**UNITED STATESSECURITIES 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 September 30, 2005**                                                                                                                                                                  |
|                                                                                                                                                                                                                         |       |                                                                                                     |
| **OR**                                                                                                                                                                                                                       |
|                                                                                                                                                                                                                         |       |                                                                                                     |
| o                                                                                                                                                                                                                            | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                         |       |                                                                                                     |
| **For the  transition period from                  to               ** |

 

**Commission file number  1-8681**

 

**RUSS BERRIE AND COMPANY, INC.**

(Exact name of registrant asspecified 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 telephonenumber, including area code)

 

 

(Former name, former addressand former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15 (d) of theSecurities 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 registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act).Yes  ý   No  o

 

Indicate by check mark whether theregistration is a shell company (as defined in Rule 12b-2 of the Exchange Act)Yes o No ý

 

The number of shares outstanding of each of theregistrant’s classes of common stock, as of November 2, 2005 was asfollows:

 
| **CLASS**                         |   | **OUTSTANDING AT  November 2, 2005** |
|-----------------------------------|--------|-------------------------------------------|
| Common Stock, $0.10 stated  value |   | 20,824,475                                |

 

 

----

 

**RUSS BERRIEAND COMPANY, INC.**

 

**INDEX**

 
| **PART I – FINANCIAL INFORMATION** |
|----------------------------------------------|
|                                         |   |   |
| Item  1.                                     |   | Financial Statements (unaudited) |
|                                         |   |   |
| a)                                           |   | Consolidated  Balance Sheets as of September 30, 2005 and December 31, 2004 |
|                                         |   |   |
| b)                                           |   | Consolidated  Statements of Operations for the three and nine months ended September 30,  2005 and 2004 |
|                                         |   |   |
| c)                                           |   | Consolidated  Statements of Cash Flows for the nine months ended September 30, 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 5.                                      |   | Other  Information |
|                                         |   |   |
| Item 6.                                      |   | Exhibits |
|                                         |   |   |
| Signature                                    |   |   |

 

2

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**PART 1 – FINANCIAL INFORMATION**

**ITEM 1.  Financial Statements**

 

**RUSS BERRIE AND COMPANY, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**

**(Dollars inthousands, except per share data)**

**(UNAUDITED)**

 
|                                                                                                                                                |       | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ***ASSETS***                                                                                                                                        |       |                         |       |                        |       |
| Current assets                                                                                                                                      |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                                           |       | $                            | 4,551      |                        | $          | 48,099 |   |
| Restricted cash                                                                                                                                     |       | —                       |       | 4,604                       |       |
| Accounts receivable, trade, less allowances of  $2,643 in 2005 and $2,950 in 2004                                                                   |       | 74,659                       |       | 75,722                      |       |
| Inventories — net                                                                                                                              |       | 56,682                       |       | 47,391                      |       |
| Prepaid expenses and other current assets                                                                                                           |       | 6,342                        |       | 6,090                       |       |
| Income tax receivable                                                                                                                               |       | 3,793                        |       | 11,359                      |       |
| Deferred income taxes                                                                                                                               |       | 3,326                        |       | 2,860                       |       |
| **Total current assets**                                                                                                                            | ** ** | 149,353                      |       | 196,125                     |       |
|                                                                                                                                                |       |                         |       |                        |       |
| Property, plant and equipment — net                                                                                                            |       | 24,103                       |       | 28,690                      |       |
| Goodwill                                                                                                                                            |       | 89,242                       |       | 89,213                      |       |
| Intangible assets                                                                                                                                   |       | 61,604                       |       | 61,927                      |       |
| Restricted cash                                                                                                                                     |       | 782                          |       | 11,026                      |       |
| Deferred income taxes                                                                                                                               |       | 816                          |       | 4,518                       |       |
| Other assets                                                                                                                                        |       | 8,432                        |       | 10,852                      |       |
| Assets held for sale                                                                                                                                |       | —                       |       | 8,747                       |       |
| **Total assets**                                                                                                                                    | ** ** | $                            | 334,332    |                        | $          | 411,098 |   |
|                                                                                                                                                |       |                         |       |                        |       |
| ***LIABILITIES  AND SHAREHOLDERS’ EQUITY***                                                                                                    |       |                         |       |                        |       |
| Current liabilities                                                                                                                                 |       |                         |       |                        |       |
| Current portion of long-term debt                                                                                                                   |       | $                            | 2,600      |                        | $          | 25,250 |   |
| Short-term debt                                                                                                                                     |       | 12,629                       |       | —                      |       |
| Accounts payable                                                                                                                                    |       | 21,375                       |       | 12,137                      |       |
| Accrued expenses                                                                                                                                    |       | 28,870                       |       | 35,204                      |       |
| Accrued income taxes                                                                                                                                |       | 4,161                        |       | 4,241                       |       |
| **Total current liabilities**                                                                                                                       |       | 69,635                       |       | 76,832                      |       |
| Long-term debt, excluding current portion                                                                                                           |       | 49,750                       |       | 99,750                      |       |
| Deferred income tax                                                                                                                                 |       | 1,777                        |       | —                      |       |
| **Total liabilities**                                                                                                                               |       | $                            | 121,162    |                        | $          | 176,582 |   |
| Commitments and contingencies                                                                                                                       |       |                         |       |                        |       |
| Shareholders’ equity                                                                                                                           |       |                         |       |                        |       |
| Common stock: $0.10 stated value per share;  50,000,000 shares authorized; 26,460,759 issued at September 30, 2005  and December 31, 2004 |       | 2,648                        |       | 2,648                       |       |
| Additional paid in capital                                                                                                                          |       | 88,677                       |       | 88,693                      |       |
| Retained earnings                                                                                                                                   |       | 219,362                      |       | 237,937                     |       |
| Accumulated other comprehensive income                                                                                                              |       | 12,633                       |       | 15,388                      |       |
| Treasury stock, at cost (5,636,284 shares at September 30,  2005 and  December 31, 2004)                                             |       | (110,150                     | )          | (110,150                    | )          |
|                                                                                                                                                |       |                         |       |                        |       |
| **Total shareholders’ equity**                                                                                                                 | ** ** | 213,170                      |       | 234,516                     |       |
| **Total liabilities and  shareholders’ equity**                                                                                                | ** ** | $                            | 334,332    |                        | $          | 411,098 |   |

 

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

 

3

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**RUSS BERRIE AND COMPANY, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Dollars inthousands, except per share data)**

**(UNAUDITED)**

 
| ** **                                                                          | ** ** | **THREE MONTHS ENDED  SEPTEMBER 30,** | ** ** | **NINE MONTHS ENDED  SEPTEMBER 30,** | ** ** |
|-------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                          | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                |       |                                       |       |                                      |       |   |   |   |   |
| Net sales                                                                           |       | $                                          | 83,237     |                                      | $          | 79,272 |   | $ | 215,996 |   | $ | 198,405 |   |
|                                                                                |       |                                       |       |                                      |       |   |   |   |   |
| Cost of Sales                                                                       |       | 48,643                                     |       | 41,893                                    |       | 124,985 |   | 117,094 |   |
|                                                                                |       |                                       |       |                                      |       |   |   |   |   |
| **Gross  profit**                                                                   |       | 34,594                                     |       | 37,379                                    |       | 91,011 |   | 81,311 |   |
|                                                                                |       |                                       |       |                                      |       |   |   |   |   |
| Selling, general and administrative  expenses                                       |       | 29,936                                     |       | 35,349                                    |       | 89,831 |   | 103,819 |   |
|                                                                                |       |                                       |       |                                      |       |   |   |   |   |
| **Operating  income/(loss)**                                                        |       | 4,658                                      |       | 2,030                                     |       | 1,180 |   | (22,508 | ) |
|                                                                                |       |                                       |       |                                      |       |   |   |   |   |
| Other income (expense):                                                             |       |                                       |       |                                      |       |   |   |   |   |
| Interest  expense, including amortization and write-off of deferred financing costs |       | (1,424                                     | )          | (13                                       | )          | (13,143 | ) | (77 | ) |
| Interest and  investment (loss)/income                                              |       | 116                                        |       | 353                                       |       | 761 |   | 3,164 |   |
| Other, net                                                                          |       | (132                                       | )          | (30                                       | )          | (654 | )  | (586 | ) |
|                                                                                |       | (1,440                                     | )          | 310                                       |       | (13,036 | ) | 2,501 |   |
|                                                                                |       |                                       |       |                                      |       |   |   |   |   |
| **Income/(loss)  before income tax benefit**                                        |       | 3,218                                      |       | 2,340                                     |       | (11,856 | ) | (20,007 | ) |
|                                                                                |       |                                       |       |                                      |       |   |   |   |   |
| Income tax provision/(benefit)                                                      |       | 11,824                                     |       | 92                                        |       | 4,637 |   | (7,141 | ) |
|                                                                                |       |                                       |       |                                      |       |   |   |   |   |
| **Net  (loss)/income**                                                              |       | $                                          | (8,606     | )                                         | $          | 2,248 |   | $ | (16,493 | ) | $ | (12,866 | ) |
|                                                                                |       |                                       |       |                                      |       |   |   |   |   |
| **Net (loss)/income per share:**                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                                               |       | $                                          | (0.41      | )                                         | $          | 0.11 |   | $ | (0.79 | ) | $ | (0.62 | ) |
| Diluted                                                                             |       | $                                          | (0.41      | )                                         | $          | 0.11 |   | $ | (0.79 | ) | $ | (0.62 | ) |
|                                                                                |       |                                       |       |                                      |       |   |   |   |   |
| **Weighted average shares:**                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                                               |       | 20,824,000                                 |       | 20,829,000                                |       | 20,824,000 |   | 20,767,000 |   |
| Diluted                                                                             |       | 20,824,000                                 |       | 20,829,000                                |       | 20,824,000 |   | 20,767,000 |   |

 

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

 

4

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**RUSS BERRIE AND COMPANY, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Dollars inthousands)**

**(UNAUDITED)**

 
|                                                                                       |   | **NINE MONTHS ENDED  SEPTEMBER 30,** | ** ** |
|--------------------------------------------------------------------------------------------|--------|-------------------------------------------|------------|
|                                                                                       |   | **2005**                                  | ** ** | **2004** | ** ** |
| **Cash flows from operating  activities:**                                                 |   |                                      |       |   |   |
| Net loss                                                                                   |   | $                                         | (16,493    | ) | $ | (12,866 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operating activities: |   |                                      |       |   |   |
| Depreciation and amortization                                                              |   | 4,971                                     |       | 4,949 |   |
| Amortization and write-off of deferred financing  costs                                    |   | 5,855                                     |       | 3⁄4 |   |
| Provision for accounts receivable reserves                                                 |   | 371                                       |       | 1,095 |   |
| Provision for inventory reserves                                                           |   | 667                                       |       | 14,426 |   |
| Deferred income taxes – net                                                           |   | 5,013                                     |       | (5,457 | ) |
| Loss on sale of subsidiary                                                                 |   | —                                    |       | 235 |   |
| Other                                                                                      |   | 405                                       |       | 1,764 |   |
| Changes in assets and liabilities:                                                         |   |                                      |       |   |   |
| Restricted cash                                                                            |   | 14,848                                    |       | 3⁄4 |   |
| Accounts receivable                                                                        |   | 692                                       |       | 11,733 |   |
| Inventories                                                                                |   | (9,958                                    | )          | (6,379 | ) |
| Prepaid expenses and other current assets                                                  |   | (252                                      | )          | 425 |   |
| Other assets                                                                               |   | 62                                        |       | 1,178 |   |
| Accounts payable                                                                           |   | 9,238                                     |       | (5,690 | ) |
| Accrued expenses                                                                           |   | (6,333                                    | )          | 1,237 |   |
| Accrued income taxes                                                                       |   | 7,486                                     |       | (8,000 | ) |
| Total adjustments                                                                          |   | 33,065                                    |       | 11,516 |   |
| Net cash provided by (used in) operating  activities                                       |   | 16,572                                    |       | (1,350 | ) |
|                                                                                       |   |                                      |       |   |   |
| **Cash flows from investing  activities:**                                                 |   |                                      |       |   |   |
| Purchase of marketable securities and other  investments                                   |   | —                                    |       | (322,794 | ) |
| Proceeds from sale of marketable securities and  other investments                         |   | —                                    |       | 464,618 |   |
| Proceeds from sale of property, plant and  equipment                                       |   | 8,961                                     |       | 4,715 |   |
| Capital expenditures                                                                       |   | (950                                      | )          | (1,527 | ) |
| Net cash provided by investing activities                                                  |   | 8,011                                     |       | 145,012 |   |
|                                                                                       |   |                                      |       |   |   |
| **Cash flows from financing  activities:**                                                 |   |                                      |       |   |   |
| Proceeds from issuance of common stock                                                     |   | 3⁄4                                    |       | 3,270 |   |
| Dividends paid to shareholders                                                             |   | (2,082                                    | )          | (164,520 | ) |
| Payment of deferred financing cost                                                         |   | (3,513                                    | )          | 3⁄4 |   |
| Issuance of debt                                                                           |   | 81,983                                    |       | 3⁄4 |   |
| Payment of long term debt                                                                  |   | (142,004                                  | )          | 3⁄4 |   |
| Net cash used in financing activities                                                      |   | (65,616                                   | )          | (161,250 | ) |
|                                                                                       |   |                                      |       |   |   |
| Effect of exchange rate changes on cash and cash  equivalents                              |   | (2,515                                    | )          | 634 |   |
| Net decrease in cash and cash equivalents                                                  |   | (43,548                                   | )          | (16,954 | ) |
| Cash and cash equivalents at beginning of period                                           |   | 48,099                                    |       | 81,535 |   |
| Cash and cash equivalents at end of period                                                 |   | $                                         | 4,551      |   | $ | 64,581 |   |
|                                                                                       |   |                                      |       |   |   |
| **Cash paid during the period for:**                                                       |   |                                      |       |   |   |
| Interest                                                                                   |   | $                                         | 7,437      |   | $ | 77 |   |
| Income taxes                                                                               |   | $                                         | 1,831      |   | $ | 859 |   |

 

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

 

5

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

(Unaudited)

 

**NOTE 1 – ORGANIZATION AND BASIS OFPRESENTATION**

 

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, certain information and footnotedisclosures normally included in financial statements prepared under generallyaccepted accounting principles have been condensed or omitted pursuant to suchprinciples and regulations.  The information furnished reflects alladjustments, which are, in the opinion of management, of a normal recurring natureand necessary for a fair presentation of the Company’s consolidated financialposition, results of operations and cash flows for the interim periodspresented.  Results for interim periods are not necessarily an indicationof results to be expected for the year.

 

Priorto the acquisition of Kids Line, LLC in December 2004, the Company had tworeportable segments: the core segment, which consisted of the Company’s giftbusiness, and the non-core segment, which consisted of the businesses of Sassy, Inc.and Bright of America, Inc.  Afterthe acquisition of Kids Line as of December 15, 2004, the Companyreclassified 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 adjusted its 2004 segment disclosures to conform to the new segmentclassifications.  However, as a result ofthe sale of Bright of America, the Company currently operates in twosegments:  (i) its gift business and(ii) its infant and juvenile business. The segmentation of the Company’s operations reflects how the Company’schief operating decision makers currently view results of operations.  There are no intersegment revenues.

 

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 independent distributors.  The Company’s infant and juvenile businessesdesign, manufacture through third parties and market products in a number ofbaby categories including, among others, infant bedding and accessories, bathtoys and accessories, developmental toys, feeding items and baby comfortingproducts,  and consist 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’snon-core business consisted of Bright of America, Inc. until its sale bythe Company effective August 2, 2004. Non-core products included educational products, placemats, candles andhome fragrance products, which were sold to customers primarily in the UnitedStates through mass marketers.

 

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

 

This Quarterly Report on Form 10-Q should beread in conjunction with the Company’s Quarterly Reports on Form 10-Q forthe period ended March 31, 2005 (the “First Quarter 10-Q”) and the periodended June 30, 2005 (the “Second Quarter 10-Q”), as well as the Company’sAnnual Report on Form 10-K for the year ended December 31, 2004 (the “200410-K”).

 

**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, nocompensation cost has been recognized for the options granted by the Companywith an initial exercise price equal to the fair value of the common stock exceptfor the application of Financial Accounting Interpretation No. 44, “Accountingfor Certain Transactions Involving Stock Compensation”, the effect of which wasimmaterial.  Had compensation cost forthe Company’s stock grants been determined based on the fair recognitionprovisions of SFAS No. 123 at the grant date, in the three and nine monthsended September 30, 2005 and 2004, the Company’s net income/(loss) and netincome/(loss) per share would have been as follows:

 

6

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| ** **                                                                                               | ** ** | **(Dollars in thousands)**                 | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
| ** **                                                                                               | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net  (loss)/income -as reported                                                                          |       | $                                          | (8,606     | ) | $ | 2,248 |   | $ | (16,493 | ) | $ | (12,866 | ) |
| Deduction  for stock-based compensation expense determined under fair value method net  of tax-pro forma |       | 319                                        |       | 91 |   | 676 |   | 403 |   |
|                                                                                                     |       |                                       |       |   |   |   |   |   |   |
| Net  income/(loss) -pro forma                                                                            |       | (8,925                                     | )          | 2,157 |   | (17,169 | ) | (13,269 | ) |
|                                                                                                     |       |                                       |       |   |   |   |   |   |   |
| Earnings/(loss)  per share (basic) - as reported                                                         |       | (0.41                                      | )          | 0.11 |   | (0.79 | ) | (0.62 | ) |
| Earnings/(loss)  per share (basic) – pro forma                                                      |       | (0.43                                      | )          | 0.10 |   | (0.82 | ) | (0.64 | ) |
| Earnings/(loss)  per share (diluted) – as reported                                                  |       | (0.41                                      | )          | 0.11 |   | (0.79 | ) | (0.62 | ) |
| Earnings/(loss)  per share (diluted) – pro forma                                                    |       | (0.43                                      | )          | 0.10 |   | (0.82 | ) | (0.64 | ) |
|                                                                                                          |            |                                            |            |  |  |  |  |  |  |  |  |  |  |

 

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

 
| ** **                                                      | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Dividend  yield                                                 |       | 1.50                                       | %          | 3.52                                      | %          | 1.50 | % | 3.52 | % |
| Risk-free  interest rate                                        |       | 4.12                                       | %          | 2.40                                      | %          | 4.96 | % | 2.40 | % |
| Volatility                                                      |       | 36.5                                       | %          | 30.71                                     | %          | 35.45 | % | 30.71 | % |
| Expected  life (years)                                          |       | 3.7                                        |       | 3.7                                       |       | 3.7 |   | 3.7 |   |
| Weighted  average fair value of options granted during the year |       | $                                          | 5.48       |                                      | $          | 4.43 |   | $ | 5.68 |   | $ | 4.43 |   |
|                                                                 |            |                                            |            |                                           |            |  |  |  |  |  |  |  |  |

 

**NOTE 3 – WEIGHTED AVERAGE COMMONSHARES**

 

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

 
| ** **                                                                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Weighted average common shares outstanding                                 |       | 20,824,000                                 |       | 20,829,000                                |       | 20,824,000 |   | 20,767,000 |   |
|                                                                       |       |                                       |       |                                      |       |   |   |   |   |
| Dilutive effect of common shares issuable under  outstanding stock options |       | —                                     |       | —                                    |       | — |   | — |   |
| Weighted average common shares outstanding  assuming dilution              |       | 20,824,000                                 |       | 20,829,000                                |       | 20,824,000 |   | 20,767,000 |   |

 

Stock options outstanding at September 30, 2005and September 30, 2004 to purchase 803,752 and 460,482 shares of commonstock, respectively, were not included in the computation of earnings percommon share for such period because they were antidilutive.

 

**NOTE 4 – ACQUISITIONS**

 

In December 2004,  the Company purchased all of the outstandingequity interests in Kids Line, LLC (the “Purchase”), in accordance with theterms and provisions of a Membership Interest Purchase Agreement (the “PurchaseAgreement”) 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 

 

7

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Agreement, however, includes the potential paymentof contingent consideration (the “Earnout Consideration”).   The Earnout Consideration shall equal11.724% of the Agreed Enterprise Value (described below) of Kids Line as of thelast day of the Measurement Period (the three year period ended November 30,2007), and shall be paid at the times described in the Purchase Agreement(approximately the third anniversary of the closing date).  The “Agreed Enterprise Value” shall be theproduct of (i) Kids Line’s EBITDA during the twelve (12) months ending onthe last day of the Measurement Period and (ii) the applicable multiple(ranging from zero to eight) as set forth in the Purchase Agreement. The amountof the Earnout Consideration will be charged to goodwill when and if it isearned.

 

Inconnection with the Purchase, the Company and certain of its subsidiariesentered into a Financing Agreement dated as of December 15, 2004, asamended on March 18 and March 31, 2005 (the “Financing Agreement”),with the lenders named therein and Ableco Finance LLC, as collateral agent andas administrative agent (the “Agent”). The Financing Agreement consisted of aterm loan in the original principal amount of $125 million which was scheduledto mature 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 the Company’s form 10-Q for the quarter ended March 31, 2005(the First Quarter 10-Q).

 

Asof June 28, 2005, the Company and certain of its domestic wholly-ownedsubsidiaries entered into a new $105 million Credit Agreement, amended as of August 4and October 11, 2005 (defined and described more fully in Note 5below).  All obligations under theFinancing Agreement were repaid using proceeds from the Credit Agreement andother available cash, and the Financing Agreement was terminated concurrentlywith the execution of the Credit Agreement. In addition, on June 30, 2005, as of June 28, 2005, theCompany’s Canadian subsidiary, Amram’s Distributing Ltd., executed the CanadianCredit Agreement, amended as of August 4 and October 11, 2005,defined and described more fully in Note 5 below.

 

**Pro Forma Information**

 

The following unaudited pro forma consolidatedresults of operations for the three and nine months ended September 30,2004 assumes the acquisition of Kids Line LLC occurred as of January 1,2004.

 
| ** **                   | ** ** | **Three Months Ended  September 30, 2004** | ** ** | **Nine Months Ended  September 30, 2004** | ** ** |
|------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Net sales                    |       | $                                                         | 95,912     |                                                     | $          | 243,937 |   |
| Net income (loss)            |       | 4,074                                                     |       | (8,477                                                   | )          |
| Net income (loss) per share: |       |                                                      |       |                                                     |       |
| Basic                        |       | $                                                         | 0.20       |                                                     | $          | (0.41 | ) |
| Diluted                      |       | $                                                         | 0.20       |                                                     | $          | (0.41 | ) |

 

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 the FinancingAgreement. The Financing Agreement consisted of a term loan in the originalprincipal amount of $125 million which was scheduled to mature on November 14,2007 (the “Term Loan”).  The Company usedthe proceeds of the Term Loan to substantially finance the Purchase and payfees and expenses related thereto.  TheTerm Loan was repaid in full and the Financing Agreement was terminated inconnection with the execution of the Credit Agreement as of June 28,2005.  A detailed description of theFinancing Agreement can be found in the First Quarter 10-Q.  There were no fees triggered as a result ofthe early termination of the Financing Agreement.  However, in conjunction therewith, theCompany wrote off the remaining unamortized balance of approximately $4.8million in deferred financing costs.

 

8

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LaSalle Credit Agreement

 

TheCompany and certain of its domestic wholly-owned subsidiaries party thereto(the “Specified Subsidiaries”), entered into a $105 million credit agreementdated as of June 28, 2005, and amended as of August 4 and October 11,2005 (the “Credit Agreement”), with the financial institutions parties theretoas Facility A Lenders, the financial institutions parties thereto as Facility BLenders, LaSalle Bank National Association, in its capacity as “Issuing Bank”thereunder, LaSalle Business Credit, LLC (in its individual capacity, “LaSalle”),as administrative agent (in such capacity, the “Administrative Agent”) for thelenders and the Issuing Bank, and those lenders, if any designated therein asthe “Documentation Agent” or “Syndication Agent”.  On October 11, 2005, the Company and itslenders amended provisions of the Credit Agreement unrelated to the FinancialCovenants.  Unless otherwise specifiedherein, capitalized terms used but undefined herein shall have the meaningsascribed to them in the Credit Agreement. Unused amounts available under the Credit Agreement will be used forworking capital requirements and general corporate purposes.

 

Theobligations under the Credit Agreement (the “Commitments”) consist of FacilityA Obligations and Facility B Obligations. The Facility A Obligations are comprised of: (a) a $52.0 millionrevolving credit facility (the “Revolving Loan”), with a subfacility forletters of credit to be issued by the Issuing Bank in an amount not to exceed$10.0 million; and (b) a $13.0 million term loan facility (“Term Loan A”).  The Facility B Obligations consist of a $40.0million term loan facility (“Term Loan B”). If there is no default or event of default occurring, on the terms andconditions set forth in the Credit Agreement, and subject to the payment ofapplicable fees, the Revolving Loan may be increased to a maximum of $75.0million.  As of September 30, 2005,the Company had $12.5 million outstanding under the Revolving Loan.

 

Theprincipal of Term Loan A is due in equal monthly installments of $216,666.67(subject to reduction by prepayments), to be made on the last day of each month(commencing July 31, 2005).  A finalinstallment in the aggregate amount of the unpaid principal balance of TermLoan A (in addition to all outstanding amounts under the Revolving Loan) is dueand payable on June 28, 2010, and the principal of Term Loan B is due andpayable on December 28, 2010, in each case subject to earlier terminationin accordance with the terms of the Credit Agreement.  Notwithstanding the foregoing, the Companyshall be required to repay Term Loan B in full upon a full redemption of theFacility A Obligations.

 

TheCommitments bear interest at a rate per annum equal to the sum of the Base Rate(for Base Rate Loans) or the LIBOR Rate (for LIBOR Loans) plus an applicablemargin, in accordance with a pricing grid based on the most recent quarter-endTotal Debt to EBITDA Ratio, as described in the Company's Form 10Q for thequarter ended June 30, 2005 (the "Second Quarter 10Q).  Interest rates as of September 30, 2005were as follows:

 
| ** **    | ** ** | **LIBOR loans** | ** ** | **Base rate loans** | ** ** |
|---------------|------------|-----------------|------------|---------------------|------------|
| Revolver Loan |       | 5.48375         | %          | 7.00                | %          |
| Term Loan A   |       | 5.98375         | %          | 7.50                | %          |
| Term Loan B   |       | 10.71           | %          | —              |       |

 

Interestwill be due and payable (i) with respect to Base Rate Loans, monthly inarrears on the last day of each calendar month, upon a prepayment and atmaturity and (ii) with respect to LIBOR Loans, on the last day of eachInterest Period, upon a prepayment (and if the Interest Period is in excess ofthree months, on the three-month anniversary of the first day of such InterestPeriod), and at maturity.

 

In connection with theexecution of the Credit Agreement and the Canadian Credit Agreement (definedbelow), the Company recorded approximately $2.3 million of deferred financingcosts which are included in “other assets” on the Consolidated Balance Sheet atSeptember 30, 2005 and are being amortized over the five-year period ofthe Commitments. Aggregate agency fees of $40,000 will be payable on eachannual anniversary of the Closing Date. The Revolving Loan shall be subject to an annual non-use fee (payable monthly,in arrears, and upon termination of the relevant obligations) based on the mostrecent quarter-end Total Debt to EBITDA Ratio ranging from 0.375% - 0.50% forunused amounts under the Revolving Loan, an annual letter of credit fee(payable monthly, in arrears, and upon termination of the relevant obligations)for undrawn amounts with respect to each letter of credit based on the mostrecent quarter-end Total Debt to EBITDA Ratio ranging from 1.50% - 2.25%(subject to increase by 2% at any time an event of default exists), customaryletter of credit administration fees and a letter of credit fronting fee inamounts agreed to by the Company and the Issuing Bank.  Notwithstanding the foregoing, during theInitial Period, the non-use fee shall equal 0.375% and the letter of credit feeshall equal 1.75%.  Early terminationfees are described in the Second Quarter 10-Q.

 

The Credit Agreementcontains the following financial covenants (the “Financial Covenants”):  (i) a minimum Fixed Charge CoverageRatio, (ii) a maximum Total Debt to EBITDA Ratio and (iii) a minimumExcess Revolving Loan 

 

9

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Availability requirement of$2,500,000.  Excess Revolving LoanAvailability at September 30, 2005 was approximately $36,493,000.  With respect to dividends, the Company ispermitted to pay a dividend so long as before and after giving effect to thepayment of such dividends, Excess Revolving Loan Availability will equal orexceed $15,000,000 and no violation of the Financial Covenants would thenexist, or would, on a pro forma basis, result therefrom.  Any such dividends may be declared no morefrequently than quarterly and must take the form of regular cashdividends.  With respect to the EarnoutConsideration, the Company will be permitted to pay all or a portion of theEarnout Consideration to the extent that, before and after giving effect tosuch payment, Excess Revolving Loan Availability will equal or exceed$15,000,000 and no violation of the Financial Covenants would then exist, orwould, on a pro forma basis, result therefrom. As of September 30, 2005, the Company was in compliance with the FinancialCovenants contained in the Credit Agreement.

 

TheCompany’s ability to maintain compliance with the Financial Covenants under theCredit Agreement is dependent upon the successful implementation of both therestructuring plan described in Note 8 below (and Item 2 herein) and currentoperational plans, which will likely include, among other things, theinitiation of financing arrangements with respect to certain of the Company’sforeign receivables.  Based on theseplans and management’s current projections, the Company anticipates that itwill remain in compliance with the Financial Covenants at the end of the fourthquarter of 2005 and for the foreseeable future. However, in the event that theCompany is unable to successfully implement the key elements of its plans,there can be no assurance that the Company will remain in compliance with suchFinancial Covenants.

 

Amore detailed description of the Credit Agreement, including a description ofvarious covenants, events of default and consequences thereof can be found inthe Second Quarter 10-Q.

 

Inorder to secure the obligations of the Company and the Specified Subsidiaries,the Company has pledged 100% of the equity interests of the SpecifiedSubsidiaries and 65% of the equity interests of its First Tier ForeignSubsidiaries to the Administrative Agent, and has granted security interests tothe Administrative Agent in substantially all of its personal property, allpursuant to the terms of a Guaranty and Collateral Agreement made on June 28,2005 among the Company, the Specified Subsidiaries and the Administrative Agent(the “GC Agreement”). In addition, pursuant to the GC Agreement, the SpecifiedSubsidiaries have provided guarantees of the Company’s and their obligationsunder the Credit Agreement and have granted security interests to theAdministrative Agent in substantially all of their personal property and havepledged 65% of the equity of their First Tier Foreign Subsidiaries in order tosecure the Company’s and their obligations to the lenders under the CreditAgreement and such subsidiaries’ guarantees. As additional security for Sassy, Inc.’s obligations under theCredit Agreement, Sassy, Inc. has granted a mortgage for the benefit ofthe Administrative Agent and the lenders on the real property located at 2305Breton Industrial Park Drive, S.E., Kentwood, Michigan.

 

Ascontemplated by the Credit Agreement, the Company’s Canadian subsidiary, Amram’sDistributing Ltd. (“Amrams”), entered into on June 30, 2005, as of June 28,2005, and amended as of August 4 and October 11, 2005, aseparate  credit agreement with thefinancial institutions party thereto and LaSalle Business Credit, a division ofABN AMRO Bank, N.V., Canada Branch, a Canadian branch of a Netherlands bank(the “Canadian Credit Agreement”) with respect to a maximum U.S. $10.0 millionrevolving loan (the “Canadian Revolving Loan”), with a subfacility for lettersof credit in an amount not to exceed U.S. $2.0 million.  If there is no default or event of defaultoccurring under the Canadian Credit Agreement, upon the terms and conditionsset forth therein, and subject to the payment of applicable fees, the CanadianRevolving Loan may be increased to a maximum commitment of U.S. $15.0million.  All outstanding amounts underthe Canadian Revolving Loan will be due and payable on June 28, 2010,subject to earlier termination in accordance with the terms of the CanadianCredit Agreement.

 

TheCanadian Revolving Loan will bear interest at a rate per annum equal to the sumof (x)(i) the Base Rate or the Canadian Base Rate (as defined in theCanadian Credit Agreement), at the option of Amrams (for Base Rate Loans) or (ii) theLIBOR Rate (for LIBOR Loans) plus (y) an applicable margin, in accordance witha pricing grid based on the most recent quarter-end Total Debt to EBITDARatio.  The interest rate as of September 30,2005 is 6.75%.  The Canadian CreditAgreement is described in further detail in the Second Quarter 10-Q.

 

Inorder to secure its obligations under the Canadian Credit Agreement, Amrams hasgranted security interests to the administrative agent thereunder insubstantially all of its real and personal property.  In addition, the Company has executed anunsecured Guarantee (the “Canadian Guaranty”) to guarantee the obligations ofAmrams under the Canadian Credit Agreement.

 

Ashas been previously reported, the Company executed the Earnout SecurityDocuments in order to secure the Company’s obligation to pay the EarnoutConsideration (each as defined in the Credit Agreement).  The guarantees and security interests grantedunder the Earnout Security Documents remain in effect and remain subordinatedto the senior indebtedness of the Company arising under the Credit Agreement.

 

10

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Inconnection with the purchase of imported merchandise, the Company at September 30,2005, had no letters of credit outstanding.

 

**NOTE 6 – GOODWILL AND INTANGIBLEASSETS**

 

Under SFAS No. 142, goodwill andindefinite-lived intangible assets are no longer amortized.  However, they are reviewed annually or morefrequently, if required, for impairment. Separable intangible assets that are not deemed to have an indefinitelife will continue to be amortized over their useful lives.  The Company performs the required annualimpairment tests as of the first day of the fourth quarter of each fiscal year.

 

The significant components of intangible assetsconsist of the following:

 
| ** **                                  | ** ** | **Weighted Average  Amortization Period** | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------|------------|-------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                  | ** ** | ** **                                | ** ** | **($’s in ‘000)**  | ** ** | **($’s in ‘000)** | ** ** |
| MAM distribution agreement and relationship |       | Indefinite  life                          |       | $                            | 10,400     |                        | $          | 10,400 |   |
| Sassy trade name                            |       | Indefinite  life                          |       | 7,100                        |       | 7,100                       |       |
| Applause trade name                         |       | Indefinite  life                          |       | 7,645                        |       | 7,679                       |       |
| Kids Line customer relationships            |       | Indefinite  life                          |       | 31,100                       |       | 31,100                      |       |
| Kids Line trade name                        |       | Indefinite  life                          |       | 5,300                        |       | 5,300                       |       |
| Other intangible assets                     |       | 0.3 years                                 |       | 59                           |       | 348                         |       |
|                                        |       |                                      |       |                         |       |                        |       |
| Total intangible assets                     |       |                                      |       | $                            | 61,604     |                        | $          | 61,927 |   |

 

Amortization expense was $288,000 and $13,000 forthe first nine months of 2005 and the full year of 2004, respectively.

 

All of the Company’s goodwill is in the infant andjuvenile segment.  The changes togoodwill for the three and nine months ended September 30, 2005 - reflectsthe final purchase price adjustment for KidsLine.

 
| Balance as  of December 31, 2004 |   | $      | 89,213,000 |   |
|---------------------------------------|--------|--------|------------|--------|
| Adjustments to goodwill               |   | 29,000 |       |
| Balance as of September 30, 2005 |   | $      | 89,242,000 |   |

 

**NOTE 7 - DIVIDENDS**

 

No cash dividends were paid in the quarter ended September 30,2005 and $2,082,000 was paid during the nine months ended September 30,2005.  Cash dividends of $6,249,000($0.30 per share) were paid in the quarter ended September 30, 2004. Cash dividends of $164,520,000 ($0.30 per share per quarter plus $7.00 pershare special dividend) were paid in the nine months ended September 30,2004.  On April 12, 2004, the Company declared a one-time specialcash dividend in the amount of $7.00 per common share payable on May 28,2004, to shareholders of record of the Company’s Common Stock on May 14,2004.  This one-time special dividend of $145,799,000 is included in thedividend payment stated above, for the three and nine months ended September 30,2004.

 

Asis discussed in Note 5, in accordance with the terms of the Credit Agreement,the Company is permitted to pay a dividend as long as before and after givingeffect to the payment of such dividends, Excess Revolving Loan Availability (asdefined therein) will equal or exceed $15,000,000 and no violation of theFinancial Covenants would then exist, or would, on a pro forma basis, resulttherefrom.  Any such dividends may bedeclared no more frequently than quarterly and must take the form of regularcash dividends.  In light of theforegoing, the Company cannot assure the ability to pay dividends in thefuture.

 

**NOTE 8 – COST ASSOCIATED WITHDISPOSAL ACTIVITY**

 

OnSeptember 28, 2004, the Company announced a corporate restructuringdesigned to align the Company’s management and sales organization with itsstrategic plans and to right-size its expense structure.  Therestructuring included the immediate elimination of approximately 75 domesticpositions, and resulted in a pretax charge of $4.1 million in the third quarterof 2004, primarily related to severance costs.  Although these employeesare no longer employees of the Company, payments continued through the thirdquarter of 2005.  These costs are included in 

 

11

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selling,general and administrative expenses in the Consolidated Statements ofOperations and are all related to the Company’s gift segment.

 

Infurtherance of its efforts to right-size its infrastructure, during the fourthquarter of 2004, the Company reduced headcount by 38 positions in the Company’sFar East operations and recorded a restructuring charge of $0.6 million inconnection therewith. Also during the fourth quarter of 2004, with respect toits domestic operations, the Company reduced headcount by nine 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 Statements 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 at  12/31/04** | ** ** | **2005  Provision** | ** ** | **Payments/  Write-offs** | ** ** | **Additional Cost  Incurred** | ** ** | **Balance at  9/30/05** | ** ** |
|---------------------|------------|--------------------------|------------|---------------------|------------|---------------------------|------------|-------------------------------|------------|-------------------------|------------|
| Employee separation |       | $                        | 3,935,000  |                | $          | 1,265,000                 |       | $                             | 3,950,000  |                    | $          | — |   | $ | 1,250,000 |   |
| Facility exit cost  |       | 20,000                   |       | —              |       | 20,000                    |       | —                        |       | —                  |       |
| Total               |       | $                        | 3,955,000  |                | $          | 1,265,000                 |       | $                             | 3,970,000  |                    | $          | — |   | $ | 1,250,000 |   |

 

In November 2005, the Company began implementationof a further restructuring of its domestic gift business to reduce expenses, “rightsize” the infrastructure consistent with current business levels and re-aligndomestic gift operations to better meet the needs of different distributionchannels.  The restructuring includes theimmediate elimination of approximately 50 positions, which will result in apre-tax restructuring charge of approximately $1.4 million in the fourthquarter of 2005, primarily related to employee severance costs.  As part of the restructuring, the Companyalso commenced a plan to reduce its facilities expenses by rationalizingcertain warehouse and distribution activities, which is expected to result inadditional pre-tax restructuring charges in 2006 of approximately $2.5million.  The Company expects to incuradditional restructuring costs during the implementation of the November 2005restructuring, and may incur further restructuring costs as it continues toinvestigate other areas for cost reduction and efficiency imporovements in itsefforts to right-size its infrastructure.

 

Management believes that future operatingexpenses will be reduced by an aggregate of approximately $15 million on anannualized basis as a result of the restructuring commenced in November2005.  A portion of these expense savingswill be reflected in the Company’s results of operations for the fourth quarterof 2005, with the remaining cost reductions expected to be achieved during thefirst half of 2006. Severance payments to employees impacted by therestructuring will continue through the end of 2006, although such paymentswill not impact the Company’s results of operations.

 

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.

 

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

 

Prior to the acquisition of Kids Line, LLC in December 2004,the Company had two reportable segments: the core segment, which consisted ofthe Company’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 in December 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.  The Companyhas adjusted its 2004 segment disclosures to conform to the new segmentclassifications.  However, as a result ofthe sale of Bright of America, the Company currently operates in two segments:  (i) its gift business; and (ii) itsinfant and juvenile business.  Thesegmentation of the Company’s operations reflects how the Company’s chiefoperating decision makers currently view results of operations.  There are no intersegment revenues.

 

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 independent 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 design,manufacture through third parties and market products in a number of babycategories including, among others, infant bedding and accessories, bath toysand accessories, developmental toys, feeding items and baby comfortingproducts,  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.

 

12

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| ** **                        | ** ** | **(Dollars in thousands)**                 | ** ** |
|-----------------------------------|------------|--------------------------------------------|------------|
| ** **                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine months Ended  September 30,** | ** ** |
| ** **                        | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Gift:                             |       |                                       |       |   |   |   |   |   |   |
| Net sales                         |       | $                                          | 50,303     |   | $ | 63,678 |   | $ | 116,977 |   | $ | 153,411 |   |
| Operating loss                    |       | (4,269                                     | )          | (372 | ) | (24,587 | ) | (28,105 | ) |
| (Loss) Income before income taxes |       | (4,257                                     | )          | 138 |   | (24,440 | ) | (25,596 | ) |
|                              |       |                                       |       |   |   |   |   |   |   |
| Infant and juvenile:              |       |                                       |       |   |   |   |   |   |   |
| Net Sales                         |       | 32,934                                     |       | 14,745 |   | 99,019 |   | 40,104 |   |
| Operating income                  |       | 8,927                                      |       | 2,307 |   | 25,767 |   | 5,180 |   |
| Income before income taxes        |       | 7,475                                      |       | 2,307 |   | 12,584 |   | 5,180 |   |
|                              |       |                                       |       |   |   |   |   |   |   |
| Non-core:                         |       |                                       |       |   |   |   |   |   |   |
| Net sales                         |       | —                                     |       | 849 |   | — |   | 4,890 |   |
| Operating income                  |       | —                                     |       | 95 |   | — |   | 417 |   |
| (Loss) income before taxes        |       | —                                     |       | (105 | ) | — |   | 409 |   |
|                              |       |                                       |       |   |   |   |   |   |   |
| Consolidated:                     |       |                                       |       |   |   |   |   |   |   |
| Net Sales                         |       | $                                          | 83,237     |   | $ | 79,272 |   | $ | 215,996 |   | $ | 198,405 |   |
| Operating income (loss)           |       | 4,658                                      |       | 2,030 |   | 1,180 |   | (22,508 | ) |
| Income (loss) before income taxes |       | 3,218                                      |       | 2,340 |   | (11,856 | ) | (20,007 | ) |

 

Additionally, total assets of each segment were asfollows:

 
| ** **          | ** ** | **(Dollars in thousands)**   | ** ** |
|---------------------|------------|------------------------------|------------|
| ** **          | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
| Gift                |       | $                            | 119,769    |   | $ | 201,096 |   |
| Infant and juvenile |       | 214,563                      |       | 210,002 |   |
| Non-core            |       | —                       |       | — |   |
|                |       |                         |       |   |   |
| Total               |       | $                            | 334,332    |   | $ | 411,098 |   |

 

**Concentration of Risk**

 

As disclosed in the 2004 10-K, while 88% of theCompany’s purchases are attributable to manufacturers in the People’s Republicof China, the supplier accounting for the greatest dollar volume of purchasesaccounted for approximately 13% and the five largest suppliers accounted forapproximately 41% in the aggregate.  The Company utilizes approximately100 manufacturers in the Far East.  The Company believes that there aremany alternative 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 vendor relationship.

 

In addition, Toys "R" Us, Inc. andBabies "R" Us, in the aggregate accounted for in excess of 10 percentof the Company's consolidated net sales during the three and nine month periodsended September 30, 2005.

 

**NOTE 10 - COMPREHENSIVE INCOME**

 

Comprehensive Income, representing all changes inShareholders’ equity during the period other than changes resulting from theissuance or repurchase of the Company’s common stock and payment of dividends,is reconciled to net income for the three and nine months ended September 30,2005 and 2004 as follows:

 

13

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| ** **                                                                    | ** ** | **(Dollars in thousands)**                 | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
| ** **                                                                    | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net  (loss)/income                                                            |       | $                                          | (8,606     | ) | $ | 2,248 |   | $ | (16,493 | ) | $ | (12,866 | ) |
| Other  comprehensive income (loss), net of tax:                               |       |                                       |       |   |   |   |   |   |   |
| Foreign  currency translation adjustments                                     |       | 233                                        |       | 1,282 |   | (3,113 | ) | 907 |   |
|                                                                          |       |                                       |       |   |   |   |   |   |   |
| Net  unrealized loss on securities available-for-sale                         |       | —                                     |       | 154 |   | — |   | (255 | ) |
| Net  unrealized gain on foreign currency forward exchange contracts and other |       | (57                                        | )          | 586 |   | 358 |   | 1,129 |   |
| Other  comprehensive income (loss)                                            |       | 176                                        |       | 2,022 |   | (2,755 | ) | 1,781 |   |
|                                                                          |       |                                       |       |   |   |   |   |   |   |
| Comprehensive  (loss) income                                                  |       | $                                          | (8,430     | ) | $ | 4,270 |   | $ | (19,248 | ) | $ | (11,085 | ) |

 

**NOTE 11 - OTHER INCOME(EXPENSE)**

 

Interest expense includes the amortization andwrite-off of deferred financing costs of $143,810 and $5,855,000 in the threeand nine month periods ended September 30, 2005.

 

**NOTE 12 – 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. The Company believes theoutcome of these legal procedures will not have a material adverse effect onthe Company’s financial condition or results of operations.

 

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.  With the exception of the agreement with MAMBabyartikel GmbH (which has a remaining term of six years), the terms of theCompany’s license agreements typically range from two to three years, withpotential extensions agreed to by both parties. Some of these license agreements include prepayments and minimumguarantee royalty payments.  The amountof guaranteed royalty payments with respect to all license agreements over thenext three years aggregates approximately $3,654,000.  The Company’s royalty expense for the firstnine months of 2005 and 2004 was $1,326,000 and $681,000, respectively.

 

In connection with the Company’s expansion of itsoperations in the People’s Republic of China (“PRC”), the Company completed avoluntary review in 2003 of the activities of its offices in the PRC to assesstheir compliance with applicable laws and regulations. As a result of thisreview, 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 prioryear individual income tax underpayments and associated penalties, totalingapproximately $464,000, which was expensed in 2004.

 

**NOTE 13 – TENDER OFFER**

 

On May 7, 2004, the Company announced that theBoard of Directors authorized a cash tender offer to purchase outstandingoptions issued under the Company’s various equity compensation plans, as ismore fully described in the Statement on Schedule TO and relatedamendments filed by the Company with the Securities and Exchange Commission in May andJune 2004.  The tender offer closed in June 2004 with anaggregate purchase price of 

 

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approximately $844,000 paid by the Company, whichwas recorded as compensation expense in the second quarter of 2004.

 

**NOTE 14 – SALE OF BRIGHT OF AMERICA**

 

EffectiveAugust 2, 2004, the Company sold substantially all of the net assets ofits non-core subsidiary, Bright of America, Inc. (“Bright”).  Assetsof approximately $5.8 million less assumed liabilities of $0.8 million weresold for $4.0 million in cash and a $1 million promissory note bearing interestat 9% per annum, payable on October 31, 2007.  The Company recorded aloss of approximately $153,000, net of tax, in the third quarter 2004 as aresult of the sale, due primarily to transaction related costs.  Duringthe nine months ended September 30, 2004, Bright generated net sales ofapproximately $4,900,000 and net income of approximately $300,000.

 

**NOTE 15- RECENTLY ISSUED ACCOUNTINGSTANDARDS**

 

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.  SFAS No. 123(R) will beeffective beginning with the first interim or annual reporting period of thefirst fiscal year beginning on or after June 15, 2005 (for the Company,the first quarter of 2006).  The Companyis currently evaluating the standard to determine its effect on theConsolidated Financial Statements.

 

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

 

**OVERVIEW**

 

The Company is a leader in the gift industry.  The Company’s gift business designs,manufactures through third parties and markets a wide variety of gift productsto retail stores throughout the world. The Company’s infant and juvenile businesses design, manufacture throughthird parties and market products in a number of baby categories, includinginfant bedding and accessories, bath toys and accessories, developmental toys,feeding items and baby comforting products. These products are sold toconsumers, primarily in the United States, through mass merchandisers, toyspecialty, food, drug and independent retailers, apparel stores and militarypost exchanges.

 

TheCompany’s revenues are primarily derived from sales of its products, asignificant portion of which is attributable its gift segment.  Sales andoperating profits in the Company’s gift segment began to decline during 2003 asa result of several factors including: (i) retailer consolidation and adeclining number of independent retail outlets, which in turn had a negativeimpact on sales from such outlets; (ii) increased competition from otherentities, both wholesellers and retailers, which offered lower pricing andachieved greater customer acceptance of their products; and (iii) changingbuying habits of consumers, marked by a shift from independent retailers tomass market retailers.  Commencing in thethird quarter of 2003, the Company began to implement a multi-pronged approachto address these trends, which consists of: (i) focusing on categorizingand rationalizing its product range; (ii) segmenting its selling effortsto address customer requirements and shifting channels of distribution; (iii) increasingits focus on national accounts, in order to build and strengthen the Company’spresence in the mass market through the use if its APPLAUSE ® Trademark as themass market brand platform; (iv) focusing on growing its internationalbusiness and infant and juvenile segments; (v) selectively increasing itsuse of licensing to differentiate its products from its competitors;  (vi) implementinga three tiered “good”, “better”, “best” branding strategy within its giftsegment to differentiate products sold into the mass market, the Company’straditional specialty retail market and the upscale department store market; and(vii) ”right-sizing” its operations in order to reduce overhead expensesthrough headcount reductions and the closure of certain domestic showrooms.

 

During2004, the Company implemented a comprehensive strategic review of the Company’sbusiness, which resulted in an inventory write-down of $13 million (pre tax)recorded in cost of sales in the second quarter of 2004. In addition, theCompany continued to evaluate “right sizing” its infrastructure in response tothe changing business environment.  As a resultof such evaluation, the Company reduced headcount during the second half of2004 by an aggregate of approximately 122 positions and recorded arestructuring charge of an aggregate of $6.3 million in the third and fourthquarters of 2004.  Management believesthat future operating expenses, predominantly through reduced employee costs,will be reduced by an aggregate of approximately $10.5 million on an annualizedbasis as a result of these reductions. The effects of these reduced costs began in the third and fourthquarters of 2004.  Although theseemployees are no longer employees of the Company, payments will continuethrough the third and fourth quarters of 2005.

 

The Company has continued to address the challenges in its giftbusiness through the multi-pronged approach discussed above, which has enabledthe Company to reduce significantly its operating expenses. However, to date,the Company has achieved only limited success in reversing the challengesfacing its gift business and the industry in general. As a result, in November2005, the Company commenced the implementation of a further restructuring ofits domestic gift business designed to “right size” the infrastructureconsistent with current business levels and re-align domestic gift operationsto better meet the needs of different distribution channels. The restructuringincludes the immediate elimination of approximately 50 positions, which willresult in a pre-tax restructuring charge of approximately $1.4 million in thefourth quarter of 2005, primarily related to employee severance costs. As partof the restructuring, the Company also commenced a plan to reduce itsfacilities expenses by rationalizing certain warehouse and distributionactivities, which is expected to result in additional pre-tax restructuringcharges in 2006 of approximately $2.5 million. The Company expects to incuradditional restructuring costs as it continues to implement the November 2005restructuring and may incur further restructuring costs as it continues to investigateother areas for cost reduction and efficiency improvements in its efforts toright-size its infrastructure.

 

Management believes that future operating expenses will be reduced byapproximately $15 million on an annualized basis as a result of the restructuringcommenced in November 2005.  A portion ofthese expense savings will be reflected in the Company’s results of operationsfor the fourth quarter of 2005, with the remaining cost reductions expected tobe achieved during the first half of 2006. Severance payments to employeesimpacted by the restructuring will continue through the end of 2006, althoughsuch payments will not impact the Company’s results of operations.

 

Allcosts associated with the restructurings have been recorded in selling, generaland administrative expenses.  Inconnection with the restructuring, the Company also intends to evaluate therecoverability of certain fixed assets used in its domestic gift business, andwill, if necessary, record any adjustments in the values thereof.  See Item 5 “Other Information” below foradditional information with respect to the restructuring.

 

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**SEGMENTS**

 

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.

 

**RESULTS OF OPERATIONS—THREE MONTHSENDED SEPTEMBER 30, 2005 AND 2004**

 

The Company’s consolidated net sales for the threemonths ended September 30, 2005 increased 5.0% to $83,237,000 millioncompared to $79,272,000 million for the three months ended September 30,2004.  The net sales increase was attributable to the Company’s infant andjuvenile segment, which includes sales of Kids Line LLC since its acquisitionas of December 15, 2004.

 

The Company’s gift segment net sales for the threemonths ended September 30, 2005 decreased 21.0% to $50,303,000 compared to$63,677,000 for the three months ended September 30, 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 $474,000 for the threemonths ended September 30, 2005.  The Company’s infant and juvenilesegment net sales for the three months ended September 30, 2005 increased123.4% to $32,934,000 compared to $14,745,000 for the three months ended September 30,2004. This increase is comprised of $19,272,000 of sales attributable to KidsLine, partially offset by a sales decrease of 7.3% ($1.1 million) at SassyInc.  As a result of the sale of Brightof America effective August 2004, there were no non-core sales for thethree months ended September 30, 2005, compared to $849,000 for the threemonths ended September 30, 2004.

 

Consolidated gross profit was 41.6% of consolidatednet sales for the three months ended September 30, 2005, compared to 47.2%of consolidated net sales for the three months ended September 30,2004.  The decrease in the consolidated gross profit percentage isprimarily due to the competitive pricing pressure in the gift segment, as wellas the increase in infant and juvenile sales as a percent of consolidatedsales, which typically have lower gross profit margins compared to gift segmentmargins. Gross profit for the Company’s gift segment was 42.1% of netsales for the three months ended September 30, 2005 as compared to 50.5%of net sales for the three months ended September 30, 2004.  GrossProfit for the Company’s infant and juvenile segment increased to 40.8% of netsales for the three months ended September 30, 2005 as compared to 33.0%of net sales for the three months ended September 30, 2004, primarilyreflecting the December 2004 acquisition of KidsLine.

 

Consolidated selling, general and administrativeexpenses were $29,936,000, or 36.0% of consolidated net sales, for the threemonths ended September 30, 2005 compared to $35,349,000, or 44.6% ofconsolidated net sales, for the three months ended September 30,2004.  This decrease in consolidated selling, general and administrativeexpenses is due primarily to lower selling, product development, administrationand advertising cost, predominately as a result of the Company’s restructuringefforts in 2004.  These reductions werepartially offset by increased selling, general and administrative expenses as aresult of the acquisition of Kids Line.

 

Consolidated other income/(expense) was an expenseof $1,440,000 for the three months ended September 30, 2005, compared toincome of $310,000 for the three months ended September 30, 2004, adecrease of $1,750,000.  This decrease was primarily the result ofinterest expense incurred in connection with the outstanding loans under theCredit Agreement.

 

Theconsolidated provision for income tax in the three months ended September 30,2005 was $11,824,000 compared to $92,000 for the same period in 2004.  The consolidated income tax as a percent ofincome before income tax for the three months ended September 30, 2005 was368% compared to 3.9% for the three months ended September 30, 2004.  The increase in the effective tax rate andthe increased provision for income tax is primarily related to the Companyestablishing valuation allowances against the Company’s deferred tax assets primarilyrelating to foreign tax credit carry forwards, contribution carry forwards andNet Operating Loss carry forwards related to its European operations and thepartial reversal of income tax benefits recorded in the first two quarters of2005. These valuation allowances were established because the Company believesit is more likely than not that it may not realize the tax benefits on thesedeferred tax assets.  

 

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As a result of the foregoing, consolidated net lossfor the three months ended September 30, 2005 was $8,606,000, or $0.41 perdiluted share, compared to the consolidated net gain of $2,248,000, or $0.11per diluted share, for the three months ended September 30, 2004,representing a decrease of $10,854,000, or $0.52 per diluted share.

 

**RESULTS OF OPERATIONS - NINE MONTHSENDED SEPTEMBER 30, 2005 AND 2004**

 

The Company’s consolidated net sales for the ninemonths ended September 30, 2005 increased 8.9% to $215,996,000, comparedto $198,405,000 for the nine months ended September 30, 2004.  Thenet sales increase was attributable to the Company’s infant and juvenilesegment, which has included sales of Kids Line LLC since its acquisition as of December 15,2004.

 

The Company’s gift segment net sales for the ninemonths ended September 30, 2005 decreased 23.7% to $116,977,800, comparedto $153,411,000 for the nine months ended September 30, 2004, primarily asa result of the factors discussed in the “Overview” above.  Net sales in the Company’s gift segmentbenefited from foreign exchange rates by approximately $1,655,000 for the ninemonths ended September 30, 2005.  The Company’s infant and juvenilesegment net sales for the nine months ended September 30, 2005 increased146.9% to $99,018,000, compared to $40,104,000 for the nine months ended September 30,2004. This increase is comprised of $57,153,000 of sales attributable to KidsLine and sales growth of 4.4% ($1,761,000) at Sassy Inc.  As a result of the sale of Bright of Americaeffective August 2004, there were no non-core sales for the nine monthsended September 30, 2005, compared to $4,890,000 for the nine months endedSeptember 30, 2004.

 

Consolidated gross profit was 42.3% of consolidatednet sales for the nine months ended September 30, 2005, as compared to41.0% of consolidated net sales for the nine months ended September 30,2004.  The increase in the consolidated gross profit percentage for thenine-month period is primarily due to the significant inventory write-down forthe gift segment in the second quarter of 2004, described in the “Overview” section above,offset partially by competitive pricing pressure in the gift segment, as wellas the increase in infant and juvenile sales as a percent of consolidatedsales, which typically have lower gross profit margins compared to gift segmentmargins. Gross profit for the Company’s gift segment was 44.0% of netsales for the nine months ended September 30, 2005 as compared to 43.2% ofnet sales for the nine months ended September 30, 2004.  Gross Profitfor the Company’s infant and juvenile segment was 40.0% of net sales for thenine months ended September 30, 2005, as compared to 32.5% of net salesfor the nine months ended September 30, 2004, primarily reflecting the December 2004acquisition of KidsLine.

 

Consolidated selling, general and administrativeexpenses were $89,831,000, or 41.6% of consolidated net sales, for the ninemonths ended September 30, 2005 compared to $103,819,000, or 52.3% ofconsolidated net sales, for the nine months ended September 30,2004.  This decrease in consolidated selling, general and administrativeexpenses is due primarily to lower selling, product development, administrationand advertising cost, predominately as a result of the Company’s restructuringefforts in 2004.  These reductions werepartially offset by increased selling, general and administrative expenses as aresult of the acquisition of Kids Line.

 

Consolidated other income/(expense) was an expenseof $13,036,000 for the nine months ended September 30, 2005, compared toincome of $2,501,000 for the nine months ended September 30, 2004, adecrease of $15,537,000.  This decrease was primarily the result ofinterest expense incurred under the Financing Agreement and the CreditAgreement, the write-off in the second quarter of 2005 of deferred financingcosts of approximately $4,800,000 associated with the termination of theFinancing Agreement, and decreased interest income as all marketable securitybalances were liquidated in 2004 to fund the Company’s special dividend of$7.00 per share in April 2004.

 

Theincome tax expense for the nine months ended September 30, 2005 was$4,637,000 compared to $7,141,000 for the same period in 2004.  The consolidated income tax expense as apercent of loss before income tax expense for the nine months ended September 30,2005 was (39.1%), compared to 35.7% for the nine months ended September 30,2004.  The increase in the effective taxrate results primarily from the Company establishing valuation allowancesagainst the Company’s deferred tax assets primarily relating to foreign taxcredit carry forwards, contribution carry forwards and net operating loss carryforwards related to its European operations and the partial reversal of incometax benefits recorded in the first two quarters of 2005. These valuationallowances were established because the Company believes it is more likely thannot that it may not realize the tax benefits on these deferred tax assets.  The increase was offset partially by thechanges in the rules relating to dividends from foreign subsidiaries,which resulted in a tax benefit of approximately $2,200,000 recorded in thesecond quarter of 2005. 

 

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As a result of the foregoing, consolidated net lossfor the nine months ended September, 2005 was $16,493,000, or $0.79 per dilutedshare, compared to $12,866,000, or $0.62 per diluted share, for the nine monthsended September 30, 2004, representing an increase of $3,627,000, or $0.17per diluted share.

 

**Liquidity and Capital Resources**

 

The Company’s principal sources of liquidity arecash and cash equivalents, funds from operations, and availability under theRevolving Loan. The Company believes that it will able to fund its capitalrequirements for 2005 from such sources. In addition, subject to the discussionbelow under “Kids Line and Related Financing” with respect to the EarnoutConsideration and the Company’s continued compliance with its FinancialCovenants. The Company believes that, after payment of the expenditures setforth in this “Liquidity and Capital Resources” section, the Company remains ina liquid position, and that such sources will be sufficient to meet thecurrently anticipated requirements of its business.

 

As of September 30, 2005, the Company had cashand cash equivalents of $4,551,000 compared to $48,099,000 at December 31,2004. This reduction of $43,548,000 was primarily the result of the repaymentof debt, partially offset by proceeds from the Credit Agreement, proceeds fromthe sale of assets in the UK and Hong Kong during the first quarter of 2005, aUS Federal tax refund received in the second quarter of 2005, and collectionsof accounts receivable.  As of September 30,2005 and December 31, 2004, working capital was $79,718,000 and$119,293,000, respectively.  Thisdecrease of $39,575,000 was primarily the result of a decrease in cash used torepay the Term Loan under the Financing Agreement.

 

Cash and cash equivalents decreased by $43,548,000during the nine months ended September 30, 2005 compared to a decrease of$16,954,000 during the nine months ended September 30, 2004, primarily asa result of the factors described in the preceding paragraph. The decrease inthe first nine months of 2004 was primarily the result of the payment ofspecial and regular dividends, partially offset by the Company’s sale of asignificant portion of its available-for-sale marketable securities during thenine months ended September 30, 2004. Net cash (used) provided in operating activities was approximately$16,587,000 during the nine months ended September 30, 2005 as compared toapproximately ($1,350,000) during the nine months ended September 30,2004. This increase of $17,937,000 was due primarily to the reduction inrestricted cash in 2005 related to the termination of the Financing Agreement.Net cash provided by investing activities was approximately $8,011,000 for thenine months ended September 30, 2005, as compared to approximately$145,012,000 for the nine months ended September 30, 2004. This decreaseof approximately $137,001,000 was due primarily to the liquidation of theCompany’s marketable securities in the first nine months of 2004.  Net cash used in financing activities of$65,631,000 and $161,250,000 for the nine months ended September 30, 2005and 2004, respectively, consisted primarily of payment of long-term debtobligations during the first nine months of 2005 (as described in “Kids Lineand Related Financing” below) and payment of the special and regular dividendsduring the first nine months of 2004.

 

During the nine months ended September 30,2005, the Company paid approximately $1,831,000 for income taxes. The Companycurrently expects that its cash flows will exceed any income tax paymentsduring 2005. The Company received a United States federal tax refund ofapproximately $8,393,000 in the second quarter of 2005 and expects furtherrefunds of approximately $1,012,000 as a result of net operating losscarry-backs for the calendar year ended December 31, 2004.

 

Working capital requirements during the nine monthsended September 30, 2005 were met entirely through internally generatedfunds and borrowings under the Revolving Loan. The Company’s capitalexpenditures during the nine months ended September 30, 2005 wereapproximately $955,000 primarily for continued system implementation anddevelopment costs. Capital expenditures for 2005 are currently estimated to beapproximately $1,200,000 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 as of December 15, 2004. At closing, the Company paidapproximately $130,532,000, which represented the portion of the purchase pricedue at closing plus various transaction costs. The aggregate purchase priceunder the Purchase Agreement, however, includes the potential payment of theEarnout Consideration, which is defined as 11.724% of the Agreed EnterpriseValue of Kids Line, LLC as of the last day of the three year period ending November 30,2007 (the “Measurement Period”). The Earnout Consideration shall be paid asprovided in the Purchase Agreement (approximately the third anniversary of theClosing Date.) The “Agreed Enterprise Value” 

 

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shall be the product of (i) Kids Line’s EBITDAduring the twelve (12) months ending on the last day of the Measurement Periodand (ii) the applicable multiple (ranging from zero to eight) as set forthin the Purchase Agreement. The amount of the Earnout Consideration will becharged to goodwill if and when it is earned. Because the amount payable withrespect to the Earnout Consideration, if any, and the Company’s financialcondition at the time any such payment is due are not currently determinable,the Company cannot assure that payment of the Earnout Consideration will nothave a material impact on the Company’s liquidity.

 

TheKids Line acquisition was financed with the proceeds of the FinancingAgreement, which was subsequently replaced by the Credit Agreement and theCanadian Credit Agreement.  The CreditAgreement and the Canadian Credit Agreement and security therefore is describedin further detail in Note 5 to the Notes to Consolidated Financial Statementsand in the Second Quarter 10-Q. On October 11, 2005 the Company and its lendersamended provisions of the Credit Agreement unrelated to the Financial Covenants.

 

In accordance with the termsof the Credit Agreement, the Company is permitted to pay a dividend as long as,before and after giving effect to the payment of such dividends, ExcessRevolving Loan Availability will equal or exceed $15,000,000 and no violationof the financial covenants therein would then exist, or would, on a pro formabasis, result therefrom.  Any suchdividends may be declared no more frequently than quarterly and must take theform of regular cash dividends.  Withrespect to the Earnout Consideration, the Company will be permitted to pay allor a portion of the Earnout Consideration to the extent that, before and aftergiving effect to such payment, Excess Revolving Loan Availability will equal orexceed $15,000,000 and no violation of the financial covenants would thenexist, or would, on a pro forma basis, result therefrom.  As of September 30, 2005, the Company was incompliance with the Financial Covenants contained in the Credit Agreement.

 

TheCompany’s ability to maintain compliance with the Financial Covenants under theCredit Agreement is dependent upon the successful implementation of both therestructuring plan described under “Overview” above and its current operationalplans, which will likely include, among other things, the initiation of financingarrangements with respect to certain of the Company’s foreign receivables.  Based on these plans and management’s currentprojections, the Company currently anticipates that it will remain incompliance with the Financial Covenants at the end of the fourth quarter of2005 and for the foreseeable future. However, in the event that the Company is unable to successfullyimplement the key elements of its plans, there can be no assurance that theCompany will remain in compliance with such Financial Covenants.

 

**Other Events and CircumstancesPertaining to Liquidity**

 

Cash dividends of $2,082,000 ($0.10) per share werepaid on April 21, 2005 to shareholders of record of the Company’s CommonStock on April 11, 2005.  Cash dividends of $6,249,000 ($0.30 pershare) were paid in the three months ended September 30, 2004.  Cashdividends of $164,520,000 ($0.30 per share per quarter plus $7.00 per sharespecial dividends) were paid in the nine months ended September 30,2004.  See Note 5 to the Notes toConsolidated Financial Statement for a discussion of the restrictions on theCompany’s ability to pay dividends as long as any obligations under the CreditAgreement remain outstanding.

 

The Company enters into forward exchange contracts, principallyto manage the economic currency risks associated with the purchase of inventoryby its European, Canadian and Australian subsidiaries in the gift segment andby 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. Domestic implementation wascompleted in 2003.  The Company’s priorcustom software that had been utilized to operate and manage its business andother third party software systems are being replaced using a strategic andphased approach. During 2004 and continuing in 2005,  certain of the Company’s internationalsubsidiaries began and continued to phase-in certain aspects of the Company’snew ERP system and the transition to order management, inventory and financemodules is now anticipated to be substantially complete by the end of thefourth quarter of 2005. In connection with its November 2005 infrastructure“right sizing” initiative the Company is currently evaluating whether remaininginternational operations should be converted to the new ERP system in thefuture due to the size of these operations. This timetable is meant to continueto enable the Company to enhance its proficiency in utilizing the new system,to help ensure the efficiency of the international implementations and allowthe Company to continue to comply with its obligations regarding internalcontrols as required by Section 404 of the Sarbanes-Oxley Act of 2002. TheCompany has experienced certain startup issues but has not experienced anysignificant business disruptions related to the replacement of these systems.

 

In March 1990, The Board of Directorsauthorized the Company to repurchase an aggregate of up to 7,000,000 shares ofcommon stock. As of September 30, 2005, 5,643,200 shares have beenrepurchased since the beginning of 

 

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the Company’s stock repurchase program. During thenine months ended September 30, 2005, the Company did not repurchase anyshares pursuant 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.

 

TheCompany expects to incur additional restructuring costs as it continues toimplement its November 2005 restructuring and may incur furtherrestructuring costs as it continues to investigate other areas for costreduction and efficiency improvements in its efforts to right-size itsinfrastructure.  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 or equity financingto fund prospective acquisitions.  The Credit Agreement imposesrestrictions on the Company which could limit its ability to respond to marketconditions or to take advantage of acquisitions or other 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 2004 10-K.

 

**Contractual Obligations**

 

The following table summarizes the Company’ssignificant known contractual obligations as of September 30, 2005 and thefuture periods in which such obligations are expected to be settled in cash:

 
| ** **                     | ** ** | **Total** | ** **  | **2005** | ** ** | **2006**   | ** ** | **2007** | ** ** | **2008** | ** ** | **2009**   | ** ** | **Thereafter** | ** ** |
|--------------------------------|------------|-----------|-------------|----------|------------|------------|------------|----------|------------|----------|------------|------------|------------|----------------|------------|
| Operating  Lease Obligations   |       | $         | 62,849,000  |     | $          | 1,862,000  |       | $        | 7,799,000  |     | $          | 6,655,000  |       | $              | 6,001,000  |   | $ | 5,239,000 |   | $ | 35,293,000 |   |
| Purchase  Obligations          |       | $         | 14,711,000  |     | $          | 14,711,000 |       | $        | —     |     | $          | —     |       | $              | —     |   | $ | — |   | $ | — |   |
| Debt  Repayment Obligations    |       | $         | 64,949,000  |     | $          | 13,249,000 |       | $        | 2,600,000  |     | $          | 2,600,000  |       | $              | 2,600,000  |   | $ | 2,600,000 |   | $ | 41,300,000 |   |
| Commercial  Letters of Credit  |       | $         | —      |     | $          | —     |       | $        | —     |     | $          | —     |       | $              | —     |   | $ | — |   | $ | — |   |
| Royalty  Obligations           |       | $         | 3,654,000   |     | $          | 580,000    |       | $        | 1,649,000  |     | $          | 1,375,000  |       | $              | 50,000     |   | $ | — |   | $ | — |   |
| Total  Contractual Obligations |       | $         | 146,163,000 |     | $          | 30,402,000 |       | $        | 12,048,000 |     | $          | 10,630,000 |       | $              | 8,651,000  |   | $ | 7,839,000 |   | $ | 76,593,000 |   |

 

**Off Balance Sheet Arrangements**

 

Asof September 30, 2005, there have been no material changes in theinformation provided under the caption “Off Balance Sheet Arrangements” of Item2 of the Second Quarter 10-Q.

 

**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 of operations and require application of management’s mostdifficult, subjective or complex judgments, often as a result of the need tomake estimates about the effects of matters that are inherently uncertain.

 

Management is required to make certain estimates andassumptions during the preparation of its consolidated financial statementsthat affect 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 materialchanges to the Company’s significant

 

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accounting estimates and assumptions or thejudgments affecting the application of such estimates and assumptions duringthe period covered by this report from those described in the Company’s 2004 10-K.

 

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

 

Note 2 of the Notes to Consolidated FinancialStatements of the 2004 10-K contains a summary of the significant accountingpolicies used in the preparation of the Company’s consolidated financialstatements.

 

**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 anticipated effects, if determined, on theCompany’s results of operations and financial 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 forforward-looking statements.  These statements may be identified by the useof forward-looking words or phrases including, but not limited to, “anticipate”,“projects”, “believe”, “expect”, “intend”, “may”, “planned”, “potential”, “should”,“will” or “would”.  The Company cautions readers that results predicted byforward-looking statements, including, without limitation, those relating tothe Company’s future business prospects, revenues, working capital, liquidity,capital needs, interest costs and income are subject to certain risks anduncertainties that could cause actual results to differ materially from thoseindicated in the forward-looking statements.  Specific risks anduncertainties include, but are not limited to, the Company’s ability tocontinue to manufacture its products in the Far East, the seasonality ofrevenues, the actions of competitors, ability to increase production capacity,price competition, the effects of government regulation, results of anyenforcement action by the People’s Republic of China (“PRC”) authorities withrespect to the Company’s PRC operations, the resolution of various legalmatters, possible delays in the introduction of new products, customeracceptance of products, changes in foreign currency exchange rates, issuesrelated to the Company’s computer systems, the ability to obtain financing tofund acquisitions, the current and future outlook of the global retail market,the ability to integrate new business ventures, the ability to meet covenantsin the Credit Agreement and other factors.

 

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

 

As of September 30, 2005, there have been nomaterial changes in the Company’s market risks, as described in Item 3 of theCompany’s Second Quarter 10-Q.

 

**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 Financial Officer have concluded that, as of the end of the periodcovered by this report, the Company’s disclosure controls and procedures (asdefined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act),are effective.

 

No change in the Company’s internal control overfinancial reporting has been identified in connection with the evaluationrequired by paragraph (d) of Rule 13a-15 or 15d-15 under the ExchangeAct that occurred during the fiscal quarter ended September 30, 2005 thathas materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

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**PART II - OTHER INFORMATION**

 

**ITEM 5. OTHER INFORMATION**

 

*CostsAssociated with Exit or Disposal Activities*.  On November 3, 2005, in response tocontinuing challenges in the Company's domestic gift business, the Companyannounced a corporate restructuring of its domestic gift business designed to “rightsize” the infrastructure consistent with current business levels and re-aligndomestic gift operations to better meet the needs of different distributionchannels. The restructuring includes the immediate elimination of approximately50 positions, which will result in a pre-tax restructuring charge ofapproximately $1.4 million in the fourth quarter of 2005, primarily related toemployee severance costs. As part of the restructuring, the Company alsocommenced a plan to reduce its facilities expenses by rationalizing certainwarehouse and distribution activities, which is expected to result inadditional pre-tax restructuring charges in 2006 of approximately $2.5 million.The Company expects to incur additional restructuring costs as it continues toimplement the November 2005 restructuring and may incur further restructuringcosts as it continues to investigate other areas for cost reduction andefficiency improvements in its efforts to right-size its infrastructure.

 

*Entry intoa Material Definitive Agreement*.  On November 9, 2005, Russ Berrie andCompany, Inc. (the “Company”) entered into an employment arrangement (the “Agreement”)with Keith Schneider, with respect to his employment as Executive VicePresident and General Sales Manager – U.S. Specialty Gift Division of theCompany.  Mr. Schneider has beenemployed by the Company since 1985 and most recently served as Vice President,International Sales and Marketing and General Manager of the Company’sAustralian operations.  In accordancewith the terms of the Agreement, Mr. Schneider will be entitled to anannual base salary of $350,000.  Mr. Schneiderwill also be entitled to participate in the Company’s Incentive CompensationProgram (“IC Program”), with an Applicable Percentage (as defined in the ICProgram) for 2006 of 50% and an IC Factor (as defined in the IC Program) of$175,000.  For the year 2006, $100,000 ofMr. Schneider’s IC bonus is guaranteed to be paid, which amount will bepaid in four equal quarterly installments during 2006.  In addition, Mr. Schneider will beentitled to a one-time Super-Incentive Bonus (“SIB”) of a maximum of $100,000for 2006, which SIB can be earned based upon the achievement of certainoperating milestones for the Company’s domestic gift business.  The Company will also reimburse Mr. Schneiderfor certain relocation and travel expenses.

 

                                                Inaddition, on December 1, 2005, Mr. Schneider will be granted 75,000 stockoptions pursuant to the Company's 2004 Stock Option, Restricted and Non-RestrictedStock Plan.  Future option grants will beat the discretion of the Compensation Committee of the Board of Directors ofthe Company.

 

                                                Mr.Schneider is also entitled to participate generally in all retirement, savings,welfare and other employee benefit plans and arrangements provided to otherexecutive officers of the Company, including the Company's Severance Policy forDomestic Vice Presidents (and Above), and will receive a monthly car allowance.Mr. Schneider is a participant in the Company's Change of Control SeverancePlan.

 

**ITEM 6.  EXHIBITS**

 
| Exhibits to this Quarterly Report on Form 10-Q. |
|------------------------------------------------------|
|                                                 |   |   |
| 10.95                                                |   | Employment Agreement dated September 26,  2005, between Russ Berrie and Company, Inc. and Marc S. Goldfarb,  incorporated herein by reference to the Current report on Form 8-K filed  by the Company on September 29, 2005 (the September 8-K”)* |
|                                                 |   |   |
| 10.96                                                |   | Severance Agreement dated September 28, 2005,  between Russ Berrie and Company, Inc. and Arnold S. Bloom, incorporated  herein by reference to the September 8-K.* |
|                                                 |   |   |
| 10.97                                                |   | Consulting Agreement dated September 28,  2005, between Russ Berrie and Company, Inc. and Arnold S. Bloom,  incorporated herein by reference to the September 8-K.* |
|                                                 |   |   |
| 10.98                                                |   | Employment arrangement, dated as of November 07, 2005, between Russ Berrie and Company, Inc. and Keith Schneider. |
|                                                 |   |   |
| 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, and 4 are notapplicable and have been omitted.**

 

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**SIGNATURE**

 

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:  November 9, 2005 |   |                           |  John D. Wille                                        |   |
|                              |   |                           | * Vice President and    Chief Financial Officer* |   |
|                                   |        |                                |                                                            |        |  |  |

 

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**Exhibit Index**

 
| 10.98  |   | Employment arrangement, dated as of November 07, 2005, between Russ Berrie and Company, Inc. and Keith Schneider. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                              |
| 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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