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

_________________

FORM 10-K

Commission file number 1-11908

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

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

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 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   x     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 an accelerated filer (as defined in Rule 12b-2 of the Act).      Yes   x     No   o

The aggregate market value of the voting and non-voting stock held by non-affiliates of the registrant as of July 2, 2004 was $175,024,685 (based on the closing price of consolidated trading in the Common Stock on July 2, 2004, being the last trading day of the registrant’s most recently completed second fiscal quarter). For purposes of this computation, shares held by affiliates and by directors and officers of the registrant have been excluded. Such exclusion of shares held by directors and officers is not intended, nor shall it be deemed, to be an admission that such persons are affiliates of the registrant.

Number of Shares of Common Stock, par value $.01 per share, outstanding as of March 8, 2005: 13,753,634.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company’s definitive Proxy Statement for the 2005 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K (the “2005 Proxy Statement”) are incorporated by reference in Part III.

ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

PART I

ITEM 1.   BUSINESS

General:

Department 56, Inc. and its subsidiaries (Department 56 or the Company) is a leading designer, distributor, wholesaler and retailer of fine quality collectibles and other giftware products sold through gift, home accessory and specialty retailers, department stores, and general merchandise chains, as well as through its own stores and consumer-direct home show sales business. The Company is best known for its Village Series of collectible, handcrafted, lighted ceramic and porcelain houses, buildings and related accessories in The Original Snow Village^® Collection and other Village Series as well as its extensive line of holiday, special occasion and home decorative products, including its Snowbabies™ collectible porcelain figurines. The Company’s principal executive offices are located at One Village Place, 6436 City West Parkway, Eden Prairie, MN, 55344. The Company’s telephone number is (952) 944-5600.

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

The Company seeks to grow and acquire businesses that reinforce synergies, allowing it to complement its internal product development and accelerating its penetration into new markets and new channels. Since the second quarter of fiscal year 2002, the Company has operated its Time to Celebrate™ direct selling business that reaches consumers through a network of independent sales consultants to sell giftware and home decorative products through the home show sales method. Also since 2002, the Company has sold its differentiated Village and giftware products, which were developed and distributed for the unique needs of select general merchandise chains and select specialty retail chains. The Company tailors its products, designs, packaging and prices to satisfy the varying demands of customers and consumers within each distribution channel. This focused, multi-faceted strategy is intended to position Department 56 as the premier giftware and collectibles company for the future.

The Company has two reportable segments – wholesale and retail. Although the product produced and sold for each segment is similar, the type of customer for the product and the method used to distribute the product are different. The segmentation of these operations also reflects how the Company’s chief executive officer currently reviews the results of these operations. See Note 10 within the Notes to Consolidated Financial Statements beginning on page F-19.

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

The Company makes its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, available free of charge through a direct link to the SEC on the Company’s website www.department56.com, as soon as is reasonably practicable after such material is electronically filed with or furnished to the SEC. In addition, each of the key standing committees of the Board of Directors has a charter that sets forth the committee’s role and responsibilities. All of those charters, the Company’s Corporate Governance Guidelines and the Company’s Code of Ethics and Business Conduct are available on the Company’s website and are available in print by written request directed to Corporate Secretary – Department 56, Inc., One Village Place, 6436 City West Parkway, Eden Prairie, MN 55344. The information on the Company’s website is not incorporated by reference into this annual report.

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

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Disposition of Geppeddo Seasonal Kiosk Operations:

During 2001, the Company acquired the net assets of Axis Corporation, a privately held designer, importer and specialty retailer based in Salt Lake City, Utah. The acquired business sold dolls and doll accessories under the brand name of Geppeddo® at kiosks located in major shopping centers throughout the United States during the peak holiday shopping season. The original strategy behind the Geppeddo acquisition was to give the Company additional differentiated and branded products and access to a new channel of distribution. However, since the acquisition, the demand for porcelain dolls declined substantially. This softening combined with significantly reduced traffic at the kiosks resulted in a business model that the Company did not believe could be profitable going forward. As a result, in December 2003, the Company committed to a plan to cease operations of Geppeddo.

In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company recorded Geppeddo’s results in continuing operations in 2003 and 2004 until the run-off of operations was completed in the second quarter of 2004. Upon completion of the run-off, the Geppeddo results were reclassified into discontinued operations for all periods presented. Additional information regarding the disposition of the Geppeddo seasonal kiosk operations is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations beginning on page 11 and Note 2 within the Notes to Consolidated Financial Statements beginning on page F-14.

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

Wholesale Operations:

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

The Company’s domestic wholesale operations serve an extensive base of retailers, primarily consisting of approximately 12,500 independent gift retailers across the U.S. and Canada who account for approximately 85% of the Company’s wholesale sales (the Company refers to this portion of its customer base as its “Gift and Specialty” channel). Approximately 4,110 of the Company’s principal wholesale customers receive the Company’s Village Series and/or Snowbabies products (which the Company sometimes refers to as its “collectible” products and/or lines). These retailers include approximately 1,210 independently owned Club 56^SM, Gold Key^SM and Showcase^SM Dealers, who receive special recognition and qualify for improved sales terms by satisfying certain volume, merchandising and/or promotional requirements. Approximately 12% of the Company’s wholesale sales are made to department stores, select general merchandise chains, and mail order houses. No single account represented more than 2% of the Company’s wholesale sales in fiscal 2004. The Company provides volume discounts to its customers on most of its products. The Company has generally had only limited sales outside the United States. International wholesale sales, which are made primarily in Canada, were approximately 4% of the Company’s wholesale sales in fiscal 2004.

Over the past five years, the Company’s principal wholesale customers have decreased in number by approximately 5,075, or 29%. Similarly, customers who sell the Company’s Village Series and/or Snowbabies products have decreased over the same period by approximately 2,220, or 35%. The Company believes the decrease in customers and related decrease in sales since 1999 is a result of the overall weakness of the Gift and Specialty channel. The Company has enacted programs to curb the decline in customers and wholesale sales experienced over the past four years including implementing new customer ordering and shipping programs, strengthening its sales organization, refining its product development process, broadening the seasonal coverage of its product lines, and pursuing alternative channels of retail distribution. Management believes that some customer attrition is likely to continue within its core Gift and Specialty channel. The Company plans to continue to seek complementary retailers and to offer differentiated product to select general merchandise retail chains in order to augment revenue and to introduce more new consumers to the Company’s products.

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

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

Retail Operations:

The Company sells its products to consumers through its retail operations, which in 2004 included six retail stores located in tourist destinations at Mall of America^®, outside Minneapolis, Minnesota; Aladdin Hotel and Casino^® in Las Vegas, Nevada; Downtown Disney^® in Anaheim, California; Water Tower Place^® in Chicago, Illinois; Florida Mall^® in Orlando, Florida; and Pier 39® in San Francisco, California, which opened in June 2004.

The Company’s direct selling business, Time to Celebrate has been in operation since the second quarter of 2002. Independent Time to Celebrate sales consultants, known as Celebration Specialists, who are not agents or employees of the Company, market and distribute giftware and home decorative products to their customers principally through the home show method of direct sales. A Celebration Specialist contacts consumers, selling primarily at home-based shows using seasonal brochures and product samples. The Celebration Specialist collects payment from the consumer at the time the consumer’s order is submitted. Celebration Specialists have access to a web-based consultant care tool, allowing them to preview products, policies and procedures and to place and make payment against their orders. Orders are processed and the products are then delivered to the home show host. The host then handles delivery of the merchandise to the consumer. The Celebration Specialists are the customers of Time to Celebrate and the Company generally has no transaction or arrangement with any end user of its product beyond the consultant. Celebration Specialists are responsible for payment to the Company upon or prior to shipment, whether or not the products are delivered to an end user.

Typical characteristics of companies engaged in direct sales include a high rate of turnover among sales consultants, and a positive correlation between the number of sales consultants and revenue. For these reasons, the recruiting and training of new Time to Celebrate Celebration Specialists is expected to be continually necessary. The two primary means of obtaining new Celebration Specialists is by recruiting people who are themselves experienced with the home show sales format and through personal contacts resulting from home show activity. All of the Celebration Specialists earn a margin on their own sales and are eligible to receive bonuses from sales by Celebration Specialists they have recruited. This rewards program and development of sales leadership is an essential part of Time to Celebrate’s long-term growth strategy. At the end of 2004, there were approximately 1,000 Time to Celebrate independent Celebration Specialists located in 47 states and 19 located in Canada.

Products:

Village Series Products – Department 56 is best known for its Village Series, which includes several different series of collectible, handcrafted, lighted ceramic and porcelain houses, buildings and related accessories that depict nostalgic scenes. The Company introduces new pieces, limited edition pieces, figurines and other accessories each year to complement and provide continuity to the collections. To allow for these new introductions and to keep each series appropriately balanced, the Company has traditionally retired a number of its existing pieces from production each year. Retirement decisions are based on management’s judgment as to, among other things, expected consumer demand, whether a piece continues to fit the evolving design characteristics of a series, manufacturing considerations and, importantly, injecting an element of surprise. The Company also introduces new lighted pieces and accessories for a variety of holidays and special days, including Halloween, St. Patrick’s Day, Easter, Valentine’s Day and Fourth of July. The Company will continue to consider the introduction of new lighted pieces and accessories for other holidays and special day themes. In December 2004, the Company introduced Long-Life Cordless Lighting, a battery-powered lighting mechanism for selected Village buildings manufactured to hold the battery housing. It allows consumers to more effectively display their lighted buildings in a variety of venues such as tabletop centerpieces.

Giftware – The Company offers a wide range of other decorative giftware and home accessory items including the Company’s Snowbabies figurines; holiday and seasonal decorative items; as well as tableware. Giftware product lines are product lines developed around either a seasonal or unique design theme. The Company generally introduces new products and refines its product offerings twice a year. The Company currently maintains an aggregate of approximately 5,200 stock keeping units, of which approximately 4,500 are Giftware products. The Company continues to build its general Giftware business by developing new product lines and signing license agreements with nationally-recognized artists.

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Design and Production:

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

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

Department 56 believes that its relationships with its manufacturers, and the quality of their craftsmanship, provide a competitive advantage and are a significant contributor to the Company’s success. The Company imports most of its products from the Pacific Rim, primarily the People’s Republic of China and the Philippines. The Company also imports a small percentage of its products from India and Europe. During fiscal 2004, the Company imported products from approximately 150 independent manufacturing sources, some of which are represented by independent trading companies. The Company’s single largest manufacturing source represented approximately 30% of the Company’s imports in fiscal 2004. The Company’s emphasis on high-quality craftsmanship at affordable prices limits the sources from which the Company chooses to obtain products. The Company has long-standing relationships with the majority of its manufacturers (several for 20 years or more) and may purchase, typically on a year-to-year basis, a substantial portion of a manufacturer’s entire annual output. As a result of these relationships, the Company has experienced a low turnover of its manufacturing sources.

Distribution and Systems:

The products sold by the Company to its company-owned retail stores, its retail customers, and the Time to Celebrate Celebration Specialists in the U.S. are generally shipped by ocean freight from abroad and then by rail to the Company’s distribution center located in the Minneapolis/St. Paul metropolitan area. Certain shipments to some retail customers are sent directly to those customers. Shipments from the Company to its wholesale customers and Time to Celebrate Celebration Specialists are handled primarily by parcel post or commercial trucking lines.

The Company’s systems maintain order processing from the time a product enters the Company’s system through shipping and ultimate payment collection from its wholesale customers and Time to Celebrate Celebration Specialists. The Company also uses handheld optical scanners and bar coded labels in accepting orders at wholesale showrooms and in the field throughout the U.S. and Canada. These systems also provide a range of order and product information and ordering capabilities to customers subscribing to its WIN business-to-business site and to Time to Celebrate Celebration Specialists.

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

Backlog and Seasonality:

The Company receives products, pays its suppliers and ships products throughout the year, although historically the majority of shipments have occurred in the second and third quarters of each year as retailers stock merchandise in anticipation of the winter holiday season. The Company continues to ship wholesale merchandise until mid-December each year. Accordingly, the Company’s wholesale backlog typically is lowest at the beginning of January. As of January 1, 2005, Department 56 had unfilled wholesale orders of approximately $3.2 million compared to $3.5 million at January 3, 2004. The entire backlog is scheduled to be shipped to customers during the 2005 fiscal year. Approximately 7% to 8% of the Company’s total annual wholesale customer orders have been cancelled in each of the last three years for a number of reasons, primarily customer credit considerations and inventory stock-outs.

Historically, due to the timing of wholesale trade shows early in the calendar year, the Company has received the majority of its total annual wholesale customer orders during the first quarter of each year. During the first quarter of each of the past three years, the Company has received approximately 63% to 67% of its annual wholesale orders for such years. The Company can experience fluctuations in quarterly sales due to the timing of receipt of product from suppliers and

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subsequent shipment of product from the Company to customers, as well as the timing of orders placed by customers. As a result of the Company’s sales pattern, the Company has historically recorded a substantial portion of its wholesale revenues in its second and third quarters, and the majority of its store-based retail and Time to Celebrate sales occur in the fourth quarter during the peak holiday shopping season.

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

Trademarks and Other Proprietary Rights:

The Company owns 44 U.S. trademark registrations and has pending U.S. trademark applications with respect to certain of its logos and brand names. In addition, the Company maintains selected trademarks in certain foreign countries.

Department 56 regards its trademarks and other proprietary rights as valuable assets and intends to maintain its trademarks and their registrations and vigorously defend against infringement. The U.S. registrations for the Company’s trademarks are currently scheduled to be cancelled at various times between 2005 and 2015 but can be maintained and renewed provided that the marks are still in use for the goods and services covered by such registrations. The Company has historically renewed its registered trademarks and expects to continue to renew them as business needs dictate.

Competition:

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

Imports:

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

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

Fluctuations in currency exchange also present risk inherent in the Company’s method for inventory procurement. The Company’s costs could be adversely affected if the currencies of other countries in which the Company sources product appreciate significantly relative to the U.S. dollar; this could result, for example, from a decision by China to allow its currency to float instead of being pegged to the U.S. dollar at a fixed rate.

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

In fiscal 2004, approximately 90% of the Company’s imports were manufactured in China, and the Company anticipates that such percentage will hold constant or increase for the foreseeable future. China has joined the World Trade Organization and been accorded permanent “Normal Trade Relations” status by the U.S. government. However, various commercial and legal practices widespread in China, including the handling of intellectual properties and certain labor practices, as well as certain political and military actions taken or suggested by China, are under review by the U.S. government. China, moreover, has been designated a Country of Particular Concern (CPC) pursuant to the International Religious Freedom Act of 1998 (IRFA). The IRFA enumerates several specific retaliatory actions that may be taken by the U.S. government, none of which the Company believes would have a material impact on its business. The IRFA, however, also accords the President broad discretion in fashioning other or additional actions and, due to the breadth of the presidential powers under the IRFA, the Company is unable to predict what, if any, action the President could take in the future.

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

Employees:

As of February 11, 2005, the Company had 303 full-time employees in the U.S., three in Canada and one in Hong Kong. Of the total workforce, approximately 47 are engaged in wholesale sales representation throughout North America and 86 are associated with the Company’s retail operations. Local Union No. 638 of the Teamsters Union represents 61 of the Company’s U.S.-based warehouse, shipping and receiving personnel under a contract that expires on December 31, 2007. The Company believes that its labor relations are good and has never experienced a work stoppage.

Executive Officers of the Registrant:

Susan E. Engel, 58, has been Chairwoman of the Board of the Company and of D 56, Inc. (the Company’s principal operating subsidiary) since September 18, 1997 and a director of the Company since February 1996. She has been Chief Executive Officer of the Company and of D 56, Inc. since November 13, 1996, and was president and Chief Operating Officer from 1994 to 1996. From 1991 until joining the Company, she was president and CEO of Champion Products, Inc., the athletic apparel division of Sara Lee Corporation. From 1977 until 1991, she was a vice president with Booz, Allen and Hamilton, heading up that company’s eastern retail practice group. She is a public company director of Wells Fargo & Company and SuperValu, Inc. She is Board President of the Guthrie Theater in Minneapolis and serves on the boards of the Minnesota Women’s Campaign Fund and the Board of Overseers of the Carlson School of Management at the University of Minnesota. She is also a member of the President’s Council of Cornell Women at Cornell University and on the Board of Advisors of the Minneapolis League of Women Voters.

Elise M. Linehan, 43, has been Executive Vice President — Product Development and Retail of the Company and D 56, Inc. since December 16, 2003. She was Senior Vice President — Retail Stores of the Company and of D 56, Inc. from January 27, 2002 to December 16, 2003. She was Vice President — Marketing of the Company and of D 56, Inc. from June 28, 2001 to January 27, 2002. She was Managing Director of Product Marketing of the Company and of D 56, Inc. from September 10, 1999 to June 28, 2001. She was Director of Product Marketing of the Company and of D 56, Inc. from July 1, 1998 until September 10, 1999.

Andrew E. Melville, 44, has been Executive Vice President — Customer Development and Time to Celebrate for the Company and D 56, Inc. since December 16, 2003. He was Executive Vice President — Sales of the Company and of D 56, Inc. from May 8, 2002 to December 16, 2003. He was Senior Vice President — Sales of the Company and of D 56, Inc. from October 11, 1999 until May 8, 2002. He was Vice President of Sales and Trade Marketing at Walt Disney Records from January 1998 to October 1999.

Michael J. Rothmeier, 55, has been Executive Vice President — Marketing and Corporate Strategy of the Company and of D 56, Inc. since March 22, 2004. From 1999 until March 22, 2004 he was a business consultant. From 1997 until 1999 he was a Senior Vice President and Relationship Manager with Bronner Slosberg Humphrey, a professional marketing

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services company. Prior to that time he held a number of executive positions with IDS Financial Services, Inc. (1984-1989), Fidelity Investments (1989-1992), and Fleet Financial Group/Shawmut National Corp (1992-1996). In April 2000 he agreed to settle charges brought by the SEC alleging violations of the Investment Advisers Act of 1940 pursuant to which settlement he neither admitted or denied the finding of any violations and received a nine months’ suspension from association with any investment adviser.

David H. Royer, 45, has been Vice President — Sales of the Company and of D 56, Inc. since December 16, 2003. He was Vice President — Sales Planning and Development of the Company and of D 56, Inc. from February 18, 2002 until December 16, 2003. Mr. Royer was Vice President of Sales Development at Frito-Lay, Inc. from March 2001 to February 2002. Prior to then he was Director of Sales for the Midwest North Region of Frito-Lay, Inc. from March 1997 to March 2001.

Timothy J. Schugel, 46, has been Executive Vice President and Chief Financial Officer of the Company and of D 56, Inc. since April 1, 2002. He was Senior Vice President — Sourcing Management and Production Control of the Company and of D 56, Inc. from January 29, 2001 until April 1, 2002. Mr. Schugel was Vice President of the Company and of D 56, Inc. from April 10, 1995 until January 29, 2001.

Environmental Matters:

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

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ITEM 2.   PROPERTIES

The Company owns or leases buildings that contain approximately 477,000 square feet of floor space, as identified in the following table. The Company’s primary corporate showroom, executive offices and creative center are located in Eden Prairie, Minnesota. The office building in Eden Prairie, Minnesota is owned by the Company and the rest of the Company’s facilities are leased.

ITEM 3.   LEGAL PROCEEDINGS

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

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

No matters were submitted to a vote of the Company’s security holders during the last quarter of the year ended January 1, 2005.

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PART II

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

Department 56’s common stock trades on the New York Stock Exchange (NYSE) under the symbol “DFS.” The table below sets forth the high and low sales prices for each quarter during the last two fiscal years, as reported by the NYSE.

The Company has not declared or paid dividends on its common stock. The Company’s strategy includes the pursuit of a significant acquisition that aligns with and complements its existing business. As a result, the Company has accumulated cash to help finance a potential acquisition. The Company also has the ability to use its revolving credit facility to finance an acquisition. However, depending on the size of the acquisition, the Company may have to find additional financing to complete an acquisition. In the event the Company is not able to identify an acceptable acquisition by mid-2005, the Company intends to return cash to its stockholders. As a holding company, the ability of the Company to pay cash dividends will depend upon the receipt of dividends or other payments from its subsidiaries. See “Item 7. – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” below with respect to restrictions under the Company’s credit agreement pertaining to its right to pay dividends.

As of March 8, 2005, the number of holders of record of the Company’s Common Stock was 790.

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ITEM 6.   SELECTED FINANCIAL DATA

FIVE-YEAR SUMMARY (In thousands, except per share amounts)
YEARS ENDED JANUARY 1, 2005, JANUARY 3, 2004, DECEMBER 28, 2002,
DECEMBER 29, 2001, AND DECEMBER 30, 2000

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ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(In millions, except per share amounts)

STRATEGIC OVERVIEW

The Company’s financial results for 2004 as well as for the prior two years were significantly impacted by fundamental changes occurring in our core Gift and Specialty account base. We continue to see substantial attrition in the Gift and Specialty channel, which accounted for over 85% of the Company’s wholesale sales in 2004. In addition to account attrition, on-going accounts have been very cautious in ordering the Company’s Village product. Largely due to this account attrition and the cautious buying of Village product from existing Gift and Specialty dealers, Village product revenue decreased 17% in 2004 which is consistent with a longer term trend. See five year Village sales trend at “Item 6. Selected Financial Data – Five Year Summary.”

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

Developing Year-Round Celebratory Products:

The Company has repositioned itself from a strong Christmas collectibles business to a company providing premier home decorative products to celebrate life’s extraordinary moments. The Company has expanded its Village lines to incorporate celebrations of all major holidays, special moments and seasons. This re-positioning strategy has also led to a strengthening, broadening and increased focus on the Company’s Giftware line with the goal of developing cohesive, multi-season product lines that will attract consumers year-round. While further progress needs to be made, the Company’s Giftware sales have demonstrated positive results. The Company’s Giftware sales, excluding its figurine business, increased 10% and 16% during 2004 and 2003, respectively.

Expand Multi-Channels of Distribution:

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

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Leverage and Grow Our Core Consumer Base:

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

SUMMARY OF 2004 RESULTS OF OPERATIONS

Reconciliation of Non-GAAP Financial Measure
(In millions)

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COMPARISON OF RESULTS OF CONTINUING OPERATIONS 2004 TO 2003

(In millions, except per share amounts)

The Company measures its performance through two segments – Wholesale and Retail. Net sales, gross profit, and specifically identified selling costs are measured for each segment. Expenses generally not allocated to specific operating segments are reflected in the Corporate category and represent general and administrative costs. Other components of the statement of operations which are classified below income from operations (i.e. interest expense, provision for income taxes, etc.) are not allocated by segment and are discussed separately.

Wholesale

Net sales decreased $13.8 million, or 8%, from $166.9 million in 2003 to $153.1 million in 2004. Net sales of the Company’s Village Series products decreased $15.1 million, or 17%, while sales of Giftware products increased $1.4 million, or 2%. Village Series products represented 47% of the Company’s wholesale sales during 2004 versus 52% during 2003. Village sales continued to be negatively impacted by both the cautious buying patterns of Village dealers and the continued attrition in the number of these dealers, which is a trend the Company expects to continue. See five-year Village sales trend at “Item 6. Selected Financial Data – Five-Year Summary.”

Gross profit decreased $9.0 million, or 10%, from $88.1 million in 2003 to $79.1 million in 2004. Gross profit as a percentage of sales decreased from 53% in 2003 to 52% in 2004. The decrease in gross profit dollars was principally due to the decrease in wholesale segment sales. The decrease in gross profit as a percentage of sales was due to a change in the mix of wholesale product shipments from higher margin Village product to lower margin Giftware product, partially offset by lower provisions for both excess product, and sales returns and credits.

Selling expenses decreased $0.4 million, or 3%, from $15.9 million in 2003 to $15.5 million in 2004. Selling expenses as a percentage of wholesale net sales were 10% in both 2003 and 2004. The decrease in selling expenses in dollars was due to the decrease in wholesale segment net sales.

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Operating income from continuing operations decreased $8.6 million, or 12%, from $72.2 million in 2003 to $63.6 million in 2004. The decrease in operating income was principally due to the decrease in wholesale segment sales as explained above.

Retail

Net sales increased $2.6 million, or 29%, from $8.9 million in 2003 to $11.6 million in 2004. The increase in net sales was principally due to the opening of new retail stores and increased Time to Celebrate operations. Comparable store sales increased 3% in 2004. Comparable store sales represent a comparison of the sales (during the corresponding weeks of the two fiscal years compared) of the stores included in our comparable store sales base. A store first enters our comparable store sales base after completing 12 fiscal months of operations. In 2004, there were five stores included in our comparable store sales base and two of these stores were included for less than a year.

Gross profit increased $1.8 million, or 32%, from $5.6 million in 2003 to $7.4 million in 2004. Gross profit as a percentage of sales increased from 62% in 2003 to 64% in 2004. The increase in gross profit dollars was primarily due to the increase in retail segment sales. The increase in gross profit as a percentage of sales was principally due to the mix of product sales and lower markdowns.

Selling expenses increased $1.8 million, or 28%, from $6.4 million in 2003 to $8.2 million in 2004. Selling expenses as a percentage of retail net sales decreased from 72% in 2003 to 71% in 2004. The increase in selling expenses was due to the addition of two new stores in the fall of 2003 (which were open for a full year in 2004), the addition of a new store in the summer of 2004, and increased Time to Celebrate operations.

Operating loss from continuing operations decreased $0.1 million, or 5%, from $0.9 million in 2003 to $0.8 million in 2004. The decrease in loss from operations was due to the increase in retail segment sales, partially offset by the increase in selling expenses as explained above.

Corporate

General and administrative expenses decreased $1.4 million, or 4%, from $31.5 million in 2003 to $30.2 million in 2004. The decrease in general and administrative expenses was principally due to decreases in depreciation and marketing expenses of $0.9 million and $0.6 million, respectively, partially offset by the $0.7 million charge for severance costs related to staff reductions in the third quarter of 2004.

Interest Expense

Interest expense decreased $1.4 million, or 70%, between 2003 and 2004. The decrease in interest expense was principally due to lower average debt outstanding.

Litigation Settlement

During 2004, the Company received net proceeds (before income taxes) of $6.9 million in settlement of the Company’s litigation against a third party related to the implementation of its information systems. This recovery was recorded in other income.

Provision for Income Taxes

The effective income tax rate was 36% in both 2003 and 2004.

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Discontinued Operations

In December 2003, the Company committed to a plan to cease operations of its Geppeddo seasonal kiosk business. Geppeddo ceased operations during the first quarter of 2004, and in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company has reclassified Geppeddo’s results into discontinued operations for all periods presented.

COMPARISON OF RESULTS OF CONTINUING OPERATIONS 2003 TO 2002

Wholesale

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

Gross profit decreased $10.9 million, or 11%, from $99.1 million in 2002 to $88.1 million in 2003. Gross profit as a percentage of wholesale segment sales decreased from 55% in 2002 to 53% in 2003. The decrease in gross profit dollars was due to a decrease in wholesale segment sales. The decrease in gross profit as a percentage of sales was due to a change in the mix of wholesale product shipments from higher margin Village product to lower margin Giftware product.

Selling expenses decreased $0.9 million, or 6%, from $16.9 million in 2002 to $15.9 million in 2003. Selling expenses as a percentage of wholesale segment net sales increased from 9% in 2002 to 10% in 2003. The decrease in selling expenses in dollars was due to the decrease in wholesale segment net sales.

Operating income from continuing operations decreased $10.0 million, or 12%, from $82.2 million in 2002 to $72.2 million in 2003. The decrease in operating income was principally due to the decrease in wholesale segment sales and a lower gross profit rate due to a change in product mix as noted previously.

Retail

Net sales decreased $1.2 million, or 12%, from $10.1 million in 2002 to $8.9 million in 2003. The decrease in net sales was principally due to the fact that the Company did not operate its seasonal stores beyond January 2003. The decrease in seasonal store sales was partially offset by an increase in sales at the Company’s retail stores as a result of opening two new stores in 2003 and an increase in Time to Celebrate operations. Comparable store sales in 2003 decreased 1% compared to 2002. Comparable store sales represent a comparison of the sales (during the corresponding weeks of the two fiscal years compared) of the stores included in our comparable store sales base. A store first enters our comparable store sales base after completing 12 fiscal months of operations. In 2003, there were three stores included in our comparable store sales base, all for the full year.

Gross profit decreased $1.6 million, or 22%, from $7.1 million in 2002 to $5.6 million in 2003. Gross profit as a percentage of sales decreased from 70% in 2002 to 62% in 2003. The decrease in gross profit dollars was due to the decrease in seasonal store sales. The decrease in gross profit as a percentage of sales was principally due to the liquidation of seasonal store inventory in January 2003 as a result of the Company’s decision to stop operating seasonal stores and increased Time to Celebrate operations (which carry lower gross profit rates than the Company’s retail stores).

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Selling expenses decreased $1.1 million, or 15%, from $7.6 million in 2002 to $6.4 million in 2003. Selling expenses as a percentage of retail segment net sales decreased from 75% in 2002 to 72% in 2003. The decrease in selling expenses in dollars was due to lower seasonal store expense because the seasonal stores were not operated beyond January 2003. This decrease in seasonal store expenses was partially offset by the opening of two new retail stores in the fall of 2003 and increased Time to Celebrate operations.

Operating loss from continuing operations increased $0.4 million, or 95%, from a loss of $0.5 million in 2002 to a loss of $0.9 million in 2003. The increased operating loss was principally due to larger losses from the Time to Celebrate business. Time to Celebrate was in operation for all of 2003 compared to approximately four months in 2002 (its first year of operations).

Corporate

General and administrative expenses decreased $4.7 million, or 13%, from $36.2 million in 2002 to $31.5 million in 2003. The decrease in general and administrative expenses was principally due to a decrease in incentive compensation of $3.4 million and a decrease in marketing expense of $0.7 million.

Interest Expense

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

Litigation Settlement

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

Provision for Income Taxes

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

SEASONALITY

Historically, due to the timing of wholesale trade shows early in the calendar year, the Company has received the majority of its total annual wholesale customer orders during the first quarter of each year. The Company entered 67% and 63% of its total net annual wholesale customer orders during the first quarter of 2004 and 2003, respectively. Cancellations of total annual wholesale customer orders were 8% in 2004 and 7% in 2003. Orders not shipped in a particular year, net of cancellations, are carried into backlog for the following year and have historically been orders for Spring and Easter products. The Company’s backlog of wholesale customer orders was $3.2 million and $3.5 million at January 1, 2005 and January 3, 2004, respectively.

The Company receives products, pays its suppliers and ships products throughout the year, although historically the majority of wholesale shipments occur in the second and third quarters as retailers stock merchandise in anticipation of the holiday season. As a result of this seasonal pattern, the Company generally records its highest wholesale sales during the second and third quarters of each year. However, the Company can experience fluctuations in quarterly sales and related net income compared with the prior year due to the timing of receipt of product from suppliers and subsequent shipment of product from the Company to customers, as well as the timing of orders placed by customers. In addition, the Company recognizes the majority of its retail sales in the fourth quarter during the peak holiday shopping season. The Company is not managed to maximize quarter-to-quarter results, but rather to achieve annual objectives designed to achieve long-term growth consistent with the Company’s business strategy.

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LIQUIDITY AND CAPITAL RESOURCES

Cash Flows from Operations

Net cash provided by operating activities decreased $15.1 million, or 45%, from $33.7 million in 2003 to $18.6 million in 2004. The decrease was principally due to lower cash collections, partially offset by lower payments for inventory. Cash collections were lower in 2004 principally due to lower net sales and higher accounts receivable balances at the end of the year. Accounts receivable balances were higher at the end of 2004 due to shipping product later in the year compared to 2003 and due to two less days of cash collections in 2004 as a result of the 2004 fiscal year ending on January 1, 2005 compared to the 2003 fiscal year ending on January 3, 2004. Inventory payments were lower in 2004 due to the decrease in net sales.

Accounts receivable, net of reserves, which principally consists of wholesale trade receivables, increased by 36%, from $21.0 million at January 3, 2004 to $28.5 million at January 1, 2005 due to the reasons described above. Management believes there is adequate provision for any doubtful accounts receivable and product claims that may arise.

Because the Company’s wholesale business is not capital intensive, the Company has historically not incurred significant capital expenditures. Capital expenditures for the retail business were $1.0 million, $1.9 million, and $0.5 million in 2004, 2003 and 2002, respectively. Other capital expenditures were $1.2 million, $0.6 million and $1.2 million in 2004, 2003 and 2002, respectively.

Sources of Liquidity

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

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

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

In November 2003, the Company entered into a new three-year credit agreement. In connection therewith, the Company recorded $0.2 million in deferred financing fees, which are being amortized over the life of the credit agreement. The Company used the new credit facility to refinance the remaining term and revolving loans under its former credit agreement. As of January 1, 2005, no revolving loans were outstanding under the new credit agreement. The credit agreement expires November 26, 2006.

The revolving credit facility provides for borrowings of up to $75 million, which may be in the form of letters of credit and revolving credit loans. The letters of credit are issued primarily in connection with inventory purchases. The revolving credit facility includes an annual clean-down provision whereby the Company’s outstanding revolving credit loans and letters of credit may not exceed an aggregate of $30 million during any one 30-consecutive-day period beginning November 1 and ending March 31 of the following year. Borrowings under the credit agreement are subject to certain borrowing base limitations (as defined in the agreement). The Company’s borrowing capacity under the revolving credit facility as of January 1, 2005 was $75 million and will fluctuate during 2005 based on accounts receivable and inventory levels. The revolving line of credit provides for commitment fees of 0.20% to 0.375% per annum on the daily average of the unused commitment.

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

The credit agreement includes restrictions as to, among other things, the amount of additional indebtedness, liens, contingent obligations, investments and dividends. Under the most restrictive of these covenants, approximately $246 million of retained earnings were restricted at January 1, 2005. The credit agreement also requires maintenance of minimum levels of interest coverage, net worth and maximum levels of leverage, in each case at the end of each fiscal quarter. None of these restrictions are expected to have a material adverse effect on the Company’s ability to operate in the future.

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

OFF-BALANCE SHEET ARRANGEMENTS

The Company does not have off-balance sheet arrangements.

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CONTRACTUAL OBLIGATIONS

As of January 1, 2005, the Company is obligated to make cash payments in connection with its operating leases, purchase obligations, and royalty guarantees in the amounts listed below. The Company does not have any long-term debt or capital lease obligations. The Company has no off-balance sheet debt or other unrecorded obligations other than the items noted in the following table:

See Note 7 to the Consolidated Financial Statements for a discussion of the Company’s deferred compensation obligation.

WHOLESALE CREDIT AND RETURN POLICIES

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

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

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Management believes the following critical accounting policies require the most difficult, subjective or complex judgments about matters that are inherently uncertain and are therefore particularly important to an understanding of our results of operations and financial position:

Sales Returns and Credits – An allowance is established for credits related to possible returned or damaged product, pricing and shipping discrepancies. The amount of the allowance is based on historical ratios of credits to sales, the historical average length of time between the sale and the credit, and other factors. Changes in customers’ behavior versus historical experience, changes in product damage or defect rates, or changes in the Company’s return policies are among the factors that would result in materially different amounts for this item. Based on 2004 sales returns and credits, a 10% increase or decrease in sales returns and credits would have had an impact of approximately $0.5 million.

Inventory Valuation – Inventory is valued at the lower of cost or net realizable value. The amount is determined by analyzing historical and projected sales information, plans for discontinued products and other factors. The Company procures product based on forecasted sales volume. If actual sales were significantly lower than forecasted sales due to unexpected economic or competitive conditions, it could result in materially higher surplus and discontinued inventories. Based on 2004 inventory write-downs, a 10% increase or decrease in inventory write-downs would have had an impact of less than $0.3 million.

Allowance for Doubtful Accounts – An allowance is established for estimated uncollectible accounts receivable. The required allowance is determined by reviewing each significant customer account and making estimates of amounts that may be uncollectible. Factors considered in determining the amount of the reserve include the age of the receivable, the financial condition of the customer, general business, economic and political conditions, and other relevant facts and circumstances. Additionally, since the majority of the Company’s wholesale sales have dating terms which come due in November and December, the Company does not have visibility into overdue balances for most of its wholesale customers until the fourth quarter of its fiscal year. Due to the seasonality of the Company’s business, the extended dating terms provided to customers and the relative size of accounts receivable balances at year end, it is not uncommon for the Company to experience fluctuations in the provision for bad debt expense from quarter to quarter as the Company refines its estimate. Unexpected changes in the aforementioned factors would result in materially different amounts for this item. In addition, results could be materially different if economic conditions worsened for the Company’s customers. Based on 2004 bad debt write-offs, a 10% increase or decrease in bad debt write-offs would have had an impact of less than $0.3 million.

Valuation of Long-Lived Assets – Long-lived assets on the Company’s consolidated balance sheet consist primarily of property and equipment. The Company periodically reviews the carrying value of these assets based, in part, upon projections of anticipated undiscounted cash flows. Management undertakes this review when facts and circumstances suggest that cash flows emanating from those assets may be diminished. Any impairment charge recorded reduces earnings. While the Company believes future estimates are reasonable, different assumptions regarding items such as future cash flows and the volatility inherent in markets the Company operates could affect evaluations and result in impairment charges against the carrying value of those assets.

Valuation of Goodwill, Trademarks and Other Intangible Assets – The Company evaluates goodwill, trademarks and other intangible assets on a periodic basis. This evaluation relies on assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or related assumptions change, the Company may be required to recognize impairment charges. Effective at the beginning of fiscal year 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, which requires that goodwill and intangible assets with indefinite lives no longer be amortized, but instead tested for impairment annually. Upon adoption of SFAS No. 142, the Company performed impairment testing and concluded that goodwill related to the wholesale operating segment was impaired and recorded a $93.7 million charge to write-down its goodwill. This impairment was recorded as a cumulative effect of a change in accounting principle and therefore did not impact fiscal 2002 operating income. Additionally, the Company determined that its trademarks are indefinite-lived intangible assets and ceased amortization. Intangible assets associated with non-compete agreements are amortized over the life of the agreement and reviewed for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.

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The Company completed its impairment analyses for 2004 and found no indication of impairment of its recorded goodwill, trademarks and other intangible assets. Additional write-downs of intangible assets may be required if future valuations do not support current carrying value.

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

RECENT ACCOUNTING PRONOUNCEMENTS

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

FOREIGN EXCHANGE

Approximately 96% of the Company’s sales in 2004 were denominated in United States dollars and, as a result, were not subject to changes in exchange rates. Approximately 4% of the Company’s sales were denominated in foreign currencies that were subject to changes in exchange rates. At this time, the Company does not use derivative instruments to manage the exchange rate risk.

The Company imports its product from manufacturers located in the Pacific Rim, principally China. Although the Company generally pays for its product in United States dollars, the cost of such product may fluctuate with the value of the Chinese currency because the purchase price paid to the Company’s vendors in United States dollars would be worth more or less in the Chinese currency. As a result, the Company’s costs could be adversely affected if the Chinese currency appreciates significantly relative to the United States dollar; this could result from a decision by the People’s Republic of China to allow its currency to float instead of being pegged to the U.S. dollar at a fixed rate. Conversely, the Company’s costs would be favorably affected if the Chinese currency depreciates significantly relative to the United States dollar. In addition, less than 1% of the Company’s product purchases in 2004 were denominated in foreign currencies that were subject to changes in exchange rates. During 2004, the Company did not use derivative instruments to manage the exchange rate risk.

See also “Item 1. Business – Imports.”

EFFECT OF INFLATION

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

FORWARD-LOOKING STATEMENTS AND FACTORS AFFECTING FUTURE EARNINGS

Certain statements made in this Annual Report on Form 10-K and the documents incorporated by reference in this Annual Report on Form 10-K include forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. All statements regarding the Company’s expected future financial position, results of operations, cash flows, financing plans, business strategy, budgets, tax rates, capital expenditures, competitive positions, growth opportunities, plans and objectives of management, as well as statements containing the words such as “anticipate,” “approximate,” “believe,” “plan,” “estimate,”

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“expect,” “project,” “could,” “should,” “will,” “intend,” “may” and other similar expressions, are forward-looking statements. Forward-looking statements do not relate strictly to historical or current facts.

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

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

ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

The Company’s market risks relate primarily to changes in interest rates and currency exchange rates. The first component of the Company’s interest rate risk relates to its debt outstanding. The Company’s credit facility bears interest at variable rates. Because this facility carries a variable interest rate, the Company’s results of operations and cash flows will be exposed to changes in interest rates. Based on average borrowings in 2004, a 1% increase or decrease in current market interest rates would have an impact of approximately $0.2 million.

The second component of the Company’s interest rate risk involves the short-term investment of excess cash. Excess cash flow is typically invested in high-quality fixed income securities issued by banks, corporations and the U.S. government; municipal securities; and overnight repurchase agreements backed by U.S. government securities. These securities are classified as cash equivalents on the Company’s balance sheet. At January 1, 2005, the Company’s cash balance was approximately $44.9 million. Earnings from cash equivalents were

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approximately $0.2 million for the fifty-two weeks ended January 1, 2005. Based on the January 1, 2005 cash balance, a 1% increase or decrease in current market interest rates would have an impact of approximately $0.4 million.

Approximately 4% of the Company’s wholesale sales and less than 1% of the Company’s product purchases in fiscal year 2004 were denominated in a foreign currency. Based on these sales and product purchases, a 10% increase or decrease in the foreign currency exchange rates would have an impact of less than $1 million.

ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See Consolidated Financial Statements on page F-1 and quarterly data under the caption “Seasonality” within Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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

None.

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, the “Exchange Act”). Based upon and as of the date of that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that those disclosure controls and procedures were adequately designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms.

Management’s Report on Internal Control over Financial Reporting

Management’s Report on Internal Control over Financial Reporting on Page F-1 of this 2004 Annual Report on Form 10-K is incorporated herein by reference.

Report of Independent Registered Public Accounting Firm

The Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting on page F-2 of this 2004 Annual Report on Form 10-K is incorporated herein by reference.

Changes in Internal Control over Financial Reporting

During the fourth quarter, there has been no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

ITEM 9B.   OTHER INFORMATION

On November 9, 2004, the Company entered into a Separation Agreement and General Release with David H. Weiser, the Company’s former Senior Vice President – Legal/Human Resources, General Counsel and Secretary. A copy of the agreement is filed as Exhibit 10.21 to this Annual Report on Form 10-K and is incorporated herein by reference.

On April 23, 1997, the Company entered into a Rights Agreement with ChaseMellon Shareholder Services, L.L.C. (as Rights Agent). Such agreement was subsequently amended as of March 13, 1998 and February 25, 1999 (as amended, the “1997 Rights Agreement”). Subsequent to the end of the Company’s 2004 fiscal year and in connection with the Company’s change in transfer agents, the Company terminated the 1997 Rights Agreement in accordance with its terms on March 11, 2005, and entered into a Letter Agreement with Wells Fargo Bank N.A. (as Rights Agent) on March 14, 2005, pursuant to which Wells Fargo Bank N.A. adopted the 1997 Rights Agreement in its entirety (as so adopted, the “2005 Rights Agreement”). The material terms of the 2005 Rights Agreement are substantially identical to the material terms of the 1997 Rights Agreement. A summary of the material terms of the 2005 Rights Agreement is contained in the Company’s (1) Registration Statement on Form 8-A, dated April 23, 1997, (2) Amendment No. 2, dated March 16, 1998, to Registration Statement on Form 8-A, dated April 23, 1997, and (3) Current Report on Form 8-K dated February 26, 1999. A copy of the 2005 Rights Agreement is filed as Exhibits 4.2 through 4.5 to this Annual Report on Form 10-K and is incorporated herein by reference.

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PART III

ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Board of Directors

SUSAN E. ENGEL serves as Chairwoman of the Board. See Ms. Engel’s biographical information at, “Item 1 – Executive Officers of the Registrant.”

JAMES E. BLOOM, 62, has been a director of the Company since November 2001. Mr. Bloom has been a business consultant with Bloom Consulting, Inc. since July 2001. Prior to July 2001, he was Vice President — Sales & Marketing with Charter Systems LLC, a software developer of business communications solutions for the telecommunications industry, from January 1995 to June 2001.

MICHAEL R. FRANCIS, 42, has been a director of the Company since July 2001. Mr. Francis has been Executive Vice President — Marketing of Target Corporation, an operator of largestore general merchandise formats, as well as a direct mail and on-line business, since February 2003. Prior to February 2003, Mr. Francis was Senior Vice President — Marketing of Target Corporation since January 2001 and Senior Vice President, Marketing and Visual Presentation of its department stores division since December 1994. Mr. Francis is a public company director of Piper Jaffray Companies.

CHARLES N. HAYSSEN, 54, has been a director of the Company since March 26, 2004. Mr. Hayssen has been Chief Operating Officer of AllOver Media, Inc., an out-of-home media company, since August, 2004. Mr. Hayssen was a private investor from April 2004 to August 2004 and Chief Operating Officer of ThinkEquity Partners LLC, an equity capital markets firm from September 2002 to April 2004. Prior to September 2002, he was a private investor from November 2001 to September 2002 and Chief Financial Officer of Access Cash International L.L.C. from February 2000 to November 2001. Previously, Mr. Hayssen held a number of positions over a nineteen-year career with Piper Jaffray Companies Inc. including three years as Chief Information Officer, two years as Chief Operating Officer of Piper Capital Management and eight years as Chief Financial Officer.

STEWART M. KASEN, 65, has been a director of the Company since December 2000. Mr. Kasen has been President of S&K Famous Brands, Inc., a retailer of menswear, since April 2002. He was President of Schwarzschild Jewelers, a retail jewelry chain, from September 2001 to April 2002. From October 1999 until September 2001, Mr. Kasen was a consultant to the retail industry and a private investor. He was Chairman, President and Chief Executive Officer of Factory Card Outlet Corp., a specialty retailer, from May 1998 until October 1999. Mr. Kasen is a public company director of S&K Famous Brands, Inc., K2, Inc., Markel Corp., and Singer Co.

REATHA CLARK KING, 66, has been a director of the Company since May 2002. Dr. King was President and Executive Director, General Mills Foundation from November 1988 until May 2002, and served as Chairperson of the Foundation’s Board of Trustees from May 2002 until June 2003. She performs consulting work in organizational governance and philanthropic programs. Prior to joining General Mills Foundation, Dr. King held a variety of scientific and educational positions. She is a public company director of Exxon Mobil Corporation and Wells Fargo & Co. She is a former director of H. B. Fuller Company and Minnesota Life Insurance Company.

GARY S. MATTHEWS, 47, has been a director of the Company since September 1997. Mr. Matthews was President of Bristol Myers Squibb Worldwide Consumer Medicines, a major producer and distributor of medicines, from December 2001 until January 2005. From 1999 to 2001 he was President and Chief Executive Officer and a director of Derby Cycle Corporation, a leading bicycle designer, manufacturer and marketer. Prior to 1999, Mr. Matthews was Managing Director of Guinness Great Britain, the U.K. subsidiary of Diageo PLC.

24

VIN WEBER, 52, has been a director of the Company since February 1993. Mr. Weber served in the United States House of Representatives from 1981 to 1993, representing Minnesota’s 2nd Congressional District. Since 1994, Mr. Weber has been a Partner of Clark & Weinstock, Inc., providing strategic advice to institutions interested in issues before the legislative and executive branches of the federal government. Mr. Weber is Chairman of the National Endowment for Democracy, a private, nonprofit organization created in 1983 to strengthen democratic institutions around the world through nongovernmental efforts. He was co-director of the Domestic Policy Project of the Aspen Institute and currently serves as a full Trustee for the Institute. He also is a fellow at the Humphrey Institute at the University of Minnesota, where he is a co-director of the Policy Forum (formerly the Mondale Forum). Mr. Weber is a board member of several private sector and non-profit organizations, including ITT Educational Services, the German Marshall Fund and The Council on Foreign Relations.

See also, “Item 1 – Executive Officers of the Registrant.”

Compliance with Section 16(a) of the Exchange Act

Information required by this Item will be included in the 2005 Proxy Statement under the heading “Section 16(a) Beneficial Ownership Reporting Compliance,” and such information is incorporated herein by reference.

Audit Committee Members and Audit Committee Financial Expert

The information under the heading “Meetings and Committees of the Board” of the Company’s Proxy Statement is incorporated herein by reference.

Corporate Governance Guidelines, Committee Charters and Code of Ethics

The Company has adopted Corporate Governance Guidelines and Charters for the Audit, Governance, and Management Organization and Compensation Committees. The Company also has in place a Code of Ethics and Business Conduct that applies to the Company’s principal executive officer, principal financial officer, principal accounting officer, all officers, directors, and employees of the Company and all of its subsidiaries. The Corporate Governance Guidelines, Committee Charters, and Code of Ethics and Business Conduct, with any amendments or waivers thereto, may be accessed free of charge by visiting the Department 56 website at www.department56.com. Copies of these documents are also available in print by written request directed to Corporate Secretary – Department 56, Inc., One Village Place, 6436 City West Parkway, Eden Prairie, MN 55344.

The Company intends to post on its website any amendment to, or waiver from, a provision of the Code of Ethics and Business Conduct that applies to its principal executive officer, principal financial officer, principal accounting officer, and other persons performing similar functions, in accordance with the rules of the Securities and Exchange Commission and the New York Stock Exchange.

Certifications

The certifications of the Chief Executive Officer and the Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002, regarding the quality of the Company’s disclosure in this Annual Report on Form 10-K, have been filed as exhibits 31.1 and 31.2 to this 2004 Annual Report on Form 10-K. The Company’s Annual CEO Certification as required by NYSE Rule 303A.12(a) has been submitted to the New York Stock Exchange.

25

ITEM 11.   EXECUTIVE COMPENSATION

Information required by this Item will be included in the 2005 Proxy Statement in the sections captioned “Information about the Board and Corporate Governance — Director Compensation,” and “Compensation of Executive Officers,” and such information, except for the information under the section captioned, “Performance Graph,” is incorporated herein by reference.

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

Information required by this Item will be included in the 2005 Proxy Statement in the section captioned “Equity Compensation Plan Information” and “Security Ownership of Certain Beneficial Owners and Management,” and such information is incorporated herein by reference.

ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

None.

ITEM 14.   PRINCIPAL ACCOUNTANT FEES AND SERVICES

Information required by this Item will be included in the 2005 Proxy Statement in the sections captioned “Fees for Services Provided by Independent Auditor” and “Pre-Approval Policy for Services of Independent Auditor,” and such information is incorporated herein by reference.

26

PART IV

ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULE

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

27

† Management contract or compensatory plan.
* Filed herewith.

28

SIGNATURES

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

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

29

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control system was designed to provide reasonable assurance to management and the board of directors regarding the reliability of financial reporting and preparation of financial statements in accordance with generally accepted accounting principles.

Management assessed the effectiveness of Department 56, Inc.’s (the “Company”) internal control over financial reporting as of January 1, 2005. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework.

Based on our assessment and those criteria, management believes the Company’s internal control over financial reporting was effective as of January 1, 2005.

The Company’s independent auditors have issued an attestation report on management’s assessment of the Company’s internal control over financial reporting. This report appears on the following page.

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Internal Control over Financial Reporting

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

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Controls over Financial Reporting, that Department 56, Inc. and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of January 1, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. 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 opinions.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel 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 the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

F-2

In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of January 1, 2005, is fairly stated, in all material respects, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 1, 2005, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended January 1, 2005, of the Company and our report dated March 16, 2005, expressed an unqualified opinion on those financial statements and financial statement schedule.

Minneapolis, Minnesota
March 16, 2005

F-3

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Consolidated Financial Statements

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

We have audited the accompanying consolidated balance sheets of Department 56, Inc. and subsidiaries (the “Company”) as of January 1, 2005 and January 3, 2004, and the related consolidated statements of income, cash flows, and stockholders’ equity for the years ended January 1, 2005, January 3, 2004 and December 28, 2002. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the 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, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at January 1, 2005 and January 3, 2004, and the results of their operations and their cash flows for the years ended January 1, 2005, January 3, 2004 and December 28, 2002, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

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

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of January 1, 2005, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 16, 2005 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

Minneapolis, Minnesota
March 16, 2005

F-4

DEPARTMENT 56, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
AS OF JANUARY 1, 2005 AND JANUARY 3, 2004

See notes to consolidated financial statements.

F-5

DEPARTMENT 56, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
YEARS ENDED JANUARY 1, 2005, JANUARY 3, 2004 AND DECEMBER 28, 2002

See notes to consolidated financial statements.

F-6

DEPARTMENT 56, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
YEARS ENDED JANUARY 1, 2005, JANUARY 3, 2004 AND DECEMBER 28, 2002