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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended:   April 2, 2005

Commission file number:     1-11908

        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         

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes    X      No         

        As of April 29, 2005, 13,774,967 shares of the registrant’s common stock, par value $.01 per share, were outstanding.

PART I — FINANCIAL INFORMATION

Item 1.    Financial Statements

DEPARTMENT 56, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands)

See notes to condensed consolidated financial statements.

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DEPARTMENT 56, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share amounts)

See notes to condensed consolidated financial statements.

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DEPARTMENT 56, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)

See notes to condensed consolidated financial statements.

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DEPARTMENT 56, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share amounts)

        The accompanying condensed consolidated balance sheet as of January 1, 2005 was derived from the audited consolidated balances as of that date. The remaining accompanying condensed consolidated financial statements are unaudited and, in the opinion of management, include all adjustments necessary for a fair presentation.

        The results of operations for the quarter ended April 2, 2005 are not necessarily indicative of the results for the full fiscal year. It is suggested that these financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the 2004 Annual Report to Stockholders and Annual Report on Form 10-K as filed by Department 56, Inc. (the Company) with the Securities and Exchange Commission. Comprehensive income for the periods ended April 2, 2005 and April 3, 2004 was equivalent to reported net income.

        Reclassifications – Certain prior year amounts have been reclassified to conform to the current year presentation. These reclassifications had no impact on net income (loss) or retained earnings as presented. Auction rate securities, previously classified as cash and cash equivalents, are now classified as short-term investments for all periods presented. The Company classifies these short-term investments as “available for sale” securities under SFAS No. 115. As of April 2, 2005, January 1, 2005, and April 3, 2004, auction rate securities were $20.0 million, $11.2 million, and $17.5 million, respectively.

        Net income (loss) per common share is calculated by dividing net income (loss) by the weighted average number of shares outstanding during the period. Net income (loss) per common share assuming dilution reflects per share amounts that would have resulted had the Company’s dilutive outstanding stock options been converted to common stock. Restricted stock is considered outstanding on the date the restrictions lapse when computing net income (loss) per common share – basic. Restricted stock is considered outstanding on the grant date when computing net income per common share – assuming dilution. All options and unvested restricted stock were considered anti – dilutive and excluded from the computation of common equivalent shares at April 2, 2005 and April 3, 2004 because the Company reported a net loss.

        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 classified Geppeddo’s results in discontinued operations for all periods presented. Geppeddo’s sales for the first quarter of 2005 were $0, compared to $3,396 during the first quarter of 2004.

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        The Company accounts for its stock option plans using the intrinsic value method and has adopted the “disclosure only” provisions of SFAS No. 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure. Accordingly, no compensation cost has been recognized for stock options granted. Had compensation cost been determined based upon fair value (using the Black-Scholes option-pricing method) at the grant date for awards under these plans, the Company’s net loss and loss per share would have been increased as follows:

        The Company accounts for its goodwill and other intangible assets under SFAS No. 142, Goodwill and Other Intangible Assets. The Company has determined that its trademarks are indefinite-lived intangible assets.

In accordance with SFAS No. 142, the Company will continue to amortize its finite-lived intangible assets, which currently consist of non-compete agreements. Amortization of non-compete agreements was $35 during the first quarters of both 2004 and 2005. Expected annual amortization expense for non-compete agreements recorded as of January 1, 2005 is as follows:

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

        Included in Goodwill and Trademarks and Other Intangibles on the Company’s condensed consolidated balance sheets as of April 2, 2005 and April 3, 2004, are the following acquired intangible assets for the wholesale segment (net of accumulated amortization). Accumulated amortization of non-compete agreements was $2,084, $2,049 and $1,944 as of April 2, 2005, January 1, 2005 and April 3, 2004, respectively.

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

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        In December 2004, the FASB issued SFAS No. 123R (revised 2004), Share-Based Payment, which replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. On April 14, 2005, the U.S. Securities and Exchange Commission (the “SEC”) announced a deferral of the effective date of SFAS 123(R) which will require our adoption in the first quarter of 2006. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS No. 123 no longer will be an alternative to financial statement recognition. Under SFAS No. 123R, we must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include modified prospective and modified retrospective adoption options. Under the modified retrospective option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The modified prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. We are evaluating the requirements of SFAS No. 123R and expect that the adoption of SFAS No. 123R will have a material impact on our consolidated results of operations and earnings (loss) per share. We have not yet determined the method of adoption or the effect of adopting SFAS No. 123R.

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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

RESULTS OF OPERATIONS

Comparison of Results of Operations for the Quarter Ended April 2, 2005 to the Quarter Ended April 3, 2004.

        This Item should be read in conjunction with the segment financial table presented in Note 6 to the Condensed Consolidated Financial Statements. Other components of the statement of operations which are classified below income (loss) from operations (i.e. interest expense, provision (benefit) for income taxes, etc.) are not allocated by segment and are discussed separately.

Wholesale

        Net sales decreased $0.5 million, or 2.5%, from $18.7 million in 2004 to $18.3 million in 2005. The decrease in wholesale sales was principally due to a decrease in liquidation shipments.

        Gross profit as a percentage of net sales was 51% and 44% in the first quarter of 2004 and 2005, respectively. The decrease in the gross profit percentage was due to a higher provision for excess inventory as a result of lower wholesale orders.

        Selling, general and administrative expenses were $3.0 million or 16% of sales in 2004 compared to $3.2 million or 17% of sales in 2005. The increase in selling, general and administrative expenses was principally due to an increase in the provision for doubtful accounts.

        Operating income from continuing operations decreased from $6.7 million in 2004 to $4.9 million in 2005. The decrease in operating income was principally due to the lower gross profit rate as explained above.

Retail

        Net sales increased $0.3 million, or 18%, from $1.5 million in 2004 to $1.8 million in 2005. The increase was due to the opening of a new retail store in June 2004 (which operated during the first quarter of 2005, but not the first quarter of 2004).

        Gross profit as a percentage of net sales was 60% and 50% in the first quarter of 2004 and 2005, respectively. The decrease in the gross profit percentage was due to higher markdowns and an increase in the provision for excess Time to Celebrate inventory.

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        Selling, general and administrative expenses were $1.8 million in 2004 compared to $2.1 million in 2005. The increase in selling, general and administrative expenses was principally due to the opening of the new retail store in June 2004.

        Operating loss from continuing operations increased from $0.9 million in 2004 to $1.2 million in 2005. The increase in loss from operations was principally due to the opening of the new retail store in June 2004. The Company’s retail operations historically generate losses from operations in the first three quarters of the Company’s fiscal year and income from operations during the fourth quarter.

Corporate

        Unallocated general and administrative expense was $7.9 million in the first quarter of both 2004 and 2005.

Provision for Income Taxes

        The effective income tax rate was 36% during the first quarter of both 2004 and 2005.

Loss from Discontinued Operations, Net of Tax

        The Company completed the closing of its Geppeddo subsidiary during the first quarter of 2004 and classified its results as discontinued operations for all periods presented.

SEASONALITY AND WHOLESALE CUSTOMER ORDERS

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

        Wholesale customer orders decreased $15.7 million, or 15.5%, from $101.0 million in the first quarter of 2004 to $85.3 million in the first quarter of 2005. Orders for the Company’s Giftware products were down 12% while Village product orders were down 19%. Orders for both Giftware and Village products continue to be negatively impacted by cautious buying patterns and the continued attrition among the Company’s dealers.

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        Historically, due to the timing of wholesale trade shows early in the calendar year, the Company has received the majority of its total annual wholesale customer orders during the first quarter of each year. The Company entered 67% and 63% of its total net annual wholesale 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 $86.4 million and $70.2 million at April 3, 2004 and April 2, 2005, 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.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows from Operations

        Net cash used in operating activities decreased $3.5 million, from $4.6 million in 2004 to $1.1 million in 2005, principally due to higher cash collections and lower net income tax payments, partially offset by higher inventory purchases.

        Accounts receivable, net of reserves, which principally consists of wholesale trade receivables, increased from $15.5 million at April 3, 2004 to $21.0 million at April 2, 2005. Accounts receivable increased due to a $2.0 million increase in sales of spring seasonal merchandise with payment due dates after the end of the first quarter, with the balance of the increase coming from slower customer payments. Management believes it has adequately provided for doubtful accounts.

        Inventories increased from $13.1 million at April 3, 2004 to $18.4 million at April 2, 2005. The increase was principally due to the timing of receipt of wholesale inventory from overseas vendors, higher retail segment inventories resulting from the addition of a new retail store and an increase in Time to Celebrate operations.

        Because the Company’s wholesale business is not capital intensive, the Company has historically not incurred significant capital expenditures. Capital expenditures were $0.4 million in the first quarter of 2004 and $0.1 million in the first quarter of 2005.

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Sources of Liquidity

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

        Consistent with customary practice in the giftware industry, the Company offers extended payment 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 its cash balances and/or seasonal borrowings under its revolving credit facility. The Company’s cash and cash equivalents and short-term investment 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.

        The Company’s 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. 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 April 2, 2005 was $75 million and will fluctuate during 2005 based on accounts receivable and inventory levels. 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 $244 million of the Company’s $299 million retained earnings balance at April 2, 2005 were restricted. 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 foreseeable future.

OFF-BALANCE SHEET ARRANGEMENTS

        The Company does not have off-balance sheet arrangements.

CONTRACTUAL OBLIGATIONS

        The Company had open purchase orders to suppliers of $24.2 million at the end of the first quarter of 2005 compared to $8.3 million and $19.5 million at January 1, 2005 and April 3, 2004, respectively. There were no other material changes in contractual obligations from those disclosed in the Company’s 2004 Annual Report on Form 10-K.

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WHOLESALE CREDIT AND RETURN POLICIES

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

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

CRITICAL ACCOUNTING POLICIES

        Our consolidated financial statements are prepared in accordance with generally accepted accounting principles of the United States. In connection with the preparation of the financial statements, we are required to make assumptions, 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.

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

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

        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.

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

        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 within which 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.

        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.

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Notes concerning forward-looking statements:
Any conclusions or expectations expressed in, or drawn from, the statements in this filing concerning matters that are not historical corporate financial results are “forward-looking statements” that involve risks and uncertainties. These statements are based on management’s estimates, assumptions and projections as of today and are not guarantees of future performance. 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. Please read the bases, assumptions and factors set out in Item 7 in the Company’s Form 10-K for 2004 dated March 17, 2005 and filed under the Securities Exchange Act of 1934, all of which is incorporated herein by reference and applicable to the forward-looking statements set forth herein.

Item 3.    Quantitative and Qualitative Disclosures about Market Risk

        There has been no significant change in the Company’s exposure to market risk since year end. The Company’s risk is limited to interest rate risk associated with investment balances and credit instruments as well as foreign currency exchange rate risk.

Item 4.    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). Based upon and as of the date of that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that those disclosure controls and procedures were effective.

        There have been no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 6.    Exhibits

        The following documents are exhibits to this Report:

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* Filed herewith

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SIGNATURES

        Pursuant to the requirements 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.

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EXHIBIT INDEX

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