**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 June 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 telephone  number, including area code)                          |
|                                                                                |
|                                                                                |
| (Former name, former  address and former fiscal year, if changed since last report) |

 

Indicate by check mark whether the registrant (1) 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

 

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

 
| **CLASS**                         | ** ** | **OUTSTANDING  AT  August 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 Sheet  as of June 30, 2005 and December 31, 2004 |   |
|                                          |   |   |   |
| b)                                            |   | Consolidated  Statement of Operations for the three and six months ended June 30, 2005  and 2004 |   |
|                                          |   |   |   |
| c)                                            |   | Consolidated  Statement of Cash Flows for the six months ended June 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  4.                                      | Submission  of Matters to a Vote of Security Holders |   |
|                                          |   |   |
| Item 6.                                       | Exhibits |   |
|                                          |   |
|                                          | Signatures |   |
|                                               |  |  |  |  |  |  |

 

2

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**PART 1 - FINANCIAL INFORMATION**

**ITEM 1.  FINANCIAL STATEMENTS**

 

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

**CONSOLIDATEDBALANCE SHEETS**

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

**(UNAUDITED)**

 
| ** **                                                                                                                          | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ***ASSETS***                                                                                                                        |       |                    |       |                        |       |
| Current assets                                                                                                                      |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                           |       | $                       | 15,498     |                        | $          | 48,099 |   |
| Restricted cash                                                                                                                     |       | —                  |       | 4,604                       |       |
| Accounts receivable, trade, less allowances of $2,640  in 2005 and $2,950 in 2004                                                   |       | 55,200                  |       | 75,722                      |       |
| Inventories — net                                                                                                              |       | 50,069                  |       | 47,391                      |       |
| Prepaid expenses and other current assets                                                                                           |       | 5,658                   |       | 6,090                       |       |
| Income tax receivable                                                                                                               |       | 11,491                  |       | 11,359                      |       |
| Deferred income taxes                                                                                                               |       | 3,278                   |       | 2,860                       |       |
| **Total current assets**                                                                                                            | ** ** | 141,194                 |       | 196,125                     |       |
|                                                                                                                                |       |                    |       |                        |       |
| Property, plant and equipment — net                                                                                            |       | 25,297                  |       | 28,690                      |       |
| Goodwill                                                                                                                            |       | 89,213                  |       | 89,213                      |       |
| Intangible assets                                                                                                                   |       | 61,647                  |       | 61,927                      |       |
| Restricted cash                                                                                                                     |       | 783                     |       | 11,026                      |       |
| Deferred income taxes                                                                                                               |       | 6,359                   |       | 4,518                       |       |
| Other assets                                                                                                                        |       | 8,009                   |       | 10,852                      |       |
| Assets held for sale                                                                                                                |       | —                  |       | 8,747                       |       |
| **Total assets**                                                                                                                    | ** ** | $                       | 332,502    |                        | $          | 411,098 |   |
|                                                                                                                                |       |                    |       |                        |       |
| ***LIABILITIES  AND SHAREHOLDERS’ EQUITY***                                                                                    |       |                    |       |                        |       |
| Current liabilities                                                                                                                 |       |                    |       |                        |       |
| Current portion of long term debt                                                                                                   |       | $                       | 2,600      |                        | $          | 25,250 |   |
| Short term debt                                                                                                                     |       | 13,800                  |       | —                      |       |
| Accounts payable                                                                                                                    |       | 9,162                   |       | 12,137                      |       |
| Accrued expenses                                                                                                                    |       | 28,208                  |       | 35,204                      |       |
| Accrued income taxes                                                                                                                |       | 6,731                   |       | 4,241                       |       |
| **Total current liabilities**                                                                                                       |       | 60,501                  |       | 76,832                      |       |
| Long term debt, excluding current portion                                                                                           |       | 50,400                  |       | 99,750                      |       |
| **Total liabilities**                                                                                                               |       | $                       | 110,901    |                        | $          | 176,582 |   |
| Commitments and contingencies                                                                                                       |       |                    |       |                        |       |
| Shareholders’ equity                                                                                                           |       |                    |       |                        |       |
| Common stock: $0.10 stated value per share;  authorized 50,000,000 shares; issued 2005, 26,460,759 shares; 2004, 26,460,759  shares |       | 2,648                   |       | 2,648                       |       |
| Additional paid in capital                                                                                                          |       | 88,676                  |       | 88,693                      |       |
| Retained earnings                                                                                                                   |       | 227,970                 |       | 237,937                     |       |
| Accumulated other comprehensive income                                                                                              |       | 12,457                  |       | 15,388                      |       |
| Treasury stock, at cost (5,636,284 shares at June 30,  2005 and 5,636,284 shares at December 31, 2004)                    |       | (110,150                | )          | (110,150                    | )          |
|                                                                                                                                |       |                    |       |                        |       |
| **Total shareholders’ equity**                                                                                                 | ** ** | 221,601                 |       | 234,516                     |       |
| **Total liabilities and  shareholders’ equity**                                                                                | ** ** | $                       | 332,502    |                        | $          | 411,098 |   |

 

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

 

3

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

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 

**(Dollars inThousands, Except Per Share Data)**

 

**(UNAUDITED)**

 
| ** **                                                                          | ** ** | **THREE  MONTHS ENDED  JUNE 30,** | ** ** | **SIX  MONTHS ENDED  JUNE 30,** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                          | ** ** | **2005**                               | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                |       |                                   |       |                                 |       |   |   |   |   |
| Net sales                                                                           |       | $                                      | 62,019     |                                 | $          | 53,420 |   | $ | 132,759 |   | $ | 119,133 |   |
|                                                                                |       |                                   |       |                                 |       |   |   |   |   |
| Cost of Sales                                                                       |       | 36,997                                 |       | 42,591                               |       | 76,341 |   | 75,201 |   |
|                                                                                |       |                                   |       |                                 |       |   |   |   |   |
| **Gross profit**                                                                    |       | 25,022                                 |       | 10,829                               |       | 56,418 |   | 43,932 |   |
|                                                                                |       |                                   |       |                                 |       |   |   |   |   |
| Selling, general and administrative expenses                                        |       | 29,182                                 |       | 34,029                               |       | 59,867 |   | 68,471 |   |
|                                                                                |       |                                   |       |                                 |       |   |   |   |   |
| **Operating loss**                                                                  |       | (4,160                                 | )          | (23,200                              | )          | (3,449 | ) | (24,539 | ) |
|                                                                                |       |                                   |       |                                 |       |   |   |   |   |
| Other income (expense):                                                             |       |                                   |       |                                 |       |   |   |   |   |
| Interest expense, including amortization and write-off  of deferred financing costs |       | (8,227                                 | )          | (49                                  | )          | (11,719 | ) | (64 | )  |
| Interest and investment income                                                      |       | 343                                    |       | 514                                  |       | 645 |   | 2,814 |   |
| Other, net                                                                          |       | (287                                   | )          | (237                                 | )          | (548 | ) | (558 | ) |
|                                                                                |       | (8,171                                 | )          | 228                                  |       | (11,622 | ) | 2,192 |   |
|                                                                                |       |                                   |       |                                 |       |   |   |   |   |
| **Loss before income tax benefit**                                                  |       | (12,331                                | )          | (22,972                              | )          | (15,071 | ) | (22,347 | ) |
|                                                                                |       |                                   |       |                                 |       |   |   |   |   |
| Income tax benefit                                                                  |       | (6,169                                 | )          | (7,422                               | )          | (7,187 | ) | (7,233 | ) |
|                                                                                |       |                                   |       |                                 |       |   |   |   |   |
| **Net loss**                                                                        |       | $                                      | (6,162     | )                                    | $          | (15,550 | ) | $ | (7,884 | ) | $ | (15,114 | ) |
|                                                                                |       |                                   |       |                                 |       |   |   |   |   |
| **Net loss per share:**                                                             |       |                                   |       |                                 |       |   |   |   |   |
| Basic                                                                               |       | $                                      | (0.30      | )                                    | $          | (0.75 | ) | $ | (0.38 | ) | $ | (0.73 | ) |
| Diluted                                                                             |       | $                                      | (0.30      | )                                    | $          | (0.75 | ) | $ | (0.38 | ) | $ | (0.73 | ) |
|                                                                                |       |                                   |       |                                 |       |   |   |   |   |
| **Weighted average shares:**                                                        |       |                                   |       |                                 |       |   |   |   |   |
| Basic                                                                               |       | 20,824,000                             |       | 20,786,000                           |       | 20,824,000 |   | 20,735,000 |   |
| Diluted                                                                             |       | 20,824,000                             |       | 20,786,000                           |       | 20,824,000 |   | 20,735,000 |   |

 

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

 

4

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

**CONSOLIDATED STATEMENT OF CASH FLOWS**

** **

**(Dollars inThousands)**

**(UNAUDITED)**

 
| ** **                                                                       | ** ** | **SIX  MONTHS ENDED  JUNE 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                       | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| **Cash flows from operating  activities:**                                       |       |                                 |       |   |   |
| Net loss                                                                         |       | $                                    | (7,884     | ) | $ | (15,114 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |       |                                 |       |   |   |
| Depreciation and amortization                                                    |       | 3,480                                |       | 3,286 |   |
| Amortization and write-off of deferred financing  cost                           |       | 5,711                                |       | — |   |
| Provision for accounts receivable reserves                                       |       | 167                                  |       | 797 |   |
| Provision for inventory reserves                                                 |       | 517                                  |       | 13,988 |   |
| Deferred income taxes – net                                                 |       | (2,259                               | )          | (5,603 | ) |
| Other                                                                            |       | 409                                  |       | 1,120 |   |
| Changes in assets and liabilities:                                               |       |                                 |       |   |   |
| Restricted cash                                                                  |       | 14,847                               |       | — |   |
| Accounts receivable                                                              |       | 20,355                               |       | 37,514 |   |
| Inventories                                                                      |       | (3,195                               | )          | (9,112 | ) |
| Prepaid expenses and other current assets                                        |       | 432                                  |       | (862 | ) |
| Other assets                                                                     |       | 245                                  |       | 1,961 |   |
| Accounts payable                                                                 |       | (2,975                               | )          | (4,769 | ) |
| Accrued expenses                                                                 |       | (6,996                               | )          | (3,707 | ) |
| Accrued income taxes                                                             |       | 2,358                                |       | (8,000 | ) |
| Total adjustments                                                                |       | 33,096                               |       | 26,613 |   |
| Net cash provided by operating activities                                        |       | 25,212                               |       | 11,499 |   |
|                                                                             |       |                                 |       |   |   |
| **Cash flows from investing  activities:**                                       |       |                                 |       |   |   |
| Purchase of marketable securities and other  investments                         |       | —                               |       | (304,054 | ) |
| Proceeds from sale of marketable securities and  other investments               |       | —                               |       | 443,887 |   |
| Proceeds from sale of property, plant and equipment                              |       | 8,914                                |       | 45 |   |
| Capital expenditures                                                             |       | (614                                 | )          | (1,163 | ) |
| Net cash provided by investing activities                                        |       | 8,300                                |       | 138,715 |   |
|                                                                             |       |                                 |       |   |   |
| **Cash flows from financing  activities:**                                       |       |                                 |       |   |   |
| Proceeds from issuance of common stock                                           |       | (17                                  | )     | 3,469 |   |
| Dividends paid to shareholders                                                   |       | (2,082                               | )          | (158,263 | ) |
| Payment of deferred financing cost                                               |       | (3,113                               | )          | — |   |
| Issuance of debt                                                                 |       | 76,800                               |       | — |   |
| Payment of long term debt                                                        |       | (135,000                             | )          | — |   |
| Net cash used in financing activities                                            |       | (63,412                              | )          | (154,794 | ) |
|                                                                             |       |                                 |       |   |   |
| Effect of exchange rate changes on cash and cash  equivalents                    |       | (2,701                               | )          | (351 | ) |
| Net decrease in cash and cash equivalents                                        |       | (32,601                              | )          | (4,931 | ) |
| Cash and cash equivalents at beginning of period                                 |       | 48,099                               |       | 81,535 |   |
| Cash and cash equivalents at end of period                                       |       | $                                    | 15,498     |   | $ | 76,604 |   |
|                                                                             |       |                                 |       |   |   |
| **Cash paid during the period for:**                                             |       |                                 |       |   |   |
| Interest                                                                         |       | $                                    | 6,008      |   | $ | 64 |   |
| Income taxes                                                                     |       | $                                    | 1,377      |   | $ | 767 |   |

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

 

5

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

(Unaudited)

 

**NOTE 1 - INTERIM CONSOLIDATEDFINANCIAL STATEMENTS**

 

The accompanying unaudited interim consolidatedfinancial statements have been prepared by Russ Berrie and Company, Inc.and its subsidiaries (the “Company”) in accordance with accounting principlesgenerally accepted in the United States of America for interim financialreporting and the instructions to the Quarterly Report on Form 10-Q and Rule 10-01of Regulation S-X.  Accordingly, 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 all adjustments,which are, in the opinion of management, of a normal recurring nature andnecessary 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 redefined 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 executive officer currently views 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 distributors.  The Company’s infant and juvenile businessesdesign and market products in a number of baby categories including, amongothers, infant bedding and accessories, bath toys and accessories,developmental toys, feeding items and baby comforting products,  and consists of Sassy, Inc. and KidsLine LLC.  These products are sold toconsumers, primarily in the United States, through mass merchandisers, toy,specialty, food, drug and independent retailers, apparel stores and militarypost exchanges.  The Company’s non-corebusiness consisted of Bright of America, Inc. until its sale by thecompany 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 Report on Form 10-Q forthe three months ended March 31, 2005 (The “First Quarter 10-Q”) and theCompany’s Annual Report on Form 10-K for the year ended December 31,2004 (the “2004 10-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, no compensation cost has been recognized for theoptions granted by the Company with an initial exercise price equal to the fairvalue of the common stock except for the application of Financial AccountingInterpretation No. 44, “Accounting for Certain Transactions InvolvingStock Compensation”, which resulted in non-cash income of $9,000 and $253,000during the three months ended June 30, 2005 and June 30, 2004,respectively, and non-cash income of $17,000 and $223,000 for the six monthsended June 30, 2005 and 2004, respectively, due to options granted during2000 that were repriced as of February 29, 2000 upon approval of the Boardof Directors and Shareholders.  Had compensation cost for the Company’sstock grants been determined based on the fair recognition provisions of SFAS No. 123at the grant date, in the three months and six months ended June 30, 2005and 2004, the Company’s net loss and net loss per share would have been reducedto the pro forma amounts indicated below:

 

6

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| ** **                                                                                              | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                              | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss -as reported                                                                                   |       | $                                     | (6,162,000 | )                                   | $          | (15,550,000 | ) | $ | (7,884,000 | ) | $ | (15,114,000 | ) |
| Deduction for stock-based compensation  expense determined under fair value method net of tax-pro forma |       | 239,000                               |       | 156,000                             |       | 357,000 |   | 312,000 |   |
|                                                                                                    |       |                                  |       |                                |       |   |   |   |   |
| Net loss -pro forma                                                                                     |       | (6,401,000                            | )          | (15,706,000                         | )          | (8,241,000 | ) | (15,426,000 | ) |
|                                                                                                    |       |                                  |       |                                |       |   |   |   |   |
| Loss per share (basic) - as reported                                                                    |       | (0.30                                 | )          | (0.75                               | )          | (0.38 | ) | (0.73 | ) |
| Loss per share (basic) – pro forma                                                                 |       | (0.31                                 | )          | (0.76                               | )          | (0.40 | ) | (0.74 | ) |
| Loss per share (diluted) – as reported                                                             |       | (0.30                                 | )          | (0.75                               | )          | (0.38 | ) | (0.73 | ) |
| Loss per share (diluted) – pro forma                                                               |       | (0.31                                 | )          | (0.76                               | )          | (0.40 | ) | (0.74 | ) |
|                                                                                                         |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |

 

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

 
| ** **                                                      | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Dividend yield                                                  |       | 2.50                                  | %          | 3.52                                | %          | 2.50 | % | 3.52 | % |
| Risk-free interest rate                                         |       | 3.74                                  | %          | 2.40                                | %          | 3.84 | % | 2.40 | % |
| Volatility                                                      |       | 34.62                                 | %          | 30.76                               | %          | 33.89 | % | 30.76 | % |
| Expected life (years)                                           |       | 4.5                                   |       | 3.8                                 |       | 4.5 |   | 3.8 |   |
| Weighted average fair value of options  granted during the year |       | $                                     | 4.72       |                                | $          | 6.58 |   | $ | 4.28 |   | $ | 6.58 |   |
|                                                                 |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |

 

**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  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Weighted average common shares outstanding                                 |       | 20,824,000                            |       | 20,786,000                          |       | 20,824,000 |   | 20,735,000 |   |
|                                                                       |       |                                  |       |                                |       |   |   |   |   |
| Dilutive effect of common shares issuable  under outstanding stock options |       | —                                |       | —                              |       | — |   | — |   |
| Weighted average common shares outstanding  assuming dilution              |       | 20,824,000                            |       | 20,786,000                          |       | 20,824,000 |   | 20,735,000 |   |

 

Stock options outstanding at June 30, 2005 and June 30,2004 to purchase 581,000 and 368,848 shares of common stock, respectively, werenot included in the computation of earnings per common share assuming dilutionfor such period as they are antidilutive.

 

**NOTE 4 – ACQUISITIONS**

 

As previously disclosed in the 2004 10-K, in December 2004,  the Company purchased all of the outstandingequity interests and warrants in Kids Line, LLC (the “Purchase”), in accordancewith the terms 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 and distributor ofinfant bedding products, and its assets consist primarily of accountsreceivable and inventory and intangible assets. At closing, the Company paid approximately $130,532,000, whichrepresented the portion of the purchase price due at closing plus varioustransaction costs.  The aggregatepurchase price under the Purchase Agreement, however, includes the potentialpayment of 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 

 

7

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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 Note 5 below.

 

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 4,2005(defined and described more fully in Note 5 below).  All obligations under the Financing Agreementwere repaid using proceeds from the Credit Agreement and other available cash,and such Financing Agreement was terminated concurrently with the execution ofthe Credit Agreement.  In addition, on June 30,2005, as of June 28, 2005, the Company’s Canadian subsidiary, Amram’sDistributing Ltd., executed the Canadian Credit Agreement, amendedas of August 4, 2005 defined more fully in Note 5 below.

 

**Pro Forma Information**

 

The following unaudited pro forma consolidatedresults of operations for the three and six months ended June 30, 2004assumes the acquisition of KidsLine LLC occurred as of January 1, 2004.

 
| ** **            | ** ** | **Three Months Ended  June 30, 2004** | ** ** | **Six Months Ended  June 30, 2004** | ** ** |
|-----------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| Net sales             |       | $                                                    | 68,995     |                                               | $          | 148,025 |   |
| Net income            |       | (14,178                                              | )          | (12,770                                            | )          |
| Net income per share: |       |                                                 |       |                                               |       |
| Basic                 |       | $                                                    | (0.68      | )                                                  | $          | (0.62 | ) |
| Diluted               |       | $                                                    | (0.68      | )                                                  | $          | (0.62 | ) |

 

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 pay feesand expenses related thereto.  The Term Loanwas repaid in full and the Financing Agreement was terminated in connectionwith the execution of the Credit Agreement as of June 28, 2005.

 

Ableco Financing Agreement

 

The following is a summary of the materialprovisions of the Financing Agreement, relevant until its termination as of June 28,2005.  A more detailed description of theFinancing Agreement can be found in the First Quarter 10-Q.

 

The Financing Agreement, as originally executed,provided the Company with two interest rate options for the borrowing under theTerm Loan, to which a margin spread was added: (1) the LIBOR Rate (whichwas subject to a minimum rate of 1.75% per annum) plus a spread of 7.00% perannum and (2) JPMorgan Chase Bank’s base or prime rate (the “ReferenceRate”) (which was subject to a minimum rate of 4.75% per annum) plus a spreadof 4.25% per annum. Pursuant to the terms of the March 31, 2005 amendment(the “Amendment”) the Term Loan bore interest as follows: (i) if therelevant portion of the Term Loan was a LIBOR Rate Loan (as described in the 

 

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Financing Agreement), at a rate per annum equal tothe LIBOR Rate plus 8.00 percentage points, and (ii) otherwise, at a rateper annum equal to the Reference Rate plus 5.25 percentage points (as isdescribed more fully in the First Quarter 10-Q, the achievement of specifiedEBITDA levels would have lowered the foregoing interest rates).

 

Under the Financing Agreement, as amended, theCompany was required to make prepayments of the Term Loan in an amount equal to$1,750,000 per quarter with the balance due at maturity. The first suchprepayment was made on March 31, 2005; subsequent prepayments would havebeen payable on the last day of the relevant quarter. In connection with theAmendment, as further described below, the Company made a$18,250,000 prepayment on March 31, 2005. In addition, beginning with thefiscal year ending December 31, 2005, the Company would have been requiredto make annual mandatory prepayments of the Term Loan, with specifiedpercentages of excess cash flow (as defined in the Financing Agreement) and theproceeds of certain asset sales, debt issuances, equity issuances, tax refundsother than the Federal tax refund resulting from net operating loss carrybacksfor 2004, insurance and other extraordinary receipts.

 

On March 18, 2005, the Agent waived, withrespect to the year ending December 31, 2004, the Company’s non-compliancewith a covenant in the Financing Agreement as originally executed,that limited the amount of its aggregate operating lease expense, andamended such covenant to increase the amount of the annual expense limitationfor the term of the Financing Agreement. In addition, the Financing Agreement,as originally executed, contained, among other things, various financialcovenants to which the Company and its subsidiaries must adhere on a monthlyand quarterly basis (a Funded Debt Ratio, a Fixed Charge Coverage Ratio, aConsolidated EBITDA covenant, an Infant Line EBITDA covenant and a MinimumQualified Cash covenant). The Company was in compliance with such financialcovenants as of December 31, 2004. However, because management believedthat the Company would not be in compliance as of March 31, 2005, with theConsolidated EBITDA Covenant and the Funded Debt Ratio set forth in theFinancing Agreement as originally executed, and had substantial concerns overwhether the Company would be in compliance with such covenants for theremainder of 2005, on March 31, 2005, the Agent, the Required Lendersunder the Financing Agreement, the Company and its subsidiaries party theretoexecuted the Amendment, which amended the Consolidated EBITDA covenant for thequarters ending March 31, June 30, September 30 and December 31,2005 (in light of the additional $18,250,000 prepayment of principal discussedabove, no amendment of the Funded Debt Ratio or any other financial covenantwas required).  The amended covenants areset forth in the First Quarter 10-Q.

 

In connection with the Amendment, in addition to thedividend restrictions set forth below, the Company agreed to (i) simultaneouslywith the execution of the Amendment, prepay a portion of the principal of theTerm Loan in the amount of $18,250,000 (in lieu of payment to the Agent of aportion of a Federal tax refund as a result of net operating loss carrybacksfor 2004, as required in the original Financing Agreement but in addition tothe required quarterly principal payment), (ii) amend the interest rateprovisions applicable to the term loan as discussed above, (iii) increasethe Minimum Qualified Cash level required by the Financing Agreement from$40,000,000 to $45,000,000, (iv) maintain the Term Loan LC throughout theterm of the Financing Agreement (such Term Loan LC would otherwise have beenreleased when the Funded Debt Ratio became less than 3.0:1.0), and (v) paya fee of $787,500 in connection with the execution of the Amendment.

 

 In accordance with the Amendment, as long asall or any portion of the Term Loan remained outstanding, the Company would nothave been permitted to declare and/or pay dividends unless, except in all caseswith respect to the dividend declared by the Company on March 31, 2005 andpaid during the month of April, 2005 (the “First Quarter 2005 Dividend”), (i) noDefault or Event of Default shall have occurred and been continuing eitherbefore or after giving effect to such declaration and payment; (ii) at thetime of declaration of such dividends, the chief financial officer of theCompany shall have certified in writing to the Agent that as of such date andafter due investigation and inquiry, such chief financial officer would have noreason to believe that, after giving effect to the payment of such dividends,the Company would not be in compliance with any of the financial covenants inthe Financing Agreement generally as of the end of the fiscal quarter in whichsuch dividends are to be paid; and (iii) the Company satisfies a minimumConsolidated EBITDA test for the fiscal quarter immediately preceding thefiscal quarter in which such dividend is to be paid (in any event, no suchdividend shall exceed $6,250,000 per quarter); provided further,notwithstanding the foregoing or any other provision of the FinancingAgreement, (a) the Company may declare and pay only the December 2004Dividend in the fiscal quarter ending December 31, 2004; (b) theamount of the First Quarter 2005 Dividend would be no greater than either (i) tencents ($0.10) per share or (ii) $2,100,000; and  (c) the Companymay declare and pay a dividend not greater than either $0.05 per share (subjectto corresponding adjustment for stock splits, stock dividends andrecapitalizations) or $1,050,000 for each of the second, third and fourthquarters of 2005, provided that the Company has the Dollar Equivalent Amount ofQualified Cash (as defined in the Financing Agreement) of at least $55,000,000,after giving effect to any such dividend, and the Company is in compliance withclauses (i), (ii) and (iii) above.

 

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The Financing Agreement contained certainaffirmative and negative covenants and events of default, as described in theFirst Quarter 10-Q.

 

In connection with the original execution andamendments to the Financing Agreement, the Company incurred an aggregate ofapproximately $5,800,000 in specified fees.  These costs were included in “otherassets” on the Consolidated Balance Sheet for the applicable periods and werebeing amortized over the three year term of the loan until termination of theloan in June of 2005, at which time all remaining unamortized cost werewritten-off to interest expense.

 

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, 2005 (the “CreditAgreement”) with the financial institutions parties thereto as Facility ALenders, the financial institutions parties thereto as Facility B Lenders,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”.  Unless otherwise specified herein,capitalized terms used but undefined herein shall have the meanings ascribed tothem in the Credit Agreement.  Inaddition, the Company’s Canadian subsidiary, Amram’s Distributing Ltd., enteredinto on June 30, 2005, as of June 28, 2005, and amened as of August 4,2005, a separate  creditagreement with the financial institutions party thereto and LaSalle BusinessCredit, a division of ABN AMRO Bank, N.V., Canada Branch, a Canadian branch ofa Netherlands bank, with respect to a maximum U.S. $10.0 million revolving loan(the Canadian Credit Agreement”) described below.  The Credit Agreement replaces the FinancingAgreement. All obligations under the Financing Agreement were repaid usingproceeds from the Credit Agreement and other available cash, and such FinancingAgreement was terminated concurrently with the execution of the CreditAgreement.  There were no fees triggeredas a result of the early termination of the Financing Agreement, however, inconjunction therewith, the Company wrote-off the remaining unamortized balanceof approximately $4,808,000 in deferred financing costs.  Unused amounts available under the CreditAgreement will be used for working capital requirements and general corporatepurposes.

 

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 $40.0 million term loan facility (“TermLoan B”).  If there is no default orevent of default occurring, on the terms and conditions set forth in the CreditAgreement, and subject to the payment of applicable fees, the Revolving Loanmay be increased to a maximum of $75.0 million. The Company drew down $23.8 million on the Revolving Loan on the ClosingDate.

 

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(with the first such payment being due on July 31, 2005).  A final installment in the aggregate amountof the unpaid principal balance of Term Loan A (in addition to all outstandingamounts under the Revolving Loan) is due and payable on June 28, 2010, andthe principal of Term Loan B is due and payable on December 28, 2010, ineach case subject to earlier termination in accordance with the terms of theCredit Agreement.  Notwithstanding theforegoing, the Company shall be required to repay Term Loan B in full upon afull redemption of the Facility A Obligations.

 

TheCommitments will bear interest at a rate per annum equal to the sum of the BaseRate (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, which applicable margin shall range: (i) withrespect to the Revolving Loan, from 1.50% - 2.25% for LIBOR Loans and from 0.0%- 0.75% for Base Rate Loans, (ii) with respect to Term Loan A, from 2.00%- 2.75% for LIBOR Loans and from 0.50% - 1.25% for Base Rate Loans, and (iii) withrespect to Term Loan B (a deemed LIBOR Loan), from 6.00% - 7.50%; *provided, however*, that from the closingdate under the Credit Agreement, until delivery of the financial statements andcompliance certificate with respect to the fiscal year ending December 31,2005 (the “Initial Period”), the applicable interest rate margins shall be asfollows:  (i) with respect to the RevolvingLoan, 1.75% for LIBOR Loans and 0.25% for Base Rate Loans, (ii) withrespect to Term Loan A, 2.25% for LIBOR Loans and 0.75% for Base Rate Loans,and (iii) with respect to Term Loan B, 7.00%. Under the Credit Agreement,if LaSalle could not achieve a complete distribution of the 

 

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FacilityB Obligations, the Administrative Agent would have been entitled (within 45days of the Closing Date) to increase the interest rate margins on Term Loan Bby up to 1.50%.  As of August 4,2005, however, a complete distribution of the Facility B Obligation hasbeen achieved.  Interest rates shallincrease to the highest level in the grid if required financial statements andcompliance certificates are not delivered when due until the first business dayafter such items are delivered.

 

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.

 

Inconnection with the execution of the Credit Agreement and the Canadian CreditAgreement, the Company recorded approximately $2,326,000 of deferred financingcosts, consisting of approximately $1.4 million in aggregate underwriting andagency fees and approximately $.9 million of other transaction costs, which areincluded in “other assets” on the Consolidated Balance Sheet at June 30, 2005 andare being amortized over the five-year period of the Commitments. Aggregateagency fees of $40,000 will be payable on each anniversary of the ClosingDate.  The Revolving Loan shall besubject to an annual non-use fee (payable monthly, in arrears, and upontermination of the relevant obligations) based on the most recent quarter-endTotal Debt to EBITDA Ratio ranging from 0.375% - 0.50% for unused amounts underthe Revolving Loan, an annual letter of credit fee (payable monthly, inarrears, and upon termination of the relevant obligations) for undrawn amountswith respect to each letter of credit based on the most recent quarter-endTotal Debt to EBITDA Ratio ranging from 1.50% - 2.25% (subject to increase by2% at any time an event of default exists), customary letter of creditadministration fees and a letter of credit fronting fee in amounts agreed to bythe Company and the Issuing Bank.  Notwithstandingthe foregoing, during the Initial Period, the non-use fee shall equal 0.375%and the letter of credit fee shall equal 1.75%. In addition, if the Facility A Termination Date occurs prior to thefirst anniversary of the Closing Date, the Company shall pay a termination feeequal to 1% of the sum of (i) the highest Maximum Revolving Commitmentthat had been in effect at any time prior to such termination plus (ii) theoriginal principal balance of Term Loan A. Under certain circumstances set forth in the Credit Agreement,prepayment of all or a portion of Term Loan B will require the payment of aprepayment premium ranging from 1.0% - 2.0% of the amount so prepaid dependingon the date of such prepayment, in addition to payment of costs associated withbreakfunding on LIBOR loans (no such prepayment premium will be required afterthe second anniversary of the Closing Date).

 

Mandatoryprepayments of the Commitments shall be required until paid in full upon thereceipt of (i) any Net Cash Proceeds from any Asset Disposition (orfinancing or refinancing any Obligations with specified debt), and (ii) anyNet Cash Proceeds from any issuance of Capital Securities of any Loan Party(excluding specified issuances) or the issuance of any Debt of any Loan Party(excluding specified Debt), in an amount equal to 100% of such Net CashProceeds, which amounts shall be applied as set forth in the Credit Agreement.

 

The Credit Agreementcontains affirmative and negative covenants, including, without limitation, financialreporting (including annual delivery of projections), notice requirements withrespect to specified events, required compliance certificates, requiredborrowing base certificates, limitations on the issuance of equity, limitationson liens, limitations on the incurrence of further indebtedness, limitations onmergers, consolidations, sales of assets and other transactions outside of theordinary course of business, limitations on dividends (described below), stockredemptions or repurchases and/or the prepayment or redemption of other debt(including the Earnout Consideration, as described below), limitations on thepayment of fees to equityholders or affiliates thereof, limitations oninvestments and limitations on transactions with affiliates.  The Credit Agreement contains the followingfinancial covenants (the “Financial Covenants”):  (i) a minimum Fixed Charge CoverageRatio, (ii) a maximum Total Debt to EBITDA Ratio and (iii) a minimumExcess Revolving Loan Availability requirement of $2,500,000.  Excess Revolving Loan availability at June 30,2005 was approximately $40,700,000.  Withrespect to dividends, the Company is permitted to pay a dividend so long asbefore 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 would then exist, or would, on a pro forma basis,result therefrom.  Any such dividends maybe declared no more frequently than quarterly and must take the form of regularcash dividends.  With respect to theEarnout Consideration, the Company will be permitted to pay all or a portion ofthe Earnout 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.

 

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TheCredit Agreement contains certain events of default, including, among others,non-payment of principal, interest, fees, reimbursement obligations withrespect to any letter of credit or other amounts, breach of representations andwarranties in any material respect, violation of covenants, specified crossdefaults, bankruptcy events, judgments, ERISA or other pension plan violations,specified losses of collateral, the occurrence of a change of control of theCompany, and/or any drawing under the EDA Standby L/C.  If an event of default occurs and iscontinuing: (i) the Administrative Agent is entitled to, and underspecified circumstances is required to, declare the Commitments to beterminated in whole or in part and/or declare all or any part thereof to be dueand payable and/or demand that the Company and the Specified Subsidiariesimmediately cash collateralize all or any letters of credit, (provided thatupon events of bankruptcy, the Commitments will be immediately due and payable,and the Company and the Specified Subsidiaries will be required to immediately cashcollateralize all or any letters of credit), and (ii) a default interestrate may, and in the event of specified payment defaults or bankruptcy eventswill, become applicable to the Commitments at a rate per annum equal to therate of interest otherwise in effect plus 2%.

 

The Credit Agreementcontains various conditions to lending, including that no event of default orunmatured event of default shall have occurred or be continuing.

 

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.

 

TheSecurity Agreement made on December 15, 2004 among the Company, itssubsidiaries party thereto and the agent under the Financing Agreement,executed in connection with the Financing Agreement and described in the FirstQuarter 10-Q, and all other loan and/or security agreements executed inconnection with such Financing Agreement or Security Agreement, were terminatedconcurrently with the execution of the Credit Agreement.

 

Ascontemplated by the Credit Agreement, Amrams entered into the Canadian Credit Agreementwith respect to a maximum U.S. $10.0 million revolving loan (the “CanadianRevolving Loan”), with a subfacility for letters of credit in an amount not toexceed U.S. $2.0 million.  If there is nodefault or event of default occurring under the Canadian Credit Agreement, uponthe terms and conditions set forth therein, and subject to the payment ofapplicable fees, the Canadian Revolving Loan may be increased to a maximumcommitment of U.S. $15.0 million.  Alloutstanding amounts under the Canadian Revolving Loan will be due and payableon June 28, 2010, subject to earlier termination in accordance with theterms of the Canadian Credit Agreement.

 

All capitalized terms used inthis paragraph but undefined in this or the preceding paragraph shall have themeanings ascribed to them in the Canadian Credit Agreement.  The Canadian Revolving Loan will bearinterest at a rate per annum equal to the sum of (x)(i) the Base Rate orthe Canadian Base Rate, 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 EBITDA Ratio,ranging from 1.50% - 2.25% for LIBOR Loans and from 0.0% - 0.75% for eitherBase Rate Loans or Canadian Base Rate Loans; *provided,however*, that from the closing date under the Canadian CreditAgreement, until delivery of the financial statements and compliancecertificate with respect to the fiscal year ending December 31, 2005 (the “CanadianInitial Period”), the applicable interest rate margins shall be 1.75% for LIBORLoans and 0.25% for either Base Rate Loans or Canadian Base Rate Loans; and *provided further*, that at all times, theapplicable margin for that portion of the Canadian Revolving Loan that on anyday is equal to the Notional Real Estate Sublimit shall equal the otherwiseapplicable rate plus 0.50%.  Interestrates shall increase to the highest level in the grid if required financialstatements and compliance certificates are not delivered when due until thefirst business day after such items are delivered.  

 

Accruedinterest under the Canadian Revolving Loan is due and payable under the sameterms and conditions as the Revolving Loan under the Credit Agreement.

 

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TheCanadian Revolving Loan shall be subject to an annual non-use fee, an annualletter of credit fee, customary letter of credit administration fees, and aletter of credit fronting fee on substantially similar terms as the Facility A Obligations under the Credit Agreement (including feeswith respect to the Canadian Initial Period). However, if the Canadian Revolving Loan is terminated prior to the firstanniversary of the closing date of the Canadian Credit Agreement, Amrams shallpay a termination fee equal to 1.0% of the highest Maximum Revolving Commitment(as defined thereunder) that had been in effect at any time prior to suchtermination.

 

TheCanadian Credit Agreement contains mandatory prepayment provisions, affirmativeand negative covenants (but no financial covenants), and events of defaultsubstantially similar to those set forth under the Credit Agreement.  An event of default under or termination ofthe Credit Agreement shall be an event of default under the Canadian CreditAgreement.

 

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 Earnout Consideration(each as defined in the Credit Agreement). The guarantees and security interests granted under the Earnout SecurityDocuments remain in effect and remain subordinated to the senior indebtednessof the Company arising under the Credit Agreement.

 

Thedomestic lines of credit in place prior to December 15, 2004 totaling$50,000,000 have been canceled effective December 15, 2004.  The maximum amounts available to the Company’sforeign operations at June 30, 2005, under local lines of credit are approximately$7,778,000.

 

Inconnection with the purchase of imported merchandise, the Company at June 30,2005, had letters of credit outstanding of $113,000, all related to foreignoperations which were collateralized under their existing lines of credit.

 

**NOTE 6 – GOODWILL AND INTANGIBLEASSETS**

 

The significant components of intangible assetsconsist of the following:

 
| ** **                                  | ** ** | **Weighted Average  Amortization Period** | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------|------------|-------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                        |       |                                      |       |                    |       |                        |       |
| MAM distribution agreement and relationship |       | Indefinite life                           |       | $                       | 10,400,000 |                        | $          | 10,400,000 |   |
| Sassy trade name                            |       | Indefinite life                           |       | 7,100,000               |       | 7,100,000                   |       |
| Applause trade name                         |       | Indefinite life                           |       | 7,679,000               |       | 7,679,000                   |       |
| Kids Line customer relationships            |       | Indefinite life                           |       | 31,100,000              |       | 31,100,000                  |       |
| Kids Line trade name                        |       | Indefinite life                           |       | 5,300,000               |       | 5,300,000                   |       |
| Other intangible assets                     |       | 0.3 years                                 |       | 68,000                  |       | 348,000                     |       |
|                                        |       |                                      |       |                    |       |                        |       |
| Total intangible assets                     |       |                                      |       | $                       | 61,647,000 |                        | $          | 61,927,000 |   |

 

Other intangible assets as of June 30, 2005includes Kidsline and Sassy non-compete agreements which are being amortizedover four and five years, respectively. Other intangible assets as of December 31, 2004 includes Kids Linebacklog which was amortized over two months and Kids Line and Sassy non-competeagreements.  Amortization expense was $280,000and $9,000 for the first six months of 2005 and 2004, respectively.

 

All of the Company’s goodwill is in the infant andjuvenile segment.  There were no changesto the carrying amount of goodwill for the three and six months ended June 30,2005:

 
| Balance as of December 31, 2004 |   | $      | 89,213,000 |   |
|--------------------------------------|--------|--------|------------|--------|
| Adjustments to goodwill              |   | — |       |
| Balance as of June 30, 2005     |   | $      | 89,213,000 |   |

 

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**NOTE 7 - DIVIDENDS**

 

Cash dividends of $2,082,000 ($0.10 per share) werepaid in the quarter and six months ended June 30, 2005 (no cash dividendswere paid during the three months ended March 31, 2005).  Cash dividends of $152,048,000 ($0.30 pershare regular dividend plus $7.00 per share one-time special dividend) werepaid in the quarter ended June 30, 2004.  Cash dividends of $158,263,000($0.30 per share per quarter plus $7.00 per share special dividend) were paidin the six months ended June 30, 2004.  On April 12, 2004, theCompany declared a one-time special cash dividend in the amount of $7.00 percommon share payable on May 28, 2004, to shareholders of record of theCompany’s Common Stock on May 14, 2004.  This one-time specialdividend of $145,799,000 is included in the dividend payment, stated above, forthe quarter and six months ended June 30, 2004.  A dividend of $0.30per share was paid on June 4, 2004, to shareholders of record of theCompany’s Common Stock on May 21, 2004.

 

Dividend restrictions under the Financing Agreement,which was terminated as of June 28, 2005, are described in Note 5.

 

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, Russ Berrie and Company, Inc. announced acorporate restructuring designed to align the Company’s management and salesorganization with its strategic plans and to right-size its expensestructure.  The restructuring included the immediate elimination ofapproximately 75 domestic positions, and resulted in a pretax charge of $4.1million in the third quarter of 2004, primarily related to severancecosts.  Although these employees are no longer employees of the Company,payments will continue through the third quarter of 2005.  These costs areincluded in selling general and administrative expenses in the ConsolidatedStatement of Operations and are all related to the Company’s gift segment.

 

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

 

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

 

 
| ** **          | ** ** | **Balance  12/31/04** | ** ** | **2005  Provision** | ** ** | **Payments/  Write-offs** | ** ** | **Additional  Cost  Incurred** | ** ** | **Balance  at  6/30/05** | ** ** |
|---------------------|------------|-----------------------|------------|---------------------|------------|---------------------------|------------|--------------------------------|------------|--------------------------|------------|
| Employee separation |       | $                     | 3,935,000  |                | $          | 365,000                   |       | $                              | 2,577,000  |                     | $          | 3⁄4 |   | $ | 1,723,000 |   |
| Facility exit cost  |       | 20,000                |       | —              |       | 20,000                    |       | —                         |       | —                   |       |
| Total               |       | $                     | 3,955,000  |                | $          | 365,000                   |       | $                              | 2,597,000  |                     | $          | 3⁄4 |   | $ | 1,723,000 |   |

 

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

 

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

 

14

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**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 as of December 15,2004, the Company reclassified its operations into three reportable segments: (i) theCompany’s gift business, (ii) the Company’s infant and juvenile business,which consists of the businesses of Sassy, Inc. and Kids Line, LLC, and (iii) itsnon-core business, which consisted of Bright of America, Inc., until itssale effective August 2, 2004.  TheCompany has redefined its 2004 segment disclosures to conform to the 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 executive officer currently views 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 distributors.  The Company’s gift products are designed toappeal to the emotions of consumers to reflect their feelings of happiness, friendship,fun, love and affection.

 

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

 

The Company’s non-core business consisted of Brightof America, Inc. until its sale by the Company effective August 2,2004.  Non-core products includededucational products, placemats, candles and home fragrance products, whichwere sold to customers primarily in the United States through mass marketers.
| ** **** **              | ** ** | **Three  Months Ended  June 30,** | ** ** | **Six  months Ended  June 30,** | ** ** |
|-----------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                        | ** ** | **2005**                               | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Gift:                             |       |                                   |       |                                 |       |   |   |   |   |
| Net sales                         |       | $                                      | 28,771,000 |                                 | $          | 38,378,000 |   | $ | 66,676,000 |   | $ | 89,734,000 |   |
| Operating loss                    |       | (12,612,000                            | )          | (24,909,000                          | )          | (20,288,000 | ) | (27,734,000 | ) |
| (Loss) Income before income taxes |       | (12,531,000                            | )          | (24,774,000                          | )          | (20,180,000 | ) | (25,734,000 | ) |
|                              |       |                                   |       |                                 |       |   |   |   |   |
| Infant and juvenile:              |       |                                   |       |                                 |       |   |   |   |   |
| Net Sales                         |       | 33,248,000                             |       | 13,089,000                           |       | 66,083,000 |   | 25,359,000 |   |
| Operating income                  |       | 8,452,000                              |       | 1,519,000                            |       | 16,839,000 |   | 2,873,000 |   |
| Income before income taxes        |       | 200,000                                |       | 1,519,000                            |       | 5,109,000 |   | 2,873,000 |   |
|                              |       |                                   |       |                                 |       |   |   |   |   |
| Non-core:                         |       |                                   |       |                                 |       |   |   |   |   |
| Net sales                         |       | —                                 |       | 1,953,000                            |       | — |   | 4,040,000 |   |
| Operating income                  |       | —                                 |       | 190,000                              |       | — |   | 322,000 |   |
| Income before taxes               |       | —                                 |       | 283,000                              |       | — |   | 514,000 |   |
|                              |       |                                   |       |                                 |       |   |   |   |   |
| Consolidated:                     |       |                                   |       |                                 |       |   |   |   |   |
| Net Sales                         |       | 62,019,000                             |       | 53,420,000                           |       | 132,759,000 |   | 119,133,000 |   |
| Operating loss                    |       | (4,160,000                             | )          | (23,200,000                          | )          | (3,449,000 | ) | (24,539,000 | ) |
| (Loss) Income before income taxes |       | (12,331,000                            | )          | (22,972,000                          | )          | (15,071,000 | ) | (22,347,000 | ) |
|                                   |            |                                        |            |                                      |            |  |  |  |  |  |  |  |  |

 

Additionally, total assets of each segment were asfollows:

 
| ** **          | ** ** | **June 30,  2005** | ** **  | **December 31,  2004** | ** ** |
|---------------------|------------|-------------------------|-------------|-----------------------------|------------|
|                |       |                    |        |                        |       |
| Gift                |       | $                       | 125,550,000 |                        | $          | 201,096,000 |   |
| Infant and juvenile |       | 206,952,000             |        | 210,002,000                 |       |
| Non-core            |       | —                  |        | —                      |       |
|                |       |                    |        |                        |       |
| Total               |       | $                       | 332,502,000 |                        | $          | 411,098,000 |   |

 

15

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**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 relationship.

 

**NOTE 10 - FOREIGN CURRENCY FORWARDEXCHANGE CONTRACTS**

 

Certain of the Company’s foreign subsidiariesperiodically enter into foreign currency forward exchange contracts (“ForwardContracts”) to hedge inventory purchases, both anticipated and firmcommitments, denominated in the United States dollar.  One of the Company’sdomestic subsidiaries periodically enters into Forward Contracts to hedgeinventory purchases, both anticipated and firm commitments, denominated in theEuro.  These contracts reduce foreign currency risk caused by changes inexchange rates and are used to hedge these inventory purchases, generally forperiods up to 13 months.  At June 30, 2005, the Company’s ForwardContracts have expiration dates which range from one to eight months.

 

Since there is a direct relationship between theForward Contracts and the currency denomination of the underlying transaction,such Forward Contracts are highly effective in hedging the cash flows ofcertain of the Company’s foreign subsidiaries related to transactionsdenominated in the United States dollar and certain of the Company’s domesticsubsidiaries related to transactions denominated in the Euro.  TheseForward Contracts meet the criteria for cash flow hedge accounting treatmentand accordingly, gains or losses are included in other comprehensive income(loss) and are recognized in cost of sales based on the turnover of inventory.

 

**NOTE 11 - 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 six months ended June 30,2005 and 2004 as follows:

 

 
| ** **                                                                          | ** ** | **Three  Months Ended  June 30,** | ** ** | **Six  Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                          | ** ** | **2005**                               | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss                                                                            |       | $                                      | (6,162,000 | )                                    | $          | (15,550,000 | ) | $ | (7,884,000 | ) | $ | (15,114,000 | ) |
| Other comprehensive loss, net of tax:                                               |       |                                   |       |                                 |       |   |   |   |   |
| Foreign currency translation adjustments                                            |       | (1,899,000                             | )          | (1,916,000                           | )          | (3,346,000 | ) | (375,000 | ) |
|                                                                                |       |                                   |       |                                 |       |   |   |   |   |
| Net unrealized loss on securities available-for-sale                                |       | —                                 |       | (154,000                             | )          | — |   | (409,000 | ) |
| Net unrealized gain  on foreign currency forward exchange  contracts and other |       | 336,000                                |       | 434,000                              |       | 415,000 |   | 544,000 |   |
| Other comprehensive loss                                                            |       | (1,563,000                             | )          | (1,636,000                           | )          | (2,931,000 | ) | (240,000 | ) |
|                                                                                |       |                                   |       |                                 |       |   |   |   |   |
| Comprehensive loss                                                                  |       | $                                      | (7,725,000 | )                                    | $          | (17,186,000 | ) | $ | (10,815,000 | ) | $ | (15,354,000 | ) |

 

 

**NOTE 12 - OTHER INCOME (EXPENSE)**

 

Interest expense includes the amortization andwrite-off of deferred financing costs of $5,295,000 and $5,711,000 in the threeand six month periods ended June 30, 2005.

 

**NOTE 13 – LITIGATION ANDCOMMITMENTS**

 

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

 

16

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

 

The Company enters into various license agreementsrelating to trademarks, copyrights, designs, and products which enable theCompany to market items compatible with its product line.  All license agreements other than theagreement with MAM Babyartikel GmbH (which has a remaining term of six years),are for three year terms with extensions agreed to by both parties.  Some of these license agreements includeprepayments and minimum guarantee royalty payments.  The amount of guaranteed royalty paymentswith respect to all license agreements over the next three years aggregates $3,838,000.  The Company’s royalty expense for the first sixmonths of 2005 and 2004 were $983,800 and $250,900, respectively.

 

In connection with the Company’s continuingexpansion of its operations in the People’s Republic of China (“PRC”), theCompany completed a voluntary review in 2003 of the activities of its officesin the PRC to assess their compliance with applicable laws and regulations. Asa result of this review, management became aware of some potential operationaland tax compliance issues under applicable PRC laws and regulations and hastaken appropriate corrective actions, including the establishment of a newsubsidiary in the PRC which became effective January 2004, and settlementof prior year individual income tax underpayments and associated penalties,totaling approximately $464,000, which was expensed in 2004.

 

**NOTE 14 – 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 on May 7,2004, May 28, 2004, June 15, 2004, June 22, 2004 and June 30,2004, respectively.  The tender offer closed in June, 2004 with anaggregate purchase price of approximately $844,000 paid by the Company, whichwas treated as a compensation expense in the second quarter of 2004.

 

**NOTE 15 - RECENTLY ISSUEDACCOUNTING STANDARDS**

 

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

 

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

 

The financial and business analysis below providesinformation which the Company believes is relevant to an assessment andunderstanding of the Company’s consolidated financial condition, changes infinancial condition and results of operations.  This financial andbusiness analysis should be read in conjunction with the Company’s consolidatedfinancial statements and accompanying notes to the consolidated financialstatements set forth in Part I, Financial Information, Item 1, “FinancialStatements” of this Quarterly Report on Form 10-Q, the Company’sQuarterly Report on Form 10-Q for the quarter ended March 31, 2005 (the“First Quarter 10-Q”) and the Company’s Annual Report on Form 10-K for theyear ended December 31, 2004 (the “2004 10-K”).

 

**OVERVIEW**

 

TheCompany’s revenues are primarily derived from sales of its products, asignificant portion of which is attributable to sales of products in its giftsegment.  Sales and operating profits in the Company’s gift segment beganto decline during 2003 as a result of several factors including (i) retailerconsolidation and a declining number of independent retail outlets, which inturn had a negative impact on sales from such outlets, (ii) increasedcompetition 

 

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from other entities, both wholesellers and retailers, which offered lowerpricing and achieved greater customer acceptance of their products and (iii) changingbuying habits of consumers, marked by a shift from independent retailers tomass market retailers.  During the firsthalf of 2003, management realized that the factors discussed above wereunlikely to abate, and as a result, began an evaluation of how best torespond.  The result was a multi-prongedapproach begun in the third quarter of 2003, which consisted of (i) focusingon categorizing and rationalizing its product range, (ii) segmenting itsselling efforts to address management’s perception of new customer requirementsand shifting channels of distribution, (iii) focusing on growing itsinternational business and infant and juvenile segment and (iv) restructuringits operations in order to reduce overhead expenses through headcountreductions and the closure of certain domestic showrooms.  See the 2004 10-K for a discussion of theimpact of such 2003 restructurings.

 

Duringthe first half of 2004, the Company continued to be negatively impacted by thefactors discussed above.  As a result,its gift segment’s sales continued to decline. In response to this continued decline, in addition to the initiativesdescribed above, the Company discontinued pursuit of previously announcedstrategic alternatives and hired Andrew Gatto as its President and  Chief ExecutiveOfficer (“CEO”), effective June 1, 2004. In June 2004, the new CEO implemented a comprehensive strategicreview of the Company’s worldwide inventory, with a view towards his perceptionof the Company’s future direction in light of the current factors affecting itsgift segment.  As a result of this review, an additional inventorywrite-down of $13 million (pre tax) was recorded in cost of sales in the secondquarter of 2004 to reflect inventory in the gift segment at the lower of its costor market value.  The Company has sold substantially allof this inventory through other than its normal sales channels.Therefore, no future impact on results of operations or liquidity isanticipated related to this inventory. Although the Company does not anticipate further material inventorywrite-downs at this time, a significant change in demand for the Company’sproducts could result in a change in the amount of excess inventories onhand.  The Company manages inventory andmonitors product purchasing to minimize this risk.

 

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

 

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

 

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

 

In addition to the “right-sizing” efforts discussedabove, the Company is continuing to respond to these developments affecting itsgift business by (i) continuing to focus on realigning its product lineand distribution channels to better meet the changing demands of its customersand improve its competitive position in the industry, (ii) segmenting itsselling efforts with an increased focus on national accounts, in order to buildand strengthen the Company’s presence in the mass market (the Company intendsto use the APPLAUSE ® Trademark as the brand platform upon which the Company’sgrowth in the mass market will be positioned), (iii) continuing to focuson realigning growth opportunities in its international markets and its infantand juvenile business segment, as demonstrated by the acquisition of Kids Line,LLC as of December 15, 2004, (iv) selectively increasing its use oflicensing to differentiate its products from its competitors,  includingduring 2004 the license of certain intellectual 

 

18

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property from Marvel Enterprises, Inc. relatingto Spider-Man® and X-MenTM classic characters and Fantastic Fourä characters; Andrew McMeel Universal (licensing representative for Ziggy® and Friends, Inc.)to create a “Ziggy”® product  line,Sanrio, Inc. to develop and market certain products in connection withthe  “KEROPPI” property;  DreamWorks Animation L.L.C. to design andmarket certain products related to the animated movie MadagascarTM; WarnerBrothers Consumer Products Inc. relating to Scooby-DooTM and certain othercharacters; Hasbro International, Inc. and Simm R Schuster, Inc.relating to the Raggedy Ann and AndyTM property; and during the first half of2005, the license of certain intellectual property from Universal Studiosrelating to Curious GeorgeTM; the Beanstock Group relating to Zelda WisdomTM, andthe 20th Century Fox Group relating to The SimpsonsTM, (v) pursuingstrategic acquisition opportunities; and (vi) implementing a three tiered “good”,“better”, “best” branding strategy within its gift segment to differentiateproducts sold into the mass market, Russ Berrie’s traditional specialty retailmarket and upscale department store market. As full implementation of the initiatives discussed above is an ongoingprocess, the Company does not anticipate immediate material results from theforegoing program of changes.  Managementdoes believe, however, that such changes are appropriate to address the variousdevelopments affecting its gift business, and will yield positive results inthe future.

 

See “Kids Line and Related Financing” under “Liquidityand Capital Resources” below for a discussion of the termination of theFinancing Agreement and execution of the Credit Agreement and the CanadianCredit Agreement (each as defined below).

 

**SEGMENTS**

 

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.  However,as a result of the sale of Bright of America, the Company currently operates intwo segments:  (i) its gift businessand (ii) its infant and juvenile business. See Note 9 of the Notes to the Consolidated Financial Statements for adiscussion on reclassification of the Company’s segments.  The Company’s gift business designs,manufactures through third parties and markets a wide variety of gift productsto retail stores throughout the United States and throughout the world via theCompany’s international wholly-owned subsidiaries and distributors. The Company’sinfant and juvenile businesses design 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.  These products are sold toconsumers, primarily in the United States, through mass merchandisers, toy,specialty, food, drug and independent retailers, apparel stores and militarypost exchanges. Until the Company’s sale of Bright of America, Inc.effective August 2, 2004, the Company’s non-core products includededucational products, placemats, candles and home fragrance products, whichwere sold primarily to customers in the United States through mass marketers.

 

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

 

The Company’s consolidated net sales for the threemonths ended June 30, 2005 increased 16.1% to $62,019,000 compared to$53,420,000 for the three months ended June 30, 2004.  The net salesincrease was attributable to the Company’s infant and juvenile segment, whichhas included sales of KidsLine LLC since its acquisition on December 15,2004.

 

The Company’s gift segment’s net sales for the threemonths ended June 30, 2005 decreased 25.0% to $28,771,000 compared to$38,378,000 for the three months ended June 30, 2004, primarily as a resultof the factors discussed in the “Overview” above.  Net sales in the Company’s gift segmentbenefited from foreign exchange rates by approximately $436,000 for the threemonths ended June 30, 2005.  The Company’s infant and juvenilesegment’s net sales for the three months ended June 30, 2005 increased154.0% to $33,248,000 compared to $13,089,000 for the three months ended June 30,2004. This increase is comprised of $19,007,000 of sales attributable to KidsLine and sales growth of 8.8% ($1.1 million) in Sassy Inc.  As a result of the sale of Bright of Americaeffective August 2004, there were no non-core sales for the three monthsended June 30, 2005 compared to $1,953,000 for the three months ended June 30,2004.

 

Consolidated gross profit was 40.3% of consolidatednet sales for the three months ended June 30, 2005, compared to 20.3% ofconsolidated net sales for the three months ended June 30, 2004.  Theincrease in the consolidated gross profit percentage is primarily due to thesignificant inventory write-down for the gift segment in the second quarter 

 

19

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of 2004, described in the “Overview” section above,offset partially by competitive pricing pressure in the gift segment, and theincrease in infant and juvenile sales as a percent of consolidated sales, whichhave lower gross profit margins compared to gift segment margins. Grossprofit for the Company’s gift segment was 41.9% of net sales for the threemonths ended June 30, 2005 as compared to 14.9% of net sales for the threemonths ended June 30, 2004.  Gross Profit for the Company’s infantand juvenile segment was 39.0% of net sales for the three months ended June 30,2005 as compared to 32.7% of net sales for the three months ended June 30,2004 resulting from the December 2004 acquisition of KidsLine.

 

Consolidated selling, general and administrativeexpenses were $29,182,000 or 47.1% of consolidated net sales for the threemonths ended June 30, 2005 compared to $34,029,000 or 63.7% of consolidatednet sales for the three months ended June 30, 2004.  This decrease inconsolidated selling, general and administrative expenses is due primarily tolower selling, product development, administration and advertising cost,predominately as a result of our restructuring efforts in 2004.  These reductions were partially offset by increasedselling, general and administrative expenses as a result of the acquisition ofKids Line.

 

Consolidated other income/(expense) was an expenseof $8,171,000 for the three months ended June 30, 2005 compared to incomeof $228,000 for the three months ended June 30, 2004, a decrease of $8,399,000. This decrease was primarily the result of interest expense incurred inconnection with the Term Loan under the Financing Agreement and the write-offin the second quarter of 2005, deferred financing costs of approximately$4,808,000 associated with the termination of the Financing Agreement (each asdefined in “Kids Line and Related Financing” below).

 

The consolidated income tax (benefit) in the threemonths ended June 30, 2005 was $(6,169,000) as compared to $(7,422,000) forthe same period in 2004.  Theconsolidated benefit income tax as a percent of loss before income tax benefitfor the three months ended June 30, 2005 was 50.0% compared to 32.3% forthe three months ended June 30, 2004.  The increase in the effective taxrate results primarily from a decrease in tax-advantaged investment income, anincrease in state taxes, and the May 10, 2005 Treasury Department issuance of Notice2005-38 which had a material impact on the tax calculations related to Section965 dividends (dividends from foreign subs). As a result of Notice 2005-38, the Company recorded a tax benefit ofapproximately $2.2 million in the second quarter of 2005.

 

As a result of the foregoing, consolidated net lossfor the three months ended June 30, 2005 was $(6,162,000) or $(0.30) perdiluted share compared to $(15,550,000) or $(0.75) per diluted share for thethree months ended June 30, 2004, representing an increase of $9,388,000and an increase of $.45 per diluted share.

 

**RESULTS OF OPERATIONS - SIX MONTHSENDED JUNE 30, 2005 AND 2004**

 

The Company’s consolidated net sales for the sixmonths ended June 30, 2005 increased 11.4% to $132,626,000 compared to$119,133,000 for the six months ended June 30, 2004.  The net salesincrease was attributable to the Company’s infant and juvenile segment, whichhas included sales of KidsLine LLC since its acquisition on December 15, 2004.

 

The Company’s gift segment’s net sales for the sixmonths ended June 30, 2005 decreased 25.7% to $66,676,000 compared to$89,734,000 for the six months ended June 30, 2004, primarily as a resultof the factors discussed in the “Overview” above.  Net sales in the Company’s gift segmentbenefited from foreign exchange rates by approximately $1,331,000 for the sixmonths ended June 30, 2005.  The Company’s infant and juvenilesegment’s net sales for the six months ended June 30, 2005 increased160.6% to $66,083,000 compared to $25,359,000 for the six months ended June 30,2004. This increase is comprised of $37,880,000 of sales attributable to KidsLine and sales growth of 11.2% ($2.8 million) in Sassy Inc.  As a result of the sale of Bright of Americaeffective August 2004, there were no non-core sales for the six monthsended June 30, 2005 compared to $4,040,000 for the six months ended June 30,2004.

 

Consolidated gross profit was 42.5% of consolidatednet sales for the six months ended June 30, 2005 as compared to 36.9% ofconsolidated net sales for the six months ended June 30, 2004.  Theincrease in the consolidated gross profit percentage is primarily due to thesignificant inventory write-down for the gift segment in the second quarter of2004, described in the “Overview” section above, offset partially bycompetitive pricing pressure in the gift segment, and the increase in infantand juvenile sales as a percent of consolidated sales, which have lower grossprofit margins compared to gift segment margins. Gross profit for theCompany’s gift segment was 45.4% of net sales for the six months ended June 30,2005 as compared to 38.0% of net sales for the six months ended June 30,2004.  Gross Profit for the Company’s infant and juvenile segment was39.6% of net sales for the six months ended 

 

20

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June 30, 2005 as compared to 32.3% of net salesfor the six months ended June 30, 2004 resulting from the December 2004acquisition of KidsLine.

 

Consolidated selling, general and administrativeexpenses were $59,867,000 or 45.1% of consolidated net sales for the six monthsended June 30, 2005 compared to $68,471,000 or 57.5% of consolidated netsales for the six months ended June 30, 2004.  This decrease inconsolidated selling, general and administrative expenses is due primarily tolower selling, product development, administration and advertising cost,predominately as a result of our restructuring efforts in 2004.  These reductions were partially offset by increasedselling, general and administrative expenses as a result of the acquisition of KidsLine.

 

Consolidated other income/(expense) was an expenseof $11,622,000 for the six months ended June 30, 2005 compared to incomeof $2,192,000 for the six months ended June 30, 2004, a decrease of $13,814,000. This decrease was primarily the result of interest expense incurred inconnection with the Term Loan under the Financing Agreement, the write-off inthe second quarter of 2005 of deferred financing costs of approximately$4,808,000 associated with the termination of the Financing Agreement (each asdefined in “Kids Line and Related Financing” below), and decreased interestincome as all marketable security balances were liquidated in 2004.

 

The income tax (benefit) in the six months ended June 30,2005 was $(7,187,000) as compared to $(7,233,000) for the same period in2004.  The consolidated income taxbenefit as a percent of loss before income tax benefit for the six months endedJune 30, 2005 was 47.7% compared to 32.4% for the six months ended June 30,2004.  The increase in the effective rate results primarily from adecrease in tax-advantaged investment income, an increase in state taxes, andthe May 10, 2005 Treasury Department issuance of Notice 2005-38 which had amaterial impact on the tax calculations related to Section 965 dividends(dividends from foreign subs).  As aresult of Notice 2005-38, the Company recorded a tax benefit of approximately$2.2 million in the second quarter of 2005.

 

As a result of the foregoing, consolidated net lossfor the six months ended June 30, 2005 was $(7,884,000) or ($0.38) perdiluted share compared to $(15,114,000) or $(0.73) per diluted share for thesix months ended June 30, 2004, representing an increase of $7,230,000 andan increase of $.35 per diluted share.

 

**Liquidity and Capital Resources**

 

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

 

As of June 30, 2005, the Company had cash andcash equivalents of $15,498,000 compared to $48,099,000 at December 31,2004. This reduction of $32,601,000 was primarily the result of the repaymentof debt related to the termination of the Financing Agreement (defined in “KidsLine and Related Financing” below), partially offset by proceeds from the CreditAgreement (defined in “Kids Line and Related Financing” below), proceeds from thesale of assets in the UK and Hong Kong during the first quarter of 2005, theU.S. Federal tax refund received in the second quarter and collections ofaccounts receivable.  As of June 30,2005 and December 31, 2004, working capital was $80,693,000 and$119,293,000, respectively.  This decreaseof $38,600,000 was primarily the result of a decrease in cash used to repay theTerm Loan under the Financing Agreement.

 

Cash and cash equivalents decreased by $32,601,000during the six months ending June 30, 2005 compared to a decrease of $4,931,000during the six months ending June 30, 2004, primarily as a result of the factorsdescribed in the preceding paragraph.  Thedecrease in the first six months of 2004 was primarily the result of the paymentof special and regular dividends offset somewhat by the Company’s sale of asignificant portion of its available-for-sale marketable securities during the sixmonths ended June 30, 2004.  Netcash provided by operating activities was approximately $25,212,000 during the sixmonths ending June 30, 2005 as compared to approximately $11,499,000during the six months ending June 30, 2004. This increase of $13,713,000was due primarily to the reduction in restricted cash in 2005 related to thetermination of the Financing Agreement. Net cash provided by investingactivities was approximately $8,300,000 for the six months ending June 30,2005 as compared to approximately $138,715,000 for the six months ending June 30,2004. This decrease of approximately $130,415,000 was due primarily to the liquidationof the Company’s marketable securities in the first six months of 

 

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2004.  Netcash used in financing activities of $63,412,000 and $154,794,000 for the sixmonths ending June 30, 2005 and 2004, respectively, consisted primarily ofpayment of long-term debt obligations during the first six months of 2005 (asdescribed in “Kids Line and Related Financing” below) and payment of thespecial and regular dividends during the first six months of 2004.

 

During the six months ending June 30, 2005, theCompany paid approximately $1,416,000 for income taxes. The Company currentlyexpects that its cash flows will exceed any income tax payments during 2005 andreceived a United States federal tax refund of approximately $8,393,000 in thesecond quarter of 2005 and expects further refunds of approximately $1,012,000as a result of net operating loss carry-backs for the calendar year ended December 31,2004.

 

Working capital requirements during the six monthsending June 30, 2005 were met entirely through internally generatedfunds. The Company’s capital expenditures during the six months ending June 30,2005 were approximately $614,000 primarily for continued system implementationand development costs. In the 2004 10-K, the Company estimated that capitalexpenditure requirements for 2005 would be approximately $3,800,000 fordistribution center improvements and continued system development costs.  Due to revised estimates based on actualcosts related to such items in the first quarter of 2005, capital expendituresfor 2005 are now estimated to be approximately $2,000,000 in the aggregate.

 

***Kids Line andRelated Financing***

 

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

 

In connection with the Purchase, the Company andcertain of its subsidiaries entered into a Financing Agreement dated as of December 15,2004 amended on March 18, 2005 and March 31, 2005 (the “FinancingAgreement”), with the lenders named therein and Ableco Finance LLC, ascollateral agent and as administrative agent (the “Agent”). The FinancingAgreement consisted of a term loan in the original principal amount of $125million which was scheduled to mature on November 14, 2007 (the “Term Loan”).The Company used the proceeds of the Term Loan to substantially finance thePurchase and pay fees and expenses related thereto. The terms of the FinancingAgreement are further described in Note 5 to the Notes to ConsolidatedFinancial Statements and the First Quarter 10-Q.

 

TheCompany and certain of its domestic wholly-owned subsidiaries party thereto(the “Specified Subsidiaries”), entered into a $105,000,000 credit agreementdated as of June 28, 2005, and amended as of August 4, 2005 (the “CreditAgreement”) with the financial institutions parties thereto as Facility ALenders, the financial institutions parties thereto as Facility B Lenders,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”.  Unless otherwise specified herein,capitalized terms used but undefined herein shall have the meanings ascribed tothem in the Credit Agreement.  The CreditAgreement replaces the Financing Agreement. All obligations under the Financing Agreement were repaid using proceedsfrom the Credit Agreement and other available cash, and such FinancingAgreement was terminated concurrently with the execution of the CreditAgreement.  There were no fees triggeredas a result of the early termination of the Financing Agreement, however, inconjunction therewith, the Company wrote off approximately $4,808,000 in remainingunamortized deferred financing costs in the second quarter of 2005.  Remaining amounts available under the CreditAgreement will be used for working capital requirements and general corporatepurposes.

 

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TheCredit Agreement is described in further detail in Note 5 to the Notes toConsolidated Financial Statements.

 

In accordance with the termsof the Credit Agreement, the Company is permitted to pay a dividend as long asbefore 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 the formof regular cash dividends.  With respectto the Earnout Consideration, the Company will be permitted to pay all or aportion 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.

 

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, 2005, a separate Credit Agreement(acknowledged by the Company) with the financial institutions party thereto andLaSalle Business Credit, a division of ABN AMRO Bank, N.V., Canada Branch, aCanadian branch of a Netherlands bank, as issuing bank and administrative agent(the “Canadian Credit Agreement”), and related loan documents with respect to amaximum U.S. $10.0 million revolving loan (the “Canadian Revolving Loan”), witha subfacility for letters of credit in an amount not to exceed U.S. $2.0million.  The Canadian Credit Agreementis described in Note 5 to the Notes to Consolidated Financial Statements.  In order to secure its obligations under theCanadian Credit Agreement, Amrams has granted security interests to theadministrative agent thereunder in substantially all of its real and personalproperty.  In addition, the Company hasexecuted an unsecured Guarantee to guarantee the obligations of Amrams underthe Canadian Credit Agreement.

 

**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.  No cash dividends were paid during thefirst quarter of 2005.  Cash dividends of$158,263,000 ($0.30 per share per quarter plus $7.00 per share special dividends)were paid in the six months ended June 30, 2004.  See Note 5 to theNotes to Consolidated Financial Statement for a discussion of the restrictionson the Company’s ability to pay dividends as long as any obligations under theCredit Agreement remain outstanding.

 

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

 

The Company is dependent upon information technologysystems in many aspects of its business. The Company is continuingimplementation of an Enterprise Resource Planning (“ERP”) system for theCompany’s gift businesses, which began in 2002. In 2002 and 2003, the Companysuccessfully completed the replacement of its warehouse management system inits South Brunswick, New Jersey and Petaluma, California, Canadian and Europeandistribution facilities in addition to the implementation of the purchasingmodule of its new ERP system worldwide. The Company’s prior custom softwarethat had been utilized to operate and manage its business and other third partysoftware systems are being replaced using a strategic and phased approach. TheCompany’s worldwide headquarters in the United States completed theimplementation of the finance module of the new ERP system in the first quarterof 2003 and transitioned to the order management and inventory modules duringthe second quarter of 2003. During 2004 and continuing in 2005, certain of theCompany’s international subsidiaries began and continued to phase-

 

23

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in certain aspects of the Company’s new ERP systemand the transition to order management, inventory and finance modules is nowanticipated to be substantially complete by the end of the third quarter of2005. The Company is currently evaluating whether remaining internationaloperations should be converted to the new ERP system in the future due to thesize of these operations. This timetable is meant to continue to enable theCompany to enhance its proficiency in utilizing the new system, to help ensurethe efficiency of the international implementations and allow the Company tocontinue to comply with its obligations regarding internal controls as requiredby Section 404 of the Sarbanes-Oxley Act of 2002. The Company hasexperienced certain startup issues but has not experienced any significantbusiness disruptions related to the replacement of these systems.

 

In March 1990, The Board of Directors hadauthorized the Company to repurchase an aggregate of 7,000,000 shares of commonstock. As of June 30, 2005, 5,643,200 shares have been repurchased sincethe beginning of the Company’s stock repurchase program. During the six monthsended June 30, 2005, the Company did not repurchase any shares pursuant tothis program or otherwise.

 

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

 

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

 

Consistent with its past practices and in the normalcourse of its business, the Company regularly reviews acquisition opportunitiesof varying sizes. The Company may consider the use of debt financing to fundprospective acquisitions.  Note that the Credit Agreement imposesrestrictions on the Company which could limit its ability to respond to marketconditions or to take advantage of business opportunities.

 

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 June 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     |       | $         | 65,332,000  |     | $          | 3,877,000  |       | $        | 7,801,000  |     | $          | 6,669,000  |       | $              | 6,033,000  |   | $ | 5,271,000 |   | $ | 35,681,000 |   |
| Purchase Obligations            |       | $         | 28,713,000  |     | $          | 28,713,000 |       | $        | —     |     | $          | —     |       | $              | —     |   | $ | — |   | $ | — |   |
| Debt Repayment Obligations      |       | $         | 66,800,000  |     | $          | 15,100,000 |       | $        | 2,600,000  |     | $          | 2,600,000  |       | $              | 2,600,000  |   | $ | 2,600,000 |   | $ | 41,300,000 |   |
| Commercial Letters of Credit    |       | $         | 113,000     |     | $          | 113,000    |       | $        | —     |     | $          | —     |       | $              | —     |   | $ | — |   | $ | — |   |
| Open Forward Exchange Contracts |       | $         | 6,903,000   |     | $          | 5,552,000  |       | $        | 1,351,000  |     | $          | —     |       | $              | —     |   | $ | — |   | $ | — |   |
| Royalty Obligations             |       | $         | 3,938,000   |     | $          | 952,000    |       | $        | 1,661,000  |     | $          | 1,275,000  |       | $              | 50,000     |   | $ | — |   | $ | — |   |
| Total Contractual Obligations   |       | $         | 171,799,000 |     | $          | 54,307,000 |       | $        | 13,413,000 |     | $          | 10,544,000 |       | $              | 8,683,000  |   | $ | 7,871,000 |   | $ | 76,981,000 |   |

 

The numbers above reflect updates to the table of ContractualObligations set forth in item 7 of the 2004 10-K to reflect (i) changes createdby the termination of the Financing Agreement and the execution of the Credit Agreement ,(ii) increased purchase obligations forpurchase orders of inventory, and (iii) reduction of open forward exchangecontracts and commercial letters of credit obligations.

 

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**Off Balance Sheet Arrangements**

 

As of June 30, 2005, there have been nomaterial changes in the information provided under the caption “Off BalanceSheet Arrangements” of Item 7 of the 2004 10-K, except for the following:

 

TheSecurity Agreement made on December 15, 2004 among the Company, itssubsidiaries party thereto and the agent under the Financing Agreement,executed in connection with the Financing Agreement and described in the FirstQuarter 10-Q, and all other loan and/or security agreements executed inconnection with such Financing Agreement or Security Agreement, were terminatedconcurrently with the termination of the Financing Agreement and the executionof the Credit Agreement.

 

Inorder to secure the obligations of the Company and the Specified Subsidiariesunder the Credit Agreement, the Company has pledged 100% of the equityinterests of the Specified Subsidiaries and 65% of the equity interests of itsFirst Tier Foreign Subsidiaries (each as defined in the Credit Agreement) tothe Administrative Agent, and has granted security interests to theAdministrative 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.

 

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 to guarantee the obligations of Amrams under the CanadianCredit 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.

 

**CRITICAL ACCOUNTING POLICIES**

 

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

 

Management is required to make certain estimates andassumptions during the preparation of its consolidated financial statementsthat effect the reported amounts of assets,liabilities, revenue and expenses, and related disclosure of contingent assetsand liabilities. Estimates and assumptions are reviewed periodically, andrevisions made as determined to be necessary by management. The Company’ssignificant accounting estimates have historically been and are expected toremain reasonably accurate, but actual results could differ from thoseestimates under different assumptions or conditions.  There have been no material changes to theCompany’s significant accounting estimates and assumptions or the judgmentsaffecting the application of such estimates and assumptions during the periodcovered by this report from those described in the Company’s 2004 10-K.

 

There have been no changes to the criticalaccounting polices in the second 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 on results ofoperations and financial condition.

 

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**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”,“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 debt financingto fund acquisitions, the current and future outlook of the global retailmarket, the ability to integrate new business ventures, the ability to meetcovenants in the Credit Agreement and other factors.

 

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

 

As of June 30, 2005, there have been nomaterial changes in the Company’s market risks associated with marketablesecurities and foreign currency exchange rates, as described in Item 7A of theCompany’s 2004 10-K. The market risk associated with long-term debt has changedas a result of the termination of the Financing Agreement and the execution ofthe Credit Agreement more fully described in Note 5 to the Notes of the ConsolidatedFinancial Statements.  The interestapplicable to the Loans under the Credit Agreement is based upon (x) the LIBORRate (as defined in the Credit Agreement) and (y) the Base Rate which is thegreater of (i) the Federal Funds Rate plus 0.5% and (ii) the Prime Rate (eachas defined in the Credit Agreement).  At June 302005, a sensitivity analysis to measure potential changes in applicable interestrates indicates that a one percentage point increase in interest rates wouldincrease the Company’s interest expense by approximately $668,000.

 

**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 June 30, 2005 that hasmaterially affected, or is reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

**PART II - OTHER INFORMATION**

 

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

On May 4, 2005, the Company held its annualmeeting of shareholders to elect nine Directors to its Board ofDirectors.  Each of the nine nominated directors was elected withoutcontest.  No other matters were brought before the shareholders at theannual meeting.  The votes for and the votes withheld for each of thenominees for director were as follows:

 
| **Nominee**        | ** ** | **For**    | ** ** | **%** | ** ** | **Withhold** | ** ** | **%** | ** ** |
|--------------------|------------|------------|------------|-------|------------|--------------|------------|-------|------------|
| Raphael Benaroya   |       | 15,558,233 |       | 81.5  |       | 3,526,549    |       | 18.5  |       |
| Angelica Berrie    |       | 18,114,371 |       | 94.9  |       | 970,411      |       | 5.1   |       |
| Carl Epstein       |       | 18,726,852 |       | 98.1  |       | 357,930      |       | 1.9   |       |
| Andrew R. Gatto    |       | 18,621,815 |       | 97.6  |       | 462,967      |       | 2.4   |       |
| Ilan Kaufthal      |       | 18,094,526 |       | 94.8  |       | 990,256      |       | 5.2   |       |
| Charles Klatskin   |       | 18,059,357 |       | 94.6  |       | 1,025,425    |       | 5.4   |       |
| Joseph Kling       |       | 18,374,591 |       | 96.3  |       | 710,191      |       | 3.7   |       |
| William A. Landman |       | 17,775,737 |       | 93.1  |       | 1,309,045    |       | 6.9   |       |
| Josh S. Weston     |       | 16,731,018 |       | 87.7  |       | 2,353,764    |       | 12.3  |       |

 

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**ITEM 6.  EXHIBITS**

 
| Exhibits to this Quarterly Report on  Form 10-Q. |
|-------------------------------------------------------|
|                                                  |   |   |
| 4.5                                                   |   | Credit Agreement (the “Credit Agreement”), dated as of June 28,  2005, among Russ Berrie and Company, Inc. and specified domestic  wholly-owned subsidiaries thereof, the financial institutions parties thereto  as Facility A Lenders, the financial institutions parties thereto as Facility  B Lenders, LaSalle Bank National Association, in its capacity as “Issuing  Bank” thereunder, and LaSalle Business Credit, LLC as administrative agent  (the “Administrative Agent”) for the lenders and the Issuing Bank, and those  lenders, if any designated therein as the “Documentation Agent” or  “Syndication Agent”, incorporated herein by reference to the Company’s  Current Report on Form 8-K, filed on July 5, 2005 (the “July 5  8-K”).* |
|                                                  |   |   |
| 4.6                                                   |   | Guaranty and Collateral Agreement made on June 28, 2005 among  Russ Berrie and Company, Inc., its subsidiaries party thereto and the  Administrative Agent, incorporated herein by reference to the July 5  8-K. * |
|                                                  |   |   |
| 4.7                                                   |   | Credit Agreement dated as of June 28, 2005, (the “Canadian  Credit Agreement”), among Amram’s Distributing Ltd., the financial  institutions party thereto and LaSalle Business Credit, a division of ABN  AMRO Bank, N.V., Canada Branch, a Canadian branch of a Netherlands bank, as  agent, incorporated herein by reference to the July 5 8-K.* |
|                                                  |   |   |
| 4.8                                                   |   | Guarantee dated as of June 28, 2005, among Russ Berrie and  Company, Inc., the financial institutions party thereto and LaSalle  Business Credit, a division of ABN AMRO Bank, N.V., Canada Branch, a Canadian  branch of a Netherlands bank, as agent, incorporated herein by reference to  the July 5 8-K.* |
|                                                  |   |   |
| 4.9                                                   |   | First Amendment to Credit Agreement, dated as of  August 4, 2005, among Russ Berrie and Company, Inc. its domestic  signatories party thereto, the Facility A Lenders and the Facility B Lenders  from time to time parties to the Credit Agreement, the Issuing Bank and the  Administrative Agent. |
|                                                  |   |   |
| 10.94                                                 |   | Employment Agreement dated July 27, 2005,  effective August 1, 2005. between Russ Berrie and Company, Inc. and  Mr. Anthony Cappiello, incorporated herein by reference to the Company’s  Current Report on Form 8-K, filed on August 2, 2005. |
|                                                  |   |   |
| 31.1                                                  |   | Certification of CEO required by Section 302  of the Sarbanes Oxley Act of 2002. |
|                                                  |   |   |
| 31.2                                                  |   | Certification of CFO required by Section 302  of the Sarbanes Oxley Act of 2002. |
|                                                  |   |   |
| 32.1                                                  |   | Certification of CEO required by Section 906  of the Sarbanes Oxley Act of 2002. |
|                                                  |   |   |
| 32.2                                                  |   | Certification of CFO required by Section 906  of the Sarbanes Oxley Act of 2002. |
|                                                  |   |   |

 

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 *  Schedules and otherattachments are omitted, but will be furnished supplementally to the Commissionupon request.

 

TheAmendment to the Canadian Credit Agreement will be furnished to the Commissionupon request.

 

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

 

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**SIGNATURES**

 

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

 
|                            | RUSS BERRIE AND COMPANY,  INC. |
|---------------------------------|--------------------------------|
|                            | (Registrant)                   |
|                            |                           |
|                            | By                             | /s/ John D. Wille |   |
| Date:  August 9, 2005 |                           | John D. Wille |
|                            |                           | *Vice President and  Chief Financial Officer* |

 

28

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**Exhibit Index**

 
| 4.9    |   | First Amendments to Credit Agreement, dated as of  August 4, 2005, among Russ Berrie and Company, Inc. its domestic  signatories party thereto, the Facility A Lenders and the Facility B Lenders  from time to time parties to the Credit Agreement, the Issuing Bank and the  Administrative Agent. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                            |
| 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.                                                                                                                                                                                                                           |

 

29

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