
| December 31, 2005                 |       | $                        | 44,000,000 |   |
| March 31, 2006                    |       | $                        | 46,000,000 |   |
| June 30, 2006                     |       | $                        | 50,000,000 |   |
| September 30, 2006                |       | $                        | 52,000,000 |   |
| December 31, 2006                 |       | $                        | 52,000,000 |   |
| March 31, 2007                    |       | $                        | 55,000,000 |   |
| June 30, 2007                     |       | $                        | 55,000,000 |   |
| September 30, 2007 and thereafter |       | $                        | 55,000,000 |   |

 

Under the Financing Agreement, as amended, theCompany is required to make prepayments of the Term Loan in an amount equal to$1,750,000 per quarter with the balance due at maturity. The first suchprepayment was made on March 31, 2005; subsequent prepayments will bepayable on the last day of the relevant quarter. In connection with theAmendment, further described below, the Company made a $18,250,000 prepaymenton March 31, 2005. In addition, beginning with the fiscal year ending December 31,2005, the Company will be required to make annual mandatory prepayments of theTerm Loan, with specified percentages of excess cash flow (as defined in theFinancing Agreement) and the proceeds of certain asset sales, debt issuances,equity issuances, tax refunds other than the Federal tax refund that theCompany expects to receive as a result of net operating loss carrybacks for2004, insurance and other extraordinary receipts.

 

Ableco Finance LLC, as agent, has a lien onsubstantially all of the assets of the Company, pursuant to the terms of theSecurity Agreement dated as of December 15, 2004 among the Company, itsdomestic subsidiaries party thereto and Ableco. Such lien includes a mortgage onthe real property located at 2305 Breton Industrial Park Drive, S.E., Kentwood,MI (the “Facility Encumbrance”). California KL Holdings, Inc., as agent,has a subordinated lien with respect to the Facility Encumbrance, among otherthings, pursuant to the terms of the Subordinated Security Agreement dated asof December 15, 2004 among the agent, the Company and its domesticsubsidiaries party thereto.

 

OnMarch 18, 2005, the Agent waived, with respect to the year ending December 31,2004, the Company’s non-compliance with a covenant in the Financing Agreementas originally executed, that limited the amount of its aggregate operatinglease expense, and amended such covenant to increase the amount of the annualexpense limitation for the term of the Financing Agreement. In addition, theFinancing Agreement, as originally executed, contains, among other things,various financial covenants to which the Company and its subsidiaries mustadhere on a monthly and quarterly basis (a Funded Debt Ratio, a Fixed Charge CoverageRatio, a Consolidated EBITDA covenant, an Infant Line EBITDA covenant and aMinimum Qualified Cash covenant, all as defined in the

 

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FinancingAgreement). The Company was in compliance with such financial covenants as of December 31,2004. However, because management believed that the Company would not be incompliance as of March 31, 2005, with the Consolidated EBITDA Covenant andthe Funded Debt Ratio set forth in the Financing Agreement as originallyexecuted, and had substantial concerns over whether the Company would be incompliance with such covenants for the remainder of 2005, on March 31,2005, the Agent, the Required Lenders under the Financing Agreement, theCompany and its subsidiaries party thereto executed the Amendment, whichamended the Consolidated EBITDA covenant for the quarters ending March 31,June 30, September 30 and December 31, 2005 (in light of theadditional $18,250,000 prepayment of principal discussed above, no amendment ofthe Funded Debt Ratio or any other financial covenant was required).  Theamended covenants are set forth below:

 
| ** **              | ** ** | **Original Required Consolidated EBITDA** | ** ** | **Amended Required Consolidated EBITDA** | ** ** |
|-------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
|                    |       |                                      |       |                                     |       |
| March 31, 2005     |       | $                                         | 29,000,000 |                                     | $          | 27,500,000 |   |
| June 30, 2005      |       | $                                         | 34,000,000 |                                     | $          | 31,000,000 |   |
| September 30, 2005 |       | $                                         | 39,000,000 |                                     | $          | 33,000,000 |   |
| December 31, 2005  |       | $                                         | 44,000,000 |                                     | $          | 36,000,000 |   |

 

Management believes that the Company will be incompliance with such amended covenants and all of the covenants of theFinancing Agreement through March 31, 2006. In connection with theAmendment, in addition to the dividend restrictions set forth below, theCompany agreed to (i) simultaneously with the execution of the Amendment,prepay a portion of the principal of the Term Loan in the amount of $18,250,000(in lieu of payment to the Agent of a portion of the Federal tax refund thatthe Company expects to receive as a result of net operating loss carrybacks for2004, as required in the original Financing Agreement prior to the Amendmentbut in addition to the required quarterly principal payment), (ii) amendthe interest rate provisions applicable to the term loan as discussed above, (iii) increasethe Minimum Qualified Cash level (as defined) required by the FinancingAgreement from $40,000,000 to $45,000,000, (iv) maintain the Term Loan LC(as defined below) throughout the term of the Financing Agreement (such TermLoan LC would otherwise have been released when the Funded Debt Ratio is lessthan 3.0:1.0), and (v) pay a fee of $787,500 in connection with theexecution of the Amendment.

 

In accordance with the Amendment, as long as all orany portion of the Term Loan is outstanding, the Company is not permitted todeclare and/or pay dividends unless, except in all cases with respect to thedividend declared by the Company on March 31, 2005 and paid during themonth of April, 2005 (the “First Quarter 2005 Dividend”), (i) no Defaultor Event of Default (as defined in the Financing Agreement) shall have occurredand be continuing either before or after giving effect to such declaration andpayment; (ii) at the time of declaration of such dividends, the chieffinancial officer of the Company shall have certified in writing to the Agentthat as of such date and after due investigation and inquiry, such chieffinancial officer has no reason to believe that, after giving effect to thepayment of such dividends, the Company will not be in compliance with any ofthe financial covenants in the Financing Agreement generally as of the end ofthe fiscal quarter in which such dividends are to be paid; and (iii) theCompany satisfies a minimum Consolidated EBITDA test for the fiscal quarterimmediately preceding the fiscal quarter in which such dividend is to be paid(in any event, no such dividend shall exceed $6,250,000 per quarter); providedfurther, notwithstanding the foregoing or any other provision of the FinancingAgreement, (a) the Company may declare and pay only the December 2004Dividend in the fiscal quarter ending December 31, 2004; (b) theamount of the First Quarter 2005 Dividend shall be no greater than either (i) tencents ($0.10) per share or (ii) $2,100,000; and (c) the Company maydeclare and pay a dividend not greater than either $0.05 per share (subject tocorresponding adjustment for stock splits, stock dividends andrecapitalizations) or $1,050,000 for each of the second, third and fourthquarters of 2005, *provided* thatthe Company has the Dollar Equivalent Amount of Qualified Cash (as defined inthe Financing Agreement) of at least $55,000,000, after giving effect to anysuch dividend, and the Company is in compliance with clauses (i), (ii) and(iii) above. In light of the foregoing, the Company cannot assure theability to pay dividends in the future.

 

In connection with the original execution of andamendments to the Financing Agreement, the Company incurred an aggregate ofapproximately $5,800,000 in specified fees. These costs are included in “otherassets” on the Consolidated Balance Sheet for the applicable periods and arebeing amortized over the three year term of the loan. Additionally, under theFinancing Agreement, the Company was required to establish a standby letter ofcredit of $10,000,000 in support of the Term Loan (the “Term Loan LC”).

 

**Other Events and CircumstancesPertaining to Liquidity**

 

Cashdividends of $2,082,000 ($0.10) per share were paid on April 21, 2005 toshareholders of record of the Company’s Common Stock on April 11,2005.  Cash dividends of $6,215,000 per($0.30) share were paid on March 26, 2004 to shareholders of record of theCompany’s Common Stock on March 12, 2004. See “Kids Line and

 

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RelatedFinancing” above for a discussion of the restrictions on the Company’s abilityto pay dividends as long as all or any portion of the Term Loan remainsoutstanding.

 

During the fourth quarter of 2004, the Companyentered into a sales agreement to sell one of its two office locations in HongKong as a result of the Company transitioning a number of functions that hadpreviously been performed in Hong Kong into our offices in mainland China. Thesales price was $2.8 million and the closing occurred on January 31, 2005.As a result of this transaction, the Company recorded an impairment charge of$1.9 million pre-tax.  In addition,during 2004, the Company had also decided to sell one of its two distributioncenters in the UK to reduce future operating expenses. The sales price was $5.9million and the closing occurred on March 14, 2005. As a result of thistransaction, the Company recorded an impairment charge of $1.7 millionpre-tax.  These impairments were bothrecorded in the fourth quarter of 2004.

 

The Company enters into forward exchange contracts,principally to manage the economic currency risks associated with the purchaseof inventory by its European, Canadian and Australian subsidiaries in the giftsegment and by Sassy Inc. in the infant and juvenile segment.

 

The Company is dependent upon information technologysystems in many aspects of its business. The Company is continuingimplementation of an Enterprise Resource Planning (“ERP”) system for theCompany’s gift businesses, which began in 2002. In 2002 and 2003, the Companysuccessfully completed the replacement of its warehouse management system inits South Brunswick, 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 custom softwarethat had been utilized to operate and manage its business and other third partysoftware systems are being replaced using a strategic and phased approach. TheCompany’s worldwide headquarters in the United States completed theimplementation of the finance module of the new ERP system in the first quarterof 2003 and transitioned to the order management and inventory modules duringthe second quarter of 2003. During 2003 and continuing in 2005, the Company’sinternational subsidiaries began and continued to phase-in certain aspects ofthe Company’s new ERP system and the transition to order management, inventoryand finance modules is now anticipated to be substantially complete by the endof the third quarter of 2005.  Thistimetable is meant to continue to enable the Company to enhance its proficiencyin utilizing the new system, to help ensure the efficiency of the internationalimplementations and allow the Company to continue to comply with itsobligations regarding internal controls as required by Section 404 of theSarbanes-Oxley Act of 2002. The Company has experienced certain startup issuesbut has not experienced any significant business disruptions related to thereplacement of these systems.

 

In March 1990, The Board of Directors hadauthorized the Company to repurchase an aggregate of 7,000,000 shares of commonstock. As of March 31, 2005, 5,643,200 shares have been repurchased sincethe beginning of the Company’s stock repurchase program. During the threemonths ended March 31, 2005, the Company did not repurchase any sharespursuant to this program or otherwise.

 

The Company is subject to legal proceedings andclaims arising in the ordinary course of its business that the Company believeswill not have a material adverse impact on the Company’s consolidated financialcondition, results of operations or cash flows.

 

The Company may incur further restructuring costs asit continues to investigate other areas for cost reduction and efficiencyimprovements in its efforts to right-size its infrastructure, although theCompany has no current intention to incur and material restructuring charges inthe immediate future.  See “Overview”above.

 

Consistent with its past practices and in the normalcourse of its business, the Company regularly reviews acquisition opportunitiesof varying sizes. The Company may consider the use of debt financing to fundprospective acquisitions.  Note that theFinancing Agreement imposes restrictions on the Company which could limit itsability to respond to market conditions or to take advantage of businessopportunities.

 

The Company has entered into certain transactionswith related parties which are disclosed in Note 16 of the Notes toConsolidated Financial Statements and ITEM 13 “CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS” of the Company’s Annual Report on Form 10-K for theyear ended December 31, 2004.

 

**Contractual Obligations**

 

As of March 31, 2005, there have been nomaterial changes outside the ordinary course of business in the Company’scontractual obligations as described under the caption “Contractual Obligations”of Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31,2004.

 

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**Off Balance Sheet Arrangements**

 

As of March 31, 2005, there have been nomaterial changes in the information provided under the caption “Off BalanceSheet Arrangements” of Item 7 of the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004.

 

**CRITICAL ACCOUNTING POLICIES**

 

The SEC has issued disclosure advice regarding “criticalaccounting policies”, defined as accounting policies that management believesare both most important to the portrayal of the Company’s financial conditionand results and require application of management’s most difficult, subjectiveor complex judgments, often as a result of the need to make estimates about theeffects of matters that are inherently uncertain.

 

Management is required to make certain estimates andassumptions during the preparation of its consolidated financial statementsthat effect the reported amounts of assets, liabilities, revenue and expenses,and related disclosure of contingent assets and liabilities. Estimates andassumptions are reviewed periodically, and revisions made as determined to benecessary by management. The Company’s significant accounting estimates havehistorically been and are expected to remain reasonably accurate, but actualresults could differ from those estimates under different assumptions orconditions. There have been no material changes to the Company’s significantaccounting estimates and assumptions or the judgments affecting the applicationof such estimates and assumptions during the period covered by this report fromthose described in the Company's 2004 10-K.

 

There have been no changes to the criticalaccounting polices in the first quarter of 2005 from those disclosed in theCompany’s 2004 10K.

 

Note 2 of the Notes to Consolidated FinancialStatements of the Company’s Annual Report on Form 10K for the year endedDecember 31, 2004 contains a summary of the significant accounting policiesused in the preparation of the Company’s consolidated financial statements.

 

**Recently Issued AccountingStandards**

 

See Note 15 of the Notes to Consolidated FinancialStatements for a description of recently issued accounting standards includingthe respective dates of adoption and effects on results of operations andfinancial condition.

 

**Forward-Looking Statements**

 

This Quarterly Report on Form 10-Q containscertain forward-looking statements.  Additional written and oralforward-looking statements may be made by the Company from time to time inSecurities and Exchange Commission (SEC) filings and otherwise.  ThePrivate Securities Litigation Reform Act of 1995 provides a safe-harbor for forward-lookingstatements.  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 by forward-lookingstatements, including, without limitation, those relating to the Company’sfuture business prospects, revenues, working capital, liquidity, capital needs,interest costs and income are subject to certain risks and uncertainties thatcould cause actual results to differ materially from those indicated in theforward-looking statements.  Specific risks and uncertainties include, butare not limited to, the Company’s ability to continue to manufacture itsproducts 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’s Republic of China (“PRC”) authorities with respect to the Company’sPRC operations, the resolution of various legal matters, possible delays in theintroduction of new products, customer acceptance of products, changes inforeign currency exchange rates, issues related to the Company’s computersystems, the ability to obtain debt financing to fund acquisitions, the currentand future outlook of the global retail market, the ability to integrate newbusiness ventures, the ability to meet covenants in Financing Agreement andother factors.

 

**ITEM 3.  QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

As of March 31, 2005, there have been nomaterial changes in the Company’s market risks as described in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2004.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

Based on the evaluation required by paragraph (b) ofRule 13a-15 or 15d-15 promulgated under the Securities Exchange Act of1934, as amended (the “Exchange Act”), the Company’s Chief Executive Officerand Chief

 

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Financial Officer have concluded that, as of the endof the period covered by this report, the Company’s disclosure controls andprocedures (as defined in Rules 13a-15(e) or 15d-15(e) under theExchange Act), are effective.

 

There has been no change in the Company’s internalcontrol over financial reporting that occurred during the fiscal quarter ended March 31,2005 that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

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**PART II -OTHER INFORMATION**

 

**ITEM 6.  EXHIBITS**

 
|   |   | Exhibits to this Quarterly Report on Form 10-Q. |
|--------|--------|------------------------------------------------------|
|   |   |                                                 |   |   |
|   |   | 3.2 (n)                                              |   | Amendment to Revised Bylaws of the Company, adopted  March 31, 2005, effective as of March 11, 2005 |
|   |   |                                                 |   |   |
|   |   | 4.4                                                  |   | Amendment Number Two to the Financing Agreement,  dated March 31, 2005 by and among Russ Berrie and Company, Inc.,  the lenders party thereto, and Ableco Finance LLC as collateral agent and administrative  agent. |
|   |   |                                                 |   |   |
|   |   | 10.93                                                |   | Incentive Compensation Program adopted on  March 11, 2005. |
|   |   |                                                 |   |   |
|   |   | 31.1                                                 |   | Certification of CEO required by Section 302  of the Sarbanes Oxley Act of 2002. |
|   |   | 31.2                                                 |   | Certification of CFO required by Section 302  of the Sarbanes Oxley Act of 2002. |
|   |   |                                                 |   |   |
|   |   | 32.1                                                 |   | Certification of CEO required by Section 906  of the Sarbanes Oxley Act of 2002. |
|   |   |                                                 |   |   |
|   |   | 32.2                                                 |   | Certification of CFO required by Section 906  of the Sarbanes Oxley Act of 2002. |

 

**Items 1, 2, 3, 4 and 5 are notapplicable and have been omitted.**

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|   | RUSS BERRIE AND COMPANY, INC. |                                       |
|--------|-------------------------------|--------------------------------------------|
|   | (Registrant)                  |                                       |
|   |                          |
|   |                          |
|   | By                            | /s/ John D. Wille                     |   |
| Date:  | May 10, 2005        |                                       |   | John D. Wille |
|   |                          | Vice President and Chief Financial Officer |
|        |                               |                                            |  |  |  |  |  |

 

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**EXHIBIT INDEX**

 
| 3.2(n) |   | Amendment to Revised Bylaws of the Company,  adopted March 31, 2005 effective as of March 11, 2005.                                                                                                                 |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                          |
| 4.4    |   | Amendment Number Two to the Financing Agreement,  dated March 31, 2005 by and among Russ Berrie and Company, Inc.,  the lenders party thereto and Ableco Finance LLC as collateral agent and  administrative agent. |
|   |   |                                                                                                                                                                                                                          |
| 10.93  |   | Incentive Compensation Program adopted on  March 11, 2005.                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                          |
| 31.1   |   | Certification of CEO required by Section 302  of the Sarbanes Oxley Act of 2002.                                                                                                                                         |
|   |   |                                                                                                                                                                                                                          |
| 31.2   |   | Certification of CFO required by Section 302  of the Sarbanes Oxley Act of 2002.                                                                                                                                         |
|   |   |                                                                                                                                                                                                                          |
| 32.1   |   | Certification of CEO required by Section 906  of the Sarbanes Oxley Act of 2002.                                                                                                                                         |
|   |   |                                                                                                                                                                                                                          |
| 32.2   |   | Certification of CFO required by Section 906  of the Sarbanes Oxley Act of 2002.                                                                                                                                         |

 

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