UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Commission files number 1-8681

RUSS BERRIE AND COMPANY, INC.

(Exact name of registrant as specified in its charter)

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

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o              No ý

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o              No ý

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 ý              No o

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. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

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

The aggregate market value of the voting stock held by non-affiliates of the Registrant computed by reference to the price of such stock at the close of business on June 30, 2005 was $150.8 million.

The number of shares outstanding of each of the Registrant’s classes of common stock, as of March 24, 2006, was as follows:

Documents Incorporated by Reference

Certain information called for by Part III is incorporated by reference to the definitive Proxy Statement for the Company’s 2006 Annual Meeting of Stockholders, which will be filed on or before May 1, 2006.

PART I

ITEM 1. BUSINESS

General

Russ Berrie and Company, Inc. is a leading designer, importer, marketer and distributor of gift, infant and juvenile consumer products with annual net sales of $290.2 million in 2005. The Company currently operates in two segments: (i) its gift business and (ii) its infant and juvenile business. The term “Company” refers to Russ Berrie and Company, Inc. and its consolidated subsidiaries, unless the context requires otherwise.

The Company’s gift business designs, manufactures through third parties and markets a wide variety of gift products to retail stores throughout the United States and throughout the world via the Company’s international wholly-owned subsidiaries and independent distributors. The Company’s gift products are designed to appeal to the emotions of consumers to reflect their feelings of happiness, friendship, fun, love and affection. The Company believes that its present position as one of the leaders in the gift industry is due primarily to its imaginative product design, broad marketing of its products, efficient distribution, high product quality and commitment to customer service.

The Company’s infant and juvenile segment designs, manufactures through third parties and markets products in a number of baby categories including, among others, infant bedding and accessories, bath toys and accessories, developmental toys, feeding items and baby comforting products. The infant and juvenile segment consists of Sassy, Inc. (“Sassy”), since its acquisition on July 26, 2002, and Kids Line LLC (“Kids Line”), since its acquisition as of December 15, 2004. These products are sold to consumers, primarily in the United States, through mass merchandisers, toy, specialty, food, drug and independent retailers, apparel stores and military post exchanges.

The Company maintains a direct sales force and distribution network to serve its customers in the United States, Europe, Canada and Australia. In countries where the Company does not maintain a direct salesforce and distribution network, the Company’s products are sold through distributors. See Note 22 of Notes to Consolidated Financial Statements for information regarding segment and geographic information.

For a discussion of the implementation of various Company initiatives during 2005, including a restructuring, an increased use of licensing, and implementation of a branding strategy, see Item 7, “Management’s Discussion and Analysis of Results of Operations and Financial Condition” under the captions “Overview” and “Results of Operations—Years Ended December 31, 2005 and 2004.”

The Company was founded in 1963 by the late Mr. Russell Berrie, and was incorporated in New Jersey in 1966. The Company’s common stock has been traded on the New York Stock Exchange under the symbol “RUS” since its initial public offering on March 29, 1984.

The Company maintains its principal executive offices at 111 Bauer Drive, Oakland, New Jersey, 07436, along with its flagship 18,000 square foot showroom, and also maintains satellite showrooms in Atlanta, Chicago and Los Angeles, and internationally in Australia, Canada, England and Hong Kong. The Company’s wholly-owned subsidiaries are located worldwide with distribution centers situated in key locations in the United States, Canada, the United Kingdom and Australia. The Company’s telephone number is (201) 337-9000.

Products

Gift Segment. The Company’s gift product line of approximately 12,870 products is marketed under the trade names and trademarks RUSS® and APPLAUSE®. The APPLAUSE® trade name was purchased on October 26, 2004, and serves as the Company’s brand platform for the mass market. The extensive gift line encompasses both seasonal and everyday products that focus on theme or concept groupings such as collectible heirloom bears, stuffed animals, wedding, anniversary and baby gifts, tabletop accessories and home décor, including home and garden accessories, glass, porcelain and ceramic gifts and contemporary lifestyle gifts and accessories. Extensive seasonal lines include products for all major holidays.

Most of the Company’s gift products have suggested retail prices between $1.00 and $30.00. Product sales are highly diverse, and no single gift item represented more than 1% of the Company’s gift segment’s net sales in 2005 or 1% of the Company’s consolidated net sales in 2005.

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In connection with the Company’s recent 2006 bank refinancing, the Company formed a wholly-owned Delaware subsidiary, Russ Berrie U.S. Gift, Inc. (“Newco”), to which it assigned (the “Assignment”) substantially all of its assets and liabilities which pertain primarily to its domestic gift business. See Item 7, “Management’s Discussion and Analysis of Results of Operations and Financial Condition” under the caption “Liquidity and Capital Resources.”

Infant and Juvenile Segment. The Company’s infant and juvenile product line currently consists of approximately 3,340 products that principally focus on children of the age group newborn to two years, primarily under the trade names Sassy™ and Kids Line™. Sassy has concept groupings such as bath toys and accessories, developmental toys, feeding utensils and bowls, pacifiers, bottles, bibs, soft toys, mobiles and feeders. Sassy benefits from United States distribution rights to certain baby soothing and comforting products from MAM Babyartikel GmbH, of Vienna, Austria, a developer and manufacturer of children’s products. Since December 15, 2004, when the Company acquired Kids Line, LLC, (see Note 3 of Notes to Consolidated Financial Statements), the Company’s infant and juvenile product line has been expanded to include Kids Line™ products. Kids Line™ products consist primarily of infant bedding and related accessories such as blankets, rugs, mobiles, nightlights, hampers, lamps and wall art.

Most of the Company’s infant and juvenile businesses’ products have suggested retail prices between $2.00 and $300.00. Product sales are highly diverse, and no single infant and juvenile item represented more than 3% of the Company’s infant and juvenile segment’s net sales in 2005 or 1% of the Company’s consolidated net sales in 2005.

Design and Production

The Company has a continuing program of new product development. The Company designs most of its own gift and infant and juvenile products and then generally evaluates consumer response in selected unaffiliated retail stores and consumer focus groups. Items are added to the product line only if the Company believes that they can be obtained and marketed on a basis that meets the Company’s profitability standards.

The Company has approximately 100 employees, located in the United States and in Eastern Asia, responsible for its gift and infant and juvenile product development and design. Generally, a new design is brought to market in less than one year after a decision is made to produce the product. Sales of the Company’s products are, in large part, dependent on the Company’s ability to identify and react quickly to changing consumer preferences and to effectively utilize its sales and distribution systems to bring new products to market.

The Company engages in market research and test marketing to evaluate consumer reactions to its products. Research into consumer buying trends often suggests new products. The Company assembles information from retail stores, the Company’s salesforce, focus groups and the Company’s internal Product Development department. The Company continually analyzes its products to determine whether they should be adapted into new or different products using elements of the initial design or whether they should be removed from the product line.

Substantially all of the Company’s gift and infant and juvenile products are produced by independent manufacturers, generally in Eastern Asia, under the quality review of the Company’s personnel. During 2005, approximately 89% of the Company’s products were produced in Eastern Asia, approximately 3% in the United States and approximately 8% in other foreign countries. Purchases in the United States predominantly consist of displays, corrugated and retail packaging items and plastic feeding items.

The Company utilizes approximately 130 manufacturers in Eastern Asia, with facilities primarily in the People’s Republic of China (“PRC”). During 2005, approximately 89% of the Company’s dollar volume of purchases was attributable to manufacturing in the PRC. The PRC currently enjoys “permanent normal trade relations” (“PNTR”) status under U.S. tariff laws, which provides a favorable category of U.S. import duties. The loss of such PNTR status would result in a substantial increase in the import duty for products manufactured for the Company in the PRC and imported into the United States and would result in increased costs for the Company.

A significant portion of the Company’s staff of approximately 200 employees in Hong Kong and Korea, and in the cities of Shenzhen and Qingdao in the PRC, monitor the production process with responsibility for the quality, safety and prompt delivery of the Company’s products, as well as design and product development. Members of the Company’s Eastern Asia staff make frequent visits to such manufacturers. Certain of the Company’s manufacturers sell exclusively to the Company. In 2005, the supplier accounting for the greatest dollar volume of the Company’s purchases accounted for approximately 16% of such purchases and the five largest suppliers accounted for

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approximately 40% in the aggregate. The Company believes that there are many alternate manufacturers for the Company’s products and sources of raw materials.

Marketing and Sales

The Company’s gift business products are marketed primarily through its own direct salesforce of approximately 330 full-time employees as of December 31, 2005. The Company’s gift business maintains a telemarketing department which is responsible for servicing the Company’s smaller customers. The Company’s gift products are sold directly to retail customers in the United States and certain foreign countries, including but not limited to gift stores, pharmacies, card shops, home decor shops, apparel stores, craft stores, garden stores, book stores, stationery stores, hospitals, college and airport gift shops, resort and hotel shops, florists, chain stores, department stores, military post exchanges and internet companies. In recent years, the Company has also expanded its distribution to national accounts, primarily through the use of its APPLAUSE® trademark as the mass market brand platform. During 2005, the Company sold gift products to approximately 30,000 customers worldwide.

The Company’s infant and juvenile segment’s products are marketed through its own direct salesforce of nine full-time employees as of December 31, 2005 and through independent manufacturers’ representatives to retail customers in the United States and certain foreign countries including, but not limited to, mass merchandisers, toy, specialty, food, drug and independent retailers, apparel stores and military post exchanges. During 2005, the Company sold infant and juvenile products to approximately 1,900 customers worldwide. Toys “R” Us, Inc. and Babies “R” Us, Inc. in the aggregate accounted for approximately 18% of the consolidated net sales of the Company and approximately 39% of the net sales of the infant and juvenile segment during 2005. The loss of this customer, or the loss of certain other large customers of the infant and juvenile segment, could have a material adverse affect on the infant and juvenile segment and the consolidated results of the Company.

The Company’s products are sold under the RUSS®, RUSS® Baby, Sassy™, APPLAUSE®, and Kids Line™ brand names and under trademark names of licensed products.

The Company reinforces the marketing efforts of its salesforce through an active promotional program, including showrooms, participation in trade shows, trade and consumer advertising and a program of seasonal and theme based catalogs. The Company maintains a marketing plan which recognizes its most valued gift segment customers as “Preferred Partners”, based upon attainment of certain sales levels, and offers them special benefits and privileges including, but not limited to, access to exclusive product offerings and dedicated customer service.

The Company believes that effective packaging and merchandising of its product lines are also very important to its marketing success. Many products are shipped in colorful, corrugated cartons which can be used as freestanding displays and then recycled or discarded when all the products have been sold. The Company also provides to certain of its customers semi-permanent freestanding Lucite, metal and wooden displays, thereby providing an efficient promotional vehicle for selling the Company’s products at retail locations.

The Company believes that customer service is another essential component of its marketing strategy and therefore maintains a Customer Service Department that responds to customer requests, investigates and resolves problems and generally assists customers.

The Company believes its general terms of sale are competitive with others in its industries. The Company provides extended payment terms to its gift segment’s customers, which typically do not exceed five months, on sales of seasonal merchandise, e.g., Christmas, Halloween, Easter and other seasonal items. The Company has a general policy that all sales are final.

In 2005, the Company also maintained a direct sales force and distribution network to serve its gift segment’s customers in England, Holland, Belgium, Ireland, Spain, Germany, Canada, France and Australia. Where the Company does not maintain a direct sales force and distribution network, the Company’s gift segment products are sold worldwide through distributors. The Company’s consolidated foreign sales, including export sales from the United States, aggregated $81.4 million, $96.7 million, and $121.1 million for the years ended December 31, 2005, 2004 and 2003, respectively.

In connection with the ongoing development and phased implementation of the Company’s Profit Improvement Program (the “PIP”), the Company is currently evaluating the need to maintain direct sales and distribution efforts in several European countries. To date, the Company has determined to terminate its direct sales and distribution operations in France, Germany, Belgium and Holland, and has restructured certain of its sales operations in the U.K.

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The Company anticipates that it will establish alternative means of reaching certain customers in the affected countries, including through the use of independent sales representatives or distributors, although the Company expects that its aggregate sales from France, Germany, Belgium and Holland will be reduced by approximately $6 million on an annualized basis as a result of these actions, at least for the near term. See “Management’s Discussion and Analysis of Results of Operations and Financial Condition – Overview.”

Distribution

The Company’s gift customers are located in the United States and throughout the world and are principally served through U.S. distribution centers in South Brunswick, New Jersey, and Petaluma, California, each of which receives products directly from suppliers and then distributes such products to the Company’s gift customers. On January 19, 2006, the Company announced its intention to consolidate its domestic gift warehousing and distribution into the South Brunswick, New Jersey facility and close its Petaluma, California distribution center during the second quarter of 2006. The Company also maintains distribution facilities in the Toronto, Canada area, in Southampton, England and in the Sydney, Australia area, to serve its gift customers in Canada, Europe and Australia, respectively. The Company generally uses common carriers to distribute its products to its customers. See Note 16 of Notes to Consolidated Financial Statements and Item 13, “Certain Relationships and Related Transactions.”

The Company’s infant and juvenile customers are located primarily in the United States and are served by distribution centers in Grand Rapids, Michigan and Southgate, California.

Seasonality

In addition to its everyday products, the Company’s gift segment produces specially designed products for holiday seasons which include: Christmas/Chanukah, Valentine’s Day, Easter, Mother’s Day, Father’s Day, Halloween/Thanksgiving, Graduation and St. Patrick’s Day.

During 2005, gift items specially designed for individual seasons accounted for approximately 25% of the Company’s consolidated net sales, although no individual season accounted for more than 13% of the Company’s consolidated net sales.

The following table sets forth the Company’s consolidated quarterly net sales as a percentage of the Company’s consolidated annual sales during 2005, 2004 and 2003.

The pattern of the Company’s gift segment sales is influenced by the shipment of seasonal merchandise. The Company ships the majority of orders each year for Christmas in the quarter ended September 30, for Valentine’s Day in the quarter ended December 31 and for Easter in the quarter ended March 31. The Company’s infant and juvenile segment is not significantly influenced by shipments of seasonal merchandise.

Backlog

It is characteristic of the Company’s gift segment for seasonal merchandise orders to be taken in advance of shipment. The Company’s gift segment represents 65% of the Company’s backlog at December 31, 2005. The Company’s infant and juvenile segment is not significantly influenced by shipments of seasonal merchandise. The Company’s consolidated backlog at December 31, 2005 and 2004 was $21.2 million and $21.7 million, respectively. It is expected that substantially all of the Company’s backlog at December 31, 2005 will be shipped during 2006.

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Competition

The Company’s gift segment operates in a highly competitive market. The Company believes that the principal competitive factors in the gift segment include price/value, marketing ability, reliable delivery, product design and quality and customer service. The Company believes that its positive principal competitive factors are its marketing ability, reliable delivery, proprietary product design, quality, customer service and licensing agreements. Certain of the Company’s existing or potential competitors, however, may have financial resources that are greater than those of the Company, greater customer acceptance of products and/or more profitable distribution outlets.

The infant and juvenile segment industry is highly competitive and is characterized by the frequent introduction of new products and includes numerous domestic and foreign competitors, many of which are substantially larger and have greater financial and other resources than the Company. The Company competes with a number of different competitors, depending on the product category, and competes against no single company across all product categories. The Company’s competition includes large, infant and juvenile product companies and specialty infant and juvenile product manufacturers. The Company competes principally on the basis of brand name recognition, product quality, innovation, proprietary product design, and customer service and price/value relationship. In addition, the Company believes that it competes favorably with respect to breadth of product line.

In addition, certain of the potential customers of each of our segments, in particular mass merchandisers, have the financial and other resources necessary to buy products similar to those that we sell directly from manufacturers in Asia and elsewhere, thereby reducing the size of our potential market.

Copyrights, Trademarks, Patents and Licenses

The Company prints notices of claim of copyright on substantially all of its products and has registered hundreds of its designs with the United States Copyright Office. The Company has registered, in various countries throughout the world, the trademark RUSS® with a distinctive design and APPLAUSE®, for use on most of its gift products, and Sassy™ and Kids Line™ for use on its infant and juvenile products. The Company believes its copyrights, trademarks and patents are valid, and has pursued a policy of aggressively protecting them from infringement. Copyright and trademark protections are limited or even unavailable in some foreign countries and preventing unauthorized use of the Company’s intellectual properties can be difficult even in countries with substantial legal protection. In addition, the portion of the Company’s business that relies on the use of intellectual property is subject to the risk of challenges by third parties claiming infringement of their proprietary rights. However, even in light of the Company’s increased use of licensing (discussed below) it does not consider its business materially dependent on copyright, trademark or patent protection due to the availability of substitutes, creation of other designs, and the variety of other Russ® products.

The Company enters into license agreements relating to trademarks, copyrights, patents, designs and products which enable the Company to market items compatible with its product line. The Company’s gift segment has increased its use of licensing in recent years to differentiate its products from its competitors. During 2004,  the Company entered into license agreements, some of which include: (i) Marvel Enterprises, Inc. relating to Spider-Man® and X-Men™ classic characters and certain other characters; (ii) Hasbro International, Inc. and Simon & Schuster, Inc. relating to the Raggedy Ann and Andy™ property; and (iii) DreamWorks Animation LLC relating to Madagascar. In 2005, the company entered into additional license agreements, including: (i) Universal Studios Licensing LLP relating to Curious George™ and The Little Engine That Could™; (ii) New England Confectionary Company relating to Necco Sweetheart™; and (iii) Twentieth Century Fox and Merchandising, a division of Fox Entertainment Group, Inc., relating to The Simpsons™. All gift segment license agreements mentioned above are for three year terms with extensions possible if agreed to by both parties. The Company’s infant and juvenile segment’s primary license is with MAM Babyartikel GmbH, of Vienna, Austria, which has a remaining term of five years with a renewal option. Royalties are paid on licensed items and, in many cases, advance royalties and minimum guarantees are required by these license agreements.

Employees

As of December 31, 2005, the Company employed approximately 1,220 persons. The Company considers its employee relations to be good. Most of the Company’s employees are not covered by a collective bargaining agreement, although approximately 50 employees of the Company’s infant and juvenile segment, representing 23% of such segment’s employees or 4% of the Company’s total employees, are represented by a collective bargaining agreement.

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The Company’s policy is to require that its management, sales, product development, and design personnel enter into confidentiality agreements and, in the case of sales management and sales personnel, non-competition agreements (subject to certain territorial limitations) which restrict their ability to compete with the Company for periods ranging between six months and one year after termination of their employment.

Government Regulation

Certain of the Company’s products are subject to the provisions of, among other laws, the Federal Hazardous Substances Act and the Federal Consumer Product Safety Act. Those laws empower the Consumer Product Safety Commission (the “Commission”) to protect consumers from certain hazardous articles by regulating their use or excluding them from the market and requiring a manufacturer to repurchase articles that become banned. The Commission’s determination is subject to judicial review. Similar laws exist in some states and cities in the United States and in certain foreign jurisdictions in which the Company’s products are sold. The Company maintains a quality control program in order to comply with such laws, and the Company believes it is in substantial compliance with all the foregoing laws. Notwithstanding the foregoing, no assurance can be made that all products are or will be hazard-free or free from defects.

Corporate Governance and Available Information

The Company makes available a wide variety of information free of charge on its website at www.russberrie.com. The Company’s filings with the United States Securities and Exchange Commission (the “SEC”), including our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to such reports, are available on the Company’s website as soon as reasonably practicable after the reports are electronically filed with the SEC. The Company’s website also contains news releases, financial information, Company profiles and certain corporate governance information, including copies of the “Company’s Complaint Procedures for Accounting and Auditing Matters”, “Corporate Governance Guidelines”, the Company’s “Code of Business Conduct and Ethics”, the Company’s “Code of Ethics for Principal Executive Officer and Senior Financial Officers”, the charters of the Audit Committee, the Compensation Committee and the Nominating/Governance Committee of the Board of Directors, and information regarding how interested parties may contact the Board. To access our SEC reports or amendments, log onto our website and click onto “Investor Relations” on the main menu and then onto the “SEC Filings” link provided under “Investor News.”  Mailed copies of such information can be obtained free of charge by writing to the Company at Russ Berrie and Company, Inc., 111 Bauer Drive, Oakland, NJ  07436, Attention: Corporate Secretary. The contents of the Company’s websites are not incorporated into this filing.

ITEM 1A. RISK FACTORS

The risks described below are not the only risks we face. Additional risks that we do not yet know of or that we currently believe are immaterial may also impair our business operations. If any of the events or circumstances described in the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected. In such cases, the trading price of our common stock could decline.

Our net sales and profitability depend on our ability to continue to conceive, design and market products that appeal to consumers.

The introduction of new products is critical in our industry and to our growth strategy. A significant percentage of our product line is replaced each year with new products. Our business depends on our ability to continue to conceive, design and market new products and upon continuing market acceptance of our product offerings. Rapidly changing consumer preferences and trends make it difficult to predict how long consumer demand for our existing products will continue or which new products will be successful. Our current products may not continue to be popular or new products that we introduce may not achieve adequate consumer acceptance for us to recover development, manufacturing, marketing and other costs. A decline in consumer demand for our products, our failure to develop new products on a timely basis in anticipation of changing consumer preferences or the failure of our new products to achieve and sustain consumer acceptance could reduce our net sales and profitability.

Increased consolidation and a declining number of independent retail outlets may have a continued negative impact on sales.

The Company’s gift segment has incurred significant losses during the past two years as a result of (i) retailer consolidation and a declining number of independent retail outlets; (ii) increased competition from other entities; and (iii) changing buying habits of consumers, marked by a shift from independent retailers to mass market retailers.

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Although the Company has increased its presence in, and focus on, the mass market, a significant portion of the Company’s gift segment products continue to be marketed to independent retail outlets. If increased consolidation of such outlets continues, as well as a continued decline in the number of such outlets, the Company’s sales therefrom will likely continue to decline.

The success of our gift segment will depend largely on the results of our Profit Improvement Program.

The Company is developing and implementing in phases a Profit Improvement Program (the “PIP”) with respect to its global gift business, which reflects a continuation and expansion of certain restructuring activities undertaken in the past two years. The PIP involves an analysis and, in some instances, reevaluation of key operational aspects of the Company’s gift business and will be designed to help enable the Company to return its gift business to a sustainable level of profitability. The PIP is expected to involve reengineering the manner in which the gift segment operates, and will likely involve reducing the size of the gift business by focusing on the most profitable products, customers and territories as a means of providing a platform for potential profitable growth in the future. The scope of the PIP is intended to be broad and significant and may cause losses to our business that we cannot predict, including a loss of gift segment sales. Although the Company has not yet completed the development of its Profit Improvement Program, the implementation of the PIP will result in the recognition of certain significant restructuring charges and the incurrence of certain severance obligations. The Company may also be required to make certain investments to generate the efficiencies that the PIP will be designed to achieve, although the nature and magnitude of these investments cannot be determined at this time. There can be no assurance that the PIP will ultimately be successful in stemming the losses generated by the gift segment and returning the segment to profitability, or that we will be able to successfully grow the gift segment at any time. If we fail to successfully implement the PIP, our results of operations and financial position will suffer and our ability to maintain compliance with the financial covenants in our Giftline Credit Agreement will be impaired. See “Business – Marketing and Sales” and “Management’s Discussion and Analysis of Results of Operations and Financial Condition – Overview” and “– Liquidity and Capital Resources.”

Gross margin could be adversely affected by several factors.

Gross margin may be adversely affected in the future by increases in vendor costs (including as a result of increases in the cost of raw materials), excess inventory, obsolescence charges, changes in shipment volume, price competition and changes in channels of distribution or in the mix of products sold. Gross margin may also be impacted by the geographic mix of products sold. Gross margin is often lower in the mass market distribution channel, which represents a growing percentage of our sales.

Competition in our markets could reduce our net sales and profitability.

We operate in highly competitive markets. Many of our competitors have greater brand recognition and greater financial, technical, marketing and other resources than we have. In addition, we may face competition from new participants in our markets because the gift and infant/juvenile product industries have limited barriers to entry. In addition, certain of our potential customers, in particular mass merchandisers, have the financial and other resources necessary to buy products similar to those that we sell directly from manufacturers in Eastern Asia and elsewhere, thereby reducing the size of our potential market. We also experience price competition for our products, competition for shelf space at retailers and competition for licenses, all of which may increase in the future. If we cannot compete successfully in the future, our net sales and profitability will likely decline.

Our debt covenants may affect our liquidity or limit our ability to complete acquisitions, incur debt, make investments, sell assets, merge or complete other significant transactions.

Our 2006 Credit Agreements include provisions that place limitations on a number of our activities, including our ability to:

•                  incur additional debt;

•                  create liens on our assets or make guarantees;

•                  make certain investments or loans;

•                  pay dividends;

•                  dispose of or sell assets or enter into a merger or similar transaction; or

•                  distribute cash from our domestic subsidiaries to the Company or to other subsidiaries, which could impact our ability to pay our corporate overhead expenses.

These covenants could restrict our ability to pursue opportunities to expand our business operations. The Giftline Credit Agreement (defined below) also provides that the lenders will sweep all cash of the Giftline Borrowers (defined below) on a daily basis, which will restrict such borrowers’ ability to use such cash. In addition, during

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2005, we funded losses in our gift division with cash flow from our infant and juvenile business. The covenants in our 2006 Credit Agreements limit the ability of our domestic subsidiaries to distribute cash to the Company or to other subsidiaries, which could negatively impact the liquidity of the Company or its gift business. See “Management’s Discussion and Analysis of Results of Operations and Financial Condition – Liquidity and Capital Resources” and Note 8 of Notes to Consolidated Financial Statements.

Inability to maintain compliance with the bank covenants.

The Company’s ability to maintain compliance with the financial and other covenants in its credit facilities is dependent upon the successful implementation of its PIP and various current operational plans. If an event of default in such covenants occurs and is continuing, among other things, the lenders may accelerate the loans, declare the commitments thereunder to be terminated, seize collateral or take other actions of secured creditors. If the loans are accelerated or commitments terminated, we could face substantial liquidity problems and may be forced to dispose of material assets or operations, seek to obtain equity capital, or restructure or refinance our indebtedness. Such alternative measures may not be available or successful. Also, our bank covenants may limit our ability to dispose of material assets or operations or to restructure or refinance our indebtedness. Even if we are able to restructure or refinance our indebtedness, the economic terms may not be favorable to us. All of the foregoing could have serious consequences to our financial condition and results of operations and could cause us to become bankrupt or insolvent.

Our cash flows and capital resources may be insufficient to make required payments on our indebtedness.

Our ability to generate cash to meet scheduled payments with respect to our debt depends on our financial and operating performance, which, in turn, is subject to prevailing economic and competitive conditions and the other factors discussed in this “Risk Factors” section. If our cash flow and capital resources are insufficient to fund our debt service obligations, we could face substantial liquidity problems and may be forced to dispose of material assets or operations, seek to obtain equity capital, or restructure or refinance our indebtedness. As discussed in the immediately preceding risk factor, such alternative measures may not be successful and may not permit us to meet our scheduled debt services obligations. The breach of any covenants or restrictions in the Credit Agreements could result in a default thereunder, which would permit the lenders to take the actions discussed in the immediately preceding risk factor. As discussed above, this could have serious consequences to our financial condition and results of operations and could cause us to become bankrupt or insolvent.

If we lose key personnel we may not be able to achieve our objectives.

We are dependent on the continued efforts of various members of senior management, as well as senior executives of several of our subsidiaries, including Andrew R. Gatto, President and Chief Executive Officer, Michael Levin, President and Chief Executive Officer of Kids Line, LLC and Fritz Hirsch, President of Sassy, Inc. If for any reason, these or other senior executives or other key members of management do not continue to be active in management, our business, financial condition or results of operations could be adversely affected. We cannot assure you that we will be able to continue to retain our senior executives or other personnel necessary for the continued success of our business.

Our infant and juvenile business is dependent on several large customers.

The continued success of our infant and juvenile segment depends on our ability to continue to sell our products to several large mass market retailers. We typically do not have long-term contracts with these customers and the loss of one or more of these customers could have a material adverse affect on the results of operations of our infant and juvenile segment and ultimately the Company. In addition, our access to shelf space at retailers for the products of both of our segments may be reduced by store closings, consolidation among these retailers and competition from other products. An adverse change in our relationship with, or the financial viability of, one or more of our customers could reduce our net sales and profitability. See “Business – Marketing and Sales” and Note 5 of Notes to Consolidated Financial Statements.

We may not be able to collect outstanding accounts receivable from our major retail customers.

Certain of our retail customers purchase large quantities of our products on credit, which may cause a concentration of accounts receivable among some of our largest customers. Our profitability may be harmed if one or more of our largest customers were unable or unwilling to pay these accounts receivable when due or demand credits or other concessions for products they are unable to sell.

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Disruptions in our current information technology system or difficulties in implementing an alternative global information technology system could harm our business.

Our global gift operations are currently managed and monitored with an Enterprise Resource Planning (“ERP”) system. System failure or malfunctioning in the ERP system may result in disruption of operations and the inability to process transactions and could adversely affect our financial results. In addition, the Company has recently begun the exploration of whether the implementation of an alternative global information technology system for the gift business would provide greater efficiencies, lower costs and greater reporting capabilities than those provided by the current ERP system. Implementation of a new system solution would likely proceed in stages across the geographic breadth of the Company, and could require several years for completion. In the event that we elect to implement a new system, we anticipate incurring significant financial and resource costs, and our business may be subject to transitional difficulties as we replace the current ERP system. These difficulties may include disruption of our operations, loss of data, and the diversion of our management and key employees’ attention away from other business matters. The difficulties associated with any such implementation, and our failure to realize the anticipated benefits from the implementation, could harm our business, results of operations and cash flows.

We rely on foreign suppliers, primarily in the PRC, to manufacture most of our products, which subjects us to numerous international business risks that could increase our costs or disrupt the supply of our products.

Approximately 89% of the Company’s purchases are attributable to manufacturers in the PRC. The supplier accounting for the greatest dollar volume of purchases accounted for approximately 16% and the five largest suppliers accounted for approximately 40% in the aggregate. The Company uses approximately 130 manufacturers in Eastern Asia. While we believe that there are many other manufacturing sources available for our product lines, difficulties encountered by one or several of our larger suppliers such as a fire, accident, natural disaster or an outbreak of illness (e.g., SARS or avian flu) at one or more of their facilities, could halt or disrupt production at the affected facilities, delay the completion of orders, cause the cancellation of orders, delay the introduction of new products or cause us to miss a selling season applicable to some of our products. In addition, our international operations subject us to certain other risks, including:

•                  economic and political instability;

•                  restrictive actions by foreign governments;

•                  greater difficulty enforcing intellectual property rights and weaker laws protecting intellectual property rights;

•                  changes in import duties or import or export restrictions;

•                  delays in shipping of product and unloading of product through ports, as well as timely rail/truck delivery to the Company’s warehouses and/or a customer’s warehouse;

•                  complications in complying with the laws and policies of the United States affecting the importation of goods, including duties, quotas and taxes;

•                  complications in complying with trade and foreign tax laws; and

•                  the effects of terrorist activity, armed conflict and epidemics.

Any of these risks could disrupt the supply of our products or increase our expenses. The costs of compliance with trade and foreign tax laws increase our expenses and actual or alleged violations of such laws could result in enforcement actions or financial penalties that could result in substantial costs.

Currency exchange rate fluctuations could increase our expenses.

Our net sales are primarily denominated in U.S. dollars, except for a small amount of net sales denominated in U.K. pounds, Australian dollars, Euros or Canadian dollars. Our purchases of finished goods from Chinese manufacturers are denominated in Hong Kong dollars. Expenses for these manufacturers are denominated in Chinese Yuan. As a result, any material increase in the value of the Hong Kong dollar or the Yuan relative to the U.S. dollar or the U.K. pound would increase our expenses and therefore could adversely affect our profitability. We are also subject to exchange rate risk relating to transfers of funds denominated in U.K. pounds, Australian dollars, Canadian dollars or Euros from our foreign subsidiaries to the United States. See Note 5 of Notes to Consolidated Financial Statements for more information regarding foreign currency forward exchange contracts.

Product liability, product recalls and other claims relating to the use of our products could increase our costs.

We face product liability risks relating to the use of our products. We also must comply with a variety of product safety and product testing regulations. If we fail to comply with these regulations or if we face product liability claims, we may be subject to damage awards or settlement costs that exceed our insurance coverage and we may incur significant costs in complying with recall requirements. In addition, substantially all of our licenses give the licensor the right to terminate the license agreement if any products marketed under the license are subject to a product liability claim, recall or similar violations of product safety regulations or if we breach covenants relating to

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the safety of the products or their compliance with product safety regulations. A termination of a license could adversely affect our net sales. Even if a product liability claim is without merit, the claim could harm our reputation and divert management’s attention and resources from our business.

Competition for licenses could increase our licensing costs or limit our ability to market products.

We market a growing portion of our products, particularly in the gift segment, through licenses with other parties. These licenses are generally limited in scope and duration and generally authorize the sale of specific licensed products on a nonexclusive basis. Our license agreements often require us to make minimum guaranteed royalty payments that may exceed the amount we are able to generate from actual sales of the licensed products. Any termination of or failure to renew our significant licenses, or inability to develop and enter into new licenses, could limit our ability to market our licensed products or develop new products, and could reduce our net sales and profitability. Competition for licenses could require us to pay licensors higher royalties and higher minimum guaranteed payments in order to obtain or retain attractive licenses, which could increase our expenses. In addition, licenses granted to other parties, whether or not exclusive, could limit our ability to market products, including products we currently market, which could cause our net sales and profitability to decline.

Trademark infringement or other intellectual property claims relating to our products could increase our costs.

Our industry is characterized by frequent litigation regarding trademark infringement and other intellectual property rights. We are and have been a defendant in trademark and other intellectual property infringement claims and claims of breach of license from time to time, and we may continue to be subject to such claims in the future. The defense of intellectual property litigation is both costly and disruptive of the time and resources of our management, even if the claim is without merit. We also may be required to pay substantial damages or settlement costs to resolve intellectual property litigation.

We may experience difficulties in integrating strategic acquisitions.

As part of our growth strategy, we may pursue acquisitions that are consistent with our mission and enable us to leverage our competitive strengths. We acquired Sassy, Inc. in 2002 and Kids Line, LLC in 2004. The integration of acquired companies and their operations into our operations involves a number of risks including:

•                  possible failure to maintain customer, licensor and other relationships after the closing of the transaction of the acquired company;

•                  the acquired business may experience losses which could adversely affect our profitability;

•                  unanticipated costs relating to the integration of acquired businesses may increase our expenses;

•                  difficulties in achieving planned cost-savings and synergies may increase our expenses or decrease our net sales;

•                  diversion of management’s attention could impair their ability to effectively manage our business operations, and unanticipated management or operational problems or liabilities may adversely affect our profitability and financial condition; or

•                  possible failure to obtain any necessary consents to the transfer of licenses or other agreements of the acquired company.

Additionally, we financed our acquisition of Kids Line, LLC with senior debt financing. This debt leverage could adversely affect our profit margins and limit our ability to capitalize on future business opportunities. See Note 8 of Notes to Consolidated Financial Statements.

Sales of our gift segment products are seasonal, which causes our operating results to vary from quarter to quarter.

Sales of our gift segment products are seasonal. Historically, our net sales with respect to gift segment products have peaked in the third and fourth quarters due to holiday season buying patterns. See “Business – Seasonality.”

The trading price of our common stock has been volatile and investors in our common stock may experience substantial losses.

The trading price of our common stock has been volatile and may continue to be volatile in the future. The trading price of our common stock could decline or fluctuate in response to a variety of factors, including:

•                  changes in financial estimates of our net sales and operating results or buy/sell recommendations by securities analysts;

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•                  the timing of announcements by us or our competitors concerning significant product developments, acquisitions or financial performance;

•                  fluctuation in our quarterly operating results;

•                  other economic or external factors;

•                  continued losses in our gift segment;

•                  our failure to meet the performance estimates of securities analysts;

•                  substantial sales of our common stock; or

•                  general stock market conditions.

You may be unable to sell your stock at or above your purchase price.

A limited number of our shareholders can exert significant influence over us.

As of March 31, 2006, The Russell Berrie Foundation, The Russell Berrie 2002A Trust and the Estate of Mr. Russell Berrie beneficially owned an aggregate of approximately 43% of the outstanding shares of our common stock. This share ownership would permit these stockholders, if they chose to act together, to exert significant influence over the outcome of stockholder votes, including votes concerning the election of directors, by-law amendments, possible mergers, corporate control contests and other significant corporate transactions.

Various restrictions in our charter documents, policies, New Jersey law and our 2006 Credit Agreements could prevent or delay a change in control of us which is not supported by our board of directors.

We are subject to a number of provisions in our charter documents, policies, New Jersey law and our 2006 Credit Agreements that may discourage, delay or prevent a merger, acquisition or change of control that a stockholder may consider favorable. These anti-takeover provisions include:

•                  advance notice procedures for nominations of candidates for election as directors and for stockholder proposals to be considered at stockholders’ meetings;

•                  covenants in our credit agreement restricting mergers, asset sales and similar transactions and a provision in our credit agreement that triggers an event of default upon certain acquisitions by a person or group of persons with beneficial ownership of 50.1% or more of our outstanding common stock; and

•                  the New Jersey Shareholders Protection Act.

The New Jersey Shareholders Protection Act, as it pertains to the Company, prohibits a merger, consolidation, specified asset sale or other similar business combination or disposition between the Company and any stockholder of 10% or more of our voting stock for a period of five years after the stockholder acquires 10% or more of our voting stock, unless the transaction is approved by our board of directors before the stockholder acquires 10% or more of our voting stock. In addition, no such transaction shall occur at any time unless: (1) the transaction is approved by our board of directors before the stockholder acquires 10% or more of our voting stock, (2) the transaction is approved by the holders of two-thirds of our voting stock excluding shares of our voting stock owned by such “interested” stockholder or (3) (A) the aggregate consideration received per share by stockholders in such transaction is at least equal to the higher of (i) the highest per share price paid by the interested stockholder (x) within the 5-year period preceding the announcement date of such transaction or (y) within the 5-year period preceding, or in the transaction, in which the stockholder became an interested stockholder, whichever is higher, in each case plus specified interest, less the value of dividends paid up to the amount of such interest, and (ii) the market value per share of common stock on the announcement date of such transaction or on the date the interested stockholder became an interested stockholder, whichever is higher, plus specified interest, less the value of dividends paid up to the amount of such interest, (B) the consideration in the transaction received by stockholders is in cash or in the same form as the interested stockholder used to acquire the largest number of shares previously acquired by it, and (C) after the date the interested stockholder became an interested stockholder, and prior to the consummation of the transaction, such interested stockholder has not become the beneficial owner of additional shares of our stock, except (w) as part of the transaction which resulted in the interested stockholder becoming an interested stockholder, (x) by virtue of proportionate stock splits, stock dividends or other distributions not constituting a transaction covered by the New Jersey Shareholders Protection Act, (y) through a transaction meeting the conditions of paragraph (B) above and this paragraph (C) or (z) through purchase by the interested stockholder at any price, which, if that price had been paid in an otherwise permissible transaction under the New Jersey Shareholders Protection Act, the announcement date and consummation date of which were the date of that purchase, would have satisfied the requirements of paragraphs (A) and (B) above.

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Actual results differing from estimates.

If actual events, circumstances, outcomes and amounts differ from judgments, assumptions and estimates made or used in determining the amount of certain assets (including the amounts of related allowances and reserves), liabilities and/or other items reflected in our financial statements, it could adversely affect our results of operations and financial condition.

Increased costs associated with corporate governance compliance may affect our results of operations.

The Sarbanes Oxley Act of 2002 has required changes in some of our corporate governance and securities disclosure and compliance practices, and requires ongoing review of our internal control procedures. These developments have increased our legal compliance and financial reporting costs, and to the extent that we identify areas of our disclosures controls and procedures and/or internal controls requiring improvement (such as the material weakness in internal controls identified as of December 31, 2005 and discussed in Item 9A, “Controls and Procedures – Management’s Report on Internal Control Over Financial Reporting” included herein), we may have to incur additional costs and diversion of management’s time. Any such action could adversely affect our results of operations and financial condition.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2. PROPERTIES

The principal facilities of the Company’s gift segment consist of its corporate offices in Oakland, New Jersey (120,000 square feet), and distribution centers in South Brunswick, New Jersey (522,000 square feet), and Petaluma, California (234,000 square feet), all of which the Company leases. On January 19, 2006, the Company announced it would be closing its Petaluma distribution center during the second quarter of 2006. Additionally, leased principal office and distribution facilities are located in Southampton, England (157,000 square feet), the Sydney, Australia area (67,000 square feet) and the Toronto, Canada area (117,000 square feet). The Toronto area facility had been owned by the Company’s wholly-owned subsidiary, Amram’s Distributing, Limited (“Amram’s”), until December 29, 2005, when the facility was sold to a third party with whom Amram’s entered into a long-term lease. See “Management’s Discussion and Analysis of Results of Operations and Financial Condition – Liquidity and Capital Resources” and the Current Reports filed by the Company with the SEC on December 15, 2005 and December 30, 2005 for more information regarding this sale-leaseback transaction. The Company also operates showroom facilities for its gift business segment in Oakland, New Jersey; Los Angeles, California; Atlanta, Georgia; Chicago, Illinois; Sydney, Australia; Montreal, Vancouver and Toronto, Canada; Southampton, England; and Kowloon, Hong Kong. Certain showrooms are located within the leased facilities listed above; others are leased separately with remaining lease terms primarily ranging between three months and three years.

The Company owns office and distribution facilities used by its infant and juvenile operations in Grand Rapids, Michigan. Another facility used by its infant and juvenile operations, located in South Gate, California, is leased.

LaSalle Business Credit, LLC and certain of its affiliates (“LaSalle”), as administrative agent for the lenders under the 2006 Credit Agreements, has a lien on substantially all of the assets of the Company. Such lien includes a mortgage on the real property located at 2305 Breton Industrial Park Drive, S.E., Kentwood, Michigan (the “Facility Encumbrance”). California KL Holdings, Inc., as agent, has a subordinated lien with respect to the Facility Encumbrance and all of the assets of the infant and juvenile segment. See Note 8 of Notes to Consolidated Financial Statements.

The Company believes that the facilities of the Company are maintained in good operating condition and are, in the aggregate, adequate for the Company’s purposes and are generally fully utilized. At December 31, 2005, the Company and its subsidiaries were obligated under operating lease agreements (principally for buildings and other leased facilities) for remaining lease terms ranging from three months to seventeen years. See “Management’s Discussion and Analysis of Results of Operations and Financial Condition – Contractual Obligations.”

Certain of the properties leased by the Company’s gift segment are leased from parties related to the late Mr. Russell Berrie, including Angelica Berrie, entities established by him or his estate. See Note 16 of Notes to Consolidated Financial Statements and Item 13, “Certain Relationships and Related Transactions,” with respect to encumbrances on the South Brunswick, New Jersey facility leased by the Company.

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ITEM 3. LEGAL PROCEEDINGS

In the ordinary course of its business, the Company is party to various copyright, patent and trademark infringement, unfair competition, breach of contract, customs, employment and other legal actions incidental to its business, as plaintiff or defendant. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially adversely affect the consolidated results of operations, financial condition or cash flows of the Company.

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

Not applicable.

EXECUTIVE OFFICERS OF THE REGISTRANT

The following table provides information with respect to the executive officers of the Company. All officers are elected by the Board of Directors and may be removed with or without cause by the Board.

(1)             Member of the Company’s Board of Directors

(2)             Member of the Company’s Disclosure Committee

(3)             Member of the Company’s Executive Management Committee

Jeffrey A. Bialosky was appointed Senior Vice President—National Accounts in February 2004 and joined the Company as Senior Vice President—Product Development (Plush) in April 2003. Prior to joining the Company, Mr. Bialosky was employed with Commonwealth Toy, a designer, developer, manufacturer and marketer of toys to the mass market, as Senior Vice President of Product Development and Marketing since February 1995.

Anthony P. Cappiello has been employed as Executive Vice President and Chief Administrative Officer since August 2005. Prior to joining the Company, Mr. Cappiello was Chief Operating Officer at Waterford & Wedgwood U.S.A, a marketer, manufacturer and distributor of fine crystal, china, linens, jewelry, cookware, heirlooms and flatware, since May 1991.

Teresa Chan was appointed Vice President—Far East Operations in January 2004. Ms. Chan was elected as an officer of the Company in October 1999 and had been employed by the Company as Vice President—International Sales since January 1997.

Andrew R. Gatto joined the Company as President and Chief Executive Officer in June 2004. Prior to joining the Company, Mr. Gatto was employed with Toys “R” Us, Inc. as Senior Vice President, Product Development, Imports and Strategic Sourcing since October 1997.

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Eva J. Goldenberg was elected an officer of the Company in January 2001 and has been employed by the Company as Vice President—Human Resources since April 2000. Prior to that, Ms. Goldenberg was Director of Human Resources since September 1999 and Associate General Counsel since August 1994.

Marc S. Goldfarb joined the Company as Vice President, General Counsel and Corporate Secretary in September 2005. Prior to joining the Company, Mr. Goldfarb was Vice President, General Counsel and Corporate Secretary of Journal Register Company, a publicly traded newspaper publishing company, from January 2003 to September 2005. From July 1998 to January 2003, he served as Managing Director and General Counsel of The Vertical Group, an international private equity firm. Prior to that, Mr. Goldfarb was a Partner at Bachner, Tally, Polevoy & Misher LLP.

Thomas K. Higgerson was appointed Vice President—Operations in October 2004 and joined the Company as Vice President—Global Logistics in January 2000. Prior to joining the Company, Mr. Higgerson was employed with Hygrade Integrated Logistics Systems, Inc., a third party logistics company, as Executive Vice President, responsible for operations, information systems, transportation/logistics, and project management, since March 1997.

Y.B. Lee was appointed Senior Vice President—Design and Development, Far East Operations and President—Korean Operations in 2004. Prior to that, Mr. Lee was Senior Vice President—Far East and President—Far East Operations since June 1996.

James J. O’Reardon, Jr. has been employed by the Company as Vice President—Corporate Audits since April 2000. Prior to that, Mr. O’Reardon was Vice President—Administration since September 1997.

Chris Robinson was appointed President—International Division in February 2003. Prior to that Mr. Robinson served as Managing Director of Russ Berrie U.K. Ltd. since June 1988.

Thomas J. Sancetta was appointed Vice President—Inventory Management in July 2003. Mr. Sancetta was elected an officer of the Company in January 2003 and had been employed by the Company as Vice President—Sales Administration since January 2002. Prior to that Mr. Sancetta was Director of Internal Audit since September 1997.

Keith Schneider was appointed Executive Vice President—Sales in November 2005. Prior to that, Mr. Schneider was Managing Director of Russ Australia since August 1999.

Arline Wall joined the Company as Senior Vice President—Product Development and Marketing in December 2005. Prior to joining the Company, from September 2004 to November 2005, Ms. Wall was employed by MAF Marketing, Inc., a premium incentive sales company, as Vice President—New Product Development. Prior to that, from August 1998 to September 2004, Ms. Wall was employed by Toys “R” Us, Inc., most recently holding the position of Global Brand Director.

John D. Wille has been employed by the Company as Vice President and Chief Financial Officer since February 2001. Prior to joining the Company, Mr. Wille was employed by the Betesh Group, a privately held designer, manufacturer and distributor of handbags, small leather goods, infant accessories and toys, as Vice President Finance and Chief Financial Officer since November 2000. Prior to that, Mr. Wille was employed by Time Life Inc., a book, music and video publisher, as Vice President and Corporate Controller since May 1997.

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PART II

ITEM 5.      MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

At March 31, 2006, the Company’s Common Stock was held by approximately 427 shareholders of record. The Company’s Common Stock has been traded on the New York Stock Exchange, under the symbol RUS, since its initial public offering on March 29, 1984. The following table sets forth the high and low sale prices on the New York Stock Exchange Composite Tape for the calendar periods indicated, as furnished by the New York Stock Exchange:

The Board of Directors declared its first dividend to holders of the Company’s Common Stock in November 1986. Cash dividends were paid quarterly from November 1986 through the first quarter of 2005. In addition, the Board declared a special cash dividend of $7.00 per share that was paid in June 2004. The quarterly dividend rate was decreased from $0.30 in 2004 to $0.10 per common share for the first quarter of 2005. The Company has not paid a dividend since April 2005 and currently does not anticipate paying any dividends at least through 2006.

In accordance with the terms of the 2006 Credit Agreements, the Company’s domestic operating subsidiaries are subject to certain restrictions in distributing cash to the Company for the purpose of enabling the Company to pay dividends to its shareholders. See Item 7, “Managements Discussion and Analysis of Results of Operations and Financial Condition – Liquidity and Capital Resources” and Note 8 of Notes to Consolidated Financial Statements for a description of the material terms of the Credit Agreements.

See Item 12 of this Annual Report on Form 10-K for Equity Compensation Plan Information.

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ITEM 6. SELECTED FINANCIAL DATA

*                 The years ended December 31, 2005, 2004, 2003 and 2002 include the results of Sassy, Inc. since its acquisition on July 26, 2002. The years ended December 31, 2005 and December 31, 2004 include the results of Kids Line, LLC since its acquisition on December 15, 2004. All years include Bright of America Inc. until its sale as of July 30, 2004.

**          Dividends per share for the years ended December 31, 2004 and 2001 include a one-time special cash dividend in the amount of $7.00 and $0.50 per common share, respectively.

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The financial and business analysis below provides information which the Company believes is relevant to an assessment and understanding of the Company’s consolidated financial condition, changes in financial condition and results of operations. This financial and business analysis should be read in conjunction with the Company’s consolidated financial statements and accompanying Notes to Consolidated Financial Statements set forth in Item 8 below.

Overview

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

The Company’s revenues are primarily derived from sales of its products, a significant portion of which are attributable its gift segment. Sales and operating profits in the Company’s gift segment began to decline during 2003 as a result of several factors including: (i) retailer consolidation and a declining number of independent retail outlets, which in turn had a negative impact on sales from such outlets; (ii) increased competition from other entities, both wholesalers and retailers, which offered lower pricing and achieved greater customer acceptance of their products; and (iii) changing buying habits of consumers, marked by a shift from independent retailers to mass market retailers. Commencing in the third quarter of 2003, the Company began to implement a multi-pronged approach to address these trends, which consists of: (i) focusing on categorizing and rationalizing its product range; (ii) segmenting its selling efforts to address customer requirements and shifting channels of distribution; (iii) increasing its focus on national accounts, in order to build and strengthen the Company’s presence in the mass market through the use if its APPLAUSE® trademark as the mass market brand platform; (iv) focusing on growing its international business and infant and juvenile segments; (v) selectively increasing its use of licensing to differentiate its products from its competitors;  (vi) implementing a three tiered “good”, “better”, “best” branding strategy within its gift segment to differentiate products sold into the mass market, the Company’s traditional specialty retail market and the upscale department store market; and (vii) “right-sizing” its operations in order to reduce overhead expenses through headcount reductions and the closure of certain domestic showrooms and warehouses.

During 2004, the Company implemented a comprehensive strategic review of the Company’s business, which resulted in an inventory write-down of $13 million (pre-tax) recorded in cost of sales in the second quarter of 2004. In addition, the Company continued to evaluate “right-sizing” its infrastructure in response to the changing business environment. As a result of such evaluation, the Company reduced headcount during the second half of 2004 by an aggregate of approximately 120 positions and recorded a restructuring charge of an aggregate of $6.3 million in the third and fourth quarters of 2004. Management believes that future operating expenses, predominantly through reduced employee costs, were reduced by an aggregate of approximately $10.5 million on an annualized basis as a result of these reductions. The effects of these reduced costs began in the third and fourth quarters of 2004. Severance payments for employees affected by this restructuring continued through the third and fourth quarters of 2005.

The Company has continued to address the challenges in its gift business through the multi-pronged approach discussed above, which has enabled the Company to reduce significantly its operating expenses. However, the Company achieved only limited success in reversing the challenges facing its gift business and the industry in general. As a result, in November 2005, the Company commenced the implementation of a further restructuring of its domestic gift business designed to “right size” the infrastructure consistent with existing business levels and re-align domestic gift operations to better meet the needs of different distribution channels. The restructuring included the immediate elimination of approximately 50 positions, which resulted in a pre-tax restructuring charge of approximately $1.4 million in the fourth quarter of 2005, primarily related to employee severance costs. As part of the November 2005 restructuring, the Company also commenced a plan to reduce its facilities expenses by

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rationalizing certain warehouse and distribution activities, which is expected to result in additional pre-tax restructuring charges in 2006 of approximately $2.5 million, primarily related to employee severance and facility exit costs. In connection with this rationalization, the Company announced in January 2006 its intention to consolidate its domestic gift warehousing and distribution into its South Brunswick, New Jersey facility and intends to close the Petaluma, California facility during the second quarter of 2006. In addition, in connection with the November 2005 restructuring, the Company conducted another comprehensive review of its gift product line to identify product categories and individual items that did not fit into its future sales and marketing plans. As a result of product line decisions made in the fourth quarter, an additional inventory write-down of $4.2 million (pre-tax) was recorded in the fourth quarter of 2005. The Company anticipates selling substantially all of this inventory through other than its normal sales channels. The Company expects to incur additional restructuring costs as it continues to implement the November 2005 restructuring plan and expects to incur further restructuring costs as it implements the Profit Improvement Program currently under development, as described below.

Management believes that future operating expenses will be reduced by approximately $15 million on an annualized basis as a result of the restructuring commenced in November 2005. A portion of these expense savings related to employee expenses are reflected in the Company’s results of operations for the fourth quarter of 2005, with the remaining cost reductions expected to be achieved during 2006. Severance payments to employees impacted by the restructuring will continue through the end of 2006, although such payments will not impact the Company’s results of operations, as they are reflected in the restructuring charge recorded in the fourth quarter of 2005. All of the restructuring costs recorded in the fourth quarter of 2005 have been recorded in selling, general and administrative expenses.

As an expansion of its November 2005 restructuring and ongoing analysis, in 2006, the Company commenced the development and phased implementation of a Profit Improvement Program (“PIP”) with respect to its global gift business. The Company has retained the services of an independent advisor to assist in the development of the PIP. The PIP involves an analysis and, in some instances, re-evaluation of key operational aspects of the Company’s gift business and will, when completed, be designed to help enable the Company to return its gift business to a sustainable level of profitability. The PIP is expected to involve reengineering the manner in which the gift segment operates, and will likely involve reducing the size of the gift business by focusing on the most profitable products, customers and territories as a means of providing a platform for potential profitable growth in the future. The scope of the PIP is intended to be broad and significant and may cause losses to our business that we cannot predict, including a loss of gift segment sales. Although the Company has not yet completed the development of the PIP, the implementation (portions of which are already underway in phases) will result in the recognition of certain significant restructuring charges and the incurrence of related severance obligations. The Company may also be required to make certain investments to generate the efficiencies and focus on profitable operations that the PIP will be designed to achieve. Because the PIP is still being developed, estimates of the total charges to be incurred and investments or other expenditures required cannot be determined at this time, although the Company believes that it will have the resources available to implement the PIP plan.

As part of the PIP, the Company is currently evaluating the need to maintain direct sales and distribution efforts in several European countries. To date, the Company has determined to terminate its direct sales and distribution operations in France, Germany, Belgium and Holland, and has restructured certain of its sales operations in the U.K. As a result of these actions, the Company will reduce headcount by an aggregate of approximately 48 positions during the first half of 2006 and intends to record a restructuring charge of an aggregate of approximately $1.7 million in the first quarter of 2006. Management believes that future operating expenses, predominantly through reduced employee costs, will be reduced by an aggregate of approximately $4.2 million on an annualized basis as a result of these reductions. The Company is currently evaluating the legal requirements related to severance payments in each affected country, but anticipates that a substantial portion of the severance will be required to be paid upon termination of the related positions. The Company anticipates that it will establish alternative means of reaching certain customers in the affected countries, including through the use of independent sales representatives or distributors, although the Company expects that its aggregate sales from France, Germany, Belgium and Holland will be reduced by approximately $6 million on an annualized basis as a result of these actions, at least for the near term. See Item 1A, “Risk Factors” and “– Liquidity and Capital Resources.”

Effective December 28, 2005, the Company amended all outstanding stock option agreements which pertained to options with exercise prices in excess of the market price for the Company’s Common Stock at the close of business on December 28, 2005 (“Underwater Options”) which have remaining vesting requirements. As a result of these amendments, all Underwater Options, which represent all outstanding options (to purchase approximately 1,497,000 shares of the Company’s common stock) which had not yet fully-vested, became fully vested and immediately exercisable at the close of business on December 28, 2005.  Of the options accelerated, approximately 120,000 options are held by non-employee directors, approximately 868,000 are held by officers of the Company and the balance are held by other employees of the Company.  Because the company has accounted for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (APB) Opinion No. 25, and because these options were priced above the then current market price, the acceleration of vesting of these options did not require accounting recognition in the Company’s financial statements. The options were accelerated to reduce the financial statement expense impact in 2006 and beyond of a new accounting standard (SFAS No. 123(R), “Share Based Payment”) for stock based compensation (described below under the heading “Recently Issued Accounting Standards”).  Management believes that accelerating the vesting of these options prior to the adoption of the new accounting standard will result in the Company not being required to recognize compensation expense in 2006 in the amount of approximately $1.6 million (pre-tax) and in subsequent years through 2010 of approximately $3.7 million (pre-tax).

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Segments

The Company currently operates in two segments:  (i) its gift business and (ii) its infant and juvenile business. See Note 22 of Notes to Consolidated Financial Statements for a discussion on reclassification of the Company’s segments.

Results of Operations

Fiscal year ended December 31, 2005 compared to fiscal year ended December 31, 2004

The Company’s consolidated net sales for the year ended December 31, 2005 increased 9.1% to $290.2 million compared to $266.0 million, for the year ended December 31, 2004. The net sales increase was primarily attributable to growth in the Company’s infant and juvenile segment as a result of the acquisition in December 2004 of Kids Line LLC, partially offset by a sales decrease in the Company’s gift segment.

The Company’s gift segment net sales for the year ended December 31, 2005 decreased 22.2% to $158.5 million compared to $203.9 million for the year ended December 31, 2004, primarily as a result of the factors discussed in the “Overview” above. Net sales in the Company’s gift segment benefited by foreign exchange rates of approximately $1.4 million for the year ended December 31, 2005. The Company’s infant and juvenile segment net sales for the year ended December 31, 2005 increased 130.1% to $131.6 million compared to $57.2 million for the year ended December 31, 2004, primarily as a result of the acquisition of Kids Line as of December 15, 2004. Non-core sales for the year ended December 31, 2005 were $0 compared to $4.9 million for the year December 31, 2004, as a result of the sale of Bright of America, Inc. as of July 31, 2004.

Consolidated gross profit was 40.1% of consolidated net sales for the year ended December 31, 2005 as compared to 41.6% of consolidated net sales for the year ended December 31, 2004. The decrease in the consolidated gross profit percentage is primarily due to greater competitive pricing pressure in the gift segment, partially offset by lower inventory write-downs in 2005 in the gift business segment and a higher gross profit margin in the Company’s infant and juvenile segment. (See Note 6 of Notes to Consolidated Financial Statements and “Overview” above for a discussion of the inventory write-downs.)  Gross profit for the Company’s gift segment was 40.0% of net sales for the year ended December 31, 2005 as compared to 43.7% of net sales for the year ended December 31, 2004 as a result of the foregoing. Gross profit for the Company’s infant and juvenile segment was 40.3% of net sales for the year ended December 31, 2005 as compared to 34.1% of net sales for the year ended December 31, 2004 due primarily to the full year impact in 2005 of Kids Line.

Consolidated selling, general and administrative expense was $124.4 million, or 42.9% of consolidated net sales, for the year ended December 31, 2005 compared to $134.5 million, or 50.6% of consolidated net sales, for the year ended December 31, 2004. This decrease in consolidated selling, general and administrative expense is due primarily to lower expenses in the gift segment as a result of the impact of the 2004 restructuring initiatives partially offset by increased selling, general and administrative expenses in the infant and juvenile segment. The infant and juvenile segment increase is attributable to the full year impact in 2005 of Kids Line.

Consolidated operating loss was $8.0 million for the year ended December 31, 2005 compared to a loss of $23.9 million for the year ended December 31, 2004. The $15.9 million improvement was primarily the result of an increase in operating income in the Company’s infant and juvenile segment, to $34.1 million for the year ended December 31, 2005, as compared to operating income of $8.5 million for the year ended December 31, 2004, partially offset by an increase in the operating loss in the Company’s gift segment, from a loss of $32.8 million for

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the year ended December 31, 2004 to a loss of $42.1 million for the year ended December 31, 2005. The increase in operating income in the Company’s infant and juvenile segment was a result of the full year impact of Kids Line, acquired in December 2004. The increased operating loss in the Company’s gift segment was a result of lower net sales and a lower gross profit margin, partially offset by decreased selling, general and administrative expense.

Consolidated other income/(expense) was an expense of $14.9 million for the year ended December 31, 2005 compared to an expense of $1.4 million for the year ended December 31, 2004, an increase of $13.5 million. This increase in expense was primarily the result of (i) a decrease in investment income of $2.6 million due to lower investment balances and (ii) an increase of $14.8 million in interest expense in 2005, due to the financing for the Kids Line acquisition which was consummated on December 15, 2004, partially offset by an impairment charge in 2004 associated with a write-down to fair value of facilities held for disposal with no such comparable charge in 2005. See Note 2 of Notes to Consolidated Financial Statements.

The income tax provision in 2005 was $12.2 million as compared to an income tax benefit of $5.4 million in 2004. The income tax provision in 2005 was the result of the Company increasing the valuation allowance on its deferred tax assets by $13.8 million, partially offset by a reduction in the Company’s reserve for tax exposures of $1.8 million. During 2005 and 2004, the Company repatriated earnings from its foreign subsidiaries which were offset by losses from operations, the Section 965 Dividends Received Deduction, and foreign tax credits.

As a result of the foregoing, consolidated net loss for the year ended December 31, 2005 was $35.1 million, or $1.69 per diluted share, compared to consolidated net loss of $20.0 million, or $0.96 per diluted share, for the year ended December 31, 2004. See Note 15 of Notes to Consolidated Financial Statements.

Fiscal year ended December 31, 2004 compared to fiscal year ended December 31, 2003

The Company’s consolidated net sales for the year ended December 31, 2004 decreased 19.3% to $266.0 million compared to $330.0 million for the year ended December 31, 2003. The net sales decline was primarily attributable to the Company’s gift segment, as described below. The Company’s infant and juvenile segment’s net sales increased 13.7% for the year ended December 31, 2004. Such segment’s net sales included two weeks of Kids Line, LLC net sales (discussed below), as compared to the year ended December 31, 2003.

 The Company’s gift segment’s net sales for the year ended December 31, 2004 decreased 24.3% to $203.9 million compared to $269.3 million for the year ended December 31, 2003, primarily as a result of the factors discussed in the “Overview” above. Net sales in the Company’s gift segment benefited from foreign exchange rates by approximately $7.5 million for the year ended December 31, 2004. The Company’s infant and juvenile segment net sales for the year ended December 31, 2004 increased 13.7% to $57.2 million compared to $50.3 million for the year ended December 31, 2003. Infant and juvenile sales were positively affected by approximately $3.0 million by the purchase of Kids Line, LLC as of December 15, 2004. Non-core sales for the year ended December 31, 2004 were $4.9 million compared to $10.0 million for the year December 31, 2003, primarily as a result of the sale of Bright of America, Inc. effective August 2, 2004.

Consolidated gross profit was 41.6% of consolidated net sales for the year ended December 31, 2004 as compared to 53.1% of consolidated net sales for the year ended December 31, 2003. The erosion in the consolidated gross profit percentage is primarily due to a significant inventory write-down (as discussed below) and competitive pricing pressure in the gift segment. In response to strategic changes in product direction made in June 2004 under its recently appointed CEO, the Company undertook a comprehensive review of its worldwide inventory during the second quarter. As a result of this review, an additional inventory write-down of $13 million (pre tax) was recorded in the second quarter to reflect excess inventory in the gift segment at the lower of its cost or market value. The Company sold substantially all of this inventory through other than its normal sales channels. See “Overview” above and Note 6 to the Notes to Consolidated Financial Statements for a discussion of the additional inventory write-down. Gross profit for the Company’s gift segment was 43.7% of net sales for such segment for the year ended December 31, 2004 as compared to 57.1% of net sales for the year ended December 31, 2003 as a result of the forgoing. Gross profit for the Company’s infant and juvenile segment was 34.1% of net sales for such segment for the year ended December 31, 2004 as compared to 34.6% of net sales for the year ended December 31, 2003. Gross profit for the Company’s non-core segment was 40.2% of net sales for such segment for the year ended December 31, 2004 as compared to 39.3% of net sales for the year ended December 31, 2003.

Consolidated selling, general and administrative expense was $134.5 million, or 50.6% of consolidated net sales, for the year ended December 31, 2004 compared to $132.7 million, or 40.3% of consolidated net sales, for the year

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ended December 31, 2003. This increase in consolidated selling, general and administrative expense is due primarily to a $4.9 million increase in restructuring expenses in 2004 compared to 2003 as described in Note 10 of Notes to Consolidated Financial Statements and the “Overview” above, unfavorable exchange rate variances of $3.9 million, costs associated with the Company’s tender offer for outstanding plan options of $0.9 million (See Notes 10 and 19 of Notes to Consolidated Financial Statements and “Liquidity and Capital Resources” below) and costs associated with the Company’s Sarbanes-Oxley Section 404 compliance efforts of $1.7 million, partially offset by lower selling costs of $3.6 million, lower system implementation costs of $1.1 million and  the fact that there were no Troll litigation settlement costs in 2004 as compared to $2.9 million expensed in connection therewith in 2003.

Consolidated other expense/(income) was an expense of $1.4 million for the year ended December 31, 2004 compared to income of $6.1 million for the year ended December 31, 2003, a decrease of $7.6 million. This decrease was primarily the result of lower investment income due to lower investment balances and the losses associated with a write-down of facilities to fair value at the Company’s offices in Hong Kong and the United Kingdom, for the year ended December 31, 2004 as compared to the year ended December 31, 2003 in the Company’s gift segment. See Note 2 of Notes to Consolidated Financial Statements.

The consolidated (benefit)/provision for income taxes as a percent of income before taxes for the year ended December 31, 2004 was a (21.1%) benefit compared to a 28.3% expense for the year ended December 31, 2003. The decrease in the effective rate reflects the Company’s lower taxes on foreign dividend remittances, tax associated with the limitations on the deductibility of anticipated losses related to foreign real estate transactions, partially offset somewhat by lower relative tax-exempt interest income and charitable contributions.

As a result of the foregoing, consolidated net loss for the year ended December 31, 2004 was $20.0 million compared to consolidated net income of $34.7 million for the year ended December 31, 2003, representing a decrease of $54.7 million and a decrease of $2.64 per diluted share. See Note 15 of Notes to Consolidated Financial Statements.

Liquidity and Capital Resources

The Company’s principal sources of liquidity are cash and cash equivalents, funds from operations, and availability under its bank facilities. The Company believes that it will be able to fund its capital requirements for 2006 from such sources. In addition, subject to the discussion below under “Kids Line and Related Financing” with respect to the Earnout Consideration and the Company’s continued compliance with the financial covenants included in its 2006 Credit Agreements (defined below), the Company believes that cash flows from operations and future borrowings will be sufficient to fund its operating needs for at least the next 12 months.

As of December 31, 2005, the Company had cash and cash equivalents of $28.7 million compared to $48.1 million at December 31, 2004. This reduction of $19.4 million was primarily the result of the repayment of debt, partially offset by proceeds from the sale of receivables in the UK during the fourth quarter of 2005, the sale-leaseback of the Company’s Canadian facility, proceeds from a tax refund, proceeds from the sale of assets held for disposal as of December 31, 2004 and collections of accounts receivable. As of December 31, 2005 and December 31, 2004, working capital was $71.1 million and $119.3 million, respectively. This decrease of $48.2 million was primarily the result of a decrease in cash for the aforementioned reasons as well as a decrease in accounts receivable of $22.4 million in 2005 and an increase in short-term debt to $34.5 million as of December 31, 2005 from $25.3 million as of December 31, 2004.

Cash and cash equivalents decreased by $19.4 million during the twelve months ended December 31, 2005 compared to a decrease of $33.4 million during the twelve months ended December 31, 2004, primarily as a result of the factors described in the preceding paragraph. Net cash provided by operating activities was approximately $20.6 million for the year ended December 31, 2005, as compared to net cash used by operating activities of approximately $4.4 million during the year ended December 31, 2004. This increase of $25.0 million was due primarily to the higher net loss in 2005 compared to 2004, offset by reduced restricted cash requirements under the 2005 Credit Agreement and a decrease in the Company’s deferred income taxes. Net cash provided by investing activities was approximately $15.1 million for the year ended December 31, 2005, compared to net cash provided by investing activities of approximately $14.0 million for the year ended December 31, 2004. This increase of approximately $1.1 million was due primarily to the proceeds in the year ended December 31, 2005 from the sale and leaseback of the Company’s Canadian office and distribution center and from the sale of assets held for disposal as of December 31, 2004, offset in part by proceeds from the sale of marketable securities offset by the purchase of Kids Line LLC in the year ended December 31, 2004. Net cash used in financing activities was approximately

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$54.3 million for the year ended December 31, 2005, compared to net cash used of $47.2 million for the year ended December 31, 2004. The increase in net cash used in financing activities of approximately $7.1 million was due primarily to a reduction in long-term debt in 2005 offset in part by proceeds from long term debt offset by dividends paid to shareholders in the year ended December 31, 2004.

During the year ended December 31, 2005, the Company paid approximately $2.5 million for income taxes. The Company currently expects that its cash flows will exceed any income tax payments during 2005.

Kids Line and Related Financing

The Company purchased all of the outstanding equity interests and warrants in Kids Line (the “Purchase”) in accordance with the terms and provisions of a Membership Interest Purchase Agreement (the “Purchase Agreement”) executed as of December 15, 2004. At closing, the Company paid approximately $130.5 million, which represented the portion of the purchase price due at closing plus various transaction costs. The aggregate purchase price under the Purchase Agreement, however, also includes the potential payment of the Earnout Consideration, which is defined as 11.724% of the Agreed Enterprise Value of Kids Line as of the last day of the three year period ending November 30, 2007 (the “Measurement Period”). The Earnout Consideration shall be paid as provided in the Purchase Agreement (approximately the third anniversary of the Closing Date). The “Agreed Enterprise Value” shall be the product of (i) Kids Line’s EBITDA during the twelve (12) months ending on the last day of the Measurement Period and (ii) the applicable multiple (ranging from zero to eight) as set forth in the Purchase Agreement. The amount of the Earnout Consideration will be charged to goodwill if and when it is earned. Because the amount payable with respect to the Earnout Consideration, if any, and the Company’s financial condition at the time any such payment is due are not currently determinable, the Company cannot assure that payment of the Earnout Consideration will not have a material impact on the Company’s liquidity.

The Kids Line acquisition was financed with the proceeds of a term loan (the “Financing Agreement”), which is described in further detail in the Current Report on Form 8-K filed by the Company with the SEC on December 22, 2004. The Financing Agreement was subsequently replaced by the 2005 Credit Agreement and the 2005 Canadian Credit Agreement (as defined below), which are described in further detail in Note 8 of Notes to Consolidated Financial Statements and in the Current Report on Form 8-K filed by the Company with the SEC on July 5, 2005. On October 11, 2005, the Company and its lenders amended certain provisions of the 2005 Credit Agreement unrelated to the financial covenants contained therein. As of December 31, 2005, the Company was not in compliance with the “Total Debt to EBITDA Ratio” covenant in the 2005 Credit Agreement.

In order to reduce overall interest expense and gain increased flexibility with respect to the financial covenant structure of the Company’s senior bank financing, on March 14, 2006, the 2005 Credit Agreement was terminated and the obligations thereunder were refinanced (the “LaSalle Refinancing”). For a detailed description of the 2006 Credit Agreements, which are defined and summarized below, see Note 8 of Notes to Consolidated Financial Statements and the Company’s Current Report on Form 8-K filed with the SEC on March 17, 2006. On March 14, 2006, in connection with the LaSalle Refinancing, all outstanding obligations under the 2005 Credit Agreement (approximately $76.3 million) were repaid using proceeds from the Infantline Credit Agreement (defined below). The Company paid a fee of approximately $1.3 million in connection with the early termination of the 2005 Credit Agreement, which had been scheduled to mature on June 28, 2010. In addition, the Company will write-off, in the first quarter of 2006, approximately $2.5 million in deferred financing costs in connection with the LaSalle Refinancing.

As part of the LaSalle Refinancing, the Company formed a wholly-owned Delaware subsidiary, Russ Berrie U.S. Gift, Inc. (“Newco”), to which it assigned (the “Assignment”) substantially all of its assets and liabilities which pertain primarily to its domestic gift business, such that separate loan facilities could be made directly available to each of the Company’s domestic gift business and infant and juvenile business, respectively. The Assignment transaction reinforces the operation of the Company as two separate segments, and the credit facilities that have been extended to each segment are separate and distinct. There are no cross-default provisions between the new Infantline Credit Agreement and Giftline Credit Agreement (described below).

Infantline Credit Agreement. Accordingly, on March 14, 2006, Kids Line and Sassy (the “Infantline Borrowers”), entered into a credit agreement as borrowers, on a joint and several basis, with LaSalle Bank National Association as administrative agent and arranger (the “Agent”), the lenders from time to time party thereto, the Company as loan party representative, Sovereign Bank as syndication agent, and Bank of America, N.A. as documentation agent (the

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“Infantline Credit Agreement”). The commitments under the Infantline Credit Agreement consist of (a) a $35.0 million revolving credit facility (the “Revolving Loan”), with a subfacility for letters of credit in an amount not to exceed $5.0 million, and (b) a $60.0 million term loan facility (the “Term Loan”). The Infantline Borrowers drew down approximately $79.7 million under the Infantline Credit Agreement on the Closing Date, including the full amount of the Term Loan, which reflects the payoff of all amounts outstanding under the 2005 Credit Agreement and certain fees and expenses associated with the LaSalle Refinancing. The Infantline loans will bear interest at a rate per annum equal to the Base Rate (for Base Rate Loans) or the LIBOR Rate (for LIBOR Loans) plus an applicable margin, in accordance with a pricing grid based on the most recent quarter-end Total Debt to EBITDA Ratio, which applicable margin shall range from 1.75% - 2.50% for LIBOR Loans and from 0.25% - 1.00% for Base Rate Loans.

The principal of the Term Loan under the Infantline Credit Agreement must be repaid in installments as follows: (a) $750,000 on the last day of each calendar month for the period commencing March 2006 through and including February 2008, (b) $1 million on the last day of each calendar month for the period commencing March 2008 through and including February 2009, (c) $1.25 million on the last day of each calendar month for the period commencing March 2009 through and including February 2011. A final installment in the aggregate amount of the unpaid principal balance of the Term Loan (in addition to all outstanding amounts under the Revolving Loan) is due and payable on March 14, 2011, in each case subject to earlier termination in accordance with the terms of the Infantline Credit Agreement.

The Infantline Credit Agreement contains customary affirmative and negative covenants, as well as the following financial covenants:  (i) a minimum EBITDA test, (ii) a minimum Fixed Charge Coverage Ratio, (iii) a maximum Total Debt to EBITDA Ratio and (iv) an annual capital expenditure limitation.

Giftline Credit Agreement. Also on March 14, 2006 (as amended on April 11, 2006 to clarify the application of a financial covenant), Newco and other specified wholly-owned domestic subsidiaries of the Company (collectively, the Giftline Borrowers”), entered into a credit agreement as borrowers, on a joint and several basis, with LaSalle Bank National Association, as issuing bank (the “Issuing Bank”), LaSalle Business Credit, LLC as administrative agent (the “Administrative Agent”), the lenders from time to time party thereto, and the Company, as loan party representative (the “Giftline Credit Agreement” and, together with the Infantline Credit Agreement, the “2006 Credit Agreements”). The Giftline Credit Agreement contemplates the potential inclusion of additional lenders subsequent to the initial closing, and a simultaneous increase in the commitment, and the facility consists of a revolving credit loan commitment (a) before such commitment is increased, if at all, in an amount equal to the Borrowing Base minus amounts outstanding under the Canadian Credit Agreement (as defined below) and (b) after such commitment is increased, if at all, in an amount equal to the lesser of (i) $25.0 million and (ii) the then-current Borrowing Base, in each case minus amounts outstanding under the Canadian Credit Agreement (the “Giftline Revolver”), with a subfacility for letters of credit to be issued by the Issuing Bank in an amount not to exceed $8.0 million. The Borrowing Base is primarily a function of a percentage of eligible accounts receivable and eligible inventory and, as of March 14, 2006, the Borrowing Base was approximately $18.9 million. The Giftline Borrowers did not draw down on the Giftline Revolver on the Closing Date. The Giftline Revolver will bear interest at a rate per annum equal to the sum of the Base Rate (for Base Rate Loans) or the LIBOR Rate (for LIBOR Loans) plus a margin of 2.75% for LIBOR Loans and 1.25% for Base Rate Loans.

The Giftline Credit Agreement contains the following financial covenants:  (i) a minimum EBITDA test, (ii) a minimum Excess Revolving Loan Availability requirement of $5.0 million, (iii) an annual capital expenditure limitation and (iv) a minimum Fixed Charge Coverage Ratio (for quarters commencing with the quarter ending March 31, 2008). In addition, at any time after December 31, 2007 in respect of which the Fixed Charge Coverage Ratio for the Computation Period ending as of the Fiscal Quarter end most recently preceding such date was less than 1.00 to 1.00, the aggregate amounts outstanding under the Giftline Agreement and the Canadian Loan Agreement may not exceed $10.0 million.

As contemplated by the 2005 Credit Agreement, on June 28, 2005, the Company’s Canadian subsidiary, Amram’s Distributing Ltd. (“Amrams”), executed a separate Credit Agreement (acknowledged by the Company) with the financial institutions party thereto and LaSalle Business Credit, a division of ABN AMRO Bank, N.V., Canada Branch, a Canadian branch of a Netherlands bank, as issuing bank and administrative agent (the “Canadian Credit Agreement”), and related loan documents with respect to a maximum U.S. $10.0 million revolving loan (the “Canadian Revolving Loan”). Russ Berrie and Company, Inc. (“RB”), a corporate holding company, executed an unsecured Guarantee (the “Canadian Guarantee”) to guarantee the obligations of Amrams under the Canadian Credit

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Agreement. In connection with the LaSalle Refinancing, on March 14, 2006, the Canadian Credit Agreement was amended to (i) replace references to the 2005 Credit Agreement with the Giftline Credit Agreement (such that, among other conforming changes, a default under the Giftline Credit Agreement will be a default under the Canadian Credit Agreement), (ii) release the Company from the Canadian Guaranty and (iii) provide for a maximum U.S. $5 million revolving loan. In connection with the release of the Company from the Canadian Guaranty, Newco executed an unsecured Guarantee (the “Newco Guarantee”) to guarantee the obligations of Amrams under the Canadian Credit Agreement. A default under the Infantline Credit Agreement will not constitute a default under the Canadian Credit Agreement.

The Company believes that the lower interest rates that were extended to the Company’s subsidiaries in connection with the LaSalle Refinancing will enable the Company to reduce its aggregate interest expense, on a comparable basis, by approximately $2 million per year. However, because the 2006 Credit Agreements are extended directly to RB’s domestic subsidiaries, RB is dependent upon its operating subsidiaries to provide the cash necessary to enable the Company to fund its corporate overhead and other expenses.

The 2006 Credit Agreements restrict the ability of the Company’s domestic subsidiaries to distribute cash to RB for the purpose of paying dividends to the shareholders of the Company or for the purpose of satisfying the Company’s corporate overhead expenses. Subject to certain exceptions, the aggregate maximum amount that can be distributed by the Company’s domestic subsidiaries to RB to enable to pay corporate overhead expenses is $6.5 million for each of 2006 and 2007, and $7.0 million annually thereafter, with only $2.0 million of this amount permitted to be distributed by the Infantline Borrowers on an annualized basis. The Company believes that the amounts permitted to be distributed to it by its subsidiaries will be sufficient to fund its corporate overhead expenses, although there can be no assurance that such expenses will not exceed current estimates. There are no restrictions in the 2006 Credit Agreements on the ability of the Company’s foreign subsidiaries to distribute cash to the Company.

As a result of the LaSalle Refinancing, the obligation to pay the Earnout Consideration is no longer the obligation of RB, but the joint and several obligations of the Infantline Borrowers. With respect to the Earnout Consideration, the Infantline Borrowers will be permitted to pay all or a portion of the Earnout Consideration to the extent that, before and after giving effect to such payment, (i) Excess Revolving Loan Availability will equal or exceed $3.0 million and (ii) no violation of the Infantline Financial Covenants would then exist, or would, on a pro forma basis, result therefrom.

The Company’s ability to maintain compliance with the financial covenants under the 2006 Credit Agreements is dependent, particularly in the case of the Giftline Credit Agreement, upon the successful implementation of the restructuring plan and the PIP described under “Overview” above and current operational plans. Based on these plans and management’s current projections, the Company anticipates that it will remain in compliance with the financial covenants in the 2006 Credit Agreements at least through December 31, 2006. However, in the event that the Company is unable to successfully implement the key elements of the PIP, there can be no assurance that the Company will remain in compliance with such financial covenants, particularly the financial covenants in the Giftline Credit Agreement.

Other Events and Circumstances Pertaining to Liquidity

Although the Company has not yet completed the development of the PIP, the implementation of the PIP (portions of which are already underway in phases) will result in the recognition of certain significant restructuring charges and the incurrence of related severance obligations. See “Overview” above for a more detailed description of the PIP and the restructuring activities undertaken in 2005.

On December 30, 2005, Russ Berrie (U.K.) Limited (“Russ UK”) entered into a Framework Agreement (“the A/R Agreement”) with Barclays Bank PLC (“Barclays”), pursuant to which Russ UK sold to Barclays all existing and future accounts receivable created during the term of the A/R Agreement, subject to an aggregate maximum facility limit of £6.0 million (approximately $10.2 million) outstanding at any time. For each transaction, Barclays will advance to Russ UK 75% of the value of the eligible accounts receivable, subject to reduction under certain circumstances and applicable reserves, in advance of their due dates. The remaining portion of the accounts receivable sold, including the full amount of any receivables not eligible for advance, less fees and expenses owing to Barclays, is paid to Russ UK upon collection of the related receivable. The amount due from Barclays of approximately $4.9 million is included in prepaid expenses and other current assets as of December 31, 2005.

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The term of the A/R Agreement is one year with automatic renewals for additional one year periods unless either party provides advance notice of its intention to terminate. A one-time fee of £30,000 (approximately $50,000) was payable at closing and facility fees of £1,750 (approximately $3,000) are due monthly. The discount on the receivables sold is calculated monthly on the net advance balance at month end at the rate of Barclays’ base rate plus 1.5%.

As a condition of the A/R Agreement, Russ UK took out an insurance policy with respect to certain of the receivables naming Barclays as loss payee. In the event of a customer default, Barclays has only limited recourse to Russ UK and only under circumstances where Russ UK fails to perform its obligations in respect of a particular debt transferred, which obligations consist only of (i) providing evidence that Russ UK is not in breach of the relevant sales contract of the underlying debt and (ii) issuing a written demand for payment from the relevant account debtor.

On December 30, 2005, Russ UK sold net receivables outstanding pursuant to the A/R Agreement of approximately £6.7 million (approximately $11.5 million) and received a cash advance of approximately £3.8 million (approximately $6.5 million), consisting of 75% of the eligible accounts receivable sold, less approximately £1.2 million (approximately $2.1 million) due to the initial sales of receivables not eligible for advance.

Effective as of December 7, 2005, Amram’s entered into an agreement with Bentall Investment Management LP (“Bentall”) as purchaser (the “Sale-Leaseback Agreement”), pursuant to which Amram’s agreed to sell its principal facility located in Brampton, Ontario (Canada) (the “Facility”) to Bentall for an aggregate purchase price of $10.2 million Canadian dollars (approximately US $8.8 million), subject to customary adjustments (the “Sale”). The Sale closed on December 29, 2005. In accordance with the terms of the Sale-Leaseback Agreement, on the closing date, Amram’s entered into a lease agreement of approximately ten years at an annual net rental ranging over the term from approximately $737,498 Canadian dollars to $769,206 Canadian dollars (approximately U.S $632,773 to $659,979), payable monthly in advance, plus applicable taxes and defined operating costs (the “Amram’s Lease”). The Amram’s Lease is also subject to a management fee of 2% of the minimum annual rental, subject to adjustment as set forth therein. Amram’s has the option of extending the 10-year term for one additional term of 5 years, provided it is not then in default, at then-market rental rates. The gain on the Sale-Leaseback of approximately $4.0 million has been deferred and will be recognized as income over the term of the lease. See the Current Reports filed by the Company with the SEC on December 15, 2005 and December 30, 2005 for more information regarding this sale-leaseback transaction.

As disclosed under “Overview” above, during the fourth quarter of 2005, the Company recorded an additional inventory write-down of $4.2 million (pre-tax). The Company anticipates selling substantially all of this inventory through other than its normal sales channels.

Cash dividends of $2.1 million ($0.10 per share) were paid on April 21, 2005 to shareholders of record of the Company’s Common Stock on April 11, 2005. Cash dividends of $170.8 million ($0.30 per share per quarter plus $7.00 per share special dividend) were paid in the twelve months ended December 31, 2004. See Note 8 of Notes to Consolidated Financial Statement for a discussion of the restrictions on the Company’s ability to pay dividends as long as any obligations under the Credit Agreement remain outstanding. The Company currently does not anticipate paying any additional dividends at least through 2006.

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

The Company is dependent upon information technology systems in many aspects of its business. In 2002 the Company commenced a global implementation of an Enterprise Resource Planning (“ERP”) system for its gift businesses. During 2003 and continuing into 2004, certain of the Company’s international gift subsidiaries began to phase-in aspects of the new ERP system. In late 2005, the Company began to explore alternative global information technology systems for its gift business that could provide greater efficiencies, lower costs and greater reporting capabilities than those provided by the current ERP system. As a result of this review, all remaining international implementations were placed on hold pending a decision on whether or not to replace the current ERP system. The Company expects to make a decision on whether to replace its current ERP system in the first half of 2006.

In March 1990, the Board of Directors authorized the Company to repurchase an aggregate of up to 7,000,000 shares of common stock. As of December 31, 2005, 5,643,200 shares have been repurchased since the beginning of the Company’s stock repurchase program. The Company did not repurchase any shares pursuant to this program or otherwise during fiscal 2005.

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

Consistent with its past practices and in the normal course of its business, the Company regularly reviews acquisition opportunities of varying sizes. The Company may consider the use of debt or equity financing to fund potential acquisitions. The 2006 Credit Agreements impose restrictions on the Company that could limit its ability to respond to market conditions or to take advantage of acquisitions or other business opportunities.

The Company has entered into certain transactions with related parties which are disclosed in Note 16 of Notes to Consolidated Financial Statements and Item 13, “Certain Relationships and Related Transactions.”

Contractual Obligations

The following table summaries the Company’s significant known contractual obligations as of December 31, 2005 and the future periods in which such obligations are expected to be settled in cash (dollars in thousands):

(1)          See Note 17 of Notes to Consolidated Financial Statements.

(2)          The Company’s purchase obligations consist of purchase orders for inventory.

(3)          Reflects repayment obligations under the 2005 Credit Agreement, which was refinanced and terminated on March 14, 2006. Mandatory repayment obligations under the 2006 Credit Agreements are as follows (dollars in thousands): $7,500 in 2006; $9,000 in 2007; $11,500 in 2008; $14,500 in 2009; $15,000 in 2010; and $2,500 in 2011. See Note 8 of Notes to Consolidated Financial Statements for a description of (i) the 2005 Credit Agreement, effective from June 28, 2005 until its termination, including provisions that create, increase and/or accelerate obligations thereunder and (ii) the 2006 Credit Agreements, each effective March 14, 2006.

Off Balance Sheet Arrangements

Since 1983, the Company had been a guarantor of a loan agreement between the late Mr. Russell Berrie and the New Jersey Economic Development Authority (the “EDA”), which was entered into on December 1, 1983, pursuant to which the EDA issued its Economic Development Bonds in the principal amount of $7,000,000 (the “EDA Bonds”) to finance the construction of the South Brunswick, New Jersey facility now leased by the Company from the Estate of Mr. Russell Berrie, as described in further detail in Note 16 of the Notes to Consolidated Financial Statements. Such guarantee was not issued or modified after December 31, 2002. Mr. Berrie (and after his death, his Estate) was the primary obligor with respect to the EDA Bonds. In connection therewith, the Company, in 1983, caused the issuance of a letter of credit in an amount of approximately $7.4 million (and on March 14, 2006, caused the issuance of a back-stop letter of credit in the same amount) to secure the payment obligations with respect to the EDA Bonds and had granted a security interest on accounts receivable and inventory of the Company up to $2.0 million to secure its obligations under its guarantee and the Amended and Restated Letter of Credit Reimbursement Agreement (“L/C RA”) executed in connection therewith. On April 3, 2006, the Estate (with funds provided by Ms. Berrie) redeemed the EDA Bonds. As a result, the Company’s obligations under the guarantee discussed above (as well as the L/C RA, all letters of credit and related security interests) are in the process of being terminated. Further detail with respect to EDA matters can be found in the Company’s Current Report on Form 8-K filed on March 17, 2006.

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The Company has obligations under certain letters of credit that contingently require the Company to make payments to guaranteed parties upon the occurrence of specified events. See Note 8 of Notes to Consolidated Financial Statements for further descriptions of the Company’s letters of credit. There have not been any draws under any of the foregoing obligations, although there can be no assurance that no such draws will be required in the future.

In order to secure their respective obligations under the Infantline Credit Agreement and the Giftline Credit Agreement, (A) (i) the Infantline Borrowers have pledged and have granted security interests to the Agent in substantially all of their existing and future personal property, (ii) each Infantline Borrower has guaranteed the performance of the other Infantline Borrower, (iii) Sassy granted a mortgage for the benefit of the Agent and the lenders on its real property located at 2305 Breton Industrial Park Drive, S.E., Kentwood, Michigan and (iv) RB pledged 100% of the equity interests of each of the Infantline Borrowers to the Agent and (B) (i) the Giftline Borrowers pledged and have granted security interests to the Administrative Agent in substantially all of their existing and future personal property, (ii) each Giftline Borrower guaranteed the performance of the other Giftline Borrowers under the Giftline Credit Agreement and (iii) RB provided a limited recourse guaranty of the obligations of the Giftline Borrowers under the Giftline Credit Agreement, which guarantee is secured by a lien on the assets intended to be assigned to Newco pursuant to the Assignment. RB also pledged 100% of the equity interests of each of the Giftline Borrowers and 65% of its equity interests in certain of its First Tier Foreign Subsidiaries to the Administrative Agent. In addition, Newco provided the Newco Guarantee to guarantee the obligations of Amram’s under the Canadian Credit Agreement.

In addition, the Infantline Borrowers have agreed, on a joint and several basis, to assume sole responsibility to pay the Earnout Consideration in the place of the Company. To secure the obligations of the Infantline Borrowers to pay the Earnout Consideration, the Infantline Borrowers have granted a subordinated lien on substantially all of their assets, on a joint and several basis, and RB has granted a subordinated lien on the equity interests of each of the Infantline Borrowers to the Earnout Sellers’ Agent. All such security interests and liens are subordinated to the senior indebtedness of the Infantline Borrowers arising under the Infantline Credit Agreement. The Earnout Consideration is not secured by the Giftline Borrowers or their assets or equity interests.

Critical Accounting Policies

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

Management is required to make certain estimates and assumptions during the preparation of its consolidated financial statements that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Estimates and assumptions are reviewed periodically, and revisions made as determined to be necessary by management. The Company’s significant accounting estimates described below have historically been and are expected to remain reasonably accurate, but actual results could differ from those estimates under different assumptions or conditions.

Note 2 of Notes to Consolidated Financial Statements includes a summary of the significant accounting policies used in the preparation of the Company’s consolidated financial statements. The following, however, is a discussion of those accounting policies which management considers being “critical” within the SEC definition discussed above.

Accounts Receivable Allowances

In the normal course of business, the Company extends credit to customers which satisfy established credit criteria. The Company’s infant and juvenile segment sells to certain large customers, the loss of any one of which could have a material adverse affect on the Company and the infant and juvenile segment. Accounts receivable, trade, as shown on the Consolidated Balance Sheets, is net of allowances, discounts and estimated bad debts. An allowance for doubtful accounts is determined through analysis of the aging of accounts receivable at the date of the financial statements, assessments of collectibles based on historical trends and an evaluation of the impact of current and projected economic conditions. If such historical trends or economic conditions deteriorate the results could differ from the Company’s estimates.

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Revenue Recognition

The Company recognizes revenue when persuasive evidence of a sales arrangement exists, title and risk of loss has passed to its customers, the selling price is fixed and determinable, and collectability is reasonably assured.

Inventory Reserves

The Company values inventory at the lower of cost or estimated market value. The Company regularly reviews inventory quantities on hand, by item, and records a write-down of inventory to fair market value based primarily on the Company’s historical experience and estimated forecast of product demand using historical and recent ordering data relative to the quantity on hand for each item. See “Management’s Discussion and Analysis of Results of Operations and Financial Condition – Overview” for information regarding inventory valuation reserves.

Long-Lived Assets

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets”, long-lived assets, such as property, plant, and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset, which is generally based on discounted cash flows. If such actual future cash flows are less than the estimated future cash flows, certain of the Company’s long-lived assets could be impaired.

Goodwill and intangible assets not subject to amortization are tested annually for impairment, and are tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. Based on the Company’s annual test performed in 2005 there was no impairment, however, if actual future cash flows are less than the estimated future cash flows, the Company’s goodwill and intangible assets could be impaired.

The Company uses third party valuation specialists to assist in the valuation of intangible assets and their related estimated lives. The Company follows the provisions of SFAS No. 141 “Business Combinations” in determining whether an intangible asset has an indefinite life or is amortizable.

Accrued Liabilities and Deferred Tax Valuation Allowances

The preparation of the Company’s Consolidated Financial Statements in conformity with generally accepted accounting principles in the United States requires management to make certain estimates and assumptions that affect the reported amounts of liabilities and disclosure of contingent liabilities at the date of the financial statements. Such liabilities include, but are not limited to, accruals for various legal matters, tax accruals and valuation allowances for deferred tax assets. The settlement of the actual liabilities could differ from the estimates included in the Company’s consolidated financial statements. The Company’s valuation allowances for its deferred tax assets could change if the Company’s estimate of future taxable income changes.

Recently Issued Accounting Standards

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), “Share-Based Payment”, which establishes standards for transactions in which an entity exchanges its equity instruments for goods or services. This statement is a revision to SFAS 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”. SFAS No. 123(R) requires Companies to recognize an expense for compensation cost related to share-based payment arrangements including stock options and employee stock purchase plans, based on the grant-date fair value of the award. This Statement applies to all awards unvested or granted after the required effective date and to awards modified, repurchased, or cancelled after that date. SFAS No. 123(R) is effective as of the beginning of the first annual period beginning on or after June 15, 2005 (for the Company, the first quarter of 2006). The Company adopted SFAS No. 123(R) effective January 1, 2006, using the modified prospective method and expects that the impact, if any, will be immaterial to the Company’s financial position or results of operations.

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Forward-Looking Statements

This Annual Report on Form 10-K contains certain forward-looking statements. Additional written and oral forward-looking statements may be made by the Company from time to time in Securities and Exchange Commission (“SEC”) filings and otherwise. The Private Securities Litigation Reform Act of 1995 provides a safe-harbor for forward-looking statements. These statements may be identified by the use of forward-looking words or phrases including, but not limited to, “anticipate”, “project”, “believe”, “expect”, “intend”, “may”, “planned”, “potential”, “should”, “will” or “would”. The Company cautions readers that results predicted by forward-looking statements, including, without limitation, those relating to the Company’s future business prospects, revenues, working capital, liquidity, capital needs, interest costs and income are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements. Specific risks and uncertainties include, but are not limited to, those set forth under Item 1A, “Risk Factors.”

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to market risk primarily from changes in interest rates and foreign currency exchange rates.

Interest Rate Changes

Marketable Securities. At December 31, 2005 and 2004, a sensitivity analysis to measure potential changes in the market value of the Company’s investments in marketable securities from a change in interest rates is not applicable as the Company liquidated its entire portfolio of marketable securities during 2004.

Debt. The interest applicable to the loans under the 2005 Credit Agreement, as amended, is based upon the LIBOR Rate (as defined in the Credit Agreement) and LaSalle’s Base Rate. At December 31, 2005, a sensitivity analysis to measure potential changes in interest rates indicates that a one percentage point increase in interest rates would increase the Company’s interest expense by approximately $765,000. See Note 8 of Notes to Consolidated Financial Statements for a discussion of the interest rate applicable to the Company’s senior bank facilities.

Foreign Currency Exchange Rates

At December 31, 2005 and 2004, a sensitivity analysis to changes in the value of the U.S. dollar on foreign currency denominated derivatives and monetary assets and liabilities indicates that if the U.S. dollar uniformly weakened by 10% against all currency exposures, the Company’s loss before income taxes would increase by approximately $476,000 in 2005 and the Company’s loss before income taxes would increase by approximately $201,000 in 2004. Additional information required for this Item is included in the section above entitled “Liquidity and Capital Resources” of Item 7. Management’s Discussion and Analysis of Results of Operations and Financial Condition and Note 5 of Notes to Consolidated Financial Statements.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

1. Financial Statements:

Reports of Independent Registered Public Accounting Firm

Consolidated Balance Sheets at December 31, 2005 and 2004

Consolidated Statements of Operations for the years ended December 31, 2005, 2004 and 2003

Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2005, 2004 and 2003

Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003

Notes to Consolidated Financial Statements

2. Financial Statement Schedule:

Schedule II—Valuation and Qualifying Accounts

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Report of Independent Registered Public Accounting Firm

The Board of Directors

Russ Berrie and Company, Inc.:

We have audited the accompanying consolidated balance sheets of Russ Berrie and Company, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005. In connection with our audits of the consolidated financial statements, we also have audited the consolidated financial statement schedule, “Schedule II – Valuation and Qualifying Accounts.”   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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the 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, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Russ Berrie and Company, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related 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.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Russ Berrie and Company, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated April 18, 2006 expressed an unqualified opinion on management’s assessment of, and an adverse opinion on the effective operation of, internal control over financial reporting.

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Report of Independent Registered Public Accounting Firm

The Board of Directors

Russ Berrie and Company, Inc.:

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting (Item 9A.b.), that Russ Berrie and Company, Inc. (the Company) did not maintain effective internal control over financial reporting as of December 31, 2005, because of the effect of the material weakness identified in management’s assessment, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management’s assessment:  As of December 31, 2005, the Company did not maintain sufficient personnel resources with the requisite technical accounting and financial reporting expertise to: effect a timely financial closing process; sufficiently address non-routine and/or complex accounting issues that arise from time-to-time in the course of the Company’s operations; and effectively prepare timely account reconciliations and analyses. This lack of sufficient personnel resources with the requisite technical accounting and financial reporting expertise resulted in: material errors in the classification of long-term

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debt and income tax expense; errors in equity accounts, inter-company accounts, depreciation expense, inventory, and foreign currency transactions; and material omissions of dislosures in the Company’s preliminary 2005 consolidated financial statements. This material weakness also results in more than a remote likelihood that material misstatements to the Company’s annual or interim consolidated financial statements would not be prevented or detected.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Russ Berrie and Company, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005. The aforementioned material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2005 consolidated financial statements, and this report does not affect our report dated April 18, 2006, which expressed an unqualified opinion on those consolidated financial statements.

In our opinion, management’s assessment that the Company did not maintain effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

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RUSS BERRIE AND COMPANY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2005 and 2004
(Dollars in Thousands)

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

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RUSS BERRIE AND COMPANY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2005, 2004 and 2003
(Dollars in Thousands, Except Per Share Data)

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

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RUSS BERRIE AND COMPANY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2005, 2004 and 2003

(Dollars in Thousands)