# UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________

# FORM 10-K

|(Mark One) |  | 
|---------- |  | 

|Q |  | ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended January 3, 2004
|- |  | ------------------------------------------------------------------------------------------------------------------------------

OR

|q |  | TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES           EXCHANGE ACT OF 1934
For the transition period from _____________ to ______________.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

Commission file number 1-11908

DEPARTMENT 56, INC.
(Exact name of registrant as specified in its charter)

|                                         | 
|---------------------------------------- | 
|Delaware                                 | 
|(State or other jurisdiction of          | 
|incorporation or organization)           | 
|                                        
|One Village Place                        | 
|6436 City West Parkway                   | 
|Eden Prairie, MN                         | 
|(Address of principal executive offices) | 

(952) 944-5600
(Registrants telephone number, including area code)

Securities registered pursuant to
Section 12(b) of the Act:

|Title of each class                    | Name of each exchangeon which registered
|-------------------------------------- | ----------------------------------------
|Common Stock, par value $.01 per share | New York Stock Exchange                 

Securities registered pursuant to
Section 12(g) of the Act:None

Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes
Q No q

Indicate by check mark if disclosure
of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and
will not be contained, to the best of registrants knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.Q

Indicate by check mark whether the
registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes
Q No q

The aggregate market value of the
voting stock held by non-affiliates of the registrant as of March 8, 2004 was
$197,006,080 (based on the closing price of consolidated trading in the Common Stock on
July 3, 2003, being the last trading day of the registrants most recently completed
second fiscal quarter). For purposes of this computation, shares held by affiliates and
by directors and officers of the registrant have been excluded. Such exclusion of shares
held by directors and officers is not intended, nor shall it be deemed, to be an
admission that such persons are affiliates of the registrant.

Number of Shares of Common Stock,
par value $.01 per share, outstanding as of March 8, 2004: 13,181,186.

DOCUMENTS INCORPORATED
BY REFERENCE

Portions of the Companys
definitive Proxy Statement for the 2004 Annual Meeting of Stockholders to be filed with
the Securities and Exchange Commission not later than 120 days after the end of the
fiscal year covered by this Form 10-K (the 2004 Proxy Statement) are
incorporated by reference in Parts II and III.

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# FORM 10-K TABLE OF CONTENTS

|           |  | Page                                                                                 
|---------- |  | -------------------------------------------------------------------------------------
|          
|Part I     |  |                                                                                      
|Item 1.    |  | Business                                                                             
|Item 2.    |  | Properties                                                                           
|Item 3.    |  | Legal Proceedings                                                                    
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                  
|Part II    | 
|Item 5.    |  | Market for the Registrants Common Equity and Related Stockholder Matters            
|Item 6.    |  | Selected Financial Data                                                              
|Item 7.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations
|Item 7A.   |  | Quantitative and Qualitative Disclosures about Market Risk                           
|Item 8.    |  | Financial Statements and Supplementary Data                                          
|Item 9.    |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 
|Item 9A.   |  | Controls and Procedures                                                              
|Part III   | 
|Item 10.   |  | Directors and Executive Officers of the Registrant                                   
|Item 11.   |  | Executive Compensation                                                               
|Item 12.   |  | Security Ownership of Certain Beneficial Owners and Management                       
|Item 13.   |  | Certain Relationships and Related Transactions                                       
|Item 14.   |  | Principal Accountant Fees and Services                                               
|Part IV    | 
|Item 15.   |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                     
|Signatures |  |                                                                                      

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PART I

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# ITEM 1.   BUSINESS

General:

Department 56, Inc.
(including its direct and indirect subsidiaries, Department 56 or
the Company) is a leading designer, distributor, wholesaler and
retailer of fine quality collectibles and other giftware products sold through
gift, home accessory and specialty retailers, department stores, general
merchandise chains and Big-Box specialty chains, as well as through
its own stores and consumer-direct home show sales business. The Company is best
known for its Village Series of collectible, handcrafted, lighted ceramic and
porcelain houses, buildings and related accessories in The Original Snow
Village® Collection and other Village series as well as its
extensive line of holiday, special occasion and home decorative products,
including its Snowbabies collectible porcelain figurines.

The Company was incorporated in
Delaware in 1992 to hold the equity of a Minnesota corporation formed in 1984 under the
name Department 56, Inc., which has since changed its name to D 56,
Inc. and has continued as the Companys principal operating subsidiary.

The Company seeks to grow
and acquire businesses that reinforce synergies, allowing it to complement its
internal product development and accelerating its penetration into new markets
and new channels. In the second quarter of fiscal year 2002, the Company
commenced its Time to Celebrate initiative, a direct selling business that
reaches consumers by using a network of independent sales consultants to sell
giftware and home decorative products through the home show sales method. Also
in 2002, the Company launched its Simple Traditions by Department 56 line
of Village products, developed and distributed for the unique needs of select
general merchandise chains and Big-Box specialty retailers. The Company tailors
its products, designs, packaging and prices to satisfy the varying demands of
customers and consumers within each distribution channel. This focused,
multi-faceted strategy is intended to position Department 56 as the premier
giftware and collectibles company for the future.

The Company has two
reportable segments  wholesale and retail. Although the product produced
and sold for each segment is similar, the type of customer for the product and
the method used to distribute the product are different. The segmentation of
these operations also reflects how the Companys chief executive officer
currently reviews the results of these operations. See Note 11 within the Notes
to Consolidated Financial Statements beginning on page F-6.

The Company is organized
under the laws of Delaware. The Companys principal executive offices are
located at One Village Place, 6436 City West Parkway, Eden Prairie, MN, 55344,
and telephone (952) 944-5600.

The Company files annual,
quarterly and current reports and other information with the Securities and
Exchange Commission (the Commission). You may read and copy any of the information on file with
the Commission at the Commissions Public Reference Room, at 450 Fifth Street,
N.W., Room 1024, Washington, DC 20549. Please call the Commission at
1-800-SEC-0330 for further information on the public reference room. In
addition, the Commission maintains an Internet site at www.sec.gov that
contains reports, proxy and information statements and other information
regarding issuers that file, as the Company does, electronically with the
Commission.

The Company makes
available, free of charge through a direct link to the SEC on the Companys
website www.department56.com its annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934, as soon as is reasonably practicable after such material
is electronically filed with or furnished to the Commission. In addition, each
of the key standing committees of the Board of Directors has a charter that sets
forth the committees role and responsibilities. All of those charters are
available on the Companys website. The Board has also adopted its
Governance Principles, a copy of which is also available on the Companys
website. The information on the Companys website is not incorporated by
reference into this annual report.

This Annual Report on Form 10-K
includes forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended (the Securities Act), and Section 21E of the Securities
Exchange Act of 1934, as amended (the Exchange Act). See Item 7.  Managements
Discussion and Analysis of Results of Operations and Financial Condition  Forward-Looking Statements
and Factors Affecting Future Earnings herein.

Planned
Disposition of Geppeddo Seasonal Kiosk Operations:

During 2001, the Company
acquired the net assets of Axis Corporation, a privately held designer, importer
and specialty retailer based in Salt Lake City, Utah. The acquired business sold
dolls and doll accessories under the brand name of Geppeddo at kiosks located in
major shopping centers throughout the United States during the peak holiday
shopping season. The original strategy behind the Geppeddo acquisition was to
give the Company additional differentiated and branded products and access to a
new channel of distribution. However, since the acquisition, the demand for
porcelain

1

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dolls has declined
substantially. This softening combined with significantly reduced traffic at the
kiosks resulted in a business model that the Company does not believe can be
profitable going forward. As a result, in December 2003, the Company committed
to a plan to cease operations of Geppeddo.

In accordance with
Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets, the Company will record
Geppeddos results in continuing operations in 2003 and 2004 until the
run-off of operations is complete, which is expected to be in the second quarter
of 2004. When the run-off is complete, the Geppeddo results will be reclassified
into discontinued operations for all periods presented. Additional information
regarding the plan to cease operations is included in Managements
Discussion and Analysis of Results of Operations and Financial Condition
beginning on page 10 and Note 2 within the Notes to Consolidated Financial
Statements beginning on page F-6.

Unless otherwise noted, the
following discussion relates to operations excluding the Geppeddo seasonal kiosk
operations.

Wholesale Operations:

The Company
sells its products to retailers through its wholesale operations, the principal facilities
of which consist of eight corporate showrooms and two independently operated wholesale
showrooms covering the major giftware market areas and trade shows in the U.S. In
addition, the Company from time to time attends and solicits orders at giftware trade
shows in select other markets throughout the U.S. and Canada.

The
Companys domestic wholesale operations serve an extensive base of retailers,
primarily consisting of approximately 13,000 independent gift retailers across the U.S.
and Canada who account for approximately 85% of its wholesale sales (the Company refers to
this portion of its customer base as its Gift and Specialty channel).
Approximately 4,660 of the Companys principal wholesale customers receive the
Companys Village Series and/or Snowbabies products (which the Company sometimes
refers to as its collectible products and/or lines). These retailers include
approximately 1,410 independently owned Club 56SM, Gold KeySM and
ShowcaseSM Dealers, who receive special recognition and qualify for improved
sales terms by satisfying certain volume, merchandising and/or promotional requirements.
Approximately 15% of the Companys wholesale sales are made to department stores,
select general merchandise chains, and mail order houses. No single account represented
more than 3% of the Companys wholesale sales in fiscal 2003. The Company provides
volume discounts to its customers on most of its products. The Company has generally had
only limited sales outside the United States. International wholesale sales, which are
made primarily in Canada, were approximately 3% of the Companys wholesale sales in
fiscal 2003.

Over the past
four years, the Companys principal wholesale customers have decreased in number by
approximately 4,400, or 25%. Similarly, customers who sell the Companys Village
Series and/or Snowbabies products have decreased over the same period by approximately
1,670, or 26%. The Company believes the decrease in customers and related decrease in
sales since 1999 is due to several factors including: the problems experienced during the
implementation of the Companys enterprise-wide computer system, an overall weakness
in the economy which has forced some of the Companys customers to go out of business
or reduce their demand, and the typical characteristic of new customer order volume to be
lower than order volume of exiting customers. The Company has enacted programs to curb the
decline in customers and wholesale sales experienced over the past four years including
implementing new customer ordering and shipping programs, strengthening its sales
organization, refining its product development process, broadening the seasonal coverage
of its product lines, and pursuing alternative channels of retail distribution. Management
believes that some customer attrition is likely to continue within the base of customers
carrying the Companys collectible products. The Company plans to continue to seek
complementary retailers and to offer its Simple Traditions and giftware lines for select
general merchandise retail chains in order to augment revenue and to introduce more new
consumers to the Companys products.

Certain of
the Companys limited edition and year of production lighted Village Series and
Snowbabies products are sold on allocation. Under its allocation practice, the Company
specifies certain items among its Village Series and Snowbabies product lines which it
does not allow customers to purchase in unlimited quantities. The Company periodically
evaluates and adjusts its distribution network and reviews its policies with a view of
optimizing both the Companys distribution strategy and the store-level operations of
its independent retailers.

The Company continues to market and
advertise its products to retailers principally through giftware trade shows, brochures
and trade journals. The Company provides merchandising and product information to its
customers distributing Village and Giftware products through its business-to-business
Internet site (WINSM or Web Information NetworkSM). WIN
also provides ordering, order status information and other transaction processing
capabilities to its subscribers.

2

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The Company continues to expand the use
of WIN in order to help its retailers with merchandising ideas and to obtain greater
operational efficiencies for its customers and the Company.

The Company
markets and advertises to existing and potentially new consumers through seasonal
advertisements in magazines and newspapers, brochures and point-of-sale information. In
addition, the Company publishes and sells Celebrations, a quarterly consumer
magazine, which contains product-related articles and descriptions of its product lines,
and maintains an interactive consumer information center on its Internet web site
(www.department56.com). Department 56 maintains a toll-free telephone line for
collector and consumer questions and participates in collector conventions. The Company
also extends its consumer advertising through the use of cooperative advertising with certain
of its dealers using various media formats.

Retail Operations:

The Company
sells its products to consumers through its retail operations, which in 2003 included five
retail stores located in tourist destinations at Mall of America®, outside
Minneapolis, Minnesota; Aladdin Hotel and Casino® in Las Vegas, Nevada;
Downtown Disney® in Anaheim, California; Water Tower Place®
in Chicago, Illinois; and Florida Mall® in Orlando, Florida. The Company
recently entered into a lease agreement for a retail store in the Pier 39®
shopping complex in San Francisco, California. The Company anticipates that this store will
open during the second quarter of 2004.

In the second
quarter of 2002, the Company commenced its Time to Celebrate direct selling business.
Independent Time to Celebrate sales consultants, who are not agents or employees of the
Company, market and distribute giftware and home decorative products to their customers
principally through the home show method of direct sales. A consultant contacts consumers,
selling primarily at home-based shows using seasonal brochures and product samples. The
consultant collects payment from the consumer at the time the consumers order is
submitted. A web-based consultant care tool has been created, allowing consultants to
preview products, policies and procedures and to place and make payment against their
orders. A consultant can place an order 24 hours a day, seven days a week. The order is
processed and the products then delivered to the home show host. The host then handles
delivery of the merchandise to the consumer. The consultants are the customers of Time to
Celebrate and the Company generally has no transaction or arrangement with any end user of
its product beyond the consultant. Consultants are responsible for payment to the Company
upon or prior to shipment, whether or not the products are delivered to an end user.

Typical
characteristics of companies engaged in direct sales include a high rate of turnover among
sales consultants, and a positive correlation between the number of sales consultants and
revenue. For these reasons, the recruiting and training of new Time to Celebrate sales
consultants is expected to be continually necessary. Recruitment of people who are
themselves experienced with the home show sales format and personal contacts resulting
from home show activity constitute the primary means of obtaining new consultants. All
consultants earn margin on their own sales and are eligible to receive bonuses from sales
by consultants they have recruited. This rewards program and development of sales
leadership is an essential part of Time to Celebrates long-term growth strategy. At
the end of 2003, there were approximately 500 Time to Celebrate independent sales
consultants located in 47 states. The Company does not expect the Time to Celebrate
business to have a material financial impact on the Companys retail operations until
at least the end of 2004.

Products:

Village Series
Products Department 56 is best known for its Village Series,
which includes several different series of collectible, handcrafted, lighted
ceramic and porcelain houses, buildings and related accessories that depict
nostalgic scenes. The Company introduces new pieces, limited edition pieces,
figurines and other accessories each year to complement and provide continuity
to the collections. To allow for these new introductions and to keep each series
appropriately balanced, the Company has traditionally retired a number of its
existing pieces from production each year. Retirement decisions are based on
managements judgment as to, among other things, expected consumer demand,
whether a piece continues to fit the evolving design characteristics of a
series, manufacturing considerations and, importantly, injecting an element of
surprise. The Company also introduces new lighted pieces and accessories for a
variety of holidays and special days, including Halloween, St. Patricks
Day, Easter, Valentines Day and Fourth of July. The Company will continue
to consider the introduction of new lighted pieces and accessories for other
holidays and special day themes.

GiftwareThe
Company offers a wide range of other decorative giftware and home accessory items
including the Companys Snowbabies and Snowbunnies®figurines; holiday
and seasonal decorative items; as well as tableware. Giftware product lines are product
lines developed around either a seasonal or unique design theme. The Company

3

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generally introduces new products
and refines its product offerings twice a year. The Company currently maintains an
aggregate of approximately 4,650 stock keeping units, of which approximately 3,900 are
Giftware products.

Design and Production:

Each year, the Company
introduces new products in its existing product lines and also develops entirely
new design and product concepts. The design and manufacture of the
Companys products are complex processes. The path from initial conception
of the design idea to market introduction generally takes approximately six to
12 months, although the Company continues to investigate processes intended to
reduce this time. The Companys Village Series and Simple Traditions
products are principally composed of ceramic and porcelain clays, and the
Companys other products are designed in a variety of media, including
paper maché, acrylic and resin.

The Company
continues to add licensed trademarks and characters to its Village and Snowbabies lines.
Since 1995, the Company has entered into license agreements with the owners of a variety
of well-known American icons which are featured with Village buildings and as character
guests of the Snowbabies. Adding licensed names and icons has allowed the
Company to market to consumers who are enthusiasts of the licensed icons.

Department 56
believes that its relationships with its manufacturers, and the quality of their
craftsmanship, provide a competitive advantage and are a significant contributor to the
Companys success. The Company imports most of its products from the Pacific Rim,
primarily the Peoples Republic of China and the Philippines. The Company also
imports a small percentage of its products from India and Europe. During fiscal 2003, the
Company imported products from approximately 150 independent manufacturing sources, some
of which are represented by independent trading companies. The Companys single
largest manufacturing source represented approximately 25% of the Companys imports
in fiscal 2003. The Companys emphasis on high-quality craftsmanship at affordable
prices limits the sources from which the Company chooses to obtain products. The Company
has long-standing relationships with the majority of its manufacturers (several for 20
years or more) and may purchase, typically on a year-to-year basis, a substantial portion
of a manufacturers entire annual output. As a result of these relationships, the
Company has experienced a low turnover of its manufacturing sources.

Distribution and Systems:

The products sold by the
Company to its retail customers in the U.S. are generally shipped by ocean
freight from abroad and then by rail to the Companys distribution center
located in the Minneapolis/St. Paul metropolitan area. Shipments from the
Company to its wholesale customers and Time to Celebrate sales consultants are
handled primarily by United Parcel Service or commercial trucking lines.

The Companys systems
maintain order processing from the time a product enters the Companys
system through shipping and ultimate payment collection from its wholesale
customers and Time to Celebrate sales consultants. The Company also uses
handheld optical scanners and bar coded labels in accepting orders at wholesale
showrooms and in the field throughout the U.S. In addition, computer and
communication software systems allow on-line information access between the
Companys headquarters and its showrooms, and those systems generally
provide direct linkage with the Companys field sales force. These systems
also provide a range of order and product information and ordering capabilities
to customers subscribing to its WIN business-to-business site and to Time to
Celebrate sales consultants.

The Companys retail
systems also monitor and transmit to the Company on a daily basis the POS (point
of sales) data for the Companys owned retail stores.

Backlog and Seasonality:

The Company receives
products, pays its suppliers and ships products throughout the year, although
historically the majority of shipments have occurred in the second and third
quarters of each year as retailers stock merchandise in anticipation of the
winter holiday season. The Company continues to ship wholesale merchandise until
mid-December each year. Accordingly, the Companys wholesale backlog
typically is lowest at the beginning of January. As of January 3, 2004,
Department 56 had unfilled wholesale orders of approximately $3.5 million
compared to $5.0 million at December 28, 2002. The entire backlog is
scheduled to be shipped to customers during the 2004 fiscal year. Approximately
7% to 8% of the Companys total annual wholesale customer orders have been
cancelled in each of the last three years for a number of reasons, primarily
customer credit considerations and inventory stock-outs.

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Historically, due to the
timing of wholesale trade shows early in the calendar year, the Company has
received the majority of its total annual wholesale customer orders during the
first quarter of each year. During the first quarter of each of the past three
years, the Company has received approximately 62% to 64% of its annual wholesale
orders for such year. The Company can experience fluctuations in quarterly sales
due to the timing of receipt of product from suppliers and subsequent shipment
of product from the Company to customers, as well as the timing of orders placed
by customers. As a result of the Companys sales pattern, the Company has
historically recorded a substantial portion of its wholesale revenues in its
second and third quarters, and the majority of its store-based retail sales
occur in the fourth quarter during the peak holiday shopping season.

The extended
payment terms that the Company provides to many of its wholesale customers create a
significant seasonal pattern in its working capital requirements. Due to the seasonal
pattern of shipping and accounts receivable collection, the Company generally has greater
working capital needs in its second and third quarters and experiences greater cash
availability in its first and fourth quarters. The cash from the Companys retail
operations is also generated predominantly in the fourth quarter. The Company typically
finances its operations through cash and marketable securities balances, internally
generated cash flow and short-term seasonal borrowings.

Trademarks and Other Proprietary Rights:

The Company owns 40 U.S.
trademark registrations and has pending U.S. trademark applications with respect
to certain of its logos and brand names. In addition, the Company maintains
selected trademarks in certain foreign countries.

Department 56 regards its
trademarks and other proprietary rights as valuable assets and intends to
maintain its trademarks and their registrations and vigorously defend against
infringement. The U.S. registrations for the Companys trademarks are
currently scheduled to be cancelled at various times between 2004 and 2013 but
can be maintained and renewed provided that the marks are still in use for the
goods and services covered by such registrations. The Company has historically
renewed its registered trademarks and expects to continue to renew them as
business needs dictate.

Competition:

Department 56
competes generally for the discretionary income of consumers with other producers of
collectibles, specialty giftware and home decorative accessory products. The collectibles
area, in particular, is affected by changing consumer tastes and interests. The giftware
industry is highly competitive, with a large number of both large and small participants.
The Companys competitors distribute their products through independent gift
retailers, department stores, mass market and specialty chain stores, televised home
shopping networks, Internet commerce and mail order houses, and through the home show
sales method or other direct response marketing methods. The Company believes that the
principal elements of competition in the specialty giftware industry are brand loyalty,
design, quality, display and price. The Company believes that its competitive position is
enhanced by a variety of factors, including the uniqueness, quality and enduring themes of
the Companys products, its reputation among retailers and consumers, its in-house
design expertise, its sourcing and marketing capabilities, and the pricing of its
products.

Imports:

The Company
does not own or operate any manufacturing facilities and imports most of its products from
manufacturers in the Pacific Rim, primarily the Peoples Republic of China (China) and the
Philippines. The Company also imports a small percentage of its products from sources in
India and Europe.

The
Companys ability to import products and thereby satisfy customer orders is affected
by the availability of, and demand for, quality production capacity abroad. The Company
competes with other importers of specialty giftware products for the limited number of
foreign manufacturing sources that can produce detailed, high-quality products at
affordable prices. Foreign manufacturing and procurement of imports is subject to the
following inherent risks: labor, economic and political instability; cost and capacity
fluctuations and delays in transportation, dockage and materials handling; restrictive
actions by governments; nationalizations; the laws and policies of the U.S. affecting
importation of goods (including duties, quota and taxes); international
political/military/terrorist developments; and foreign trade and tax laws. Moreover, the
Company cannot predict what relevant political, legal or regulatory changes may occur, or
the type or amount of any financial impact on the Company such changes may have in the
future.

Fluctuations in currency exchange
also present risk inherent in the Companys method for inventory procurement. The
Companys costs could be adversely affected if the currencies of other countries in
which the Company sources product

5

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appreciate significantly relative to
the U.S. dollar; this could result, for example, from a decision by China
to allow its currency to float instead of being pegged to the U.S. dollar at a fixed rate.

The
Companys products are subject to customs duties and regulations pertaining
to the importation of goods, including requirements for the marking of certain
information regarding the country of origin on the Companys products.In its ordinary course of business, the Company may be involved in disputes
with the U.S. Bureau of Customs and Border Protection (U.S. Customs)
regarding the amount of duty to be paid, the value of merchandise to be reported
or other customs regulations relating to certain of the Companys imports,
which may result in the payment of additional duties and/or penalties, or which
may result in the refund of duties to the Company. Since the terrorist attacks
of September 11, 2001, U.S. Customs has enacted various security protocols
affecting the importation of goods. Such protocols could adversely affect the
speed or cost involved in the Companys receipt of inventory from its
overseas vendors.

In fiscal
2003, approximately 88% of the Companys imports were manufactured in China, and the
Company anticipates that such percentage will hold constant or increase for the
foreseeable future. China has joined the World Trade Organization and been accorded
permanent Normal Trade Relations status by the U.S. government. However,
various commercial and legal practices widespread in China, including the handling of
intellectual properties and certain labor practices, as well as certain political and
military actions taken or suggested by China, are under review by the U.S. government.
China, moreover, has been designated a Country of Particular Concern (CPC)
pursuant to the International Religious Freedom Act of 1998 (IRFA). The IRFA
enumerates several specific retaliatory actions that may be taken by the U.S. government,
none of which the Company believes would have a material impact on its business. The IRFA,
however, also accords the President broad discretion in fashioning other or additional
actions and, due to the breadth of the presidential powers under the IRFA, the Company is
unable to predict what, if any, action the President could take in the future.

Accordingly,
the ability to continue to conduct business with vendors located in China is subject to
political uncertainties, the financial impact of which the Company is unable to estimate.
To the extent China may have its exports or transaction of business with U.S. persons
subject to political retaliation, the cost of Chinese imports could increase significantly
and/or the ability to import goods from China may be materially impaired. In such an
event, there could be an adverse effect on the Company until alternative arrangements for
the manufacture of its products were obtained on economic, production and operational
terms at least as favorable as those currently in effect.

Employees:

As of February 18, 2004,
the Company had 293 full-time employees in the U.S., three in Canada and one in
Taiwan. Of the total workforce, approximately 57 are engaged in wholesale sales
representation throughout North America and 83 are associated with the
Companys retail operations. Local Union No. 638 of the Teamsters Union
represents 61 of the Companys U.S.-based warehouse, shipping and receiving
personnel under a contract that expires on December 31, 2004. The Company
believes that its labor relations are good and has never experienced a work
stoppage.

Environmental Matters:

The Company
is subject to various federal, state and local laws and regulations governing the use,
discharge and disposal of hazardous materials. Compliance with current laws and
regulations has not had and is not expected to have a material adverse effect on the
Companys financial condition. It is possible, however, that environmental issues may
arise in the future that the Company cannot currently predict.

6

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# ITEM 2.   PROPERTIES

The Company owns or leases
buildings that contain approximately 541,000 square feet of floor space, as
identified in the following table. The Companys primary corporate
showroom, executive offices and creative center are located in Eden Prairie,
Minnesota. The office building in Eden Prairie, Minnesota is owned by the
Company and the rest of the Companys facilities are leased.

|Facility                                                            |  | Location           |  | OperatingSegment(s) |  | LeaseExpirationDate   |  | ApproximateNumber ofSquare Feet | 
|------------------------------------------------------------------- |  | ------------------ |  | ------------------- |  | --------------------- |  | ------------------------------- | 
|                                                                   
|Executive Offices, Creative Center   and Primary Corporate Showroom |  | Eden Prairie, MN   |  | Wholesale & Retail  |  | Company-ownedfacility |  | 66,400                         
|Warehouse and Distribution Facility                                 |  | Rogers, MN         |  | Wholesale & Retail  |  | 6-30-2010             |  | 333,700                         | 
|Warehouse and Distribution Facility   and Offices                   |  | Salt Lake City, UT |  | Retail              |  | 6-30-2004             |  | 54,400                          | 
|Showroom                                                            |  | Atlanta, GA        |  | Wholesale           |  | 12-31-2006            |  | 12,946                          | 
|Showroom                                                            |  | Chicago, IL        |  | Wholesale           |  | 11-30-2006            |  | 7,480                           | 
|Showroom                                                            |  | Dallas, TX         |  | Wholesale           |  | 1-31-2007             |  | 9,143                           | 
|Showroom                                                            |  | Los Angeles, CA    |  | Wholesale           |  | 12-31-2008            |  | 6,600                           | 
|Showroom                                                            |  | New York, NY       |  | Wholesale           |  | 12-31-2005            |  | 10,300                          | 
|Showroom                                                            |  | Bedford, MA        |  | Wholesale           |  | 6-30-2004             |  | 1,800                           | 
|Showroom                                                            |  | Columbus, OH       |  | Wholesale           |  | 5-31-2009             |  | 2,485                           | 
|Retail Store                                                        |  | Bloomington, MN    |  | Retail              |  | 4-30-2009             |  | 10,200                          | 
|Retail Store                                                        |  | Las Vegas, NV      |  | Retail              |  | 10-31-2010            |  | 3,100                           | 
|Retail Store                                                        |  | Anaheim, CA        |  | Retail              |  | 3-31-2012             |  | 6,250                           | 
|Retail Store                                                        |  | Chicago, IL        |  | Retail              |  | 1-31-2014             |  | 3,836                           | 
|Retail Store                                                        |  | Orlando, FL        |  | Retail              |  | 5-1-2013              |  | 5,711                           | 
|Retail Store                                                        |  | San Francisco, CA  |  | Retail              |  | 3-31-2014             |  | 6,800                           | 

# ITEM 3.   LEGAL PROCEEDINGS

In the ordinary course of
its business, the Company is involved in various legal proceedings, claims and
governmental audits. In the opinion of management, the ultimate disposition of
these proceedings, claims and audits will not have a material adverse effect on
the results of operations, financial position or cash flows of the Company.

# ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted
to a vote of the Companys security holders during the last quarter of the
year ended January 3, 2004.

7

---

PART II

---

# ITEM 5.   MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Department 56s common
stock trades on the New York Stock Exchange (NYSE) under the symbol
DFS. The table below sets forth the high and low sales prices as
reported by the NYSE.

|               | High |       | Low
|-------------- | ---- | ----- | ---
|              
|Fiscal 2003    |      |       |    
|First quarter  |      | 13.40 |    
|Second quarter |      | 15.42 |    
|Third quarter  |      | 15.76 |    
|Fourth quarter |      | 14.53 |    
|Fiscal 2002    |     
|First quarter  |      | 14.32 |    
|Second quarter |      | 19.97 |    
|Third quarter  |      | 16.26 |    
|Fourth quarter |      | 13.99 |    

The Company has not
declared or paid dividends on its Common Stock. The Companys strategy
includes the pursuit of a significant acquisition that aligns with and
complements its existing business. As a result, the Company intends to
accumulate cash. In the event the Company is not able to identify any acceptable
acquisition by mid-2005, the Company intends to return cash to its shareholders
at that time. As a holding company, the ability of the Company to pay cash
dividends will depend upon the receipt of dividends or other payments from its
subsidiaries. See Item 7.  Managements Discussion and Analysis
of Financial Condition and Results of Operations  Liquidity and Capital
Resources below with respect to restrictions under the Companys
credit agreement pertaining to its right to pay dividends.

As of March 8, 2004, the
number of holders of record of the Companys Common Stock was 817.

8

---

# ITEM 6.   SELECTED FINANCIAL DATA

FIVE-YEAR SUMMARY (In thousands, except per share amounts)
YEARS ENDED JANUARY 3, 2004, DECEMBER 28, 2002, DECEMBER 29, 2001,
DECEMBER 30, 2000, AND JANUARY 1, 2000

---

The following selected
consolidated financial data should be read in conjunction with Managements
Discussion and Analysis of Financial Condition and Results of Operations, and
the Consolidated Financial Statements and related Notes thereto, included
elsewhere herein.

|                                              | January 3,20041 |  | December 28,20021 |         | December 29,20011 |   | December 30,20001 |   | January 1,20001 |        
|--------------------------------------------- | --------------- |  | ----------------- | ------- | ----------------- | - | ----------------- | - | --------------- | -------
|                                             
|STATEMENTS OF INCOME                          |                 |  |                   |         |                   |   |                   |   |                 |        
|Wholesale segment sales:                      |                 | 
|Village sales                                 |                 |  | $                 | 86,592  |                   | $ | 107,097           |   | $               | 110,295
|Giftware sales                                |                 |  |                   | 80,303  |                   |   | 73,267            |   |                 | 70,761 
|                                              |                 |  |                   |         |                   |   |                   |   |                 |        
|                                              |                 |  |                   | 166,895 |                   |   | 180,364           |   |                 | 181,056
|Retail segment sales                          |                 |  |                   | 24,819  |                   |   | 28,260            |   |                 | 19,391 
|                                              |                 |  |                   |         |                   |   |                   |   |                 |        
|Net sales                                     |                 |  |                   | 191,714 |                   |   | 208,624           |   |                 | 200,447
|Cost of sales                                 |                 |  |                   | 89,053  |                   |   | 90,305            |   |                 | 89,845 
|                                              |                 |  |                   |         |                   |   |                   |   |                 |        
|Gross profit                                  |                 |  |                   | 102,661 |                   |   | 118,319           |   |                 | 110,602
|Operating expenses:                           |                 | 
|Selling, general and administrative           |                 |  |                   | 66,632  |                   |   | 76,758            |   |                 | 68,589 
|Impairment of Geppeddo assets2                |                 |  |                   | 9,140   |                   |   |                  |   |                 |       
|Amortization of goodwill, trademarks and      |                 | 
|other intangibles                             |                 |  |                   | 235     |                   |   | 248               |   |                 | 5,189  
|                                              |                 |  |                   |         |                   |   |                   |   |                 |        
|Total operating expenses                      |                 |  |                   | 76,007  |                   |   | 77,006            |   |                 | 73,778 
|                                              |                 |  |                   |         |                   |   |                   |   |                 |        
|Income from operations                        |                 |  |                   | 26,654  |                   |   | 41,313            |   |                 | 36,824 
|Other expense (income):                       |                 | 
|Interest expense                              |                 |  |                   | 1,954   |                   |   | 3,426             |   |                 | 7,036  
|Litigation settlement3                        |                 |  |                   |        |                   |   | (5,388            | ) |                 |       
|Impairment and equity in losses               |                 | 
|of minority investment4                       |                 |  |                   |        |                   |   |                  |   |                 | 3,304  
|Other, net                                    |                 |  |                   | (938    | )                 |   | (386              | ) |                 | (662   
|                                              |                 |  |                   |         |                   |   |                   |   |                 |        
|Income before income taxes                    |                 |  |                   | 25,638  |                   |   | 43,661            |   |                 | 27,146 
|Provision for income taxes                    |                 |  |                   | 9,230   |                   |   | 11,820            |   |                 | 11,184 
|                                              |                 |  |                   |         |                   |   |                   |   |                 |        
|Net income before cumulative effect of change |                 | 
|in accounting principle                       |                 |  |                   | 16,408  |                   |   | 31,841            |   |                 | 15,962 
|                                              |                 |  |                   |         |                   |   |                   |   |                 |        
|Cumulative effect of change in accounting     |                 | 
|principle5                                    |                 |  |                   |        |                   |   | (93,654           | ) |                 |       
|                                              |                 |  |                   |         |                   |   |                   |   |                 |        
|Net income (loss)                             |                 |  | $                 | 16,408  |                   | $ | (61,813           | ) | $               | 15,962 
|                                              |                 |  |                   |         |                   |   |                   |   |                 |        
|Net income (loss) per common share  basic    |                 |  | $                 | 1.25    |                   | $ | (4.76             | ) | $               | 1.24   
|Net income (loss) per common share           |                 | 
|assuming dilution                             |                 |  | $                 | 1.24    |                   | $ | (4.70             | ) | $               | 1.24   
|BALANCE SHEET DATA                            |                 | 
|Working capital                               |                 |  | $                 | 49,649  |                   | $ | 72,885            |   | $               | 63,998 
|Total assets                                  |                 |  |                   | 142,304 |                   |   | 181,325           |   |                 | 279,032
|Total debt                                    |                 |  |                   |        |                   |   | 54,000            |   |                 | 85,000 
|Total stockholders equity6                   |                 |  |                   | 114,296 |                   |   | 96,748            |   |                 | 156,747

|1 |  | The year ended
January 3, 2004 is a 53-week fiscal year whereas all other fiscal years
presented are 52-week periods.
|- |  | ---------------------------------------------------------------------------------------------------------------------

|2 |  | As a result of
the Companys decision to exit the Geppeddo seasonal kiosk business, the
Company recorded non-cash charges of $9.1 million to write-off all goodwill,
trademarks, other intangible assets and to recognize the impairment of the
long-lived assets of the subsidiary.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3 |  | During 2002, the
Company received net proceeds (before income taxes) of $11.0 million in
settlement of the Companys litigation against Arthur Andersen LLP and
Andersen Worldwide Société Coopérative concerning
implementation of its information systems. This recovery resulted in other
income of $5.4 million and a $5.6 million reduction in net depreciable assets.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4 |  | During 2001, the
Company recognized a $3.0 million impairment of the Companys minority
investment in 2-Day Designs, Inc. The impairment charge taken reduced the
carrying value of the Companys minority investment to zero.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|5 |  | During 2002, the
Company adopted SFAS No. 142, Goodwill and Other Intangible Assets. Upon
adoption of SFAS No. 142, the Company performed impairment testing and concluded
that the goodwill related to the leveraged buy-out of the Company in 1992 was
impaired. As a result, the Company recognized a $93.7 million charge to
write-down its goodwill.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|6 |  | The Company has
not declared or paid dividends on its Common Stock. As a holding company, the
ability of the Company to pay cash dividends will depend upon the receipt of
dividends or other payments from its subsidiaries. See Item 5. 
Market for Registrants Common Equity and Related Stockholder
Matters.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

9

---

# ITEM 7.   MANAGEMENTSDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                 AND RESULTS OF OPERATIONS

# (in millions, except per share amounts)

# STRATEGIC OVERVIEW

The Companys
financial results for 2003 as well as for the prior two years were significantly
impacted by fundamental changes occurring in our core Gift and Specialty account
base; results for 2003 and 2002 were also impacted by a decline in demand for
Geppeddos products in its channel of distribution.

We continued to see
substantial attrition last year in the Gift and Specialty channel, which
accounted for over 85% of the Companys wholesale sales. This channel
remained under stress during this past year, which resulted in accounts
representing 7% of the Companys 2002 Village product sales to cease doing
business during 2003. Because the Companys average Village customer
represents higher average revenue to the Company than an average Giftware
customer, losing Village accounts is a more difficult problem to overcome than
losing Giftware accounts. The Company typically must open several new Village
accounts to offset the revenue impact of losing one long-time Village account as
the new accounts need time to build up their own consumer bases and demand
within their stores. We have also found that our ongoing Village accounts
continue to be more cautious in investing in inventory since the onset of tough
economic conditions in 2001 and with their increased confidence in the
Companys ability to replenish Village product. Largely due to a decline in
sales to this channel, the Companys Village product sales declined 19%
during 2003.

In addition to the impact
of attrition in the Gift and Specialty channel, the Companys Geppeddo
division suffered further significant deterioration in its business during 2003.
As the Company stated last year, our focus was to return Geppeddo to its
historic level of profitability, but with conditions only worsening the decision
was made to exit the business at the end of 2003. The financial implications of
this decision are discussed in detail below.

In response to the changing
nature of the Gift and Specialty channel, in particular as it has impacted the
Companys core Village business, the Company has continued to develop and
implement a number of growth strategies designed to offset the impact of the
decline in the Gift and Specialty channel and to grow both revenue and earnings
in the long-term. A summary of these strategies and the progress made during
2003 follows:

Developing Year-Round Celebratory Products:

The Company is in the
process of repositioning itself from a strong Christmas collectibles business to
a company providing premier home decorative products to celebrate lifes
extraordinary moments. The Company has expanded its Village lines to incorporate
celebrations of all major holidays, special moments and seasons. This
re-positioning strategy has also led to a strengthening, broadening and
increased focus on the Companys Giftware line with the goal of developing
cohesive, multi-season product lines that will attract consumers year-round.
While further progress needs to be made, the Companys Giftware sales
demonstrated early positive results during 2003 posting a 10% increase in sales.

Expand Multi-Channels of Distribution:

The continued difficulties
with its core Gift and Specialty channel has led the Company to participate in
more wholesale and direct channels of distribution in an effort to reach a
broader base of consumers and take advantage of how and where consumers shop
today. The Company has three strategic initiatives which it is pursuing:

| | >> |  | Department 56 Retail
The Companys initial retail strategy has been to build flagship stores
showcasing the breadth of its product in high traffic locations which enjoy a
balanced mix of tourist and local population traffic, and where there is no
significant wholesale distribution. The Companys retail stores have been
profitable during the past two years. During 2003, the Company opened new stores
in Chicago and Orlando. Retail expansion will continue during 2004 with the
Companys mid-year opening of its store at Pier 39 in San Francisco and the
expected opening of an additional store during the latter half of the year,
although an appropriate site currently has not yet been identified. The Company
is also in process of exploring the viability of other Department 56 Retail
formats and expects to finalize its strategy and plans by year end. | 
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 

10

---

| | >> |  | Wholesale Channels
Although the Gift and Specialty channel will continue to be the
Companys core channel of distribution, the Company has adopted a
multi-wholesale channel approach to better expose its products and make them
more accessible to a broader range of consumers. New, simpler and less costly
Village as well as Giftware lines are being offered to select general
merchandise chains as well as select Big Box retailers. Sell-through
results for the Village lines have been mixed, while Giftware sell-through has
generally been good. The Company plans to continue to pursue new accounts and
deepen penetration in its current accounts where an opportunity exists to
provide value to the consumer through branded offerings. | 
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | 

| | >> |  | Time to Celebrate
Launched during 2002, Time to Celebrate is the Companys direct
sales business. Time to Celebrate uses independent sales consultants to market
and sell its products directly to the consumer at parties held by a host,
generally in the hosts own home, with consumers the host has invited.
During 2003, the division focused much of its effort on the recruiting of sales
consultants. Time to Celebrate had approximately 500 consultants at the end of
2003, which met our initial expectations. It is not anticipated that this
business will have a material impact on the Companys results until at
least the end of 2004. We strongly believe this channel can add significant
revenue in the future and provides an opportunity to interact closely with our
Time to Celebrate customers on a long-term basis. | 
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 

Leverage and Grow Our Core Consumer Base:

The Company is fortunate to
have long enjoyed a strong consumer following for its core brands. It is our
intention to forge closer links with this group and augment it with the
consumers shopping at Department 56 Retail and Time to Celebrate as well as
those consumers who visit us at www.department56.com. We will use a
variety of direct marketing and consumer relationship marketing techniques to
expand our relationships with our consumers.

11

---

# SUMMARY OF 2003 RESULTS OF OPERATIONS

         Net income decreased by 48% from $31.8 million in 2002 (before the cumulative
effect of adopting SFAS No. 142) to $16.4 million in 2003. Certain items affected the
comparability of the Companys earnings during 2003 with those of 2002, as shown in
the following table:

# Items Impacting Earnings Comparability
(In thousands)

|                                               | Quarter Ended | 
|---------------------------------------------- | ------------- | 
|
|                                              
|Income (loss) before cumulative effect of      |               | 
|change in accounting principle                 |               | 
|Litigation settlement1                         |               | 
|Income tax effect of litigation settlement     |               | 
|Reversal of prior year tax accruals2           |               | 
|Impairment of Geppeddo assets3                 |               | 
|Income tax benefit from impairment of          |               | 
|Geppeddo assets                                |               | 
|Write-down of Geppeddo inventory to net        |               | 
|realizable value4                              |               | 
|Income tax benefit from write-down of Geppeddo |               | 
|inventory                                      |               | 
|                                               |               | 
|Income before cumulative effect of change      |               | 
|in accounting principle after removing         |               | 
|the above items                                |               | 
|                                               |               | 

|1 |  | The Company
recorded $5.4 million of other income in 2002 in connection with the settlement
of litigation involving its information systems.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------

|2 |  | The Company
recorded adjustments to its income tax provision of $3.5 million in 2002 for the
reversal of prior year tax accruals that were no longer necessary.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

|3 |  | As a result of
the Companys decision to exit the Geppeddo seasonal kiosk business, the
Company recorded non-cash charges of $9.1 million to write-off all goodwill,
trademarks and other intangible assets and to recognize the impairment of the
long-lived assets of the subsidiary.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4 |  | In connection
with the decision to exit the Geppeddo seasonal kiosk business, the Company
recorded non-cash charges of $0.6 million to write-down Geppeddo inventory to
its net realizable value. This write-down is included in 2003 cost of sales.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

          After adjusting for the above items, net income (before the cumulative effect
of adopting SFAS No. 142) decreased by 9% in 2003 principally due to a 7% decrease in
wholesale sales and a decrease in the gross profit rate from 57% in 2002 to 54% in 2003.
The 7% decrease in wholesale sales was driven by a 19% decrease in Village product sales,
partially offset by a 10% increase in Giftware sales. The decrease in the gross profit
rate was driven by a change in product mix from higher margin Village product to lower
margin Giftware product.

         In December 2003, the Company committed to a plan to cease operations of its
Geppeddo seasonal kiosk business. In connection with this decision, the Company
recorded total non-cash, pre-tax charges of $9.7 million noted in the table
above. In accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, the Company will record Geppeddos
results in continuing operations in 2003 and 2004 until the run-off of
operations is complete (expected to be in the second quarter of 2004). When the
run-off is complete, the Geppeddo results will be reclassified into discontinued
operations for all periods presented.

12

---

# CONSOLIDATED RESULTS

The following discussion of
the results of operations and financial condition should be read in conjunction
with the selected financial data in Item 6 and the Companys Consolidated Financial Statements and related notes
thereto, included elsewhere herein.

|(In millions, except per share amounts)      
|---------------------------------------------
|
|
|                                             
|Wholesale segment sales:                     
|Village sales                                
|Giftware sales                               
|                                             
|                                             
|Retail segment sales                         
|                                             
|Total net sales                              
|Gross profit                                 
|Selling, general and administrative expenses 
|Impairment of Geppeddo assets                
|Amortization of goodwill, trademarks and     
|other intangibles                            
|Income from operations                       
|Interest expense                             
|Litigation settlement                        
|Impairment and equity in losses              
|of minority investment                       
|Other, net                                   
|Income before income taxes                   
|Provision for income taxes                   
|Net income before cumulative effect of change
|in accounting principle                      
|Cumulative effect of change in accounting    
|principle                                    
|Net income (loss)                            
|Net income (loss) per common share  assuming
|dilution                                     

# COMPARISON OF RESULTS OF OPERATIONS 2003 TO 2002

Net Sales

Net sales decreased $16.9
million, or 8%, from $208.6 million in 2002 to $191.7 million in 2003. The
decrease in net sales was principally due to a decrease in net sales to wholesale
customers.

Wholesale sales decreased
$13.5 million, or 7%, from $180.4 million in 2002 to $166.9 million in 2003.
Wholesale sales of the Companys Village Series products decreased $20.5
million, or 19%, while sales of Giftware products increased $7.0 million, or 10%
between the two periods. Village Series products represented 52% of the
Companys wholesale sales during 2003 versus 59% during 2002. Village sales
continued to be negatively impacted by both the cautious buying patterns of
Village dealers and the continued attrition in the number of these dealers,
which is a trend that may continue. See five-year Village sales trend at
Item 6. Selected Financial Data  Five-Year Summary.

13

---

Retail sales decreased $3.5
million, or 12%, from $28.3 million in 2002 to $24.8 million in 2003. The
decrease in retail sales was due to a decrease in Geppeddo sales and the fact
that the Company did not operate its seasonal stores beyond January 2003. The
decrease in sales was partially offset by an increase in sales at the
Companys retail stores as a result of opening two new stores in 2003 and
an increase in Time to Celebrate sales. Comparable sales in the Companys
three stores that were open for a full year in both years decreased 1%.

Gross Profit

Gross profit as a
percentage of net sales was 57% and 54% in 2002 and 2003, respectively. The
decrease in the gross profit rate was principally due to a change in the mix of
wholesale product shipments from higher margin Village product to lower margin
Giftware product, a decrease in gross profit margins on Geppeddo sales due to
higher markdowns and a $0.6 million charge to write-down inventory to its net
realizable value, along with a decrease in seasonal store retail sales described
above (which carry higher gross profit margins than the wholesale business).

Selling, General and Administrative Expenses

Selling, general and
administrative expenses decreased $10.1 million, or 13%, between 2002 and 2003.
Selling, general and administrative expenses as a percentage of net sales were
37% in 2002 and 35% in 2003. The decrease was principally due to lower seasonal
store, kiosk and incentive compensation expenses in 2003. Seasonal store
expenses were lower as the Company did not operate seasonal stores beyond
January 2003. Kiosk expenses were lower as the Company operated 346 kiosks
during the 2003 selling season compared to 417 kiosks during the 2002 selling
season.

Impairment of Geppeddo Assets

In December 2003, the
Company committed to a plan to cease operations of its Geppeddo seasonal kiosk
business. In connection with this decision, the Company recorded a $9.1 million
impairment charge related to Geppeddos assets. The impairment charge was
comprised of $8.2 million for the write-off of goodwill, trademarks and other
intangible assets, and $0.9 million for the impairment of long-lived assets.

Interest Expense

Interest expense decreased
$1.5 million, or 43%, between 2002 and 2003. The decrease in interest expense
resulted from a lower interest rate environment, as well as a decrease in the
amount of debt outstanding. The Company paid off its remaining long term debt of
$54 million during 2003.

Provision for Income Taxes

The effective income tax
rate was 27% and 36% during 2002 and 2003, respectively. The lower effective
income tax rate in 2002 was due to a $3.5 million reversal of prior year tax
accruals that were no longer needed. Excluding this, the effective income tax
rate was 36% in 2002. Management anticipates that the income tax provision rate
for 2004 will be approximately 36%.

# COMPARISON OF RESULTS OF OPERATIONS 2002 TO 2001

Net Sales

Net sales
increased $8.2 million, or 4%, from $200.4 million in 2001 to $208.6 million in 2002. The
increase in sales was principally due to an increase in retail sales, partially offset by
a decrease in sales to wholesale customers.

Wholesale sales decreased $0.7
million, or 0.4%, from $181.1 million in 2001 to $180.4 million in 2002. Wholesale sales
of the Companys Village Series products decreased $3.2 million, or 3%, while sales
of

14

---

Giftware products increased $2.5
million, or 4% between the two periods. Village Series products represented 59% of the
Companys sales during 2002 versus 61% during 2001. The decrease in wholesale
Village sales was principally due to a decrease in the number of Gift and Specialty
customers carrying the Companys Village product as a result of the continued
contraction of the Gift and Specialty channel.

Retail sales
increased $8.9 million from $19.4 million in 2001 to $28.3 million in 2002. The increase
in retail revenues for the year was primarily attributable to the inclusion of January
2002 results from the seasonal stores and kiosks opened for the first time during 2001 as
well as the increase in the number of seasonal stores and kiosks operated in 2002. The
Company operated 20 seasonal stores and 417 seasonal kiosks during 2002 compared to 10
seasonal stores and 359 seasonal kiosks operated in 2001. Comparable sales in the
Companys two stores that were open for a full year in both years increased 2%.

Gross Profit

Gross profit
as a percentage of net sales was 55% and 57% in 2001 and 2002, respectively. The increase
in the gross profit rate for the year was principally due to the increase in retail sales
(which carry higher gross profit than wholesale sales) and a decreased provision for
excess and slow moving inventory. The gross profit rate increase was partially offset by a
shift in the mix of wholesale product shipments from higher margin Village product to
lower margin Giftware product. Retail sales represented 14% of sales in fiscal 2002
compared to 10% in 2001.

Selling, General and Administrative Expenses

Selling,
general and administrative expenses increased $8.2 million, or 12%, between 2001 and 2002.
Selling, general and administrative expenses as a percentage of net sales were
approximately 34% in 2001 and 37% in 2002. The increase in selling, general and
administrative expenses for fiscal 2002 was principally due to the increase in retail
operations (which have higher selling, general and administrative expenses as a percentage
of sales than the wholesale business) partially offset by non-recurring expenses related
to the Companys 25th Anniversary Celebration in 2001, wholesale cost
control initiatives and decreased depreciation expense as a result of the $5.6 million
reduction in net depreciable assets from the litigation settlement described below.

Interest Expense

Interest
expense decreased $3.6 million, or 51%, between 2001 and 2002. The decrease in interest
expense resulted from a lower interest rate environment, as well as a decrease in the
amount of term debt outstanding. The Company pre-paid $30 million of its term debt in May
of 2002.

Litigation Settlement

On March 1, 2002, the
Company received net proceeds (before income taxes) of $11.0 million in
settlement of the Companys litigation against Arthur Andersen LLP and
Andersen Worldwide Société Coopérative concerning
implementation of its information systems. This recovery resulted in other
income of $5.4 million and a $5.6 million reduction in net depreciable assets.

Provision for Income Taxes

The effective
income tax rate was 41% and 27% during 2001 and 2002, respectively. The change in income
tax rates is due to several factors. First, the Company recorded adjustments to its income
tax provision of $1.0 million and $3.5 million in 2001 and 2002, respectively, for the
reversal of prior year tax accruals that were no longer needed. Secondly, 2001 reflects
the recognition of a deferred tax valuation allowance of $1.5 million to reserve against
the future deductibility of the capital losses recognized from its minority investment in
2-Day Designs, Inc. Finally, the Companys decreased income tax provision rate for
2002 reflected the change in accounting for goodwill and other intangible assets
previously reported.

15

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Cumulative Effect of Change in Accounting Principle

The Company adopted SFAS
No. 142, Goodwill and Other Intangible Assets, effective December 30,
2001. Under SFAS No. 142, goodwill and indefinite-lived intangible assets are no
longer amortized, but are reviewed for impairment annually, or more frequently
if certain indicators arise. With the adoption of this statement, the Company
ceased amortization of its goodwill and indefinite-lived trademarks as of
December 30, 2001 and recorded a $93.7 million charge to write-down its goodwill
related to the leveraged buy-out of the Company in 1992. See Note 4 to the
Consolidated Financial Statements.

# PLANNED DISPOSITION OF GEPPEDDO SEASONAL KIOSK BUSINESS

In December 2003, the
Company committed to a plan to cease operations of its Geppeddo seasonal kiosk
business. The Company plans to wind-down operations in 2004 and anticipates that
operations will cease in the second quarter of 2004. The original strategy
behind the Geppeddo acquisition was to give the Company additional
differentiated and branded products and access to a new channel of distribution.
However, since the acquisition, the demand for porcelain dolls has decreased.
This softening combined with reduced traffic at the kiosks has resulted in a
business model that the Company does not believe can be profitable going
forward.

In accordance with SFAS No.
144, the Company will present Geppeddos results in continuing operations
in 2003 and 2004 until the run-off of operations is complete (expected to be in
the second quarter of 2004). When the run-off is complete, the Geppeddo results
will be reclassified into discontinued operations for all periods presented.

The results from
Geppeddos operations are as follows:

|(in millions)                                | 2003 |  | 2002 |       | 20011 | 
|-------------------------------------------- | ---- |  | ---- | ----- | ----- | 
|
|                                             |     
|Net sales                                    |      |  | $    | 15.9  |       | 
|Gross profit                                 |      |  |      | 9.0   |       | 
|Selling, general and administrative expenses |      |  |      | 12.9  |       | 
|Impairment of assets                         |      |  |      | 9.1   |       | 
|Amortization of goodwill, trademarks and     |      | 
|other intangibles                            |      |  |      | 0.1   |       | 
|(Loss) income from operations                |      |  |      | (13.1 | )     | 
|Income tax (benefit) provision               |      |  |      | (4.8  | )     | 
|Net (loss) income                            |      |  |      | (8.3  | )     | 

|1 |  | Reflects results
of operations of Geppeddo subsequent to the acquisition date in the third
quarter of 2001.
|- |  | -----------------------------------------------------------------------------------------------------------

# SEASONALITY

Historically, due to the
timing of wholesale trade shows early in the calendar year, the Company has
received the majority of its total annual wholesale customer orders during the
first quarter of each year. The Company entered 63% and 64% of its total net
annual wholesale customer orders during the first quarter of 2003 and 2002,
respectively. Cancellations of total annual wholesale customer orders were
approximately 7% in both 2003 and 2002. Orders not shipped in a particular year,
net of cancellations, are carried into backlog for the following year and have
historically been orders for Spring and Easter products. The Companys
backlog of wholesale customer orders was $3.5 million and $5.0 million at
January 3, 2004 and December 28, 2002, respectively.

The Company receives products, pays
its suppliers and ships products throughout the year, although historically the majority
of wholesale shipments occur in the second and third quarters as retailers stock
merchandise in anticipation of the holiday season. As a result of this seasonal pattern,
the Company generally records its highest wholesale sales during the second and third
quarters of each year. However, the Company can experience fluctuations in quarterly
sales and related net income compared with the prior year due to the timing of receipt

16

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of product from suppliers and
subsequent shipment of product from the Company to customers, as well as the timing of
orders placed by customers. In addition, the Company recognizes the majority of its
retail sales in the fourth quarter during the peak holiday shopping season. The Company
is not managed to maximize quarter-to-quarter results, but rather to achieve annual
objectives designed to achieve long-term growth consistent with the Companys
business strategy.

|(in millions, except per share amounts) | 2003 |  | 2002 |      
|--------------------------------------- | ---- |  | ---- | -----
|
|                                       
|Wholesale customer                      |      |  |      |      
|orders entered1                         |      |  | $    | 103.6
|Net sales  wholesale                   |      |  |      | 28.1 
|Net sales  retail                      |      |  |      | 6.7  
|Net sales  total                       |      |  |      | 34.9 
|Gross profit                            |      |  |      | 18.7 
|Income (loss) before cumulative         |      | 
|effect of change in                     |      | 
|accounting principle                    |      |  |      | 0.3  
|Net income (loss)                       |      |  |      | 0.3  
|Income (loss) per common                |      | 
|share assuming dilution before          |      | 
|cumulative effect of change in          |      | 
|accounting principle                    |      |  |      | 0.02 
|Net income (loss) per common            |      | 
|share assuming dilution                 |      |  |      | 0.02 

|1 |  | Customer orders
entered are orders received and approved by the Company, net of any cancellation
for various reasons including credit considerations, inventory stock-outs, and
customer requests. Customer orders entered do not include freight and other
revenue adjustments, which are included in net sales. Additionally, wholesale
customer orders entered exclude orders from company-operated retail stores.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# LIQUIDITY AND CAPITAL RESOURCES

# Cash Flows from Operations

Net cash
provided by operating activities increased $15.4 million, or 75%, from $20.6 million in
2002 to $35.9 million in 2003. The increase was principally due to higher cash
collections, partially offset by lower income from operations (excluding the $9.1 million
Geppeddo non-cash impairment charge). Cash collections were higher in 2003 principally due
to five additional days of cash collections in 2003 as a result of the 2003 fiscal year
ending on January 3, 2004 compared to the 2002 fiscal year ending on December 28, 2002.
Cash collections were also lower in 2002 due to an increase in the amount of sales
qualifying for extended dating terms.

Accounts
receivable, net of reserves, which principally consists of wholesale trade receivables,
decreased by 36%, from $32.6 million at December 28, 2002 to $21.0 million at
January 3, 2004. The decrease in accounts receivable was principally due to the additional
five days of cash collections in fiscal 2003 as a result of the year ending on January 3,
2004 (compared to December 28, 2002 in fiscal 2002). Management believes there is adequate
provision for any doubtful accounts receivable and product claims that may arise.

Because the
Companys wholesale business is not capital intensive, the Company has historically
not incurred significant capital expenditures. Capital expenditures for the retail
business were $1.9 million, $0.7 million, and $1.5 million in 2003, 2002 and 2001
respectively. Other capital expenditures were $0.6 million, $1.2 million and $1.4 million
in 2003, 2002 and 2001, respectively. Capital expenditures for the retail business are
anticipated to be approximately $0.9 million for each retail store opened during the year.
Management anticipates other 2004 capital expenditures to approximate 1% of annual
revenues. The Company has signed a lease to open its sixth retail store during the second
quarter of 2004 at the Pier 39 shopping complex in San Francisco, California, and plans to
open a seventh store during the second half of 2004.

17

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# Sources of Liquidity

The Companys primary
source of cash is the funds generated from operations. Additionally, the Company
has a revolving credit facility available for working capital and investment
needs as described below. Based on current levels of operations, the Company
believes its funds generated from operations, its available cash, and its
revolving credit facility will be sufficient to finance any capital
expenditures, contractual obligations or strategic initiatives in the
foreseeable future.

The Companys strategy
includes the pursuit of a significant acquisition that aligns with and
complements its existing business. As a result, the Company intends to
accumulate cash over the next year to help finance a potential acquisition. The
Company also has the ability to use its revolving credit facility to finance an
acquisition. However, depending on the size of the acquisition, the Company may
have to find additional financing to complete an acquisition. In the event the
Company is not able to identify an acceptable acquisition by mid-2005, the
Company intends to return cash to its shareholders at that time.

Consistent with customary
practice in the giftware industry, the Company offers extended accounts
receivable terms to many of its wholesale customers. This practice has typically
created significant working capital requirements in the second and third
quarters that the Company has generally financed with seasonal borrowings under
its revolving credit facility. The Companys cash and cash equivalents
balances peak early in the first quarter of the subsequent year, following the
collection of wholesale customer accounts receivable with extended payment terms
and cash receipts from the Companys retail operations.

In November 2003, the
Company entered into a new three-year credit agreement. In connection therewith,
the Company recorded $0.2 million in deferred financing fees, which are being
amortized over the life of the credit agreement. The Company used the new credit
facility to refinance the remaining term and revolving loans under its former
credit agreement. As of January 3, 2004, no revolving loans were outstanding
under the new credit agreement.

The revolving credit
facility provides for borrowings of up to $75 million, which may be in the form
of letters of credit and revolving credit loans. The letters of credit are
issued primarily in connection with inventory purchases. The revolving credit
facility includes an annual clean-down provision whereby the Companys
outstanding revolving credit loans and letters of credit may not exceed an
aggregate of $30 million during any one 30-consecutive-day period beginning
November 1 and ending March 31 of the following year. Borrowings under
the credit agreement are subject to certain borrowing base limitations (as
defined in the agreement). The Companys borrowing capacity under the revolving credit
facility as of January 3, 2004 was $75 million and will fluctuate during 2004
based on accounts receivable and inventory levels. The revolving line of credit
provides for commitment fees of 0.20% to 0.375% per annum on the daily average
of the unused commitment.

The credit agreement allows
the Company to choose between two interest rate options in connection with its
revolving credit loans. The interest rate options are the Floating Rate (as
defined in the agreement) or the Eurodollar Rate (as defined in the agreement) plus an applicable margin. The
applicable margin ranges from 0% to 0.375% for Floating Rate loans and from
0.875% to 1.25% for Eurodollar Rate loans. The credit agreement expires November
26, 2006.

The credit agreement
includes restrictions as to, among other things, the amount of additional
indebtedness, liens, contingent obligations, investments and dividends. Under
the most restrictive of these covenants, approximately $251 million of retained
earnings were restricted at January 3, 2004. The credit agreement also requires
maintenance of minimum levels of interest coverage, net worth and maximum levels
of leverage, in each case at the end of each fiscal quarter. None of these
restrictions are expected to have a material adverse effect on the
Companys ability to operate in the future.

The Company has pledged the
common stock of certain of its subsidiaries, direct and indirect, as collateral
under the credit agreement, and certain of its subsidiaries, direct and
indirect, have guaranteed repayment of amounts borrowed under the credit
agreement.

18

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# OFF-BALANCE SHEET ARRANGEMENTS

The Company does not have
off-balance sheet arrangements.

# CONTRACTUAL OBLIGATIONS

As of January 3, 2004, the
Company is obligated to make cash payments in connection with its operating
leases and purchase obligations in the amounts listed below. The Company does
not have any long-term debt or capital lease obligations. The Company has no
off-balance sheet debt or other unrecorded obligations other than the items
noted in the following table:

|(in thousands) | Payments Due
|-------------- | ------------
|
|              
|2004           |             
|2005           |             
|2006           |             
|2007           |             
|2008           |             
|Thereafter     |             
|               |             
|               |             
|               |             

|1 |  | The Company is
committed to pay suppliers of Village and Giftware product under the terms of
open purchase orders issued in the normal course of business.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------

See Note 7 to the
Consolidated Financial Statements for a discussion of the Companys other
long-term liabilities.

# WHOLESALE CREDIT AND RETURN POLICIES

The Company has credit
policies that establish specific criteria related to creditworthiness that its
customers must meet prior to the shipment of product to the customer. The
Company periodically makes limited and selective exceptions to its policy of not
shipping to customers with overdue balances when the particular customer has met
specific criteria, which are indicative of a wherewithal and willingness to pay
their past due and future balances.

The Company does not accept
returns from wholesale customers without its prior authorization. Returns are
typically accepted only for damaged or defective goods, or shipping
discrepancies. The Company reserves the right to refuse authorization of any
returns and to discard any unauthorized returns. If the Company accepts an
unauthorized return or if a return is the result of a customer error, the
wholesale customer may be subject to a 20% handling charge. The Company reserves
the right to cancel open orders or backorders for those wholesale customers who
abuse or excessively use return privileges.

# CRITICAL ACCOUNTING POLICIES

Our consolidated financial
statements are prepared in accordance with generally accepted accounting
principles of the United States. In connection with the preparation of the financial statements, we
are required to make assumptions, make estimates and apply judgment that affect
the reported amounts of assets, liabilities, revenue, expenses and related
disclosures. The Company bases its assumptions, estimates and judgments on
historical experience, current trends and other factors that management believes
to be relevant at the time the consolidated financial statements are prepared.
On a regular basis, management reviews the accounting policies, assumptions,
estimates and judgments to ensure that our financial statements are presented
fairly and in accordance with generally accepted accounting principles. However,
because future events and their effects cannot be determined with certainty,
actual results could differ from our assumptions and estimates, and such
differences could be material.

19

---

The following accounting
policies are the accounting policies that management believes require the most
difficult, subjective or complex judgments about matters that are inherently
uncertain:

Sales Returns and
Credits  An allowance is established for credits related to possible
returned or damaged product, pricing and shipping discrepancies. The amount of
the allowance is based on historical ratios of credits to sales, the historical
average length of time between the sale and the credit, and other factors.
Changes in customers behavior versus historical experience, changes in
product damage or defect rates, or changes in the Companys return policies
are among the factors that would result in materially different amounts for this
item. Based on 2003 sales returns and credits, a 10% increase or decrease in
sales returns and credits would have had an impact of approximately $0.5
million.

Inventory Valuation
 Inventory is valued at the lower of cost or net realizable value. The
amount is determined by analyzing historical and projected sales information,
plans for discontinued products and other factors. The Company procures product
based on forecasted sales volume. If actual sales were significantly lower than
forecasted sales due to unexpected economic or competitive conditions, it could
result in materially higher surplus and discontinued inventories. Based on 2003
inventory write-downs, a 10% increase or decrease in inventory write-downs would
have had an impact of less than $0.5 million.

Allowance for Doubtful
Accounts  An allowance is established for estimated uncollectible
accounts receivable. The required allowance is determined by reviewing customer
accounts and making estimates of amounts that may be uncollectible. Factors
considered in determining the amount of the reserve include the age of the
receivable, the financial condition of the customer, general business, economic
and political conditions, and other relevant facts and circumstances.
Additionally, since the majority of the Companys wholesale sales have
dating terms which come due in November and December, the Company does not have
visibility into overdue balances for most of its wholesale customers until the
fourth quarter of its fiscal year. Due to the seasonality of the Companys
business, the extended dating terms provided to customers and the relative size
of accounts receivable balances at year end, it is not uncommon for the Company
to experience fluctuations in the provision for bad debt expense from quarter to
quarter as the Company refines its estimate. Unexpected changes in the
aforementioned factors would result in materially different amounts for this
item. In addition, results could be materially different if economic conditions
worsened for the Companys customers. Based on 2003 bad debt write-offs, a
10% increase or decrease in bad debt write-offs would have had an impact of less
than $0.5 million.

Tax Contingencies
 The Company is periodically contacted or audited by federal and state tax
authorities. These contacts or audits include questions regarding the timing and
amount of deductions and the allocation of income among various tax
jurisdictions. In evaluating the exposure associated with various filing
positions, the Company records a reserve for estimated probable exposures. The
estimate of this reserve contains uncertainty because management must use
judgment to estimate the exposure associated with its various filing positions.
To the extent the Company does not have to pay taxes for which reserves have
been established or is required to pay amounts in excess of its reserves, the
Companys tax rate in a given financial period could be materially
impacted.

# RECENT ACCOUNTING PRONOUNCEMENTS

See Note 1 to the
Consolidated Financial Statements regarding discussion of new accounting
standards.

# FOREIGN EXCHANGE

Approximately 97% of the
Companys sales in 2003 were denominated in United States dollars and, as a
result, were not subject to changes in exchange rates. Approximately 3% of the
Companys sales were denominated in foreign currencies that were subject to
changes in exchange rates. At this time, the Company does not use derivative
instruments to manage the exchange rate risk.

The Company imports its product from
manufacturers located in the Pacific Rim, principally China. Although the Company
generally pays for its product in United States dollars, the cost of such product may
fluctuate with the value of the Chinese currency because the purchase price paid to the
Companys vendors in United States dollars would be worth more or less in the
Chinese currency. As a result, the Companys costs could be adversely affected if
the Chinese currency appreciates significantly relative to the United States dollar; this
could result from a decision by the Peoples Republic of China to allow its currency
to float instead of being

20

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pegged to the U.S. dollar at a fixed rate.
Conversely, its costs would be favorably affected if the Chinese currency depreciates
significantly relative to the United States dollar. In addition, less than 1% of the
Companys product purchases in 2003 were denominated in foreign currencies that were
subject to changes in exchange rates. During 2003, the Company did not use derivative
instruments to manage the exchange rate risk.

See also Item 1.
Business  Restrictions on Imports.

# EFFECT OF INFLATION

The Company continually
attempts to minimize any effect of inflation on earnings by controlling its
operating costs and selling prices. During the past few years, the rate of
inflation has been low and has not had a material impact on the Companys
results of operations.

# FORWARD-LOOKING STATEMENTS AND FACTORS AFFECTING FUTURE EARNINGS

Certain statements made in
this Annual Report on Form 10-K and the documents incorporated by reference in
this Annual Report on Form 10-K include forward-looking statements within the
meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act. All statements regarding the Companys expected future financial
position, results of operations, cash flows, financing plans, business strategy,
budgets, tax rates, capital expenditures, competitive positions, growth
opportunities, plans and objectives of management, as well as statements
containing the words such as anticipate, approximate,
believe, plan, estimate, expect,
project, could, should, will,
intend, may and other similar expressions, are
forward-looking statements. Forward-looking statements do not relate strictly to
historical or current facts.

Such forward-looking
statements are inherently uncertain, and you must recognize that actual results
may differ materially from forward-looking statements as a result of a variety
of factors, including, without limitation, those discussed below. Such
forward-looking statements are based on managements current expectations
and include known and unknown risks, uncertainties and other factors, many of
which the Company is unable to predict or control, that may cause the
Companys actual results or performance to differ materially from any
future results or performance expressed or implied by such forward-looking
statements. These statements involve risks, uncertainties and other factors
discussed below or described from time to time in the Companys filings
with the Commission.

Such factors include, among
other things, the following: consumer acceptance of new products; changing
public and consumer taste; product development efforts; identification and
retention of sculpting and other talent; shift in product mix; completion of
third-party product manufacturing; customer reorders and order cancellations;
the volume, number, mix and timing of customer orders, reseller inventory
policies, and the Companys ability to forecast and fulfill changes in
anticipated product demand; control of operating expenses; collection of
accounts receivable; management of inventory; changes in the cost and
availability of cargo transportation, dockage and materials handling with
respect to both the importation of inventory and the shipment of product to the
Companys customers; the effect of regulations and operating protocols
affecting the importation of goods into the U.S., including security measures
adopted by U.S. Customs in light of heightened terrorism; changes in
foreign exchange rates; corporate cash flow application, including share
repurchases; cost of debt capital; functionality of information, operating and
distribution systems; identification, completion and results of acquisitions,
investments, Company-owned retail expansion, and other strategic business
initiatives; capital expenditures and depreciation, and the timing thereof;
grants of stock options or other equity equivalents; actual or deemed exercises
of stock options; industry, general economic, regulatory, transportation, labor,
and international trade and monetary conditions; adverse weather conditions,
natural disasters (such as hurricanes and epidemics), terrorist activities and
international political/military developments which may, among other things,
impair performance at the retail stores of the Company and its customers; and
actions of competitors. Actual results may vary materially from forward-looking
statements and the assumptions on which they are based. The Company undertakes
no obligation to update or publish in the future any forward-looking statements.

21

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# ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following discussion of the
Companys exposure to market risk contains forward-looking statements that
involve risks and uncertainties. The information presented has been prepared utilizing
certain assumptions considered reasonable in light of information currently available to
management. Given the unpredictability of interest rates as well as other factors, actual
results could differ materially from those projected in such forward-looking information.

The Companys market
risks relate primarily to changes in interest rates and currency exchange rates.
The first component of the Companys interest rate risk relates to its debt
outstanding. The Companys credit facility bears interest at variable
rates. Because this facility carries a variable interest rate, the
Companys results of operations and cash flows will be exposed to changes
in interest rates. Based on average borrowings in 2003, a 1% increase or
decrease in current market interest rates would have an impact of approximately
$0.5 million.

The second component of the
Companys interest rate risk involves the short-term investment of excess
cash. Excess cash flow is typically invested in high-quality fixed income
securities issued by banks, corporations and the U.S. government; municipal
securities; and overnight repurchase agreements backed by U.S. government
securities. These securities are classified as cash equivalents on the
Companys balance sheet. At January 3, 2004, the Companys cash
balance was approximately $22.5 million. Earnings from cash equivalents were
approximately $0.2 million for the fifty-three weeks ended January 3, 2004.
Based on the January 3, 2004 cash balance, a 1% increase or decrease in current
market interest rates would have an impact of approximately $0.2 million.

Approximately 3% of the
Companys sales and less than 1% of the Companys product purchases in
fiscal year 2003 were denominated in a foreign currency. Based on these sales
and product purchases, a 10% increase or decrease in the foreign currency
exchange rates would have an impact of less than $1 million.

# ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See Consolidated Financial
Statements on page F-1 herein.

# ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
                 AND FINANCIAL DISCLOSURE

Not applicable.

# ITEM 9A.   CONTROLS AND PROCEDURES

As of the end of the period
covered by this report, an evaluation was carried out under the supervision and
with the participation of the Companys management, including its Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Companys disclosure controls and procedures
(as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934). Any control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. The design of a control system inherently has
limitations, including that the benefits of controls must be considered relative
to their costs. Additionally, controls can be circumvented by the individual
acts of some persons, or by collusion of two or more people. Therefore, even
effective disclosure controls and procedures can only provide reasonable
assurance of achieving their control objective. Based upon and as of the date of
that evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that those disclosure controls and procedures are effective to provide
reasonable assurance that information required to be disclosed by the Company in
the reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Commissions rules and forms.

There have been no changes in the
Companys internal control over financial reporting (as defined in Rules
13a-15 and 15d-15 of the Exchange Act) during the Companys most recently
completed fiscal quarter that have materially affected, or are reasonably likely
to materially affect, the Companys internal control over financial
reporting.



22

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PART III

---

# ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information required by
this Item will be included in the 2004 Proxy Statement in the sections captioned
Item 1  Election of Directors  Nominees for
Terms Ending at the 2005 Annual Meeting of Stockholders,
Information About the Board and Corporate Governance, Biographical Information Regarding Executive Officers, and Section
16(a) Beneficial Ownership Reporting Compliance, and such information is incorporated herein by reference.

# ITEM 11.   EXECUTIVE COMPENSATION

Information required by
this Item will be included in the 2004 Proxy Statement in the sections captioned
Information About the Board and Corporate Governance  Director Compensation, and Compensation
of Executive Officers, and such information is incorporated herein by
reference.

# ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
                   AND RELATED STOCKHOLDER MATTERS

Information required by
this Item will be included in the 2004 Proxy Statement in the section captioned
Equity Compensation Plan Information, and
Security Ownership of Certain Beneficial Owners and Management, and
such information is incorporated herein by reference.

# ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Not applicable.

# ITEM 14.   PRINCIPAL ACCOUNTANT FEES AND SERVICES

Information required by
this Item will be included in the 2004 Proxy Statement in the section captioned Audit Committee Report,
and such information is incorporated herein by reference.

23

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PART IV

---

# ITEM 15.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

The Exhibits, and other
documents filed as part of this Annual Report on Form 10-K, including those
exhibits which are incorporated by reference herein, are:

|    | Page                                                                          
|--- | ------------------------------------------------------------------------------
|   
|(a) |                                                                               
|    | Independent Auditors Report                                                  
|    | Consolidated Balance Sheets as of January 3, 2004 and December 28, 2002       
|    | For the years ended January 3, 2004, December 28, 2002, and December 29, 2001:
|    | Consolidated Statements of Income                                             
|    | Consolidated Statements of Cash Flows                                         
|    | Consolidated Statements of Stockholders Equity                               
|    | Notes to Consolidated Financial Statements                                    
|    | 2.                                                                            
|    | II.  Valuation and Qualifying Accounts                                        
|    | All other schedules have been omitted because they are not applicable         
|    | 3.                                                                            

Exhibits required in connection with this Annual Report on Form 10-K are listed below.

|Exhibit |  | Description
|------- |  | -----------

---

| | 3.1 |  | Restated
Certificate of Incorporation of the Company.  (Incorporated herein by reference to
Exhibit 3.1 of Registrants Quarterly Report on Form 10-Q for the quarter ended July 3,
1993.  SEC File No. 1-11908.)
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.2 |  | Certificate
of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock
of the Company. (Incorporated herein by reference to Exhibit 1.1 of Registrants
Amendment No. 1, dated May 12, 1997, to Registration                   Statement on Form
8-A, dated April 23, 1997.  SEC File No. 1-11908.)
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.3 |  | Restated
By-Laws of the Company.  (Incorporated herein by reference to Exhibit 3.2 of Registrants
Registration Statement on Form S-1, No. 33-61514 and to Exhibits 1 and 2 of Registrants
Current Report on Form 8-K dated February 15,                   1996.  SEC File No.
1-11908.)
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4.1 |  | Specimen
Form of Companys Common Stock Certificate.  (Incorporated herein by reference to Exhibit
4.1 of Registrants Annual Report on Form 10-K for the fiscal year ended December 31,
1994. SEC File No. 1-11908.)
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4.2 |  | Rights
Agreement (including Exhibits A, B and C thereto) dated as of April 23, 1997, between the
Company and ChaseMellon Shareholder Services, L.L.C., as Rights Agent.  (Incorporated
herein by reference to Exhibit 1 of Registrants                   Registration Statement
on Form 8-A, dated April 23, 1997.  SEC File No. 1-11908.)
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4.3 |  | First
Amendment dated as of March 13, 1998, to Rights Agreement between the Company and
ChaseMellon Shareholder Services, L.L.C., as Rights Agent.  (Incorporated herein by
reference to Exhibit 1 to Registrants Amendment No. 2, dated                   March 16,
1998, to Registration Statement on Form 8-A, dated April 23, 1997.                   SEC
File No. 1-11908.)
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4.4 |  | Amendment
No. 2 to Rights Agreement, dated as of February 25, 1999, between the Company and
ChaseMellon Shareholder Services, L.L.C., as Rights Agent.  (Incorporated herein by
reference to Exhibit 99.2 of Registrants Current Report                   on Form 8-K
dated February 26, 1999.  SEC File No. 1-11908.)
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.1 |  | Lease
Agreement dated April 14, 1999 between D 56, Inc. and Ryan Companies US, Inc. pertaining
to the Rogers warehouse and distribution facility.  (Incorporated herein by reference to
Exhibit 10.4 of Registrants Annual Report on                   Form 10-K for the fiscal
year ended January 1, 2000.  SEC File No. 1-11908.)
| | ---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.2 |  | Guaranty
of Lease dated April 14, 1999 between the Company and Ryan Companies US, Inc. pertaining
to the Rogers warehouse and distribution facility.  (Incorporated herein by reference to
Exhibit 10.5 of Registrants Annual Report on                   Form 10-K for the fiscal
year ended January 1, 2000.  SEC File No. 1-11908.)
| | ---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.3 |  | Credit
Agreement, dated as of November 25, 2003 among the Company, the Bank parties thereto and
Bank One NA as LC Issuer, Swing Line Lender and as Administrative Agent. (Incorporated
herein by reference to Exhibit 10.1 of                   Registrants 8-K filed on
December 1, 2003.  SEC File No. 1-11908.)
| | ---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.4 |  | Guarantee
and Collateral Assignment, dated as of November 25, 2003, by the Company and certain of
its direct or indirect subsidiaries in favor of Bank One, NA  (Incorporated herein by
reference to Exhibit 10.2 of Registrants 8-K                   filed on December 1,
2003.  SEC File No. 1-11908.)
| | ---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.5 |  | Form
of Indemnification Agreement between the Company and its directors and executive
officers.  (Incorporated herein by reference to Exhibit 10.24 of Registrants
Registration Statement on Form S-1, No. 33-61514.)
| | ---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.6 |  | Department
56, Inc. 1992 Stock Option Plan.  (Incorporated herein by reference to Exhibit 10.1 of
Registrants Registration Statement on Form S-1, No. 33-61514.) 
| | ---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

24

---

|Exhibit |  | Description
|------- |  | -----------

---

| | 10.7 |  | Department
56, Inc. 1993 Stock Incentive Plan.  (Incorporated herein by reference to Exhibit 10.10
of Registrants Annual Report on Form 10-K for the fiscal year ended December 29, 2001.
 SEC File No. 1-11908.) 
| | ---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.8 |  | Department
56, Inc. 1995 Stock Incentive Plan.  (Incorporated herein by reference to Exhibit 10.11
of Registrants Annual Report on Form 10-K for the fiscal year ended December 29, 2001.
 SEC File No. 1-11908.) 
| | ---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.9 |  | Department
56, Inc. 1997 Stock Incentive Plan.  (Incorporated herein by reference to Exhibit 10.12
of Registrants Annual Report on Form 10-K for the fiscal year ended December 29, 2001.
 SEC File No. 1-11908.) 
| | ---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.10 |  | Department
56, Inc. 2004 Cash Incentive Plan.  *
| | ----- |  | -------------------------------------------------

| | 10.11 |  | Department
56, Inc. 2004 Stock Incentive Plan.  *
| | ----- |  | --------------------------------------------------

| | 10.12 |  | Form
of Executive Stock Option Agreement in connection with Department 56, Inc. 1992 Stock
Option Plan, Department 56, Inc. 1993 Stock Incentive Plan, Department 56, Inc. 1995
Stock Incentive Plan, and Department 56, Inc. 1997 Stock                   Incentive
Plan.  (Incorporated herein by reference to Exhibit 10.13 of Registrants Annual Report
on Form 10-K for the fiscal year ended January 1, 2000.  SEC File No. 1-11908.) 
| | ----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.13 |  | Form
of Performance - Accelerated Vesting Stock Option Agreement in connection with Department
56, Inc.                   1993, 1995 and 1997 Stock Incentive Plans.  (Incorporated
herein by reference to Exhibit 10.14 of Registrants Annual Report on Form 10-K for the
fiscal year ended January 1, 2000.  SEC File No. 1-11908.) 
| | ----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.14 |  | Forms
of Letter Agreement between the Company and its executive officers. (Incorporated herein
by reference to Exhibit 10.14 of Registrants Annual Report on Form 10-K for the fiscal
year ended December 28, 2002. SEC File No. 1-11908.) 
| | ----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.15 |  | Form
of Department 56, Inc. Restricted Stock Agreement.  (Incorporated herein by reference to
Exhibit 10.16 of Registrants Annual Report on Form 10-K for the fiscal year ended
December 29, 2001. SEC File No. 1-11908.) 
| | ----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.16 |  | Form
of Department 56, Inc. 2001 Non-Officer Stock Option Plan. (Incorporated herein by
reference to Exhibit 10.17 of Registrants Annual Report on Form 10-K for the fiscal year
ended December 29, 2001. SEC File No. 1-11908.) 
| | ----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.17 |  | Asset
Purchase Agreement By and Among Department 56, Inc., Axis Holdings Corporation, Axis
Corporation, All Shareholders of Axis Corporation, and Kirk Willey in the Capacity of
Shareholders Representative.  (Incorporated herein by                   reference to
Exhibit 10.19 of Registrants Annual Report on Form 10-K for the fiscal year ended
December 29, 2001. SEC File No. 1-11908.) 
| | ----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10.18 |  | Letter Agreement
between Department 56, Inc. and David Dewey, dated December 15, 2003.  *
| | ----- |  | ------------------------------------------------------------------------------------------

| | 21.1 |  | Subsidiaries
of the Company. *
| | ---- |  | ------------------------------

| | 23.1 |  | Independent
Auditors Consent. *
| | ---- |  | --------------------------------

| | 31.1 |  | Certification of
Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002. *
| | ---- |  | -----------------------------------------------------------------------------------------------------

| | 31.2 |  | Certification
of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. *
| | ---- |  | -----------------------------------------------------------------------------------------------------

| | 32.1 |  | Certification
of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, 18 U.S.C. Section 1350. *
| | ---- |  | -----------------------------------------------------------------------------------------------------------------------------

| | 32.2 |  | Certification of
Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, 18 U.S.C. Section 1350. *
| | ---- |  | -----------------------------------------------------------------------------------------------------------------------------

  Management contract or compensatory plan.
*  Filed herewith.

(b)   Reports on Form 8-K

The Company filed the following Current Reports on Form 8-K during the fourth quarter of 2003:
             Form 8-K dated October 30, 2003.
             Form 8-K dated December 1, 2003.

25

---

# SIGNATURES

Pursuant to the requirements of
Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

|                       |                                                                  |                     |  |                      | 
|---------------------- | ---------------------------------------------------------------- | ------------------- |  | -------------------- | 
|                       |                                                                  | DEPARTMENT 56, INC.
|Date:   March 17, 2004 |                                                                  | By:                 |  | /s/   Susan E. Engel | 
|                       |                                                                 
|                       | Susan E. EngelChairwoman of the Boardand Chief Executive Officer |                    

Pursuant to the
requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the capacities
and on the dates indicated.

|Signature                   |  | Capacity in which signed         |  | Date          
|--------------------------- |  | -------------------------------- |  | --------------
|/s/   SUSAN E. ENGEL        |  | Chairwoman of the Board and      |  | March 17, 2004
|                            |  | Chief Executive Officer          | 
|Susan E. Engel              |  | (Principal Executive Officer)    | 
|/s/   TIMOTHY J. SCHUGEL    |  | Chief Financial Officer and      |  | March 17, 2004
|                            |  | Executive Vice President         | 
|Timothy J. Schugel          |  | (Principal Financial Officer)    | 
|/s/   GREGG A. PETERS       |  | Managing Director of Finance and |  | March 17, 2004
|                            |  | Principal Accounting Officer     | 
|Gregg A. Peters             |  | (Principal Accounting Officer)   | 
|/s/   JAMES E. BLOOM        |  | Director                         |  | March 17, 2004
|                           
|James E. Bloom              | 
|/s/   MICHAEL R. FRANCIS    |  | Director                         |  | March 17, 2004
|                           
|Michael R. Francis          | 
|/s/   STEWART M. KASEN      |  | Director                         |  | March 17, 2004
|                           
|Stewart M. Kasen            | 
|/s/   DR. REATHA CLARK KING |  | Director                         |  | March 17, 2004
|                           
|Dr. Reatha Clark King       | 
|/s/   GARY S. MATTHEWS      |  | Director                         |  | March 17, 2004
|                           
|Gary S. Matthews            | 
|/s/   STEVEN G. ROTHMEIER   |  | Director                         |  | March 17, 2004
|                           
|Steven G. Rothmeier         | 
|/s/   VIN WEBER             |  | Director                         |  | March 17, 2004
|                           
|Vin Weber                   | 

26

---

# INDEPENDENT AUDITORS REPORT

To  the Board of Directors and
Stockholders of     Department 56, Inc.:

We have
audited the consolidated balance sheets of Department 56, Inc. and subsidiaries (the
Company) as of January 3, 2004 and December 28, 2002 and the related consolidated
statements of income, cash flows, and stockholders equity for the years ended
January 3, 2004, December 28, 2002, and December 29, 2001. Our audit also included the
financial statement schedule listed in the Index at Item 15. These consolidated financial
statements and financial statement schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.

We conducted
our audits in accordance with auditing standards generally accepted in the United States
of America. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements. An audit also
includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.

In our
opinion, such consolidated financial statements present fairly, in all material respects,
the financial position of the Company as of January 3, 2004 and December 28, 2002 and the
results of its operations and its cash flows for the years ended January 3, 2004, December
28, 2002, and December 29, 2001 in conformity with accounting principles generally
accepted in the United States of America. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial statements taken
as a whole, presents fairly in all material respects the information set forth therein.

As discussed
in Note 1 to the consolidated financial statements, in 2002 the Company changed its method
of accounting for goodwill and other intangible assets to conform to Statement of
Financial Accounting Standards No. 142.

Deloitte & Touche LLP

Minneapolis, Minnesota
March 1, 2004

F-1

---

# DEPARTMENT 56, INC. AND SUBSIDIARIES

# CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
AS OF JANUARY 3, 2004 AND DECEMBER 28, 2002

---

|                                                                            |  |  |   | 2003     |   |   | 2002     |  
|--------------------------------------------------------------------------- |  |  | - | -------- | - | - | -------- | -
|ASSETS                                                                      |  | 
|CURRENT ASSETS:                                                             |  | 
|Cash and cash equivalents                                                   |  |  | $ | 22,487   |   | $ | 42,494   |  
|Accounts receivable, net of allowances of $8,678 and $10,382, respectively  |  |  |   | 20,999   |   |   | 32,620   |  
|Inventories                                                                 |  |  |   | 14,594   |   |   | 14,324   |  
|Deferred taxes                                                              |  |  |   | 7,797    |   |   | 5,955    |  
|Other current assets                                                        |  |  |   | 3,924    |   |   | 3,138    |  
|                                                                            |  |  |   |         
|Total current assets                                                        |  |  |   | 69,801   |   |   | 98,531   |  
|PROPERTY AND EQUIPMENT, net                                                 |  |  |   | 17,664   |   |   | 20,908   |  
|GOODWILL, net of accumulated amortization of $38,708                        |  |  |   | 37,074   |   |   | 44,986   |  
|TRADEMARKS AND OTHER INTANGIBLES, net of accumulated amortization           |  | 
|of $6,048 and $6,035, respectively                                          |  |  |   | 14,557   |   |   | 15,075   |  
|OTHER ASSETS                                                                |  |  |   | 3,208    |   |   | 1,825    |  
|                                                                            |  |  |   |         
|                                                                            |  |  | $ | 142,304  |   | $ | 181,325  |  
|                                                                            |  |  |   |         
|LIABILITIES AND STOCKHOLDERS EQUITY                                        |  | 
|CURRENT LIABILITIES:                                                        |  | 
|Current portion of long-term debt                                           |  |  | $ |         |   | $ | 2,235    |  
|Accounts payable                                                            |  |  |   | 8,563    |   |   | 8,172    |  
|Accrued compensation and benefits                                           |  |  |   | 6,509    |   |   | 9,936    |  
|Income taxes payable                                                        |  |  |   | 3,513    |   |   | 3,252    |  
|Other current liabilities                                                   |  |  |   | 1,567    |   |   | 2,051    |  
|                                                                            |  |  |   |         
|Total current liabilities                                                   |  |  |   | 20,152   |   |   | 25,646   |  
|OTHER LIABILITIES                                                           |  |  |   | 3,015    |   |   | 1,358    |  
|DEFERRED TAXES                                                              |  |  |   | 4,841    |   |   | 5,808    |  
|LONG-TERM DEBT                                                              |  |  |   |         |   |   | 51,765   |  
|COMMITMENTS AND CONTINGENCIES (Note 8)                                      |  | 
|STOCKHOLDERS EQUITY:                                                       |  | 
|Preferred stock, $.01 par value; authorized 20,000 shares; no shares issued |  | 
|Common stock, $.01 par value; authorized 100,000 shares; issued             |  | 
|22,363 and 22,259 shares, respectively                                      |  |  |   | 224      |   |   | 223      |  
|Additional paid-in capital                                                  |  |  |   | 54,020   |   |   | 52,900   |  
|Unearned compensation - restricted shares                                   |  |  |   | (514     | ) |   | (754     | )
|Treasury stock, at cost; 9,195 and 9,178 shares, respectively               |  |  |   | (216,963 | ) |   | (216,742 | )
|Retained earnings                                                           |  |  |   | 277,529  |   |   | 261,121  |  
|                                                                            |  |  |   |         
|Total stockholders equity                                                  |  |  |   | 114,296  |   |   | 96,748   |  
|                                                                            |  |  |   |         
|                                                                            |  |  | $ | 142,304  |   | $ | 181,325  |  
|                                                                            |  |  |   |         

See notes to
consolidated financial statements.

F-2

---

# DEPARTMENT 56, INC. AND SUBSIDIARIES

# CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
YEARS ENDED JANUARY 3, 2004, DECEMBER 28, 2002, AND DECEMBER 29, 2001

---

|                                                           |  |  |   | 2003    |   |   | 2002    |   |   | 2001    |  
|---------------------------------------------------------- |  |  | - | ------- | - | - | ------- | - | - | ------- | -
|                                                          
|NET SALES                                                  |  |  | $ | 191,714 |   | $ | 208,624 |   | $ | 200,447 |  
|                                                          
|COST OF SALES                                              |  |  |   | 89,053  |   |   | 90,305  |   |   | 89,845  |  
|                                                           |  |  |   |         |   |  
|Gross profit                                               |  |  |   | 102,661 |   |   | 118,319 |   |   | 110,602 |  
|                                                          
|OPERATING EXPENSES:                                        |  | 
|Selling, general and administrative                        |  |  |   | 66,632  |   |   | 76,758  |   |   | 68,589  |  
|Impairment of Geppeddo assets                              |  |  |   | 9,140   |   |   |        |   |   |        |  
|Amortization of goodwill, trademarks and other intangibles |  |  |   | 235     |   |   | 248     |   |   | 5,189   |  
|                                                           |  |  |   |         |   |  
|Total operating expenses                                   |  |  |   | 76,007  |   |   | 77,006  |   |   | 73,778  |  
|                                                           |  |  |   |         |   |  
|                                                          
|INCOME FROM OPERATIONS                                     |  |  |   | 26,654  |   |   | 41,313  |   |   | 36,824  |  
|                                                          
|OTHER EXPENSE (INCOME):                                    |  | 
|Interest expense                                           |  |  |   | 1,954   |   |   | 3,426   |   |   | 7,036   |  
|Litigation settlement                                      |  |  |   |        |   |   | (5,388  | ) |   |        |  
|Impairment and equity in losses of minority investment     |  |  |   |        |   |   |        |   |   | 3,304   |  
|Other, net                                                 |  |  |   | (938    | ) |   | (386    | ) |   | (662    | )
|                                                           |  |  |   |         |   |  
|                                                          
|INCOME BEFORE INCOME TAXES                                 |  |  |   | 25,638  |   |   | 43,661  |   |   | 27,146  |  
|                                                          
|PROVISION FOR INCOME TAXES                                 |  |  |   | 9,230   |   |   | 11,820  |   |   | 11,184  |  
|                                                           |  |  |   |         |   |  
|                                                          
|INCOME BEFORE CUMULATIVE EFFECT OF CHANGE                  |  | 
|IN ACCOUNTING PRINCIPLE                                    |  |  |   | 16,408  |   |   | 31,841  |   |   | 15,962  |  
|                                                          
|CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING                  |  | 
|PRINCIPLE                                                  |  |  |   |        |   |   | (93,654 | ) |   |        |  
|                                                           |  |  |   |         |   |  
|                                                          
|NET INCOME (LOSS)                                          |  |  | $ | 16,408  |   | $ | (61,813 | ) | $ | 15,962  |  
|                                                           |  |  |   |         |   |  
|                                                          
|INCOME (LOSS) PER SHARE  BASIC:                           |  | 
|                                                          
|INCOME PER SHARE BEFORE CUMULATIVE EFFECT OF CHANGE        |  | 
|IN ACCOUNTING PRINCIPLE                                    |  |  | $ | 1.25    |   | $ | 2.45    |   | $ | 1.24    |  
|                                                          
|CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE        |  |  |   |        |   |   | (7.21   | ) |   |        |  
|                                                           |  |  |   |         |   |  
|                                                          
|NET INCOME (LOSS) PER COMMON SHARE  BASIC                 |  |  | $ | 1.25    |   | $ | (4.76   | ) | $ | 1.24    |  
|                                                           |  |  |   |         |   |  
|                                                          
|INCOME (LOSS) PER SHARE  DILUTED:                         |  | 
|                                                          
|INCOME PER SHARE BEFORE CUMULATIVE EFFECT OF CHANGE        |  | 
|IN ACCOUNTING PRINCIPLE                                    |  |  | $ | 1.24    |   | $ | 2.42    |   | $ | 1.24    |  
|                                                          
|CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE        |  |  |   |        |   |   | (7.13   | ) |   |        |  
|                                                           |  |  |   |         |   |  
|                                                          
|NET INCOME (LOSS) PER COMMON SHARE  DILUTED               |  |  | $ | 1.24    |   | $ | (4.70   | ) | $ | 1.24    |  
|                                                           |  |  |   |         |   |  

See notes to
consolidated financial statements.

F-3

---

# DEPARTMENT 56, INC. AND SUBSIDIARIES

# CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
YEARS ENDED JANUARY 3, 2004, DECEMBER 28, 2002, AND DECEMBER 29, 2001

---

|                                                            |  |  |   | 2003    |   |   | 2002    |   |   | 2001    |  
|----------------------------------------------------------- |  |  | - | ------- | - | - | ------- | - | - | ------- | -
|CASH FLOWS FROM OPERATING ACTIVITIES:                       |  | 
|Net income (loss)                                           |  |  | $ | 16,408  |   | $ | (61,813 | ) | $ | 15,962  |  
|                                                            |  | 
|Adjustments to reconcile net income (loss) to net           |  | 
|cash provided by operating activities:                      |  | 
|Cumulative effect of change in accounting principle         |  |  |   |        |   |   | 93,654  |   |   |        |  
|Depreciation                                                |  |  |   | 4,758   |   |   | 4,888   |   |   | 5,873   |  
|Loss (gain) on sale of assets                               |  |  |   | 37      |   |   | 111     |   |   | (62     | )
|Impairment of Geppeddo assets                               |  |  |   | 9,140   |   |   |        |   |   |        |  
|Impairment and equity in losses of minority investment      |  |  |   |        |   |   |        |   |   | 3,304   |  
|Amortization of goodwill, trademarks and other intangibles  |  |  |   | 235     |   |   | 248     |   |   | 5,189   |  
|Amortization of deferred financing fees                     |  |  |   | 474     |   |   | 385     |   |   | 385     |  
|Compensation expense  restricted shares                    |  |  |   | 240     |   |   | 263     |   |   | 152     |  
|Deferred taxes                                              |  |  |   | (2,809  | ) |   | (546    | ) |   | 2,773   |  
|Changes in assets and liabilities:                          |  | 
|Accounts receivable                                         |  |  |   | 11,621  |   |   | (9,825  | ) |   | 13,488  |  
|Inventories                                                 |  |  |   | (270    | ) |   | (3,173  | ) |   | 5,102   |  
|Other assets                                                |  |  |   | (2,418  | ) |   | 620     |   |   | (797    | )
|Accounts payable                                            |  |  |   | 391     |   |   | (2,639  | ) |   | 2,659   |  
|Accrued compensation and benefits payable                   |  |  |   | (3,427  | ) |   | 2,508   |   |   | 1,026   |  
|Accrued income taxes payable                                |  |  |   | 261     |   |   | (5,374  | ) |   | 1,831   |  
|Other liabilities                                           |  |  |   | 1,292   |   |   | 1,276   |   |   | (2      | )
|                                                            |  |  |   |         |   |  
|Net cash provided by operating activities                   |  |  |   | 35,933  |   |   | 20,583  |   |   | 56,883  |  
|                                                            |  | 
|CASH FLOWS FROM INVESTING ACTIVITIES:                       |  | 
|Purchases of property and equipment                         |  |  |   | (2,510  | ) |   | (1,928  | ) |   | (2,906  | )
|Proceeds from sale of assets                                |  |  |   |        |   |   |        |   |   | 142     |  
|Litigation settlement  reduction in net depreciable assets |  |  |   |        |   |   | 5,618   |   |   |        |  
|Acquisitions                                                |  |  |   |        |   |   |        |   |   | (9,729  | )
|                                                            |  |  |   |         |   |  
|Net cash (used in) provided by investing activities         |  |  |   | (2,510  | ) |   | 3,690   |   |   | (12,493 | )
|                                                            |  | 
|CASH FLOWS FROM FINANCING ACTIVITIES:                       |  | 
|Proceeds from the exercise of common stock options          |  |  |   | 1,016   |   |   | 1,239   |   |   |        |  
|Payments of deferred financing fees                         |  |  |   | (225    | ) |   |        |   |   |        |  
|Borrowings on revolving credit agreement                    |  |  |   | 42,000  |   |   | 38,000  |   |   | 35,000  |  
|Principal payments on revolving credit agreement            |  |  |   | (42,000 | ) |   | (38,000 | ) |   | (35,000 | )
|Purchases of treasury stock                                 |  |  |   | (221    | ) |   | (106    | ) |   |        |  
|Principal payments on long-term debt                        |  |  |   | (54,000 | ) |   | (31,000 | ) |   | (20,000 | )
|                                                            |  |  |   |         |   |  
|Net cash used in financing activities                       |  |  |   | (53,430 | ) |   | (29,867 | ) |   | (20,000 | )
|                                                            |  | 
|NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS        |  |  |   | (20,007 | ) |   | (5,594  | ) |   | 24,390  |  
|                                                            |  | 
|CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD            |  |  |   | 42,494  |   |   | 48,088  |   |   | 23,698  |  
|                                                            |  |  |   |         |   |  
|                                                            |  | 
|CASH AND CASH EQUIVALENTS AT END OF PERIOD                  |  |  | $ | 22,487  |   | $ | 42,494  |   | $ | 48,088  |  
|                                                            |  |  |   |         |   |  

See notes to consolidated financial statements.

F-4

---

# DEPARTMENT 56, INC. AND SUBSIDIARIES

# CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(In thousands)
YEARS ENDED JANUARY 3, 2004, DECEMBER 28, 2002, AND DECEMBER 29, 2001

---

|                                   | Common StockShares     Amount | AdditionalPaid-inCapital | UnearnedCompensationRestrictedShares | TreasuryStock | RetainedEarnings | TotalStockholdersEquity
|---------------------------------- | ----------------------------- | ------------------------ | ------------------------------------ | ------------- | ---------------- | ------------------------
|                                   |                              
|BALANCE AS OF DECEMBER 30, 2000    |                               |                          |                                      | 12,824        |                  | $                       
|                                   |                               |                         
|Net income                         |                               |                          |                                      | 15,962        |                  |                         
|Restricted shares issued           |                               |                          |                                      | 67            |                  |                         
|Restricted shares vested           |                               |                          |                                      |               |                  |                         
|Other                              |                               |                          |                                      | 6             |                  |                         
|                                   |                               |                          |                                      |               |                  |                         
|BALANCE AS OF DECEMBER 29, 2001    |                               |                          |                                      | 12,897        |                  |                         
|                                   |                               |                         
|Net loss                           |                               |                          |                                      |               |                  |                         
|Shares issued upon the exercise of |                               |                         
|common stock options               |                               |                          |                                      | 142           |                  |                         
|Restricted shares surrendered      |                               |                          |                                      | (12           | )                |                         
|Restricted shares issued           |                               |                          |                                      | 50            |                  |                         
|Restricted shares vested           |                               |                          |                                      | 263           |                  |                         
|Other                              |                               |                          |                                      | 4             |                  |                         
|                                   |                               |                          |                                      |               |                  |                         
|                                   |                               |                         
|BALANCE AS OF DECEMBER 28, 2002    |                               |                          |                                      | 13,081        |                  |                         
|                                   |                               |                         
|Net income                         |                               |                          |                                      |               |                  |                         
|Shares issued upon the exercise of |                               |                         
|common stock options               |                               |                          |                                      | 100           |                  |                         
|Restricted shares surrendered      |                               |                          |                                      | (17           | )                |                         
|Restricted shares vested           |                               |                          |                                      |               |                  |                         
|Other                              |                               |                          |                                      | 4             |                  |                         
|                                   |                               |                          |                                      |               |                  |                         
|                                   |                               |                         
|BALANCE AS OF JANUARY 3, 2004      |                               |                          |                                      | 13,168        |                  | $                       
|                                   |                               |                          |                                      |               |                  |                         

See notes to consolidated financial statements.

F-5

---

# DEPARTMENT 56, INC. AND SUBSIDIARIES

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share amounts)

---

|1. |  | SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
|-- |  | ------------------------------------------

| | Business 
Department 56, Inc. and Subsidiaries (the Company) is engaged in the original
design and wholesale and retail distribution of specialty giftware products and
dolls. The majority of the Companys products are developed and designed by
the Companys in-house creative team and are manufactured for the Company
by independently owned foreign manufacturers located primarily in the
Peoples Republic of China. The Companys wholesale customer base and
accounts receivable are primarily composed of, and are due from, retail stores
of various sizes located throughout the United States and Canada. Approximately
3% of total revenue is derived from customers outside the United States and all
long-lived assets are located within the United States. No customer represents
more than 3% of total revenue in any period presented.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Principles of
Consolidation  The consolidated financial statements of the Company
include the accounts of the Company and its subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Fiscal
Year End  The Companys policy is to end its fiscal year on the Saturday
closest to December 31. The year ended January 3, 2004 includes 53 weeks and the
years ended December 28, 2002 and December 29, 2001 include 52 weeks.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Cash
Equivalents  All highly liquid debt instruments with original
maturities of three months or less are considered to be cash equivalents. These
investments are carried at cost, which approximates market value.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Inventories Inventories consist of finished goods and are
stated at the lower of average cost, which approximates first-in, first-out
cost, or net realizable value. The Company records inventory at the date of
taking title, which typically occurs when product is delivered to a foreign
port. As a result, at certain times during the year, the Company has significant
in-transit quantities, as inventory is sourced primarily from the Peoples
Republic of China and other Pacific Rim countries. Each period, the Company
adjusts identified excess and slow-moving inventory to its net realizable value.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Property and
Equipment Property and equipment are stated at cost. Depreciation is
computed on a straight-line method over the estimated useful lives of the assets
(or in the case of leasehold improvements, the shorter of the estimated useful
lives or lease terms). Estimated useful lives range from 2 to 45 years.
Major improvements and replacements of property are capitalized. Maintenance,
repairs, and minor improvements are expensed.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Long-Lived
Assets  The Companys principal long-lived assets are its
property and equipment, which consists of its building at its corporate
headquarters and computer equipment, furniture and fixtures, machinery, and
leasehold improvements at its corporate headquarters, distribution center,
showrooms and retail stores. The Company annually reviews its long-lived assets
for impairment. In 2003, the Company recognized an impairment charge of $0.9
million related to long-lived assets at its Geppeddo subsidiary. See Note 2.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Goodwill,
Trademarks, and Other Intangible Assets  On December 30, 2001, the
Company adopted Statement of Financial Accounting Standards (SFAS) No. 142,
Goodwill and Other Intangible Assets, which requires that goodwill and
intangible assets with indefinite lives no longer be amortized, but
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-6

---

| | instead tested
for impairment annually. Upon adoption of SFAS No. 142, the Company performed
impairment testing and concluded that goodwill related to the wholesale
operating segment was impaired. As a result, the Company recorded a $93,654
charge to write-down its goodwill. The Company determined that its trademarks
are indefinite-lived intangible assets and ceased amortization. Intangible
assets associated with non-compete agreements are amortized over the life of the
agreement. See Note 4.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
2003, the Company recorded an $8,193 charge to write-down its goodwill, trademarks and
other intangible assets related to Geppeddo as a result of the decision to cease
operations. See Note 2.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenue
Recognition  The Company sells its products through wholesale channels
and directly to retail customers. Revenue from wholesale customers is recognized
when shipped while revenue from the sale of merchandise to retail customers is
recognized at the time of sale. The Company believes that these are the times
when persuasive evidence of an arrangement exists, delivery has occurred, the
Companys price is fixed and collectibility is reasonably assured. Revenue
is recognized net of any applicable discounts and allowances. Customers, be they
wholesale or retail, do have the right to return product in certain limited
situations. Such rights of returns have not precluded revenue recognition
because the Company has a long history with such returns on which it constructs
a reserve. Sales returns and credits as a percentage of wholesale sales have
historically been between 3% and 5%.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Advertising Expense  The Company records advertising expense in
accordance with Statement of Position No. 93-7. Costs to produce an
advertisement are expensed when the advertisement occurs. Costs to reimburse
retailers for cooperative advertising are accrued and expensed when the product
is shipped. All advertising costs are recorded in selling, general and
administrative expense. Advertising expense for 2003, 2002, and 2001 was $2,124,
$2,754, and $1,767, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Product
Development Expense  The Companys product development costs consist
principally of salaries to internal creative talent, royalties paid to outside artists,
and costs incurred in developing product samples. The Company expenses as incurred the
salaries of creative talent and records it in selling, general and administrative
expense. The Company capitalizes into inventory the cost of royalties paid to outside
artists and records it in cost of sales as the product is sold. The cost to develop
product samples is expensed as incurred and recorded in cost of sales.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Freight
Expense  Freight expenses for products shipped to customers (freight-out) are
included in cost of products sold, in accordance with Emerging Issues Task Force Issue
No. 00-10, Accounting for Shipping and Handling Fees and Costs.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Pre-Opening
Costs  Non-capital expenditures associated with opening new Company-owned
retail stores are expensed as incurred.
| | ------------------------------------------------------------------------------------------------------------------------------

| | Income
Taxes  Deferred income taxes are recognized for the tax consequences in future
years of differences between the tax bases of assets and liabilities and their financial
reporting amounts at each year-end based on enacted tax laws and statutory tax rates
applicable to the periods in which the differences are expected to affect taxable income.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Foreign
Currency Exchange Rate Gains and Losses  The Company imports most of its
products and, while the majority of these purchases are denominated in United States
dollars, some of the purchases are denominated in foreign currency. In addition, the
Companys sales to Canadian customers are denominated in Canadian dollars. Foreign
exchange rate gains and losses are included in other expense (income) within the
accompanying consolidated statements of income. During 2003, the Company benefited from
the appreciation of the Canadian dollar relative to the United States dollar and
recognized $677 in foreign currency exchange rate gains. There were no significant
foreign currency exchange rate gains or losses in 2002, and in 2001 the Company
recognized a $301 loss. The
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-7

---

| | Company may
periodically enter into foreign exchange contracts or build foreign currency
deposits as a partial hedge against currency fluctuations. The Company did not
enter into any foreign exchange contracts during 2003, 2002 or 2001.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Fair Value of
Financial Instruments The carrying amount of the majority of the
Companys assets and liabilities including cash and cash equivalents,
accounts receivable, accounts payable, and commissions payable approximates fair
value because of the short-term nature of these instruments. Other assets and
liabilities are recorded at fair value. See Note 7.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Stock-Based
Compensation  The Companys stock-based compensation plans consist of
fixed stock options and restricted stock.
| | ----------------------------------------------------------------------------------------------------------------------------

| | The Company
applies Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations in accounting for its
plans. Accordingly, no compensation cost has been recognized for options
granted. Had compensation cost been determined based on the fair value of the
2001, 2002, and 2003 stock option grants consistent with the method of SFAS No.
123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148,
Accounting for Stock-BasedCompensation  Transition and
Disclosure, the Companys net income and net income per common share
assuming dilution would have been reduced to the pro forma amounts indicated
below:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                        | 2003 |  | 2002 |        | 2001
|------------------------------------------------------- | ---- |  | ---- | ------ | ----
|Net income (loss):                                      |      |  |      |        |     
|As reported                                             |      |  | $    | 16,408 |     
|Pro forma                                               |      |  |      | 14,518 |     
|Net income (loss) per common share  basic:             |      | 
|As reported                                             |      |  | $    | 1.25   |     
|Pro forma                                               |      |  |      | 1.11   |     
|Net income (loss) per common share  assuming dilution: |      | 
|As reported                                             |      |  | $    | 1.24   |     
|Pro forma                                               |      |  |      | 1.10   |     

| | In
determining the preceding pro forma amounts under SFAS No. 148, the fair value of each
option grant is estimated on the date of grant using the Black-Scholes option-pricing
model with the following weighted-average assumptions used for grants in 2003, 2002, and
2001, respectively: risk-free interest rates of 3.2 percent, 4.9 percent, and 4.9
percent; expected volatility of 50 percent; expected lives of six years; and no expected
dividends. The effects of applying SFAS No. 148 in this pro forma disclosure are not
indicative of future compensation costs; additional awards are anticipated. SFAS No. 148
does not apply to awards prior to 1995.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
issuances of restricted stock, the Company records unearned compensation expense on the
grant date based on the fair market value of the Companys stock and amortizes the
balance over the vesting period.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Net
Income (Loss) per Common Share Net income (loss) per common share is
calculated by dividing net income (loss) by the weighted average number of shares
outstanding during the period. Net income (loss) per common share assuming dilution
reflects per share amounts that would have resulted had the Companys outstanding
stock options been converted to common stock. See Note 13.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-8

---

| | Management
Estimates The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Reclassifications Certain
previous year amounts have been reclassified to conform to current year presentation.
These reclassifications had no impact on consolidated net income or retained earnings as
previously reported.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | New
Accounting Standards  In July 2002, the Financial Accounting Standards Board
(FASB) issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities. This Statement requires that a liability for a cost associated with an
exit or disposal activity be recognized when the liability is incurred, rather than when
a company commits to an exit plan as was previously required. SFAS No. 146 is effective
for exit or disposal activities that are initiated after December 31, 2002. The new
standard will cause the Company to recognize liabilities related to the planned
discontinuance of Geppeddo operations once the liability is incurred.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity. This Statement requires that
certain financial instruments previously accounted for as equity under previous guidance
be classified as liabilities in statements of financial position. Such financial
instruments include (i) mandatorily redeemable shares that the issuer is obligated to buy
back in exchange for cash or other assets; (ii) instruments, including put options and
forward purchase contracts, that require the issuer to buy back some of its shares in
exchange for cash or other assets; and (iii) obligations that can be settled with shares,
the monetary value of which is fixed, tied solely or predominantly to a variable such as
a market index, or varies inversely with the value of the issuers shares. SFAS No.
150 became effective for all financial instruments entered into or modified after May 31,
2003 and otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. The adoption of SFAS No. 150 on July 6, 2003 did not have a material
impact on the Companys results of operations or financial condition.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
November 2002, the FASB issued FASB Interpretation No. (FIN) 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. FIN 45 elaborates on the disclosures to be made by a
guarantor about its obligations under certain guarantees that it has issued. It also
clarifies that a guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the guarantee. The
recognition and measurement provisions of FIN 45 were effective for all guarantees
issued or modified after December 31, 2002. The Company currently does not have any
guarantees requiring disclosure or measurement under FIN 45.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
January 2003, the FASB issued FIN 46, Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51. In December 2003, the FASB issued FIN 46R, Consolidation
of Variable Interest Entities, a revision of FIN 46. The provisions of FIN 46R are
effective for interests in variable interest entities (VIE) as of the first interim, or
annual, period ending after December 15, 2003 except for VIEs considered special-purpose
entities or for those VIEs that already applied FIN 46 in a previous period. The adoption
of FIN 46R did not have a material impact on the Companys results of operations or
financial condition.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-9

---

|2. |  | PLANNED
DISPOSITION OF GEPPEDDO SEASONAL KIOSK BUSINESS
|-- |  | -------------------------------------------------------

| | In December
2003, the Company committed to a plan to cease operations of its Geppeddo
seasonal kiosk business. The Company plans to wind down operations in 2004 and
anticipates that operations will cease in the second quarter of 2004. In
accordance with SFAS No. 144, the Company will present Geppeddos results
in continuing operations in 2003 and 2004 until the run-off of operations is
complete. When the run-off is complete, the Geppeddo results will be
reclassified into discontinued operations for all periods presented.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As a result of
the decision to cease Geppeddos operations, the Company recognized $9,140
in asset impairment charges. The charges included an $8,193 charge related to
the full write-off of goodwill, trademarks, and other intangible assets, and a
$947 charge related to the impairment of long-lived assets. In addition, the
Company recognized a $607 charge within cost of sales to write down inventory to
its net realizable value.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The results
from Geppeddos operations are as follows:
| | ------------------------------------------------------

|                                     | 2003 |  | 2002 |         | 20011
|------------------------------------ | ---- |  | ---- | ------- | -----
|
|                                     |     
|Net sales                            |      |  | $    | 15,877  |      
|Gross profit                         |      |  |      | 8,960   |      
|Selling, general and administrative  |      | 
|expenses                             |      |  |      | 12,861  |      
|Impairment of assets                 |      |  |      | 9,140   |      
|Amortization of goodwill, trademarks |      | 
|and other intangibles                |      |  |      | 92      |      
|(Loss) income from operations        |      |  |      | (13,133 | )    
|Other (income) expense               |      |  |      | (14     | )    
|(Loss) income before income taxes    |      |  |      | (13,119 | )    
|Income tax (benefit) provision       |      |  |      | (4,781  | )    
|Net (loss) income                    |      |  |      | (8,338  | )    

| | 1 Reflects
results of operations of Geppeddo subsequent to the acquisition date in the
third quarter of 2001.
| | -------------------------------------------------------------------------------------------------------------

|3. |  | PROPERTY AND
EQUIPMENT
|-- |  | ----------------------

| | Property and
equipment at January 3, 2004 and December 28, 2002 is comprised of the
following:
| | ----------------------------------------------------------------------------------------------

|                               | 2003 |  | 2002
|------------------------------ | ---- |  | ----
|Leasehold improvements         |      |  | $   
|Furniture and fixtures         |      |  |     
|Computer hardware and software |      |  |     
|Other equipment                |      |  |     
|Building                       |      |  |     
|Land                           |      |  |     
|                               |      |  |     
|                               |      |  |     
|Less accumulated depreciation  |      |  |     
|                               |      |  |     
|Property and equipment, net    |      |  | $   
|                               |      |  |     

| | The long-lived
assets of Geppeddo were written-off during 2003 as a result of the decision to
cease operations of the subsidiary. See Note 2.
| | ---------------------------------------------------------------------------------------------------------------------------------------------

F-10

---

|4. |  | GOODWILL AND
OTHER INTANGIBLE ASSETS  ADOPTION OF SFAS No. 142
|-- |  | ---------------------------------------------------------------

| | Effective at
the beginning of fiscal year 2002, the Company adopted SFAS No. 142, Goodwill
and Other Intangible Assets. Upon adoption of SFAS No. 142, amortization of
goodwill and indefinite-lived intangible assets ceased. The Company determined
that its trademarks are indefinite-lived intangible assets and ceased
amortization. Recorded goodwill was tested for impairment by comparing the fair
value to its carrying value. As a result of the fair market value analysis, the
Company recorded a $93,654 charge as a cumulative effect of change in accounting
principle during the first quarter of 2002.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Had SFAS No.
142 been effective at the beginning of 2001, the non-amortization provisions
would have had the following effect on the results of the years ended January 3,
2004, December 28, 2002 and December 29, 2001:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                    | 2003 |  | 2002 |        | 2001
|--------------------------------------------------- | ---- |  | ---- | ------ | ----
|Reported net income (loss)                          |      |  | $    | 16,408 |     
|Add back:  Goodwill amortization                    |      |  |      |       |     
|Add back:  Trademark amortization, net of tax       |      |  |      |       |     
|                                                    |      |  |      |        |     
|Adjusted net income (loss)                          |      |  | $    | 16,408 |     
|Add back:  Cumulative effect of change              |      | 
|in accounting principle                             |      |  |      |       |     
|                                                    |      |  |      |        |     
|Adjusted earnings before                            |      | 
|cumulative effect of change in accounting principle |      |  | $    | 16,408 |     
|                                                    |      |  |      |        |     
|Basic earnings per share:                           |      | 
|Reported net income (loss) per share                |      |  | $    | 1.25   |     
|Goodwill amortization                               |      |  |      |       |     
|Trademark amortization, net of tax                  |      |  |      |       |     
|                                                    |      |  |      |        |     
|Adjusted net income (loss) per share                |      |  | $    | 1.25   |     
|Add back:  Cumulative effect of change              |      | 
|in accounting principle                             |      |  |      |       |     
|                                                    |      |  |      |        |     
|Adjusted earnings per share before cumulative       |      | 
|effect of change in accounting principle            |      |  | $    | 1.25   |     
|                                                    |      |  |      |        |     
|Diluted earnings per share:                         |      | 
|Reported net income (loss) per share                |      |  | $    | 1.24   |     
|Goodwill amortization                               |      |  |      |       |     
|Trademark amortization, net of tax                  |      |  |      |       |     
|                                                    |      |  |      |        |     
|Adjusted net income (loss) per share                |      |  | $    | 1.24   |     
|Add back:  Cumulative effect of change              |      | 
|in accounting principle                             |      |  |      |       |     
|                                                    |      |  |      |        |     
|Adjusted earnings per share before cumulative       |      | 
|effect of change in accounting principle            |      |  | $    | 1.24   |     
|                                                    |      |  |      |        |     

| | During the
fourth quarter of 2003, the Company performed its annual review of goodwill and
other intangible assets for possible impairment as required by SFAS No. 142. The
Company evaluated the goodwill and other intangible assets related to its
wholesale operating segment and determined there was no impairment. As a result
of its decision to cease operations at Geppeddo, the Company recognized an
$8,193 charge to write-off all of the goodwill, trademarks and non-compete
agreements related to Geppeddo. See Note 2.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-11

---

| | In
accordance with SFAS No. 142, the Company will continue to amortize non-compete
agreements (i.e. finite-lived intangible assets). Amortization of non-compete agreements
was $235, $248 and $304 during the years ended January 3, 2004, December 28, 2002, and
December 29, 2001, respectively. Expected annual amortization expense for non-compete
agreements recorded as of January 3, 2004 is as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2004       |  |  | $ | 140 | 
|---------- |  |  | - | --- | 
|2005       |  |  |   | 140 | 
|2006       |  |  |   | 140 | 
|2007       |  |  |   | 140 | 
|2008       |  |  |   | 140 | 
|Thereafter |  |  |   | 96  | 
|           |  | 
|           |  |  | $ | 796 | 
|           |  | 

| | The above
amortization expense forecast is an estimate. Actual amounts of amortization
expense may differ from estimated amounts due to additional intangible asset
acquisitions, impairment of intangible assets, accelerated amortization of
intangible assets, and other events.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Included in
Goodwill, Trademarks and Other Intangibles on the Companys consolidated
balance sheet as of January 3, 2004, December 28, 2002 and December 29, 2001,
are the following acquired intangible assets by operating segment (net of
accumulated amortization):
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                       | 2003 |  | 2002 |        | 2001
|---------------------- | ---- |  | ---- | ------ | ----
|WHOLESALE:             |      |  |      |        |     
|Goodwill               |      |  | $    | 37,074 |     
|Trademarks             |      |  |      | 13,761 |     
|Non-compete agreements |      |  |      | 796    |     
|                       |      |  |      |        |     
|                       |      |  | $    | 51,631 |     
|                       |      |  |      |        |     
|RETAIL:                |      | 
|Goodwill               |      |  | $    |       |     
|Trademarks             |      |  |      |       |     
|Non-compete agreements |      |  |      |       |     
|                       |      |  |      |        |     
|                       |      |  | $    |       |     
|                       |      |  |      |        |     

|5. |  | CREDIT AGREEMENT
|-- |  | ----------------

| | Long-term debt
at January 3, 2004 and December 28, 2002 is comprised of the following:
| | --------------------------------------------------------------------------------------

|                                      | 2003 |  | 2002
|------------------------------------- | ---- |  | ----
|Total debt                            |      |  | $   
|Less borrowings classified as current |      |  |     
|                                      |      |  |     
|                                      |      |  | $   
|                                      |      |  |     

| | In November
2003, the Company entered into a new three-year credit agreement. In connection
therewith, the Company recorded $0.2 million in deferred financing fees,
which are being amortized over the life of the credit agreement. The Company
used the new credit facility to refinance the remaining term and revolving loans
under its former credit agreement. As of January 3, 2004, no revolving
loans were outstanding under the new credit agreement.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-12

---

| | The revolving
credit facility provides for borrowings of up to $75 million, which may be in
the form of letters of credit and revolving credit loans. The letters of credit
are issued primarily in connection with inventory purchases. The revolving
credit facility includes an annual clean-down provision whereby the
Companys outstanding revolving credit loans and letters of credit may not
exceed an aggregate of $30 million during any one 30-consecutive-day period
beginning November 1 and ending March 31 of the following year. Borrowings under
the credit agreement are subject to certain borrowing base limitations (as
defined). The Companys borrowing capacity under the revolving credit
facility as of January 3, 2004 was $75 million and will fluctuate during 2004
based on accounts receivable and inventory levels. The revolving line of credit
provides for commitment fees of 0.20% to 0.375% per annum on the daily average
of the unused commitment.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The credit
agreement allows the Company to choose between two interest rate options in
connection with its revolving credit loans. The interest rate options are the
Floating Rate (as defined) or the Eurodollar Rate (as defined) plus an
applicable margin. The applicable margin ranges from 0% to 0.375% for Floating
Rate loans and from 0.875% to 1.25% for Eurodollar Rate loans. The credit
agreement expires November 26, 2006.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
credit agreement includes restrictions as to, among other things, the amount of
additional indebtedness, liens, contingent obligations, investments and dividends. Under
the most restrictive of these covenants, approximately $251 million of retained earnings
were restricted at January 3, 2004. The credit agreement also requires maintenance of
minimum levels of interest coverage, net worth and maximum levels of leverage, in each
case at the end of each fiscal quarter. None of these restrictions are expected to have a
material adverse effect on the Companys ability to operate in the future.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has pledged the common stock of certain of its subsidiaries, direct and indirect,
as collateral under the credit agreement, and certain of its subsidiaries, direct and
indirect, have guaranteed repayment of amounts borrowed under the credit agreement.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The Company paid
interest of $1,954, $3,735, and $6,648 during the years ended January 3,
2004, December 28, 2002, and December 29, 2001, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------

|6. |  | INCOME TAXES
|-- |  | ------------

| | The
provision for income taxes for the years ended January 3, 2004, December 28, 2002, and
December 29, 2001 consisted of the following:
| | ----------------------------------------------------------------------------------------------------------------------------------------

|                                      | 2003 | 2002 | 2001
|------------------------------------- | ---- | ---- | ----
|
|Current:                              |      |      |     
|Federal                               |      |      | $   
|State                                 |      |      |     
|Foreign                               |      |      |     
|Deferred:                             |      |     
|Federal                               |      |      |     
|State                                 |      |      |     
|Adjustment of prior year tax accruals |      |      |     
|                                      |      |      |     
|                                      |      |      | $   
|                                      |      |      |     

F-13

---

| | The
reconciliation between income tax expense based on statutory income tax rates
and the provision for income taxes is as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------

|                                       | 2003 |  | 2002 |       | 2001
|-------------------------------------- | ---- |  | ---- | ----- | ----
|Income taxes at federal statutory rate |      |  | $    | 8,973 |     
|State income taxes, net of             |      | 
|federal income tax deductions          |      |  |      | 625   |     
|Goodwill amortization                  |      |  |      |      |     
|Deferred tax valuation allowance       |      |  |      |      |     
|Charitable donations of inventory      |      |  |      | (255  | )   
|Adjustment of prior year tax accruals  |      |  |      |      |     
|Other                                  |      |  |      | (113  | )   
|                                       |      |  |      |       |     
|Provision for income taxes             |      |  | $    | 9,230 |     
|                                       |      |  |      |       |     

| | The components
of the net deferred tax asset at January 3, 2004 and December 28, 2002 were as
follows:
| | ------------------------------------------------------------------------------------------------------

|                                       | 2003 |  | 2002
|-------------------------------------- | ---- |  | ----
|DEFERRED TAX ASSETS:                   |      |  |     
|Asset valuation reserves               |      |  | $   
|Loss on minority investment            |      |  |     
|Deferred compensation                  |      |  |     
|Accrued liabilities                    |      |  |     
|Impairment of Geppeddo assets          |      |  |     
|Other                                  |      |  |     
|Less: Deferred tax valuation allowance |      |  |     
|                                       |      |  |     
|Total deferred tax assets              |      |  |     
|DEFERRED TAX LIABILITIES:              |      | 
|Trademark amortization                 |      |  |     
|Property and equipment depreciation    |      |  |     
|Other                                  |      |  |     
|                                       |      |  |     
|Total deferred tax liabilities         |      |  |     
|                                       |      |  |     
|                                       |      |  | $   
|                                       |      |  |     

| | The $2,956 net
deferred tax asset at January 3, 2004 is presented as a net deferred current
asset of $7,797 and a net deferred noncurrent liability of $4,841. The $147 net
deferred tax asset at December 28, 2002 is presented as a net deferred current
asset of $5,955 and a net deferred noncurrent liability of $5,808. The $1,520
deferred tax asset valuation allowance at December 28, 2002 represents a reserve
against the future deductibility of the capital losses the Company recognized
from its minority investment in 2-Day Designs. Management believes the
probability of deducting the capital losses in the future is remote.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The Company paid
income taxes of $11,616, $17,432, and $6,739 during the years ended January 3,
2004, December 28, 2002, and December 29, 2001, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|7. |  | OTHER ASSETS AND
OTHER LIABILITIES
|-- |  | ----------------------------------

| | The Company has
a compensation plan for its officers and Board of Directors whereby participants
may elect to forego a portion of their current compensation in exchange for
options to purchase shares from several publicly traded mutual funds. The
Company funds this plan by purchasing and owning the underlying assets which are
considered trading securities in accordance with SFAS No. 115,
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-14

---

| | Accounting
for Certain Investments in Debt and Equity Securities, and are consequently
marked-to-market. The plan participants bear the potential economic risks and rewards of
the underlying investments performance and their interests in the underlying plan
assets are subordinate to general creditors. While officers and Board members may request
payment at any time, the liability is classified as noncurrent as supported by historical
experience and because any payment would be funded by noncurrent assets. The assets of
the plan (included in other assets on the balance sheet) and the related liability to
participants (included in other liabilities on the balance sheet) were $1,358 and $3,015
as of December 28, 2002 and January 3, 2004, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|8. |  | COMMITMENTS AND
CONTINGENCIES
|-- |  | -----------------------------

| | Operating
Leases  The Company leases warehouse, office and retail store space, equipment,
and showroom display facilities under renewable operating leases with remaining terms of
up to 10 years. In addition to the base rent, the Company pays its proportionate share of
taxes, special assessments, and operating expenses of the warehouse and retail store
space and showroom display facilities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The following is
a schedule of future annual minimum lease payments for noncancelable operating
leases as of January 3, 2004:
| | -----------------------------------------------------------------------------------------------------------------------------

|2004       |  |  | $ | 4,140  | 
|---------- |  |  | - | ------ | 
|2005       |  |  |   | 4,245  | 
|2006       |  |  |   | 3,889  | 
|2007       |  |  |   | 3,017  | 
|2008       |  |  |   | 3,021  | 
|Thereafter |  |  |   | 5,850  | 
|           |  | 
|           |  |  | $ | 24,162 | 
|           |  | 

| | The
Companys rental expense was $8,786, $9,368, and $7,252 for the years ended
January 3, 2004, December 28, 2002, and December 29, 2001, respectively.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------

| | Letters of
Credit  The Company had outstanding standby and commercial letters of
credit amounting to $1,993 at January 3, 2004 relating primarily to purchase
commitments issued to foreign suppliers and vendors.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Legal
Proceedings  On March 1, 2002, the Company received net proceeds
(before income taxes) of $11.0 million in settlement of the Companys
litigation against Arthur Andersen LLP and Andersen Worldwide
Société Coopérative concerning implementation of its
information systems. This recovery resulted in other income of $5.4 million and
a $5.6 million reduction in net depreciable assets.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition to the above lawsuit, the Company is involved in various legal proceedings,
claims, and governmental audits in the ordinary course of its business. The Company
believes it has meritorious defenses to all proceedings, claims, and audits. Management
believes the impact, if any, of these legal proceedings would not be material to the
results of operations, financial position or cash flows of the Company.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|9. |  | RETIREMENT PLAN
|-- |  | ---------------

| | The
Company has a qualified contributory retirement plan (the Plan) under Section 401(k) of
the Internal Revenue Code which covers substantially all full-time employees who meet
certain eligibility requirements. Voluntary contributions are made by participants and
Company matching contributions are made at the discretion of the Board of Directors,
subject to certain limitations. The Plan also allows the Company to make discretionary
profit-sharing contributions to the Plan up to the maximum amount deductible for income
tax purposes. All company contributions are invested in a series of diversified
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-15

---

| | investment
options at the election of the employee. The Company does not make matching or profit
sharing contributions in company stock. The Companys total profit-sharing
contributions were $1,854, $1,361, and $1,857 for the years ended January 3, 2004,
December 28, 2002, and December 29, 2001, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10. |  | ACQUISITIONS
|--- |  | ------------

| | During 2001, the
Company completed its $9.7 million acquisition of the business of Axis
Corporation, a privately held designer, importer, and specialty retailer based
in Salt Lake City, Utah. Axis products, primarily dolls, doll accessories,
and plush items, are marketed under the brand name Geppeddo. The acquired
business operated customized kiosks located in major malls and shopping centers
throughout the United States during the peak holiday shopping season. The asset
acquisition was accounted for under the purchase method of accounting. In
December 2003, the Company committed to a plan to cease operations of its
Geppeddo seasonal kiosk business. See Note 2.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During 2001, the
Company recognized a $3.0 million impairment of the Companys minority
investment in 2-Day Designs, Inc. The impairment charge reduced the carrying
value of the Companys minority investment to zero. The Company has not
guaranteed any debt obligations of 2-Day Designs, Inc.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|11. |  | SEGMENTS
OF THE COMPANY AND RELATED INFORMATION
|--- |  | -----------------------------------------------

| | The Company has
two reportable segments  wholesale and retail. Although the product
produced and sold for each segment is similar, the type of customer for the
product and the method used to distribute the product are different. The
segmentation of these operations also reflects how the Companys chief
executive officer (the CEO) currently reviews the results of these
operations. Income from operations for each operating segment includes
specifically identifiable operating costs such as cost of sales and selling
expenses. General and administrative expenses are generally not allocated to
specific operating segments and are therefore reflected in the other category.
Other components of the statement of operations, which are classified below
income from operations, are also not allocated by segment. In addition, the
Company generally does not account for or report assets, capital expenditures,
or depreciation and amortization by segment. All transactions between operating
segments have been eliminated and are not included in the table below.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The following
table presents the Companys segment information for the last three fiscal
years:
| | -----------------------------------------------------------------------------------------------

|                                         | Wholesale |  | Retail |         | Other |   | Consolidated |  
|---------------------------------------- | --------- |  | ------ | ------- | ----- | - | ------------ | -
|                                        
|Fifty-Three Weeks Ended January 3, 2004: |           |  |        |         |       |   |              |  
|Net sales                                |           |  | $      | 166,895 |       | $ | 24,819       |  
|Income (loss) from operations            |           |  |        | 72,191  |       |   | (14,007      | )
|Fifty-Two Weeks Ended December 28, 2002: |           | 
|Net sales                                |           |  | $      | 180,364 |       | $ | 28,260       |  
|Income (loss) from operations            |           |  |        | 82,177  |       |   | (4,621       | )
|Fifty-Two Weeks Ended December 29, 2001: |           | 
|Net sales                                |           |  | $      | 181,056 |       | $ | 19,391       |  
|Income (loss) from operations            |           |  |        | 81,219  |       |   | 1,851        |  

F-16

---

|12. |  | STOCKHOLDERS EQUITY
|--- |  | --------------------

| | Stock-Based
Compensation Plans At January 3, 2004, the Company has compensation
plans allowing the Company to grant options, stock appreciation rights, shares
or performance units to employees, directors, officers, consultants, and
advisors. Under the stock option plans, all employee options granted have an
exercise price equal to the market value of the common stock at the date of
grant, generally have a term of ten years, and generally are exercisable in
equal installments beginning on each of the first, second, and third
anniversaries of the date of the grant. At January 3, 2004, 256,831 shares were
available for granting under the stock option and incentive plans.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A summary of the
status of the Companys stock option and incentive plans as of January 3,
2004, December 28, 2002, and December 29, 2001, and changes during the
years then ended is presented below:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                   | 2003 |  | 2002 |           | 2001
|---------------------------------- | ---- |  | ---- | --------- | ----
|
|                                  
|Outstanding at beginning of year   |      |  |      | 2,266,409 |     
|Granted                            |      |  |      | 46,405    |     
|Exercised                          |      |  |      | (100,066  | )   
|Forfeited                          |      |  |      | (27,967   | )   
|                                   |      |  |      |           |     
|Outstanding at end of year         |      |  |      | 2,184,781 |     
|                                   |      |  |      |           |     
|Options exercisable at end of year |      |  |      | 1,665,676 |     
|Weighted average fair value of     |      | 
|options granted during the year    |      |  | $    | 6.85      |     

| | The following
table summarizes information about the Companys stock option and incentive
plans at January 3, 2004:
| | -------------------------------------------------------------------------------------------------------------------

|Range ofExercisePrices |  | NumberOutstandingat January 3,2004 |  | WeightedAverageRemainingContractualLife (years) |  | WeightedAverageExercisePrice |     | NumberExercisableat January 3,2004 |   | WeightedAverageExercisePrice | 
|---------------------- |  | ---------------------------------- |  | ----------------------------------------------- |  | ---------------------------- | --- | ---------------------------------- | - | ---------------------------- | 
|                      
|$  6.54-12.50          |  |                                    |  | 387,661                                         |  |                              | 7.1 |                                    | $ | 8.65                         | 
|12.51-13.75            |  |                                    |  | 800,236                                         |  |                              | 8.2 |                                    |   | 12.80                        | 
|13.76-15.00            |  |                                    |  | 540,633                                         |  |                              | 7.1 |                                    |   | 13.85                        | 
|15.01-37.75            |  |                                    |  | 456,251                                         |  |                              | 3.6 |                                    |   | 25.98                        | 
|                       |  |                                    |  |                                                 |  |                              |    
|                       |  |                                    |  | 2,184,781                                       |  |                              | 6.8 |                                    |   | 15.08                        | 
|                       |  |                                    |  |                                                 |  |                              |    

| | In
addition to the above option plans, additional options exercisable at $3.33 per share
were issued to directors in prior years. Of those options, the remaining 15,000 were
exercised in 2002.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Shareholder
Rights PlanIn April 1997, the Company adopted a shareholder rights
plan. Under the shareholder rights plan, each shareholder received a dividend of one
preferred share purchase right for each share held of the Companys common stock.
Each right entitles the holder to purchase one one-thousandth of a share of Series A
Participating Preferred Stock at an exercise price of $100, subject to adjustment, or at
the discretion of the Board of Directors of the Company, the right to purchase common
stock of the Company at a 50% discount. The rights become exercisable only upon the
occurrence of certain events involving a buyer acquiring 18.5% or greater beneficial
ownership in the Companys common stock or the announcement of a tender offer or
exchange offer which, if consummated, would give the buyer beneficial ownership of an
18.5% or greater position in the Company. Preferred share purchase rights owned by the
buyer become null and void following this occurrence. The rights will
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-17

---

| | expire April
2007, and the Company may redeem the rights at any time (prior to the occurrence
of a specified event) at a price of one cent per right. If the Company is
acquired in a merger or similar transaction after such an occurrence, all rights
holders, except the buyer, will have the right to purchase stock in the buyer at
a 50% discount.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Performance-Accelerated
Vesting Restricted Stock  The Company granted 66,499 and 49,625
performance-accelerated vesting restricted shares of common stock (PARS) to
executive officers during 2002 and 2001, respectively. There were no grants of
PARS during 2003. PARS generally vest over five years in equal annual
installments on December 31 of the calendar year in which the grant was made and
on each December 31 thereafter. For all PARS grants, accelerated vesting is
possible upon achievement of targeted diluted earnings per share performance.
Of the 49,625 PARS granted in 2001, 10,359 were issued at an exchange ratio of 1:100
for the surrender by certain executive officers of options to purchase 1,035,833 shares
of common stock. At January 3, 2004, 44,985 PARS were unvested and outstanding.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The Company
records unearned compensation expense on the grant date based on the publicly
quoted fair market value of the Companys common stock, and amortizes the
balance over the vesting period. The Company recorded unearned compensation of
approximately $0.6 million in both 2002 and 2001, which is recorded within
stockholders equity. The Company recognized compensation expense of $240,
$263 and $152 for the years ended January 3, 2004, December 28, 2002, and December
29, 2001, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|13. |  | INCOME PER
COMMON SHARE
|--- |  | -----------------------

| | The following
tables reconcile net income (loss) per common share and net income (loss) per
common share assuming dilution:
| | ---------------------------------------------------------------------------------------------------------------------------

|                                              | 2003 |  | 2002 |            | 2001
|--------------------------------------------- | ---- |  | ---- | ---------- | ----
|Net income (loss)                             |      |  | $    | 16,408     |     
|Weighted average number of shares outstanding |      |  |      | 13,118,000 |     
|Net income (loss) per common share  basic    |      |  | $    | 1.25       |     
|Net income (loss)                             |      |  | $    | 16,408     |     
|Weighted average number of shares outstanding |      |  |      | 13,118,000 |     
|Dilutive impact of options outstanding        |      |  |      | 92,000     |     
|                                              |      |  |      |            |     
|Weighted average number of shares and         |      | 
|potential dilutive shares outstanding         |      |  |      | 13,210,000 |     
|Net income (loss) per common share           |      | 
|assuming dilution                             |      |  | $    | 1.24       |     

| | Options to
purchase 998,884, 990,278, and 1,225,577 shares of common stock were outstanding
at January 3, 2004, December 28, 2002, and December 29, 2001, respectively, but
were not included in the computation of net income (loss) per common share
assuming dilution because the exercise prices were greater than the average
market price of the common stock.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-18

---

# DEPARTMENT 56, INC. AND
SUBSIDIARIES

# SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)

---

|Column A                                |  | Column B |   | Column C |  | Column D |       | Column E |  
|--------------------------------------- |  | -------- | - | -------- |  | -------- | ----- | -------- | -
|
|Year ended January 3, 2004:             |  |          |   |          |  |          |       |          |  
|Allowance for doubtful accounts         |  |          | $ | 6,529    |  | $        | 1,761 |          | $
|Allowance for sales returns and credits |  |          |   | 3,853    |  |          | 4,582 |          |  
|                                        |  |          |   |          |  |          |       |         
|                                        |  |          | $ | 10,382   |  | $        | 6,343 |          | $
|                                        |  |          |   |          |  |          |       |         
|Year ended December 28, 2002:           |  |         
|Allowance for doubtful accounts         |  |          | $ | 6,462    |  | $        | 1,232 |          | $
|Allowance for sales returns and credits |  |          |   | 5,480    |  |          | 4,132 |          |  
|                                        |  |          |   |          |  |          |       |         
|                                        |  |          | $ | 11,942   |  | $        | 5,364 |          | $
|                                        |  |          |   |          |  |          |       |         
|Year ended December 29, 2001:           |  |         
|Allowance for doubtful accounts         |  |          | $ | 10,483   |  | $        | 545   |          | $
|Allowance for sales returns and credits |  |          |   | 9,108    |  |          | 4,603 |          |  
|                                        |  |          |   |          |  |          |       |         
|                                        |  |          | $ | 19,591   |  | $        | 5,148 |          | $
|                                        |  |          |   |          |  |          |       |         

|(a) |  | Accounts
determined to be uncollectible and charged against allowance account, net of
collections on accounts previously charged against allowance account.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------

S-1

---