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

FORM 10-K

(Mark One)

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 / /

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. / /

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

The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 13, 2003 was $209,728,337 (based on the closing price of consolidated trading in the Common Stock on June 28, 2002, 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 13, 2003: 13,079,209.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company's definitive Proxy Statement for the 2003 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 "2003 Proxy Statement") are incorporated by reference in Part III.

FORM 10-K TABLE OF CONTENTS

PART I

ITEM 1. BUSINESS

General:

Department 56, Inc. (including its direct and indirect subsidiaries, "Department 56" or "the Company") is a leading designer, distributor, wholesaler and retailer of fine quality collectibles and other giftware products sold through gift, home accessory, specialty retailers, department stores and mid-tier general merchandise chains, as well as through its own stores and consumer-direct home party plan 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 The Heritage Village Collection® as well as its extensive line of holiday, special occasion and home decorative products, including its Snowbabies™ collectible porcelain figurines.

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

The Company seeks to grow and acquire businesses that reinforce synergies, allowing it to complement its internal product development and accelerating its penetration into new markets and new channels. In the third quarter of fiscal year 2001, the Company completed its acquisition of the business of Axis Corporation (the "Geppeddo Business" or "Geppeddo"), a designer and importer of porcelain and vinyl dolls, doll accessories and plush items sold through customized seasonal kiosks under the Geppeddo® brand. In the second quarter of fiscal year 2002, the Company commenced its Time to Celebrate™ initiative, a direct selling business that reaches consumers by using a network of independent sales consultants to sell giftware and home decorative products through the home party plan sales method. Also in 2002, the Company launched its Simple Traditions™ line of village products, developed and distributed for the unique needs of mid-tier and general merchandise retailers. The Company tailors its products, designs, packaging and prices to satisfy the varying demands of customers and consumers within each distribution channel. This focused, multi-faceted strategy is intended to position Department 56 as the premier giftware and collectibles company for the future.

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

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

The Company makes available, free of charge through its website, http://www.department56.com its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as is reasonably practicable after such material is electronically filed with or furnished to the Commission. The information on the Company's website is not incorporated by reference into this Annual Report.

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Wholesale Operations:

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

The Company's domestic wholesale operations serve an extensive base of retailers primarily consisting of small, independent gift stores. The Company's principal customers (accounting for approximately 90% of its wholesale sales) are approximately 14,000 independent gift retailers across the U.S. and Canada. These retailers include approximately 1,520 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 merchandising and promotional requirements. Approximately 11% of the Company's wholesale sales are made to department stores, mid-tier general merchandise chains, and mail order houses. No single account represented more than 2% of the Company's wholesale sales in fiscal 2002. The Company provides volume discounts to its customers with respect to most of its products. The Company has generally had only limited sales outside the United States. International wholesale sales, which are made primarily in Canada, were approximately 3% of the Company's wholesale sales in fiscal 2002.

As part of the Company's strategy of selective distribution, only approximately 4,950 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). Certain of the Company's limited edition and year of production lighted Village Series and Snowbabies products are sold on allocation. Under its allocation practice, the Company specifies certain items among its principal Village Series and Snowbabies product lines, which it does not allow customers to purchase in unlimited quantities. The Company periodically evaluates and adjusts its distribution network and reviews its policies with a view of optimizing both the Company's distribution strategy and the store-level operations of its independent retailers. While the Company remains committed to selective distribution for the Village Series and Snowbabies products, the Company plans to continue to seek complementary retailers and to offer its Simple Traditions line for mid-tier retail chains in order to maintain sufficient market presence to build consumer awareness, interest and trial of the Company's products.

Over the past three years, the Company's wholesale customers have decreased in number by approximately 3,400, or 19%. Similarly, customers who sell the Company's Village Series and/or Snowbabies products have decreased over the same period by approximately 950, or 16%. The Company believes the decrease in customers and related decrease in sales since 1999 is due to several factors including: the problems experienced during the implementation of the Company's enterprise-wide computer system, an overall weakness in the economy which has forced some of the Company's customers to go out of business or reduce their demand, and the typical characteristic of total new customer order volume to be lower than historical total order volume of exiting customers. The Company has enacted programs to curb the decline in customers and wholesale sales experienced over the past three years including implementing new customer ordering and shipping programs, strengthening its sales organization, refining its product development process, improving the gift and decorating appeal of its product, broadening the seasonal coverage of its product lines, and pursuing alternative channels of retail distribution through the Simple Traditions product framework. Although management believes that some customer attrition is likely to continue, the Company experienced a net increase in the number of specialty retail and other General Giftware customers in 2002 over 2001, and 2002's net decrease in the number of collectible product accounts has slowed to approximately 40% of that decrease experienced in 2001.

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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 collectible products through its business-to-business Internet site ("WIN"^SM or Web Information Network^SM). The Company continues to expand the use of WIN in order to develop greater merchandising effectiveness and operational efficiencies for its customers and the Company. The Company also extends its consumer advertising through use of cooperative advertising with its Club 56 and Gold Key Dealers using various media formats.

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

Retail Operations:

The Company sells its products to existing and potentially new consumers through its retail operations which include three retail stores located in tourist destinations at the Mall of America, outside Minneapolis, Minnesota; Aladdin Casino and Resort in Las Vegas, Nevada; and Downtown Disney® in Anaheim, California. During 2002, the Company also operated 20 seasonal stores under the name "Holidays by Department 56" and through the Geppeddo business distributed Geppeddo brand products through customized seasonal kiosks located in 417 major malls and shopping centers throughout the U.S. For 2003, the Company does not anticipate operating seasonal store locations and plans to reduce the number of Geppeddo seasonal kiosks to increase profitability. The Company currently plans to open two year-round stores in 2003.

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

Typical characteristics of companies engaged in direct sales include a positive correlation between the number of sales consultants and revenue, and a high rate of turnover among sales consultants. For these reasons, the recruiting and training of new Time to Celebrate sales consultants is expected to be continually necessary. Personal contacts, including referrals from current sales consultants, constitute the primary means of obtaining new consultants. All consultants are eligible to participate in a rewards system that gives them the opportunity to earn margin on their own sales, as well as

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bonuses from sales by consultants they have recruited. This rewards program and development of sales leadership is an essential part of Time to Celebrate's long-term growth strategy. Presently there are approximately 100 Time to Celebrate independent sales consultants, principally located in the Northern and Central tiers of the U.S. The Company does not expect the Time to Celebrate business to have a material financial impact on the Company's retail operations until 2004.

Products:

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

Village Accessories – Department 56 also produces a range of accessories for its Villages Series product, including figurines, vehicles, landscaping, lighting and other complementary and animated items. The sale of accessories for its Village Series is an important part of the Company's strategy to encourage the continued purchase of its products. Accessories allow collectors and consumers to personalize their collections. Many of the accessories can be used interchangeably between the various series, although certain accessories are designed uniquely for specific series.

General Giftware – The Company offers a wide range of other decorative giftware and home accessory items including the Company's Snowbabies and Snowbunnies® figurines; holiday and seasonal decorative items; as well as tableware. Under the Geppeddo brand, the Company also offers a range of porcelain and vinyl dolls, doll accessories and plush items. General 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 4,300 stock keeping units, of which approximately 3,600 are General Giftware products.

Design and Production:

The Company has an ongoing program of new product development. Each year, the Company introduces new products in its existing product lines and also develops entirely new design and product concepts. The Company endeavors to develop new products that fit the Company's quality and creativity requirements as well as the needs of customers and end-consumers for all of the distribution channels the Company serves.

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 2002, the Company imported products from approximately 136 independent manufacturing sources, some of which are represented by independent trading

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companies. The Company's single largest manufacturing source represented approximately 21% of the Company's imports in fiscal 2002. 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 (many for 20 years or more) and may purchase, typically on a year-to-year basis, a manufacturer's entire output for a year. As a result of these relationships, the Company has experienced a low turnover of its manufacturing sources.

The design and manufacture of the Company's products are complex processes. The path from initial conception of the design idea to market introduction generally takes approximately six to 12 months, although the Company continues to investigate processes intended to reduce this time. The Company's Village Series and Simple Traditions products are principally composed of ceramic and porcelain clays and the Company's other products are designed in a variety of media, including paper maché, acrylic and resin.

Distribution and Systems:

The products sold by the Company to its retail customers in the U.S. are generally shipped by ocean freight from abroad and then by rail to the Company's distribution center located within the northwest quadrant of the Minneapolis/St. Paul metropolitan area. Similarly, the products sold by Geppeddo are shipped to a distribution center in Salt Lake City, Utah. Shipments from the Company to its wholesale customers and Time to Celebrate sales consultants are handled primarily by United Parcel Service or commercial trucking lines.

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

The Company's retail systems also monitor and transmit to the Company on a daily basis the POS (point of sales) data for the Company's three 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 December 28, 2002, Department 56 had unfilled wholesale orders of approximately $5.0 million compared to $4.6 million at December 29, 2001. The entire backlog is scheduled to be shipped to customers during the current 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, including customer credit considerations and inventory stock-outs.

The Company's order and sales seasonality has been gradually shifting towards later in the year. During the first quarter of 2000, the Company received approximately 68% of its annual wholesale orders for such year; by comparison, first

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quarter wholesale orders for 2001 and 2002 averaged 63%. This timing shift in the wholesale business is due to a number of factors, including changes in the Company's shipping and ordering policies and its sales force organization, as well as customers' growing recognition of the Company's enhanced ability to receive and fulfill orders later in the year and increased customer reluctance to commit at high order levels early in the year due largely to general economic uncertainty. The Company can experience fluctuations in quarterly sales due to the timing of receipt of product from suppliers and subsequent shipment of product from the Company to customers, as well as the timing of orders placed by customers. As a result of the Company's sales pattern, the Company has historically recorded a substantial portion of its wholesale revenues in its second and third quarters, and the majority of its store- and kiosk-based retail sales occur in the fourth quarter during the peak holiday shopping season.

Coupled with the seasonality of its operations, 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 had greater working capital needs in its second and third quarters and has experienced greater cash availability in its fourth and first quarters. The cash from the Company's retail operations is also generated predominantly in the fourth quarter. The Company typically finances its operations through net cash and marketable securities balances, internally generated cash flow and short-term seasonal borrowings.

Trademarks and Other Proprietary Rights:

The Company owns 38 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 from time to time registers selected trademarks in certain foreign countries.

Department 56 regards its trademarks and other proprietary rights as valuable assets and intends to maintain and renew 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 2003 and 2011, 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 trademarks and expects to continue to renew them.

Competition:

Department 56 competes generally for the discretionary income of consumers and, in particular, with other producers of fine quality collectibles, specialty giftware and home decorative accessory products. The collectibles area, in particular, is affected by changing consumer tastes and interests. The giftware industry is highly competitive, with a large number of both large and small participants. The Company's competitors distribute their products through independent gift retailers, department stores, mass market and specialty chain stores, televised home shopping networks, Internet commerce and mail order houses, or through the party plan method or other direct response marketing methods. The Company believes that the principal elements of competition in the specialty giftware industry are product 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.

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Restrictions on 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 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 demands 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: fluctuations in currency exchange rates; 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 developments; and foreign trade and tax laws. 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. 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.

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. Customs Service regarding the amount of duty to be paid, the value of merchandise to be reported or other customs regulations with respect 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, the U.S. Customs Service has enacted various security protocols affecting the importation of goods. Such protocols can adversely affect the speed or cost involved in the Company's receipt of inventory from its overseas vendors.

In fiscal 2002, approximately 90% of the Company's imports were manufactured in the People's Republic of China ("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

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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 March 3, 2003, the Company had 322 full-time employees in the U.S., three in Canada and one in Taiwan. Of the total workforce, approximately 72 are engaged in wholesale sales representation throughout North America and 32 are associated with the Company's retail operations. The Company's 58 U.S.-based warehouse, shipping and receiving personnel employed as of that date are represented by Local Union No. 638 of the Teamsters under a contract that expires on December 31, 2004. The Company believes that its labor relations are good and has never experienced a work stoppage.

Environmental Matters:

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

ITEM 2. PROPERTIES

The Company owns or leases buildings that contain approximately 525,000 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 remainder of the Company's facilities are leased. In addition, the Company temporarily leased space for 437 seasonal stores and kiosks located throughout the U.S. during the 2002 peak holiday shopping season.

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ITEM 3. LEGAL PROCEEDINGS

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

On May 1, 2002, the U.S. District Court, District of Minnesota entered the order of its Chief Judge granting Department 56 and Susan Engel's Motion to Dismiss the previously reported class action lawsuit, In Re Department 56, Inc., Securities Litigation.

In the ordinary course of its business, the Company is involved in various legal proceedings, claims and governmental audits, in addition to the above lawsuits. The Company believes it has meritorious defenses to all pending proceedings, claims and audits. While management cannot predict the eventual outcome of these proceedings, management believes the impact, if any, of these legal proceedings would not be material to the results of operations, financial position or cash flows of the Company.

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 December 28, 2002.

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PART II

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

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

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

As of March 13, 2003, the number of holders of record of the Company's Common Stock was 830.

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ITEM 6. SELECTED FINANCIAL DATA

FIVE-YEAR SUMMARY (In thousands, except per share amounts)
YEARS ENDED DECEMBER 28, 2002, DECEMBER 29, 2001, DECEMBER 30, 2000, JANUARY 1, 2000, AND JANUARY 2, 1999

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

¹

All fiscal years presented are 52-week periods.

²

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.

³

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

⁴

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

⁵

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

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

(In millions, except per share amounts)

The following discussion of the results of operations and financial condition should be read in conjunction with the Department 56, Inc. Consolidated Financial Statements and related Notes thereto, included elsewhere herein.

COMPARISON OF RESULTS OF OPERATIONS 2002 TO 2001

Net Sales

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

Wholesale sales decreased $0.7 million, or 0.4%, from $181.1 million in 2001 to $180.4 million in 2002. Wholesale sales of the Company's Village Series products decreased $3.2 million, or 3%, while sales of General Giftware products increased $2.5 million, or 4% between the two periods. Village Series products represented 59% of the Company's sales during 2002 versus 61% during 2001. The decrease in wholesale sales is due to several factors, including an overall weakness in the economy which has forced some of the Company's customers to go out of business or reduce their demand, and the inability of total new customer order volume to offset historical total order volume of exiting customers. The Company has enacted programs to curb the decline in customers and wholesale sales experienced over the past three years including implementing new customer ordering and shipping programs, strengthening its sales organization, refining its product development process, improving the gift and decorating appeal of its product,

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broadening the seasonal coverage of its product lines, and pursuing alternative channels of retail distribution through the Simple Traditions product framework. Although management believes that some customer attrition is likely to continue, the Company experienced a net increase in the number of specialty retail and other General Giftware customers in 2002 over 2001, and 2002's net decrease in the number of collectible product accounts has slowed to approximately 40% of the decrease experienced in 2001.

Retail sales increased $8.9 million from $19.4 million in 2001 to $28.3 million in 2002. The increase in retail revenues for the year was primarily attributable to the inclusion of January 2002 results from the seasonal stores and kiosks opened for the first time during 2001 as well as the increase in the number of seasonal stores and kiosks operated in 2002. During 2002, the Company operated 20 seasonal stores and 417 seasonal kiosks compared to 10 seasonal stores and 359 seasonal kiosks operated in 2001. Comparable sales in the Company's two year-round stores that were open for a full year in both years increased 2%. Average sales per location for the seasonal stores and kiosks during the fourth quarter decreased 9% and 1%, respectively.

Gross Profit

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

Selling, General and Administrative Expenses

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

Income from Operations

Income from operations decreased $0.4 million, or 1%, from 2001 to 2002, excluding goodwill and trademark amortization. Operating margins decreased from 21% of net sales in 2001 to 20% of net sales in 2002. The decrease in income from operations was primarily attributable to the losses from the Company's seasonal store and kiosk operations due to the difficult retail environment. For fiscal 2003, the Company does not anticipate operating seasonal store locations and plans to reduce the number of seasonal kiosks to increase profitability. The Company currently plans to open two year-round stores in 2003 and to continue to expand its Time to Celebrate direct selling business. The International Longshore and Warehouse Union workers' West Coast labor dispute (previously reported in the Company's Quarterly Report on Form 10-Q for the third quarter of fiscal 2002) did not have a material impact on income from operations in 2002.

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Interest Expense

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

Litigation Settlement

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

Provision for Income Taxes

The effective income tax rate was 41% and 27% during 2001 and 2002, respectively. The change in income tax rates is due to several factors. First, the Company recorded adjustments to its income tax provision of $1.0 million and $3.5 million in 2001 and 2002, respectively, for the reversal of prior year tax accruals that were no longer needed. Secondly, 2001 reflects the recognition of a deferred tax valuation allowance of $1.5 million to reserve against the future deductibility of the capital losses recognized from its minority investment in 2-Day Designs, Inc. Finally, the Company's decreased income tax provision rate for 2002 reflects the change in accounting for goodwill and other intangible assets previously reported. Management anticipates that the income tax provision rate for 2003 will be approximately 36%, excluding any unanticipated one-time adjustments.

Cumulative Effect of Change in Accounting Principle

The Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, effective December 30, 2001. Under SFAS No. 142, goodwill and indefinite-lived intangible assets are no longer amortized, but are reviewed for impairment annually, or more frequently if certain indicators arise. With the adoption of this statement, the Company ceased amortization of its goodwill and indefinite-lived trademarks as of December 30, 2001 and recorded a $93.7 million charge to write-down its goodwill related to the leveraged buyout of the Company in 1992. See Note 3 to the Consolidated Financial Statements.

COMPARISON OF RESULTS OF OPERATIONS 2001 TO 2000

Net Sales

Net sales decreased $33.7 million, or 14%, from $234.1 million in 2000 to $200.4 million in 2001. The decrease in sales was principally due to a decrease in wholesale sales, partially offset by an increase in retail sales.

Wholesale sales decreased $50.1 million, or 22%, from $231.2 million in 2000 to $181.1 million in 2001. This decrease was due to lower sales volume to existing wholesale customers as well as sales to fewer wholesale customers in 2001 than in 2000. The decrease in customers was principally due to the problems experienced during the implementation of the Company's enterprise-wide computer system and an overall weakness in the economy that has forced some of the Company's customers to go out of business. The decrease in sales was partially offset by the impact of a customer appreciation discount that the Company offered on orders taken during the first quarter of 2000 and higher charges for

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product claims in 2000. Product claims returned to normal levels during 2001. Wholesale sales of the Company's Village Series products decreased $39.9 million, or 27%, while sales of General Giftware products decreased $10.2 million, or 13% between the two periods. Village Series products represented 61% of the Company's sales during 2001 versus 65% during 2000.

Retail sales increased $16.5 million from $2.9 million in 2000 to $19.4 million in 2001 principally due to the Company's acquisition of Geppeddo during the third quarter of 2001 (see Note 8 to the Consolidated Financial Statements). Retail sales also increased due to the Company opening its third "full-line" Department 56-branded retail store as well as testing ten Department 56-branded seasonal stores during the peak holiday shopping season.

Gross Profit

Gross profit as a percentage of net sales was 53% and 55% in 2000 and 2001, respectively. Excluding the impact of the customer appreciation discount and the higher charges for product claims, gross profit as a percent of sales would have been approximately 56% in 2000. The decrease in gross profit as a percentage of net sales during 2001 compared to this adjusted gross profit as a percentage of net sales for 2000 was primarily the result of higher charges recorded to provide for excess inventories and a shift in product mix toward general giftware as noted above.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased $5.6 million, or 8%, between 2000 and 2001. Selling, general and administrative expenses as a percentage of net sales were approximately 32% in 2000 and 34% in 2001. In 2000, the Company recorded higher than normal bad debt costs as a result of the problems experienced during the implementation of the Company's new enterprise-wide computer system beginning in early 1999, as previously communicated. Excluding the impact on net sales of the customer appreciation discount and the higher charges for product claims and the impact on selling, general and administrative expense from higher bad debt costs, selling, general and administrative expenses as a percentage of net sales would have been approximately 28% in 2000.

The increase in selling, general and administrative expenses as a percentage of net sales in 2001 compared to the adjusted percentage in 2000 is principally due to an increase in retail store operations resulting from the acquisition of Geppeddo, the Company opening its third retail store, consumer research and the testing of ten seasonal stores during the peak holiday shopping season. Retail net sales, which have higher selling, general and administrative expenses as a percentage of net sales than wholesale net sales, represented 10% of total net sales in 2001 compared to 1% in 2000. Selling, general and administrative expense as a percentage of net sales was also higher in 2001 due to the decrease in wholesale sales. Many of the Company's wholesale operating expenses such as rent and labor do not vary directly with net sales. As a result, wholesale operating expenses were not reduced proportionately with the decrease in wholesale net sales.

Income from Operations

Income from operations decreased $8.1 million, or 18%, from 2000 to 2001 due to the factors described above. Operating margins decreased from 19% of net sales in 2000 to 18% of net sales in 2001. Excluding the impact of the customer appreciation discount and the higher charges for product claims and bad debts, income from operations would have been approximately 26% of net sales in 2000.

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Interest Expense

Interest expense decreased $4.7 million, or 40%, between 2000 and 2001 principally due to decreased borrowings under the Company's credit facilities as a result of improved cash collections, lower inventory balances, and higher cash balances at the beginning of 2001. Interest expense also decreased due to lower interest rates paid by the Company in 2001.

Impairment and Equity in Losses of Minority Investment

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

Provision for Income Taxes

The effective income tax rate was 38% and 41% during 2000 and 2001, respectively. The effective income tax rate in 2001 was higher primarily because the Company recognized no tax benefit associated with its impairment charge of 2-Day Designs, Inc. (see Note 5 to the Consolidated Financial Statements). This increase was partially offset by a $1.0 million tax benefit that the Company recorded related to prior year tax accruals that were no longer needed.

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. Changes in the Company's ordering and shipping programs and its sales force organization, together with customers' growing recognition of the Company's enhanced ability to receive and fulfill orders throughout the year and increased customer reluctance to commit early at high order levels due largely to general economic uncertainty, have been the principal factors in gradually shifting the seasonality of order input towards later in the year. Thus, the Company entered 68% of its total net annual wholesale customer orders for 2000 during the first quarter of that year; by comparison, first quarter wholesale orders for 2001 and 2002 averaged 63% of the total net annual wholesale order input. Cancellations of total annual wholesale customer orders were approximately 7% and 8% in 2002 and 2001, respectively. 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 $5.0 million and $4.6 million at December 28, 2002 and December 29, 2001, 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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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. Wholesale customer orders entered exclude orders from company-operated retail stores.

LIQUIDITY AND CAPITAL RESOURCES

Net cash provided by operating activities decreased $36.3 million, or 64%, from $56.9 million in 2001 to $20.6 million in 2002 principally due to lower cash collections, higher income tax payments, and higher inventory balances, offset partially by the $5.4 million in other income recorded as a result of the litigation settlement. Cash collections were lower than sales in 2002 due to an increase in sales qualifying for extended dating terms that resulted in cash collections in the first quarter of 2003. Cash collections were higher than sales in 2001 due to higher than normal accounts receivable balances at the end of 2000. Income tax payments were higher in 2002 due to the tax associated with the $11.0 million in net proceeds (before income taxes) from the litigation settlement as well as the timing of when income tax payments were made. Inventory balances were higher in 2002 due to the increase in the Company's seasonal store and kiosk locations which continue operations (and thus carry inventory) into the following year. Additionally, the Company accelerated payments on certain inventory purchases during 2002 to take advantage of favorable terms.

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 internally generated cash flow and seasonal borrowings. 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.

Accounts receivable, net of reserves, which principally consists of wholesale trade receivables increased by 43%, from $22.8 million at December 29, 2001 to $32.6 million at December 28, 2002. The increase in accounts receivable was principally due to an increase in the amount of sales qualifying for extended dating terms that result in cash collections in the first quarter of the subsequent year as well as a decrease in the allowance for sales returns and credits. Management believes there is adequate provision for any doubtful accounts receivable and product claims that may arise.

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Inventories increased from $11.2 million at December 29, 2001 to $14.3 million at December 28, 2002. The increase in inventories was principally due to the increase in the Company's seasonal store and kiosk locations, which continue operations (and thus carry inventory) into the following year.

Capital expenditures were $1.9 million, $2.9 million and $7.1 million in 2002, 2001 and 2000, respectively. Management anticipates 2003 capital expenditures to approximate 1% to 2% of annual wholesale revenues plus approximately $0.9 million for each year-round retail store opened during the year. The Company plans to open two year-round stores in fiscal 2003.

During the third quarter of 2001, the Company completed its $9.7 million acquisition of Geppeddo, a privately held designer, importer and specialty retailer based in Salt Lake City whose products, primarily porcelain dolls, doll accessories and plush items, are marketed under the brand name Geppeddo. The selling shareholders of the acquired business have the ability to earn up to an additional $6.0 million of cash consideration if certain pre-specified financial performance measures are attained by February 29, 2004.

During 2000, the Company repurchased 2.4 million shares at an average price of $14 per share. No shares were repurchased in 2001 and 2002. Since January 1997, the Company has repurchased a total of 9.2 million shares. The Company had no remaining authorization from the Board of Directors to repurchase any additional shares at the end of 2002, except to accept officer surrenders of restricted shares upon vesting as payment for estimated income tax liabilities incurred as a result of such vesting.

The Company's strategy includes the pursuit of a significant acquisition that aligns with and complements its existing business. As a result, the Company intends to accumulate cash over the next several years. In the event the Company is not able to identify any acceptable acquisition by mid-2005, the Company intends to return cash to its shareholders at that time.

The Company's credit agreement provides for a revolving credit facility and a term loan facility. As of December 28, 2002, the total term debt outstanding was $54 million and required amortization payments of $2.2 million and $51.8 million due in March 2003 and 2004, respectively. On March 14, 2003, the Company committed to prepay $30 million of its term debt in March 2003.

The revolving line of credit provides for borrowings of up to $100 million, which may be in the form of letters of credit, bankers' acceptances, and revolving credit loans. The letters of credit are issued primarily in connection with inventory purchases. The revolving line of credit includes a clean-down provision whereby the Company's revolving credit loans and bankers' acceptances may not exceed an aggregate of $30 million during any one 30-consecutive-day period beginning November 1 and ending March 31. Borrowings under the credit agreement are subject to certain borrowing base limitations (as defined). The Company's borrowing capacity under the revolving credit facility as of December 28, 2002 was $38 million and will fluctuate during 2003 based on accounts receivable and inventory levels. The revolving line of credit provides for commitment fees of 0.25% to 0.50% 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 term loan and revolving credit loans. The interest rate options are the Alternate Base Rate (as defined) or the LIBOR rate (as

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defined) plus an applicable margin. The applicable margin ranges from 0.875% to 1.625% for LIBOR rate loans. The credit agreement expires March 19, 2004.

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 $183 million of retained earnings were restricted at December 28, 2002. 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 its subsidiaries, direct and indirect, as collateral under the credit agreement, and the Company and its subsidiaries, direct and indirect, have guaranteed repayment of amounts borrowed under the credit agreement.

The Company believes that its internally generated cash flow and seasonal borrowings under the revolving credit facility will be adequate to fund operations and capital expenditures for the next 12 months.

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 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 for pricing 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

The Company believes that the selection and application of its accounting policies are appropriately reasoned. The following 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. 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. In 2002, sales returns and credits as a percentage of wholesale sales were approximately 3%. Historically, sales returns and credits as a percentage of wholesale sales have been between 3% and 5%. Based on 2002 sales returns and credits, a 10% increase or decrease in sales returns and credits would have had an impact of approximately $0.6 million.

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Inventory Valuation – Inventory is written down for estimated surplus and discontinued inventory items. 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 2002 inventory write-downs, a 10% increase or decrease in inventory write-downs would have had an impact of less than $0.5 million.

Allowance for Doubtful Accounts – An allowance is established for estimated uncollectible accounts receivable. The required allowance is determined by reviewing customer accounts and making estimates of amounts that may be uncollectible. Factors considered in determining the amount of the reserve include the age of the receivable, the financial condition of the customer, general business, economic and political conditions, and other relevant facts and circumstances. 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 2002 bad debt write-offs, a 10% increase or decrease in bad debt write-offs would have had an impact of less than $0.5 million.

RECENT DEVELOPMENTS

On March 17, 2003, the Company issued a press release stating in relevant part:

"[The Company] . . . today released a preliminary estimate of fully diluted earnings per share (EPS) for fiscal 2003 within the range of $1.70 to $1.80. The Company's preliminary EPS estimate is driven by its forecast of wholesale customer orders for fiscal 2003 to be down approximately 8% to 12% compared to orders received in fiscal 2002. Wholesale customer orders through the first eleven weeks ended March 15, 2003 have decreased 17% compared to the same period in 2002.

"Commenting on the preliminary EPS estimate and wholesale order forecast, Susan Engel, Chairwoman and Chief Executive Officer, said, 'Our estimate today is highly preliminary in that it is based mainly on current orders from Gift and Specialty accounts. Over the past few years we have seen a gradual shift toward retailers reducing their initial orders and placing more re-orders and we believe that this trend is continuing this year.' The Company's first quarter order input in fiscal 2000 represented 68% of total net wholesale orders for that year; by comparison, first quarter orders in fiscal 2001 and 2002 averaged 63%.

"In addition, the Company also stated that the implementation of a needed restructuring within its wholesale sales force at the end of 2002 changed the mix and identity of account assignments for many of its sales representatives. This change has been an additional factor that has delayed order input from some of its gift and specialty retail accounts.

"Ms. Engel also stated, 'As we have previously discussed, our strategies for growth include revenue generation from initiatives such as the Time to Celebrate party plan business and our Simple Traditions program for mid-tier general merchandise retailers. We foresee that this increased diversification in the Company's business model will affect our ability to provide early guidance to investors. Furthermore, as we expect our retail segment to be a significant contributor to sales and earnings, our 2003 results will be dependent on our fourth quarter performance, particularly with a planned return this year of Geppeddo to its historic levels of profitability.'

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"On the initial wholesale order input Ms. Engel noted, 'We are coming off of several difficult years for the Gift and Specialty retail channel. Signs from last year suggest that attrition in the number of accounts in this channel – albeit continuing – has moderated meaningfully. We were pleased to realize in 2002 a net gain in the number of our General Giftware accounts and a slowing in the attrition of collectible customers over 2001's metrics.'

"'For this year,' Ms. Engel continued, 'anecdotal feedback indicates that the channel is continuing to take a cautious approach in 2003 given the current state of the economy, consumer confidence levels and geo-political uncertainty. Our retailers have also expressed their growing confidence in our ability to accept and fill orders later in the year, which enables them to defer some of their purchase commitments until they have better clarity on consumer demand."'

See also "Forward-Looking Statements and Factors Affecting Future Earnings" below.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 143, Accounting for Asset Retirement Obligations, which addresses the recognition and measurement of obligations associated with the retirement of tangible long-lived assets. SFAS No. 143 is effective December 29, 2002, with early adoption permitted. The Company adopted SFAS No. 143 effective December 29, 2002 and does not expect the adoption of the statement to have a material effect on its financial statements.

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which supersedes Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred as opposed to at the date an entity commits to an exit plan. SFAS No. 146 is effective for exit or disposal activities initiated after December 28, 2002. The Company adopted SFAS No. 146 as of December 29, 2002, for any exit or disposal activities occurring after and including that date.

The Company accounts for its stock option plans using the intrinsic value method and has adopted the "disclosure only" provision of SFAS No. 123, as amended in 2002 by SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure. No compensation cost has been recognized for the stock options granted under the various stock incentive plans. In accordance with SFAS No. 148, pro forma net (loss) income and (loss) income per share are disclosed in Note 10 to the Consolidated Financial Statements, as if the fair value based method had been applied for all periods presented.

See Note 1 to the Consolidated Financial Statements for a more complete discussion of new accounting standards.

FOREIGN EXCHANGE

Approximately 97% of the Company's sales in 2002 were denominated in United States dollars and, as a result, were not subject to changes in exchange rates. Approximately 3% of the Company's sales were denominated in foreign currencies that were subject to changes in exchange rates.

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

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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. Conversely, its costs would be favorably affected if the Chinese currency depreciates significantly relative to the United States dollar. In addition, the Company purchased less than 2% of its product from Taiwan (Republic of China) in 2002. These purchases were denominated in New Taiwan Dollars and were subject to changes in exchange rates.

The Company, from time to time, will enter into foreign exchange contracts or build foreign currency deposits as a partial hedge against currency fluctuations. The Company did not enter into any foreign exchange contracts nor have any foreign exchange contracts outstanding in fiscal 2001 and 2002.

See also "Item 1. Business – Restrictions on Imports."

EFFECT OF INFLATION

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

FORWARD-LOOKING STATEMENTS AND FACTORS AFFECTING FUTURE EARNINGS

The federal securities laws provide "safe harbor" status to certain statements that go beyond historical information and may provide an indication of future results. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. Words such as "believes," "anticipates," "expects," "intends," "estimates" and "plans" and similar expressions are intended to identify forward-looking statements but these are not the exclusive means of identifying such statements.

Any conclusions or expectations expressed in, or drawn from, the statements in this annual report or the Company's press releases or other disclosures concerning matters that are not historical corporate financial results are "forward-looking statements" that involve risks, uncertainties and other factors. Such forward-looking statements are based on management's assumptions and expectations.

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; retailer reorders and order cancellations; the volume, number, mix and timing of retailers' orders, retailer 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 the Customs Services 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, 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

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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.

See also "Recent Developments" above.

During the fourth quarter of 2002, the Company evaluated the remaining goodwill related to its wholesale operating segment and determined no additional write-down was necessary. The Company also evaluated for impairment the goodwill related to its Geppeddo business and determined no write-down was necessary. In 2002, the Geppeddo business had a loss from operations. If these operating losses should continue, the goodwill resulting from the Geppeddo acquisition may become impaired.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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. At December 28, 2002, the Company had $54.0 million outstanding under its credit facility, which 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 December 28, 2002 borrowing levels, a 1% increase or decrease in current market interest rates would have an impact of approximately $0.5 million.

The second component of the Company's interest rate risk involves the short-term investment of excess cash. Excess cash flow is typically invested in high-quality fixed income securities issued by banks, corporations and the U.S. government; municipal securities; and overnight repurchase agreements backed by U.S. government securities. These securities are classified as cash equivalents on the Company's balance sheet. At December 28, 2002, the Company's cash balance was approximately $42.5 million. Earnings from cash equivalents were approximately $0.5 million for the fifty-two weeks ended December 28, 2002. Based on the December 28, 2002 cash balance, a 1% increase or decrease in current market interest rates would have an impact of approximately $0.4 million.

Approximately 3% of the Company's sales and less than 2% of the Company's product purchases in fiscal year 2002 were denominated in a foreign currency. Based on these sales and product purchases, a 10% increase or decrease in the foreign currency exchange rates would have an impact of less than $1 million.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See Consolidated Financial Statements on page F-1 herein.

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

None.

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PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information required by this Item is included in the 2003 Proxy Statement in the sections captioned "Item 1 – Election of Directors – Nominees for Terms Ending at the 2004 Annual Meeting of Stockholders" and "Biographical Information Regarding Executive Officers," and such information is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

Information required by this Item is included in the 2003 Proxy Statement in the section captioned "Further Information Concerning the Board of the Directors and Committees – "Director Compensation" and in the section captioned "Compensation of Executive Officers", and such information is incorporated herein by reference.

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

Information required by this Item is included in the 2003 Proxy Statement in the section captioned "Security Ownership of Certain Beneficial Owners and Management," and such information is incorporated herein by reference.

Equity Compensation Plan Information:

The following table provides information about the Company's equity compensation plans as of December 28, 2002.

The only equity compensation plan not approved by shareholders pursuant to which options are outstanding or remaining available for grant as reflected in the table above is the Company's 2001 Non-Officer Stock Option Plan (the "Plan"). The Plan provides for the issuance only of "nonqualified options" to purchase Company common stock ("Plan Options"). Plan Options may be issued only to non-officer employees, consultants and advisors to the Company and its subsidiaries. The Plan and the issuance of Plan Options is determined and administered by the Company's Chief Executive Officer and its Chief Human Resources Officer (the "Committee"). The Committee determines all terms of Plan Options, including such terms as the amount of Company common shares subject to a Plan Option, exercise price and vesting, but no Plan Option may be transferred by the optionee (other than by will or otherwise in the case of death)

Page 24

and no Plan Option may have a duration greater than ten years from the date of grant. Vesting and exercisability of Plan Options accelerate immediately upon a "Change in Control" (as defined in the Plan). The Plan will terminate immediately prior to the tenth anniversary of its adoption by the Company's Board of Directors, although the Board may terminate or amend the Plan at any earlier time so long as no such amendment or termination adversely affects any Plan Option then outstanding. This summary of the Plan does not purport to be complete and is qualified in its entirety by the terms of the Plan, the entire text of which was filed as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the 2001 fiscal year.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

None.

ITEM 14. CONTROLS AND PROCEDURES

Within the 90-day period prior to the filing of 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-14 and 15d-14 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 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. There have been no significant changes in the Company's internal controls (as embodied in Section 13(b)(2)(B) of the Securities Exchange Act of 1934) or in other factors that could significantly affect these internal controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Any control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. The design of a control system inherently has limitations, including that the benefits of controls must be considered relative to their costs. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people. Therefore, no evaluation of a cost-effective system of controls can provide absolute assurance that all control issues and instances of fraud, if any, will be detected.

Page 25

PART IV

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

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

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

Page 26

†

Management contract or compensatory plan.

*

Filed herewith.

(b)

Reports on Form 8-K

The Company filed the following Current Reports on Form 8-K during the fourth quarter of 2002:

•

The Company filed Form 8-K dated October 24, 2002 containing a press release and financial statements.



•

Form 8-K dated November 7, 2002.

Page 27

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.

Page 28

CERTIFICATIONS

I, Susan E. Engel, certify that:

1.

I have reviewed this annual report on Form 10-K of Department 56, Inc.;

2.

Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.

Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a)

designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b)

evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

c)

presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

a)

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.

The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Page 29

CERTIFICATIONS

I, Timothy J. Schugel, certify that:

1.

I have reviewed this annual report on Form 10-K of Department 56, Inc.;

2.

Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.

Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.

The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a)

designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b)

evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

c)

presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

a)

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.

The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Page 30

INDEPENDENT AUDITORS' REPORT

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

We have audited the consolidated balance sheets of Department 56, Inc. and subsidiaries (the Company) as of December 28, 2002 and December 29, 2001 and the related consolidated statements of income, cash flows, and stockholders' equity for the years ended December 28, 2002, December 29, 2001, and December 30, 2000. Our audit also included the financial statement schedule listed in the Index at Item 15. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

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

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 28, 2002 and December 29, 2001 and the results of its operations and its cash flows for the years ended December 28, 2002, December 29, 2001, and December 30, 2000 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

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

Deloitte & Touche LLP

Minneapolis, Minnesota
February 19, 2003
(March 17, 2003 as to Note 4)

Page F-1

DEPARTMENT 56, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
AS OF DECEMBER 28, 2002 AND DECEMBER 29, 2001

See notes to consolidated financial statements.

Page F-2

DEPARTMENT 56, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
YEARS ENDED DECEMBER 28, 2002, DECEMBER 29, 2001, AND DECEMBER 30, 2000

See notes to consolidated financial statements.

Page F-3

DEPARTMENT 56, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
YEARS ENDED DECEMBER 28, 2002, DECEMBER 29, 2001, AND DECEMBER 30, 2000