Table of Contents

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**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

** **

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** **

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

 

**For the quarterly period ended September 30, 2008**

** **

**Or**

 

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

 

**For the transition period from            to            **

 

**Commissionfile number: 1-8681**

 

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**RUSS BERRIE AND COMPANY, INC.**

(Exact name of registrant as specified in itscharter)

 

| **New Jersey**                                                     | ** ** | **22-1815337**                          |
|--------------------------------------------------------------------|------------|-----------------------------------------|
| (State of or other jurisdiction of  incorporation or organization) | ** ** | (I.R.S. Employer Identification Number) |
|                                                               | ** ** |                                    |
| **111 Bauer Drive, Oakland, New Jersey**                           | ** ** | **07436**                               |
| (Address of principal executive offices)                           | ** ** | (Zip Code)                              |

 

**(201) 337-9000**

(Registrant’s Telephone Number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x          No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reportingcompany.  See the definitions of “largeaccelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.  (Check one):

Largeaccelerated filer o     Acceleratedfiler x     Non-acceleratedfiler o     Smallerreporting company o

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o     No x

 

Thenumber of shares outstanding of each of the registrant’s classes of commonstock, as of November 3, 2008 was as follows:

** **

| **CLASS**                        | ** ** | **OUTSTANDING  At November 3, 2008** |
|----------------------------------|------------|-------------------------------------------|
| Common Stock, $0.10 stated value |       | 21,300,518                                |

 

 

 

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**RUSS BERRIEAND COMPANY, INC.**

 

**INDEX**

 
| **PART I –  FINANCIAL INFORMATION** |                                                 |                                                                                                         |
|-----------------------------------------------|------------------------------------------------------|--------------------------------------------------------------------------------------------------------------|
|                                          |                                                 |                                                                                                         |   |
| Item 1.                                       |                                                 | Financial  Statements (unaudited)                                                                            |   |   |
|                                          |                                                 |                                                                                                         |   |   |
| a)                                            |                                                 | Consolidated  Balance Sheets as of September 30, 2008 and December 31, 2007                        |   | 3 |
|                                          |                                                 |                                                                                                         |   |   |
| b)                                            |                                                 | Consolidated  Statements of Operations for the three and nine months ended  September 30, 2008 and 2007 |   | 4 |
|                                          |                                                 |                                                                                                         |   |   |
| c)                                            |                                                 | Consolidated  Statements of Cash Flows for the nine months ended September 30, 2008  and 2007           |   | 5 |
|                                          |                                                 |                                                                                                         |   |   |
| d)                                            |                                                 | Notes to  Unaudited Consolidated Financial Statements                                                        |   | 6 |
|                                          |                                                 |                                                                                                         |   |   |
| Item 2.                                       |                                                 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                  |   | 24 |
|                                          |                                                 |                                                                                                         |   |   |
| Item 3.                                       |                                                 | Quantitative  and Qualitative Disclosures About Market Risk                                                  |   | 38 |
|                                          |                                                 |                                                                                                         |   |   |
| Item 4.                                       |                                                 | Controls and  Procedures                                                                                     |   | 38 |
|                                          |                                                 |                                                                                                         |   |   |
| **PART II  – OTHER INFORMATION**    |                                                 |                                                                                                         |
| ** **                                    |                                                 |                                                                                                         |   |
| Item  1A.                                     | Risk  Factors                                        |                                                                                                         | 39 |
|                                          |                                                 |                                                                                                         |   |
| Item 4.                                       | Submission of  Matters to a Vote of Security Holders |                                                                                                         | 39 |
| ** **                                    |                                                 |                                                                                                         |   |
| Item 6.                                       | Exhibits                                             |                                                                                                         | 40 |
|                                          |                                                 |                                                                                                         |   |
| Signatures                                    |                                                 |                                                                                                         | 41 |
|                                          |                                                 |                                                                                                         |   |
| Exhibit Index                            |                                                 |                                                                                                         | 42 |

 

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**PART 1- FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

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

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

 
| ** **                                                                                                                                       | ** ** | **September 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **Assets**                                                                                                                                       |       |                             |       |                            |       |
| Current assets:                                                                                                                                  |       |                             |       |                            |       |
| Cash and cash equivalents                                                                                                                        |       | $                                | 13,620     |                            | $          | 21,925 |   |
| Accounts receivable, trade,  less allowances of $2,600 in 2008 and $2,756 in 2007                                                                |       | 78,288                           |       | 64,077                          |       |
| Inventories, net                                                                                                                                 |       | 65,033                           |       | 59,069                          |       |
| Prepaid expenses and other  current assets                                                                                                       |       | 3,014                            |       | 3,137                           |       |
| Income tax receivable                                                                                                                            |       | 814                              |       | 663                             |       |
| Deferred income taxes                                                                                                                            |       | 1,601                            |       | 1,619                           |       |
| **Total current assets**                                                                                                                         |       | 162,370                          |       | 150,490                         |       |
| Property, plant and equipment,  net                                                                                                              |       | 4,859                            |       | 13,093                          |       |
| Goodwill                                                                                                                                         |       | 130,198                          |       | 120,777                         |       |
| Intangible assets                                                                                                                                |       | 94,998                           |       | 51,172                          |       |
| Restricted cash                                                                                                                                  |       | 844                              |       | 916                             |       |
| Deferred income taxes                                                                                                                            |       | 845                              |       | 897                             |       |
| Other assets                                                                                                                                     |       | 4,778                            |       | 4,163                           |       |
| **Total assets**                                                                                                                                 |       | $                                | 398,892    |                            | $          | 341,508 |   |
| **Liabilities and Shareholders’  Equity**                                                                                                   |       |                             |       |                            |       |
| Current liabilities:                                                                                                                             |       |                             |       |                            |       |
| Current portion of long-term  debt                                                                                                               |       | $                                | 14,933     |                            | $          | 11,500 |   |
| Short-term debt                                                                                                                                  |       | 29,538                           |       | 23,344                          |       |
| Accounts payable                                                                                                                                 |       | 21,384                           |       | 19,822                          |       |
| Accrued expenses                                                                                                                                 |       | 28,527                           |       | 30,822                          |       |
| Income taxes payable                                                                                                                             |       | 5,698                            |       | 1,869                           |       |
| **Total current liabilities**                                                                                                                    |       | 100,080                          |       | 87,357                          |       |
| Income taxes payable long-term                                                                                                                   |       | 4,252                            |       | 9,406                           |       |
| Deferred income taxes                                                                                                                            |       | 7,807                            |       | 3,736                           |       |
| Long-term debt                                                                                                                                   |       | 79,345                           |       | 32,000                          |       |
| Other long-term liabilities                                                                                                                      |       | 5,381                            |       | 4,370                           |       |
| **Total liabilities**                                                                                                                            |       | 196,865                          |       | 136,869                         |       |
|                                                                                                                                             |       |                             |       |                            |       |
| Commitments and contingencies                                                                                                                    |       |                             |       |                            |       |
|  Shareholders’ equity:                                                                                                                 |       |                             |       |                            |       |
| Common stock: $0.10 stated  value; authorized 50,000,000 shares; issued 26,727,780 shares at  September 30, 2008 and December 31, 2007 |       | 2,674                            |       | 2,674                           |       |
| Additional paid-in capital                                                                                                                       |       | 92,184                           |       | 90,844                          |       |
| Retained earnings                                                                                                                                |       | 198,294                          |       | 200,228                         |       |
| Accumulated other comprehensive  income                                                                                                          |       | 14,941                           |       | 16,976                          |       |
| Treasury stock, at cost,  5,427,262 and 5,428,137 shares at September 30, 2008 and  December 31, 2007, respectively                    |       | (106,066                         | )          | (106,083                        | )          |
| **Total shareholders’ equity**                                                                                                              |       | 202,027                          |       | 204,639                         |       |
| **Total liabilities and  shareholders’ equity**                                                                                             |       | $                                | 398,892    |                            | $          | 341,508 |   |

 

*Theaccompanying notes are an integral part of these unaudited consolidatedfinancial statements.*

 

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

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(UNAUDITED)**

 
| ** **                                                            | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                            | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                                             |       | $                                                        | 108,075    |                                                    | $          | 100,928 |   | $ | 271,692 |   | $ | 246,715 |   |
|                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Cost of sales                                                         |       | 69,080                                                   |       | 60,569                                                  |       | 173,636 |   | 146,661 |   |
|                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| **Gross profit**                                                      |       | 38,995                                                   |       | 40,359                                                  |       | 98,056 |   | 100,054 |   |
|                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Selling, general and  administrative expenses                         |       | 29,015                                                   |       | 27,132                                                  |       | 92,296 |   | 79,270 |   |
|                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| **Operating income**                                                  |       | 9,980                                                    |       | 13,227                                                  |       | 5,760 |   | 20,784 |   |
|                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Other (expense) income:                                               |       |                                                     |       |                                                    |       |   |   |   |   |
| Interest expense, including  amortization of deferred financing costs |       | (2,264                                                   | )          | (1,228                                                  | )          | (6,170 | ) | (3,740 | ) |
| Interest and investment income                                        |       | 85                                                       |       | 135                                                     |       | 365 |   | 446 |   |
| Other, net                                                            |       | 382                                                      |       | 377                                                     |       | 1,031 |   | 287 |   |
|                                                                  |       | (1,797                                                   | )          | (716                                                    | )          | (4,774 | ) | (3,007 | ) |
|                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| **Income before income tax  provision**                               |       | 8,183                                                    |       | 12,511                                                  |       | 986 |   | 17,777 |   |
|                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Income tax (benefit) provision                                        |       | (22                                                      | )          | (1,796                                                  | )          | 2,920 |   | 559 |   |
|                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| **Net income (loss)**                                                 |       | $                                                        | 8,205      |                                                    | $          | 14,307 |   | $ | (1,934 | ) | $ | 17,218 |   |
|                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| **Net income (loss) per share:**                                      |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic                                                                 |       | $                                                        | 0.39       |                                                    | $          | 0.68 |   | $ | (0.09 | ) | $ | 0.82 |   |
| Diluted                                                               |       | $                                                        | 0.39       |                                                    | $          | 0.67 |   | $ | (0.09 | ) | $ | 0.81 |   |
|                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| **Weighted average shares:**                                          |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic                                                                 |       | 21,300,000                                               |       | 21,157,000                                              |       | 21,300,000 |   | 21,105,000 |   |
| Diluted                                                               |       | 21,310,000                                               |       | 21,318,000                                              |       | 21,300,000 |   | 21,257,000 |   |

 

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

 

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In Thousands)(UNAUDITED)**

 
| ** **                                                                                          | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| **Cash flows from operating  activities:**                                                          |       |                                                    |       |   |   |
| Net (loss) income                                                                                   |       | $                                                       | (1,934     | ) | $ | 17,218 |   |
| Adjustments to reconcile net  (loss) income to net cash provided by (used in) operating activities: |       |                                                    |       |   |   |
| Depreciation and amortization                                                                       |       | 4,630                                                   |       | 3,650 |   |
| Write off on disposal of fixed  assets                                                              |       | —                                                  |       | 361 |   |
| Provision for impairment of  fixed assets                                                           |       | 7,041                                                   |       | — |   |
| Amortization of deferred  financing costs                                                           |       | 605                                                     |       | 474 |   |
| Accounts receivable allowance                                                                       |       | 940                                                     |       | 1,631 |   |
| Provision for inventory reserve                                                                     |       | 3,541                                                   |       | 198 |   |
| Deferred income taxes                                                                               |       | 4,082                                                   |       | 2,986 |   |
| Share-based compensation  expense                                                                   |       | 1,357                                                   |       | 141 |   |
| Impairment of intangible asset                                                                      |       | —                                                  |       | 3,600 |   |
| Other                                                                                               |       | (444                                                    | )          | (92 | ) |
| Change in assets and  liabilities, excluding the effect of acquisitions:                            |       |                                                    |       |   |   |
| Restricted cash                                                                                     |       | 16                                                      |       | 12 |   |
| Accounts receivable                                                                                 |       | (2,028                                                  | )          | (28,272 | ) |
| Income tax receivable                                                                               |       | (447                                                    | )          | 2,233 |   |
| Inventories                                                                                         |       | (1,261                                                  | )          | (4,650 | ) |
| Prepaid expenses and other  current assets                                                          |       | 420                                                     |       | 7,722 |   |
| Other assets                                                                                        |       | 313                                                     |       | (1,544 | ) |
| Accounts payable                                                                                    |       | (1,518                                                  | )          | (2,371 | ) |
| Accrued expenses                                                                                    |       | (772                                                    | )          | 3,574 |   |
| Accrued income taxes                                                                                |       | (1,552                                                  | )          | (3,291 | ) |
| Net cash provided by operating  activities                                                          |       | 12,989                                                  |       | 3,580 |   |
|                                                                                                |       |                                                    |       |   |   |
| **Cash flows from investing  activities:**                                                          |       |                                                    |       |   |   |
| Capital expenditures                                                                                |       | (1,718                                                  | )          | (1,584 | ) |
| Payment for purchase of LaJobi  Industries, Inc., net of cash acquired                         |       | (52,044                                                 | )          | — |   |
| Payment for purchase of  CoCaLo, Inc., net of cash acquired                                    |       | (16,643                                                 | )          | — |   |
| Other                                                                                               |       | (23                                                     | )          | — |   |
| Payment of Kids Line, LLC  earnout consideration                                                    |       | (3,622                                                  | )          | — |   |
| Net cash used in investing  activities                                                              |       | (74,050                                                 | )          | (1,584 | ) |
| **Cash flows from financing  activities:**                                                          |       |                                                    |       |   |   |
| Proceeds from issuance of  common stock                                                             |       | —                                                  |       | 1,111 |   |
| Issuance of long-term debt                                                                          |       | 100,000                                                 |       | 45 |   |
| Repayment of long-term debt                                                                         |       | (53,721                                                 | )          | (8,500 | ) |
| Payment of financing fees                                                                           |       | (1,655                                                  | )          | — |   |
| Net borrowing on revolving credit  facility                                                         |       | 9,094                                                   |       | 10,237 |   |
| Payment of capital lease  obligations                                                               |       | (165                                                    | )          | — |   |
| Net cash provided by financing  activities                                                          |       | 53,553                                                  |       | 2,893 |   |
|                                                                                                |       |                                                    |       |   |   |
| Effect of exchange rate changes  on cash and cash equivalents                                       |       | (797                                                    | )          | 514 |   |
| Net (decrease) increase in cash  and cash equivalents                                               |       | (8,305                                                  | )          | 5,403 |   |
| Cash and cash equivalents at  beginning of period                                                   |       | 21,925                                                  |       | 11,526 |   |
| Cash and cash equivalents at  end of period                                                         |       | $                                                       | 13,620     |   | $ | 16,929 |   |
| **Cash paid during the period  for:**                                                               |       |                                                    |       |   |   |
| Interest expense                                                                                    |       | $                                                       | 4,762      |   | $ | 3,062 |   |
| Income taxes                                                                                        |       | $                                                       | 704        |   | $ | 1,075 |   |
| **Noncash items:**                                                                                  |       |                                                    |       |   |   |
| Note Payable-CoCaLo purchase                                                                        |       | $                                                       | 1,439      |   | $ | — |   |
| Increase in Goodwill from  Earnout Consideration                                                    |       | $                                                       | —     |   | $ | 31,000 |   |
| Increase in short-term  liability- Earnout Consideration                                            |       | $                                                       | —     |   | $ | 11,000 |   |
| Increase in long-term  liability- Earnout Consideration                                             |       | $                                                       | —     |   | $ | 20,000 |   |

 

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

 

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**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 - INTERIM CONSOLIDATED FINANCIAL STATEMENTS**

 

The accompanying unaudited interim consolidated financial statements havebeen prepared by Russ Berrie and Company, Inc. and its subsidiaries (the “Company”)in accordance with accounting principles generally accepted in the UnitedStates of America for interim financial reporting and the instructions to theQuarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X.Accordingly, certain information and footnote disclosures normally included infinancial statements prepared under generally accepted accounting principleshave been condensed or omitted pursuant to such principles andregulations.  The information furnished reflects all adjustments, whichare, in the opinion of management, of a normal recurring nature and necessaryfor a fair presentation of the Company’s consolidated financial position,results of operations and cash flows for the interim periods presented. Results for interim periods are not necessarily an indication of results to beexpected for the year.

 

The Company currently operates in two segments: (i) its infant andjuvenile segment and (ii) its gift segment. This segmentation of theCompany’s operations reflects how the chief operating decision makers currentlyview the results of operations.

 

The Company’s infant and juvenile segment is currentlycomposed of: Kids Line, LLC; Sassy, Inc.; LaJobi Inc.; and CoCaLo, Inc.,all wholly-owned subsidiaries, whose products focus principally on children ofthe age group newborn to two years and are generally sold to national accountsand independent retailers.  Kids Lineproducts consist primarily of infant bedding and related nursery accessories,such as blankets, rugs, mobiles, nightlights, hampers, lamps and wall art.Sassy has concept groupings such as bath toys and accessories, developmentaltoys, feeding utensils and bowls, bottles, bibs, soft toys, mobiles andfeeders, and recently entered the baby gear category.  LaJobi designs, imports and sells infant andjuvenile furniture and related products (including cribs, changing tables,dressers, hutches, armoires, bookcases and end tables, mattresses and changingpads).  CoCaLo designs, outsources,markets and distributes infant bedding (including crib bumpers, blankets, cribsheets and dust ruffles) and related accessories (including wall hangings, musicalmobiles, blankets, diaper stackers, valances, wall paper borders, lamps,shades, nightlights, switch plates, decorative pillows and rugs).

 

The Company’s gift segment designs, manufactures through third partiesand markets a wide variety of gift products to mass market, toy, specialty,food, drug and independent retailers throughout the United States andthroughout the world via the Company’s domestic and international wholly-ownedsubsidiaries and independent distributors.

 

Certain prior year amounts have been reclassified to conform to the 2008presentation.

 

This Quarterly Report on Form 10-Q should be read in conjunctionwith the Company’s Annual Report on Form 10-K for the year ended December 31,2007, as amended (the “2007 10-K”).

 

**NOTE 2 – Acquisitions**

 

I. LaJobi

 

On April 1, 2008, LaJobi, Inc. (“LaJobi”), anewly-formed and indirect, wholly-owned Delaware subsidiary of the Companyentered into an Asset Purchase Agreement (the “Asset Agreement”) with LaJobiIndustries, Inc., a New Jersey corporation (“Seller”), and each ofLawrence Bivona and Joseph Bivona (collectively, the “Stockholders”), for thepurchase of substantially all of the assets used in the business of Seller andspecified obligations. The transactions contemplated by the Asset Agreementwere consummated as of April 2, 2008.

 

The acquisition of LaJobi has enabled theCompany to expand its infant and juvenile segment and offer a more completerange of products for the baby nursery.

 

The aggregate purchase price payable for the business ofSeller was equal to: $47.0 million, reduced by the amount of assumedindebtedness (including capitalized lease obligations) as adjusted pursuant toa working capital adjustment, plus the earnout consideration described below.At Closing, LaJobi paid $44.5 million in cash to Seller, plus $3.2 million (theestimated amount of the working capital adjustment). As the final workingcapital adjustment was $3.0 million, the Seller subsequently refunded $0.2million.  The remaining $2.5 millionof the purchase price was deposited in escrow at Closing in respect ofpotential indemnification claims.  Asadditional consideration, if the following conditions have been satisfied,LaJobi will pay the earnout consideration described below:

 

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

 

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**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

Enterprise Value” will be the product of (i) theBusiness’s EBITDA during the twelve (12) months ending on the MeasurementDate or Early Measurement Date (or, in the event an Early Measurement Dateselected by Seller, as permitted by the Asset Agreement, is a date prior to January 1,2009, the annualized EBITDA of the Business for such period), as the case maybe, multiplied by (ii) an applicable multiple (ranging from 5 to9) depending on the specified levels of CAGR achieved, subject to the$15.0 million cap described above.

 

(b)    In the event LaJobi, prior to theMeasurement Date, relocates the principal location of the Business beyond anagreed distance, the calculation and payment of the LaJobi EarnoutConsideration may be accelerated upon election of Seller. For purposes ofdetermining the LaJobi Earnout Consideration, the CAGR shall be based on theperiod from January 1, 2008 through the last day of the month (the “EarlyMeasurement Date”) immediately preceding the date of the relocation. In suchevent, any LaJobi Earnout Consideration payable will be discounted, at theAgreed Rate, from the scheduled payment date to, and including, the specifiedearly payment date.

 

Any LaJobi Earnout Consideration will be recorded asadditional goodwill when and if paid.

 

Under the Asset Agreement, LaJobi is entitled toindemnification from Seller and the Stockholders for various matters,including, but not limited to, breaches of representations, warranties orcovenants, and specified excluded obligations, subject, in the case ofspecified matters, to certain minimum thresholds and a maximum aggregateindemnification limit of $10.0 million. The right to indemnification(other than with respect to certain specified exceptions) terminates18 months after the Closing Date.

 

In accordance with the Asset Agreement, LaJobi enteredinto (i) a transitional services agreement with a Thailand affiliate ofSeller, and (ii) a three year employment agreement with Lawrence Bivona asPresident of LaJobi. Mr. Bivona was formerly the President of Seller.

 

In connection with the Asset Agreement, the Company paida finder’s fee to a financial institution in the amount of $1.5 million atthe closing of the transaction, and has agreed to pay to such financialinstitution 1% of the Agreed Enterprise Value of LaJobi, payable in the samemanner and at the same time as the LaJobi Earnout Consideration is paid toSeller.  Including the finder’s fee paidat closing, the Company incurred aggregate transaction expenses ofapproximately $2.0 million in connection with the LaJobi acquisition.

 

The purchase price has been allocated to thenet assets acquired based on information currently available with regard to thevalue of such assets.  The estimated fairvalues contained herein are preliminary in nature, and may not be indicative ofthe final purchase price allocation. Accordingly, the final determination of fair value could result in anincrease or decrease in amortization expense in future periods from the amountscurrently estimated.

 

The following table summarizes the preliminaryallocation of the purchase price based upon the fair values of the assetsacquired and liabilities assumed at the date of the acquisition of theBusiness. This initial purchase price allocation will be finalized during thefourth quarter ending December 31, 2008. The fair values are as follows:

 
| ** **                    | ** ** | **At April 2, 2008** | ** ** |
|-------------------------------|------------|-------------------------------------|------------|
| ** **                    | ** ** | **(in thousands)**             | ** ** |
| **Assets acquired:**          | ** ** | ** **                          | ** ** |
| Current assets                |       | $                                   | 14,556     |   |
| Property, plant and equipment |       | 243                                 |       |
| Other assets                  |       | 61                                  |       |
| Goodwill                      |       | 9,425                               |       |
| Customer relationships        |       | 12,700                              |       |
| Trademarks                    |       | 18,700                              |       |
| Royalty agreements            |       | 2,284                               |       |
| Backlog                       |       | 600                                 |       |
| Total assets acquired         |       | 58,569                              |       |
| Liabilities assumed:          |       |                                |       |
| Accounts payable              |       | 2,391                               |       |
| Accrued expenses              |       | 2,156                               |       |
| Other long term liabilities   |       | 1,978                               |       |
| Net assets acquired           |       | $                                   | 52,044     |   |

 

Goodwill of $9,425,000 was assigned to the Company’s infant and juvenilesegment for the Business. The aggregate amount of goodwill and intangibleassets expected to be deductible for tax purposes is estimated to be$43,709,000.

 

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**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

II.   CoCaLo

 

On April 1, 2008, a newly-formed, wholly-ownedDelaware subsidiary of the Company, I&J Holdco, Inc. (the “CoCaLoBuyer”), entered into a Stock Purchase Agreement (the “Stock Agreement”) witheach of Renee Pepys Lowe and Stanley Lowe (collectively, the “Sellers”), forthe purchase of all of the issued and outstanding capital stock of CoCaLo, Inc.,a California corporation (“CoCaLo”). The transactions contemplated by the StockAgreement were consummated as of April 2, 2008.

 

The acquisition of CoCaLo has enabled theCompany to expand its infant and juvenile segment and offer a more completerange of products for the baby nursery.

 

The aggregate base purchase price payable for CoCaLo wasequal to: (i) $16.0 million, minus (ii) the aggregate Debt ofCoCaLo outstanding at Closing (including accrued interest) of $4.0 million,minus (iii) specified transaction expenses ($0.3 million), plus (iv) aworking capital adjustment of $1.5 million paid by the CoCaLo Buyer. A portionof the purchase price ($1.6 million which was discounted to $1.4 millionfor financial statement purposes) was evidenced by a non-interest bearingpromissory note and will be paid as additional consideration in equal annualinstallments over a three year period from the Closing Date. The CoCaLo Buyerwill also pay the Additional Earnout Payments, if payable as described below.

 

The Additional Earnout Payments provide for a potentialpayment ranging from zero to a maximum of $4.0 million, payable withrespect to performance on three metrics – sales, gross profit and combined KidsLine and CoCaLo EBITDA – as follows:

 

(i)                                     $666,667 will be paidif CoCaLo’s aggregate net sales for the three years ending December 31,2010 (the “Measurement Period”) exceeds a specified target, and up to anadditional $666,667 will be paid, on a straight line sliding scale basis, tothe extent that CoCaLo’s net sales for the Measurement Period are between theinitial performance target and a specified maximum target.

 

(ii)                                  $666,667 will be paidif CoCaLo’s aggregate gross profit for the Measurement Period exceeds aspecified target, and up to an additional $666,667 will be paid, on astraight-line sliding scale basis, to the extent that CoCaLo’s aggregate grossprofit for the Measurement Period is between the initial performance target anda specified maximum target.

 

(iii)                               $666,666 will be paidif the aggregate EBITDA of Kids Line and CoCaLo for the Measurement Periodexceeds a specified target, and up to an additional $666,666 will be paid, on astraight-line sliding scale basis, to the extent that the aggregate EBITDA ofKids Line and CoCaLo is between the initial performance target and a specifiedmaximum target.

 

Any Additional Earnout Payments will be recorded asadditional goodwill when and if paid.

 

Kids Line has guaranteed all of the obligations of theCoCaLo Buyer under the Stock Agreement.

 

Under the Stock Agreement, the CoCaLo Buyer is entitledto indemnification from the Sellers for various matters, including, but notlimited to, breaches of representations, warranties or covenants, andliabilities with respect to specified proceedings and obligations, subject, inthe case of specified matters, to certain minimum thresholds and a maximumaggregate indemnification limit of $3.0 million. The right toindemnification (other than with respect to certain specified exceptions)terminates on the third anniversary of the Closing Date.

 

In accordance with the Stock Agreement, CoCaLo enteredinto a three year employment agreement with Renee Pepys Lowe as President andChief Executive Officer. Ms. Pepys Lowe was formerly the President andChief Executive Officer of CoCaLo.

 

The purchase price has been allocated to thenet assets acquired based on information currently available with regard to thevalue of such assets.  The estimated fairvalues contained herein are preliminary in nature, and may not be indicative ofthe final purchase price allocation. Accordingly, the final determination of fair value could result in anincrease or decrease in amortization expense in future periods from the amountscurrently estimated.

 

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**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

The following table summarizes the preliminary allocation of the purchaseprice based upon the fair values of the assets acquired and liabilities assumedat the date of the CoCaLo acquisition. This initial purchase price allocationwill be finalized during the fourth quarter ending December 31, 2008. Thefair values are as follows:

 
| ** **                    | ** ** | **At April 2, 2008** | ** ** |
|-------------------------------|------------|-------------------------------------|------------|
| ** **                    | ** ** | **(000’s)**                    | ** ** |
| Current assets                |       | $                                   | 9,272      |   |
| Property, plant and equipment |       | 164                                 |       |
| Customer relationships        |       | 2,700                               |       |
| Trademarks                    |       | 8,000                               |       |
| Backlog                       |       | 100                                 |       |
| Total assets acquired         |       | 20,236                              |       |
| Liabilities assumed           |       | 1,992                               |       |
| Net assets acquired           |       | $                                   | 18,244     |   |

 

The excess value received of $628,000 above the purchase price wasrecorded in other long term liabilities and will be recognized in theconsolidated financial statements upon the settlement of the contingentpurchase consideration as a reduction of goodwill or an extraordinary gain.

 

The intangibles were assigned to the Company’s infant and juvenilesegment for the purchase of CoCaLo. The aggregate amount of intangible assetsexpected to be deductible for tax purposes is estimated to be $10,800,000.

 

**Pro Forma Information**

 

The following unaudited pro forma consolidated results of operations ofthe Company for the three and nine months ended September 30, 2007 andnine months ended September 30, 2008 assumes the acquisition of CoCaLo andLaJobi occurred as of January 1 of each period (in thousands).

 
| ** **                   | ** ** | **Three Months  Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------|------------|------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                   | ** ** | **2007**                                             | ** ** | **2007**                                                | ** ** | **2008** | ** ** |
| Net sales                    |       | $                                                    | 122,426    |                                                    | $          | 300,613 |   | $ | 294,194 |   |
| Net income (loss)            |       | $                                                    | 14,796     |                                                    | $          | 17,584 |   | $ | (1,284 | ) |
| Net income (loss) per share: |       |                                                 |       |                                                    |       |   |   |
| Basic                        |       | $                                                    | 0.70       |                                                    | $          | 0.85 |   | $ | (0.06 | ) |
| Diluted                      |       | $                                                    | 0.69       |                                                    | $          | 0.84 |   | $ | (0.06 | ) |

 

The above amounts are based upon certain assumptions and estimates, anddo not reflect any benefits from combined operations. The pro forma resultshave not been audited and do not necessarily represent results which would haveoccurred if the acquisitions had taken place on the basis assumed above, andmay not be indicative of the results of future combined operations.

 

**NOTE 3 - SHAREHOLDERS’ EQUITY**

 

The costs resulting fromshare-based payment transactions are recognized in the financial statements attheir grant date fair value. The grant date fair value of options granted understock option plans (or otherwise) is estimated on the date of grant using aBlack-Scholes options pricing model using the assumptions below. Expectedvolatilities are calculated based on the historical volatility of the Company’sstock, management’s estimate of implied volatility of the Company’s stock andother factors.  The expected term ofoptions granted is derived from the vesting period of the award, as well ashistorical exercise behavior, and represents the period of time that optionsare expected to be outstanding. Management monitors stock option exercises andemployee termination patterns to estimate forfeiture rates within the valuationmodel. Separate groups of employees, directors and officers that have similarhistorical exercise behavior are considered separately for valuation purposes.The risk-free interest rate is based on the Treasury note interest rate ineffect on the date of grant for the expected term of the stock option.

 

***Stock Plans***

 

As of September 30,2008, the Company maintained the Russ Berrie and Company, Inc. EquityIncentive Plan (the “EI Plan”) and the Amended and Restated 2004 Employee StockPurchase Plan (the “2004 ESPP”).  As of September 30,2008 there were an aggregate of 1,477,769 shares of common stock reserved forissuance under the EI Plan and the 2004 ESPP. The Company also continues to have options outstanding (although nofurther grants can be made) under certain equity plans that it previouslymaintained, including without limitation the 2004 Stock Option, Restricted andNon-Restricted Stock Plan (the “2004 Option 

 

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**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

Plan”)(collectively, the “PredecessorPlans” and together with the EI Plan, the “Plans”).  In addition, the Company may issue stockoptions outside of the plans discussed above. As of September 30, 2008,there were 370,000 stock options outstanding that were granted outside theseplans.  The exercise price for equityawards issued under the Plans or otherwise is generally equal to the closingprice of the Company’s common stock as of the date the award is granted.Generally, equity awards under the Plans (or otherwise) vest over a periodranging from one to five years from the grant date as provided in the specificgrant. Options generally expire 10 years from the date of grant.

 

The Board of Directors (the “Board”) adopted theEI Plan on June 3, 2008, subject to approval by its shareholders, whichwas obtained at the 2008 Annual Meeting of Shareholders held on July 10,2008 (the “2008 Meeting”).  The 2004Option Plan was terminated as of the date of the 2008 Meeting, and no furtherawards under the 2004 Option Plan may be made thereafter.  The EI Plan provides for awards in any one ora combination of:  (a) StockOptions, (b) Stock Appreciation Rights, (c) Restricted Stock, (d) StockUnits, (e) Non-Restricted Stock, and/or (f) Dividend EquivalentRights.  Any award under the EI Plan may,as determined by the committee administering the EI Plan (the “Plan Committee”)in its sole discretion, constitute a “Performance-Based Award” (an award thatqualifies for the performance-based compensation exemption of Section 162(m) ofthe Internal Revenue Code of 1986, as amended). All awards granted under the EI Plan will be evidenced by a writtenagreement between the Company and each participant (which need not be identicalwith respect to each grant or participant) that will provide the terms andconditions, not inconsistent with the requirements of the EI Plan, associatedwith such awards, as determined by the Plan Committee in its solediscretion.  Award agreements must beexecuted by the Company and a participant in order for the award covered bysuch agreement to be effective.  A totalof 1,500,000 shares of Common Stock have been reserved for issuance under theEI Plan.  Options to purchase an aggregateof 105,000 shares of the Company’s Common Stock were granted to directors underthe EI Plan as of July 10, 2008.

 

The Board adopted the Russ Berrie and Company, Inc.2009 Employee Stock Purchase Plan (the “2009 ESPP”) on June 3, 2008,subject to approval by holders of a majority of the shares of Common Stockvoting at the 2008 Meeting.  The 2009ESPP, which is similar to the 2004 ESPP, will become effective on January 1,2009, immediately after the 2004 ESPP terminates by its terms on December 31,2008.  A total of 200,000 shares ofCommon Stock have been reserved for issuance under the 2009 ESPP.

 

***Stock Options***

 

The following table summarizesactivity regarding outstanding options as of September 30, 2008, andchanges during the nine months ended September 30, 2008:

 
| ** **                                         | ** ** | **Options** | ** ** | **Weighted  Average  Exercise Price  per Option** | ** ** | **Option Price per  Share** | ** **      | **Weighted  Average  Remaining  Contractual  Term (years)** | ** ** | **Aggregate  Intrinsic  Value $(000)** | ** ** |
|----------------------------------------------------|------------|-------------|------------|-------------------------------------------------------------|------------|---------------------------------------|-----------------|------------------------------------------------------------------|------------|---------------------------------------------|------------|
| Options outstanding at  December 31, 2007     |       | 1,775,417   |       | $                                                           | 18.20      |                                  | $11.19 - $34.80 |                                                             | 7.2        |                                        | $          | 1,400 |   |
| Granted                                            |       | 256,000     |       | $                                                           | 11.50      |                                  | $7.28 - $14.83  |                                                             | 4.5        |                                        | $          | — |   |
| Exercised                                          |       | —      |       | —                                                      |       | —                                |            |                                                             |       |                                        |       |
| Forfeited/cancelled                                |       | (29,638     | )          | $                                                           | 22.15      |                                  | $16.77 - $34.05 |                                                             |       |                                        |       |   |
| Options outstanding at  September 30, 2008    |       | 2,001,779   |       | $                                                           | 17.28      |                                  | $7.28 - $34.80  |                                                             | 6.2        |                                        | $          | — |   |
| Vested and exercisable at  September 30, 2008 |       | 1,165,679   |       | $                                                           | 18.99      |                                  | $11.19 - $34.80 |                                                             | 5.6        |                                        | $          | — |   |

 

During the three months ended March 31,2008, 100,000 options were granted to our Chief Executive Officer pursuant tothe terms of his employment agreement with the Company.  During the three months ended June 30,2008, 51,000 additional stock options and 7,900 shares of restricted stock weregranted to employees.  During the threemonths ended September 30, 2008, 105,000 stock options were granted todirectors under the Company’s new EI Plan, each at an exercise price of $7.28.During the three months ended September 30, 2007 there were 17,500 stockoptions and 4,475 shares of restricted stock granted under the 2004 OptionPlan. No options or shares of restricted stock were granted in either the firstor second quarters of 2007.

 

Share-based compensationexpense related to the Company’s stock options recorded in selling, general andadministrative expense for the three and nine months ended September 30,2008 was approximately $222,000 and $675,000, respectively. Share-basedcompensation expense related to the Company’s stock options, recorded inselling, general and administrative expense for the three and nine months endedSeptember 30, 2007, was approximately $15,000 and $26,000, respectively.Share-based compensation expense related to the Company’s outstandingrestricted stock, recorded in selling, general and administrative expense forthe three and nine months ended September 30, 2008, was approximately$185,000 and $548,000, respectively. Share-based compensation expense relatedto restricted stock for the three and nine months ended September 30, 2007was approximately $2,000.  No 

 

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**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

compensation cost related toequity grants was capitalized (in inventory or any other assets) as of September 30,2008 and 2007. For the three and nine months ended September 30, 2008 and2007, there were no excess tax benefits recognized as a result of share-basedcompensation exercises.

 

The assumptions used toestimate the fair value of the stock options granted during the nine monthsended September 30, 2008 has been estimated on the date of grant using theBlack-Scholes option-pricing model with the following weighted averageassumptions:

 
| ** **              | ** ** | **Nine Months Ended  September 30, 2008** | ** ** |
|-------------------------|------------|---------------------------------------------------------------|------------|
| Dividend Yield          |       | —                                                        |       |
| Risk-free Interest Rate |       | 3.06                                                          | %          |
| Volatility              |       | 40.51                                                         | %          |
| Expected Life (years)   |       | 5                                                             |       |

 

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

 

As of September 30, 2008, there wasapproximately $3.4 million of total unrecognized compensation cost relatedto 836,100 non-vested stock options. This cost is expected to be recognizedover a weighted-average period of 3.9 years.

 

A summary of the Company’s non-vested stock options at September 30, 2008 and changesduring the nine months ended September 30,2008 are presented below:

 
| **Non-vested stock options** | ** ** | **Shares** | ** ** | **Weighted Average  Grant Date Fair  Value Per Share** | ** ** |
|----------------------------------------|------------|------------|------------|---------------------------------------------------------------------------------|------------|
| Non-vested at December 31,  2007  |       | 618,600    |       | $                                                                               | 16.41      |   |
| Granted                                |       | 256,000    |       | $                                                                               | 11.50      |   |
| Vested                                 |       | (23,500    | )          | $                                                                               | 15.88      |   |
| Forfeited                              |       | (15,000    | )          | $                                                                               | 16.77      |   |
| Non-vested at  September 30, 2008 |       | 836,100    |       | $                                                                               | 14.91      |   |

 

During the year ended December 31, 2007, there were 170,675 sharesof restricted stock issued under the 2004 Option Plan, 169,800 of which remainnon-vested These restricted stock grants have vesting periods ranging fromthree to five years, with fair values at date of grant ranging from $13.65 to$16.77 per share. Compensation expense is determined for the issuance ofrestricted stock by amortizing over the requisite service period, or thevesting period, the aggregate fair value of the restricted stock awarded basedon the closing price of the Company’s Common Stock on the date the award ismade. There were 7,900 shares of restricted stock granted during the secondquarter of 2008.

 

A summary of the Company’s non-vested restricted stock grants at September 30,2008 and changes during the nine months ended September 30, 2008 arepresented below:

 
| **Non-vested  restricted stock grants** | ** ** | **Shares** | ** ** | **Weighted Average  Grant Date Fair  Value Per Share** | ** ** |
|---------------------------------------------------|------------|------------|------------|---------------------------------------------------------------------------------|------------|
| Restricted at December 31,  2007             |       | 170,675    |       | $                                                                               | 16.31      |   |
| Granted                                           |       | 7,900      |       | $                                                                               | 13.65      |   |
| Vested                                            |       | (875       | )          | $                                                                               | 14.90      |   |
| Forfeited                                         |       | —     |       | $                                                                               | —     |   |
| Restricted at  September 30, 2008            |       | 177,700    |       | $                                                                               | 16.20      |   |

 

As of September 30, 2008, the totalremaining unrecognized compensation cost related to outstanding shares ofrestricted stock was approximately $2.2 million, and is expected to berecognized over a weighted-average period of 3.1 years.

 

***Employee Stock Purchase Plan***

 

Under the 2004 ESPP, eligible employees are provided theopportunity to purchase the Company’s common stock at a discount.  Pursuant to this plan, options are granted toparticipants as of the first trading day of each plan year, which is thecalendar year, and may be exercised as of the last trading day of each planyear, to purchase from the Company the number of shares of common stock thatmay be purchased at the relevant purchase price with the aggregate amountcontributed by each participant.  In 

 

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**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

each plan year, an eligible employee may elect toparticipate in the plan by filing a payroll deduction authorization form for upto 10% (in whole percentages) of his or her compensation.  No employee shall have the right to purchasethe Company’s common stock under the 2004 ESPP which has a fair value in excessof $25,000 in any plan year.  Thepurchase price is the lesser of 85% of the closing market price of the Company’scommon stock on either the first trading day or the last trading day of theplan year.  If an employee does not electto exercise his or her option, the total amount credited to his or her accountduring that plan year is returned to such employee, and his or her optionexpires.  As of September 30, 2008,the 2004 ESPP had approximately 80,269 shares reserved for future issuance.

 

Total share-based compensation expense related to the2004 ESPP was approximately $45,000 and $134,000 for the three and nine monthsended September 30, 2008, respectively. Total share-based compensationexpense related to the 2004 ESPP was approximately $38,000 and $113,000 for thethree months and nine months ended September 30, 2007, respectively.

 

The fair value of each option granted under the 2004ESPP is estimated on the date of grant using the Black-Scholes option-pricingmodel with the following assumptions:

 
| ** **              | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|
| ** **              | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| Dividend yield          |       | —                                              |       | — |   |
| Risk-free interest rate |       | 3.17                                                | %          | 4.98 | % |
| Volatility              |       | 34.40                                               | %          | 36.70 | % |
| Expected life (years)   |       | 1                                                   |       | 1 |   |

 

Expected volatilities are calculated based on thehistorical volatility of the Company’s stock; management’s estimate of impliedvolatility of the Company’s stock and other factors. The risk-free interestrate is based on the U.S. Treasury yield with a term that is consistent withthe expected life of the options. The expected life of options under the 2004ESPP is one year, or the equivalent of the annual plan year.

 

**NOTE 4 - WEIGHTED AVERAGE COMMON SHARES**

 

The weighted average common shares outstanding included in thecomputation of basic and diluted net income/loss per share is set forth below(in thousands):

 
| ** **                                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Weighted average common shares  outstanding                               |       | 21,300                                               |       | 21,157                                              |       | 21,300 |   | 21,105 |   |
| Dilutive effect of common  shares issuable upon exercise of stock options |       | 10                                                   |       | 161                                                 |       | — |   | 152 |   |
| Weighted average common shares  outstanding assuming dilution             |       | 21,310                                               |       | 21,318                                              |       | 21,300 |   | 21,257 |   |

 

The computation of diluted net income (loss) per common share for thethree and nine months ended September 30, 2008 did not include options topurchase approximately 2.0 million shares of common stock because the exerciseprices were greater than the average market price of the common stock duringsuch period. The computation of diluted net income (loss) per common share forthe nine months ended September 30, 2008 did not include options to purchaseapproximately 38,000 shares of common stock because there was a net loss forsuch period and inclusion of such shares would be anti-dilutive.

 

For the three and nine months ended September 30, 2007,approximately 0.8 million stock options were excluded from the computation ofdiluted earnings per share because the exercise prices were greater than theaverage market price of the common stock during such period.

 

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**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

** **

**NOTE 5 – DEBT**

 

Consolidated long-term debt at September 30,2008 and December 31, 2007 consisted of the following (in thousands):

 
| ** **                               | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                                     |       |                         |       |                        |       |
| Term Loan (Infantline Credit  Agreement) |       | $                            | 92,800     |                        | $          | 43,500 |   |
| Note Payable(CoCaLo purchase)            |       | 1,478                        |       | —                      |       |
| Total                                    |       | 94,278                       |       | 43,500                      |       |
| Less current portion                     |       | 14,933                       |       | 11,500                      |       |
| Long-term debt                           |       | $                            | 79,345     |                        | $          | 32,000 |   |

 

At September 30, 2008, there wasapproximately $23.1 million borrowed under the New Revolving Loan, andapproximately $6.4 million borrowed under the Giftline Revolver (each asdefined below), all of which is classified as short-term debt.  At December 31, 2007, there wasapproximately $15.5 million borrowed under the Original Revolving Loan (asdefined below) and approximately $7.8 million borrowed under the GiftlineRevolver, all of which is classified as short-term debt.

 

*A. The Infantline Credit Agreement*

 

On March 14, 2006 (the “Closing Date”), Kids Line,LLC (“KL”) and Sassy, Inc. (“Sassy”) entered into a credit agreement asborrowers, on a joint and several basis, with LaSalle Bank National Associationas administrative agent and arranger (the “Agent”), the lenders from time totime party thereto, Russ Berrie and Company, Inc. (“RB”) as loan partyrepresentative, Sovereign Bank as syndication agent, and Bank of America, N.A.as documentation agent (as amended on December 22, 2006, the “InfantlineCredit Agreement”). The original commitments under the Infantline CreditAgreement consisted of (a) a $35.0 million revolving credit facility (the “OriginalRevolving Loan”), with a subfacility for letters of credit in an amount not toexceed $5.0 million, and (b) a term loan facility in the original amountof $60 million (the “Original Term Loan”).

 

As of December 22, 2006, the Infantline CreditAgreement was amended (the “First Amendment”) to permit the repayment andsubsequent reborrowing of up to $20 million under the Original Term Loan, whichwas intended to enable KL and Sassy to continue to utilize cash flows expectedto be generated from operations to repay debt until the earnout considerationfor the purchase of Kids Line, LLC (the “KL Earnout Consideration”) becamedue.  Pursuant to the First Amendment, KLand Sassy borrowed $20 million under the Original Revolving Loan, theoutstanding balance of which had previously been reduced to zero, and utilizedthe proceeds of such draw to prepay $20 million of the Original Term Loan. Thelenders then provided an additional term loan reborrowing commitment (the “TRCommitment”) of an aggregate maximum principal amount of $20 million, whichamounts could only be reborrowed during specified periods and only to fund thepayment of the KL Earnout Consideration. Pursuant to the First Amendment, KL and Sassy paid a non-use fee inrespect of undrawn amounts of the TR Commitment at a per annum rate of 0.375%of the daily average of the undrawn amounts. In December 2007, KL and Sassy paid $28.5 million of the KL EarnoutConsideration, which amount was financed by drawing the TR Commitment of $20million and drawing an additional $8.5 million on the Original Revolving Loan.The remaining portion of the KL Earnout Consideration ($3.6 million) was paidby KL and Sassy in January of 2008, also through a draw on the OriginalRevolving Loan.

 

As of April 2, 2008, RB, KL, Sassy, the CoCaLoBuyer, LaJobi and CoCaLo (via a Joinder Agreement) entered into an Amended andRestated Credit Agreement (the “Amendment”) with certain financial institutionsparty to the Infantline Credit Agreement or their assignees (the “Lenders”),LaSalle Bank National Association, as Agent and Fronting Bank, Sovereign Bankas Syndication Agent, Wachovia Bank, N.A. as Documentation Agent and Banc ofAmerica Securities LLC as Lead Arranger. KL, Sassy, the CoCaLo Buyer, LaJobi and CoCaLo are referred to hereincollectively as the “Infantline Borrowers”, and the CoCaLo Buyer, LaJobi andCoCaLo are referred to herein as the “New Borrowers”.  The Amendment amends and restates theInfantline Credit Agreement, and adds the New Borrowers as partiesthereto.  The Pledge Agreement dated as ofMarch 14, 2006 between RB and the Agent (as amended on December 22,2006) was also amended and restated as of April 2, 2008, to provide, amongother things, for a pledge of the capital stock of the CoCaLo Buyer by RB.  In connection with the Amendment, 100% of theequity of each Infantline Borrower, including each New Borrower, has beenpledged as collateral to the Agent.  Inaddition, the Guaranty and Collateral Agreement (as defined in the Amendment)was also amended and restated as of April 2, 2008, to add the NewBorrowers as parties and to include substantially all of the existing andfuture assets and properties of the New Borrowers as security for thesatisfaction of the obligations of all Infantline Borrowers, including the NewBorrowers, under the Amendment and the other related loan documents.

 

The commitments under the Amendment consist of (a) a$75.0 million revolving credit facility (the “New Revolving Loan”), with asubfacility for letters of credit in an amount not to exceed $5.0 million, and (b) a$100.0 million term loan facility (the “New Term Loan”). The InfantlineBorrowers drew down $31.0 million under the New Revolving Loan and the entire$100 million available under the New Term Loan on the Closing Date, in order tofinance the acquisitions of LaJobi and CoCaLo, and pay related 

 

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**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

transaction expenses of such acquisitions and theAmendment, and to reallocate the existing indebtedness among the banksyndicate.  The scheduled maturity datehas been extended from March 14, 2011 to April 1, 2013 (subject tocustomary early termination provisions). The principal of the Original Term Loan was to be repaid on a monthlybasis as follows: $9.0 million for each of years 1-2; $12.0 million for year 3;and $15.0 million for each of years 4-5. Pursuant to the Amendment, the principal of the New Term Loan will berepaid, on a quarterly basis, at an annual rate of $14.4 million per year,commencing June 30, 2008 thru June 30, 2012 with $31.6 million due onApril 1, 2013.

 

The Infantline Loans bear interest at a rate per annumequal to the Base Rate (for Base Rate Loans) or the LIBOR Rate (for LIBORLoans) at the option of the Infantline Borrowers, plus an applicable margin, inaccordance with a pricing grid based on the most recent quarter-end Total Debtto EBITDA Ratio, which applicable margin, prior to the execution of theAmendment, ranged from 1.75% - 2.50% for LIBOR Loans and from 0.25% - 1.00% forBase Rate Loans.  Pursuant to theAmendment, the margins now range from 2.0% - 3.0% for LIBOR Loans and from0.50% - 1.50% for Base Rate Loans.

 

The applicable interest rate margins as of September 30,2008 were: 2.75% for LIBOR Loans and 1.25% for Base Rate Loans. The weightedaverage interest rates for the outstanding loans as of September 30, 2008were as follows:

 
| ** **           | ** ** | **At September 30, 2008** | ** ** |
|----------------------|------------|------------------------------------------|------------|
| ** **           | ** ** | **LIBOR Loans**                     | ** ** | **Base Rate Loans** | ** ** |
| Infantline Revolver  |       | 5.22                                     | %          | 6.25 | % |
| Infantline Term Loan |       | 5.22                                     | %          | 6.25 | % |

 

Inconnection with the Amendment, the Infantline Borrowers paid the Agent andLenders a closing fee of approximately $1.5 million, and the Company incurred$0.7 million of other third party costs. Of the aggregate fees and costs, $0.4 million was expensed to interestexpense in the three months ended June 30, 2008 and the remainder wastreated as deferred financing costs and will be recognized over the term of therespective types of indebtedness using the effective interest method.   In connection with the Amendment, theCompany also wrote-off during the second quarter of 2008 $0.3 million ofunamortized deferred financing costs.

 

Inaddition, pursuant to the Amendment, the following fees are nowapplicable:  an agency fee of $35,000 perannum, an annual non-use fee (payable monthly, in arrears, and upon terminationof the relevant obligations) of 0.40% to 0.60% of the unused amounts under theRevolving Loan, an annual letter of credit fee (payable monthly, in arrears,and upon termination of the relevant obligations) for undrawn amounts withrespect to each letter of credit based on the most recent quarter-end Total Debtto EBITDA Ratio ranging from 2.75% - 3.25% and other customary letter of creditadministration fees.  On August 13,2008, the Amendment was further amended (the “August Modification”) toclarify the definition of EBITDA as applied to, among other things, the TotalDebt to EBITDA Ratio for the last three quarters of 2008.

 

The Infantline Borrowers are required to makeprepayments of the New Term Loan upon the occurrence of certain transactions,including most asset sales or debt or equity issuances, and pursuant to theAmendment, extraordinary receipts. Commencing in early 2008 with respect tofiscal year 2007, annual mandatory prepayments of the Original Term Loan wouldhave been required in an amount equal to 50% of Excess Cash Flow for eachfiscal year unless the Total Debt to EBITDA Ratio for such fiscal year wasequal to or less than 2.00:1.00. For fiscal year 2007, no Excess Cash Flowpayment was required, and pursuant to the Amendment, this requirement has beeneliminated in its entirety.

 

TheAmendment contains customary affirmative and negative covenants.  as well as the following financial covenants:(i) a minimum Fixed Charge Coverage Ratio, (ii) a maximum Total Debtto EBITDA Ratio and (iii) an annual capital expenditure limitation.  Upon the occurrence of an event of defaultunder the Amendment, including a failure to remain in compliance with allapplicable financial covenants, the lenders could elect to declare all amountsoutstanding under the Amendment to be immediately due and payable.  The Infantline Borrowers were in compliancewith all applicable financial covenants in the Amendment as of September 30,2008.

 

TheAmendment contains significant limitations on the ability of the InfantlineBorrowers to distribute cash to RB, which became a corporate holding company byvirtue of the Assignment, for the purpose of paying dividends to theshareholders of the Company or for the purpose of paying their allocableportion of RB’s corporate overhead expenses. Prior to the effectiveness of the Amendment, KL and Sassy were notpermitted (except in specified situations) to distribute cash to RB to pay RB’soverhead expenses unless: (i) before and after giving effect to suchdistribution, no event of default would exist and (ii) before and aftergiving effect to such distribution, Excess Revolving Loan Availability willequal or exceed $4.0 million; provided that the aggregate amount of suchdistributions could not exceed $2.0 million per year.  Pursuant to the Amendment, the $4.0 millionavailability threshold was increased to $5.0 million, and the aggregate maximumamount of such distributions was increased to $3.5 million, and apply in eachcase to all Infantline Borrowers.  Otherrestrictions on dividends and distributions to RB remain unchanged by theAmendment.

 

The Amendment also effected the following additionalchanges, among others, to the Infantline Credit Agreement:

 

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**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIALSTATEMENTS**

 

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

 

(ii)           Payment of the amountsoutstanding under the promissory note under the Stock Agreement is prohibitedif before and after giving effect to any such repayment, a default or event ofdefault would exist;

 

(iii)          Payment of the LaJobiEarnout Consideration or the CoCaLo Additional Earnout Payments is prohibitedif before and after giving effect to any such repayment, (a) a default orevent of default would exist, (b) Excess Revolving Loan Availability willnot equal or exceed $9.0 million, or (c) before and after giving effect toany such repayment, the Infantline Financial Covenants will not be satisfied(the “Earnout Conditions”);

 

(iv)          Specified defaults withrespect to the LaJobi Earnout Consideration and/or the CoCaLo AdditionalEarnout Payments have been added as events of default (including failure todeliver to the Agent specified certifications and calculations within aspecified time period, the reasonable determination by the Agent that anyEarnout Conditions will not be satisfied as of the applicable payment date, ifany material information provided to the Agent with respect to the EarnoutConditions shall be incorrect in any material respect and remain unremediedprior to the relevant payment date, or any LaJobi Earnout Consideration orAdditional Earnout Payments are paid at any time that the Earnout Conditionsare not satisfied); and

 

(v)           The InfantlineBorrowers are required to maintain in effect Hedge Agreements that protectagainst potential fluctuations in interest rates with respect to a minimum of50% of the outstanding amount of the New Term Loan.

 

The Revolving Loan availability at September 30,2008 was $27.2 million.

 

Pursuant to the requirement to maintain Hedge Agreements discussedabove, on May 2, 2008, the Infantline Borrowers entered into an interestrate swap agreement with a notional amount of $70 million as a risk managementtool to lock the interest cash outflows on the floating rate debt.  However, because the Company did not meet thecriteria for hedge accounting under SFAS No. 133 for this instrument,changes in the fair value of the interest rate swap will be remeasured throughoperations each period.  Changes betweenits cost and its fair value as of September 30, 2008 resulted in anexpense of approximately $125,000 for the three months ended September 30,2008, resulting in a net $33,000 of income for the nine months ended September 30,2008, and such amounts are included in interest expense in the respectiveconsolidated statements of operations.

 

*B. The Giftline Credit Agreement*

 

On March 14, 2006, as amended on April 11,2006, August 8, 2006, December 28, 2006 and August 7, 2007, RussBerrie U.S. Gift Inc. (“U.S. Gift”) and other specified wholly-owned domesticsubsidiaries of RB (collectively, the “Giftline Borrowers”), entered into acredit agreement as borrowers, on a joint and several basis, with LaSalle BankNational Association, as issuing bank (the “Issuing Bank”), LaSalle BusinessCredit, LLC as administrative agent (the “Administrative Agent”), thelenders from time to time party thereto, and the Company, as loan partyrepresentative (as amended, the “Giftline Credit Agreement”). Unless otherwisespecified herein, capitalized terms used but undefined in this Note 5, Section Bshall have the meanings ascribed to them in the Giftline Credit Agreement.

 

Prior to the August 8, 2007 amendment to theGiftline Credit Agreement (the “Fourth Amendment”), the Giftline CreditAgreement consisted of a maximum revolving credit loan commitment (the “GiftlineRevolver”) in an amount equal to the lesser of (i) $15.0 million(with a maximum availability of $13.5 million) and (ii) thethen-current Borrowing Base, in each case minus amounts outstanding under theCanadian Credit Agreement (as defined below), with a sub-facility for lettersof credit to be issued by the Issuing Bank in an amount not to exceed$8.0 million. The Fourth Amendment increased the aggregate totalCommitment under the Giftline Credit Agreement from $15.0 million to$25.0 million, and amended the definition of Revolving Loan Availabilityso that it now equals the difference between (a) the lesser of (x) theMaximum Revolving Commitment in effect at such time and (y) the BorrowingBase at such time, minus (b) the sum of the aggregate principal amount ofall “Loans”, “Specified Hedging Obligations” and the “Stated Amount” of all “Lettersof Credit” outstanding or requested but not yet funded under the Canadian LoanAgreement. The Borrowing Base is primarily a function of a percentage ofeligible accounts receivable and eligible inventory. As of September 30,2008, the outstanding balance on the Giftline Revolver was $6.4 million,there was no outstanding balance on the Canadian Revolving Loan (see Section Cbelow), and there was $1.1 million utilized under the Canadiansub-facility for letters of credit. At September 30, 2008, based onavailable collateral, the unused amount available to be borrowed under theGiftline Revolver was $2.7 million.

 

All outstanding amounts under the GiftlineRevolver are due and payable on March 14, 2011, subject to earliertermination in accordance with the terms of the Giftline Credit Agreement.

 

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**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

The Giftline Revolver bears interest at a rateper annum equal to the sum of the Base Rate (for Base Rate Loans) or the LIBORRate (for LIBOR Loans), at the Company’s option plus an applicable margin,which margin was originally 2.75% for LIBOR Loans and 1.25% for Base RateLoans. However, pursuant to the December 28, 2006 amendment to theGiftline Credit Agreement (the “Third Amendment”), the interest ratesapplicable to the Giftline Revolver were reduced such that the applicablemargin is now determined in accordance with a pricing grid based on the mostrecent quarter-end Daily Average Excess Revolving Loan Availability, whichapplicable margins range from 2.00% - 2.75% for LIBOR Loans and from0% - 0.50% for Base Rate Loans. Interest is due and payable in the samemanner as with respect to the Infantline Loans. The applicable interest ratemargins as of September 30, 2008 were 2.25% for LIBOR Loans and 0.25% forBase Rate Loans. As of September 30, 2008, the interest rate was 5.25% forthe one outstanding Base Rate loan ($0.4 million) and 5.44% for oneoutstanding LIBOR loan ($6.0 million).

 

In connection with the execution of the GiftlineCredit Agreement, the Infantline Borrowers paid (on behalf of the GiftlineBorrowers) aggregate closing fees of $0.15 million and an aggregate agencyfee of $20,000. Aggregate agency fees of $20,000 will be payable by theGiftline Borrowers on each anniversary of the Closing Date. Pursuant to theThird Amendment, the Giftline Revolver is subject to an annual non-use fee(payable monthly, in arrears, and upon termination of the relevant obligations),ranging from 0.375% to 0.50% for unused amounts under the Giftline Revolver,and an annual letter of credit fee ranging from 2.00% to 2.75%. Other fees areas described in the Giftline Credit Agreement.

 

Receivable and disbursement bank accounts of theGiftline Borrowers are required to be with the Administrative Agent or itsaffiliates, and cash in such accounts is swept on a daily basis to pay downoutstanding amounts under the Giftline Revolver.

 

The Giftline Credit Agreement contains customaryaffirmative and negative covenants substantially similar to those applicable tothe Amendment. The Giftline Credit Agreement originally contained the followingfinancial covenants: (i) a minimum EBITDA test, (ii) a minimum ExcessRevolving Loan Availability requirement of $5.0 million, (iii) anannual capital expenditure limitation and (iv) a minimum Fixed ChargeCoverage Ratio (for quarters commencing with the quarter ended June 30,2008). On August 8, 2006, the Giftline Credit Agreement was amended tolower the threshold on the Minimum EBITDA covenant by $1.0 million perquarter for each of four consecutive quarters commencing with the quarterending September 30, 2006. The Third Amendment (i) eliminated intheir entirety both the minimum EBITDA financial covenant and the Fixed ChargeCoverage Ratio financial covenant and (ii) reduced the minimum ExcessRevolving Loan Availability requirement from $5.0 million to$3.5 million. The Fourth Amendment eliminated the existing ExcessRevolving Loan Availability requirement, and re-instituted a Fixed ChargeCoverage Ratio covenant based on the last day of any month for the applicableComputation Period (as defined in the Fourth Amendment) ending on such date.The Fixed Charge Coverage Ratio now specifies that the Fixed Charge CoverageRatio, as determined for the Computation Period ending on the last day of anymonth, may not be less than 1.1:1.0. This covenant is only applicable, however,if during the three month period then ending on such date of determination (the“Test Period”) Revolving Loan Availability (defined above) was less than$3.5 million for any three (3) consecutive business day period (the “TestCondition”). If compliance is required because the Test Condition was not met,the Giftline Borrowers will be required to deliver a specified compliancecertificate to the Administrative Agent. In addition, the Giftline Borrowersmust comply with the Fixed Charge Coverage Ratio covenant for a period of threeconsecutive months after they fail to satisfy the Test Condition. The Company’savailability was not less than $3.5 million during the quarter ended September 30,2008 and the Fixed Charge Coverage Ratio was not applicable during the quarter.As of September 30, 2008, the Company was in compliance with the applicablefinancial covenants contained in the Giftline Credit Agreement.

 

In addition to the changes discussed above, theFourth Amendment permits, subject to specified conditions, the mergers ofspecified inactive subsidiaries of RB with and into RB (including certainGiftline Borrowers), and increases the amount of in-transit inventory which maybe deemed “Eligible Inventory” under specified circumstances from$3.0 million to $8.0 million.

 

The Giftline Credit Agreement containssignificant limitations on the ability of the Giftline Borrowers to distributecash to RB for the purpose of paying dividends to the shareholders of theCompany or for the purpose of paying RB’s corporate overhead expenses,including a cap (subject to certain exceptions) on the amount that can beprovided to RB to reimburse for its allocable portion of corporate overheadexpenses equal to $5.0 million for each fiscal year commencing in 2008.The Third Amendment permits the Giftline Borrowers to pay dividends or makedistributions to RB if no default or event of default exists or would resulttherefrom and immediately after giving effect to such payments, there is atleast $1.5 million available to be drawn under the Giftline Revolver. Theamount of any such payments to RB cannot exceed the amount of capitalcontributions made by RB to the Giftline Borrowers after December 28,2006, which are used by the Giftline Borrowers to pay down the GiftlineRevolver minus the total amount of dividends or other distributions made by theGiftline Borrowers to RB under this provision of the Giftline Credit Agreement.

 

In order to secure the obligations of theGiftline Borrowers, the Giftline Borrowers pledged and have granted securityinterests to the Administrative Agent in substantially all of their existingand future personal property, and each Giftline Borrower guaranteed theperformance of the other Giftline Borrowers under the Giftline CreditAgreement. In addition, RB provided a limited recourse guaranty of theobligations of the Giftline Borrowers under the Giftline Credit Agreement. Thisguarantee is secured by a lien

 

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**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

on the assets intended to be assigned to U.S. Giftpursuant to the Assignment. RB also pledged 100% of the equity interests ofeach of the Giftline Borrowers and 65% of its equity interests in certain ofits First Tier Foreign Subsidiaries to the Administrative Agent (the “GiftlinePledge Agreement”). The Giftline Pledge Agreement contains substantiallysimilar limitations on the activities of RB as is set forth in the InfantlinePledge Agreement.

 

*C. Canadian Credit Agreement*

 

As contemplated by the 2005 Credit Agreement, on June 28,2005, the Company’s Canadian subsidiary, Amram’s Distributing Ltd. (“Amrams”),executed a separate Credit Agreement (acknowledged by RB) with the financialinstitutions party thereto and LaSalle Business Credit, a division of ABN AMROBank, N.V., Canada Branch, a Canadian branch of a Netherlands bank, asissuing bank and administrative agent (the “Canadian Credit Agreement”), andrelated loan documents with respect to a maximum U.S. $10.0 millionrevolving loan (the “Canadian Revolving Loan”). RB executed an unsecuredGuarantee (the “Canadian Guarantee”) to guarantee the obligations of Amramsunder the Canadian Credit Agreement. In connection with the LaSalle Refinancing,on March 14, 2006, the Canadian Credit Agreement was amended to (i) replacereferences to the 2005 Credit Agreement with the Giftline Credit Agreement(such that, among other conforming changes, a default under the Giftline CreditAgreement will be a default under the Canadian Credit Agreement), (ii) releaseRB from the Canadian Guaranty and (iii) provide for a maximum U.S.$5.0 million revolving loan. In connection with the release of the Companyfrom the Canadian Guaranty, U.S. Gift executed an unsecured Guarantee toguarantee the obligations of Amrams under the Canadian Credit Agreement. Adefault under the Amendment will not constitute a default under the CanadianCredit Agreement. There were no borrowings under the Canadian Revolving Loan asof September 30, 2008 and December 31, 2007.

 

The Commitments under the Canadian CreditAgreement bear interest at a rate per annum equal to the sum of the Base Rate(for Base Rate Loans) or the LIBOR Rate (for LIBOR Loans) plus an applicablemargin. As of September 30, 2008 and December 31, 2007, there was noBase Rate or Libor Loans outstanding under the Canadian Credit Agreement.

 

*D. Russ Berrie (UK) LimitedBusiness Overdraft Facility*

 

On March 19, 2007, Russ Berrie UK Limitedentered into a Business Overdraft Facility (the “Facility”) with NationalWestminster Bank PLC (the “Bank”) and The Royal Bank of Scotland plc(“RBS”), acting as agent for the Bank. The Facility, as amended, consists of amaximum credit line of £1.5 million. Interest is charged on amountsoutstanding under the Facility at an annual rate of 1.5% over the Bank’s BaseRate, which interest rate spread will be increased to 3.5% for any amountsoutstanding in excess of the maximum limit. The Facility is secured by a lienon substantially all of the assets of Russ Berrie UK Limited. The Facility wasestablished to assist in meeting the working capital requirements of RussBerrie UK Limited. As of September 30, 2008 and December 31, 2007,there were no borrowings outstanding under the Facility.

 

**NOTE 6 – GOODWILL AND INTANGIBLEASSETS**

 

As of September 30, 2008, all of the Company’sgoodwill (approximately $130.2 million) was recorded in the infant and juvenilesegment and results from the acquisitions of: LaJobi Inc. in April 2008;Kids Line, LLC in 2004; and Sassy in 2002. As a result of the acquisition ofLaJobi, the carrying amount of goodwill increased by $9.4 million during thenine months ended September 30, 2008.

 

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

 
| ** **                        | ** ** | **Weighted  Average  Amortization  Period** | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------------------------|------------|---------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Sassy trade name                  |       | Indefinite life                             |       | $                            | 7,100      |                        | $          | 7,100 |   |
| Applause trade name               |       | Indefinite life                             |       | 7,646                        |       | 7,646                       |       |
| Kids Line customer  relationships |       | Indefinite life                             |       | 31,100                       |       | 31,100                      |       |
| Kids Line trade name              |       | Indefinite life                             |       | 5,300                        |       | 5,300                       |       |
| LaJobi trade name                 |       | Indefinite life                             |       | 18,700                       |       | —                      |       |
| LaJobi customer relationships     |       | 20 years                                    |       | 12,382                       |       | —                      |       |
| LaJobi royalty agreements         |       | 4.2 years                                   |       | 1,864                        |       | —                      |       |
| CoCaLo trade name                 |       | Indefinite life                             |       | 8,000                        |       | —                      |       |
| CoCaLo customer relationships     |       | 20 years                                    |       | 2,632                        |       | —                      |       |
| Other intangible assets           |       | 0.83 years                                  |       | 274                          |       | 26                          |       |
|                              |       |                                        |       | $                            | 94,998     |                        | $          | 51,172 |   |

 

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**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

Other intangible assets as of September 30,2008 and December 31, 2007 include Kids Line non-compete agreements, whichare being amortized over four years, a patent and, for the three and ninemonths ended September 30, 2008, backlog for LaJobi and CoCaLo which arebeing amortized over nine months. Amortization expense of $159,000 and $318,000 was recorded in the threeand nine months ended September 30, 2008, respectively, for the customerrelationships of LaJobi, based upon a preliminary valuation. Amortizationexpense of $34,000 and $68,000 was recorded in the three and nine months ended September 30,2008, respectively, for the customer relationships of CoCaLo, based upon apreliminary valuation. Upon finalization of such valuation, any adjustment tothe amortization expense will be adjusted in subsequent periods. Aggregateamortization expense, which includes LaJobi and CoCaLo for the second and thirdquarters of 2008, was approximately $644,000 and $1,287,000 for the three andnine months ended September 30, 2008, respectively. Amortization expensewas approximately $406,000 and $424,000 for the three and nine months ended September 30,2007, respectively.

 

Under SFAS No. 142,Goodwill and Other Intangible Assets, goodwill and other indefinite-livedintangible assets are no longer amortized but are reviewed for impairment atleast annually, and more frequently if a triggering event occurs indicatingthat an impairment may exist.  TheCompany’s annual impairment testing is performed as of December 31 of eachyear.

 

**NOTE 7 – IMPAIRMENTS**

 

During the third quarter offiscal 2007, due to the adverse impact of foreign exchange rates on the MAMBabyartikel GmbH distribution agreement, the Company performed an analysis ofthe value of certain of its intangible assets. In connection with this analysis and the preparation of the Company’sfinancial statements for the three and nine months ended September 30,2007, the Company concluded that an impairment charge was required undergenerally accepted accounting principles relating to the value of adistribution agreement between Sassy and MAM Babyartikel GmbH. Based upon thefair values derived using a discounted cash flows analysis, an impairmentcharge of $3.6 million was reflected in the Company’s consolidatedstatements of operations for the three and nine months ended September 30,2007, which was recorded in cost of goods sold in the Company’s infant andjuvenile segment.  Based upon a valuationanalysis prepared during the third quarter of 2007, the Company had determinedthat the MAM Agreement is a finite-lived asset and, as such, was to beamortized over an 8.5 year life.

 

Inconnection with the preparation of the Company’s financial statements for thesecond quarter of 2008, stemming from deteriorating macro-economic factors anddeclining revenues in the gift segment during the first half of 2008, as wellas current and projected shortfalls of cash flows from the gift segment, theCompany conducted an impairment test of the gift segment, in accordance withSFAS No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets*.  As a result of this review, the Companydetermined that the fixed assets in the gift segment were impaired and,accordingly, the Company recorded an aggregate impairment charge ofapproximately $7.0 million in the second quarter of 2008.   Also during the second quarter of 2008, theCompany recorded a non-cash charge of $1.0 million related to the write-off ofShining Stars website development expenses, resulting from the Company’sagreement with the licensor to return to the licensor the operationalresponsibility of the website in exchange for reduced future royalties and theelimination of future web-site responsibility.

 

**NOTE 8 – SEGMENTS OF THE COMPANY ANDRELATED INFORMATION**

 

The Company operates intwo segments: (i) the infant and juvenile segment, which as of September 30,2008 is comprised of Kids Line, Sassy, LaJobi and CoCaLo and (ii) theCompany’s gift segment.  Thissegmentation of the Company’s operations reflects how the Company’s chiefoperating decision makers currently view the results of operations.  There are no inter-segment revenues toeliminate.  Corporate assets and overheadexpenses are included in the gift segment. See Note 2 for a description of therecent acquisitions of LaJobi and CoCaLo in the infant and juvenile segment.

 
| ** **                                       | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(in thousands)**                          | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Infant and juvenile: (A)**                     |       |                                                     |       |                                                    |       |   |   |   |   |
| Net sales                                        |       | $                                                        | 69,803     |                                                    | $          | 45,171 |   | $ | 173,646 |   | $ | 120,724 |   |
| Selling, general and  administrative expenses    |       | 11,896                                                   |       | 6,663                                                   |       | 31,917 |   | 20,142 |   |
| Operating income (loss) (F)                      |       | 10,934                                                   |       | 7,079                                                   |       | 26,271 |   | 22,541 |   |
| Other income (expense)                           |       | (2,110                                                   | )          | (715                                                    | )          | (5,435 | ) | (3,041 | ) |
| Depreciation and amortization                    |       | 850                                                      |       | 426                                                     |       | 1,844 |   | 789 |   |
| Income before income tax  provision              |       | $                                                        | 8,824      |                                                    | $          | 6,364 |   | $ | 20,836 |   | $ | 19,500 |   |
| **Gift:**                                        |       |                                                     |       |                                                    |       |   |   |   |   |
| Net sales                                        |       | $                                                        | 38,272     |                                                    | $          | 55,757 |   | $ | 98,046 |   | $ | 125,991 |   |
| Selling, general and  administrative expenses(B) |       | 17,119                                                   |       | 20,469                                                  |       | 60,379 |   | 59,128 |   |
| Operating income (loss)  (B) (D) (E)   |       | (954                                                     | )          | 6,148                                                   |       | (20,511 | ) | (1,757 | ) |

 

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| Other income (expense)                            |   | 313    |    | (1     | )      | 661     |   | 34     |    |
|---------------------------------------------------|--------|--------|---------|--------|--------|---------|--------|--------|---------|
| Depreciation and amortization  (C)                |   | 122    |    | 880    |   | 2,786   |   | 2,861  |    |
| Loss before income tax  provision                 |   | $      | (641    | )      | $      | 6,147   |   | $      | (19,850 | ) | $ | (1,723 | ) |
| **Consolidated:**                                 |   |   |    |   |   |    |   |   |    |
| Net sales                                         |   | $      | 108,075 |   | $      | 100,928 |   | $      | 271,692 |   | $ | 246,715 |   |
| Selling, general and  administrative expenses (B) |   | 29,015 |    | 27,132 |   | 92,296  |   | 79,270 |    |
| Operating income  (B) (D) (E) (F)  |   | 9,980  |    | 13,227 |   | 5,760   |   | 20,784 |    |
| Other income (expense)                            |   | (1,797 | )       | (716   | )      | (4,774  | )      | (3,007 | )       |
| Depreciation and amortization  (C)                |   | 972    |    | 1,306  |   | 4,630   |   | 3,650  |    |
| Income before income tax  provision               |   | $      | 8,183   |   | $      | 12,511  |   | $      | 986     |   | $ | 17,777 |   |

 

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(A)  LaJobi and CoCaLo wereacquired on April 2, 2008 and, accordingly, only six months of activityare included in this summary.

 

(B)  The nine months ended September 30,2008, includes an impairment charge of $7.0 million for the write-down of fixed assets in the gift segment. Ofthis amount, $6.7 million was recorded in selling, general and administrativeexpense and $0.3 million was recorded in cost of sales.

 

(C)  The nine months ended September 30,2008 includes a $1.0 million charge, recorded in cost of goods sold, related tothe write-off of Shining Stars website development expenses.

 

(D)  The nine months ended September 30,2008 includes a $1.6 million inventory charge in connection with theunfavorable results of a voluntary quality test on a certain gift segmentproduct.

 

(E)   For the three and ninemonths ended September 30, 2007, operating income (loss) for the giftsegment is impacted by charges of $0.8 million for additional inventoryreserves, as well as personnel costs associated with its foreign operations.

 

(F)   For the three and ninemonths ended September 30, 2007, cost of goods sold for the infant andjuvenile segment includes an impairment charge of $3.6 million related to theMAM distribution agreement.

 

Total assets of each segment were as follows:

 
| **(Dollars in thousands)** | ** ** | **September 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Infant and juvenile                  |       | $                                | 321,045    |                            | $          | 236,597 |   |
| Gift                                 |       | 77,847                           |       | 104,911                         |       |
| Total                                |       | $                                | 398,892    |                            | $          | 341,508 |   |

 

**Concentration of Risk**

 

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

 

With respect to customers, Toys “R” Us, Inc.and Babies “R” Us, Inc., in the aggregate, accounted for 31.8% and 33.7%of the Company’s consolidated net sales during the three and nine month periodsended September 30, 2008, respectively, and 26.4% and 25.3% for the threeand nine month periods ended September 30, 2007, respectively.

 

**NOTE 9 - FOREIGN CURRENCY FORWARDEXCHANGE CONTRACTS**

 

Certain of the Company’s subsidiariesperiodically enter into foreign currency forward exchange contracts to hedgeinventory purchases, both anticipated and firm commitments, denominated in theUnited States dollar. These contracts reduce foreign currency risk caused bychanges in exchange rates and are used to offset the currency impact of theseinventory purchases, generally for periods up to 13 months. At September 30,2008, the Company’s forward contracts had expiration dates which ranged fromone to six months.

 

The Company accounts for its forward exchangecontracts as an economic hedge, with subsequent changes in fair value recordedin the Consolidated Statements of Operations. Unrealized gains of $0.3 million relating to forward contracts areincluded in 

 

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**RUSSBERRIE AND COMPANY, INC. AND SUBSIDIARIES**

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

other current assets on the balance sheet at September 30,2008 and December 31, 2007. Unrealized losses of $0.1 million are includedin other current liabilities at December 31, 2007.

 

The Company has forward contracts to exchangeBritish pounds, Canadian dollars and Australian dollars for United Statesdollars with notional amounts of $3.1 million and $9.7 million as of September 30,2008 and December 31, 2007, respectively. The Company has forwardcontracts to exchange United States dollars to Euros with notional amounts of$0.6 million and $2.8 million as of September 30, 2008 and December 31,2007, respectively. The Company does not anticipate any material adverse impacton its results of operations or financial position from these contracts.  See Note 10 below for information withrespect to the fair value of financial instruments, including the Company’sforward exchange contracts.

 

**NOTE 10 – FINANCIAL INSTRUMENTS**

 

The Company adopted SFAS No. 157 on January 1,2008, the first day of its 2008 fiscal year, for its financial assets andliabilities that are remeasured and reported at fair value at each reportingperiod.  SFAS No. 157 defines fair value of assets and liabilities asthe price that would be received to sell an asset or paid to transfer aliability in an orderly transaction between market participants at themeasurement date (an exit price). The standard outlines a valuation frameworkand creates a fair value hierarchy in order to increase the consistency andcomparability of fair value measurements and the related disclosures. Undergenerally accepted accounting principles, certain assets and liabilities mustbe measured at fair value, and SFAS No. 157 details the disclosures thatare required for items measured at fair value.

 

Financial assets and liabilities are measuredusing inputs from the three levels of the SFAS No. 157 fair valuehierarchy. The three levels are as follows:

 

Level 1—Inputs are unadjusted quoted prices inactive markets for identical assets or liabilities.

 

Level 2—Inputs include quoted prices for similar assetsand liabilities in active markets, quoted prices for identical or similarassets or liabilities in markets that are not active, inputs other than quotedprices that are observable for the asset or liability (i.e., interest rates,yield curves, etc.), and inputs that are derived principally from orcorroborated by observable market data by correlation or other means (marketcorroborated inputs). Most of the Company’s assets and liabilities fall withinLevel 2 and include foreign exchange contracts and interest rate swapagreements. The fair value of foreign currency and interest rate swap contractsare based on third-party market maker valuation models that discount cash flowsresulting from the differential between the contract rate and the market-basedforward rate or curve capturing volatility and establishing intrinsic and carryingvalues.

 

Level 3—Unobservable inputs that reflect our assessmentabout the assumptions that market participants would use in pricing the assetor liability. The Company currently has no Level 3 assets or liabilities thatare measured at a fair value on a recurring basis.

 

This hierarchy requires the Company to minimize the useof unobservable inputs and to use observable market data, if available, whendetermining fair value.  Observableinputs are based on market data obtained from independent sources, whileunobservable inputs are based on the Company’s market assumptions. Unobservableinputs require significant management judgment or estimation. In some cases,the inputs used to measure an asset or liability may fall into different levelsof the fair value hierarchy. In those instances, the fair value measurement isrequired to be classified using the lowest level of input that is significantto the fair value measurement.  Inaccordance with SFAS No. 157, the Company is not permitted to adjust quotedmarket prices in an active market.

 

In accordance with the fair value hierarchydescribed above, the following table shows the fair value of the Company’sforeign exchange contracts and interest rate swap agreement as of September 30,2008 (in thousands):

 
| ** **                   | ** ** | ** **                       | ** ** | **Fair Value Measurements as of September 30, 2008** | ** ** |
|------------------------------|------------|----------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| ** **                   | ** ** | **September 30, 2008** | ** ** | **Level 1**                                                                        | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Forward Exchange Contracts   |       | $                                | 345        |                                                                                    | $          | — |   | $ | 345 |   | $ | — |   |
| Interest Rate Swap Agreement |       | $                                | 33         |                                                                                    | $          | — |   | $ | 33 |   | $ | — |   |

 

Cash and cash equivalents, trade accountsreceivable, inventory, income tax receivable, trade accounts payable andaccrued expenses are reflected in the consolidated balance sheets at carryingvalue, which approximates fair value due to the short-term nature of theseinstruments.

 

The carrying value of the Company’s term loanborrowings approximates fair value because interest rates under the term loanborrowings are variable, based on prevailing market rates.

 

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

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

There have been no material changes to the Company’s valuation techniquesduring the nine months ended September 30, 2008.

 

**NOTE 11 - COMPREHENSIVE INCOME (LOSS)**

 

Comprehensive Income (Loss), representing all changes in Shareholders’Equity during the period other than changes resulting from the issuance orrepurchase of the Company’s common stock and payment of dividends, isreconciled to net income (loss) for the three and nine months ended September 30,2008 and 2007 as follows (in thousands):

 
| ** **                                | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net income (loss)                         |       | $                                                        | 8,205      |                                                    | $          | 14,307 |   | $ | (1,934 | ) | $ | 17,218 |   |
| Other comprehensive income:               |       |                                                     |       |                                                    |       |   |   |   |   |
| Foreign currency translation  adjustments |       | (2,587                                                   | )          | 1,046                                                   |       | (2,035 | ) | 2,560 |   |
| Comprehensive income (loss)               |       | $                                                        | 5,618      |                                                    | $          | 15,353 |   | $ | (3,969 | ) | $ | 19,778 |   |

 

**NOTE 12 – INCOME TAXES**

 

In July 2006 the Financial Accounting StandardsBoard (“FASB”) issued FASB Interpretation No. 48, “Accounting forUncertainty in Income Taxes” (“FIN 48”) and in May 2007 issued FASB StaffPosition (“FSP”) FSP FIN 48-1.  FIN 48prescribes a comprehensive model for how a company should recognize, measure,present and disclose in its financial statements uncertain tax positions thatthe company has taken or expects to take on a tax return.  FIN 48 states that a tax benefit from anuncertain tax position may be recognized only if it is “more likely than not”that the position is sustainable, based on its technical merits.  The tax benefit of a qualifying position isthe largest amount of tax benefit that is greater than 50% likely of beingrealized upon settlement with a taxing authority having full knowledge of allrelevant information.  A tax benefit froman uncertain position was previously recognized if it was probable of beingsustained.  Under FIN 48, the liabilityfor unrecognized tax benefits is classified as noncurrent unless the liabilityis expected to be settled in cash or the relevant statute will expire withintwelve months of the reporting date.  TheCompany adopted the provisions of FIN 48 on January 1, 2007.  The Company did not make any adjustments toits opening balance sheet related to the implementation of FIN 48, other thanto reclassify the portion of its tax liabilities to non-current which theCompany did not anticipate will settle, or for which the statute of limitationswill not close, in the next twelve months, and the Company did not make anyadjustments to its opening retained earnings related to the implementation ofFIN 48.

 

The Company operates in multiple tax jurisdictions, bothwithin the United States and outside of the United States, and faces auditsfrom various tax authorities regarding the inclusion of certain items intaxable income, the deductibility of certain expenses, transfer pricing, theutilization and carryforward of various tax credits, and the utilization ofvarious carryforward items such as charitable contributions and net operatingloss carryforwards (“NOLS”).  At September 30,2008, the amount of liability for unrecognized tax benefits related to federal,state, and foreign taxes was approximately $9.6 million, includingapproximately $0.1 million of accrued interest. The Company has various tax attributes such as NOL’s, charitablecontribution carryovers, and foreign tax credit carryovers which could beutilized to offset these uncertain tax positions.

 
| ** **                                                   | ** ** | **(in thousands)** | ** ** |
|--------------------------------------------------------------|------------|-------------------------|------------|
| Balance at January 1, 2008                              |       | $                       | 13,394     |   |
| Increases related to prior year  tax positions               |       | 5                       |       |
| Decreases related to prior year  tax positions               |       | 0                       |       |
| Increases related to current  year tax positions/settlements |       | 0                       |       |
| Lapse of statute of limitations                              |       | (3,778                  | )          |
| Balance at September 30,  2008                          |       | $                       | 9,621      |   |

 

The Company is currently under examination in severaltax jurisdictions and remains subject to examination until the statute oflimitations expires for the respective tax jurisdiction.  Based upon the expiration of statutes oflimitations and/or the conclusion of tax examinations in several jurisdictions,the Company believes it is reasonably possible that the total amount ofpreviously unrecognized tax benefits discussed above may decrease by up to $5.2million within twelve months of September 30, 2008.  If recognized, approximately $0.2 million ofthe decrease would impact the Company’s effective tax rate.  For the remaining amounts, the Companyanticipates that the valuation allowances of the deferred tax assets associatedwith various tax attributes such as foreign tax credit carryforwards andcharitable contribution carryforwards would be increased.

 

The Company’s policy is to classify interest and penaltiesrelated to unrecognized tax benefits as income tax expense.

 

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** **

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

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 13 – LITIGATION; COMMITMENTS AND CONTINGENCIES**

 

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

 

The Company enters into various license and distributionagreements relating to trademarks, copyrights, designs, and products whichenable the Company to market items compatible with its product line.  Most of these agreements are for three yearterms with extensions if agreed to by both parties.  Several of these agreements requireprepayments of certain minimum guaranteed royalty amounts.  The amount of minimum guaranteed royaltypayments with respect to all license agreements through the end of theircurrent terms aggregates approximately $9.0 million, of which approximately$4.7 million remained unpaid at September 30, 2008, substantially all ofwhich is due prior to December 31, 2009. Royalty expense for the three andnine months ended September 30, 2008 was $1.6 million and $4.9 million,respectively, as compared to $3.1 million and $6.3 million for the three andnine months ended September 30, 2007, respectively.

 

In connection with the Company’s purchase of the LaJobiBusiness and CoCaLo, the aggregate purchase price with respect to each suchpurchase includes a potential payment of earnout consideration as more fullydescribed in Note 2.  The Company cannotcurrently determine the amount of such earnout consideration, if any, that maybe required to be paid pursuant to either the Asset Agreement or StockAgreement.

 

**NOTE 14 – RECENTLY ISSUED ACCOUNTING STANDARDS**

 

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements” (SFAS No. 157), which defines fair value,establishes a framework for measuring fair value and expands disclosures aboutfair value measurements.   In February 2008, the FASB issuedFASB Staff Position SFAS No. 157-2, “Effective Date of FASB Statement No. 157”,which delayed the effective date of SFAS No. 157 for all non-financialassets and liabilities, except those that are recognized or disclosed at fairvalue in the financial statements on a recurring basis, until January 1,2009.  On January 1, 2008, theCompany adopted SFAS 157 for financial assets and liabilities, as well as forany other assets and liabilities that are carried at fair value on a recurringbasis in financial statements.  As of June 30,2008, the Company did not have any non-financial assets and liabilities thatare carried at fair value on a recurring basis in the financial statements. Theimpact of the adoption of SFAS No. 157 for financial assets andliabilities was not material to its consolidated interim financialstatements.  The expanded disclosures about fair value measurements forfinancial assets and liabilities on a recurring basis are presented in Note10.  The Company has not yet determined the impact that the adoption of SFASNo. 157 will have on its non-financial assets and liabilities which arenot recognized on a recurring basis; however, the Company does not anticipateit will materially impact its consolidated financial position, results ofoperations and cash flows.

 

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

 

In December 2007, SFAS No. 141R(revised 2007), “Business Combinations,” was issued.  This statement requires an acquirer torecognize assets acquired, the liabilities assumed, and any noncontrollinginterest in the acquiree at their fair values on the acquisition date, withgoodwill being the excess value over the net identifiable assets acquired.  This statement is effective for businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15,2008.  The Company is evaluating theeffect the adoption of this standard will have on any potential futureacquisitions that may occur on or after January 1, 2009.

 

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

 

In April 2008, the FASB issued StaffPosition No. 142-3, “Determination of the Useful Life of Intangible Assets”(“FSP 142-3”). FSP 142-3 amends the factors that should be considered indeveloping renewal or extension assumptions used to determine the useful lifeof a recognized intangible asset under SFAS No. 142, “Goodwill and OtherIntangible Assets.” FSP 142-3 is effective for fiscal years beginning after December 15,2008 and interim periods within those fiscal years, requiring prospectiveapplication to intangible assets acquired after the effective date. The Companywill be required to adopt the principles of FSP 142-3 with respect tointangible assets acquired on or after January 1, 2009. Due to theprospective application requirement, the Company is unable to 

 

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

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

determine what effect, if any, the adoption of FSP 142-3will have on its consolidated financial position, results of operations andcash flows.

 

In June 2008, the FASB ratified EITF Issue No. 08-3,“Accounting by Lessees for Nonrefundable Maintenance Deposits” (“EITF No. 08-3”).  EITF No. 08-3 requires that allnonrefundable maintenance deposits be accounted for as a deposit with thedeposit expensed or capitalized in accordance with the lessee’s maintenanceaccounting policy when the underlying maintenance is performed. Once it isdetermined that an amount on deposit is not probable of being used to fundfuture maintenance expense, it is to be recognized as additional expense at thetime such determination is made. EITF No. 08-3 is effective beginningafter January 1, 2009.  The Companyis currently evaluating the effect of adopting EITF No. 08-3 on itsconsolidated financial position, results of operations and cash flows.

 

**NOTE 15 – RELATED PARTY TRANSACTIONS**

 

An employee of the Company, along with variousfamily members, established L&J Industries, in Asia. The purpose of theentity is to provide quality control services to the Company for goods beingshipped from Asian ports. The Company used this service commencing April 2008.For the three and nine months ended September 30, 2008, the Companyincurred costs totaling approximately $219,000 and $426,000, respectively,related to the services provided.

 

The same employee of the Company has utilizedsince April 2008 a portion of one of the Company’s warehouses to store andship merchandise unrelated to the Company’s business. The employee reimbursesthe Company for expenses incurred in connection with this arrangement. For thethree and nine months ended September 30, 2008, the Company receivedreimbursements totaling approximately $36,000 and $73,000, respectively, forthe space and services provided.

 

In addition, certain of our principal stockholders own significantequity stakes in certain customers of the Company.  In particular:

 

(1)     D. E. Shaw LaminarPortfolios, L.L.C. ("Laminar") owns approximately 20% of theoutstanding shares of the Company's Common Stock, and an affiliate of Laminarowns a majority equity interest in FAO Schwarz ("FAO"), a customer ofthe Company with purchases of approximately $703,000 and $723,000 during thethree and nine month periods ended September 30, 2008 and purchases ofapproximately $51,000 and $123,000 during the three and nine month periodsended September 30, 2007.  Ms. Krueger, adirector of the Company and a Laminar designee to the Company's Board, is avice president of D. E. Shaw & Co., L.P. ("DES"), an affiliateand investment advisor of Laminar, and a director of FAO.  Mr. Benaroya, the Chairman of the Board ofthe Company, is also the Chairman of the Board of FAO and, as previouslydisclosed, is a consultant for DES.  

 

(2)     Investment entities andaccounts managed and advised by Prentice Capital Management, L.P. (“Prentice”)own approximately 20% of the outstanding shares of the Company's Common Stock,and Prentice indirectly owns a majority equity interest in KB Toys, Inc.("KB"), a customer of the Company with purchases of approximately$17,000 and $49,000 during the three and nine month periods ended September 30,2008 and purchases of approximately $654,000 and $862,000 during the three andnine month periods ended September 30, 2007. Mr. Ciampi, a director of the Company and a Prentice designee to theCompany's Board, is a partner of Prentice and the Chairman of the Board ofKB.  

 

The Company believes that arrangements with FAO, KB and other customersare negotiated on an arms-length basis without regard to such relationships.

 

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**ITEM 2.  MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS**

 

The financial and business analysis below provides information which theCompany believes is relevant to an assessment and understanding of the Company’sconsolidated financial condition, changes in financial condition and results ofoperations. This financial and business analysis should be read in conjunctionwith the Company’s unaudited consolidated financial statements and accompanyingNotes to Unaudited Consolidated Financial Statements set forth in Part I,Financial Information, Item 1, “Financial Statements” of this QuarterlyReport on Form 10-Q, the Company’s Annual Report on Form 10-K for theyear ended December 31, 2007, as amended (the “2007 10-K”), and theCompany’s Quarterly Reports on Form 10-Q for the quarters ended March 31,2008 and June 30, 2008, in each case including the consolidated financialstatements and notes thereto.

 

**OVERVIEW**

 

The Company is a leader in the infant and juvenile and gift industries.The Company’s infant and juvenile segment is currently composed of: Kids Line,LLC; Sassy, Inc.; LaJobi Inc.; and CoCaLo, Inc, all wholly-ownedsubsidiaries, whose products focus principally on children of the age groupnewborn to two years and are generally sold to national accounts andindependent retailers.  Kids Lineproducts consist primarily of infant bedding and related nursery accessoriessuch as blankets, rugs, mobiles, nightlights, hampers, lamps and wall art.Sassy has concept groupings such as bath toys and accessories, developmentaltoys, feeding utensils and bowls, bottles, bibs, soft toys, mobiles andfeeders, and recently entered the baby gear category.  LaJobi designs, imports and sells infant andjuvenile furniture and related products (including cribs, changing tables,dressers, hutches, armoires, bookcases and end tables, mattresses and changingpads).  CoCaLo designs, outsources,markets and distributes infant bedding (including crib bumpers, blankets, cribsheets and dust ruffles) and related accessories (including wall hangings,musical mobiles, blankets, diaper stackers, valances, wall paper borders,lamps, shades, nightlights, switch plates, decorative pillows and rugs). TheCompany’s gift segment designs, manufactures through third parties and marketsa wide variety of gift products to mass market, toy, specialty, food, drug andindependent retailers throughout the United States and throughout the world viathe Company’s domestic and international wholly-owned subsidiaries andindependent distributors.

 

The Company’s revenues are primarily derived from sales of itsproducts.  For the three months ended September 30,2008, 64.6% of revenues were generated by the infant and juvenile segment and35.4% of revenues were generated by the gift segment, as compared to 44.8% and55.2%, respectively, for the same period in the prior year.  The increase in the percentage of salesgenerated by the infant and juvenile segment largely reflects the acquisitionsof LaJobi and CoCaLo in April 2008.

 

The principal elements of our global businessstrategy include:

 

·                  focusing on design-ledand branded product development in each of our segments, to enable us tocontinue to introduce compelling new products, with the intention of increasingour market share;

 

·                  pursuing organic growthopportunities, including:

 

(i)                                   expanding our productofferings into related categories; and

 

(ii)                                expanding and diversifyingof our distribution channels, with particular emphasis on further extending theinfant and juvenile segment into international markets and further expandingour sales channels to include business-to-business and web-based offerings;

 

·                  growing throughlicensing, distribution or other strategic alliances, including pursuingacquisition opportunities in businesses complementary to ours;

 

·                  implementing strategiesto further capture synergies within our segments, through cross-marketingopportunities and consolidation of back-office activities; and

 

·                  continuing efforts tomanage costs within each of our segments, with particular focus on furtherstreamlining our gift segment by concentrating on more profitable product linesand creating additional operational efficiencies.

 

We believe that we continue to make progress insuccessfully implementing this strategy. Specifically, as a result of our renewed focus on growth through theexploration of strategic acquisitions, on April 2, 2008, we consummatedthe acquisitions of each of: (i) the assets of LaJobi Industries, Inc.and (ii) CoCaLo, Inc.  Theseacquisitions have helped to expand our infant and juvenile segment, and enableus to offer a more complete range of products for the baby nursery.  In connection with such acquisitions, theCompany amended and restated the Infantline Credit Agreement (defined below) toamend such agreement in 

 

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order to, among other things, increase the facilitiesavailable thereunder and to permit the acquisitions of LaJobi and CoCaLo. See “Liquidityand Capital Resources” below under the sections captioned “*RecentAcquisitions and**Financings*”.

 

With respect to our gift business, we continue tofocus on creating compelling new products in product categories where webelieve we can command an authoritative position.  However, largely as a result of deterioratingmacro-economic conditions and various competitive factors, including thedecline in Shining Stars revenues that was anticipated and previously disclosedby the Company resulting in part from the popularity of other dimensionalproducts that include a virtual play component, revenues in our gift segmenthave declined during the first nine months of 2008.  The Company believes that this decline isconsistent with overall trends in gift industry product sales, as well as theaforementioned decline in Shining Stars sales from 2007.  As a result of current and projected cashflowshortfalls in the gift segment and other gift industry trends, the Companyinitiated an analysis of the carrying value of certain long-lived assets in thegift segment, which analysis resulted in a non-cash impairment charge recordedin the quarter ended June 30, 2008, as described in “Results of Operations– Nine Months Ended September 30, 2008 and 2007” below. See “Note 7 ofNotes to Unaudited Consolidated Financial Statements for a discussion of theimpairment charge and “Liquidity and Capital Resources” below for a discussionof the liquidity of the gift segment for future periods.

 

In addition, like many companies in theindustries in which we operate, we continue to experience margin pressure inboth segments of our business, primarily as a result of rising raw materialprices, higher expenses associated with manufacturing in Asia and currencyfluctuations between the U.S. dollar and the Chinese yuan.  We continue to seek to mitigate thispressure, including through the development of new products that can commandhigher pricing, the identification of alternative, lower-cost sources of supplyand, where possible, price increases. Particularly in the mass market, our ability to increase prices islimited by market and competitive factors, and, while we have implementedselective price increases, we have generally focused on maintaining (orincreasing) shelf space at retailers and, as a result our market share.  We believe that the market ultimately willaccept broader price increases, although there can be no assurance of whetheror when this will occur.

 

**SEGMENTS**

 

The Company currently operates in two segments:  (i) its infantand juvenile segment and (ii) its gift segment.

 

**RESULTS OF OPERATIONS—THREE MONTHS ENDED SEPTEMBER 30, 2008AND 2007**

 

The Company’s consolidated net sales for the three months ended September 30,2008 increased 7.1% to $108.1 million compared to $100.9 million for the threemonths ended September 30, 2007, primarily as a result of an increase ininfant and juvenile segment net sales of $24.4 million. This increase wasprimarily attributable to the inclusion of sales generated by LaJobi and CoCaLoin the third quarter of 2008 and sales growth at Kids Line, partially offset bya decrease in gift segment net sales of $17.5 million for the third quarter ascompared to the third quarter of 2007.

 

Net sales for the infant and juvenile segment for the three months ended September 30,2008 increased 54.5% to $69.8 million, compared to $45.2 million for the threemonths ended September 30, 2007, primarily resulting from sales generatedby LaJobi and CoCaLo. The Company’s gift segment net sales for the three monthsended September 30, 2008 decreased 31.4% to $38.3 million compared to$55.8 million for the three months ended September 30, 2007, primarily asa result of decreases in sales of Shining Star products and further weakness inthe gift market as a result of the continuing economic slowdown. Net sales inthe Company’s gift segment were favorably impacted by approximately $0.1million for the three months ended September 30, 2008 as a result offoreign exchange rate gains.

 

Consolidated gross profit percentage was 36.1% of consolidated net salesfor the three months ended September 30, 2008 as compared to 40.0% for thethree months ended September 30, 2007, which was the result of a decreasein the gift segment of 5.5% offset by an increase in the infant and juvenilesegment of 2.3%. Gross profit for the Company’s infant and juvenile segmentincreased to 32.7% of net sales for the three months ended September 30,2008, compared to 30.4% of net sales for the three months ended September 30,2007, primarily as a result of a $3.6 million impairment charge related to theMAM distribution agreement incurred in the three months ended September 30,2007.  Gross profit percentage for theCompany’s gift segment decreased to 42.2% of net sales for the three monthsended September 30, 2008 as compared to 47.7% of net sales for the threemonths ended September 30, 2007, primarily as a result of: (i) anadditional inventory reserve of $0.6 million recorded in the September 30,2008 quarter; (ii) higher margins achieved in the third quarter of 2007due to Shining Star sales that commanded a higher margin; and (iii) thegreater impact of fixed costs in the gross profit percentage in the quarterended September 30, 2008 due to lower sales volume as compared to theprior year quarter.

 

Consolidated selling, general and administrative expense was $29.0million, or 26.8% of consolidated net sales, for the three months ended September 30,2008, compared to $27.1 million, or 26.9% of consolidated net sales, for thethree months ended September 30, 2007.  The primary reason for thisincrease in absolute terms was the acquisitions of LaJobi and CoCaLo, offset bythe reduction of selling expense related to lower gift segment sales volume andthe elimination in 2008 of advertising expense incurred in 

 

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therollout of Shining Stars product in the third quarter of 2007. Selling, generaland administrative expense in the Company’s infant and juvenile segmentincreased from $6.7 million, or 14.8% of net sales, in the third quarter of2007, to $11.9 million, or 17.0% of net sales, in the third quarter of 2008,primarily as a result of: (i) the acquisitions of LaJobi and CoCaLo; (ii) increasedproduct development costs; and (iii) advertising expense incurred tosupport growth in the infant and juvenile segment. Selling, general andadministrative expense in the Company’s gift segment was $17.1 million, or44.7% of net sales, in the third quarter of 2008 as compared to $20.5 million,or 36.7% of net sales, in the prior year period primarily for the reasons setforth above.

 

Consolidated other expense was $1.8 million for the three months ended September 30,2008 compared to $0.7 million for the three months ended September 30,2007, or an increase of $1.1 million. Other expense in the Company’s infant andjuvenile segment increased by $1.4 million to $2.1 million in the third quarterof 2008 compared to $0.7 million in the prior year period as a result ofadditional borrowing costs related to the expanded infant and juvenile creditfacility. Other income in the Company’s gift segment for the three months endedSeptember 30, 2008 was $0.3 million compared to zero for the prior yearperiod primarily due to gains from foreign currency exchange in 2008.

 

The Company recorded a consolidated tax benefit ofapproximately $22,000 and $1.8 million for the three months ended September 30,2008 and 2007, respectively.  The Companyrecorded a deferred tax liability associated with the tax amortization of intangibleassets related to the Kids Line, Sassy, LaJobi, CoCaLo and Applauseacquisitions of approximately $1.4 million and $1.0 million for the threemonths ended September 30, 2008 and 2007 respectively.  The deferred tax liability for the threemonths ended September 30, 2007 was offset by a tax benefit ofapproximately $1.4 million associated with the impairment of the MAMdistribution agreement.  These deferredtax liabilities are indefinite in nature for accounting purposes, and thereforecannot be offset by the Company’s deferred tax assets.  The Company recorded full valuationallowances against those deferred tax assets as management believed it was morelikely than not that those deferred tax assets would not be realized.  This deferred tax expense was offset by a taxbenefit of approximately $1.6 million and $1.1 million for the three monthsended September 30, 2008 and 2007 respectively, related to an adjustmentof the Company’s liability for uncertain tax positions under FIN 48 related tothe statute of limitations expiring on the Company’s 2004 and 2003 federalincome tax returns respectively.  TheCompany recorded approximately $0.1 million of state income tax expense for thethree months ended September 30, 2008 related to profitable operations inNew Jersey, and foreign tax expense of approximately $0.1 million and $0.7million for the three months ended September 30, 2008 and 2007respectively, related to profitable operations in Hong Kong and Australia.  For the three months ended September 30,2007 the Company recorded a tax benefit of $1.0 million related to a reductionin the valuation allowance related to its foreign tax credit carryforwardswhich the Company estimated it would be able to utilize in 2007.

 

As a result of the foregoing, consolidated net income for the threemonths ended September 30, 2008 was $8.2 million, or $0.39 per dilutedshare, compared to consolidated net income of $14.3 million, or $0.67 perdiluted share, for the three months ended September 30, 2007.

 

**RESULTS OF OPERATIONS—NINE MONTHS ENDED SEPTEMBER 30, 2008AND 2007**

 

The Company’s consolidated net sales for the nine months ended September 30,2008 increased 10.1% to $271.7 million compared to $246.7 million for the ninemonths ended September 30, 2007, as a result of an increase in the infantand juvenile segment net sales of $52.9 million.  This increase is attributable to theacquisitions of LaJobi and CoCaLo and sales growth at both Kids Line and Sassy,partially offset by a decrease in gift segment net sales of $27.9 million forthe nine months as compared, to the nine months of 2007.

 

Net sales for the infant and juvenile segment for the nine months ended September 30,2008 increased 43.8% to $173.6 million, compared to $120.7 million for the ninemonths ended September 30, 2007, primarily resulting from the acquisitionsof LaJobi and CoCaLo, as well as sales increases at both Sassy and KidsLine.  Sales increases at Sassy and KidsLine accounted for a 5.3% increase in the infant and juvenile segment duringthe first nine months of 2008, as compared to the same period in the prioryear, and  were generated primarily bynew product introductions and growth in international sales. The Company’s giftsegment net sales for the nine months ended September 30, 2008 decreased22.2% to $98.0 million compared to $126.0 million for the nine months ended September 30,2007, primarily as a result of (i) decreases in sales of Shining Starsproducts as compared to the nine months ended September 30, 2007; and (ii) furtherweakness in the gift market as a result of the continuing economicslowdown.  Net sales in the Company’sgift segment were favorably impacted by approximately $2.1 million for the ninemonths ended September 30, 2008 as a result of foreign exchange gains.

 

Consolidated gross profit percentage was 36.1% of consolidated net salesfor the nine months ended September 30, 2008 as compared to 40.6% ofconsolidated net sales for the nine months ended September 30, 2007, whichwas the result of decreases in gross profit percentage in both segments as wellas the impact of certain unusual charges in the gift segment during the secondquarter of 2008, as described below.  Gross profit for the Company’s infant and juvenile segment decreasedfrom 35.4% of net sales for the nine months ended September 30, 2007 to33.5% of net sales for the nine months ended September 30, 2008, primarilyas a result of competitive pricing pressure, increased raw material costs andproduct mix partially offset by the non-recurrence of a $3.6 million 

 

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impairmentcharge related to the MAM distribution agreement incurred in the nine monthsended September 30, 2007. Gross profit for the Company’s gift segmentdecreased to 40.7% of net sales for the nine months ended September 30,2008 as compared to 45.5% of net sales for the nine months ended September 30,2007. The decrease in the gift segment gross profit as a percentage of saleswas primarily attributable to (i) the impact of a $1.6 million inventorycharge recorded in the second quarter of 2008 in connection with unfavorableresults of a voluntary quality test on a certain gift segment product, (ii) a$1.0 million non-cash charge related  tothe write-off of Shining Star website development expenses, resulting from theCompany’s agreement with the licensor to return to the licensor the operational responsibility of the website inexchange for reduced future royalties and the elimination of future web-siteresponsibility; (iii) a non-cash impairment charge of $0.3 million inconnection with a gift segment asset impairment described in the nextparagraph; (iv) an additional inventory reserve of $0.6 million recordedin the September 30, 2008 quarter; (v) higher margins achieved in thenine months ended September 30, 2007 due to Shining Stars sales thatcommanded higher margins; and (vi) the greater impact of fixed costs inthe gross profit percentage in the nine months ended September 30, 2008due to lower sales volume.

 

Consolidated selling, general and administrative expense was $92.3million, or 34.0% of consolidated net sales, for the nine months ended September 30,2008, compared to $79.3 million, or 32.1% of consolidated net sales, for thenine months ended September 30, 2007. The primary reason for this increase in both absolute and relative termswas an impairment charge of $7.0 million in the gift segment attributable tothe write down of fixed assets, of which $6.7 million was recorded in selling,general and administrative expense for the quarter ended June 30, 2008 and$0.3 million was recorded in cost of sales. Selling, general and administrative expense in the Company’s infant andjuvenile segment increased from $20.1 million, or 16.7% of net sales during thenine months ended September 30, 2007, to $31.9 million, or 18.4% of netsales, in the nine months ended September 30, 2008, primarily as a resultof the acquisitions of LaJobi and CoCaLo, increased product development costsand advertising expenses incurred to support growth in this segment. Selling,general and administrative expense in the Company’s gift segment increased to$60.4 million, or 61.6% of net sales, in the nine month period ended September 30,2008 as compared to $59.1 million, or 46.9% of net sales, in the comparableprior year period.  As noted above, thisincrease was primarily the result of a $6.7 impairment charge recorded in thesecond quarter of 2008 in selling, general and administrative expense from thewrite-down of fixed assets.

 

Consolidated other expense was $4.8 million for the nine months ended September 30,2008 compared to $3.0 million for the nine months ended September 30,2007, or an increase of $1.8 million. Other expense in the Company’s infant andjuvenile segment increased by $2.4 million to $5.4 million in the nine monthsended September 30, 2008 compared to $3.0 million in the prior year periodas a result of additional borrowing costs associated with the expanded infantand juvenile credit facility, the related write-off of $0.7 million of deferredfinancing and other costs incurred in connection with  the infant and juvenile credit facility thatwere charged directly to interest expense. Other income in the Company’s giftsegment for the nine months ended September 30, 2008 increased to $0.7million from $34,000 in the prior year period due to foreign exchange rategains.

 

The Company recorded consolidated tax expense ofapproximately $2.9 million and $ 0.6 million for the nine months ended September 30,2008 and 2007, respectively. The Company recorded a deferred tax liabilityassociated with the tax amortization of intangible assets relating to the KidsLine, Sassy, LaJobi, CoCaLo and Applause acquisitions of approximately $4.0million and $3.0 million for the nine months ended September 30, 2008 and2007, respectively.  The deferred taxliability for the three months ended September 30, 2007 was offset by atax benefit of approximately $1.4 million associated with the impairment of theMAM distribution agreement.  Thesedeferred tax liabilities are indefinite in nature for accounting purposes, andtherefore cannot be offset by the Company’s deferred tax assets.  The Company recorded full valuation allowancesagainst those deferred tax assets as management believed it was more likelythan not that those deferred tax assets would not be realized.  This deferred tax expense was offset by areduction of approximately $1.6 million and $1.1 million for the nine monthsended September 30, 2008 and 2007, respectively, related to an adjustmentof the Company’s liability for uncertain tax positions under FIN 48 related tothe statute of limitations expiring on the Company’s 2004 and 2003 federalincome tax returns, respectively.  TheCompany recorded approximately $0.3 million of state income tax expense for thenine months ended September 30, 2008 related to profitable operations inNew Jersey, and foreign tax expense of approximately $0.2 million and $1.1million for the nine months ended September 30, 2008 and 2007,respectively related to profitable operations in Canada, Hong Kong andAustralia.  For the nine months ended September 30,2007, the Company recorded a tax benefit of $1.0 million related to a reductionin the valuation allowance related to its foreign tax credit carryforwardswhich the Company estimated it would be able to utilize in 2007.

 

As a result of the foregoing, consolidated net loss for the nine monthsended September 30, 2008 was $1.9 million, or a loss of ($0.09) perdiluted share, compared to consolidated net income of $17.2 million, or $0.81per diluted share, for the nine months ended September 30, 2007.

 

**Liquidity and Capital Resources**

 

TheCompany’s principal sources of liquidity are cash and cash equivalents, fundsfrom operations, and availability under its bank facilities. The Companybelieves that cash flows from operations and future borrowings will besufficient to fund its operating needs and capital requirements for at leastthe next 12 months on a consolidated basis and segment basis. However,depending on the 

 

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performanceof the gift segment in future periods, the Company likely will be required totake additional measures, including without limitation additional financing oroperational measures, to ensure sufficient liquidity for the gift segment incoming periods and future years.  However,there are no assurances that the Company will be able to obtain sufficientadditional financing on acceptable terms, if at all, and/or that operationalmeasures taken will be able to ensure the continued liquidity of the giftsegment.  See “Our debt covenants mayaffect our liquidity or limit our ability to complete acquisitions, incur debt,make investments, sell assets, merge or complete other significant transactions”,and “Our cash flows and capital resources may be insufficient to make required paymenton our indebtedness” in the “Risk Factors” section of the 2007 Form 10-K.

 

As of September 30,2008, the Company had cash and cash equivalents of $13.6 million compared to$21.9 million at December 31, 2007. Cash and cash equivalents decreased by$8.3 million during the nine months ending September 30, 2008 compared toan increase of $5.4 million during the nine months ending September 30,2007.  The decrease in cash and cashequivalents primarily reflects the use of excess cash to fund the losses incurredin the gift segment. As of September 30, 2008 and December 31, 2007,working capital was $62.3 million and $63.1 million, respectively.

 

Net cash provided by operating activities was $13.0 million during thenine months ended September 30, 2008 compared to net cash provided byoperating activities of $3.6 million during the nine months ended September 30,2007. The increase in the cash provided by operating activities for the ninemonths ended September 30, 2008 as compared to 2007 was primarily theresult of the acquisitions of LaJobi and CoCaLo.

 

Net cash used in investing activities was $74.1 million for the ninemonths ended September 30, 2008 compared to net cash used of $1.6 millionfor the nine months ended September 30, 2007. The increased usage wasprimarily related to: (i) the purchase of LaJobi ($52.0 million), (ii) thepurchase of CoCaLo ($16.6 million), and (iii) the $3.6 million payment ofthe Kids Line Earnout consideration.  Netcash provided by financing activities was $53.6 million for the nine monthsended September 30, 2008 compared to net cash provided by financingactivities of $2.9 million for the nine months ended September 30,2007.  The increase was due primarily therefinancing of the infant and juvenile credit facility to fund the Company’srecent acquisitions.

 

***RecentAcquisitions***

 

I.                                         LaJobi

 

On April 1, 2008,LaJobi, Inc. (“LaJobi”), a newly-formed and indirect, wholly-ownedDelaware subsidiary of the Company entered into an Asset Purchase Agreement(the “Asset Agreement”) with LaJobi Industries, Inc., a New Jerseycorporation (“Seller”), and each of Lawrence Bivona and Joseph Bivona(collectively, the “Stockholders”), for the purchase of substantially all ofthe assets used in the business of Seller and specified obligations.  The transactions contemplated by the AssetAgreement were consummated as of April 2, 2008.  All capitalized terms used in this Section Ibut undefined herein shall have the meanings ascribed to them in the AssetAgreement, which is filed as Exhibit 2.3 to the 2007 10-K.

 

The aggregate purchase price payable for the business ofSeller was equal to: $47.0 million, reduced by the amount of assumedindebtedness (including capitalized lease obligations) as adjusted pursuant toa working capital adjustment, plus the earnout consideration described below.At Closing, LaJobi paid $44.5 million in cash to Seller, plus $3.2 million (theestimated amount of the working capital adjustment). As the final workingcapital adjustment was $3.0 million, the Seller subsequently refunded $0.2million.  The remaining $2.5 millionof the purchase price was deposited in escrow at Closing in respect ofpotential indemnification claims.  Asadditional consideration, if the following conditions have been satisfied,LaJobi will pay the earnout consideration described below:

 

(a)     Subjectto paragraph (b) below, provided that the EBITDA of Seller’s business(the “Business”) (determined as provided in the Asset Agreement) has grown at acompound annual growth rate (“CAGR”) of not less than 4% during the period fromJanuary 1, 2008 through December 31, 2010 (the “Measurement Date”),as compared to the specified EBITDA of the Business for calendar year 2007,LaJobi will pay to Seller a percentage of the Agreed Enterprise Value of LaJobias of the Measurement Date or Early Measurement Date (as defined inparagraph (b) below), as the case may be. The amount of such paymentwill range from zero to a maximum amount of $15.0 million (the “LaJobi EarnoutConsideration”). The “Agreed Enterprise Value” will be the product of (i) theBusiness’s EBITDA during the twelve (12) months ending on the MeasurementDate or Early Measurement Date (or, in the event an Early Measurement Dateselected by Seller, as permitted by the Asset Agreement, is a date prior to January 1,2009, the annualized EBITDA of the Business for such period), as the case maybe, multiplied by (ii) an applicable multiple (ranging from 5 to9) depending on the specified levels of CAGR achieved, subject to the$15.0 million cap described above.

 

(b)    In the eventLaJobi, prior to the Measurement Date, relocates the principal location of theBusiness beyond an agreed distance, the calculation of the LaJobi EarnoutConsideration may be accelerated upon election of Seller. For purposes of 

 

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determining the LaJobi Earnout Consideration, the CAGRshall be based on the period from January 1, 2008 through the last day ofthe month (the “Early Measurement Date”) immediately preceding the date of therelocation. In such event, any LaJobi Earnout Consideration payable will bediscounted, at the Agreed Rate, from the scheduled payment date to, andincluding, the specified early payment date.

 

Any LaJobi Earnout Consideration will be recorded asadditional goodwill when and if paid.

 

Under the Asset Agreement, LaJobi is entitled toindemnification from Seller and the Stockholders for various matters,including, but not limited to, breaches of representations, warranties orcovenants, and specified excluded obligations, subject, in the case ofspecified matters, to certain minimum thresholds and a maximum aggregateindemnification limit of $10.0 million. The right to indemnification(other than with respect to certain specified exceptions) terminates18 months after the Closing Date.

 

In accordance with the Asset Agreement, LaJobi enteredinto (i) a transitional services agreement with a Thailand affiliate ofSeller, and (ii) a three year employment agreement with Lawrence Bivona asPresident of LaJobi. Mr. Bivona was formerly the President of Seller.

 

In connection with the Asset Agreement, the Company paida finder’s fee to a financial institution in the amount of $1.5 million atthe closing of the transaction, and has agreed to pay to such financialinstitution 1% of the Agreed Enterprise Value of LaJobi, payable in the samemanner and at the same time as the LaJobi Earnout Consideration is paid toSeller. Including the finder’s fee paid at the closing, the Company incurredaggregate transaction expenses of approximately $2.0 million in connection withthe LaJobi acquisition.

 

II.                           CoCaLo

 

On April 1, 2008, a newly-formed, wholly-ownedDelaware subsidiary of the Company, I&J Holdco, Inc. (the “CoCaLoBuyer”), entered into a Stock Purchase Agreement (the “Stock Agreement”) witheach of Renee Pepys Lowe and Stanley Lowe (collectively, the “Sellers”), forthe purchase of all of the issued and outstanding capital stock of CoCaLo, Inc.,a California corporation (“CoCaLo”). The transactions contemplated by the StockAgreement were consummated as of April 2, 2008.  All capitalized terms used in this Section Ibut undefined herein shall have the meanings ascribed to them in the StockAgreement, which is filed as Exhibit 2.4 to the 2007 10-K.

 

The aggregate base purchase price payable for CoCaLo wasequal to: (i) $16.0 million, minus (ii) the aggregate Debt ofCoCaLo outstanding at Closing (including accrued interest) of $4.0 million,minus (iii) specified transaction expenses ($0.3 million), plus (iv) aworking capital adjustment of $1.5 million paid by the CoCaLo Buyer. A portionof the purchase price ($1.6 million which was discounted to $1.4 millionfor financial statement purposes) was evidenced by a non-interest bearingpromissory note and will be paid as additional consideration in equal annualinstallments over a three year period from the Closing Date. The CoCaLo Buyerwill also pay the Additional Earnout Payments, if payable as described below.

 

The Additional Earnout Payments provide for a potentialpayment ranging from zero to a maximum of $4.0 million, payable withrespect to performance on three metrics – sales, gross profit and combined KidsLine and CoCaLo EBITDA — as follows:

 

(i)                                     $666,667 will be paidif CoCaLo’s aggregate net sales for the three years ending December 31,2010 (the “Measurement Period”) exceeds a specified target, and up to anadditional $666,667 will be paid, on a straight line sliding scale basis, tothe extent that CoCaLo’s net sales for the Measurement Period are between theinitial performance target and a specified maximum target.

 

(ii)                                  $666,667 will be paidif CoCaLo’s aggregate gross profit for the Measurement Period exceeds aspecified target, and up to an additional $666,667 will be paid, on astraight-line sliding scale basis, to the extent that CoCaLo’s aggregate grossprofit for the Measurement Period is between the initial performance target anda specified maximum target.

 

(iii)                               $666,666 will be paidif the aggregate EBITDA of Kids Line and CoCaLo for the Measurement Periodexceeds a specified target, and up to an additional $666,666 will be paid, on astraight-line sliding scale basis, to the extent that the aggregate EBITDA ofKids Line and CoCaLo is between the initial performance target and a specifiedmaximum target.

 

Any Additional Earnout payments will be recorded as additionalgoodwill when and if paid.

 

Kids Line has guaranteed all of the obligations of theCoCaLo Buyer under the Stock Agreement.

 

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Under the Stock Agreement, the CoCaLo Buyer is entitledto indemnification from the Sellers for various matters, including, but notlimited to, breaches of representations, warranties or covenants, andliabilities with respect to specified proceedings and obligations, subject, inthe case of specified matters, to certain minimum thresholds and a maximumaggregate indemnification limit of $3.0 million. The right to indemnification(other than with respect to certain specified exceptions) terminates on thethird anniversary of the Closing Date.

 

In accordance with the Stock Agreement, CoCaLo enteredinto a three year employment agreement with Renee Pepys Lowe as President andChief Executive Officer. Ms. Pepys Lowe was formerly the President andChief Executive Officer of CoCaLo.

 

***Financings***

 

*Background*

 

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

 

The Purchase was originally financed with the proceedsof a term loan, which was subsequently replaced by a $105.0 million creditfacility with LaSalle Bank as agent (the “2005 Credit Agreement”) and the 2005Canadian Credit Agreement (defined below). In order to reduce overall interestexpense and gain increased flexibility with respect to the financial covenantstructure of the Company’s senior financing, on March 14, 2006, the 2005Credit Agreement was terminated and the obligations thereunder were refinanced(the “LaSalle Refinancing”) with the execution of separate credit agreementsfor each of the Company’s infant and juvenile segment and domestic giftsegment. For a detailed description of such credit agreements, which aresummarized below, see Note 5 of Notes to Unaudited Consolidated FinancialStatements herein. In connection with the LaSalle Refinancing, all outstandingobligations under the 2005 Credit Agreement (approximately $76.3 million) wererepaid using proceeds from the senior credit facility of the infant andjuvenile segment executed in connection with the LaSalle Refinancing.

 

As part of the LaSalle Refinancing, RB formed awholly-owned Delaware subsidiary, Russ Berrie U.S. Gift Inc. (“U.S. Gift”) towhich it assigned (the “Assignment”) substantially all of its assets andliabilities which pertain primarily to its domestic gift business, such thatseparate loan facilities could be made directly available to each of theCompany’s infant and juvenile business and domestic gift business. TheAssignment transaction reinforced the operation of the Company as two separatesegments, and the credit facilities that have been extended to each segment areseparate and distinct. There are no cross-default provisions between the loanfacilities extended to the infant and juvenile segment and gift segment,respectively.

 

Pursuant to the Assignment, RB, our parent company, isnow organized as a holding company, with all of its operations being conductedthrough its subsidiaries.  RB, however,has continuing cash needs for corporate overhead expenses, taxes and otherpurposes (collectively, the “Requirements”). Our current credit agreementscontain significant limitations on the ability of RB’s domestic subsidiaries,to distribute cash, including in the form of dividends, loans or otheradvances, to RB to pay for its Requirements (such limitations are described inmore detail below). Management believes that the amounts permitted to bedistributed to RB by its domestic subsidiaries will be sufficient to fund theRequirements, although there can be no assurance that such Requirements willnot exceed current estimates. Although there are no restrictions in our currentcredit agreements on the ability of RB’s foreign subsidiaries to distributecash to RB, available cash therefrom may be insufficient to cover theRequirements without additional distributions from RB’s domestic subsidiaries.Because RB is dependent upon cash distributions from its domestic subsidiaries,if such domestic subsidiaries are unable to distribute sufficient cash to RB tomeet its Requirements without triggering a default under our current creditagreements, this could have a material adverse impact on the Company’sliquidity.

 

In connection with the purchases of LaJobi and CoCaLo(described above under the section captioned “Recent Acquisitions”), the creditagreement applicable to the Company’s infant and juvenile segment was amendedand restated to, among other things, increase the facilities availablethereunder and permit such acquisitions, all as described below.

 

At September 30, 2008, there was approximately$23.1 million borrowed under the New Revolving Loan and approximately $6.4million borrowed under the Giftline Revolver (each as defined below), all ofwhich is classified as short-term debt. At 

 

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December 31, 2007, there was approximately $15.5million borrowed under the Original Revolving Loan (as defined below) andapproximately $7.8 million borrowed under the Giftline Revolver, all of whichis classified as short-term debt.

 

*A. The Infantline Credit Agreement*

 

On March 14, 2006 (the “Closing Date”), Kids Line,LLC. (“KL”) and Sassy, Inc. (“Sassy”) entered into a credit agreement asborrowers, on a joint and several basis, with LaSalle Bank National Associationas administrative agent and arranger (the “Agent”), the lenders from time totime party thereto, Russ Berrie and Company, Inc. (“RB”) as loan partyrepresentative, Sovereign Bank as syndication agent, and Bank of America, N.A.as documentation agent (as amended on December 22, 2006, the “InfantlineCredit Agreement”). The original commitments under the Infantline CreditAgreement consisted of (a) a $35.0 million revolving credit facility (the “OriginalRevolving Loan”), with a subfacility for letters of credit in an amount not toexceed $5.0 million, and (b) a term loan facility in the original amountof $60 million (the “Original Term Loan”).

 

As of December 22, 2006 the Infantline CreditAgreement was amended (the “First Amendment”) to permit the repayment andsubsequent reborrowing of up to $20 million under the Original Term Loan, whichwas intended to enable KL and Sassy to continue to utilize cash flows expectedto be generated from operations to repay debt until the earnout considerationfor the purchase of Kids Line, LLC (the “KL Earnout Consideration”) becamedue.  Pursuant to the First Amendment, KLand Sassy borrowed $20 million under the Original Revolving Loan, theoutstanding balance of which had previously been reduced to zero, and utilizedthe proceeds of such draw to prepay $20 million of the Original Term Loan. Thelenders then provided an additional term loan reborrowing commitment (the “TRCommitment”) of an aggregate maximum principal amount of $20 million, whichamounts could only be reborrowed during specified periods and only to fund thepayment of the KL Earnout Consideration. Pursuant to the First Amendment, KL and Sassy paid a non-use fee inrespect of undrawn amounts of the TR Commitment at a per annum rate of 0.375%of the daily average of the undrawn amounts. In December 2007, KL and Sassy paid $28.5 million of the KL EarnoutConsideration, which amount was financed by drawing the TR Commitment of $20million and drawing an additional $8.5 million on the Original Revolving Loan.The remaining portion of the KL Earnout Consideration ($3.6 million) was paidby KL and Sassy in January of 2008, also through a draw on the OriginalRevolving Loan.

 

As of April 2, 2008, RB, KL, Sassy, the CoCaLoBuyer, LaJobi and CoCaLo (via a Joinder Agreement) entered into an Amended andRestated Credit Agreement (the “Amendment”) with certain financial institutionsparty to the Infantline Credit Agreement or their assignees (the “Lenders”),LaSalle Bank National Association, as Agent and Fronting Bank, Sovereign Bankas Syndication Agent, Wachovia Bank, N.A. as Documentation Agent and Banc ofAmerica Securities LLC as Lead Arranger. KL, Sassy, the CoCaLo Buyer, LaJobi and CoCaLo are referred to hereincollectively as the “Infantline Borrowers”, and the CoCaLo Buyer, LaJobi andCoCaLo are referred to herein as the “New Borrowers”.  The Amendment amends and restates theInfantline Credit Agreement, and adds the New Borrowers as partiesthereto.  The Pledge Agreement dated asof March 14, 2006 between RB and the Agent (as amended on December 22,2006) was also amended and restated as of April 2, 2008, to provide, amongother things, for a pledge of the capital stock of the CoCaLo Buyer by RB.  In connection with the Amendment, 100% of theequity of each Infantline Borrower, including each New Borrower, has beenpledged as collateral to the Agent.  Inaddition, the Guaranty and Collateral Agreement (as defined in the Amendment)was also amended and restated as of April 2, 2008, to add the NewBorrowers as parties and to include substantially all of the existing andfuture assets and properties of the New Borrowers as security for thesatisfaction of the obligations of all Infantline Borrowers, including the NewBorrowers, under the Amendment and the other related loan documents.

 

The commitments under the Amendment consist of (a) a$75.0 million revolving credit facility (the “New Revolving Loan”), with asubfacility for letters of credit in an amount not to exceed $5.0 million, and (b) a$100.0 million term loan facility (the “New Term Loan”). The InfantlineBorrowers drew down $31.0 million under the New Revolving Loan and the entire$100 million available under the New Term Loan on the Closing Date, in order tofinance the acquisitions of LaJobi and CoCaLo, and pay related transactionexpenses of such acquisitions and the Amendment, and to reallocate the existingindebtedness among the bank syndicate. The scheduled maturity date has been extended from March 14, 2011to April 1, 2013 (subject to customary early termination provisions).  The principal of the Original Term Loan wasto be repaid on a monthly basis as follows: $9.0 million for each of years 1-2;$12.0 million for year 3; and $15.0 million for each of years 4-5.  Pursuant to the Amendment, the principal ofthe New Term Loan will be repaid, on a quarterly basis, at an annual rate of$14.4 million per year, commencing June 30, 2008 thru June 30, 2012and $31.6 million due on April 1, 2013.

 

The Infantline Loans bear interest at a rate per annumequal to the Base Rate (for Base Rate Loans) or the LIBOR Rate (for LIBORLoans) at the option of the Infantline Borrowers, plus an applicable margin, inaccordance with a pricing grid based on the most recent quarter-end Total Debtto EBITDA Ratio, which applicable margin, prior to the execution of theAmendment ranged from 1.75% - 2.50% for LIBOR Loans and from 0.25% - 1.00% forBase Rate Loans.  Pursuant to theAmendment, the margins now range from 2.0% - 3.0% for LIBOR Loans and from0.50% - 1.50% for Base Rate Loans.

 

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The applicable interest rate margins as of September 30,2008 were: 2.75% for LIBOR Loans and 1.25% for Base Rate Loans. The weightedaverage interest rates for the outstanding loans as of September 30, 2008were as follows:

 
| ** **           | ** ** | **At September 30, 2008** | ** ** |
|----------------------|------------|------------------------------------------|------------|
| ** **           | ** ** | **LIBOR Loans**                     | ** ** | **Base Rate Loans** | ** ** |
| Infantline Revolver  |       | 5.22                                     | %          | 6.25 | % |
| Infantline Term Loan |       | 5.22                                     | %          | 6.25 | % |

 

Inconnection with the Amendment, the Infantline Borrowers paid the Agent andLenders a closing fee of approximately $1.5 million, and the Company incurred$0.7 million of other third party costs. Of the aggregate fees and costs, $0.4 million was expensed to interestexpense in the three months ended June 30, 2008 and the remainder wastreated as deferred financing costs and will be recognized over the term of therespective types of indebtedness using the effective interest method.   In connection with the Amendment, theCompany also wrote-off during the second quarter of 2008 $0.3 million ofunamortized deferred financing costs.

 

Inaddition, pursuant to the Amendment, the following fees are nowapplicable:  an agency fee of $35,000 perannum, an annual non-use fee (payable monthly, in arrears, and upon terminationof the relevant obligations) of 0.40% to 0.60% of the unused amounts under theRevolving Loan, an annual letter of credit fee (payable monthly, in arrears,and upon termination of the relevant obligations) for undrawn amounts withrespect to each letter of credit based on the most recent quarter-end TotalDebt to EBITDA Ratio ranging from 2.75% - 3.25% and other customary letter ofcredit administration fees.  On August 13,2008, the Amendment was further amended (the “August Modification”) toclarify the definition of EBITDA as applied to, among other things, the TotalDebt to EBITDA Ratio for the last three quarters of 2008.

 

The Infantline Borrowers are required to makeprepayments of the New Term Loan upon the occurrence of certain transactions,including most asset sales or debt or equity issuances, and pursuant to theAmendment, extraordinary receipts. Commencing in early 2008 with respect tofiscal year 2007, annual mandatory prepayments of the Original Term Loan wouldhave been required in an amount equal to 50% of Excess Cash Flow for eachfiscal year unless the Total Debt to EBITDA Ratio for such fiscal year wasequal to or less than 2.00:1.00. For fiscal year 2007, no Excess Cash Flowpayment was required, and pursuant to the Amendment, this requirement has beeneliminated in its entirety.

 

TheAmendment contains customary affirmative and negative covenants.  as well as the following financial covenants:(i) a minimum Fixed Charge Coverage Ratio, (ii) a maximum Total Debtto EBITDA Ratio and (iii) an annual capital expenditure limitation.  Upon the occurrence of an event of defaultunder the Amendment, including a failure to remain in compliance with allapplicable financial covenants, the lenders could elect to declare all amountsoutstanding under the Amendment to be immediately due and payable.  If tested on such date, the InfantlineBorrowers would have been non-compliant with the Total Debt to EBITDA Ratio on June 30,2008.  The August Modification,however, which clarified the definition of EBITDA (among other things, as itapplies to such ratio for the last three quarters of 2008), was executed priorto any default with respect to such ratio. As a result, the Infantline Borrowers were in compliance with allapplicable financial covenants in the Amendment as of September 30, 2008.

 

The Amendment contains significant limitations on theability of the Infantline Borrowers to distribute cash to RB, which became acorporate holding company by virtue of the Assignment, for the purpose ofpaying dividends to the shareholders of the Company or for the purpose ofpaying their allocable portion of RB’s corporate overhead expenses.  Prior to the effectiveness of the Amendment,KL and Sassy were not permitted (except in specified situations) to distributecash to RB to pay RB’s overhead expenses unless: (i) before and aftergiving effect to such distribution, no event of default would exist and (ii) beforeand after giving effect to such distribution, Excess Revolving LoanAvailability will equal or exceed $4.0 million; provided that the aggregateamount of such distributions could not exceed $2.0 million per year.  Pursuant to the Amendment, the $4.0 millionavailability threshold was increased to $5.0 million, and the aggregate maximumamount of such distributions was increased to $3.5 million, and apply in eachcase to all Infantline Borrowers.  Otherrestrictions on dividends and distributions to RB remain unchanged by theAmendment.

 

The Amendment also effected the following additionalchanges, among others, to the Infantline Credit Agreement:

 

(i)            Thedefinition of Borrowing Base was amended from 85% of eligible receivables plus55% of eligible inventory to 85% of eligible receivables plus the lesser of (x) $25.0million and (y) 55% of eligible inventory;

 

(ii)           Paymentof the amounts outstanding under the promissory note under the Stock Agreementis prohibited if before and after giving effect to any such repayment, adefault or event of default would exist;

 

(iii)          Paymentof the LaJobi Earnout Consideration or the CoCaLo Additional Earnout Paymentsis prohibited if before and after giving effect to any such repayment, (a) adefault or event of default would exist, (b) Excess Revolving LoanAvailability will not equal or exceed $9.0 million, or (c) before andafter giving effect to any such repayment, the Infantline Financial Covenantswill not be satisfied (the “Earnout Conditions”);

 

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(iv)                             Specified defaults withrespect to the LaJobi Earnout Consideration and/or the CoCaLo AdditionalEarnout Payments have been added as events of default (including failure todeliver to the Agent specified certifications and calculations within aspecified time period, the reasonable determination by the Agent that anyEarnout Conditions will not be satisfied as of the applicable payment date, ifany material information provided to the Agent with respect to the EarnoutConditions shall be incorrect in any material respect and remain unremediedprior to the relevant payment date, or any LaJobi Earnout Consideration orAdditional Earnout Payments are paid at any time that the Earnout Conditionsare not satisfied); and

 

(v)                                The InfantlineBorrowers are required to maintain in effect Hedge Agreements that protectagainst potential fluctuations in interest rates with respect to a minimum of50% of the outstanding amount of the New Term Loan.

 

TheRevolving Loan Availability at September 30, 2008 was $27.2 million.

 

Pursuant to the requirement to maintain Hedge Agreements discussedabove, on May 2, 2008, the Infantline Borrowers entered into an interestrate swap agreement with a notional amount of $70 million as a risk managementtool to lock the interest cash outflows on the floating rate debt.  However, because the Company did not meet thecriteria for hedge accounting under SFAS No. 133 for this instrument,changes in the fair value of the interest rate swap will be remeasured throughoperations each period.  Changes betweenits cost and its fair value as of September 30, 2008 resulted in an expenseof approximately $125,000 for the three months ended September 30, 2008,resulting in a net $33,000 of income for the nine months ended September 30,2008 and such amounts are included in interest expense in the respectiveconsolidated statements of operations.

 

*B. The Giftline Credit Agreement*

 

On March 14, 2006, as amended on April 11,2006, August 8, 2006, December 28, 2006 and August 7, 2007, RussBerrie U.S. Gift Inc. (“U.S. Gift”) and other specified wholly-owned domesticsubsidiaries of RB (collectively, the “Giftline Borrowers”), entered into acredit agreement as borrowers, on a joint and several basis, with LaSalle BankNational Association, as issuing bank (the “Issuing Bank”), LaSalle BusinessCredit, LLC as administrative agent (the “Administrative Agent”), thelenders from time to time party thereto, and the Company, as loan partyrepresentative (as amended, the “Giftline Credit Agreement”). Unless otherwisespecified herein, capitalized terms used but undefined in this, Section Bshall have the meanings ascribed to them in the Giftline Credit Agreement.

 

Prior to the August 8, 2007 amendment to theGiftline Credit Agreement (the “Fourth Amendment”), the Giftline CreditAgreement consisted of a maximum revolving credit loan commitment (the “GiftlineRevolver”) in an amount equal to the lesser of (i) $15.0 million(with a maximum availability of $13.5 million) and (ii) thethen-current Borrowing Base, in each case minus amounts outstanding under theCanadian Credit Agreement (as defined below), with a sub-facility for lettersof credit to be issued by the Issuing Bank in an amount not to exceed$8.0 million. The Fourth Amendment increased the aggregate totalCommitment under the Giftline Credit Agreement from $15.0 million to $25.0 million,and amended the definition of Revolving Loan Availability so that it now equalsthe difference between (a) the lesser of (x) the Maximum RevolvingCommitment in effect at such time and (y) the Borrowing Base at such time,minus (b) the sum of the aggregate principal amount of all “Loans”, “SpecifiedHedging Obligations” and the “Stated Amount” of all “Letters of Credit”outstanding or requested but not yet funded under the Canadian Loan Agreement.The Borrowing Base is primarily a function of a percentage of eligible accountsreceivable and eligible inventory. As of September 30, 2008, theoutstanding balance on the Giftline Revolver was $6.4 million, there wasno outstanding balance on the Canadian Revolving Loan (see Section Cbelow), and there was $1.1 million utilized under the Canadiansub-facility for letters of credit. At September 30, 2008, based onavailable collateral, the unused amount available to be borrowed under theGiftline Revolver was $2.7 million.

 

All outstanding amounts under the Giftline Revolver aredue and payable on March 14, 2011, subject to earlier termination inaccordance with the terms of the Giftline Credit Agreement.

 

The Giftline Revolver bears interest at a rate per annumequal to the sum of the Base Rate (for Base Rate Loans) or the LIBOR Rate (forLIBOR Loans), at the Company’s option plus an applicable margin, which marginwas originally 2.75% for LIBOR Loans and 1.25% for Base Rate Loans. However,pursuant to the December 28, 2006 amendment to the Giftline CreditAgreement (the “Third Amendment”), the interest rates applicable to theGiftline Revolver were reduced such that the applicable margin is nowdetermined in accordance with a pricing grid based on the most recentquarter-end Daily Average Excess Revolving Loan Availability, which applicablemargins shall range from 2.00% - 2.75% for LIBOR Loans and from 0% -0.50% for Base Rate Loans. Interest is due and payable in the same manner aswith respect to the Infantline Loans. The applicable interest rate margins asof September 30, 2008 were 2.25% for LIBOR Loans and 0.25% for Base RateLoans. At September 30, 2008, the interest rate was 5.25% for the oneoutstanding Base Rate loan ($0.4 million) and 5.44% for one outstanding LIBORloan ($6.0 million).

 

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In connection with the execution of the Giftline CreditAgreement, the Infantline Borrowers paid (on behalf of the Giftline Borrowers)aggregate closing fees of $0.15 million and an aggregate agency fee of$20,000.  Aggregate agency fees of$20,000 will be payable by the Giftline Borrowers on each anniversary of theClosing Date. Pursuant to the Third Amendment, the Giftline Revolver is subjectto an annual non-use fee (payable monthly, in arrears, and upon termination ofthe relevant obligations), ranging from 0.375% to 0.50% for unused amountsunder the Giftline Revolver, and an annual letter of credit fee ranging from2.00% to 2.75%. Other fees are as described in the Giftline Credit Agreement.

 

Receivable and disbursement bank accounts of theGiftline Borrowers are required to be with the Administrative Agent or itsaffiliates, and cash in such accounts is swept on a daily basis to pay downoutstanding amounts under the Giftline Revolver.

 

The Giftline Credit Agreement contains customaryaffirmative and negative covenants substantially similar to those applicable tothe Amendment. The Giftline Credit Agreement originally contained the followingfinancial covenants: (i) a minimum EBITDA test, (ii) a minimum ExcessRevolving Loan Availability requirement of $5.0 million, (iii) anannual capital expenditure limitation and (iv) a minimum Fixed ChargeCoverage Ratio (for quarters commencing with the quarter ended March 31,2008). On August 8, 2006, the Giftline Credit Agreement was amended tolower the threshold on the Minimum EBITDA covenant by $1.0 million perquarter for each of four consecutive quarters commencing with the quarterending September 30, 2006. The Third Amendment (i) eliminated intheir entirety both the minimum EBITDA financial covenant and the Fixed ChargeCoverage Ratio financial covenant and (ii) reduced the minimum ExcessRevolving Loan Availability requirement from $5.0 million to$3.5 million. The Fourth Amendment eliminated the existing ExcessRevolving Loan Availability requirement, and re-instituted a Fixed ChargeCoverage Ratio covenant based on the last day of any month for the applicableComputation Period (as defined in the Fourth Amendment) ending on such date.The Fixed Charge Coverage Ratio now specifies that the Fixed Charge CoverageRatio, as determined for the Computation Period ending on the last day of anymonth, may not be less than 1.1:1.0. This covenant is only applicable, however,if during the three month period then ending on such date of determination (the“Test Period”) Revolving Loan Availability (defined above) was less than$3.5 million for any three (3) consecutive business day period (the “TestCondition”). If compliance is required because the Test Condition was not met,the Giftline Borrowers will be required to deliver a specified compliancecertificate to the Administrative Agent. In addition, the Giftline Borrowersmust comply with the Fixed Charge Coverage Ratio covenant for a period of threeconsecutive months after they fail to satisfy the Test Condition. The Company’savailability was not less than $3.5 million during the quarter ended September 30,2008 and the Fixed Charge Coverage Ratio was not applicable during thequarter.  As of September 30, 2008,the Company was in compliance with the remaining financial covenants containedin the Giftline Credit Agreement.

 

In addition to the changes discussed above, the FourthAmendment permits, subject to specified conditions, the mergers of specifiedinactive subsidiaries of RB with and into RB (including certain GiftlineBorrowers), and increases the amount of in-transit inventory which may bedeemed “Eligible Inventory” under specified circumstances from$3.0 million to $8.0 million.

 

The Giftline Credit Agreement contains significantlimitations on the ability of the Giftline Borrowers to distribute cash to RBfor the purpose of paying dividends to the shareholders of the Company or forthe purpose of paying their allocable portion of RB’s corporate overheadexpenses, including a cap (subject to certain exceptions) on the amount thatcan be provided to RB to reimburse for corporate overhead expenses equal to$5.0 million for each fiscal year commencing in 2008. The Third Amendmentpermits the Giftline Borrowers to pay dividends or make distributions to RB ifno default or event of default exists or would result therefrom and immediatelyafter giving effect to such payments, there is at least $1.5 millionavailable to be drawn under the Giftline Revolver. The amount of any suchpayments to RB cannot exceed the amount of capital contributions made by RB tothe Giftline Borrowers after December 28, 2006, which are used by theGiftline Borrowers to pay down the Giftline Revolver minus the total amount ofdividends or other distributions made by the Giftline Borrowers to RB underthis provision of the Giftline Credit Agreement.

 

In order to secure the obligations of theGiftline Borrowers, the Giftline Borrowers pledged and have granted securityinterests to the Administrative Agent in substantially all of their existingand future personal property, and each Giftline Borrower guaranteed theperformance of the other Giftline Borrowers under the Giftline CreditAgreement. In addition, RB provided a limited recourse guaranty of theobligations of the Giftline Borrowers under the Giftline Credit Agreement. Thisguarantee is secured by a lien on the assets intended to be assigned to U.S.Gift pursuant to the Assignment. RB also pledged 100% of the equity interestsof each of the Giftline Borrowers and 65% of its equity interests in certain ofits First Tier Foreign Subsidiaries to the Administrative Agent (the “GiftlinePledge Agreement”). The Giftline Pledge Agreement contains substantiallysimilar limitations on the activities of RB as is set forth in the InfantlinePledge Agreement.

 

*C. Canadian Credit Agreement*

 

As contemplated by the 2005 Credit Agreement, on June 28,2005, the Company’s Canadian subsidiary, Amram’s Distributing Ltd. (“Amrams”),executed a separate Credit Agreement (acknowledged by RB) with the financialinstitutions party 

 

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thereto and LaSalle Business Credit, a division of ABNAMRO Bank, N.V., Canada Branch, a Canadian branch of a Netherlands bank,as issuing bank and administrative agent (the “Canadian Credit Agreement”), andrelated loan documents with respect to a maximum U.S. $10.0 millionrevolving loan (the “Canadian Revolving Loan”). RB executed an unsecuredGuarantee (the “Canadian Guarantee”) to guarantee the obligations of Amramsunder the Canadian Credit Agreement. In connection with the LaSalleRefinancing, on March 14, 2006, the Canadian Credit Agreement was amendedto (i) replace references to the 2005 Credit Agreement with the GiftlineCredit Agreement (such that, among other conforming changes, a default underthe Giftline Credit Agreement will be a default under the Canadian CreditAgreement), (ii) release RB from the Canadian Guaranty and (iii) providefor a maximum U.S. $5.0 million revolving loan. In connection with therelease of the Company from the Canadian Guaranty, U.S. Gift executed anunsecured Guarantee to guarantee the obligations of Amrams under the CanadianCredit Agreement. A default under the Amendment will not constitute a defaultunder the Canadian Credit Agreement. There were no borrowings under theCanadian Revolving Loan as of September 30, 2008 and December 31,2007.

 

The Commitments under the Canadian Credit Agreement bearinterest at a rate per annum equal to the sum of the Base Rate (for Base RateLoans) or the LIBOR Rate (for LIBOR Loans) plus an applicable margin. As of September 30,2008 and December 31, 2007, there were no Base Rate or Libor Loansoutstanding under the Canadian Credit Agreement.

 

*D.  Russ Berrie (UK) LimitedBusiness Overdraft Facility*

 

On March 19, 2007, Russ Berrie UK Limitedentered into a Business Overdraft Facility (the “Facility”) with NationalWestminster Bank PLC (the “Bank”) and The Royal Bank of Scotland plc(“RBS”), acting as agent for the Bank. The Facility, as amended, consists of amaximum credit line of £1.5 million. Interest is charged on amountsoutstanding under the Facility at an annual rate of 1.5% over the Bank’s BaseRate, which interest rate spread will be increased to 3.5% for any amountsoutstanding in excess of the maximum limit. The Facility is secured by a lienon substantially all of the assets of Russ Berrie UK Limited. The Facility wasestablished to assist in meeting the working capital requirements of RussBerrie UK Limited. As of September 30, 2008 and December 31, 2007,there were no borrowings outstanding under the Facility.

 

**Other Events and Circumstances Pertaining to Liquidity**

 

In theevent that additional initiatives related to the previously implemented ProfitImprovement Program (“PIP”) are undertaken, certain significant restructuringcharges may be recognized.  As thedetermination to implement any or all such initiatives has not yet been made,estimates of the range of any additional charges or other related expenditurescannot be determined at this time.  Seeour Annual Report on Form 10-K for the year ended December 31, 2007for a detailed description of the PIP. Depending on the performance of the giftsegment in future periods, the Company likely will be required to takeadditional measures, including without limitation additional financing or operationalmeasures, to ensure sufficient liquidity for the gift segment.

 

Sassy has operated under a distributionagreement with MAM Babyartikel GmbH of Vienna, Austria (the “MAM Agreement”)prior to and after the acquisition of Sassy by the Company in 2002. Based onseveral factors, including the views of the Company’s new chief executiveofficer (in consultation with senior management), the inability to obtainconcessions from MAM during discussions in December 2007, the decreasingprofitability of the products sold under the MAM Agreement and specifiedrestrictions contained therein limiting the Company’s ability to enter intocompetitive product categories, the Company exercised its right to terminatethe MAM Agreement and recognized an impairment charge for $6.4 million,effective as of March 26, 2008. The Company expects to continue todistribute MAM products throughout 2008 pursuant to contractual transitionprocedures, but anticipates that it will experience a 2009 sales decline ofapproximately $20-25 million (although, as noted above, the agreementgenerates only limited profitability), until such time as the Company cangenerate replacement or alternate product sales. Pursuant to the MAM Agreement,the Company will be restricted from selling products competitive with the MAMproducts for a period of one year following the termination of the MAMAgreement.

 

The Company enters into foreign currency 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.  As of September 30, 2008, the Companyhad outstanding forward contracts with a notional amount totaling approximately$3.7 million.  See Note 9 of Notes toUnaudited Consolidated Financial Statements.

 

The Company is dependent upon information technology systems in manyaspects of its business. In 2002, the Company commenced a global implementationof an Enterprise Resource Planning (“ERP”) system for its gift businesses.  During 2003 and continuing into 2004, certainof the Company’s international gift subsidiaries began to phase in aspects ofthe new ERP system.  In late 2005, theCompany began to explore alternative global information technology systems forits gift business that could provide greater efficiencies, lower costs andgreater reporting capabilities than those provided by the current ERPsystem.  As a result of this review, allremaining international implementations were placed on hold pending a decisionon whether or not to replace the current 

 

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ERPsystem.  The Company has not yet made adecision on whether to replace its current ERP system and will continue toexplore whether such replacement is advisable.

 

The Company is subject to legal proceedings and claims arising in theordinary course of its business that the Company believes will not have amaterial adverse impact on the Company’s consolidated financial condition,results of operations or cash flows.

 

Consistent with its past practices and in the normal course of itsbusiness, the Company regularly reviews acquisition opportunities of varyingsizes.  See Note 2 of Notes to UnauditedConsolidated Financial Statements and “Recent Acquisitions” above for adescription of our recent acquisitions of LaJobi and CoCaLo.  The Company may consider the use of debt orequity financing to fund potential future acquisitions.  Our currentcredit agreements impose restrictions on the Company that could limit itsability to respond to market conditions or to take advantage of acquisitions orother business opportunities.  See “Financings”above.

 

The Company has entered into certain transactions withcertain parties who are considered related parties, and these transactions aredisclosed in Note 15 of Notes to Consolidated Financial Statements andItem 13, “Certain Relationships and Related Transactions and DirectorIndependence” of the 2007 10-K and Note 15 to Unaudited Consolidated FinancialStatement herein.  In addition, certain of our principalstockholders own significant equity stakes in certain customers of the Company.  Arrangements with such customers arenegotiated on an arms-length basis without regard to such relationships. SeeNote 15 of Notes to Consolidated Financial Statements herein.

 

**Contractual Obligations**

 

The following table summaries the Company’s significant known contractualobligations as of September 30, 2008 and the future periods in which suchobligations are expected to be settled in cash (in thousands):

 
| ** **                                 | ** ** | **Total** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **Thereafter** | ** ** |
|--------------------------------------------|------------|-----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|
| Operating Lease Obligations                |       | $         | 43,902     |     | $          | 2,071    |       | $        | 7,705      |     | $          | 6,897    |       | $              | 6,172      |   | $ | 6,177 |   | $ | 14,880 |   |
| Capitalized Leases                         |       | 684       |       | 103      |       | 367      |       | 211      |       | 3        |       | —   |       | —         |       |
| Purchase Obligations(1)                    |       | 56,842    |       | 56,842   |       | —   |       | —   |       | —   |       | —   |       | —         |       |
| Debt Repayment Obligations(2)              |       | 92,800    |       | 3,600    |       | 14,400   |       | 14,400   |       | 14,400   |       | 14,400   |       | 31,600         |       |
| Note Payable (3)                           |       | 1,600     |       | —   |       | 533      |       | 533      |       | 534      |       | —   |       | —         |       |
| Interest on Debt Repayment  Obligations(4) |       | 14,974    |       | 1,251    |       | 4,510    |       | 3,718    |       | 2,926    |       | 2,134    |       | 435            |       |
| Royalty Obligations                        |       | 4,696     |       | 636      |       | 2,355    |       | 555      |       | 500      |       | 650      |       | —         |       |
| Total Contractual Obligations              |       | $         | 215,498    |     | $          | 64,503   |       | $        | 29,870     |     | $          | 26,314   |       | $              | 24,535     |   | $ | 23,361 |   | $ | 46,915 |   |

 

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

 

(2)           Reflects repayment obligations underthe Amendment effective as of April 2, 2008. See Note 5 of Notes toUnaudited Consolidated Financial Statements for a description of the Amendment,including amounts and dates of repayment obligations and provisions thatcreate, increase and/or accelerate obligations thereunder. Excludes revolvingloan facilities, including, as of September 30, 2008, approximately$23.1 million borrowed under the New Revolving Loan and approximately$6.4 million borrowed under the Giftline Revolver. The estimated interestpayment for these Revolving Loans using a 5.5% interest rate for 2008 is $1.2million.  The revolving loan facilitiesmature in March 2011 (the Giftline Revolver) and April 2013 (the NewRevolving Loan), at which time any amounts outstanding are due and payable.

 

(3)           Reflects note payable with respect toCoCaLo purchase. The present value of the note is $1,479,000 and the aggregateremaining imputed interest at 5.5% is $121,000. Upon the occurrence of an eventof default under the note, the holder could elect to declare all amountsoutstanding to be immediately due and payable.

 

(4)           This amount reflects estimatedinterest payments on the long-term debt repayment obligation as of September 30,2008 calculated using an interest rate of 5.5% and then- current levels ofoutstanding long-term debt. Such amounts are estimates only and actual interestpayments could differ materially.

 

Of the total income tax payable of $9.9 million, theCompany has classified $5.7 million as current; as such amount is expectedto be resolved within one year. The remaining amount has been classified as along-term liability. These amounts are not included in the above table as thetiming of their potential settlement is not reasonably estimable.

 

In connection with the acquisitions of LaJobi andCoCaLo, the Company has agreed to make certain potential earnout payments basedon the performance of the acquired businesses. See “Management’s Discussion and Analysis of Results of Operations andFinancial Condition — Recent Acquisitions.”

 

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**Off Balance Sheet Arrangements**

 

As of September 30, 2008, there have been nomaterial changes in the information provided under the caption “Off BalanceSheet Arrangements” of Item 7 of the 2007 10-K.

 

**CRITICAL ACCOUNTING POLICIES**

 

The SEC has issued disclosure advice regarding “critical accountingpolicies”, defined as accounting policies that management believes are bothmost important to the portrayal of the Company’s financial condition andresults and require application of management’s most difficult, subjective orcomplex 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 and assumptions duringthe preparation of its consolidated financial statements that affect thereported amounts of assets, liabilities, revenue and expenses, and relateddisclosure of contingent assets and liabilities. Estimates and assumptions arereviewed periodically, and revisions made as determined to be necessary bymanagement.  There have been no materialchanges to the Company’s significant accounting estimates and assumptions orthe judgments affecting the application of such estimates and assumptionsduring the period covered by this report from those described in the Company’s2007 10-K.

 

Also see Note 2 of Notes to Consolidated Financial Statements of the 200710-K for a summary of the significant accounting policies used in thepreparation of the Company’s consolidated financial statements.  See Note 3 of Notes to Unaudited ConsolidatedFinancial Statements herein for a discussion of the assumptions used inshare-based payment valuations.

 

**Recently Issued Accounting Standards**

 

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements” (SFAS No. 157), which defines fair value,establishes a framework for measuring fair value and expands disclosures aboutfair value measurements.  In February 2008, the FASB issued FASBStaff Position SFAS No. 157-2, “Effective Date of FASB Statement No. 157”,which delayed the effective date of SFAS No. 157 for all non-financialassets and liabilities, except those that are recognized or disclosed at fairvalue in the financial statements on a recurring basis, until January 1,2009.  The impact of the adoption of SFAS No. 157 for financialassets and liabilities on a recurring basis was not material to itsconsolidated interim financial statements.  The expanded disclosures aboutfair value measurements for financial assets and liabilities are presented inNote 10 of Notes to Unaudited Consolidated Financial Statements herein. On January 1, 2008, the Company adopted SFAS 157 for financial assets andliabilities, as well as for any other assets and liabilities that are carriedat fair value on a recurring basis in financial statements.  As of September 30, 2008, the Companydid not have any non-financial assets and liabilities that are carried at fairvalue on a recurring basis in the financial statements.  The Company has not yet determined the impactthat the adoption of SFAS No. 157 will have on its non-financial assetsand liabilities which are not recognized on a recurring basis; however theCompany does not anticipate it will materially impact its consolidatedfinancial position, results of operations and cash flows.

 

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

 

In December 2007, SFAS No. 141R(revised 2007), “Business Combinations,” was issued.  This statement requires an acquirer torecognize assets acquired, the liabilities assumed, and any noncontrollinginterest in the acquiree at their fair values on the acquisition date, withgoodwill being the excess value over the net identifiable assets acquired.  This statement is effective for businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15,2008.  The Company is currentlyevaluating the effect the adoption of this standard will have on any potentialfuture acquisitions that may occur on or after January 1, 2009.

 

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

 

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In April 2008, the FASB issued Staff Position No. 142-3,“Determination of the Useful Life of Intangible Assets” (“FSP 142-3”). FSP142-3 amends the factors that should be considered in developing renewal orextension assumptions used to determine the useful life of a recognizedintangible asset under SFAS No. 142, “Goodwill and Other IntangibleAssets.” FSP 142-3 is effective for fiscal years beginning after December 15,2008 and interim periods within those fiscal years, requiring prospectiveapplication to intangible assets acquired after the effective date. The Companywill be required to adopt the principles of FSP 142-3 with respect tointangible assets acquired on or after January 1, 2009. Due to theprospective application requirement, the Company is unable to determine whateffect, if any, the adoption of FSP 142-3 will have on its consolidatedfinancial position, results of operations and cash flows.

In June 2008, FASB ratified EITF Issue No. 08-3,“Accounting by Lessees for Nonrefundable Maintenance Deposits” (“EITF No. 08-3”).  EITF No. 08-3 requires that allnonrefundable maintenance deposits be accounted for as a deposit with thedeposit expensed or capitalized in accordance with the lessee’s maintenanceaccounting policy when the underlying maintenance is performed. Once it isdetermined that an amount on deposit is not probable of being used to fundfuture maintenance expense, it is to be recognized as additional expense at thetime such determination is made. EITF No. 08-3 is effective beginningafter January 1, 2009.  The Companyis currently evaluating the effect of adopting EITF No. 08-3 on itsconsolidated financial position, results of operations and cash flows`.

 

**Forward-Looking Statements**

 

ThisQuarterly Report on Form 10-Q contains certain forward-lookingstatements.  Additional written and oral forward-looking statements may bemade by the Company from time to time in Securities and Exchange Commission(SEC) filings and otherwise.  The Private Securities Litigation Reform Actof 1995 provides a safe-harbor for forward-looking statements.  Thesestatements may be identified by the use of forward-looking words or phrasesincluding, but not limited to, “anticipate”, “project”, “believe”, “expect”, “intend”,“may”, “planned”, “potential”, “should”, “will” or “would”.  The Companycautions readers that results predicted by forward-looking statements,including, without limitation, those relating to the Company’s future businessprospects, revenues, working capital, liquidity, capital needs, interest costsand income are subject to certain risks and uncertainties that could causeactual results to differ materially from those indicated in the forward-lookingstatements.   Specific risks and uncertainties include, but arenot limited to, those set forth under Item 1A, “Risk Factors”, of the 2007 10-Kand Item 1A in Part II herein.  TheCompany undertakes no obligation to publicly update any forward-lookingstatement, whether as a result of new information, future events or otherwise.

 

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

 

As of September 30, 2008, there have been no material changes in theCompany’s market risks associated with marketable securities and foreigncurrency exchange rates, as described in Item 7A of the 2007 10-K.  The interest applicable to the Company’scredit facilities as of September 30, 2008 was based upon (i) theLIBOR Rate and (ii) the Base Rate (each as defined in the Amendment andthe Giftline Credit Agreement), plus an applicable margin.  At September 30, 2008, a sensitivityanalysis to measure potential changes in applicable interest rates indicatesthat a one percentage point increase in interest rates would increase theCompany’s interest expense by approximately $1.2  million annually, based upon the level ofdebt at September 30, 2008. See Note 5 of Notes to Unaudited ConsolidatedFinancial Statements for a description of the interest rates applicable to theloans under the Company’s current credit facilities.  On May 2, 2008, the Company entered intoan interest rate swap agreement with a notional amount of $70 million as a riskmanagement tool to lock the interest cash outflows on the floating ratedebt.  See Note 5 of Notes to UnauditedConsolidated Financial Statements.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

***Evaluation of Disclosure Controls andProcedures***

 

We maintain disclosure controls and proceduresas defined in Rules 13a-15(e) or 15d-15(e) of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”) that are designed toensure that information required to be disclosed in our Exchange Act reports isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms and that suchinformation is accumulated and communicated to our management, including ourprincipal executive officer and principal financial officer (together, the “CertifyingOfficers”), to allow for timely decisions regarding required disclosure.

 

In designing and evaluating disclosure controlsand procedures, management recognizes that any controls and procedures, nomatter how well designed and operated, can provide only reasonable, notabsolute assurance of achieving the desired objectives.

 

Under the supervision and with theparticipation of management, including the Certifying Officers, we carried outan evaluation of the effectiveness of the design and operation of ourdisclosure controls and procedures pursuant to paragraph (b) of 

 

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Exchange Act Rules 13a-15 or 15d-15 as of September 30,2008.  Based upon that evaluation, theCertifying Officers have concluded that our disclosure controls and proceduresare effective as of September 30, 2008.

 

***Changes in Internal Control overFinancial Reporting***

 

There was no change in our internal controlover financial reporting identified in connection with the evaluation requiredby paragraph (d) of Exchange Act Rule 13a-15 or 15d-15 that occurredduring the fiscal quarter ended September 30, 2008 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**PART II -OTHER INFORMATION**

 

**ITEM 1A.  RISK FACTORS**

 

There have been no material changes to the risk factors set forth in Part I,Item 1A, “Risk Factors”, of the Company’s 2007 10-K, except as set forth below.

 

**The state of the economy may impact our business.**

 

Many economists are now predicting that the United States economy, andpossibly the global economy, may enter into a recession as a result of thecredit crisis and a variety of other factors. A downturn in the United Statesor global economy could hurt our business in a number of ways, includinglimiting the capital resources available to us and others with whom we conductbusiness, delays in signing or failing to sign customer contracts or signingcustomer agreements at reduced purchase levels. In addition, The Company’s operations and performance dependsignificantly on levels of consumer spending, which have recently deterioratedsignificantly in many countries and regions, including without limitation theUnited States, and may remain depressed for the foreseeable future. Forexample, some of the factors that could influence the levels of consumerspending include continuing increases in fuel and other energy costs,conditions in the residential real estate and mortgage markets, labor andhealthcare costs, access to credit, consumer confidence and other macroeconomicfactors affecting consumer spending behavior. These and other economic factorscould have a material adverse effect on our revenues ,results of operations,access to suppliers and our customer’s ability to pay.

 

**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

On July 10,2008 the Company held its annual meeting of shareholders (the “2008 AnnualMeeting”).  Each of the eight nominateddirectors was elected, without contest, as a member of the Board of Directorsat the 2008 Annual Meeting.  The votes for and the votes withheld for eachof the nominees for director were as follows:

 
| **Nominee**             | ** ** | **For**    | ** ** | **%** | ** ** | **Withheld** | ** ** | **%** | ** ** |
|-------------------------|------------|------------|------------|-------|------------|--------------|------------|-------|------------|
| Raphael Benaroya        |       | 16,503,175 |       | 81.3  |       | 3,795,408    |       | 18.7  |       |
| Mario Ciampi            |       | 19,308,463 |       | 95.1  |       | 990,120      |       | 4.9   |       |
| Bruce G.  Crain         |       | 20,072,183 |       | 98.9  |       | 226,400      |       | 1.1   |       |
| Frederick J.  Horowitz  |       | 19,859,073 |       | 97.8  |       | 439,510      |       | 2.2   |       |
| Lauren  Krueger         |       | 19,299,497 |       | 95.1  |       | 999,086      |       | 4.9   |       |
| Salvatore M.  Salibello |       | 17,288,302 |       | 85.2  |       | 3,010,281    |       | 14.8  |       |
| John  Schaefer          |       | 19,308,003 |       | 95.1  |       | 990,590      |       | 4.9   |       |
| Michael  Zimmerman      |       | 20,045,236 |       | 98.8  |       | 253,347      |       | 1.2   |       |

 

A brief description of each matter voted upon at the 2008 AnnualMeeting other than the election of directors follows:

 

Approval of the CompanyEquity Incentive Plan, effective as of the date of the 2008 Annual Meeting:

 
| **For**    | ** ** | **%** | ** ** | **Against** | ** ** | **%** | ** ** | **Abstain** | ** ** | **%** | ** ** | **Broker non-vote** | ** ** | **%** | ** ** |
|------------|------------|-------|------------|-------------|------------|-------|------------|-------------|------------|-------|------------|--------------------------|------------|-------|------------|
| 12,854,250 |       | 69.6  |       | 5,618,122   |       | 30.4  |       | 492,057     |       | 2.4   |       | 1,334,154                |       | 6.6   |       |

 

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Approval of the Company2009 Employee Stock Purchase Plan, effective as of January 1, 2009:

 
| **For**    | ** ** | **%** | ** ** | **Against** | ** ** | **%** | ** ** | **Abstain** | ** ** | **%** | ** ** | **Broker non-vote** | ** ** | **%** | ** ** |
|------------|------------|-------|------------|-------------|------------|-------|------------|-------------|------------|-------|------------|--------------------------|------------|-------|------------|
| 18,571,112 |       | 97.9  |       | 392,425     |       | 2.1   |       | 892         |       | 0.0   |       | 1,334,154                |       | 6.6   |       |

 

**ITEM 6.  EXHIBITS**

 
|   |   | Exhibits  to this Quarterly Report on Form 10-Q. |
|--------|--------|-------------------------------------------------------|
|   |   |                                                  |   |   |
|   |   | 31.1                                                  |   | Certification  of CEO required by Section 302 of the Sarbanes Oxley Act of 2002. |
|   |   |                                                  |   |   |
|   |   | 31.2                                                  |   | Certification  of CFO required by Section 302 of the Sarbanes Oxley Act of 2002. |
|   |   |                                                  |   |   |
|   |   | 32.1                                                  |   | Certification  of CEO required by Section 906 of the Sarbanes Oxley Act of 2002. |
|   |   |                                                  |   |   |
|   |   | 32.2                                                  |   | Certification  of CFO required by Section 906 of the Sarbanes Oxley Act of 2002. |

 

**Items 1, 2, 3 and 5 are not applicable and have been omitted.**

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|   |                    | RUSS  BERRIE AND COMPANY, INC. |
|--------|-------------------------|--------------------------------|
|   |                    | (Registrant)                   |
|   |                    |                           |
|   |                    |                           |
|   |                    |                           | By | /s/ Anthony Cappiello |
| Date:  | November 10,  2008 |                           |   | Anthony  Cappiello |
|   |                    |                           | Executive  Vice President and Chief   Administrative Officer (Principal Financial   Officer) |

 

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**EXHIBITINDEX**

 
| 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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